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 and deferred sales inducements, are capitalized and amortized into expense. We also record an asset, value of insurance in force acquired, for the cost assigned to insurance contracts when an insurance company is acquired. For nonparticipating traditional life 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, interest sensitive and index 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 (also known as “unlocked”) when the Life Companies revise their estimate of current or future gross profits or margins. For example, deferred policy acquisition costs and deferred sales inducements 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.
At December 31, 2006, we had 782 fixed maturity and equity securities with gross unrealized losses totaling $122.6 million. Included in the gross unrealized losses are losses attributable to both movements in market interest rates as well as temporary credit issues. Details regarding these securities are included in the “Financial Condition - Investments” section that follows. Net income would have been reduced by approximately $33.8 million if all these securities were deemed to be other-than-temporarily impaired on December 31, 2006.
The determination of net periodic pension expense and related accrued/prepaid pension cost requires the use of estimates as to the expected return on plan assets, discount rate on plan liabilities and other actuarial assumptions. Pension expense for 2006 totaled $6.4 million.
account value represents the value of the contract to the contract holder before application of surrender charges or reduction for any policy loans outstanding.
The derivative instruments (including certain derivative instruments embedded in other contracts) associated with our index annuity products are recognized in the consolidated balance sheets at their fair values and changes in fair value are recognized immediately in earnings. The net impact of changes in fair value of call option assets and embedded derivatives related to future annual index credits totaled $1.0 million in 2006, ($1.9) million in 2005 and $0.8 million in 2004, net of adjustments for amortization of deferred policy acquisition costs, deferred sales inducements and income taxes.
Effective January 1, 2006, we adopted Statement of Financial Accounting Standards (Statement) No. 123(R), “Share-Based Payment,” using the modified-prospective-transition method. Statement No. 123(R) is a revision of Statement No. 123, “Accounting for Stock-Based Compensation.” As a result of adopting Statement No. 123(R), net income for the full year 2006 was $0.2 million lower (less than $0.01 per basic and diluted common share), than if we had continued to account for share-based compensation under Statement No. 123.
Premiums and product charges increased 5.4% in 2006 to $243.8 million and 4.0% in 2005 to $231.3 million. The increases in interest sensitive and index product charges in 2006 and 2005 are driven principally by surrender charges on annuity and universal life products, cost of insurance charges on variable universal life and universal life products and mortality and expense fees on variable products.
Mortality and expense fees totaled $8.1 million in 2006, $6.9 million in 2005 and $5.8 million in 2004. Mortality and expense fees increased due to increases in the separate account balances on which fees are based. The average separate account balance increased to $697.6 million for 2006, from $588.0 million for 2005 and $500.9 million for 2004 due to the impact of new sales and favorable investment results. Transfers of premiums to the separate accounts totaled $93.6 million for 2006, $118.2 million for 2005 and $96.6 million for 2004. Net investment income and net realized and unrealized gains on separate account assets totaled $39.8 million for 2006, $37.7 million for 2005 and $49.0 million for 2004.
Traditional premiums increased in 2006 and 2005 due to an increase in the volume of business in force. The increase in the business in force is attributable primarily to sales of traditional life products by our Farm Bureau Life agency force exceeding the loss of in force amounts through deaths, lapses and surrenders. Our average aggregate traditional life insurance in force, net of reinsurance ceded, totaled $18,295 million for 2006, $17,344 million for 2005 and $16,246 million for 2004. The change in life insurance in force is not proportional to the change in premium income due to a shift in the composition of our traditional life block of business from whole life policies to term policies. The premium for a term policy per $1,000 face amount is less than that for a whole life policy.
investments maturing or being paid down. The average yields on fixed maturity securities purchased were 6.04% for 2006, 5.44% for 2005 and 5.56% for 2004. The average yields on fixed maturity securities maturing or being paid down were 6.62% for 2006, 6.10% for 2005 and 6.34% for 2004. For 2005, the impact of these market conditions on our portfolio yield was offset by increased fee income. Fee income from bond calls, tender offers and mortgage loan prepayments totaled $8.9 million in 2006, $8.4 million in 2005 and $2.5 million in 2004. Net investment income also includes $0.1 million in 2006, ($0.6) million in 2005 and ($0.5) million in 2004 representing the acceleration (reversal) of net discount accretion on mortgage and asset-backed securities resulting from changing prepayment speed assumptions during the respective periods. See “Financial Condition - Investments” section that follows for a description of how changes in prepayment speeds impact net investment income.
Gains received at expiration are attributable to growth in the volume of index annuities in force and appreciation in the market indices on which our options are based. The average aggregate account value of index annuities in force, which has increased due to new sales, totaled $3,200.1 million for 2006, $2,299.1 million for 2005 and $1,593.6 million for 2004. The changes in the difference between the fair value of the call options and the remaining option costs are caused primarily by the change in the S&P 500 Index® (upon which the majority of our options are based). The range of index appreciation for S&P 500 Index options during 2006, 2005 and 2004 is as follows:
The change in fair value is also reduced by participation rates and caps, as applicable, on the underlying options. Furthermore, the change in fair value is impacted by options based on other underlying indices and the timing of option settlements. The cost of money for call options increased due primarily to the impact of growth in the volume of index annuities in force. Other derivative income (loss) is comprised of changes in the value of the conversion feature embedded in convertible fixed maturity securities and the embedded derivative included in our modified coinsurance contracts. Derivative income (loss) will fluctuate based on market conditions.
The level of realized/unrealized gains (losses) is subject to fluctuation from period to period depending on the prevailing interest rate and economic environment and the timing of the sale of investments. Gains on sales in 2006 include $13.5 million related to the sale of 2,500,000 shares of our investment in American Equity Investment Life Holding Company (AEL) common stock. It also includes a $1.9 million dollar gain related to the sale of our equity investment in an affiliate, Western Agricultural Insurance Company, to another affiliate, Farm Bureau Mutual Insurance Company. See “Financial Condition - Investments” for details regarding our unrealized gains and losses on available-for-sale securities at December 31, 2006 and 2005.
The increases in amortization of deferred sales inducements are due to capitalization of costs incurred with new sales and profitability on the underlying business. Deferred sales inducements on interest sensitive and index products totaled $225.1 million at December 31, 2006, $147.0 million at December 31, 2005 and $78.4 million at December 31, 2004. Amortization of deferred sales inducements includes increases (decreases) of $1.4 million in 2006, ($0.6) million in 2005 and $0.2 million in 2004 due to the impact of realized/unrealized gains and losses on investments and the change in unrealized gains and losses on derivatives.
Traditional life insurance and accident and health policy benefits are as follows:
Income taxes increased 20.6% in 2006 to $44.4 million and increased 32.7% in 2005 to $36.8 million. The effective tax rate was 33.2% for 2006, 33.9% for 2005 and 30.0% for 2004. Our effective tax rates are impacted by tax accrual reversals. Based on events and analysis performed, we determined that these tax accruals were no longer necessary and related benefits totaling $0.5 million in 2006 and 2005 and $4.5 million in 2004 were recorded. The effective rates, excluding the impact of the accrual reversals, were 33.6% in 2006, 34.4% in 2005 and 34.8% in 2004. The effective tax rates were lower than the federal statutory rate of 35% due primarily to tax-exempt interest and tax-exempt dividend income. The decrease in the 2006 effective rate is primarily attributable to less nondeductible interest due to the redemption of the Series C preferred stock in December 2005.
