The principal operations of the Company and its subsidiaries are conducted from owned property consisting of approximately 400,000 square feet of space on a 68 acre site located at 5400 University Avenue, West Des Moines, Iowa 50266. Approximately 60,000 square feet of this property are leased to an unaffiliated company under an operating lease expiring in 1999, and approximately 140,000 square feet are leased to the Iowa Farm Bureau Federation and affiliated companies. During the first quarter of 1998, the Company's Board of Directors approved a transaction whereby the Company will exchange its home office properties for 1,268,056 unregistered shares of Class A common stock owned by the Iowa Farm Bureau Federation. The Company will lease back approximately 200,000 square feet of space from the Iowa Farm Bureau Federation under a 15 year operating lease.
(1) The comparability of selected data from year to year is impacted by the acquisition of Western Farm Bureau Life Insurance Company and the minority interests in FBL Insurance Company and Rural Security Life Insurance Company in January 1994.
(10) Loss and loss adjustment expense ratio equals the sum of statutory incurred losses and loss adjustment expenses divided by statutory earned premiums.
The costs related to acquiring new business, including certain costs of issuing policies and certain other variable selling expenses (principally commissions), defined as deferred policy acquisition costs, are capitalized and amortized into expense. For nonparticipating traditional life and accident and health insurance products, these costs are amortized over the premium paying period of the related policies, in proportion to the ratio of annual premium revenues to total anticipated premium revenues. Such anticipated premium revenues are estimated using the same assumptions used for computing liabilities for future policy benefits. For participating traditional life insurance and interest sensitive products, these costs are amortized generally in proportion to expected gross profits from surrender charges and investment, mortality, and expense margins. This amortization is adjusted when the Life Companies revise their estimate of current or future gross profits or margins. For example, deferred policy acquisition costs are amortized earlier than originally estimated when policy terminations are higher than originally estimated or when investments backing the related policyholder liabilities are sold at a gain prior to their anticipated maturity. Death and other policyholder benefits reflect exposure to mortality risk and fluctuate from period to period based on the level of claims incurred under insurance retention limits. The profitability of the Life Companies is primarily affected by expense levels, investment results and fluctuations in mortality and other policyholder benefits. The Company has the ability to mitigate adverse experience through adjustments to credited interest rates, policyholder dividends or cost of insurance charges.
Net investment income increased $13.6 million, or 6.4%, to $224.3 million for 1997 compared to $210.7 million for 1996. The increase resulted principally from a 6.8% increase in average invested assets, excluding invested assets of FBL Ventures of South Dakota, Inc. (FBL Ventures), a venture capital subsidiary, to $2,913.4 million in 1997 from $2,728.6 million in 1996, and a four basis point increase in the annualized yield earned on average invested assets (excluding yield attributable to FBL Ventures) to 7.66% in 1997 from 7.62% in 1996. Yield on invested assets increased in 1997 compared to 1996 despite a general decline in market interest rates during the same period due principally to the sale of equity securities which generate little current income and reinvestment of the proceeds in fixed maturity securities. During 1997 and 1996, the Company had net sales of equity securities with a fair value totaling $65.4 million and $72.6 million, respectively. The increase in average invested assets is attributable to net positive cash flows from operating activities totaling $106.1 million and net gains on investments during 1997. Offsetting the increase in net investment income was a $1.8 million decrease in the net investment income of FBL Ventures to $1.1 million for 1997 from $2.9 million for 1996. See "Adjusted Operating Income".
Commission expense decreased $0.2 million, or 1.7%, to $9.0 million for 1997 compared to $9.2 million for 1996. This decrease occurred despite a 3.0% increase in direct life insurance premiums collected during 1997. During 1996, first year commissions totaling $0.2 million were charged to expense rather than capitalized due to marginal profits on products no longer sold by the Company. In addition, commissions decreased due to multi-tiered commission structures on certain life insurance products whereby renewal commission rates decline over the life of the underlying policies.
Amortization of deferred policy acquisition costs increased $1.6 million, or 10.5%, to $17.1 million for 1997 compared to $15.5 million for 1996. Amortization attributable to property-casualty operations increased $1.8 million due primarily to the changes in Utah Insurance's reinsurance pool participation. Amortization attributable to life operations decreased $0.2 million.
Interest expense was $1.5 million for 1997 compared to $0.9 million for 1996 due primarily to an increase in the average debt outstanding to $24.6 million for 1997 from $15.5 million for 1996.
Other expenses increased $1.2 million, or 6.1%, to $20.2 million for 1997 compared to $19.0 million for 1996 due principally to an increase in the level of leasing, management and financial services provided to affiliates and third parties.
Net investment income decreased $12.4 million, or 5.5%, to $210.7 million for 1996 compared to $223.1 million for 1995. The decrease was predominately the result of the nonrecurrence in 1996 of gains recognized on two private equity investments held by FBL Ventures of South Dakota Inc. (FBL Ventures), a venture capital subsidiary, during 1995. During 1996, this subsidiary recognized net investment income of $2.9 million compared to $25.4 million for 1995. See "Adjusted Operating Income." Also contributing to the decrease was a 26 basis point decline in the annualized yield earned on average invested assets (excluding yield attributable to FBL Ventures) to 7.62% in 1996 from 7.88% in 1995. These decreases were partially offset by a 9.3% increase in average invested assets (excluding invested assets of FBL Ventures) to $2,728.6 million in 1996 from $2,496.3 million in 1995. The increase in average invested assets is primarily attributable to net positive cash flows from operating activities and net positive cash flows from interest sensitive products totaling $143.5 million and $34.7 million, respectively, during 1996. The decline in yield on average invested assets is the result of investing a majority of these positive cash flows and cash from investing activities in lower yielding securities. The newer securities have lower yields due principally to market interest rates during 1996 being lower than the average effective yield of the investment portfolio and the average yield on those securities sold, maturing or repaid during the year.
