Our principal operations are conducted from property leased from a subsidiary of the Iowa Farm Bureau Federation under a 15 year operating lease which 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 22,000 square feet of an office building in Manhattan, Kansas under an operating lease that expires in 2006. We consider the current facilities to be adequate for the foreseeable future.
(1) Amounts for 2001 are impacted by the acquisition of Kansas Farm Bureau Life Insurance Company, Inc. effective January 1, 2001 and coinsurance transactions with National Travelers Life Insurance Company and American Equity Investment Life Insurance Company during 2001. (2) Operating income equals net income adjusted to eliminate certain items which we believe are not indicative of operating trends because they are unusual and/or nonrecurring in nature, including the impact of realized gains (losses) on investments, gain on sale of discontinued operations and cumulative effect of change in accounting for derivative instruments. (3) Statutory data has been derived from the annual statements of our insurance subsidiaries, as filed with insurance regulatory authorities and prepared in accordance with statutory accounting practices. (4) Net statutory premiums include premiums collected from annuities and universal life-type products. For GAAP reporting, such premiums received are not reported as revenues. Amounts include internal rollover premiums to variable universal life or variable annuity contracts totaling $10.2 million in 2001, $25.0 million in 2000, $17.1 million in 1999, $29.5 million in 1998 and $14.1 million in 1997.
THE FOLLOWING SECTIONS INCLUDE A SUMMARY OF FBL FINANCIAL GROUP, INC.'S CONSOLIDATED RESULTS OF OPERATIONS, FINANCIAL CONDITION AND WHERE APPROPRIATE, FACTORS THAT MANAGEMENT BELIEVES MAY AFFECT FUTURE PERFORMANCE. PLEASE READ THIS DISCUSSION IN CONJUNCTION WITH THE ACCOMPANYING CONSOLIDATED FINANCIAL STATEMENTS AND RELATED NOTES. UNLESS NOTED OTHERWISE, ALL REFERENCES TO FBL FINANCIAL GROUP, INC. (WE OR THE COMPANY) INCLUDE ALL OF ITS DIRECT AND INDIRECT SUBSIDIARIES, INCLUDING ITS PRIMARY LIFE INSURANCE SUBSIDIARIES, FARM BUREAU LIFE INSURANCE COMPANY (FARM BUREAU LIFE) AND EQUITRUST LIFE INSURANCE COMPANY (EQUITRUST) (COLLECTIVELY, THE LIFE COMPANIES).
We use both net income and operating income to measure our performance. Operating income represents net income excluding the impact of realized gains and losses on investments, cumulative effect of change in accounting principle and discontinued operations. The impact of realized gains and losses on investments includes adjustments for income taxes and that portion of amortization of deferred policy acquisition costs, unearned revenue reserve and value of insurance in force acquired attributable to such gains. While operating income is commonly used in the insurance industry as a measure of on-going earnings performance, it is not a substitute for net income determined in accordance with accounting principles generally accepted in the United States (GAAP).
In accordance with GAAP, premiums and considerations received for interest sensitive products such as universal life insurance and ordinary annuities are reflected as increases in liabilities for policyholder account balances and not as revenues. Revenues reported for interest sensitive products consist of policy charges for the cost of insurance, administration charges, amortization of policy initiation fees and surrender charges assessed against policyholder account balances. Surrender benefits paid relating to these products are reflected as decreases in liabilities for policyholder account balances and not as expenses. The Life Companies receive investment income earned from the funds deposited into account balances, a portion of which is passed through to the policyholders in the form of interest credited. Amounts for interest credited to policyholder account balances and benefit claims in excess of policyholder account balances are reported as expenses in the consolidated financial statements.
The costs related to acquiring new business, including certain costs of issuing policies and other variable selling expenses (principally commissions), defined as deferred policy acquisition costs, are capitalized and amortized into expense. For nonparticipating traditional life and accident and health insurance products, these costs are amortized over the premium paying period of the related policies, in proportion to the ratio of annual premium revenues to total anticipated premium revenues. Such anticipated premium revenues are estimated using the same assumptions used for computing liabilities for future policy
benefits and are generally "locked in" at the date the policies are issued. For participating traditional life insurance and interest sensitive products, these costs are amortized generally in proportion to expected gross profits from surrender charges and investment, mortality and expense margins. This amortization is adjusted when the Life Companies revise their estimate of current or future gross profits or margins. For example, deferred policy acquisition costs are amortized earlier than originally estimated when policy terminations are higher than originally estimated or when investments backing the related policyholder liabilities are sold at a gain prior to their anticipated maturity.
The preparation of financial statements in conformity with 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 following areas:
When the value of a security declines and the decline is determined to be other than temporary, the carrying value of the investment is reduced to its fair value and a realized loss is recorded to the extent of the decline. In determining if and when a decline in market value below amortized cost is other-than-temporary for our investments in fixed maturity and equity securities, our investment professionals evaluate the operating results of the underlying issuer, general market conditions, causes for the decline in value, the length of time there has been a decline in value and other key economic measures. Considerable judgement is used in this evaluation process. While we believe we record other than temporary impairments on a timely basis, our key assumptions used in not writing down a particular security may prove to be wrong with the passage of time. The evaluation of securities that have a decline in fair value below amortized cost is an ongoing process and we continue to challenge the assumptions and inputs used in the evaluation process.
