(1) The comparability of selected data from year to year is impacted by the acquisition of Rural Security Life Insurance Company in March 1993 and the acquisition of Western Farm Bureau Life Insurance Company and the minority interests in FBL Insurance Company and Rural Security Life Insurance Company in January 1994.
(2) During 1994, the Company ceased writing medical insurance business. The Company continues to sell individual disability income insurance.
(3) The Company recognized net income (loss) related to its discontinued cable television operations of $6.5 million, or $0.28 per share, $(2.9) million, or $(0.16) per share and $(4.9) million, or $(0.29) per share for the years ended December 31, 1994, 1993 and 1992, respectively.
(4) Adjusted operating income equals net income adjusted to eliminate certain items which management believes are not indicative of operating trends because they are unusual and/or nonrecurring in nature, including realized gains (losses) on investments (less that portion of amortization of deferred policy acquisition costs and value of insurance in force acquired and income taxes attributable to such gains), discontinued operations and net income (loss) from a venture capital investment company subsidiary. Adjusted operating income and adjusted operating income per common share should not be considered as necessarily being better indicators of the Company's overall operating performance than net income or net income per common share, nor are they better indicators of the Company's liquidity than cash flows. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Adjusted Operating Income."
(6) Statutory capital and surplus reflects amounts related to Farm Bureau Life Insurance Company and Western Farm Bureau Life Insurance Company (after 1993) only and does not include the Asset Valuation Reserve, Interest Maintenance Reserve or Mandatory Securities Valuation Reserve for the appropriate years.
(8) Loss and loss adjustment expense ratio equals the sum of statutory incurred losses and loss adjustment expenses divided by statutory earned premiums.
(10) Combined ratio equals the sum of the loss and loss adjustment expense and expense ratios.
LIFE INSURANCE OPERATIONS. The Life Companies sell universal life, variable universal life, traditional life and disability income insurance and traditional and variable annuity products. These products are marketed to Farm Bureau members and other individuals and businesses in 15 midwestern and western states. Several subsidiaries support various functional areas of Farm Bureau Life, Western Life and other affiliates, by providing investment advisory, marketing and distribution, and leasing services.
For variable universal life and variable annuities, premiums received are not reported as revenues. Similar to universal life and ordinary annuities, revenues reported consist of fee income and product charges collected from the policyholders. Expenses related to these products include interest credited to policyholder account balances and benefit claims incurred in excess of policyholder account balances.
SEGMENT INFORMATION. The Company's revenues and net income are primarily derived from its life insurance segment. For information concerning amounts of revenue, operating profit and loss and identifiable assets attributable to each of the Company's segments, see Note 13 of Notes to Consolidated Financial Statements.
Net investment income decreased $12.4 million, or 5.5%, to $210.7 million for 1996 compared to $223.1 million for 1995. The decrease was predominately the result of the nonrecurrence in 1996 of gains recognized on two private equity investments held by FBL Ventures of South Dakota Inc. (FBL Ventures), a venture capital subsidiary, during 1995. During 1996, this subsidiary recognized net investment income of $2.9 million compared to $25.4 million for 1995. See "Adjusted Operating Income." Also contributing to the decrease was a 26 basis point decline in the annualized yield earned on average invested assets (excluding yield attributable to FBL Ventures) to 7.62% in 1996 from 7.88% in 1995. These decreases were partially offset by a 9.3% increase in average invested assets (excluding invested assets of FBL Ventures) to $2,728.6 million in 1996 from $2,496.3 million in 1995. The increase in average invested assets is primarily attributable to net positive cash flows from operating activities and net positive cash flows from interest sensitive products totaling $145.8 million and $32.4 million, respectively, during 1996. The decline in yield on average invested assets is the result of investing a majority of these positive cash flows and cash from investing activities in lower yielding securities. The newer securities have lower yields due principally to market interest rates during 1996 being lower than the average effective yield of the investment portfolio and the average yield on those securities sold, maturing or repaid during the year.
Policy benefits increased $29.8 million, or 13.3%, to $253.6 million for 1996 compared to $223.8 million for 1995. Included in this increase was a $7.1 million increase in universal life and annuity benefits consisting of a $4.8 million increase in interest credited to these contracts and a $2.3 million increase in universal life death benefits in excess of related account balances. The increase in interest credited is principally attributable to a larger volume of business in force as the Company's interest crediting rates decreased during the periods. The weighted average crediting rate for the Company's universal life liabilities decreased to 6.39% for 1996 from 6.68% for 1995, and the weighted average crediting rate for the Company's annuity liabilities decreased to 6.35% for 1996 from 6.57% for 1995. The decrease in interest crediting rates was greater than the decrease (20 basis points) in the annualized yield on the types of invested assets supporting universal life and annuity liabilities due primarily to the timing of the Company's adjustments to its interest crediting rates for fluctuations in portfolio yield. Traditional life and accident and health benefits increased $7.4 million, or 10.3%, consisting of a $3.4 million increase in death and surrender benefits, a $2.9 million increase in the change in the reserves on these products, a $1.4 million increase in accident and health benefits and a $0.3 million net decrease in other benefits. Distributions to policyholders increased to $26.3 million from $25.7 million due to an increase in the amount of participating business in force, partially offset by a reduction in the average dividend rate credited to these policies to 6.12% from 6.49%. Losses and loss adjustment expenses incurred on property-casualty policies increased $14.8 million, or 108.2%, to $28.4 million for 1996 from $13.6 million for 1995 due primarily to the increase in Utah Insurance's reinsurance pool participation percentage, resulting in $13.5 million of additional losses and loss adjustment expenses. In addition, less favorable weather conditions in 1996 caused an increase in property losses, including approximately $0.8 million in assumed losses attributable to Hurricane Fran. During 1997, the Company discontinued participation in assumed reinsurance with coastal catastrophe exposures. The loss and loss adjustment expense ratio increased in 1996 to 86.0% from 72.8% in 1995.
