The Company owns three buildings in Los Angeles, six regional offices, seven business support centers and 1 commercial claims center in which its administrative operations are conducted. In addition, the Company owns a building in Washington in which the operations of FNWL 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, 1997, and the consolidated balance sheet data of the Company as of December 31, 1997 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 the acquisition of the Company by B.A.T in December 1988. See Note A to the Company's Consolidated Financial Statements. Major items incorporated in the purchase price of the Company include goodwill and the value of the AIF contracts of the P&C Group. 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 1993 through 1997.
- ---------------------------- (1) Net income reflects the charge resulting from expensing the transition obligation upon the implementation of SFAS No. 112, "Employers' Accounting for Postemployment Benefits". Such amounts were $4.5 million and $0.2 million, after tax, for Management services to property and casualty insurance companies; and other and the Life Insurance Subsidiaries, respectively, for the year ended December 31, 1994. (2) Includes cash, short-term investments and notes receivable-affiliate. (3) The ratio of earnings to fixed charges has been determined by dividing the sum of net income before income taxes plus fixed charges by fixed charges. Fixed charges consist of interest, capitalized interest, dividends paid to QUIPS holders, amortization of QUIPS offering expenses and that portion of rent expenses deemed to be interest.
Operating Revenues. Operating revenues increased from $1,245.4 million in 1996 to $1,324.9 million in 1997, an increase of $79.5 million, or 6.4%. Operating revenues primarily consist of management fees paid to the Company as a percentage of gross premiums earned by the P&C Group. Such premiums increased from $9,458.2 million in 1996 to $10,070.1 million in 1997 due primarily to higher average premium levels for the Auto and Fire lines of business and an increase in the number of policies-in-force between years reflecting stricter enforcement of the California mandatory auto insurance law following enactment of California Assembly Bill 650 and the P&C Group's re-entry into the California homeowners' market. Partially offsetting these increases is the fact that, in recognition of expense savings realized as a result of improved operating efficiencies, the Company waived an additional 0.43% from the Farmers Preferred Auto Management fee rate that was in effect prior to November 1, 1996. This rate waiver resulted in a $22.3 million reduction in management fees in 1997 from what such fees would have been using the rates in effect during 1996.
Salaries and Employee Benefits. Salaries and employee benefits decreased from $337.2 million in 1996 to $335.8 million in 1997, a decrease of $1.4 million, or 0.4%, primarily due to a reduction in employee complement.
General and Administrative Expenses. General and administrative expenses increased from $170.3 million in 1996 to $202.6 million in 1997, an increase of $32.3 million, or 19.0%. This increase was primarily due to higher expenses attributable to increased business levels and the re-entry of the P&C Group into the California homeowners' market. Also contributing to the increase in expense was a $4.6 million increase in costs associated with the modification of existing computer program logic to accommodate years 2000 and beyond (Year 2000 Project).
Net Realized Gains. Net realized gains increased from $5.1 million in 1996 to $73.4 million in 1997, an increase of $68.3 million, due primarily to gains realized on equities formerly held by FNWL that were sold while restructuring the portfolio.
Gain on Sale of Subsidiaries. The estimated gain on the April 15, 1997 sale of OSL and IGL amounted to $19.0 million in 1997.
Provision for Income Taxes. Provision for income taxes increased from $275.1 million in 1996 to $332.2 million in 1997, an increase of $57.1 million, or 20.8%. This increase was due to the increase in pretax income between years and an estimated $26.8 million of taxes associated with the sale of OSL and IGL.
Management Services Income. As a result of the foregoing, management services income increased from $348.5 million for the year ended December 31, 1996 to $450.2 million for the year ended December 31, 1997, an increase of $101.7 million, or 29.2%.
On April 15, 1997, OSL and IGL were sold to Great Southern Life Insurance Company, a subsidiary of Americo Life, Inc.. OSL and IGL contributed $5.5 million to net income in 1997, compared to $17.2 million in 1996 and $11.6 million in 1995. The following commentary addresses the results of the Company's remaining life insurance subsidiary, FNWL.
Policy Charges. Policy charges increased $12.5 million, or 6.6%, over 1996, reflecting a 4.2% growth in universal life-type insurance in- force.
