The Company owns three buildings in Los Angeles and eleven business service centers in which its administrative operations are conducted. In addition, the Company owns a building in the state of Washington in which the operations of Farmers Life are conducted.
The following table sets forth summary consolidated income statement data, consolidated balance sheet data and other operating data for the periods indicated. The following consolidated income statement data of the Company for each of the years in the five-year period ended December 31, 2000, and the consolidated balance sheet data of the Company as of December 31, 2000 and each of the preceding four years ended December 31, have been derived from the Company's audited consolidated financial statements. The following data should be read in conjunction with the Company's Consolidated Financial Statements and related notes, "Management's Discussion and Analysis of Financial Condition and Results of Operations" and other financial information appearing elsewhere herein.
Income statement data includes the effect of amortizing the purchase accounting entries related to B.A.T's acquisition of the Company in December 1988. Major items incorporated in the purchase price of the Company include goodwill and the value of the AIF relationships of the P&C Group (see Note A). The amortization of these two items, which is being taken on a straight-line basis over forty years, reduced annual pretax income by approximately $102.8 million in each of the years 1996 through 2000.
Operating Revenues. Operating revenues, which primarily consist of management fees paid to the Company as a percentage of gross premiums earned by the P&C Group, increased from $1,489.7 million in 1999, to a record level of $1,588.8 million in 2000, an increase of $99.1 million, or 6.7%. This growth was primarily attributable to higher volumes of gross premiums earned by the P&C Group, which increased $589.5 million, or 5.5%, to $11,394.4 million in 2000. The increase in gross premiums earned was driven primarily by $390.3 million of premiums earned as a result of the acquisition of Foremost. Growth in Commercial and Fire management fees also contributed to the increase in management fees between years.
of expenses incurred in connection with providing management services to the business assumed from Foremost.
Net Realized Gains. Net realized gains decreased from $75.3 million in 1999 to $68.5 million in 2000, a decrease of $6.8 million, or 9.0%. This decrease was due primarily to losses incurred on sales of bonds in the third quarter of 2000 as a result of the liquidation of a sizable portion of the fixed income portfolio which was used to help fund the payment of the $1,075.0 million special dividend associated with the Zurich capital structure unification in October 2000.
Dividends on Preferred Securities of Subsidiary Trusts. Dividend expense related to the $500.0 million of QUIPS issued in 1995 was $42.1 million in both 1999 and 2000.
Management Services Income. As a result of the foregoing, management services income increased from $481.1 million for the year ended December 31, 1999 to $503.1 million for the year ended December 31, 2000, an increase of $22.0 million, or 4.6%.
Under the quota share reinsurance treaty, Farmers Re assumed $1,000.0 million of premiums in each of the years ended 2000 and 1999. Losses and loss adjustment expenses incurred under this treaty were $686.9 million in 2000 and $661.3 million in 1999 and non-life reinsurance commissions paid were $288.1 million in 2000 and $313.7 million in 1999. Income before taxes increased from $53.3 million in 1999 to $77.3 million in 2000, an increase of $24.0 million, or 45.0%. This increase was due primarily to increased realized capital gains and
Net Commissions. Net commissions expense decreased from $13.5 million in 1999 to $3.9 million in 2000, due to higher co-insurance activity.
General and Administrative Expenses. General and administrative expenses increased $7.2 million, from $44.1 million in 1999 to $51.3 million in 2000. This increase was due primarily to expenses incurred in 2000 related to entering the variable market as well as expanding the number of states in which Farmers Life is licensed.
Farmers Life Income. As a result of the foregoing, Farmers Life income increased from $158.2 million in 1999 to $169.6 million in 2000, an increase of $11.4 million, or 7.2%.
Effective January 1, 1999, the P&C Group began assuming all personal lines business written by Zurich's subsidiary, Maryland Casualty Company ("MCC"). The Company provides management services in respect of this business and, as with its services to the P&C Group, receives compensation based on a percentage of gross premiums earned.