Deferred policy acquisition costs totaled $360.2 million at December 31, 2001. Of this total, approximately 89.2%, or $321.3 million, relates to participating traditional life or interest sensitive products and 10.8%, or $38.9 million, relates to nonparticipating traditional life insurance products. Calculation of the amortization of deferred policy acquisition costs for participating life insurance and interest sensitive products involves significant judgement. As described above, amortization of these costs is dependent upon estimates of current and future gross profits or margins on this business. For nonparticipating traditional life insurance products, amortization is more straightforward as these costs are amortized over the premium paying period of the related policies, in proportion to the ratio of annual premium revenues to total anticipated premium revenues.
At the end of each year, we determine the discount rate to be used to discount plan liabilities. The discount rate reflects the current rate at which the pension liabilities could be effectively settled at the end of the year. In estimating this rate, we look to rates of return on high quality, fixed-income investments. At December 31, 2001, we determined this rate to be 7.25%. Changes in discount rates over the past three years have not materially affected pension expense, and the net effect of changes in the discount rate, as well as the net effect of other changes in actuarial assumptions and experience, have been deferred as allowed by Statement No. 87.
Effective May 1, 2001, we entered into a coinsurance agreement with NTL whereby we assumed 90% of NTL's traditional life, universal life and annuity business in force. In addition, we agreed to assume 50% of NTL's traditional life, universal life and annuity business issued subsequent to May 1, 2001. Assets acquired on May 1, 2001 in connection with this transaction totaled $337.2 million. Collected premiums assumed during 2001 as a result of the NTL agreement totaled $13.3 million.
Revenues and expenses for 2001 increased compared to 2000 and 1999 as a result of the American Equity, NTL and Kansas Farm Bureau Life transactions. Operating income increased approximately $3.9 million, or $0.14 per common share, during the year ended December 31, 2001 as a result of this new business. See Notes 2 and 5 of the notes to consolidated financial statements for additional information regarding these transactions.
Consistent with our objective to exit the disability income line of business, effective September 1, 2001, we entered into a 100% coinsurance agreement to reinsure the individual disability income business acquired through the Kansas Farm Bureau Life transaction. As a result, the consolidated statements of income include the operating results from this accident and health business only through August 31, 2001. Effective September 1, 2000, we entered into a 100% coinsurance agreement to reinsure the individual disability income business on our books at that time. As a result, the consolidated statements of income include the operating results from this business only through August 31, 2000. A loss totaling $1.5 million on these coinsurance transactions has been deferred and is being recognized over the term of the underlying policies.
RESULTS OF OPERATIONS FOR THE THREE YEARS ENDED DECEMBER 31, 2001
The change in earnings per common share from year to year is positively impacted by a decrease in the weighted average common shares outstanding during the three-year period ended December 31, 2001. Weighted average common shares outstanding, assuming dilution, decreased 9.5% in 2001 to 27,867,140 and 6.2% in 2000 to 30,799,891. These decreases are the result of acquisitions of common stock by the Company, primarily in 2000 and 1999.
NET INVESTMENT INCOME, which excludes investment income on separate account assets relating to variable products, increased 28.8% in 2001 to $285.1 million and decreased 2.0% in 2000 to $221.4 million. The increase in 2001 is due to an increase in average invested assets and an increase in fee income from mortgage loan prepayments and bond calls. Average invested assets (based on securities at amortized cost) totaled $3,850.2 million in 2001, $2,991.3 million in 2000 and $2,982.1 million in 1999. Average invested assets increased in 2001 due primarily to the acquisition of approximately $620.9 million in investments in connection with the Kansas Farm Bureau Life transaction, $299.3 million in investments in connection with the NTL transaction and $347.7 million in cash from the American Equity transaction. The annualized yield earned on average invested assets was 7.40% in 2001 and 2000 and 7.57% in 1999. Changing market conditions in 2001 and 2000 decreased our investment portfolio yield as investment rates were, in general, lower than our portfolio yield or yield on investments maturing or being paid down. However, in 2001 an increase in prepayment fees and bond call income offset the impact of these market conditions. Fee income from mortgage loan prepayments and bond calls totaled $4.8 million in 2001, $0.4 million in 2000 and $5.2 million in 1999. In addition, we recorded $1.7 million in interest income during 1999 relating to the settlement of a fixed maturity security that had been in default. We had discontinued the accrual of interest on this security during 1996.
