Amounts for 2001 and 2002 are impacted by the acquisition of Kansas Farm Bureau Life Insurance Company, Inc. effective January 1, 2001 and coinsurance transactions with National Travelers Life Insurance Company and American Equity Investment Life Insurance Company during 2001.
This section includes a summary of FBL Financial Group, Inc.’s consolidated results of operations, financial condition and where appropriate, factors that management believes may affect future performance. Please read this discussion in conjunction with the accompanying consolidated financial statements and related notes. Unless noted otherwise, all references to FBL Financial Group, Inc. (we or the Company) include all of its direct and indirect subsidiaries, including its primary life insurance subsidiaries, Farm Bureau Life Insurance Company (Farm Bureau Life) and EquiTrust Life Insurance Company (EquiTrust) (collectively, the Life Companies).
The costs related to acquiring new business, including certain costs of issuing policies and other variable selling expenses (principally commissions), defined as deferred policy acquisition costs, are capitalized and amortized into expense. For nonparticipating traditional life products, these costs are amortized over the premium paying period of the related policies, in proportion to the ratio of annual premium revenues to total anticipated premium revenues. Such anticipated premium revenues are estimated using the same assumptions used for computing liabilities for future policy benefits and are generally “locked in” at the date the policies are issued. For participating traditional
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and the disclosure of contingent assets and liabilities. 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. The following is a summary of our significant accounting estimates, as well as the hypothetical effects of changes in the material assumptions used to develop each estimate:
We estimate the fair values of securities that are not actively traded.
We believe that reasonable changes in the interest spread, ranging from 20 basis points to 100 basis points, depending upon credit quality, would produce a total value ranging from $264.0 million to $272.4 million, as compared to the recorded amount of $268.1 million. Unrealized gains and losses on these securities are recorded directly in stockholders’ equity, net of offsets, as a component of accumulated other comprehensive income or loss.
At December 31, 2002, we had 177 fixed maturity and equity securities with gross unrealized losses totaling $55.5 million. Included in the gross unrealized losses are losses attributable to both movement in market interest rates as well as temporary credit issues. Details regarding these securities are included in the “Financial Condition-Investments” section that follows. Net income would be reduced by approximately $30.1 million if all these securities were deemed to be other than temporarily impaired.
These estimates, which are revised at least annually, are based on historical results and our best estimate of future experience.
Amortization of deferred policy acquisition costs for participating life insurance and interest sensitive products is expected to total $26.3 million for 2003, excluding the impact of new production in 2003. A 10 percent increase in estimated gross profits for 2003 would result in $3.5 million of additional amortization expense. Correspondingly, a 10 percent decrease in estimated gross profits would result in $3.6 million less amortization expense.
Due to the number of independent variables inherent in the calculation of traditional life insurance reserves and reserves for the embedded derivatives in equity-indexed annuities, it is not practical to perform a sensitivity analysis on the impact of reasonable changes in the underlying assumptions. The cost of performing detailed calculations using different assumption scenarios outweighs the benefit that would be derived. We believe our assumptions are realistic and produce reserves that are fairly stated in accordance with GAAP.
We have assumed the expected long-term rate of return on plan assets will be 7.00%, which is approximately equal to the rate earned historically. In estimating the discount rate (7.25% for 2002), we based it on the rate of return currently available on high quality, fixed-income investments.
During 2001, we entered into a coinsurance agreement with American Equity whereby we assumed 70% of certain fixed and equity-indexed annuity business written by American Equity from August 1, 2001 to December 31, 2001. The agreement also provides for us to assume 40% of certain new business written by American Equity during 2002 and 2003. This agreement was accounted for as the reinsurance of an in force block of business as of October 1, 2001, and the regular coinsurance of the business written thereafter. Accordingly, our consolidated statements of income include revenues and expenses pertaining to this business for 2002 and the fourth quarter of 2001. Reserves transferred to us in connection with the assumption of the in force block of business totaled $138.7 million. Collected premiums assumed as a result of this agreement totaled $837.9 million for 2002 and $280.0 million for the fourth quarter of 2001.
2000. Changing market conditions in 2002, 2001 and 2000 decreased our investment portfolio yield as investment rates were, in general, lower than our portfolio yield or yield on investments maturing or being paid down. However, in 2001 an increase in prepayment fees and bond call income offset the impact of these market conditions. Fee income from mortgage loan prepayments and bond calls totaled $1.8 million in 2002, $4.8 million in 2001 and $0.4 million in 2000. Net investment income includes $4.0 million in 2002, $0.6 million in 2001 and $0.1 million in 2000 representing an acceleration of net discount accretion on mortgage and asset-backed securities resulting from increasing prepayment speed assumptions during the respective periods. See “Financial Condition-Investments” section that follows for a description of how changes in prepayment speeds impact net investment income.
Derivative income (loss) totaled ($10.4) million in 2002 compared to $0.1 million in 2001. Our derivative income (loss) consists of unrealized gains and losses on the value of call options used to fund returns on our equity-indexed annuity contracts assumed from American Equity and on the value of the conversion feature embedded in convertible fixed maturity securities. In addition, derivative income (loss) includes proceeds from the exercise of the call options. The increase in derivative loss is due to the increase in equity-indexed business assumed from American Equity and a decline in the value of the related call options resulting from the passage of time and a general decline in the equity markets during 2002. Changes in the value of the call options are partially offset by corresponding changes in the value of the embedded derivatives in the underlying equity-indexed contracts. Changes in the value of these embedded derivatives are recorded as a component of interest sensitive product benefits. Derivative income (loss) will fluctuate based on market conditions and could result in income or loss.
