The Company owns three buildings in Los Angeles and nine business service centers in which its administrative operations are conducted. In addition, the Company owns a building in the state of Washington in which the operations of Farmers Life are conducted.
The following table sets forth summary consolidated income statement data, consolidated balance sheet data and other operating data for the periods indicated. The following consolidated income statement data of the Company for each of the years in the five-year period ended December 31, 2001, and the consolidated balance sheet data of the Company as of December 31, 2001 and as of December 31, for each of the preceding four years have been derived from the Company's audited consolidated financial statements. The following data should be read in conjunction with the Company's Consolidated Financial Statements and related notes, "Management's Discussion and Analysis of Financial Condition and Results of Operations" and other financial information appearing elsewhere herein.
Income statement data includes the effect of amortizing the purchase accounting entries related to B.A.T's acquisition of the Company in December 1988. Major items incorporated in the purchase price of the Company include goodwill and the value of the AIF relationships of the P&C Group Companies (see Note A). Through December 31, 2001, the amortization of these two items is being taken on a straight-line basis over forty years and reduced annual pretax income by $102.8 million in each of the years 1997 through 2001.
The Company's principal activities are the provision of management services to the P&C Group Companies and the ownership and operation of the Insurance Subsidiaries. Revenues and expenses relating to these principal business activities are reflected in the Company's Consolidated Financial Statements prepared in accordance with GAAP, which differs from SAP, which the Insurance Subsidiaries are required to use for regulatory reporting purposes.
A description of the Company's major customer and related matters are discussed in Part I, Item 1, of this Report.
AIF. As AIF, the Company receives a substantial portion of its revenues and profits through the management services the Company provides to the P&C Group Companies. As a result, the Company's ongoing financial performance depends on the volume of business written by, and the efficiency and financial strength of, the P&C Group Companies. As a result, a portion of the purchase price ($1.7 billion) associated with B.A.T's acquisition of the Company in 1988 was assigned to these AIF relationships. As of December 31, 2001, the value so assigned is being amortized on a straight-line basis over forty years. The carrying amount of the AIF relationships is regularly reviewed for indications of impairment in value which in the view of management are other than temporary, including unexpected or adverse changes in the following: (1) the economic or competitive environments in which the Company operates, (2) profitability analyses and (3) cashflow analyses. As of December 31, 2001, management believes that the reported value related to the AIF relationships is recoverable.
Company operates, (2) profitability analyses and (3) cashflow analyses. As of December 31, 2001, management believes that the reported value is recoverable.
In compliance with a SEC staff announcement, the Company has recorded certain entries to the DAC and VOLBA line of the consolidated balance sheet in connection with SFAS No. 115. The SEC requires that companies record entries to those assets and liabilities that would have been adjusted had the unrealized investment gains or losses from securities classified as available-for-sale actually been realized, with corresponding credits or charges reported directly to stockholders' equity. Accordingly, DAC and VOLBA are increased or decreased to reflect what would have been the impact on estimated future gross profits, had net unrealized gains or losses on securities been realized at the balance sheet date. Net unrealized gains or losses on securities, within stockholders' equity, also reflect this impact.
Impairment of Investments. The Company regularly reviews its investment portfolio to determine whether declines in the value of investments are other than temporary as defined by SFAS No. 115. The Company's review for declines in value includes reviewing historical and forecasted financial information as well as reviewing the market performance of similar types of investments. As a result of this review, the Company determined that some of its investments had declines in value that were other than temporary as of December 31, 2001 due to unfavorable market and economic conditions. Accordingly, for the year ended December 31, 2001, the Company recorded $151.0 million of impairment losses on investments, primarily in the equity portfolios. This included $32.4 million of impairment losses related to Enron Corporation. Impairment losses were recorded for each reporting segment and, for the year ended December 31, 2001, amounted to $57.2 million, $11.0 million and $82.8 million for Farmers Management Services, Farmers Re and Farmers Life, respectively. For the year ended December 31, 2000, Farmers Life recorded $22.4 million of impairment losses on fixed income securities of Armstrong World Industries, Inc. and Owens Corning.
