NWLI 2015 Q2 10Q


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
 
FORM 10-Q
 
 
x     QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended June 30, 2015
o        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: 2-17039
 
 
 
 
NATIONAL WESTERN LIFE INSURANCE COMPANY
(Exact name of Registrant as specified in its charter)
 
 
 
 
 
 
COLORADO
84-0467208
(State of Incorporation)
(I.R.S. Employer Identification Number)
 
 
850 EAST ANDERSON LANE
 
AUSTIN, TEXAS 78752-1602
(512) 836-1010
(Address of Principal Executive Offices)
(Telephone Number)


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 x   No o
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 x   No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.  See definition of "accelerated filer and large accelerated file" in Rule 12b-2 of the Exchange Act.
Large accelerated filer  o     Accelerated filer  x   Non-accelerated filer  o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o   No x
As of August 6, 2015, the number of shares of Registrant's common stock outstanding was: Class A – 3,436,166 and  Class B - 200,000.




TABLE OF CONTENTS
 
Page
 
 
 
 
 
 
June 30, 2015 (Unaudited) and December 31, 2014
 
 
For the Three Months Ended June 30, 2015 and 2014 (Unaudited)
 
 
For the Six Months Ended June 30, 2015 and 2014 (Unaudited)
 
 
For the Three Months Ended June 30, 2015 and 2014 (Unaudited)
 
 
For the Six Months Ended June 30, 2015 and 2014 (Unaudited)
 
 
For the Six Months Ended June 30, 2015 and 2014 (Unaudited)
 
 
For the Six Months Ended June 30, 2015 and 2014 (Unaudited)
 
 
 
 
Item 2.  Management's Discussion and Analysis of Financial Condition and Results of Operations
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


2
Table of Contents

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

NATIONAL WESTERN LIFE INSURANCE COMPANY AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)

 
(Unaudited)
 
 
ASSETS
June 30,
2015
 
December 31,
2014
 
 
 
 
Investments:
 
 
 
Securities held to maturity, at amortized cost (fair value: $7,370,596 and $7,175,443)
$
7,121,439

 
6,841,543

Securities available for sale, at fair value (cost: $2,740,993 and $2,590,074)
2,840,589

 
2,728,680

Mortgage loans, net of allowance for possible losses ($650 and $650)
132,261

 
149,503

Policy loans
61,933

 
63,645

Derivatives, index options
72,527

 
114,287

Other long-term investments
28,961

 
28,774

 
 
 
 
Total investments
10,257,710

 
9,926,432

 
 
 
 
Cash and cash equivalents
71,710

 
277,078

Deferred policy acquisition costs
826,083

 
802,919

Deferred sales inducements
156,371

 
159,766

Accrued investment income
99,438

 
96,127

Federal income tax receivable
7,546

 
—

Other assets
96,436

 
89,570

 
 
 
 
Total assets
$
11,515,294

 
11,351,892


See accompanying notes to condensed consolidated financial statements (unaudited).

3
Table of Contents

NATIONAL WESTERN LIFE INSURANCE COMPANY AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share amounts)
 
(Unaudited)
 
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
June 30,
2015
 
December 31,
2014
 
 
 
 
LIABILITIES:
 
 
 
 
 
 
 
Future policy benefits:
 
 
 
Universal life and annuity contracts
$
9,484,080

 
9,384,297

Traditional life reserves
137,451

 
138,225

Other policyholder liabilities
143,781

 
139,222

Deferred Federal income tax liability
40,001

 
31,675

Federal income tax payable
—

 
3,336

Other liabilities
117,853

 
98,817

 
 
 
 
Total liabilities
9,923,166

 
9,795,572

 
 
 
 
COMMITMENTS AND CONTINGENCIES (Note 8)


 


 
 
 
 
STOCKHOLDERS’ EQUITY:
 

 
 

 
 
 
 
Common stock:
 

 
 

Class A - $1 par value; 7,500,000 shares authorized; 3,436,166 issued and outstanding in 2015 and 2014
3,436

 
3,436

Class B - $1 par value; 200,000 shares authorized, issued, and outstanding in 2015 and 2014
200

 
200

Additional paid-in capital
38,116

 
38,116

Accumulated other comprehensive income
27,410

 
41,786

Retained earnings
1,522,966

 
1,472,782

 
 
 
 
Total stockholders’ equity
1,592,128

 
1,556,320

 
 
 
 
Total liabilities and stockholders' equity
$
11,515,294

 
11,351,892


Note:  The Condensed Consolidated Balance Sheet at December 31, 2014 has been derived from the audited Consolidated Financial Statements as of that date.

See accompanying notes to condensed consolidated financial statements (unaudited).


4
Table of Contents

NATIONAL WESTERN LIFE INSURANCE COMPANY AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS
For the Three Months Ended June 30, 2015 and 2014
(Unaudited)
(In thousands, except per share amounts)
 
2015
 
2014
 
 
 
 
Premiums and other revenues:
 
 
 
Universal life and annuity contract charges
$
38,345

 
38,217

Traditional life premiums
5,162

 
5,169

Net investment income
102,259

 
155,179

Other revenues
5,194

 
5,211

Net realized investment gains (losses):
 

 
 

Total other-than-temporary impairment (“OTTI”) gains (losses)
(2
)
 
—

Portion of OTTI (gains) losses recognized in other comprehensive income
(105
)
 
—

Net OTTI losses recognized in earnings
(107
)
 
—

Other net investment gains (losses)
4,365

 
3,065

Total net realized investment gains (losses)
4,258

 
3,065

 
 
 
 
Total revenues
155,218

 
206,841

 
 
 
 
Benefits and expenses:
 

 
 

Life and other policy benefits
16,120

 
14,796

Amortization of deferred policy acquisition costs
28,070

 
27,258

Universal life and annuity contract interest
49,431

 
102,429

Other operating expenses
18,802

 
19,500

 
 
 
 
Total benefits and expenses
112,423

 
163,983

 
 
 
 
Earnings before Federal income taxes
42,795

 
42,858

 
 
 
 
Federal income taxes
13,937

 
13,675

 
 
 
 
Net earnings
$
28,858

 
29,183

 
 
 
 
Basic earnings per share:
 

 
 

Class A
$
8.16

 
$
8.26

Class B
$
4.08

 
$
4.13

 
 
 
 
Diluted earnings per share:
 

 
 

Class A
$
8.16

 
$
8.25

Class B
$
4.08

 
$
4.13


See accompanying notes to condensed consolidated financial statements (unaudited).


5
Table of Contents

NATIONAL WESTERN LIFE INSURANCE COMPANY AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS
For the Six Months Ended June 30, 2015 and 2014
(Unaudited)
(In thousands, except per share amounts)
 
2015
 
2014
 
 
 
 
Premiums and other revenues:
 
 
 
Universal life and annuity contract charges
$
75,658

 
76,222

Traditional life premiums
9,509

 
9,440

Net investment income
202,182

 
263,630

Other revenues
10,523

 
10,974

Net realized investment gains (losses):
 

 
 

Total other-than-temporary impairment (“OTTI”) gains (losses)
158

 
(32
)
Portion of OTTI (gains) losses recognized in other comprehensive income
(265
)
 
(3
)
Net OTTI losses recognized in earnings
(107
)
 
(35
)
Other net investment gains (losses)
5,343

 
4,613

Total net realized investment gains (losses)
5,236

 
4,578

 
 
 
 
Total revenues
303,108

 
364,844

 
 
 
 
Benefits and expenses:
 

 
 

Life and other policy benefits
35,386

 
27,759

Amortization of deferred policy acquisition costs
55,722

 
55,837

Universal life and annuity contract interest
98,470

 
165,365

Other operating expenses
39,312

 
42,963

 
 
 
 
Total benefits and expenses
228,890

 
291,924

 
 
 
 
Earnings before Federal income taxes
74,218

 
72,920

 
 
 
 
Federal income taxes
24,034

 
23,911

 
 
 
 
Net earnings
$
50,184

 
49,009

 
 
 
 
Basic earnings per share:
 

 
 

Class A
$
14.19

 
$
13.86

Class B
$
7.10

 
$
6.93

 
 
 
 
Diluted earnings per share:
 

 
 

Class A
$
14.19

 
$
13.86

Class B
$
7.10

 
$
6.93

 
 
 
 

See accompanying notes to condensed consolidated financial statements (unaudited).


6
Table of Contents

NATIONAL WESTERN LIFE INSURANCE COMPANY AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
For the Three Months Ended June 30, 2015 and 2014
(Unaudited)
(In thousands)
 
2015
 
2014
 
 
 
 
Net earnings
$
28,858

 
29,183

 
 
 
 
Other comprehensive income (loss), net of effects of deferred costs and taxes:
 

 
 

Unrealized gains (losses) on securities:
 

 
 

Net unrealized holding gains (losses) arising during period
(21,202
)
 
10,892

Net unrealized liquidity gains (losses)
32

 
28

Reclassification adjustment for net amounts included in net earnings
(1,855
)
 
(1,946
)
 
 
 
 
Net unrealized gains (losses) on securities
(23,025
)
 
8,974

 
 
 
 
Foreign currency translation adjustments
(53
)
 
(122
)
 
 
 
 
Benefit plans:
 

 
 

Amortization of net prior service cost and net gain (loss)
(304
)
 
(175
)
 
 
 
 
Other comprehensive income (loss)
(23,382
)
 
8,677

 
 
 
 
Comprehensive income (loss)
$
5,476

 
37,860


See accompanying notes to condensed consolidated financial statements (unaudited).


7
Table of Contents

NATIONAL WESTERN LIFE INSURANCE COMPANY AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
For the Six Months Ended June 30, 2015 and 2014
(Unaudited)
(In thousands)
 
2015
 
2014
 
 
 
 
Net earnings
$
50,184

 
49,009

 
 
 
 
Other comprehensive income, net of effects of deferred costs and taxes:
 

 
 

Unrealized gains (losses) on securities:
 

 
 

Net unrealized holding gains (losses) arising during period
(11,830
)
 
21,894

Net unrealized liquidity gains (losses)
93

 
51

Reclassification adjustment for net amounts included in net earnings
(2,020
)
 
(2,371
)
 
 
 
 
Net unrealized gains (losses) on securities
(13,757
)
 
19,574

 
 
 
 
Foreign currency translation adjustments
(12
)
 
(633
)
 
 
 
 
Benefit plans:
 

 
 

Amortization of net prior service cost and net gain (loss)
(607
)
 
(351
)
 
 
 
 
Other comprehensive income (loss)
(14,376
)
 
18,590

 
 
 
 
Comprehensive income (loss)
$
35,808

 
67,599

 
 
 
 

See accompanying notes to condensed consolidated financial statements (unaudited).


8
Table of Contents

NATIONAL WESTERN LIFE INSURANCE COMPANY AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
For the Six Months Ended June 30, 2015 and 2014
(Unaudited)
(In thousands)
 
2015
 
2014
 
 
 
 
Common stock:
 
 
 
Balance at beginning of period
$
3,636

 
3,635

Shares exercised under stock option plan
—

 
1

 
 
 
 
       Balance at end of period
3,636

 
3,636

 
 
 
 
Additional paid-in capital:
 

 
 

Balance at beginning of period
38,116

 
37,767

Shares exercised under stock option plan
—

 
349

 
 
 
 
       Balance at end of period
38,116

 
38,116

 
 
 
 
Accumulated other comprehensive income:
 

 
 

Unrealized gains on non-impaired securities:
 

 
 

Balance at beginning of period
54,229

 
46,693

Change in unrealized gains (losses) during period, net of tax
(13,850
)
 
19,523

 
 
 
 
   Balance at end of period
40,379

 
66,216

 
 
 
 
Unrealized losses on impaired held to maturity securities:
 

 
 

Balance at beginning of period
(1,262
)
 
(1,287
)
Amortization
172

 
117

Other-than-temporary impairments, non-credit, net of tax
—

 
—

Additional credit loss on previously impaired securities
—

 
—

Change in shadow deferred policy acquisition costs
(79
)
 
(67
)
 
 
 
 
   Balance at end of period
(1,169
)
 
(1,237
)
 
 
 
 
Unrealized losses on impaired available for sale securities:
 

 
 

Balance at beginning of period
(1
)
 
(2
)
Other-than-temporary impairments, non-credit, net of tax
—

 
—

Change in shadow deferred policy acquisition costs
—

 
(1
)
Recoveries, net of tax
—

 
2

 
 
 
 
  Balance at end of period
(1
)
 
(1
)
 
 
 
 
 
Continued on Next Page
 
 
 
 
 
 
 
 
 
 
 
 
 

9
Table of Contents

NATIONAL WESTERN LIFE INSURANCE COMPANY AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY(continued)
For the Six Months Ended June30, 2015 and 2014
(Unaudited)
(In thousands)
 
2015
 
2014
 
 
 
 
Foreign currency translation adjustments:
 

 
 

Balance at beginning of period
2,685

 
3,241

Change in translation adjustments during period
(12
)
 
(633
)
 
 
 
 
  Balance at end of period
2,673

 
2,608

 
 
 
 
Benefit plan liability adjustment:
 

 
 

Balance at beginning of period
(13,865
)
 
(10,565
)
Amortization of net prior service cost and net loss, net of tax
(607
)
 
(351
)
 
 
 
 
  Balance at end of period
(14,472
)
 
(10,916
)
 
 
 
 
Accumulated other comprehensive income at end of period
27,410

 
56,670

 
 
 
 
Retained earnings:
 
 
 
   Balance at beginning of period
1,472,782

 
1,368,466

   Net earnings
50,184

 
49,009

   Stockholder dividends
—

 
—

 
 
 
 
   Balance at end of period
1,522,966

 
1,417,475

 
 
 
 
Total stockholders' equity
$
1,592,128

 
$
1,515,897


See accompanying notes to condensed consolidated financial statements (unaudited).



10
Table of Contents

NATIONAL WESTERN LIFE INSURANCE COMPANY AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Six Months Ended June 30, 2015 and 2014
(Unaudited)
(In thousands)
 
2015
 
2014
 
 
 
 
Cash flows from operating activities:
 
 
 
Net earnings
$
50,184

 
49,009

Adjustments to reconcile net earnings to net cash from operating activities:
 

 
 

Universal life and annuity contract interest
98,470

 
165,365

Surrender charges and other policy revenues
(8,302
)
 
(9,104
)
Realized (gains) losses on investments
(5,236
)
 
(4,578
)
Accretion/amortization of discounts and premiums, investments
102

 
(465
)
Depreciation and amortization
1,671

 
1,741

(Increase) decrease in value of derivatives
17,069

 
(45,799
)
(Increase) decrease in deferred policy acquisition and sales inducement costs
(2,190
)
 
(6,062
)
(Increase) decrease in accrued investment income
(3,311
)
 
(449
)
(Increase) decrease in other assets
(6,938
)
 
(1,635
)
Increase (decrease) in liabilities for future policy benefits
2,588

 
1,344

Increase (decrease) in other policyholder liabilities
4,558

 
7,127

Increase (decrease) in Federal income taxes liability
(10,882
)
 
(13,501
)
Increase (decrease) in deferred Federal income tax
15,735

 
12,517

Increase (decrease) in other liabilities
4,658

 
(2,806
)
Other, net
—

 
(1
)
 
 
 
 
Net cash provided by operating activities
158,176

 
152,703

 
 
 
 
Cash flows from investing activities:
 

 
 

Proceeds from sales of:
 

 
 

Securities held to maturity
—

 
—

Securities available for sale
13,131

 
5,334

Other investments
—

 
1,016

Proceeds from maturities and redemptions of:
 

 
 

Securities held to maturity
257,063

 
360,420

Securities available for sale
163,057

 
102,813

Derivatives, index options
64,619

 
105,268

Purchases of:
 

 
 

Securities held to maturity
(534,663
)
 
(477,353
)
Securities available for sale
(310,637
)
 
(195,023
)
Derivatives, index options
(40,977
)
 
(33,610
)
Other investments
(420
)
 
(296
)
Net change in short-term investments
—

 
—

 
 
 
 
 
Continued on Next Page
 
 
 
 
 
 
 
 
 

11
Table of Contents

NATIONAL WESTERN LIFE INSURANCE COMPANY AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS, (continued)
For the Six Months Ended June 30, 2015 and 2014
(Unaudited)
(In thousands)
 
2015
 
2014
 
 
 
 
Principal payments on mortgage loans
18,962

 
10,240

Cost of mortgage loans acquired
(1,632
)
 
(29,611
)
Decrease (increase) in policy loans
1,712

 
981

Other, net
—

 
2

 
 
 
 
Net cash used in investing activities
(369,785
)
 
(149,819
)
 
 
 
 
Cash flows from financing activities:
 

 
 

Deposits to account balances for universal life and annuity contracts
452,124

 
460,611

Return of account balances on universal life and annuity contracts
(445,871
)
 
(450,565
)
Issuance of common stock under stock option plan
—

 
350

 
 
 
 
Net cash provided by (used in) financing activities
6,253

 
10,396

 
 
 
 
Effect of foreign exchange
(12
)
 
(633
)
 
 
 
 
Net increase (decrease) in cash and cash equivalents
(205,368
)
 
12,647

Cash and cash equivalents at beginning of period
277,078

 
120,859

 
 
 
 
Cash and cash equivalents at end of period
$
71,710

 
$
133,506

 
 
 
 
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
 

 
 

 
 
 
 
Cash paid during the period for:
 

 
 

Interest
$
20

 
20

Income taxes
$
22,647

 
24,416

 
 
 
 
Noncash operating activities:
 
 
 
   Deferral of sales inducements
$
(6,895
)
 
(4,851
)

See accompanying notes to condensed consolidated financial statements (unaudited).



12
Table of Contents

NATIONAL WESTERN LIFE INSURANCE COMPANY AND SUBSIDIARIES
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 annual financial statements. In the opinion of management, the accompanying condensed consolidated financial statements contain all adjustments necessary to present fairly the financial position of National Western Life Insurance Company and its subsidiaries (“Company” or "National Western") as of June 30, 2015, and the results of its operations and its cash flows for the for the three and six months ended June 30, 2015 and 2014. The results of operations for the six months ended June 30, 2015 are not necessarily indicative of the results to be expected for the full year. It is recommended that these condensed consolidated financial statements 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, 2014 and are accessible free of charge through the Company's internet site at www.nationalwesternlife.com or the Securities and Exchange Commission internet site at www.sec.gov. The condensed consolidated balance sheet at December 31, 2014 has been derived from the audited consolidated financial statements as of that date.

The accompanying unaudited condensed consolidated financial statements include the accounts of National Western Life Insurance Company and its wholly-owned subsidiaries: The Westcap Corporation, NWL Investments, Inc., NWL Services, Inc., NWL Financial, Inc., NWLSM, Inc. and Regent Care San Marcos Holdings, LLC. All significant intercorporate transactions and accounts have been eliminated in consolidation.

The preparation of financial statements in accordance with U.S. generally accepted accounting principles ("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 benefits, (2) valuation of derivative instruments, (3) recoverability and amortization of deferred policy acquisition costs, (4) valuation allowances for deferred tax assets, (5) other-than-temporary impairment losses on debt securities, (6) commitments and contingencies, and (7) valuation allowances for mortgage loans and real estate.

The table below shows the unrealized gains and losses on available-for-sale securities that were reclassified out of accumulated other comprehensive income for the three and six months ended June 30, 2015 and 2014.

Affected Line Item in the
Statements of Earnings
 
Amount Reclassified From Accumulated Other Comprehensive Income
 
 
Three Months Ended June 30,
 
Six months ended June 30,
 
 
2015
 
2014
 
2015
 
2014
 
 
(In thousands)
 
 
 
 
 
 
 
 
 
 
 
 
 
Other net investment gains (losses)
 
$
2,961

 
2,993

 
3,215

 
3,682

Net OTTI losses recognized in earnings
 
(107
)
 
—

 
(107
)
 
(35
)
Earnings before Federal income taxes
 
2,854

 
2,993

 
3,108

 
3,647

Federal income taxes
 
999

 
1,047

 
1,088

 
1,276

 
 
 
 
 
 
 
 
 
Net earnings
 
$
1,855

 
1,946

 
2,020

 
2,371




13
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NATIONAL WESTERN LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

(2)
 NEW ACCOUNTING PRONOUNCEMENTS

In July 2013, the FASB issued guidance to amend the financial statement presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. The new guidance states that an unrecognized tax benefit, or a portion of an unrecognized tax benefit, should be presented in the financial statements as reduction to deferred tax assets for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward. This guidance is effective for annual reporting periods beginning on or after December 15, 2013 and interim periods within those annual periods. The Company adopted this guidance as of January 1, 2014 and the adoption did not have an effect on the deferred tax asset or liability classification on the Company's balance sheet and did not result in any additional disclosures to the financial statements.

In June 2014, the FASB issued guidance that applies to all reporting entities that grant their employees share-based payments in which the terms of the award provide that a performance target that affects vesting could be achieved after the requisite service period. It requires that a performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition and follows existing accounting guidance for the treatment of performance conditions. The standard will be effective for annual periods and interim periods within those annual periods beginning after December 15, 2015, with early adoption permitted. The Company’s current employee share-based plans do not require performance targets and the adoption of this guidance is not expected to have a material impact on the Company’s financial position or results of operations.
Other recent accounting pronouncements issued by the FASB (including its Emerging Issues Task Force), the American Institute of Certified Public Accountants ("AICPA"), and the SEC are not believed by management to, have a material impact on the Company’s present or future consolidated financial statements.


