Actual experience and changes in assumptions for expected surrender and withdrawal rates, mortality, and spreads used in the amortization of deferred policy acquisition expense and deferred sales inducement amounts.
The volatile and illiquid market conditions increased levels of credit spreads (difference between bond yields and risk-free interest rates) on fixed maturity securities during 2008. While the increase in credit spreads generated a steeper yield curve making our annuity products more attractive to investors, it also caused a significant reduction in the carrying value of our investments, negatively impacting our financial condition and reported book value per share. These conditions also caused us to hold a higher amount of cash and short-term investments in order to maintain a more liquid position during uncertain times.
losses on our investments due to the downturn in economic activity, increased level of credit spreads and limited liquidity conditions. In 2008, we incurred additional debt to assist with our capital requirements and provide additional liquidity. During the last half of 2008, we also took rate and other actions to reduce sales of new fixed rate annuity contracts at EquiTrust Life and are evaluating the terms and conditions for future products to preserve our capital position. See the “Liquidity and Capital Resources” section below for additional details regarding our capital position.
Amounts are net of portion ceded to and include amounts assumed from alliance partners.
The weighted average yield on cash and invested assets represents the yield on cash and investments backing the universal life and traditional annuity products net of investment expenses. The yield also includes gains or losses relating to our interest rate swap program for certain individual traditional annuities. The impact of the swap program was previously reported in the weighted average crediting rate/index costs and the 2007 and 2006 results above have been restated to conform to the 2008 presentation. With respect to our index annuities, index costs represent the expenses we incur to fund the annual index credits through the purchase of options and minimum guaranteed interest credited on the index business. The weighted average crediting rate/index cost and spread are computed excluding the impact of the amortization of deferred sales inducements. The spread noted above decreased in 2008 and 2007 partially due a shift in the mix of direct business to products with a lower spread target and a decrease in spread earned on assumed business. In addition, in 2008 we had a decrease in prepayment fee income. We also retained a higher amount of cash and short-term investments due to the volatile financial markets limiting the availability of high quality fixed maturity securities and our desire to maintain a more liquid position during uncertain economic times. See the “Segment Information” section that follows for further discussion of our spreads.
As noted in the “Segment Information” section that follows, we use both net income (loss) and operating income to measure our operating results. Operating income for the years covered by this report equals net income (loss), excluding the impact of: (1) realized gains and losses on investments, (2) the change in net unrealized gains and losses on derivatives, (3) the cumulative effect of change in accounting principles and (4) a lawsuit settlement. The rationale for excluding these items from operating income is explained in the “Segment Information” section that follows and Note 14 to our consolidated financial statements.
Premiums and product charges increased 6.6% in 2008 to $276.4 million and 6.5% in 2007 to $259.2 million. The increases in interest sensitive and index product charges in 2008 and 2007 are principally driven by surrender charges on annuity and universal life products and cost of insurance charges on variable universal life and universal life products.
The average aggregate account value for annuity and universal life insurance in force, which increased due to increases in premiums collected as summarized in the “Other data” table above, totaled $9,715.4 million for 2008, $8,428.8 million for 2007 and $6,861.7 million for 2006. We believe aging of the business in force is also driving a portion of the increase in surrender charges relating to the annuity business assumed under coinsurance agreements and business written directly through the EquiTrust Life independent agents as the surrender charge rate decreases with the passage of time (at a rate generally equal to 1.0% per year). This makes a surrender later in the contract period more economical for the contract holder, which results in higher lapse rates as the business ages. We started
assuming business under coinsurance agreements in 2001 and started selling annuities directly through EquiTrust Life independent agents in the fourth quarter of 2003. Net surrender charges on this coinsurance and direct business totaled $30.5 million for 2008, $20.5 million for 2007 and $15.6 million for 2006.
Cost of insurance charges totaled $68.0 million in 2008, $65.3 million in 2007 and $63.8 million in 2006. Cost of insurance charges increased primarily due to aging of the business in force as the cost of insurance charge rate per each $1,000 in force increases with the age of the insured, and sales of our new universal life secondary guarantee product introduced in 2008. The average age of our universal life and variable universal life policyholders was 46.0 years in 2008, 45.4 years in 2007 and 45.0 years in 2006.
Traditional premiums increased in 2008 and 2007 due to an increase in the volume of business in force. The increase in the 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. Our average aggregate traditional life insurance in force, net of reinsurance ceded, totaled $22,060.9 million for 2008, $20,089.8 million for 2007 and $18,294.4 million for 2006. The change in life insurance in force is not proportional to the change in premium income due to a shift in the composition of our traditional life block of business from whole life policies to term policies. The premium for a term policy per $1,000 face amount is less than that for a whole life policy.
The level of realized/unrealized 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. Gains on sales include $4.1 million in 2008, $6.1 million in 2007 and $13.5 million in 2006 related to sales of a portion of our investment in American Equity Investment Life Holding Company (AEL) common stock. Gains on sales in 2006 also included a $1.9 million gain related to the sale of our equity investment in an affiliate, Western Agricultural Insurance Company, to another affiliate, Farm Bureau Mutual Insurance Company (Farm Bureau Mutual). Realized losses on sales in 2008 include a $2.3 million loss on a bank and a $2.1 million loss on a printing and publishing company. Both of these companies experienced a significant deterioration of financial results during 2008 and filed for
If we determine that an unrealized loss is other than temporary, the security is written down to its fair value with the difference between amortized cost and fair value recognized as a realized loss.
The average aggregate account value of annuity contracts in force, which increased due to additional premiums collected as summarized in the “Other data” table above, totaled $8,821.1 million for 2008, $7,536.9 million for
2007 and $5,970.0 million for 2006. These account values include values relating to index contracts totaling $4,709.6 million for 2008, $4,106.8 million for 2007 and $3,200.1 million for 2006.
As discussed above under “Derivative Income (Loss),” the change in the amount of index credits is impacted by growth in the volume of index annuities in force and the amount of appreciation/depreciation in the underlying market indices on which our options are based. The change in the value of the embedded derivative is impacted by the change in expected index credits on the next policy anniversary dates, which is related to the change in the fair value of the options acquired to fund these index credits. The value of the embedded derivative is also impacted by the timing of the posting of index credits and changes in reserve discount rates and assumptions used in estimating future call option costs. In addition, during 2006, we reduced our reserves for the embedded derivative in our coinsured index annuities $7.1 million. This adjustment, which is the correction of an overstatement that started in 2001, increased net income (loss) $2.6 million ($0.09 per basic and diluted common share) after offsets for taxes and the amortization of deferred policy acquisition costs and deferred sales inducements. This adjustment does not impact our segment results as the segment results are based on operating income which, as explained in the “Segment Information” section, excludes the impact of changes in the valuation of derivatives.
The changes in amortization of deferred sales inducements are primarily due to the impact of changes in unrealized gains and losses on derivatives and unlocking assumptions used in the amortization calculation. In addition, the impact of new sales increased amortization in 2008 and 2007. Deferred sales inducements on interest sensitive and index products totaled $417.1 million at December 31, 2008, $319.2 million at December 31, 2007 and $225.1 million at December 31, 2006. The impact of unlocking and the change in unrealized gains/losses on derivatives is detailed in the sections above.
During the first quarter of 2009, we announced certain cost-saving measures that we anticipate will reduce expenses by approximately $7.0 million, partially offset by approximately $1.2 million in one-time charges associated with implementing these cost-saving measures. In addition, we anticipate our pension expense will increase approximately $3.1 million in 2009, primarily due to losses on plan assets during 2008. The majority of the net decrease will be reflected in other underwriting, acquisition and insurance expenses, while the remainder will decrease other expenses.
Income tax expense (benefit) totaled ($13.7) million in 2008, $41.1 million in 2007 and $44.4 million in 2006. The effective tax rate was 42.9% for 2008, 32.6% for 2007 and 33.2% for 2006. The effective tax rates differ from the federal statutory rate of 35% primarily due to the impact of tax-exempt interest and tax-exempt dividend income. The permanent differences between book and tax income increase the effective rate when there is a net loss and decrease the effective rate when there is a net gain. Permanent differences have a greater impact on the effective rates in 2008 due to the size of the pre-tax loss for the year relative to the size of the permanent differences. The
We analyze our segment results based on pre-tax operating income (loss). Accordingly, income taxes are not allocated to the segments. In addition, operating results are generally reported net of any transactions between the segments. Operating income for the years ended December 31, 2008, 2007 and 2006 represents net income (loss) excluding, as applicable, the after tax impact of:
The impact of realized and unrealized gains and losses on investments and unrealized gains and losses on derivatives also includes adjustments for that portion of amortization of deferred policy acquisition costs, deferred sales inducements, unearned revenue reserve and value of insurance in force acquired attributable to such gains or losses. Our rationale for using operating income, in addition to net income (loss) to measure our performance is summarized in Note 14, “Segment Information,” to our consolidated financial statements.
