Our principal operations are conducted from property leased from a subsidiary of the Iowa Farm Bureau Federation under a 15 year operating lease that expires in 2013. The property leased currently consists of approximately 180,000 square feet of a 400,000 square foot office building in West Des Moines, Iowa. We also lease 22,000 square feet of an office building in Manhattan, Kansas under an annually renewable operating lease. The office space used in these buildings is shared with affiliates and the square feet disclosed is the amount of space allocated to us. The amount of space allocated to us is determined annually. We consider the current facilities to be adequate for the foreseeable future.
Amounts are impacted by unrealized gains (losses) on investments, net of deferred income taxes and other adjustments for assumed changes in the amortization of deferred policy acquisition costs, value of insurance in force acquired and unearned revenue reserves, totaling $95.1 million in 2002, $39.4 million in 2001, ($22.4) million in 2000, ($49.9) million in 1999 and $50.1 million in 1998.
Statutory data has been derived from the annual statements of our insurance subsidiaries, as filed with insurance regulatory authorities and prepared in accordance with statutory accounting practices.
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 1,990 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 three 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 American Equity Investment Life Insurance Company (American Equity) and National Travelers Life Company (NTL). 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 three Farm Bureau affiliated property-casualty insurance companies.
In accordance with accounting principles generally accepted in the United States (GAAP), premiums and considerations received for equity-indexed products and interest sensitive products such as universal life insurance and ordinary annuities are reflected as increases in liabilities for policyholder account balances and not as revenues. Revenues reported for these 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. Surrender benefits paid relating to these products are reflected as decreases in liabilities for policyholder account balances and not as expenses. The Life Companies receive investment income earned from the funds deposited into account balances, a portion of which is passed through to the policyholders in the form of interest credited. For equity-indexed products, proceeds from call options are earned from a portion of the funds deposited, which are passed through to the contract holders in the form of index credits. Index credits and interest credited to policyholder account balances and benefit claims in excess of policyholder account balances are reported as expenses in the consolidated financial statements.
Death and other policyholder benefits reflect exposure to mortality risk and fluctuate from year to year based on the level of claims incurred under insurance retention limits. The profitability of the Life Companies is primarily affected by fluctuations in mortality, other policyholder benefits, expense levels, interest spreads (i.e., the difference between interest earned on investments and interest credited to policyholders) and persistency. We have the ability to mitigate adverse experience through adjustments to credited interest rates, policyholder dividends or cost of insurance charges.
Fair values are principally estimated using a matrix calculation assuming a spread over U. S. Treasury bonds. The spread is based on current interest rates, risk assessment of the bonds and the current market environment.
Amortization of deferred policy acquisition costs for participating life insurance and interest sensitive products is dependent upon estimates of current and future gross profits or margins on this business. Key assumptions used include the following:
Reserves for future policy benefits for traditional life insurance products requires the use of many assumptions, including the duration of the policies, mortality experience, lapse rates, surrender rates, and dividend crediting rates.
These assumptions are made based upon historical experience, industry standards and a best estimate of future results and, for traditional life products, include a provision for adverse deviation. For traditional life insurance, once established for a particular series of products, these assumptions are generally held constant. For equity-indexed products, these assumptions are revised at each balance sheet date.
The determination of net periodic pension expense and related accrued/prepaid pension cost requires the use of estimates as to the expected return on plan assets, discount rate on plan liabilities and other actuarial assumptions. Pension expense for 2002 totaled $4.4 million.
A 50 basis point decrease in the expected return on assets would result in a $0.2 million increase in pension expense. A 50 basis point decrease in the assumed discount rate would result in a $0.2 million increase in pension expense. A 50 basis point increase in these rates would result in a decrease to expense at a level generally commensurate with that noted above.
Effective January 1, 2001, we acquired the assets and liabilities of Kansas Farm Bureau Life Insurance Company, Inc. (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 in Kansas totaled $124.6 million in 2002 and $77.3 million in 2001.
Net income applicable to common stock increased 26.8% in 2002 to $46.3 million and decreased 6.8% in 2001 to $36.5 million. The increase in net income for 2002 is due to an increase in the volume of business in force resulting from the inclusion of a full year of business from American Equity and NTL, as well as increases in sales from our core distribution agency force. Results in 2002 also benefited from an acceleration of net discount accretion on mortgage and asset-backed securities resulting from increasing prepayment speed assumptions. 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. The change in earnings per common share from year to year is impacted by changes in the weighted average common shares outstanding. Weighted average common shares outstanding, assuming dilution, increased 1.1% to 28,168,508 in 2002 and decreased 9.5% to 27,867,140 in 2001 from 30,799,891 in 2000. The decrease in 2001 is the result of acquisitions of common stock by the Company primarily during 2000.
