The following table sets forth summary consolidated income statement data, consolidated balance sheet data and other operating data for the periods indicated. The following consolidated income statement data of the Company for each of the years in the five-year period ended December 31, 1999, and the consolidated balance sheet data of the Company as of December 31, 1999 and each of the preceding four years ended December 31, have been derived from the Company's audited consolidated financial statements. The following data should be read in conjunction with the Company's Consolidated Financial Statements and related notes, "Management's Discussion and Analysis of Financial Condition and Results of Operations" and other financial information appearing elsewhere herein.
Income statement data includes the effect of amortizing the purchase accounting entries related to B.A.T's acquisition of the Company in December 1988. Major items incorporated in the purchase price of the Company include goodwill and the value of the AIF contracts of the P&C Group (see Note A). The amortization of these two items, which is being taken on a straight-line basis over forty years, reduced annual pretax income by approximately $102.8 million in each of the years 1995 through 1999.
Amortization of AIF Contracts and Goodwill. The purchase accounting entries related to the acquisition of the Company by B.A.T in December 1988 include both goodwill (capitalized at $2.4 billion) and the value of the AIF contracts of the P&C Group (capitalized at $1.7 billion). The amortization of these two items, which is being taken on a straight-line basis over forty years, reduced pretax income by approximately $102.8 million for both 1999 and 1998.
Life and Annuity Premiums. Life and annuity premiums increased $35.8 million, or 20.6%, between years. This increase was due to growth in the volume of term and whole life insurance in-force coupled with Farmers Life entering the structured settlement market in January 1999.
Life Policy Charges. Life policy charges increased $4.2 million in 1999, or 2.1%, over 1998, reflecting a 1.9% growth in universal life-type insurance in-force.
Total Operating Expenses. Total operating expenses increased from $458.8 million in 1998 to $508.0 million in 1999, an increase of $49.2 million, or 10.7%.
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 $150.6 million in 1998 to $157.8 million in 1999, or 4.8%, reflecting growth in the universal life and annuity fund balances.
General Operating Expenses. General operating expenses increased from $150.5 million in 1998 to $160.2 million in 1999, an increase of $9.7 million, or 6.4%.
The $102.6 million of expenses in 1999 reflects adjustments which were made to the fixed universal product DAC asset and the VOLBA asset during the year. DAC amortization expense was reduced $23.3 million due to favorable persistency experience on the fixed universal life business. This reduction in expense was largely offset by a $21.3 million increase in VOLBA amortization expense resulting from unfavorable persistency experience on the pre-1988 business. The net impact of these adjustments was a $2.0 million reduction in amortization expense in 1999.
Provision for Income Taxes. Provision for income taxes increased from $71.2 million in 1998 to $86.0 million in 1999 due to higher pretax operating income.
Consolidated net income of the Company increased from $576.8 million in 1998 to $677.0 million in 1999, an increase of $100.2 million, or 17.4%.
Salaries and Employee Benefits. Salaries and employee benefits decreased from $335.8 million in 1997 to $328.6 million in 1998, a decrease of $7.2 million, or 2.1%, primarily due to a reduction in
employee complement due to increased operating efficiency as a result of automation through the greater use of information technology systems.
Buildings and Equipment Expenses. Buildings and equipment expenses increased from $95.8 million in 1997 to $145.4 million in 1998, an increase of $49.6 million, or 51.8%. Contributing to this increase were the write-off of $43.6 million of capitalized costs that were no longer deemed to be recoverable and higher amortization expense associated with information technology systems software.
Net Investment Income. Net investment income decreased from $144.2 million in 1997 to $135.1 million in 1998, a decrease of $9.1 million, or 6.3%. Of this decrease, $8.6 million was due to the redemption of certificates of contribution of the P&C Group and the subsequent issuance of the BAFS notes at lower interest rates (see Note T). The remaining decrease was due substantially to lower market yield rates.
Management Services Income. As a result of the foregoing, management services income decreased from $450.2 million for the year ended December 31, 1997 to $420.8 million for the year ended December 31, 1998, a decrease of $29.4 million, or 6.5%. Exclusive of the merger related expenses and the write-off of impaired assets, management services income increased $12.5 million, or 2.8%, between years.