Realized losses on investments decreased 6.3% in 2002 to $14.9 million and decreased 38.8% in 2001 to $15.9 million. Realized losses include writedowns of investments that became other-than-temporarily impaired totaling $29.3 million in 2002, $16.8 million in 2001 and $24.5 million in 2000. These writedowns are the result of the issuers of the securities having deteriorating operating trends, alleged corporate fraud, decreases in debt ratings, defaults on loan payments, unsuccessful efforts to raise capital and various other operational or economic factors that became evident in the respective years. Approximately $8.5 million of the realized losses in 2002 were from securities issued by or affiliated with WorldCom Inc., including $1.9 million of losses assumed from an investment in WorldCom, Inc. bonds made by a variable alliance partner. Our 2002 losses also include approximately $7.8 million from securities issued by United Air Lines. Approximately $8.4 million of the realized losses in 2001 were from four securities issued by or affiliated with Enron Corporation. Approximately $14.4 million of the realized losses in 2000 were from eight securities that were investment grade when acquired. The level of realized gains (losses) is subject to fluctuation from year to year depending on the prevailing interest rate and economic environment and the timing of the sale of investments.
Pension expense, which is included in other underwriting, acquisition and insurance expenses, is expected to increase to approximately $5.3 million in 2003 from $4.4 million in 2002. This increase is due to several factors including salary increases, the impact of actual investment experience of plan assets and other experience being different than expected and a decrease in the discount rate used to calculate plan liabilities.
Income taxes increased 28.5% in 2002 to $23.9 million and 36.6% in 2001 to $18.6 million. The effective tax rate was 30.1% for 2002, 29.2% for 2001 and 30.3% for 2000. The effective tax rates were lower than the federal statutory rate of 35% due primarily to the tax benefit associated with the payment of dividends on mandatorily redeemable preferred stock of subsidiary trust, tax-exempt interest and tax-exempt dividend income in 2002, 2001 and 2000. The decrease in the effective tax rate in 2001 compared to 2000 is due primarily to a change in the estimate of certain deferred tax liabilities.
Equity income, net of related income taxes, decreased 15.7% in 2002 to $0.2 million and decreased 97.9% in 2001 to $0.3 million. Equity income includes our proportionate share of gains and losses attributable to our ownership interest in partnerships, joint ventures and certain companies where we exhibit some control but have a minority ownership interest. Given the timing of when financial information from these entities is available, we will consistently use information that is as much as three months in arrears for certain of these entities. Several of these entities are venture capital investment companies, whose operating results are derived primarily from unrealized and realized gains and losses generated by their investment portfolios. The income in 2000 is primarily unrealized appreciation on two internet-related equity securities owned by two of these venture capital investment companies. A substantial portion of the positions held by the equity investees in these two entities was distributed to us and subsequently sold during 2000. As is normal with these types of entities, the level of these gains and losses is subject to fluctuation from period to period depending on the prevailing economic environment, changes in prices of equity securities held by the investment partnerships, timing and success of initial public offerings and other exit strategies, and the timing of the sale of investments held by the partnerships and joint ventures. As a result of our common stock investment in American Equity Investment Life Holding Company, equity income includes $1.4 million in 2002 and 2001 and $0.4 million in 2000, representing our share of its net income. In addition, equity income is net of goodwill amortization totaling $0.4 million in 2001 and 2000. See Note 1 to the consolidated financial statements for a discussion of the accounting for goodwill amortization beginning in 2002. Also, see the “Other Assets” section following for additional information regarding the composition of our equity investees.
Dividends on Series B and C preferred stock totaled $4.3 million in 2002, $4.2 million in 2001 and $0.2 million in 2000. The increase for 2002 is due to the accretion of the original issue discount on the Series C preferred stock. The increase for 2001 is due to the issuance of the Series C preferred stock in connection with our acquisition of Kansas Farm Bureau Life on January 1, 2001.
We recorded a gain of $0.6 million in 2000, net of related income taxes, on the sale of Utah Farm Bureau Insurance Company (Utah Insurance), a former wholly-owned property-casualty insurance company, to Farm Bureau Mutual Insurance Company (Farm Bureau Mutual), an affiliate. We did not record any gain during 2002 or 2001 as the loss ratio of the related Utah business was higher than the threshold loss ratio in the earn-out calculation included in the sales agreement. The earn-out period under the sales agreement ended December 31, 2002.
Management analyzes financial information regarding products that are aggregated into three product segments. These segments are (1) traditional annuity, (2) traditional and universal life insurance and (3) variable. We also have various support operations and corporate capital that is aggregated into a corporate and other segment. See Note 13 of the notes to consolidated financial statements for additional information regarding segment information.
Pre-tax operating income (loss) for the variable segment totaled ($0.8) million in 2002, compared to $5.5 million in 2001 and $1.2 million in 2000. The 2002 pre-tax operating loss is primarily attributable to increases in death
benefits and amortization of deferred policy acquisition costs. Death benefits in excess of related account values on variable universal life policies increased 62.5% to $9.7 million in 2002 and increased 9.9% to $6.0 million in 2001. Amortization of deferred policy acquisition costs increased $3.7 million in 2002 and decreased $1.5 million in 2001 due to changes in the assumptions used to calculate deferred policy acquisition costs. As noted above, on a consolidated basis the impact of these assumption changes was largely offset by the impact of assumption changes made in the amortization of deferred policy acquisition costs in the traditional and universal life insurance segment. Expenses were reduced by $1.0 million in 2001 as a result of the recovery of certain royalty fees as discussed above. Operating revenues increased 12.4% in 2002 compared to 11.9% in 2001, due to growth in the volume of business in force. The variable segment does not currently contribute significantly to our bottom line due to fee income structure on these products and the significant administrative costs associated with the sale and processing of this business. Profitability of this line of business is expected to increase as the volume of business grows and the significant fixed costs of administering the business are spread over a larger block of policies.
