The Company also leases office space totaling approximately 16,000 square feet for a service center in Denver, Colorado. This space is in facilities owned by Colorado Farm Bureau Mutual Insurance Company, a related party.
(2) During 1994, the Company ceased writing medical insurance business. As a result, accident and health premiums decreased $48.4 million in 1994 compared to 1993. The Company continues to sell individual disability income insurance.
(3) The earnings per common share amounts prior to 1997 have been restated as required to comply with Statement of Financial Accounting Standards No. 128, "Earnings Per Share." For further discussion of earnings per common share and the impact of Statement No. 128, see Note 13 of Notes to Consolidated Financial Statements.
(4) The Company recognized net income (loss) related to its discontinued cable television operations of $6.5 million, or $0.28 per share and $(2.9) million, or $(0.16) per share for the years ended December 31, 1994 and 1993, respectively.
(5) Excludes unrealized appreciation (depreciation) of fixed maturity securities, net (after 1993).
(6) Adjusted operating income equals net income adjusted to eliminate certain items which management believes are not indicative of operating trends because they are unusual and/or nonrecurring in nature, including the impact of realized gains on investments, discontinued operations and net income (loss) from a venture capital investment company subsidiary. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Adjusted Operating Income."
(8) Statutory capital and surplus reflects amounts related to Farm Bureau Life Insurance Company and Western Farm Bureau Life Insurance Company (after 1993) only and does not include the Asset Valuation Reserve or Interest Maintenance Reserve for the appropriate years.
(9) Net statutory premiums as presented for statutory reporting purposes include premiums collected from annuities and universal life-type products. For GAAP reporting, such premiums received are not reported as revenues.
(11) Expense ratio equals all statutory expenses, including policyholder dividends and excluding loss and loss adjustment expenses, divided by statutory net written premiums.
(12) Combined ratio equals the sum of the loss and loss adjustment expense and expense ratios.
THE FOLLOWING ANALYSIS OF THE CONSOLIDATED RESULTS OF OPERATIONS AND FINANCIAL CONDITION OF THE COMPANY SHOULD BE READ IN CONJUNCTION WITH THE CONSOLIDATED FINANCIAL STATEMENTS AND RELATED NOTES INCLUDED ELSEWHERE HEREIN. UNLESS NOTED OTHERWISE, ALL REFERENCES INCLUDED HEREIN TO THE COMPANY INCLUDE ALL OF ITS DIRECT AND INDIRECT SUBSIDIARIES, INCLUDING ITS PRIMARY LIFE INSURANCE SUBSIDIARIES, FARM BUREAU LIFE INSURANCE COMPANY (FARM BUREAU LIFE) AND WESTERN FARM BUREAU LIFE INSURANCE COMPANY (WESTERN LIFE) (COLLECTIVELY, THE LIFE COMPANIES) AND ITS PROPERTY-CASUALTY INSURANCE SUBSIDIARY, UTAH FARM BUREAU INSURANCE COMPANY (UTAH INSURANCE).
For variable universal life and variable annuities, premiums received are not reported as revenues. Similar to universal life and ordinary annuities, revenues reported consist of fee income and product charges collected from the policyholders. Expenses related to these products include benefit claims incurred in excess of policyholder account balances.
PROPERTY-CASUALTY OPERATIONS. The Company's property-casualty product lines and the percentage of property-casualty premiums associated with such lines for 1997 were as follows: automobile (55.1%), farm and ranch owners (14.2%), homeowners (9.2%), crop (5.6%), workers' compensation (4.7%), reinsurance assumed (4.6%) and other (6.6%).
Property-casualty business written by Utah Insurance is currently pooled with business written by Farm Bureau Mutual Insurance Company and three other property-casualty affiliates (hereinafter, the Farm Bureau Mutual pool). Under the terms of the reinsurance agreement, Utah Insurance and the other affiliates cede to Farm Bureau Mutual Insurance Company all of their insurance business and assume back from Farm Bureau Mutual Insurance Company an amount equal to their participation in the pooling agreement. Also, losses, loss adjustment expenses, and other underwriting and administrative expenses are prorated among the companies on the basis of their participation in the pooling agreement. Through December 31, 1995, Utah Insurance's participation in the Farm Bureau Mutual pool (which only included three companies at the time) was 8%. On June 30, 1996, Utah Insurance's share of the pool was increased to 20%, retroactive to January 1, 1996. Effective January 1, 1997, Western Agricultural Insurance Company and Western Farm Bureau Mutual Insurance Company, two affiliates of the Company, became full participants in the Farm Bureau Mutual pool and Utah Insurance's pool participation percentage decreased from 20% to 18%. Accordingly, the property-casualty results included in the statement of operations include that amount applicable to 8% of the Farm Bureau Mutual pool for the year ended December 31, 1995 and six months ended June 30, 1996, 20% of the Farm Bureau Mutual pool for the six month period ended December 31, 1996 and 18% of the Farm Bureau Mutual pool for the year ended December 31, 1997. Participation in the development of loss and loss adjustment expense reserves during the periods remain at the rate in effect when the underlying claims were incurred. In addition, effective January 1, 1997, the reinsurance pool no longer includes reinsurance assumed from reinsurance intermediaries and certain other insurance companies. As a result, beginning January 1, 1997, Utah Insurance has eliminated its exposure to coastal catastrophes.