In 1998, Farmers Re assumed $1,000.0 million of premiums, incurred $655.1 million of non-life losses and loss adjustment expenses and incurred $319.9 million of non-life reinsurance commissions expense. For the year ended December 31, 1998, Farmers Re contributed $37.2 million to income before taxes and $25.4 million to net income.
Life Policy Charges. Policy charges increased $5.6 million in 1998, or 2.8% over 1997, reflecting growth in the average volume of universal life-type insurance in-force.
Net Realized Gains/(Losses). Net realized gains/(losses) decreased $23.6 million, from a $10.1 million gain in 1997 to a $13.5 million loss in 1998. This decrease was due to realized losses recognized as a result of the $26.0 million writedown of Russian bond holdings in 1998.
General Operating Expenses. General operating expenses decreased from $152.5 million in 1997 to $150.5 million in 1998, a decrease of $2.0 million, or 1.3%.
The Year 2000 issue has not presented any significant disruptions to the operations of the Company or the P&C Group. However, the Company will continue to monitor its systems throughout the year to ensure that all systems are operating properly.
Net cash provided by operating activities decreased from $1,092.2 million in 1998 to $926.3 million in 1999, a decrease of $165.9 million, or 15.2%. This decrease in cash was due to a $273.7 million increase in reinsurance payables to the P&C Group and non-life losses and loss adjustment expenses in 1998. Partially offsetting this decrease in cash was a $100.1 million increase in consolidated net income.
Net cash used in investing activities decreased from $951.1 million in 1998 to $561.6 million in 1999, which resulted in an increase in cash of $389.5 million, or 41.0%. This increase in cash was the result of an $840.9 million increase in proceeds received from sales and maturities of investments available-for-sale in 1999 coupled with the purchase of the $119.0 million surplus note of the P&C Group (see Note F) in 1998. Partially offsetting these increases in cash was a $305.4 million increase in the purchases of investments available-for-sale and the issuance of the $250.0 million loan to OSDH in 1999.
Net cash used in financing activities increased from $329.8 million in 1998 to $378.7 million in 1999, which resulted in a decrease in cash of $48.9 million, or 14.8%, due to a $78.2 million increase in dividends paid to stockholders. This decrease in cash was offset in part by higher cash flows from annuity contracts in 1999.
Farmers Life. The principal uses of funds by Farmers Life are (i) policy benefits and claims, (ii) loans to policyholders, (iii) capital expenditures, (iv) life commissions, (v) operating expenses and (vi) stockholder's dividends. The principal sources of funds available to Farmers Life are premiums and amounts earned from the investment of premiums and deposits. These sources of funds have historically satisfied the liquidity needs of Farmers Life.
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 and investment income.
FARMERS GROUP, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (Amounts in thousands)
The accompanying consolidated financial statements of Farmers Group, Inc. ("FGI") and its subsidiaries (together "the Company") have been prepared in accordance with generally accepted accounting principles ("GAAP"). All material inter-company transactions have been eliminated. Certain amounts applicable to prior years have been reclassified to conform with the 1999 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.
In December 1988, B.A.T Industries p.l.c. ("B.A.T") acquired 100% ownership of the Company for $5,212,619,000 through its wholly owned subsidiary BATUS Financial Services. Immediately thereafter, BATUS Financial Services was merged into Farmers Group, Inc.. The acquisition was accounted for as a purchase and, accordingly, the acquired assets and liabilities were recorded in the Company's consolidated balance sheets based on their estimated fair values at December 31, 1988.
Prior to April 15, 1997 the Company's life insurance operations were conducted by three wholly owned subsidiaries. A portion of the purchase price ($662,778,000) was assigned to the "Value of Life Business Acquired" ("VOLBA"), which represented an actuarial determination of the expected profits from the business in force at the date of B.A.T's acquisition of the Company. The amount so assigned is being amortized over its actuarially determined useful life with the unamortized amount included in "Deferred Policy Acquisition Costs and Value of Life Business Acquired" in the accompanying consolidated balance sheets.