Net investment income includes $1.5 million in 2008, $4.6 million in 2007 and $3.5 million in 2006 in fee income from bond calls, tender offers and mortgage loan prepayments and the change in net discount accretion on mortgage and asset-backed securities as noted in the “Net Investment Income” section above. The weighted average yield on
cash and invested assets was negatively impacted in 2008 and 2007 by reinvestment rates being lower than the yield on investments maturing or being paid down. The weighted average yield also includes the impact of our interest rate swap program. Income from these swaps was netted against interest credited through March 31, 2007, but included in derivative income (loss) starting in the second quarter of 2007. Operating income (loss) from these swaps totaled ($2.5) million in 2008, $3.9 million in 2007 and $3.7 million in 2006. See “Market Risks of Financial Instruments” following and Note 3 to our consolidated financial statements for additional information regarding these hedges and the accounting change in 2007.
Premiums collected increased 96.3% to $249.0 million in 2008 and decreased 9.6% to $126.8 million in 2007. The amount of traditional annuity premiums collected is highly dependent upon the relationship between the current crediting rates on our products and the crediting rates available on competing products, including bank-offered certificates of deposit. We believe the increase in annuity premiums in 2008 is due to lower short-term market interest rates making certificates of deposit and other short-term investments less attractive in relation to these traditional annuities. We believe the decrease in annuity premiums in 2007 was due to a rise in short-term market interest rates. We also believe this environment resulted in fewer surrenders in 2008 and increased surrenders in 2007 and 2006, which impacted the withdrawal rates. For the company in total, the changes in annuity premiums were partially offset by changes in variable annuity premiums as discussed in the “Variable Segment” section that follows.
The changes in derivative income (loss) are primarily due to changes in proceeds from call option settlements and the cost of money for call options as discussed under “Derivative Income (Loss)” above. Call option settlements totaled $35.9 million in 2008, $155.3 million in 2007 and $68.5 million in 2006. The cost of money for call options increased to $128.1 million in 2008, $108.0 million in 2007 and $72.8 million in 2006.
Benefits and expenses decreased in 2008 and increased in 2007 primarily due to changes in index credits, partially offset by the impact of unlocking. Index credits totaling $35.5 million in 2008, $154.0 million in 2007 and $71.2 million in 2006 were primarily impacted by changes in the underlying market indices. These changes were partially offset by the impact of unlocking adjustments, which increased amortization of deferred policy acquisition costs and deferred sales inducements $28.7 million in 2008, and decreased amortization $1.9 million in 2007 and less than
The weighted average yield on cash and invested assets increased in 2008 and decreased in 2007 primarily due to the impact of changes in market investment rates, as discussed under “Net Investment Income” above. These changes were partially offset by fee income (loss) from bond calls, tender offers, mortgage loan prepayments and the change of net discount accretion on mortgage and asset-backed securities totaling ($0.4) million in 2008, $0.7 million in 2007 and $2.1 million in 2006. The weighted average crediting rate increased in 2008 due to the sale of products with higher crediting rates and increases in option costs. The decrease in spread is due to lower spreads on assumed business and a shift in business to our multi-year guaranteed annuity which has a lower spread target than other products in our portfolio. In addition, in the second half of 2008, we retained a higher amount of cash and short-term investments due to the volatile financial markets limiting the availability of high quality fixed maturity securities and our desire to maintain a more liquid position that would provide greater flexibility for managing in these unprecedented economic times.
Traditional life insurance premiums increased in 2008 and 2007 primarily due to sales of life products by our Farm Bureau Life agency force. The decrease in net investment income in 2008 is primarily due to the impact of fee income from bond calls, tender offers and mortgage loan prepayments and the change of net discount accretion on mortgage and asset-backed securities totaling $1.7 million in 2008, $2.9 million in 2007 and $2.8 million in 2006.
Net investment income was positively impacted in 2008 and 2007 by an increase in invested assets, principally due to net premium inflows, partially offset by market investment rates being lower than our investment portfolio yield or yield on investments maturing or being paid down.
Pre-tax operating income (loss) for the Variable segment totaled ($1.6) million in 2008, $12.5 million in 2007 and $3.6 million in 2006. The loss in 2008 is primarily due to an increase in death benefits and amortization of deferred policy acquisition costs, partially offset by an increase in interest sensitive product charges. The increase in 2007 is primarily due to an increase in the volume of business in force and a decrease in death benefits.
Interest sensitive product charges increased in 2008 from 2007 primarily due to the impact of the aging of business in force. Cost of insurance charges increased 5.4% to $29.7 million in 2008 and 5.4% to $28.2 million in 2007. Death benefits in excess of related account values on variable policies increased 54.6% to $16.3 million in 2008 and decreased 28.3% to $10.5 million in 2007. Amortization of deferred policy acquisition costs increased $8.0 million in 2008 due to the impact of negative separate account performance in 2008 and updating the amortization model for the current volume of business in force.
Our total investment portfolio decreased 1.9% to $10,854.1 million at December 31, 2008 compared to $11,067.1 million at December 31, 2007. This decrease is primarily the result of an increase in unrealized depreciation on fixed maturity securities classified as available for sale and a decrease in the value of our derivatives, partially offset by net cash received from interest sensitive and index products and proceeds from issuance of the 2011 Senior Notes in November 2008. Net unrealized depreciation of fixed maturity securities increased $1,399.2 million during 2008 to a net unrealized loss of $1,539.6 million at December 31, 2008, principally due to the impact of a general widening of credit spreads, partially offset by a decrease in risk-free interest rates and write-downs for other-than-temporary impairments recorded in 2008. We believe credit spreads widened primarily due to the continued deterioration of the U.S. housing market, tightened lending conditions and decreased liquidity in the market. In addition, there is a severe global recession which has caused significant market strain. Early steps taken by the government to stabilize the financial system have proven ineffective and pressures on the financial system continued to build throughout 2008. Details regarding the investment impairments are discussed above in the “Realized/Unrealized Gains (Losses) on Investments” section under “Results of Operations.” Additional details regarding securities in an unrealized loss position at December 31, 2008 are included in the discussion that follows and in Note 2 to our consolidated financial statements.
Internal investment professionals manage our investment portfolio. The investment strategy is designed to achieve superior risk-adjusted returns consistent with the investment philosophy of maintaining a largely investment grade portfolio and providing adequate liquidity for obligations to policyholders and other requirements.
As of December 31, 2008, 96.2% (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 generally provide higher yields and involve greater risks than investment grade debt securities because their issuers typically are 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, 2008, the investment in non-investment grade debt was 3.8% of available-for-sale fixed maturity securities. At that time, no single non-investment grade holding exceeded 0.2% of total investments.
increased credit spreads on commercial real estate investment trust bonds, due to the underlying real estate exposure and market concerns about the ability to access capital markets,
a decrease in market liquidity and credit quality concerns of assets held by banking institutions and
increased credit spreads from weaker operating results in the manufacturing sector.
Note 2 to our consolidated financial statements for additional analysis of these unrealized losses.
Mortgage and asset-backed securities comprised 28.7% at December 31, 2008 and 28.2% at December 31, 2007 of our total available-for-sale fixed maturity securities. These securities are purchased when we believe these types of investments provide superior risk-adjusted returns compared to returns of more conventional investments such as corporate bonds and mortgage loans. These securities are diversified as to collateral types, cash flow characteristics and maturity.
The residential mortgage-backed portfolio includes pass-through and collateralized mortgage obligation (CMO) securities. With a pass-through security, we receive a pro rata share of principal payments as payments are made on the underlying mortgage loans. CMOs consist of pools of mortgages divided into sections or “tranches” which provide sequential retirement of the bonds. We invest in sequential tranches which provide cash flow stability in that principal payments do not occur until the previous tranches are paid off. In addition, to provide call protection and more stable average lives, we invest in CMOs such as planned amortization class (PAC) and targeted amortization class (TAC) securities. CMOs of these types provide more predictable cash flows within a range of prepayment speeds by shifting the prepayment risks to support tranches. We generally do not purchase certain types of CMOs that we believe would subject the investment portfolio to greater than average risk. These include, but are not limited to, principal only, floater, inverse floater, PAC II and support tranches.
The commercial and other asset-backed securities are primarily sequential securities. Commercial mortgage-backed securities typically have cash flows that are less sensitive to interest rate changes than residential securities of similar types due principally to prepayment restrictions on many of the underlying commercial mortgage loans. The other asset-backed securities, whose collateral is primarily second lien, fixed rate home-equity loans, are also less sensitive to interest rate changes due to the borrowers typically having less ability to refinance as compared to homeowners with a first lien mortgage only.