Other income decreased $5.1 million, or 17.3%, to $23.9 million for 1996 compared to $29.0 million for 1995 due primarily to a $4.4 million decrease in commission income from the sale of unaffiliated insurers' medical products. Effective January 1, 1996, a majority of these products are marketed through Farm Bureau Mutual Insurance Company, an affiliate.
Policy benefits increased $29.8 million, or 13.3%, to $253.6 million for 1996 compared to $223.8 million for 1995. Included in this increase was a $7.1 million increase in interest sensitive product benefits consisting of a $4.8 million increase in interest credited to these contracts and a $2.3 million increase in universal life death benefits in excess of related account balances. The increase in interest credited is principally attributable to a larger volume of business in force as the Company's interest crediting rates decreased during the periods. The weighted average crediting rate for the Company's universal life liabilities decreased to 6.39% for 1996 from 6.68% for 1995, and the weighted average crediting rate for the Company's annuity liabilities decreased to 6.35% for 1996 from 6.57% for 1995. The decrease in interest crediting rates was greater than the decrease (20 basis points) in the annualized yield on the types of invested assets supporting universal life and annuity liabilities due primarily to the timing of the Company's adjustments to its interest crediting rates for fluctuations in portfolio yield. Traditional life and accident and health benefits increased $7.4 million, or 10.3%, consisting of a $3.4 million increase in death and surrender benefits, a $2.9 million increase in the change in the reserves on these products, a $1.4 million increase in accident and health benefits and a $0.3 million net decrease in other benefits. Distributions to policyholders increased to $26.3 million from $25.7 million due to an increase in the amount of participating business in force, partially offset by a reduction in the average dividend rate credited to these policies to 6.12% from 6.49%. Losses and loss adjustment expenses incurred on property-casualty policies increased $14.8 million, or 108.2%, to $28.4 million for 1996 from $13.6 million for 1995 due primarily to the increase in Utah Insurance's reinsurance pool participation percentage, resulting in $13.5 million of additional losses and loss adjustment expenses. In addition, less favorable weather conditions in 1996 caused an increase in property losses, including approximately $0.8 million in assumed losses attributable to Hurricane Fran. During 1997, the Company discontinued participation in assumed reinsurance with coastal catastrophe exposures. The loss and loss adjustment expense ratio increased in 1996 to 86.0% from 72.8% in 1995.
Other underwriting, acquisition and insurance expenses decreased $13.0 million, or 23.6%, to $41.7 million for 1996 compared to $54.7 million for 1995. This decrease is primarily attributable to new marketing agreements with Farm Bureau property-casualty insurance companies doing business in the Company's marketing territory whereby the property-casualty insurance companies develop and manage the Company's agency force for a fee based on commissions on first year life insurance premiums and annuity deposits. As a result of the agreements, various fixed marketing costs that were charged to expense in 1995 have been replaced by lower fees ($3.6 million for 1996) which vary based on premium volume and are deferred and amortized with other policy acquisition costs. In addition, expense reductions were realized as a result of discontinuing the sale of unaffiliated insurers' medical products (see discussion regarding other income above). Also, approximately $1.9 million of the decrease is attributable to the elimination of an agent bonus program in 1996 and one-time severance benefit payments to certain employees in 1995. Furthermore, amortization of value of insurance in force acquired decreased $0.6 million in 1996 compared to 1995 due to the impact of realized gains and losses on investments. Partially offsetting these decreases was a $0.9 million increase in property-casualty underwriting and insurance expenses as a result of the increase in Utah Insurance's reinsurance pool participation percentage.
Interest expense was $0.9 million for 1996 compared to $1.0 million for 1995 due to relatively consistent average outstanding debt balances during the periods.
Net income applicable to common stock increased $21.0 million, or 35.2%, to $80.6 million for 1996 compared to $59.6 million for 1995. The increase was primarily the result of the changes in pretax income and effective tax rate discussed above. In addition, there was a $2.7 million increase in equity income principally arising from eight equity investments whose principal assets were sold or liquidated during 1996. Partially offsetting the increase in net income applicable to common stock was $2.3 million in dividends paid during 1996 to the Company's preferred stockholder as a result of the exchange of 5.0 million shares of Class A Common Stock for 5.0 million shares of Series A Preferred Stock on July 18, 1996.
In 1996, the Company began selling the venture capital investments owned by FBL Ventures in an attempt to exit most aspects of the venture capital investment business. During 1997, the remaining investments of FBL Ventures (13 venture capital securities with a total carrying value of $15.0 million) were transferred to Farm Bureau Life and FBL Ventures was dissolved. The transfer of investments had no impact on net income.
