The following discussion and analysis of financial condition and results of operations includes the operations of Farm Family Holdings, Inc. ("Farm Family Holdings") and its wholly owned subsidiaries (collectively referred to as the "Company" or "we"). The primary subsidiaries of Farm Family Holdings are Farm Family Casualty Insurance Company ("Farm Family Casualty") and Farm Family Life Insurance Company ("Farm Family Life"). On April 6, 1999, Farm Family Holdings acquired Farm Family Life and Farm Family Life's wholly owned subsidiary, United Farm Family Insurance Company ("United Farm Family"). The following should be read in conjunction with the Consolidated Financial Statements and related Notes.
On February 27, 2001, Farm Family Holdings' stockholders voted to adopt the merger agreement with American National. The proposal to adopt the merger agreement was approved by the holders of a majority of Farm Family Holdings' outstanding voting stock. The proposed merger remains subject to the satisfaction of certain closing conditions, including the approval of the New York State Insurance Department.
On March 28, 2001, American National and Farm Family Holdings announced that the termination date of their merger agreement was automatically extended for up to an additional 90 days from March 31, 2001 in order to allow American National further time to obtain the approval of the New York State Insurance Department for the merger. The automatic extension was in accordance with the terms of the merger agreement. American National expects to receive the New York State Insurance Department's approval by the end of the first week of April. The companies expect to close the merger promptly after the receipt of the New York State Insurance Department's approval. See Notes 3 and 20 to the accompanying Consolidated Financial Statements for further details regarding the merger agreement and Notes 12 and 16 regarding commitments and contingencies relating to the merger agreement.
2000 was another year of growth for Farm Family Holdings. For the year ended December 31, 2000, property and casualty net written premiums were $223,183,000 compared to $191,702,000 for the same period in 1999, which includes the operations of United Farm Family since April 6, 1999. The increase in property and casualty net written premiums for the year ended December 31, 2000 was primarily attributable to an increase of $35,407,000 in direct written premiums (excluding assigned risk automobile business premiums) largely as a result of the conversion of our personal and commercial automobile policies in certain states from six-month to twelve-month policies. Excluding the impact of converting personal and commercial automobile policies from six-month to twelve-month policies in certain states, we estimate that property and casualty direct written premiums (excluding assigned risk automobile business premiums) would have increased approximately $16,227,000 or 8.6% to $204,131,000 for the year ended December 31, 2000. For the year ended December 31, 2000, life insurance premium revenue was $38,094,000 compared to $27,799,000 for the same period in 1999. The 1999 revenue includes amounts subsequent to April 6, 1999, the effective date of Farm Family Holdings' acquisition of Farm Family Life.
As a condition of our license to do business in various states, we are required to participate in a variety of mandatory residual market mechanisms (including mandatory pools) which provide certain insurance (most notably automobile insurance) to consumers who are otherwise unable to obtain such coverages from private insurers. In all such states, residual market premium rates are subject to the approval of the state insurance departments. Residual market premium rates for automobile insurance have generally been inadequate. The amount of future losses or assessments from residual market mechanisms cannot be predicted with certainty and could have a material adverse effect on our results of operations.
The calculation of interest rate sensitivity uses numerous assumptions, requires significant estimates and assumes an immediate change in interest rates without any management of the investment portfolio in reaction to such a change. Consequently, the estimated change in the fair value of our fixed maturity portfolio will likely be different from the actual change experienced under the given interest rate scenario, and the difference may be material.
We currently do not have any investments in derivative financial instruments such as futures, forward, swap, or option contracts, or other financial instruments with similar characteristics.
In June 1999, the Financial Accounting Standards Board ("FASB") delayed the effective date of Statement of Financial Accounting Standard No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133"). SFAS 133 replaces existing pronouncements and practices with a single, integrated accounting framework for derivatives and hedging activities. This statement requires that all derivatives be recognized on the balance sheet at fair value. Derivatives that are not hedges must be adjusted to fair value through income. If the derivative is a hedge, depending on the nature of the hedge, changes in the fair value of derivatives will either be offset against the change in fair value of the hedged assets, liabilities, or firm commitments through earnings or recognized in other comprehensive income until the hedged item is recognized in earnings. Additionally, the change in fair value of a derivative which is not effective as a hedge will be immediately recognized in earnings.
The delay in implementation was effected through the issuance of SFAS No. 137, which extends the SFAS No. 133 requirements to fiscal years beginning after June 15, 2000. In June 2000, the FASB issued SFAS No. 138, which amends the accounting and reporting standards of Statement 133 for certain derivative instruments and certain hedging activities. Therefore, we adopted the provisions of SFAS No. 133 and SFAS No. 138 as of January 1, 2001. Since we do not have any investments in derivative financial instruments, the adoption of these statements did not have an impact on the Company's financial statements.