The mortgage and asset-backed portfolios include securities with exposure to the Alt-A and subprime home equity loan sectors. Securities with Alt-A and subprime exposure are backed by loans to borrowers with credit scores below those of prime grade borrowers. Prior to 2008, we based our definition of Prime, Alt-A and subprime securities primarily on credit scores, whereby Alt-A securities included borrowers with credit scores ranging from 725 to 641 and subprime securities included borrowers with credit scores of 640 or less. During 2008, we refined our definitions to be more aligned with others in the industry and we now consider owner occupancy, the level of documentation, and quality of collateral, in addition to credit scores, for determining the appropriate classification of the securities in the portfolio. We believe the revised classifications are more appropriate as a security’s performance is highly dependent on the quality of the borrower. This refinement resulted in the reclassification from Alt-A to prime of securities from the 2003 origination year that had a fair value of $167.4 million at December 31, 2007.
Insurance on 2006 Alt-A issues is provided by Financial Guaranty Insurance Co. (38% in 2008 and 63% in 2007) and AMBAC Assurance Corporation (34% in 2008 and 17% in 2007). Insurance on 2007 Alt-A issues is provided by AMBAC Assurance Corporation (57% in 2008 and 32% in 2007), MBIA Insurance Corporation (29% in 2008 and 16% in 2007) and Financial Guaranty Insurance Co. (14% in 2008 and 48% in 2007). The
2006 and 2007 Government & Prime issues are 100% insured by AMBAC Assurance Corporation (2006 issues) and MBIA Insurance Corporation (2007 issues). There is no insurance coverage on other asset-backed securities with non-mortgage collateral or collateral originating prior to 2006.
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, 2008, the fair value of our insured mortgage and asset-backed holdings totaled $83.5 million, or 3.3% of our mortgage and asset-backed portfolios and 0.9% of our total fixed income portfolio. The amortized cost of these insured holdings decreased 33.5% from December 31, 2007 primarily due to taking write downs for other-than-temporary impairments on a portion of other asset-backed securities wrapped by Financial Guarantee Insurance Co. (FGIC). During 2008, FGIC was downgraded by two rating agencies, homeowner delinquencies increased and collateral backing these issues declined, increasing the probability that these securities may experience a cash flow shortfall.
We do not consider the investments wrapped by other monoline bond insurers to be other-than-temporarily impaired at December 31, 2008 because we do not have reason to believe that those guarantees, if needed, will not be honored. In addition, we have the intent and ability to hold these investments until a recovery of fair value, which may be maturity. We do not directly own any fixed income or equity investments in monoline bond insurers.
Collateralized debt obligation investments are included in the corporate securities portfolio. Our investments in collateralized debt obligations are backed by credit default swaps with no home equity exposure. These securities had a carrying value of $7.4 million and unrealized loss of $45.6 million at December 31, 2008 and a carrying value of $42.1 million and unrealized loss of $9.9 million at December 31, 2007. The unrealized loss increased in 2008 primarily due to actual defaults in the collateral, general spread widening and market concerns of increased defaults in the future. Our investment professionals have stress tested all of these securities and determined that future principal losses are not expected based on reasonably adverse conditions. Assuming a 35% recovery, on average these investments could all withstand seven to twelve more defaults without losing any principal. The number of defaults is an estimate based on the remaining credit enhancement (subordination) that remains in each security. Each default that occurs reduces subordination to the security, depending on the loss amount and exposure. Depending on the investment, the synthetic collateralized debt obligations we own have exposure to approximately 120 to 150 reference names, which results in an average default level of 5.0% to 10.0% before we would lose principal. Based on historical performance and current economic conditions, we do not expect future defaults will exceed these levels and believe the existing subordination is sufficient to maintain the value of our investments. In addition, we have the intent and ability to hold these investments until a recovery of fair value, which may be maturity, therefore we do not consider these investments to be other-than-temporarily impaired at December 31, 2008.
In addition, one collateralized debt obligation was partially backed by subprime mortgages and was written down during the first and second quarters of 2008 to the estimated fair value of $0.2 million. This security had an amortized cost of $10.0 million and fair value of $1.5 million at December 31, 2007. This security was sold during the third quarter of 2008 for the estimated fair value of $0.2 million.
State, municipal and other government securities 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. 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.
No formal public rating issued. Approximately 58% in 2008 and 53% in 2007 of the non-rated securities relate to military housing bonds, which we believe have an “A-” shadow rating; approximately 29% in 2008 and 31% in 2007 are revenue obligation bonds; and approximately 13% in 2008 and 2007 are general obligation bonds. Insurance on these bonds is provided by AMBAC Assurance Corporation (61% in 2008 and 64% in 2007), Financial Security Assurance, Inc. (16% in 2008 and 18% 2007), MBIA Insurance Corporation (17% in 2008 and 11% in 2007), Financial Guaranty Insurance Co. (5% in 2008 and 6% in 2007) and other (1% in 2008 and 2007).
Mortgage loans totaled $1,381.9 million at December 31, 2008 and $1,221.6 million at December 31, 2007. Our mortgage loans are diversified as to property type, location and loan size, and are collateralized by the related properties. The total number of commercial mortgage loans outstanding was 352 at December 31, 2008 and 335 at December 31, 2007. New loans are generally $5 million to $15 million in size, with an average loan size of $5.5 million and an average loan term of 12 years. 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 8.2% that are interest only loans at December 31, 2008. At December 31, 2008, the average loan-to-value of the current outstanding principal balance to the appraised value at origination was 59% and the weighted average debt service coverage ratio was 1.48.
Derivative instruments consist primarily of call options supporting our index annuity business net of collateral received from counterparties totaling $12.9 million at December 31, 2008 and $43.9 million at December 31, 2007. See “Market Risks of Financial Instruments” for details regarding how we manage counterparty credit risk.
We participate in a securities lending program whereby certain fixed maturity securities from our investment portfolio are loaned to other institutions for a short period of time. We require collateral equal to or greater than 102% of the fair value of the loaned securities and at least 100% collateral be maintained through the period the securities are on loan. The collateral is invested by the lending agent, in accordance with our guidelines, generating fee income that is recognized as net investment income over the period the securities are on loan. The collateral is accounted for as a secured borrowing and is recorded as an asset on our consolidated balance sheets, with a corresponding liability reflecting our obligation to return this collateral upon the return of the loaned securities. Securities recorded on our consolidated balance sheets with a fair value of $66.4 million at December 31, 2008 and $179.5 million at December 31, 2007 were on loan under the program, and we were liable for cash collateral under our control totaling $69.6 million at December 31, 2008 and $185.3 million at December 31, 2007. As discussed under “Realized/Unrealized Gains (Losses) on Investments” above, during 2008 we recorded an other-than-temporary impairment for one security in the collateral fund totaling $1.7 million, which reduced the collateral held for securities lending. During 2008 we discontinued entering into any new securities lending agreements and we expect the existing loaned securities to decrease in 2009 as the underlying collateral matures.
Policy liabilities and accruals and other policyholders’ funds increased 9.5% to $11,933.4 million at December 31, 2008 primarily due to increases in the volume of business in force. Long-term debt, including debt with affiliates, increased 17.1% to $371.0 million, primarily due to the issuance of $100.0 million of 2011 Senior Notes. We also increased the borrowings on our line of credit agreement and reclassified the total outstanding amount to short-term debt at December 31, 2008, as we intend to repay this debt in the first quarter of 2009, which will increase our access to liquidity with the Federal Home Loan Bank. See additional details on these credit arrangements in Note 7 to our consolidated financial statements.
Stockholders’ equity decreased 71.4% to $258.4 million at December 31, 2008, compared to $902.9 million at December 31, 2007. This decrease is primarily attributable to the change in unrealized appreciation/depreciation on fixed maturity securities, the net loss during 2008 and dividends paid.
A majority of our insurance liabilities are backed by fixed maturity securities and mortgage loans. The weighted average life of the fixed maturity and mortgage loan portfolio, based on fair values and excluding convertible bonds, was approximately 8.9 years at December 31, 2008 and 9.3 years at December 31, 2007. Accordingly, the earned rate on the portfolio lags behind changes in market yields. The extent that the portfolio yield lags behind changes in market yields generally depends upon the following factors:
For 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 contracts for which minimum guaranteed interest rates apply, the options are generally purchased to fund the amount of the annual index credits in excess of minimum guaranteed interest accrued on the contracts. In addition, in 2008, certain contracts assumed from a coinsurer are not hedged due to the limited availability and high cost of call options for bond indices in the current market environment. At December 31, 2008 the assumed account value of unhedged contracts totaled $88.5 million, which represented 8.0% of assumed index annuities, or 1.8% of our total index annuity business. In 2008, proceeds from the maturity of call options totaled $36.3 million while related index amounts credited to contract holders’ account balances totaled $35.6 million. The difference between index credits and option proceeds is primarily attributable to call options being purchased for contracts that had a full or partial surrender during the year, partially offset by the timing of option purchases in volatile market conditions and proceeds not received from a counterparty that filed for bankruptcy in 2008.
