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 primarily of approximately 168,000 square feet of a 400,000 square foot office building in West Des Moines, Iowa. Operations related to our EquiTrust Life independent distribution are conducted from approximately 26,000 square feet of another office building in West Des Moines, Iowa. We consider the current facilities to be adequate for the foreseeable future.
Amounts are impacted by accumulated other comprehensive income (loss) totaling ($36.3) million in 2007, $28.2 million in 2006, $82.3 million in 2005, $141.2 million in 2004 and $121.6 million in 2003. These amounts are net of deferred income taxes and other adjustments for assumed changes in the amortization of deferred policy acquisition costs, deferred sales inducements, unearned revenue reserve and value of insurance in force acquired.
As described in more detail in Note 1 to our consolidated financial statements and in the “Net income applicable to common stock” section that follows, in 2007 we changed our accounting policies for modifications or exchanges of insurance contracts, income tax contingencies and cash flow hedges on certain fixed annuity contracts. In 2006, we changed our method of computing share-based compensation expense and changed our presentation of the related excess tax deductions in the consolidated statement of cash flows.
At December 31, 2007, our fixed maturity securities classified as available for sale had a market value of $9,522.6 million, with gross unrealized gains totaling $146.7 million and gross unrealized losses totaling $287.1 million. Due to the large number of fixed maturity securities held, the unique attributes of each security and the complexity of valuation methods, it is not practical to estimate a potential range of market values for different assumptions and methods that could be used in the valuation process.
Amortization of deferred policy acquisition costs and deferred sales inducements for participating life insurance and interest sensitive and index products is expected to total $101.6 million for 2008, excluding the impact of new production in 2008. A 10% increase in estimated gross profits for 2008 would result in $8.7 million of additional amortization expense. Correspondingly, a 10% decrease in estimated gross profits would result in an $8.8 million reduction of amortization expense.
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 2007 totaled $5.9 million.
We assume an expected long-term rate of return on plan assets of 7.00% and discount rate of 5.60%. Details regarding the method used to determine the discount rate are summarized in Note 9, “Retirement and Compensation Plans,” to the consolidated financial statements.
A 100 basis point decrease in the expected return on assets would result in a $0.6 million increase in pension expense and a 100 basis point increase would result in a $0.6 million decrease to pension expense. A 100 basis point decrease in the assumed discount rate would result in a $0.2 million increase in pension expense while a 100 basis point increase would result in a $0.2 million decrease to pension expense.
Premiums collected is a non-GAAP financial measure for which there is no comparable GAAP financial measure. We use premiums collected to measure the productivity of our exclusive and independent agents. Direct Traditional Annuity - Independent Distribution premiums collected decreased in 2007 primarily due to a more favorable market environment during 2006 for the sale of our multi-year guaranteed annuity product combined with a competitive environment for index annuity sales in 2007. In addition, during 2007 we took actions to further increase the profitability of our products.
The amounts of the unlocking adjustments and whether they increase or decrease income depend upon the nature of the underlying assumption changes made in the amortization models. See the “Segment Information” section that follows for additional discussion of our unlocking adjustments.
Effective April 1, 2007, we adopted Statement of Financial Accounting Standards (Statement) 133 Implementation Issue No. G26, “Cash Flow Hedges: Hedging Interest Cash Flows on Variable-Rate Assets and Liabilities That Are Not Based on a Benchmark Interest Rate,” (DIG G26) which required us to discontinue the use of hedge accounting for interest rate swaps backing our annuity contracts. As a result of adopting DIG G26, net income for 2007 was
$2.2 million ($0.07 per basic and diluted common share) lower than if we continued to use hedge accounting for the interest rate swaps. The adoption of DIG G26 did not have any impact on comprehensive income.
Effective January 1, 2007, we adopted Statement of Position (SOP) 05-1, “Accounting by Insurance Enterprises for Deferred Acquisition Costs in Connection with Modifications or Exchanges of Insurance Contracts” issued by the Accounting Standards Executive Committee of the American Institute of Certified Public Accountants. The impact of adopting SOP 05-1 was not material to our consolidated financial statements for 2007 (estimated to be a $0.1 million decrease to net income - less than $0.01 per basic and diluted common share) as our previous accounting policy for internal replacements substantially conformed to current interpretations of the guidance in the SOP.
Cost of insurance charges totaled $65.3 million in 2007, $63.8 million in 2006 and $61.9 million in 2005. Cost of insurance charges increased primarily due to aging of the business in force as the cost of insurance charge rate per each $1,000 in force increases with the age of the insured. The average age of our universal life and variable universal life policyholders was 45.4 years in 2007, 45.0 years in 2006 and 44.6 years in 2005.
Gains received at expiration are attributable to growth in the volume of index annuities in force and appreciation in the market indices on which our options are based. The average aggregate account value of index annuities in force, which has increased due to new sales, totaled $4,106.8 million for 2007, $3,200.1 million for 2006 and $2,299.1 million for 2005. The changes in the difference between the fair value of the call options and the remaining option costs are caused primarily by the timing of index settlements and the change in the S&P 500 Index® (upon which the majority of our options are based). The range of index appreciation for S&P 500 Index options during 2007, 2006 and 2005 is as follows:
The change in fair value is also reduced by participation rates and caps, as applicable, on the underlying options. Furthermore, the change in fair value is impacted by options based on other underlying indices and the timing of option settlements. The cost of money for call options increased primarily due to the impact of growth in the volume of index annuities in force. In addition, the price of call options increased during 2007 due to an increase in the volatility of the equity markets during the year. Other derivative loss is comprised of changes in the value of the conversion feature embedded in convertible fixed maturity securities and the embedded derivative included in our modified coinsurance contracts. In addition, beginning in the second quarter of 2007, other derivative loss includes cash flows and the change in fair value of the interest rate swaps relating to our flexible premium deferred annuity contracts due to the adoption of Statement 133 Implementation Issue No. G26, “Cash Flow Hedges: Hedging Interest Cash Flows on Variable Rate Assets and Liabilities That Are Not Based on a Benchmark Interest Rate.” See Note 1 to our consolidated financial statements for additional details on this change in accounting. Derivative income (loss) will fluctuate based on market conditions.
The level of realized/unrealized gains (losses) is subject to fluctuation from period to period depending on the prevailing interest rate and economic environment and the timing of the sale of investments. Gains on sales include $6.1 million in 2007 and $13.5 million in 2006 related to sales of a portion of our investment in American Equity Investment Life Holding Company (AEL) common stock. Gains on sales in 2006 also included a $1.9 million gain related to the sale of our equity investment in an affiliate, Western Agricultural Insurance Company, to another affiliate, Farm Bureau Mutual Insurance Company. See “Financial Condition - Investments” for details regarding our unrealized gains and losses on available-for-sale securities at December 31, 2007 and 2006.
If we determine that an unrealized loss is other than temporary, the security is written down to its fair value with the difference between amortized cost and fair value recognized as a realized loss. Details regarding investment impairments individually exceeding $0.5 million for 2007, 2006 and 2005, including the circumstances requiring the write downs, are summarized in the following table:
Negative trends in this segment of the industry were considered in our analysis, which is done on an issue-by-issue basis. We concluded that there is no impact on other material investments in addition to amounts already written down.
The average aggregate account value of annuity contracts in force, which increased due to additional premiums collected as summarized in the “Other data” table above, totaled $7,536.9 million for 2007, $5,970.0 million for 2006 and $4,637.6 million for 2005. These account values include values relating to index contracts totaling $4,106.8 million for 2007, $3,200.1 million for 2006 and $2,299.1 million for 2005.