Amortization of deferred policy acquisition costs increased $4.8 million, or 44.6%, to $15.5 million for 1996 compared to $10.7 million for 1995 principally due to the increase in Utah Insurance's reinsurance pool participation which resulted in $3.8 million of additional amortization during 1996. In addition, amortization increased due to a greater volume of business in force and an increase in the emergence of profits on the underlying business. Partially offsetting these increases was a $1.8 million reduction in amortization due to the impact of realized gains and losses on investments backing the related policyholder liabilities
Other underwriting, acquisition and insurance expenses decreased $13.0 million, or 23.6%, to $41.7 million for 1996 compared to $54.7 million for 1995. This decrease is primarily attributable to new marketing agreements with Farm Bureau property-casualty insurance companies doing business in the Company's marketing territory whereby the property-casualty insurance companies develop and manage the Company's agency force for a fee based on commissions on first year life insurance premiums and annuity deposits. As a result of the agreements, various fixed marketing costs that were charged to expense in 1995 have been replaced by lower fees ($3.6 million for 1996) which vary based on premium volume and are deferred and amortized with other policy acquisition costs. In addition, expense reductions were realized as a result of discontinuing the sale of unaffiliated insurers' medical products (see discussion regarding other income above). Also, approximately $1.9 million of the decrease is attributable to the elimination of an agent bonus program in 1996 and one-time severance benefit payments to certain employees in 1995. Furthermore, amortization of value of insurance in force acquired decreased $0.6 million in 1996 compared to 1995 due to the impact of realized gains and losses on investments. Partially offsetting these decreases was a $0.9 million increase in property-casualty underwriting and insurance expenses as a result of the increase in Utah Insurance's reinsurance pool participation percentage. While management strives to reduce operating expenses and increase the efficiency of operations, the Company does not anticipate any significant changes in its cost structure in 1997. As a result, the 1997 underwriting expense level is expected to be comparable to that in 1996, as opposed to the expense reductions experienced in 1996 compared to 1995.
Other expenses increased $1.7 million, or 9.8%, to $19.0 million for 1996 compared to $17.3 million for 1995 due principally to an increase in the level of investment advisory and management services provided to affiliates and other third parties.
Pretax income before minority interest in earnings of subsidiaries and equity income increased $26.5 million, or 29.2%, to $116.9 million for 1996 compared to $90.4 million for 1995. This increase was primarily the result of the impact of realized gains on investments offset, in part, by the $22.5 million decrease in net investment income attributable to FBL Ventures.
YEAR ENDED DECEMBER 31, --------------------- 1995 1994 --------- --------- (DOLLARS IN THOUSANDS) Premiums and product charges: Universal life and annuity product charges $ 43,722 $ 42,734 Traditional life insurance premiums 75,450 72,222 Accident and health premiums 10,161 (1,956) Property-casualty premiums 18,709 17,778 --------- --------- Total $ 148,042 $ 130,778 ========= =========
Premiums and product charges increased $17.2 million, or 13.2%, to $148.0 million for 1995 compared to $130.8 million for 1994. Approximately $12.1 million of this increase was attributable to an increase in accident and health premiums due primarily to the Company's exit from the medical insurance business in 1994. In 1994, the Company recorded net negative accident and health premiums of $2.0 million, consisting of $11.9 million in disability income premiums net of $13.9 million in negative premiums from ceding the medical insurance business to other carriers. In 1995, accident and health premiums totaled $10.2 million, consisting primarily of disability income business. Life insurance premiums and universal life and annuity product charges increased $4.2 million, or 3.7%, as a result of new sales coupled with favorable persistency. Property-casualty premiums increased 5.2% to $18.7 million in 1995 from $17.8 million in 1994, due to premium rate increases and a modest growth in the number of policies in force. Although the life and property-casualty insurance industries are competitive, the Company has not experienced any unusual pricing pressures in its lines of business or states of operation.
Realized gains on investments decreased $3.5 million, or 37.7%, to $5.9 million for 1995 compared to $9.4 million for 1994. This decrease resulted primarily from the timing of the sale of certain private equity investments. The level of realized gains 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.
Policy benefits increased $27.8 million, or 14.2%, to $223.8 million for 1995 compared to $196.0 million for 1994. Of this increase, $14.4 million was attributable to an increase in universal life and annuity benefits largely resulting from an increase in interest credited amounts and growth in the amount of business in force. During 1995 the weighted average crediting rate for the Company's individual annuity liabilities increased to 6.49% from 6.16% in 1994, and the weighted average crediting rate for the Company's universal life liabilities decreased to 6.68% from 6.71% for the respective periods. It is the Company's policy to change rates credited to policy accounts as the Company's investment portfolio yield changes. The crediting rate for universal life insurance products decreased despite an increase in the yield on average invested assets due primarily to a decrease in the rate credited to a universal life product sold by Western Life that previously had an above-market crediting rate. In addition, there was an $11.9 million increase in traditional life and accident and health policy benefits as a result of general growth in the amount of business in force. This increase included a $10.9 million increase in the change in reserves on those products, a $1.5 million increase in surrender benefits and a $0.9 million increase in death benefits, offset, in part, by a $1.4 million decrease in accident and health benefits. Distributions to participating policyholders increased to $25.7 million from $24.4 million due to increases in the face amount of policies in force and an increase in the average dividend rate credited to these policies to 6.49% from 6.31%. Losses and loss expenses incurred on property-casualty policies increased to $13.6 million, or 1.3%, in 1995 from $13.4 million in 1994. The loss and loss adjustment expense ratio improved in 1995 to 72.8% from 75.6% in 1994 primarily due to more favorable loss experience resulting from premium rate increases and re-underwriting activities.
Commission expense decreased $2.3 million, or 22.2%, to $8.0 million in 1995 from $10.3 million in 1994. This decrease includes a $2.2 million decline in nondeferrable first year commissions and a $0.1 million decline in renewal commissions. Nondeferrable first year commissions decreased due primarily to an $18.7 million decline in first year premiums received in 1995 compared to 1994. Renewal commissions decreased in 1995 compared to 1994 despite a $13.1 million increase in renewal premiums received due primarily to multi-tiered commission structures on certain life insurance products whereby renewal commission rates decline over the life of the underlying policies.
