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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998 COMMISSION FILE NO. 1-12785
NATIONWIDE FINANCIAL SERVICES, INC.
(Exact name of registrant as specified in its charter)
<TABLE>
<S> <C>
DELAWARE 31-1486870
(State or other jurisdiction of incorporation (I.R.S. Employer Identification No.)
or organization)
ONE NATIONWIDE PLAZA, COLUMBUS, OHIO 43215 (614) 249-7111
(Address of principal executive offices) (Registrant's telephone number, including area
code)
Securities registered pursuant to Section 12(b) of the Act:
CLASS A COMMON STOCK (par value $.01 per share) NEW YORK STOCK EXCHANGE
(Title of Class) (Name of each exchange on which registered)
</TABLE>
Securities registered pursuant to Section 12(g) of the Act:
NONE
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports) and (2) has been subject to the
filing requirements for at least the past 90 days.
YES X NO ____
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
The aggregate market value of voting stock held by non-affiliates on March
19, 1999 was $1,014,897,447.
The number of shares outstanding of each of the registrant's classes of
common stock on March 19, 1999 was as follows:
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<S> <C>
CLASS A COMMON STOCK (par value $.01 per share) 23,775,050 shares issued and outstanding
CLASS B COMMON STOCK (par value $.01 per share) 104,745,000 shares issued and outstanding
(Title of Class)
</TABLE>
DOCUMENTS INCORPORATED BY REFERENCE
Parts I and II of this Form 10-K incorporate by reference certain
information from the registrant's 1998 Annual Report to Shareholders. Part III
of this Form 10-K incorporates by reference certain information from the
registrant's definitive Proxy Statement for the 1999 Annual Shareholders'
Meeting.
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PART I
ITEM 1 BUSINESS
OVERVIEW
Nationwide Financial Services, Inc. (NFS) was formed in November 1996 as a
holding company for Nationwide Life Insurance Company (NLIC) and the other
companies within the Nationwide Insurance Enterprise that offer or distribute
long-term savings and retirement products. NFS is incorporated in Delaware and
maintains its principal executive offices in Columbus, Ohio.
On March 11, 1997, NFS sold, in an initial public offering, 23.6 million
shares of its newly-issued Class A common stock for net proceeds of $524.2
million (the Equity Offering). In March 1997, NFS also sold, in companion public
offerings, $300.0 million of 8% Senior Notes (the Notes) and, through a wholly
owned subsidiary trust, $100.0 million of 7.899% Capital Securities (the Capital
Securities). Aggregate net proceeds from the Equity Offering, the offering of
the Notes and the sale of the Capital Securities totaled $917.0 million. NFS
contributed $836.8 million of the proceeds to the capital of NLIC and retained
$80.2 million of the proceeds for general corporate purposes.
Prior to the initial public offering, NFS was a wholly owned subsidiary of
Nationwide Corporation (Nationwide Corp.). Nationwide Corp. continues to own all
of the outstanding shares of Class B common stock, which represents
approximately 81% of the total number of common shares outstanding and
approximately 98% of the combined voting power of the stockholders of NFS.
During the first quarter of 1997, NFS's Board of Directors approved a 104,745
for one split of the Company's Class B common stock, which became effective
February 10, 1997.
During 1996 and 1997, Nationwide Corp. and NFS completed transactions in
anticipation of the initial public offering that focused the business of NFS on
long-term savings and retirement products. On September 24, 1996, NLIC declared
a dividend payable to Nationwide Corp. on January 1, 1997 consisting of the
outstanding shares of common stock of certain subsidiaries that do not offer or
distribute long-term savings or retirement products. In addition, during 1996,
NLIC entered into two reinsurance agreements whereby all of NLIC's accident and
health and group life insurance business was ceded to two affiliates effective
January 1, 1996. These subsidiaries and all accident and health and group life
insurance business have been accounted for as discontinued operations for all
periods presented. See notes 14 and 19 to the consolidated financial statements.
On January 27, 1997, Nationwide Corp. contributed the common stock of NLIC and
three marketing and distribution companies to NFS. Accordingly, the consolidated
financial statements include the results of NLIC and its subsidiaries and the
three marketing and distribution companies as if they were consolidated with NFS
for all periods presented. NFS and its subsidiaries are collectively referred to
as "the Company."
In addition to the transactions discussed previously, the Company paid
$900.0 million of dividends to Nationwide Corp., $50.0 million on December 31,
1996 and $850.0 million on February 24, 1997, as part of the restructuring.
The Company is a leading provider of long-term savings and retirement
products in the United States. The Company develops and sells a diverse range of
products including variable annuities, fixed annuities and life insurance as
well as investment management services, pension products and administrative
services to address an increasing spectrum of customer needs. The Company
markets its products through a broad network of wholesale and retail
distribution channels, including independent investment dealers, national and
regional brokerage firms, financial institutions, pension plan administrators,
exclusive retail sales representatives, and Nationwide Insurance Enterprise
insurance agents. The Company believes its unique combination of product
innovation and strong distributor relationships positions it to compete
effectively in the rapidly growing retirement savings market under various
economic conditions.
The Company has grown substantially in recent years as a result of its
long-term investments in developing the distribution channels necessary to reach
its target customers and the products required to meet the demands of these
customers. The Company believes its growth has been enhanced further by
favorable demographic trends, the growing tendency of Americans to supplement
traditional sources of retirement income with self-directed
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investments, such as products offered by the Company, and the performance of the
financial markets, particularly the United States (U.S.) stock markets, in
recent years. From 1993 to 1998, the Company's assets grew from $24.70 billion
to $74.67 billion, a compound annual growth rate of 24.7%. Asset growth during
this period resulted from sales of the Company's products as well as market
appreciation of assets in the Company's separate accounts and in its general
account investment portfolio. The Company's sales of variable annuities grew
from $2.41 billion in 1993 to $9.54 billion in 1998, a compound annual growth
rate of 32.0%. The Company's separate account assets, which are generated by the
sale of variable annuities and variable universal life insurance, grew from
36.5% of total assets as of December 31, 1993 to 68.2% of total assets as of
December 31, 1998. During this period of substantial growth, the Company
controlled its operating expenses by taking advantage of economies of scale and
by increasing productivity through investments in technology.
BUSINESS SEGMENTS
The Company has three product segments: Variable Annuities, Fixed Annuities
and Life Insurance. In addition, the Company reports certain other revenues and
expenses in a Corporate and Other segment. All information set forth below
relating to the Company's Variable Annuities segment excludes the fixed option
under the Company's variable annuity contracts. Such information is included in
the Company's Fixed Annuities segment.
Variable Annuities
The Variable Annuities segment consists of annuity contracts that provide
the customer with the opportunity to invest in mutual funds managed by
independent investment managers and the Company, with investment returns
accumulating on a tax-deferred basis. Variable Annuity segment revenues,
operating income before federal income tax expense and policy reserves are
summarized in the following table.
<TABLE>
<CAPTION>
1998 1997 1996
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(IN MILLIONS OF DOLLARS)
<S> <C> <C> <C>
Total revenues............................ $ 529.5 $ 404.0 $ 284.6
Operating income before federal income tax
expense................................. 218.4 150.9 90.3
Policy reserves as of year end............ $46,420.8 $34,486.7 $24,278.1
</TABLE>
The Company is one of the leaders in the development and sale of variable
annuities. For the year ended December 31, 1998, the Company was the third
largest writer of individual variable annuity contracts in the U.S. based on
sales, according to The Variable Annuity Research & Data Service. The Company
believes that demographic trends and shifts in attitudes toward retirement
savings will continue to support increased consumer demand for its products. The
Company believes that it possesses distinct competitive advantages in the market
for variable annuities. Some of the Company's most important advantages include
its innovative product offerings and strong relationships with independent,
well-known fund managers. Its principal annuity series, The BEST of AMERICA(R),
allows the customer to choose from up to 39 investment options managed by
premier mutual fund managers. In the aggregate, the Company's group variable
annuity products offer over 100 underlying investment options. A recent example
of product innovation was the Company's November 1997 launch of a new individual
variable annuity product, America's FUTURE Annuity, a breakthrough product that
combines the flexibility and dozens of investment choices of The BEST of
AMERICA(R) brand products with insurance charges that are lower than comparable
products sold through the financial planning community. Sales of this product
reached $2.4 billion during 1998, its first full year of availability.
The Company markets its variable annuity products through a broad spectrum
of distribution channels, including independent broker/dealers, national and
regional brokerage firms, financial institutions, pension plan administrators,
exclusive retail sales representatives and Nationwide Insurance Enterprise
insurance agents. The Company seeks to capture a growing share of variable
annuity sales in these channels by working closely with its investment managers
and product distributors to adapt the Company's products and services to changes
in the retail and institutional marketplace in order to enhance its leading
position in the market for variable annuities.
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The Company is following a strategy of extending The BEST of AMERICA(R) brand
name to more of its products and distribution channels in an effort to build
upon its brand name recognition.
The Company believes that the variable annuity business is attractive
because it generates fee income. In addition, because the investment risk on
variable annuities is borne principally by the customer and not the Company, the
variable annuity business requires significantly less capital support than fixed
annuity and traditional life insurance products. The Company receives income
from variable annuity contracts primarily in the form of asset and
administration fees. In addition, most of the Company's variable annuity
products provide for a contingent deferred sales charge, also known as a
"surrender charge" or "back-end load," that is assessed against premium
withdrawals in excess of specified amounts made during a specified period,
usually the first seven years of the contract. Surrender charges are intended to
protect the Company from withdrawals early in the contract period, before the
Company has had the opportunity to recover its sales expenses. Generally,
surrender charges on individual variable annuity products are 7% of premiums
withdrawn during the first year, scaling ratably to 0% for the eighth year and
each year thereafter. For group annuity products, the surrender charge amounts
and periods can vary significantly, depending on the terms of each contract.
The Company's variable annuity products consist almost entirely of flexible
premium deferred variable annuity (FPVA) contracts. FPVA contracts are
distributed through broker/dealers, financial planners, banks, pension plan
administrators and Nationwide Insurance Enterprise insurance agents. Such
contracts are savings vehicles in which the customer makes a single deposit or
series of deposits. The customer has the flexibility to invest in mutual funds
managed by independent investment managers and the Company. Deposits may be at
regular or irregular intervals and in regular or irregular amounts. The value of
the annuity fluctuates in accordance with the investment experience of the
mutual funds chosen by the customer. The customer is permitted to withdraw all
or part of the accumulated value of the annuity, less any applicable surrender
charges. As specified in the FPVA contract, the customer generally can elect
from a number of payment options that provide either fixed or variable benefit
payments.
The Company offers individual variable annuities under The BEST of
AMERICA(R) brand name. In addition to The BEST of AMERICA(R) individual variable
annuities, the Company markets employer-sponsored variable annuities to both
public sector employees and teachers for use in connection with plans described
under Sections 457 and 403(b) of the Internal Revenue Code (IRC), and to private
sector employees for use in connection with IRC Section 401(k) plans. These
employer-sponsored variable annuities are marketed under several brand names,
including Group BEST of AMERICA(R). The Company also markets variable annuities
as "private label" products.
The BEST of AMERICA(R). The Company's principal individual FPVA contracts
are sold under the brand names The BEST of AMERICA-America's Vision(R), The BEST
of AMERICA IV(R) and The BEST of AMERICA-America's FUTURE Annuity. The BEST of
AMERICA(R) brand name individual variable annuities accounted for $4.66 billion
(or 49%) of the Company's variable annuity sales in 1998, and $24.64 billion (or
53%) of the Company's variable annuity policy reserves as of year end. The
Company's The BEST of AMERICA-America's Vision(R) and The BEST of
AMERICA-America's FUTURE Annuity products are intended to appeal to distributors
in the market for large initial deposits. The contracts require initial minimum
deposits of $15,000. The Company's The BEST of AMERICA IV(R) product is intended
primarily for the tax-qualified, payroll deduction market, where initial
deposits are often smaller. The BEST of AMERICA IV(R) generally pays a lower
up-front commission to distributors but requires only $1,500 as an initial
deposit. All three products generate an annual asset fee and may also generate
annual administration fees for the Company.
Group BEST of AMERICA(R). These group variable annuity products accounted
for $2.56 billion (or 27%) of the Company's variable annuity sales in 1998, and
$8.85 billion (or 19%) of the Company's variable annuity policy reserves as of
year end. Group BEST of AMERICA(R) products are typically offered only on a
tax-qualified basis. These products may be structured with a variety of features
which may be arranged in over 600 combinations of front-end loads, back-end
loads and asset-based fees.
Section 457 Contracts. These products accounted for $1.61 billion (or 17%)
of the Company's variable annuity sales in 1998, and $8.63 billion (or 19%) of
the Company's variable annuity policy reserves as of year end. The Company
offers a variety of group variable annuity contracts that are designed primarily
for use in
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conjunction with plans described under IRC Section 457. Section 457 permits
employees of state and local governments to defer a certain portion of their
yearly income and invest such income on a tax-deferred basis. These contracts
typically generate an annual asset fee and may also generate annual
administration fees for the Company.
Private Label Variable Annuities. These products accounted for $616.4
million (or 6%) of the Company's variable annuity sales in 1998, and $3.64
billion (or 8%) of the Company's variable annuity policy reserves as of year
end. The Company has developed several private label variable annuity products
in conjunction with other financial intermediaries. The products allow financial
intermediaries to market products with substantially the same features as the
Company's brand name products to their own customer bases under their own brand
names. The Company believes these private label products strengthen the
Company's ties to certain significant distributors of the Company's products.
These contracts generate an annual asset fee and may also generate annual
administration fees for the Company.
The NEA Valuebuilder. This product accounted for $161.0 million (or 2%) of
the Company's variable annuity sales in 1998, and $660.7 million (or 1%) of the
Company's variable annuity policy reserves as of year end. The Company offers
individual variable annuity contracts to the Teacher Market under Section 403(b)
of the IRC. Section 403(b) permits teachers and other employees of educational
organizations to defer a certain portion of their yearly income and invest such
income on a tax-deferred basis. These contracts generate an annual asset fee and
may also generate annual administration fees for the Company.
Fixed Annuities
The Company has sought to maintain its ability to grow profitably in a
variety of market environments. The Company believes that periods of rising
interest rates, that tend to cause lower sales growth in its Variable Annuities
segment, make its fixed annuity products more attractive to consumers. In
addition to providing balance to the Company's variable annuity business, its
fixed annuity business allows the Company to offer a comprehensive portfolio of
savings alternatives to its customers and distributors as the Company seeks to
capture a growing share of sales in all distribution channels. The Fixed
Annuities segment includes the fixed option under the Company's variable annuity
products. Customers who purchase variable annuities are able to designate some
or all of their deposits to fixed options which, like the Company's fixed
annuity contracts, offer a guarantee of principal and a guaranteed interest rate
for a specified period of time. The fixed option under the Company's variable
annuity products accounted for $1.68 billion (or 81%) of the Company's fixed
annuity sales in 1998, and $11.19 billion (75%) of the Company's fixed annuity
policy reserves as of year end.
Fixed Annuity segment revenues, operating income before federal income tax
expense and policy reserves are summarized in the following table.
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
(IN MILLIONS OF DOLLARS)
<S> <C> <C> <C>
Total revenues............................ $ 1,152.3 $ 1,141.4 $ 1,092.6
Operating income before federal income tax
expense................................. 175.3 169.5 135.4
Policy reserves as of year end............ $14,898.9 $14,194.2 $13,511.8
</TABLE>
Fixed annuity products are marketed to individuals who choose to allocate
long-term savings to products that provide a guarantee of principal, a stable
net asset value and a guarantee of the interest rate to be credited to the
principal amount for some period of time. The Company's fixed annuity products
are offered both to individuals and as group products to employers for use in
employee benefit programs. The Company's individual fixed annuity products are
distributed through its wholesale and retail channels and include single premium
deferred annuity contracts, flexible premium deferred annuity contracts and
single premium immediate annuity contracts. The Company's group fixed annuity
contracts are also distributed through its wholesale and retail channels. The
Company invests fixed annuity customer deposits in its general account
investment portfolio. Unlike variable annuity assets that are held in the
Company's separate account, the Company bears the
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investment risk on assets held in its general account. The Company attempts to
earn a spread by investing a customer's deposits for higher yields than the
interest rate it credits to the customer's fixed annuity contract.
During 1998, the average crediting rate on contracts (including the fixed
option under the Company's variable contracts) in the Fixed Annuities segment
was 5.95%. Substantially all of the Company's crediting rates on its fixed
annuity contracts are guaranteed for a period not exceeding 15 months.
Fixed Option Under Variable Annuity Contracts. Fixed options are available
to customers who purchase certain of the Company's variable annuities by
designation of some or all of their deposits to such options. A fixed option
offers the customer a guarantee of principal and a guaranteed interest rate for
a specified period of time. Such contracts have no maturity date and remain in
force until the customer elects to take the proceeds of the annuity as a single
payment or as a specified income for life or for a fixed number of years. The
Company reports its fixed option business in its Fixed Annuities segment because
the characteristics of such business are similar to those of its fixed annuity
business. Although the customer may elect, subject to limitations for certain
products, to transfer balances from the fixed option to other investment
options, it is the Company's experience that historically few have made such
election.
Single Premium Deferred Annuity (SPDA) Contracts. SPDA contracts accounted
for $308.5 million (or 15%) of the Company's fixed annuity sales in 1998, and
$1.99 billion (or 14%) of the Company's fixed annuity policy reserves as of year
end. SPDA contracts are distributed through broker/dealers, financial planners,
banks and Nationwide Insurance Enterprise insurance agents. An SPDA contract is
a savings vehicle in which the customer makes a single deposit with the Company.
The Company guarantees the customer's principal and credits the customer's
account with earnings at an interest rate that is stated and fixed for an
initial period, typically at least one year. Thereafter, the Company resets,
typically annually, the interest rate credited to the contract based upon market
and other conditions. SPDA contracts have no maturity date and remain in force
until the customer elects to take the proceeds of the annuity as a single
payment or as a specified income for life or for a fixed number of years. No
front-end sales charges are imposed for the Company's SPDA contracts. All such
contracts, however, provide for the imposition of certain surrender charges,
which are assessed against premium withdrawals in excess of specified amounts
and which occur during the surrender charge period. The surrender charges are
typically set within the range of 7% and 0% and typically decline from year to
year, disappearing after seven contract years.
Flexible Premium Deferred Annuity (FPDA) Contracts. FPDA contracts
accounted for $29.1 million (or 1%) of the Company's fixed annuity sales in
1998, and $638.2 million (or 4%) of the Company's fixed annuity policy reserves
as of year end. FPDA contracts are distributed through broker/dealers, financial
planners, banks and Nationwide Insurance Enterprise insurance agents. FPDA
contracts are typically marketed to teachers and employees of tax-exempt
organizations as tax-qualified retirement programs. Under these contracts, the
Company accepts a single deposit or a series of deposits. Deposits may be paid
at intervals which are either regular or irregular. FPDA contracts contain
substantially the same guarantee of principal and interest rate terms included
in the Company's SPDA contracts. Surrender charges are typically set within the
range of 7% and 0% and typically decline from year to year, disappearing after
seven contract years.
Single Premium Immediate Annuity (SPIA) Contracts. SPIA contracts accounted
for $53.0 million (or 3%) of the Company's fixed annuity sales for 1998, and
$1.08 billion (or 7%) of the Company's fixed annuity policy reserves as of year
end. The Company's SPIA contracts are offered through its retail and wholesale
distribution channels and are offered as either direct purchases or as fixed
annuity options under the Company's various individual and group annuity
contracts. An SPIA is an annuity that requires a one-time deposit in exchange
for guaranteed, periodic annuity benefit payments, often for the contract
holder's lifetime. SPIA contracts are often purchased by persons at or near
retirement age who desire a steady stream of future income.
Life Insurance
The Company's life insurance segment is composed of a wide range of
variable universal life insurance, whole life insurance, universal life
insurance, term life insurance and corporate-owned life insurance products. In
recent years, the Company has placed particular emphasis within this segment on
the sale of variable life insurance products that offer multiple investment
options. The Company distributes its variable universal life
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insurance products through its wholesale distribution channels as well as
through Nationwide Insurance Enterprise insurance agents. The Company's target
markets for its life insurance products include the holders of personal
automobile and homeowners' insurance policies issued by members of the
Nationwide Insurance Enterprise and select customers to whom the accumulation of
cash values is important.
Life Insurance segment revenues, operating income before federal income tax
expense, policy reserves and life insurance in force are summarized in the
following table.
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
(IN MILLIONS OF DOLLARS)
<S> <C> <C> <C>
Total revenues............................ $ 551.2 $ 473.1 $ 435.6
Operating income before federal income tax
expense................................. 94.8 70.9 67.2
Life insurance policy reserves as of year
end..................................... 4,613.4 3,487.0 2,938.9
Life insurance in force as of year end.... $45,830.5 $39,259.4 $36,274.6
</TABLE>
Universal Life and Variable Universal Life Insurance Products. The Company
offers universal life insurance and variable universal life insurance products
including both flexible premium and single premium designs. These products
provide life insurance under which the benefits payable upon death or surrender
depend upon the policyholder's account value. Universal life insurance provides
whole life insurance with flexible premiums and adjustable death benefits. For
universal life insurance, the policyholder's account value is credited based on
an adjustable rate of return set by the Company relating to current interest
rates. For variable universal life insurance, the policyholder's account value
is credited with the investment experience of the mutual funds chosen by the
customer. The variable universal life insurance products also typically include
a general account guaranteed interest investment option. All of the Company's
variable universal life insurance products are marketed under the Company's The
BEST of AMERICA(R)brand name and have the same wide range of investment options
as the Company's variable annuity products. These products are distributed on a
retail basis by Nationwide Insurance Enterprise insurance agents as well as
through wholesale distribution channels by broker/dealers, financial planners
and banks.
Traditional Life Insurance Products. The Company offers whole life and term
life insurance. Whole life insurance combines a death benefit with a savings
plan that increases gradually in amount over a period of years. The customer
pays a level premium over the customer's expected lifetime. The customer may
borrow against the savings and also has the option of surrendering the policy
and receiving the accumulated cash value rather than the death benefit. Term
life insurance provides only a death benefit without any savings component.
These traditional life insurance products are distributed on a retail basis by
Nationwide Insurance Enterprise insurance agents.
Corporate-owned Life Insurance Products: The Company offers corporate-owned
life insurance (COLI). Corporations purchase COLI to provide protection against
the death of selected employees and to fund non-qualified benefit plans.
Corporations may make a single premium payment or a series of premium payments.
Premium payments made are credited with a guaranteed interest rate which is
fixed for a specified period of time. For variable corporate-owned life
insurance products, the contractholder's account value is credited with the
investment experience of the mutual funds selected by the contractholder.
MARKETING AND DISTRIBUTION
The Company sells its products through a broad distribution network
comprised of wholesale and retail distribution channels. The Company defines
wholesale channels of distribution as channels in which an unaffiliated company,
such as an independent broker/dealer, national or regional brokerage firm,
pension plan administrator, bank or other financial institution, or life
specialist firm sells the Company's products to its own customer base. The
Company defines retail channels as those in which the Company's representatives,
such as Nationwide Insurance Enterprise insurance agents and exclusive retail
sales representatives of the Company's sales subsidiaries, market products
directly to a customer base identified by the Company. The Company provides,
through both its retail and wholesale channels, the means for employers
sponsoring tax-favored
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retirement plans (such as those described in IRC Sections 401(k), 403(b) and
457) to allow their employees to make contributions to such plans through
payroll deductions. Typically, the Company receives the right from an employer
to market products to employees and arrange to deduct periodic deposits from the
employees' regular paychecks. The Company believes that the payroll deduction
market is characterized by more predictable levels of sales than other markets
because these customers are less likely, even in times of market volatility, to
stop making annuity deposits than customers in other markets. In addition, the
Company believes that payroll deduction access to customers provides significant
insulation from competition by providing the customer with a convenient, planned
method of periodic saving. In both the Pension Market, where the Company's
products are distributed primarily on a wholesale basis, and in the Public
Sector and Teachers Markets, where the Company's products are distributed
primarily on a retail basis, payroll deduction is the primary method used for
collecting premiums and deposits.
A table showing statutory premiums and deposits by distribution channel for
each of the last three years is presented in Management's Discussion and
Analysis of Financial Condition and Results of Operations (MD&A) on page 32 of
the Company's 1998 Annual Report to Shareholders.
Wholesale Channels
Independent Broker/Dealer and National and Regional Brokerage Firms. The
Company sells individual and group variable annuities, fixed annuities and
variable life insurance through independent broker/dealers in all 50 states and
the District of Columbia. The Company historically has focused on distributing
through mid-sized regional broker/dealers and financial planning firms, but
recently has added national "wirehouse" firms to this channel. The Company
believes that it has strong broker/dealer relationships based on its diverse
product mix, large selection of fund options and administrative technology. In
addition to such relationships, the Company believes its financial strength and
The BEST of AMERICA(R)brand name are competitive advantages in this distribution
channel. The Company regularly seeks to add new broker/dealers to its
distribution network.
Pension Plan Administrators. The Company markets group variable annuities,
group fixed annuities and record-keeping services to plans organized pursuant to
Section 401 of the IRC sponsored by employers as part of employee retirement
programs primarily through regional pension plan administrators. The Company has
also linked pension plan administrators with the financial planning community to
sell group pension products. The Company targets employers having between 25 and
2,000 employees because it believes that these plan sponsors tend to require
more extensive record-keeping services from pension plan administrators and
therefore tend to become long-term customers.
Financial Institutions. The Company markets individual variable and fixed
annuities (under its brand names and on a private-label basis), and variable
universal life insurance through financial institutions, consisting primarily of
banks and their subsidiaries. The Company believes that its expertise in
training financial institution personnel to sell annuities, its breadth of
product offerings, its financial strength, the Nationwide and The BEST of
AMERICA(R) brand names, and the ability to offer private label products are
competitive advantages in this distribution channel.
Life Specialists: The Company markets corporate-owned life insurance
through life specialists, which are firms that specialize in the design,
implementation and administration of executive benefit plans.
Retail Channels
Exclusive Retail Sales Representatives. The Company markets various
products and services on a retail basis through several subsidiary sales
organizations to both the Public Sector and Teachers Markets. With respect to
the Public Sector Market, the Company markets group variable annuities and fixed
annuities to state and local governments for use in their IRC Section 457
retirement programs. The Company believes that its existing relationships with
state and local government entities and the Company's sponsorship by such
entities as the National Association of Counties (NACO) and The United States
Conference of Mayors (USCM) provide it with distinct competitive advantages in
this market. NACO sponsorship, which began in 1980 and has been renewed three
times, expires December 31, 2005, and USCM sponsorship, which began in 1979 and
has been renewed twice, expires on December 31, 2004.
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With respect to the Teacher Market, the Company has an exclusive
contractual arrangement with the NEA to offer and sell certain products to its
members. Under The NEA Valuebuilder brand name, the Company markets both
qualified and non-qualified (under IRC Section 403(b)) individual variable
annuity contracts. The Company also offers IRAs in this market. The NEA
exclusive contractual arrangement, which began in 1990, automatically renewed on
July 26, 1995 for an additional 5-year period.
Nationwide Insurance Enterprise Insurance Agents. The Company sells
traditional life insurance, universal life insurance and variable universal life
insurance products and individual annuities through licensed Nationwide
Insurance Enterprise insurance agents who primarily target the holders of
personal automobile and homeowners' insurance policies issued by the Nationwide
Insurance Enterprise. The Nationwide Insurance Enterprise insurance agents sell
exclusively Nationwide Insurance Enterprise products and may not offer products
which compete with those of the Company.
CORPORATE AND OTHER SEGMENT
Revenues in the Corporate and Other segment consist of net investment
income on invested assets not allocated to the three product segments,
investment management fees and other revenues earned from investment management
services (other than the portion allocated to the Variable Annuities and Life
Insurance segments), commissions and other income earned by the marketing and
distribution subsidiaries of the Company and net investment income and policy
charges from group annuity contracts issued to Nationwide Insurance Enterprise
employee and agent benefit plans.
Corporate and Other segment revenues, operating income before federal
income tax expense (which excludes realized gains and losses on investments and
results of discontinued operations) and policy reserves are summarized in the
following table.
<TABLE>
<CAPTION>
1998 1997 1996
---- -------- --------
(IN MILLIONS OF DOLLARS)
<S> <C> <C> <C>
Total operating revenues..................... $ 278.7 $ 219.9 $ 203.8
Operating (loss) income before federal income
tax expense................................ (0.9) 4.6 35.4
Policy reserves as of year end............... $4,365.5 $3,791.9 $3,302.5
</TABLE>
REINSURANCE
The Company follows the customary industry practice of reinsuring a portion
of its life insurance and annuity risks with other companies in order to reduce
net liability on individual risks, to provide protection against large losses
and to obtain greater diversification of risks. The maximum amount of individual
ordinary life insurance retained by the Company on any one life is $1.0 million.
The Company cedes insurance primarily on an automatic basis, under which risks
are ceded to a reinsurer on specific blocks of business where the underlying
risks meet certain predetermined criteria, and on a facultative basis, under
which the reinsurer's prior approval is required for each risk reinsured. The
Company also cedes insurance on a case-by-case basis particularly where the
Company may be writing new risks or is unwilling to retain the full costs
associated with new lines of business. The ceding of risk does not discharge the
original insurer from its primary obligation to the policyholder. The Company
has entered into a reinsurance contract to cede a portion of its general account
individual annuity reserves to Franklin Life Insurance Company (Franklin). Total
recoveries due from Franklin were $187.9 million and $220.2 million as of
December 31, 1998 and 1997, respectively. Under the terms of the contract,
Franklin has established a trust as collateral for the recoveries. The trust
assets are invested in investment grade securities, the market value of which
must at all times be greater than or equal to 102% of the reinsured reserves.
The Company has no other material reinsurance arrangements with unaffiliated
reinsurers. The only material reinsurance agreements the Company has with
affiliates are the modified coinsurance agreements pursuant to which NLIC
reinsured all of its accident and health and group life insurance business to
other members of the Nationwide Insurance Enterprise as described in note 14 to
the Company's consolidated financial statements.
9
<PAGE> 10
RATINGS
Ratings with respect to claims-paying ability and financial strength have
become an increasingly important factor in establishing the competitive position
of insurance companies. Ratings are important to maintaining public confidence
in the Company and its ability to market its annuity and life insurance
products. Rating organizations continually review the financial performance and
condition of insurers, including the Company. Any lowering of the Company's
ratings could have a material adverse effect on the Company's ability to market
its products and could increase the surrender of the Company's annuity products.
Both of these consequences could, depending upon the extent thereof, have a
material adverse effect on the Company's liquidity and, under certain
circumstances, net income. NLIC is rated "A+" (Superior) by A.M. Best Company,
Inc. and its claims-paying ability is rated "Aa2" (Excellent) by Moody's
Investor Services, Inc. (Moody's), "AA+" (Excellent) by Standard & Poor's
Corporation (S&P) and "AA+" (Excellent) by Duff & Phelps Credit Rating Co.
The foregoing ratings reflect each rating agency's opinion of NLIC's
financial strength, operating performance and ability to meet its obligations to
policyholders and are not evaluations directed toward the protection of
investors. Such factors are of concern to policyholders, agents and
intermediaries.
The Company's financial strength is also reflected in the ratings of the
senior notes and capital and preferred securities of subsidiary trusts. The
senior notes are rated "A+" by S&P and "A1" by Moody's. The capital and
preferred securities issued by subsidiary trusts are rated "A-" by S&P and "a1"
by Moody's.
COMPETITION
The Company competes with a large number of other insurers as well as
non-insurance financial services companies, such as banks, broker/dealers and
mutual funds, some of whom have greater financial resources, offer alternative
products and, with respect to other insurers, have higher ratings than the
Company. The Company believes that competition in the Company's lines of
business is based on price, product features, commission structure, perceived
financial strength, claims-paying ratings, service and name recognition.
National banks, with their preexisting customer bases for financial services
products, may pose increasing competition in the future to insurers who sell
annuities, including the Company, as a result of the U.S. Supreme Court's 1994
decision in NationsBank of North Carolina v. Variable Annuity Life Insurance
Company, which permits national banks to sell annuity products of life insurance
companies in certain circumstances.
Several proposals to repeal or modify the Glass-Steagall Act of 1933, as
amended, and the Bank Holding Company Act of 1956, as amended, have been made by
members of Congress and the Clinton Administration. Currently, the Bank Holding
Company Act restricts banks from being affiliated with insurance companies. None
of these proposals has yet been enacted, and it is not possible to predict
whether any of these proposals will be enacted, or if enacted, their potential
effect on the Company.