Premiums and product charges increased 6.6% in 2002 to $201.0 million and 23.0% in 2001 to $188.5 million. The increase in 2002 is due primarily to the inclusion of a full year of American Equity and NTL activity. Revenues from the American Equity and NTL business included interest sensitive product charges totaling $11.9 million in 2002 and $6.9 million in 2001 and traditional life insurance premiums totaling $5.1 million in 2002 and $3.8 million in 2001. In addition, the 2002 cost of insurance charges, which are included in interest sensitive product charges, increased as a result of an increase in the volume and age of business in force. The 2001 increase in premiums and product charges is due primarily to the addition of the Kansas Farm Bureau Life, NTL and American Equity business. Revenues from the Kansas Farm Bureau Life business in 2001 included interest sensitive product charges of $1.4 million, traditional life insurance premiums of $25.0 million and accident and health premiums of $2.7 million. Accident and health premiums decreased as a result of 100% coinsurance agreements to reinsure our individual long-term disability income business effective September 1, 2001 and 2000.
Net investment income, which excludes investment income on separate account assets relating to variable products, increased 22.2% in 2002 to $348.4 million and increased 28.8% in 2001 to $285.1 million. These increases are due to an increase in average invested assets of 25.8% to $4,845.3 million (based on securities at amortized cost) compared to $3,850.2 million in 2001 and $2,991.3 million in 2000. The increase in average invested assets in 2002 and 2001 is due to cash and investments received pursuant to the American Equity and NTL coinsurance agreements and net premium inflows from our core distribution agency force. Average invested assets also increased in 2001 due to the acquisition of approximately $620.9 million in investments from the Kansas Farm Bureau Life transaction. The annualized yield earned on average invested assets was 7.19% in 2002 and 7.40% in 2001 and
Policy benefits increased 14.2% in 2002 to $346.1 million and 30.6% in 2001 to $303.0 million. The increase in 2002 is due primarily to the inclusion of a full year of American Equity and NTL business and an increase in our direct business in force. Benefits incurred from the American Equity and NTL business include interest sensitive product benefits of $50.6 million in 2002 and $17.2 million in 2001, traditional life insurance and accident and health benefits, including change in reserves, of $4.3 million in 2002 and $3.1 million in 2001 and distributions to participating policyholders of $1.2 million in 2002 and $0.8 million in 2001. Partially offsetting the increase in
2002 was the impact of reductions in dividend and interest crediting rates on many of our products made in response to a declining investment portfolio yield. Interest crediting rates were decreased at various dates throughout the year to 5.20% on our primary fixed annuity product and 5.55% on our primary universal life insurance product. The dividend rate on our participating life policies was also reduced effective October 1, 2002. The increase in policy benefits during 2002 was also offset by a $1.3 million reduction in reserves relating to the discontinuation of certain group life business. Changes in the value of the embedded derivatives included in the equity-indexed annuity contracts resulted in an increase in the reserve for interest sensitive products totaling $1.0 million for 2002 and $1.2 million for 2001. The increase in policy benefits in 2001 is due primarily to the addition of the Kansas Farm Bureau Life, NTL and American Equity business. Benefits incurred from the Kansas Farm Bureau Life business in 2001 included interest sensitive product benefits of $24.2 million, traditional life insurance and accident and health benefits, including change in reserves, of $26.4 million and distributions to participating policyholders of $3.4 million. Traditional life benefits also increased in 2001 due to increased death benefits on our direct business and our participation in a reinsurance pool for catastrophic events. We incurred $1.6 million of death benefits in 2001 for losses from this pool resulting from the terrorist attacks on September 11, 2001. Partially offsetting these increases was a decrease in accident and health benefits as a result of the 100% coinsurance of our long-term disability income business during 2001 and 2000. Policy benefits can tend to fluctuate from period to period as a result of changes in mortality and morbidity experience.
Underwriting, acquisition and insurance expenses increased 10.8% in 2002 to $102.4 million and 26.8% in 2001 to $92.5 million. The increase in 2002 is due primarily to the inclusion of a full year of American Equity and NTL business, while the increase in 2001 is due primarily to the addition of Kansas Farm Bureau Life, NTL and American Equity business. Expenses from NTL and American Equity business include commission and expense allowances totaling $4.1 million for 2002 compared to $2.2 million for 2001 and amortization of deferred policy acquisition costs totaling $7.6 million for 2002 compared to $0.6 million for 2001. Underwriting, acquisition and insurance expenses relating to the Kansas Farm Bureau Life business totaled $13.0 million in 2001. The increases in 2002 are offset by (i) a $2.0 million decrease in amortization of value of insurance in force acquired resulting principally from the impact of realized losses on investments backing the related policyholder liabilities, (ii) a reduction in other underwriting expense due to the discontinuation of the amortization of goodwill and (iii) a reduction in expenses as a result of the 100% coinsurance of our long-term disability income business during 2001. The 2001 increase in expenses 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. Other underwriting, acquisition and insurance expenses includes goodwill amortization totaling $0.9 million in 2001 and $0.7 million in 2000. See Note 1 to the consolidated financial statements for a discussion of the accounting for goodwill amortization beginning in 2002.