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 the call options is managed through the terms of the index annuities, which permit adjustments to annual participation rates, asset fees, and/or caps, subject to guaranteed minimums. Extremely volatile market conditions, such as those experienced in 2008, generally cause the cost of options to increase. The minimum guaranteed contract values for the majority of annuities marketed by our EquiTrust Life distribution channel are equal to 87.5% of the premium collected plus interest credited at a range of 1.00% to 3.00%. In addition, five products with an account value totaling $1,125.3 million at December 31, 2008 offer a minimum guarantee of 100% of premium collected accumulated at a range of 1.50% to 3.00%. Premium bonuses paid are not guaranteed. The minimum guaranteed contract values for index annuities assumed are equal to 80% to 100% of the premium collected plus interest credited at rates ranging between 2.25% to 3.50%. 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.
We design our products and manage our investment portfolio in a manner to encourage persistency and to help ensure targeted spreads are earned. In addition to the ability to change interest crediting rates on our direct products, certain interest sensitive and index contracts have surrender and withdrawal penalty provisions. Products such as supplementary contracts with life contingencies are not subject to surrender or discretionary withdrawal. Other products such as index and fixed rate annuities may be subject to surrender charges. Depending on the product and length of time the contract has been in force, surrender charge rates range up to 20.0% and surrender charge periods range up to 14 years. Depending on the contract, the surrender charge rate typically decreases 1.0% for every one-to-two years the contract is in force.
Surrender and Discretionary Withdrawal Characteristics of Interest Sensitive and Index Products and Supplementary Contracts Without Life Contingencies
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.
As of December 31, 2008, we have entered into two interest rate swaps to manage interest rate risk associated with a portion of our flexible premium deferred annuity contracts. Under the interest rate swaps, we pay a fixed rate of interest and receive a floating rate of interest on a notional amount totaling $100.0 million. These interest rate swaps effectively fix the interest crediting rate on a portion of our flexible premium deferred annuity contract liabilities thereby hedging our exposure to increases in market interest rates. We also have one interest rate swap to hedge the variable component of the interest rate on a portion of our line of credit borrowings. The terms of this swap provide that we pay a fixed rate of interest and receive a floating rate of interest on a notional amount of $46.0 million. Any gain or loss on the interest rate swap settlements offset any increase or decrease in the interest paid, effectively fixing our interest expense related to that portion of our line of credit. See Note 3 to our consolidated financial statements for additional discussion of these interest rate swaps.
simulations of the cash flows generated from existing insurance policies under various interest rate scenarios. Information from these models is used in the determination of investment strategies. Effective duration is a common measure for price sensitivity to changes in interest rates. It measures the approximate percentage change in the fair value of a portfolio when interest rates change by 100 basis points. This measure includes the impact of estimated changes in portfolio cash flows from features such as bond calls and prepayments. When the estimated durations of assets and liabilities are similar, exposure to interest rate risk is reduced because a change in the value of assets should be largely offset by a change in the value of liabilities.
Our exposure to interest rate risk stems largely from our annuity products as the cash flows of these products can vary significantly with changes in interest rates. We have holdings in fixed maturity and mortgage loan portfolios to offset the interest rate risk of our annuity products. We actively manage the duration of these assets and liabilities by minimizing the difference between the two. The effective duration of the fixed maturity and mortgage loan portfolios backing our annuity products was 6.7 at December 31, 2008 and 6.5 at December 31, 2007. The effective duration of our annuity liabilities was approximately 7.5 at December 31, 2008 and 6.7 at December 31, 2007.
We have exposure to credit risk as it relates to the uncertainty associated with the continued ability of a given obligator to make timely payments of principal and interest. See “Financial Condition - Investments” for additional information about credit risk in our investment portfolio.
In connection with our use of interest rate swaps and call options, we are exposed to counterparty credit risk (the risk that a counterparty fails to perform under the terms of the derivative contract). While we do not anticipate nonperformance by any of our counterparties, we did experience nonperformance on an interest rate swap agreement with one counterparty that filed for bankruptcy protection in 2008. We terminated the agreement and realized a loss
totaling $0.5 million. The default of this counterparty also caused us to realize a $2.9 million loss relating to call options assumed through a coinsurance agreement. In addition, it is likely we will not receive proceeds when the call options purchased from this counterparty expire in 2009, however we will be required to fund index credits owed to contract holders for appreciation in the underlying market indices based on the contract terms.
During 2008, our operating activities generated cash flows totaling $404.1 million. This is primarily due to net income (loss) of ($18.1) million adjusted for non-cash revenues and expenses netting to $422.2 million. We used cash of $1,525.0 million in our investing activities during 2008. The primary uses were related to $2,312.6 million of investment acquisitions, partially offset by $777.9 million of sales, maturities or the repayment of investments. Our financing activities provided cash of $1,074.6 million during 2008. The primary sources were $2,162.4 million for receipts from interest sensitive and index products credited to policyholder account balances and $113.4 million in proceeds from additional debt borrowings, partially offset by $1,187.4 million for return of policyholder account balances on interest sensitive and index products.
Parent company cash inflows from operations consists primarily 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 2008 included management fees from subsidiaries and affiliates of $10.1 million and investment income of $1.7 million. Cash outflows are principally for salaries, taxes and other expenses related to providing these management services, dividends on outstanding stock, interest and principal repayments on our parent company debt and capital contributions to subsidiaries.
The Life Companies’ cash inflows consist primarily of premium income, deposits to policyholder account balances, income from investments, sales, maturities and calls of investments, repayments of investment principal and proceeds from call option exercises. In addition, EquiTrust Life has received capital contributions from FBL Financial Group, Inc. to help fund its growth or replenish capital. The Life Companies’ cash outflows are primarily related to withdrawals of policyholder account balances, investment purchases, payment of policy acquisition costs, policyholder benefits, income taxes, dividends and current operating expenses. Life insurance companies generally produce a positive cash flow which may be measured by the degree to which cash inflows are adequate to meet benefit obligations to policyholders and normal operating expenses as they are incurred. The remaining cash flow is generally used to increase the asset base to provide funds to meet the need for future policy benefit payments and for writing new business. The Life Companies’ continuing operations and financing activities relating to interest sensitive and index products provided funds totaling $1,370.5 million in 2008, $1,418.4 million in 2007 and $1,599.1 million in 2006.
We paid cash dividends on our common and preferred stock totaling $15.1 million in 2008, $14.4 million in 2007 and $13.7 million in 2006. Interest payments on our debt totaled $18.8 million in 2008, $15.1 million in 2007 and $11.7 million in 2006. It is anticipated that quarterly cash dividend requirements for 2009 will be $0.0075 per Series B redeemable preferred share and up to $0.125 per common share. The level of common stock dividends will be analyzed quarterly and will be dependent upon our capital and liquidity positions. Assuming a common dividend rate of $0.125 per common share, the common and preferred dividends would total approximately $15.1 million during 2009. In addition, interest payments on our debt outstanding at December 31, 2008 are estimated to be $25.1 million for 2009.
Death benefits on universal life business in excess of projected account values
Net cost of insurance charges on variable and universal life business
reserves for supplementary contracts and similar instruments are computed as the present value of future cash payments while the table above includes cash payments without the impact of discounting.
Interest on the revolving line of credit is estimated at 3.73%.
Includes our estimated future contributions to multiemployer defined benefit plans. Contributions related to the qualified pension plan are included through 2009. No amounts related to the qualified pension plan are included beyond 2009 as the contribution amounts will be re-evaluated based on actual results.
Pension assets and liabilities are affected by the estimated market value of plan assets, estimates of the expected return on plan assets and/or discount rates. Actual changes in the fair market value of plan assets and differences between the actual return on plan assets and the expected return on plan assets will affect the amount of pension expense ultimately recognized. The December 31, 2008 pension obligation was computed based on an average 5.93% discount rate, which was based on yields for high-quality corporate bonds with a maturity approximating the duration of our pension liability. The long-term return on plan assets is determined based on current market values of our pension investments. Declines in comparable bond yields would increase our net pension liability. Our net pension liability could increase or decrease depending on the extent to which returns on pension plan assets are lower or higher than the discount rate.
Excluding U.S. government treasury securities, very few of our fixed maturity securities trade on the balance sheet date. For those securities without a trade on the balance sheet date, fair values are determined using valuation processes that require judgment.