REGULATION
General Regulation at State Level
As an insurance holding company, the Company is subject to regulation by
the states in which its insurance subsidiaries are domiciled and/or transact
business. Most states have enacted legislation that requires each insurance
holding company and each insurance company in an insurance holding company
system to register with the insurance regulatory authority of the insurance
company's state of domicile and, annually, to furnish financial and other
information concerning the operations of companies within the holding company
system that materially affect the operations, management or financial condition
of the insurers within such system. The Company is subject to the insurance
holding company laws in Ohio. Under such laws, all transactions within an
insurance holding company system affecting insurers must be fair and equitable
and each insurer's policyholder surplus following any such transaction must be
both reasonable in relation to its outstanding liabilities and adequate for its
needs. The Ohio insurance holding company laws also require prior notice or
regulatory approval of the change of control of an insurer or its holding
company and of material intercorporate transfers of assets within the holding
company structure. Generally, under such laws, a state insurance authority must
approve in
10
<PAGE> 11
advance the direct or indirect acquisition of 10% or more of the voting
securities of an insurance company domiciled in its state.
In addition, the laws of the various states establish regulatory agencies
with broad administrative powers to approve policy forms, grant and revoke
licenses to transact business, regulate trade practices, license agents, require
statutory financial statements and prescribe the type and amount of investments
permitted. In recent years, a number of life and annuity insurers have been the
subject of regulatory proceedings and litigation relating to alleged improper
life insurance pricing and sales practices. Some of these insurers have incurred
or paid substantial amounts in connection with the resolution of such matters.
In addition, state insurance regulatory authorities regularly make inquiries,
hold investigations and administer market conduct examinations with respect to
insurers' compliance with applicable insurance laws and regulations. None of the
Company's insurance subsidiaries is the subject of any such investigation by any
regulatory authority or any such market conduct examination in any state at this
time. The Company's subsidiaries continuously monitor sales, marketing and
advertising practices and related activities of their agents and personnel and
provide continuing education and training in an effort to ensure compliance with
applicable insurance laws and regulations. There can be no assurance that any
non-compliance with such applicable laws and regulations would not have a
material adverse effect on the Company.
Insurance companies are required to file detailed annual and quarterly
financial statements with state insurance regulators in each of the states in
which they do business, and their business and accounts are subject to
examination by such agencies at any time. In addition, insurance regulators
periodically examine an insurer's financial condition, adherence to statutory
accounting practices and compliance with insurance department rules and
regulations. Applicable state insurance laws, rather than federal bankruptcy
laws, apply to the liquidation or the restructuring of insurance companies.
As part of their routine regulatory oversight process, state insurance
departments conduct detailed examinations periodically (generally once every
three to four years) of the books, records and accounts of insurance companies
domiciled in their states. Such examinations are generally conducted in
cooperation with the departments of two or three other states under guidelines
promulgated by the National Association of Insurance Commissioners (NAIC). The
most recently completed examination of the Company's insurance subsidiaries was
conducted by the Ohio and Delaware insurance departments for the four-year
period ended December 31, 1996. The final reports of these examinations did not
result in any significant issues or adjustments.
Regulation of Dividends and Other Payments from Insurance Subsidiaries
As an insurance holding company, the Company's ability to meet debt service
obligations and pay operating expenses and dividends depends primarily on the
receipt of sufficient funds from its primary operating subsidiary, NLIC. The
inability of NLIC to pay dividends to the Company in an amount sufficient to
meet debt service obligations and pay operating expenses and dividends would
have a material adverse effect on the Company. The payment of dividends by NLIC
is subject to restrictions set forth in the insurance laws and regulations of
Ohio, its domiciliary state. The Ohio insurance laws require Ohio-domiciled life
insurance companies to seek prior regulatory approval to pay a dividend or
distribution of cash or other property if the fair market value thereof,
together with that of other dividends or distributions made in the preceding 12
months, exceeds the greater of (i) 10% of statutory-basis policyholders' surplus
as of the prior December 31 or (ii) the statutory-basis net income of the
insurer for the 12-month period ending as of the prior December 31. The Ohio
insurance laws also require insurers to seek prior regulatory approval for any
dividend paid from other than earned surplus. Earned surplus is defined under
the Ohio insurance laws as the amount equal to the Company's unassigned funds as
set forth in its most recent statutory financial statements, including net
unrealized capital gains and losses or revaluation of assets. Additionally,
following any dividend, an insurer's policyholder surplus must be reasonable in
relation to the insurer's outstanding liabilities and adequate for its financial
needs. The payment of dividends by NLIC may also be subject to restrictions set
forth in the insurance laws of New York that limit the amount of statutory
profits on NLIC's participating policies (measured before dividends to
policyholders) that can inure to the benefit of the Company and its
stockholders. The Company currently does not expect such regulatory requirements
to impair its ability to pay operating expenses and dividends in the future.
11
<PAGE> 12
Risk-Based Capital Requirements
In order to enhance the regulation of insurer solvency, the NAIC has
adopted a model law to implement risk-based capital (RBC) requirements for life
insurance companies. The requirements are designed to monitor capital adequacy
and to raise the level of protection that statutory surplus provides for
policyholders. The model law measures four major areas of risk facing life
insurers: (i) the risk of loss from asset defaults and asset value fluctuation;
(ii) the risk of loss from adverse mortality and morbidity experience; (iii) the
risk of loss from mismatching of asset and liability cash flow due to changing
interest rates and (iv) business risks. Insurers having less statutory surplus
than required by the RBC model formula will be subject to varying degrees of
regulatory action depending on the level of capital inadequacy.
Based on the formula adopted by the NAIC, NLIC's adjusted capital exceeded
the level at which the Company would be required to take corrective action by a
substantial amount as of December 31, 1998.
Assessments Against Insurers
Insurance guaranty association laws exist in all states, the District of
Columbia and Puerto Rico. Insurers doing business in any of these jurisdictions
can be assessed for policyholder losses incurred by insolvent insurance
companies. The amount and timing of any future assessment on the Company's
insurance subsidiaries under these laws cannot be reasonably estimated and are
beyond the control of the Company and its insurance subsidiaries. A large part
of the assessments paid by the Company's insurance subsidiaries pursuant to
these laws may be used as credits for a portion of the Company's insurance
subsidiaries' premium taxes. For the years ended December 31, 1998, 1997 and
1996, the Company paid $2.4 million, $7.2 million and $4.5 million,
respectively, in assessments pursuant to state insurance guaranty association
laws.
General Regulation at Federal Level
Although the federal government generally does not directly regulate the
insurance business, federal initiatives often have an impact on the business in
a variety of ways. Current and proposed federal measures that may significantly
affect the insurance business include limitations on antitrust immunity, minimum
solvency requirements and the removal of barriers restricting banks from
engaging in the insurance and mutual fund business.
Securities Laws
Certain of the Company's insurance subsidiaries and certain policies and
contracts offered by them are subject to regulation under the federal securities
laws administered by the Securities and Exchange Commission (the Commission) and
under certain state securities laws. Certain separate accounts of the Company's
insurance subsidiaries are registered as investment companies under the
Investment Company Act of 1940, as amended (Investment Company Act). Separate
account interests under certain variable annuity contracts and variable
insurance policies issued by the Company's insurance subsidiaries are also
registered under the Securities Act of 1933, as amended. Certain other
subsidiaries of the Company are registered as broker/dealers under the
Securities Exchange Act of 1934, as amended and are members of, and subject to
regulation by, the National Association of Securities Dealers.
Certain of the Company's subsidiaries are investment advisors registered
under the Investment Advisors Act of 1940, as amended. The investment companies
managed by such subsidiaries are registered with the Commission under the
Investment Company Act and the shares of certain of these entities are qualified
for sale in certain states in the U.S. and the District of Columbia. A
subsidiary of the Company is registered with the Commission as a transfer agent.
Certain subsidiaries of the Company are also subject to the Commission's net
capital rules.
All aspects of the Company's subsidiaries' investment advisory activities
are subject to various federal and state laws and regulations in jurisdictions
in which they conduct business. These laws and regulations are primarily
intended to benefit investment advisory clients and investment company
shareholders and generally grant supervisory agencies broad administrative
powers, including the power to limit or restrict the carrying on of
12
<PAGE> 13
business for failure to comply with such laws and regulations. In such event,
the possible sanctions which may be imposed include the suspension of individual
employees, limitations on the activities in which the investment advisor may
engage, suspension or revocation of the investment advisor's registration as an
advisor, censure and fines.
ERISA Considerations
On December 31, 1993, the United States Supreme Court issued its opinion in
John Hancock Mutual Life Insurance Company v. Harris Trust and Savings Bank
holding that certain assets in excess of amounts necessary to satisfy guaranteed
obligations held by John Hancock in its general account under a participating
group annuity contact are "plan assets" and therefore subject to certain
fiduciary obligations under the Employee Retirement Income Security Act of 1974,
as amended (ERISA), which specify that fiduciaries must perform their duties
solely in the interest of ERISA plan participants and beneficiaries. The Court
limited the imposition of ERISA fiduciary obligations in these instances to
assets in the insurer's general account that were not reserved to pay benefits
of guaranteed benefit policies (i.e. benefits whose value would not fluctuate in
accordance with the insurer's investment experience). The Secretary of Labor
issued proposed regulations in December 1997, providing guidance for the purpose
of determining, in cases where an insurer issues one or more policies backed by
the insurer's general account to or for the benefit of an employee benefit plan,
which assets of the insurer constitute plan assets for purposes of ERISA and the
IRC. The regulations, once final, will apply only with respect to a policy
issued by an insurer on or before December 31, 1998. In the case of such a
policy, the regulations will take effect at the end of the 18-month period
following the date such regulations become final, or perhaps sooner in some
cases if necessary to prevent avoidance of the regulations. Generally, no person
will be liable under ERISA or the IRC for conduct occurring prior to the end of
such 18-month period, where the basis of a claim is that insurance company
general account assets constitute plan assets. New policies issued after
December 31, 1998, which are not guaranteed benefit policies will be subject to
the fiduciary obligations under ERISA.
Potential Tax Legislation
Congress has, from time to time, considered possible legislation that would
eliminate many of the tax benefits currently afforded to annuity products.
EMPLOYEES
As of December 31, 1998, the Company had approximately 4,060 employees.
None of the employees of the Company are covered by a collective bargaining
agreement and the Company believes that its employee relations are satisfactory.
ITEM 2 PROPERTIES
The Company's principal executive offices are located in Columbus, Ohio.
The Company leases its home office complex, consisting of approximately 491,000
square feet, from Nationwide Mutual Insurance Company (NMIC) and its
subsidiaries at One Nationwide Plaza, Two Nationwide Plaza and Three Nationwide
Plaza, Columbus, Ohio. The Company believes that its present facilities are
adequate for the anticipated needs of the Company.
ITEM 3 LEGAL PROCEEDINGS
The Company is a party to litigation and arbitration proceedings in the
ordinary course of its business, none of which is expected to have a material
adverse effect on the Company.
In recent years, life insurance companies have been named as defendants in
lawsuits, including class action lawsuits, relating to life insurance and
annuity pricing and sales practices. A number of these lawsuits have resulted in
substantial jury awards or settlements.
13
<PAGE> 14
In February 1997, NLIC was named as a defendant in a lawsuit filed in New
York Supreme Court related to the sale of whole life policies on a " vanishing
premium" basis (John H. Snyder v. Nationwide Mutual Insurance Company and
Nationwide Life Insurance Co.). In April 1998, NLIC was named as a defendant in
a lawsuit filed in Ohio State Court similar to the Snyder lawsuit (David and
Joan Mishler v. Nationwide Life Insurance Co.). In August 1998, Nationwide
Mutual Insurance Company and NLIC and the plaintiffs executed a stipulation of
settlement and submitted it to the New York Supreme Court for approval. On
August 20, 1998, the Court in the Snyder lawsuit signed an order preliminarily
approving a class for settlement purposes (which would include the Mishler
lawsuit) and scheduled a fairness hearing for December 17, 1998. At that
hearing, the Court reviewed the fairness and reasonableness of the proposed
settlement and issued a final order and judgment. The approved settlement
provides for the dismissal of the Snyder and Mishler lawsuits, bars class
members from pursuing litigation against Nationwide Mutual Insurance Company and
its affiliates, including the Company and its subsidiaries, relating to the
allegations in the Snyder lawsuit, and provides class members with a potential
value of approximately $100 million in policy adjustments, discounted premiums,
and discounted products.
In November 1997, two plaintiffs, one who was the owner of a variable life
insurance contract and the other who was the owner of a variable annuity
contract, commenced a lawsuit in a federal court in Texas against NLIC and the
American Century group of defendants (Robert Young and David D. Distad v.
Nationwide Life Insurance Company et al.). In this lawsuit, plaintiffs seek to
represent a class of variable life insurance contract owners and variable
annuity contract owners whom they claim were allegedly misled when purchasing
these variable contracts into believing that the performance of their underlying
mutual fund option managed by American Century, whose shares may only be
purchased by insurance companies, would track the performance of a mutual fund,
also managed by American Century, whose shares are publicly traded. The amended
complaint seeks unspecified compensatory and punitive damages. On April 27,
1998, the District Court denied, in part, and granted, in part, motions to
dismiss the complaint filed by NLIC and American Century. The remaining claims
against NLIC allege securities fraud, common law fraud, civil conspiracy, and
breach of contract. On December 2, 1998, the District Court issued an order
denying plaintiffs' motion for class certification. On December 10, 1998, the
District Court stayed the lawsuit pending plaintiffs' petition to the United
States Court of Appeals for the Fifth Circuit for interlocutory review of the
order denying class certification. On December 14, 1998 plaintiffs filed their
petition for interlocutory review, on which the Fifth Circuit has not yet ruled.
NLIC intends to defend the case vigorously.
On October 29, 1998, the Company and certain of its subsidiaries were named
in a lawsuit filed in the Common Pleas Court of Franklin County, Ohio related to
the sale of deferred annuity products for use as investments in tax-deferred
contributory retirement plans (Mercedes Castillo v. Nationwide Financial
Services, Inc., Nationwide Life Insurance Company and Nationwide Life and
Annuity Insurance Company). The plaintiff in such lawsuit seeks to represent a
national class of the Company's customers and seeks unspecified compensatory and
punitive damages. The Company is currently evaluating this lawsuit, which has
not been certified as a class. The Company intends to defend this lawsuit
vigorously.
There can be no assurance that any litigation relating to pricing or sales
practices will not have a material adverse effect on the Company in the future.
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<PAGE> 15
ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
During the fourth quarter of 1998 no matters were submitted to a vote of
security holders, through the solicitation of proxies or otherwise.
EXECUTIVE OFFICERS OF THE REGISTRANT
<TABLE>
<CAPTION>
NAME AGE POSITION WITH THE COMPANY
---- --- -------------------------
<S> <C> <C>
Dimon Richard McFerson... 62 Chairman and Chief Executive Officer -- Nationwide
Insurance Enterprise
Joseph J. Gasper......... 55 President and Chief Operating Officer
Galen R. Barnes.......... 51 Executive Vice President
Richard D. Crabtree...... 58 Executive Vice President
Robert A. Oakley......... 52 Executive Vice President -- Chief Financial Officer
Robert J. Woodward,
Jr..................... 57 Executive Vice President -- Chief Investment Officer
James E. Brock........... 51 Senior Vice President -- Corporate Development
John R. Cook, Jr......... 55 Senior Vice President -- Chief Communications Officer
Philip C. Gath........... 51 Senior Vice President -- Chief Actuary
Richard D. Headley....... 50 Senior Vice President -- Chief Information Technology
Officer
Donna A. James........... 41 Senior Vice President -- Human Resources
Richard A. Karas......... 56 Senior Vice President -- Sales -- Financial Services
Douglas C. Robinette..... 44 Senior Vice President -- Marketing and Product Management
Susan A. Wolken.......... 48 Senior Vice President -- Life Company Operations
Dennis W. Click.......... 60 Vice President and Secretary
Bruce C. Barnes.......... 51 Vice President -- Technology Strategy and Planning
David A. Diamond......... 43 Vice President -- Controller
Matthew S. Easley........ 42 Vice President -- Investment Life Actuarial
R. Dennis Noice.......... 52 Vice President -- Systems
Joseph P. Rath........... 49 Vice President -- Chief Compliance Officer
Mark R. Thresher......... 42 Vice President -- Finance and Treasurer
</TABLE>
Business experience for each of the individuals listed in the above table
is set forth below.
DIMON RICHARD MCFERSON has been Chief Executive Officer of the Nationwide
Insurance Enterprise since December 1992. He has been Chairman and Chief
Executive Officer -- Nationwide Insurance Enterprise of the Company since
December 1996 and a director of the Company since November 1996. Mr. McFerson
has been a director of NLIC and NMIC since April 1988 and Chairman and Chief
Executive Officer -- Nationwide Insurance Enterprise of NLIC and NMIC since
April 1996. Previously he was elected Chief Executive Officer of NLIC in
December 1992, and President and Chief Executive Officer -- Nationwide Insurance
Enterprise of NLIC in December 1993. He was President and General Manager of
NMIC from April 1988 to April 1991; President and Chief Operating Officer of
NMIC from April 1991 to December 1992; and President and Chief Executive Officer
of NMIC from December 1992 to April 1996. Mr. McFerson has been with the
Nationwide Insurance Enterprise for 19 years.
JOSEPH J. GASPER has been President and Chief Operating Officer of the
Company since December 1996 and a director of the Company since November 1996.
Mr. Gasper has been President and Chief Operating Officer of NLIC and director
since April 1996. Previously, he was Executive Vice
President -- Property/Casualty Operations of NMIC from April 1995 to April 1996.
He was Senior Vice President -- Property/Casualty Operations of NMIC from
September 1993 to April 1995. Prior to that time, Mr. Gasper held numerous
positions
15
<PAGE> 16
within the Nationwide Insurance Enterprise. Mr. Gasper has been with the
Nationwide Insurance Enterprise for 32 years.
GALEN R. BARNES has been Executive Vice President of the Company since
December 1996. Mr. Barnes has been President of the Nationwide Insurance
Enterprise since April 1996. Previously, he was Director and Vice Chairman of
the Wausau Insurance Companies, members of the Nationwide Insurance Enterprise,
from September 1996 to December 1998; and Director, President and Chief
Operating Officer from May 1993 to September 1996. He was Senior Vice President
of the Nationwide Insurance Enterprise from May 1993 to April 1996. Prior to
that time, Mr. Barnes held several positions within the Nationwide Insurance
Enterprise. Mr. Barnes has been with the Nationwide Insurance Enterprise for 23
years.
RICHARD D. CRABTREE has been Executive Vice President of the Company since
December 1996. Mr. Crabtree has been a director and President and Chief
Operating Officer of NMIC, Nationwide Mutual Fire Insurance Company and
Nationwide Property and Casualty Insurance Company since April 1996. Previously,
he was Executive Vice President -- Property/Casualty Operations of the
Nationwide Insurance Enterprise from April 1995 to April 1996. Prior to that
time, Mr. Crabtree held various positions within the Nationwide Insurance
Enterprise. Mr. Crabtree has been with the Nationwide Insurance Enterprise for
33 years.
ROBERT A. OAKLEY has been Executive Vice President -- Chief Financial
Officer of the Company since December 1996. Mr. Oakley has been Executive Vice
President -- Chief Financial Officer of the Nationwide Insurance Enterprise
since April 1995. Previously, he was Senior Vice President -- Chief Financial
Officer of the Nationwide Insurance Enterprise from October 1993 to April 1995.
Prior to that time, Mr. Oakley held several positions within the Nationwide
Insurance Enterprise. Mr. Oakley has been with the Nationwide Insurance
Enterprise for 23 years.
ROBERT J. WOODWARD, JR. has been Executive Vice President -- Chief
Investment Officer of the Company since December 1996. Mr. Woodward has been
Executive Vice President -- Chief Investment Officer of the Nationwide Insurance
Enterprise since August 1995. Previously, he was Senior Vice President -- Fixed
Income Investments of the Nationwide Insurance Enterprise from March 1991 to
August 1995. Prior to that time, Mr. Woodward held several positions within the
Nationwide Insurance Enterprise. Mr. Woodward has been with the Nationwide
Insurance Enterprise for 34 years.
JAMES E. BROCK has been Senior Vice President -- Corporate Development of
the Company since July 1997. Mr. Brock has been Senior Vice
President -- Corporate Development of the Nationwide Insurance Enterprise since
July 1997. Previously, he was Senior Vice President -- Company Operations from
December 1996 to July 1997 and was also Senior Vice President -- Life Company
Operations of NLIC from April 1996 to July 1997. Mr. Brock was Senior Vice
President -- Investment Product Operations of NLIC from November 1990 to April
1996. Prior to that time, Mr. Brock held several positions within the Nationwide
Insurance Enterprise. Mr. Brock has been with the Nationwide Insurance
Enterprise for 29 years.
JOHN R. COOK, JR. has been Senior Vice President -- Chief Communications
Officer of the Company since October 1997. Mr. Cook has been Senior Vice
President -- Chief Communications Officer of the Nationwide Insurance Enterprise
since May 1997. Previously, Mr. Cook was Senior Vice President -- Chief
Communications Officer of USAA from July 1989 to May 1997.
PHILIP C. GATH has been Senior Vice President -- Chief Actuary of the
Company since June 1998. Mr. Gath has been Senior Vice President -- Chief
Actuary -- Nationwide Financial Services of the Nationwide Insurance Enterprise
since May 1998. Previously, Mr. Gath was Vice President -- Product
Manager -- Individual Variable Annuity of the Company from July 1997 to May
1998. Mr. Gath was Vice President -- Individual Life Actuary from August 1989 to
July 1997. Prior to that time, Mr. Gath held several positions within the
Nationwide Insurance Enterprise. Mr. Gath has been with the Nationwide Insurance
Enterprise for 30 years.
RICHARD D. HEADLEY has been Senior Vice President -- Chief Information
Technology Officer of the Company since October 1997. Mr. Headley has been
Senior Vice President -- Chief Information Technology Officer of the Nationwide
Insurance Enterprise since October 1997. Previously, Mr. Headley was Chairman
and Chief Executive Officer of Banc One Services Corporation from 1992 to
October 1997. From January 1975 until 1992 Mr. Headley held several positions
with Banc One Corporation.
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<PAGE> 17
DONNA A. JAMES has been Senior Vice President -- Human Resources of the
Company since December 1997. Ms. James has been Senior Vice President -- Human
Resources of the Nationwide Insurance Enterprise since December 1997.
Previously, she was Vice President -- Human Resources of the Nationwide
Insurance Enterprise from July 1996 to December 1997. Prior to that time Ms.
James was Vice President -- Assistant to the CEO of the Nationwide Insurance
Enterprise from March 1996 to July 1996. From May 1994 to March 1996 she was
Associate Vice President -- Assistant to the CEO for the Nationwide Insurance
Enterprise. Prior to that time Ms. James held several positions within the
Nationwide Insurance Enterprise. Ms. James has been with the Nationwide
Insurance Enterprise for 17 years.
RICHARD A. KARAS has been Senior Vice President -- Sales -- Financial
Services of the Company since December 1996. Mr. Karas has been Senior Vice
President -- Sales -- Financial Services of the Nationwide Insurance Enterprise
since March 1993. Previously, he was Vice President -- Sales -- Financial
Services of the Nationwide Insurance Enterprise from February 1989 to March
1993. Prior to that time, Mr. Karas held several positions within the Nationwide
Insurance Enterprise. Mr. Karas has been with the Nationwide Insurance
Enterprise for 34 years.
DOUGLAS C. ROBINETTE has been Senior Vice President -- Marketing and
Product Management of the Company since May 1998. Mr. Robinette has been Senior
Vice President -- Marketing and Product Management -- Nationwide Financial
Services of the Nationwide Insurance Enterprise since May 1998. Previously, Mr.
Robinette was Executive Vice President, Customer Services of Employers Insurance
of Wausau (Wausau), a member of the Nationwide Insurance Enterprise until
December 1998, from September 1996 to May 1998. Prior to that time he was
Executive Vice President, Finance and Insurance Services of Wausau from May 1995
to September 1996. From November 1994 to May 1995 Mr. Robinette was Senior Vice
President, Finance and Insurance Services of Wausau. From May 1993 to November
1994 he was Senior Vice President, Finance of Wausau. Prior to that time Mr.
Robinette held several positions within the Nationwide Insurance Enterprise. Mr.
Robinette has been with the Nationwide Insurance Enterprise for 12 years.
SUSAN A. WOLKEN has been Senior Vice President -- Life Company Operations
of the Company since July 1997. Ms. Wolken has been Senior Vice
President -- Life Company Operations of the Nationwide Insurance Enterprise
since June 1997. Previously, she was Senior Vice President -- Enterprise
Administration of the Nationwide Insurance Enterprise from July 1996 to June
1997. Prior to that time, she was Senior Vice President -- Human Resources of
the Nationwide Insurance Enterprise from April 1995 to July 1996. From September
1993 to April 1995 Ms. Wolken was Vice President -- Human Resources of the
Nationwide Insurance Enterprise. From October 1989 to September 1993 she was
Vice President -- Individual Life and Health Operations of the Nationwide
Insurance Enterprise. Ms. Wolken has been with the Nationwide Insurance
Enterprise for 24 years.
DENNIS W. CLICK has been Vice President -- Secretary of the Company since
December 1997. Mr. Click has been Vice President -- Secretary of the Nationwide
Insurance Enterprise since December 1997. Previously, he was Vice
President -- Assistant Secretary of the Company from December 1996 to December
1997. Mr. Click was Vice President -- Assistant Secretary of the Nationwide
Insurance Enterprise from August 1994 to December 1997. Mr. Click was Associate
Vice President and Assistant Secretary of the Nationwide Insurance Enterprise
from August 1989 to August 1994. Prior to that time, he held several positions
within the Nationwide Insurance Enterprise. Mr. Click has been with the
Nationwide Insurance Enterprise for 38 years.
BRUCE C. BARNES has been Vice President -- Technology Strategy and Planning
of the Company and of the Nationwide Insurance Enterprise since May 1998.
Previously, Mr. Barnes was Vice President -- Information Systems of the Company
from February 1997 to May 1998. Mr. Barnes was Vice President -- Life Systems of
the Nationwide Insurance Enterprise from May 1996 to May 1998. Previously, he
was Vice President -- Investment Product Systems of Nationwide Insurance
Enterprise from April 1995 to May 1996. Prior to that time, Mr. Barnes was Vice
President -- Individual Investment Products/Common Systems of the Nationwide
Insurance Enterprise from May 1994 to April 1995 and Associate Vice
President -- Individual Investment Products/Common Systems of NLIC from May 1992
to May 1994. Mr. Barnes was Vice President -- Information Services of PHP
Benefits Systems, Inc. from January 1987 to January 1992. Mr. Barnes has been
with the Nationwide Insurance Enterprise for 7 years.
17
<PAGE> 18
DAVID A. DIAMOND has been Vice President -- Controller of the Company since
December 1996. Mr. Diamond has been Vice President -- Enterprise Controller of
Nationwide Insurance Enterprise since August 1996. Previously, he was Vice
President -- Controller of NLIC from October 1993 to August 1996. Prior to that
time, Mr. Diamond held several positions within the Nationwide Insurance
Enterprise. Mr. Diamond has been with the Nationwide Insurance Enterprise for 10
years.
MATTHEW S. EASLEY has been Vice President -- Investment Life Actuarial of
the Company since June 1998. Mr. Easley has been Vice President -- Investment
Life Actuarial of the Nationwide Insurance Enterprise since June 1998.
Previously, Mr. Easley was Vice President -- Marketing and Administrative
Services of the Company from December 1996 to June. Mr. Easley was Vice
President -- Life Marketing and Administrative Services of the Nationwide
Insurance Enterprise from May 1996 to June 1998. Mr. Easley was Vice
President -- Annuity and Pension Actuarial of the Nationwide Insurance
Enterprise from August 1989 to May 1996. Prior to that time, Mr. Easley held
several positions within the Nationwide Insurance Enterprise. Mr. Easley has
been with the Nationwide Insurance Enterprise for 16 years.
R. DENNIS NOICE has been Vice President -- Systems of the Company since
April 1998. Mr. Noice has been Vice President -- Systems -- Nationwide Financial
Services of the Nationwide Insurance Enterprise since April 1998. Previously, he
was Vice President -- Retail Operations of the Nationwide Insurance Enterprise
from March 1997 to April 1998. Prior to that time, Mr. Noice was Vice
President -- Individual Investment Products of the Nationwide Insurance
Enterprise from October 1989 to March 1997. Prior to that time, Mr. Noice held
several positions within the Nationwide Insurance Enterprise. Mr. Noice has been
with the Nationwide Insurance Enterprise for 27 years.
JOSEPH P. RATH has been Vice President -- Chief Compliance Officer of the
Company since April 1997. Mr. Rath has been Vice President -- Compliance for
Nationwide Advisory Services, Inc. and Nationwide Investment Services Corp.
since April 1997. He has also been Vice President -- Product and Market
Compliance for the Nationwide Insurance Enterprise since April 1997. Previously,
he was Vice President -- Associate General Counsel of the Nationwide Insurance
Enterprise from October 1988 to April 1997. Prior to that time, Mr. Rath held
several positions within the Nationwide Insurance Enterprise. Mr. Rath has been
with the Nationwide Insurance Enterprise for 22 years.
MARK R. THRESHER has been Vice President -- Finance and Treasurer of the
Company since February 1997. Mr. Thresher has been Vice President -- Controller
of NLIC since August 1996. He was Vice President and Treasurer of the Company
from November 1996 to February 1997. Previously, he was Vice President and
Treasurer of the Nationwide Insurance Enterprise from June 1996 to August 1996.
Prior to joining the Nationwide Insurance Enterprise, Mr. Thresher served as a
partner with KPMG LLP since July 1988.
PART II
ITEM 5 MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED SHAREHOLDER MATTERS
The Class A Common Stock of NFS is traded on the New York Stock Exchange
under the symbol "NFS". As of March 1, 1999, NFS had approximately 900
registered shareholders of Class A Common Stock.
There is no established public trading market for the Company's Class B
Common Stock. All 104,745,000 shares of Class B Common Stock are owned by
Nationwide Corp.
18
<PAGE> 19
Information regarding the high and low sales prices of NFS Class A Common
Stock and cash dividends declared on such shares, as required by this item, is
set forth in the following table:
<TABLE>
<CAPTION>
QUARTER
QUARTER ENDED HIGH LOW CLOSE DIVIDENDS
------------- ---- --- ------- ---------
<S> <C> <C> <C> <C>
March 31, 1998................................ $45.75 $34.19 $43.48 $0.06
June 30, 1998................................. $51.38 $42.19 $51.00 $0.08
September 30, 1998............................ $55.84 $41.13 $45.44 $0.08
December 31, 1998............................. $51.69 $28.25 $51.69 $0.08
March 31, 1997................................ $28.50 $25.75 $25.75 --
June 30, 1997................................. $29.75 $23.38 $26.75 $0.06
September 30, 1997............................ $31.94 $25.75 $27.88 $0.06
December 31, 1997............................. $38.25 $27.00 $36.16 $0.06
</TABLE>
Information regarding restrictions on the ability of NFS's insurance
subsidiaries to pay dividends to NFS, as required by this item, is set forth
under "Item 1: Business-Regulation-Regulation of Dividends and Other Payments
from Insurance Subsidiaries" above and in note 13 of the consolidated financial
statements on page 74 of the 1998 Annual Report to Shareholders, and is
incorporated herein by reference.
ITEM 6 SELECTED CONSOLIDATED FINANCIAL DATA
Information required by this item is set forth in the table titled "Five
Year Summary" on pages 48 and 49 of the Company's 1998 Annual Report to
Shareholders, and is incorporated herein by reference.
ITEM 7 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Information required by this item is set forth on pages 27 through 47 of
the Company's 1998 Annual Report to Shareholders, and is incorporated herein by
reference.
ITEM 7A QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Information required by this item is set forth on pages 44 through 47 of
the Company's 1998 Annual Report to Shareholders, and is incorporated herein by
reference.
ITEM 8 CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Information required by this item is set forth on pages 50 through 81
(consolidated financial statements) and page 83 (independent auditors' report)
of the Company's 1998 Annual Report to Shareholders, and is incorporated herein
by reference. Reference is made to the index to consolidated financial
statements included in Item 14.
Financial statement schedules are included on pages 25 through 33 herein.