Parent company cash inflows from operations consist primarily of dividends from subsidiaries, if declared and paid, fees which it charges the various subsidiaries and affiliates for management of their operations and income tax settlements received pursuant to the Company's intercompany tax allocation agreement. Cash outflows are principally for salaries and other expenses related to providing such management services, dividends on outstanding stock and interest on holding company debt issued to a subsidiary. In addition, the parent company will on occasion enter into capital transactions such as the acquisition of its common stock.
On April 4, 1997, the parent company purchased 965,370 shares of its Class A common stock under a stock repurchase plan for $24.8 million. The shares were purchased from certain Farm Bureau property-casualty insurance companies which had a concentration of their investments in the Company. The concentrations arose principally due to the appreciation of the Company's stock price which caused the investments to exceed statutory or internal guidelines.
During 1997, the Company paid common stock dividends of $7.3 million and preferred stock dividends of $2.2 million. During 1996, the Company paid common stock dividends of $1.3 million and preferred stock dividends of $2.3 million. No dividends were paid during 1995. It is anticipated dividend requirements for 1998 will be $0.15 per quarter per common share and $0.0075 per quarter per preferred share, or approximately $10.4 million. In addition, interest payments on the Notes are estimated to be $5.0 million for 1998.
With the dividend of the home office properties, the dividends available from the Life Companies without prior approval from an insurance commissioner are in excess of the parent company's anticipated dividend and interest requirements for 1998. Dividend and interest requirements of the parent company for 1998 total $15.4 million while dividends available from the Life Companies without prior regulatory approval total $9.0 million. Based on the capital position of Farm Bureau Life, the Company anticipates that it will receive regulatory approval from the Iowa insurance commissioner for an extraordinary dividend to cover this temporary shortfall of funds. If such approval is not obtained, it is anticipated the parent company would obtain the necessary funds through a short-term borrowing with a bank or affiliate.
The Life Companies' cash inflows consist primarily of premium income, deposits to policyholder account balances, income from investments, sales, maturities and calls of investments and repayments of investment principal. 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 1997, with cash inflows at levels sufficient to provide the funds necessary to meet their obligations.
For property-casualty operations, the major sources of cash inflow are premiums and investment income. Major sources of cash outflow are losses and loss adjustment expenses paid and other underwriting expenses. As with the Life Companies, the liquidity position of Utah Insurance continued to be favorable in 1997, with cash inflows at levels sufficient to provide the funds necessary to meet its obligations.
For all insurance operations, cash outflow requirements for operations are typically met from the year's normal premium and deposit cash inflows. This has been the case for all reported periods as the insurance companies' operations and financing activities relating to interest sensitive products provided funds amounting to $121.2 million in 1997, $177.1 million in 1996 and $156.5 million in 1995. These funds were primarily used to increase the insurance companies' fixed maturity investment portfolios.
Matching the investment portfolio maturities to the cash flow demands of the type of insurance being provided is an important consideration for each type of life insurance. The Life Companies continually monitor benefit and claim statistics to provide projections of future cash requirements. As part of this monitoring process, the Life Companies perform cash flow testing of their assets and liabilities under various scenarios to evaluate the adequacy of reserves. 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.
Through its membership in the Federal Home Loan Bank of Des Moines, Farm Bureau Life is eligible to borrow on a line of credit available to provide it additional liquidity. The line of credit available is based on the amount of capital stock of the Federal Home Loan Bank of Des Moines owned by Farm Bureau Life, which supported a borrowing capacity of $43.9 million as of December 31, 1997. Interest is payable at the current market rate on the date of issuance. As of December 31, 1997, no line of credit agreement was open and there were no borrowings outstanding.
The Company may from time to time review potential acquisition opportunities. The Company anticipates that funding for any such acquisition may be provided from available cash resources, debt or equity financing. As of December 31, 1997, the Company had no material commitments for capital expenditures. As noted above, during the first quarter of 1998, the Company agreed to exchange its home office properties for 1,268,056 shares of Class A common stock owned by the Iowa Farm Bureau Federation.
The Company's total investment portfolio increased $120.8 million, or 4.2%, to $3,009.9 million at December 31, 1997 compared to $2,889.1 million at December 31, 1996. This increase is primarily the result of positive cash flows from operations and unrealized appreciation on fixed maturity securities available for sale. These increases are offset, in part, by the acquisition of 965,370 shares of Class A common stock for $24.8 million during 1997. In addition, the Company invested $33.3 million in two entities which are accounted for using the equity method. These investments are included in the securities and indebtedness of related parties line item on the balance sheet.
Mortgage and other asset-backed securities constitute a significant portion of the Company's portfolio of securities. These securities were purchased at a time when, management believed, these types of investments provided 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. At December 31, 1997, the Company held $640.6 million (21.3% of total investments) in residential mortgage-backed securities, $276.9 million (9.2% of total investments) in commercial mortgage-backed securities and $229.7 million (7.6% of total investments) in other asset-backed securities.
At December 31, 1997, the Company held $323.6 million or 10.8% of invested assets in mortgage loans. These mortgage loans are diversified as to property type, location and loan size, and are collateralized by the related properties. At December 31, 1997, mortgages more than 60 days delinquent accounted for 0.1% of the carrying value of the mortgage portfolio. The Company's mortgage lending policies establish limits on the amount that can be loaned to one borrower and require diversification by geographic location and collateral type. Regions with the largest concentration of the Company's mortgage loan portfolio at December 31, 1997 include: West South Central (25% in 1997 and 17% in 1996), which includes Oklahoma and Texas; Pacific (24% in 1997 and 26% in 1996), which includes California, Oregon and Washington; and Mountain (16% in 1997 and 22% in 1996), which includes Arizona, Colorado, Idaho, New Mexico, Utah and Wyoming. Mortgage loans on real estate have also been analyzed by collateral types with office buildings (48% in 1997 and 1996) and retail facilities (33% in 1997 and 32% in 1996), representing the largest holdings.
