ITEM 1. BUSINESS
ACCOUNTS A & C
NML Variable Annuity Account A (“Account A”) and NML Variable Annuity Account C (“Account C”) are segregated asset accounts of The Northwestern Mutual Life Insurance Company (“Northwestern Mutual”) formed to provide retirement annuity benefits for (i) self-employed individuals (and their eligible employees) who adopt plans (“HR-10 Plans”) meeting the requirements of Sections 401 or 403(a) of the Internal Revenue Code of 1986, as amended (the “Code”) and (ii) employees of corporate employers who adopt pension or profit sharing plans meeting the requirements of Section 401(a) of the Code, or annuity purchase plans meeting the requirements of Section 403(a) of the Code (collectively, “Corporate Plans”). Account A receives payments under individual variable annuity contracts issued by Northwestern Mutual in connection with HR-10 Plans and Corporate Plans. Account C receives payments under group combination variable annuity contracts issued by Northwestern Mutual in connection with HR-10 Plans and Corporate Plans. The variable annuity contracts issued by Northwestern Mutual in connection with HR-10 Plans and Corporate Plans are hereinafter referred to as the “Contracts.” Account A and Account C were established on February 14, 1968 and July 22, 1970, respectively, by action of the Board of Trustees of Northwestern Mutual in accordance with the provisions of Wisconsin insurance law. Neither Account A nor Account C is registered as an investment company under the Investment Company Act of 1940.
The Contracts provide for the accumulation of funds and the payment of retirement benefits to participants and their beneficiaries (“Annuitants”). Account A and Account C each have 24 divisions. Money invested to provide variable benefits under the Contracts is placed in one or more divisions of the applicable Account which are in turn invested in 18 portfolios of Northwestern Mutual Series Fund, Inc. (Small Cap Growth Stock Portfolio, T. Rowe Price Small Cap Value Portfolio, Aggressive Growth Stock Portfolio, International Growth Portfolio, Franklin Templeton International Equity Portfolio, AllianceBernstein Mid Cap Value Portfolio, Index 400 Stock Portfolio, Janus Capital Appreciation Portfolio, Growth Stock Portfolio, Large Cap Core Stock Portfolio, Capital Guardian Domestic Equity Portfolio, T. Rowe Price Equity Income Portfolio, Index 500 Stock Portfolio, Asset Allocation Portfolio, Balanced Portfolio, High Yield Bond Portfolio, Select Bond Portfolio, and Money Market Portfolio), the Fidelity VIP Mid Cap Portfolio (a fund of Variable Insurance Products Fund III), and 5 funds of Russell Investment Funds (Multi-Style Equity Fund, Aggressive Equity Fund, Non-U.S. Fund, Real Estate Securities Fund and Core Bond Fund), each of which corresponds to one of the Account divisions, all as directed by the Annuitant. Northwestern Mutual Series Fund, Inc. and Russell Investment Funds, which are sponsored by Northwestern Mutual and a Northwestern Mutual affiliate, respectively, and Variable Insurance Products Fund III, which is not affiliated with Northwestern Mutual, are each registered as investment companies under the Investment Company Act of 1940. The Contracts also permit investment on a fixed basis, at rates determined by Northwestern Mutual. The Contracts are sold through individuals who, in addition to being licensed insurance agents of Northwestern Mutual, are registered representatives of Northwestern Mutual Investment Services, LLC (“NMIS”), a wholly-owned company of Northwestern Mutual and a registered broker-dealer under the Securities Exchange Act of 1934.
Under Wisconsin law, the investment operations of each of Account A and Account C (other than those Contract investments on a fixed basis) are kept separate from the operations of Northwestern Mutual. Northwestern Mutual and its creditors cannot reach assets in Account A or Account C to satisfy non-Contract related obligations until all obligations under the Contracts have been satisfied.
See Item 6 herein for Account A and Account C historical financial information regarding results of operations, changes in equity and total assets. See Item 8 herein for the audited financial statements of Account A and Account C.
NORTHWESTERN MUTUAL
Founded in 1857, Northwestern Mutual is a mutual insurance company organized under the laws of the State of Wisconsin. Northwestern Mutual’s products consist of a complete range of permanent and term life insurance, disability income insurance and annuities for the personal, business, estate planning and pension markets. Mutual funds, equity and debt securities, long-term care insurance and trust services are offered and/or sold through subsidiaries. Northwestern Mutual markets its insurance products and services in all 50 states of the United States and in the District of Columbia through an exclusive network of
approximately 7,900 financial representatives at December 31, 2003 located in approximately 350 offices nationwide. At December 31, 2003, Northwestern Mutual had approximately 4,400 full- and part-time employees. Northwestern Mutual’s website address is www.nmfn.com.
Northwestern Mutual’s principal lines of business are: (i) life insurance, which provides a wide range of individual life insurance products, including traditional whole life, permanent and term combination, variable life and term policies to meet the needs of middle to upper income individuals, small business owners and professionals, estates and selected large corporations; (ii) disability income insurance, which provides a line of individual and group products, including individual non-cancelable, guaranteed renewable loss of earnings, buyout, key person, and short-term and long-term group coverages, marketed primarily to middle to upper income individuals, professionals, and small- to medium-sized businesses and their owners; (iii) investment products and services, which provide individual variable, fixed and immediate annuities offered in conjunction with qualified pension plans, retirement plans for self-employed individuals, individual retirement and personal non-tax qualified situations, group annuities, retail mutual funds (including associated funds offered by Mason Street Funds, Inc. and Frank Russell Investment Company), brokerage services (offered through its subsidiary Northwestern Mutual Investment Services, LLC) and trust services (offered through its subsidiary Northwestern Mutual Trust Company), marketed primarily to middle to upper income individuals, business owners and professionals; and (iv) long-term care insurance, offered through its subsidiary Northwestern Long Term Care Insurance Company, marketed primarily to middle to upper income individuals, small business owners and professionals. For the years ended December 31, 2003, 2002 and 2001, Northwestern Mutual had (a) total premiums of $10.3 billion, $10.1 billion and $9.4 billion, respectively, of which $8.7 billion, $8.6 billion and $7.9 billion, respectively, was attributable to life insurance, $0.7 billion, $0.6 billion and $0.6 billion, respectively, was attributable to disability income insurance, and $0.9 billion for each year was attributable to annuity products in the investment products and services line of business; (b) net income of $692 million, $158 million and $650 million, respectively, of which $493 million, $(18) million and $440 million, respectively, was attributable to life insurance, $179 million, $149 million and $147 million, respectively, was attributable to disability income insurance, $29 million, $44 million and $74 million, respectively, was attributable to annuity products in the investment products and services line of business, and $(9) million, $(17) million and $(11) million, respectively, was attributable to long term care insurance; and (c) total assets of $113.8 billion, $102.9 billion and $98.4 billion, respectively, of which $92.2 billion, $82.8 billion and $77.2 billion, respectively, was attributable to life insurance, $6.1 billion, $5.9 billion and $5.8 billion, respectively, was attributable to disability income insurance, and $15.5 billion, $14.2 billion and $15.4 billion, respectively, was attributable to annuity products in the investment products and services line of business.
The life insurance industry is mature and highly competitive. Competitiveness in the life insurance business is affected by various factors including, but not limited to, product quality, financial strength and stability, third party ratings, size and competence of agency force, range of product lines, customer service, and reputation. Based on total admitted statutory assets at September 30, 2003 (the most recent data available), Northwestern Mutual was the 4th largest U.S. domiciled life insurance company on an individual company basis and the 9th largest on a corporate family basis. During 2003, there were more than 1,000 life insurance companies doing business in the United States and many of these companies offer individual life insurance and annuity products similar to those offered by Northwestern Mutual. In addition, Northwestern Mutual competes with banks, brokerage firms, investment advisers, mutual funds and other financial entities for investment and savings customers. In the individual and group disability markets, Northwestern Mutual competes with a limited number of major national and regional companies offering these specialized products. In the long-term care business, Northwestern Mutual competes primarily with a limited number of national companies. National banks, with their pre-existing customer bases for financial services products, may pose increasing competition in the future to insurers who sell life insurance and annuity products, including Northwestern Mutual. United States Supreme Court decisions have expanded the authority of national banks to sell life insurance products and annuities. In addition, legislation enacted in 1999 to overturn Depression-era restrictions on bank affiliations, the Gramm-Leach-Bliley Act (the “Act”), implemented fundamental changes in the regulation of the financial services industry in the U.S. The Act eliminated certain barriers to and restrictions on affiliations between banks, securities firms and insurance companies that were previously contained in the Glass-Steagall Act of 1933, as amended, and the Bank Holding Company Act of 1956, as amended. Under the Act, through the use of two new structures, financial holding companies and financial subsidiaries, qualifying bank holding companies and state and national banks are allowed to provide a wide variety of financial services, including the authority to engage in certain insurance activities (e.g., the sale and, in the case of qualifying bank holding companies only, the underwriting of insurance and annuities). As a result of the Act, among other things, bank holding companies may acquire insurers and insurance holding companies may acquire banks. Over time, the Act may change the competitive and regulatory environment in which Northwestern Mutual and its subsidiaries conduct their businesses and may result in additional competition in one or more markets in which they sell their products and services.
Northwestern Mutual, and its insurance subsidiary Northwestern Long Term Care Insurance Company, are licensed to transact their insurance business in, and are subject to regulation and supervision by, all 50 states of the United States and the District of Columbia. The extent of such regulation varies, but most jurisdictions have laws and regulations governing the financial aspects of insurance companies, including standards of solvency, reserves, reinsurance, capital adequacy and the business conduct of
insurance companies. In addition, statutes and regulations usually require the licensing of insurers and their agents, the approval of policy forms and related materials and, for certain lines of insurance, the approval of rates. Such statutes and regulations also prescribe the permitted types and concentration of investments. The Act reaffirms that the states remain responsible for regulating the business of insurance. However, subject to certain exceptions, no state authority can prevent or restrict depository institutions and their affiliates from affiliating with insurance companies as permitted under the Act. In addition, certain state laws and regulations that place restrictions on a depository institution’s insurance sales activities are preempted.
Frank Russell Company (“Russell”), a subsidiary of Northwestern Mutual, is a global investment services firm providing multi-manager investment products and services in 35 countries. Together with its subsidiaries, Russell managed $94.5 billion in assets at December 31, 2003 and advised clients representing $1.6 trillion worldwide. Russell is also well known for its family of market indices, including the Russell 2000, which provide complete sets of performance benchmarks for investors in the United States.
Robert W. Baird & Co. Incorporated (“Baird”), a subsidiary of Northwestern Mutual, is a registered broker-dealer providing (through it and its affiliates) asset management, investment banking, wealth management and private equity services via offices in the United States, United Kingdom and Germany. Baird serves individuals, corporations, institutional investors and municipalities as financial advisor, asset manager, equity research specialist, investment banker, private equity investor and public finance specialist. It is a member of the New York Stock Exchange.
NMIS, a wholly-owned company of Northwestern Mutual, is a full-service registered broker-dealer serving the investment planning and product needs of individuals and businesses. Through its registered representatives, NMIS offers mutual funds, variable annuities, variable life insurance products, stocks and bonds to its customers in more than 60 cities nationwide. NMIS is a member of the National Association of Securities Dealers, Inc.
See Item 15 herein for the audited consolidated financial statements of Northwestern Mutual.
PURPOSE OF ANNUAL REPORT
This Annual Report on Form 10-K is filed with respect to Account A and Account C of Northwestern Mutual. While certain information in this Form 10-K relates to Northwestern Mutual as a whole, this Form 10-K is intended to provide information with respect to such Account A and Account C where relevant.
ITEM 2.
ITEM 2. PROPERTIES
Account A and Account C own no physical properties. Northwestern Mutual owns and occupies all of the space in its home office complex in Milwaukee, Wisconsin. Northwestern Mutual owns land in Franklin, Wisconsin on which it has been constructing an additional office campus that it expects to occupy in the second quarter of 2004. Northwestern Mutual, as lessee, also occupies temporary space in three buildings adjacent to its Milwaukee complex. Northwestern Mutual is the lessee of eight leases covering its real estate regional offices in locations throughout the United States. Russell and Baird lease their principal office space located in Tacoma, Washington and Milwaukee, Wisconsin, respectively. Northwestern Mutual believes that its owned and leased properties are suitable and adequate for its current operations.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
Neither Account A nor Account C are parties to any pending legal proceedings. Northwestern Mutual is subject to various claims and proceedings, including claims or proceedings related to its investments, that occur in the ordinary course of its business. Based on information currently available to Northwestern Mutual, Northwestern Mutual believes that none of these current claims or proceedings, either individually or in the aggregate, will have a material adverse effect on the financial position of Northwestern Mutual.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
PART II
ITEM 5.
ITEM 5. MARKET FOR THE REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
As segregated asset accounts, Account A and Account C do not issue common equity securities. As a mutual life insurance company, Northwestern Mutual does not issue common equity securities.
The Contracts issued in connection with Account A and Account C, and interests in those Contracts, are offered on a continuous basis to Corporate Plans and HR-10 Plans. The Contracts for Corporate Plans are not registered under the Securities Act of 1933, in reliance on the exemption provided by Section 3(a)(2) thereof. All of the Contracts are offered exclusively by financial representatives of Northwestern Mutual who are also registered representatives of NMIS.
During 2003, the following aggregate dollar amounts of such unregistered securities were sold to Corporate Plans, generating the aggregate commissions stated:
(A) Reflects premiums paid by Contract holders, dividend additions and Northwestern Mutual plan contributions, as applicable.
(B) Reflects an estimate of amounts paid to Northwestern Mutual financial representatives for sales to Corporate Plans based on a pro rata allocation of Contract sales generating commissions under the Account.