Other expenses increased 0.4% to $17.3 million in 1995 from $17.2 million in 1994 due primarily to general growth in the Company's non-insurance support operations.
Pretax income before minority interest in earnings of subsidiaries, equity income (loss) and discontinued operations increased $30.5 million, or 51.1%, to $90.4 million compared to $59.9 million for 1994. This increase was the result of growth in investment income from the private equity investments of FBL Ventures to $25.4 million compared to a loss of $0.2 million for 1994, coupled with improved profitability in the life insurance lines from lower expense ratios and increased spreads. These increases were partially offset by a reduction in realized capital gains.
Net income increased $17.5 million, or 41.7%, to $59.6 million for 1995 compared to $42.1 million for 1994. The increase was the result of increases in the pretax income discussed above, partially offset by a $6.5 million decrease in income from discontinued operations sold in 1994. In addition, equity income (loss) increased $3.0 million to $1.6 million in 1995 compared to a loss of $1.4 million in 1994.
The following table reflects net income adjusted to eliminate certain items which management believes are not indicative of overall operating trends, including net realized gains on investments (less that portion of amortization of deferred policy acquisition costs and value of insurance in force acquired and income taxes attributable to such gains), net income from a venture capital investment company subsidiary and discontinued operations.
FBL Ventures is a wholly owned investment company subsidiary of Farm Bureau Life which invests in start-up and mezzanine level venture capital investments in various sectors. Operating results of FBL Ventures are recognized in accordance with accounting principles for investment companies and, as such, unrealized and realized gains and losses on investments are included in net investment income. Because of the venture capital nature of the underlying investments, the results of FBL Ventures tend to fluctuate significantly from year to year and need to be evaluated over a much longer period of time. Therefore, the net income attributable to FBL Ventures is not included in adjusted operating income. As of December 31, 1996, FBL Ventures had venture capital investments of $13.8 million, consisting of 13 private equity securities issued by 10 companies. Of the 10 companies in which FBL Ventures held investments on December 31, 1996, five are public with an aggregate carrying value of $7.0 million and five are private with an aggregate carrying value of $6.8 million. In addition, of the 10 companies, four with an aggregate carrying value of $8.5 million operate in the health care industry. The balance of the companies operate in the computer hardware/software, communication technology and biotechnology industries.
During 1996, FBL Ventures ceased making new venture capital investments and began selling its private equity securities. During 1996, 20 securities with a fair value of $9.7 million were sold at their carrying value, which management believes approximated fair value. Accordingly, the sales did not have a significant effect on the Company's operating results. Proceeds from the sales were invested in fixed maturity securities and mortgage loans. It is anticipated that the remaining securities will be sold to unaffiliated third parties or transferred to Farm Bureau Life during 1997. Management believes the sale of FBL Venture's investments will provide the Company with more consistent and predictable investment returns and will facilitate the Company's asset/liability management process.
During 1990, the Company invested in a cable television operation which provided cable service to rural communities in the midwest. The investment consisted of a direct investment in a partnership interest, notes and a guarantee of bank debt. As a result of market and other factors, the cable operation suffered substantial operating losses during each year it was owned. In December 1993, a decision was made to sell the cable operation, and at that time the operations were classified as discontinued operations for financial reporting purposes. On December 23, 1994, the cable operation was sold.
FBL Financial Group, Inc.'s cash flow from operations consists of dividends from subsidiaries, if declared and paid, and fees which it charges the various operating subsidiaries and affiliates for management of their operations, partially offset by the expenses incurred for salaries and other expenses related to providing such services.
During 1996, the Company paid common stock dividends of $1.3 million and preferred stock dividends of $2.3 million. No dividends were paid during 1995 or 1994. It is anticipated dividend requirements for 1997 will be $1.00 per preferred share and $0.40 per common share, or approximately $12.5 million. FBL Financial Group, Inc. relies primarily on dividends from the Life Companies to make any dividend payments to its stockholders. The ability of the Life Companies to pay dividends to FBL Financial Group, Inc. is limited by law to earned profits (statutory unassigned surplus) as of the date the dividend is paid, as determined in accordance with accounting practices prescribed or permitted by insurance regulatory authorities of the State of Iowa for Farm Bureau Life and the State of Colorado for Western Life. In addition, under the Iowa and Colorado Insurance Holding Company Acts, the Life Companies may not pay an "extraordinary" dividend without prior notice to and approval by the respective insurance commissioner. An "extraordinary" dividend is defined under the Iowa and Colorado Insurance Holding Company Acts as any dividend or distribution of cash or other property whose fair market value, together with that of other dividends or distributions made within the preceding 12 months, exceeds the greater of (i) 10% of policyholders' surplus (total statutory capital stock and statutory surplus) as of December 31 of the preceding year, or (ii) the statutory net gain from operations of the insurer for the 12 month period ending the December 31 of the preceding year. During 1997, the maximum amount legally available for distribution to FBL Financial Group, Inc. without further regulatory approval is approximately $34.9 million from Farm Bureau Life and $8.2 million from Western Life. Similar restrictions exist with respect to the payments of dividends by Utah Insurance. Such restrictions are not considered to bear significantly on the ability of the Company to meet its obligations or its anticipated dividends.
The Life Companies' cash inflows consist primarily of premium income, deposits to policyholder account balances, income from investments, sales, maturities and calls of investments and repayments of investment principal. The Life Companies' cash outflows are primarily related to withdrawals of policyholder account balances, investment purchases, payment of policy acquisition costs, policyholder benefits, income taxes, dividends and current operating expenses. Life insurance companies generally produce a positive cash flow which may be measured by the degree to which cash inflows are adequate to meet benefit obligations to policyholders and normal operating expenses as they are incurred. The remaining cash flow is generally used to increase the asset base to provide funds to meet the need for future policy benefit payments and for writing new business. The Life Companies' liquidity positions continued to be favorable in fiscal year 1996, with cash inflows at levels sufficient to provide the funds necessary to meet their obligations.