Traditional life insurance policy benefits increased 2.1% in 2007 to $149.9 million and 1.6% in 2006 to $146.8 million. These increases are attributable to an increase in the volume of traditional life business in force, partially offset, in 2007, by decreases in traditional life insurance death benefits. Traditional life insurance death benefits decreased 5.0% to $51.1 million in 2007 and increased 4.5% to $53.8 million in 2006. Surrender benefits increased 7.5% to $35.4 million in 2007 and 9.8% to $32.9 million in 2006. The change in traditional life and future policy benefits may not be proportional to the change in traditional premiums and benefits as reserves on term policies are generally less than reserves on whole life policies. Distributions to participating policyholders decreased in 2007 and 2006 due to reductions in our dividend crediting rates in response to the impact of declining market interest rates on our investment portfolio yield as discussed in the “Net investment income” section above. Traditional life insurance benefits can fluctuate from period to period primarily as a result of changes in mortality experience.
The decrease in other underwriting, acquisition and insurance expenses in 2007 is primarily due to a $4.9 million lawsuit settlement in 2006 ($0.11 per basic and diluted common share, after taxes). In 2006, the increase from the lawsuit settlement was partially offset by expense savings initiatives, mostly relating to the closure of a life processing unit in Manhattan, Kansas during the third quarter of 2005. This closure and other unrelated terminations also contributed to a $2.3 million charge for severance, early retirement benefits and other closing costs in 2005. See Note 1 of our notes to the consolidated financial statements for further details regarding the lawsuit settlement and a related unrecorded gain contingency.
The impact of realized and unrealized gains and losses on investments and unrealized gains and losses on derivatives also includes adjustments for that portion of amortization of deferred policy acquisition costs, deferred sales inducements, unearned revenue reserve and value of insurance in force acquired attributable to such gains or losses. Our rationale for using operating income, in addition to net income to measure our performance is summarized in Note 14, “Segment Information,” to the consolidated financial statements.
Amortization of deferred policy acquisition costs increased $1.2 million in 2007, decreased $1.7 million in 2006 and increased $2.4 million in 2005 from unlocking.
The average aggregate account value for annuity contracts in force in the Exclusive Annuity segment totaled $1,488.9 million for 2007, $1,479.5 million for 2006 and $1,428.8 million for 2005.
Net investment income includes $4.6 million in 2007, $3.5 million in 2006 and $4.2 million in 2005 in fee income from bond calls, tender offers and mortgage loan prepayments and the change in net discount accretion on mortgage and asset-backed securities as noted in the “Net investment income” section above. This additional income was offset by the impact of market investment rates being lower than our portfolio yield or yield on investments maturing or being paid down.
The changes in the weighted average yield on cash and invested assets are primarily attributable to the items affecting net investment income noted above. In 2006, we increased the crediting rate on our primary fixed premium deferred annuity product ten basis points in response to increased income generated from interest rate swaps we utilize to hedge a portion of our annuity portfolio. Income from these swaps totaled $3.9 million in 2007, $3.7 million in 2006 and $1.0 million in 2005. Income from these swaps is netted against interest credited through March 31, 2007, but included in derivative income (loss) starting in the second quarter of 2007. See “Market Risks of Financial Instruments” following and Note 1 and Note 3 to the consolidated financial statements for additional information regarding these hedges.
Pre-tax operating income for the Independent Annuity segment increased 31.0% in 2007 to $39.9 million and 37.3% in 2006 to $30.4 million. These increases are principally due to growth in the volume of business in force, partially offset by a decrease in spreads earned on individual deferred annuities. Revenues, benefits, expenses and the volume of business in force increased in 2007 and 2006 due to growth of our EquiTrust Life distribution channel. The number of individual agents increased to 19,781 at December 31, 2007 from 15,326 at December 31, 2006 and 8,482 at December 31, 2005. The average aggregate account value for annuity contracts in force in the Independent Annuity segment totaled $5,966.7 million for 2007, $4,401.2 million for 2006 and $3,114.7 million for 2005.
The increases in interest sensitive and index product charges in 2007 and 2006 are due to an increase in surrender charges. Surrender charges increased due to increases in surrenders relating to growth in the volume and aging of business in force. The increases in net investment income in 2007 and 2006 are attributable to growth in invested assets due principally to net premium inflows. In addition, net investment income includes income from bond calls, tender offers and mortgage loan prepayments and the change in net discount accretion on mortgage and asset-backed securities totaling $0.7 million in 2007, $2.1 million in 2006 and $0.5 million in 2005. In 2006, these increases were partially offset by the impact of a decline in our investment yield.
Premiums collected from the independent channel decreased in 2007 primarily due to a more favorable market environment during 2006 for the sale of our multi-year guaranteed annuity product combined with a competitive environment for index annuity sales in 2007. In addition, during 2007 we took actions to further increase the profitability of our products.
Pre-tax operating income for the Traditional and Universal Life Insurance segment decreased less than 0.1% in 2007 to $58.7 million and increased 7.1% in 2006 to $58.7 million. The impact of the increase in the volume of business in force contributed to pre-tax operating income in 2007 and 2006. In 2007, this increase, combined with increased spreads on our interest sensitive life business and lower death benefits, was offset by the impact of unlocking on deferred policy acquisition costs and the value of insurance in force acquired. The increase in 2006 was also due to a decrease in other underwriting expenses, partially offset by an increase in death benefits and reduction in spreads.
Traditional life insurance premiums increased in 2007 and 2006 due primarily to sales of life products by our Farm Bureau Life agency force. The increase in net investment income is primarily due to an increase in invested assets, principally due to net premium inflows, partially offset by the impact of market investment rates being lower than our investment portfolio yield or yield on investments maturing or being paid down. In addition, net investment income includes $2.9 million in 2007, $2.8 million in 2006 and $1.7 million in 2005 in fee income from bond calls, tender offers and mortgage loan prepayments and the change of net discount accretion on mortgage and asset-backed securities.
Death benefits totaled $77.3 million in 2007, $81.2 million in 2006 and $75.4 million in 2005. Surrender benefits totaled $39.7 million in 2007, $37.0 million in 2006 and $33.8 million in 2005. Amortization of deferred policy acquisition costs increased primarily due to higher gross margins resulting from the increase in traditional life premiums. In addition, amortization of deferred policy acquisition costs increased $1.2 million in 2007 and decreased $1.8 million in 2006 and $3.2 million in 2005 due to the impact of unlocking. Other underwriting
Pre-tax operating income for the Variable segment totaled $12.5 million in 2007, $3.6 million in 2006 and $2.6 million in 2005. These increases are primarily due to an increase in the volume of business in force and, for 2007, a decrease in death benefits.
Other income includes revenues relating primarily to our non-insurance operations. These operations include management, advisory, marketing and distribution services and leasing activities. Fluctuations in other income are generally attributable to fluctuations in the level of these services provided during the years.
Interest expense increased in 2007 due to our 2017 Senior Notes offering. Interest expense decreased in 2006 due to the redemption of our Series C preferred stock, partially offset by an increase in the effective interest rate on our line of credit as discussed in the “Interest expense” section above.
As described in more detail in Note 1 to the consolidated financial statements, we will be subject to certain pending accounting changes. During 2008, we plan to adopt the following:
Statement No. 157, “Fair Value Measurements,” which defines fair value, establishes a framework for measuring fair value and expands the required disclosures about fair value measurements. We are currently evaluating the requirements of this Statement and have not yet determined the impact of adoption on our consolidated financial statements as guidance regarding the proper methodology for determining the fair value of liabilities is still emerging as of the filing of this Form 10-K.
Our total investment portfolio increased 13.9% to $11,137.9 million at December 31, 2007 compared to $9,782.6 million at December 31, 2006. This increase is primarily the result of net cash received from interest sensitive and index products and proceeds from issuance of the 2017 Senior Notes, partially offset by the impact of a decrease in net unrealized appreciation on fixed maturity securities classified as available for sale. Net unrealized appreciation of fixed maturity securities decreased $161.6 million during 2007 to a net unrealized loss of $140.4 million at December 31, 2007, principally due to the impact of a general widening of credit spreads (difference between bond yields and risk-free interest rates), partially offset by a decrease in risk-free interest rates.
