ITEM 1. BUSINESS
GENERAL
FBL Financial Group, Inc. (we or the Company) sells universal life, variable universal life and traditional life insurance and traditional and variable annuity products. Through December 31, 2000, these products were principally marketed through a core distribution force consisting of approximately 1,645 exclusive Farm Bureau agents in 14 midwestern and western states. On January 1, 2001, our agency force and geographic marketing territory expanded with the acquisition of the assets and liabilities of Kansas Farm Bureau Life Insurance Company (Kansas Farm Bureau Life), a single-state life insurance company selling traditional life and annuity products in the state of Kansas. In addition to traditional life and annuity products, since 1995, Kansas Farm Bureau Life also sold variable life insurance and variable annuities through an alliance with us. At December 31, 2000, Kansas Farm Bureau Life had 336 exclusive agents and held the largest market share of combined life insurance and annuity business in the state of Kansas.
Our variable universal life and variable annuity products are also marketed in other states through alliances with other life insurance companies and a regional broker-dealer. Several of our subsidiaries support various functional areas of the Company and affiliates, by providing investment advisory, marketing and distribution, and leasing services. In addition, we provide management and administrative services to four Farm Bureau affiliated property-casualty insurance companies.
FBL Financial Group, Inc. was incorporated in Iowa in October 1993 and our principal insurance subsidiaries include Farm Bureau Life Insurance Company (Farm Bureau Life) and EquiTrust Life Insurance Company (EquiTrust). Farm Bureau Life commenced operations in 1945 and EquiTrust commenced operations in 1998.
BUSINESS STRATEGY
We have a three-pronged growth strategy that consists of (1) internal growth within our traditional Farm Bureau distribution network in 15 midwestern and western states, (2) alliances with other companies and (3) consolidations. Our growth strategies are detailed below:
GROWTH STRATEGY #1 - INTERNAL GROWTH WITHIN OUR TRADITIONAL FARM BUREAU DISTRIBUTION NETWORK.
We are focused on growing our core business, which comes through our Farm Bureau distribution network in 15 states, through cross selling opportunities, new products and competitive product features. We have significant opportunities to increase our sales through cross selling life insurance products to Farm Bureau members who already own a property-casualty policy offered by Farm Bureau affiliated property-casualty companies. For example, in the six-state region where we manage the affiliated property-casualty insurance company and related field force (Iowa, Minnesota, South Dakota, Utah, Arizona and New Mexico), approximately 25% of the Farm Bureau members own at least one of our life products, 63% own at least one Farm Bureau property-casualty product and approximately 20% own both. Cross selling and other opportunities have been enhanced in recent years through the introduction of new products including last survivor variable universal life insurance, simplified issue traditional life insurance and variable settlement options.
Several programs introduced in 2000 are targeted at increasing life insurance and annuity sales within our core distribution system. These programs include life specialists, wholesalers and the BUILDING A PROFESSIONAL PRACTICE series. The intent of these programs is to provide support to our multi-line agents as they cross-sell to their customers and provide a model for growth in the way they approach their business. Life specialists are hired by a multi-line manager and work as a resource within the agency for life sales, including advanced markets. The wholesalers are responsible for increasing variable product and mutual fund sales within their own territory, and assist with agency training, case analysis support, and may have direct client involvement on large cases. The goal of our BUILDING A PROFESSIONAL PRACTICE series is to help agents position themselves for a dramatic increase in productivity. This program teaches agents to examine the way they have their business structured, how they are spending their time, and encourages them to hire assistants so that they may spend more time with direct client contact.
GROWTH STRATEGY #2 - ALLIANCES WITH OTHER COMPANIES.
Significant growth opportunities exist through forming alliances with other companies for the sale of products developed and administered by us. To date, we have leveraged our variable product expertise and used alliances for the distribution of variable products. With this strategy, we obtain access to additional distribution systems and our partners are provided with access to variable products and share in the underwriting results without developing the infrastructure and know-how to underwrite and administer the business. Since December 1998, we have developed variable product alliances with the following companies:
Growth can be achieved through increasing sales with these existing partners and developing new alliance partners. Sales from existing partners are increasing with additional product offerings, an increase in the number of the partners' registered representatives and a higher average production per registered representative, as they become more familiar with our variable products. In addition, during 2000 we developed the capability of selling traditional products through EquiTrust and have the ability to expand our alliance strategy in this area as well.
Variable sales by our alliance partners are generally underwritten by EquiTrust, but may be underwritten by our alliance partner. With respect to our alliances with insurance companies, the risks, costs and profits of the business are shared, generally on an equal basis, through reinsurance arrangements. For all of our alliance partners, we perform various administrative processing and other services with respect to the variable business written.
GROWTH STRATEGY #3 - CONSOLIDATIONS.
At the beginning of 2001, we finalized our acquisition of the assets and liabilities of Kansas Farm Bureau Life and we see additional growth opportunities through the consolidation with other companies. Consolidations expand our distribution systems, generate top-line revenue growth and provide us with a larger base over which to spread our fixed operating costs. These items, in turn, put us in a better position to offer competitive products and to invest in the infrastructure necessary to stay competitive in the maturing life insurance industry.
We have a successful history of being a consolidator among Farm Bureau affiliated insurance companies. In addition to taking over the management of four property-casualty companies since 1984, we acquired Utah Farm Bureau Life Insurance Company in 1984, Rural Security Life Insurance Company in 1993, Western Farm Bureau Life Insurance Company in 1994 and Kansas Farm Bureau Life Insurance Company in 2001. Currently there are seven Farm Bureau affiliated life insurance groups. We expect there to be further consolidation within the Farm Bureau network and we believe, as a publicly held company, we are well positioned to be the consolidator of choice among these companies.
We are not able to dictate the pace at which the further consolidation, if any, of the Farm Bureau life insurance companies will happen. Accordingly, we are seeking smaller insurance companies that will not be able to compete as the marketplace continues to demand increased technological and customer service capabilities. We are profiling possible acquisition candidates that we think would be a compatible fit for us. As we seek to grow our operations via consolidation, we will only look at consolidation opportunities that grow our earnings.
SEGMENT INFORMATION
In general, we are organized by the types of products and services we offer for sale. Our principal and only reportable operating segment is our life insurance segment. Life operations have been aggregated into the same segment due to the similarity of the products, including the underlying economic characteristics, the method of distribution and the regulatory environment. We also have several other operating segments that do not meet the quantitative threshold for separate segment reporting. A summary of these segments, along with the related source of revenues, is as follows:
SEGMENT SOURCE OF REVENUES Investment advisory.......... Fee income from the management of investments Marketing and distribution... Commissions and distribution fee income from the sale of mutual funds and insurance products not issued by us Leasing...................... Income from operating leases Corporate.................... Fees from management and administrative services
See Note 14 of Notes to Consolidated Financial Statements for additional information regarding the financial results by operating segment.
MARKETING
MARKET AREA
Our sales are principally conducted in the following 15 state core marketing region: multi-line states (we own the Farm Bureau affiliated life company and manage the Farm Bureau affiliated property-casualty company) - Arizona, Iowa, Minnesota, New Mexico, South Dakota and Utah; and life only states (we own the Farm Bureau affiliated life company only) - Colorado, Idaho, Kansas, Montana, Nebraska, North Dakota, Oklahoma, Wisconsin and Wyoming. Additionally, our variable alliance partners market throughout the United States.
Our core target market consists primarily of farmers, ranchers, rural and suburban residents and related individuals and businesses. We believe that this target market represents a relatively financially conservative and stable customer base, which is generally familiar with Farm Bureau and the benefits of Farm Bureau membership. Many of our customers are self-employed individuals who are responsible for providing for their own insurance needs. Their financial planning needs tend to focus on security, primary insurance needs and retirement savings.
AFFILIATION WITH FARM BUREAU
Many of our customers are members of Farm Bureau organizations affiliated with the American Farm Bureau Federation, the nation's largest grass roots farm and ranch organization with over 5.0 million member families. In order to market insurance products in a given state using the "Farm Bureau" and "FB" designations and related trademarks and service marks, a company must have permission from the state's Farm Bureau federation. Generally, these marketing rights have only been granted to companies owned by or closely affiliated with Farm Bureau federations. For each of the 15 states in our core marketing territory, we have the exclusive right to use the "Farm Bureau" name and "FB" logo for marketing products in those states.
The American Farm Bureau Federation has the right to terminate our right to use the "Farm Bureau" and "FB" designations in all of our states (i) in the event of a material breach of the trademark license that we do not cure within 60 days, (ii) immediately in the event of termination by the American Farm Bureau of the Iowa Farm Bureau's membership in the American Farm Bureau or (iii) in the event of a material breach of the Iowa Farm Bureau Federation's membership agreement with the American Farm Bureau Federation, including by reason of the failure of the Iowa Farm Bureau Federation to cause us to adhere to the American Farm Bureau Federation's policies. Each state Farm Bureau federation in our trade territory could terminate our right to use the Farm Bureau designations in that particular state without cause on 60 days' notice. We believe that the occurrence of any termination is highly unlikely.
We believe our relationship with Farm Bureau provides a number of advantages. Farm Bureau organizations in our current territory tend to be well known and long established, have active memberships and provide a number of benefits other than financial services. The strength of these organizations provides enhanced prestige and brand awareness for our products and increased access to Farm Bureau members. Additionally, Farm Bureau members provide a financially conservative and stable target market which has resulted in persistency for our products that exceeds industry averages.
Our life insurance products are currently available for sale to both members and non-members. Property-casualty products sold by the property-casualty insurance companies affiliated with Farm Bureau are generally only available for sale to Farm Bureau members. Annual Farm Bureau memberships in our core marketing territory generally cost $24 to $112 and are available to individuals and families who are farmers and ranchers, and to the general public as well.
To facilitate our working relationship with state Farm Bureau organizations, the Presidents of the 15 state Farm Bureau federations in our core marketing territory serve on our Board of Directors. Each state Farm Bureau federation, or its assignee, benefits from its relationship with us through receipt of royalties. The royalties paid to a particular federation are based on the sale of our products in the respective state. For 2000, total royalties paid to Farm Bureau organizations were approximately $1.9 million.
We have marketing agreements with all of the Farm Bureau property-casualty companies in our core marketing area, pursuant to which the property-casualty companies develop and manage an agency force that sells both property-casualty products for that company and life products for us. We pay them a fee for this service in the nature of an overwrite commission based on first year life insurance premiums and annuity deposits. The overwrite commissions are generally equal to one-third of the first year commissions paid to the agent. We paid overwrite commissions totaling $6.0 million in 2000.
Our Advisory Committee, which consists of certain executives of Farm Bureau property-casualty insurance companies in our marketing territory, assists us in our relationships with the property-casualty organizations. The Advisory Committee meets on a regular basis to coordinate efforts and issues relating to the agency force and other related matters. We view the Advisory Committee as an important contributor to our success in marketing products through the Farm Bureau system.
All of the state Farm Bureau federations in our current marketing area are associated with the American Farm Bureau Federation. The primary goal of the American Farm Bureau Federation is to improve the financial well-being and the quality of life of farmers, ranchers and other rural residents through education and representation with respect to public policy issues. There are currently Farm Bureau federations in all 50 states and Puerto Rico. Within each state, Farm Bureau is generally organized at the county level. Farm Bureau programs generally include policy development, state and national lobbying activities, leadership development, speaker corps, media relations, crime prevention, marketing clubs, women's activities, young farmers activities, promotion and education and commodity promotion activities. Member services provided by Farm Bureau vary by state but often include newspapers and magazines, theft and arson rewards, eye care programs, accidental death insurance, credit card programs, computerized farm accounting services, electronic information networks, feeder cattle procurement services, health care insurance and financial planning services.
EXCLUSIVE AGENCY FORCE - CORE MARKETING TERRITORY
Our life insurance, annuities and sponsored mutual funds are currently marketed throughout our core marketing territory by an exclusive Farm Bureau force of approximately 1,980 agents and agency managers. We have a written contract with each member of our agency force. The contracts do the following:
* Specify and limit the authority of the agents to solicit insurance applications on our behalf. * Describe the nature of the independent contractor relationship between us and the agent. * Define the agent as an exclusive agent limited to selling insurance of the types sold on our behalf, or for certain products, on the behalf of other insurance companies approved by us. * Allow either party to immediately terminate the contract. * Specify the compensation payable to the agents. * Reserve our ownership of customer lists. * Set forth all other terms and conditions of the relationship.
Sales activities of our agents focus on personal contact and on cross selling the multiple lines of products available through Farm Bureau affiliated companies. Agents' offices are often located in or serve as the Farm Bureau office for their community. We believe that Farm Bureau name recognition and access to Farm Bureau membership leads to additional customers and cross selling of additional insurance products.
Our agents are independent contractors and exclusive agents. In the multi-line states where we manage the Farm Bureau affiliated property-casualty company, our agents are supervised by agency managers and assistant managers employed by the property-casualty companies which are under our direction. There are approximately 750 agents
and managers in our multi-line states, all of whom market a full range of our life insurance products and most of whom market our mutual funds. These agents and agency managers also market property-casualty products for the property-casualty companies that we manage.
In our life only states, our life insurance products and sponsored mutual funds are marketed through agents managed by the property-casualty company affiliated with the Farm Bureau federation of that state. These agents, of which there are approximately 1,230, market our life and mutual fund products on an exclusive basis and market the property-casualty products of that state's affiliated property-casualty companies. Agents as well as agency managers in our life only states are independent contractors.
Approximately 96% of the agents in our multi-line states are licensed with the National Association of Securities Dealers (NASD) to sell our variable life and annuity products and sponsored mutual funds. We continue to emphasize the training of agents for NASD licensing in our life only territories, where approximately 71% of the agents are NASD licensed.
We are responsible for product and sales training for all lines of business in our multi-line states, and for training the agency force in life insurance products and sales methods in our life only states.
We structure our agents' life products compensation system to encourage production and persistency. Agents receive commissions for new life insurance and annuity sales and service fees on premium payments in subsequent years. Production bonuses are paid based on the volume of new life business written in the prior 12 months and on premium payments in the first three years after new business is written. Production bonuses allow agents to increase their compensation significantly. Persistency is a common measure of the quality of life business and is included in calculating the bonus to either increase or decrease (or even eliminate) the production bonuses earned, because we are willing to pay added incentives for higher volumes of business only as long as the business is profitable. In 2000, approximately 42% of agent compensation in our multi-line states was derived from the sale of life and annuity products.
The focus of agency managers is to recruit and train agents to achieve high production levels of profitable business. Agency managers receive overwrite commissions on each agent's life insurance commissions which vary according to that agent's productivity level and persistency of business. During the first three years of an agent's relationship with us, the agent's manager receives additional overwrite commissions to encourage early agent development. Early agent development is also encouraged through financing arrangements and, at the option of the agent, the annualization of commissions paid when a life policy is sold.
We have a variety of incentives and recognitions to focus agents on production of quality life insurance business. Some recognitions are jointly conducted with the property-casualty companies. We believe that these programs provide significant incentives for the most productive agents. Approximately 15% of our agents qualify for our annual incentive trip.
Agent recruiting, training and financing programs are designed to develop a productive agent for the long term. The one-year agency force retention rate for 2000 in our multi-line states was approximately 91%. We believe retention of agents is enhanced because of their ability to sell both life and property-casualty insurance products, as well as mutual funds.
AGENCY FORCE - ALLIANCE PARTNERS
Our Farm Bureau alliance partners have approximately 6,100 exclusive agents that are dedicated to selling insurance products using the Farm Bureau brand. The number of Farm Bureau alliance partner agents licensed to sell variable products has grown steadily from 3% at December 31, 1998 to approximately 27% at February 28, 2001. Our partners continue working with their other agents to license them to become registered representatives. Our Farm Bureau alliance partners have incentive programs, like ours, to promote the sale of life insurance and annuity products. The agents earn credit for these incentives by selling our variable products.
Our alliance partners outside the Farm Bureau network have over 27,600 agents, most of which are independent agents that have access to outside variable products and are not limited solely to our variable products. While many of our alliance partners' agents are not currently licensed for the sale of variable life insurance and variable annuity products, the alliance partners are promoting the licensing of existing agents and the recruitment of agents that are licensed.