Reference is made to the index to financial statement schedules included on page
24 herein.
ITEM 9 CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURES
None.
PART III
ITEM 10 DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information set forth under the caption "Election of Directors" on
pages 3 through 6 of the Company's 1999 Proxy Statement is incorporated herein
by reference. Refer to Part I of the Form 10-K for information as to the
executive officers of NFS.
19
<PAGE> 20
ITEM 11 EXECUTIVE COMPENSATION
Information required by this item is set forth from the heading "Executive
Compensation and Other Information" on pages 7 through 18 of the Company's 1999
Proxy Statement, and is incorporated herein by reference.
ITEM 12 SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information required by this item is set forth under the caption
"Beneficial Ownership of Common Stock" on pages 2 and 3 of the Company's 1999
Proxy Statement, and is incorporated herein by reference.
ITEM 13 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information required by this item is set forth under the caption "CERTAIN
TRANSACTIONS" on pages 21 through 24 of the Company's 1999 Proxy Statement, and
is incorporated herein by reference.
20
<PAGE> 21
PART IV
ITEM 14 EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
<TABLE>
<CAPTION>
ANNUAL
REPORT
PAGE
------
<S> <C>
CONSOLIDATED FINANCIAL STATEMENTS:
Consolidated Statements of Income for the years ended
December 31, 1998, 1997 and 1996....................... 50
Consolidated Balance Sheets as of December 31, 1998 and
1997................................................... 51
Consolidated Statements of Shareholder's Equity for the
years ended December 31, 1998, 1997 and 1996........... 52
Consolidated Statements of Cash Flows for the years ended
December 31, 1998, 1997 and 1996....................... 53
Notes to Consolidated Financial Statements................ 54-81
Independent Auditors' Report.............................. 83
FORM
10-K
PAGE
-----
INDEX TO FINANCIAL STATEMENT SCHEDULES...................... 24
EXHIBIT INDEX............................................... 34
REPORTS ON FORM 8-K:
On October 15, 1998, NFS filed a Current Report on Form
8-K concerning NFS's announcement of the offering of
$200 million of Trust Preferred Securities.
On October 19, 1998, NFS filed a Current Report on Form
8-K concerning NFS's announcement that it had ended
discussions with UAM regarding the possible acquisition
of UAM's investment management affiliate, Pilgrim
Baxter & Associates.
On October 23, 1998, NFS filed a Current Report on Form
8-K to file certain exhibits related to NFS's $200
million Trust Preferred Securities.
On February 10, 1999 NFS filed a Current Report on Form
8-K announcing the expansion of its $20 billion
investment management business by establishing an
investment management company that will be led by Paul
Hondros, an industry leader.
</TABLE>
21
<PAGE> 22
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
NATIONWIDE FINANCIAL SERVICES, INC.
(Registrant)
By /s/ DIMON R. MCFERSON
-------------------
Dimon R. McFerson, Chairman and
Chief Executive
Officer -- Nationwide
Insurance Enterprise
Date: March 3, 1999
22
<PAGE> 23
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
<TABLE>
<S> <C>
/s/ DIMON R. MCFERSON March 3, 1999
- ------------------------------ ----------------
Dimon R. McFerson, Chairman Date
and Chief Executive Officer --
Nationwide Insurance
Enterprise and Director
/s/ JAMES G. BROCKSMITH, JR. March 8, 1999
- ------------------------------ ----------------
James G. Brocksmith, Jr., Date
Director
/s/ HENRY S. HOLLOWAY March 8, 1999
- ------------------------------ ----------------
Henry S. Holloway, Director Date
/s/ DONALD L. MCWHORTER March 7, 1999
- ------------------------------ ----------------
Donald L. McWhorter, Director Date
/s/ JAMES F. PATTERSON March 2, 1999
- ------------------------------ ----------------
James F. Patterson, Director Date
/s/ ARDEN L. SHISLER March 2, 1999
- ------------------------------ ----------------
Arden L. Shisler, Director Date
/s/ MARK R. THRESHER February 9, 1999
- ------------------------------ ----------------
Mark R. Thresher, Vice Date
President -- Finance and
Treasurer (Chief Accounting
Officer)
/s/ JOSEPH J. GASPER February 2, 1999
- ------------------------------ ----------------
Joseph J. Gasper, President Date
and Chief Operating Officer
and Director
/s/ CHARLES L. FUELLGRAF, JR March 2, 1999
- ------------------------------ ----------------
Charles L. Fuellgraf, Jr., Date
Director
/s/ LYDIA MICHEAUX MARSHALL March 7, 1999
- ------------------------------ ----------------
Lydia Micheaux Marshall, Date
Director
/s/ DAVID O. MILLER March 2, 1999
- ------------------------------ ----------------
David O. Miller, Director Date
/s/ GERALD D. PROTHRO March 19, 1999
- ------------------------------ ----------------
Gerald D. Prothro, Director Date
/s/ ROBERT A. OAKLEY February 9, 1999
- ------------------------------ ----------------
Robert A. Oakley, Executive Date
Vice President -- Chief
Financial Officer
</TABLE>
23
<PAGE> 24
NATIONWIDE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
INDEX TO FINANCIAL STATEMENT SCHEDULES
<TABLE>
<CAPTION>
PAGE
----
<S> <C> <C>
Independent Auditors' Report on Financial Statement Schedules............ 25
Schedule I Consolidated Summary of Investments -- Other Than
Investments in Related Parties as of December 31, 1998.... 26
Schedule II Condensed Financial Information of Registrant............... 27-30
Schedule
III Supplementary Insurance Information as of December 31, 1998,
1997 and 1996 and for each of the years then ended........ 31
Schedule IV Reinsurance as of December 31, 1998, 1997 and 1996 and for
each of the years then ended.............................. 32
Schedule V Valuation and Qualifying Accounts for the years ended
December 31, 1998, 1997 and 1996.......................... 33
</TABLE>
All other schedules are omitted because they are not applicable or not
required, or because the required information has been included in the audited
consolidated financial statements or notes thereto.
24
<PAGE> 25
INDEPENDENT AUDITORS' REPORT
ON FINANCIAL STATEMENT SCHEDULES
The Board of Directors
Nationwide Financial Services, Inc.:
Under date of January 29, 1999, we reported on the consolidated balance
sheets of Nationwide Financial Services, Inc. and subsidiaries as of December
31, 1998 and 1997, and the related consolidated statements of income,
shareholders' equity, and cash flows for each of the years in the three-year
period ended December 31, 1998, as contained in the 1998 annual report to
shareholders. These consolidated financial statements and our report thereon are
incorporated by reference in the annual report on Form 10-K for the year 1998.
In connection with our audits of the aforementioned consolidated financial
statements, we also audited the related financial statement schedules as listed
in the accompanying index. These financial statement schedules are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statement schedules based on our audits.
In our opinion, such financial statement schedules, when considered in
relation to the basic consolidated financial statements taken as a whole,
present fairly, in all material respects, the information set forth therein.
KPMG LLP
Columbus, Ohio
January 29, 1999
25
<PAGE> 26
SCHEDULE I
NATIONWIDE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED SUMMARY OF INVESTMENTS -
OTHER THAN INVESTMENTS IN RELATED PARTIES
(IN MILLIONS OF DOLLARS)
AS OF DECEMBER 31, 1998
<TABLE>
<CAPTION>
- ------------------------------------------------------------ --------- --------- -------------
COLUMN A COLUMN B COLUMN C COLUMN D
- ------------------------------------------------------------ --------- --------- -------------
AMOUNT AT
WHICH SHOWN
IN THE
MARKET CONSOLIDATED
TYPE OF INVESTMENT COST VALUE BALANCE SHEET
------------------ ---- ------ -------------
<S> <C> <C> <C>
Fixed maturity securities available-for-sale:
Bonds:
U.S. Government and government agencies and
authorities.......................................... $ 3,716.4 $ 3,831.2 $ 3,831.2
States, municipalities and political subdivisions...... 1.6 1.6 1.6
Foreign governments.................................... 106.5 111.0 111.0
Public utilities....................................... 1,456.9 1,475.8 1,475.8
All other corporate.................................... 8,442.7 8,828.3 8,828.3
--------- --------- ---------
Total fixed maturity securities available-for-sale... 13,724.1 14,247.9 14,247.9
--------- --------- ---------
Equity securities available-for-sale:
Common stocks:
Industrial, miscellaneous and all other................ 116.9 134.0 134.0
Non-redeemable preferred stock............................ -- -- --
--------- --------- ---------
Total equity securities available-for-sale........... 116.9 134.0 134.0
--------- --------- ---------
Mortgage loans on real estate, net.......................... 5,371.7 5,328.4(1)
Real estate, net:
Investment properties..................................... 184.6 186.8(1)
Acquired in satisfaction of debt.......................... 60.0 56.8(1)
Policy loans................................................ 464.3 464.3
Other long-term investments................................. 43.1 44.0(2)
Short-term investments...................................... 478.3 478.3
--------- ---------
Total investments.................................... $20,443.0 $20,940.5
========= =========
</TABLE>
- ---------------
(1) Difference from Column B is primarily due to valuation allowances due to
impairments on mortgage loans on real estate and due to accumulated
depreciation and valuation allowances due to impairments on real estate. See
note 3 to the consolidated financial statements.
(2) Difference from Column B is primarily due to operating gains (losses) of
investments in limited partnerships.
See accompanying independent auditors' report.
26
<PAGE> 27
SCHEDULE II
NATIONWIDE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
(IN THOUSANDS OF DOLLARS)
CONDENSED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------
1998 1997
---- ----
<S> <C> <C>
ASSETS
Investment in subsidiaries.................................. $2,867,887 $2,474,386
Short-term investments...................................... 172,231 67,534
Cash........................................................ 846 --
Accrued investment income................................... 1,268 762
Other assets................................................ 40,410 8,704
---------- ----------
$3,082,642 $2,551,386
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Long-term debt.............................................. $ 607,670 $ 401,469
Other liabilities........................................... 27,443 25,754
---------- ----------
635,113 427,223
---------- ----------
Shareholders' equity........................................ 2,447,529 2,124,163
---------- ----------
$3,082,642 $2,551,386
========== ==========
</TABLE>
CONDENSED STATEMENT OF INCOME
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
------------------------
1998 1997
---- ----
<S> <C> <C>
Revenues:
Dividends received from subsidiaries...................... $103,000 $850,000
Investment income......................................... 4,467 3,965
Realized losses on investments............................ (10,589) --
Other..................................................... 79 --
-------- --------
96,957 853,965
-------- --------
Expenses:
Interest expense on long-term debt........................ 35,587 26,111
Other operating expenses.................................. 3,175 510
-------- --------
38,762 26,621
-------- --------
Income before federal income tax benefit............... 58,195 827,344
Federal income tax benefit.................................. 15,459 7,930
-------- --------
Income before equity in net income of subsidiaries..... 73,654 835,274
Equity in undistributed net income of subsidiaries.......... 258,716 (570,093)
-------- --------
Net income........................................... $332,370 $265,181
======== ========
</TABLE>
See accompanying notes to condensed financial statements and independent
auditors' report.
27
<PAGE> 28
NATIONWIDE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
SCHEDULE II -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT, CONTINUED
(IN THOUSANDS OF DOLLARS)
CONDENSED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
------------------------
1998 1997
---- ----
<S> <C> <C>
Cash flows from operating activities:
Net income................................................ $332,370 $265,181
Adjustments to reconcile net income to net cash provided
by operating activities:
Equity in net income of subsidiaries................... (258,716) (279,907)
Amortization........................................... 1,281 --
Realized losses on investments......................... 10,589 --
Other, net............................................. (27,349) 17,502
-------- --------
Net cash provided by operating activities............ 58,175 2,776
-------- --------
Cash flows from investing activities:
Cash paid to acquire companies and capital contributed to
subsidiaries........................................... (105,970) (839,873)
Other, net................................................ (115,286) (67,534)
-------- --------
Net cash used in investing activities................ (221,256) (907,407)
-------- --------
Cash flows from financing activities:
Net proceeds from issuance of common stock................ -- 524,191
Net proceeds from issuance of long-term debt.............. 199,901 395,862
Cash dividends paid....................................... (35,990) (15,423)
Other..................................................... 16 --
-------- --------
Net cash provided by financing activities............ 163,927 904,630
-------- --------
Net increase (decrease) in cash............................. 846 (1)
Cash, beginning of year..................................... -- 1
-------- --------
Cash, end of year........................................... $ 846 $ --
======== ========
</TABLE>
See accompanying notes to condensed financial statements and independent
auditors' report.
28
<PAGE> 29
NATIONWIDE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
SCHEDULE II -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT, CONTINUED
(IN THOUSANDS OF DOLLARS)
NOTES TO CONDENSED FINANCIAL STATEMENTS
(1) ORGANIZATION AND PRESENTATION
Nationwide Financial Services, Inc. (NFS) was formed in November 1996 as a
holding company for Nationwide Life Insurance Company (NLIC) and the other
companies within the Nationwide Insurance Enterprise that offer or distribute
long-term savings and retirement products. On March 11, 1997, NFS sold, in an
initial public offering, 23.6 million shares of its newly-issued Class A common
stock for net proceeds of $524,191 (the Equity Offering). In March 1997, NFS
also sold, in companion public offerings, $300,000 of 8% Senior Notes (the
Notes) and, Nationwide Financial Services Capital Trust (NFSCT), a wholly owned
subsidiary of NFS, issued $100,000 of 7.899% Capital Securities (the Capital
Securities). Concurrent with the sale of the Capital Securities by NFSCT, NFS
sold to NFSCT $103,093 in principal amount of its 7.899% Junior Subordinated
Deferrable Interest Debentures (Junior Subordinated Debentures). Aggregate net
proceeds from the Equity Offering, the offering of the Notes and the sale of the
7.899% Junior Subordinated Debentures totaled $920,053. NFS contributed $836,780
and $3,093 of the proceeds to the capital of NLIC and NFSCT, respectively, and
retained $80,180 of the proceeds for general corporate purposes.
Prior to the initial public offering, NFS was a wholly owned subsidiary of
Nationwide Corporation (Nationwide Corp.). Nationwide Corp. continues to own all
of the outstanding shares of Class B common stock, which represents
approximately 98% of the combined voting power of the shareholders of NFS.
During 1996 and 1997, Nationwide Corp. and NFS completed certain
transactions in anticipation of the initial public offering that focused the
business of NFS on long-term savings and retirement products. On September 24,
1996, NLIC declared a dividend payable to Nationwide Corp. on January 1, 1997
consisting of the outstanding shares of common stock of certain subsidiaries
that do not offer or distribute long-term savings or retirement products. In
addition, during 1996, NLIC entered into two reinsurance agreements whereby all
of NLIC's accident and health and group life insurance business was ceded to two
affiliates effective January 1, 1996. On January 27, 1997, Nationwide Corp.
contributed the common stock of NLIC and three marketing and distribution
companies to NFS. Additionally, NFS received a dividend from NLIC on February
24, 1997 and immediately thereafter paid a dividend to Nationwide Corp.
consisting of securities with a fair value of $850,000.
NFS conducted no operations during 1996, except for the deferral of certain
costs associated with the public offerings, and accordingly, has not presented a
condensed statement of income for the year ended December 31, 1996.
(2) LONG-TERM DEBT AND GUARANTEES
Long-term debt outstanding as of December 31, 1998 and 1997 consists of the
following:
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
8% Senior Notes due March 1, 2027 (net of unamortized
discount of $1,609 in 1998 and $1,624 in 1997)............ $298,391 $298,376
7.899% Junior Subordinated Deferrable Interest Debentures
due March 1, 2037......................................... 103,093 103,093
7.10% Junior Subordinated Deferrable Interest Debentures due
October 31, 2028.......................................... 206,186 --
-------- --------
$607,670 $401,469
======== ========
</TABLE>
See accompanying independent auditors' report
29
<PAGE> 30
NATIONWIDE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
SCHEDULE II -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT, CONTINUED
(IN THOUSANDS OF DOLLARS)
NOTES TO CONDENSED FINANCIAL STATEMENTS, CONTINUED
The Notes are redeemable in whole or in part, at the option of NFS, at any
time on or after March 1, 2007 at scheduled redemption premiums through March 1,
2016, and thereafter, at 100% of the principal amount thereof plus, in each
case, accrued and unpaid interest. The Notes are not subject to any sinking fund
payments. The terms of the Notes contain various restrictive covenants including
limitations on the disposition of subsidiaries. As of December 31, 1998, NFS was
in compliance with all such covenants. NFS made interest payments on the Notes
of $24,000 and $11,400 in 1998 and 1997, respectively.
The 7.899% Junior Subordinated Debentures are redeemable by NFS in whole at
any time or in part from time to time at par plus an applicable make-whole
premium. The 7.899% Junior Subordinated Debentures will mature or be called
simultaneously with the Capital Securities. The Capital Securities, through
obligations of NFS under the 7.899% Junior Subordinated Debentures, the Capital
Securities Guarantee Agreement and the related Declaration of Trust and
Indenture, are fully and unconditionally guaranteed by NFS. NFS made interest
payments on the 7.899% Junior Subordinated Debentures of $8,143 and $3,845 in
1998 and 1997, respectively.
On October 19, 1998, Nationwide Financial Services Capital Trust II
(NFSCTII) sold, in a public offering, $200,000 of 7.10% Trust Preferred
Securities representing preferred undivided beneficial interests in the assets
of NFSCTII generating net proceeds of $193,700. Concurrent with the sale of the
Preferred Securities, NFS sold to Trust II $206,186 of 7.10% Junior Subordinated
Debentures due October 31, 2028. The 7.10% Junior Subordinated Debentures are
the sole assets of NFSCTII and are redeemable, in whole or in part, on or after
October 19, 2003 at a redemption price equal to the principal amount to be
redeemed plus any accrued and unpaid interest. The Preferred Securities have a
liquidation amount of $25 per security and must be redeemed by NFSCTII when the
7.10% Junior Subordinated Debentures mature or are redeemed by NFS.
The Preferred Securities, through obligations of NFS under the 7.10% Junior
Subordinated Debentures, the Preferred Securities Guarantee Agreement and the
related Amended and Restated Declaration of Trust, are fully and unconditionally
guaranteed by NFS. Distributions on the Preferred Securities are cumulative and
payable quarterly beginning January 31, 1999.
See accompanying independent auditors' report.
30
<PAGE> 31
SCHEDULE III
NATIONWIDE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
SUPPLEMENTARY INSURANCE INFORMATION
(IN MILLIONS OF DOLLARS)
AS OF DECEMBER 31, 1998, 1997 AND 1996 AND FOR EACH OF THE YEARS THEN ENDED
<TABLE>
<CAPTION>
- ------------------------- -------------- ------------------- ------------------ ------------------ --------
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E COLUMN F
- ------------------------- -------------- ------------------- ------------------ ------------------ --------
DEFERRED FUTURE POLICY OTHER POLICY
POLICY BENEFITS, LOSSES, UNEARNED CLAIMS AND
ACQUISITION CLAIMS AND PREMIUMS BENEFITS PAYABLE PREMIUM
SEGMENT COSTS LOSS EXPENSES (1) (1) REVENUE
------- ----------- ----------------- -------- ---------------- -------
<S> <C> <C> <C> <C> <C>
1998: Variable
Annuities.............. $1,247.9 $ -- $ --
Fixed Annuities........ 316.8 14,597.4 23.1
Life Insurance......... 574.2 3,173.9 176.9
Corporate and Other.... (116.6) 2,000.9 --
-------- --------- --------
Total.................. $2,022.3 $19,772.2 $ 200.0
======== ========= ========
1997: Variable
Annuities.............. $1,018.4 $ -- $ --
Fixed Annuities........ 277.9 14,103.1 27.3
Life Insurance......... 472.9 2,683.4 178.1
Corporate and Other.... (103.8) 1,916.3 --
-------- --------- --------
Total............... $1,665.4 $18,702.8 $ 205.4
======== ========= ========
1996: Variable
Annuities.............. $ 792.1 $ -- $ --
Fixed Annuities........ 242.0 13,388.9 24.0
Life Insurance......... 414.4 2,391.5 174.6
Corporate and Other.... (82.0) 1,820.2 --
-------- --------- --------
Total............... $1,366.5 $17,600.6 $ 198.6
======== ========= ========
</TABLE>
<TABLE>
<CAPTION>
- ------------------------- -------------- ------------------- ------------------ ------------------ --------
COLUMN A COLUMN G COLUMN H COLUMN I COLUMN J COLUMN K
- ------------------------- -------------- ------------------- ------------------ ------------------ --------
NET INVESTMENT BENEFITS, CLAIMS, AMORTIZATION OTHER
INCOME LOSSES AND OF DEFERRED POLICY OPERATING EXPENSES PREMIUMS
SEGMENT (2) SETTLEMENT EXPENSES ACQUISITION COSTS (2) WRITTEN
- ------------------------- -------------- ------------------- ------------------ ------------------ --------
<S> <C> <C> <C> <C> <C>
1998: Variable
Annuities.............. $ (31.3) $ 3.5 $123.9 $183.7
Fixed Annuities........ 1,116.6 847.6 44.2 85.2
Life Insurance......... 231.6 268.7 46.5 101.7
Corporate and Other.... 169.9 125.0 -- 101.5
-------- --------- ------ ------
Total............... $1,486.8 $ 1,244.8 $214.6 $472.1
======== ========= ====== ======
1997: Variable
Annuities.............. $ (26.8) $ 5.9 $ 87.8 $159.4
Fixed Annuities........ 1,098.2 846.7 39.8 85.4
Life Insurance......... 189.1 227.5 39.6 94.5
Corporate and Other.... 153.4 114.7 -- 63.4
-------- --------- ------ ------
Total............. $1,413.9 $ 1,194.8 $167.2 $402.7
======== ========= ====== ======
1996: Variable
Annuities.............. $ (21.4) $ 4.6 $ 57.4 $132.3
Fixed Annuities........ 1,050.6 838.5 38.6 79.7
Life Insurance......... 174.0 211.4 37.4 79.0
Corporate and Other.... 154.6 106.1 -- 62.5
-------- --------- ------ ------
Total............. $1,357.8 $ 1,160.6 $133.4 $353.5
======== ========= ====== ======
</TABLE>
- ---------------
(1) Unearned premiums and other policy claims and benefits payable are included
in Column C amounts.
(2) Allocations of net investment income and certain operating expenses are
based on a number of assumptions and estimates, and reported operating
results would change by segment if different methods were applied.
See accompanying independent auditors' report.
31
<PAGE> 32
SCHEDULE IV
NATIONWIDE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
REINSURANCE
(IN MILLIONS OF DOLLARS)
AS OF DECEMBER 31, 1998, 1997 AND 1996 AND FOR EACH OF THE YEARS THEN ENDED
<TABLE>
<CAPTION>
- ------------------------------------------- --------- --------- -------- --------- ----------
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E COLUMN F
- ------------------------------------------- --------- --------- -------- --------- ----------
ASSUMED PERCENTAGE
CEDED TO FROM OF AMOUNT
GROSS OTHER OTHER NET ASSUMED
AMOUNT COMPANIES COMPANIES AMOUNT TO NET
--------- --------- ------ --------- ----
<S> <C> <C> <C> <C> <C>
1998:
Life insurance in force.................. $63,215.9 $17,413.4 $ 28.0 $45,830.5 0.1%
========= ========= ====== ========= ====
Premiums:
Life insurance........................ $ 225.4 $ 27.4 $ 2.0 $ 200.0 1.0%
Accident and health insurance......... 169.7 179.4 9.7 -- N/A
--------- --------- ------ --------- ----
Total............................... $ 395.1 $ 206.8 $ 11.7 $ 200.0 5.8%
========= ========= ====== ========= ====
1997:
Life insurance in force.................. $52,648.4 $13,678.7 $289.7 $39,259.4 0.7%
========= ========= ====== ========= ====
Premiums:
Life insurance........................ $ 235.9 $ 32.7 $ 2.2 $ 205.4 1.1%
Accident and health insurance......... 261.2 272.6 11.4 -- N/A
--------- --------- ------ --------- ----
Total............................... $ 497.1 $ 305.3 $ 13.6 $ 205.4 6.6%
========= ========= ====== ========= ====
1996:
Life insurance in force.................. $47,150.6 $11,164.6 $288.6 $36,274.6 0.8%
========= ========= ====== ========= ====
Premiums:
Life insurance........................ $ 225.6 $ 29.3 $ 2.3 $ 198.6 1.2%
Accident and health insurance......... 291.9 305.8 13.9 -- N/A
--------- --------- ------ --------- ----
Total............................... $ 517.5 $ 335.1 $ 16.2 $ 198.6 8.2%
========= ========= ====== ========= ====
</TABLE>
- ---------------
Note: The life insurance caption represents principally premiums from
traditional life insurance and life-contingent immediate annuities and
excludes deposits on investment products and universal life insurance
products.
See accompanying independent auditors' report.
32
<PAGE> 33
SCHEDULE V
NATIONWIDE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
(IN MILLIONS OF DOLLARS)
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
<TABLE>
<CAPTION>
- -------------------------------------------- ---------- ---------- ---------- ---------- ----------
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E COLUMN F
- -------------------------------------------- ---------- ---------- ---------- ---------- ----------
BALANCE AT CHARGED TO CHARGED TO BALANCE AT
BEGINNING COSTS AND OTHER DEDUCTIONS END OF
DESCRIPTION OF PERIOD EXPENSES ACCOUNTS (1) PERIOD
- -------------------------------------------- ----- ------ --- ----- -----
<S> <C> <C> <C> <C> <C>
1998:
Valuation allowances -- fixed maturity
securities............................. $ -- $ 7.5 $-- $ -- $ 7.5
Valuation allowances -- mortgage loans on
real estate............................ 42.5 (0.1) -- -- 42.4
Valuation allowances -- real estate....... 11.1 (5.7) -- -- 5.4
----- ------ --- ----- -----
Total.................................. $53.6 $ 1.7 $-- $ -- $55.3
===== ====== === ===== =====
1997:
Valuation allowances -- fixed maturity
securities............................. $ -- $ 16.2 $-- $16.2 $ --
Valuation allowances -- mortgage loans on
real estate............................ 51.0 (1.2) -- 7.3 42.5
Valuation allowances -- real estate....... 15.2 (4.1) -- -- 11.1
----- ------ --- ----- -----
Total.................................. $66.2 $ 10.9 $-- $23.5 $53.6
===== ====== === ===== =====
1996:
Valuation allowances -- mortgage loans on
real estate............................ $49.1 $ 4.5 $-- $ 2.6 $51.0
Valuation allowances -- real estate....... 25.8 (10.6) -- -- 15.2
----- ------ --- ----- -----
Total.................................. $74.9 $ (6.1) $-- $ 2.6 $66.2
===== ====== === ===== =====
</TABLE>
- ---------------
(1) Amounts represent direct write-downs charged against the valuation
allowance.
See accompanying independent auditors' report.
33
<PAGE> 34
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
- -------
<S> <C>
3.1 Form of Restated Certificate of Incorporation of Nationwide
Financial Services, Inc. (previously filed as Exhibit 3.1 to
Form S-1, Registration Number 333-18527, filed March 5,
1997, and incorporated herein by reference)
3.2 Form of Restated Bylaws of Nationwide Financial Services,
Inc. (previously filed as Exhibit 3.2 to Form S-1,
Registration Number 333-18527, filed March 5, 1997, and
incorporated herein by reference)
4.1 Form of Indenture relating to the Notes, including the form
of Global Note and the form of Definitive Note (previously
filed as Exhibit 4.1 to Form S-1, Registration Number
333-18527, filed March 5, 1997, and incorporated herein by
reference)
4.2 Form of Indenture relating to the Junior Subordinated
Deferrable Interest Debentures due 2037 of Nationwide
Financial Services, Inc. (previously filed as Exhibit 4.1 to
Form S-1, Registration Number 333-18533, filed March 5,
1997, and incorporated herein by reference)
4.3 Subordinated Indenture relating to the Junior Subordinated
Debentures due 2028 of Nationwide Financial Services, Inc.
(previously filed as Exhibit 4.2 to Form 8-K, Commission
File No. 1-12785, filed October 23, 1998, and incorporated
herein by reference)
4.4 First Supplemental Indenture relating to the Junior
Subordinated Debentures due 2028 of Nationwide Financial
Services, Inc. (previously filed as Exhibit 4.3 to Form 8-K,
Commission File No. 1-12785, filed October 23, 1998, and
incorporated herein by reference)
10.1 Form of Intercompany Agreement among Nationwide Mutual
Insurance Company, Nationwide Corporation and Nationwide
Financial Services, Inc. (previously filed as Exhibit 10.1
to Form S-1, Registration Number 333-18527, filed March 5,
1997, and incorporated herein by reference)
10.2 Form of Tax Sharing Agreement among Nationwide Mutual
Insurance Company and any corporation that may hereafter be
a subsidiary of Nationwide Mutual Insurance Company
(previously filed as Exhibit 10.2 to Form S-1, Registration
Number 333-18527, filed March 5, 1997, and incorporated
herein by reference)
10.2.1 First Amendment to the Tax Sharing Agreement among
Nationwide Mutual Insurance Company and any corporation that
may hereafter be a subsidiary of Nationwide Mutual Insurance
Company (previously filed as Exhibit 10.2 to Form 10-K,
Commission File Number 1-12785, filed March 31, 1998, and
incorporated herein by reference)
10.3 Form of First Amendment to Cost Sharing Agreement among
parties named therein (previously filed as Exhibit 10.3 to
Form S-1, Registration Number 333-18527, filed March 5,
1997, and incorporated herein by reference)
10.4 Modified Coinsurance Agreement between Nationwide Life
Insurance Company and Nationwide Mutual Insurance Company
(previously filed as Exhibit 10.4 to Form S-1, Registration
Number 333-18527, filed March 5, 1997, and incorporated
herein by reference)
10.5 Modified Coinsurance Agreement between Employers Life
Insurance Company of Wausau and Nationwide Life Insurance
Company (previously filed as Exhibit 10.5 to Form S-1,
Registration Number 333-18527, filed March 5, 1997, and
incorporated herein by reference)
10.6 Credit Facility, dated August 12, 1996, among Nationwide
Life Insurance Company, Nationwide Mutual Insurance Company,
the banks named therein and Morgan Guaranty Trust Company of
New York, the administrative agent (previously filed as
Exhibit 10.6 to Form S-1, Registration Number 333-18527,
filed March 5, 1997, and incorporated herein by reference)
10.6.1 Amendment dated as of September 8, 1997 to the Credit
Agreement dated as of August 12, 1996 among Nationwide
Mutual Insurance Company, Nationwide Life Insurance Company,
the Banks party thereto and Morgan Guaranty Trust Company of
New York, as administrative agent (previously filed as
Exhibit 10(a) to Quarterly Report on Form 10-Q for the
quarterly period ended September 30, 1997, and incorporated
herein by reference)
</TABLE>
34
<PAGE> 35
<TABLE>
<CAPTION>
EXHIBIT
- -------
<S> <C>
10.7 Form of Lease Agreement between Nationwide Mutual Insurance
Company, Nationwide Life Insurance Company, Nationwide Life
and Annuity Insurance Company and Nationwide Financial
Services, Inc. (previously filed as Exhibit 10.7 to Form
S-1, Registration Number 333-18527, filed March 5, 1997, and
incorporated herein by reference)
10.8 Form of Nationwide Financial Services, Inc. 1996 Long-Term
Equity Compensation Plan (previously filed as Exhibit 10.8
to Form S-1, Registration Number 333-18527, filed March 5,
1997, and incorporated herein by reference)
10.9 General Description of Nationwide Insurance Enterprise
Executive Incentive Plan (previously filed as Exhibit 10.9
to Form S-1, Registration Number 333-18527, filed March 5,
1997, and incorporated herein by reference)
10.10 General Description of Nationwide Insurance Enterprise
Management Incentive Plan (previously filed as Exhibit 10.10
to Form S-1, Registration Number 333-18527, filed March 5,
1997, and incorporated herein by reference)
10.11 Nationwide Insurance Enterprise Excess Benefit Plan
effective as of December 31, 1996 (previously filed as
Exhibit 10.11 to Form S-1, Registration Number 333-18527,
filed March 5, 1997, and incorporated herein by reference)
10.12 Nationwide Insurance Enterprise Supplemental Retirement Plan
effective as of December 31, 1996 (previously filed as
Exhibit 10.12 to Form S-1, Registration Number 333-18527,
filed March 5, 1997, and incorporated herein by reference)
10.13 Nationwide Salaried Employees Severance Pay Plan (previously
filed as Exhibit 10.13 to Form S-1, Registration Number
333-18527, filed March 5, 1997, and incorporated herein by
reference)
10.14 Nationwide Insurance Enterprise Supplemental Defined
Contribution Plan effective as of January 1, 1996
(previously filed as Exhibit 10.14 to Form S-1, Registration
Number 333-18527, filed March 5, 1997, and incorporated
herein by reference)
10.15 General Description of Nationwide Insurance Enterprise
Individual Deferred Compensation Program (previously filed
as Exhibit 10.15 to Form S-1, Registration Number 333-18527,
filed March 5, 1997, and incorporated herein by reference)
10.16 General Description of Nationwide Mutual Insurance Company
Directors Deferred Compensation Program (previously filed as
Exhibit 10.16 to Form S-1, Registration Number 333-18527,
filed March 5, 1997, and incorporated herein by reference)
10.17 Deferred Compensation Agreement, dated as of September 3,
1979, between Nationwide Mutual Insurance Company and D.