As of December 31, 2007, 96.2% (based on carrying value) of the available-for-sale fixed maturity securities were investment grade debt securities, defined as being in the highest two National Association of Insurance Commissioners (NAIC) designations. Non-investment grade debt securities generally provide higher yields and involve greater risks than investment grade debt securities because their issuers typically are more highly leveraged
and more vulnerable to adverse economic conditions than investment grade issuers. In addition, the trading market for these securities is usually more limited than for investment grade debt securities. We regularly review the percentage of our portfolio that is invested in non-investment grade debt securities (NAIC designations 3 through 6). As of December 31, 2007, the investment in non-investment grade debt was 3.8% of available-for-sale fixed maturity securities. At that time, no single non-investment grade holding exceeded 0.2% of total investments. The following table sets forth the credit quality, by NAIC designation and Standard & Poor’s (S&P) rating equivalents, of available-for-sale fixed maturity securities:
Included in the above table are 863 securities from 538 issuers at December 31, 2007 and 780 securities from 513 issuers at December 31, 2006. These increases are primarily due to an increase in spreads between the risk-free interest rates and corporate and other bond yields. The following summarizes the details describing the more significant unrealized losses by investment category as of December 31, 2007.
Excluding mortgage and asset-backed securities, no securities from the same issuer had an aggregate unrealized loss in excess of $1.2 million at December 31, 2006. With respect to mortgage and asset-backed securities not backed by the United States Government, no securities from the same issuer had an aggregate unrealized loss in excess of $4.5 million at December 31, 2006. The $4.5 million unrealized loss from one issuer relates to five different securities that are backed by different pools of residential mortgage loans. All five securities are rated investment grade and the largest unrealized loss on any one security totaled $2.3 million at December 31, 2006.
The mortgage-backed portfolio includes pass-through and collateralized mortgage obligation (CMO) securities. With a pass-through security, we receive a pro rata share of principal payments as payments are made on the underlying mortgage loans. CMOs consist of pools of mortgages divided into sections or “tranches” which provide sequential retirement of the bonds. We invest in sequential tranches which provide cash flow stability in that principal payments do not occur until the previous tranches are paid off. In addition, to provide call protection and more stable average lives, we invest in CMOs such as planned amortization class (PAC) and targeted amortization class (TAC) securities. CMOs of these types provide more predictable cash flows within a range of prepayment speeds by shifting the prepayment risks to support tranches. We generally do not purchase certain types of CMOs that we believe would
subject the investment portfolio to greater than average risk. These include, but are not limited to, principal only, floater, inverse floater, PAC II and support tranches.
The following table sets forth the amortized cost, par value and carrying value of our mortgage and asset-backed securities summarized by type of security:
The mortgage and asset-backed portfolios include securities with exposure to the Alt-A and subprime home equity loan sectors. Securities with Alt-A and subprime exposure are backed by loans to borrowers with credit scores below those of A-grade borrowers. Alt-A securities generally include borrowers with credit scores ranging from 725 to 641, and subprime securities include borrowers with credit scores of 640 or less. The slowing U.S. housing market, increased interest rates, greater use of affordable mortgage products and relaxed underwriting standards for some originators of below-prime loans have recently led to higher delinquency and loss rates, especially for subprime loans originated in 2006. These factors have caused market illiquidity and repricing of risk, which has led to an increase in unrealized losses in 2007. We expect delinquency rates and loss rates will increase in the future, however, we continue to expect to receive payments in accordance with contractual terms of our securities, largely due to the seniority of our claims on the collateral, represented by AAA rated securities.
Our exposure to the Alt-A and subprime home equity loan sectors is limited to investments in structured securities collateralized by senior tranches of commercial or residential mortgage loans with this exposure. We do not own any direct investments in subprime lenders or adjustable rate mortgages. At December 31, 2007, all mortgage and asset-backed securities with subprime or Alt-A exposure, except for one, are AAA rated. We held one asset-backed
A summary of our mortgage and asset-backed portfolios by collateral type is as follows:
Our exposure to the Alt-A and subprime mortgage and asset-backed sectors summarized by origination year is as follows:
above. Our other investments in collateralized debt obligations are backed by investment grade credit default swaps with no home equity exposure. These are all actively managed investments rated AA or above with a carrying value totaling $45.2 million and unrealized loss of $10.1 million at December 31, 2007 and a carrying value of $25.5 million and unrealized loss of $0.8 million at December 31, 2006.
Our state, municipal and other government securities include investments in general obligation, revenue, military housing and municipal housing bonds. Our investment strategy is to utilize municipal bonds in addition to corporate bonds, as we believe they provide additional diversification and historically low default rates compared with similarly rated corporate bonds. We evaluate the credit strength of the underlying issues on both a quantitative and qualitative basis, excluding insurance, prior to acquisition. The majority of the municipal bonds we hold are investment grade credits without consideration of insurance. The insolvency of one or more of the credit enhancing entities would be a meaningful short-term market liquidity event, but would not dramatically increase our investment portfolio’s risk profile.
A summary of our insured and uninsured municipal holdings by rating of the insurer and underlying issue is as follows:
No formal public rating issued. Approximately 53% of the non-rated securities relate to military housing bonds, which we believe have an “A-” shadow rating; approximately 31% are revenue obligation bonds; and approximately 16% are general obligation bonds. Insurance on these bonds is provided by AMBAC Assurance Corporation (64%), Financial Security Assurance, Inc. (18%), MBIA Insurance Corporation (11%); Financial Guaranty Insurance Co. (6%) and other (1%).
Deferred policy acquisition costs increased 19.7% to $991.2 million and deferred sales inducements increased 41.7% to $321.3 million at December 31, 2007, primarily due to the capitalization of costs incurred with new sales. In addition, deferred policy acquisition costs increased $58.1 million and deferred sales inducements increased $20.5 million due to the impact of the change in unrealized appreciation/depreciation on fixed maturity securities and interest rate swaps. Other assets decreased 38.8% to $32.4 million due primarily to a $21.3 million decrease for receivables for securities sold. Assets held in separate accounts increased 12.9% to $862.7 million at December 31, 2007 primarily due to the transfer of net premiums to the separate accounts and positive investment returns.
bonds, was approximately 9.3 years at December 31, 2007 and 9.6 years at December 31, 2006. Accordingly, the earned rate on the portfolio lags behind changes in market yields. The extent that the portfolio yield lags behind changes in market yields generally depends upon the following factors:
For a substantial portion of our direct business in force, we have the ability to adjust interest or dividend crediting rates in reaction to changes in portfolio yield. We had the ability to adjust rates on 96% of our policyholder liabilities at December 31, 2007 and December 31, 2006. However, the ability to adjust these rates is limited by competitive factors. Surrender rates could increase and new sales could be negatively impacted if the crediting rates are not competitive with the rates on similar products offered by other insurance companies and financial services institutions. In addition, if market rates were to decrease substantially and stay at a low level for an extended period of time, our spread could be lowered due to interest rate guarantees on many of our interest sensitive products. At December 31, 2007, interest rate guarantees on our direct interest sensitive products ranged from 1.50% to 5.50%, with a weighted average guarantee of 2.30%. This range excludes certain contracts with an account value totaling $2.5 million at December 31, 2007 with guarantees ranging up to 9.70%. The following table sets forth account values of direct individual deferred annuities (excluding index annuities) and interest sensitive life products, including the general account portion of variable contracts, broken out by the excess of current interest crediting rates over guaranteed rates at December 31, 2007.