REALIZED LOSSES ON INVESTMENTS decreased to $15.9 million in 2001 and increased to $26.0 million in 2000. Realized losses include writedowns of investments that became other-than-temporarily impaired totaling $16.8 million in 2001, $24.5 million in 2000 and $7.2 million in 1999. These writedowns are the result of deteriorating operating trends, lowered debt ratings, defaults on loan payments, unsuccessful efforts to raise capital and various other operational or economic factors that became evident in the respective years. Approximately $8.4 million of the realized losses in 2001 were from four securities issued by or affiliated with Enron Corporation. Approximately $14.4 million of the realized losses in 2000 were from eight securities that were of investment grade when acquired. The level of realized gains (losses) is subject to fluctuation from year to year depending on the prevailing interest rate and economic environment and the timing of the sale of investments.
POLICY BENEFITS increased 30.6% in 2001 to $303.0 million and 2.6% in 2000 to $231.9 million. The increase in 2001 is due primarily to the addition of the Kansas Farm Bureau Life, NTL and American Equity business. Benefits incurred from this business in 2001 included interest sensitive product benefits of $41.0 million, traditional life insurance and accident and health benefits, including change in reserves, of $29.9 million and distributions to participating policyholders of $4.2 million. The increase in traditional life benefits is also due to increased death benefits on our direct business and our participation in a reinsurance pool for catastrophic events. We accrued $1.6 million of death benefits in 2001 for anticipated losses from this pool resulting from the terrorist attacks on September 11, 2001. Partially offsetting these increases was a decrease in accident and health benefits as a result of the 100% coinsurance of our long-term disability income business during 2001 and 2000. Policy benefits can tend to fluctuate from period to period as a result of changes in mortality and morbidity experience.
INCOME TAXES increased 36.6% in 2001 to $18.6 million and decreased 47.5% in 2000 to $13.6 million. The effective tax rate was 29.2% for 2001, 30.3% for 2000 and 31.9% for 1999. The effective tax rates were lower than the federal statutory rate of 35% due primarily to the tax benefit associated with the payment of dividends on mandatorily redeemable preferred stock of subsidiary trust, tax-exempt interest and tax-exempt dividend income in 2001, 2000 and 1999. The impact of these permanent differences, which are relatively consistent from year to year, on the effective tax rate is more significant in 2000 compared to 1999 due to the decrease in pre-tax income. The decrease in the effective tax rate in 2001 compared to 2000 is due primarily to a change in the estimate of certain deferred tax liabilities.
Prior to January 1, 2001, our life insurance segment was our only reportable operating segment. The life insurance segment included activities related to the sale of life insurance, annuities and accident and health insurance products. Operations were aggregated into the same segment due to the similarity of the products, including the underlying economic characteristics, the method of distribution and the regulatory environment. During the first quarter of 2001, a financial reporting project to refine our line of business detail was completed. With the availability of more detailed line of business information, management now utilizes financial information regarding products that are aggregated into three product segments. These product segments are (1) traditional annuity, (2) traditional and universal life insurance and (3) variable. We also have various support operations and corporate capital that is aggregated into a corporate and other segment. See Note 15 of the notes to consolidated financial statements for additional information regarding segment information.
Pre-tax operating income for the traditional annuity segment increased 30.0% in 2001 to $20.5 million and decreased 16.1% in 2000 to $15.8 million. Pre-tax operating income and the volume of business in force increased in 2001 primarily due to the addition of the Kansas Farm Bureau Life, NTL and American Equity business. Annuity premiums collected from this new business in 2001 totaled $330.4 million. The decrease in pre-tax operating income in 2000 compared to 1999 is due to a decrease in the spread between net investment income and interest credited. This decrease is a result of a decrease in the yield on investments and a 0.25% increase, due to competitive factors, in the crediting rate on our flexible premium deferred annuity in September 2000. The crediting rate on our flexible premium deferred annuity was reduced 0.25% in April 2001 and 0.15% in December 2001 as a result of the general decline in market interest rates during 2001.
Pre-tax operating income for the variable segment increased 349.1% to $5.5 million in 2001 and decreased 23.6% to $1.2 million in 2000. The increase in pre-tax operating income in 2001 is generally attributable to an increase in the volume of business in force, favorable mortality experience and a decrease in expenses. During 2001, amortization of deferred policy acquisition costs was reduced by $1.5 million due to changes in lapse rate, expense and other assumptions used to calculate the deferred policy acquisition cost asset. In addition, expenses were reduced by $1.0 million in 2001 as a result of the recovery of certain royalty fees as discussed above. Operating revenues increased 11.9% in 2001, due to growth in the volume of business in force. Death benefits in excess of related account values on variable universal life policies increased 9.9% to $6.0 million for 2001. Profitability of this line of business is expected to increase as the volume of business grows.
Pre-tax operating income (loss) for the corporate and other segment decreased 115.8% to ($3.5) million in 2001 and increased 42.2% to $21.9 million in 2000. The changes in pre-tax operating income are primarily due to the fluctuations in equity income as described above. The decrease in net investment income in 2001 is due to a decrease in average invested assets resulting from a smaller volume of accident and health business in force and a $75.0 million stock repurchase and tender offer during the fourth quarter of 2000. As noted above, we sold our long-term disability income business through two coinsurance agreements in 2000 and 2001. These agreements decreased the level of operations reflected in the corporate and other segment.
