☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended September 30, 2023
☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from __________ to __________
Commission File Number: 000-55522
NATIONAL WESTERN LIFE GROUP, INC.
(Exact name of Registrant as specified in its charter)
Delaware
47-3339380
(State or Other Jurisdiction of Incorporation)
(IRS Employer Identification No.)
10801 N. Mopac Expy Bldg 3
Austin,
Texas
78759
(512)
836-1010
(Address of Principal Executive Offices) (Zip Code)
(Telephone Number, including area code)
Securities registered pursuant to Section 12 (b) of the Act:
Title of each class to be so registered:
Trading Symbol
Name of each exchange on which each class is to be registered:
Class A Common Stock, $0.01 par value
NWLI
The NASDAQ Stock Market LLC
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 such filing requirements for the past 90 days: Yes☒No ☐
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). : Yes☒No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See definition of "accelerated filer." "large accelerated filer," and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large Accelerated Filer ☐Accelerated filer☒ Non-accelerated filer (Do not check if a smaller reporting company) ☐Smaller reporting company ☐Emerging growth company ☐
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐No ☒
As of November 7, 2023, the number of shares of Registrant's common stock outstanding was: Class A – 3,436,020 and Class B - 200,000.
Liability for policyholder account balances (Note 1)
$
7,078,891
7,661,785
Additional liability for benefits in excess of account balance (Note 1)
158,040
148,708
Liability for future policy benefits (Note 1)
843,636
900,146
Market risk benefits liability (Note 1)
220,506
215,777
Other policyholder liabilities
137,169
175,089
Funds withheld liability
1,161,155
1,333,036
Other liabilities
215,934
157,482
Total liabilities
9,815,331
10,592,023
COMMITMENTS AND CONTINGENCIES (Note 11)
STOCKHOLDERS’ EQUITY:
Common stock:
Class A - $0.01 par value; 7,500,000 shares authorized; 3,436,020 issued and outstanding in 2023 and 2022
34
34
Class B - $0.01 par value; 200,000 shares authorized, issued, and outstanding in 2023 and 2022
2
2
Additional paid-in capital
41,716
41,716
Accumulated other comprehensive income (loss) (Note 1)
(531,705)
(478,219)
Retained earnings (Note 1)
2,734,052
2,627,389
Total stockholders’ equity
2,244,099
2,190,922
Total liabilities and stockholders' equity
$
12,059,430
12,782,945
Note: The Condensed Consolidated Balance Sheet at December 31, 2022 has been derived from the audited Consolidated Financial Statements as of that date.
See accompanying notes to Condensed Consolidated Financial Statements (unaudited). (Note 1)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(1)CONSOLIDATION AND BASIS OF PRESENTATION
The accompanying unaudited Condensed Consolidated Financial Statements have been prepared in accordance with U.S. generally accepted accounting principles ("GAAP") for interim financial information and the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete annual financial statements. Except for the retroactive adoption of a required change in accounting standard as discussed below and as further described in Note (2) New Accounting Pronouncements, in the opinion of management, the accompanying Condensed Consolidated Financial Statements contain all adjustments necessary to present fairly the financial position and results of operations of National Western Life Group, Inc. ("NWLGI") and its wholly owned subsidiaries (collectively, the “Company”), on a basis consistent with the prior audited consolidated financial statements, as of September 30, 2023, and for the three and nine months ended September 30, 2023 and September 30, 2022. Certain reclasses of prior year balances have been made for comparison. The results of operations for the nine months ended September 30, 2023 are not necessarily indicative of the results to be expected for the full year. It is recommended that these Condensed Consolidated Financial Statements, excluding balances affected by the adoption of Accounting Standards Update (ASU) 2018-12 noted below, be read in conjunction with the audited consolidated financial statements and notes included in the Company's Annual Report on Form 10-K for the year ended December 31, 2022 which is accessible free of charge through the Company's internet site at www.nwlgi.com or the Securities and Exchange Commission internet site at www.sec.gov. Except for balances affected by the adoption of ASU 2018-12 noted below, the Condensed Consolidated Balance Sheet at December 31, 2022 has been derived from the audited consolidated financial statements as of that date.
The accompanying unaudited Condensed Consolidated Financial Statements include the accounts of NWLGI and its wholly owned subsidiaries: National Western Life Insurance Company ("NWLIC" or "National Western"), Regent Care San Marcos Holdings, LLC, NWL Services, Inc., and N.I.S. Financial Services, Inc. ("NIS"). National Western's wholly owned subsidiaries include The Westcap Corporation, NWL Financial, Inc., NWLSM, Inc., Braker P III, LLC, and Ozark National Life Insurance Company ("Ozark National"). All significant intercorporate transactions and accounts have been eliminated in consolidation.
The preparation of financial statements in accordance with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosures of contingent assets and liabilities, and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates. Significant estimates in the accompanying Condensed Consolidated Financial Statements include: (1) liabilities for future policy obligations and market risk benefits, (2) valuation of derivative instruments, (3) recoverability and amortization of deferred policy acquisition costs ("DPAC"), deferred sales inducements ("DSI"), the value of business acquired ("VOBA"), and the cost of reinsurance ("COR"), (4) valuation allowances for deferred tax assets, (5) goodwill, (6) allowances for credit losses on available-for-sale debt securities, (7) allowance for credit losses for mortgage loans and reinsurance recoverables, and (8) commitments and contingencies.
As a result of executing a funds withheld coinsurance agreement at December 31, 2020, the Company implemented accounting policies related to trading debt securities and the embedded derivative on reinsurance in its financial statements. Trading securities represent debt securities that are included in the fund assets withheld as part of the funds withheld coinsurance agreements to support the policyholder liability obligations ceded to the reinsurer. Trading debt securities are reported in the accompanying Condensed Consolidated Financial Statements at their fair values with changes in their fair values reflected as a component of Net investment income in the Condensed Consolidated Statements of Earnings. Since these trading debt securities pertain to investment activities related to coinsurance agreements rather than as an income strategy based on active trading, they are classified as investing activities in the Condensed Consolidated Statements of Cash Flows. Under the terms of a coinsurance funds withheld agreement, while the assets are withheld, the associated interest and credit risk of these assets are transferred to the reinsurer creating an embedded derivative on reinsurance in the funds withheld liability. Accordingly, the Company is required to bifurcate the embedded derivative from the host contract in accordance with ASC 815-15. The bifurcated embedded derivative on reinsurance is computed as the fair value unrealized gain (loss) on the underlying funds withheld assets. This amount is included as a component of the funds withheld liability balance reported on the Condensed Consolidated Balance Sheets, with changes in the embedded derivative on reinsurance reported in Net investment income in the Condensed Consolidated Statements of Earnings.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
On July 27, 2022, National Western entered into a Funds Withheld Coinsurance Agreement with Aspida Life Re Ltd. (“Aspida"), a reinsurer organized under the Laws of Bermuda. Pursuant to this agreement, the Company agreed to cede, on a coinsurance with funds withheld basis, a specified quota share of certain liabilities pertaining to an in-force block of annuity contracts issued by the Company before July 1, 2022. The initial amount of statutory reserve liabilities ceded by the Company to Aspida under the agreement approximated $250.0 million. In addition, pursuant to the agreement, the Company agreed to cede, on a coinsurance with funds withheld basis, a specified quota share of certain annuity contracts issued or to be issued by the Company on or after July 1, 2022.
As consideration for Aspida’s agreement to provide reinsurance pursuant to the agreement, the Company transferred into a funds withheld account permitted assets approximating the initial statutory reserve liabilities ceded to Aspida. In accordance with the agreement and in order to provide additional security for Aspida’s obligations under the agreement, the parties established a trust account for the benefit of the Company in which Aspida maintains certain assets and grants the Company a first priority security interest in such assets.
The table below shows the net unrealized gains and losses on available-for-sale securities that were reclassified out of accumulated other comprehensive income (loss) for the three and nine months ended September 30, 2023 and September 30, 2022.
Affected Line Item in the Condensed Consolidated Statements of Earnings
Amount Reclassified From Accumulated Other Comprehensive Income (Loss)
Three Months Ended September 30,
Nine Months Ended September 30,
2023
2022
2023
2022
(In thousands)
Other net investment gains
$
231
(163)
344
5,061
Earnings before Federal income taxes
231
(163)
344
5,061
Federal income taxes
48
(34)
72
1,063
Net earnings
$
183
(129)
272
3,998
Restatement of prior period consolidated financial statements as a result of adopting ASU 2018-12
As a result of the adoption of Accounting Standards Update 2018-12 Financial Services - Insurance (Topic 944) - Targeted Improvements to the Accounting for Long-Duration Contracts ("LDTI" or "ASU 2018-12"), the results and related disclosures for the comparative 2022 periods presented in this Form 10-Q were recast to be presented as if the requirements of LDTI had been in effect during those periods. Implementation of LDTI affected various line items in each condensed consolidated financial statement. Refer to Note (2) New Accounting Policies for more details about the new guidance and a summary of the restated balances.
The Company adopted ASU 2018-12 guidance effective January 1, 2023 using the modified retrospective transaction method, where permitted, for changes in the liability for future policy benefits and deferred policy acquisition costs and related balances, and the retrospective transition method for market risk benefits. The transition date for restatement was January 1, 2021 and amounts previously reported were retroactively restated, including those amounts shown for the three and nine months ended September 30, 2022, and as of December 31, 2022.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
The following tables present amounts as previously reported, the effect of adoption of the guidance under ASU 2018-12, and the resulting adjusted amounts reported in interim Condensed Consolidated Financial Statements included herein. The tables include only those line items impacted by restatement.
Restated Lines of Condensed Consolidated Balance Sheet:
December 31, 2022
As previously Reported
Effect of Change
As Currently Reported
(In thousands)
Assets:
Deferred policy acquisition costs
$
909,786
(245,904)
663,882
Deferred sales inducements
114,399
(29,096)
85,303
Value of business acquired
146,494
(7,999)
138,495
Market risk benefits asset
—
48,759
48,759
Deferred federal income tax asset
57,867
(48,835)
9,032
Amounts recoverable from reinsurer, net of allowance for credit losses
1,723,347
(34,559)
1,688,788
Other assets
110,339
352
110,691
Total Assets
13,100,227
(317,282)
12,782,945
Liabilities:
Future policy benefits:
Universal life and annuity contracts
8,498,684
(8,498,684)
—
Traditional life reserves
919,650
(919,650)
—
Liability for policyholder account balances
—
7,661,785
7,661,785
Additional liability for benefits in excess of account balance
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Interim Condensed Consolidated Statement of Cash Flows:
Nine Months Ended September 30, 2022
As previously Reported
Effect of Change
As Currently Reported
(In thousands)
Cash flows from operating activities:
Net earnings
$
88,710
140,567
229,277
Adjustments to reconcile net earnings to net cash from operating activities:
Universal life and annuity contract interest
(11,058)
13,524
2,466
(Increase) decrease in deferred policy acquisition and sales inducement costs, and value of business acquired
47,694
(23,396)
24,298
(Increase) decrease in reinsurance recoverable
81,454
61,012
142,466
(Increase) decrease in other assets
(333)
22
(311)
Increase (decrease) in liabilities for future policy benefits
93,088
(83,024)
10,064
Increase (decrease) in market risk benefits liability
—
(149,083)
(149,083)
Increase (decrease) in deferred Federal income tax
15,658
37,365
53,023
Increase (decrease) in other liabilities
(15,347)
159
(15,188)
Net cash provided by (used in) operating activities
234,590
(2,854)
231,736
Cash flows from financing activities:
Deposits to account balances for universal life and annuity contracts
258,248
(5,375)
252,873
Return of account balances on universal life and annuity contracts
(637,119)
8,219
(628,900)
Net cash provided by (used in) financing activities
(379,125)
2,844
(376,281)
Effect of foreign exchange
429
10
439
(2)NEW ACCOUNTING PRONOUNCEMENTS
Recent accounting pronouncements not yet adopted
None noted.
Accounting pronouncements adopted
Targeted Improvements to the Accounting for Long-Duration Contracts
In August 2018, the FASB issued ASU 2018-12 Financial Services-Insurance (Topic 944) - Targeted Improvements to the Accounting for Long-Duration Contracts ("LDTI" or "ASU 2018-12"). This update pertains to long-duration contracts and improving the timeliness of recognizing changes in the liability for future policy benefits, simplifying accounting for certain market-based options, simplifying the amortization of deferred policy acquisition costs, and improving the effectiveness of required disclosures. Amendments include the following:
A. Require an insurance entity to (1) review and update assumptions used to measure cash flows at least annually (with changes recognized in net income) and (2) update discount rate assumptions at each quarterly reporting date with the impact recognized in Other comprehensive income ("OCI").
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
B. Require an insurance entity to measure all market risk benefits, which are contracts or contract features that provide protection to the policyholder from capital market risk, associated with deposit (i.e. account balance) contracts at fair value. The periodic change in fair value attributable to change in instrument-specific credit risk is recognized in OCI.
C. Simplify amortization of deferred policy acquisition costs and other balances amortized in proportion to premiums, gross profits, or gross margins and require those balances be amortized on a constant basis over the expected term of the related contracts. Deferred policy acquisition costs are required to be written off for unexpected contract terminations but are not subject to impairment testing.
D. Require an insurance entity to add disclosures of disaggregated rollforwards of significant insurance liabilities and other account balances (i.e. beginning to ending balances of the liability for future policy benefits, policyholder account balances, market risk benefits, separate account liabilities, and deferred acquisition costs). The insurance entity must also disclose information about significant inputs, judgments, assumptions, and methods used in measurement, including changes in those inputs, judgments, and assumptions, and the effect of those changes on measurement.
In November 2020, the FASB released ASU 2020-11 Financial Services – Insurance (Topic 944). The amendments in this update deferred the effective date of adoption of ASU 2018-12 for all entities by one year. In particular, for publicly traded business entities, adoption of LDTI was made effective for fiscal years beginning after December 15, 2022, and interim periods within those fiscal years.
On January 1, 2023, the Company adopted the requirements of the new standard, using the modified retrospective approach for market risk benefits, the liability for future policy benefits, and deferred policy acquisition costs and related balances, such that those balances were adjusted to conform to ASU 2018-12 as of January 1, 2021, the transition date.
The following table summarizes the restated Deferred policy acquisition costs ("DPAC") and Deferred sales inducements ("DSI") balances as of the transition date, January 1, 2021, due to the adoption of ASU 2018-12.
Domestic Traditional Life
Domestic Universal Life
International Traditional Life
International Universal Life
Annuities excl. SPIAs WLC
ONL & Affiliates
(In thousands)
Deferred policy acquisition costs:
Balance, December 31, 2020
$
4,014
96,513
13,399
157,186
103,179
7,789
Removal of shadow balances in Accumulated other comprehensive income (loss)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Domestic Traditional Life
Domestic Universal Life
International Traditional Life
International Universal Life
Annuities excl. SPIAs WLC
ONL & Affiliates
(In thousands)
Deferred sales inducements:
Balance, December 31, 2020
$
—
—
—
—
43,845
—
Removal of shadow balances in Accumulated other comprehensive income (loss)
—
—
—
—
52,533
—
Adjusted balance, January 1, 2021
$
—
—
—
—
96,378
—
The following table summarizes restated DPAC and DSI balances by product line in the Consolidated Balance Sheet as of January 1, 2021.
DPAC Balances
DSI Balances
(In thousands)
Domestic traditional life
$
4,014
—
Domestic universal life
144,133
—
International traditional life
13,399
—
International universal life
184,262
—
Annuities, excluding SPIAs with life contingencies
342,278
96,378
ONL & Affiliates
7,789
—
Balance Sheet balance as of January 1, 2021
$
695,875
96,378
A table presenting the change in Value of business acquired (VOBA) between December 31, 2020 and January 1, 2021 for the adoption of ASU 2018-12 is not included as VOBA is not impacted by shadow balance accounting. However, the method of recognizing amortization expense of VOBA in the Condensed Consolidated Statements of Earnings subsequent to January 1, 2021 has changed consistent with the method of determining amortization expense for DPAC and DSI balances. Refer to Note (5) Deferred Transaction Costs for further information concerning amortization of Deferred Transaction Costs balances effected by the adoption of ASU 2018-12.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
The following table summarizes restated Future policyholder obligations liability and the Market risk benefits liability balances in the Consolidated Balance Sheet as of January 1, 2021.
Policyholder Account Balances
Additional Liability for Benefits
Liability for Future Policy Benefits
Market Risk Benefits Liability
(In thousands)
Domestic traditional life
$
—
—
102,407
—
Domestic universal life
1,222,694
45,136
—
—
International traditional life
—
—
95,402
—
International universal life
677,900
63,046
—
—
SPIAs with life contingencies
—
—
238,127
—
Annuities, excluding SPIAs with life contingencies
6,477,443
11,192
—
301,601
ONL & Affiliates
—
—
866,852
—
Balance Sheet balances as of January 1, 2021
$
8,378,037
119,374
1,302,788
301,601
The following table presents the effect of the transition adjustment, net of foreign exchange and deferred tax adjustments, on total equity for the adoption of ASU 2018-12 as of January 1, 2021.
January 1, 2021
Retained Earnings
Accumulated Other Comprehensive Income
Total
(In thousands)
Liability for future policy benefits
$
(9,650)
(112,734)
(122,384)
Liability for policyholder account balances
303,503
—
303,503
Additional liability for excess death/annuitization benefits
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
The net transition adjustment for the Liability for future policy benefits is due to the difference in the discount rate used previously and the discount rate used for the adoption of ASU 2018-12 at January 1, 2021. The transition adjustment for DPAC and DSI removed the shadow adjustments pertaining to unrealized investment gains/(losses) previously required to be allocated from Accumulated Other Comprehensive Income (Loss). The transition adjustment for Market risk benefits is the difference between reporting certain contracts and contract features at fair value under ASU 2018-12 as opposed to the carrying amount previously required under GAAP.
Prior to the adoption of ASU 2018-12, VOBA and Cost of Reinsurance (COR) balances were amortized consistent with the methodologies employed for amortizing DPAC and DSI balances. Although not otherwise impacted by ASU 2018-12, the Company elected to continue using the amortization method consistent with that used for amortizing DPAC and DSI balances after the adoption of the new accounting standard. VOBA and COR balances did not have shadow accounting requirements under GAAP prior to the adoption of ASU 2018-12 and consequently did not have a transition adjustment.
The following tables summarize restated DPAC, DSI, and VOBA balances as of December 31, 2021 and the changes in these balances subsequent to the January 1, 2021 transition date. The balances as of December 31, 2021 establish the beginning balances for reporting the results for the nine months ended September 30, 2022.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
The following table summarizes the restated Liability for policyholder account balances as of December 31, 2021 and the changes in this balance subsequent to the January 1, 2021 transition date. The balance as of December 31, 2021 establishes the beginning balance for reporting the results for the nine months ended September 30, 2022.
Domestic Universal Life
International Universal Life
Annuities excl. SPIAs WLC
(In thousands)
Adjusted balance, January 1, 2021
$
1,222,694
677,900
6,477,443
Issuances
—
—
—
Premiums received
225,349
46,147
430,846
Policy charges
(76,147)
(68,800)
(28,643)
Surrenders and withdrawals
(47,483)
(47,644)
(580,269)
Benefit payments
(25,418)
(2,040)
(207,302)
Interest credited
89,508
36,902
155,783
Other
23,555
5,121
(86,558)
Adjusted balance, December 31, 2021
1,412,058
647,586
6,161,300
Less reinsurance recoverable
—
—
(1,458,076)
Adjusted balance, December 31, 2021 net of reinsurance
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
The following table summarizes the restated Additional liability in excess of account balances as of December 31, 2021 and the changes in this balance subsequent to the January 1, 2021 transition date. The balance as of December 31, 2021 establishes the beginning balance for reporting the results for the nine months ended September 30, 2022.
Domestic Universal Life
International Universal Life
Annuities excl. SPIAs WLC
(In thousands)
Adjusted balance, January 1, 2021 net of reinsurance
$
45,136
63,046
—
Beginning balance before shadow reserve adjustments
45,136
63,046
11,192
Effect of changes in cash flow ("CF") assumptions
7,061
(14,524)
—
Effect of actual variances from expected experience
—
—
1,512
Adjusted beginning of year balance:
52,197
48,522
12,704
Issuances
—
—
—
Interest accrual
4,767
3,264
459
Assessments collected
14,775
8,304
749
Benefit payments
(17,687)
(10,565)
(1,198)
Derecognition (lapses and withdrawals)
45
(1,189)
4
Ending balance before shadow reserve adjustments
54,097
48,336
12,718
Effect of shadow reserve adjustments
—
—
—
Adjusted balance, December 31, 2021
54,097
48,336
12,718
Less: Reinsurance recoverable
—
—
(12,718)
Adjusted balance, December 31, 2021 net of reinsurance
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
The following table summarizes the restated Liability for future policy benefits balance as of December 31, 2021 and the changes in this balance subsequent to the January 1, 2021 transition date. The balance as of December 31, 2021 establishes the beginning balance for reporting the results for the nine months ended September 30, 2022.
Domestic Traditional Life
International Traditional Life
SPIAs With Life Contingencies
ONL & Affiliates
(In thousands)
Adjusted balance, January 1, 2021
$
102,407
95,402
238,127
866,852
Beginning balance at original discount rate
65,928
69,270
200,737
780,836
Effect of changes in CF assumptions
—
—
(316)
—
Effect of actual variances from expected experience
(525)
(252)
5,724
114
Adjusted beginning of year balance:
65,403
69,018
206,145
780,950
Issuances
—
—
39,338
227
Interest accrual
4,058
4,391
7,076
23,801
Net premium collected
16
5,602
—
35,640
Benefit payments
(6,538)
(17,221)
(22,173)
(56,616)
Derecognition (lapses and withdrawals)
—
—
(6,840)
—
Other
597
2,608
358
(770)
Ending balance at original discount rate
63,536
64,398
223,904
783,232
Effect of changes in discount rate
26,933
17,186
20,646
34,913
Adjusted balance, December 31, 2021
90,469
81,584
244,550
818,145
Less reinsurance recoverable
(13,841)
(578)
(211,912)
(31,476)
Adjusted balance, December 31, 2021 net of reinsurance
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
The following table summarizes the net Market risk benefit liability balance as of December 31, 2021 and the changes in this net balance subsequent to the January 1, 2021 transition date. The net balance as of December 31, 2021 establishes the beginning net balance for reporting the results for the nine months ended September 30, 2022.
(In thousands)
Adjusted balance, January 1, 2021
$
301,601
Balance, beginning of year, before effect of changes in instrument-specific credit risk:
301,601
Issuances
3,184
Interest accrual
—
Attributed fees collected
38,182
Benefit payments
—
Effect of changes in interest rates
(36,112)
Effect of changes in equity markets
—
Effect of changes in equity index volatility
—
Actual policyholder behavior different from expected behavior
(7,022)
Effect of changes in future expected policyholder behavior
—
Effect of changes in other future expected assumptions
—
Balance, end of year, before effect of changes in instrument-specific credit risk
299,833
Effect of changes in the instrument-specific credit risk
—
Adjusted balance, December 31, 2021
299,833
Less reinsurance recoverable, end of year
(68,238)
Adjusted balance, December 31, 2021 net of reinsurance
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
The following table summarizes restated Future policyholder obligations liability and the Market risk benefits liability balances in the Consolidated Balance Sheets as of December 31, 2021.
Policyholder Account Balances
Additional Liability for Benefits
Liability for Future Policy Benefits
Market Risk Benefits Liability
(In thousands)
Domestic traditional life
$
—
—
90,469
—
Domestic universal life
1,412,058
54,097
—
—
International traditional life
—
—
81,584
—
International universal life
647,586
48,336
—
—
SPIAs with life contingencies
—
—
244,550
—
Annuities, excl. SPIAs with life contingencies
6,161,300
12,718
—
299,833
ONL & Affiliates
—
—
818,145
—
Balances as of December 31, 2021
$
8,220,944
115,151
1,234,748
299,833
Other Accounting Pronouncements
In March 2022, the FASB released ASU 2022-02 Financial Instruments – Credit Losses (Topic 326) Troubled Debt Restructurings and Vintage Disclosures. The amendments in this Update eliminate the accounting guidance for troubled-debt restructurings by creditors in Subtopic 310-40, Receivables - Troubled Debt Restructurings by Creditors, but enhances disclosure requirements for certain loan modifications in which the debtor is experiencing financial difficulties. Additionally, the amendments in this Update require public business entities to disclose current-period gross write offs by year of origination for financing receivables and net investment in leases within the scope of Subtopic 326-20, Financial Instruments - Credit Losses - Measured at Amortized Cost. The updates are required to be applied prospectively beginning in fiscal years after December 15, 2022, including interim periods within those fiscal years. The Company elected to adopt the requirements of this update in its Consolidated Financial Statements for the year ended December 31, 2022. The adoption of this ASU did not have a material impact on the results of operations or financial position of the Company.
Other recent accounting pronouncements issued by the FASB (including its Emerging Issues Task Force), the AICPA, and the SEC did not, or are not believed by management to, have a material impact on the Company’s present or future Consolidated Financial Statements.
(3) STOCKHOLDERS' EQUITY
Prior to his death on November 7, 2023, Robert L. Moody, Sr., the Chairman Emeritus of the Company, was the controlling stockholder of the Company because he controlled, through the Moody Revocable Trust, 99.0% of the total outstanding shares of the Company's Class B Common Stock as of September 30, 2023. Under the terms of the Moody Revocable Trust, the shares of Class B Common Stock held by the Moody Revocable Trust pass to Three R Trust, a trust created by Robert L. Moody Sr. for the benefit of his children and their lineal descendants. The trustee of the Moody Revocable Trust, however, is authorized to retain trust properties, including the shares of Class B Common Stock, for as long as is necessary to administer the trust and Robert L. Moody Sr.'s estate, including the payment of debts, expenses and taxes. Therefore, upon Robert L. Moody, Sr.'s death, Three R Trust acquired beneficial ownership of the shares of Class B Common Stock held by the Moody Revocable Trust. However, legal title will remain with the Moody Revocable Trust for the foreseeable future. Therefore, until the transfer of legal title to Three R Trust, Moody National Bank (as trustee of the Moody Revocable Trust) retains the voting power with respect to those shares of Class B Common Stock.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Holders of the Company's Class A Common Stock elect one-third of the Board of Directors of the Company, and holders of the Class B Common Stock elect the remainder. Any cash or in-kind dividends paid on each share of Class B Common Stock are limited to one-half of the cash or in-kind dividends paid on each share of Class A Common Stock. In the event of liquidation of the Company by dissolution, the holders of Class A Common Stock will receive the par value of their shares; then the holders of Class B Common Stock will receive the par value of their shares; and the remaining net assets of the Company shall be divided between the stockholders of both Class A Common Stock and Class B Common Stock based upon the number of shares held.
As the sole owner of National Western, all dividends declared by National Western are payable entirely to NWLGI and are eliminated in consolidation. National Western is restricted by state insurance laws as to dividend amounts which may be paid to stockholders without prior approval from the Colorado Division of Insurance. The restrictions are based on the lesser of statutory earnings from operations, excluding capital gains, or 10% of statutory surplus of National Western as of the previous year-end. Under these guidelines, the maximum dividend payment which may be made without prior approval in 2023 is $66.5 million. National Western did not declare or pay cash dividends to NWLGI during the nine months ended September 30, 2023. Dividends in the amount of $2.0 million were paid to NWLGI in the nine months ended September 30, 2022.
Ozark National is similarly restricted under the state insurance laws of Missouri as to dividend amounts which may be paid to stockholders without prior approval to the greater of 10.0% of the statutory surplus of the company from the preceding year-end or the company's net gain from operations, excluding capital gains, from the prior calendar year. Based upon this restriction, the maximum dividend payment which may be made in 2023 without prior approval is $21.6 million. All dividends declared by Ozark National are payable entirely to NWLIC as the sole owner and are eliminated in consolidation. Ozark National did not declare or pay cash dividends to NWLIC during the nine months ended September 30, 2023 and 2022.
NIS is restricted under FINRA rules as to the maximum dividend amounts that can be paid out to stockholders. Maximum allowable dividend amounts are determined based on calculations which require that certain net capital thresholds be maintained after dividends are paid out. Under these guidelines, the maximum dividend payment amount at December 31, 2022 was $13.6 million. During the nine months ended September 30, 2023, NIS declared and paid a $12.0 million dividend to NWLGI as its sole stock owner. No dividends were declared or paid in the nine months ended September 30, 2022. All dividends declared and paid by NIS are eliminated in consolidation.
The Company entered into an agreement and plan of merger on October 8, 2023 with S. USA Life Insurance Company Inc. and PGH Merger Inc. At the effective time of the merger, each issued and outstanding share of Class A Common Stock and Class B Common Stock will be converted into the right to receive $500.00 per share in cash, without interest.
