An essential ingredient in maintaining Northwestern Mutual’s financial strength andability to deliver value to policyowners is the performance of the company’s generalaccount investment portfolio, which at year-end 2010 included about $142 billion ofmanaged assets backing the company’s insurance and annuity products.*The investment earnings generated by this portfolio produce capital that helpsbuild the company’s strong financial base. They are also the primary determinantof the interest component of the dividend scale for traditional permanent lifeinsurance policies.In 2011, Northwestern Mutual expects to pay almost $4.9 billion in dividends, mostlyon traditional permanent life insurance policies, fueled in part by the company’s highlycompetitive 6.00 percent dividend scale interest rate on unborrowed funds. In 2010,the company’s total surplus, with the help of investment earnings, grew by $3.4 billionto $17.6 billion.All of these results that drive the company’s financial strength and life insurancecash values are possible in part because of the power of the company’s generalaccount investment portfolio.Read on for more information about the investment strategies Northwestern Mutualfollows, how it is able to invest in ways that some other companies cannot and howthe general account investment portfolio supports the dividend scale interest rateapplied to traditional permanent life insurance from Northwestern Mutual. The vast majority of managed assets back the company’s surplus and most of the life, disability and long-term care* insurance liabilities. The investment strategies described in this booklet apply to the investment of those assets. A portion of managed assets back the remaining liabilities (including fixed-rate annuity liabilities) and have different investment exposures than described in the pages that follow.
Long-term Disciplined Investment StrategyNorthwestern Mutual’s investment objective is to Consistent with the company’s investment policy,generate superior returns while maintaining a well- Northwestern Mutual may also enter into transactionsbalanced and diversified investment portfolio to that are designed to manage the company’s exposure topreserve the company’s exceptional financial strength. fluctuations in interest rates, foreign currency exchangeThis time-tested strategy fundamentally supports rates and market volatility. These strategies includeNorthwestern Mutual’s ability to deliver lifelong the use of forwards, futures, options and swaps. Infinancial security to its policyowners and clients. implementing these strategies, the company closely manages and monitors counterparty risk, utilizingMason Street Advisors, LLC, and Northwestern minimum ratings requirements, maximum exposureInvestment Management Company, LLC, both limits and collateral agreements, which require thewholly owned subsidiaries of Northwestern Mutual, counterparty to post collateral should the market valueinvest the company’s managed assets in accordance of a contract exceed established thresholds.with the company’s investment policy. Consistentwith this policy, the company invests approximately Ultimately, the combination of asset diversification,80 percent of managed assets in investment- active portfolio management and a long-termgrade bonds and other high-quality fixed income perspective supports outstanding product valueinstruments, and the remaining 20 percent in equities and enhances the company’s financial strength.and high-yield bonds. Northwestern Mutual’s prudent investment strategy and unique business model have contributed toFixed income investments represent the core of more than 150 years of strength and stability. nNorthwestern Mutual’s investment portfolio,providing a stable foundation for the overallportfolio while generating current income. | 1Northwestern Mutual’s portfolio of fixed incomeinvestments is largely highly rated and is well Investment Principlesdiversified within and among fixed income sectors • aintain a balance between high-quality fixed Mto minimize risk. income investments and higher-risk assets.Northwestern Mutual’s equity investments • iversify among and within asset classes and Dinclude private equities, real estate and public specific investments.common stock. Typically, such diversification • articipate in all major asset classes and Pacross different types of equities enables the market sectors.company to offset weakness in any one area withattractive performance in another. Furthermore, • anage risk across the entire investment Msimilar to fixed income, equity investments are portfolio and preserve capital to assure financialhighly diversified across countries, industries, strength.company sizes and other parameters. • eek opportunity in investment activity. SNorthwestern Mutual’s significant allocation • anage portfolios to maximize total returns. Mto equities and high-yield bonds – investments The vast majority of managed assets back the company’s surpluswith a higher risk level and corresponding higher and most of the life, disability and long-term care insurancereturn potential – relative to fellow insurers is liabilities. The investment strategies described in this bookleta distinguishing component of the company’s apply to the investment of those assets. A portion of managed assets back the remaining liabilities (including fixed-rate annuityinvestment portfolio. Over the long term, liabilities) and have different investment exposures thanthese investments have generated higher returns described in the pages that follow.than investment-grade fixed income securities,providing a distinct advantage to NorthwesternMutual insurance policyowners.
Northwestern Mutual’s Advantage Northwestern Mutual’s core strategic attributes Mutual structure: Northwestern Mutual’s mutual allow the company to invest its general account company structure allows it to take a long-term portfolio in a steady and consistent manner. view of investing. Because it is not subject to the They provide the confidence to endure the ups quarter-by-quarter financial pressures faced by and downs of the investment markets that often public companies, it can invest with patience, produce favorable returns. These attributes include ride out downturns in the market and develop the company’s significant capitalization, mutual opportunities that may not realize their full company structure, and excellent persistency and potential for years. mortality rates. Persistency and mortality: Northwestern Mutual Capital levels: One measure of financial strength policyowners stay with Northwestern Mutual for is the company’s total surplus level, which provides many years once they buy a policy and, as a group, a cushion against the volatility of higher-risk assets tend to live longer lives. That means the company (which come with corresponding higher rewards) can count on a consistent stream of premium while maintaining the overall strength of the payments coming in the door, allowing it to make company. Northwestern Mutual’s total surplus, more than $1 billion per month in new investments. composed of surplus and asset valuation reserve That strong, positive cash flow lets it seize (AVR), remains sound compared to its historical opportunities that others cannot and refine the levels (as illustrated in the chart below). portfolio’s investments based on market conditions. n Surplus provides the company and its policyowners2 | with protection against the unexpected, while AVR supports a long-term investment strategy by cushioning surplus against market volatility. Surplus Ratio Surplus and asset valuation reserve (AVR) as a percentage of general account insurance reserves (consolidated statutory basis) 15% 12% 1.48% 9.96% 9% 6% 3% AVR Surplus 0% 1971 1976 1981 1986 1991 1996 2001 2006 2010
Opportunistic and FlexibleIn 2010, Northwestern Mutual made more than substantial new investments in public common stock,$15 billion in new investments, following a “flexible including about $1 billion in high-quality, dividend-allocation” policy, which allows the company to paying companies. It made new purchases of aboutallocate money to areas that offer the greatest value $1 billion in high-yield bonds and another $1 billionat the time. As the relative attractiveness and volatility of state and municipal bond issues. It was active inof different assets changes, so does the allocation the commercial mortgage market, underwriting aboutstrategy. For example, in 2010, the company made $3.5 billion in new loans. nBalance and DiversificationNorthwestern Mutual’s optimum portfolio balance includes public and private bonds and commercialrelated to assets backing insurance products mortgage loans. The equity portfolio includesrelies largely on a portfolio of investment-grade commercial real estate and public and privatefixed income assets, with the balance made up of common stock. Northwestern Mutual achievesequities, commercial mortgage loans, high-yield even greater diversification by selecting a largebonds and mezzanine securities. This balanced number of investments within each asset class. Instrategy is expected to provide above-average other words, it doesn’t “bet the ranch” on any onereturns through a variety of business cycles and investment. Company investment managers alsoeconomic conditions.In addition to maintaining a balanced portfolio, participate in all major asset classes and market sectors because history has proven that no single asset class is always the highest-performing. | 3the company diversifies by investing in a variety of As shown in the graph below, the performanceasset classes. The fixed income portfolio primarily of asset classes varies from year to year. nNorthwestern MutualMutual Asset Class Performance Northwestern Asset Class Performance Rank RankOne-year total returns One-Year Total Returns 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Highest-Performing Private Fixed Real Estate Public Private Private Private Private Private Fixed Public Fixed Private Fixed Convertibles Convertibles Income Mortgages Equities Equities Equities Equities Equities Income Income Class Real Estate Public Fixed Public High Private Real Estate Private Private Private Fixed Private Private Mortgages Income Yield Mezzanine Equities Mezzanine Mezzanine Income Mezzanine Equities Public Fixed Private Fixed Real Estate Private Real Estate Public Real Estate Public High Public Convertibles Income Income Equities Mezzanine Equities Equities Equities Yield Equities Real Estate Real Estate Private Public Public Public Real Estate Private Public Real Estate Equities Equities Mezzanine Equities Equities Equities Equities Equities Equities Mortgages Private Private Public High Real Estate Private Fixed Public High Convertibles Convertibles Convertibles Convertibles Mezzanine Equities Yield Mortgages Income Yield Public High Real Estate Public High Public High Public Fixed Public High Real Estate Private Convertibles Convertibles Yield Equities Yield Yield Income Yield Mortgages Mezzanine Private Public High Private Fixed Private Fixed Private Fixed Real Estate Private Fixed Private Public Fixed Real Estate Mezzanine Yield Income Income Income Mortgages Income Mezzanine Income Equities Private Private Real Estate Real Estate Public Fixed Private Fixed Real Estate Private Private Fixed Convertibles Equities Equities Mortgages Mortgages Income Income Mortgages Equities Income Lowest- Public Public Public Fixed Public Fixed Real Estate Public Fixed Public High Public Real Estate Public FixedPerforming Equities Equities Income Income Mortgages Income Yield Equities Equities Income Class
Investment Portfolio Breakdown Fixed Income Northwestern Mutual’s investments in private bonds Northwestern Mutual’s fixed income investments and preferred stock provide further diversification serve as the foundation of the overall investment to the company’s overall portfolio and often benefit portfolio. Fixed income assets include money market from higher yields and more attractive terms relative investments, public bonds and preferred stock, to public bonds. private bonds and preferred stock, and commercial Northwestern Mutual concentrates its mortgage mortgage loans. The fixed income portfolio is lending in commercial mortgage loans on fixed-rate designed to provide liquidity and current income permanent loans greater than $15 million, secured while minimizing loss of principal. by income-producing property. The company invests This well-diversified portfolio is generally invested primarily in apartments, office buildings, shopping in investment-grade assets. centers and industrial warehouses throughout the nation. These transactions offer more control over both The company’s investments in fixed income property quality and choice of borrowers than publicly instruments are actively managed to maximize traded commercial mortgage-backed securities. This returns while preserving a high level of safety, portfolio has historically produced attractive yields and liquidity and diversification. To manage portfolio risk, low delinquency and loss percentages. investments are broadly diversified by security type.4 | Fixed Income Portfolio Composition | 2010 Year-End Total fixed income investments: $122.0 billion (statement value) Corporate 52% 2%1% 3% 4% Commercial Mortgage Loans 17% 6% Residential Mortgage-Backed Securities 15% US Government and Agencies 6% Municipal/Other 4% 15% 52% Commercial Mortgage-Backed Securities 3% Asset-Backed Securities 2% 17% Money Market Investments 1%
Equities diversification benefits. Northwestern Mutual’s long-Equity investments are a distinguishing element of term investment horizon allows the company to holdthe company’s investments related to assets backing significant investments in this asset class.insurance products. Northwestern Mutual’s equity Real Estate Equitiesportfolio is broadly diversified across private equities, Commercial real estate equity investments at year-real estate and public common stock. At year-end end 2010 totaled $5.7 billion, or 4 percent of total2010, this portfolio represented 14 percent of total managed assets. The real estate equity portfoliomanaged assets. consists primarily of apartment, warehouse and officeOver time, the company expects equities to contribute properties held through both direct and joint venturehigher returns and provide incremental diversification to ownership. Through partnerships with developersthe overall portfolio. The company’s significant allocation nationwide, Northwestern Mutual developsto equities has enhanced Northwestern Mutual’s financial apartment communities and warehouse propertiesstrength and the dividend scale interest rate applied to and also purchases properties directly. Assettraditional permanent life insurance. managers, operating out of regional real estate field offices, monitor local markets and actively manage thePrivate Equities investment properties, creating additional value.Private equity investments at year-end 2010 totaled$6.7 billion, or 5 percent of total managed assets. Public Common StockThe private equity portfolio includes direct mezzanine At year-end 2010, the public common stockand equity investments in buyouts of companies, portfolio totaled $7.3 billion, or 5 percent of totallimited partnerships, and direct investments in selected managed assets. The public equity portfolio includesother companies and subsidiaries. Northwestern investments in domestic large-, medium- and small- |Mutual’s private equity investments offer an capitalization companies, as well as in foreignadditional potential source of attractive returns, companies. Risk is well diversified by company size, 5primarily in the form of capital gains. Additionally, industry and country.these assets have generally exhibited lower volatilitythan their public market counterparts and provide Investment Portfolio Product Mix Equity Portfolio Composition | 2010 Year-End Total equity investments: $19.7 billion (statement value) Public Common Stock 37% Private Equities* 34% Real Estate 29% 29% 37% 34% * As presented in this report, private equities include direct investment in certain subsidiaries and affiliates.
Quality of Fixed Income Portfolio Investment Portfolio Breakdown continued Quality of Public and Private Bond and Preferred Stock Investments | 2010 Year-End Investment Grade AAA 32% 4%2% AA 7% 4% A 20% 7% BBB 31% 32% 20% Below Investment Grade BB 4% 31% B 4%6 | CCC Below 2% Ninety percent of the company’s portfolio of public and private bonds and preferred stock Bond Portfolio Duration was rated investment grade (BBB or greater), and 32 percent held the highest quality rating The average duration of bond holdings that back life of AAA at year-end 2010. insurance products is relatively short. The portfolio strategically maintains an average duration of five Credit quality is defined as the ability of the to six years. As a result, the value of the bond issuer to pay interest and principal on a timely holdings is not overly sensitive to changes in the basis. These ratings are based on the lower of the interest rate environment. credit ratings from Standard Poor’s, Moody’s Investors Service or Fitch Ratings when available, or internal rating evaluations when third-party ratings are not available. n
Investment Portfolio PerformanceNorthwestern Mutual’s portfolio strategy is stock portfolio but could not be expected to generateto hold a higher percentage than most other the same high returns over the long term. Given theinsurance companies of equities and high-yield characteristics of different types of investments andbonds – investments with a higher risk level and how they perform relative to one another (covariance),corresponding higher return potential – in a well- modern portfolio theory says public, private and realdiversified, actively managed portfolio. This strategy estate equities can be mixed with a bond portfoliohas proven to reduce overall portfolio volatility and, in the process, reduce risk while adding return.while increasing returns over time. Northwestern Mutual not only believes this in theory, it has proven it in practice.That may sound counterintuitive, but the reason itworks can be explained by modern portfolio theory, During the 20-year period ending in 2010, thewhich includes a concept known as the efficient return to policyowners in the form of the dividendfrontier. If your portfolio consisted of 100 percent scale interest rate applied to traditional permanentcommon stocks, you would expect high returns but life insurance policies was higher than it would havewith high risk or high volatility of return. This portfolio been if the portfolio had been 100 percent investedwould be far too risky for Northwestern Mutual in bonds, as shown in the “Risk vs. Reward” graphpolicyowners and, probably, for most other people. below. Just as important, this additional return was earned with lower volatility than if the assets had beenAt the other end of the spectrum is a portfolio 100 percent invested in bonds.composed of 100 percent bonds. Obviously, the risk inthis portfolio would be much less than that of an all- | 7 Risk vs. Reward 1991-2010 Hypothetical Portfolio Northwestern Mutual 80% Bonds Dividend Scale 12% Stock Interest Rate* 8% Real Estate 12% 100% Stocks 10% r” Frontie ficient “The Ef Rate of Return (Reward) 8% 100% 100% Bonds Real Estate 6% 4% T-Bills 2% Inflation 0% 0% 2% 4% 6% 8% 10% 12% 14% 16% 18% 20% Standard Deviation (Risk) * verage Dividend Scale Interest Rate for unborrowed funds for most permanent life insurance A policies with direct recognition (see description on back cover). Source: The performance data above is based on the following investment indices: BarCap US Agg Bond TR USD, SP 500 TR, NCREIF Property and Ibbotson US 30-Day T-Bill TR. All points in graphic assume no taxes or transaction costs.
Portfolio Performance and Northwestern Mutual’s Dividend Scale Interest Rate How can Northwestern Mutual achieve a dividend • Second, Northwestern Mutual’s investment scale interest rate for its traditional permanent life strategy is to actively manage a well-diversified insurance policies that currently exceeds the yield portfolio with a long-term investment horizon, available through most long-term corporate bonds? as explained on the prior pages. The company’s ability to generate total returns reflecting current Two key factors explain how the company can income from fixed income investments plus gains support a competitive dividend scale interest rate in from equities can produce an overall portfolio a variety of different financial environments. return greater than if the portfolio invested exclusively in fixed income instruments. • First, the dividend scale interest rate applied to traditional permanent life insurance cash values It is, of course, impossible to know what the is a portfolio rate, based on the total yield of all dividend scale interest rate will be in the future. applicable investments. The portfolio includes The graph below provides a historical view of how older fixed income investments made at higher Northwestern Mutual’s dividend scale interest rate rates and newer fixed income investments made applied to most traditional permanent life insurance at the current lower rates. Thus, the collective cash values compares to rates on long-term performance of the portfolio will differ from corporate bonds. Note that the dividend scale interest prevailing new investment rates. This approach rate tends to follow the general trend of new money for determining an interest rate is called the rates, but it lags and is less volatile. In other words,8 | portfolio method. it is generally lower than the new money rate when new money rates are rising and higher than the new money rates when new money rates are falling. n Long-Term Bond Yields Compared to Northwestern Mutual’s Dividend Scale Interest Rate 16 Northwestern Mutual Dividend Scale Interest Rate1 16 14 Moody’s Corporate Bond Average2 14 12 12 10 10 8 8 6 6 4 4 2 2 0 0 1930 1935 1940 1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 1 A verage Dividend Scale Interest Rate for unborrowed funds for most permanent life insurance policies with direct recognition (see description on back cover). 2 The Economic Report of the President: Moody’s Corporate Bond Average (Data available beginning in 1939).
How Is the Dividend Scale InterestRate Determined?Northwestern Mutual’s dividend scale interest rateapplied to most traditional permanent life insurancecash values is based on the actual investment Dividends Are More Than Just Interestperformance of the assets in the investment portfolio It is important to note that the dividend scalethat back this product. This performance is referred interest rate applied to most traditional permanentto as the portfolio earned rate. life insurance cash values is just one element thatA portfolio earned rate reflects a company’s overall determines the actual dollar amount of dividends.rate of return on those assets, regardless of when the The other important factors include mortalityassets were acquired, so the portfolio approach is (representing the cost of death benefits paid toquite simple: Determine the ratio of total investment beneficiaries) and expenses. In fact, more than halfearnings (interest, dividends, capital gains and so of Northwestern Mutual’s expected 2011 dividendon) to invested assets (bonds, stocks, mortgages and payout is attributable to favorable expense andother investments). The result is one interest rate, claims experience.even though the assets consist of many differentinvestments made at different times, each earning Northwestern Mutual’s goal is to pay the highesta different rate of return. possible policyowner dividends consistent withTo arrive at the dividend scale interest rate, maintaining a strong financial position. Since |a deduction is made from the portfolio earned rate Northwestern Mutual is a mutual company, it has no stockholders and, thus, no dividends to 9to cover items such as investment expenses, taxesand a contribution to surplus. The dividend scale be paid to stockholders. All the money earnedinterest rate is credited to all applicable life policies over and above what is needed to pay benefits toeven though premiums were paid at different times policyowners, to run the operation and to keep theand were invested at different interest rates. company on a solid financial footing is returned to policyowners as dividends.Northwestern Mutual believes that the portfoliomethod of crediting interest is currently thebest approach for its traditional permanent lifeinsurance policies. These policies have premiumsthat are paid over a long period, during bothrising and falling interest rate cycles. The portfoliomethod of crediting interest protects policyownersby smoothing the effects of large swings in currentinterest rates.
This material describes the investment strategy for the managed assets in Northwestern Mutual’s general account investment portfolio. The vast majority of managed assets back the company’s surplus and most of the life, disability and long-term care insurance liabilities. The investment strategies described in this booklet apply to the investment of those assets. A portion of managed assets back the remaining liabilities (including fixed-rate annuity liabilities) and have different investment exposures than described in this booklet. The company’s dividend scale interest rate for unborrowed funds for most traditional permanent life insurance policies reflects the investment performance of the applicable managed assets net of taxes and any contribution to surplus. This rate is used for crediting interest on unborrowed funds for most traditional permanent life insurance policy values after mortality and expense charges have been deducted. It reflects investment performance of managed assets. Depending on the terms of the particular policy, adjustments are made to reflect either individual policy loan activity or average loan activity of all policies in the dividend class. Because of the mortality and expense charges, the dividend scale interest rate should not be used as a measure of the policy’s internal rate of return. The dividend scale and the underlying interest rates are reviewed annually and are subject to change. Future dividends are not guaranteed, although Northwestern Mutual has paid a dividend every year since 1872. Decisions with respect to the amount and appropriate allocation of divisible surplus for participating policies of Northwestern Mutual are left to the discretion and business judgment of the Board of Trustees. There is no guaranteed approach or formula for determining the amount of divisible surplus or the manner in which it is allocated as dividends. Further, there is no guarantee that any dividend will be paid on an individual policy in any given year. The approach described in this brochure for determining dividends, the dividend scale interest rate and other dividend factors are subject to change without notice. Similarly, the investment philosophy and strategy described in this booklet is subject to change without notice at the discretion of Northwestern Mutual’s management and Board of Trustees. The Northwestern Mutual Life Insurance Company’s operational results, investment holdings and financial position for year-end 2010 are reported in the company’s Consolidated Financial Statement (CFS). PricewaterhouseCoopers LLP is the company’s independent auditor. A copy of Northwestern Mutual’s CFS is available online at www. northwesternmutual.com or by written request to: Northwestern Mutual, Corporate Communications, N04, 720 E. Wisconsin Avenue, Milwaukee, WI 53202. The Northwestern Mutual Life Insurance Company • Milwaukee, WI www.northwesternmutual.com29-4692 (0502) (REV 0511)