In 2000, the FASB Emerging Issues Task Force ("EITF") reached a consensus regarding Issue No. 99-20, "Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets" ("EITF 99-20"). EITF 99-20 sets forth the rules for (1) recognizing interest income (including amortization of premium or discount) on all credit-sensitive mortgage and asset-backed securities and certain prepayment-sensitive securities and (2) determining when these securities must be written down to fair value because of impairment. EITF 99-20 adopts the "prospective method" for adjusting the level yield used to recognize interest income when estimates of future cash flows on the security either increase or decrease since the date of the last evaluation. The impairment provisions of EITF 99-20 generally require an other-than-temporary write down for any decrease in the estimated future cash flows from the security when the fair value of the security is less than the carrying amount. EITF 99-20 is effective for us in the second quarter of 2001. The adoption of EITF 99-20 will not have a material impact on the Company's financial statements.
Premium revenue increased to $239.2 million in 2000 from $216.7 million in 1999. The increase was attributable to an increase of $12.2 million in property and casualty insurance premium revenue and an increase of $10.3 million in life insurance premium revenue.
Property and casualty net written premiums increased $31.5 million to $223.2 million in 2000 compared to $191.7 million for the same period in 1999. The increase in net written premiums was primarily attributable to an increase of $35.4 million in direct writings (excluding assigned risk automobile business premiums). Premiums from direct writings increased primarily as a result of the conversion of our personal and commercial automobile policies in certain states from six-month to twelve-month policies. Excluding the impact of converting personal and commercial automobile policies from six-month to twelve-month policies in certain states and premiums from assigned risk automobile business, we estimate direct written premiums increased approximately $16.2 million or 8.6% to $204.1 million in 2000 compared to $187.9 million in 1999. This increase was offset by a decrease of $1.1 million in assigned risk automobile premiums, an increase of $1.1 million in premiums ceded to our reinsurers and a decrease of $1.7 in assumed reinsurance premiums.
Excluding the effects of converting personal and commercial automobile policies in certain states from six-month to twelve-month policies and premiums from assigned risk automobile business, direct writings increased in each of the twelve states we serve and for each of our primary products in 2000 compared to 1999.
Life insurance premium revenue was $38.1 million in 2000, compared to $27.8 million in 1999. Life insurance premium revenue includes premiums and contract charges primarily from the sale of individual whole life, term and universal life products, and disability income insurance products. The 1999 revenue includes amounts subsequent to April 6, 1999, the effective date of Farm Family Holdings' acquisition of Farm Family Life.
Net investment income for the property and casualty insurance segment increased $2.8 million, or 13.9% to $23.3 million in 2000 from $20.5 million in 1999. The taxable equivalent yield on the property and casualty insurance segment's investment portfolio was 7.0% and 6.8% for 2000 and 1999, respectively. The increase in net investment income for the property and casualty insurance segment was primarily the result of an increase in the average cash and invested assets (at amortized cost) of $40.8 million, or 12.6%, and to a lesser extent, an increase in the prevailing interest rate environment.
Net investment income for the life insurance segment increased $14.5 million to $52.2 million in 2000 compared to $37.7 million in 1999. The increase is primarily attributable to the 1999 net investment income including amounts subsequent to April 6, 1999, the effective date of Farm Family Holdings' acquisition of Farm Family Life. The yield on the life insurance segment's investment portfolio was 6.6% in 2000 compared to 6.5% in 1999.
Federal income tax expense increased $5.8 million to $13.2 million in 2000 from $7.4 million in 1999. Federal income tax expense was 30.2% of income before federal income tax expense and preferred stock dividends in 2000 compared to 28.3% in 1999.
The property and casualty insurance segment's premium revenue has been adversely impacted by the mandated reduction in personal automobile rates in New Jersey of approximately 15% effective March 22, 1999. In addition, certain changes in the New Jersey Farm Bureau's membership requirements have had a favorable impact on reducing the growth of our personal automobile policies written in New Jersey. For the year ended December 31, 1999, the number of personal automobile policies we had in New Jersey decreased by 2.3% compared to an increase of 18.8% during the year ended December 31, 1998.
The $7.2 million increase in premium revenue on additional business directly written by Farm Family Casualty was primarily attributable to an increase of $5.5 million, or 3.6%, in earned premiums from Farm Family Casualty's primary products (personal and commercial automobile products other than assigned risk automobile business, the Special Farm Package, businessowners products, homeowners products, and Special Home Package) and an increase of $1.7 million in earned premiums from other products. Farm Family Casualty had approximately 173,300 policies in force at December 31, 1999 compared to approximately 167,100 at December 31, 1998. The number of policies in force related to Farm Family Casualty's primary products increased by 3.4% to approximately 142,500 as of December 31, 1999 from approximately 137,800 as of December 31, 1998 and the average premium earned for each such policy was approximately the same in 1999 compared to 1998.