Accumulation units in Account A and Account C represent the interests of Contract owners. Purchase payments are applied to credit additional accumulation units based on the accumulation unit value next determined after each payment is received. Accumulation units are valued as of the close of business on the New York Stock Exchange for each day the Exchange is open, and at any other time required by the Investment Act of 1940.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following tables set forth selected historical financial data for Account A for the five years in the period ended December 31, 2003. The data should be read in conjunction with the financial statements and notes thereto of Account A contained in Item 8 of this Annual Report.
RESULTS OF OPERATIONS FOR ACCOUNT A
(IN THOUSANDS)
** Became an investment option under the Contracts effective April 30, 1999.
# Became an investment option under the Contracts effective July 31, 2001.
^ Prior to January 31, 2003 this Division was named the J.P. Morgan Select Growth and Income Stock Division.
## Became an investment option under the Contracts effective May 1, 2003.
CHANGES IN EQUITY FOR ACCOUNT A
(IN THOUSANDS)
TOTAL ASSETS OF ACCOUNT A
(IN THOUSANDS)
# Became an investment option under the Contracts effective July 31, 2001.
^ Prior to January 31, 2003 this Division was named the J.P. Morgan Select Growth and Income Stock Division.
## Became an investment option under the Contracts effective May 1, 2003.
The following tables set forth selected historical financial data for Account C for the five years in the period ended December 31, 2003. The data should be read in conjunction with the financial statements and notes thereto of Account C contained in Item 8 of this Annual Report.
RESULTS OF OPERATIONS FOR ACCOUNT C
(IN THOUSANDS)
** Became an investment option under the Contracts effective April 30, 1999.
# Became an investment option under the Contracts effective July 31, 2001.
^ Prior to January 31, 2003 this Division was named the J.P. Morgan Select Growth and Income Stock Division.
## Became an investment option under the Contracts effective May 1, 2003.
CHANGES IN EQUITY FOR ACCOUNT C
(IN THOUSANDS)
TOTAL ASSETS OF ACCOUNT C
(IN THOUSANDS)
# Became an investment option under the Contracts effective July 31, 2001.
^ Prior to January 31, 2003 this Division was named the J.P. Morgan Select Growth and Income Stock Division.
## Became an investment option under the Contracts effective May 1, 2003.
ITEM 7.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
INTRODUCTION
The results of operations for Accounts A and C are primarily impacted by the investment results of the underlying Divisions. The investment results of the underlying Divisions are primarily driven by the investment results of the related Portfolio of the Northwestern Mutual Series Fund, Inc., Fidelity Variable Insurance Products Fund III or Russell Investment Funds. The pro-rata portion of the investment results of the related Portfolio attributable to Accounts A and C are reflected in the Statement of Operations and Statement of Changes in Equity as Dividend Income, Realized Gain (Loss) on Investments and Unrealized Appreciation (Depreciation) of Investments. The other item impacting the results of operations is the Annuity Rate and Expense Guarantees, which are owed to Northwestern Mutual and are an expense of the Division.
Sources of cash for Accounts A and Account C include premium payments which are reflected on the Statement of Changes in Equity, in the Equity Transactions section line item titled Contract Owners’ Net Payments. Uses of cash for Accounts A and C include annuity payments and policy surrenders. These are also reflected on the Statement of Changes in Equity.
The primary risks associated with assets of Accounts A and C are investment related risks or market risk. It should be noted that Accounts A and C represent a small portion of the net assets of the related Portfolio for each Division.
LIQUIDITY
The assets of Accounts A and C are invested solely in shares of Northwestern Mutual Series Fund, Inc. (“Series Fund”), the Fidelity Variable Insurance Products Fund III (“Fidelity Fund”), and the Russell Investment Funds (“Russell Funds,” and collectively with the Series Fund and Fidelity Fund, the “Funds”). The Series Fund consists of the Small Cap Growth Stock Portfolio, T. Rowe Price Small Cap Value Portfolio, Aggressive Growth Stock Portfolio, International Growth Portfolio, Franklin Templeton International Equity Portfolio, AllianceBernstein Mid Cap Value Portfolio, Index 400 Stock Portfolio, Janus Capital Appreciation Portfolio, Growth Stock Portfolio, Large Cap Core Stock Portfolio, Capital Guardian Domestic Equity Portfolio, T. Rowe Price Equity Income Portfolio, Index 500 Stock Portfolio, Asset Allocation Portfolio, Balanced Portfolio, High Yield Bond Portfolio, Select Bond Portfolio, and Money Market Portfolio. The Fidelity Fund consists of the Fidelity VIP Mid Cap Portfolio (for purposes of Account A and C investment). The Russell Funds consist of the Multi-Style Equity Fund, Aggressive Equity Fund, Non-U.S. Fund, Core Bond Fund and Real Estate Securities Fund. The Funds are open-end investment companies registered under the Investment Company Act of 1940. In order to pay annuity benefits and expenses, the Accounts redeem shares in the Funds.
CAPITAL RESOURCES
Accounts A and C have no material commitments for capital expenditures as of December 31, 2003, the end of the most recent fiscal year. All payments from Contract owners of Account A and Account C, less any sales load or installation fee, are invested in shares of the Funds. The capital resources of Account A and Account C are the equity in the respective Accounts. This consists of payments from the Contract owners, plus unrealized and realized appreciation on the investment of these payments, plus investment income received from the Funds, minus payment of annuity benefits and expenses.
RESULTS OF OPERATIONS
Accumulation units in Account A and Account C represent the interests of Contract owners. The value of an accumulation unit in each Division varies with the investment experience of the Division, which in turn is determined by the investment experience of the corresponding Portfolio or Fund. Set forth below for each of Account A and Account C are accumulation unit values at December 31, 2003, 2002, and 2001 for each Division, and the percentage change in such values from year to year.
ACCOUNT A
ACCUMULATION UNIT VALUES
CONTRACTS ISSUED PRIOR TO DECEMBER 17, 1981:
^ Prior to January 31, 2003 this Division was named the J.P. Morgan Select Growth and Income Stock Division.
* Includes accumulation unit values at inception date in 2003 for portfolios becoming effective after December 31, 2002.
## Became an investment option under the Contracts effective May 1, 2003.
ACCUMULATION UNIT VALUES
CONTRACTS ISSUED AFTER DECEMBER 16, 1981 AND PRIOR TO MARCH 31, 1995:
^ Prior to January 31, 2003 this Division was named the J.P. Morgan Select Growth and Income Stock Division.
* Includes accumulation unit values at inception date in 2003 for portfolios becoming effective after December 31, 2002.
## Became an investment option under the Contracts effective May 1, 2003.
ACCOUNT A
ACCUMULATION UNIT VALUES
CONTRACTS ISSUED ON OR AFTER MARCH 31, 1995 AND PRIOR TO MARCH 31, 2000 - FRONT LOAD VERSION:
^ Prior to January 31, 2003 this Division was named the J.P. Morgan Select Growth and Income Stock Division.
* Includes accumulation unit values at inception date in 2003 for portfolios becoming effective after December 31, 2002.
## Became an investment option under the Contracts effective May 1, 2003.
ACCUMULATION UNIT VALUES
CONTRACTS ISSUED ON OR AFTER MARCH 31, 1995 AND PRIOR TO MARCH 31, 2000 - BACK LOAD VERSION:
^ Prior to January 31, 2003 this Division was named the J.P. Morgan Select Growth and Income Stock Division.
* Includes accumulation unit values at inception date in 2003 for portfolios becoming effective after December 31, 2002.
## Became an investment option under the Contracts effective May 1, 2003.
ACCOUNT A
ACCUMULATION UNIT VALUES
CONTRACTS ISSUED ON OR AFTER MARCH 31, 2000 - FRONT LOAD VERSION:
^ Prior to January 31, 2003 this Division was named the J.P. Morgan Select Growth and Income Stock Division.
* Includes accumulation unit values at inception date in 2003 for portfolios becoming effective after December 31, 2002.
## Became an investment option under the Contracts effective May 1, 2003.
ACCUMULATION UNIT VALUES
CONTRACTS ISSUED ON OR AFTER MARCH 31, 2000 - BACK LOAD VERSION:
^ Prior to January 31, 2003 this Division was named the J.P. Morgan Select Growth and Income Stock Division.
* Includes accumulation unit values at inception date in 2003 for portfolios becoming effective after December 31, 2002.
## Became an investment option under the Contracts effective May 1, 2003.
ACCOUNT A
TOTAL EQUITY:
(IN THOUSANDS)
The increase in 2003’s Total Equity was attributable primarily to investment activities within the Account A: the net change in unrealized appreciation of $98,006 led to an increase in equity derived from investment activities of $89,262 for the year ended December 31, 2003. The remaining change in equity is attributed to the equity transactions for the year ended December 31, 2003. The decline in 2002’s Total Equity was attributable primarily to investment activities within the Account: the net change in unrealized depreciation of $74,854 led to a decrease in equity derived from investment activities of $82,876 for the year ended December 31, 2002. The remaining change in equity is attributed to the equity transactions for the year ended
December 31, 2002.
ACCOUNT C
ACCUMULATION UNIT VALUES
CONTRACTS ISSUED PRIOR TO DECEMBER 17, 1981 OR BETWEEN APRIL 30, 1984 AND
DECEMBER 31, 1991:
^ Prior to January 31, 2003 this Division was named the J.P. Morgan Select Growth and Income Stock Division.
* Includes accumulation unit values at inception date in 2003 for portfolios becoming effective after December 31, 2002.
## Became an investment option under the Contracts effective May 1, 2003.
ACCOUNT C
ACCUMULATION UNIT VALUES
CONTRACTS ISSUED AFTER DECEMBER 16, 1981 AND PRIOR TO MAY 1, 1984:
^ Prior to January 31, 2003 this Division was named the J.P. Morgan Select Growth and Income Stock Division.
* Includes accumulation unit values at inception date in 2003 for portfolios becoming effective after December 31, 2002.
## Became an investment option under the Contracts effective May 1, 2003.
ACCUMULATION UNIT VALUES
CONTRACTS ISSUED AFTER DECEMBER 31, 1991 - FRONT LOAD VERSION:
^ Prior to January 31, 2003 this Division was named the J.P. Morgan Select Growth and Income Stock Division.
* Includes accumulation unit values at inception date in 2003 for portfolios becoming effective after December 31, 2002.
## Became an investment option under the Contracts effective May 1, 2003.
ACCOUNT C
ACCUMULATION UNIT VALUES
CONTRACTS ISSUED AFTER DECEMBER 31, 1991 - SIMPLIFIED LOAD VERSION:
^ Prior to January 31, 2003 this Division was named the J.P. Morgan Select Growth and Income Stock Division.
* Includes accumulation unit values at inception date in 2003 for portfolios becoming effective after December 31, 2002.
## Became an investment option under the Contracts effective May 1, 2003.
TOTAL EQUITY:
(IN THOUSANDS)
The changes in 2003’s Total Equity was attributable primarily to investment activities within the Account: the net change in unrealized appreciation of $103,646 led to a decrease in equity derived from investment activities of $86,530 for the year ended December 31, 2003. The remaining change in equity is attributed to the equity transactions for the year ended December 31, 2003. The changes in 2002’s Total Equity was attributable primarily to investment activities within the Account: the net change in unrealized depreciation of $58,211 led to a decrease in equity derived from investment activities of $85,767 for the year ended December 31, 2002. The remaining change in equity is attributed to the equity transactions for the year ended December 31, 2002.
CRITICAL ACCOUNTING POLICIES
Dividend income and distributions of net realized gains received from the Funds are recorded on the ex-date of the dividends. Transactions in the Funds’ shares are accounted for on the trade date. Annuity reserves are based on published annuity tables. A deduction for annuity rate and expense guarantees is determined daily. Under current law, no federal income taxes are payable with respect to Accounts A and C. Accordingly, no provisions for any such liability has been made.
OFF-BALANCE SHEET ARRANGEMENTS
Each of Account A and Account C had no off-balance sheet arrangement (as defined by S-K 303) during 2003 that have or are reasonably likely to have a current or future effect on the respective Account’s financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to Contract holders.
CONTRACTUAL OBLIGATIONS
At December 31, 2003, neither Account A nor Account C had any contractual obligations classified as long-term debt obligations, capital (finance) lease obligations, operating lease obligations, purchase obligations or other long-term liabilities reflected on their respective balance sheets.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
The assets of Account A and Account C consist entirely of shares of the 18 portfolios of the Series Fund, the Fidelity VIP Mid Cap Portfolio (the “Fidelity Portfolio”), and 5 funds of the Russell Funds, together with current amounts due from the sale of Series Fund, Fidelity Portfolio, and Russell Funds shares and due from Northwestern Mutual. The liabilities of each of Account A and Account C consist of current amounts due to Contract owners, due to Northwestern Mutual and due on purchase of Series Fund, Fidelity Portfolio, and Russell Funds shares. Neither of the Accounts enters into any market risk sensitive instruments, either for trading purposes or for purposes other than trading purposes.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
NML VARIABLE ANNUITY ACCOUNT A
STATEMENTS OF ASSETS AND LIABILITIES
(IN THOUSANDS)
NML VARIABLE ANNUITY ACCOUNT A
STATEMENTS OF ASSETS AND LIABILITIES CONTINUED
(IN THOUSANDS)
^ Prior to January 31, 2003 this Division was named the J.P. Morgan Select Growth and Income Stock Division.
## The initial investment was made May 1, 2003.
The Accompanying Notes are an Integral Part of the Financial Statements.
NML VARIABLE ANNUITY ACCOUNT A
STATEMENTS OF OPERATIONS
(IN THOUSANDS)
^ Prior to January 31, 2003 this Division was named the J.P. Morgan Select Growth and Income Stock Division.
## The initial investment in this Division was made on May 1, 2003.
NML VARIABLE ANNUITY ACCOUNT A
STATEMENTS OF OPERATIONS CONTINUED
(IN THOUSANDS)
^ Prior to January 31, 2003 this Division was named the J.P. Morgan Select Growth and Income Stock Division.