Utah Insurance's premium volume in 1997 was not significantly impacted by the decrease in reinsurance pool participation from 20% to 18% or the elimination of certain reinsurance assumed business from the pool due to the increase in the size of the pool with the addition of Western Agricultural Insurance Company and Western Farm Bureau Mutual Insurance Company.
SEGMENT INFORMATION. The Company's revenues and net income are primarily derived from its life insurance segment. For information concerning amounts of revenue, operating profit and loss and identifiable assets attributable to each of the Company's segments, see Note 14 of Notes to Consolidated Financial Statements.
Realized gains on investments decreased $11.8 million to $41.0 million for 1997 compared to $52.8 million for 1996. The 1997 and 1996 gains resulted primarily from the sale of equity securities. Realized gains during 1997 were partially offset by $23.8 million in realized losses resulting from writedowns of investments that became other-than-temporarily impaired during 1997. These writedowns are attributable primarily to four equity securities and are the result of sustained operating losses, unsuccessful efforts to raise capital, rejection of product design by regulatory authorities and various other economic factors that became evident during 1997. The level of realized gains is subject to fluctuation from period to period depending on the prevailing interest rate and economic environment and the timing of the sale of investments.
Other income increased $4.7 million, or 19.7%, to $28.6 million for 1997 compared to $23.9 million for 1996 due primarily to an increase in the level of leasing, management and financial services provided to affiliates and third parties. In addition, during 1997 the company increased the investment advisory rate charged for certain types of investments.
Other underwriting, acquisition and insurance expenses increased $7.3 million, or 17.3%, to $49.0 million for 1997 compared to $41.7 million for 1996. Expenses attributable to property-casualty operations increased $2.5 million due primarily to the changes in Utah Insurance's reinsurance pool participation. Amortization of value of insurance in force acquired increased $1.6 million in 1997 compared to 1996 due to the impact of realized gains and losses on investments backing the related policyholder liabilities. In connection with the adoption of a new accounting pronouncement during 1997, the Company established a reserve for future assessments from guarantee fund associations and certain other entities which resulted in a $1.8 million increase in insurance expenses. In addition, the Company incurred $1.0 million in consulting fees during 1997, including $0.3 million allocated to the property-casualty segment, in connection with the modification of its computer systems to help ensure the systems are Year 2000 compliant. See "Impact of Year 2000".
Pretax income before minority interest and equity income decreased $1.6 million, or 1.4%, to $115.3 million for 1997 compared to $116.9 million for 1996. Pretax income was generated principally from the life insurance segment as the property-casualty segment experienced pretax income of $0.7 million in 1997 and a pretax loss of $2.0 million in 1996. The decrease in pretax income from life operations is primarily the result of the impact of realized gains on investments.
Equity income, net of related income taxes, decreased $2.3 million, or 52.0%, to $2.1 million during 1997 compared to $4.4 million for 1996. Equity income includes the Company's proportionate share of gains and losses on investments owned by the underlying partnerships and joint ventures. The level of these gains and losses is subject to fluctuation from period to period depending on the prevailing economic environment and the timing of the sale of investments held by the partnerships and joint ventures.
Net income applicable to common stock decreased $6.9 million, or 8.7%, to $73.7 million for 1997 compared to $80.6 million for 1996. The decrease was partially the result of the changes in pretax and equity income discussed above. Contributing to the decrease in net income applicable to common stock is a $2.8 million increase in dividends on company-obligated madatorily redeemable preferred stock of subsidiary trust resulting from the issuance of these securities on May 30, 1997. During 1998, it is expected that dividends on the mandatorily redeemable preferred stock will increase approximately $2.1 million, to $4.9 million. This increase is expected to be offset by a $2.0 million decrease in dividends on Series A and B preferred stock to $0.2 million for 1998. See "Liquidity and Capital Resources - FBL Financial Group, Inc." and Note 2 of Notes to Consolidated Financial Statements.