For a substantial portion of business assumed through coinsurance agreements, the ceding companies have the ability to adjust interest and dividend crediting rates in reaction to portfolio yield. Most of the traditional annuity and universal life insurance contracts assumed through the coinsurance agreements have guaranteed minimum crediting rates. These rates range from 2.25% to 4.00%, with a weighted average guaranteed crediting rate of approximately 3.10% at December 31, 2007. The following table sets forth account values broken out by the excess of current interest crediting rates over guaranteed rates for fixed rate annuities and universal life business assumed through the coinsurance agreements at December 31, 2007.
Profitability on the portion of the index annuities tied to market indices is significantly impacted by the spread on interest earned on investments and the sum of (1) cost of underlying call options purchased to fund the credits owed to contract holders and (2) minimum interest guarantees owed to the contract holder, if any. The cost of the call options is managed through the terms of the index annuities, which permit adjustments to annual participation rates, asset fees, and/or caps, subject to guaranteed minimums. The minimum guaranteed contract values for the majority of annuities marketed by our EquiTrust Life distribution channel are equal to 87.5% of the premium collected plus interest credited at 3.00%. In addition, two of the products introduced in 2007 offer a minimum guarantee of 100% of premium accumulated at 3.00%. The minimum guaranteed contract values for index annuities assumed are equal to 80% to 100% of the premium collected plus interest credited at rates ranging between 2.25% to 3.50%. If there were little or no gains in the entire series of options purchased over the expected life of an index annuity (typically 15 to 20 years), we would incur expenses for credited interest over and above our option costs. This would cause our spreads to tighten and reduce our profits.
As of December 31, 2007, we have entered into six interest rate swaps to manage interest rate risk associated with a portion of our flexible premium deferred annuity contracts. Under the interest rate swaps, we pay a fixed rate of
A major component of our asset-liability management program is structuring the investment portfolio with cash flow characteristics consistent with the cash flow characteristics of our insurance liabilities. We use models to perform simulations of the cash flows generated from existing insurance policies under various interest rate scenarios. Information from these models is used in the determination of investment strategies. Effective duration is a common measure for price sensitivity to changes in interest rates. It measures the approximate percentage change in the 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 and mortgage loan portfolios was 6.3 at December 31, 2007 and 6.1 at December 31, 2006. The effective duration of the interest sensitive products was approximately 6.9 at December 31, 2007 and 2006.
We also have exposure to credit risk associated from the uncertainty associated with the continued ability of a given obligator to make timely payments of principal and interest. See “Financial Condition - Investments” for additional information about credit risk in our investment portfolio.
Parent company cash inflows from operations consists primarily of (i) dividends from subsidiaries, if declared and paid, (ii) fees that it charges the various subsidiaries and affiliates for management of their operations, (iii) expense reimbursements from subsidiaries and affiliates, (iv) proceeds from the exercise of employee stock options, (v) proceeds from borrowings and (vi) tax settlements between the parent company and its subsidiaries. Cash outflows are principally for salaries, taxes and other expenses related to providing these management services, dividends on outstanding stock, interest on our parent company debt and capital contributions to subsidiaries.
On March 12, 2007, we issued $100.0 million of 5.875% Senior Notes due March 15, 2017. Interest on the 2017 Senior Notes is payable semi-annually on March 15 and September 15 each year. The 2017 Senior Notes are redeemable in whole or in part at any time at our option at a “make-whole” redemption price equal to the greater of 100% of their principal amount or the sum of the present values of the remaining scheduled payments of principal and interest on the 2017 Senior Notes, discounted to the redemption date on a semiannual basis at the treasury rate plus 20 basis points. We received net proceeds of approximately $98.5 million from the issuance of the 2017 Senior Notes after underwriting fees, offering expenses and an original issue discount. We intend to use the net proceeds to fund the continued growth of EquiTrust Life.
We have a $60.0 million revolving line of credit agreement with LaSalle Bank National Association and Bankers Trust Company, N.A. due October 2010. Debt outstanding on this line of credit totaled $46.0 million at December 31, 2007 and December 31, 2006. Interest on any borrowings accrues at a variable rate (5.99% at December 31, 2007 and 6.12% at December 31, 2006). In 2006, we entered into a $46.0 million interest rate swap to hedge the variable component of the interest rate on the line of credit borrowings. See “Market Risks of Financial Instruments” and Note 3 to the consolidated financial statements for additional details on this interest rate swap.
We paid cash dividends on our common and preferred stock totaling $14.4 million in 2007, $13.7 million in 2006 and $12.3 million in 2005. Interest payments on our debt totaled $15.1 million in 2007, $11.7 million in 2006 and $11.8 million in 2005. It is anticipated that quarterly cash dividend requirements for 2008 will be $0.125 per common share and $0.0075 per Series B redeemable preferred share, or approximately $15.1 million. In addition, interest payments on our debt outstanding at December 31, 2007 are estimated to be $17.7 million for 2008.
FBL Financial Group, Inc. expects to rely on available cash resources and dividends from Farm Bureau Life to make dividend payments to its stockholders and interest payments on its debt.
In the normal course of business, we enter into insurance contracts, 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, 2007:
Interest on the revolving line of credit is assumed to be 5.99% until maturity.
Includes our estimated future contributions to multiemployer defined benefit plans. Contributions related to the qualified pension plan are included through 2008. No amounts related to the qualified pension plan are included beyond 2008 as the contribution amounts will be re-evaluated based on actual results.
We engage Ernst & Young LLP as independent auditors to audit our financial statements and internal control over financial reporting and express their opinion thereon. A copy of Ernst & Young LLP’s audit opinions follow this letter.
We have audited FBL Financial Group, Inc.’s internal control over financial reporting as of December 31, 2007, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). FBL Financial Group, Inc.’s management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the company’s internal control over financial reporting based on our audit.
In our opinion, FBL Financial Group, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2007, based on the COSO criteria.
Effective January 1, 2007, we adopted Financial Accounting Standards Board (FASB) Interpretation No. 48, “Accounting for Uncertainty in Income Taxes.” Interpretation No. 48 creates a single model to address uncertainty in tax positions and clarifies the accounting for income taxes by prescribing the minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. Under the Interpretation, a tax position can be recognized in the financial statements if it is more likely than not that the position will be sustained upon examination by taxing authorities who have full knowledge of all relevant information. A tax position that meets the more-likely-than-not recognition threshold is measured at the largest amount of benefit that is greater than 50 percent likely of being realized upon settlement. Interpretation No. 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. The impact of adopting Interpretation No. 48 was not material to our consolidated financial statements; therefore the cumulative effect of change in this accounting principle, totaling $0.3 million, is reflected as an increase to income tax expense
in our 2007 consolidated income statement. Net income for the full year 2007 was $0.3 million lower ($0.01 per basic and diluted common share) as a result of adopting this Interpretation. We recognize interest accrued related to unrecognized tax benefits in interest expense and penalties in other expenses.
In December 2007, the FASB issued Statement No. 141(R), “Business Combinations,” which changes the accounting and reporting of business combination transactions effective for the first annual reporting period beginning on or after December 15, 2008. Statement 141(R) has no immediate impact on our consolidated financial statements, though it will impact our accounting of future acquisitions or consolidations.
early application permitted. At December 31, 2007, we had master netting agreements with counterparties covering cash collateral payable totaling $73.2 million and cash collateral receivable totaling $7.5 million. These amounts are included in the collateral payable for securities lending and other transactions and collateral held for securities lending and other transactions lines on our consolidated balance sheet at December 31, 2007, but will be netted against the fair value of the call options included in derivative instruments and swaps included in other liabilities upon adoption of FSP FIN 39-1 in 2008. This FSP will have no impact on our consolidated statements of income.
In September 2006, the FASB issued Statement No. 157, “Fair Value Measurements,” which defines fair value, establishes a framework for measuring fair value and expands the required disclosures about fair value measurements. This Statement is effective for fiscal years beginning after November 15, 2007. We are currently evaluating the requirements of this Statement and have not yet determined the impact of adoption on our consolidated financial statements, as guidance regarding the proper methodology for determining the fair value of liabilities is still emerging as of the filing date of this Form 10-K.