Commissions. Commissions decreased from $18.3 million in 1996 to $17.3 million in 1997, or 5.5%. The decrease results from the commutation, by IGL in the third quarter of 1997, of the block of business ceded to FNWL under the Yearly Renewable Term reinsurance treaty.
General and Administrative Expenses. General and administrative expenses increased from $60.9 million in 1996 to $61.5 million in 1997, or 1.0%, due primarily to higher legal and
Provision for Income Taxes. Provision for income taxes increased from $71.1 million in 1996 to $73.8 million in 1997, an increase of $2.7 million, due to a decrease in tax preference items, particularly tax exempt interest.
FNWL Income. As a result of the foregoing, FNWL income decreased from $142.3 million in 1996 to $137.8 million in 1997, a decrease of $4.5 million, or 3.2%.
Total Operating Expenses. Total operating expenses as a percentage of operating revenues decreased from 58.9% in 1995 to 56.0% in 1996, a decrease of 2.9%. Specifically, labor costs (salaries and employee benefits) decreased from 29.5% of operating revenues for the year ended December 31, 1995 to 27.1% of operating revenues for the year ended December 31, 1996.
Buildings and Equipment Expenses. Buildings and equipment expenses increased from $75.1 million in 1995 to $87.3 million in 1996, an increase of $12.2 million, or 16.2%. This increase was primarily due to the amortization of new information technology systems software, offset in part by a decrease in computer mainframe related expenses.
General and Administrative Expenses. General and administrative expenses decreased $0.2 million between years, from $170.5 million in 1995 to $170.3 million in 1996.
Management Services Income. As a result of the foregoing, management services income increased from $330.8 million for the year ended December 31, 1995 to $348.5 million for the year ended December 31, 1996, an increase of $17.7 million, or 5.4%.
Total Revenues. Total revenues increased from $558.4 million in 1995 to $613.3 million in 1996, an increase of $54.9 million, or 9.8%.
Policy charges. Policy charges increased $18.5 million, or 10.9%, over 1995, reflecting an 8.5% growth in universal life-type insurance-in-force.
Net realized gains. Net realized gains increased by $6.9 million in 1996 due primarily to gains realized on common stock as a result of favorable market conditions.
Commissions. Commissions increased from $17.7 million in 1995 to $18.3 million in 1996, reflecting increased renewal premiums from traditional and universal life products.
Provision for Income Taxes. Provision for income taxes increased from $60.2 million in 1995 to $71.1 million in 1996, an increase of $10.9 million. This increase was attributable to the increase in pretax operating income.
FNWL Income. As a result of the foregoing, FNWL income increased from $128.3 million in 1995 to $142.3 million in 1996, an increase of $14.0 million, or 10.9%.
The principal sources of funds available to the Company are (i) the management fees that it receives for managing the P&C Group, (ii) investment income and (iii) dividends from its subsidiaries. Historically, funds available from the first two of these sources have been sufficient to satisfy the liquidity needs of the Company, and the Company anticipates that such funds will continue to be adequate to satisfy such needs in the future. A portion of the net income of FNWL is available for payment as a dividend to the Company, subject to certain limitations imposed by the insurance laws of the State of Washington and additional state taxation. As of December 31, 1997, an aggregate of $122.7 million was available for distribution as a dividend without approval of the state insurance department (see Note G). Additionally, as of December 31, 1997, the Company had available revolving credit facilities enabling it to borrow up to $500.0 million in the event such a need should arise (see Note T).
In order to maintain the policyholders' surplus of the Exchanges, the Company has purchased approximately $850.0 million of surplus certificates of the Exchanges ($400.0 million of which were purchased in 1996, $250.0 million of which were purchased in 1995 and $200.0
Net cash provided by operating activities decreased from $688.7 million in 1996 to $655.4 million in 1997, a decrease in cash of $33.3 million, or 4.8%. This decrease in cash was principally due to a $34.9 million decrease in Universal life type contracts as a result of a reduction in new life business due to the sale of OSL and IGL. In addition, cash decreased $89.1 million due to an increase in non-current assets. The above decreases in cash were partially offset by a $85.6 million increase in consolidated net income.