Premiums and product charges increased $21.4 million, or 14.4%, to $169.4 million for 1996 compared to $148.0 million for 1995. This increase included a $7.2 million, or 8.4%, increase in traditional life insurance and accident and health premiums which, management believes, is principally attributable to implementation of a new incentive agent compensation program effective January 1, 1996, introduction of a uniform portfolio of life insurance and annuity products throughout the Company's marketing territory in March 1996 and more effective and increased training of its agency force. Interest sensitive product charges decreased $0.1 million, or 0.2%, to $43.7 million for 1996 principally due to decreases in cost of insurance rates ranging from 4% to 12% (approximately $2.7 million) which took effect March 14, 1996, and a decrease in the amortization of unearned revenues. These decreases were partially offset by growth in the volume of business in force and a $0.8 million increase in fees on premium deposits as a result of an increase in receipts from interest sensitive products. Property-casualty premiums increased $14.3 million, or 76.3%, primarily due to the increase in Utah Insurance's reinsurance pool participation percentage from 8% to 20%, which resulted in $14.4 million of additional premiums during 1996. This increase was partially offset by the Company's nonrenewal of certain unaffiliated reinsurance assumed contracts and premium rate decreases on workers' compensation insurance which collectively totaled approximately $0.4 million.
Realized gains on investments increased $46.9 million, or 797.4%, to $52.8 million for 1996 compared to $5.9 million for 1995. The increase resulted primarily from a $50.4 million gain from sales of a portion of one equity investment during 1996. The level of realized gains is subject to fluctuation from period to period depending on the prevailing interest rate and economic environment and the timing of the sale of investments.
Amortization of deferred policy acquisition costs increased $4.8 million, or 44.6%, to $15.5 million for 1996 compared to $10.7 million for 1995 principally due to the increase in Utah Insurance's reinsurance pool participation which resulted in $3.8 million of additional amortization during 1996. In addition, amortization increased due to a greater volume of business in force and an increase in the emergence of profits on the underlying business. Partially offsetting these increases was a $1.8 million reduction in amortization due to the impact of realized gains and losses on investments backing the related policyholder liabilities.
The following table reflects net income adjusted to eliminate certain items which management believes are not indicative of overall operating trends, including net realized gains on investments (less that portion of amortization of deferred policy acquisition costs, unearned revenue reserve, value of insurance in force acquired and income taxes attributable to such gains) and net income from a venture capital investment company subsidiary.
FBL Ventures was a wholly owned investment company subsidiary of Farm Bureau Life which invested in start-up and mezzanine level venture capital investments in various sectors. Operating results of FBL Ventures were recognized in accordance with accounting principles for investment companies and, as such, unrealized and realized gains and losses on investments were included in net investment income. Because of the venture capital nature of the underlying investments, the results of FBL Ventures tended to fluctuate significantly from year to year and needed to be evaluated over a much longer period of time. Therefore, the net income attributable to FBL Ventures has not been included in adjusted operating income.
During the first quarter of 1998, the Company's Board of Directors approved a transaction whereby the Company will exchange its home office properties for 1,268,056 unregistered shares of Class A common stock owned by the Iowa Farm Bureau Federation, the Company's majority shareholder. The value of the transaction is $45.7 million, or $36.00 per common share. As a result of the exchange, the common shares outstanding at December 31, 1997 will decrease 1,268,056, or approximately seven percent.
The Company will lease a portion of the properties back from the Iowa Farm Bureau Federation under a 15-year operating lease. A gain on the transaction of approximately $21.0 million will be deferred by the Company and recognized over the term of the operating lease. During 1997, the Company earned $3.1 million in rental income from the property and incurred related operating expenses and depreciation charges totaling $4.8 million. During 1998, it is estimated the Company's annual lease expense, net of rental income from subleases with certain affiliates, will total approximately $3.8 million.
The transaction is structured as a tax-free exchange of a real estate subsidiary. Farm Bureau Life will transfer a subsidiary which owns the buildings to FBL Financial Group in the form of a dividend. FBL Financial Group will then exchange the real estate subsidiary's common stock for the Class A common stock. The real estate subsidiary has no assets or operations other than the home office properties. The dividend from Farm Bureau Life has been approved by the Insurance Division, Department of Commerce, State of Iowa. See "Liquidity and Capital Resources - FBL Financial Group, Inc.".
The purchase of Series A preferred stock and simultaneous issuance of Series B preferred stock and 5% Preferred Securities were noncash transactions. Except for the maturity of the Notes on June 1, 2047, the parent company's future cash flow requirements were not changed significantly by the aforementioned transactions. See Note 2 of Notes to Consolidated Financial Statements for additional information.