Life insurance premium revenue was $27.8 million. This amount includes premiums and contract charges primarily from the sale of individual whole life, term and universal life products, and disability income insurance products, subsequent to April 6, 1999, the effective date of Farm Family Holdings' acquisition of Farm Family Life.
Net investment income increased $39.5 million to $58.6 million in 1999 from $19.1 million in 1998. The increase was attributable to an increase of $1.8 million in property and casualty net investment income and $37.7 million from the addition of the life insurance segment's net investment income.
Losses and loss adjustment expenses on property and casualty insurance increased $7.2 million, or 5.4%, to $141.5 million in 1999 from $134.3 million in 1998. Losses and loss adjustment expenses were 74.9% of premium revenue in 1999 compared to 73.9% of premium revenue in 1998. Excluding United Farm Family, losses and loss adjustment expenses were 73.8% of premium in 1999 compared to 73.9% in 1998.
Losses and loss adjustment expenses incurred were reduced by $2.8 million and $3.2 million in 1999 and 1998, respectively, as a result of coverage provided by our aggregate stop loss reinsurance program. This program, which became effective January 1, 1998, covers net losses incurred on the Company's net earned premium.
Amortization expense increased $3.2 million, or 9.0%, to $38.2 million in 1999 from $35.0 million in 1998. The increase was attributable to the inclusion of amortization expense of deferred acquisition costs and present value of future profits for the life insurance segment of $1.8 million and an increase in amortization of deferred acquisition costs for the property and casualty segment of $1.4 million. The increase in amortization of deferred acquisition costs for the property and casualty segment is due to the increase in premium volume and the inclusion of United Farm Family's amortization of $0.5 million.
Participating policyholders' interest of $9.7 million in 1999 is attributable to the inclusion of Farm Family Life since its acquisition by Farm Family Holdings.
Farm Family Holdings may receive dividends from subsidiaries, if declared and paid. The New York State Insurance Law regulates the distribution of dividends and other payments to Farm Family Holdings by Farm Family Casualty and Farm Family Life. As of December 31, 2000, the maximum amount of shareholder dividends that could be paid by Farm Family Casualty without the prior approval of the New York State Insurance Department (the "Department") was approximately $4.6 million. During 2000, Farm Family Casualty declared and paid dividends of $0.5 million to Farm Family Holdings.
Our asset/liability management process is designed to mitigate the risks associated with interest-sensitive assets and liabilities. We price our annuity and universal life products based on assumptions considering prevailing and expected interest rates and other factors to achieve a positive difference, or spread, between the expected return on investments and the crediting rate. We attempt to achieve this spread by active portfolio management focusing on matching the duration of invested assets and related liabilities to minimize the exposure to fluctuations in interest rates and by the adjustment of the crediting rate on annuity products. In addition, we perform cash flow analysis under multiple interest rate scenarios to further analyze the assets and liabilities of our life insurance segment. We believe that we will continue to achieve a positive spread and that the amount of lapses and surrender rates generally will remain consistent with those assumed in the pricing of the products. To assist in the management of our assets and liabilities, we utilize the services of a professional investment management firm specializing in managing insurance company assets. We believe this supplements our internal capabilities and will further improve the management of the invested assets.
We currently do not have any investments in financial instruments such as futures, forward, swap, or option contracts, or other financial instruments with similar characteristics.
On April 25, 2000, Farm Family Holdings' Board of Directors adopted a stock repurchase plan that authorized Farm Family Holdings to repurchase shares of its common stock in an aggregate amount of up to $7.5 million. During 2000, we repurchased 110,000 shares of our common stock for $3.0 million at an average cost of $27.45 per share. The repurchases were financed through cash generated from operations. As of December 31, 2000, $4.5 million remained authorized under the stock repurchase plan for future share repurchases. Pursuant to the merger agreement with American National, Farm Family Holdings may not repurchase any additional shares prior to the closing of the merger with American National, without the prior consent of American National. See Notes 3 and 20 to the Consolidated Financial Statements for further details regarding the merger.