Equity income, net of related income taxes, totaled $1.1 million in 2006, $1.2 million in 2005 and $1.4 million in 2004. Equity income includes our proportionate share of gains and losses attributable to our ownership interest in partnerships, joint ventures and certain companies where we exhibit some control but have a minority ownership interest. Given the timing of availability of financial information from our equity investees, we will consistently use information that is as much as three months in arrears for certain of these entities. Several of these entities are investment companies whose operating results are derived primarily from unrealized and realized gains and losses generated by their investment portfolios. As is normal with these types of entities, the level of these gains and losses is subject to fluctuation from period to period depending on the prevailing economic environment, changes in prices of equity securities held by the investment partnerships, timing and success of initial public offerings and other exit strategies, and the timing of the sale of investments held by the partnerships and joint ventures.
We analyze operations by reviewing financial information regarding products that are aggregated into four product segments. The product segments are: (1) Traditional Annuity - Exclusive Distribution (“Exclusive Annuity”), (2) Traditional Annuity - Independent Distribution (“Independent Annuity”), (3) Traditional and Universal Life Insurance and (4) Variable. We also have various support operations and corporate capital that are aggregated into a Corporate and Other segment.
We analyze our segment results based on pre-tax operating income (loss). Accordingly, income taxes are not allocated to the segments. In addition, operating results are analyzed net of any transactions between the segments. Operating income (loss) represents net income excluding the impact, net of tax, of (1) realized and unrealized gains and losses on investments, (2) changes in net unrealized gains and losses on derivatives and (3) for 2006, a lawsuit settlement. The impact of realized and unrealized gains and losses on investments and unrealized gains and losses on derivatives also includes adjustments for that portion of amortization of deferred policy acquisition costs, deferred sales inducements, unearned revenue reserve and value of insurance in force acquired attributable to such gains or losses. Our rationale for using operating income, in addition to net income to measure our performance is summarized in Note 14, “Segment Information,” to the consolidated financial statements.
Pre-tax operating income for the Exclusive Annuity segment increased 3.3% in 2006 to $35.6 million and 31.0% in 2005 to $34.4 million. The increase in 2005 was primarily driven by an increase in net investment income. The average aggregate account value for annuity contracts in force in the Exclusive Annuity segment totaled $1,479.5 million for 2006, $1,428.8 million for 2005 and $1,308.5 million for 2004.
The changes in the weighted average yield on cash and invested assets are primarily attributable to the items affecting net investment income noted above. We reduced the crediting rates on most of our annuity products in 2004 in response to the impact of declining market interest rates on our investment portfolio yield. In 2006 we increased the crediting rate on our primary fixed premium deferred annuity product ten basis points in response to increased income generated from interest rate swaps we utilize to hedge a portion of our annuity portfolio. Income from these swaps, which is netted against interest credited, totaled $3.7 million in 2006 and $1.0 million in 2005, compared to a net cost of $1.6 million in 2004. See “Market Risks of Financial Instruments” following and Note 3 to the consolidated financial statements for additional information regarding these hedges.
Pre-tax operating income for the Independent Annuity segment increased 37.3% in 2006 to $30.4 million and 61.8% in 2005 to $22.2 million. These increases are due principally to growth in the volume of business in force and, for 2005, an increase in spreads earned on individual deferred annuities. Revenues, benefits, expenses and the volume of business in force increased in 2006 and 2005 due to growth of our EquiTrust Life distribution channel. The average aggregate account value for annuity contracts in force in the Independent Annuity segment totaled $4,401.2 million for 2006, $3,114.7 million for 2005 and $2,359.8 million for 2004.
The increases in interest sensitive and index product charges in 2006 and 2005 are due to an increase in surrender charges. Surrender charges increased due to increases in surrenders relating to growth in the volume and aging of business in force. The increases in net investment income in 2006 and 2005 are attributable to growth in invested assets due principally to net premium inflows, partially offset by the impact of a decline in our investment yield. Net investment income includes $2.1 million in 2006, $0.5 million in 2005 and ($0.1) million in 2004 in fee income from bond calls, tender offers and mortgage loan prepayments and the acceleration (reversal) of net discount accretion on mortgage and asset-backed securities. Net investment income for 2005 was also positively impacted by the change in allocation of capital discussed above. The changes in derivative income (loss) are primarily due to increases in the cost of money for call options, partially offset by increases in proceeds from option settlements as discussed under “Derivative income (loss)” above. The cost of money for call options totaled $72.8 million in 2006, $44.3 million in 2005 and $26.3 million in 2004. Call option settlements totaled $68.5 million in 2006, $41.9 million in 2005 and $33.2 million in 2004.
Premiums collected increased significantly in 2006 and 2005 period due to continued growth of our EquiTrust Life distribution channel. This is driven largely by an increase in the number of licensed independent agents to 18,849 at December 31, 2006, from 10,162 at December 31, 2005, and 4,778 at December 31, 2004.
In 2006, the weighted average yields on cash and invested assets were impacted by market investment rates being lower than our portfolio yield, partially offset by the increase in fee income discussed above. For 2006, the weighted average interest crediting rate/index cost was primarily impacted by an increase in the cost of options, offset by an increase in the sale of fixed rate annuities. Fixed rate annuities sold are primarily multi-year guarantee products that typically have a lower crediting rate and spread target. Our spreads earned for 2005 and 2004 were primarily impacted by changes in spreads on index annuities assumed under the coinsurance agreement, which is driven by option costs, the extent to which the business was over hedged and fluctuations in the minimum guarantees credited to the contracts.
Traditional life insurance premiums increased in 2006 and 2005 due primarily to sales of life products by our Farm Bureau Life agency force. Net investment income includes $2.8 million in 2006, $1.7 million in 2005 and $1.1 million in 2004 in fee income from bond calls, tender offers and mortgage loan prepayments and the acceleration (reversal) of net discount accretion on mortgage and asset-backed securities. Net investment income was also positively impacted in 2005 by a decrease in our cash position and increased investment in corporate bonds. These factors were partially offset by the impact of market investment rates being lower than our investment portfolio yield or yield on investments maturing or being paid down.
Death benefits totaled $81.2 million in 2006, $75.4 million in 2005 and $69.9 million in 2004. Surrender benefits totaled $37.0 million in 2006, $33.8 million in 2005 and $35.2 million in 2004. Amortization of deferred policy acquisition costs was reduced by $1.8 million in 2006, $3.2 million in 2005 and $1.4 million in 2004 due to changes in the assumptions used to calculate deferred policy acquisition costs. The 2005 unlocking adjustment is primarily due to a change in the estimate of projected investment income on traditional participating life business. Other underwriting expenses also decreased 12.4% to $31.1 million in 2006 due to a reduction in software costs and expense saving initiatives, primarily relating to the closure of a life insurance processing unit during 2005. Other underwriting expenses in 2005 include approximately $0.8 million of severance benefits as a result of closing the life processing unit and other unrelated terminations.
