The principal executive offices of the Company are located at 1055 Broadway, Kansas City, Missouri 64105 and the Company's telephone number is (816) 391-2000.
The principal operations of the insurance subsidiaries are conducted from Kansas City, Missouri and Dallas, and Austin, Texas. The Company's locations include leased office space located at 1055 Broadway, Kansas City, Missouri 64105 and 333 West 11th Street, Kansas City, Missouri 64105. These properties are leased from Broadway Square Partners, a Missouri limited partnership of which a corporation controlled by the Merriman family is a 50% partner. The leases expire on August 31, 2010 and August 31, 2013, respectively.
(2) On July 10, 1995, the Company acquired all of the outstanding common stock of Victory Life.
Revenues and income before provision for income taxes for the Company's operating segments, as defined by Financial Accounting Standard No. 131, "Financial Reporting for Segments of a Business Enterprise", is summarized as follows:
Life insurance operations. Income before income taxes increased only slightly from 1998 and 1997. Income before income taxes increased $8.5 million from 1996 to 1997 due to certain acquisitions completed in 1997 as more fully described in the "Consolidated Year to Year Comparisons" section included elsewhere in this Management's Discussion and Analysis of Financial Condition and Results of Operations.
Asset accumulation products operations. Income before income taxes increased $9.2 million from 1997 to 1998. The primary reasons for the increase were (i) adjustments to deferred policy acquisition costs resulting from revisions made to the Company's estimate of future gross profits from its interest sensitive and annuity products, and (ii) the addition in 1998 of the results of operations from business which was previously ceded to an affiliated insurance company and recaptured in 1998 in conjunction with the Company's consolidation of its asset accumulation operations.
Significant reconciling items of the segment revenues and income before income taxes shown above to amounts reported in the Company's consolidated financial statements appearing elsewhere in this Form 10-K include net investment income and operating expenses not allocated to segments, net realized investment gains (losses) not allocated to segments, interest expense and certain non-recurring transactions such as gains from the sale of subsidiaries. These reconciling items had the effect of decreasing income before income taxes, by $25.4 million from 1997 to 1998. The primary reasons for the decrease were (i) net realized investment losses in 1998 and (ii) an increase in operating expenses not allocated to segments in 1998. These reconciling items had the effect of decreasing income before income taxes by $25.8 million from 1996 to 1997. The primary reasons for the decrease were (i) a gain on dispostion of a partnership interest in 1996 and (ii) an increase in operating expenses not allocated to segments in 1997.
The Company entered into two transactions during the period 1996 through 1998 which affect the comparability of its results of operations between periods.
Income before provision for income taxes decreased $19.3 million to $12.0 million in 1998. The primary reasons for the decrease were (i) realized investment losses, (ii) an increase in amortization expense and (iii) an increase in other operating expenses, partially offset by (iv) lower death benefits. The Company recorded $2.8 million of expense for the relocation of its Columbus, Ohio operations during 1998. These items and significant changes in individual income statement components are discussed in more detail below.
Net realized investment gains. Net realized investment gains totaled $8.3 million in 1998 compared with $3.0 million in 1997. Excluding the effect of the Acquisitions, net realized investment gains decreased $1.4 million. In 1998, the Company reported $8.3 million of realized gains including $16.7 million of gains from the sale of fixed maturity investments held by the Reinsurer. As described below, the sale of fixed maturity investments held by the Reinsurer resulted in increased amortization of cost of business acquired assets. Excluding the $16.7 million of gains described above, the Company realized losses of $8.4 million in 1998 compared to gains of $3.0 million in 1997. There were no sales of investments held by the Reinsurer in 1997 and no impact on amortization from other gains realized in 1997. The difference between realized losses in 1998 and realized gains in 1997 resulted in an $11.4 million reduction in income before provision for income taxes in 1998 compared with 1997.
Other income. Other income totaled $12.2 million in 1998 compared to $12.3 million in 1997. Other income includes an administrative service fee paid to the Company associated with the reinsurance of 30% of the Ohio State and Investors Guaranty policies, which amounts are included in the effects of the Acquisitions. Excluding these amounts, other income decreased $0.5 million from 1997 to 1998. The Company recorded a gain of $4.9 million from the sale of Investors Guaranty in May 1998 and a gain of $4.8 million from the sale of Loyalty Life Insurance Company ("Loyalty") in 1997.
Policyholder benefits. Policyholder benefits totaled $251.5 million in 1998 compared with $262.9 million in 1997. Excluding the effect of the Acquisitions, policyholder benefits decreased $23.3 million from 1997 to 1998. This decrease resulted primarily from (i) an $8.9 million decrease in death benefits, (ii) a $4.3 million decrease in interest credited on universal life and annuity fund balances, and (iii) a $5.5 million increase in the amount of benefit reserves released from 1997 to 1998 associated with the lower traditional premiums referred to above. The decrease in interest credited is comprised of an $8.8 million decrease resulting from reduced fund values in a closed block of annuity business, offset by a $5.9 million increase related to increased fund values of the Company's asset accumulation products. The balance of the decrease results from a reduction, made in response to market conditions, in the rate of interest credited on interest-sensitive products.