Pre-tax operating income (loss) for the corporate and other segment totaled ($2.2) million in 2002, compared to ($3.5) million in 2001 and $21.9 million in 2000. The fluctuations in pre-tax operating income are primarily due to the fluctuations in equity income as described above. The decrease in net investment income in 2001 is due to a decrease in average invested assets resulting from a smaller volume of accident and health business in force and a $75.0 million stock repurchase and tender offer during the fourth quarter of 2000. As noted above, we sold our long-term disability income business through two coinsurance agreements in 2000 and 2001. These agreements decreased the level of operations reflected in the corporate and other segment.
The following table sets forth the composition by credit quality of the fixed maturity securities with gross unrealized losses as of December 31, 2002.
As of December 31, 2002, $27.8 million, or 51.3%, of the gross unrealized losses on our fixed maturity securities are rated below investment grade. We believe the issuers of these securities will continue to make payments as scheduled, and we have the ability and intent to hold these securities until they recover in value or mature. The scheduled maturity dates for securities in an unrealized loss position at December 31, 2002 is as follows.
The mortgage-backed portfolio includes pass-through and collateralized mortgage obligation (CMO) securities. With a pass-through security, we receive a pro rata share of principal payments as payments are made on the underlying mortgage loans. CMOs consist of pools of mortgages divided into sections or “tranches” which provide sequential retirement of the bonds. We invest in sequential tranches, which provide cash flow stability in that principal payments do not occur until the previous tranches are paid off. In addition, to provide call protection and more stable average lives, we invest in CMOs such as planned amortization class (PAC) and targeted amortization class (TAC) securities. CMOs of these types provide more predictable cash flows within a range of prepayment speeds by shifting the prepayment risks to support tranches. We do not purchase certain types of collateralized mortgage obligations that we believe would subject the investment portfolio to greater than average risk. These include, but are not limited to, interest only, principal only, floater, inverse floater, PAC II, Z and support tranches. However, in connection with the Kansas Farm Bureau Life acquisition, we did acquire Z securities with a carrying value of $37.5 million at December 31, 2002. These securities generally tend to have more duration risk (risk the security’s price will change significantly with a given change in market interest rates) than the other types of mortgage-backed securities in our portfolio.
At December 31, 2002, we held $483.6 million or 9.0% of invested assets in mortgage loans. These mortgage loans are diversified as to property type, location and loan size, and are collateralized by the related properties. At December 31, 2002, mortgages more than 60 days delinquent accounted for less than 2.0% of the carrying value of the mortgage portfolio. Our mortgage lending policies establish limits on the amount that can be loaned to one borrower and require diversification by geographic location and collateral type. Regions with the largest
The securities and indebtedness of related parties line on the balance sheet, which includes the investments that generate our equity income, is comprised of the following:
Securities and indebtedness of related parties decreased 16.4% to $48.3 million due principally to a decrease in real estate held as securities and indebtedness of related parties and an increase in our share of unrealized investment losses on investments (primarily fixed maturity securities) owned by American Equity Investment Life Holding Company. Since we record American Equity Investment Life Holding Company’s results one quarter in arrears, this reflects the valuation of its investments as of September 30, 2002 and 2001.
49.5% of the Series C preferred stock will be redeemed at par value, or $45.3 million, on January 2, 2004 with the remaining 50.5% redeemed at par value, or $46.3 million, on January 3, 2006.
Stockholders’ equity increased 16.9%, to $661.4 million at December 31, 2002, compared to $565.8 million at December 31, 2001. This increase is principally attributable to net income for the year and the change in unrealized appreciation/depreciation on fixed maturity and equity securities, partially offset by dividends paid.
At December 31, 2002, common stockholders’ equity was $658.4 million, or $23.71 per share, compared to $562.8 million, or $20.53 per share at December 31, 2001. Included in stockholders’ equity per common share is $3.43 at December 31, 2002 and $1.43 at December 31, 2001 attributable to net unrealized investment gains resulting from marking our fixed maturity and equity securities classified as available for sale to market value. The change in unrealized appreciation of fixed maturity and equity securities increased stockholders’ equity $55.8 million during 2002, after related adjustments to deferred policy acquisition costs, value of insurance in force acquired, unearned revenue reserve and deferred income taxes. The change in unrealized appreciation is primarily the result of a decrease in market interest rates as of December 31, 2002 compared to December 31, 2001.
A majority of our insurance liabilities are backed by fixed maturity securities and mortgage loans. The fixed maturity securities have laddered maturities and a weighted average life of 6.0 years at December 31, 2002 and 8.4 years at December 31, 2001. Accordingly, the earned rate on the portfolio lags behind changes in market yields. The extent that the portfolio yield lags behind changes in market yields generally depends upon the following factors:
For a majority of our traditional insurance products, profitability is significantly affected by the spreads between interest yields on investments and rates credited on insurance liabilities. For variable and equity-indexed products, profitability on the portion of the policyholder’s account balance invested in the fixed general account option, if any, is also affected by the spreads earned. For the variable products, the policyholder assumes essentially all the investment earnings risk for the portion of the account balance invested in the separate accounts.
