- ---------------------------- (1) Includes cash and cash equivalents, marketable securities and notes receivable-affiliates. (2) On October 23, 2000, a $1,075,000,000 special dividend was paid to Allied Zurich in connection with the Zurich capital structure unification in October 2000. (3) The ratio of debt to total capitalization has been determined by dividing the sum of total debt plus QUIPS by stockholders' equity plus QUIPS. (4) The ratio of earnings to fixed charges has been determined by dividing the sum of income before income taxes plus fixed charges by fixed charges. Fixed charges consist of interest, capitalized interest, dividends paid to QUIPS holders, amortization of QUIPS offering expenses and that portion of rent expenses deemed to be interest.
On March 7, 2000, the Exchanges acquired Foremost. Foremost is a prominent writer of insurance on manufactured homes, recreational vehicles and other specialty lines. The Company provides management services in respect of this business and receives compensation based on a percentage of gross premiums earned.
Farmers Life, a wholly owned subsidiary of the Company, underwrites and sells life insurance, structured settlement and annuity products as well as variable universal life and variable annuity products. Revenues attributable to traditional life insurance products, such as whole life or term life contracts, as well as structured settlements with life contingencies are classified as premiums as they become due. Future benefits are associated with such premiums (through increases in liabilities for future policy benefits), and prior period capitalized costs are amortized (through amortization of DAC) so that profits are generally recognized over the same period as revenue income. Revenues attributable to universal life, variable universal life and variable annuity products consist of policy charges for the cost of insurance, policy administration charges, surrender charges and investment income on assets allocated to support policyholder account balances on deposit. Revenues for deferred annuity products consist of surrender charges and investment income on assets allocated to support policyholder account balances. Expenses on universal life and annuity policies as well as on variable products include interest credited to policyholders on policy balances as well as benefit claims incurred in excess of policy account balances. Revenues attributable to structured settlements without life contingencies consist of investment income on assets allocated to support the policyholder benefits schedule and expenses consist of interest credited to policyholders on policy balances.
The Company provides reinsurance coverage to the P&C Group Companies through its subsidiary, Farmers Re, which was formed and licensed to conduct business in December 1997. Effective April 1, 2001, the APD reinsurance agreement between Farmers Re and the P&C Group Companies which had been in force since January 1998 was cancelled and replaced with a similar APD reinsurance agreement supported by Farmers Re, Zurich affiliates and outside reinsurers. Under the new agreement, premiums ceded by the P&C Group Companies increased from $1.0 billion to $2.0 billion, with Farmers Re assuming 10%, or $200.0 million. The remaining $1.8 billion is ceded to the Zurich affiliates and outside reinsurance companies identified in the agreement. As a result of this new agreement, Farmers Re's premiums decreased from $1.0 billion for the year ended December 31, 2000 to $400.0 million for the year ended December 31, 2001. Additionally, on a monthly basis, premiums assumed by Farmers Re decreased from $83.3 million in 2000 to $16.7 million in 2001. Farmers Re continues to assume a quota share percentage of ultimate net losses sustained by the P&C Group Companies in their APD lines of business. This new agreement, which can be terminated by any of the parties, also provides for the P&C Group Companies to receive a ceding commission of 18% of premiums, versus 20% under the old agreement, with additional experience commissions that depend on loss experience. Similar to the old agreement, this experience commission arrangement limits Farmers Re's potential underwriting gain on the assumed business to 2.5% of premiums assumed.
The consolidated financial statements of the Company have been prepared in accordance with GAAP. The preparation of these financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements as well as the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.
The Company's critical accounting policies relate to revenue recognition, valuation of intangible assets, impairment of investments and the fair value of financial instruments.
Revenue Recognition. Through its AIF relationships with the Exchanges, the Company provides management services to the non-claims side of the P&C Group Companies' business and receives management fees for the services rendered. The Company recognizes management fee revenue according to the revenue recognition criteria established by Staff Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements".
The Company, through its AIF relationships with the Exchanges, is contractually permitted to receive a management fee based on the gross premiums earned by the P&C Group Companies. The range of fees has varied by line of business over time. During the past five years, aggregate management fees have averaged between 12% and 13% of gross premiums earned by the P&C Group Companies. In order to enable the P&C Group Companies to maintain appropriate capital and surplus while offering competitive insurance rates, each AIF has historically charged a lower management fee than the contractually permitted fee of 20% (25% in the case of the Fire Insurance Exchange). In order to ensure that its management fees remain competitive, the Company periodically reviews the fee it charges for the services it provides based on the level and cost of the services as well as market conditions.
As the P&C Group Companies earn gross premiums ratably over the life of the underlying insurance policy, the Company receives and recognizes the corresponding management fee ratably over the life of the underlying policies for which it is providing services. The risk of uncollectable premiums is borne by the P&C Group Companies and collectability of the premiums does not affect the amount of revenues the Company recognizes in a given period.