Pre-tax operating income for the Variable segment totaled $3.6 million in 2006, $2.6 million in 2005 and $2.2 million in 2004. The increase in 2006 is due to the impact of an increase in the volume of business in force, partially offset by an increase in death benefits and amortization of deferred policy acquisition costs. The increase in 2005 is due to an increase in the volume of business in force, partially offset by an increase in death benefits and a loss on the recapture by a former variable alliance partner of a previously coinsured block of variable annuity contracts.
During the third quarter of 2005, a former variable alliance partner recaptured a block of variable annuity contracts previously assumed by us with an account value totaling $45.5 million. The block was assumed through a modified coinsurance agreement. Accordingly, the related insurance reserves and supporting investments were not recorded on our financial statements. A pre-tax loss of $0.9 million, representing the excess of the related deferred policy acquisition costs ($3.9 million) over the consideration received ($3.0 million), was recorded as a component of amortization of deferred policy acquisition costs.
As described in more detail in Note 1 to the consolidated financial statements, we will be subject to certain pending accounting changes. During 2007, we plan to adopt the following:
Financial Accounting Standards Board (FASB) Interpretation No. 48, “Accounting for Uncertainty in Income Taxes,” which creates a single model to address uncertainty in tax positions and clarifies the accounting for income taxes. Upon adoption, we expect to record a tax liability for tax positions totaling less than $0.5 million.
Statement of Position (SOP) 05-1, “Accounting by Insurance Enterprises for Deferred Acquisition Costs in Connection with Modifications or Exchanges of Insurance Contracts,” which provides guidance on accounting for internal replacements of one insurance contract for another insurance contract. We do not expect to record a cumulative effect of accounting change adjustment upon adoption of this SOP in 2007 as adoption is expected to have an insignificant impact on lapse assumptions included in our deferred policy acquisition cost and related models. In addition, net income is not expected to be impacted materially going forward as our current accounting policy for internal replacements substantially conforms to current interpretations of the guidance in the SOP.
maturity securities. At that time, no single non-investment grade holding exceeded 0.2% of total investments. The following table sets forth the credit quality, by NAIC designation and Standard & Poor’s (S&P) rating equivalents, of available-for-sale fixed maturity securities:
A summary of the gross unrealized gains and gross unrealized losses on our available-for-sale fixed maturity securities, by internal industry classification, as of December 31, 2006 and 2005, is as follows:
Included in the above table are 780 securities from 513 issuers at December 31, 2006 and 515 securities from 328 issuers at December 31, 2005. These increases are primarily due to the impact of increases in market interest rates during 2006. The following summarizes the details describing the more significant unrealized losses by investment category as of December 31, 2006.
Corporate securities: The unrealized losses on corporate securities totaled $59.4 million, or 48.5% of our total unrealized losses. The largest losses were in the manufacturing sector ($467.7 million carrying value and $21.8 million unrealized loss) and in the financial services sector ($788.1 million carrying value and $18.8 million unrealized loss). The largest unrealized losses in the manufacturing sector were in the paper and allied products sector ($91.2 million carrying value and $5.6 million unrealized loss) and the printing and publishing sector ($42.2 million carrying value and $3.8 million unrealized loss). The unrealized losses in the paper and allied products sector and the printing and publishing sector are due to a rise in market interest rates and spread widening that is the result of weaker operating results. In addition, we believe there are concerns that these sectors may experience increased equity enhancing activity by management, such as common stock buybacks, which could be detrimental to
credit quality. The unrealized loss in the financial services sector and the remaining corporate sectors was caused primarily by a rise in market interest rates. Because we have the ability and intent to hold these investments until a recovery of fair value, which may be maturity, we do not consider these investments to be other-than-temporarily impaired at December 31, 2006.
State municipal and other governments: The unrealized losses on state, municipal and other governments totaled $14.0 million, or 11.4% of our total unrealized losses, and were caused by increases in market interest rates. We purchased most of these investments at a discount to their face amount and the contractual cash flows of these investments are based on the taxing authority of a municipality or the revenues of a municipal project. Because the decline in market value is attributable to changes in market interest rates and not credit quality, and because we have the ability and intent to hold these investments until a recovery of fair value, which may be maturity, we do not consider these investments to be other-than-temporarily impaired at December 31, 2006.
Public utilities: The unrealized losses on public utilities totaled $8.0 million, or 6.5% of our total unrealized losses, and were caused primarily by an increase in market interest rates. Because the decline in market value is attributable to changes in market interest rates and not credit quality, and because we have the ability and intent to hold these investments until recovery of fair value, which may be maturity, we do not consider these investments to be other-than-temporarily impaired at December 31, 2006.
Excluding mortgage and asset-backed securities, no securities from the same issuer had an aggregate unrealized loss in excess of $1.6 million at December 31, 2005. With respect to mortgage and asset-backed securities not backed by the United States Government, no securities from the same issuer had an aggregate unrealized loss in excess of $2.6 million at December 31, 2005. The $2.6 million unrealized loss from one issuer relates to six different securities that are backed by different pools of residential mortgage loans. All six securities are rated investment grade and the largest unrealized loss on any one security totaled $1.2 million at December 31, 2005.
The carrying value and estimated market value of our portfolio of available-for-sale fixed maturity securities, 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.
Mortgage and other asset-backed securities comprised 28.0% at December 31, 2006 and 31.8% at December 31, 2005 of our total available-for-sale fixed maturity securities. These securities are purchased when we believe these types of investments provide superior risk-adjusted returns compared to returns of more conventional investments such as corporate bonds and mortgage loans. These securities are diversified as to collateral types, cash flow characteristics and maturity. During 2006 and 2005, we reduced our allocation of assets to residential mortgage-backed securities to reduce or exposure to unwanted changes in the duration of our investment portfolio with changes in market interest rates.
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 generally do not purchase certain types of CMOs that we believe would subject the investment portfolio to greater than average risk. These include, but are not limited to, principal only, floater, inverse floater, PAC II and support tranches.
The commercial and other asset-backed securities are primarily sequential securities. Commercial mortgage-backed securities typically have cash flows that are less sensitive to interest rate changes than residential securities of similar types due principally to prepayment restrictions on many of the underlying commercial mortgage loans. The other asset-backed securities, whose collateral is primarily home-equity loans, generally exhibit more stable cash flows relative to mortgage-backed issues.
Fixed maturity securities held for trading consist of U.S. Treasury securities totaling $14.9 million at December 31, 2006 and $14.8 million at December 31, 2005. These securities had an unrealized loss of $0.1 million at December 31, 2006 and $0.2 million at December 31, 2005.