FBL Financial Group, Inc. relies primarily on dividends from the Life Companies to make any dividend payments to its stockholders and interest payments on its Notes. The ability of the Life Companies to pay dividends to FBL Financial Group, Inc. is limited by law to earned profits (statutory unassigned surplus) as of the date the dividend is paid, as determined in accordance with accounting practices prescribed by insurance regulatory authorities of the State of Iowa for Farm Bureau Life and the State of Colorado for Western Life. In addition, under the Iowa and Colorado Insurance Holding Company Acts, the Life Companies may not pay an "extraordinary" dividend without prior notice to and approval by the respective insurance commissioner. An "extraordinary" dividend is defined under the Iowa and Colorado Insurance Holding Company Acts as any dividend or distribution of cash or other property whose fair market value, together with that of other dividends or distributions made within the preceding 12 months, exceeds the greater of (i) 10% of policyholders' surplus (total statutory capital stock and statutory surplus) as of December 31 of the preceding year, or (ii) the statutory net gain from operations of the insurer for the 12-month period ending December 31 of the preceding year. During 1998, the maximum amount legally available for distribution to FBL Financial Group, Inc. without further regulatory approval is approximately $37.8 million from Farm Bureau Life (before giving effect to the dividend of the home office properties which has a value of $45.7 million), and $9.0 million from Western Life. Similar restrictions exist with respect to the payments of dividends by Utah Insurance. Such restrictions are not considered to bear significantly on the ability of the Company to meet its obligations or its anticipated dividends.
Management anticipates that funds to meet its short-term and long-term capital expenditures, cash dividends to stockholders and operating cash needs will come from existing capital and internally generated funds. Management believes that the current level of cash and available-for-sale and short-term securities, combined with expected net cash inflows from operations, maturities of fixed maturity investments, principal payments on mortgage and asset-backed securities, mortgage loans and its insurance products, are adequate to meet the Company's anticipated cash obligations for the foreseeable future. Notwithstanding the above, management currently anticipates refinancing the Company's $24.5 million lease-backed note payable that is due August, 1999.
The Company's investment portfolio is managed by its internal investment professionals. The investment strategy is designed to achieve superior risk-adjusted returns consistent with the Company's investment philosophy of maintaining a largely investment grade portfolio and providing adequate liquidity for expected liability durations and other requirements. Management continually reviews the returns on invested assets and changes the mix of invested assets as deemed prudent under the current market environment to help maximize current income. In addition, management monitors the cash flow characteristics of the investment portfolio to help ensure funds are available to satisfy policyholder and other obligations.
As of December 31, 1997, 95.3% (based on carrying value) of the fixed maturity securities were investment grade debt securities, defined as being in the highest two National Association of Insurance Commissioners (NAIC) designations. Non-investment grade debt securities generally provide higher yields and involve greater risks than investment grade debt securities because their issuers typically are more highly leveraged and more vulnerable to adverse economic conditions than investment grade issuers. In addition, the trading market for these securities is usually more limited than for investment grade debt securities. The Company regularly reviews the percentage of its portfolio which is invested in non-investment grade debt securities (NAIC designations 3 through 6). As of December 31, 1997, the Company's investment in non-investment grade debt was 4.7% of fixed maturity securities. At that time no single non-investment grade holding exceeded 0.3% of total investments.
(1) 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 the Company's portfolio.
At December 31, 1997, the Company held residential collateralized mortgage obligation (CMO) investments with a market value of $597.8 million as part of its mortgage-backed securities holdings. CMOs consist of pools of mortgages divided into sections or "tranches" which provide sequential retirement of the bonds. To provide call protection and more stable average lives, the Company invests in planned amortization classes (PACs), which provide more predictable cash flows within a range of prepayment speeds (e.g., the rate of individuals refinancing their home mortgages at lower rates) by shifting the prepayment risks to support tranches. The Company also invests in sequential tranches, which provide stability in that repayments of principal do not occur until the previous tranches are paid off. As of December 31, 1997, 80.4% of the Company's CMO investments are in PAC and sequential pay securities. The Company does not purchase certain types of collateralized mortgage obligations which it believes subjects the investment portfolio to greater than average risk. These include, but are not limited to, interest only, principal only, floater, inverse floater, PAC II, Z and support tranches.
During 1997, the Company invested $25.0 million in an unaffiliated life insurance company and $8.3 million in a broker-dealer in connection with alliances to sell variable insurance and variable annuity products. These investments are the primary reason for the $27.2 million increase in securities and indebtedness of related parties to $64.4 million at December 31, 1997 from $37.2 million at December 31, 1996. Deferred policy acquisition costs increased $18.3 million, or 10.9%, due principally to the capitalization of costs incurred with new sales. Assets held in separate accounts increased $59.4 million, or 75.1%, to $138.4 million at December 31, 1997 due primarily to net transfers to the separate accounts resulting from sales of the Company's variable products and appreciation in the value of separate account investments. At December 31, 1997, the Company had total assets of $3,601.5 million, a 6.9% increase from total assets at December 31, 1996.