Goodwill. The excess of the purchase price over the fair value of the net assets ("Goodwill") of the Company at the date of the Company's acquisition by B.A.T ($2.4 billion) is being amortized on a straight-line basis over forty years as of December 31, 2001. The carrying amount of the Goodwill is regularly reviewed for indications of impairment in value which in the view of management are other than temporary, including unexpected or adverse changes in the following: (1) the economic or competitive environments in which the
VOLBA. At the date of B.A.T's acquisition of the Company, a portion of the purchase price ($662.8 million) was assigned to the VOLBA asset, which represented an actuarial determination of the expected profits from the life business in force at that time. The amount so assigned is being amortized over its actuarially determined useful life with the unamortized amount included in the "Deferred Policy Acquisition Costs and Value of Life Business Acquired" line in the accompanying consolidated balance sheets.
The following is a summary of recent FASB pronouncements. Please refer to Note A for further information related to these pronouncements.
- In June 2001, the FASB issued SFAS No. 141, "Business Combinations". This Statement, effective for all business combinations initiated after June 30, 2001, establishes standards for accounting and reporting business combinations. It requires that all business combinations be accounted for by the purchase method and prohibits the pooling of interest method of accounting except for transactions initiated before July 1, 2001. The adoption of this Statement did not have a material impact on the Company's consolidated financial statements.
The Company has adopted the provisions of SFAS No. 142 effective January 1, 2002, as applicable to all goodwill and other intangibles recognized in its financial statements at that date. The Company is in the process of completing the transitional goodwill impairment test and has identified the AIF relationships as intangible assets with indefinite useful lives. The Company will perform impairment tests of goodwill and the AIF relationships using discounted future cashflows and, based on such tests, the Company does not expect any impairment of recorded goodwill or AIF relationships. Additionally, as SFAS No. 142 ceases amortization of goodwill and AIF relationships with indefinite useful lives, the Company expects that it
- In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations". This Statement establishes the standard to record the fair value of a liability for an asset retirement obligation in the period in which it is incurred. The provisions of this Statement are effective for fiscal years beginning after June 15, 2002, with early application encouraged. The Company does not expect the adoption of this Statement to have a material impact on its consolidated financial statements.
Total Expenses. Total expenses as a percentage of operating revenues decreased from 56.1% in 2000 to 55.5% in 2001, a decrease of 0.6 percentage points.
General and Administrative Expenses. General and administrative expenses increased from $278.0 million in 2000 to $314.5 million in 2001, an increase of $36.5 million, or 13.1%. This increase was primarily due to increased levels of business activity between years, an increase in expenses incurred in connection with providing management services to the business assumed from Foremost as well as increased postage expense resulting from the recent privacy notice requirements called for by the Gramm-Leach-Bliley Act.
Net Investment Income. Net investment income decreased from $127.1 million in 2000 to $80.5 million in 2001, a decrease of $46.6 million, or 36.7%. This decrease was due mainly to a decrease in the average invested asset base resulting from the liquidation of a sizable portion of the fixed income portfolio, which was used to help fund the payment of the $1,075.0 million special dividend paid in October 2000, and lower investment yields. Investment income earned from related parties is disclosed in Notes G and L of this Report
Impairment Losses on Investments. Impairment losses on investments were $57.2 million for the year ended December 31, 2001.
Net Realized Gains. Net realized gains decreased $21.0 million, or 33.7%, from $62.3 million to $41.3 million in 2001 due primarily to unfavorable market conditions experienced in 2001.
Life Policyholders' Benefits and Charges. Life policyholders' benefits expense and charges increased from $381.0 million in 2000 to $459.2 million in 2001, an increase of $78.2 million, or 20.5%.
Interest Credited to Policyholders. Interest credited to policyholders, which represents the amount credited to policyholder funds on deposit under universal life-type contracts and deferred annuities, increased from $162.9 million in 2000 to $178.8 million in 2001, or 9.8%, reflecting growth in the universal life, structured settlements with life contingencies and fixed annuity fund balances.
General Operating Expenses. General operating expenses decreased from $164.0 million in 2000 to $151.6 million in 2001, a decrease of $12.4 million, or 7.6%.
Consolidated net income of the Company decreased from $725.3 million in 2000 to $580.0 million in 2001, a decrease of $145.3 million, or 20.0%.
Salaries and Employee Benefits. Salaries and employee benefits increased from $373.2 million in 1999 to $406.3 million in 2000, an increase of $33.1 million, or 8.9%. This increase was due to $35.9 million of expenses incurred in connection with providing management services to the business assumed from Foremost.
Merger Related Expenses. Expenses incurred by the Company as a result of the merger between B.A.T's financial services businesses and ZIC amounted to $0.2 million in 1999.
Net Investment Income. Net investment income increased from $117.5 million in 1999 to $127.1 million in 2000, an increase of $9.6 million, or 8.2%, due to higher investment yields. Investment income earned from related parties is disclosed in Notes G and L of this Report.
Net Realized Gains. Net realized gains decreased from $75.3 million in 1999 to $68.5 million in 2000, a decrease of $6.8 million, or 9.0%. This decrease was due primarily to losses incurred on sales of bonds in the third
quarter of 2000 as a result of the liquidation of a sizable portion of the fixed income portfolio, which was used to help fund the payment of the $1,075.0 million special dividend associated with the Zurich capital structure unification in October 2000.