Cash and cash equivalents increased to $112.3 million at December 31, 2006 from $5.1 million at December 31, 2005 due primarily to a $64.1 million increase in cash received as collateral for open derivative positions with counterparties. Deferred policy acquisition costs increased 19.1% to $827.7 million and deferred sales inducements increased 54.2% to $226.6 million at December 31, 2006 primarily due to the capitalization of costs incurred with new sales. In addition, deferred policy acquisition costs increased $11.1 million and deferred sales inducements increased $8.0 million due to the impact of the change in unrealized appreciation/depreciation on fixed maturity securities. Other assets increased 85.4% to $55.0 million due primarily to an $18.4 million increase for receivables for securities. Assets held in separate accounts increased 19.5% to $764.4 million at December 31, 2006 due primarily to positive investment returns and the transfer of net premiums to the separate accounts.
Stockholders’ equity increased 4.3%, to $880.7 million at December 31, 2006, compared to $844.2 million at December 31, 2005. This increase is attributable to net income for the year and proceeds from stock option exercises, partially offset by dividends paid and a decrease in the change in unrealized appreciation/depreciation on investments.
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 96% of our policyholder liabilities at December 31, 2006 and 95% at December 31, 2005. 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, 2006, interest rate guarantees on our direct interest sensitive products ranged from 1.50% to 5.50%, with a weighted average guarantee of 2.47%. These ranges exclude certain contracts with an account value totaling $3.4 million with guarantees ranging up to 9.70%. This range excludes certain contracts with an account value totaling $3.4 million at December 31, 2006 with guarantees ranging up to 9.70%. The following table sets forth account values of direct individual deferred annuities (excluding index annuities) and interest
sensitive life products, including the general account portion of variable contracts, broken out by the excess of current interest crediting rates over guaranteed rates at December 31, 2006.
For index annuities, call options are purchased to fund the index credits owed to contract holders who elect to participate in one or more market indices. Except for certain contracts for which minimum guaranteed interest rates apply, the options are purchased to fund the full amount of the annual index credits. For contracts for which minimum guaranteed interest rates apply, the options are generally purchased to fund the amount of the annual index credits in excess of minimum guaranteed interest accrued on the contracts. In 2006, proceeds from the maturity of call options totaled $67.9 million while related index amounts credited to contract holders’ account balances totaled $71.3 million. The difference between index credits and option proceeds is primarily attributable to call options being purchased out-of-the-money by the amount of minimum guarantees applicable to certain coinsured contracts.
The models used to estimate the impact of a 10% change in market interest rates use many assumptions and estimates that materially impact the fair value calculations. Key assumptions used by the models include an immediate and parallel shift in the yield curve and an acceleration of bond calls and principal prepayments on mortgage and other asset-backed securities. The above estimates do not attempt to measure the financial statement impact on the resulting change in deferred policy acquisition costs, deferred sales inducements, value of insurance in force acquired, unearned revenue reserves and income taxes. Due to the subjectivity of these assumptions, the actual impact of a 10% change in rates on the fair market values would likely be different from that estimated.
Equity price risk is not material to us due to the relatively small equity portfolio held at December 31, 2006. 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 2006, 2005 and 2004. The mortality and expense fee rates range from 0.90% to 1.40% for 2006, 2005 and 2004. 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. In addition, we have equity price risk to the extent we may owe amounts under the guaranteed minimum death benefit and incremental death benefit provisions of our variable annuity contracts. See Note 1 to the consolidated financial statements for additional discussion of these provisions.
We paid cash dividends on our common and preferred stock totaling $13.7 million in 2006, $12.3 million in 2005, and $11.6 million in 2004. Interest payments on our debt totaled $11.7 million in 2006, $11.8 million in 2005 and $8.6 million in 2004. It is anticipated that quarterly cash dividend requirements for 2007 will be $0.12 per common share and $0.0075 per Series B redeemable preferred share, or approximately $14.6 million. In addition, interest payments on our debt outstanding at December 31, 2006 are estimated to be $11.8 million for 2007.
FBL Financial Group, Inc. expects to rely on available cash resources and dividends from Farm Bureau Life to make dividend payments to its stockholders and interest payments on its debt. In 2006 FBL Financial Group relied on dividends from Farm Bureau Life to support the capital needs of EquiTrust Life. During 2006, Farm Bureau Life obtained regulatory approval and paid dividends totaling $94.9 million to FBL Financial Group, which were subsequently contributed to EquiTrust Life. Additional funding for EquiTrust Life’s growth over the near term is expected to come primarily from external debt financing.
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, 2006, we had no material commitments for capital expenditures. The parent company had available cash and investments totaling $3.1 million at December 31, 2006.
The Life Companies’ cash inflows consist primarily of premium income, deposits to policyholder account balances, income from investments, sales, maturities and calls of investments, repayments of investment principal and proceeds from call option exercises. In addition, EquiTrust Life receives capital contributions from FBL Financial Group to help fund its growth. The Life Companies’ cash outflows are primarily related to withdrawals of policyholder account balances, investment purchases, payment of policy acquisition costs, policyholder benefits, income taxes, dividends and current operating expenses. Life insurance companies generally produce a positive cash flow which may be measured by the degree to which cash inflows are adequate to meet benefit obligations to policyholders and normal operating expenses as they are incurred. The remaining cash flow is generally used to increase the asset base to provide funds to meet the need for future policy benefit payments and for writing new business. The Life Companies’ liquidity positions continued to be favorable in 2006, with cash inflows at levels sufficient to provide the funds necessary to meet their obligations.
For the life insurance operations, cash outflow requirements for operations are typically met from normal premium and deposit cash inflows. This has been the case for all reported periods as the Life Companies’ continuing operations and financing activities relating to interest sensitive and index products provided funds totaling $1,599.1 million in 2006, $892.2 million in 2005 and $833.4 million in 2004. Positive cash flow from operations is generally
used to increase the Life Companies’ fixed maturity securities and other investment portfolios. In developing their investment strategy, the Life Companies establish a level of cash and securities which, combined with expected net cash inflows from operations, maturities of fixed maturity investments and principal payments on mortgage and asset-backed securities and mortgage loans, are believed adequate to meet anticipated short-term and long-term benefit and expense payment obligations.
It is anticipated that our parent company will borrow approximately $100.0 million during 2007 to fund the continued growth of EquiTrust Life. We expect to be able to obtain a waiver for the debt restriction on our existing revolving line of credit agreement to allow the additional borrowing. While the terms of any future debt issuance are not known at this time, the parent company has available cash resources to fund any related interest payments.
We do not have any off-balance sheet arrangements as of December 31, 2006 or 2005, except for collateral held for derivative transactions as discussed in Note 2 of our notes to the consolidated financial statements.
Amounts shown in this table are projected payments through the year 2056 which we are contractually obligated to pay to our life insurance and annuity contract holders. The payments are derived from actuarial models which assume a level interest rate scenario and incorporate assumptions regarding mortality and persistency when applicable. These assumptions are based on our historical experience. The total of the contractual obligations relating to insurance contracts noted above differs from the liability balance on our consolidated balance sheet as follows:
Interest on the revolving line of credit is assumed to be 6.12% until maturity.
Includes our estimated future contributions to multiemployer defined benefit plans. Contributions related to the qualified pension plan are included through 2007. No amounts related to the qualified pension plan are included beyond 2007 as the contribution amounts will be re-evaluated based on actual results.
