Amounts are impacted by accumulated other comprehensive income (loss) totaling $39.9 million in 2010, ($118.7) million in 2009, ($649.8) million in 2008, ($36.3) million in 2007 and $28.2 million in 2006. These amounts are net of deferred income taxes and other adjustments for assumed changes in the amortization of deferred policy acquisition costs, deferred sales inducements, unearned revenue reserve and value of insurance in force acquired.
Certain amounts in the 2007 consolidated balance sheet data have been reclassified to conform to the 2008 financial statement presentation.
Our fixed annuity products contain features that allow contract holders to surrender a policy. To encourage persistency, we impose a surrender charge against the account balance for early termination of a contract within a specified period after its effective date. Most of the fixed annuity products sold by the EquiTrust Life independent channel offered a market value adjustment (MVA) feature based on U.S. Treasury rates. This feature provides us interest rate protection when U.S. Treasury interest rates are greater than the rates in effect when a contract is issued and provides a benefit to contract holders when U.S. Treasury interest rates are less than the rates in effect when a contract is issued. The unprecedented low U.S. Treasury yields in early 2009 provided an environment where contract holders received an increase in the amount paid upon surrender, which significantly increased the level of surrender activity. Surrender activity began declining toward the end of the first quarter of 2009 and continued declining throughout the remainder of 2009 to expected levels in the fourth quarter of 2009. Surrender activity during 2010 initially continued at or below expected levels, but with the decline of U.S. Treasury rates in the third quarter 2010, there was a modest increase in surrender activity, which in turn slowed toward the end of the fourth quarter as interest rates rebounded. See "Market Risks of Financial Instruments" below for further discussion of the potential impact of changes in the interest environment.
We maintain capital levels in accordance with certain statutory and rating agency requirements. Fixed annuity products generally place a strain on statutory capital when sold and add to capital in subsequent years. Due to the significant growth of the EquiTrust Life independent distribution channel business, our need for capital has increased in recent years. As a result of the economic downturn during 2008 and early 2009, we experienced unusual realized and unrealized investment losses and increased surrender activity at EquiTrust Life, which caused our capital levels to decline. To rebuild capital we took rate and other actions to reduce sales of new annuity contracts at EquiTrust Life, modified contract terms on many products,
Net income (loss) attributable to FBL Financial Group, Inc. (FBL Net Income (Loss)) was $120.7 million for 2010 compared to $69.8 million in 2009 and ($18.1) million in 2008. As discussed in detail below, net income increased in 2010 primarily due to an increase in spreads earned, a decrease in impairment losses on investments, the impact of unlocking and an increase in the volume of business in force. These items were partially offset by a nonrecurring gain from a reinsurance recapture transaction
in 2009. Net income (loss) improved in 2009 primarily due to realized capital gains on the sale of investments, a decrease in impairment losses on investments, the gain from a reinsurance recapture transaction, the impact of refinements made to reserve calculations and the impact of an increase in the volume of business in force in the Traditional Annuity - Exclusive Distribution and Traditional and Universal Life Insurance segments. These items were partially offset by the impact of the change in unrealized gains and losses on derivatives and increased surrenders in the Traditional Annuity - Independent Distribution segment. The increase in volume of business in force is quantified in the detailed discussion that follows by summarizing the face amount of insurance in force for life products or account values of contracts in force for interest sensitive products. The face amount of life insurance in force represents the gross death benefit payable to policyholders and account value represents the value of the contract to the contract holder before application of surrender charges or reduction for any policy loans outstanding. The following discussion provides additional details on the items impacting FBL Net Income (Loss).
Refinements were made to the calculation of reserves for certain traditional life contracts in 2010 and for certain interest sensitive life insurance and annuity contracts in 2009. These refinements, along with associated adjustments to deferred policy acquisition costs and taxes, resulted in an increase to after tax net income of $3.0 million ($0.10 per basic and diluted common share) in 2010 and $7.2 million ($0.24 per basic and diluted common share) in 2009.
Effective October 1, 2009, we entered into an agreement with EMC National Life Company (EMCNL), under which EMCNL recaptured a block of annuity and life insurance policies with net reserves and other liabilities totaling $244.5 million. We originally assumed this business as part of a closed block transaction in 2001. A one-time after-tax gain of approximately $7.2 million ($0.24 per basic and diluted common share) was recorded in 2009 in connection with this transaction. The gain is recognized immediately as we have no contingent liabilities associated with the recaptured policies. After-tax forgone income from this block is approximately $0.7 million per quarter ($0.02 per basic and diluted common share).
We periodically revise the key assumptions used in the calculation of the amortization of deferred policy acquisition costs,
deferred sales inducements, value of insurance in force acquired and unearned revenues for participating life insurance, variable and interest sensitive and index products, as applicable, through an "unlocking" process. Revisions are made based on historical results and our best estimate of future experience. The impact of unlocking is recorded in the current period as an increase or decrease to amortization of the respective balances. While the unlocking process can take place at any time, as needs dictate, the process typically takes place annually with different blocks of business unlocked each quarter. The impact in 2010 and 2009 was primarily due to updating the amortization models for assumptions relating to withdrawal rates, earned spreads, mortality and the current volume of business in force. The impact of unlocking in 2008 was primarily due to updating the amortization models for assumptions relating to the significant increase to surrender and withdrawal rates late in 2008 and into 2009 on annuities sold through our independent distribution channel, as discussed above in the "Impact of Recent Business Environment" section. See the "Segment Information" section that follows for additional discussion of our unlocking adjustments.
A detailed discussion of changes in FBL Net Income (Loss) follows.
The cost of money for call options decreased primarily due to a decrease in the volume of business in force and a decrease in the cost of hedging programs on our direct and assumed business. In 2009, this decrease was partially offset by the impact of
being in an overhedged position on our direct business. The average aggregate account value of index annuities in force, which has decreased due to increased surrender activity from the independent distribution channel and the run-off of assumed business, totaled $4,077.2 million for 2010, $4,392.4 million for 2009 and $4,709.6 million for 2008. While our index account values decreased 14.3% in 2009, our account values have been relatively stable in 2010. The estimated cost of being in an overhedged position on our direct business totaled $7.3 million for 2009. Our overhedged position was significantly reduced by the end of 2009 after sales and maturities of excess call option during the last part of the year.
The level of realized gains (losses) is subject to fluctuation from period to period depending on the prevailing interest rate and economic environment and the timing of the sale of investments. Realized losses on sales during 2010 and 2009 were on securities that we did not intend to sell at the prior balance sheet date or on securities that were impaired in a prior period, but decreased in value during the year. Realized losses on sales in 2008 were on securities that we had the intent and ability to hold until recovery at the prior balance sheet date, but had experienced a significant deterioration of financial results during 2008 resulting in bankruptcy. See "Financial Condition - Investments" and Note 2 to our consolidated financial statements for details regarding our unrealized gains and losses on available-for-sale securities at December 31, 2010 and 2009.
The weighted average interest crediting rate/index cost and spread are computed excluding the impact of the amortization of deferred sales inducements and in 2009, the impact of refining certain reserve estimates. The weighted average crediting rates were 3.67% for 2010, 3.96% for 2009 and 3.94% for 2008. See the "Segment Information" section that follows for additional details on our spreads.
Traditional life insurance policy benefits increased 3.9% in 2010 to $154.8 million and decreased 7.0% in 2009 to $149.0 million. The increase in 2010 and decrease in 2009 are primarily due to the impact of reserve refinements and fluctuations in death benefits. Both periods were also impacted by lower policyholder dividends, an increase in business in force and the impact of the EMCNL reinsurance transaction. Traditional life insurance death benefits, net of reserves released, increased 18.4% to $37.9 million in 2010 and decreased 18.6% to $32.0 million in 2009.
As discussed under "Premiums and Product Charges" above, the increase in business in force is primarily attributable to sales of traditional life products by our Farm Bureau Life agency force exceeding the loss of in force amounts through deaths, lapses and surrenders. The change in traditional life future policy benefits may not be proportional to the change in traditional premiums and benefits as reserves on term policies are generally less than reserves on whole life policies. Also, as discussed in "Results of Operations" above, during 2010, we refined the calculation of traditional life reserve estimates resulting in decreases to traditional life future policy benefits of $5.7 million in 2010.