Our variable product alliance partners are responsible for managing and training their own agency force. We provide each partner with assistance on how to train their agents in the sale of variable products.
PRODUCTS CURRENTLY UNDERWRITTEN
We are currently engaged in selling a varied portfolio of insurance products including variable, interest sensitive, traditional permanent, and term life insurance, and variable and traditional annuities primarily to individuals in the rural and suburban areas of our marketing territory.
VARIABLE UNIVERSAL LIFE INSURANCE. The variable universal life policy provides permanent life insurance protection with a flexible premium structure which allows the customer to pre-fund future insurance costs and accumulate savings on a tax-deferred basis. Premiums received, less policy assessments for administration expenses and mortality costs, are credited to the policyholder's account balance. The policyholder has the ability to direct cash value of the policy to an assortment of variable sub-accounts and, in turn, assumes the investment risk passed through by those funds. Variable universal life policyholders can also elect a declared interest option under which the cash values are credited with interest as declared.
Policyholders can select from variable sub-accounts managed by us as well as sub-accounts that are managed by outside investment advisors. See "Variable Sub-Accounts and Mutual Funds."
UNIVERSAL LIFE INSURANCE. We offer a universal life policy which is similar in design to the variable universal life policy, but without the additional investment options for the cash value. Interest is credited to the cash value at rates that we periodically set. Agents need not be registered with the NASD to offer this product.
We also market last survivor universal life and last survivor variable universal life policies designed especially for the estate planning market.
TRADITIONAL LIFE INSURANCE. We offer traditional participating whole life insurance products. Participating whole life insurance provides benefits for the life of the insured. It provides level premiums and a level death benefit and requires payments in excess of mortality charges in early years to offset increasing mortality costs in later years. Under the terms of these policies, policyholders have a right to participate in our surplus to the extent determined by the Board of Directors, generally through annual dividends. For 2000, participating life policies represented 10% of first year life insurance collected premiums. We have a substantial book of in-force participating policies with persistency that has historically exceeded industry averages.
We currently market non-participating term insurance policies that provide life insurance protection for a specified period. Term insurance is mortality based and generally has no accumulation values. We may change the premium scales at any time but may not increase rates above guaranteed levels. In the past, we sold participating term insurance, but this product has been discontinued.
ANNUITIES. We offer annuities which are generally marketed to individuals in anticipation of retirement. We offer variable and traditional annuities principally in the form of flexible premium deferred annuities that allow policyholders to make contributions over a number of periods. For traditional annuity products, policyholder account balances are credited interest at rates that we determine. For variable annuities, policyholders have the right to direct the cash value of the policy into an assortment of sub-accounts, thereby assuming the investment risk passed through by those sub-accounts. Approximately 58% of our existing individual annuity business based on account balances is held in qualified retirement plans. To further encourage persistency, a surrender charge against the policyholders' account balance is imposed for early termination of the annuity contract within a specified period after its effective date.
The sub-account options for variable annuity contracts are the same as those available for variable universal life policies. See "Variable Sub-Accounts and Mutual Funds."
In addition to flexible premium deferred annuities, we also market single premium immediate annuity (SPIA) and single premium deferred annuity (SPDA) products. These products feature a single premium paid when the contract is issued and interest crediting similar to other traditional annuities. Benefit payments on SPIA contracts begin immediately after the issuance of the contract and, for SPDA, are similar to our other traditional annuity products.
ACCIDENT AND HEALTH INSURANCE. During 2000, we discontinued underwriting individual long-term disability income insurance and began to offer a long-term disability income product underwritten by Country Life Insurance Company. We do not share in the risks, costs or profits of the new product, but will earn a commission on new sales. The existing block of individual disability income business was reinsured to another insurance company through a 100% coinsurance agreement.
KANSAS PRODUCT PORTFOLIO. The agents in Kansas currently sell the portfolio of products previously offered by Kansas Farm Bureau Life Insurance Company. The products are very similar to the universal life insurance, traditional life insurance and annuity products described above. In addition, the Kansas agents market individual disability income and hospital income insurance. The individual disability income policy provides for payment of benefits in the event of a disabling accident or illness. Disability benefits reimburse the policyholder for a specified dollar amount payable over a specific time period or for the duration of the disability. Disability is defined as the inability to pursue the policyholder's own occupation for the first two years after disability, and the inability to pursue any occupation thereafter. The risks insured are similar to those insured in a medical expense policy but the claim costs are much more predictable. Since the policies are guaranteed renewable rather than noncancellable, we may change the premium scale at any time based on claim costs incurred, subject to regulatory approval. Hospital income policies generally provide for payment of benefits when an insured is admitted to a hospital for a specified period of time.
Beginning in 2001, the product portfolio currently available to the Kansas agents will be integrated with the products available to the agents in the balance of our core marketing territory. During this integration process, which we expect to complete during 2002, we will select the most desirable products and plans and create a new uniform portfolio for all of our agents.
The following table sets forth the first year and renewal premiums collected for our life, annuity and accident and health products for the years indicated:
(1) Amounts are net of portion ceded to or assumed from alliance partners.
During the five years in the period ended December 31, 2000, we have emphasized the marketing of our variable products. This marketing emphasis, coupled with the popularity of variable products and a program for the rollover of universal life policies to variable universal life policies, has resulted in a shift in premiums during the period from traditional and interest sensitive products to variable products.
The amount of premiums collected in 2001 will be impacted by the acquisition of Kansas Farm Bureau Life. During 2000, premiums collected by Kansas Farm Bureau Life, net of reinsurance, totaled $25.5 million for life insurance, $44.4 million for annuities and $3.9 million for accident and health.
LIFE INSURANCE AND ANNUITIES IN FORCE
The following table sets forth information regarding life insurance and annuities in force at the end of each year presented:
Substantially all of the deposit funds relate to the funding of the Farm Bureau retirement plans. In 1998, the funding vehicle for a portion ($48.0 million) of the Farm Bureau retirement plans was changed from group annuities to deposit administration funds.
Going forward, the amount of life insurance and annuities in force will be impacted by our acquisition of Kansas Farm Bureau Life. At December 31, 2000, Kansas Farm Bureau Life had 65,317 life insurance policies with $3.4 billion of direct insurance in force. Also at December 31, 2000, Kansas Farm Bureau Life had 12,254 direct annuity policies and $390.8 million in reserves on interest sensitive product benefits.
A summary of our individual life insurance lapse rates, compared to industry averages, is outlined in the following table:
(A) The industry lapse rate for 2000 is not available as of the filing date of this Form 10-K.
UNDERWRITING
We follow formal underwriting standards and procedures designed to properly assess and quantify life insurance risks before issuing policies to individuals. To implement these procedures, we employ a professional underwriting staff of 14 underwriters who have an average of 16 years of experience in the insurance industry. Our underwriters review each applicant's written application, which is prepared under the supervision of our agents, and any required medical records. We employ blood testing (including HIV antibody testing) to provide additional information whenever the applicant is over 40 and the face amount is over $100,000. Additionally, urine testing is done whenever the applicant is over 60. Based on the results of these tests, we may adjust the mortality charge or decline coverage completely. Any tobacco use by a life insurance applicant within the preceding one year results in a substantially higher mortality charge. In accordance with industry practice, material misrepresentation on a policy application can result in the cancellation of the policy upon the return of any premiums paid.
REINSURANCE
We reinsure a portion of our life insurance exposure with unaffiliated insurance companies under traditional indemnity reinsurance agreements. New insurance sales are reinsured above prescribed limits and do not require the reinsurer's prior approval within certain guidelines. These treaties are automatically renewed and nonterminable for the first 10 years with regard to cessions already made and are terminable after 90 days with regard to future cessions. After 10 years, we have the right to terminate and can generally discontinue the reinsurance on a block of business. This is normally done to increase our retention on older business to the same level as current cessions.
Generally, we enter into indemnity reinsurance arrangements to assist in diversifying our risks and to limit our maximum loss on risks that exceed our policy retention limits. Our maximum retention limit on life policies issued after June 30, 1999 is $1,100,000. For policies issued prior to July 1, 1999, the maximum retention is generally limited to $600,000. Indemnity reinsurance does not fully discharge our obligation to pay claims on the reinsured business. As the ceding insurer, we remain responsible for policy claims to the extent the reinsurer fails to pay claims. No reinsurer of business ceded by us has failed to pay any material policy claims (either individually or in the aggregate) with respect to our ceded business. We continually monitor the financial strength of our reinsurers. If for any reason reinsurance coverages would need to be replaced, we believe that replacement coverages from financially responsible reinsurers would be available. A summary of our primary reinsurers as of December 31, 2000 is as follows:
A.M. BEST AMOUNT OF IN REINSURER RATING FORCE CEDED ----------- -------------- (DOLLARS IN MILLIONS) Lincoln National Life Insurance Company............ A $ 730.3 Business Men's Assurance Company................... A 545.0 Swiss Re Life & Health America Inc ................ A++ 251.3 The Cologne Life Reinsurance Company............... A+ 243.2 All other.......................................... 289.2 -------------- Total.......................................... $ 2,059.0 ==============
POLICY RESERVES
The policy liabilities reflected in the consolidated financial statements are calculated in accordance with accounting principles generally accepted in the United States. Liabilities for universal life and annuity policies consist of the premiums and considerations received plus accumulated credited interest, less accumulated policyholder assessments and benefits. For traditional policies, liabilities for future policy benefits have been provided based on the net level premium method, including assumptions as to interest, mortality and other assumptions underlying the guaranteed policy cash values. See Note 1 of Notes to Consolidated Financial Statements for additional information regarding policy liability assumptions.
INTEREST CREDITING AND PARTICIPATING DIVIDEND POLICY
We have an asset/liability management committee that meets monthly, or more frequently if required, to review and establish current period interest rates based upon existing and anticipated investment opportunities. This applies to new sales and to universal life insurance and annuity products after any initial guaranteed period. We examine earnings on assets by portfolio. We then establish rates based on each product's required interest spread and competitive market conditions at the time.
We pay dividends, credit interest and determine other nonguaranteed elements on the individual insurance policies depending on the type of product. Some elements, such as dividends, are generally declared for a year at a time. Interest rates and other nonguaranteed elements are determined based on experience as it emerges and with regard to competitive factors.
Policyholder dividends are currently being paid and will continue to be paid as declared on traditional participating whole life business, some term business, and the participating annuity policies. Policyholder dividend scales are
generally established annually and are based on the performance of assets supporting these policies, the mortality experience of the policies, and expense levels. Other factors, such as changes in tax law, may be considered as well. Average contractual credited rates on our universal life contracts were 5.99% in 2000, 6.01% in 1999 and 6.12% in 1998 and average credited rates on our annuity contracts were 5.75% in 2000, 5.69% in 1999 and 6.05% in 1998.
RATINGS
Ratings are an important factor in establishing the competitive position of insurance companies. Farm Bureau Life is rated "A+(Superior)" by A.M. Best, A.M. Best's second highest rating of 13 ratings assigned to solvent insurance companies, which currently range from "A++(Superior)" to "D(Poor)." Farm Bureau Life has maintained its existing "A+(Superior)" rating since A.M. Best first began using this rating methodology. EquiTrust is rated "A- (Excellent)" by A.M. Best. A.M. Best ratings consider claims paying ability and are not a rating of investment worthiness.
VARIABLE SUB-ACCOUNTS AND MUTUAL FUNDS
We sponsor the EquiTrust Series Fund, Inc. (the Series Fund) and EquiTrust Variable Insurance Series Fund (the Insurance Series Fund) (collectively, the EquiTrust Funds) which are open-end, diversified series management investment companies. The Series Fund is available to the general public. The Variable Insurance Series Fund offers its shares, without a sales charge, only to our separate accounts and our alliance partners as the investment medium for variable annuity contracts or variable life insurance policies. These Funds each currently issue shares in six investment series (a Portfolio or collectively the Portfolios) with the following distinct investment objectives: (1) long-term capital appreciation by investing in equity securities which have a potential to earn a high return on capital or are undervalued by the marketplace; (2) as high a level of current income as is consistent with investment in a portfolio of debt securities deemed to be of high grade; (3) as high a level of current income as is consistent with investment in a portfolio of fixed-income securities rated in the lower categories of established rating services; (4) high total investment return of income and capital appreciation by investing in growth common stocks, high grade debt securities and preferred stocks and high quality short-term money market instruments; (5) high current income consistent with liquidity and stability of principal, and (6) an unmanaged index fund, which seeks growth of capital and income by investing primarily in common stocks of designated well-capitalized, established companies. The net assets of the equity EquiTrust Funds at December 31, 2000 aggregated $411.3 million.
Our variable products also include sub-accounts that invest in mutual funds managed by outside investment advisors in addition to our proprietary funds. We receive an administrative service fee from the outside investment advisors ranging from 0.05% to 0.25% (annualized) of the sub-account values, generally once the sub-accounts meet a predetermined asset threshold.
EquiTrust Investment Management Services, Inc. (the Advisor), a subsidiary, receives an annual fee based on the average daily net assets of each EquiTrust Portfolio that ranges from 0.25% to 0.60% for the Series Fund and from 0.20% to 0.45% for the Variable Insurance Series Fund. The Advisor also serves as distributor and principal underwriter for the EquiTrust Funds. The Advisor receives from the Series Fund a 0.50% annual distribution services fee, a 0.25% annual administration services fee and a 0.05% accounting fee, and receives directly any contingent deferred sales charge paid on the early redemption of shares. EquiTrust Marketing Services, LLC, another subsidiary, serves as the principal dealer for the Series Fund and receives commissions and service fees.
We also sponsor a money market fund, EquiTrust Money Market Fund, Inc. (Money Market Fund), which is a no-load open-end diversified management investment company with an investment objective of maximum current income consistent with liquidity and stability of principal. The Advisor acts as the investment advisor, manager and principal underwriter of the Money Market Fund and receives an annual management fee, accrued daily and payable monthly at 0.25%, and certain other fees. The net assets of the Money Market Fund were $28.9 million at December 31, 2000.
EquiTrust Series Fund, Inc. and EquiTrust Money Market Fund, Inc. are offered through registered representatives of EquiTrust Marketing Services, LLC. For more complete information including fees, charges and other expenses, obtain a prospectus from EquiTrust Marketing Services, LLC, 5400 University Avenue, West Des Moines, Iowa 50266. Read the prospectus before you invest or pay money.
COMPETITION
We operate in a highly competitive industry. The operating results of companies in the insurance industry have been historically subject to significant fluctuations due to competition, economic conditions, interest rates, investment performance, maintenance of insurance ratings from rating agencies such as A.M. Best and other factors. We believe our ability to compete with other insurance companies is dependent upon, among other things, our ability to attract and retain agents to market our insurance products, our ability to develop competitive and profitable products and our ability to maintain high ratings from A.M. Best. In connection with the development and sale of our products, we encounter significant competition from other insurance companies, and other financial institutions, such as banks and broker-dealers, many of which have financial resources substantially greater than ours.
REGULATION
Our insurance subsidiaries are subject to government regulation in each of the states in which they conduct business. This regulatory authority is vested in state agencies having broad administrative power dealing with all aspects of the insurance business, including rates, policy forms and capital adequacy, and is concerned primarily with the protection of policyholders rather than stockholders. Our variable insurance products, mutual funds, investment advisor and certain licensed broker-dealers and agents are also subject to regulation by the Securities and Exchange Commission, the NASD and state agencies.
Increased scrutiny has been placed upon the insurance regulatory framework, and certain state legislatures have considered or enacted laws that alter, and in many cases increase, state authority to regulate insurance companies and insurance holding company systems. In light of ongoing legislative developments, the National Association of Insurance Commissioners (NAIC) and state insurance regulators continue to reexamine existing laws and regulations, accounting policies and procedures, specifically focusing on insurance company investments and solvency issues, risk-adjusted capital guidelines, interpretations of existing laws, the development of new laws, the implementation of nonstatutory guidelines and the circumstances under which dividends may be paid. We do not believe the adoption in any of our operating states of any of the current NAIC initiatives will have a material adverse impact on us; however, we cannot predict the form of any future proposals or regulation.
EMPLOYEES
At February 1, 2001, we had approximately 1,260 employees. Many employees and the executive officers also provide services to Farm Bureau Mutual Insurance Company and other affiliates pursuant to management agreements. None of our employees are members of a collective bargaining unit. We believe that we have good employee relations.
