Amounts are impacted by accumulated other comprehensive income (loss) totaling ($649.8) million in 2008, ($36.3) million in 2007, $28.2 million in 2006, $82.3 million in 2005, and $141.2 million in 2004. These amounts are net of deferred income taxes and other adjustments for assumed changes in the amortization of deferred policy acquisition costs, deferred sales inducements, unearned revenue reserve and value of insurance in force acquired.
When reading the following Management’s Discussion and Analysis of Financial Condition and Results of Operations, please refer to our consolidated financial statements and related notes included in Item 8, “Financial Statements and Supplementary Data,” of this report. Unless noted otherwise, all references to FBL Financial Group, Inc. (we or the Company) include all of its direct and indirect subsidiaries, including its primary life insurance subsidiaries, Farm Bureau Life Insurance Company (Farm Bureau Life) and EquiTrust Life Insurance Company (EquiTrust Life) (collectively, the Life Companies).
We review our financial condition addressing investment portfolio, market risks, sources and uses of cash, capital resources and requirements and commitments.
We sell individual life insurance and annuity products through an exclusive distribution channel and individual annuity products through independent agents and brokers. Our exclusive agency force consists of 1,962 Farm Bureau agents and managers operating in the Midwestern and Western sections of the United States. Our independent channel, which we began in 2003, consists of 19,098 agents and brokers operating throughout the United States. In addition to writing direct insurance, we assume business through various coinsurance agreements. Several subsidiaries support various functional areas of the Life Companies and other affiliates, by providing investment advisory, marketing and distribution, and leasing services. In addition, we manage two Farm Bureau affiliated property-casualty companies.
The amount of fees we earn on contract holders’ separate account balances.
Our ability to price our life insurance products to earn acceptable margins over the cost of providing benefits and the expenses of acquiring and administering the products. Competitive conditions, mortality experience, persistency, investment results and our ability to maintain expenses in accordance with pricing assumptions
drive our margins on the life products. On many products, we have the ability to mitigate adverse experience through adjustments to credited interest rates, policyholder dividends or cost of insurance charges.
The financial markets experienced stress during the second half of 2007, which continued and significantly increased during 2008 and into 2009. The volatility and disruption in the financial markets have reached unprecedented levels, causing the availability and cost of credit to be materially affected. These factors, combined with volatile oil prices, depressed home prices and increasing foreclosures, falling equity market values, declining business and consumer confidence and the risks of increased inflation and unemployment, have precipitated a severe recession. These economic conditions did not negatively impact our sales in 2008. However, an economic downturn characterized by higher unemployment, lower family income, lower consumer spending, lower corporate earnings and lower business investment may adversely impact the demand for our products in the future. We also may experience a higher incidence of claims, lapses or surrenders of policies. We cannot predict whether or when such actions may occur, or what impact, if any, such actions could have on our business, results of operations, cash flows and financial condition.
We maintain certain capital levels in accordance with statutory and rating agency requirements. Fixed annuity products generally place a strain on statutory capital when sold and add to capital in subsequent years. As a result of the significant growth of the EquiTrust Life independent distribution channel business, our need for capital has increased in recent years. In addition, our capital levels were negatively impacted during 2008 as a result of realized
Premiums collected is not a measure used in financial statements prepared according to U.S. generally accepted accounting principles (GAAP). There is no comparable GAAP financial measure. We use premiums collected to measure the productivity of our exclusive and independent agents. Direct premiums collected in the Traditional Annuity - Exclusive Distribution segment increased in 2008 primarily due to lower short-term market interest rates making certificates of deposits and other short-term investments less attractive in relation to our traditional fixed annuity products. Direct premiums collected in the Traditional Annuity - Independent Distribution segment decreased in 2008 as a result of rate and other actions taken to preserve capital in the second half of 2008, partially offset by a more favorable market environment for traditional annuity products. Direct premiums collected in the Traditional Annuity - Independent Distribution segment decreased in 2007, primarily due to a more favorable market environment during 2006 for the sale of our multi-year guaranteed annuity product combined with a competitive environment for index annuity sales in 2007. We also took actions to further increase the profitability of our products in 2007. Variable premiums collected tend to vary with volatility, performance of and confidence level in the equity markets as well as crediting and interest rates on competing products, including fixed rate annuities and bank-offered certificates of deposit.
The increase in the withdrawal rate for the Independent Distribution segment in 2008 is primarily due to the impact of low U.S. Treasury yields on the market value adjustment feature for our direct fixed annuity products, which
provided an environment where contract holders could surrender with smaller net surrender charges. See additional details on this feature in the “Market Risk of Financial Instruments” section that follows. We also believe aging of the business in force relating to the annuity business assumed under coinsurance agreements and business written directly through the EquiTrust Life independent agents is driving a portion of the increase in withdrawal rates as the surrender charge rate decreases with the passage of time (at a rate generally equal to 1.0% per year). This makes a surrender later in the contract period more economical for the contract holder, which results in higher lapse rates as the business ages.
Net income (loss) decreased 121.0% in 2008 to ($18.1) million and decreased 4.2% in 2007 to $86.3 million. As discussed in detail below, net income (loss) decreased in 2008 primarily due to realized losses on investments, the impact of changes in the assumptions used to amortize deferred policy acquisition costs and deferred sales inducements and an increase in death benefits. Net income decreased in 2007 due to the impact of changes in unrealized gains and losses on derivatives and a decrease in realized gains on investments, partially offset by the impact of growth in the volume of business in force and decrease in death benefits. The increase in volume of business in force is quantified in the detailed discussion that follows by summarizing the face amount of insurance in force for life products or account values of contracts in force for interest sensitive products. The face amount of life insurance in force represents the gross death benefit payable to policyholders and account value represents the value of the contract to the contract holder before application of surrender charges or reduction for any policy loans outstanding. The following discussion provides additional details on the items impacting net income (loss).
Spreads Earned on our Universal Life and Individual Traditional Annuity Products
We periodically revise the key assumptions used in the calculation of the amortization of deferred policy acquisition costs, deferred sales inducements, value of insurance in force acquired and unearned revenues for participating life insurance, variable and interest sensitive and index products, as applicable, through an “unlocking” process. Revisions are made based on historical results and our best estimate of future experience. The impact of unlocking is recorded in the current period as an increase or decrease to amortization of the respective balances. While the unlocking process can take place at any time, as needs dictate, the process typically takes place annually with different blocks of business unlocked each quarter. The impact of unlocking in 2008 was primarily due to updating the amortization models for assumptions relating to the significant increase to surrender and withdrawal rates late in 2008 and into 2009 on annuities sold through our independent distribution channel, as discussed above in the “Impact of Recent Business Environment” section. These assumption changes resulted in an unlocking adjustment which totaled $29.6 million in the fourth quarter of 2008. See the “Segment Information” section that follows for additional discussion of our unlocking adjustments.
Surrender charges totaled $33.6 million in 2008, $23.4 million in 2007 and $18.3 million in 2006. Surrender charges increased primarily due to an increase in surrenders relating to the impact of market value adjustments on certain products sold by our EquiTrust Life independent distribution, as discussed in the “Impact of Recent Business Environment” section above, and also due to growth in the volume and aging of business in force.
Net investment income, which excludes investment income on separate account assets relating to variable products, increased 12.7% in 2008 to $707.9 million and increased 17.2% in 2007 to $628.0 million. These increases are primarily due to increases in average invested assets. Average invested assets increased 13.5% to $11,835.2 million (based on securities at amortized cost) in 2008 and 18.2% to $10,430.4 million in 2007. Average invested assets totaled $8,822.7 million in 2006. The increase in average invested assets in 2008 and 2007 is principally due to net premium inflows from the Life Companies and proceeds from borrowings in March 2007 and the last half of 2008.
Net investment income was impacted by fee income from bond calls, tender offers and mortgage loan prepayments, which totaled $2.8 million in 2008, $10.1 million in 2007 and $8.9 million in 2006. Net investment income also includes less than $0.1 million in 2008, ($1.3) million in 2007 and $0.1 million in 2006 representing the acceleration (reversal) of net discount accretion on mortgage and asset-backed securities resulting from changing prepayment speed assumptions at the end of each respective period. See the “Financial Condition - Investments” section that follows for a description of how changes in prepayment speeds impact net investment income.
The annualized yield earned on average invested assets decreased to 6.17% in 2008 from 6.19% in 2007 and 6.25% in 2006. The decrease in yield earned in 2008 is primarily due to the reduction in fee income described above and an increase in the level of cash and short-term investments we retained due to the volatile financial markets limiting the availability of high quality fixed maturity securities and our desire to maintain a more liquid position during uncertain economic times. Market conditions also impacted the investment portfolio yields based on the level of market investment rates for new acquisitions compared to our average portfolio yield or the yield on investments maturing or being paid down. The average yields on fixed maturity securities purchased were 6.32% for 2008, 6.11% for 2007 and 6.04% for 2006. The average yields on fixed maturity securities maturing or being paid down were 6.13% for 2008, 6.59% for 2007 and 6.62% for 2006.
Range of Index Appreciation for S&P 500 Index Options Expiring During the Periods
not applicable as option strategy was not offered during the prior period.
The change in fair value is also reduced by participation rates and caps, as applicable, on the underlying options. Furthermore, the change in fair value is impacted by options based on other underlying indices. The cost of money for call options increased due to the impact of growth in the volume of index annuities in force. In addition, the price of call options increased due to an increase in the volatility of the equity markets during 2008 and 2007. Other derivative loss is comprised of changes in the value of the conversion feature embedded in convertible fixed maturity securities and the embedded derivative included in our modified coinsurance contracts. In addition, beginning in the second quarter of 2007, other derivative loss includes cash flows and the change in fair value of the interest rate swaps relating to our flexible premium deferred annuity contracts due to the adoption of Statement of Financial Accounting Standards (Statement) 133 Implementation Issue No. G26, “Cash Flow Hedges: Hedging Interest Cash Flows on Variable Rate Assets and Liabilities That Are Not Based on a Benchmark Interest Rate.” See Note 3 to our consolidated financial statements for additional details on this change in accounting. Derivative income (loss) will fluctuate based on market conditions.
bankruptcy. See “Financial Condition - Investments” and Note 2 for details regarding our unrealized gains and losses on available-for-sale securities at December 31, 2008 and 2007.