At December 31, 2008, our fixed maturity securities classified as available for sale had a fair value of $8,965.4 million, with gross unrealized gains totaling $110.2 million and gross unrealized losses totaling $1,649.8 million. Due to the large number of fixed maturity securities held, the unique attributes of each security and the complexity of valuation methods, it is not practical to estimate a potential range of fair values for different assumptions and methods that could be used in the valuation process.
• amount of death and surrender benefits and the length of time the policies will stay in force,
A 100 basis point decrease in the expected return on assets would result in a $1.0 million increase in pension expense and a 100 basis point increase would result in a $1.0 million decrease to pension expense. A 100 basis point decrease in the assumed discount rate would result in a $0.2 million increase in pension expense while a 100 basis point increase would result in a $0.1 million decrease to pension expense.
accounting and reporting standards for the noncontrolling (minority) interest in a subsidiary, which requires that the minority interest be reported in equity, and the related net income (loss) and comprehensive income be included in the respective lines of our consolidated financial statements. This Statement is effective for the first annual reporting period beginning on or after December 15, 2008 and early adoption is prohibited. The impact of this adoption on our consolidated financial statements is expected to be immaterial and will primarily result in a reclassification of minority interest as noted above.
As discussed in Note 1 to the consolidated financial statements, in 2007 the Company changed its methods of accounting for the treatment of modifications or exchanges of insurance contracts, income tax contingencies and cash flow hedges on certain fixed annuity contracts.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), FBL Financial Group, Inc.’s internal control over financial reporting as of December 31, 2008, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 18, 2009 expressed an unqualified opinion thereon.
FBL Financial Group, Inc. (we or the Company) operates predominantly in the life insurance industry through its principal subsidiaries, Farm Bureau Life Insurance Company (Farm Bureau Life) and EquiTrust Life Insurance Company (EquiTrust Life) (collectively, the Life Companies). Farm Bureau Life markets individual life insurance policies and annuity contracts to Farm Bureau members and other individuals and businesses in the Midwestern and Western sections of the United States through an exclusive agency force. EquiTrust Life markets individual annuity products through independent agents and brokers and variable products through alliances with other insurance companies. These sales take place throughout the United States. In addition to writing direct insurance business, EquiTrust Life has assumed closed blocks of life insurance and annuity business through coinsurance agreements. Several subsidiaries support various functional areas of the Life Companies and other affiliates, by providing investment advisory, marketing and distribution, and leasing services. In addition, we manage two Farm Bureau affiliated property-casualty companies.
Effective January 1, 2008, we adopted Statement of Financial Accounting Standards (Statement) No. 157, “Fair Value Measurements,” which defines fair value, establishes a framework for measuring fair value and expands the required disclosures about fair value measurements. See Note 4, “Fair Value,” for detailed information regarding our fair value measurements. The impact of adoption was to decrease the carrying value of certain investments and certain policy liabilities and accruals in our consolidated financial statements, resulting in an increase to net income (loss) of $5.6 million ($0.19 per basic and diluted common share). The primary impact of this change was a decrease to the embedded derivatives in the index annuity reserves of $26.7 million. The impact of this change on net income (loss) was mitigated by offsets for the amortization of deferred policy acquisition costs and deferred sales inducements and income taxes.
liabilities in our consolidated balance sheets. At December 31, 2007, we had master netting agreements with counterparties covering cash collateral payable totaling $70.9 million and cash collateral receivable totaling $7.5 million. These amounts have been restated in the prior year balance sheet. Any excess collateral that remains after the netting is included in the collateral held or payable for securities lending and other transactions on our consolidated balance sheets. We held excess collateral totaling $0.1 million at December 31, 2007. We did not have any excess collateral at December 31, 2008. This FSP has no impact on our consolidated statements of operations.
During 2009, we plan to adopt Statement No. 160, “Accounting and Reporting of Noncontrolling Interest in Consolidated Financial Statements, an amendment of ARB No. 51,” which was issued by the FASB in December 2007. This Statement establishes accounting and reporting standards for the noncontrolling (minority) interest in a subsidiary, which requires that the minority interest be reported in equity, and the related net income (loss) and comprehensive income (loss) be included in the respective lines of the consolidated financial statements. This Statement is effective for the first annual reporting period beginning on or after December 15, 2008 and early adoption is prohibited. The impact of this adoption on our consolidated financial statements is expected to be immaterial and will primarily result in a reclassification of minority interest as noted above.
Fixed maturity securities, comprised of bonds and redeemable preferred stocks, which may be sold, are designated as “available for sale.” Available-for-sale securities are reported at fair value and unrealized gains and losses on these securities, with the exception of unrealized gains and losses relating to the conversion feature embedded in convertible fixed maturity securities, are included directly in stockholders’ equity as a component of accumulated other comprehensive income (loss). Unrealized gains and losses relating to the conversion feature embedded in convertible fixed maturity securities are recorded as a component of derivative income (loss) in the consolidated statements of operations. The unrealized gains and losses are reduced by a provision for deferred income taxes and adjustments to deferred policy acquisition costs, deferred sales inducements, value of insurance in force acquired and unearned revenue reserve that would have been required as a charge or credit to income had such amounts been realized.
Fixed maturity securities that are purchased with the intent to sell within a short period of time are classified as “trading.” These securities are carried at fair value and unrealized gains and losses are reflected in the consolidated statements of operations as a component of realized/unrealized gains (losses) on investments. 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.
Investment 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 were no real estate investments requiring a valuation allowance at December 31, 2008 or 2007.
Policy loans are reported at unpaid principal balance. Short-term investments are reported at cost adjusted for amortization of premiums and accrual of discounts. Other long-term investments include an investment deposit which is reported at amortized cost. In 2008, other long-term investments also includes our ownership interest in aircraft acquired in the troubled debt restructuring with a bond issuer that filed for bankruptcy. This investment is reported at cost, less accumulated depreciation.
Realized gains and losses on sales of investments are determined on the basis of specific identification. This line item also includes the change in unrealized gains and losses on trading securities. The carrying values of all our investments are reviewed on an ongoing basis for credit deterioration. If this review indicates a decline in fair value that is other than temporary, the carrying value of the investment is reduced to its fair value and a specific write down is taken. Such reductions in carrying value are recognized as realized losses on investments. For fixed maturity securities and equity securities, the fair value becomes the new cost basis for the security and the cost basis is generally not adjusted for subsequent recoveries in fair value. However, for fixed maturity securities for which we can reasonably estimate future cash flows after a write down, the discount or reduced premium recorded, based on the new cost 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. It is difficult to estimate cash flows on securities that have been written down for an other-than-temporary impairment due to the inherent variability of cash flows associated with distressed securities. Net investment income for 2008 includes accretion totaling $0.4 million on five previously impaired securities, with maturity dates prior to 2011. Net investment income for 2007 includes accretion totaling $0.5 million on two previously impaired securities that matured in 2008. No such accretion was recorded in 2006.
Fair values for the embedded derivatives in our modified coinsurance contracts are based on the difference between the fair value and the cost basis of the underlying investments. Fair values for the embedded derivatives in our reinsurance recoverable relating to call options are based on quoted market prices adjusted for a credit risk component. See Note 3, “Derivative Instruments,” for more information regarding call options and see Note 5, “Reinsurance and Policy Provisions,” for additional details on our reinsurance agreements.
Deferred policy acquisition costs include certain costs of acquiring new insurance business, principally commissions and other expenses related to the production of new business, to the extent recoverable from future policy revenues and gross profits. Deferred sales inducements include premium bonuses and bonus interest credited to contracts during the first contract year only. The value of insurance in force acquired represents the cost assigned to insurance contracts when an insurance company is acquired. The initial value is determined by an actuarial study using expected future gross profits as a measurement of the net present value of the insurance acquired. Interest accrued on the unamortized balance at a weighted average rate of 4.89% in 2008, 4.96% in 2007 and 4.95% in 2006.
For participating traditional life insurance, interest sensitive and index products, these costs are being amortized generally in proportion to expected gross profits (after dividends to policyholders, if applicable) from surrender charges and investment, mortality and expense margins. That amortization is adjusted retrospectively through an unlocking process when estimates of current or future gross profits/margins (including the impact of investment gains and losses) to be realized from a group of products are revised. 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.
Property and equipment, comprised primarily of furniture, equipment and capitalized software costs, are reported at cost less allowances for depreciation and amortization. At December 31, 2008, it also includes $6.6 million in assets held for sale, which are reported at fair value. Depreciation and amortization expense is computed primarily using the straight-line method over the estimated useful lives of the assets. Furniture and equipment had a carrying value of $9.4 million at December 31, 2008 and $33.4 million at December 31, 2007, and estimated useful lives that generally range from two to twenty years. Capitalized software costs had a carrying value of $13.7 million at December 31, 2008 and $15.8 million at December 31, 2007, and estimated useful lives that range from two to five years. Depreciation expense for furniture and equipment was $8.4 million in 2008, $9.0 million in 2007 and $9.4 million in 2006. Amortization expense for capitalized software was $7.2 million in 2008, $5.3 million in 2007 and $4.9 million in 2006.