The Company's investment portfolio at December 31, 1997, also included $35.6 million of short-term investments and $242.6 million in carrying value of U.S. Government and U.S. Government agency backed securities that could be readily converted to cash at or near carrying value.
The Company's asset-liability management program includes (i) designing and developing products which encourage persistency and, as a result, creating a stable liability structure; and (ii) structuring the investment portfolio with duration and cash flow characteristics consistent with the duration and cash flow characteristics of the Company's insurance liabilities. At December 31, 1997, the weighted average life of the fixed maturity portfolio, based on market values excluding convertible bonds, was approximately 7.5 years. Based on the fixed income analytical system utilized by the Company, including its mortgage backed prepayment assumptions, the effective duration of the fixed income portfolio was 4.6 as of December 31, 1997.
Stockholders' equity decreased $33.2 million, or 5.2%, to $605.3 million at December 31, 1997 compared to $638.5 million at December 31, 1996. This decrease is principally attributable to a $97 million decrease in preferred stock. On May 30, 1997, the Company purchased $100.0 million of Series A preferred stock from and issued $3.0 million of Series B preferred stock to the Iowa Farm Bureau Federation. In addition, on April 4, 1997, the Company purchased 965,370 shares of its Class A common stock under a stock repurchase plan for $24.8 million. See "Liquidity and Capital Resources - FBL Financial Group, Inc." and Note 2 of Notes to Consolidated Financial Statements for more information regarding these transactions. These decreases were offset by net income during the year ended December 31, 1997 and net unrealized appreciation of fixed maturity securities classified as available for sale.
At December 31, 1997, common stockholders' equity was $602.3 million, or $33.53 per share, compared to $538.5 million, or $28.55 per share at December 31, 1996. Included in stockholders' equity per common share is $2.80 and $1.05 at December 31, 1997 and 1996, respectively, attributable to unrealized investment gains resulting from marking the Company's fixed maturity securities classified as available for sale to market value. The change in unrealized appreciation of fixed maturity and equity securities classified as available for sale increased stockholders' equity $20.7 million during the year ended December 31, 1997, after related adjustments to deferred policy acquisition costs, value of insurance in force acquired, unearned revenue reserve and deferred income taxes.
During 1997, the Company completed a comprehensive assessment of the Year 2000 issue and developed a plan to address the issue in a timely manner. The Company is currently in the process of modifying or replacing portions of its software to help ensure that its computer systems will function properly when using date-sensitive information. The testing of these modifications is also currently being performed. Furthermore, the Company has initiated formal communications with all of its significant vendors to determine the extent to which the Company's interface systems are vulnerable to those third parties' failure to remediate their own Year 2000 issues.
* Changes to interest rate levels and stock market performance may impact the Company's lapse rates, market value of investment portfolio and the Company's ability to sell its life insurance products, notwithstanding product features to mitigate the financial impact of such changes. * Extraordinary acts of nature or man may result in higher than expected claim activity. * Changes in federal and state income tax laws and regulations may affect the relative tax advantage of the Company's products.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of FBL Financial Group, Inc. at December 31, 1997 and 1996, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 1997, in conformity with generally accepted accounting principles.
FBL FINANCIAL GROUP, INC. CONSOLIDATED BALANCE SHEETS (CONTINUED) (DOLLARS IN THOUSANDS)
Fixed maturity securities, comprised of bonds and redeemable preferred stocks, that the Company has the positive intent and ability to hold to maturity are designated as "held for investment". Held for investment securities are reported at cost adjusted for amortization of premiums and discounts. Changes in the market value of these securities, except for declines that are other than temporary, are not reflected in the Company's financial statements. Fixed maturity securities 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 are included directly in stockholders' equity, net of certain adjustments (see Note 3). Premiums and discounts are amortized/accrued using methods which result in a constant yield over the securities' expected lives. Amortization/accrual of premiums and discounts on mortgage and asset-backed securities incorporates prepayment assumptions to estimate the securities' expected lives.
Securities and indebtedness of related parties include investments in partnerships and corporations over which the Company may exercise significant influence. Such investments are accounted for using the equity method. Changes in the value of the Company's investment in equity investees attributable to capital transactions of the investee, such as a public offering of stock, are recorded directly to stockholders' equity. Securities and indebtedness of related parties also includes advances and loans to the partnerships and corporations which are principally reported at cost.
To the extent recoverable from future policy revenues and gross profits, certain costs of acquiring new insurance business, principally commissions and other expenses related to the production of new business, have been deferred. The value of insurance in force acquired represents the cost assigned to insurance contracts when an insurance company is acquired. The initial value is determined by an actuarial study using expected future gross profits as a measurement of the net present value of the insurance acquired. Interest accrues on the unamortized balance at rates that range from 5.91% to 6.79%.