Dividends on Preferred Securities of Subsidiary Trusts. Dividend expense was $42.1 million in each of the years ended December 31, 1999 and 2000.
Total Revenues. Total revenues increased from $752.2 million in 1999 to $805.0 million in 2000, an increase of $52.8 million, or 7.0%.
Net Investment Income. Net investment income increased $14.3 million, or 4.7%, over 1999 due primarily to an increase in average invested assets.
Impairment Losses on Investments. Impairment losses on investments were $22.4 million in 2000.
Total Operating Expenses. Total operating expenses increased from $508.0 million in 1999 to $545.0 million in 2000, an increase of $37.0 million, or 7.3%.
Life Policyholders' Benefits and Charges. Life policyholders' benefits expense and charges increased from $347.8 million in 1999 to $381.0 million in 2000, an increase of $33.2 million, or 9.5%.
Interest Credited to Policyholders. Interest credited to policyholders increased from $157.8 million in 1999 to $162.9 million in 2000 or 3.2%, reflecting growth in the universal life fund balance.
General Operating Expenses. General operating expenses increased from $160.2 million in 1999 to $164.0 million in 2000, an increase of $3.8 million, or 2.4%.
Amortization of DAC and VOLBA. Amortization expense increased from $102.6 million in 1999 to $108.8 million in 2000 due to differences in the mix of business.
In order to maintain the policyholders' surplus of the P&C Group Companies, the Company has, from time to time, made surplus contributions to the P&C Group Companies, receiving certificates of contribution or surplus notes which bear interest at various rates. As of December 31, 2001, the Company held $949.8 million of certificates of contribution and an $87.5 million surplus note of the P&C Group Companies (see Note H). The Company is under no obligation to make these contributions to the P&C Group Companies. However, the Company believes that these purchases of certificates of contribution and surplus notes have helped to support the historical growth in premiums earned by the P&C Group Companies and the related growth in management fees paid to the Company. As of December 31, 2001, the P&C Group Companies had total assets of $14.9 billion, surplus as regards policyholders of $3.5 billion, policies-in-force of 17.4 million and for the year ended December 31, 2001, had gross premiums earned of $12.4 billion.
Net cash provided by operating activities decreased from $1,062.1 million in 2000 to $987.4 million in 2001, a decrease of $74.7 million, or 7.0%. This decrease was primarily driven by the changes in assets and liabilities held by Farmers Re, which resulted from Farmers Re's reduced retention under the new APD reinsurance agreement. Although net income declined $145.3 million between years, this was primarily a result of a $128.5 million increase in impairment losses, which had no effect on cash.
Farmers Re. The principal uses of funds by Farmers Re are (i) the payment of non-life losses and loss adjustment expenses, (ii) the payment of reinsurance commissions and (iii) operating expenses. The principal sources of funds available to Farmers Re are premiums assumed from the P&C Group Companies and investment income.
The accompanying consolidated financial statements of Farmers Group, Inc. ("FGI") and its subsidiaries (together "the Company"; references to attorney-in-fact ("AIF"), as applicable in context, are to FGI, dba Farmers Underwriters Association, attorney-in-fact of Farmers Insurance Exchange; or Fire Underwriters Association, attorney-in-fact of Fire Insurance Exchange; or Truck Underwriters Association, attorney-in-fact of Truck Insurance Exchange) have been prepared in accordance with accounting principles generally accepted in the United States ("GAAP"). All material inter- company transactions have been eliminated. Certain amounts applicable to prior years have been reclassified to conform with the 2001 presentation. The preparation of the Company's financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements as well as the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.
The Company is AIF for three inter-insurance exchanges: Farmers Insurance Exchange, Fire Insurance Exchange and Truck Insurance Exchange (collectively the "Exchanges"), which operate in the property and casualty insurance industry. On March 7, 2000, the Exchanges acquired Foremost Corporation of America and its subsidiaries ("Foremost"), a prominent writer of insurance for manufactured homes, recreational vehicles and other specialty lines. Each policyholder of each Exchange appoints the Company as the exclusive AIF to provide management services to each Exchange. For such services, the Company earns management fees based on a percentage of gross premiums earned by the Exchanges, their respective subsidiaries, Farmers Texas County Mutual Insurance Company, Foremost County Mutual Insurance Company and Foremost Lloyds of Texas (collectively the "P&C Group Companies"). Each AIF also receives a management fee based on reinsurance premiums earned by the Exchanges on business of the P&C Group Companies insured by the Exchanges. The P&C Group Companies are owned by the respective policyholders of the Exchanges, Farmers Texas County Mutual Insurance Company and Foremost County Mutual Insurance Company as well as the underwriters of Foremost Lloyds of Texas. Accordingly, the Company has no ownership interest in the P&C Group Companies.
As part of the Company's strategic plan to focus its life insurance efforts on Farmers Life, the Company sold OSL and IGL to Great Southern Life Insurance Company, a subsidiary of Americo Life, Inc. in April 1997. Farmers Life markets a broad line of individual life insurance products, including universal life, term life and whole life insurance, structured settlement and annuity products, predominately flexible premium deferred annuities, as well as variable universal life insurance and variable annuity products. The products and services offered by Farmers Life are sold directly by the P&C Group Companies' agents.