We monitor the financial condition and operations of the issuers of securities rated below investment grade and of the issuers of certain investment grade securities on which we have concerns regarding credit quality. In determining whether or not an unrealized loss is other than temporary, we review factors such as:
Other income and other expenses include revenues and expenses, respectively, relating primarily to our non-insurance operations. Our non-insurance operations include management, advisory, marketing and distribution services and leasing activities. Fluctuations in these financial statement line items are generally attributable to fluctuations in the level of these services provided during the years.
Interest sensitive and index product benefits and change in value of index product embedded derivatives decreased 42.5% in 2008 to $251.1 million and increased 6.7% in 2007 to $436.6 million. The decrease in 2008 is primarily due to market depreciation on the indices backing the index annuities, partially offset by the impact of unlocking of amortization of deferred sales inducements associated with increased surrenders and withdrawals. In addition, interest credited increased due to an increase in the volume of annuity business in force and there was an increase in interest sensitive death benefits. In 2007, the increase was primarily due to an increase in volume of annuity business in force, partially offset by market depreciation and a decrease in interest sensitive death benefits. Interest sensitive and index product benefits tend to fluctuate from period to period primarily as a result of changes in mortality experience and the impact of changes in the equity markets on index credits, amortization of deferred sales inducements and the value of the embedded derivatives in our index annuities.
The weighted average interest crediting rate/index cost for universal life and individual traditional annuity products, excluding the impact of the amortization of deferred sales inducements, was 3.94% for 2008, 3.72% for 2007 and 3.63% for 2006. See the “Segment Information” section that follows for additional details on our spreads.
Traditional life insurance policy benefits increased 6.9% in 2008 to $160.2 million and 2.1% in 2007 to $149.9 million. Traditional life insurance death benefits increased 18.6% to $60.6 million in 2008 and decreased 5.0% to $51.1 million in 2007. Surrender benefits decreased 7.8% to $32.6 million in 2008 and increased 7.5% to $35.4 million in 2007. The change in traditional life and future policy benefits may not be proportional to the change in traditional premiums and benefits as reserves on term policies are generally less than reserves on whole life policies. Distributions to participating policyholders decreased in 2008 and 2007 due to reductions in our dividend crediting rates in response to the impact of declining market interest rates on our investment portfolio yield as discussed in the “Net Investment Income” section above. Traditional life insurance benefits can fluctuate from period to period primarily as a result of changes in mortality experience.
Underwriting, acquisition and insurance expenses increased 36.8% in 2008 to $221.4 million and decreased 1.7% in 2007 to $161.8 million. Amortization of deferred policy acquisition costs increased in 2008 primarily due to the impact of unlocking assumptions used in the amortization calculation. See sections above and the “Market Risks of Financial Instruments - Interest Rate Risk” section that follows for additional information on the impact of increased surrender activity on the amortization of deferred policy acquisition costs. In addition, amortization of deferred policy acquisition costs increased due to the impact of unrealized gains/losses on derivatives and an increase in the volume of business in force resulting primarily from direct sales from our EquiTrust Life distribution channel, partially offset by the impact of realized/unrealized gains and losses on investments. Amortization of deferred policy acquisition costs on our direct EquiTrust Life business, excluding the impact of unlocking, changes in unrealized gains/losses on investments and derivatives, totaled $42.5 million in 2008, $24.6 million in 2007 and $15.1 million in 2006. The impact of realized/unrealized gains and losses on investments and the change in unrealized gains/losses on derivatives is detailed in the sections above. Amortization of value of insurance in force acquired decreased in 2008 and increased in 2007 primarily due to the impact of unlocking in 2007 and realized losses on investments in 2008.
The increase in other underwriting, acquisition and insurance expenses in 2008 is primarily due to a $1.0 million increase in software amortization and a $0.5 million increase in salaries and benefits. The decrease in other underwriting, acquisition and insurance expenses in 2007 is primarily due to a $4.9 million lawsuit settlement in 2006 ($0.11 per basic and diluted common share, after taxes). See Note 1 to our consolidated financial statements for further details regarding the lawsuit settlement and a related unrecorded gain contingency.
Interest expense increased 17.4% to $19.6 million in 2008 and 41.9% to $16.7 million in 2007 primarily due to an increase in our debt. Our average debt outstanding was $336.7 million in 2008 compared to $296.6 million in 2007 and $218.4 million in 2006. As discussed in the “Liquidity and Capital Resources” section that follows, our average debt outstanding increased due to issuance of the 2017 Senior Notes in March 2007 and the 2011 Senior Notes in November 2008 and an increase in the borrowing on our line of credit agreement in September 2008.
decrease in the 2007 effective rate is primarily attributable to higher tax-exempt interest and dividend income and lower state income taxes.
In its Revenue Ruling 2007-61, issued on September 25, 2007, the Internal Revenue Service (IRS) announced its intention to issue regulations which would limit our ability to receive a dividends-received deduction (DRD) on separate account assets held in connection with variable annuity and variable universal life insurance contracts. Revenue Ruling 2007-61 suspended Revenue Ruling 2007-54 issued in August 2007 that purported to change accepted industry and IRS interpretations of the statutes governing these computation questions. No regulations were issued during 2008. Any regulations that the IRS ultimately proposes for issuance in this area will be subject to public notice and comment, at which time insurance companies and other members of the public will have the opportunity to raise legal and practical questions about the content, scope and application of such regulations. As a result, the ultimate timing, substance, and effective date of any such regulations are unknown, but they could result in the elimination of some or all of the separate account DRD tax benefit we receive. We recorded separate account DRD tax benefits totaling $1.7 million in 2008, $2.4 million in 2007 and $1.6 million in 2006.
Equity income (loss), net of related income taxes, totaled less than ($0.1) million in 2008, $1.5 million in 2007 and $1.1 million in 2006. Equity income includes our proportionate share of gains and losses attributable to our ownership interest in partnerships, joint ventures and certain companies where we exhibit some control but have a minority ownership interest. Given the timing of availability of financial information from our equity investees, we will consistently use information that is as much as three months in arrears for certain of these entities. Several of these entities are investment companies whose operating results are derived primarily from unrealized and realized gains and losses generated by their investment portfolios. As is normal with these types of entities, the level of these gains and losses is subject to fluctuation from period to period depending on the prevailing economic environment, changes in prices of equity securities held by the investment partnerships, timing and success of initial public offerings and other exit strategies, and the timing of the sale of investments held by the partnerships and joint ventures.
Pre-tax operating income for the Exclusive Annuity segment decreased 15.3% in 2008 to $27.9 million and 7.2% in 2007 to $33.0 million. The decrease in 2008 is primarily due to losses on our interest rate swaps and a reduction in investment prepayment fee income, partially offset by reducing crediting rates during 2008 and 2007 and growth of the volume of business in force. The decrease in 2007 was primarily due to the impact of unlocking on deferred policy acquisition costs as discussed under “Net Income (Loss).”
Benefits and expenses decreased in 2008 primarily due to a decrease in interest credited and index credits on contract holders’ account balances. Effective March 1, 2008, we decreased the interest crediting rate on a significant portion of our annuity portfolio 30 basis points in response to the decline in portfolio yield. The increase in benefits and expenses in 2007 was primarily due to the impact of unlocking, which increased amortization of deferred policy acquisition costs $0.6 million in 2008 and $1.2 million in 2007 and decreased amortization $1.7 million in 2006.
The decrease in spreads is primarily due to the items impacting net investment income. While we have decreased interest crediting rates for many contracts, certain other products have reached the minimum guarantee crediting rates, which contributes to the decrease in spreads. Also contributing to the decrease in spreads is a shift of business to a new money product that has a short guaranteed interest period and lower spread target.
The average aggregate account value for annuity contracts in force in the Exclusive Annuity segment totaled $1,564.1 million for 2008, $1,488.9 million for 2007 and $1,479.5 million for 2006.
Pre-tax operating income for the Independent Annuity segment decreased 86.6% in 2008 to $5.4 million and increased 31.0% in 2007 to $39.9 million. The decrease in 2008 is primarily attributable to the impact of unlocking on our direct business and a reduction in spreads on assumed business, partially offset by increased volume of business in force. The increase in 2007 is principally due to growth in the volume of business in force, partially offset by a decrease in spreads. The volume of business in force increased due to the growth of our EquiTrust Life distribution channel and lower short-term market interest rates making certificates of deposits and other short-term investments less attractive in relation to our traditional annuity products. The average aggregate account value for annuity contracts in force in the Independent Annuity segment totaled $7,169.2 million for 2008, $5,966.7 million for 2007 and $4,401.2 million for 2006.
$0.1 million in 2006. Growth in the volume of business in force also increased benefits and expenses in 2008 and 2007. The impact of unlocking in 2008 was primarily due to updating the amortization models for the increase in surrenders and withdrawals discussed above.
Premiums collected from the independent channel decreased in 2008 as a result of crediting rate and other actions taken to preserve capital in the second half of 2008, partially offset by a more favorable market environment for traditional annuity products. Direct premiums collected decreased in 2007, primarily due to a more favorable market environment during 2006 for the sale of our multi-year guaranteed annuity product combined with a competitive environment for index annuity sales in 2007. We also took actions to further increase the profitability of our products in 2007.
Pre-tax operating income for the Traditional and Universal Life Insurance segment decreased 9.6% in 2008 to $53.1 million and decreased less than 0.1% in 2007 to $58.7 million. The impact of an increase in the volume of business in force contributed to pre-tax operating income in 2008, 2007 and 2006. In 2008, this increase, combined with a decrease in dividends to participating policyholders, was offset by higher death benefits and a reduction in prepayment fee income. The decrease in pre-tax income in 2007 was primarily due to the impact of unlocking on deferred policy acquisition cost and the value of insurance in force acquired, partially offset by lower death benefits and increased spreads on our interest sensitive life business.
Death benefits totaled $91.0 million in 2008, $77.3 million in 2007 and $81.2 million in 2006. Amortization of deferred policy acquisition costs and the value of insurance in force decreased in 2008 and increased in 2007 primarily due the impact of unlocking, which increased amortization $0.3 million in 2008 and $2.4 million in 2007 and decreased amortization $1.2 million in 2006. In addition, amortization was impacted by changes in gross margins due to fluctuations in mortality and traditional life premiums.
The changes in the weighted average yield on cash and invested assets are attributable to the items affecting net investment income noted above. The decrease in weighted average interest crediting rate in 2007 is due to a decrease in credited rates on our direct business.
Variable premiums tend to vary with the volatility, performance of and confidence level in the equity markets as well as crediting and interest rates on competing products, including fixed rate annuities and bank-offered certificates of deposit. The S&P 500 Index decreased 38.5% in 2008, and increased 3.5% in 2007 and 13.6% in 2006.
Pre-tax operating loss totaled $12.4 million in 2008 compared to $2.0 million in 2007 and $3.9 million in 2006. Net investment income decreased in 2008 due to decreases in average invested assets and short-term market interest rates. Average invested assets decreased due to transfers to meet the capital needs of other operating segments during the year, partially offset by proceeds from debt borrowings. In addition, net investment income was lower in 2008 due to our desire to maintain a more liquid portfolio during the fourth quarter. Net investment income increased in 2007 due to an increase in invested assets, primarily from the proceeds of the 2017 Senior Notes.
The changes in other income and other expense are primarily due to operating results of our non-insurance operations. These operations include management, advisory, marketing and distribution services and leasing activities. The changes in equity income are discussed in the “Equity Income” section above.
Interest expense increased in 2008 and 2007 due to an increase in our average debt outstanding resulting from additional debt borrowings as discussed in the “Interest Expense” section above.
We account for our investments in accordance with Statement No. 157, “Fair Value Measurements.” Statement No. 157 defines fair value, establishes a framework for measuring fair value and expands the required disclosures about fair value measurements. See further discussion of Statement No. 157 in the “Accounting Changes” section that follows and Note 4 to our consolidated financial statements.
Credit Quality by NAIC Designation and Standard & Poor’s (S&P) Rating Equivalents
Available-For-Sale Fixed Maturity Securities with Unrealized Losses by Length of Time
At December 31, 2008, unrealized losses on available-for-sale fixed maturity securities totaled $1,649.8 million primarily due to $1,027.4 million in unrealized losses on corporate securities. The unrealized losses on corporate securities were primarily due to:
In addition, the unrealized losses on mortgage and asset-backed securities totaling $479.0 million, were primarily due an increase in credit spreads and decrease in market liquidity resulting from concerns about mortgage defaults on subprime and other risky mortgages and potential downgrades or defaults of monoline bond insurers. We have the ability and intent to hold these investments until a recovery of fair value, which may be maturity, therefore we do not consider these investments to be other-than-temporarily impaired at December 31, 2008. See
The repayment pattern on mortgage and other asset-backed securities is more variable than that of more traditional fixed maturity securities because the repayment terms are tied to underlying debt obligations that are subject to
prepayments. The prepayment speeds (e.g., the rate of individuals refinancing their home mortgages) can vary based on a number of economic factors that cannot be predicted with certainty. These factors include the prevailing interest rate environment and general status of the economy.
At each balance sheet date, we review and update our expectation of future prepayment speeds and the book value of the mortgage and other asset-backed securities purchased at a premium or discount is reset, if needed, to result in a constant effective yield over the life of the security. This effective yield is computed using historical principal payments and expected future principal payment patterns. Any adjustments to book value to derive the constant effective yield, which may include the reversal of premium or discount amounts previously amortized or accrued, are recorded in the current period as a component of net investment income. Accordingly, deviations in actual prepayment speeds from that originally expected or changes in expected prepayment speeds can cause a change in the yield earned on mortgage and asset-backed securities purchased at a premium or discount and may result in adjustments that have a material positive or negative impact on reported results. Increases in prepayment speeds, which typically occur in a decreasing interest rate environment, generally increase the rate at which discount is accrued and premium is amortized into income. Decreases in prepayment speeds, which typically occur in an increasing interest rate environment, generally slow down the rate at which these amounts are recorded into income.
Our direct exposure to the Alt-A home equity and subprime first-lien loan sectors is limited to investments in structured securities collateralized by senior tranches of residential mortgage loans with this exposure. We do not own any direct investments in subprime lenders or adjustable rate mortgages.
Insurance on 2006 Alt-A issues is provided by MBIA Insurance Corporation (78% in 2008 and 2007). Insurance on 2007 Alt-A issues is provided by Assured Guaranty Ltd. (32% in 2008 and 2007) and MBIA Insurance Corporation (25% in 2008 and 2007). There is no insurance coverage on Government & Prime investments or Alt-A investments with collateral originating prior to 2006.
Government National Mortgage Association (GNMA or Ginnie Mae), guarantees principal and interest on mortgage backed securities. The guarantee is backed by the full faith and credit of the United States Government. The Federal National Mortgage Association (FNMA or Fannie Mae) and the Federal Home Loan Mortgage Association (FHLMC or Freddie Mac), are government-sponsored enterprises (GSE’s) that were chartered by Congress to reduce borrowing costs for certain homeowners. GSE’s have carried an implicit backing of the U.S. Government but do not have explicit guarantees like GNMA. The Housing and Economic Recovery act of 2008 allows the government to expand its line of credit to Fannie Mae and Freddie Mac and gives the U.S. Treasury the power to purchase an equity stake in the firms through the end of 2009.
The AAA rated commercial mortgage-backed securities are broken down into categories based on subordination levels. Rating agencies disclose subordination levels, which measure of the amount of credit support that the bonds (or tranches) have from subordinated bonds (or tranches). Generic AAA is a term used for securities issued prior to 2005. The super senior securities have subordination levels greater than 27%, the mezzanine securities have subordination levels in the 17-27% range and the junior securities have subordination levels in the 9-17% range.
AAA uninsured bonds includes $57.7 million in 2008 and $47.2 million in 2007 of bonds with GNMA and/or FNMA collateral.
Equity securities totaled $44.9 million at December 31, 2008 and $23.6 million at December 31, 2007. The increase in equity securities in 2008 is primarily due to the reclassification of non-redeemable perpetual preferred securities with a fair value of $28.0 million, which were previously classified with fixed maturity securities, and additional acquisitions of these types of securities during 2008. Gross unrealized gains totaled $4.2 million and gross unrealized losses totaled $11.3 million at December 31, 2008. At December 31, 2007, gross unrealized gains totaled $1.3 million and gross unrealized losses totaled $0.1 million on these securities. The unrealized losses in 2008 are primarily attributable to perpetual preferred securities from issuers in the financial sector. We believe these losses are due to concerns regarding the quality of the assets the issuers hold and uncertainty regarding when these securities will be called. These securities are similar to fixed maturities as they provide periodic cash flows, contain call features and are similarly rated and priced like long-term callable bonds. We have the intent and ability to hold these investments until a recovery of fair value; therefore we do not consider them to be other-than-temporarily impaired at December 31, 2008. Also included in equity securities is our investment in AEL which totaled $0.4 million at December 31, 2008 and $12.6 million at December 31, 2007.
Mortgage loans are considered impaired when, based on current information and events, it is probable that we will be unable to collect all amounts due according to contractual terms of the loan agreement. At December 31, 2008 we had one mortgage loan in the process of foreclosure with a current outstanding principal balance of $9.4 million
and property appraised value of $11.1 million. There were no other mortgage loans in foreclosure or more than 60 days delinquent at December 31, 2008 or December 31, 2007.
At December 31, 2008, common stockholders’ equity was $255.4 million, or $8.46 per share, compared to $899.9 million, or $29.98 per share at December 31, 2007. Included in stockholders’ equity per common share is $21.54 at December 31, 2008 and $1.21 at December 31, 2007 attributable to accumulated other comprehensive loss.
Our investment earnings are also dependent upon our ability to purchase quality investments. These opportunities were limited in the fourth quarter of 2008 due to the limited liquidity conditions in the financial markets. In addition, it was our desire to maintain a more liquid position to provide greater flexibility for managing in these unprecedented economic times.
For a substantial portion of business assumed through coinsurance agreements, the ceding companies have the ability to adjust interest and dividend crediting rates in reaction to portfolio yield. Most of the traditional annuity and universal life insurance contracts assumed through the coinsurance agreements have guaranteed minimum
crediting rates. These rates range from 2.25% to 4.00%, with a weighted average guaranteed crediting rate of approximately 3.11% at December 31, 2008.
Annuities sold directly through our independent distribution channel with reserves totaling $6,044.3 million at December 31, 2008 have a market value adjustment (MVA) feature that may increase or decrease the amount of the charge applied to a surrender or withdrawal. The MVA is determined by a mathematical formula which uses changes in U.S. Treasury interest rates since the inception of the contract. The MVA provides us interest rate protection through an increased surrender charge when U.S. Treasury interest rates rise. Conversely, the MVA provides a benefit to the contract holder through a reduced surrender charge when U.S. Treasury interest rates decrease.
During the fourth quarter of 2008, credit spreads widened significantly while the U.S. Treasury rates decreased. As a result, we experienced an increase in surrender activity while the value of our fixed maturity securities declined. Surrender and withdrawals benefits for our EquiTrust Life direct index and fixed rate annuity contracts during 2008 totaled $79.4 million in first quarter, $94.2 million in second quarter, $118.6 million in third quarter and $187.1 million in the fourth quarter. During 2008, we received gross surrender charges on this direct business totaling $37.5 million, which were reduced by MVAs totaling $15.5 million. The unanticipated increase in requested surrenders, which began in late 2008 and averaged $13.3 million per business day during January 2009, required us to update assumptions in the models used to calculate amortization of deferred policy acquisition costs and deferred sales inducements, which resulted in a $29.6 million increase to amortization in 2008.
A major component of our asset-liability management program is structuring the investment portfolio with cash flow characteristics consistent with the cash flow characteristics of our insurance liabilities. We use models to perform
If interest rates were to increase 10% from levels at December 31, 2008 and 2007, the fair value of our fixed maturity securities and short-term investments would decrease approximately $127.5 million at December 31, 2008 and $254.2 million at December 31, 2007, and the value of our interest rate swaps would increase approximately $0.3 million at December 31, 2008 and $4.9 million at December 31, 2007. These hypothetical changes in value do not take into account any offsetting change in the value of insurance liabilities for investment contracts since we estimate such value to be the cash surrender value for a majority of the underlying contracts. If interest rates were to decrease 10% from levels at December 31, 2008 and 2007 the fair value of our debt would increase $1.8 million at December 31, 2008 and $6.5 million at December 31, 2007, while the value of the interest rate swap on our line of credit would decrease $0.1 million at December 31, 2008 and $0.5 million at December 31, 2007.
Equity price risk is limited due to the relatively small equity portfolio held at December 31, 2008. However, we do earn investment management fees (on those investments managed by us) and mortality and expense fee income based on the value of our separate accounts. On an annualized basis, the investment management fee rates range from 0.20% to 0.45% for 2008, 2007 and 2006. The annual mortality and expense fee rates range from 0.00% to 1.44% for 2008 and 0.90% to 1.40% for 2007 and 2006. As a result, revenues from these sources do fluctuate with changes in the fair value of the equity, fixed maturity and other securities held by the separate accounts. In addition, we have equity price risk to the extent we may owe amounts under the guaranteed minimum death benefit and guaranteed minimum income benefit provisions of our variable annuity contracts. See Note 5 to our consolidated financial statements for additional discussion of these provisions. Furthermore, as discussed above, our profitability would be impacted if there were little or no gains in the entire series of options purchased over the expected life of an index annuity contract.
In November 2008, the parent company issued 9.25% notes payable to affiliates totaling $100.0 million (2011 Senior Notes) that mature in November 2011. One note for $75.0 million was issued to Farm Bureau Mutual and a $25.0 million note was issued to an investment affiliate of Iowa Farm Bureau Federation, our majority shareholder. During 2008, the parent company also borrowed the remaining $14.0 million on a bank line of credit, which is due in October 2010. A portion of these proceeds was used for a $55.0 million capital contribution to EquiTrust Life and to repay a $20.0 million short-term note that was issued to Farm Bureau Mutual during 2008. This capital
contribution was needed to fund EquiTrust Life’s significant growth and to replenish capital used as a result of write-downs of securities for other-than-temporary impairments during the year. In the second half of 2008, we took rate and other actions to slow sales from EquiTrust Life in order to preserve capital. The remaining debt proceeds are being held at the parent company to be used as needs dictate. Additional details regarding these borrowings are summarized in Note 7, “Credit Arrangements,” to our consolidated financial statements.
During 2009, we expect Farm Bureau Life to generate sufficient cash flows from premiums and deposits to meet cash outflow requirements. At EquiTrust Life, an increase in surrenders due to market value adjustments on certain products, combined with the reduction in sales to preserve capital, may cause cash outflows in 2009 to exceed cash inflows. Any net cash outflow is expected to be funded by cash on hand and sales of investments or additional borrowings, to the extent necessary. See the “Market Risks of Financial Instruments” section above for additional discussion on the impact of market value adjustments on surrender activity and liquidity.
The ability of the Life Companies to pay dividends to FBL Financial Group, Inc. is limited by law to earned profits (statutory unassigned surplus) as of the date the dividend is paid, as determined in accordance with accounting practices prescribed by insurance regulatory authorities of the State of Iowa. During 2009, the maximum amount legally available for distribution to FBL Financial Group, Inc., without further regulatory approval, from Farm Bureau Life is $38.2 million. EquiTrust Life cannot pay a dividend without regulatory approval in 2009 due to its unassigned surplus position at December 31, 2008. See Note 13 of our consolidated financial statements for additional details on the dividend limitation.
FBL Financial Group, Inc. expects to rely on available cash resources and dividends from Farm Bureau Life to make dividend payments to its stockholders and interest payments on its debt. The parent company had available cash and investments totaling $83.5 million at December 31, 2008. As discussed under “Liabilities” above, we anticipate using a portion of these liquid assets to pay off our $60.0 million line of credit borrowings in the first quarter of 2009. During 2008, Farm Bureau Life paid dividends totaling $20.0 million to the parent company. We anticipate that Farm Bureau Life will pay dividends totaling $15.0 million in 2009. As of December 31, 2008, we had no material commitments for capital expenditures.
On a consolidated basis, we anticipate that funds to meet our short-term and long-term capital expenditures, cash dividends to stockholders, operating cash needs and the repayment of our short-term debt will come from existing capital and internally generated funds. We believe that current levels of cash, available-for-sale and short-term securities, combined with expected net cash inflows from operations, maturities of fixed maturity investments, principal payments on mortgage and asset-backed securities and mortgage loans and premiums and deposits on our insurance products, will be adequate to meet our anticipated cash obligations for the foreseeable future. However, there can be no assurance that future experience regarding benefits and surrenders will be similar to historic
experience since benefits and surrender levels are influenced by such factors as the interest rate environment, our financial strength ratings, the economy and other factors that impact policyholder behavior. Our investment portfolio at December 31, 2008, included $262.5 million of short-term investments, $37.7 million of cash and $1,232.6 million in carrying value of U.S. Government and U.S. Government agency backed securities that could be readily converted to cash at or near carrying value.
We do not have any off-balance sheet arrangements as of December 31, 2008 or 2007.
Amounts shown in this table are projected payments through the year 2057 which we are contractually obligated to pay to our life insurance and annuity contract holders. The payments are derived from actuarial models which assume a level interest rate scenario and incorporate assumptions regarding mortality and persistency when applicable. These assumptions are based on our historical experience. The total of the contractual obligations relating to insurance contracts noted above differs from the liability balance on our consolidated balance sheet as follows:
Reserves based on account values, including separate accounts, per table above
traditional life reserves are computed as the present value of future benefits less the present value of future premiums while the contractual obligations table includes gross benefit payments and
In addition, contractual obligations totaling $323.0 million relating to dividend accumulations and other policy claims are included in the “Other policy claims and benefits” and “Advance premiums and other deposits” lines on our consolidated balance sheets.
In accordance with U.S. generally accepted accounting principles (GAAP), premiums and considerations received for interest sensitive and index products, such as ordinary annuities and universal life insurance, are reflected as increases in liabilities for policyholder account balances and not as revenues. Revenues reported for these products consist of policy charges for the cost of insurance, administration charges, amortization of policy initiation fees and surrender charges assessed against policyholder account balances. Surrender benefits paid relating to these products are reflected as decreases in liabilities for policyholder account balances and not as expenses. The Life Companies receive investment income earned from the funds deposited into account balances, a portion of which is passed through to the policyholders in the form of interest credited. For index annuities, proceeds from call options are earned from a portion of the funds deposited, which are passed through to the contract holders in the form of index credits. Index credits and interest credited to policyholder account balances and benefit claims in excess of policyholder account balances are reported as expenses in our consolidated financial statements.
We test our goodwill balances by comparing the fair value of our reporting units to the carrying value of the goodwill. We have performed impairment testing using cash flow and other analyses and determined that of our goodwill was not impaired as of December 31, 2008 or December 31, 2007.
Fair values are obtained primarily from a variety of independent pricing sources, whose results undergo evaluation by our internal investment professionals. Details regarding valuation techniques and processes are summarized in Note 1, “Significant Accounting Policies - Investments - Fair Values,” and Note 4, “Fair Values of Financial Instruments,” to our consolidated financial statements.
We evaluate the operating results of the underlying issuer, near-term prospects of the issuer, general market conditions, causes for the decline in value, the length of time there has been a decline in value, other key economic measures and our intent and ability to hold a security to recovery of fair value.
At December 31, 2008, we had 1,458 fixed maturity and equity securities with gross unrealized losses totaling $1,661.1 million. Included in the gross unrealized losses are losses attributable to both movements in market interest rates as well as temporary credit issues. Details regarding these securities are included in the “Financial Condition - Investments” section that follows. Net income (loss) would have been reduced by approximately $1,012.1 million if all these securities were deemed to be other-than-temporarily impaired on December 31, 2008.
These assumptions are made based upon historical experience, industry standards and a best estimate of future results and, for traditional life products, include a provision for adverse deviation. For traditional life insurance, once established for a particular series of products, these assumptions are generally held constant. For index annuities, these assumptions are revised at each balance sheet date.
Due to the number of independent variables inherent in the calculation of traditional life insurance reserves and reserves for the embedded derivatives in index annuities, it is not practical to perform a sensitivity analysis on the impact of reasonable changes in the underlying assumptions. The cost of performing detailed calculations using different assumption scenarios outweighs the benefit that would be derived. We believe our assumptions are realistic and produce reserves that are fairly stated in accordance with GAAP.
The determination of net periodic pension expense and related accrued/prepaid pension cost requires the use of estimates as to the expected return on plan assets, discount rate on plan liabilities and other actuarial assumptions. Pension expense for 2008 totaled $5.4 million.
Effective September 30, 2008, the Financial Accounting Standards Board (FASB) issued Staff Position (FSP) No. FAS 157-3, “Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active.” This FSP clarifies the application of Statement No. 157 in a market that is not active and applies to financial assets within the scope of accounting pronouncements that require or permit fair value measurements in accordance with Statement No. 157. The impact of this adoption did not have a material effect on our consolidated financial statements.
Effective January 1, 2008, we adopted Statement No. 157, “Fair Value Measurements,” which defines fair value, establishes a framework for measuring fair value and expands the required disclosures about fair value measurements. The impact of adoption was to decrease the carrying value of certain investments and certain policy liabilities and accruals in our consolidated financial statements, resulting in an increase to net income of $5.6 million ($0.19 per basic and diluted common share). The primary impact of this change was a decrease to the embedded derivatives in the index annuity reserves of $26.7 million. The impact of this change on net income was mitigated by offsets for the amortization of deferred policy acquisition costs and deferred sales inducements and income taxes.
Effective January 1, 2008, we adopted FSP FIN 39-1, which amends certain aspects of FASB Interpretation No. 39, “Offsetting of Amounts Related to Certain Contracts - an interpretation of APB Opinion No. 10 and FASB Statement No. 105.” This FSP allows a reporting entity to offset fair value amounts recognized for the right to reclaim cash collateral (a receivable) or the obligation to return cash collateral (a payable) against fair value amounts recognized for derivative instruments executed with the same counterparty under the same master netting arrangement. Cash collateral payable totaling $10.9 million at December 31, 2008 and $70.9 at December 31, 2007 is netted against the fair value of the call options included in derivative instruments. Cash collateral receivable totaling $9.7 million at December 31, 2008 and $4.3 million at December 31, 2007 is netted with interest rate swaps included in other liabilities in our consolidated balance sheets. This FSP has no impact on our consolidated statements of operations.
As described in more detail in Note 1 to our consolidated financial statements, we will be subject to certain pending accounting changes. During 2009, we plan to adopt the following:
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a - 15(f). Under the supervision and the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation under the framework in Internal Control - Integrated Framework, our management concluded that our internal control over financial reporting was effective as of December 31, 2008.
We engage Ernst & Young LLP as independent auditors to audit our financial statements and internal control over financial reporting and express their opinion thereon. A copy of Ernst & Young LLP’s audit opinions follows this letter.
We have audited FBL Financial Group, Inc.’s internal control over financial reporting as of December 31, 2008, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). FBL Financial Group, Inc.’s management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the company’s internal control over financial reporting based on our audit.
inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, FBL Financial Group, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2008, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets as of December 31, 2008 and 2007, and the related statements of operations, changes in stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2008 of FBL Financial Group, Inc. and our report dated February 18, 2009 expressed an unqualified opinion thereon.
We have audited the accompanying consolidated balance sheets of FBL Financial Group, Inc. as of December 31, 2008 and 2007, and the related consolidated statements of operations, changes in stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2008. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of FBL Financial Group, Inc. at December 31, 2008 and 2007, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2008, in conformity with U.S. generally accepted accounting principles.
On September 30, 2008, we adopted Financial Accounting Standards Board (FASB) Staff Position (FSP) FAS 157-3, “Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active.” This FSP clarifies the application of Statement No. 157 in a market that is not active and applies to financial assets within the scope of accounting pronouncements that require or permit fair value measurements in accordance with Statement No. 157. The impact of this adoption did not have a material effect on our consolidated financial statements.
Effective January 1, 2008, we adopted FSP FIN 39-1, which amends certain aspects of FASB Interpretation No. 39, “Offsetting of Amounts Related to Certain Contracts - an interpretation of APB Opinion No. 10 and FASB Statement No. 105.” This FSP allows a reporting entity to offset fair value amounts recognized for the right to reclaim cash collateral (a receivable) or the obligation to return cash collateral (a payable) against fair value amounts recognized for derivative instruments executed with the same counterparty under the same master netting arrangement. We elected to implement this statement and have adopted a policy to offset the collateral against the derivatives. At December 31, 2008, we had master netting agreements with counterparties covering cash collateral payable totaling $10.9 million and cash collateral receivable totaling $9.7 million. These amounts are netted against the fair value of the call options included in derivative instruments and interest rate swaps included in other
Equity securities, comprised of common and non-redeemable preferred stocks are designated as “available for sale” and are reported at fair value. The change in unrealized appreciation and depreciation of equity securities is included directly in stockholders’ equity, net of any related deferred income taxes, as a component of accumulated other comprehensive income (loss).
Mortgage loans on real estate are reported at cost adjusted for amortization of premiums and accrual of discounts. If we determine that the value of any mortgage loan is impaired (i.e., when it is probable we will be unable to collect all amounts due according to the contractual terms of the loan agreement), the carrying value of the mortgage loan is
reduced to its fair value, which may be based upon the present value of expected future cash flows from the loan, or the fair value of the underlying collateral. The carrying value of impaired loans is reduced by the establishment of a valuation allowance, changes to which are recognized as realized gains or losses on investments. Interest income on impaired loans is recorded on a cash basis.
Derivative instruments include interest rate swaps used to reduce our exposure to increases in market interest rates and call options used to fund index credits on index annuities. In addition, we have embedded derivatives associated with our index annuity business and certain modified coinsurance contracts. All derivatives are measured at fair value and recognized as either assets or liabilities, net of related collateral receivable or payable, in the consolidated balance sheets.
Interest rate swaps are carried on the consolidated balance sheets as either a derivative instrument or other liability. The swap on our line of credit and, prior to April 1, 2007, the swaps related to our flexible premium deferred annuity contracts are accounted for as cash flow hedges. The effective portion of any unrealized gain or loss is recorded in accumulated other comprehensive income (loss). If a portion of the hedges becomes ineffective, the ineffective portion of any unrealized gain or loss on the swap will be recorded in earnings as a component of derivative income (loss) as it occurs. Prior to April 1, 2007, the net periodic interest settlement between the interest paid and the interest received under the swaps hedging our annuity contracts was recorded as a component of interest sensitive and index product benefits.
We participate in a securities lending program whereby certain fixed maturity securities from our investment portfolio are loaned to other institutions for a short period of time. We require collateral equal to or greater than 102% of the fair value of the loaned securities and at least 100% collateral be maintained through the period the securities are on loan. The collateral is invested by the lending agent, in accordance with our guidelines, generating fee income that is recognized as net investment income over the period the securities are on loan. The collateral is accounted for as a secured borrowing and is recorded as an asset on the consolidated balance sheets, with a corresponding liability reflecting our obligation to return this collateral upon the return of the loaned securities. During the second quarter of 2008 we discontinued entering into any new securities lending agreements and we expect the existing loaned securities to decrease in 2009 as the underlying collateral matures.
Fair values of fixed maturity securities are based on quoted market prices in active markets when available. Fair values of fixed maturity securities that are not actively traded are estimated using valuation models that vary by asset class. See Note 4, “Fair Values of Financial Instruments,” for more information on assumptions and the amount of securities priced using the valuation models. Fair values for all securities are reviewed for reasonableness by considering overall market conditions and values for similar securities.
Fair values of the conversion features embedded in convertible fixed maturity securities are estimated using an option-pricing model. Fair values of redeemable preferred stocks, equity securities, call options and interest rate swaps are based on the latest quoted market prices, or for those stocks not readily marketable, generally at values which are representative of the fair values of comparable issues. In addition, fair values for all derivative instruments include a credit risk adjustment for the liable party.
For purposes of our consolidated statements of cash flows, we consider all highly liquid debt instruments purchased with a maturity of three months or less to be cash equivalents. Cash collateral received for derivative positions is invested in cash equivalents and reported with derivative instruments in the consolidated balance sheets.
Late in the fourth quarter of 2008 and the beginning of 2009, we experienced an unanticipated increase in surrender and withdrawal rates on annuities sold through our independent distribution channel, primarily due to the impact of low U.S. Treasury yields on the market value adjustment feature for our direct fixed annuity products, which provided an environment where contract holders could surrender with smaller net surrender charges. This unanticipated activity required us to update the assumptions in our amortization models, which decreased deferred policy acquisition costs $17.0 million and deferred sales inducements $12.6 million in 2008. After taxes, this increased the 2008 net loss $19.2 million ($0.64 per basic and diluted common share).
Goodwill includes $9.9 million related to the excess of the amounts paid to acquire companies over the fair value of its net assets acquired. Goodwill also includes $1.2 million of identifiable intangible assets relating to insurance licenses obtained with the acquisition of EquiTrust Life Insurance Company. Goodwill and identifiable intangible assets with indefinite lives are not amortized but are subject to annual impairment testing. We test our goodwill balances by comparing the fair value of our reporting units to the carrying value of the goodwill. In the event that we were to dispose one of our reporting units, a discounted cash flow approach would be used to estimate the fair value of that reporting unit; therefore we believe this approach better approximates the fair value of our goodwill than a market capitalization approach. A number of significant assumptions and estimates are involved in the application of the discounted cash flow model to forecast operating cash flows, including future premiums, product lapses, investment yields and discount rate. Underlying assumptions are based on historical experience and our best estimates given information available at the time of testing. We have performed impairment testing using cash flow and other analyses and determined none of our goodwill was impaired as of December 31, 2008 or December 31, 2007.
Deferred income tax assets or liabilities are computed based on the difference between the financial statement and income tax bases of assets and liabilities using the enacted marginal tax rate. Deferred income tax expenses or credits are based on the changes in the asset or liability from period to period.
Revenues for interest sensitive, index and variable products consist of policy charges for the cost of insurance, asset charges, administration charges, amortization of policy initiation fees and surrender charges assessed against policyholder account balances. The timing of revenue recognition as it relates to these charges and fees is determined based on the nature of such charges and fees. Policy charges for the cost of insurance, asset charges and policy administration charges are assessed on a daily or monthly basis and are recognized as revenue when assessed and earned. Certain policy initiation fees that represent compensation for services to be provided in the future are reported as unearned revenue and recognized in income over the periods benefited. Surrender charges are determined based upon contractual terms and are recognized upon surrender of a contract. Policy benefits and claims charged to expense include interest or index amounts credited to policyholder account balances (excluding sales inducements) and benefit claims incurred in excess of policyholder account balances during the period. Changes in the reserves for the embedded derivatives in the index annuities and amortization of deferred policy acquisition costs and deferred sales inducements are recognized as expenses over the life of the policy.
Underwriting, acquisition and insurance expenses include a pre-tax charge of $4.9 million ($0.11 per basic and diluted common share) for 2006 relating to the settlement of a lawsuit with a husband and wife who had applied for life insurance policies. The settlement ended litigation regarding the process we followed in denying insurance coverage for medical reasons. The settlement was entered into after adverse judicial rulings were made against us in June 2006. Prior to the issuance of the adverse judicial rulings, a material loss, net of insurance recoveries, was not deemed to be reasonably possible.
Other income and other expenses consist primarily of revenue and expenses generated by our various non-insurance subsidiaries for investment advisory, marketing and distribution, and leasing services. They also include revenues and expenses generated by our parent company for management services. Certain of these activities are performed on behalf of our affiliates. In addition, certain revenues generated by our insurance subsidiaries are classified as other income. Revenues of the insurance subsidiaries included as other income totaled $2.8 million in 2008, $3.2 million in 2007 and $1.7 million in 2006. Lease income from leases with affiliates totaled $11.1 million in 2008, $12.2 million in 2007 and $12.0 million in 2006. Investment advisory fee income from affiliates totaled $1.4 million in 2008 and $1.5 million in 2007 and 2006.
See Note 9, “Retirement and Compensation Plans,” for additional details on these plans.
Unrealized gains and losses on our available-for-sale securities and certain interest rate swaps are included in accumulated other comprehensive income (loss) in stockholders’ equity. Other comprehensive income (loss) excludes net investment gains and losses included in net income (loss) which represent transfers from unrealized to realized gains and losses, which totaled ($75.3) million in 2008, $2.7 million in 2007 and $7.9 million in 2006. These amounts, which have been measured through the date of sale, are net of income taxes and adjustments to deferred policy acquisition costs, deferred sales inducements, value of insurance in force acquired and unearned revenue reserve totaling $73.3 million in 2008, ($0.3) million in 2007 and ($4.0) million in 2006. Other comprehensive income (loss) also includes the initial recognition and subsequent changes in the underfunded status of our single employer health and medical postretirement benefit plans totaling $0.2 million in 2008, 2007 and 2006.
The changes in net unrealized investment gains and losses are recorded net of deferred income taxes and other adjustments for assumed changes in the amortization pattern of deferred policy acquisition costs, deferred sales inducements, value of insurance in force acquired and unearned revenue reserve totaling $796.8 million in 2008, $115.9 million in 2007 and $48.1 million in 2006.
Included in the above table are 1,442 securities from 937 issuers at December 31, 2008 and 863 securities from 538 issuers at December 31, 2007. These increases are primarily due to an increase in spreads between the risk-free and corporate and other bond yields. The following summarizes the more significant unrealized losses by investment category as of December 31, 2008.
related products sector ($151.9 million carrying value and $15.9 million unrealized loss). The unrealized losses in these three sectors are due to spread widening that is the result of weaker operating results. The unrealized losses in the remaining corporate sectors are also primarily attributable to spread widening due to a decrease in market liquidity, and increase in market volatility and concerns about the general health of the economy.
Mortgage and asset-backed securities: The unrealized losses on mortgage and asset-backed securities totaled $479.0 million, or 28.9% of our total unrealized losses, and were caused primarily by concerns regarding mortgage defaults on subprime and other risky mortgages. There were also concerns regarding potential downgrades or defaults of monoline bond insurers providing credit protection for underlying securities. These concerns resulted in spread widening in the sector as liquidity decreased in the market. We purchased most of these investments at a discount to their face amount and the contractual cash flows of these investments are based on mortgages and other assets backing the securities. Because we have the ability and intent to hold these investments until a recovery of fair value, which may be maturity, we do not consider these investments to be other-than-temporarily impaired at December 31, 2008.
United States Government and agencies: The unrealized losses on U.S. Governments and agencies totaled $4.0 million, or 0.2% of our total unrealized losses, and were caused by spread widening. We purchased most of these investments at a discount to their face amount and the contractual cash flows of these investments are based on direct guarantees from the U.S. Government and by agencies of the U.S. Government. Because the decline in fair value is attributable to increases in general market spreads and market interest rates and not credit quality, and because we have the ability and intent to hold these investments until a recovery of fair value, which may be maturity, we do not consider these investments to be other-than-temporarily impaired at December 31, 2008.
Excluding mortgage and asset-backed securities, no securities from the same issuer had an aggregate unrealized loss in excess of $16.7 million at December 31, 2008. The $16.7 million unrealized loss is from one BB rated security, which is a synthetic collateralized debt obligation backed by investment grade credit default swaps. This security has been impacted by the loss of market liquidity, actual defaults in the collateral and spread widening. We have the ability and intent to hold this security until a recovery of fair value, which may be maturity and therefore, do not consider it to be other-than-temporarily impaired at December 31, 2008. With respect to mortgage and asset-backed securities not backed by the United States Government, no securities from the same issuer had an aggregate unrealized loss in excess of $66.8 million at December 31, 2008. The $66.8 million unrealized loss from one issuer relates to 21 different securities that are backed by different pools of residential mortgage loans. All but one of the 21 securities are rated investment grade and the largest unrealized loss on any one security totaled $9.4 million at December 31, 2008. The non-investment grade security had an unrealized loss of $2.1 million at December 31, 2008. We have the intent and ability to hold these investments until a recovery of fair value, which may be at maturity, and therefore do not consider these investments to be other-than-temporary impaired at December 31, 2008.
Our investments in synthetic collateralized debt obligations are backed by credit default swaps with no home equity exposure. These securities have a carrying value of $7.4 million and unrealized loss of $44.6 million at December 31, 2008 and a carrying value of $42.1 million and unrealized loss of $9.9 million at December 31, 2007. The unrealized loss increased in 2008 primarily due to actual defaults in the collateral, general spread widening and market concerns of increased defaults in the future. Our investment professionals have stress tested all of these securities and determined that future principal losses are not expected based on reasonably adverse conditions. Assuming a 35% recovery, on average these investments could all withstand seven to twelve more defaults without losing any principal. The number of defaults is an estimate based on the remaining credit enhancement (subordination) that remains in each security. Each default that occurs reduces subordination to the security, depending on the loss amount and exposure. Depending on the investment, the synthetic collateralized debt obligations we own have exposure to approximately 120 to 150 reference names, which results in an average default level of 5.0% to 10.0% before we would lose principal. Based on historical performance and current economic conditions, we do not expect future defaults will exceed these levels and believe the existing subordination is sufficient to maintain the value of our investments. In addition, we have the intent and ability to hold these investments until a recovery of fair value, which may be maturity, therefore we do not consider these investments to be other-than-temporarily impaired at December 31, 2008.
The income on fixed maturity securities classified as trading in 2006 represents unrealized gains relating to securities held as of December 31, 2006 that were realized upon maturity in 2007.
Realized losses on sales in 2008 include a $2.3 million loss on a bank and $2.1 million on a printing and publishing company that experienced significant losses during 2008 and filed for bankruptcy protection.
We have investments in variable interest entities for which we are not considered the primary beneficiary. These investments consist of a real estate limited partnership and certain mezzanine commercial real estate loans on real estate properties. The real estate limited partnership had revenues totaling $3.7 million for 2008, $2.7 million for 2007 and $3.2 million for 2006. There was one real estate project in 2008, two in 2007 and one in 2006. Each real estate project has assets totaling less than $42.0 million at December 31, 2008, less than $21.0 million at December 31, 2007 and less than $5.0 million at December 31, 2006. Our investments in these real estate projects were made during the period from 2005 to 2007. Our maximum exposure to loss is the carrying value of our investments which totaled $12.1 million at December 31, 2008 and $13.2 million at December 31, 2007 for the real estate limited partnership and $2.5 million at December 31, 2008 and $3.6 million at December 31, 2007 for the mezzanine commercial real estate loans.
At December 31, 2008, affidavits of deposits covering investments with a carrying value totaling $10,448.1 million were on deposit with state agencies to meet regulatory requirements. Also, fixed maturity securities with a carrying value of $41.0 million were on deposit with the Federal Home Loan Bank as collateral for a funding agreement.
At December 31, 2008, there were no commitments to provide additional funding for mortgage loans on real estate.
We held cash collateral for derivative and other transactions totaling $10.9 million at December 31, 2008 and $87.9 million at December 31, 2007. These amounts were invested and included in the consolidated balance sheets with corresponding amounts netted against call options in derivative instruments or collateral payable for security lending and other transactions. No off-balance sheet collateral was held at December 31, 2008 or December 31, 2007.
No investment in any entity or its affiliates (other than bonds issued by agencies of the United States Government) exceeded ten percent of stockholders’ equity at December 31, 2008.
In 2006, we also entered into one interest rate swap to hedge the variable component of the interest rate on a portion of our line of credit borrowings. The terms of this swap provide that we pay a fixed rate of interest and receive a floating rate of interest on a notional amount of $46.0 million. Any gain or loss on the interest rate swap settlements offset any increase or decrease in the interest paid on the line of credit, effectively fixing our interest expense related
We held call options relating to our direct business, net of collateral received for counterparty credit risk, with a fair value of $12.9 million at December 31, 2008 and $43.9 million at December 31, 2007. Our share of call options assumed, which is recorded as an embedded derivative in reinsurance recoverable, totaled $5.6 million at December 31, 2008 and $22.4 million at December 31, 2007. Derivative income (loss) includes ($202.0) million for 2008, ($3.0) million for 2007 and $70.5 million for 2006 relating to call option proceeds and changes in fair value.
was $0.3 million at December 31, 2008 and $0.2 million at December 31, 2007. Derivative income (loss) from our modified coinsurance contracts totaled ($0.8) million in 2008, $0.1 million in 2007, and less than $0.1 million in 2006.
Statement No. 107, “Disclosures About Fair Value of Financial Instruments,” requires disclosure of fair value information about financial instruments, whether or not recognized in the consolidated balance sheets, for which it is practicable to estimate value. Statement No. 107 excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements and allows companies to forego the disclosures when those estimates can only be made at excessive cost.
We used the following methods and assumptions in estimating the fair value of our financial instruments in 2008. Fair values for 2007 used similar methodologies, however there were no adjustments for credit risk or adverse deviation.
Fixed maturity securities: Fair values of fixed maturity securities are based on quoted market prices in active markets when available. Investments for which market prices are not observable are generally private investments, securities valued using non-binding broker quotes or securities with very little trading activity where reasonable prices from independent sources cannot be obtained. We have valued our investments, in the absence of observable market prices, using the valuation methodologies described below applied on a consistent basis.
Collateral held and payable for securities lending and other transactions: Fair values are obtained from an independent pricing source whose results undergo evaluation by our internal investment professionals.
Future policy benefits and other policyholders’ funds: Fair values of our liabilities under contracts not involving significant mortality or morbidity risks (principally deferred annuities, deposit administration funds, funding agreements and supplementary contracts) are estimated using one of two methods. For contracts with known maturities, fair value is determined using discounted cash flow valuation techniques based on current interest rates adjusted to reflect our credit risk and an additional provision for adverse deviation. For deposit liabilities with no defined maturities, fair value is the amount payable on demand. We are not required to estimate the fair value of our liabilities under other insurance contracts.
Short-term and long-term debt: The fair values for long-term debt are estimated using discounted cash flow analysis based on our current incremental borrowing rate for similar types of borrowing arrangements adjusted, as needed, to reflect our credit risk.
Financial instruments measured and reported at fair value are classified and disclosed in one of the following categories.
Level 1 - Quoted prices are available in active markets for identical financial instruments as of the reporting date. The types of financial instruments included in Level 1 are listed equities, mutual funds, money market funds and non-interest bearing cash. As required by Statement No. 157, we do not adjust the quoted price for these financial instruments, even in situations where we hold a large position and a sale could reasonably impact the quoted price.
Level 2 - Pricing inputs are other than quoted prices in active markets which are either directly or indirectly observable as of the reporting date, and fair value is determined through the use of models or other valuation methods. Financial instruments which are generally included in this category include publicly traded issues priced by independent sources, short-term securities, less liquid and restricted equity securities and over-the-counter derivatives.
Fair values of all Level 2 fixed maturity securities are obtained primarily from a variety of independent pricing sources, whose results undergo evaluation by our internal investment professionals. We generally obtain one price per security, which is compared to relevant credit information, perceived market movements and sector news. Market indices of similar rated asset class spreads are consulted for valuations and broker indications of similar securities are compared. If the issuer has had trades in similar debt outstanding but not necessarily the same rank in the capital structure, spread information is used to support fair value. If discrepancies are identified additional quotes are obtained and the quote that best reflects a fair value exit price at the reporting date is selected.
Approximately 10.1% of the total fixed maturities are included in the Level 3 group. The fair value of the assets and liabilities above include the financial instruments’ nonperformance risk. Nonperformance risk is the risk that the instrument will not be fulfilled and affects the value at which the instrument could be transferred in an orderly transaction. The nonperformance risk for our assets was valued at less than $0.1 million at December 31, 2008. The nonperformance risk for our liabilities was valued at $236.6 million at December 31, 2008.
GMDB, IDB and GMIB Net Amount at Risk by Type of Guarantee
Deferred income taxes have been established based upon the temporary differences between the financial statement and income tax bases of assets and liabilities. The reversal of the temporary differences will result in taxable or deductible amounts in future years when the related asset or liability is recovered or settled. A valuation allowance is required if it is more likely than not that a deferred tax asset will not be realized. In assessing the need for a valuation allowance we considered the scheduled reversal of deferred tax assets, projected future taxable income, taxable income from prior years available for recovery and tax planning strategies. Our tax planning strategies assume deferred tax assets related to unrealized losses on our investments are temporary as we have the intent and ability to hold the investments until maturity, at which time, the existing temporary difference is expected to reverse. As such, we have determined that the establishment of a valuation allowance was not necessary at December 31, 2008 and 2007.
Tax Effect of Temporary Differences Giving Rise to Deferred Income Tax Assets and Liabilities
In March 2007, we issued $100.0 million of 5.875% Senior Notes due March 15, 2017 (2017 Senior Notes). Interest on the 2017 Senior Notes is payable semi-annually on March 15 and September 15 each year. The 2017 Senior Notes are redeemable in whole or in part at any time at our option at a “make-whole” redemption price equal to the greater of 100% of their principal amount or the sum of the present values of the remaining scheduled payments of principal and interest, discounted to the redemption date on a semiannual basis at the treasury rate plus 20 basis points. We received net proceeds of approximately $98.5 million from the issuance of the 2017 Senior Notes after underwriting fees, offering expenses and original issue discount, which are being amortized over the term of the 2017 Senior Notes, using the effective interest method. We amended our line of credit agreement with Bank of America National Association and Bankers Trust Company, N.A in 2007 to allow for the 2017 Senior Notes without violating the financial covenants of that agreement.
In April 2004, we issued $75.0 million of 5.85% Senior Notes due April 15, 2014 (2014 Senior Notes). Interest on the Senior Notes due 2014 is payable semi-annually on April 15 and October 15 each year. The 2014 Senior Notes are redeemable in whole or in part at any time at our option at a “make-whole” redemption price equal to the greater of 100% of their principal amount or the sum of the present values of the remaining scheduled payments of principal and interest, discounted to the redemption date on a semiannual basis at the treasury rate plus 25 basis points. We received net proceeds of approximately $75.5 million from the issuance of the 2014 Senior Notes after underwriting fees, offering expenses, original issue discount and the impact of a rate lock, which are being amortized over the term of the 2014 Senior Notes, using the effective interest method. We amended our line of credit agreement with Bank of America National Association and Bankers Trust Company, N.A in 2004 to allow for the 2014 Senior Notes without violating the financial covenants of that agreement.
Long-term debt includes $97.0 million of our subordinated debt obligation to FBL Financial Group Capital Trust (the Trust). We issued 5% Subordinated Deferrable Interest Notes, due June 30, 2047 (the Notes) with a principal amount of $100.0 million to support $97.0 million of 5% Preferred Securities issued by the Trust. We also have a $3.0 million equity investment in the Trust, which is netted against the Notes on the consolidated balance sheets due to a contractual right of setoff. The sole assets of the Trust are and will be the Notes and any interest accrued thereon. The interest payment dates on the Notes correspond to the distribution dates on the 5% Preferred Securities. The 5% Preferred Securities, which have a liquidation value of $1,000.00 per share plus accrued and unpaid distributions, mature simultaneously with the Notes and are owned by AEL. As of December 31, 2008 and 2007, 97,000 shares of 5% Preferred Securities were outstanding, all of which we unconditionally guarantee.
The plans’ prior service costs are amortized using a straight-line amortization method over the average remaining service period of the employees. For actuarial gains and losses, we use a corridor, as allowed under Statement No. 87, “Employers Accounting for Pensions,” to determine the amounts to amortize. It is expected that net periodic pension cost for all employers in 2009 will include $8.9 million for amortization of the actuarial loss and $0.7 million of prior service cost amortization.
Net periodic pension cost recorded in our consolidated income statements totaled $5.4 million in 2008, $5.9 million in 2007 and $6.4 million in 2006. As mentioned in Note 1 above, in 2008 we also recorded a portion of the net periodic pension costs as a charge to retained earnings totaling $0.8 million as a result of adopting the measurement date portion of Statement No. 158.
We estimate the discount rate by projecting and discounting future benefit payments inherent in the projected benefit obligation using a “spot” yield curve known as the Citigroup Pension Discount Liability Index yield curve. This curve is constructed from the Treasury curve by adding option-adjusted spreads that are drawn from the double-A
We employ a long-term investment strategy of diversifying the plans’ assets into equity securities with the long-term target allocation being approximately 60% deposit administration fund contracts and 40% equities. At December 31, 2008, the plans’ assets were invested 77% in deposit administration fund contracts held by Farm Bureau Life and 23% in diversified equities. Our investment strategy is to (1) achieve a long-term return sufficient to satisfy all plan obligations, (2) assume a prudent level of risk and (3) to maintain adequate liquidity. The expected return on plan assets is set at the long-term rate expected to be earned based on the long term investment strategy of the plans. In estimating the expected rate of return for each asset class, we take into account factors such as historical rates of return, expected future risk free rates of return and anticipated returns expected given the risk profile of each asset class.
We participate with several affiliates in a 401(k) defined contribution plan which covers substantially all employees. Through October 2008, we contributed FBL Financial Group, Inc. stock in an amount equal to 100% of an employee’s contributions up to 2% of the annual salary contributed by the employee and an amount equal to 50% of an employee’s contributions between 2% and 4% of the annual salary contributed by the employee. Beginning in November 2008, we made cash contributions at the same contribution levels noted above. Costs are allocated among the affiliates on a basis of time incurred by the respective employees for each company. Expense related to the plan totaled $1.1 million in 2008, $1.0 million in 2007 and $0.9 million in 2006.
We have two share-based payment arrangements under our Class A Common Stock Compensation Plan, which are described below. Compensation expense for these arrangements totaled $1.0 million for 2008, $4.9 million for 2007 and $3.1 million for 2006. The income tax benefit (expense) recognized in the income statement for these arrangements totaled ($0.3) million for 2008, $1.8 million for 2007 and $1.1 million for 2006.
Represents the difference between the stock price and exercise price for each option, excluding options where the exercise price is above the stock price, at December 31, 2008.
The weighted average grant-date fair value of options granted per common share was $7.82 for 2008, $9.27 for 2007 and $8.64 for 2006. The intrinsic value of options exercised during the year totaled $0.6 million for 2008, $5.4 million for 2007 and $6.9 million for 2006.
We issue new shares to satisfy stock option exercises. We do not have a policy of repurchasing shares on the open market to satisfy share-based payment arrangements. Cash received from stock options exercised totaled $1.0 million for 2008, $5.9 million for 2007 and $6.6 million for 2006. The actual tax benefit realized from stock options exercised totaled $0.1 million for 2008, $1.6 million for 2007 and $2.0 million for 2006.
Unrecognized compensation expense related to unvested share-based compensation granted under the restricted stock arrangement totaled less than $0.1 million as of December 31, 2008. This expense is expected to be recognized over a weighted-average period of 1.1 years. The tax benefit realized from restricted stock released to employees was $0.3 million as of December 31, 2008. We have a policy of withholding shares to cover estimated future tax payments.
At December 31, 2008, shares of Class A common stock available for grant as additional awards under the Class A Common Stock Compensation Plan totaled 3,788,923.
401k contribution guidelines are allowed to purchase unregistered deferred stock units. Under this plan, we have deferred stock units outstanding totaling 5,769 at December 31, 2008.
We share certain office facilities and services with the IFBF and its affiliated companies. These expenses are allocated on the basis of cost and time studies that are updated annually and consist primarily of rent, salaries and
related expenses, travel and other operating costs. In 2008, we also entered into an expense allocation agreement with Farm Bureau Mutual for the use of property and equipment.
We have management agreements with Farm Bureau Mutual and other affiliates under which we provide general business, administrative and management services. Fee income for these services totaled $3.5 million in 2008, $3.1 million in 2007 and $2.6 million in 2006. In addition, Farm Bureau Management Corporation, a wholly-owned subsidiary of the IFBF, provides certain management services to us under a separate arrangement. We incurred related expenses totaling $0.5 million in 2008, $1.0 million in 2007 and $1.1 million in 2006.
In the third quarter of 2008, the jury from a trial in Federal District Court in Utah involving an agency matter awarded Farm Bureau Life and Farm Bureau Mutual actual damages totaling $3.6 million and punitive damages totaling $62.7 million. Approximately 25% of the award is allocable to Farm Bureau Life with the remaining 75% allocable to Farm Bureau Mutual. In February 2009 the court ruled on various post trial motions, upholding the actual damages, but reducing the punitive damages to $3.6 million. The time for appealing the verdict and award will not begin until post trial motions have been filed and ruled on by the court. Regardless of the outcome of any rulings, we anticipate an appeal by the defendants unless a settlement has been reached. In addition, see Note 1, “Significant Accounting Policies - Underwriting, Acquisition and Insurance Expenses” for disclosure of a $4.9 million gain contingency relating to a lawsuit settlement in 2006. Recoveries from third parties are required to be accounted for as gain contingencies and not recorded in our financial statements until the lawsuit is resolved.
From time to time, assessments are levied on our insurance subsidiaries by guaranty associations in most states in which the subsidiaries are licensed. These assessments, which are accrued for, are to cover losses of policyholders of insolvent or rehabilitated companies. In some states, these assessments can be partially recovered through a
reduction in future premium taxes. Expenses incurred for guaranty fund assessments, net of related premium tax offsets, totaled less than $0.1 million in 2008, 2007 and 2006.
differ from statutory reserves; (e) future policy benefit reserves on certain interest sensitive products are based on full account values, rather than discounting methodologies utilizing statutory interest rates; (f) net realized gains or losses attributed to changes in the level of market interest rates are recognized as gains or losses in the statements of operations when the sale is completed rather than deferred and amortized over the remaining life of the fixed maturity security or mortgage loan; (g) the established formula-determined statutory investment reserve, changes in which are charged directly to surplus, is not recorded as a liability; (h) certain deferred income tax assets, agents’ balances and certain other assets designated as “nonadmitted assets” for statutory purposes are reported as assets rather than being charged to surplus; (i) revenues for interest sensitive, indexed and variable products consist of policy charges for the cost of insurance, policy administration charges, amortization of policy initiation fees and surrender charges assessed rather than premiums received; (j) pension income or expense is recognized for all employees in accordance with Statement No. 87, rather than for vested employees only; (k) the financial statements of subsidiaries are consolidated with those of the insurance subsidiary rather than being accounted for under the equity method, and (l) assets and liabilities are restated to fair values when a change in ownership occurs that is accounted for as a purchase, with provisions for goodwill and other intangible assets, rather than continuing to be presented at historical cost.
Net income (loss) of the Life Companies, as determined in accordance with statutory accounting practices prescribed or permitted by regulatory authorities, was ($145.6) million in 2008, $77.4 million in 2007 and $73.8 million in 2006. Statutory net gain from operations, which excludes the impact of realized capital gains and losses on investments, totaled $1.1 million in 2008, $76.9 million in 2006 and $63.3 million in 2006. Statutory capital and surplus totaled $802.3 million at December 31, 2008 and $756.6 million at December 31, 2007.
The ability of the Life Companies to pay dividends to the parent company is restricted because prior approval of the Iowa Insurance Commissioner is required for payment of dividends to the stockholder which exceed an annual limitation. An annual dividend limitation is defined under the Iowa Insurance Holding Company Act as any dividend or distribution of cash or other property whose fair value, together with that of other dividends or distributions made within the preceding 12 months, exceeds the greater of (i) 10% of adjusted policyholders’ surplus (total statutory capital stock and statutory surplus less certain admitted deferred tax assets) as of December 31 of the preceding year, or (ii) the statutory net gain from operations of the insurer for the 12-month period ending December 31 of the preceding year. During 2009, the maximum amount legally available for distribution to FBL Financial Group, Inc. without further regulatory approval from Farm Bureau Life is $38.2 million. EquiTrust Life cannot pay a dividend without regulatory approval in 2009 due to its unassigned surplus position at December 31, 2008.
The Exclusive Annuity segment primarily consists of fixed rate annuities and supplementary contracts (some of which involve life contingencies) sold through our exclusive agency distribution. Fixed rate annuities provide for tax-deferred savings and supplementary contracts provide for the systematic repayment of funds that accumulate interest. Fixed rate annuities consist primarily of flexible premium deferred annuities, but also include single premium deferred and immediate contracts. With fixed rate annuities, we bear the underlying investment risk and credit interest to the contracts at rates we determine, subject to interest rate guarantees.
The Traditional and Universal Life Insurance segment consists of whole life, term life and universal life policies. These policies provide benefits upon the death of the insured and may also allow the customer to build cash value on a tax-deferred basis.
investments and related investment income not specifically allocated to our product segments;
accident and health insurance products, primarily a closed block of group policies;
We analyze our segment results based on pre-tax operating income (loss). Accordingly, income taxes are not allocated to the segments. In addition, operating results are generally reported net of any transactions between the segments. Operating income (loss) for 2008, 2007 and 2006 represents net income (loss) excluding the impact of:
We use operating income (loss), in addition to net income (loss), to measure our performance since realized and unrealized gains and losses on investments and the change in net unrealized gains and losses on derivatives can fluctuate greatly from quarter to quarter. Also, the cumulative effect of changes in accounting principles, discontinued operations and the lawsuit settlement in 2006 are nonrecurring items. These fluctuations make it difficult to analyze core operating trends. In addition, for derivatives not designated as hedges, there is a mismatch between the valuation of the asset and liability when deriving net income (loss). Specifically, call options relating to our index business are one or two-year assets while the embedded derivative in the index contracts represents the rights of the contract holder to receive index credits over the entire period the index annuities are expected to be in force. For our other embedded derivatives in the product segments and interest rate swaps backing our annuity liabilities, the derivatives are marked to market, but the associated insurance liabilities are not marked to market. A view of our operating performance without the impact of these mismatches and nonrecurring items enhances the analysis of our results. We use operating income (loss) for goal setting, determining company-wide short-term
Depreciation and amortization related to property and equipment are allocated to the product segments while the related property, equipment and capitalized software are generally allocated to the Corporate and Other segment. Depreciation and amortization for the Corporate and Other segment include $5.9 million for 2008, $7.8 million for 2007 and $7.6 million for 2006 relating to leases with affiliates. In the consolidated statements of operations, we record these depreciation amounts net of related lease income from affiliates.
Our investment in equity method investees and the related equity income and interest expense are attributable to the Corporate and Other segment. Expenditures for long-lived assets were not significant during the periods presented above. Goodwill at December 31, 2008 and 2007 is allocated among the segments as follows: Exclusive Annuity ($3.9 million), Traditional and Universal Life Insurance ($6.1 million) and Corporate ($1.2 million).
Net income (loss) decreased $19.2 million in the fourth quarter of 2008 due to changes in assumptions used to amortize deferred policy acquisition costs and deferred sales inducements on direct business issued by EquiTrust Life. See Note 1, “Significant Accounting Policies,” for more information regarding amortization of deferred policy acquisition costs and deferred sales inducements.