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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, 1998
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
(323) 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)*
8.25% 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, 1998 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 11
ITEM 3. Legal Proceedings 11
ITEM 4. Submission of Matters to a Vote of Security Holders 12
PART II
ITEM 5. Market for Farmers Group, Inc.'s Common Equity and
Related Stockholders Matters 12
ITEM 6. Selected Financial Data 12
ITEM 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations 14
ITEM 7a. Quantitative and Qualitative Disclosures about Market
Risks 21
ITEM 8. Financial Statements and Supplementary Data 22
ITEM 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosures 62
PART III
ITEM 10. Directors and Executive Officers of Farmers Group, Inc. 62
ITEM 11. Executive Compensation 65
ITEM 12. Security Ownership of Certain Beneficial Owners
and Management 68
ITEM 13. Certain Relationships and Related Transactions 69
PART IV
ITEM 14. Exhibits, Financial Statement Schedules and Reports
on Form 8-K 69
SIGNATURES 71
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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"),
their respective subsidiaries and Farmers Texas County Mutual Insurance
Company ("FTCM"), (iii) references to Farmers Life are to Farmers New World
Life Insurance Company, (iv) references to the Life Insurance Subsidiaries are
to Farmers Life, The Ohio State Life Insurance Company ("OSL") and Investors
Guaranty Life Insurance Company ("IGL") and (v) references to the Insurance
Subsidiaries are to Farmers Life and Farmers Reinsurance Company ("Farmers
Re") in 1998, to Farmers Life, OSL, IGL and Farmers Re in 1997 and to Farmers
Life, OSL and IGL in 1996. Unless otherwise indicated, financial information,
operating statistics and ratios applicable to the Company and the Insurance
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 statutory
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.. Any reference to "Note" is to the Notes to
Consolidated Financial Statements included in Item 8 of this Report.
PART I
ITEM 1. Business
The Company
General. The Company's principal activities are the provision of
management services to the P&C Group and the ownership and operation of the
Insurance Subsidiaries. As of December 31, 1998, the Company had total assets
of $12.7 billion, stockholders' equity of $7.0 billion and for the period
ended December 31, 1998, the Company had consolidated operating revenues of
$3.0 billion. As of December 31, 1998, the Insurance Subsidiaries had total
assets of $6.4 billion, combined SAP capital and surplus (including asset
valuation reserve) of $1.4 billion, life policies-in-force of 1.1 million and
for the period ended December 31, 1998, the Insurance Subsidiaries had
combined SAP life premiums and deposits received of $0.5 billion and non-life
reinsurance premiums of $1.0 billion. 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 market 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.
On December 22, 1997, a definitive agreement was reached to merge B.A.T's
Financial Services Businesses, which included the Company, with Zurich
Insurance Company ("Zurich"). In June 1998, the merger was approved by the
shareholders of B.A.T and Zurich. In September 1998, this merger was
completed and the businesses of Zurich and B.A.T's Financial Services
Businesses were transferred to Zurich Financial Services ("ZFS"), a new Swiss
company with headquarters in Zurich. As a result, each two shares of the
Company's prior outstanding stock were recapitalized into one share of Class A
Common Stock, par value $1.00 per share ("Ordinary Share"), and one share of
Class B Common Stock, par value $1.00 per share ("Income Share"). Under the
merger agreement, all Ordinary Shares became wholly owned by ZFS and all
Income Shares became wholly owned by Allied Zurich Holdings Limited, an
affiliated company created during the restructuring of B.A.T. This merger was
accounted for by ZFS as a pooling of interests and, therefore, no purchase
accounting adjustments were made to the Company's assets and liabilities.
Operating Segments
Financial information by operating segment can be found in Note Z.
Following are descriptions of the Company's operating segments.
Provision of Management Services to the P&C Group; and Other. The P&C
Group is owned by the policyholders of the Exchanges and FTCM. Accordingly,
the Company has no ownership interest in the P&C Group. The policyholders each
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
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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 AIF of the P&C Group, the Company selects risks, prepares and mails
policy forms and invoices, collects premiums and performs certain other
administrative and managerial functions. The P&C Group is responsible for its
own claims functions, including the settlement and payment of claims and
claims adjustment expenses. The P&C Group is also responsible for the payment
of commissions, benefits for agents and district managers, and its 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 premiums which has generated a corresponding rise in management fee
income to the Company. Gross premiums earned by the P&C Group were $10.3
billion, $10.1 billion and $9.5 billion for 1998, 1997 and 1996, respectively,
giving rise to management fee revenues to the Company of $1.27 billion, $1.24
billion and $1.17 billion, respectively, for the same years.
The P&C Group markets personal auto, homeowners and selected commercial
insurance products in 31 states. For the year ended December 31, 1998,
approximately 67.4% of net premiums earned was from auto insurance policies,
22.3% was from homeowner policies and the remainder was primarily from
commercial policies. As of December 31, 1998, the P&C Group had total assets
of $14.8 billion, surplus as regards policyholders of $4.5 billion, policies-
in-force of 15.9 million and for the year ended December 31, 1998, had gross
premiums earned of $10.3 billion.
The Company, through its wholly owned subsidiary Prematic Service
Corporation ("Prematic"), enables individuals and businesses purchasing
insurance from one or more members of the P&C Group and Farmers Life to
combine all premiums due into a single monthly payment. In practice, Prematic
combines amounts due from a single insured associated with auto, fire,
commercial and life policies into a single amount and then bills the insured
on a monthly basis for all policies-in-force. For this service, Prematic
collected service fees totaling $77 million in 1998 and generated net income
of approximately $25 million for the year. The Company has certain other
nonmaterial subsidiaries, the results of which are included in the Company's
consolidated results.
Life Insurance. On April 15, 1997, the Company sold two of its life
insurance subsidiaries, OSL and IGL, to Great Southern Life Insurance Company,
a subsidiary of Americo Life, Inc.. These subsidiaries contributed $5,502,000
to net income in 1997 and their combined net assets as of April 15, 1997 were
$316,448,000.
The Company's remaining life insurance subsidiary, Farmers Life, markets
a broad line of individual life insurance products, including universal life,
term life and whole life insurance and annuity products, predominantly
flexible premium deferred annuities. As of December 31, 1998, Farmers Life
provided insurance to more than one million people and managed more than $1.6
billion of annuity funds. Farmers Life's investment philosophy emphasizes
long-term fundamental value in the selection of the investment mix for its
portfolio. As of December 31, 1998, approximately 89.7% of Farmers Life's
portfolio was invested in fixed income securities and cash and 1.4% in equity
securities and owned real estate. As of December 31, 1998, approximately
91.7% of Farmers Life's fixed income securities were rated investment grade.
Farmers Life's ratio of SAP capital and surplus (including asset valuation
reserve) to total assets as of December 31, 1998 was 21.4%, well over the
industry average of approximately 12.4% as of September 30, 1998, as
published in the Statistical Bulletin issued by the American Council of Life
Insurance.
6
Farmers Reinsurance Company. Farmers Re is a wholly owned subsidiary of
the Company. On January 1, 1998, Farmers Re entered into an auto physical
damage reinsurance agreement with the P&C Group. This agreement provided for
monthly premiums of $83.3 million and recoveries of a quota share percentage
of ultimate net losses sustained by the P&C Group in its auto physical damage
lines of business. This agreement also provided for the P&C Group to receive
a provisional ceding commission of 20% of premiums with additional experience
commissions that depend on loss experience. This experience commission
arrangement limits Farmers Re's potential underwriting gain on the assumed
business to 2.5% of premiums assumed.
In 1998, the first accident year under the reinsurance treaty, losses
paid by Farmers Re were $543,445,000, loss adjustment expenses were
$5,736,000, reinsurance commissions were $319,875,000 and premiums assumed
were $1,000,000,000. As of December 31, 1998, Farmers Re had loss reserves
of $105,944,000.
Employees
As of December 31, 1998, the Company had 6,753 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 nearly 8.3
million existing households while focusing its efforts on the growth of
Farmers Life, (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 Farmers Insurance Group of Companies( in its 31 state operating
territory, (v) selectively expanding into new geographic markets and (vi)
expanding the products and services offered to its policyholders by taking
advantage of horizontal marketing opportunities.
Year 2000 Project. In 1995, the Company initiated the "Year 2000
Project" in order to prepare for the information processing challenges
presented by the approach of the new millennium. This project encompasses all
major areas of the Company's operations, including internal and vendor
mainframe applications, mainframe systems software, third party interfaces,
non-mainframe systems software, forms, facilities and equipment. As the
Company and the P&C Group rely on computer software logic to maintain accurate
records, the impact of the issues relating to the approach of the new
millennium is significant to the Company's ongoing performance. As such, a
phased plan has been developed for completing this project. As of December
31, 1998, the first two phases of the project (the "Awareness and Initial
Impact Assessment" and the "Year 2000 Workpackage and Development Blueprint
Project" phases) have been successfully completed. The project is currently
in its final phase (the "Year 2000 Conversion and Implementation" phase) which
is expected to be completed in mid-1999. Additional information relating to
the Year 2000 Project can be found in the "Management's Discussion and
Analysis of Financial Condition and Results of Operations" section of this
Report.
Marketing and Distribution. The P&C Group and Farmers Life operate using
common trade names and logos, including Farmers Insurance Group of Companies(,
Farmers Insurance Group( and Farmers(, and distribute their respective
insurance products in 31 states (primarily in western and midwestern states)
through a common network of direct writing agents and district managers. As
of December 31, 1998, this network consisted of 14,743 direct writing agents
and 499 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.
7
The Farmers' 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 nearly 8.3 million
households provide a potential resource for future growth in policies-in-force
and life insurance sales. Higher retention rates and profitability are
expected to be achieved on business written with households having multiple
policies.
Farmers maintains its brand name recognition throughout its operating
territory through television, radio and print advertising on both a national
and local basis. To further assist the agency force in marketing Farmers'
products, they are provided access to the Farmers Agency Information
Management System which enables the agent to deliver high-quality consumer
focused service at the point of sale. Furthermore, Farmers' formalized
policyholder recontact program, the "Farmers Friendly Review(", builds
customer loyalty and provides a vehicle for enhanced policy retention and
future internal growth through the cross-selling of property and casualty and
life products.
As part of the merger with Zurich, Zurich Personal Insurance employees,
based in Baltimore, Maryland will assist FGI and the P&C Group with their
expansion efforts into new states in the eastern United States. These Zurich
Personal Insurance employees will also help the P&C Group expand into new
specialty lines of business, such as recreational vehicles and non-standard
auto, thereby increasing the range of products available to meet the P&C
Group's customers' needs.
Competition. Property and casualty insurance is a very competitive
industry with over 3,600 insurers operating in the United States. 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 in its selected markets 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 Farmers Life. Nearly 1,800 life
insurance companies in the United States offer products similar to those
offered by Farmers Life, and many use similar marketing techniques. Farmers
Life competes on the basis of customer service, product features, financial
strength and price. Many of the products offered by Farmers Life 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 Insurance Subsidiaries and the P&C
Group are subject to extensive state regulatory oversight in the jurisdictions
in which they do business. The Company and the P&C Group constitute 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, 1998,
neither the P&C Group nor the Insurance Subsidiaries were subject to such
regulatory actions. Most of Farmers Life's 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 Farmers Life 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.
Investments
During the years ended December 31, 1998, 1997 and 1996, the Insurance
Subsidiaries had pretax net investment income and realized investment gains/
(losses) of $292.6 million, $306.4 million and $355.6 million, respectively,
and the Company other than the Insurance Subsidiaries (collectively, the
"Noninsurance investment portfolio") had pretax net investment income and
realized investment gains of $197.5 million, $217.6 million and $117.9
million, respectively. As of December 31, 1998, the book value of the
Insurance Subsidiaries investment portfolio was approximately $5.0 billion and
the book value of the Noninsurance investment portfolio was approximately
8
$2.4 billion. The Board of Directors of the Company is responsible for
developing investment policies and the Investment Committee, which is
comprised of 10 officers of the Company who are appointed by the Board of
Directors, is responsible for administering such policies. During 1998,
Scudder Kemper Investments, Inc. took over management of the Insurance
Subsidiaries investment portfolio and the Noninsurance investment portfolio in
accordance with these policies. Prior to that, the Company's investment
department managed these portfolios.
The investment philosophy for both the Insurance Subsidiaries investment
portfolio and the Noninsurance investment portfolio emphasizes long-term
fundamental value in the selection of the investment mix. For the Insurance
Subsidiaries, the assets backing the Farmers Life interest sensitive
investment 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 Noninsurance investment
portfolio, excluding certificates of contribution of the P&C Group, relatively
short maturities are maintained for capital preservation purposes and to
ensure liquidity.
The Insurance Subsidiaries investment portfolio and the Noninsurance
investment portfolio are both comprised of a broad range of assets,
including corporate fixed income securities, mortgage-backed securities,
taxable and tax-exempt government securities, preferred stock, common stock,
owned real estate, mortgage loans and short-term instruments. The Insurance
Subsidiaries investment portfolio also includes policy loans and Standard &
Poor's 500 Composite Stock Price Index ("S&P 500") call options.
Approximately 43.6% of the Noninsurance investment portfolio consists of notes
issued by British American Financial Services (UK and International), Ltd.
("BAFS"), a subsidiary of ZFS. Approximately 1.4% of the Noninsurance
investment portfolio consists of certificates of contribution of the P&C Group
and approximately 2.4% of the Insurance Subsidiaries investment portfolio
consists of a surplus note of the P&C Group. See Item 13 and Notes F and T.
Approximately 92.6% of the fixed income securities in the Insurance
Subsidiaries investment portfolio are rated investment grade and approximately
98.9% of the fixed income securities in the Noninsurance investment portfolio
are rated investment grade. Approximately 62.7% of the mortgage-backed
securities in the Insurance Subsidiaries investment 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 approximately 75.2% of
the remaining 37.3% are rated "AAA". Approximately 60.2% of the mortgage-
backed securities in the Noninsurance investment portfolio are guaranteed by
GNMA, FHA, FNMA, or FHLMC, and the remaining 39.8% are rated "AAA".
9
The following table sets forth the book value of each portfolio, by asset
category, as of December 31, 1998 and 1997.
Book Value of Invested Assets
($ in millions)
As of December 31,
-------------------------------------------------------------
1998 1997
------------------------- ---------------------------
Book Value % Book Value %
---------- --------- ---------- ----------
Insurance Subsidiaries
Fixed income securities $ 4,356.1 87.5 % $ 3,578.9 90.5 %
Mortgage loans 52.9 1.1 89.9 2.3
Equity securities 107.4 2.1 1.3 0.0
Owned real estate 59.0 1.2 67.2 1.7
Cash and cash equivalents 73.7 1.5 36.3 0.9
Surplus note of the P&C Group 119.0 2.4 0.0 0.0
Policy loans 185.2 3.7 165.9 4.2
S&P 500 call options 14.8 0.3 3.3 0.1
Other 8.5 0.2 11.6 0.3
--------- ------- ---------- ----------
Total $ 4,976.6 100.0 % $ 3,954.4 100.0 %
========= ======= ========== ==========
Noninsurance
Fixed income securities $ 662.1 27.3 % $ 592.8 22.6 %
Mortgage loans 0.2 0.0 0.2 0.0
Equity securities 354.5 14.6 389.0 14.9
Owned real estate 62.8 2.6 63.5 2.4
Cash and cash equivalents 253.8 10.5 479.9 18.3
Certificates of contribution of
the P&C Group 34.4 1.4 684.4 26.1
BAFS notes 1,057.0 43.6 0.0 0.0
B.A.T Capital Corporation notes 0.0 0.0 407.0 15.5
Other 0.8 0.0 4.8 0.2
--------- ------- ---------- ----------
Total $ 2,425.6 100.0 % $ 2,621.6 100.0 %
========= ======= ========== ==========
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 market values and for all investments in debt securities.
As of December 31, 1998 and 1997, the Company classified all investments in
equity and debt securities as available-for-sale under SFAS No. 115, with the
exception of $53.0 million in 1998 and $47.0 million in 1997 which relate to a
grantor trust and are classified as trading securities under SFAS No. 115.
The available-for-sale investments are reported on the balance sheet at market
value, with unrealized gains and losses, net of tax, excluded from earnings
and reported as a component of stockholders' equity. The trading investments
are reported on the "Other assets" line of the consolidated balance sheet at
market value with both realized and unrealized gains and losses included in
earnings, net of tax, in the year in which they occur.
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 ("VOLBA") 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 stockholders' equity.
10
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 was amortized over a period approximately equal to the
remaining time to maturity. As of December 31, 1998, this writedown was fully
amortized.
Real estate investments are accounted for on a depreciated cost basis.
Real estate acquired in foreclosure and held for sale is carried at the lower
of market value or depreciated cost less a valuation allowance. Marketable
securities are carried at cost. Other investments, which consist primarily of
the BAFS notes receivable, certificates of contribution of the P&C Group, a
surplus note of the P&C Group and policy loans, are carried at the unpaid
principal balances.
S&P 500 call options, which are held by Farmers Life, are carried at
estimated fair value. Unrealized gains and losses resulting from changes in
the estimated fair value of the call options are recorded as an adjustment to
the interest liability credited to policyholders. In addition, realized gains
and losses from maturity or termination of the call options are offset against
the interest credited to policyholders during the period incurred. Premiums
paid on call options are amortized to net investment income over the term of
the contracts.
Fixed Income Securities. As of December 31, 1998, approximately 87.5% of
the Insurance Subsidiaries investment portfolio and 27.3% of the Noninsurance
investment portfolio were invested in fixed income securities. These
investments included taxable and tax-exempt government securities, domestic
and foreign corporate bonds, redeemable preferred stock and mortgage-backed
securities. Approximately 92.6% and 98.9% of the fixed income securities in
the Insurance Subsidiaries investment portfolio and Noninsurance investment
portfolio, respectively, 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, 1998.
Value of Fixed Income Securities
($ in millions)
Insurance Subsidiaries Noninsurance Total
---------------------- ----------------------- -----------------------
Market Market Market
Value % Value % Value %
----------- -------- ----------- --------- ----------- ---------
Mortgage-backed $ 1,978.9 45.4 % $ 53.8 8.1 % $ 2,032.7 40.5 %
Corporate 1,053.1 24.1 44.4 6.7 1,097.5 21.9
U.S. Government 504.4 11.6 0.3 0.0 504.7 10.1
Municipal 651.6 15.0 539.0 81.5 1,190.6 23.7
Foreign 81.4 1.9 0.0 0.0 81.4 1.6
Redeemable preferred stock 86.7 2.0 24.6 3.7 111.3 2.2
--------- ------- -------- ------- --------- -------
Total $ 4,356.1 100.0 % $ 662.1 100.0 % $ 5.018.2 100.0 %
========= ======= ======== ======= ========= =======
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, 1998, the
Insurance Subsidiaries held $323.1 million in below investment grade bonds,
representing 6.5% of total invested assets, and the Noninsurance investment
portfolio held $6.5 million in below investment grade bonds, representing 0.3%
of total invested assets.
Mortgage-backed Securities. Mortgage-backed securities ("MBS") are the
largest component of the Insurance Subsidiaries fixed income portfolio,
representing approximately 45.4% of its fixed income portfolio, as of December
31, 1998. The Noninsurance investment portfolio's MBS represented
approximately 8.1% of its fixed income portfolio as of December 31, 1998.