As of December 31, 2001, the Company held the following commitments and obligations related to the QUIPS (see Note I) and long-term operating leases on equipment and buildings (see Note S):
- In September 2000, the FASB issued SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities". This Statement revises accounting standards for securitizations and other transfers of financial assets and collateral. The adoption of this Statement did not have a material impact on the Company's consolidated financial statements.
- In June 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible Assets". This Statement addresses financial accounting and reporting for intangible assets acquired individually or with a group of other assets (but not those acquired in a business combination) at acquisition. This Statement also addresses financial accounting and reporting for goodwill and other intangible assets subsequent to their acquisition. Upon adoption of this Statement, goodwill and other intangible assets that are determined to have an indefinite useful life will no longer be amortized. Instead, goodwill and intangible assets with indefinite useful lives will be tested for impairment at least annually and intangible assets with indefinite useful lives will be evaluated to determine whether an indefinite useful life is still supported.
will no longer record $102.8 million of pretax annual amortization, $64.0 million net of tax, relating to such intangibles.
Operating Revenues. Operating revenues, which primarily consist of management fees paid to Farmers Management Services as a percentage of gross premiums earned by the P&C Group Companies, increased $101.5 million, or 6.4%, to $1,690.3 million for the year ended December 31, 2001. This growth in operating revenues was primarily attributable to higher volumes of gross premiums earned by the P&C Group Companies, which increased $968.6 million, or 8.5%, to $12,363.0 million in 2001. The increase in gross premiums earned was driven primarily by continued growth in all lines of business, which benefited from a rising premium rate environment. Also contributing to the increase in operating revenues was the fact that revenues earned in connection with the provision of management services on the business the P&C Group Companies assumed from Foremost increased $12.0 million due to the fact that the Foremost acquisition was not completed until March 2000.
Amortization of AIF Relationships and Goodwill. Purchase accounting entries related to the acquisition of the Company by B.A.T in December 1988 include both goodwill (capitalized at $2.4 billion) and the value of the AIF relationships (capitalized at $1.7 billion). Through December 31, 2001, the amortization of these two items was taken on a straight- line basis over forty years and reduced pretax income by $102.8 million for each of the years ended December 31, 2001 and 2000.
Provision for Income Taxes. Provision for income taxes decreased from $348.1 million in 2000 to $310.5 million in 2001, a decrease of $37.6 million, or 10.8%, as a result of a decrease in pretax income between years.
Life and Annuity Premiums. Life and annuity premiums increased $46.8 million, or 20.5%, between years. This increase was due to a 19.4% growth in the volume of traditional life insurance in-force, as well as a 113.2% increase in structured settlements with life contingencies premiums issued in 2001.
Life Policy Charges. Life policy charges increased $3.8 million in 2001, or 1.8%, over 2000, reflecting a 1.4% growth in universal life-type insurance in-force.
Net Investment Income. Net investment income increased $9.4 million, or 2.9%, over 2000 due primarily to an increase in average invested assets.
Impairment Losses on Investments. Impairment losses on investments increased $60.4 million, or 270.0%, from $22.4 million to $82.8 million in 2001.
Policy Benefits. Policy benefits, which consist primarily of death and surrender benefits on life products, increased $23.3 million over 2000 to $165.1 million, due to a 9.3% growth in the volume of life insurance in-force in 2001.
Increase in Liability for Future Benefits. Increase in liability for future benefits expense increased from $76.3 million in 2000 to $115.3 million in 2001. This increase was primarily attributable to a 113.2% increase in deposits for structured settlement products.
Amortization of DAC and VOLBA. Amortization expense decreased from $108.8 million in 2000 to $97.4 million in 2001, due to differences in the mix of business and favorable persistency on the Farmers Flexible Universal Life ("FFUL") product line.
General and Administrative Expenses. General and administrative expenses increased $3.8 million, from $51.3 million in 2000 to $55.1 million in 2001. This increase was due primarily to business growth.
Provision for Income Taxes. Provision for income taxes decreased from $90.4 million in 2000 to $56.7 million in 2001 due mainly to a decrease in pretax income between years.
