We sell universal life, variable universal life, and traditional life insurance and traditional and variable annuity products. These products are principally marketed through a core distribution force consisting of approximately 1,980 exclusive Farm Bureau agents in the midwestern and western sections of the United States. Variable universal life and variable annuity products are also marketed in other states through alliances with unaffiliated Farm Bureau companies. We also market variable products through alliances with two life insurance companies and a regional broker/dealer not affiliated with Farm Bureau. In addition to writing direct insurance business, we assume through coinsurance agreements a percentage of certain business written by National Travelers Life Company (NTL) and American Equity Investment Life Insurance Company (American Equity). These coinsurance agreements utilize excess capital and increase our volume of business in force. 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 NTL and two Farm Bureau affiliated property-casualty insurance companies.
It is reasonably possible that actual experience could differ from the estimates and assumptions utilized which could have a material impact on the consolidated financial statements. The following is a discussion of these significant areas of judgement.
Our fixed maturity securities classified as available for sale and our equity securities are reported at market value. Approximately 77% of our fixed maturity securities, and 76% of our equity securities, are actively traded. For actively traded securities market values are determined using quoted market prices obtained from various pricing sources. For fixed maturity securities that are not actively traded, fair values are principally estimated using a matrix calculation assuming a spread over U. S. Treasury bonds. The spread used in the matrix calculation is based on current interest rates, risk assessment of the bonds and the current market environment. For equity securities that are not actively traded, estimated fair values are principally based on values of comparable issues. Our internal investment professionals perform or review the valuation of securities that are not actively traded. This review and valuation process requires significant judgement in the determination of the inputs into the matrix calculations and in the identification of comparable issues. Our estimates of fair value for not actively traded securities have proven to be reliable based on the prices obtained when these types of securities are sold. However, although we believe our estimates reasonably reflect the fair value of the securities, our key assumptions used in the valuation process may not reflect those of an active market.
o yield on investments supporting the liabilities, o amount of interest or dividends credited to the policies, o amount of policy fees and charges, o amount of expenses necessary to maintain the policies, o amount of death and surrender benefits and o the length of time the policies will stay in force.
Our estimate of how long the policies will remain in force varies by the type of product with life insurance products at 30 years and annuity products ranging from 15 to 30 years. The expected yield on investments supporting the liabilities ranges from 7.30% to 7.78% for traditional products and is 10.0% for variable products. The amount of expected interest or dividends to be credited to policies and policy fees and charges assessed are generally set at amounts equal to current levels. Future maintenance expense assumptions are based on current expense levels adjusted for inflation. These estimates, which are revised annually, are based on historical results and our best estimate of future experience. Amortization of deferred policy acquisition costs may increase or decrease if actual results vary from that currently anticipated or if a key assumption is revised.
As of December 31, 2001, we have approximately $97.1 million of deferred tax assets for which no valuation allowance has been recorded. The deferred tax assets relate principally to book-to-tax differences in the recording of reserves for future policy benefits. The realization of these assets is based upon estimates of future taxable income and the timing of the reversal of offsetting deferred tax liabilities. We have historically generated sufficient taxable income to realize the deferred tax assets recorded as of December 31, 2001 and, based upon future projections of taxable income, do not believe a valuation allowance is necessary.
The development of reserves for future policy benefits for non-interest sensitive insurance products requires the use of many assumptions, all of which require a certain level of judgement. Once established for a particular series of products, these assumptions are generally held constant. The underlying assumptions include the lives of the policies, mortality experience, lapse rates, surrender rates, and dividend crediting rates. These assumptions are made based upon our historical experience, industry standards and our best estimate of future results.
We participate with other Farm Bureau companies in a multiemployer defined benefit pension plan and record as expense our proportionate share of net periodic pension cost of the plan as determined in accordance with Statement of Financial Accounting Standard (Statement) No. 87, "Employers' Accounting for Pensions". Statement No. 87 generally reduces the volatility of pension expense from changes in pension liability discount rates and the performance of the pension plan's assets.
The most significant element in determining our pension expense in accordance with Statement No. 87 is the expected return on plan assets. We have assumed that the expected long-term rate of return on plan assets will be 7.0%, which is approximately equal to the rate earned historically. We believe a long-term rate of 7.0% is reasonable. The assumed long-term rate of return on assets is applied to a calculated value of plan assets, which produces the expected return on plan assets that is included in pension expense. The difference between this expected return and the actual return on plan assets is deferred. The net deferral of past asset gains (losses) affects the calculated value of plan assets and, ultimately, future pension expense. If plan assets have a rate of return substantially less than 7.0%, future pension expense will be greater than that if rate of return was equal to or greater than 7.0%.
We recognized consolidated pretax pension expense of $5.3 million in 2001, $5.2 million in 2000 and $4.5 million in 1999. We do not expect that changes to pension plan assumptions will have a significant impact on pension expense for 2002.
During 2001, we entered into a coinsurance agreement with American Equity whereby we assumed 70% of certain fixed and equity-indexed annuity business written by American Equity from August 1, 2001 to December 31, 2001. The agreement also provides for reinsuring 40% of certain new business written by American Equity during 2002 and 2003. This agreement was accounted for as the reinsurance of an in force block of business as of October 1, 2001, and the regular coinsurance of the business written during the fourth quarter of 2001. Accordingly, our consolidated statement of income for 2001 includes revenues and expenses pertaining to this business for only the fourth quarter of 2001. Collected premiums assumed during the fourth quarter of 2001 totaled $280.0 million. Reserves transferred to us in connection with the assumption of the in force block of business totaled $138.7 million.