Approximately 62.7% of the MBS in the Insurance Subsidiaries investment
portfolio are guaranteed by various government agencies and government
sponsored entities, including the GNMA, FHA, FNMA or FHLMC, and 75.2% of the
remaining 37.3% are rated "AAA". Approximately 60.2% of the MBS in the
Noninsurance investment portfolio are guaranteed by GNMA, FHA, FNMA or FHLMC,
and the remaining 39.8% are rated "AAA".
11
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 Insurance Subsidiaries
investment portfolio held significant MBS investments in collateralized
mortgage obligations ("CMOs") including $624.9 million of planned amortization
classes ("PACs") and $20.6 million of targeted amortization classes ("TACs")
and the Noninsurance investment portfolio held $23.1 million of PACs. These
securities provide protection by passing a substantial portion of the risk of
prepayment uncertainty to other tranches.
Equity Investments-Common Stock. In 1997, the Company restructured its
common stock portfolio to diversify and to limit its exposure in any one
market sector. As a result, the Company's common stock portfolio is invested
in the equities of many of the 3,000 largest United States Companies, which
represent approximately 98% of the investable United States equity market.
Mortgage Loans. As of December 31, 1998, the Insurance Subsidiaries
investment portfolio included mortgage loans with an aggregate book value of
approximately $52.9 million (net of loss provisions of $7.3 million), or 1.1%
of total invested assets, and the Noninsurance investment portfolio included
mortgage loans of $0.2 million.
All mortgage loans included in the Insurance Subsidiaries investment
portfolio are secured by first mortgages. The majority of the 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 mortgage loan foreclosures
and the operation or sale of properties acquired through foreclosures is
limited because the Insurance Subsidiaries have not issued any mortgage loans
since 1989, and the majority of the individual remaining mortgage loan
balances are less than $1.0 million.
Owned Real Estate Investments. As of December 31, 1998, the Insurance
Subsidiaries investment portfolio included owned real estate investments with
a book value of $59.0 million (net of loss provisions of $3.2 million), or
1.2% of total invested assets, and the Noninsurance investment portfolio
included owned real estate investments with a book value of $62.8 million, or
2.6% of total invested assets. The Insurance 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. The
Noninsurance investment portfolio owned real estate holdings were all acquired
directly as equity investments.
Problem Investments-Fixed Income Securities. As of December 31, 1998,
none of the fixed income securities held in the Insurance Subsidiaries
investment portfolio or the Noninsurance investment portfolio were classified
as "problem" or "potential problem" assets.
Problem Investments-Mortgage Loan Investments. As of December 31, 1998,
none of the mortgage loans held by the Insurance Subsidiaries investment
portfolio or the Noninsurance investment portfolio were classified as
"troubled loans".
ITEM 2. Properties
The Company owns three buildings in Los Angeles and thirteen business
service centers in which its administrative operations are conducted. In
addition, the Company owns a building in the state of Washington in which the
operations of Farmers Life 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
12
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
On September 4, 1998, at a special meeting of the Stockholder, the
Company's sole Stockholder, B.A.T, approved an amendment to Article Fourth of
the Restated Articles of Incorporation which restructured the capital
structure of the Company. For additional information, refer to the Form 8-K
filed by the Company dated September 6, 1998.
PART II
ITEM 5. Market for Farmers Group, Inc.'s Common Equity and Related
Stockholders Matters
On September 4, 1998, after approval by the Company's Stockholder, each
two shares of the Company's outstanding stock were recapitalized into the
following:
- One share Class A Common Stock ("Ordinary Share"), par value $1.00 per
share.
Holders of Ordinary Shares are entitled to one vote per share upon
election of directors and all other matters upon which stockholders generally
are entitled to vote. In addition, holders of Ordinary Shares are entitled to
receive dividends and, in the event of a liquidation, are entitled to any and
all distributions of money or other property of the Company.
- One share Class B Common Stock ("Income Share"), par value $1.00 per
share.
Holders of Income Shares are entitled to one-ninth vote per share upon
election of directors and all other matters upon which stockholders generally
are entitled to vote. In addition, holders of Income Shares are entitled to
receive dividends, but have no right to capital in the event of a liquidation.
Dividends may be paid to holders of Ordinary Shares and Income Shares in
equal amounts, at the exclusion of one class of stock or in any ratio
determined solely at the discretion of the Board of Directors of the Company.
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, 1998, and the
consolidated balance sheet data of the Company as of December 31, 1998 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 B.A.T's acquisition of the Company in December
1988. Major items incorporated in the purchase price of the Company include
goodwill and the value of the AIF contracts of the P&C Group (see Note A).
The amortization of these two items, which is being taken on a straight-line
basis over forty years, reduced annual pretax income by approximately $102.8
million in each of the years 1994 through 1998.
13
Year Ended December 31,
-------------------------------------------------------------------
1998 1997 1996 1995 1994
----------- ----------- ----------- ----------- -----------
($ in millions)
INCOME STATEMENT DATA
Consolidated operating revenues $ 3,031.2 $ 2,009.0 $ 2,013.2 $ 1,892.4 $ 1,779.2
=========== =========== =========== =========== ===========
Management services to property
and casualty insurance companies;
and other:
Operating revenues $ 1,358.2 $ 1,324.9 $ 1,245.4 $ 1,183.1 $ 1,130.1
----------- ----------- ----------- ----------- -----------
Salaries and employee benefits 328.6 335.8 337.2 348.8 348.8
Buildings and equipment expenses 145.4 95.8 87.3 75.0 55.1
Amortization of AIF contracts
and goodwill 102.8 102.8 102.8 102.8 102.8
General and administrative expenses 204.1 202.6 170.3 170.5 172.8
----------- ----------- ----------- ----------- -----------
Total operating expenses 780.9 737.0 697.6 697.1 679.5
Merger related expenses(see Note E) 21.1 0.0 0.0 0.0 0.0
----------- ----------- ----------- ----------- -----------
Total expenses 802.0 737.0 697.6 697.1 679.5
----------- ----------- ----------- ----------- -----------
Operating income 556.2 587.9 547.8 486.0 450.6
Net investment income 135.1 144.2 112.8 78.0 59.1
Net realized gains 62.4 73.4 5.1 1.5 2.7
Gain on sale of subsidiaries 0.0 19.0 0.0 0.0 0.0
Dividends on preferred securities
of subsidiary trusts (42.1) (42.1) (42.1) (10.4) 0.0
----------- ----------- ----------- ----------- -----------
Income before provision for
taxes 711.6 782.4 623.6 555.1 512.4
Provision for income taxes 290.8 332.2 275.1 224.3 208.1
----------- ----------- ----------- ----------- -----------
Management services income 420.8 450.2 348.5 330.8 304.3
----------- ----------- ----------- ----------- -----------
Insurance Subsidiaries:
Life premiums 173.9 161.1 170.4 158.8 153.1
Non-life reinsurance premiums 1,000.1 0.0 0.0 0.0 0.0
Life policy charges 206.4 216.6 241.7 220.6 197.6
Investment income, net of expenses 307.4 293.2 317.7 298.3 251.6
Net realized gains/(losses) (14.8) 13.2 38.0 31.6 46.8
----------- ----------- ----------- ----------- -----------
Total revenues 1,673.0 684.1 767.8 709.3 649.1
----------- ----------- ----------- ----------- -----------
Non-life losses and loss adjustment
expenses 655.1 0.0 0.0 0.0 0.0
Life policyholders' benefits 308.3 294.4 335.1 316.7 276.4
Amortization of deferred policy
acquisition costs and value of
life business acquired 90.1 104.0 108.8 103.2 92.8
Life commissions 18.9 18.2 21.0 20.1 18.7
Non-life reinsurance commissions 319.9 0.0 0.0 0.0 0.0
General and administrative expenses 41.7 47.8 63.4 60.9 57.4
----------- ----------- ----------- ----------- -----------
Total operating expenses 1,434.0 464.4 528.3 500.9 445.3
----------- ----------- ----------- ----------- -----------
Income before provision for
taxes 239.0 219.7 239.5 208.4 203.8
Provision for income taxes 83.0 76.4 80.1 68.5 67.7
----------- ----------- ----------- ----------- -----------
Insurance Subsidiaries
income 156.0 143.3 159.4 139.9 136.1
----------- ----------- ----------- ----------- -----------
Consolidated net income before
cumulative effect of accounting
change 576.8 593.5 507.9 470.7 440.4
Cumulative effect of accounting
change 0.0 0.0 0.0 0.0 (4.7)(1)
----------- ----------- ----------- ----------- -----------
Consolidated net income $ 576.8 $ 593.5 $ 507.9 $ 470.7 $ 435.7
=========== =========== =========== =========== ===========
BALANCE SHEET DATA
Total investments (2) $ 7,402.2 $ 6,576.0 $ 6,605.3 $ 6,545.7 $ 5,181.9
Total assets 12,682.1 12,117.4 12,928.8 12,630.6 11,270.9
Total short term debt 0.0 0.0 0.0 200.0 0.0
Total long term debt 0.0 0.1 0.2 0.3 200.4
Company obligated mandatorily
redeemable preferred securities
of subsidiary trusts holding
solely junior subordinated
debentures ("QUIPS") 500.0 500.0 500.0 500.0 0.0
Stockholders' equity 7,034.4 6,781.6 6,503.8 6,493.6 6,148.0
OTHER OPERATING DATA (unaudited)
Ratio of debt to total
capitalization 6.6 % 6.9 % 7.1 % 9.7 % 3.2 %
Ratio of earnings to fixed
charges (3) 19.5 x 20.2 x 15.5 x 21.5 x 28.9 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 Insurance
Subsidiaries, respectively, for the year ended December 31, 1994.
(2) Includes cash and cash equivalents, marketable securities 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.
14
ITEM 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
General
The Company's principal activities are providing management services to
the property and casualty insurance companies, underwriting life insurance and
annuity products and providing reinsurance coverage to the P&C Group.
Revenues and expenses relating to these principal business activities are
reflected in the Company's Consolidated Financial Statements prepared in
accordance with GAAP, which differs from SAP, which the Insurance Subsidiaries
are required to use for regulatory reporting purposes.
The Company underwrites life insurance and annuity products through
Farmers Life. Revenues attributable to traditional life insurance products,
such as whole life or term life 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.
The Company provides reinsurance coverage to the P&C Group through its
subsidiary, Farmers Re, which was formed and licensed to conduct business in
December 1997. In January 1998, Farmers Re entered into a quota share
reinsurance treaty with the P&C Group under which it reinsures a percentage of
the auto physical damage business written by the P&C Group (see Note C).
Year Ended December 31, 1998 Compared to Year Ended December 31, 1997
Management Services to Property and Casualty Insurance Companies; and Other
Operating Revenues. Operating revenues increased from $1,324.9 million
in 1997 to $1,358.2 million in 1998, an increase of $33.3 million, or 2.5%.
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 $10,070.1 million in 1997 to $10,331.0 million in 1998 due
primarily to an increase in the number of Auto and Fire policies-in-force
between years and higher average premium levels in the Fire line of business.
Total Expenses. Total expenses as a percentage of operating revenues
increased from 55.6% in 1997 to 59.0% in 1998, an increase of 3.4 percentage
points. This increase was due to $21.1 million of merger related expenses and
a $46.0 million write-off of impaired assets in 1998. Excluding these two
items, expenses as a percentage of revenues decreased by 1.5 percentage points
between years.
Salaries and Employee Benefits. Salaries and employee benefits
decreased from $335.8 million in 1997 to $328.6 million in 1998, a
decrease of $7.2 million, or 2.1%, primarily due to a reduction in
employee complement due to increased operating efficiency as a result of
automation through the greater use of information technology systems.
Buildings and Equipment Expenses. Buildings and equipment expenses
increased from $95.8 million in 1997 to $145.4 million in 1998, an
increase of $49.6 million, or 51.8%. A review of capitalized software in
1998 resulted in a write-off of $43.6 million of capitalized costs that
were no longer expected to be recoverable. In addition, expenses
increased between years due to higher amortization expense associated
with information technology systems software.
15
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 1998 and 1997.
General and Administrative Expenses. General and administrative
expenses increased from $202.6 million in 1997 to $204.1 million in 1998
due to a $2.4 million write-off of impaired assets as well as a $0.8
million increase in Year 2000 Project related expenses. Despite these
two items, the Company has held the increase in general and
administrative expenses between years to less than one percent as a
result of continued attention to cost control and automation through the
greater use of information technology systems.
Merger Related Expenses. Expenses incurred by the Company as a
result of the merger between B.A.T's Financial Services Businesses and
Zurich amounted to $21.1 million for the year ended December 31, 1998
(see Note E).
Net Investment Income. Net investment income decreased from $144.2
million in 1997 to $135.1 million in 1998, a decrease of $9.1 million, or
6.3%. Of this decrease, $8.6 million was due to the redemption of
certificates of contribution of the P&C Group and the subsequent issuance of
the BAFS notes receivable at lower interest rates (see Note T). The remaining
decrease was due substantially to lower market yield rates.
Net Realized Gains. Net realized gains decreased from $73.4 million in
1997 to $62.4 million in 1998, a decrease of $11.0 million, due to the fact
that significant gains were realized in 1997 in connection with restructuring
the equities portfolio.
Gain on Sale of Subsidiaries. The gain recorded on the April 15, 1997
sale of OSL and IGL amounted to $19.0 million in 1997.
Dividends on Preferred Securities of Subsidiary Trusts. Dividends
expense related to the $500.0 million of Cumulative Quarterly Income Preferred
Securities ("QUIPS") issued in 1995 was $42.1 million in both 1997 and 1998.
Provision for Income Taxes. Provision for income taxes decreased from
$332.2 million in 1997 to $290.8 million in 1998, a decrease of $41.4 million,
or 12.5%. This decrease was due to the decrease in pretax income between years
as well as the fact that $26.8 million of taxes were recorded in 1997 related
to the sale of OSL and IGL.
Management Services Income. As a result of the foregoing, management
services income decreased from $450.2 million for the year ended December 31,
1997 to $420.8 million for the year ended December 31, 1998, a decrease of
$29.4 million, or 6.5%. Exclusive of the merger related expenses and the
write-off of impaired assets, management services income increased $12.5
million, or 2.8%, between years.
Insurance Subsidiaries
In 1998, Farmers Re assumed $1.0 billion of premiums, incurred $655.1
million of non-life losses and loss adjustment expenses and incurred $319.9
million of non-life reinsurance commissions expense. For the year ended
December 31, 1998, Farmers Re contributed $37.2 million to income before taxes
and $25.4 million to net income.
On April 15, 1997, OSL and IGL were sold to Great Southern Life Insurance
Company, a subsidiary of Americo Life, Inc.. As a result, there was no
contribution to net income from OSL or IGL in 1998, compared to $5.5 million
in 1997. The following commentary addresses the results of the Company's
remaining life insurance subsidiary, Farmers Life.
Total Revenues. Total revenues increased from $638.6 million in 1997 to
$660.6 million in 1998, an increase of $22.0 million, or 3.4%.
16
Life Premiums. Premiums increased $22.0 million, or 14.5%, between
years. This increase was due to a 15.8% growth in the average volume of
insurance in-force which was driven by sales of the Premier Whole Life
("PWL") and the Farmers Premier 20 Year Term ("FP20") products. Also
contributing to the increase in premiums was an increase in the number
of annuities in the payment phase ("AIP").
Life Policy Charges. Policy charges increased $5.6 million in 1998,
or 2.8% over 1997, reflecting growth in the average volume of universal
life-type insurance in-force.
Investment Income. Net investment income increased $18.0 million in
1998, or 6.5% over 1997, due to a higher invested asset base.
Net Realized Gains/(Losses). Net realized gains/(losses) decreased
$23.6 million, from a $10.1 million gain in 1997 to a $13.5 million loss
in 1998. This decrease was due mainly to realized losses recognized as a
result of a $26.0 million writedown of Russian bond holdings in 1998.
Total Operating Expenses. Total operating expenses increased from $427.0
million in 1997 to $458.8 million in 1998, an increase of $31.8 million, or
7.4%.
Life Policyholders' Benefits and Charges. Life policyholders'
benefits expense and charges increased from $274.5 million in 1997 to
$308.3 million in 1998, an increase of $33.8 million, or 12.3%.
Policy Benefits. Policy benefits, which consist primarily of
death and surrender benefits on life products, increased $21.6
million over 1997 to $134.0 million, due to growth in the volume of
life insurance in-force and an increase in mortality experience
between periods.
Increase in Liability for Future Benefits. Increase in
liability for future benefits expense increased from $15.7 million
in 1997 to $23.7 million in 1998. This increase was primarily
attributable to an increase in AIP and sales of the PWL and Farmers
Premier Term products, particularly the FP20 product introduced in
October 1997.
Interest Credited to Policyholders. Interest credited to
policyholders, which represents the amount credited to policyholder
funds on deposit under universal life-type contracts and deferred
annuities, increased from $146.4 million in 1997 to $150.6 million
in 1998, or 2.9%, reflecting growth in the universal life fund
balance.
General Operating Expenses. General operating expenses decreased
from $152.5 million in 1997 to $150.5 million in 1998, a decrease of $2.0
million, or 1.3%.
Amortization of DAC and VOLBA. Amortization expense decreased
from $94.7 million in 1997 to $90.1 million in 1998 due to higher
universal life death claims experience in 1998.
Commissions. Commissions increased from $17.3 million in 1997
to $19.0 million in 1998 due to the increase in the volume of
business-in-force.
General and Administrative Expenses. General and administrative
expenses increased from $40.5 million in 1997 to $41.5 million in
1998, an increase of just $1.0 million. This increase resulted
mainly from increased premium taxes.
Provision for Income Taxes. Provision for income taxes decreased from
$73.8 million in 1997 to $71.2 million in 1998, a decrease of $2.6 million,
due to the decrease in pretax operating income.
17
Farmers Life Income. As a result of the foregoing, Farmers Life income
decreased from $137.8 million in 1997 to $130.6 million in 1998, a decrease of
$7.2 million, or 5.2%.
Consolidated Net Income
Consolidated net income of the Company decreased from $593.5 million in
1997 to $576.8 million in 1998, a decrease of $16.7 million, or 2.8%, due
primarily to the merger related expenses and the write-off of impaired assets.
Year Ended December 31, 1997 Compared to Year Ended December 31, 1996
Management Services to Property and Casualty Insurance Companies; and Other
Operating Revenues. Operating revenues increased from $1,245.4 million in
1996 to $1,324.9 million in 1997, an increase of $79.5 million, or 6.4%. This
growth reflects higher gross premiums earned by the P&C Group, which increased
from $9,458.2 million in 1996 to $10,070.1 million in 1997 due primarily to
higher average premium levels for the Auto and Fire lines of business and an
increase in the number of policies-in-force between years reflecting stricter
enforcement of the California mandatory auto insurance law following the
enactment of California Assembly Bill 650 and the P&C Group's re-entry into
the California homeowners' market. Partially offsetting these increases is
the fact that, in recognition of expense savings realized as a result of
improved operating efficiencies, the Company waived 0.43% from the Farmers
Preferred Auto Management fee rate that was in effect prior to November 1,
1996. This rate waiver resulted in a $22.3 million reduction in management
fees in 1997 from what such fees would have been using the rates in effect
during 1996.