Fixed maturity securities, comprised of bonds and redeemable preferred stocks, which may be sold, are designated as “available for sale.” Available-for-sale securities are reported at market value and unrealized gains and losses on these securities, with the exception of unrealized gains and losses relating to the conversion feature embedded in convertible fixed maturity securities, are included directly in stockholders’ equity as a component of accumulated other comprehensive income (loss). Unrealized gains and losses relating to the conversion feature embedded in convertible fixed maturity securities are recorded as a component of derivative income (loss) in the consolidated statements of income. The unrealized gains and losses are reduced by a provision for deferred income taxes and adjustments to deferred policy acquisition costs, deferred sales inducements, value of insurance in force acquired and unearned revenue reserve that would have been required as a charge or credit to income had such amounts been realized. Fixed maturity securities that are purchased with the intent to sell within a short period of time are classified as “trading.” These securities are carried at fair value and unrealized gains and losses are reflected in the consolidated statements of income as a component of realized/unrealized gains on investments. Premiums and discounts are amortized/accrued using methods which result in a constant yield over the securities’ expected lives. Amortization/accrual of premiums and discounts on mortgage and asset-backed securities incorporates prepayment assumptions to estimate the securities’ expected lives.
For derivatives not designated as a hedging instrument, the change in fair value is recognized in earnings in the period of change. See “Accounting Changes” above and Note 3, “Derivative Instruments,” for more information regarding our derivative instruments and embedded derivatives.
Investment real estate is reported at cost less allowances for depreciation, as applicable. The carrying value of these assets is subject to regular review. For properties not held for sale, if indicators of impairment are present and a property’s expected undiscounted cash flows are not sufficient to recover the property’s carrying value, an impairment loss is recognized and the property’s cost basis is reduced to fair value. If the fair value, less estimated sales costs, of real estate held for sale decreases to an amount lower than its carrying value, the carrying value of the real estate is reduced by the establishment of a valuation allowance, changes to which are recognized as realized gains or losses on investments.
We participate in a securities lending program whereby certain fixed maturity securities from our investment portfolio are loaned to other institutions for a short period of time. We require collateral equal to or greater than 100 percent of the market value of the loaned securities. The collateral is invested by the lending agent, in accordance with our guidelines, generating fee income that is recognized as net investment income over the period the securities are on loan. The collateral is accounted for as a secured borrowing and is recorded as an asset on the consolidated balance sheets, with a corresponding liability reflecting our obligation to return this collateral upon the return of the loaned securities. Securities recorded on our consolidated balance sheet with a market value of $179.5 million were on loan under the program and we were liable for cash collateral under our control totaling $185.3 million at December 31, 2007.
We also obtain or are required to provide collateral relating to certain derivative transactions. We invest cash collateral received and record a liability for amounts owed to counterparties for these transactions. See Note 2, “Investment Operations,” for more information regarding our collateral.
Realized gains and losses on sales of investments are determined on the basis of specific identification. This line item also includes the change in unrealized gains and losses on trading securities. The carrying values of all our investments are reviewed on an ongoing basis for credit deterioration. If this review indicates a decline in market value that is other than temporary, the carrying value of the investment is reduced to its fair value and a specific write down is taken. Such reductions in carrying value are recognized as realized losses on investments. For fixed maturity securities and equity securities, the fair value becomes the new cost basis for the security and the cost basis is not adjusted for subsequent recoveries in fair value. However, for fixed maturity securities for which we can reasonably estimate future cash flows after a write down, the discount or reduced premium recorded, based on the new cost basis, is amortized over the remaining life of the security. Amortization in this instance is computed using the prospective method and the current estimate of the amount and timing of future cash flows. It is difficult to estimate cash flows on securities that have been written down for an other-than-temporary impairment due to the inherent variability of cash flows associated with distressed securities. Net investment income for 2007 includes accretion totaling $0.5 million on two previously impaired securities that mature in 2008. No such accretion was recorded in 2006 or 2005.
Independent pricing sources are used to obtain market values for nearly all of our fixed maturity securities. The pricing service providers utilize valuation models that vary by asset class and incorporate available trade, bid and other market information. Many fixed income securities in the portfolio do not trade on a daily basis, so available information such as benchmark curves, benchmarking of like securities, reported trades, broker/dealer quotes, issuer spreads, bids, offers, and matrix pricing are utilized in the valuation process. For each type of security, information is gathered from market sources that integrate relevant credit information, perceived market movements and sector news into the pricing process. In addition, models are utilized to develop prepayment and interest rate scenarios. All prices obtained from pricing sources are reviewed by our internal investment trading group for reasonableness based on the underlying characteristics of the security, including relative yield, credit rating market activity and valuations of similar securities. Price discrepancies between providers and any prices that look unusual are investigated by our internal investment professionals for final price determination. In addition, certain fixed maturity securities with a market value totaling $86.8 million at December 31, 2007 and $296.8 at December 31, 2006 are valued by us using a matrix calculation assuming a spread (based on interest rates and a risk assessment of
Market values of the conversion features embedded in convertible fixed maturity securities are estimated using an option-pricing model. Market values of redeemable preferred stocks, equity securities, call options and interest rate swaps are based on the latest quoted market prices, or for those stocks not readily marketable, generally at values which are representative of the market values of comparable issues. Market values for the embedded derivatives in our modified coinsurance contracts are based on the difference between the fair value and the cost basis of the underlying investments. Market values for the embedded derivatives in our reinsurance recoverable relating to call options are based on quoted market prices.
Deferred policy acquisition costs include certain costs of acquiring new insurance business, principally commissions and other expenses related to the production of new business, to the extent recoverable from future policy revenues and gross profits. Deferred sales inducements include premium bonuses and bonus interest credited to contracts during the first contract year only. The value of insurance in force acquired represents the cost assigned to insurance contracts when an insurance company is acquired. The initial value is determined by an actuarial study using expected future gross profits as a measurement of the net present value of the insurance acquired. Interest accrued on the unamortized balance at a weighted average rate of 4.96% in 2007, 4.95% in 2006 and 4.88% in 2005.
results as the segment results are based on operating income which, as explained in Note 14, excludes the impact of changes in the valuation of derivatives.
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 our affiliates. In addition, certain revenues generated by our insurance subsidiaries are classified as other income. Revenues of the insurance subsidiaries included as other income totaled $3.2 million in 2007, $1.7 million in 2006 and $1.1 million in 2005. Lease income from leases with affiliates totaled $12.2 million in 2007, $12.0 million in 2006 and $11.0 million in 2005. Investment advisory fee income from affiliates totaled $1.5 million in 2007 and 2006 and $2.5 million in 2005.
investment gains included in net income which represent transfers from unrealized to realized gains and losses. These amounts totaled $2.7 million in 2007, $7.9 million in 2006 and $1.9 million in 2005. These amounts, which have been measured through the date of sale, are net of income taxes and adjustments to deferred policy acquisition costs, deferred sales inducements, value of insurance in force acquired and unearned revenue reserve totaling ($0.3) million in 2007, ($4.0) million in 2006 and ($1.5) million in 2005. Beginning in 2006, other comprehensive income (loss) also includes the initial recognition and subsequent changes in the underfunded status of our single employer health and medical postretirement benefit plans totaling $0.2 million in 2007 and 2006.
We have agreed that we will not pay dividends on the Class A or Class B Common Stock, nor on the Series B Preferred Stock, if we are in default of our line of credit agreement with LaSalle Bank National Association, or in default of the Subordinated Deferrable Interest Note Agreement Dated May 30, 1997 with FBL Financial Group Capital Trust. See Note 7, “Credit Arrangements,” for additional information regarding these agreements.
Certain amounts in the 2006 and 2005 consolidated financial statements have been reclassified to conform to the 2007 financial statement presentation.