(3)
 STOCKHOLDERS' EQUITY

The Company 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 greater of statutory earnings from operations excluding capital gains or 10% of statutory surplus of the Company.  The maximum dividend payment which may be made without prior approval in 2015 is $118.2 million. The Company did not declare or pay cash dividends on its common stocks during the six months ended June 30, 2015 and 2014.

On April 6, 2015, the Company, National Western Life Group, Inc., a Delaware corporation and wholly-owned subsidiary of the Company (“Newco”), and NWLIC MergerCo, Inc., a Colorado corporation and wholly-owned subsidiary of Newco (“MergerCo”), entered into an Agreement and Plan of Merger (the “Reorganization Agreement”), that provides for the merger (the “Merger”) of the Company with MergerCo, with the Company surviving the Merger as a wholly-owned subsidiary of Newco. The Merger provides for the conversion of each share of Class A common stock, par value $1.00 per share, of the Company and each share of Class B common stock, par value $1.00 per share, of the Company issued and outstanding immediately prior to the effective time of the Merger, into one duly issued, fully paid and non-assessable share of Class A common stock, par value $0.01 per share, of Newco ("Newco Class A Stock") or Class B common stock, par value $0.01 per share, of Newco, respectively (collectively with the other transactions contemplated by the Reorganization Agreement, the “Reorganization”). In addition, each outstanding option to acquire, or SARs relating to, shares of the Company's Class A Stock would automatically convert into an option to acquire, or SARs relating to, on the same terms and conditions, an identical number of shares of Newco Class A Stock.

Upon completion of the Reorganization, Newco, a Delaware corporation, would, in effect, replace the Company, a Colorado corporation, as the publicly held corporation traded on the NASDAQ Global Select Market under the symbol “NWLI”, and the holders of the Company's Class A Stock and Class B Stock would hold the same number of shares and same ownership percentage
of Newco after the Reorganization as they held of the Company immediately prior to the Reorganization. The directors of Newco immediately following the Reorganization would be the same individuals who were directors of the Company immediately prior to the Reorganization.

The Reorganization Agreement is subject to specified conditions, including approval by the Company's shareholders, which was granted at the Annual Meeting of Shareholders (the "Annual Meeting") on Friday, June 19, 2015. It is currently expected that the Reorganization will be completed in the latter part of 2015 once the other conditions set forth in the Reorganization Agreement are satisfied.


14
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NATIONAL WESTERN LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

(4)
 EARNINGS PER SHARE

Basic earnings per share of common stock are computed by dividing net income by the weighted-average basic common shares outstanding during the period. Diluted earnings per share assumes the issuance of common shares applicable to stock options in the denominator.
 
Three Months Ended June 30,
 
2015
 
2014
 
Class A
 
Class B
 
Class A
 
Class B
 
(In thousands except per share amounts)
 
 
 
 
 
 
 
 
Numerator for Basic and Diluted Earnings Per Share:
 
 
 
 
 
 
 
Net income
$
28,858

 
 
 
29,183

 
 
Dividends - Class A shares
—

 
 
 
—

 
 
Dividends - Class B shares
—

 
 
 
—

 
 
 
 
 
 
 
 
 
 
Undistributed income
$
28,858

 
 
 
29,183

 
 
 
 
 
 
 
 
 
 
Allocation of net income:
 

 
 
 
 

 
 
Dividends
$
—

 
—

 
—

 
—

Allocation of undistributed income
28,042

 
816

 
28,358

 
825

 
 
 
 
 
 
 
 
Net income
$
28,042

 
816

 
28,358

 
825

 
 
 
 
 
 
 
 
Denominator:
 

 
 

 
 

 
 

Basic earnings per share - weighted-average shares
3,436

 
200

 
3,435

 
200

Effect of dilutive stock options
1

 
—

 
2

 
—

 
 
 
 
 
 
 
 
Diluted earnings per share - adjusted weighted-average shares for assumed conversions
3,437

 
200

 
3,437

 
200

 
 
 
 
 
 
 
 
Basic Earnings Per Share
$
8.16

 
4.08

 
8.26

 
4.13

 
 
 
 
 
 
 
 
Diluted Earnings Per Share
$
8.16

 
4.08

 
8.25

 
4.13


Stock options that were outstanding during the three months ended June 30, 2015 and 2014, but were not included in the computation of diluted earnings per share because the effect was anti-dilutive, were approximately 20,800 and 22,300, respectively.

15
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NATIONAL WESTERN LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

 
Six Months Ended June 30,
 
2015
 
2014
 
Class A
 
Class B
 
Class A
 
Class B
 
(In thousands except per share amounts)
 
 
 
 
 
 
 
 
Numerator for Basic and Diluted Earnings Per Share:
 
 
 
 
 
 
 
Net income
$
50,184

 
 
 
49,009

 
 
Dividends - Class A shares
—

 
 
 
—

 
 
Dividends - Class B shares
—

 
 
 
—

 
 
 
 
 
 
 
 
 
 
Undistributed income
$
50,184

 
 
 
49,009

 
 
 
 
 
 
 
 
 
 
Allocation of net income:
 

 
 
 
 

 
 
Dividends
$
—

 
—

 
—

 
—

Allocation of undistributed income
48,765

 
1,419

 
47,623

 
1,386

 
 
 
 
 
 
 
 
Net income
$
48,765

 
1,419

 
47,623

 
1,386

 
 
 
 
 
 
 
 
Denominator:
 

 
 

 
 

 
 

Basic earnings per share - weighted-average shares
3,436

 
200

 
3,435

 
200

Effect of dilutive stock options
1

 
—

 
2

 
—

 
 
 
 
 
 
 
 
Diluted earnings per share - adjusted weighted-average shares for assumed conversions
3,437

 
200

 
3,437

 
200

 
 
 
 
 
 
 
 
Basic Earnings Per Share
$
14.19

 
7.10

 
13.86

 
6.93

 
 
 
 
 
 
 
 
Diluted Earnings Per Share
$
14.19

 
7.10

 
13.86

 
6.93


Stock options that were outstanding during the six months ended June 30, 2015 and 2014, but were not included in the computation of diluted earnings per share because the effect was anti-dilutive were approximately 21,300 and 22,300, respectively.


16
Table of Contents

NATIONAL WESTERN LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

(5)
 PENSION AND OTHER POSTRETIREMENT PLANS

(A)
Defined Benefit Pension Plans

The Company 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 complies with the minimum funding provisions of the Employee Retirement Income Security Act of 1974 ("ERISA"). On October 19, 2007, the Company'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. Fair values of plan assets and liabilities are measured as of the prior December 31 for each respective year. The following table summarizes the components of net periodic benefit cost.

 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2015
 
2014
 
2015
 
2014
 
(In thousands)
 
 
 
 
 
 
 
 
Service cost
$
51

 
42

 
102

 
84

Interest cost
246

 
239

 
492

 
479

Expected return on plan assets
(330
)
 
(319
)
 
(660
)
 
(639
)
Amortization of prior service cost
1

 
1

 
2

 
2

Amortization of net loss
196

 
106

 
392

 
211

 
 
 
 
 
 
 
 
Net periodic benefit cost
$
164

 
69

 
328

 
137


The service costs shown in the above table represent plan expenses expected to be paid out of plan assets. Under clarification provided by 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 2015 plan year is $0.0 million. The Company had no remaining contribution payable for the 2014 plan year as of June 30, 2015. As of June 30, 2015, the Company had contributed a total of $0.0 million to the plan for the 2015 and 2014 plan years.

The Company also sponsors a nonqualified defined benefit plan primarily for senior officers. The plan provides benefits based on the participants' years of service and compensation. The pension obligations and administrative responsibilities of the plan are maintained by a pension administration firm, which is a subsidiary of American National Insurance Company ("ANICO"). ANICO 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 the Company 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, the Company 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 the 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 Chairman and the President of the Company in order to comply with law changes under the American Jobs Creation Act of 2004 ("Act").

Effective July 1, 2005, the Company established a second nonqualified defined benefit plan for the benefit of the Chairman and the President 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 nonqualified defined benefit plan, while complying with the requirements of the Act.


17
Table of Contents

NATIONAL WESTERN LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

The following table summarizes the components of net periodic benefit costs for the Chairman and President's nonqualified defined benefit plans.

 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2015
 
2014
 
2015
 
2014
 
(In thousands)
 
 
 
 
 
 
 
 
Service cost
$
64

 
74

 
128

 
147

Interest cost
219

 
251

 
438

 
502

Amortization of prior service cost
15

 
14

 
30

 
29

Amortization of net loss
379

 
324

 
757

 
647

 
 
 
 
 
 
 
 
Net periodic benefit cost
$
677

 
663

 
1,353

 
1,325


The Company expects to contribute $2.0 million to these plans in 2015.  As of June 30, 2015, the Company has contributed $0.9 million to the plans.

(B)
Defined Benefit Postretirement Healthcare Plans

The Company sponsors two healthcare plans to provide postretirement benefits to certain fully-vested individuals.  The following table summarizes the components of net periodic benefit costs.

 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2015
 
2014
 
2015
 
2014
 
(In thousands)
 
 
 
 
 
 
 
 
Interest cost
$
33

 
27

 
65

 
55

Amortization of prior service cost
26

 
26

 
52

 
52

Amortization of net loss
15

 
(1
)
 
30

 
(2
)
 
 
 
 
 
 
 
 
Net periodic benefit cost
$
74

 
52

 
147

 
105


The Company expects to contribute minimal amounts to the plan in 2015.



18
Table of Contents

NATIONAL WESTERN LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

(6)
SEGMENT AND OTHER OPERATING INFORMATION

The Company defines its reportable operating segments as domestic life insurance, international life insurance, and annuities. These segments are organized based on product types and geographic marketing areas.  A summary of segment information for the quarters ended June 30, 2015 and June 30, 2014 is provided below.

Selected Segment Information:
 
 
 
 
 
 
 
 
 
 
Domestic
Life
Insurance
 
International
 Life
Insurance
 
Annuities
 
All
 Others
 
Totals
 
 
 
 
 
(In thousands)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
June 30, 2015
 
 
 
 
 
 
 
 
 
Condensed Consolidated Balance Sheet Items:
 
 
 
 
 
 
 
 
 
Deferred policy acquisition costs and sales inducements
$
70,561

 
254,785

 
657,108

 
—

 
982,454

Total segment assets
811,768

 
1,247,941

 
9,000,323

 
264,269

 
11,324,301

Future policy benefits
702,621

 
954,684

 
7,964,226

 
—

 
9,621,531

Other policyholder liabilities
11,846

 
16,398

 
115,537

 
—

 
143,781

 
 
 
 
 
 
 
 
 
 
Three Months Ended
 
 
 
 
 
 
 
 
 

June 30, 2015
 
 
 
 
 
 
 
 
 

Condensed Consolidated Income Statements:
 
 
 
 
 
 
 
 
 

Premiums and contract revenues
$
7,937

 
29,364

 
6,206

 
—

 
43,507

Net investment income
8,005

 
8,785

 
79,509

 
5,960

 
102,259

Other revenues
4

 
(25
)
 
4

 
5,211

 
5,194

 
 
 
 
 
 
 
 
 
 
Total revenues
15,946

 
38,124

 
85,719

 
11,171

 
150,960

 
 
 
 
 
 
 
 
 
 
Life and other policy benefits
3,882

 
5,587

 
6,651

 
—

 
16,120

Amortization of deferred acquisition costs
1,698

 
5,163

 
21,209

 
—

 
28,070

Universal life and annuity contract interest
5,460

 
6,927

 
37,044

 
—

 
49,431

Other operating expenses
3,442

 
5,212

 
5,434

 
4,714

 
18,802

Federal income taxes (benefit)
467

 
4,932

 
4,961

 
2,086

 
12,446

 
 
 
 
 
 
 
 
 
 
Total expenses
14,949

 
27,821

 
75,299

 
6,800

 
124,869

 
 
 
 
 
 
 
 
 
 
Segment earnings (loss)
$
997

 
10,303

 
10,420

 
4,371

 
26,091


19
Table of Contents

NATIONAL WESTERN LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

 
Domestic
Life
Insurance
 
International
Life
Insurance
 
Annuities
 
All
Others
 
Totals
 
 
 
 
 
(In thousands)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Six months ended
 
 
 
 
 
 
 
 
 
June 30, 2015
 
 
 
 
 
 
 
 
 
Condensed Consolidated Income Statements:
 
 
 
 
 
 
 
 
 
Premiums and contract revenues
$
14,424

 
59,697

 
11,046

 
—

 
85,167

Net investment income
15,170

 
17,399

 
158,745

 
10,868

 
202,182

Other revenues
20

 
61

 
19

 
10,423

 
10,523

 
 
 
 
 
 
 
 
 
 
Total revenues
29,614

 
77,157

 
169,810

 
21,291

 
297,872

 
 
 
 
 
 
 
 
 
 
Life and other policy benefits
8,995

 
11,792

 
14,599

 
—

 
35,386

Amortization of deferred acquisition costs
4,879

 
4,513

 
46,330

 
—

 
55,722

Universal life and annuity contract interest
10,399

 
14,057

 
74,014

 
—

 
98,470

Other operating expenses
7,157

 
11,134

 
11,612

 
9,409

 
39,312

Federal income taxes (benefit)
(584
)
 
11,477

 
7,484

 
3,824

 
22,201

 
 
 
 
 
 
 
 
 
 
Total expenses
30,846

 
52,973

 
154,039

 
13,233

 
251,091

 
 
 
 
 
 
 
 
 
 
Segment earnings (loss)
$
(1,232
)
 
24,184

 
15,771

 
8,058

 
46,781

 
 
 
 
 
 
 
 
 
 

20
Table of Contents

NATIONAL WESTERN LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

Selected Segment Information:
 
 
 
 
 
 
 
 
 
 
Domestic
Life
Insurance
 
International
 Life
Insurance
 
Annuities
 
All
 Others
 
Totals
 
 
 
 
 
(In thousands)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
June 30, 2014
 
 
 
 
 
 
 
 
 
Condensed Consolidated Balance Sheet Items:
 
 
 
 
 
 
 
 
 
Deferred policy acquisition costs and sales inducements
$
57,354

 
238,211

 
638,108

 
—

 
933,673

Total segment assets
670,565

 
1,229,589

 
8,749,666

 
274,434

 
10,924,254

Future policy benefits
581,946

 
934,791

 
7,776,048

 
—

 
9,292,785

Other policyholder liabilities
13,259

 
12,399

 
124,056

 
—

 
149,714

 
 
 
 
 
 
 
 
 
 
Three Months Ended
 

 
 

 
 

 
 

 
 

June 30, 2014
 

 
 

 
 

 
 

 
 

Condensed Consolidated Income Statements:
 

 
 

 
 

 
 

 
 

Premiums and contract revenues
$
7,065

 
29,663

 
6,658

 
—

 
43,386

Net investment income
10,902

 
16,911

 
122,666

 
4,700

 
155,179

Other revenues
3

 
60

 
3

 
5,145

 
5,211

 
 
 
 
 
 
 
 
 
 
Total revenues
17,970

 
46,634

 
129,327

 
9,845

 
203,776

 
 
 
 
 
 
 
 
 
 
Life and other policy benefits
1,423

 
1,668

 
11,705

 
—

 
14,796

Amortization of deferred acquisition costs
1,780

 
8,808

 
16,670

 
—

 
27,258

Universal life and annuity contract interest
8,158

 
15,659

 
78,612

 
—

 
102,429

Other operating expenses
3,992

 
4,835

 
5,824

 
4,849

 
19,500

Federal income taxes (benefit)
851

 
4,963

 
5,227

 
1,561

 
12,602

 
 
 
 
 
 
 
 
 
 
Total expenses
16,204

 
35,933

 
118,038

 
6,410

 
176,585

 
 
 
 
 
 
 
 
 
 
Segment earnings (loss)
$
1,766

 
10,701

 
11,289

 
3,435

 
27,191



21
Table of Contents

NATIONAL WESTERN LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

 
Domestic
Life
Insurance
 
International
Life
Insurance
 
Annuities
 
All
Others
 
Totals
 
 
 
 
 
(In thousands)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Six months ended
 
 
 
 
 
 
 
 
 
June 30, 2014
 
 
 
 
 
 
 
 
 
Condensed Consolidated Income Statements:
 
 
 
 
 
 
 
 
 
Premiums and contract revenues
$
15,230

 
58,771

 
11,661

 
—

 
85,662

Net investment income
17,185

 
27,629

 
209,283

 
9,533

 
263,630

Other revenues
21

 
301

 
40

 
10,612

 
10,974

 
 
 
 
 
 
 
 
 
 
Total revenues
32,436

 
86,701

 
220,984

 
20,145

 
360,266

 
 
 
 
 
 
 
 
 
 
Life and other policy benefits
3,915

 
6,703

 
17,141

 
—

 
27,759

Amortization of deferred acquisition costs
4,180

 
15,553

 
36,104

 
—

 
55,837

Universal life and annuity contract interest
13,263

 
25,864

 
126,238

 
—

 
165,365

Other operating expenses
8,271

 
11,860

 
12,920

 
9,912

 
42,963

Federal income taxes (benefit)
916

 
8,722

 
9,329

 
3,342

 
22,309

 
 
 
 
 
 
 
 
 
 
Total expenses
30,545

 
68,702

 
201,732

 
13,254

 
314,233

 
 
 
 
 
 
 
 
 
 
Segment earnings (loss)
$
1,891

 
17,999

 
19,252

 
6,891

 
46,033



22
Table of Contents

NATIONAL WESTERN LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

Reconciliations of segment information to the Company's condensed consolidated financial statements are provided below.

 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2015
 
2014
 
2015
 
2014
 
(In thousands)
 
 
 
 
 
 
 
 
 
 
 
 
Premiums and Other Revenues:
 
 
 
 
 
 
 
Premiums and contract revenues
$
43,507

 
43,386

 
85,167

 
85,662

Net investment income
102,259

 
155,179

 
202,182

 
263,630

Other revenues
5,194

 
5,211

 
10,523

 
10,974

Realized gains (losses) on investments
4,258

 
3,065

 
5,236

 
4,578

 
 
 
 
 
 
 
 
Total condensed consolidated premiums and other revenues
$
155,218

 
206,841

 
303,108

 
364,844


 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2015
 
2014
 
2015
 
2014
 
(In thousands)
 
 
 
 
 
 
 
 
Federal Income Taxes:
 
 
 
 
 
 
 
Total segment Federal income taxes
$
12,446

 
12,602

 
22,201

 
22,309

Taxes on realized gains (losses) on investments
1,491

 
1,073

 
1,833

 
1,602

 
 
 
 
 
 
 
 
Total condensed consolidated Federal income taxes
$
13,937

 
13,675

 
24,034

 
23,911


 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2015
 
2014
 
2015
 
2014
 
(In thousands)
 
 
 
 
 
 
 
 
 
 
 
 
Net Earnings:
 
 
 
 
 
 
 
Total segment earnings
$
26,091

 
27,191

 
46,781

 
46,033

Realized gains (losses) on investments, net of taxes
2,767

 
1,992

 
3,403

 
2,976

 
 
 
 
 
 
 
 
Total condensed consolidated net earnings
$
28,858

 
29,183

 
50,184

 
49,009




23
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NATIONAL WESTERN LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

 
June 30,
 
2015
 
2014
 
(In thousands)
 
 
 
 
Assets:
 
 
 
Total segment assets
$
11,324,301

 
10,924,254

Other unallocated assets
190,993

 
171,827

 
 
 
 
Total condensed consolidated assets
$
11,515,294

 
11,096,081



(7)
  SHARE-BASED PAYMENTS

The Company had a stock and incentive plan ("1995 Plan") which provided 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, in tandem with stock options or freestanding; (3) restricted stock; and, (4) performance awards. The 1995 Plan began on April 21, 1995, and was amended on June 25, 2004 to extend the termination date to April 20, 2010. The number of shares of Class A, $1.00 par value, common stock which were allowed to be issued under the 1995 Plan, or as to which stock appreciation rights ("SARs") or other awards were allowed to be granted, could not exceed 300,000. Effective June 20, 2008, the Company's shareholders approved a 2008 Incentive Plan (“2008 Plan”). The 2008 Plan is substantially similar to the 1995 Plan and authorized an additional number of Class A, $1.00 par value, common stock shares eligible for issue not to exceed 300,000. These shares may be authorized and unissued shares. The Company has issued only nonqualified stock options and SARs under these plans.

All of the employees of the Company and its subsidiaries are eligible to participate in the current 2008 Plan (as well as previously in the expired 1995 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. The directors' grants vest 20% annually following one full year of service to the Company from the date of grant. The employees' grants vest 20% annually following three full years of service to the Company from the date of grant. All grants issued expire after ten years. No awards were issued during the first six months of 2015 or 2014.

Effective during March 2006, the Company adopted and implemented a limited stock buy-back program with respect to the 1995 Plan which provides option holders the additional alternative of selling shares acquired through the exercise of options directly back to the Company. Option holders may elect to sell such 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. The buy-back program did not alter the terms and conditions of the 1995 Plan; however, the program necessitated a change in accounting from the equity classification to the liability classification.