For a substantial portion of our direct business in force, we have the ability to adjust interest or dividend crediting rates in reaction to changes in portfolio yield. We had the ability to adjust rates on 93% of our liabilities at December 31, 2002 and 92% at December 31, 2001. However, the ability to adjust these rates is limited by competitive factors. Surrender rates could increase and new sales could be negatively impacted if the crediting rates are not competitive with the rates on similar products offered by other insurance companies and financial services institutions. In addition, if market rates were to decrease substantially and stay at a low level for an extended period of time, our spread could be lowered due to interest rate guarantees on many of our interest sensitive products. At December 31, 2002 and 2001, interest rate guarantees on our direct interest sensitive products ranged from 3.00% to 5.50%. The weighted average guarantee was 3.39% at December 31, 2002 and 3.50% at December 31, 2001. At December 31, 2002, direct annuities and universal life products with an aggregate account value of $62.5 million were receiving interest credited at the guaranteed rate and direct annuities and universal life products with an aggregate account value of $14.3 million were receiving interest credited at a rate within 50 basis points of the applicable guaranteed rate.
We design our products and manage our investment portfolio in a manner to encourage persistency and to help ensure targeted spreads are earned. In addition to the ability to change interest crediting rates on our direct products, certain interest sensitive contracts have surrender and withdrawal penalty provisions.
If interest rates were to increase 10% from levels at December 31, 2002 and 2001, our fixed maturity securities and short-term investments would decrease approximately $68.0 million at December 31, 2002 and $94.3 million at December 31, 2001. This hypothetical change in value does not take into account any offsetting change in the value of insurance liabilities for investment contracts since we estimate such value to be the cash surrender value of the underlying contracts. If interest rates were to decrease 10% from levels at December 31, 2002 and 2001, the fair value of our debt and mandatorily redeemable preferred stock of subsidiary trust would increase $2.1 million at December 31, 2002 and $2.8 million at December 31, 2001.
We acquired Class A common shares totaling 5,900 in 2001 and 4,358,397 in 2000 as a result of stock repurchases. These transactions reduced stockholders’ equity by $0.1 million in 2001 and $85.8 million in 2000.
extraordinary, special or otherwise non-recurring dividends) as long as any Series C redeemable preferred stock is outstanding.
FBL Financial Group, Inc. expects to rely on available cash resources and on dividends from Farm Bureau Life to make any dividend payments to its stockholders and interest payments on its Notes. In addition, it is anticipated that a combination of available cash resources, additional borrowings and dividends from Farm Bureau Life will be used to fund the scheduled redemption of the Series C preferred stock in 2004 ($45.3 million) and 2006 ($46.3 million).
The ability of Farm Bureau Life to pay dividends to FBL Financial Group, Inc. is limited by law to earned profits (statutory unassigned surplus) as of the date the dividend is paid, as determined in accordance with accounting practices prescribed by insurance regulatory authorities of the State of Iowa. In addition, under the Iowa Insurance Holding Company Act, Farm Bureau Life may not pay an “extraordinary” dividend without prior notice to and approval by the Iowa insurance commissioner. An “extraordinary” dividend is defined under the Iowa Insurance Holding Company Act as any dividend or distribution of cash or other property whose fair market value, together with that of other dividends or distributions made within the preceding 12 months, exceeds the greater of (i) 10% of policyholders’ surplus (total statutory capital stock and statutory surplus) as of December 31 of the preceding year, or (ii) the statutory net gain from operations of the insurer for the 12-month period ending December 31 of the preceding year. During 2003, the maximum amount legally available for distribution to FBL Financial Group, Inc. without further regulatory approval is $39.2 million.
We may from time to time review potential acquisition opportunities. It is anticipated that funding for any such acquisition would be provided from available cash resources, debt or equity financing. As of December 31, 2002, we had no material commitments for capital expenditures. The parent company had available cash and investments totaling $28.3 million at December 31, 2002.
The Life Companies’ cash inflows consist primarily of premium income, deposits to policyholder account balances, product charges on variable products, 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 2002, with cash inflows at levels sufficient to provide the funds necessary to meet their obligations.
For the life insurance operations, cash outflow requirements for operations are typically met from normal premium and deposit cash inflows. Net cash inflows (outflows) for the Life Companies’ continuing operations and financing activities relating to interest sensitive products provided funds totaling $1,068.0 million in 2002, $536.0 million in 2001 and ($36.5) million in 2000. The significant increases in net cash flows in 2002 and 2001 are due principally to the impact of the American Equity, Kansas Farm Bureau Life and NTL transactions. Net cash inflows are primarily used to increase the insurance companies’ fixed maturity and short-term investment portfolios. The net cash outflow for 2000 is primarily the result of a $32.8 million net payment for reserves pursuant to the individual disability income coinsurance arrangement and increased surrender benefits on interest sensitive products and rollovers from traditional products to variable products. This cash outflow was funded with available cash and cash provided from investing activities. 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 membership in the Federal Home Loan Bank of Des Moines (FHLB), the Life Companies are eligible to establish and borrow on a line of credit to provide additional liquidity. The line of credit available is based on the amount of capital stock of the FHLB owned by the Life Companies, which supported a borrowing capacity of $84.6 million as of December 31, 2002. At December 31, 2002, we had outstanding borrowings of $40.0 million under this arrangement, leaving a borrowing capacity of $44.6 million. Additional collateral would need to be deposited with the FHLB in order to access this additional borrowing capacity. The outstanding debt is due September 17, 2003, and interest on the debt is charged at a variable rate equal to the London Interbank Offered Rate less 0.0475%
Effective January 1, 2002, we adopted Statement of Financial Accounting Standards (Statement) No. 141, “Business Combinations,” and Statement No. 142, “Goodwill and Other Intangible Assets.” Under these Statements, goodwill is not amortized but is subject to annual impairment tests in accordance with the Statements. In addition, Statement No. 142 requires the identification and amortization of certain intangible assets that had previously been included as a component of goodwill. We have performed impairment testing and determined none of our goodwill was impaired as of December 31, 2002. In addition, we have no intangible assets included as a component of goodwill that require separate accounting. On a pro forma basis without goodwill amortization, net income applicable to common stock for 2001 would have been $37.7 million ($1.38 per share-basic and $1.35-assuming dilution) and for 2000 would have been $40.2 million ($1.32 per share-basic and $1.31-assuming dilution).