ITEM 2.
ITEM 2. PROPERTIES
Our principal operations are conducted from property leased from a subsidiary of the Iowa Farm Bureau Federation under a 15 year operating lease which expires in 2013. The property leased currently consists of approximately 183,000 square feet of a 400,000 square foot office building in West Des Moines, Iowa. We also lease 22,000 square feet of an office building in Manhattan, Kansas under a 5 year operating lease which expires in 2006. We consider the current facilities to be adequate for the foreseeable future.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
We are a party to lawsuits arising in the normal course of business. We believe the resolution of these lawsuits will not have a material adverse effect on our financial condition or results of operations.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
STOCK MARKET AND DIVIDEND INFORMATION
The Class A common stock of FBL Financial Group, Inc. is traded on the New York Stock Exchange under the symbol FFG. The following table sets forth the cash dividends per common share and the high and low prices of FBL Financial Group Class A common stock for each quarter of 2000 and 1999.
There is no established public trading market for our Class B common stock. As of March 1, 2001, there were approximately 2,800 holders of Class A common stock, including participants holding securities under the name of a broker (i.e., in "street name"), and 26 holders of Class B common stock.
We intend to declare regular quarterly cash dividends in the future, subject to the discretion of the Board of Directors, which depends in part upon general business conditions, legal restrictions and other factors the Board of Directors deems relevant. It is anticipated the quarterly dividend rate during 2001 will be $0.10 per common share.
For restrictions on dividends, see "Management's Discussion and Analysis of Financial Condition and Results of Operation - Liquidity" and Note 13 to the consolidated financial statements.
On January 1, 2001, we acquired the assets and liabilities of Kansas Farm Bureau Life Insurance Company. As consideration for the purchase, we issued 3,429,500 shares of Series C cumulative voting mandatorily redeemable preferred stock with a fair value of $80.4 million to The Kansas Farm Bureau. Each share of Series C preferred stock has a par value of $26.8404 and voting rights identical to that of Class A common stock. Dividends on the Series C preferred stock are payable quarterly at a rate equal to the common stock dividend per share then payable. The mandatory redemption is structured so that 49.5% of the Series C preferred stock will be redeemed at par value, or $45.6 million, on January 2, 2004 with the remaining 50.5% redeemed at par value, or $46.5 million, on January 3, 2006. In the event of a change in the control of the Company, at the option of the holder, each share of Series C preferred stock is convertible into one share of Class A common stock or redeemable for cash at par. The Series C preferred stock is exempt from registration pursuant to Section 4(2) of the Securities Act of 1933.
ITEM 6.
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
NOTES TO SELECTED CONSOLIDATED FINANCIAL DATA
(1) Excludes the effect of reporting certain fixed maturity securities at fair value.
(2) Adjusted operating income equals net income adjusted to eliminate certain items which we believe are not indicative of operating trends because they are unusual and/or nonrecurring in nature, including the impact of realized gains (losses) on investments, gain on sale of discontinued operations and net income (loss) from a venture capital investment company subsidiary. See "Management's Discussion and Analysis of Financial Condition and Results of Operations."
(3) Statutory data has been derived from the annual statements of our insurance subsidiaries, as filed with insurance regulatory authorities and prepared in accordance with statutory accounting practices.
(4) Net statutory premiums include premiums collected from annuities and universal life-type products. For GAAP reporting, such premiums received are not reported as revenues. Amounts include internal rollover premiums to variable universal life or variable annuity contracts totaling $25.0 million in 2000, $17.1 million in 1999, $29.5 million in 1998, $14.1 million in 1997 and $3.6 million in 1996.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
THE FOLLOWING SECTIONS INCLUDE A SUMMARY OF FBL FINANCIAL GROUP, INC.'S CONSOLIDATED RESULTS OF OPERATIONS, FINANCIAL CONDITION AND WHERE APPROPRIATE, FACTORS THAT MANAGEMENT BELIEVES MAY AFFECT FUTURE PERFORMANCE. PLEASE READ THIS DISCUSSION IN CONJUNCTION WITH THE ACCOMPANYING CONSOLIDATED FINANCIAL STATEMENTS AND RELATED NOTES. UNLESS NOTED OTHERWISE, ALL REFERENCES TO FBL FINANCIAL GROUP, INC (WE OR THE COMPANY) INCLUDE ALL OF ITS DIRECT AND INDIRECT SUBSIDIARIES, INCLUDING ITS PRIMARY LIFE INSURANCE SUBSIDIARIES, FARM BUREAU LIFE INSURANCE COMPANY (FARM BUREAU LIFE) AND EQUITRUST LIFE INSURANCE COMPANY (EQUITRUST) (COLLECTIVELY, THE LIFE COMPANIES).
OVERVIEW
We sell universal life, variable universal life, and traditional life insurance and traditional and variable annuity products. Through December 31, 2000, these products were principally marketed through a core distribution force consisting of approximately 1,645 exclusive Farm Bureau agents in 14 midwestern and western states. On January 1, 2001, our agency force and geographic marketing territory expanded with the acquisition of the assets and liabilities of Kansas Farm Bureau Life Insurance Company, a single-state life insurance company selling traditional life and annuity products in the state of Kansas. At December 31, 2000, Kansas Farm Bureau Life had 336 exclusive agents and held the largest market share of combined life insurance and annuity business in the state of Kansas.
Variable universal life and variable annuity products are also marketed in other states through alliances with unaffiliated Farm Bureau companies. We also market variable products through alliances with two life insurance companies and a regional broker-dealer not affiliated with Farm Bureau. Several subsidiaries support various functional areas of the Life Companies and other affiliates, by providing investment advisory, marketing and distribution, and leasing services. In addition, we manage four Farm Bureau affiliated property-casualty insurance companies.
In accordance with accounting principles generally accepted in the United States (GAAP), premiums and considerations received for interest sensitive products such as universal life insurance and ordinary annuities are reflected as increases in liabilities for policyholder account balances and not as revenues. Revenues reported for interest sensitive products consist of policy charges for the cost of insurance, administration charges, amortization of policy initiation fees and surrender charges assessed against policyholder account balances. Surrender benefits paid relating to these products are reflected as decreases in liabilities for policyholder account balances and not as expenses. The Life Companies receive investment income earned from the funds deposited into account balances, a portion of which is passed through to the policyholders in the form of interest credited. Amounts for interest credited to policyholder account balances and benefit claims in excess of policyholder account balances are reported as expenses in the consolidated financial statements.
Premium revenues reported for traditional life insurance products are recognized as revenues when due. Future policy benefits are recognized as expenses over the life of the policy by means of the provision for future policy benefits.
For variable universal life and variable annuities, premiums received are not reported as revenues. Similar to universal life and traditional annuities, revenues reported consist of fee income and product charges collected from the policyholders. Expenses related to these products include benefit claims incurred in excess of policyholder account balances.
The costs related to acquiring new business, including certain costs of issuing policies and other variable selling expenses (principally commissions), defined as deferred policy acquisition costs, are capitalized and amortized into expense. For nonparticipating traditional life and accident and health insurance products, these costs are amortized over the premium paying period of the related policies, in proportion to the ratio of annual premium revenues to total anticipated premium revenues. Such anticipated premium revenues are estimated using the same assumptions used for computing liabilities for future policy benefits. For participating traditional life insurance and interest sensitive products, these costs are amortized generally in proportion to expected gross profits from surrender charges and investment, mortality and expense margins. This amortization is adjusted when the Life Companies revise their estimate of current or future gross profits or margins. For example, deferred policy acquisition costs are amortized
earlier than originally estimated when policy terminations are higher than originally estimated or when investments backing the related policyholder liabilities are sold at a gain prior to their anticipated maturity. Death and other policyholder benefits reflect exposure to mortality risk and fluctuate from year to year based on the level of claims incurred under insurance retention limits. The profitability of the Life Companies is primarily affected by fluctuations in mortality, morbidity, other policyholder benefits, expense levels, interest spreads (i.e., the difference between interest earned on investments and interest credited to policyholders) and persistency. We have the ability to mitigate adverse experience through adjustments to credited interest rates, policyholder dividends or cost of insurance charges.
Revenues and income from continuing operations are primarily derived from our life insurance segment. Revenues and expenses of our other segments, which consist of investment advisory, marketing and distribution, leasing and management operations, are principally recorded in the other income and other expense line items on the Consolidated Statements of Income. See Note 14 of the Notes to Consolidated Financial Statements for additional information regarding segment information.
RESULTS OF OPERATIONS FOR THE THREE YEARS ENDED DECEMBER 31, 2000
Net income totaled $39.3 million in 2000, $55.7 million in 1999 and $53.9 million in 1998. The decrease in net income in 2000 is generally attributable to an increase in realized losses on investments, due principally to writedowns for other-than-temporary impairments in value. In addition, net investment income decreased due primarily to a decrease in fee income from mortgage loan prepayments and bond calls. These items are partially offset by an increase in equity income. The increase in net income in 1999 is primarily the result of a decrease in realized losses on investments and increased equity income. These items are offset by an increase in operating expenses relating to the closing of an administrative service center and an increase in the level of operations to support our expanding variable alliances. In addition, net investment income decreased in 1999 due partially to a decrease in fee income from mortgage loan prepayments and bond calls. Adjusted operating income, which does not include the impact of realized gains and losses on investments and other items that management believes are not indicative of operating trends, totaled $54.5 million in 2000, $55.4 million in 1999 and $56.1 million in 1998. The following is a reconciliation of net income to adjusted operating income.
The adjustment for realized losses on investments noted in the table above is net of adjustments for that portion of amortization of deferred policy acquisition costs, unearned revenue reserve, value of insurance in force acquired and income taxes attributable to such gains and losses.
The change in earnings per common share from year to year is positively impacted by a decrease in the weighted average common shares outstanding during the three-year period ended December 31, 2000. Weighted average common shares outstanding, assuming dilution, totaled 30,799,891 in 2000, 32,829,972 in 1999 and 34,400,513 in 1998. These decreases are the result of acquisitions of common stock by the Company. Weighted average shares outstanding in 2001 will be similarly impacted by the acquisition of 3,750,018 shares during the fourth quarter of 2000.
Our acquisition of the assets and liabilities of Kansas Farm Bureau Life on January 1, 2001 impacts our financial position and results of operations. See "Kansas Farm Bureau Life Insurance Company Acquisition - Subsequent Event" for additional information regarding the acquisition.
Effective September 1, 2000, we entered into a 100% coinsurance agreement to reinsure our individual disability income business with an unaffiliated insurer. As a result, the Consolidated Statements of Income include the operating results from our individual accident and health business only through August 31, 2000. A loss of $0.7 million on the coinsurance transaction has been deferred and is being recognized over the term of the underlying policies. Effective September 1, 2000, our agents began to offer a long-term disability income product underwritten by one of our variable alliance partners. We do not share in the risks, costs or profits of the new product, but earn a commission on new sales. We still have a small block of group long-term disability income business that has annualized premiums of approximately $0.9 million.
A summary of our premiums and product charges is as follows:
INTEREST SENSITIVE PRODUCT CHARGES increased 8.0% in 2000 to $59.8 million and 6.1% in 1999 to $55.4 million. These increases are primarily due to increased cost of insurance charges resulting from an increase in the volume and age of business in force. In addition, mortality and expense charges have increased as a result of growth in variable product account balances. Surrender charge income increased 18.3% in 2000 to $2.5 million and decreased 27.6% in 1999 to $2.1 million as a result of changes in the level of interest sensitive product surrenders.
TRADITIONAL LIFE INSURANCE PREMIUMS increased 1.5% in 2000 to $83.8 million and 1.0% in 1999 to $82.6 million. Management believes the modest increase in the sale of traditional life insurance products is the result of a marketing emphasis placed on the sale of variable universal life insurance contracts. Premiums collected on variable universal life insurance products increased 14.4% to $48.3 million in 2000 and 11.8% to $42.3 million in 1999.
ACCIDENT AND HEALTH PREMIUMS decreased 27.7% in 2000 to $9.7 million and increased 14.0% in 1999 to $13.4 million. The decrease in 2000 is the result of our exit from the individual disability income business effective September 1, 2000. The increase in 1999 is primarily the result of the recapture of certain reinsurance ceded business.
NET INVESTMENT INCOME, which excludes investment income on separate account assets relating to variable products, decreased 2.0% in 2000 to $221.4 million and 1.0% in 1999 to $225.8 million. The decreases are attributable to decreases in yield, partially offset by increases in average invested assets. Average invested assets (based on assets excluding the impact of recording certain fixed maturity securities at market value) totaled $2,991.3 million in 2000, $2,982.1 million in 1999 and $2,895.5 million in 1998. The annualized yield earned on average invested assets was 7.40% in 2000 compared to 7.57% in 1999 and 7.88% in 1998. The yield during 2000 and 1999 declined due to changing market conditions and a reduction in the amount of prepayment and bond call fee income. Fee income from mortgage loan prepayments and bond calls totaled $0.4 million in 2000, $5.2 million in 1999 and $9.8 million in 1998. In addition, we recorded $1.7 million in interest income during 1999 relating to the settlement of a fixed maturity security that had been in default. We had discontinued the accrual of interest on this security during 1996. Net investment income in 2001 will be impacted by our acquisition of 3,750,018 FBL Class A common shares for $75.3 million during the fourth quarter of 2000.
REALIZED LOSSES ON INVESTMENTS increased to $26.0 million in 2000 and decreased to $2.3 million in 1999. Realized losses include writedowns of investments that became other-than-temporarily impaired totaling $24.5 million in 2000, $7.2 million in 1999 and $9.4 million in 1998. These writedowns are the result of sustained operating losses, defaults on loan payments, declarations of bankruptcy, unsuccessful efforts to raise capital and various other operational or economic factors that became evident in the respective years. Approximately $14.4 million of the realized losses in 2000 were from eight securities that were of investment grade when acquired. The level of realized
gains (losses) is subject to fluctuation from year to year depending on the prevailing interest rate and economic environment and the timing of the sale of investments.
OTHER INCOME decreased 6.3% in 2000 to $18.9 million and 2.8% in 1999 to $20.2 million. The decrease in 2000 is primarily due to a decrease in the level of leasing and investment advisory services provided to affiliates and third parties. The decrease in 1999 is primarily due to a decrease in rental income. A summary of our policy benefits is as follows:
INTEREST SENSITIVE PRODUCT BENEFITS increased 3.5% in 2000 to $127.6 million and 0.6% in 1999 to $123.2 million. The components of interest sensitive product benefits, along with selected average contractual interest crediting rates, are as follows:
The average crediting rate on our product portfolio has been relatively consistent during 2000 and 1999. However, due to competitive factors, we did increase the crediting rate on our flexible premium deferred annuity 0.25% in September 2000. In addition, we decreased the crediting rate on our universal life contracts 0.15% in November 2000. During 1998 we reduced the crediting rate on many of our products, in response to the general decline in market interest rates during that year. Interest sensitive death benefits increased due to an increase in the amount of insurance in force. Interest sensitive death benefits can tend to fluctuate from year to year as a result of mortality experience.
TRADITIONAL LIFE INSURANCE AND ACCIDENT AND HEALTH BENEFITS, INCLUDING THE RELATED CHANGES IN RESERVES, increased 2.3% in 2000 to $79.3 million and 0.5% in 1999 to $77.5 million. Death and surrender benefits on traditional products increased 6.1% in 2000 to $52.2 million and 2.1% in 1999 to $49.2 million. These increases were offset by a decrease in the change in reserves on life policies. Accident and health benefits, including the related change in reserves, increased 65.9% in 2000 to $9.7 million and increased 2.1% in 1999 to $5.8 million. Traditional life insurance and accident and health benefits tend to fluctuate from year to year as a result of changes in mortality and morbidity experience. As stated above, effective September 1, 2000, all individual disability income benefits are ceded to a third party.
DISTRIBUTIONS TO PARTICIPATING POLICYHOLDERS decreased 1.3% in 2000 to $25.0 million and 1.8% in 1999 to $25.4 million. The decrease for 2000 is primarily attributable to a decrease in the amount of participating business in force. The decrease for 1999 is principally due to a decrease in the average interest rate used in the dividend formula for these policies. This average interest rate was 5.72% at December 31, 2000 and 1999 and 5.84% at December 31, 1998.