In August 2008, the Company implemented another limited stock buy-back program, substantially similar to the 2006 program, for shares issued under the 2008 Plan.


24
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NATIONAL WESTERN LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

The Company uses the current fair value method to measure compensation cost. As of June 30, 2015 and 2014, the liability balance was $7.3 million and $7.7 million, respectively. A summary of shares available for grant and activity is detailed below.

 
 
 
Options Outstanding
 
Shares
Available
For Grant
 
Shares
 
Weighted-
Average
Exercise
Price
 
 
 
 
 
 
Stock Options:
 
 
 
 
 
Balance at January 1, 2015
291,000

 
29,768

 
$
242.48

Exercised
—

 
—

 
$
—

Forfeited
—

 
(1,000
)
 
$
255.13

Expired
—

 
—

 
$
—

Stock options granted
—

 
—

 
$
—

 
 
 
 
 
 
Balance at June 30, 2015
291,000

 
28,768

 
$
242.04


 
Stock Appreciation Rights Outstanding
 
Awards
 
Weighted-
Average
Exercise
Price
 
 
 
 
Stock Appreciation Rights:
 
 
 
Balance at January 1, 2015
92,186

 
$
157.71

Exercised
(3,975
)
 
$
143.19

Forfeited
—

 
$
—

Granted
—

 
$
—

 
 
 
 
Balance at June 30, 2015
88,211

 
$
158.36


Stock options and SARs shown as forfeited in the above tables represent vested and unvested awards not exercised by plan participants prior to their termination from the Company. Forfeited stock options during the six months ended June 30, 2015 were awarded under the 1995 Plan. As the 1995 Plan terminated during calendar year 2010, the forfeited shares are not shown as being added back to the "Shares Available For Grant" balance.

The total intrinsic value of SARs exercised was $0.4 million and $0.7 million for the six months ended June 30, 2015 and 2014, respectively. The total share-based liabilities paid for the exercised SARs were $0.4 million and $0.6 million for the six months ended June 30, 2015 and 2014, respectively. The total fair value of stock options and SARs vested during the six months ended June 30, 2015 and 2014 was $0.6 million and $0.6 million, respectively. For the six months ended June 30, 2015 and 2014, the total cash received from the exercise of stock options under the Plans was $0 million and $0.2 million, respectively.


25
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NATIONAL WESTERN LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

The following table summarizes information about stock options and SARs outstanding at June 30, 2015.

 
 
Options/SARs Outstanding
 
 
Number
Outstanding
 
Weighted-
Average
Remaining
Contractual Life
 
Number
Exercisable
 
 
 
 
 
 
 
Exercise prices:
 
 
 
 
 
 $255.13 (options)
 
20,768

 
2.8 years
 
20,768

 $208.05 (options)
 
8,000

 
3.0 years
 
8,000

 $236.00 (SARs)
 
250

 
3.1 years
 
200

 $114.64 (SARs)
 
23,943

 
3.6 years
 
19,764

 $132.56 (SARs)
 
29,518

 
6.5 years
 
8,704

 $210.22 (SARs)
 
34,500

 
8.4 years
 
1,800

 
 
 
 
 
 
 
Totals
 
116,979

 
 
 
59,236

 
 

 
 
 
 

Aggregate intrinsic value (in thousands)
$
7,408

 
 
 
$
3,703


The aggregate intrinsic value in the table above is based on the closing stock price of $239.49 per share on June 30, 2015.

In estimating the fair value of the options outstanding at June 30, 2015 and December 31, 2014, the Company employed the Black-Scholes option pricing model with assumptions detailed below.

 
June 30,
2015
 
December 31,
2014
 
 
 
 
Expected term of options
2.8 to 8.4 years

 
3.3 to 9.0 years

Expected volatility:
 
 
 
Range
21.14% to 37.77%

 
19.67% to 37.75%

Weighted-average
23.96
%
 
22.91
%
Expected dividend yield
0.15
%
 
0.13
%
Risk-free rate:
 
 
 
Range
0.22% to 1.54%

 
0.13% to 1.62%

Weighted-average
0.52
%
 
0.56
%

The Company reviewed the contractual term relative to the options as well as perceived future behavior patterns of exercise.  Volatility is based on the Company’s historical volatility over the expected term of the option’s expected exercise date.

The pre-tax compensation cost (benefit) recognized in the financial statements related to the two plans defined above was $(0.8) million and $(1.6) million for the three and six months ended June 30, 2015 compared to $0.8 million and $2.5 million for the three and six months ended June 30, 2014. The related tax (expense)/benefit recognized was $0.3 million and $0.6 million for the three and six months ended June, 2015 and 2014 compared to $(0.3) million and $(0.8) million for the three and six months ended June 30, 2014.

As of June 30, 2015, the total compensation cost related to nonvested options not yet recognized was $1.8 million.  This amount is expected to be recognized over a weighted-average period of 2.0 years.  The Company recognizes compensation cost over the graded vesting periods.

26
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NATIONAL WESTERN LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

(8)
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. The Company has been a defendant over the past several years in two 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.

The Company resolved a class action lawsuit pending since June 12, 2006, in the U.S. District Court for the Southern District of California. The case is titled In Re National Western Life Insurance Deferred Annuities Litigation. The complaint asserted claims for RICO violations, Financial Elder Abuse, Violation of Cal. Bus. & Prof. Code 17200, et seq, Violation of Cal. Bus. & Prof. Code 17500, et seq, Breach of Fiduciary Duty, Aiding and Abetting Breach of Fiduciary Duty, Fraudulent Concealment, Cal. Civ. Code 1710, et seq, Breach of the Duty of Good Faith and Fair Dealing, and Unjust Enrichment and Imposition of Constructive Trust. On July 12, 2010 the Court certified a nationwide class of policyholders under the RICO allegation and a California class under all of the remaining causes of action except breach of fiduciary duty. The parties entered into a Settlement and Release Agreement in August of 2013 ("Settlement") which was finally approved by the Court on February 11, 2014. On February 12, 2014, the Court issued a redacted final approval order granting the Motion for Final Approval of Class Action Settlement. The Settlement became final and non-appealable on April 12, 2014. The Settlement Agreement and Plaintiffs' Request for Attorneys' Fees and Costs were approved by the Court, and the Company paid the Court-approved amount of attorneys’ fees and costs in April 2014. The Company also made certain payments to surrendered and annuitized policyholders in June 2014. In addition, the Company agreed to provide bonuses on annuitization for active policyholders who choose a 10-year or a 20-year certain and life settlement option. The Company had held reserves of $6.5 million for the matter which approximated the ultimate settlement amounts described above.

On October 26, 2011 the Brazilian Superintendence of Private Insurance (“SUSEP”) attempted to serve the Company with a subpoena regarding an administrative proceeding initiated by SUSEP in which it alleged that the Company was operating as an insurance company in Brazil without due authorization.  The Company had been informed that SUSEP was attempting to impose a penal fine of approximately $6.0 billion on the Company.  SUSEP unsuccessfully attempted to serve the Company with notice regarding this matter.  The Company does not transact business in Brazil and has no officers, employees, property, or assets in Brazil.  The Company believes that SUSEP has no jurisdiction over the Company, that SUSEP's attempts at service of process were invalid, and that any penal fine would be unenforceable.  For the reasons described above, the Company does not believe that this matter meets the definition of a material pending legal proceeding as such term is defined in Item 103 of Regulation S-K but has included the foregoing description solely due to the purported amount of the fine sought at that time.

Although there can be no assurances, at the present time, the Company does not anticipate that the ultimate liability arising from such other potential, pending, or threatened legal actions will have a material adverse effect on the financial condition or operating results of the Company.

Separately, the Brazilian authorities have commenced an investigation into possible violations of Brazilian criminal law in connection with the issuance of the Company's insurance policies to Brazilian residents, and in assistance of such investigation a Commissioner appointed by the U.S. District Court for the Western District of Texas has issued a subpoena upon the Company to provide information relating to such possible violations. No conclusion can be drawn at this time as to the outcome of this investigation or how such outcome may impact the Company's business, results of operations, or financial condition. The Company continues to cooperate with the relevant governmental authorities in regard to this matter.

(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 sheet.


27
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NATIONAL WESTERN LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

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 $2.8 million commitments to extend credit relating to mortgage loans at June 30, 2015. The Company evaluates each customer's creditworthiness on a case-by-case basis.


(9)
INVESTMENTS

(A)
Investment Gains and Losses

The table below presents realized investment gains and losses, excluding impairment losses, for the periods indicated.

 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2015
 
2014
 
2015
 
2014
 
(In thousands)
 
 
 
 
 
 
 
 
 
 
 
 
Available for sale debt securities:
 
 
 
 
 
 
 
Realized gains on disposal
$
2,985

 
2,985

 
3,198

 
3,677

Realized losses on disposal
(65
)
 
(14
)
 
(74
)
 
(22
)
Held to maturity debt securities:
 
 
 
 
 
 
 
Realized gains on disposal
1,404

 
32

 
2,128

 
814

Realized losses on disposal
—

 
(6
)
 
—

 
(17
)
Equity securities realized gains (losses)
41

 
23

 
91

 
27

Real estate gains (losses)
—

 
45

 
—

 
134

 
 
 
 
 
 
 
 
Totals
$
4,365

 
3,065

 
5,343

 
4,613



28
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NATIONAL WESTERN LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

The Company uses the specific identification method in computing realized gains and losses. For the three and six months ended June 30, 2015 the percentage of gains on bonds due to the call of securities was 94% and 91%, respectively. This includes calls out of the Company's available for sale portfolio of debt securities.

The table below presents net impairment losses recognized in earnings for the periods indicated.

 
 
Three Months Ended
 
Six Months Ended
 
 
June 30,
 
June 30,
 
 
2015
 
2014
 
2015
 
2014
 
 
(In thousands)
 
 
 
 
 
 
 
 
 
Total other-than-temporary impairment gains (losses) on debt securities
 
$
105

 
—

 
265

 
(4
)
Portion of loss (gain) recognized in comprehensive income
 
(105
)
 
—

 
(265
)
 
(3
)
 
 
 
 
 
 
 
 
 
Net impairment losses on debt securities recognized in earnings
 
—

 
—

 
—

 
(7
)
Equity securities impairments
 
(107
)
 
—

 
(107
)
 
(28
)
 
 
 
 
 
 
 
 
 
Totals
 
$
(107
)
 
—

 
(107
)
 
(35
)


The table below presents a roll forward of credit losses on securities for which the Company also recorded non-credit other-than-temporary impairments in other comprehensive loss.

 
Three Months Ended June 30, 2015
 
Six Months Ended June 30, 2015
 
Twelve Months
Ended
December 31,
2014
 
 
 
(In thousands)

 
 
 
 
 
 
 
 
Beginning balance, cumulative credit losses related to other-than-temporary impairments
$
2,278

 
2,298

 
2,472

Reductions for securities sold during current period
—

 
(20
)
 
(181
)
Additions for credit losses not previously recognized in other-than-temporary impairments
—

 
—

 
7

 
 
 
 
 
 
Ending balance, cumulative credit losses related to other-than-temporary impairments
$
2,278

 
2,278

 
2,298



29
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NATIONAL WESTERN LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

(B)
Debt and Equity Securities

The table below presents amortized costs and fair values of securities held to maturity at June 30, 2015.

 
Securities Held to Maturity
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
 
(In thousands)
 
 
 
 
 
 
 
 
Debt securities:
 
 
 
 
 
 
 
U.S. agencies
$
15,038

 
517

 
(137
)
 
15,418

U.S. Treasury
1,923

 
369

 
—

 
2,292

States and political subdivisions
439,504

 
26,535

 
(2,536
)
 
463,503

Foreign governments
—

 
—

 
—

 
—

Public utilities
1,010,342

 
53,640

 
(4,433
)
 
1,059,549

Corporate
4,056,712

 
153,167

 
(37,448
)
 
4,172,431

Mortgage-backed
1,575,798

 
62,921

 
(8,333
)
 
1,630,386

Home equity
18,380

 
4,574

 
—

 
22,954

Manufactured housing
3,742

 
321

 
—

 
4,063

 
 
 
 
 
 
 
 
Totals
$
7,121,439

 
302,044

 
(52,887
)
 
7,370,596


The table below presents amortized costs and fair values of securities available for sale at June 30, 2015.

 
Securities Available for Sale
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
 
(In thousands)
 
 
 
 
 
 
 
 
Debt securities:
 
 
 
 
 
 
 
States and political subdivisions
$
588

 
—

 
(53
)
 
535

Foreign governments
9,943

 
482

 
—

 
10,425

Public utilities
150,042

 
8,407

 
(480
)
 
157,969

Corporate
2,512,794

 
105,156

 
(22,270
)
 
2,595,680

Mortgage-backed
42,184

 
3,734

 
—

 
45,918

Home equity
11,381

 
199

 
(8
)
 
11,572

Manufactured housing
1,411

 
43

 
—

 
1,454

 
2,728,343

 
118,021

 
(22,811
)
 
2,823,553

 
 
 
 
 
 
 
 
Equity securities
12,650

 
4,637

 
(251
)
 
17,036

 
 
 
 
 
 
 
 
Totals
$
2,740,993

 
122,658

 
(23,062
)
 
2,840,589


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NATIONAL WESTERN LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)


The table below presents amortized costs and fair values of securities held to maturity at December 31, 2014.

 
Securities Held to Maturity
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
 
(In thousands)
 
 
 
 
 
 
 
 
Debt securities:
 
 
 
 
 
 
 
U.S. agencies
$
10,061

 
705

 
—

 
10,766

U.S. Treasury
1,920

 
409

 
—

 
2,329

States and political subdivisions
432,186

 
31,417

 
(336
)
 
463,267

Public utilities
978,847

 
67,836

 
(757
)
 
1,045,926

Corporate
3,754,222

 
183,650

 
(18,591
)
 
3,919,281

Mortgage-backed
1,640,582

 
68,726

 
(4,164
)
 
1,705,144

Home equity
18,886

 
4,734

 
(57
)
 
23,563

Manufactured housing
4,839

 
328

 
—

 
5,167

 
 
 
 
 
 
 
 
Totals
$
6,841,543

 
357,805

 
(23,905
)
 
7,175,443


The table below presents amortized costs and fair values of securities available for sale at December 31, 2014.

 
Securities Available for Sale
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
 
(In thousands)
 
 
 
 
 
 
 
 
Debt securities:
 
 
 
 
 
 
 
States and political subdivisions
$
589

 
—

 
(36
)
 
553

Foreign governments
9,939

 
386

 
—

 
10,325

Public utilities
169,179

 
10,163

 
(126
)
 
179,216

Corporate
2,334,700

 
128,280

 
(8,961
)
 
2,454,019

Mortgage-backed
48,674

 
4,116

 
—

 
52,790

Home equity
11,702

 
225

 
(9
)
 
11,918

Manufactured housing
2,492

 
64

 
—

 
2,556

 
2,577,275

 
143,234

 
(9,132
)
 
2,711,377

 
 
 
 
 
 
 
 
Equity securities
12,799

 
4,849

 
(345
)
 
17,303

 
 
 
 
 
 
 
 
Totals
$
2,590,074

 
148,083

 
(9,477
)
 
2,728,680



31
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NATIONAL WESTERN LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

The following table shows the gross unrealized losses and fair values of the Company's held to maturity investments by investment category and length of time the individual securities have been in a continuous unrealized loss position at June 30, 2015.

 
Securities Held to Maturity
 
Less than 12 Months
 
12 Months or Greater
 
Total
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
(In thousands)
 
 
 
 
 
 
 
 
 
 
 
 
Debt securities:
 
 
 
 
 
 
 
 
 
 
 
U.S. agencies
$
4,858

 
(137
)
 
—

 
—

 
4,858


(137
)
States and political subdivisions
65,904

 
(1,633
)
 
12,567

 
(903
)
 
78,471

 
(2,536
)
Public utilities
228,627

 
(3,727
)
 
17,802

 
(706
)
 
246,429

 
(4,433
)
Corporate
1,176,531

 
(25,477
)
 
300,133

 
(11,971
)
 
1,476,664

 
(37,448
)
Mortgage-backed
234,516

 
(4,501
)
 
85,928

 
(3,832
)
 
320,444

 
(8,333
)
 
 
 
 
 
 
 
 
 
 
 
 
Total temporarily impaired securities
$
1,710,436

 
(35,475
)
 
416,430

 
(17,412
)
 
2,126,866

 
(52,887
)

The following table shows the gross unrealized losses and fair values of the Company's available for sale investments by investment category and length of time the individual securities have been in a continuous unrealized loss position at June 30, 2015.

 
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)
 
 
 
 
 
 
 
 
 
 
 
 
Debt securities:
 
 
 
 
 
 
 
 
 
 
 
States and political subdivisions
$
—

 
—

 
535

 
(53
)
 
535

 
(53
)
Public utilities
17,472

 
(480
)
 
—

 
—

 
17,472

 
(480
)
Corporate
740,487

 
(16,629
)
 
114,467

 
(5,641
)
 
854,954

 
(22,270
)
Home equity
—

 
—

 
4,827

 
(8
)
 
4,827

 
(8
)
 
757,959

 
(17,109
)
 
119,829

 
(5,702
)
 
877,788

 
(22,811
)
 
 
 
 
 
 
 
 
 
 
 
 
Equity securities
2,989

 
(196
)
 
1,378

 
(55
)
 
4,367

 
(251
)
 
 
 
 
 
 
 
 
 
 
 
 
Total temporarily impaired securities
$
760,948

 
(17,305
)
 
121,207

 
(5,757
)
 
882,155

 
(23,062
)

Unrealized losses for securities held to maturity and securities available for sale increased during the first six months of 2015 due primarily to the upward movement in market interest rates. The Company does not consider investments with unrealized losses to be other-than-temporarily impaired since it does not anticipate selling these securities prior to maturity and expects to receive all amounts due relative to principal and interest.


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NATIONAL WESTERN LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

The Company does not consider securities to be other-than-temporarily impaired when the market decline is attributable to factors such as interest rate movements, market volatility, liquidity, spread widening and credit quality and when recovery of all amounts due under the contractual terms of the security is anticipated. Based on the review and the Company's ability and intent not to sell these securities until maturity, the Company does not consider these investments to be other-than-temporarily impaired at June 30, 2015. The Company will monitor the investment portfolio for future changes in issuer facts and circumstances that could result in future impairments beyond those currently identified.

During the second quarter of 2015, the Company recorded $0.1 million other-than-temporary impairment on equity securities.

Debt securities. The gross unrealized losses for debt securities are made up of 364 individual issues, or 27.3% of the total debt securities held by the Company. The market value of these bonds as a percent of amortized cost averages 97.5%. Of the 364 securities, 77, or 21.2%, fall in the 12 months or greater aging category; and 361 were rated investment grade at June 30, 2015.

Equity securities.  The gross unrealized losses for equity securities are made up of 23 individual issues.  These holdings are reviewed quarterly for impairment.  

The following table shows the gross unrealized losses and fair values of the Company's held to maturity investments by investment category and length of time the individual securities have been in a continuous unrealized loss position at December 31, 2014.

 
Securities Held to Maturity
 
Less than 12 Months
 
12 Months or Greater
 
Total
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
(In thousands)
 
 
 
 
 
 
 
 
 
 
 
 
Debt securities:
 
 
 
 
 
 
 
 
 
 
 
States and political subdivisions
$
—

 
—

 
23,076

 
(336
)
 
23,076

 
(336
)
Public utilities
7,078

 
(13
)
 
48,198

 
(744
)
 
55,276

 
(757
)
Corporate
156,839

 
(2,997
)
 
698,316

 
(15,594
)
 
855,155

 
(18,591
)
Mortgage-backed
17,698

 
(240
)
 
181,694

 
(3,924
)
 
199,392

 
(4,164
)
Home equity
2,206

 
(57
)
 
—

 
—

 
2,206

 
(57
)
 
 
 
 
 
 
 
 
 
 
 
 
Total temporarily impaired securities
$
183,821

 
(3,307
)
 
951,284

 
(20,598
)
 
1,135,105

 
(23,905
)


33
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NATIONAL WESTERN LIFE INSURANCE COMPANY AND SUBSIDIARIES
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 investments by investment category and length of time that the individual securities have been in a continuous unrealized loss position at December 31, 2014.
 
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)
 
 
 
 
 
 
 
 
 
 
 
 
Debt securities:
 
 
 
 
 
 
 
 
 
 
 
States and political subdivisions
$
—

 
—

 
553

 
(36
)
 
553

 
(36
)
Public utilities
—

 
—

 
14,827

 
(126
)
 
14,827

 
(126
)
Corporate
100,373

 
(2,990
)
 
187,699

 
(5,971
)
 
288,072

 
(8,961
)
Home equity
—

 
—

 
4,826

 
(9
)
 
4,826

 
(9
)
 
100,373

 
(2,990
)
 
207,905

 
(6,142
)
 
308,278

 
(9,132
)
 
 
 
 
 
 
 
 
 
 
 
 
Equity securities
305

 
(52
)
 
3,801

 
(293
)
 
4,106

 
(345
)
 
 
 
 
 
 
 
 
 
 
 
 
Total temporarily impaired securities
$
100,678

 
(3,042
)
 
211,706

 
(6,435
)
 
312,384

 
(9,477
)

(C)
 Transfer of Securities

During the three and six months ended June 30, 2015 and 2014, the Company made no transfers to the held to maturity category from securities available for sale.