Total Operating Expenses. Total operating expenses as a percentage of
operating revenues decreased from 56.0% in 1996 to 55.6% in 1997, a decrease
of 0.4 percentage points.
Salaries and Employee Benefits. Salaries and employee benefits
decreased from $337.2 million in 1996 to $335.8 million in 1997, a
decrease of $1.4 million, or 0.4%, primarily due to a reduction in
employee complement.
Buildings and Equipment Expenses. Buildings and equipment expenses
increased from $87.3 million in 1996 to $95.8 million in 1997, an
increase of $8.5 million, or 9.7%. This increase was primarily due to
higher amortization expense associated with information technology
systems software.
Amortization of AIF Contracts and Goodwill. 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
1997 and 1996.
General and Administrative Expenses. General and administrative
expenses increased from $170.3 million in 1996 to $202.6 million in 1997,
an increase of $32.3 million, or 19.0%. This increase was primarily due
to higher expenses attributable to increased business levels and the
re-entry of the P&C Group into the California homeowners' market. Also
contributing to the increase in expense was a $4.6 million increase in
Year 2000 Project costs.
Net Investment Income. Net investment income increased from $112.8
million in 1996 to $144.2 million in 1997, an increase of $31.4 million, or
27.8%. This increase was primarily due to a larger invested asset base as a
result of common stock received as part of a $374.9 million dividend from
Farmers Life to Farmers Group, Inc. in December 1996 and the reinvestment of
cash generated by the sale of OSL and IGL.
Net Realized Gains. Net realized gains increased from $5.1 million in
1996 to $73.4 million in 1997, an increase of $68.3 million, due primarily to
gains realized on equities formerly held by Farmers Life that were sold while
restructuring the portfolio.
18
Gain on Sale of Subsidiaries. The gain recorded on the April 15, 1997
sale of OSL and IGL amounted to $19.0 million in 1997.
Dividends on Preferred Securities of Subsidiary Trusts. Dividends
expense related to the $500.0 million of QUIPS issued in 1995 was $42.1
million in both 1996 and 1997.
Provision for Income Taxes. Provision for income taxes increased from
$275.1 million in 1996 to $332.2 million in 1997, an increase of $57.1
million, or 20.8%. This increase was due to the increase in pretax income
between years and the $26.8 million of taxes associated with the sale of OSL
and IGL.
Management Services Income. As a result of the foregoing, management
services income increased from $348.5 million for the year ended December 31,
1996 to $450.2 million for the year ended December 31, 1997, an increase of
$101.7 million, or 29.2%.
Insurance Subsidiaries
Since OSL and IGL were sold to Great Southern Life Insurance Company on
April 15, 1997, they contributed only $5.5 million to net income in 1997
compared to $17.2 million in 1996. The following commentary addresses the
results of the Company's remaining life insurance subsidiary, Farmers Life.
Total Revenues. Total revenues increased from $613.3 million in 1996 to
$638.6 million in 1997, an increase of $25.3 million, or 4.1%.
Life Premiums. Premiums increased $15.0 million, or 11.0% between
years. This increase was due to growth in renewal and first year
business resulting from increased sales of the PWL product.
Life Policy Charges. Policy charges increased $12.5 million in
1997, or 6.6% over 1996, reflecting a 4.2% growth in universal life-type
insurance in-force.
Investment Income. Net investment income increased $17.9 million in
1997, or 6.9% over 1996, due largely to higher bond interest income
resulting primarily from an increase in bond investments.
Net Realized Gains. Net realized gains decreased by $20.1 million,
from $30.2 million in 1996 to $10.1 million in 1997, due to the fact that
Farmers Life's common stock portfolio was transferred to FGI as part of
the 1996 dividend.
Total Operating Expenses. Total operating expenses increased from $399.9
million in 1996 to $427.0 million in 1997, an increase of $27.1 million, or
6.8%.
Life Policyholders' Benefits and Charges. Life policyholders'
benefits expense and charges increased from $260.3 million in 1996 to
$274.5 million in 1997, an increase of $14.2 million, or 5.5%.
Policy Benefits. Policy benefits increased $1.5 million over
1996 to $112.4 million, due to an increase in death claims resulting
from an increase in insurance in-force.
Increase in Liability for Future Benefits. Increase in
liability for future benefits expense increased from $11.4 million
in 1996 to $15.7 million in 1997. This increase was primarily
attributable to lower terminations on older whole life business
carrying higher future benefit provisions and increased PWL sales in
1997 and 1996.
19
Interest Credited to Policyholders. Interest credited to
policyholders increased from $138.0 million in 1996 to $146.4
million in 1997, or 6.1%, reflecting a 4.2% growth in universal
life-type insurance in-force and a 3.5% increase in annuity funds on
deposit.
General Operating Expenses. General operating expenses increased
from $139.6 million in 1996 to $152.5 million in 1997, an increase of
$12.9 million, or 9.2%.
Amortization of DAC and VOLBA. Amortization expense increased
from $80.8 million in 1996 to $94.7 million in 1997. This increase
reflects the continued growth in the volume of universal life-type
and traditional business in-force.
Commissions. Commissions decreased from $18.3 million in 1996
to $17.3 million in 1997, or 5.5%. The decrease results from IGL's
commutation, in the third quarter of 1997, of the block of business
ceded to Farmers Life under a reinsurance treaty.
General and Administrative Expenses. General and
administrative expenses remained unchanged from the 1996 level of
$40.5 million.
Provision for Income Taxes. Provision for income taxes increased from
$71.1 million in 1996 to $73.8 million in 1997, an increase of $2.7 million,
due to a decrease in tax preference items, particularly tax exempt interest.
Farmers Life Income. As a result of the foregoing, Farmers Life income
decreased from $142.3 million in 1996 to $137.8 million in 1997, a decrease of
$4.5 million, or 3.2%.
Consolidated Net Income
Consolidated net income of the Company increased from $507.9 million in
1996 to $593.5 million in 1997, an increase of $85.6 million, or 16.9%.
Year 2000 Issue
Many computer systems in use today were designed and developed using two
digits, rather than four, to specify the year. As a result, such systems will
recognize "00" as the year 1900 rather than the year 2000. This could cause
many computer applications to fail completely or to create erroneous results
unless corrective measures are taken. As early as 1995, the Company's
management recognized that its information systems were at risk to produce
erroneous results due to the effect of the century rollover. Significant
efforts have been expended to gain a complete understanding of Year 2000
implications and to develop a strategy to make the Company's and the P&C
Group's systems Year 2000 compliant. The costs associated with the Year 2000
Project are being expensed as incurred. The cumulative costs through December
31, 1998 totaled $17.3 million, of which $3.5 million was allocated to the P&C
Group. Total costs of the project are expected to be approximately $23.2
million, of which approximately $5.4 million is expected to be allocated to
the P&C Group.
To remedy the Year 2000 issue, management has devised a three-phase plan:
Phase I -"Awareness and Initial Impact Assessment". This phase was
completed in May 1996. During this phase, Year 2000 "Impact Assessment" was
performed using a mainframe analysis tool to determine which areas were at
risk.
20
Phase II -"Year 2000 Workpackage and Development Blueprint Project".
This phase was completed in November 1996 and consisted of creating a
comprehensive master plan which included establishing and prioritizing
clusters (groups of similar computer programs) and agreeing upon a definition
of what would be acceptable Year 2000 compliance. In addition, a timeframe
was established for the conversion, compliance testing and the implementation
of Year 2000 compliant programs into production.
Phase III -"Year 2000 Conversion and Implementation". The Company is
currently in the process of converting, implementing and testing these Year
2000 conversion programs. Management expects this phase to be completed by
mid-1999.
In addition, the Company has evaluated its relationships with third
parties with which the Company has a direct and material relationship to
determine whether they are Year 2000 compliant. The Company has sent out
questionnaires and warranty requests to all third party vendors and is
currently in the process of performing compliance testing with all vendors to
validate the vendors' claims regarding Year 2000 compliance. Management
anticipates that by mid-1999, compliance testing related to third party
relationships will be completed. However, it is not possible to state with
certainty that the operations of third parties will not be materially impacted
in turn by other parties with whom they themselves have a relationship.
The Year 2000 issue may not only affect the Company's information
technology ("IT") systems but also its non-IT systems. The Company has
assessed the readiness of its non-IT systems and believes that in the event of
an interruption of these systems, contingency plans have been established such
that no major disruptions will occur.
The first drafts of the Company's Year 2000 contingency plans have been
completed. These plans will be reviewed and updated as more information
becomes available. In the event that the Company's vendors do not expect to
be Year 2000 compliant, the Company's contingency plans may include replacing
such vendors. The operations of the Company and the P&C Group are such that
in the event all electronic communications are down, the Company and the P&C
Group could continue to operate until an alternative communication source is
acquired.
Liquidity and Capital Resources
General. The principal uses of funds by the Company are (i) operating
expenses, (ii) dividends to the shareholders of the Company's QUIPS, (iii)
capital expenditures and (iv) dividends to its stockholders. In 1998,
dividends paid on the QUIPS totaled $42.1 million, capital expenditures
totaled $59.9 million and cash dividends paid to the stockholders totaled
$355.2 million.
The principal sources of funds available to the Company are (i) the
management fees that it receives for providing management services to 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 Farmers Life is available for
payment as a dividend to the Company, subject to certain limitations imposed
by the insurance laws of the State of Washington and additional state
taxation. As of December 31, 1998, an aggregate of $115.9 million is available
for distribution as a dividend without approval of the state insurance
department (see Note I). Additionally, as of December 31, 1998, the Company
had available revolving credit facilities enabling it to borrow up to $500.0
million in the event such a need should arise (see Note V).
In order to maintain the policyholders' surplus of the P&C Group, Farmers
Life purchased a $119.0 million surplus note of the P&C Group in 1998 (see
Note F). The Company has, from time to time, made other surplus contributions
to the P&C Group totaling approximately $684.4 million, receiving certificates
of contribution which bear interest at various rates. In 1998, $650.0 million
of these certificates of contribution of the P&C Group were repaid. The
Company believes that these purchases of certificates of contribution and the
surplus note have helped to support the historical growth in premiums earned
by the P&C Group and the related growth in management fees paid to the Company.
21
In 1998, the $407.0 million of B.A.T Capital Corporation notes receivable
was settled. Using the $650.0 million of proceeds received from the
redemption of the certificates of contribution mentioned above, and the
settlement of the $407.0 million B.A.T notes receivable, the Company issued
$1,057.0 million of notes receivable to BAFS in September 1998 (see Note T).
Net cash provided by operating activities increased from $660.4 million
in 1997 to $1,092.2 million in 1998, an increase in cash of $431.8 million,
or 65.4%. This increase in cash was principally due to a $163.2 million
increase in reinsurance payables to the P&C Group in 1998, a $105.9 million
increase in the Farmers Re provision for non-life losses and loss adjustment
expenses in 1998 and a $131.3 million decrease in non-current liabilities in
1997.
Net cash used in investing activities increased from $356.9 million in
1997 to $951.1 million in 1998, a decrease in cash of $594.2 million, or
166.5%, between years. This decrease in cash was primarily due to the
$1,057.0 million of notes receivable issued to BAFS in 1998, the $119.0
million surplus note of the P&C Group purchased by Farmers Life in 1998 and
the fact that $336.7 million of proceeds were received from the sale of OSL
and IGL in 1997. Partially offsetting these decreases in cash were $650.0
million of proceeds received from the redemption of certificates of
contribution of the P&C Group in 1998 and $407.0 million of proceeds received
from the settlement of the B.A.T Capital Corporation notes receivable in 1998.
Net cash used in financing activities increased from $286.5 million in
1997 to $329.8 million in 1998, a decrease in cash of $43.3 million, or 15.1%.
This decrease in cash was due to a $41.1 million increase in annuity contract
withdrawals by policyholders between years and an $18.0 million increase in
dividends paid to the Company's stockholders in 1998.
Farmers Life. The principal uses of funds by Farmers Life are (i) policy
benefits and claims, (ii) loans to policyholders, (iii) capital expenditures,
(iv) operating expenses and (v) stockholder's dividends. The principal sources
of funds available to Farmers Life are premiums and amounts earned from the
investment of premiums and deposits. These sources of funds have historically
satisfied the liquidity needs of Farmers Life.
Farmers Re. The principal uses of funds by Farmers Re are (i) the
payment of non-life losses and loss adjustment expenses, (ii) the payment of
reinsurance commissions and (iii) operating expenses. The principal sources
of funds available to Farmers Re are premiums assumed from the P&C Group and
investment income.
ITEM 7a. Quantitative and Qualitative Disclosures about Market Risks
The information required is presented under the caption "Risk Management"
in Exhibit No. 99 of this Report.
22
ITEM 8. Financial Statements and Supplementary Data
Index for Financial Statements and Supplementary Data
Page
----
Independent Auditors' Report 23
Consolidated Financial Statements of Farmers Group, Inc.
and Subsidiaries
Consolidated Balance Sheets as of December 31, 1998 and 1997 24
Consolidated Statements of Income for the years ended
December 31, 1998, 1997 and 1996 26
Consolidated Statements of Comprehensive Income for the years ended
December 31, 1998, 1997 and 1996 27
Consolidated Statements of Stockholders' Equity for the years ended
December 31, 1998, 1997 and 1996 28
Consolidated Statements of Cash Flows for the years ended
December 31, 1998, 1997 and 1996 29
Notes to Consolidated Financial Statements 30
Quarterly Financial Data (Unaudited) 61
23
INDEPENDENT AUDITORS' REPORT
To the Board of Directors of Farmers Group, Inc.
We have audited the accompanying consolidated balance sheets of Farmers
Group, Inc. and subsidiaries (the "Company") as of December 31, 1998 and 1997,
and the related consolidated statements of income, comprehensive income,
stockholders' equity, and cash flows for each of the three years in the period
ended December 31, 1998. Our audits also included the financial statement
schedules listed in the Table of Contents 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, 1998 and 1997, and the results of its operations and its cash flows for
each of the three years in the period ended December 31, 1998 in conformity
with generally accepted accounting principles.
Our audits were conducted for the purpose of forming an opinion on the
basic financial statements taken as a whole. The financial statement
schedules listed in the Table of Contents at Item 14 are presented for the
purpose of additional analysis and are not a required part of the basic
financial statements. These schedules are the responsibility of the Company's
management. Such schedules have been subjected to the auditing procedures
applied in our audits of the basic financial statements and, in our opinion,
are fairly stated in all material respects when considered in relation to the
basic financial statements as a whole.
/s/ Deloitte & Touche LLP
DELOITTE & TOUCHE LLP
Los Angeles, California
March 11, 1999
24
FARMERS GROUP, INC.
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands)
ASSETS
December 31,
-----------------------------
1998 1997
------------- -------------
Current assets, excluding Insurance Subsidiaries:
Cash and cash equivalents $ 253,828 $ 479,935
Marketable securities, at market value 53,536 104,485
Accrued interest 32,542 43,849
Accounts receivable, principally from the P&C Group 35,271 34,804
Notes receivable - affiliate 0 137,000
Deferred taxes 27,044 28,925
Prepaid expenses and other 22,126 13,725
------------- -------------
Total current assets 424,347 842,723
------------- -------------
Investments, excluding Insurance Subsidiaries:
Fixed maturities available-for-sale, at market value
(cost: $597,262 and $482,355) 608,539 488,245
Mortgage loans on real estate 196 240
Common stocks available-for-sale, at market value
(cost: $278,107 and $322,741) 354,465 388,966
Certificates of contribution of the P&C Group 34,380 684,380
Real estate, at cost (net of accumulated depreciation:
$32,363 and $29,212) 62,820 63,512
Joint ventures, at equity 840 4,825
------------- -------------
1,061,240 1,630,168
------------- -------------
Other assets, excluding Insurance Subsidiaries:
Notes receivable - affiliate 1,057,000 270,000
Goodwill (net of accumulated amortization: $600,440
and $540,396) 1,801,315 1,861,359
Attorney-in-fact contracts (net of accumulated
amortization: $427,260 and $384,534) 1,281,783 1,324,509
Securities lending collateral 0 49,908
Other assets 258,912 297,602
------------- -------------
4,399,010 3,803,378
------------- -------------
Properties, plant and equipment, at cost: (net of
accumulated depreciation: $293,425 and $242,392) 402,061 450,880
------------- -------------
Investments of Insurance Subsidiaries:
Fixed maturities available-for-sale, at market value
(cost: $4,178,305 and $3,408,426) 4,356,066 3,555,148
Mortgage loans on real estate 52,879 89,903
Non-redeemable preferred stocks available-for-sale, at market
value (cost: $1,153 and $1,153) 1,270 1,227
Common stocks available-for-sale, at market value
(cost: $98,399 and $0) 106,095 120
Surplus note of the P&C Group 119,000 0
Policy loans 185,211 165,894
Real estate, at cost (net of accumulated depreciation:
$28,366 and $27,714) 59,047 67,214
Joint ventures, at equity 8,456 11,566
S&P 500 call options, at fair value (cost: $11,305 and $3,450) 14,817 3,299
------------- -------------
4,902,841 3,894,371
------------- -------------
Other assets of Insurance Subsidiaries:
Cash and cash equivalents 73,724 36,318
Marketable securities, at market value 0 23,731
Reinsurance premiums receivable - P&C Group 75,576 0
Accrued investment income 59,910 52,017
Deferred policy acquisition costs and value of life business
acquired 801,690 798,725
Securities lending collateral 461,801 544,580
Other assets 19,856 40,542
------------- -------------
1,492,557 1,495,913
------------- -------------
Total assets $ 12,682,056 $ 12,117,433
============= =============
The accompanying notes are an integral part of these financial statements.
25
FARMERS GROUP, INC.
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands)
LIABILITIES AND STOCKHOLDERS' EQUITY
December 31,
-----------------------------
1998 1997
------------- -------------
Current liabilities, excluding Insurance Subsidiaries:
Notes and accounts payable:
P&C Group $ 137 $ 2,547
Other 28,420 28,204
Accrued liabilities:
Profit sharing 50,404 51,067
Income taxes 69,906 82,279
Other 30,724 12,245
------------- -------------
Total current liabilities 179,591 176,342
------------- -------------
Other liabilities, excluding Insurance Subsidiaries:
Real estate mortgages payable 25 92
Non-current deferred taxes 601,047 643,910
Securities lending liability 0 49,908
Other 136,135 131,056
------------- -------------
737,207 824,966
------------- -------------
Liabilities of Insurance Subsidiaries:
Policy liabilities:
Future policy benefits 3,184,248 3,010,162
Claims 26,177 22,156
Policyholder dividends 1 0
Other policyholder funds 57,357 60,072
Provision for non-life losses and loss adjustment expenses 105,944 0
Income taxes (including deferred taxes: $164,729 and $153,006) 168,618 148,868
Unearned investment income 971 1,016
Reinsurance payable - P&C Group 163,161 0
Securities lending liability 461,801 544,580
Other liabilities 62,573 47,697
------------- -------------
4,230,851 3,834,551
------------- -------------
Total liabilities 5,147,649 4,835,859
------------- -------------
Commitments and contingencies
Company obligated mandatorily redeemable preferred
securities of subsidiary trusts holding solely junior
subordinated debentures 500,000 500,000
------------- -------------
Stockholders' Equity:
Common stock, $1 par value per share; authorized, issued
and outstanding: as of December 31, 1997 - 1,000 shares 0 1
Class A common stock, $1 par value per share; authorized,
issued and outstanding: as of December 31, 1998 - 500 shares 0.5 0
Class B common stock, $1 par value per share; authorized,
issued and outstanding: as of December 31, 1998 - 500 shares 0.5 0
Additional capital 5,212,618 5,212,618
Accumulated other comprehensive income (net of deferred taxes:
$77,897 and $61,193) 144,742 113,549
Retained earnings 1,677,046 1,455,406
------------- -------------
Total stockholders' equity 7,034,407 6,781,574
------------- -------------
Total liabilities and stockholders' equity $ 12,682,056 $ 12,117,433
============= =============
The accompanying notes are an integral part of these financial statements.
