The Company owns three buildings in Los Angeles and thirteen business service centers in which its administrative operations are conducted. In addition, the Company owns a building in the state of Washington in which the operations of Farmers Life are conducted.
- ---------------------------- (1) Net income reflects the charge resulting from expensing the transition obligation upon the implementation of SFAS No. 112, "Employers' Accounting for Postemployment Benefits". Such amounts were $4.5 million and $0.2 million, after tax, for Management services to property and casualty insurance companies; and other and the Insurance Subsidiaries, respectively, for the year ended December 31, 1994. (2) Includes cash and cash equivalents, marketable securities and notes receivable-affiliate. (3) The ratio of earnings to fixed charges has been determined by dividing the sum of net income before income taxes plus fixed charges by fixed charges. Fixed charges consist of interest, capitalized interest, dividends paid to QUIPS holders, amortization of QUIPS offering expenses and that portion of rent expenses deemed to be interest.
The Company's principal activities are providing management services to the property and casualty insurance companies, underwriting life insurance and annuity products and providing reinsurance coverage to the P&C Group. Revenues and expenses relating to these principal business activities are reflected in the Company's Consolidated Financial Statements prepared in accordance with GAAP, which differs from SAP, which the Insurance Subsidiaries are required to use for regulatory reporting purposes.
The Company underwrites life insurance and annuity products through Farmers Life. Revenues attributable to traditional life insurance products, such as whole life or term life contracts, are classified as premiums as they become due. Future benefits are associated with such premiums (through increases in liabilities for future policy benefits), and prior period capitalized costs are amortized (through amortization of DAC) so that profits are generally recognized over the same period as revenue income. Revenues attributable to universal life products consist of policy charges for the cost of insurance, policy administration charges, surrender charges and investment income on assets allocated to support policyholder account balances on deposit. Revenues for deferred annuity products consist of surrender charges and investment income on assets allocated to support policyholder account balances. Expenses on universal life and annuity policies include interest credited to policyholders on policy balances as well as benefit claims incurred in excess of policy account balances.
Operating Revenues. Operating revenues increased from $1,324.9 million in 1997 to $1,358.2 million in 1998, an increase of $33.3 million, or 2.5%. Operating revenues primarily consist of management fees paid to the Company as a percentage of gross premiums earned by the P&C Group. Such premiums increased from $10,070.1 million in 1997 to $10,331.0 million in 1998 due primarily to an increase in the number of Auto and Fire policies-in-force between years and higher average premium levels in the Fire line of business.
Buildings and Equipment Expenses. Buildings and equipment expenses increased from $95.8 million in 1997 to $145.4 million in 1998, an increase of $49.6 million, or 51.8%. A review of capitalized software in 1998 resulted in a write-off of $43.6 million of capitalized costs that were no longer expected to be recoverable. In addition, expenses increased between years due to higher amortization expense associated with information technology systems software.
Amortization of AIF Contracts and Goodwill. The purchase accounting entries related to the acquisition of the Company by B.A.T in December 1988 include goodwill (capitalized at $2.4 billion) and the value of the AIF contracts of the P&C Group (capitalized at $1.7 billion). The amortization of these two items, which is being taken on a straight-line basis over forty years, reduced pretax income by approximately $102.8 million for both 1998 and 1997.
Merger Related Expenses. Expenses incurred by the Company as a result of the merger between B.A.T's Financial Services Businesses and Zurich amounted to $21.1 million for the year ended December 31, 1998 (see Note E).
Dividends on Preferred Securities of Subsidiary Trusts. Dividends expense related to the $500.0 million of Cumulative Quarterly Income Preferred Securities ("QUIPS") issued in 1995 was $42.1 million in both 1997 and 1998.
Provision for Income Taxes. Provision for income taxes decreased from $332.2 million in 1997 to $290.8 million in 1998, a decrease of $41.4 million, or 12.5%. This decrease was due to the decrease in pretax income between years as well as the fact that $26.8 million of taxes were recorded in 1997 related to the sale of OSL and IGL.
On April 15, 1997, OSL and IGL were sold to Great Southern Life Insurance Company, a subsidiary of Americo Life, Inc.. As a result, there was no contribution to net income from OSL or IGL in 1998, compared to $5.5 million in 1997. The following commentary addresses the results of the Company's remaining life insurance subsidiary, Farmers Life.