Richard McFerson (previously filed as Exhibit 10.17 to Form
S-1, Registration Number 333-18527, filed March 5, 1997, and
incorporated herein by reference)
10.18 Nationwide Financial Services, Inc. Stock Retainer Plan for
Non-Employee Directors (previously filed as Exhibit 10.18 to
Form S-1, Registration Number 333-18527, filed March 5,
1997, and incorporated herein by reference)
12 Computation of Ratio of Earnings to Fixed Charges
13 Pages 27-81 and page 83 of the Company's 1998 Annual Report
to Shareholders
21 Subsidiaries of the Registrant
23 Consent of KPMG LLP, Independent Auditors
27 Financial Data Schedule (electronic filing only)
</TABLE>
- ---------------
All other exhibits referenced by Item 601 of Regulation S-K are not required
under the related instructions or are inapplicable and therefore have been
omitted.
35
<PAGE> 1
EXHIBIT 12
NATIONWIDE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
STATEMENT REGARDING COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES
(in millions of dollars)
<TABLE>
<CAPTION>
Year Ended December 31,
--------------------------------------------------------------------
1998 1997 1996 1995 1994
---------- ---------- ---------- ---------- -----------
<S> <C> <C> <C> <C> <C>
Earnings:
Income from continuing
operations before federal
income tax expense and
cumulative effect of
accounting changes $ 505.5 $ 407.0 $ 328.1 $ 281.2 $ 240.4
Fixed charges 1,104.1 1,042.7 982.3 950.3 844.6
---------- ---------- ---------- ---------- ----------
$ 1,609.6 $ 1,449.7 $ 1,310.4 $ 1,231.5 $ 1,085.0
========== ========== ========== ========== ==========
Fixed charges:
Interest credited to policyholder
account balances $ 1,069.0 $ 1,016.6 $ 982.3 $ 950.3 $ 844.6
Interest expense on debt and
capital securities of subsidiary
trust 35.1 26.1 - - -
---------- ---------- ---------- ---------- ----------
$ 1,104.1 $ 1,042.7 $ 982.3 $ 950.3 $ 844.6
========== ========== ========== ========== ==========
Ratio of earnings to fixed charges 1.5x 1.4x 1.3x 1.3x 1.3x
========== ========== ========== ========== ==========
Ratio of earnings to fixed charges,
excluding interest credited to
policyholder account balances 15.4x 16.6x N/A N/A N/A
========== ========== ========== ========== ==========
</TABLE>
<PAGE> 1
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
INTRODUCTION
Management's discussion and analysis of financial condition and results of
operations of Nationwide Financial Services, Inc. and its subsidiaries (NFS or
collectively the Company) for the three years ended December 31, 1998 follows.
This discussion should be read in conjunction with the Company's consolidated
financial statements and related notes included elsewhere in this report.
NFS is the holding company for Nationwide Life Insurance Company (NLIC) and
other companies that comprise the retirement savings operations of the
Nationwide Insurance Enterprise. The Company is a leading provider of long-term
savings and retirement products in the United States. The Company develops and
sells a diverse range of products including variable annuities, fixed annuities
and life insurance as well as investment management services, pension products
and administrative services to address an increasing spectrum of customer needs.
The Company markets its products through a broad network of wholesale and retail
distribution channels, including independent investment dealers, national and
regional brokerage firms, financial institutions, pension plan administrators,
exclusive retail sales representatives, and Nationwide Insurance Enterprise
insurance agents. The Company believes its unique combination of product
innovation and strong distributor relationships positions it to compete
effectively in the rapidly growing retirement savings market under various
economic conditions.
In March 1997, the Company sold 23.6 million newly-issued Class A shares of
common stock in an initial public offering (IPO). Prior to and at the time of
the IPO certain other transactions were completed to further access the capital
markets and to focus the business of NFS on long-term savings and retirement
products. These transactions included the sale of $400 million of senior notes
and capital securities, the payment of $900 million of dividends to NFS's parent
and the dividend of certain companies that do not offer long-term savings
products. See note 1 to the Company's consolidated financial statements for a
further description of these transactions.
Management's discussion and analysis contains certain forward-looking
statements within the meaning of the Private Securities Litigation Reform Act of
1995 with respect to the results of operations and businesses of the Company.
These forward-looking statements involve certain risks and uncertainties.
Factors that may cause actual results to differ materially from those
contemplated or projected, forecast, estimated or budgeted in such forward
looking statements include, among others, the following possibilities: (i)
Nationwide Corporation's control of the Company through its beneficial ownership
of approximately 97.8% of the combined voting power of all the outstanding
common stock and approximately 81.5% of the economic interest in the Company;
(ii) the Company's primary reliance, as a holding company, on dividends from its
subsidiaries to meet debt payment obligations and the applicable regulatory
restrictions on the ability of the Company's subsidiaries to pay such dividends;
(iii) the potential impact on the Company's reported net income that could
result from the adoption of certain accounting standards issued by the FASB;
(iv) tax law changes impacting the tax treatment of life insurance and
investment products; (v) heightened competition, including specifically the
intensification of price competition, the entry of new competitors and the
development of new products by new and existing competitors; (vi) adverse state
and federal legislation and regulation, including limitations on premium levels,
increases in minimum capital and reserves, and other financial viability
requirements; (vii) failure to expand distribution channels in order to obtain
new customers or failure to retain existing customers; (viii) inability to carry
out marketing and sales plans, including, among others,
27
<PAGE> 2
changes to certain products and acceptance of the revised products in the
market; (ix) changes in interest rates and the capital markets causing a
reduction of investment income or asset fees, reduction in the value of the
Company's investment portfolio or a reduction in the demand for the Company's
products; (x) general economic and business conditions which are less favorable
than expected; (xi) unanticipated changes in industry trends ratings assigned by
nationally recognized statistical rating organizations or A.M. Best Company,
Inc.; (xii) inaccuracies in assumptions regarding future persistency, mortality,
morbidity and interest rates used in calculating reserve amounts; and (xiii)
failure of the Company or its significant business partners and vendors to
identify and correct all non-Year 2000 compliant systems, or to develop and
execute adequate contingency plans.
- --------------------------------------------------------------------------------
RESULTS OF OPERATIONS
In addition to net income, the Company reports net operating income, which
excludes realized investment gains and losses and results of discontinued
operations. Net operating income is commonly used in the insurance industry as a
measure of on-going earnings performance.
The following table reconciles the Company's reported net income to net
operating income for each of the last three years. In addition, net operating
income reflecting pro forma adjustments for the IPO, companion senior notes and
capital securities public offerings and special dividends as discussed
previously is also presented for 1997 and 1996. Note 1 to the Company's
consolidated financial statements further describes these transactions. This pro
forma information is not necessarily indicative of what the Company's results
would have been had the above transactions actually occurred at the beginning of
each year presented, or of future results of the Company.
<TABLE>
<CAPTION>
(IN MILLIONS OF DOLLARS, EXCEPT PER SHARE AMOUNTS) 1998 1997 1996
- ------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Net income $332.4 $265.2 $223.6
Realized gains on investments, net of tax (11.7) (7.9) (1.0)
Income from discontinued operations, net of tax -- -- (11.3)
- ------------------------------------------------------------------------------------------
Net operating income 320.7 257.3 211.3
Pro forma adjustments, net of tax -- (2.9) (26.2)
- ------------------------------------------------------------------------------------------
Pro forma net operating income $320.7 $254.4 $185.1
- ------------------------------------------------------------------------------------------
Basic and diluted pro forma net operating income per share $ 2.49 $ 1.98 $ 1.44
- ------------------------------------------------------------------------------------------
</TABLE>
REVENUES
Revenues, excluding realized gains and losses on investments, increased $266.5
million, or 12%, to $2.49 billion in 1998 compared to $2.23 billion in 1997.
Revenues in 1997 were up 10% from $2.02 billion reported in 1996. The growth in
revenues over the past two years has primarily been driven by increases in
policy charges and net investment income. Growth in other income also
contributed significantly to revenue growth in 1998.
Policy charges include asset fees, which are primarily earned from separate
account assets generated from sales of variable annuities; cost of insurance
charges earned on universal life insurance products; administration fees, which
include fees charged per contract on a variety of the Company's products and
premium loads on universal life insurance products; and surrender fees, which
are charged as a percentage of premiums
28
<PAGE> 3
withdrawn during a specified period of annuity and certain life insurance
contracts. Policy charges for each of the last three years were as follows:
<TABLE>
<CAPTION>
(IN MILLIONS OF DOLLARS) 1998 1997 1996
- ------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Asset fees $494.7 $384.8 $275.5
Cost of insurance charges 88.8 68.5 53.2
Administrative fees 73.8 59.5 50.1
Surrender fees 41.6 32.4 22.1
- ------------------------------------------------------------------------------------------
Total policy charges $698.9 $545.2 $400.9
- ------------------------------------------------------------------------------------------
</TABLE>
The growth in asset fees reflects increases in total separate account assets
of $13.2 billion, or 35%, in 1998 and $10.8 billion, or 40%, in 1997. Record
variable annuity sales and strong equity market performance in each of the last
three years have resulted in separate account balances increasing 145% from
$20.81 billion at the beginning of 1996 to $50.94 billion at the end of 1998.
Cost of insurance charges are assessed as a percentage of the net amount
at risk on universal life insurance policies. The net amount at risk is
equal to a policy's death benefit minus the related policyholder account
value. The increase in cost of insurance charges is due primarily to growth
in the net amount at risk related to individual variable universal life
insurance reflecting expanded distribution and increased customer demand
for variable life products. The net amount at risk related to individual
variable universal life insurance grew to $14.95 billion at the end of 1998
compared to $10.44 billion and $7.52 billion at the end of 1997 and 1996,
respectively.
The growth in administrative fees is consistent with the increased number
of annuity and life insurance contracts in force during 1998 compared to
the prior two years. Nearly all of the increase in surrender charges over
the past two years is attributable to policyholder withdrawals in the
Variable Annuities segment, and is driven by an overall increase in
variable annuity policy reserves.
<TABLE>
<CAPTION>
Separate Account Assets
(in billions)
<S> <C> <C> <C> <C>
94 95 96 97 98
$12.1 $18.6 $26.9 $37.7 $50.9
</TABLE>
Net investment income includes the gross investment income earned on
investments supporting fixed annuities and certain life insurance products as
well as the yield on the Company's general account invested assets which are not
allocated to product segments. Net investment income grew from $1.36 billion and
$1.41 billion in 1996 and 1997, respectively, to $1.49 billion in 1998 primarily
due to increased invested assets to support growth in fixed annuity and life
insurance policy reserves. Fixed annuity policy reserves, which include the
fixed option of the Company's variable annuity products, increased $682.4
million in 1997 and $704.7 million in 1998 and were $14.90 billion as of year
end 1998. The growth in life insurance reserves was led by corporate-owned life
insurance products, where fixed reserves increased $201.1 million in 1997 and
$596.7 million in 1998. The increase in net investment income due to growth in
invested assets was partially offset by declining investment yields in 1998 and
1997 due to lower market interest rates.
Realized gains and losses on investments are not considered by the Company to
be recurring components of earnings. The Company makes decisions concerning the
sale of invested assets based on a variety of market, business, tax and other
factors.
Other income includes fees earned by the Company's investment management
subsidiaries as well as commissions and other income earned by other
subsidiaries of the Company that provide marketing, distribution and
administration services. During 1998, NFS acquired three companies for a total
purchase price of
29
<PAGE> 4
$61.1 million in an effort to expand the Company's investment management and
large case pension plan administration services. All three acquisitions were
accounted for using the purchase method, and the related revenues and expenses
have only been included in the Company's consolidated results since the date of
acquisition. Other income included in the Company's current year results earned
by companies that were acquired in 1998 totaled $20.5 million. The remaining
$24.8 million increase in other income during 1998 is primarily attributable to
growth in the Company's mutual fund operations that were in place during all the
years presented. Other income in 1997 compared to 1996 was relatively unchanged.
BENEFITS AND EXPENSES
Interest credited to policyholder account balances totaled $1.07 billion in
1998 compared to $1.02 billion in 1997 and $982.3 million in 1996 and
principally relates to fixed annuity and corporate-owned life insurance
products. The growth in interest credited reflects the increase in policy
reserves previously discussed partially offset by reduced average crediting
rates. The average crediting rate on fixed annuity policy reserves was 5.95% in
1998 compared to 6.12% and 6.30% in 1997 and 1996, respectively.
Amortization of deferred policy acquisition costs (DAC) increased $47.4
million in 1998 and $33.8 million in 1997 principally due to the Variable
Annuities segment, which accounted for $36.1 and $30.4 million of the increases
as a result of strong sales growth in each of the last two years.
Operating expenses were $472.1 million in 1998, a 17% increase from 1997
operating expenses of $402.7 million. Operating expenses were $353.5 million in
1996. The increase reflects the growth in the number of annuity and life
insurance contracts in-force and the related increase in administrative
processing costs as well as the effect of acquisitions and start-up companies.
In addition to the three acquisitions discussed previously, two subsidiaries,
Nationwide Trust Company, F.S.B. and Nationwide Financial Services (Bermuda),
Ltd., began operations in 1998. Excluding the effects of the 1998 acquisitions
and start-up companies, operating expenses increased 11% in 1998, down from the
14% increase reported in 1997.
The increase in interest expense reflects the senior notes and capital
securities issued at the IPO in March 1997 being outstanding for the entire year
in 1998 as well as the interest expense on $200 million of preferred securities
issued through a subsidiary trust in October 1998.
Federal income tax expense was $173.1 million representing an effective tax
rate of 34.2% for 1998. Federal income tax expense in 1997 and 1996 was $141.8
million and $115.8 million, respectively, representing effective rates of 34.8%
and 35.3%.
YEAR 2000
The Company has developed and implemented a plan to address issues related to
the Year 2000. The problem relates to many existing computer systems using only
two digits to identify a year in a date field. These systems were designed and
developed without considering the impact of the upcoming change in the century.
If not corrected, many computer systems could fail or create erroneous results
when processing information dated after December 31, 1999. Like many
organizations, the Company is required to renovate or replace many computer
systems so that the systems will function properly after December 31, 1999.
The Company has completed an inventory and assessment of all computer systems
and has implemented a plan to renovate or replace all applications that were
identified as not Year 2000 compliant. The Company
30
<PAGE> 5
has renovated all applications that required renovation. Testing of the
renovated programs included running each application in a Year 2000 environment
and was completed as planned during 1998. For applications being replaced, the
Company had all replacement systems in place and functioning as planned by
year-end 1998. Conversions of existing traditional life policies will continue
through second quarter, 1999. In addition, the shareholder services system that
support mutual fund products will be fully deployed in the first quarter of
1999.
The Company has completed an inventory and assessment of all vendor products
and has tested and certified that each vendor product is Year 2000 compliant.
Any vendor products that could not be certified as Year 2000 compliant were
replaced or eliminated in 1998.
The Company has also addressed issues associated with the exchange of
electronic data with external organizations. The Company has completed an
inventory and assessment of all business partners including electronic
interfaces. Processes have been put in place and programs initiated to process
data irrespective of the format by converting non-compliant data into a Year
2000 compliant format.
Systems supporting the Company's infrastructure such as telecommunications,
voice and networks will be compliant by March 1999. The Company's assessment of
Year 2000 issues has also included non-information technology systems with
embedded computer chips. The Company's building systems such as fire, security,
and elevators and escalators supporting facilities in Columbus, Ohio have been
tested and are Year 2000 compliant.
In addition to resolving internal Year 2000 readiness issues, the Company is
surveying significant external organizations (business partners) to assess if
they will be Year 2000 compliant and be in a position to do business in the Year
2000 and beyond. Specifically, the Company has contacted mutual fund
organizations that provide funds for our variable annuity and life products. The
same action will continue during the first quarter of 1999 with wholesale
producers. The Company continues its efforts to identify external risk factors
and is planning to develop contingency plans as part of its ongoing risk
management strategy.
The preceding Year 2000 discussion excludes the three companies acquired in
1998. The Company has reviewed the acquired companies' systems, applications,
and business partners, and work plans have been developed for the acquired
companies to become Year 2000 compliant during the second and third quarters of
1999.
Operating expenses in 1998 and 1997 include approximately $44.7 million and
$45.4 million, respectively, for technology projects, including costs related to
Year 2000. The company anticipates spending approximately $5 million on Year
2000 activities in 1999. Management does not anticipate that the completion of
Year 2000 renovation and replacement activities will result in a reduction in
operating expenses. Rather, personnel and resources currently allocated to Year
2000 issues will be assigned to other technology-related projects.
RECENTLY ISSUED ACCOUNTING STANDARDS
In June 1998, the FASB issued Statement of Financial Accounting Standards
(SFAS) No. 133 -- Accounting for Derivative Instruments and Hedging Activities.
SFAS 133 establishes accounting and reporting standards for derivative
instruments and for hedging activities. Contracts that contain embedded
derivatives, such as certain insurance contracts, are also addressed by the
Statement. SFAS 133 requires that an
31
<PAGE> 6
entity recognize all derivatives as either assets or liabilities in the
statement of financial position and measure those instruments at fair value. The
Statement is effective for fiscal years beginning after June 15, 1999. It may be
implemented earlier provided adoption occurs as of the beginning of any fiscal
quarter after issuance. The Company plans to adopt this Statement in first
quarter 2000 and is currently evaluating the impact on results of operations and
financial condition.
In March 1998, The American Institute of Certified Public Accountant's
Accounting Standards Executive Committee issued Statement of Position
98-1 -- Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use (SOP 98-1). SOP 98-1 provides guidance intended to standardize
accounting practices for costs incurred to develop or obtain computer software
for internal use. Specifically, SOP 98-1 provides guidance for determining
whether computer software is for internal use and when costs incurred for
internal use software are to be capitalized. SOP 98-1 is effective for financial
statements for fiscal years beginning after December 15, 1998. The Company does
not expect the adoption of SOP 98-1, which occurred on January 1, 1999, to have
a material impact on the Company's financial statements.
STATUTORY PREMIUMS AND DEPOSITS
The Company sells its products through a broad distribution network comprised
of wholesale and retail distribution channels. Wholesale distributors are
unaffiliated entities that sell the Company's products to their own customer
base and include independent broker/dealers, national and regional brokerage
firms, pension plan administrators and financial institutions. Retail
distributors are representatives of the Company who market products directly to
a customer base identified by the Company and include exclusive sales
representatives and Nationwide Insurance Enterprise insurance agents. Statutory
premiums and deposits by distribution channel for each of the last three years
are summarized as follows:
<TABLE>
<CAPTION>
(IN MILLIONS OF DOLLARS) 1998 1997 1996
- -------------------------------------------------------------------------------------------
<S> <C> <C> <C>
WHOLESALE CHANNELS
Independent broker/dealers $ 3,682.0 $ 3,699.1 $ 3,607.8
National and regional brokerage firms (1) 337.4 -- --
Financial institutions 2,036.0 1,653.2 947.2
Pension plan administrators 2,854.6 2,325.0 1,911.6
Life specialists 645.7 195.0 20.0
- -------------------------------------------------------------------------------------------
Total wholesale channels 9,555.7 7,872.3 6,486.6
- -------------------------------------------------------------------------------------------
RETAIL CHANNELS
Exclusive retail sales representatives 2,327.9 1,862.1 1,528.0
Nationwide agents 935.5 602.7 525.5
- -------------------------------------------------------------------------------------------
Total retail channels 3,263.4 2,464.8 2,053.5
- -------------------------------------------------------------------------------------------
Total external premiums and deposits 12,819.1 10,337.1 8,540.1
- -------------------------------------------------------------------------------------------
Nationwide Insurance Enterprise employee and agent
benefit plans 323.3 174.9 502.5
- -------------------------------------------------------------------------------------------
Total statutory premiums and deposits $13,142.4 $10,512.0 $ 9,042.6
- -------------------------------------------------------------------------------------------
</TABLE>
(1) Prior to 1998, national and regional brokerage firm sales were included in
independent broker/dealer sales.
32
<PAGE> 7
Excluding Nationwide Insurance Enterprise benefit plan sales, the Company
achieved annual sales growth of 24%, 21%, and 29% in 1998, 1997 and 1996,
respectively.
The Company's flagship products are marketed under The BEST of AMERICA(R)
brand, and include individual and group variable annuities and variable life
insurance. The BEST of AMERICA(R) products allow customers to choose from among
investment options managed by premier mutual fund managers. The Company has also
developed private label variable and fixed annuity products in conjunction with
other financial services providers which allow those providers to sell products
to their own customer bases under their own brand name.
The Company also markets group deferred compensation retirement plans to
employees of state and local governments for use under Internal Revenue Code
(IRC) Section 457. The Company utilizes its sponsorship by the National
Association of Counties and The United States Conference of Mayors when
marketing IRC Section 457 products. In addition, the Company utilizes an
exclusive arrangement with the National Education Association (NEA) to market
tax-qualified annuities under IRC 403(b) to NEA members. Variable annuities
developed for the NEA members are sold under the NEA Valuebuilder brand.
External statutory premiums and deposits by product for each of the last three
years are as follows:
<TABLE>
<CAPTION>
(IN MILLIONS OF DOLLARS) 1998 1997 1996
- -------------------------------------------------------------------------------------------
<S> <C> <C> <C>
The BEST of AMERICA(R) products:
Individual variable annuities $ 4,661.1 $ 4,269.6 $3,801.5
Group variable annuities 2,760.0 2,220.5 1,807.1
Variable universal life 315.9 220.0 165.4
Private label annuities 1,093.3 1,006.4 625.9
IRC Section 457 annuities 2,155.3 1,716.5 1,425.8
The NEA Valuebuilder annuities 172.6 145.6 102.2
Traditional/Universal life 246.0 248.4 253.9
Corporate owned life insurance 645.8 195.0 20.0
Other 769.1 315.1 338.3
- -------------------------------------------------------------------------------------------
$12,819.1 $10,337.1 $8,540.1
- -------------------------------------------------------------------------------------------
</TABLE>
- --------------------------------------------------------------------------------
BUSINESS SEGMENTS
The Company has three product segments: Variable Annuities, Fixed Annuities
and Life Insurance. In addition, the Company reports certain other revenues and
expenses in a Corporate and Other segment. All information set forth below
relating to the Company's Variable Annuities segment excludes the fixed option
under the Company's variable annuity contracts. Such information is included in
the Company's Fixed Annuities segment.
33
<PAGE> 8
The following table summarizes operating income (loss) before federal income
tax expense for the Company's business segments for each of the last three
years.
<TABLE>
<CAPTION>
(IN MILLIONS OF DOLLARS) 1998 1997 1996
- ----------------------------------------------------------------------------------------
<S> <C> <C> <C>
Variable annuities $218.4 $150.9 $ 90.3
Fixed annuities 175.3 169.5 135.4
Life insurance 94.8 70.9 67.2
Corporate and other (0.9) 4.6 35.4
- ----------------------------------------------------------------------------------------
$487.6 $395.9 $328.3
- ----------------------------------------------------------------------------------------
</TABLE>
VARIABLE ANNUITIES
The Variable Annuities segment consists of annuity contracts that provide the
customer with the opportunity to invest in mutual funds managed by independent
investment managers and the Company, with investment returns accumulating on a
tax-deferred basis. The Company's variable annuity products consist almost
entirely of flexible premium deferred variable annuity contracts.
The following table summarizes certain selected financial data for the
Company's Variable Annuities segment for the years indicated.
<TABLE>
<CAPTION>
(IN MILLIONS OF DOLLARS) 1998 1997 1996
- ----------------------------------------------------------------------------------------
<S> <C> <C> <C>
INCOME STATEMENT DATA
Revenues $ 529.5 $ 404.0 $ 284.6
Benefits and expenses 311.1 253.1 194.3
- ----------------------------------------------------------------------------------------
Operating income before federal income tax expense $ 218.4 $ 150.9 $ 90.3
- ----------------------------------------------------------------------------------------
OTHER DATA
Statutory premiums and deposits (1) $ 9,543.3 $ 7,535.8 $ 6,500.3
Policy reserves as of year end $46,420.8 $34,486.7 $24,278.1
Pre-tax operating income to average policy reserves 0.54% 0.51% 0.44%
- ----------------------------------------------------------------------------------------
</TABLE>
(1) Statutory data have been derived from the Annual Statements of the Company's
life insurance subsidiaries, as filed with insurance regulatory authorities
and prepared in accordance with statutory accounting practices.
Variable Annuities segment revenues reflect a significant increase in policy
charges, primarily asset fees, consistent with the growth in variable annuity
policy reserves. Asset fees were $479.1 million in 1998 up 29% from $370.2
million in 1997 and totaled $261.8 million in 1996. Asset fees are charged as a
percentage of policy reserves which have increased substantially in the past
three years as a result of steady premium growth and through market appreciation
on investments underlying reserves. Variable annuity policy reserves grew $11.93
billion during 1998 reaching $46.42 billion as of year end 1998 compared to
growth in 1997 of $10.21 billion and year end 1997 reserves of $34.49 billion.
During 1996, policy reserves increased $7.52 billion.
The Company has continued to achieve high sales growth through deeper
penetration of existing distribution channels and the addition of new sales
outlets. In addition, growing consumer acceptance of equity-based retirement
savings products, a robust United States stock market and low interest rates
have all combined to provide a very favorable environment for variable annuity
sales. The Company's broad network of strong
34
<PAGE> 9
distribution relationships coupled with product innovation allowed the Company
to maintain its ranking as the third largest seller of individual variable
annuities in the United States during 1998. Company sales of all variable
annuities increased 27% during 1998 to a record $9.54 billion compared to $7.54
billion in 1997. Variable annuity sales in 1997 represented a 16% increase over
1996 sales of $6.50 billion.
An example of the Company's ability to develop innovative products and to
leverage its strong distributor relationships to maintain its competitive
position is America's FUTURE Annuity. This individual variable annuity
product was developed in late 1997 in association with mutual fund partners
and distributors and offers the customer greater flexibility and investment
choice with insurance charges lower than comparable products sold through
the financial planning community. Sales of this product reached $2.4
billion during 1998, its first full year of availability.
Although the equity markets were more volatile in 1998 than in the
previous two years, equity market conditions over each of the past three
years have contributed significantly to the growth in variable annuity
policy reserves. Variable annuity policy reserves reflect market
appreciation of $6.80 billion, $5.21 billion and $2.72 billion in 1998,
1997 and 1996, respectively.
Increased variable annuity revenues were partially offset by increased
amortization of DAC in 1998 compared to 1997 and 1996 due to overall growth
in the variable annuity business and by increased operating expenses.
<TABLE>
<CAPTION>
Variable Annuity Reserves
(in billions)
<S> <C> <C> <C> <C>
94 95 96 97 98
$10.8 $16.8 $24.3 $34.5 $46.4
</TABLE>
Operating expenses increased 15% during 1998 and 20% during 1997; however, the
growth in expenses was far outpaced by the 31% and 42% increases in revenues
over those same periods. As a result, operating income as a percentage of
reserves has improved to 0.54% in 1998 up 3 basis points from 1997 and up 10
basis points from 1996. The Company has controlled operating expense growth by
increasing productivity through investments in technology and economies of
scale.
FIXED ANNUITIES
The Fixed Annuities segment consists of annuity contracts that generate a
return for the customer at a specified interest rate, fixed for a prescribed
period, with returns accumulating on a tax-deferred basis. Such contracts
consist of single premium deferred annuities, flexible premium deferred
annuities and single premium immediate annuities. The Fixed Annuities segment
includes the fixed option under the Company's variable annuity contracts.
35
<PAGE> 10
The following table summarizes certain selected financial data for the
Company's Fixed Annuities segment for the years indicated.
<TABLE>
<CAPTION>
(IN MILLIONS OF DOLLARS) 1998 1997 1996
- -----------------------------------------------------------------------------------------
<S> <C> <C> <C>
INCOME STATEMENT DATA
Revenues:
Net investment income $ 1,116.6 $ 1,098.2 $ 1,050.6
Other 35.7 43.2 42.0
- -----------------------------------------------------------------------------------------
1,152.3 1,141.4 1,092.6
- -----------------------------------------------------------------------------------------
Benefits and expenses:
Interest credited to policyholder account balances 828.6 823.4 805.0
Other benefits and expenses 148.4 148.5 152.2
- -----------------------------------------------------------------------------------------
977.0 971.9 957.2
- -----------------------------------------------------------------------------------------
Operating income before federal income tax expense $ 175.3 $ 169.5 $ 135.4
- -----------------------------------------------------------------------------------------
OTHER DATA
Statutory premiums and deposits (1) $ 2,068.0 $ 2,137.9 $ 1,600.5
Policy reserves as of year end $14,898.9 $14,194.2 $13,511.8
Pre-tax operating income to average policy reserves 1.21% 1.22% 1.03%
- -----------------------------------------------------------------------------------------
</TABLE>
(1) Statutory data have been derived from the Annual Statements of the Company's
life insurance
subsidiaries, as filed with insurance regulatory authorities and prepared in
accordance with statutory accounting practices.
Fixed Annuities segment results reflect an increase in interest spread income
attributable to growth in fixed annuity policy reserves and wider interest
margins. Interest spread is the differential between net investment income and
interest credited to policyholder account balances. Interest spreads vary
depending on crediting rates offered by competitors, performance of the
investment portfolio, changes in market interest rates and other factors.
The following table depicts the interest margins on general account policy
reserves in the Fixed Annuities segment for each of the last three years.
<TABLE>
<CAPTION>
1998 1997 1996
- -----------------------------------------------------------------------------------------
<S> <C> <C> <C>
Net investment income 8.02% 8.16% 8.22%
Interest credited 5.95 6.12 6.30
- -----------------------------------------------------------------------------------------
2.07% 2.04% 1.92%
- -----------------------------------------------------------------------------------------
</TABLE>
The declining interest rate environment has put pressure on interest margins
as fixed income investments have matured or prepaid and have been reinvested at
lower rates; however, mortgage loan and bond prepayment income actually
increased interest margins in 1998. Prepayment income added 8 additional basis
points to the 1998 interest margin compared to 1997. The Company expects 1999
interest margins excluding prepayment income to return to historically normal
levels of 190 to 195 basis points.
The Company is able to mitigate the effects of lower investment yields by
periodically resetting the rates credited on fixed annuity contracts. As of
December 31, 1998, $7.17 billion, or 48% of fixed annuity policy reserves, were
in contracts where the guaranteed interest rate is reestablished each quarter.
Fixed annuity policy reserves of $5.29 billion are in contracts that adjust the
crediting rate on an annual basis with portions
36
<PAGE> 11
resetting in each calendar quarter. The Company also has $1.36 billion of fixed
annuity policy reserves that call for the crediting rate to be reset annually on
each January 1. The remaining $1.08 billion of fixed annuity policy reserves are
in payout status where the Company has guaranteed periodic, typically monthly,
payments.
Fixed annuity policy reserves increased to $14.90 billion as of year-end
compared to $14.19 billion a year ago and $13.51 billion as of the end of
1996. Fixed annuity sales during 1998 were $2.07 billion, essentially even
with 1997 sales of $2.14 billion, reflecting the low interest rate
environment and customer preference for equity-linked products. Sales in
1996 were $1.60 billion. The increase in sales in 1998 and 1997 over 1996
reflects the impact of first year bonus crediting rate programs for certain
of the Company's variable annuity products. Such programs initially attract
sales to the Fixed Annuities segment. Over the subsequent twelve months,
the funds are then systematically transferred to variable investments. Most
of the Company's fixed annuity sales are premiums allocated to the
guaranteed fixed option of variable annuity contracts. Fixed annuity sales
for 1998 include $1.68 billion in premiums allocated to the fixed option
under a variable annuity contract, compared to $1.67 billion in 1997 and
$1.24 billion in 1996.