In our opinion, management’s assessment that FBL Financial Group, Inc. maintained effective internal control over financial reporting as of December 31, 2006, is fairly stated, in all material respects, based on the COSO criteria. Also, in our opinion, FBL Financial Group, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2006, based on the COSO criteria.
In September 2006, the FASB issued Statement No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB Statements No. 87, 88, 106 and 132(R).” This Statement requires the recognition of an asset or liability in the consolidated balance sheet based on the funded status of a defined benefit postretirement plan and changes in the funded status of the plan are recorded as a component of comprehensive income in the year in which the changes occur. These requirements are effective for fiscal years ending after December 15, 2006. Statement No. 158 also requires measurement of a plan’s assets and benefit obligations as of the end of the employer’s fiscal year, beginning with fiscal years ending after December 15, 2008. Statement No. 158 has minimal impact on our consolidated financial statements as we participate with several affiliates and an unaffiliated organization in various multiemployer defined benefit and other postretirement plans, which are exempt from this Statement. However, we did adopt Statement No. 158 in the fourth quarter of 2006 for two small single employer health and medical postretirement plans. The impact of this adoption at December 31, 2006 was to increase other liabilities $0.3 million for the underfunded status of these plans, reduce accumulated
other comprehensive income $0.2 million and record a deferred tax asset of $0.1 million. This Statement has no impact on our consolidated statement of income.
In September 2006, the FASB issued Statement No. 157, “Fair Value Measurements,” which defines fair value, establishes a framework for measuring fair value and expands the required disclosures about fair value measurements. This Statement is effective for fiscal years beginning after November 15, 2007. The impact of adoption is not expected to be material to our consolidated financial statements.
Fixed maturity securities, comprised of bonds and redeemable preferred stocks, which may be sold, are designated as “available for sale.” Available-for-sale securities are reported at market value and unrealized gains and losses on these securities, with the exception of unrealized gains and losses relating to the conversion feature embedded in convertible fixed maturity securities, are included directly in stockholders’ equity as a component of accumulated
Equity securities, comprised of common and non-redeemable preferred stocks are designated as “available for sale” and are reported at market value. The change in unrealized appreciation and depreciation of equity securities is included directly in stockholders’ equity, net of any related deferred income taxes, as a component of accumulated other comprehensive income.
Derivative instruments include interest rate swaps used to reduce our exposure to increases in market interest rates and call options used to fund index credits on index annuities. In addition, during 2004 we had a treasury rate lock agreement (“rate lock”) in effect in connection with a debt offering. Furthermore, we have embedded derivatives associated with our index annuity business, certain modified coinsurance contracts and when-issued investment trading activity. All derivatives are recognized as either assets or liabilities in the consolidated balance sheets and measured at fair value.
During 2004, we entered into the rate lock to hedge the interest rate on a portion of a debt offering. The rate lock was accounted for as a cash flow hedge and proceeds from the rate lock were deferred and are being amortized over the term of the debt using the effective interest method.
Investment real estate is reported at cost less allowances for depreciation. Real estate acquired through foreclosure, which is included with investment real estate in our consolidated balance sheets, is recorded at the lower of cost (which includes the balance of the mortgage loan, any accrued interest and any costs incurred to obtain title to the property) or estimated fair value on the foreclosure date. The carrying value of these assets is subject to regular review. For properties not held for sale, if indicators of impairment are present and a property’s expected
undiscounted cash flows are not sufficient to recover the property’s carrying value, an impairment loss is recognized and the property’s cost basis is reduced to fair value. If the fair value, less estimated sales costs, of real estate held for sale decreases to an amount lower than its carrying value, the carrying value of the real estate is reduced by the establishment of a valuation allowance, changes to which are recognized as realized gains or losses on investments.
Property and equipment, comprised primarily of furniture, equipment and capitalized software costs, are reported at cost less allowances for depreciation and amortization. Depreciation and amortization expense is computed primarily using the straight-line method over the estimated useful lives of the assets. Furniture and equipment had a carrying value of $35.2 million at December 31, 2006 and $36.3 million at December 31, 2005, and estimated useful lives that generally range from two to ten years. Capitalized software costs had a carrying value of $10.8 million at December 31, 2006 and $10.5 million at December 31, 2005, and estimated useful lives that range from two to five years. Depreciation expense for furniture and equipment was $9.4 million in 2006, $8.7 million in 2005 and $8.2 million in 2004. Amortization expense for capitalized software was $4.9 million in 2006, $4.8 million in 2005 and $4.1 million in 2004.
For our direct business, interest crediting rates for interest sensitive products ranged from 2.30% to 5.50% in 2006, from 2.40% to 5.50% in 2005 and from 1.75% to 5.50% in 2004. These ranges exclude certain contracts with an account value totaling $3.4 million with guarantees ranging up to 9.70%. For interest sensitive products assumed through coinsurance agreements, interest crediting rates ranged from 3.00% to 6.00% in 2006 and from 3.00% to 11.50% in 2005 and 2004. A portion of the interest credited on our direct business and assumed through the coinsurance agreement ($3.9 million in 2006, $1.2 million in 2005 and $9.5 million in 2004) represents an additional interest credit on first-year premiums, payable at policy issue or until the first contract anniversary date (first-year bonus interest). These amounts are included as deferred sales inducements.
The liability for future policy benefits for direct participating traditional life insurance is based on net level premium reserves, including assumptions as to interest, mortality and other factors underlying the guaranteed policy cash values. Reserve interest assumptions are level and range from 2.00% to 6.00%. The average rate of assumed investment yields used in estimating gross margins was 6.33% in 2006, 6.28% in 2005 and 6.51% in 2004. Accrued dividends for participating business are established for anticipated amounts earned to date that have not been paid. The declaration of future dividends for participating business is at the discretion of the Board of Directors of Farm Bureau Life. Participating business accounted for 42% of direct receipts from policyholders during 2006, and 43% for 2005 and 2004 and represented 14% of life insurance in force at December 31, 2006 (2005 - 14% and 2004 - 15%). The liability for future policy benefits for non-participating traditional life insurance is computed using a net level method, including assumptions as to mortality, persistency and interest and includes provisions for possible unfavorable deviations.
We had undiscounted reserves of $0.1 million at December 31, 2006 and December 31, 2005 to cover estimated future assessments on known insolvencies. We had assets totaling $0.3 million at December 31, 2006 and $0.4 million at December 31, 2005 representing estimated premium tax offsets on paid and future assessments. Expenses incurred for guaranty fund assessments, net of related premium tax offsets, totaled less than $0.1 million in 2006,
In July 2005, we announced the closing of our life insurance processing unit in Manhattan, Kansas. As a result of the closure and some additional unrelated terminations, we incurred a pre-tax charge of $2.3 million during 2005, relating primarily to severance and early retirement benefits. These expenses are recorded in the underwriting, acquisition and insurance expense line of the consolidated statements of income.