Our total investment portfolio increased 49.8% to $4,300.9 million at December 31, 2001 compared to $2,870.7 million at December 31, 2000. This increase is primarily the result of the acquisition of approximately $620.9 million in
investments in connection with the Kansas Farm Bureau Life transaction, $299.3 million in investments in connection with the NTL transaction and $347.7 million in cash from the American Equity transaction. In addition, we experienced unrealized appreciation on our fixed maturity securities and positive cash flow from operations. Furthermore, the carrying value of our investment portfolio increased as a result of the reclassification of our fixed maturity securities classified as held for investment to the available-for-sale category in connection with an accounting change for derivatives. See Note 1 to the notes to consolidated financial statements for additional information regarding this reclassification.
As of December 31, 2001, 94.6% (based on carrying value) of the fixed maturity securities were investment grade debt securities, defined as being in the highest two National Association of Insurance Commissioners (NAIC) designations. Non-investment grade debt securities generally provide higher yields and involve greater risks than investment grade debt securities because their issuers typically are more highly leveraged and more vulnerable to adverse economic conditions than investment grade issuers. In addition, the trading market for these securities is usually more limited than for investment grade debt securities. We regularly review the percentage of our portfolio that is invested in non-investment grade debt securities (NAIC designations 3 through 6). As of December 31, 2001, the investment in non-investment grade debt was 5.4% of fixed maturity securities. At that time no single non-investment grade holding exceeded 0.3% of total investments.
- ------------- (1) Private placement securities are generally rated by the Securities Valuation Office of the NAIC. Comparisons between NAIC designations and S & P ratings are published by the NAIC. S & P has not rated some of the fixed maturity securities in our portfolio.
The mortgage-backed portfolio includes pass-through and collateralized mortgage obligation (CMO) securities. With a pass-through security, we receive a pro rata share of principal payments as payments are made on the underlying mortgage loans. CMOs consist of pools of mortgages divided into sections or "tranches" which provide sequential retirement of the bonds. We invest in sequential tranches, which provide cash flow stability in that principal payments do not occur until the previous tranches are paid off. In addition, to provide call protection and more stable average lives, we invest in CMOs such as planned amortization class (PAC) and targeted amortization class (TAC) securities. CMOs of these types provide more predictable cash flows within a range of prepayment speeds by shifting the prepayment risks to support tranches. We do not purchase certain types of collateralized mortgage obligations that we believe would subject the investment portfolio to greater than average risk. These include, but are not limited to, interest only, principal only, floater, inverse floater, PAC II, Z and support tranches. However, in connection with the Kansas Farm Bureau Life acquisition, we did acquire Z securities with a carrying value of $32.5 million at December 31, 2001. These securities generally tend to have more duration risk (risk the security's price will change significantly with a given change in market interest rates) than the other types of mortgage-backed securities in our portfolio.
At December 31, 2001, we held $385.3 million or 9.0% of invested assets in mortgage loans. These mortgage loans are diversified as to property type, location and loan size, and are collateralized by the related properties. At December 31, 2001, mortgages more than 60 days delinquent accounted for less than 0.1% of the carrying value of the mortgage portfolio. Our mortgage lending policies establish limits on the amount that can be loaned to one borrower and require diversification by geographic location and collateral type. Regions with the largest concentration of our mortgage loan portfolio at December 31, 2001 include: Pacific (27.2%), which includes California; and West South Central (21.2%), which includes Oklahoma and Texas. Mortgage loans on real estate are also diversified by collateral type with office buildings (38.7%), retail facilities (34.6%) and industrial facilities (21.3%) representing the largest holdings at December 31, 2001.
Policy liabilities and accruals increased 56.3% to $4,185.9 million at December 31, 2001 primarily due to the addition of Kansas Farm Bureau Life, NTL and American Equity business. Policy related liabilities recorded at the inception of these transactions totaled $1,078.3 million. As noted under the "Investments" section above, the shift in sales to variable products will have an impact on the future growth rate of our policy liabilities and accruals as well as the separate account liabilities. Deferred income taxes increased 202.0% to $59.6 million at December 31, 2001 due primarily to an increase in deferred taxes on the change in unrealized appreciation/depreciation on fixed maturity securities and deferred taxes recorded in connection with the Kansas Farm Bureau Life acquisition. Other liabilities at December 31, 2001 include payables for security purchases totaling $163.1 million. At December 31, 2001, we had total liabilities of $4,883.6 million, a 56.0% increase from total liabilities at December 31, 2000.