<TABLE>
<CAPTION>
Fixed Annuity Reserves
(in billions)
<S> <C> <C> <C> <C>
94 95 96 97 98
$11.2 $12.8 $13.5 $14.2 $14.9
</TABLE>
Results in 1996 were adversely impacted by a $13.0 million charge related to
reserve strengthening for the immediate annuity line.
LIFE INSURANCE
The Life Insurance segment consists of insurance products, including variable
universal life insurance and corporate-owned life insurance products, that
provide a death benefit and also allow the customer to build cash value on a
tax-deferred basis.
The following table summarizes certain selected financial data for the
Company's Life Insurance segment for the years indicated.
<TABLE>
<CAPTION>
(IN MILLIONS OF DOLLARS) 1998 1997 1996
- -------------------------------------------------------------------------------------------
<S> <C> <C> <C>
INCOME STATEMENT DATA
Revenues $ 551.2 $ 473.1 $ 435.6
Benefits and expenses 456.4 402.2 368.4
- -------------------------------------------------------------------------------------------
Operating income before federal income tax expense $ 94.8 $ 70.9 $ 67.2
- -------------------------------------------------------------------------------------------
OTHER DATA
Statutory premiums (1):
Traditional and universal life $ 246.0 $ 248.4 $ 253.9
Variable universal life 316.0 220.0 165.4
Corporate-owned life 645.8 195.0 20.0
Policy reserves as of year end:
Traditional and universal life 2,439.7 2,369.5 2,295.5
Variable universal life 1,270.1 895.6 622.6
Corporate-owned life 903.6 221.9 20.8
- -------------------------------------------------------------------------------------------
</TABLE>
(1) Statutory data have been derived from the Annual Statements of the Company's
life insurance subsidiaries, as filed with insurance regulatory authorities
and prepared in accordance with statutory accounting practices.
37
<PAGE> 12
The increase in Life Insurance segment earnings is attributable to strong
growth in investment life insurance products, which include individual variable
universal life insurance and corporate-owned life insurance, where the Company
has aggressively expanded its distribution capabilities. Investment life
premiums and deposits increased from $185.4 million in 1996 to $415.0
million in 1997 to $961.8 million in 1998. As a result of the sales growth
and high persistency, revenues from investment life products increased to
$150.4 million in 1998 from $71.9 million in 1997 and $45.5 million in
1996. The Company believes there are growth opportunities for investment
life products and in 1999 will be introducing new products and expanding
distribution to new outlets to better penetrate these markets.
<TABLE>
<CAPTION>
Life Insurance Reserves
(in billions)
<S> <C> <C> <C> <C>
94 95 96 97 98
$2.4 $2.7 $2.9 $3.5 $4.6
</TABLE>
The increase in benefits and expenses is composed primarily of increased
interest credited to policyholders and increased operating expenses. Death
claims and other policyholder benefits reflected modest growth during 1997
and 1998. Interest credited to policyholders increased $36.9 million in
1998 reaching $115.4 million compared to $78.5 million a year ago. Interest
credited to policyholders totaled $70.2 million in 1996. The increased
corporate-owned life insurance business discussed previously accounted for most
of the increases. Operating expenses grew to $101.7 million in 1998 compared to
$94.5 million and $78.9 million in 1997 and 1996, respectively, reflecting the
increased number of policies in-force as well as technology related
expenditures.
CORPORATE AND OTHER
The following table summarizes certain selected financial data for the
Company's Corporate and Other segment for the years indicated.
<TABLE>
<CAPTION>
(IN MILLIONS OF DOLLARS) 1998 1997 1996
- ------------------------------------------------------------------------------------------
<S> <C> <C> <C>
INCOME STATEMENT DATA
Revenues $260.8 $208.8 $204.0
Benefits and expenses 261.7 204.2 168.6
- ------------------------------------------------------------------------------------------
Operating income before federal income tax expense (1) $ (0.9) $ 4.6 $ 35.4
- ------------------------------------------------------------------------------------------
</TABLE>
(1) Excludes realized gains (losses) on investments and discontinued operations.
Revenues in the Corporate and Other segment consist of net investment income
on invested assets not allocated to the three product segments, investment
management fees and other revenues earned from investment management services
(other than the portion allocated to the Variable Annuities and Life Insurance
segments), commissions and other income earned by the marketing and distribution
subsidiaries of the Company and net investment income and policy charges from
group annuity contracts issued to Nationwide Insurance Enterprise employee and
agent benefit plans.
The decrease in operating income in 1998 and 1997 compared to 1996 primarily
relates to interest expense on the notes and capital securities issued in March
1997 concurrent with the IPO and on the preferred securities issued in October
1998. Interest expense totaled $35.1 million and $26.1 million in 1998 and 1997,
respectively.
38
<PAGE> 13
- --------------------------------------------------------------------------------
INVESTMENTS
GENERAL
The Company's assets are divided between separate account and general account
assets. As of December 31, 1998, $50.94 billion (or 68%) of the Company's total
assets were held in separate accounts and $23.73 billion (or 32%) were held in
the Company's general account, including $20.94 billion of general account
investments. Separate account assets consist primarily of deposits from the
Company's variable annuity business. Most separate account assets are invested
in various mutual funds. All of the investment risk in the Company's separate
account assets is borne by the Company's customers, with the exception of $743.9
million of policy reserves as of December 31, 1998 ($365.5 million as of
December 31, 1997) for which the Company bears the investment risk. In addition
to the information presented herein, see note 3 to the consolidated financial
statements for further information regarding the Company's investments.
The following table summarizes the Company's consolidated general account
invested assets by asset category.
<TABLE>
<CAPTION>
December 31, 1998 December 31, 1997
----------------------------------------------
CARRYING % OF CARRYING % OF
(IN MILLIONS OF DOLLARS) VALUE TOTAL VALUE TOTAL
- -----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Fixed maturity securities $14,247.9 68.0% $13,210.1 67.2%
Mortgage loans, net 5,328.4 25.5 5,181.6 26.3
Real estate, net 243.6 1.2 311.4 1.6
Policy loans 464.3 2.2 415.3 2.1
Equity securities 134.0 0.6 80.4 0.4
Other long-term investments 44.0 0.2 25.2 0.1
Short-term investments 478.3 2.3 449.2 2.3
- -----------------------------------------------------------------------------------------
Total $20,940.5 100.0% $19,673.2 100.0%
- -----------------------------------------------------------------------------------------
</TABLE>
FIXED MATURITY SECURITIES
The following table summarizes the composition of the Company's general
account fixed maturity securities by category.
<TABLE>
<CAPTION>
December 31, 1998 December 31, 1997
----------------------------------------------
CARRYING % OF CARRYING % OF
(IN MILLIONS OF DOLLARS) VALUE TOTAL VALUE TOTAL
- -----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
U.S. government/agencies $ 269.0 1.9% $ 319.7 2.4%
Foreign governments 111.0 0.8 95.8 0.7
State and political subdivisions 1.6 -- 1.6 --
Mortgage-backed securities:
U.S. government/agencies 3,562.2 25.0 3,750.3 28.4
Non-government/agencies -- -- -- --
Corporate:
Public 5,194.3 36.4 4,597.3 34.8
Private 5,109.8 35.9 4,445.4 33.7
- -----------------------------------------------------------------------------------------
Total $14,247.9 100.0% $13,210.1 100.0%
- -----------------------------------------------------------------------------------------
</TABLE>
39
<PAGE> 14
The average duration and average maturity of the Company's general account
fixed maturity securities as of December 31, 1998 were approximately 3.24 and
7.45 years, respectively. As a result, the market value of the Company's general
account investments may fluctuate significantly in response to changes in
interest rates. In addition, the Company may also be likely to experience
investment losses to the extent its liquidity needs require the disposition of
general account fixed maturity securities in unfavorable interest rate
environments.
The National Association of Insurance Commissioners (NAIC) assigns securities
quality ratings and uniform valuations called "NAIC Designations" which are used
by insurers when preparing their annual statements. The NAIC assigns
designations to publicly traded as well as privately placed securities. The
designations assigned by the NAIC range from class 1 to class 6, with a
designation in class 1 being of the highest quality. Of the Company's general
account fixed maturity securities, 97% were in the highest two NAIC Designations
as of December 31, 1998.
The following table sets forth an analysis of credit quality, as determined by
NAIC Designation, of the Company's general account fixed maturity securities
portfolio.
<TABLE>
<CAPTION>
December 31, 1998 December 31, 1997
(in millions of dollars) ----------------------------------------------
NAIC RATING AGENCY CARRYING % OF CARRYING % OF
DESIGNATION(1) EQUIVALENT DESIGNATION(2) VALUE TOTAL VALUE TOTAL
- --------------------------------------------------------------------------------------------
<C> <S> <C> <C> <C> <C>
1 Aaa/Aa/A $ 9,166.1 64.3% $ 8,815.3 66.7%
2 Baa 4,715.1 33.1 4,116.6 31.2
3 Ba 347.2 2.5 220.9 1.7
4 B 5.6 -- 53.7 0.4
5 Caa and lower 13.9 0.1 3.6 --
6 In or near default -- -- -- --
- --------------------------------------------------------------------------------------------
$14,247.9 100.0% $13,210.1 100.0%
- --------------------------------------------------------------------------------------------
</TABLE>
(1) NAIC Designations are assigned no less frequently than annually. Some
designations for securities shown have been assigned to securities not yet
assigned an NAIC Designation in a manner approximating equivalent public
rating categories.
(2) Comparison's between NAIC and Moody's designations are published by the
NAIC. In the event no Moody's rating is available, the Company has assigned
internal ratings corresponding to the public rating.
The Company's general account mortgage-backed security (MBS) investments
include residential MBSs and multi-family mortgage pass-through certificates. As
of December 31, 1998, MBSs were $3.56 billion (or 25%) of the carrying value of
the general account fixed maturity securities available-for-sale, all of which
were guaranteed by the U.S. government or an agency of the U.S. government.
The Company believes that general account MBS investments add diversification,
liquidity, credit quality and additional yield to its general account fixed
maturity securities portfolio. The objective of the Company's general account
MBS investments is to provide reasonable cash flow stability and increased
yield. General account MBS investments include collateralized mortgage
obligations (CMOs), Real Estate Mortgage Investment Conduits (REMICs) and
mortgage-backed pass-through securities. The Company's general account MBS
investments do not include interest-only securities or principal-only securities
or other MBSs which may exhibit extreme market volatility.
40
<PAGE> 15
Prepayment risk is an inherent risk of holding MBSs. However, the degree of
prepayment risk is particular to the type of MBS held. The Company limits its
exposure to prepayments by purchasing less volatile types of MBSs. As of
December 31, 1998, $2.43 billion (or 68%) of the carrying value of the general
account MBS portfolio was invested in planned amortization class CMOs/REMICs
(PACs). PACs are securities whose cash flows are designed to remain constant
over a variety of mortgage prepayment environments. Other classes in the
CMO/REMIC security are structured to accept the volatility of mortgage
prepayment changes, thereby insulating the PAC class.
The following table sets forth the distribution by investment type of the
Company's general account MBS portfolio.
<TABLE>
<CAPTION>
December 31, 1998 December 31, 1997
---------------------------------------
CARRYING % OF CARRYING % OF
(IN MILLIONS OF DOLLARS) VALUE TOTAL VALUE TOTAL
- ---------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Accrual $ 77.3 2.2% $ 48.5 1.3%
Planned Amortization Class 2,433.4 68.3 2,645.3 70.5
Sequential 45.6 1.3 19.8 0.5
Scheduled 143.8 4.0 160.6 4.3
Targeted Amortization Class 92.0 2.6 90.8 2.4
Very Accurately Defined Maturity 477.8 13.4 550.1 14.7
Multi-family Mortgage Pass-through
Certificates 251.0 7.0 235.2 6.3
Other 41.3 1.2 -- --
- ---------------------------------------------------------------------------------------
$ 3,562.2 100.0% $3,750.3 100.0%
- ---------------------------------------------------------------------------------------
</TABLE>
The Company invests in private fixed maturity securities because of the (i)
generally higher nominal yield available compared to comparably rated public
fixed maturity securities, (ii) more restrictive financial and business
covenants available in private fixed maturity security loan agreements and (iii)
stronger prepayment protection. Although private fixed maturity securities are
not registered with the Securities and Exchange Commission and generally are
less liquid than public fixed maturity securities, restrictive financial and
business covenants included in private fixed maturity security loan agreements
generally are designed to compensate for the impact of increased liquidity risk.
A significant majority of the private fixed maturity securities that the Company
holds are participations in issues that are also owned by other investors. In
addition, some of the private fixed maturity securities are rated by nationally
recognized rating agencies and substantially all have been assigned a rating
designation by the NAIC.
MORTGAGE LOANS
As of December 31, 1998, general account mortgage loans were $5.33 billion (or
25%) of the carrying value of consolidated general account invested assets. As
of such date, commercial mortgage loans constituted substantially all (99.9%) of
total general account mortgage loans. Commitments to fund mortgage loans of
$156.0 million extending into 1999 were outstanding as of December 31, 1998.
In June 1997, the Company exchanged $359.7 million of multi-family mortgage
loans with the Federal Home Loan Mortgage Corporation (FHLMC) for FHLMC
multi-family mortgage pass-through certificates supported by the exchanged
loans. The transaction resulted in the reclassification of the exchanged amount
41
<PAGE> 16
from mortgage loans on real estate to fixed maturity securities
available-for-sale on the consolidated balance sheet. No gain or loss was
recognized as a result of the exchange.
The summary below depicts loans by remaining principal balance as of December
31, 1998:
<TABLE>
<CAPTION>
APARTMENT
(IN MILLIONS OF DOLLARS) OFFICE WAREHOUSE RETAIL & OTHER TOTAL
- ------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
East North Central $116.6 $ 163.8 $ 607.6 $ 180.8 $1,068.8
East South Central 32.4 28.1 126.4 90.3 277.2
Mountain 32.5 19.6 101.7 105.1 258.9
Middle Atlantic 145.4 98.3 167.6 58.4 469.7
New England 29.6 45.8 123.4 -- 198.8
Pacific 216.9 345.2 440.8 123.9 1,126.8
South Atlantic 115.9 152.6 484.5 444.1 1,197.1
West North Central 127.9 8.5 55.9 61.6 253.9
West South Central 124.9 91.7 144.3 160.3 521.2
- ------------------------------------------------------------------------------------------
$942.1 $ 953.6 $2,252.2 $1,224.5 5,372.4
- ------------------------------------------------------------------------------
Less valuation allowances and unamortized discount 44.0
--------
Total mortgage loans on real estate, net $5,328.4
- ------------------------------------------------------------------------------------------
</TABLE>
As of December 31, 1998, the Company's largest exposure to any single
borrowing group was $101.4 million, or 2% of the Company's general account
mortgage portfolio.
As of December 31, 1998 none of the Company's mortgage loans were classified
as delinquent compared to 0.19% a year ago. Foreclosed and restructured loans
totaled only 0.64% and 1.84% of the Company's mortgage loans as of December 31,
1998 and 1997, respectively.
- --------------------------------------------------------------------------------
LIQUIDITY AND CAPITAL RESOURCES
Liquidity and capital resources demonstrate the overall financial strength of
the Company and its ability to generate strong cash flows from its operations
and borrow funds at competitive rates to meet operating and growth needs. The
Company's capital structure consists of debt, capital and preferred securities
of subsidiary trusts and equity, summarized in the following table.
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------------------
1996
(IN MILLIONS OF DOLLARS) 1998 1997 Pro forma (1)
- --------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Long-term debt $ 298.4 $ 298.4 $ 298.4
Capital and preferred securities of subsidiary trusts 300.0 100.0 100.0
- --------------------------------------------------------------------------------------------
Total long-term debt and capital and preferred
securities 598.4 398.4 398.4
- --------------------------------------------------------------------------------------------
Shareholders' equity, excluding accumulated other
comprehensive income 2,201.6 1,877.1 1,632.3
Accumulated other comprehensive income 275.9 247.1 173.6
- --------------------------------------------------------------------------------------------
Total shareholders' equity 2,447.5 2,124.2 1,805.9
- --------------------------------------------------------------------------------------------
Total capital $3,045.9 $2,522.6 $ 2,204.3
- --------------------------------------------------------------------------------------------
</TABLE>
(1) Adjusts 1996 shareholders' equity for the net proceeds of the IPO and for
the special dividends paid in anticipation of the IPO.
42
<PAGE> 17
NFS is a holding company whose principal asset is the common stock of NLIC.
The principal sources of funds for NFS to pay interest, dividends and operating
expenses are existing cash and investments, and dividends from NLIC and other
subsidiaries.
State insurance laws generally restrict the ability of insurance companies to
pay cash dividends in excess of certain prescribed limitations without prior
approval. The ability of NLIC to pay dividends is subject to restrictions set
forth in the insurance laws and regulations of Ohio, its domiciliary state. The
Ohio insurance laws require life insurance companies to seek prior regulatory
approval to pay a dividend if the fair market value of the dividend, together
with that of other dividends made within the preceding 12 months, exceeds the
greater of (i) 10% of statutory-basis policyholders' surplus as of the prior
December 31 or (ii) the statutory-basis net income of the insurer for the prior
year. NLIC's statutory-basis policyholders' surplus as of December 31, 1998 was
$1.32 billion and statutory-basis net income for 1998 was $171.0 million. Total
dividends paid in the twelve months preceding December 31, 1998 were $100.0
million. The payment of dividends by NLIC may also be subject to restrictions
set forth in the insurance laws of New York that limit the amount of statutory
profits on NLIC's participating policies (measured before dividends to
policyholders) that can inure to the benefit of NFS and its stockholders. NFS
currently does not expect such regulatory requirements to impair its ability to
pay interest, dividends, operating expenses, and principal in the future.
Also available as a source of funds to the Company is a $600.0 million
revolving credit facility entered into by NLIC and Nationwide Mutual Insurance
Company in August 1996 with a five year term with a group of national financial
institutions. In September 1997, the credit agreement was amended to include NFS
as a party to and borrower under the agreement. The facility provides for
several and not joint liability with respect to any amount drawn by any party.
To date, no amounts have been drawn down on the facility. The facility provides
covenants, including, but not limited to, requirements that the Company maintain
consolidated tangible net worth, as defined, in excess of $1.23 billion and NLIC
maintain statutory surplus in excess of $875 million. The Company had no amounts
outstanding under this agreement as of December 31, 1998.
A primary liquidity concern with respect to annuity and life insurance
products is the risk of early policyholder withdrawal. The Company mitigates
this risk by offering variable products where the investment risk is transferred
to the policyholder, charging surrender fees at the time of withdrawal for
certain products, applying a market value adjustment to withdrawals for certain
products in the Company's general account, and monitoring and matching
anticipated cash inflows and outflows.
For individual annuity products ($34.2 billion of reserves as of December 31,
1998) the surrender charge is calculated as a percentage of the lesser of
deposits made or the amount surrendered and is assessed at declining rates
during the first seven years after a deposit is made.
For group annuity products ($26.0 billion of reserves as of December 31,
1998), the surrender charge amounts and periods can vary significantly,
depending on the terms of each contract and the compensation structure for the
producer. Generally, surrender charge percentages for group products are less
than individual products because the Company incurs lower expenses at contract
origination for group products. In addition, over ninety percent of the general
account group annuity reserves are subject to a market value adjustment at
withdrawal.
43
<PAGE> 18
Life insurance policies are also subject to withdrawal. However, they are less
susceptible to withdrawal than are annuity products because policyholders
generally must undergo a new underwriting process and may incur a surrender fee
in order to obtain a new insurance policy.
The short-term and long-term liquidity requirements of the Company are
monitored regularly to match cash inflows with cash requirements. The Company
periodically reviews its short-term and long-term projected sources and uses of
funds and the asset/liability, investment and cash flow assumptions underlying
these projections. Adjustments are made periodically with respect to the
Company's investment policies to reflect changes in the Company's short-term and
long-term cash needs and changing business and economic conditions.
Given the Company's historic cash flow and current financial results,
management of the Company believes that the cash flow from the operating
activities of the Company over the next year will provide sufficient liquidity
for the operations of the Company, as well as provide sufficient funds to enable
the Company to make dividend and interest payments.
- --------------------------------------------------------------------------------
MARKET RISK SENSITIVE FINANCIAL INSTRUMENTS
The Company is subject to potential fluctuations in earnings and the fair
value of certain of its assets and liabilities, as well as variations in
expected cash flows due to changes in market interest rates and equity prices.
The following discussion focuses on specific exposures the Company has to
interest rate and equity price risk and describes strategies used to manage
these risks. The discussion is limited to financial instruments subject to
market risks and is not intended to be a complete discussion of all of the risks
the Company is exposed to.
INTEREST RATE RISK
Fluctuations in interest rates can potentially impact the Company's earnings
and cash flows, and the fair value of its assets and liabilities. Generally, in
a declining interest rate environment, the Company may be required to reinvest
the proceeds from matured and prepaid investments at rates lower than the
overall yield of the portfolio, which could reduce interest spread income. In
addition, minimum guaranteed crediting rates (typically 3% or 3.5%) on certain
annuity contracts could result in a reduction of the Company's interest spread
income in the event of a significant and prolonged decline in interest rates
from market rates at the end of 1998. The average crediting rate of annuity
products during 1998 was 5.95%, well in excess of the guaranteed rates. The
Company mitigates this risk by investing in assets with maturities and durations
that match the expected characteristics of the liabilities and by investing in
mortgage backed securities with limited prepayment exposure.
Conversely, a rising interest rate environment could result in a reduction of
interest spread income or an increase in policyholder surrenders. Investments
supporting annuity liabilities have a weighted average maturity of seven years
when purchased and therefore, the change in yield of the portfolio will lag
changes in market interest rates. This lag is increased if the rate of
prepayments of mortgage-backed securities slows. To the extent the Company sets
renewal rates based on current market rates, this will result in reduced
interest spreads. Alternatively, if the Company sets renewal crediting rates
while attempting to maintain a desired spread from the portfolio yield, the
rates offered by the Company may be less than new money rates offered by
44
<PAGE> 19
competitors. This difference could result in an increase in surrender activity
by policyholders. If the Company could not fund the surrenders with its cash
flow from operations, the Company may be required to sell investments, which
likely would have declined in value due to the increase in interest rates. The
Company mitigates this risk by offering products that assess surrender charges
or market value adjustments at the time of surrender, by investing in assets
with maturities and durations that match the expected characteristics of the
liabilities, and by investing in mortgage backed securities with limited
prepayment exposure.
ASSET/LIABILITY MANAGEMENT STRATEGIES TO MANAGE INTEREST RATE RISK
The Company employs an asset/liability management approach tailored to the
specific requirements of each of its products. The Company's general account
investments are primarily managed in a number of pools that are segregated by
weighted average maturity of the assets acquired by the pools. For fixed
maturity securities and mortgages, the weighted average maturity is based on
repayments which are scheduled to occur under the terms of the asset. For
mortgage backed securities, repayments are determined using the current rate of
repayment of the underlying mortgages and the terms of the securities. Each
product line has an investment strategy based on its specific characteristics.
The strategy establishes asset duration, quality and other guidelines. The
Company determines the amount of new investments needed for each line to arrive
at the amount of new investments needed for each pool by month. The investments
acquired for each pool are shared on a proportional basis by each of the lines
requesting investments in the pool based on their actual investment needs.
For all business having future benefits which cannot be changed at the option
of the policyholder, the underlying assets are managed in a separate pool. The
duration of assets and liabilities in this pool are kept as close together as
possible. For assets, the repayment cash flows, plus anticipated coupon
payments, are used in calculating asset duration. Future benefits and expenses
are used for liabilities. On December 31, 1998, the average duration of assets
in this pool was 7.5 years and the average duration of the liabilities was 7.8
years. Policy reserves on this business were $1.1 billion as of December 31,
1998.
Because the timing of the payment of future benefits on the majority of the
Company's business can be changed by the policyholder, the Company employs cash
flow testing techniques in its asset/liability management process. Annually, the
Company's annuity and insurance business is analyzed to determine the adequacy
of the reserves supporting such business. This analysis is accomplished by
projecting under a number of possible future interest rate scenarios the
anticipated cash flows from such business and the assets required to support
such business. The first seven of these scenarios are required by the state
insurance laws. Projections are also made using 13 additional scenarios which
involve more extreme fluctuations in future interest rates. Finally, to get a
statistical analysis of possible results and to minimize any bias in the 20
predetermined scenarios, additional projections are made using 50 randomly
generated interest rate scenarios. For the Company's 1998 cash flow testing
process, interest rates for 90-day treasury bills ranged from 0.7% to 9.5% under
the 20 predetermined scenarios and 1.2% to 21.9% under the 50 random scenarios.
Interest rates for longer maturity treasury securities had comparable ranges.
The values produced by each projection are used to determine future gains or
losses from the Company's annuity and insurance business, which, in turn, are
used to quantify the adequacy of the Company's reserves over the entire
projection period. The results of the Company's cash flow testing indicated that
the Company's reserves were adequate as of December 31, 1998.
45
<PAGE> 20
CHARACTERISTICS OF INTEREST RATE SENSITIVE FINANCIAL INSTRUMENTS
The following table provides information about the Company's financial
instruments that are sensitive to changes in interest rates. Insurance contracts
that subject the Company to significant mortality risk, including life insurance
contracts and life-contingent immediate annuities, do not meet the definition of
a financial instrument and are not included in the table.
<TABLE>
<CAPTION>
THERE- FAIR
(IN MILLIONS OF DOLLARS) 1999 2000 2001 2002 2003 AFTER TOTAL VALUE
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
ASSETS
Fixed maturity
securities:
Corporate bonds:
Principal $1,092.7 $1,049.2 $1,667.6 $1,386.3 $ 882.7 $2,866.7 $ 8,945.2 $ 9,366.9
Average interest rate 8.0% 7.5% 7.3% 7.2% 7.0% 7.6%
Mortgage and other
asset-backed
securities:
Principal $ 905.3 $ 964.3 $ 870.7 $ 588.9 $ 367.3 $ 718.3 $ 4,414.8 $ 4,499.4
Average interest rate 7.3% 7.4% 7.2% 7.4% 7.4% 7.0%
Other fixed maturity
securities:
Principal $ 7.8 $ 72.0 $ 54.6 $ 103.3 $ 60.6 $ 65.8 $ 364.1 $ 381.6
Average interest rate 8.5% 6.4% 7.0% 6.6% 6.9% 6.8%
Mortgage loans on real
estate:
Principal $ 185.9 $ 373.9 $ 313.1 $ 339.5 $ 408.8 $3,751.2 $ 5,372.4 $ 5,527.6
Average interest rate 9.2% 9.3% 7.0% 8.5% 7.6% 7.1%
LIABILITIES
Deferred fixed
annuities:
Principal $1,639.6 $1,548.3 $1,733.7 $1,232.5 $1,169.6 $8,270.7 $15,594.4 $15,282.0
Average credited rate 5.2% 4.8% 4.5% 4.3% 4.1% 4.1%
Immediate annuities:
Principal $ 20.6 $ 20.7 $ 22.3 $ 25.2 $ 29.9 $ 53.1 $ 171.8 $ 201.6
Average credited rate 7.3% 7.3% 7.3% 7.3% 7.4% 7.4%
Long-term debt:
Principal -- -- -- -- -- $ 300.0 $ 300.0 $ 339.9
Average interest rate -- -- -- -- -- 8.0%
Capital and preferred
securities of
subsidiary trusts:
Principal -- -- -- -- -- $ 300.0 $ 300.0 $ 314.5
Average interest rate -- -- -- -- -- 7.6%
- -----------------------------------------------------------------------------------------------------------------
</TABLE>
Additional information about the characteristics of the financial instruments
and assumptions underlying the data presented in the table above are as follows:
Mortgage and other asset-backed securities (MBSs): The maturity year is
determined based on the terms of the securities and the current rate of
prepayment of the underlying pools of mortgages. The Company limits its exposure
to prepayments by purchasing less volatile types of MBSs (see "Management's
Discussion and Analysis of Financial Condition and Results of
Operations -- Investments -- Fixed Maturity Securities").
Other Fixed Maturity Securities and Mortgage Loans on Real Estate: The
maturity year is determined based on the maturity date of the security or loan.
46
<PAGE> 21
Deferred Fixed Annuities: The maturity year is based on the expected date of
policyholder withdrawal, taking into account actual experience, current interest
rates, and contract terms. Included are group annuity contracts ($10.30 billion)
which are generally subject to market value adjustment upon surrender and may
also be subject to surrender charges. Of the total group annuity liabilities,
$7.17 billion was in contracts where the crediting rate is reset quarterly. For
the remaining $3.13 billion of group annuity reserves, the crediting rate is
reset annually on January 1. Also included are $5.29 billion of individual
annuity liabilities where the crediting rate is reset annually, with portions
resetting in each calendar quarter. Such individual annuity contracts are also
subject to surrender charges calculated as a percentage of the lesser of
deposits made or the amount surrendered and assessed at declining rates during
the first seven years after a deposit is made. The average crediting rate is
calculated as the difference between the projected yield of the assets backing
the liabilities and a targeted interest spread.
Immediate Annuities: Included are non-life contingent contracts in payout
status where the Company has guaranteed periodic, typically monthly, payments.
The maturity year is based on the terms of the contract.
Long-term Debt and Capital and Preferred Securities of Subsidiary Trusts: The
maturity year is the stated maturity date of the obligation. While each
obligation is callable, either at a premium or with a make-whole provision, the
Company currently has no plans to call the obligations prior to the stated
maturity date.
EQUITY MARKET RISK
Asset fees calculated as a percentage of the separate account assets are a
significant source of revenue to the Company. At December 31, 1998, 86% of
separate account assets were invested in equity mutual funds. Gains and losses
in the equity markets will result in corresponding increases and decreases in
the Company's separate account assets and the reported asset fee revenue. In
addition, a decrease in separate account assets may decrease the Company's
expectations of future profit margins which may require the Company to
accelerate the amortization of deferred policy acquisition costs.
- --------------------------------------------------------------------------------
INFLATION
The rate of inflation did not have a material effect on the revenues or
operating results of the Company during 1998, 1997 or 1996.
47
<PAGE> 22
FIVE-YEAR SUMMARY
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
----------------------------------------------------
(IN MILLIONS OF DOLLARS, EXCEPT PER SHARE AMOUNTS) 1998 1997 1996 1995 1994
- --------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
RESULTS OF OPERATIONS (1)
Policy charges $ 698.9 $ 545.2 $ 400.9 $ 286.6 $ 217.2
Life insurance premiums 200.0 205.4 198.6 199.1 176.7
Net investment income 1,486.8 1,413.9 1,357.8 1,294.0 1,210.8
Realized gains (losses) on investments 17.9 11.1 (0.2) (1.7) (16.5)
Other 108.1 62.8 59.5 59.0 45.9
- --------------------------------------------------------------------------------------------------------
Total revenues 2,511.7 2,238.4 2,016.6 1,837.0 1,634.1
- --------------------------------------------------------------------------------------------------------
Interest credited and other benefits 1,284.4 1,235.4 1,201.6 1,155.4 1,031.5
Interest expense on debt and capital and preferred
securities 35.1 26.1 -- -- --
Other operating expenses 686.7 569.9 486.9 400.4 362.2
- --------------------------------------------------------------------------------------------------------
Total benefits and expenses 2,006.2 1,831.4 1,688.5 1,555.8 1,393.7
- --------------------------------------------------------------------------------------------------------
Income from continuing operations before federal
income tax expense 505.5 407.0 328.1 281.2 240.4
Federal income tax expense 173.1 141.8 115.8 96.3 82.5
- --------------------------------------------------------------------------------------------------------
Income from continuing operations $ 332.4 $ 265.2 $ 212.3 $ 184.9 $ 157.9
- --------------------------------------------------------------------------------------------------------
Net income $ 332.4 $ 265.2 $ 223.6 $ 209.6 $ 178.4
- --------------------------------------------------------------------------------------------------------
Basic and diluted net income per common share (2) $ 2.58 $ 2.14
Cash dividends declared $ 0.30 $ 0.18
Diluted average shares outstanding (in millions) 128.6 124.1
RECONCILIATION OF NET INCOME TO NET OPERATING
INCOME (1)
Net income $ 332.4 $ 265.2 $ 223.6 $ 209.6 $ 178.4
Less: Realized (gains) losses on investments, net
of tax (11.7) (7.9) (1.0) (0.1) 10.3
Less: Income from discontinued operations, net of
tax -- -- (11.3) (24.7) (20.5)
- --------------------------------------------------------------------------------------------------------
Net operating income 320.7 257.3 211.3 184.8 $ 168.2
--------
Pro forma adjustments -- (2.9) (26.2) (26.2)
- ---------------------------------------------------------------------------------------------
Pro forma net operating income $ 320.7 $ 254.4 $ 185.1 $ 158.6
- ---------------------------------------------------------------------------------------------
Pro forma net operating income per common share $ 2.49 $ 1.98 $ 1.44 $ 1.24
- --------------------------------------------------------------------------------------------------------
</TABLE>
(1) Comparisons between 1998 results of operations and those of prior years are
affected by the Company's initial public offering in March 1997 and
companion offerings of senior notes and capital securities as well as the
payment of certain special dividends. Pro forma amounts adjust for these
transactions. See note 1 to the consolidated financial statements for
further description of these transactions and the related pro forma
adjustments.