We have two share-based payment arrangements under our Class A Common Stock Compensation Plan, which are described in more detail in Note 9, “Retirement and Compensation Plans - Stock Compensation Plans.” Effective January 1, 2006, we adopted Statement No. 123(R), “Share-Based Payment,” using the modified-prospective-transition method. In 2006 we recognized compensation expense for all share-based payments granted, modified or settled after the date of adoption, as well as for any awards that were granted prior to the adoption date for which the requisite service had not been provided as of the adoption date. The stock option expense is recognized over the shorter of our five-year vesting schedule or the period ending when the employee becomes eligible for retirement using the straight-line method. In addition, the impact of forfeitures is estimated and compensation expense is recognized only for those options expected to vest. Also, under Statement No. 123(R) we have reported stock option-related tax deductions in excess of recognized compensation expense as a financing cash flow.
As a result of adopting Statement No. 123(R), net income for 2006 is $0.2 million lower (less than $0.01 per basic and diluted common share) than if we had continued to account for share-based compensation under Statement No. 123. This includes a cumulative effect adjustment of $0.1 million (less than $0.01 per basic and diluted common share) relating to the change in accounting for forfeitures which is recorded as a reduction to compensation expense in our 2006 consolidated income statement. Also, for 2006, $1.6 million of excess tax deductions are classified as financing cash inflows instead of operating cash inflows as they would have been under Statement No. 123. Results for prior periods have not been restated.
Prior to January 1, 2006, we followed the prospective method under Statement No. 123. Under the prospective method, expense was recognized for those options granted, modified or settled after the date of adoption. The expense was generally recognized ratably over our five-year vesting period without regard to when an employee became eligible for retirement and immediate vesting. In addition, the impact of forfeitures was recognized when they occurred.
The following table illustrates the effect on net income and earnings per share if the fair value based method under Statement No. 123 had been applied to all outstanding and unvested awards.
Certain amounts in the 2005 and 2004 consolidated statements of cash flows have been reclassified to conform to the 2006 financial statement presentation.
Net unrealized investment gains on fixed maturity and equity securities classified as available for sale and interest rate swaps, recorded directly to stockholders’ equity, were comprised of the following:
Corporate securities: The unrealized losses on corporate securities totaled $59.4 million, or 48.5% of our total unrealized losses. The largest losses were in the manufacturing sector ($467.7 million carrying value and $21.8 million unrealized loss) and in the financial services sector ($788.1 million carrying value and $18.8 million unrealized loss). The largest unrealized losses in the manufacturing sector were in the paper and allied products sector ($91.2 million carrying value and $5.6 million unrealized loss) and the printing and publishing sector ($42.2 million carrying value and $3.8 million unrealized loss). The unrealized losses in the paper and allied products sector and the printing and publishing sector are due to a rise in market interest rates and spread widening that is the result of weaker operating results. In addition, we believe there are concerns that these sectors may experience increased equity enhancing activity by management, such as common stock buybacks, which could be detrimental to credit quality. The unrealized loss in the financial services sector and the remaining corporate sectors was caused primarily by a rise in market interest rates. Because we have the ability and intent to hold these investments until a recovery of fair value, which may be maturity, we do not consider these investments to be other-than-temporarily impaired at December 31, 2006.
Mortgage and asset-backed securities: The unrealized losses on mortgage and asset-backed securities totaled $27.6 million, or 22.5% of our total unrealized losses, and were caused primarily by increases in market interest rates. We purchased most of these investments at a discount to their face amount and the contractual cash flows of these investments are based on mortgages and other assets backing the securities. Because the decline in market value is attributable to changes in market interest rates and not credit quality, and because we have the ability and intent to hold these investments until a recovery of fair value, which may be maturity, we do not consider these investments to be other-than-temporarily impaired at December 31, 2006.
We have investments in several variable interest entities for which we are not considered the primary beneficiary. These investments consist of common and preferred stock investments in a company that operates in the broker/ dealer industry and certain mezzanine commercial real estate loans on real estate properties. The broker/dealer had revenues totaling $51.9 million for 2006, $49.7 million for 2005 and $43.9 million for 2004. There was one real estate project in 2006, three in 2005 and four real estate projects in 2004. Each real estate project has assets totaling less than $5.0 million at December 31, 2006 and less than $17.0 million at December 31, 2005 and December 31, 2004. Our investments in these entities were made during the period from 2002 to 2005. Our maximum exposure to loss is the carrying value of our investments which totaled $5.5 million at December 31, 2006 and $5.0 million at December 31, 2005 for the broker/dealer and $0.8 million at December 31, 2006 and $4.3 million at December 31, 2005 for the mezzanine commercial real estate loans.
During 2006, we sold our equity investment in Western Agricultural Insurance Company, an affiliate, at its fair market value of $7.9 million, to Farm Bureau Mutual Insurance Company (Farm Bureau Mutual), another affiliate. A realized gain of $1.9 million was recognized on this transaction. During 2004, we also sold certain investment real estate properties to Farm Bureau Mutual at their fair market value of $20.0 million and realized a gain of $5.3 million from these transactions.
At December 31, 2006, affidavits of deposits covering investments with a carrying value totaling $9,431.4 million were on deposit with state agencies to meet regulatory requirements. Also, fixed maturity securities with a carrying value of $47.3 million were on deposit with the Federal Home Loan Bank as collateral for a funding agreement.
The carrying value of investments which have been non-income producing for the twelve months preceding December 31, 2006 include real estate, fixed income, equity securities and other long-term investments totaling $2.9 million.
No investment in any entity or its affiliates (other than bonds issued by agencies of the United States Government) exceeded ten percent of stockholders’ equity at December 31, 2006.
Beginning in 2006, we also entered into one interest rate swap to hedge the variable component of the interest rate on our line of credit borrowings. The terms of this swap provide that we pay a fixed rate of interest and receive a floating rate of interest on a notional amount of $46.0 million. Any gain or loss on the interest rate swap settlements offset any increase or decrease in the interest paid on the line of credit, effectively fixing our interest expense related to the outstanding debt on this line of credit at a rate of 5.51%. Interest expense decreased $0.2 million in 2006 as a result of the net interest settlements on this swap.
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 in immediate settlement of the instrument. Statement No. 107 also excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements and allows companies to forego the disclosures when those estimates can only be made at excessive cost. Accordingly, the aggregate fair value amounts presented herein are limited by each of these factors and do not purport to represent our underlying value.
Fixed maturity securities: Fair values for fixed maturity securities are based on quoted market prices, where available. For fixed maturity securities not actively traded, fair values are estimated using a matrix calculation assuming a spread (based on interest rates and a risk assessment of the bonds) over U.S. Treasury bond yields.
Mortgage loans on real estate: Fair values are estimated by discounting expected cash flows using interest rates based on a spread above the U.S. Treasury curve. These spreads are based on overall performance of the commercial real estate market and the average life and historical performance of the loans in our portfolio.
Cash, short-term investments and other long-term investments: The carrying amounts reported in the consolidated balance sheets for these instruments approximate their fair values.