Operating Revenues. Operating revenues increased from $1,489.7 million in 1999, to a record level of $1,588.8 million in 2000, an increase of $99.1 million, or 6.7%. This growth was primarily attributable to higher volumes of gross premiums earned by the P&C Group Companies, which increased $589.5 million, or 5.5%, to $11,394.4 million in 2000. The increase in gross premiums earned was driven primarily by $390.3 million of premiums earned as a result of the acquisition of Foremost. Growth in Commercial and Fire management fees also contributed to the increase in management fees between years.
Buildings and Equipment Expenses. Buildings and equipment expenses increased from $91.5 million in 1999 to $104.0 million in 2000, an increase of $12.5 million, or 13.7%, due primarily to expenses incurred in connection with providing management services to the business assumed from Foremost.
Amortization of AIF Relationships and Goodwill. The amortization of these two items reduced pretax income by $102.8 million for each of the years ended December 31, 2000 and 1999.
Farmers Management Services. As a result of the foregoing, Farmers Management Services income increased from $481.1 million for the year ended December 31, 1999 to $503.1 million for the year ended December 31, 2000, an increase of $22.0 million, or 4.6%.
Under the quota share reinsurance treaty in effect as of December 31, 2000, Farmers Re assumed $1,000.0 million of premiums in each of the years ended 2000 and 1999. Losses and loss adjustment expenses incurred under this treaty were $686.9 million in 2000 and $661.3 million in 1999 and non- life reinsurance commissions paid were $288.1 million in 2000 and $313.7 million in 1999. Income before taxes increased from $53.3 million in 1999 to $77.3 million in 2000, an increase of $24.0 million, or 45.0%. This increase was due primarily to increased realized capital gains and investment income. Farmers Re's contribution to net income was $52.6 million and $37.7 million in 2000 and 1999, respectively.
Life and Annuity Premiums. Life and annuity premiums increased $19.0 million, or 9.1%, between years. This growth in premiums was due to an increase in the volume of traditional policies in-force as well as an increase in the number of structured settlements with life contingencies issued in 2000.
Policy Benefits. Policy benefits increased $4.0 million over 1999 to $141.8 million due to higher mortality experience in the FFUL product line as well as growth in the volume of policies in-force in 2000.
Consolidated net income of the Company increased from $677.0 million in 1999 to $725.3 million in 2000, an increase of $48.3 million, or 7.1%.
General. The principal uses of funds by the Company are (i) operating expenses, (ii) dividends to the shareholders of the Company's QUIPS, (iii) capital expenditures and (iv) dividends to its stockholders. In 2001, dividends paid on QUIPS totaled $42.1 million, capital expenditures totaled $128.0 million and cash dividends paid to stockholders totaled $461.7 million.
the Company had available revolving credit facilities enabling it to borrow up to $500.0 million in the event such a need should arise (see Note V).
Net cash used in investing activities increased $790.1 million between years to $337.9 million in 2001. This decrease in cash was mainly the result of the partial liquidation of the Farmers Management Services investment portfolio in 2000 due to the $1,075.0 million special dividend paid in October 2000.
Net cash used in financing activities decreased from $1,611.1 million in 2000 to $468.8 million in 2001, resulting in an increase in cash of $1,142.3 million. This increase in cash was substantially due to a $1,096.1 million decrease in dividends paid to the Company's stockholders resulting mainly from the payment of the $1,075.0 million special dividend associated with the Zurich capital structure unification in October 2000.
In our opinion, the consolidated financial statements listed in the index appearing under Item 14(a)(2) on page 81 present fairly, in all material respects, the financial position of Farmers Group, Inc. and subsidiaries (the "Company") at December 31, 2001, and the results of their operations and their cash flows for the year ended December 31, 2001 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedules for the year ended December 31, 2001 listed in the index appearing under Item 14(a)(2) on page 81 present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedules are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audit. We conducted our audit of these statements in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
We have audited the accompanying consolidated balance sheet of Farmers Group, Inc. and subsidiaries (the "Company") as of December 31, 2000 and the related consolidated statements of income, comprehensive income, stockholders' equity, and cash flows for each of the two years in the period then ended December 31, 2000. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2000, and the results of its operations and its cash flows for each of the two years in the period then ended in conformity with accounting principles generally accepted in the United States of America.