The changes in net unrealized investment gains and losses are recorded net of deferred income taxes and other adjustments for assumed changes in the amortization pattern of deferred policy acquisition costs, deferred sales inducements, value of insurance in force acquired and unearned revenue reserve totaling ($115.9) million in 2007, ($48.1) million in 2006 and ($66.4) million in 2005.
Corporate securities: The unrealized losses on corporate securities, which include redeemable preferred stocks, totaled $151.6 million, or 52.8% of our total unrealized losses. The largest losses were in the financial services sector ($1,106.7 million carrying value and $91.7 million unrealized loss) and in the manufacturing sector ($507.8 million carrying value and $31.7 million unrealized loss). The largest unrealized losses in the financial services sector were in the depository institutions sector ($345.3 million carrying value and $32.9 million unrealized loss) and the holding and other investment offices sector ($480.7 million carrying value and $30.8 million unrealized loss). The unrealized losses in the depository institutions sector are primarily due to a decrease in market liquidity and concerns regarding the underlying credit quality of subprime and other assets these institutions hold. The majority of securities in the holding and other investment offices sector are real estate investment trust bonds. The unrealized losses in this sector are primarily due to an increase in credit spreads due to the sector’s exposure to commercial real estate and market concerns about the ability to access the capital markets. The largest unrealized losses in the manufacturing sector were in the paper and allied products sector ($90.7 million carrying value and $10.0 million unrealized loss) and the printing and publishing sector ($31.9 million carrying value and $4.1 million unrealized loss). The unrealized losses in the paper and allied products sector and the printing and publishing sector are due to spread widening that is the result of weaker operating results. The unrealized losses in the remaining corporate sectors are also primarily attributable to spread widening due to a decrease in market liquidity, an increase in market volatility and concerns about the general health of the economy. Because we have the ability and intent to hold these investments until a recovery of fair value, which may be maturity, we do not consider these investments to be other-than-temporarily impaired at December 31, 2007.
Mortgage and asset-backed securities: The unrealized losses on mortgage and asset-backed securities totaled $102.6 million, or 35.8% of our total unrealized losses, and were caused primarily by concerns regarding mortgage defaults on subprime and other risky mortgages. There were also concerns regarding potential downgrades or defaults of bond insurers providing credit protection for underlying issuers. These concerns resulted in spread widening in the sector as liquidity decreased in the market. We purchased most of these investments at a discount to their face amount and the contractual cash flows of these investments are based on mortgages and other assets backing the securities. At December 31, 2007, our investment in subprime mortgages totaled $29.3 million, or 0.3% of our total fixed income portfolio. We also held investments with exposure to the Alt-A home equity loan sector, ($728.9 million carrying value and $55.8 million unrealized loss). All securities with subprime or Alt-A exposure, except for one are AAA rated. In addition, at December 31, 2007, $209.3 million of our mortgage and asset-backed securities were wrapped with credit enhancing insurance. We believe these securities were underwritten at investment grade excluding any credit enhancing protection. Because we have the ability and intent to hold these investments until a recovery of fair value, which may be maturity, we do not consider these investments to be other-than-temporarily impaired at December 31, 2007.
United States Government and agencies: The unrealized losses on U.S. Governments and agencies totaled $4.5 million, or 1.6% of our total unrealized losses, and were caused by spread widening. We purchased most of these investments at a discount to their face amount and the contractual cash flows of these investments are based on direct guarantees from the U.S. Government and by agencies of the U.S. Government. Because the decline in market value is attributable to changes in market interest rates and not credit quality, and because we have the ability and intent to hold these investments until a recovery of fair value, which may be maturity, we do not consider these investments to be other-than-temporarily impaired at December 31, 2007.
State, municipal and other governments: The unrealized losses on state, municipal and other governments totaled $15.1 million, or 5.2% of our total unrealized losses, and were primarily caused by general spread widening. We purchased most of these investments at a discount to their face amount and the contractual cash flows of these investments are based on the taxing authority of a municipality or the revenues of a municipal project. Because the decline in market value is attributable to increased spreads and not credit quality, and because we have the ability and intent to hold these investments until a recovery of fair value, which may be maturity, we do not consider these investments to be other-than-temporarily impaired at December 31, 2007.
We establish an allowance, consisting of specific reserves, for possible losses against our mortgage loan portfolio. There were no 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) requiring a valuation allowance at December 31, 2007, 2006 and 2005. An analysis of the allowance provided in 2005 is as follows:
The income on fixed maturity securities classified as trading represents unrealized gains (losses) relating to securities held as of December 31, 2006 and December 31, 2005 that matured in 2007.
Realized losses on fixed maturities totaling $4.3 million in 2007, $2.3 million in 2006 and $2.2 million in 2005 were incurred as a result of writedowns for other-than-temporary impairment of fixed maturity securities.
We have investments in variable interest entities for which we are not considered the primary beneficiary. These investments consist of a real estate limited partnership and certain mezzanine commercial real estate loans on real estate properties. The real estate limited partnership had revenues totaling $2.7 million for 2007, $3.2 million for 2006 and $2.8 million for 2005. There were two real estate projects in 2007, one in 2006 and three in 2005. Each real estate project has assets totaling less than $21.0 million at December 31, 2007, less than $5.0 million at December 31 2006 and less than $17.0 million at December 31, 2005. Our investments in these real estate projects were made during the period from 2002 to 2007. Our maximum exposure to loss is the carrying value of our investments which totaled $13.2 million at December 31, 2007 and $11.7 million at December 31, 2006 for the real estate limited partnership and $3.6 million at December 31, 2007 and $0.8 million at December 31, 2006 for the mezzanine commercial real estate loans.
During 2006, we sold our equity investment in Western Agricultural Insurance Company, an affiliate, at its fair market value of $7.9 million, to Farm Bureau Mutual Insurance Company (Farm Bureau Mutual), another affiliate. A realized gain of $1.9 million was recognized on this transaction.
No investment in any entity or its affiliates (other than bonds issued by agencies of the United States Government) exceeded ten percent of stockholders’ equity at December 31, 2007.
We have entered into six interest rate swaps to manage interest rate risk associated with a portion of our flexible premium deferred annuity contracts. Under the interest rate swaps, we pay a fixed rate of interest and receive a floating rate of interest on a notional amount totaling $300.0 million. These interest rate swaps effectively fix the interest crediting rate on a portion of our flexible premium deferred annuity contract liabilities thereby hedging our
exposure to increases in market interest rates. As described in Note 1, “Significant Accounting Policies - Accounting Changes,” we were required to undesignated these hedging relationships in the second quarter of 2007. As a result, the net interest rate settlements on the interest rate swaps are recorded as a component of derivative income beginning April 1, 2007. The interest rate settlements increased derivative income $2.9 million in 2007 and decreased interest sensitive product benefits $1.0 million in 2007, $3.7 million in 2006 and $1.0 million in 2005.
Beginning in 2006, we also entered into one interest rate swap to hedge the variable component of the interest rate on our line of credit borrowings. The terms of this swap provide that we pay a fixed rate of interest and receive a floating rate of interest on a notional amount of $46.0 million. Any gain or loss on the interest rate swap settlements offset any increase or decrease in the interest paid on the line of credit, effectively fixing our interest expense related to the outstanding debt on this line of credit. Interest expense decreased $0.3 million in 2007 and $0.2 million in 2006 as a result of the net interest settlements on this swap.