For property-casualty operations the major sources of cash inflow are premiums and investment income. Major sources of cash outflow are losses and loss adjustment expenses paid and other underwriting expenses. As with the Life Companies, the liquidity position of Utah Insurance continued to be favorable in 1996, with cash inflows at levels sufficient to provide the funds necessary to meet its obligations.
For all insurance operations, cash outflow requirements for operations are typically met from the year's normal premium and deposit cash inflows. This has been the case for all reported periods as the insurance companies' continuing operations provided funds amounting to $144.7 million in 1996, $106.5 million in 1995 and $94.0 million in 1994. Cash inflows from financing activities are principally the result of the significant growth in net deposits to policyholder account balances for both universal life insurance and annuities during 1996, 1995, and 1994. These funds, along with the excess operating inflows, were primarily used to increase the insurance companies' fixed maturity investment portfolios.
Matching the investment portfolio maturities to the cash flow demands of the type of insurance being provided is an important consideration for each type of life insurance. The Life Companies continually monitor benefit and claim statistics to provide projections of future cash requirements. As part of this monitoring process, the Life Companies perform cash flow testing of their assets and liabilities under various scenarios to evaluate the adequacy of reserves. In developing their investment strategy, the Life Companies establish a level of cash and securities which, combined with expected net cash inflows from operations, maturities of fixed maturity investments and principal payments on mortgage-backed securities and mortgage loans, are believed adequate to meet anticipated short-term and long-term benefit and expense payment obligations.
Through its membership in the Federal Home Loan Bank of Des Moines, Farm Bureau Life is eligible to borrow on a line of credit available to provide it additional liquidity. The line of credit available is based on the amount of capital stock of the Federal Home Loan Bank of Des Moines owned by Farm Bureau Life, which supported a borrowing capacity of $48.2 million as of December 31, 1996. Interest is payable at a current market rate upon issuance. As of December 31, 1996, no line of credit agreement was open and there were no borrowings outstanding.
Management anticipates that funds to meet its short-term and long-term capital expenditures, cash dividends to stockholders and operating cash needs will come from existing capital and internally generated funds. Management believes that the current level of cash and available-for-sale and short-term securities, combined with expected net cash inflows from operations, maturities of fixed maturity investments, principal payments on mortgage-backed securities, mortgage loans and its insurance products, are adequate to meet the Company's anticipated cash obligations. The Company may from time to time review potential acquisition opportunities. The Company anticipates that funding for any such acquisition may be provided from available cash resources, debt or equity financing. As of December 31, 1996, the Company had no material commitments for capital expenditures.
The Company's investment portfolio is managed by its internal investment professionals. The investment strategy is designed to achieve superior risk-adjusted returns consistent with the Company's investment philosophy of maintaining a largely investment grade portfolio and providing adequate liquidity for expected liability durations and other requirements. Management continually reviews the returns on invested assets and changes the mix of invested assets as deemed prudent under the current market environment to help maximize current income.
As of December 31, 1996, 93.1% (based on carrying value) of the 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. The Company regularly reviews the percentage of its portfolio which is invested in non-investment grade debt securities (NAIC designations 3 through 6). As of December 31, 1996, the Company's investment in non-investment grade debt was 6.9% of fixed maturity securities. At that time no single non-investment grade holding exceeded 0.2% of total investments.
Mortgage and other asset-backed securities constitute a significant portion of the Company's portfolio of securities. Management believes these types of investments, in general, provided superior risk-adjusted returns during 1996 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. At December 31, 1996, the Company held $576.7 million (20.0% of total investments) in residential mortgage-backed securities, $305.2 million (10.6% of total investments) in commercial mortgage-backed securities and $181.7 million (6.3% of total investments) in other asset-backed securities.
At December 31, 1996, the Company held residential collateralized mortgage obligation (CMO) investments with a market value of $538.1 million as part of its mortgage-backed securities holdings. CMOs consist of pools of mortgages divided into sections or "tranches" which provide sequential retirement of the bonds. To provide call protection and more stable average lives, the Company invests in planned amortization classes (PACs), which provide more predictable cash flows within a range of prepayment speeds (the rate of individuals refinancing their home mortgages at lower rates) by shifting the prepayment risks to support tranches. The Company also invests in sequential tranches, which provide stability in that repayments of principal do not occur until the previous tranches are paid off. As of December 31, 1996, 78.8% of the Company's CMO investments are in PAC and sequential pay securities. The Company does not purchase certain types of collateralized mortgage obligations. These include, but are not limited to, interest only, principal only, floater, inverse floater, PAC II, Z and support tranches.
Securities and indebtedness of related parties decreased $37.3 million, or 50.1%, due to the repayment of several lines of credit and mortgage loans and the sale or liquidation of several partnership interests. Deferred policy acquisition costs increased $29.1 million, or 21.1%, due primarily to new sales, the increase in Utah Insurance's reinsurance pool participation percentage and an adjustment ($10.7 million increase) related to the valuation of fixed maturity securities designated as available for sale. Value of insurance in force acquired increased $5.5 million, or 37.9%, principally due to an adjustment ($5.6 million increase) related to the valuation of fixed maturity securities designated as available for sale. At December 31, 1996, the Company had total assets of $3,368.2 million, an 8.9% increase from total assets at December 31, 1995.
Policy liabilities and accruals increased $133.5 million, or 6.3%, due principally to an increase in the volume of business in force and the increase in Utah Insurance's reinsurance pool participation percentage. Long-term debt increased $12.0 million to $24.6 million at December 31, 1996 principally due to $14.0 million in additional debt incurred during 1996 to support the increase in Utah Insurance's reinsurance pool participation percentage. At December 31, 1996, the Company had total liabilities of $2,724.9 million, a 7.9% increase from total liabilities at December 31, 1995.