Our audits were conducted for the purpose of forming an opinion on the basic financial statements taken as a whole. The financial statement schedules for each of the two years in the period ended December 31, 2000 listed in the Table of Contents at Item 14 are presented for the purpose of additional analysis and are not a required part of the basic financial statements. These schedules are the responsibility of the Company's management. Such schedules have been subjected to the auditing procedures applied in our audits of the basic financial statements and, in our opinion, are fairly stated in all material respects when considered in relation to the basic financial statements as a whole.
The excess of the purchase price over the fair value of the net assets ("Goodwill") of the Company at the date of the Company's acquisition by B.A.T ($2,401,755,000) is being amortized on a straight-line basis over forty
years as of December 31, 2001. The carrying amount of the Goodwill is regularly reviewed for indications of impairment in value which in the view of management are other than temporary, including unexpected or adverse changes in the following: (1) the economic or competitive environments in which the Company operates, (2) profitability analyses and (3) cashflow analyses. As of December 31, 2001, management believes that the reported value is recoverable.
At the date of the Company's acquisition by B.A.T, the Company's life insurance operations were conducted by three wholly owned subsidiaries, Farmers New World Life Insurance Company ("Farmers Life"), The Ohio State Life Insurance Company ("OSL") and Investors Guaranty Life Insurance Company ("IGL"). A portion of the purchase price ($662,778,000) was assigned to the "Value of Life Business Acquired" ("VOLBA"), which represented an actuarial determination of the expected profits from the business in force at the date of B.A.T's acquisition of the Company. The amount so assigned is being amortized over its actuarially determined useful life with the unamortized amount included in the "Deferred Policy Acquisition Costs and Value of Life Business Acquired" line in the accompanying consolidated balance sheets.
Farmers Re is a wholly owned subsidiary of FGI. On January 1, 1998, Farmers Re entered into an auto physical damage ("APD") reinsurance agreement with the P&C Group Companies. Effective April 1, 2001, this APD reinsurance agreement was cancelled and replaced with a similar APD reinsurance agreement supported by Farmers Re, Zurich affiliates and outside re-insurers. Under the new agreement, annual premiums ceded by the P&C Group Companies increased from $1,000,000,000 to $2,000,000,000 with Farmers Re assuming 10%, or $200,000,000. The remaining $1,800,000,000 is ceded to the Zurich affiliates and outside reinsurance companies identified in the agreement. As a result of the new agreement, Farmers Re's premiums decreased from $1,000,000,000 for the year ended December 31, 2000 to $400,000,000 for the year ended December 31, 2001. Additionally, on a monthly basis, premiums assumed decreased from $83,333,000 in 2000 to $16,667,000 in 2001. This new agreement, which can be terminated by any of the parties, also provides for the P&C Group Companies to receive a ceding commission of 18% of premiums, versus 20% under the old agreement, with additional experience commissions that depend on loss experience. Similar to the old agreement, this experience commission arrangement limits Farmers Re's potential underwriting gain on the assumed business to 2.5% of premiums assumed.
In 1998, the Financial Accounting Standards Board ("FASB") released Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging Activities". This Statement establishes accounting and reporting standards for derivative instruments (including certain derivative instruments embedded in other contracts) and for hedging activities. SFAS No. 133 requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at market value. Subsequently, in June 1999, the FASB released SFAS No. 137, "Deferral of the Effective Date of FASB Statement No. 133", which deferred the effective date of SFAS No. 133 to fiscal years beginning after June 15, 2000. Finally, in June 2000, the FASB released SFAS No. 138, "Accounting for Certain Derivative Instruments and Certain Hedging Activities". This Statement amends the accounting and reporting standards of SFAS No. 133 for the following items: normal purchases and normal sales exception, interest rate risk, recognized foreign-currency-denominated debt instruments and intercompany derivatives. This Statement also amends SFAS No. 133 for certain provisions related to the implementation guidance arising from the Derivative Implementation Group process. SFAS No. 133, No. 137 and No.138 are effective for financial statements issued by the Company for periods ending after December 31, 2000. The adoption of these Statements did not have a material impact on the Company's consolidated financial statements.