26
FARMERS GROUP, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Amounts in thousands)
Year ended December 31,
-------------------------------------
1998 1997 1996
----------- ----------- -----------
Consolidated operating revenues $ 3,031,191 $ 2,008,988 $ 2,013,152
=========== =========== ===========
Management services to property and casualty
insurance companies; and other:
Operating revenues $ 1,358,175 $ 1,324,895 $ 1,245,375
----------- ----------- -----------
Salaries and employee benefits 328,611 335,781 337,238
Buildings and equipment expenses 145,461 95,833 87,276
Amortization of AIF contracts and goodwill 102,770 102,770 102,770
General and administrative expenses 204,101 202,607 170,256
----------- ----------- -----------
Total operating expenses 780,943 736,991 697,540
Merger related expenses 21,056 0 0
----------- ----------- -----------
Total expenses 801,999 736,991 697,540
----------- ----------- -----------
Operating income 556,176 587,904 547,835
Net investment income 135,062 144,131 112,780
Net realized gains 62,428 73,403 5,079
Gain on sale of subsidiaries 0 19,019 0
Dividends on preferred securities of subsidiary trusts (42,070) (42,070) (42,070)
----------- ----------- -----------
Income before provision for taxes 711,596 782,387 623,624
Provision for income taxes 290,752 332,184 275,152
----------- ----------- -----------
Management services income 420,844 450,203 348,472
----------- ----------- -----------
Insurance Subsidiaries:
Life premiums 173,936 161,058 170,421
Non-life reinsurance premiums 1,000,104 0 0
Life policy charges 206,393 216,609 241,737
Investment income, net of expenses 307,391 293,190 317,630
Net realized gains/(losses) (14,808) 13,236 37,989
----------- ----------- -----------
Total revenues 1,673,016 684,093 767,777
----------- ----------- -----------
Non-life losses and loss adjustment expenses 655,125 0 0
Life policy benefits 133,984 124,261 155,110
Increase in liability for future life policy benefits 23,711 14,863 11,089
Interest credited to life policyholders 150,618 155,301 168,912
Amortization of deferred policy acquisition costs and
value of life business acquired 90,082 103,975 108,802
Life commissions 18,972 18,188 20,986
Non-life reinsurance commissions 319,875 0 0
General and administrative expenses 41,683 47,786 63,359
----------- ----------- -----------
Total operating expenses 1,434,050 464,374 528,258
----------- ----------- -----------
Income before provision for taxes 238,966 219,719 239,519
Provision for income taxes 82,970 76,424 80,050
----------- ----------- -----------
Insurance Subsidiaries income 155,996 143,295 159,469
----------- ----------- -----------
Consolidated net income $ 576,840 $ 593,498 $ 507,941
=========== =========== ===========
The accompanying notes are an integral part of these financial statements.
27
FARMERS GROUP, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF
COMPREHENSIVE INCOME
(Amounts in thousands)
Year ended December 31,
-------------------------------------
1998 1997 1996
----------- ----------- -----------
Consolidated net income $ 576,840 $ 593,498 $ 507,941
----------- ----------- -----------
Other comprehensive income, net of tax:
Unrealized holding gains/(losses) on securities:
Unrealized holding gains arising during the period,
net of tax of $26,193 48,738
Less: reclassification adjustment for gains
included in net income, net of tax of ($7,105) (13,195)
----------- ----------- -----------
Net unrealized holding gains/(losses) on securities,
net of tax of $19,088, $16,844 and ($23,036) 35,543 31,533 (42,649)
Change in effect of unrealized gains/(losses) on other
insurance accounts, net of tax of ($1,949),($5,432)
and $5,272 (3,619) (10,088) 9,791
Minimum pension liability adjustment, net of tax of ($435) (731) 0 0
----------- ----------- -----------
Other comprehensive income 31,193 21,445 (32,858)
----------- ----------- -----------
Comprehensive income $ 608,033 $ 614,943 $ 475,083
=========== =========== ===========
The accompanying notes are an integral part of these financial statements.
28
FARMERS GROUP, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Years ended December 31, 1998, 1997 and 1996
(Amounts in thousands)
Accumulated Other Total
Common Additional Comprehensive Retained Stockholders'
Stock Capital Income Earnings Equity
-------- ----------- --------------- ------------ ------------
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 other
comprehensive income,
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
Net income, 1997 593,498 593,498
Change in other
comprehensive income,
net of tax of $11,412 21,445 21,445
Cash dividends paid (337,200) (337,200)
-------- ----------- ------------- ------------ ------------
Balance, December 31, 1997 1 5,212,618 113,549 1,455,406 6,781,574
Net income, 1998 576,840 576,840
Unrealized holding gains
arising during the period,
net of tax of $26,193 48,738 48,738
Reclassification adjustment
for gains included in net
income, net of tax of
($7,105) (13,195) (13,195)
Change in effect of
unrealized losses on other
insurance accounts, net of
tax of ($1,949) (3,619) (3,619)
Minimum pension liability
adjustment, net of tax
of ($435) (731) (731)
Cash dividends paid (355,200) (355,200)
-------- ----------- ------------- ------------ -----------
Balance, December 31, 1998 $ 1 $ 5,212,618 $ 144,742 $ 1,677,046 $ 7,034,407
======== =========== ============= ============ ===========
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,
------------------------------------
1998 1997 1996
---------- ---------- ----------
Cash Flows from Operating Activities:
Consolidated net income $ 576,840 $ 593,498 $ 507,941
Non-cash and operating activities adjustments:
Depreciation and amortization 180,089 176,899 168,263
Amortization of deferred policy acquisition costs and
value of life business acquired 84,514 103,975 108,802
Policy acquisition costs deferred (93,047) (98,372) (129,922)
Life insurance policy liabilities 25,085 15,001 3,468
Provision for non-life losses and loss
adjustment expenses 105,944 0 0
Universal life type contracts:
Deposits received 299,007 295,747 317,742
Withdrawals (241,765) (232,728) (235,658)
Interest credited 67,585 62,247 78,112
Equity in earnings of joint ventures (4,275) (4,046) (1,332)
Gain on sales of assets (48,154) (87,760) (44,584)
Gain on sale of subsidiaries 0 (19,019) 0
Changes in assets and liabilities:
Current assets and liabilities 110,354 31,182 10,068
Non-current assets and liabilities 63,351 (153,157) (64,024)
Other, net (33,345) (23,075) (24,597)
---------- ---------- ----------
Net cash provided by operating activities 1,092,183 660,392 694,279
---------- ---------- ----------
Cash Flows from Investing Activities:
Purchases of investments available-for-sale (1,869,877) (1,685,693) (1,279,073)
Purchases of properties (37,806) (36,532) (43,546)
Purchases of notes receivable - affiliate (1,057,000) 0 0
Purchase of a surplus note of the P&C Group (119,000) 0 0
Purchase of certificates of contribution of the P&C Group 0 0 (400,000)
Proceeds from sales and maturities of investments
available-for-sale 1,032,173 1,001,351 979,701
Proceeds from sales of properties 27,329 16,778 27,822
Proceeds from redemption of certificates of contribution
of the P&C Group 650,000 0 200,000
Proceeds from redemption of notes receivable - affiliate 407,000 0 0
Proceeds from sale of subsidiaries 0 336,714 0
Mortgage loan collections 36,883 32,849 23,624
Increase in policy loans (19,317) (17,836) (22,020)
Other, net (1,481) (4,554) (24,199)
---------- ---------- ----------
Net cash used in investing activities (951,096) (356,923) (537,691)
---------- ---------- ----------
Cash Flows from Financing Activities:
Dividends paid to stockholders (355,200) (337,200) (464,900)
Annuity contracts:
Deposits received 144,793 131,651 141,046
Withdrawals (202,244) (161,150) (133,018)
Interest credited 82,930 80,280 87,160
Issuance cost of cumulative quarterly income
preferred securities 0 0 (438)
Payment of long-term notes payable (67) 0 (200,000)
Payment of real estate mortgages payable 0 (125) (116)
---------- ---------- ----------
Net cash used in financing activities (329,788) (286,544) (570,266)
---------- ---------- ----------
Increase/(decrease) in cash and cash equivalents (188,701) 16,925 (413,678)
Cash and cash equivalents - at beginning of year 516,253 499,328 913,006
---------- ---------- ----------
Cash and cash equivalents - at end of year $ 327,552 $ 516,253 $ 499,328
========== ========== ==========
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 accompanying consolidated financial statements of Farmers Group, Inc.
("FGI") and its subsidiaries (together "the Company") have been prepared in
accordance with generally accepted accounting principles ("GAAP"). All
material inter-company transactions have been eliminated. Certain amounts
applicable to prior years have been reclassified to conform with the 1998
presentation. 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 the disclosure
of contingent assets and liabilities at the date of the financial statements
as well as the reported amounts of revenues and expenses during the reporting
periods. Actual results could differ from those estimates.
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 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 ("AIF") 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 AIF, FGI, or its subsidiaries,
as applicable, provides certain management services to 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 gross 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 B.A.T's acquisition of the
Company was assigned to these 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 the Company's acquisition by B.A.T
($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, 1998, management
believes that the reported value is recoverable and the remaining life of
Goodwill is appropriate.
Prior to April 15, 1997 the Company's life insurance operations were
conducted by its three wholly owned subsidiaries. A portion of the purchase
price ($662,778,000) was assigned to the "Value of Life Business Acquired"
("VOLBA"), which represented an actuarial determination of the expected
profits from the business in force at the date of B.A.T's acquisition of the
Company. 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.
On April 15, 1997, upon receipt of regulatory approval, the Company sold
two of its life insurance subsidiaries, The Ohio State Life Insurance Company
("OSL") and Investors Guaranty Life Insurance Company ("IGL"), to Great
Southern Life Insurance Company, a subsidiary of Americo Life, Inc.. The sale
of these subsidiaries resulted in a $19,019,000 gain and was reported on the
"Gain on sale of subsidiaries" line of the income statement. In addition,
taxes
31
associated with the sale increased 1997 tax expense by $26,826,000 and were
reflected on the "Provision for income taxes" line. Both of these amounts
were reflected in the "Management services to property and casualty insurance
companies; and other" section of the Company's consolidated income statement
for the year ended December 31, 1997. The decision to sell these subsidiaries
was part of the Company's strategic plan to focus its life insurance efforts
on the growth of its remaining life insurance subsidiary, Farmers New World
Life Insurance Company ("Farmers Life"), by far its largest life insurance
company, through increased sales to the P&C Group's customer base. Farmers
Life markets 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. These products and
services are sold directly by the P&C Group's agents.
In December 1997, Farmers Reinsurance Company ("Farmers Re"), a wholly
owned property and casualty insurance subsidiary of FGI, was formed and
licensed to conduct business. In January 1998, Farmers Re entered into a
quota share reinsurance treaty with the P&C Group under which it reinsures a
percentage of the auto physical damage business written by the P&C Group.
As a result of the foregoing, references to the "Insurance Subsidiaries"
within the 1998 consolidated financial statements and the 1997 balance sheet
are to Farmers Life and Farmers Re, whereas, references to the "Insurance
Subsidiaries" within the 1997 consolidated statements of income and
comprehensive income and consolidated statement of cash flows and to the 1996
consolidated financial statements are to Farmers Life, OSL and IGL.
On December 22, 1997, a definitive agreement was reached to merge B.A.T's
Financial Services Businesses, which included the Company, with Zurich
Insurance Company ("Zurich"). In June 1998, the merger was approved by the
shareholders of B.A.T and Zurich. In September 1998, this merger was
completed and the businesses of Zurich and B.A.T's Financial Services
Businesses were transferred to Zurich Financial Services ("ZFS"), a new Swiss
company with headquarters in Zurich. As a result, each two shares of the
Company's prior outstanding stock were recapitalized into one share of Class A
Common Stock, par value $1.00 per share ("Ordinary Share"), and one share of
Class B Common Stock, par value $1.00 per share ("Income Share"). Under the
merger agreement, all Ordinary Shares became wholly owned by ZFS and all
Income Shares became wholly owned by Allied Zurich Holdings Limited, an
affiliated company created during the restructuring of B.A.T. This merger was
accounted for by ZFS as a pooling of interests and, therefore, no purchase
accounting adjustments were made to the Company's assets and liabilities.
The Company's 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 to 10 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 February 1997, the Financial Accounting Standards Board ("FASB")
released Statement of Financial Accounting Standards ("SFAS") No. 128,
"Earnings per Share". This Statement, effective for financial statements
issued for periods ending after December 15, 1997, established standards for
computing and presenting earnings per share and applies to entities with
publicly held common stock or potential common stock. The Company does not
have any publicly held common stock and, therefore, is not subject to the
requirements of this Statement.
In 1998, the Company adopted SFAS No. 129, "Disclosure of Information
about Capital Structure". This Statement, effective for financial statements
issued for periods ending after December 15, 1997, established standards for
disclosing information about an entity's capital structure.
In 1998, the Company adopted SFAS No. 130, "Reporting Comprehensive
Income". This Statement, effective for fiscal periods beginning after
December 15, 1997, established standards for reporting and displaying
comprehensive income and its components. This Statement mandated that all
items that are required to be recognized under accounting standards as
components of comprehensive income be reported in a financial statement with
the same prominence as
32
other financial statements. As a result of adopting this Statement, the
components of comprehensive income are now stated in the consolidated
statements of comprehensive income.
In 1998, the Company adopted SFAS No. 131, "Disclosures about Segments of
an Enterprise and Related Information". This Statement, effective for
financial statements of public enterprises issued for periods beginning after
December 15, 1997, established standards for reporting information about
operating segments in annual financial statements and required the reporting
of selected information about operating segments in interim financial reports
issued to shareholders. It also established standards for related disclosures
about products and services, geographic areas and major customers. This
Statement superseded SFAS No. 14, "Financial Reporting for Segments of a
Business Enterprise", and amended SFAS No. 94, "Consolidation of All Majority-
Owned Subsidiaries".
In 1998, the Company adopted SFAS No. 132, "Employers' Disclosures about
Pensions and Other Postretirement Benefits". This Statement, effective for
financial statements of public and nonpublic enterprises issued for fiscal
years beginning after December 15, 1997, standardized the disclosure
requirements relating to pension and other postretirement benefit plans. It
addressed disclosure only and, as such, did not change the requirements for
measurement or recognition of such plans. This Statement superceded the
disclosure requirements set forth in SFAS No. 87, "Employers' Accounting for
Pensions", SFAS No. 88, "Employers' Accounting for Settlements and
Curtailments of Defined Benefit Pension Plans and for Termination Benefits"
and SFAS No. 106, "Employers' Accounting for Postretirement Benefits Other
Than Pensions".
In March 1998, the American Institute of Certified Public Accountants
(AICPA) issued Statement of Position ("SOP") No. 98-1, "Accounting for the
Costs of Computer Software Developed or Obtained for Internal Use". This SOP,
effective for financial statements issued for periods beginning after December
15, 1998, applies to all nongovernmental entities and establishes the rules
for capitalizing or expensing internally developed software. The Company does
not expect the adoption of this Statement to have a material impact on its
consolidated financial statements.
In 1998, the FASB released SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities". This Statement, effective for financial
statements of public and nonpublic entities issued for fiscal years beginning
after June 15, 1999, establishes accounting and reporting standards for
derivative instruments (including certain derivative instruments embedded in
other contracts) and for hedging activities. SFAS No. 133 requires that an
entity recognize all derivatives as either assets or liabilities in the
statement of financial position and measure those instruments at market value.
This Statement amends SFAS No. 52, "Foreign Currency Translation" and SFAS No.
107, "Disclosures about Fair Value of Financial Instruments". It supersedes
SFAS No. 80, "Accounting for Futures Contracts", SFAS No. 105, "Disclosure of
Information about Financial Instruments with Off-Balance-Sheet Risk and
Financial Instruments with Concentrations of Credit Risk" and SFAS No. 119,
"Disclosure about Derivative Financial Instruments and Fair Value of Financial
Instruments". The Company does not expect the adoption of this Statement to
have a material impact on its consolidated financial statements.
In 1998, the AICPA issued SOP No. 98-5, "Reporting on the Costs of Start
Up Activities". This SOP, effective for financial statements issued for
periods beginning after December 15, 1998, addresses the recording of costs
associated with a one-time activity related to opening a new facility,
introducing a new product or service, conducting business in a new territory
or conducting business with a new class of customer. The Company does not
expect the adoption of this Statement to have a material impact on its
consolidated financial statements.
B. Life insurance accounting
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
33
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 9.00%, depending on the year of policy issue. Mortality is
calculated principally on select and ultimate tables in common usage in the
industry, modified for actual experience, and withdrawals are estimated based
primarily on 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 VOLBA also include amounts associated with the unrealized gains
and losses recorded as a component of stockholders' equity in accordance with
the application of SFAS No. 115, "Accounting for Certain Investments in Debt
and Equity Securities". Accordingly, DAC and VOLBA are increased or decreased
to reflect what would have been the impact on estimated future gross profits,
had net unrealized gains or losses on securities been realized at the balance
sheet date. Net unrealized gains or losses on securities, within
stockholders' equity, also reflect this impact. These entries decreased the
DAC and VOLBA assets by $49,015,000 and $43,447,000 as of December 31, 1998
and 1997, respectively.
C. Non-life reinsurance
Farmers Re is a wholly owned subsidiary of the Company. On January 1,
1998, Farmers Re entered into an auto physical damage reinsurance agreement
with the P&C Group. This agreement provided for monthly premiums of $83.3
million and recoveries of a quota share percentage of ultimate net losses
sustained by the P&C Group in its auto physical damage lines of business.
This agreement also provided for the P&C Group to receive a provisional ceding
commission of 20% of premiums with additional experience commissions that
depend on loss experience. This experience commission arrangement limits
Farmers Re's potential underwriting gain on the assumed business to 2.5% of
premiums assumed.
In 1998, the first accident year under the reinsurance treaty, losses
paid by Farmers Re were $543,445,000, loss adjustment expenses were
$5,736,000, reinsurance commissions were $319,875,000 and premiums assumed
were $1,000,000,000. As of December 31, 1998, Farmers Re had loss reserves
of $105,944,000.
D. Property, plant and equipment
A schedule of the Company's operating properties, plant and equipment at
cost as of December 31 follows:
1998 1997
----------- -----------
(Amounts in thousands)
Buildings and improvements $ 218,268 $ 227,406
Data processing equipment and software 291,159 283,923
Furniture and equipment 117,233 111,489
----------- -----------
626,660 622,818
Land 68,826 70,454
----------- -----------
$ 695,486 $ 693,272
=========== ===========
34
E. Merger related expenses
As a result of the merger between B.A.T's Financial Services Businesses
and Zurich in 1998, the Company recorded various merger related expenses
totaling $21,056,000, of which $16,545,000 related to losses the Company will
incur in connection with taking over the management of Zurich's United States
personal lines business. In addition, $2,728,000 related to the write-off of
redundant capitalized software and $1,783,000 related to miscellaneous audit,
legal and travel expenses incurred by the Company in connection with the
merger.