## The initial investment in this Division was made on May 1, 2003.
NML VARIABLE ANNUITY ACCOUNT A
STATEMENTS OF OPERATIONS CONTINUED
(IN THOUSANDS)
# The initial investment in this Division was made on July 31, 2001.
^ Prior to January 31, 2003 this Division was named the J.P. Morgan Select Growth and Income Stock Division.
The Accompanying Notes are an Integral Part of the Financial Statements
NML VARIABLE ANNUITY ACCOUNT A
STATEMENTS OF CHANGES IN EQUITY
(IN THOUSANDS)
^ Prior to January 31, 2003 this Division was named the J.P. Morgan Select Growth and Income Stock Division.
## The initial investment in this Division was made on May 1, 2003.
NML VARIABLE ANNUITY ACCOUNT A
STATEMENTS OF CHANGES IN EQUITY CONTINUED
(IN THOUSANDS)
^ Prior to January 31, 2003 this Division was named the J.P. Morgan Select Growth and Income Stock Division.
## The initial investment in this Division was made on May 1, 2003.
NML VARIABLE ANNUITY ACCOUNT A
STATEMENTS OF CHANGES IN EQUITY CONTINUED
(IN THOUSANDS)
^ Prior to January 31, 2003 this Division was named the J.P. Morgan Select Growth and Income Stock Division.
## The initial investment in this Division was made on May 1, 2003.
NML VARIABLE ANNUITY ACCOUNT A
STATEMENTS OF CHANGES IN EQUITY CONTINUED
(IN THOUSANDS)
# The initial investment in this Division was made on July 31, 2001.
^ Prior to January 31, 2003 this Division was named the J.P. Morgan Select Growth and Income Stock Division.
NML VARIABLE ANNUITY ACCOUNT A
STATEMENTS OF CHANGES IN EQUITY CONTINUED
(IN THOUSANDS)
# The initial investment in this Division was made on July 31, 2001.
^ Prior to January 31, 2003 this Division was named the J.P. Morgan Select Growth and Income Stock Division.
The Accompanying Notes are an Integral Part of the Financial Statements
NML VARIABLE ANNUITY ACCOUNT A
FINANCIAL HIGHLIGHTS
(FOR A UNIT OUTSTANDING DURING THE PERIOD)
NML VARIABLE ANNUITY ACCOUNT A
FINANCIAL HIGHLIGHTS CONTINUED
(FOR A UNIT OUTSTANDING DURING THE PERIOD)
(1) Division commenced operations on July 31, 2001.
(2) Division commenced operations on May 1, 2003.
(3) The lowest and highest unit value is as of the respective period-end date.
(4) Total Return includes deductions for management and other expenses; excludes deductions for sales loads and other charges. Returns are not annualized for periods less than one year.
(5) Prior to January 31, 2003 this Division was named the J.P. Morgan Select Growth and Income Stock Division.
The Accompanying Notes are an Integral Part of the Financial Statements.
NML VARIABLE ANNUITY ACCOUNT A
NOTES TO FINANCIAL STATEMENTS
NOTE 1-NML Variable Annuity Account A (the “Account”) is a segregated asset account of The Northwestern Mutual Life Insurance Company (“Northwestern Mutual”) used to fund variable annuity contracts (“contracts”) for HR-10 and corporate pension and profit-sharing plans which qualify for special tax treatment under the Internal Revenue Code. Currently, two versions of the contract are offered: Front Load contracts with a sales charge up to 4.5% of purchase payments and Back Load contracts with a withdrawal charge of 0-6%.
NOTE 2-The preparation of the financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Principal accounting policies are summarized below.
NOTE 3-All assets of each Division of the Account are invested in shares of the corresponding Portfolio of Northwestern Mutual Series Fund, Inc., Fidelity VIP Mid Cap Portfolio and the Russell Investment Funds (collectively known as the “Funds”). The shares are valued at the Funds’ offering and redemption price per share. The Funds are open-end investment companies registered under the Investment Company Act of 1940.
NOTE 4-Annuity reserves, included in equity, are based on published annuity tables with age adjustment and benefit payments which reflect actual investment experience. For variable payment plans issued prior to January 1, 1974, annuity reserves are based on the 1955 American Annuity Table with assumed interest rates of 3% or 5%. For variable payment plans issued on or after January 1, 1974 and before January 1, 1985, annuity reserves are based on the 1971 Individual Annuity Mortality Table with assumed interest rates of 3.5% or 5%. For variable payment plans issued on or after January 1, 1985, annuity reserves are based on the 1983 Annuity Table a adjusted with assumed interest rates of 3.5% or 5%.
NOTE 5-Dividend income and distributions of net realized gains from the Funds are recorded on the ex-date of the dividends. Transactions in the Funds’ shares are accounted for on the trade date. The basis for determining cost on sale of the Funds’ shares is identified cost. Purchases and sales of the Funds’ shares for the years ended December 31 by each Division are shown below: (in thousands)
# Initial Investment in this division was made on July 31, 2001.
^ Prior to January 31, 2003 this Division was named the J.P. Morgan Select Growth and Income Stock Division.
## Initial Investment in this division was made on May 1, 2003.
NML VARIABLE ANNUITY ACCOUNT A
NOTES TO FINANCIAL STATEMENTS CONTINUED
# Initial Investment in this division was made on July 31, 2001.
^ Prior to January 31, 2003 this Division was named the J.P. Morgan Select Growth and Income Stock Division.
## Initial Investment in this division was made on May 1, 2003.
NML VARIABLE ANNUITY ACCOUNT A
NOTES TO FINANCIAL STATEMENTS CONTINUED
NOTE 6-A deduction for annuity rate and expense guarantees is determined daily and paid to Northwestern Mutual as compensation for assuming the risk that annuity payments will continue for longer periods than anticipated because the annuitants as a group live longer than expected, and the risk that the charges made by Northwestern Mutual may be insufficient to cover the actual costs incurred in connection with the contracts.
For contracts issued prior to December 17, 1981, the deduction is at an annual rate of .75% of the net assets of each Division attributable to these contracts. For these contracts, the rate may be increased or decreased by the Board of Trustees of Northwestern Mutual not to exceed a 1% annual rate.
For contracts issued after December 16, 1981 and prior to March 31, 1995, the deduction is at an annual rate of 1.25% of the net assets of each Division attributable to these contracts. For these contracts, the rate may be increased or decreased by the Board of Trustees of Northwestern Mutual not to exceed a 1.5% annual rate.
For contracts issued on or after March 31, 1995 and prior to March 31, 2000, for the Front Load version and the Back Load version, the deduction for annuity rate and expense guarantees is determined daily at annual rates of .4% and 1.25%, respectively, of the net assets of each Division attributable to these contracts and is paid to Northwestern Mutual. For these contracts, the rates may be increased or decreased by the Board of Trustees of Northwestern Mutual not to exceed .75% and 1.5%, respectively.
For contracts issued on or after March 31, 2000, for the Front Load version and the Back Load version, the deduction for annuity rate and expense guarantees is determined daily at annual rates of .5% and 1.25%, respectively, of the net assets of each Division attributable to these contracts and is paid to Northwestern Mutual. For these contracts, the rates may be increased or decreased by the Board of Trustees of Northwestern Mutual not to exceed .75% and 1.5% annual rates, respectively. The current charges will not be increased for five years from the date of the most recent Prospectus.
Since 1995, Northwestern Mutual has paid a dividend to certain contracts. The dividend is reinvested in the Account and has been reflected as a Contract Owners’ Net Payment in the accompanying financial statements.
NOTE 7-Northwestern Mutual is taxed as a “life insurance company” under the Internal Revenue Code and the operations of the Account form a part of and are taxed with those of Northwestern Mutual. Under current law, no federal income taxes are payable with respect to the Account. Accordingly, no provision for any such liability has been made.
NML VARIABLE ANNUITY ACCOUNT A
NOTES TO FINANCIAL STATEMENTS CONTINUED
NOTE 8- The changes in units outstanding for the years ended December 31, 2003, 2002 and 2001 by each Division are shown as follows: (in thousands)
^ Prior to January 31, 2003 this Division was named the J.P. Morgan Select Growth and Income Stock Division.
## Initial Investment in this division was made on May 1, 2003.
NML VARIABLE ANNUITY ACCOUNT A
NOTES TO FINANCIAL STATEMENTS CONTINUED
^ Prior to January 31, 2003 this Division was named the J.P. Morgan Select Growth and Income Stock Division.
# Initial Investment in this division was made on July 31, 2001.
NOTE 9-Equity Values by Division for the year ended December 31, 2003 are shown below: (in thousands, except accumulation unit values)
^ Prior to January 31, 2003 this Division was named the J.P. Morgan Select Growth and Income Stock Division.
## Initial Investment in this division was made on May 1, 2003.
NML VARIABLE ANNUITY ACCOUNT A
NOTES TO FINANCIAL STATEMENTS CONTINUED
^ Prior to January 31, 2003 this Division was named the J.P. Morgan Select Growth and Income Stock Division.
## Initial Investment in this division was made on May 1, 2003.
NML VARIABLE ANNUITY ACCOUNT A
NOTES TO FINANCIAL STATEMENTS CONTINUED
^ Prior to January 31, 2003 this Division was named the J.P. Morgan Select Growth and Income Stock Division.
## Initial Investment in this division was made on May 1, 2003.
NML VARIABLE ANNUITY ACCOUNT A
NOTES TO FINANCIAL STATEMENTS CONTINUED
Equity Values by Division for the year ended December 31, 2002 are shown below: (in thousands, except accumulation unit values)
^ Prior to January 31, 2003 this Division was named the J.P. Morgan Select Growth and Income Stock Division.
NML VARIABLE ANNUITY ACCOUNT A
NOTES TO FINANCIAL STATEMENTS CONTINUED
^ Prior to January 31, 2003 this Division was named the J.P. Morgan Select Growth and Income Stock Division.
REPORT OF INDEPENDENT AUDITORS
To The Northwestern Mutual Life Insurance Company and Contract Owners of NML Variable Annuity Account A
In our opinion, the accompanying statements of assets and liabilities and the related statements of operations and of changes in equity and the financial highlights present fairly, in all material respects, the financial position of NML Variable Annuity Account A and its Small Cap Growth Stock Division, T. Rowe Price Small Cap Value Division, Aggressive Growth Stock Division, International Growth Stock Division, Franklin Templeton International Equity Division, AllianceBernstein Mid Cap Value Division, Index 400 Stock Division, Janus Capital Appreciation Division, Growth Stock Division, Large Cap Core Stock Division, Capital Guardian Domestic Equity Division, T. Rowe Price Equity Income Division, Index 500 Stock Division, Asset Allocation Division, Balanced Division, High Yield Bond Division, Select Bond Division, Money Market Division, Fidelity VIP Mid Cap Division, Russell Multi-Style Equity Division, Russell Aggressive Equity Division, Russell Non-U.S. Division, Russell Core Bond Division, and Russell Real Estate Securities Division at December 31, 2003 and 2002, and the results of each of their operations, the changes in each of their equity and their financial highlights for the three years ended December 31, 2003, in conformity with accounting principles generally accepted in the United States of America. These financial statements and financial highlights (hereafter referred to as “financial statements”) are the responsibility of The Northwestern Mutual Life Insurance Company’s management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these financial statements in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits, which included direct confirmation of securities owned at December 31, 2003 with Northwestern Mutual Series Fund, Inc., Fidelity VIP Mid Cap Portfolio and the Russell Investment Funds, provide a reasonable basis for our opinion.
/s/ PRICEWATERHOUSECOOPERS LLP
Milwaukee, Wisconsin
January 28, 2004
NML VARIABLE ANNUITY ACCOUNT C
STATEMENTS OF ASSETS AND LIABILITIES
(IN THOUSANDS)
NML VARIABLE ANNUITY ACCOUNT C
STATEMENTS OF ASSETS AND LIABILITIES CONTINUED
(IN THOUSANDS)
^ Prior to January 31, 2003 this Division was named the J.P. Morgan Select Growth and Income Stock Division.
## The initial investment was made on May 1, 2003.
The Accompanying Notes are an Integral Part of the Financial Statements.
NML VARIABLE ANNUITY ACCOUNT C
STATEMENTS OF OPERATIONS
(IN THOUSANDS)
^ Prior to January 31, 2003 this Division was named the J.P. Morgan Select Growth and Income Stock Division.
## The initial investment in this Division was made on May 1, 2003.
NML VARIABLE ANNUITY ACCOUNT C
STATEMENTS OF OPERATIONS CONTINUED
(IN THOUSANDS)
^ Prior to January 31, 2003 this Division was named the J.P. Morgan Select Growth and Income Stock Division.
## The initial investment in this Division was made on May 1, 2003.
NML VARIABLE ANNUITY ACCOUNT C
STATEMENTS OF OPERATIONS CONTINUED
(IN THOUSANDS)
# The initial investment in this Division was made on July 31, 2001.
^ Prior to January 31, 2003 this Division was named the J.P. Morgan Select Growth and Income Stock Division.
The Accompanying Notes are an Integral Part of the Financial Statements
NML VARIABLE ANNUITY ACCOUNT C
STATEMENTS OF CHANGES IN EQUITY
(IN THOUSANDS)
^ Prior to January 31, 2003 this Division was named the J.P. Morgan Select Growth and Income Stock Division.
## The initial investment in this Division was made on May 1, 2003.
NML VARIABLE ANNUITY ACCOUNT C
STATEMENTS OF CHANGES IN EQUITY CONTINUED
(IN THOUSANDS)
^ Prior to January 31, 2003 this Division was named the J.P. Morgan Select Growth and Income Stock Division.
## The initial investment in this Division was made on May 1, 2003.
NML VARIABLE ANNUITY ACCOUNT C
STATEMENTS OF CHANGES IN EQUITY CONTINUED
(IN THOUSANDS)
^ Prior to January 31, 2003 this Division was named the J.P. Morgan Select Growth and Income Stock Division.