Stockholders' equity increased 18.7%, to $565.8 million at December 31, 2001, compared to $476.8 million at December 31, 2000. This increase is principally attributable to net income for the year, the change in unrealized appreciation/depreciation on fixed maturity and equity securities and the effect of reclassifying our fixed maturity securities from held-for-investment to the available-for-sale category, 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 8.4 years at December 31, 2001 and 7.9 years at December 31, 2000. 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:
For a majority of our traditional insurance products, profitability is significantly affected by the spreads between interest yields on investments and rates credited on insurance liabilities. For variable and equity-indexed products, profitability on the portion of the policyholder's account balance invested in the fixed general account option, if any, is also affected by the spreads earned. For the variable products, the policyholder assumes essentially all the investment earnings risk for the portion of the account balance invested in the separate accounts. For the equity-indexed products, we purchase, indirectly through American Equity, call options that are designed to match the return owed to contract holders who elect to participate in one or more market indices. Profitability on the portion of the equity-indexed products tied to market indices is significantly impacted by the spread on interest earned on investments and the sum of (1) cost of underlying call options purchased to match the returns owed to contract holders and (2) minimum interest guarantees owed to the contract holder, if any. The minimum guaranteed contract values are equal to 80% to 100% of the premium collected plus interest credited at an annual rate of 3%. Profitability on the equity-indexed 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 we only purchase one-year call options, through American Equity, to fund the returns 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 equity-indexed annuities can fluctuate with changes in assumptions as to future volatility of the market indices, risk free interest rates, market returns and the lives of the contracts.
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 liabilities at December 31, 2001 and 2000. 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, 2001 and 2000, interest rate guarantees on our direct interest sensitive products ranged from 3.0% to 5.5%. The weighted average guarantee was 3.5% at December 31, 2001 and 3.7% at December 31, 2000.
For a substantial portion of business assumed from NTL and American Equity, NTL and American Equity, respectively, 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 do manage certain aspects of NTL through a management agreement and have a representative on American Equity's Board of Directors.
The following is a summary of the surrender and discretionary withdrawal characteristics of our interest sensitive products and supplementary contracts without life contingencies:
Equity price risk is not material to us due to the relatively small equity portfolio held at December 31, 2001. However, we do earn investment management fees (on those investments managed by us) and mortality and expense fee income based on the value of our separate accounts. On an annualized basis, the investment management fee rates range from 0.20% to 0.45% for 2001 and 2000. The mortality and expense fee rates range from 0.90% to 1.40% for 2001 and 2000. As a result, revenues from these sources do fluctuate with changes in the market value of the equity, fixed maturity and other securities held by the separate accounts.
We may receive consideration during the period ending December 31, 2003 in accordance with an earn-out provision related to our sale in 1998 of Utah Insurance to Farm Bureau Mutual. Under the earn-out arrangement, we and Farm Bureau Mutual share equally in the dollar amount by which the incurred losses on direct business written in the state of Utah, net of reinsurance ceded, is less than the incurred losses assumed in the valuation model used to derive the initial acquisition price. The earn-out calculation is performed and any settlement (subject to a maximum of $2.0 million per year) is made on a calendar year basis. Earn-out settlements received, on a pre-tax basis, totaled $2.0 million in 2000 and $1.2 million in 1999. We did not record any gain during 2001 as the loss ratio of Utah Insurance was higher than the threshold loss ratio in the earn-out calculation.
We paid common and preferred stock dividends totaling $12.5 million in 2001, $11.0 million in 2000 and $10.8 million in 1999. Interest payments on the parent company's 5% Subordinated Deferrable Interest Notes (the Notes), relating to the company-obligated mandatorily redeemable preferred stock of subsidiary trust, totaled $5.0 million in 2001, 2000 and 1999. It is anticipated that cash dividend requirements for 2002 will be $0.10 per quarter per common and Series C preferred share and $0.0075 per quarter per Series B preferred share, or approximately $12.5 million. In addition, interest payments on the Notes are estimated to be $5.0 million for 2002.
The ability of Farm Bureau Life to pay dividends to FBL Financial Group, Inc. is limited by law to earned profits (statutory unassigned surplus) as of the date the dividend is paid, as determined in accordance with accounting practices prescribed by insurance regulatory authorities of the State of Iowa. In addition, under the Iowa Insurance Holding Company Act, Farm Bureau Life may not pay an "extraordinary" dividend without prior notice to and approval by the Iowa insurance commissioner. An "extraordinary" dividend is defined under the Iowa Insurance Holding Company Act as any dividend or distribution of cash or other property whose fair market value, together with that of other dividends or distributions made within the preceding 12 months, exceeds the greater of (i) 10% of policyholders' surplus (total statutory capital stock and statutory surplus) as of December 31 of the preceding year, or (ii) the statutory net gain from operations of the insurer for the 12-month period ending December 31 of the preceding year. During 2002, the maximum amount legally available for distribution to FBL Financial Group, Inc. without further regulatory approval is $37.8 million.
We may from time to time review potential acquisition opportunities. It is anticipated that funding for any such acquisition would be provided from available cash resources, debt or equity financing. As of December 31, 2001, we had no material commitments for capital expenditures. The parent company had available cash and investments totaling $16.3 million at December 31, 2001.
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, 2001, included $32.9 million of short-term investments and $522.7 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. In addition, our cash balance at December 31, 2001 totaled $271.5 million.