F. Certificates of contribution and surplus note of the P&C Group
On September 8, 1998, Farmers Life purchased a $119,000,000 surplus note
of the P&C Group which bears interest at 6.10% annually. In addition, the
Company has from time to time made surplus contributions to the P&C Group and,
in return, received certificates of contribution of the P&C Group which bear
interest at various rates. As of December 31, 1998, the Company held
certificates of contribution of the P&C Group totaling $34,380,000.
Conditions governing repayment of these amounts are outlined in the
certificates of contribution and the surplus note. Generally, repayment may
be made only when the surplus balance of the issuer reaches a certain
specified level, and then only after approval is granted by the issuer's
governing Board and the appropriate Department of Insurance.
On July 10, 1998, the Company received $675,647,000 from the P&C Group as
follows:
- Redemption of a $100,000,000 certificate of contribution, issued on
December 20, 1996, bearing interest at 8.95% annually.
- Redemption of a $135,000,000 certificate of contribution, issued on
September 30, 1996, bearing interest at 8.95% annually.
- Redemption of a $165,000,000 certificate of contribution, issued on
June 27, 1996, bearing interest at 8.95% annually.
- Redemption of a $250,000,000 certificate of contribution, issued in
1995, bearing interest at 8.95% annually.
- A $25,647,000 repayment of accrued interest.
G. Company Obligated Mandatorily Redeemable Preferred Securities of
Subsidiary Trusts Holding Solely Junior Subordinated 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 ("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.
35
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, 1998 and 1997, a total of 20,000,000 shares of QUIPS
were outstanding.
H. Employees' profit sharing plans
The Company has two profit sharing plans providing for cash payments to
all eligible employees. The two plans, Deferred Profit Sharing and Cash
Profit Sharing (consisting of Cash and Quest for Gold in 1998 and Cash and
Cash Plus in 1997 and 1996), 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 10% of pretax earnings, as adjusted,
or 15% of the salary or wage paid or accrued to the eligible employee,
provides for an annual contribution by the Company to a trust for eventual
payment to employees as provided in the Plan. The Cash Profit Sharing Plan
and Quest for Gold Program provide for annual cash distributions to eligible
employees. The Cash Profit Sharing Plan is limited to 5% of pretax earnings,
as adjusted, or 5% of employee salaries or wages paid or accrued. The Quest
for Gold Program is limited to 1.25% of pretax earnings, as adjusted, or 6% of
eligible employee salaries or wages paid or accrued. The Cash Plus Plan was
limited to 1.25% of pretax earnings, as adjusted.
Expense under these plans was $51,869,000, $52,235,000 and $55,772,000 in
1998, 1997 and 1996, respectively.
I. Retained earnings
Statutory capital and surplus of Farmers Life was $922,426,000 and
$817,588,000 as of December 31, 1998 and 1997, respectively. Statutory net
income for the year ended December 31, 1998 was $98,796,000, while statutory
net income for the year ended December 31, 1997 was $128,461,000, reflecting
the results of Farmers Life for the year and the results of OSL and IGL
through April 15, 1997. Combined statutory net income of the Life Insurance
Subsidiaries was $167,517,000 for the year ended December 31, 1996.
There are certain statutory limitations on the distribution of surplus.
As of December 31, 1998, $115,923,000 is available for distribution without
approval from the Washington State Department of Insurance, the state in which
Farmers Life is domiciled.
J. 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 market values and for all investments in debt
securities. As of December 31, 1998 and 1997, the Company classified all
investments in equity and debt securities as available-for-sale under SFAS No.
115 with the exception of $53.0 million in 1998 and $47.0 million in 1997
which relate to a grantor trust and are classified as trading securities under
SFAS No. 115. The available-for-sale investments are reported on the balance
sheet at market value, with unrealized gains and losses, net of tax, excluded
from earnings and reported as a component of stockholders' equity. The
investments classified as trading investments are reported on the "Other
assets" line of the consolidated balance sheet at market value with both
realized and unrealized gains and losses included in earnings, net of tax, in
the year in which they occur. Real estate investments are accounted for on a
depreciated cost basis. Real estate acquired in foreclosure and held for sale
is carried at the lower of market value or depreciated cost less a valuation
allowance. Marketable securities are carried at cost. The Standard & Poor's
500 Composite Stock Price Index
36
("S&P 500") call options are carried at estimated fair value. Other
investments, which consist primarily of certificates of contribution of the
P&C Group, a surplus note of the P&C Group, policy loans, B.A.T Capital
Corporation notes and British American Financial Services (UK and
International), Ltd. ("BAFS") notes, are carried at the unpaid principal
balances.
In compliance with a Securities and Exchange Commission ("SEC") staff
announcement, the Company has recorded certain entries to the DAC and VOLBA
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 stockholders' equity.
The sources of investment income on securities owned by the Company
(excluding the Insurance Subsidiaries) for the years ended December 31 are:
1998 1997 1996
---------- ---------- ---------
(Amounts in thousands)
Related parties:
B.A.T Capital Corporation notes $ 14,672 $ 23,620 $ 18,151
BAFS notes 19,481 0 0
---------- ---------- ----------
Total related parties 34,153 23,620 18,151
---------- ---------- ----------
Non-related parties:
Interest income-
certificates of contribution
of the P&C Group 33,417 61,131 45,448
Interest income-
fixed income securities 50,373 36,264 41,714
Dividend income 7,825 9,268 4,863
Interest income-
marketable securities 4,205 10,263 11,385
Interest expense 0 0 (8,938)
Other * 5,089 3,585 157
---------- ---------- ----------
Total non-related parties 100,909 120,511 94,629
---------- ---------- ----------
Total investment income
by component $ 135,062 $ 144,131 $ 112,780
========== ========== ==========
* Includes $3.4 million, $1.6 million and $0.7 million in 1998, 1997 and
1996, respectively, of unrealized gains associated with the trading
securities reported on the "Other assets" line of the balance sheet.
The sources of investment income on securities owned by the Insurance
Subsidiaries for the years ended December 31 are:
1998 1997 1996
---------- ---------- ----------
(Amounts in thousands)
Fixed income securities $ 279,157 $ 251,727 $ 258,828
Equity securities 249 12,863 25,299
Mortgage loans 8,789 12,205 14,721
Owned real estate 9,907 9,575 10,477
Policy loans 12,993 12,118 12,152
Marketable securities 7,302 2,552 4,097
Surplus note of the P&C Group 2,279 0 0
Investment expenses (13,658) (13,442) (13,430)
Other 373 5,592 5,486
---------- ---------- ----------
Total investment income
by component $ 307,391 $ 293,190 $ 317,630
========== ========== ==========
37
Realized gains and losses on sales, redemptions and writedowns of
investments owned by the Company (excluding the Insurance 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:
1998 1997 1996
---------- ---------- ----------
(Amounts in thousands)
Bonds $ 280 $ (12) $ 1,626
Redeemable preferred stocks 57 365 623
Common stocks 59,864 69,505 (524)
Investment real estate (34) 0 2,528
Other 2,261 3,545 826
---------- ---------- ----------
Net realized investment gains/(losses) $ 62,428 $ 73,403 $ 5,079
========== ========== ==========
Realized gains and losses on sales, redemptions and writedowns of
investments owned by the Insurance 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:
1998 1997 1996
---------- ---------- ----------
(Amounts in thousands)
Bonds $ (16,461) $ 8,619 $ 874
Redeemable preferred stocks 25 1,734 1,738
Non-redeemable preferred stocks 0 71 (2,799)
Common stocks 117 2,798 41,007
Investment real estate 1,393 3 (2,131)
Other 118 11 (700)
---------- ---------- ----------
Net realized investment gains/(losses) $ (14,808) $ 13,236 $ 37,989
========== ========== ==========
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 Company (excluding the
Insurance Subsidiaries) are as follows:
As of December 31, 1998
--------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
--------- ---------- ---------- ---------
(Amounts in thousands)
Equity Securities Available-for-Sale
Non-redeemable preferred stocks $ 0 $ 0 $ 0 $ 0
Common stocks 278,107 87,372 (11,014) 354,465
--------- ---------- ---------- ---------
Total $ 278,107 $ 87,372 $ (11,014) $ 354,465
========= ========== ========== =========
As of December 31, 1997
---------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
--------- ---------- ---------- ---------
(Amounts in thousands)
Equity Securities Available-for-Sale
Non-redeemable preferred stocks $ 0 $ 0 $ 0 $ 0
Common stocks 322,741 76,153 (9,928) 388,966
--------- ---------- ---------- ---------
Total $ 322,741 $ 76,153 $ (9,928) $ 388,966
========= ========== ========== =========
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 Insurance Subsidiaries in 1998
and 1997 are as follows:
As of December 31, 1998
---------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
--------- ---------- ---------- ---------
(Amounts in thousands)
Equity Securities Available-for-Sale
Non-redeemable preferred stocks $ 1,153 $ 165 $ (48) $ 1,270
Common stocks 98,399 9,751 (2,055) 106,095
--------- ---------- ---------- ---------
Total $ 99,552 $ 9,916 $ (2,103) $ 107,365
========= ========== ========== =========
As of December 31, 1997
---------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
--------- ---------- ---------- ---------
(Amounts in thousands)
Equity Securities Available-for-Sale
Non-redeemable preferred stocks $ 1,153 $ 111 $ (37) $ 1,227
Common stocks 0 120 0 120
--------- ---------- ----------- ---------
Total $ 1,153 $ 231 $ (37) $ 1,347
========= ========== =========== =========
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 Insurance
Subsidiaries) are as follows:
As of December 31, 1998
---------------------------------------------
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 $ 242 $ 10 $ 0 $ 252
Obligations of states and political
subdivisions 530,322 8,667 0 538,989
Corporate securities 43,474 885 0 44,359
Mortgage-backed securities 53,316 594 (71) 53,839
Other debt securities 23,444 1,192 0 24,636
--------- ---------- ----------- ---------
Total $ 650,798 $ 11,348 $ (71) $ 662,075
========= ========== =========== =========
As of December 31, 1997
----------------------------------------------
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 $ 25,000 $ 338 $ 0 $ 25,338
Obligations of states and political
subdivisions 392,962 3,578 (235) 396,305
Corporate securities 63,837 684 0 64,521
Mortgage-backed securities 67,149 541 (22) 67,668
Other debt securities 37,892 1,202 (196) 38,898
--------- --------- ----------- ---------
Total $ 586,840 $ 6,343 $ (453) $ 592,730
========= ========= =========== =========
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 Insurance Subsidiaries in 1998 and
1997 are as follows:
As of December 31, 1998
-----------------------------------------------------
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 $ 460,097 $ 44,434 $ (124) $ 504,407
Obligations of states and political
subdivisions 620,279 31,444 (149) 651,574
Debt securities issued by foreign governments 95,077 2,446 (16,144) 81,379
Corporate securities 999,412 59,625 (5,938) 1,053,099
Mortgage-backed securities 1,921,350 67,598 (10,003) 1,978,945
Other debt securities 82,090 4,747 (175) 86,662
----------- ----------- ------------ -----------
Total $ 4,178,305 $ 210,294 $ (32,533) $ 4,356,066
=========== =========== ============ ===========
As of December 31, 1997
-----------------------------------------------------
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 $ 393,538 $ 24,174 $ (104) $ 417,608
Obligations of states and political
subdivisions 294,233 13,346 (58) 307,521
Debt securities issued by foreign governments 136,127 15,686 (5,113) 146,700
Corporate securities 842,838 48,429 (1,578) 889,689
Mortgage-backed securities 1,655,679 56,243 (5,376) 1,706,546
Other debt securities 109,742 3,628 (2,555) 110,815
----------- ----------- ------------ ----------
Total $ 3,432,157 $ 161,506 $ (14,784) $3,578,879
=========== =========== ============ ==========
41
The amortized cost and estimated market value of debt securities,
including marketable securities, owned by the Company (excluding the Insurance
Subsidiaries) as of December 31, 1998, 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 $ 53,536 $ 53,536
Due after one year through five years 340,779 347,001
Due after five years through ten years 15,359 15,621
Due after ten years 164,364 167,442
----------- ----------
574,038 583,600
Mortgage-backed securities 53,316 53,839
Redeemable preferred stocks
with no stated maturities 23,444 24,636
---------- ----------
$ 650,798 $ 662,075
========== ==========
The amortized cost and estimated market value of debt securities owned by
the Insurance Subsidiaries as of December 31, 1998, 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 $ 23,445 $ 23,813
Due after one year through five years 615,476 632,423
Due after five years through ten years 785,720 819,956
Due after ten years 750,224 814,267
----------- ----------
2,174,865 2,290,459
Mortgage-backed securities 1,921,350 1,978,945
Redeemable preferred stocks
with no stated maturities 82,090 86,662
----------- ----------
$4,178,305 $4,356,066
========== ==========
Proceeds from sales of available-for-sale securities received by the
Company were $1,504,131,000, $735,192,000 and $551,122,000 in 1998, 1997 and
1996, respectively. Gross gains of $88,751,000, $100,269,000 and $76,431,000
and gross losses of $50,798,000, $21,274,000 and $32,009,000 were realized on
sales and writedowns during 1998, 1997 and 1996, respectively.
42
The change in the net unrealized gains or (losses) of the Company
(excluding the Insurance Subsidiaries) for the years ended December 31 are as
follows:
1998 1997
---------- ----------
(Amounts in thousands)
Fixed maturities $ 5,387 $ 3,535
Equity securities 10,133 8,823
The change in the net unrealized gains or (losses) of the Insurance
Subsidiaries in 1998 and 1997 are as follows:
1998 1997
---------- ----------
(Amounts in thousands)
Fixed maturities $ 31,039 $ 56,788
Equity securities 7,619 (18,462)
K. Equity-indexed annuities
During 1997, Farmers Life began selling an equity-indexed annuity product.
At the end of its seven year term, this product credits interest to the annuity
participant at a rate based on a specified portion of the change in the value
of the S&P 500, subject to a guaranteed annual minimum return. In order to
hedge the interest liability generated on the annuities as the index rises,
Farmers Life purchases call options on the S&P 500. Farmers Life considers
such S&P 500 call options to be held as a hedge. As of December 31, 1998 and
1997, Farmers Life had S&P 500 call options with contract values of $40,229,000
and $13,180,000, respectively, and carrying values of $14,817,000 and
$3,299,000, respectively.
Hedge accounting is used to account for the call options as Farmers Life
believes that the options reduce the risks associated with increases in the
account value of the annuities that result from increases in the S&P 500. The
call options effectively hedge the annuity contracts since they are both
purchased and sold with identical parameters. Periodically, the value of the
assets (S&P 500 call options) are matched to the potential liability (annuity
contracts) to ensure the hedge has remained effective. The annuities were
written based on a seven year investment term, absent early termination by
participants. Therefore, the anticipated hedged transaction (i.e., payment of
interest to the policyholder at the end of the investment term and maturity of
the call option) for each annuity is generally expected to occur in seven years
or less. The amount of unrealized hedging gains/(losses) was $3,511,000 and
($151,000) in 1998 and 1997, respectively.
The S&P 500 call options are carried at estimated fair value. Unrealized
gains and losses resulting from changes in the estimated fair value of the call
options are recorded as an adjustment to the interest credited to
policyholders. In addition, realized gains and losses from maturity or
termination of the call options are offset against the interest credited to
policyholders during the period incurred. Premiums paid on call options are
amortized to net investment income over the term of the contracts. There were
no early terminations by annuity participants, or maturities or sales of the
S&P 500 call options during 1998.
The cash requirement of the call options consists of the initial premium
paid to purchase the call options. Should a liability exist to the annuity
participant at maturity of the annuity policy, the termination or maturity of
the option contracts will generate positive cash flow to Farmers Life. The
appropriate amount of cash will then be remitted to the annuity participant
based on the respective participation rate. The call options are generally
expected to be held for a seven year term, but can be terminated at any time.
There are certain risks associated with the call options, primarily with
respect to significant movements in the United States stock market and
counterparty nonperformance. The Company believes that the counterparties to
its call option agreements are financially responsible and that the
counterparty risk associated with these transactions is minimal.
43
L. 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, 1998
---------------------------
Carrying Estimated
Value Fair Value
----------- -----------
(Amounts in thousands)
Assets and liabilities excluding Insurance
Subsidiaries:
Assets:
Cash and cash equivalents $ 253,828 $ 253,828
Marketable securities 53,536 53,536
Fixed maturities available-for-sale 608,539 608,539
Common stocks available-for-sale 354,465 354,465
Mortgage loans 196 214
Certificates of contribution of the P&C Group 34,380 34,380
Notes receivable - affiliate 1,057,000 1,087,259
Grantor trust 53,016 53,016
Other assets 20,695 15,148
Liabilities:
Real estate mortgages payable 25 27
Company obligated mandatorily redeemable
preferred securities of subsidiary trusts
holding solely junior subordinated debentures 500,000 513,608
Insurance Subsidiaries:
Assets:
Cash and cash equivalents 73,724 73,724
Fixed maturities available-for-sale 4,356,066 4,356,066
Non-redeemable preferred stocks
available-for-sale 1,270 1,270
Common stocks available-for-sale 106,095 106,095
Mortgage loans 52,879 67,615
Surplus note of the P&C Group 119,000 119,000
Policy loans 185,211 192,620
Joint ventures, at equity 8,456 6,668
S&P 500 call options 14,817 14,817
Liabilities:
Future policy benefits - deferred annuities 1,492,032 1,433,494
44
December 31, 1997
---------------------------
Carrying Estimated
Value Fair Value
----------- -----------
(Amounts in thousands)
Assets and liabilities excluding Insurance
Subsidiaries:
Assets:
Cash and cash equivalents $ 479,935 $ 479,935
Marketable securities 104,485 104,485
Fixed maturities available-for-sale 488,245 488,245
Common stocks available-for-sale 388,966 388,966
Mortgage loans 240 256
Certificates of contribution of the P&C Group 684,380 684,380
Notes receivable - affiliate 407,000 404,256
Grantor trust 46,969 46,969
Joint ventures, at equity 4,825 6,897
Other assets 20,746 17,219
Liabilities:
Real estate mortgages payable 92 96
Company obligated mandatorily redeemable
preferred securities of subsidiary trusts
holding solely junior subordinated debentures 500,000 518,332
Insurance Subsidiaries:
Assets:
Cash and cash equivalents 36,318 36,318
Marketable securities 23,731 23,731
Fixed maturities available-for-sale 3,555,148 3,555,148
Non-redeemable preferred stocks
available-for-sale 1,227 1,227
Common stocks available-for-sale 120 120
Mortgage loans 89,903 105,235
Policy loans 165,894 172,115
Joint ventures, at equity 11,566 10,037
S&P 500 call options 3,299 3,299
Liabilities:
Future policy benefits - deferred annuities 1,473,578 1,403,455
45
The following methods and assumptions were used to estimate the fair value
of financial instruments as of December 31, 1998 and 1997:
Cash and cash equivalents and 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.
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.
Certificates of contribution and surplus note of the P&C Group. The
carrying amounts of these items 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.
Grantor trust. The carrying amount is a reasonable estimate of its fair
value.
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.
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.
S&P 500 call options. S&P 500 call options are purchased as hedges
against the interest liabilities generated on the equity-indexed annuity
products. These call options are carried at an estimated fair value based on
stock price, strike price, time to expiration, interest rates, dividends and
volatility per the methodology of the Black-Scholes Option Pricing Formula.
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.
Company obligated mandatorily 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
M. Value of Life Business Acquired
The changes in the Value of Life Business Acquired were as follows:
1998 1997 1996
---------- ---------- ----------
(Amounts in thousands)
Balance, beginning of year $ 359,146 $ 443,318 $ 473,398
Amortization related to operations (53,598) (60,134) (69,894)
Interest accrued 29,701 36,207 41,714
Amortization related to net
unrealized losses (807) (1,700) (1,900)
Sale of OSL and IGL 0 (58,545) 0
---------- ---------- ----------
Balance, end of year $ 334,442 $ 359,146 $ 443,318
========== ========== ==========
Based on current conditions and assumptions as to future events, Farmers
Life expects to amortize the December 31, 1998 balance as follows:
approximately 3.5% in 1999, 3.7% in 2000, 3.9% in 2001, 4.2% in 2002 and 4.3%
in 2003. The discount rate used to determine the amortization rate of the
VOLBA ranged from 12.5% to 7.5%.
N. Mortgage loans
The Company follows the principles of SFAS No. 118, "Accounting by
Creditors for Impairment of a Loan" (which amends SFAS No. 114). 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:
1998 1997
---------- ----------
(Amounts in thousands)
Total recorded investment in impaired mortgage
loans and for which an allowance for
credit losses exists $ 1,567 $ 5,819
Total allowance for credit losses
related to impaired mortgage loans 437 1,409
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:
1998 1997
---------- ---------
(Amounts in thousands)
Average recorded investment in impaired
loans during the period $ 1,570 $ 5,860
Interest income recognized on the
impaired mortgage loans during the period 131 230
47
The activity in the total allowance for credit losses related to impaired
mortgage loans follows:
1998 1997
--------- ----------
(Amounts in thousands)
Beginning balance $ 1,409 $ 1,394
Additions/(deductions) charged to operations (972) 15
Direct writedowns charged against the allowance 0 0
--------- ---------
Ending balance $ 437 $ 1,409
========= =========
O. Security lending arrangements
The Company has security lending agreements with a financial institution.
The agreements in effect as of December 31, 1998 authorize the institution to
lend securities held in the Company's portfolio to a list of authorized
borrowers. Concurrent with delivery of the securities, the borrower provides
the Company 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 arrangements was allocated 60% to the Company
and 40% to the institution. Income earned by the Company was $968,000,
$856,000 and $422,000 in 1998, 1997 and 1996, respectively. The collateral
under these agreements as of December 31, 1998 and 1997 was $461,801,000 and
$594,488,000, respectively.
P. 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 P&C Group 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 and the P&C Group.
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.
Assets of the Regular Plan are held by an independent trustee. 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.
48
Information regarding the Regular Plan's and the Restoration Plan's funded
status is not developed separately for the Company and the P&C Group. The
funded status of the Plans for the Company and the P&C Group as of December 1,
1998 and 1997 (the latest date for which information is available) was as
follows:
1998 1997
---------- ----------
(Amounts in thousands)
Change in Benefit Obligation
Net benefit obligation at beginning of the year $ 747,069 $ 695,346
Service cost 26,423 26,229
Interest cost 54,998 51,890
Plan participants' contributions 0 0
Plan amendments 0 7,722
Actuarial (gain)/loss 54,218 (5,213)
Benefits paid (29,534) (28,905)
---------- ----------
$ 853,174 $ 747,069
========== ==========
Change in Plan Assets
Fair value of plan assets at beginning of the year $ 817,552 $ 744,340
Actual return on plan assets 135,313 101,303
Employer contributions 0 0
Plan participants' contributions 0 0
Benefits paid (28,564) (28,091)
---------- ----------
Fair value of plan assets at end of the year $ 924,301 $ 817,552
========== ==========
Funded status at end of the year $ 71,127 $ 70,483
Unrecognized net actuarial (gain)/loss (140,910) (136,691)
Unrecognized prior service cost 31,255 34,555
Unrecognized net transition obligation/(asset) (26,186) (30,862)
---------- ----------
Net amount recognized at end of the year $ (64,714) $ (62,515)
========== ==========
Amounts recognized in the statement of
financial position consist of:
Prepaid benefit cost $ 0 $ 0
Accrued benefit cost (64,714) (62,515)
Additional minimum liability (7,263) (3,685)
Intangible asset 6,097 3,685
Accumulated other comprehensive income 1,166 0
---------- ----------
Net amount recoginized at end of the year $ (64,714) $ (62,515)
========== ==========
Upon B.A.T's 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, 1998 and
1997 was $20,622,000 and $24,304,000, respectively.
49
Components of net periodic pension expense for the Company follow:
1998 1997 1996
---------- ---------- ----------
(Amounts in thousands)
Service costs $ 13,240 $ 14,238 $ 15,275
Interest costs 27,810 28,362 27,409
Return on plan assets (35,817) (35,116) (35,671)
Amortization of:
Transition obligation 1,365 1,229 1,264
Prior service cost 1,986 2,298 1,359
Actuarial (gain)/loss (2,447) (1,248) (624)
---------- ---------- ----------
Net periodic pension expense $ 6,137 $ 9,763 $ 9,012
========== ========== ==========
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 a
weighted average interest rate of 6.75% in 1998 and 7.25% in 1997 and 1996,
while the expected return on plan assets was computed using a weighted average
interest rate of 9.25% in 1998 and 9.00% in 1997 and 1996. The weighted
average rate of increase in future compensation levels used in determining the
actuarial present value of the projected benefit obligation was 4.50% in 1998
and 5.00% in 1997 and 1996.
The Company's postretirement benefits plan is a contributory defined
benefit plan for employees who were retired or who were eligible for early
retirement as of January 1, 1995, and is a contributory defined dollar plan for
all other employees retiring after January 1, 1995. Health benefits are
provided for all employees who participated in the Company's and the P&C
Group's 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 insurance coverage for 15 years prior to
retirement at age 55 or later.
There are no assets separated and allocated to this plan.
50
The funded status of the entire plan, which includes the Company and the
P&C Group, as of December 1, 1998 and 1997 (the latest date for which
information is available), was as follows:
1998 1997
---------- ----------
(Amounts in thousands)
Change in Benefit Obligation
Net benefit obligation at beginning of the year $ 70,758 $ 75,142
Service cost 1,280 1,395
Interest cost 5,080 5,402
Plan participants' contributions 1,297 1,216
Plan amendments 0 0
Actuarial (gain)/loss 6,936 (8,205)
Benefits paid (4,984) (4,192)
---------- ----------
$ 80,367 $ 70,758
========== ==========
Change in Plan Assets
Fair value of plan assets at beginning of the year $ 0 $ 0
Actual return on plan assets 0 0
Employer contributions 0 0
Plan participants' contributions 0 0
Benefits paid 0 0
---------- ----------
Fair value of plan assets at end of the year $ 0 $ 0
========== ==========
Funded status at end of the year $ (80,367) $ (70,758)
Unrecognized net actuarial (gain)/loss (8,193) (15,976)
Unrecognized prior service cost 0 0
Unrecognized net transition obligation/(asset) 18,354 19,665
---------- ----------
Net amount recognized at end of the year $ (70,206) $ (67,069)
========== ==========
Amounts recognized in the statement of
financial position consist of:
Prepaid benefit cost $ 0 $ 0
Accrued benefit cost (70,206) (67,069)
Additional minimum liability 0 0
Intangible asset 0 0
Accumulated other comprehensive income 0 0
---------- ----------
Net amount recognized at end of the year $ (70,206) $ (67,069)
========== ==========
51
The Company's share of the accrued postretirement benefit cost was
approximately $53,206,000 in 1998 and $51,930,000 in 1997. The unrecognized
net transition obligation of $18,354,000 in 1998 and $19,665,000 in 1997
represents the remaining transition obligation of the P&C Group.
Components of postretirement benefits expense for the Company follow:
1998 1997 1996
---------- ---------- ----------
(Amounts in thousands)
Service costs $ 636 $ 753 $ 1,016
Interest costs 2,527 2,918 3,018
Return on plan assets 0 0 0
Amortization of:
Transition obligation 0 0 0
Prior service cost 0 0 0
Actuarial (gain)/loss (435) (13) 0
---------- ---------- ----------
Net periodic expense $ 2,728 $ 3,658 $ 4,034
========== ========== ==========
The weighted average interest rate used in the above benefit computations
was 6.75% in 1998 and 7.25% in 1997 and 1996. Beginning in 1996, the initial
medical inflation rate was 7.50%, to be graded over a 3-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 weighted
average rate of increase in future compensation levels used in determining the
actuarial present value of the accumulated benefit obligation was 4.50% in 1998
and 5.00% in 1997 and 1996.
A 1.00% increase or decrease in the medical inflation rate assumption
would have resulted in the following:
1% increase 1% decrease
------------- -------------
(Amounts in thousands)
Effect on 1998 service and interest components
of net periodic cost $ 64 $ (59)
Effect on accumulated postretirement benefit
obligation at December 31, 1998 772 (710)
52
Q. Commitments and contingencies
Rental expense incurred by the Company was $22,332,000, $20,322,000 and
$20,121,000 in 1998, 1997 and 1996, 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, 1998, the remaining commitments payable over the next five years
under these leases were:
Equipment Buildings
----------- -----------
(Amounts in thousands)
1999 $ 16,148 $ 1,336
2000 7,077 796
2001 3,332 648
2002 87 518
2003 15 132
----------- -----------
$ 26,659 $ 3,430
=========== ===========
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.
The Company has entered into employment agreements with certain
executives of the Company. Each agreement obligates the Company to compensate
the executive should the executive's employment be terminated due to a
qualifying event, as defined within the agreement. In the opinion of
management, any payments made as a result of these agreements would not have a
material adverse effect on the Company's consolidated results of operations or
financial position.
R. 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. On April 15, 1997, OSL and IGL were sold pursuant to Internal
Revenue Code 338(h)(10). Federal and state taxes incurred as a result of
this transaction amounted to $26,826,000.
53
The components of the provision for income taxes are:
1998 1997 1996
---------- ---------- ----------
(Amounts in thousands)
Management services to the P&C
Group; and other:
Current
Federal $ 302,669 $ 317,396 $ 240,918
State 38,271 42,601 63,963
Deferred
Federal (46,701) (25,286) (27,959)
State (3,487) (2,527) (1,770)
----------- ---------- ----------
Total 290,752 332,184 275,152
----------- ---------- ----------
Insurance Subsidiaries:
Current
Federal 83,981 80,119 101,712
State 1,089 1,704 869
Deferred
Federal (2,100) (5,399) (22,531)
State 0 0 0
----------- ---------- ----------
Total 82,970 76,424 80,050
----------- ---------- ----------
Consolidated total $ 373,722 $ 408,608 $ 355,202
=========== ========== ==========
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:
1998 1997 1996
----------- ---------- ----------
(Amounts in thousands)
Management services to the P&C
Group; and other:
Expected tax expense $ 249,059 $ 273,836 $ 218,268
State income taxes, net of
federal income tax benefits 22,059 21,152 40,100
Tax exempt investment income (11,086) (8,490) (8,571)
Tax-effect of gain on sale of
OSL and IGL in excess of U.S.
statutory rate 0 20,169 0
Goodwill 21,015 21,015 21,015
Other, net 9,705 4,502 4,340
----------- ---------- ----------
Reported income tax expense 290,752 332,184 275,152
----------- ---------- ----------
Insurance Subsidiaries:
Expected tax expense 83,637 76,902 83,832
Tax exempt investment income (3,013) (2,337) (3,843)
State taxes 362 1,704 869
Other, net 1,984 155 (808)
----------- ----------- ----------
Reported income tax expense 82,970 76,424 80,050
----------- ----------- ----------
Consolidated income tax expense $ 373,722 $ 408,608 $ 355,202
=========== =========== ==========
54
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, 1998 and 1997 are presented in the following tables:
As of December 31, 1998
-----------------------------------------------
Current Non-current Total
------------ ------------- ------------
(Amounts in thousands)
Management services to the P&C
Group; and other:
Depreciation $ 0 $ (68,069) $ (68,069)
Achievement awards 693 0 693
Employee benefits 5,381 12,982 18,363
Capitalized expenditures 0 (50,441) (50,441)
California franchise tax 23,779 0 23,779
Postretirement benefits 0 22,416 22,416
Postemployment benefits 0 161 161
Valuation of investments
in securities (3,947) (25,439) (29,386)
Attorney-in-fact contracts 0 (483,232) (483,232)
Other 1,138 (9,425) (8,287)
----------- ------------ ------------
Total deferred tax
asset/(liability) 27,044 (601,047) (574,003)
----------- ------------ ------------
Insurance Subsidiaries:
Deferred policy acquisition
costs and value of life
business acquired (251,626) (251,626)
Future policy benefits 135,215 135,215
Investments 10,842 10,842
Valuation of investments
in securities (47,659) (47,659)
Depreciable assets (5,520) (5,520)
Loss reserves 2,596 2,596
Other (8,577) (8,577)
----------- ---------- ----------
Total deferred tax liability (164,729) (164,729)
----------- ---------- ----------
Consolidated total deferred tax
asset/(liability) $ 27,044 $ (765,776) $ (738,732)
=========== ========== ==========
As of December 31, 1997
----------------------------------------------
Current Non-current Total
---------- ----------- -----------
(Amounts in thousands)
Management services to the P&C
Group; and other:
Depreciation $ 0 $ (72,028) $ (72,028)
Achievement awards 1,269 0 1,269
Employee benefits 5,368 4,481 9,849
Capitalized expenditures 0 (77,718) (77,718)
California franchise tax 20,973 0 20,973
Postretirement benefits 0 28,678 28,678
Postemployment benefits 0 165 165
Valuation of investments
in securities (254) (21,284) (21,538)
Attorney-in-fact contracts 0 (499,340) (499,340)
Other 1,569 (6,864) (5,295)
---------- ----------- -----------
Total deferred tax
asset/(liability) 28,925 (643,910) (614,985)
---------- ----------- -----------
Insurance Subsidiaries:
Deferred policy acquisition
costs and value of life
business acquired (243,270) (243,270)
Future policy benefits 145,733 145,733
Investments 5,323 5,323
Valuation of investments
in securities (43,320) (43,320)
Depreciable assets (6,425) (6,425)
Other (11,047) (11,047)
----------- ----------- ----------
Total deferred tax liability (153,006) (153,006)
----------- ----------- -----------
Consolidated total deferred tax
asset/(liability) $ 28,925 $ (796,916) $ (767,991)
=========== =========== ===========
55
S. Management fees
As AIF, the Company, or its subsidiaries, as applicable, manages the
affairs of the P&C Group and receives management fees for the services
rendered. As a result, the Company received management fees from the P&C
Group of $1,271,763,000, $1,241,153,000 and $1,167,704,000 in 1998, 1997 and
1996, respectively.
T. Related parties
Certain directors of the Company are partners in legal firms that
received fees for legal services from the Company and the P&C Group. These
fees totaled $6,544,000, $5,208,000 and $1,853,000 in 1998, 1997 and 1996,
respectively.
On September 3, 1998, the Company received $423,734,000 from B.A.T
Capital Corporation, a subsidiary of B.A.T, in settlement of $407,000,000 of
notes receivable and $16,734,000 of accrued interest. These notes were fixed
rate medium-term notes with maturity dates as follows: $137,000,000 in
October 1998, $135,000,000 in October 1999 and $135,000,000 in October 2000.
Interest on these notes was paid semi-annually at coupon rates of 5.35%, 6.68%
and 6.33%, respectively. On October 7, 1997, a four year $135,000,000 note
with an interest rate of 5.10% matured and the $135,000,000 note that would
have matured in October 2000 was subsequently issued at an interest rate of
6.33%. Income earned on the notes for the years ended December 31, 1998 and
December 31, 1997 was $16,734,000 and $23,620,000, respectively.
In addition, on September 3, 1998, the Company, using $407,000,000 of
proceeds from the B.A.T notes redemption and $650,000,000 of proceeds from
the redemption of the certificates of contribution of the P&C Group
(see Note F), issued $1,057,000,000 of notes receivable to BAFS. These
notes are fixed rate medium-term notes with maturity dates as follows:
$200,000,000 in September 2000, $207,000,000 in September 2001, $200,000,000
in September 2002, $200,000,000 in September 2003 and $250,000,000 in
September 2004. Interest on these notes is paid semi-annually at coupon
rates of 5.44%, 5.48%, 5.67%, 5.71% and 5.78%, respectively. Income earned
on these notes through December 31, 1998 was $19,481,000.
U. 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.
Excluding
Insurance Insurance
Subsidiaries Subsidiaries Consolidated
------------ ------------ ------------
(Amounts in thousands)
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
1997 Activity 16,925
----------
Cash and cash equivalents --December 31, 1997 479,935 36,318 516,253
1998 Activity (188,701)
----------
Cash and cash equivalents --December 31, 1998 253,828 73,724 $ 327,552
==========
Cash payments for interest were $2,671,000, $2,247,000 and $17,305,000
in 1998, 1997 and 1996, respectively, while cash payments for dividends to
the holders of the Company's QUIPS were $42,070,000 in 1998, 1997 and 1996.
Cash payments for income taxes were $423,803,000, $430,588,000 and
$379,455,000 in 1998, 1997 and 1996, respectively.
56
In 1998, the Company used $650,000,000 of proceeds it received from the
redemption of the certificates of contribution of the P&C Group (see Note F)
and $407,000,000 of proceeds it received from the settlement of the B.A.T
Capital Corporation notes receivable (see Note T), to issue $1,057,000,000
of notes receivable to BAFS (see Note T), a subsidiary of ZFS. In addition,
Farmers Life purchased a $119,000,000 surplus note of the P&C Group on
September 8, 1998 (see Note F).
In 1997, net cash proceeds from the sale of OSL and IGL amounted to
$336,714,000 and were in consideration primarily for the following:
Investments $ 823,666,000
Deferred policy acquisition costs and Value of Life
Business Acquired 181,196,000
Life insurance policy liabilities (690,426,000)
In July 1996, the Company used $200,000,000 of proceeds it received
from the P&C Group in connection with the redemption of $200,000,000 of
certificates of contribution of the P&C Group, made in 1986, to extinguish
$200,000,000 of 8.25% Notes Payable the Company issued in July 1986.
As a result of the adoption of SFAS No. 115, Farmers Life decreased the
DAC asset and increased the VOLBA asset to account for the impact on
estimated future gross profits of the net unrealized gains or losses on
securities.
V. Revolving credit agreement
As of December 31, 1998 and 1997, the Company had a revolving credit
agreement 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 P&C Group.
As of December 31, 1998 and 1997, facility fees were payable on the aggregate
borrowing facility in the amount of 7 basis points per annum and were
reimbursable to the Company by the P&C Group. 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 one percentage point,
the federal funds effective rate plus 1/2 of one percentage point or the
London Interbank Offered Rate plus certain percentages. As of December 31,
1998 and 1997, the Company did not have any outstanding borrowings under the
revolving credit agreement. Facility fees were $350,000, $399,000 and
$592,000 for the years ended December 31, 1998, 1997 and 1996, respectively,
and were reimbursed by the P&C Group. The revolving credit agreement in
effect as of December 31, 1998 expires on July 1, 2002.
W. Participating policies
Participating business, which consists of group business, comprised
approximately 8.6% of Farmers Life's total insurance in-force as of December
31, 1998 and 8.8% of its total insurance in-force as of December 31, 1997.
In addition, participating business represented 2.1% and 2.2% of Farmers
Life's premium income for the years ended December 31, 1998 and December
31, 1997 and 2.2% of the Life Insurance Subsidiaries' premium income for the
year ended December 31, 1996.
The amount of dividends paid on participating business is determined by
the Farmers Life 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.
57
X. Life reinsurance
In 1997, Farmers Life raised the retention limit for automatic
reinsurance ceded. The primary change was to set the maximum retention on
new issues at $2,000,000 per life for the Farmers Flexible Universal Life
policy; $1,500,000 per life for all Traditional policies except Farmers
Yearly Renewable Term; and $800,000 per life for Farmers Yearly Renewable
Term. The excess is reinsured with a third party reinsurer and is not
material. Premiums ceded under these agreements totaled $3,728,000 in 1998
and $4,236,000 in 1997. Life reinsurance receivables, which totaled
$8,453,000 and $8,627,000 for Farmers Life at December 31, 1998 and 1997,
respectively, were included in "Other assets" of the Insurance Subsidiaries.
Y. Current liabilities accrued, other
Current liabilities accrued, other consisted of the following:
As of December 31,
------------------------------
1998 1997
------------ ------------
(Amounts in thousands)
Accrued employee bonuses $ 9,403 $ 9,390
Accrued restructuring costs (see Note E) 16,545 0
Other 4,776 2,855
----------- ------------
$ 30,724 $ 12,245
=========== ============
Z. Operating segments
The Company's principal activities are the provision of management
services to the P&C Group and the ownership and operation of the life and
reinsurance subsidiaries. These activities are managed separately as each
offers a unique set of services. As a result, the Company is comprised of
the following three reportable operating segments as defined in SFAS No.
131: the management services segment, the life insurance segment and the
reinsurance segment.
As the Company is the exclusive AIF of the P&C Group, the management
services segment is primarily responsible for providing management services
to the P&C Group. Management fees earned from the P&C Group totaled
$1,271,763,000, $1,241,153,000 and $1,167,704,000 for the years ended 1998,
1997 and 1996, respectively. The life insurance segment provides individual
life insurance products, including universal life, term life and whole life
insurance and annuity products. Finally, the reinsurance segment provides
reinsurance coverage to a percentage of the auto physical damage business
written by the P&C Group.
The basis of accounting used by the Company's management in evaluating
segment performance and determining how resources should be allocated is
referred to as the Company's GAAP historical basis, which excludes the
effects of the purchase accounting ("PGAAP") adjustments related to the
acquisition of the Company by B.A.T in December 1988 (see Note A).
This differs from the basis used in preparing the Company's financial
statements included in the SEC Form 10-K and 10-Q Reports, which
incorporates the effects of the PGAAP adjustments.
The Company accounts for intersegment transactions as if they were to
third parties and, as such, records the transactions at current market
prices. There were no intersegment revenues among the Company's three
reportable operating segments for the years ended 1998, 1997 or 1996.
The Company operates in 31 states and does not earn revenues or hold
assets in any foreign countries.
58
Information regarding the Company's reportable operating segments follows:
Year ended December 31, 1998
---------------------------------------------------------------------------------------------------------
GAAP historical basis PGAAP adjustments Consolidated
------------------------------------------------------ -------------------------------------
Management Life Management Life PGAAP
services insurance Reinsurance Total services insurance Total basis
------------------------------------------------------ ------------------------------------- -----------
(Amounts in thousands)
Revenues $1,358,175 $ 660,419 (a) $1,012,390 (a) $3,030,984 $ 0 $ 207 $ 207 $ 3,031,191
Investment
income 136,024 307,221 13,621 456,866 (962) 207 (755) 456,111
Investment
expenses 0 (13,658) 0 (13,658) 0 0 0 (13,658)
Net realized
gains/(losses) 64,430 (13,473) (1,335) 49,622 (2,002) 0 (2,002) 47,620
Dividends
on preferred
securities of
subsidiary
trusts (42,070) 0 0 (42,070) 0 0 0 (42,070)
Income before
provision for
taxes 821,885 (b) 199,609 37,178 1,058,672 (110,289)(c) 2,179 (108,110) 950,562
Provision for
income taxes 309,992 71,072 11,784 392,848 (19,240) 114 (19,126) 373,722
Assets 3,089,150 5,437,577 793,436 9,320,163 3,183,651 (d) 178,242 (e) 3,361,893 12,682,056
Capital
expenditures 59,300 572 0 59,872 0 0 0 59,872
Depreciation &
amortization 71,658 89,334 (f) 0 160,992 104,891 (c) (1,280)(g) 103,611 264,603
- -----------------------
(a) Revenues for the insurance operating segments include net investment
income and net realized gains/(losses).
(b) Amount includes $35.1 million of corporate expenses.
(c) Amount includes PGAAP adjustments associated with the amortization of
the AIF contracts ($42.7 million) and goodwill ($60.0 million).
(d) Amount includes PGAAP adjustments associated with the AIF contracts
($1,281.8 million) and goodwill ($1,801.3 million).
(e) Amount includes PGAAP adjustments related to the DAC (($168.3) million)
and VOLBA ($334.4 million) assets.
(f) Amount includes the historical basis amortization associated with the
DAC asset.
(g) Amount includes PGAAP adjustments related to the amortization of the DAC
(($26.2) million) and VOLBA ($23.9 million) assets.
59
Year ended December 31, 1997
---------------------------------------------------------------------------------------------------------
GAAP historical basis PGAAP adjustments Consolidated
------------------------------------------------------ -------------------------------------
Management Life Management Life PGAAP
services insurance Reinsurance Total services insurance Total basis
------------------------------------------------------ ------------------------------------- -----------
(Amounts in thousands)
Revenues $1,324,895 $ 683,330 (a) $ 47 (a) $2,008,272 $ 0 $ 716 $ 716 $ 2,008,988
Investment
income 144,525 305,869 47 450,441 (394) 716 322 450,763
Investment
expenses 0 (13,442) 0 (13,442) 0 0 0 (13,442)
Net realized
gains 73,403 13,236 0 86,639 0 0 0 86,639
Gain on sale
of subsidiaries 12,044 0 0 12,044 6,975 0 6,975 19,019
Dividends
on preferred
securities of
subsidiary
trusts (42,070) 0 0 (42,070) 0 0 0 (42,070)
Income before
provision for
taxes 883,234 (b) 223,156 9 1,106,399 (100,847)(c) (3,446) (104,293) 1,002,106
Provision for
income taxes 350,557 78,266 3 428,826 (18,373) (1,845) (20,218) 408,608
Assets 3,418,785 5,177,311 50,115 8,646,211 3,293,963 (d) 177,259 (e) 3,471,222 12,117,433
Capital
expenditures 64,534 1,696 0 66,230 0 0 0 66,230
Depreciation &
amortization 68,916 102,958 (f) 0 171,874 104,437 (c) 4,563 (g) 109,000 280,874
- -----------------------
(a) Revenues for the insurance operating segments include net investment
income and net realized gains/(losses).
(b) Amount includes $35.1 million of corporate expenses.
(c) Amount includes PGAAP adjustments associated with the amortization of the
AIF contracts ($42.7 million) and goodwill ($60.0 million).
(d) Amount includes PGAAP adjustments associated with the AIF contracts
($1,324.5 million) and goodwill ($1,861.4 million).
(e) Amount includes PGAAP adjustments related to the DAC (($195.2) million)
and VOLBA ($359.1 million) assets.
(f) Amount includes the historical basis amortization associated with the
DAC asset.
(g) Amount includes PGAAP adjustments related to the amortization of the DAC
(($20.2) million) and VOLBA ($23.9 million) assets.
60
Year ended December 31, 1996
---------------------------------------------------------------------------------------------------------
GAAP historical basis PGAAP adjustments Consolidated
----------------------------------------------------- -------------------------------------
Management Life Management Life PGAAP
services insurance Reinsurance Total services insurance Total basis
----------------------------------------------------- ------------------------------------- -----------
(Amounts in thousands)
Revenues $1,245,375 $ 767,767 (a) $ 0 $2,013,142 $ 0 $ 10 $ 10 $ 2,013,152
Investment
income 123,087 331,050 0 454,137 (1,369) 10 (1,359) 452,778
Investment
expenses (8,938) (13,430) 0 (22,368) 0 0 0 (22,368)
Net realized
gains 5,079 37,989 0 43,068 0 0 0 43,068
Dividends
on preferred
securities of
subsidiary
trusts (42,070) 0 0 (42,070) 0 0 0 (42,070)
Income before
provision for
taxes 732,880 (b) 243,068 0 975,948 (109,256)(c) (3,549) (112,805) 863,143
Provision for
income taxes 294,245 96,234 0 390,479 (19,093) (16,184) (35,277) 355,202
Assets 2,967,434 6,356,131 0 9,323,565 3,396,894 (d) 208,368 (e) 3,605,262 12,928,827
Capital
expenditures 75,679 132 0 75,811 0 0 0 75,811
Depreciation &
amortization 59,476 108,815 (f) 0 168,291 105,005 (c) 3,769 (g) 108,774 277,065
- -----------------------
(a) Revenues for the insurance operating segments include net investment
income and net realized gains/(losses).
(b) Amount includes $34.0 million of corporate expenses.
(c) Amount includes PGAAP adjustments associated with the amortization of the
AIF contracts ($42.7 million) and goodwill ($60.0 million).
(d) Amount includes PGAAP adjustments associated with the AIF contracts
($1,367.2 million) and goodwill ($1,921.4 million).
(e) Amount includes PGAAP adjustments related to the DAC (($250.7) million)
and VOLBA ($443.3 million) assets.
(f) Amount includes the historical basis amortization associated with
the DAC asset.
(g) Amount includes PGAAP adjustments related to the amortization of the DAC
(($25.2) million) and VOLBA ($28.1 million) assets.
61
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)
1998
- ------
Revenues:
Management services $ 335,539 $ 336,373 $ 343,904 $ 342,359 $ 1,358,175
Insurance Subsidiaries 417,609 422,838 430,450 402,119 1,673,016
----------- ----------- ----------- ----------- ------------
Consolidated 753,148 759,211 774,354 744,478 3,031,191
----------- ----------- ----------- ----------- ------------
Income before provision for
income taxes:
Management services 190,985 185,975 110,259 224,377 711,596
Insurance Subsidiaries 64,205 64,710 68,617 41,434 238,966
----------- ----------- ----------- ----------- ------------
Consolidated 255,190 250,685 178,876 265,811 950,562
----------- ----------- ----------- ----------- ------------
Provision for income taxes:
Management services 76,826 74,300 47,329 92,297 290,752
Insurance Subsidiaries 23,652 22,585 23,965 12,768 82,970
----------- ----------- ----------- ----------- ------------
Consolidated 100,478 96,885 71,294 105,065 373,722
----------- ----------- ----------- ----------- ------------
Consolidated net income $ 154,712 $ 153,800 $ 107,582 $ 160,746 $ 576,840
=========== =========== =========== =========== ============
1997
- ------
Revenues:
Management services $ 320,852 $ 328,686 $ 331,569 $ 343,788 $ 1,324,895
Insurance Subsidiaries 194,094 166,678 162,453 160,868 684,093
----------- ----------- ----------- ----------- ------------
Consolidated 514,946 495,364 494,022 504,656 2,008,988
----------- ----------- ----------- ----------- ------------
Income before provision for
income taxes:
Management services 194,635 197,906 190,058 199,788 782,387
Insurance Subsidiaries 55,359 54,835 57,384 52,141 219,719
----------- ----------- ----------- ----------- ------------
Consolidated 249,994 252,741 247,442 251,929 1,002,106
----------- ----------- ----------- ----------- ------------
Provision for income taxes:
Management services 96,692 79,282 76,861 79,349 332,184
Insurance Subsidiaries 18,265 18,346 19,475 20,338 76,424
----------- ----------- ----------- ----------- ------------
Consolidated 114,957 97,628 96,336 99,687 408,608
----------- ----------- ----------- ----------- ------------
Consolidated net income $ 135,037 $ 155,113 $ 151,106 $ 152,242 $ 593,498
=========== =========== =========== =========== ============
62
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.
MANAGEMENT
Executive Officers and Directors
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) 50 Chairman of the Board, President and Chief Executive Officer
Jason L. Katz (1) 51 Executive Vice President, General Counsel and Director
James A. Mackinnon 63 Executive Vice President, Chief Operating Officer and Director
Keitha T. Schofield 47 Executive Vice President - Support Services and Director
Cecilia Claudio 44 Senior Vice President and Chief Information Officer
Gerald E. Faulwell 57 Senior Vice President and Chief Financial Officer
Leonard H. Gelfand 54 Senior Vice President and President of Farmers Business Insurance
Paul N. Hopkins 42 Senior Vice President and Chief Marketing Officer
John H. Lynch 47 Senior Vice President and President of Farmers Personal Lines
Paul G. Secord 52 Senior Vice President and Chief Investment Officer
David P. Allvey (2) (3) 54 Director
Edwin A. Heafey, Jr. (3) 68 Director
Benjamin C. Neff (2) 64 Director
Jack C. Parnell (1) (2) (3) 63 Director
Cornelius J. Pings (2) (3) 70 Director
Van Gordon Sauter (3) 63 Director
M. Faye Wilson (2) 61 Director
Clayton Yeutter (2) (3) 68 Director
- - -----------------
(1) Member of the Executive Committee
(2) Member of the Audit Committee
(3) Member of the Compensation Committee
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 Chairman of the Board since November
1997, 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 also has served as a director of Allied Zurich p.l.c. since
March 1998 and is a member of the Group Executive Board of Zurich Financial
Services. In addition, Mr. Feinstein served as a director of B.A.T from
January 1997 to September 1998. 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
and Casualty Staff from October 1993 to January 1995 and as Chief Operating
Officer of FGI from January 1995 to January 1997.
63
Jason L. Katz has served as Executive Vice President and General Counsel
of FGI since June 1998 and as a director of FGI since May 1986. Previously,
Mr. Katz served as Vice President and General Counsel of FGI from August 1984
through February 1992 and Senior Vice President and General Counsel of FGI
from February 1992 to June 1998.
James A. MacKinnon has served as Executive Vice President and Chief
Operating Officer since July 1998 and as a director of FGI since May 1997.
Previously, Mr. MacKinnon served as Senior Vice President-Field Operations-
Mid-West Zone of FGI from January 1992 to January 1996, Senior Vice
President-Property and Casualty of FGI from January 1996 to January 1997 and
Executive Vice President-Insurance Operations from January 1997 to July 1998.
Mr. MacKinnon will retire effective May 1, 1999, pursuant to normal retirement
policy.
Keitha T. Schofield has served as Executive Vice President-Support
Services since January 1998 and as a director of FGI since May 1997. Ms.
Schofield served as Senior Vice President and Chief Information Officer of
FGI from May 1995 to January 1997 and Executive Vice President-Support
Services and Chief Information Officer from January 1997 to January 1998.
Previously, Ms. Schofield served as Vice President-Technology Division of
Continental Airlines, Inc. from 1988 to May 1995.
Cecilia Claudio has served as Senior Vice President and Chief
Information Officer of FGI since July 1998. Previously, Ms. Claudio served
as Chief Information Officer and Senior Vice President of Information
Technology of Harvard Pilgrim Health Care from 1994 to 1996 and Chief
Information Officer and Senior Vice President of Information Technology
of Anthem, Inc. from 1996 to May 1998.
Gerald E. Faulwell has served as Senior Vice President and Chief
Financial Officer of FGI since September 1998. Previously, Mr. Faulwell
served as Vice President-Corporate Investments and Treasurer of FGI from
October 1987 to January 1993, Vice President-Strategic Planning, Budgeting
and Administration of FGI from January 1993 to January 1996 and Senior Vice
President-Strategic Planning, Budgeting and Administration of FGI from
January 1996 to September 1998.
Leonard H. Gelfand has served as Senior Vice President of FGI and
President of Farmers Business Insurance since July 1998. Previously, Mr.
Gelfand served as Vice President-Commercial of FGI and President-Truck
Underwriters Association from April 1991 to January 1995 and Senior Vice
President-Commercial of FGI and President-Truck Underwriters Association
from January 1995 to July 1998.
Paul N. Hopkins has served as Senior Vice President and Chief Marketing
Officer of FGI since September 1998. Previously, Mr. Hopkins served as
Assistant Vice President-Regional Operations of FGI from June 1992 to
November 1994, Vice President-Agencies of FGI from November 1994 to October
1997 and Senior Vice President-Agencies of FGI from October 1997 to September
1998.
John H. Lynch has served as Senior Vice President of FGI and President-
Farmers Personal Lines since July 1998. Previously, Mr. Lynch served as
Vice President of FGI and Regional Manager of the Pleasanton Region from
January 1993 to January 1995, Vice President-Personal Lines Operations of
FGI from January 1995 to October 1995, Vice President of FGI and Regional
Manager of the Colorado Springs Region from October 1995 to January 1997,
Vice President-Personal Lines Operations of FGI from January 1997 to October
1997 and Senior Vice President-Personal Lines Operations of FGI from October
1997 to July 1998.
Paul G. Secord has served as Senior Vice President and Chief Investment
Officer of FGI since September 1998. Mr. Secord served as Senior Vice
President-Asset Management of FGI from December 1995 to September 1998.
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 has also served as Chief of Corporate Operations of Zurich
Financial Services since September 1998, director of Allied Zurich p.l.c.
since March 1998 and as a member of the Group Executive Board of Zurich
Financial Services. Previously, Mr. Allvey held various positions
64
at B.A.T including serving as Finance Adviser and Manager of Taxation
at British-American Tobacco Co., Head of Finance of B.A.T and Finance
Director of B.A.T.
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 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 since
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 served as the President of the Association of American Universities
from February 1993 to June 1998 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 as Chairman of the Board of
Directors of Pacific Horizon Funds, Inc.. He previously served on the
boards of Hughes Aircraft Co. and 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 previously served as President and General Manager of PBS affiliate
KVIE in Sacramento, California and President of CBS News and Fox News.
M. Faye Wilson has served as a director of FGI since May 1996. Ms.
Wilson has served as Senior Vice President of Home Depot since June 1998
and also serves on the Board of Directors of Home Depot. Previously, Ms.
Wilson served as Executive Vice President of BankAmerica from 1977 to June
1998.
Clayton Yeutter has served as a director of FGI since 1994. Mr.
Yeutter has served as a non-executive director of Zurich Financial Services
and Allied Zurich p.l.c. since March 1998 and as a non-executive director of
Zurich Allied AG since September 1998. Previously, Mr. Yeutter served as a
non-executive director of B.A.T from January 1993 until September 1998. Mr.
Yeutter has been 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.
65
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, 1998, 1997
and 1996 of those persons who were, as of December 31, 1998, (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 (#) ($)(2) Compensation ($)(3)
- -------------------------- ----- ---------- ------------ ----------- ------------ -------------------
Martin D. Feinstein 1998 900,000 948,192 0 0 135,000
Chairman of the 1997 600,000 615,477 0 0 91,582
Board, President 1996 400,000 279,918 0 0 61,235
and Chief Executive
Officer
Jason L. Katz 1998 345,000 407,642 0 0 51,750
Executive Vice President 1997 328,800 351,813 0 0 50,187
and General Counsel 1996 317,800 222,653 0 0 48,651
James A. MacKinnon 1998 345,000 326,642 0 0 51,750
Executive Vice 1997 318,300 335,701 0 0 48,584
President 1996 257,300 172,077 0 0 39,390
Keitha T. Schofield 1998 332,500 330,784 0 0 49,875
Executive Vice 1997 275,000 275,489 0 0 41,975
President 1996 215,000 151,046 0 0 16,457
Paul G. Secord 1998 255,000 248,192 0 0 38,250
Senior Vice President 1997 241,900 231,025 0 0 36,923
1996 230,267 161,670 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) In 1998, Messrs. Feinstein, Katz, MacKinnon, Secord and Ms. Schofield
received awards of 90,000, 17,000, 17,000, 12,750 and 15,750 Long Term
Incentive Plan Units ("LTIPs"), respectively, under FGI's 1998 Long
Term Incentive Plan. The Value of the LTIPs 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 over a three year
period.
In 1997, Messrs. Feinstein, Katz, MacKinnon, Secord and Ms. Schofield
received awards of 17,982, 8,200, 8,000, 6,000 and 8,200 Premier Award
Units ("PAUs"), respectively, under FGI's Premier Award Units Plan. In
1996, Mr. Secord received an interim award of 5,620 PAUs. 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.
Effective September 8, 1998, the B.A.T ADR performance category was
replaced by a measurement of Allied Zurich p.l.c. and Zurich Allied AG
stock performance.
The value of the LTIPs and PAUs will be paid to eligible employees 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 LTIPs and PAUs
immediately or make other appropriate adjustments to the LTIPs and PAUs.
(3) 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.
66
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").
Effective May 7, 1997, the Employee Benefits Restoration Plan was
amended to include awards made under the Executive Incentive Plan as
compensation in calculating pension benefits, starting with the 1996 awards
paid in 1997. The entire benefit derived from inclusion of the Executive
Incentive Plan award(s) will be paid from the Employee Benefits Restoration
Plan. This amendment impacts certain key officers and includes the Named
Executive Officers.
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.
Unreduced monthly pension 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
- ------------------------------ ----------- ------------ ------------ ------------ ------------
$ 150,000 $ 38,268 $ 51,024 $ 63,780 $ 76,536 $ 89,292
200,000 51,393 68,524 85,655 102,786 119,917
250,000 64,518 86,024 107,530 129,036 150,542
300,000 77,643 103,524 129,405 155,286 181,167
350,000 90,768 121,024 151,280 181,536 211,792
400,000 103,893 138,524 173,155 207,786 242,417
450,000 117,018 156,024 195,030 234,036 273,042
500,000 130,143 173,524 216,905 260,286 303,667
600,000 156,393 208,524 260,655 312,786 364,917
700,000 182,643 243,524 304,405 365,286 426,167
800,000 208,893 278,524 348,155 417,786 487,417
900,000 235,143 313,524 391,905 470,286 548,667
67
At the end of 1998, Messrs. Feinstein, Katz, MacKinnon, Secord and Ms.
Schofield were credited under the Pension Plans with 25.0, 14.4, 35.0, 3.0
and 3.6 years of service, respectively. The average annual salary for the
five-year period ended December 31, 1998 for Messrs. Feinstein, Katz,
MacKinnon, Secord and Ms. Schofield was $608,573, $424,100, $369,850,
$365,422 and $374,279, respectively. These figures include the 1996 and
1997 Executive Incentive Plan Awards paid in 1997 and 1998.
Employment Agreements and Change-in-Control Arrangements
The Company has entered into employment agreements with each of Messrs.
Feinstein, Katz, MacKinnon, Secord and Ms. Schofield. Each of the agreements
provide that if the executive's employment is terminated following a
"Change-in-Control" (as defined in the agreement), the executive will
receive a severance payment equal to two (2) times the executive's "Cash
Compensation" (as defined in the agreement, but generally including certain
base salary, bonus and profit sharing plan allocation amounts). In addition
to the Cash Compensation amount payable, the executive is also entitled to
(i) continued coverage under applicable group welfare benefit plans of the
Company (for example, the Company's life, disability and health
insurance plans), (ii) a benefit under the Company's long-term incentive
plan (determined as if the executive terminated employment due to
retirement, and as if any remaining performance criteria had been waived)
and (iii) a lump sum payment of certain enhanced benefit amounts under the
Company's pension plans (including the supplemental pension plan). In the
cases of Messrs. Feinstein and Katz, the agreements provide for a tax gross
- -up payment equal to the amount of any excise tax payable under Section
4999 of the Internal Revenue Code of 1986, as amended. In the case of the
other executives, amounts payable under the agreements will be reduced to
the extent necessary to avoid the application of such excise tax.
The payments under the agreement will be made if the executive is
employed at the time of the Change-in-Control and his or her termination
is (i) by the Company other than for "Cause" (as defined in the agreement),
(ii) by the executive for "Good Reason" (as defined in the agreement) or
(iii) other than due to the executive's death, disability or retirement.
The agreement provides for an extension of the "Initial Term" (as
defined in the agreement), in the event of a Change-in-Control. As a Change
- -in-Control occurred in 1998, the agreements have been extended to October
31, 2000. In all cases, however, the agreements will expire upon the death,
retirement or disability termination of the executive.
Compensation of Directors
Directors who are not employees of FGI or of Zurich Financial Services
receive an annual retainer of $25,000, together with $1,000 plus expenses
for each FGI Board of Directors (the "Board") meeting attended in 1998.
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 Zurich Financial Services 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, Yeutter and Ms. Wilson amounted to $28,300, $29,800,
$33,600, $34,200, $29,800, $30,700 and $29,800, respectively, in 1998 for
services rendered in that year.
FGI has established an Outside Directors' Retirement Benefit Program.
Any director who is not an employee of FGI or of Zurich Financial Services
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 ten annual payments, and Messrs. Neff, Parnell,
Pings, Sauter, Yeutter and Ms. Wilson have accrued no benefits under this
Program. Benefits for this Program were funded through a grantor trust
through 1995.
68
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 $51,000 in 1998.
Compensation Committee Interlocks and Insider Participation
During 1998, 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 Mr. Feinstein and certain senior officers are
approved by the Chairman of Zurich Financial Services.
The law firm of Crosby, Heafey, Roach and May received fees of
$6,206,000 for legal services rendered to the Company or the P&C Group in 1998.
Mr. Heafey is a partner in such firm and has been a director of FGI
since 1978. The law firm of Kahn, Soares and Conway received $329,000
for legal services rendered to the Company or the P&C Group in 1998. Mr.
Parnell is an advisor to such firm and has been a director of FGI since 1995.
In addition, the law firm of Hogan and Hartson, LLP, received fees
of $9,000 for legal services rendered to the Company or the P&C Group
in 1998. Mr. Yeutter is Of Counsel in such firm and has been a director
of FGI since 1994.
ITEM 12. Security Ownership of Certain Beneficial Owners and Management
All of the outstanding Class A common stock, which has 90% of the
voting power of FGI, are owned beneficially and of record by Zurich
Financial Services, Mythenquai 2, P.O. Box 8022, Zurich, Switzerland.
All of the outstanding Class B common stock, which has the remaining 10%
of the voting power of FGI, are owned beneficially and of record by
Allied Zurich Holdings Limited, Mourant du Feu & Jeune, P.O. Box 87,
22 Grenville Street, St. Helier, Jersey JE4 8PX, Channel Islands.
The following table sets forth information regarding beneficial
ownership of Allied Zurich p.l.c. ADRs and ordinary shares as of
December 31, 1998 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.
Allied Zurich p.l.c. Allied Zurich p.l.c.
ADRs Ordinary Shares
Beneficially Owned Beneficially Owned
------------------- ----------------------
Name Number Percent Number Percent
- ------ --------- --------- ---------- ---------
Martin D. Feinstein 0 17,564 (1)
Jason L. Katz 0 0
James A. MacKinnon 0 0
Keitha T. Schofield 0 0
Paul G. Secord 0 0
All Directors and Executive Officers as a group 994 (2) 102,390 (1)
- ------------
(1) Less than 1% of the outstanding Allied Zurich p.l.c. ordinary shares.
(2) Less than 1% of the outstanding Allied Zurich p.l.c. ADRs.
69
ITEM 13. Certain Relationships and Related Transactions
Certain directors of the Company are partners in legal firms that
received fees for legal services from the Company and the P&C Group. These
fees totaled $6,544,000, $5,208,000 and $1,853,000 in 1998, 1997 and 1996,
respectively.
On September 3, 1998, the Company received $423,734,000 from B.A.T
Capital Corporation, a subsidiary of B.A.T, in settlement of $407,000,000
of notes receivable and $16,734,000 of accrued interest. These notes were
fixed rate medium-term notes with maturity dates as follows: $137,000,000
in October 1998, $135,000,000 in October 1999 and $135,000,000 in October 2000.
Interest on these notes was paid semi-annually at coupon rates of
5.35%, 6.68% and 6.33%, respectively. On October 7, 1997, a four year
$135,000,000 note with an interest rate of 5.10% matured and the
$135,000,000 note that would have matured in October 2000 was subsequently
issued at an interest rate of 6.33%. Income earned on the notes
outstanding for the years ended December 31, 1998 and December 31, 1997
was $16,734,000 and $23,620,000, respectively.
In addition, on September 3, 1998, the Company, using $407,000,000 of
proceeds from the B.A.T notes redemption and $650,000,000 of proceeds from
the redemption of the certificates of contribution of the P&C Group
(see Note F), issued $1,057,000,000 of notes receivable to BAFS. These
notes are fixed rate medium-term notes with maturity dates as follows:
$200,000,000 in September 2000, $207,000,000 in September 2001,
$200,000,000 in September 2002, $200,000,000 in September 2003 and
$250,000,000 in September 2004. Interest on these notes is paid semi-
annually at coupon rates of 5.44%, 5.48%, 5.67%, 5.71% and 5.78%,
respectively. Income earned on these notes through December 31, 1998
was $19,481,000.
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), as further amended September 4, 1998(vi)
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),
as further amended November 10, 1997 (v)
10.5 Farmers Group, Inc. Executive Incentive Program (ii), as amended
May 7, 1997 and August 13, 1997 (v)
10.6 Description of Farmers Group, Inc. Outside Directors' Retirement
Program (ii)
10.7 The Farmers Group, Inc. Discretionary Management Incentive
Program for Exceptional Performance (ii), as amended December
1996 (iv)
70
10.8 Farmers Group, Inc. Employee Benefits Restoration Plan (ii), as
amended May 7, 1997 (v)
10.10 Form of Employment Agreement with certain officers (v), as
amended June 15, 1998
12 Statement of Computation of the Ratio of Earnings to Fixed Charges
21 Subsidiaries of FGI (v)
24 Power of Attorney (ii)
99 Risk Manangment
- --------------------
(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.
(iv) Incorporated by reference to the corresponding Exhibit to FGI's
Annual Report on Form 10-K for the year ended December 31, 1996.
(v) Incorporated by reference to the corresponding Exhibit to FGI's
Annual Report on Form 10-K for the year ended December 31, 1997.
(vi) Incorporated by reference to the corresponding Exhibit to FGI's
Quarterly Report on Form 10-Q for the quarterly period ended
September 30, 1998.
(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. 22
b. Financial Statement Schedules
Schedule I - Marketable Securities - Other Investments, as
of December 31, 1998 S-1
Schedule III - Supplementary Insurance Information, for the
years ended December 31, 1998, 1997 and 1996 S-2
Schedule IV - Reinsurance, for the years ended
December 31, 1998, 1997 and 1996 S-3
Schedule V - Valuation and Qualifying Accounts, for the
years ended December 31, 1998, 1997 and 1996 S-4
(b) Reports on Form 8-K
On July 17, 1998, FGI filed a report on Form 8-K announcing the
private placement of $650,000,000 Exchange Trust Surplus Note Securities.
On September 6, 1998, FGI filed a report on Form 8-K announcing the
completion of the merger between the financial services businesses of B.A.T
Industries p.l.c. (which includes the Company) and Zurich Insurance Company
to form a new company known as Zurich Financial Services, a company organized
under the laws of Switzerland.
71
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
FARMERS GROUP, INC.
---------------------------------------------
(Registrant)
Date: March 24, 1999 By: /s/ Martin D. Feinstein
---------------------------------------------
Martin D. Feinstein, Chairman of the Board,
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 Chairman of the Board, March 24, 1999
- --------------------------------President and Chief
(Martin D. Feinstein) Executive Officer
Principal Financial and
Accounting Officer
/s/ Gerald E. Faulwell Senior Vice President and March 24, 1999
- --------------------------------Chief Financial Officer
(Gerald E. Faulwell)
Directors
/s/ James A. MacKinnon Executive Vice President, March 24, 1999
- --------------------------------Chief Operating Officer
(James A. MacKinnon) and Director
/s/ Keitha T. Schofield Executive Vice President March 24, 1999
- --------------------------------and Director
(Keitha T. Schofield)
/s/ Jason L. Katz Executive Vice President, March 24, 1999
- --------------------------------General Counsel and Director
(Jason L. Katz)
/s/ David P. Allvey Director March 24, 1999
- --------------------------------
(David P. Allvey)
/s/ Edwin A. Heafey, Jr. Director March 24, 1999
- --------------------------------
(Edwin A. Heafey, Jr.)
/s/ Benjamin C. Neff Director March 24, 1999
- --------------------------------
(Benjamin C. Neff)
/s/ Jack C. Parnell Director March 24, 1999
- --------------------------------
(Jack C. Parnell)
/s/ Cornelius J. Pings Director March 24, 1999
- --------------------------------
(Cornelius J. Pings)
/s/ Van Gordon Sauter Director March 24, 1999
- --------------------------------
(Van Gordon Sauter)
/s/ M. Faye Wilson Director March 24, 1999
- --------------------------------
(M. Faye Wilson)
/s/ Clayton Yeutter Director March 24, 1999
- --------------------------------
(Clayton Yeutter)
S-1
FARMERS GROUP, INC.
AND SUBSIDIARIES
SCHEDULE I - MARKETABLE SECURITIES - OTHER INVESTMENTS
December 31, 1998
(Amounts in thousands)
Market value Amount at which
at balance shown in the
Type of Investment Cost sheet date balance sheet
- -------------------- ------------ ------------- ---------------
Insurance Subsidiaries:
Marketable securities - available-for-sale:
United States government and its agencies $ 1,762,608 $ 1,846,606 $ 1,846,606
States and municipalities 620,279 651,574 651,574
Public utilities 65,287 69,949 69,949
Foreign government 95,077 81,379 81,379
All other corporate 1,552,964 1,619,896 1,619,896
Preferred stocks (redeemable) 82,090 86,662 86,662
------------ ------------- ---------------
4,178,305 4,356,066 4,356,066
------------ ------------- ---------------
Preferred stocks (non-redeemable) 1,153 1,270 1,270
------------ ------------- ---------------
Common stocks:
Public utilities 2,581 2,758 2,758
Banks, trusts and insurance companies 11,151 11,539 11,539
Industrial, miscellaneous and all other 84,668 91,798 91,798
------------ ------------- ---------------
98,400 106,095 106,095
------------ ------------- ---------------
Mortgage loans on real estate 52,879 xxxxx 52,879
------------ ------------- ---------------
Policy loans 185,211 xxxxx 185,211
------------ ------------- ---------------
Real estate (1) 59,047 (1) xxxxx 59,047
------------ ------------- ---------------
Joint ventures 8,456 xxxxx 8,456
------------ ------------- ---------------
Surplus note of the P&C Group 119,000 xxxxx 119,000
------------ ------------- ---------------
S&P 500 call options 11,305 14,817 14,817
------------ ------------- ---------------
Total investments $ 4,713,756 $ 4,478,248 $ 4,902,841
============ ============= ===============
(1) Net of accumulated depreciation of $28,366.
S-2
FARMERS GROUP, INC.
AND SUBSIDIARIES
SCHEDULE III - SUPPLEMENTARY INSURANCE INFORMATION
For the years ended December 31, 1998, 1997 and 1996
(Amounts in thousands)
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
Insurance acquisition and loss Unearned benefits charge investment
Subsidiaries costs (1) expenses premiums payable revenues income
- -------------- ----------- -------------- -------- ---------- --------- ----------
December 31, 1998 $ 801,690 $ 3,316,369 $ 1,696 $ 55,661 $1,380,433 $ 307,391
=========== ============= ======== ========== ========== ==========
December 31, 1997 798,725 3,032,318 1,543 58,529 377,667 293,190
=========== ============= ======== ========== ========== ==========
December 31, 1996 412,158 317,630
========== ==========
Column A Column H Column I Column J
- ---------- -------- -------- --------
Benefits, Amortization
claims, of deferred
losses and policy Other
Insurance settlement acquisition operating
Subsidiaries expenses costs (1) expenses
- -------------- ---------- -------------- ------------
December 31, 1998 $ 812,820 $ 90,082 $ 380,530
========== ============= ============
December 31, 1997 139,124 103,975 65,974
========== ============= ============
December 31, 1996 166,199 108,802 84,345
========== ============= ============
- -------------------
(1) Includes value of life business acquired
S-3
FARMERS GROUP, INC.
AND SUBSIDIARIES
SCHEDULE IV - REINSURANCE
For the years ended December 31, 1998, 1997 and 1996
(Amounts in thousands)
Column A Column B Column C Column D Column E Column F
- --------- ------------ ------------ ------------ ------------- ------------
Percentage
Ceded to Assumed of amount
Gross other from other Net assumed
amount companies companies amount to net
------------ ------------ ------------ ------------- ------------
1998
- ----------
Life insurance in-force $ 96,883,459 $ 968,606 $ 8,893,263 $ 104,808,116 8.5%
------------ ------------ ------------ ------------- ------------
Life premium & policy charges 375,259 3,728 8,798 380,329 2.3
------------ ------------ ------------ ------------- ------------
Non-life premiums 104 0 1,000,000 1,000,104 100.0
------------ ------------ ------------ ------------- ------------
1997
- ----------
Life insurance in-force $ 89,613,224 $ 1,209,978 $ 8,428,465 $ 96,831,711 8.7%
------------ ------------ ------------ ------------- ------------
Life premiums & policy charges 371,606 4,236 10,297 377,667 2.7
------------ ------------ ------------ ------------- ------------
1996
- ----------
Life insurance in-force $100,529,124 $ 847,883 $ 10,568,578 $ 110,249,819 9.6%
------------ ------------ ------------ ------------- ------------
Life premiums & policy charges 405,654 3,868 10,372 412,158 2.5
------------ ------------ ------------ ------------- ------------
S-4
FARMERS GROUP, INC.
AND SUBSIDIARIES
SCHEDULE V - VALUATION AND QUALIFYING ACCOUNTS
(Amounts in thousands)
Balance at Balance at
beginning end of
of year year
------------ ------------
YEAR
- ----------
1998 $ 15,118 $ 14,206
1997 18,960 15,118
1996 14,164 18,960