As a result of a unification of the holding structure of the Zurich Financial Services Group in October 2000, Zurich Financial Services was renamed Zurich Group Holding, as noted above, and a new group holding company, Zurich Financial Services, was formed. As such, references to "Zurich" are to the group holding company, Zurich Financial Services.
In June 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible Assets". This Statement addresses financial accounting and reporting for intangible assets acquired individually or with a group of other assets (but not those acquired in a business combination) at acquisition. This Statement also addresses financial accounting and reporting for goodwill and other intangible assets subsequent to their acquisition. Upon adoption of this Statement, goodwill and other intangible assets that are determined to have an indefinite useful life will no longer be amortized. Instead, goodwill will be tested annually for impairment using a two-step process. The first step is to identify a potential impairment and, in transition, this step must be measured as of the beginning of the
fiscal year. The second step of the goodwill impairment test measures the amount of impairment loss (measured as of the beginning of the year of adoption), if any, and must be completed by the end of the year of initial adoption.
Additionally, intangible assets with indefinite useful lives will be evaluated each reporting period to determine whether an indefinite useful life is still supported. Further, such assets will be tested for impairment using a one-step process which compares the fair value to the carrying amount of the asset as of the beginning of the fiscal year. Any intangible asset that is determined to have a finite useful life shall be amortized over this period and its useful life shall be evaluated each reporting period to determine whether revisions to the remaining amortization period are warranted. This Statement is effective for financial statements issued for fiscal years beginning after December 15, 2001 and supersedes APB Opinion No. 17, "Intangible Assets". This Statement is required to be applied at the beginning of an entity's fiscal year and to be applied to all goodwill and other intangible assets recognized in its financial statements at that date.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets". This Statement addresses financial accounting and reporting for the impairment of long-lived assets and for long-lived assets to be disposed of. This Statement supersedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of". However, this Statement retains the fundamental provisions of SFAS No. 121 for a) recognition and measurement of the impairment of long-lived assets to be held and used and b) measurement of long-lived assets to be disposed of by sale. This Statement also supersedes the accounting and reporting provisions of APB Opinion No. 30, "Reporting the Results of Operations-Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions", for segments of a business to be disposed of. However, this Statement retains the requirements of APB Opinion No. 30 to report discontinued operations separately from continuing operations and extends that reporting to a component (rather than a segment of a business) of an entity that either has been disposed of or is classified as held for sale. The provisions of this Statement are effective for financial statements issued for fiscal years beginning after December 15, 2001, and interim periods within those fiscal years, with early application encouraged. The provisions of this Statement generally are to be applied prospectively. The Company does not expect the adoption of this Statement to have a material impact on its consolidated financial statements.
Shares"). Prior to a recapitalization of the Company's capital structure which occurred in connection with a private placement of an aggregate of $1,125,000,000 of securities by six Zurich RegCaPS Funding Trusts on February 9, 2001, the Company had 500 shares of Class A Common Stock, par value $1.00 per share, and 500 shares of Class B Common Stock, par value $1.00 per share. All Class A Shares were wholly owned by ZGH and all Class B Shares were wholly owned by Allied Zurich Holdings Limited ("Allied Zurich"), an affiliated company created during the restructuring of B.A.T.
The holders of Class C Shares are entitled to receive non-cumulative dividends when, as and if declared by the Board of Directors out of funds legally available therefor. No cash dividends may be declared or paid on any Class A Shares, Class B Shares or any other shares of common stock that rank junior to the Class C Shares with respect to payment of dividends, unless (i) full dividends have been declared for payment on the Class C Shares in an amount at least equal to the greater of (A) the dividends payable or set apart during the dividend period during which such cash dividends are paid at the respective Class C Share indicative rate (as defined in the Certificates of Designations of Class C-1 through Class C-6 Shares) or (B) 7.4503311% (as adjusted as set forth above) of the amount of dividends paid or set apart for payment by the Company on its common shares (including the Class C
The Company, through its AIF relationships with the Exchanges, provides management services to the non-claims side of the P&C Group Companies and receives management fees for the services rendered. As a result, the Company received management fees from the P&C Group Companies of $1,582,200,000, $1,492,217,000 and $1,402,107,000 in 2001, 2000 and 1999, respectively.