The Audit Committee of the Board of Directors, composed solely of nonmanagement directors, meets periodically with management, internal auditors and Ernst & Young LLP to review internal accounting controls, audit activities, auditor independence and financial reporting matters. The internal auditors and Ernst & Young LLP have free access to the Audit Committee, with and without the presence of management, to discuss the adequacy of internal controls and to review the quality of financial reporting. The Audit Committee is also responsible for making recommendations to the Board of Directors concerning the selection of independent auditors.
As discussed in Note 1 to the consolidated financial statements, in 2001 the Company changed its method of accounting for derivative instruments.
FBL FINANCIAL GROUP, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED) (DOLLARS IN THOUSANDS)
These derivatives are described more fully in this note under the captions "Investments - Fixed Maturities and Equity Securities," "Reinsurance Recoverable" and "Future Policy Benefits."
The cumulative effect of adopting these Statements on net income was $0.3 million. This amount represents the difference in accumulated net unrealized capital gains (losses) on the date of adoption, net of tax, resulting from the change in accounting for the conversion features embedded in our convertible fixed maturity securities. Income before cumulative effect of change in accounting for derivative instruments for 2001 was approximately $0.6 million less than what would have been recorded without the accounting change due to a decrease in the fair value of these conversion features during the period. The impact of the accounting change on 2001 income relating to the equity-indexed annuity derivatives has not been quantified, but is not believed to be material to our financial position or results of operations.
Upon the adoption of Statement No. 133, we transferred our fixed maturity securities classified as held for investment to the available-for-sale category. In connection with this transfer, the securities were marked to market
In October 2001, the FASB issued Statement No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." Statement No. 144 provides a single accounting model for long lived assets to be disposed of and changes the criteria that must be met to classify an asset as held-for-sale. Statement No. 144 also requires expected future operating losses from discontinued operations to be displayed in discontinued operations in the period(s) in which losses are incurred rather than as of the measurement date as presently required. The Statement is effective for the year beginning January 1, 2002, with earlier adoption encouraged. While we have not quantified the impact of adopting this Statement, we believe the Statement will not have a material effect on our financial position or results of operations.
Mortgage loans on real estate are reported at cost adjusted for amortization of premiums and accrual of discounts. If we determine that the value of any mortgage loan is impaired (i.e., when it is probable we will be unable to collect all amounts due according to the contractual terms of the loan agreement), the carrying value of the mortgage loan is reduced to its fair value, which may be based upon the present value of expected future cash flows from the loan (discounted at the loan's effective interest rate), or the fair value of the underlying collateral. The carrying value of impaired loans is reduced by the establishment of a valuation allowance, changes to which are recognized as realized gains or losses on investments. Interest income on impaired loans is recorded on a cash basis.
Other long-term investments include investment deposits which are reported at cost and securities held by subsidiaries engaged in the broker-dealer industry. In accordance with accounting practices for the broker-dealer industry, marketable securities held by subsidiaries in this industry are valued at market value. The resulting difference between cost and market is included in the consolidated statements of income as net investment income. Realized gains and losses are also reported as a component of net investment income.
To the extent recoverable from future policy revenues and gross profits, certain costs of acquiring new insurance business, principally commissions and other expenses related to the production of new business, have been deferred. 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 accrues on the unamortized balance at a weighted average rate of 6.04%.
Goodwill represents the excess of the fair value of assets exchanged over the net assets acquired. Through December 31, 2001, goodwill was being amortized on a straight-line basis generally over a period of 20 years. The carrying value of goodwill was regularly reviewed for indicators of impairment in value, which in the view of management were other than temporary. If facts and circumstances suggested that goodwill was impaired, we assessed the fair value of the underlying business and would have reduced goodwill to an amount that resulted in the book value of the underlying business approximating fair value. We did not record any impairments in 2001, 2000 or 1999. See the "Accounting Changes" section in this note for a discussion of the accounting of goodwill subsequent to December 31, 2001.
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, amortization of deferred policy acquisition costs, valuation of allowances for deferred tax assets, 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.
Acquisition costs totaling $0.7 million have been deferred and included as a component of goodwill. Goodwill was being amortized during 2001 using the straight-line method and a 20-year amortization schedule. As discussed in Note 1 under "Accounting Changes," goodwill will not be amortized beginning in 2002.
The carrying value and estimated market value of our portfolio of fixed maturity securities at December 31, 2001, 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.
Net unrealized investment gains (losses) on equity securities and fixed maturity securities classified as available for sale and recorded directly to stockholders' equity were comprised of the following:
Income taxes include a credit of $5.6 million in 2001, $9.1 million in 2000 and $0.8 million in 1999 for the tax effect of realized losses.
Equity investees distributed to us equity securities with a fair value totaling $2.8 million in 2001 and $14.5 million in 2000. Also during 2000, we received an interest in ten real estate properties with a fair value of $5.0 million in satisfaction of a fixed maturity security that had been in default. These transactions were treated as noncash items for purposes of the statements of cash flow.
At December 31, 2001, affidavits of deposits covering investments with a carrying value totaling $4,030.0 million were on deposit with state agencies to meet regulatory requirements.
At December 31, 2001, we had committed to provide additional funding for mortgage loans on real estate aggregating $30.8 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, 2001 include real estate, fixed maturities, mortgage loans and other long-term investments totaling $6.7 million.