Underwriting, acquisition and insurance expenses decreased 14.4% in 2010 to $199.4 million and increased 5.3% in 2009 to $233.1 million. Amortization of deferred policy acquisition costs decreased in 2010 and increased in 2009 primarily due to the impact of operating income adjustments, unlocking and surrender activity from the Traditional Annuity - Independent Distribution segment. Amortization of deferred policy acquisition costs on our direct EquiTrust Life business, excluding the impact of unlocking and operating adjustments totaled $47.4 million in 2010, $58.3 million in 2009 and $42.5 million in 2008. See sections above and the "Market Risks of Financial Instruments - Interest Rate Risk" section that follows for additional information on the impact of increased surrender activity on amortization. Also, see the "Impact of Operating Adjustments on FBL Net Income (Loss)" and "Impact of Unlocking" sections above for additional details on these items.
Other underwriting, acquisition and insurance expenses decreased 4.5% in 2010 and increased 3.1% in 2009, partially due to $1.8 million in one-time charges incurred in 2009 primarily associated with the implementation of cost-saving measures announced in the first quarter. Employee benefit expenses also decreased $2.4 million in 2010 and increased $3.4 million in 2009, primarily due to changes in pension and stock-compensation expense. In addition, expenses decreased in 2010 as a result of the reinsurance recapture transaction with EMCNL.
Interest expense decreased 3.3% to $24.5 million in 2010 and increased 29.2% to $25.3 million in 2009 primarily due to the change in our average debt outstanding. Our average debt outstanding was $371.1 million in 2010 compared to $380.2 million in 2009 and $336.7 million in 2008. As discussed in the "Liquidity and Capital Resources" section that follows, our average debt outstanding changed due to issuance of Senior Notes November 2008 and the pay-off of our line of credit borrowings in February 2009.
Equity income (loss), net of related income taxes, totaled $5.4 million in 2010, $0.8 million in 2009 and less than ($0.1) million in 2008. 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. Equity income increased during 2010 due to an investment in a limited partnership acquired late in the fourth quarter of 2009 and the sale of real estate by another limited partnership. Given the timing of availability of financial information from our equity investees, we will consistently use information that is as much as three months in arrears for certain of these entities. Several of these entities are investment companies whose operating results are derived primarily from unrealized and realized gains and losses generated by their investment portfolios. 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 bond and 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.
We analyze operations by reviewing financial information regarding products that are aggregated into four product segments. The product segments are: (1) Traditional Annuity - Exclusive Distribution ("Exclusive Annuity"), (2) Traditional Annuity - Independent Distribution ("Independent Annuity"), (3) Traditional and Universal Life Insurance and (4) Variable. We also have various support operations and corporate capital that are aggregated into a Corporate and Other segment.
Pre-tax operating income for the Exclusive Annuity segment increased 49.8% in 2010 to $53.9 million and increased 28.8% in 2009 to $36.0 million. The increases in 2010 and 2009 are primarily due increases in spreads earned, the volume of business in force and for 2009, the impact of unlocking. The average aggregate account value for annuity contracts in force in the Exclusive Annuity segment totaled $1,939.8 million in 2010, $1,744.2 million in 2009 and $1,564.1 million in 2008 due to sales from Farm Bureau Life and in 2010, advances on a funding agreement with the FHLB totaling $228.5 million.
Benefits and expenses increased in 2010 primarily due to an increase in the volume of business in force partially offset by the impact of decreases made to interest crediting rates, unlocking and a decrease in amortization of deferred policy acquisition costs and the value of insurance in force. Benefits and expenses decreased during 2009, despite the impact of an increase in the volume of business in force, primarily due to decreases made to interest crediting rates and the impact of unlocking. Amortization of deferred policy acquisition costs and the value of insurance in force changed over the three year period primarily due to changes in earned spreads and expected profits on the underlying business. Excluding the impact of unlocking, amortization of these items totaled $8.9 million in 2010, $15.8 million in 2009 and $12.6 million in 2008. The impact of unlocking of decreased amortization $1.3 million in 2010 and $4.2 million in 2009, and increased amortization $0.9 million in 2008.
Premiums collected increased 3.6% to $316.6 million in 2010 and 22.7% to $305.7 million in 2009. The amount of traditional annuity premiums collected is highly dependent upon the relationship between the current crediting rate and perceived security of our products compared to competing products.
Pre-tax operating income for the Independent Annuity segment increased 92.9% in 2010 to $44.8 million and 333.6% in 2009 to $23.2 million. The increase in 2010 is primarily due to an increase in spreads earned and the impact of unlocking. The increase in 2009 was primarily due to an increase in surrender charges from the EquiTrust Life independent distribution channel and the impact of unlocking, partially offset by a decrease in spreads earned.
The average aggregate account value for annuity contracts in force in the Independent Annuity segment totaled $7,004.1 million for 2010, $7,359.5 million for 2009 and $7,169.0 million for 2008. The decline in account value began in 2009 as we slowed annuity sales to preserve capital and surrender activity increased within the EquiTrust Life independent distribution channel, coupled with a reduction in our coinsured business.
Interest sensitive and index product charges decreased in 2010 due to lower surrender activity, which had increased during late 2008 and 2009 during the economic downturn and as a result of lower U.S. Treasury interest rates, which increased the amount paid to contract holders upon surrender of direct fixed annuity products with a MVA feature. See additional details in the "Impact of Recent Business Environment" and "Premiums and Product Charges" sections above for discussion on the impact of MVAs on our direct fixed annuity products. The changes in derivative income (loss) are primarily due to increased proceeds from call option settlements and lower cost of money for call options as discussed under "Derivative Income" above.
Pre-tax operating income for the Traditional and Universal Life Insurance segment decreased 30.0% in 2010 to $60.1 million and increased 62.0% in 2009 to $85.9 million. The decrease in 2010 was attributable to the impact of the sale of a block of coinsurance business during the fourth quarter of 2009, refinements made to certain reserve estimates, an increase in expenses allocated from the Variable segment and increased mortality experience on our direct business, partially offset by an increase in our direct traditional and universal life insurance in force. The increase in 2009 was primarily attributable to the reserve refinements, the coinsurance sale, a decrease in death benefits and the impact of an increase in the volume of business in force.
The coinsurance block of business sold during the fourth quarter of 2009 contributed approximately $13.5 million in pre-tax income in 2009, which included a one time pre-tax gain of $8.3 million reported in other income. The impact of refining estimates on certain life insurance reserves decreased benefits and expenses $4.6 million in 2010 and $12.1 million 2009. Excluding the impact of our coinsurance business, other underwriting expenses increased $6.1 million in 2010 primarily due to an increase in expenses allocated from the Variable segment. Death benefits incurred on our direct business, after the impact of reserves released, increased $7.6 million in 2010 and decreased $5.4 million in 2009.
Other income and other expense, primarily related to operating results of our non-insurance subsidiaries which include management, advisory, marketing and distribution services and leasing activities, decreased in 2010 and 2009 primarily due to a reduction in leasing activities. In 2009, this decrease was offset by a $1.2 million increase in stock-compensation expense and $1.4 million in one-time expenses associated with the implementation of cost-saving measures announced in the first quarter of 2009.
A portion of the securities acquired during 2010 were acquired with the proceeds from advances on our funding agreements with the FHLB. The securities acquired to support these funding agreements often carry a lower average yield than securities acquired to support our other insurance products, due to the relatively low interest rate paid on those advances. The average yield of the securities acquired, excluding the securities supporting these funding agreements, was 5.17% during 2010.
As of December 31, 2010, 93.8% (based on carrying value) of the available-for-sale fixed maturity securities were investment
grade debt securities, defined as being in the highest two National Association of Insurance Commissioners (NAIC) designations. Non-investment grade debt securities typically provide higher yields and involve greater risks than investment grade debt securities because their issuers are often more highly leveraged and more vulnerable to adverse economic conditions than investment grade issuers. In addition, the trading market for these securities is usually more limited than for investment grade debt securities. We regularly review the percentage of our portfolio that is invested in non-investment grade debt securities (NAIC designations 3 through 6). As of December 31, 2010, the investment in non-investment grade debt was 6.2% of available-for-sale fixed maturity securities. At that time, no single non-investment grade holding exceeded 0.2% of total investments.