(D) Mortgage Loans

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. Mortgage, equity, participation and mezzanine loans on real estate are considered financing receivables reported by the Company.

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 guaranteed by the lease payments and also by the borrower. 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.

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 June 30, 2015 or 2014 and as a result all interest income was recognized at June 30, 2015 or 2014.


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NATIONAL WESTERN LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

The following table represents the mortgage loan portfolio by loan-to-value ratio.

 
June 30, 2015
 
December 31, 2014
 
Amount
 
%
 
Amount
 
%
 
(In thousands)
 
 
 
(In thousands)
 
 
 
 
 
 
 
 
 
 
Mortgage Loans by Loan-to-Value Ratio (1):
 
 
 
 
 
 
 
Less than 50%
$
44,743

 
33.7

 
$
52,564

 
35.0

50% to 60%
44,385

 
33.4

 
50,553

 
33.7

60% to 70%
19,935

 
15.0

 
14,567

 
9.7

70% to 80%
4,291

 
3.2

 
12,656

 
8.4

80% to 90%
19,557

 
14.7

 
5,399

 
3.6

Greater than 90%
—

 
—

 
14,414

 
9.6

Gross balance
132,911

 
100.0

 
150,153

 
100.0

 
 
 
 
 
 
 
 
Allowance for possible losses
(650
)
 
(0.5
)
 
(650
)
 
(0.4
)
 
 
 
 
 
 
 
 
Totals
$
132,261

 
99.5

 
$
149,503

 
99.6


(1) Loan-to-Value Ratio 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.

The mortgage loans in the greater than 90% category at December 31, 2014 relate to loans made with a long standing borrower. The loans are backed by the investment property, contracted leases, as well as a separate and additional guarantee of the long standing borrower and at June 30, 2015 are included in the 80% to 90% category.

All mortgage loans are analyzed quarterly in order to monitor the financial quality of these assets. Based on ongoing monitoring, mortgage loans with a likelihood of becoming delinquent are identified and placed on an internal “watch list”. Among the criteria that may indicate a potential problem include: major tenant vacancies or bankruptcies, late payments, and loan relief/restructuring requests. The mortgage loan portfolio is analyzed for the need for a valuation allowance on any loan that is on the internal watch list, in the process of foreclosure or that currently has a valuation allowance.

Mortgage loans are considered impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. When it is determined that a loan is impaired, a loss is recognized for the difference between the carrying amount of the mortgage loan and the estimated value reduced by the cost to sell. Estimated value is typically based on the loan's observable market price or the fair value of the collateral less cost to sell. Impairments and changes in the valuation allowance are reported in net realized investment gains (losses) in the Condensed Consolidated Statements of Earnings.

The following table represents the mortgage loan allowance.
 
June 30, 2015
 
December 31, 2014
 
(In thousands)
 
 
 
 
Balance, beginning of period
$
650

 
650

Provision
—

 
—

Releases
—

 
—

 
 
 
 
Balance, end of period
$
650

 
650



35
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NATIONAL WESTERN LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

(10)
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 the required 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.

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), and preferred stock.  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 are over-the-counter derivative contracts and the Company’s Level 3 liabilities consist of share-based compensation obligations and certain product-related embedded derivatives.  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:

 
June 30, 2015
 
Total
 
Level 1
 
Level 2
 
Level 3
 
(In thousands)
 
 
 
 
 
 
 
 
Debt securities, available for sale
$
2,823,553

 
—

 
2,823,553

 
—

Equity securities, available for sale
17,036

 
16,533

 
503

 
—

Derivatives, index options
72,527

 
—

 
—

 
72,527

 
 
 
 
 
 
 
 
Total assets
$
2,913,116

 
16,533

 
2,824,056

 
72,527

 
 
 
 
 
 
 
 
Policyholder account balances (a)
$
88,109

 
—

 
—

 
88,109

Other liabilities (b)
7,259

 
—

 
—

 
7,259

 
 
 
 
 
 
 
 
Total liabilities
$
95,368

 
—

 
—

 
95,368



36
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NATIONAL WESTERN LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

During the three and six months ended June 30, 2015, the Company had no transfers into or out of Levels 1, 2 or 3.

 
December 31, 2014
 
Total
 
Level 1
 
Level 2
 
Level 3
 
(In thousands)
 
 
 
 
 
 
 
 
Debt securities, available for sale
$
2,711,377

 
—

 
2,711,377

 
—

Equity securities, available for sale
17,303

 
16,862

 
441

 
—

Derivatives, index options
114,287

 
—

 
—

 
114,287

 
 
 
 
 
 
 
 
Total assets
$
2,842,967

 
16,862

 
2,711,818

 
114,287

 
 
 
 
 
 
 
 
Policyholder account balances (a)
$
133,236

 
—

 
—

 
133,236

Other liabilities (b)
9,256

 
—

 
—

 
9,256

 
 
 
 
 
 
 
 
Total liabilities
$
142,492

 
—

 
—

 
142,492


(a)  Represents the fair value of certain product-related embedded derivatives that were recorded at fair value.
(b)  Represents the liability for share-based compensation.

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:

 
June 30, 2015
 
Total
 
Level 1
 
Level 2
 
Level 3
 
(In thousands)
 
 
 
 
 
 
 
 
Debt securities, available for sale:
 
 
 
 
 
 
 
Priced by third-party vendors
$
2,823,553

 
—

 
2,823,553

 
—

Priced internally
—

 
—

 
—

 
—

Subtotal
2,823,553

 
—

 
2,823,553

 
—

 
 
 
 
 
 
 
 
Equity securities, available for sale:
 

 
 

 
 

 
 

Priced by third-party vendors
17,036

 
16,533

 
503

 
—

Priced internally
—

 
—

 
—

 
—

Subtotal
17,036

 
16,533

 
503

 
—

 
 
 
 
 
 
 
 
Derivatives, index options:
 

 
 

 
 

 
 

Priced by third-party vendors
72,527

 
—

 
—

 
72,527

Priced internally
—

 
—

 
—

 
—

Subtotal
72,527

 
—

 
—

 
72,527

 
 
 
 
 
 
 
 
Total
$
2,913,116

 
16,533

 
2,824,056

 
72,527

 
 
 
 
 
 
 
 
Percent of total
100.0
%
 
0.6
%
 
96.9
%
 
2.5
%


37
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NATIONAL WESTERN LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

 
December 31, 2014
 
Total
 
Level 1
 
Level 2
 
Level 3
 
(In thousands)
 
 
 
 
 
 
 
 
Debt securities, available for sale:
 
 
 
 
 
 
 
Priced by third-party vendors
$
2,711,377

 
—

 
2,711,377

 
—

Priced internally
—

 
—

 
—

 
—

Subtotal
2,711,377

 
—

 
2,711,377

 
—

 
 
 
 
 
 
 
 
Equity securities, available for sale:
 

 
 

 
 

 
 

Priced by third-party vendors
17,303

 
16,862

 
441

 
—

Priced internally
—

 
—

 
—

 
—

Subtotal
17,303

 
16,862

 
441

 
—

 
 
 
 
 
 
 
 
Derivatives, index options:
 

 
 

 
 

 
 

Priced by third-party vendors
114,287

 
—

 
—

 
114,287

Priced internally
—

 
—

 
—

 
—

Subtotal
114,287

 
—

 
—

 
114,287

 
 
 
 
 
 
 
 
Total
$
2,842,967

 
16,862

 
2,711,818

 
114,287

 
 
 
 
 
 
 
 
Percent of total
100.0
%
 
0.6
%
 
95.4
%
 
4.0
%


38
Table of Contents

NATIONAL WESTERN LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

The following tables provide additional information about fair value measurements for which significant unobservable (Level 3) inputs were utilized to determine fair value.

 
For the Three Months Ended June 30, 2015
 
Debt
Securities,
Available
for Sale
 
Equity
Securities,
Available
for Sale
 
Derivatives, Index Options
 
Total
Assets
 
Other
Liabilities
 
(In thousands)
 
 
 
 
 
 
 
 
 
 
Balance at April 1, 2015
$
—

 
—

 
95,987

 
95,987

 
119,987

Total realized and unrealized gains (losses):


 


 
 
 
 

 
 
Included in net income
—

 
—

 
(8,782
)
 
(8,782
)
 
(9,653
)
Included in other comprehensive income
—

 
—

 
—

 
—

 
—

Purchases, sales, issuances and settlements, net:
 
 
 
 
 
 
 
 
 
Purchases
—

 
—

 
21,473

 
21,473

 
21,473

Sales
—

 
—

 
—

 
—

 
—

Issuances
—

 
—

 
—

 
—

 
—

Settlements
—

 
—

 
(36,151
)
 
(36,151
)
 
(36,439
)
Transfers into (out of) Level 3
—

 
—

 
—

 
—

 
—

 
 
 
 
 
 
 
 
 
 
Balance at end of period
$
—

 
—

 
72,527

 
72,527

 
95,368

 
 
 
 
 
 
 
 
 
 
Change in unrealized gains or losses for the period included in earnings (or changes in net assets) for assets held at the end of the reporting period:
 
 
 
 
 
 
 
 
 
   Net investment income
$
—

 
—

 
(11,922
)
 
(11,922
)
 
—

Benefits and expenses
—

 
—

 
—

 
—

 
(813
)
 
 
 
 
 
 
 
 
 
 
Total
$
—

 
—

 
(11,922
)
 
(11,922
)
 
(813
)


39
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NATIONAL WESTERN LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

 
For the Three Months ended June 30, 2014
 
Debt
Securities,
Available
for Sale
 
Equity
Securities,
Available
for Sale
 
Derivatives, Index Options
 
Total
Assets
 
Other
Liabilities
 
(In thousands)
 
 
 
 
 
 
 
 
 
 
Balance at April 1, 2014
$
—

 
—

 
134,916

 
134,916

 
160,536

Total realized and unrealized gains (losses):
 
 
  

 
 

 
 

 
  

Included in net income
—

 
—

 
45,251

 
45,251

 
44,779

Included in other comprehensive income
—

 
—

 
—

 
—

 
—

Purchases, sales, issuances and settlements, net:
 
 
 
 
 
 
 
 
 
Purchases
—

 
—

 
18,232

 
18,232

 
18,232

Sales
—

 
—

 
—

 
—

 
—

Issuances
—

 
—

 
—

 
—

 
—

Settlements
—

 
—

 
(51,885
)
 
(51,885
)
 
(52,119
)
Transfers into (out of) Level 3
—

 
—

 
—

 
—

 
—

 
 
 
 
 
 
 
 
 
 
Balance at end of period
$
—

 
—

 
146,514

 
146,514

 
171,428

 
 
 
 
 
 
 
 
 
 
Change in unrealized gains or losses for the period included in earnings (or changes in net assets) for assets held at the end of the reporting period:
 
 
 
 
 
 
 
 
 
   Net investment income
$
—

 
—

 
43,313

 
43,313

 
—

Benefits and expenses
—

 
—

 
—

 
—

 
1,006

 
 
 
 
 
 
 
 
 
 
Total
$
—

 
—

 
43,313

 
43,313

 
1,006


40
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NATIONAL WESTERN LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

 
Six Months Ended June 30, 2015
 
Debt
Securities,
Available
for Sale
 
Equity
Securities,
Available
for Sale
 
Derivatives, Index Options
 
Total
Assets
 
Other
Liabilities
 
(In thousands)
 
 
 
 
 
 
 
 
 
 
Beginning balance, January 1, 2015
$
—

 
—

 
114,287

 
114,287

 
142,492

Total realized and unrealized gains (losses):
 
 
 
 
 

 
 

 
 
Included in net income
—

 
—

 
(17,069
)
 
(17,069
)
 
(22,036
)
Included in other comprehensive income
—

 
—

 
—

 
—

 
—

Purchases, sales, issuances and settlements, net:
 
 
 
 
 
 
 
 
 
Purchases
—

 
—

 
39,929

 
39,929

 
39,929

Sales
—

 
—

 
—

 
—

 
—

Issuances
—

 
—

 
—

 
—

 
—

Settlements
—

 
—

 
(64,620
)
 
(64,620
)
 
(65,017
)
Transfers into (out of) Level 3
—

 
—

 
—

 
—

 
—

 
 
 
 
 
 
 
 
 
 
Balance at end of period
$
—

 
—

 
72,527

 
72,527

 
95,368

 
 
 
 
 
 
 
 
 
 
Amount of total gains (losses) for the period included in net income attributable to the change in unrealized gains (losses) relating to assets still held at end of period:
 
 
 
 
 
 
 
 
 
   Net investment income
$
—

 
—

 
(17,830
)
 
(17,830
)
 
—

   Other operating expenses
—

 
—

 
—

 
—

 
(1,600
)
 
 
 
 
 
 
 
 
 
 
Total
$
—

 
—

 
(17,830
)
 
(17,830
)
 
(1,600
)

41
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NATIONAL WESTERN LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

 
Six Months Ended June 30, 2014
 
Debt
Securities,
Available
for Sale
 
Equity
Securities,
Available
for Sale
 
Derivatives, Index Options
 
Total
Assets
 
Other
Liabilities
 
(In thousands)
 
 
 
 
 
 
 
 
 
 
Beginning balance, January 1, 2014
$
—

 
—

 
169,314

 
169,314

 
193,338

Total realized and unrealized gains (losses):
 
 
 
 
 

 
 

 
 
Included in net income
—

 
—

 
45,799

 
45,799

 
47,430

Included in other comprehensive income
—

 
—

 
—

 
—

 


Purchases, sales, issuances and settlements, net:
 
 
 
 
 
 
 
 
 
Purchases
—

 
—

 
33,569

 
33,569

 
33,569

Sales
—

 
—

 
—

 
—

 
—

Issuances
—

 
—

 
—

 
—

 
—

Settlements
—

 
—

 
(102,168
)
 
(102,168
)
 
(102,909
)
Transfers into (out of) Level 3
—

 
—

 
—

 
—

 
—

 
 
 
 
 
 
 
 
 
 
Balance at end of period
$
—

 
—

 
146,514

 
146,514

 
171,428

 
 
 
 
 
 
 
 
 
 
Change in unrealized gains or losses for the period included in earnings (or changes in net assets) for assets held at the end of the reporting period:
 
 
 
 
 
 
 
 
 
   Net investment income
$
—

 
—

 
44,200

 
44,200

 
—

   Other operating expenses
—

 
—

 
—

 
—

 
3,091

 
 
 
 
 
 
 
 
 
 
Total
$
—

 
—

 
44,200

 
44,200

 
3,091


The following tables show the quantitative information about the Company's level 3 assets and liabilities.

 
June 30, 2015
 
Fair Value
 
Valuation Technique
 
Unobservable Input
 
(In thousands)
 
 
 
 
 
 
 
 
 
 
Derivatives, index options
$
72,527

 
Broker prices
 
Implied volatility
 
 
 
 
 
Inputs from broker proprietary models
 
 
 
 
 
 
Total assets
$
72,527

 
 
 
 
 
 
 
 
 
 
Policyholder account balances
$
88,109

 
Deterministic cash flow model
 
Projected option cost
Other liabilities
7,259

 
Black-Scholes model
 
Expected term
 
 
 
 
 
Forfeiture assumptions
 
 
 
 
 
 
Total liabilities
$
95,368

 
 
 
 

42
Table of Contents

NATIONAL WESTERN LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

 
December 31, 2014
 
Fair Value
 
Valuation Technique
 
Unobservable Input
 
(In thousands)
 
 
 
 
 
 
 
 
 
 
Derivatives, index options
$
114,287

 
Broker prices
 
Implied volatility
 
 
 
 
 
Inputs from broker proprietary models
 
 
 
 
 
 
Total assets
$
114,287

 
 
 
 
 
 
 
 
 
 
Policyholder account balances
$
133,236

 
Deterministic cash flow model
 
Projected option cost
Other liabilities
9,256

 
Black-Scholes model
 
Expected term
 
 
 
 
 
Forfeiture assumptions
 
 
 
 
 
 
Total liabilities
$
142,492

 
 
 
 

Realized gains (losses) on debt and equity securities are reported in the Condensed Consolidated Statements of Earnings as net investment gains (losses). Unrealized gains (losses) on available for sale debt and equity securities are reported as other comprehensive income (loss) within the stockholders' equity of the Condensed Consolidated Balance Sheet.

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.


43
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NATIONAL WESTERN LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

The carrying amounts and fair values of the Company's financial instruments are as follows:

 
June 30, 2015
 
 
 
Fair Value Hierarchy Level
 
Carrying
Values
 
Fair
Values
 
Level 1
 
Level 2
 
Level 3
 
(In thousands)
ASSETS
 
 
 
 
 
 
 
 
 
Investments in debt and equity securities:
 
 
 
 
 
 
 
 
 
Securities held to maturity
$
7,121,439

 
7,370,596

 
—

 
7,370,596

 
—

Securities available for sale
2,840,589

 
2,840,589

 
16,533

 
2,824,056

 
—

 
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
71,710

 
71,710

 
71,710

 
—

 
—

Mortgage loans
132,261

 
137,917

 
—

 
—

 
137,917

Policy loans
61,933

 
107,914

 
—

 
—

 
107,914

Other loans
2,598

 
2,773

 
—

 
—

 
2,773

Derivatives, index options
72,527

 
72,527

 
—

 
—

 
72,527

Short-term investments
—

 
—

 
—

 
—

 
—

Life interest in Trust
—

 
12,775

 
—

 
—

 
12,775

 
 
 
 
 
 
 
 
 
 
LIABILITIES
 
 
 
 
 
 
 
 
 
Deferred annuity contracts
$
7,597,966

 
7,215,118

 
—

 
—

 
7,215,118

Immediate annuity and supplemental contracts
439,889

 
467,034

 
—

 
—

 
467,034



44
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NATIONAL WESTERN LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

 
December 31, 2014
 
 
 
Fair Value Hierarchy Level
 
Carrying
Values
 
Fair
Values
 
Level 1
 
Level 2
 
Level 3
 
(In thousands)
ASSETS
 
 
 
 
 
 
 
 
 
Investments in debt and equity securities:
 
 
 
 
 
 
 
 
 
Securities held to maturity
$
6,841,543

 
7,175,443

 
—

 
7,175,443

 
—

Securities available for sale
2,728,680

 
2,728,680

 
16,862

 
2,711,818

 
—

 
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
277,078

 
277,078

 
277,078

 
—

 
—

Mortgage loans
149,503

 
156,548

 
—

 
—

 
156,548

Policy loans
63,645

 
111,040

 
—

 
—

 
111,040

Other loans
2,171

 
2,300

 
—

 
—

 
2,300

Derivatives, index options
114,287

 
114,287

 
—

 
—

 
114,287

Life interest in Trust
—

 
12,775

 
—

 
—

 
12,775

 
 
 
 
 
 
 
 
 
 
LIABILITIES
 
 
 
 
 
 
 
 
 
Deferred annuity contracts
$
7,546,504

 
7,178,535

 
—

 
—

 
7,178,535

Immediate annuity and supplemental contracts
446,458

 
474,843

 
—

 
—

 
474,843


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.


(11)
  DERIVATIVE INVESTMENTS

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 Sheet. 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.

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.


45
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NATIONAL WESTERN LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

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 tables below present the fair value of derivative instruments as of June 30, 2015 and December 31, 2014, respectively.

 
June 30, 2015
 
Asset Derivatives
 
Liability Derivatives
 
Balance
Sheet
Location
 
Fair
Value
 
Balance
Sheet
Location
 
Fair
Value
 
 
 
(In thousands)
 
 
 
(In thousands)
 
 
 
 
 
 
 
 
Derivatives not designated as hedging instruments
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Equity index options
Derivatives, Index Options
 
$
72,527

 
 
 
 
 
 
 
 
 
 
 
 
Fixed-index products
 
 
 
 
Universal Life and Annuity Contracts
 
$
88,109

 
 
 
 
 
 
 
 
Total
 
 
$
72,527

 
 
 
$
88,109


 
December 31, 2014
 
Asset Derivatives
 
Liability Derivatives
 
Balance
Sheet
Location
 
Fair
Value
 
Balance
Sheet
Location
 
Fair
Value
 
 
 
(In thousands)
 
 
 
(In thousands)
 
 
 
 
 
 
 
 
Derivatives not designated as hedging instruments
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Equity index options
Derivatives, Index Options
 
$
114,287

 
 
 
 
 
 
 
 

 
 
 
 
Fixed-index products
 
 
 

 
Universal Life and Annuity Contracts
 
$
133,236

 
 
 
 
 
 
 
 
Total
 
 
$
114,287

 
 
 
$
133,236



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Table of Contents

NATIONAL WESTERN LIFE INSURANCE COMPANY AND SUBSIDIARIES
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 June 30, 2015 and 2014.

 
 
 
 
June 30,
2015
 
June 30,
2014
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
 
$
(8,782
)
 
45,251

 
 
 
 
 
 
 
Fixed-index products
 
Universal life and annuity contract interest
 
8,840

 
(43,986
)
 
 
 
 
 
 
 
 
 
 
 
$
58

 
1,265


The table below presents the effect of derivative instruments in the Condensed Consolidated Statements of Earnings for the six months ended June 30, 2015 and 2014.