Net cash provided by operating activities was $73.9 million, $64.5 million, and $29.5 million during the years ended December 31, 2000, 1999, and 1998, respectively. The $9.4 million increase in net cash provided by operating activities in 2000 was primarily in the life insurance segment which included a full year of Farm Family Life's operations compared to 1999 which included Farm Family Life's operations subsequent to the effective date of the acquisition on April 6, 1999. The $35.0 million increase in net cash provided by operating activities in 1999 compared to 1998 resulted primarily from additional cash provided by operating activities of the life insurance segment subsequent to the acquisition of Farm Family Life on April 6, 1999.
Pursuant to the merger agreement with American National, Farm Family Holdings may not make any capital expenditure involving a payment in excess of $0.5 million, with an aggregate limit of $3.0 million, without the prior consent of American National. See Notes 3 and 20 to the accompanying Consolidated Financial Statements for further details regarding the merger.
Net cash used in financing activities was $30.2 million, $19.9 million, and $1.3 million for the years ended December 31, 2000, 1999, and 1998, respectively. Net cash used in 2000 and 1999 was primarily the result of policyholder fund withdrawals on interest sensitive products exceeding the related deposits for these products. The 2000 amounts include a full year of policyholder activity and the 1999 policyholder amounts include activity since the acquisition of Farm Family Life on April 6, 1999. Also, during June 1999, we marketed a single premium deferred annuity at a special rate ("special annuity"). We received $55.1 million in premiums from sales of the special annuity. The total amount received included $50.4 million of money from other policies held with the Company that did not have surrender protection which were exchanged for special annuity policies that have seven-year surrender protection. The 1998 net cash used was due to principal payments on surplus notes.
The Company's liability for funds on deposit from policyholders includes amounts subject to discretionary withdrawal. Withdrawal characteristics as of December 31, 2000 are as follows:
The Company's property catastrophe reinsurance provides $48 million of protection per event in excess of $3 million retention. In addition, the Company has aggregate stop loss reinsurance covering: net property losses incurred in excess of 65% of net earned property premiums, up to a maximum of $5.0 million, for accident year 2000; and net losses incurred in excess of 66% of net earned premiums, up to a maximum of $12.5 million per accident year, for accident years 1998 and 1999. Aggregate stop loss reinsurance covers our direct written and assumed reinsurance business, net of reinsurance ceded. The Company's reinsurance program is structured to partially mitigate the impact of large or unusual losses as well as the aggregation of smaller, more frequent losses on liquidity and operating results.
We believe that the Company's liquidity and capital resources are adequate for the coming year.
Certain reclassifications have been made to prior periods' financial statements to conform to the current period's presentation.
The preparation of financial statements in accordance with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
The Company considers all highly liquid investments purchased with a maturity of three months or less to be cash equivalents.
Other invested assets, which consist primarily of investments in real estate, are carried at cost, which approximates fair value.
Investment income consists primarily of interest and dividends. Interest is recognized on an accrual basis and dividends are recorded on the ex-dividend date. Interest income on mortgage-backed and asset-backed securities is determined by the effective yield method based on estimated principal repayments. Realized investment gains and losses are determined on a specific identification basis.
The income tax provision is calculated under the liability method. Deferred income tax assets and liabilities are recorded based on the difference between the financial statement and tax bases of assets and liabilities and the enacted tax rates. The principal assets and liabilities giving rise to such differences are reserves for losses and loss adjustment expenses, unearned premiums, reserves for life policies and contract benefits, funds on deposit from policyholders, present value of future profits, participating policyholders' interest and deferred acquisition costs. Deferred income taxes also arise from unrealized investment gains or losses on equity securities and fixed maturities classified as available for sale.
The Company has elected to account for its stock compensation plan using the intrinsic value based method as prescribed by Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25"). Accordingly, no compensation cost is recognized in the financial statements for employee stock options that are issued with an exercise price equal to the fair market value of the stock.
Universal life-type policies are insurance contracts with terms that are not fixed and guaranteed. The terms that may be changed could include one or more of the amounts assessed to the policyholder, premiums paid by the policyholder or interest credited to policyholder balances. Revenues for universal life-type policies consist of charges assessed against policy account values for the cost of insurance and policy administration. Other amounts received as payments for such contracts are not reported as premium revenues. Payments received are considered deposits and are classified as funds on deposit from policyholders. Account balances are increased by interest credited and reduced by withdrawals, mortality charges and administrative expenses charged to policyholders.
Contracts that do not subject the Company to risks arising from policyholder mortality or morbidity are referred to as investment contracts. Certain annuity contracts are considered investment contracts. Revenues for investment contracts consist of investment income and policy administration charges. Other amounts received as payments for such contracts are not reported as premium revenues. Payments received are considered deposits and are classified as funds on deposit from policyholders. Account balances are increased by interest credited and reduced by withdrawals.
All insurance related revenues, losses, benefits and expenses are reported net of reinsurance.