Equivalent ratings are based on those provided by nationally recognized rating agencies with some exceptions for certain residential, commercial and asset-backed securities where they are based on the expected loss of the security rather than the probability of default.
with a fair value of $30.1 million at December 31, 2010 and $25.0 million at December 31, 2009. We do not own any direct investments in subprime lenders or adjustable rate mortgages.
Insurance on 2006 Alt-A issues is provided by MBIA Insurance Corporation (79% in 2010 and 78% in 2009). Insurance on 2007 Alt-A issues is provided by Assured Guaranty Ltd. (32% in 2010 and 33% in 2009) and MBIA Insurance Corporation (26% in 2010 and 2009). There is no insurance coverage on Government & Prime investments or Alt-A investments with collateral originating prior to 2006 or after 2007.
The AAA, AA and A rated commercial mortgage-backed securities are broken down into categories based on subordination levels. Rating agencies disclose subordination levels, which measure of the amount of credit support that the bonds (or tranches) have from subordinated bonds (or tranches). Generic is a term used for securities issued prior to 2005. The super senior securities have subordination levels greater than 27%, the mezzanine securities have subordination levels in the 17% to 27% range and the junior securities have subordination levels in the 9% to 16% range.
Insurance on 2006 Alt-A issues is provided by Financial Guaranty Insurance Co. (FGIC) (40% in 2010 and 44% in 2009) and AMBAC Assurance Corporation (Ambac) (34% in 2010 and 30% in 2009). Insurance on 2007 Alt-A issues is provided by Ambac (46% in 2010 and 53% in 2009), MBIA Insurance Corporation (31% in 2010 and 27% in 2009) and FGIC (23% in 2010 and 21% in 2009). The 2006 and 2007 Government & Prime issues are 100% insured by Ambac (2006 issues) and MBIA Insurance Corporation (2007 issues). There is no insurance coverage on other asset-backed securities with subprime or non-mortgage collateral or on collateral originating prior to 2006 or after 2007.
The mortgage and asset-backed portfolios include securities wrapped by monoline bond insurers to provide additional credit enhancement for the investment. We believe these securities were underwritten at investment grade levels excluding any credit enhancing protection. At December 31, 2010, the fair value of our insured mortgage and asset-backed holdings totaled $94.8
million, or 2.9% of our mortgage and asset-backed portfolios and 0.9% of our total fixed income portfolio.
State, municipal and other government securities totaled $2.3 billion, or 20.3% of our portfolio and include investments in general obligation, revenue, military housing and municipal housing bonds. Our investment strategy is to utilize municipal bonds in addition to corporate bonds, as we believe they provide additional diversification and have historically low default rates compared with similarly rated corporate bonds. We evaluate the credit strength of the underlying issues on both a quantitative and qualitative basis, excluding insurance, prior to acquisition. The majority of the municipal bonds we hold are investment grade credits without consideration of insurance. Our municipal bonds are well diversified by type and geography with the top exposure being school general obligation bonds. Our municipal bond exposure has an average rating of AA and is trading at 96.3% of book value. The insolvency of one or more of the credit enhancing entities would be a meaningful short-term market liquidity event, but would not dramatically increase our investment portfolio's risk profile.
consolidated financial statements for further discussion regarding our analysis of unrealized losses related to these securities.
Mortgage loans totaled $1,254.4 million at December 31, 2010 and $1,293.9 million at December 31, 2009. Our mortgage loans are diversified as to property type, location and loan size, and are collateralized by the related properties. There were two mortgage loans more than 60 days delinquent as of December 31, 2010 with a carrying value of $16.8 million and one delinquent mortgage loan as of December 31, 2009 with a carrying value of $1.5 million. The total number of commercial mortgage loans outstanding was 326 at December 31, 2010 and 332 at December 31, 2009. In 2010, new loans were generally $1.6 million to $10.0 million in size, with an average loan size of $5.8 million and an average loan term of 13 years. We did not issue any new loans in 2009. 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. The majority of our mortgage loans amortize principal, with 6.8% that are interest only loans at December 31, 2010. At December 31, 2010, the average loan-to-value of the current outstanding principal balance using the most recent appraised value was 56.4% and the weighted average debt service coverage ratio was 1.5 based on the results of our 2009 annual study.
liabilities increased 103.0% to $177.2 million primarily due to increases in payables for securities purchased and payables for certain reinsurance contracts.
For a substantial portion of our direct business in force, we have the ability to adjust interest or dividend crediting rates, participation rates, and asset fees and caps, as applicable, in response to changes in portfolio yield. 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. For business assumed through coinsurance agreements, the ceding company has the ability to adjust interest crediting rates in reaction to portfolio yield. In addition, contracts assumed through coinsurance have guaranteed minimum crediting rates. See "Part 1, Item 1 - Business, Segmentation of Our Business" for the ranges of guaranteed rates and where our products fall within those ranges.
For the majority of index annuities, call options are purchased to fund the index credits owed to contract holders who elect to participate in one or more market indices. Except for certain contracts for which minimum guaranteed interest rates apply, the options are purchased to fund the full amount of the annual index credits. For a majority of contracts for which minimum guaranteed interest rates apply, the options are purchased to fund the amount of the annual index credits in excess of minimum guaranteed interest accrued on the contracts. In 2010, proceeds from the maturity of call options totaled $130.4 million while related index amounts credited to contract holders' account balances totaled $130.9 million. The difference between index credits and option proceeds is primarily attributable to the timing of option purchases in volatile market conditions and proceeds not received from a counterparty that filed for bankruptcy in 2008, partially offset by call options being purchased for contracts that had a full or partial surrender during the year.
Profitability on the portion of the index annuities tied to market indices is significantly impacted by the spread on interest earned on investments and the sum of (1) cost of underlying call options purchased to fund the credits owed to contract holders and (2) minimum interest guarantees owed to the contract holder, if any. The cost of call options is impacted by actual and expected volatility in the marketplace. An increase in volatility increases option costs while a decrease in volatility decreases option costs. We manage the cost of the call options through the terms of the index annuities, which permit adjustments to annual participation rates, asset fees, and/or caps, subject to guaranteed minimums. If there were little or no gains in the entire series of options purchased over the expected life of an index annuity (typically 15 to 20 years), we would incur expenses for credited interest over and above our option costs. This can cause our spreads to decrease and reduce our profits.
Profitability on the index annuities in any given year is also impacted by changes in the fair value of the embedded option which provides the contract holder the right to participate in market index returns after the next index reset date of the contract. This impacts profitability because only one or two-year call options are purchased to fund the index credits owed to the contract holders at the inception of each reset period. This practice matches well with the contract holders' rights to switch to different indices on each reset date. The value of the forward starting options embedded in the index annuities can fluctuate with changes in assumptions as to the expected cost of the options, which is driven by expectations as to the future volatility of the market indices, risk free interest rates, market returns, contractual features such as participation rates, asset fees, and/or caps and the lives of the contracts. In addition, the fair value of the embedded derivative fluctuates with changes in our credit risk.
Historical surrenders paid on products sold by our EquiTrust Life independent distribution and the average U.S. Treasury rate in the respective periods were as follows:
There were a number of factors that contributed to the level of surrender activity we experienced within EquiTrust Life during the past two years. We believe the decrease in surrender activity in the latter half of 2009 and during 2010 was the result of the following:
While the 10-year U.S. Treasury rate dipped to a low of 2.41% in the fourth quarter of 2010, we did not have the level of surrender activity experienced in early 2009 due to the actions noted above and more stable market conditions in 2010. In addition, there was a lag in processing surrenders requested late in 2008, when the 10-year U.S. Treasury reached a low of 2.08%.
The impact of MVAs increased account values paid upon surrender for this direct business 8.6% in 2010, 10.9% in 2009 and 6.2% in 2008. In 2009, the fair value of the fixed maturity securities backing these surrendered policies did not increase commensurately with the amount of the MVA offset due, in part, to credit spreads widening significantly during this period. We sold certain securities to fund the increased surrender activity and realized gains on those sales totaling $24.5 million during 2010 and $41.2 million during 2009. The unanticipated increase in requested surrenders required us to update assumptions in the models used to calculate amortization of deferred policy acquisition costs and deferred sales inducements, which resulted in a $29.6 million increase to amortization in 2008.
The potential impact of U.S. Treasury rates on contracts surrendering with the MVA feature is illustrated below.
(1) A 10-year U.S. Treasury rate is used for the fixed index annuities. A 5-year U.S. Treasury rate is used for the fixed rate annuities. These U.S. Treasury rates approximate the interest rate feature of the respective annuities.
To hedge our exposure to future MVA losses, we purchased a zero-coupon U.S. Treasury bond with a maturity date in 2039. At December 31, 2010, this security has a book value and fair value of $54.4 million and average effective duration of 28 years. Accordingly, the fair value of this security is estimated to increase approximately 30.0% for a 100 basis point drop in market interest rates. Gains on this zero-coupon bond can be used to help offset any MVA losses that we may incur in scenarios where U.S. Treasury rates decrease and credit spreads widen decreasing the value of our fixed maturity securities. In addition, beginning in 2010, we modified the MVA feature on new sales of our index annuity products to tie the amount of the MVA to an index that more closely matches the changes in the value of our underlying investment portfolio and also reduces the amount of the MVA given a change in market interest rates.
A prolonged period of low interest rates may result in lower earnings as higher yielding fixed maturity securities and mortgages are sold, mature or are prepaid and replaced with lower yielding investments. In addition, mortgage-backed and mortgage borrower prepayment activity may increase as borrowers seek lower rates. Lower investment income may cause us to lower crediting rates on our spread based annuity and life insurance products, which in turn may reduce their attractiveness to potential customers. Failure to lower crediting rates as portfolio investment yields decline either by choice, to ensure our spread based insurance products are competitive within the market place, or for contractual reasons in the case of products earning guaranteed rates, will result in lower earnings.
We expect that additional surrenders on the index annuity business sold through our independent agents, as a result of the impact of the MVA, would further reduce earnings due to the loss of the related spread income in the current period, partially offset by additional surrender charge income and gains, if any, on the underlying options in the period of the surrender. For the hypothetical low interest rate scenario discussed above, we estimate this impact would decrease after-tax operating income by approximately $1.6 million, or $0.05 per common share. This estimate does not incorporate any realized gains that would be recognized on the sale of investments to fund the excess surrenders. If the level of excess surrenders increased beyond those assumed in our amortization models, there would be an additional write-off of deferred acquisition costs due to the reduction in future profits, which would further reduce our earnings.
Conversely if interest rates increased and the 10-year U.S. Treasury rate was at 6.00% throughout 2011, we estimate earnings would increase, primarily due to the positive impact of the MVA and less spread compression. This estimate assumes a certain level of crediting rate changes necessary to retain business in the higher interest rate environment. Accordingly such a scenario is not expected to be a material risk for us. However, if we increased crediting rates beyond this assumed level in order to make our spread based insurance products more competitive within the market place, it could adversely impact earnings. In addition, if the level of surrenders increased beyond those assumed in our amortization models, there would be a write-off of deferred acquisition costs due to the reduction in future profits, which would reduce earnings.
We earn investment management fees (on those investments managed by us) and mortality and expense fee income based on the value of our separate accounts. On an annualized basis, the investment management fee rates range from 0.20% to 0.45% for 2010, 2009 and 2008. The annual mortality and expense fee rates range from 0.00% to 1.45% for 2010 and 0.00% to 1.44% for 2009 and 2008. As a result, revenues from these sources do fluctuate with changes in the fair value of the equity, fixed maturity and other securities held by the separate accounts.
We have equity price risk to the extent we may owe amounts under the guaranteed minimum death benefit and guaranteed minimum income benefit provisions of our variable annuity contracts. See Note 5 to our consolidated financial statements for additional discussion of these provisions.
During 2010, our operating activities generated cash flows totaling $515.8 million consisting of net income of $120.6 million adjusted for non-cash revenues and expenses netting to $395.2 million. We used cash of $657.8 million in our investing activities during 2010. The primary uses were from $1,841.5 million of investment acquisitions, mostly in fixed maturity securities, partially offset by $1,369.5 million of sales, maturities or the repayment of investments. Our financing activities provided cash of $135.2 million during 2010. The primary sources were $1,319.2 million in receipts from interest sensitive and index products credited to policyholder account balances, partially offset by $1,181.5 million for return of policyholder account balances on interest sensitive and index products.
Parent company cash inflows from operations primarily consist of (i) dividends from subsidiaries, if declared and paid, (ii) fees that it charges the various subsidiaries and affiliates for management of their operations, (iii) expense reimbursements from subsidiaries and affiliates, (iv) proceeds from the exercise of employee stock options, (v) proceeds from borrowings, (vi) tax settlements between the parent company and its subsidiaries and (vii) investment income. Revenue sources for the parent company during 2010 included management fees from subsidiaries and affiliates of $6.6 million. Cash outflows are principally for salaries, taxes and other expenses related to providing these management services, dividends on outstanding stock, interest
Amounts shown in this table are projected payments through the year 2060 which we are contractually obligated to pay to our life insurance and annuity contract holders. The payments are derived from actuarial models which assume a level interest rate scenario and incorporate assumptions regarding mortality and persistency when applicable. These assumptions are based on our historical experience. The total of the contractual obligations relating to insurance contracts noted above differs from the liability balance on our consolidated balance sheet as follows:
Amount shown is net of $3.0 million equity investment in the Capital Trust due to the contractual right of setoff upon repayment of the note.
Includes our estimated future contributions to multiemployer defined and postretirement benefit plans. Contributions related to the qualified pension plan are included through 2011. No amounts related to the qualified pension plan are included beyond 2011 as the contribution amounts will be re-evaluated based on actual results.
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 and deferred sales inducements, are capitalized and amortized into expense. We also record an asset, value of insurance in force acquired, for the cost assigned to insurance contracts when an insurance company is acquired. 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 life insurance, interest sensitive and index products, these costs are amortized generally in proportion to expected gross profits from surrender charges and investment, mortality and expense margins. This amortization is adjusted (also known as "unlocked") when the Life Companies revise their estimate of current or future gross profits or margins. For example, deferred policy acquisition costs and deferred sales inducements are amortized earlier than originally estimated when policy terminations are higher than originally estimated or when investments backing the related policyholder liabilities are sold at a gain prior to their anticipated maturity.
We test our goodwill balances by comparing the fair value of our reporting units to the carrying value of the goodwill. We have performed impairment testing using cash flow and other analyses and determined that our goodwill was not impaired as of December 31, 2010 or December 31, 2009.
Fair values are obtained primarily from a variety of independent pricing sources, whose results we evaluate internally. Details regarding valuation techniques and processes are summarized in Note 1, "Significant Accounting Policies - Investments - Fair Values," and Note 4, "Fair Values," to our consolidated financial statements.
We are required to exercise judgment to determine when a decline in the value of a security is other than temporary. Whether a realized loss needs to be recognized in earnings and the amount of the loss primarily depends on whether (1) a decline in market value is other than temporary, (2) the extent to which a decline is related to credit versus non-credit related factors, (3) our intent to sell the security, and (4) whether or not we could be required to sell prior to recovery. The previous amortized cost is adjusted by the loss reported in earnings to provide a new cost basis for fixed maturity securities and the fair value becomes the new cost basis for equity securities.
At December 31, 2010, we had 631 fixed maturity and equity securities with gross unrealized losses totaling $340.2 million. Included in the gross unrealized losses are losses attributable to both movements in market interest rates as well as temporary credit issues. Details regarding these securities are included in the "Financial Condition - Investments" section above.
Due to the large number of securities within the investment portfolio and the unique credit characteristic of each, it is not practical to estimate a range of other-than-temporary impairment losses. As discussed in Note 2 to our consolidated financial statements, we believe that all other-than-temporary impairment losses within the portfolio have been recognized.
Estimates used in the calculation of amortization of deferred policy acquisition costs and deferred sales inducements, which are revised at least annually, are based on historical results and our best estimate of future experience.
Amortization of deferred policy acquisition costs and deferred sales inducements for participating life insurance and interest sensitive and index products is expected to total approximately $95.2 million for 2011, excluding the impact of new production in 2011.
Based upon a historical analysis of fluctuations in estimated gross profits, we believe it is reasonably likely that a 10% change in estimated gross profits could occur. A 10% increase in estimated gross profits for 2011 would result in $6.3 million of additional amortization expense. Correspondingly, a 10% decrease in estimated gross profits would result in $6.4 million reduction of amortization expense. The information above is for illustrative purposes only and does not reflect our expectations regarding future changes in estimated gross profits.
We utilize tax planning strategies, which require forward-looking assumptions and management judgment, to determine the deductibility of certain items and to assess the need for a valuation allowance.
During periods in which we have deferred tax assets related to unrealized investment losses, we utilize tax planning strategies, including a buy-and-hold investment philosophy for securities experiencing unrealized losses and the sale of appreciated securities to ensure the deductibility of such losses in future periods.
At December 31, 2010, we held deferred tax assets totaling $302.6 million none of which related to unrealized losses on fixed maturity and equity securities. During the economic downturn, a significant portion of the deferred tax asset we held during 2009 related to unrealized investment losses on our fixed maturity and equity securities. With the increase in the fair value of our investment portfolio during 2010, none of the deferred tax assets above related to fixed maturity and equity securities. A significant decline in the value of assets incorporated into our tax planning strategies could lead to the establishment of a valuation allowance on deferred tax assets having an adverse effect on earnings
Given the number of variables involved, including the difficulty in developing a range of reasonably likely fair values of fixed maturity securities as
discussed above, it is not practical to estimate a range of changes to the valuation allowance.
See Note 1 to our consolidated financial statements for a discussion of recent accounting pronouncements that have been implemented during 2010 and those that have been issued and will be implemented in the future.
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a - 15(f). Under the supervision and the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation under the framework in Internal Control - Integrated Framework, our management concluded that our internal control over financial reporting was effective as of December 31, 2010.
We have audited FBL Financial Group, Inc.'s internal control over financial reporting as of December 31, 2010, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Management of FBL Financial Group, Inc. (the Company) is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management's Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit.
In our opinion, FBL Financial Group, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2010, based on the COSO criteria.
As discussed in Note 1 to the consolidated financial statements, in response to new accounting standards, effective July 1, 2010, the Company changed its method of accounting with respect to certain investments with embedded credit derivatives and effective January 1, 2009, the Company changed its method of accounting for other-than-temporary impairments.
Adjustment resulting from capital transaction of an equity investee was allocated to Class B common stock in the amount of ($3) for 2008. All other activity for the periods shown relates to Class A Common Stock.
Comprehensive income (loss) attributable to FBL Financial Group, Inc. was $274,587 for 2010, $616,504 for 2009 and ($631,562) for 2008.
Effective December 31, 2010, we adopted guidance that requires new and expanded disclosures related to the credit quality of financing receivables and the allowance for credit losses. We are required to provide qualitative and quantitative disclosures on the allowance for credit losses, credit quality, impaired loans, modifications and nonaccrual and past due financing receivables. The disclosures are required to be presented on a disaggregated basis by portfolio segment and class of financing receivable. Disclosures required by the guidance that relate to the end of a reporting period are included in the "Investments" section below and in Note 2, "Investment Operations." Other than the expansion of disclosures, the adoption of this guidance did not have any impact on our consolidated financial statements.
Effective July 1, 2010, we adopted guidance issued by the Financial Accounting Standards Board (FASB), which clarifies the type of embedded credit derivative that is exempt from bifurcation. This guidance requires that the only form of embedded credit derivatives that qualify for the exemption are credit derivatives related to the subordination of one financial instrument to another. For securities no longer exempt under the new guidance, companies may continue to forgo bifurcating the embedded derivatives if they elect, on an instrument-by-instrument basis, and report the security at fair value with changes in fair value reported through the statement of operations. Upon adoption of this guidance, we elected the fair value option for a synthetic collateralized debt obligation security, reclassifying $4.7 million of unrealized loss, net of offsets, from accumulated other comprehensive income (loss) to retained earnings.
Effective January 1, 2010, we adopted guidance issued by the FASB which requires expanded disclosures within Note 4, "Fair Values," of 1) transfers in and out of the Level 1 and 2 categories, 2) the level of disaggregation of assets and liabilities and 3) inputs and valuation techniques. Other than the expansion of disclosures, the adoption of this guidance did not have any impact on our consolidated financial statements.
Effective January 1, 2009, we adopted guidance that specifies criteria for determining whether impairments in debt securities are other than temporary and requires that the non-credit portion of an impairment be recorded in accumulated other
Effective January 1, 2011, we will adopt guidance issued by the FASB which will require expanded disclosures within Note 4, "Fair Value," of the purchases, sales, issuances and settlements of Level 3 financial instruments. Other than the expansion of disclosures, the adoption of this guidance will not have any impact on our consolidated financial statements.
Effective January 1, 2011, we will adopt guidance issued by the FASB which clarifies that investments held within the separate accounts of an insurance entity should not be combined with the insurer's general account interest in the same investments when determining whether consolidation is required, unless the separate account interests are held for the benefit of a related party. The adoption of this guidance is not expected to have any impact on our consolidated financial statements.
In September 2010, the FASB ratified the Emerging Issues Task Force's consensus related to accounting for costs associated with acquiring or renewing insurance contracts. The guidance defines allowable deferred acquisition costs as the incremental direct cost of contract acquisition and certain costs related directly to underwriting, policy issuance and processing. This guidance also allows for the deferral of advertising costs if 1) the primary purpose of the advertising is to elicit to customers who could be shown to have responded specifically to the advertising, and 2) the direct-response advertising results in probable future benefits. This guidance will be effective for fiscal years beginning after December 15, 2011, with early adoption permitted. Companies may choose to apply the new guidance either prospectively or retroactively. We plan to retrospectively adopt this guidance on January 1, 2012. This guidance is a significant change to current industry practice. We have not completed our evaluation of the new standard, however, adoption will likely result in a significant reduction to deferred policy acquisition costs and future related deferrals and amortization.
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.
For derivatives not designated as a hedging instrument, the change in fair value is recognized in earnings in the period of the change. Prior to 2009, an interest rate swap on our line of credit was accounted for as a cash flow hedge. The effective portion of any unrealized gain or loss was recorded in accumulated other comprehensive income (loss) and any gain or loss on the interest rate swap settlements offset any increase or decrease in the interest paid on the line of credit. In 2009, we paid off the line of credit and the cash flow hedge became ineffective. Therefore, in 2009 and 2010 the ineffective portion of the unrealized gain or loss on the swap was recorded in earnings as a component of derivative income (loss).
See Note 3, "Derivative Instruments," for more information regarding our derivative instruments and embedded derivatives.
Real estate is reported at cost less allowances for depreciation, as applicable. The carrying value of these assets is subject to regular review. For properties not held for sale, if indicators of impairment are present and a property's expected undiscounted cash flows are not sufficient to recover the property's carrying value, an impairment loss is recognized and the property's cost basis is reduced to fair value. If the fair value, less estimated sales costs, of real estate held for sale decreases to an amount lower than its carrying value, the carrying value of the real estate is reduced by the establishment of a valuation allowance, changes to which are recognized as realized gains or losses on investments. There was one property held for investment with a valuation allowance as of December 31, 2010 of less than $0.1 million. There were no properties held for sale with a valuation allowance as of December 31, 2010, and one real estate property held for sale with a valuation allowance of less than $0.1 million at December 31, 2009.
basis, is amortized over the remaining life of the security. Amortization in this instance is computed using the prospective method and the current estimate of the amount and timing of future cash flows.
Fair values of fixed maturity securities are based on quoted market prices in active markets when available. Fair values of fixed maturity securities that are not actively traded are estimated using valuation models that vary by asset class. See Note 4, "Fair Value" for more information on assumptions and the amount of securities priced using the valuation models. Fair values for all securities are reviewed for reasonableness by considering overall market conditions and values for similar securities.
Fair values of redeemable preferred stocks, equity securities, call options and interest rate swaps are based on the latest quoted market prices, or for those stocks not readily marketable, generally at values which are representative of the fair values of comparable issues. In addition, fair values for all derivative instruments include a credit risk adjustment for the liable party.
The liabilities for future policy benefits for accident and health insurance are computed using a net level (or an equivalent) method, including assumptions as to morbidity, mortality and interest and include provisions for possible unfavorable deviations. Policy benefit claims are charged to expense in the period that the claims are incurred.
We have accrued dividends for participating business that 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 of Farm Bureau Life. Participating business accounted for 38% of direct receipts from policyholders during 2010 (2009 - 40% and 2008 - 41%) and represented 12% of life insurance in force at December 31, 2010 and 2009 and 13% in 2008.
Deferred income tax assets or liabilities are computed based on the difference between the financial statement and income tax bases of assets and liabilities using the enacted marginal tax rate. Deferred income tax expenses or credits are based on the changes in the asset or liability from period to period. A valuation allowance against deferred income tax assets is established if it is more likely than not that some portion or all of the deferred income tax assets will not be realized.
We participate with several affiliates and an unaffiliated organization in various multiemployer defined benefit plans. We employ a long-term investment strategy of maintaining diversified plan assets in equity securities and a group annuity contract. The expected return on plan assets is set at the long-term rate expected to be earned based on the long term investment strategy of the plans for assets at the end of the reporting period.
We also have two share-based payment arrangements under our Class A Common Stock Compensation Plan. We recognize compensation expense for all share-based payments granted, modified or settled. The non performance related stock-based expense is recognized over the shorter of our five-year vesting schedule or the period ending when the employee becomes eligible for retirement using the straight-line method. The performance related stock-based expense is recorded on the number of shares expected to vest and is recognized over the required service period. The impact of forfeitures is estimated and compensation expense is recognized only for those stock-based instruments expected to vest. We report tax deductions related to stock-based instruments in excess of recognized compensation expense as a financing cash flow.
Certain amounts in the 2009 and 2008 consolidated financial statements have been reclassified to conform to the current financial statement presentation.
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. For example, significant estimates and assumptions are utilized in the valuation of investments, determination of other-than-temporary impairments of investments, amortization of deferred policy acquisition costs and deferred sales inducements, 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.
Gross unrealized losses include non-credit losses on other-than-temporarily impaired corporate securities totaling $20.5 million at December 31, 2010 and $0.3 million at December 31, 2009, other asset-backed securities totaling $33.4 million at December 31, 2010 and $32.4 million at December 31, 2009, and residential mortgage-backed securities totaling $12.4 million at December 31, 2010 and $7.4 million at December 31, 2009.
Included in fixed maturities in the above table are 625 securities from 478 issuers at December 31, 2010 and 953 securities from 651 issuers at December 31, 2009. The unrealized losses in fixed maturities are due to wider spreads between the risk-free and corporate and other bond yields relative to the spreads when the securities were purchased. Because we do not intend to sell or believe we will be required to sell these fixed maturity investments before their anticipated recovery of amortized cost, we do not consider these investments to be other-than-temporarily impaired at December 31, 2010. The following summarizes the more significant unrealized losses of fixed maturity investments by investment category as of December 31, 2010.
Commercial mortgage-backed securities: The unrealized losses on commercial mortgage-backed securities represent 6.7% of our total unrealized losses, and were caused primarily by spread widening and industry concerns regarding the potential for future commercial mortgage defaults. There were also concerns regarding current and future downgrades by the three major rating agencies for tranches below the super senior AAA level. The contractual cash flows of these investments are based on mortgages backing the securities.
Any loan delinquent on contractual payments are considered non-performing. Non-performing loans were $16.8 million at December 31, 2010 and $1.5 million at December 31, 2009. One non-performing loan with a carrying value of $14.9 million was less than 90 days past due at December 31, 2010. There was one non-performing loan over 90 days past due on contractual
Proceeds from sales of fixed maturity securities-available for sale were $689.0 million in 2010, $1,321.9 million in 2009 and $105.9 million in 2008.
As discussed in Note 1, on January 1, 2010, we adopted authoritative guidance that changed the method of determining when we would be considered the primary beneficiary of a variable interest entity (VIE) and thus required to consolidate the entity. Prior to January 1, 2010, the primary beneficiary was the enterprise who absorbed the majority of the entity's expected losses, received a majority of the expected residual returns or both. The new guidance identifies the primary beneficiary of a VIE as the enterprise with the power to direct the activities of a VIE that most significantly impacts the entity's economic performance and who has the obligation to absorb losses of the entity or the right to receive benefits from the entity that could potentially be significant to the VIE. When evaluating our VIE investments, we consider our contractual rights or obligations to the entity, and our ability to direct its operations. We were not the primary beneficiary under either current or prior guidance during 2010, 2009 or 2008. Our investment in VIEs and exposure to loss is summarized below:
At December 31, 2010, affidavits of deposits covering investments with a carrying value totaling $12,277.1 million were on deposit with state agencies to meet regulatory requirements. Fixed maturity securities with a carrying value of $525.8 million were on deposit with the Federal Home Loan Bank as collateral for funding agreements. Also, fixed maturity securities with a carrying value of $2.6 million were on deposit as collateral for an operating lease on software.
At December 31, 2010, we had committed to provide additional funding for mortgage loans on real estate totaling $6.9 million. These commitments arose in the normal course of business at terms that are comparable to similar investments.
At December 31, 2010, we had committed to provide additional funds for investments in limited partnerships. The amounts of these unfunded commitments totaled $26.7 million.
No investment in any entity or its affiliates (other than bonds issued by agencies of the United States Government) exceeded 10.0% of stockholders' equity at December 31, 2010.
We also had one interest rate swap that we entered into to hedge the variable component of the interest rate on a $46.0 million line of credit borrowing that expired on October 7, 2010. The terms of this instrument provided that we pay a fixed rate of interest and receive a floating rate of interest on a notional amount of $46.0 million. We closed the line of credit agreement in the first quarter of 2009 and began recording the change in fair value of the underlying swap and interest payments in derivative income (loss). Prior to 2009, any gain or loss on the interest rate swap settlements offset any increase or decrease in
The reserve for index annuity contracts includes a series of embedded derivatives that represent the contract holder's right to participate in index returns over the expected lives of the applicable contracts. The reserve includes the value of the embedded forward options despite the fact that call options are not purchased for a period longer than the period of time to the next index reset date. The change in the value of this embedded derivative is reported on a separate line in the consolidated statements of operations and totaled $19.3 million for 2010, $148.9 million for 2009 and ($189.4) million for 2008.
We have modified coinsurance agreements where interest on funds withheld is determined by reference to a pool of fixed maturity securities. These arrangements contain embedded derivatives requiring bifurcation. Embedded derivatives in these contracts are recorded at fair value at each balance sheet date and changes in the fair values of the derivatives are recorded as derivative income or loss. The fair value of the embedded derivatives pertaining to funds withheld on variable business assumed by us totaled $2.7 million at December 31, 2010 and $1.6 million at December 31, 2009, and the fair value of the embedded derivatives pertaining to funds withheld on business ceded by us was ($0.1) million at December 31, 2010 and $0.2 million at December 31, 2009. Derivative income (loss) from our modified coinsurance contracts totaled $0.8 million in 2010, $2.4 million in 2009 and ($0.8) million in 2008.
Other long-term investments, cash and short-term investments: Amounts are reported at historical cost, adjusted for amortization of premiums, depreciation or accrual of discounts, as applicable, which approximates the fair values due to the nature of these assets.
embedded derivatives in our modified coinsurance contracts under which we cede or assume business are based on the difference between the fair value and the cost basis of the underlying fixed maturity securities. We are not required to estimate fair value for the remainder of the reinsurance recoverable balance.
Short-term and long-term debt: Fair values are estimated using discounted cash flow analysis based on our current incremental borrowing rate for similar types of borrowing arrangements adjusted, as needed, to reflect our credit risk.
Other liabilities: Fair values for interest rate swaps are based on counterparty market prices adjusted for a credit component of the counterparty, net of collateral paid. Prices are verified internally using analytical tools. Other liabilities also include the embedded derivatives in our modified coinsurance contracts under which we cede business. Fair values of these derivatives are based on the difference between the fair value and the cost basis of the underlying fixed maturity securities. We are not required to estimate fair values for the remainder of the other liabilities balances.
Fair values of all Level 2 fixed maturity public securities are obtained primarily from a variety of independent pricing sources, whose results we evaluate internally. We generally obtain one or two prices per security, which are compared to relevant credit information, perceived market movements and sector news. Market indices of similar rated asset class spreads are consulted for valuations and broker indications of similar securities are compared. If the issuer has had trades in similar debt outstanding but not necessarily the same rank in the capital structure, spread information is used to support fair value. If discrepancies are identified, additional quotes are obtained and the quote that best reflects a fair value exit price at the reporting date is selected. Fair value of most of our private investments are determined using matrix pricing with substantially all observable inputs, such as industry classification, duration and rating.
The change in unrealized gains (losses) included in net income relating to positions still held on CDOs was $0.6 million.
In addition, the Life Companies have an annual 100% quota share accidental death reinsurance agreement. Coverage includes all acts of terrorism including those of a nuclear, chemical or biological origin. Coverage is subject to an annual aggregate retention of $12.0 million. A maximum occurrence limit of $50.0 million applies to policies written on agents of the Company who are participating in Company-sponsored incentive trips. All other occurrence catastrophes are unlimited in amount.
Life insurance in force assumed on a consolidated basis totaled $92.3 million (0.2% of total life insurance in force) at December 31, 2010 and $94.0 million (0.3% of total life insurance in force) at December 31, 2009. Premiums and product charges assumed totaled $6.8 million in 2010, $17.1 million in 2009 and $22.1 million in 2008. Insurance benefits assumed totaled $0.1 million in 2010, $8.0 million in 2009 and $12.4 million in 2008. The decreases in assumed business are due to the EMCNL reinsurance recapture transaction.
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: 2011 - $3.5 million; 2012 - $3.4 million; 2013 - $3.3 million; 2014 - $3.1 million; 2015 - $3.2 million and thereafter, through 2030 - $17.0 million.
Certain variable annuity and variable universal life contracts in our separate accounts have minimum interest guarantees on funds deposited in our general account and guaranteed minimum death benefits (GMDBs) on our variable annuities. In addition, we have certain variable annuity contracts that have an incremental death benefit (IDB) rider that pays a percentage of the gain on the contract upon death of the contract holder and certain variable annuity contracts that have a guaranteed minimum income benefit (GMIB) that provides monthly income to the contract holder after the eighth policy year.
The separate account assets are principally comprised of stock and bond mutual funds. The net amount at risk for these contracts is based on the amount by which GMDB, IDB or GMIB exceeds account value. The reserve for GMDBs, IDBs or GMIBs determined using modeling techniques and industry mortality assumptions, that is included in future policy benefits, totaled $1.5 million at December 31, 2010 and $0.9 million at December 31, 2009. The weighted average age of the contract holders with GMDB, IDB or GMIB rider was 56 years at December 31, 2010 and 54 years at December 31, 2009. Paid benefits for GMDBs, IDBs and GMIBs totaled $0.4 million for 2010, $0.7 million for 2009 and $0.4 million for 2008.
In November 2008, we issued 9.25% Senior Notes payable to affiliates totaling $100.0 million that mature in November 2011 (2011 Senior Notes). One note for $75.0 million was issued to Farm Bureau Property & Casualty and a $25.0 million note was issued to an investment affiliate of the Iowa Farm Bureau Federation (IFBF), our majority stockholder. Interest is payable quarterly on March 31, June 30, September 30 and December 31 of each year.
redemption date on a semiannual basis at the treasury rate plus 20 basis points. We received net proceeds of approximately $98.5 million from the issuance of the 2017 Senior Notes after underwriting fees, offering expenses and original issue discount, which are being amortized over the term of the 2017 Senior Notes, using the effective interest method.
We expect combined contributions to the plans for 2011 to be approximately $18.4 million, of which $7.2 million is expected to
Our plan assets are primarily invested in annuity products and insurance company pooled separate accounts that invest predominately in equity securities and real estate. We have certain pension obligations that are fully funded though annuity contracts with Farm Bureau Life which are presented as funded annuity contracts below. Excluding the funded annuity contracts, we employ a long-term investment strategy of diversifying the plans' assets with the long-term target allocation being approximately 60% in group annuity contracts held by Farm Bureau Life and 40% in pooled separate accounts, which is primarily comprised of equity securities. At December 31, 2010, the plans' assets were invested 50% in a group annuity contract and 50% in diversified equities. Our investment strategy is to (1) achieve a long-term return sufficient to satisfy all plan obligations, (2) assume a prudent level of risk and (3) maintain adequate liquidity. The expected return on plan assets is set at the long-term rate expected to be earned based on the long term investment strategy of the plans. In estimating the expected rate of return for each asset class, we take into account factors such as historical rates of return, expected future risk free rates of return and anticipated returns expected given the risk profile of each asset class.
Pooled separate accounts: the net asset value of our separate account shares is based on the latest quoted market price of the underlying investments or in the case of a real estate separate account, estimates of the current market value of the underlying property held.
In addition to benefits offered under the aforementioned benefit plans, we and several other affiliates sponsor a plan that provides group term life insurance benefits to retirees who have worked full-time for ten years and attained age 55 while in service. Postretirement benefit expense for this plan is allocated in a manner consistent with pension expense discussed above. We also have two single employer plans that provide health and medical benefits to retirees. Postretirement benefit expense aggregated $0.1 million in 2010, 2009 and 2008.
We have three share-based payment arrangements under our Class A Common Stock Compensation Plan, which are described below. Compensation expense for these arrangements totaled $3.0 million for 2010 and 2009 and $1.0 million for 2008. The income tax benefit (expense) recognized in the statements of operations for these arrangements totaled $0.9 million for 2010, $1.0 million for 2009 and ($0.3) million for 2008.
Represents the difference between the share price and exercise price for each option, excluding options where the exercise price is above the share price, at December 31, 2010.
Unrecognized compensation expense related to nonvested share-based compensation granted under the stock option arrangement totaled $1.9 million as of December 31, 2010. This expense is expected to be recognized over a weighted-average period of 2.4 years.
During 2010, nonvested shares were granted to the chief executive officer. The restrictions on part of the shares lapse based on the same performance criteria as the 2010 executive nonvested shares grant. Restrictions on the remaining shares lapse after five years based on book value targets.
During 2009, nonvested shares were granted to the chief executive officer. The restrictions on part of the shares lapsed based on continued employment with the Company during 2009. Restrictions on the remaining shares lapsed in 2010 based on performance criteria set by the Board of Directors.
We share certain office facilities and services with the IFBF and its affiliated companies. These expenses are allocated on the basis of cost and time studies that are updated annually and primarily consist of rent, salaries and related expenses, travel and other operating costs. In 2008, we also entered into an expense allocation agreement with Farm Bureau Property & Casualty for the use of property and equipment. Expense relating to this agreement totaled $1.6 million in 2010, $1.4 million in 2009 and less than $0.1 million in 2008.
We have management agreements, which include Farm Bureau Property & Casualty and other affiliates, under which we provide general business, administrative and management services. Fee income for these services totaled $3.4 million in 2010, $3.8 million in 2009 and $3.5 million in 2008. In addition, Farm Bureau Management Corporation, a wholly-owned subsidiary of the IFBF, provides certain management services to us under a separate arrangement. We incurred related expenses totaling $1.0 million in 2010, $0.8 million in 2009 and $0.5 million in 2008.
We are licensed by the IFBF to use the "Farm Bureau" and "FB" designations in Iowa. In connection with this license, we incurred royalty expense totaling $0.5 million in 2010, 2009 and 2008. We have similar arrangements with other state Farm Bureau organizations in our market territory. Total royalty expense to Farm Bureau organizations other than the IFBF totaled $1.5 million in 2010 and $1.4 million in 2009 and 2008. The royalty agreement with the IFBF provides them an option to terminate the agreement when the quarterly common stock dividend is below $0.10 per share. Assuming no further reduction in the quarterly dividend, the IFBF has agreed to temporarily forgo its right of termination through March 31, 2011 and we anticipate they will continue to forgo such right thereafter.
In the normal course of business, we may be involved in litigation where damages are alleged that are substantially in excess of contractual policy benefits or certain other agreements. In recent years, companies in the life insurance and annuity business have faced litigation, including class action lawsuits, alleging improper product design, improper sales practices and similar claims. We are currently a defendant in two purported class action lawsuits against EquiTrust Life alleging claims as described below. We believe that many of the asserted claims will be defeated by dispositive motions. As discussed below, several of the claims were eliminated from class certification in a ruling certifying a class in one of the two pending cases. We remain optimistic that class certification will be defeated in the other lawsuit. However, courts have a great deal of discretion in deciding whether to certify a class, and it is impossible to accurately predict how the court will rule on such a motion. Given these uncertainties, we are unable to make a reliable evaluation of the likelihood of an unfavorable outcome or an estimate of the amount or range of potential loss to the extent the matters proceed through litigation. We do not believe that these lawsuits will have a material adverse effect on our financial position, results of operations or cash flows. However, the outcome of such matters is always uncertain, and unforeseen results can occur. It is possible that such outcomes could materially affect net income in a particular quarter or annual period.
The first case is Tabares v. EquiTrust Life Insurance Company, filed in Los Angeles Superior Court on May 5, 2008. Tabares is a California class action on behalf of all persons who purchased certain deferred annuities from EquiTrust Life. The complaint asserts a sub-class of purchasers that were age 60 or older at the time of purchasing those annuities from EquiTrust Life. Plaintiffs seek restitution and injunctive relief on behalf of all class members, compensatory damages for breach of contract and punitive damages for breach of the covenant of good faith and fair dealing and common law fraud. Plaintiffs' motion for class certification was heard on June 22, 2010. On August 2, 2010, the trial court issued an Order “Denying in Part and Granting in Part Class Certification.” The Court denied certification on Plaintiffs' core claims: for fraud and violation of the consumer protection statute. The Court did grant certification on the claims for breach of contract, declaratory relief and the claims for breach of the covenant of good faith and fair dealing. This certification does not represent a finding on the merits with respect to Plaintiffs' claim, only that it meets the criteria for the establishment of a class. In addition, the Court dismissed the only class representative of “senior” status and ordered the attorneys to confer and draft a suitable notice to be sent to all class members. Plaintiffs filed a motion to reconsider the August 2, 2010 ruling. EquiTrust Life opposed that motion. A brief hearing was conducted and in January 2011, the Court overruled Plaintiff's motion and requested further briefing.
January 12, 2009. This purported national class action includes all persons who purchased EquiTrust Life index annuities, with one sub-class for all persons age 65 and older that purchased an EquiTrust Life index annuity contract with a maturity date beyond the annuitant's actuarial life expectancy; and a 30-state sub-class under various consumer protection and unfair insurance practices statutes. This case seeks rescission and injunctive relief including restitution and disgorgement of profits on behalf of all class members, compensatory damages, unjust enrichment and punitive damages. The original deadline for the Plaintiffs to file their class certification motion was in January 2011. Several deadlines have been pushed further into 2011 and the Plaintiff's class certification motion is expected late in the first quarter of 2011.
We lease our home office properties under a 15-year operating lease from a wholly-owned subsidiary of the IFBF. Future remaining minimum lease payments under this lease, as of December 31, 2010, are as follows: 2011 - $2.7 million; 2012 - $2.7 million; and 2013 - $0.7 million. Rent expense for the lease totaled $3.3 million in 2010 and 2009 and $3.4 million in 2008. These amounts are net of $1.4 million in 2010, 2009 and 2008 in amortization of a deferred gain on the exchange of our home office properties for common stock in 1998. The remaining unamortized deferred gain totaled $3.1 million at December 31, 2010 and $4.5 million at December 31, 2009.
Statutory accounting practices prescribed or permitted by regulatory authorities for the Company's insurance subsidiaries differ from GAAP. The National Association of Insurance Commissioners (NAIC) has issued model laws and regulations, many of which have been adopted by state insurance regulators. However, states have the right to prescribe practices that differ from those issued by the NAIC, and the Commissioner of Insurance has the right to permit other specific practices that deviate from prescribed practices.
assumptions which may differ from statutory reserves; (e) future policy benefit reserves on certain interest sensitive products are based on full account values, rather than discounting methodologies utilizing statutory interest rates; (f) net realized gains or losses attributed to changes in the level of market interest rates are recognized as gains or losses in the statements of operations when the sale is completed rather than deferred and amortized over the remaining life of the fixed maturity security or mortgage loan; (g) the established formula-determined statutory investment reserve, changes in which are charged directly to surplus, is not recorded as a liability; (h) certain deferred income tax assets, agents' balances and certain other assets designated as "nonadmitted assets" for statutory purposes are reported as assets rather than being charged to surplus; (i) revenues for interest sensitive, indexed and variable products consist of policy charges for the cost of insurance, policy administration charges, amortization of policy initiation fees and surrender charges assessed rather than premiums received; (j) pension income or expense is recognized for all employees, rather than for vested employees only; (k) the financial statements of subsidiaries are consolidated with those of the insurance subsidiary rather than being accounted for under the equity method, and (l) assets and liabilities are restated to fair values when a change in ownership occurs that is accounted for as a purchase, with provisions for goodwill and other intangible assets, rather than continuing to be presented at historical cost.
The Exclusive Annuity segment primarily consists of fixed rate annuities and supplementary contracts (some of which involve life contingencies) sold through our exclusive agency distribution. Fixed rate annuities provide for tax-deferred savings and supplementary contracts provide for the systematic repayment of funds that accumulate interest. Fixed rate annuities primarily consist of flexible premium deferred annuities, but also include single premium deferred and immediate contracts. With fixed rate annuities, we bear the underlying investment risk and credit interest to the contracts at rates we determine, subject to interest rate guarantees.
interest in an amount equal to a percentage of the gain in a specified market index, subject to minimum guarantees.
We use operating income (loss), in addition to net income (loss), to measure our performance since realized and unrealized gains and losses on investments and the change in net unrealized gains and losses on derivatives can fluctuate greatly from quarter to quarter. These fluctuations make it difficult to analyze core operating trends. In addition, for derivatives not designated as hedges, there is a mismatch between the valuation of the asset and liability when deriving net income (loss). Specifically, call options relating to our index business are one or two-year assets while the embedded derivative in the index contracts represents the rights of the contract holder to receive index credits over the entire period the index annuities are expected to be in force. For our other embedded derivatives and interest rate swaps, the derivatives are marked to market, but the associated insurance liabilities are not marked to market. A view of our operating performance without the impact of these mismatches enhances the analysis of our results. We use operating income for goal setting, determining company-wide short-term incentive compensation and evaluating performance on a basis comparable to that used by many in the investment community.
Beginning in 2010, other classification adjustments are no longer required due to methodology changes in allocating assets.
Depreciation and amortization related to property and equipment are allocated to the product segments while the related property, equipment and capitalized software are allocated to the Corporate and Other segment. Depreciation and amortization for the Corporate and Other segment include $2.2 million for 2010, $2.9 million for 2009 and $5.9 million for 2008 relating to leases with affiliates. In the consolidated statements of operations, we record these depreciation amounts net of related lease income from affiliates.
Net income increased $3.0 million in the second quarter of 2010 and $7.2 million in the fourth quarter of 2009 due to the impact of refining certain reserve estimates and related items such as deferred policy acquisition costs as discussed in Note 1, "Significant Accounting Policies - Future Policy Benefits." Net income also increased $7.2 million in the fourth quarter of 2009
due to the gain on the reinsurance recapture transaction with EMCNL as discussed in Note 5, "Reinsurance and Policy Provisions."