NWLGI did not declare or pay cash dividends on its common shares during the nine months ended September 30, 2023 and 2022. Under the terms of the merger agreement, the Company is not permitted to pay cash dividends prior to the closing of the merger, except for annual cash dividends of not more than $0.36 per share on Class A Common Stock ($0.18 per share for Class B Common Stock), consistent with the Company's historical payment schedule. Accordingly, on October 26, 2023, the Company's board of directors declared a cash dividend in the respective per share amounts described above, payable December 1, 2023 to stockholders of records as of November 6, 2023.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(4) EARNINGS PER SHARE
Basic earnings per share of common stock are computed by dividing net earnings available to each class of common stockholders on an as if distributed basis by the weighted-average number of common shares outstanding for the period. Diluted earnings per share, by definition, reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock, that then shared in the distributed earnings of each class of common stock. U.S. GAAP requires a two-class presentation for the Company's two classes of common stock. The Company currently has no share-based compensation awards outstanding that could be redeemed for shares of common stock.
As previously described in Note (1) Consolidation and Basis of Presentation and Note (2) New Accounting Pronouncements, the results for the three and nine months ended September 30, 2022 have been restated for the adoption of Accounting Standards Update 2018-12 Financial Services-Insurance (Topic 944) - Targeted Improvements to the Accounting for Long-Duration Contracts. Accordingly, the earnings per share information presented in the following table for the three and nine months ended September 30, 2022 has been updated and differs from that previously reported.
Net earnings for the periods shown below are allocated between Class A shares and Class B shares based upon (1) the proportionate number of shares issued and outstanding as of the end of the period, and (2) the per share dividend rights of the two classes under the Company's Restated Certificate of Incorporation (the Class B dividend per share is equal to one-half the Class A dividend per share).
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(5) DEFERRED TRANSACTION COSTS
Deferred transaction costs include deferred policy acquisition costs ("DPAC"), deferred sales inducements ("DSI"), value of business acquired ("VOBA"), and cost of reinsurance ("COR").
Deferred policy acquisition costs ("DPAC") include certain costs of successfully acquiring new insurance business, including commissions and other expenses related directly to the production of new business (indirect or unsuccessful acquisition costs, maintenance, product development and overhead expenses are charged to expenses as incurred). Also included are premium bonuses and bonus interest credited to contracts during the first contract year only which are recorded as deferred sales inducements ("DSI").
Prior to the adoption of LDTI, DPAC and DSI balances were amortized in relation to the present value of expected gross profits for interest sensitive universal life and annuity products, and over the premium paying period for nonparticipating traditional life products proportional to the ratio of annual premium revenues to total anticipated premium revenues. Under LDTI guidance, deferred policy acquisition costs and deferred sales inducements are amortized on a constant level cohort basis over the expected term of the contracts approximating a straight-line amortization on an individual contract basis. Contracts are grouped consistent with the groupings used to estimate the liability for future policy benefits. The constant-level basis for amortizing DAC is generally in proportion to the initial face amount of life insurance in force for life insurance policies, in proportion to deposits for deferred annuity contracts, and in proportion to annual benefit payments for annuity contracts in payout mode.
The Company is required to write off deferred policy acquisition costs and unearned revenue liabilities upon internal replacement of certain contracts as well as annuitizations of deferred annuities. All insurance and investment contract modifications and replacements are reviewed to determine if the internal replacement results in a substantially changed contract. If so, the acquisition costs, sales inducements and unearned revenue associated with the new contract are deferred and amortized over the lifetime of the new contract. In addition, the existing deferred policy acquisition costs, sales inducement costs and unearned revenue balances associated with the replaced contract are written off. If an internal replacement results in a substantially unchanged contract, the acquisition costs, sales inducements and unearned revenue associated with the new contract are immediately recognized in the period incurred. In addition, the existing deferred policy acquisition costs, sales inducement costs or unearned revenue balance associated with the replaced contract are not written off, but instead are carried over to the new contract.
Current period amortization of DPAC and DSI is impacted by changes in actual insurance in force during the period as well as changes in future assumptions as of the end of each reporting period, where applicable. Assumptions used for DPAC are consistent with those used in estimating the liability for future policy benefits (or any other related balance) for the corresponding contracts. Determining the level of aggregation and actuarial assumptions used in projecting in force terminations requires judgment.
The value of insurance in force business acquired ("VOBA") is a purchase accounting convention for life insurance companies in business combinations based upon an actuarial determination of the difference between the fair value of policy liabilities acquired and the same policyholder liabilities measured in accordance with the acquiring company's accounting policies. The difference, referred to as VOBA, is an intangible asset subject to periodic amortization. It represents the portion of the purchase price allocated to the value of the rights to receive future cash flows from the business in force at the acquisition date. The Company performs recoverability testing of VOBA consistent with the recoverability analysis performed for DPAC and DSI balances. Under LDTI guidance, VOBA is amortized on the same basis used for DPAC and DSI balances.
The Cost of Reinsurance ("COR") asset represents the amount of assets transferred at the closing date of a funds withheld agreement (debt securities, policy loans, and cash) in excess of the GAAP liability ceded plus a $48.0 million ceding commission paid to the reinsurer. The original COR balance of $102.8 million is amortized commensurate with the runoff of the ceded block of funds withheld business and the amortization expense is reported in the Condensed Consolidated Statements of Earnings.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Cost of Reinsurance - A summary of information related to COR is provided in the following table.
Nine Months Ended September 30,
2023
2022
SPIAs WLC
Annuities excl. SPIAs WLC
SPIAs WLC
Annuities excl. SPIAs WLC
(In thousands)
Balance, beginning of period
$
11,897
66,431
12,591
77,095
Additions
—
—
—
—
Amortization
(604)
(7,779)
(503)
(7,689)
Experience Adjustment
—
—
—
—
Balance as of end of period
$
11,293
58,652
12,088
69,406
The following table summarizes the COR balance by product line as of the end of the following periods.
September 30,
2023
2022
(In thousands)
SPIAs with life contingencies
$
11,293
12,088
Annuities, excl. SPIAs with life contingencies
58,652
69,406
Total
$
69,945
81,494
(6) POLICYHOLDER OBLIGATIONS
For universal life and annuity contracts, the liability for future policy benefits represents the account balance. Fixed-index products combine features associated with traditional fixed annuities and universal life contracts, with the option to have interest rates linked in part to an equity index. In accordance with GAAP guidance, the equity return component of such policy contracts must be identified separately and accounted for as embedded derivatives. The remaining portions of these policy contracts are considered the host contracts and are recorded separately as fixed annuity or universal life contracts. The host contracts are accounted for under GAAP guidance provisions that require debt instrument type accounting. The host contracts are recorded as discounted debt instruments that are accreted, using the effective yield method, to their minimum account values at their projected maturities or termination dates.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
A liability for future policy benefits, which is the present value of estimated future policy benefits to be paid to or on behalf of policyholders and certain related expenses less the present value of estimated future net premiums to be collected from policyholders, is accrued as premium revenue is recognized. Under GAAP, the liability for future policy benefits on traditional life products has been calculated using assumptions as to future mortality and withdrawals based on Company experience. Contracts are grouped into cohorts by product features and issue year. The liability is adjusted for differences between actual and expected experience. With the exception of the expense assumption, the Company reviews its historical and future cash flow assumptions quarterly and updates the net premium ratio used to calculate the liability each time the assumptions are changed. Each quarter, the Company updates its estimate of cash flows expected over the entire life of a group of contracts using actual historical experience and current future cash flow assumptions. These updated cash flows are used to calculate the revised net premiums and net premium ratio, which are used to derive an updated liability for future policy benefits as of the beginning of the current reporting period, discounted at the original contract issuance discount rate. This amount is then compared to the carrying amount of the liability as of that same date, before the updating of cash flow assumptions, to determine the current period change in liability estimate. This current period change in the liability is the liability remeasurement gain or loss and is presented as a separate component of benefit expense in the Condensed Consolidated Statements of Earnings. In subsequent periods, the revised net premiums are used to measure the liability for future policy benefits, subject to future revisions.
The discount rate assumption is an equivalent single rate that is derived based on A-credit-rated fixed-income instruments with similar duration to the liability. The Company selects fixed-income instruments that have been A-rated by one of the major credit rating agencies, such as Moody's, Standard & Poor's, or Fitch. The discount rate assumption is updated quarterly and used to remeasure the liability at the reporting date, with the resulting change reflected in other comprehensive income. For liability cash flows that are projected beyond the duration of market-observable A-credit-rated fixed-income instruments, the Company uses the last market-observable yield level, and uses linear interpolation to determine yield assumptions for durations that do not have market-observable yields.
The embedded derivatives are recorded at fair value. The fair value of the embedded derivative component of policy benefit reserves is estimated at each valuation date by (a) projecting policy and contract values and minimum guaranteed values over the expected lives of the policies and contracts and (b) discounting the excess of the projected value amounts at the applicable risk free interest rates adjusted for nonperformance risk related to those liabilities. The projections of policy and contract values are based upon best estimate assumptions for future policy growth and future policy decrements. Best estimate assumptions for future policy growth includes assumptions for the expected index credit on the next policy anniversary date which are derived from the fair values of the underlying call options purchased to fund such index credits and the expected costs of annual cost options purchased in the future to fund index credits beyond the next policy anniversary. The projections of minimum guaranteed contract values include the same best estimate assumptions for policy decrements as were used to project policy contract values.
Other policy claims and benefits - Unearned revenue reserves are maintained that reflect the unamortized balance of charges assessed to interest sensitive contract holders which serve as compensation for services to be performed over future periods (policy premium loads). These charges have been deferred and are being recognized in income over the period benefited using the same assumptions and factors used to amortize deferred acquisition costs.
In both 2022 and 2023, the Company updated the net premium ratio for actual historical experience each quarter. Future cash flow assumptions are reviewed each quarter and are updated in the third quarter.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Liability for Policyholder Account Balances - The Company recognizes a liability for policyholder account balances, which includes universal life products and annuities other than single premium immediate annuities with life contingencies. The following tables summarize balances and changes in the Liability for policyholder account balances.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
The following table presents the account values by range of guaranteed minimum crediting rates and the related range of difference, in basis points, between rates being credited to policyholders and the respective guaranteed minimums.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Additional Liability for Benefits in Excess of Account Balances And Liability for Future Policy Benefits - The following table provides the balances and changes in insurance liabilities related to universal life and annuities that are in addition to the account balance, including annuitization benefits and death or other insurance benefits.
Nine Months Ended September 30, 2023
Domestic Universal Life
International Universal Life
Annuities
(In thousands)
Balance, beginning of period
$
63,804
46,402
38,502
Beginning balance before shadow reserve adjustments
63,804
46,402
38,502
Effect of changes in cash flow assumptions
1,870
6,055
(1,759)
Effect of actual variances from expected experience
5,898
(736)
625
Adjusted beginning of period balance
71,572
51,721
37,368
Issuances
—
—
—
Interest accrual
950
340
1,093
Assessments collected
15,875
7,546
(98)
Benefit payments
(18,318)
(7,610)
(1,343)
Derecognition (lapses and withdrawals)
—
—
—
Other
(39)
(1,002)
(15)
Ending balance before shadow reserve adjustments
70,040
50,995
37,005
Effect of shadow reserve adjustments
—
—
—
Balance, end of period
70,040
50,995
37,005
Less reinsurance recoverable, end of period
—
—
(37,005)
Net additional liability, after reinsurance recoverable
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Nine Months Ended September 30, 2022
Domestic Universal Life
International Universal Life
Annuities
(In thousands)
Balance, beginning of period
$
54,097
48,336
12,718
Beginning balance before shadow reserve adjustments
54,097
48,336
12,718
Effect of changes in cash flow assumptions
3,844
(18)
24,599
Effect of actual variances from expected experience
5,493
7,118
1,843
Adjusted beginning of period balance
63,434
55,436
39,160
Issuances
—
—
—
Interest accrual
1,993
1,154
589
Assessments collected
13,436
6,011
(69)
Benefit payments
(16,031)
(15,768)
(1,146)
Derecognition (lapses and withdrawals)
—
—
—
Other
(30)
524
(9)
Ending balance before shadow reserve adjustments
62,802
47,357
38,525
Effect of shadow reserve adjustments
—
—
—
Balance, end of period
62,802
47,357
38,525
Less reinsurance recoverable, end of period
—
—
(38,525)
Net additional liability, after reinsurance recoverable
$
62,802
47,357
—
The following table summarizes the Additional liability for benefits in excess of account balance by line of business as of the end of the following periods.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
The following table provides the amount of gross assessments and interest expense related to annuitization and death or other insurance benefits recognized in the Condensed Consolidated Statements of Earnings related to additional insurance liabilities.
Gross Assessments
Interest Expenses
Nine Months Ended September 30,
Nine Months Ended September 30,
2023
2022
2023
2022
(In thousands)
Domestic universal life
$
45,525
39,029
950
1,993
International universal life
30,401
25,005
340
1,154
Annuities
(127)
(2,952)
1,093
589
Total
$
75,799
61,082
2,383
3,736
The following tables summarize balances and changes in the Liability for future policy benefits balance for traditional life contracts and single premium immediate annuities with life contingencies.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
The following table summarizes the net Liability for future policy benefits by product line as of the end of the following periods.
September 30,
2023
2022
(In thousands)
Domestic traditional life
$
65,784
69,395
International traditional life
60,857
64,298
SPIAs with life contingencies
182,468
191,784
ONL & Affiliates
534,527
596,775
Total
$
843,636
922,252
The following tables summarize the amount of revenue and interest related to traditional life contracts and single premium immediate annuities with life contingencies recognized in the Condensed Consolidated Statements of Earnings.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
The following table provides the amount of undiscounted expected gross premiums and expected future benefits and expenses for traditional life contracts and single premium immediate annuities with life contingencies.
September 30,
2023
2022
Expected Future Gross Premiums
Expected Future Benefit Payments
Expected Future Gross Premiums
Expected Future Benefit Payments
(In thousands)
Domestic traditional life
$
32,013
103,177
33,319
108,001
International traditional life
162,304
221,506
163,976
225,183
SPIAs with life contingencies
—
281,949
—
291,505
ONL & Affiliates
1,411,244
2,272,002
953,990
1,704,224
Total
$
1,605,561
2,878,634
1,151,285
2,328,913
The following tables summarize the annualized actual experience and expected experience for mortality and lapses of the Liability for future policy benefits and the Additional liability for benefits in excess of account balance.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
2023
2022
Actual Experience
Expected Experience
Actual Experience
Expected Experience
Lapses:
Domestic traditional life
4.36%
6.02%
6.91%
6.51%
International traditional life
8.35%
7.75%
8.03%
7.92%
Domestic universal life
5.68%
3.40%
4.74%
4.69%
International universal life
11.94%
6.92%
8.39%
7.16%
SPIAs with life contingencies
N/A
N/A
N/A
N/A
Annuities excl. SPIAs with life contingencies
6.20%
4.27%
4.05%
4.24%
ONL & Affiliates
4.24%
4.75%
3.90%
7.96%
The following table provides the weighted-average durations in years of the Liability for future policy benefits and the Additional liability for benefits in excess of account balance.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
The following table provides the weighted-average interest rates for the Liability for future policy benefits and the Additional liability for benefits in excess of account balance.
Interest Accretion Rate
Current Discount Rate
September 30,
September 30,
2023
2022
2023
2022
Domestic traditional life
6.73%
6.80%
5.60%
5.30%
Domestic universal life
4.56%
0.98%
4.56%
0.98%
International traditional life
5.16%
5.24%
5.60%
5.30%
International universal life
1.93%
1.53%
1.93%
1.53%
SPIAs with life contingencies
3.48%
3.36%
5.60%
5.30%
Annuities excl. SPIAs with life contingencies
1.02%
0.93%
1.02%
0.93%
ONL & Affiliates
3.25%
3.25%
6.15%
5.85%
The Company realized actual-expected experience variances but made no changes to assumptions for the periods shown other than the interest rates employed for purposes of calculating discounted values.
(7) MARKET RISK BENEFITS
Market risk benefits are contracts or contract features that both provide protection to the contract holder from other-than-nominal capital market risk and expose the Company to other-than-nominal capital market risk. Market risk benefits include certain contract features on annuity products that provide minimum guarantees to policyholders, such as guaranteed minimum withdrawal benefits, guaranteed annuitization benefits, and guaranteed minimum death benefits. Market risk benefits are measured at fair value using a risk-neutral valuation model based on current net amounts at risk, benefit utilization rates, market data, Company experience, and other factors. Changes in fair value are recognized in net income each period, with the exception of the portion of the change in fair value due to a change in the instrument-specific credit risk, which is recognized in Other comprehensive income.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
The following tables present the balances of and changes in market risk benefits associated with guaranteed minimum withdrawal benefits, guaranteed annuitization benefits, and guaranteed minimum death benefits.
Nine Months Ended September 30, 2023
Guaranteed Minimum Withdrawal Benefits
Guaranteed Annuitization Benefits
Guaranteed Minimum Death Benefits
(In thousands)
Balance, beginning of period
$
97,552
69,466
—
Balance, beginning of period, before effect of changes in instrument-specific credit risk
97,552
69,466
—
Issuances
64
—
—
Interest accrual
—
—
—
Attributed fees collected
37,572
—
—
Benefit payments
—
—
—
Effect of changes in interest rates
(25,485)
(5,426)
—
Effect of changes in equity markets
—
—
—
Effect of changes in equity index volatility
—
—
—
Actual policyholder behavior different from expected behavior
(1,304)
—
—
Effect of changes in future expected policyholder behavior
(173)
—
—
Effect of changes in other future expected assumptions
—
—
—
Balance, end of period, before effect of changes in instrument-specific credit risk
108,226
64,040
—
Effect of changes in the instrument-specific credit risk
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
The following table summarizes Market risk benefits liability balances separately by amounts in an asset position and amounts in a liability position to the Market risk benefits liability amounts as of the end of the following periods.
September 30, 2023
September 30, 2022
Asset
Liability
Net liability
Asset
Liability
Net liability
(In thousands)
Guaranteed minimum withdrawal benefit
$
48,240
156,466
108,226
51,881
133,365
81,484
Guaranteed annuitization benefits
—
64,040
64,040
—
69,266
69,266
Balance, end of period
$
48,240
220,506
172,266
51,881
202,631
150,750
For the periods shown, there were no notable changes made to the inputs to the fair value estimates of market risk benefit calculations other than the interest rates employed for purposes of calculating fair value.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(8) PENSION AND OTHER POSTRETIREMENT PLANS
(A)Defined Benefit Pension Plans
National Western sponsors a qualified defined benefit pension plan covering employees enrolled prior to 2008. The plan provides benefits based on the participants' years of service and compensation. The Company makes annual contributions to the plan that comply with the minimum funding provisions of the Employee Retirement Income Security Act of 1974 ("ERISA"). On October 19, 2007, National Western's Board of Directors approved an amendment to freeze the pension plan as of December 31, 2007. The freeze ceased future benefit accruals to all participants and closed the plan to any new participants. In addition, all participants became immediately 100% vested in their accrued benefits as of that date. As participants are no longer earning a credit for service, future qualified defined benefit plan expense is projected to be minimal. Fair values of plan assets and liabilities are measured as of the prior December 31 for each year. The following table summarizes the components of net periodic benefit cost.
Three Months Ended
Nine Months Ended
September 30,
September 30,
2023
2022
2023
2022
(In thousands)
Service cost
$
27
32
81
98
Interest cost
200
145
599
435
Expected return on plan assets
(311)
(394)
(931)
(1,181)
Amortization of net loss
70
34
209
101
Net periodic benefit cost
$
(14)
(183)
(42)
(547)
The service cost shown above for each period represents plan expenses expected to be paid out of plan assets. Under the clarified rules of the Pension Protection Act, plan expenses paid from plan assets are to be included in the plan's service cost component.
The Company's minimum required contribution for the 2023 plan year is $0.0 million. There were no planned contributions remaining for the 2022 plan year as of September 30, 2023. There were no planned contributions remaining for the 2023 plan year as of September 30, 2023. As of September 30, 2023, the Company has made no contributions to the plan for the 2022 plan year and no contributions to the plan for the 2023 plan year.
The components of net periodic benefit cost including service cost are reported in the line item “Other operating expenses” in the Condensed Consolidated Statements of Earnings.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
National Western also sponsors three non-qualified defined benefit pension plans. The first plan covers certain senior officers and provides benefits based on the participants' years of service and compensation. The primary pension obligations and administrative responsibilities of the plan are maintained by a pension administration firm, which is a subsidiary of American National Group, Inc. ("American National"), previously a related party. In the second quarter of 2022, American National was acquired by Brookfield Asset Management Reinsurance Partners Ltd. (subsequently renamed Brookfield Reinsurance Ltd.) and is therefore no longer a related party of National Western. American National (subsequently reorganized as a Limited Liability Corporation) has guaranteed the payment of pension obligations under the plan. However, the Company has a contingent liability with respect to the plan should these entities be unable to meet their obligations under the existing agreements. Also, the Company has a contingent liability with respect to the plan in the event that a plan participant continues employment with National Western beyond age seventy, the aggregate average annual participant salary increases exceed 10% per year, or any additional employees become eligible to participate in the plan. If any of these conditions are met, NWLGI would be responsible for any additional pension obligations resulting from these items. Amendments were made to the plan to allow an additional employee to participate and to change the benefit formula for Robert L. Moody, Sr., who was then Chairman of the Company. As previously mentioned, these additional obligations are a liability to the Company. Effective December 31, 2004, this plan was frozen with respect to the continued accrual of benefits of the then Chairman and Ross R. Moody (then President of the Company) in order to comply with law changes under the American Jobs Creation Act of 2004 ("Act").
Effective July 1, 2005, National Western established a second non-qualified defined benefit plan for the benefit of Robert L. Moody, Sr., who was then Chairman of the Company. This plan is intended to provide for post-2004 benefit accruals that mirror and supplement the pre-2005 benefit accruals under the previously discussed non-qualified plan, while complying with the requirements of the Act.
On November 7, 2023, Robert L. Moody, Sr., Chairman Emeritus of the Company, passed away. Mr. Moody, Sr.'s wife predeceased him. Accordingly, the Company has no obligation to make any additional payments with respect to Mr. Moody, Sr.'s participation in the qualified pension plan and non-qualified defined benefit plans described above.
Effective November 1, 2005, National Western established a third non-qualified defined benefit plan for the benefit of Ross R. Moody, who was then President of the Company. This plan is intended to provide for post-2004 benefit accruals that supplement the pre-2005 benefit accruals under the first non-qualified plan as previously discussed, while complying with the requirements of the Act.
The following table summarizes the components of net periodic benefit costs for the non-qualified defined benefit plans.
Three Months Ended
Nine Months Ended
September 30,
September 30,
2023
2022
2023
2022
(In thousands)
Service cost
$
203
260
611
779
Interest cost
410
278
1,227
835
Amortization of prior service cost
14
14
44
44
Amortization of net loss
—
585
—
1,754
Net periodic benefit cost
$
627
1,137
1,882
3,412
As the plans are not funded, there is no expected return on plan assets shown in the net periodic benefit cost table above. The Company expects to contribute $2.0 million to these plans in 2023. As of September 30, 2023, the Company had contributed $1.3 million to the plans.
The components of net periodic benefit cost including service cost are reported in the line item “Other operating expenses” in the Condensed Consolidated Statements of Earnings.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Ozark National and NIS have no defined benefit plans.
(B)Postretirement Employment Plans Other Than Pension
National Western sponsors two healthcare plans that were amended in 2004 to provide postretirement benefits to certain fully-vested individuals. The plans are unfunded. The following table summarizes the components of net periodic benefit costs.
Three Months Ended
Nine Months Ended
September 30,
September 30,
2023
2022
2023
2022
(In thousands)
Interest cost
$
60
44
182
130
Amortization of net loss
—
52
—
156
Net periodic benefit cost
$
60
96
182
286
As the plans are not funded, there is no expected return on plan assets shown in the net periodic benefit cost table above. The Company expects to contribute minimal amounts to the plans in 2023. Ozark National and NIS do not offer postemployment benefits.
The components of net periodic benefit cost including service cost are reported in the line item “Other operating expenses” in the Condensed Consolidated Statements of Earnings.
(9) SEGMENT AND OTHER OPERATING INFORMATION
The Company defines its reportable operating segments as domestic life insurance, international life insurance, annuities, and ONL & Affiliates. These segments are organized based on product types, geographic marketing areas, and business groupings. Ozark National and NIS have been combined into a separate segment given its inter-related marketing and sales approach which consists of a coordinated sale of a non-participating whole life insurance product (Ozark National) and a mutual fund investment product (NIS). A fifth category "All Others" primarily includes investments and earnings of non-operating subsidiaries as well as other remaining investments and assets not otherwise supporting specific segment operations. In accordance with GAAP guidance for segment reporting, the Company excludes or segregates realized investment gains and losses.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
A summary of segment information as of September 30, 2023 and December 31, 2022 for the Condensed Consolidated Balance Sheet items and for the three and nine months ended September 30, 2023 and September 30, 2022 for the Condensed Consolidated Statements of Earnings is provided below.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Three Months Ended September 30,
Nine Months Ended September 30,
2023
2022
2023
2022
(In thousands)
Federal Income Taxes:
Total segment Federal income taxes
$
28,713
9,554
38,937
58,546
Taxes on realized gains on investments
5,435
156
5,455
1,323
Total condensed consolidated Federal income taxes
$
34,148
9,710
44,392
59,869
Three Months Ended September 30,
Nine Months Ended September 30,
2023
2022
2023
2022
(In thousands)
Net Earnings:
Total segment earnings
$
44,277
34,599
86,142
224,295
Realized gains on investments, net of taxes
20,448
589
20,521
4,982
Total condensed consolidated net earnings
$
64,725
35,188
106,663
229,277
September 30,
December 31,
2023
2022
(In thousands)
Assets:
Total segment assets
$
11,538,524
12,292,874
Other unallocated assets
520,906
490,071
Total condensed consolidated assets
$
12,059,430
12,782,945
(10) SHARE-BASED PAYMENTS
The Company's stockholders approved an Incentive Plan in 2016 which provides for the grant of any or all of the following types of awards to eligible employees: (1) stock options, including incentive stock options and nonqualified stock options; (2) stock appreciation rights ("SARs"), in tandem with stock options or freestanding; (3) restricted stock or restricted stock units; and (4) performance awards. The number of shares of Class A Common Stock, $0.01 par value, allowed to be issued under the Incentive Plan, cannot exceed 300,000. The Incentive Plan includes additional provisions, most notably regarding the definition of performance objectives which can be used in the issuance of the fourth type of award noted above (performance awards). The term of the Incentive Plan is for ten years from the date of stockholder approval.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
All of the employees of the Company and its subsidiaries are eligible to participate in the Incentive Plan. In addition, directors of the Company are eligible to receive the same types of awards as employees except that they are not eligible to receive incentive stock options. Company directors, including members of the Compensation and Stock Option Committee, are eligible for nondiscretionary stock options. SARs granted prior to 2016 vest 20% annually following three years of service following the grant date. Employee SARs granted 2016 and thereafter vest 33.3% annually following one year of service from the date of the grant. Directors' SARs grants vest 20% annually following one year of service from the date of grant.
The Incentive Plan allows for certain other share or unit awards which are solely paid out in cash based on the value of the Company's shares, or changes therein, as well as the financial performance of the Company under pre-determined target performance metrics. Certain awards, such as restricted stock units ("RSUs") provide solely for cash settlement based upon the market price of the Company's Class A Common Stock, often referred to as "phantom stock-based awards" in equity compensation plans. Unlike share-settled awards, which have a fixed grant-date fair value, the fair value of unsettled or unvested liability awards is remeasured at the end of each reporting period based on the change in fair value of a share. The liability and corresponding expense are adjusted accordingly until the award is settled. For employees, the vesting period for RSUs is 100% at the end of three years from the grant date. RSUs granted prior to 2019 were paid in cash at the vesting date equal to the closing price of the Company's Class A Common Stock on the three year anniversary date. RSUs granted in 2019 and after are payable in cash at the three year vesting date equal to the 20-day moving average closing price of the Company’s Class A Common Stock at that time.
Other awards may involve performance share units ("PSUs") which are units granted at a specified dollar amount per unit, typically linked to the share price of the Class A Common Stock, that are subsequently multiplied by an attained performance factor to derive the number of PSUs to be paid as cash compensation at the vesting date. PSUs also vest three years from the date of grant. For PSUs, the performance period begins the first day of the calendar year for which the PSUs are granted and runs three calendar years. At that time, the three-year performance outcome is measured against the pre-defined target amounts to determine the number of PSUs earned as compensation. PSUs granted prior to 2019 were paid at the closing price of the Class A Common Stock on the vesting date. PSUs granted in 2019 and forward are payable at the 20-day moving average closing price of the Class A Common Stock at the vesting date.