For traditional life insurance products, these costs are amortized, with interest, in proportion to the ratio of estimated annual revenues to the estimated total revenues over the contract period. For most life insurance, a 15-year to 40-year amortization period is used, and a 25-year period is used for annuities.
Amortization of deferred acquisition costs includes amounts relating to property and casualty and life insurance business and has been reported as amortization expense in the accompanying consolidated statements of income and comprehensive income.
Reserves for losses and loss adjustment expenses represent estimates of the ultimate amounts necessary to settle reported losses and a provision for incurred but not reported claims of insured losses for property and casualty insurance business. The reserve estimates are based on known facts and circumstances, including the Company's experience with similar cases and historical trends involving reserving patterns, loss payments, pending levels of unpaid claims and product mix, as well as other factors including court decisions, economic conditions and public attitudes. The reserves for losses and loss adjustment expenses include case basis estimates of reported losses, estimates of incurred but not reported losses based upon prior experience adjusted for current trends, and estimates of losses to be paid under assumed reinsurance contracts. Estimated amounts of recoverable salvage and subrogation are deducted from the reserves for losses and loss adjustment expenses. The establishment of appropriate reserves, as well as related amounts recoverable under reinsurance contracts is an inherently uncertain process. Reserve estimates are regularly reviewed and updated, using the most current information available. Any resulting adjustments, which may be material, are reflected in current operations (see Note 10).
The liabilities for future policy and contract benefits for long-term disability income contracts are based upon interest rate assumptions and morbidity and termination rates from published tables.
The actuarially determined present value of anticipated net cash flows to be realized from insurance, annuity and investment contracts in force at the date of an acquisition is recorded as PVFP. This balance is amortized and evaluated for recoverability in the same manner as the deferred acquisition costs described above. PVFP amortization is projected to range from 8.3% to 12.1% of the December 31, 2000 unamortized balance for each of the next five years.
Property and equipment are stated at cost, net of accumulated depreciation. The Company uses the straight-line method of depreciation. The estimated useful lives of the Company's depreciable assets range from 10 to 20 years for property and 3 to 7 years for equipment and software. The Company reviews its property and equipment for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable.
The impact of including Excess Interest and Spreads in the Company's estimate of the profits on participating life insurance business allocable to stockholders increased the profits allocable to stockholders and is included in participating policyholders' interest on the accompanying Consolidated Statements of Income and Comprehensive Income. The effect of retroactively including Excess Interest and Spreads in the Company's calculation of its estimate of profits on participating life insurance business allocable to stockholders for periods through December 31, 1999 increased net income for the year ended December 31, 2000 by $12.7 million (after tax expense of $6.3 million) or $2.07 per common share on a fully diluted basis.
The Company accrues assessments levied by guaranty associations, and potential assessments for events that have occurred, in certain states.
The delay in implementation was effected through the issuance of SFAS No. 137, which extends the SFAS No. 133 requirements to fiscal years beginning after June 15, 2000. In June 2000, the FASB issued SFAS No. 138, which amends the accounting and reporting standards of Statement 133 for certain derivative instruments and certain hedging activities. Therefore, the Company adopted the provisions of SFAS No. 133 and SFAS No. 138 as of January 1, 2001. Since the Company does not have any investments in derivative financial instruments, the adoption of these statements did not have an impact on the Company's financial statements.
In 1998, the National Association of Insurance Commissioners ("NAIC") adopted the Codification of Statutory Accounting Principles guidance (the "Codification"), which will replace the current Accounting Practices and Procedures Manual as the NAIC's primary guidance on statutory accounting. Statutory accounting is a comprehensive basis of accounting based on prescribed accounting practices, which include state laws, regulations and general administrative rules, as well as a variety of publications of the NAIC. The Codification provides guidance for the areas where statutory accounting has been silent and changes current statutory accounting in some areas. The NAIC has established January 1, 2001 as the effective date of the Codification. However, individual states retain the right to adopt Codification in whole or in part. The New York Insurance Department has adopted the Codification, with modifications to conform to provisions in New York statute which conflict with particular points in the Codification rules. The impact of adopting Codification will be reported as an adjustment to the statutory surplus of our insurance subsidiaries on the effective date. The Company estimates the adoption of the Codification will increase the statutory surplus of its insurance subsidiaries by approximately $5.5 million in the aggregate. The Company expects that statutory surplus after adoption will continue to be in excess of the regulatory risk-based capital requirements.
On October 31, 2000, Farm Family Holdings announced that it entered into an Agreement and Plan of Merger, dated as of October 31, 2000, among Farm Family Holdings, American National Insurance Company ("American National"), a Texas insurance company, and American National Acquisition Company, a newly formed Delaware corporation and subsidiary of American National.