Policy liabilities and accruals increased $95.9 million, or 4.2%, due primarily to an increase in the volume of life insurance business in force. At December 31, 1997, the Company had total liabilities of $2,894.7 million, a 6.2% increase from total liabilities at December 31, 1996. Minority interest in subsidiaries increased $96.7 million to $101.5 million at December 31, 1997, as a result of the issuance of 5% Preferred Securities during May 1997. See "Liquidity and Capital Resources - FBL Financial Group, Inc." and Note 2 of Notes to Consolidated Financial Statements for more information regarding this transaction.
In June 1997, the Financial Accounting Standards Board (FASB) issued Statement No. 131, "Disclosure about Segments of an Enterprise and Related Information". Statement No. 131 establishes standards for reporting information about operating segments, products and markets. Generally, Statement No. 131 requires financial information to be reported on the basis on which it is used internally for evaluating segment performance and deciding how to allocate resources to segments. Under Statement No. 131, it is anticipated that the Company will continue to report two primary operating segments: life and property-casualty. However, the non-insurance support operations, including investment advisory, marketing and distribution and leasing services, will no longer be part of the life insurance segment. While each of these non-insurance operations constitute a separate segment under the new rules, their operations do not currently meet the statement's quantitative thresholds for separate segment reporting. Accordingly, it is anticipated that such non-insurance operations will be aggregated and disclosed in total. While earlier application is allowed, Statement No. 131 is effective for and will be adopted in the fourth quarter of 1998.
The NAIC is in the process of codifying statutory accounting practices (Codification). Codification will likely change, to some extent, prescribed statutory accounting practices and may result in changes to the accounting practices that the Company's insurance subsidiaries use to prepare their statutory-basis financial statements. Codification, which is expected to be approved by the NAIC in 1998, will require adoption by the various state insurance departments before it becomes the prescribed statutory basis of accounting for insurance companies domesticated within those states. Accordingly, before Codification becomes effective for the Company's insurance subsidiaries, the respective states of domicile must adopt Codification as the prescribed basis of accounting on which domestic insurers must report their statutory-basis results. At this time it is unclear whether the respective states of domicile will adopt Codification.
Many of the Company's computer programs were originally written using two digits rather than four to define a particular year. As a result, these computer programs have time-sensitive software that may recognize a date using "00" as the year 1900 rather than the year 2000. This could cause a system failure or miscalculations causing disruptions to operations, including, but not limited to, a temporary inability to process transactions, send premium notices and calculate policy reserves and accruals.
The costs of the project and the date on which the Company believes it will complete the Year 2000 modifications are based on management's best estimates, which were derived utilizing numerous assumptions of future events, including the continued availability of certain resources, third party modification plans and other factors. However, there can be no guarantees that these estimates will be achieved and actual results could differ materially from those anticipated. Specific factors that might cause such material differences include, but are not limited to, the availability and cost of personnel trained in this area, the ability to locate and correct all relevant computer codes and similar uncertainties.
The Company does not believe that inflation has had a material effect on its consolidated results of operations. The Company attempts to invest new funds in securities with expected durations that match the related policyholder obligations to reduce its exposure to interest rate fluctuations. In general, the market value of the Company's fixed maturity and mortgage loan portfolios increase or decrease in inverse relationship with fluctuations in interest rates, and the yield realized by the Company on new investments increases or decreases in direct relationship with interest rate changes.
From time to time, the Company may publish forward-looking statements relating to such matters as anticipated financial performance, business prospects, new products, and similar matters. The Private Securities Litigation Reform Act of 1995 provides a safe harbor for forward-looking statements. In order to comply with the terms of the safe harbor, the Company notes that a variety of factors could cause the Company's actual results and experiences to differ materially from the anticipated results or other expectations expressed in the Company's forward-looking statements. The risks and uncertainties that may affect the operations, performance, development and results of the Company's business, in addition to those identified under "Impact of Year 2000", include the following:
FBL FINANCIAL GROUP, INC. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
Consolidated Balance Sheets............................................... 40 Consolidated Statements of Income......................................... 42 Consolidated Statements of Changes in Stockholders' Equity................ 43 Consolidated Statements of Cash Flows..................................... 44 Notes to Consolidated Financial Statements................................ 46
The management of FBL Financial Group, Inc. is responsible for the integrity of the financial information contained in this annual report. The accompanying consolidated financial statements have been prepared in accordance with generally accepted accounting principles appropriate in the circumstances and have been audited by Ernst & Young LLP. A copy of their audit opinion follows this letter. The financial information contained elsewhere in this annual report is consistent with that of the financial statements except for information described as being in accordance with statutory accounting practices.
The Audit Committee of the Board of Directors, composed solely of nonmanagement directors, meets periodically with management, internal auditors and Ernst & Young LLP to review internal accounting control, audit activities and financial reporting matters. The internal auditors and Ernst & Young LLP have free access to the Audit Committee, with and without the presence of management, to discuss the adequacy of internal control and to review the quality of financial reporting.