Revenues associated with universal life products as well as structured settlements involving life contingencies consist of policy charges for the cost of insurance, policy administration fees, surrender charges and investment income on assets allocated to support policyholder account balances. Revenues for deferred annuity products consist of surrender charges and investment income on assets allocated to support policyholder account balances. Expenses include interest credited to policyholder account balances and benefit claims incurred in excess of policyholder account balances. Revenues and expenses related to structured settlements not involving life contingencies are recorded consistent with guidelines for investment contracts, which are not subject to mortality risks. Liabilities for future policy benefits on universal life and deferred annuity products are determined under the retrospective deposit method. DAC is amortized in relation to the present value of expected gross profit margins on the policies, after giving recognition to differences between actual and expected gross profit margins to date. In compliance with a Securities and Exchange Commission ("SEC") staff announcement, the Company has recorded certain entries to the DAC and VOLBA line of the consolidated balance sheet in connection with SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities". The SEC requires that companies record entries to those assets and liabilities that would have been adjusted had the unrealized investment gains or losses from securities classified as available- for-sale actually been realized, with corresponding credits or charges reported directly to stockholders' equity. Accordingly, DAC and VOLBA are increased or decreased to reflect what would have been the impact on estimated future gross profits, had net unrealized gains or losses on securities been realized at the balance sheet date. Net unrealized gains or losses on securities, within stockholders' equity, also reflect this impact. These entries decreased the DAC and VOLBA assets by $24,869,000 and $6,097,000 as of December 31, 2001 and 2000, respectively.
In 2000, Farmers Life introduced variable universal life and deferred variable annuity contracts. Revenues and expenses for variable universal life annuities are recognized in a manner similar to universal life products. Recognition of revenues and expenses for deferred variable annuities is consistent with that of deferred annuity products. However, unlike other Farmers Life products, assets and liabilities for both variable universal life and deferred variable annuity contracts are legally segregated from the general assets of the Company and are reported on the Separate Accounts lines on the Company's consolidated balance sheets.
Farmers Re, a wholly owned subsidiary of the Company, reinsures a percentage of the APD business written by the P&C Group Companies. Effective April 1, 2001, the APD reinsurance agreement between Farmers Re and the P&C Group Companies which had been in force since January 1998 was cancelled and replaced with a similar APD reinsurance agreement supported by Farmers Re, Zurich affiliates and outside re-insurers. Under the new agreement, annual premiums ceded by the P&C Group Companies increased from $1,000,000,000 to $2,000,000,000, with Farmers Re assuming 10%, or $200,000,000. The remaining $1,800,000,000 is ceded to the Zurich affiliates and outside reinsurance companies identified in the agreement. As a result of this new agreement, Farmers Re's premiums decreased from $1,000,000,000 for the year ended December 31, 2000 to $400,000,000 for the year ended December 31, 2001. On a monthly basis, premiums assumed by Farmers Re decreased from $83,333,000 in 2000 to $16,667,000 in 2001.
Farmers Re continues to assume a quota share percentage of ultimate net losses sustained by the P&C Group Companies in their APD lines of business. This new agreement, which can be terminated by any of the parties, also provides for the P&C Group Companies to receive a ceding commission of 18% of premiums, versus 20% under the old agreement, with additional experience commissions that depend on loss experience. Similar to the old agreement, this experience commission arrangement limits Farmers Re's potential underwriting gain on the assumed business to 2.5% of premiums assumed.
On March 31, 2001, Farmers Re and the P&C Group Companies commuted $89,936,000 of losses and loss adjustment expenses associated with the 2000 accident year. As a result, in May 2001, Farmers Re paid the P&C Group Companies $89,936,000 of losses and loss adjustment expenses and $8,766,000 of accrued interest in settlement of this commutation. Additionally, on August 15, 2001, Farmers Re and the P&C Group Companies commuted $100,797,000 of losses and loss adjustment expenses due to the cancellation of the original APD reinsurance agreement. As a result, Farmers Re paid the P&C Group Companies $100,797,000 of losses and loss adjustment expenses and $1,036,000 of accrued interest in settlement of this commutation.
In March 2000, Farmers Re and the P&C Group Companies commuted $106,444,000 of losses and loss adjustment expenses associated with the 1999 accident year. As a result, in May 2000, Farmers Re paid the P&C Group Companies $106,444,000 of losses and loss adjustment expenses and $8,966,000 of accrued interest in settlement of this commutation.
The Company follows the provisions of Statement of Position No. 98-1, "Accounting for the Cost of Computer Software Developed or Obtained for Internal Use". The Company expenses costs incurred in the preliminary project stage and, thereafter, capitalizes costs incurred in developing or obtaining internal use software. Certain costs, such as maintenance and training, are expensed as incurred. Capitalized costs are amortized on a straight-line basis over the useful life of the software once it is placed into service.
As of December 31, 1999, the Company was committed to a plan to sell one of its business service centers at a market price which was $1,789,000 lower than the carrying value of the property. In accordance with SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of", the Company recognized an impairment loss of $1,789,000 which was reflected on the "General and administrative expenses" line in the Farmers Management Services section of the Company's consolidated income statement for the year ended December 31, 1999. This business service center was subsequently sold on July 20, 2001.
- A $250,000,000 note receivable from ZGA US Limited ("ZGAUS"), a subsidiary of Zurich, formerly known as Orange Stone (Delaware) Holdings Limited. The Company loaned $250,000,000 to ZGAUS on December 15, 1999 and, in return, received a medium-term note with a 7.50% fixed interest rate that matures on December 15, 2004. Interest on this note is paid semi-annually. Income earned on this note totaled $18,750,000 for each of the years ended December 31, 2001 and 2000 and $781,000 for the year ended December 31, 1999.