A summary of our underwriting, acquisition and insurance expenses is as follows:
COMMISSION EXPENSE increased 2.2% in 2000 to $10.0 million and 6.7% in 1999 to $9.7 million. Commission expense increased during the periods due primarily to an increase in direct life insurance premiums collected.
AMORTIZATION OF DEFERRED POLICY ACQUISITION COSTS decreased 13.0% in 2000 to $10.8 million and increased 22.2% in 1999 to $12.4 million. Amortization decreased during 2000 due principally to the impact of realized losses on investments backing the related policyholder liabilities. The increase in 1999 is due partly to a shift in product profitability to blocks of business that have a larger acquisition cost remaining to be amortized or that have higher amortization factors. For both 2000 and 1999, amortization increased due to an increase in the unamortized acquisition cost asset due to growth in the volume of business in force.
OTHER UNDERWRITING, ACQUISITION AND INSURANCE EXPENSES increased 8.7% in 2000 to $52.2 million and 7.4% in 1999 to $48.0 million. Salaries, benefits and other operating expenses increased in 2000 and 1999 primarily due to increased operating expenses associated with administering our variable product business and developing variable product alliances. In addition, other information system expenses, agent training and retirement benefit costs increased in 2000 compared to 1999. Other items impacting the comparison of expenses include (i) restructuring charges of $1.2 million in 1999 and related cost savings in 2000 relating to the closing of an administrative service center, (ii) expenses totaling $0.8 million in 1999 and $2.2 million in 1998 to modify our computer systems to prepare for the Year 2000 date conversion and (iii) a credit of $1.2 million in 1998 due to changes in the amounts and timing of estimated guaranty fund assessments. Other underwriting, acquisition and insurance expenses includes goodwill amortization totaling $0.7 million in 2000, 1999 and 1998. See "Restructuring" discussion below.
INTEREST EXPENSE increased 43.2% in 2000 to $3.7 million and 51.1% in 1999 to $2.6 million due primarily to increases in average debt outstanding.
OTHER EXPENSES decreased 5.4% in 2000 to $14.2 million and 2.8% in 1999 to $15.0 million due primarily to a decrease in the level of leasing and investment advisory services provided to affiliates and third parties.
INCOME TAXES decreased 47.5 % in 2000 to $13.6 million and 1.9% in 1999 to $25.9 million. The effective tax rate was 30.3% for 2000, 31.9% for 1999 and 31.8% for 1998. The effective tax rates were lower than the federal statutory rate of 35% due primarily to the tax benefit associated with the payment of dividends on mandatorily redeemable preferred stock of subsidiary trust, tax-exempt interest and tax-exempt dividend income in 2000, 1999 and 1998. The impact of these permanent differences, which are relatively consistent from year to year, on the effective tax rate is more significant in 2000 due to the decrease in pre-tax income.
EQUITY INCOME, NET OF RELATED INCOME TAXES, increased 207.0% in 2000 to $12.2 million and 215.7% in 1999 to $4.0 million. Equity income includes our proportionate share of gains and losses attributable to our ownership interest in partnerships, joint ventures and certain companies where we exhibit some control but have a minority ownership interest. Given the timing of availability of financial information from these entities, we will consistently use information that is as much as three months in arrears for certain of these entities. Several of these entities are venture capital investment companies, whose operating results are derived primarily from unrealized and realized gains and losses generated by their investment portfolios. The income in 2000 is primarily driven by unrealized appreciation on two internet-related equity securities owned by two of these venture capital investment companies. A substantial portion of the positions held by the equity investees in these two entities was distributed to us and subsequently sold during 2000. As is normal with these types of entities, the level of these gains and losses is subject to fluctuation from period to period depending on the prevailing economic environment, changes in prices of equity securities held by the investment partnerships, timing and success of initial public offerings and other exit strategies, and the timing of the sale of investments held by the partnerships and joint ventures. Equity income includes goodwill amortization totaling $0.4 million in 2000, 1999 and 1998.
RESTRUCTURING
We closed an administrative service center during July 1999 and merged two life insurance subsidiaries effective July 1, 1999. As a result of the closing of the service center, a leased property was vacated, 22 job positions were eliminated and moving costs were incurred. During 1999, we charged to expense costs totaling $1.2 million for related severance benefits, lease costs and other costs primarily associated with closing the service center.
DISCONTINUED OPERATIONS
We recorded a gain of $0.6 million in 2000, $1.4 million in 1999 and $1.0 million in 1998, net of related income taxes, on the sale of Utah Farm Bureau Insurance Company (Utah Insurance), a former wholly-owned property-casualty insurance company, to Farm Bureau Mutual Insurance Company (Farm Bureau Mutual), an affiliate. In addition, during 1998 the increase in net unrealized appreciation on securities classified as available for sale was reduced $1.4 million, net of related income taxes, as a result of the sale. The gain on the sale may be increased in future years in accordance with an earn-out provision included in the related sales agreement. See "Liquidity - FBL Financial Group, Inc."
Income from discontinued operations totaled $0.3 million for 1998 and revenues from discontinued operations totaled $12.9 million through the date of sale in 1998.
KANSAS FARM BUREAU LIFE INSURANCE COMPANY ACQUISITION - SUBSEQUENT EVENT
Revenues, benefits and expenses will increase in 2001 as a result of our acquisition of the assets and liabilities of Kansas Farm Bureau Life Insurance Company. As a privately held company, Kansas Farm Bureau Life did not prepare financial statements in accordance with GAAP. Accordingly, historical GAAP financial statements and pro forma results assuming the acquisition on a historical basis are not available. Net income, based on statutory accounting principles, totaled $1.7 million in 2000, $4.8 million in 1999 and $4.7 million in 1998. We believe the acquisition will be slightly accretive to earnings per share in 2001.
The acquisition will be accounted for using purchase accounting. A condensed statement of the assets and liabilities acquired as of January 1, 2001, on a GAAP basis, is as follows (dollars in thousands):
As consideration for the purchase, we issued 3,429,500 shares of Series C cumulative voting mandatorily redeemable preferred stock with an estimated fair value of $80.4 million. Each share of Series C preferred stock has a par value of $26.8404 and voting rights identical to that of Class A common stock. Dividends on the Series C preferred stock are payable quarterly at a rate equal to the common stock dividend per share then payable. The mandatory redemption is structured so that 49.5% of the Series C preferred stock will be redeemed at par value, or $45.6 million, on January 2, 2004 with the remaining 50.5% redeemed at par value, or $46.5 million, on January 3, 2006. In the event of a change in the control of the Company, at the option of the holder, each share of Series C preferred stock is convertible into one share of Class A common stock or redeemable for cash at par. The Series C preferred stock was issued at an $11.6 million discount to par. This discount will accrete to preferred stock dividends during the life of the securities using the effective interest method. The effective cost of capital is approximately 5.0%. Acquisition costs totaling $0.7 million have been deferred and are included as a component of goodwill.
FINANCIAL CONDITION
INVESTMENTS
Our total investment portfolio decreased 2.7% to $2,870.7 million at December 31, 2000 compared to $2,950.2 million at December 31, 1999. This decrease is primarily the result of (i) the acquisition of our common stock, (ii) a $32.8 million net payment for reserves pursuant to the individual disability income coinsurance arrangement, (iii) net cash outflows on interest sensitive and variable products and (iv) an increase in writedowns on other-than-temporarily impaired securities. These items were partially offset by positive cash flow from operations and a decrease in net unrealized depreciation on fixed maturity securities classified as available for sale.
Over the last several years, the mix of our life insurance business has been shifting from traditional and interest sensitive products to variable products. In addition, we have an exchange program for the rollover of universal life policies to variable universal life policies. We expect the shift to variable products to continue due to this program and the continued popularity of variable products. A majority of premiums received on variable products are typically invested in our separate accounts as opposed to the general account investments. This trend is expected to impact the future growth rate of our investment portfolio and separate account assets.
Internal investment professionals manage our investment portfolio. The investment strategy is designed to achieve superior risk-adjusted returns consistent with the investment philosophy of maintaining a largely investment grade portfolio and providing adequate liquidity for obligations to policyholders and other requirements. We continually review the returns on invested assets and change the mix of invested assets as deemed prudent under the current market environment to help maximize current income.
Our investment portfolio is summarized in the table below:
As of December 31, 2000, 93.4% (based on carrying value) of the fixed maturity securities were investment grade debt securities, defined as being in the highest two National Association of Insurance Commissioners (NAIC) designations. Non-investment grade debt securities generally provide higher yields and involve greater risks than investment grade debt securities because their issuers typically are more highly leveraged and more vulnerable to adverse economic conditions than investment grade issuers. In addition, the trading market for these securities is usually more limited than for investment grade debt securities. We regularly review the percentage of our portfolio that is invested in non-investment grade debt securities (NAIC designations 3 through 6). As of December 31, 2000, the investment in non-investment grade debt was 6.6% of fixed maturity securities. At that time no single non-investment grade holding exceeded 0.3% of total investments.
The following table sets forth the credit quality, by NAIC designation and Standard & Poors (S & P) rating equivalents, of fixed maturity securities.
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(1) Private placement securities are generally rated by the Securities Valuation Office of the NAIC. Comparisons between NAIC designations and S & P ratings are published by the NAIC. S & P has not rated some of the fixed maturity securities in our portfolio.
Mortgage and other asset-backed securities constitute a significant portion of our portfolio of securities. These securities were purchased at a time when we believed these types of investments provided superior risk-adjusted returns compared to returns of more conventional investments such as corporate bonds and mortgage loans. These securities are diversified as to collateral types, cash flow characteristics and maturity.
The return of principal on mortgage and other asset-backed securities occurs more frequently and is more variable than that of more traditional fixed maturity securities. The principal prepayment speeds (e.g., the rate of individuals refinancing their home mortgages) can vary based on a number of economic factors that can not be predicted with certainty. These factors include the prevailing interest rate environment and general status of the economy. Deviations in actual prepayment speeds from that originally expected can cause a change in the yield earned on mortgage and asset-backed securities purchased at a premium or discount. Increases in prepayment speeds, which typically occur in a decreasing interest rate environment, generally increases the rate at which discount is accrued and premium is amortized into income. Decreases in prepayment speeds, which typically occur in an increasing interest rate environment, generally slows down the rate these amounts are recorded into income.
The mortgage-backed portfolio includes pass-through and collateralized mortgage obligation (CMO) securities. With a pass-through security, we receive a pro rata share of principal payments as payments are made on the underlying mortgage loans. CMOs consist of pools of mortgages divided into sections or "tranches" which provide sequential retirement of the bonds. We invest in sequential tranches, which provide cash flow stability in that principal payments do not occur until the previous tranches are paid off. In addition, to provide call protection and more stable average lives, we invest in CMOs such as planned amortization class (PAC) and targeted amortization class (TAC) securities. CMOs of these types provide more predictable cash flows within a range of prepayment speeds by shifting the prepayment risks to support tranches. We do not purchase certain types of collateralized mortgage obligations that we believe would subject the investment portfolio to greater than average risk. These include, but are not limited to, interest only, principal only, floater, inverse floater, PAC II, Z and support tranches.
The following table sets forth the par value, amortized cost and carrying value of our mortgage and asset-backed securities at December 31, 2000, summarized by type of security.
The commercial and other asset-backed securities are primarily sequential securities. Commercial mortgage-backed securities typically have cash flows that are less sensitive to interest rate changes than residential securities of similar types due principally to prepayment restrictions on many of the underlying commercial mortgage loans. Other asset-backed securities are principally mortgage related (manufactured housing and home equity loans) which historically have also demonstrated relatively less cash flow volatility than residential securities of similar types.
At December 31, 2000, we held $321.9 million or 11.2% of invested assets in mortgage loans. These mortgage loans are diversified as to property type, location and loan size, and are collateralized by the related properties. At December 31, 2000, mortgages more than 60 days delinquent accounted for less than 0.1% of the carrying value of the mortgage portfolio. Our mortgage lending policies establish limits on the amount that can be loaned to one borrower and require diversification by geographic location and collateral type. Regions with the largest concentration of our mortgage loan portfolio at December 31, 2000 include: Pacific (30.9%), which includes California; and West South Central (22.5%), which includes Oklahoma and Texas. Mortgage loans on real estate are also diversified by collateral type with office buildings (44.2%) and retail facilities (34.3%) representing the largest holdings at December 31, 2000.
OTHER ASSETS
Securities and indebtedness of related parties decreased 14.4% to $52.5 million at December 31, 2000 due primarily to distributions from equity investees and unrealized depreciation on fixed maturity securities owned by an equity investee. These items were partially offset by the impact of equity income on the securities and indebtedness balance during 2000. Reinsurance recoverable increased 966.3% to $51.3 million at December 31, 2000 due principally to the reinsurance of our individual disability income business. Deferred policy acquisition costs increased 6.2% in 2000 to $251.0 million. This increase is due to the capitalization of costs incurred with new sales, partially offset by amortization and an $11.8 million decrease resulting from the reinsurance of our individual disability income business. Assets held in separate accounts increased 27.9%, to $327.4 million at December 31, 2000 due primarily to net transfers to the separate accounts resulting from sales of our variable products. At December 31, 2000, we had total assets of $3,704.0 million, a 1.1% increase from total assets at December 31, 1999.
LIABILITIES
Policy liabilities and accruals decreased 0.2% to $2,412.1 million at December 31, 2000. The slight decrease in policy liabilities is partially attributable to our marketing emphasis on the sale of variable products. As noted under the "Investments" section above, the shift in sales to variable products will have an impact on the future growth rate of our policy liabilities and accruals as well as the separate account liabilities. In addition, future policy benefit reserves on interest sensitive products decreased due to an increase in surrender benefits during 2000. Other liabilities decreased 28.4% to $55.2 million at December 31, 2000 due primarily to a decrease in payables for investment securities purchased. At December 31, 2000, we had total liabilities of $3,130.1 million, a 2.3% increase from total liabilities at December 31, 1999.
STOCKHOLDERS' EQUITY
Stockholders' equity decreased 5.6%, to $476.8 million at December 31, 2000, compared to $505.0 million at December 31, 1999. This decrease is principally attributable to stock repurchases and dividends paid, offset, in part, by net income and a change in net unrealized investment gains/losses.
At December 31, 2000, common stockholders' equity was $473.8 million, or $17.35 per share, compared to $502.0 million, or $15.94 per share at December 31, 1999. Included in stockholders' equity per common share is ($0.78) at December 31, 2000 and ($1.52) at December 31, 1999 attributable to unrealized investment gains (losses) resulting from marking our fixed maturity securities classified as available for sale to market value. The change in unrealized appreciation of fixed maturity and equity securities classified as available for sale increased stockholders' equity $27.5 million during 2000, after related adjustments to deferred policy acquisition costs, value of insurance in force acquired, unearned revenue reserve and deferred income taxes.
MARKET RISKS OF FINANCIAL INSTRUMENTS
Interest rate risk is our primary market risk exposure. Substantial and sustained increases and decreases in market interest rates can affect the profitability of insurance products and market value of investments. The yield realized on new investments generally increases or decreases in direct relationship with interest rate changes. The market value of our fixed maturity and mortgage loan portfolios generally increases when interest rates decrease, and decreases when interest rates increase.
A majority of our insurance liabilities are backed by fixed maturity securities and mortgage loans. The fixed maturity securities have laddered maturities and a weighted average life of 7.9 years at December 31, 2000 and 8.6 years at December 31, 1999. Accordingly, the earned rate on the portfolio lags behind changes in market yields. The extent that the portfolio yield lags behind changes in market yields generally depends upon the following factors:
* The average life of the portfolio. * The amount and speed at which market interest rates rise or fall. * The amount by which bond calls, mortgage loan prepayments and paydowns on mortgage and asset-backed securities accelerate during periods of declining interest rates. * The amount by which bond calls, mortgage loan prepayments and paydowns on mortgage and asset-backed securities decelerate during periods of increasing interest rates.
For a majority of our traditional insurance products, profitability is significantly affected by the spreads between interest yields on investments and rates credited on insurance liabilities. For variable products, profitability on the portion of the policyholder's account balance invested in our general account, if any, is also affected by the spreads earned. The variable policyholder assumes essentially all the investment earnings risk for the portion of the account balance invested in the separate accounts.