Effective January 1, 2001, we acquired the assets and liabilities of Kansas Farm Bureau Life Insurance Company (Kansas Farm Bureau Life), a single-state life insurance company selling traditional life and annuity products in Kansas. In connection with this acquisition, we assumed all of Kansas Farm Bureau Life's insurance business through an assumption reinsurance agreement. As a result of the acquisition, our geographic market territory expanded into the state of Kansas for our traditional products and our exclusive agency force increased by 336 agents. Assets acquired with this transaction totaled $695.4 million. Premiums collected on business issued as a result of this acquisition during 2001 totaled $77.3 million.
Net income applicable to common stock decreased 6.8% in 2001 to $36.5 million and 29.5% in 2000 to $39.2 million. Operating income applicable to common stock decreased 16.8% in 2001 to $45.2 million and 1.6% in 2000 to $54.3 million. The decrease in net income in 2001 is due primarily to a decrease in equity income and a reduction of net investment income resulting from stock repurchase activity during 2000. The impact of these items were partially offset by net income generated from the Kansas Farm Bureau Life, NTL and American Equity transactions, an increase in fee income from mortgage loan prepayments and bond calls and a reduction in realized losses on investments. See discussion following for details on the positive impact the stock repurchase activity had on a per share basis. The decrease in net income in 2000 is generally attributable to an increase in realized losses on investments, due principally to writedowns for other-than-temporary impairments in value. In addition, net investment income decreased due primarily to a decrease in fee income from mortgage loan prepayments and bond calls. These items are partially offset by an increase in equity income. The primary drivers of the differences in operating income are the contributions made by our 2001 acquisition and reinsurance transactions and the differences noted above in investment and equity income.
The following is a reconciliation of net income to operating income.
DERIVATIVE INCOME totaled $0.1 million in 2001. Derivative income is a new line in the consolidated statement of income for 2001 that is the result of the adoption of a new accounting standard. Under the new standard, derivatives are recorded at market value and changes in market value are reported as a component of net income. Our derivative income consists of unrealized gains and losses on the value of the conversion feature embedded in convertible fixed maturity securities and on the value of call options used to fund returns on our equity-indexed annuity contracts assumed from American Equity. Also included in derivative income is amortization of the underlying call options. Derivative income will fluctuate based on market conditions and may be negative.
OTHER INCOME and OTHER EXPENSES include revenues and expenses, respectively, relating primarily to our non-insurance operations. These operations include management, advisory, marketing and distribution services and leasing activities. Fluctuations in these financial statement line items are generally attributable to fluctuations in the level of these services provided during the periods.
UNDERWRITING, ACQUISITION AND INSURANCE EXPENSES increased 26.8% in 2001 to $92.5 million and 3.9% in 2000 to $72.9 million. The increase in 2001 is due primarily to the addition of the Kansas Farm Bureau Life and NTL business. Underwriting, acquisition and insurance expenses relating to this business totaled $15.8 million in 2001. The impact of the new business was partially offset by a $1.0 million recovery of excess royalty fees paid in prior years for our agreement with the Iowa Farm Bureau Federation to use the "Farm Bureau" and "FB" designations in the State of Iowa. The increase in amortization of deferred policy acquisition costs in 2001 is due partly to a shift in product profitability to blocks of business that have a larger acquisition cost remaining to be amortized or that have higher amortization factors. In addition, amortization increased due to an increase in the unamortized acquisition cost asset caused by the growth in the volume of business in force. The increase in other underwriting, acquisition and insurance expenses is also partially attributable to an increase in salaries, information system expenses and other operating expenses due to general growth in areas that support our growing insurance operations and amortization of capitalized software costs associated with system enhancements. Another item impacting the comparison of expenses are restructuring charges of $1.2 million in 1999 and related cost savings in 2000 relating to the closing of an administrative service center. Other underwriting, acquisition and insurance expenses includes goodwill amortization totaling $0.9 million in 2001 and $0.7 million in 2000 and 1999.
INTEREST EXPENSE decreased 51.4% in 2001 to $1.8 million and increased 43.2% in 2000 to $3.7 million. The decrease in 2001 is due to a decrease in average debt outstanding and a decrease in the interest rate on our $40.0 million of variable-rate debt. The increase in 2000 was due to an increase in the average debt outstanding during the year.
EQUITY INCOME, NET OF RELATED INCOME TAXES, decreased 97.9% in 2001 to $0.3 million and increased 207.0% in 2000 to $12.2 million. Equity income includes our proportionate share of gains and losses attributable to our ownership interest in partnerships, joint ventures and certain companies where we exhibit some control but have a minority ownership interest. Given the timing of availability of financial information from these entities, we will consistently use information that is as much as three months in arrears for certain of these entities. Several of these entities are venture capital investment companies, whose operating results are derived primarily from unrealized and realized gains and losses generated by their investment portfolios. The income in 2000 is primarily driven by unrealized appreciation on two internet-related equity securities owned by two of these venture capital investment companies. A substantial portion of the positions held by the equity investees in these two entities was distributed to us and subsequently sold during 2000. As is normal with these types of entities, the level of these gains and losses is subject to fluctuation from period to period depending on the prevailing economic environment, changes in prices of equity securities held by the investment partnerships, timing and success of initial public offerings and other exit strategies, and the timing of the sale of investments held by the partnerships and joint ventures. As a result of our common stock investment in American Equity Investment Life Holding Company, equity income includes $1.4 million in 2001, $0.4 million in 2000 and $0.6 million in 1999, representing our share of its net income. In addition, equity income includes goodwill amortization totaling $0.4 million in 2001, 2000 and 1999.
We closed an administrative service center during 1999, after the merger of two of our life insurance subsidiaries. As a result of the closing of the service center, a leased property was vacated, 22 job positions were eliminated and moving costs were incurred. During 1999, we charged to expense costs totaling $1.2 million for related severance benefits, lease costs and other costs primarily associated with closing the service center. The restructuring expenses are recorded in the underwriting, acquistion and insurance expenses line of the 1999 consolidated statement of income.
We recorded a gain of $0.6 million in 2000 and $1.4 million in 1999, net of related income taxes, on the sale of Utah Farm Bureau Insurance Company (Utah Insurance), a former wholly-owned property-casualty insurance company, to Farm Bureau Mutual Insurance Company (Farm Bureau Mutual), an affiliate. We did not record any gain during 2001 as the loss ratio of Utah Insurance was higher than the threshold loss ratio in the earn-out calculation included in the sales agreement. The gain on the sale may be increased in 2002 in accordance with an earn-out provision. See "Liquidity - FBL Financial Group, Inc."
Pre-tax operating income for the traditional and universal life insurance segment increased 13.9% in 2001 to $50.4 million and decreased 9.3% in 2000 to $44.3 million. Pre-tax operating income and the volume of business in force increased in 2001 primarily due to the addition of the Kansas Farm Bureau Life and NTL business. Life insurance premiums collected from this new business in 2001 totaled $37.4 million. The positive impact of the Kansas Farm Bureau Life and NTL business on pre-tax operating income was partially offset by an increase in death benefits, including $1.6 million in anticipated losses resulting from the terrorist attacks on September 11, 2001. Excluding the impact of the Kansas and NTL business, traditional benefits and the related change in reserves increased to $73.0 million in 2001 compared to $69.6 million in 2000. During 2001, amortization of deferred policy acquisition costs was increased $1.4 million due to changes in lapse rate, expense and other assumptions used to calculate the deferred policy acquisition cost asset. The decrease in pre-tax operating income in 2000 compared to 1999 is due principally to a decrease in investment income and increase in death benefits on interest sensitive products.
Mortgage and other asset-backed securities constitute a significant portion of our portfolio of securities. These securities are purchased from time to time 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.
Assets other than investments generally increased due to the addition of the Kansas Farm Bureau Life, NTL and American Equity business. Cash and cash equivalents increased to $271.5 million at December 31, 2001 from $3.1 million at December 31, 2000 due to an increase in short-term investments with a maturity date of three months or less when acquired, resulting principally from cash received from American Equity in December 2001. Reinsurance recoverable increased 97.4% to $101.3 million at December 31, 2001 due to the impact of acquiring new business in 2001 and the coinsurance of our individual disability income business. Property and equipment decreased 31.7% to $40.4 million at December 31, 2001 due principally to the sale of capitalized software during 2001 to Farm Bureau Mutual. Assets held in separate accounts increased 8.9%, to $356.4 million at December 31, 2001 due primarily to net transfers to the separate accounts resulting from sales of our variable products, partially offset by the decline in the market value of the assets. At December 31, 2001, we had total assets of $5,629.2 million, a 52.0% increase from total assets at December 31, 2000.
We issued Series C redeemable preferred stock with a carrying value of $82.7 million at December 31, 2001 in connection with the Kansas Farm Bureau Life transaction. See Note 2 of the notes to consolidated financial statements for additional details regarding the terms of this preferred stock.
At December 31, 2001, common stockholders' equity was $562.8 million, or $20.53 per share, compared to $473.8 million, or $17.35 per share at December 31, 2000. Included in stockholders' equity per common share is $1.43 at December 31, 2001 and ($0.78) at December 31, 2000 attributable to net unrealized investment gains (losses) resulting from marking our fixed maturity securities classified as available for sale to market value. The change in unrealized appreciation of fixed maturity and equity securities classified as available for sale increased stockholders' equity $59.4 million during 2001, after related adjustments to deferred policy acquisition costs, value of insurance in force acquired, unearned revenue reserve and deferred income taxes.
o The average life of the portfolio. o The amount and speed at which market interest rates rise or fall. o The amount by which bond calls, mortgage loan prepayments and paydowns on mortgage and asset-backed securities accelerate during periods of declining interest rates. o The amount by which bond calls, mortgage loan prepayments and paydowns on mortgage and asset-backed securities decelerate during periods of increasing interest rates.
If interest rates were to increase 10% from levels at December 31, 2001 and 2000, our fixed maturity securities and short-term investments would decrease approximately $94.3 million at December 31, 2001 and $54.1 million at December 31, 2000. This hypothetical change in value does not take into account any offsetting change in the value of insurance liabilities for investment contracts since we estimate such value to be the cash surrender value of the underlying contracts. If interest rates were to decrease 10% from levels at December 31, 2001 and 2000, the fair value of our debt and mandatorily redeemable preferred stock of subsidiary trust would increase $2.8 million at December 31, 2001 and 2000.
We acquired Class A common shares totaling 5,900 in 2001, 4,358,397 in 2000 and 1,322,920 in 1999 as a result of stock repurchases. These transactions reduced stockholders' equity by $0.1 million in 2001, $85.8 million in 2000 and $25.7 million in 1999.
FBL Financial Group, Inc. expects to rely on available cash resources and on dividends from Farm Bureau Life to make any dividend payments to its stockholders and interest payments on its Notes. In addition, it is anticipated that dividends from Farm Bureau Life will be used to fund the scheduled redemption of the Series C preferred stock in 2004 ($45.3 million) and 2006 ($46.3 million).
The Life Companies' cash inflows consist primarily of premium income, deposits to policyholder account balances, product charges on variable products, 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 2001, with cash inflows at levels sufficient to provide the funds necessary to meet their obligations.
For the life insurance operations, cash outflow requirements for operations are typically met from normal premium and deposit cash inflows. Net cash inflows (outflows) for the Life Companies' continuing operations and financing activities relating to interest sensitive products provided funds totaling $536.0 million in 2001, ($36.5) million in 2000 and $104.1 million in 1999. The significant increase in net cash flows in 2001 is due principally to the impact of the Kansas, NTL and American Equity transactions. Net cash inflows are primarily used to increase the insurance companies' fixed maturity and short-term investment portfolios. The net cash outflow for 2000 is primarily the result of a $32.8 million net payment for reserves pursuant to the individual disability income coinsurance arrangement and increased surrender benefits on interest sensitive products and rollovers from traditional products to variable products. This cash outflow was funded with available cash and cash provided from investing activities. 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 and asset-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 (FHLB), Farm Bureau Life is eligible to establish and borrow on a line of credit to provide it additional liquidity. The line of credit available is based on the amount of capital stock of the FHLB owned by Farm Bureau Life, which supported a borrowing capacity of $78.9 million as of December 31, 2001. At December 31, 2001, Farm Bureau Life had outstanding borrowings of $40.0 million under this arrangement, leaving a borrowing capacity of $38.9 million. Additional collateral would need to be deposited with the FHLB in order to access this additional borrowing capacity. The outstanding debt is due September 17, 2003, and interest on the debt is charged at a variable rate equal to the London Interbank Offered Rate less 0.0475% (1.85% at December 31, 2001). Fixed maturity securities with a carrying value of $44.4 million are on deposit with the FHLB as collateral for the note.
In the normal course of business, we enter into financing transactions, lease agreements, or other commitments which are necessary or beneficial to our operations. These commitments may obligate us to certain cash flows during future periods. The following table summarizes such obligations.
We have the following three different forms of derivatives on our balance sheet which are subject to Statement No. 133:
These derivatives are described more fully in Note 1 of the notes to consolidated financial statements under the captions "Investments - Fixed Maturities and Equity Securities", "Reinsurance Recoverable" and "Future Policy Benefits".
Upon the adoption of Statement No. 133, we transferred our fixed maturity securities classified as held for investment to the available-for-sale category. In connection with this transfer, the securities were marked to market and the corresponding increase in carrying value totaling $2.8 million, net of offsetting adjustments to deferred acquisition costs, value of insurance in force acquired, unearned revenue reserve and income taxes, was credited to stockholders' equity. Prior year financial statements were not restated.
From time to time, we may publish statements relating to anticipated financial performance, business prospects, new products, and similar matters. These statements and others that include words such as "expect", "anticipate", "believe", "intend", and other similar expressions, constitute forward-looking statements under the Private Securities Litigation Reform Act of 1995. The Private Securities Litigation Reform Act of 1995 provides a safe harbor for these types of statements. In order to comply with the terms of the safe harbor, please note that a variety of factors could cause our actual results and experiences to differ materially from the anticipated results or other expectations expressed in our forward-looking statements. The risks and uncertainties that may affect the operations, performance, development and results of our business include but are not limited to the following:
o Changes to interest rate levels and stock market performance may impact our lapse rates, market value of our investment portfolio and our ability to sell life insurance products, notwithstanding product features to mitigate the financial impact of such changes. o The degree to which our products are accepted by customers and agents (including the agents of our alliance partners) will impact our future growth rate. o Extraordinary acts of nature or man may result in higher than expected claim activity. o Changes in federal and state income tax laws and regulations may affect the relative tax advantage of our products.
FBL FINANCIAL GROUP, INC. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
Consolidated Balance Sheets................................................. 39 Consolidated Statements of Income........................................... 41 Consolidated Statements of Changes in Stockholders' Equity.................. 42 Consolidated Statements of Cash Flows....................................... 43 Notes to Consolidated Financial Statements.................................. 45
Management maintains a system of internal controls designed to meet its responsibilities for preparing reliable financial statements. The system is designed to provide reasonable assurance that assets are safeguarded and transactions are properly authorized and reported. Reasonable assurance is based upon the premise that the cost of controls should not exceed the benefits derived from them. An internal audit department is maintained to continually monitor and challenge the adequacy of internal control. It is management's opinion that its system of internal control during the periods covered by this annual report was effective in providing reasonable assurance that the financial statements are fairly stated in all material respects.
We have audited the accompanying consolidated balance sheets of FBL Financial Group, Inc. as of December 31, 2001 and 2000, 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, 2001. 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.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of FBL Financial Group, Inc. at December 31, 2001 and 2000, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2001, in conformity with accounting principles generally accepted in the United States.
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) (collectively, the Life Companies). We currently market 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. Variable universal life insurance and variable annuity contracts are also marketed in these and other states through alliances with other insurance companies and a regional broker/dealer. In addition to writing direct insurance business, we assume through coinsurance agreements a percentage of certain business written by National Travelers Life Company (NTL) and American Equity Investment Life Insurance Company (American Equity). These coinsurance agreements utilize excess capital and increase our volume of business in force. 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 NTL and two Farm Bureau affiliated property-casualty companies.
Effective January 1, 2001, we adopted the Financial Accounting Standards Board's (FASB) Statement of Financial Accounting Standards (Statement) No. 133, "Accounting for Derivative Instruments and Hedging Activities" and Statement No. 138, "Accounting for Certain Derivative Instruments and Certain Hedging Activities." Statement No. 133 requires companies to record derivatives on the balance sheet as assets or liabilities, measured at fair value. Accounting for gains or losses resulting from changes in the values of those derivatives is dependent on the use of the derivative and whether it qualifies for hedge accounting. Without hedge accounting, these gains or losses are recorded as a component of net income. Statement No. 133 also allows companies to transfer securities classified as held for investment to either available-for-sale or trading categories in connection with the adoption of the new standard. Statement No. 138 amends Statement No. 133 to clarify the appropriate accounting for certain hedging transactions.
We have the following three different forms of derivatives on our balance sheet which are subject to Statement No. 133: o the feature of a convertible fixed maturity security that allows the conversion of a fixed maturity security into an equity security is considered an embedded derivative, o the rights of an equity-indexed annuity contract holder to participate in the index returns available under the contract are considered embedded derivatives, and o our reinsurance recoverable as it relates to call options purchased to fund returns to equity-indexed annuity contract holders is considered a derivative.
In December 2001, the Accounting Standards Executive Committee of the American Institute of Certified Public Accountants issued Statement of Position (SOP) 01-6, "Accounting by Certain Entities (Including Entities with Trade Receivables) That Lend to or Finance the Activities of Others." The SOP requires loans and trade receivables that management has the intent and ability to hold for the forseeable future or until maturity or payoff to be reported in the balance sheet at outstanding principal adjusted for any chargeoffs, the allowance for loan losses, any deferred fees or costs on originated loans and any unamortized premiums or discounts on purchased loans. We currently report our mortgage loans in accordance with this SOP and we do not believe it will have a material effect on our financial statements.
In June 2001, the FASB issued Statement No. 141, "Business Combinations," and Statement No. 142, "Goodwill and Other Intangible Assets." Under the new Statements, goodwill will no longer be amortized but will be subject to annual impairment tests in accordance with the Statements. In addition, Statement No. 142 requires the identification and amortization of certain intangible assets that had previously been included as a component of goodwill. We will apply the new Statements in the first quarter of 2002. Application of the nonamortization provisions of the Statement is expected to result in an increase in net income of $1.2 million per year, or $0.04 per share. During 2002, we will perform the first of the required impairment tests of goodwill as of January 1, 2002. While we have not completed this testing we do not expect this testing to require the impairment of any goodwill.
All of our fixed maturity securities, comprised of bonds and redeemable preferred stocks, are designated as "available for sale" and are reported at market value. 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 or loss. Unrealized gains and losses relating to the conversion feature embedded in convertible fixed maturity securities are recorded as a component of net investment income in the consolidated statements of income. The unrealized gains and losses are reduced by a provision for deferred income taxes and 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. Prior to the adoption of Statement No. 133, we had certain securities classified as "held for investment." Held for investment securities were reported at cost adjusted for amortization of premiums and discounts. Changes in the market value of these securities, except for declines that are other than temporary, are not reflected in our financial statements. 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.
Policy loans are reported at unpaid principal balance. Short-term investments are reported at cost adjusted for amortization of premiums and accrual of discounts.
Securities and indebtedness of related parties include investments in partnerships and corporations over which we may exercise significant influence. These partnerships and corporations operate predominately in the insurance, broker-dealer, investment company and real estate industries. Such investments are accounted for using the equity method. In applying the equity method, we record our share of income or loss reported by the equity investees. For partnerships operating in the investment company industry, this income or loss includes changes in unrealized gains and losses in the partnerships' investment portfolios. Changes in the value of our investment in equity investees attributable to capital transactions of the investee, such as an additional offering of stock, are recorded directly to stockholders' equity. Securities and indebtedness of related parties also includes advances and loans to the partnerships and corporations which are principally reported at cost.
Market values of fixed maturity securities are reported based on quoted market prices, where available. Market values of fixed maturity securities not actively traded in a liquid market are estimated using a matrix calculation assuming a spread (based on interest rates and a risk assessment of the bonds) over U. S. Treasury bonds. Market values of the conversion features embedded in convertible fixed maturity securities is estimated using an option-pricing model. Market values of redeemable preferred stocks and equity securities are based on the latest quoted market prices, or for those not readily marketable, generally at values which are representative of the market values of comparable issues.
We use reinsurance to manage certain risks associated with our insurance operations. These reinsurance arrangements provide for greater diversification of business, allow management to control exposure to potential risks arising from large claims and provide additional capacity for growth. For business ceded to other companies, reinsurance recoverable generally consists of the reinsurers share of policyholder liabilities, claims and expenses, net of amounts due the reinsurers for premiums. For business assumed from other companies, reinsurance recoverable generally consists of premium receivable, net of our share of benefits and expenses we owe to the ceding company.
During 2001, we assumed under a coinsurance agreement, 70% of certain equity-indexed annuity contracts issued by American Equity. The call options used to fund the index credits on the equity-indexed annuities are purchased by and maintained on the books of American Equity. We record our proportionate share of the option value supporting the business we reinsure as a reinsurance recoverable. This component of the reinsurance contract is an embedded derivative and we record our share of the returns on the underlying options, net of the amortization of the option costs, in derivative income. See Note 5, "Reinsurance and Policy Provisions," for additional information regarding this reinsurance agreement.
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 factors underlying the guaranteed policy cash values. Reserve interest assumptions are level and range from 2.25% to 6.0%. The average rate of assumed investment yields used in estimating gross margins was 7.69% in 2001, 7.74% in 2000 and 7.83% in 1999. 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. Participating business accounted for 40% of receipts from policyholders during 2001 and represented 16% of life insurance in force at December 31, 2001. Participating business accounted for 38% of receipts from policyholders during 2000 (1999 - 40%) and represented 16% of life insurance in force at December 31, 2000.