Interest expense decreased 61.5% in 2002 to $0.7 million and decreased 51.4% in 2001 to $1.8 million. The decreases in 2002 and 2001 are due to a decrease in the interest rate on our $40.0 million variable-rate debt. In addition, for 2001 there was as a decrease in average debt outstanding.
We analyze our segment results based on pre-tax operating income. Accordingly, income taxes are not allocated to the segments. In addition, operating results are analyzed net of any transactions between the segments. Operating income represents net income excluding the impact of realized gains and losses on investments, cumulative effect of change in accounting principle and discontinued operations. The impact of realized gains and losses on investments includes adjustments for income taxes and that portion of amortization of deferred policy acquisition costs, unearned revenue reserve and value of insurance in force acquired attributable to such gains or losses. A reconciliation of net income to pre-tax operating income follows.
2002 in response to a decline in our investment portfolio yield. The crediting rate on our flexible premium deferred annuity was also reduced 40 basis points during 2001 as a result of the general decline in market interest rates during 2001.
Pre-tax operating income for the traditional and universal life insurance segment increased 21.0% in 2002 to $61.0 million and 13.9% in 2001 to $50.4 million. Revenues, benefits, expenses and pre-tax operating income for 2002 increased due principally to the inclusion of a full year of NTL business and increases in the volume of business from our core distribution agency force. The increase in pre-tax income and the volume of business in force in 2001 is due primarily to the addition of the Kansas Farm Bureau Life and NTL business. Life insurance premiums collected from the NTL business totaled $16.0 million in 2002 and $11.5 million in 2001. Life insurance premiums received as a result of the Kansas Farm Bureau Life acquisition totaled $25.9 million in 2001. As noted in the discussion of policy benefits above, pre-tax operating income in 2002 benefited from a $1.3 million reserve reduction relating to the discontinuation of certain group life business. Total benefits and expenses were also impacted by decreases in interest and dividend crediting rates, including decreases of 30 basis points in 2002 and 25 basis points in 2001 on our primary universal life insurance product. Benefits for 2001 include $1.6 million in losses resulting from the terrorist attacks on September 11, 2001. Also, amortization of deferred policy acquisition costs decreased by $4.2 million in 2002 and increased $1.4 million in 2001 due to changes in the assumptions used to calculate deferred policy acquisition costs. On a consolidated basis the impact of these assumption changes was largely offset by the impact of assumption changes made in the amortization of deferred policy acquisition costs in the variable segment.
Our total investment portfolio increased 25.3% to $5,387.4 million at December 31, 2002 compared to $4,300.9 million at December 31, 2001. This increase is primarily the result of net cash received from interest sensitive and equity-indexed products and positive cash flow provided by operating activities.
As of December 31, 2002, 94.9% (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. We regularly review the percentage of our portfolio that is invested in non-investment grade debt securities (NAIC designations 3 through 6). As of December 31, 2002, the investment in non-investment grade debt was 5.1% of fixed maturity securities. At that time no single non-investment grade holding exceeded 0.2% of total investments. A summary of the gross unrealized gains and gross unrealized losses on our fixed maturity securities, by internal industry classification, as of December 31, 2002 is as follows:
Private placement securities are generally rated by the Securities Valuation Office of the NAIC. Comparisons between NAIC designations and S & P ratings are published by the NAIC. S & P has not rated some of the fixed maturity securities in our portfolio.
As of December 31, 2002, $26.4 million or 48.7%, of the gross unrealized losses on our fixed maturity securities are rated investment grade. Unrealized losses on investment grade securities principally relate to changes in market interest rates or changes in credit spreads since the securities were acquired. Any such unrealized losses are recognized in income if, and when, we decide to sell the securities.
The return of principal on mortgage and other asset-backed securities occurs more frequently and is more variable than that of more traditional fixed maturity securities. The principal prepayment speeds (e.g., the rate of individuals refinancing their home mortgages) can vary based on a number of economic factors that can not be predicted with certainty. These factors include the prevailing interest rate environment and general status of the economy. Deviations in actual prepayment speeds from that originally expected can cause a change in the yield earned on mortgage and asset-backed securities purchased at a premium or discount. Increases in prepayment speeds, which typically occur in a decreasing interest rate environment, generally increase the rate at which discount is accrued and premium is amortized into income. Decreases in prepayment speeds, which typically occur in an increasing interest rate environment, generally slow down the rate these amounts are recorded into income.
The following table sets forth the amortized cost, par value and carrying value of our mortgage and asset-backed securities at December 31, 2002, summarized by type of security.
At December 31, 2002, we held $21.5 million or 0.4% of invested assets in equity securities. At December 31, 2002, gross unrealized gains totaled $0.7 million and gross unrealized losses totaled $1.4 million on these securities.
Deferred policy acquisition costs increased 30.2% to $468.8 million at December 31, 2002 due to the capitalization of costs incurred with new sales, principally from the American Equity coinsurance agreement. Assets held in separate accounts decreased 2.4% to $347.7 million at December 31, 2002 due primarily to fluctuations in market value, partially offset by the transfer of net premiums to the separate accounts. At December 31, 2002, we had total assets of $6,799.5 million, a 20.8% increase from total assets at December 31, 2001.
Policy liabilities and accruals and other policyholders’ funds increased 27.1% to $5,318.3 million at December 31, 2002 primarily due to the addition of the American Equity business and growth in the volume of business in force from our core distribution system. We reclassified our $40.0 million debt from long-term to short-term as the debt is due September 17, 2003. Deferred income taxes increased 69.7% to $101.2 million at December 31, 2002 due primarily to an increase in deferred taxes on the change in unrealized appreciation/depreciation on fixed maturity securities. Other liabilities decreased 38.6% to $147.5 million at December 31, 2002 due primarily to a decrease in payables for security purchases. At December 31, 2002, we had total liabilities of $5,955.4 million, a 21.9% increase from total liabilities at December 31, 2001.
Our variable annuity contracts contain a guaranteed minimum death benefit (GMDB) rider. For a majority of our contracts, the GMDB provides for a return of the contract holder’s premiums deposited into the contract, net of partial withdrawals, upon the contract holder’s death. Our exposure to the GMDBs (GMDB exceeds account value), net of reinsurance ceded, totaled $43.7 million at December 31, 2002 and $17.2 million at December 31, 2001. Reserves for this benefit, which take into account the probability of death before the account value increases to an amount equal to or greater than the GMDB, totaled $0.5 million at December 31, 2002 and $0.2 million at December 31, 2001.
Series C redeemable preferred stock increased 3.4% to $85.5 million at December 31, 2002 from $82.7 million at December 31, 2001. This increase represents the accretion of the discount on these securities. The Series C redeemable preferred stock was issued at an $11.6 million discount. The mandatory redemption is structured so that
For a substantial portion of business assumed from NTL and American Equity, NTL and American Equity, respectively, have the ability to adjust interest and dividend crediting rates in reaction to portfolio yield. While we are precluded from directly controlling these rates, we do manage certain aspects of NTL through a management agreement and have a representative on American Equity’s Board of Directors. Most of the traditional annuity and universal life insurance contracts assumed from American Equity and NTL have guaranteed minimum crediting rates. For contracts assumed from American Equity, these rates range from 3.00% to 4.00%, with a weighted average crediting rate of 3.13% at December 31, 2002. For contracts assumed from NTL, these rates range from 3.00% to 4.00% with a weighted average crediting rate of 3.68% at December 31, 2002. At December 31, 2002, none of the contracts assumed from American Equity or NTL were receiving interest credited at a rate within 50 basis points of the applicable guaranteed rate.
For the equity-indexed products, we purchase, indirectly through American Equity, call options that are designed to match the return owed to contract holders who elect to participate in one or more market indexes. In 2002, proceeds from the maturity of call options totaled $3.8 million while related index amounts credited to contract holders’ account balances totaled $4.2 million. Profitability on the portion of the equity-indexed products tied to market indexes is significantly impacted by the spread on interest earned on investments and the sum of (1) cost of underlying call options purchased to match the returns owed to contract holders and (2) minimum interest guarantees owed to the contract holder, if any. American Equity manages the cost of the call options through the terms of the equity-indexed annuities, which permit adjustments to annual participation rates, asset fees, and/or caps, subject to guaranteed minimums. The minimum guaranteed contract values are equal to 80% to 100% of the premium collected plus interest credited at a cumulative annual rate of 3.00%. Profitability on the equity-indexed annuities in any given year is also impacted by changes in the fair value of the embedded option which provides the contract holder the right to participate in market index returns after the next anniversary date of the contract. This impacts profitability because we only purchase one-year call options, through American Equity, to fund the returns owed to the contract holders at the inception of each contract year. This practice matches well with the contract holders’ rights to switch to different indexes on each anniversary date. The value of the forward starting options embedded in the equity-indexed annuities can fluctuate with changes in assumptions as to future volatility of the market indexes, risk free interest rates, market returns and the lives of the contracts.
approximate percentage change in the market value of a portfolio when interest rates change by 100 basis points. This measure includes the impact of estimated changes in portfolio cash flows from features such as bond calls and prepayments. When the estimated durations of assets and liabilities are similar, exposure to interest rate risk is reduced because a change in the value of assets should be largely offset by a change in the value of liabilities. The effective duration of our fixed maturity portfolio was approximately 4.1 at December 31, 2002 and 5.1 at December 31, 2001. The effective duration of the interest sensitive products was approximately 4.4 at December 31, 2002 and 4.1 at December 31, 2001.