During 2002, we announced that effective January 1, 2003 we will expense the cost of stock options in accordance with Statement No. 123, “Accounting for Stock-Based Compensation.” Under Statement No. 123, compensation expense is recognized as stock options vest in an amount equal to the estimated fair value of the options on the date of grant. In December 2002, the Financial Accounting Standards Board (FASB) issued Statement No. 148 “Accounting for Stock-Based Compensation-Transition and Disclosure.” Statement No. 148 amends Statement No. 123 by requiring more prominent and frequent disclosures regarding the effects of stock-based compensation and provides for different transition methods in the adoption of Statement No. 123. Historically we have applied Accounting Principles Board Opinion (APB) No. 25, “Accounting for Stock Issued to Employees,” to stock option grants, which generally has resulted in no compensation expense being recognized. We anticipate using the prospective method in the adoption of Statement No. 123. Under the prospective method, expense will be recognized for those options granted, modified or settled after the date of adoption. Assuming our historical level of stock option issuance and similar option terms, we estimate that expensing stock options in 2003 will reduce net income by approximately $0.2 million ($0.01 per common share). The impact of adoption will increase over the
We have the following three different forms of derivatives on our consolidated balance sheets which are subject to Statement No. 133:
Upon the adoption of Statement No. 133, we transferred our fixed maturity securities classified as held for investment, formerly recorded at amortized cost, to the available-for-sale category. In connection with this transfer,
From time to time, we may publish statements relating to anticipated financial performance, business prospects, new products, and similar matters. These statements and others that include words such as “expect”, “anticipate”, “believe”, “intend”, and other similar expressions, constitute forward-looking statements under the Private Securities Litigation Reform Act of 1995. The Private Securities Litigation Reform Act of 1995 provides a safe harbor for these types of statements as long as the information is identified as forward-looking and is accompanied by meaningful, cautionary statements identifying important factors that could cause actual results to differ materially from those projected in the information. The risks and uncertainties that may affect the operations, performance, development and results of our business include but are not limited to the following:
extraordinary acts of nature or man may result in higher than expected claim activity, and
changes in federal and state income tax laws and regulations may affect the relative tax advantage of our products.
As discussed in Note 1 to the consolidated financial statements, in 2002 the Company changed its method of accounting for goodwill and in 2001 the Company changed its method of accounting for derivative instruments.
FBL Financial Group, Inc. (we or the Company) operates predominantly in the life insurance industry through its principal subsidiaries, Farm Bureau Life Insurance Company (Farm Bureau Life) and EquiTrust Life Insurance Company (EquiTrust) (collectively, the Life Companies). We currently market individual life insurance policies and annuity contracts to Farm Bureau members and other individuals and businesses in the midwestern and western sections of the United States through an exclusive agency force. Variable universal life insurance and variable annuity contracts are also marketed in these and other states through alliances with other insurance companies and a regional broker/dealer. In addition to writing direct insurance business, we assume through coinsurance agreements a percentage of certain business written by American Equity Investment Life Insurance Company (American Equity) and National Travelers Life Company (NTL). These coinsurance agreements utilize excess capital and increase our volume of business in force. Several subsidiaries support various functional areas of the Life Companies and other affiliates, by providing investment advisory, marketing and distribution, and leasing services. In addition, we manage three Farm Bureau affiliated property-casualty companies.
In January 2003, the FASB issued FASB Interpretation No. 46, “Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51.” Interpretation No. 46 establishes a variable interests model to follow when determining whether or not to consolidate an entity that is not evaluated for consolidation under the traditional voting interests model. This Interpretation generally requires that a company (investee) being evaluated under the variable interests model be consolidated if (a) the investor has decision making powers over the entity-that is, the
ability to buy and sell assets or conduct operations or (b) the investor is exposed to the majority of the risks or rewards of the entity. In addition, the Interpretation requires that investments made by related parties be analyzed together in applying the variable interests model. The disclosure provisions of this Interpretation are effective for financial statements issued after January 31, 2003. The consolidation provisions are effective for new transactions entered into after January 31, 2003 and for pre-existing entities as of July 1, 2003. We have one investment in a storage facility, jointly owned with an affiliate, which will be consolidated under this Interpretation. At December 31, 2002, this company, which is currently being accounted for using the equity method, had total assets and total liabilities of less than $10.0 million.
These derivatives are described more fully in this note under the captions “Investments-Fixed Maturities and Equity Securities,” “Reinsurance Recoverable” and “Future Policy Benefits.”