In December 2008, we sold furniture, office equipment, computer equipment and vehicles to two leasing companies. These assets were subsequently leased by Farm Bureau Mutual Insurance Company (Farm Bureau Mutual), an affiliate, under an operating lease. We have entered into an expense allocation agreement with Farm Bureau Mutual permitting the continued use of certain assets in our operation. We recognized a loss of $0.3 million on the sale of these assets.
For our direct business, interest crediting rates for interest sensitive products ranged from 3.00% to 6.00% in 2008 and from 2.65% to 5.50% in 2007 and 2006. For interest sensitive products assumed through coinsurance agreements, interest crediting rates ranged from 3.10% to 5.10% in 2008 and from 3.00% to 6.00% in 2007 and 2006. A portion of the interest credited on our direct business ($7.1 million in 2008, $9.6 million in 2007 and $3.9 million in 2006) represents an additional interest credit on first-year premiums, payable at policy issue or until the first contract anniversary date (first-year bonus interest). These amounts are included as deferred sales inducements.
The liability for future policy benefits for direct participating traditional life insurance is based on net level premium reserves, including assumptions as to interest, mortality and other factors underlying the guaranteed policy cash values. Reserve interest assumptions are level and range from 2.00% to 6.00%. The average rate of assumed
investment yields used in estimating gross margins was 6.27% in 2008, 6.32% in 2007 and 6.33% in 2006. Accrued dividends for participating business are established for anticipated amounts earned to date that have not been paid. The declaration of future dividends for participating business is at the discretion of the Board of Directors of Farm Bureau Life. Participating business accounted for 41% of direct receipts from policyholders during 2008 (2007 and 2006 - 42%) and represented 13% of life insurance in force at December 31, 2008 (2007 - 13% and 2006 - 14%). The liability for future policy benefits for non-participating traditional life insurance is computed using a net level method, including assumptions as to mortality, persistency and interest and includes provisions for possible unfavorable deviations.
During 2006, we reduced our reserves for the embedded derivative in our coinsured index annuities $7.1 million. This adjustment, which is the correction of an overstatement that started in 2001, increased 2006 net income $2.6 million ($0.09 per basic and diluted common share) after offsets for taxes and the amortization of deferred policy acquisition costs and deferred sales inducements. The impact to the financial statement line items and prior period financial statements affected by this overstatement is not material. This adjustment does not impact our segment results as the segment results are based on operating income (loss) which, as explained in Note 14, exclude the impact of changes in the valuation of derivatives.
See the “Deferred Policy Acquisition Costs, Deferred Sales Inducements and Value of Insurance In Force Acquired” section above regarding the impact of an unlocking adjustment in 2008 on amortization of deferred policy acquisition costs.
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 deposit administration fund contracts. 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 have agreed that we will not pay dividends on the Class A or Class B Common Stock, nor on the Series B Preferred Stock, if we are in default of our line of credit agreement with Bank of America National Association (formerly LaSalle Bank National Association), or in default of the Subordinated Deferrable Interest Note Agreement Dated May 30, 1997 with FBL Financial Group Capital Trust. We are compliant with all terms for both agreements at December 31, 2008. See Note 7, “Credit Arrangements,” for additional information regarding these agreements.
Certain amounts in the 2007 and 2006 consolidated financial statements have been reclassified to conform to the 2008 financial statement presentation.
Fixed Maturity Securities with Unrealized Losses by Length of Time Unrealized
Corporate securities: The unrealized losses on corporate securities, including redeemable preferred stocks, totaled $1,027.4 million, or 62.4% of our total unrealized losses. The largest losses were in the financial services sector ($1,132.8 million carrying value and $547.6 million unrealized loss). The largest unrealized losses in the financial services sector were in the holding and other investment offices sector ($421.6 million carrying value and $261.0 million unrealized loss) and the depository institutions sector ($337.2 million carrying value and $159.3 million unrealized loss). The majority of unrealized losses in the holding and other investment offices sector are commercial real estate investment trust bonds and synthetic collateralized debt obligations. The unrealized losses in the real estate investment trust bonds are primarily due to an increase in credit spreads due to the sector’s exposure to commercial real estate and market concerns about the ability to access the capital markets. The unrealized losses in the synthetic collateralized debt obligations are explained below. The unrealized losses in the depository institutions sector are primarily due to a decrease in market liquidity and concerns regarding the underlying credit quality of subprime and other assets held by foreign or large national and regional domestic banks.
The manufacturing sector ($922.0 million carrying value and $183.4 million unrealized loss) had a concentration of losses in the paper and allied products sector ($87.5 million carrying value and $37.9 million unrealized loss), the printing and publishing sector ($46.6 million carrying value and $16.0 million unrealized loss) and the food and
Because we have the ability and intent to hold these investments until a recovery of fair value, which may be maturity, we do not consider these investments to be other-than-temporarily impaired at December 31, 2008.
State, municipal and other governments: The unrealized losses on state, municipal and other governments totaled $139.4 million, or 8.4% of our total unrealized losses, and were primarily caused by general spread widening and concerns regarding the stability of the credit quality of the monoline bond insurers. We purchased most of these investments at a discount to their face amount and the contractual cash flows of these investments are based on the taxing authority of a municipality or the revenues of a municipal project. Because the decline in fair value is primarily attributable to increased spreads and concerns regarding the stability of the monoline bond insurers, and because we have the ability and intent to hold these investments until a recovery of fair value, which may be maturity, we do not consider these investments to be other-than-temporarily impaired at December 31, 2008.
Excluding mortgage and asset-backed securities and one collateralized debt obligation that was impaired during 2008 (see discussion that follows), our largest exposure to securities from any one issuer had an aggregate unrealized loss of $4.5 million at December 31, 2007. With respect to mortgage and asset-backed securities not
backed by the United States Government, no securities from the same issuer had an aggregate unrealized loss in excess of $17.9 million at December 31, 2007. The $17.9 million unrealized loss from one issuer relates to 14 different securities that are backed by different pools of residential mortgage loans. All 14 securities are rated investment grade and the largest unrealized loss on any one security totaled $5.9 million at December 31, 2007.
We also have $11.3 million of gross unrealized losses on equity securities with an estimated fair value of $44.9 million at December 31, 2008 and $0.1 million of gross unrealized losses on equity securities with an estimated fair value of $0.7 million at December 31, 2007. The majority of the unrealized losses at December 31, 2008 are attributable to perpetual preferred securities in the financial sector ($21.7 million carrying value and $10.9 million unrealized loss). These equity securities have been in an unrealized loss position for less than one year. The unrealized losses on these securities increased in 2008 due to concerns about the quality of the assets the issuers hold and uncertainty regarding when these securities will be called. These securities are similar to fixed maturities as they provide periodic cash flows, contain call features and are similarly rated and priced like other long-term callable bonds. We have the intent and ability to hold these investments until a recovery of fair value; therefore we do not consider them to be other-than-temporarily impaired at December 31, 2008.
Our mortgage loan portfolio consists principally of commercial mortgage loans that we have originated. Our lending policies require that the loans be collateralized by the value of the related property, establish limits on the amount that can be loaned to one borrower and require diversification by geographic location and collateral type.
We establish an allowance as needed, consisting of specific reserves, for possible losses against our mortgage loan portfolio. An allowance is needed for loans in which we do not believe we will collect all amounts due according to the contractual terms of the respective loan agreements. There were no impaired loans requiring a valuation allowance during 2008, 2007 or 2006. At December 31, 2008, we had one mortgage loan in the process of foreclosure with a current outstanding principal balance of $9.4 million and property appraised value of $11.1 million.
Change in Unrealized Appreciation/Depreciation of Investments - Recorded in Accumulated Other Comprehensive Income (Loss)
Realized losses on fixed maturities totaling $155.3 million in 2008, $4.3 million in 2007 and $2.3 million in 2006 were incurred as a result of writedowns for other-than-temporary impairments on fixed maturity securities.
We have a common stock investment in American Equity Investment Life Holding Company (AEL), valued at $0.4 million at December 31, 2008 and $12.6 million at December 31, 2007. American Equity underwrites and markets life insurance and annuity products throughout the United States. We sold a portion of our investment in AEL and realized gains totaling $4.1 million in 2008, $6.1 million in 2007 and $13.5 million in 2006. We also coinsure a closed block of annuity business from a subsidiary of AEL.
During 2006, we sold our equity investment in Western Agricultural Insurance Company, an affiliate, at its fair value of $7.9 million, to Farm Bureau Mutual. A realized gain of $1.9 million was recognized on this transaction.