The Company does not believe that inflation has had a material effect on its consolidated results of operations. The Company attempts to invest new funds in securities with expected durations that match the related policyholder obligations to reduce its exposure to interest rate fluctuations. In general, the market value of the Company's fixed maturity portfolio increases or decreases in inverse relationship with fluctuations in interest rates, and the yield realized by the Company on new investments increases or decreases in direct relationship with interest rate changes.
The NAIC currently is in the process of codifying statutory accounting practices, the result of which is expected to constitute the only source of "prescribed" statutory accounting practices. That project, which is expected to be completed in the near term, will likely change certain statutory accounting practices. The codification may result in changes to the accounting practices that the Company's insurance subsidiaries use to prepare their statutory-basis financial statements.
The Company's insurance subsidiaries are subject to government regulation in each of the states in which they conduct business. Such regulatory authority is vested in state agencies having broad administrative power dealing with all aspects of the insurance business, including rates, policy forms and capital adequacy, and is concerned primarily with the protection of policyholders rather than stockholders. The Company's variable insurance products, mutual funds, investment advisor and certain licensed broker-dealers and agents are also subject to regulation by the Securities and Exchange Commission, the National Association of Securities Dealers (NASD), and state agencies.
During the past several years, increased scrutiny has been placed upon the insurance regulatory framework, and certain state legislatures have considered or enacted laws that alter, and in many cases increase, state authority to regulate insurance companies and insurance holding company systems. In light of recent legislative developments, the NAIC and state insurance regulators are reexamining existing laws and regulations, specifically focusing on insurance company investments and solvency issues, risk-adjusted capital guidelines, interpretations of existing laws, the development of new laws, the implementation of nonstatutory guidelines and the circumstances under which dividends may be paid. The NAIC has approved one version and is considering another version of a model investment law that defines and sets guidelines for investment policies and activities for insurance companies. Management does not believe the adoption in any of its states of operation of any of the current NAIC initiatives will have a material adverse impact on the Company; however, the Company cannot predict the form of any future proposals or regulation.
Assessments are, from time to time, levied on the insurance subsidiaries of the Company by guaranty associations in most states in which the subsidiaries are licensed to cover losses of policyholders of insolvent or rehabilitated companies. In some states, these assessments can be partially recovered through a reduction in future premium taxes. Because the Company is not able to reasonably estimate the potential amounts of future assessments, the Company recognizes its obligation for guaranty fund assessments when it receives notice that an amount is payable to a guaranty fund. Expenses incurred for guaranty fund assessments were $0.6 million, $1.3 million and $1.6 million during the years ended December 31, 1996, 1995 and 1994, respectively.
* Extraordinary acts of nature or man may result in higher than expected claim activity.
* Changes in federal and state income tax laws and regulations may affect the relative tax advantage of the Company's products.
FBL FINANCIAL GROUP, INC. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
Consolidated Balance Sheets 41 Consolidated Statements of Income 43 Consolidated Statements of Changes in Stockholders' Equity 44 Consolidated Statements of Cash Flows 45 Notes to Consolidated Financial Statements 47
The management of FBL Financial Group, Inc. is responsible for the integrity of information contained in the accompanying consolidated financial statements. The statements have been prepared in accordance with generally accepted accounting principles appropriate in the circumstances and have been audited by Ernst & Young LLP. A copy of their audit opinion follows this letter. The financial information contained elsewhere in this annual report is consistent with that of the financial statements except for information described as being in accordance with statutory accounting practices.
Certain financial information presented depends on management's estimates and judgments regarding the ultimate outcome of transactions which are not yet complete. Management believes these estimates and judgements are fair and reasonable based upon available information.
The Audit Committee of the Board of Directors, composed solely of nonmanagement directors, meets periodically with management, internal auditors and Ernst & Young LLP to review internal accounting control, audit activities and financial reporting matters. The internal auditors and Ernst & Young LLP have free access to the Audit Committee, without the presence of management, to discuss the adequacy of internal control and to review the quality of financial reporting.
We have audited the accompanying consolidated balance sheets of FBL Financial Group, Inc. as of December 31, 1996 and 1995, and the related consolidated statements of income, changes in stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1996. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
FBL FINANCIAL GROUP, INC. CONSOLIDATED BALANCE SHEETS (CONTINUED) (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
FBL FINANCIAL GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1996
The Company has certain subsidiaries involved as broker-dealers and another as a venture capital investment company. In accordance with accounting practices for these specialized industries, marketable securities are valued at market value if readily marketable or at fair value, as determined by the Board of Directors of the subsidiary holding the security, if not readily marketable. The resulting difference between cost and market is included in the statements of income as net investment income. Realized gains and losses are also reported as a component of net investment income.
Mortgage loans on real estate are reported at cost adjusted for amortization of premiums and accrual of discounts. If the value of any mortgage loan is determined to be impaired (i.e., when it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement), the carrying value of the mortgage loan is reduced to its fair value, which may be based upon the present value of expected future cash flows from the loan (discounted at the loan's effective interest rate), or the fair value of the underlying collateral. The carrying value of impaired loans is reduced by the establishment of a valuation allowance, changes to which are recognized as realized gains or losses on investments.
Policy loans are reported at unpaid principal. Other long-term investments and short-term investments are reported at cost adjusted for amortization of premiums and accrual of discounts. Investments accounted for by the equity method include investments in, and advances to, various joint ventures and partnerships and are reported as securities and indebtedness of related parties. Changes in the value of the Company's investment in equity investees attributable to capital transactions of the investee, such as a public offering of stock, are recorded directly to stockholders' equity.
The carrying values of all the Company's investments are reviewed on an ongoing basis for credit deterioration, and if this review indicates a decline in market value that is other than temporary, the Company's carrying value in the investment is reduced to its estimated realizable value (the sum of the estimated nondiscounted cash flows for securities or fair value for mortgage loans on real estate) and a specific writedown is taken. Such reductions in carrying value are recognized as realized losses on investments. Realized gains and losses on sales are determined on the basis of specific identification of investments. If the Company expects that an issuer of a security will modify its payment pattern from contractual terms but no writedown is required, future investment income is recognized at the rate implicit in the calculation of net realizable value under the expected payment pattern.