The cumulative effect of adopting these Statements on net income was $0.3 million in 2001. This amount represents the difference in accumulated net unrealized capital gains (losses) on the date of adoption, net of tax, resulting from the change in accounting for the conversion features embedded in our convertible fixed maturity securities. Income before cumulative effect of change in accounting for derivative instruments for 2001 was approximately $0.6 million less than what would have been recorded without the accounting change due to a decrease in the fair value of these conversion features during the period. The impact of the accounting change on 2001 income relating to the equity-indexed annuity derivatives was not quantified, but is not believed to be material to our financial position or results of operations.
financial statements if we accounted for our modified coinsurance contracts as having an embedded derivative. However, the impact is not expected to be material due to the relatively small balances of funds withheld.
All of our fixed maturity securities, comprised of bonds and redeemable preferred stocks, are designated as “available for sale” and are reported at market value. Unrealized gains and losses on these securities, with the exception of unrealized gains and losses relating to the conversion feature embedded in convertible fixed maturity securities, are included directly in stockholders’ equity as a component of accumulated other comprehensive income or loss. Unrealized gains and losses relating to the conversion feature embedded in convertible fixed maturity securities are recorded as a component of derivative income (loss) in the consolidated statements of income. The unrealized gains and losses are reduced by a provision for deferred income taxes and adjustments to deferred policy acquisition costs, value of insurance in force acquired and unearned revenue reserve that would have been required as a charge or credit to income had such amounts been realized. 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 we may exercise significant influence. These partnerships and corporations operate predominately in the insurance,
broker-dealer, investment company and real estate industries. Such investments are accounted for using the equity method. In applying the equity method, we record our share of income or loss reported by the equity investees. For partnerships operating in the investment company industry, this income or loss includes changes in unrealized gains and losses in the partnerships’ investment portfolios. Changes in the value of our investment in equity investees attributable to capital transactions of the investee, such as an additional 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.
Market values of fixed maturity securities are reported based on quoted market prices, where available. Market values of fixed maturity securities not actively traded in a liquid market are estimated using a matrix calculation assuming a spread (based on interest rates and a risk assessment of the bonds) over U. S. Treasury bonds. Market values of the conversion features embedded in convertible fixed maturity securities are estimated using an option-pricing model. Market values of redeemable preferred stocks and equity securities are based on the latest quoted market prices, or for those not readily marketable, generally at values which are representative of the market values of comparable issues.
Property and equipment, comprised primarily of furniture, equipment and capitalized software costs, are reported at cost less allowances for depreciation and amortization. Depreciation and amortization expense is computed primarily using the straight-line method over the estimated useful lives of the assets. Furniture and equipment had a carrying value of $28.3 million at December 31, 2002 and $33.4 million at December 31, 2001, and estimated useful lives that range from three to ten years. Capitalized software costs had a carrying value of $6.8 million at December 31, 2002 and $7.0 million at December 31, 2001, and estimated useful lives that range from two to five years. Depreciation expense was $7.1 million in 2002, $7.4 million in 2001 and $8.1 million in 2000. Amortization expense was $4.0 million in 2002, $6.0 million in 2001 and $4.8 million in 2000.
Goodwill represents the excess of the fair value of assets exchanged over the net assets acquired. Effective January 1, 2002, we adopted Statement No. 141, “Business Combinations,” and Statement No. 142, “Goodwill and Other Intangible Assets.” Under these Statements, goodwill is not amortized but is subject to annual impairment tests in accordance with the Statements. In addition, Statement No. 142 requires the identification and amortization of certain intangible assets that had previously been included as a component of goodwill. We have performed impairment testing and determined none of our goodwill was impaired as of December 31, 2002. In addition, we have no intangible assets included as a component of goodwill that require separate accounting.
Through December 31, 2001, goodwill was being amortized on a straight-line basis generally over a period of 20 years. The carrying value of goodwill was regularly reviewed for indicators of impairment in value, which in the view of management were other than temporary. If facts and circumstances suggested that goodwill was impaired, we assessed the fair value of the underlying business and would have reduced goodwill to an amount that resulted in the book value of the underlying business approximating fair value. We did not record any impairments in 2001 or 2000.
Future policy benefit reserves for interest sensitive products are computed under a retrospective deposit method and represent policy account balances before applicable surrender charges. Future policy benefit reserves for equity-indexed products are equal to the sum of the fair value of the embedded index options, accumulated index credits and the host contract reserve computed using a method similar to that used for interest sensitive product benefits. Policy benefits and claims that are charged to expense include benefit claims incurred in the period in excess of related policy account balances.
The liability for future policy benefits for direct participating traditional life insurance is based on net level premium reserves, including assumptions as to interest, mortality and other factors underlying the guaranteed policy cash values. Reserve interest assumptions are level and range from 2.00% to 6.00%. The average rate of assumed investment yields used in estimating gross margins was 7.47% in 2002, 7.69% in 2001 and 7.74% in 2000. Accrued dividends for participating business are established for anticipated amounts earned to date that have not been paid. The declaration of future dividends for participating business is at the discretion of the Board of Directors. Participating business accounted for 41% of direct receipts from policyholders during 2002 and represented 15% of life insurance in force at December 31, 2002. Participating business accounted for 40% of direct receipts from policyholders during 2001 (2000-38%) and represented 16% of life insurance in force at December 31, 2001 (16% in 2000). The liability for future policy benefits for non-participating traditional life insurance is computed using a net level method, including assumptions as to mortality, persistency and interest and include provisions for possible unfavorable deviations.