Securities recorded on our consolidated balance sheets with a fair value of $66.4 million at December 31, 2008 and $179.5 million at December 31, 2007 were on loan as part of our securities lending program. In addition, we were liable for cash collateral under our control from this program totaling $69.6 million at December 31, 2008 and $185.3 million at December 31, 2007.
December 31, 2008 include real estate, fixed income and equity securities totaling $1.2 million.
We have entered into interest rate swaps to manage interest rate risk associated with a portion of our flexible premium deferred annuity contracts. Under the interest rate swaps, we pay a fixed rate of interest and receive a floating rate of interest on a notional amount which totaled $100.0 million at December 31, 2008 and $300.0 million at December 31, 2007. These interest rate swaps effectively fix the interest crediting rate on a portion of our flexible premium deferred annuity contract liabilities thereby hedging our exposure to increases in market interest rates. Effective April 1, 2007, we adopted Statement 133 Implementation Issue No. G26, “Cash Flow Hedges: Hedging Interest Cash Flows on Variable-Rate Assets and Liabilities That Are Not Based on a Benchmark Interest Rate,” which clarified that the only permitted benchmarks are the risk-free rate and rates based on the LIBOR swap curve. Upon adoption, we were required to undesignate these hedging relationships and begin recording the net interest rate settlements on the interest rate swaps as a component of derivative income. The interest rate settlements decreased derivative income $2.5 million in 2008 and increased derivative income $2.9 million in 2007. The interest rate settlements decreased interest sensitive product benefits $1.0 million in 2007 and $3.7 million in 2006. In 2008, we experienced nonperformance by a counterparty on an interest rate swap agreement that was originally scheduled to mature on December 1, 2010. We terminated this agreement and realized a loss totaling $0.5 million.
We write index annuities directly and assume index annuity business under a coinsurance agreement. Index annuities guarantee the return of principal to the contract holder and credit amounts based on a percentage of the gain in a specified market index. Most of the premium received is invested in investment grade fixed income securities and a portion of the premium received from the contract holder is used to purchase derivatives consisting of one-year or two-year call options on the applicable market indices to fund the index credits due to the index annuity contract holders. On the respective anniversary dates of the index annuity contracts, the market index used to compute the index credits is reset and new call options are purchased to fund the next index credit. Although the call options are designed to be effective hedges from an economic standpoint, they do not meet the requirements for hedge accounting treatment under Statement No. 133, “Accounting for Derivative Instruments and Hedging Activities.” Therefore, the change in fair value of the options is recognized in earnings in the period of change. The cost of the options can be managed through the terms of the index annuities, which permit changes to participation rates, asset fees and/or caps, subject to guaranteed minimums.
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 ($189.4) million for 2008, ($5.9) million for 2007 and $70.3 million for 2006.
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 ($0.9) million at December 31, 2008 and less than $0.1 million at December 31, 2007 and the fair value of the embedded derivatives pertaining to funds withheld on business ceded by us
As discussed in Note 1 above, Statement No. 157, “Fair Value Measurements,” defines fair value, establishes a framework for measuring fair value and expands the required disclosures about fair value measurements. Fair value is based on an exit price, which is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Statement No. 157 also establishes a hierarchal disclosure framework which prioritizes and ranks the level of market price observability used in measuring financial instruments at fair value. Market price observability is affected by a number of factors, including the type of instrument and the characteristics specific to the instrument. Financial instruments with readily available active quoted prices or for which fair value can be measured from actively quoted prices generally will have a higher degree of market price observability and a lesser degree of judgment used in measuring fair value. For some investments little market activity may exist and management’s determination of fair value is then based on the best information available in the circumstances, and may incorporate management’s own assumptions of what a market participant would consider for the fair value, which involves a significant degree of judgment.
The fixed income markets in 2008 experienced a period of extreme volatility and limited market liquidity conditions, which affected a broad range of asset classes and sectors. In addition, there were credit downgrade events and an increased probability of default for many fixed income instruments. These volatile market conditions increased the difficulty of valuing certain instruments as trading was less frequent and/or market data was less observable. There were certain instruments that were in active markets with significant observable data that became illiquid due to the current financial environment or market conditions. As a result, certain valuations require greater estimation and judgment as well as valuation methods which are more complex. These values may not ultimately be realizable in a market transaction, and such values may change very rapidly as market conditions change and valuation assumptions are modified.
Equity securities: The fair values for equity securities are based on quoted market prices, where available. For equity securities that are not actively traded, estimated fair values are based on values of comparable issues.
Derivative instruments: Fair values for call options and interest rate swaps are based on counterparty market prices adjusted for a credit component of the counterparty, net of collateral paid. Prices are verified using analytical tools by our internal investment professionals.
Assets held in separate accounts: Separate account assets are reported at estimated fair value in our consolidated balance sheets based on quoted net asset values of the underlying mutual funds.
private corporate securities, non-binding broker and internally priced mortgage or other assets backed securities and other publicly traded issues and index annuity embedded derivatives.
Fair values of private investments are determined by reference to public market, private transactions or valuations for comparable companies or assets in the relevant asset class when such amounts are available. For other securities where an exit price based on relevant observable inputs is not obtained from quoted market prices, the fair value is determined by our investment professionals using an enhanced matrix calculation. The matrix pricing performed by pricing services and our internal investment professionals includes a discounted cash flow analysis using a spread, including the specific creditors’ credit default swap spread (if available), over U.S. Treasury bond yields, adjusted for the maturity/average life differences. Spread adjustments are intended to reflect an illiquidity premium and take into account a variety of factors including but not limited to: senior unsecured versus secured status, par amount outstanding, number of holders, maturity, average life, composition of lending group and debt rating. These valuation methodologies involve a significant degree of judgment.
In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, a financial instrument’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement. Our assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and considers factors specific to the financial instrument.
Included in the transfers in and/or out line above is $270.1 million of securities that were priced using a broker only quote at December 31, 2007 and were transferred to a pricing service that uses observable market data in the prices and $193.6 million that were transferred into Level 3 that did not have enough observable data to include in Level 2 at December 31, 2008, primarily due to a reduction in market activity.
We participate in a reinsurance pool with various unaffiliated life insurance companies to mitigate the impact of a catastrophic event on our financial position and results of operations. Members of the pool share in the eligible catastrophic losses based on their size and contribution to the pool. Under the pool arrangement, we will be able to cede approximately 64% of catastrophic losses after other reinsurance and a deductible of $0.9 million. Pool losses are capped at $17.8 million per event and the maximum loss we could incur as a result of losses assumed from other pool members is $6.4 million per event.
Life insurance in force ceded on a consolidated basis totaled $9,144.2 million (21.0% of direct life insurance in force) at December 31, 2008 and $8,482.8 million (20.6% of direct life insurance in force) at December 31, 2007. Insurance premiums and product charges have been reduced by $31.8 million in 2008, $30.8 million in 2007 and $30.7 million in 2006 and insurance benefits have been reduced by $19.1 million in 2008, $13.7 million in 2007 and $21.2 million in 2006 as a result of cession agreements.
We have assumed closed blocks of certain traditional life, universal life and annuity business through coinsurance agreements. In addition, we assume variable annuity and variable life business from alliance partners through modified coinsurance arrangements.
Life insurance in force assumed on a consolidated basis totaled $1,503.8 million (4.2% of total life insurance in force) at December 31, 2008 and $1,573.7 million (4.6% of total life insurance in force) at December 31, 2007. Premiums and product charges assumed totaled $22.1 million in 2008, $24.5 million in 2007 and $26.0 million in 2006. Insurance benefits assumed totaled $12.4 million in 2008, $9.7 million in 2007 and $10.9 million in 2006.
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: 2009 - $2.7 million; 2010 - $2.7 million; 2011 - $2.6 million; 2012 - $2.4 million; 2013 - $2.2 million; and thereafter, through 2030 - $25.3 million.
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 $1.4 million at December 31, 2008 and $1.2 million at December 31, 2007. The weighted average age of the contract holders with GMDB, IDB or GMIB rider exposure was 53 years at December 31, 2008 and 54 years at December 31, 2007. Paid benefits for GMDBs, IDBs and GMIBs totaled $0.4 million for 2008, $0.1 million for 2007 and less than $0.1 million for 2006.
We file a consolidated federal income tax return with the Life Companies and FBL Financial Services, Inc. and certain of their subsidiaries. The companies included in the consolidated federal income tax return each report
We recognize interest accrued related to unrecognized tax benefits in interest expense and penalties in other expenses. We are no longer subject to U.S. federal, state and local income tax examinations by tax authorities for years prior to 2001.
We have a $60.0 million revolving line of credit agreement with Bank of America National Association (formerly LaSalle Bank National Association) and Bankers Trust Company, N.A. This agreement is effective through October 31, 2010 and interest on any borrowings accrues at a variable rate (5.00% at December 31, 2008 and 5.99% at December 31, 2007). Debt outstanding on this line of credit totaled $60.0 million at December 31, 2008 and $46.0 million at December 31, 2007.
Under the bank line of credit agreement, we are required to meet financial covenants, which include compliance with certain financial ratios and maintaining certain rating agency levels. In addition, we are prohibited from incurring additional indebtedness in excess of $10.0 million without prior approval from the banks while this line of credit is in effect. We are compliant with all terms of the line of credit agreement at December 31, 2008. We intend to pay off the borrowings in the first quarter of 2009 with funds readily available at the parent company to increase our access to liquidity with the Federal Home Loan Bank. Therefore we have classified the outstanding amount as short-term debt on our consolidated balance sheet at December 31, 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 Mutual 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. The 2011 Senior Notes, which are prepayable at par, would have caused us to violate the covenants of our revolving line of credit agreement with Bank of America National Association and Bankers Trust Company, N.A. Therefore, in November 2008, the line of credit agreement was amended to allow for the 2011 Senior Notes without violating the financial covenants.
Holders of the Class A common stock and Series B preferred stock vote together as a group in the election of Class A Directors (eight to ten). The Class B common stock votes as a separate class to elect the Class B Directors (five to seven). Voting for the Directors is noncumulative. In addition, various ownership aspects of our Class B common stock are governed by a Class B Shareholder Agreement resulting in the IFBF, which owns 65% of our voting stock as of December 31, 2008, maintaining control of the Company. Holders of Class A common stock and Class B common stock receive equal per-share common stock dividends.
As multiemployer plans, the assets we contribute to the plans are commingled with the assets contributed by the other employers. Accordingly, unless noted otherwise, we do not separate the disclosure information below between amounts attributable to us and amounts attributable to the other employers. For 2008, the measurement date for the plans is December 31. Prior to 2008, the measurement date for the plans was September 30. This change was required due to the adoption of FASB Statement No. 158 as discussed in Note 1, “Significant Accounting Policies - Accounting Changes.”
Statement No. 158 does not require the recognition of an asset or liability in the consolidated balance sheets for the funded status of multiemployer plans. Under Statement No. 158, a liability totaling $102.9 million at December 31, 2008 and $53.3 million at December 31, 2007 would have been recorded for all employers for the underfunded status of the plans.
Information for Pension Plans with Accumulated Benefit Obligations in Excess of Plan Assets
corporate sector of the Salomon Broad Investment-Grade Bond Index. The bonds with “excessive” call exposure are excluded, as well as securities with abnormal option-adjusted spreads. The final spreads are determined using this “call-protected” sample of AA corporate bonds.
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 2008, 2007 and 2006. In addition, with the adoption of Statement No. 158 in 2006, we increased other liabilities $0.3 million for the underfunded status of these plans, reduced accumulated other comprehensive income (loss) $0.2 million and recorded a deferred tax asset of $0.1 million.
We grant stock options for Class A common stock to directors, officers and employees. For officers and employees, the options have a contractual term of 10 years and generally vest over a period up to five years, contingent upon continued employment with us. Options to directors are fully vested upon grant and have a contractual term that varies with the length of time the director remains on the Board, up to ten years. The stock price for all options is equal to the fair value of the common stock on the grant date. The fair value of each option award is estimated on the date of grant using a Black-Scholes-Merton option valuation model. Beginning in 2009, stock based compensation for our directors will be in the form of grants of stock or restricted stock.
The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of grant. We use the historical realized volatility of our stock for the expected volatility assumption within the valuation model. For options granted in 2008, the weighted average expected term for the majority of our options was calculated using average historical behavior. For options granted in 2007 and earlier, the weighted-average expected term for the majority of our options was presumed to be the mid-point between the vesting date and the end of the contractual term, also known as the “shortcut method” under Statement No. 123(R), “Share-Based Payment.”
Unrecognized compensation expense related to nonvested share-based compensation granted under the stock option arrangement totaled $3.2 million as of December 31, 2008. This expense is expected to be recognized over a weighted-average period of 2.4 years.
We also grant restricted Class A common shares to certain executives. The restrictions on this stock lapse and the stock vests if we meet or exceed operating goals, such as earnings per share and return on equity targets within or during a three year period. Depending on performance, the actual amount of shares issued could range from zero to 100% of the granted amount. The value of the awards is based on the grant date fair value of the restricted stock adjusted for expected forfeitures and an estimate of the number of shares expected to vest. The estimate for the number of shares to vest is reviewed each period and the impact of any changes in the estimate on expense is recorded in the current period. These awards are charged to expense using the straight-line method over the required service period. Dividends on the restricted stock during the restriction period are contingent upon vesting.
We have marketing agreements with the Farm Bureau property-casualty companies operating within our marketing territory, including Farm Bureau Mutual and another affiliate. Under the marketing agreements, the property-casualty companies are responsible for development and management of our agency force for a fee. We incurred expense totaling $8.5 million in 2008, $7.6 million in 2007 and $7.2 million in 2006 relating to these arrangements.
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 2008, 2007 and 2006. We have similar arrangements with the Kansas Farm Bureau and other state Farm Bureau organizations in our market territory. Total royalty expense to Farm Bureau organizations other than the IFBF totaled $1.4 million in 2008, $1.3 million in 2007 and $1.2 million in 2006.
In the normal course of business, we may be involved in litigation where amounts are alleged that are substantially in excess of contractual policy benefits or certain other agreements. At December 31, 2008, management is not aware of any claims for which a material loss is reasonably possible.
We self-insure our employee health and dental claims. However, claims in excess of our self-insurance limits are fully insured. We fund insurance claims through a self-insurance trust. Deposits to the trust are made at an amount equal to our best estimate of claims incurred during the period. Accordingly, no accruals are recorded on our financial statements for unpaid claims and claims incurred but not reported. Adjustments, if any, resulting in changes in the estimate of claims incurred will be reflected in operations in the periods in which such adjustments are known.
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, 2008, are as follows: 2009 - $2.7 million; 2010 - $2.7 million; 2011 - $2.7 million; 2012 - $2.7 million and 2013 - $0.7 million. Rent expense for the lease totaled $3.4 million in 2008, $3.1 million in 2007 and $3.0 million in 2006. These amounts are net of $1.4 million in 2008, 2007 and 2006 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 $5.9 million at December 31, 2008 and $7.3 million at December 31, 2007.
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.
The financial statements of the Life Companies included herein differ from related statutory-basis financial statements principally as follows: (a) the bond portfolio is classified as available-for-sale and carried at fair value rather than generally being carried at amortized cost; (b) beginning in 2008, call options that provide an economic hedge for the growth in interest credited to an index annuity policy are accounted at fair value rather than at amortized cost; (c) acquisition costs of acquiring new business are deferred and amortized over the life of the policies rather than charged to operations as incurred; (d) future policy benefit reserves for participating traditional life insurance products are based on net level premium methods and guaranteed cash value assumptions which may
Effective December 31, 2008, we adopted a prescribed practice issued by the Insurance Division, Department of Commerce, of the State of Iowa, which changed the accounting for derivative instruments hedging fixed index annuities and reserves for index annuities. These changes improve the accounting relationship between the call option asset and statutory reserve, providing a more fair representation of our capital position. We also adopted a permitted practice, which increased the amount of deferred tax assets that may be admitted on the statutory financial statements at December 31, 2008. The statutory capital and surplus for the Life Companies at December 31, 2008 reported above is approximately $82.1 million higher than it would have been without these practices.
State laws specify regulatory actions if an insurer’s risk-based capital (RBC), a measure of an solvency, falls below certain levels. The NAIC has a standard formula for annually assessing RBC based on the various risk factors related to an insurance company’s capital and surplus, including insurance, business, asset and interest rate risks. At December 31, 2008, both of the Life Companies exceeded the minimum RBC requirements. In addition, excluding the impact of the permitted and prescribed practices above would not have reduced the total adjusted capital to levels subjecting the Life Companies to any regulatory action.
The Variable segment consists of variable universal life insurance and variable annuity contracts. These products are similar to universal life insurance and traditional annuity contracts, except the contract holder has the option to direct the cash value of the contract to a wide range of investment sub-accounts, thereby passing the investment risk to the contract holder.
incentive compensation and evaluating performance on a basis comparable to that used by many in the investment community.
The differences between the derivative income (loss) by quarter primarily correspond to the performance of the indices upon which our call options are based and the timing of option settlements. These differences are partially offset by changes to the embedded derivatives in index contracts included in benefits and expenses. The net impact of changes in unrealized gains and losses on derivates on net income (loss) is as follows: