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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Fiscal Year Ended December 31, 1996
Commission File Number 33-94670-01
FARMERS GROUP, INC.
Incorporated in Nevada I.R.S. Employer Identification No.
4680 Wilshire Boulevard 95-0725935
Los Angeles, California 90010
(213) 932-3200
Securities registered pursuant to Section 12(b) of the Act:
Name of Each Exchange
Title of Each Class on which registered
- ------------------- -------------------
8.45% Cumulative Quarterly Income New York Stock Exchange
Preferred Securities, Series A (QUIPS)
(liquidation preference $25 per share)*
8.45% Cumulative Quarterly Income New York Stock Exchange
Preferred Securities, Series B (QUIPS)
(liquidation preference $25 per share)*
*Issued by Farmers Group Capital (Series A) and Farmers Group Capital II
(Series B) and the payments of trust distributions and payments on
liquidation or redemption are guaranteed under certain circumstances by
Farmers Group, Inc., the owner of 100% of the common securities issued by
Farmers Group Capital and Farmers Group Capital II, Delaware statutory
business trusts.
Securities registered pursuant to Section 12(g) of the Act: None.
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that
the registrant was required to file such reports), and (2) has been subject
to such filing requirements for the past 90 days.
Yes /X/ No / /
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this form 10-K or any
amendment to this Form 10-K. /X/
Registrant's Common Stock outstanding on December 31, 1996 was 1,000 shares.
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FARMERS GROUP, INC.
AND SUBSIDIARIES
TABLE OF CONTENTS
Page
------
PART I
ITEM 1. Business 4
ITEM 2. Properties 13
ITEM 3. Legal Proceedings 13
ITEM 4. Submission of Matters to a Vote of Security Holders 13
PART II
ITEM 5. Market for Farmers Group, Inc.'s Common Equity and
Related Stockholder Matters 14
ITEM 6. Selected Financial Data 14
ITEM 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations 16
ITEM 8. Financial Statements and Supplementary Data 23
ITEM 9. Changes in and Disagreements With Accountants on
Accounting and Financial Disclosures 59
PART III
ITEM 10. Directors and Executive Officers of Farmers Group, Inc. 59
ITEM 11. Executive Compensation 62
ITEM 12. Security Ownership of Certain Beneficial Owners
and Management 66
ITEM 13. Certain Relationships and Related Transactions 66
PART IV
ITEM 14. Exhibits, Financial Statement Schedules and Reports
on Form 8-K 67
SIGNATURES 69
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DOCUMENT SUMMARY
The following summary is qualified in its entirety by the more detailed
information and the Consolidated Financial Statements of the Company, including
the notes thereto, appearing elsewhere in this document. Unless the context
requires otherwise, (i) references to the Company are to Farmers Group, Inc.
("FGI") and its subsidiaries, (ii) references to the P&C Group are to Farmers
Insurance Exchange, Fire Insurance Exchange and Truck Insurance Exchange
(each an "Exchange" and collectively, the "Exchanges") and their respective
subsidiaries and Farmers Texas County Mutual Insurance Company ("FTCM"), and
(iii) references to the Life Subsidiaries are to Farmers New World Life
Insurance Company ("FNWL"), The Ohio State Life Insurance Company ("OSL")
and Investors Guaranty Life Insurance Company ("IGL"). Unless otherwise
indicated, financial information, operating statistics and ratios applicable
to the Company and the Life Subsidiaries set forth in this document are based
on generally accepted accounting principles ("GAAP") and the same information
with regard to the P&C Group is based on statutory accounting practices
("SAP"). Unless otherwise specified, the financial information for the P&C
Group is on a combined basis. Any reference to the "Subsidiary Trusts" is
to Farmers Group Capital and Farmers Group Capital II, consolidated wholly
owned subsidiaries of Farmers Group, Inc..
PART I
ITEM 1. Business
The Company
General. Founded in 1928, the Company's principal activities are the
provision of management services to the P&C Group and the ownership and
operation of the Life Subsidiaries. As of December 31, 1996, the Company
had total assets of $12.9 billion, stockholder's equity of $6.5 billion and
consolidated operating revenues for 1996 of $2.0 billion. As of
December 31, 1996, the Life Subsidiaries had total assets of $6.6 billion,
combined SAP capital and surplus (including asset valuation reserve) of $0.9
billion, combined SAP premium and deposits received for 1996 of $0.7 billion
and policies-in-force of 1.3 million. The financial results and assets and
liabilities of the P&C Group are not reflected in the consolidated financial
statements of the Company.
In December 1988, BATUS Inc. ("BATUS"), a subsidiary of B.A.T Industries
p.l.c. ("B.A.T"), acquired 100% ownership of the Company through its wholly
owned subsidiary BATUS Financial Services. Immediately thereafter, BATUS
Financial Services was merged into Farmers Group, Inc.. The acquisition was
accounted for as a purchase and, accordingly, the acquired assets and
liabilities were recorded in the Company's consolidated balance sheets based
on their estimated fair values at December 31, 1988. In January 1990,
ownership of the Company was transferred to South Western Nominees Limited,
a subsidiary of B.A.T.
B.A.T is one of the United Kingdom's leading business enterprises with
interests principally in tobacco and financial services. B.A.T operates in
more than 100 countries, employing some 164,000 people. As of
December 31, 1996, B.A.T reported total assets of $80.3 billion (based on an
exchange rate of $1.711 per British pound sterling as of December 31, 1996)
and, for the year then ended, reported total revenues and income before taxes
of $38.2 billion and $3.9 billion, respectively (based on an average exchange
rate of $1.562 per British pound sterling for the year ended December 31, 1996).
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Financial Information About Industry Segments
Financial information about industry segments can be found in Note Z
contained in the Notes to Consolidated Financial Statements. Following are
descriptions of the Company's industry segments.
Provision of Management Services to the P&C Group. The insurers
constituting the P&C Group are owned by their policyholders. Accordingly,
the Company has no ownership interest in the P&C Group. The policyholders
appoint the Company as the exclusive attorney-in-fact ("AIF") to provide
management services to the P&C Group. For such services, the Company earns
management fees based primarily on the gross premiums earned by the P&C Group.
Consequently, the Company is not directly affected by the underwriting
results of the P&C Group. This is in contrast to a typical property and
casualty insurance holding company which depends on dividends from owned
and operated subsidiaries which are subject to fluctuations in underwriting
results. The management fees comprise a major part of the Company's revenue
and, as a result, the Company's ongoing financial performance depends on
the volume of business written by, and the business efficiency and financial
strength of, the P&C Group.
As manager of the P&C Group, the Company selects risks, issues policies,
prepares and mails invoices, collects premiums, manages the investment
portfolios and performs certain other administrative functions. The insurers
of the P&C Group are responsible for the claims functions, including the
settlement and payment of claims and claims adjustment expenses. They are
also responsible for the payment of commissions, benefits for agents and
district managers, and their respective premium and income taxes.
The Company is entitled to receive a management fee of up to 20% (25%
in the case of Fire Insurance Exchange) of the gross premiums earned by the
P&C Group. In order to enable the P&C Group to maintain appropriate capital
and surplus while offering competitive insurance rates, the Company has
historically charged a lower management fee than permitted. The Company has
been able to do this while maintaining appropriate profit margins through
enhanced operating efficiencies that encompass the use of economies of
scale, the use of technology and the standardization of procedures. The
range of fees has varied by line of business over time and from year to
year. During the past five years, aggregate management fees averaged between
12% and 13% of gross premiums earned by the P&C Group. The P&C Group has
reported a growing volume of premium which has generated a corresponding
rise in management fee income to the Company. Gross premiums earned by the
P&C Group were $9.5 billion, $9.0 billion and $8.7 billion for 1996, 1995
and 1994, respectively, giving rise to management fee revenues to the
Company of $1.17 billion, $1.11 billion, and $1.06 billion, respectively,
for the same years.
The P&C Group markets personal auto, homeowners and selected commercial
insurance products in 29 states. For the year ended December 31, 1996,
approximately 68% of net premiums earned was from auto insurance policies,
21% was from homeowner policies, and the remainder was from commercial
policies. As of December 31, 1996, the P&C Group had total assets of $12.0
billion, surplus as regards policyholders of $3.1 billion, gross premiums
earned of $9.5 billion and policies-in-force of 14.8 million.
Life Subsidiaries. FNWL, a Washington insurance company, OSL, an Ohio
insurance company, and IGL, a California insurance company, are each a
wholly owned subsidiary of FGI. They market a broad line of individual life
insurance products, including universal life, term life
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and whole life insurance, and annuity products, predominately flexible premium
deferred annuities. As of December 31, 1996, the Life Subsidiaries provided
insurance to more than one million people and managed more than $1.7 billion
of annuity funds. The Life Subsidiaries' investment philosophy emphasizes
long-term fundamental value in the selection of the investment mix for their
portfolio. As of December 31, 1996, approximately 89% of the Life
Subsidiaries' portfolio was invested in fixed income securities and cash,
7% in other fixed income instruments, and 4% in equity securities and owned
real estate. As of December 31, 1996, approximately 93% of the Life
Subsidiaries' fixed income securities were rated investment grade.
The Life Subsidiaries' aggregate ratio of SAP capital and surplus (including
asset valuation reserve) to total assets as of December 31, 1996 was 19.4%,
well over the industry average of approximately 11.0% as of September 30,
1996, as published in the Statistical Bulletin issued by the American Council
of Life Insurance.
On January 23, 1997, the Company announced an agreement to sell OSL and
IGL to Great Southern Life Insurance Company, a subsidiary of Americo Life,
Inc.. This decision is part of the Company's strategic plan to focus its life
insurance efforts on the growth of FNWL, by far its largest insurance company,
whose products and services are sold directly by the Company's agents to the
more than eight million property and casualty households. The sale is
expected to be completed by April 1, 1997, subject to regulatory approval.
Other Businesses. The Prematic Service Corporation ("Prematic"), a
subsidiary of the Company, was established in 1961 to enable individuals
and businesses purchasing insurance from one or more members of the P&C
Group to combine all premiums due into a single monthly payment. In practice,
Prematic combines amounts due from a single insured associated with auto
policies, fire policies and commercial policies into a single amount, and
Prematic then bills the insured on a monthly basis for all policies-in-force.
For its services, Prematic collects a service fee, but since Prematic does
not finance the premium, there is no interest charged. Approximately 21.0%
of the P&C Group's policies-in-force are currently billed by Prematic, and
in 1996, Prematic generated approximately $72 million in service charge
income. Net income earned by this subsidiary was approximately $22 million
in 1996. The Company has certain other nonmaterial subsidiaries, the results
of which are included in the Company's consolidated results.
Employees
As of December 31, 1996, the Company had 8,601 employees.
Business Environment
Strategic Objectives. The Company's strategic objectives are to assist
the P&C Group in growing the volume of profitably underwritten insurance and
to increase life insurance and annuity sales to the P&C Group's existing
policyholder base. The Company intends to achieve these objectives by (i)
cross-selling insurance products and services to the P&C Group's more than
eight million existing households while focusing its life insurance efforts
on the growth of FNWL, (ii) investing in technology to improve the efficiency
and quality of service, (iii) maintaining its long-standing tradition of
providing high-quality customer service, (iv) capitalizing on the strong brand
name recognition of the Farmers Insurance Group of Companies in its 29 state
operating territory, and (v) selectively expanding into new geographic
markets.
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Technology. The Company makes substantial use of information technology
in its business. Information technology is utilized for accounting and
billing, to provide management information services, to process policies
and claims, to analyze and select risks, and to automate premium remittance
processing. An integrated network of computer workstations connects the
Company's offices and the P&C Group's offices, district managers and agents
with the Company's two data centers.
The Company is committed to an ongoing program of proprietary software
development which enhances the operating efficiency of the Life
Subsidiaries and the management services it provides to the members of the
P&C Group. The Company's major technology enhancements, together with other
operating efficiencies, have allowed its operating expenses to be held at
virtually last year's levels. Examples of the Company's commitment to using
technology to improve operating efficiencies are the Auto Policy Processing
System ("APPS"), which has been successfully implemented in all Farmers'
territories and the Fire Policy Processing System ("FPPS"), which the Company
plans to begin implementing in 1997. These software systems are designed to
significantly reduce the time and expense associated with processing a
Personal Lines policy. In addition, by allowing network access to more
comprehensive policy and policyholder information, these systems increase
cross-selling opportunities for the agent and provide better data to monitor
and manage the quality of the book of business. The above mentioned projects
are expected to cost approximately $299 million, of which an aggregate of $256
million has already been capitalized as of December 31, 1996.
Marketing and Distribution. The P&C Group and FNWL operate under a
common trade name and logo - The Farmers Insurance Group of Companies - and
distribute their respective insurance products in 29 states (primarily in
western and midwestern states) through a common network of approximately
14,200 direct writing agents and 513 district managers, each of whom is an
independent contractor. The size, efficiency and scope of this agency force
have made it a major factor in the Company's growth. Each agent is required
to first submit business to the insurers in the Farmers Insurance Group of
Companies within the classes and lines of business written by such insurers.
To the extent that such insurers decline such business or do not underwrite
it, the agents may offer the business to other insurers.
The Farmers Insurance Group of Companies' agents direct their marketing
efforts toward family accounts and small businesses. They leverage these
relationships using an extensive portfolio of products to increase the number
of policies per household or account. The P&C Group's existing relationships
with over eight million households provide a potential resource for future
growth in policies-in-force and life insurance sales. Management believes
that higher retention rates and profitability are achieved on business
written with households having multiple policies.
The Farmers Insurance Group of Companies maintains its brand name
recognition throughout its operating territory through television, radio
and print advertising on both a national and local basis. The Farmers Agency
Information Management System provides the agency force with a marketing
advantage by delivering high-quality consumer focused service at the point of
sale. Furthermore, the Farmers Insurance Group of Companies' formalized
policyholder recontact program, the "Farmers Friendly Review", builds customer
loyalty and provides a vehicle for enhanced policy retention and future
internal growth through cross-selling of property and casualty and life
products.
8
The life insurance and annuity products written by OSL are distributed
nationwide through an independent general agency system. The principal means
of distribution for the life insurance and annuity products written by IGL
is through independent marketing organizations for whom IGL provides products
and other administrative services.
Competition. Property and casualty insurance is a very competitive
industry with over 2,200 insurers. Many property and casualty insurers with
a small all-lines national market share have a significant market share
within a single state or a specialty market. The P&C Group competes through
brand name recognition of the Farmers Insurance Group of Companies, customer
service, product features, financial strength, price and the direct writing
agency force.
There is substantial competition among insurance companies seeking
customers for the types of products sold by the Life Subsidiaries. Most of
the 1,700 life insurance companies in the United States offer products
similar to those offered by the Life Subsidiaries, and many use similar
marketing techniques. Competitiveness in the insurance business is affected
by various factors including, but not limited to, price, financial and
claims-paying ratings, size and strength of agency force, range of product
lines, product quality, servicing ability and general reputation. The Life
Subsidiaries compete on the basis of customer service, product features,
financial strength and price. Many of the Life Subsidiaries' products contain
significant cash accumulation features; therefore, these products compete with
product offerings of banks, mutual funds and other financial institutions as
well.
Regulatory and Related Matters. The Life Subsidiaries and the P&C Group
are subject to extensive state regulatory oversight in the jurisdictions in
which they do business. The Company, its affiliates, and the P&C Group are an
insurance holding company system as defined by the insurance laws and
regulations of various jurisdictions. As such, certain transactions between
an insurance company and any other member company of the system, including
investments in subsidiaries and distributions by an insurance company to its
shareholders, are subject to regulation and oversight by the state of domicile
of the applicable insurance company. Insurers having insufficient statutory
capital and surplus are subject to varying degrees of regulatory action
depending on the level of capital inadequacy. As of December 31, 1996,
neither the P&C Group nor the Life Subsidiaries were subject to such
regulatory actions. Most of the Life Subsidiaries' and the P&C Group's
business is subject to regulation with respect to policy rates and related
matters. In addition, assessments are levied against the Life Subsidiaries and
the P&C Group as a result of participation in various types of mandatory state
guaranty associations. Existing federal laws and regulations affect the
taxation of life insurance products and insurance companies.
9
Investments
During the years ended December 31, 1996, 1995, and 1994, the Life
Subsidiaries had pretax net investment income and realized investment gains of
$355.4 million, $329.6 million, and $298.4 million, respectively, and the
Company other than the Life Subsidiaries (collectively, the "FGI/Nonlife
Account") had pretax net investment income and realized investment gains of
$117.9 million, $79.5 million, and $61.8 million, respectively. As of December
31, 1996, the book value of the Life Subsidiaries' investment portfolio was
approximately $4.4 billion, not including separate account assets, and the book
value of the FGI/Nonlife Account investment portfolio was approximately $2.2
billion. Both of these portfolios are managed by the Company's Investment
Department in accordance with investment policies approved by the Board of
Directors of the Company as well as the Investment Committee, which is
comprised of 10 officers of the Company appointed by the Board of Directors of
the Company.
The Company's investment philosophy for both the Life Subsidiaries'
portfolio and the FGI/Nonlife Account portfolio emphasizes long-term
fundamental value in the selection of the investment mix. In the Life
Subsidiaries, the assets backing the interest sensitive portfolio are
internally segregated along product lines in order to closely match the
funding assets with the underlying liabilities to policyholders. The
asset/liability matching system is the basis by which credited interest rates
are determined. In the FGI/Nonlife Account, excluding certificates in
surplus of the Exchanges, relatively short maturities are maintained for
capital preservation purposes and to ensure liquidity.
The Life Subsidiaries' portfolio and the FGI/Nonlife Account portfolio
are both comprised of a broad range of assets, including corporate fixed
income securities (which, in the case of the Life Subsidiaries, include
mortgage-backed securities), taxable and tax-exempt government securities,
preferred stock, common stock, owned real estate and short-term instruments.
The Life Subsidiaries' portfolio also includes commercial mortgage loans and
policy loans. Approximately 50.3% of the FGI/Nonlife Account portfolio
consists of notes issued by B.A.T Capital Corporation, a subsidiary of B.A.T,
and surplus certificates issued by the P&C Group. See "Certain Relationships
and Related Transactions" and Notes D and S contained in the Notes to the
Consolidated Financial Statements.
All of the fixed income securities in the FGI/Nonlife Account portfolio
and approximately 92.6% of the fixed income securities in the Life
Subsidiaries' portfolio are rated investment grade. Approximately 71.4% of
the mortgage-backed securities in the Life Subsidiaries' portfolio are
guaranteed by the Government National Mortgage Association ("GNMA"), Federal
Housing Authority ("FHA"), Federal National Mortgage Association ("FNMA"),
or Federal Home Loan Mortgage Corporation ("FHLMC"), and of the remaining
approximately 28.6% are rated "A" or better.
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The following table sets forth the book value of each portfolio, by
asset category, as of December 31, 1996 and 1995.
Book Value of Invested Assets
($ in millions)
As of December 31,
------------------------------------------------------------
1996 1995
------------------------- --------------------------
Book Value % Book Value %
---------- --------- ---------- ---------
Life Subsidiaries
Fixed income securities $ 3,854.1 86.9 % $ 3,506.6 78.1 %
Equity securities 110.2 2.5 370.0 8.2
Mortgage loans 122.6 2.8 148.8 3.3
B.A.T Capital Corporation notes 0.0 0.0 64.4 1.5
Owned real estate 61.7 1.4 69.4 1.6
Policy loans 187.3 4.2 165.3 3.7
Cash and cash equivalents 87.3 2.0 149.8 3.3
Other 12.0 0.2 13.2 0.3
--------- ------- ---------- -------
Total $ 4,435.2 100.0 % $ 4,487.5 100.0 %
========= ======= ========== =======
FGI/Nonlife Account
Fixed income securities $ 303.1 14.0 % $ 405.7 19.7 %
Equity securities 307.8 14.2 0.0 0.0
Certificates in surplus of exchanges 684.4 31.5 484.4 23.5
B.A.T Capital Corporation notes 407.0 18.8 342.6 16.7
Owned real estate 45.3 2.1 49.8 2.4
Cash and cash equivalents 412.0 19.0 763.2 37.1
Other 10.4 0.4 12.5 0.6
--------- ------- ---------- -------
Total $ 2,170.0 100.0 % $ 2,058.2 100.0 %
========= ======= ========== =======
Investment Accounting Policies. The Company follows the provisions of
Statement of Financial Accounting Standards ("SFAS") No. 115, "Accounting
for Certain Investments in Debt and Equity Securities". This statement
addresses the accounting and reporting for investments in equity securities
that have readily determinable fair values and for all investments in debt
securities. As of December 31, 1996 and 1995, the Company classified all
investments in equity and debt securities as available-for-sale under SFAS No.