## The initial investment in this Division was made on May 1, 2003.
NML VARIABLE ANNUITY ACCOUNT C
STATEMENTS OF CHANGES IN EQUITY CONTINUED
(IN THOUSANDS)
# The initial investment in this Division was made on July 31, 2001.
^ Prior to January 31, 2003 this Division was named the J.P. Morgan Select Growth and Income Stock Division.
NML VARIABLE ANNUITY ACCOUNT C
STATEMENTS OF CHANGES IN EQUITY CONTINUED
(IN THOUSANDS)
# The initial investment in this Division was made on July 31, 2001.
^ Prior to January 31, 2003 this Division was named the J.P. Morgan Select Growth and Income Stock Division.
The Accompanying Notes are an Integral Part of the Financial Statements
NML VARIABLE ANNUITY ACCOUNT C
FINANCIAL HIGHLIGHTS
(FOR A UNIT OUTSTANDING DURING THE PERIOD)
NML VARIABLE ANNUITY ACCOUNT C
FINANCIAL HIGHLIGHTS CONTINUED
(FOR A UNIT OUTSTANDING DURING THE PERIOD)
(1) Division commenced operations on July 31, 2001.
(2) Division commenced operations on May 1, 2003.
(3) The lowest and highest unit value is as of the respective period-end date.
(4) Total Return includes deductions for management and other expenses; excludes deductions for sales loads and other charges. Returns are not annualized for periods less than one year.
(5) Prior to January 31, 2003 this Division was named the J.P. Morgan Select Growth and Income Stock Division.
The Accompanying Notes are an Integral Part of the Financial Statements.
NML VARIABLE ANNUITY ACCOUNT C
NOTES TO FINANCIAL STATEMENTS
NOTE 1 - NML Variable Annuity Account C (the “Account”) is a segregated asset account of The Northwestern Mutual Life Insurance Company (“Northwestern Mutual”) used to fund variable annuity contracts (“contracts”) for HR-10 and corporate pension and profit-sharing plans which qualify for special tax treatment under the Internal Revenue Code. Currently, two versions of the contract are offered: Front Load contracts with a sales charge up to 4.5% of purchase payments and Simplified Load contracts with an installation fee of $750.
NOTE 2 - The preparation of the financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Principal accounting policies are summarized below.
NOTE 3 - All assets of each Division of the Account are invested in shares of the corresponding Portfolio of Northwestern Mutual Series Fund, Inc., Fidelity VIP Mid Cap Portfolio and the Russell Investment Funds (collectively know as the “Funds”). The shares are valued at the Funds’ offering and redemption price per share. The Funds are open-end investment companies registered under the Investment Company Act of 1940.
NOTE 4 - Annuity reserves, included in equity, are based on published annuity tables with age adjustments and benefit payments which reflect actual investment experience. Annuity reserves are based on the 1983 Annuity Table a adjusted with assumed interest rates of 3.5% or 5%.
NOTE 5 - Dividend income and distributions of net realized gains from the Funds is recorded on the ex-date of the dividends. Transactions in the Funds’ shares are accounted for on the trade date. The basis for determining cost on sale of the Funds’ shares is identified cost. Purchases and sales of the Funds’ shares for the years ended December 31 by each Division are shown below: (in thousands)
# Initial Investment in this division was made on July 31, 2001.
^ Prior to January 31, 2003 this Division was named the J.P. Morgan Select Growth and Income Stock Division.
## Initial Investment in this division was made on May 1, 2003.
NML VARIABLE ANNUITY ACCOUNT C
NOTES TO FINANCIAL STATEMENTS CONTINUED
# Initial Investment in this division was made on July 31, 2001.
^ Prior to January 31, 2003 this Division was named the J.P. Morgan Select Growth and Income Stock Division.
## Initial Investment in this division was made on May 1, 2003.
NML VARIABLE ANNUITY ACCOUNT C
NOTES TO FINANCIAL STATEMENTS CONTINUED
NOTE 6 - A deduction for annuity rate and expense guarantees is determined daily and paid to Northwestern Mutual as compensation for assuming the risk that annuity payments will continue for longer periods than anticipated because the annuitants as a group live longer than expected and the risk that the charges made by Northwestern Mutual may be insufficient to cover the actual costs incurred in connection with the contracts.
For contracts issued after December 16, 1981, and prior to May 1, 1984, the deduction is determined daily at an annual rate of .5% of the net assets of each Division attributable to these contracts and is paid to Northwestern Mutual. For these contracts, the rate may be increased or decreased by the Board of Trustees of Northwestern Mutual not to exceed a .75% annual rate.
Generally, for contracts issued after December 31, 1991, for the Front Load Version and the Simplified Load Version, the deduction for annuity rate and expense guarantees is determined daily at annual rates of .65% and 1.25%, respectively, of the net assets of each Division attributable to these contracts and is paid to Northwestern Mutual. For these contracts, the rates may be increased or decreased by the Board of Trustees of Northwestern Mutual not to exceed 1% and 1.5% annual rates, respectively.
Since 1996, Northwestern Mutual has paid a dividend to certain contracts. The dividend is re-invested in the Account and has been reflected as a Contract Owners’ Net Payment in the accompanying financial statements.
NOTE 7 - Northwestern Mutual is taxed as a “life insurance company” under the Internal Revenue Code and the operations of the Account form a part of and are taxed with those of Northwestern Mutual. Under current law, no federal income taxes are payable with respect to the Account. Accordingly, no provision for any such liability has been made.
NML VARIABLE ANNUITY ACCOUNT C
NOTES TO FINANCIAL STATEMENTS CONTINUED
NOTE 8 - The changes in units outstanding for the years ended December 31, 2003, 2002 and 2001 by each Division are shown as follows: (in thousands)
^ Prior to January 31, 2003 this Division was named the J.P. Morgan Select Growth and Income Stock Division.
## Initial Investment in this division was made on May 1, 2003.
NML VARIABLE ANNUITY ACCOUNT C
NOTES TO FINANCIAL STATEMENTS CONTINUED
^ Prior to January 31, 2003 this Division was named the J.P. Morgan Select Growth and Income Stock Division.
# Initial Investment in this division was made on July 31, 2001.
NOTE 9 - Equity Values by Division for the year ended December 31, 2003 are shown below: (in thousands, except accumulation unit values)
^ Prior to January 31, 2003 this Division was named the J.P. Morgan Select Growth and Income Stock Division.
## Initial Investment in this division was made on May 1, 2003.
NML VARIABLE ANNUITY ACCOUNT C
NOTES TO FINANCIAL STATEMENTS CONTINUED
^ Prior to January 31, 2003 this Division was named the J.P. Morgan Select Growth and Income Stock Division.
## Initial Investment in this division was made on May 1, 2003.
NML VARIABLE ANNUITY ACCOUNT C
NOTES TO FINANCIAL STATEMENTS CONTINUED
Equity Values by Division for the year ended December 31, 2002 are shown below: (in thousands, except accumulation unit values)
^ Prior to January 31, 2003 this Division was named the J.P. Morgan Select Growth and Income Stock Division.
REPORT OF INDEPENDENT AUDITORS
To The Northwestern Mutual Life Insurance Company and Contract Owners of NML Variable Annuity Account C
In our opinion, the accompanying statements of assets and liabilities and the related statements of operations and of changes in equity and the financial highlights present fairly, in all material respects, the financial position of NML Variable Annuity Account C and its Small Cap Growth Stock Division, T. Rowe Price Small Cap Value Division, Aggressive Growth Stock Division, International Growth Stock Division, Franklin Templeton International Equity Division, AllianceBernstein Mid Cap Value Division, Index 400 Stock Division, Janus Capital Appreciation Division, Growth Stock Division, Large Cap Core Stock Division, Capital Guardian Domestic Equity Division, T. Rowe Price Equity Income Division, Index 500 Stock Division, Asset Allocation Division, Balanced Division, High Yield Bond Division, Select Bond Division, Money Market Division, Fidelity VIP Mid Cap Portfolio Division, Russell Multi-Style Equity Division, Russell Aggressive Equity Division, Russell Non-U.S. Division, Russell Core Bond Division, and Russell Real Estate Securities Division at December 31, 2003 and 2002, and the results of each of their operations, the changes in each of their equity and their financial highlights for the three years ended December 31, 2003, in conformity with accounting principles generally accepted in the United States of America. These financial statements and financial highlights (hereafter referred to as “financial statements”) are the responsibility of The Northwestern Mutual Life Insurance Company’s management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these financial statements in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits, which included direct confirmation of securities owned at December 31, 2003 with Northwestern Mutual Series Fund, Inc., Fidelity VIP Mid Cap Portfolio and the Russell Investment Funds, provide a reasonable basis for our opinion.
/s/ PRICEWATERHOUSECOOPERS LLP
Milwaukee, Wisconsin
January 28, 2004
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
The registrant’s management, with the participation of its Chief Executive Officer and Chief Financial Officer, have evaluated the effectiveness of the registrant’s disclosure controls and procedures (as such term is defined in Rule 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this report. Based on such evaluation, the registrant’s Chief Executive Officer and Chief Financial Officer have concluded that, as of December 31, 2003, those disclosure controls and procedures were effective to provide reasonable assurance that the information required to be disclosed by the registrant in the reports it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Commission’s rules and forms.
There have not been any changes in the registrant’s internal control over financial reporting (as such term is defined in Rule 15d-15(f) under the Exchange Act) during the fourth quarter of 2003 that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Neither Account A nor Account C have any directors or executive officers. The following information, as of March 1, 2004, is provided with respect to each director, including persons nominated or chosen to become directors, of Northwestern Mutual. Northwestern Mutual uses the title of Trustee to denote the directors.
(1) Candidate proposed for re-election by the Board of Trustees for the election to be held at the May 2004 Annual meeting of Policyowners. If re-elected, these Trustees’ terms will expire in May 2008.
The business experience and public company directorships of Northwestern Mutual’s Trustees as of March 1, 2004 are as follows:
Neither Account A nor Account C have Boards of Directors or Audit Committees. Northwestern Mutual’s Board of Trustees has determined that its Audit Committee has at least one “Audit Committee Financial Expert” serving on the Audit Committee. In 2003 Northwestern Mutual’s Board determined Mr. Stephen N. Graff to be the Audit Committee Financial Expert and concurrently determined that he was independent (applying the NASD definition of independent director then in effect).
The following information as of March 1, 2004, is provided with respect to each Executive Officer of Northwestern Mutual. The term of office for all Executive Officers is one year expiring May 31, 2004.
NAME
AGE
CURRENT POSITION AND YEAR ASSUMED
Edward J. Zore
President and Chief Executive Officer (2001)
John M. Bremer
Chief Operating Officer (Chief Compliance Officer) (2001)
Peter W. Bruce
Chief Insurance Officer (2002)
Deborah A. Beck
Executive Vice President (Planning and Technology) (2000)
William H. Beckley
Executive Vice President (Agencies) (2000)
Mason G. Ross
Executive Vice President and Chief Investment Officer (2001)
Mark G. Doll
Senior Vice President (Public Markets) (1996)
Richard L. Hall
Senior Vice President (Life Product) (2004)
William C. Koenig
Senior Vice President and Chief Actuary (1995)
Gregory C. Oberland
Senior Vice President (Insurance Operations) (2004)
Barbara F. Piehler
Senior Vice President and Chief Information Officer (2002)
Gary A. Poliner
Senior Vice President & Chief Financial Officer (2001)
Marcia Rimai
Senior Vice President (Marketing) (2004)
Charles D. Robinson
Senior Vice President (Investment Products and Services) (2001)
John E. Schlifske
Senior Vice President (Investment Products and Services and Affiliates) (2004)
Leonard F. Stecklein
Senior Vice President (Investment Products Operations) (2004)
Frederic H. Sweet
Senior Vice President (Corporate and Government Relations) (1998)
Robert J. Berdan
Vice President, General Counsel and Secretary (2001)
Michael G. Carter
Vice President (Policyowner Services) (2004)
Steven T. Catlett
Vice President (Investment Products) (2004)
David D. Clark
Vice President (Real Estate) (2004)
Gloster B. Current
Vice President (Corporate Planning) (2004)
Thomas E. Dyer
Vice President (Corporate Services) (1998)
Christine H. Fiasca
Vice President (Field System Administration) (2002)
John M. Grogan
Vice President (Field Services and Support) (2004)
John C. Kelly
Vice President and Controller (2004)
Susan A. Lueger
Vice President (Human Resources) (1994)
Jeffrey J. Lueken
Vice President (Securities) (2004)
Jean M. Maier
Vice President (New Business) (2004)
Meridee J. Maynard
Vice President (Disability Income and Long-Term Care) (2004)
Lora A. Rosenbaum
Vice President (Compliance/Best Practices) (2000)
Brenda F. Skelton
Vice President (Communications) (2003)
J. Edward Tippetts
Vice President (Field Development) (2002)
Martha M. Valerio
Vice President (Technology Research and Web Resources) (2001)
W. Ward White
Vice President (Corporate Relations) (2003)
Michael L. Youngman
Vice President (Government Relations) (2001)
All of the Executive Officers, except Charles D. Robinson, Gloster B. Current and Brenda F. Skelton, have been employed by Northwestern Mutual in an executive or management position for more than five years. Mr. Robinson joined Northwestern Mutual in 2001. Prior thereto he was with AIG, Global Retirement Services Division as Chief Marketing Officer and Senior Vice President from 1999 to 2000. From 1980 to 1999, Mr. Robinson served in various positions of increasing responsibility with VALIC/American General Group, most recently as Senior Vice President, Institutional Marketing. Prior to joining Northwestern Mutual in 2003, Mr. Current was Vice President and Chief Marketing Officer for Lincoln Financial Group from 1995 to 2003. Prior to Lincoln Financial, Mr. Current served as Vice President at Citibank, North America in a variety of operations and marketing management assignments, and in key leadership roles at Kentucky Fried Chicken Co., Canadian Canners Ltd., Del Monte Corp., R.J. Reynolds Foods, Inc., Procter and Gamble Co. and AT&T Long Lines. Ms. Skelton joined Northwestern Mutual in 2002. Prior to Northwestern Mutual, Ms. Skelton worked for the Milwaukee Wave professional soccer team from 2001 to 2002 as the general manager of business operations. Ms. Skelton also headed up the marketing function for Midwest Airlines from 1987 to 2000. During her tenure at Midwest Airlines, Ms. Skelton held the positions of Senior Vice President of Marketing, Vice President of Marketing and Director of Marketing Programs. She also served on the Midwest Air Group Inc. Board of Directors from 1995 until her departure in 2000. Prior to Midwest Airlines, Ms. Skelton held a variety of other marketing and product management positions of progressive responsibility.