For a substantial portion of our business in force, we have the ability to adjust interest or dividend crediting rates in reaction to changes in portfolio yield. We had the ability to adjust rates on 92% of our liabilities at December 31, 2000 and 93% of our liabilities at December 31, 1999. However, the ability to adjust these rates is limited by competitive factors. Surrender rates could increase and new sales could be negatively impacted if the crediting rates are not competitive with the rates on similar products offered by other insurance companies and financial service institutions. In addition, if market rates were to decrease substantially and stay at a low level for an extended period of time, our spread could be lowered due to interest rate guarantees on many of our interest sensitive products. At December 31, 2000 and 1999, interest rate guarantees on interest sensitive products ranged from 3.0% to 5.5%. The weighted average guarantee was 3.7% at December 31, 2000 and 1999.
We design our products and manage our investment portfolio in a manner to encourage persistency and to help ensure targeted spreads are earned. In addition to the ability to change interest crediting rates on our products, certain interest sensitive contracts have surrender and withdrawal penalty provisions.
The following is a summary of the surrender and discretionary withdrawal characteristics of our interest sensitive products and supplementary contracts without life contingencies:
A major component of our asset-liability management program is structuring the investment portfolio with cash flow characteristics consistent with the cash flow characteristics of our insurance liabilities. We use computer models to perform simulations of the cash flows generated from existing insurance policies under various interest rate scenarios. Information from these models is used in the determination of interest crediting rates and investment strategies. Effective duration is a common measure for price sensitivity to changes in interest rates. It measures the approximate percentage change in the market value of a portfolio when interest rates change by 100 basis points. This measure includes the impact of estimated changes in portfolio cash flows from features such as bond calls and prepayments. When the estimated durations of assets and liabilities are similar, exposure to interest rate risk is reduced because a change in the value of assets should be largely offset by a change in the value of liabilities. The effective duration of our fixed maturity portfolio was approximately 4.3 at December 31, 2000 and 4.7 at December 31, 1999. The effective duration of the interest sensitive products was approximately 4.7 at December 31, 2000 and 4.5 at December 31, 1999.
If interest rates were to increase 10% from levels at December 31, 2000 and 1999, our fixed maturity securities and short-term investments would decrease approximately $54.1 million at December 31, 2000 and $75.1 million at December 31, 1999. This hypothetical change in value does not take into account any offsetting change in the value of insurance liabilities for investment contracts since we estimate such value to be the cash surrender value of the underlying contracts. If interest rates were to decrease 10% from levels at December 31, 2000 and 1999, the fair value of our debt and mandatorily redeemable preferred stock of subsidiary trust would increase $2.8 million at December 31, 2000 and $2.9 million at December 31, 1999.
The computer models used to estimate the impact of a 10% change in market interest rates use many assumptions and estimates that materially impact the fair value calculations. Key assumptions used by the models include an immediate and parallel shift in the yield curve and an acceleration of bond calls and principal prepayments on mortgage and other asset-backed securities. The above estimates do not attempt to measure the financial statement impact on the resulting change in deferred policy acquisition costs, value of insurance in force acquired, unearned revenue reserves and income taxes. Due to the subjectivity of these assumptions, the actual impact of a 10% change in rates on the fair market values would likely be different from that estimated.
Equity price risk is not material to us due to the relatively small equity portfolio held at December 31, 2000. However, we do earn investment management fees (on those investments managed by us) and mortality and expense fee income based on the value of our separate accounts. On an annualized basis, the investment management fee rates range from 0.20% to 0.45% for 2000 and 1999. The mortality and expense fee rates range from 0.90% to 1.40% for 2000 and 1999. As a result, revenues from these sources do fluctuate with changes in the market value of the equity, fixed maturity and other securities held by the separate accounts.
LIQUIDITY
FBL FINANCIAL GROUP, INC.
Parent company cash inflows from operations consists primarily of (i) dividends from subsidiaries, if declared and paid, (ii) fees which it charges the various subsidiaries and affiliates for management of their operations, (iii) expense reimbursements from subsidiaries and affiliates and (iv) tax settlements between the parent company and its subsidiaries. Cash outflows are principally for salaries and other expenses related to providing these management
services, dividends on outstanding stock and interest on our holding company debt issued to a subsidiary. In addition, our parent company will on occasion enter into capital transactions such as the acquisition of our common stock.
We received $25.0 million in cash on March 31, 1998 in connection with the sale of Utah Insurance. We received $5.2 million (before applicable taxes) subsequent to the sale in accordance with an earn-out provision included in the underlying sales agreement. We may receive additional consideration during each of the two years in the period ending December 31, 2003, in accordance with the earn-out provision. Under the earn-out arrangement, we and Farm Bureau Mutual share equally in the dollar amount by which the incurred losses on Utah Insurance's direct business, net of reinsurance ceded, is less than the incurred losses assumed in the valuation model used to derive the initial $25.0 million acquisition price. The earn-out calculation is performed and settlements (subject to a maximum of $2.0 million per year) are made on a calendar year basis.
We acquired Class A common shares totaling 4,358,397 in 2000, 1,322,920 in 1999 and 3,497,648 in 1998 as a result of stock repurchases and an exchange of a subsidiary owning our home office properties in 1998. These transactions reduced stockholders' equity $85.8 million in 2000, $25.7 million in 1999 and $70.7 million in 1998.
We paid common and preferred stock dividends totaling $11.0 million in 2000, $10.8 million in 1999 and $10.2 million in 1998. Interest payments on the parent company's 5% Subordinated Deferrable Interest Notes (the Notes), relating to the company-obligated mandatorily redeemable preferred stock of subsidiary trust, totaled $5.0 million in 2000, 1999 and 1998. It is anticipated that cash dividend requirements for 2001 will be $0.10 per quarter per common and Series C preferred share and $0.0075 per quarter per Series B preferred share, or approximately $12.5 million. In addition, interest payments on the Notes are estimated to be $5.0 million for 2001.
FBL Financial Group, Inc. expects to rely on available cash resources and on dividends from Farm Bureau Life to make any dividend payments to its stockholders and interest payments on its Notes. In addition, it is anticipated that dividends from Farm Bureau Life will be used to fund the scheduled redemption of the Series C preferred stock in 2004 ($45.6 million) and 2006 ($46.5 million). The ability of Farm Bureau Life to pay dividends to FBL Financial Group, Inc. is limited by law to earned profits (statutory unassigned surplus) as of the date the dividend is paid, as determined in accordance with accounting practices prescribed by insurance regulatory authorities of the State of Iowa. In addition, under the Iowa Insurance Holding Company Act, Farm Bureau Life may not pay an "extraordinary" dividend without prior notice to and approval by the Iowa insurance commissioner. An "extraordinary" dividend is defined under the Iowa Insurance Holding Company Act as any dividend or distribution of cash or other property whose fair market value, together with that of other dividends or distributions made within the preceding 12 months, exceeds the greater of (i) 10% of policyholders' surplus (total statutory capital stock and statutory surplus) as of December 31 of the preceding year, or (ii) the statutory net gain from operations of the insurer for the 12-month period ending December 31 of the preceding year. During 2001, the maximum amount legally available for distribution to FBL Financial Group, Inc. without further regulatory approval is $49.9 million.
The parent company had available cash and investments totaling $22.2 million at December 31, 2000. As of December 31, 2000, we had no commitments for capital expenditures other than for the assets and liabilities of Kansas Farm Bureau Life, which was funded with the issuance of Series C preferred stock on January 1, 2001.
INSURANCE OPERATIONS
The Life Companies' cash inflows consist primarily of premium income, deposits to policyholder account balances, product charges on variable products, income from investments, sales, maturities and calls of investments and repayments of investment principal. The Life Companies' cash outflows are primarily related to withdrawals of policyholder account balances, investment purchases, payment of policy acquisition costs, policyholder benefits, income taxes, dividends and current operating expenses. Life insurance companies generally produce a positive cash flow which may be measured by the degree to which cash inflows are adequate to meet benefit obligations to policyholders and normal operating expenses as they are incurred. The remaining cash flow is generally used to increase the asset base to provide funds to meet the need for future policy benefit payments and for writing new business. The Life Companies' liquidity positions continued to be favorable in 2000, with cash inflows at levels sufficient to provide the funds necessary to meet their obligations.
During 2000, the Life Companies experienced net cash outflows of $36.5 million from continuing operations and financing activities related to interest sensitive products. The net cash outflow is primarily a result of a $32.8 million net payment for reserves pursuant to the individual disability income coinsurance arrangement and increased surrender benefits on interest sensitive products and rollovers from traditional products to variable products. This cash outflow was funded with available cash and cash provided from investing activities. The Life Companies had net cash inflows from continuing operations and financing activities related to interest sensitive products of $104.1 million in 1999 and $121.5 million in 1998. During 1999 and 1998, these funds were primarily used to increase the Life Companies' short-term and fixed maturity investment portfolios. In developing their investment strategy, the Life Companies establish a level of cash and securities which, combined with expected net cash inflows from operations, maturities of fixed maturity investments and principal payments on mortgage and asset-backed securities and mortgage loans, are believed adequate to meet anticipated short-term and long-term benefit and expense payment obligations.
Through its membership in the Federal Home Loan Bank of Des Moines (FHLB), Farm Bureau Life is eligible to establish and borrow on a line of credit to provide it additional liquidity. The line of credit available is based on the amount of capital stock of the FHLB owned by Farm Bureau Life, which supported a borrowing capacity of $132.7 million as of December 31, 2000. At December 31, 2000, Farm Bureau Life had outstanding borrowings of $40.0 million under this arrangement, leaving a borrowing capacity of $92.7 million. Additional collateral would need to be deposited with the FHLB in order to access this additional borrowing capacity. The outstanding debt is due September 17, 2003, and interest on the debt is charged at a variable rate equal to the London Interbank Offered Rate less 0.0475% (6.50% at December 31, 2000). Fixed maturity securities with a carrying value of $43.1 million are on deposit with the FHLB as collateral for the note.
We have a $12.0 million line of credit with Farm Bureau Mutual in the form of a revolving demand note. Borrowings on the note, which totaled $9.9 million at December 31, 2000 and $11.7 million at December 31, 1999, were used to acquire assets that were leased to certain affiliates, including Farm Bureau Mutual. Interest was payable at a rate equal to the prime rate of a national bank (9.50% at December 31, 2000). During January 2001, this note was repaid through the sale of the related assets to Farm Bureau Mutual.
We anticipate that funds to meet our short-term and long-term capital expenditures, cash dividends to stockholders and operating cash needs will come from existing capital and internally generated funds. We believe that the current level of cash and available-for-sale and short-term securities, combined with expected net cash inflows from operations, maturities of fixed maturity investments, principal payments on mortgage and asset-backed securities, mortgage loans and our insurance products, are adequate to meet our anticipated cash obligations for the foreseeable future. Our investment portfolio at December 31, 2000, included $64.7 million of short-term investments and $271.1 million in carrying value of U.S. Government and U.S. Government agency backed securities that could be readily converted to cash at or near carrying value.
PENDING ACCOUNTING CHANGE
In June 1998, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (Statement) No. 133, "Accounting for Derivative Instruments and Hedging Activities." In June 2000, the FASB issued Statement 138, "Accounting for Certain Derivative Instruments and Certain Hedging Activities." Statement No. 133 requires companies to record derivatives on the balance sheet as assets or liabilities, measured at fair value. Accounting for gains or losses resulting from changes in the values of those derivatives is dependent on the use of the derivative and whether it qualifies for hedge accounting. Statement No. 133 allows companies to transfer securities classified as held for investment to either the available-for-sale or trading categories in connection with the adoption of the new standard. Statement 138 amends Statement 133 to clarify the appropriate accounting for certain hedging transactions. We adopted the Statements on January 1, 2001, their effective dates.
Because of our minimal use of derivatives, we do not anticipate that the adoption of the new Statements will have a significant effect on our earnings or financial position. However, at December 31, 2000, we do own 11 convertible fixed maturity securities with a carrying value of $36.1 million. The conversion features on these securities are considered embedded derivatives and, accordingly, changes in fair value of the conversion features will be reflected in net income in future periods. The fair value of these embedded derivatives is estimated to be $3.7 million at December 31, 2000. Since it is not possible to predict future changes in fair value, the impact of adopting the Statements on these securities cannot be predicted. The cumulative effect of this accounting change on net income, representing the difference in accumulated net unrealized capital gains (losses) under the two methods, totaled $0.5 million.
Effective January 1, 2001, upon adoption of the Statements, we transferred our fixed maturity securities classified as held for investment to the available-for-sale category. In connection with this transfer, the securities were marked to market and the corresponding increase in carrying value totaling $2.8 million, net of offsetting adjustments to deferred acquisition costs, value of insurance in force acquired, unearned revenue reserve and income taxes, will be credited to stockholders' equity during the first quarter of 2001.
EFFECTS OF INFLATION
We do not believe that inflation has had a material effect on our consolidated results of operations.
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION
From time to time, we may publish statements relating to anticipated financial performance, business prospects, new products, and similar matters. These statements and others that include words such as "expect", "anticipate", "believe", "intend", and other similar expressions, constitute forward-looking statements under the Private Securities Litigation Reform Act of 1995. The Private Securities Litigation Reform Act of 1995 provides a safe harbor for these types of statements. In order to comply with the terms of the safe harbor, please note that a variety of factors could cause our actual results and experiences to differ materially from the anticipated results or other expectations expressed in our forward-looking statements. The risks and uncertainties that may affect the operations, performance, development and results of our business include but are not limited to the following:
* Changes to interest rate levels and stock market performance may impact our lapse rates, market value of our investment portfolio and our ability to sell life insurance products, notwithstanding product features to mitigate the financial impact of such changes. * The degree to which our products are accepted by customers and agents (including the agents of our alliance partners) will impact our future growth rate. * Extraordinary acts of nature or man may result in higher than expected claim activity. * Changes in federal and state income tax laws and regulations may affect the relative tax advantage of our products.
ITEM 7a.
ITEM 7a. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK
See Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations - Market Risks of Financial Instruments", for our qualitative and quantitative disclosures about market risk.
ITEM 8.
ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
FBL FINANCIAL GROUP, INC. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998
Report of Management........................................................ 30 Report of Independent Auditors.............................................. 31
Audited Consolidated Financial Statements
Consolidated Balance Sheets................................................. 32 Consolidated Statements of Income........................................... 34 Consolidated Statements of Changes in Stockholders' Equity.................. 35 Consolidated Statements of Cash Flows....................................... 36 Notes to Consolidated Financial Statements.................................. 38
REPORT OF MANAGEMENT
To Our Stockholders
The management of FBL Financial Group, Inc. is responsible for the integrity of the financial information contained in this annual report. The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States. Certain financial information presented depends on management's estimates and judgments regarding the ultimate outcome of transactions that are not yet complete. Management believes these estimates and judgements are fair and reasonable based upon available information.
Management maintains a system of internal control designed to meet its responsibilities for preparing reliable financial statements. The system is designed to provide reasonable assurance that assets are safeguarded and transactions are properly authorized and reported. Reasonable assurance is based upon the premise that the cost of controls should not exceed the benefits derived from them. An internal audit department is maintained to continually monitor and challenge the adequacy of internal control. It is management's opinion that its system of internal control during the periods covered by this annual report was effective in providing reasonable assurance that the financial statements are fairly stated in all material respects.
We engage Ernst & Young LLP as independent auditors to audit our financial statements and express their opinion thereon. Their audits include reviews and tests of our internal controls to the extent they believe necessary to determine and conduct the audit procedures that support their opinion. A copy of Ernst & Young LLP's audit opinion follows this letter.
The Audit Committee of the Board of Directors, composed solely of nonmanagement directors, meets periodically with management, internal auditors and Ernst & Young LLP to review internal accounting control, audit activities, auditor independence and financial reporting matters. The internal auditors and Ernst & Young LLP have free access to the Audit Committee, with and without the presence of management, to discuss the adequacy of internal controls and to review the quality of financial reporting. The Audit Committee is also responsible for making recommendations to the Board of Directors concerning the selection of independent auditors.
/s/ William J. Oddy -------------------- CHIEF EXECUTIVE OFFICER AND DIRECTOR
/s/ James W. Noyce ------------------ CHIEF FINANCIAL OFFICER
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Stockholders FBL Financial Group, Inc.