115. Correspondingly, these investments are reported on the balance sheet at
fair value, with unrealized gains and losses, net of tax, excluded from
earnings and reported as a component of stockholder's equity.
On November 15, 1995, the Financial Accounting Standards Board ("FASB")
issued a special report, "A Guide to Implementation of Statement 115 on
Accounting for Certain Investments in Debt and Equity Securities", in which
they discussed a "fresh start" transition provision that allowed reporting
entities to reassess their securities holdings that were classified pursuant
to the provisions in SFAS No. 115. As a result of this "fresh start", the
Company decided to reclassify all of its debt securities originally classified
as held to maturity under SFAS No. 115 to available-for-sale at December 31,
1995. This resulted in the transfer of debt securities with an amortized cost
of approximately $1.1 billion and net unrealized gains of approximately $51.0
million from held to maturity to available-for-sale.
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In compliance with a Securities and Exchange Commission ("SEC") staff
announcement, the Company has recorded certain entries to the Deferred Policy
Acquisition Costs ("DAC") and Value of Life Business Acquired line of the
consolidated balance sheet in connection with SFAS No. 115. The SEC requires
that companies record entries to those assets and liabilities that would have
been adjusted had the unrealized investment gains or losses from securities
classified as available-for-sale actually been realized, with corresponding
credits or charges reported directly to stockholder's equity.
Bonds acquired prior to the December 31, 1988 acquisition of the Company
by B.A.T were marked-to-market at the time of the acquisition and the
resulting net writedown is being amortized over a period approximately equal
to the remaining time to maturity.
Real estate investments are accounted for using the equity method. Real
estate acquired in foreclosure and held for sale is carried at the lower of
fair value or depreciated cost less a valuation allowance. Short-term
instruments are carried at cost. Other investments, which consist primarily
of certificates in surplus of the Exchanges, policy loans and the B.A.T
Capital Corporation notes, are carried at the unpaid principal balances.
Fixed Income Securities. As of December 31, 1996, approximately 86.9%
of the Life Subsidiaries' portfolio and 14.0% of the FGI/Nonlife Account
portfolio were invested in fixed income securities. These investments include
taxable and tax-exempt government securities, domestic and foreign corporate
bonds, redeemable preferred stock and, with respect to the Life Subsidiaries'
portfolio, mortgage-backed securities. All of the fixed income securities
in the FGI/Nonlife Account portfolio and approximately 92.6% of the fixed
income securities in the Life Subsidiaries' portfolio were rated investment
grade. The following table sets forth the market values of the various
categories of fixed income securities included within the portfolios as
of December 31, 1996.
Value of Fixed Income Securities
($ in millions)
Life Subsidiaries FGI/Nonlife Account Total
---------------------- ----------------------- -----------------------
Market Market Market
Value % Value % Value %
----------- -------- ----------- --------- ----------- ---------
Mortgage-backed $ 1,867.6 48.5 % $ 0.0 0.0 % $ 1,867.6 44.9 %
Corporate 961.5 24.9 0.0 0.0 961.5 23.1
U.S. Government 377.9 9.8 0.2 0.1 378.1 9.1
Municipal 376.9 9.8 245.6 81.0 622.5 15.0
Foreign 69.2 1.8 0.0 0.0 69.2 1.7
Redeemable preferred stock 201.0 5.2 57.3 18.9 258.3 6.2
--------- ------- -------- ------- --------- -------
Total $ 3,854.1 100.0 % $ 303.1 100.0 % $ 4.157.2 100.0 %
========= ======= ======== ======= ========= =======
Credit Ratings. The National Association of Insurance Commissioners
("NAIC") maintains a valuation system that assigns quality ratings known as
"NAIC Designations" to publicly traded and privately placed fixed income
securities. The NAIC Designations range from 1 to 6, with categories 1
(highest) and 2 considered investment grade and categories 3 through 6
(lowest) considered non-investment grade. As of December 31, 1996, the Life
Subsidiaries held $283.9 million in below investment grade bonds, representing
6.4% of total invested assets. All FGI/Nonlife Account fixed income
securities were rated investment grade.
Mortgage-backed Securities. Mortgage-backed securities ("MBS") are
the largest component of the Life Subsidiaries' fixed income portfolio and
represented approximately 48.5% of its fixed income portfolio as of
December 31, 1996. The FGI/Nonlife Account does not have any MBS
investments. Approximately 71.4% of the MBS in the Life Subsidiaries'
portfolio are guaranteed by various government agencies, including the
GNMA, FHA, FNMA, or the FHLMC, and the remaining 28.6% are rated "A" or
better. The primary risk in holding MBS is the cash flow uncertainty that
arises from changes to prepayment speeds as interest rates fluctuate. To
reduce the uncertainties surrounding the cash flows of MBS, the Life
Subsidiaries hold significant MBS investments in collateralized mortgage
obligations ("CMOs") such as $916.1 million of planned amortization classes
("PACs") and $57.5 million of targeted amortization classes ("TACs").
These securities provide protection by passing a substantial portion of the
risk of prepayment uncertainty to other tranches.
Equity Investments-Common Stock. As of December 31, 1996, approximately
$10.4 million, or 10.0%, of the Life Subsidiaries' common stock portfolio was
comprised of small and medium capitalization stocks (market capitalization of
less than $1.25 billion). Approximately $17.9 million, or 17.3%, was
comprised of foreign stocks and the remaining $75.6 million, or 72.7%, was
comprised of large capitalization domestic stocks. In December 1996, FGI
received common stock, with a cost basis of $251.9 million, as part of an
extraordinary dividend paid to FGI by FNWL (see Note G). As of December 31,
1996, the market value of this portfolio was $307.8 million. Of that amount,
approximately $30.1 million, or 9.8%, was comprised of small and medium
capitalization stocks. Approximately $50.1 million, or 16.3%, was comprised of
foreign stocks and the remaining $227.6 million, or 73.9%, was comprised of
large capitalization domestic stocks.
Commercial Mortgage Loans. As of December 31, 1996, the Life
Subsidiaries' portfolio included commercial mortgage loans with an aggregate
book value of approximately $122.6 million, net of loan loss provisions of
$8.3 million. The commercial mortgage loans represent 2.8% of total invested
assets. The FGI/Nonlife Account portfolio does not include any commercial
mortgage loans.
All commercial mortgage loans included in the Life Subsidiaries'
portfolio are secured by first mortgages. The majority of the commercial
mortgage loan portfolio consists of loans secured by office buildings, light
industrial properties and retail properties located primarily in unanchored
shopping centers. Exposure to potential losses from future commercial
mortgage loan foreclosures and the operation or sale of properties acquired
through foreclosures is limited because the Life Subsidiaries have not issued
any commercial mortgage loans since 1989, and the majority of the individual
remaining commercial mortgage loan balances are less than $1.0 million.
Owned Real Estate Investments. As of December 31, 1996, the Life
Subsidiaries' portfolio included owned real estate investments with a book
value of $61.7 million (net of loss provisions of $8.4 million), or 1.4% of
total invested assets, and the FGI/Nonlife Account's portfolio included owned
real estate investments with a book value of $45.3 million, or 2.1% of total
invested assets. The FGI/Nonlife Account owned real estate holdings were all
acquired directly as equity investments. The Life Subsidiaries' real estate
holdings fall into two categories: real property assets that were acquired
directly as an equity investment and foreclosed equity real estate properties.
Problem Investments-Fixed Income Securities. As of December 31, 1996,
$0.4 million of the fixed income securities held by the Life Subsidiaries
were classified as "problem" or "potential problem" assets. These assets were
in default with respect to principal and/or interest. As of
13
December 31, 1996, all of the fixed income securities held in the FGI/Nonlife
Account were rated investment grade and were not "problem" or "potential
problem" assets.
Problem Investments-Mortgage Loan Investments. As of December 31, 1996,
only one of the mortgage loans held by the Life Subsidiaries was classified as
a "troubled loan". This mortgage loan represents less than 0.01% of total
invested assets and, as of December 31, 1996, was in foreclosure.
ITEM 2. Properties
The Company owns three buildings in Los Angeles, 15 regional offices and
2 commercial claims centers in which its administrative operations are
conducted. In addition, the Company owns a building in Ohio and a building
in Washington in which the Life Subsidiaries' operations are conducted.
ITEM 3. Legal Proceedings
The Company is a party to numerous lawsuits arising from its normal
business activities. These actions are in various stages of discovery and
development, and some seek punitive as well as compensatory damages. In the
opinion of management, the Company has not engaged in any conduct which
should warrant the award of any material punitive or compensatory damages.
The Company intends to vigorously defend its position in each case, and
management believes that, while it is not possible to predict the outcome
of such matters with absolute certainty, ultimate disposition of these
proceedings should not have a material adverse effect on the Company's
consolidated results of operations or financial position. In addition, the
Company is, from time to time, involved as a party in various governmental
and administrative proceedings.
ITEM 4. Submission of Matters to a Vote of Security Holders
There were no matters submitted to a vote of security holders during the
year ended December 31, 1996.
14
PART II
ITEM 5. Market for Farmers Group, Inc.'s Common Equity and Related
Stockholder Matters
N/A
ITEM 6. Selected Financial Data
The following table sets forth summary consolidated income statement
data, consolidated balance sheet data and other operating data for the
periods indicated. The following consolidated income statement data of the
Company for each of the years in the five-year period ended December 31,
1996, and the consolidated balance sheet data of the Company as of December
31, 1996 and each of the preceding four years ended December 31, have been
derived from the Company's audited consolidated financial statements. The
following data should be read in conjunction with the Company's Consolidated
Financial Statements and related notes, "Management's Discussion and Analysis
of Financial Condition and Results of Operations" and other financial
information appearing elsewhere herein.
Income statement data includes the effect of amortizing the purchase
accounting entries related to the acquisition of the Company by B.A.T in
December 1988. See Note A to the Company's Consolidated Financial
Statements. Major items incorporated in the purchase price of the Company
include goodwill and the value of the AIF contracts of the P&C Group.
The amortization of these two items, which is being taken on a straight-line
basis over forty years, reduced annual pretax income by approximately $102.8
million in each of the years 1992 through 1996.
15
Year Ended December 31,
-------------------------------------------------------------------
1996 1995 1994 1993 1992
----------- ----------- ----------- ----------- -----------
($ in millions)
INCOME STATEMENT DATA
Consolidated operating revenues $ 2,012.9 $ 1,892.1 $ 1,779.2 $ 1,709.0 $ 1,577.1
=========== =========== =========== =========== ===========
Management services to property
and casualty insurance companies;
and other:
Operating revenues $ 1,245.4 $ 1,183.1 $ 1,130.1 $ 1,107.7 $ 1,042.6
----------- ----------- ----------- ----------- -----------
Salaries and employee benefits 337.2 348.8 348.8 340.1 318.6
Buildings and equipment expenses 86.1 75.0 55.1 53.6 47.5
Amortization of AIF contracts
and goodwill 102.8 102.8 102.8 102.8 102.8
General and administrative expenses 171.5 170.5 172.8 166.7 170.2
----------- ----------- ----------- ----------- -----------
Total operating expenses 697.6 697.1 679.5 663.2 639.1
----------- ----------- ----------- ----------- -----------
Operating income 547.8 486.0 450.6 444.5 403.5
Net Investment income 117.9 79.5 61.8 48.7 49.8
Dividends on preferred securities
of subsidiary trusts (42.1) (10.4) 0.0 0.0 0.0
----------- ----------- ----------- ----------- -----------
Income before provision for
taxes 623.6 555.1 512.4 493.2 453.3
Provision for income taxes 275.1 224.3 208.1 215.5 185.8
----------- ----------- ----------- ----------- -----------
Management services income 348.5 330.8 304.3 277.7 267.5
----------- ----------- ----------- ----------- -----------
Life Subsidiaries:
Premiums 170.4 158.8 153.1 146.6 134.3
Policy charges 241.7 220.6 197.6 173.9 152.7
Investment income, net of expenses 317.4 298.0 251.6 241.8 233.6
Net realized gains 38.0 31.6 46.8 39.0 13.9
----------- ----------- ----------- ----------- -----------
Total revenues 767.5 709.0 649.1 601.3 534.5
----------- ----------- ----------- ----------- -----------
Policyholders' benefits 335.1 316.7 276.4 262.2 239.1
Amortization of deferred policy
acquisition costs and value of
life business acquired 108.8 103.2 92.8 65.4 60.0
Commissions 21.0 20.1 18.7 16.9 15.5
General and administrative expenses 64.0 61.6 57.4 58.0 56.6
----------- ----------- ----------- ----------- -----------
Total operating expenses 528.9 501.6 445.3 402.5 371.2
----------- ----------- ----------- ----------- -----------
Income before provision for
taxes 238.6 207.4 203.8 198.8 163.3
Provision for income taxes 79.2 67.5 67.7 68.3 51.9
----------- ----------- ----------- ----------- -----------
Life Subsidiaries income 159.4 139.9 136.1 130.5 111.4
----------- ----------- ----------- ----------- -----------
Consolidated net income before
cumulative effect of accounting
change 507.9 470.7 440.4 408.2 378.9
Cumulative effect of accounting
change 0.0 0.0 (4.7) (1) 0.0 0.0
----------- ----------- ----------- ----------- -----------
Consolidated net income $ 507.9 $ 470.7 $ 435.7 $ 408.2 $ 378.9
=========== =========== =========== =========== ===========
BALANCE SHEET DATA
Total investments (2) $ 6,605.3 $ 6,545.7 $ 5,181.9 $ 4,914.8 $ 4,284.5
Total assets 12,928.8 12,630.6 11,270.9 10,929.8 10,056.3
Total short term debt 0.0 200.0 0.0 0.0 0.0
Total long term debt 0.2 0.3 200.4 209.4 211.6
Company obligated mandatorily
redeemable preferred securities
of subsidiary trusts holding
solely junior subordinated
debentures ("QUIPS") 500.0 500.0 0.0 0.0 0.0
Stockholder's equity 6,503.8 6,493.6 6,148.0 6,142.0 5,911.7
OTHER OPERATING DATA (unaudited)
Ratio of debt to total
capitalization 7.1 % 9.7 % 3.2 % 3.3 % 3.5 %
Ratio of earnings to fixed
charges (3) 15.5 x 21.5 x 28.9 x 27.7 x 25.4 x
__________________
(1) Net income reflects the charge resulting from expensing the transition
obligation upon the implementation of SFAS No. 112, "Employers'
Accounting for Postemployment Benefits". Such amounts were $4.5 million
and $0.2 million, after tax, for Management services to property and
casualty insurance companies; and other and the Life Subsidiaries,
respectively, for the year ended December 31, 1994.
(2) Includes cash, short-term investments and notes receivable-affiliate.
(3) The ratio of earnings to fixed charges has been determined by dividing
the sum of net income before income taxes plus fixed charges by fixed
charges. Fixed charges consist of interest, capitalized interest,
dividends paid to QUIPS holders, amortization of QUIPS offering expenses
and that portion of rent expenses deemed to be interest.
16
ITEM 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
General
The Company is engaged in the management of property and casualty
insurance companies and the underwriting of life insurance and annuity
products. The Company does not own any property and casualty insurers, but
rather serves as the manager of the P&C Group. The Company receives
management fees based primarily on the gross premiums earned by the P&C Group.
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 the Life Subsidiaries
are required to use for regulatory reporting purposes.
The Company underwrites life insurance and annuity products through
its life insurance subsidiaries. Revenues attributable to traditional life
insurance products, such as whole life or term insurance contracts, are
classified as premiums as they become due. Future benefits are associated
with such premiums (through increases in liabilities for future policy
benefits), and prior period capitalized costs are amortized (through
amortization of DAC) so that profits are generally recognized over the same
period as revenue income. Revenues attributable to universal life products
consist of policy charges for the cost of insurance, policy administration
charges, surrender charges, and investment income on assets allocated to
support policyholder account balances on deposit. Revenues for deferred
annuity products consist of surrender charges and investment income on assets
allocated to support policyholder account balances. Expenses on universal
life and annuity policies include interest credited to policyholders on
policy balances as well as benefit claims incurred in excess of policy
account balances.
Year Ended December 31, 1996 Compared to Year Ended December 31, 1995
Management Services to Property and Casualty Insurance Companies; and Other
Operating Revenues. Operating revenues increased from $1,183.1 million
in 1995 to $1,245.4 million in 1996, an increase of $62.3 million, or 5.3%.
Operating revenues primarily consist of management fees paid to the Company
as a percentage of gross premiums earned by the P&C Group. Such premiums
increased from $9,003.8 million in 1995 to $9,458.2 million in 1996 due
primarily to higher average premium levels across all major lines of business
and an increase in the number of policies-in-force between years. Partially
offsetting these increases is the fact that, in recognition of expense savings
realized as a result of improved operating efficiencies, the Farmers Preferred
Auto Management fee rate was reduced by 0.45% on November 1, 1996. This
resulted in a $4.1 million reduction in management fees in 1996 from what such
fees would have been using the 1995 rates. As the Company continues to
benefit from improved operating efficiencies, it may further reduce
management fee rates in the future.
Total Operating Expenses. Total operating expenses as a percentage of
operating revenues decreased from 58.9% in 1995 to 56.0% in 1996, a decrease
of 2.9%. Specifically, labor costs (salaries and employee benefits)
decreased from 29.5% of operating revenues for the year ended December 31,
1995 to 27.1% of operating revenues for the year ended December 31, 1996.
17
Salaries and Employee Benefits. Salaries and employee benefits
decreased from $348.8 million in 1995 to $337.2 million in 1996, a
decrease of $11.6 million, or 3.3%, primarily due to a reduction in
employee complement.
Buildings and Equipment Expenses. Buildings and equipment expenses
increased from $75.0 million in 1995 to $86.1 million in 1996, an
increase of $11.1 million, or 14.8%. This increase was primarily due
to the amortization of new information technology systems software,
offset in part by a decrease in computer mainframe related expenses.
Amortization of AIF Contracts and Goodwill. The purchase
accounting entries related to the acquisition of the Company by
B.A.T in December 1988 include goodwill (capitalized at $2.4
billion) and the value of the AIF contracts of the P&C Group
(capitalized at $1.7 billion). The amortization of these two items,
which is being taken on a straight-line basis over forty years,
reduced pretax income by approximately $102.8 million for both 1996
and 1995.
General and Administrative Expenses. General and administrative
expenses increased from $170.5 million in 1995 to $171.5 million
in 1996. The increase in expense between years has been held to less
than one percent as a result of attention to cost controls and
automation through the greater use of information technology systems.
Net Investment Income. Net investment income increased from $79.5
million in 1995 to $117.9 million in 1996, an increase of $38.4 million,
or 48.3%. This increase was primarily due to higher yield rates and a
larger invested asset base in 1996.
Dividends on Preferred Securities of Subsidiary Trusts. Dividend expense
related to the $500.0 million of Cumulative Quarterly Income Preferred
Securities ("QUIPS") issued in September and October of 1995 increased from
$10.4 million in 1995 to $42.1 million in 1996.
Provision for Income Taxes. Provision for income taxes increased from
$224.3 million in 1995 to $275.1 million in 1996, an increase of $50.8
million, or 22.6%. This increase was due in part to $22.5 million of taxes
that resulted from the $374.9 million extraordinary dividend paid to FGI by
FNWL in December 1996. The remaining increase is attributable to an increase
in pretax operating income between years.
Management Services Income. As a result of the foregoing, management
services income increased from $330.8 million for the year ended December 31,
1995 to $348.5 million for the year ended December 31, 1996, an increase of
$17.7 million, or 5.4%.
18
Life Subsidiaries
Total Revenues. Total revenues increased from $709.0 million in 1995
to $767.5 million in 1996, an increase of $58.5 million, or 8.3%.
Premiums. Premiums increased $11.6 million, or 7.3%. This increase
is due to growth in renewal and first year business. The increase in renewal
premiums is attributable to a 10.3% growth in traditional life insurance in-
force resulting from improved persistency and an increase in average policy
size. The higher first year premiums are due primarily to growth in Premier
Whole Life ("PWL") and Mortgage Protection Plan products.
Policy Charges. Policy charges increased $21.1 million, or 9.6%,
over 1995, reflecting continued growth in universal life-type insurance in-
force.
Investment Income. Net investment income increased $19.4 million
in 1996, or 6.5%, over 1995 due largely to higher bond interest income
resulting primarily from a higher invested asset base.
Net Realized Gains. Net realized gains increased by $6.4 million
in 1996 due primarily to gains realized on common stock as a result of
favorable market conditions.
Total Operating Expenses. Total operating expenses increased from
$501.6 million in 1995 to $528.9 million in 1996, an increase of $27.3
million, or 5.4%.
Policyholders' Benefits. Policyholders' benefits expense increased
from $316.7 million in 1995 to $335.1 million in 1996, an increase of
$18.4 million, or 5.8%. Policy benefits, which consist primarily of
death and surrender benefits on life products, increased $2.2 million
over 1995 due to an increase in death claims resulting from an increase
in average insurance-in-force. Increase in liability for future
benefits expense increased from $9.1 million in 1995 to $11.0 million
in 1996. This increase was primarily attributable to increases in PWL
and other traditional product premiums and to lower terminations in
1996. Interest credited to policyholders, which represents the amount
credited under universal life-type contracts and deferred annuities for
policyholder funds on deposit, increased from $154.6 million in 1995 to
$168.9 million in 1996, or 9.2%, reflecting a 7.0% growth in universal
life-type insurance in-force and a 6.0% increase in annuity funds on
deposit.
Amortization of DAC and Value of Life Business Acquired.
Amortization expense increased from $103.2 million in 1995 to $108.8
million in 1996, or 5.4%. This increase reflects the continued
growth in universal life-type business and lower traditional terminations
in 1996.
Commissions. Commissions increased from $20.1 million in 1995 to
$21.0 million in 1996, reflecting increased renewal premiums from
universal life products.
General and Administrative Expenses. General and administrative
expenses increased from $61.6 million in 1995 to $64.0 million in 1996,
or 3.9%, due to higher salaries and benefits expense.
19
Provision for Income Taxes. Provision for income taxes increased from
$67.5 million in 1995 to $79.2 million in 1996, an increase of $11.7 million.
This increase is attributable to the increase in pretax operating income.
Life Subsidiaries Income. As a result of the foregoing, Life
Subsidiaries income increased from $139.9 million in 1995 to $159.4 million
in 1996, an increase of $19.5 million, or 13.9%.
Consolidated Net Income
Consolidated net income of the Company increased from $470.7 million in
1995 to $507.9 million in 1996, an increase of $37.2 million, or 7.9%.
Year Ended December 31, 1995 Compared to Year Ended December 31, 1994
Management Services to Property and Casualty Insurance Companies; and Other
Operating Revenues. Operating revenues increased from $1,130.1 million
in 1994 to $1,183.1 million in 1995, an increase of $53.0 million, or 4.7%.
This growth reflects higher gross premiums earned by the P&C Group, which
increased from $8,667.9 million in 1994 to $9,003.8 million in 1995 due
primarily to a 3.9% increase in the number of policies-in-force and, to a
lesser extent, from an increase in average premium levels. Recognizing
that efficiencies from automation and greater use of information technology
systems lowered its operating costs, in 1995, the Company reduced management
fee rates from the rates in place during 1994. Preferred Auto rates were
reduced by 0.30%, Residential Fire rates were reduced 4.0% and Protector
Landlord rates were reduced 0.75%, which resulted in a $22.5 million
reduction in management fees in 1995 from what such fees would have been
using the 1994 rates.
Total Operating Expenses. Total operating expenses as a percentage
of operating revenues decreased from 60.1% in 1994 to 58.9% in 1995, a
decrease of 1.2%. Although total operating expenses increased by 2.6%,
this increase was less than the 3.9% increase in policies-in-force. In
particular, the Company controlled its labor costs, reducing salaries
and benefits from 30.9% of operating revenues in 1994 to 29.5% of
operating revenues in 1995.
Salaries and Employee Benefits. Salaries and employee benefits
remained constant at $348.8 million for the years 1995 and 1994.
Although salaries expense decreased slightly due to a reduction in
employee complement, this decrease was offset by higher average
salaries per employee and an increase in various employee benefits
expenses, including profit sharing.
Buildings and Equipment Expenses. Buildings and equipment expenses
increased from $55.1 million in 1994 to $75.0 million in 1995, an
increase of $19.9 million, or 36.1%. This increase was primarily due to
the amortization of new information technology systems software and
greater depreciation, maintenance and lease costs resulting from
additional equipment purchases and software leases.
Amortization of AIF Contracts and Goodwill. Amortization expense
was $102.8 million in both 1995 and 1994. These assets are being
amortized on a straight-line basis over forty years.
20
General and Administrative Expenses. General and administrative
expenses decreased from $172.8 million in 1994 to $170.5 million in
1995, a decrease of $2.3 million, or 1.3%.
Net Investment Income. Net investment income increased from $61.8
million in 1994 to $79.5 million in 1995, an increase of $17.7 million, or
28.6%, due to higher yield rates and a larger amount of invested assets in
1995.
Dividends on Preferred Securities of Subsidiary Trusts. As a result
of the $500.0 million of QUIPS issued in 1995, dividend expense in 1995 was
$10.4 million.
Provision for Income Taxes. Provision for income taxes increased from
$208.1 million in 1994 to $224.3 million in 1995, an increase of $16.2 million,
or 7.8%. This increase was primarily attributable to the increase in pretax
operating income between years.
Management Services Income. As a result of the foregoing, management
services income increased from $304.3 million in 1994 to $330.8 million in
1995, an increase of $26.5 million, or 8.7%.
Life Subsidiaries
Total Revenues. Total revenues increased from $649.1 million in 1994
to $709.0 million in 1995, an increase of $59.9 million, or 9.2%.
Premiums. Premiums increased $5.7 million, or 3.7%, over 1994 due
in part to an increase in renewal premiums from growth in traditional
life insurance in-force resulting from improved persistency and an
increase in average policy size. Also contributing to the increase in
premiums were higher Annuity in Payment ("AIP") premiums resulting from
an increase in the number of annuities entering the payment phase in
1995.
Policy charges. Policy charges increased $23.0 million, or 11.6%,
over 1994, reflecting growth in universal life-type insurance-in-force.
Investment income. Net investment income increased $46.4 million in
1995, or 18.4%, over 1994 due largely to higher bond interest income
resulting from a higher invested asset base and higher yield rates.
Net realized gains. Net realized gains decreased by $15.2 million
in 1995 due primarily to lower gains on common stock and bond sales in
1995.
Total Operating Expenses. Total operating expenses increased from
$445.3 million in 1994 to $501.6 million in 1995, an increase of $56.3
million, or 12.6%.
Policyholders' Benefits. Policyholders' benefits expense increased
from $276.4 million in 1994 to $316.7 million in 1995, an increase of
$40.3 million, or 14.6%. Policy benefits increased $20.0 million over
1994 primarily due to an increase in death claims resulting from higher
average insurance-in-force and higher death claims per insurance-
in-force. Increase in liability for future benefits expense increased
from $6.6 million in 1994 to $9.1 million in 1995, or 37.9%. This
increase was primarily due to increases in traditional and AIP provisions
for future benefits as a result of higher premiums in 1995. Interest
credited to
21
policyholders increased from $136.8 million in 1994 to $154.6 million in
1995, or 13.0%, reflecting a 10.4% growth in universal life-type
insurance in-force and a 13.1% increase in annuity funds on deposit.
Amortization of DAC and Value of Life Business Acquired.
Amortization expense increased from $92.8 million in 1994 to $103.2
million in 1995, or 11.2%, reflecting the growth in universal life-type
business and traditional business in 1995.
Commissions. Commissions increased from $18.7 million in 1994 to
$20.1 million in 1995, reflecting increased renewal premiums from
traditional and universal life products.
General and Administrative Expenses. General and administrative
expenses increased from $57.4 million in 1994 to $61.6 million in 1995,
or 7.3%. The increase resulted mainly from higher premium taxes,
guaranty assessments and advertising expenses in 1995. Partially
offsetting these increases were lower salaries and benefits expenses.
Provision for Income Taxes. Provision for income taxes decreased from
$67.7 million in 1994 to $67.5 million in 1995, a decrease of $0.2 million.
This decrease was attributable to a lower effective tax rate in 1995 of
32.5%, compared to a 33.2% effective tax rate in 1994. Incorporated in the
effective tax rates were permanent tax adjustments which, in 1995, increased
in the area of tax preference items, particularly tax exempt interest, thus
resulting in a decrease in the effective tax rate between years.
Life Subsidiaries Income. As a result of the foregoing, Life
Subsidiaries income increased from $136.1 million in 1994 to $139.9 million
in 1995, an increase of $3.8 million, or 2.8%.
Consolidated Net Income
Consolidated net income of the Company increased from $435.7 million in
1994 to $470.7 million in 1995, an increase of $35.0 million, or 8.0%.
Consolidated net income for 1994 included the expensing of $4.7 million, net
of tax, for the SFAS No. 112, "Employers' Accounting for Postemployment
Benefits", transition obligation.
Liquidity and Capital Resources
General. The principal uses of funds by the Company are (i) operating
expenses, (ii) dividends to the holders of the Company's QUIPS, (iii) capital
expenditures and (iv) dividends to its stockholder. In 1996, dividends paid
on the QUIPS issuance were $42.1 million, capital expenditures totaled $75.8
million and cash dividends paid to the stockholder totaled $464.9 million.
The principal sources of funds available to the Company are (i) the
management fees that it receives for managing the P&C Group, (ii) investment
income and (iii) dividends from its subsidiaries. Historically, funds
available from the first two of these sources have been sufficient to
satisfy the liquidity needs of the Company, and the Company anticipates that
such funds will continue to be adequate to satisfy such needs in the future.
A portion of the net income of the Life Subsidiaries is available for payment
as a dividend to the Company, subject to certain limitations imposed by the
insurance laws of the States of California, Ohio and Washington, and
additional state taxation. As of December 31, 1996, an aggregate of
22
$192.2 million was available for distribution as a dividend without approval
of the state insurance departments (see Note G). Additionally, the Company
had available revolving credit facilities as of December 31, 1996 enabling it
to borrow up to $500.0 million in the event such a need should arise (see
Note T).
In order to maintain the policyholders' surplus of the Exchanges, the
Company has purchased approximately $850.0 million of surplus certificates
of the Exchanges ($400.0 million of which were purchased in 1996, $250.0
million of which were purchased in 1995 and $200.0 million of which were
purchased in 1986 and repaid in 1996). In addition, in 1991, the Company
arranged for two subsidiaries of B.A.T to purchase an aggregate of $400.0
million of surplus notes of two subsidiaries of the Exchanges. The Company
has, from time to time, made other surplus contributions to the Exchanges
totaling approximately $34.4 million, receiving certificates of contribution
which bear interest at various rates. The Company believes that these
purchases of surplus certificates and notes have helped to support the
historical growth in premiums earned and the related growth in management fees
paid to the Company (see Note D).
Net cash provided by operating activities decreased from $803.5 million
in 1995, to $761.8 million in 1996, a decrease in cash of $41.7 million, or
5.2%. This decrease in cash was principally due to a $75.7 million decrease
in life insurance policy liabilities and a $10.1 million increase in realized
gains on sale of assets. The above decreases in cash were partially offset by
a $37.2 million increase in consolidated net income.
Net cash used in investing activities decreased from $626.7 million in
1995 to $510.1 million in 1996, an increase in cash of $116.6 million, or
18.6%, between years. This increase in cash was principally due to a $438.3
million increase in proceeds received from sales and maturities of investments
available-for-sale coupled with the receipt of $200.0 million received from
the Exchanges in repayment of the $200.0 million certificate of contribution
issued in 1986. Partially offsetting the above increases in cash was a $339.9
million increase in purchases of investments available-for-sale and a $150.0
million increase in the purchase of surplus certificates of the Exchanges
between years. The Company purchased $400.0 million of surplus certificates
of the Exchanges in 1996, compared to $250.0 million in 1995.
Net cash used in financing activities increased $862.4 million, or
437.9%, to $665.5 million in 1996. This decrease in cash was primarily due to
the $500.0 million of proceeds received in 1995 as a result of the issuance
of the QUIPS. In addition, cash decreased between years due to the repayment
of $200.0 million of 8.25% Notes Payable in July 1996 and the fact that cash
dividends paid to B.A.T increased $179.7 million, from $285.2 million in 1995
to $464.9 million in 1996.
Life Subsidiaries. The principal uses of funds by the Life Subsidiaries
are (i) policy benefits and claims and policyholder dividends, (ii) loans
to policyholders, (iii) capital expenditures, (iv) operating expenses, and
(v) stockholder's dividends. The principal sources of funds available to the
Life Subsidiaries are premiums and amounts earned from the investment of
premiums and deposits. These sources of funds have historically satisfied the
liquidity needs of the Life Subsidiaries.
23
ITEM 8. Financial Statements and Supplementary Data
Index for Financial Statements and Supplementary Data
Page
----
Independent Auditors' Report 24
Consolidated Financial Statements of Farmers Group, Inc.
and Subsidiaries
Consolidated Balance Sheets as of December 31, 1996 and 1995 25
Consolidated Statements of Income for the years ended
December 31, 1996, 1995 and 1994 27
Consolidated Statements of Stockholder's Equity for the years ended
December 31, 1996, 1995 and 1994 28
Consolidated Statements of Cash Flows for the years ended
December 31, 1996, 1995 and 1994 29
Notes to Consolidated Financial Statements 30
Quarterly Financial Data (Unaudited) 58
24
INDEPENDENT AUDITORS' REPORT
To the Board of Directors of Farmers Group, Inc.
We have audited the consolidated balance sheets of Farmers Group, Inc.
and subsidiaries (the "Company") as of December 31, 1996 and 1995, and the
related consolidated statements of income, stockholder's equity, and cash
flows for each of the three years in the period ended December 31, 1996.
Our audits also included the financial statement schedules listed in the
Index at Item 14. These financial statements and financial statement
schedules are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements and
financial statement schedules based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements.
An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly,
in all material respects, the financial position of the Company as of
December 31, 1996 and 1995, and the results of their operations and their
cash flows for each of the three years in the period ended December 31,
1996 in conformity with generally accepted accounting principles. Also,
in our opinion, such financial statement schedules, when considered in
relation to the basic consolidated financial statements taken as a whole,
present fairly in all material respects the information set forth therein.
As discussed in Notes H and Q, in 1994 the Company changed its method
of accounting for investments to conform with Statement of Financial
Accounting Standards No. 115.
/s/ Deloitte & Touche LLP
DELOITTE & TOUCHE LLP
Los Angeles, California
February 13, 1997
25
FARMERS GROUP, INC.
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands)
ASSETS
December 31,
-----------------------------
1996 1995
------------- -------------
Current assets, excluding life subsidiaries:
Cash and cash equivalents $ 412,018 $ 763,212
Marketable securities, at market value 118,253 94,138
Accrued interest 39,148 33,297
Accounts receivable, principally from the exchanges 28,641 16,270
Notes receivable - affiliate 135,000 135,000
Deferred taxes 35,003 18,935
Prepaid expenses and other 23,985 12,551
------------- -------------
Total current assets 792,048 1,073,403
------------- -------------
Investments, excluding life subsidiaries:
Fixed maturities available-for-sale, at market value
(cost: $182,474 and $304,863) 184,829 311,594
Non-redeemable preferred stocks available-for-sale, at
market value (cost: $18 and $0) 20 0
Common stocks available-for-sale, at market value
(cost: $250,421 and $0) 307,821 0
Certificates in surplus of exchanges 684,380 484,380
Real estate, at cost (net of accumulated depreciation:
$16,944 and $14,843) 45,358 49,809
Joint ventures, at equity 10,366 12,459
------------- -------------
1,232,774 858,242
------------- -------------
Other assets, excluding life subsidiaries:
Notes receivable - affiliate 272,000 207,600
Goodwill (net of accumulated amortization: $480,352
and $420,308) 1,921,403 1,981,447
Attorney-in-fact contracts (net of accumulated
amortization: $341,808 and $299,082) 1,367,235 1,409,961
Other assets 357,104 194,831
------------- -------------
3,917,742 3,793,839
------------- -------------
Properties, plant and equipment, at cost: (net of
accumulated depreciation: $202,085 and $155,255) 447,636 460,030
------------- -------------
Investments of life subsidiaries:
Fixed maturities available-for-sale, at market value
(cost: $3,764,192 and $3,342,199) 3,854,126 3,506,572
Mortgage loans on real estate 122,635 148,852
Non-redeemable preferred stocks available-for-sale, at market
value (cost: $7,007 and $34,127) 6,308 36,305
Common stocks available-for-sale, at market value
(cost: $84,532 and $271,599) 103,887 333,661
Policy loans 187,285 165,265
Real estate, at cost (net of accumulated depreciation:
$16,824 and $16,240) 61,715 69,379
Joint ventures, at equity 11,971 13,267
------------- -------------
4,347,927 4,273,301
------------- -------------
Other assets of life subsidiaries:
Cash and cash equivalents 87,310 149,794
Accrued investment income 53,063 51,377
Deferred policy acquisition costs and value of life business
acquired 1,001,044 964,861
Notes receivable - affiliate 0 64,400
Other assets 252,667 226,603
Assets held in Separate Account 796,616 714,794
------------- -------------
2,190,700 2,171,829
------------- -------------
Total assets $ 12,928,827 $ 12,630,644
============= =============
The accompanying notes are an integral part of these financial statements.
26
FARMERS GROUP, INC.
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands)
LIABILITIES AND STOCKHOLDER'S EQUITY
December 31,
--------------------------
1996 1995
------------- ------------
Current liabilities, excluding life subsidiaries:
Notes and accounts payable:
Exchanges $ 8,234 $ 1,748
Other 21,004 228,797
Accrued liabilities:
Profit sharing 52,690 51,274
Income taxes 29,831 556
Other 18,474 24,821
------------- -------------
Total current liabilities 130,233 307,196
------------- -------------
Other liabilities, excluding life subsidiaries:
Real estate mortgages payable 217 333
Non-current deferred taxes 675,900 674,578
Other 251,315 109,432
------------- -------------
927,432 784,343
------------- -------------
Liabilities of life subsidiaries:
Policy liabilities:
Future policy benefits 3,474,862 3,213,562
Claims 32,732 32,192
Policyholder dividends 13,358 13,594
Other policyholder funds 70,816 73,568
Income taxes (including deferred taxes: $195,188 and $248,717) 194,222 249,349
Unearned investment income 2,302 2,221
Other liabilities 282,423 246,177
Liabilities related to Separate Account 796,616 714,794
------------- -------------
4,867,331 4,545,457
------------- -------------
Total liabilities 5,924,996 5,636,996
------------- -------------
Commitments and contingencies
Company obligated mandatorily redeemable preferred
securities of subsidiary trusts holding solely junior
subordinated debentures 500,000 500,000
------------- ------------
Stockholder's Equity:
Common stock, $1 par value per share; authorized, issued
and outstanding: 1996 and 1995 -- 1000 shares 1 1
Additional capital 5,212,618 5,212,618
Unrealized gains (net of deferred taxes of $49,781
and $67,545) 92,104 124,962
Retained earnings 1,199,108 1,156,067
------------- -------------
Total stockholder's equity 6,503,831 6,493,648
------------- -------------
Total liabilities and stockholder's equity $ 12,928,827 $ 12,630,644
============= =============
The accompanying notes are an integral part of these financial statements.
27
FARMERS GROUP, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Amounts in thousands)
Year ended December 31,
-------------------------------------
1996 1995 1994
----------- ----------- ------------
Consolidated operating revenues $ 2,012,915 $ 1,892,113 $ 1,779,171
=========== =========== ===========
Management services to property and casualty
insurance companies; and other:
Operating revenues $ 1,245,375 $ 1,183,098 $ 1,130,072
----------- ----------- -----------
Salaries and employee benefits 337,238 348,829 348,772
Buildings and equipment expenses 86,076 75,053 55,116
Amortization of AIF contracts and goodwill 102,770 102,770 102,770
General and administrative expenses 171,456 170,470 172,854
----------- ----------- -----------
Total operating expenses 697,540 697,122 679,512
----------- ----------- -----------
Operating income 547,835 485,976 450,560
Net investment income 117,859 79,518 61,818
Dividends on preferred securities of subsidiary trusts (42,070) (10,414) 0
----------- ----------- -----------
Income before provision for taxes 623,624 555,080 512,378
Provision for income taxes 275,152 224,289 208,086
----------- ----------- -----------
Management services income 348,472 330,791 304,292
----------- ----------- -----------
Life subsidiaries:
Premiums 170,421 158,827 153,107
Policy charges 241,737 220,609 197,581
Investment income, net of expenses 317,393 297,960 251,635
Net realized gains 37,989 31,619 46,776
----------- ----------- -----------
Total revenues 767,540 709,015 649,099
----------- ----------- -----------
Policy benefits 155,110 152,951 133,018
Increase in liability for future policy benefits 11,089 9,147 6,595
Interest credited to policyholders 168,912 154,579 136,783
Amortization of deferred policy acquisition costs and
value of life business acquired 108,802 103,201 92,841
Commissions 20,986 20,160 18,698
General and administrative expenses 63,991 61,600 57,343
----------- ----------- -----------
Total operating expenses 528,890 501,638 445,278
----------- ----------- -----------
Income before provision for taxes 238,650 207,377 203,821
Provision for income taxes 79,181 67,438 67,713
----------- ----------- -----------
Life subsidiaries income 159,469 139,939 136,108
----------- ----------- -----------
Consolidated net income before cumulative effect
of accounting change 507,941 470,730 440,400
Cumulative effect of accounting change
(net of tax of $2,817) 0 0 (4,691)
----------- ----------- -----------
Consolidated net income $ 507,941 $ 470,730 $ 435,709
=========== =========== ===========
The accompanying notes are an integral part of these financial statements.
28
FARMERS GROUP, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDER'S EQUITY
Years ended December 31, 1996, 1995 and 1994
(Amounts in thousands)
Net Unrealized Total
Common Additional Gains (Losses) Retained Stockholder's
Stock Capital On Investments Earnings Equity
-------- ----------- ------------- ---------- ------------
Balance, December 31, 1993 $ 1 $ 5,212,618 $ 45,181 $ 884,213 $ 6,142,013
Net income, 1994 435,709 435,709
Cumulative effect on
adoption of SFAS No. 115
on January 1, 1994 net
of tax of $23,903 44,231 44,231
Change in net unrealized
losses on investments
net of tax of ($67,064) (124,558) (124,558)
Cash dividends paid (349,385) (349,385)
-------- ----------- ------------- ---------- ------------
Balance, December 31, 1994 1 5,212,618 (35,146) 970,537 6,148,010
Net income, 1995 470,730 470,730
Change in net unrealized
gains on investments
net of tax of $86,448 160,108 160,108
Cash dividends paid (285,200) (285,200)
-------- ----------- ------------- ---------- ------------
Balance, December 31, 1995 1 5,212,618 124,962 1,156,067 6,493,648
Net income, 1996 507,941 507,941
Change in net unrealized
losses on investments
net of tax of ($17,764) (32,858) (32,858)
Cash dividends paid (464,900) (464,900)
-------- ----------- ------------- ---------- ------------
Balance, December 31, 1996 $ 1 $ 5,212,618 $ 92,104 $1,199,108 $ 6,503,831
======== =========== ============= ========== ============
The accompanying notes are an integral part of these financial statements.
29
FARMERS GROUP, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in thousands)
Year ended December 31,
------------------------------------
1996 1995 1994
---------- ---------- ----------
Cash Flows from Operating Activities:
Consolidated net income $ 507,941 $ 470,730 $ 435,709
Non-cash and operating activities adjustments:
Depreciation and amortization 168,263 153,096 135,401
Amortization of deferred policy acquisition costs and
value of life business acquired 108,802 103,201 92,841
Policy acquisition costs deferred (129,922) (133,166) (133,805)
Life insurance policy liabilities 258,852 334,592 360,716
Equity in earnings of joint ventures 2,164 510 (147)
Gain on sales of assets (44,584) (34,505) (50,770)
Changes in assets and liabilities:
Current assets and liabilities 10,068 21,184 (23,594)
Non-current assets and liabilities (86,044) (85,339) (47,834)
Other, net (33,691) (26,846) (4,950)
---------- ---------- ----------
Net cash provided by operating activities 761,849 803,457 763,567
---------- ---------- ----------
Cash Flows from Investing Activities:
Purchases of investments available-for-sale (1,279,073) (939,186) (882,246)
Purchases of investments held-to-maturity 0 0 (372,205)
Purchases of properties (43,546) (34,682) (34,261)
Purchase of surplus certificates of the exchanges (400,000) (250,000) 0
Proceeds from sales and maturities of investments
available-for-sale 979,701 541,376 627,743
Proceeds from calls and maturities of investments
held-to-maturity 0 0 231,592
Proceeds from sales of properties 27,822 20,201 12,955
Proceeds from surplus certificates of the
exchanges 200,000 0 0
Purchases of mortgage loans 0 (75) 0
Mortgage loan collections 23,624 20,418 37,544
Other, net (18,601) 15,220 (25,751)
---------- ---------- ----------
Net cash used in investing activities (510,073) (626,728) (404,629)
---------- ---------- ----------
Cash Flows from Financing Activities:
Dividends paid to stockholder (464,900) (285,200) (349,385)
Proceeds from issuance of cumulative quarterly
income preferred securities 0 500,000 0
Issuance cost of cumulative quarterly income
preferred securities (438) (17,803) 0
Payment of long-term notes payable (200,000) 0 0
Payment of real estate mortgages payable (116) (81) (8,965)
---------- ---------- ----------
Net cash provided/(used) in financing activities (665,454) 196,916 (358,350)
---------- ---------- ----------
Increase/(decrease) in cash and cash equivalents (413,678) 373,645 588
Cash and cash equivalents - at beginning of year 913,006 539,361 538,773
---------- ---------- ----------
Cash and cash equivalents - at end of year $ 499,328 $ 913,006 $ 539,361
========== ========== ==========
The accompanying notes are an integral part of these financial statements.
30
FARMERS GROUP, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A. Basis of presentation and summary of significant accounting policies
The consolidated financial statements have been prepared in accordance
with generally accepted accounting principles ("GAAP"). The consolidated
financial statements include the Company and its subsidiaries. All material
inter-company transactions have been eliminated. Certain amounts applicable
to prior years have been reclassified to conform with the 1996 presentation.
In December 1988, BATUS Inc. ("BATUS"), a subsidiary of B.A.T Industries
p.l.c. ("B.A.T"), acquired 100% ownership of Farmers Group, Inc. (the
"Company") for $5,212,619,000 in cash, including related expenses, through
its wholly owned subsidiary BATUS Financial Services. Immediately thereafter,
BATUS Financial Services was merged into Farmers Group, Inc.. The acquisition
was accounted for as a purchase and, accordingly, the acquired assets and
liabilities were recorded in the Company's consolidated balance sheets based
on their estimated fair values at December 31, 1988. In January 1990,
ownership of the Company was transferred to South Western Nominees Limited, a
subsidiary of B.A.T.
The Company is attorney-in-fact for three inter-insurance exchanges:
Farmers Insurance Exchange, Fire Insurance Exchange and Truck Insurance
Exchange (collectively the "Exchanges"), which operate in the property and
casualty insurance industry. As attorney-in-fact, the Company, or its
subsidiaries, as applicable, manages the affairs of the Exchanges, their
respective subsidiaries and Farmers Texas County Mutual Insurance Company
(collectively the "P&C Group") and receives compensation based on a
percentage of earned premiums. The management services generate a
substantial portion of the Company's revenue and profits, and as a
result, the Company's ongoing financial performance depends on the volume
of business written by, and the efficiency and financial strength of, the
P&C Group. A portion of the purchase price ($1,709,043,000) associated
with the acquisition was assigned to these attorney-in-fact ("AIF")
contract relationships. The value so assigned is being amortized on a
straight-line basis over forty years.
The excess of the purchase price over the fair value of the net assets
("Goodwill") of the Company at the date of acquisition ($2,401,755,000) is
being amortized on a straight-line basis over forty years. The carrying
amount of the Goodwill is regularly reviewed for indications of impairment
in value which in the view of management are other than temporary, including
unexpected or adverse changes in the following: (1) the economic or
competitive environments in which the Company operates, (2) profitability
analyses and (3) cashflow analyses. As of December 31, 1996, the reported
value and the remaining life of Goodwill are considered appropriate.
31
The Company's life insurance operations are conducted by three wholly
owned subsidiaries. They market a broad line of individual life insurance
products, including universal life, term life and whole life insurance, and
annuity products, predominately flexible premium deferred annuities. A
portion of the purchase price ($662,778,000) was assigned to the "Value of
Life Business Acquired", which represented an actuarial determination of
the expected profits from the business in force at the date of acquisition.
The amount so assigned is being amortized over its actuarially determined
useful life with the unamortized amount included in "Deferred Policy
Acquisition Costs and Value of Life Business Acquired" in the accompanying
consolidated balance sheets.
Properties are depreciated over the following estimated useful lives:
Buildings and improvements 10 to 35 years
Furniture and equipment 5 to 10 years
Data processing equipment and software 5 years
Depreciation is calculated for financial statement purposes by the
straight-line method. Repairs and maintenance are charged to operations;
significant renewals and betterments are capitalized.
In 1996, the Company adopted Financial Accounting Standards Board
("FASB") Statement of Financial Accounting Standards ("SFAS") No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets
to Be Disposed Of". This Statement requires that long-lived assets and
certain identifiable intangibles to be held and used by an entity be reviewed
for impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. The adoption of this
Statement did not have a material impact on the Company's consolidated
financial statements.
In 1996, the Company adopted SFAS No. 123, "Accounting for Stock-Based
Compensation". This Statement establishes accounting and disclosure
requirements using a fair value based method of accounting for stock-based
employee compensation plans. Under SFAS No. 123, a company may either adopt
the new fair value based accounting method or continue to apply the intrinsic
value based method and provide pro forma disclosures of net income and
earnings per share as if the accounting provisions of SFAS No. 123 had been
adopted. Farmers Group, Inc. adopted only the disclosure requirements of SFAS
No. 123; therefore, the adoption of this Statement had no effect on its
consolidated financial statements.
In June 1996, the FASB released SFAS No.125, "Accounting for Transfers
and Servicing of Financial Assets and Extinguishments of Liabilities". This
Statement, effective for fiscal years beginning after December 31, 1996,
establishes accounting and reporting standards for transfers and servicing of
financial assets and extinguishments of liabilities based on a consistent
application of a financial-components approach that focuses on the issue of
control. In December 1996, the FASB issued SFAS No. 127, "Deferral of the
Effective Date of Certain Provisions of FASB Statement No. 125", which delays
for one year the effective date of the provisions that apply to certain
transactions. These transactions include repurchase agreements, dollar-rolls,
securities lending, secured borrowings and collateral. The Company does not
expect the adoption of these Statements to have a significant impact on its
consolidated financial statements.
32
The preparation of the Company's financial statements in conformity with
GAAP requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of contingent assets
and liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the reporting periods. Actual results
could differ from those estimates.
B. Life insurance accounting
The Company's life insurance operations are conducted through its
subsidiaries Farmers New World Life Insurance Company, The Ohio State Life
Insurance Company and Investors Guaranty Life Insurance Company (the "Life
Subsidiaries").
Traditional product premiums are recognized as revenues when they become
due, and future benefits and expenses are matched with such premiums so that
the majority of profits are recognized over the premium-paying period of
the policy. This matching of revenues and expenses is accomplished through
the provision for future policy benefits and the amortization of deferred
policy acquisition costs ("DAC").
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 business), are deferred and
amortized proportionately over the estimated period during which the related
premiums will be recognized as income, based on the same assumptions that are
used for computing the liabilities for future policy benefits. Liabilities
for future policy benefits are computed principally by means of a net level
premium method reflecting estimated future investment yields, mortality,
morbidity and withdrawals. Interest rate assumptions range from 2.25% to
9.50%, depending on the year of policy issue. Mortality is calculated
principally on select and ultimate tables in common usage in the industry,
modified for the Life Subsidiaries' experience, and withdrawals are estimated
based primarily on the Life Subsidiaries' experience.
Revenues associated with universal life products consist of policy
charges for the cost of insurance, policy administration fees, surrender
charges and investment income on assets allocated to support policyholder
account balances. Revenues for deferred annuity products consist of surrender
charges and investment income on assets allocated to support policyholder
account balances. Expenses include interest credited to policyholder account
balances and benefit claims incurred in excess of policyholder account
balances. Liabilities for future policy benefits on universal life and
deferred annuity products are determined under the retrospective deposit
method. DAC is amortized in relation to the present value of expected gross
profit margins on the policies, after giving recognition to differences
between actual and expected gross profit margins to date. DAC and Value of
Life Business Acquired also includes amounts associated with the unrealized
gains and losses recorded as a component of stockholder's equity in
accordance with the application of SFAS No. 115, "Accounting
for Certain Investments in Debt and Equity Securities". Accordingly, DAC and
Value of Life Business Acquired is increased or decreased for the impact on
estimated future gross profits as if net unrealized gains or losses on
securities had been realized at the balance sheet date. Net unrealized
gains or losses on securities within stockholder's equity also reflects
this impact. These entries decrease the DAC and Value of Life Business
Acquired asset by $27,927,000 and $42,992,000 as of December 31, 1996 and
1995, respectively.
33
C. Property, plant and equipment
A schedule of the Company's operating properties, plant and equipment at
cost as of December 31 follows:
1996 1995
----------- -----------
(Amounts in thousands)
Buildings and improvements $ 260,937 $ 259,686
Data processing equipment and software 206,400 191,283
Furniture and equipment 105,264 85,902
----------- -----------
572,601 536,871
Land 77,120 78,414
----------- -----------
$ 649,721 $ 615,285
=========== ===========
D. Certificates in surplus of exchanges
The Company, as attorney-in-fact for the Exchanges, has made surplus
contributions to the Exchanges from time to time. In return, the Company has
received the following certificates of contribution totaling $684,380,000 as
of December 31, 1996:
A $100,000,000 certificate of contribution, issued on December 20, 1996,
bearing interest at 8.95% annually.
A $135,000,000 certificate of contribution, issued on September 30, 1996,
bearing interest at 8.95% annually.
A $165,000,000 certificate of contribution, issued on June 27, 1996,
bearing interest at 8.95% annually.
A $250,000,000 certificate of contribution, issued in 1995, bearing
interest at 8.95% annually.
Miscellaneous other certificates of contribution totaling $34,380,000
which bear interest at various rates.
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.
On July 1, 1996, the Company received $200,000,000 from the Exchanges in
repayment of a surplus contribution made by the Company in 1986.
E. Company Obligated Mandatorily Redeemable Preferred Securities of
Subsidiary Trusts Holding Solely Junior Subordinate Debentures
In 1995, Farmers Group Capital and Farmers Group Capital II (the
"Subsidiary Trusts"), consolidated wholly owned subsidiaries of Farmers
Group, Inc., issued $410 million of 8.45% Cumulative Quarterly Income
Preferred Securities ("QUIPS"), Series A and $90 million of 8.25% QUIPS,
Series B, respectively. In connection with the Subsidiary Trusts' issuance
of the QUIPS and the related purchase by Farmers Group, Inc. of all of the
Subsidiary Trusts' Common Securities
34
("Common Securities"), Farmers Group, Inc. issued to Farmers Group Capital
$422,680,399 principal amount of its 8.45% Junior Subordinated Debentures,
Series A due on December 31, 2025, (the "Junior Subordinated Debentures,
Series A") and issued to Farmers Group Capital II $92,783,505 principal
amount of its 8.25% Junior Subordinated Debentures, Series B due on December
31, 2025 (the "Junior Subordinated Debentures, Series B" and, together with
the Junior Subordinated Debentures, Series A, the "Junior Subordinated
Debentures"). The sole assets of Farmers Group Capital are the Junior
Subordinated Debentures, Series A. The sole assets of Farmers Group Capital II
are the Junior Subordinated Debentures, Series B. In addition, these
arrangements are governed by various agreements between Farmers Group, Inc.
and the Subsidiary Trusts (the Guarantee Agreements, the Trust Agreements, the
Expense Agreements, the Indentures and the Junior Subordinated Debentures)
which considered together constitute a full and unconditional guarantee by
Farmers Group, Inc. of the Subsidiary Trusts' obligations under the Preferred
Securities.
Under certain circumstances, the Junior Subordinated Debentures may be
distributed to holders of the QUIPS and holders of the Common Securities in
liquidation of the Subsidiary Trusts. The QUIPS are subject to mandatory
redemption upon repayment of the Junior Subordinated Debentures at maturity,
or upon their earlier redemption, at a redemption price of $25 per Preferred
Security, plus accrued and unpaid distributions thereon to the date fixed for
redemption. Farmers Group, Inc. will have the option at any time on or after
September 27, 2000 to redeem, in whole or part, the Junior Subordinated
Debentures.
As of December 31, 1996 and 1995, a total of 20,000,000 shares of QUIPS
were outstanding.
F. Employees' profit sharing plans
The Company has two profit sharing plans providing for cash payments to
all eligible employees. The two plans, Cash Profit Sharing (consisting of
Cash and Cash Plus) and Deferred Profit Sharing, provide for a maximum
aggregate expense of 16.25% of the Company's consolidated annual pretax
earnings, as adjusted. The Deferred Profit Sharing Plan, limited to 15% of
the salary or wage paid or accrued to the eligible employee, provides for
an annual payment by the Company to a trust for eventual payment to employees
as provided in the Plan. The Cash Profit Sharing Plan provides for annual
cash distributions limited to 5% (Cash) and 1.25% (Cash Plus) of the salary
or wage paid or accrued to the eligible employee.
Expense under these plans was $55,772,000, $55,070,000, and $53,939,000
in 1996, 1995 and 1994, respectively.
G. Retained earnings
Combined statutory capital and surplus of the Life Subsidiaries was
$894,738,000 and $1,142,625,000 as of December 31, 1996 and 1995,
respectively. Combined statutory net income for the years ended December 31,
1996, 1995 and 1994 was $167,517,000, $116,998,000, and $83,671,000,
respectively.
In December 1996, upon approval of the Washington State Department of
Insurance, Farmers New World Life Insurance Company paid a $374,916,000
extraordinary dividend to its parent company, Farmers Group, Inc., which
consisted primarily of common stock investments. As
35
of December 31, 1996, an aggregate of $192,219,000 was still available for
distribution without approval from the state insurance departments in which
the Life Subsidiaries are domiciled.
H. Investments
The Company follows the provisions of SFAS No. 115. This statement
addresses the accounting and reporting for investments in equity securities
that have readily determinable fair values and for all investments in debt
securities. As of December 31, 1996 and 1995, the Company classified all
investments in equity and debt securities as available-for-sale under SFAS No.
115. Correspondingly, these investments are reported on the balance sheet at
fair value, with unrealized gains and losses, net of tax, excluded from
earnings and reported as a component of stockholder's equity.
On November 15, 1995, the FASB issued a special report, "A Guide to
Implementation of Statement 115 on Accounting for Certain Investments in Debt
and Equity Securities", in which they discussed a "fresh start" transition
provision that allowed reporting entities to reassess their securities
holdings that were classified pursuant to the provision in SFAS No. 115. As a
result of this "fresh start", the Company decided to reclassify all of its
debt securities originally classified as held-to-maturity under SFAS No. 115
to available-for-sale as of December 31, 1995. This resulted in the transfer
of debt securities with an amortized cost of approximately $1.1 billion and
net unrealized gains of approximately $51.0 million from held-to-maturity to
available-for-sale.
In compliance with a Securities and Exchange Commission ("SEC") staff
announcement, the Company has recorded certain entries to the DAC and Value of
Life Business Acquired line of the consolidated balance sheet in connection
with SFAS No. 115. The SEC requires that companies record entries to those
assets and liabilities that would have been adjusted had the unrealized
investment gains or losses from securities classified as available-for-sale
actually been realized, with corresponding credits or charges reported
directly to stockholder's equity.
36
The sources of investment income on securities owned by the Company
(excluding the Life Subsidiaries) for the years ended December 31 are:
1996 1995 1994
---------- ---------- ---------
(Amounts in thousands)
Related parties:
B.A.T Capital Corporation notes $ 18,151 $ 17,331 $ 20,154
---------- ---------- ----------
Total related parties 18,151 17,331 20,154
---------- ---------- ----------
Non-related parties:
Interest Income --
certificates in surplus
of exchanges 45,448 31,408 21,035
Interest income --
fixed income securities 41,714 27,762 22,885
Dividend income 4,863 5,263 4,824
Interest income --
short-term instruments 11,385 10,398 7,429
Realized investment gains, net 5,079 1,497 2,696
Investment expenses (8,938) (16,500) (16,500)
Other 157 2,359 (705)
---------- ---------- ----------
Total non-related parties 99,708 62,187 41,664
---------- ---------- ----------
Total investment income
by component $ 117,859 $ 79,518 $ 61,818
========== ========== ==========
The sources of investment income on securities owned by the Life
Subsidiaries for the years ended December 31 are:
1996 1995 1994
---------- ---------- ---------
(Amounts in thousands)
Fixed income securities $ 258,828 $ 235,596 $ 196,287
Equity securities 25,299 27,995 26,494
Mortgage loans 14,721 16,526 19,275
B.A.T Capital Corporation notes 2,580 3,975 605
Owned real estate 10,477 10,291 10,844
Policy loans 12,152 10,571 9,317
Short-term instruments 4,097 5,228 3,070
Other 2,906 3,193 1,698
Investment expenses (13,667) (15,415) (15,955)
---------- ----------- ----------
Total investment income
by component $ 317,393 $ 297,960 $ 251,635
========== ========== ==========
Realized gains and losses on sales, redemptions and writedowns of
investments owned by the Company (excluding the Life Subsidiaries) are
determined based on either the cost of the individual securities or the
amortized cost of real estate. Net realized investment gains or losses for
the years ended December 31 are:
1996 1995 1994
---------- ---------- ----------
(Amounts in thousands)
Bonds $ 1,626 $ (23) $ (85)
Redeemable preferred stocks 623 41 (50)
Non-redeemable preferred stocks 0 0 0
Common stocks (524) 0 705
Investment real estate 3,354 1,479 2,126
---------- ---------- ----------
Net realized investment gains $ 5,079 $ 1,497 $ 2,696
========== ========== ==========
37
Realized gains and losses on sales, redemptions and writedowns of
investments owned by the Life Subsidiaries are determined based on either
the cost of the individual securities or the amortized cost of real estate.
Net realized investment gains or losses for the years ended December 31 are:
1996 1995 1994
---------- ---------- ---------
(Amounts in thousands)
Bonds $ 874 $ 2,942 $ 12,650
Redeemable preferred stocks 1,738 25 (105)
Non-redeemable preferred stocks (2,799) 742 921
Common stocks 41,007 28,846 33,881
Investment real estate (2,131) (919) (571)
Other (700) (17) 0
---------- ---------- ----------
Net realized investment gains $ 37,989 $ 31,619 $ 46,776
========== ========== ==========
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 the Life Subsidiaries) are as follows:
As of December 31, 1996
--------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
--------- ---------- ---------- ---------
(Amounts in thousands)
Equity Securities Available-for-Sale
Non-redeemable preferred stocks $ 18 $ 2 $ 0 $ 20
Common stocks 250,421 69,446 (12,046) 307,821
--------- ---------- ---------- ---------
Total $ 250,439 $ 69,448 $ (12,046) $ 307,841
========= ========== ========== =========
38
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 Life
Subsidiaries are as follows:
As of December 31, 1996
--------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
--------- ---------- ---------- ---------
(Amounts in thousands)
Equity Securities Available-for-Sale
Non-redeemable preferred stocks $ 7,007 $ 261 $ (960) $ 6,308
Common stocks 84,532 21,198 (1,843) 103,887
--------- ---------- ---------- ---------
Total $ 91,539 $ 21,459 $ (2,803) $ 110,195
========= ========== ========== =========
As of December 31, 1995
--------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
--------- ---------- ---------- ---------
(Amounts in thousands)
Equity Securities Available-for-Sale
Non-redeemable preferred stocks $ 34,127 $ 4,138 $ (1,960) $ 36,305
Common stocks 271,599 81,243 (19,181) 333,661
--------- ---------- ---------- ---------
Total $ 305,726 $ 85,381 $ (21,141) $ 369,966
========= ========== ========== =========
39
The amortized cost, gross unrealized gains and losses, and estimated
market values of investments in debt securities, including bonds and
redeemable preferred stocks, owned by the Company (excluding the Life
Subsidiaries) are as follows:
As of December 31, 1996
--------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
--------- ---------- ---------- ---------
(Amounts in thousands)
Debt Securities Available-for-Sale,
including Marketable Securities
U.S. Treasury securities and obligations of
U.S. government corporations and agencies $ 247 $ 3 $ 0 $ 250
Obligations of states and political
subdivisions 244,380 1,193 (17) 245,556
Corporate securities 20 0 0 20
Other debt securities 56,080 1,410 (234) 57,256
--------- ---------- ---------- ---------
Total $ 300,727 $ 2,606 $ (251) $ 303,082
========= ========== ========== =========
As of December 31, 1995
----------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
--------- ---------- ---------- ---------
(Amounts in thousands)
Debt Securities Available-for-Sale,
including Marketable Securities
U.S. Treasury securities and obligations of
U.S. government corporations and agencies $ 55 $ 5 $ 0 $ 60
Obligations of states and political
subdivisions 304,652 4,439 (27) 309,064
Corporate securities 20,020 0 (20) 20,000
Other debt securities 74,274 2,760 (426) 76,608
--------- --------- ---------- ---------
Total $ 399,001 $ 7,204 $ (473) $ 405,732
========= ========= ========== =========
40
The amortized cost, gross unrealized gains and losses, and estimated
market values of investments in debt securities, including bonds and
redeemable preferred stocks, owned by the Life Subsidiaries are as follows:
As of December 31, 1996
----------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
----------- ----------- ------------ ---------
(Amounts in thousands)
Debt Securities Available-for-Sale
U.S. Treasury securities and obligations of
U.S. government corporations and agencies $ 369,543 $ 11,169 $ (2,726) $ 377,986
Obligations of states and political
subdivisions 364,836 13,014 (950) 376,900
Debt securities issued by foreign governments 52,133 17,057 (13) 69,177
Corporate securities 934,695 35,790 (9,018) 961,467
Mortgage-backed securities 1,843,673 44,630 (20,704) 1,867,599
Other debt securities 199,312 6,469 (4,784) 200,997
----------- ----------- ----------- -----------
Total $ 3,764,192 $ 128,129 $ (38,195) $ 3,854,126
=========== =========== =========== ===========
As of December 31, 1995
-----------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
----------- ----------- ------------ ----------
(Amounts in thousands)
Debt Securities Available-for-Sale
U.S. Treasury securities and obligations of
U.S. government corporations and agencies $ 302,556 $ 19,083 $ (185) $ 321,454
Obligations of states and political
subdivisions 311,482 16,066 (737) 326,811
Debt securities issued by foreign governments 75,708 4,641 (2,778) 77,571
Corporate securities 849,734 57,467 (5,076) 902,125
Mortgage-backed securities 1,558,198 70,134 (5,826) 1,622,506
Other debt securities 244,521 14,018 (2,434) 256,105
----------- ----------- ------------ ----------
Total $3,342,199 $ 181,409 $ (17,036) $3,506,572
=========== =========== ============ ==========
41
The amortized cost and estimated market value of debt securities,
including marketable securities, owned by the Company (excluding the Life
Subsidiaries) as of December 31, 1996, by contractual maturity, are shown
below. Expected maturities will differ from contractual maturities because
borrowers may have the right to call or prepay obligations with or without
call or prepayment penalties.
Estimated
Amortized Market
Cost Value
----------- ----------
(Amounts in thousands)
Debt Securities Available-for-Sale,
including Marketable Securities
Due in one year or less $ 118,860 $ 118.860
Due after one year through five years 40,093 40,866
Due after five years through ten years 14,548 14,655
Due after ten years 71,146 71,445
----------- ----------
244,647 245,826
Redeemable preferred stocks
with no stated maturities 56,080 57,256
---------- ----------
$ 300,727 $ 303,082
========== ==========
The amortized cost and estimated market value of debt securities owned
by the Life Subsidiaries as of December 31, 1996, by contractual maturity,
are shown below. Expected maturities will differ from contractual maturities
because borrowers may have the right to call or prepay obligations with or
without call or prepayment penalties.
Estimated
Amortized Market
Cost Value
----------- ----------
(Amounts in thousands)
Debt Securities Available-for-Sale
Due in one year or less $ 33,747 $ 34,057
Due after one year through five years 367,197 373,846
Due after five years through ten years 642,043 654,855
Due after ten years 678,220 722,772
----------- ----------
1,721,207 1,785,530
Mortgage-backed securities 1,843,673 1,867,599
Redeemable preferred stocks
with no stated maturities 199,312 200,997
----------- ----------
$3,764,192 $3,854,126
========== ==========
Proceeds from sales of available-for-sale securities received by the
Company were $551,122,000 during 1996. Gross gains of $76,431,000 and gross
losses of $32,009,000 were realized on sales and writedowns during 1996.
Proceeds from sales and maturities of available-for-sale securities
received by the Company were $541,376,000 and $627,743,000 during 1995 and
1994, respectively. Gross gains of $45,944,000 and $72,818,000 and gross
losses of $13,371,000 and $24,628,000 were realized on sales and writedowns
during 1995 and 1994, respectively.
42
The change in the net unrealized gains or losses of the Company
(excluding the Life Subsidiaries) for the years ended December 31 is as
follows:
1996 1995
---------- ----------
(Amounts in thousands)
Fixed maturities $ (4,376) $ 10,152
Equity securities 57,402 0
The change in the net unrealized gains or losses of the Life
Subsidiaries for the years ended December 31 is as follows:
1996 1995
---------- ----------
(Amounts in thousands)
Fixed maturities $ (74,439) $ 345,802
Equity securities (45,584) 34,235
43
I. Fair value of financial instruments
The estimated fair values of financial instruments disclosed have been
determined using available market information and appropriate valuation
methodologies. However, considerable judgment is required to interpret market
data to develop the estimates of fair value. Accordingly, the estimates
presented may not be indicative of the amounts the Company could realize
in a current market exchange. The use of different market assumptions and/or
estimation methodologies could have a significant effect on the estimated
fair value amounts.
December 31, 1996
---------------------------
Carrying Estimated
Value Fair Value
----------- -----------
(Amounts in thousands)
Assets and liabilities excluding life subsidiaries:
Assets:
Cash and cash equivalents $ 412,018 $ 412,018
Short-term marketable securities 118,253 118,253
Fixed maturities available-for-sale 184,829 184,829
Non-redeemable preferred stocks
available-for-sale 20 20
Common stocks available-for-sale 307,821 307,821
Certificates in surplus of exchanges 684,380 684,380
Notes receivable - affiliate 407,000 402,400
Joint ventures, at equity 10,366 16,241
Other assets 20,103 16,370
Liabilities:
Real estate mortgages payable 217 227
Company obligated mandatorily redeemable
preferred securities of subsidiary trusts
holding solely junior subordinated debentures 500,000 507,600
Life subsidiaries:
Assets:
Cash and cash equivalents 87,310 87,310
Fixed maturities available-for-sale 3,854,126 3,854,126
Non-redeemable preferred stocks
available-for-sale 6,308 6,308
Common stocks available-for-sale 103,887 103,887
Mortgage loans 122,635 138,515
Policy loans 187,285 188,627
Joint ventures, at equity 11,971 14,748
Assets held in separate account 796,616 796,616
Liabilities:
Liabilities related to separate account 796,616 796,616
Future policy benefits - deferred annuities 1,600,983 1,518,075
44
December 31, 1995
---------------------------
Carrying Estimated
Value Fair Value
----------- -----------
(Amounts in thousands)
Assets and liabilities excluding life subsidiaries:
Assets:
Cash and cash equivalents $ 763,212 $ 763,212
Short-term marketable securities 94,138 94,138
Fixed maturities available-for-sale 311,594 311,594
Certificates in surplus of exchanges 484,380 484,380
Notes receivable - affiliate 342,600 338,400
Joint ventures, at equity 12,459 13,885
Other assets 21,362 17,270
Liabilities:
Real estate mortgages payable 333 352
Notes payable 200,000 202,520
Company obligated mandatorily redeemable
preferred securities of subsidiary trusts
holding solely junior subordinated debentures 500,000 519,100
Life subsidiaries:
Assets:
Cash and cash equivalents 149,794 149,794
Fixed maturities available-for-sale 3,506,572 3,506,572
Non-redeemable preferred stocks
available-for-sale 36,305 36,305
Common stocks available-for-sale 333,661 333,661
Notes receivable - affiliate 64,400 63,786
Mortgage loans 148,852 170,709
Policy loans 165,265 169,471
Joint ventures, at equity 13,267 16,562
Assets held in separate account 714,794 714,794
Liabilities:
Liabilities related to separate account 714,794 714,794
Future policy benefits - deferred annuities 1,506,572 1,424,677
45
The following methods and assumptions were used to estimate the fair
value of financial instruments as of December 31, 1996 and 1995:
Cash and cash equivalents and short-term marketable securities-The
carrying amounts of these items are a reasonable estimate of their fair values.
Fixed maturities, non-redeemable preferred stocks and common stocks-The
estimated fair values of bonds, redeemable and non-redeemable preferred
stocks and common stocks are based upon quoted market prices, dealer quotes,
and prices obtained from independent pricing services.
Certificates in surplus of exchanges-The carrying amounts of these
certificates are a reasonable estimate of their fair values.
Notes receivable-affiliate-The fair values are estimated by discounting
the future cash flows using the current rates at which similar loans would be
made by the Company to borrowers for the same remaining maturities.
Joint ventures, at equity-The estimated fair values are based upon
quoted market prices, current appraisals, and independent pricing services.
Other assets-Other assets consist primarily of advances to agents, the
fair value of which is determined by discounting the estimated future cash
flows using credit quality, the average maturity of related advances, and the
current rates at which similar loans would be made to borrowers by the Company.
Mortgage loans-The estimated fair value of the mortgage loans portfolio
is determined by discounting the estimated future cash flows, using a year-
end market rate which is applicable to the yield, credit quality and average
maturity of the composite portfolio.
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.
Assets held in separate account and liabilities related to separate
account-The carrying values are a reasonable estimate of their fair values
since assets and liabilities of separate accounts are carried at market value.
Real estate mortgages payable-The estimated fair values are determined
by discounting the estimated future cash flows at a rate which approximates
the Company's incremental borrowing rate.
Notes payable-The estimated fair values are determined by discounting
the estimated future cash flows at a rate which approximates the Company's
incremental borrowing rate.
Company obligated manditorily redeemable preferred securities of
subsidiary trusts holding solely junior subordinated debentures-The estimated
fair values are based on quoted market prices.
Future policy benefits-deferred annuities-The estimated fair values of
flexible premium and single premium deferred annuities are based on their cash
surrender values.
46
J. Value of Life Business Acquired
The changes in the Value of Life Business Acquired were as follows:
1996 1995 1994
---------- ---------- ----------
(Amounts in thousands)
Balance, beginning of year $ 473,398 $ 525,699 $ 530,405
Amortization related to operations (69,894) (76,235) (77,573)
Interest accrued 41,714 44,634 47,067
Amortization related to net
unrealized gains (losses) (1,900) (20,700) 25,800
---------- ---------- ----------
Balance, end of year $ 443,318 $ 473,398 $ 525,699
========== ========== ==========
Based on current conditions and assumptions as to future events, the
Company expects to amortize the December 31, 1996 balance as follows:
approximately 4.6% in 1997, 4.2% in 1998, 2.9% in 1999, 2.7% in 2000, and
2.6% in 2001. The discount rate used to determine the amortization rate of
the Value of Life Business Acquired ranged from 12.5% to 7.5%.
K. Mortgage loans
The Company follows the principles of SFAS No. 118 (amending SFAS No.
114), "Accounting by Creditors for Impairment of a Loan". This statement
requires that an impaired loan be measured based on the present value of
expected future cash flows discounted at the loan's effective interest rate
or, as a practical expedient, at the loan's observable market price or the
fair value of the collateral, if the loan is collateral dependent.
The total recorded investment in impaired mortgage loans and the amount
of recorded investment for which an allowance for credit losses exists as of
December 31 follows:
1996 1995
---------- ----------
(Amounts in thousands)
Total recorded investment in impaired mortgage
loans and for which an allowance for
credit losses exists $ 5,034 $ 7,290
Total allowance for credit losses
related to impaired mortgage loans 1,394 1,955
47
The Company records interest income received on impaired mortgage loans
on a cash basis. The average recorded investment and income recognized on
impaired mortgage loans follows:
1996 1995
---------- ---------
(Amounts in thousands)
Average recorded investment in impaired
loans during the period $ 5,061 $ 7,324
Interest income recognized on the
impaired mortgage loans during the period 233 518
The activity in the total allowance for credit losses related to
impaired mortgage loans follows:
1996 1995
---------- ----------
(Amounts in thousands)
Beginning balance $ 1,955 $ 1,982
Additions/(deductions) charged to operations 51 471
Direct writedowns charged against the allowance (612) (498)
Recovery of amounts previously charged-off 0 0
--------- ---------
Ending balance $ 1,394 $ 1,955
========= =========
L. Security lending arrangement
The Life Subsidiaries have security lending agreements with a financial
institution. The agreements in effect as of December 31, 1996 authorize the
institution to lend securities held in the Life Subsidiaries' portfolios to
a list of authorized borrowers. Concurrent with delivery of the securities,
the borrower provides the Life Subsidiaries with cash collateral equal to
at least 102% of the market value of domestic securities and 105% of the
market value of other securities subject to the "loan."
The securities are marked-to-market on a daily basis and the collateral
is adjusted on the next business day. The collateral is invested in highly
liquid, fixed income assets with a maturity of less than one year. Income
earned from the security lending arrangement was allocated 60% to the Life
Subsidiaries and 40% to the institution. Income earned by the Life
Subsidiaries was $422,000, $233,000 and $653,000 in 1996, 1995 and 1994,
respectively. The collateral under these agreements as of December 31, 1996
and 1995 was $221,216,000 and $195,377,000, respectively, and was recorded
in both Other Assets and Other Liabilities of Life Subsidiaries.
M. Employees' retirement plans
The Company has two noncontributory defined benefit pension plans (the
Regular Plan and the Restoration Plan). The Regular Plan covers substantially
all employees of the Company and the Exchanges who have reached age 21 and
have rendered one year of service. Benefits are based on years of service
and the employee's compensation during the last five years of employment.
The Restoration Plan provides supplemental retirement benefits for certain
key employees of the Company.
The Company's policy is to fund the amount determined under the
aggregate cost method, provided it does not exceed funding limitations.
There has been no change in funding policy from prior years.
48
Assets of the Regular Plan are held by an independent trustee. Assets
and liabilities of the Regular Plan are recorded by Farmers New World Life
Insurance Company in Separate Accounts and are not commingled with the
general assets and liabilities of that company. Assets held are primarily
in fixed maturity and equity investments. The principal liability is for
annuity benefit payments of current and future retirees. Assets of the
Restoration Plan are considered corporate assets and are held in a grantor
trust.
Information regarding the Regular Plan's funded status is not developed
separately for the Company and the Exchanges. Information regarding the
Restoration Plan pertains only to the Company. The funded status of the
Plans for the Company and the Exchanges as of December 1, 1996 and 1995 (the
latest date for which information is available) was as follows:
1996 1995
---------- ----------
(Amounts in thousands)
Actuarial present value of benefit obligations:
Vested benefit obligation $ (520,715) $ (475,831)
Accumulated benefit obligation (545,459) (504,750)
Projected benefit obligation (695,346) (660,708)
Assets at fair market value 744,340 709,549
Plan assets in excess of projected benefit obligation 48,994 48,841
Unrecognized net transition (asset) (35,538) (40,214)
Unrecognized prior service cost 30,132 32,583
Unrecognized net (gain)/loss (98,544) (88,011)
Accrued pension cost (54,956) (46,801)
Upon purchase of the Company in 1988, the Company allocated part of the
purchase price to its portion of the Regular Plan assets in excess of the
projected benefit obligation at the date of acquisition. The asset is being
amortized for the difference between the Company's net pension cost and
amounts contributed to the Plan. The unamortized balance as of December 31,
1996 and 1995 was $29,252,000 and $33,101,000, respectively.
Components of net periodic pension expense for the Company follow:
1996 1995 1994
---------- ---------- ----------
(Amounts in thousands)
Service costs $ 15,275 $ 12,829 $ 14,774
Interest costs 27,409 25,533 24,088
Return on plan assets (35,671) (31,842) (32,246)
Net amortization and deferral 1,999 (235) 1,172
---------- ---------- ----------
Net periodic pension expense $ 9,012 $ 6,285 $ 7,788
========== ========== ==========
The Company uses the projected unit credit cost actuarial method for
attribution of expense for financial reporting purposes. The interest cost
and the actuarial present value of benefit obligations were computed using
an interest rate of 7.25% in 1996 and 1995 and 8.25% in 1994, while the
expected return on plan assets was computed using an interest rate of 9.00%
in 1996, 9.25% in 1995 and 9.00% in 1994. The rate of increase in future
compensation levels used in determining the actuarial present value of the
projected benefit obligation was 5.00% in 1996, 4.50% in 1995 and 5.50% in
1994.
The Company's postretirement benefits plan is a contributory defined
benefit plan for current retirees and those employees who were eligible for
early retirement on January 1,
49
1991, and is a contributory defined dollar plan for all other employees.
Health benefits are provided for all employees who participated in the
Company's and the Exchanges' group medical benefits plan for 15 years prior to
retirement at age 55 or later. A life insurance benefit of $5,000 is provided
at no cost to retirees who maintained group life coverage for 15 years prior
to retirement at age 55 or later.
There are no assets separated and allocated to this plan.
The funded status of the entire plan, which includes the Company and the
Exchanges, as of December 1, 1996 and 1995 (the latest date for which
information is available) was as follows:
1996 1995
---------- ----------
(Amounts in thousands)
Actuarial present value of benefit obligations:
Vested benefit obligation $ 0 $ 0
Accumulated benefit obligation
Retirees 44,051 39,335
Eligible active plan participants 11,564 11,801
Other active plan participants 19,527 23,055
Assets at fair market value 0 0
Unrecognized net gains 7,796 4,842
Unrecognized net transition obligation (20,976) (22,287)
---------- ----------
Accrued postretirement benefit cost $ 61,962 $ 56,746
========== ==========
The Company's share of the accrued postretirement benefit cost was
approximately $47,948,000 in 1996 and $44,726,000 in 1995. The unrecognized
net transition obligation of $20,976,000 in 1996 and $22,287,000 in
1995 represents the remaining transition obligation of the Exchanges.
Components of postretirement benefits expense for the Company follow:
1996 1995 1994
---------- ---------- ----------
(Amounts in thousands)
Service costs $ 1,016 $ 956 $ 1,636
Interest costs 3,018 3,308 3,172
Return on plan assets 0 0 0
---------- ---------- ----------
Net periodic expense $ 4,034 $ 4,264 $ 4,808
========== ========== ==========
The interest rate used in the above benefit computations was 7.25% in
1996 and 1995 and 8.25% in 1994. Beginning in 1993, the initial medical
inflation rate was 9.00%, to be graded over a 6-year period to 6.00% and level
thereafter, and contribution levels from retirees were the same as applicable
medical cost increases where defined benefits exist. The rate of increase in
future compensation levels used in determining the actuarial present value
of the accumulated benefit obligation was 5.00% in 1996, 4.50% in 1995 and
5.50% in 1994. A 1.00% increase in the medical inflation rate assumption
would have resulted in an approximate increase of $1,231,000 in 1996 and
$1,626,000 in 1995 in the accumulated benefit obligation for the Company.
50
N. Commitments and contingencies
Rental expense incurred by the Company was $20,121,000, $21,944,000 and
$22,104,000 in 1996, 1995 and 1994, respectively.
The Company has long-term operating lease commitments on equipment and
buildings, with options to renew at the end of the lease periods. As of
December 31, 1996, the remaining commitments payable over the next five years
under these leases are:
Equipment Buildings
----------- -----------
(Amounts in thousands)
1997 $ 13,559 $ 1,132
1998 11,200 630
1999 8,786 275
2000 1,280 71
2001 1,252 54
----------- -----------
$ 36,077 $ 2,162
=========== ===========
The Company is a party to numerous lawsuits arising from its normal
business activities. These actions are in various stages of discovery and
development, and some seek punitive as well as compensatory damages. In the
opinion of management, the Company has not engaged in any conduct which
should warrant the award of any material punitive or compensatory damages.
The Company intends to vigorously defend its position in each case, and
management believes that, while it is not possible to predict the outcome of
such matters with absolute certainty, ultimate disposition of these
proceedings should not have a material adverse effect on the Company's
consolidated results of operations or financial position.
O. Notes payable
In July 1996, the Company used the $200,000,000 of proceeds it received
from the Exchanges in connection with the repayment of the 1986 surplus
contribution (see note D) to extinguish the $200,000,000 of 8.25% Notes
Payable the Company issued in July 1986.
P. Income taxes
The Company follows the provisions of SFAS No. 109, "Accounting for
Income Taxes". Deferred tax assets and deferred tax liabilities are recorded
to reflect the tax consequences in future years of differences between the
tax bases of assets and liabilities and the corresponding bases used for
financial statements. In September 1996, the Company filed an amended 1994
consolidated federal income tax return which included a "deemed dividend
election" for all of its subsidiary companies. The 1994 tax year was the
last year the IRS allowed companies to make such an election. This election
resulted in a substantial step-up in the tax basis of the stock of each
subsidiary. For the Life Subsidiaries, it also triggered a $14.2 million
"Policyholders' Surplus Account" distribution for tax purposes (Phase III tax).
However, upon acquisition of the Company by B.A.T in 1988, a tax reserve was
established for this liability and, as a result, the "Phase III tax" had no
effect on the Company's current year net income.
51
The components of the provision for income taxes are:
1996 1995 1994
---------- ---------- ----------
(Amounts in thousands)
Management services to P&C
Group; and other:
Current
Federal $ 240,918 $ 206,373 $ 187,746
State 63,963 27,842 24,867
Deferred
Federal (27,959) (10,848) (5,776)
State (1,770) 922 1,249
----------- ---------- ----------
Total 275,152 224,289 208,086
----------- ---------- ----------
Life subsidiaries:
Current
Federal 101,712 77,233 77,684
State 0 0 0
Deferred
Federal (22,531) (9,795) (9,971)
State 0 0 0
----------- ---------- ----------
Total 79,181 67,438 67,713
----------- ---------- ----------
Consolidated total $ 354,333 $ 291,727 $ 275,799
=========== ========== ==========
The table below reconciles the provision for income taxes computed at
the U.S. statutory income tax rate of 35% to the Company's provision for
income taxes:
1996 1995 1994
---------- ----------- ------------
(Amounts in thousands)
Management services to P&C
Group; and other:
Expected tax expense $ 218,268 $ 194,278 $ 179,332
State income taxes, net of
federal income tax benefits 40,100 18,950 17,303
Tax exempt investment income (8,571) (9,438) (8,349)
Effect of change in enacted tax
rate on deferred tax liability 0 0 0
Goodwill 21,015 21,015 21,015
Other, net 4,340 (516) (1,215)
----------- ---------- ----------
Reported income tax expense 275,152 224,289 208,086
----------- ---------- ----------
Life subsidiaries:
Expected tax expense 83,528 72,582 71,337
Tax exempt investment income (3,843) (4,424) (3,784)
Effect of change in enacted
tax rate on deferred tax liability 0 0 0
Other, net (504) (720) 160
----------- ---------- ---------
Reported income tax expense 79,181 67,438 67,713
------------ ----------- ----------
Consolidated income tax expense $ 354,333 $ 291,727 $ 275,799
=========== =========== ==========
52
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities as of
December 31, 1996 and 1995 are presented in the following tables:
As of December 31, 1996
----------------------------------------------
Current Non-current Total
----------- ------------- ------------
(Amounts in thousands)
Management services to P&C
Group; and other:
Depreciation $ 0 $ (73,396) $ (73,396)
Achievement awards 1,514 0 1,514
Employee benefits 6,861 (9,702) (2,841)
Capitalized expenditures 0 (86,076) (86,076)
California franchise tax 22,531 0 22,531
Postretirement benefits 0 26,544 26,544
Postemployment benefits 0 155 155
Valuation of investments
in securities 742 0 742
Propostion 103 provision 147 0 147
Attorney-in-fact contracts 0 (515,448) (515,448)
Other 3,208 (17,977) (14,769)
----------- ---------- ----------
Total deferred tax
asset (liability) 35,003 (675,900) (640,897)
----------- ---------- ----------
Life subsidiaries:
Deferred policy acquisition
costs and value of life
business acquired (326,958) (326,958)
Future policy benefits 180,718 180,718
Investments (2,336) (2,336)
Valuation of investments
in securities (37,159) (37,159)
Depreciable assets (10,519) (10,519)
Other 1,066 1,066
----------- ---------- ----------
Total deferred tax liability (195,188) (195,188)
----------- ---------- ----------
Consolidated total deferred tax
asset (liability) $ 35,003 $ (871,088) $ (836,085)
=========== ========== ==========
53
As of December 31, 1995
----------------------------------------------
Current Non-current Total
--------- ----------- -----------
(Amounts in thousands)
Management services to P&C
Group; and other:
Depreciation $ 0 $ (73,135) $ (73,135)
Achievement awards 1,512 0 1,512
Employee benefits 6,331 (5,243) 1,088
Capitalized expenditures 0 (79,206) (79,206)
California franchise tax 9,927 0 9,927
Postretirement benefits 0 24,350 24,350
Postemployment benefits 0 129 129
Valuation of investments
in securities (2,341) 0 (2,341)
Propostion 103 provision 943 0 943
Attorney-in-fact contracts 0 (531,555) (531,555)
Other 2,563 (9,918) (7,355)
---------- ---------- ----------
Total deferred tax
asset (liability) 18,935 (674,578) (655,643)
---------- ---------- ----------
Life subsidiaries:
Deferred policy acquisition
costs and value of life
business acquired (297,822) (297,822)
Future policy benefits 177,456 177,456
Investments (1,410) (1,410)
Valuation of investments
in securities (80,793) (80,793)
Depreciable assets (8,032) (8,032)
Other (38,116) (38,116)
----------- ----------- ----------
Total deferred tax liability (248,717) (248,717)
----------- ----------- -----------
Consolidated total deferred tax
asset (liability) $ 18,935 $ (923,295) $ (904,360)
=========== =========== ===========
Q. Supplemental cash flow information
For financial statement purposes, the Company considers all investments
with original maturities of 90 days or less as cash equivalents. Following is
a reconciliation of the individual balance sheet cash and cash equivalent
totals to the consolidated cash flow total.
Management
Services to
P&C Group; Life
and Other Subsidiaries Consolidated
------------ ------------ ------------
(Amounts in thousands)
Cash and cash equivalents --December 31, 1993 $ 370,883 $ 167,890 $ 538,773
1994 Activity 588
----------
Cash and cash equivalents --December 31, 1994 415,064 124,297 539,361
1995 Activity 373,645
----------
Cash and cash equivalents --December 31, 1995 763,212 149,794 913,006
1996 Activity (413,678)
----------
Cash and cash equivalents --December 31, 1996 412,018 87,310 $ 499,328
==========
Cash payments for interest were $18,674,000, $18,995,000, and $18,276,000
in 1996, 1995, and 1994, respectively, while cash payments for dividends to
the holders of the Company's QUIPS were $42,070,000, $10,414,000, and $0
in 1996, 1995 and 1994, respectively. Cash payments for income taxes were
$379,455,000, $315,603,000 and $299,993,000 in 1996, 1995 and 1994,
respectively.
54
In 1996, 1995 and 1994, the Life Subsidiaries decreased the DAC asset and
increased the Value of Life Business Acquired asset to account for the impact
on estimated future gross profits of the net unrealized gains or losses on
securities which resulted from the adoption of SFAS No. 115. In addition,
the entries made in December 1996 to record the $374,916,000 extraordinary
dividend (consisting primarily of common stock investments) paid by Farmers New
World Life Insurance Company to its parent company, Farmers Group, Inc., had no
effect on cash (see note G).
R. Management fees
As attorney-in-fact, the Company, or its subsidiaries, as applicable,
manages the affairs of the P&C Group and receives management fees for the
services rendered to the Exchanges. As a result, the Company received
management fees from the Exchanges of $1,167,704,000, $1,109,425,000 and
$1,058,492,000 in 1996, 1995 and 1994, respectively.
S. Related parties
In 1996, a law firm, of which a director of the Company was a partner,
received fees for legal services from the Company and the Exchanges totaling
$1,853,000. In 1995 and 1994, two law firms, of which directors of the
Company were partners, received fees for legal services from the Company and
the Exchanges totaling $2,231,000 and $2,192,000, respectively.
As of December 31, 1996, the Company had $407,000,000 in notes receivable
related to loans made to B.A.T Capital Corporation, a subsidiary of B.A.T
Industries. These notes are fixed rate medium term notes with maturity dates
as follows: $135,000,000 in October 1997, $137,000,000 in October 1998 and
$135,000,000 in October 1999. Interest on these notes is paid semi-annually
at coupon rates of 5.10%, 5.35% and 6.68%, respectively. On October 7, 1996,
a three year $135,000,000 note with an interest rate of 4.76% matured and the
$135,000,000 note, maturing in October 1999, was subsequently issued at an
interest rate of 6.68%. Income earned on the notes outstanding during 1996,
1995 and 1994 was $21,245,000, $20,697,000 and $20,584,000, respectively.
T. Revolving credit agreements
As of December 31, 1996, the Company had revolving credit agreements with
certain financial institutions and had an aggregate borrowing facility of
$500,000,000. The proceeds of the facility were available to the Company for
general corporate purposes, including loans to the Exchanges. Facility fees
were payable on the aggregate borrowing facility in the amount of 9 basis
points per annum and were reimbursable to the Company by the Exchanges. In
the case of a draw on the facility, the Company has the option to borrow at
annual rates equal to the prime rate, the banks' certificate of deposit rate
plus 1%, the federal funds effective rate plus 1/2 of 1% or the London
Interbank Offered Rate ("LIBOR") plus certain percentages. As of December 31,
1996, the Company did not have any outstanding borrowings under the revolving
credit agreements. Facility fees were $592,000 for the year ended December 31,
1996 and were reimbursed by the Exchanges. The revolving credit agreements
expire in April 2001.
As of December 31, 1995, the Company had revolving credit agreements with
certain financial institutions and had an aggregate borrowing facility of
$500,000,000. The proceeds of
55
the facility were available to the Company for general corporate purposes,
including loans to the Exchanges. Facility fees were payable on the aggregate
borrowing facility in the amount of 10 basis points per annum and were
reimbursable to the Company by the Exchanges. In the case of a draw on the
facility, interest for the relevant borrowing period was payable periodically
at an annual rate equal to LIBOR, plus 20 basis points. As of December 31,
1995, the Company did not have any outstanding borrowings under the revolving
credit agreements. Facility fees were $526,000 for the year ended December 31,
1995 and were reimbursed by the Exchanges. The revolving credit agreements
expired in 1996.
U. Real estate mortgages payable
As of December 31, 1996, the Company, excluding the Life Subsidiaries,
was liable for two mortgages, one with an interest rate of 6.92% maturing in
June 1998 and one with an interest rate of 7.11% maturing in June 2004. The
amount of principal due within one year is approximately $125,000. As of
December 31, 1996, there were no real estate mortgage notes payable by the
Life Subsidiaries.
V. Separate Accounts
The assets and liabilities held in Separate Accounts relate to the
Company's and the Exchanges' employees pension plan. Assets consist primarily
of fixed maturity and equity investments. The principal liability is the
liability for annuity benefit payments.
W. Participating policies
Participating business comprises approximately 7.5% of the Life
Subsidiaries' total insurance-in-force as of December 31, 1996 and 6.9% of the
total insurance-in-force as of December 31, 1995. In addition, participating
business represents 2.2% of premium income for the years ended December 31,
1996 and 1995 and 2.3% for the year ended December 31, 1994.
The amount of dividends is determined by the appropriate life company
Board of Directors and is paid annually on the policyholder's anniversary
date. Amounts allocable to participating policyholders are based on
published dividend projections or expected dividend scales.
X. Reinsurance
The Life Subsidiaries have reciprocal reinsurance treaties in place
among themselves so that the maximum exposure to the Life Subsidiaries,
in the aggregate, for any one life is the sum of their individual retention
levels, or $1,400,000. Any coverage in excess of $1,400,000 is reinsured with
an outside reinsurance company pursuant to one of several facultative
reinsurance agreements. Premiums ceded under these agreements totaled
$3,868,000, $3,577,000 and $2,925,000 for the years ended December 31, 1996,
1995 and 1994, respectively. Reinsurance receivables, which totaled
$10,621,000 and $12,969,000 at December 31, 1996 and 1995, respectively, were
included in Other assets under Other assets of Life Subsidiaries.
56
Y. Current liabilities accrued, other
Current liabilities accrued, other consisted of the following:
As of December 31,
------------------------------
1996 1995
------------ ------------
(Amounts in thousands)
Accrued employee bonuses $ 8,171 $ 7,914
Accrued interest 766 7,646
Other 9,537 9,261
----------- ------------
$ 18,474 $ 24,821
=========== ============
The 1995 accrued interest balance includes $7,562,500 of interest payable
on the $200,000,000 of Notes Payable extinguished by the Company in July 1996
(see Note O).
Z. Operations in different industries
The Company operates primarily in two industries - management of
property and casualty insurance companies (principally reciprocal
insurance exchanges) and the life insurance industry. Total revenue by
industry includes both revenues as reported in the Company's consolidated
income statement, and intersegment revenues which are eliminated in
consolidation.
Operating profit is comprised of total revenues less operating expenses.
Accordingly, investment income on securities and real estate investment income
earned as a result of the management services to the P&C Group have not been
added, and general corporate expenses and income taxes have not been deducted.
The Management Services to the P&C Group segment incurred depreciation expense
of $40,096,000, $28,023,000 and $12,147,000 in 1996, 1995 and 1994,
respectively, while depreciation for the Life Subsidiaries was $3,108,000
in 1996, $3,699,000 in 1995 and $3,687,000 in 1994. Capital expenditures for
the Management Services to the P&C Group totaled $51,605,000, $55,811,000 and
$58,321,000 in 1996, 1995 and 1994, respectively, while capital expenditures
for the Life Subsidiaries were $132,000 in 1996, $301,000 in 1995 and $507,000
in 1994. The Other industry category includes certain subsidiary companies
engaged in real estate investment and leasing activities. These companies
incurred depreciation expenses of $20,202,000, $17,270,000 and $14,720,000 in
1996, 1995 and 1994, respectively. Capital expenditures within the Other
industry category were $24,074,000 in 1996, $17,493,000 in 1995 and
$16,088,000 in 1994.
Identifiable assets by industry are those assets used in the Company's
operations within each industry. Corporate assets are principally marketable
securities owned by the Company and its non-life insurance subsidiaries and
amounts invested by the Company in joint ventures.
57
Information regarding the Company's operations in different industries
follows:
Management Eliminations
Services to Life and
P&C Group Subsidiaries Other Adjustments Consolidated
----------- ------------ ------------ ------------ ------------
(Amounts in thousands)
Year ended December 31, 1996
Revenues $ 1,167,704 $ 767,540 $ 77,671 $ 0 $ 2,012,915
Intersegment revenues 20,526 0 18,878 (39,404) 0
----------- ------------ ------------ ------------ ------------
Total revenues 1,188,230 767,540 96,549 (39,404) 2,012,915
=========== ============ ============ ============ ============
Operating profit 486,510 238,650 50,307 0 775,467
=========== ============ ============ ============
General corporate expenses (31,052)
Net investment income 117,859
------------
Income before provision
for income taxes 862,274
============
Identifiable assets $ 5,217,924 $ 6,484,917 $ 149,182 $ (3,012) 11,849,011
=========== ============ ============ ============
Corporate assets 1,079,816
------------
Total assets $ 12,928,827
============
Year ended December 31, 1995
Revenues $ 1,109,425 $ 709,015 $ 73,673 $ 0 $ 1,892,113
Intersegment revenues 21,085 0 18,860 (39,945) 0
----------- ------------ ------------ ------------ -----------
Total revenues 1,130,510 709,015 92,533 (39,945) 1,892,113
=========== ============ ============ ============ ===========
Operating profit 460,684 207,377 48,320 0 716,381
=========== ============ ============ ============
General corporate expenses (33,442)
Net investment income 79,518
-----------
Income before provision
for income taxes 762,457
===========
Identifiable assets $ 4,814,316 $ 6,452,211 $ 138,171 $ (5,266) 11,399,432
=========== ============ ============ ============
Corporate assets 1,231,212
-----------
Total assets $12,630,644
===========
Year ended December 31, 1994
Revenues $ 1,058,492 $ 649,099 $ 71,580 $ 0 $ 1,779,171
Intersegment revenues 26,725 0 18,621 (45,346) 0
----------- ------------ ------------ ------------ -----------
Total revenues 1,085,217 649,099 90,201 (45,346) 1,779,171
=========== ============ ============ ============ ===========
Operating profit 430,559 203,821 50,504 0 684,884
=========== ============ ============ ============
General corporate expenses (30,503)
Net investment income 61,818
-----------
Income before provision
for income taxes 716,199
===========
Identifiable assets $ 4,602,833 $ 5,665,648 $ 138,155 $ (3,362) 10,403,274
=========== ============ ============ ============
Corporate assets 867,624
-----------
Total assets $11,270,898
===========
AA. Subsequent events
On January 23, 1997, the Company announced an agreement to sell The Ohio
State Life Insurance Company and Investors Guaranty Life Insurance Company to
Great Southern Life Insurance Company, a subsidiary of Americo Life, Inc..
The sale is expected to be completed by April 1, 1997, subject to regulatory
approval. The contribution to net income of these subsidiaries for the year
ended December 31, 1996 was $25,423,000. The combined net assets of these
subsidiaries as of December 31, 1996 was $385,330,000.
58
FARMERS GROUP, INC.
AND SUBSIDIARIES
QUARTERLY FINANCIAL DATA
(Unaudited)
Three months ended Year ended
-------------------------------------------------------- ------------
Mar. 31 June 30 Sept. 30 Dec. 31 Dec. 31
---------- ----------- ----------- ----------- ------------
(Amounts in thousands)
1996
- ----
Revenues
Management services $ 306,585 $ 311,677 $ 317,708 $ 309,405 $ 1,245,375
Life subsidiaries 197,500 183,023 199,296 187,721 767,540
----------- ----------- ----------- ----------- ------------
Consolidated 504,085 494,700 517,004 497,126 2,012,915
----------- ----------- ----------- ----------- ------------
Income before provision for
income taxes:
Management services 146,459 157,956 158,214 160,995 623,624
Life subsidiaries 68,118 53,073 67,127 50,332 238,650
----------- ----------- ----------- ----------- ------------
Consolidated 214,577 211,029 225,341 211,327 862,274
----------- ----------- ----------- ----------- ------------
Provision for income taxes:
Management services 59,450 63,680 64,278 87,744 275,152
Life subsidiaries 22,868 17,619 22,476 16,218 79,181
----------- ----------- ----------- ----------- ------------
Consolidated 82,318 81,299 86,754 103,962 354,333
----------- ----------- ----------- ----------- ------------
Consolidated net income $ 132,259 $ 129,730 $ 138,587 $ 107,365 $ 507,941
=========== =========== =========== =========== ============
1995
- ----
Revenues
Management services $ 290,387 $ 292,226 $ 297,931 $ 302,554 $ 1,183,098
Life subsidiaries 169,658 173,670 177,063 188,624 709,015
----------- ----------- ----------- ----------- ------------
Consolidated 460,045 465,896 474,994 491,178 1,892,113
----------- ----------- ----------- ----------- ------------
Income before provision for
income taxes:
Management services 132,565 136,228 144,869 141,418 555,080
Life subsidiaries 51,057 49,739 46,199 60,382 207,377
----------- ----------- ----------- ----------- ------------
Consolidated 183,622 185,967 191,068 201,800 762,457
----------- ----------- ----------- ----------- ------------
Provision for income taxes:
Management services 53,742 55,625 58,409 56,513 224,289
Life subsidiaries 17,024 16,551 15,311 18,552 67,438
----------- ----------- ----------- ----------- ------------
Consolidated 70,766 72,176 73,720 75,065 291,727
----------- ----------- ----------- ----------- ------------
Consolidated net income $ 112,856 $ 113,791 $ 117,348 $ 126,735 $ 470,730
=========== =========== =========== =========== ============
59
ITEM 9. Changes in and Disagreements With Accountants on Accounting and
Financial Disclosures
None.
PART III
ITEM 10. Directors and Executive Officers of Farmers Group, Inc.
The following table sets forth certain information concerning each
person who is an executive officer or director of FGI as of the filing
date:
Name Age Position
------ ----- -----------
Martin D. Feinstein (1) 48 President, Chief Executive Officer and Director
James A. MacKinnon 61 Executive Vice President - Insurance Operations
Keitha T. Schofield 45 Executive Vice President - Support Services and Chief
Information Officer
Anthony L.R. Clark 52 Senior Vice President and Chief Financial Officer
Gerald E. Faulwell 55 Senior Vice President - Strategic Planning, Budgeting
and Administration
Leonard H. Gelfand 52 Senior Vice President - Commercial
Jason L. Katz 49 Senior Vice President, General Counsel and Director
Paul G. Secord 51 Senior Vice President - Asset Management
David P. Allvey (2) (3) 52 Director
Edwin A. Heafey, Jr. (3) 66 Director
Benjamin C. Neff (2) 62 Director
Jack C. Parnell (1) (2) (3) 61 Director
Cornelius J. Pings (2) (3) 68 Director
Van Gordon Sauter (3) 61 Director
M. Faye Wilson (2) 59 Director
Clayton Yeutter (2) (3) 66 Director
- -----------------
(1) Member of the Executive Committee
(2) Member of the Audit Committee
(3) Member of the Compensation Committee
Leo E. Denlea, Jr. served as Chairman of the Board and Chief Executive
Officer of FGI from 1986 to 1996. Mr. Denlea also served as a director of
B.A.T from April 1990 to March 1997. Mr. Denlea retired as Chief Executive
Officer effective January 1, 1997 and as Chairman of the Board effective March
1, 1997 pursuant to normal retirement policy.
The present position and principal occupation during each of the last
five years of the executive officers and directors named above are set forth
below.
Martin D. Feinstein has served as Chief Executive Officer of FGI since
January 1997, President of FGI since January 1995 and as a director of FGI
since February 1995. Mr. Feinstein has also served as a director of B.A.T
since January 1997. Previously, Mr. Feinstein held various positions with
FGI, including serving as Vice President-Sales and Marketing from November
1989 to January 1993, as Senior Vice President-Special Projects from January
1993 to October 1993, as Senior Vice President-Property, Casualty Staff from
October 1993 to January 1995 and as Chief Operating Officer of FGI from
January 1995 to January 1997.
60
James A. MacKinnon has served as Executive Vice President-Insurance
Operations since January 1997. Mr. MacKinnon served as Senior Vice President-
Field Operations-Mid-West Zone of FGI from 1989 to 1995 and Senior Vice
President-Personal Lines Operations of FGI from August 1995 to January 1997.
Keitha T. Schofield has served as Executive Vice President-Support
Services and Chief Information Officer since January 1997. Ms. Schofield
served as Senior Vice President and Chief Information Officer of FGI from May
1995 to January 1997. Previously, Ms. Schofield served as Vice President-
Technology Division of Continental Airlines, Inc. from 1988 to May 1995.
Anthony L.R. Clark has served as Vice President and Chief Financial
Officer of FGI since March 1995 and effective January 1996 was appointed
Senior Vice President. Previously, Mr. Clark served as Finance Director of
Eagle Star Insurance Co. Ltd., a subsidiary of B.A.T, from January 1991 to
March 1995. Previously, he held a number of financial positions with B.A.T
including Group Chief Accountant.
Gerald E. Faulwell has served as Vice President-Strategic Planning,
Budgeting and Administration of FGI since January 1993 and effective January
1996 was appointed Senior Vice President. Previously, Mr. Faulwell served as
Vice President-Corporate Investments and Treasurer of FGI from January 1988 to
January 1993.
Leonard H. Gelfand has served as Vice President-Commercial of FGI and
President-Truck Underwriters Association since April 1991 and effective
January 1995, was appointed Senior Vice President. Previously, Mr. Gelfand
served as Vice President, Regional Manager of the Santa Ana Region from 1984 to
1987 and Regional Manager of the Pleasanton Region from 1987 to 1991.
Jason L. Katz has served as Senior Vice President and General Counsel of
FGI since February 1992 and a director of FGI since May 1986. Mr. Katz served
as Vice President and General Counsel from August 1984 through February 1992.
Paul G. Secord has served as Senior Vice President-Asset Management of FGI
since December 1995. Previously, Mr. Secord served as Vice President-Equity of
John Hancock Advisors from 1990 to 1993 and Senior Vice President-Equity of
Penn Mutual from 1993 to 1995.
David P. Allvey has served as a director of FGI since February 1995. Mr.
Allvey joined B.A.T as Group Deputy Tax Manager in 1980. His positions have
included Finance Adviser and Manager of Taxation at British-American Tobacco
Co., Head of Finance of B.A.T and Finance Director. Mr. Allvey was appointed
Finance Director at B.A.T in April 1989.
Edwin A. Heafey, Jr. has served as a director of FGI since 1978. Mr.
Heafey is a practicing attorney and has been a partner of the law firm of
Crosby, Heafey, Roach and May since 1962.
Benjamin C. Neff has served as a director of FGI since 1995. Mr. Neff has
served as Chairman of NECO Financial Services, Inc. since May 1995. During
the period from May 1992 through May 1995, Mr. Neff was the Managing Director
of Seabury & Smith, Inc., a wholly owned subsidiary of Marsh & McClennan,
Inc.. Prior to May 1992, Mr.Neff served as the
61
President of Smith Sternau Insurance Services, Inc., a wholly owned subsidiary
of Marsh & McClennan, Inc..
Jack C. Parnell has served as a director of FGI since 1995. Mr. Parnell has
served as a Governmental Relations Advisor to the law firm of Kahn, Soares &
Conway and the public relations firm of Fleishman, Hilliard from 1991.
Previously, Mr. Parnell served as the Deputy Secretary-United States Department
of Agriculture from 1989 to 1991. Mr. Parnell also serves on the Board of
Directors of Neogen Corporation, a company engaged in the veterinary
instruments and diagnostics business.
Cornelius J. Pings has served as a director of FGI since August 1991. Dr.
Pings has served as the President of the Association of American Universities
since February 1993 and served as the Provost (Senior Vice President for
Academic Affairs) for the University of Southern California from 1981 to
early 1993. Dr. Pings also serves on the Board of Directors of Pacific Horizon
Funds, Inc. and until 1992 served on the board of Maxtor, Inc., a company
engaged in the disk drive business.
Van Gordon Sauter has served as a director of FGI since May 1996. Mr.
Sauter is the President and General Manager of PBS affiliate KVIE in
Sacramento, California. Previously, he served as President of CBS News and
Fox News.
M. Faye Wilson has served as a director of FGI since May 1996. Ms. Wilson
is Chairman and President of Security Pacific Financial Services, BankAmerica's
nationwide consumer finance company. Ms. Wilson also serves on the board of
Home Depot, a company engaged in the retail hardware and building supplies
business.
Clayton Yeutter has served as a director of FGI since 1994. Mr. Yeutter
was appointed a non-executive director of B.A.T in January 1993. Mr. Yeutter
is Of Counsel to the law firm of Hogan and Hartson since February 1993. During
the preceding four years, he served in a series of positions in the Bush
Administration, first as Secretary of Agriculture, then as Chairman of the
Republican National Committee and finally as Counselor to the President for
Domestic Policy.
62
ITEM 11. Executive Compensation
The following table sets forth the annual compensation for services in
all capacities to FGI for the fiscal years ended December 31, 1996, 1995 and
1994 of those persons who were, as of December 31, 1996, (i) FGI's Chief
Executive Officer and (ii) the other four most highly compensated executive
officers of FGI (the "Named Executive Officers").
SUMMARY COMPENSATION TABLE
Annual Compensation Long Term Compensation
------------------------ -------------------------
Awards Payouts
----------- ------------
Securities
Underlying
Name and Options/ LTIP Payouts All Other
Principal Position Year Salary ($) Bonus ($)(1) SARs (#)(2) ($)(3) Compensation ($)(4)
- ------------------------ ----- ---------- ------------ ----------- ------------ -------------------
Leo E. Denlea, Jr. 1996 860,750 600,238 0 0 131,770
Chairman of the 1995 787,500 458,539 0 0 120,850
Board 1994 750,000 20,807 5,649 0 114,787
Martin D. Feinstein 1996 400,000 279,278 0 0 61,235
President and Chief 1995 300,000 204,920 0 0 46,038
Executive Officer 1994 242,100 103,472 0 0 37,053
Jason L. Katz 1996 317,800 222,013 0 0 48,651
Senior Vice President 1995 308,700 196,002 0 0 47,373
and General Counsel 1994 299,700 127,930 0 0 45,869
James A. MacKinnon 1996 257,300 171,437 0 0 39,390
Executive Vice 1995 238,550 137,230 0 0 36,608
President 1994 227,700 74,683 0 0 34,849
Paul G. Secord 1996 230,267 161,030 0 0 35,251
Senior Vice President 1995 13,636 524 0 0 0
1994 0 0 0 0 0
- -------------------
(1) Bonus amounts reported in the year in which service related to such bonus
is rendered. Payment does not occur until the year subsequent to the year
of service.
(2) Represents Phantom Stock Units based on the price of B.A.T American
Depository Receipts ("ADRs"). Only Mr. Denlea, among the Named Executive
Officers, is a participant in this plan. However, no Phantom Stock
Units/Options/Stock Appreciation Rights ("SARs") were granted to Mr.
Denlea in 1995 and 1996.
(3) In 1995, Messrs. Denlea, Feinstein, Katz and MacKinnon received awards of
19,980, 7,495, 7,710 and 5,805 Premier Award Units ("PAUs"),
respectively, under FGI's Premier Award Units Plan. In 1993, Messrs.
Denlea, Feinstein, Katz and MacKinnon received awards of 17,985, 5,170,
7,270 and 5,470 PAUs. Mr. Secord received interim awards of 5,620 PAUs
in 1996. The value of the PAUs is linked to performance goals set by the
Compensation Committee based on the financial and operating results of
the Company and the P&C Group and the price of B.A.T ADRs over a
four-year period. The value of the PAUs will be paid to eligible
employees in B.A.T ADRs if such ADRs are eligible for unrestricted issue
pursuant to applicable law, or, if not, then in cash. The receipt of such
amounts may be deferred at the election of participants, subject to the
approval of the Compensation Committee. In the event of certain changes
in the capital structure of FGI or other events relating to control of
FGI, the Compensation Committee has the discretion to pay out the value of
outstanding PAUs immediately or make other appropriate adjustments to the
PAUs.
(4) Represents estimated amounts to be contributed by FGI under the
Employees' Profit Sharing Savings Plan Trust (the "Deferred Plan") and
reported in the year of service as earned. To the extent that a
participant's annual benefits under the Deferred Plan exceed certain
limits imposed by law, such amounts will be paid under FGI's nonqualified
Employee Benefits Restoration Plan (the "Benefits Restoration Plan"),
which is funded through a grantor trust.
63
The following table sets forth the number and value of phantom stock
units held by the Named Executive Officers as of December 31, 1996 under
the B.A.T Phantom ADR Stock Option Plan.
Aggregrated Option/SAR Exercises in Last Fiscal Year
and FY-End Option/SAR Values
Number of
Securities Value of
Underlying Unexercised
Unexercised In-the-Money
Options/SARs Options/SARs
at FY-End (#) at FY-End ($)
Shares --------------- ---------------
Acquired on Value Exercisable/ Exercisable/
Name Exercise (#) Realized ($) Unexercisable Unexercisable
- ----- ------------- ------------- -------------- ---------------
Leo E. Denlea, Jr. 0 0 0/238,039 (1) 0/1,168,673
Martin D. Feinstein 0 0 0/0 0/0
Jason L. Katz 0 0 0/0 0/0
James A. MacKinnon 0 0 0/0 0/0
Paul G. Secord 0 0 0/0 0/0
- -------------------
(1) Represents Phantom Stock Units based on the price of B.A.T ADRs. Mr.
Denlea, as a Director of B.A.T, was awarded a total of 238,039 Phantom
Stock Units from 1990 to 1994, with base prices equal to the fair market
value of B.A.T ADRs as of the award dates. The value of each Phantom Stock
Unit is equal to the excess (if any) of (i) the fair market value of B.A.T
ADRs on the date of the exercise over (ii) the base price of each award,
and is payable solely in cash. These awards will vest 100% on December
31, 1997.
Employees' Pension Plan
In addition to the compensation set forth above, the Named Executive
Officers participate with all eligible employees of the Company in the
Company's tax-qualified Employees' Pension Plan (the "Pension Plan"). The
Named Executive Officers also participate in the Benefits Restoration Plan,
funded through a grantor trust, which provides supplemental benefits to the
extent amounts otherwise payable under the Pension Plan and the Deferred Plan
are limited under applicable laws. (Together, the Pension Plan and the Benefits
Restoration Plan are referred to as the "Retirement Plans").
The Pension Plan bases retirement benefits upon the employee's final
five-year average annual base salary and the total years of credited service,
subject to a maximum of 35 years of credited service. Employees who are at
least 21 years of age and who have completed one year of service participate
in the Pension Plan retroactive to the first day of the month following their
hire date. Eligible participants become vested and earn a nonforfeitable right
to Pension Plan benefits after completing five years of service or upon
reaching the first day of the month in which they become age 65. In addition,
the Pension Plan provides that if, following a Change in Control of the Company
(as defined in the Pension Plan), the Pension Plan is terminated or the
employment of a participant in the Pension Plan is terminated, and if at the
time of such termination there are surplus assets in the Pension Plan, such
surplus assets shall be used to increase the benefits payable to each affected
plan participant. The Retirement Plans both provide for the full vesting of
accrued benefits in the event of a Change in Control.
64
Normal retirement benefits begin at age 62 with 30 years of service and at
age 65 with less than 30 years of service, but participants may retire as early
as age 55 at actuarially reduced rates, provided that they have at least 15
years of service. Participants who become totally and permanently disabled may
qualify for disability retirement benefits if they have 10 or more years of
service and are between the ages of 35 and 65.
For purposes of illustration, the following table provides examples of the
annual pension benefits payable at age 65 pursuant to the defined benefit
portions of the Retirement Plans, assuming benefits are paid in the form of a
straight life annuity. Such benefits are not reduced for Social Security
payments or other offset amounts.
PENSION PLAN TABLE
Years of Credited Service
-----------------------------------------------------------------------
Five-Year Average Remuneration 15 20 25 30 35
- ------------------------------ ----------- ------------ ------------ ------------ ------------
$ 125,000 $ 31,746 $ 42,328 $ 52,910 $ 63,492 $ 74,074
150,000 38,308 51,078 63,847 76,617 89,386
175,000 44,871 59,828 74,785 89,742 104,699
200,000 51,433 68,578 85,722 102,867 120,011
225,000 57,996 77,328 96,660 115,992 135,324
250,000 64,558 86,078 107,597 129,117 150,636
275,000 71,121 94,828 118,535 142,242 165,949
300,000 77,683 103,578 129,472 155,367 181,261
400,000 103,933 138,578 173,222 207,867 242,511
450,000 117,058 156,078 195,097 234,117 273,136
500,000 130,183 173,578 216,972 260,367 303,761
600,000 156,433 208,578 260,722 312,867 365,011
700,000 182,683 243,578 304,472 365,367 426,261
750,000 195,808 261,078 326,347 391,617 456,886
800,000 208,933 278,578 348,222 417,867 487,511
850,000 222,058 296,078 370,097 444,117 518,136
900,000 235,183 313,578 391,972 470,367 548,761
At the end of 1996, Messrs. Denlea, Feinstein, Katz, MacKinnon and Secord
were credited under the Pension Plans with 15.5, 23.0, 12.5, 35.0 and 1.0 years
of service, respectively. The average annual salary for the five-year period
ended December 31, 1996 for Messrs. Denlea, Feinstein, Katz, MacKinnon and
Secord was $757,650, $267,420, $298,860, $229,790 and $230,267, respectively.
In addition, Mr. Denlea is entitled to a supplemental pension benefit at
retirement equal to the difference between (i) the benefit payable under the
Pension Plan calculated by using twice Mr. Denlea's actual years of credited
service, up to a maximum of 35 years, and (ii) the actual benefit payable to
Mr. Denlea under the Retirement Plans.
65
Compensation of Directors
Directors who are not employees of FGI or B.A.T receive an annual
retainer of $21,000, together with $1,000 plus expenses for each FGI Board of
Directors (the "Board") meeting attended in 1996. Additionally, committee
members of the Board receive $950 plus expenses for each committee meeting
attended and Committee Chairs receive $1,100 plus expenses for each committee
meeting attended. Directors who are employees of FGI or of B.A.T do not receive
the retainer fees, Board meeting fees or committee fees referred to above.
Total payments, excluding reimbursement of expenses, to Messrs. Heafey, Neff,
Parnell, Pings, Sauter, Wilson, and Yeutter amounted to $27,300, $28,800,
$32,600, $33,200, $20,650, $20,650 and $29,700, respectively, in 1996 for
services rendered in that year. John E. Sauer was a director from 1986 until
he retired from the Board in February 1996 and received payments of $5,250 in
1996.
FGI has established an Outside Directors' Retirement Benefit Program. Any
director who is not an employee of FGI or of B.A.T who has attained age 70 at
the time such director retires from service as a member of the Board and has
either accrued 10 or more calendar years of service as a Board member or who
was a Board member as of August 7, 1987, the inception date of this Program,
is entitled to an annual benefit commencing in May of the calendar year
following the director's retirement from the Board. Such annual benefit is
equal to 100% of the annual retainer fee in effect during the last year the
director served on the Board. Benefit payments are made for five or more years,
depending on the director's length of service on the Board. Based on their
tenure as Board members, Mr. Heafey has accrued benefits of seven annual
payments, Mr. Sauer had accrued benefits of five annual payments as of his
retirement from the Board in February 1996, and Messrs. Neff, Parnell, Pings,
Sauter, Wilson and Yeutter have accrued no benefits under this Program.
Benefits for this Program were funded through a grantor trust through 1995.
Effective January 1, 1996, retirement payments to directors retiring after
January 1, 1996 will be paid directly by FGI. Payments under this Program to
former Board members amounted to $216,000 in 1996.
Compensation Committee Interlocks and Insider Participation
During 1996, FGI's Compensation Committee (the "Committee") consisted of
Mr.Heafey, who is Chairman, and Messrs. Allvey, Parnell, Pings, Sauter and
Yeutter. None of these individuals is now or has ever been an officer or
employee of the Company.
The Committee receives compensation recommendations from the Chief
Executive Officer and amends or revises them as appropriate. The Committee
then submits a recommendation regarding executive compensation to the Board.
Compensation levels for Messrs. Denlea and Feinstein are approved by the Board
of B.A.T following recommendations of that Board's Compensation Committee,
whose composition consists of no members who are employees or executive
officers of FGI. The compensation levels of certain senior officers are also
reviewed by the Chief Executive's Committee of B.A.T.
The law firm of Crosby, Heafey, Roach and May received fees of $1,853,000
for legal services rendered to the Company or the Exchanges in 1996. Mr. Heafey
is a partner in such firm and has been a director of FGI since 1978.
66
ITEM 12. Security Ownership of Certain Beneficial Owners and Management
All of the outstanding voting securities of FGI are owned beneficially
and of record by South Western Nominees Limited, Windsor House, 50 Victoria
Street, London, England SW1H ONL. South Western Nominees Limited is a wholly
owned subsidiary of B.A.T.
The following table sets forth information regarding beneficial
ownership of B.A.T ADRs and ordinary shares as of December 31, 1996 by
(a) the Chief Executive Officer of FGI, (b) each of the four most highly
compensated executive officers of FGI other than the Chief Executive Officer
and (c) all directors and executive officers of FGI, as a group.
B.A.T ADRs B.A.T Ordinary Shares
Beneficially Owned Beneficially Owned
------------------ ----------------------
Name Number Percent Number Percent
- ---------- ------- -------- ------------ -------
Leo E. Denlea, Jr. 4,160 (1) 37,160 (2) (3)
Martin D. Feinstein 0 0
Jason L. Katz 0 0
James A. MacKinnon 0 0
Paul G. Secord 0 0
All Directors and Executive Officers as a group 5,460 (1) 590,778 (3)
______________
(1) Less than 1% of the outstanding B.A.T ADRs.
(2) Issuable upon exercise of an option granted under B.A.T Stock Plan "D"
that vested and became exercisable on October 31, 1993.
(3) Less than 1% of the outstanding B.A.T ordinary shares.
ITEM 13. Certain Relationships and Related Transactions
In 1996, a law firm, of which a director of the Company was a partner,
received fees for legal services from the Company and the Exchanges totaling
$1,853,000. In 1995 and 1994, two law firms, of which directors of the Company
were partners, received fees for legal services from the Company and the
Exchanges totaling $2,231,000 and $2,192,000 in 1995 and 1994, respectively.
As of December 31, 1996, the Company had $407,000,000 in notes receivable
related to loans made to B.A.T Capital Corporation, a subsidiary of B.A.T
Industries. These notes are fixed rate medium term notes with maturity dates
as follows: $135,000,000 in October 1997, $137,000,000 in October 1998 and
$135,000,000 in October 1999. Interest on these notes is paid semi-annually
at coupon rates of 5.10%, 5.35% and 6.68%, respectively. On October 7, 1996,
a three year $135,000,000 note with an interest rate of 4.76% matured and the
$135,000,000 note, maturing in October 1999, was subsequently issued at an
interest rate of 6.68%. Income earned on the notes outstanding during
1996, 1995 and 1994 was $21,245,000, $20,697,000, and $20,584,000,
respectively.
67
PART IV
ITEM 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a) Exhibits and Financial Statement Schedules
(1) Exhibits
3.1 Restated Articles of Incorporation of FGI, as amended
May 23, 1977, as further amended September 24, 1984, as further
amended May 19, 1986 (i), as further amended February 3, 1989 (ii)
3.2 Bylaws of FGI (i)
3.3 Form of Certificate of Trust of the Issuer (ii)
3.4 Trust Agreement (ii)
4.1 Form of Amended and Restated Trust Agreement (ii)
4.2 Form of Indenture among FGI and The Chase Manhattan Bank, N.A.,
as Debenture Trustee (ii)
4.3 Form of Preferred Security (included in Exhibit 4.1) (ii)
4.4 Form of Junior Subordinated Debentures (included in
Exhibit 4.2) (ii)
4.5 Form of Guarantee by FGI and The Chase Manhattan Bank,
N.A., as Guarantee Trustee (ii)
10.1 Form of Subscription Agreement (Farmers Underwriters
Association) (ii)
10.2 Form of Subscription Agreement (Truck Underwriters
Association) (ii)
10.3 Form of Subscription Agreement (Fire Underwriters
Association) (ii)
10.4 The Farmers Group, Inc. 1993 Premier Award Unit Plan, as amended
November 4, 1993 (ii), as further amended February 14, 1996 (iii)
10.5 Farmers Group, Inc. Executive Incentive Program (ii)
10.6 Agreement between Farmers Group, Inc. and Leo E. Denlea, Jr.
re: Supplemental Pension Plan (ii)
10.7 Description of Farmers Group, Inc. Outside Directors' Retirement
Program (ii)
10.8 The Farmers Group, Inc. Discretionary Management Incentive
Program for Exceptional Performance (ii), as amended December
1996
10.9 Farmers Group, Inc. Employee Benefits Restoration Plan (ii)
10.10 Description of Phantom B.A.T ADR Stock Option Plan (ii)
10.11 Indemnification Agreement between Farmers Group, Inc. and
Leo E. Denlea, Jr. (ii)
12 Statement of Computation of the Ratio of Earnings to Fixed Charges
21 Subsidiaries of FGI
24 Power of Attorney (ii)
- ------------------
(i) Incorporated by reference to the corresponding Exhibit to FGI's Annual
Report on Form 10-K for the year ended December 31, 1987.
(ii) Incorporated by reference to the corresponding Exhibit to FGI's
Registration Statement No. 33-94670 and No. 33-94670-01 on Form S-1.
(iii) Incorporated by reference to the corresponding Exhibit to FGI's Annual
Report on Form 10-K for the year ended December 31, 1995.
68
(2) Financial Statement Schedules
Page
------
a. Financial Statements. See Index to Financial Statements and
Supplementary Data for a list of financial statements
included in this Report. 23
b. Financial Statement Schedules
Schedule I - Marketable Securities - Other Investments, at
December 31, 1996 S-1
Schedule III - Supplementary Insurance Information, for the
years ended December 31, 1996, 1995 and 1994 S-2
Schedule IV - Reinsurance, for the years ended
December 31, 1996, 1995 and 1994 S-3
Schedule V - Valuation and Qualifying Accounts for the
years ended December 31, 1996, 1995, and 1994 S-4
(b) Reports on Form 8-K
The Company did not file any Reports on Form 8-K during the year ended
December 31, 1996.
69
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized, in the City of
Los Angeles, State of California on March 27, 1997.
FARMERS GROUP, INC.
---------------------------------------------
(Registrant)
Date: March 27,1997 By: /s/ Martin D. Feinstein
---------------------------------------------
Martin D. Feinstein, President and Chief Executive
Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of
the Registrant and in the capacities and on the dates indicated.
Signature Title Date
--------- ----- ----
Principal Executive Officer
/s/ Martin D. Feinstein President and Chief March 27, 1997
- ------------------------------
(Martin D. Feinstein) Executive Officer
Principal Financial and Accounting
Officer
/s/ Anthony L.R. Clark Senior Vice President and March 27, 1997
- ------------------------------
(Anthony L.R. Clark) Chief Financial Officer
Directors
/s/ Jason L. Katz Senior Vice President, March 27, 1997
- ------------------------------
(Jason L. Katz) General Counsel and Director
/s/ David P. Allvey * Director March 27, 1997
- ------------------------------
(David P. Allvey)
/s/ Edwin A. Heafey, Jr. * Director March 27, 1997
- ------------------------------
(Edwin A. Heafey, Jr.)
/s/ Benjamin C. Neff * Director March 27, 1997
- ------------------------------
(Benjamin C. Neff)
/s/ Jack C. Parnell * Director March 27, 1997
- ------------------------------
(Jack C. Parnell)
/s/ Cornelius J. Pings * Director March 27, 1997
- ------------------------------
(Cornelius J. Pings)
/s/ Van Gordon Sauter Director March 27, 1997
- ------------------------------
(Van Gordon Sauter)
/s/ M. Faye Wilson Director March 27, 1997
- ------------------------------
(M. Faye Wilson)
/s/ Clayton Yeutter * Director March 27, 1997
- ------------------------------
(Clayton Yeutter)
* By /s/ Anthony L.R. Clark March 27, 1997
- ------------------------------
(Anthony L.R. CLark)
Power of Attorney
S-1
FARMERS GROUP, INC.
AND SUBSIDIARIES
SCHEDULE I - MARKETABLE SECURITIES - OTHER INVESTMENTS
December 31, 1996
Market value Amount at which
at balance shown in the
Type of Investment Cost sheet date balance sheet
- ------------------ ----------- ------------- ---------------
(Amounts in thousands)
Life Subsidiaries:
Marketable securities - available-for-sale:
United States government and its agencies $ 2,213,216 $ 2,245,585 $ 2,245,585
States and municipalities 364,836 376,900 376,900
Public utilities 63,524 65,891 65,891
Foreign government 52,133 69,177 69,177
All other corporate 871,171 895,576 895,576
Preferred stocks (redeemable) 199,312 200,997 200,997
------------ ------------- ---------------
3,764,192 3,854,126 3,854,126
------------ ------------- ---------------
Preferred stocks (non-redeemable) 7,007 6,308 6,308
------------ ------------- ---------------
Common stocks:
Public utilities 7,348 8,632 8,632
Banks, trusts and insurance companies 1,448 2,551 2,551
Industrial, miscellaneous and all other 75,736 92,704 92,704
------------ ------------- ---------------
84,532 103,887 103,887
------------ ------------- ---------------
Mortgage loans on real estate 122,635 xxxxx 122,635
------------ ------------- ---------------
Policy loans 187,285 xxxxx 187,285
------------ ------------- ---------------
Real estate (1) 61,715 (1) xxxxx 61,715
------------ ------------- ---------------
Joint ventures 11,971 xxxxx 11,971
------------ ------------- ---------------
Total investments $ 4,239,337 $ xxxxx $ 4,347,927
============ ============= ===============
- -------------------
(1) Net of accumulated depreciation of $16,824
S-2
FARMERS GROUP, INC.
AND SUBSIDIARIES
SHEDULE III - SUPPLEMENTARY INSURANCE INFORMATION
For the years ended December 31, 1996, 1995, and 1994
Column A Column B Column C Column D Column E Column F Column G
- -------- -------- -------- -------- -------- -------- --------
Future policy
Deferred benefits, Other policy Premium
policy losses, claims claims and and policy Net
acquisition and loss Unearned benefits charge investment
Life insurance costs (1) expenses premiums payable revenues income
- -------------- ----------- -------------- -------- ---------- --------- ----------
(Amounts in thousands)
December 31, 1996 $ 1,001,044 $ 3,507,594 $ 1,663 $ 82,511 $ 412,158 $ 317,393
=========== ============= ======== ========== ========= ==========
December 31, 1995 964,861 3,245,754 1,610 85,552 379,436 297,960
=========== ============= ======== ========== ========= ==========
December 31, 1994 350,688 251,635
========= ==========
Column A Column H Column I Column J
- -------- -------- -------- --------
Benefits, Amortization
claims, of deferred
losses and policy Other
settlement acquisition operating
Life insurance expenses costs (1) expenses
---------- ----------- ---------
December 31, 1996 $ 166,199 $ 108,802 $ 84,977
========== ========== =========
December 31, 1995 162,098 103,201 81,760
========== ========== =========
December 31, 1994 139,613 92,841 76,041
========== ========== =========
- -----------------
(1) Includes value of life business acquired
S-3
FARMERS GROUP, INC.
AND SUBSIDIARIES
SCHEDULE IV - REINSURANCE
For the years ended December 31, 1996, 1995, and 1994
Column A Column B Column C Column D
- -------- -------- -------- --------
Ceded to Assumed
Gross other from other
amount companies companies
---------------- ---------------- ----------------
(Amounts in thousands)
1996
- --------
Life insurance in-force $ 100,529,124 $ 847,883 $ 10,568,578
---------------- ---------------- ----------------
Premiums & policy charges 405,654 3,868 10,372
---------------- ---------------- ----------------
1995
- --------
Life insurance in-force 93,142,714 629,649 9,130,641
---------------- ---------------- ----------------
Premiums & policy charges 373,688 3,577 9,325
---------------- ---------------- ----------------
1994
- --------
Life insurance in-force 85,885,455 502,002 8,644,056
---------------- ---------------- ----------------
Premiums & policy charges 344,865 2,925 8,748
---------------- ---------------- ----------------
Column A Column E Column F
- -------- -------- --------
Percentage
of amount
Net assumed
Amount to net
---------------- -----------
1996
- --------
Life insurance in-force $ 110,249,819 9.6 %
---------------- -----------
Premiums & policy charges 412,158 2.5
---------------- -----------
1995
- --------
Life insurance in-force 101,643,706 9.0
---------------- -----------
Premiums & policy charges 379,436 2.5
---------------- -----------
1994
- --------
Life insurance in-force 94,027,509 9.2
---------------- -----------
Premiums & policy charges 350,688 2.5
---------------- -----------
S-4
FARMERS GROUP, INC.
AND SUBSIDIARIES
SCHEDULE V - VALUATION AND QUALIFYING ACCOUNTS
Balance at Balance at
beginning end of
of year year
------------- -------------
(Amounts in thousands)
YEAR
- ----------
1996 $ 14,164 $ 18,960
1995 12,916 14,164
1994 12,753 12,916