The table below presents the amortized cost and fair value of fixed maturities at December 31, 2000, by contractual maturity. Actual maturities may differ from contractual maturities as a result of prepayments.
The change in unrealized appreciation (depreciation) of investments included in stockholders' equity as accumulated other comprehensive income and participating policyholders' interest is as follows:
The components of net investment income for the years 2000, 1999 and 1998 are as follows:
A summary of realized investment gains (losses), net for the years 2000, 1999 and 1998 is as follows:
The amount of net realized investment losses attributable to participating policyholders for 2000 and 1999 was approximately $2.4 million and $1.6 million, respectively. There were no participating policyholders prior to the acquisition of Farm Family Life effective April 6, 1999.
The following table presents the carrying amounts and estimated fair values of financial instruments held by the Company at December 31, 2000 and 1999. The fair value of a financial instrument is the amount at which the instrument could be exchanged in a current transaction between willing parties. The table excludes cash and cash equivalents, insurance receivables, receivables from affiliates, accrued investment income and other assets, and accrued expenses and other liabilities, all of which had fair values approximating carrying values. As a number of the Company's significant assets (including deferred acquisition costs, and deferred income taxes) and liabilities (including reserves for property/casualty insurance losses and loss adjustment expenses and reserves for life policies and contract benefits) are not considered financial instruments, the disclosures that follow do not reflect the fair value of the Company as a whole.
Mortgage loans - The fair value is based on discounted cash flows using interest rates at which similar loans would be made to borrowers with similar characteristics.
Policy loans - Future cash flows of policy loans are uncertain and difficult to predict. Therefore management believes that the fair value of policy loans approximates the unpaid principal balance.
Amortization and depreciation expense was $2.4 million for 2000 and $2.0 million for 1999. Included in these totals are amortization expense relating to software of $0.2 million for 2000 and $0.1 million for 1999.
The Company purchases property and casualty reinsurance to limit its exposure to losses from catastrophic events, such as hurricanes, tornadoes or earthquakes, and to limit losses from any single large risk. Reinsurance contracts do not relieve the Company from its obligations to policyholders as the primary insurer. The Company evaluates the financial condition of its reinsurers and monitors concentrations of risk arising from similar geographic regions, activities and economic characteristics of the reinsurers to minimize its exposure to significant losses from reinsurer insolvencies. The Company regularly evaluates amounts recoverable and an allowance for uncollectible reinsurance is provided when collection is in doubt. At December 31, 2000 and 1999, the Company determined it was not necessary to provide an allowance for uncollectible reinsurance. Reinsurance receivables at December 31, 2000 include $34.7 million related to the property and casualty insurance segment and $1.7 million related to the life insurance segment. Approximately 92% of the property and casualty reinsurance receivable balances at December 31, 2000 were due from eight reinsurers.
Effective December 31, 1997, the Company revised its property and casualty reinsurance program. Certain reinsurance agreements with its affiliate, United Farm Family, were terminated effective December 31, 1997. As a result, United Farm Family discontinued reinsuring losses incurred by Farm Family Casualty which exceeded $100,000 up to $300,000 and, accordingly, Farm Family Casualty's retention increased from $100,000 to $300,000 effective January 1, 1998. The Company's property catastrophe reinsurance provides $48 million of protection per event in excess of a $3 million retention. In addition, the Company has aggregate stop loss reinsurance covering: net property losses incurred in excess of 65% of net earned property premiums, up to a maximum of $5.0 million per accident year, for accident year 2000; and net losses incurred in excess of 66% of net earned premiums, up to a maximum of $12.5 million per accident year, for accident years 1998 and 1999. Aggregate stop loss reinsurance covers our direct written and assumed reinsurance business, net of reinsurance ceded. The Company's reinsurance program is structured to partially mitigate the impact of large or unusual losses as well as the aggregation of smaller, more frequent losses on liquidity and operating results.
The effects of reinsurance on premiums written and earned, and losses and loss adjustment expenses incurred, for the years ended December 31, were as follows:
The components of the deferred income tax assets and liabilities at December 31, 2000 and 1999 are:
The components of income tax expense (benefit) for the years ended December 31, are as follows:
The Company paid income taxes of $ 9.7 million, $9.8 million, and $6.7 million in 2000, 1999 and 1998 respectively.
As described in Note 2, the Company establishes reserves for losses and loss adjustment expenses on reported and incurred but not reported claims. The establishment of appropriate reserves for losses and loss adjustment expenses is an inherently uncertain process and the ultimate cost may vary materially from the recorded amounts. Reserve estimates are regularly reviewed and updated, using the most current information. Any resulting adjustments, which may be material, are reflected in current operations.