Independent Auditors' Report 24 Consolidated Financial Statements of Farmers Group, Inc. and Subsidiaries Consolidated Balance Sheets as of December 31, 1997 and 1996 25 Consolidated Statements of Income for the years ended December 31, 1997, 1996 and 1995 27 Consolidated Statements of Stockholder's Equity for the years ended December 31, 1997, 1996 and 1995 28 Consolidated Statements of Cash Flows for the years ended December 31, 1997, 1996 and 1995 29 Notes to Consolidated Financial Statements 30 Quarterly Financial Data (Unaudited) 58
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 1997 and 1996, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1997 in conformity with generally accepted accounting principles. Also, in our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly in all material respects the information set forth therein.
FARMERS GROUP, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (Amounts in thousands) LIABILITIES AND STOCKHOLDER'S EQUITY
FARMERS GROUP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDER'S EQUITY Years ended December 31, 1997, 1996 and 1995 (Amounts in thousands)
On April 15, 1997, upon receipt of regulatory approval, the Company sold OSL and IGL. The sale of these subsidiaries resulted in an estimated $19,019,000 gain and was reported on the "Gain on sale of subsidiaries" line of the income statement. In addition, taxes associated with the sale increased current year tax expense by an estimated $26,826,000 and were reflected on the "Provision for income taxes" line. Both of these amounts were reflected in the "Management services to property and casualty insurance companies; and other" section of the Company's consolidated income statement for the year ended December 31, 1997. The decision to sell these subsidiaries was part of the Company's strategic plan to focus its life insurance efforts on the growth of FNWL, by far its largest insurance company, through increased sales to the P&C Group's customer base. FNWL markets a broad line of individual life insurance products, including universal life, term life and whole life insurance, and annuity products, predominately flexible premium deferred annuities. These products and services are sold directly by the Exchanges' agents.
A $250,000,000 certificate of contribution, issued in 1995, bearing interest at 8.95% annually.
E. Company Obligated Mandatorily Redeemable Preferred Securities of Subsidiary Trusts Holding Solely Junior Subordinate Debentures
As of December 31, 1997 and 1996, a total of 20,000,000 shares of QUIPS were outstanding.
Combined statutory capital and surplus of the Life Insurance Subsidiaries was $894,738,000 as of December 31, 1996 and combined statutory net income was $167,517,000 and $116,998,000 for the years ended December 31, 1996, and 1995, respectively. Due to the sale of OSL and IGL on April 15, 1997, statutory capital and surplus as of December 31, 1997 reflects only the results of the Company's remaining life insurance subsidiary, FNWL. However, statutory net income for the year ended December 31, 1997, reflects the results of FNWL for the year and the results of OSL and IGL through the date of sale. As a result, statutory capital and surplus of FNWL was $817,588,000, and statutory net income of the Life Insurance Subsidiaries was $122,863,000 for the year.
investment gains or losses from securities classified as available-for-sale actually been realized, with corresponding credits or charges reported directly to stockholder's equity.
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 FNWL in 1997 and the Life Insurance Subsidiaries in 1996 are as follows:
The amortized cost and estimated market value of debt securities, including marketable securities, owned by the Company (excluding FNWL) as of December 31, 1997, 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 FNWL as of December 31, 1997, 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.
Proceeds from sales of available-for-sale securities received by the Company were $735,192,000 and $551,122,000 during 1997 and 1996, respectively. Gross gains of $100,269,000 and $76,431,000 and gross losses of $21,274,000 and $32,009,000 were realized on sales and writedowns during 1997 and 1996, respectively.
Proceeds from sales and maturities of available-for-sale securities received by the Company were $541,376,000 during 1995. Gross gains of $45,944,000 and gross losses of $13,371,000 were realized on sales and writedowns during 1995.