Life Premiums. Premiums increased $22.0 million, or 14.5%, between years. This increase was due to a 15.8% growth in the average volume of insurance in-force which was driven by sales of the Premier Whole Life ("PWL") and the Farmers Premier 20 Year Term ("FP20") products. Also contributing to the increase in premiums was an increase in the number of annuities in the payment phase ("AIP").
Investment Income. Net investment income increased $18.0 million in 1998, or 6.5% over 1997, due to a higher invested asset base.
Increase in Liability for Future Benefits. Increase in liability for future benefits expense increased from $15.7 million in 1997 to $23.7 million in 1998. This increase was primarily attributable to an increase in AIP and sales of the PWL and Farmers Premier Term products, particularly the FP20 product introduced in October 1997.
Interest Credited to Policyholders. Interest credited to policyholders, which represents the amount credited to policyholder funds on deposit under universal life-type contracts and deferred annuities, increased from $146.4 million in 1997 to $150.6 million in 1998, or 2.9%, reflecting growth in the universal life fund balance.
Amortization of DAC and VOLBA. Amortization expense decreased from $94.7 million in 1997 to $90.1 million in 1998 due to higher universal life death claims experience in 1998.
Commissions. Commissions increased from $17.3 million in 1997 to $19.0 million in 1998 due to the increase in the volume of business-in-force.
Consolidated net income of the Company decreased from $593.5 million in 1997 to $576.8 million in 1998, a decrease of $16.7 million, or 2.8%, due primarily to the merger related expenses and the write-off of impaired assets.
Operating Revenues. Operating revenues increased from $1,245.4 million in 1996 to $1,324.9 million in 1997, an increase of $79.5 million, or 6.4%. This growth reflects higher gross premiums earned by the P&C Group, which increased from $9,458.2 million in 1996 to $10,070.1 million in 1997 due primarily to higher average premium levels for the Auto and Fire lines of business and an increase in the number of policies-in-force between years reflecting stricter enforcement of the California mandatory auto insurance law following the enactment of California Assembly Bill 650 and the P&C Group's re-entry into the California homeowners' market. Partially offsetting these increases is the fact that, in recognition of expense savings realized as a result of improved operating efficiencies, the Company waived 0.43% from the Farmers Preferred Auto Management fee rate that was in effect prior to November 1, 1996. This rate waiver resulted in a $22.3 million reduction in management fees in 1997 from what such fees would have been using the rates in effect during 1996.
Buildings and Equipment Expenses. Buildings and equipment expenses increased from $87.3 million in 1996 to $95.8 million in 1997, an increase of $8.5 million, or 9.7%. This increase was primarily due to higher amortization expense associated with information technology systems software.
Amortization of AIF Contracts and Goodwill. The amortization of these two items, which is being taken on a straight-line basis over forty years, reduced pretax income by approximately $102.8 million for both 1997 and 1996.
General and Administrative Expenses. General and administrative expenses increased from $170.3 million in 1996 to $202.6 million in 1997, an increase of $32.3 million, or 19.0%. This increase was primarily due to higher expenses attributable to increased business levels and the re-entry of the P&C Group into the California homeowners' market. Also contributing to the increase in expense was a $4.6 million increase in Year 2000 Project costs.
Provision for Income Taxes. Provision for income taxes increased from $275.1 million in 1996 to $332.2 million in 1997, an increase of $57.1 million, or 20.8%. This increase was due to the increase in pretax income between years and the $26.8 million of taxes associated with the sale of OSL and IGL.
Since OSL and IGL were sold to Great Southern Life Insurance Company on April 15, 1997, they contributed only $5.5 million to net income in 1997 compared to $17.2 million in 1996. The following commentary addresses the results of the Company's remaining life insurance subsidiary, Farmers Life.
Total Revenues. Total revenues increased from $613.3 million in 1996 to $638.6 million in 1997, an increase of $25.3 million, or 4.1%.
Life Premiums. Premiums increased $15.0 million, or 11.0% between years. This increase was due to growth in renewal and first year business resulting from increased sales of the PWL product.
Investment Income. Net investment income increased $17.9 million in 1997, or 6.9% over 1996, due largely to higher bond interest income resulting primarily from an increase in bond investments.
Policy Benefits. Policy benefits increased $1.5 million over 1996 to $112.4 million, due to an increase in death claims resulting from an increase in insurance in-force.
Interest Credited to Policyholders. Interest credited to policyholders increased from $138.0 million in 1996 to $146.4 million in 1997, or 6.1%, reflecting a 4.2% growth in universal life-type insurance in-force and a 3.5% increase in annuity funds on deposit.