As indicated above, neither Account A nor Account C have executive officers and thus do not have a “Code of Ethics.” However, Northwestern Mutual has adopted a “Code of Ethics” that applies to Northwestern Mutual’s Chief Executive Officer, Chief Financial Officer and Controller, as well as to the rest of its employees. A copy of Northwestern Mutual’s Guidelines for Business Conduct, which satisfy the Code of Ethics requirements, are filed as Exhibit 14.1 to this Annual Report on Form 10-K.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
Not applicable. Account A and Account C have no directors or executive officers, the Executive Officers and Trustees of Northwestern Mutual spend no substantial portion of their time on matters relating to Accounts A and C, such persons receive no compensation tied specifically to any services provided to Accounts A and C, and the amounts of compensation received by the Executive Officers and Trustees of Northwestern Mutual have no bearing on the values associated with the Contracts issued in connection with Accounts A and C.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Not applicable. As segregated asset accounts, Account A and Account C have no shareholders. As a mutual life insurance company, Northwestern Mutual has no shareholders. No Contract owner is the beneficial owner of more than 5% of Account A, Account C or Northwestern Mutual’s voting securities. Neither Accounts A or C, nor Northwestern Mutual, maintain equity compensation plans under which equity securities are authorized for issuance.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Northwestern Mutual’s subsidiary, Mason Street Advisors, LLC (“MSA”), serves as the investment adviser to the Series Fund. Various Trustees and Executive Officers of Northwestern Mutual serve as directors and officers of the Series Fund and/or MSA and may be deemed to have a direct or indirect material interest in the existence of the investment advisory agreement.
Northwestern Mutual’s subsidiary, Frank Russell Company, provides the Russell Funds and its investment adviser, Frank Russell Investment Management Company (“FRIMCo”), a subsidiary of Frank Russell Company, with asset management consulting services that it provides to its other consulting clients. The Russell Funds do not compensate Russell for these services. FRIMCo is party to an investment advisory agreement with the Russell Funds. Certain Trustees and Executive Officers of Northwestern Mutual serve as directors of Frank Russell Company and may be deemed to have a direct or indirect material interest in the existence of the investment management agreement.
Various Trustees and Executive Officers of Northwestern Mutual (and their family members and associates) may have securities accounts with Baird and/or NMIS and may have effected transactions through such accounts during 2003 and through the date hereof, including transactions in mutual funds sponsored by Northwestern Mutual and Russell.
Trustees and executive officers of Northwestern Mutual (and their family members and associates) own insurance policies and/or other contracts issued by Northwestern Mutual or an insurance affiliate in the ordinary course of business. Loans are made to Northwestern Mutual’s Trustees and Executive Officers (and their family members and associates) in accordance with the provisions of insurance policies or other contracts which they may own. Such loans are made in the ordinary course of business, in accordance with applicable law and are administered solely pursuant to the terms of such policies.
In the ordinary course of its business, Northwestern Mutual makes loans to its field force Managing Partners in connection with their business operations. Interest on such loans is tied to Northwestern Mutual’s cost of funds or the prime rate, depending upon the purpose of the loan. On occasion, a Managing Partner who has received such a loan may assume an Executive Officer position at Northwestern Mutual. In such circumstances, historically the outstanding loans have remained in place and are satisfied in accordance with the terms of the underlying loan documentation.
At December 31, 2003, Mr. Peter M. Sommerhauser, a Northwestern Mutual Trustee since May 1999, was the beneficial owner of approximately 9.1% of the outstanding common stock of Kohl’s Corporation, primarily by virtue of his serving as a trustee of several trusts for the benefit of the families of current and former executive officers of Kohl’s Corporation and as a director of charitable foundations established by executive officers of Kohl’s Corporation. While Mr. Sommerhauser has sole or shared voting and investment power over such shares held in the trusts and foundations, he has no pecuniary interest in those shares. In 1994, a number of years prior to Mr. Sommerhauser becoming a Northwestern Mutual Trustee, Northwestern Mutual lent as part of its normal portfolio investment activities to Kohl’s Department Stores, Inc., a subsidiary of Kohl’s Corporation, $40,000,000
and received a 6.57% Senior Note, guaranteed by Kohl’s Corporation, due March 31, 2004. The principal amount of such indebtedness was reduced to $6,666,667 during 2003, which remains outstanding at March 1, 2004.
Mr. Sommerhauser is a shareholder in the law firm Godfrey & Kahn, S.C. Godfrey & Kahn provided services to Northwestern Mutual during 2003. The aggregate amount of such services billed to Northwestern Mutual is less than 1% of the law firm’s gross revenues for its last fiscal year.
Mr. David A. Erne, a Northwestern Mutual Trustee since July 2002, is a shareholder of Reinhart Boerner Van Deuren s.c. Reinhart Boerner Van Deuren s.c. provided legal services to Northwestern Mutual and certain related entities during 2003. The aggregate amount of such legal services billed to Northwestern Mutual or related entities is less than 1% of the law firm’s gross revenues for its last fiscal year.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
AUDIT FEES
PricewaterhouseCoopers LLP is Account A’s and Account C’s principal accountant. Set forth below are the aggregate fees billed for each of the last two fiscal years for professional services rendered by the principal accountant for the audit or review of Account A’s and Account C’s financial statements or other services that are normally provided by the accountant in connection with statutory and regulatory filings or engagements for those fiscal years.
AUDIT-RELATED FEES
Neither Account A nor Account C had any fees billed for each of the last two fiscal years for assurance and related services by the principal accountant that are reasonably related to the performance of the audit or review of Account A’s and Account C’s financial statements and that are not reported under the caption “Audit Fees” above.
TAX FEES
Neither Account A nor Account C had any fees billed for each of the last two fiscal years for tax compliance, tax advice or tax planning services rendered by their principal accountant.
ALL OTHER FEES
Neither Account A nor Account C had any fees billed for each of the last two fiscal years for products and services provided by their principal accountant that are not otherwise reported under the captions “Audit Fees,” “Audit-Related Fees” and “Tax Fees” above.
PRE-APPROVAL POLICIES AND PROCEDURES
Neither Account A nor Account C have a Board of Directors or Audit Committee and have therefore not adopted pre-approval policies and procedures for audit and non-audit services. However, in 2003 Northwestern Mutual’s Audit Committee adopted an Audit and Non-Audit Services Pre-Approval Policy that does apply to Account A and Account C (the “Policy”).
Under the Policy, the Audit Committee must pre-approve all audit and permissible non-audit services provided by the independent accountant. The Policy requires certain services to be approved on a case-by-case basis by the Audit Committee. Such services that must be approved on a case-by-case basis include the annual financial statement audits of Northwestern Mutual and its subsidiaries. The Policy also provides that other audit services (e.g., services associated with statements, reports and other documents filed with the Commission), audit-related services (e.g., employee benefit plan audits and internal control reviews), tax services (e.g., U.S. federal, state and local tax planning and advice) and all other permissible services may be pre-approved through the adoption by the Audit Committee of a list of authorized services along with specific budgeted amounts for such services. The Audit Committee has established such a list of authorized services. Audit and non-audit services to be provided by Northwestern Mutual’s independent accountant not on such list, or that would exceed the budgeted amount for such
service, must be pre-approved by the Audit Committee on a case-by-case basis. The Policy requires the Northwestern Mutual Audit Committee to be informed on a timely basis of any services rendered by the independent accountant pursuant to such authorized list of services.
The Policy also permits the Audit Committee to delegate to one or more of its members pre-approval authority, which the Audit Committee has done. Those Audit Committee members are required to report any pre-approval decisions to the Audit Committee at its next scheduled meeting.
In 2003, there were no fees paid to Account A’s and Account C’s independent accountant under a de minimis exception to the rules that waives the pre-approval requirements for certain non-audit services.
ITEM 15.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) Financial Statements and Exhibits
REPORT OF INDEPENDENT AUDITORS
To the Board of Trustees and Policyowners of The Northwestern Mutual Life Insurance Company
We have audited the accompanying consolidated statement of financial position of The Northwestern Mutual Life Insurance Company and its subsidiary (“the Company”) as of December 31, 2003 and 2002, and the related consolidated statements of operations, of changes in surplus and of cash flows for each of the three years in the period ended December 31, 2003. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
As described in Note 1 to the financial statements, the Company prepared these consolidated financial statements using accounting practices prescribed or permitted by the Office of the Commissioner of Insurance of the State of Wisconsin (statutory basis of accounting), which practices differ from accounting principles generally accepted in the United States of America. Accordingly, the consolidated financial statements are not intended to represent a presentation in accordance with accounting principles generally accepted in the United States of America. The effects on the consolidated financial statements of the variances between the statutory basis of accounting and accounting principles generally accepted in the United States of America, although not reasonably determinable, are presumed to be material.
In our opinion, the consolidated financial statements audited by us (1) do not present fairly in conformity with generally accepted accounting principles, the financial position of The Northwestern Mutual Life Insurance Company and its subsidiary as of December 31, 2003 and 2002, or the results of their operations or their cash flows for each of the three years in the period ended December 31, 2003 because of the effects of the variances between the statutory basis of accounting and accounting principles generally accepted in the United States of America referred to in the preceding paragraph, and (2) do present fairly, in all material respects, the financial position of The Northwestern Mutual Life Insurance Company and its subsidiary as of December 31, 2003 and 2002 and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2003, on the basis of accounting described in Note 1.
As discussed in Note 15 to the financial statements, the Company adopted the accounting policies in the revised National Association of Insurance Commissioners “Accounting Practices and Procedures Manual” - Effective January 1, 2001, as required by the Office of the Commissioner of Insurance of the State of Wisconsin. The effect of adoption is recorded as an adjustment to surplus as of January 1, 2001.
/s/ PRICEWATERHOUSECOOPERS LLP
Milwaukee, Wisconsin
January 26, 2004
THE NORTHWESTERN MUTUAL LIFE INSURANCE COMPANY
CONSOLIDATED STATEMENT OF FINANCIAL POSITION
(IN MILLIONS)
The accompanying notes are an integral part of these financial statements.
THE NORTHWESTERN MUTUAL LIFE INSURANCE COMPANY
CONSOLIDATED STATEMENT OF OPERATIONS
(IN MILLIONS)
The accompanying notes are an integral part of these financial statements.
THE NORTHWESTERN MUTUAL LIFE INSURANCE COMPANY
CONSOLIDATED STATEMENT OF CHANGES IN SURPLUS
(IN MILLIONS)
The accompanying notes are an integral part of these financial statements.
THE NORTHWESTERN MUTUAL LIFE INSURANCE COMPANY
CONSOLIDATED STATEMENT OF CASH FLOWS
(IN MILLIONS)
The accompanying notes are an integral part of these financial statements.
THE NORTHWESTERN MUTUAL LIFE INSURANCE COMPANY
NOTES TO CONSOLIDATED STATUTORY FINANCIAL STATEMENTS
DECEMBER 31, 2003, 2002 AND 2001
1. BASIS OF PRESENTATION AND CHANGES IN ACCOUNTING PRINCIPLES
The accompanying consolidated statutory financial statements include the accounts of The Northwestern Mutual Life Insurance Company and its wholly-owned subsidiary, Northwestern Long Term Care Insurance Company (together, “the Company”). All intercompany balances and transactions have been eliminated. The Company offers life, annuity, disability income and long-term care insurance products to the personal, business, and estate markets.
The consolidated financial statements were prepared in conformity with accounting practices prescribed or permitted by the Office of the Commissioner of Insurance of the State of Wisconsin (“statutory basis of accounting”). Financial statements prepared on the statutory basis of accounting differ from financial statements prepared in accordance with generally accepted accounting principles (“GAAP”), primarily because on a GAAP basis: (1) certain policy acquisition costs are deferred and amortized, (2) investment valuations and policy benefit reserves use different methods and assumptions, (3) deposit-type contracts, for which premiums, benefits and reserve changes are not included in revenue or benefits as reported in the statement of operations, are defined differently, (4) majority-owned, non-insurance subsidiaries are consolidated, (5) changes in deferred taxes are reported as a component of net income, and (6) no deferral of realized investment gains and losses is permitted. The effects on the financial statements of the Company attributable to the differences between the statutory basis of accounting and GAAP are material.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The preparation of financial statements in conformity with the statutory basis of accounting required management to use assumptions or make estimates that affected the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual future results could differ from these assumptions and estimates.
INVESTMENTS
See Note 3 regarding the reported statement value and estimated fair value of the Company’s investments in bonds, common and preferred stocks, mortgage loans and real estate.
POLICY LOANS
Policy loans primarily represent amounts borrowed from the Company by life insurance policyowners, secured by the cash value of the related policies. They are reported in the financial statements at unpaid principal balance.
OTHER INVESTMENTS
Other investments consist primarily of real estate joint ventures, partnership investments (including real estate, venture capital and leveraged buyout fund limited partnerships), leveraged leases and unconsolidated non-insurance subsidiaries. These investments are valued based on the equity method of accounting, which approximates fair value. Other investments also include derivative financial instruments. See Note 4 regarding the Company’s use of derivatives and their valuation in the financial statements.