The change in the net unrealized gains or losses of FNWL in 1997 and the Life Insurance Subsidiaries in 1996 are as follows:
The cash requirement of the call options consists of the initial premium paid to purchase the index options. Should a liability exist to the annuity participant at maturity of the annuity policy, the termination or maturity of the option contracts will generate positive cash flow to FNWL. The appropriate amount of cash will then be remitted to the annuity participant based on the respective
There are certain risks associated with the index call options, primarily with respect to significant movements in the United States stock market and counterparty nonperformance. The Company believes that the counterparties to its call option agreements are financially responsible and that the counterparty risk associated with these transactions is minimal.
The estimated fair values of financial instruments disclosed have been determined using available market information and appropriate valuation methodologies. However, considerable judgment is required to interpret market data to develop the estimates of fair value. Accordingly, the estimates presented may not be indicative of the amounts the Company could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies could have a significant effect on the estimated fair value amounts.
The following methods and assumptions were used to estimate the fair value of financial instruments as of December 31, 1997 and 1996:
Cash and cash equivalents and short-term marketable securities The carrying amounts of these items are a reasonable estimate of their fair values.
Fixed maturities, non-redeemable preferred stocks and common stocks The estimated fair values of bonds, redeemable and non-redeemable preferred stocks and common stocks are based upon quoted market prices, dealer quotes, and prices obtained from independent pricing services.
Mortgage loans The estimated fair value of the mortgage loans portfolio is determined by discounting the estimated future cash flows, using a year-end market rate which is applicable to the yield, credit quality and average maturity of the composite portfolio. 	 Certificates in surplus of Exchanges The carrying amounts of these certificates are a reasonable estimate of their fair values.
Assets held in separate account and liabilities related to separate account The carrying values are a reasonable estimate of their fair values since assets and liabilities of separate accounts are carried at market value. 	 Real estate mortgages payable The estimated fair values are determined by discounting the estimated future cash flows at a rate which approximates the Company's incremental borrowing rate.
Company obligated mandatorily redeemable preferred securities of subsidiary trusts holding solely junior subordinated debentures The estimated fair values are based on quoted market prices.
Future policy benefits-deferred annuities The estimated fair values of flexible premium and single premium deferred annuities are based on their cash surrender values.
The Company has a security lending agreement with a financial institution. The agreement in effect as of December 31, 1997 authorizes the institution to lend securities held in the Company's portfolio to a list of authorized borrowers. Concurrent with delivery of the securities, the borrower provides the Company with cash collateral equal to at least 102% of the market value of domestic securities and 105% of the market value of other securities subject to the "loan."
The securities are marked-to-market on a daily basis and the collateral is adjusted on the next business day. The collateral is invested in highly liquid, fixed income assets with a duration of less than one year. Income earned from the security lending arrangement was allocated 60% to the Company and 40% to the lending agent. Income earned by the Company was approximately $856,000 in 1997. As of December 31, 1997, the collateral under the agreement was $594,488,000.
Upon 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, 1997 and 1996 was $24,304,000 and $29,252,000, respectively.
The interest rate used in the above benefit computations was 7.25% in 1997, 1996 and 1995. Beginning in 1995, the initial medical inflation rate was 8.00%, to be graded over a 4-year period to 6.00% and level thereafter, and contribution levels from retirees were the same as applicable medical cost increases where defined benefits exist. The rate of increase in future compensation levels used in determining the actuarial present value of the accumulated benefit obligation was 5.00% in 1997 and 1996 and 4.50% in 1995. A 1.00% increase in the medical inflation rate assumption would have resulted in an approximate increase of $1,179,000 in 1997 and $1,231,000 in 1996 in the accumulated benefit obligation for the Company.
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, 1997, the remaining commitments payable over the next five years under these leases are:
The Company is a party to numerous lawsuits arising from its normal business activities. These actions are in various stages of discovery and development, and some seek punitive as well as compensatory damages. In the opinion of management, the Company has not engaged in any conduct which should warrant the award of any material punitive or compensatory damages. The Company intends to vigorously defend its position in each case, and management believes that, while it is not possible to predict the outcome of such matters with absolute certainty, ultimate disposition of these proceedings should not have a material adverse effect on the Company's consolidated results of operations or financial position.