On April 15, 1997, upon receipt of regulatory approval, the Company sold two of its life insurance subsidiaries, The Ohio State Life Insurance Company ("OSL") and Investors Guaranty Life Insurance Company ("IGL"), to Great Southern Life Insurance Company, a subsidiary of Americo Life, Inc.. The sale of these
subsidiaries resulted in a $19,019,000 gain and was reported on the "Gain on sale of subsidiaries" line of the income statement. In addition, taxes associated with the sale increased 1997 tax expense by $26,826,000 and were reflected on the "Provision for income taxes" line. Both of these amounts were reflected in the "Management services to property and casualty insurance companies; and other" section of the Company's consolidated income statement for the year ended December 31, 1997. The decision to sell these subsidiaries was part of the Company's strategic plan to focus its life insurance efforts on the growth of its remaining life insurance subsidiary, Farmers New World Life Insurance Company ("Farmers Life"), by far its largest life insurance company, through increased sales to the P&C Group's customer base. Farmers Life markets a broad line of individual life insurance products, including universal life, term life and whole life insurance and structured settlement and annuity products, predominately flexible premium deferred annuities. These products and services are sold directly by the P&C Group's agents.
In September 1998, B.A.T's Financial Services Businesses, which included the Company, were merged with Zurich Insurance Company ("ZIC"). The businesses of ZIC and B.A.T's Financial Services Businesses were transferred to Zurich Financial Services ("Zurich"), a new Swiss company with headquarters in Zurich. As a result, each two shares of the Company's prior outstanding stock were recapitalized into one share of Class A Common Stock, par value $1.00 per share ("Ordinary Shares"), and one share of Class B Common Stock, par value $1.00 per share ("Income Shares"). Under the merger agreement, all Ordinary Shares became wholly owned by Zurich and all Income Shares became wholly owned by Allied Zurich Holdings Limited, an affiliated company created during the restructuring of B.A.T. This merger was accounted for by Zurich as a pooling of interests and, therefore, no purchase accounting adjustments were made to the Company's assets and liabilities.
Depreciation is calculated for financial statement purposes by the straight-line method. Repairs and maintenance are charged to operations; significant renewals and betterments are capitalized.
In 1999, the Company adopted SOP No. 98-5, "Reporting on the Costs of Start Up Activities". This SOP addresses the recording of costs associated with a one-time activity, such as opening a new facility, introducing a new product or service, conducting business in a new territory or conducting business with a new class of customer.
In June 1999, the Financial Accounting Standards Board ("FASB") released Statement of Financial Accounting Standards ("SFAS") No. 137, "Deferral of the Effective Date of FASB Statement No. 133", which defers the effective date of SFAS No. 133 to fiscal years beginning after June 15, 2000. In 1998, the FASB
Farmers Re, a wholly owned subsidiary of the Company, reinsures a percentage of the auto physical damage business written by the P&C Group. Under the quota share reinsurance treaty, entered into in January 1998, Farmers Re assumes monthly premiums of $83,333,000 and a quota share percentage of ultimate net losses sustained by the P&C Group in its auto physical damage lines of business. This treaty also provides for the P&C Group to receive a provisional ceding commission of 20% of premiums with additional experience commissions that depend on loss experience. This experience commission arrangement limits Farmers Re's potential underwriting gain on the assumed business to 2.5% of premiums assumed.
In March 1999, Farmers Re and the P&C Group commuted $105,944,000 of losses and loss adjustment expenses associated with the 1998 accident year. As a result, in May 1999, Farmers Re paid the P&C Group $105,944,000 of losses and loss adjustment expenses and $8,205,000 of accrued interest in settlement of this commutation.
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 "Management services to property and casualty insurance companies; and other" section of the Company's consolidated income statement for the year ended December 31, 1999.
employee salaries or wages paid or accrued. The Cash Plus Plan was limited to 1.25% of pretax earnings, as adjusted.
Expense under these plans was $52,984,000, $51,869,000 and $52,235,000 in 1999, 1998 and 1997, respectively.