PSU awards covering the three year measurement period ended December 31, 2022 were paid out in the first four months of 2023. The performance factor during the measurement period used to determine compensation payouts was 74.54% of the pre-defined metric target.
PSU awards covering the three year measurement period ended December 31, 2021 were paid out in the first quarter of 2022. The performance factor during the measurement period used to determine compensation payouts was 110.19% of the pre-defined metric target.
Directors of the Company are eligible to receive RSUs under the Incentive Plan. Unlike RSUs granted to officers, the RSUs granted to directors vest one year from the date of grant and are payable in cash at the vesting date equal to the 20-day moving average closing price of the Class A Common Stock at that time.
The following table shows all grants issued to officers and directors during the three and nine months ended September 30, 2023 and 2022. Grants made are based upon the 20-day moving average closing market price of the Company's Class A common share at the grant date.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Nine Months Ended
September 30, 2023
September 30, 2022
Officers
Directors
Officers
Directors
SARs
—
—
—
—
RSUs
—
2,170
—
3,710
PSUs
—
—
—
—
The Company uses the current fair value method to measure compensation costs for awards granted under the share-based plans. As of September 30, 2023 and December 31, 2022, the liability balance was $61.4 million and $20.5 million, respectively. The Company establishes its liability balance for share-based plans and recognizes related compensation cost over the graded vesting periods of each individual award. As disclosed in Note (16) Subsequent Events, the Company entered into an agreement and plan of merger on October 8, 2023 with S. USA Life Insurance Company Inc. and PGH Merger Inc. Under the terms of the merger agreement, all outstanding unvested share-based awards would fully vest at the closing date of the merger agreement which is currently expected to occur sometime in the first half of the 2024 calendar year. As a result, the liability balance and expense amortization for all awards outstanding at September 30, 2023 has been calculated assuming an ultimate amortization ending date of June 30, 2024. The effect of using this date was to increase the share-based liability and related compensation expense by $5.4 million in the three months ended September 30, 2023.
A summary of awards by type and related activity is detailed below.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
SARs, RSUs, and PSUs shown as forfeited in the above tables represent vested and unvested awards not exercised by plan participants upon their termination from the Company in accordance with the expiration provisions of the awards. Furthermore, under the terms of all outstanding SARs, RSUs and PSUs, all such awards may be settled only in cash. Accordingly, no shares of Class A Common Stock are issuable under the terms of such awards.
The total intrinsic value of share-based compensation exercised and paid was $1.8 million and $1.1 million for the nine months ended September 30, 2023 and 2022, respectively. The total fair value of SARs, RSUs, and PSUs vested during the nine months ended September 30, 2023 and 2022 was $1.4 million and $0.1 million, respectively. No cash amounts were received from the exercise of stock options under the Plans during the periods reported on.
The following table summarizes information about SARs outstanding at September 30, 2023.
SARs Outstanding
Number Outstanding
Weighted- Average Remaining Contractual Life
Number Exercisable
Exercise prices:
$210.22
21,650
0.2 years
21,650
$216.48
10,342
2.4 years
10,342
$311.16
7,807
3.4 years
7,807
$334.34
7,443
4.2 years
7,443
$303.77
9,357
5.2 years
9,357
$252.91
16,626
6.2 years
16,626
$192.10
35,861
7.2 years
23,899
$218.44
59,087
8.2 years
19,731
$220.61
109,629
9.2 years
—
Totals
277,802
116,855
Aggregate intrinsic value (in thousands)
$
58,799
$
23,467
The aggregate intrinsic value in the table above is based on the closing Class A Common Stock price of $437.49 per share on September 30, 2023.
The SARs shown above with an exercise price of $210.22 have a remaining contractual life of less than one year. The holders of this grant have until December 11, 2023, the end of the contractual term of the award grant, to exercise these holdings or otherwise forfeit them. The announced agreement and plan of merger noted above may potentially induce incremental exercise activity of vested SARs during the fourth quarter of 2023.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
In estimating the fair value of the SARs outstanding at September 30, 2023 and December 31, 2022, the Company employed the Black-Scholes option pricing model with assumptions detailed below.
September 30, 2023
December 31, 2022
Expected term
0.2 to 0.8 years
0.9 to 6.7 years
Expected volatility weighted-average
40.06
%
36.18
%
Expected dividend yield
0.08
%
0.13
%
Risk-free rate weighted-average
5.50
%
4.19
%
The Company reviewed the contractual term relative to the SARs as well as perceived future behavior patterns of exercise. Volatility is based on the Company’s historical volatility over the expected term of the SARs by expected exercise date. As noted previously, the Company made an adjustment at September 30, 2023 assuming the expected term of outstanding SARs to coincide with an estimated closing date of June 30, 2024 for the announced agreement and plan of merger.
The pre-tax compensation cost/(benefit) recognized in the Condensed Consolidated Financial Statements related to these plans was $11.3 million and $43.6 million in the three and nine months ended September 30, 2023, and $(1.2) million and $1.4 million in the three and nine months ended September 30, 2022, respectively. The related tax expense/(benefit) recognized was $(2.4) million and $(9.2) million in the three and nine months ended September 30, 2023 and $0.2 million and $(0.3) million in the three and nine months ended September 30, 2022, respectively. Compensation expense for the three and nine months ended September 30, 2023 is indicative of the Class A Common Stock price increasing from $281.00 per share at December 31, 2022 and $242.62 per share at March 31, 2023 to $415.56 per share at June 30, 2023 and $437.49 per share at September 30, 2023.
As of September 30, 2023, the total pre-tax compensation expense related to non-vested share-based awards not yet recognized was $16.8 million. This amount is expected to be recognized over a weighted-average period of 0.8 years.
(11) COMMITMENTS AND CONTINGENCIES
(A) Legal Proceedings
In the normal course of business, the Company is involved or may become involved in various legal actions in which claims for alleged economic and punitive damages have been or may be asserted, some for substantial amounts. In recent years, carriers offering life insurance and annuity products have faced litigation, including class action lawsuits, alleging improper product design, improper sales practices, and similar claims. As previously disclosed, the Company has been a defendant in prior years in such class action lawsuits. Given the uncertainty involved in these types of actions, the ability to make a reliable evaluation of the likelihood of an unfavorable outcome or an estimate of the amount of or range of potential loss is endemic to the particular circumstances and evolving developments of each individual matter on its own merits.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
In April of 2019, National Western defended a two-week jury trial in which it was alleged that the Company committed actionable Financial Elder Abuse in its issuance of a $100,000 equity indexed annuity to the Plaintiff in the case of Williams v Pantaleoni et al, Case No. 17CV03462, Butte County California Superior Court. The Court entered an Amended Judgment on the Jury Verdict on July 27, 2019 against National Western in the amount of $14,949 for economic damages and $2.9 million in non-economic and punitive damages. National Western vigorously disputed the verdicts and the amounts awarded, and in furtherance of such, filed a Motion for Judgment Notwithstanding Jury Verdict and a Motion for New Trial, both of which were rejected by the Court. On September 9, 2019, NWLIC filed its Notice of Appeal. On November 11, 2019, the judge awarded the Plaintiff attorney’s fees in the amount of $1.26 million. Both the Plaintiff and NWLIC appealed this ruling. On June 11, 2021, the appellate court reversed the judgment and directed the trial court to enter judgment in favor of NWLIC. Plaintiff then filed an appeal with the Supreme Court of California. On September 22, 2021, the California Supreme Court granted review and transferred the case back to the appellate court with instructions to vacate its decision and reconsider its finding that Mr. Pantaleoni did not have an agency relationship with NWLIC. On March 4, 2022, the appellate court filed an opinion completely striking the award of punitive damages that had been in the amount of $2.5 million, affirming economic damages of $14,949 and non-economic damages of $420,000, and awarding Plaintiff costs on appeal. The appellate court remanded the case to the trial court to reconsider the attorney fee award of $1.26 million in light of the reversal of punitive damages. Upon petitions for rehearing separately filed by both parties, the appellate court vacated its March 4th decision. On May 10, 2022, the appellate court filed its new opinion once again completely striking the award of punitive damages that had been in the amount of $2.5 million, affirming economic damages of $14,949 and non-economic damages of $420,000, and awarding Plaintiff costs on appeal. The appellate court again remanded the case to the trial court to reconsider the attorney fee award of $1.26 million in light of the reversal of punitive damages. The California Supreme Court denied National Western’s appeal while ordering the appellate decision depublished. This denial made the appellate court’s decision final, which was to strike the award of punitive damages, to affirm the award of economic damages of $14,949 and non-economic damages of $420,000, and to award Plaintiff costs on appeal. The trial court subsequently awarded Plaintiff appellate costs of $538,461, and reduced Plaintiff's trial fees to $842,380. The parties agreed to a judgment, and final payment of fees was tendered by the Company in January 2023. The amount was accrued for and included in the Company's financial statements for the year ended December 31, 2022.
In the Form 10-Q for the three months ended September 30, 2020, the Company reported that it experienced a data event in which an intruder accessed and exfiltrated certain data from the Company's network and that it was aware of two proposed class actions filed against National Western: Mildred Baldwin, on behalf of herself and others similarly situated vs. National Western Life Insurance Company, Missouri Circuit Court for the 18th Judicial Circuit (Pettis County) filed February 16, 2021, and Douglas Dyrssen Sr., individually and on behalf of all others similarly situated vs. National Western Life Insurance Company and National Western Life Group, Inc., United States District Court for the Eastern District of California filed March 8, 2021. The parties subsequently agreed to consolidate those two proposed class actions into a single proposed class action, Mildred Baldwin, on behalf of herself and others similarly situated vs. National Western Life Insurance Company, United States District Court for the Western District of Missouri. Baldwin was seeking an undetermined amount of damages, attorneys' fees and costs, injunctive relief, declaratory and other equitable relief, and enjoinment. National Western filed a Motion to Dismiss on July 16, 2021. On July 26, 2021, the parties filed a Joint Motion to Stay Pending Mediation, which the court denied.On September 15, 2021, the court granted in part and denied in part National Western’s Motion to Dismiss. At a mediation held on October 12, 2021, the parties agreed on preliminary terms to settle the litigation. The parties filed a Joint Notice of Settlement and Motion to Stay Deadlines with the court on October 20, 2021. The Company accrued $4.4 million for this matter at December 31, 2021. The Court issued an order preliminarily approving the settlement on January 19, 2022. The Court issued an order granting final approval of the settlement on June 16, 2022. The ultimate payments due under the settlement terms were paid in 2022.
The Company was informed by the Internal Revenue Service (“IRS”) that it had countersigned a previously negotiated closing agreement effective February 11, 2022 (“Agreement”) by and between National Western and the Commissioner of Internal Revenue pertaining to an open matter regarding the tax status of certain of the Company’s international life insurance products. Under terms of the Agreement, the Company remitted to the IRS a payment in the amount of $4.9 million within sixty days of the effective date of the Agreement and agreed to make stipulated adjustments to the policies covered under the Agreement within ninety days of the effective date. The Company had previously accrued for this contingency in a financial statement period predating the financial statements for the three years ended December 31, 2022.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
The agreement and plan of merger described above (the "Merger Agreement") contains certain termination rights for both the Company and S.USA. If the Merger has not closed by July 8, 2024 (the “Outside Date”), either the Company or S.USA may terminate the Merger Agreement. However, if the closing has not occurred because the required insurance regulatory approvals have not been obtained, and all other conditions to closing have been satisfied (other than those conditions that by their terms are to be satisfied at the closing, each of which is capable of being satisfied at the closing) or waived, the Outside Date will be automatically extended to October 8, 2024. The Merger Agreement requires the Company to pay S.USA a $66.5 million termination fee under certain circumstances. Specifically, a termination fee would be payable by the Company if:
▪S.USA terminates the Merger Agreement due to the occurrence of a Company terminable breach and (i) a competing proposal was announced after the date of the Merger Agreement but prior to the termination that was not withdrawn and (ii) within 12 months after the termination, the Company enters into a definitive agreement with respect to, or otherwise consummates, the competing proposal (or does not oppose it, in the case of a tender or exchange offer);
▪The Company or S.USA terminates the Merger Agreement because of the Company’s failure to obtain the required vote at a duly held meeting of its stockholders and (i) a competing proposal was announced after the date of the Merger Agreement but prior to the termination that was not withdrawn and (ii) within 12 months after the termination, the Company enters into a definitive agreement with respect to, or otherwise consummates, the competing proposal (or does not oppose it, in the case of a tender or exchange offer);
▪S.USA terminates the Merger Agreement because prior to receipt of Company stockholder approval there has been a change in the NWLGI board of directors’ recommendation, regardless of whether permitted by the Merger Agreement; or
▪the Company terminates the Merger Agreement prior to the receipt of Company stockholder approval in order to enter into a definitive written agreement providing for a superior proposal received after the signing of the Merger Agreement that did not result from a breach of the nonsolicitation covenant binding on the Company and the Company complied with the nonsolicitation covenant’s requirements binding on the Company.
(B) Financial Instruments
In order to meet the financing needs of its customers in the normal course of business, the Company is a party to financial instruments with off-balance sheet risk. These financial instruments are commitments to extend credit which involve elements of credit and interest rate risk in excess of the amounts recognized in the Condensed Consolidated Balance Sheets.
The Company's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit is represented by the contractual amounts, assuming that the amounts are fully advanced and that collateral or other security is of no value. Commitments to extend credit are legally binding agreements to lend to a customer that generally have fixed expiration dates or other termination clauses and may require payment of a fee. Commitments do not necessarily represent future liquidity requirements, as some could expire without being drawn upon. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. The Company controls the credit risk of these transactions through credit approvals, limits, and monitoring procedures.
The Company had no commitments to fund new loans and $25.3 million commitments to extend credit relating to existing loans at September 30, 2023. The Company evaluates each customer's creditworthiness on a case-by-case basis. The Company also had open commitments to make capital contributions to alternative investment debt and equity funds of $177.2 million as of September 30, 2023. The Company had unfunded commitments on private placements of $0.0 million and unfunded commitments on revolver loans of $0.0 million as of September 30, 2023.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(12) INVESTMENTS
(A)Investment Gains and Losses
The Company uses the specific identification method in computing realized gains and losses. The table below presents realized gains and losses for the periods indicated.
Three Months Ended September 30,
Nine Months Ended September 30,
2023
2022
2023
2022
(In thousands)
Available-for-sale debt securities:
Realized gains on disposal
$
231
27
344
5,254
Realized losses on disposal
—
(190)
—
(193)
Real estate gains (losses)
—
908
(20)
1,244
Other
25,652
—
25,652
—
Totals
$
25,883
745
25,976
6,305
For the three months ended September 30, 2023 and 2022, the percentage of total gains (losses) on bonds due to the call of securities was 100.0% and 100.0%, respectively. For the nine months ended September 30, 2023 and 2022 the percentage of total gains on bonds due to the call of securities was 81.6% and 92.2%, respectively.
The Other realized gain in the three and nine months ended September 30, 2023 represents the tender of shares held in Moody Bancshares, Inc. The Company's cost basis in the shares was $195,000 and the tender proceeds approximated $25.8 million.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(B)Debt Securities
The table below presents amortized costs and fair values of debt securities available-for-sale at September 30, 2023.
Debt Securities Available-for-Sale
Amortized Cost
Gross Unrealized Gains
Gross Unrealized Losses
Fair Value
Allowance for Credit Losses
(In thousands)
U.S. agencies
$
12,102
—
(460)
11,642
—
U.S. Treasury
2,820
—
(141)
2,679
—
States and political subdivisions
454,240
97
(79,618)
374,719
—
Foreign governments
62,951
—
(19,551)
43,400
—
Public utilities
611,901
—
(76,290)
535,611
—
Corporate
5,665,482
9
(648,756)
5,016,735
—
Commercial mortgage-backed
22,452
—
(2,023)
20,429
—
Residential mortgage-backed
265,707
3
(19,150)
246,560
—
Asset-backed
896,488
300
(96,009)
800,779
—
Totals
$
7,994,143
409
(941,998)
7,052,554
—
The table below presents amortized costs and fair values of debt securities available-for-sale at December 31, 2022.
Debt Securities Available-for-Sale
Amortized Cost
Gross Unrealized Gains
Gross Unrealized Losses
Fair Value
Allowance for Credit Losses
(In thousands)
U.S. agencies
$
21,003
—
(377)
20,626
—
U.S. Treasury
2,813
6
(90)
2,729
—
States and political subdivisions
476,338
668
(65,507)
411,499
—
Foreign governments
62,964
—
(17,076)
45,888
—
Public utilities
681,785
117
(66,765)
615,137
—
Corporate
6,199,886
1,940
(570,255)
5,631,571
—
Commercial mortgage-backed
21,965
—
(1,680)
20,285
—
Residential mortgage-backed
337,186
183
(16,338)
321,031
—
Asset-backed
634,820
168
(92,121)
542,867
—
Totals
$
8,438,760
3,082
(830,209)
7,611,633
—
Unrealized losses for debt securities available-for-sale increased at September 30, 2023 from comparable balances at December 31, 2022 primarily due to increases in interest rate levels during the period. The ten-year U.S. Treasury bond increased 69 basis points during the nine months ended September 30, 2023.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Debt securities balances at September 30, 2023 and December 31, 2022 include Ozark National holdings of $663.0 million and $674.8 million, respectively, in available-for-sale.
The following table shows the gross unrealized losses and fair values of the Company's available-for-sale debt securities by investment category and length of time the individual securities have been in a continuous unrealized loss position at September 30, 2023.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
The following table shows the gross unrealized losses and fair values of the Company's available-for-sale debt securities by investment category and length of time that the individual securities have been in a continuous unrealized loss position at December 31, 2022.
Debt Securities Available-for-Sale
Less than 12 Months
12 Months or Greater
Total
Fair Value
Unrealized Losses
Fair Value
Unrealized Losses
Fair Value
Unrealized Losses
(In thousands)
U.S. agencies
$
20,626
(377)
—
—
20,626
(377)
U.S. Treasury
1,749
(90)
—
—
1,749
(90)
States and political subdivisions
346,009
(55,014)
28,420
(10,493)
374,429
(65,507)
Foreign governments
22,591
(7,658)
23,296
(9,420)
45,887
(17,078)
Public utilities
601,824
(61,970)
10,747
(4,795)
612,571
(66,765)
Corporate
4,985,075
(432,492)
434,625
(137,763)
5,419,700
(570,255)
Commercial mortgage-backed
20,285
(1,680)
—
—
20,285
(1,680)
Residential mortgage-backed
307,410
(16,338)
—
—
307,410
(16,338)
Asset-backed
368,132
(59,936)
156,719
(32,185)
524,851
(92,121)
Totals
$
6,673,701
(635,555)
653,807
(194,656)
7,327,508
(830,211)
Debt securities. The gross unrealized losses for debt securities are made up of 1,076 individual issues, or 97.6% of the total debt securities held available-for-sale by the Company at September 30, 2023. The market value of these bonds as a percent of amortized cost approximates 88.0%. Of the 1,076 securities, 966, or 89.8%, fall in the 12 months or greater aging category and 1,060 were rated investment grade at September 30, 2023.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
The amortized cost and fair value of investments in debt securities available-for-sale at September 30, 2023, by contractual maturity, are shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Debt Securities Available-for-Sale
Amortized Cost
Fair Value
(In thousands)
Due in 1 year or less
$
845,731
835,118
Due after 1 year through 5 years
2,725,641
2,576,629
Due after 5 years through 10 years
1,303,748
1,123,633
Due after 10 years
1,934,376
1,449,406
6,809,496
5,984,786
Mortgage and asset-backed securities
1,184,647
1,067,768
Totals before allowance for credit losses
7,994,143
7,052,554
Allowance for credit losses
—
—
Totals
$
7,994,143
7,052,554
The Company determines current expected credit losses for available-for-sale debt securities when fair value is less than amortized cost, interest payments are missed, and the security is experiencing credit issues. Provisions to and releases from the allowance for credit losses are recorded in net investment income in the Condensed Consolidated Statements of Earnings. Based on its review, the Company determined none of these investments required an allowance for credit loss at September 30, 2023 or December 31, 2022. The Company's operating procedures include monitoring the investment portfolio on an ongoing basis for any changes in issuer facts and circumstances that might lead to future need for a credit loss allowance.
(C)Transfer of Securities
During the nine months ended September 30, 2023 and 2022, the Company made no transfers between debt securities available-for-sale and trading. The Company does not classify any debt securities as held-to-maturity.
(D) Mortgage Loans and Real Estate
A financing receivable is a contractual right to receive money on demand or on fixed or determinable dates that is recognized as an asset in a company’s statement of financial position. The Company’s mortgage, participation and mezzanine loans on real estate are the only financing receivables included in the Condensed Consolidated Balance Sheets.
In general, the Company originates loans on high quality, income-producing properties such as shopping centers, freestanding retail stores, office buildings, storage units, industrial and sales or service facilities, selected apartment buildings, hotels, and health care facilities. The location of these properties are typically in major metropolitan areas that offer a potential for property value appreciation. Credit and default risk are minimized through strict underwriting guidelines and diversification of underlying property types and geographic locations. In addition to being secured by the property, mortgage loans with leases on the underlying property are supported by the lease payments. This approach has proven to result in quality mortgage loans with few defaults. Mortgage loan interest income is recognized on an accrual basis with any premium or discount amortized over the life of the loan. Prepayment and late fees are recorded on the date of collection.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
The Company targets a minimum specified yield on mortgage loan investments determined by reference to currently available debt security instrument yields plus a desired amount of incremental basis points. A low interest rate environment and a competitive marketplace, have resulted in fewer loan opportunities being available meeting the Company's required rate of return. The subsequent rapid rise in interest rate levels beginning in 2022 caused potential mortgage loan opportunities to fall outside the Company's underwriting criteria further causing a lower level of originations. Mortgage loans originated by the Company totaled $6.8 million in the nine months ended September 30, 2023 compared with $45.4 million in the nine months ended September 30, 2022 and $47.4 million in the year ended December 31, 2022.
Loans in foreclosure, loans considered impaired or loans past due 90 days or more are placed on a non-accrual status. If a mortgage loan is determined to be on non-accrual status, the mortgage loan does not accrue any revenue into the Condensed Consolidated Statements of Earnings. The loan is independently monitored and evaluated as to potential impairment or foreclosure. If delinquent payments are made and the loan is brought current, then the Company returns the loan to active status and accrues income accordingly. The Company had no mortgage loans past due 90 days or more at September 30, 2023 or 2022 and as a result all interest income was recognized at September 30, 2023 and 2022.
Included in the mortgage loan investment balance at September 30, 2023 and December 31, 2022 were three mortgage loan investments made by Prosperity under the funds withheld reinsurance agreement totaling $19.3 million and $19.3 million, respectively. The Company has elected fair value measurement for these mortgage loans, and similar to trading debt securities, these loans are reported at fair market values in order to allow the market value fluctuation to be recorded directly in the Condensed Consolidated Statements of Earnings and to offset the embedded derivative liability change due to market value fluctuations.
The following table represents the mortgage loan portfolio by loan-to-value ratio.
September 30, 2023
December 31, 2022
Amount
%
Amount
%
(In thousands)
(In thousands)
Mortgage Loans by Loan-to-Value Ratio (1):
Less than 50%
$
114,675
23.1
$
100,757
19.7
50% to 60%
158,291
31.9
145,093
28.4
60% to 70%
192,448
38.8
217,445
42.6
70% to 80%
30,183
6.2
47,300
9.3
Gross balance
495,597
100.0
510,595
100.0
Market value adjustment
(1,242)
(0.3)
(1,290)
(0.3)
Allowance for credit losses
(4,296)
(0.9)
(3,575)
(0.7)
Totals
$
490,059
98.8
$
505,730
99.0
(1) Loan-to-Value Ratio is determined using the most recent appraised value. Appraisals are required at the time of funding and may be updated if a material change occurs from the original loan agreement.
All mortgage loans, excluding mortgage loans carried at fair value, are analyzed on an ongoing basis in order to monitor the financial quality of these assets. Mortgage loans with a likelihood of becoming delinquent are identified and placed on an internal “watch list.” Among the criteria that would indicate a potential problem include: major tenant vacancies or bankruptcies, late payments, and loan relief/restructuring requests. Specific mortgage loans on the internal watch list are analyzed to determine whether an impairment has occurred on any loan that would require a write down of its carrying value in the financial statements.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
The Company maintains a general valuation allowance following the GAAP standard for current expected credit losses ("CECL"). The objective of the CECL model is for the reporting entity to recognize its estimate of current expected credit losses for affected financial assets in a valuation allowance deducted from the amortized cost basis of the related financial assets that results in presenting the net carrying value of financial assets at the amount expected to be collected. For mortgage loan investments the Company employs the Weighted Average Remaining Maturity ("WARM") method in estimating current expected losses with respect to mortgage loan investments. The WARM method applies publicly available data of default incidence of commercial real estate properties by several defined segmentations combined with future assumptions regarding economic conditions (i.e. GDP forecasts) both in the near term and the long term. Changes in the allowance for current expected credit losses are reported in Net investment income in the Condensed Consolidated Statements of Earnings.
The following table represents the mortgage loan allowance for credit losses.
Three Months Ended September 30,
Nine Months Ended September 30,
2023
2022
2023
2022
(In thousands)
Mortgage Loans Allowance for Credit Losses:
Balance, beginning of the period
$
3,736
2,573
3,575
2,987
Provision during the period
560
1,225
721
811
Total ending allowance for credit losses
$
4,296
3,798
4,296
3,798
The Company's direct investments in real estate are reported in Other long-term investments in the Condensed Consolidated Balance Sheets. These amounts are not a significant portion of the total investment portfolio and totaled approximately $27.3 million and $27.7 million at September 30, 2023 and December 31, 2022, respectively. These investments consist primarily of a half-dozen income-producing properties which are being operated by a wholly owned subsidiary of National Western. The Company recognized operating income on real estate properties of approximately $2.3 million and $2.3 million for the first nine months of 2023 and 2022, respectively. During the nine months ended September 30, 2022, the Company sold land located in Freeport, Texas and Houston, Texas along with a retail property located in Ruidoso, New Mexico for a net realized gain of $1.2 million.
(13) FAIR VALUES OF FINANCIAL INSTRUMENTS
For financial instruments the FASB provides guidance which defines fair value, establishes a framework for measuring fair value under GAAP, and requires additional disclosures about fair value measurements. In compliance with this GAAP guidance, the Company has categorized its financial instruments, based on the priority of the inputs to the valuation technique, into a three level hierarchy. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities ("Level 1") and the lowest priority to unobservable inputs ("Level 3"). If the inputs used to measure fair value fall within different levels of the hierarchy, the category level is based on the lowest priority level input that is significant to the fair value measurement of the instrument.
Financial assets and liabilities recorded at fair value on the Condensed Consolidated Balance Sheets are categorized as follows:
Level 1: Fair value is based on unadjusted quoted prices in active markets that are accessible to the Company for identical assets or liabilities. Active markets are those in which transactions for the asset or liability occur in sufficient frequency and volume to provide pricing information on an ongoing basis. These generally provide the most reliable evidence and are used to measure fair value whenever available. The Company's Level 1 assets are equity securities that are traded in an active exchange market. Valuations are obtained from readily available pricing sources for market transactions involving identical assets.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Level 2: Fair value is based upon significant inputs other than quoted prices in active markets included in Level 1, which are either directly or indirectly observable for substantially the full term of the asset or liability through corroboration with observable market data as of the reporting date. Level 2 inputs include quoted market prices in active markets for similar assets and liabilities, quoted market prices in markets that are not active for identical or similar assets or liabilities, model-derived valuations whose inputs are observable or whose significant value drivers are observable and other observable inputs. The Company’s Level 2 assets include fixed maturity debt securities (corporate and private bonds, government or agency securities, asset-backed and mortgage-backed securities). The Company's Level 2 liabilities include the embedded derivative on reinsurance. Valuations are generally obtained from third party pricing services for identical or comparable assets or determined through use of valuation methodologies using observable market inputs.
Level 3: Fair value is based on significant unobservable inputs which reflect the entity’s or third party pricing service’s assumptions about the assumptions market participants would use in pricing an asset or liability. The Company’s Level 3 assets include private debt securities available-for-sale, private trading securities, over-the-counter derivative contracts, mortgage loans, and market risk benefits assets. The Company’s Level 3 liabilities consist of share-based compensation obligations, certain equity-index product-related embedded derivatives, market risk benefits liabilities and an embedded derivative on reinsurance. Valuations are estimated based on non-binding broker prices or internally developed valuation models or methodologies, discounted cash flow models and other similar techniques.
The following tables set forth the Company’s assets and liabilities that are measured at fair value on a recurring basis as of the date indicated.