The Company follows the provisions of SFAS No. 109, "Accounting for Income Taxes". Deferred tax assets and deferred tax liabilities are recorded to reflect the tax consequences in future years of differences between the tax bases of assets and liabilities and the corresponding bases used for financial statements. On April 15, 1997, OSL and IGL were sold pursuant to Internal Revenue Code Section 338(h)(10). Federal and state taxes incurred as a result of this transaction amounted to an estimated $26,826,000.
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities as of December 31, 1997 and 1996 are presented in the following tables:
In 1997, net cash proceeds from the sale of OSL and IGL amounted to an estimated $336,714,000 and were in consideration primarily for the following:
Also in 1997, the change in the Separate Accounts assets and liabilities netted to $0 and was reflected in the Statements of Cash Flows (see Note V).
In July 1996, the Company used $200,000,000 of proceeds it received from the Exchanges in connection with the repayment of the 1986 surplus contribution (see Note D) to extinguish the $200,000,000 of 8.25% Notes Payable the Company issued in July 1986.
As attorney-in-fact, the Company, or its subsidiaries, as applicable, manages the affairs of the P&C Group and receives management fees for the services rendered to the Exchanges. As a result, the Company received management fees from the Exchanges of $1,241,153,000, $1,167,704,000 and $1,109,425,000 in 1997, 1996, and 1995, respectively.
Certain directors of the Company are partners in legal firms that received fees for legal services from the Company and the Exchanges. These fees totaled $5,208,000, $1,853,000 and $2,231,000 in 1997, 1996 and 1995, respectively.
On October 7, 1996, a three year $135,000,000 note with an interest rate of 4.76% matured and the $135,000,000 note, maturing in October 1999, was subsequently issued at an interest rate of 6.68%.
The assets and liabilities held in Separate Accounts as of December 31, 1996 related to the pension plan for the employees of the Company and the Exchanges. The assets were held primarily in fixed maturity and equity investments, while the principal liability was for annuity benefit payments under the pension plan. A review of the trust agreement with Chase Manhattan Bank, the trustee for the pension plan, led to the conclusion that Separate Account treatment was no longer required. Therefore, FNWL excluded the pension plan assets and liabilities from Separate Accounts as of November 30, 1997.
Participating business, primarily group insurance, comprised approximately 8.8% of FNWL's total insurance-in-force as of December 31, 1997 and 7.5% of the Life Insurance Subsidiaries' total insurance-in-force as of December 31, 1996. In addition, participating business represented 2.2% of FNWL's premium income for the year ended December 31, 1997, and 2.2% of the Life Insurance Subsidiaries' premium income for the years ended December 31, 1996 and 1995. 	 X. Life reinsurance
Premiums ceded to non-affiliates totaled $3,868,000 and $3,577,000 for the years ended December 31, 1996 and 1995, respectively. Reinsurance receivables, which totaled $10,621,000 as of December 31, 1996, were included in Other Assets of Life Insurance Subsidiaries.
Operating profit is comprised of total revenues less operating expenses. Accordingly, investment income and realized gains on securities and real estate investment income earned as a result of the management services to the P&C Group have not been added, and general corporate expenses and income taxes have not been deducted. The Management Services to the P&C Group segment incurred depreciation expense of $51,579,000, $40,096,000, and $28,023,000 in 1997, 1996 and 1995, respectively, while depreciation for the Life Insurance Subsidiaries was $2,838,000 in 1997, $3,108,000 in 1996 and $3,699,000 in 1995. Capital expenditures for the Management Services to the P&C Group totaled $41,732,000, $51,605,000 and $55,811,000 in 1997, 1996 and 1995, respectively, while capital expenditures for the Life Insurance Subsidiaries were $1,696,000 in 1997, $132,000 in 1996 and $301,000 in 1995. The Other industry category includes certain subsidiary companies engaged in real estate investment and leasing activities. These companies incurred depreciation expenses of $18,634,000, $20,202,000 and $17,270,000 in 1997, 1996 and 1995, respectively. Capital expenditures within the Other industry category were $22,802,000 in 1997, $24,074,000 in 1996 and $17,493,000 in 1995.
Identifiable assets by industry are those assets used in the Company's operations within each industry. Corporate assets are principally marketable securities owned by the Company and its non-life subsidiaries and amounts invested by the Company in joint ventures.