Equity price risk is not material to us due to the relatively small equity portfolio held at December 31, 2002. However, we do earn investment management fees (on those investments managed by us) and mortality and expense fee income based on the value of our separate accounts. On an annualized basis, the investment management fee rates range from 0.20% to 0.45% for 2002, 2001 and 2000. The mortality and expense fee rates range from 0.90% to 1.40% for 2002, 2001 and 2000. As a result, revenues from these sources do fluctuate with changes in the market value of the equity, fixed maturity and other securities held by the separate accounts. In addition, we have equity price risk to the extent we may owe amounts under the guaranteed minimum death benefit provisions of our variable annuity contracts. See “Financial Condition-Liabilities and Redeemable Preferred Stock” for discussion of this exposure.
(1.37% at December 31, 2002). Fixed maturity securities with a carrying value of $46.8 million are on deposit with the FHLB as collateral for the note. It is management’s intention to refinance this note when it matures. 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 as of December 31, 2002.
We anticipate that funds to meet our short-term and long-term capital expenditures, cash dividends to stockholders and operating cash needs will come from existing capital and internally generated funds. We believe 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 and asset-backed securities, mortgage loans and our insurance products, are adequate to meet our anticipated cash obligations for the foreseeable future. Our investment portfolio at December 31, 2002, included $50.9 million of short-term investments and $659.6 million in carrying value of U.S. Government and U.S. Government agency backed securities that could be readily converted to cash at or near carrying value. In addition, our cash balance at December 31, 2002 totaled $263.0 million.
five year vesting period of the underlying options as options issued before the date of adopting Statement No. 123 will continue to be accounted for under APB No. 25.
In November 2002, the FASB issued FASB Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others.” Interpretation No. 45 requires that a guarantor recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. The recognition provisions of this Interpretation are applicable to guarantees issued or modified after December 31, 2002. We do not anticipate that we will enter into any guarantees that would require recognition as a liability, and accordingly, do not expect the impact of this Interpretation to be material to our financial statements.
In January 2003, the FASB issued FASB Interpretation No. 46, “Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51.” Interpretation No. 46 establishes a variable interests model to follow when determining whether or not to consolidate an entity that is not evaluated for consolidation under the traditional voting interests model. This Interpretation generally requires that a company (investee) being evaluated under the variable interests model must be consolidated if (a) the investor has decision making powers over the entity - that is, the ability to buy and sell assets or conduct operations or (b) the investor is exposed to the majority of the risks or rewards of the entity. In addition, the Interpretation requires that investments made by related parties be analyzed together in applying the variable interests model. The disclosure provisions of this Interpretation are effective for financial statements issued after January 31, 2003. The consolidation provisions are effective for new transactions entered into after January 31, 2003 and for pre-existing entities as of July 1, 2003. We have one investment in a storage facility, jointly owned with an affiliate, which will be consolidated under this Interpretation. At December 31, 2002, this company, which is currently being accounted for using the equity method, had total assets and total liabilities of less than $10.0 million.
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,
These derivatives are described more fully in Note 1 of the notes to the consolidated financial statements under the captions “Investments-Fixed Maturities and Equity Securities,” “Reinsurance Recoverable” and “Future Policy Benefits.”
In addition to the embedded derivatives noted above, we have modified coinsurance arrangements on certain variable annuity and variable life insurance business under which the ceding company withholds funds. These assets support the portion of the contract holder’s funds allocated to the variable contract’s declared interest option. The investment return earned by the assuming company is based on a referenced pool of fixed maturity securities held by the ceding company. Currently, there are varying interpretations as to whether or not these funds withheld arrangements give rise to an embedded derivative to be accounted for separate from the debt host. For accounting purposes, we do not treat these funds withheld arrangements as containing an embedded derivative. It is anticipated that the FASB will provide guidance on this issue during 2003. If it is determined that our modified coinsurance agreements contain an embedded derivative, we will be required to estimate the fair value of the embedded derivatives at each balance sheet date and changes in the fair values of the derivatives will be recorded as income or expense. At December 31, 2002, funds withheld on variable business assumed by us totaled $4.4 million and funds withheld on variable business ceded by us totaled $3.1 million. We have not quantified the impact on our financial statements if we accounted for our modified coinsurance contracts as having an embedded derivative. However, the impact is not expected to be material due to the relatively small balances of funds withheld.
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,
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,
We have audited the accompanying consolidated balance sheets of FBL Financial Group, Inc. as of December 31, 2002 and 2001, 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, 2002. 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, 2002 and 2001, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2002, in conformity with accounting principles generally accepted in the United States.
As discussed in the “Goodwill” section that follows, effective January 1, 2002 we changed our method of accounting for goodwill.
Effective January 1, 2001, we adopted 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 allowed 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.
the rights of an equity-indexed annuity contract holder to participate in the index returns available under the contract are considered embedded derivatives, and
our reinsurance recoverable as it relates to call options purchased to fund returns to equity-indexed annuity contract holders is considered an embedded derivative.
Upon the adoption of Statement No. 133, we transferred our fixed maturity securities classified as held for investment, formerly recorded at amortized cost, 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 policy 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.
In addition to the embedded derivatives noted above, we have modified coinsurance arrangements on certain variable annuity and variable life insurance business under which the ceding company withholds funds. The funds withheld pertain to the portion of the contract holder’s funds allocated to the variable contract’s declared interest option. The investment return earned by the assuming company is based on a referenced pool of fixed maturity securities held by the ceding company. Currently, there are varying interpretations as to whether or not these funds withheld arrangements give rise to an embedded derivative to be accounted for separate from the debt host. For accounting purposes, we do not treat these funds withheld arrangements as containing an embedded derivative. It is anticipated that the FASB will provide guidance on this issue during 2003. If it is determined that our modified coinsurance agreements contain embedded derivatives, we will be required to estimate the fair value of the embedded derivatives at each balance sheet date and changes in the fair values of the derivatives will be recorded as income or expense. At December 31, 2002, funds withheld on variable business assumed by us totaled $4.4 million and funds withheld on variable business ceded by us totaled $3.1 million. We have not quantified the impact on our
Equity securities, comprised of common and non-redeemable preferred stocks, are reported at market value. The change in unrealized appreciation and depreciation of equity securities is included directly in stockholders’ equity, net of any related deferred income taxes, as a component of accumulated other comprehensive income or loss.
Investment real estate is reported at cost less allowances for depreciation. Real estate acquired through foreclosure, which is included with investment real estate in our consolidated balance sheets, is recorded at the lower of cost (which includes the balance of the mortgage loan, any accrued interest and any costs incurred to obtain title to the property) or estimated fair value on the foreclosure date. The carrying value of these assets is subject to regular review. If the fair value, less estimated sales costs, of real estate owned decreases to an amount lower than its carrying value, the carrying value of the real estate is reduced by the establishment of a valuation allowance, changes to which are recognized as realized gains or losses on investments.
Other long-term investments include investment deposits and other miscellaneous investments which are reported at amortized cost and securities held by subsidiaries engaged in the broker-dealer industry. In accordance with accounting practices for the broker-dealer industry, marketable securities held by subsidiaries in this industry are valued at market value. The resulting difference between cost and market is included in the consolidated statements of income as net investment income. Realized gains and losses are also reported as a component of net investment income.
During 2002 and 2001, we assumed under a coinsurance agreement, 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 reinsurance recoverable on the consolidated balance sheets. This component of the reinsurance contract is an embedded derivative and we record our share of the call options at market value. Our share of the call options totaled $17.2 million at December 31, 2002 and $9.0 million at December 31, 2001. Changes in market value of the call options, as well as option proceeds, are included as a component of derivative income (loss) on our consolidated statements of income. See Note 4, “Acquisition, Reinsurance and Policy Provisions,” for additional information regarding this reinsurance agreement.
Deferred policy acquisition costs includes certain costs of acquiring new insurance business, principally commissions, first-year bonus interest and other expenses related to the production of new business, to the extent recoverable from future policy revenues and gross profits. 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 a weighted average rate of 5.78%.
We had undiscounted reserves of $0.1 million at December 31, 2002 and $0.2 million at December 31, 2001 to cover estimated future assessments on known insolvencies. We had assets totaling $0.7 million at December 31, 2002 and $1.0 million at December 31, 2001 representing estimated premium tax offsets on paid and future assessments. Expenses (credits) incurred for guaranty fund assessments, net of related premium tax offsets, totaled ($0.1) million in 2002, $0.2 million in 2001 and ($0.1) million in 2000. It is anticipated that estimated future guaranty fund assessments on known insolvencies will be paid during 2003 and substantially all the related future premium tax offsets will be realized during the six year period ending December 31, 2008. We believe the reserve for guaranty fund assessments is sufficient to provide for future assessments based upon known insolvencies and projected premium levels.
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, changes in the reserves for the embedded derivatives in the equity-indexed annuities, benefit claims incurred in excess of policyholder account balances and amortization of deferred policy acquisition costs.
We apply Accounting Principles Board Opinion (APB) No. 25, “Accounting for Stock Issued to Employees,” and related Interpretations in accounting for our stock options. No compensation expense is recognized under APB No. 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. As described in “Accounting Changes,” beginning January 1, 2003, we will expense the cost of stock options granted in accordance with Statement No. 123. Under Statement No. 123, compensation expense is recognized as options vest in an amount equal to the estimated fair value of the options on the date of grant.
The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options that 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.
Unrealized gains and losses on our available-for-sale securities are included in accumulated other comprehensive income 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 excludes net investment losses included in net income which represent transfers from unrealized to realized gains and losses. These amounts totaled $7.0 million in 2002, $10.0 million in 2001 and $14.4 million in 2000. 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 $5.9 million in 2002, $7.4 million in 2001 and $9.5 million in 2000.
The preparation of financial statements in conformity with accounting principles generally accepted in the United States (GAAP) requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and the disclosure of contingent assets and liabilities. For example, significant
Net unrealized investment gains on equity securities and fixed maturity securities classified as available for sale, recorded directly to stockholders’ equity, were comprised of the following:
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 $68.4 million in 2002, $49.8 million in 2001 and $18.6 million in 2000.
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, 2002 and 2001.
Realized losses on fixed maturities totaling $26.9 million in 2002, $14.5 million in 2001 and $18.5 million in 2000 were incurred as a result of writedowns for other than temporary impairment of fixed maturity securities. Approximately $8.5 million of the realized losses in 2002 were from securities issued by or affiliated with WorldCom Inc., including $1.9 million of losses assumed from a variable alliance partner. Realized losses in 2002 also include $7.8 million from United Air Lines securities. Realized losses in 2001 include $8.4 million related to sales and impairments from our ownership in Enron-related securities.
We reported equity income (loss), net of tax, from APEX Investment Fund III, an equity investee that operates in the investment company industry, totaling ($0.6) million in 2002, ($1.2) million in 2001 and $7.7 million in 2000. Summarized financial information for APEX Investment Fund III is as follows:
At December 31, 2002, affidavits of deposits covering investments with a carrying value totaling $5,160.2 million were on deposit with state agencies to meet regulatory requirements.
At December 31, 2002, we had committed to provide additional funding for mortgage loans on real estate aggregating $54.1 million. These commitments arose in the normal course of business at terms that are comparable to similar investments.
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, 2002.
Future policy benefits and other policyholders’ funds: Fair values of our liabilities under contracts not involving significant mortality or morbidity risks (principally deferred annuities, deposit administration funds and supplementary contracts) are estimated at cash surrender value, the cost we would incur to extinguish the liability. We are not required to estimate the fair value of our liabilities under other insurance contracts.
Company-obligated mandatorily redeemable preferred stock of subsidiary trust and Series C redeemable preferred stock: Fair values are estimated by discounting expected cash flows using interest rates currently being offered for similar securities.
Reinsurance contracts do not relieve us of our obligations to policyholders. To the extent that reinsuring companies are later unable to meet obligations under reinsurance agreements, our insurance subsidiaries would be liable for these obligations, and payment of these obligations could result in losses. To limit the possibility of such losses, we evaluate the financial condition of our reinsurers and monitor concentrations of credit risk. No allowance for uncollectible amounts has been established against our asset for reinsurance recoverable since none of our receivables are deemed to be uncollectible.
Through July 1, 2002, we participated 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 shared in the eligible catastrophic losses based on their size and contribution to the pool. Under the pool arrangement, we were 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 incurred losses from this pool totaling $1.6 million in 2001 resulting from the terrorist acts on September 11, 2001. We no longer participate in this pool due to structural changes in the pool, including an increase in the cap on losses.
Effective September 1, 2001, we entered into a 100% coinsurance agreement to reinsure our individual disability income business acquired in the Kansas Farm Bureau Life acquisition with an unaffiliated insurer. Effective September 1, 2000, we entered into a similar arrangement with the same insurer to reinsure our individual disability income business in force at that time. At September 1, 2001, the related accident and health reserves totaled $14.4 million, deferred policy acquisition costs totaled $0.7 million and value of insurance in force acquired totaled $3.1 million. At September 1, 2000, the related accident and health reserves totaled $43.6 million and deferred
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 and 40% of certain annuity business written during 2002. The agreement also provides for reinsuring 40% of certain new annuity business written by American Equity during 2003. The reinsurance of the business written prior to October 1, 2001 was accounted for as the acquisition of an in force block of business on October 1, 2001. With the reinsurance of the in force block, we recorded cash and reinsurance recoverable totaling $120.4 million, deferred acquisition costs of $18.3 million and policy liabilities of $138.7 million. Premiums collected on this assumed business, not included in revenues in the consolidated statements of income, totaled $837.9 million in 2002 and $280.0 million in the fourth quarter of 2001.
All of the call options are one-year options, the terms of which are closely matched with the equity-indexed annuity terms that define the amount of index credits payable under the contract at the next anniversary date. On the respective anniversary dates of the equity-indexed contracts, the market index used to compute the annual index credits is reset and we, through American Equity, purchase new one-year call options to fund the next annual index credit. American Equity manages the cost of these purchases through the terms of the equity-indexed annuities, which permit American Equity to change annual participation rates, asset fees, and/or caps, subject to guaranteed minimums. By reducing participation rates and caps, or increasing asset fees, American Equity can limit option costs to budgeted amounts except in cases where the minimum guarantees prevent further reductions in these contract terms.
The reserve for equity-indexed annuity contracts includes a series of embedded derivatives that represent the contact holder’s right to participate in index returns over the lives of the applicable contracts. The reserve includes the value of the embedded forward options despite the fact that call options are not purchased for a period longer than the period of time to the next contract anniversary date.
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 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):
Unpaid claims on accident and health policies (principally disability income products) 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:
The gain on disposal of discontinued property-casualty operations in 2000 is net of income tax expense totaling $1.4 million.