Property and equipment, comprised primarily of home office properties, furniture and equipment, are reported at cost less allowances for depreciation. Depreciation expense is computed primarily using the straight-line method over the estimated useful lives of the assets. Depreciation expense for the years ended December 31, 1997, 1996 and 1995 was $11.0 million, $10.0 million and $9.7 million, respectively.
Interest crediting rates for interest sensitive products ranged from 4.00% to 7.00% in 1997 and from 4.00% to 7.50% in 1996 and 1995.
Unpaid property-casualty losses and loss adjustment expenses represent the estimated liability for reported claims plus those incurred but not yet reported and the related estimated adjustment expenses. The reserve for unpaid claims and related adjustment expenses is determined using case-basis evaluations and statistical analyses and represents estimates of the ultimate cost of all unpaid losses incurred through December 31 of each year. Although considerable variability is inherent in such estimates, management believes that the reserve for unpaid losses and related loss adjustment expenses is adequate. The estimates are continually reviewed and adjusted as necessary; such adjustments are included in current operations and are accounted for as changes in estimates.
At December 31, 1997, the Company had an undiscounted reserve of $2.8 million to cover estimated future assessments on known insolvencies and had an asset totaling $3.9 million representing estimated premium tax offsets on paid and future assessments. Expenses incurred for guaranty fund assessments, net of related premium tax offsets, totaled $1.9 million (including $1.6 million related to the adoption of SOP 97-3), $0.1 million and $0.2 million during the years ended December 31, 1997, 1996 and 1995, respectively. It is estimated future guarantee fund assessments on known insolvencies will be paid during the three year period ended December 31, 2000 and substantially all the related future premium tax offsets will be realized during the six year period ended December 31, 2003. The Company believes the reserve for guarantee fund assessments is sufficient to provide for future assessments based upon known insolvencies and projected premium levels.
Deferred tax assets or liabilities are computed based on the difference between the financial statement and income tax bases of assets and liabilities using the enacted marginal tax rate. Deferred income tax expenses or credits are based on the changes in the asset or liability from period to period.
Revenues for interest sensitive products consist of policy charges for the cost of insurance, administration charges, amortization of policy initiation fees and surrender charges assessed against policyholder account balances. Expenses related to these products include interest credited to policyholder account balances and benefit claims incurred in excess of policyholder account balances.
The Company's property-casualty operations assume and cede reinsurance, principally as a participant in a reinsurance pooling agreement with certain affiliates. The Company's contracts are generally prospective and the cost of insurance is amortized over the contract periods in proportion to the amount of insurance protection provided. During 1996, the Company had one reinsurance contract with both retrospective and prospective provisions. The retrospective portion of the contract was accounted for separately and the related net loss relating to that portion of the contract was deferred and amortized over the remaining terms of the underlying policies in proportion to the amount of insurance protection provided.
Other income and other expenses include revenue and expenses generated by the Company's various non-insurance subsidiaries for investment advisory, marketing and distribution, and leasing services. A portion of these activities are performed on behalf of affiliates of the Company. In addition, certain revenue generated by the Company's insurance subsidiaries have been classified as other income. During the years ended December 31, 1997, 1996 and 1995, revenues of the insurance subsidiaries included as other income aggregated $4.6 million, $3.2 million and $9.8 million, respectively. Lease income from leases with affiliates totaled $3.0 million for the year ended December 31, 1997 and $2.4 million for each of the years ended December 31, 1996 and 1995. Investment advisory fee income
In 1997, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standard (Statement) No. 128, "Earnings per Share". Statement No. 128 replaced the calculation of primary and fully diluted earnings per share with basic and diluted earnings per share. Unlike primary earnings per share, basic earnings per share excludes any dilutive effects of options, warrants and convertible securities. Diluted earnings per share is similar to the previously reported fully diluted earnings per share, except in determining the number of dilutive shares outstanding for options and warrants. Under Statement No. 128, diluted earnings per share assumes the proceeds that would be received upon the exercise of all dilutive options and warrants would be used to repurchase the Company's common shares at the average market price of such stock during the period. Under prior rules, the higher of the average market price or ending market price was used. All earnings per share amounts for all periods have been presented, and where appropriate, restated to conform to the requirements of Statement No. 128.
Certain amounts in the 1996 and 1995 consolidated financial statements have been reclassified to conform to the 1997 financial statement presentation.
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. For example, significant estimates and assumptions are utilized in the calculation of deferred policy acquisition costs, policyholder liabilities and accruals and valuation allowances on investments. It is reasonably possible that actual experience could differ from the estimates and assumptions utilized which could have a material impact on the consolidated financial statements.
In June 1997, the FASB issued Statement No. 131, "Disclosure about Segments of an Enterprise and Related Information". Statement No. 131 establishes standards for reporting information about operating segments, products and markets. Generally, Statement No. 131 requires financial information to be reported on the basis on which it is used internally for evaluating segment performance and deciding how to allocate resources to segments. Under Statement No. 131, it is anticipated that the Company will continue to report two primary operating segments: life and property-casualty. However, the non-insurance support operations, including investment advisory, marketing and distribution and leasing services, will no longer be part of the life insurance segment. While each of these non-insurance operations constitute a separate segment under the new rules, their operations do not currently meet the statement's quantitative thresholds for separate segment reporting. Accordingly, it is anticipated that such non-insurance operations will be aggregated and disclosed in total. While earlier application is allowed, Statement No. 131 is effective for and will be adopted in the fourth quarter of 1998.
Also in June 1997, the FASB issued Statement No. 130, "Reporting Comprehensive Income". Statement No. 130 establishes standards for reporting comprehensive income and its components which include net income and items currently recorded directly in stockholders' equity such as unrealized gains and losses on fixed maturity securities classified as available for sale. The impact of Statement No. 130 is not expected to be material to the Company as the Statement does not change the computation or disclosure of net income or stockholders' equity. Statement No. 130 is effective for and will be adopted in the first quarter of 1998.
On April 29, 1996, the Company designated 5,000,000 shares of its preferred stock as Series A preferred stock and on July 18, 1996, such shares were exchanged for 5,000,000 shares of Class A common stock. The Series A preferred stock paid quarterly cash dividends of $0.25 per share and had voting rights identical to that of Class A common stock. As described below, the Series A preferred stock was redeemed during 1997.
On May 30, 1997, FBL Financial Group Capital Trust (the Trust), a consolidated wholly-owned subsidiary of the Company, issued $97.0 million of 5% Preferred Securities to the Company's majority stockholder, the Iowa Farm Bureau Federation. In connection with the Trust's issuance of the 5% Preferred Securities and the related purchase by the Company of all of the Trust's common securities, the Company issued to the Trust $100.0 million principal amount of its 5% Subordinated Deferrable Interest Notes, due June 30, 2047 (the Notes). The sole assets of the Trust are and will be the Notes and any interest accrued thereon. The interest payment dates on the Notes correspond to the distribution dates on the 5% Preferred Securities. The 5% Preferred Securities, which have a liquidation value of $1,000.00 per share plus accrued and unpaid distributions, mature simultaneously with the Notes. As of December 31, 1997, 97,000 shares of 5% Preferred Securities were outstanding, all of which are unconditionally guaranteed by the Company.
Concurrent with the issuance of the 5% Preferred Securities, the Company purchased from the Iowa Farm Bureau Federation the Company's Series A preferred stock at its liquidation value of $100.0 million. In addition, the Company issued 5,000,000 shares of Series B preferred stock to the Iowa Farm Bureau Federation for $3.0 million. Each share of Series B preferred stock has a liquidation preference of $0.60 and voting rights identical to that of Class A common stock. The Series B preferred stock pays cumulative annual cash dividends of $0.03 per share, payable quarterly, and is redeemable by the Company, at the option of the Company, at $0.60 per share plus unpaid dividends if the stock ceases to be beneficially owned by a Farm Bureau organization.
The purchase of Series A preferred stock and simultaneous issuance of Series B preferred stock and 5% Preferred Securities were treated as noncash transactions for purposes of the statement of cash flows.
The following tables contain amortized cost and market value information on fixed maturities and equity securities at December 31, 1997 and 1996:
The carrying value and estimated market value of the Company's portfolio of fixed maturity securities at December 31, 1997, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
The Company's mortgage loan portfolio consists principally of commercial mortgage loans. The Company's lending policies require that the loans be collateralized by the value of the related property, establish limits on the amount that can be loaned to one borrower and require diversification by geographic location and collateral type. Regions in which at least 20% of the Company's mortgage loan portfolio is invested during the years presented include: West South Central (25% in 1997 and 17% in 1996), which includes Oklahoma and Texas; Pacific (24% in 1997 and 26% in 1996), which includes California, Oregon and Washington; and Mountain (16% in 1997 and 22% in 1996), which includes Arizona, Colorado, Idaho, New Mexico, Utah and Wyoming. Mortgage loans on real estate have also been analyzed during the years presented by collateral types with office buildings (48% in 1997 and 1996) and retail facilities (33% in 1997 and 32% in 1996), representing the largest holdings.
Investment income from other long-term investments, which includes investments held by subsidiaries engaged in the broker-dealer and investment company industries, is comprised of:
An analysis of sales, maturities and principal repayments of the Company's fixed maturities portfolio for the years ended December 31, 1997, 1996, and 1995 is as follows:
realized gains of $24.3 million during the year ended December 31, 1997 and $50.4 million during the year ended December 31, 1996.
At December 31, 1997, affidavits of deposits covering investments with a carrying value totaling $2,085.4 million were on deposit with state agencies to meet regulatory requirements.
At December 31, 1997, the Company had committed to provide additional funding for mortgage loans on real estate aggregating $10.4 million. These commitments arose in the normal course of business at terms which are comparable to similar investments.
No investment in any person or its affiliates (other than bonds issued by agencies of the United States Government) exceeded ten percent of stockholders' equity at December 31, 1997.
OTHER LONG-TERM INVESTMENTS: The fair values for nontraditional debt instruments and investment deposits are estimated by discounting expected cash flows using interest rates currently being offered for similar investments. The fair values for investments held by subsidiaries in the broker-dealer and investment company industries are based on quoted market prices, where available. For holdings that are not actively traded, fair values are determined in good faith by the Board of Directors of the subsidiary holding the security.
COMPANY-OBLIGATED MANDATORILY REDEEMABLE PREFERRED STOCK OF SUBSIDIARY TRUST: Fair values are estimated by discounting expected cash flows using interest rates currently being offered for similar securities.