Other income and other expenses consist primarily of revenue and expenses generated by our various non-insurance subsidiaries for investment advisory, marketing and distribution, and leasing services. They also include revenues and expenses generated by our parent company for management services. Certain of these activities are performed on behalf of affiliates of the Company. In addition, certain revenues generated by our insurance subsidiaries are classified as other income. Revenues of the insurance subsidiaries included as other income totaled $1.2 million in 2002, $0.8 million in 2001 and $1.2 million in 2000. Lease income from leases with affiliates totaled $5.8 million in 2002, $5.2 million in 2001 and $9.2 million in 2000. Investment advisory fee income from affiliates totaled $1.5 million in 2002, $1.4 million in 2001 and $1.2 million in 2000.
Pro forma information regarding net income and earnings per common share is required by Statement No. 123 as amended by Statement No. 148, and has been determined as if we had accounted for all stock options under the fair value method. The fair value of our stock options was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted-average assumptions:
For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options’ vesting period. Our pro forma net earnings and earnings per common share are as follows:
The non-employee directors on our Board may elect to receive their compensation in the form of cash, Class A common shares or deferred stock units pursuant to the Director Compensation Plan. The fair value of Class A common shares and deferred stock units, as measured by the fair value of the underlying Class A common stock, are charged to expense in the period they are earned by the directors.
We have agreed that we will not declare or pay dividends on any class or series of stock except for regular cash dividends (defined as regular, fixed, quarterly or other periodic cash dividends as declared by our Board of Directors as part of the stated cash dividend policy and do not include any other dividends or distributions, such as extraordinary, special or otherwise non-recurring dividends) as long as any Series C redeemable preferred stock is outstanding.
estimates and assumptions are utilized in the valuation of investments, determination of other-than-temporary impairments of investments, amortization of deferred policy acquisition costs, calculation of policyholder liabilities and accruals and determination of pension expense. It is reasonably possible that actual experience could differ from the estimates and assumptions utilized which could have a material impact on the consolidated financial statements.
The following tables contain amortized cost and estimated market value information on fixed maturities and equity securities:
The carrying value and estimated market value of our portfolio of fixed maturity securities at December 31, 2002, 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.
Income taxes include a credit of $5.2 million in 2002, $5.6 million in 2001 and $9.1 million in 2000 for the tax effect of realized losses.
Equity investees distributed to us equity securities with a fair value of less than $0.1 million in 2002, $2.8 million in 2001 and $14.5 million in 2000. Also during 2000, we received an interest in ten real estate properties with a fair value of $5.0 million in satisfaction of a fixed maturity security that had been in default. These transactions were treated as noncash items for purposes of the statements of cash flow.
Fixed maturity securities: Fair values for fixed maturity securities are based on quoted market prices, where available. For fixed maturity securities not actively traded, fair values are estimated using a matrix calculation assuming a spread (based on interest rates and a risk assessment of the bonds) over U. S. Treasury bonds.
Other long-term investments: The fair values for investment deposits are generally estimated by discounting expected cash flows using interest rates currently being offered for similar investments. The fair values for investments held by broker-dealer subsidiaries are based on quoted market prices. We are not required to estimate the fair value of our other miscellaneous investments.
Cash and short-term investments: The carrying amounts reported in the consolidated balance sheets for these instruments approximate their fair values.
Securities and indebtedness of related parties: Fair values for loans and advances are estimated by discounting expected cash flows using interest rates currently being offered for similar investments. For equity securities that are not actively traded, estimated fair values are based on values of comparable issues. As allowed by Statement No. 107, fair values are not assigned to investments accounted for using the equity method.
Reinsurance recoverable: Reinsurance recoverable relating to our portion of the call options used to fund index credits on the equity-indexed annuities assumed from American Equity is reported at fair value. Fair value is determined using quoted market prices. We are not required to estimate fair value for the remainder of the reinsurance recoverable balance.
In the normal course of business, we seek to limit our exposure to loss on any single insured and to recover a portion of benefits paid by ceding reinsurance to other insurance enterprises or reinsurers. Our reinsurance coverage for life insurance varies according to the age and risk classification of the insured with retention limits ranging up to $1.1 million of coverage per individual life. We do not use financial or surplus relief reinsurance. Life insurance in force ceded on a consolidated basis totaled $5,363.9 million (17.6% of direct life insurance in force) at December 31, 2002 and $4,772.5 million (16.8% of direct life insurance in force) at December 31, 2001.
acquisition costs totaled $11.8 million. We settled these transactions by transferring cash and investments equal to the reserves on the business. In addition, we received cash totaling $3.0 million in 2001 and $11.1 million in 2000 as consideration for the transactions. Losses totaling $0.8 million in 2001 and $0.7 million in 2000 on the transactions have been deferred and are being recognized over the term of the underlying policies.
In total, insurance premiums and product charges have been reduced by $26.8 million in 2002, $22.1 million in 2001 and $9.5 million in 2000 and insurance benefits have been reduced by $12.9 million in 2002, $13.7 million in 2001 and $6.2 million in 2000 as a result of cession agreements.
The equity-indexed annuity products assumed from American Equity guarantee the return of principal to the contract holder and credit amounts based on a percentage of the gain in a specified market index. A portion of the premium assumed from American Equity is invested in investment grade fixed income securities to cover our share of the minimum guaranteed value due to the contract holder at the end of the contract term. A portion of the premium received from the contract holder is used to purchase derivatives consisting of call options on the applicable market indexes to fund the index credits due to the equity-indexed annuity contract holders. As described in Note 1, “Significant Accounting Policies - Reinsurance Recoverable,” the call options are purchased by and maintained on the books of American Equity and we record our proportionate share of the option value supporting the business we reinsure as reinsurance recoverable. Changes in market value of the call options, as well as option proceeds, are included as a component of derivative income (loss).