We have audited the accompanying consolidated balance sheets of FBL Financial Group, Inc. as of December 31, 2000 and 1999, and the related consolidated statements of income, changes in stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2000. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States. 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, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of FBL Financial Group, Inc. at December 31, 2000 and 1999, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2000, in conformity with accounting principles generally accepted in the United States.
/s/ Ernst & Young LLP
Des Moines, Iowa February 5, 2001
FBL FINANCIAL GROUP, INC. CONSOLIDATED BALANCE SHEETS (DOLLARS IN THOUSANDS)
FBL FINANCIAL GROUP, INC. CONSOLIDATED BALANCE SHEETS (CONTINUED) (DOLLARS IN THOUSANDS)
See accompanying notes.
FBL FINANCIAL GROUP, INC. CONSOLIDATED STATEMENTS OF INCOME (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
See accompanying notes.
FBL FINANCIAL GROUP, INC. CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (DOLLARS IN THOUSANDS)
See accompanying notes.
FBL FINANCIAL GROUP, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (DOLLARS IN THOUSANDS)
FBL FINANCIAL GROUP, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED) (DOLLARS IN THOUSANDS)
See accompanying notes.
FBL FINANCIAL GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SIGNIFICANT ACCOUNTING POLICIES
NATURE OF BUSINESS
FBL Financial Group, Inc. (we or the Company) operates predominantly in the life insurance industry through its principal subsidiaries, Farm Bureau Life Insurance Company (Farm Bureau Life) and EquiTrust Life Insurance Company (EquiTrust) (collectively, the Life Companies). We currently market individual life insurance policies and annuity contracts to Farm Bureau members and other individuals and businesses in 15 midwestern and western states through an exclusive agency force. Variable universal life insurance and variable annuity contracts are also marketed in these and other states through alliances with other insurance companies and a regional broker/dealer. Several subsidiaries support various functional areas of the Life Companies and other affiliates, by providing investment advisory, marketing and distribution, and leasing services. In addition, we manage four Farm Bureau affiliated property-casualty companies.
On January 1, 2001, our agency force and geographic marketing territory expanded with the acquisition of the assets and liabilities of Kansas Farm Bureau Life Insurance Company, a single-state life insurance company selling traditional life and annuity products in the state of Kansas. See Note 15, "Kansas Farm Bureau Life Insurance Company Acquisition - Subsequent Event," for additional information regarding this transaction.
CONSOLIDATION
Our consolidated financial statements include the financial statements of FBL Financial Group, Inc. and its direct and indirect subsidiaries. All significant intercompany transactions have been eliminated.
INVESTMENTS
FIXED MATURITIES AND EQUITY SECURITIES
Fixed maturity securities, comprised of bonds and redeemable preferred stocks that we have a positive intent and ability to hold to maturity, are designated as "held for investment." Held for investment securities are reported at cost adjusted for amortization of premiums and discounts. Changes in the market value of these securities, except for declines that are other than temporary, are not reflected in our financial statements. Fixed maturity securities which may be sold are designated as "available for sale." Available for sale securities are recorded at market value and unrealized gains and losses on these securities are included directly in stockholders' equity as a component of accumulated other comprehensive income or loss. The unrealized gains and losses included in accumulated other comprehensive income or loss are reduced by a provision for deferred income taxes and adjustments to deferred policy acquisition costs, value of insurance in force acquired and unearned revenue reserve that would have been required as a charge or credit to income had these amounts been realized. Premiums and discounts are amortized/accrued using methods which result in a constant yield over the securities' expected lives. Amortization/accrual of premiums and discounts on mortgage and asset-backed securities incorporates prepayment assumptions to estimate the securities' expected lives.
Equity securities, comprised of common and non-redeemable preferred stocks, are reported at market value. The change in unrealized appreciation and depreciation of equity securities is included directly in stockholders' equity, net of any related deferred income taxes, as a component of accumulated other comprehensive income or loss.
MORTGAGE LOANS ON REAL ESTATE
Mortgage loans on real estate are reported at cost adjusted for amortization of premiums and accrual of discounts. If we determine that the value of any mortgage loan is impaired (i.e., when it is probable we will be unable to collect all amounts due according to the contractual terms of the loan agreement), the carrying value of the mortgage loan is reduced to its fair value, which may be based upon the present value of expected future cash flows from the loan (discounted at the loan's effective interest rate), or the fair value of the underlying collateral. The carrying value of impaired loans is reduced by the establishment of a valuation allowance, changes to which are recognized as realized gains or losses on investments. Interest income on impaired loans is recorded on a cash basis.
FBL FINANCIAL GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
INVESTMENT REAL ESTATE
Investment real estate is reported at cost less allowances for depreciation. Real estate acquired through foreclosure, which is included with investment real estate in our consolidated balance sheets, is recorded at the lower of cost (which includes the balance of the mortgage loan, any accrued interest and any costs incurred to obtain title to the property) or estimated fair value on the foreclosure date. The carrying value of these assets is subject to regular review. If the fair value, less estimated sales costs, of real estate owned decreases to an amount lower than its carrying value, a specific writedown is taken. Such reductions are recorded as realized losses on investments.
OTHER INVESTMENTS
Policy loans are reported at unpaid principal balance. Short-term investments are reported at cost adjusted for amortization of premiums and accrual of discounts.
Other long-term investments include certain nontraditional investments and securities held by subsidiaries engaged in the broker-dealer industry. Nontraditional investments include a debt-related instrument and investment deposits which are reported at cost. In accordance with accounting practices for the broker-dealer industry, marketable securities held by subsidiaries in this industry are valued at market value. The resulting difference between cost and market is included in the statements of income as net investment income. Realized gains and losses are also reported as a component of net investment income.
Securities and indebtedness of related parties include investments in partnerships and corporations over which we may exercise significant influence. These partnerships and corporations operate predominately in the insurance, broker-dealer, investment company and real estate industries. Such investments are accounted for using the equity method. In applying the equity method, we record our share of income or loss reported by the equity investees. For partnerships operating in the investment company industry, this income or loss includes changes in unrealized gains and losses in the partnerships' investment portfolios. Changes in the value of our investment in equity investees attributable to capital transactions of the investee, such as an additional offering of stock, are recorded directly to stockholders' equity. Securities and indebtedness of related parties also includes advances and loans to the partnerships and corporations which are principally reported at cost.
REALIZED GAINS AND LOSSES ON INVESTMENTS
The carrying values of all our investments are reviewed on an ongoing basis for credit deterioration. If this review indicates a decline in market value that is other than temporary, carrying value of the investment is reduced to its estimated realizable value, or fair value, and a specific writedown is taken. Such reductions in carrying value are recognized as realized losses on investments. Realized gains and losses on sales are determined on the basis of specific identification of investments. If we expect that an issuer of a security will modify its payment pattern from contractual terms but no writedown is required, future investment income is recognized at the rate implicit in the calculation of net realizable value under the expected payment pattern.
MARKET VALUES
Market values of fixed maturity securities are reported based on quoted market prices, where available. Market values of fixed maturity securities not actively traded in a liquid market are estimated using a matrix calculation assuming a spread (based on interest rates and a risk assessment of the bonds) over U. S. Treasury bonds. Market values of redeemable preferred stocks and equity securities are based on the latest quoted market prices, or for those not readily marketable, generally at values which are representative of the market values of comparable issues.
CASH AND CASH EQUIVALENTS
For purposes of our consolidated statements of cash flows, we consider all highly liquid debt instruments purchased with a maturity of three months or less to be cash equivalents.
FBL FINANCIAL GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DEFERRED POLICY ACQUISITION COSTS AND VALUE OF INSURANCE IN FORCE ACQUIRED
To the extent recoverable from future policy revenues and gross profits, certain costs of acquiring new insurance business, principally commissions and other expenses related to the production of new business, have been deferred. The value of insurance in force acquired represents the cost assigned to insurance contracts when an insurance company is acquired. The initial value is determined by an actuarial study using expected future gross profits as a measurement of the net present value of the insurance acquired. Interest accrues on the unamortized balance at a weighted average rate of 5.73%.
For participating traditional life insurance and interest sensitive products (principally universal life insurance policies and annuity contracts), these costs are being amortized generally in proportion to expected gross profits (after dividends to policyholders, if applicable) from surrender charges and investment, mortality, and expense margins. That amortization is adjusted retrospectively when estimates of current or future gross profits/margins (including the impact of investment gains and losses) to be realized from a group of products are revised. For nonparticipating traditional life and accident and health insurance products, these costs are amortized over the premium paying period of the related policies, in proportion to the ratio of annual premium revenues to total anticipated premium revenues. Such anticipated premium revenues are estimated using the same assumptions used for computing liabilities for future policy benefits.
PROPERTY AND EQUIPMENT
Property and equipment, comprised primarily of furniture, equipment and capitalized software costs, are reported at cost less allowances for depreciation and amortization. Depreciation and amortization expense is computed primarily using the straight-line method over the estimated useful lives of the assets. Furniture and equipment had a carrying value of $38.8 million at December 31, 2000 and $39.2 million at December 31, 1999, and estimated useful lives that range from three to ten years. Capitalized software costs had a carrying value of $20.4 million at December 31, 2000 and $21.3 million at December 31, 1999, and estimated useful lives that range from two to five years. Depreciation expense was $8.1 million in 2000, $8.6 million in 1999 and $8.5 million in 1998. Amortization expense was $4.8 million in 2000, $2.6 million in 1999 and $1.3 million in 1998.
GOODWILL
Goodwill represents the excess of the fair value of assets exchanged over the net assets acquired. Goodwill is generally being amortized on a straight-line basis over a period of 20 years. The carrying value of goodwill is regularly reviewed for indicators of impairment in value, which in the view of management are other than temporary. If facts and circumstances suggest that goodwill is impaired, we assess the fair value of the underlying business and reduce goodwill to an amount that results in the book value of the underlying business approximating fair value. We have not recorded any such writedowns during 2000, 1999 or 1998.
FUTURE POLICY BENEFITS
The liability for future policy benefits for participating traditional life insurance is based on net level premium reserves, including assumptions as to interest, mortality, and other factors underlying the guaranteed policy cash values. Reserve interest assumptions are level and range from 2.5% to 6.0%. The average rate of assumed investment yields used in estimating gross margins was 7.74% in 2000, 7.83% in 1999 and 8.03% in 1998. Accrued dividends for participating business are established for anticipated amounts earned to date that have not been paid. The declaration of future dividends for participating business is at the discretion of the Board of Directors. Participating business accounted for 38% of receipts from policyholders during 2000 and represented 16% of life insurance in force at December 31, 2000. Participating business accounted for 40% of receipts from policyholders during 1999 (1998 - 41%) and represented 17% of life insurance in force at December 31, 1999.
The liabilities for future policy benefits for accident and health insurance are computed using a net level (or an equivalent) method, including assumptions as to morbidity, mortality and interest and to include provisions for possible unfavorable deviations. Policy benefit claims are charged to expense in the period that the claims are incurred.
FBL FINANCIAL GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Future policy benefit reserves for interest sensitive products are computed under a retrospective deposit method and represent policy account balances before applicable surrender charges. Policy benefits and claims that are charged to expense include benefit claims incurred in the period in excess of related policy account balances.
Interest crediting rates for interest sensitive products ranged from 4.00% to 6.50% in 2000, from 4.00% to 6.25% in 1999 and from 4.00% to 6.50% in 1998.
The unearned revenue reserve reflects the unamortized balance of the excess of first year administration charges over renewal period administration charges (policy initiation fees) on interest sensitive products. These excess charges have been deferred and are being recognized in income over the period benefited using the same assumptions and factors used to amortize deferred policy acquisition costs.
GUARANTY FUND ASSESSMENTS
From time to time, assessments are levied on our insurance subsidiaries by guaranty associations in most states in which the subsidiaries are licensed. These assessments, which are accrued for, are to cover losses of policyholders of insolvent or rehabilitated companies. In some states, these assessments can be partially recovered through a reduction in future premium taxes.
We had undiscounted reserves of $0.1 million at December 31, 2000 and $1.3 million at December 31, 1999 to cover estimated future assessments on known insolvencies. We had assets totaling $1.0 million at December 31, 2000 and $2.8 million at December 31, 1999 representing estimated premium tax offsets on paid and future assessments. Expenses (credits) incurred for guaranty fund assessments, net of related premium tax offsets, totaled ($0.1) million in 2000 and 1999 and ($1.2) million in 1998. It is anticipated that estimated future guaranty fund assessments on known insolvencies will be paid during 2001 and substantially all the related future premium tax offsets will be realized during the five year period ended December 31, 2005. We believe the reserve for guaranty fund assessments is sufficient to provide for future assessments based upon known insolvencies and projected premium levels.
DEFERRED INCOME TAXES
Deferred income tax assets or liabilities are computed based on the difference between the financial statement and income tax bases of assets and liabilities using the enacted marginal tax rate. Deferred income tax expenses or credits are based on the changes in the asset or liability from period to period.
SEPARATE ACCOUNTS
The separate account assets and liabilities reported in our accompanying consolidated balance sheets represent funds that are separately administered for the benefit of certain policyholders that bear the underlying investment risk. The separate account assets and liabilities are carried at fair value. Revenues and expenses related to the separate account assets and liabilities, to the extent of benefits paid or provided to the separate account policyholders, are excluded from the amounts reported in the accompanying consolidated statements of income.
RECOGNITION OF PREMIUM REVENUES AND COSTS
Revenues for interest sensitive and variable products consist of policy charges for the cost of insurance, administration charges, amortization of policy initiation fees and surrender charges assessed against policyholder account balances. Expenses related to these products include interest credited to policyholder account balances, benefit claims incurred in excess of policyholder account balances and amortization of deferred policy acquisition costs.
Traditional life insurance premiums are recognized as revenues over the premium-paying period. Future policy benefits and policy acquisition costs are recognized as expenses over the life of the policy by means of the provision for future policy benefits and amortization of deferred policy acquisition costs.
FBL FINANCIAL GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
REINSURANCE
We use reinsurance to manage certain risks associated with our insurance operations. These reinsurance arrangements provide for greater diversification of business, allow management to control exposure to potential risks arising from large claims and provide additional capacity for growth. The cost of reinsurance ceded is generally amortized over the contract periods of the reinsurance agreements.
All insurance-related revenues, benefits and expenses are reported net of reinsurance ceded.
OTHER INCOME AND OTHER EXPENSES
Other income and other expenses consist primarily of revenue and expenses generated by our various non-insurance subsidiaries for investment advisory, marketing and distribution, and leasing services. They also include revenues and expenses generated by our parent company for management services. Certain of these activities are performed on behalf of affiliates of the Company. In addition, certain revenues generated by our insurance subsidiaries are classified as other income. Revenues of the insurance subsidiaries included as other income aggregated $1.2 million in 2000, $0.6 million in 1999 and $1.4 million in 1998. Lease income from leases with affiliates totaled $9.2 million in 2000, $7.9 million in 1999 and $5.8 million in 1998. Investment advisory fee income from affiliates totaled $1.2 million in 2000, $1.5 million in 1999 and $1.3 million in 1998.
COMPREHENSIVE INCOME (LOSS)
Unrealized gains and losses on our available-for-sale securities are included in accumulated other comprehensive income (loss) in stockholders' equity. Other comprehensive income (loss) excludes net investment gains (losses) included in net income which merely represent transfers from unrealized to realized gains and losses. These amounts totaled ($14.4) million in 2000, ($0.1) million in 1999 and ($0.9) million in 1998. These amounts, which have been measured through the date of sale, are net of income taxes and adjustments to deferred policy acquisition costs, value of insurance in force acquired and unearned revenue reserve totaling $9.5 million in 2000, $0.2 million in 1999 and $0.5 million in 1998.
RECLASSIFICATIONS
Certain amounts in the 1999 and 1998 consolidated financial statements have been reclassified to conform to the 2000 financial statement presentation.
USE OF ESTIMATES
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and the disclosure of contingent assets and liabilities. For example, significant estimates and assumptions are utilized in the calculation of deferred policy acquisition costs, policyholder liabilities and accruals and valuation allowances on investments. It is reasonably possible that actual experience could differ from the estimates and assumptions utilized which could have a material impact on the consolidated financial statements.