The liabilities for future policy benefits for accident and health insurance are computed using a net level (or an equivalent) method, including assumptions as to morbidity, mortality and interest and to include provisions for possible unfavorable deviations. Policy benefit claims are charged to expense in the period that the claims are incurred.
Revenues for interest sensitive, equity-indexed and variable products consist of policy charges for the cost of insurance, administration charges, amortization of policy initiation fees and surrender charges assessed against policyholder account balances. Expenses related to these products include interest or index amounts credited to policyholder account balances, benefit claims incurred in excess of policyholder account balances and amortization of deferred policy acquisition costs.
Other income and other expenses consist primarily of revenue and expenses generated by our various non-insurance subsidiaries for investment advisory, marketing and distribution, and leasing services. They also include revenues and expenses generated by our parent company for management services. Certain of these activities are performed on behalf of affiliates of the Company. In addition, certain revenues generated by our insurance subsidiaries are classified as other income. Revenues of the insurance subsidiaries included as other income aggregated $0.8 million in 2001, $1.2 million in 2000 and $0.6 million in 1999. Lease income from leases with affiliates totaled $5.2 million in 2001, $9.2 million in 2000 and $7.9 million in 1999. Investment advisory fee income from affiliates totaled $1.4 million in 2001, $1.2 million in 2000 and $1.5 million in 1999.
Unrealized gains and losses on our available-for-sale securities are included in accumulated other comprehensive income (loss) in stockholders' equity. Also included in comprehensive income for 2001 is $2.4 million relating to the transfer of our fixed maturity securities classified as held for investment to the available-for-sale category. Other comprehensive income (loss) excludes net investment losses included in net income which represent transfers from unrealized to realized gains and losses. These amounts totaled $10.0 million in 2001, $14.4 million in 2000 and $0.1 million in 1999. These amounts, which have been measured through the date of sale, are net of income taxes and adjustments to deferred policy acquisition costs, value of insurance in force acquired and unearned revenue reserve totaling $7.4 million in 2001, $9.5 million in 2000 and $0.2 million in 1999.
As consideration for the purchase, we issued 3,411,000 shares of Series C cumulative voting mandatorily redeemable preferred stock with an estimated fair value of $80.0 million. Each share of Series C preferred stock has a par value of $26.8404 and voting rights identical to that of Class A common stock. Dividends on the Series C preferred stock are payable quarterly at a rate equal to the regular cash dividends per share of common stock, as defined, then payable. The mandatory redemption is structured so that 49.5% of the Series C preferred stock will be redeemed at par value, or $45.3 million, on January 2, 2004 with the remaining 50.5% redeemed at par value, or $46.3 million, on January 3, 2006. In the event of a change in the control of the Company, at the option of the holder, each share of Series C preferred stock is convertible into one share of Class A common stock or redeemable for cash at par. The Series C preferred stock was issued at an $11.6 million discount to par. This discount accretes to preferred stock dividends during the life of the securities using the effective interest method.
The changes in net unrealized investment gains/losses are recorded net of deferred income taxes and other adjustments for assumed changes in the amortization pattern of deferred policy acquisition costs, value of insurance in force acquired and unearned revenue reserve totaling $49.8 million in 2001, $18.6 million in 2000 and ($64.2) million in 1999.
The carrying value of impaired loans (those loans in which we do not believe we will collect all amounts due according to the contractual terms of the respective loan agreements) was under $0.1 million at December 31, 2001 and 2000.
During 2001, we also recorded an allowance for possible losses against our real estate portfolio totaling $0.8 million. We did not record any real estate allowance during 2000.
Realized losses on fixed maturities totaling $14.5 million in 2001, $18.5 million in 2000 and $5.2 million in 1999 were incurred as a result of writedowns for other than temporary impairment of fixed maturity securities. During the fourth quarter of 2001, realized losses include $8.4 million related to sales and impairments from our ownership in Enron-related securities.
We have a common stock investment in American Equity's parent, American Equity Investment Life Holding Company, valued at $26.7 million at December 31, 2001 and $13.9 million at December 31, 2000. American Equity underwrites and markets life insurance and annuity products throughout the United States. The investment is accounted for using the equity method and is included in the securities and indebtedness of related parties line on the consolidated balance sheets. Due to the timing of the availability of financial information, during 2000 we switched from recording our share of American Equity's results from a current basis to one quarter in arrears. The financial information presented is as of or for the twelve months ended September 30, 2001, the nine months ended September 30, 2000 and the twelve months ended December 31, 1999. The impact of this change on our financial statements was not material. The carrying value of our common stock investment in American Equity Investment Life Holding Company includes goodwill totaling $4.7 million in 2001 and $5.0 million in 2000. In addition to the common stock, during 1999 we acquired $2.3 million in preferred stock issued by American Equity.
Summarized financial information for American Equity Investment Life Holding Company and our common stock ownership percentage is as follows:
We reported equity income (loss), net of tax, from APEX Investment Fund III, an equity investee that operates in the investment company industry, totaling ($1.2) million in 2001, $7.7 million in 2000 and $1.5 million in 1999. Summarized financial information for APEX Investment Fund III is as follows:
No investment in any person or its affiliates (other than bonds issued by agencies of the United States Government) exceeded ten percent of stockholders' equity at December 31, 2001.
in immediate settlement of the instrument. Statement No. 107 also excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements and allows companies to forego the disclosures when those estimates can only be made at excessive cost. Accordingly, the aggregate fair value amounts presented herein are limited by each of these factors and do not purport to represent our underlying value.
REINSURANCE RECOVERABLE: Reinsurance recoverable relating to our portion of the call options used to fund index credits on the equity-indexed annuities assumed from American Equity is reported at fair value. Fair value is determined using quoted market prices. We are not required to estimate fair value for the remainder of the reinsurance recoverable balance.
Furthermore, we participate with various unaffiliated life insurance companies in a reinsurance pool 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 are able to cede catastrophic losses after other reinsurance and a deductible of $0.4 million, subject to a pool cap of $125.0 million per event. We accrued $1.6 million for anticipated losses from this pool resulting from the terrorist acts on September 11, 2001.
In total, insurance premiums and product charges have been reduced by $22.1 million in 2001, $9.5 million in 2000 and $5.3 million in 1999 and insurance benefits have been reduced by $13.7 million in 2001, $6.2 million in 2000 and $2.4 million in 1999 as a result of cession agreements.
Effective May 1, 2001, we entered into a coinsurance agreement with NTL whereby we assumed 90% of NTL's traditional life, universal life and annuity business in force. In addition, we agreed to assume 50% of NTL's traditional life, universal life and annuity business issued after May 1, 2001. We received investments and other assets in consideration for the policy liabilities assumed. Assets and liabilities recorded in connection with this agreement as of May 1, 2001 were as follows (dollars in thousands):
In addition to these reinsurance assumption agreements, we also assume variable annuity business from American Equity and another alliance partner through modified coinsurance arrangements.
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:
At December 31, 2000, we had a $9.9 million note payable to Farm Bureau Mutual Insurance Company (Farm Bureau Mutual), an affiliate. The note had been used to acquire certain assets that were leased to Farm Bureau Mutual and other affiliates. During 2001, this note was paid off, principally by transferring the underlying assets to Farm Bureau Mutual. No gain or loss was recorded on this transaction, as fair value of the assets was equal to book value on the transfer date.
Minority interest in the consolidated balance sheets includes $97.0 million of 5% Preferred Securities issued by FBL Financial Group Capital Trust (the Trust), one of our wholly-owned subsidiaries. FBL Financial Group, Inc. (parent company) issued 5% Subordinated Deferrable Interest Notes, due June 30, 2047 (the Notes) with a principal amount of $100.0 million to support the 5% Preferred Securities. The sole assets of the Trust are and will be the Notes and any interest accrued thereon. The interest payment dates on the Notes correspond to the distribution dates on the 5% Preferred Securities. The 5% Preferred Securities, which have a liquidation value of $1,000.00 per share plus accrued and unpaid distributions, mature simultaneously with the Notes. As of December 31, 2001 and 2000, 97,000 shares of 5% Preferred Securities were outstanding, all of which we unconditionally guarantee.
The 5% Preferred Securities were originally issued to the Iowa Farm Bureau Federation, our majority stockholder. On October 31, 1999, the Iowa Farm Bureau Federation exchanged the 5% Preferred Securities for $97.0 million face amount of 5% trust preferred securities issued by American Equity Investment Life Holding Company. In preparing our consolidated financial statements, we do not eliminate our portion of the 5% Preferred Securities owned by the equity investee since the terms of the preferred securities issued by the equity investee are substantially similar to the terms of the 5% Preferred Securities.
The Iowa Farm Bureau Federation owns our Series B preferred stock. Each share of Series B preferred stock has a liquidation preference of $0.60 and voting rights identical to that of Class A common stock with the exception that each Series B share is entitled to two votes while each Class A share is entitled to one vote. The Series B preferred stock pays cumulative annual cash dividends of $0.03 per share, payable quarterly, and is redeemable by us, at our option, at $0.60 per share plus unpaid dividends if the stock ceases to be beneficially owned by a Farm Bureau organization.
We repurchased 5,900 shares in 2001, 4,358,397 shares in 2000 and 1,322,920 shares in 1999 of Class A common stock in accordance with repurchase plans and a tender offer approved by our Board of Directors. The cost of the repurchases totaled $0.1 million in 2001, $85.8 million in 2000 and $25.7 million in 1999. Of the shares repurchased in 2000, 2,974,735 were unregistered shares owned by various Farm Bureau entities. The purchase amounts were allocated partly to Class A common stock based on the average common stock balance per share on the acquisition dates with the remainder allocated to retained earnings.
We participate with several affiliates in various defined benefit plans covering substantially all of our employees. The benefits of these plans are based primarily on years of service and employees' compensation. Net periodic pension cost of the plans is allocated between participants generally on a basis of time incurred by the respective employees for each employer. Such allocations are reviewed annually. Pension expense aggregated $5.3 million in 2001, $5.2 million in 2000 and $4.5 million in 1999.
We have a 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. 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, up to ten years. Option shares granted to officers and employees have a contractual term of 10 years and generally vest over a period up to five years, contingent upon continued employment with us.
At December 31, 2001, shares of Class A common stock available for grant as additional awards under the Plan totaled 807,907.
We apply Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" (APB 25), and related Interpretations in accounting for our stock options. No compensation expense is recognized under APB 25 for stock options granted because the exercise price of our stock options equals the market price of the underlying stock on the date of grant. Under the alternative accounting method provided by Statement No. 123, compensation expense is recognized in an amount equal to the estimated fair value of stock options on the date of grant. We have not adopted the accounting provisions of Statement No. 123 because the valuation of non-traded stock options is highly subjective and, in management's opinion, the existing pricing models do not necessarily provide a reliable single measure of the fair value of our options.
The fair value for these options was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted-average assumptions:
The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Our employee stock options have characteristics significantly different from those of traded options and the subjective input assumptions can materially affect the fair value estimate produced by the Black-Scholes option valuation model.