(2) Actual earnings and book value per common share amounts have not been
presented for periods prior to 1997, because such amounts are not meaningful
due to the effects of initial public offering and the $900.0 million of
dividends paid prior to the initial public offering as described in note 1
to the consolidated financial statements.
48
<PAGE> 23
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
---------------------------------------------------------
(IN MILLIONS OF DOLLARS, EXCEPT PER SHARE AMOUNTS) 1998 1997 1996 1995 1994
- -------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
SUMMARY OF FINANCIAL POSITION (1)
Total investments $20,940.5 $19,673.2 $18,317.3 $17,837.0 $15,239.1
Deferred policy acquisition costs 2,022.3 1,665.4 1,366.5 1,020.4 995.6
Separate account assets 50,935.8 37,724.4 26,926.7 18,591.1 12,087.1
Other assets 772.6 829.9 1,159.7 1,057.6 921.5
- -------------------------------------------------------------------------------------------------------------
Total assets $74,671.2 $59,892.9 $47,770.2 $38,506.1 $29,243.3
- -------------------------------------------------------------------------------------------------------------
Policy reserves $19,772.2 $18,702.8 $17,600.6 $16,771.9 $15,072.7
Separate account liabilities 50,935.8 37,724.4 26,926.7 18,591.1 12,087.1
Other liabilities 917.3 943.1 1,111.2 526.4 222.9
Long-term debt 298.4 298.4 -- -- --
- -------------------------------------------------------------------------------------------------------------
Total liabilities 71,923.7 57,668.7 45,638.5 35,889.4 27,382.7
NFS-obligated mandatorily redeemable capital and
preferred securities of subsidiary trusts 300.0 100.0 -- -- --
Shareholders' equity 2,447.5 2,124.2 2,131.7 2,616.7 1,860.6
- -------------------------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $74,671.2 $59,892.9 $47,770.2 $38,506.1 $29,243.3
- -------------------------------------------------------------------------------------------------------------
Book value per common share(2) $ 19.04 $ 16.53
- -------------------------------------------------------------------------------------------------------------
GROSS POLICY RESERVES BY BUSINESS SEGMENT
Variable annuities $46,420.8 $34,486.7 $24,278.1 $16,761.8 $10,751.1
Fixed annuities 14,898.9 14,194.2 13,511.8 12,784.0 11,247.0
Life insurance 4,613.4 3,487.0 2,938.9 2,660.5 2,425.2
Corporate and other 4,365.5 3,791.9 3,302.5 2,644.3 2,252.7
Reserves ceded 409.4 467.5 495.9 512.4 483.8
- -------------------------------------------------------------------------------------------------------------
$70,708.0 $56,427.3 $44,527.2 $35,363.0 $27,159.8
- -------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
---------------------------------------------------------
(IN MILLIONS OF DOLLARS) 1998 1997 1996 1995 1994
- -----------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
OPERATING INCOME BEFORE FEDERAL
INCOME TAX EXPENSE BY BUSINESS
SEGMENT (1)
Variable annuities $ 218.4 $ 150.9 $ 90.3 $ 50.8 $ 24.6
Fixed annuities 175.3 169.5 135.4 137.0 139.0
Life insurance 94.8 70.9 67.2 67.6 53.0
Corporate and other (0.9) 4.6 35.4 27.5 40.3
- -----------------------------------------------------------------------------------------------
$ 487.6 $ 395.9 $ 328.3 $ 282.9 $ 256.9
- -----------------------------------------------------------------------------------------------
EXTERNAL SALES BY BUSINESS SEGMENT
Variable annuities $ 9,543.3 $ 7,535.8 $ 6,500.3 $ 4,399.3 $ 3,821.2
Fixed annuities 2,068.0 2,137.9 1,600.5 1,864.2 1,308.6
Life insurance 1,207.8 663.4 439.3 352.4 320.8
- -----------------------------------------------------------------------------------------------
$12,819.1 $10,337.1 $ 8,540.1 $ 6,615.9 $ 5,450.6
- -----------------------------------------------------------------------------------------------
</TABLE>
49
<PAGE> 24
CONSOLIDATED FINANCIAL STATEMENTS
CONSOLIDATED STATEMENTS OF INCOME
(in millions of dollars, except per share amounts)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31, 1998 1997 1996
- -------------------------------------------------------------------------------------------
<S> <C> <C> <C>
REVENUES
Policy charges $ 698.9 $ 545.2 $ 400.9
Life insurance premiums 200.0 205.4 198.6
Net investment income 1,486.8 1,413.9 1,357.8
Realized gains (losses) on investments 17.9 11.1 (0.2)
Other 108.1 62.8 59.5
- -------------------------------------------------------------------------------------------
2,511.7 2,238.4 2,016.6
- -------------------------------------------------------------------------------------------
BENEFITS AND EXPENSES
Interest credited to policyholder account balances 1,069.0 1,016.6 982.3
Other benefits and claims 175.8 178.2 178.3
Policyholder dividends on participating policies 39.6 40.6 41.0
Amortization of deferred policy acquisition costs 214.6 167.2 133.4
Interest expense on debt and capital and preferred
securities of subsidiary trusts 35.1 26.1 --
Other operating expenses 472.1 402.7 353.5
- -------------------------------------------------------------------------------------------
2,006.2 1,831.4 1,688.5
- -------------------------------------------------------------------------------------------
Income from continuing operations before federal income
tax expense 505.5 407.0 328.1
Federal income tax expense 173.1 141.8 115.8
- -------------------------------------------------------------------------------------------
Income from continuing operations 332.4 265.2 212.3
Income from discontinued operations (less federal income
tax expense of $4.5 in 1996) -- -- 11.3
- -------------------------------------------------------------------------------------------
Net income $ 332.4 $ 265.2 $ 223.6
- -------------------------------------------------------------------------------------------
NET INCOME PER COMMON SHARE
Basic $ 2.58 $ 2.14
Diluted $ 2.58 $ 2.14
Weighted average common shares outstanding (in millions) 128.5 124.0
Weighted average diluted common shares outstanding (in
millions) 128.6 124.1
</TABLE>
See accompanying notes to consolidated financial statements.
50
<PAGE> 25
CONSOLIDATED BALANCE SHEETS
(in millions of dollars, except per share amounts)
<TABLE>
<CAPTION>
DECEMBER 31, 1998 1997
- ------------------------------------------------------------------------------------
<S> <C> <C>
ASSETS
Investments:
Securities available-for-sale, at fair value:
Fixed maturity securities $14,247.9 $13,204.1
Equity securities 134.0 80.4
Fixed maturity securities held-to-maturity, at amortized
cost (fair value $6.0 in 1997) -- 6.0
Mortgage loans on real estate, net 5,328.4 5,181.6
Real estate, net 243.6 311.4
Policy loans 464.3 415.3
Other long-term investments 44.0 25.2
Short-term investments 478.3 449.2
- ------------------------------------------------------------------------------------
20,940.5 19,673.2
- ------------------------------------------------------------------------------------
Cash 24.5 180.9
Accrued investment income 218.7 211.2
Deferred policy acquisition costs 2,022.3 1,665.4
Other assets 529.4 437.8
Assets held in separate accounts 50,935.8 37,724.4
- ------------------------------------------------------------------------------------
$74,671.2 $59,892.9
- ------------------------------------------------------------------------------------
LIABILITIES AND SHAREHOLDERS' EQUITY
Future policy benefits and claims $19,772.2 $18,702.8
Long-term debt 298.4 298.4
Other liabilities 917.3 943.1
Liabilities related to separate accounts 50,935.8 37,724.4
- ------------------------------------------------------------------------------------
71,923.7 57,668.7
- ------------------------------------------------------------------------------------
Commitments and contingencies (notes 10 and 16)
NFS-obligated mandatorily redeemable capital and preferred
securities of subsidiary trusts holding solely junior
subordinated debentures of NFS 300.0 100.0
- ------------------------------------------------------------------------------------
Shareholders' equity:
Preferred stock, $.01 par value. Authorized 50.0 million
shares; no shares issued and outstanding -- --
Class A common stock, $.01 par value. Authorized 750.0
million shares; 23.8 million shares issued and
outstanding 0.2 0.2
Class B common stock, $.01 par value. Authorized 750.0
million shares; 104.7 million shares issued and
outstanding 1.0 1.0
Additional paid-in capital 629.5 629.2
Retained earnings 1,541.5 1,247.8
Unearned compensation (0.6) (1.1)
Accumulated other comprehensive income 275.9 247.1
- ------------------------------------------------------------------------------------
2,447.5 2,124.2
- ------------------------------------------------------------------------------------
$74,671.2 $59,892.9
- ------------------------------------------------------------------------------------
</TABLE>
See accompanying notes to consolidated financial statements.
51
<PAGE> 26
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
ACCUMULATED
CLASS A CLASS B ADDITIONAL OTHER TOTAL
COMMON COMMON PAID-IN RETAINED UNEARNED COMPREHENSIVE SHAREHOLDERS'
(IN MILLIONS OF DOLLARS) STOCK STOCK CAPITAL EARNINGS COMPENSATION INCOME EQUITY
- ----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
DECEMBER 31, 1995 $ -- $1.0 $ 680.7 $1,550.7 $ -- $ 384.3 $2,616.7
Comprehensive income:
Net income -- -- -- 223.6 -- -- 223.6
Net unrealized losses on
securities
available-for-sale
arising during the year -- -- -- -- -- (170.9) (170.9)
-------------
Total comprehensive income 52.7
-------------
Dividends to shareholder -- -- (129.3) (368.6) -- (39.8) (537.7)
- ----------------------------------------------------------------------------------------------------------------------
DECEMBER 31, 1996 -- 1.0 551.4 1,405.7 -- 173.6 2,131.7
Comprehensive income:
Net income -- -- -- 265.2 -- -- 265.2
Net unrealized gains on
securities
available-for-sale
arising during the year -- -- -- -- 73.5 73.5
-------------
Total comprehensive income 338.7
-------------
Issuance of Class A common
stock 0.2 -- 524.0 -- -- -- 524.2
Dividends to shareholders -- -- (450.0) (423.1) -- -- (873.1)
Other, net -- -- 3.8 -- (1.1) -- 2.7
- ----------------------------------------------------------------------------------------------------------------------
DECEMBER 31, 1997 0.2 1.0 629.2 1,247.8 (1.1) 247.1 2,124.2
Comprehensive income:
Net income -- -- -- 332.4 -- -- 332.4
Net unrealized gains on
securities
available-for-sale
arising during the year -- -- -- -- -- 28.8 28.8
-------------
Total comprehensive income 361.2
-------------
Cash dividends declared -- -- -- (38.7) -- -- (38.7)
Other, net -- -- 0.3 -- 0.5 -- 0.8
- ----------------------------------------------------------------------------------------------------------------------
DECEMBER 31, 1998 $0.2 $1.0 $ 629.5 $1,541.5 $(0.6) $ 275.9 $2,447.5
- ----------------------------------------------------------------------------------------------------------------------
</TABLE>
See accompanying notes to consolidated financial statements.
52
<PAGE> 27
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in millions of dollars)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31, 1998 1997 1996
- --------------------------------------------------------------------------------------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 332.4 $ 265.2 $ 223.6
Adjustments to reconcile net income to net cash
provided by operating activities:
Interest credited to policyholder account balances 1,069.0 1,016.6 982.3
Capitalization of deferred policy acquisition costs (584.2) (487.9) (422.6)
Amortization of deferred policy acquisition costs 214.6 167.2 133.4
Amortization and depreciation (6.6) (0.6) 7.3
Realized gains on invested assets, net (17.9) (11.1) (0.6)
(Increase) decrease in accrued investment income (7.5) (1.0) 2.8
Increase in other assets (94.5) (16.5) (93.6)
Decrease in policy liabilities (8.3) (23.1) (151.0)
(Decrease) increase in other liabilities (54.5) 270.3 177.4
Other, net (4.6) (5.7) (5.3)
- --------------------------------------------------------------------------------------------
Net cash provided by operating activities 837.9 1,173.4 853.7
- --------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from maturity of securities available-for-sale 1,557.0 993.4 1,162.8
Proceeds from sale of securities available-for-sale 610.5 574.5 299.6
Proceeds from maturity of fixed maturity securities
held-to-maturity 6.0 -- --
Proceeds from repayments of mortgage loans on real
estate 678.2 437.3 309.0
Proceeds from sale of real estate 103.8 34.8 18.5
Proceeds from repayments of policy loans and sale of
other invested assets 23.6 22.7 22.8
Cost of securities available-for-sale acquired (3,192.5) (2,828.1) (1,573.6)
Cost of mortgage loans on real estate acquired (829.1) (752.2) (972.8)
Cost of real estate acquired (0.8) (24.9) (7.9)
Policy loans issued and other invested assets acquired (88.4) (62.5) (57.7)
Short-term investments, net (29.1) (441.0) 33.4
- --------------------------------------------------------------------------------------------
Net cash used in investing activities (1,160.8) (2,046.0) (765.9)
- --------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Net proceeds from issuance of Class A common stock -- 524.2 --
Net proceeds from issuance of NFS-obligated mandatorily
redeemable capital and preferred securities of
subsidiary trusts 193.7 98.3 --
Net proceeds from issuance of long-term debt -- 294.5 --
Cash dividends paid (36.0) (15.4) (52.0)
Increase in investment product and universal life
insurance product account balances 2,682.1 2,488.5 1,781.8
Decrease in investment product and universal life
insurance product account balances (2,673.3) (2,379.8) (1,784.5)
- --------------------------------------------------------------------------------------------
Net cash provided by (used in) financing activities 166.5 1,010.3 (54.7)
- --------------------------------------------------------------------------------------------
Net (decrease) increase in cash (156.4) 137.7 33.1
Cash, beginning of year 180.9 43.2 10.1
- --------------------------------------------------------------------------------------------
Cash, end of year $ 24.5 $ 180.9 $ 43.2
- --------------------------------------------------------------------------------------------
</TABLE>
See accompanying notes to consolidated financial statements.
53
<PAGE> 28
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
1. ORGANIZATION AND DESCRIPTION OF BUSINESS
Nationwide Financial Services, Inc. (NFS) was formed in November 1996 as a
holding company for Nationwide Life Insurance Company (NLIC) and the other
companies within the Nationwide Insurance Enterprise that offer or distribute
long-term savings and retirement products. NFS and its subsidiaries are
collectively referred to as "the Company." On March 11, 1997, NFS sold, in an
initial public offering, 23.6 million shares of its newly-issued Class A common
stock for net proceeds of $524.2 million (the Equity Offering). In March 1997,
NFS also sold, in companion public offerings, $300.0 million of 8% Senior Notes
(the Notes) and, through a wholly owned subsidiary trust, $100.0 million of
7.899% Capital Securities (the Capital Securities). Aggregate net proceeds from
the Equity Offering, the offering of the Notes and the sale of the Capital
Securities totaled $917.0 million. NFS contributed $836.8 million of the
proceeds to the capital of NLIC and retained $80.2 million of the proceeds for
general corporate purposes.
Prior to the initial public offering, NFS was a wholly owned subsidiary of
Nationwide Corporation (Nationwide Corp.). Nationwide Corp. continues to own all
of the outstanding shares of Class B common stock, which represents
approximately 98% of the combined voting power of the shareholders of NFS.
During the first quarter of 1997, NFS's Board of Directors approved a 104,745
for one split of the NFS Class B common stock, which became effective February
10, 1997. Share information for all periods presented has been restated to
reflect the split.
During 1996 and 1997, Nationwide Corp. and NFS completed certain transactions
in anticipation of the initial public offering that focused the business of NFS
on long-term savings and retirement products. On September 24, 1996, NLIC
declared a dividend payable to Nationwide Corp. on January 1, 1997 consisting of
the outstanding shares of common stock of certain subsidiaries that do not offer
or distribute long-term savings or retirement products. In addition, during
1996, NLIC entered into two reinsurance agreements whereby all of NLIC's
accident and health and group life insurance business was ceded to two
affiliates effective January 1, 1996. These subsidiaries, through December 31,
1996, and all accident and health and group life insurance business have been
accounted for as discontinued operations for all periods presented. See notes 14
and 19. On January 27, 1997, Nationwide Corp. contributed the common stock of
NLIC and three marketing and distribution companies to NFS. Accordingly, the
1996 consolidated financial statements include the results of NLIC and its
subsidiaries and the three marketing and distribution companies as if they were
consolidated with NFS for all periods presented. Additionally, the Company paid
$900.0 million of dividends to Nationwide Corp., $50.0 million on December 31,
1996 and $850.0 million on February 24, 1997.
The Company is a leading provider of long-term savings and retirement
products, including variable annuities, fixed annuities and life insurance.
The following table compares actual 1998 results of operations to pro forma
results of operations of the Company for the years ended December 31, 1997 and
1996, with pro forma adjustments to net investment income and interest expense
giving effect to (i) the Equity Offering and companion offerings of the Notes
and the Capital Securities, (ii) the $850.0 million dividend paid by the Company
on February 24, 1997 and (iii) for 1996 only, the $50.0 million dividend paid by
the Company on December 31, 1996, as if each had been consummated at the
beginning of the year indicated. This pro forma information is not necessarily
54
<PAGE> 29
indicative of what would have occurred had the above transactions been made on
the dates indicated, or of future results of the Company.
<TABLE>
<CAPTION>
(Unaudited)
-------------------
(IN MILLIONS OF DOLLARS, EXCEPT PER SHARE AMOUNTS) 1998 1997 1996
- -------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Revenues $2,511.7 $2,240.1 $2,008.4
Benefits and expenses 2,006.2 1,837.5 1,720.6
- -------------------------------------------------------------------------------------------
Income from continuing operations before federal income tax
expense 505.5 402.6 287.8
Federal income tax expense 173.1 140.3 101.7
- -------------------------------------------------------------------------------------------
Income from continuing operations 332.4 262.3 186.1
Income from discontinued operations, net of federal income
tax expense -- -- 11.3
- -------------------------------------------------------------------------------------------
Net income $ 332.4 $ 262.3 $ 197.4
- -------------------------------------------------------------------------------------------
Diluted earnings per common share:
Income from continuing operations $ 2.58 $ 2.04 $ 1.45
Net income $ 2.58 $ 2.04 $ 1.54
Weighted average number of diluted shares of common stock
outstanding (in millions) 128.6 128.6 128.4
- -------------------------------------------------------------------------------------------
</TABLE>
The impact on the above per common share amounts of realized gains on
investments, net of tax, was $0.09 in 1998, $0.06 in 1997 and $0.01 in 1996.
- --------------------------------------------------------------------------------
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The significant accounting policies followed by the Company that materially
affect financial reporting are summarized below. The accompanying consolidated
financial statements have been prepared in accordance with generally accepted
accounting principles which differ from statutory accounting practices
prescribed or permitted by regulatory authorities. Annual Statements for the
Company's insurance subsidiaries, filed with the department of insurance of each
insurance company's state of domicile, are prepared on the basis of accounting
practices prescribed or permitted by each department. Prescribed statutory
accounting practices include a variety of publications of the National
Association of Insurance Commissioners (NAIC), as well as state laws,
regulations and general administrative rules. Permitted statutory accounting
practices encompass all accounting practices not so prescribed. The Company's
insurance subsidiaries have no material permitted statutory accounting
practices.
In preparing the consolidated financial statements, management is required to
make estimates and assumptions that affect the reported amounts of assets and
liabilities and the disclosures of contingent assets and liabilities as of the
date of the consolidated financial statements and the reported amounts of
revenues and expenses for the reporting period. Actual results could differ
significantly from those estimates.
The most significant estimates include those used in determining deferred
policy acquisition costs, valuation allowances for mortgage loans on real estate
and real estate investments and the liability for future policy benefits and
claims. Although some variability is inherent in these estimates, management
believes the amounts provided are adequate.
55
<PAGE> 30
(A) CONSOLIDATION POLICY
The consolidated financial statements include the accounts of NFS and its
wholly owned subsidiaries. Operations that are classified and reported as
discontinued are not consolidated but rather are reported as "Income from
discontinued operations" in the accompanying consolidated statements of income.
All significant intercompany balances and transactions have been eliminated.
(B) VALUATION OF INVESTMENTS AND RELATED GAINS AND LOSSES
The Company is required to classify its fixed maturity securities and equity
securities as either held-to-maturity, available-for-sale or trading. Fixed
maturity securities are classified as held-to-maturity when the Company has the
positive intent and ability to hold the securities to maturity and are stated at
amortized cost. Fixed maturity securities not classified as held-to-maturity and
all equity securities are classified as available-for-sale and are stated at
fair value, with the unrealized gains and losses, net of adjustments to deferred
policy acquisition costs and deferred federal income tax, reported as a separate
component of shareholders' equity. The adjustment to deferred policy acquisition
costs represents the change in amortization of deferred policy acquisition costs
that would have been required as a charge or credit to operations had such
unrealized amounts been realized. The Company has no fixed maturity securities
classified as trading as of December 31, 1998 or 1997.
Mortgage loans on real estate are carried at the unpaid principal balance less
valuation allowances. The Company provides valuation allowances for impairments
of mortgage loans on real estate based on a review by portfolio managers. The
measurement of impaired loans is based on the present value of expected future
cash flows discounted at the loan's effective interest rate or, as a practical
expedient, at the fair value of the collateral, if the loan is collateral
dependent. Loans in foreclosure and loans considered to be impaired are placed
on non-accrual status. Interest received on non-accrual status mortgage loans on
real estate is included in interest income in the period received.
Real estate is carried at cost less accumulated depreciation and valuation
allowances. Other long-term investments are carried on the equity basis,
adjusted for valuation allowances. Impairment losses are recorded on long-lived
assets used in operations when indicators of impairment are present and the
undiscounted cash flows estimated to be generated by those assets are less than
the assets' carrying amount.
Realized gains and losses on the sale of investments are determined on the
basis of specific security identification. Estimates for valuation allowances
and other than temporary declines are included in realized gains and losses on
investments.
(C) REVENUES AND BENEFITS
Investment Products and Universal Life Insurance Products: Investment products
consist primarily of individual and group variable and fixed deferred annuities.
Universal life insurance products include universal life insurance, variable
universal life insurance, corporate owned life insurance and other
interest-sensitive life insurance policies. Revenues for investment products and
universal life insurance products consist of net investment income, asset fees,
cost of insurance and policy administration and surrender charges that have been
earned and assessed against policy account balances during the period. Policy
benefits and claims that
56
<PAGE> 31
are charged to expense include interest credited to policy account balances and
benefits and claims incurred in the period in excess of related policy account
balances.
Traditional Life Insurance Products: Traditional life insurance products
include those products with fixed and guaranteed premiums and benefits and
consist primarily of whole life insurance, limited-payment life insurance, term
life insurance and certain annuities with life contingencies. Premiums for
traditional life insurance products are recognized as revenue when due. Benefits
and expenses are associated with earned premiums so as to result in recognition
of profits over the life of the contract. This association is accomplished by
the provision for future policy benefits and the deferral and amortization of
policy acquisition costs.
(D) DEFERRED POLICY ACQUISITION COSTS
The costs of acquiring new business, principally commissions, certain expenses
of the policy issue and underwriting department and certain variable sales
expenses have been deferred. For investment products and universal life
insurance products, deferred policy acquisition costs are being amortized with
interest over the lives of the policies in relation to the present value of
estimated future gross profits from projected interest margins, asset fees, cost
of insurance, policy administration and surrender charges. For years in which
gross profits are negative, deferred policy acquisition costs are amortized
based on the present value of gross revenues. For traditional life insurance
products, these deferred policy acquisition costs are predominantly being
amortized with interest over the premium paying period of the related policies
in proportion to the ratio of actual annual premium revenue to the anticipated
total premium revenue. Such anticipated premium revenue was estimated using the
same assumptions as were used for computing liabilities for future policy
benefits. Deferred policy acquisition costs are adjusted to reflect the impact
of unrealized gains and losses on fixed maturity securities available-for-sale
as described in note 2(b).
(E) SEPARATE ACCOUNTS
Separate account assets and liabilities represent contractholders' funds which
have been segregated into accounts with specific investment objectives. For all
but $743.9 million of separate account assets, the investment income and gains
or losses of these accounts accrue directly to the contractholders. The activity
of the separate accounts is not reflected in the consolidated statements of
income and cash flows except for the fees the Company receives.
(F) FUTURE POLICY BENEFITS
Future policy benefits for investment products in the accumulation phase,
universal life insurance and variable universal life insurance policies have
been calculated based on participants' contributions plus interest credited less
applicable contract charges. The average interest rate credited on investment
product policy reserves was 5.95%, 6.12% and 6.30% for the years ended December
31, 1998, 1997 and 1996, respectively.
Future policy benefits for traditional life insurance policies have been
calculated by the net level premium method using interest rates varying from
6.0% to 10.5% and estimates of mortality, morbidity, investment
57
<PAGE> 32
yields and withdrawals which were used or which were being experienced at the
time the policies were issued, rather than the assumptions prescribed by state
regulatory authorities.
(G) PARTICIPATING BUSINESS
Participating business represents approximately 40% in 1998 (50% in 1997 and
52% in 1996) of the Company's life insurance in force, 74% in 1998 (77% in 1997
and 78% in 1996) of the number of life insurance policies in force, and 14% in
1998 (27% in 1997 and 40% in 1996) of life insurance statutory premiums. The
provision for policyholder dividends is based on current dividend scales and is
included in "Future policy benefits and claims" in the accompanying consolidated
balance sheets.
(H) FEDERAL INCOME TAX
The Company files a consolidated federal income tax return with Nationwide
Mutual Insurance Company (NMIC), the majority shareholder of Nationwide Corp.
The members of the consolidated tax return group have a tax sharing arrangement
which provides, in effect, for each member to bear essentially the same federal
income tax liability as if separate tax returns were filed.
The Company utilizes the asset and liability method of accounting for income
tax. Under this method, deferred tax assets and liabilities are recognized for
the future tax consequences attributable to differences between the financial
statement carrying amounts of existing assets and liabilities and their
respective tax bases and operating loss and tax credit carryforwards. Deferred
tax assets and liabilities are measured using enacted tax rates expected to
apply to taxable income in the years in which those temporary differences are
expected to be recovered or settled. Under this method, the effect on deferred
tax assets and liabilities of a change in tax rates is recognized in income in
the period that includes the enactment date. Valuation allowances are
established when necessary to reduce the deferred tax assets to the amounts
expected to be realized.
(I) REINSURANCE CEDED
Reinsurance premiums ceded and reinsurance recoveries on benefits and claims
incurred are deducted from the respective income and expense accounts. Assets
and liabilities related to reinsurance ceded are reported on a gross basis. All
of the Company's accident and health and group life insurance business is ceded
to affiliates and is accounted for as discontinued operations. See notes 14 and
19.
(J) RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
On January 1, 1998 the Company adopted SFAS No. 131 -- Disclosures about
Segments of an Enterprise and Related Information. SFAS 131 supersedes SFAS No.
14 -- Financial Reporting for Segments of a Business Enterprise. SFAS 131
establishes standards for public business enterprises to report information
about operating segments in annual financial statements and selected information
about operating segments in interim financial reports. SFAS 131 also establishes
standards for related disclosures about products and services, geographic areas,
and major customers. The adoption of SFAS 131 did not affect results of
operations or financial position, nor did it affect the manner in which the
Company defines its operating segments. The segment information required for
annual financial statements is included in note 17.
58
<PAGE> 33
On January 1, 1998, the Company adopted SFAS No. 132 -- Employers' Disclosures
about Pensions and Other Postretirement Benefits (SFAS 132). SFAS 132 revises
employers' disclosures about pension and other postretirement benefit plans. The
Statement does not change the measurement or recognition of benefit plans in the
financial statements. The revised disclosures required by SFAS 132 are included
in note 11.
In June 1998, the FASB issued SFAS No. 133 -- Accounting for Derivative
Instruments and Hedging Activities (SFAS 133). SFAS 133 establishes accounting
and reporting standards for derivative instruments and for hedging activities.
Contracts that contain embedded derivatives, such as certain insurance
contracts, are also addressed by the Statement. SFAS 133 requires that an entity
recognize all derivatives as either assets or liabilities in the statement of
financial position and measure those instruments at fair value. The Statement is
effective for fiscal years beginning after June 15, 1999. It may be implemented
earlier provided adoption occurs as of the beginning of any fiscal quarter after
issuance. The Company plans to adopt this statement in first quarter 2000 and is
currently evaluating the impact on results of operations and financial
condition.
In March 1998, The American Institute of Certified Public Accountant's
Accounting Standards Executive Committee issued Statement of Position
98-1 -- Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use (SOP 98-1). SOP 98-1 provides guidance intended to standardize
accounting practices for costs incurred to develop or obtain computer software
for internal use. Specifically, SOP 98-1 provides guidance for determining
whether computer software is for internal use and when costs incurred for
internal use software are to be capitalized. SOP 98-1 is effective for financial
statements for fiscal years beginning after December 15, 1998. The Company does
not expect the adoption of SOP 98-1, which occurred on January 1, 1999, to have
a material impact on the Company's financial statements.
(K) RECLASSIFICATION
Certain items in the 1997 and 1996 consolidated financial statements have been
reclassified to conform to the 1998 presentation.
59
<PAGE> 34
- --------------------------------------------------------------------------------
3. INVESTMENTS
The amortized cost, gross unrealized gains and losses and estimated fair value
of securities available-for-sale as of December 31, 1998 and 1997 were:
<TABLE>
<CAPTION>
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED ESTIMATED
(IN MILLIONS OF DOLLARS) COST GAINS LOSSES FAIR VALUE
- -----------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
DECEMBER 31, 1998
Fixed maturity securities:
U.S. Treasury securities and obligations of
U.S Government corporations and agencies $ 256.0 $ 13.0 $ -- $ 269.0
Obligations of states and political
subdivisions 1.6 -- -- 1.6
Debt securities issued by foreign
governments 106.5 4.5 -- 111.0
Corporate securities 9,899.6 423.2 (18.7) 10,304.1
Mortgage-backed securities 3,460.4 104.2 (2.4) 3,562.2
- -----------------------------------------------------------------------------------------------
Total fixed maturity securities 13,724.1 544.9 (21.1) 14,247.9
Equity securities 116.9 18.6 (1.5) 134.0
- -----------------------------------------------------------------------------------------------
$13,841.0 $563.5 $(22.6) $14,381.9
- -----------------------------------------------------------------------------------------------
DECEMBER 31, 1997
Fixed maturity securities:
U.S. Treasury securities and obligations of
U.S Government corporations and agencies $ 305.1 $ 8.6 $ -- $ 313.7
Obligations of states and political
subdivisions 1.6 -- -- 1.6
Debt securities issued by foreign
governments 93.3 2.7 (0.2) 95.8
Corporate securities 8,698.7 355.5 (11.5) 9,042.7
Mortgage-backed securities 3,634.2 118.6 (2.5) 3,750.3
- -----------------------------------------------------------------------------------------------
Total fixed maturity securities 12,732.9 485.4 (14.2) 13,204.1
Equity securities 67.8 12.9 (0.3) 80.4
- -----------------------------------------------------------------------------------------------
$12,800.7 $498.3 $(14.5) $13,284.5
- -----------------------------------------------------------------------------------------------
</TABLE>
The amortized cost and estimated fair value of the U.S. Treasury security
classified as held-to-maturity were $6.0 million as of December 31, 1997. The
security matured on March 31, 1998.
As of December 31, 1998 the Company had entered into S&P 500 futures contracts
with a notional amount of $20.0 million to reduce the risk of changes in the
fair market value of certain investments classified as equity securities. These
contracts had an unrealized loss of $1.3 million as of December 31, 1998 which
is included in the recorded amount of the equity securities and in accumulated
other comprehensive income, net of tax, similar to other unrealized gains and
losses on securities available-for-sale.