September 30, 2023
Total
Level 1
Level 2
Level 3
(In thousands)
Debt securities, available-for-sale
$
7,052,554
—
6,562,141
490,413
Debt securities, trading
1,000,355
—
872,462
127,893
Equity securities
21,913
18,475
3,438
—
Mortgage loans
19,285
—
—
19,285
Derivatives, index options
55,278
—
—
55,278
Short-term investments
7,821
—
7,821
—
Total assets
$
8,157,206
18,475
7,445,862
692,869
Policyholder account balances (a)
$
383,034
—
—
383,034
Market risk benefits liabilities, net (b)
172,266
—
—
172,266
Embedded derivative contra-liability (c)
(349,275)
—
(338,252)
(11,023)
Other liabilities (d)
61,379
—
—
61,379
Total liabilities
$
267,404
—
(338,252)
605,656
(a) Represents the fair value of certain product-related embedded derivatives that were recorded at fair value.
(b) Represents the fair value of the net market risk benefits liability which is recorded at fair value.
(c) Represents the embedded derivative for funds withheld which is recorded at fair value.
(d) Represents the liability for share-based compensation which is recorded at fair value.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
During the three and nine months ended September 30, 2023, the Company made no transfers from Level 2 to Level 3 for debt securities available-for-sale. During the nine months ended September 30, 2022, a portion of the funds withheld embedded derivative liability was reclassified from Level 2 into Level 3 due to the presence of unobservable inputs in its valuation.
December 31, 2022
Total
Level 1
Level 2
Level 3
(In thousands)
Debt securities, available-for-sale
$
7,611,633
—
7,148,838
462,795
Debt security, trading
1,065,993
—
942,756
123,237
Equity securities
22,076
18,407
3,669
—
Mortgage loans
19,334
—
—
19,334
Derivatives, index options
23,669
—
—
23,669
Short-term investments
3,937
—
3,937
—
Total assets
$
8,746,642
18,407
8,099,200
629,035
Policyholder account balances (a)
$
387,686
—
—
387,686
Market risk benefits liabilities, net (b)
167,018
—
—
167,018
Embedded derivative contra-liability (c)
(334,955)
—
(324,712)
(10,243)
Other liabilities (d)
20,542
—
—
20,542
Total liabilities
$
240,291
—
(324,712)
565,003
(a) Represents the fair value of certain product-related embedded derivatives that were recorded at fair value.
(b) Represents the fair value of the net market risk benefits liability which is recorded at fair value.
(c) Represents the embedded derivative for funds withheld which is recorded at fair value.
(d) Represents the liability for share-based compensation which is recorded at fair value.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
The following tables present, by pricing source and fair value hierarchy level, the Company's assets that are measured at fair value on a recurring basis.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
The following tables provide additional information about fair value measurements for Level 3 for which significant unobservable inputs were utilized to determine fair value.
Three Months Ended September 30, 2023
Total Assets
Debt Securities, Available-for-Sale
Trading Securities
Derivatives, Index Options
Mortgage Loans
Total Assets
(In thousands)
Beginning balance, July 1, 2023
$
483,980
141,624
72,863
19,422
717,889
Total realized and unrealized gains (losses):
Included in net earnings
—
(1,492)
(19,809)
(104)
(21,405)
Included in other comprehensive income (loss)
(16,193)
—
—
—
(16,193)
Purchases, sales, issuances and settlements, net:
Purchases
28,582
2,223
14,070
—
44,875
Settlements
(5,956)
(14,462)
(11,846)
(33)
(32,297)
Balance at end of period September 30, 2023
$
490,413
127,893
55,278
19,285
692,869
Change in unrealized gains or losses for the period included in earnings (or changes in net assets) for assets/liabilities held at the end of the reporting period:
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Three Months Ended September 30, 2023
Total Liabilities
Embedded Derivative on Funds Withheld Liability
Policyholder Account Balances
Other Liabilities
Market Risk Benefits Liabilities, net
Total Liabilities
Beginning balance, July 1, 2023
$
(9,426)
430,320
50,295
208,803
679,992
Total realized and unrealized (gains) losses:
Included in net earnings
(1,597)
(49,510)
11,068
(36,514)
(76,553)
Purchases, sales, issuances and settlements, net:
Purchases
—
14,070
—
—
14,070
Issuances
—
—
239
(23)
216
Settlements
—
(11,846)
(223)
—
(12,069)
Balance at end of period September 30, 2023
$
(11,023)
383,034
61,379
172,266
605,656
Change in unrealized gains or losses for the period included in earnings (or changes in net assets) for assets/liabilities held at the end of the reporting period:
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Three Months Ended September 30, 2022
Total Assets
Debt Securities, Available-for-Sale
Trading Securities
Derivatives, Index Options
Mortgage Loans
Total Assets
(In thousands)
Beginning balance, July 1, 2022
$
373,957
99,769
6,071
18,738
498,535
Total realized and unrealized gains (losses):
Included in net earnings
—
(3,102)
(12,550)
(551)
(16,203)
Included in other comprehensive income (loss)
(12,642)
—
—
—
(12,642)
Purchases, sales, issuances and settlements, net:
Purchases
55,888
3,904
13,386
1,234
74,412
Settlements
(6,656)
(265)
(92)
(31)
(7,044)
Balance at end of period September 30, 2022
$
410,547
100,306
6,815
19,390
537,058
Change in unrealized gains or losses for the period included in earnings (or changes in net assets) for assets/liabilities held at the end of the reporting period:
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Three Months Ended September 30, 2022
Total Liabilities
Embedded Derivative on Funds Withheld Liability
Policyholder Account Balances
Other Liabilities
Market Risk Benefits Liabilities
Total Liabilities
(In thousands)
Beginning balance, July 1, 2022
$
(6,534)
382,721
9,332
176,758
562,277
Total realized and unrealized (gains) losses:
Included in net earnings
(3,681)
(23,145)
(1,319)
(26,016)
(54,161)
Included in other comprehensive income (loss)
—
—
—
—
—
Purchases, sales, issuances and settlements, net:
Purchases
—
13,386
—
—
13,386
Sales
—
—
—
—
—
Issuances
—
—
155
8
163
Settlements
—
(92)
—
—
(92)
Transfers into (out of) Level 3
—
—
—
—
—
Balance at end of period September 30, 2022
$
(10,215)
372,870
8,168
150,750
521,573
Change in unrealized gains or losses for the period included in earnings (or changes in net assets) for assets/liabilities held at the end of the reporting period:
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Nine Months Ended September 30, 2023
Total Assets
Debt Securities, Available-for-Sale
Trading Securities
Derivatives, Index Options
Mortgage Loans
Total Assets
(In thousands)
Beginning balance, January 1, 2023
$
462,796
123,236
23,669
19,334
629,035
Total realized and unrealized gains (losses):
Included in net earnings
—
(828)
4,045
48
3,265
Included in other comprehensive income (loss)
(11,338)
—
—
—
(11,338)
Purchases, sales, issuances and settlements, net:
Purchases
64,239
30,985
39,680
—
134,904
Sales
—
—
—
—
—
Issuances
—
—
—
—
—
Settlements
(25,284)
(25,500)
(12,116)
(97)
(62,997)
Transfers into (out of) Level 3
—
—
—
—
—
Balance at end of period September 30, 2023
$
490,413
127,893
55,278
19,285
692,869
Change in unrealized gains or losses for the period included in earnings (or changes in net assets) for assets/liabilities held at the end of the reporting period:
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Nine Months Ended September 30, 2023
Total Liabilities
Embedded Derivative on Funds Withheld Liability
Policyholder Account Balances
Other Liabilities
Market Risk Benefits Liabilities
Total Liabilities
(In thousands)
Beginning balance, January 1, 2023
$
(10,243)
387,686
20,542
167,018
565,003
Total realized and unrealized (gains) losses:
Included in net earnings
(780)
(32,216)
43,336
5,184
15,524
Included in other comprehensive income (loss)
—
—
—
—
—
Purchases, sales, issuances and settlements, net:
Purchases
—
39,680
—
—
39,680
Sales
—
—
—
—
—
Issuances
—
—
261
64
325
Settlements
—
(12,116)
(2,760)
—
(14,876)
Transfers into (out of) Level 3
—
—
—
—
—
Balance at end of period September 30, 2023
$
(11,023)
383,034
61,379
172,266
605,656
Change in unrealized gains or losses for the period included in earnings (or changes in net assets) for assets/liabilities held at the end of the reporting period:
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Nine Months Ended September 30, 2022
Total Assets
Debt Securities, Available-for-Sale
Trading Securities
Derivatives, Index Options
Mortgage Loans
Total Assets
(In thousands)
Beginning balance, January 1, 2022
$
326,962
74,822
101,622
8,469
511,875
Total realized and unrealized gains (losses):
Included in net earnings
—
(9,705)
(89,173)
(1,679)
(100,557)
Included in other comprehensive income (loss)
(43,335)
—
—
—
(43,335)
Purchases, sales, issuances and settlements, net:
Purchases
151,872
35,454
39,642
12,693
239,661
Sales
—
—
—
—
—
Issuances
—
—
—
—
—
Settlements
(24,952)
(265)
(45,276)
(93)
(70,586)
Transfers into (out of) Level 3
—
—
—
—
—
Balance at end of period September 30, 2022
$
410,547
100,306
6,815
19,390
537,058
Change in unrealized gains or losses for the period included in earnings (or changes in net assets) for assets/liabilities held at the end of the reporting period:
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Nine Months Ended September 30, 2022
Total Liabilities
Embedded Derivative on Funds Withheld Liability
Policyholder Account Balances
Other Liabilities
Market Risk Benefits Liabilities
Total Liabilities
(In thousands)
Beginning balance, January 1, 2022
$
—
550,596
7,869
299,833
858,298
Total realized and unrealized (gains) losses:
Included in net earnings
(11,384)
(172,092)
1,192
(149,503)
(331,787)
Included in other comprehensive income (loss)
—
—
—
—
—
Purchases, sales, issuances and settlements, net:
Purchases
—
39,642
—
—
39,642
Sales
—
—
—
—
—
Issuances
—
—
184
420
604
Settlements
—
(45,276)
(1,077)
—
(46,353)
Transfers into (out of) Level 3
1,169
—
—
—
1,169
Balance at end of period September 30, 2022
$
(10,215)
372,870
8,168
150,750
521,573
Change in unrealized gains or losses for the period included in earnings (or changes in net assets) for assets/liabilities held at the end of the reporting period:
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
The following table presents the valuation method for financial assets and liabilities priced internally and categorized as level 3, as well as the unobservable inputs used in the valuation of those financial instruments:
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
December 31, 2022
Fair Value
Valuation Technique
Unobservable Input
Range (Weighted Average)
(In thousands)
Assets:
Debt securities available-for-sale
$
76,003
Discounted cash flows
Discount rate
4.32% - 7.28% (5.79%)
Mortgage loans
19,334
Discounted cash flows
Spread
150 - 300 bps
Total assets
$
95,337
Liabilities:
Policyholder account balances
$
387,686
Deterministic cash flow model
Projected option cost
0.00% - 5.70% (2.92%)
Share-based compensation
20,542
Black-Scholes model
Expected term
0.9 to 6.7 years
Expected volatility
36.18%
Market risk benefits liabilities, net
167,018
Risk-neutral valuation
Benefit utilization rates
5.00% - 20.00% (5.00%)
Total liabilities
$
575,246
The tables above exclude certain securities for which fair values are obtained and unadjusted from third party vendors, including the funds withheld trading debt securities supporting the embedded derivative liability. Realized gains (losses) on debt securities are reported in the Condensed Consolidated Statements of Earnings as Net realized investment gains (losses) with liabilities reported as expenses. Unrealized gains (losses) on available-for-sale debt securities are reported as Other comprehensive income (loss) within the stockholders' equity section of the Condensed Consolidated Balance Sheets. Unrealized gains (losses) on trading debt securities are reported in the Condensed Consolidated Statements of Earnings as Net investment income.
The fair value hierarchy classifications are reviewed each reporting period. Reclassification of certain financial assets and liabilities may result based on changes in the observability of valuation attributes. Reclassifications are reported as transfers into and out of Level 3 at the beginning fair value for the reporting period in which the changes occur.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
December 31, 2022
Fair Value Hierarchy Level
Carrying Values
Fair Values
Level 1
Level 2
Level 3
(In thousands)
ASSETS
Debt securities, available-for-sale
$
7,611,633
7,611,633
—
7,148,837
462,796
Debt securities, trading
1,065,993
1,065,993
—
942,756
123,237
Cash and cash equivalents
295,270
295,270
295,270
—
—
Mortgage loans
505,730
457,873
—
—
457,873
Real estate
27,712
47,867
—
—
47,867
Policy loans
70,495
87,478
—
—
87,478
Other loans
31,586
31,915
—
—
31,915
Derivatives, index options
23,669
23,669
—
—
23,669
Equity securities
22,076
22,076
18,407
3,669
—
Short-term investments
3,937
3,937
—
3,937
—
Life interest in Libbie Shearn Moody Trust
7,100
12,775
—
—
12,775
Other investments
4,513
26,230
—
—
26,230
LIABILITIES
Deferred annuity contracts
$
5,583,038
3,934,517
—
—
3,934,517
Immediate annuity and supplemental contracts
367,128
373,346
—
—
373,346
Market risk benefits liabilities, net
167,018
167,018
—
—
167,018
Fair value estimates are made at a specific point in time based on relevant market information and information about the financial instruments. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company's entire holdings of a particular financial instrument. Because no market exists for a portion of the Company's financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates.
(14) DERIVATIVES
Fixed-index products provide traditional fixed annuities and universal life contracts with the option to have credited interest rates linked in part to an underlying equity index or a combination of equity indices. The equity return component of such policy contracts is identified separately and accounted for in future policy benefits as embedded derivatives on the Condensed Consolidated Balance Sheets. The remaining portions of these policy contracts are considered the host contracts and are recorded separately as fixed annuity or universal life contracts. The host contracts are accounted for under debt instrument type accounting in which future policy benefits are recorded as discounted debt instruments and accreted, using the effective yield method, to their minimum account values at their projected maturities or termination dates.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
The Company purchases over-the-counter index options, which are derivative financial instruments, to hedge the equity return component of its fixed-index annuity and life products. The index options act as hedges to match closely the returns on the underlying index or indices. The amounts which may be credited to policyholders are linked, in part, to the returns of the underlying index or indices. As a result, changes to policyholders' liabilities are substantially offset by changes in the value of the options. Cash is exchanged upon purchase of the index options and no principal or interest payments are made by either party during the option periods. Upon maturity or expiration of the options, cash may be paid to the Company depending on the performance of the underlying index or indices and terms of the contract.
The Company does not elect hedge accounting relative to these derivative instruments.The index options are reported at fair value in the accompanying Condensed Consolidated Financial Statements. The changes in the values of the index options and the changes in the policyholder liabilities are both reflected in the Condensed Consolidated Statements of Earnings. Any changes relative to the embedded derivatives associated with policy contracts are reflected in contract interest in the Condensed Consolidated Statements of Earnings. Any gains or losses from the sale or expiration of the options, as well as period-to-period changes in values, are reflected as net investment income in the Condensed Consolidated Statements of Earnings.
Although there is credit risk in the event of nonperformance by counterparties to the index options, the Company does not expect any of its counterparties to fail to meet their obligations, given their high credit ratings. In addition, credit support agreements are in place with all counterparties for option holdings in excess of specific limits, which may further reduce the Company's credit exposure.
The Company maintains two coinsurance funds withheld reinsurance agreements under which identified assets with underlying unrealized gains (losses) are maintained in a funds withheld account. While the assets are withheld, the associated interest and credit risk of these assets are transferred to the reinsurer, creating an embedded derivative on reinsurance in the funds withheld liability. Accordingly, the Company is required to bifurcate the embedded derivative from the host contract in accordance with GAAP. The fair value of the embedded derivative on reinsurance is computed as the unrealized gain (loss) on the underlying funds withheld assets. This amount is included as a component of the funds withheld liability balance on the Condensed Consolidated Balance Sheets with changes in the embedded derivative on reinsurance reported in Net investment income in the Condensed Consolidated Statements of Earnings. Changes in the funds withheld liability are reported in operating activities in the Condensed Consolidated Statements of Cash Flows.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
The table below presents the effect of derivative instruments in the Condensed Consolidated Statements of Earnings for the three months ended September 30, 2023 and 2022.
September 30, 2023
September 30, 2022
Derivatives Not Designated As Hedging Instruments
Location of Gain or (Loss) Recognized In Income on Derivatives
Amount of Gain or (Loss) Recognized in Income on Derivatives
(In thousands)
Equity index options
Net investment income
$
(19,655)
(12,550)
Fixed-index products
Universal life and annuity contract interest
49,355
23,145
Embedded derivative on reinsurance contract
Net investment income
35,531
70,610
$
65,231
81,205
The table below presents the effect of derivative instruments in the Condensed Consolidated Statements of Earnings for the nine months ended September 30, 2023 and 2022.
September 30, 2023
September 30, 2022
Derivatives Not Designated As Hedging Instruments
Location of Gain or (Loss) Recognized In Income on Derivatives
Amount of Gain or (Loss) Recognized in Income on Derivatives
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(15) INTANGIBLES AND GOODWILL
Identifiable Intangible Assets
The gross carrying amounts and accumulated amortization for each specifically identifiable intangible asset were as follows.
September 30, 2023
December 31, 2022
Weighted-Average Amortization Period
Gross Carrying Amount
Accumulated Amortization
Gross Carrying Amount
Accumulated Amortization
(In thousands)
Trademarks/trade names
15
$
2,800
(871)
2,800
(731)
Internally developed software
7
3,800
(2,533)
3,800
(2,126)
Insurance licenses
N/A
3,000
—
3,000
—
$
9,600
(3,404)
9,600
(2,857)
The value of trademarks was estimated using the relief from royalty method, based on the assumption that in lieu of ownership, an organization would be willing to pay a royalty in order to receive the related benefits of using the brand. The value of insurance licenses was estimated using the market approach to value, based on values paid for licenses in recent shell company transactions. The value of internally developed software was estimated using the replacement cost method. Trademarks, trade names and internally developed software are amortized using a straight-line method over the estimated useful lives. These intangible assets are evaluated for impairment if indicators of impairment arise. Insurance licenses were determined to have an indefinite useful life. The Company evaluates the useful life of the insurance licenses at each reporting period to determine whether the useful life remains indefinite.
As of September 30, 2023, expected amortization expense relating to purchased intangible assets for each of the next 5 years and thereafter is as follows:
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Goodwill
The changes in the carrying amount of goodwill were as follows:
September 30,
December 31,
2023
2022
(In thousands)
Gross goodwill as of beginning of year
$
13,864
13,864
Goodwill resulting from business acquisition
—
—
Gross goodwill, before impairments
13,864
13,864
Accumulated impairment as of beginning of year
—
—
Current year impairments
—
—
Net goodwill as of end of period
$
13,864
13,864
The Company periodically evaluates the goodwill balance for potential impairment and, as of the dates presented, determined that there was sufficient evidence to support not impairing the balance.
(16) SUBSEQUENT EVENTS
On October 8, 2023, the Company entered the Merger Agreement with S. USA Life Insurance Company, Inc. ("S.USA”) and its direct wholly owned subsidiary PGH Merger Inc. (“Merger Sub”), under which, at the effective time of the merger, the Company would merge with and into Merger Sub (the “Merger”) and survive the Merger as a wholly owned subsidiary of S.USA. In the Merger, all outstanding shares of Class A Common Stock and Class B Common Stock will be converted into the right to receive $500.00 per share in cash, without interest. Including the vesting and cash settlement of all outstanding SARs, RSUs and PSUs (at target performance) at closing, the total merger consideration to be paid by S.USA would be approximately $1.9 billion. S.USA is an Arizona domiciled insurance company affiliated with Prosperity Group Holdings. The closing of the Merger is subject to approval by the holders of a majority of the outstanding shares of Class A Common Stock and Class B Common stock, voting together as a single class, antitrust clearance, regulatory approvals and other customary closing conditions. The Merger is currently expected to close in the first half of 2024.
Other subsequent events have been evaluated through the date of filing and no other reportable items were identified.
On October 8, 2023, the Company entered an agreement and plan of merger (the “Merger Agreement”) with S. USA Life Insurance Company, Inc. (“S.USA”) and its direct wholly owned subsidiary PGH Merger Inc. (“Merger Sub”), under which, at the effective time of the merger (the “Effective Time”), the Company would merge with and into Merger Sub (the “Merger”) and survive the Merger as a wholly owned subsidiary of S.USA. In the Merger, all outstanding shares of Class A Common Stock and Class B Common Stock will be converted into the right to receive $500.00 per share in cash, without interest. Including the vesting and cash settlement of all outstanding SARs, RSUs and PSUs (at target performance) at closing, the total merger consideration to be paid by S.USA would be approximately $1.9 billion. S.USA is an Arizona domiciled insurance company affiliated with Prosperity Group Holdings.
The Merger is currently expected to close in the first half of 2024.
Stockholder Approval. The closing of the Merger is subject to approval by the holders of a majority of the outstanding shares of Class A Common Stock and Class B Common stock, voting together as a single class.
Regulatory Approval Process. The completion of the Merger and other transactions contemplated by the Merger Agreement (the “Proposed Transaction”) is subject to satisfaction or waiver of certain customary closing conditions, including antitrust clearance and obtaining the required regulatory approval from the insurance authorities in Colorado, Missouri and Arizona. However, because state insurance regulatory approval remains outstanding, the Company cannot provide assurance the Proposed Transaction will be completed on the terms or timeline currently contemplated, or at all.
Merger Agreement’s Restrictions on Interim Operations. The Company has agreed to certain covenants in the Merger Agreement restricting the conduct of its business between the date of the Merger Agreement and the earlier of the Effective Time and the termination of the Merger Agreement. The general effect of these covenants is that, during such interim period, the Company will be limited in its ability to pursue strategic and operational matters outside the ordinary course of business. The Company has agreed that it and its subsidiaries will conduct their business in the ordinary course consistent with past practice in all material respects and use reasonable best efforts to preserve their business organizations, goodwill and assets, keep available the services of their current key officers and employees, and preserve their present relationships with governmental entities and other key third parties, including customers, reinsurers, distributors, suppliers and other persons with whom the Company and its subsidiaries have business relationships.
In addition, the Company has agreed to specific restrictions relating to the conduct of its business between the date of the Merger Agreement and the earlier of the Effective Time and the termination of the Merger Agreement, including, but not limited to, not taking (or permitting any of its subsidiaries to take) the following actions (subject, in each case, to exceptions specified below and in the Merger Agreement or previously disclosed in writing to S.USA as provided in the Merger Agreement or as consented to in writing in advance by S.USA (which consent shall not be unreasonably withheld, delayed or conditioned)) or as required by law:
▪subject to certain limited exceptions, offer, issue, sell, transfer, pledge, dispose of or encumber any shares of, or securities convertible into or exchangeable for, or options, warrants, calls, commitments or rights of any kind to acquire, any shares of capital stock or other equity or voting interests or ownership interests of any class or series of the Company or its subsidiaries;
▪amend or propose to amend the Company’s or its subsidiaries’ certificate of incorporation, bylaws or other comparable organizational documents;
▪authorize, recommend, propose, enter into or adopt a plan or agreement of complete or partial liquidation, rehabilitation, dissolution, merger, consolidation, restructuring, recapitalization or other reorganization of the Company or any of its subsidiaries;
▪merge, consolidate, combine or amalgamate with any person;
▪subject to certain limited exceptions (including permitting the Company to execute investment portfolio transactions in the ordinary course of business consistent with past practice and in accordance with its existing investment guidelines), acquire or agree to acquire any business or any corporation, partnership, association or other business organization or division thereof or any other assets for consideration in excess of $1,250,000 individually or $2,500,000 in the aggregate;
▪subject to certain limited exceptions, sell, lease, license, transfer, pledge, encumber or otherwise dispose of any of the Company’s or its subsidiaries’ assets or properties;
▪incur, guarantee or assume any indebtedness (other than indebtedness owing between or among the Company and any of its wholly-owned subsidiaries), subject to certain limited exceptions, including investment portfolio transactions in the ordinary course of business consistent with past practice and other incurrences of indebtedness not to exceed $5,000,000 in the aggregate;
▪enter into any material contract or reinsurance contract other than in the ordinary course of business consistent with past practice;
▪settle or compromise any claim, demand, lawsuit or state or federal regulatory proceeding or waive any claims, other than with respect to the Company’s and its subsidiaries’ ordinary course claims activity, (i) in an amount in excess of $1,250,000 individually or $2,500,000 in the aggregate or (ii) that imposes any material obligation to be performed by, or material restriction imposed against, the Company or its subsidiaries; or
▪terminate, amend, modify, assign or waive any material right under any material contract or reinsurance contract except in the ordinary course of business consistent with past practice.
The Merger Agreement permits the Company to continue to pay regular annual cash dividends not to exceed $0.36 per share of Class A Common Stock ($0.18 per share of Class B Common Stock) prior to completion of the Proposed Transaction. Accordingly, on October 26, 2023, the Company’s board of directors declared a cash dividend in the respective per share amounts described above, payable December 1, 2023 to stockholders of record as of November 6, 2023.
The above is a summary of certain material terms of the Merger Agreement and is qualified in its entirety by the terms and conditions of the Merger Agreement, which was filed as an exhibit to the Company’s current report on Form 8-K filed on October 10, 2023.
FORWARD-LOOKING STATEMENTS
Certain statements made in this report, including but not limited to the accompanying condensed consolidated financial statements, and the notes thereto appearing in Item 1 herein, Management’s Discussion and Analysis of Financial Condition and Results of Operations in this Item 2 (“MD&A”), and the exhibits and financial statement schedules filed as a part hereof or incorporated by reference herein, may contain or incorporate by reference information that includes or is based upon forward-looking statements within the meaning of the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements generally are indicated by words such as “expects,” “intends,” “anticipates,” “plans,” “believes,” “estimates,” “will” or words of similar meaning, and include, without limitation, statements regarding the outlook of our business and expected financial performance. These forward-looking statements are subject to changes and uncertainties that are, in many instances, beyond our control and have been made based upon our assumptions, expectations and beliefs concerning future developments and their potential effect upon us. There can be no assurance that future developments will be in accordance with our expectations, that the effect of future developments on us will be as anticipated, or that our risk management policies and procedures will be effective. We do not make public specific projections relating to future earnings, and we do not endorse any projections regarding future performance made by others. Additionally, we do not publicly update or revise forward-looking statements based on the outcome of various foreseeable or unforeseeable events.
Forward-looking statements are not guarantees of future performance and involve various risks and uncertainties. Forward-looking statements relate to the Proposed Transaction contemplated by the Merger Agreement, as well as to the Company’s financial and operating performance on a stand-alone basis prior to the consummation of the Proposed Transaction or if the Proposed Transaction is not consummated. There are certain important factors that could cause actual results to differ, possibly materially, from expectations or estimates reflected in such forward-looking statements, including without limitation risks, uncertainties and other factors discussed in Item 1A of our 2022 Annual Report on Form 10-K filed with the SEC on March 15, 2023 and elsewhere in this report, and the following factors relating to the Proposed Transaction:
▪conditions to the closing of the Proposed Transaction may not be satisfied;
▪regulatory approvals required for the Proposed Transaction may not be obtained, or required regulatory approvals may delay the Proposed Transaction or result in the imposition of conditions that could have a material adverse effect on the Company or S.USA or cause certain conditions to closing not to be satisfied, which could result in the termination of the Merger Agreement;
▪the timing of completion of the Proposed Transaction is uncertain;
▪the business of the Company or S.USA could suffer as a result of uncertainty surrounding the Proposed Transaction;
▪events, changes or other circumstances could occur that could give rise to the termination of the Merger Agreement;
▪there are risks related to disruption of management’s attention from the ongoing business operations of the Company or S.USA due to the Proposed Transaction;
▪the announcement or pendency of the Proposed Transaction could affect the relationships of the Company or S.USA with its clients, and operating results and business generally, including on our ability to retain and attract employees;
▪the outcome of any legal proceedings initiated against the Company or S.USA following the announcement of the Proposed Transaction could adversely affect the Company or S.USA, including their ability to consummate the Proposed Transaction; and
▪the Company or S.USA may be adversely affected by other economic, business, and/or competitive factors as well as management’s response to any of the aforementioned factors.
The foregoing review of important factors related to the Proposed Transaction should not be construed as exhaustive and should be read in conjunction with the other cautionary statements that are included herein and elsewhere, including the risk factors included in the Company’s most recent Annual Report on Form 10-K and other documents of the Company on file with the SEC. The Company undertakes no obligation to update, correct or otherwise revise any forward-looking statements. All subsequent written and oral forward-looking statements attributable to the Company and/or any person acting on behalf of the Company are expressly qualified in their entirety by this paragraph. The information contained on any websites referenced in this Quarterly Report on Form 10-Q is not incorporated by reference into this Quarterly Report on Form 10-Q.
Management's discussion and analysis of the financial condition and results of operations (“MD&A”) of National Western Life Group, Inc. ("NWLGI") for the three and nine months ended September 30, 2023 follows. Where appropriate, discussion specific to the insurance operations of National Western Life Insurance Company is denoted by "National Western" or "NWLIC". This discussion should be read in conjunction with the Company's Condensed Consolidated Financial Statements and related notes beginning on page 3 of this report and with the 2022 Annual Report filed on Form 10-K.