 
 
 
 
June 30,
2015
 
June 30,
2014
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
 
$
(17,069
)
 
45,799

 
 
 
 
 
 
 
Fixed-index products
 
Universal life and annuity contract interest
 
20,436

 
(44,970
)
 
 
 
 
 
 
 
 
 
 
 
$
3,367

 
829

 
 
 
 
 
 
 


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

FORWARD-LOOKING STATEMENTS

The Private Securities Litigation Reform Act of 1995 provides a “safe harbor” for forward-looking statements. Certain information contained herein or in other written or oral statements made by or on behalf of National Western Life Insurance Company or its subsidiaries are or may be viewed as forward-looking. Although the Company has taken appropriate care in developing any such information, forward-looking information involves risks and uncertainties that could significantly impact actual results. These risks and uncertainties include, but are not limited to, matters described in the Company's SEC filings such as exposure to market risks, anticipated cash flows or operating performance, future capital needs, and statutory or regulatory related issues. However, National Western, as a matter of policy, does not make any specific projections as to future earnings, nor does it endorse any projections regarding future performance that may be made by others. Whether or not actual results differ materially from forward-looking statements may depend on numerous foreseeable and unforeseeable events or developments. Also, the Company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future developments, or otherwise.


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Table of Contents

Management's discussion and analysis of the financial condition and results of operations (“MD&A”) of National Western Life Insurance Company for the three and six months ended June 30, 2015 follows. 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 2014 Annual Report filed on Form 10-K with the SEC.

Overview

The Company provides life insurance products on a global basis for the savings and protection needs of policyholders and annuity contracts for the asset accumulation and retirement needs of contract holders, both domestically and internationally. The Company 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.

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 business and profitability include the following:
•
the level of sales and premium revenues collected
•
persistency of policies and contracts
•
returns 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 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
•
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 reinsurance
•
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 six months ended June 30, 2015, incorporating required disclosures in accordance with the rules and regulations of the Securities and Exchange Commission.

Insurance Operations - Domestic

The Company is currently licensed to do business in all states and the District of Columbia except for New York. Products marketed are annuities, universal life insurance, fixed-index universal life, and traditional life insurance, which include both term and whole life products. The Company's domestic sales have historically been more heavily weighted toward annuity products, which include single and flexible premium deferred annuities, single premium immediate annuities, and fixed-index annuities. Most of these annuities can be sold as tax qualified or nonqualified products. At June 30, 2015, the Company maintained approximately 138,400 annuity contracts in force and 55,000 domestic life insurance policies in force representing $3.1 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. The Company's agents are independent contractors who are compensated on a commission basis. The Company currently has approximately 19,800 domestic independent agents contracted. Roughly 14% of these contracted agents have submitted policy applications to the Company in the past twelve months.


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Table of Contents

Insurance Operations - International

The Company's international clientèle consists mainly of foreign nationals in upper socioeconomic classes. Insurance products are issued primarily to residents of countries in Central and South America, the Caribbean, Eastern Europe, Asia and the Pacific Rim based upon applications received in the Company's home office in Austin, Texas. Issuing policies to residents of countries in these different regions provides diversification that helps to minimize large fluctuations that could arise due to various economic, political, and competitive pressures that may occur from one country to another. Products issued to international residents are almost entirely universal life and traditional life insurance products. However, certain annuity and investment contracts are also available. At June 30, 2015, the Company had approximately 70,000 international life insurance policies in force representing approximately $19.8 billion in face amount of coverage.

International applications are submitted by independent contractor consultants and broker-agents. The Company has approximately 2,400 independent international consultants and brokers currently contracted, 42% of which have submitted policy applications to the Company in the past twelve months.

There are some inherent risks of accepting international applications, which are not present within the domestic market, that are reduced substantially by the Company in several ways. As previously described, the Company accepts applications from foreign nationals in upper socioeconomic classes who have substantial financial resources. This targeted customer base coupled with the Company's conservative underwriting practices have historically resulted in claims experience, due to natural causes, similar to that in the United States. The Company minimizes exposure to foreign currency risks by requiring payment of premiums, claims and other benefits almost entirely in United States dollars. The Company's fifty plus years of experience with the international products and its longstanding independent consultant and broker-agent relationships further serve to minimize risks.

SALES

Life Insurance

The following table sets forth information regarding the Company's life insurance sales activity as measured by annualized first year premiums. 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 a leading 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
 
Six Months Ended
 
June 30,
 
June 30,
 
2015
 
2014
 
2015
 
2014
 
(In thousands)
 
 
 
 
 
 
 
 
International:
 
 
 
 
 
 
 
Universal life
$
742

 
1,045

 
1,427

 
2,200

Traditional life
656

 
905

 
1,493

 
1,870

Equity-index life
4,077

 
3,109

 
7,241

 
6,542

 
 
 
 
 
 
 
 
 
5,475

 
5,059

 
10,161

 
10,612

Domestic:
 

 
 

 
 

 
 

Universal life
16

 
56

 
34

 
66

Traditional life
(8
)
 
43

 
91

 
82

Equity-index life
4,903

 
4,344

 
8,894

 
7,791

 
 
 
 
 
 
 
 
 
4,911

 
4,443

 
9,019

 
7,939

 
 
 
 
 
 
 
 
Totals
$
10,386

 
9,502

 
19,180

 
18,551



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Table of Contents

Life insurance sales, as measured by annualized first year premiums, increased 9% in the second quarter of 2015 as compared to the second quarter of 2014. By market segment, the domestic life insurance line of business posted an 11% increase over the comparable results during the second quarter of 2014 while international life sales increased 8% during the same time frame. For the six months ended June 30, 2015 total life sales increased over 2014 levels by 3% as domestic life insurance sales increased 14% during this period and international life insurance sales declined 4%.

Equity-index universal life products continue to be the predominant product sold in the domestic life market. 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). The Company began offering graded death benefit whole life and term insurance (traditional) products on a trial basis through a contracted distributor and intends to make these products available to all contracted agents by the third quarter of 2015.

The Company's international life business consists of applications accepted from residents of various regions outside of the United States, the volume of which typically varies based upon changes in the socioeconomic climates of these regions. Historically, the Company has experienced a simultaneous combination of rising and declining sales in various countries; however, the appeal of the Company's dollar-denominated life insurance products overcomes many of the local and national difficulties.

Applications submitted from residents of Latin America and the Pacific Rim perennially have historically comprised the majority of the Company's international life insurance sales. As noted previously, the Company's international sales by geographic market tend to fluctuate with the socio and economic climates in these regions. The Company's mix of international sales by geographic region is as follows.

 
Six Months Ended June 30,
 
2015
 
2014
 
 
 
 
Percentage of International Sales:
 
 
 
Latin America
86.7
%
 
84.9
%
Pacific Rim
10.2

 
10.5

Eastern Europe
3.1

 
4.6

 
 
 
 
Totals
100.0
%
 
100.0
%

Year-to-date, the Company has accepted new business from residents outside of the United States in over thirty different countries with Venezuela (22%), Peru (17%), and Brazil (12%) comprising the regions with contributions greater than 10% of total international sales. Sales to residents of Venezuela and Peru increased in the first six months of 2015 compared to the same period in 2014 while sales to residents of Brazil declined during the same period.

The Company's domestic operations life product portfolio include 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. These life insurance products were designed to facilitate the wealth transfer of accumulated savings of the Baby Boomer segment of the population entering their retirement years, via systematic funding mechanisms such as single premium immediate annuities. The wealth transfer life products have been valuable offerings for the Company's distributors as evidenced by comprising nearly 99% of total domestic life sales in the first six months of 2015.


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Table of Contents

The Company's domestic life product portfolio including the wealth transfer products has gradually increased the average new policy face amount since the Company implemented commission caps on domestic policies in 2009 as shown in the following table.

 
Average New Policy Face Amount
 
Domestic
 
International
 
 
 
 
Year ended December 31, 2009
201,400

 
315,300

Year ended December 31, 2010
164,800

 
338,600

Year ended December 31, 2011
178,500

 
363,600

Year ended December 31, 2012
254,900

 
380,200

Year ended December 31, 2013
286,000

 
384,000

Year ended December 31, 2014
286,600

 
382,600

Six months ended June 30, 2015
276,500

 
354,000


The Company's efforts are directed toward maintaining its competitive advantages in accepting applications from upper socio-economic residents of international countries and to its wealth transfer strategies for domestic life sales. In both of these strategies the Company's portfolio of fixed-index (equity indexed) life insurance products plays an important role. Fixed-index life products accounted for 84% of total life sales in the first six months of 2015, as compared to 77% for the same period in 2014.

The table below sets forth information regarding the Company's life insurance in force for each date presented.

 
Insurance In Force as of
 
June 30,
 
2015
 
2014
 
($ in thousands)
 
 
 
 
Universal life:
 
 
 
Number of policies
49,330

 
52,470

Face amounts
$
6,388,970

 
6,924,620

 
 
 
 
Traditional life:
 
 
 

Number of policies
36,490

 
38,130

Face amounts
$
3,623,850

 
3,515,490

 
 
 
 
Fixed-index life:
 
 
 

Number of policies
39,220

 
37,050

Face amounts
$
9,824,820

 
9,261,500

 
 
 
 
Rider face amounts
$
3,066,080

 
2,827,290

 
 
 
 
Total life insurance:
 
 
 

Number of policies
125,040

 
127,650

Face amounts
$
22,903,720

 
22,528,900


At June 30, 2015, the Company’s face amount of life insurance in force was comprised of $19.8 billion from the international line of business and $3.1 billion from the domestic line of business. At June 30, 2014, these amounts were $19.6 billion and $2.9 billion for the international and domestic lines of business, respectively.


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Table of Contents

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.

 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2015
 
2014
 
2015
 
2014
 
(In thousands)
 
 
 
 
 
 
 
 
Fixed-index annuities
$
183,140

 
198,326

 
337,502

 
352,888

Other deferred annuities
17,035

 
19,969

 
29,913

 
32,962

Immediate annuities
1,060

 
2,057

 
2,017

 
4,717

 
 
 
 
 
 
 
 
Totals
$
201,235

 
220,352

 
369,432

 
390,567


Annuity sales in the second quarter of 2015 were 9% lower than in the second quarter of 2014 and were 5% lower for the six months ended June 30th. Annuity sales in the first six months of 2015 are generally in line with the Company's projected sales goal for the year of $800 million. Approximately 74% of the annuity premium submitted as of June 30, 2015 is comprised of "1035 Exchange" business. This refers to the Internal Revenue Code section that allows the tax-deferred inside build-up on certain insurance and financial products to transfer from one product to another intact (i.e. does not trigger a current tax event). With this type of sale, the Company must pursue collection of identified funds held by other financial institutions in order to place the policy in force. There are inherent delays in collecting 1035 Exchange funds from other financial institutions. With a significant portion of the Company's annuity sales emanating from these fund sources, a backlog of future sales awaiting collection of 1035 Exchange proceeds existed at the end of the second quarter.

The recessionary contraction and financial market crisis that began in the latter half of 2007 and persisted into 2009 impacted many annuity carriers. Losses from investment impairments and equity exposure (for insurers with variable annuity product offerings) crippled the capital position of numerous companies and limited their ability to write new business. In contrast, the Company's substantial capital position attained through profitable operations and limited investment loss exposure positioned it to write additional levels of annuity business. During 2010 and 2011, the Company sold approximately $1.4 billion of annuity products per year indicative of the Company's enhanced competitive position in the marketplace.

Under the auspices of the Company's enterprise risk management (ERM) processes, in 2012 Company management evaluated the potential ramifications of continuing a high level of annuity sales in the depressed interest rate environment precipitated by the "quantitative easing" programs enacted by the Federal Reserve and the European debt crisis. Taken into consideration was the Federal Reserve's ongoing announced intention to maintain interest rates at historically reduced levels over several years. While the Company does not subsidize its interest crediting rates on new policies in order to obtain market share, the Company's ERM considerations determined that managing to a lower level of annuity sales was prudent given the environment.

The Company's mix of annuity sales have historically shifted with interest rate levels and the relative performance of the equity market. Over the past several years, sales of fixed-index products have accounted for 60% to 90% of all annuity sales. During the first six months of 2015 this percentage reached 91% reflecting the ongoing bull market run in equities since bottoming out in 2009 and the persisting low level of fixed interest rates. 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.

The level of annuity business in force requires a focused discipline on asset/liability analysis. The Company monitors its asset/liability matching within the self-constraints of desired capital levels and risk tolerance. Despite the amounts of new business generated over the past several years, the Company's capital level remains substantially above industry averages and regulatory targets. Management has performed analyses of the capital strain associated with incrementally higher levels of annuity new business and determined that the Company's capital position is more than sufficient to handle increased sales activity.


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Table of Contents

The following table sets forth information regarding annuities in force for each date presented.

 
Annuities In Force as of
 
June 30,
 
2015
 
2014
 
($ in thousands)
 
 
 
 
Fixed-index annuities
 
 
 
Number of policies
70,800

 
66,550

GAAP annuity reserves
$
5,370,138

 
4,997,973

 
 
 
 
Other deferred annuities
 
 
 

Number of policies
52,310

 
56,340

GAAP annuity reserves
$
2,181,772

 
2,372,493

 
 
 
 
Immediate annuities
 
 
 

Number of policies
15,290

 
16,440

GAAP annuity reserves
$
362,898

 
369,030

 
 
 
 
Total annuities
 
 
 

Number of policies
138,400

 
139,330

GAAP annuity reserves
$
7,914,808

 
7,739,496


Impact of Recent Business Environment

The Company's business is generally aided by an economic environment undergoing expansion, whether moderate or vibrant. Conversely, a muted economic recovery could adversely impact the demand for the Company's products. After a first quarter of substandard U.S. GDP growth, subsequent financial data has been generally supportive of a modestly growing domestic economy. However, the economic indicators still offer a mixture of positive and negative signals. U.S. employers added to job growth at a healthy pace in the second quarter which helped to buoy consumer confidence and the housing market. Conversely, corporate earnings continue to moderate in part due to a strong U.S. dollar which causes business overseas to be more expensive for American companies. Additional global concerns muddying the waters include ongoing instability in the Middle East, fears of a Greek exit from the Euro, and a perceived contraction in the Chinese economy.

With positive trends remaining somewhat underwhelming a good level of uncertainty remains as to how much longer the Federal Reserve will choose to hold short-term interest rates near zero percent. The Federal Reserve continued to hold interest rates at historically low levels during the second quarter, although Federal officials estimated modest rate hikes by year end 2015. This uncertainty, like others, introduces additional volatility to financial markets which in turn influences consumer spending and savings behavior.
  
Industry analysts and observers generally agree that a sudden jump in interest rate levels would be harmful to life insurers with interest-sensitive products as it could provide an impetus for abnormal levels of product surrenders and withdrawals at the same time fixed debt securities held by insurers declined in market value. It is generally held that a move up to 100 basis points would not be sufficient to drive the policyholder behavior in this direction. However, a relatively quick expansion of 200 to 300 basis points in rates may increase the potential for incremental policy lapses. Observers of credit markets anticipate an eventual rise in yields and speculate as to what the timing and rate of increase may be. Sentiment at the present time is that the conditions for a sudden increase in rates are not evident or on the near-term horizon. Irrespective, it is uncertain what direction and at what pace interest rate movements may occur in the future and what impact, if any, such movements would have on the Company's business, results of operations, cash flows or financial condition.


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Table of Contents

Our operating strategy continues to be to maintain capital levels substantially above regulatory and rating agency requirements. Our business model is predicated upon steady growth in invested assets while managing the block of business within profitability objectives. A key premise of our financial management is maintaining a high quality investment portfolio, well matched in terms of duration with the Company's policyholder obligations, that continues to outperform the industry with respect to adverse impairment experience. This discipline enables the Company to sustain resources more than adequate to fund future growth and absorb abnormal periods of cash outflows.


RESULTS OF OPERATIONS

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

Revenues.  The following details Company revenues.

 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2015
 
2014
 
2015
 
2014
 
(In thousands)
 
 
 
 
 
 
 
 
Universal life and annuity contract charges
$
38,345

 
38,217

 
75,658

 
76,222

Traditional life premiums
5,162

 
5,169

 
9,509

 
9,440

Net investment income (excluding derivatives)
111,041

 
109,928

 
219,251

 
217,831

Other revenues
5,194

 
5,211

 
10,523

 
10,974

 
 
 
 
 
 
 
 
Operating revenues
159,742

 
158,525

 
314,941

 
314,467

Derivative gain (loss)
(8,782
)
 
45,251

 
(17,069
)
 
45,799

Net realized investment gains (losses)
4,258

 
3,065

 
5,236

 
4,578

 
 
 
 
 
 
 
 
Total revenues
$
155,218

 
206,841

 
303,108

 
364,844



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Table of Contents

Universal life and annuity contract charges - Revenues for universal life and annuity contracts were slightly lower for the first six months in 2015 compared to 2014 primarily due to a decrease in surrender charge fees recognized. Revenues for universal life and annuity products consist of policy charges for the cost of insurance, administration charges, and surrender charges assessed against policyholder account balances, less reinsurance premiums, as shown in the following table.

 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2015
 
2014
 
2015
 
2014
 
(In thousands)
 
 
 
 
 
 
 
 
Contract Revenues:
 
 
 
 
 
 
 
Cost of insurance and administrative charges
$
33,239

 
31,813

 
66,243

 
63,554

Surrender charges
9,778

 
11,146

 
18,725

 
21,036

Other charges
(1,080
)
 
(1,160
)
 
(1,802
)
 
(857
)
Gross contract revenues
41,937

 
41,799

 
83,166

 
83,733

 
 
 
 
 
 
 
 
Reinsurance premiums
(3,592
)
 
(3,582
)
 
(7,508
)
 
(7,511
)
 
 
 
 
 
 
 
 
Net contract revenues
$
38,345

 
38,217

 
75,658

 
76,222


Cost of insurance charges typically trend with the size of the life insurance block in force and the amount of new business issued during the period. Life insurance in force during the six months ended June 30, 2015 averaged approximately $23.0 billion while for the same period of 2014 averaged $22.5 billion. Accordingly, for the six months ended June 30, 2015, cost of insurance charges increased to $52.3 million from $50.5 million at June 30, 2014. For the second quarter ended June 30th, cost of insurance charges recognized increased to $26.1 million in 2015 from $25.2 million in the same period of 2014. Administrative charges pertaining to new business issued increased to $13.9 million from $13.1 million for the six months ended June 30, 2015 versus June 30, 2014 primarily due to a 20% increase in domestic life insurance policies issued. For the three months ended June 30, 2015 and 2014, administrative charges from new business issued were $7.1 million and $6.6 million, respectively.

Surrender charges assessed against policyholder account balances upon withdrawal declined 11% in the first six months of 2015 versus the comparable prior year period. 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, additional contract revenues are realized and the Company continues to make an interest rate spread on outstanding policyholder account balances (the difference between what is earned on invested assets and the amount credited to policyholders). In the first six months of 2015, lapse rates on life insurance and annuity policies were consistent with the prior year. The decrease in surrender charge income recognized in the current quarter reflects a change in the duration of policies at the time of surrender with later duration policy surrenders having a lower surrender charge assessed.

Traditional life and annuity premiums - Traditional life and annuity premiums were generally level in the first six months of 2015 compared to the same period in 2014. Traditional life insurance premiums for products such as whole life and term life are recognized as revenues over the premium-paying period. The Company began offering graded death benefit whole life and term products in its domestic markets during 2014 and is in the process of expanding the availability of this portfolio of products to contracted producers. The Company's life insurance sales focus has historically been primarily centered around universal life products. Universal life products, especially the Company'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 such as the S&P 500 Index®, have been more popular product offerings in the Company's markets.


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Table of Contents

Net investment income - To ensure the Company will be able to honor future commitments to policyholders and provide a financial return, the funds received as premium payments and deposits are invested in high quality investments, primarily fixed maturity debt securities. The income from these investments is closely monitored by the Company due to its significant impact on the business. A detail of net investment income (with and without index option gains and losses) is provided below.

 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2015
 
2014
 
2015
 
2014
 
(In thousands)
 
 
 
 
 
 
 
 
 
 
 
 
Gross investment income:
 
 
 
 
 
 
 
Debt securities
$
104,160

 
102,688

 
207,387

 
205,209

Mortgage loans
2,150

 
2,418

 
4,856

 
4,711

Policy loans
998

 
1,055

 
1,950

 
2,138

Short-term investments
46

 
76

 
155

 
121

Other invested assets
3,938

 
3,956

 
5,456

 
6,234

 
 
 
 
 
 
 
 
Total investment income
111,292

 
110,193

 
219,804

 
218,413

Less: investment expenses
251

 
265

 
553

 
582

 
 
 
 
 
 
 
 
Net investment income (excluding derivatives)
111,041

 
109,928

 
219,251

 
217,831

Derivative gain (loss)
(8,782
)
 
45,251

 
(17,069
)
 
45,799

 
 
 
 
 
 
 
 
Net investment income
$
102,259

 
155,179

 
202,182

 
263,630


For the six months ended June 30, 2015, debt securities generated approximately 95% of total investment income, excluding derivative gain (loss). The stable level of investment income from debt securities through the second quarter of 2015 versus 2014 despite higher portfolio balances in the current period reflects higher yielding debt securities maturing or being called by borrowers and being replaced with lower yielding securities in the current interest rate environment. Investment yields on new bond purchases during the first six months of 2015 remained below the portfolio's weighted average yield. Mortgage loan investment income for the six months ended June 30, 2015 increased over the comparable period in 2014 reflecting incremental new loan volume and profit participation receipts in the current year. The Company's new mortgage loan activity has been relatively low by historical standards in recent years given the low level of rates and the higher level of risk associated with commercial properties in the current economic environment. During the six months ended June 30, 2015 the Company originated new mortgage loans in the amount of $1.6 million.