We assume index annuity business under a coinsurance agreement and write index annuities directly. Index annuities guarantee the return of principal to the contract holder and credit amounts based on a percentage of the gain in a specified market index. Most of the premium received is invested in investment grade fixed income securities and a portion of the premium received from the contract holder is used to purchase derivatives consisting of one-year or two-year call options on the applicable market indices to fund the index credits due to the index annuity contract holders. On the respective anniversary dates of the index annuity contracts, the market index used to compute the index credits is reset and new call options are purchased to fund the next index credit. Although the call options are designed to be effective hedges from an economic standpoint, they do not meet the requirements for hedge accounting treatment under Statement No. 133, “Accounting for Derivative Instruments and Hedging Activities.” Therefore, the change in fair value of the options is recognized in earnings in the period of change. The cost of the options can be managed through the terms of the index annuities, which permit changes to participation rates, asset fees and/or caps, subject to guaranteed minimums.
The reserve for index annuity contracts includes a series of embedded derivatives that represent the contract holder’s right to participate in index returns over the expected lives of the applicable contracts. The reserve includes the value of the embedded forward options despite the fact that call options are not purchased for a period longer than
We used the following methods and assumptions in estimating the fair value of our financial instruments.
Cash, short-term investments, other long-term investments and collateral held and payable for securities lending: The carrying amounts reported in the consolidated balance sheets for these instruments approximate their fair values.
Other assets and other liabilities: Fair values for the embedded derivatives in our modified coinsurance contracts under which we cede business are based on the difference between the fair value and the cost basis of the underlying fixed maturity securities. Other liabilities also include interest rate swaps with fair values based on quoted market prices. We are not required to estimate fair value for the remainder of the other assets or other liabilities balances.
In the normal course of business, we seek to limit our exposure to loss on any single insured or event and to recover a portion of benefits paid by ceding a portion of our exposure to other insurance enterprises or reinsurers. Our reinsurance coverage for life insurance varies according to the age and risk classification of the insured with retention limits ranging up to $1.1 million of coverage per individual life. New sales of certain term life products are reinsured on a first dollar quota share basis. We do not use financial or surplus relief reinsurance. Life insurance in force ceded on a consolidated basis totaled $8,482.8 million (20.6% of direct life insurance in force) at December 31, 2007 and $8,012.8 million (20.9% of direct life insurance in force) at December 31, 2006.
We participate in a reinsurance pool with various unaffiliated life insurance companies to mitigate the impact of a catastrophic event on our financial position and results of operations. Members of the pool share in the eligible catastrophic losses based on their size and contribution to the pool. Under the pool arrangement, we will be able to cede approximately 65% of catastrophic losses after other reinsurance and a deductible of $0.8 million. Pool losses are capped at $12.8 million per event and the maximum loss we could incur as a result of losses assumed from other pool members is $4.5 million per event.
Life insurance in force assumed on a consolidated basis totaled $1,573.7 million (4.6% of total life insurance in force) at December 31, 2007 and $1,626.5 million (5.1% of total life insurance in force) at December 31, 2006. Premiums and product charges assumed totaled $24.5 million in 2007, $26.0 million in 2006 and $24.8 million in 2005. Insurance benefits assumed totaled $9.7 million in 2007, $10.9 million in 2006 and $10.7 million in 2005.
Net amortization of the value of insurance in force acquired, based on expected future gross profits/margins, for the next five years and thereafter is expected to be as follows: 2008 - $2.6 million; 2009 - $2.6 million; 2010 - $2.7 million; 2011 - $2.5 million; 2012 - $2.3 million; and thereafter, through 2030 - $27.9 million.
We have a $60.0 million revolving line of credit agreement with LaSalle Bank National Association and Bankers Trust Company, N.A. This agreement is effective through October 31, 2010 and interest on any borrowings accrues at a variable rate (5.99% at December 31, 2007 and 6.12% at December 31, 2006). Under this agreement, we are required to meet certain financial covenants. In addition, we are prohibited from incurring additional indebtedness in excess of $25.0 million without prior approval from the banks while this line of credit is in effect. Debt outstanding on this line of credit totaled $46.0 million at December 31, 2007 and 2006.
In connection with the 2001 acquisition of Kansas Farm Bureau Life Insurance Company, 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. Each share of Series C preferred stock had a par value of $26.8404 and voting rights identical to that of Class A common stock. Dividends on the Series C preferred stock were payable quarterly at a rate equal to the regular cash dividends per share of common stock, as defined, then payable. We redeemed 1,687,000 shares, or $45.3 million, of the Series C preferred stock in January 2004 and 1,724,000 shares, or $46.3 million in December 2005. The Series C preferred stock was initially issued with conversion rights based upon certain contingencies not involving market price triggers. Both parties signed an agreement to waive these rights, so this instrument was not contingently convertible. The Series C preferred stock was issued at an $11.6 million discount to par. This discount accreted to interest expense during the life of the securities using the effective interest method.
Long-term debt includes $97.0 million of our subordinated debt obligation to FBL Financial Group Capital Trust (the Trust). 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 $97.0 million of 5% Preferred Securities issued by the Trust. FBL Financial Group, Inc. also has a $3.0 million equity investment in the Trust, which is netted against the Notes on the consolidated balance sheets due to a contractual right of setoff. 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 and are owned by AEL. As of December 31, 2007 and 2006, 97,000 shares of 5% Preferred Securities were outstanding, all of which we unconditionally guarantee.
Holders of the Class A common stock and Series B preferred stock vote together as a group in the election of Class A Directors (eight to ten). The Class B common stock votes as a separate class to elect the Class B Directors (five to seven). Voting for the Directors is noncumulative. In addition, various ownership aspects of our Class B common stock are governed by a Class B Shareholder Agreement which results in the IFBF, which owns 64% of our voting stock as of December 31, 2007, maintaining control of the Company. Holders of Class A common stock and Class B common stock receive equal per-share common stock dividends.
We participate with several affiliates and an unaffiliated organization in various multiemployer defined benefit plans. These plans cover substantially all our employees and the employees of the other participating companies who have attained age 21 and one year of service. Benefits are based on years of service and the employee’s compensation. One of these plans provides supplemental pension benefits to employees with salaries and/or pension benefits in excess of the qualified plan limits imposed by federal tax law. 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.
As multiemployer plans, the assets we contribute to the plans are commingled with the assets contributed by the other employers. Accordingly, unless noted otherwise, we do not separate the disclosure information below between amounts attributable to us and amounts attributable to the other employers. The measurement date for the plans is September 30. As mentioned in Note 1, “Significant Accounting Policies - Accounting Changes” beginning in 2008, the measurement date for the plans will be changed to December 31 as required by Statement No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB Statements No. 87, 88, 106 and 132(R).”
The plans’ funded status for all employers combined, compared to amounts recognized in our consolidated financial statements under rules for multiemployer plans follows:
As also mentioned in Note 1, Statement No. 158 does not require the recognition of an asset or liability in the consolidated balance sheets for the funded status of multiemployer plans. Under Statement No. 158, a liability totaling $53.3 million at December 31, 2007 and $78.8 million at December 31, 2006 would have been recorded for all employers for the underfunded status of the plans. The following table illustrates the incremental effect of applying Statement No. 158 at December 31, 2006 if the employers followed the single-employer accounting model.
Net periodic pension cost recorded in our consolidated income statements totaled $5.9 million in 2007, $6.4 million in 2006 and $7.8 million in 2005.
Information for pension plans with accumulated benefit obligations in excess of plan assets is as follows:
We estimate the discount rate by projecting and discounting future benefit payments inherent in the projected benefit obligation using a “spot’ yield curve known as the Citigroup Pension Discount Liability Index yield curve. This curve is constructed from the Treasury curve by adding option-adjusted spreads that are drawn from the double-A corporate sector of the Salomon Broad Investment-Grade Bond Index. The bonds with “excessive” call exposure are excluded, as well as securities with abnormal option-adjusted spreads. The final spreads are determined using this “call-protected” sample of double-A corporate bonds.
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. Costs are allocated among the affiliates on a basis of time incurred by the respective employees for each company. Expense related to the plan totaled $1.0 million in 2007 and $0.9 million in 2006 and 2005.
