Our principal operations are conducted from property leased from a subsidiary of the Iowa Farm Bureau Federation under a 15 year operating lease that expires in 2013. The property leased currently consists of approximately 180,000 square feet of a 400,000 square foot office building in West Des Moines, Iowa. We also lease 23,000 square feet of an office building in Manhattan, Kansas under an annually renewable operating lease. The office space used in these buildings is shared with affiliates and the square feet disclosed is the amount of space allocated to us. The amount of space allocated to us is determined annually. We also lease 16,000 square feet of another office building in West Des Moines, Iowa under two operating leases which expire in 2006. Operations related to our EquiTrust Life expansion are conducted from this location. We consider the current facilities to be adequate for the foreseeable future.
(1) Amounts for 2001, 2002, 2003 and 2004 are impacted by the acquisition of Kansas Farm Bureau Life Insurance Company, Inc. effective January 1, 2001 and the assumption of business through two coinsurance transactions during 2001.
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 fast growing independent channel, which we began in 2003, consists of 4,778 agents and brokers operating throughout the United States. In addition to writing direct insurance business, we assume through a coinsurance agreement a percentage of certain annuities written by American Equity Investment Life Insurance Company (American Equity) prior to August 1, 2004. 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 three Farm Bureau affiliated property-casualty companies.
• The amount of fees we earn on contract holders’ separate account balances.
• Our ability to manage our investment portfolio to maximize investment returns while providing adequate liquidity for obligations to policyholders and minimizing the risk of defaults or impairments of invested assets.
• Beginning July 1, 2003, our company-obligated mandatorily redeemable preferred stock of subsidiary trust and Series C preferred stock are classified as debt and related dividend payments are classified as interest expense.
We believe that reasonable changes in the interest spread, ranging from 20 basis points to 100 basis points, depending upon credit quality, would produce a total value ranging from $294.6 million to $313.0 million, as compared to the recorded amount of $299.4 million. Unrealized gains and losses on these securities are recorded directly in stockholders’ equity, net of offsets, as a component of accumulated other comprehensive income or loss.
We have assumed the expected long-term rate of return on plan assets will be 7.00%. In estimating the discount rate (6.25% for 2004), we based it on the rate of return currently available on high quality, fixed-income investments.
A 100 basis point decrease in the expected return on assets would result in a $0.5 million increase in pension expense. A 100 basis point decrease in the assumed discount rate would result in a $0.4 million increase in pension expense. A 100 basis point increase in these rates would result in a decrease to expense in approximately the same amount noted above.
Premium collected is a non-GAAP financial measure for which there is no comparable GAAP financial measure. We use premiums collected to measure the productivity of our exclusive and independent agents. Direct traditional annuity - independent distribution premiums collected increased significantly during 2004 due to the successful expansion of our EquiTrust Life independent distribution channel. Reinsurance assumed and other premiums collected decreased during 2004 due to the suspension of our coinsurance agreement (the coinsurance agreement) with American Equity effective August 1, 2004. As a result of this suspension, no transfers of new business will occur unless we and American Equity agree to resume the coinsurance of new business. The business assumed by us prior to the suspension will remain as part of our in force business.
With respect to our index annuities, index costs represent the expenses we incur to fund the annual income credits through the purchase of options and minimum guaranteed interest credited on the index business. See the “Segment Information” section that follows for a discussion of our spreads.
Premiums and product charges increased 4.0% in 2004 to $222.3 million and 6.3% in 2003 to $213.7 million. The increases in interest sensitive and index product charges in 2004 and 2003 are driven principally by surrender charges on annuity and universal life products, increases in cost of insurance charges on universal life products and mortality and expense fees on variable products. Surrender charges increased due to increases in surrenders relating to growth in the volume and aging of business in force. Cost of insurance charges increased due to aging of the business in force. Mortality and expense fees increased due to increases in the separate account balances on which fees are based. Traditional premiums increased in 2004 and 2003 due primarily to sales of term and whole life products by our Farm Bureau Life agency force.
Net investment income, which excludes investment income on separate account assets relating to variable products, increased 5.1% in 2004 to $416.1 million and increased 13.6% in 2003 to $395.9 million. These increases are due to an increase in average invested assets of 15.5% to $6,734.7 million (based on securities at amortized cost) in 2004 compared to $5,828.5 million in 2003 and $4,845.3 million in 2002. The increases in average invested assets in 2004 and 2003 are due principally to net premium inflows from the Farm Bureau Life and EquiTrust Life distribution channels and the coinsurance agreement. The annualized yield earned on average invested assets was 6.18% in 2004, 6.79% in 2003 and 7.19% in 2002. Market conditions in 2004, 2003 and 2002 decreased our investment portfolio yield as market investment rates were, in general, lower than our portfolio yield or yield on investments maturing or being paid down. For 2003, an increase in fee income from bond calls and mortgage loan prepayments partially offset the impact of these market conditions. Fee income from mortgage loan prepayments and bond calls totaled $2.2 million in 2004, $9.6 million in 2003 and $1.8 million in 2002. Net investment income includes ($0.5) million in 2004, $3.3 million in 2003 and $4.0 million in 2002 representing acceleration (reversal) of net discount accretion on mortgage and asset-backed securities resulting from changing prepayment speed assumptions during the respective periods. The amount of bond call and prepayment fee income we earn typically increases with a decrease in market interest rates as more bonds and mortgage loans are prepaid before their contractual maturity. See “Financial Condition - Investments” section that follows for a description of how changes in prepayment speeds impact net investment income.
The increases in gains received at expiration or termination are attributable to growth in the volume of index annuities in force and appreciation in the underlying equity market indices on which our options are based. The
changes in the difference between the fair value of the call options and the remaining option costs for 2004 and 2003 are caused primarily by the general change in the S&P 500 Index (upon which the majority of our options are based). For 2004, the S&P 500 Index increased on a point-to-point basis by 9.0%, compared to a point-to-point increase of 26.4% for 2003. While the difference between the fair value of the call options and the remaining option costs generally corresponds to the point-to-point change in the S&P 500 Index, the change in fair value is also impacted by options based on daily or monthly S&P 500 Index averages and options which are based on other underlying indices. Furthermore, the timing of option settlements also impacts the change in fair value. The cost of money for call options increased due primarily to the impact of growth in the volume of index annuities in force. Other derivative income (loss) is comprised of changes in the value of (i) the conversion feature embedded in convertible fixed maturity securities, (ii) the embedded derivative included in our modified coinsurance contracts and (iii) the forward commitments for the purchase of certain when-issued securities. Derivative income (loss) will fluctuate based on market conditions.