Statement No. 107, "Disclosures About Fair Value of Financial Instruments," requires disclosure of fair value information about financial instruments, whether or not recognized in the consolidated balance sheets, for which it is practicable to estimate value. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized
ASSETS HELD IN SEPARATE ACCOUNTS: Separate account assets are reported at estimated fair value in our consolidated balance sheets.
LIABILITIES RELATED TO SEPARATE ACCOUNTS: Separate account liabilities are estimated at cash surrender value, the cost we would incur to extinguish the liability.
COMPANY-OBLIGATED MANDATORILY REDEEMABLE PREFERRED STOCK OF SUBSIDIARY TRUST AND SERIES C REDEEMABLE PREFERRED STOCK: Fair values are estimated by discounting expected cash flows using interest rates currently being offered for similar securities.
In the normal course of business, we seek to limit our exposure to loss on any single insured and to recover a portion of benefits paid by ceding reinsurance to other insurance enterprises or reinsurers. Our reinsurance coverage for life insurance varies according to the age and risk classification of the insured with retention limits ranging up to $1.1 million of coverage per individual life. We do not use financial or surplus relief reinsurance. Life insurance in force ceded on a consolidated basis totaled $4,772.5 million (16.8% of direct life insurance in force) at December 31, 2001 and $2,059.0 million (9.1% of direct life insurance in force) at December 31, 2000.
In addition to the cession of risks in excess of specific retention limits, we also have reinsurance agreements with variable alliance partners to cede a specified percentage of risks associated with variable universal life and variable annuity contracts. Under these agreements, we pay the alliance partners their reinsurance percentage of charges and deductions collected on the reinsured polices. The alliance partners in return pay us their reinsurance percentage of benefits in excess of related account balances. In addition, the alliance partners pay us an expense allowance for certain new business, development and maintenance costs on the reinsured contracts.
Effective September 1, 2001, we entered into a 100% coinsurance agreement to reinsure our individual disability income business acquired in the Kansas Farm Bureau Life acquisition with an unaffiliated insurer. Effective September 1, 2000, we entered into a similar arrangement with the same insurer to reinsure our individual disability income business in force at that time. At September 1, 2001, the related accident and health reserves totaled $14.4 million, deferred policy acquisition costs totaled $0.7 million and value of insurance in force acquired totaled $3.1 million. At September 1, 2000, the related accident and health reserves totaled $43.6 million and deferred acquisition costs totaled $11.8 million. We settled these transactions by transferring cash and investments equal to the reserves on the business. In addition, we received cash totaling $3.0 million in 2001 and $11.1 million in 2000 as consideration for the transactions. A loss of $0.8 million in 2001 and $0.7 million in 2000 on the transactions has been deferred and is being recognized over the term of the underlying policies.
During 2001 we entered into a coinsurance agreement with American Equity whereby we assumed 70% of certain fixed and equity-indexed annuity business written by American Equity from August 1, 2001 to December 31, 2001. The agreement also provides for reinsuring 40% of certain new annuity business written by American Equity during 2002 and 2003. The reinsurance of the business written prior to October 1, 2001 is accounted for as the acquisition of an in force block of business on October 1, 2001. With the reinsurance of the in force block, we recorded cash and reinsurance recoverable totaling $120.4 million, deferred acquisition costs of $18.3 million and policy liabilities of $138.7 million.
Unpaid claims on accident and health policies (principally disability income products) include amounts for losses and related adjustment expense and are estimates of the ultimate net costs of all losses, reported and unreported.
Prior to 1984, a portion of Farm Bureau Life's current income was not subject to current income taxation, but was accumulated, for tax purposes, in a memorandum account designated as "policyholders' surplus account." The aggregate accumulation in this account at December 31, 2001 was $11.9 million. Should the policyholders' surplus account exceed the limitation prescribed by federal income tax law, or should distributions be made to the parent company in excess of $523.0 million, such excess would be subject to federal income taxes at rates then effective. Deferred income taxes of $4.2 million have not been provided on amounts included in this memorandum account.
Holders of the Class A common stock, Series B preferred stock and Series C preferred stock, vote together as a group. The Class B common stock votes as a separate class on all issues. The holders of the Class A common stock, Series B preferred stock and Series C preferred stock vote for the election of Class A Directors (three to five) and only holders of the Class B common stock vote for the election of Class B Directors (ten to twenty). Voting for the Directors is noncumulative. In addition, various ownership aspects of our Class B common stock are governed by a Class B Shareholder Agreement which results in the Iowa Farm Bureau Federation, which owns 63.0% of our voting stock as of December 31, 2001, maintaining control of the Company. Holders of Class A common stock and Class B common stock are entitled to share ratably on a share-for-share basis with respect to common stock dividends.
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 the amount equal to 50% of an employee's contributions up to 4% of the annual salary contributed by the employees. Beginning in 2002, we will 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. Related expense totaled $0.5 million in 2001, $0.4 million in 2000 and $0.3 million in 1999.