PENDING ACCOUNTING CHANGE
In June 1998, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (Statement) No. 133, "Accounting for Derivative Instruments and Hedging Activities." In June 2000, the FASB issued Statement 138, "Accounting for Certain Derivative Instruments and Certain Hedging Acitivites." Statement No. 133 requires companies to record derivatives on the balance sheet as assets or liabilities, measured at fair value. Accounting for gains or losses resulting from changes in the values of those derivatives is dependent on the use of the derivative and whether it qualifies for hedge accounting. Statement No. 133 allows companies to transfer securities classified as held for investment to either the available-for-sale or trading categories in connection with the adoption of the new standard. Statement 138 amends Statement 133 to clarify the appropriate accounting for certain hedging transactions. We adopted the Statements on January 1, 2001, their effective dates.
FBL FINANCIAL GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Because of our minimal use of derivatives, we do not anticipate that the adoption of the new Statements will have a significant effect on our earnings or financial position. However, at December 31, 2000, we do own 11 convertible fixed maturity securities with a carrying value of $36.1 million. The conversion features on these securities are considered embedded derivatives and, accordingly, changes in fair value of the conversion features will be reflected in net income in future periods. The fair value of these embedded derivatives is estimated to be $3.7 million at December 31, 2000. Since it is not possible to predict future changes in fair value, the impact of adopting the Statements on these securities cannot be predicted. The cumulative effect of this accounting change on net income, representing the difference in accumulated net unrealized capital gains (losses) under the two methods, totaled $0.5 million.
Effective January 1, 2001, upon adoption of the Statements, we transferred our fixed maturity securities classified as held for investment to the available-for-sale category. In connection with this transfer, the securities were marked to market and the corresponding increase in carrying value totaling $2.8 million, net of offsetting adjustments to deferred acquisition costs, value of insurance in force acquired, unearned revenue reserve and income taxes, will be credited to stockholders' equity during the first quarter of 2001.
2. INVESTMENT OPERATIONS
FIXED MATURITIES AND EQUITY SECURITIES
The following tables contain amortized cost and estimated market value information on fixed maturities and equity securities:
FBL FINANCIAL GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
As described in Note 1, "Significant Accounting Policies - Pending Accounting Change," effective January 1, 2001 the fixed maturity securities classified as held for investment were transferred to the available-for-sale category.
Short-term investments have been excluded from the above schedules as amortized cost approximates market value for these securities.
The carrying value and estimated market value of our portfolio of fixed maturity securities at December 31, 2000, 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.
Net unrealized investment losses on equity securities and fixed maturity securities classified as available for sale were comprised of the following:
FBL FINANCIAL GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The change in net unrealized investment gains/losses are recorded net of deferred income taxes and other adjustments for assumed changes in the amortization pattern of deferred policy acquisition costs, value of insurance in force acquired and unearned revenue reserve totaling $18.6 million in 2000, ($64.2) million in 1999 and $1.2 million in 1998.
MORTGAGE LOANS ON REAL ESTATE
Our mortgage loan portfolio consists principally of commercial mortgage loans. Our lending policies require that the loans be collateralized by the value of the related property, establish limits on the amount that can be loaned to one borrower and require diversification by geographic location and collateral type.
We have provided an allowance for possible losses against our mortgage loan portfolio. An analysis of this allowance, which consist of specific and general reserves, is as follows:
The carrying value of impaired loans (those loans in which we do not believe we will collect all amounts due according to the contractual terms of the respective loan agreements) were under $0.1 million at December 31, 2000 and 1999.
NET INVESTMENT INCOME
Components of net investment income are as follows:
FBL FINANCIAL GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
REALIZED AND UNREALIZED GAINS AND LOSSES
Realized gains (losses) and the change in unrealized appreciation/depreciation on investments, excluding amounts attributed to investments held by subsidiaries engaged in the broker-dealer industry, are summarized below:
An analysis of sales, maturities and principal repayments of our fixed maturities portfolio is as follows:
Realized losses on fixed maturities totaling $18.5 million in 2000, $5.2 million in 1999 and $2.8 million in 1998 were incurred as a result of writedowns for other than temporary impairment of fixed maturity securities.
FBL FINANCIAL GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Income taxes (credits) include a provision of ($9.1) million in 2000, ($0.8) million in 1999 and ($1.7) million in 1998 for the tax effect of realized gains and losses.
OTHER
We have a common stock investment in American Equity Investment Life Holding Company (American Equity), an insurance company that underwrites and markets life insurance and annuity products throughout the United States. The investment is accounted for using the equity method and is included in the securities and indebtedness of related parties line on the consolidated balance sheets. Due to the timing of the availability of financial information, during 2000 we switched from recording our share of American Equity's results from a current basis to one quarter in arrears. The impact of this change on our financial statements was not material. The carrying value of our common stock investment in American Equity includes goodwill totaling $5.0 million in 2000 and $5.3 million in 1999. In addition to the common stock, during 1999 we acquired $2.3 million in preferred stock issued by a subsidiary of American Equity. Summarized financial information for American Equity and our common stock ownership percentage is as follows:
We reported equity income, net of tax, from APEX Investment Fund III, an equity investee that operates in the investment company industry, totaling $7.7 million in 2000, $1.5 million in 1999 and $1.0 million in 1998. Summarized financial information for APEX Investment Fund III is as follows:
During 2000, equity investees distributed to us equity securities with a fair value totaling $14.5 million. Also during 2000, we received an interest in ten real estate properties with a fair value of $5.0 million in satisfaction of a fixed maturity security that had been in default. These transactions were treated as noncash items for purposes of the 2000 statement of cash flow.
At December 31, 2000, affidavits of deposits covering investments with a carrying value totaling $2,595.7 million were on deposit with state agencies to meet regulatory requirements.
At December 31, 2000, we had committed to provide additional funding for mortgage loans on real estate aggregating $8.9 million. These commitments arose in the normal course of business at terms that are comparable to similar investments.
The carrying value of investments which have been non-income producing for the twelve months preceding December 31, 2000 include real estate, fixed maturities and other long-term investments totaling $7.7 million.
FBL FINANCIAL GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
No investment in any person or its affiliates (other than bonds issued by agencies of the United States Government) exceeded ten percent of stockholders' equity at December 31, 2000.
3. FAIR VALUES OF FINANCIAL INSTRUMENTS
Statement No. 107, "Disclosures About Fair Value of Financial Instruments," requires disclosure of fair value information about financial instruments, whether or not recognized in the consolidated balance sheets, for which it is practicable to estimate value. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instrument. Statement No. 107 also excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements and allows companies to forego the disclosures when those estimates can only be made at excessive cost. Accordingly, the aggregate fair value amounts presented herein are limited by each of these factors and do not purport to represent our underlying value.
We used the following methods and assumptions in estimating the fair value of our financial instruments.
FIXED MATURITY SECURITIES: Fair values for fixed maturity securities are based on quoted market prices, where available. For fixed maturity securities not actively traded, fair values are estimated using a matrix calculation assuming a spread (based on interest rates and a risk assessment of the bonds) over U. S. Treasury bonds.
EQUITY SECURITIES: The fair values for equity securities are based on quoted market prices, where available. For equity securities that are not actively traded, estimated fair values are based on values of comparable issues.
MORTGAGE LOANS ON REAL ESTATE AND POLICY LOANS: Fair values are estimated by discounting expected cash flows using interest rates currently being offered for similar loans.
OTHER LONG-TERM INVESTMENTS: The fair values for nontraditional debt instruments and investment deposits are estimated by discounting expected cash flows using interest rates currently being offered for similar investments. The fair values for investments held by broker-dealer subsidiaries are based on quoted market prices.
CASH AND SHORT-TERM INVESTMENTS: The carrying amounts reported in the consolidated balance sheets for these instruments approximate their fair values.
SECURITIES AND INDEBTEDNESS OF RELATED PARTIES: Fair values for loans and advances are estimated by discounting expected cash flows using interest rates currently being offered for similar investments. As allowed by Statement No. 107, fair values are not assigned to investments accounted for using the equity method.
ASSETS HELD IN SEPARATE ACCOUNTS: Separate account assets are reported at estimated fair value in our consolidated balance sheets.
FUTURE POLICY BENEFITS AND OTHER POLICYHOLDERS' FUNDS: Fair values of our liabilities under contracts not involving significant mortality or morbidity risks (principally deferred annuities, deposit administration funds and supplementary contracts) are estimated at cash surrender value, the cost we would incur to extinguish the liability. We are not required to estimate the fair value of our liabilities under other insurance contracts.
SHORT-TERM AND LONG-TERM DEBT: The fair values for long-term debt are estimated using discounted cash flow analysis based on our current incremental borrowing rate for similar types of borrowing arrangements. For short-term debt, the carrying value approximates fair value.
LIABILITIES RELATED TO SEPARATE ACCOUNTS: Separate account liabilities are estimated at cash surrender value, the cost we would incur to extinguish the liability.
COMPANY-OBLIGATED MANDATORILY REDEEMABLE PREFERRED STOCK OF SUBSIDIARY TRUST: Fair values are estimated by discounting expected cash flows using interest rates currently being offered for similar securities.
FBL FINANCIAL GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The following sets forth a comparison of the fair values and carrying values of our financial instruments subject to the provisions of Statement No. 107:
4. REINSURANCE AND POLICY PROVISIONS
In the normal course of business, we seek to limit our exposure to loss on any single insured and to recover a portion of benefits paid by ceding reinsurance to other insurance enterprises or reinsurers. Our reinsurance coverage for life insurance varies according to the age and risk classification of the insured with retention limits ranging up to $1.1 million of coverage per individual life. We do not use financial or surplus relief reinsurance. Life insurance in force ceded on a consolidated basis totaled $2,059.0 million (9.1% of total life insurance in force) at December 31, 2000 and $1,826.3 million (8.7% of total life insurance in force) at December 31, 1999.
Reinsurance contracts do not relieve us of our obligations to policyholders. To the extent that reinsuring companies are later unable to meet obligations under reinsurance agreements, our insurance subsidiaries would be liable for these obligations, and payment of these obligations could result in losses. To limit the possibility of such losses, we evaluate the financial condition of our reinsurers and monitor concentrations of credit risk. No allowance for uncollectible amounts has been established against our asset for reinsurance recoverable since none of our receivables are deemed to be uncollectible.
In addition to the cession of risks in excess of specific retention limits, we also have reinsurance agreements with variable alliance partners to cede a specified percentage of risks associated with variable universal life and variable annuity contracts. Under these agreements, we pay the alliance partners their reinsurance percentage of charges and deductions collected on the reinsured polices. The alliance partners in return pay us their reinsurance percentage of benefits in excess of related account balances. In addition, the alliance partners pay us an expense allowance for certain new business, development and maintenance costs on the reinsured contracts.
FBL FINANCIAL GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Effective September 1, 2000, we entered into a 100% coinsurance agreement to reinsure our individual disability income business with an unaffiliated insurer. At September 1, 2000, the related accident and health reserves totaled $43.6 million and deferred acquisition costs totaled $11.8 million. We settled this transaction by transferring cash and investments equal to the reserves on this business at September 1, 2000. In addition, we received $11.1 million in cash as consideration for the transaction. A loss of $0.7 million on the transaction has been deferred and is being recognized over the term of the underlying policies.
In total, insurance premiums and product charges have been reduced by $9.5 million in 2000, $5.3 million in 1999 and $5.9 million in 1998 and insurance benefits have been reduced by $6.2 million in 2000, $2.4 million in 1999 and $2.2 million in 1998 as a result of cession agreements.
We assume variable annuity business from American Equity and another alliance partner through a modified coinsurance arrangement. Product charges from this business totaled $0.1 million in 2000 and less than $0.1 million in 1999 and 1998. In 1998, we assumed a block of ordinary annuity policies with reserves totaling $22.0 million from another alliance partner.
Unpaid claims on accident and health policies (entirely disability income products) include amounts for losses and related adjustment expense and are estimates of the ultimate net costs of all losses, reported and unreported. These estimates are subject to the impact of future changes in claim severity, frequency and other factors. The activity in the liability for unpaid claims and related adjustment expense, net of reinsurance, is summarized as follows:
We develop reserves for unpaid claims by using industry mortality and morbidity data. One year development on prior year reserves represents our experience being more or less favorable than that of the industry. Over time, we expect our experience with respect to disability income business to be comparable to that of the industry. A certain level of volatility in development is inherent in these reserves since the underlying block of business is relatively small.
FBL FINANCIAL GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
An analysis of the value of insurance in force acquired is as follows:
Net amortization of the value of insurance in force acquired, based on expected future gross profits/margins, for the next five years and thereafter is expected to be as follows: 2001 - $1.1 million; 2002 - $1.0 million; 2003 - $1.0 million; 2004 - $0.9 million; 2005 - $0.8 million; and thereafter, through 2023 - $9.2 million.
5. INCOME TAXES
We file a consolidated federal income tax return with Farm Bureau Life and FBL Financial Services, Inc. and certain of their subsidiaries. The companies included in the consolidated federal income tax return each report current income tax expense as allocated under a consolidated tax allocation agreement. Generally, this allocation results in profitable companies recognizing a tax provision as if the individual company filed a separate return and loss companies recognizing a benefit to the extent their losses contribute to reduce consolidated taxes.
Deferred income taxes have been established based upon the temporary differences between the financial statement and income tax bases of assets and liabilities. The reversal of the temporary differences will result in taxable or deductible amounts in future years when the related asset or liability is recovered or settled.
Income tax expenses (credits) are included in the consolidated financial statements as follows:
FBL FINANCIAL GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The effective tax rate on income from continuing operations before income taxes, minority interest in earnings of subsidiaries and equity income is different from the prevailing federal income tax rate as follows:
The tax effect of temporary differences giving rise to our deferred income tax assets and liabilities is as follows:
Prior to 1984, a portion of Farm Bureau Life's current income was not subject to current income taxation, but was accumulated, for tax purposes, in a memorandum account designated as "policyholders' surplus account." The aggregate accumulation in this account at December 31, 2000 was $11.9 million. Should the policyholders' surplus account exceed the limitation prescribed by federal income tax law, or should distributions be made to the parent company in excess of $511.9 million, such excess would be subject to federal income taxes at rates then effective. Deferred income taxes of $4.2 million have not been provided on amounts included in this memorandum account.
6. CREDIT ARRANGEMENTS
We have a note payable to the Federal Home Loan Bank (FHLB) totaling $40.0 million at December 31, 2000 and December 31, 1999. The note is due September 17, 2003, and interest on the note is charged at a variable rate equal to the London Interbank Offered Rate less 0.0475% (6.50% at December 31, 2000 and 5.77% at December 31, 1999). Fixed maturity securities with a carrying value of $43.1 million are on deposit with the FHLB as collateral for the note. As an investor in the FHLB, we have the ability to borrow an additional $92.7 million from the FHLB at December 31, 2000 with appropriate increased collateral deposits.
FBL FINANCIAL GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
We have a $12.0 million line of credit with Farm Bureau Mutual Insurance Company (Farm Bureau Mutual), an affiliate, in the form of a revolving demand note. Borrowings on the note, which totaled $9.9 million at December 31, 2000 and $11.7 million at December 31, 1999 were used to acquire assets that were leased to certain affiliates, including Farm Bureau Mutual. Interest was payable at a rate equal to the prime rate of a national bank (9.50% at December 31, 2000 and 8.50% at December 31, 1999). Rental income from the related leases included a provision for interest on the carrying value of the assets. During January 2001, this note was paid off, principally by transferring the underlying assets to Farm Bureau Mutual. No gain or loss was recorded on this transaction, as fair value of the assets was equal to book value on the transfer date.
7. MINORITY INTEREST AND STOCKHOLDERS' EQUITY
Minority interest in the consolidated balance sheets includes $97.0 million of 5% Preferred Securities issued by FBL Financial Group Capital Trust (the Trust), one of our wholly-owned subsidiaries. FBL Financial Group, Inc. (parent company) issued 5% Subordinated Deferrable Interest Notes, due June 30, 2047 (the Notes) with a principal amount of $100.0 million to support the 5% Preferred Securities. The sole assets of the Trust are and will be the Notes and any interest accrued thereon. The interest payment dates on the Notes correspond to the distribution dates on the 5% Preferred Securities. The 5% Preferred Securities, which have a liquidation value of $1,000.00 per share plus accrued and unpaid distributions, mature simultaneously with the Notes. As of December 31, 2000 and 1999, 97,000 shares of 5% Preferred Securities were outstanding, all of which we unconditionally guarantee.