TEMPORARY INVESTMENTS
Temporary investments represent securities that had maturities of one year or less at purchase, and are reported at amortized cost, which approximates fair value.
NET INVESTMENT INCOME
Net investment income primarily represents interest and dividends received or accrued on bonds, mortgage loans, policy loans and other investments. It also includes amortization of any purchase premium or discount using the interest method, adjusted prospectively for any change in estimated yield-to-maturity. Accrued investment income more than 90 days past due is nonadmitted and reported as a direct reduction of surplus. Accrued investment income that is ultimately deemed uncollectible is reported as a reduction of net investment income in the period that such determination is made. Net investment income also includes dividends paid to the Company from accumulated earnings of joint ventures, partnerships, and unconsolidated
THE NORTHWESTERN MUTUAL LIFE INSURANCE COMPANY
NOTES TO CONSOLIDATED STATUTORY FINANCIAL STATEMENTS CONTINUED
DECEMBER 31, 2003, 2002 AND 2001
subsidiaries. Net investment income is reduced by investment management expenses, real estate depreciation, depletion related to energy assets and interest costs associated with securities lending.
INTEREST MAINTENANCE RESERVE
The Company is required to maintain an interest maintenance reserve (“IMR”). The IMR is used to defer realized gains and losses, net of income tax, on fixed income investments that are attributable to changes in interest rates. Net realized gains and losses deferred to the IMR are amortized into investment income over the estimated remaining term to maturity of the investment sold.
INVESTMENT CAPITAL GAINS AND LOSSES
Realized capital gains and losses are recognized based upon specific identification of securities sold. Realized capital losses also include valuation adjustments for impairment of bonds, stocks, mortgage loans, real estate and other investments that have experienced a decline in fair value that management considers to be other-than-temporary. Factors considered in evaluating whether a decline in value is other-than-temporary include: (1) whether the decline is substantial, (2) the Company’s ability and intent to retain the investment for a period of time sufficient to allow for an anticipated recovery in value, (3) the duration and extent to which the fair value has been less than cost, and (4) the financial condition and near-term prospects of the issuer. Realized capital gains and losses as reported in the consolidated statement of operations exclude any IMR deferrals. See Note 3 regarding details of realized capital gains and losses.
Unrealized capital gains and losses primarily represent changes in the reported fair value of common stocks and changes in valuation adjustments made for bonds in or near default. Changes in the Company’s share of undistributed earnings of joint ventures, partnerships, and unconsolidated subsidiaries are also classified as changes in unrealized capital gains and losses. See Note 3 regarding details of changes in unrealized capital gains and losses.
ASSET VALUATION RESERVE
The Company is required to maintain an asset valuation reserve (“AVR”). The AVR represents a general reserve liability for invested asset valuation using a formula prescribed by the National Association of Insurance Commissioners (“NAIC”). The AVR is designed to protect surplus against potential declines in the value of the Company’s investments. Increases or decreases in AVR are reported as direct adjustments to surplus.
SEPARATE ACCOUNTS
See Note 7 regarding separate account assets and liabilities reported by the Company.
PREMIUM REVENUE
Life insurance premiums are recognized as revenue at the beginning of each policy year. Annuity, disability income and long-term care insurance premiums are recognized as revenue when received by the Company. Considerations received on supplementary insurance contracts without life contingencies are deposit-type transactions and thereby excluded from revenue in the consolidated statement of operations. Premium revenue is reported net of ceded reinsurance, see Note 9.
OTHER INCOME
Other income primarily represents ceded reinsurance expense allowances and various insurance policy charges.
BENEFIT PAYMENTS TO POLICYOWNERS AND BENEFICIARIES
Benefit payments to policyowners and beneficiaries include death, surrender and disability benefits, as well as matured endowments and payments on supplementary insurance contracts that include life contingencies. Benefit payments on supplementary insurance contracts without life contingencies are deposit-type transactions and thereby excluded from benefits in the consolidated statement of operations. Benefit payments are reported net of ceded reinsurance recoveries, see Note 9.
THE NORTHWESTERN MUTUAL LIFE INSURANCE COMPANY
NOTES TO CONSOLIDATED STATUTORY FINANCIAL STATEMENTS CONTINUED
DECEMBER 31, 2003, 2002 AND 2001
RESERVES FOR POLICY BENEFITS
See Note 5 regarding the methods and assumptions used to establish the Company’s reserves for future insurance policy benefits.
COMMISSIONS AND OPERATING EXPENSES
Commissions and other operating costs, including costs of acquiring new insurance policies, are generally charged to expense as incurred.
ELECTRONIC DATA PROCESSING EQUIPMENT AND SOFTWARE
The cost of electronic data processing (“EDP”) equipment and operating system software used in the Company’s business is generally capitalized and depreciated over three years using the straight-line method. Non-operating system software is generally capitalized and depreciated over a maximum of five years. EDP equipment and operating software assets of $25 million and $20 million at December 31, 2003 and 2002, respectively, are reported in other assets in the consolidated statement of financial position and are net of accumulated depreciation of $56 million and $48 million, respectively. Non-operating software costs, net of accumulated depreciation, are nonadmitted assets and thereby excluded from reported assets and surplus in the consolidated statement of financial position. Depreciation expense totaled $42 million, $27 million and $14 million for the years ended December 31, 2003, 2002 and 2001, respectively.
FURNITURE AND EQUIPMENT
The cost of furniture, fixtures and equipment, including leasehold improvements, is generally capitalized and depreciated over the useful life of the assets using the straight-line method. Furniture, fixtures and equipment costs, net of accumulated depreciation, are nonadmitted assets and thereby excluded from reported assets and surplus in the consolidated statement of financial position. Depreciation expense totaled $6 million, $6 million and $5 million for the years ended December 31, 2003, 2002 and 2001, respectively.
POLICYOWNER DIVIDENDS
Almost all life insurance and disability income policies and certain annuity contracts and long-term care policies issued by the Company are participating. Annually, the Company’s Board of Trustees approves dividends payable on participating policies during the subsequent fiscal year, which are accrued and charged to operations when approved. Participating policyowners generally have the option to direct their dividends to be paid in cash, used to reduce future premiums due or used to purchase additional insurance. A majority of dividends are used by policyowners to purchase additional insurance and are reported as premiums in the consolidated statement of operations, but are not included in premiums received or policy benefits paid in the consolidated statement of cash flows.
NONADMITTED ASSETS
Certain assets are designated as nonadmitted on the statutory basis of accounting. Such assets, principally assets related to pension funding, amounts advanced to or due from the Company’s financial representatives and furniture, fixtures, equipment, and non-operating software (net of accumulated depreciation) are excluded from reported assets and surplus in the consolidated statement of financial position. Changes in nonadmitted assets are reported as a direct adjustment to surplus.
RECLASSIFICATIONS
Certain financial statement balances have been reclassified to conform to the current year presentation.
THE NORTHWESTERN MUTUAL LIFE INSURANCE COMPANY
NOTES TO CONSOLIDATED STATUTORY FINANCIAL STATEMENTS CONTINUED
DECEMBER 31, 2003, 2002 AND 2001
3. INVESTMENTS
BONDS
Investments in bonds are reported in the financial statements at amortized cost, less any valuation adjustment. The interest method is used to amortize any purchase premium or discount. Use of the interest method for loan-backed bonds and structured securities includes estimates of future prepayments obtained from independent sources. Prepayment assumptions are updated at least annually, with the prospective adjustment method used to recognize related changes in the estimated yield-to-maturity of such securities.
Valuation adjustments are made for bonds in or near default, which are reported at the lower of amortized cost or fair value, or for bonds with a decline in fair value that management considers to be other-than-temporary.
Estimated fair value is based upon values published by the Securities Valuation Office (“SVO”) of the NAIC. In the absence of SVO-published values, estimated fair value is based upon quoted market prices, if available. For bonds without quoted market prices, fair value is estimated using independent pricing services or internally developed pricing models.
Statement value and estimated fair value of bonds at December 31, 2003 and 2002 were as follows:
Statement value and estimated fair value of bonds by contractual maturity at December 31, 2003 are shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
THE NORTHWESTERN MUTUAL LIFE INSURANCE COMPANY
NOTES TO CONSOLIDATED STATUTORY FINANCIAL STATEMENTS CONTINUED
DECEMBER 31, 2003, 2002 AND 2001
COMMON AND PREFERRED STOCKS
Common stocks are generally reported in the financial statements at fair value, which is based upon quoted market prices, if available. For common stocks without quoted market prices, fair value is estimated using independent pricing services or internally developed pricing models. The equity method is used to value investments in common stock of unconsolidated subsidiaries.
Preferred stocks rated “1” (highest quality), “2” (high quality), or “3” (medium quality) by the SVO are reported in the financial statements at amortized cost. All other preferred stock is reported at the lower of amortized cost or fair value. Estimated fair value is based upon quoted market prices, if available. For preferred stock without quoted market prices, fair value is estimated using independent pricing services or internally developed pricing models.
MORTGAGE LOANS
Mortgage loans are reported in the financial statements at unpaid principal balance, less any valuation allowance or unamortized commitment or origination fee. Such fees are generally deferred upon receipt and amortized into investment income using the interest method. Mortgage loans are collateralized by properties located throughout the United States and Canada. The Company attempts to minimize mortgage loan investment risk by diversification of borrowers, geographic locations and types of collateral properties.
The maximum and minimum interest rates for mortgage loans originated during 2003 were 8.5% and 3.6%, respectively, while these rates during 2002 were 8.2% and 5.0%, respectively. The aggregate average ratio of amounts loaned to the value of collateral for mortgage loans originated during 2003 and 2002 were 66% and 65%, respectively, with a maximum of 100% for any single loan during each of 2003 and 2002.
Mortgage loans are considered impaired when, based on current information, management considers it probable that the Company will be unable to collect all principal and interest due according to the contractual terms of the loan. If necessary, a valuation adjustment is made to reduce the carrying value of an impaired loan to the lower of unpaid principal balance or estimated net realizable value based on appraisal of the collateral property. If the impairment is considered to be temporary, the valuation adjustment is reported as an unrealized loss. Valuation adjustments for impairments considered to be other-than-temporary are reported as realized losses. At December 31, 2003 and 2002, the reported value of mortgage loans was reduced by $13 million and $44 million, respectively, in valuation adjustments.
REAL ESTATE
Real estate investments are reported in the financial statements at cost, less any valuation adjustment, encumbrances and accumulated depreciation of buildings and other improvements using a straight-line method over the estimated useful lives of the improvements. An investment in real estate is considered impaired when, based on current information, the estimated fair value of the property is lower than depreciated cost. The estimated fair value is primarily based upon the present value of future cash flow (for commercial properties) or the capitalization of stabilized net operating income (for residential properties). When the Company determines that an investment in real estate is impaired, a valuation adjustment is made to reduce the carrying value to estimated fair value, net of encumbrances. Valuation adjustments are reported as a realized loss. At both December 31, 2003 and 2002 there was no valuation adjustment in determining the reported value of real estate investments.
At December 31, 2003 and 2002, the reported value of real estate included $180 million and $124 million, respectively, of real estate properties occupied by the Company.
LEVERAGED LEASES
Leveraged leases are reported in the financial statements at the present value of future minimum lease payments, plus the residual value of the leased asset. At December 31, 2003 and 2002, the reported value of leveraged leases was $513 million and $532 million, respectively. The reported value of leveraged leases at December 31, 2003 and 2002 was reduced by $0 and $108 million, respectively, to reflect a decline in value of certain aircraft leases that management considered to be other-than-temporary. The decline in value was charged against an existing valuation allowance and was not reported as a realized capital loss during 2002.
THE NORTHWESTERN MUTUAL LIFE INSURANCE COMPANY
NOTES TO CONSOLIDATED STATUTORY FINANCIAL STATEMENTS CONTINUED
DECEMBER 31, 2003, 2002 AND 2001
Leveraged leases are included in other investments and primarily represent investments in commercial aircraft or real estate property that are leased to third parties and serve as collateral for non-recourse borrowings.
CAPITAL GAINS AND LOSSES
Realized investment gains and losses for the years ended December 31, 2003, 2002 and 2001 were as follows:
Proceeds from the sale of bond investments totaled $83 billion, $53 billion and $30 billion for the years ended December 31, 2003, 2002, and 2001, respectively. Realized losses (before capital gains taxes) included $405 million, $588 million, and $457 million for the years ended December 31, 2003, 2002, and 2001, respectively, of valuation adjustments for declines in fair value of investments that were considered to be other-than-temporary.
The amortized cost and estimated fair value of bonds and common and preferred stocks for which the estimated fair value had temporarily declined and remained below cost as of December 31, 2003, were as follows:
Changes in net unrealized investment gains and losses for the years ended December 31, 2003, 2002, and 2001 were as follows:
THE NORTHWESTERN MUTUAL LIFE INSURANCE COMPANY
NOTES TO CONSOLIDATED STATUTORY FINANCIAL STATEMENTS CONTINUED
DECEMBER 31, 2003, 2002 AND 2001
SECURITIES LENDING
The Company has entered into securities lending agreements whereby certain investment securities are loaned to third parties, primarily major brokerage firms. The Company’s policy requires a minimum of 102% of the fair value of the loaned securities, calculated on a daily basis, as collateral in the form of either cash or securities held by the Company or a trustee. At December 31, 2003 and 2002, unrestricted cash collateral held by the Company of $2.5 billion and $1.6 billion, respectively, is reported in cash and invested assets and the offsetting collateral liability of $2.5 billion and $1.6 billion, respectively, is reported in other liabilities in the consolidated statement of financial position. Additional non-cash collateral of $482 million and $389 million is held on the Company’s behalf by a trustee at December 31, 2003 and 2002, respectively, and is not included in the consolidated statement of financial position.