Overview
National Western provides life insurance products on a global basis for the savings and protection needs of policyholders and issues annuity contracts for the asset accumulation and retirement needs of contract holders. Historically, it has done so for both domestic and international residents. However, the Company discontinued accepting applications for its international life insurance products from foreign nationals outside the U.S. in 2018.
The Company, National Western and Ozark National Life Insurance Company ("Ozark National"), accepts funds from policyholders or contract holders and establishes a liability representing future obligations to pay the policy or contract holders and their beneficiaries. To ensure the Company will be able to pay these future commitments, the funds received as premium payments and deposits are invested in high quality investments, primarily fixed income securities. National Western maintains its home office in Austin, Texas where substantially all of its 273 employees at September 30, 2023 are located. Ozark National maintains its home office facility in Kansas City, Missouri along with NIS where most of their combined employees are located.
Due to the business of accepting funds to pay future obligations in later years and the underlying economics, the relevant factors affecting the Company’s overall business and profitability include the following:
●
the level of sales and premium revenues collected
●
the volume of life insurance and annuity business in force
●
persistency of policies and contracts
●
the ability to price products to earn acceptable margins over benefit costs and expenses
●
return on investments sufficient to produce acceptable spread margins over interest crediting rates
●
investment credit quality which minimizes the risk of default or impairment
●
levels of policy benefits and costs to acquire business
●
the ability to manage the level of operating expenses
●
effect of interest rate changes on revenues and investments including asset and liability matching
●
maintaining adequate levels of capital and surplus
●
corporate tax rates and the treatment of financial statement items under tax rules and accounting
●
actual levels of surrenders, withdrawals, claims and interest spreads
●
changes in assumptions for amortization of deferred policy acquisition expenses and deferred sales inducements
●
changes in the fair value of derivative index options and embedded derivatives pertaining to fixed-index life and annuity products
●
pricing and availability of adequate counterparties for reinsurance and index option contracts
●
litigation subject to unfavorable judicial development, including the time and expense of litigation
The Company monitors these factors continually as key business indicators. The discussion that follows in this Item 2 includes these indicators and presents information useful to an overall understanding of the Company's business performance for the nine months ended September 30, 2023, incorporating required disclosures in accordance with the rules and regulations of the SEC.
Insurance Operations - Domestic
National Western is currently licensed to do business in all states (except New York) and the District of Columbia. Products marketed are annuities, universal life insurance, fixed-index universal life, and traditional life insurance, which include both term and whole life products. Domestic sales in terms of premium levels have historically been more heavily weighted toward annuities. Most of these annuities can be sold either as tax qualified or non-qualified products. More recently, a greater proportion of sales activity has been derived from single premium life insurance products, predominantly those with an equity-index crediting mechanism. Presently, nearly 100% of National Western's life premium sales come from single premium life products. At September 30, 2023, National Western maintained 92,489 annuity contracts in force representing account balances of $5.5 billion and 43,211 domestic life insurance policies in force representing in excess of $3.5 billion in face amount of coverage.
National Western markets and distributes its domestic products primarily through independent national marketing organizations ("NMOs"). These NMOs assist the Company in recruiting, contracting, and managing independent agents. These agents are independent contractors who are compensated on a commission basis. At September 30, 2023, approximately 31,766 domestic independent agent contracts were in place.
Although reported separately for segment disclosure purposes, domestic insurance operations include the activities of Ozark National. Ozark National is a Missouri domiciled, stock life insurance company currently licensed to conduct business in thirty states. Organized and incorporated in 1964, its largest markets by state are Missouri, Iowa, Minnesota, Nebraska, and Kansas. Ozark National utilizes a unique distribution system to market its flagship Balanced Program which consists of a coordinated sale of a non-participating whole life insurance product with a mutual fund investment product offered through N.I.S. Financial Services, Inc. ("NIS'), its affiliated broker-dealer. Due to Ozark National's coordinated sale of a non-participating whole life insurance policy with a mutual fund investment product, its agents hold a securities license in addition to an insurance license. At September 30, 2023, Ozark National maintained 168,960 life insurance policies in force representing approximately $5.6 billion in face amount of coverage.
National Western's international operations consists solely of a closed block of in force policies. At September 30, 2023, National Western had 34,067 international life insurance policies in force representing nearly $9.4 billion in face amount of coverage. The Company previously did not conduct business or maintain offices or employees in any other country, but until the fourth quarter of 2018, did accept applications at its home office in Austin, Texas, and issued policies from there to non-U.S. residents. Insurance products issued were primarily to residents of countries in South America consisting of product offerings not available in the local markets.
Issuing policies to residents of countries in these different regions had provided diversification that helped to minimize large fluctuations that could arise due to various economic, political, and competitive pressures that could occur from one country to another. These policies also provided diversification of earnings relative to the Company's domestic life insurance segment. International life insurance products issued to international residents were almost entirely universal life and traditional life products.
There were some inherent risks of accepting international applications which are not present within the domestic market that were reduced substantially by the Company in several ways. National Western accepted applications from foreign nationals of other countries in upper socioeconomic classes who had substantial financial resources. This targeted customer base, coupled with National Western's conservative underwriting practices, historically resulted in claims experience, due to natural causes, similar to that in the United States. The Company minimized exposure to foreign currency risks by requiring payment of premiums and claims in United States dollars. In addition, the Company adopted an extensive anti-money laundering compliance program in order to fully comply with all applicable U.S. monitoring and reporting requirements pertaining to anti-money laundering and other illegal activities. All of the above served to minimize risks.
SALES
Life Insurance
The following table sets forth information regarding life insurance sales activity as measured by total premium for single premium life insurance products and annualized first year premiums for all other universal life and traditional life insurance products. While the figures shown below are in accordance with industry practice and represent the amount of new business sold during the periods indicated, they are considered a non-GAAP financial measure. The Company believes sales are a measure of distribution productivity and are an indicator of future revenue trends. However, revenues are driven by sales in prior periods as well as in the current period and therefore, a reconciliation of sales to revenues is not meaningful or determinable.
Three Months Ended
Nine Months Ended
September 30,
September 30,
2023
2022
2023
2022
(In thousands)
Single premium life
$
26,484
29,279
72,026
104,498
Traditional life
836
782
2,872
2,723
Universal life
—
—
—
1
Totals
$
27,320
30,061
74,898
107,222
Life insurance sales, as measured by total and annualized first year premiums, decreased 9% in the third quarter of 2023 as compared to the third quarter of 2022 reflecting a decline in activity in the Company's single premium equity-index product sales. Sales for the three months ended September 30, 2023, included $0.8 million from Ozark National, level with the $0.8 million reported in the third quarter of 2022, representing their traditional life sales activity. Ozark National's business model, which is heavily dependent upon in person contact for agent recruiting and obtaining applications for coverage from prospective policyholders, has been attempting to recover from the disruption of the pandemic effects upon its business. For the nine months ended September 30, 2023, total life insurance sales decreased 30% from the level in 2022. Included in these nine-month amounts were $2.9 million and $2.7 million in 2023 and 2022, respectively, from Ozark National.
National Western's life insurance product portfolio includes single premium universal life ("SPUL") and equity-index universal life ("EIUL") products as well as hybrids of the EIUL and SPUL products, combining features of these core products. Equity-index universal life products have been the predominant product sold in the domestic life market for a number of years. Most of these sales are single premium mode products (one year, five year, or ten year) designed for transferring accumulated wealth tax efficiently into life insurance policies with limited underwriting due to lesser net insurance amounts at risk (face amount of the insurance policy less cash premium contributed). These products were designed targeting the accumulated savings of the segment of the population entering their retirement years. The wealth transfer life products have been valuable offerings for the Company's distributors as evidenced by their comprising 100% of total National Western life sales in the first nine months of 2023. With the meaningful increase in market interest rates during the past year, industry sales have gravitated away from single premium life products toward fixed interest rate annuity products, particularly multi-year guaranteed annuity products.
The average new policy face amounts, excluding insurance riders, since 2019 are as shown in the following table.
Average New Policy Face Amount
NWLIC Domestic
Ozark National
Year ended December 31, 2019
$
179,900
45,200
Year ended December 31, 2020
209,900
46,230
Year ended December 31, 2021
221,300
47,620
Year ended December 31, 2022
219,600
45,920
Nine Months Ended September 30, 2023
234,600
48,100
The average face amount of insurance coverage per policy for domestic life insurance contracts reflects the sales of single premium life products, primarily fixed-index, as part of its wealth transfer strategy for domestic life sales.
The table below sets forth information regarding life insurance in force for each date presented.
Insurance In Force as of
September 30,
December 31,
2023
2022
($ in thousands)
National Western
Universal life:
Number of policies
24,598
26,378
Face amounts
$
3,323,560
3,621,812
Traditional life:
Number of policies
21,676
22,751
Face amounts
$
1,999,000
2,103,366
Fixed-index life:
Number of policies
31,004
32,788
Face amounts
$
7,578,293
8,224,415
Total life insurance:
Number of policies
77,278
81,917
Face amounts
$
12,900,853
13,949,593
Ozark National
Total life insurance (all traditional):
Number of policies
168,960
171,915
Face amounts
$
5,577,329
5,718,817
At September 30, 2023, National Western’s face amount of life insurance in force was comprised of $9.4 billion from the international line of business and $3.5 billion from the domestic line of business. At December 31, 2022, these amounts were $10.3 billion and $3.6 billion for the international and domestic lines of business, respectively.
Annuities
The following table sets forth information regarding the Company's annuity sales activity as measured by single and annualized first year premiums. Similar to life insurance sales, these figures are considered a non-GAAP financial measure but are shown in accordance with industry practice and depict the Company's sales productivity.
Annuity sales decreased 32% in the third quarter of 2023 compared to 2022 and were 56% lower in the nine months ended September 30, 2023 relative to the comparable period of 2022. With the sharp rise in interest rate levels, industry annuity sales have gravitated toward multi-year guaranteed annuity products. These products guarantee a stated fixed interest rate for an extended term, typically three or five years. The Company does not offer this type of product in its annuity portfolio. In recent years, the Company's annuity product portfolio has consisted principally of offerings that emphasize income features. The change in consumer preference, prompted by higher interest rate levels, redirected annuity sales toward products emphasizing accumulation in value, resulting in decreased sales activity for the Company. During this time period, the Company has endeavored to introduce new annuity products with accumulation features that are suitable for sale through financial institutions such as banks. These products were made available for sale towards the end of 2022 and have resulted in marginal sales activity in 2023.
The Company's mix of annuity sales has historically shifted with interest rate levels and the relative performance of the equity market. Since the decline in secular interest rates subsequent to the subprime crisis, the Company's fixed-index products have comprised the majority of annuity sales, generally accounting for 90% or more of all annuity sales. During the first nine months of 2023, this percentage approximated 98% reflecting the ongoing popularity of products with crediting rates linked to equity market performance in combination with the Company's limited fixed interest rate product offerings. For all fixed-index products, the Company purchases over the counter call options to hedge the equity return feature. The options are purchased relative to the issuance of the annuity contracts in such a manner to minimize timing risk. Generally, the index return during the indexing period (if the underlying index increases) becomes a component in a formula (set forth in the annuity), the result of which is credited as interest to contract holders electing the index formula crediting method at the beginning of the indexing period. The formula result can never be less than zero with these products. The Company does not deliberately mismatch or under hedge for the equity feature of the products. Fixed-index products also provide the contract holder the alternative to elect a fixed interest rate crediting option.
While National Western does not subsidize its interest crediting rates on new policies in order to obtain market share, until 2022, the Company faced a scenario of declining yields on its investment portfolio as securities backing annuity policies and investment portfolio cash proceeds were subsequently reinvested at substantially lower yields. The resulting compression on interest rate margins caused decrements to fixed interest rate renewal rates provided to annuity contractholders often to the minimum interest rate guarantee levels prescribed by state insurance regulators under non-forfeiture laws.
To address this situation, the Company entered into a coinsurance funds withheld reinsurance arrangement at December 31, 2020 with Prosperity Life Assurance Limited ("Prosperity") under which 100% of the policyholder obligations associated with its fixed interest rate and payout annuity block of policies at that time, approximating $1.7 billion, were reinsured with Prosperity. The Company then redirected its attention toward rebuilding annuity sales momentum by developing products, targeting new channels of distribution to supplement its current partnerships with national marketing organizations, and focusing its offerings away from fixed interest rate products. Effective July 27, 2022, the Company entered into a second funds withheld coinsurance agreement with Aspida Life Re Ltd. ("Aspida"), another third party reinsurer. At the inception of this agreement, annuity policy obligations approximating $250.0 million were reinsured with Aspida. In addition, for specified new annuity product sales, the Company is reinsuring an agreed upon quota share of this business, currently 80%, in a flow reinsurance structure. The objective is to be able to more competitively price these annuity products utilizing the investment expertise of Aspida and their ability to obtain higher investment yields.
The following table sets forth information regarding annuities in force for each date presented. These amounts include the policies and reserves associated with the funds withheld reinsurance transactions discussed above.
Annuities In Force as of
September 30,
December 31,
2023
2022
($ in thousands)
Fixed-index annuities:
Number of policies
57,392
61,292
GAAP annuity reserves
$
4,303,054
4,723,558
Other deferred annuities:
Number of policies
25,299
27,526
GAAP annuity reserves
$
919,080
1,026,497
Immediate annuities:
Number of policies
9,798
10,223
GAAP annuity reserves
$
307,609
324,499
Total annuities:
Number of policies
92,489
99,041
GAAP annuity reserves
$
5,529,743
6,074,554
Impact of Recent Business Environment
The Company's business is generally aided by an economic environment experiencing growth, whether moderate or vibrant, characterized by improving employment data and increases in personal income. Important metrics indicating sustained economic growth over the longer term principally revolve around employment and confidence, both consumer and business sentiment. Changing economic conditions have caused policies and decisions made by central banks to be more crucial to business outlooks for insurers. The insurance market has gone from a low inflation, low interest rate environment to a higher inflation, increasing interest rate environment in a relatively short period of time. Central bankers have been focused on corralling inflation consistent with their stated mission. Consequently, global activity is subject to slowing and has caused the outlook to be more uncertain.
Higher interest rates generally soften the compression of interest rate spreads on interest-sensitive products for life insurers. Conversely, higher interest rates may also serve to induce annuity surrender activity as policyholders seek the greater interest rates offered on new policies backed by higher investment yields. The Company's overall profitability is enhanced by increased interest rate spread margins and with the retention and persistency of policies in force.
In an environment such as this, the need for a strong capital position that can cushion against unexpected bumps is critical for stability and ongoing business activity. The Company's operating strategy continues to be focused on maintaining capital levels substantially above regulatory requirements and rating agency standards. In addition, its business model is predicated upon steady growth in invested assets while managing the block of business within profitability objectives. A key premise of the Company's financial management is maintaining a high quality investment portfolio, well matched in terms of duration with policyholder obligations, that continues to outperform the industry with respect to adverse impairment experience. This discipline helps provide the Company with resources to fund future growth and cushion the Company in periods of abnormal cash outflows.
The Company's Condensed Consolidated Financial Statements are prepared in accordance with U.S. generally accepted accounting principles (“GAAP”). In addition, the Company regularly evaluates operating performance using non-GAAP financial measures which exclude or segregate derivative and realized investment gains and losses from operating revenues. Similar measures are commonly used in the insurance industry in order to assess profitability and results from ongoing operations. The Company believes that the presentation of these non-GAAP financial measures enhances the understanding of the Company's results of operations by highlighting the results from ongoing operations and the underlying profitability factors of the Company's business. The Company excludes or segregates derivative and realized investment gains and losses because such items are often the result of events which may or may not be at the Company's discretion and the fluctuating effects of these items could distort trends in the underlying profitability of the Company's business. Therefore, in the following sections discussing condensed consolidated operations and segment operations, appropriate reconciliations have been included to report information management considers useful in enhancing an understanding of the Company's operations to reportable GAAP balances reflected in the Condensed Consolidated Financial Statements.
Consolidated Operations
Premiums and other revenues. The following details Company revenues.
Three Months Ended September 30,
Nine Months Ended September 30,
2023
2022
2023
2022
(In thousands)
Universal life and annuity contract charges
$
34,471
33,810
106,952
99,428
Traditional life and SPIA WLC premiums
21,631
22,337
64,435
71,119
Net investment income (excluding index option derivatives)
88,619
92,054
276,141
293,875
Other revenues
5,741
5,761
16,731
17,136
Index option derivative gain (loss)
(19,655)
(12,550)
5,246
(89,173)
Net realized investment gains
25,883
745
25,976
6,305
Total revenues
$
156,690
142,157
495,481
398,690
Universal life and annuity contract charges - Revenues for universal life and annuity contracts were higher for the first nine months in 2023 compared to 2022 with the component sources shown below. Revenues for universal life and annuity products consist of policy charges for the cost of insurance, administration charges, surrender charges assessed against policyholder account balances, and other charges less reinsurance premiums, as shown in the following table.
Cost of insurance charges were $25.5 million in the three months ended September 30, 2023 level with $25.5 million reported in the third quarter of 2022, and were $78.2 million for the nine months ended September 30, 2023 compared to $74.0 million for the same period in 2022. Cost of insurance charges typically trend with the size of the universal life insurance block in force and the amount of new business issued during the period. The volume of universal life insurance in force at September 30, 2023 declined to $10.9 billion from approximately $11.8 billion at December 31, 2022 and $12.7 billion at December 31, 2021. Countering the downward trend in the level of life insurance in force are higher cost of insurance charges that National Western implemented on its International Life insurance products in accordance with policy contract provisions. Administrative charges pertaining to new business issued decreased to $6.5 million for the three months ended September 30, 2023 from $7.0 million for the same period in 2022, and to $19.6 million for the first nine months of 2023 compared to $20.6 million for the first nine months of 2022.
Surrender charges assessed against policyholder account balances upon withdrawal increased in the three and nine months ended September 30, 2023 versus the comparable prior year periods. While the Company earns surrender charge income that is assessed upon policy terminations, the Company's overall profitability is enhanced when policies remain in force and additional contract revenues are realized and the Company continues to make an interest rate spread equivalent to the difference it earns on its investments and the amount that it credits to policyholders. In the three and nine months ended September 30, 2023, lapse rates on annuity products were higher compared to prior year periods and a larger increase in lapsations were notable during the second quarter of 2023. Surrender charge income recognized is also dependent upon the duration of policies at the time of surrender (i.e. later duration policy surrenders have lower surrender charges assessed and earlier policy surrenders having a higher surrender charge assessed).
Other charges include the net amount of current period premium load amounts on new sales of single premium life insurance products which are deferred (recorded as negative revenue) and the subsequent amortization into income of these deferred premium loads. These products comprise substantially all of domestic life insurance sales. The increase in Other charges in the three and nine months ended September 30, 2023 versus the comparable 2022 periods reflect lower current period premium loads deferred due to decreased sales levels relative to the amounts currently being amortized into income.
Traditional life premiums - Ozark National's principal product is a non-participating whole life insurance policy with premiums remitted primarily on a monthly basis. The product is sold in tandem with a mutual fund investment product offered through its broker-dealer affiliate, NIS. Traditional life insurance premiums for products such as whole life and term life are recognized as revenues over the premium-paying period. A sizable portion of National Western's traditional life business resided in the International Life insurance segment. However, National Western's overall life insurance sales focus has historically been centered around universal life products. The addition of Ozark National's business of repetitive paying permanent life insurance adds an important complement to National Western's life insurance sales. Included in the amount for the three months ended September 30, 2023 is $17.6 million of life insurance renewal premium from Ozark National compared to $17.8 million in the third quarter of 2022. For the nine months ended September 30, 2023 and 2022, Ozark National life insurance renewal premium amounts were $53.3 million and $54.0 million, respectively. Universal life products, especially National Western's equity indexed universal life products, which offer the opportunity for consumers to acquire life insurance protection and receive credited interest linked in part to an outside market index, have been the more popular product offerings in the Company's markets.
Net investment income (with and without derivatives) - A detail of net investment income is provided below.
Three Months Ended September 30,
Nine Months Ended September 30,
2023
2022
2023
2022
(In thousands)
Gross investment income:
Debt and equities
$
74,719
75,463
226,208
219,680
Mortgage loans
4,496
3,541
14,894
15,292
Policy loans
686
674
2,016
1,919
Short-term investments
3,680
1,777
9,334
2,459
Other invested assets
5,676
2,036
28,689
18,236
Total investment income
89,257
83,491
281,141
257,586
Less investment expenses
620
619
2,007
1,993
Net investment income (excluding derivatives and trading securities)
88,637
82,872
279,134
255,593
Index option derivative gain (loss)
(19,655)
(12,550)
5,246
(89,173)
Embedded derivative on reinsurance
35,531
70,610
14,320
256,499
Trading securities market adjustments
(35,549)
(61,428)
(17,313)
(218,217)
Net investment income
$
68,964
79,504
281,387
204,702
The Company's strategy has been to invest a substantial portion of its cash flows in fixed debt securities within its guidelines for credit quality, duration, and diversification. As a result of an asset allocation strategy study that was conducted, an increase in allocations toward mortgage loans and alternative investments was identified as a strategic objective. Investment yields on new bond purchases during the first nine months of 2023 approximated 6.58% as compared to the 4.21% yield achieved during the full year 2022. National Western's weighted average bond portfolio yield was 3.84% at September 30, 2023 increasing from 3.76% at December 31, 2022. Ozark National's weighted average portfolio yield at September 30, 2023 was 3.91%.
Changes in fair values of equity securities are included in net investment income in the Condensed Consolidated Statements of Earnings. For the three months ended September 30, 2023 and 2022, unrealized gains/(losses) of $(1.8) million and $(0.4) million, respectively, are included in investment income reflecting the change in fair value of equity securities during the periods. For the nine months ended September 30, 2023 and 2022, unrealized gains/(losses) were $(0.3) million and $(6.3) million, respectively. The carrying value of the Company's portfolio of equity securities was $21.9 million at September 30, 2023.
During 2022 and thus far into 2023, the Company's new mortgage loan activity has been challenged as interest rate levels have appreciated considerably. The increase in interest rates has resulted in fewer mortgage loan opportunities meeting the Company's underwriting standards. Consequently, the mortgage loan portfolio balance declined to $490.1 million at September 30, 2023 from $505.7 million at December 31, 2022. During the nine months ended September 30, 2023 the Company originated new mortgage loans of $6.8 million compared to $45.4 million in the comparable period of 2022.
The increase in short-term investment income reflects the rapid increase in short-term interest rates over the past year in tandem with the Federal Reserve interest rate increases implemented to counter inflationary pressures. Short-term investment fund interest rates averaged approximately 0.9% for the first nine months of 2022. For the first nine months of 2023, interest rates ranged from 4.0% to 5.1% for the same short-term investment vehicles.
In order to obtain incremental investment yield, the Company expanded its invested asset portfolio to include alternative investments. These assets are typically capital pools with specific investment objectives managed by investment firms having specific expertise in designated asset opportunities. The Company held balances of $221.5 million, $186.9 million, and $67.7 million at September 30, 2023, December 31, 2022, and December 31, 2021, respectively, in this investment category, excluding any associated structured note amounts. Other invested assets investment income in the first nine months of 2022 includes a non-recurring $6.8 million profit participation payment on a mezzanine loan.
The Company's net investment income is reduced for amounts ceded to reinsurers under the funds withheld reinsurance agreements associated with funds withheld assets. In the quarters ended September 30, 2023 and 2022, the Company ceded net investment income of $19.6 million and $17.1 million, respectively. For the nine months ended September 30, 2023 and 2022, these amounts were $58.6 million and $44.8 million, respectively.
The Company is required to maintain an allowance pertaining to current expected credit losses on financial instruments ("CECL") under GAAP. Remeasurement of the CECL allowance for mortgage loans is performed quarterly and for the three months ended September 30, 2023 and 2022 resulted in an increase in the allowance of $0.6 million and $1.2 million, respectively, which is applied against gross investment income. For the nine months ended September 30, 2023 and 2022, the change in the CECL allowance applied against gross investment income for mortgage loans was an increase of $0.7 million and $0.8 million, respectively.
Credit loss allowances for available-for-sale debt securities are recorded when unrealized losses and missed payments indicate a credit loss has occurred and a full recovery of the investment principal is not expected. Credit loss allowances are recorded through net investment income in the Condensed Consolidated Statements of Earnings. No credit loss allowances for available-for-sale debt securities were recorded in the three and nine months ended September 30, 2023 or 2022.
In order to evaluate underlying profitability and results from ongoing operations, net investment income performance is analyzed excluding index option derivative gain (loss), the embedded derivative on reinsurance, and trading securities market value adjustments, which is a common practice in the insurance industry. Although this is considered a non-GAAP financial measure, Company management believes this financial measure provides useful supplemental information by removing the swings associated with fair value changes in derivative instruments. Net investment income and average invested assets shown below includes cash and cash equivalents. Net investment income performance is summarized as follows:
Nine Months Ended September 30,
2023
2022
(In thousands)
Excluding derivatives and funds withheld securities:
Net investment income
$
279,134
255,593
Average invested assets, at amortized cost
$
9,077,035
9,420,038
Annual yield on average invested assets
4.10
%
3.62
%
Including derivatives and funds withheld securities:
Net investment income
$
281,387
204,702
Average invested assets, at amortized cost
$
10,691,053
11,107,582
Annual yield on average invested assets
3.51
%
2.46
%
The average invested asset yield, excluding derivatives and trading securities, for the first nine months of 2023 increased compared to 2022 due to the incremental yield on newly invested cash flows into debt securities and alternative investments as well as the increase in short-term investment yields. Net investment income in the first nine months of 2023 and 2022 includes non-recurring profit participation payments related to mezzanine loans of $1.4 million and $6.8 million, respectively.
The average yield on bond purchases during the nine months ended September 30, 2023 to fund National Western insurance operations was 6.58% representing a 2.85% spread over treasury rates. The weighted average quality of new purchases during the first nine months of 2023 was "A" which was higher than the "A-" weighted average quality of purchases during 2022. The composite duration of purchases during the first nine months of 2023 was 6.1 years, which is significantly less than National Western's historical duration of purchases, indicative of the inverted yield curve during the first nine months of 2023. The Company's general investment strategy has been to purchase debt securities with maturity dates approximating ten years in the future. The strategic decision to expand diversification into alternative investments funds and private debt securities may shorten or lengthen investment duration dependent upon the instrument purchased.
The pattern in average invested asset yield, including derivatives and funds withheld securities, incorporates increases and decreases in the fair value of index options purchased by National Western to support its fixed-index products as well as net investment income from the embedded derivative funds withheld liability. Fair values of purchased call options recorded a net gain during the first nine months of 2023 and a net loss during the first nine months of 2022, corresponding to the movement in the S&P 500 Index® during these periods (the primary index the fixed-index products employ). Refer to the derivatives discussion below for a more detailed explanation.
With the execution of a funds withheld reinsurance agreement with Prosperity at the end of 2020, the Company initiated embedded derivative accounting with respect to the policyholder obligations reinsured. The Company entered into a second funds withheld reinsurance agreement with Aspida during 2022 which follows the same embedded derivative accounting treatment. During the nine months ended September 30, 2023, the embedded derivative contra-liability for reinsurance decreased by $14.3 million while in the nine months ended September 30, 2022 the embedded derivative contra-liability decreased by $256.5 million. These amounts are included in net investment income and served to increase net investment income in the first nine months of 2023 and 2022. Debt securities supporting the funds withheld policyholder obligations classified as trading incurred unrealized gains/(losses) of $(17.3) million in the first nine months of 2023 and $(218.2) million in the corresponding period for 2022, which were also recorded as a component of net investment income. The combination/net of these two amounts increased/(decreased) net investment income during the nine months ended September 30, 2023 and 2022 by $(3.0) million and $38.3 million, respectively.
Other revenues - Other revenues pertain to NIS, the broker-dealer affiliate of Ozark National; the operations of Braker P III, LLC ("BP III"), a subsidiary which owns and manages a commercial office building which includes the home office operations of National Western; and allowances earned by National Western for administering the funds withheld policies ceded to third party reinsurers.
NIS revenues were $2.8 million and $2.7 million for the three months ended September 30, 2023 and 2022, respectively. For the nine months ended September 30, 2023 and 2022, NIS revenues were $8.1 million and $8.8 million, respectively. NIS revenues typically move in tandem with equity market performance.
Revenues associated with BP III were $1.0 million and $1.3 million for the three months ended September 30, 2023 and 2022, respectively. For the nine months ended September 30, 2023 and 2022, revenues were $2.9 million and $3.9 million, respectively. Rental income received from National Western is eliminated in reporting consolidated results. The decreased rental income in 2023 compared with 2022 amounts reflects a $3.8 million buyout of the remaining lease term from a tenant at the end of 2022. The space vacated is currently not leased and being marketed.