For purposes of the consolidated statement of cash flows, the Company considers all highly liquid debt instruments purchased with a maturity of three months or less to be cash equivalents.
To the extent recoverable from future policy revenues and gross profits, certain costs of acquiring new insurance business, principally commissions and other expenses related to the production of new business, have been deferred. 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 accrues on the unamortized balance at rates that range from 6.50% to 6.79%.
Property and equipment, comprised primarily of home office properties, furniture and equipment, are reported at cost less allowances for depreciation. Depreciation expense is computed primarily using the straight-line method over the estimated useful lives of the assets. Depreciation expense for the years ended December 31, 1996, 1995 and 1994 was $10.0 million, $9.7 million and $9.4 million, respectively.
Goodwill represents the excess of the fair value of assets exchanged over the net assets acquired. Goodwill is generally being amortized on a straight-line basis over a period of 20 years. The carrying value of goodwill is regularly reviewed for indicators of impairment in value, which in the view of management are other than temporary. If facts and circumstances suggest that goodwill is impaired, the Company assesses the fair value of the underlying business and reduces goodwill to an amount that results in the book value of the underlying business approximating fair value. The Company has not recorded any such writedowns during the years ended December 31, 1996, 1995 or 1994.
The liability for future policy benefits for participating traditional life insurance is based on net level premium reserves, including assumptions as to interest, mortality, and other assumptions underlying the guaranteed policy cash values. Reserve interest assumptions are level and range from 2.5% to 6.0%. The average rate of assumed investment yields used in estimating gross margins was 8.34% in 1996, 8.14% in 1995 and 8.10% in 1994. Accrued dividends for participating business are established for anticipated amounts earned to date for the period through the policy's next anniversary and are provided for as a separate liability. The declaration of future dividends for participating business is at the discretion of the Board of Directors. Participating business accounted for 43% of receipts from policyholders during the year ended December 31, 1996 and represented 20% of life insurance inforce at December 31, 1996.
Future policy benefit reserves for universal life insurance and investment products are computed under a retrospective deposit method and represent policy account balances before applicable surrender charges. Policy benefits and claims that are charged to expense include benefit claims incurred in the period in excess of related policy account balances. Interest crediting rates for universal life and investment products ranged from 4.00% to 7.50% in 1996 and 1995 and 4.00% to 7.25% in 1994.
For the year ended December 31, 1996, the Company paid a cash dividend of $0.07 per common share. No dividends were paid during the years ended December 31, 1995 or 1994.
Certain amounts in the 1995 and 1994 consolidated financial statements have been reclassified to conform to the 1996 financial statement presentation.
FIXED MATURITY SECURITIES: Fair values for fixed maturity securities are based on quoted market prices, where available. For fixed maturity securities not actively traded, fair values are estimated using values obtained from independent pricing services or, in the case of private placements, are estimated by discounting the expected future cash flows using current market rates applicable to the coupon rate, credit, and maturity of the investments.
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 issues of comparable yield and quality.
HELD IN INVENTORY: The fair values for investments held in inventory are based on quoted market prices, where available. For holdings that are not actively traded, fair values are determined in good faith by the Board of Directors of the subsidiary holding the security.
CASH AND SHORT-TERM INVESTMENTS: The carrying amounts reported in the consolidated balance sheet for these instruments approximate their fair values.
FUTURE POLICY BENEFITS AND OTHER POLICYHOLDERS' FUNDS: Fair values of the Company's liabilities under contracts not involving significant mortality or morbidity risks (principally deferred annuities and supplementary contracts) are stated at cash surrender value, the cost the Company would incur to extinguish the liability. The Company is not required to estimate the fair value of its liabilities under other contracts.
DEPOSIT ADMINISTRATION FUNDS: The Company administers the funded portion of certain employee benefit plans of its affiliates through deposit administration funds. The fair value of the deposit administration funds attributed to the Agent's Career Incentive Plan are stated at amounts which are estimated to be currently vested, based on service and production criteria. Other funds are stated at carrying value.
At the effective date of the aforementioned affiliation agreement, Farm Bureau Life had assets of $2,142.8 million and Western Life had assets of $550.0 million. Subsequent to the agreement, many administrative functions of Western Life were assumed by, and consolidated with those of, Farm Bureau Life. Additionally, the former majority owners of Farm Bureau Life continue to be majority owners of the Company. As a result, the Company has treated the issuance of holding company stock in exchange for the stock of Farm Bureau Life as a reorganization for accounting purposes, thereby applying the principles of the pooling method for business combinations. The issuance of holding company stock in exchange for the stock of Western Life has been accounted for as a purchase and the purchase price of $88.1 million, based upon the appraised value of the Company's stock at the time of purchase, was allocated to the assets and liabilities acquired. Additionally, the issuance of holding company stock in exchange for the minority interests of FBL Insurance Company and Rural Security Life has been accounted for as a purchase and the purchase price of $24.7 million, based upon the appraised value of the Company's stock at the time of purchase, was allocated to the assets and liabilities acquired. These allocations resulted in goodwill of approximately $4.4 million, which is being amortized over 20 years. Goodwill associated with Rural Security Life remains attributable to the still existing operations in Wisconsin which include a license to do business in Wisconsin, an active agency force, customer lists, a marketing relationship with the Wisconsin Farm Bureau Federation and an exclusive use of the Farm Bureau trademark in Wisconsin in connection with the sale of life insurance and annuity products.
On March 12, 1996, the Company's stockholders approved a change to the Company's capital structure and a related revision to the Company's Articles of Incorporation (the recapitalization). The restated Articles of Incorporation authorize the Company to issue 88.5 million shares of Class A Common Stock, without par value; 1.5 million shares of Class B Common Stock, without par value, and 10.0 million shares of Preferred Stock. Pursuant to the recapitalization, each outstanding share of Common Stock prior to recapitalization was converted on a pro rata basis to 1,900 shares of Class A Common Stock and 100 shares of Class B Common Stock.