Buildings and Equipment Expenses. Buildings and equipment expenses decreased from $145.4 million in 1998 to $91.5 million in 1999, a decrease of $53.9 million, or 37.1%. A key driver behind this reduction was the $43.6 million write-off of capitalized software costs that were no longer deemed recoverable in 1998. Exclusive of this write-off, buildings and equipment expenses were $10.3 million lower than the prior year due to a $23.2 million decrease in information technology systems software amortization expense in 1999, offset in part by $6.7 million of expenses incurred in connection with providing management services to the personal lines business previously managed by MCC.
General and Administrative Expenses. General and administrative expenses increased from $204.1 million in 1998 to $266.3 million in 1999, an increase of $62.2 million, or 30.5%. This increase in expense was primarily due to $19.1 million of expenses incurred in connection with providing management services to the personal lines business previously managed by MCC, $18.0 million of expenses related to a project to implement a new financial accounting and reporting system for the Company and the P&C Group and a $4.6 million increase in expenses resulting from outsourcing the management of the Company's investment portfolios beginning in July 1998. The remaining increase is primarily due to higher business levels.
Net Investment Income. Net investment income decreased $17.6 million, or 13.0%, from $135.1 million in 1998 to $117.5 million in 1999. This decrease was primarily due to the redemption of $650.0 million of certificates of contribution of the P&C Group in July 1998, which yielded 8.95% interest, and the subsequent purchase of $1,057.0 million of notes from BAFS, yielding 5.62% interest.
General. The principal uses of funds by the Company are (i) operating expenses, (ii) dividends to the shareholders of the Company's QUIPS, (iii) capital expenditures and (iv) dividends to its stockholders. In 2000, dividends paid on QUIPS totaled $42.1 million, capital expenditures totaled $100.9 million and cash dividends paid to stockholders totaled $1,557.7 million.
In order to maintain the policyholders' surplus of the P&C Group, the Company has, from time to time, made surplus contributions to the P&C Group, receiving certificates of contribution or surplus notes which bear interest at various rates. In 2000, $175.0 million of surplus notes of the P&C Group were assigned to the Company (see Note G). Also in 2000, to help fund the Exchanges' acquisition of Foremost, the Company purchased $370.0 million of certificates of contribution of the P&C Group (see Note G). As of December 31, 2000, the Company held $393.3 million of certificates of contribution of the P&C Group and $294.0 million of surplus notes of the P&C Group. The Company believes that these purchases of certificates of contribution and surplus notes have helped to support the historical growth in premiums earned by the P&C Group and the related growth in management fees paid to the Company.
Net cash provided by investing activities increased $1,013.8 million between years to $452.2 million in 2000. This increase in cash was mainly the result of a $565.0 million increase in proceeds from redemptions of notes receivable from affiliates, due primarily to the fact that in October 2000, to help fund the payment of the $1,075.0 million special dividend associated with the Zurich capital structure unification, the Company sold $580.0 million of notes receivable from UKISA to ZIC for par value (see Note F). Adding to the increase in cash between years was a $462.5 million decrease in purchases of investments available-for-sale in 2000, a $234.8 million increase in proceeds from sales and maturities of investments available-for-sale in 2000 and the fact that $440.0 million of notes receivable from affiliates were purchased in 1999. Partially offsetting these increases in cash was a $545.0 million decrease in cash due to the purchases of certificates of contribution and surplus notes of the P&C Group in 2000 (see Note G).
Net cash used in financing activities increased from $378.7 million in 1999 to $1,587.4 million in 2000, resulting in a decrease in cash of $1,208.7 million. This decrease in cash was substantially due to a $1,124.3 million increase in dividends paid to stockholders resulting mainly from the payment of the $1,075.0 million special dividend associated with the Zurich capital structure unification in October 2000.
We have audited the accompanying consolidated balance sheets of Farmers Group, Inc. and subsidiaries (the "Company") as of December 31, 2000 and 1999, and the related consolidated statements of income, comprehensive income, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2000. 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, such consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2000 and 1999, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2000 in conformity with accounting principles generally accepted in the United States of America.
FARMERS GROUP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY Years ended December 31, 2000, 1999 and 1998 (Amounts in thousands)
In December 1988, B.A.T Industries p.l.c. ("B.A.T") acquired 100% ownership of the Company for $5,212,619,000 through its wholly owned subsidiary BATUS Financial Services. Immediately thereafter, BATUS Financial Services was merged into FGI. The acquisition was accounted for as a purchase and, accordingly, the acquired assets and liabilities were recorded in the Company's consolidated balance sheets based on their estimated fair values at December 31, 1988.
Management services generate a substantial portion of the Company's revenue and profits and, as a result, the Company's ongoing financial performance depends on the volume of business written by, and the efficiency and financial strength of, the P&C Group. A portion of the purchase price ($1,709,043,000) associated with B.A.T's acquisition of the Company was assigned to these AIF relationships. The value so assigned is being amortized on a straight-line basis over forty years.
The excess of the purchase price over the fair value of the net assets ("Goodwill") of the Company at the date of the Company's acquisition by B.A.T ($2,401,755,000) is being amortized on a straight-line basis over forty years. The carrying amount of the Goodwill is regularly reviewed for indications of impairment in value which in the view of management are other than temporary, including unexpected or adverse changes in the following: (1) the economic or competitive environments in which the Company operates, (2) profitability analyses and (3) cashflow analyses. As of December 31, 2000, management believes that the reported value is recoverable and the remaining life of Goodwill is appropriate.
At the date of the Company's acquisition by B.A.T, the Company's life insurance operations were conducted by three wholly owned subsidiaries, Farmers New World Life Insurance Company ("Farmers Life"), The Ohio State Life Insurance Company ("OSL") and Investors Guaranty Life Insurance Company ("IGL"). A portion
As part of the Company's strategic plan to focus its life insurance efforts on Farmers Life, the Company sold OSL and IGL to Great Southern Life Insurance Company, a subsidiary of Americo Life, Inc. in April 1997. Farmers Life markets a broad line of individual life insurance products, including universal life, term life and whole life insurance and structured settlement and annuity products, predominately flexible premium deferred annuities. Additionally, in 2000, Farmers Life entered the variable universal life and annuities markets. The products and services offered by Farmers Life are sold directly by the P&C Group's agents.
In September 1998, the financial services businesses of B.A.T, which included the Company, were merged with Zurich Insurance Company ("ZIC"). The businesses of ZIC and the financial services businesses of B.A.T were transferred to Zurich Group Holding ("ZGH"), formerly known as Zurich Financial Services, a Swiss company with headquarters in Zurich, Switzerland. As a result, each two shares of the Company's prior outstanding stock were recapitalized into one share of Class A Common Stock, par value $1.00 per share ("Ordinary Shares"), and one share of Class B Common Stock, par value $1.00 per share ("Income Shares"). Under the merger agreement, all Ordinary Shares became wholly owned by ZGH and all Income Shares became wholly owned by Allied Zurich Holdings Limited, an affiliated company created during the restructuring of B.A.T. This merger was accounted for by ZGH as a pooling of interests under International Accounting Standards.
FASB Statement No. 133", which deferred the effective date of SFAS No. 133 to fiscal years beginning after June 15, 2000. Finally, in June 2000, the FASB released SFAS No. 138, "Accounting for Certain Derivative Instruments and Certain Hedging Activities". This Statement amends the accounting and reporting standards of SFAS No. 133 for the following items: normal purchases and normal sales exception, interest rate risk, recognized foreign-currency- denominated debt instruments and intercompany derivatives. This Statement also amends SFAS No. 133 for certain provisions related to the implementation guidance arising from the Derivative Implementation Group process. SFAS No. 133, No. 137, and No.138 will be effective for financial statements issued by the Company for periods ending after December 31, 2000. The Company does not expect the adoption of these Statements to have a material impact on its consolidated financial statements.
In September 2000, the FASB issued SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities". This Statement revises accounting standards for securitizations and other transfers of financial assets and collateral. SFAS No. 140 replaces SFAS No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities", and rescinds SFAS No. 127, "Deferral of the Effective Date of Certain Provisions of FASB Statement No. 125". This Statement, which is required to be applied prospectively with certain exceptions, is effective for transfers and servicing of financial assets and extinguishments of liabilities occurring after March 31, 2001. Additionally, this Statement is effective for recognition and reclassification of collateral and for disclosures relating to securitization transactions and collateral for fiscal years ending after December 15, 2000. The adoption of this Statement did not have a material impact on the Company's consolidated financial statements.
Revenues associated with universal life products as well as structured settlements involving life contingencies consist of policy charges for the cost of insurance, policy administration fees, surrender charges and investment income on assets allocated to support policyholder account balances. Revenues for deferred annuity products consist of surrender charges and investment income on assets allocated to support policyholder account balances. Expenses include interest credited to policyholder account balances and benefit claims incurred in excess of policyholder account balances. Revenues and expenses related to structured settlements not involving life contingencies are recorded consistent with guidelines for investment contracts, which are not subject to mortality risks. Liabilities for future policy benefits on universal life and deferred annuity products are determined under the retrospective deposit method. DAC is amortized in relation to the present value of expected gross profit margins on the policies, after giving recognition to differences between actual and expected gross profit margins to date. In compliance with a Securities and Exchange Commission ("SEC") staff announcement, the Company has recorded certain entries to the DAC and VOLBA line of the consolidated balance sheet in connection with SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities". The SEC requires that companies record entries to those assets and liabilities that would have been adjusted had the unrealized investment gains or losses
from securities classified as available-for-sale actually been realized, with corresponding credits or charges reported directly to stockholders' equity. Accordingly, DAC and VOLBA are increased or decreased to reflect what would have been the impact on estimated future gross profits, had net unrealized gains or losses on securities been realized at the balance sheet date. Net unrealized gains or losses on securities, within stockholders' equity, also reflect this impact. These entries decreased the DAC and VOLBA assets by $6,097,000 as of December 31, 2000 and increased the DAC and VOLBA assets by $31,933,000 as of December 31, 1999.
Farmers Re, a wholly owned subsidiary of the Company, reinsures a percentage of the auto physical damage business written by the P&C Group. Under the quota share reinsurance treaty, entered into in January 1998, Farmers Re assumes monthly premiums of $83,333,000 and a quota share percentage of ultimate net losses sustained by the P&C Group in its auto physical damage lines of business. This treaty, which will remain in effect until terminated by either party, also provides for the P&C Group to receive a provisional ceding commission of 20% of premiums with additional experience commissions that depend on loss experience. This experience commission arrangement limits Farmers Re's potential underwriting gain on the assumed business to 2.5% of premiums assumed.
Total losses paid by Farmers Re were $590,214,000, $547,827,000 and $543,445,000 in 2000, 1999 and 1998, respectively, while total loss adjustment expenses were $6,725,000, $6,980,000 and $5,736,000 in 2000, 1999 and 1998, respectively. Additionally, reinsurance commissions were $288,126,000 in 2000, $313,749,000 in 1999 and $319,875,000 in 1998. Farmers Re had loss reserves of $89,936,000 and $106,444,000 as of December 31, 2000 and 1999, respectively.
As a result of the merger between B.A.T's Financial Services Businesses and ZIC in 1998, the Company recorded various merger related expenses totaling $244,000 in 1999 and $21,056,000 in 1998. The expenses recorded in 1999 related to audit and legal costs incurred by the Company in connection with the merger, while the expenses recorded in 1998 were primarily related to $16,545,000 of losses the Company incurred in connection with taking over the management of ZIC's United States personal lines business. An additional $2,728,000 was recorded in 1998 relating to the write-off of redundant capitalized software and $1,783,000 was recorded relating to miscellaneous audit, legal and travel expenses incurred by the Company in connection with the merger. No merger related expenses were incurred in 2000.
As of December 31, 2000, the Company held a $250,000,000 note receivable from Orange Stone (Delaware) Holdings Limited ("OSDH"), a subsidiary of Zurich, formerly known as Old Stone (Delaware) Holdings Limited. The Company loaned $250,000,000 to OSDH on December 15, 1999 and, in return, received a medium-term note with a 7.50% fixed interest rate that matures on December 15, 2004. Interest on this note is paid semi-annually and, for the years ended December 31, 2000 and December 31, 1999, income earned on this note totaled $18,750,000 and $781,000, respectively.
G. Certificates of Contribution and surplus notes of the P&C Group
Under certain circumstances, the Junior Subordinated Debentures may be distributed to holders of the QUIPS and holders of the Common Securities in liquidation of the Subsidiary Trusts. As of September 27, 2000, Farmers Group, Inc. had the option to redeem, in whole or part, the Junior Subordinated Debentures. The QUIPS are subject to mandatory redemption upon repayment of the Junior Subordinated Debentures at maturity, or upon their earlier redemption, at a redemption price of $25 per Preferred Security, plus accrued and unpaid distributions thereon to the date fixed for redemption.
The Company has two profit sharing plans providing for cash payment to all eligible employees. The two plans, Deferred Profit Sharing and Cash Profit Sharing (consisting of Cash and Quest for Gold), provide for a maximum aggregate expense of 16.25% of the Company's consolidated annual pretax earnings, as adjusted. The Deferred Profit Sharing Plan, limited to 10% of pretax earnings, as adjusted, or 15% of the salary or wage paid or accrued to the eligible employee, provides for an annual contribution by the Company to a trust for eventual payment to employees as provided in the Plan. The Cash Profit Sharing Plan and Quest for Gold Program provide for annual cash distributions to eligible employees. The Cash Profit Sharing Plan is limited to 5% of pretax earnings, as adjusted, or 5% of employee salaries or wages paid or accrued. The Quest for Gold Program is limited to 1.25% of pretax earnings, as adjusted, or 6% of eligible employee salaries or wages paid or accrued.
There are certain statutory limitations on the distribution of surplus. As of December 31, 2000, an aggregate of $194,786,000 was available for distribution as dividends by the Insurance Subsidiaries without the approval of the state insurance departments in which they are domiciled.
* Includes ($1.8 million), $4.1 million and $3.4 million in 2000, 1999, and 1998, respectively, of unrealized gains/(losses) associated with the trading securities reported on the "Other assets" line of the consolidated balance sheet.
Realized gains and losses on sales, redemptions and write-downs of investments owned by the Insurance Subsidiaries are determined based on either the cost of the individual securities or the amortized cost of real estate. Net realized investment gains or losses for the years ended December 31 are:
The amortized cost, gross unrealized gains and losses, and estimated market values of investments in debt securities, including bonds and redeemable preferred stocks, owned by the Company (excluding the Insurance Subsidiaries) are as follows:
The amortized cost, gross unrealized gains and losses, and estimated market values of investments in debt securities, including bonds and redeemable preferred stocks, owned by the Insurance Subsidiaries in 2000 and 1999 are as follows:
The amortized cost and estimated market value of debt securities, including marketable securities, owned by the Company (excluding the Insurance Subsidiaries) as of December 31, 2000, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
The amortized cost and estimated market value of debt securities owned by the Insurance Subsidiaries as of December 31, 2000, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
The change in the net unrealized gains or (losses) of the Company (excluding the Insurance Subsidiaries) for the years ended December 31 are as follows:
Hedge accounting is used to account for the call options as Farmers Life believes that the options reduce the risks associated with increases in the account value of the annuities that result from increases in the S&P 500. The call options effectively hedge the annuity contracts since they are both purchased and sold with identical parameters. Periodically, the value of the assets (S&P 500 call options) is matched to the potential liability (annuity contracts) to ensure the hedge has remained effective. The annuities were written based on a seven year investment term, absent early termination by participants. Therefore, the anticipated hedged transaction (i.e., payment of interest to the policyholder at the end of the investment term and maturity of the call option) for each annuity is generally expected to occur in seven years or less. The amount of unrealized hedging gains/(losses) was ($3,425,000) and $13,197,000 in 2000 and 1999, respectively.
Future policy benefits-deferred annuities. The estimated fair values of flexible premium and single premium deferred annuities are based on their cash surrender values.
Based on current conditions and assumptions as to future events, Farmers Life expects to amortize the December 31, 2000 balance as follows: approximately 7.0% in 2001 and 2002 and 8.0% in 2003, 2004 and 2005. The discount rate used to determine the amortization rate of the VOLBA asset ranged from 12.5% to 7.5%.
For the year ended December 31, 2000, Farmers Life held one mortgage loan which was considered impaired. This loan was paid off in November 2000 and, as a result, no loans were considered to be impaired, and no impaired loan allowance was recorded as of December 31, 2000. For the year ending December 31, 1999, no loans were considered to be impaired, and no impaired loan allowance was recorded.
Upon B.A.T's purchase of the Company in 1988, the Company allocated part of the purchase price to its portion of the Regular Plan assets in excess of the projected benefit obligation at the date of acquisition. The asset is being amortized for the difference between the Company's net pension cost and amounts contributed to the Plan. The unamortized balance as of December 31, 2000 and 1999 was $13,258,000 and $16,940,000, respectively.
The Company uses the projected unit credit cost actuarial method for attribution of expense for financial reporting purposes. The interest cost and the actuarial present value of benefit obligations were computed using a weighted average interest rate of 7.75% in 2000, 8.00% in 1999 and 6.75% in 1998, while the expected return on plan assets was computed using a weighted average interest rate of 9.50% in 2000 and 9.25% in 1999 and 1998. The weighted average rate of increase in future compensation levels used in determining the actuarial present value of the projected benefit obligation was 4.70% in 2000, 5.00% in 1999 and 4.50% in 1998.
The funded status of the entire plan, which includes the Company and the P&C Group, as of December 1, 2000 and 1999 (the latest date for which information is available), was as follows:
The Company has long-term operating lease commitments on equipment and buildings, with options to renew at the end of the lease periods. As of December 31, 2000, the remaining commitments payable over the next five years under these leases were:
As AIF, the Company, or its subsidiaries, as applicable, manages the affairs of the P&C Group and receives management fees for the services rendered. As a result, the Company received management fees from the P&C Group of $1,492,217,000, $1,402,107,000 and $1,271,763,000 in 2000, 1999 and 1998, respectively.
Cash payments for interest were $1,742,000, $1,693,000 and $2,671,000 in 2000, 1999 and 1998, respectively, while cash payments for dividends to the holders of the Company's QUIPS were $42,070,000 in 2000, 1999 and 1998. Cash payments for income taxes were $440,008,000, $426,017,000 and $423,803,000 in 2000, 1999 and 1998, respectively.
In 1999, the Company used $190,000,000 of proceeds it received from the settlement of a loan to Centre Reinsurance Holdings (Delaware II) Ltd., a subsidiary of Zurich, to substantially fund the issuance of the $250,000,000 loan to OSDH (see Note F).
Participating business, which consists of group business, comprised approximately 7.7% of Farmers Life's total insurance in-force as of December 31, 2000 and 8.6% of the total insurance-in-force as of December 31, 1999. In addition, participating business represented 2.0% of Farmers Life's premium income for the years ended December 31, 2000 and 1999 and 2.1% for the year ended December 31, 1998.
The basis of accounting used by the Company's management in evaluating segment performance and determining how resources should be allocated is referred to as the Company's GAAP historical basis, which excludes the effects of the purchase accounting ("PGAAP") adjustments related to the acquisition of the Company by B.A.T in December 1988 (see Note A). This differs from the basis used in preparing the Company's financial statements included in the SEC Form 10-K and 10-Q Reports, which incorporates the effects of the PGAAP adjustments.
(f) Amount includes PGAAP adjustments related to the DAC (($169.8) million) and VOLBA ($300.1 million) assets.
(f) Amount includes PGAAP adjustments related to the DAC (($190.1) million) and VOLBA ($328.7 million) assets.
(e) Amount includes PGAAP adjustments related to the DAC (($168.3) million) and VOLBA ($334.4 million) assets.