60
<PAGE> 35
The amortized cost and estimated fair value of fixed maturity securities
available-for-sale as of December 31, 1998, by expected maturity, are shown
below. Expected maturities will differ from contractual maturities because
borrowers may have the right to call or prepay obligations with or without call
or prepayment penalties.
<TABLE>
<CAPTION>
AMORTIZED ESTIMATED
(IN MILLIONS OF DOLLARS) COST FAIR VALUE
- ---------------------------------------------------------------------------------------
<S> <C> <C>
Fixed maturity securities available for sale:
Due in one year or less $ 2,019.9 $ 2,048.0
Due after one year through five years 8,171.9 8,473.4
Due after five years through ten years 2,795.0 2,927.7
Due after ten years 737.3 798.8
- ---------------------------------------------------------------------------------------
$13,724.1 $14,247.9
- ---------------------------------------------------------------------------------------
</TABLE>
The components of unrealized gains on securities available-for-sale, net, were
as follows as of December 31:
<TABLE>
<CAPTION>
(IN MILLIONS OF DOLLARS) 1998 1997
- ----------------------------------------------------------------------------------
<S> <C> <C>
Gross unrealized gains $ 540.9 $ 483.8
Adjustment to deferred policy acquisition costs (116.6) (103.7)
Deferred federal income tax (148.4) (133.0)
- ----------------------------------------------------------------------------------
$ 275.9 $ 247.1
- ----------------------------------------------------------------------------------
</TABLE>
An analysis of the change in gross unrealized gains (losses) on securities
available-for-sale and fixed maturity securities held-to-maturity follows for
the years ended December 31:
<TABLE>
<CAPTION>
(IN MILLIONS OF DOLLARS) 1998 1997 1996
- ------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Securities available-for-sale:
Fixed maturity securities $52.6 $137.5 $(289.2)
Equity securities 4.5 (2.7) 8.9
Fixed maturity securities held-to-maturity -- -- (0.2)
- ------------------------------------------------------------------------------------------
$57.1 $134.8 $(280.5)
- ------------------------------------------------------------------------------------------
</TABLE>
Proceeds from the sale of securities available-for-sale during 1998, 1997 and
1996 were $610.5 million, $574.5 million and $299.6 million, respectively.
During 1998, gross gains of $9.0 million ($9.9 million and $6.4 million in 1997
and 1996, respectively) and gross losses of $7.6 million ($18.0 million and
$13.7 million in 1997 and 1996, respectively) were realized on those sales. In
addition, gross gains of $15.1 million and gross losses of $0.7 million were
realized in 1997 when the Company paid a dividend to Nationwide Corp. consisting
of securities having an aggregate fair value of $850.0 million.
Investments that were non-income producing for the twelve month period
preceding December 31, 1998 amounted to $42.4 million ($19.4 million for 1997)
and consisted of $32.7 million ($3.0 million in 1997) in securities
available-for-sale and $9.7 million ($16.4 million in 1997) in real estate.
Real estate is presented at cost less accumulated depreciation of $21.5
million as of December 31, 1998 ($45.1 million as of December 31, 1997) and
valuation allowances of $5.4 million as of December 31, 1998 ($11.1 million as
of December 31, 1997).
61
<PAGE> 36
The recorded investment of mortgage loans on real estate considered to be
impaired as of December 31, 1998 was $3.7 million. No valuation allowance has
been recorded for these loans as of December 31, 1998. The recorded investment
of mortgage loans on real estate considered to be impaired as of December 31,
1997 was $19.9 million which includes $3.9 million of impaired mortgage loans on
real estate for which the related valuation allowance was $0.1 million and $16.0
million of impaired mortgage loans on real estate for which there was no
valuation allowance. During 1998, the average recorded investment in impaired
mortgage loans on real estate was approximately $9.1 million ($31.8 million in
1997) and interest income recognized on those loans was $0.3 million ($1.0
million in 1997), which is equal to interest income recognized using a
cash-basis method of income recognition.
Activity in the valuation allowance account for mortgage loans on real estate
is summarized for the years ended December 31:
<TABLE>
<CAPTION>
(IN MILLIONS OF DOLLARS) 1998 1997
- ------------------------------------------------------------------------------
<S> <C> <C>
Allowance, beginning of year $42.5 $51.0
Reductions credited to operations (0.1) (1.2)
Direct write-downs charged against the allowance -- (7.3)
- ------------------------------------------------------------------------------
Allowance, end of year $42.4 $42.5
- ------------------------------------------------------------------------------
</TABLE>
An analysis of investment income by investment type follows for the years
ended December 31:
<TABLE>
<CAPTION>
(IN MILLIONS OF DOLLARS) 1998 1997 1996
- -------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Gross investment income:
Securities available-for-sale:
Fixed maturity securities $ 982.5 $ 911.6 $ 917.1
Equity securities 0.8 0.8 1.3
Fixed maturity securities held-to-maturity -- 0.4 0.4
Mortgage loans on real estate 458.9 457.7 432.8
Real estate 40.4 42.9 44.3
Short-term investments 23.1 26.9 4.2
Other 30.6 21.1 3.6
- -------------------------------------------------------------------------------------------
Total investment income 1,536.3 1,461.4 1,403.7
Less investment expenses 49.5 47.5 45.9
- -------------------------------------------------------------------------------------------
Net investment income $1,486.8 $1,413.9 $1,357.8
- -------------------------------------------------------------------------------------------
</TABLE>
An analysis of realized gains (losses) on investments, net of valuation
allowances, by investment type follows for the years ended December 31:
<TABLE>
<CAPTION>
(IN MILLIONS OF DOLLARS) 1998 1997 1996
- -----------------------------------------------------------------------------------------
<S> <C> <C> <C>
Securities available-for-sale:
Fixed maturity securities $(0.7) $ 3.6 $(3.5)
Equity securities 2.1 2.7 3.2
Mortgage loans on real estate 3.9 1.6 (4.1)
Real estate and other 12.6 3.2 4.2
- -----------------------------------------------------------------------------------------
$17.9 $11.1 $(0.2)
- -----------------------------------------------------------------------------------------
</TABLE>
62
<PAGE> 37
Fixed maturity securities with an amortized cost of $6.5 million as of
December 31, 1998 and $6.2 million as of December 31, 1997 were on deposit with
various regulatory agencies as required by law.
- --------------------------------------------------------------------------------
4. LONG-TERM DEBT
On March 10, 1997, NFS sold the Notes in a public offering generating net
proceeds of $294.5 million. The Notes bear interest at the rate of 8% per annum
and mature on March 1, 2027. The Notes are redeemable in whole or in part, at
the option of NFS, at any time on or after March 1, 2007 at scheduled redemption
premiums through March 1, 2016, and, thereafter, at 100% of the principal amount
thereof plus, in each case, accrued and unpaid interest. The Notes are not
subject to any sinking fund payments. The terms of the Notes contain various
restrictive covenants including limitations on the disposition of subsidiaries.
As of December 31, 1998, NFS was in compliance with all such covenants. The
Company made interest payments on the Notes in 1998 and 1997 of $24.0 million
and $11.4 million, respectively.
- --------------------------------------------------------------------------------
5. MANDATORILY REDEEMABLE CAPITAL AND PREFERRED SECURITIES OF SUBSIDIARY TRUSTS
Nationwide Financial Services Capital Trust (Trust I) and Nationwide Financial
Services Capital Trust II (Trust II, or collectively, the Trusts), wholly owned
subsidiaries of NFS, were formed under the laws of the state of Delaware. The
Trusts exist for the exclusive purposes of (i) issuing Capital and Preferred
Securities representing undivided beneficial interests in the assets of the
Trusts; (ii) investing the gross proceeds from the sale of the Capital and
Preferred Securities in Junior Subordinated Debentures of NFS; and (iii)
engaging in only those activities necessary or incidental thereto. These Junior
Subordinated Debentures and the related income effects are eliminated in the
consolidated financial statements.
On March 11, 1997, Trust I sold, in a public offering, $100.0 million of
7.899% Capital Securities, representing preferred undivided beneficial interests
in the assets of Trust I generating net proceeds of $98.3 million. Concurrent
with the sale of the Capital Securities, NFS sold to Trust I $103.1 million in
principal amount of its 7.899% Junior Subordinated Debentures due March 1, 2037.
The Junior Subordinated Debentures are the sole assets of Trust I and are
redeemable by NFS in whole at any time or in part from time to time at par plus
an applicable make-whole premium. The Capital Securities will mature or be
called simultaneously with the Junior Subordinated Debentures and have a
liquidation value of $1,000 per Capital Security.
The Capital Securities, through obligations of NFS under the Junior
Subordinated Debentures, the Capital Securities Guarantee Agreement and the
related Declaration of Trust and Indenture, are fully and unconditionally
guaranteed by NFS. Distributions on the Capital Securities are cumulative and
payable semi-annually in arrears.
On October 19, 1998, Trust II sold, in a public offering, $200 million of
7.10% Trust Preferred Securities representing preferred undivided beneficial
interests in the assets of Trust II generating net proceeds of $193.7 million.
Concurrent with the sale of the Preferred Securities, NFS sold to Trust II
$206.2 million of Junior Subordinated Debentures due October 31, 2028. The
Junior Subordinated Debentures are the sole assets of Trust II and are
redeemable, in whole or in part, on or after October 19, 2003 at a redemption
price equal to the principal amount to be redeemed plus any accrued and unpaid
interest. The Preferred Securities
63
<PAGE> 38
have a liquidation amount of $25 per security and must be redeemed by Trust II
when the Junior Subordinated Debentures mature or are redeemed by NFS.
The Preferred Securities, through obligations of NFS under the Junior
Subordinated Debentures, the Preferred Securities Guarantee Agreement and the
related Amended and Restated Declaration of Trust, are fully and unconditionally
guaranteed by NFS. Distributions on the Preferred Securities are cumulative and
payable quarterly beginning January 31, 1999. Including amortization of issue
costs and amortization of a deferred loss on hedging transactions the effective
interest rate on the Preferred Securities is 7.41%.
Distributions on the Capital and Preferred Securities have been classified as
interest expense in the consolidated statements of income. The Company made
distributions on the Capital and Preferred Securities in 1998 and 1997 of $7.9
million and $3.8 million, respectively.
- --------------------------------------------------------------------------------
6. FEDERAL INCOME TAX
The Company's current federal income tax liability was $65.8 million and $59.4
million as of December 31, 1998 and 1997, respectively.
The tax effects of temporary differences that give rise to significant
components of the net deferred tax liability as of December 31, 1998 and 1997
are as follows:
<TABLE>
<CAPTION>
(IN MILLIONS OF DOLLARS) 1998 1997
- --------------------------------------------------------------------------------
<S> <C> <C>
DEFERRED TAX ASSETS
Future policy benefits $207.7 $200.1
Liabilities in separate accounts 319.9 242.0
Mortgage loans on real estate and real estate 17.5 19.0
Other assets and other liabilities 63.1 63.1
- --------------------------------------------------------------------------------
Total gross deferred tax assets 608.2 524.2
Less valuation allowance (7.0) (7.0)
- --------------------------------------------------------------------------------
Net deferred tax assets 601.2 517.2
- --------------------------------------------------------------------------------
DEFERRED TAX LIABILITIES
Deferred policy acquisition costs 568.7 480.5
Fixed maturity securities 212.2 193.3
Deferred tax on realized investment gains 34.8 40.1
Equity securities and other long-term investments 9.6 7.5
Other 21.6 22.2
- --------------------------------------------------------------------------------
Total gross deferred tax liabilities 846.9 743.6
- --------------------------------------------------------------------------------
Net deferred tax liability $245.7 $226.4
- --------------------------------------------------------------------------------
</TABLE>
In assessing the realizability of deferred tax assets, management considers
whether it is more likely than not that some portion of the total gross deferred
tax assets will not be realized. Nearly all future deductible amounts can be
offset by future taxable amounts or recovery of federal income tax paid within
the statutory carryback period. The valuation allowance was unchanged for the
year ended December 31, 1998 (decreased $0.8 million during 1997 and no change
during 1996).
64
<PAGE> 39
Federal income tax expense attributable to income from continuing operations
for the years ended December 31 was as follows:
<TABLE>
<CAPTION>
(IN MILLIONS OF DOLLARS) 1998 1997 1996
- ------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Currently payable $168.9 $114.4 $116.0
Deferred tax expense (benefit) 4.2 27.4 (0.2)
- ------------------------------------------------------------------------------------------
$173.1 $141.8 $115.8
- ------------------------------------------------------------------------------------------
</TABLE>
Total federal income tax expense for the years ended December 31, 1998, 1997
and 1996 differs from the amount computed by applying the U.S. federal income
tax rate to income before tax as follows:
<TABLE>
<CAPTION>
1998 1997 1996
---------------------------------------------
(IN MILLIONS OF DOLLARS) AMOUNT % AMOUNT % AMOUNT %
- -----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Computed (expected) tax expense $176.9 35.0 $142.5 35.0 $114.8 35.0
Tax exempt interest and dividends received
deduction (4.9) (1.0) -- 0.0 (0.2) (0.1)
Other, net 1.1 0.2 (0.7) (0.2) 1.2 0.4
- -----------------------------------------------------------------------------------------
Total (effective rate of each year) $173.1 34.2 $141.8 34.8 $115.8 35.3
- -----------------------------------------------------------------------------------------
</TABLE>
Total federal income tax paid was $160.0 million, $84.2 million and $117.3
million during the years ended December 31, 1998, 1997 and 1996, respectively.
- --------------------------------------------------------------------------------
7. EARNINGS PER SHARE
Basic earnings per share is the amount of earnings for the period available to
each share of common stock outstanding during the reporting period. Diluted
earnings per share is the amount of earnings for the period available to each
share of common stock outstanding during the reporting period adjusted for the
potential issuance of common shares for stock options.
The calculation of basic and diluted earnings per share for the years ended
December 31 are as follows:
<TABLE>
<CAPTION>
(IN MILLIONS, EXCEPT PER SHARE AMOUNTS) 1998 1997
- --------------------------------------------------------------------------------
<S> <C> <C>
Basic and diluted net income $332.4 $265.2
- --------------------------------------------------------------------------------
Weighted average number of shares of common stock
outstanding 128.5 124.0
Dilutive effect of stock options 0.1 0.1
- --------------------------------------------------------------------------------
Diluted average number of shares of common stock outstanding 128.6 124.1
- --------------------------------------------------------------------------------
Net income per common share:
Basic $ 2.58 $ 2.14
Diluted $ 2.58 $ 2.14
- --------------------------------------------------------------------------------
</TABLE>
Earnings per common share amounts have not been presented for periods prior to
1997, because such amounts are not meaningful due to the effects of the initial
public offering and the $900 million of dividends paid prior to the initial
public offering as described in note 1.
65
<PAGE> 40
- --------------------------------------------------------------------------------
8. COMPREHENSIVE INCOME
Pursuant to SFAS No. 130 -- Reporting Comprehensive Income, which the Company
adopted January 1, 1998, the Consolidated Statements of Shareholders' Equity
include a new measure called "Comprehensive Income". Comprehensive Income
includes net income as well as certain items that are reported directly within
separate components of shareholders' equity that bypass net income. Currently,
the Company's only component of Other Comprehensive Income is unrealized gains
(losses) on securities available-for-sale. The related before and after federal
tax amounts are as follows:
<TABLE>
<CAPTION>
(IN MILLIONS OF DOLLARS) 1998 1997 1996
- -------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Unrealized gains (losses) on securities
available-for-sale arising during the period:
Gross $ 58.5 $ 141.1 $(272.4)
Adjustment to deferred policy acquisition costs (12.9) (21.8) 57.0
Related federal income tax (expense) benefit (15.9) (41.7) 44.0
- -------------------------------------------------------------------------------------------
Net 29.7 77.6 (171.4)
- -------------------------------------------------------------------------------------------
Reclassification adjustment for net (gains) losses on
securities available-for-sale realized during the
period:
Gross (1.4) (6.3) 0.7
Related federal income tax expense (benefit) 0.5 2.2 (0.2)
- -------------------------------------------------------------------------------------------
Net (0.9) (4.1) 0.5
- -------------------------------------------------------------------------------------------
Total Other Comprehensive Income $ 28.8 $ 73.5 $(170.9)
- -------------------------------------------------------------------------------------------
</TABLE>
- --------------------------------------------------------------------------------
9. FAIR VALUE OF FINANCIAL INSTRUMENTS
The following disclosures summarize the carrying amount and estimated fair
value of the Company's financial instruments. Certain assets and liabilities are
specifically excluded from the disclosure requirements of financial instruments.
Accordingly, the aggregate fair value amounts presented do not represent the
underlying value of the Company.
The fair value of a financial instrument is defined as the amount at which the
financial instrument could be exchanged in a current transaction between willing
parties. In cases where quoted market prices are not available, fair value is to
be based on estimates using present value or other valuation techniques. Many of
the Company's assets and liabilities subject to the disclosure requirements are
not actively traded, requiring fair values to be estimated by management using
present value or other valuation techniques. These techniques are significantly
affected by the assumptions used, including the discount rate and estimates of
future cash flows. Although fair value estimates are calculated using
assumptions that management believes are appropriate, changes in assumptions
could cause these estimates to vary materially. In that regard, the derived fair
value estimates cannot be substantiated by comparison to independent markets
and, in many cases, could not be realized in the immediate settlement of the
instruments.
Although insurance contracts, other than policies such as annuities that are
classified as investment contracts, are specifically exempted from the
disclosure requirements, estimated fair value of policy reserves on life
insurance contracts is provided to make the fair value disclosures more
meaningful.
The tax ramifications of the related unrealized gains and losses can have a
significant effect on fair value estimates and have not been considered in the
estimates.
66
<PAGE> 41
The following methods and assumptions were used by the Company in estimating its
fair value disclosures:
Fixed maturity and equity securities: The fair value for fixed maturity
securities is based on quoted market prices, where available. For fixed maturity
securities not actively traded, fair value is estimated using values obtained
from independent pricing services or, in the case of private placements, is
estimated by discounting expected future cash flows using a current market rate
applicable to the yield, credit quality and maturity of the investments. The
fair value for equity securities is based on quoted market prices. The carrying
amount and fair value for equity securities exclude the fair value of futures
contracts designated as hedges of equity securities.
Mortgage loans on real estate, net: The fair value for mortgage loans on real
estate is estimated using discounted cash flow analyses, using interest rates
currently being offered for similar loans to borrowers with similar credit
ratings. Loans with similar characteristics are aggregated for purposes of the
calculations. Fair value for mortgage loans in default is the estimated fair
value of the underlying collateral.
Policy loans, short-term investments and cash: The carrying amount reported in
the consolidated balance sheets for these instruments approximates their fair
value.
Separate account assets and liabilities: The fair value of assets held in
separate accounts is based on quoted market prices. The fair value of
liabilities related to separate accounts is the amount payable on demand, which
is net of certain surrender charges.
Investment contracts: The fair value for the Company's liabilities under
investment type contracts is disclosed using two methods. For investment
contracts without defined maturities, fair value is the amount payable on
demand. For investment contracts with known or determined maturities, fair value
is estimated using discounted cash flow analysis. Interest rates used are
similar to currently offered contracts with maturities consistent with those
remaining for the contracts being valued.
Policy reserves on life insurance contracts: Included are disclosures for
individual life insurance, universal life insurance and supplementary contracts
with life contingencies for which the estimated fair value is the amount payable
on demand. Also included are disclosures for the Company's limited payment
policies, which the Company has used discounted cash flow analyses similar to
those used for investment contracts with known maturities to estimate fair
value.
Long-term Debt: The fair value for long-term debt is based on quoted market
prices.
Capital and preferred securities of subsidiary trusts: The fair value for
capital and preferred securities of subsidiary trusts is based on quoted market
prices.
Commitments to extend credit: Commitments to extend credit have nominal fair
value because of the short-term nature of such commitments. See note 10.
Futures contracts: The fair value for futures contracts is based on quoted
market prices.
67
<PAGE> 42
Carrying amount and estimated fair value of financial instruments subject to
disclosure requirements and policy reserves on life insurance contracts were as
follows as of December 31:
<TABLE>
<CAPTION>
1998 1997
--------------------------------------------------------
CARRYING ESTIMATED CARRYING ESTIMATED
(IN MILLIONS OF DOLLARS) AMOUNT FAIR VALUE AMOUNT FAIR VALUE
- ----------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
ASSETS
Investments:
Securities available-for-sale:
Fixed maturity securities $14,247.9 $14,247.9 $13,204.1 $13,204.1
Equity securities 135.3 135.3 80.4 80.4
Fixed maturity securities
held-to-maturity -- -- 6.0 6.0
Mortgage loans on real estate,
net 5,328.4 5,527.6 5,181.6 5,509.7
Policy loans 464.3 464.3 415.3 415.3
Short-term investments 478.3 478.3 449.2 449.2
Cash 24.5 24.5 180.9 180.9
Assets held in separate accounts 50,935.8 50,935.8 37,724.4 37,724.4
LIABILITIES
Investment contracts 15,473.8 15,163.8 14,708.2 14,322.1
Policy reserves on life insurance
contracts 4,298.4 4,153.3 3,994.6 3,831.6
Long-term debt 298.4 339.9 298.4 327.0
Liabilities related to separate
accounts 50,935.8 49,926.5 37,724.4 36,747.0
Futures contracts 1.3 1.3 -- --
Capital and preferred securities of
subsidiary trusts 300.0 314.5 100.0 109.4
</TABLE>
- --------------------------------------------------------------------------------
10. RISK DISCLOSURES
The following is a description of the most significant risks facing life
insurers and how the Company mitigates those risks:
Credit Risk: The risk that issuers of securities owned by the Company or
mortgagors on mortgage loans on real estate owned by the Company will default or
that other parties, including reinsurers, which owe the Company money, will not
pay. The Company minimizes this risk by adhering to a conservative investment
strategy, by maintaining reinsurance and credit and collection policies and by
providing for any amounts deemed uncollectible.
Interest Rate Risk: The risk that interest rates will change and cause a
decrease in the value of an insurer's investments. This change in rates may
cause certain interest-sensitive products to become uncompetitive or may cause
disintermediation. The Company mitigates this risk by charging fees for
non-conformance with certain policy provisions, by offering products that
transfer this risk to the purchaser, and/or by attempting to match the maturity
schedule of its assets with the expected payouts of its liabilities. To the
extent that liabilities come due more quickly than assets mature, an insurer
would have to borrow funds or sell assets prior to maturity and potentially
recognize a gain or loss.
Legal/Regulatory Risk: The risk that changes in the legal or regulatory
environment in which an insurer operates will result in increased competition,
reduced demand for a company's products, or create additional expenses not
anticipated by the insurer in pricing its products. The Company mitigates this
risk by offering a
68
<PAGE> 43
wide range of products and by operating throughout the United States, thus
reducing its exposure to any single product or jurisdiction, and also by
employing underwriting practices which identify and minimize the adverse impact
of this risk.
Financial Instruments with Off-Balance-Sheet Risk: The Company is a party to
financial instruments with off-balance-sheet risk in the normal course of
business through management of its investment portfolio. These financial
instruments include commitments to extend credit in the form of loans. These
instruments involve, to varying degrees, elements of credit risk in excess of
amounts recognized on the consolidated balance sheets.
Commitments to fund fixed rate mortgage loans on real estate are agreements to
lend to a borrower and are subject to conditions established in the contract.
Commitments generally have fixed expiration dates or other termination clauses
and may require payment of a deposit. Commitments extended by the Company are
based on management's case-by-case credit evaluation of the borrower and the
borrower's loan collateral. The underlying mortgage property represents the
collateral if the commitment is funded. The Company's policy for new mortgage
loans on real estate is to lend no more than 75% of collateral value. Should the
commitment be funded, the Company's exposure to credit loss in the event of
nonperformance by the borrower is represented by the contractual amounts of
these commitments less the net realizable value of the collateral. The
contractual amounts also represent the cash requirements for all unfunded
commitments. Commitments on mortgage loans on real estate of $156.0 million
extending into 1999 were outstanding as of December 31, 1998. The Company also
had $43.3 million of commitments to purchase fixed maturity securities
outstanding as of December 31, 1998.
Significant Concentrations of Credit Risk: The Company grants mainly
commercial mortgage loans on real estate to customers throughout the United
States. The Company has a diversified portfolio with no more than 22% (20% in
1997) in any geographic area and no more than 2% (2% in 1997) with any one
borrower as of December 31, 1998. As of December 31, 1998, 42% (46% in 1997) of
the remaining principal balance of the Company's commercial mortgage loan
portfolio financed retail properties.
Reinsurance: The Company has entered into a reinsurance contract to cede a
portion of its general account individual annuity business to The Franklin Life
Insurance Company (Franklin). Total recoveries due from Franklin were $187.9
million and $220.2 million as of December 31, 1998 and 1997, respectively. The
contract is immaterial to the Company's results of operations. The ceding of
risk does not discharge the original insurer from its primary obligation to the
policyholder. Under the terms of the contract, Franklin has established a trust
as collateral for the recoveries. The trust assets are invested in investment
grade securities, the market value of which must at all times be greater than or
equal to 102% of the reinsured reserves.
- --------------------------------------------------------------------------------
11. PENSION PLAN AND POSTRETIREMENT BENEFITS OTHER THAN PENSIONS
The Company is a participant, together with other affiliated companies, in a
pension plan covering all employees who have completed at least one year of
service. The Company funds pension costs accrued for direct employees plus an
allocation of pension costs accrued for employees of affiliates whose work
efforts benefit the Company. Assets of the Retirement Plan are invested in group
annuity contracts of NLIC and Employers Life Insurance Company of Wausau
(ELICW).
69
<PAGE> 44
Pension costs charged to operations by the Company during the years ended
December 31, 1998, 1997 and 1996 were $3.0 million, $8.3 million and $8.2
million, respectively. The Company has recorded a prepaid pension asset of $5.0
million as of December 31, 1998 and a net accrued pension expense as of December
31, 1997 of $0.2 million.
In addition to the defined benefit pension plan, the Company, together with
other affiliated companies, participates in life and health care defined benefit
plans for qualifying retirees. Postretirement life and health care benefits are
contributory and generally available to full time employees who have attained
age 55 and have accumulated 15 years of service with the Company after reaching
age 40. Postretirement health care benefit contributions are adjusted annually
and contain cost-sharing features such as deductibles and coinsurance. In
addition, there are caps on the Company's portion of the per-participant cost of
the postretirement health care benefits. These caps can increase annually, but
not more than three percent. The Company's policy is to fund the cost of health
care benefits in amounts determined at the discretion of management. Plan assets
are invested primarily in group annuity contracts of NLIC.
The Company elected to immediately recognize its estimated accumulated
postretirement benefit obligation (APBO), however, certain affiliated companies
elected to amortize their initial transition obligation over periods ranging
from 10 to 20 years.
The Company's accrued postretirement benefit expense as of December 31, 1998
and 1997 was $40.1 million and $36.5 million, respectively, and the net periodic
postretirement benefit cost (NPPBC) for 1998, 1997 and 1996 was $4.1 million,
$3.0 million and $3.4 million, respectively.
70
<PAGE> 45
Information regarding the funded status of the pension plan as a whole and the
postretirement life and health care benefit plan as a whole as of December 31,
1998 and 1997 follows:
<TABLE>
<CAPTION>
POSTRETIREMENT
PENSION BENEFITS BENEFITS
--------------------------------------------------
(IN MILLIONS OF DOLLARS) 1998 1997 1998 1997
- ----------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
CHANGE IN BENEFIT OBLIGATION
Benefit obligation at beginning of year $2,033.8 $1,847.8 $ 237.9 $ 200.7
Service cost 87.6 77.3 9.8 7.0
Interest cost 123.4 118.6 15.4 14.0
Actuarial loss 123.2 60.0 15.6 24.4
Plan curtailment in 1998/merger in 1997 (107.2) 1.5 -- --
Benefits paid (75.8) (71.4) (8.6) (8.2)
- ----------------------------------------------------------------------------------------------
Benefit obligation at end of year 2,185.0 2,033.8 270.1 237.9
- ----------------------------------------------------------------------------------------------
CHANGE IN PLAN ASSETS
Fair value of plan assets at beginning of
year 2,212.9 1,947.9 69.2 63.0
Actual return on plan assets 300.7 328.1 5.0 3.6
Employer contribution 104.1 7.2 12.1 10.6
Plan merger -- 1.1 -- --
Benefits paid (75.8) (71.4) (8.4) (8.0)
- ----------------------------------------------------------------------------------------------
Fair value of plan assets at end of year 2,541.9 2,212.9 77.9 69.2
- ----------------------------------------------------------------------------------------------
Funded status 356.9 179.1 (192.2) (168.7)
Unrecognized prior service cost 31.5 34.7 -- --
Unrecognized net (gains) losses (345.7) (330.7) 16.0 1.6
Unrecognized net (asset) obligation at
transition (11.0) 33.3 1.3 1.5
- ----------------------------------------------------------------------------------------------
Prepaid (accrued) benefit cost $ 31.7 $ (83.6) $ (174.9) $ (165.6)
- ----------------------------------------------------------------------------------------------
</TABLE>
Basis for measurements, funded status of the pension plan and postretirement
life and health care benefit plan:
<TABLE>
<CAPTION>
POSTRETIREMENT
PENSION BENEFITS BENEFITS
--------------------------------------------
1998 1997 1998 1997
- ----------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Weighted average discount rate 5.50% 6.00% 6.65% 6.70%
Rate of increase in future compensation levels 3.75% 4.25% -- --
Assumed health care cost trend rate:
Initial rate -- -- 15.00% 12.13%
Ultimate rate -- -- 8.00% 6.12%
Uniform declining period -- -- 15 YEARS 12 Years
- ----------------------------------------------------------------------------------------------
</TABLE>
71
<PAGE> 46
The net periodic pension cost for the pension plan as a whole for the years
ended December 31, 1998, 1997 and 1996 follows:
<TABLE>
<CAPTION>
(IN MILLIONS OF DOLLARS) 1998 1997 1996
- -------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Service cost (benefits earned during the period) $ 87.6 $ 77.3 $ 75.5
Interest cost on projected benefit obligation 123.4 118.6 105.5
Expected return on plan assets (159.0) (139.0) (116.1)
Recognized gains (3.8) -- --
Amortization of prior service cost 3.2 3.2 3.2
Amortization of unrecognized transition obligation 4.2 4.2 4.1
- -------------------------------------------------------------------------------------------
$ 55.6 $ 64.3 $ 72.2
- -------------------------------------------------------------------------------------------
</TABLE>
Effective December 31, 1998, Wausau Service Corporation (WSC) ended its
affiliation with the Nationwide Insurance Enterprise and employees of WSC ended
participation in the plan. A curtailment gain of $67.1 million resulted
(consisting of a $107.2 million reduction in the projected benefit obligation,
net of the write-off of the $40.1 million remaining unamortized transition
obligation related to WSC). The Company anticipates that the plan will settle
the obligation related to WSC employees with a transfer of assets during 1999.
Basis for measurements, net periodic pension cost for the pension plan:
<TABLE>
<CAPTION>
1998 1997 1996
- -----------------------------------------------------------------------------------------
<S> <C> <C> <C>
Weighted average discount rate 6.00% 6.50% 6.00%
Rate of increase in future compensation levels 4.25% 4.75% 4.25%
Expected long-term rate of return on plan assets 7.25% 7.25% 6.75%
- -----------------------------------------------------------------------------------------
</TABLE>
The amount of NPPBC for the postretirement benefit plan as a whole for the
years ended December 31, 1998, 1997 and 1996 was as follows:
<TABLE>
<CAPTION>
(IN MILLIONS OF DOLLARS) 1998 1997 1996
- -----------------------------------------------------------------------------------------
<S> <C> <C> <C>
Service cost (benefits attributed to employee service during
the year) $ 9.8 $ 7.0 $ 6.5
Interest cost on accumulated postretirement benefit
obligation 15.4 14.0 13.7
Actual return on plan assets (5.0) (3.6) (4.3)
Amortization of unrecognized transition obligation of
affiliates 0.2 0.2 0.2
Net amortization and deferral 1.2 (0.5) 1.8
- -----------------------------------------------------------------------------------------
$21.6 $17.1 $17.9
- -----------------------------------------------------------------------------------------
</TABLE>
Actuarial assumptions used for the measurement of the accumulated
postretirement benefit obligation (APBO) and the NPPBC for the postretirement
benefit plan for 1998, 1997 and 1996 were as follows:
<TABLE>
<CAPTION>
1998 1997 1996
- --------------------------------------------------------------------------------------------
<S> <C> <C> <C>
NPPBC:
Discount rate 6.70% 7.25% 6.65%
Long term rate of return on plan assets, net of tax 5.83% 5.89% 4.80%
Assumed health care cost trend rate:
Initial rate 12.00% 11.00% 11.00%
Ultimate rate 6.00% 6.00% 6.00%
Uniform declining period 12 YEARS 12 Years 12 Years
- --------------------------------------------------------------------------------------------
</TABLE>
72
<PAGE> 47
For the postretirement benefit plan as a whole, a one percentage point
increase or decrease in the assumed health care cost trend rate would have no
impact on the APBO as of December 31, 1998 and have no impact on the NPPBC for
the year ended December 31, 1998.