- $95,000,000 of notes receivable from Zurich Financial Services (UKISA) Limited ("UKISA"), a subsidiary of Zurich. The Company purchased $1,057,000,000 of notes from UKISA on September 3, 1998. Subsequently, on March 1, 2000, Eagle Star Life Assurance Company Limited ("Eagle Star"), also an affiliate of Zurich, assigned $175,000,000 of matured surplus notes of the P&C Group Companies to the Company and, in return, the Company reduced the outstanding balance of the notes receivable from UKISA by $175,000,000. Additionally, on September 3, 2000, $25,000,000 of the notes receivable from UKISA, bearing interest at a coupon rate of
Finally, effective November 2001 and December 2001, the Company purchased $350,000,000 and $206,500,000, respectively, of certificates of contribution of the P&C Group Companies, which mature in September 2006. Of the $206,500,000 of certificates of contribution of the P&C Group Companies purchased in December 2001, $107,000,000 was purchased by Farmers Life and was settled in January 2002. As a result, Farmers Life held a $107,000,000 payable to the P&C Group Companies as of December 31, 2001.
At December 31, 2001, the Company held the following certificates of contribution and surplus note of the P&C Group Companies:
- An $87,500,000 surplus note, issued in March 2000, bearing interest at 8.50% annually and maturing in February 2005.
- Other certificates of contribution totaling $23,330,000 which bear interest at various rates.
I. Company Obligated Mandatorily Redeemable Preferred Securities of Subsidiary Trusts Holding Solely Junior Subordinate Debentures
Under certain circumstances, the Junior Subordinated Debentures may be distributed to holders of the QUIPS and holders of the Common Securities in liquidation of the Subsidiary Trusts. As of September 27, 2000, FGI had the option to redeem, in whole or part, the Junior Subordinated Debentures. The QUIPS are subject to mandatory redemption upon repayment of the Junior Subordinated Debentures at maturity, or upon their earlier redemption, at a redemption price of $25 per Preferred Security, plus accrued and unpaid distributions thereon to the date fixed for redemption.
The Company has two profit sharing plans providing for cash payment to all eligible employees. The two plans, Deferred Profit Sharing and Cash Profit Sharing, provide for a maximum aggregate expense of 16.25% of the Company's consolidated annual pretax earnings, as adjusted. The Deferred Profit Sharing Plan, limited to 10% of pretax earnings, as adjusted, or 15% of the salary or wage paid or accrued to eligible employees, provides for an annual contribution by the Company to a trust for eventual payment to employees as provided in the Plan. The Cash Profit Sharing Plan provides for annual cash distributions to eligible employees if certain criteria are met. The Cash Profit Sharing Plan is limited to 5% of pretax earnings, as adjusted, or 5% of employee salaries or wages paid or accrued.
Expense under these plans was $51,100,000, $59,491,000 and $52,984,000 in 2001, 2000 and 1999, respectively.
Statutory capital and surplus of the Insurance Subsidiaries was $1,863,927,000 and $1,728,378,000 as of December 31, 2001 and 2000, respectively. Statutory net income was $55,234,000, $187,712,000 and $152,716,000 for the years ended December 31, 2001, 2000 and 1999, respectively. The decrease in statutory net income between 2000 and 2001 was due primarily to realized losses and impairment losses on investments.
The Company follows the provisions of SFAS No. 115. This Statement addresses the accounting and reporting for investments in equity securities that have readily determinable market values and for all investments in debt securities. The Company classified all investments in equity and debt securities as available-for-sale under SFAS No. 115, with the exception of an investment held as of December 31, 2001 in Endurance Specialty Insurance Limited ("Endurance") as well as investments held as of December 31, 2001 and 2000 related to the grantor trusts. The available-for-sale investments are reported on the balance sheet at market value, with unrealized gains and losses, net of tax, excluded from earnings and reported as a component of stockholders' equity.
As of December 31, 2001, the Company held $50,000,000 of common stock of Endurance. The Company purchased the Endurance equity securities in a private placement offer in December 2001. As non-exchange traded securities, these investments were carried at cost as of December 31, 2001 and were reported on the "Other investments" line in the Farmers Management Services section of the consolidated balance sheet. In addition, as of December 31, 2001 and 2000, investments related to the grantor trusts totaled $60,721,000 and $61,131,000, respectively, and were classified as trading securities under SFAS No. 115. As a result, these investments were reported on the "Other assets" line in the Farmers Management Services section of the consolidated balance sheets at market value with both realized and unrealized gains and losses included in earnings, net of tax, in the year in which they occurred.
The Company regularly reviews its investment portfolio to determine whether declines in the value of investments are other than temporary as defined by SFAS No. 115. The Company's review for declines in value includes reviewing historical and forecasted financial information as well as reviewing the market performance of similar types of investments. As a result of this review, the Company determined that some of its investments had declines in value that were other than temporary as of December 31, 2001 due to unfavorable market and economic conditions. Accordingly, for the year ended December 31, 2001, the Company recorded $150,978,000 of impairment losses on investments, primarily in the equity portfolios. This included $32,389,000 of impairment losses related to Enron Corporation. Also, for the year ended December 31, 2000, Farmers Life recorded $22,429,000 of impairment losses on fixed income securities of Armstrong World Industries, Inc. and Owens Corning.