Other operating expenses. Other operating expenses totaled $89.4 million in 1998 compared with $77.0 million in 1997. The increase in other operating expenses resulted from (i) the inclusion of twelve months of operating expenses related to Ohio State and Investors Guaranty in 1998 compared with nine months of operating expenses for these entities in 1997 following their April 1997 acquisition by the Company, (ii) $2.8 million of expenses related to the relocation of the Company's Columbus, Ohio operations to other Company locations during 1998, (iii) the operating expenses of marketing operations purchased by the Company in October 1998 and (iv) increased expenses associated with the continued development and expansion of the Company's product offerings and marketing capabilities. Increased expenses in these areas included both product development expenses and expenses incurred on the Company's administrative systems.
Premiums and policy revenues. Premiums and policy revenues totaled $203.7 million in 1997 compared to $165.6 million in 1996. Excluding the Acquisitions, premiums and policy revenues decreased $11.8 million from 1996 to 1997. The decrease is primarily due to the Company currently writing small amounts of new traditional life insurance products and, therefore, traditional life insurance premiums are decreasing as the amount of in-force business decreases. Also, the 1996 results included $2.5 million of traditional premiums on supplementary contracts and $3.4 million of accident and health premiums which did not recur in 1997.
Liquidity. The liquidity needs of Americo, whose principal assets are investments in its insurance subsidiaries, are dependent upon receipt of sufficient funds from its subsidiaries. The cash requirements of Americo consist of debt service requirements on notes payable, amounts due to FHC under advisory and data processing agreements and its own operating expenses. These cash requirements are met by payments of principal and interest on surplus debentures that Americo holds which are issued by United Fidelity and dividends from United Fidelity. Americo also receives payments under investment advisory and data processing agreements with the insurance subsidiaries which permit Americo to recover a portion of the amounts paid by it under similar agreements with FHC. On a stand-alone basis, at December 31, 1998, Americo had $33.2 million of cash and cash equivalents and marketable equity securities available for debt service and other corporate requirements.
Americo's bank credit agreement, which was last amended in 1998, is a revolving credit facility until December 1999, at which time amounts then outstanding convert into a term loan repayable in six, equal semi-annual installments commencing July 1, 2000. Amounts outstanding under the credit facility bear interest at either a bank prime rate or 7/8% over LIBOR.
The ability of life insurance subsidiaries to pay dividends also may be affected by reinsurance treaties. Under reinsurance treaties with an unrelated reinsurer, National Farmers Union is restricted from declaring dividends if adjusted surplus is less than $27.5 million. Adjusted surplus is defined in the treaties as statutory capital and surplus, plus AVR, less the admitted asset value of all affiliated investments. At December 31, 1998, National Farmers Union had adjusted surplus of $52.2 million.
The principal sources of liquidity for the Company's insurance subsidiaries are premium receipts, net investment income received and net proceeds from investments that have been sold or matured or from mortgage loans that have been repaid. Cash flows from premiums received and investment income are generally sufficient to meet the subsidiaries' obligations, which consist of the payment of claims and benefits on insurance policies, purchases of investments and the payment of operating expenses. Although there is no intent to dispose of investments at this time, the Company's investments are substantially in readily marketable securities.
(2) Carrying amount is amortized cost. The market value of held to maturity securities as December 31, 1998 was $914.7 million.
(3) Carrying amount is market value. The amortized cost of available for sale securities at December 31, 1998 was $893.7 million.
The Company continually reviews its non-investment grade debt securities (NAIC designations 3 through 6) for evidence of declines in value which are other than temporary. The Company does not anticipate any material increase in its investments in non-investment grade debt securities. At December 31, 1998, the Company's investment portfolio contained no securities which were in default as to principal or interest.
The Company maintains a mortgage-backed securities ("MBS") portfolio, which consists of "pass-through" obligations and collateralized mortgage obligations ("CMOs"). Approximately 90% of the MBS portfolio consists of securities or pools of securities guaranteed by the U.S. government, including those issued by Government National Mortgage Association, or those issued by Federal National Mortgage Association and Federal Home Loan Mortgage Corporation.
Non-Insurance Subsidiaries. During 1998, Americo received dividends from Argus consisting of $9.5 million of cash and received a $0.4 million cash distribution from Hereford, LLP.