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. Furthermore, during a portion of 2001 we offered certain retiree health benefits to employees and retirees formerly employed by Kansas Farm Bureau Life. During 2001, we discontinued offering this benefit to active employees and wrote off the related liability. Postretirement benefit expense is allocated in a manner consistent with pension expense discussed above. Postretirement benefit expense (benefit) aggregated ($0.5) million in 2001, $0.1 million in 2000 and $0.2 million in 1999.
For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting period. Our pro forma net earnings and earnings per common share are as follows:
We have marketing agreements with the Farm Bureau property-casualty companies operating within our marketing territory, including Farm Bureau Mutual and other affiliates. 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 $6.2 million in 2001, $6.0 million in 2000 and $5.0 million in 1999 to the property-casualty companies under these arrangements.
We are licensed by the Iowa Farm Bureau Federation to use the "Farm Bureau" and "FB" designations in Iowa. In connection with this license, we incurred royalty expense totaling $0.5 million in 2001, $0.7 million in 2000 and $0.9 million in 1999. The expense set forth above in 2001 is before the recovery of $1.0 million in overpayment of royalties in prior years under the terms of the royalty contract. We have similar arrangements with Farm Bureau organizations in other
states in our market territory. Total royalty expense to Farm Bureau organizations other than the Iowa Farm Bureau Federation totaled $1.0 million in 2001, $1.2 million in 2000 and $1.0 million in 1999.
On March 31, 1998, we sold our wholly-owned subsidiary, Utah Farm Bureau Insurance Company, to Farm Bureau Mutual. We may earn additional consideration in the period ended December 31, 2002 in accordance with an earn-out provision included in the related sales agreement. Under the earn-out arrangement, the Company and Farm Bureau Mutual share equally in the dollar amount by which the incurred losses on direct business written in the state of Utah, net of reinsurance ceded, is less than the incurred losses assumed in the valuation model used to derive the initial acquisition price. The earn-out calculation is performed and any settlement (subject to a maximum of $2.0 million per year) is made on a calendar year basis. We have not accrued any contingent consideration for 2002 as such amounts, if any, cannot be reasonably estimated as of December 31, 2001. Receipts as a result of the earn-out provision, if any, are recorded as an adjustment to the gain on the disposal of the discontinued segment.
We closed an administrative processing center during 1999, subsequent to the merger of Western Farm Bureau Life Insurance Company, a former wholly-owned subsidiary, into Farm Bureau Life. As a result of the closing of the service center, a leased property was vacated, 22 positions were eliminated and moving costs were incurred. During 1999, we charged to expense costs totaling $1.2 million for related severance benefits, lease costs and other costs primarily associated with the closing of the service center. The restructuring expenses are recorded in the underwriting, acquisition and insurance expense line of the 1999 consolidated statement of income.
Options to purchase 564,419 shares of common stock in 2000 at $15.00 to $24.25 per share were granted during 1997, 1998, 1999 and 2000 but were not included in the computation of 2000 diluted earnings per share because the options' exercise price was greater than the average market price of common shares during 2000. The options, which expire in 2007 through 2010, were still outstanding at December 31, 2000.
Prior to January 1, 2001, our life insurance segment was our only reportable operating segment. The life insurance segment included activities related to the sale of life insurance, annuities and accident and health insurance products. Operations were aggregated into the same segment due to the similarity of the products, including the underlying economic characteristics, the method of distribution and the regulatory environment. During the first quarter of 2001, a financial reporting project to refine our line of business detail was completed. With the availability of more detailed line of business information, management now utilizes financial information regarding products that are aggregated into three product segments. The product segments are: (1) traditional annuity, (2) traditional and universal life insurance and (3) variable. We also have various support operations and corporate capital that are aggregated into a corporate and other segment.
The traditional annuity segment consists of traditional annuities, equity-indexed annuities and supplementary contracts (some of which involve life contingencies). Traditional and equity-indexed annuities provide for tax-deferred savings and supplementary contracts provide for the systematic repayment of funds that accumulate interest. Traditional annuities consist primarily of flexible premium deferred annuities, but also include single premium deferred and immediate contracts. With traditional annuities, we bear the underlying investment risk and credit interest to the contracts at rates we determine, subject to interest rate guarantees. With equity-indexed 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.
o Investments and related investment income not specifically allocated to our product segments; o Interest expense and minority interest pertaining to distributions on trust preferred securities; o Accident and health insurance products, primarily long-term disability income insurance; o Advisory services for the management of investments and other companies; o Marketing and distribution services for the sale of mutual funds and insurance products not issued by us; and o Leasing services, primarily with affiliates.
(A) Amounts are net of adjustments, as applicable, to amortization of unearned reserves, deferred policy acquisition costs, value of insurance in-force acquired and income taxes attributable to gains and losses on investments.
Depreciation and amortization 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 charges relating to leases with affiliates totaling $4.6 million for 2001 and 2000 and $3.1 million for 1999. In the consolidated statements of income, we record these depreciation amounts net of related lease income from affiliates.