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In order to evaluate underlying profitability and results from ongoing operations, net investment income performance is analyzed excluding derivative gain (loss), which is a common practice in the insurance industry.  Net investment income performance is summarized as follows.

 
Six Months Ended June 30,
 
2015
 
2014
 
(In thousands)
 
 
 
 
Excluding derivatives:
 
 
 
Net investment income
$
219,251

 
217,831

Average invested assets, at amortized cost
$
10,044,392

 
9,512,513

Annual yield on average invested assets
4.37
%
 
4.58
%
 
 
 
 
Including derivatives:
 

 
 

Net investment income
$
202,182

 
263,630

Average invested assets, at amortized cost
$
10,137,799

 
9,670,426

Annual yield on average invested assets
3.99
%
 
5.45
%

The lower yield on average invested assets, excluding derivatives, through the second quarter of 2015 compared to 2014 is due to lower yields obtained on new fixed maturity debt securities investments. During 2014, the average yield on bond purchases to fund insurance operations was 3.68% representing a 1.12% spread over treasury rates. Insurance operation bond purchases through the second quarter of 2015 had an average yield of 3.36% with spreads increasing slightly to 1.26% over treasury rates. The yield rates during both 2014 and 2015 are below the weighted average bond portfolio rate which approximated 4.3% at June 30, 2015. The weighted average quality of new purchases during the first six months was "A-", which was the same as the overall quality rating of purchases during 2014. The composite duration of purchases during the first six months of 2015 matched that for 2014 purchases. The Company's general investment strategy is to purchase securities with maturity dates approximating ten years in the future. Accordingly, an appropriate measure for benchmarking the direction of interest rate levels for the Company's debt security purchases is the ten year treasury bond rate. After ending 2014 at a rate of 2.17%, the daily closing yield of the ten year treasury bond ranged from a low of approximately 1.65% to a high of 2.50% during the first six months of 2015, and ended the second calendar quarter at 2.35%.

Other revenues - Other revenues primarily pertain to the Company's two nursing home operations in Reno, Nevada and San Marcos, Texas. Revenues associated with these operations were $10.4 million and $10.6 million for the six months ended June 30, 2015 and 2014, respectively. Lower nursing home revenues reflect lower census figures at the facilities thus far in 2015.

Derivative gain (loss) - Index options are derivative financial instruments used to hedge the equity return component of the Company'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 also reflected as a component of net investment income.


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Gains and losses from index options are 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. For the quarter ended June 30, 2015, the reference indices decreased and the Company recorded an overall loss from index options with substantially a corresponding decrease in contract interest expense during this period.

 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2015
 
2014
 
2015
 
2014
 
(In thousands)
 
 
 
 
 
 
 
 
Derivatives:
 
 
 
 
 
 
 
Unrealized gain (loss)
$
(26,701
)
 
9,872

 
(48,119
)
 
(28,226
)
Realized gain (loss)
17,919

 
35,379

 
31,050

 
74,025

 
 
 
 
 
 
 
 
Total gain (loss) included in net investment income
$
(8,782
)
 
45,251

 
(17,069
)
 
45,799

 
 
 
 
 
 
 
 
Total contract interest
$
49,431

 
102,429

 
98,470

 
165,365


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. Rather, the Company's profitability with respect to these options is dependent upon the purchase cost of the option remaining within the financial budget for purchasing 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 within the product pricing budgets.

Net realized investment gains (losses) - Realized gains on investments in 2015 primarily resulted from bond calls and sales. The net gains reported for the six months ended June 30, 2015 consisted of gross gains of $5.4 million offset by gross losses of $0.2 million. Other-than-temporary impairment losses of $0.1 million were recorded during the six months ended June 30, 2015.

The Company records impairment write-downs when a decline in value is considered to be other-than-temporary and full recovery of the investment is not expected. Impairments due to credit factors are recorded in the Company's Condensed Consolidated Statements of Earnings while non-credit (liquidity) impairment losses are included in other specific statement comprehensive income (loss). Impairment and valuation write-downs reflected in the Company's Condensed Consolidated Statements of Earnings are summarized in the following table.

 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2015
 
2014
 
2015
 
2014
 
(In thousands)
 
 
 
 
 
 
 
 
Impairment or valuation write-downs:
 
 
 
 
 
 
 
Bonds
$
—

 
—

 
—

 
7

Equities
107

 
—

 
107

 
28

 
 
 
 
 
 
 
 
Total
$
107

 
—

 
107

 
35


As shown in the table above, the Company recognized minimal impairments during the first six months of 2015 and 2014. Equity securities (common stocks) represent 0.1% of invested assets and individual common stock holdings have an average cost basis of approximately $42,000.


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Benefits and Expenses.  The following table details benefits and expenses.

 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2015
 
2014
 
2015
 
2014
 
(In thousands)
 
 
 
 
 
 
 
 
Life and other policy benefits
$
16,120

 
14,796

 
35,386

 
27,759

Amortization of deferred policy acquisition costs
28,070

 
27,258

 
55,722

 
55,837

Universal life and annuity contract interest
49,431

 
102,429

 
98,470

 
165,365

Other operating expenses
18,802

 
19,500

 
39,312

 
42,963

 
 
 
 
 
 
 
 
Totals
$
112,423

 
163,983

 
228,890

 
291,924


Life and other policy benefits - Death claim benefits, the largest component of policy benefits, increased to $21.5 million year-to-date in 2015 compared to $17.3 million for the first six months of 2014. For the three months ended June 30, 2015 and 2014, death claim benefits were $8.5 million and $9.6 million, respectively. Death claim amounts are generally subject to variation from period to period and the Company's mortality experience has generally been consistent with or better than its product pricing assumptions.

Amortization of deferred policy acquisition costs - Life insurance companies are required to defer certain expenses that vary with, and are primarily related to, the cost of acquiring new business. The majority of these acquisition expenses consist of commissions paid to agents, underwriting costs, and certain marketing expenses. Recognition of these deferred policy acquisition costs (“DPAC”) as an expense in the condensed consolidated financial statements occurs over future periods in relation to the expected emergence of profits priced into the products sold. This emergence of profits is based upon assumptions regarding premium payment patterns, mortality, persistency, investment performance, and expense patterns. Companies are required to review universal life and annuity contract assumptions periodically to ascertain whether actual experience has deviated significantly from that assumed. If it is determined that a significant deviation has occurred, the emergence of profits pattern is to be "unlocked" and reset based upon the actual experience. DPAC balances are also adjusted each period to reflect current policy lapse or termination rates, expense levels and credited rates on policies compared to anticipated experience (“true-up”) with the adjustment reflected in current period amortization expense. 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 following table identifies the effects of unlocking and true-up adjustments on DPAC balances recorded through amortization expense for the three and six months ended June 30, 2015 and 2014.

Increase (Decrease) in DPAC Balance
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2015
 
2014
 
2015
 
2014
 
(In thousands)
 
 
 
 
 
 
 
 
Unlocking
$
—

 
—

 
1,810

 
—

True-up
4,100

 
208

 
5,520

 
4,098

 
 
 
 
 
 
 
 
Totals
$
4,100

 
208

 
7,330

 
4,098


True-up adjustments were recorded in 2015 and 2014 relative to partial surrender rates, mortality rates, credited interest rates and earned rates for the current year's experience. In the second quarter, true-up adjustments resulted in a $4.1 million decrease in amortization expense for 2015 and a $0.2 million decrease for 2014. These adjustments further produced a $5.5 million decrease in amortization expense for the six months ended June 30, 2015, and a $4.1 million decrease for the six months ended June 30, 2014. The true-up adjustments for the life insurance lines of business were positive (decrease to amortization expense) by $9.7 million in the first six months of 2015 whereas the true-up adjustments for the annuity line of business during the same period were negative by $4.2 million incrementally adding to amortization expense. For the six months ended June 30, 2014, true-up adjustments for the life insurance lines of business were positive (decrease to amortization expense) by $8.0 million while true-up adjustments for the annuity line of business increased amortization expense by approximately $3.9 million.


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No unlocking adjustments were made by the Company in the first six months of 2014. In the six months ended June 30, 2015, the Company unlocked the DPAC balance associated with its International Life segment for favorable mortality experience on one of its universal life products. The effect of the prospective unlocking was to increase DPAC balances by $7.1 million (and decrease amortization expense). In addition, the Company unlocked the DPAC balance associated with its annuity segment for future expense assumptions pertaining to product development override costs (trailer commissions) which it is obligated to pay certain contracted National Marketing Organizations. The effect of the prospective unlocking was to decrease DPAC balances by $5.3 million (and increase amortization expense). While the Company is required to evaluate its emergence of profits continually, management believes that the current amortization patterns of deferred policy acquisition costs, incorporating these unlocking adjustments, are reflective of actual experience.

Universal life and annuity contract interest - The Company closely monitors its credited interest rates on interest sensitive policies, 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 as described above. The difference between yields earned on investments over policy credited rates is often referred to as the "interest spread".

The Company's approximated average credited rates through the first six months, excluding and including fixed-index (derivative) products, were as follows:

 
June 30,
 
June 30,
 
2015
 
2014
 
2015
 
2014
 
(Excluding fixed-index products)
 
(Including fixed-index products)
 
 
 
 
 
 
 
 
Annuity
2.47
%
 
2.52
%
 
1.84
%
 
3.29
%
Interest sensitive life
3.73
%
 
3.79
%
 
3.52
%
 
6.16
%

Contract interest including fixed-index products also encompasses the performance of the index options associated with the Company's fixed-index products. As previously noted, the market performance of these derivative features resulted in net realized and unrealized gains/(losses) of $(8.8) million and $45.3 million for the quarters ended June 30, 2015 and 2014, respectively.

Similar to deferred policy acquisition costs, the Company defers sales inducements in the form of first year credited interest bonuses on annuity products that are directly related to the production of new business. These bonus interest charges are deferred and amortized using the same methodology and assumptions used to amortize other capitalized acquisition costs and the amortization is included in contract interest. In addition, deferred sales inducement balances are also reviewed periodically to ascertain whether actual experience has deviated significantly from that assumed (unlock) and are adjusted to reflect current policy lapse or termination rates, expense levels and credited rates on policies compared to anticipated experience (true-up). These adjustments, plus or minus, are included in contract interest expense. For the six months ended June 30, 2015 and 2014, the Company recorded true-up adjustments of its deferred sales inducement balances resulting in increased (decreased) balance sheet amounts of $(1.1) million and $(0.8) million, respectively, which thereby (increased) decreased contract interest expense by a like amount. For the quarter ended June 30th, the true-up adjustments recorded were $(0.6) million and $(1.0) million in 2015 and 2014, respectively.

The Company also unlocked its deferred sales inducement balance in the first six months of 2015 associated with its annuity segment for future expense assumptions pertaining to product development override costs as previously discussed. The effect of the prospective unlocking was to decrease the deferred sales inducement balance by $1.8 million which increased contract interest expense by the same amount. No unlocking adjustments were made in the first six months of 2014.


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Other operating expenses - Other operating expenses consist of general administrative expenses, licenses and fees, commissions not subject to deferral, nursing home expenses and compensation costs. These expenses for the six months ended June 30, 2015 and 2014 are summarized in the table that follows.

 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2015
 
2014
 
2015
 
2014
 
(In thousands)
 
 
 
 
 
 
 
 
General insurance expenses
$
4,718

 
3,490

 
11,911

 
9,715

Nursing home expenses
4,714

 
4,849

 
9,409

 
9,912

Compensation expenses
4,688

 
6,356

 
9,185

 
14,380

Commission expenses
2,958

 
2,661

 
5,704

 
5,281

Taxes, licenses and fees
1,724

 
2,144

 
3,103

 
3,675

 
 
 
 
 
 
 
 
Totals
$
18,802

 
19,500

 
39,312

 
42,963


General insurance expenses include reserve provisions for potentially uncollectible receivable balances from independent contractor agents. Receivable balances from agents typically result from reversing commission balances previously paid on policies in which the policyholder subsequently exercised the right to cancel the policy under the policy contract's "free look" provision. During the first six months of 2015, the reserve balance for agent receivables was increased by $0.9 million while in the first six months of 2014 the reserve balance was decreased $0.1 million. The amounts for the three and six months ended June 30, 2014 also include a recoupment of $1.0 million previously paid on a prior lawsuit settlement.

Nursing home expenses reflect the operations of the two facilities owned by the Company. Expenses during 2015 have decreased as a result of discontinuing higher acuity services at the homes. The decline in expenses as a result of discontinuing these services has similarly decreased the revenue associated with these operations.

Compensation expenses include share-based compensation costs for the Company’s stock option plans related to outstanding vested and nonvested stock and SARs options. These costs move in tandem with the number of stock options outstanding as well as the market price of the Company's Class A common share as a result of marking the stock options to fair value under the liability method of accounting. Consequently, the related expense amount varies positively or negatively in any given period. For the three months ended June 30, 2015 share based compensation expense was $(0.8) million while for the comparable period in 2014 share based compensation expense was $0.8 million. For the six months ended June 30, 2015 share based compensation expense was $(1.6) million while for the comparable period in 2014 share based compensation expense was $2.5 million. In addition to the Company's closing stock price dropping from $269.25 at December 31, 2014 to $239.49 at June 30, 2015, compensation costs related to share-based compensation declined during the six months ended June 30, 2015 compared to the same period in 2014 due to a lesser number of outstanding options as a result of stock option exercises and forfeitures between June 30, 2014 and June 30, 2015.

Taxes, licenses and fees include premium taxes and licensing fees paid to state insurance departments, guaranty fund assessments, the company portion of social security and Medicare taxes, and other state and municipal taxes. For the six months ended June 30, 2015 these amounts decreased from the comparable period in 2014 largely due to lower licensing fees paid to state insurance departments which were $0.5 million in the current year compared to $0.8 million in the prior year.

Federal Income Taxes. Federal income taxes on earnings from operations reflect an effective tax rate of 32.4% for the six months ended June 30, 2015 compared to 32.8% for the six months ended June 30, 2014. The Company's effective tax rate is typically lower than the Federal rate of 35% due to tax-exempt investment income related to municipal securities and dividends-received deductions on income from stocks.



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Segment Operations

Summary of Segment Earnings
A summary of segment earnings for the three and six months ended June 30, 2015 and 2014 is provided below. The segment earnings exclude realized gains and losses on investments, net of taxes.

 
Domestic
Life
Insurance
 
International
Life
Insurance
 
Annuities
 
All
Others
 
Totals
 
(In thousands)
 
 
 
 
 
 
 
 
 
 
Segment earnings (losses):
 
 
 
 
 
 
 
 
 
Three months ended:
 
 
 
 
 
 
 
 
 
June 30, 2015
$
997

 
10,303

 
10,420

 
4,371

 
26,091

June 30, 2014
$
1,766

 
10,701

 
11,289

 
3,435

 
27,191

 
 
 
 
 
 
 
 
 
 
Six months ended:
 
 
 
 
 
 
 
 
 

June 30, 2015
$
(1,232
)
 
24,184

 
15,771

 
8,058

 
46,781

June 30, 2014
$
1,891

 
17,999

 
19,252

 
6,891

 
46,033


Domestic Life Insurance Operations

A comparative analysis of results of operations for the Company's domestic life insurance segment is detailed below.

 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2015
 
2014
 
2015
 
2014
 
(In thousands)
 
 
 
 
 
 
 
 
Premiums and other revenues:
 
 
 
 
 
 
 
Premiums and contract charges
$
7,937

 
7,065

 
14,424

 
15,230

Net investment income
8,005

 
10,902

 
15,170

 
17,185

Other revenues
4

 
3

 
20

 
21

 
 
 
 
 
 
 
 
Total revenues
15,946

 
17,970

 
29,614

 
32,436

 
 
 
 
 
 
 
 
Benefits and expenses:
 

 
 

 
 

 
 

Life and other policy benefits
3,882

 
1,423

 
8,995

 
3,915

Amortization of deferred policy acquisition costs
1,698

 
1,780

 
4,879

 
4,180

Universal life insurance contract interest
5,460

 
8,158

 
10,399

 
13,263

Other operating expenses
3,442

 
3,992

 
7,157

 
8,271

 
 
 
 
 
 
 
 
Total benefits and expenses
14,482

 
15,353

 
31,430

 
29,629

 
 
 
 
 
 
 
 
Segment earnings (loss) before Federal income taxes
1,464

 
2,617

 
(1,816
)
 
2,807

Provision (benefit) for Federal income taxes
467

 
851

 
(584
)
 
916

 
 
 
 
 
 
 
 
Segment earnings (loss)
$
997

 
1,766

 
(1,232
)
 
1,891


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Table of Contents

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.

 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2015
 
2014
 
2015
 
2014
 
(In thousands)
 
 
 
 
 
 
 
 
Universal life insurance revenues
$
7,207

 
8,321

 
14,404

 
15,970

Traditional life insurance premiums
2,464

 
84

 
3,447

 
2,307

Reinsurance premiums
(1,734
)
 
(1,340
)
 
(3,427
)
 
(3,047
)
 
 
 
 
 
 
 
 
Totals
$
7,937

 
7,065

 
14,424

 
15,230


The Company's domestic life insurance in force in terms of policy counts has been declining for several years resulting in lower universal life contract revenue charges. The pace of new policies issued has lagged the number of policies terminated from death or surrender by roughly a two-to-one rate over the past couple of years causing a declining level of insurance in force from which contract charge revenue is received. Consequently, the number of domestic life insurance policies in force has declined from 57,700 at December 31, 2013 to 55,700 at December 31, 2014, and to 55,000 at June 30, 2015. 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. Revenues associated with issuing new business are typically greater than that realized in a renewal period for in force policies. The number of domestic life policies issued in the first six months of 2015 was 20% higher than in the comparable period for 2014 and the volume of insurance issued was 19% greater than that in 2014.

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 June 30,
 
Six Months Ended June 30,
 
2015
 
2014
 
2015
 
2014
 
(In thousands)
 
 
 
 
 
 
 
 
Universal life insurance:
 
 
 
 
 
 
 
First year and single premiums
$
34,250

 
28,629

 
60,729

 
52,159

Renewal premiums
5,426

 
5,133

 
10,487

 
9,906

 
 
 
 
 
 
 
 
Totals
$
39,676

 
33,762

 
71,216

 
62,065


During the past couple of years the Company has achieved some success in growing its domestic life insurance business with the number of new policies issued trending higher. Sales have been substantially weighted toward single premium policies which do not have recurring premium payments. These products are targeting 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 not been exhibiting a corresponding level of increase.

Net investment income for this segment of business has been gradually increasing due to the increased new business activity described above and a higher level of investments needed to support the corresponding growth in policy obligations. The increase in net investment income has been partially muted by lower investment yields from debt security investment purchases during this time frame. Net investment income also includes the gains and losses on index options purchased to back the index crediting mechanism on fixed-index universal products.


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Table of Contents

A detail of net investment income for domestic life insurance operations is provided below.

 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2015
 
2014
 
2015
 
2014
 
(In thousands)
 
 
 
 
 
 
 
 
Net investment income (excluding derivatives)
$
8,117

 
7,819

 
15,267

 
13,358

Derivative gain (loss)
(112
)
 
3,083

 
(97
)
 
3,827

 
 
 
 
 
 
 
 
Net investment income
$
8,005

 
10,902

 
15,170

 
17,185


Life and policy benefits for a smaller block of business are subject to variation from quarter to quarter. Claim activity during the first six months of 2015 was elevated compared to historical trends. While the number of incurred claims during the first six months of 2015 declined 13% compared to the first six months of 2014. The average claim amount increased from $16,000 to $24,000. The low face amount per claim reflects the older block of domestic life insurance policies sold which were final expense type products (i.e. purchased to cover funeral costs). The increase in the average face amount reflects a small addition of more claims from recent policy sales which have much higher face amounts of insurance coverage per policy. The Company's overall mortality experience for this segment is in line with pricing assumptions.

As noted previously in the discussion of Results of Operations, the Company records true-up adjustments to DPAC balances each period to reflect current policy lapse or termination rates, expense levels and credited rates on policies as compared to anticipated experience with the adjustment reflected in current period amortization expense. To the extent required, the Company may also record unlocking adjustments to DPAC balances. The following table identifies the effects of unlocking and true-up adjustments on domestic life insurance DPAC balances recorded through amortization expense for the three and six months ended June 30, 2015 and 2014.

 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2015
 
2014
 
2015
 
2014
 
(In thousands)
 
 
 
 
 
 
 
 
Increase (Decrease) in DPAC Balance
 
 
 
 
 
 
 
Unlocking
$
—

 
—

 
—

 
—

True-up
2,240

 
2,511

 
3,190

 
4,278

 
 
 
 
 
 
 
 
Totals
$
2,240

 
2,511

 
3,190

 
4,278


As noted in the table above, the true-up adjustments recorded increased the DPAC balance on the condensed consolidated balance sheet which conversely reduced amortization expense in current earnings by a like amount for the periods shown.