Under terms of the Prosperity funds withheld reinsurance contract, National Western earns a monthly expense allowance equal to the average policy count of the funds withheld reinsured block of business multiplied by a stated amount per policy. The Company reported maintenance expense allowance revenue of $1.1 million and $1.1 million in the three months ended September 30, 2023 and 2022, and $3.4 million and $3.7 million in the nine months ended September 30, 2023 and 2022, respectively. As the block that was reinsured is a closed block of business, maintenance expense allowance revenue declines over time with the run off of the in force block.
Under the terms of the Aspida funds withheld reinsurance contract, National Western also earns a monthly expense allowance based upon the average policy count of the funds withheld reinsurance block of policies. In addition, National Western earns a ceding commission and certain policy acquisition allowance based upon new policies issued and coinsured with Aspida. The Company reported $0.3 million and $0.8 million in the three and nine months ended September 30, 2023, respectively, related to these revenue sources.
Effective July 27, 2022, the Company recorded as a liability (deferred revenue) on its Condensed Consolidated Balance Sheet a deferred Cost of Reinsurance ("COR") amount of $21.2 million associated with the funds withheld reinsurance transaction with Aspida (original COR amount reported of $30.8 million has been restated for the adoption of ASU 2018-12). This represents the net amount of GAAP reserves, deferred policy acquisition costs and sales inducements reinsured at the closing date, plus a $68.2 million ceding commission payable by the reinsurer, which in the aggregate was in excess of the Statutory Reserves ceded to Aspida (reflected as funds held assets). This COR balance is amortized and included in Other revenues. COR amortization revenue included in Other revenues totaled $0.4 million and $0.4 million for the three months ended September 30, 2023 and 2022, respectively, and $1.2 million and $0.4 million for the nine months ended September 30, 2023 and 2022, respectively.
Index option derivative gain (loss) - Index options are derivative financial instruments used to hedge the equity return component of National Western's fixed-index products. Derivative gain or loss includes the amounts realized from the sale or expiration of the options. Since the index options do not meet the requirements for hedge accounting under GAAP, they are marked to fair value on each reporting date and the resulting unrealized gain or loss is reflected as a component of net investment income. The options hedging the notional amount of policyholder contract obligations are purchased as close as possible to like amounts resulting in the amount of the option returns correlating closely with indexed interest credited.
Gains and losses from index options are substantially due to changes in equity market conditions. Index options are intended to act as hedges to match the returns on the product's underlying reference index and the rise or decline in the index relative to the index level at the time of the option purchase which causes option values to likewise rise or decline. As income from index options fluctuates with the underlying index, the contract interest expense to policyholder accounts for the Company's fixed-index products also fluctuates in a similar manner and direction. The Company recorded realized and unrealized gains/(losses) from index options as shown below.
Three Months Ended September 30,
Nine Months Ended September 30,
2023
2022
2023
2022
(In thousands)
Index option derivatives:
Unrealized gain (loss)
$
(18,248)
(749)
31,508
(100,373)
Realized gain (loss)
(1,407)
(11,801)
(26,262)
11,200
Total gain (loss) included in net investment income
$
(19,655)
(12,550)
5,246
(89,173)
Total contract interest
$
(10,417)
42,235
52,742
2,466
The economic impact of option performance in the Company's financial statements is not generally determined solely by the option gain or loss included in net investment income as there is a corresponding amount recorded in the contract interest expense line. The Company's profitability with respect to these options is largely dependent upon the purchase cost of the option remaining within the financial budget for acquiring options embedded in the product pricing. Option prices vary with interest rates, volatility, and dividend yields among other things. As option prices vary, the Company manages for the variability by making offsetting adjustments to product caps, participation rates, and management fees. For the periods shown, the Company's option costs have been close to or within the product pricing budgets.
Net realized investment gains (losses) - Realized gains (losses) on investments generally include proceeds from bond calls, sales and impairment write-downs, as well as gains and losses on the sale of real estate property. Net gains reported for the nine months ended September 30, 2023 consisted of gross gains of $26.0 million offset by gross losses of $0.0 million. Realized gains include the tender of shares held in Moody Bancshares, Inc. The Company's cost basis in the shares was $195,000 and the tender proceeds approximated $25.8 million. The net gains reported for the nine months ended September 30, 2022 consisted of gross gains of $6.5 million offset by gross losses of $(0.2) million.
Benefits and Expenses. The following table details benefits and expenses.
Three Months Ended September 30,
Nine Months Ended September 30,
2023
2022
2023
2022
(In thousands)
Life and other policy benefits
$
26,557
27,768
83,435
87,481
Policy benefit remeasurement (gains) and losses
8,360
9,827
8,360
9,827
Market risk benefits expense
(29,439)
(33,571)
6,733
(150,069)
Amortization of deferred transaction costs
20,326
21,613
63,600
67,549
Universal life and annuity contract interest
(10,417)
42,235
52,742
2,466
Other operating expenses
42,430
29,387
129,556
92,290
Totals
$
57,817
97,259
344,426
109,544
Life and other policy benefits - Death claim benefits, the largest component of policy benefits, were $54.1 million in the first nine months of 2023 compared to $59.1 million for the first nine months of 2022. Of the amount included in the nine months ended September 30, 2023, $27.1 million was associated with National Western business and $27.0 million pertained to Ozark National. In the first nine months of 2022, these amounts were $31.9 million and $27.2 million for National Western and Ozark National, respectively. Death claim amounts are subject to variation from period to period. For the first nine months of 2023, the number of National Western life insurance claims increased 9% versus the comparable period in 2022 while the average dollar amount per net claim declined to $53,700 from approximately $62,600. National Western's overall mortality experience has generally been consistent with or better than its product pricing assumptions. The average net claim for Ozark National during the 2023 and 2022 nine-month periods was $15,500 and $15,700, respectively. Mortality exposure is managed through reinsurance treaties under which National Western's retained maximum net amount at risk on any one life is capped at $500,000. Ozark National's retained maximum net amount at risk is capped at $200,000 under its reinsurance treaties with limited exceptions related to the conversion of child protection and guaranteed insurability riders.
With the inception of the pandemic, both National Western and Ozark National established specific coding to track the death claim experience associated with COVID-19. During the nine months ended September 30, 2023, National Western incurred 22 death claims on life insurance policies in which the reported cause of death was due to the coronavirus (COVID-19) totaling a net claim amount (after reinsurance) of $1.1 million. For the comparable nine-month period in 2022, National Western incurred 72 COVID-19 related death claims on life insurance policies totaling a net amount after reinsurance of $5.4 million. During the nine months ended September 30, 2023, Ozark National incurred 19 confirmed COVID-19 death claims aggregating to a net claim amount of approximately $0.4 million. For the nine months ended September 30, 2022, Ozark National reported 106 COVID-19 death claims totaling to a net amount of $2.8 million. The COVID-19 claim activity is included in the claim disclosures made in the preceding paragraph. Subsequent to 2021, the incidence of COVID-19 death claim reporting has dropped substantially.
Life and other policy benefits also includes other policy liabilities held associated with the Company's traditional life products and policies with life contingencies. The changes in other policy liabilities for National Western were $12.4 million and $18.3 million in the nine months ended September 30, 2023 and 2022, respectively. Life and other policy benefits in the nine months ended September 30, 2023 and 2022 includes changes in traditional life reserves and miscellaneous benefit payments associated with Ozark National's operations of $17.0 million and $10.1 million, respectively.
Policy benefit remeasurement (gains) and losses - The Company's practice is to annually review its actuarial assumptions as part of its reporting for the third quarter period and to "unlock" those assumptions which deviate materially from actual experience. Under ASU 2018-12 ("LDTI"), the impact of unlocking the Liability for Future Policyholder Benefits ("LFPB") and the Additional Liabilities in Excess of Account Balance is presented separately in the Condensed Consolidated Statements of Earnings as Policy benefit remeasurement (gains) and losses. During the three and nine months ended September 30, 2023, the Company unlocked its traditional life reserves and its excess death benefit reserves for mortality experience, lapse rates, and investment portfolio yield rates, the effect of which was to increase reserves by $8.4 million. The Company unlocked similar assumptions in the three and nine months ended September 30, 2022 the effect of which was to increase reserves by $9.8 million.
Market risk benefits expense - Market risk benefits expense is a new income statement line item emanating from the adoption of the LDTI accounting standard. The Market risk benefits liability represents the reserve pertaining to certain contract features on annuity products that provide minimum guarantees to policyholders, such as guaranteed minimum withdrawal benefits, that provide protection to contractholders from other-than-nominal capital market risk and expose the Company to other-than-nominal capital market risk. Market risk benefits are measured at fair value with changes in fair value not caused by credit risk recognized in net income each period. The change in fair value of the Market risk benefits liability reported in the Condensed Consolidated Statements of Earnings is impacted by interest rate movements. For the quarters ended September 30, 2023 and 2022, the change in the Market risk benefits liability due to interest rates was an expense/(benefit) of $(53.0) million and $(41.7) million, respectively, and for the nine months ended September 30, 2023 and 2022 the change was an expense/(benefit) of $(30.9) million and $(183.3) million, respectively. Refer to Note (7) Market Risk Benefits Liability in the Notes to Condensed Consolidated Statements for further discussion.
Amortization of deferred transaction costs - Life insurance companies are required to defer certain expenses directly related to the successful acquisition of new business. The majority of these acquisition expenses consist of commissions paid to agents, underwriting costs, costs of policy issuance, and certain other expenses directly related to the successfully acquired policies. Recognition of these deferred policy acquisition costs (“DPAC”) as an expense in the Condensed Consolidated Financial Statements occurs over future periods. Under LDTI guidance, deferred policy acquisition costs are amortized on a constant-level cohort basis over the expected term of the underlying contracts approximating a straight-line amortization on an individual contract basis. In accordance with GAAP guidance, the Company must also write-off deferred acquisition costs and unearned revenue liabilities upon internal replacement of certain contracts as well as annuitizations of deferred annuities.
The Company's practice is to annually review during the third quarter its actuarial assumptions pertaining to its blocks of businesses and to update those assumptions which deviate significantly from actual experience. The Company records these adjustments whenever necessary. The following table identifies the current effect of actuarial assumption adjustments on DPAC balances recorded through amortization expense separate from recurring amortization expense for the three and nine months ended September 30, 2023 and 2022.
Three Months Ended September 30,
Nine Months Ended September 30,
2023
2022
2023
2022
(In thousands)
Amortization of DPAC:
Actuarial assumption adjustments
$
(64)
(65)
(64)
(65)
Recurring amortization
15,966
15,886
48,790
49,903
Totals
$
15,902
15,821
48,726
49,838
Amortization expense for the three and nine months ended September 30, 2023 was comprised of DPAC amortization by National Western of $15.7 million and $48.1 million, respectively, and by Ozark National of $0.2 million and $0.6 million, respectively. Amortization expense three and nine months ended September 30, 2022 was comprised of DPAC amortization by National Western of $15.7 million and $49.3 million, respectively, and $0.2 million and $0.6 million by Ozark National, respectively. Amortization expense for National Western for the three and nine months ended September 30, 2023 was reduced by $1.0 million and $2.3 million, respectively, for amounts pertaining to the policies ceded under the funds withheld reinsurance agreements. Ceded amortization expense for the three and nine months ended September 30, 2022 was similarly reduced by $1.5 million and $2.9 million, respectively.
As part of the purchase accounting required with the acquisition of Ozark National, the Company recorded an intangible asset of $180.9 million referred to as the value of business acquired ("VOBA"). VOBA represents the difference between the acquired assets and liabilities of Ozark National measured in accordance with the Company's accounting policies and the fair value of these same assets and liabilities. The VOBA balance sheet amount is amortized following a methodology similar to that used for amortizing deferred policy acquisition costs. In the quarters ended September 30, 2023 and 2022, the Company's VOBA amortization expense was $2.1 million and $3.1 million, respectively, and for the nine months then ended $6.5 million and $9.5 million, respectively.
At December 31, 2020, the Company recorded as an asset on its Consolidated Balance Sheet a deferred Cost of Reinsurance ("COR") amount of $102.8 million associated with the funds withheld reinsurance transaction with Prosperity. This original balance represents the amount of assets transferred at the closing date of funds withheld agreement (debt securities, policy loans, and cash) in excess of the GAAP liability ceded plus a $48 million ceding commission paid to the reinsurer. The COR balance is amortized commensurate with the runoff of the ceded block of funds withheld business. For the three months ended September 30, 2023 and 2022, COR amortization expense of $2.3 million and $2.7 million, respectively, is included in Amortization of deferred transaction costs. For the nine months ended September 30, 2023 and 2022, COR amortization expense of $8.4 million and $8.2 million, respectively, is included in Amortization of deferred transaction costs.
Universal life and annuity contract interest - The Company closely monitors its credited interest rates on interest sensitive policies (National Western products), taking into consideration such factors as profitability goals, policyholder benefits, product marketability, and economic market conditions. As long term interest rates change, the Company's credited interest rates are often adjusted accordingly, taking into consideration the factors described above. The difference between yields earned on investments over policy credited rates is often referred to as the "interest spread" within the industry.
Contract interest expense includes other items which increase or decrease reported contract interest in a particular reporting period. For the three and nine months ended September 30, 2023 and 2022, contract interest expense includes the amounts shown in the table below.
Three Months Ended September 30,
Nine Months Ended September 30,
2023
2022
2023
2022
(In thousands)
Contract Interest Expense:
Credited fixed interest
$
18,509
20,077
56,939
63,898
Credited equity-index interest
11,854
94
11,854
45,696
Gross reserve changes
15,907
36,704
38,048
57,857
Withdrawal benefit rider charges
(7,276)
(7,189)
(22,342)
(21,959)
Ceded credited interest and reserve changes
(7,528)
(38,246)
(31,015)
(67,121)
Unlocking adjustment
(19,376)
27,993
(19,376)
27,993
Index option embedded derivative reserve changes
(22,507)
2,802
18,634
(103,898)
Totals
$
(10,417)
42,235
52,742
2,466
Contract interest expense includes gross reserve changes for immediate annuities, two tier annuities, excess death benefit reserves, excess annuitizations, and changes in deferred sales inducement balances. These gross reserve items are offset by policy charges assessed for policies having the withdrawal benefit rider ("WBR") and by amounts ceded to reinsurers.
For contract interest expense pertaining to funds withheld annuity policies ceded to the reinsurers, contract interest expense is adjusted to remove credited interest ceded and reserve change items ceded which are shown in the above table for the three and nine months ended September 30, 2023 and 2022. The amount of ceded interest credited on the funds withheld annuity policies included these amounts for the three months ended September 30, 2023 and 2022, was $6.2 million and $7.4 million, respectively. For the nine months ended September 30, 2023 and 2022, the interest credited ceded was $18.9 million and $24.2 million, respectively.
As part of the Company's unlocking process in the 2023 calendar third quarter, the Company unlocked its equity-indexed reserves for lapse rates, annuitization rates, and the portfolio investment yield, the effect of which was to reduce contract interest expense by $(19.4) million. The Company employed a similar unlocking process in the 2022 calendar third quarter the effect of which was to increase fixed-index annuities contract interest expense by $28.0 million.
Generally, the impact of the market value change of index options on asset values aligns closely with the movement of the embedded derivative liability held for the Company's fixed-index products such that the net effect upon pretax earnings is not significant. The market value changes of these index options for the three months ended September 30, 2023 and 2022, offsetting the index option embedded derivative reserve changes shown above, were $(17.6) million and $0.7 million, respectively. For the nine months ended September 30, 2023 and 2022, these amounts were $31.6 million and $(94.8) million, respectively. Policyholders of equity-indexed products cannot receive an interest credit below 0% according to the policy contract terms.
Other operating expenses - Other operating expenses consist of general administrative expenses, licenses and fees, commissions not subject to deferral, real estate expenses, brokerage expenses, compensation costs, and reinsurance ceded commission expense. These expenses for the three and nine months ended September 30, 2023 and 2022 are summarized in the table that follows.
Three Months Ended September 30,
Nine Months Ended September 30,
2023
2022
2023
2022
(In thousands)
General administrative expenses
$
14,608
15,810
38,936
41,566
Compensation expenses
20,931
6,348
70,155
25,360
Commission expenses
1,735
2,026
5,769
7,453
Real estate expenses
1,479
1,493
4,376
4,696
Brokerage expenses (NIS)
1,341
1,433
3,816
4,445
Reinsurance ceded commission expense
(92)
—
(199)
3
Taxes, licenses and fees
2,428
2,277
6,703
8,767
Totals
$
42,430
29,387
129,556
92,290
General administrative expenses include software amortization expense associated with National Western's proprietary policy administration systems as well as other acquired software. Expenses pertaining to these items were $2.3 million and $4.1 million in the third quarter of 2023 and 2022, respectively, and $7.5 million and $11.4 million in the first nine months of 2023 and 2022, respectively. The lesser amount in the 2023 period reflects legacy internally developed operating systems reaching their full amortization. Expenditures for consulting costs were $4.8 million in the three months ended September 30, 2023 versus $4.0 million in the comparable quarter of 2022, and $10.8 million in the first nine months of 2023 as compared to $15.4 million in the first nine months of 2022. Consulting costs in the three and nine months ended September 30, 2023 include services provided in conjunction with the Merger Agreement and related transactions. Consulting costs in the three and nine months ended September 30, 2022 include IT expenditures for consulting and contractor resources needed to compensate for IT staffing shortages. This category of expenses also includes legal fees and expenses which were $2.6 million and $0.9 million in the quarters September 30, 2023 and 2022, respectively and $4.0 million and $3.0 million in the first nine months of 2023 and 2022, respectively. In addition to expenses associated with litigation and lawsuits, these amounts in 2023 include legal services provided in connection with the Merger Agreement and related matters.
Compensation expenses include share-based compensation costs related to outstanding vested and nonvested stock appreciation rights ("SARs"), restricted stock units ("RSUs") and performance share units ("PSUs"). The related share-based compensation costs move in tandem not only with the number of awards outstanding but also with the movement in the market price of the Company's Class A Common Stock as a result of marking the SARs, RSUs, and PSUs to fair value under the liability method of accounting. Consequently, the related expense amount varies positively or negatively in any given period. In the Compensation expenses amounts shown above, share-based compensation expense totaled $11.3 million and $(1.2) million in the quarters ended September 30, 2023 and 2022, respectively. For the nine month periods shown share-based compensation expense was $43.6 million in 2023 and $1.4 million in 2022. The share-based compensation amount in the nine months ended September 30, 2023 reflects the change in the Company's Class A common share price which increased from $281.00 at December 31, 2022 to $437.49 at September 30, 2023. No performance share awards were granted in the first nine months of 2023 nor in 2022. Ozark National compensation expenses were $1.3 million and $1.0 million in the third quarter of 2023 and 2022, respectively, and $4.2 million and $3.0 million in the nine months ended 2023 and 2022, respectively.
Taxes, licenses and fees include premium taxes and licensing fees paid to state insurance departments, the company portion of social security and Medicare taxes, state income taxes, and other state and municipal taxes. Taxes, licenses and fees in the nine months ended September 30, 2023 include premium tax expenses of $3.0 million compared to $5.2 million in the comparable period of 2022 which reflects credits received in the first nine months of 2023 for 2022 tax premium overpayments which were the result of prescribed payment methods in certain states requiring estimated payments during the year to be based upon prior year obligations.
Federal Income Taxes. Federal income taxes on earnings reflect an effective tax rate of 29.4%for the first nine months ended September 30, 2023 compared to 20.7% for the nine months ended September 30, 2022. The Federal corporate tax rate was set at 21% under the 2017 Tax Cuts and Jobs Act ("Tax Act"). The Company's effective tax rate is typically slightly lower than the Federal statutory rate due to tax-exempt investment income related to municipal securities and dividends-received deductions on income from stocks, absent other permanent tax items. In the three and nine months ended September 30, 2023, the Company's effective tax rate increased due to IRS section 162(m) nondeductible salary expense limitations for highly compensated employees. These thresholds were surpassed due to the increased value of share-based compensation awards to officers and directors resulting from the Company's substantial increase in its publicly traded stock price during 2023.
The Company's current tax expense is also elevated due to a provision of the Tax Act which imposed a limitation on the amount of tax reserves a life insurer is able to deduct in arriving at its taxable income. The limitation is the greater of net surrender value or 92.81% of the reserve method prescribed by the National Association of Insurance Commissioners. Implementation of this provision was required as of January 1, 2018 and the Company ultimately determined that the resultant tax reserve adjustment was a decrease of $332.9 million. The Tax Act provided that this tax reserve adjustment could be brought into taxable income ratably over a period of eight (8) years. Based upon the tax reserve adjustment derived, the effect of the Tax Act limiting the tax reserve deductible in the current tax computation serves to increase the Company's taxable income by approximately $41.6 million per year through 2025. At the Federal statutory rate of 21%, the impact upon current tax expense is an increase of approximately $8.7 million per year or approximately $2.2 million each quarter.
Segment Operations
Summary of Segment Earnings
A summary of segment earnings for the three and nine months ended September 30, 2023 and 2022 is provided below. The segment earnings exclude realized gains and losses on investments, net of taxes.
A comparative analysis of results of operations for the Company's domestic life insurance segment is detailed below.
Three Months Ended September 30,
Nine Months Ended September 30,
2023
2022
2023
2022
(In thousands)
Premiums and other revenues:
Premiums and contract revenues
$
12,807
13,466
38,229
39,278
Net investment income
4,181
8,489
51,985
(453)
Other revenues
10
26
24
77
Total premiums and other revenues
16,998
21,981
90,238
38,902
Benefits and expenses:
Life and other policy benefits
6,180
6,647
13,569
14,425
Policy benefit remeasurement (gain)/loss
1,370
3,843
1,370
3,843
Amortization of deferred transaction costs
3,407
5,586
9,782
12,127
Universal life insurance contract interest
638
826
39,985
(15,751)
Other operating expenses
8,740
7,133
27,162
20,013
Total benefits and expenses
20,335
24,035
91,868
34,657
Segment earnings (loss) before Federal income taxes
(3,337)
(2,054)
(1,630)
4,245
Provision for Federal income taxes
(875)
(414)
(545)
880
Segment earnings (loss)
$
(2,462)
(1,640)
(1,085)
3,365
Revenues from domestic life insurance operations include life insurance premiums on traditional type products and contract revenues from universal life insurance. Revenues from traditional products are simply premiums collected, while revenues from universal life insurance consist of policy charges for the cost of insurance, policy administration fees, and surrender charges assessed during the period. A comparative detail of premiums and contract revenues is provided below.
Universal life insurance revenues are predominantly earned based upon the amount of life insurance policies that are in force. National Western's pace of new policies issued has lagged the number of policies terminated from death or surrender causing a declining level of policies in force from which contract revenue is received. Consequently, the number of domestic life insurance policies in force has declined from 46,060 at December 31, 2021 to 44,560 at December 31, 2022, and to 43,211 at September 30, 2023. Policy lapse rates in the first nine months of 2023 approximated 5.9% compared to 5.7% and 6.3% in the first nine months of 2022 and 2021, respectively. The face amount of life insurance in force has decreased from $3.65 billion at December 31, 2021 to $3.61 billion at December 31, 2022 and to $3.54 billion at September 30, 2023.
Universal life insurance revenues are also generated with the issuance of new business based upon amounts per application and percentages of the face amount (volume) of insurance issued. The number of domestic life policies issued in the first nine months of 2023 was 37% lower than in the comparable period for 2022 and the volume of insurance issued was 32% lower than that in 2022.
Universal life insurance revenues also include surrender charge income realized on terminating policies and, in the case of domestic universal life, amortization into income of the premium load on single premium policies which is deferred. The net premium load amortization was $7.1 million and $5.7 million in the nine months ended September 30, 2023 and 2022, respectively.
Premiums collected on universal life products are not reflected as revenues in the Company's Condensed Consolidated Statements of Earnings in accordance with GAAP. Actual domestic universal life premiums collected are detailed below.
Three Months Ended September 30,
Nine Months Ended September 30,
2023
2022
2023
2022
(In thousands)
Universal life insurance:
First year and single premiums
$
26,538
29,671
71,971
104,808
Renewal premiums
3,376
3,831
11,030
12,911
Totals
$
29,914
33,502
83,001
117,719
Domestic life insurance sales for some time have consisted substantially of single premium policies which do not have much in the way of recurring premium payments. These products utilize wealth transfer strategies involving the movement of accumulated wealth in alternative investment vehicles, including annuities, into life insurance products. As a result, renewal premium levels have generally not been exhibiting substantial increases.
Net investment income for this segment of business, excluding derivative gain/(loss), had been gradually increasing due to the new business activity described above (single premium policies) and a higher level of investments needed to support the corresponding growth in policy obligations, especially those for single premium policies. The recent decline in sales activity has served to mitigate the growth in net investment income. In addition, the increase in net investment income has been partially muted by lower investment yields from debt security investment purchases prior to 2023. Net investment income also includes the gains and losses on index options purchased to back the index crediting mechanism on fixed-index universal products.
A detail of net investment income for domestic life insurance operations is provided below.
As seen in the above table, reported net investment income includes the gains and losses on index options purchased to back the index crediting mechanism on fixed-index universal life products. The gain or loss on index options follows the movement of the S&P 500 Index (the primary index for the Company's fixed-index products) with realized gains or losses being recognized on the anniversary of each index option based upon the S&P 500 Index level at each expiration date relative to the index level at the time the index option was purchased, and unrealized gains and losses being recorded for index options outstanding based upon the S&P 500 Index at the balance sheet reporting date as compared to the index level at the time each respective option was purchased.
Life and policy benefits for a smaller block of business are more exposed to variation from period to period. Claim count activity during the first nine months of 2023 increased 13% compared to the first nine months of 2022 while the average net claim amount (after reinsurance) increased to $45,240 from $41,650. GAAP reporting requires that claims be recorded net of any cash value amounts that have been accumulated in the policies. Claims in 2023 have been skewed toward single premium universal life policies which typically have very high accounts value and very low net amounts as risk (face amount of policies less accumulated account values). The Company's overall mortality experience for this segment has been consistent with pricing assumptions.
As discussed in the Results of Consolidated Operations section, during the three and nine months ended September 30, 2023 and 2022, the Company unlocked its traditional life reserves and its excess death benefit reserves for mortality experience, lapse rates, and investment portfolio yield rates. The impact of unlocking the Liability for Future Policyholder Benefits ("LFPB") is presented separately in the Condensed Consolidated Statements of Earnings as Policy benefit remeasurement (gains) and losses and approximated $1.4 million and $3.8 million in 2023 and 2022, respectively, for domestic life insurance operations.
Included in amortization of deferred transaction costs is DPAC amortization. The Company's practice is to annually review during the third quarter its actuarial assumptions pertaining to its blocks of businesses and to update those assumptions which deviate significantly from actual experience. The Company records these adjustments whenever necessary. The following table identifies the current effect of actuarial assumption adjustments on domestic life insurance DPAC balances recorded through amortization expense separate from recurring amortization expense for the three and nine months ended September 30, 2023 and 2022.
Three Months Ended September 30,
Nine Months Ended September 30,
2023
2022
2023
2022
(In thousands)
Amortization of DPAC:
Actuarial assumption adjustments
$
99
(29)
99
(29)
Recurring amortization
3,308
5,615
9,683
12,156
Totals
$
3,407
5,586
9,782
12,127
Contract interest expense includes the fluctuations that are the result of the effect upon the embedded derivative for the performance of underlying equity indices associated with fixed-index universal life products. For liability purposes, the embedded option in the Company's policyholder obligations for this feature is bifurcated and reserved for separately. Accordingly, the impact for the embedded derivative component in the equity-index universal life product is reflected in contract interest expense for approximately the same amounts as in net investment income for each respective period.
Other operating expenses are allocated to the Company's lines of business based upon a functional cost analysis performed each year. As the Company's overall Other operating expenses have in increased in 2023 over 2022 levels, as discussed in the Results of Consolidated Operations section, Domestic life insurance operations operating expenses are correspondingly higher in 2023.
A comparative analysis of results of operations for the Company's international life insurance segment is detailed below.
Three Months Ended September 30,
Nine Months Ended September 30,
2023
2022
2023
2022
(In thousands)
Premiums and other revenues:
Premiums and contract revenues
$
22,871
18,303
64,476
56,612
Net investment income (loss)
2,229
3,986
16,296
(3,051)
Other revenues
2
24
6
63
Total premiums and other revenues
25,102
22,313
80,778
53,624
Benefits and expenses:
Life and other policy benefits
3,880
6,419
9,410
13,048
Policy benefit remeasurement (gain)/loss
6,469
(18)
6,469
(18)
Amortization of deferred transaction costs
4,148
3,771
12,225
12,610
Universal life insurance contract interest
646
2,421
11,592
(7,922)
Other operating expenses
7,300
4,384
22,208
14,121
Total benefits and expenses
22,443
16,977
61,904
31,839
Segment earnings before Federal income taxes
2,659
5,336
18,874
21,785
Provision for Federal income taxes
3,179
1,138
6,314
4,518
Segment earnings
$
(520)
4,198
12,560
17,267
As with domestic life operations, revenues from the international life insurance segment include both premiums on traditional type products and contract revenues from universal life insurance. A comparative detail of premiums and contract revenues is provided below.
Three Months Ended September 30,
Nine Months Ended September 30,
2023
2022
2023
2022
(In thousands)
Universal life insurance revenues
$
22,694
18,099
64,180
55,992
Traditional life insurance premiums
1,635
1,824
4,747
5,430
Reinsurance premiums
(1,458)
(1,620)
(4,451)
(4,810)
Totals
$
22,871
18,303
64,476
56,612
Universal life revenues and operating earnings are largely generated from the amount of life insurance in force. The volume of in force for this segment, primarily universal life, has contracted from $11.3 billion at December 31, 2021 to $10.3 billion at December 31, 2022 and to $9.4 billion at September 30, 2023. The international life insurance block of business is a closed book that is expected to run off over a number of years.
Another component of international universal life revenues includes surrender charges assessed upon surrender of contracts by policyholders. Prior to 2023, termination rates had been trending lower resulting in lower surrender charge fee revenue being recognized. Surrender activity in this line of business has picked up noticeably thus far in 2023. In addition, policy contract provisions which provide for lower surrender charge fees to be assessed later in the contract term can produce variability in surrender fee revenue. The following table illustrates National Western's recent international life termination experience.
Amount in $'s
Annualized Termination Rate
(millions)
Volume In Force Terminations:
Nine Months Ended September 30, 2023
$
945.4
12.2
%
Year ended December 31, 2022
1,018.8
9.0
%
Year ended December 31, 2021
1,080.1
8.7
%
Year ended December 31, 2020
1,295.2
9.5
%
Year ended December 31, 2019
1,671.5
10.9
%
Year ended December 31, 2018
1,706.3
10.0
%
As noted previously, premiums collected on universal life products are not reflected as revenues in the Company's Condensed Consolidated Statements of Earnings in accordance with GAAP. Actual international universal life premiums collected are detailed below.
Three Months Ended September 30,
Nine Months Ended September 30,
2023
2022
2023
2022
(In thousands)
Universal life insurance:
First year and single premiums
$
—
—
—
—
Renewal premiums
9,354
10,944
30,003
34,547
Totals
$
9,354
10,944
30,003
34,547
National Western's most popular international products were its fixed-index universal life products in which the policyholder could elect to have the interest rate credited to their policy account values linked in part to the performance of an outside equity index. These products issued were not generally available in the local markets when sold. Included in the totals in the above table are collected renewal premiums for fixed-index universal life products of approximately $17.0 million and $19.5 million for the first nine months of 2023 and 2022, respectively. The declining trend in renewal premiums during these periods corresponds with the decline in policies in force due to elimination of new sales and the termination activity as discussed above.
As previously noted, net investment income and contract interest include period-to-period changes in fair values pertaining to call options purchased to hedge the interest crediting feature on the fixed-index universal life products. With the relatively large size of the fixed-index universal life block of business, the period-to-period changes in fair values of the underlying options have a significant effect on net investment income and universal life contract interest. A detail of net investment income (loss) for international life insurance operations is provided below.
Three Months Ended September 30,
Nine Months Ended September 30,
2023
2022
2023
2022
(In thousands)
Net investment income (excluding index option derivatives)
$
5,275
5,421
15,960
16,610
Index option derivative gain (loss)
(3,046)
(1,435)
336
(19,661)
Net investment income (loss)
$
2,229
3,986
16,296
(3,051)
The gain or loss on index options follows the movement of the reference indices/index with realized gains or losses being recognized on the anniversary of each index option based upon the reference indices/index level at expiration date relative to the index level at the time the index option was purchased. Unrealized gains and losses are recorded for index options outstanding based upon their fair values, largely determined by the reference indices/index level, at the balance sheet reporting date as compared to the original purchase cost of each respective option.
Life and policy benefits primarily consist of death claims on policies. National Western's clientèle for international products are generally wealthy individuals with access to U.S. dollars and quality medical care. Consequently, the amounts of coverage purchased historically tended to be larger amounts. Life and policy benefit expense for the international life segment reflects the larger policies historically purchased, however mortality due to natural causes is comparable to that in the United States. The Company's maximum risk exposure per insured life is capped at $500,000 through reinsurance. The average international life net claim amount (after reinsurance) in the first nine months of 2023 decreased to $185,850 from $222,600 in the first nine months of 2022 while the number of claims incurred decreased 21%. Net claims, after reinsurance, associated with COVID-19 were $0.4 million in the nine months ended September 30, 2023 as compared to $2.2 million reported in the nine months ended September 30, 2022.
As discussed in the Results of Consolidated Operations section, during the three and nine months ended September 30, 2023 and 2022, the Company unlocked its traditional life reserves and its excess death benefit reserves for mortality experience, lapse rates, and investment portfolio yield rates. The impact of unlocking the Liability for Future Policyholder Benefits ("LFPB") is presented separately in the Condensed Consolidated Statements of Earnings as Policy benefit remeasurement (gains) and losses and approximated $6.5 million and $0.0 million in 2023 and 2022, respectively, for international life operations.
Included in amortization of deferred transaction costs is DPAC amortization. The Company's practice is to annually review during the third quarter its actuarial assumptions pertaining to its blocks of businesses and to update those assumptions which deviate significantly from actual experience. The Company records these adjustments whenever necessary. The following table identifies the current effect of actuarial assumption adjustments on international life insurance DPAC balances recorded through amortization expense separate from recurring amortization expense for the three and nine months ended September 30, 2023 and 2022.
Contract interest expense includes fluctuations that are the result of the effect upon the embedded derivative for the performance of underlying equity indices associated with fixed-index universal life products. For liability purposes, the embedded option in the Company's policyholder obligations for this feature is bifurcated and reserved for separately. Accordingly, the impact of the embedded derivative component in the equity-index universal life product is reflected in the contract interest expense for approximately the same amounts as the purchased call options are reported in net investment income for each respective period. Amounts realized on purchase call options generally approximate the amounts credited to policyholders.
As discussed previously, Other operating expenses are allocated to the Company's lines of business based upon a functional cost analysis performed each year. As the Company's overall Other operating expenses have in increased in 2023 over 2022 levels, as discussed in the Results of Consolidated Operations section, International life insurance operations operating expenses are correspondingly higher in 2023.
Annuity Operations
A comparative analysis of results of operations for National Western's annuity segment is detailed below.
Three Months Ended September 30,
Nine Months Ended September 30,
2023
2022
2023
2022
(In thousands)
Premiums and other revenues:
Premiums and contract revenues
$
1,895
5,570
12,497
17,532
Net investment income
54,169
55,365
168,439
171,575
Other revenues
1,872
1,584
5,674
4,182
Total premiums and other revenues
57,936
62,519
186,610
193,289
Benefits and expenses:
Life and other policy benefits
1,846
5,142
16,582
22,767
Policy benefit remeasurement (gain)/loss
—
93
—
93
Market risk benefits expense
(29,439)
(33,571)
6,733
(150,069)
Amortization of deferred transaction costs
10,457
9,022
34,463
32,741
Annuity contract interest
(11,701)
38,988
1,165
26,139
Other operating expenses
19,943
11,614
60,594
38,592
Total benefits and expenses
(8,894)
31,288
119,537
(29,737)
Segment earnings before Federal income taxes
66,830
31,231
67,073
223,026
Provision for Federal income taxes
22,390
6,860
22,437
46,255
Segment earnings
$
44,440
24,371
44,636
176,771
Premiums and contract charges primarily consist of surrender charge income recognized on terminated policies. The amount of the surrender charge income recognized is determined by the volume of surrendered contracts as well as the duration of each contract at the time of surrender given the pattern of declining surrender charge rates over time that is common to most annuity contracts. The Company's lapse rate for annuity contracts in the first nine months of 2023 was 9.8% which was elevated compared to historical measures and was higher than the 7.9% rate during the same period in 2022. An outcome of the COVID-19 pandemic crisis was the movement by consumers toward fortifying liquidity positions. This has manifested in greater withdrawal and surrender activity. In addition, annuity contracts with fixed interest rates are more prone to terminate as contracts approach the end of their surrender charge period and in periods of rising interest rates.
Deposits collected on annuity contracts are not reflected as revenues in the Company's Condensed Consolidated Statements of Earnings in accordance with GAAP. Actual annuity deposits collected for the three and nine months ended September 30, 2023 and 2022 are detailed below.
Three Months Ended September 30,
Nine Months Ended September 30,
2023
2022
2023
2022
(In thousands)
Fixed-index annuities
$
15,456
33,170
59,030
190,202
Other deferred annuities
186
48
1,173
1,710
Immediate annuities
1,403
5,702
691
6,417
Totals
$
17,045
38,920
60,894
198,329
Fixed-index products are attractive for consumers when interest rate levels remain low and equity markets produce positive returns. Since National Western does not offer variable products or mutual funds, fixed-index products provide an important alternative to the Company's existing fixed interest rate annuity products. The Company's legacy portfolio of fixed interest rate annuity products are not generally competitive in today's higher interest rate market. Fixed-index annuity deposits as a percentage of total annuity deposits were 97% and 96% for the nine months ended September 30, 2023 and 2022, respectively.
Some of the Company's deferred products, including fixed-index annuity products, contain a first year interest bonus, in addition to the base first year interest rate, which is credited to the account balance when premiums are applied. These sales inducements are deferred in conjunction with other capitalized policy acquisition costs. The amounts currently deferred to be amortized over future periods amounted to approximately $(4.2) million and $4.9 million during the first nine months of 2023 and 2022, respectively. Amortization of deferred sales inducements is included as a component of annuity contract interest as described later in this discussion of Annuity Operations.
A detail of net investment income for annuity operations is provided below.
Three Months Ended September 30,
Nine Months Ended September 30,
2023
2022
2023
2022
(In thousands)
Net investment income (excluding derivatives and trading securities)
$
61,759
51,774
179,605
162,063
Index option derivative gain (loss)
(7,572)
(5,593)
(8,173)
(28,770)
Embedded derivative on reinsurance
35,531
70,610
14,320
256,499
Trading securities market adjustment
(35,549)
(61,426)
(17,313)
(218,217)
Net investment income
$
54,169
55,365
168,439
171,575
For the three months ended September 30, 2023 and 2022, net investment income was reduced by $19.6 million and $17.2 million, respectively for amounts ceded to the reinsurers under the funds withheld reinsurance agreements. For the nine months ended September 30, 2023 and 2022, these amounts were $58.6 million and $44.8 million, respectively.
As seen in the above table, net investment income also includes the derivative gains and losses on index options purchased to back the index crediting mechanism on fixed-index products. The derivative gain or loss on index options follows the movement of the reference indices/index with realized gains or losses being recognized on the anniversary of each index option based upon the reference indices/index at the expiration date relative to the index level at the time the index option was purchased. Unrealized gains and losses are recorded for index options outstanding based upon their fair value, largely determined by the reference indices/index level, at the balance sheet reporting date as compared to the original purchase cost of each respective option.
The funds withheld reinsurance agreement with Prosperity executed December 31, 2020 introduced embedded derivative accounting with respect to the annuity policyholder obligations reinsured. The funds withheld reinsurance agreement with Aspida executed during the third quarter of 2022 follows the same embedded derivative accounting treatment. During the three months ended September 30, 2023, the embedded derivative contra-liability decreased by $35.5 million as a result of interest rate levels increasing during the period, which was recorded as a component of net investment income. Debt securities supporting the funds withheld policyholder obligations classified as trading securities incurred a $(35.5) million market value decrease in the three months ended September 30, 2023, which was also recorded as a component of net investment income. The net of these two amounts, the embedded liability decrease and the change in market value of trading securities, decreased net investment income in the Annuity segment by $(18.0) thousand in the three months ended September 30, 2023. For the three months ended September 30, 2022, net investment income increased $9.2 million as the embedded derivative liability decreased $70.6 million and the corresponding trading securities incurred a market value decrease of $61.4 million.
Other revenues for the three months ended September 30, 2023 and 2022 include $1.5 million and $1.1 million, respectively, of maintenance expense allowance revenue. For the nine months ended September 30, 2023 and 2022, $4.2 million and $3.6 million are included in Other revenues, respectively. Under terms of the funds withheld reinsurance contracts with reinsurers, National Western earns a monthly expense allowance equal to the average policy count of the funds withheld reinsured block of business multiplied by a stated amount per policy.
Market risk benefits expense is a new income statement line item emanating from the adoption of the LDTI accounting standard. The Market risk benefits liability represents the reserve pertaining to certain contract features on annuity products that provide minimum guarantees to policyholders, such as guaranteed minimum withdrawal benefits, that provide protection to contractholders from other-than-nominal capital market risk and expose the Company to other-than-nominal capital market risk. Market risk benefits are measured at fair value with changes in fair value not caused by credit risk recognized in net income each period. The change in fair value of the Market risk benefits liability reported in the Condensed Consolidated Statements of Earnings is impacted by interest rate movements. For the nine months ended September 30, 2023 and 2022, the change in the Market risk benefits liability due to interest rates was an expense/(benefit) of $(30.9) million and $(183.3) million, respectively. Refer to Note (7) Market Risk Benefits Liability in the Notes to Condensed Consolidated Statements for further discussion. For the three months ended September 30, 2023 and 2022, the change in the Market risk benefits liability due to interest rates was an expense/(benefit) of $(53.0) million and $(41.7) million, respectively.
Included in amortization of deferred transaction costs is DPAC amortization. The Company's practice is to annually review during the third quarter its actuarial assumptions pertaining to its blocks of businesses and to update those assumptions which deviate significantly from actual experience. The Company records these adjustments whenever necessary. The following table identifies the current effect of actuarial assumption adjustments on annuity DPAC balances recorded through amortization expense separate from recurring amortization expense for the three and nine months ended September 30, 2023 and 2022.
Three Months Ended September 30,
Nine Months Ended September 30,
2023
2022
2023
2022
(In thousands)
Amortization of deferred transaction costs:
Actuarial assumption adjustments
$
(161)
(42)
(161)
(42)
DPAC recurring amortization
8,287
6,383
26,241
24,591
COR amortization expense
2,331
2,681
8,383
8,192
Totals
$
10,457
9,022
34,463
32,741
In the three months ended September 30, 2023 and 2022, amortization expense was reduced by $1.0 million and $1.5 million, respectively, for DPAC ceded to reinsurers under the funds withheld reinsurance agreements. These amounts for the nine months ended September 30, 2023 and 2022 were $2.3 million and $2.9 million, respectively.
Amortization of deferred transaction costs includes amortization of the cost of reinsurance recorded at year-end 2020 associated with the funds withheld reinsurance agreement with Prosperity. At December 31, 2020, the Company recorded as an asset on the Consolidated Balance Sheet a deferred Cost of Reinsurance ("COR") amount of $102.8 million associated with the funds withheld reinsurance transaction. This represents the amount of assets transferred at the closing date of the funds withheld agreement (debt securities, policy loans, and cash) in excess of the GAAP liability ceded plus a $48.0 million ceding commission paid to the reinsurer. The COR balance is amortized commensurate with the runoff of the ceded block of funds withheld business. In the three and nine months ended September 30, 2023, COR amortization expense of $2.3 million and $8.4 million, respectively, is included in Amortization of deferred transaction costs, as compared to $2.7 million and $8.2 million for three and nine months ended September 30, 2022, respectively.
Annuity contract interest includes the equity component return associated with the call options purchased to hedge National Western's fixed-index annuities. The detail of fixed-index annuity contract interest as compared to contract interest for all other annuities is as follows:
Three Months Ended September 30,
Nine Months Ended September 30,
2023
2022
2023
2022
(In thousands)
Fixed-index annuities
$
(18,077)
35,757
(9,925)
23,187
All other annuities
3,096
596
716
(207)
Gross contract interest
(14,981)
36,353
(9,209)
22,980
Bonus interest deferred and capitalized
1,370
138
4,199
(4,901)
Bonus interest amortization
1,910
2,497
6,175
8,060
Total contract interest
$
(11,701)
38,988
1,165
26,139
The fluctuation in reported contract interest amounts for fixed-index annuities is driven by sales levels, the level of the business in force and the movement of the embedded derivative liability associated with the index options. As noted in the net investment income discussion, the amounts shown for contract interest for fixed-index annuities generally align with the derivative gains/(losses) included in net investment income due to the market change of index options aligning closely with the movement of the embedded derivative liability held for these products.
As part of the Company's unlocking process in the 2023 calendar third quarter, the Company unlocked its equity-indexed reserves for lapse rates, annuitization rates, and the portfolio investment yield, the effect of which was to reduce fixed-index annuities contract interest expense by $(19.4) million. The Company employed a similar unlocking process in the 2022 calendar third quarter the effect of which was to increase fixed-index annuities contract interest expense by $28.0 million.
Bonus interest deferred and capitalized is generally a reduction in total contract interest expense. The positive amounts show in the table above represent the impact of unvested bonus amounts at the time of a contract surrender. These amounts are reversed from bonus interest previously deferred and capitalized. During periods of high contract surrenders and low sales, these reversals exceed the amounts currently being deferred.
Ozark National and NIS are combined into a separate segment "ONL & Affiliates" given their inter-related marketing and sales approach which consists of a coordinated sale of a non-participating whole life insurance product (Ozark National) and a mutual fund investment product (NIS). An analysis of results of operations for the ONL & Affiliates segment is detailed below.
Three Months Ended September 30,
Nine Months Ended September 30,
2023
2022
2023
2022
(In thousands)
Premiums and other revenues:
Premiums and contract charges
$
18,529
18,808
56,185
57,125
Net investment income
8,358
7,301
24,519
21,438
Other revenues
2,829
2,778
8,154
8,866
Total premiums and other revenues
29,716
28,887
88,858
87,429
Benefits and expenses:
Life and other policy benefits
14,651
9,560
43,874
37,241
Policy benefit remeasurement (gain)/loss
521
5,909
521
5,909
Amortization of deferred transaction costs
2,314
3,234
7,130
10,071
Other operating expenses
4,949
4,755
15,167
14,826
Total benefits and expenses
22,435
23,458
66,692
68,047
Segment earnings before Federal income taxes
7,281
5,429
22,166
19,382
Provision for Federal income taxes
1,481
1,075
4,511
3,905
Segment earnings
$
5,800
4,354
17,655
15,477
Revenues from ONL & Affiliates principally include life insurance premiums on traditional type products. Unlike universal life, revenues from traditional products are simply life premiums recognized as income over the premium-paying period of the related policies. The detail of premiums is provided below.
Ozark National's traditional life block of business at September 30, 2023 included 168,960 policies in force representing approximately $5.6 billion of life insurance coverage. The repetitive pay nature of Ozark National's business generally promotes a higher level of persistency with an annualized lapse rate of 4.3% through September 30, 2023 slightly higher than the 4.2% rate experienced in the first nine months of 2022. Traditional life premiums by first year and renewal are detailed below.
Three Months Ended September 30,
Nine Months Ended September 30,
2023
2022
2023
2022
(In thousands)
Traditional life insurance premiums:
First year premiums
$
938
969
2,791
2,969
Renewal premiums
18,080
18,389
55,173
55,964
Totals
$
19,018
19,358
57,964
58,933
Other revenues consist primarily of brokerage revenue of NIS. Brokerage revenues of $8.1 million and $8.8 million for the nine months ended September 30, 2023 and 2022, respectively, had associated brokerage expense of $3.8 million and $4.4 million which is included in Other operating expenses. Brokerage revenues of $2.8 million and $2.8 million for the three months ended September 30, 2023 and 2022, respectively, had associated broker expenses of $1.3 million and $1.4 million.
The average face value of Ozark National's policies in force at September 30, 2023 was approximately $33,000. Life and policy benefits are subject to variation from quarter to quarter. Incurred net death claims, after reinsurance, for the first nine months of 2023 were $27.0 million representing an average net claim of $15,500. Incurred net death claims in the nine month period ended September 30, 2022 were $27.2 million representing a net average claim of $15,700. Ozark National's maximum retention on any single insured life is $200,000 with limited exceptions related to the conversion of child protection and guaranteed insurability riders. The balance of life and policy benefits during the three and nine months ended September 30, 2023 and 2022 consisted of increases in insurance reserves and payments of other policy benefits.
As discussed in the Results of Consolidated Operations section, during the three and nine months ended September 30, 2023 and 2022, the Company unlocked Ozark National's traditional life reserves for lapse rates. The impact of unlocking the Liability for Future Policyholder Benefits ("LFPB") is presented separately in the Condensed Consolidated Statements of Earnings as Policy benefit remeasurement (gains) and losses and approximated $0.5 million and $5.9 million in 2023 and 2022, respectively, for Ozark National's operations.
Amortization of deferred transaction costs for this segment includes amortization of DPAC and the value of business acquired ("VOBA"). VOBA represents the difference between the acquired assets and liabilities of Ozark National at the acquisition date measured in accordance with the Company's accounting policies and the fair value of these same assets and liabilities. The VOBA balance sheet amount is amortized following a methodology similar to that used for amortizing deferred policy acquisition costs. Subsequent to its acquisition effective January 31, 2019, Ozark National began deferring policy acquisition costs and amortizing these deferrals similar to the methodology employed by National Western. The following table identifies the amortization expense of Ozark National's DPAC and VOBA for the three and nine months ended September 30, 2023 and 2022.
Three Months Ended September 30,
Nine Months Ended September 30,
2023
2022
2023
2022
(In thousands)
Amortization of deferred transaction costs:
Actuarial assumption adjustments
$
(5)
—
(5)
—
VOBA amortization expense
2,093
3,111
6,491
9,519
DPAC recurring amortization
226
123
644
552
Totals
$
2,314
3,234
7,130
10,071
Other Operations
The Company's primary business encompasses its domestic and international life insurance operations, its annuity operations, and ONL & Affiliates. However, the Company also has real estate and other investment operations through its wholly owned subsidiaries.
Pre-tax operating amounts include the results of BP III, the entity owning and operating the Company's home office facility in Austin, Texas. BP III incurred pre-tax losses of $(1.5) million and $(0.8) million for the nine months ended September 30, 2023 and 2022, respectively. National Western maintains its home office in this facility leasing approximately 40% of the space available. The lease payments made by National Western to BP III have been eliminated in consolidation. The increase in pre-tax loss during the first nine months of 2023 represents vacant space during the period due to a previous tenant paying an early termination fee at the end of 2022.
The remaining pre-tax earnings of $20.2 million and $15.2 million in Other Operations during the nine-month periods includes investment income from real estate, municipal bonds, and common and preferred equities held in subsidiary company portfolios principally for tax-advantage purposes. Included in these amounts are semi-annual distributions from a life interest in the Libbie
Shearn Moody Trust ("LSM Trust") which is held in NWLSM, Inc. Pre-tax distributions from the LSM Trust were $6.1 million and $2.3 million in the nine-month periods ended September 30, 2023 and 2022, respectively. The increased distribution in the 2023 period is due to the LSM Trust reinvesting the proceeds received from the sale of American National Group, Inc. in 2022 in yields exceeding the dividend previously earned on the shares held of American National Group, Inc.
A predecessor of the Company acquired its life estate interest in 1960 as part of Robert L. Moody, Sr.'s capitalization of that predecessor insurance company. Mr. Moody, Sr. was Chairman Emeritus of the Company and was the last surviving grandchild of Libbie Shearn Moody. By its terms, the LSM Trust life estate interest provided for the payment of one-eighth of the income of the LSM Trust as long as Mr. Moody, Sr. was alive. On November 7, 2023, Robert L. Moody Sr. passed away. As a result, the Company will not receive any distributions of income received by the LSM Trust attributable to periods following Mr. Moody, Sr.'s death. Because of the nature of the LSM Trust estate interest, the Company holds a $12.8 million life insurance policy on Mr. Moody, Sr.'s life issued by National Western. All but $150,000 of that life insurance is reinsured by third party reinsurers.
Included in the pre-tax earnings for the nine months ended September 30, 2022, is a $6.8 million non-recurring profits participation payment received on a mezzanine loan. The Company holds a modest portfolio of equity securities, primarily in NWL Financial, Inc., whose fair value changes are recorded in net investment income. For the three months ended September 30, 2023 and 2022, the market value changes for these securities were $(1.8) million and $(0.4) million, respectively. For the nine months ended September 30, 2023 and 2022, the market value changes were $(0.3) million and $(6.3) million, respectively.
The Company's investment philosophy emphasizes the careful handling of policyowners' and stockholders' funds to achieve security of principal, to obtain the maximum possible yield while maintaining security of principal, and to maintain liquidity in a measure consistent with current and long-term requirements of the Company.
The Company's overall conservative investment philosophy is reflected in the allocation of its investments, which is detailed below. The Company emphasizes investment grade debt securities.
September 30, 2023
December 31, 2022
Carrying Value
%
Carrying Value
%
(In thousands)
(In thousands)
Debt securities available-for-sale
$
7,052,554
78.4
$
7,611,633
79.7
Debt securities trading
1,000,355
11.1
1,065,993
11.1
Mortgage loans
490,059
5.4
505,730
5.3
Policy loans
67,809
0.8
70,495
0.7
Derivatives, index options
55,278
0.6
23,669
0.2
Real estate
27,274
0.3
27,712
0.3
Equity securities
21,913
0.2
22,076
0.2
Other
281,625
3.1
234,394
2.5
Short-term investments
7,821
0.1
3,937
—
Totals
$
9,004,688
100.0
$
9,565,639
100.0
Invested assets at September 30, 2023 include Ozark National and NIS amounts as follows: Debt securities of $663.0 million and Policy loans of $21.0 million. These invested asset amounts at December 31, 2022 were: Debt securities of $674.8 million and Policy loans of $22.2 million.
The Company's available-for-sale debt securities and trading debt securities portfolios in aggregate had an exposure to regional bank bonds totaling $157.0 million at September 30, 2023. This represents 1.7% of the Company's total invested assets as of that date. Of this amount, $4.2 million of bank debt securities were held in the trading debt securities portfolio which is managed by reinsurers under funds withheld reinsurance agreements who bear the financial risk of any credit loss with respect to these securities. The Company carefully monitors its credit exposures to this sector and did not maintain a credit loss allowance with respect to its holdings at September 30, 2023.
Debt Securities
GAAP accounting requires investments in debt securities to be classified into one of three categories: (a) trading securities; (b) securities available-for-sale; or (c) securities held-to-maturity. Although the Company's investment philosophy calls for purchases of securities with the intent to hold to maturity, the introduction of funds withheld coinsurance arrangements precluded the Company from utilizing the held-to-maturity category when classifying its debt securities. Consequently, the Company has designated its debt securities holdings as available-for-sale and any funds-held acquisitions as trading securities. The discussion that follows reflects this category classification.
The Company maintains a diversified debt securities portfolio which consists mostly of corporate, mortgage-backed, and public utility fixed income securities. Investments in mortgage-backed securities primarily include U.S. Government agency pass-through securities and collateralized mortgage obligations ("CMO"). The Company's investment guidelines prescribe limitations by type of security as a percent of the total investment portfolio and all holdings were within these threshold limits. As of September 30, 2023 and December 31, 2022, the Company's available-for-sale debt securities portfolio consisted of the following classes of securities:
September 30, 2023
December 31, 2022
Carrying Value
%
Carrying Value
%
(In thousands)
(In thousands)
Corporate
$
5,016,735
71.1
$
5,631,572
74.0
Residential mortgage-backed securities
246,560
3.5
321,032
4.2
Public utilities
535,611
7.6
615,137
8.1
State and political subdivisions
374,719
5.3
411,499
5.4
U.S. agencies
11,642
0.2
20,626
0.3
Asset-backed securities
800,779
11.4
542,866
7.1
Commercial mortgage-backed
20,429
0.3
20,285
0.3
Foreign governments
43,400
0.6
45,887
0.6
U.S. Treasury
2,679
—
2,729
—
Totals
$
7,052,554
100.0
$
7,611,633
100.0
The Company holds minimal levels of U.S. Treasury securities due to their low yields and deposits most of these holdings with various state insurance departments in order to meet security deposit on hand requirements in these jurisdictions.
A substantial portion of the Company's investable cash flows are directed toward the purchase of long-term debt securities. The Company's investment policy calls for investing in debt securities that are investment grade, meet quality and yield objectives, and provide adequate liquidity for obligations to policyholders. Particular attention is paid to avoiding concentration in any one industry classification or in large singular credit exposures. Debt securities with intermediate maturities are typically targeted by the Company as they more closely match the intermediate nature of the Company's policy liabilities and provide an appropriate strategy for managing cash flows. Long-term debt securities purchased to fund National Western insurance company operations are summarized below.