We have established deferred compensation plans for certain key current and former employees and have certain other benefit plans which provide for retirement and other benefits. Liabilities for these plans are accrued as the related benefits are earned.
In addition to benefits offered under the aforementioned benefit plans, we and several other affiliates sponsor a plan that provides group term life insurance benefits to retirees who have worked full-time for ten years and attained age 55 while in service. Postretirement benefit expense for this plan is allocated in a manner consistent with pension expense discussed above. We also have two single employer plans that provide health and medical benefits to retirees. See Note 1, “Significant Accounting Policies - Accounting Changes,” for additional details regarding the impact of adopting Statement No. 158 for these plans. Postretirement benefit expense aggregated $0.1 million in 2007 and 2006 and $0.2 million in 2005.
Represents the difference between the stock price and exercise price for each option, excluding options where the exercise price is above the stock price, at December 31, 2007.
The weighted average grant-date fair value of options granted per common share was $9.27 for 2007, $8.64 for 2006 and $8.86 for 2005. The intrinsic value of options exercised during the year totaled $5.4 million for 2007, $6.9 million for 2006 and $5.0 million for 2005.
We issue new shares to satisfy stock option exercises. We do not have a policy of repurchasing shares on the open market to satisfy share-based payment arrangements. Cash received from stock options exercised totaled $5.9 million for 2007, $6.6 million for 2006 and $5.1 million for 2005. The actual tax benefit realized from stock options exercised totaled $1.6 million for 2007, $2.0 million for 2006 and $1.5 million for 2005.
We also grant restricted Class A common shares to certain executives. The restrictions on this stock lapse and the stock vests if we meet or exceed operating goals, such as earnings per share and return on equity targets within or during a three year period. Depending on performance, the actual amount of shares issued could range from zero to 100% of the granted amount. The value of the awards is based on the grant date fair value of the restricted stock adjusted for expected forfeitures and an estimate of the number of shares expected to vest. The estimate for the number of shares to vest is reviewed each period and the impact of any changes in the estimate on expense is recorded in the current period. These awards are charged to expense using the straight-line method over the required service period. Dividends on the restricted stock during the restriction period are currently contingent upon vesting.
At December 31, 2007, shares of Class A common stock available for grant as additional awards under the Class A Common Stock Compensation Plan totaled 4,409,078.
We leased office space from Farm Bureau Mutual through December 2005. Related lease expense totaled $0.8 million in 2005.
We have marketing agreements with the Farm Bureau property-casualty companies operating within our marketing territory, including Farm Bureau Mutual and another affiliate. Under the marketing agreements, the property-casualty companies are responsible for development and management of our agency force for a fee. We incurred expense totaling $7.6 million in 2007, $7.2 million in 2006 and $7.3 million in 2005 relating to these arrangements.
We are licensed by the IFBF to use the “Farm Bureau” and “FB” designations in Iowa. In connection with this license, we incurred royalty expense totaling $0.4 million in 2007, 2006 and 2005. We have similar arrangements with the Kansas Farm Bureau and other state Farm Bureau organizations in our market territory. Total royalty expense to Farm Bureau organizations other than the IFBF totaled $1.3 million in 2007, $1.2 million in 2006 and $1.1 million in 2005.
Prior to 2006, we had an administrative services agreement with a subsidiary of AEL under which we provided investment accounting and claims processing, accounting, compliance and other administrative services. Fee income from performing these services totaled $0.4 million in 2005.
We lease our home office properties under a 15-year operating lease from a wholly-owned subsidiary of the IFBF. Future remaining minimum lease payments under this lease, as of December 31, 2007, are as follows: 2008 - $2.6 million; 2009 - $2.7 million; 2010 - $2.7 million; 2011 - $2.7 million; 2012 - $2.7 million and 2013 - $0.7 million. Rent expense for the lease totaled $3.1 million in 2007, $3.0 million in 2006 and $3.1 million in 2005. These amounts are net of $1.4 million in 2007, 2006 and 2005 in amortization of a deferred gain on the exchange of our home office properties for common stock in 1998. The remaining unamortized deferred gain totaled $7.3 million at December 31, 2007 and $8.7 million at December 31, 2006.
Options to purchase 325,434 shares of common stock in 2006 at $25.60 to $39.48 per share were outstanding during 2006 but were not included in the computation of 2006 diluted earnings per share because the options were antidilutive to the calculation. The options, which expire through 2016, were still outstanding at December 31, 2006.
held directly by the Life Companies are recorded as a component of derivative income rather than, prior to 2006, directly to surplus; (c) acquisition costs of acquiring new business are deferred and amortized over the life of the policies rather than charged to operations as incurred; (d) future policy benefit reserves for participating traditional life insurance products are based on net level premium methods and guaranteed cash value assumptions which may differ from statutory reserves; (e) future policy benefit reserves on certain interest sensitive products are based on full account values, rather than discounting methodologies utilizing statutory interest rates; (f) net realized gains or losses attributed to changes in the level of market interest rates are recognized as gains or losses in the statements of income when the sale is completed rather than deferred and amortized over the remaining life of the fixed maturity security or mortgage loan; (g) the established formula-determined statutory investment reserve, changes in which are charged directly to surplus, is not recorded as a liability; (h) certain deferred income tax assets, agents’ balances and certain other assets designated as “nonadmitted assets” for statutory purposes are reported as assets rather than being charged to surplus; (i) revenues for interest sensitive, indexed and variable products consist of policy charges for the cost of insurance, policy administration charges, amortization of policy initiation fees and surrender charges assessed rather than premiums received; (j) pension income or expense is recognized for all employees in accordance with Statement No. 87, “Employers’ Accounting for Pensions” rather than for vested employees only; (k) the financial statements of subsidiaries are consolidated with those of the insurance subsidiary rather than being accounted for under the equity method, and (l) assets and liabilities are restated to fair values when a change in ownership occurs that is accounted for as a purchase, with provisions for goodwill and other intangible assets, rather than continuing to be presented at historical cost.
The ability of the Life Companies 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. An annual dividend limitation is defined under the Iowa Insurance Holding Company Act as any dividend or distribution of cash or other property whose fair market value, together with that of other dividends or distributions made within the preceding 12 months, exceeds the greater of (i) 10% of policyholders’ surplus (total statutory capital stock and statutory surplus) as of December 31 of the preceding year, or (ii) the statutory net gain from operations of the insurer for the 12-month period ending December 31 of the preceding year. During 2008, the maximum amount legally available for distribution to FBL Financial Group, Inc. without further regulatory approval is $51.7 million for Farm Bureau Life and $39.2 million for EquiTrust Life.
We use operating income, in addition to net income, to measure our performance since realized and unrealized gains and losses on investments and the change in net unrealized gains and losses on derivatives can fluctuate greatly from quarter to quarter. Also, the cumulative effect of changes in accounting principles, discontinued operations and the lawsuit settlement in 2006 are nonrecurring items. These fluctuations make it difficult to analyze core operating trends. In addition, for derivatives not designated as hedges, there is a mismatch between the valuation of the asset and liability when deriving net income. Specifically, call options relating to our index business are one or two-year assets while the embedded derivative in the index contracts represents the rights of the contract holder to receive index credits over the entire period the index annuities are expected to be in force. For our other embedded derivatives in the product segments and interest rate swaps backing our annuity liabilities, the derivatives are marked to market, but the associated insurance liabilities are not marked to market. A view of our operating performance without the impact of these mismatches and nonrecurring items enhances the analysis of our results. We use operating income for goal setting, determining company-wide bonuses and evaluating performance on a basis comparable to that used by many in the investment community.
The differences between the derivative income (loss) by quarter primarily correspond to the performance of the indices upon which our call options are based and the timing of option settlements. These differences are partially offset by changes to the embedded derivatives in index contracts included in benefits and expenses. The net impact of changes in unrealized gains and losses on derivates on net income is as follows: