2. An essential ingredient in maintaining Northwestern Mutual’s financial strength and
ability to deliver value to policyowners is the performance of the company’s general
account investment portfolio, which at year-end 2010 included about $142 billion of
managed assets backing the company’s insurance and annuity products.*
The investment earnings generated by this portfolio produce capital that helps
build the company’s strong financial base. They are also the primary determinant
of the interest component of the dividend scale for traditional permanent life
insurance policies.
In 2011, Northwestern Mutual expects to pay almost $4.9 billion in dividends, mostly
on traditional permanent life insurance policies, fueled in part by the company’s highly
competitive 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 billion
to $17.6 billion.
All of these results that drive the company’s financial strength and life insurance
cash values are possible in part because of the power of the company’s general
account investment portfolio.
Read on for more information about the investment strategies Northwestern Mutual
follows, how it is able to invest in ways that some other companies cannot and how
the general account investment portfolio supports the dividend scale interest rate
applied 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.
3. Long-term Disciplined Investment Strategy
Northwestern 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 transactions
balanced and diversified investment portfolio to that are designed to manage the company’s exposure to
preserve the company’s exceptional financial strength. fluctuations in interest rates, foreign currency exchange
This time-tested strategy fundamentally supports rates and market volatility. These strategies include
Northwestern Mutual’s ability to deliver lifelong the use of forwards, futures, options and swaps. In
financial security to its policyowners and clients. implementing these strategies, the company closely
manages and monitors counterparty risk, utilizing
Mason Street Advisors, LLC, and Northwestern minimum ratings requirements, maximum exposure
Investment Management Company, LLC, both limits and collateral agreements, which require the
wholly owned subsidiaries of Northwestern Mutual, counterparty to post collateral should the market value
invest the company’s managed assets in accordance of a contract exceed established thresholds.
with the company’s investment policy. Consistent
with 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-term
grade bonds and other high-quality fixed income perspective supports outstanding product value
instruments, 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 to
Fixed income investments represent the core of more than 150 years of strength and stability. n
Northwestern Mutual’s investment portfolio,
providing a stable foundation for the overall
portfolio while generating current income. | 1
Northwestern Mutual’s portfolio of fixed income
investments is largely highly rated and is well Investment Principles
diversified within and among fixed income sectors • aintain a balance between high-quality fixed
M
to minimize risk. income investments and higher-risk assets.
Northwestern Mutual’s equity investments • iversify among and within asset classes and
D
include private equities, real estate and public specific investments.
common stock. Typically, such diversification • articipate in all major asset classes and
P
across different types of equities enables the market sectors.
company to offset weakness in any one area with
attractive performance in another. Furthermore, • anage risk across the entire investment
M
similar to fixed income, equity investments are portfolio and preserve capital to assure financial
highly diversified across countries, industries, strength.
company sizes and other parameters. • eek opportunity in investment activity.
S
Northwestern Mutual’s significant allocation • anage portfolios to maximize total returns.
M
to equities and high-yield bonds – investments
The vast majority of managed assets back the company’s surplus
with a higher risk level and corresponding higher and most of the life, disability and long-term care insurance
return potential – relative to fellow insurers is liabilities. The investment strategies described in this booklet
a 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 annuity
investment portfolio. Over the long term,
liabilities) and have different investment exposures than
these investments have generated higher returns described in the pages that follow.
than investment-grade fixed income securities,
providing a distinct advantage to Northwestern
Mutual insurance policyowners.
4. 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 policyowners
2
| 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
5. Opportunistic and Flexible
In 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 about
allocate money to areas that offer the greatest value $1 billion in high-yield bonds and another $1 billion
at the time. As the relative attractiveness and volatility of state and municipal bond issues. It was active in
of different assets changes, so does the allocation the commercial mortgage market, underwriting about
strategy. For example, in 2010, the company made $3.5 billion in new loans. n
Balance and Diversification
Northwestern Mutual’s optimum portfolio balance includes public and private bonds and commercial
related to assets backing insurance products mortgage loans. The equity portfolio includes
relies largely on a portfolio of investment-grade commercial real estate and public and private
fixed income assets, with the balance made up of common stock. Northwestern Mutual achieves
equities, commercial mortgage loans, high-yield even greater diversification by selecting a large
bonds and mezzanine securities. This balanced number of investments within each asset class. In
strategy is expected to provide above-average other words, it doesn’t “bet the ranch” on any one
returns through a variety of business cycles and investment. Company investment managers also
economic 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.
| 3
the company diversifies by investing in a variety of As shown in the graph below, the performance
asset classes. The fixed income portfolio primarily of asset classes varies from year to year. n
Northwestern MutualMutual Asset Class Performance
Northwestern Asset Class Performance Rank Rank
One-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 Fixed
Performing
Equities Equities Income Income Mortgages Income Yield Equities Equities Income
Class
6. 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%
7. Equities diversification benefits. Northwestern Mutual’s long-
Equity investments are a distinguishing element of term investment horizon allows the company to hold
the company’s investments related to assets backing significant investments in this asset class.
insurance products. Northwestern Mutual’s equity Real Estate Equities
portfolio 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 total
2010, this portfolio represented 14 percent of total managed assets. The real estate equity portfolio
managed assets. consists primarily of apartment, warehouse and office
Over time, the company expects equities to contribute properties held through both direct and joint venture
higher returns and provide incremental diversification to ownership. Through partnerships with developers
the overall portfolio. The company’s significant allocation nationwide, Northwestern Mutual develops
to equities has enhanced Northwestern Mutual’s financial apartment communities and warehouse properties
strength and the dividend scale interest rate applied to and also purchases properties directly. Asset
traditional permanent life insurance. managers, operating out of regional real estate field
offices, monitor local markets and actively manage the
Private 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 Stock
The private equity portfolio includes direct mezzanine At year-end 2010, the public common stock
and equity investments in buyouts of companies, portfolio totaled $7.3 billion, or 5 percent of total
limited partnerships, and direct investments in selected managed assets. The public equity portfolio includes
other companies and subsidiaries. Northwestern investments in domestic large-, medium- and small-
|
Mutual’s private equity investments offer an capitalization companies, as well as in foreign
additional potential source of attractive returns, companies. Risk is well diversified by company size, 5
primarily in the form of capital gains. Additionally, industry and country.
these assets have generally exhibited lower volatility
than 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.
8. 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
9. Investment Portfolio Performance
Northwestern Mutual’s portfolio strategy is stock portfolio but could not be expected to generate
to hold a higher percentage than most other the same high returns over the long term. Given the
insurance companies of equities and high-yield characteristics of different types of investments and
bonds – 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 real
diversified, actively managed portfolio. This strategy estate equities can be mixed with a bond portfolio
has 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 it
works can be explained by modern portfolio theory, During the 20-year period ending in 2010, the
which includes a concept known as the efficient return to policyowners in the form of the dividend
frontier. If your portfolio consisted of 100 percent scale interest rate applied to traditional permanent
common stocks, you would expect high returns but life insurance policies was higher than it would have
with high risk or high volatility of return. This portfolio been if the portfolio had been 100 percent invested
would be far too risky for Northwestern Mutual in bonds, as shown in the “Risk vs. Reward” graph
policyowners and, probably, for most other people. below. Just as important, this additional return was
earned with lower volatility than if the assets had been
At the other end of the spectrum is a portfolio 100 percent invested in bonds.
composed of 100 percent bonds. Obviously, the risk in
this 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.
10. 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).
11. How Is the Dividend Scale Interest
Rate Determined?
Northwestern Mutual’s dividend scale interest rate
applied to most traditional permanent life insurance
cash values is based on the actual investment Dividends Are More Than Just Interest
performance of the assets in the investment portfolio It is important to note that the dividend scale
that back this product. This performance is referred interest rate applied to most traditional permanent
to as the portfolio earned rate. life insurance cash values is just one element that
A 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 mortality
assets were acquired, so the portfolio approach is (representing the cost of death benefits paid to
quite simple: Determine the ratio of total investment beneficiaries) and expenses. In fact, more than half
earnings (interest, dividends, capital gains and so of Northwestern Mutual’s expected 2011 dividend
on) to invested assets (bonds, stocks, mortgages and payout is attributable to favorable expense and
other investments). The result is one interest rate, claims experience.
even though the assets consist of many different
investments made at different times, each earning Northwestern Mutual’s goal is to pay the highest
a different rate of return. possible policyowner dividends consistent with
To 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 9
to cover items such as investment expenses, taxes
and a contribution to surplus. The dividend scale be paid to stockholders. All the money earned
interest rate is credited to all applicable life policies over and above what is needed to pay benefits to
even though premiums were paid at different times policyowners, to run the operation and to keep the
and were invested at different interest rates. company on a solid financial footing is returned to
policyowners as dividends.
Northwestern Mutual believes that the portfolio
method of crediting interest is currently the
best approach for its traditional permanent life
insurance policies. These policies have premiums
that are paid over a long period, during both
rising and falling interest rate cycles. The portfolio
method of crediting interest protects policyowners
by smoothing the effects of large swings in current
interest rates.
12. 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.com
29-4692 (0502) (REV 0511)