Impairment losses on investments owned by Farmers Management Services are determined based on the market value of those investments on the date of impairment. Impairment losses on investments for the years ended December 31 are:
The amortized cost, gross unrealized gains and losses, and estimated market values of investments in equity securities pertaining to common stocks owned by Farmers Management Services are as follows:
The amortized cost, gross unrealized gains and losses and estimated market values of investments in debt securities, including bonds and redeemable preferred stocks, owned by Farmers Management Services are as follows:
The amortized cost and estimated market value of debt securities, including marketable securities, owned by Farmers Management Services as of December 31, 2001, 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 amortized cost and estimated market value of debt securities owned by the Insurance Subsidiaries as of December 31, 2001, 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.
Proceeds from sales of available-for-sale securities received by the Company were $2,487,105,000, $2,052,734,000 and $1,808,735,000 in 2001, 2000 and 1999, respectively. Gross gains of $100,364,000, $174,940,000 and $142,027,000 and gross losses of $196,052,000, $54,563,000 and $44,999,000 were realized on sales and write-downs during 2001, 2000 and 1999, respectively.
Hedge accounting is used to account for the call options as Farmers Life believes that the options reduce the risks associated with increases in the account value of the annuities that result from increases in the S&P 500. The call options effectively hedge the annuity contracts since they are both purchased and sold with identical parameters. Periodically, the value of the assets (S&P 500 call options) is matched to the potential liability (annuity contracts) to ensure the hedge has remained effective. The annuities were written based on a seven year investment term, absent early termination by participants. Therefore, the anticipated hedged transaction (i.e., payment of interest to the policyholder at the end of the investment term and maturity of the call option) for each annuity is generally expected to occur in seven years or less. The amount of unrealized hedging losses was $23,763,000 and $3,425,000 in 2001 and 2000, respectively.
On December 27, 2001, Farmers Life disposed of 1,598 and 1,319 S&P 500 call option contracts acquired in January and February 2001, respectively. Farmers Life received $518,000 in S&P 500 disposition proceeds, resulting in a $682,000 realized loss on disposition. This disposal was necessary as Farmers Life purchased a larger than necessary quantity of S&P 500 call options to hedge against the equity indexed annuity product liability.
The cash requirement of the call options consists of the initial premium paid to purchase the call options. Should a liability exist to the annuity participant at maturity of the annuity policy, the termination or maturity of the option contracts will generate positive cash flow to Farmers Life. The appropriate amount of cash will then be remitted to the annuity participant based on the respective participation rate. The call options are generally expected to be held for a seven year term, but can be terminated at any time.
The Company follows the principles of SFAS No. 118, "Accounting by Creditors for Impairment of a Loan". This Statement requires that an impaired loan be measured based on the present value of expected future cash flows discounted at the loan's effective interest rate or, as a practical expedient, at the loan's observable market price or the fair value of the collateral, if the loan is collateral dependent.
For the year ended December 31, 2001, no loans were considered to be impaired, and no impaired loan allowance was recorded. For the year ended December 31, 2000, Farmers Life held one mortgage loan which was considered impaired. This loan was paid off in November 2000 and, as a result, no loans were considered to be impaired, and no impaired loan allowance was recorded as of December 31, 2000.
The Company records interest income received on impaired mortgage loans on a cash basis. The average recorded investment and income recognized on impaired mortgage loans follows:
The Company has security lending arrangements with a securities lending provider. The arrangements in effect as of December 31, 2001 authorize the lending provider to lend securities held in the Company's portfolio to a list of authorized borrowers. Concurrent with delivery of the securities, the borrower provides the Company's lending provider with cash collateral equal to 102% of the market value of securities subject to the "loan".
Information regarding the Regular Plan's and the Restoration Plan's funded status is not developed separately for the Company and the P&C Group Companies. The funded status of the Plans for the Company and the P&C Group Companies as of December 1, 2001 and 2000 (the latest date for which information is available) was as follows:
Upon B.A.T's purchase of the Company in 1988, the Company allocated part of the purchase price to its portion of the Regular Plan assets in excess of the projected benefit obligation at the date of acquisition. The asset is being amortized for the difference between the Company's net pension cost and amounts contributed to the Plan. The unamortized balance as of December 31, 2001 and 2000 was $9,576,000 and $13,258,000, respectively.
The Company's postretirement benefits plan is a contributory defined benefit plan for employees who were retired or who were eligible for early retirement as of January 1, 1995, and is a contributory defined dollar plan for all other employees retiring after January 1, 1995. Health benefits are provided for all employees who participated in the Company's and the P&C Group Companies' group medical benefits plan for the 10 years prior to retirement at age 55 or later. A life insurance benefit of $5,000 is provided at no cost to retirees who maintained group insurance coverage for the 10 years prior to retirement at age 55 or later.
The Company's share of the accrued postretirement benefit cost was approximately $61,544,000 in 2001 and $57,758,000 in 2000.
The Company is a party to numerous lawsuits arising from its AIF relationships with the Exchanges. The Company is also a party to additional lawsuits arising from its normal business activities. These actions are in various stages of discovery and development, and some seek punitive as well as compensatory damages. In the opinion of management, the Company has not engaged in any conduct which should warrant the award of any material punitive or compensatory damages. The Company intends to vigorously defend its position in each case, and management believes that, while it is not possible to predict the outcome of such matters with absolute certainty, ultimate disposition of these proceedings should not have a material adverse effect on the Company's consolidated results of operations or financial position.
Cash payments for interest were $2,223,000, $1,742,000 and $1,693,000 in 2001, 2000 and 1999, respectively, while cash payments for dividends to the holders of the Company's QUIPS were $42,070,000 in 2001, 2000 and 1999. Cash payments for income taxes were $455,685,000, $440,008,000 and $426,017,000 in 2001, 2000 and 1999, respectively.
In 2001, the Company used $207,000,000 of proceeds received from the settlement of the note receivable from UKISA (see Note G) as well as $206,500,000 of proceeds received from the redemption of the surplus notes of the P&C Group Companies (see Note H) to substantially fund the purchase of $556,500,000 of certificates of contribution of the P&C Group Companies (see Note H).
In 2000, the Company used $580,000,000 of proceeds received from the sale of the notes receivable from UKISA (see Note G) to help fund the payment of the $1,075,000,000 special dividend associated with the Zurich capital structure unification in October 2000. Also, in 2000, the Company purchased $370,000,000 of certificates of contribution of the P&C Group Companies to help fund the Exchanges' acquisition of Foremost (see Note H).
As of December 31, 2001 and 2000, the Company had a revolving credit agreement with certain financial institutions and had an aggregate borrowing facility of $500,000,000. The proceeds of the facility were available to the Company for general corporate purposes, including loans to the P&C Group Companies. Facility fees were payable on the aggregate borrowing facility in the amount of 6 basis points per annum as of December 31, 2001 and 7 basis points per annum as of December 31, 2000 and were reimbursable to the Company by the P&C Group Companies. In the case of a draw on the facility, the Company has the option to borrow at annual rates equal to the prime rate, the banks' certificate of deposit rate plus one percentage point, the federal funds effective rate plus 1/2 of one percentage point or the London Interbank Offered Rate plus certain percentages. As of December 31, 2001 and 2000, the Company did not have any outstanding borrowings under the revolving credit agreement. Facility fees were $300,000 for the year ended December 31, 2001 and $350,000 for each of the years ended December 31, 2000 and 1999, and were reimbursed by the P&C Group Companies. The revolving credit agreement in effect as of December 31, 2001 will expire on July 1, 2002.
The assets and liabilities held in Separate Accounts relate to the variable universal life and annuity products offered by Farmers Life. The assets and liabilities held in the Separate Accounts are legally segregated from the general assets and liabilities of the Company. The assets of the Separate Accounts are carried at fair market value. The Separate Accounts liabilities represent the contract holders' claims to the related assets and are carried at the fair market value of the assets. Investment income and realized capital gains and losses of the Separate Accounts accrue directly to the contract holders and therefore are not included in the Company's consolidated statements of income and comprehensive income. Revenues to the Company from the Separate Accounts generally consist of administration, surrender and mortality fees.
Farmers Life has retention limits for automatic reinsurance ceded which set the maximum retention on new issues at $2,000,000 per life for the Farmers Flexible Universal Life policy; $1,500,000 per life for all Traditional policies except Farmers Yearly Renewable Term; and $800,000 per life for Farmers Yearly Renewable Term. The excess is reinsured with a third party reinsurer. In addition, beginning in January 2000, Farmers Life entered into a co-insurance agreement with a third party insurer to reinsure the Farmers Level Term 2000 5, 10 and 20 year products, which replaced the Farmers Premier 5, 10 and 20 year products. Premiums ceded under these agreements totaled $54,420,000 in 2001, $33,527,000 in 2000 and $13,939,000 in 1999. Life reinsurance receivables totaled $65,240,000 and $39,063,000 at December 31, 2001 and 2000, respectively.
The basis of accounting used by the Company's management in evaluating segment performance and determining how resources should be allocated is referred to as the Company's GAAP historical basis, which
The Company accounts for intersegment transactions as if they were to third parties and, as such, records the transactions at current market prices. There were no reportable intersegment revenues among the Company's three reportable operating segments for the years ended December 31, 2001, 2000 and 1999.
(g) Amount includes the historical basis amortization associated with the DAC asset.
(d) Amount includes PGAAP adjustments associated with the amortization of the VOLBA asset and the reversal of amortization associated with the pre-1988 DAC asset. Included in this amount are adjustments totaling $21.3 million, increasing expense, due to unfavorable persistency experience on the pre-1988 business.
* Consolidated income before provision for income taxes for the three months ended September 30, 2001 and December 31, 2001 decreased $86,120,000 and $64,858,000, respectively, due to impairment losses on investments (see Note L).