In addition to these reinsurance assumption agreements, we also assume variable annuity business from American Equity and two other alliance partners through modified coinsurance arrangements. Variable life business is also assumed from one of these partners through a similar modified coinsurance arrangement.
Life insurance in force assumed on a consolidated basis totaled $1,999.2 million (6.2% of total life insurance in force) at December 31, 2002 and $3,784.2 million (13.8% of total life insurance in force) at December 31, 2001. In total, premiums and product charges assumed totaled $15.8 million in 2002, $11.3 million in 2001 and $0.1 million in 2000. Insurance benefits assumed totaled $10.3 million in 2002 and $9.0 million in 2001.
Net amortization of the value of insurance in force acquired, based on expected future gross profits/margins, for the next five years and thereafter is expected to be as follows: 2003 - $2.8 million; 2004 - $2.7 million; 2005 - $2.6 million; 2006 - $2.5 million; 2007 - $2.5 million; and thereafter, through 2023 - $44.3 million.
We file a consolidated federal income tax return with Farm Bureau Life and FBL Financial Services, Inc. and certain of their subsidiaries. The companies included in the consolidated federal income tax return each report current income tax expense as allocated under a consolidated tax allocation agreement. Generally, this allocation results in profitable companies recognizing a tax provision as if the individual company filed a separate return and loss companies recognizing a benefit to the extent their losses contribute to reduce consolidated taxes.
Deferred income taxes have been established based upon the temporary differences between the financial statement and income tax bases of assets and liabilities. 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.
Prior to 1984, a portion of Farm Bureau Life’s current income was not subject to current income taxation, but was accumulated, for tax purposes, in a memorandum account designated as “policyholders’ surplus account.” The aggregate accumulation in this account at December 31, 2002 was $12.0 million. Should the policyholders’ surplus account exceed the limitation prescribed by federal income tax law, or should distributions be made to the parent company in excess of $580.4 million, such excess would be subject to federal income taxes at rates then effective. Deferred income taxes of $4.2 million have not been provided on amounts included in this memorandum account.
Holders of the Class A common stock, Series B preferred stock and Series C preferred stock, vote together as a group. The Class B common stock votes as a separate class on all issues. The holders of the Class A common stock, Series B preferred stock and Series C preferred stock vote for the election of Class A Directors (three to five) and only holders of the Class B common stock vote for the election of Class B Directors (ten to twenty). Voting for the Directors is noncumulative. In addition, various ownership aspects of our Class B common stock are governed by a Class B Shareholder Agreement which results in the Iowa Farm Bureau Federation, which owns 62.5% of our voting stock as of December 31, 2002, maintaining control of the Company. Holders of Class A common stock and Class B common stock are entitled to share ratably on a share-for-share basis with respect to common stock dividends.
Information regarding stock options outstanding at December 31, 2002 is as follows:
We lease office space under an annually renewable lease from Farm Bureau Mutual Insurance Company, Inc. (Kansas). Farm Bureau Mutual Insurance Company, Inc. was merged into Farm Bureau Mutual Insurance Company (Farm Bureau Mutual), an affiliate, effective January 1, 2003. Related lease expense totaled $0.3 million in 2002 and 2001.
We have management agreements with Farm Bureau Mutual, NTL and other affiliates under which we provide general business, administrative and management services. Fee income for these services totaled $3.4 million in 2002, $2.0 million in 2001 and $1.1 million in 2000. In addition, Farm Bureau Management Corporation, a wholly-owned subsidiary of the Iowa Farm Bureau Federation, provides certain management services to us under a separate arrangement. We incurred related expenses totaling $0.8 million in 2002, $0.7 million in 2001 and $0.9 million in 2000.
We are licensed by the Iowa Farm Bureau Federation to use the “Farm Bureau” and “FB” designations in Iowa. In connection with this license, we incurred royalty expense totaling $0.4 million in 2002, $0.5 million in 2001 and $0.7 million in 2000. The expense set forth above in 2001 is before the recovery of $1.0 million in overpayment of royalties in prior years under the terms of the royalty contract. We have similar arrangements with the Kansas Farm Bureau Federation and other state Farm Bureau organizations in our market territory. Total royalty expense to Farm Bureau organizations other than the Iowa Farm Bureau Federation totaled $1.1 million in 2002, $1.0 million in 2001 and $1.2 million in 2000.
Based upon the provisions of the underlying agreement and the application of the “two class” method to our capital structure, we have not allocated any undistributed net income to the Class C preferred stock since the Class C
Management analyzes operations by reviewing financial information regarding products that are aggregated into three product segments. The product segments are: (1) traditional annuity, (2) traditional and universal life
interest expense and minority interest pertaining to distributions on trust preferred securities;
Amounts are net of adjustments, as applicable, to amortization of unearned revenue reserves, deferred policy acquisition costs, value of insurance in force acquired and income taxes attributable to gains and losses on investments.
We analyze our segment results based on pre-tax operating income. Accordingly, income taxes are not allocated to the segments. In addition, operating results are analyzed net of any transactions between the segments.
Net statutory premiums collected, which include premiums collected from annuities and universal life-type products that are not included in revenues for GAAP reporting, totaled $1,349.4 million in 2002. Total premiums collected in 2002 include $837.9 million assumed from American Equity, $20.8 million assumed from NTL and $471.7 million written in our core Farm Bureau marketing territory. Excluding reinsurance assumed, our total life and annuity collected premiums for 2002 are concentrated in the following core Farm Bureau distribution states-Iowa (28%), Kansas (24%) and Oklahoma (8%). Premiums collected in these states include premiums on products from all of our product segments.