The effective tax rate on income from continuing operations before income taxes, minority interest in earnings of subsidiaries, equity income and cumulative effect of change in accounting principle is different from the prevailing federal income tax rate as follows:
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, 2002 and 2001, 97,000 shares of 5% Preferred Securities were outstanding, all of which we unconditionally guarantee.
We issued 3,411,000 shares of Series C cumulative voting mandatorily redeemable preferred stock with an estimated fair value of $80.0 million to the Kansas Farm Bureau Federation in connection with the acquisition of
Kansas Farm Bureau Life. 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.
We repurchased 5,900 shares in 2001 and 4,358,397 shares in 2000 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 and $85.8 million in 2000. 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 $4.4 million in 2002, $5.3 million in 2001 and $5.2 million in 2000.
We participate with several affiliates in a 401(k) defined contribution plan which covers substantially all employees. We contribute FBL Financial Group, Inc. stock in an amount equal to 100% of an employee’s contributions up to 2% of the annual salary contributed by the employee and an amount equal to 50% of an employee’s contributions between 2% and 4% of the annual salary contributed by the employee. Prior to 2002, we contributed FBL Financial Group, Inc. stock in the amount equal to 50% of an employee’s contributions up to 4% of the annual salary contributed by the employee. Costs are allocated among the affiliates on a basis of time incurred by the respective employees for each company. Related expense totaled $0.8 million in 2002, $0.5 million in 2001 and $0.4 million in 2000.
In addition to benefits offered under the aforementioned benefit plans, we and several other affiliates sponsor a plan that provides group term life insurance benefits to retired full-time employees who have worked ten years and attained age 55 while in service. Furthermore, during a portion of 2001 we offered certain retiree health benefits to employees and retirees formerly employed by Kansas Farm Bureau Life. During 2001, we discontinued offering this benefit to active employees and wrote off the related liability. Postretirement benefit expense is allocated in a manner consistent with pension expense discussed above. Postretirement benefit expense (benefit) aggregated less than $0.1 million in 2002, ($0.5) million in 2001 and $0.1 million in 2000.
At December 31, 2002, shares of Class A common stock available for grant as additional awards under the Plan totaled 5,401,363.
We have a Director Compensation Plan under which non-employee directors on our Board may elect to receive their compensation in the form of cash, Class A common shares or deferred stock units. Under this plan, we have deferred stock units outstanding totaling 16,917 at December 31, 2002 and 13,471 at December 31, 2001. At December 31, 2002, shares of Class A common stock available for future issuance under the Director Compensation Plan totaled 33,083.
We share certain office facilities and services with the Iowa Farm Bureau Federation, Kansas Farm Bureau Federation and their affiliated companies. These expenses are allocated on the basis of cost and time studies that are updated annually and consist primarily of rent, salaries and related expenses, travel and other operating costs.
We have marketing agreements with the Farm Bureau property-casualty companies operating within our marketing territory, including Farm Bureau Mutual and other affiliates. Under the marketing agreements, the property-casualty companies are responsible for development and management of our agency force for a fee equal to a percentage of commissions on first year life insurance premiums and annuity deposits. We paid $7.2 million in 2002, $6.2 million in 2001 and $6.0 million in 2000 to the property-casualty companies under these arrangements.
In the normal course of business, we may be involved in litigation where amounts are alleged that are substantially in excess of contractual policy benefits or certain other agreements. At December 31, 2002, management is not aware of any claims for which a material loss is reasonably possible.
The following table sets forth the computation of earnings per common share and earnings per common share-assuming dilution:
preferred stockholder’s participation in dividends with the common stockholders is limited to the amount of the annual regular dividend.
Options to purchase 564,419 shares of common stock in 2000 at $15.00 to $24.25 per share were granted during 1997, 1998, 1999 and 2000 but were not included in the computation of 2000 diluted earnings per share because the options’ exercise price was greater than the average market price of common shares during 2000. The options, which expire in 2007 through 2010, were still outstanding at December 31, 2000.
The financial statements of the Life Companies included herein differ from related statutory-basis financial statements principally as follows: (a) the bond portfolio is classified as available-for-sale (carried at fair value) 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.
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 2003, Farm Bureau Life could pay dividends to the parent company of approximately $39.2 million without prior approval of insurance regulatory authorities.
insurance and (3) variable. We also have various support operations and corporate capital that are aggregated into a corporate and other segment.
The variable segment consists of variable universal life insurance and variable annuity contracts. These products are similar to universal life insurance and traditional annuity contracts, except the contract holder has the option to direct the cash value of the contract to a wide range of investment sub-accounts, thereby passing the investment risk to the contract holder.
marketing and distribution services for the sale of mutual funds and insurance products not issued by us; and
the corporate and other segment include charges relating to leases with affiliates totaling $5.0 million for 2002 and $4.6 million for 2001 and 2000. In the consolidated statements of income, we record these depreciation amounts net of related lease income from affiliates.