REPURCHASE AGREEMENTS
The Company has entered into agreements whereby the Company sells and agrees to repurchase certain mortgage-backed securities. At December 31, 2002, the book value of securities subject to these agreements and included in the reported value of bonds was $1.0 billion, while the repurchase obligation liability of $1.0 billion was reported in other liabilities in the consolidated statement of financial position. Securities subject to these agreements had contractual maturities of 30 years at December 31, 2002 and a weighted average interest rate of 5.8%. There were no outstanding repurchase commitments at December 31, 2003.
4. DERIVATIVE FINANCIAL INSTRUMENTS
In the normal course of business, the Company enters into derivative transactions, generally to mitigate the risk to Company assets and surplus of fluctuations in interest rates, foreign currency exchange rates and other market risks. Derivative investments are reported as other investments in the consolidated statement of financial position. Cash flow and fair value hedges that qualify for hedge accounting are accounted for in a manner consistent with the hedged item (e.g. amortized cost or fair value) whereas cash flow and fair value hedges that do not qualify for hedge accounting are accounted for at fair value. Fair value is estimated as the amount that the Company would expect to receive or pay upon termination of the contract at the reporting date.
In addition to cash flow and fair value hedges, the Company entered into replication transactions during 2003 and 2002. A replication transaction is a derivative transaction entered into in conjunction with other investment transactions in order to replicate the investment characteristics of otherwise permissible investments.
The Company does not take positions in derivatives for income generation purposes.
The Company implemented Statement of Statutory Accounting Principles (“SSAP”) No. 86, Accounting for Derivative Instruments and Hedging Activities, which superceded SSAP 31, effective January 1, 2003. Upon implementation the Company had the option of applying the new guidance to all derivatives to which the Company was a party to as of January 1, 2003 or continuing to use the existing guidance of SSAP 31 for all derivatives held as of December 31, 2002. The Company chose to apply SSAP 86 guidance retroactively to derivatives held prior to January 1, 2003. The impact on surplus from the adoption of SSAP 86 was considered to be immaterial.
THE NORTHWESTERN MUTUAL LIFE INSURANCE COMPANY
NOTES TO CONSOLIDATED STATUTORY FINANCIAL STATEMENTS CONTINUED
DECEMBER 31, 2003, 2002 AND 2001
The Company held the following derivative positions at December 31, 2003 and 2002:
The notional or contractual amounts of derivative financial instruments are used to denominate the transactions and do not represent the amounts exchanged between the parties.
Foreign currency swaps are cash flow hedges used to mitigate exposure to variable U.S. dollar cash flows from certain bonds denominated in foreign currencies. A foreign currency swap is a contractual agreement to exchange the currencies of two different countries at a specified rate of exchange in the future.
Interest rate swaps are cash flow hedges used to mitigate exposure to variable interest payments on certain floating rate bonds. An interest rate swap is a contractual agreement to pay a floating rate of interest, based upon a reference index, in exchange for a fixed rate of interest established at the origination of the contract.
Swaptions are cash flow hedges used to mitigate the asset/liability risks of a significant and sustained increase or decrease in interest rates for certain of the Company’s insurance products. Swaptions are a contractual agreement whereby one party holds an option to enter into an interest rate swap with another party on predefined terms.
Interest rate floors are cash flow hedges used to mitigate the asset/liability risks of a significant and sustained decrease in interest rates. Floors entitle the Company to receive settlement payments from the counterparties if interest rates decline below a specified level.
Short equity index futures contracts are fair value hedges that are used to mitigate exposure to market fluctuations for the Company’s portfolio of common stocks. Futures contracts obligate the Company to buy or sell a financial instrument at a specified future date for a specified price.
Fixed income futures contracts are fair value hedges used to mitigate interest rate risk for a portion of its fixed maturity investment portfolio. These futures contracts obligate the Company to buy or sell a financial instrument at a specified future date for a specified price.
Foreign currency forward contracts are fair value hedges used to mitigate the foreign exchange risk for portfolios of investments denominated in foreign currencies. Foreign currency forward contracts obligate the Company to deliver a specified amount of foreign currency at a future date at a specified exchange rate.
THE NORTHWESTERN MUTUAL LIFE INSURANCE COMPANY
NOTES TO CONSOLIDATED STATUTORY FINANCIAL STATEMENTS CONTINUED
DECEMBER 31, 2003, 2002 AND 2001
Credit default swaps are fair value hedges used to protect against a decrease in bond prices due to credit concerns for certain bond issuers. A credit default swap allows the Company to put the bond to a counterparty at par upon a “credit event” sustained by the bond issuer. A credit event is defined as bankruptcy, failure to pay, or obligation acceleration.
Commodity swaps are fair value hedges used to mitigate exposure to market fluctuations for the forward sale of crude oil and natural gas production. Commodity swaps are agreements whereby one party pays a floating commodity price in exchange for a specified fixed commodity price.
Credit default swap replication transactions are used by the Company to create a fixed income investment through the use of derivatives and cash market instruments. These replication transactions, including the derivative component, are reported at amortized cost. During 2003 and 2002, the average fair value of such contracts was $0 and ($1) million, respectively. No realized gains or losses were recognized during 2003 or 2002 on the termination of such contracts.
Long fixed income futures replication contracts are used by the Company to manage the duration of the fixed income portfolio and mitigate exposure to interest rate changes. These replication transactions are reported at fair value, with changes in fair value reflected as a component of unrealized gains and losses until such time as the contracts are terminated. During 2003 and 2002, the average fair value of such contracts was $0. Realized gains of $29 million and $5 million were recognized during 2003 and 2002 on the termination of such contracts.
Long equity futures replication contracts are used by the Company to gain equity market investment exposure. These replication transactions are reported at fair value, with changes in fair value reflected as a component of unrealized gains and losses until such time as the contracts are terminated. During 2003 and 2002, the average fair value of such contracts was $0 and $73 million, respectively. Realized gains of $28 million and $10 million were recognized during 2003 and 2002, respectively, on the termination of such contracts.
5. RESERVES FOR POLICY BENEFITS
Reserves for policy benefits represent the net present value of future policy benefits, less future policy premiums, estimated using actuarial methods based on mortality and morbidity experience tables and valuation interest rates prescribed or permitted by the Office of the Commissioner of Insurance of the State of Wisconsin (“OCI”). Use of these actuarial tables and methods involved assumptions regarding future mortality and morbidity. Actual future experience could differ from the assumptions used to make these estimates.
General account reserves for policy benefits at December 31, 2003 and 2002 are summarized below:
Life insurance reserves on substantially all policies issued since 1978 are based on the Commissioner’s Reserve Valuation Method (“CRVM”) with interest rates ranging from 3½% to 5½% and the 1958 or 1980 CSO mortality tables. Other life insurance reserves are primarily based on the net level premium method, using various mortality tables at interest rates ranging from 2% to 4½%. As of December 31, 2003, the Company has $810 billion of total life insurance in-force, including $8.7 billion of life insurance in-force for which gross premiums are less than net premiums according to the standard valuation methods and assumptions prescribed by the OCI.
THE NORTHWESTERN MUTUAL LIFE INSURANCE COMPANY
NOTES TO CONSOLIDATED STATUTORY FINANCIAL STATEMENTS CONTINUED
DECEMBER 31, 2003, 2002 AND 2001
As of January 1, 2001, the Company changed the valuation basis for reserves on certain term life insurance policies. The impact of this change increased policy benefit reserves by $61 million, and was reported as a direct reduction of surplus for the year ended December 31, 2001.
Tabular cost has been determined from the basic data for the calculation of policy reserves. Tabular cost less actual reserves released has been determined from the basic data for the calculation of reserves and reserves released. Tabular interest has been determined from the basic data for the calculation of policy reserves. Tabular interest on funds not involving life contingencies is calculated as the product of the valuation rate of interest times the mean of the amount of funds subject to such rate held at the beginning and end of the year of valuation.
Additional premiums are charged for substandard lives for policies issued after January 1, 1956. Net level premium or CRVM mean reserves are based on multiple mortality tables or one-half the net flat or other extra mortality charge. The Company waives deduction of fractional premiums upon death of an insured and returns any portion of the final premium beyond the date of death. Cash values are not promised in excess of the legally computed reserves.
Deferred annuity reserves on contracts issued since 1985 are primarily based on the Commissioner’s Annuity Reserve Valuation Method with interest rates ranging from 3½% to 6¼%. Other deferred annuity reserves are based on contract value. Immediate annuity reserves are based on present value of expected benefit payments at interest rates ranging from 3½% to 7½%. Changes in future policy benefits on supplementary contracts without life contingencies are classified as deposit-type transactions and thereby excluded from net additions to policy benefit reserves in the consolidated statement of operations, see Note 2.
At December 31, 2003 and 2002, the withdrawal characteristics of the Company’s general account annuity reserves and deposit liabilities were as follows:
Unpaid claims and claim reserves for DI policies are based on the present value of expected benefit payments, primarily using the 1985 CIDA (modified for Company experience in the first four years of disability) and interest rates ranging from 3% to 5½%. Unpaid claims and claim reserves for long-term care policies are based on the present values of expected benefit payments using industry-based long-term care experience with a 4.5% interest rate.
Reserves for unpaid claims, losses, and loss adjustment expenses on disability income and long-term care insurance were $3.1 billion and $2.9 billion at December 31, 2003 and December 31, 2002, respectively. The table below provides a summary of the changes in these reserves for the years ended December 31, 2003 and 2002.
THE NORTHWESTERN MUTUAL LIFE INSURANCE COMPANY
NOTES TO CONSOLIDATED STATUTORY FINANCIAL STATEMENTS CONTINUED
DECEMBER 31, 2003, 2002 AND 2001
The changes in reserves for incurred claims related to prior years are generally the result of ongoing analysis of recent loss development trends.
Active life reserves for disability income (“DI”) policies issued since 1987 are primarily based on the two-year preliminary term method using a 4% interest rate and the 1985 Commissioner’s Individual Disability Table A (“CIDA”) for morbidity. Active life reserves for prior DI policies are based on the net level premium method, with interest rates ranging from 3% to 4% and the 1964 Commissioner’s Disability Table for morbidity.
Active life reserves for long-term care policies consist of mid-terminal reserves and unearned premium. Mid-terminal reserves are based on the one-year preliminary term method, industry-based experience morbidity, total terminations based on the 1983 Individual Annuity Mortality table without lapses or the 1983 Group Annuity Mortality table with lapses, and an interest rate of either 4% or the minimum rate allowable for tax purposes. When the tax interest rate is used, lapses are not included in total terminations and reserves are compared in the aggregate to the statutory minimum and the greater of the two is held.
6. PREMIUM AND ANNUITY CONSIDERATIONS DEFERRED AND UNCOLLECTED
Gross deferred and uncollected insurance premiums represent life insurance premiums due to be received from policyowners through the next respective policy anniversary dates. Net deferred and uncollected premiums represent only the portion of gross premiums related to mortality charges and interest.
Deferred and uncollected premiums at December 31, 2003 and 2002 were as follows:
7. SEPARATE ACCOUNTS
Separate account assets and related policy liabilities represent the segregation of balances attributable to variable life insurance and variable annuity policies. Policyowners bear the investment performance risk associated with variable products. Separate account assets are invested at the direction of the policyowner in a variety of mutual fund options. Variable annuity policyowners also have the option to invest in a fixed interest rate annuity issued by the general account of the Company. Separate account assets are reported at fair value based primarily on quoted market prices.
Following is a summary of separate account liabilities by withdrawal characteristic at December 31, 2003 and 2002:
While separate account liability values are not guaranteed by the Company, the variable annuity and variable life insurance products represented in the separate accounts do include guaranteed minimum death benefits underwritten by the Company. At both December 31, 2003 and 2002, general account reserves for policy benefits included $11 million attributable to these benefits.
Premiums and other considerations received from variable life and variable annuity policyowners during the years ended December 31, 2003 and 2002 were $1.2 billion and $1.3 billion, respectively. These amounts are reported as premiums in the consolidated statement of operations. The subsequent transfer of these receipts to the Separate Accounts is reported in net
THE NORTHWESTERN MUTUAL LIFE INSURANCE COMPANY
NOTES TO CONSOLIDATED STATUTORY FINANCIAL STATEMENTS CONTINUED
DECEMBER 31, 2003, 2002 AND 2001
transfers to separate accounts in the consolidated statement of operations, net of amounts received from the Separate Accounts to provide for policy benefit payments to variable product policyowners.
Following is a summary reconciliation of amounts reported as transfers to and from separate accounts in the summary of operations of the Company’s NAIC Separate Account Annual Statement with the amount reported as net transfers to separate accounts in the accompanying consolidated statement of operations for the years ended December 31, 2003, 2002 and 2001:
8. EMPLOYEE AND REPRESENTATIVE BENEFIT PLANS
The Company sponsors noncontributory defined benefit retirement plans for all eligible employees and financial representatives. These include tax-qualified plans, as well as nonqualified plans that provide benefits to certain participants in excess of ERISA limits for qualified plans. The Company’s policy is to fully fund the obligations of qualified plans in accordance with ERISA requirements. In 2003, the Company contributed $28 million to the qualified employee retirement plan. No contributions were required during 2002 or 2001.
In addition to pension benefits, the Company provides certain health care and life insurance benefits (“postretirement benefits”) to retired employees, field representatives and eligible dependents. Substantially all employees and field representatives will become eligible for these benefits if they reach retirement age while working for the Company.
Aggregate assets and projected benefit obligations of the defined benefit plans and for postretirement benefits at December 31, 2003 and 2002, and changes in assets and obligations for the years then ended, were as follows:
Plan assets are invested primarily in common stocks and corporate debt securities through a separate account of the Company. Asset mix is re-balanced regularly to maintain ratios of approximately 60% equities, 35% fixed income investments, and 5% cash equivalents. Fair value of plan assets is based primarily on quoted market values.