In September, the company was restructuring its lease obligations with lenders and negotiating labor costs. The company stated that if labor costs are not reduced, bankruptcy is probable.
In June, the company was negotiating labor costs and we determined there was a high probability of restructuring and possible bankruptcy filing.
In September, we noted a negative outlook for recovery, based on the company’s proposed reorganization plan. This plan would provide no recovery on our issue.
In March, this mortgage loan was restructured and written down to appraised value.
In September, issue was downgraded reflecting decreased value and cash flow generating ability. The issue is secured by an older aircraft.
In June, fraud and accounting irregularities were discovered with financial restructuring highly probable.
Interest sensitive and index product benefits increased 2.9% in 2004 to $268.1 million and 24.3% in 2003 to $260.5 million. The increases in interest sensitive and index product benefits for 2004 and 2003 are due primarily to an increase in volume of annuity business in force and an increase in index product benefits, partially offset by the impact of reductions in interest crediting rates on many products. The increase for 2004 was also partially offset by a decrease in interest sensitive death benefits. The decreases in interest crediting rates were made in response to a declining investment portfolio yield. 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 3.97% for 2004, 4.45% for 2003 and 5.30% for 2002. The increases in index credits are attributable to growth in the volume of index annuities in force and appreciation in the underlying equity market indices on which our options are based. The change in the value of the embedded derivative primarily results from the change in expected index credits on the next policy anniversary dates, which are related to the change in the fair value of the options acquired to fund these index credits as discussed above under “Derivative income (loss).” The value of the embedded derivative is also impacted by the timing of the posting of index credits and changes in reserve discount rates and assumptions used in estimating future call option costs. Interest sensitive death benefits decreased 12.1% to $33.8 million for 2004 and increased 16.9% to $38.4 million for 2003. Interest sensitive and index product benefits can 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 and the value of the embedded derivatives for our index annuities.
Traditional life insurance and accident and health policy benefits increased 4.5% in 2004 to $142.2 million and decreased 1.1% in 2003 to $136.0 million. The increase in 2004 is due primarily to an 11.9% increase in traditional death benefits to $47.7 million. Distributions to participating policyholders decreased in 2004 and 2003 due to reductions in our dividend crediting rates in response to a declining investment portfolio yield. The increase in
traditional life insurance and accident and health future policy benefits for 2003 includes a $1.8 million reduction in reserves relating to a change in valuation methodology for certain traditional life business. Traditional life insurance and accident and health policy benefits for 2002 were impacted by a $1.3 million reduction in reserves relating to the discontinuation of certain group life business. Traditional life insurance and accident and health policy benefits can fluctuate from period to period primarily as a result of changes in mortality experience.
Underwriting, acquisition and insurance expenses increased 14.6% in 2004 to $150.0 million and 29.1% in 2003 to $130.9 million. Commissions increased in 2004 and 2003 due to increases in traditional life insurance and variable universal life renewal premiums. Amortization of deferred policy acquisition costs increased due principally to the impact of increases in the volume of business in force resulting from new sales and business assumed under the coinsurance agreement. Amortization of deferred policy acquisition costs on our business assumed from the coinsurance agreement totaled $24.8 million in 2004, $19.4 million in 2003 and $5.8 million in 2002. Amortization of value of insurance in force acquired was reduced $1.2 million in 2004 as a result of changes in the assumptions used to calculate the value of insurance in force acquired. Amortization of the value of insurance in force acquired was reduced $1.2 million in 2002 by the impact of realized losses on investments backing the related policyholder liabilities. Other underwriting, acquisition and insurance expenses increased in 2004 due partially to expenses relating to the expansion of our EquiTrust Life distribution through independent agents and brokers totaling $4.0 million. The increase in 2004 was also impacted by a $0.7 million loss on the sale of fixed assets and a $1.2 million increase in advertising expense. In addition, other operating expenses increased as a result of the growth of our business and increased costs for regulatory compliance. The increases in other underwriting, acquisition and insurance expenses in 2003 are due primarily to increases in salaries and employee benefits and expense allowances on reinsurance assumed.
Pre-tax operating income for the traditional annuity - exclusive distribution segment increased 8.1% in 2004 to $26.3 million and 9.2% in 2003 to $24.3 million. Revenues, benefits, expenses and the volume of business in force increased in 2004 and 2003 primarily due to the volume of sales from our Farm Bureau distribution agency force. Premiums collected increased 1.6% in 2004 to $231.2 million and 14.9% in 2003 to $227.6 million. Net investment income includes $0.7 million in 2004, $4.9 million in 2003 and $0.9 million in 2002 in fee income from bond calls and mortgage loan prepayments and the acceleration (reversal) of net discount accretion on mortgage and asset-
backed securities as noted in the investment income discussion above. Net investment income for 2004 and 2003 was also impacted by the decline in market interest rates during these periods. The impact of the decline in market interest rates is partially offset by decreases in interest credited to policyholders due to reductions in interest crediting rates. Net investment income for 2004 is also positively impacted by a decrease in our cash position and increased investment in corporate bonds. Benefits and expenses for these periods were impacted by changes in the assumptions used to calculate deferred policy acquisition costs as discussed under “Significant Accounting Policies and Estimates.” Amortization of deferred policy acquisition costs decreased $0.3 million in 2004 and increased $1.4 million in 2003 and $0.1 million in 2002 due to changes in the assumptions used to calculate deferred policy acquisition costs. Amortization of value of insurance in force acquired was reduced $0.7 million in 2004 as a result of changes in the assumptions used to calculate the value of insurance in force acquired.