The following sets forth a comparison of the fair values and carrying values of the Company's financial instruments subject to the provisions of Statement No. 107:
An analysis of the value of insurance in force acquired for the years ended December 31, 1997, 1996 and 1995 is as follows:
Reinsurance contracts do not relieve the Company of its obligations to its policyholders. To the extent that reinsuring companies are later unable to meet obligations under reinsurance agreements, the Company's life insurance subsidiaries would be liable for these obligations, and payment of these obligations could result in losses to the Company. To limit the possibility of such losses, the Company evaluates the financial condition of its reinsurers and monitors concentrations of credit risk.
No allowance for uncollectible amounts has been established against the Company's asset for reinsurance recoverable since none of the receivables are deemed to be uncollectible. Insurance premiums and product charges have been reduced by $6.0 million, $5.7 million and $14.9 million and insurance benefits have been reduced by $6.6 million, $5.1 million and $8.5 million during the years ended December 31, 1997, 1996 and 1995, respectively, as a result of cession agreements. The amount of reinsurance assumed is not significant.
Property-casualty business written by Utah Insurance is currently pooled with business written by Farm Bureau Mutual Insurance Company and three other property-casualty affiliates (hereinafter, the Farm Bureau Mutual pool). Under the terms of the reinsurance agreement, Utah Insurance and the other affiliates cede to Farm Bureau Mutual Insurance Company all of their insurance business and assume back from Farm Bureau Mutual Insurance Company an amount equal to their participation in the pooling agreement. Also, losses, loss adjustment expenses, and other underwriting and administrative expenses are prorated among the companies on the basis of their participation in the pooling agreement. Through December 31, 1995, Utah Insurance's participation in the Farm Bureau Mutual pool (which only included three companies at the time) was 8%. On June 30, 1996, Utah Insurance's share of the pool was increased to 20%, retroactive to January 1, 1996. Effective January 1, 1997, Western Agricultural Insurance Company and Western Farm Bureau Mutual Insurance Company became full participants in the Farm Bureau Mutual pool and Utah Insurance's pool participation percentage decreased from 20% to 18%. Accordingly, the property-casualty results included in the statement of operations include that amount applicable to 8% of the Farm Bureau Mutual pool for the year ended December 31, 1995 and six months ended June 30, 1996, 20% of the Farm Bureau Mutual pool for the six month period ended December 31, 1996 and 18% of the Farm Bureau Mutual pool for the year ended December 31, 1997. Participation in the development on loss and loss adjustment expense reserves during the periods remain at the rate in effect when the underlying claims were incurred.
In accordance with retrospective accounting for reinsurance assumed, the property-casualty operating results for the first six months of 1996 attributable to the increase in the Farm Bureau Mutual pool percentage ($0.8 million loss) was deferred and amortized over the premium paying period of the underlying policies (generally 6 to 12 months). As a result of the increase in the Farm Bureau Mutual pool participation percentage, the Company recorded additional investments ($13.5 million), deferred policy acquisition costs ($1.6 million), other assets ($1.3 million), reserves and unearned premiums on property-casualty policies ($16.8 million) and other liabilities ($0.4 million). There was no significant transfer of assets or liabilities in connection with the decrease in Farm Bureau Mutual pool participation from 20% to 18% due primarily to the increase in the size of the pool with the addition of Western Agricultural Insurance Company and Western Farm Bureau Mutual Insurance Company.
Deferred income taxes have been established based upon the temporary differences between the financial statement and income tax bases of assets and liabilities within each entity. The reversal of the temporary differences will result in taxable or deductible amounts in future years when the related asset or liability is recovered or settled.
The Internal Revenue Service (IRS) has examined the Company's tax years through 1994 and the Company is in the process of appealing the proposed adjustments to the IRS's Appeals Division for tax years 1988 through 1994. All tax years prior to 1993 are settled for Western Life. Management believes that any adjustments raised by the IRS as a result of their examinations will have an immaterial impact on the Company's financial statements.
The tax effect of temporary differences giving rise to the Company's deferred income tax assets and liabilities at December 31, 1997 and 1996, is as follows:
The Company's long-term debt consists primarily of a lease-backed note payable with an outstanding balance of $24.5 million at December 31, 1997 and 1996. Interest on the note is charged at a variable rate equal to LIBOR plus 0.31% (6.03% at December 31, 1997 and 5.81% at December 31, 1996) with a maximum rate of 14.0% per annum. The note is due August 1999, and is secured by rentals to be received under certain operating leases with members of the consolidated group and other affiliates.
The Company participates with several affiliates in various defined benefit plans covering substantially all employees. The benefits of these plans are based primarily on years of service and employees' compensation. The Company and affiliates have adopted a policy of allocating the net periodic pension cost of the plans between themselves generally on a basis of time incurred by the respective employees for each employer. Such allocations are reviewed annually. Pension expense aggregated $8.3 million, $9.6 million and $8.1 million for the years ended December 31, 1997, 1996 and 1995, respectively.
Prior to January 1, 1996, the Company provided benefits to agents of the Company and certain of its affiliates through the Agents' Career Incentive Plan. Company contributions to the plan were based upon the individual agent's earned commissions and varied based upon the overall production level and the number of years of service. Company contributions charged to expense with respect to this plan during the year ended December 31, 1995 were $1.4 million. During 1996, in conjunction with a restructuring of the agents' compensation program, contributions to this plan were discontinued.