THE NORTHWESTERN MUTUAL LIFE INSURANCE COMPANY
NOTES TO CONSOLIDATED STATUTORY FINANCIAL STATEMENTS CONTINUED
DECEMBER 31, 2003, 2002 AND 2001
The projected benefit obligation represents the actuarial net present value of future benefit obligations, which is estimated annually by the Company. The following table summarizes assumptions used in estimating the projected benefit obligations at December 31, 2003, 2002, and 2001:
The projected benefit obligations for post-retirement benefits at December 31, 2003 and 2002 also assumed an annual increase in future retiree medical costs of 10%, grading down to 5% over 5 years and remaining level thereafter. A further increase in the assumed healthcare cost trend of 1% in each year would increase the accumulated postretirement benefit obligation as of December 31, 2003 by $18 million and net periodic postretirement benefit expense during 2003 by $3 million. A decrease in the assumed healthcare cost trend of 1% in each year would reduce the accumulated postretirement benefit obligation as of December 31, 2003 by $18 million and net periodic postretirement benefit expense during 2003 by $3 million.
Projected benefit obligations included $28 million and $12 million for non-vested employees at December 31, 2003 and 2002, respectively.
Following is an aggregate reconciliation of the funded status of the plans to the net liability reported by the Company at December 31, 2003 and 2002:
Unrecognized net experience gains or losses represent cumulative amounts by which plan experience for return on plan assets or benefit costs has been more or less favorable than assumed. These net differences accumulate without recognition in the Company’s financial statements unless they exceed 10% of plan assets or projected benefit obligation, whichever is greater. If they exceed this limit, they are amortized into net periodic benefit costs over the remaining average years of service until retirement of the plan participants, which is currently fourteen years.
Unrecognized initial net assets represent the amount by which the fair value of plan assets exceeded the projected benefit obligation for funded pension plans upon the adoption of new statutory accounting principles at January 1, 2001. The Company has elected not to record an initial asset for this excess, electing instead to utilize the excess through amortization of this initial asset as a credit to net periodic benefit cost in a systematic manner until exhausted.
Any pension assets for funded plans are nonadmitted under statutory accounting and are thereby excluded from reported assets and surplus in the consolidated statement of financial position.
THE NORTHWESTERN MUTUAL LIFE INSURANCE COMPANY
NOTES TO CONSOLIDATED STATUTORY FINANCIAL STATEMENTS CONTINUED
DECEMBER 31, 2003, 2002 AND 2001
The components of net periodic benefit costs for the years ended December 31, 2003, 2002, and 2001, were as follows:
The Company also sponsors a contributory 401(k) plan for eligible employees and a noncontributory defined contribution plan for financial representatives. For the years ended December 31, 2003, 2002 and 2001 the Company expensed total contributions to these plans of $23 million, $22 million and $20 million, respectively.
9. REINSURANCE
The Company limits its exposure to life insurance death benefits on any single insured by ceding insurance coverage to various reinsurers under excess and coinsurance contracts. The Company retains a maximum of $25 million of coverage per individual life policy and a maximum of $35 million of coverage per joint life policy. The Company also participates in catastrophic risk sharing pools and has an excess reinsurance contract for certain disability income policies issued prior to 1999 with retention limits varying based upon coverage type.
Amounts shown in the consolidated financial statements are reported net of the impact of reinsurance. Reserves for policy benefits at December 31, 2003 and 2002 were reported net of ceded reserves of $1.0 billion and $877 million, respectively.
The effect of reinsurance on premium revenue and benefits expense for the years ended December 31, 2003, 2002 and 2001 was as follows:
In addition, the Company earned $184 million, $172 million and $161 million for the years ended December 31, 2003, 2002 and 2001, respectively, in allowances from reinsurers for reimbursement of commissions and other expenses on ceded business. These amounts are reported in other income in the consolidated statement of operations.
Reinsurance contracts do not relieve the Company from its obligations to policyowners. Failure of reinsurers to honor their obligations could result in losses to the Company. The Company attempts to minimize this risk by diversifying its reinsurance coverage among a number of reinsurers that meet its standards for strong financial condition. There were no reinsurance recoverables at December 31, 2003 and 2002, which were considered by management to be uncollectible.
THE NORTHWESTERN MUTUAL LIFE INSURANCE COMPANY
NOTES TO CONSOLIDATED STATUTORY FINANCIAL STATEMENTS CONTINUED
DECEMBER 31, 2003, 2002 AND 2001
10. INCOME TAXES
The Company files a consolidated federal income tax return including the following entities:
Northwestern Mutual Investment Services, LLC
Baird Holding Company
Northwestern International Holdings, Inc.
Frank Russell Company
NML Real Estate Holdings, LLC and subsidiaries
Bradford, Inc.
NML Securities Holdings, LLC and subsidiaries
Network Planning Advisors, LLC
Northwestern Investment Management Company, LLC
Mason Street Advisors, LLC
Northwestern Securities Holdings, LLC
NML - CBO, LLC
Northwestern Mutual Trust Company
JYD, LLC
Chateau, LLC
The Company collects from or refunds to these subsidiaries their share of consolidated income taxes determined under written tax-sharing agreements. Federal income tax returns for years through 1999 are closed as to further assessment of tax. The liability for income taxes payable in the financial statements includes a provision for additional taxes that may become due with respect to the open tax years.
The Company accounts for deferred tax assets and liabilities, which reflect the financial statement impact of cumulative temporary differences between the tax and financial statement bases of assets and liabilities. The components of the net deferred tax asset at December 31, 2003 and 2002 were as follows:
The statutory basis of accounting limits the amount of gross deferred tax assets that can be included in Company surplus. This limit is based on a formula that takes into consideration available loss carryback capacity, expected timing of reversal for existing temporary differences, gross deferred tax liabilities and the level of Company surplus. At December 31, 2003 and 2002, the Company’s gross deferred tax assets did not exceed this limitation.
Changes in deferred tax assets and liabilities related to unrealized gains and losses on investments are reported as a component of changes in unrealized capital gains and losses in the consolidated statement of changes in surplus. Other net changes in deferred tax assets and liabilities are direct adjustments to surplus and separately reported in the consolidated statement of changes in surplus.
THE NORTHWESTERN MUTUAL LIFE INSURANCE COMPANY
NOTES TO CONSOLIDATED STATUTORY FINANCIAL STATEMENTS CONTINUED
DECEMBER 31, 2003, 2002 AND 2001
The major components of current income tax expense (benefit) were as follows:
The Company’s taxable income can vary significantly from gain from operations before taxes due to temporary timing and permanent differences in revenue recognition and expense deduction between book and tax.
The Company is subject to an “equity tax” that is assessed only on mutual life insurance companies. At December 31, 2001, the liability for income taxes payable included $453 million related to the Company’s estimated liability for equity tax, primarily with respect to the 2001 tax year. In March 2002, Congress passed legislation that suspended assessments of equity tax for tax years 2001 through 2003. As a result, this liability was released as a current tax benefit during 2002. Barring any additional action by Congress, the equity tax is scheduled to be reinstated for the 2004 tax year.
The Company’s effective tax rates were 13%, 299%, and 21% for the years ended December 31, 2003, 2002, and 2001, respectively. The effective rate is not the statutory rate applied to the Company’s taxable income or loss by the Internal Revenue Service. It is a financial statement relationship that represents the ratio between the sum of total taxes, including those that affect net income and changes in deferred taxes not related to unrealized gains and losses on investments, to the sum of gain from operations before taxes and pretax net realized gains or losses. These financial statement effective rates were different than the applicable federal tax rate of 35% due primarily to differences between book and tax recognition of net investment income and realized capital gains and losses, prior year adjustments and the impact the of equity tax in 2002.
Income taxes incurred in the current and prior years of $1.2 billion are available at December 31, 2003 for recoupment in the event of future net losses.
11. FRANK RUSSELL COMPANY ACQUISITION AND GOODWILL
The Company acquired Frank Russell Company (“Russell”) effective January 1, 1999 for a purchase price of approximately $955 million plus contingent consideration based upon the financial performance of Russell from the date of acquisition through the five year period ended December 31, 2003. Through December 31, 2003 that contingent consideration had aggregated to approximately $143 million. Russell, a global leader in multi-manager investment services, provides investment products and services in more than 35 countries. This acquisition was accounted for using the statutory purchase method, and the investment is accounted for using the equity method, adjusted for the charge-off of acquisition goodwill, and is reported in common stocks in the consolidated statement of financial position. Since the date of acquisition, the Company charged-off directly from surplus approximately $958 million, representing the goodwill associated with the acquisition, including the impact on goodwill of contingent consideration. The Company has received permission from the OCI for this statutory accounting treatment, which is different than that required by the NAIC “Accounting Practices and Procedures Manual”, which prescribes amortization of goodwill over the period in which the purchasing entity benefits economically, not to exceed 10 years.
12. CONTINGENCIES
The Company has unconditionally guaranteed certain debt obligations of Russell, including $350 million of senior notes and up to $150 million of other credit facilities.
In the normal course of business, the Company has guaranteed certain obligations of other affiliates. The maximum exposure under these agreements totaled approximately $62 million at December 31, 2003 and was generally mitigated by the underlying net asset values of the affiliates. The Company believes that the likelihood is remote that payments will be required under these guarantees and therefore has not accrued a contingent liability in the consolidated statement of financial position. In addition, the
THE NORTHWESTERN MUTUAL LIFE INSURANCE COMPANY
NOTES TO CONSOLIDATED STATUTORY FINANCIAL STATEMENTS CONTINUED
DECEMBER 31, 2003, 2002 AND 2001
Company routinely makes commitments to fund mortgage loans or other investments in the normal course of business. These commitments aggregated to $2.3 billion at December 31, 2003 and were extended at market interest rates and terms.
The Company is engaged in various legal actions in the normal course of its investment and insurance operations. In the opinion of management, losses that may ultimately result from such actions would not have a material effect on the Company’s financial position at December 31, 2003.
13. RELATED PARTY TRANSACTIONS
During 2003, the Company transferred investments to a majority-owned investment subsidiary as a capital contribution. Realized capital gains (losses) of ($7) million were recognized in 2003 on the transfer of these assets.
During 2001, the Company transferred appreciated equity investments to wholly-owned subsidiaries as a capital contribution to the subsidiaries. Realized capital gains of $244 million for 2001 were reported based on the fair value of the assets at transfer.
14. FAIR VALUE OF FINANCIAL INSTRUMENTS
The fair value of investment assets, including derivatives, and certain policy liabilities at December 31, 2003 and 2002 were as follows:
Fair value of bonds, common and preferred stocks and derivative financial instruments are based upon quoted market prices, when available. For those not actively traded, fair values are estimated using independent pricing services or internally developed pricing models. The fair value of mortgage loans is estimated by discounting estimated future cash flows using market interest rates for debt with comparable credit risk and maturities. Real estate fair value is determined by discounting estimated future cash flows using market interest rates. Policy loan fair value is estimated based on discounted projected cash flows using market interest rates and assumptions regarding future loan repayments based on Company experience. Other investments primarily represent joint ventures and partnerships, for which the equity method approximates fair value.
The fair value of investment-type insurance reserves is estimated by discounting estimated future cash flows at market interest rates for similar instruments with comparable maturities.
15. CODIFICATION OF STATUTORY ACCOUNTING PRINCIPLES
Beginning January 1, 2001, insurance companies domiciled in Wisconsin were required to prepare statutory basis financial statements in accordance with the new NAIC “Accounting Practices and Procedures Manual,” subject to any variations prescribed or permitted by the OCI.
These new requirements differed from those used prior to January 1, 2001, primarily because under the new statutory accounting principles: (1) deferred tax balances were established for temporary differences between book and tax bases of certain assets and liabilities, (2) investment valuation adjustments on impaired assets were measured differently and were reported as realized losses, (3) pension and other employee benefit obligations were accounted for based on the funded status of the related plans,
THE NORTHWESTERN MUTUAL LIFE INSURANCE COMPANY
NOTES TO CONSOLIDATED STATUTORY FINANCIAL STATEMENTS CONTINUED
DECEMBER 31, 2003, 2002 AND 2001
(4) recognition of earnings from unconsolidated subsidiaries and affiliates as net investment income was limited to dividends received, (5) certain software costs were capitalized and amortized to expense over a maximum of five years, and (6) premiums, benefits and reserve changes for policies without significant mortality or morbidity risks (“deposit-type contracts”) were not included in revenue or benefits as reported in the consolidated statement of operations.
The cumulative effect of adoption of these new accounting principles was reported in the consolidated statement of changes in surplus as of January 1, 2001, with no restatement of prior periods permitted. This cumulative effect was the difference in the amount of surplus that would have been reported at that date if the new accounting principles had been retroactively applied to all prior periods. The cumulative effect of these accounting changes increased surplus by $749 million at that date, and included the following (in millions):
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
THE NORTHWESTERN MUTUAL LIFE INSURANCE COMPANY IN RESPECT OF NML VARIABLE ANNUITY ACCOUNT A AND NML VARIABLE ANNUITY ACCOUNT C
(Registrant)
By
/s/ EDWARD J. ZORE
Edward J. Zore
President and Chief Executive Officer
Date: March 23, 2004
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Each of the above signatures is affixed as of March 23, 2004
SUPPLEMENTAL INFORMATION TO BE FURNISHED WITH REPORTS FILED PURSUANT TO SECTION 15(d) OF THE ACT BY REGISTRANTS WHICH HAVE NOT REGISTERED PURSUANT TO SECTION 12 OF THE ACT
As supplemental information, the Commission is separately being furnished with four copies of each of the following documents: (1) 2003 Annual Report for NML Variable Annuity Account A; and (2) 2003 Annual Report for NML Variable Annuity Account C.
No proxy material is prepared specifically for contract holders under NML Variable Annuity Account A or NML Variable Annuity Account C. The Northwestern Mutual Life Insurance Company, a mutual company with no shareholders, does prepare a proxy statement and proxy for each policyholder of a company-issued insurance policy or annuity contract.
INDEX TO EXHIBITS