Reinsurance recoverable: Reinsurance recoverable relating to our portion of the call options used to fund index credits on the index annuities assumed from American Equity is reported at fair value. Fair value is determined using quoted market prices for the call options. Reinsurance recoverable also includes the embedded derivatives in
Long-term debt: The fair values for long-term debt are estimated using discounted cash flow analysis based on our current incremental borrowing rate for similar types of borrowing arrangements.
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. New sales of certain term life products are reinsured on a first dollar quota share basis. We do not use financial or surplus relief reinsurance. Life insurance in force ceded on a consolidated basis totaled $8,012.8 million (20.9% of direct life insurance in force) at December 31, 2006 and $7,068.2 million (19.7% of direct life insurance in force) at December 31, 2005.
In total, insurance premiums and product charges have been reduced by $30.7 million in 2006, $30.4 million in 2005 and $29.6 million in 2004 and insurance benefits have been reduced by $21.2 million in 2006, $15.7 million in 2005 and $14.7 million in 2004 as a result of cession agreements.
We assume certain annuity business issued prior to August 1, 2004 through the coinsurance agreement with American Equity. Effective August 1, 2004, we announced the suspension of this agreement and, as a result of this suspension, no transfers of new business will occur unless we and American Equity agree to resume the coinsurance of new business. The business assumed by us prior to the suspension remains as part of our in force business. Premiums collected on this assumed business, not included in revenues in the consolidated statements of income, totaled $2.9 million in 2006, $4.5 million in 2005 and $202.1 million in 2004.
Life insurance in force assumed on a consolidated basis totaled $1,626.5 million (5.1% of total life insurance in force) at December 31, 2006, $1,844.5 million (6.0% of total life insurance in force) at December 31, 2005 and $1,843.5 million (6.3% of total life insurance in force) at December 31, 2004. In total, premiums and product charges assumed totaled $26.0 million in 2006, $24.8 million in 2005 and $23.0 million in 2004. Insurance benefits assumed totaled $10.9 million in 2006, $10.7 million in 2005 and $11.1 million in 2004.
Net amortization of the value of insurance in force acquired, based on expected future gross profits/margins, for the next five years and thereafter is expected to be as follows: 2007 - $2.7 million; 2008 - $2.7 million; 2009 - $2.7 million; 2010 - $2.7 million; 2011 - $2.6 million; and thereafter, through 2030 - $32.3 million.
The separate account assets are principally comprised of stock and bond mutual funds. The reserve for GMDBs and IDBs, determined using scenario-based modeling techniques and industry mortality assumptions, that is included in future policy benefits, totaled $1.2 million at December 31, 2006 and $0.9 million at December 31, 2005. The weighted average age of the contract holders with a GMDB or IDB rider was 59 years at December 31, 2006 and 58 years at December 31, 2005.
Incurred benefits for GMDBs and IDBs totaled $0.3 million for 2006, $0.6 million for 2005 and less than ($0.1) million for 2004. Paid benefits for GMDBs and IDBs totaled less than $0.1 million for 2006 and $0.1 million for 2005 and 2004.
million in December 2005. The Series C preferred stock was initially issued with conversion rights based upon certain contingencies not involving market price triggers. Both parties signed an agreement to waive these rights, so this instrument was not contingently convertible. The Series C preferred stock was issued at an $11.6 million discount to par. This discount accreted to interest expense during the life of the securities using the effective interest method.
As mentioned in Note 1, “Significant Accounting Policies - Accounting Changes,” multiemployer plans are not impacted by Statement No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB Statements No. 87, 88, 106 and 132(R).” Under Statement No. 158, a liability totaling $78.8 million would have been recorded for all employers at December 31, 2006 for the underfunded status of the plans. The following table illustrates the incremental effect of applying Statement No. 158 at December 31, 2006 if the employers followed the single-employer accounting model.
Expected benefits to be paid for all employers are as follows: 2007 - $24.9 million, 2008 - $24.7 million, 2009 - $21.2 million, 2010 - $23.4 million, 2011 - $22.8 million and 2012 through 2016 - $115.4 million. We expect contributions to the plans for 2008 for all employers to be approximately $33.5 million, of which $12.2 million is expected to be contributed by us.
We continue to follow Statement No. 87 for multiemployer plans. We record our proportionate share of prepaid or accrued pension cost and net periodic pension cost as follows:
Net periodic pension cost recorded in our consolidated income statements totaled $6.4 million in 2006, $7.8 million in 2005 and $6.4 million in 2004.
We participate with several affiliates in a 401(k) defined contribution plan which covers substantially all employees. We contribute FBL Financial Group, Inc. stock in an amount equal to 100% of an employee’s contributions up to 2% of the annual salary contributed by the employee and an amount equal to 50% of an employee’s contributions between 2% and 4% of the annual salary contributed by the employee. Costs are allocated among the affiliates on a basis of time incurred by the respective employees for each company. Expense related to the plan totaled $0.9 million in 2006, 2005 and 2004.
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 retirees who have worked full-time for ten years and attained age 55 while in service. Postretirement benefit expense for this plan is allocated in a manner consistent with pension expense discussed above. We also have two single employer plans that provide health and medical benefits to retirees. See Note 1, “Significant Accounting Policies - Accounting Changes,” for additional details regarding the impact of adopting Statement No. 158 for these plans. Postretirement benefit expense aggregated $0.1 million in 2006, $0.2 million in 2005 and $0.1 million in 2004.
Unrecognized compensation expense related to nonvested share-based compensation granted under the stock option arrangement totaled $3.1 million as of December 31, 2006. This expense is expected to be recognized over a weighted-average period of 2.7 years.
At December 31, 2006, shares of Class A common stock available for grant as additional awards under the Class A Common Stock Compensation Plan totaled 4,995,614.
We leased office space from Farm Bureau Mutual through December 2005. Related lease expense totaled $0.8 million in 2005 and 2004.
We have management agreements with Farm Bureau Mutual and other affiliates under which we provide general business, administrative and management services. Fee income for these services totaled $2.6 million in 2006 million and 2005 and $2.8 million in 2004. In addition, Farm Bureau Management Corporation, a wholly-owned subsidiary of the IFBF, provides certain management services to us under a separate arrangement. We incurred related expenses totaling $1.1 million in 2006, $1.0 million in 2005 and $0.8 million in 2004.
We lease our home office properties under a 15-year operating lease from a wholly-owned subsidiary of the IFBF. Future remaining minimum lease payments under this lease, as of December 31, 2006, are as follows: 2007 - $2.4 million; 2008 - $2.6 million; 2009 - $2.7 million; 2010 - $2.7 million; 2011 - $2.7 million and thereafter, through 2013 - $3.3 million. Rent expense for the lease totaled $3.0 million in 2006 and $3.1 million in 2005 and 2004. These amounts are net of $1.4 million in 2006, 2005 and 2004 in amortization of a deferred gain on the exchange of our home office properties for common stock in 1998. The remaining unamortized deferred gain totaled $8.7 million at December 31, 2006 and $10.1 million at December 31, 2005.
The financial statements of the Life Companies included herein differ from related statutory-basis financial statements principally as follows: (a) the bond portfolio is classified as either available-for-sale or trading and carried at fair value rather than generally being carried at amortized cost; (b) changes in the fair value of call options held directly by the Life Companies are recorded as a component of derivative income rather than, prior to 2006, directly to surplus; (c) acquisition costs of acquiring new business are deferred and amortized over the life of the policies rather than charged to operations as incurred; (d) future policy benefit reserves for participating traditional life insurance products are based on net level premium methods and guaranteed cash value assumptions which may differ from statutory reserves; (e) future policy benefit reserves on certain interest sensitive products are based on full account values, rather than discounting methodologies utilizing statutory interest rates; (f) net realized gains or losses attributed to changes in the level of market interest rates are recognized as gains or losses in the statements of income when the sale is completed rather than deferred and amortized over the remaining life of the fixed maturity security or mortgage loan; (g) the established formula-determined statutory investment reserve, changes in which are charged directly to surplus, is not recorded as a liability; (h) certain deferred income tax assets, agents’ balances and certain other assets designated as “non-admitted assets” for statutory purposes are reported as assets rather than being charged to surplus; (i) revenues for interest sensitive, indexed and variable products consist of policy charges for the cost of insurance, policy administration charges, amortization of policy initiation fees and surrender charges assessed rather than premiums received; (j) pension income or expense is recognized for all employees in accordance with Statement No. 87, “Employers’ Accounting for Pensions” rather than for vested employees only; (k) the financial statements of subsidiaries are consolidated with those of the insurance subsidiary rather than being accounted for under the equity method, and (l) assets and liabilities are restated to fair values when a change in ownership occurs that is accounted for as a purchase, with provisions for goodwill and other intangible assets, rather than continuing to be presented at historical cost.
Net income of the Life Companies, as determined in accordance with statutory accounting practices, was $73.8 million in 2006, $66.1 million in 2005 and $61.1 million in 2004. Statutory capital and surplus totaled $663.3 million at December 31, 2006 and $611.5 million at December 31, 2005.
The Exclusive Annuity segment primarily consists of fixed rate annuities and supplementary contracts (some of which involve life contingencies) sold through our exclusive agency distribution. Fixed rate annuities provide for tax-deferred savings and supplementary contracts provide for the systematic repayment of funds that accumulate interest. Fixed rate annuities consist primarily of flexible premium deferred annuities, but also include single premium deferred and immediate contracts. With fixed rate annuities, we bear the underlying investment risk and credit interest to the contracts at rates we determine, subject to interest rate guarantees. Beginning in the fourth quarter of 2005, the Exclusive Annuity segment also includes index annuities. With index annuity products, we bear the underlying investment risk and credit interest in an amount equal to a percentage of the gain in a specified market index, subject to minimum guarantees.
• advisory services for the management of investments and other companies;
We analyze our segment results based on pre-tax operating income (loss). Accordingly, income taxes are not allocated to the segments. In addition, operating results are generally reported net of any transactions between the segments. Operating income (loss) represents net income excluding the impact of (1) realized and unrealized gains and losses on investments, (2) changes in net unrealized gains and losses on derivatives and (3) for 2006, a lawsuit settlement. The impact of realized and unrealized gains and losses on investments and unrealized gains and losses on derivatives also includes adjustments for that portion of amortization of deferred policy acquisition costs, deferred sales inducements, unearned revenue reserve and value of insurance in force acquired attributable to such gains or losses.
We use operating income, in addition to net income, to measure our performance since realized and unrealized gains and losses on investments and the change in net unrealized gains and losses on derivatives can fluctuate greatly from period to period, and the lawsuit settlement in 2006 is a nonrecurring item. These fluctuations make it difficult to analyze core operating trends. In addition, for derivatives not designated as hedges, there is a mismatch between the valuation of the asset and liability when deriving net income. Specifically, call options relating to our index business are one or two-year assets while the embedded derivative in the index contracts represents the rights of the contract holder to receive index credits over the entire period the index annuities are expected to be in force. For our other embedded derivatives in the product segments, the embedded derivatives are marked to market, but the associated insurance liabilities are not marked to market. A view of our operating performance without the impact of these mismatches enhances the analysis of our results. We use operating income for goal setting, determining company-wide bonuses and evaluating performance on a basis comparable to that used by many in the investment community.
Beginning in 2005, we changed the allocation of capital among our segments to be consistent with a change in how we manage capital at the segment level. This change, coupled with a refinement in the allocation of accrued investment income and certain other assets and liabilities among the segments, resulted in an increase (decrease) in investments in our segments as of January 1, 2005 as follows: Exclusive Annuity - $41.9 million; Independent Annuity - $19.8 million; Traditional and Universal Life Insurance - ($69.4) million; Variable - ($12.5) million and Corporate and Other - $20.2 million. Accordingly, operating revenues and pre-tax operating income (loss) by segment for 2005 are impacted by the income on the investments transferred. An estimate of the impact of this asset transfer on operating revenues and pre-tax operating income (loss) for 2005 is as follows: Exclusive Annuity - $2.7 million; Independent Annuity - $1.3 million; Traditional and Universal Life Insurance - ($4.5) million; Variable - ($0.8) million and Corporate and Other - $1.3 million.
Our investment in equity method investees and the related equity income and interest expense are attributable to the Corporate and Other segment. Expenditures for long-lived assets were not significant during the periods presented above. Goodwill at December 31, 2006 and 2005 is allocated among the segments as follows: Exclusive Annuity ($3.9 million), Traditional and Universal Life Insurance ($6.1 million) and Variable ($1.2 million).
Net statutory premiums collected, which include premiums collected from annuities and universal life-type products that are not included in revenues for GAAP reporting, totaled $2,296.2 million in 2006, $1,432.7 million in 2005 and $1,223.7 million in 2004. Excluding the Independent Annuity segment, our total life and annuity collected premiums are concentrated in the following states: Iowa (2006 - 28%, 2005 - 27%, 2004 - 28%), Kansas (2006 - 17%, 2005 - 19%, 2004 - 20%) and Oklahoma (2006 - 7%, 2005 - 7%, 2004 - 8%). For the Independent Annuity segment, excluding reinsurance assumed, our annuity collected premiums are concentrated in the following states: Florida (2006 - 10%, 2005 - 14%, 2004 - 13%), Texas (2006 - 9%, 2005 - 8%, 2004 - 4 %), Pennsylvania (2006 - 8%, 2005 - 4%, 2004 - < 1%), California (2006 - 8%, 2005 - 10%, 2004 - 11%), North Carolina (2006 - 6%, 2005 - 8%, 2004 - 6%) and Michigan (2006 - 6%, 2005 - 7%, 2004 - 11%).
The differences between the derivative income (loss) by quarter primarily correspond to the performance of the indices upon which our call options are based. Net income was decreased $3.2 million in the second quarter of 2006 due to the settlement of a lawsuit. Net income was increased $2.6 million in the third quarter of 2006 due to an adjustment to an embedded derivative. The lawsuit settlement and embedded derivative adjustment are explained in Note 1, “Significant Accounting Policies - Recognition of Premium Revenues and Costs.”