In June 2001, the FASB issued SFAS No. 141, "Business Combinations". This Statement, effective for all business combinations initiated after June 30, 2001, establishes standards for accounting and reporting business combinations. It requires that all business combinations be accounted for by the purchase method and prohibits the pooling of interest method of accounting except for transactions initiated before July 1, 2001. This Statement supersedes Accounting Principles Board ("APB") Opinion No. 16, "Business Combinations", and FASB Statement No. 38, "Accounting for Preacquisition Contingencies of Purchased Enterprises". The adoption of this Statement did not have a material impact on the Company's consolidated financial statements.
The Company has adopted the provisions of SFAS No. 142 effective January 1, 2002, as applicable to all goodwill and other intangibles recognized in its financial statements at that date. The Company is in the process of completing the transitional goodwill impairment test and has identified the AIF relationships as intangible assets with indefinite useful lives. The Company will perform impairment tests of goodwill and the AIF relationships using discounted future cashflows and, based on such tests, the Company does not expect any impairment of recorded goodwill or AIF relationships. Additionally, as SFAS No. 142 ceases amortization of goodwill and AIF relationships with indefinite useful lives, the Company expects that it will no longer record $102,770,000 of pretax annual amortization, $64,026,000, net of tax, relating to such intangibles.
In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations". This Statement establishes the standard to record the fair value of a liability for an asset retirement obligation in the period in which it is incurred. It also applies to legal obligations associated with the retirement of tangible long-lived assets that result from the acquisition, construction, development and/or normal operation of a long-lived asset, except for certain obligations of lessees. This Statement amends SFAS No. 19, "Financial Accounting and Reporting by Oil and Gas Producing Companies". The provisions of this Statement are effective for fiscal years beginning after June 15, 2002, with early application encouraged. The Company does not expect the adoption of this Statement to have a material impact on its consolidated financial statements.
Total losses paid by Farmers Re were $260,174,000, $590,214,000 and $547,827,000 in 2001, 2000 and 1999, respectively, while total loss adjustment expenses were $2,900,000, $6,725,000 and $6,980,000 in 2001, 2000 and 1999, respectively. Additionally, reinsurance commissions were $108,004,000 in 2001, $288,126,000 in 2000 and $313,749,000 in 1999. Farmers Re had loss reserves of $18,922,000 and $89,936,000 as of December 31, 2001 and 2000, respectively. The decreases between 2001 and 2000 results were due to Farmers Re's reduced retention under the new APD reinsurance agreement. All reinsurance receivables and payables were settled as of December 31, 2001.
As of December 31, 2001 and 2000, all of the members of the Company's Board of Directors were employees of the Company as a result of a restructuring of the Company's Board of Directors in April 2000. Prior to April 2000, certain directors of the Company were partners in legal firms that received fees for legal services from the Company and the P&C Group Companies. As such, for the year ended December 31, 1999, these fees totaled $8,492,000.
As of December 31, 2001, the Company held the following notes receivable from related parties:
Also, on October 23, 2000, to help fund the payment of a $1,075,000,000 special dividend associated with the Zurich capital structure unification in October 2000, the Company sold $580,000,000 of notes receivable from UKISA to ZIC for par value. Finally, on September 3, 2001, the Company received $214,625,000 from UKISA in settlement of a $207,000,000 note receivable and $7,625,000 of accrued interest. This note had a maturity date of September 3, 2001 and a coupon rate of 5.48%.