Statutory capital and surplus of Farmers Life was $1,052,177,000 and $922,426,000 as of December 31, 1999 and 1998, respectively. Statutory net income was $114,909,000 for the year ended December 31, 1999 and $98,796,000 for the year ended December 31, 1998. Combined statutory net income of the Life Insurance Subsidiaries was $128,461,000 for the year ended December 31, 1997, which reflected the results of Farmers Life for the year and the results of OSL and IGL through April 15, 1997.
There are certain statutory limitations on the distribution of surplus. As of December 31, 1999, $112,941,000 was available for distribution without approval from the Washington State Department of Insurance, the state in which Farmers Life is domiciled.
* Includes $4.1 million, $3.4 million and $1.6 million in 1999, 1998, and 1997, respectively, of unrealized gains associated with the trading securities reported on the "Other assets" line of the balance sheet.
Realized gains and losses on sales, redemptions and writedowns of investments owned by the Insurance Subsidiaries are determined based on either the cost of the individual securities or the amortized cost of real estate. Net realized investment gains or losses for the years ended December 31 are:
The amortized cost, gross unrealized gains and losses, and estimated market values of investments in debt securities, including bonds and redeemable preferred stocks, owned by the Insurance Subsidiaries in 1999 and 1998 are as follows:
The amortized cost and estimated market value of debt securities, including marketable securities, owned by the Company (excluding the Insurance Subsidiaries) as of December 31, 1999, 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 S&P 500 call options are carried at estimated fair value. Unrealized gains and losses resulting from changes in the estimated fair value of the call options are recorded as an adjustment to the interest credited to policyholders. In addition, realized gains and losses from maturity or termination of the call options are offset against the interest credited to policyholders during the period incurred. Premiums paid on call options are amortized to net investment income over the term of the contracts. There were no early terminations by annuity participants, or maturities or sales of the S&P 500 call options during 1999.
The following methods and assumptions were used to estimate the fair value of financial instruments as of December 31, 1999 and 1998:
The Company has security lending agreements with a financial institution. The agreements in effect as of December 31, 1999 authorize the financial institution 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 with cash collateral equal to at least 102% of the market value of domestic securities and 105% of the market value of other securities subject to the "loan".
Assets of the Regular Plan are held by an independent trustee. Assets held are primarily in fixed maturity and equity investments. The principal liability is for annuity benefit payments of current and future retirees. Assets of the Restoration Plan are considered corporate assets and are held in a grantor trust.
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. The funded status of the Plans for the Company and the P&C Group as of December 1, 1999 and 1998 (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, 1999 and 1998 was $16,940,000 and $20,622,000, 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's 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 unrecognized net transition obligation of $17,044,000 in 1999 and $18,354,000 in 1998 represents the remaining transition obligation of the P&C Group.
The Company's share of the accrued postretirement benefit cost was approximately $55,578,000 in 1999 and $53,206,000 in 1998.
The weighted average interest rate used in the above benefit computations was 8.00% in 1999, 6.75% in 1998 and 7.25% in 1997. Beginning in 1997, the initial medical inflation rate was 7.00%, to be graded over a 2-year period to 6.00% and level thereafter, and contribution levels from retirees were the same as applicable medical cost increases where defined benefits exist. The weighted average rate of increase in future compensation levels used in determining the actuarial present value of the accumulated benefit obligation was 5.00% in 1999, 4.50% in 1998 and 5.00% in 1997.
A 1.00% increase or decrease in the medical inflation rate assumption would have resulted in the following:
Rental expense incurred by the Company was $28,727,000, $22,332,000 and $20,322,000 in 1999, 1998 and 1997, respectively.
The Company has long-term operating lease commitments on equipment and buildings, with options to renew at the end of the lease periods. As of December 31, 1999, the remaining commitments payable over the next five years under these leases were:
Certain directors of the Company are partners in legal firms that received fees for legal services from the Company and the P&C Group. These fees totaled $8,492,000, $6,544,000 and $5,208,000 in 1999, 1998 and 1997, respectively.