We have audited the accompanying consolidated balance sheets of FBL Financial Group, Inc. as of December 31, 1997 and 1996, 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, 1997. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
FBL Financial Group, Inc. (the Company) operates predominantly in the life insurance industry through its principal subsidiaries, Farm Bureau Life Insurance Company (Farm Bureau Life) and Western Farm Bureau Life Insurance Company (Western Life). The Company currently markets its products, which consist primarily of individual life insurance policies and annuity contracts, to Farm Bureau members and other individuals and businesses in 15 midwestern and western states. Several subsidiaries support various functional areas of Farm Bureau Life, Western Life and other affiliates, by providing investment advisory, marketing and distribution, and leasing services. As these functions relate directly to the primary business activities, these entities have been included in the life insurance business segment.
The Company also owns Utah Farm Bureau Insurance Company (Utah Insurance), a property-casualty insurance company providing individual and small business coverages. The operations of Utah Insurance have been treated as a separate segment for financial reporting purposes.
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.
Investment real estate is reported at cost less allowances for depreciation. Real estate acquired through foreclosure, which is included with investment real estate in the consolidated balance sheet, 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 fair value as determined at or before 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, a valuation allowance is established for the difference. This valuation allowance can be reduced or eliminated should the fair value of the property increase. Changes in this valuation allowance are recognized as realized gains or losses on investments. At December 31, 1997 and 1996, the Company had valuation allowances on its investment real estate totaling $0.1 million and $0.3 million, respectively.
For participating traditional life insurance and interest sensitive products (principally universal life insurance policies and annuity contracts), these costs are being amortized generally in proportion to expected gross profits (after dividends to policyholders, if applicable) from surrender charges and investment, mortality, and expense margins. That amortization is adjusted retrospectively when estimates of current or future gross profits/margins (including the impact of investment gains and losses) to be realized from a group of products are revised. For nonparticipating traditional life and accident and health insurance products, these costs are amortized over the premium paying period of the related policies, in proportion to the ratio of annual premium revenues to total anticipated premium revenues. Such anticipated premium revenues are estimated using the same assumptions used for computing liabilities for future policy benefits. The deferred policy acquisition costs for property-casualty insurance are amortized over the effective period of the related insurance policies; deferred policy acquisition costs for these policies are charged to expense when such costs are deemed not to be recoverable from the related unearned premiums and any related investment income.
Goodwill represents the excess of the fair value of assets exchanged over the net assets acquired. Goodwill is generally being amortized on a straight-line basis over a period of 20 years. The carrying value of goodwill is regularly reviewed for indicators of impairment in value, which in the view of management are other than temporary. If facts and circumstances suggest that goodwill is impaired, the Company assesses the fair value of the underlying business and reduces goodwill to an amount that results in the book value of the underlying business approximating fair value. The Company has not recorded any such writedowns during the years ended December 31, 1997, 1996 or 1995.
The liability for future policy benefits for participating traditional life insurance is based on net level premium reserves, including assumptions as to interest, mortality, and other assumptions underlying the guaranteed policy cash values. Reserve interest assumptions are level and range from 2.5% to 6.0%. The average rate of assumed investment yields used in estimating gross margins was 8.15% in 1997, 8.34% in 1996 and 8.14% in 1995. Accrued dividends for participating business are established for anticipated amounts earned to date for the period through the policy's next anniversary and are provided for as a separate liability. The declaration of future dividends for participating business is at the discretion of the Board of Directors. Participating business accounted for 42% of receipts from policyholders during the year ended December 31, 1997 and represented 19% of life insurance inforce at December 31, 1997.
Future policy benefit reserves for interest sensitive products are computed under a retrospective deposit method and represent policy account balances before applicable surrender charges. Policy benefits and claims that are charged to expense include benefit claims incurred in the period in excess of related policy account balances.
Salvage and subrogation recoverables are estimated using statistical analysis. The salvage and subrogation recoverable amounts, which have been offset against reserves on property-casualty policies in the accompanying consolidated balance sheets, were $1.6 million and $1.2 million at December 31, 1997 and 1996, respectively.
From time to time assessments are levied on the Company's insurance subsidiaries by guaranty associations in most states in which the subsidiaries are licensed. These assessments are to cover losses of policyholders of insolvent or rehabilitated companies. In some states, these assessments can be partially recovered through a reduction in future premium taxes. During 1997, the Company adopted Statement of Position (SOP) 97-3, "Accounting by Insurance and Other Enterprises for Insurance-Related Assessments", which requires the accrual of such assessments. Prior to 1997, the Company recognized its obligation for guarantee fund assessments when such assessments were received and an asset was recorded for future premium tax offsets on assessments paid. The impact of adopting SOP 97-3 was not separately reported as a change in accounting principles because the impact of adoption was not material to the Company.