As a result, as of December 31, 2001, the Company held $95,000,000 of notes receivable from UKISA each with a maturity date of September 2002. The $95,000,000 of notes receivable are fixed rate short-term notes with coupon rates as follows: $25,000,000 at a coupon rate of 6.80% and $70,000,000 at a coupon rate of 5.67%. Interest on the UKISA notes is paid semi-annually and, for the years ended December 31, 2001, 2000 and 1999, income earned totaled $14,589,000, $45,425,000 and $59,434,000, respectively.
H. Certificates of contribution and surplus notes of the P&C Group Companies
From time to time, the Company has purchased certificates of contribution or surplus notes of the P&C Group Companies in order to maintain the policyholders' surplus of the P&C Group Companies. In September 2001, the Company redeemed one-half of the $175,000,000 surplus notes of the P&C Group Companies, which were obtained in March 2000 as a result of the assignment of the matured surplus notes of the P&C Group Companies from Eagle Star (see Note G). In addition, effective December 2001, Farmers Life redeemed a $119,000,000 surplus note of the P&C Group Companies bearing interest at 6.10% annually and maturing in October 2001. This redemption was settled in January 2002 and, as such, Farmers Life held a $119,000,000 receivable from the P&C Group Companies as of December 31, 2001.
- $370,000,000 of certificates of contribution, issued in March 2000, bearing interest at 7.85% annually and maturing in March 2010.
- $350,000,000 of certificates of contribution, issued in November 2001, bearing interest at 6.00% annually and maturing in September 2006.
- $206,500,000 of certificates of contribution, issued in December 2001, bearing interest at 6.00% annually and maturing in September 2006.
Conditions governing repayment of these amounts are outlined in the certificates of contribution and the surplus note. Generally, repayment may be made only when the surplus balance of the issuer reaches a certain specified level, and then only after approval is granted by the issuer's governing Board and the appropriate state insurance regulatory department.
In 1995, Farmers Group Capital and Farmers Group Capital II (the "Subsidiary Trusts"), consolidated wholly owned subsidiaries of FGI, issued $410 million of 8.45% Cumulative Quarterly Income Preferred Securities ("QUIPS"), Series A and $90 million of 8.25% QUIPS, Series B, respectively. In connection with the Subsidiary Trusts' issuance of the QUIPS and the related purchase by FGI of all of the Subsidiary Trusts' Common Securities ("Common Securities"), FGI issued to Farmers Group Capital $422,680,399 principal amount of its 8.45% Junior Subordinated Debentures, Series A due on December 31, 2025, (the "Junior Subordinated Debentures, Series A") and issued to Farmers Group Capital II $92,783,505 principal amount of its 8.25% Junior Subordinated Debentures, Series B due on December 31, 2025 (the "Junior Subordinated Debentures, Series B" and, together with the Junior Subordinated Debentures, Series A, the "Junior Subordinated Debentures"). The sole assets of Farmers Group Capital are the Junior Subordinated Debentures, Series A. The sole assets of Farmers Group Capital II are the Junior Subordinated Debentures, Series B. In addition, these arrangements are governed by various agreements between FGI and the Subsidiary Trusts (the Guarantee Agreements, the Trust Agreements, the Expense Agreements, the Indentures and the Junior Subordinated Debentures) which considered together constitute a full and unconditional guarantee by FGI of the Subsidiary Trusts' obligations under the Preferred Securities.
As of December 31, 2001 and 2000, a total of 20,000,000 shares of QUIPS were outstanding.
There are certain statutory limitations on the distribution of surplus. As of December 31, 2001, an aggregate of $212,969,000 was available for distribution as dividends by the Insurance Subsidiaries without the approval of the state insurance departments in which they are domiciled. In January 2001, Farmers Life paid a $112,000,000 dividend to Farmers Management Services.
Real estate investments are accounted for on a depreciated cost basis. Real estate acquired in foreclosure and held for sale is carried at the lower of market value or depreciated cost less a valuation allowance. Marketable securities are carried at market. The Standard & Poor's 500 Composite Stock Price Index ("S&P 500") call options are carried at estimated fair value. Other investments, which consist primarily of certificates of contribution of the P&C Group Companies, surplus notes of the P&C Group Companies, policy loans and notes receivable from affiliates, which include the UKISA notes and ZGAUS note, are carried at the unpaid principal balances.
* Includes ($3.7 million), ($1.8 million) and $4.1 million in 2001, 2000 and 1999, respectively, of unrealized gains/(losses) associated with the trading securities reported on the "Other assets" line of the consolidated balance sheets.
Realized gains and losses on sales and redemptions owned by Farmers Management Services are determined based on either the cost of the individual securities or the amortized cost of real estate. Net realized investment gains or losses for the years ended December 31 are:
Realized gains and losses on sales and redemptions by the Insurance Subsidiaries are determined based on either the cost of the individual securities or the amortized cost of real estate. Net realized investment gains or losses for the years ended December 31 are:
The amortized cost, gross unrealized gains and losses, and estimated market values of investments in equity securities pertaining to non-redeemable preferred stocks and common stocks owned by the Insurance Subsidiaries are as follows:
The amortized cost, gross unrealized gains and losses, and estimated market values of investments in debt securities, including bonds and redeemable preferred stocks, owned by the Insurance Subsidiaries are as follows:
The change in the net unrealized gains or (losses) of Farmers Management Services for the years ended December 31 are as follows:
The change in the net unrealized gains or (losses) of the Insurance Subsidiaries for the years ended December 31 are as follows:
During 1997, Farmers Life began selling an equity-indexed annuity product. At the end of its seven year term, this product credits interest to the annuity participant at a rate based on a specified portion of the change in the value of the S&P 500, subject to a guaranteed annual minimum return. In order to hedge the interest liability generated on the annuities as the index rises, Farmers Life purchases call options on the S&P 500. Farmers Life considers such S&P 500 call options to be held as a hedge. As of December 31, 2001 and 2000, Farmers Life had S&P 500 call options with contract values of $117,257,000 and $94,535,000, respectively, and carrying values of $12,690,000 and $26,271,000, respectively.
There are certain risks associated with the call options, primarily with respect to significant movements in the United States stock market and counterparty nonperformance. The Company believes that the counterparties to its call option agreements are financially responsible and that the counterparty risk associated with these transactions is minimal.
The following methods and assumptions were used to estimate the fair value of financial instruments as of December 31, 2001 and 2000:
Other investments. Other investments consist of Endurance common stock and miscellaneous notes and investments. The carrying amounts of the Endurance common stock (see Note L) and the miscellaneous notes are a reasonable estimate of their fair values. The estimated fair values related to miscellaneous investments are based upon quoted market prices, current appraisals and independent pricing services.
S&P 500 call options. S&P 500 call options are purchased as hedges against the interest liabilities generated on the equity-indexed annuity products. These call options are carried at an estimated fair value based on stock price, strike price, time to expiration, interest rates, dividends and volatility per the methodology of the Black-Scholes Option Pricing Formula.
Based on current conditions and assumptions as to future events, Farmers Life expects to amortize the December 31, 2001 balance as follows: approximately 8.0% in 2002 and 2003 and 9.0% in 2004, 2005 and 2006. The discount rate used to determine the amortization rate of the VOLBA asset ranged from 9.0% to 3.5%.
The securities are marked-to-market on a daily basis and the collateral is adjusted on the next business day. The collateral is invested in highly liquid, fixed income assets with a maturity of less than one year. Income earned from the security lending arrangements was allocated 75% to the Company and 25% to the lending provider for the years ended December 31, 2001, 2000 and 1999. Income earned by the Company was $306,000, $687,000 and $799,000 in 2001, 2000 and 1999, respectively. The collateral under these arrangements as of December 31, 2001 and 2000 was $45,494,000 and $436,744,000, respectively.
The Company has two noncontributory defined benefit pension plans (the Regular Plan and the Restoration Plan). The Regular Plan covers substantially all employees of the Company and the P&C Group Companies who have reached age 21 and have rendered one year of service. Benefits are based on years of service and the employee's compensation during the last five years of employment. The Restoration Plan provides supplemental retirement benefits for certain key employees of the Company and the P&C Group Companies.