Management is aware that prevailing interest rates may shift significantly and has strategies in place to manage either an increase or decrease in interest rates. In a rising interest rate environment, the Company's cost of funds would increase over time as it prices its new and existing interest-sensitive and investment products to maintain generally competitive market rates. Management would seek to invest new and renewal premiums in investments which are generally matched in duration to, and higher yielding than, its liabilities. Management believes that liquidity to fund withdrawals would be available through a combination of incoming cash flow, the sale of short-term or floating rate instruments, and maturing short-duration assets thereby avoiding the sale of significant amounts of longer duration fixed-rate assets in an unfavorable bond market. In a declining rate environment, the Company's cost of funds would decrease over time, reflecting lower interest crediting rates on its fixed-rate liabilities. Should increased liquidity be required for withdrawals, management believes that a significant portion of its investments could be sold without adverse consequences in light of the general strengthening which would be expected in the bond market.
Asset-liability management is utilized by the Company to reduce the risks to the Company for interest rate fluctuations and disintermediation. The Company believes that its fixed-rate liabilities should be backed by a portfolio principally composed of fixed-rate investments that generate predictable rates of return in a variety of interest rate environments. The Company does not have a specific target rate of return. Instead, its rates of return vary over time depending on the current interest rate environment, the slope of the yield curve, the spread at which fixed-rate investments are priced over the yield curve, and general economic conditions. The Company's portfolio strategy is constructed with a view to achieving adequate risk-adjusted returns consistent with its investment objectives of effective asset-liability management, liquidity and safety. The Company has structured its investment portfolio to reduce changes in the value of the assets under various rate environments. In that regard, the percentage of the Company's fixed-rate investment portfolio which is non-callable has increased from 44% in 1995 to 62% in 1998. In addition, the portfolio's concentration in mortgage-backed securities, which are subject to cash flow variability in changing interest rate environments, has decreased from 38% in 1995 to 24% in 1998. See "Investment Portfolio" section included elsewhere in Management's Discussion and Analysis of Financial Condition and Results of Operations for additional information related to the Company's investments.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities". SFAS No. 133 provides guidance related to the accounting for derivative instruments and hedging activities focusing on the recognition and measurement of derivative instruments. This statement is effective for all fiscal quarters of all fiscal years beginning after June 15, 1999. Adoption of this accounting standard will not have a significant impact on the consolidated financial statements of the Company.
Many existing computer programs were designed and developed without regard to the upcoming change in the century. If not corrected, many computer applications could fail or create erroneous results by or at the Year 2000.
The Company has developed a comprehensive Year 2000 plan that management believes will identify potential processing issues and allow the Company to take any necessary corrective actions before problems arise. A committee, comprised of a cross section of key employees from all business areas, has been formed to execute, test and implement the remediation plan. The Company's remediation plan is comprised of six phases. These phases are (i) a complete inventory of systems which the Company utilizes, (ii) an initial assessment of Year 2000 preparedness for each identified system, (iii) the development of a plan to remediate appropriate systems, (iv) the remediation of systems, (v) the testing of systems, and (vi) the implementation into production of systems. Because the Company's administration systems are outsourced to a third party vendor, the Company is coordinating the Year 2000 plan with its outsource provider. This provider has contractual responsibility for the Year 2000 remediations of the Company's administration systems.
A major part of the Company's Year 2000 plan relates to other business entities on which the Company is reliant to conduct its operations. The aforementioned Year 2000 committee has identified key business partners, customers, vendors and suppliers to participate in a survey program. These business entities are comprised of entities which impact many companies across the country in varied industries, as well as entities with more limited customers. Entities serving customers nationwide include the federal government, the banking system, the postal service, national brokerage firms, stock exchanges, and national overnight delivery providers. Local entities include the Company's reinsurers, banks, computer hardware vendors, payroll processor, public utilities and phone companies. After identifying the entities, the Company sent surveys to each requesting information related to Year 2000 readiness. Management has developed a database to track survey responses and will send any necessary second requests by April 15, 1999. If further requests do not result in a response, a determination will be made at that time whether further contact should be made. The responses to these surveys are being evaluated by Company management to determine whether potential Year 2000 problems exist. If the Company believes a problem may exist, an appropriate contingency plan will be developed to minimize any effect on the Company. The Company is specifically reliant upon the federal government for various functions including mail delivery of customer correspondence, national banking activities and electronic list bill premium processing for government employees. The federal government's policy is to not respond to Year 2000 surveys, so the Company, like most organizations, has assumed the operations of the federal government will not be significantly affected by Year 2000 problems. If problems do arise, the operations of the Company may be materially adversely impacted.
The estimates and conclusions herein contain forward-looking statements and are based on management's best estimates of future events. Risks to completing the plan include the availability of trained personnel, management's ability to discover and correct the potential Year 2000 sensitive problems which could have a serious impact on specific facilities, and the ability of suppliers and customers to bring their systems into Year 2000 compliance.