In addition to benefits offered under the aforementioned benefit plans, the Company and several other affiliates sponsor a plan that provides group term life insurance benefits to retired full-time employees who have worked ten years and attained age 55 while in service with the Company. Postretirement benefit expense is allocated in a manner consistent with pension expense discussed above. Postretirement pension expense aggregated $0.3 million, $0.2 million and $0.1 million for each of the years ended December 31, 1997, 1996 and 1995, respectively.
During 1996, the Company adopted the 1996 Class A Common Stock Compensation Plan (the Plan) under which incentive stock options, nonqualified stock options, bonus stock, restricted stock and stock appreciation rights may be granted to directors, officers and employees. Option shares granted to directors are fully vested upon grant and have a contractual term that varies with the length of time the director remains on the Board. Option shares granted to officers and employees generally vest over a period up to five years contingent upon continued employment with the Company and have a contractual term of 10 years.
Information relating to stock options during 1997 and 1996 is as follows:
Pro forma information regarding net income and earnings per common share is required by Statement No. 123, and has been determined as if the Company had accounted for its stock options under the fair value method of that Statement. The fair value for these options was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted-average assumptions for 1997 and 1996:
For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting period. The Company's pro forma net earnings and earnings per common share were as follows:
Western Life is authorized to issue up to 100,000 shares of redeemable preferred stock in series at $200.00 per share. There were 22,517 and 24,017 preferred shares outstanding at December 31, 1997 and 1996, respectively, all of which are currently redeemable at the option of Western Life. Dividends accrue at fixed or variable rates depending on the series and can range from 7.5% to 15.0%. Under certain circumstances and with respect to certain matters, the holders of redeemable preferred stock are entitled to vote separately as a class. The redeemable preferred stock and related dividends are reported as minority interest in subsidiaries in the consolidated financial statements.
The financial statements of the Company's insurance subsidiaries included herein differ from related statutory-basis financial statements principally as follows: (a) the bond portfolio is segregated into held-for-investment (carried at amortized cost) and available-for-sale (carried at fair value) classifications rather than generally being carried at amortized cost; (b) acquisition costs of acquiring new business are deferred and amortized over the life of the policies rather than charged to operations as incurred; (c) 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; (d) future policy benefit reserves on certain interest sensitive products are based on full account values, rather than discounting methodologies utilizing statutory interest rates; (e) deferred income taxes are provided for the difference between the financial statement and income tax bases of assets and liabilities; (f) net realized gains or losses attributed to changes in the level of market interest rates are recognized as gains or losses in the statement 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) declines in the estimated realizable value of investments are charged to
the statement of income when such declines are judged to be other than temporary rather than through the establishment of a formula-determined statutory investment reserve (carried as a liability), changes in which are charged directly to surplus; (h) 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 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 in accordance with Statement No. 87, "Employers' Accounting for Pensions" rather than in accordance with rules and regulations permitted by the Employee Retirement Income Security Act of 1974; (k) the financial statements of subsidiaries are consolidated with those of the insurance subsidiary; 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.
In addition, prior to January 1, 1996, the Company participated in a management agreement with Farm Bureau Management Corporation, a wholly-owned subsidiary of the Iowa Farm Bureau Federation. Under this agreement, Farm Bureau Management Corporation provided general business, administration and management services to the Company. During 1996, the Company assumed responsibility for providing a majority of these services for itself as well as Farm Bureau Management Corporation and other affiliates. During the years ended December 31, 1997, 1996 and 1995, the Company incurred expenses under this contract of $0.8 million, $2.6 million and $3.7 million, respectively. During 1997 and 1996, the Company earned management fee income of $0.2 million related to these services.
Effective January 1, 1996, the Company entered into marketing agreements with the property-casualty companies operating within its marketing territory, including Farm Bureau Mutual Insurance Company and other affiliates. Under the marketing agreements, the property-casualty companies assumed responsibility for development and management of the Company's agency force for a fee equal to a percentage of commissions on first year life insurance premiums and annuity deposits. During the years ended December 31, 1997 and 1996, the Company paid $3.9 million and $3.6 million, respectively, to the property-casualty companies under these arrangements.
The Company is licensed by the Iowa Farm Bureau Federation to use the "Farm Bureau" and "FB" designations in Iowa. In connection with this license, royalties of $0.6 million, $0.5 million and $0.3 million were paid to the Iowa Farm Bureau Federation for the years ended December 31, 1997, 1996 and 1995, respectively. The Company has similar arrangements with Farm Bureau organizations in other states in its market territory. Total royalties paid to Farm Bureau organizations other than the Iowa Farm Bureau Federation in 1997, 1996 and 1995 were $1.2 million, $0.9 million and $0.6 million, respectively.
The Company currently operates in two principal segments - life insurance (including traditional and universal life, annuity and accident and health coverages) and property-casualty insurance. Information concerning the Company's business segments for the years ended December 31, 1997, 1996 and 1995 is as follows:
Corporate revenues and income (loss) noted above for 1997 and 1996 do not include $0.3 million in revenues that are eliminated in consolidation. In addition, at December 31, 1997 and 1996, identifiable assets for the Corporate segment do not include $3.5 million and $3.0 million, respectively, in intercompany receivables that are eliminated in consolidation. Other intercompany balances that are eliminated in consolidation are not significant to the respective segments. Corporate assets consist principally of cash, receivables from affiliates and short-term investments. Capital expenditures and depreciation and amortization are not considered material.