The Company's policy is to fund the amount determined under the aggregate cost method, provided it does not exceed funding limitations. There has been no change in funding policy from prior years, and in 2001, a contribution of $25,487,000 was made to the Regular Plan. The Company's share of this contribution was $11,867,000.
The Company uses the projected unit credit cost actuarial method for attribution of expense for financial reporting purposes. The interest cost and the actuarial present value of benefit obligations were computed using a weighted average interest rate of 7.25% in 2001, 7.75% in 2000 and 8.00% in 1999, while the expected return on plan assets was computed using a weighted average interest rate of 9.50% in 2001 and 2000 and 9.25% in 1999. The weighted average rate of increase in future compensation levels used in determining the actuarial present value of the projected benefit obligation was 4.70% in 2001 and 2000 and 5.00% in 1999.
The funded status of the entire plan, which includes the Company and the P&C Group Companies, as of December 1, 2001 and 2000 (the latest date for which information is available), was as follows:
The unrecognized net transition obligation of $14,421,000 in 2001 and $15,732,000 in 2000 represents the remaining transition obligation of the P&C Group Companies.
The weighted average interest rate used in the above benefit computations was 7.25% in 2001, 7.75% in 2000 and 8.00% in 1999. Beginning in 2002, the initial medical inflation rate is assumed to be 10.00% and will be graded over a 5-year period to 6.00% and level thereafter, and contribution levels from retirees were the same as applicable medical cost increases where defined benefits exist. The weighted average rate of increase in future compensation levels used in determining the actuarial present value of the accumulated benefit obligation was 4.70% in 2001 and 2000 and 5.00% in 1999.
Rental expense incurred by the Company was $36,092,000, $33,568,000 and $28,727,000 in 2001, 2000 and 1999, respectively.
The Company has long-term operating lease commitments on equipment and buildings, with options to renew at the end of the lease periods. As of December 31, 2001, the remaining commitments payable under these leases were:
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities as of December 31, 2001 and 2000 are presented in the following tables:
In 1999, the Company used $190,000,000 of proceeds it received from the settlement of a loan to Centre Reinsurance Holdings (Delaware II) Ltd., a subsidiary of Zurich, to substantially fund the issuance of the $250,000,000 loan to ZGAUS (see Note G).
Participating business, which consists of group business, comprised approximately 10.4% of Farmers Life's total insurance in-force as of December 31, 2001 and 7.7% of the total insurance in-force as of December 31, 2000. In addition, participating business represented 2.2% of Farmers Life's premium income for the year ended December 31, 2001 and 2.0% for the years ended December 31, 2000 and 1999.
The Company's principal services are the provision of management services to the P&C Group Companies and the ownership and operation of the life and reinsurance subsidiaries. These activities are managed separately as each offers a unique set of services. As a result, the Company is comprised of the following three reportable operating segments as defined in SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information": the management services segment, the life insurance segment and the reinsurance segment.
excludes the effects of the purchase accounting ("PGAAP") adjustments related to the acquisition of the Company by B.A.T in December 1988 (see Note A). This differs from the basis used in preparing the Company's financial statements included in the SEC Form 10-K and 10-Q Reports, which incorporates the effects of the PGAAP adjustments.
The P&C Group Companies collectively represent the Company's largest customer. Management fees earned by the Company as AIF for the Exchanges totaled $1.6 billion, $1.5 billion and $1.4 billion, respectively, for the years ended December 31, 2001, 2000 and 1999, which represented 54.6%, 43.3% and 42.9%, respectively, of the Company's consolidated operating revenues for the same years. The Company has no ownership interest in the P&C Group Companies and therefore is not directly affected by the underwriting results of the P&C Group Companies. However, as management fees comprise a significant part of the Company's revenues, the ongoing financial performance of the Company depends on the volume of business written by, and the business efficiency and financial strength of, the P&C Group Companies.
(e) Amount includes PGAAP adjustments associated with the AIF relationships ($1,153.6 million) and goodwill ($1,621.2 million).
(f) Amount includes PGAAP adjustments related to the DAC (($155.0) million) and VOLBA ($274.5 million) assets.