International Life Insurance Operations

The Company's international life operations have been a significant factor in the Company's overall earnings performance and represents a niche where the Company believes it has a competitive advantage. A stable population of distribution relationships has been developed given the Company's longstanding reputation for supporting its international life products coupled with the instability of competing companies in international markets.


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Table of Contents

A comparative analysis of results of operations for the Company's international life insurance segment is detailed below.

 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2015
 
2014
 
2015
 
2014
 
(In thousands)
 
 
 
 
 
 
 
 
Premiums and other revenues:
 
 
 
 
 
 
 
Premiums and contract revenues
$
29,364

 
29,663

 
59,697

 
58,771

Net investment income
8,785

 
16,911

 
17,399

 
27,629

Other revenues
(25
)
 
60

 
61

 
301

 
 
 
 
 
 
 
 
Total revenues
38,124

 
46,634

 
77,157

 
86,701

 
 
 
 
 
 
 
 
Benefits and expenses:
 

 
 

 
 

 
 

Life and other policy benefits
5,587

 
1,668

 
11,792

 
6,703

Amortization of deferred policy acquisition costs
5,163

 
8,808

 
4,513

 
15,553

Universal life insurance and annuity contract interest
6,927

 
15,659

 
14,057

 
25,864

Other operating expenses
5,212

 
4,835

 
11,134

 
11,860

 
 
 
 
 
 
 
 
Total benefits and expenses
22,889

 
30,970

 
41,496

 
59,980

 
 
 
 
 
 
 
 
Segment earnings (losses) before Federal income taxes
15,235

 
15,664

 
35,661

 
26,721

Provision (benefit) for Federal income taxes
4,932

 
4,963

 
11,477

 
8,722

 
 
 
 
 
 
 
 
Segment earnings (loss)
$
10,303

 
10,701

 
24,184

 
17,999


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 June 30,
 
Six Months Ended June 30,
 
2015
 
2014
 
2015
 
2014
 
(In thousands)
 
 
 
 
 
 
 
 
Universal life insurance revenues
$
29,532

 
27,688

 
58,724

 
56,338

Traditional life insurance premiums
1,699

 
4,089

 
5,062

 
7,134

Reinsurance premiums
(1,867
)
 
(2,114
)
 
(4,089
)
 
(4,701
)
 
 
 
 
 
 
 
 
Totals
$
29,364

 
29,663

 
59,697

 
58,771


In general, universal life revenues and operating earnings are anticipated to emerge with growth in the amount of international life insurance in force fueled by a steady growth in new sales. The volume of insurance in force grew from $19.6 billion at December 31, 2013 to $20.0 billion at December 31, 2014 and decreased slightly to $19.8 billion at June 30, 2015. 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 international life policies issued in the first six months of 2015 was 5% lower than in the first six months of 2014 while the volume of insurance issued was 12% less than that issued in 2014 during the same period due in part to a decrease in the average face amount per policy.


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International universal life revenues also include surrender charges assessed upon surrender of contracts by policyholders. In the midst of the financial crisis several years ago, the Company's international policyholders, in particular, exhibited concern regarding the developments in U.S. financial markets. This evidenced itself in the Company's termination activity in its international life policies in force. The Company incurred higher termination experience than is typical which resulted in recognition of increased surrender charge fee income. This level of termination activity subsequently subsided. However, ongoing global uncertainties may cause a re-emerging concern with international policyholders. The following table illustrates the Company's recent international life termination experience.

 
Amount in $'s
 
Annualized Termination Rate
 
(millions)
 
 
 
 
 
 
Volume In Force Terminations
 
 
 
Year ended December 31, 2010
$
1,721.8

 
9.0
%
Year ended December 31, 2011
1,465.1

 
7.3
%
Year ended December 31, 2012
1,828.4

 
8.7
%
Year ended December 31, 2013
1,838.5

 
8.6
%
Year ended December 31, 2014
1,825.5

 
8.4
%
Six months ended June 30, 2015
1,089.8

 
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 June 30,
 
Six Months Ended June 30,
 
2015
 
2014
 
2015
 
2014
 
(In thousands)
 
 
 
 
 
 
 
 
Universal life insurance:
 
 
 
 
 
 
 
First year and single premiums
$
6,782

 
7,182

 
12,456

 
12,905

Renewal premiums
26,961

 
28,588

 
51,996

 
54,746

 
 
 
 
 
 
 
 
Totals
$
33,743

 
35,770

 
64,452

 
67,651


The Company's most popular international products have been its fixed-index universal life products in which the policyholder can elect to have the interest rate credited to their policy account values linked in part to the performance of the S&P 500 Index®. Included in the totals in the above table are collected premiums for fixed-index universal life products of approximately $41.8 million and $43.5 million for the first six months of 2015 and 2014, respectively.


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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 growth in the fixed-index universal life block of business, the period-to-period changes in fair values of the underlying options have had an increasingly greater impact on net investment income and universal life contract interest. A detail of net investment income for international life insurance operations is provided below.

 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2015
 
2014
 
2015
 
2014
 
(In thousands)
 
 
 
 
 
 
 
 
Net investment income (excluding derivatives)
$
9,651

 
10,347

 
19,404

 
20,049

Derivative gain (loss)
(866
)
 
6,564

 
(2,005
)
 
7,580

 
 
 
 
 
 
 
 
Net investment income
$
8,785

 
16,911

 
17,399

 
27,629


For liability purposes, the embedded option in the Company's policyholder obligations for this feature is bifurcated and reserved for separately. Accordingly, a comparable impact for the derivative component in the equity-index universal life product is reflected in the contract interest expense for each respective period. Refer to Note 11, Derivative Investments, of the accompanying condensed consolidated financial statements for further discussion.

Life and policy benefits primarily consist of death claims on policies. The Company's clientele for international products are wealthy individuals with access to U.S. dollars and quality medical care. Consequently, the amounts of coverage purchased tend to be larger amounts. In the year ended December 31, 2014, the average face amount of insurance purchased was $383,000, and the first six months of 2015, the average was approximately $354,000. While life and policy benefit expense for the international life segment reflects the larger policies purchased, 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. Similar to the domestic life line of business, the average net claim amount in the first six months of 2015 increased from that in the first six months of 2014 rising to $186,000 from $132,000.

The Company records true-up adjustments to DPAC balances each period to reflect current policy lapse or termination rates, expense levels and credited rates on policies as compared to anticipated experience as well as unlocking adjustments as necessary. The following table identifies the effects of unlocking and true-up adjustments on international life insurance DPAC balances recorded through amortization expense for the for the three and six months ended June 30, 2015 and 2014.

 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2015
 
2014
 
2015
 
2014
 
(In thousands)
 
 
 
 
 
 
 
 
Increase (Decrease) in DPAC Balance
 
 
 
 
 
 
 
Unlocking
$
—

 
—

 
7,120

 
—

True-up
3,940

 
1,616

 
6,540

 
3,766

 
 
 
 
 
 
 
 
Totals
$
3,940

 
1,616

 
13,660

 
3,766


In the six months ended June 30, 2015, the Company unlocked the DPAC balance associated with its International Life segment for favorable mortality experience on one of its universal life products. The effect of the prospective unlocking was to increase DPAC balances by $7.1 million (and decrease amortization expense). No unlocking adjustments were made in the first six months of 2014.

True-up adjustments in the first three and six months of 2015 and 2014 increased the DPAC balance on the condensed consolidated balance sheet and decreased amortization expense in current earnings by a like amount.


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Table of Contents

As indicated in the discussion concerning net investment income, contract interest expense includes fluctuations that are the result of the performance of underlying equity indices associated with fixed-index universal life products. The derivative gain (loss) realized on purchased call options is included in the amounts the Company credits to policyholders.

Annuity Operations

The Company's annuity operations are almost exclusively with residents of the United States. Although some of the Company's investment contracts are available to international residents, current sales are small relative to total annuity sales. A comparative analysis of results of operations for the Company's annuity segment is detailed below.

 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2015
 
2014
 
2015
 
2014
 
(In thousands)
 
 
 
 
 
 
 
 
Premiums and other revenues:
 
 
 
 
 
 
 
Premiums and contract revenues
$
6,206

 
6,658

 
11,046

 
11,661

Net investment income
79,509

 
122,666

 
158,745

 
209,283

Other revenues
4

 
3

 
19

 
40

 
 
 
 
 
 
 
 
Total revenues
85,719

 
129,327

 
169,810

 
220,984

 
 
 
 
 
 
 
 
Benefits and expenses:
 

 
 

 
 

 
 

Life and other policy benefits
6,651

 
11,705

 
14,599

 
17,141

Amortization of deferred policy acquisition costs
21,209

 
16,670

 
46,330

 
36,104

Annuity contract interest
37,044

 
78,612

 
74,014

 
126,238

Other operating expenses
5,434

 
5,824

 
11,612

 
12,920

 
 
 
 
 
 
 
 
Total benefits and expenses
70,338

 
112,811

 
146,555

 
192,403

 
 
 
 
 
 
 
 
Segment earnings (loss) before Federal income taxes
15,381

 
16,516

 
23,255

 
28,581

Provision (benefit) for Federal income taxes
4,961

 
5,227

 
7,484

 
9,329

 
 
 
 
 
 
 
 
Segment earnings (loss)
$
10,420

 
11,289

 
15,771

 
19,252


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 six months of 2015 was 6.6% compared to 6.9% during the same period in 2014.


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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 six months ended June 30, 2015 and 2014 are detailed below.

 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2015
 
2014
 
2015
 
2014
 
(In thousands)
 
 
 
 
 
 
 
 
Fixed-index annuities
$
194,630

 
200,790

 
354,937

 
356,306

Other deferred annuities
12,709

 
18,533

 
22,838

 
32,055

Immediate annuities
2,135

 
3,998

 
4,925

 
6,088

 
 
 
 
 
 
 
 
Totals
$
209,474

 
223,321

 
382,700

 
394,449


Fixed-index products are more attractive for consumers when interest rate levels remain low and equity markets produce positive returns. Since the Company 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. Fixed-index annuity deposits as a percentage of total annuity deposits were 93% and 90% for the six months ended June 30, 2015 and 2014, respectively. The increasing percentage of fixed-index products of total annuity sales reflects the low interest rate environment and the current bull market in equities.

As a selling inducement, some of the deferred products, as well as the fixed-index annuity products, include a first year interest bonus ranging from 1% to 7% depending upon the product, in addition to a base first year interest rate. Other products include a premium bonus ranging from 2% to 10% which is credited to the account balance when premiums are applied. These bonus rates are deferred in conjunction with other capitalized policy acquisition costs. The amount deferred to be amortized over future periods amounted to approximately $8.1 million and $8.9 million during the first six months of 2015 and 2014, 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 June 30,
 
Six Months Ended June 30,
 
2015
 
2014
 
2015
 
2014
 
(In thousands)
 
 
 
 
 
 
 
 
 
 
 
 
Net investment income (excluding derivatives)
$
87,313

 
87,063

 
173,712

 
174,892

Derivative gain (loss)
(7,804
)
 
35,603

 
(14,967
)
 
34,391

 
 
 
 
 
 
 
 
Net investment income
$
79,509

 
122,666

 
158,745

 
209,283


As previously described, derivatives are call options purchased to hedge the equity return component of the Company's fixed-index annuity products with any gains or losses from the sale or expiration of the options, as well as period-to-period changes in fair values, reflected in net investment income. Given the bifurcation of the embedded option in the determination of the contract reserve liability, a comparable impact for the derivative component in fixed-index annuity products is reflected in contract interest expense.


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Table of Contents

Consistent with the domestic and international life segments, the Company records true-up adjustments to DPAC balances each period to reflect current policy lapse or termination rates, expense levels and credited rates on policies as compared to anticipated experience as well as unlocking adjustments as necessary. The following table identifies the effects of unlocking and true-up adjustments on annuity DPAC balances recorded through amortization expense for the for the three and six months ended June 30, 2015 and 2014.

 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2015
 
2014
 
2015
 
2014
 
(In thousands)
 
 
 
 
 
 
 
 
Increase (Decrease) in DPAC Balance
 
 
 
 
 
 
 
Unlocking
$
—

 
—

 
(5,310
)
 
—

True-up
(2,080
)
 
(3,919
)
 
(4,210
)
 
(3,946
)
 
 
 
 
 
 
 
 
Totals
$
(2,080
)
 
(3,919
)
 
(9,520
)
 
(3,946
)

The Company unlocked the DPAC balance associated with its annuity segment in the first quarter of 2015 for future expense assumptions pertaining to product development override costs (trailer commissions) which it is obligated to pay certain contracted National Marketing Organizations. The effect of the prospective unlocking was to decrease DPAC balances by $5.3 million (and increase amortization expense). No unlocking adjustments were recorded in the first six months of 2014.

As the true-up adjustments decreased the DPAC balances on the condensed consolidated balance sheet for the three and six months ended June 30, 2015 and 2014, a corresponding increase in DPAC amortization expense was recorded in the Company's Condensed Consolidated Statements of Earnings in each respective period.

Annuity contract interest includes the equity component return associated with the call options purchased to hedge the Company's fixed-index annuities. The detail of fixed-index annuity contract interest compared to contract interest for all other annuities is as follows:

 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2015
 
2014
 
2015
 
2014
 
(In thousands)
 
 
 
 
 
 
 
 
Fixed-index annuities
$
11,621

 
48,998

 
21,658

 
70,584

All other annuities
23,218

 
28,242

 
45,481

 
50,859

 
 
 
 
 
 
 
 
Gross contract interest
34,839

 
77,240

 
67,139

 
121,443

Bonus interest deferred and capitalized
(4,311
)
 
(5,215
)
 
(8,147
)
 
(8,938
)
Bonus interest amortization
6,516

 
6,587

 
15,022

 
13,733

 
 
 
 
 
 
 
 
Total contract interest
$
37,044

 
78,612

 
74,014

 
126,238


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 positive or negative performance of equity markets on option values. The derivative gain (loss) information included in the net investment income discussion above is largely reflected in the amounts shown for contract interest for fixed-index annuities.


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Table of Contents

True-up adjustments for the deferred sales inducement balance are made each period similar to that done with respect to DPAC balances. For the six months ended June 30, 2015 and 2014, deferred sales inducement balances on the condensed consolidated balance sheet were increased (reduced) by $(1.1) million and $(0.8) million, respectively, for true-up adjustments. These adjustments are included in the above table as an (addition) decrease to bonus interest amortization. The Company also unlocked its deferred sales inducement balance in the first quarter of 2015 associated with the annuity segment for future expense assumptions pertaining to product development override costs as previously discussed. The effect of the prospective unlocking was to decrease the deferred sales inducement balance by $1.8 million which increased contract interest expense by the same amount. No unlocking adjustments were made in the first six months of 2014.

Other Operations

National Western Life Insurance Company's primary business encompasses its domestic and international life insurance operations and its annuity operations. However, National Western also has small real estate, nursing home, and other investment operations through its wholly-owned subsidiaries. Nursing home operations generated $1.0 million and $0.7 million of operating earnings in the first six months of 2015 and 2014, respectively. The remaining earnings of $8.0 million and $6.2 million in Other Operations during the six month periods represent 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 Libby Shearn Moody Trust which is an asset held in NWLSM, Inc. Pretax distributions from this trust were $3.5 million and $2.9 million in the six month periods ended June 30, 2015 and 2014, respectively.


INVESTMENTS

General

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 with smaller holdings in mortgage loans.

 
June 30, 2015
 
December 31, 2014
 
Carrying
Value
 
%
 
Carrying
Value
 
%
 
(In thousands)
 
 
 
(In thousands)
 
 
 
 
 
 
 
 
 
 
Debt securities
$
9,944,992

 
96.9
 
$
9,552,920

 
96.2
Mortgage loans
132,261

 
1.3
 
149,503

 
1.5
Policy loans
61,933

 
0.6
 
63,645

 
0.6
Derivatives, index options
72,527

 
0.7
 
114,287

 
1.2
Real estate
16,491

 
0.2
 
16,741

 
0.2
Equity securities
17,036

 
0.2
 
17,303

 
0.2
Other
12,470

 
0.1
 
12,033

 
0.1
 
 
 
 
 
 
 
 
Totals
$
10,257,710

 
100.0
 
$
9,926,432

 
100.0


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Table of Contents

Debt and Equity Securities

The Company maintains a diversified 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 June 30, 2015 and December 31, 2014, the Company's debt securities portfolio consisted of the following classes of securities:

 
June 30, 2015
 
December 31, 2014
 
Carrying
Value
 
%
 
Carrying
Value
 
%
 
(In thousands)
 
 
 
(In thousands)
 
 
 
 
 
 
 
 
 
 
Corporate
$
6,652,392

 
66.9
 
$
6,208,241

 
65.1
Mortgage-backed securities
1,621,716

 
16.3
 
1,693,372

 
17.7
Public utilities
1,168,311

 
11.7
 
1,158,063

 
12.1
State and political subdivisions
440,039

 
4.4
 
432,739

 
4.5
U.S. agencies
15,038

 
0.2
 
10,061

 
0.1
Asset-backed securities
35,148

 
0.4
 
38,199

 
0.4
Foreign governments
10,425

 
0.1
 
10,325

 
0.1
U.S. Treasury
1,923

 
—
 
1,920

 
—
 
 
 
 
 
 
 
 
Totals
$
9,944,992

 
100.0
 
$
9,552,920

 
100.0

Substantially all 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. Debt securities with intermediate maturities are 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 insurance company operations are summarized below.

 
Six Months Ended June 30,
 
Year Ended December 31,
 
2015
 
2014
 
($ In thousands)
 
 
 
 
Cost of acquisitions
$
842,886

 
$
1,166,112

Average S&P®  quality
A-

 
A-

Effective annual yield
3.36
%
 
3.68
%
Spread to treasuries
1.26
%
 
1.12
%
Effective duration
8.5 years

 
8.5 years


The mortgage-backed securities portfolio consists predominantly of agency mortgage-backed securities. Because mortgage-backed securities are subject to prepayment and extension risk, the Company has substantially reduced these risks by investing in collateralized mortgage obligations ("CMO"), which have more predictable cash flow patterns than pass-through securities. These securities, known as planned amortization class I ("PAC I"), very accurately defined maturity ("VADM") and sequential tranches are designed to amortize in a more predictable manner than other CMO classes or pass-throughs. The Company does not purchase tranches, such as PAC II and support tranches, that subject the portfolio to greater than average prepayment risk. Using this strategy, the Company can more effectively manage and reduce prepayment and extension risks, thereby helping to maintain the appropriate matching of the Company's assets and liabilities.


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Table of Contents

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 debt securities portfolio with 98.7% held in investment grade securities. In the table below, investments in debt securities are classified according to credit ratings by Standard and Poor's ("S&P®"), or other nationally recognized statistical rating organizations if securities were not rated by S&P®.

 
June 30, 2015
 
December 31, 2014
 
Carrying
Value
 
%
 
Carrying
Value
 
%
 
(In thousands)
 
 
 
(In thousands)
 
 
 
 
 
 
 
 
 
 
AAA
$
98,225

 
1.0
 
$
105,973

 
1.1
AA
2,448,970

 
24.6
 
2,519,235

 
26.4
A
3,339,013

 
33.6
 
3,216,935

 
33.7
BBB
3,927,425

 
39.5
 
3,563,641

 
37.3
BB and other below investment grade
131,359

 
1.3
 
147,136

 
1.5
 
 
 
 
 
 
 
 
Totals
$
9,944,992

 
100.0
 
$
9,552,920

 
100.0

The Company's investment guidelines do not allow for the purchase of below investment grade securities.  The investments held in debt securities below investment grade are the result of subsequent downgrades of the securities.  These holdings are further summarized below.

 
Below Investment Grade Debt Securities
 
Amortized
Cost
 
Carrying
Value
 
Fair
Value
 
% of
Invested
Assets
 
(In thousands, except percentages)
 
 
 
 
 
 
 
 
June 30, 2015
$
130,862

 
131,359

 
136,037

 
1.3
%
 
 
 
 
 
 
 
 
December 31, 2014
$
146,143

 
147,136

 
152,586

 
1.5
%

The Company's percentage of below investment grade securities compared to total invested assets decreased slightly from December 31, 2014 due to a bond holding which was upgraded to investment grade and to principal paydowns on below investment grade holdings. The Company's holdings of below investment grade securities are relatively small and as a percentage of total invested assets low compared to industry averages.


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Table of Contents

Holdings in below investment grade securities by category as of June 30, 2015 are summarized below, including June 30, 2015 and December 31, 2014 fair values for comparison. The Company continually monitors developments in these industries for issues that may affect security valuation.

 
 
Below Investment Grade Debt Securities
 
 
Amortized Cost
 
Carrying Value
 
Fair Value
 
Fair Value
Industry Category
 
June 30, 2015
 
June 30, 2015
 
June 30, 2015
 
December 31, 2014
 
 
(In thousands)
 
 
 
 
 
 
 
 
 
Retail
 
$
14,971

 
15,557

 
15,557

 
15,600

Telecommunications
 
5,047

 
5,463

 
5,463

 
5,650

Asset-backed securities
 
5,525

 
5,525

 
7,431

 
7,743

Mortgage-backed
 
2,044

 
2,074

 
2,074

 
7,244

Transportation
 
—

 
23

 
23

 
61

Manufacturing
 
40,926

 
41,275

 
43,645

 
54,823

Banking/finance
 
18,005

 
18,031

 
16,906

 
16,583

Other
 
44,344

 
43,411

 
44,938

 
44,882

 
 
 
 
 
 
 
 
 
Totals
 
$
130,862

 
131,359

 
136,037

 
152,586


The Company closely monitors 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, continued credit deterioration of some securities or the markets in general is possible, which may result in further write-downs.