On April 29, 1996, the Company designated 5.0 million shares of its preferred stock as Series A Preferred Stock and on July 18, 1996, such shares were exchanged for 5.0 million shares of Class A Common Stock. Each share of Series A Preferred Stock has a liquidation preference of $20.00 and voting rights similar to that of Class A Common Stock. The Series A Preferred Stock pays cumulative annual cash dividends of $1.00 per share, payable quarterly, and is redeemable by the Company, at the option of the Company, at $20.00 per share plus unpaid dividends if the stock ceases to be beneficially owned by a Farm Bureau organization. Net income per common share for the year ended December 31, 1996 would have been $4.12 had the preferred stock exchange been effective January 1, 1996 and preferred dividends accrued since that date.
The unrealized appreciation or depreciation on fixed maturity and equity securities available for sale is reported as a separate component of stockholders' equity, reduced by adjustments to deferred policy acquisition costs, value of insurance in force acquired and unearned revenue reserve that would have been required as a charge or credit to income had such amounts been realized, and a provision for deferred income taxes. Net unrealized investment gains as reported were comprised of the following:
Amortized cost of securities held in inventory was $10.6 million and $21.6 million at December 31, 1996 and 1995, respectively. Net unrealized appreciation on securities held in inventory as of December 31, 1996 and 1995, included gross unrealized gains of $5.6 million and $1.6 million and gross unrealized losses of $0.3 million and $1.3 million, respectively.
The Company's mortgage loan portfolio consists principally of commercial mortgage loans. The Company's lending policies establish limits on the amount that can be loaned to one borrower and require diversification by geographic location and collateral type. Regions in which at least 20% of the Company's mortgage loan portfolio is invested during the years presented include: Pacific (26% in 1996 and 22% in 1995), which includes California, Oregon and Washington; and Mountain (22% in 1996 and 27% in 1995), which includes Arizona, Colorado, Idaho, New Mexico, Utah and Wyoming. Mortgage loans on real estate have also been analyzed during the years presented by collateral types with office buildings (48% in 1996 and 39% in 1995) and retail facilities (32% in 1996 and 34% in 1995), representing the largest holdings.
YEAR ENDED DECEMBER 31, ------------------------- 1996 1995 1994 ---- ---- ---- (DOLLARS IN THOUSANDS) Balance at beginning of year $ 800 $ 800 $ 600 Realized losses 2,983 10 248 Uncollectible amounts written off, net of recoveries (2,655) (10) (48) ------- ----- ----- Balance at end of year $ 1,128 $ 800 $ 800 ======= ===== =====
The Company's investment in impaired loans (those loans in which the Company does not believe it will collect all amounts due according to the contractual terms of the respective loan agreements) totaled $4.0 million at December 31, 1996 and $3.3 million at December 31, 1995. A valuation allowance of $0.5 million was established on the impaired loans at December 31, 1996. No valuation allowance was established for the impaired loans as of December 31, 1995.
Securities and indebtedness of related parties include mortgage loans and similar advances to joint ventures and limited partnerships in which the Company maintains an equity interest. Such indebtedness aggregated $11.7 million and $34.0 million at December 31, 1996 and 1995, respectively. These loans and advances were made at similar interest rates and under similar terms as other mortgage loans.
Effective January 1, 1994, the Company adopted SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities". The cumulative effect of this change in accounting method was to increase stockholders' equity by $38.9 million, net of offsets aggregating $40.0 million.
Realized losses totaling $0.5 million and $0.2 million were incurred during the years ended December 31, 1996 and 1995, respectively, as a result of writedowns for other than temporary impairment of fixed maturity securities. No such writedowns were incurred during 1994.
At December 31, 1996, the Company had committed to provide additional funding for mortgage loans on real estate aggregating $7.9 million. These commitments arose in the normal course of business at terms which are comparable to similar investments.
The carrying value of investments which have been non-income producing for the twelve months preceding December 31, 1996, include: fixed maturities - $3.0 million; mortgage loans on real estate - $3.3 million; and other long-term investments - $1.6 million.
An analysis of the value of insurance in force acquired for the years ended December 31, 1996, 1995 and 1994 is as follows:
In the normal course of business, the Company seeks to limit its exposure to loss on any single insured and to recover a portion of benefits paid by ceding reinsurance to other insurance enterprises or reinsurers. Reinsurance coverages for life insurance vary according to the age and risk classification of the insured with retention limits ranging up to $0.5 million of coverage per individual life. The Company does not use financial or surplus relief reinsurance. At December 31, 1996, life insurance in force ceded on a consolidated basis totaled $1,082.3 million or approximately 6.3% of total life insurance in force.
No allowance for uncollectible amounts has been established against the Company's asset for reinsurance recoverable since none of the receivables are deemed to be uncollectible. Insurance premiums and product charges have been reduced by $5.7 million, $14.9 million and $23.1 million and insurance benefits have been reduced by $5.1 million, $8.5 million and $12.0 million during the years ended December 31, 1996, 1995 and 1994, respectively, as a result of cession agreements. The amount of reinsurance assumed is not significant.
Unpaid claims on accident and health policies include amounts for losses and related adjustment expense and are estimates of the ultimate net costs of all losses, reported and unreported. These estimates are subject to the impact of future changes in claim severity, frequency and other factors. The activity in the liability for unpaid claims and related adjustment expense, net of reinsurance, is summarized as follows:
Risks are reinsured with other companies to permit the recovery of a portion of losses and loss adjustment expenses incurred and are treated (to the extent of the reinsurance) as risks for which the Company is not liable; however, the Company remains liable to the extent that reinsuring companies cannot meet their obligations under these reinsurance contracts.
The effective tax rate on income from continuing operations before income taxes, minority interest in earnings of subsidiaries and equity income (loss) is different from the prevailing federal income tax rate as follows:
During 1994, Farm Bureau Life reached partial settlement with the Internal Revenue Service (IRS) for tax years 1988 through 1990 and the IRS is in the process of conducting examinations for 1991 through 1994. All tax years 1992 and prior are settled for Western Life. During the year ended December 31, 1994, the Company paid $2.8 million for settlement of certain items arising from the examination of prior years. Management believes that amounts provided in the income tax provision for IRS examinations are adequate to settle any adjustments raised by the IRS.
The Company participates with several other affiliates in various defined benefit plans covering substantially all employees. The benefits of these plans are based primarily on years of service and employees' compensation. The Company and affiliates have adopted a policy of allocating the net periodic pension cost of the plans between themselves generally on a basis of time incurred by the respective employees for each employer. Such allocations are reviewed annually. Pension expense aggregated $9.6 million, $8.1 million and $6.2 million for the years ended December 31, 1996, 1995 and 1994, respectively.
Prior to January 1, 1996, the Company provided benefits to agents of the Company and certain of its affiliates through the Agents' Career Incentive Plan. Company contributions to the plan were based upon the individual agent's earned commissions and varied based upon the overall production level and the number of years of service. Company contributions charged to expense with respect to this plan during the years ended December 31, 1995 and 1994 were $1.4 million and $1.6 million, respectively. During 1996, in conjunction with a restructuring of the agents' compensation program, contributions to this plan were discontinued.
In addition to benefits offered under the aforementioned benefit plans, the Company and several other affiliates sponsor a plan that provides group term life insurance benefits to retired full-time employees who have worked ten years and attained age 55 while in service with the Company. Postretirement benefit expense is allocated in a manner consistent with pension expense discussed above. Postretirement pension expense aggregated $0.2 million for the year ended December 31, 1996 and $0.1 million for the years ended December 31, 1995 and 1994.
During 1996, the Company adopted the 1996 Class A Common Stock Compensation Plan (the Plan) under which incentive stock options, nonqualified stock options, bonus stock, restricted stock and stock appreciation rights may be granted to directors, officers and employees. During 1996, the Company granted 621,869 incentive stock options and 199,363 nonqualified stock options under the Plan. Option shares granted 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. Option shares granted to officers and employees generally vest over a five year period contingent upon continued employment with the Company and have a contractual term of 10 years. At December 31, 1996, the Company has 821,232 option shares outstanding with an exercise price range of $17.50 to $23.50, a weighted average exercise price of $17.67 and an estimated weighted average remaining contractual life of 9.1 years. Option shares exercisable at December 31, 1996 totaled 104,000 with a weighted average exercise price of $17.62. No options were exercised or forfeited during 1996. The Company has 928,768 shares of Class A Common Stock available for grant as additional awards under the Plan as of December 31, 1996.
Certain of the Company's subsidiaries are authorized to issue, collectively, up to 110,000 shares of redeemable preferred stock in series at $200.00 per share. Dividends accrue at fixed or variable rates depending on the series and can range from 7.5% to 15.0%. Under certain circumstances and with respect to certain matters, the holders of redeemable preferred stock are entitled to vote separately as a class. There were 24,017 and 22,517 preferred shares outstanding at December 31, 1996 and 1995, respectively, all of which are currently redeemable at the option of the respective issuing company. The redeemable preferred stock and related dividends are reported as minority interest in subsidiaries in the consolidated financial statements.
The ability of Farm Bureau Life and Western Life to pay dividends to the parent company is restricted because prior approval of insurance regulatory authorities is required for payment of dividends to the stockholder which exceed an annual limitation. During 1997, Farm Bureau Life and Western Life could pay dividends to the parent company of approximately $34.9 million and $8.2 million, respectively, without prior approval of insurance regulatory authorities. Also, the amount ($209.9 million and $59.9 million for Farm Bureau Life and Western Life, respectively, at December 31, 1996) by which the stockholder's equity stated in conformity with generally accepted accounting principles exceeds statutory capital and surplus as reported is restricted and cannot be distributed.
Similar restrictions exist with respect to the payments of dividends by Utah Insurance. Such restrictions are not considered to bear significantly on the ability of the Company to meet the obligations of any member of the consolidated group.
In addition, prior to January 1, 1996, the Company participated in a management agreement with Farm Bureau Management Corporation, a wholly-owned subsidiary of the Iowa Farm Bureau Federation. Under this agreement, Farm Bureau Management Corporation provided general business, administration and management services to the Company. During 1996, the Company assumed responsibility for providing a majority of these services for itself as well as Farm Bureau Management Corporation and other affiliates. During the years ended December 31, 1996, 1995 and 1994, the Company incurred expenses under this contract of $2.6 million, $3.7 million and $3.1 million, respectively. During 1996, the Company earned management fee income of $0.2 million related to these services.
Prior to February 1995, Western Life maintained a management services agreement with Western Farm Bureau Management Corporation. Under the terms of the agreement, Western Farm Bureau Management Corporation provided all management, investment advisory, administrative, underwriting, policyholder services, legal, actuarial and other management-related services for Western Life. These services are now provided by the Company.
In the normal course of business, the Company 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, 1996, management is not aware of any claims for which a material loss is reasonably possible.
Revenues of the discontinued operations aggregated $10.2 million for the period from January 1, 1994 through December 22, 1994. Interest expense, $2.9 million for the period from January 1, 1994 through December 22, 1994, has been allocated to discontinued operations based on debt that can be identified as specifically attributed to those operations.
Information concerning the Company's continuing business segments for the years ended December 31, 1996, 1995 and 1994 is as follows:
Corporate revenues and income (loss) from continuing operations noted above for 1996 do not include $0.3 million in revenues and identifiable assets do not include $3.0 million in intercompany receivables that are eliminated in consolidation. Other intercompany balances that are eliminated in consolidation are not significant to the respective segments. Corporate assets consist principally of cash, receivables from affiliates and short-term investments. Capital expenditures and depreciation and amortization are not considered material.