Pre-tax operating income for the traditional annuity - independent distribution segment decreased 19.3% in 2004 to $14.9 million and increased 157.1% in 2003 to $18.4 million. The decrease in 2004 is due principally to decreases in individual deferred annuity spreads and increased operating expenses, partially offset by growth in the volume of business in force. The increase in 2003 is due primarily to increases in individual deferred annuity spreads and growth in the volume of business in force. Revenues, benefits, expenses and the volume of business in force increased in 2004 primarily due to the expansion of our EquiTrust Life distribution channel and business assumed under the coinsurance agreement prior to its suspension on August 1, 2004. For 2003, the increases in these items are primarily due to business assumed under the coinsurance agreement. Direct premiums collected increased to $472.3 million in 2004 compared to $0.8 million in 2003 due to the expansion of our EquiTrust Life independent distribution. The increases in net investment income are attributable to growth in invested assets due principally to net premium inflows, partially offset by the decline in our investment yield discussed above. Net investment income includes ($0.1) million in 2004, $3.1 million in 2003 and $2.8 million in 2002 in fee income from bond calls and mortgage loan prepayments and the acceleration (reversal) of net discount accretion on mortgage and asset-backed securities. The changes in derivative income are primarily due to changes in the difference between the fair values of the call options resulting from changes in the indices on which our options are based. Operating expenses in 2004 include $4.0 million relating to the expansion of our EquiTrust Life distribution channel.
Pre-tax operating income for the traditional and universal life insurance segment decreased 4.2% in 2004 to $52.2 million and decreased 10.8% in 2003 to $54.5 million. Traditional life insurance premiums increased in 2004 and 2003 due primarily to sales of whole life products by our Farm Bureau Life agency force, partially offset by an increase in term life premiums ceded. Net investment income includes $0.9 million in 2004, $2.9 million in 2003 and $2.0 million in 2002 in fee income from bond calls and mortgage loan prepayments and the acceleration (reversal) of net discount accretion on mortgage and asset-backed securities as noted in the investment income discussion above. Net investment income for 2004 and 2003 was also impacted by the decline in market interest rates during these periods. These decreases are partially offset by decreases in interest credited to policyholders and policy dividends paid due to reductions in interest and dividend crediting rates. Benefits and expenses for 2004 and 2003 increased due primarily to increases in operating expenses and death benefits. Death benefits totaled $69.9 million in 2004, $69.4 million in 2003 and $65.2 million in 2002. Amortization of value of insurance in force acquired was reduced $0.5 million in 2004 as a result of changes in the assumptions used to calculate the value of insurance in force acquired. Amortization of deferred policy acquisition costs was reduced by $1.4 million in 2004, $0.4 million in 2003 and $4.2 million in 2002 due to changes in the assumptions used to calculate deferred policy acquisition costs. On a consolidated basis, the impact of these assumption changes in 2003 and 2002 were largely offset by the impact of assumption changes made in the amortization of deferred policy acquisition costs in the other product segments. As noted in the discussion of traditional life insurance and accident and health policy benefits above, pre-tax operating income in 2003 benefited from a $1.8 million reduction in reserves relating to a change in the valuation methodology for certain traditional life business. In addition, pre-tax operating income for 2002 benefited from a $1.3 million reserve reduction relating to the discontinuation of certain group life business.
The decreases in the weighted average yield on cash and invested assets are primarily the result of the impact of the decline in market interest rates during 2004, 2003 and 2002. The decrease in 2004 is also partially attributable to decreases in fee income from bond calls and mortgage loan prepayments and discount accretion on mortgage and asset-backed securities. We reduced the dividend and interest crediting rates on many of our life products in response to this decline in yield. For example, we decreased crediting rates on our primary universal life insurance
product 20 basis points in 2004, 75 basis points in 2003 and 30 basis points in 2002. The changes in our spread earned are due primarily to the impact of the investment fee income noted above, the timing of the crediting rate changes made on our products.
Our total investment portfolio increased 18.3% to $7,501.7 million at December 31, 2004 compared to $6,341.7 million at December 31, 2003. This increase is primarily the result of net cash received from interest sensitive and index products and positive cash flow provided by operating activities. In addition, net unrealized appreciation of fixed maturity and equity securities classified as available for sale increased $42.3 million during 2004 to $265.4 million at December 31, 2004 due principally to the impact of a decline in market interest rates and appreciation of common stock investments.
portfolio and providing adequate liquidity for obligations to policyholders and other requirements. We continually review the returns on invested assets and change the mix of invested assets as deemed prudent under the current market environment to help maximize current income.
The following tables set forth the composition by credit quality of the fixed maturity securities with gross unrealized losses.
Cash and cash equivalents totaled $28.0 million at December 31, 2004 and $233.9 million at December 31, 2003. The amount of cash and cash equivalents will fluctuate from period to period depending on many different factors, including our overall investment management strategy and the timing of the settlement of security purchases and sales. Deferred policy acquisition costs increased 10.7% to $587.4 million and deferred sales inducements increased 100.4% to $78.4 million at December 31, 2004 due to the capitalization of costs incurred with new sales, partially offset by the impact of the change in unrealized appreciation on fixed maturities. Assets held in separate accounts increased 19.0% to $552.0 million at December 31, 2004 due primarily to appreciation in the value of investments and the transfer of net premiums to the separate accounts. At December 31, 2004, we had total assets of $9,100.7 million, a 14.5% increase from total assets at December 31, 2003.
Policy liabilities and accruals and other policyholders’ funds increased 14.3% to $7,200.9 million at December 31, 2004 primarily due to increases in the volume of business in force. Long-term debt increased due to the issuance of $75.0 million of Senior Notes in April 2004. Other liabilities decreased 10.8% to $121.0 million at December 31, 2004, due primarily to a decrease in payables for security purchases. At December 31, 2004, we had total liabilities of $8,267.9 million, a 14.8% increase from total liabilities at December 31, 2003.
Stockholders’ equity increased 11.3%, to $832.6 million at December 31, 2004, compared to $747.8 million at December 31, 2003. This increase is principally attributable to net income for the year, the change in unrealized appreciation/depreciation on fixed maturity and equity securities and proceeds from the issuance of common stock under compensation and stock option plans, partially offset by dividends paid.
A majority of our insurance liabilities are backed by fixed maturity securities and mortgage loans. The fixed maturity securities have laddered maturities and a weighted average life of 7.8 years at December 31, 2004 and 6.2 years at December 31, 2003. The mortgage loans have a weighted average life of 7.8 years at December 31, 2004 and 7.9 years at December 31, 2003. Accordingly, the earned rate on the portfolio lags behind changes in market yields. The extent that the portfolio yield lags behind changes in market yields generally depends upon the following factors:
• The amount and speed at which market interest rates rise or fall.