General Operating Expenses. General operating expenses increased from $139.6 million in 1996 to $152.5 million in 1997, an increase of $12.9 million, or 9.2%.
General and Administrative Expenses. General and administrative expenses remained unchanged from the 1996 level of $40.5 million.
Farmers Life Income. As a result of the foregoing, Farmers Life income decreased from $142.3 million in 1996 to $137.8 million in 1997, a decrease of $4.5 million, or 3.2%.
In addition, the Company has evaluated its relationships with third parties with which the Company has a direct and material relationship to determine whether they are Year 2000 compliant. The Company has sent out questionnaires and warranty requests to all third party vendors and is currently in the process of performing compliance testing with all vendors to validate the vendors' claims regarding Year 2000 compliance. Management anticipates that by mid-1999, compliance testing related to third party relationships will be completed. However, it is not possible to state with certainty that the operations of third parties will not be materially impacted in turn by other parties with whom they themselves have a relationship.
General. The principal uses of funds by the Company are (i) operating expenses, (ii) dividends to the shareholders of the Company's QUIPS, (iii) capital expenditures and (iv) dividends to its stockholders. In 1998, dividends paid on the QUIPS totaled $42.1 million, capital expenditures totaled $59.9 million and cash dividends paid to the stockholders totaled $355.2 million.
In order to maintain the policyholders' surplus of the P&C Group, Farmers Life purchased a $119.0 million surplus note of the P&C Group in 1998 (see Note F). The Company has, from time to time, made other surplus contributions to the P&C Group totaling approximately $684.4 million, receiving certificates of contribution which bear interest at various rates. In 1998, $650.0 million of these certificates of contribution of the P&C Group were repaid. The Company believes that these purchases of certificates of contribution and the surplus note have helped to support the historical growth in premiums earned by the P&C Group and the related growth in management fees paid to the Company.
Net cash provided by operating activities increased from $660.4 million in 1997 to $1,092.2 million in 1998, an increase in cash of $431.8 million, or 65.4%. This increase in cash was principally due to a $163.2 million increase in reinsurance payables to the P&C Group in 1998, a $105.9 million increase in the Farmers Re provision for non-life losses and loss adjustment expenses in 1998 and a $131.3 million decrease in non-current liabilities in 1997.
Net cash used in investing activities increased from $356.9 million in 1997 to $951.1 million in 1998, a decrease in cash of $594.2 million, or 166.5%, between years. This decrease in cash was primarily due to the $1,057.0 million of notes receivable issued to BAFS in 1998, the $119.0 million surplus note of the P&C Group purchased by Farmers Life in 1998 and the fact that $336.7 million of proceeds were received from the sale of OSL and IGL in 1997. Partially offsetting these decreases in cash were $650.0 million of proceeds received from the redemption of certificates of contribution of the P&C Group in 1998 and $407.0 million of proceeds received from the settlement of the B.A.T Capital Corporation notes receivable in 1998.
Net cash used in financing activities increased from $286.5 million in 1997 to $329.8 million in 1998, a decrease in cash of $43.3 million, or 15.1%. This decrease in cash was due to a $41.1 million increase in annuity contract withdrawals by policyholders between years and an $18.0 million increase in dividends paid to the Company's stockholders in 1998.
FARMERS GROUP, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (Amounts in thousands) ASSETS
FARMERS GROUP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY Years ended December 31, 1998, 1997 and 1996 (Amounts in thousands)
In December 1988, BATUS Inc. ("BATUS"), a subsidiary of B.A.T Industries p.l.c. ("B.A.T"), acquired 100% ownership of the Company for $5,212,619,000 in cash, including related expenses, through its wholly owned subsidiary BATUS Financial Services. Immediately thereafter, BATUS Financial Services was merged into Farmers Group, Inc.. The acquisition was accounted for as a purchase and, accordingly, the acquired assets and liabilities were recorded in the Company's consolidated balance sheets based on their estimated fair values at December 31, 1988. In January 1990, ownership of the Company was transferred to South Western Nominees Limited, a subsidiary of B.A.T.
The excess of the purchase price over the fair value of the net assets ("Goodwill") of the Company at the date of the Company's acquisition by B.A.T ($2,401,755,000) is being amortized on a straight-line basis over forty years. The carrying amount of the Goodwill is regularly reviewed for indications of impairment in value which in the view of management are other than temporary, including unexpected or adverse changes in the following: (1) the economic or competitive environments in which the Company operates, (2) profitability analyses and (3) cashflow analyses. As of December 31, 1998, management believes that the reported value is recoverable and the remaining life of Goodwill is appropriate.
In December 1997, Farmers Reinsurance Company ("Farmers Re"), a wholly owned property and casualty insurance subsidiary of FGI, was formed and licensed to conduct business. In January 1998, Farmers Re entered into a quota share reinsurance treaty with the P&C Group under which it reinsures a percentage of the auto physical damage business written by the P&C Group.
As a result of the foregoing, references to the "Insurance Subsidiaries" within the 1998 consolidated financial statements and the 1997 balance sheet are to Farmers Life and Farmers Re, whereas, references to the "Insurance Subsidiaries" within the 1997 consolidated statements of income and comprehensive income and consolidated statement of cash flows and to the 1996 consolidated financial statements are to Farmers Life, OSL and IGL.
In 1998, the Company adopted SFAS No. 129, "Disclosure of Information about Capital Structure". This Statement, effective for financial statements issued for periods ending after December 15, 1997, established standards for disclosing information about an entity's capital structure.
In 1998, the Company adopted SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information". This Statement, effective for financial statements of public enterprises issued for periods beginning after December 15, 1997, established standards for reporting information about operating segments in annual financial statements and required the reporting of selected information about operating segments in interim financial reports issued to shareholders. It also established standards for related disclosures about products and services, geographic areas and major customers. This Statement superseded SFAS No. 14, "Financial Reporting for Segments of a Business Enterprise", and amended SFAS No. 94, "Consolidation of All Majority- Owned Subsidiaries".
In 1998, the Company adopted SFAS No. 132, "Employers' Disclosures about Pensions and Other Postretirement Benefits". This Statement, effective for financial statements of public and nonpublic enterprises issued for fiscal years beginning after December 15, 1997, standardized the disclosure requirements relating to pension and other postretirement benefit plans. It addressed disclosure only and, as such, did not change the requirements for measurement or recognition of such plans. This Statement superceded the disclosure requirements set forth in SFAS No. 87, "Employers' Accounting for Pensions", SFAS No. 88, "Employers' Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits" and SFAS No. 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions".
In March 1998, the American Institute of Certified Public Accountants (AICPA) issued Statement of Position ("SOP") No. 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use". This SOP, effective for financial statements issued for periods beginning after December 15, 1998, applies to all nongovernmental entities and establishes the rules for capitalizing or expensing internally developed software. The Company does not expect the adoption of this Statement to have a material impact on its consolidated financial statements.
In 1998, the FASB released SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities". This Statement, effective for financial statements of public and nonpublic entities issued for fiscal years beginning after June 15, 1999, establishes accounting and reporting standards for derivative instruments (including certain derivative instruments embedded in other contracts) and for hedging activities. SFAS No. 133 requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at market value. This Statement amends SFAS No. 52, "Foreign Currency Translation" and SFAS No. 107, "Disclosures about Fair Value of Financial Instruments". It supersedes SFAS No. 80, "Accounting for Futures Contracts", SFAS No. 105, "Disclosure of Information about Financial Instruments with Off-Balance-Sheet Risk and Financial Instruments with Concentrations of Credit Risk" and SFAS No. 119, "Disclosure about Derivative Financial Instruments and Fair Value of Financial Instruments". The Company does not expect the adoption of this Statement to have a material impact on its consolidated financial statements.
In 1998, the AICPA issued SOP No. 98-5, "Reporting on the Costs of Start Up Activities". This SOP, effective for financial statements issued for periods beginning after December 15, 1998, addresses the recording of costs associated with a one-time activity related to opening a new facility, introducing a new product or service, conducting business in a new territory or conducting business with a new class of customer. The Company does not expect the adoption of this Statement to have a material impact on its consolidated financial statements.
On September 8, 1998, Farmers Life purchased a $119,000,000 surplus note of the P&C Group which bears interest at 6.10% annually. In addition, the Company has from time to time made surplus contributions to the P&C Group and, in return, received certificates of contribution of the P&C Group which bear interest at various rates. As of December 31, 1998, the Company held certificates of contribution of the P&C Group totaling $34,380,000.
- Redemption of a $250,000,000 certificate of contribution, issued in 1995, bearing interest at 8.95% annually.
G. Company Obligated Mandatorily Redeemable Preferred Securities of Subsidiary Trusts Holding Solely Junior Subordinated Debentures
In 1995, Farmers Group Capital and Farmers Group Capital II (the "Subsidiary Trusts"), consolidated wholly owned subsidiaries of Farmers Group, Inc., issued $410 million of 8.45% Cumulative Quarterly Income Preferred Securities ("QUIPS"), Series A and $90 million of 8.25% QUIPS, Series B, respectively. In connection with the Subsidiary Trusts' issuance of the QUIPS and the related purchase by Farmers Group, Inc. of all of the Subsidiary Trusts' Common Securities ("Common Securities"), Farmers Group, Inc. issued to Farmers Group Capital $422,680,399 principal amount of its 8.45% Junior Subordinated Debentures, Series A due on December 31, 2025, (the "Junior Subordinated Debentures, Series A") and issued to Farmers Group Capital II $92,783,505 principal amount of its 8.25% Junior Subordinated Debentures, Series B due on December 31, 2025 (the "Junior Subordinated Debentures, Series B" and, together with the Junior Subordinated Debentures, Series A, the "Junior Subordinated Debentures"). The sole assets of Farmers Group Capital are the Junior Subordinated Debentures, Series A. The sole assets of Farmers Group Capital II are the Junior Subordinated Debentures, Series B. In addition, these arrangements are governed by various agreements between Farmers Group, Inc. and the Subsidiary Trusts (the Guarantee Agreements, the Trust Agreements, the Expense Agreements, the Indentures and the Junior Subordinated Debentures) which considered together constitute a full and unconditional guarantee by Farmers Group, Inc. of the Subsidiary Trusts' obligations under the Preferred Securities.
As of December 31, 1998 and 1997, a total of 20,000,000 shares of QUIPS were outstanding.
The Company has two profit sharing plans providing for cash payments to all eligible employees. The two plans, Deferred Profit Sharing and Cash Profit Sharing (consisting of Cash and Quest for Gold in 1998 and Cash and Cash Plus in 1997 and 1996), provide for a maximum aggregate expense of 16.25% of the Company's consolidated annual pretax earnings, as adjusted. The Deferred Profit Sharing Plan, limited to 10% of pretax earnings, as adjusted, or 15% of the salary or wage paid or accrued to the eligible employee, provides for an annual contribution by the Company to a trust for eventual payment to employees as provided in the Plan. The Cash Profit Sharing Plan and Quest for Gold Program provide for annual cash distributions to eligible employees. The Cash Profit Sharing Plan is limited to 5% of pretax earnings, as adjusted, or 5% of employee salaries or wages paid or accrued. The Quest for Gold Program is limited to 1.25% of pretax earnings, as adjusted, or 6% of eligible employee salaries or wages paid or accrued. The Cash Plus Plan was limited to 1.25% of pretax earnings, as adjusted.
Expense under these plans was $51,869,000, $52,235,000 and $55,772,000 in 1998, 1997 and 1996, respectively.
("S&P 500") call options are carried at estimated fair value. Other investments, which consist primarily of certificates of contribution of the P&C Group, a surplus note of the P&C Group, policy loans, B.A.T Capital Corporation notes and British American Financial Services (UK and International), Ltd. ("BAFS") notes, are carried at the unpaid principal balances.
In compliance with a Securities and Exchange Commission ("SEC") staff announcement, the Company has recorded certain entries to the DAC and VOLBA line of the consolidated balance sheet in connection with SFAS No. 115. The SEC requires that companies record entries to those assets and liabilities that would have been adjusted had the unrealized investment gains or losses from securities classified as available-for-sale actually been realized, with corresponding credits or charges reported directly to stockholders' equity.
* Includes $3.4 million, $1.6 million and $0.7 million in 1998, 1997 and 1996, respectively, of unrealized gains associated with the trading securities reported on the "Other assets" line of the balance sheet.
The amortized cost, gross unrealized gains and losses, and estimated market values of investments in equity securities pertaining to non-redeemable preferred stocks and common stocks owned by the Insurance Subsidiaries in 1998 and 1997 are as follows:
The amortized cost, gross unrealized gains and losses, and estimated market values of investments in debt securities, including bonds and redeemable preferred stocks, owned by the Insurance Subsidiaries in 1998 and 1997 are as follows:
The amortized cost and estimated market value of debt securities, including marketable securities, owned by the Company (excluding the Insurance Subsidiaries) as of December 31, 1998, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
The amortized cost and estimated market value of debt securities owned by the Insurance Subsidiaries as of December 31, 1998, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
The change in the net unrealized gains or (losses) of the Insurance Subsidiaries in 1998 and 1997 are as follows:
The S&P 500 call options are carried at estimated fair value. Unrealized gains and losses resulting from changes in the estimated fair value of the call options are recorded as an adjustment to the interest credited to policyholders. In addition, realized gains and losses from maturity or termination of the call options are offset against the interest credited to policyholders during the period incurred. Premiums paid on call options are amortized to net investment income over the term of the contracts. There were no early terminations by annuity participants, or maturities or sales of the S&P 500 call options during 1998.
Grantor trust. The carrying amount is a reasonable estimate of its fair value.
Joint ventures, at equity. The estimated fair values are based upon quoted market prices, current appraisals, and independent pricing services.
Policy loans. The estimated fair values of policy loans are determined by discounting the future cash flows using the current rates at which similar loans would be made.
Real estate mortgages payable. The estimated fair values are determined by discounting the estimated future cash flows at a rate which approximates the Company's incremental borrowing rate.
Based on current conditions and assumptions as to future events, Farmers Life expects to amortize the December 31, 1998 balance as follows: approximately 3.5% in 1999, 3.7% in 2000, 3.9% in 2001, 4.2% in 2002 and 4.3% in 2003. The discount rate used to determine the amortization rate of the VOLBA ranged from 12.5% to 7.5%.
The Company has security lending agreements with a financial institution. The agreements in effect as of December 31, 1998 authorize the institution to lend securities held in the Company's portfolio to a list of authorized borrowers. Concurrent with delivery of the securities, the borrower provides the Company with cash collateral equal to at least 102% of the market value of domestic securities and 105% of the market value of other securities subject to the "loan".
The securities are marked-to-market on a daily basis and the collateral is adjusted on the next business day. The collateral is invested in highly liquid, fixed income assets with a maturity of less than one year. Income earned from the security lending arrangements was allocated 60% to the Company and 40% to the institution. Income earned by the Company was $968,000, $856,000 and $422,000 in 1998, 1997 and 1996, respectively. The collateral under these agreements as of December 31, 1998 and 1997 was $461,801,000 and $594,488,000, respectively.
The Company has two noncontributory defined benefit pension plans (the Regular Plan and the Restoration Plan). The Regular Plan covers substantially all employees of the Company and the P&C Group who have reached age 21 and have rendered one year of service. Benefits are based on years of service and the employee's compensation during the last five years of employment. The Restoration Plan provides supplemental retirement benefits for certain key employees of the Company and the P&C Group.
Information regarding the Regular Plan's and the Restoration Plan's funded status is not developed separately for the Company and the P&C Group. The funded status of the Plans for the Company and the P&C Group as of December 1, 1998 and 1997 (the latest date for which information is available) was as follows:
The Company's postretirement benefits plan is a contributory defined benefit plan for employees who were retired or who were eligible for early retirement as of January 1, 1995, and is a contributory defined dollar plan for all other employees retiring after January 1, 1995. Health benefits are provided for all employees who participated in the Company's and the P&C Group's group medical benefits plan for 15 years prior to retirement at age 55 or later. A life insurance benefit of $5,000 is provided at no cost to retirees who maintained group insurance coverage for 15 years prior to retirement at age 55 or later.
The Company's share of the accrued postretirement benefit cost was approximately $53,206,000 in 1998 and $51,930,000 in 1997. The unrecognized net transition obligation of $18,354,000 in 1998 and $19,665,000 in 1997 represents the remaining transition obligation of the P&C Group.
The weighted average interest rate used in the above benefit computations was 6.75% in 1998 and 7.25% in 1997 and 1996. Beginning in 1996, the initial medical inflation rate was 7.50%, to be graded over a 3-year period to 6.00% and level thereafter, and contribution levels from retirees were the same as applicable medical cost increases where defined benefits exist. The weighted average rate of increase in future compensation levels used in determining the actuarial present value of the accumulated benefit obligation was 4.50% in 1998 and 5.00% in 1997 and 1996.
Rental expense incurred by the Company was $22,332,000, $20,322,000 and $20,121,000 in 1998, 1997 and 1996, respectively.