With the precipitous drop in oil prices over the past year, the oil and gas industry has been experiencing a severe downturn which
may consequently affect the credit quality of individual companies included in the Company's debt security portfolio. At June 30, 2015 and December 31, 2014, the Company's aggregate holdings in this sector approximated $869 million and $802 million, respectively. These holdings represented debt securities issued by approximately forty companies in the oil and gas industry, all of which are investment grade as of both balance sheet dates.

Certain European countries have experienced varying degrees of financial stress. Risks from the lingering debt crisis in Europe could potentially disrupt financial markets and have a detrimental impact on global conditions as well as on sovereign and non-sovereign obligations.The Company has no exposure to the sovereign debt of Portugal, Ireland, Italy, Greece or Spain. These countries in particular have been or are experiencing significant economic, fiscal and political strains that could increase the likelihood of default for these countries. Additionally, the Company has no exposure to the debt of financial institutions domiciled in these countries.


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However, the Company does have exposure to the debt of non-financial companies in each of these countries except for Greece. The following tables show bond holdings at June 30, 2015 of non-financial companies that are domiciled in Portugal, Ireland, Italy, or Spain held in the available for sale and held to maturity debt security portfolios.

Securities Available for Sale
 
 
 
Amortized Cost
 
Fair Value
 
 
Company
 
S&P Rating
 
June 30, 2015
 
June 30, 2015
 
Country Domiciled
 
 
(In thousands)
 
 
 
 
 
 
 
 
 
CRH
 
BBB+
 
$
24,999

 
25,355

 
Ireland
Medtronic
 
A
 
38,635

 
40,696

 
Ireland
Telefonica
 
BBB
 
11,784

 
12,674

 
Spain
 
 
 
 
 
 
 
 
 
Totals
 
 
 
$
75,418

 
78,725

 
 



Securities Held to Maturity
 
 
 
Amortized Cost
 
Fair Value
 
 
Company
 
S&P Rating
 
June 30, 2015
 
June 30, 2015
 
Country Domiciled
 
 
(In thousands)
 
 
 
 
 
 
 
 
 
EDP
 
BB+
 
$
17,261

 
18,458

 
Portugal
Enel
 
BBB
 
19,945

 
21,904

 
Italy
Finmeccanica
 
BB+
 
15,016

 
16,050

 
Italy
Iberdrola Finance
 
BBB
 
2,932

 
3,286

 
Spain
Kerry Group
 
BBB+
 
21,958

 
21,247

 
Ireland
Medtronic
 
A
 
19,961

 
19,621

 
Ireland
Telefonica
 
BBB
 
8,092

 
9,038

 
Spain
Perrigo
 
BBB
 
25,815

 
26,182

 
Ireland
 
 
 
 
 
 
 
 
 
Totals
 
 
 
$
130,980

 
135,786

 
 

Generally accepted accounting principles require that investments in debt securities be written down to fair value when declines in value are judged to be other-than-temporary.  Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (an exit price methodology). Refer to Note 10, Fair Values of Financial Instruments, of the accompanying condensed consolidated financial statements for further discussion.

During the six months ended June 30, 2015 the Company recorded no other-than-temporary impairment credit related write-downs on debt securities and $0.1 million on equity securities. See Note 9, Investments, of the accompanying condensed consolidated financial statements for further discussion. Since the Company's adoption of the GAAP guidance on the recognition and accounting for other-than-temporary impairments due to credit loss versus non-credit loss, the Company has recognized a total of $5.8 million of other-than-temporary impairments of which $2.3 million was deemed credit related and recognized as realized investment losses in earnings, and $3.5 million was deemed a non-credit related impairment and recognized in other comprehensive income.


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The Company is required to classify its investments in debt and equity securities into one of three categories: (a) trading securities; (b) securities available for sale; or (c) securities held to maturity. The Company purchases securities with the intent to hold to maturity and accordingly does not maintain a portfolio of trading securities. Of the remaining two categories, available for sale and held to maturity, the Company makes a determination on categorization based on various factors including the type and quality of the particular security and how it will be incorporated into the Company's overall asset/liability management strategy. As shown in the table below, at June 30, 2015, approximately 27.8% of the Company's total debt and equity securities, based on fair values, were classified as securities available for sale. The holdings in available for sale 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.

 
June 30, 2015
 
Fair
Value
 
Amortized
Cost
 
Unrealized
Gains (Losses)
 
(In thousands)
 
 
 
 
 
 
Securities held to maturity:
 
 
 
 
 
Debt securities
$
7,370,596

 
7,121,439

 
249,157

Securities available for sale:
 

 
 
 
 
Debt securities
2,823,553

 
2,728,343

 
95,210

Equity securities
17,036

 
12,650

 
4,386

 
 
 
 
 
 
Totals
$
10,211,185

 
9,862,432

 
348,753


Asset-Backed Securities

The Company holds approximately $35.1 million in asset-backed securities as of June 30, 2015. This portfolio includes $5.1 million of manufactured housing bonds and $30.0 million of home equity loans (also referred to as subprime securities). The Company does not have any holdings in collaterized bond obligations (“CBO”s), collateralized debt obligations (“CDO”s), or collateralized loan obligations (“CLO”s). Principal risks in holding asset-backed securities are structural, credit, and capital market risks. Structural risks include the securities' priority in the issuer's capital structure, the adequacy of and ability to realize proceeds from collateral and the potential for prepayments. Credit risks include corporate credit risks or consumer credit risks for financing such as subprime mortgages. Capital market risks include the general level of interest rates and the liquidity for these securities in the marketplace.

During the second quarter of 2014 the Company sold its one remaining Alt-A security. The Alt-A sector is a sub-sector of the jumbo prime MBS sector. The Company's exposure to the Alt-A and subprime sectors has been limited to investments in the senior tranches of structured securities collateralized by Alt-A or subprime residential mortgage loans. The subprime sector is generally categorized under the asset-backed sector. This sector lends to borrowers who do not qualify for prime interest rates due to poor or insufficient credit history. The slowing housing market, rising interest rates, and relaxed underwriting standards for loans originated after 2005 resulted in higher delinquency rates and losses beginning in 2007. These events caused illiquidity in the market and volatility in the market prices of subprime securities. All of the loans classified as subprime in the Company's portfolio as of June 30, 2015 were underwritten prior to 2005 as noted in the table below.

 
 
June 30, 2015
 
December 31, 2014
Investment Origination Year
 
Carrying Value
 
Fair Value
 
Carrying Value
 
Fair Value
 
 
(In thousands)
 
 
 
 
 
 
 
 
 
Subprime:
 
 
 
 
 
 
 
 
1998
 
$
3,034

 
3,143

 
3,322

 
3,275

2003
 
3,606

 
5,299

 
3,709

 
5,469

2004
 
23,311

 
26,083

 
23,773

 
26,737

 
 
 
 
 
 
 
 
 
Total
 
$
29,951

 
34,525

 
30,804

 
35,481


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As of June 30, 2015, the Company held ten subprime issues of which 2 were rated AA, 4 were rated BBB, 1 was rated B, 2 were rated CC and 1 was not rated.

Mortgage Loans and Real Estate

In general, 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, motels, and health care facilities.  The location of these properties is 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 guaranteed by the lease payments and also by the borrower.  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.

The Company requires a minimum specified yield on mortgage loan investments. During the past several years, the low interest rate environment has resulted in fewer loan opportunities being available that meet the Company's required rate of return. Mortgage loans originated by the Company totaled $37.1 million for the year ended December 31, 2014 and $1.6 million for the six months ended June 30, 2015. Principal repayments on mortgage loans for the six months ended June 30, 2015 were $19.0 million.

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 has no loans past due 90 days which are accruing interest.

The Company held net investments in mortgage loans totaling $132.3 million and $149.5 million at June 30, 2015 and December 31, 2014, respectively.  The diversification of the portfolio by geographic region and by property type was as follows:

 
June 30, 2015
 
December 31, 2014
 
Amount
 
%
 
Amount
 
%
 
(In thousands)
 
 
 
(In thousands)
 
 
 
 
 
 
 
 
 
 
Mortgage Loans by Geographic Region:
 
 
 
 
 
 
 
West South Central
$
80,874

 
60.8

 
$
97,918

 
65.2

East South Central
13,934

 
10.5

 
14,137

 
9.4

New England
11,994

 
9.0

 
12,155

 
8.1

East North Central
11,037

 
8.3

 
10,714

 
7.1

Pacific
10,209

 
7.7

 
10,282

 
6.9

Middle Atlantic
1,840

 
1.4

 
1,897

 
1.3

Mountain
1,705

 
1.3

 
3,050

 
2.0

South Atlantic
1,318

 
1.0

 
—

 
—

Gross balance
132,911

 
100.0

 
150,153

 
100.0

 
 
 
 
 
 
 
 
Allowance for possible losses
(650
)
 
(0.5
)
 
(650
)
 
(0.4
)
 
 
 
 
 
 
 
 
Totals
$
132,261

 
99.5

 
$
149,503

 
99.6



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June 30, 2015
 
December 31, 2014
 
Amount
 
%
 
Amount
 
%
 
(In thousands)
 
 
 
(In thousands)
 
 
 
 
 
 
 
 
 
 
Mortgage Loans by Property Type:
 
 
 
 
 
 
 
Retail
$
116,808

 
87.9

 
$
130,544

 
86.9

Apartments
7,276

 
5.5

 
7,333

 
4.9

Land/Lots
—

 
—

 
3,333

 
2.2

Hotel/Motel
1,558

 
1.2

 
1,600

 
1.1

Office
846

 
0.6

 
893

 
0.6

All other
6,423

 
4.8

 
6,450

 
4.3

Gross balance
132,911

 
100.0

 
150,153

 
100.0

 
 
 
 
 
 
 
 
Allowance for possible losses
(650
)
 
(0.5
)
 
(650
)
 
(0.4
)
 
 
 
 
 
 
 
 
Totals
$
132,261

 
99.5

 
$
149,503

 
99.6


The Company's direct investments in real estate are not a significant portion of its total investment portfolio.  The Company also participates in several real estate joint ventures, limited partnerships, and other loans that invest primarily in income-producing retail properties.  These investments have enhanced the Company's overall investment portfolio returns. The Company's real estate investments totaled approximately $16.5 million and $16.7 million at June 30, 2015 and December 31, 2014, respectively. The Company recognized operating income on these properties of approximately $0.9 million for the first six months of 2015. 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 National Western 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 or increasing event-risk concerns.

Interest Rate Risk

A gradual increase in interest rates from current levels would generally be 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. Alternatively, a rise in interest rates would reduce the fair value of the Company's investment portfolio and if long-term rates rise dramatically within a relatively short time period could expose the Company 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.

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 will be unable to reinvest the proceeds at comparable yields. Lower interest rates will likely also cause lower net investment income, subject the Company to reinvestment rate risks, and possibly reduce profitability through reduced interest rate margins associated with products with minimum guaranteed crediting rates. Alternatively, the fair value of the Company's investment portfolio will increase when interest rates decline.


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The correlation between fair values and interest rates for debt securities is reflected in the tables below.

 
June 30,
2015
 
March 31,
2015
 
December 31,
2014
 
(In thousands except percentages)
 
 
 
 
 
 
Debt securities - fair value
$
10,194,149

 
10,307,208

 
9,886,820

Debt securities - amortized cost
$
9,849,782

 
9,716,994

 
9,418,818

Fair value as a percentage of amortized cost
103.50
%
 
106.07
 %
 
104.97
 %
Net unrealized gain balance
$
344,367

 
590,214

 
468,002

Ten-year U.S. Treasury bond – (decrease) increase in yield for the period
0.43
%
 
(0.25
)%
 
(0.86
)%

 
Net Unrealized Gain Balance
 
At
June 30, 2015
 
At
March 31,
2015
 
At
December 31,
2014
 
Quarter
Change in
Unrealized
Balance
 
Year-to-date Change in
Unrealized
Balance
 
 
 
 
 
 
 
 
 
 
Debt securities held to maturity
$
249,157

 
427,900

 
333,900

 
(178,743
)
 
(84,743
)
Debt securities available for sale
95,210

 
162,314

 
134,102

 
(67,104
)
 
(38,892
)
 
 
 
 
 
 
 
 
 
 
Totals
$
344,367

 
590,214

 
468,002

 
(245,847
)
 
(123,635
)

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 approximately 18 basis points from 2.17% at year-end 2014 to 2.35% by the end of the first six months of 2015 and the Company's unrealized gain position decreased $123.6 million on a portfolio with an amortized cost basis of approximately $9.8 billion. However, since the majority of the Company's debt securities are classified as held to maturity, which are recorded at amortized cost, changes in fair values have a relatively small effect on the Company's Condensed Consolidated Balance Sheet.

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 the 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 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 products with features encouraging persistency. Interest sensitive life and annuity products have surrender and withdrawal penalty provisions. Depending on the products, surrender charge rates on annuity contracts sold or in force range up to 25% and surrender charge periods up to 15 years. Typically, surrender charge rates gradually decrease each year the contract is in force.

The Company performed detailed sensitivity analysis as of December 31, 2014, for its interest rate-sensitive assets and liabilities. The changes in market values of the Company's debt securities in the first six months of 2015 were reasonable given the expected range of results of this analysis.


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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 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 Standard & Poor’s credit rating of “A” or higher and a Moody’s rating of “A2” 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. The amount of collateral to be provided is based upon a sliding scale tied to the credit rating of the counterparty(the higher the credit rating of the counterparty the higher the threshold of exposure before collateral is to be provided). At the highest credit rating level the maximum counterparty net exposure not subject to collateral support is $20 million. This net exposure level declines as the counterparty credit rating declines and ultimately is $0 at a rating of “BBB+”. Counterparty credit ratings and credit exposure are monitored continuously by the Company’s Investment department with adjustments to collateral levels managed as incurred under the credit support agreements.

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 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 AND CAPITAL RESOURCES

Liquidity

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. The Company may also borrow up to $40 million on its bank line of credit for short-term cash needs. There were no borrowings outstanding under the line of credit at June 30, 2015.

A primary liquidity concern for life insurers is the risk of an extraordinary level of early policyholder withdrawals as may occur in a rapidly increasing interest rate environment or other period of exceptional financial duress. 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.


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The actual amounts paid by product line in connection with surrenders and withdrawals for the periods ended June 30, for each respective year, are noted in the table below.

 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2015
 
2014
 
2015
 
2014
 
(In thousands)
 
 
 
 
 
 
 
 
Product Line:
 
 
 
 
 
 
 
Traditional Life
$
1,355

 
1,019

 
2,677

 
2,115

Universal Life
21,857

 
17,705

 
36,186

 
33,026

Annuities
132,382

 
120,057

 
240,130

 
245,418

 
 
 
 
 
 
 
 
Total
$
155,594

 
138,781

 
278,993

 
280,559


The above contractual withdrawals, as well as the level of surrenders experienced, were generally consistent with the Company's assumptions in asset/liability management, and the associated cash outflows did not have an adverse impact on overall liquidity. Individual life insurance policies are less susceptible to withdrawal than annuity reserves and deposit liabilities because policyholders may incur surrender charges and undergo a new underwriting process in order to obtain a new insurance policy. Cash flow projections and tests under various market interest rate scenarios are also performed to assist in evaluating liquidity needs and adequacy. The Company currently expects available liquidity sources and future cash flows to be more than adequate to meet the demand for funds.

In the past, cash flows from the Company's insurance operations have been sufficient to meet current needs. Cash flows from operating activities were $158.2 million and $152.7 million for the six months ended June 30, 2015 and 2014, respectively. The Company also has significant cash flows from both scheduled and unscheduled investment security maturities, redemptions, and prepayments. Investment related cash flows totaled $420.1 million and $463.2 million for the six months ended June 30, 2015 and 2014, respectively. These cash flow items could be reduced if interest rates rise. Net cash flows from the Company's universal life and investment annuity deposit product operations totaled $6.3 million and $10.0 million during the six months ended June 30, 2015 and 2014, respectively.

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 June 30, 2015, the Company had no commitments beyond its normal operating and investment activities.


OFF-BALANCE SHEET ARRANGEMENTS AND CONTRACTUAL OBLIGATIONS

It is not Company practice to 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 the Company.

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. Refer to Note 1 in the Notes to the Consolidated Financial Statements included in the Company's Annual Report on Form 10-K for the year ended December 31, 2014 for a discussion of reserving methods.


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The table below summarizes future estimated cash payments under existing contractual obligations.

 
Payment Due by Period
 
Total
 
Less Than
1 Year
 
1 - 3
Years
 
3 - 5
Years
 
More Than
5 Years
 
(In thousands)
 
 
 
 
 
 
 
 
 
 
Loan commitments
$
2,761

 
2,761

 
—

 
—

 
—

Operating lease obligations
999

 
119

 
476

 
380

 
24

Life claims payable (1)
60,163

 
60,163

 
—

 
—

 
—

Other long-term reserve liabilities reflected on the balance sheet (2)
11,158,490

 
955,121

 
1,874,592

 
1,907,350

 
6,421,427

 
 
 
 
 
 
 
 
 
 
Total
$
11,222,413

 
1,018,164

 
1,875,068

 
1,907,730

 
6,421,451


(1) Life claims payable include benefit and claim liabilities for 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 and critical illness 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. The estimated life and annuity obligations shown 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.


CHANGES IN ACCOUNTING PRINCIPLES AND CRITICAL ACCOUNTING POLICIES

Changes in Accounting Principles

There were no changes in accounting principles during the periods reported in this Form 10-Q.


REGULATORY AND OTHER ISSUES

Statutory Accounting Practices

Regulations that affect the Company and the insurance industry are often the result of efforts 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.

Risk-Based Capital Requirements

The NAIC established risk-based capital ("RBC") requirements to help state regulators monitor the financial strength and stability of life insurers by identifying those companies that may be inadequately capitalized. Under the NAIC's requirements, each insurer must maintain its total capital above a calculated threshold or take corrective measures to achieve the threshold. The threshold of adequate capital is based on a formula that takes into account the amount of risk each company faces on its products and investments. The RBC formula takes into consideration four major areas 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. Statutory laws prohibit public dissemination of certain RBC information. However, the Company's current statutory capital and surplus is significantly in excess of the threshold RBC requirements.



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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 in Debt and Equity Securities 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.

There have been no 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) during the quarter ended June 30, 2015 that have 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. 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 8(A) "Legal Proceedings" of the accompanying condensed consolidated financial statements included in this Form 10-Q.


ITEM 1A. RISK FACTORS

There have been no substantial changes relative to the risk factors disclosed in the Company's Annual Report on Form 10-K for the year ended December 31, 2014.



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ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

Effective August 22, 2008, the Company adopted and implemented a limited stock buy-back program associated with the Company's 2008 Incentive Plan which provides Option Holders the additional alternative of selling shares acquired through the exercise of options directly back to the Company. This program succeeded a similar buy-back program implemented March 10, 2006 associated with the Company's 1995 Stock Option and Incentive Plan. Option Holders may elect to sell such 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.

The following table sets forth the Company's repurchase of its Class A common shares from Option Holders for the quarter ended June 30, 2015. There were no shares repurchased during the period.

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
 
 
 
 
 
 
 
 
 
April 1, 2015 through April 30, 2015
 
—

 

 
N/A
 
N/A
May 1, 2015 through May 31, 2015
 
—

 

 
N/A
 
N/A
June 1, 2015 through June 30, 2015
 
—

 

 
N/A
 
N/A
 
 
 
 
 
 
 
 
 
Total
 
—

 

 
N/A
 
N/A

Purchased shares are reported in the Company's condensed consolidated financial statements as authorized and unissued.


ITEM 4.  Removed and Reserved.


ITEM 6.  EXHIBITS

(a)
Exhibits
Exhibit 31(a)
-
Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
 
 
Exhibit 31(b)
-
Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
 
 
Exhibit 32(a)
-
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.


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SIGNATURES

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.

NATIONAL WESTERN LIFE INSURANCE COMPANY
(Registrant)



Date:
August 7, 2015
 
 
/S/ Ross R. Moody
 
 
 
 
 
Ross R. Moody
 
 
 
 
 
President and Interim Chief Executive Officer,
 
 
 
 
 
and Director
 
 
 
 
 
(Authorized Officer)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Date:
August 7, 2015
 
 
/S/ Brian M. Pribyl
 
 
 
 
 
Brian M. Pribyl
 
 
 
 
 
Senior Vice President,
 
 
 
 
 
Chief Financial Officer and Treasurer
 
 
 
 
 
(Principal Financial Officer)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Date:
August 7, 2015
 
 
/S/ Bruce E. Wood
 
 
 
 
 
Bruce E. Wood
 
 
 
 
 
Vice President,
 
 
 
 
 
Controller and Assistant Treasurer
 
 
 
 
 
(Principal Accounting Officer)
 



85