Property-casualty insurance premiums are recognized using a daily or monthly pro rata method over the terms of the policies.
On March 12, 1996, the Company's stockholders approved a change to the Company's capital structure and a related revision to the Company's Articles of Incorporation (the Recapitalization). The restated Articles of Incorporation authorize the Company to issue 88,500,000 shares of Class A common stock, without par value; 1,500,000 shares of Class B common stock, without par value, and 10,000,000 shares of preferred stock. Pursuant to the Recapitalization, each outstanding share of common stock prior to Recapitalization was converted on a pro rata basis to 1,900 shares of Class A common stock and 100 shares of Class B common stock.
On March 18, 1997, the Company's Board of Directors approved a plan to repurchase up to 1,000,000 unregistered shares of Company's Class A common stock. On April 4, 1997, the Company purchased 965,370 shares of Class A common stock under this plan at $25.725 per share ($24.8 million), the average of the closing prices over the prior ten days of trading on the New York Stock Exchange. The shares were purchased from certain Farm Bureau property-casualty insurance companies which had a concentration of their investments in the Company. The concentrations arose principally due to the appreciation of the Company's stock price which caused the investments to exceed statutory or internal guidelines. The purchase amount was allocated partly to Class A common stock based on the average common stock balance per share on the acquisition date with the remainder allocated to retained earnings.
Amortized cost of securities held by subsidiaries engaged in the broker-dealer and investment company industries was $4.3 million and $10.6 million at December 31, 1997 and 1996, respectively. Net unrealized appreciation on these securities as of December 31, 1997 and 1996, included gross unrealized gains of $0.1 million and $5.6 million, respectively. There were no gross unrealized losses on these securities at December 31, 1997, and gross unrealized losses totaled $0.3 million at December 31, 1996. Short-term investments have been excluded from the above schedules as amortized cost approximates market value for these securities.
The Company has also provided an allowance for possible losses against its mortgage loan portfolio. An analysis of this allowance for loan losses is as follows:
Impaired loans (those loans in which the Company does not believe it will collect all amounts due according to the contractual terms of the respective loan agreements) totaled $0.3 million at December 31, 1997 and $4.0 million at December 31, 1996. No valuation allowance was established on the impaired loans at December 31, 1997, and a valuation allowance of $0.5 million was established at December 31, 1996.
Realized gains (losses) and the change in unrealized appreciation/depreciation on investments, excluding amounts attributed to investments held by subsidiaries engaged in the broker-dealer and investment company industries discussed above, are summarized below:
Realized losses totaling $0.5 million and $0.2 million were incurred during the years ended December 31, 1996 and 1995, respectively, as a result of writedowns for other than temporary impairment of fixed maturity securities. No such writedowns were recorded during the year ended December 31, 1997.
Income taxes during the years ended December 31, 1997, 1996 and 1995 include a provision of $14.3 million, $18.5 million and $2.1 million, respectively, for the tax effect of realized gains.
The carrying value of investments which have been non-income producing for the twelve months preceding December 31, 1997, include: fixed maturities - $3.2 million; mortgage loans on real estate - $0.2 million; and other long-term investments - $1.6 million.
SECURITIES AND INDEBTEDNESS OF RELATED PARTIES: Fair values for loans and advances are estimated by discounting expected cash flows using interest rates currently being offered for similar investments. As allowed by Statement No. 107, fair values are not assigned to investments accounted for using the equity method.
ASSETS AND LIABILITIES OF SEPARATE ACCOUNTS: Separate account assets and liabilities are reported at estimated fair value in the Company's consolidated balance sheet.
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: 1998 - $1.0 million; 1999 - $1.0 million; 2000 - $1.1 million; 2001 - $1.1 million; 2002 - $1.1 million; and thereafter, through 2023 - $11.8 million.
In the normal course of business, the Company seeks to limit its exposure to loss on any single insured and to recover a portion of benefits paid by ceding reinsurance to other insurance enterprises or reinsurers. Reinsurance coverages for life insurance vary according to the age and risk classification of the insured with retention limits ranging up to $0.5 million of coverage per individual life. The Company does not use financial or surplus relief reinsurance. Life insurance in force ceded on a consolidated basis totaled $1,248.6 million (6.8% of total life insurance in force) at December 31, 1997 and $1,082.3 million (6.3% of total life insurance in force) at December 31, 1996.
The Company files a consolidated federal income tax return with Utah Insurance, Farm Bureau Life and certain of its subsidiaries and FBL Financial Services, Inc. and its subsidiaries. The companies included in the consolidated federal income tax return each report current income tax expense as allocated under a consolidated tax allocation agreement. Generally, this allocation results in profitable companies recognizing a tax provision as if the individual company filed a separate return and loss companies recognizing benefits to the extent their losses contribute to reduce consolidated taxes. The companies file separate state income tax returns. Western Life files a separate federal income tax return.
The effective tax rate on income before income taxes, minority interest in earnings of subsidiaries and equity income is different from the prevailing federal income tax rate as follows:
Prior to 1984, a portion of current income of the Company's life insurance subsidiaries was not subject to current income taxation, but was accumulated, for tax purposes, in a memorandum account designated as "policyholders' surplus account". The aggregate accumulation in this account at December 31, 1997 was $11.1 million and $0.7 million for Farm Bureau Life and Western Life, respectively. Should the policyholders' surplus account of Farm Bureau Life and Western Life exceed the limitation prescribed by federal income tax law, or should distributions be made by Farm Bureau Life and Western Life to the parent company in excess of $445.3 million and $136.9 million, respectively, such excess would be subject to federal income taxes at rates then effective. Deferred income taxes of $4.2 million have not been provided on amounts included in this memorandum account since the Company contemplates no action and can foresee no events that would create such a tax.
Deferred income taxes were also reported on equity income. These taxes arise from the recognition of income and losses differently for purposes of filing federal income tax returns than for financial reporting purposes.
As an investor in the Federal Home Loan Bank (FHLB), the Company has the right to borrow up to $43.9 million from the FHLB as of December 31, 1997. As of December 31, 1997 and 1996, the Company had no outstanding debt under this credit arrangement.
Certain of the assets related to these plans are on deposit with the Company and amounts relating to these plans are included in the financial statements herein. In addition, certain amounts included in the policy liabilities for interest sensitive products relate to deposit administration funds maintained by the Company on behalf of affiliates offering substantially the same benefit programs as the Company.
At December 31, 1997 and 1996, shares of Class A common stock available for grant as additional awards under the Plan totaled 879,875 and 928,768, respectively.
The Company applies Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" (APB 25), and related Interpretations in accounting for its stock options. Under APB 25, because the exercise price of the Company's stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recognized. Under the alternative accounting method provided by Statement No. 123, compensation expense is recognized in an amount equal to the estimated fair value of stock options on the date of grant. The Company has not adopted the accounting provisions of Statement No. 123 because the valuation of non-traded stock options is highly subjective and, in management's opinion, the existing pricing models do not necessarily provide a reliable single measure of the fair value of the Company's options.
The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. The Company's 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.
The ability of Farm Bureau Life and Western Life to pay dividends to the parent company is restricted because prior approval of insurance regulatory authorities is required for payment of dividends to the stockholder which exceed an annual limitation. During 1998, Farm Bureau Life and Western Life could pay dividends to the parent company of approximately $37.8 million and $9.0 million, respectively, without prior approval of insurance regulatory authorities.
The Company's insurance subsidiaries reported the following statutory amounts to regulatory agencies, after appropriate elimination of intercompany accounts:
The National Association of Insurance Commissioners (NAIC) is in the process of codifying statutory accounting practices (Codification). Codification will likely change, to some extent, prescribed statutory accounting practices and may result in changes to the accounting practices that the Company's insurance subsidiaries use to prepare their statutory-basis financial statements. Codification, which is expected to be approved by the NAIC in 1998, will require adoption by the various state insurance departments before it becomes the prescribed statutory basis of accounting for insurance companies domesticated within those states. Accordingly, before Codification becomes effective for the Company's insurance subsidiaries, the respective states of domicile must adopt Codification as the prescribed basis of accounting on which domestic insurers must report their statutory-basis results. At this time it is unclear whether the respective states of domicile will adopt Codification.
In the normal course of business, the Company may be involved in litigation where amounts are alleged that are substantially in excess of contractual policy benefits or certain other agreements. At December 31, 1997, management is not aware of any claims for which a material loss is reasonably possible.
During the first quarter of 1998, the Company's Board of Directors approved a transaction whereby the Company will exchange its home office properties for 1,268,056 unregistered shares of Class A common stock owned by the Iowa Farm Bureau Federation. The value of the transaction is $45.7 million, or $36.00 per common share. As a result of the exchange, the common shares outstanding at December 31, 1997 will decrease 1,268,056, or approximately seven percent.
The Company will lease a portion of the properties back from the Iowa Farm Bureau Federation under a 15-year operating lease. A gain on the transaction of approximately $21.0 million will be deferred by the Company and amortized over the term of the operating lease. The transaction is structured as a tax-free exchange of a real estate subsidiary and is expected to close in March 1998.
The 1996 and first three quarters of 1997 earnings per share amounts have been restated to comply with Statement No. 128.