On September 3, 1998, the Company received $423,734,000 from B.A.T Capital Corporation, a subsidiary of B.A.T, in settlement of $407,000,000 of notes receivable and $16,734,000 of accrued interest. These notes were fixed rate medium-term notes with maturity dates as follows: $137,000,000 in October 1998, $135,000,000 in October 1999 and $135,000,000 in October 2000. Interest on these notes was paid semi-annually at coupon rates of 5.35%, 6.68% and 6.33%, respectively. On October 7, 1997, a four year $135,000,000 note with an interest rate of 5.10% matured and the $135,000,000 note that would have matured in October 2000 was subsequently issued at an interest rate of 6.33%. Income earned on the notes for the years ended December 31, 1998 and December 31, 1997 was $16,734,000 and $23,620,000, respectively.
For financial statement purposes, the Company considers all investments with original maturities of 90 days or less as cash equivalents. Following is a reconciliation of the individual balance sheet cash and cash equivalent totals to the consolidated cash flow total.
In 1998, the Company used $650,000,000 of proceeds it received from the redemption of the certificates of contribution of the P&C Group (see Note F) and $407,000,000 of proceeds it received from the settlement of the B.A.T Capital Corporation notes receivable (see Note T), to issue $1,057,000,000 of notes receivable to BAFS (see Note T), a subsidiary of ZFS. In addition, Farmers Life purchased a $119,000,000 surplus note of the P&C Group on September 8, 1998 (see Note F).
As of December 31, 1998 and 1997, the Company had a revolving credit agreement with certain financial institutions and had an aggregate borrowing facility of $500,000,000. The proceeds of the facility were available to the Company for general corporate purposes, including loans to the P&C Group. As of December 31, 1998 and 1997, facility fees were payable on the aggregate borrowing facility in the amount of 7 basis points per annum and were reimbursable to the Company by the P&C Group. In the case of a draw on the facility, the Company has the option to borrow at annual rates equal to the prime rate, the banks' certificate of deposit rate plus one percentage point, the federal funds effective rate plus 1/2 of one percentage point or the London Interbank Offered Rate plus certain percentages. As of December 31, 1998 and 1997, the Company did not have any outstanding borrowings under the revolving credit agreement. Facility fees were $350,000, $399,000 and $592,000 for the years ended December 31, 1998, 1997 and 1996, respectively, and were reimbursed by the P&C Group. The revolving credit agreement in effect as of December 31, 1998 expires on July 1, 2002.
Participating business, which consists of group business, comprised approximately 8.6% of Farmers Life's total insurance in-force as of December 31, 1998 and 8.8% of its total insurance in-force as of December 31, 1997. In addition, participating business represented 2.1% and 2.2% of Farmers Life's premium income for the years ended December 31, 1998 and December 31, 1997 and 2.2% of the Life Insurance Subsidiaries' premium income for the year ended December 31, 1996.
In 1997, Farmers Life raised the retention limit for automatic reinsurance ceded. The primary change was to set the maximum retention on new issues at $2,000,000 per life for the Farmers Flexible Universal Life policy; $1,500,000 per life for all Traditional policies except Farmers Yearly Renewable Term; and $800,000 per life for Farmers Yearly Renewable Term. The excess is reinsured with a third party reinsurer and is not material. Premiums ceded under these agreements totaled $3,728,000 in 1998 and $4,236,000 in 1997. Life reinsurance receivables, which totaled $8,453,000 and $8,627,000 for Farmers Life at December 31, 1998 and 1997, respectively, were included in "Other assets" of the Insurance Subsidiaries.
The Company's principal activities are the provision of management services to the P&C Group and the ownership and operation of the life and reinsurance subsidiaries. These activities are managed separately as each offers a unique set of services. As a result, the Company is comprised of the following three reportable operating segments as defined in SFAS No. 131: the management services segment, the life insurance segment and the reinsurance segment.
The Company operates in 31 states and does not earn revenues or hold assets in any foreign countries.
(c) Amount includes PGAAP adjustments associated with the amortization of the AIF contracts ($42.7 million) and goodwill ($60.0 million).
(g) Amount includes PGAAP adjustments related to the amortization of the DAC (($26.2) million) and VOLBA ($23.9 million) assets.
(d) Amount includes PGAAP adjustments associated with the AIF contracts ($1,324.5 million) and goodwill ($1,861.4 million).
(e) Amount includes PGAAP adjustments related to the DAC (($195.2) million) and VOLBA ($359.1 million) assets.