The Company does not discount reserves for losses and loss adjustment expenses except for certain lifetime workers' compensation indemnity reserves it assumes from mandatory pools. The amount of such discounted reserves was $1.7 million (net of a discount of $1.1 million), $2.4 million (net of a discount of $1.2 million), and $3.3 million (net of a discount of $1.2 million) for December 31, 2000, 1999 and 1998, respectively.
At December 31, 2000, the Company had no outstanding debt. On April 1, 1998 the Company redeemed all of its outstanding debt, consisting of $293,000 of debentures and $975,000 of subordinated surplus certificates, plus accrued interest of $127,000. The debentures and subordinated surplus certificates paid interest at the rate of 8% per annum, had no maturity date, and principal and interest were repayable only with the approval of the Insurance Department of the State of New York. No single holder held more than 5% of the outstanding debentures or subordinated surplus certificates at the time of redemption. The Company paid interest of $127,000 for the year ended December 31, 1998.
At December 31, 2000, the Company had a revolving credit agreement with three banks, providing for uncollateralized borrowings of up to $30.0 million with no amounts outstanding. Effective January 2001, the committed amount decreased to $20.0 million. Pursuant to the merger agreement with American National, Farm Family Holdings may not borrow against the line of credit prior to the closing of the merger with American National, without the prior consent of American National. Upon the closing of the merger, the revolving credit agreement will be terminated.
Pension plan assets include an unallocated group annuity contract issued by Farm Family Life. The fair value of the contract was $2,839,000, $852,000, and $870,000 at December 31, 2000, 1999, and 1998, respectively.
The components of the plans' accrued benefit cost as of December 31, 2000, 1999 and 1998 are as follows:
The Company's portion of net periodic pension benefit for the years ended December 31, 2000, 1999 and 1998 was $(207,000), $(505,000), and $(12,000), respectively.
The Company's portion of net periodic other benefits for the years ended December 31, 2000, 1999 and 1998 was $144,000, $137,000, and $85,000, respectively.
The Company sponsors the Omnibus Securities Plan (the "Securities Plan"), under which up to 1,000,000 shares of common stock are available for award to key employees. Stock options granted under the Securities Plan may be either incentive stock options ("ISO's") or non-qualified stock options ("NQSO's"). For ISO's, the option price may be no less than the fair market value on the date of the grant. For NQSO's, the option price may be no less than 85% of the fair market value on the date of grant. All granted options have been at exercise prices equal to the fair value of the Company's common stock on the applicable grant date. The options granted vest annually in approximately equal amounts over a three-year period. The options granted may be exercised when vested and will expire ten years after the date of grant.
No stock options were exercisable at December 31, 1998. The Company has elected to follow APB 25 and related interpretations in accounting for the Securities Plan. Under APB 25, because the exercise price of the Company's stock options equals the fair market price of the underlying stock on the date of grant, no compensation expense is recognized. If the Company had determined the compensation expense of the Securities Plan as prescribed by Statement 123, the Company's net income and earnings per share would have been reduced to the pro forma amounts as follows:
At December 31, 2000 the weighted-average contractual life of the outstanding options is 7.6 years.
Upon adoption of the merger agreement with American National by Farm Family Holdings' stockholders (see Notes 3 and 20 to the Consolidated Financial Statements), all outstanding stock options that have been granted to Farm Family Holdings' directors and officers under the Omnibus Securities Plan will vest and become exercisable. Immediately before the effective time of the merger, all outstanding stock options, whether or not vested or exercisable, will terminate and each holder of a terminated stock option will receive at the effective time of the merger a cash payment equal to the number of shares subject to his or her stock option multiplied by the excess, if any, of (1) the higher of the fair market value per share of Farm Family Holdings' common stock immediately prior to the adoption of the merger agreement, or the merger consideration per share of our common stock, which is $44.00 per share, over (2) the exercise price of the option. Based on the number of stock options outstanding as of December 31, 2000 and the exercise prices of those stock options, and assuming the merger consideration is higher than the fair market value of our common stock immediately prior to the adoption of the merger agreement by our stockholders, holders of outstanding stock options will receive approximately $8.7 million, in the aggregate, in exchange for termination of their stock options.
Prior to Farm Family Holdings' acquisition of Farm Family Life effective April 6, 1999, the operations of Farm Family Holdings (including Farm Family Casualty) were closely related with those of Farm Family Life and Farm Family Life's wholly owned subsidiary, United Farm Family. The affiliated companies operate under similar Boards of Directors, with similar senior management and shared home office premises, branch office facilities, data processing equipment, certain personnel and other operational expenses. Expenses are shared based on each company's estimated level of usage. The operations of Farm Family Life, which were not previously consolidated with Farm Family Holdings, have been consolidated subsequent to the acquisition by Farm Family Holdings. For each of the periods January 1, 1999 through April 6, 1999 and the year ended December 31, 1998, 68% of aggregate expenses totaling $7.7 million and $29.3 million, respectively, were allocated to the Company under an expense sharing agreement.