For a substantial portion of our direct business in force, we have the ability to adjust interest or dividend crediting rates in reaction to changes in portfolio yield. We had the ability to adjust rates on 92% of our policyholder liabilities at December 31, 2004 and 90% at December 31, 2003. However, the ability to adjust these rates is limited by competitive factors. Surrender rates could increase and new sales could be negatively impacted if the crediting rates are not competitive with the rates on similar products offered by other insurance companies and financial services institutions. In addition, if market rates were to decrease substantially and stay at a low level for an extended period of time, our spread could be lowered due to interest rate guarantees on many of our interest sensitive products. At December 31, 2004, interest rate guarantees on our direct interest sensitive products ranged from 1.50% to 5.50%, with a weighted average guarantee of 3.12%. The following table sets forth account values of direct individual deferred annuities (excluding index annuities) and interest sensitive life products, including the general account portion of variable contracts, broken out by the excess of current interest crediting rates over guaranteed rates at December 31, 2004.
For a substantial portion of business assumed through our coinsurance agreements with American Equity and EMC National Life Company (EMCNL), the ceding companies have the ability to adjust interest and dividend crediting rates in reaction to portfolio yield. While we are precluded from directly controlling these rates, we have a representative on American Equity’s Board of Directors. Most of the traditional annuity and universal life insurance contracts assumed through the coinsurance agreements have guaranteed minimum crediting rates. For contracts assumed from American Equity, these rates range from 2.25% to 4.00%, with a weighted average guaranteed crediting rate of 3.02% at December 31, 2004. For contracts assumed from EMCNL, these rates range from 2.50% to 4.00% with a weighted average guaranteed crediting rate of 3.65% at December 31, 2004. The following table sets forth account values broken out by the excess of current interest crediting rates over guaranteed rates for fixed rate annuities and universal life business assumed through the coinsurance agreements at December 31, 2004.
participation rates, asset fees, and/or caps, subject to guaranteed minimums. The minimum guaranteed contract values for index annuities sold by our EquiTrust Life distribution are equal to 87.5% to 100% of the premium collected plus interest credited at rates ranging between 1.5% and 2.05%. The minimum guaranteed contract values for index annuities assumed under the coinsurance agreement are equal to 80% to 100% of the premium collected plus interest credited at rates ranging between 2.25% to 3.50%. Profitability on the index annuities in any given year is also impacted by changes in the fair value of the embedded option which provides the contract holder the right to participate in market index returns after the next anniversary date of the contract. This impacts profitability because only one-year call options are purchased to fund the index credits owed to the contract holders at the inception of each contract year. This practice matches well with the contract holders’ rights to switch to different indices on each anniversary date. The value of the forward starting options embedded in the index annuities can fluctuate with changes in assumptions as to the expected cost of the options, which is driven by expectations as to the future volatility of the market indices, risk free interest rates, market returns, contractual features such as participation rates, asset fees, and/or caps and the lives of the contracts.
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 computer models to perform simulations of the cash flows generated from existing insurance policies under various interest rate scenarios. Information from these models is used in the determination of interest crediting rates and investment strategies. Effective duration is a common measure for price sensitivity to changes in interest rates. It measures the approximate percentage change in the market value of a portfolio when interest rates change by 100 basis points. This measure includes the impact of estimated changes in portfolio cash flows from features such as bond calls and prepayments. When the estimated durations of assets and liabilities are similar, exposure to interest rate risk is reduced because a change in the value of assets should be largely offset by a change in the value of liabilities. The effective duration of our fixed maturity and mortgage loan portfolios was approximately 5.8 at December 31, 2004 and 5.3 at December 31, 2003. The effective duration of the interest sensitive products was approximately 5.5 at December 31, 2004 and 4.6 at December 31, 2003.
In January 2004, we borrowed $46.0 million on a $60.0 million revolving line of credit agreement with LaSalle Bank National Association and Bankers Trust Company, N.A. This agreement is effective through October 31, 2005 and interest on any borrowings accrues at a variable rate (3.07% at December 31, 2004). Under this agreement, we are required to maintain minimum capital and surplus levels at the Life Companies and meet certain other financial covenants. We are also prohibited from incurring additional indebtedness in excess of $10.0 million while this agreement is in effect. Due to the scheduled maturity at October 31, 2005, this $46.0 million obligation is classified as short-term debt at December 31, 2004 on our consolidated balance sheet.
We paid cash dividends on our common and preferred stock totaling $11.6 million in 2004, $12.0 million in 2003 and $12.6 million in 2002. Interest payments on our debt totaled $8.6 million in 2004, $3.6 million in 2003 and $0.7 million in 2002. It is anticipated that cash dividend requirements for 2005 will be $0.105 per quarter per common share and $0.0075 per quarter per Series B redeemable preferred share, or approximately $12.4 million. In addition, interest payments on our debt, assuming no changes to the variable rate charged on our line of credit borrowings, are estimated to be $11.4 million for 2005.
FBL Financial Group, Inc. expects to rely on available cash resources and dividends from the Life Companies to make any dividend payments to its stockholders and interest payments on its debt. In addition, it is anticipated that a combination of available cash and investments, additional borrowings and dividends from the Life Companies will be used to fund the repayment of borrowings on the line of credit which are due October 31, 2005 and the scheduled final redemption of the Series C preferred stock ($46.3 million) due on January 3, 2006.
The Life Companies’ cash inflows consist primarily of premium income, deposits to policyholder account balances, income from investments, sales, maturities and calls of investments and repayments of investment principal. The Life Companies’ cash outflows are primarily related to withdrawals of policyholder account balances, investment purchases, payment of policy acquisition costs, policyholder benefits, income taxes, dividends and current operating expenses. Life insurance companies generally produce a positive cash flow which may be measured by the degree to which cash inflows are adequate to meet benefit obligations to policyholders and normal operating expenses as they are incurred. The remaining cash flow is generally used to increase the asset base to provide funds to meet the
need for future policy benefit payments and for writing new business. The Life Companies’ liquidity positions continued to be favorable in 2004, with cash inflows at levels sufficient to provide the funds necessary to meet their obligations.