On December 15, 1999, the Company received $197,805,000 from Centre Reinsurance Holdings (Delaware II) Ltd. ("Centre Re"), a subsidiary of Zurich, in settlement of a $190,000,000 loan made on June 30, 1999 and $7,805,000 of accrued interest. This note was a short-term note with a fixed interest rate of 8.75% and a maturity date of December 31, 1999.
In 1997, net cash proceeds from the sale of OSL and IGL amounted to $336,714,000 and were in consideration primarily for the following:
As of December 31, 1999 and 1998, 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. As of December 31, 1999 and 1998, facility fees were payable on the aggregate borrowing facility in the amount of 7 basis points per annum and were reimbursable to the Company by the P&C Group. 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, 1999 and 1998, the Company did not have any outstanding borrowings under the revolving credit agreement. Facility fees were $350,000 for each of the years ended December 31, 1999 and 1998 and $399,000 for the year ended December 31, 1997, and were reimbursed by the P&C Group. The revolving credit agreement in effect as of December 31, 1999 expires on July 1, 2002.
The amount of dividends paid on participating business is determined by the Farmers Life Board of Directors and is paid annually on the policyholder's anniversary date. Amounts allocable to participating policyholders are based on published dividend projections or expected dividend scales.
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 July 1999, Farmers Life entered into a coinsurance agreement with a third party insurer to reinsure the Farmers Premier 10 and 20 year products. Premiums ceded under these agreements totaled $13,939,000 in 1999, $3,728,000 in 1998 and $4,236,000 in 1997. Life reinsurance receivables, which totaled $10,846,000 and $8,453,000 at December 31, 1999 and 1998, respectively, were included in "Other assets" of the Insurance Subsidiaries.
The Company's principal services are the provision of management services to the P&C Group and the ownership and operation of the life and reinsurance subsidiaries. These activities are managed separately as each offers a unique set of services. As a result, the Company is comprised of the following three reportable operating segments as defined in SFAS No. 131: the management services segment, the life insurance segment and the reinsurance segment.
As the Company is the exclusive AIF of the P&C Group, the management services segment is primarily responsible for providing management services to the P&C Group. Management fees earned from the P&C Group totaled $1,402,107,000, $1,271,763,000 and $1,241,153,000 for the years ended December 31, 1999, 1998 and 1997, respectively. The life insurance segment provides individual life insurance products, including universal life, term life and whole life insurance and structured settlement and annuity products. Finally, the reinsurance segment provides reinsurance coverage to a percentage of the auto physical damage business written by the P&C Group.
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, 1999, 1998 and 1997.
The Company operates in 41 states and does not earn revenues or hold assets in any foreign countries.
(g) Amount includes the historical basis amortization associated with the DAC asset which included a $23.3 million adjustment, reducing expense, due to favorable persistency experience on the fixed universal life business.
In October 1999, the Exchanges announced an agreement to acquire Foremost Corporation of America ("Foremost"), the country's leading writer of manufactured homes and a prominent insurer of recreational vehicles and other specialty lines, for approximately $812,000,000. This acquisition was approved by the shareholders of Foremost on February 25, 2000 and, after receiving regulatory and other approvals, the acquisition was completed on March 7, 2000. To help fund this acquisition, the Company purchased $370,000,000 of certificates of contribution of the P&C Group bearing interest at 7.85% annually.
On March 1, 2000, Eagle Star Life Assurance Company Limited, an affiliate of Zurich, assigned $175,000,000 of matured surplus notes of the P&C Group to the Company. As a result, the P&C Group issued new surplus notes of $175,000,000 to the Company which bear interest at 8.50% annually and mature in March 2005. In return, the Company reduced the outstanding balance of the notes receivable from BAFS (see Note S), also an affiliate of Zurich, by $175,000,000. Except for the principal sum, all other terms governing the BAFS notes remained unchanged with principal amounts maturing as follows: $25,000,000 in September 2000, $207,000,000 in September 2001, $200,000,000 in September 2002, $200,000,000 in September 2003 and $250,000,000 in September 2004.