Nine Months Ended September 30,
Year Ended December 31,
2023
2022
($ In thousands)
Cost of acquisitions
$
53,291
$
697,489
Average credit quality
A
A-
Effective annual yield
6.58
%
4.21
%
Spread to treasuries
2.85
%
1.76
%
Effective duration
6.1 years
8.0 years
Prior to 2022, the Company had been purchasing a higher proportion of longer maturity debt securities to match the increased duration of its growing life insurance policy liabilities. With the inversion of the yield curve beginning in 2022, longer duration debt securities have not provided sufficient incremental yield and value to warrant extending maturities on new purchases.
In addition to diversification, an important aspect of the Company's investment approach is managing the credit quality of its investment in debt securities. Thorough credit analysis is performed on potential corporate investments including examination of a company's credit and industry outlook, financial ratios and trends, and event risks. This emphasis is reflected in the high average credit rating of the Company's available-for-sale debt securities portfolio with 98.3%, as of September 30, 2023, held in investment grade securities. In the table below, investments in available-for-sale debt securities are classified according to credit ratings by nationally recognized statistical rating organizations.
September 30, 2023
December 31, 2022
Carrying Value
%
Carrying Value
%
(In thousands)
(In thousands)
AAA
$
167,549
2.4
$
152,934
2.0
AA
933,696
13.2
1,047,929
13.8
A
2,414,526
34.2
2,625,189
34.5
BBB
3,417,983
48.5
3,673,096
48.2
BB and other below investment grade
118,800
1.7
112,485
1.5
Totals
$
7,052,554
100.0
$
7,611,633
100.0
Historically, the Company's investment guidelines have not permitted the purchase of below investment grade securities. Recently, these guidelines were amended to allow for purchases of below investment grade securities that are part of an alternative investment ("Schedule BA assets"). The Company continues its longstanding practice of not purchasing any other below investment grade securities. Investments held in available-for-sale debt securities may become below investment grade as a result of subsequent downgrades of the securities. These below investment grade holdings, including structured notes associated with the Schedule BA assets category, are further summarized below.
The Company's percentage of below investment grade securities to total invested assets at September 30, 2023 compared to December 31, 2022 remained level in the first nine months of 2023. The Company's holdings of below investment grade securities as a percentage of total invested assets continue to remain low compared to industry averages.
Holdings in below investment grade securities as of September 30, 2023 are summarized below by category, including their comparable fair value as of December 31, 2022 for those debt securities rated below investment grade at September 30, 2023. The Company continually monitors developments in these industries for issues that may affect security valuation.
The Company evaluates its below investment grade holdings by reviewing investment performance indicators, including information such as issuer operating performance, debt ratings, analyst reports and other economic factors that may affect these specific investments. While additional losses are not currently anticipated, based on the existing status and condition of these securities, credit deterioration of some securities or the markets in general is possible, which may result in future allowances or write-downs. The Company has no direct holdings of debt securities with operations in Russia, Ukraine or Belarus, nor does it hold any investments with significant exposure to these regions.
The Company's holdings in the available-for-sale category provide flexibility to the Company to react to market opportunities and conditions and to practice active management within the portfolio to provide adequate liquidity to meet policyholder obligations and other cash needs. Available-for-sale debt securities are reported at their fair market values with any change reported through Accumulated Other Comprehensive Income (Loss) in the Stockholders' Equity section of the Condensed Consolidated Balance Sheets.
Debt securities classified as trading securities represent debt security investments made by reinsurers in the funds withheld asset accounts in accordance with their respective reinsurance agreements. The designation as trading securities allows the market value fluctuation of these securities to be recorded directly in the Condensed Consolidated Statements of Earnings. This results in offsetting the embedded derivative liability change due to market value fluctuations which is also recorded directly in the Condensed Consolidated Statements of Earnings.
Debt securities available-for-sale and debt securities trading are summarized as follows at September 30, 2023.
September 30, 2023
Fair Value
Amortized Cost
Allowance for Credit Losses
Unrealized Gains (Losses)
(In thousands)
Debt securities available-for-sale
$
7,052,554
7,994,143
—
(941,589)
Debt securities trading
1,000,355
1,221,272
—
(220,917)
Totals
$
8,052,909
9,215,415
—
(1,162,506)
The unrealized loss position of the Company's debt securities holdings reflects the effect of rising interest rate levels on fair market values. At December 31, 2022, the Company's available-for-sale and trading debt securities were in an unrealized loss position of $(1.0) billion. At September 30, 2023, this position had increased slightly to an unrealized loss of $(1.2) billion reflecting a marginal increase in interest rate levels during the first nine months of 2023.
The Company's trading debt securities portfolio consisted of the following classes of securities:
In the table below, investments in trading debt securities are classified according to credit ratings by nationally recognized statistical rating organizations.
September 30, 2023
December 31, 2022
Carrying Value
%
Carrying Value
%
(In thousands)
(In thousands)
AAA
$
11,767
1.2
$
13,645
1.3
AA
81,788
8.2
54,650
5.1
A
340,590
34.0
365,770
34.3
BBB
508,569
50.8
577,424
54.2
BB and other below investment grade
57,641
5.8
54,504
5.1
Totals
$
1,000,355
100.0
$
1,065,993
100.0
The investments in the trading debt securities below investment grade are summarized below.
Below Investment Grade Trading Debt Securities
Amortized Cost
Carrying Value
Fair Value
% of Invested Assets
(In thousands, except percentages)
September 30, 2023
$
63,064
57,641
57,641
0.6
%
December 31, 2022
62,232
54,504
54,504
0.6
%
Mortgage Loans and Real Estate
The Company originates loans on high quality, income-producing properties such as shopping centers, freestanding retail stores, office buildings, industrial and sales or service facilities, selected apartment buildings, hotels, and health care facilities. The locations of these properties are typically in major metropolitan areas that offer a potential for property value appreciation. Credit and default risk is minimized through strict underwriting guidelines and diversification of underlying property types and geographic locations. In addition to being secured by the property, mortgage loans with leases on the underlying property are often secured by the lease payments. This approach has proved over time to result in quality mortgage loans with few defaults. Mortgage loan interest income is recognized on an accrual basis with any premium or discount amortized over the life of the loan. Prepayment and late fees are recorded on the date of collection.
The Company targets a minimum specified yield on mortgage loan investments determined by reference to currently available debt security instrument yields, plus a desired amount of incremental basis points. A low interest rate environment, along with a competitive marketplace, have resulted in fewer loan opportunities being available meeting the Company's required rate of return. The subsequent rapid rise in interest rate levels beginning in 2022 caused potential mortgage loan opportunities to fall outside the Company's underwriting criteria further causing a lower level of originations. Mortgage loans originated by the Company totaled $6.8 million in the nine months ended September 30, 2023 compared to $45.4 million for the nine months ended September 30, 2022 and $47.4 million for the year ended December 31, 2022.
Loans in foreclosure, loans considered impaired or loans past due 90 days or more are placed on a non-accrual status. If a mortgage loan is determined to be on non-accrual status, the mortgage loan does not accrue any revenue into the Condensed Consolidated Statements of Earnings. The loan is independently monitored and evaluated as to potential impairment or foreclosure. If delinquent payments are made and the loan is brought current, then the Company returns the loan to active status and accrues income accordingly. The Company currently has no loans past due 90 days which are accruing interest.
The Company held net investments in mortgage loans, after allowances for possible losses, totaling $490.1 million and $505.7 million at September 30, 2023 and December 31, 2022, respectively. The diversification of the portfolio by geographic region and property type was as follows.
Included in the mortgage loan investment balance at September 30, 2023 and December 31, 2022 were mortgage loan investments made by Prosperity under the funds withheld reinsurance agreement totaling $19.3 million and $19.3 million, respectively. Similar to trading debt securities, these loans are reported at fair market values in order to allow the market value fluctuation to be recorded directly in the Condensed Consolidated Statements of Earnings and to offset the embedded derivative liability change due to market value fluctuations.
The Company employs the Weighted Average Remaining Maturity ("WARM") method in estimating current expected credit losses with respect to mortgage loan investments. The WARM method applies publicly available data of default incidence of commercial real estate properties by several defined segmentations combined with future assumptions regarding economic conditions (i.e. GDP forecasts) both in the near term and the long term. Changes in the allowance for current expected credit losses are reported in Net investment income in the Condensed Consolidated Statements of Earnings.
Three Months Ended September 30,
Nine Months Ended September 30,
2023
2022
2023
2022
(In thousands)
Mortgage Loans Allowance for Credit Losses:
Balance, beginning of the period
$
3,736
2,573
3,575
2,987
Provision (release) during the period
560
1,225
721
811
Balance, end of period
$
4,296
3,798
4,296
3,798
The Company's direct investments in real estate consist primarily of a half-dozen income-producing properties which are being operated by a wholly owned subsidiary of National Western. The Company's real estate investments totaled approximately $27.3 million and $27.7 million at September 30, 2023 and December 31, 2022, respectively.
The Company recognized operating income of approximately $2.3 million and $2.3 million on real estate properties in the first nine months of 2023 and 2022, respectively. During the nine months ended September 30, 2022, the Company sold land located in Freeport, Texas and Houston, Texas along with a retail property located in Ruidoso, New Mexico for a net realized gain of $1.2 million. The Company monitors the conditions and market values of these properties on a regular basis and makes repairs and capital improvements to keep the properties in good condition.
Market Risk
Market risk is the risk of change in market values of financial instruments due to changes in interest rates, currency exchange rates, commodity prices, or equity prices. The most significant market risk exposure for the Company is interest rate risk. Substantial and sustained increases and decreases in market interest rates can affect the profitability of insurance products and fair value of investments. The yield realized on new investments generally increases or decreases in direct relationship with interest rate changes. The fair values of fixed income debt securities correlate to external market interest rate conditions as market values typically increase when market interest rates decline and decrease when market interest rates rise. However, market values may fluctuate for other reasons, such as changing economic conditions, market dislocations, declination in credit quality, or increasing event-risk concerns.
Interest Rate Risk
A gradual increase in interest rates is generally a positive development for the Company. Rate increases would be expected to provide incremental net investment income, produce increased sales of fixed rate products, and limit the potential erosion of the Company's interest rate spread on products due to minimum guaranteed crediting rates in products. Conversely, a rise in interest rates reduces the fair value of the Company's investment portfolio and if long-term rates rise dramatically within a relatively short time period the Company could be exposed to disintermediation risk. Disintermediation risk is the risk that policyholders will surrender their policies in a rising interest rate environment forcing the Company to liquidate assets when they are in an unrealized loss position. The Company seeks to minimize the impact of interest rate risk, at least with respect to some of its products, through surrender charges that are imposed to discourage policy surrenders and to offset unamortized deferred policy acquisition costs.
A decline in interest rates could cause certain mortgage-backed securities in the Company's portfolio to be more likely to pay down or prepay. In this situation, the Company typically would not be able to reinvest the proceeds at comparable yields. Lower interest rates cause lower net investment income, subject the Company to reinvestment rate risks, and possibly reduce profitability through reduced interest rate margins associated with products having minimum guaranteed crediting rates. Conversely, the fair value of the Company's investment portfolio increases when interest rates decline.
The correlation between fair values and interest rates of available-for-sale debt securities for the quarters ended September 30, 2023 and June 30, 2023, and for the year ended December 31, 2022 is reflected in the tables below.
Ten-year U.S. Treasury bond – increase (decrease) in yield for the period
0.73
%
0.37
%
2.37
%
The Company's trading debt securities, which are exclusively in funds withheld assets managed by reinsurers, are recorded at fair value upon purchase. While the recorded value of these trading debt securities subsequently fluctuates with market prices, the fair value movement of the securities is entirely offset by an identical fair value movement of the associated funds withheld liabilities.
The Company's unrealized gain (loss) balance for available-for-sale debt securities and trading debt securities held at September 30, 2023, June 30, 2023, and December 31, 2022 is shown in the following table.
Net Unrealized Gain (Loss) Balance
At September 30, 2023
At June 30, 2023
At December 31, 2022
Quarter Change in Unrealized Balance
Year-to-date Change in Unrealized Balance
(In thousands)
Debt securities available-for-sale
$
(941,589)
(759,387)
(827,129)
(182,202)
(114,460)
Debt securities trading
(220,917)
(185,368)
(203,604)
(35,549)
(17,313)
Totals
$
(1,162,506)
(944,755)
(1,030,733)
(217,751)
(131,773)
Changes in interest rates typically have a sizable effect on the fair values of the Company's debt securities. The market interest rate of the ten-year U.S. Treasury bond increased 69 basis points from 3.88% at year-end 2022 to 4.57% by the end of the first nine months of 2023. Therefore, the increase in the unrealized loss balance position from that at December 31, 2022 is the expected portfolio value movement.
The Company manages interest rate risk principally through ongoing cash flow testing as required for insurance regulatory purposes. Computer models are used to perform cash flow testing under various commonly used stress test interest rate scenarios to determine if existing assets would be sufficient to meet projected liability outflows. Sensitivity analysis allows the Company to measure the potential gain or loss in fair value of its interest-sensitive instruments and to protect its economic value and achieve a predictable spread between what is earned on invested assets and what is paid on liabilities. The Company seeks to minimize the impact of interest risk through surrender charges that are imposed to discourage policy surrenders. Interest rate changes can be anticipated in computer models and the corresponding risk addressed by management actions affecting asset and liability instruments. However, potential changes in the values of financial instruments indicated by hypothetical interest rate changes will likely be different from actual changes experienced, and the differences could be significant.
The Company has the ability to adjust interest rates, participation rates, and asset management fees and caps, as applicable, in response to changes in investment portfolio yields for a substantial portion of its business in force. The ability to adjust these rates is subject to competitive forces in the market for the Company’s products. Surrender rates could increase and new sales could be negatively affected if crediting rates are not competitive with the rates on competing products offered by other insurance companies and financial service entities. The Company designs its interest sensitive and annuity products with features encouraging persistency, such as surrender and withdrawal penalty provisions. Typically, surrender charge rates gradually decrease each year the contract is in force.
The Company performed detailed sensitivity analysis as of December 31, 2022, for its interest rate-sensitive assets and liabilities. The changes in market values of the Company's debt securities in the first nine months of 2023 were reasonable given the expected range of results of this analysis.
Credit Risk
The Company is exposed to credit risk through counterparties and within its investment portfolio. Credit risk relates to the uncertainty associated with an obligor's continued ability to make timely payments of principal and interest in accordance with the contractual terms of an instrument or contract. As previously discussed, the Company manages credit risk through established investment credit policies and guidelines which address the quality of creditors and counterparties, concentration limits, diversification practices and acceptable risk levels. These policies and guidelines are regularly reviewed and approved by senior management and the Company's Board of Directors.
In connection with the Company’s use of call options to hedge the equity return component of its fixed-indexed annuity and life products, the Company is exposed to the risk that a counterparty fails to perform under terms of the option contract. The Company purchases primarily one-year option contracts from multiple counterparties and evaluates the creditworthiness of all counterparties prior to the purchase of the contracts. For consideration in contracting with a counterparty, the rating required by the Company is a credit rating of “A” or higher. Accordingly, all options are purchased from nationally recognized financial institutions with a demonstrated performance for honoring their financial obligations and possessing substantial financial capacity. In addition, each counterparty is required to execute a credit support agreement obligating the counterparty to provide collateral to the Company when the fair value of the Company’s exposure to the counterparty exceeds specified amounts. Counterparty credit ratings and credit exposure are monitored continuously by National Western’s Investment Department with adjustments to collateral levels managed as incurred under the credit support agreements.
The Company follows the industry practice of reinsuring (ceding) portions of its insurance risks with a variety of reinsurance companies on either a coinsurance or a modified coinsurance basis in order to limit risk. Use of reinsurance does not relieve the Company of its primary liability to pay the full amount of the insurance benefit in the event the reinsurer (counterparty) fails to honor its contractual obligation. Consequently, the Company avoids concentrating reinsurance counterparty credit risk with any one reinsurer and only maintains reinsurance agreements with reputable carriers which are well-capitalized and highly rated by independent rating agencies. With respect to the funds withheld coinsurance arrangements entered into by National Western, assets backing the reserves for the policyholder obligations under the agreement are retained by the Company and are available to meet benefit payment commitments. In addition, National Western is the beneficiary of an incremental collateral trust account provided by the reinsurer providing additional security for the payment of all amounts due under the reinsurance agreement.
The Company is also exposed to credit spread risk related to market prices of investment securities and cash flows associated with changes in credit spreads. Credit spread tightening will reduce net investment income associated with new purchases of fixed debt securities and will increase the fair value of the investment portfolio. Credit spread widening will reduce the fair value of the investment portfolio and will increase net investment income on new purchases.
Liquidity requirements are met primarily by funds provided from operations. Premium deposits and annuity considerations, investment income, and investment maturities and prepayments are the primary sources of funds while investment purchases, policy benefits in the form of claims, and payments to policyholders and contract holders in connection with surrenders and withdrawals as well as operating expenses are the primary uses of funds. To ensure the Company will be able to pay future commitments, the funds received as premium payments and deposits are invested in high quality investments, primarily fixed income securities. Funds are invested with the intent that the income from investments, plus proceeds from maturities, will meet the ongoing cash flow needs of the Company. The approach of matching asset and liability durations and yields requires an appropriate mix of investments. Although the Company historically has not been put in the position of having to liquidate invested assets to provide cash flow, its investments consist primarily of marketable debt securities that could be readily converted to cash for liquidity needs. National Western maintains a line of credit facility in the amount of $75 million which it may access for short-term cash needs. There were no borrowings under the line of credit as of September 30, 2023.
In addition, National Western is a member of the Federal Home Loan Bank of Dallas ("FHLB") through an initial minimum required stock investment of $4.3 million. Through this membership, National Western is able to create a specified borrowing capacity based upon the amount of collateral it elects to establish. At September 30, 2023, securities and commercial loans with amortized values of $418.8 million (fair value of $389.3 million) were pledged as collateral to the FHLB.
A primary liquidity concern for life insurers is the risk of an extraordinary level of early policyholder withdrawals, particularly with respect to annuity products which can move more rapidly with interest rate changes. The Company includes provisions within its annuity and universal life insurance policies, such as surrender and market value adjustments, that help limit and discourage early withdrawals.
The actual amounts paid by product line in connection with surrenders and withdrawals, before reinsurance, for the three and nine months ended September 30, 2023 and 2022, are noted in the table below.
Three Months Ended September 30,
Nine Months Ended September 30,
2023
2022
2023
2022
(In thousands)
Product Line:
Traditional Life
$
4,144
3,470
12,525
11,525
Universal Life
31,137
25,554
88,952
73,477
Annuities
153,673
135,392
509,505
427,696
Total
$
188,954
164,416
610,982
512,698
The above contractual withdrawals, as well as the level of surrenders experienced, and the associated cash outflows did not have a material adverse impact on overall liquidity. The amounts shown includes funds withheld policyholder obligations and Ozark National cash outflows. Individual life insurance policies are typically less susceptible to withdrawal than annuity reserves and deposit liabilities because policyholders may need to undergo a new underwriting process in order to obtain a new insurance policy elsewhere. Annuity dollar outflows are generally more sensitive to economic conditions, interest rate levels, and the level of surrender charges assessed upon withdrawal or termination. Annuity outflows during 2023 have increased, particularly during the second quarter, with higher interest rate offerings on competing financial products. Cash flow projections and tests under various market interest rate scenarios and assumptions are performed to assist in evaluating liquidity needs and adequacy. The Company continues to augment and enhance its level of liquidity analysis given ongoing changes in the economic environment and related market conditions. Accordingly, the Company currently expects available liquidity sources and future cash flows to be adequate to meet the demand for funds.
Cash flows from the Company's insurance operations have historically been sufficient to meet current needs. Cash flows from operating activities were $199.6 million and $231.7 million for the nine months ended September 30, 2023 and 2022, respectively. The Company also has significant cash flows from both scheduled and unscheduled investment security maturities, redemptions, and prepayments. These cash flows totaled $605.4 million and $904.9 million for the nine months ended September 30, 2023 and 2022, respectively. The Company's scheduled investment security maturities beginning in the third quarter of 2023 are significantly higher than that experienced in the first six months of the year. Net cash inflows/(outflows) from the Company's universal life and investment annuity deposit product operations totaled $(647.2) million and $(376.0) million during the nine months ended September 30, 2023 and 2022, respectively. The higher negative net outflow in the first nine months of 2023 reflects lower levels of fixed-index annuity and life sales in tandem with higher surrender activity. In addition, the Company observed a period of increased surrender activity during the second calendar quarter of 2023 coinciding with its public announcement of exploring strategic opportunities.
Capital Resources
The Company relies on stockholders' equity for its capital resources as there is no long-term debt outstanding and the Company does not anticipate the need for any long-term debt in the near future. As of September 30, 2023, the Company maintained commitments for its normal operating and investment activities.
The Company has declared and paid an annual dividend on its common shares since 2005. The Company's practice has been to take a conservative approach to dividends, and the Board of Directors has adopted a strategic position to substantially reinvest earnings internally. This conservative approach yields the following benefits: (1) providing capital to finance the development of new business; (2) enabling the Company to take advantage of potential acquisitions and other competitive situations as they arise; (3) building a strong capital base to support the Company's financial strength ratings; (4) maintaining the Company's liquidity and solvency during difficult economic and market conditions; and (5) enhancing the Company's regulatory capital position.
As the largest subsidiary of NWLGI, National Western serves as the primary funding source for NWLGI. The capacity of National Western to pay dividends to NWLGI is limited by law in the state of Colorado to earned profits (statutory unassigned surplus). At December 31, 2022, the maximum amount legally available for distribution during 2023 without further regulatory approval was $66.5 million. National Western did not pay any dividends during the nine months ended September 30, 2023.
It is Company practice to not enter into off-balance sheet arrangements or to issue guarantees to third parties, other than in the normal course of issuing insurance contracts. Commitments related to insurance products sold are reflected as liabilities for future policy benefits. Insurance contracts guarantee certain performances by National Western and Ozark National.
Insurance reserves are the means by which life insurance companies determine the liabilities that must be established to assure that future policy benefits are provided for and can be paid. These reserves are required by law and based upon standard actuarial methodologies to ensure fulfillment of commitments guaranteed to policyholders and their beneficiaries, even though the obligations may not be due for many years.
The table below summarizes future estimated cash payments under existing contractual obligations.
Payment Due by Period
Total
Less Than 1 Year
1 Year or More
(In thousands)
Loan commitments
$
25,300
25,300
—
Commitments for investment capital funding (3)
177,152
45,307
131,845
Lease obligations
746
343
403
Claims payable (1)
82,575
82,575
—
Other long-term reserve liabilities reflected on the balance sheet (2)
(1) Claims payable include benefit and claim liabilities for life, accident and health policies which the Company believes the amount and timing of the payment is essentially fixed and determinable. Such amounts generally relate to incurred and reported death, critical illness, accident and health claims including an estimate of claims incurred but not reported.
(2) Other long-term liabilities include estimated life and annuity obligations related to death claims, policy surrenders, policy withdrawals, maturities and annuity payments based on mortality, lapse, annuitization, and withdrawal assumptions consistent with the Company's historical experience. These estimated life and annuity obligations are undiscounted projected cash outflows that assume interest crediting and market growth consistent with assumptions used in amortizing deferred acquisition costs. They do not include any offsets for future premiums or deposits. Other long-term liabilities also include determinable payout patterns related to immediate annuities. Due to the significance of the assumptions used, the actual cash outflows will differ both in amount and timing, possibly materially, from these estimates.
(3) Represents investment capital commitments that have not been funded as of the current balance sheet date.
The Company, through its wholly owned subsidiary Braker P III, LLC ("BP III"), owns a commercial office building for which it has entered into lease agreements with various tenants for space not occupied by the Company. Total revenues recorded pertaining to these non-Company leases for the three-month periods ended September 30, 2023 and 2022 amounted to $1.0 million and $1.3 million, respectively, and for the nine months there ended amounted to $2.9 million and $3.9 million, respectively. Under their respective terms these leases expire at various dates from 2025 through 2029.
The table below summarizes future estimated cash receipts under all existing lease agreements, including those in addition to the BP III lease agreements discussed above.
Estimated Cash Receipts by Period
Total
Less Than 1 Year
1 - 3 Years
3 - 5 Years
More Than 5 Years
(In thousands)
Real estate revenue
$
33,364
6,110
10,254
6,939
10,061
CHANGES IN ACCOUNTING PRINCIPLES AND CRITICAL ACCOUNTING POLICIES
Changes in Accounting Principles
On January 1, 2023, the Company adopted the required LDTI accounting standard employing a modified retrospective transition method, which requires that the accounting guidance be applied as of the beginning of the earliest period in which it is presented in reported financial statements, which for the Company is the year ended December 31, 2021. Accordingly, the Company's transition date for purposes of LDTI is January 1, 2021. The impact from adoption of LDTI resulted in an increase to Accumulated Other Comprehensive Income (Loss) and an increase to Retained Earnings of $176.7 million and $28.3 million, respectively, net of tax.
REGULATORY AND OTHER ISSUES
Statutory Accounting Practices
Regulations that affect the Company and the insurance industry are often the result of actions taken by the National Association of Insurance Commissioners ("NAIC"). The NAIC routinely publishes new regulations as model acts or laws which states subsequently adopt as part of their insurance regulations. Currently, the Company is not aware of any NAIC regulatory matter material to its operations or reporting of financial results.
The NAIC established risk-based capital ("RBC") standards for U.S. life insurers as well as a risk-based capital model act ("RBC Model Act"). The RBC Model Act requires that life insurers annually submit a report to state regulators regarding their RBC amounts based upon four categories of risk which are: (i) asset risk, which primarily focuses on the quality of investments; (ii) insurance risk, which encompasses mortality and morbidity risk; (iii) interest rate risk, which involves asset/liability matching issues; and (iv) other business risks. The capital requirement for each is determined by applying factors that vary based upon the degree of risk to various asset, premium, insurance in force, and policy benefit reserve items. The formula is an early warning tool used by regulators to identify potential weakly capitalized companies for purposes of initiating further regulatory action. Independent rating agencies utilize proprietary versions similar to the NAIC RBC model incorporating additional risk factors identified in their respective rating methodologies. National Western and Ozark National's current statutory capital and surplus are each substantially in excess of applicable statutory RBC requirements.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK
This information is included in Item 2, Management's Discussion and Analysis of Financial Condition and Results of Operations, in the Investments section.
ITEM 4. CONTROLS AND PROCEDURES
The Company's management, with the participation of the Company's Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Company's disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) as of the end of the period covered by this report. Based on such evaluation, the Company's Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, the Company's disclosure controls and procedures are effective in recording, processing, summarizing, and reporting, on a timely basis, information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act.
During the nine months ended September 30, 2023, the Company implemented internal controls associated with new processes supporting the adoption of Accounting Standards Update 2018-12 for long-duration insurance contracts, which the Company adopted on January 1, 2023 using a modified retrospective method. For additional information, please refer to Note (1) Consolidation and Basis of Presentation in the accompanying Notes to Condensed Consolidated Financial Statements.
Except for the change in controls over the Company's adoption of LDTI, there have not been any changes in the Company's internal controls over financial reporting as defined in Rules 13a-15(f) and 15d-15(e) under the Exchange Act, that materially affected, or are reasonably likely to materially affect, the Company's internal controls over financial reporting.
Internal controls over financial reporting change as the Company modifies or enhances its systems and processes to meet business needs. Any significant changes in controls are evaluated prior to implementation to help ensure continued effectiveness of internal controls and the control environment.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Refer to Note 11(A) "Legal Proceedings" of the accompanying Condensed Consolidated Financial Statements included in this Form 10-Q.
ITEM 1A. RISK FACTORS
The risk factors disclosed in the Company's Annual Report on Form 10-K for the year ended December 31, 2022 included a discussion of the potential ramifications of natural or man-made disasters and catastrophes including pandemic disease. There have been no substantial changes relative to the risk factors disclosed in the Company's Annual Report.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
The Company maintains a limited stock buy-back program associated with its Incentive Plan which provides Option Holders the ability to elect to sell acquired shares back to the Company at any time within ninety (90) days after the exercise of options at the prevailing market price as of the date of notice of election. Purchased shares, if any, are reported in the Company's Condensed Consolidated Financial Statements as authorized and unissued. As of September 30, 2023, there are no stock options outstanding under the Incentive Plan. More broadly, there are no immediate plans to repurchase any of its shares of Class A Common Stock or Class B Common Stock.
Period
Total Number of Shares Purchased
Average Price Paid Per Share
Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs
Approximate Dollar Value of Shares that May yet Be Purchased Under the Plans or Programs
Agreement and Plan of Merger, dated as of October 8, 2023, by and amount S. USA Life Insurance Company Inc., PGH Merger Inc. and National Westen Life Group Inc.
Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
Exhibit 104
-
Cover Page Interactive Data File (embedded within the Inline XBRL document)
Pursuant to the requirements 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.