- --------------------------------------------------------------------------------
12. STOCK COMPENSATION
The Company sponsors the Nationwide Financial Services, Inc. 1996 Long-Term
Equity Compensation Plan (LTEP) covering selected officers, directors and
employees of the Company and certain of its affiliates. The LTEP provides for
the grant of any or all of the following types of awards: (i) stock options for
shares of Class A common stock; (ii) stock appreciation rights (SARs); (iii)
restricted stock; and (iv) performance awards. The LTEP was effective December
11, 1996 and no awards may be granted under the LTEP after December 11, 2006.
The number of shares of Class A common stock which may be issued under the LTEP,
or as to which SARs or other awards may be granted, may not exceed 2.6 million.
The Company has elected to continue to follow Accounting Principles Board
Opinion No. 25 -- Accounting for Stock Issued to Employees (APB 25) and related
interpretations in accounting for its employee stock options as permitted by
SFAS No. 123 -- Accounting for Stock-Based Compensation (SFAS 123). Under APB
25, because the exercise price of the Company's employee stock options equals
the market price of the underlying stock on the date of grant, no compensation
expense is recognized. Pro forma disclosures as if the Company adopted the
expense recognition provisions of SFAS 123, which require the fair value of the
options granted to be recorded as expense over the vesting period, are required
and are presented below.
Stock options granted under the LTEP in 1998 and 1997 have ten year terms. One
third of the options vest and become fully exercisable at the end of each of
three years of continued employment, or upon retirement. No stock options were
granted in years prior to 1997.
The Company's stock option activity and related information for the two years
ended December 31, is summarized below:
<TABLE>
<CAPTION>
1998 1997
------------------------------------------------------
OPTIONS WEIGHTED OPTIONS WEIGHTED
ON CLASS A AVERAGE ON CLASS A AVERAGE
COMMON EXERCISE COMMON EXERCISE
STOCK PRICE STOCK PRICE
- -----------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Outstanding, beginning of period 242,500 $23.72 -- --
Granted 321,300 $39.51 242,500 $23.72
Exercised (1,666) $23.50 -- --
Forfeited/Expired -- -- -- --
- -----------------------------------------------------------------------------------------------
Outstanding, end of period 562,134 $32.68 242,500 $23.72
- -----------------------------------------------------------------------------------------------
Exercisable, end of period 88,610 $23.70 2,500 $23.50
- -----------------------------------------------------------------------------------------------
Weighted average fair value of options
granted during the year $15.79 $ 9.79
- -----------------------------------------------------------------------------------------------
</TABLE>
Exercise prices for options outstanding as of December 31, 1998, ranged from
$23.50 to $42.94. The weighted average remaining contractual life of these
options is 8.8 years.
73
<PAGE> 48
Fair value was estimated at the date of grant using a Black-Scholes option
pricing model with the following assumptions:
<TABLE>
<CAPTION>
1998 1997
- ----------------------------------------------------------------------------------
<S> <C> <C>
Risk free interest rate 5.50% 6.00%
Dividend yield 0.80% 0.80%
Volatility factor 0.342 0.347
Weighted average expected option life 6 YEARS 6 Years
- ----------------------------------------------------------------------------------
</TABLE>
Had the compensation cost for the employee stock options been determined in
accordance with the fair value based accounting method provided by SFAS 123, net
income and net income per common share for the years ended December 31 would
have been as follows:
<TABLE>
<CAPTION>
(IN MILLIONS OF DOLLARS) PRO FORMA AS PRESENTED
- -----------------------------------------------------------------------------------------
<S> <C> <C>
1998
Net income $330.1 $332.4
Basic and diluted earnings per common share $ 2.57 $ 2.58
1997
Net income $264.1 $265.2
Basic and diluted earnings per common share $ 2.13 $ 2.14
- -----------------------------------------------------------------------------------------
</TABLE>
Pro forma information has not been presented for the year ended December 31,
1996 as no stock awards were made prior to 1997.
- --------------------------------------------------------------------------------
13. SHAREHOLDERS' EQUITY, REGULATORY RISK-BASED CAPITAL, RETAINED EARNINGS AND
DIVIDEND RESTRICTIONS
The Board of Directors of the Company has the authority to issue 50.0 million
shares of preferred stock without further action of the shareholders. Preferred
stock may be issued in one or more classes with full, special, limited or no
voting powers, and designations, preferences and relative, participating,
optional or other special rights, and qualifications and limitations or
restrictions as stated in any resolution adopted by the Board of Directors of
the Company issuing any class of preferred stock. No shares of preferred stock
have been issued or are outstanding.
The holders of Class A common stock are entitled to one vote per share. The
holders of Class B common stock are entitled to ten votes per share. Class A
common stock has no conversion rights. Class B common stock is convertible into
Class A common stock, in whole or in part, at any time and from time to time at
the option of the holder, on the basis of one share of Class A common stock for
each share of Class B common stock converted. If at any time after the initial
issuance of shares of Class A common stock the number of outstanding shares of
Class B common stock falls below 5% of the aggregate number of issued and
outstanding shares of common stock, then each outstanding share of Class B
common stock shall automatically convert into one share of Class A common stock.
In the event of any sale or transfer of shares of Class B common stock to any
person or persons other than NMIC or its affiliates, such shares of Class B
common stock so transferred shall be automatically converted into an equal
number of shares of Class A common stock. Cash dividends of $0.30 and $0.18 per
common share were declared during 1998 and 1997, respectively.
74
<PAGE> 49
Each insurance company's state of domicile imposes minimum risk-based capital
requirements that were developed by the NAIC. The formulas for determining the
amount of risk-based capital specify various weighting factors that are applied
to financial balances or various levels of activity based on the perceived
degree of risk. Regulatory compliance is determined by a ratio of the company's
regulatory total adjusted capital, as defined by the NAIC, to its authorized
control level risk-based capital, as defined by the NAIC. Companies below
specific trigger points or ratios are classified within certain levels, each of
which requires specified corrective action. NLIC and each of its insurance
company subsidiaries exceed the minimum risk-based capital requirements.
The statutory capital and surplus of NLIC as of December 31, 1998, 1997 and
1996 was $1.32 billion, $1.13 billion and $1.00 billion, respectively. The
statutory net income of NLIC for the years ended December 31, 1998, 1997 and
1996 was $171.0 million, $111.7 million and $73.2 million, respectively.
In addition, the payment of dividends by NLIC may also be subject to
restrictions set forth in the insurance laws of New York that limit the amount
of statutory profits on NLIC's participating policies (measured before dividends
to policyholders) that can inure to the benefit of the Company and its
shareholders.
The Company currently does not expect such regulatory requirements to impair
its ability to pay operating expenses, interest and shareholder dividends in the
future.
- --------------------------------------------------------------------------------
14. TRANSACTIONS WITH AFFILIATES
As part of the restructuring described in note 1, NLIC paid a dividend valued
at $485.7 million to Nationwide Corp. on January 1, 1997 consisting of the
outstanding shares of common stock of ELICW, National Casualty Company (NCC) and
West Coast Life Insurance Company (WCLIC). Also, on February 24, 1997, NLIC paid
a dividend to NFS, and NFS paid an equivalent dividend to Nationwide Corp.,
consisting of securities having an aggregate fair value of $850.0 million. The
Company recognized a gain of $14.4 million on the transfer of securities.
The Company leases office space from NMIC and certain of its subsidiaries. For
the years ended December 31, 1998, 1997 and 1996, the Company made lease
payments to NMIC and its subsidiaries of $8.7 million, $9.1 million and $10.0
million, respectively.
Pursuant to a cost sharing agreement among NMIC and certain of its direct and
indirect subsidiaries, including the Company, NMIC provides certain operational
and administrative services, such as sales support, advertising, personnel and
general management services, to those subsidiaries. Expenses covered by this
agreement are subject to allocation among NMIC, the Company and other
affiliates. Amounts allocated to the Company were $95.0 million, $85.8 million
and $101.6 million in 1998, 1997 and 1996, respectively. The allocations are
based on techniques and procedures in accordance with insurance regulatory
guidelines. Measures used to allocate expenses among companies include
individual employee estimates of time spent, special cost studies, salary
expense, commissions expense and other methods agreed to by the participating
companies that are within industry guidelines and practices. The Company
believes these allocation methods are reasonable. In addition, the Company does
not believe that expenses recognized under the inter-company agreements are
materially different than expenses that would have been recognized had the
Company operated on a stand alone basis. Amounts payable to NMIC from the
Company under the cost sharing agreement were $31.9 million and $20.5 million as
of December 31, 1998 and 1997, respectively.
75
<PAGE> 50
The Company also participates in intercompany repurchase agreements with
affiliates whereby the seller will transfer securities to the buyer at a stated
value. Upon demand or a stated period, the securities will be repurchased by the
seller at the original sales price plus a price differential. Transactions under
the agreements during 1998 and 1997 were not material. The Company believes that
the terms of the repurchase agreements are materially consistent with what the
Company could have obtained with unaffiliated parties.
Intercompany reinsurance agreements exist between NLIC and, respectively, NMIC
and ELICW whereby all of NLIC's accident and health and group life insurance
business is ceded on a modified coinsurance basis. NLIC entered into the
reinsurance agreements during 1996 because the accident and health and group
life insurance business was unrelated to the Company's long-term savings and
retirement products. Accordingly, the accident and health and group life
insurance business has been accounted for as discontinued operations for all
periods presented. Under modified coinsurance agreements, invested assets are
retained by the ceding company and investment earnings are paid to the
reinsurer. Under the terms of the Company's agreements, the investment risk
associated with changes in interest rates is borne by ELICW or NMIC, as the case
may be. Risk of asset default is retained by the Company, although a fee is paid
by ELICW or NMIC, as the case may be, to the Company for the Company's retention
of such risk. The agreements will remain in force until all policy obligations
are settled. However, with respect to the agreement between NLIC and NMIC,
either party may terminate the contract on January 1 of any year with prior
notice. The ceding of risk does not discharge the original insurer from its
primary obligation to the policyholder. The Company believes that the terms of
the modified coinsurance agreements are consistent in all material respects with
what the Company could have obtained with unaffiliated parties. Amounts ceded to
NMIC and ELICW for the years ended December 31, 1998, 1997 and 1996 were:
<TABLE>
<CAPTION>
1998 1997 1996
--------------------------------------------------------
(IN MILLIONS OF DOLLARS) NMIC ELICW NMIC ELICW NMIC ELICW
- ------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Premiums $ 90.1 $106.3 $ 91.4 $199.8 $ 97.3 $224.2
Net investment income and other
revenue $ 11.1 $ 9.4 $ 10.7 $ 13.4 $ 10.9 $ 14.8
Benefits, claims and expenses $ 98.8 $160.5 $100.7 $225.9 $100.5 $246.6
- ------------------------------------------------------------------------------------------
</TABLE>
The Company and various affiliates entered into agreements with Nationwide
Cash Management Company (NCMC), an affiliate, under which NCMC acts as a common
agent in handling the purchase and sale of short-term securities for the
respective accounts of the participants. Amounts on deposit with NCMC were
$441.1 million and $286.0 million as of December 31, 1998 and 1997,
respectively, and are included in short-term investments on the accompanying
consolidated balance sheets.
- --------------------------------------------------------------------------------
15. BANK LINES OF CREDIT
In August 1996, NLIC, along with NMIC, entered into a $600.0 million revolving
credit facility which provides for a $600.0 million loan over a five year term
on a fully revolving basis with a group of national financial institutions. The
credit facility provides for several and not joint liability with respect to any
amount drawn by either NLIC or NMIC. NLIC and NMIC pay facility and usage fees
to the financial institutions to maintain the revolving credit facility. All
previously existing line of credit agreements were canceled. In
76
<PAGE> 51
September 1997, the credit agreement was amended to include NFS as a party to
and borrower under the agreement. As of December 31, 1998 the Company had no
amounts outstanding under the agreement.
- --------------------------------------------------------------------------------
16. CONTINGENCIES
On October 29, 1998, the Company and certain of its subsidiaries were named in
a lawsuit filed in the Common Pleas Court of Franklin County, Ohio related to
the sale of deferred annuity products for use as investments in tax-deferred
contributory retirement plans (Mercedes Castillo v. Nationwide Financial
Services, Inc., Nationwide Life Insurance Company and Nationwide Life and
Annuity Insurance Company). The plaintiff in such lawsuit seeks to represent a
national class of the Company's customers and seeks unspecified compensatory and
punitive damages. The Company is currently evaluating this lawsuit, which is in
an early stage and has not been certified as a class. The Company intends to
defend this lawsuit vigorously.
- --------------------------------------------------------------------------------
17. SEGMENT INFORMATION
The Company uses differences in products as the basis for defining its
reportable segments. The Company reports three product segments: Variable
Annuities, Fixed Annuities and Life Insurance.
The Variable Annuities segment consists of annuity contracts that provide the
customer with the opportunity to invest in mutual funds managed by independent
investment managers and the Company, with investment returns accumulating on a
tax-deferred basis. The Company's variable annuity products consist almost
entirely of flexible premium deferred variable annuity contracts.
The Fixed Annuities segment consists of annuity contracts that generate a
return for the customer at a specified interest rate, fixed for a prescribed
period, with returns accumulating on a tax-deferred basis. Such contracts
consist of single premium deferred annuities, flexible premium deferred
annuities and single premium immediate annuities. The Fixed Annuities segment
includes the fixed option under variable annuity contracts.
The Life Insurance segment consists of insurance products, including variable
universal life insurance and corporate-owned life insurance products, that
provide a death benefit and may also allow the customer to build cash value on a
tax-deferred basis.
In addition to the product segments, the Company reports corporate revenue and
expenses, investments and related investment income supporting capital not
specifically allocated to its product segments, revenues and expenses of its
distribution companies, revenues and expenses of its investment advisor
subsidiaries (other than the portion allocated to the Variable Annuities and
Life Insurance segments), revenues and expenses related to group annuity
contracts sold to Nationwide Insurance Enterprise employee and agent benefit
plans, interest expense on long-term debt and capital and preferred securities
and all realized gains and losses on investments in a Corporate and Other
segment.
77
<PAGE> 52
The following table summarizes the financial results of the Company's business
segments for the years ended December 31, 1998, 1997 and 1996.
<TABLE>
<CAPTION>
VARIABLE FIXED LIFE CORPORATE
(IN MILLIONS OF DOLLARS) ANNUITIES ANNUITIES INSURANCE AND OTHER TOTAL
- ---------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
1998
Net investment income(1) $ (31.3) $ 1,116.6 $ 231.6 $ 169.9 $ 1,486.8
Other operating revenue 560.8 35.7 319.6 90.9 1,007.0
- ---------------------------------------------------------------------------------------------
Total operating revenue(2) 529.5 1,152.3 551.2 260.8 2,493.8
- ---------------------------------------------------------------------------------------------
Interest credited to policyholder
account balances -- 828.6 115.4 125.0 1,069.0
Interest expense on debt and
capital and preferred securities
of subsidiary trusts -- -- -- 35.1 35.1
Amortization of deferred policy
acquisition costs 123.9 44.2 46.5 -- 214.6
Other benefits and expenses 187.2 104.2 294.5 101.6 687.5
- ---------------------------------------------------------------------------------------------
Total expenses 311.1 977.0 456.4 261.7 2,006.2
- ---------------------------------------------------------------------------------------------
Operating income (loss) before
federal income tax 218.4 175.3 94.8 (0.9) 487.6
Realized gains on investments -- -- -- 17.9 17.9
- ---------------------------------------------------------------------------------------------
Consolidated income before federal
tax expense $ 218.4 $ 175.3 $ 94.8 $ 17.0 $ 505.5
- ---------------------------------------------------------------------------------------------
Assets as of year end $47,668.7 $15,215.7 $5,187.6 $6,599.2 $74,671.2
- ---------------------------------------------------------------------------------------------
1997
Net investment income(1) $ (26.9) $ 1,098.2 $ 189.1 $ 153.5 $ 1,413.9
Other operating revenue 430.9 43.2 284.0 55.3 813.4
- ---------------------------------------------------------------------------------------------
Total operating revenue(2) 404.0 1,141.4 473.1 208.8 2,227.3
- ---------------------------------------------------------------------------------------------
Interest credited to policyholder
account balances -- 823.4 78.5 114.7 1,016.6
Interest expense on debt and
capital and preferred securities
of subsidiary trusts -- -- -- 26.1 26.1
Amortization of deferred policy
acquisition costs 87.8 39.8 39.6 -- 167.2
Other benefits and expenses 165.3 108.7 284.1 63.4 621.5
- ---------------------------------------------------------------------------------------------
Total expenses 253.1 971.9 402.2 204.2 1,831.4
- ---------------------------------------------------------------------------------------------
Operating income before federal
income tax 150.9 169.5 70.9 4.6 395.9
Realized gains on investments -- -- -- 11.1 11.1
- ---------------------------------------------------------------------------------------------
Consolidated income before federal
tax expense $ 150.9 $ 169.5 $ 70.9 $ 15.7 $ 407.0
- ---------------------------------------------------------------------------------------------
Assets as of year end $35,278.7 $14,436.3 $3,901.4 $6,276.5 $59,892.9
- ---------------------------------------------------------------------------------------------
</TABLE>
78
<PAGE> 53
<TABLE>
<CAPTION>
VARIABLE FIXED LIFE CORPORATE
(IN MILLIONS OF DOLLARS) ANNUITIES ANNUITIES INSURANCE AND OTHER TOTAL
- ---------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
1996
Net investment income(1) $ (21.5) $ 1,050.6 $ 174.0 $ 154.7 $ 1,357.8
Other operating revenue 306.1 42.0 261.6 49.3 659.0
- ---------------------------------------------------------------------------------------------
Total operating revenue(2) 284.6 1,092.6 435.6 204.0 2,016.8
- ---------------------------------------------------------------------------------------------
Interest credited to policyholder
account balances -- 805.0 70.2 107.1 982.3
Amortization of deferred policy
acquisition costs 57.4 38.6 37.4 -- 133.4
Benefits and expenses 136.9 113.6 260.8 61.5 572.8
- ---------------------------------------------------------------------------------------------
Total expenses 194.3 957.2 368.4 168.6 1,688.5
- ---------------------------------------------------------------------------------------------
Operating income before federal
income tax 90.3 135.4 67.2 35.4 328.3
Realized losses on investments -- -- -- (0.2) (0.2)
- ---------------------------------------------------------------------------------------------
Consolidated income from
continuing operations before
federal tax expense $ 90.3 $ 135.4 $ 67.2 $ 35.2 $ 328.1
- ---------------------------------------------------------------------------------------------
Assets as of year end $25,069.7 $13,994.7 $3,353.3 $5,352.5 $47,770.2
- ---------------------------------------------------------------------------------------------
</TABLE>
(1) The Company's method of allocating net investment income results in a charge
(negative net investment income) to the Variable Annuities segment which is
recognized in the Corporate and Other segment. The charge relates to
non-invested assets which support this segment on a statutory basis.
(2) Excludes realized gains and losses on investments.
The Company has no significant revenue from customers located outside of the
United States nor does the Company have any significant long-lived assets
located outside the United States.
- --------------------------------------------------------------------------------
18. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
The following is a summary of the unaudited quarterly results of operations
for the years ended December 31, 1998 and 1997.
<TABLE>
<CAPTION>
FIRST SECOND THIRD FOURTH
(IN MILLIONS OF DOLLARS, EXCEPT PER SHARE AMOUNTS) QUARTER QUARTER QUARTER QUARTER
- --------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
1998
Revenues other than investment gains (losses) $597.7 $620.4 $634.9 $640.8
Realized gains (losses) on investments 16.6 5.0 (5.0) 1.3
- --------------------------------------------------------------------------------------------------
Total revenues 614.3 625.4 629.9 642.1
Benefits and expenses 482.2 498.9 511.3 513.8
- --------------------------------------------------------------------------------------------------
Income before federal income tax expense 132.1 126.5 118.6 128.3
Federal income tax expense 45.4 43.5 40.7 43.5
- --------------------------------------------------------------------------------------------------
Net income $ 86.7 $ 83.0 $ 77.9 $ 84.8
- --------------------------------------------------------------------------------------------------
Basic and diluted earnings per common share $ 0.67 $ 0.65 $ 0.61 $ 0.66
- --------------------------------------------------------------------------------------------------
</TABLE>
79
<PAGE> 54
<TABLE>
<CAPTION>
FIRST SECOND THIRD FOURTH
(IN MILLIONS OF DOLLARS, EXCEPT PER SHARE AMOUNTS) QUARTER QUARTER QUARTER QUARTER
- --------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
1997
Revenues other than investment gains (losses) $531.7 $551.4 $566.7 $577.5
Realized gains (losses) on investments 21.1 (11.9) (4.8) 6.7
- --------------------------------------------------------------------------------------------------
Total revenues 552.8 539.5 561.9 584.2
Benefits and expenses 446.7 454.6 461.6 468.5
- --------------------------------------------------------------------------------------------------
Income before federal income tax expense 106.1 84.9 100.3 115.7
Federal income tax expense 37.2 29.7 34.9 40.0
- --------------------------------------------------------------------------------------------------
Net income $ 68.9 $ 55.2 $ 65.4 $ 75.7
- --------------------------------------------------------------------------------------------------
Basic and diluted earnings per common share $ 0.63 $ 0.43 $ 0.51 $ 0.59
- --------------------------------------------------------------------------------------------------
</TABLE>
- --------------------------------------------------------------------------------
19. DISCONTINUED OPERATIONS
As discussed in note 1, NFS is a holding company for NLIC and certain other
companies within the Nationwide Insurance Enterprise that offer or distribute
long-term savings and retirement products. Prior to the contribution by
Nationwide Corp. to NFS of the outstanding common stock of NLIC and other
companies, NLIC effected certain transactions with respect to certain
subsidiaries and lines of business that were unrelated to long-term savings and
retirement products.
On September 24, 1996, NLIC's Board of Directors declared a dividend payable
to Nationwide Corp. on January 1, 1997 consisting of the outstanding shares of
common stock of three subsidiaries: ELICW, NCC and WCLIC. ELICW writes group
accident and health and group life insurance business and maintains it offices
in Wausau, Wisconsin. NCC is a property and casualty company with offices in
Scottsdale, Arizona that serves as a fronting company for a property and
casualty subsidiary of NMIC. WCLIC writes high dollar term life insurance
policies and is located in San Francisco, California. ELICW, NCC and WCLIC have
been accounted for as discontinued operations in the accompanying consolidated
financial statements through December 31, 1996. The Company did not recognize
any gain or loss on the disposal of these subsidiaries.
Also, during 1996, NLIC entered into two reinsurance agreements whereby all of
NLIC's accident and health and group life insurance business was ceded to ELICW
and NMIC, effective January 1, 1996. See note 14 for a complete discussion of
the reinsurance agreements. The Company has discontinued its accident and health
and group life insurance business and in connection therewith has entered into
reinsurance agreements to cede all existing and any future writings to other
affiliated companies. NLIC's accident and health and group life insurance
business is accounted for as discontinued operations for all periods presented.
The Company did not recognize any gain or loss on the disposal of the accident
and health and group life insurance business. The assets, liabilities, results
of operations and activities of discontinued operations are distinguished
physically, operationally and for financial reporting purposes from the
remaining assets, liabilities, results of operations and activities of the
Company.
80
<PAGE> 55
A summary of the results of operations of discontinued operations for the
years ended December 31, 1998, 1997 and 1996 is as follows:
<TABLE>
<CAPTION>
(IN MILLIONS OF DOLLARS, EXCEPT PER SHARE AMOUNTS) 1998 1997 1996
- -------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Revenues $ -- $ -- $ 668.9
Net income $ -- $ -- $ 11.3
Contribution to basic and diluted earnings per common
share $ -- $ -- $ 0.10
- -------------------------------------------------------------------------------------------
</TABLE>
A summary of the assets and liabilities of discontinued operations as of
December 31, 1998, 1997 and 1996 is as follows:
<TABLE>
<CAPTION>
(IN MILLIONS OF DOLLARS) 1998 1997 1996
- -------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Assets, consisting primarily of investments $221.5 $247.3 $3,288.5
Liabilities, consisting primarily of policy benefits and
claims $221.5 $247.3 $2,802.8
- -------------------------------------------------------------------------------------------
</TABLE>
81
<PAGE> 56
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Nationwide Financial Services, Inc.:
We have audited the accompanying consolidated balance sheets of Nationwide
Financial Services, Inc. and subsidiaries (collectively the Company) as of
December 31, 1998 and 1997, and the related consolidated statements of income,
shareholders' equity and cash flows for each of the years in the three-year
period ended December 31, 1998. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Nationwide
Financial Services, Inc. and subsidiaries as of December 31, 1998 and 1997, and
the results of their operations and their cash flows for each of the years in
the three-year period ended December 31, 1998, in conformity with generally
accepted accounting principles.
As discussed in note 1 to the consolidated financial statements, the Company
was formed in November 1996 as a holding company for Nationwide Life Insurance
Company and the other companies within the Nationwide Insurance Enterprise that
offer or distribute long-term savings and retirement products. The consolidated
financial statements are presented as if these companies were consolidated for
all periods presented.
KPMG LLP
Columbus, Ohio
January 29, 1999
83
<PAGE> 1
EXHIBIT 21
NATIONWIDE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
SUBSIDIARIES OF THE REGISTRANT
As of December 31, 1998
The following are wholly owned (unless otherwise noted) subsidiaries of
Nationwide Financial Services, Inc. and their state of incorporation:
<TABLE>
<CAPTION>
State of
Subsidiary Incorporation
------------------------------------------------------------------ -----------------
<S> <C>
Nationwide Life Insurance Company Ohio
Nationwide Financial Services Capital Trust Delaware
Nationwide Retirement Solutions, Inc. Ohio
Morley Financial Services, Inc. Oregon
Nationwide Financial Institution Distributors Agency, Inc. Ohio
The 401(k) Companies, Inc. (32% owned) Ohio
Nationwide Financial Services (Bermuda), Inc. Bermuda
National Deferred Compensation, Inc. Ohio
Nationwide Trust Company, FSB Ohio
Nationwide Financial Services Capital Trust II Delaware
NFS Distributors, Inc. Ohio
Irvin L. Schwartz & Associates, Inc. (60% owned) Ohio
</TABLE>
The following are wholly owned subsidiaries of Nationwide Life Insurance Company
and their state of incorporation:
<TABLE>
<CAPTION>
State of
Subsidiary Incorporation
------------------------------------------------------------------ -----------------
<S> <C>
Nationwide Life and Annuity Insurance Company Ohio
Nationwide Advisory Services, Inc. Ohio
Nationwide Investment Services Corporation Ohio
NWE, Inc. Ohio
</TABLE>
The following are wholly owned subsidiaries of Nationwide Retirement
Services, Inc. and their state of incorporation:
<TABLE>
<CAPTION>
State of
Subsidiary Incorporation
------------------------------------------------------------------ -----------------
<S> <C>
Nationwide Retirement Solutions, Inc. of Alabama Alabama
Nationwide Retirement Solutions, Inc. of Arizona Arizona
Nationwide Retirement Solutions, Inc. of Arkansas Arkansas
Nationwide Retirement Solutions, Insurance Agency, Inc. Massachusetts
Nationwide Retirement Solutions, Inc. of Montana Montana
Nationwide Retirement Solutions, Inc. of Nevada Nevada
Nationwide Retirement Solutions, Inc. of New Mexico New Mexico
Nationwide Retirement Solutions, Inc. of South Dakota South Dakota
Nationwide Retirement Solutions, Inc. of Wyoming Wyoming
</TABLE>
<PAGE> 2
The following are wholly owned subsidiaries of Nationwide Financial
Institution Distributors Agency, Inc. and their state of incorporation:
<TABLE>
<CAPTION>
State of
Subsidiary Incorporation
------------------------------------------------------------------ -----------------
<S> <C>
Affiliate Agency, Inc. Ohio
Financial Horizons Distributors Agency of Alabama, Inc. Alabama
Landmark Financial Services of New York, Inc. New York
Financial Horizons Securities Corp. Ohio
</TABLE>
The following are wholly owned subsidiaries of Morley Financial Services, Inc.
and their state of incorporation:
<TABLE>
<CAPTION>
State of
Subsidiary Incorporation
------------------------------------------------------------------ -----------------
<S> <C>
Morley & Associates, Inc. Oregon
Morley Capital Management Oregon
Union Bond & Trust Company Oregon
Portland Investment Services, Inc. Oregon
Excaliber Funding Corporation Oregon
Caliber Funding Corporation Oregon
Morley Research Associates, Ltd. Oregon
</TABLE>
The following are wholly owned subsidiaries of The 401(k) Companies, Inc. and
their state of incorporation:
<TABLE>
<CAPTION>
State of
Subsidiary Incorporation
------------------------------------------------------------------ -----------------
<S> <C>
401(k) Investment Services, Inc. Ohio
401(k) Investment Advisors, Inc. Ohio
401(k) Company Ohio
</TABLE>
The following is a wholly owned subsidiary of Nationwide Advisory Services, Inc.
and its state of incorporation:
<TABLE>
<CAPTION>
State of
Subsidiary Incorporation
------------------------------------------------------------------ -----------------
<S> <C>
Nationwide Investor Services, Inc. Ohio
</TABLE>
All business operations of Nationwide Financial Services, Inc. and all of
its subsidiaries are conducted using each company's legally registered
name.
<PAGE> 1
EXHIBIT 23
CONSENT OF INDEPENDENT AUDITORS
The Board of Directors
Nationwide Financial Services, Inc.:
We consent to the incorporation by reference in the registration statement (No.
333-52813) on Form S-3 of Nationwide Financial Services, Inc. of our reports
dated January 29, 1999, relating to the consolidated balance sheets of
Nationwide Financial Services, Inc. and subsidiaries as of December 31, 1998 and
1997, and the related consolidated statements of income, shareholders' equity
and cash flows and the related financial statement schedules for each of the
years in the three-year period ended December 31, 1998, which reports appear or
are incorporated by reference in the December 31, 1998 Annual Report on Form
10-K of Nationwide Financial Services, Inc.
/s/ KPMG LLP
Columbus, Ohio
March 29, 1999
<TABLE> <S> <C>
<ARTICLE> 7
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM NATIONWIDE
FINANCIAL SERVICES, INC.'S ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED
DECEMBER 31, 1998, AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
CONSOLIDATED FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<DEBT-HELD-FOR-SALE> 14,248
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 134
<MORTGAGE> 5,328
<REAL-ESTATE> 244
<TOTAL-INVEST> 20,941
<CASH> 25
<RECOVER-REINSURE> 0
<DEFERRED-ACQUISITION> 2,022
<TOTAL-ASSETS> 74,671
<POLICY-LOSSES> 19,772
<UNEARNED-PREMIUMS> 0
<POLICY-OTHER> 0
<POLICY-HOLDER-FUNDS> 0
<NOTES-PAYABLE> 298
300
0
<COMMON> 1
<OTHER-SE> 2,446
<TOTAL-LIABILITY-AND-EQUITY> 74,671
200
<INVESTMENT-INCOME> 1,487
<INVESTMENT-GAINS> 18
<OTHER-INCOME> 108
<BENEFITS> 1,245
<UNDERWRITING-AMORTIZATION> 215
<UNDERWRITING-OTHER> 472
<INCOME-PRETAX> 506
<INCOME-TAX> 173
<INCOME-CONTINUING> 332
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 332
<EPS-PRIMARY> 2.58
<EPS-DILUTED> 2.58
<RESERVE-OPEN> 0
<PROVISION-CURRENT> 0
<PROVISION-PRIOR> 0
<PAYMENTS-CURRENT> 0
<PAYMENTS-PRIOR> 0
<RESERVE-CLOSE> 0
<CUMULATIVE-DEFICIENCY> 0
</TABLE>
