The Company's principal activities are the management of property and casualty insurance companies and the underwriting of life insurance and annuity products. Revenues and expenses relating to both of these principal business activities are reflected in the Company's Consolidated Financial Statements prepared in accordance with GAAP, which differs from SAP, which FNWL is required to use for regulatory reporting purposes.
Total Operating Expenses. Total operating expenses as a percentage of operating revenues decreased from 56.0% in 1996 to 55.6% in 1997, a decrease of 0.4%. Although total operating expenses increased by 5.7%, this increase was less than the 6.4% increase in operating revenues. Specifically, the Company continued to benefit from staffing efficiencies and improved information technology systems and hence was able to control its labor costs, reducing salaries and employee benefits from 27.1% of operating revenues in 1996 to 25.3% of operating revenues in 1997.
Amortization of DAC and Value of Life Business Acquired. Amortization expense increased from $60.4 million in 1996 to $73.7 million in 1997, or 22.0%. This increase reflects the continued growth in the volume of universal life-type and traditional business in-force.
On December 22, 1997, a definitive agreement was reached to merge B.A.T Industries' Financial Services Businesses ("BAFS") with Zurich Insurance Company ("Zurich"). Completion of the merger is subject to regulatory consents, tax clearance and the approval of the shareholders of B.A.T and Zurich, and is expected to be finalized in late 1998. Under the agreement, the businesses of Zurich and BAFS, which include Farmers Group, Inc., will be transferred to Zurich Financial Services, a new Swiss company with headquarters in Zurich.
In June 1997, the FASB released SFAS No. 130, "Reporting Comprehensive Income". This Statement, effective for fiscal periods beginning after December 15, 1997, establishes standards for reporting and displaying comprehensive income and its components. This Statement requires that all items that are required to be recognized under accounting standards as components of comprehensive income be reported in a financial statement with the same prominence as other financial statements. The Company does not expect the adoption of this Statement to have a material impact on its consolidated financial statements.
Certain policy acquisition costs, principally first-year commissions and other expenses for policy underwriting and issuance (which are primarily related to and vary with the production of new
Conditions governing repayment of these amounts are outlined in the certificates. Generally, repayment may be made only when the surplus balance of the appropriate Exchange reaches a certain specified level, and then only after approval is granted by the Exchange Board of Governors and the California Insurance Commissioner.
The amortized cost, gross unrealized gains and losses, and estimated market values of investments in equity securities pertaining to non-redeemable preferred stocks and common stocks owned by the Company (excluding life insurance amounts) are as follows:
The amortized cost, gross unrealized gains and losses, and estimated market values of investments in equity securities pertaining to non-redeemable preferred stocks and common stocks owned by FNWL in 1997 and the Life Insurance Subsidiaries in 1996 are as follows:
During 1997, FNWL began selling an equity-indexed annuity product. At the end of its seven year term, this product credits interest to the annuity participant at a rate based on a specified portion of the change in the value of the Standard & Poor's 500 Composite Stock Price Index ("S&P 500 Index"), subject to a guaranteed annual minimum return. In order to hedge the interest liability generated on the annuities as the index rises, FNWL purchases call options on the S&P 500 Index. FNWL considers such call options to be held as a hedge. As of December 31, 1997, FNWL had call options with contract values of $13,180,000 and carrying values of $3,299,000.
Joint ventures, at equity The estimated fair values are based upon quoted market prices, current appraisals, and independent pricing services.
Policy loans The estimated fair values of policy loans are determined by discounting the future cash flows using the current rates at which similar loans would be made.
The funded status of the entire plan, which includes the Company and the Exchanges, as of December 1, 1997 and 1996 (the latest date for which information is available) was as follows:
Cash payments for interest were $3,725,000, $18,674,000, and $18,995,000 in 1997, 1996, and 1995, respectively, while cash payments for dividends to the holders of the Company's QUIPS were $42,070,000 in 1997 and 1996 and $10,414,000 in 1995. Cash payments for income taxes were $430,588,000, $379,455,000, and $315,603,000 in 1997, 1996 and 1995, respectively.
In 1996 and 1995, the Life Insurance Subsidiaries had reciprocal reinsurance treaties in place among themselves so that the maximum exposure to the Life Insurance Subsidiaries, in the aggregate, for any one life was the sum of their individual retention levels, or $1,400,000. Due to the sale of OSL and IGL on April 15, 1997, the reciprocal reinsurance treaties which existed with FNWL ceased.
In the fourth quarter of 1997, FNWL revised the retention limit for automatic reinsurance ceded. The primary change was to set the maximum retention on new issues at $2,000,000 per life for the Farmers Flexible Universal Life policy, $1,500,000 per life for all Traditional policies except Farmers Yearly Renewable Term, and $800,000 per life for Farmers Yearly Renewable Term. The excess is reinsured with a third party reinsurer. Premiums ceded under these agreements totaled $4,236,000 in 1997. Reinsurance receivables, which totaled $8,627,000 as of December 31, 1997 were included in Other Assets of Life Insurance Subsidiaries.