We have management agreements with NTL, Farm Bureau Mutual and other affiliates under which we provide general business, administrative and management services. Fee income for these services totaled $2.0 million in 2001, $1.1 million in 2000 and $0.8 million in 1999. In addition, Farm Bureau Management Corporation, a wholly-owned subsidiary of the Iowa Farm Bureau Federation, provides certain management services to us under a separate arrangement. We incurred related expenses totaling $0.7 million in 2001, $0.9 million in 2000 and $0.5 million in 1999.
We have administrative services agreements with American Equity under which we provide underwriting, claims processing, accounting, compliance and other administrative services primarily relating to certain variable insurance products underwritten by them. Fee income from performing these services totaled $0.3 million in 2001, 2000 and 1999.
Effective January 1, 2001, we switched our insurance coverage for employee health and welfare claims from indemnity insurance primarily to self-insurance. However, claims in excess of self-insurance levels 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.
Based upon the provisions of the underlying agreement and the application of the "two class" method to our capital structure, we have not allocated any undistributed net income to the Class C preferred stock since their participation in dividends with the common stockholders is limited to the amount of the annual regular dividend.
Options to purchase 133,475 shares of common stock in 2001 at $17.13 to $24.25 per share were granted during 1997, 1998, 1999, 2000 and 2001 but were not included in the computation of 2001 diluted earnings per share because the options' exercise price was greater than the average market price of common shares during 2001. The options, which expire in 2007 through 2011, were still outstanding at December 31, 2001.
Options to purchase 56,534 shares of common stock in 1999 at $19.81 to $24.25 per share were granted during 1997, 1998 and 1999 but were not included in the computation of 1999 diluted earnings per share because the options' exercise price was greater than the average market price of common shares during 1999. The options, which expire in 2007 through 2009, were still outstanding at December 31, 1999.
The financial statements of the Life Companies included herein differ from related statutory-basis financial statements principally as follows: (a) the bond portfolio is segregated into held-for-investment (carried at amortized cost) and available-for-sale (carried at fair value) classifications rather than generally being carried at amortized cost; (b) acquisition costs of acquiring new business are deferred and amortized over the life of the policies rather than charged to operations as incurred; (c) future policy benefit reserves for participating traditional life insurance products are based on net level premium methods and guaranteed cash value assumptions which may differ from statutory reserves; (d) future policy benefit reserves on certain interest sensitive products are based on full account values, rather than discounting methodologies utilizing statutory interest rates; (e) net realized gains or losses attributed to changes in the level of market interest rates are recognized as gains or losses in the statements of income when the sale is completed rather than deferred and amortized over the remaining life of the fixed maturity security or mortgage loan; (f) the established formula-determined statutory investment reserve, changes in which are charged directly to surplus, is not recorded as a liability; (g) certain deferred income tax assets, agents' balances and certain other assets designated as "non-admitted assets" for statutory purposes are reported as assets rather than being charged to surplus; (h) revenues for interest sensitive and variable products consist of policy charges for the cost of insurance, policy administration charges, amortization of policy initiation fees and surrender charges assessed rather than premiums received; (i) pension income or expense is recognized for all employees in accordance with Statement No. 87, "Employers' Accounting for Pensions" rather than for vested employees only; (j) the financial statements of subsidiaries are consolidated with those of the insurance subsidiary; and (k) assets and liabilities are restated to fair values when a change in ownership occurs that is accounted for as a purchase, with provisions for goodwill and other intangible assets, rather than continuing to be presented at historical cost.
Net income (loss) of the Life Companies, as determined in accordance with statutory accounting practices, was ($8.8) million in 2001, $28.9 million in 2000 and $40.4 million in 1999. The net loss for 2001 is primarily attributable to the payment of ceding commissions on the NTL and American Equity coinsurance transactions. Statutory net gain from operations for the life insurance subsidiaries, which excludes realized gains and losses, totaled $5.7 million in 2001, $49.8 million in 2000 and $41.2 million in 1999. Statutory capital and surplus, after appropriate elimination of intercompany accounts, totaled $378.2 million at December 31, 2001 and $311.9 million at December 31, 2000. Statutory capital and surplus decreased $1.3 million during 2001 due to the adoption of accounting changes resulting from the codification of statutory accounting principles.
The ability of Farm Bureau Life to pay dividends to the parent company is restricted because prior approval of the Iowa insurance commissioner is required for payment of dividends to the stockholder which exceed an annual limitation. During 2002, Farm Bureau Life could pay dividends to the parent company of approximately $37.8 million without prior approval of insurance regulatory authorities.
The traditional and universal life insurance segment consists of whole life, term life and universal life policies. These policies provide benefits upon the death of the insured and may also allow the customer to build cash value on a tax-deferred basis.
Financial information concerning our operating segments is as follows. Information for the years 2000 and 1999 has been restated to conform to the new segment presentation.
Net statutory premiums collected, which include premiums collected from annuities and universal life-type products that are not included in revenues for GAAP reporting, totaled $672.1 million in 2001. Total premiums collected include $280.0 million assumed from American Equity, $13.3 million assumed from NTL and $378.7 million written in our core Farm Bureau marketing territory or through a variable alliance partner. Excluding reinsurance assumed, our total life and annuity collected premiums for 2001 are concentrated in the following core Farm Bureau distribution states - Iowa (29%), Kansas (22%) and Oklahoma (9%).
Earnings per common share for each quarter is computed independently of earnings per common share for the year. As a result, the sum of the quarterly earnings per common share amounts may not equal the earnings per common share for the year due primarily to transactions affecting the number of weighted average common shares outstanding in each quarter. Derivative income (loss) was classified with net investment income in the Form 10-Q filings for the first three quarters of 2001.