For the life insurance operations, cash outflow requirements for operations are typically met from normal premium and deposit cash inflows. This has been the case for all reported periods as the Life Companies’ continuing operations and financing activities relating to interest sensitive and index products provided funds totaling $833.4 million in 2004, $711.2 million in 2003 and $1,068.0 million in 2002. The decrease in net cash flows in 2003 is primarily due to a decrease in premiums assumed through the coinsurance agreements. Positive cash flow from operations is generally used to increase the Life Companies’ fixed maturity securities and other investment portfolios. In developing their investment strategy, the Life Companies establish a level of cash and securities which, combined with expected net cash inflows from operations, maturities of fixed maturity investments and principal payments on mortgage and asset-backed securities and mortgage loans, are believed adequate to meet anticipated short-term and long-term benefit and expense payment obligations.
We anticipate that funds to meet our short-term and long-term capital expenditures, cash dividends to stockholders and operating cash needs will come from existing capital and internally generated funds. We believe that the current level of cash and 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, mortgage loans and our insurance products, are adequate to meet our anticipated cash obligations for the foreseeable future. Our investment portfolio at December 31, 2004, included $27.5 million of short-term investments, $28.0 million of cash (consisting primarily of securities purchased with a maturity of three months or less) and $1,184.1 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, 2004 or 2003.
In the normal course of business, we enter into financing transactions, lease agreements, or other commitments which are necessary or beneficial to our operations. These commitments may obligate us to certain cash flows during future periods. The following table summarizes such obligations as of December 31, 2004:
persistency when applicable. These assumptions are based on our historical experience. Amounts shown are net of expected reinsurance recoveries.
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, 2004.
We have audited management’s assessment, included in the accompanying Management’s Report on Internal Control Over Financial Reporting, that FBL Financial Group, Inc. maintained effective internal control over financial reporting as of December 31, 2004, 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. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the company’s internal control over financial reporting based on our audit.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the accompanying consolidated balance sheets as of December 31, 2004 and 2003, and the related statements of income, changes in stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2004 of FBL Financial Group, Inc. and our report dated February 4, 2005 expressed an unqualified opinion thereon.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of FBL Financial Group, Inc.’s internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 4, 2005 expressed an unqualified opinion thereon.
As discussed in Note 1 to the consolidated financial statements, in 2004 the Company changed its method of accounting for guaranteed minimum death benefits and incremental death benefits on its variable annuities and in 2003 the Company changed its method of accounting for its Series C redeemable preferred stock, the subsidiary trust that issued the company-obligated mandatorily redeemable preferred stock and stock options.
FBL Financial Group, Inc. (we or the Company) operates predominantly in the life insurance industry through its principal subsidiaries, Farm Bureau Life Insurance Company (Farm Bureau Life) and EquiTrust Life Insurance Company (EquiTrust Life) (collectively, the Life Companies). Farm Bureau Life markets individual life insurance policies and annuity contracts to Farm Bureau members and other individuals and businesses in the Midwestern and Western sections of the United States through an exclusive agency force. EquiTrust Life markets individual annuity products through independent agents and brokers and variable products through alliances with other insurance companies and a regional broker/dealer. These sales take place throughout the United States. In addition to writing direct insurance business, EquiTrust Life assumes, through a coinsurance agreement, a percentage of certain annuities written by American Equity Investment Life Insurance Company (American Equity) prior to August 1, 2004. 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 three Farm Bureau affiliated property-casualty companies.
Effective January 1, 2004, we adopted Statement of Position (SOP) 03-1, “Accounting and Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration Contracts and for Separate Accounts,” issued by the Accounting Standards Executive Committee of the American Institute of Certified Public Accountants. The SOP provides guidance on separate account presentation and valuation, the accounting for sales inducements (including premium bonuses and bonus interest) and the classification and valuation of long-duration contract liabilities. To comply with this SOP, we changed our method of computing reserves for guaranteed minimum death benefits (GMDB) and incremental death benefits (IDB) associated with our variable annuities and changed our presentation of deferred expenses relating to sales inducements.
Variable annuity and variable universal life contracts are the only contracts reported in our separate accounts. These contracts generally do not have any minimum guarantees other than minimum interest guarantees on funds deposited in our general account and GMDBs on our variable annuities. In addition, certain variable annuity contracts have an IDB rider that pays the contract holder a percentage of the gain on the contract. Information regarding our GMDBs and IDBs by type of guarantee and related separate account balance and net amount at risk (amount by which GMDB or IDB exceeds account value) is as follows:
Certain annuity contracts contain either a premium bonus credited to the contract holder’s account balance or a bonus interest crediting rate which applies to the first contract year only. In addition, certain of our life policies have a premium bonus credited to the contracts. These sales inducements are deferred and amortized over the expected life of the contracts based primarily on the emergence of gross profits. Sales inducements deferred totaled $50.7 million in 2004, $19.8 million in 2003 and $19.1 million in 2002 and amounts amortized totaled $6.8 million in 2004, $4.0 million in 2003 and $1.0 million in 2002. The unamortized sales inducement balance totaled $78.4 million at December 31, 2004 and $39.1 million at December 31, 2003. Beginning January 1, 2004, the deferred sales inducements are reported separately on the balance sheet and the amortization of deferred sales inducements is reported in interest sensitive and index product benefits on the consolidated statement of income. Amounts related to sales inducements in the 2003 and 2002 consolidated financial statements, previously reported with deferred policy acquisition costs, have been reclassified to conform to the 2004 financial statement presentation. The adoption of SOP 03-1 provisions relating to sales inducements had no impact on net income for 2004.
Effective July 1, 2003, we also adopted Statement No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.” This Statement establishes standards for classifying and measuring as liabilities certain financial instruments that embody obligations of the issuer and have characteristics of both liabilities and equity. Upon adoption of this Statement, our company-obligated mandatorily redeemable preferred stock of subsidiary trust and Series C redeemable preferred stock were reclassified to debt on our consolidated balance sheet. There were no adjustments to the carrying values of these instruments upon reclassification. Also, in accordance with Statement No. 150, amounts previously classified as dividends on these financial instruments ($2.2 million for 2004 and $4.6 million for the six months ended December 31, 2003) are recorded as interest expense. All changes in classifications made due to the adoption of Statement No. 150 were made on a prospective basis only as reclassification of prior period amounts was not permitted. The adoption of Statement No. 150 resulted in a $2.2 million decrease to net income for 2004 and 2003. The adoption of Statement No. 150 did not impact net income applicable to common stock or earnings per common share. As discussed below, our company-obligated mandatorily redeemable preferred stock of subsidiary trust was removed from our consolidated financial statements in connection with the deconsolidation of the trust effective December 31, 2003.
Equity securities, comprised of common and non-redeemable preferred stocks are designated as “available for sale” and are reported at market 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 or loss.
Our interest rate swaps are accounted for as cash flow hedges. The swaps are carried on the consolidated balance sheet as either a derivative instrument or other liability. The effective portion of any unrealized gain or loss is recorded in accumulated other comprehensive income. If a portion of the hedges become 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. The net periodic interest settlement between the interest paid and the interest received under these swaps is recorded as a component of interest sensitive product benefits.
Market values of fixed maturity securities are reported based on quoted market prices, where available. Market values of fixed maturity securities not actively traded in a liquid market are estimated using a matrix calculation assuming a spread (based on interest rates and a risk assessment of the bonds) over U. S. Treasury bond yields. Market values of the conversion features embedded in convertible fixed maturity securities are estimated using an option-pricing model. Market 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 market values of comparable issues. Market values for the embedded derivatives in our modified coinsurance contracts and relating to our when-issued securities trading are based on the difference between the fair value and the cost basis of the underlying investments. Market values for the embedded derivatives in our reinsurance recoverable relating to call options are based on quoted market prices.
Deferred policy acquisition costs include certain costs of acquiring new insurance business, principally commissions and other expenses related to the production of new business, to the extent recoverable from future policy revenues and gross profits. Deferred sales inducements include premium bonuses and bonus interest credited to contracts during the first contract year only. The value of insurance in force acquired represents the cost assigned to insurance contracts when an insurance company is acquired. The initial value is determined by an actuarial study using expected future gross profits as a measurement of the net present value of the insurance acquired. Interest accrued on the unamortized balance at a weighted average rate of 5.02% in 2004, 5.28% in 2003 and 5.78% in 2002.
For our direct business, interest crediting rates for interest sensitive products ranged from 1.75% to 10.00% in 2004, from 2.55% to 5.55% in 2003 and from 3.00% to 6.25% in 2002. For interest sensitive products assumed through coinsurance agreements, interest crediting rates ranged from 3.00% to 11.50% in 2004, from 3.25% to 12.00% in 2003 and from 3.50% to 12.00% in 2002. A portion of the interest credited on our direct business and assumed through the coinsurance agreement ($48.9 million in 2004, $19.8 million in 2003 and $19.1 million in 2002) represents an additional interest credit on first-year premiums, payable at policy issue or until the first contract anniversary date (first-year bonus interest). These amounts are included as deferred sales inducements.
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 affiliates of the Company. In addition, certain revenues generated by our insurance subsidiaries are classified as other income. Revenues of the insurance subsidiaries included as other income totaled $1.2 million in 2004, 2003 and 2002. Lease income from leases with affiliates totaled $8.2 million in 2004, $6.9 million in 2003 and $5.8 million in 2002. Investment advisory fee income from affiliates totaled $2.3 million in 2004, $2.0 million in 2003 and $1.5 million in 2002.
Effective January 1, 2003, we adopted Statement No. 123, “Accounting for Stock-Based Compensation” and Statement No. 148, “Accounting for Stock-Based Compensation - Transition and Disclosure.” Under Statement No. 123, compensation expense is recognized as stock options vest in an amount equal to the estimated fair value of the options on the date of grant. Statement No. 148 amends Statement No. 123 by requiring more prominent and frequent disclosures regarding the effects of stock-based compensation and provides for alternative transition methods in the adoption of Statement No. 123. Prior to 2003, we applied Accounting Principles Board Opinion (APB) No. 25, “Accounting for Stock Issued to Employees,” to stock option grants, which generally resulted in no compensation expense being recognized. We are currently using the prospective method in the adoption of
In December 2004, the FASB issued Statement No. 123(R), “Share-Based Payment,” which is a revision of Statement No. 123. Statement No. 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values. While we currently follow the prospective method under Statement No. 123, we expect we will adopt the modified-prospective-transition method upon the adoption of Statement No. 123(R). Under the modified-prospective-transition method, we will recognize compensation expense in financial statements issued subsequent to the adoption for all share-based payments granted, modified or settled after the date of adoption, as well as for any awards that were granted prior to the adoption date for which the requisite service has not been provided as of the adoption date. We currently use the Black-Scholes-Merton option pricing model to estimate the value of employee stock options and expect to continue to use this acceptable option pricing model upon adoption of Statement No. 123(R). Statement No. 123(R) also requires the benefits of tax deductions in excess of recognized compensation cost to be reported as a financing cash flow rather than as an operating cash flow, as currently required. This requirement will reduce net operating cash flows and increase financing cash flows in periods after adoption. While we cannot estimate what these amounts will be in the future as they are dependent on unknown factors, such as the timing of employee stock option exercises, the amount of operating cash flows previously recognized for such excess tax deductions totaled $1.8 million in 2004, $1.0 million in 2003 and $0.7 million in 2002. We intend to adopt Statement No. 123(R) effective July 1, 2005. The adoption of Statement No. 123(R) is not expected to have a material impact on our consolidated financial statements.
Restricted stock awards that vest based on meeting performance standards and the passage of time are charged to expense using the straight-line method over the required service period. The value of the awards is based on the grant date fair value of the restricted stock adjusted for expected forfeitures and an estimate of the number of shares expected to vest. The estimate for the number of shares to vest is challenged each period and the impact of any changes in the estimate on expense is recorded in the current period.
The preparation of financial statements in conformity with accounting principles generally accepted in the United States (GAAP) requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and the disclosure of contingent assets and liabilities. For example, significant estimates and assumptions are utilized in the valuation of investments, determination of other-than-temporary impairments of investments, amortization of deferred policy acquisition costs and deferred sales inducements, calculation of policyholder liabilities and accruals and determination of pension expense. It is reasonably possible that actual experience could differ from the estimates and assumptions utilized which could have a material impact on the consolidated financial statements.
The carrying value and estimated market value of our portfolio of fixed maturity securities at December 31, 2004, 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 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 $24.4 million in 2004, ($1.6) million in 2003 and $68.4 million in 2002.
Realized losses on fixed maturities totaling $6.3 million in 2004, $9.2 million in 2003 and $26.9 million in 2002 were incurred as a result of writedowns for other than temporary impairment of fixed maturity securities.
Income taxes (credits) include a provision of $2.9 million in 2004, ($0.7) million in 2003 and ($5.2) million in 2002 for the tax effect of realized gains and losses.
We have investments in several variable interest entities for which we are not considered the primary beneficiary. These investments consist of common and preferred stock investments in a company that operates in the broker/dealer industry and mezzanine commercial real estate loans on four real estate properties. The broker/dealer had revenues totaling $43.9 million for 2004 and $30.3 million for 2003 and each real estate project has assets totaling less than $17.0 million at December 31, 2004 and less than $16.0 million at December 31, 2003. Our investments in these entities were made during the period from 1997 to 2004. Our maximum exposure to loss is the carrying value of our investments which totaled $4.6 million at December 31, 2004 and $4.1 million at December 31, 2003 for the broker/dealer and $6.2 million at December 31, 2004 and $4.6 million at December 31, 2003 for the mezzanine commercial real estate loans.
At December 31, 2004, affidavits of deposits covering investments with a carrying value totaling $6,940.3 million were on deposit with state agencies to meet regulatory requirements.
At December 31, 2004, we had committed to provide additional funding for mortgage loans on real estate aggregating $46.1 million. These commitments arose in the normal course of business at terms that are comparable to similar investments.
The carrying value of investments which have been non-income producing for the twelve months preceding December 31, 2004 include real estate, fixed maturities, equity securities and other long-term investments totaling $5.9 million.
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, 2004.
also document our risk management objectives and strategies for undertaking these transactions. Interest sensitive product benefits increased by $1.6 million in 2004 and $1.2 million in 2003 as a result of the net interest paid on the interest rate swaps. There was no ineffectiveness recorded in the consolidated statements of income during 2004 or 2003.
We assume index annuity business under the coinsurance agreement and began writing index annuities directly during 2004. Index annuities guarantee the return of principal to the contract holder and credit amounts based on a percentage of the gain in a specified market index. A portion of the premium received is invested in investment grade fixed income securities and is intended to cover the minimum guaranteed value due to the contract holder at the end of the contract term. A portion of the premium received from the contract holder is used to purchase derivatives consisting of one-year call options on the applicable market indices to fund the index credits due to the index annuity contract holders. On the respective anniversary dates of the index annuity contracts, the market index used to compute the annual index credits is reset and new one-year call options are purchased to fund the next annual index credit. Although the call options are designed to be effective hedges from an economic standpoint, they do not meet the requirements for hedge accounting treatment under Statement No. 133, “Accounting for Derivative Instruments and Hedging Activities.” Therefore, the change in fair value of the options is recognized in earnings in the period of change. The cost of the options can be managed through the terms of the index annuities, which permit changes to participation rates, asset fees and/or caps, subject to guaranteed minimums.
Other long-term investments: The fair values for investment deposits are generally estimated by discounting expected cash flows using interest rates currently being offered for similar investments. The fair values for investments held by broker/dealer subsidiaries are based on quoted market prices.
The following sets forth a comparison of the fair values and carrying values of our financial instruments subject to the provisions of Statement No. 107:
We entered into a rate lock on March 18, 2004 to hedge the interest rate on a portion of the Senior Notes. The rate lock had a $50.0 million notional amount and was based on the 10-year Treasury interest rate at the contract’s inception (3.797%). We formally documented this hedging relationship, including identification of the rate lock as the hedging instrument and the 20 semi-annual interest payments on $50.0 million of the Senior Notes as the hedged transactions. We also documented our risk management objectives and strategies for undertaking this transaction. The rate lock was settled on April 6, 2004 and proceeds totaling $1.5 million were deferred and are being amortized over the term of the Senior Notes, along with underwriting fees, offering expenses and original issue discount of the Senior Notes, using the effective interest method. We received net proceeds of approximately $75.5 million from the issuance of the Senior Notes after underwriting fees, offering expenses, original issue discount and the impact of the rate lock.
In connection with the 2001 acquisition of Kansas Farm Bureau Life Insurance Company, we issued 3,411,000 shares of Series C cumulative voting mandatorily redeemable preferred stock with an estimated fair value of $80.0 million to the Kansas Farm Bureau. Each share of Series C preferred stock has a par value of $26.8404 and voting rights identical to that of Class A common stock. Dividends on the Series C preferred stock are payable quarterly at a rate equal to the regular cash dividends per share of common stock, as defined, then payable. We redeemed 1,687,000 shares, or $45.3 million, of the Series C preferred stock on January 2, 2004, in accordance with the scheduled redemption dates under the agreement. The remaining balance is scheduled to be redeemed for cash at par value, or $46.3 million, on January 3, 2006. The Series C preferred stock was initially issued with conversion rights based upon certain contingencies not involving market price triggers. Both parties have signed an agreement to waive these rights, so this instrument is no longer contingently convertible. The Series C preferred stock was issued at an $11.6 million discount to par. This discount accretes to interest expense (preferred stock dividends prior to adoption of Statement No. 150) during the life of the securities using the effective interest method.
We have a $40.0 million funding agreement with the Federal Home Loan Bank (FHLB) classified in the interest sensitive and index products line on the consolidated balance sheets. The funding agreement is due September 12, 2006 and interest on the agreement is charged at a variable rate equal to the London Interbank Offered Rate plus 0.08% (2.47% at December 31, 2004 and 1.25% at December 31, 2003). At December 31, 2004, fixed maturity securities with a carrying value of $54.1 million are on deposit with the FHLB as collateral for the funding agreement.
For 2004, a charge of $14.1 million for all employers would have been recorded to other comprehensive income due to changes in interest rates and the plan assets earning less than that assumed.
The net amounts recognized for all employers noted above represent the amounts that would be recognized if the employers followed Statement No. 87, “Employers’ Accounting for Pensions,” as a single employer plan. We record our proportionate share of prepaid or accrued pension cost and net periodic pension cost as follows:
Net periodic pension cost recorded in our consolidated income statements totaled $6.4 million in 2004, $5.5 million in 2003 and $4.4 million in 2002. Components of net periodic pension cost for all employers are as follows:
Net periodic pension cost for all employers totaled $10.5 million for 2002. The pension plans’ prior service cost is 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, to determine the amounts to amortize.
We participate with several affiliates in a 401(k) defined contribution plan which covers substantially all employees. We contribute 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. 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 $0.9 million in 2004 and $0.8 million in 2003 and 2002.
In addition to benefits offered under the aforementioned benefit plans, we and several other affiliates sponsor a plan that provides group term life insurance benefits to retired full-time employees who have worked ten years and attained age 55 while in service. Postretirement benefit expense is allocated in a manner consistent with pension expense discussed above. Postretirement benefit expense aggregated $0.1 million in 2004 and less than $0.1 million in 2003 and 2002.
The weighted average fair value of options granted per common share was $8.50 for 2004, $5.49 for 2003 and $3.82 for 2002. The fair value of our stock options was estimated at the date of grant using the Black-Scholes-Merton option pricing model with the following weighted-average assumptions:
Information regarding stock options outstanding at December 31, 2004, is as follows:
At December 31, 2004, shares of Class A common stock available for grant as additional awards under the Plan totaled 4,474,721.
We have management agreements with Farm Bureau Mutual and other affiliates under which we provide general business, administrative and management services. We also had a management agreement with EMCNL that was terminated effective July 1, 2003. Fee income for these services totaled $2.8 million in 2004, $2.7 million in 2003 and $3.4 million in 2002. 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 $0.8 million in 2004, $0.6 million in 2003 and $0.8 million in 2002.
We have marketing agreements with the Farm Bureau property-casualty companies operating within our marketing territory, including Farm Bureau Mutual and another affiliate. Under the marketing agreements, the property-casualty companies are responsible for development and management of our agency force for a fee equal to a percentage of commissions on first year life insurance premiums and annuity deposits. We paid $7.3 million in 2004, $7.1 million in 2003 and $7.2 million in 2002 to the property-casualty companies under these arrangements.
We are licensed by the IFBF to use the “Farm Bureau” and “FB” designations in Iowa. In connection with this license, we incurred royalty expense totaling $0.4 million in 2004, 2003 and 2002. We have similar arrangements with the Kansas Farm Bureau and other state Farm Bureau organizations in our market territory. Total royalty expense to Farm Bureau organizations other than the IFBF totaled $1.1 million in 2004, $1.2 million in 2003 and $1.1 million in 2002.
We have administrative services agreements with American Equity under which we provide investment accounting and claims processing, accounting, compliance and other administrative services primarily relating to certain variable annuities written by them. Fee income from performing these services totaled $0.4 million in 2004 and $0.3 million in 2003 and 2002.
Options to purchase 25,947 shares of common stock in 2003 at $22.25 to $26.28 per share were granted during 1998, 1999, 2002 and 2003 but were not included in the computation of 2003 diluted earnings per share because the options’ exercise price was greater than the average market price of common shares during 2003. The options, which expire in 2008 through 2013, were still outstanding at December 31, 2003.
Management analyzes operations by reviewing financial information regarding products that are aggregated into four product segments. The product segments are: (1) traditional annuity - exclusive distribution (“Exclusive Annuity Segment”), (2) traditional annuity - independent distribution (“Independent Annuity Segment”), (3) traditional and universal life insurance and (4) variable. We also have various support operations and corporate capital that are aggregated into a corporate and other segment. Our segment results for 2003 and 2002 have been restated to reflect a change in the composition of our reportable segments. Prior to 2004, amounts now reported in the Exclusive Annuity Segment and the Independent Annuity Segment were reported together in a single traditional annuity segment. This change was made to better reflect how the business is managed and has no impact on our consolidated financial statements for any period reported.
The Independent Annuity Segment consists of fixed annuities and supplementary contracts (some of which involve life contingencies) sold through our independent distribution or assumed through our coinsurance agreements with American Equity and EMCNL. In addition to the types of fixed annuities included in the Exclusive Annuity Segment, the Independent Annuity Segment also includes index annuities. With index annuity products, we bear the underlying investment risk and credit interest in an amount equal to the greater of a guaranteed interest rate or a percentage of the gain in a specified market index.
• investments and related investment income not specifically allocated to our product segments;
• accident and health insurance products, primarily a closed block of group policies;
Amounts are net of adjustments, as applicable, to amortization of unearned revenue reserves, deferred policy acquisition costs, deferred sales inducements, value of insurance in force acquired and income taxes attributable to gains and losses on investments.
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 analyzed net of any transactions between the segments. Operating income (loss) represents net income excluding the impact of realized gains and losses on investments. The impact of realized gains and losses on investments includes adjustments for income taxes and that portion of amortization of deferred policy acquisition costs, deferred sales inducements, unearned revenue reserve and value of insurance in force acquired attributable to such gains or losses.
Depreciation and amortization related to property, plant 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 $5.8 million for 2004, $5.7 million for 2003 and $5.0 million for 2002 relating to leases with affiliates. In the consolidated statements of income, we record these depreciation amounts net of related lease income from affiliates.
Net statutory premiums collected, which include premiums collected from annuities and universal life-type products that are not included in revenues for GAAP reporting, totaled $1,223.7 million in 2004, $1,177.7 million in 2003 and $1,342.4 million in 2002. Excluding the Independent Annuity Segment, our total life and annuity collected premiums are concentrated in the following states: Iowa (2004 - 28%, 2003 - 29%, 2002 - 28%), Kansas (2004 - 20%, 2003 - 20%, 2002 - 24%) and Oklahoma (2004 - 8%, 2003 - 9%, 2002 - 8%). For the Independent Annuity Segment, excluding reinsurance assumed, our annuity collected premiums in 2004 are concentrated in the following states: Florida (13%), California (11%) and Michigan (11%).