See Notes 3 and 20 to the Consolidated Financial Statements for information regarding the merger agreement with American National.
(2) Net income under statutory accounting principles for 1999 includes the operations for Farm Family Life for the entire year. The Company's net income under generally accepted accounting principles only includes the operations of Farm Family Life since April 6, 1999 - the date it was acquired by Farm Family Holdings.
Catastrophes are an inherent risk in the property and casualty insurance industry and could produce significant adverse fluctuations in the Company's results of operations and financial condition. The Company is subject to a concentration of risk within the Northeastern United States. For the years ended December 31, 2000, 1999 and 1998, approximately 59%, 62%, and 63%, respectively, of the Company's property and casualty direct premiums were written in the states of New York and New Jersey. In addition, for the years ended December 31, 2000 and 1999, approximately 58% and 59%, respectively, of the life insurance segement's collected life insurance premiums were derived from policies written in the states of New York and New Jersey. As a result of the concentration of the Company's business in the states of New York and New Jersey, and more generally, in the Northeastern United States, the Company's results of operations may be significantly affected by weather conditions, catastrophic events and regulatory developments in these two states and in the Northeastern United States, despite the Company's reinsurance program designed to mitigate the impact of adverse weather and catastrophic events on the Company's operating results.
During the third quarter of 1998, the Company modified the agreements with its agents to include revised conditions under which eligible agents may receive extended earnings payments. In addition to the conditions described previously, extended earnings will be paid only if a successor agent(s) assumes the right to service the book of business of the eligible former agent and agrees to become primarily responsible for making the extended earnings payments. In the event that no successor agent(s) assumes the right to service the book of business of an eligible former agent, the Company has no obligation to make the extended earnings payments. The Company has no intention to waive this provision of its agreements with its agents. As a result, the successor agent(s), not the Company, will be the primary obligor responsible for extended earnings payments. Since the inception of the Program in 1986, the Company has always been able to identify successor agents willing to assume the rights to service such books of business. The Company will act as guarantor of the amounts payable to eligible former agents who have terminated their association with the Company by successor agents who agree to make the extended earnings payments. At December 31, 2000, the Company was guarantor of $1.7 million for such payments. The Company expects to enforce the terms of the guarantee in the event of default by a successor agent.
Farm Family Casualty and Farm Family Life are each parties to Membership List Purchase Agreements with the state Farm Bureaus in Connecticut, Delaware, Maine, Massachusetts, New Hampshire, New Jersey, New York, Rhode Island, Vermont and West Virginia. The Membership List Purchase Agreements are for six years commencing on January 1, 1996. For the years ended December 31, 2000, 1999, and 1998, the Company incurred expense of $1.4 million, $1.2 million, and $0.7 million, respectively, to the Farm Bureaus pursuant to the Membership List Purchase Agreements.
At December 31, 2000 and 1999, the gross amount of property and equipment and related depreciation recorded under capital leases was $348,000 and $365,000, respectively. The future minimum capital lease payments as of December 31, 2000 are approximately $132,000 per year for 2001 and 2002.
The following table sets forth the unaudited quarterly financial information for the periods indicated.
"Corporate and other" includes holding company activities and operations not directly related to the reportable segments.
On February 27, 2001, Farm Family Holdings held a special meeting of its stockholders at which they considered and voted upon a proposal to adopt the merger agreement with American National pursuant to which Farm Family Holdings would be sold to American National. The merger, valued at approximately $280 million, is subject to certain other closing conditions, including the approval of the New York State Insurance Department.
On March 28, 2001, American National and Farm Family Holdings announced that the termination date of their merger agreement was automatically extended for up to an additional 90 days from March 31, 2001 in order to allow American National further time to obtain the approval of the New York State Insurance Department for the merger. The automatic extension was in accordance with the terms of the merger agreement. American National expects to receive the New York State Insurance Department's approval by the end of the first week of April. The companies expect to close the merger promptly after the receipt of the New York State Insurance Department's approval.
In our opinion, the consolidated financial statements listed in the index appearing under Item 14(a)(1) present fairly, in all material respects, the financial position of Farm Family Holdings, Inc. and its subsidiaries at December 31, 2000 and 1999, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2000 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedules listed in the index appearing under 14(a)(2) present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedules are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.