The 5% Preferred Securities were originally issued to the Iowa Farm Bureau Federation, our majority stockholder. On October 31, 1999, the Iowa Farm Bureau Federation exchanged the 5% Preferred Securities for $97.0 million face amount of 5% trust preferred securities issued by an equity investee of the Company. In preparing our consolidated financial statements, we do not eliminate our portion of the 5% Preferred Securities owned by the equity investee since the terms of the preferred securities issued by the equity investee are substantially similar to the terms of the 5% Preferred Securities.
During 1999, Western Farm Bureau Life Insurance Company (Western Life), a former wholly-owned subsidiary, merged into Farm Bureau Life. Concurrent with the merger, Western Life redeemed 22,517 shares of its redeemable preferred stock for $4.5 million. The redeemable preferred stock and related dividends were reported as minority interest in subsidiaries in the consolidated financial statements.
The Iowa Farm Bureau Federation owns our Series B preferred stock. Each share of Series B preferred stock has a liquidation preference of $0.60 and voting rights identical to that of Class A common stock. The Series B preferred stock pays cumulative annual cash dividends of $0.03 per share, payable quarterly, and is redeemable by us, at our option, at $0.60 per share plus unpaid dividends if the stock ceases to be beneficially owned by a Farm Bureau organization.
We repurchased 4,358,397 shares in 2000, 1,322,920 shares in 1999 and 961,536 shares in 1998 of Class A common stock in accordance with repurchase plans and a tender offer approved by our Board of Directors. The cost of the repurchases totaled $85.8 million in 2000, $25.7 million in 1999 and $25.0 million in 1998. Of the shares repurchased in 2000 and 1998, 3,745,471 were unregistered shares owned by various Farm Bureau entities. The purchase amounts were allocated partly to Class A common stock based on the average common stock balance per share on the acquisition dates with the remainder allocated to retained earnings.
On March 30, 1998, we exchanged a subsidiary owning our home office properties for 2,536,112 unregistered shares of Class A common stock owned by the Iowa Farm Bureau Federation. The value of the transaction, which was structured as a tax-free exchange of a real estate subsidiary, was $45.7 million, or $18.00 per common share. The book value of the properties was $24.7 million on the date of the exchange. We are leasing a portion of the properties back from a wholly-owned subsidiary of the Iowa Farm Bureau Federation under a 15-year operating lease. A gain on the transaction of approximately $21.0 million was deferred and is being amortized over the term of the operating lease. The transaction was accounted for as a noncash financing activity for purposes of the 1998 statement of cash flows.
On March 17, 1998, our Board of Directors approved a two-for-one common stock split payable in the form of a 100% stock dividend, to stockholders of record as of April 6, 1998. The additional shares were distributed April 17, 1998. As required by our Articles of Incorporation, holders of the Class B common stock received Class A common
FBL FINANCIAL GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
shares in payment of the stock dividend. In addition, the 5.0 million shares of Series B preferred stock have non-dilutive voting rights. As a result, voting rights on these shares increased proportionately while the number of shares outstanding did not change.
Holders of the Class A common stock and Series B preferred stock, together as a group, and Class B common stock vote as separate classes on all issues. Only holders of the Class A common stock and Series B preferred stock vote for the election of Class A Directors (three to five) and only holders of the Class B common stock vote for the election of Class B Directors (ten to twenty). Voting for the Directors is noncumulative. In addition, various ownership aspects of our Class B common stock are governed by a Class B Shareholder Agreement which results in the Iowa Farm Bureau Federation, which owns 69.0% of our voting stock as of December 31, 2000, maintaining control of the Company. Holders of Class A common stock and Class B common stock are entitled to share ratably on a share-for-share basis with respect to common stock dividends.
8. RETIREMENT AND COMPENSATION PLANS
We participate with several affiliates in various defined benefit plans covering substantially all of our employees. The benefits of these plans are based primarily on years of service and employees' compensation. Net periodic pension cost of the plans is allocated between participants generally on a basis of time incurred by the respective employees for each employer. Such allocations are reviewed annually. Pension expense aggregated $5.2 million in 2000, $4.5 million in 1999 and $5.7 million in 1998.
We participate with several affiliates in a 401(k) defined contribution plan which covers substantially all employees. We contribute FBL Financial Group, Inc. stock in the amount equal to 50% of an employee's contributions up to 4% of the annual salary contributed by the employees. Costs are allocated among the affiliates on a basis of time incurred by the respective employees for each company. Related expense totaled $0.4 million in 2000 and $0.3 million in 1999 and 1998.
We have established deferred compensation plans for certain key current and former employees and have certain other benefit plans which provide for retirement and other benefits. Liabilities for these plans are accrued as the related benefits are earned.
Certain of the assets related to these plans are on deposit with us and amounts relating to these plans are included in our financial statements. In addition, certain amounts included in the policy liabilities for interest sensitive products relate to deposit administration funds maintained by us on behalf of affiliates.
In addition to benefits offered under the aforementioned benefit plans, we and several other affiliates sponsor a plan that provides group term life insurance benefits to retired full-time employees who have worked ten years and attained age 55 while in service. Postretirement benefit expense is allocated in a manner consistent with pension expense discussed above. Postretirement benefit expense aggregated $0.1 million in 2000, $0.2 million in 1999 and $0.1 million in 1998.
We have a Class A Common Stock Compensation Plan (the Plan) under which incentive stock options, nonqualified stock options, bonus stock, restricted stock and stock appreciation rights may be granted to directors, officers and employees. Option shares granted to directors are fully vested upon grant and have a contractual term that varies with the length of time the director remains on the Board. Option shares granted to officers and employees have a contractual term of 10 years and generally vest over a period up to five years, contingent upon continued employment with us.
FBL FINANCIAL GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Information relating to stock options is as follows:
Information regarding stock options outstanding at December 31, 2000 is as follows:
At December 31, 2000, shares of Class A common stock available for grant as additional awards under the Plan totaled 1,220,050.
We apply Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" (APB 25), and related Interpretations in accounting for our stock options. No compensation expense is recognized under APB 25 because the exercise price of our stock options equals the market price of the underlying stock on the date of grant. Under the alternative accounting method provided by Statement No. 123, compensation expense is recognized in an amount equal to the estimated fair value of stock options on the date of grant. We have not adopted the accounting provisions of Statement No. 123 because the valuation of non-traded stock options is highly subjective and, in management's opinion, the existing pricing models do not necessarily provide a reliable single measure of the fair value of our options.
FBL FINANCIAL GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Pro forma information regarding net income and earnings per common share is required by Statement No. 123, and has been determined as if we had accounted for the stock options under the fair value method of that Statement. The fair value for these options was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted-average assumptions:
The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Our employee stock options have characteristics significantly different from those of traded options and the subjective input assumptions can materially affect the fair value estimate produced by the Black-Scholes option valuation model.
For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting period. Our pro forma net earnings and earnings per common share are as follows:
The pro forma impact is likely to increase in future years as additional options are granted and amortized ratably over the vesting period.
9. MANAGEMENT AND OTHER AGREEMENTS
We share certain office facilities and services with the Iowa Farm Bureau Federation and its affiliated companies. These expenses are allocated on the basis of cost and time studies that are updated annually and consist primarily of salaries and related expenses, travel and other operating costs.
We have management agreements with Farm Bureau Mutual and other affiliates under which we provide general business, administrative and management services. Fee income for these services totaled $1.1 million in 2000, $0.8 million in 1999 and $0.5 million in 1998. In addition, Farm Bureau Management Corporation, a wholly-owned subsidiary of the Iowa Farm Bureau Federation, provides certain management services to us under a separate arrangement. We incurred related expenses totaling $0.9 million in 2000, $0.5 million in 1999 and $0.7 million in 1998.
We have marketing agreements with the Farm Bureau property-casualty companies operating within our marketing territory, including Farm Bureau Mutual and other affiliates. Under the marketing agreements, the property-casualty companies are responsible for development and management of our agency force for a fee equal to a percentage of commissions on first year life insurance premiums and annuity deposits. We paid $6.0 million in 2000, $5.0 million in 1999 and $4.5 million in 1998 to the property-casualty companies under these arrangements.
FBL FINANCIAL GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
We are licensed by the Iowa Farm Bureau Federation to use the "Farm Bureau" and "FB" designations in Iowa. In connection with this license, royalties of $0.7 million in 2000, $0.9 million in 1999 and $0.7 million in 1998 were paid to the Iowa Farm Bureau Federation. We have similar arrangements with Farm Bureau organizations in other states in our market territory. Total royalties paid to Farm Bureau organizations other than the Iowa Farm Bureau Federation were $1.2 million in 2000 and $1.0 million in 1999 and 1998.
We have administrative services agreements with American Equity under which we provide underwriting, claims processing, accounting, compliance and other administrative services primarily relating to certain variable insurance products underwritten by them. Fee income from performing these services totaled $0.3 million in 2000 and 1999 and $0.2 million in 1998
10. COMMITMENTS AND CONTINGENCIES
In the normal course of business, we may be involved in litigation where amounts are alleged that are substantially in excess of contractual policy benefits or certain other agreements. At December 31, 2000, management is not aware of any claims for which a material loss is reasonably possible.
We lease our home office properties under a 15-year operating lease from a wholly-owned subsidiary of the Iowa Farm Bureau Federation. Future remaining minimum lease payments under this lease as of December 31, 2000 are as follows: 2001 - $2.1 million; 2002 - $2.1 million; 2003 - $2.3 million; 2004 - $2.4 million; 2005 - $2.4 million and thereafter, through 2013 - $18.8 million. Rent expense for the lease totaled $3.1 million in 2000, $2.3 million in 1999 and $1.3 million in 1998. These amounts are net of $1.4 million in 2000 and 1999 and $1.0 million in 1998 in amortization of the deferred gain on the exchange of home office properties for common stock (see Note 7).
11. DISCONTINUED OPERATIONS AND RESTRUCTURING
On March 31, 1998, we sold our wholly-owned subsidiary, Utah Farm Bureau Insurance Company (Utah Insurance), to Farm Bureau Mutual. We recorded gains on the sale totaling $0.6 million in 2000, $1.4 million in 1999 and $1.0 million in 1998. The 2000 and 1999 gains and $0.8 million of the 1998 gain were earned in connection with an earn-out provision included in the underlying sales agreement. The gains are net of income taxes (credits) totaling $1.4 million in 2000, $0.6 million in 1999 and ($0.5) million in 1998.
We may earn additional consideration during each of the two years in the period ended December 31, 2002 in accordance with the earn-out provision. Under the earn-out arrangement, the Company and Farm Bureau Mutual share equally in the dollar amount by which the incurred losses on Utah Insurance's direct business, net of reinsurance ceded, is less than the incurred losses assumed in the valuation model used to derive the initial acquisition price. The earn-out calculation is performed and any settlement (subject to a maximum of $2.0 million per year) is made on a calendar year basis. We have not accrued any contingent consideration for the two-year period ending December 31, 2002 as such amounts, if any, cannot be reasonably estimated as of December 31, 2000. Receipts as a result of the earn-out provision are recorded as an adjustment to the gain on the disposal of the discontinued segment.
Income from discontinued operations in 1998 was comprised of revenues totaling $12.9 million and benefits and expenses totaling $12.6 million.
In addition to merging Western Life into Farm Bureau Life, we also closed an administrative processing center during 1999. As a result of the closing of the service center, a leased property was vacated, 22 positions were eliminated and moving costs were incurred. During 1999, we charged to expense costs totaling $1.2 million for related severance benefits, lease costs and other costs primarily associated with the closing of the service center. The restructuring expenses are recorded in the underwriting, acquisition and insurance expense line of the 1999 consolidated statement of income.
FBL FINANCIAL GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
12. EARNINGS PER SHARE
The following table sets forth the computation of earnings per common share and earnings per common share - assuming dilution:
13. STATUTORY INFORMATION
The financial statements of the Life Companies included herein differ from related statutory-basis financial statements principally as follows: (a) the bond portfolio is segregated into held-for-investment (carried at amortized cost) and available-for-sale (carried at fair value) classifications rather than generally being carried at amortized cost; (b) acquisition costs of acquiring new business are deferred and amortized over the life of the policies rather than charged to operations as incurred; (c) future policy benefit reserves for participating traditional life insurance products are based on net level premium methods and guaranteed cash value assumptions which may differ from statutory reserves; (d) future policy benefit reserves on certain interest sensitive products are based on full account values, rather than discounting methodologies utilizing statutory interest rates; (e) deferred income taxes are provided for the difference between the financial statement and income tax bases of assets and liabilities; (f) net realized gains or losses attributed to changes in the level of market interest rates are recognized as gains or losses in the statements of income when the sale is completed rather than deferred and amortized over the remaining life of the fixed maturity security or mortgage loan; (g) declines in the estimated realizable value of investments are charged to the statements of income when such declines are judged to be other than temporary rather than through the establishment of a formula-determined statutory investment reserve (carried as a liability), changes in which are charged directly to surplus; (h) agents' balances and certain other assets designated as "non-admitted assets" for statutory purposes are reported as assets rather than being charged to surplus; (i) revenues for interest sensitive and variable products consist of policy charges for the cost of insurance, policy administration charges, amortization of policy initiation fees and surrender charges assessed rather than premiums received; (j) pension income or expense is recognized in accordance with Statement No. 87, "Employers' Accounting for Pensions" rather than in accordance with rules and regulations permitted by the Employee Retirement Income Security Act of 1974; (k) the financial statements of subsidiaries are consolidated with those of the insurance subsidiary; and (l) assets and liabilities are
FBL FINANCIAL GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
restated to fair values when a change in ownership occurs that is accounted for as a purchase, with provisions for goodwill and other intangible assets, rather than continuing to be presented at historical cost.
Net income of the Life Companies, as determined in accordance with statutory accounting practices, was $28.9 million in 2000, $40.4 million in 1999 and $52.5 million in 1998. Statutory net gain from operations for the life insurance subsidiaries, which excludes realized gains and losses, totaled $49.8 million in 2000, $41.2 million in 1999 and $56.0 million in 1998. Statutory capital and surplus, after appropriate elimination of intercompany accounts, totaled $311.9 million at December 31, 2000 and $301.5 million at December 31, 1999.
The ability of Farm Bureau Life to pay dividends to the parent company is restricted because prior approval of the Iowa insurance commissioner is required for payment of dividends to the stockholder which exceed an annual limitation. During 2001, Farm Bureau Life could pay dividends to the parent company of approximately $49.9 million without prior approval of insurance regulatory authorities.
The National Association of Insurance Commissioners has revised the ACCOUNTING PRACTICES AND PROCEDURES MANUAL, the guidance that defines statutory accounting principles. The revised manual will be effective January 1, 2001, and has been adopted by the State of Iowa, our Life Companies' state of domicile. The revised manual will result in changes to the accounting practices that the Life Companies use to prepare their statutory-basis financial statements. Management believes the impact of these changes to the Life Companies' statutory-basis capital and surplus as of January 1, 2001 will not be significant.
14. SEGMENT INFORMATION
In general, we are organized by the types of products and services we offer for sale. Our principal and only reportable operating segment is our life insurance segment. The life insurance segment includes activities related to the sale of life insurance, annuities and accident and health insurance products. Operations have been aggregated into the same segment due to the similarity of the products, including the underlying economic characteristics, the method of distribution and the regulatory environment. We also have several other operating segments that do not meet the quantitative threshold for separate segment reporting and, therefore, are aggregated herein. A summary of these segments, along with the related source of revenues, is as follows:
SEGMENT SOURCE OF REVENUES Investment advisory.......... Fee income from the management of investments Marketing and distribution... Commissions and distribution fee income from the sale of mutual funds and insurance products not issued by us Leasing...................... Income from operating leases Corporate.................... Fees from management and administrative services
As noted above, we also had a property-casualty insurance segment prior to March 31, 1998. Revenues from this segment were derived from the sale of property-casualty insurance policies. See Note 11, "Discontinued Operations and Restructuring," for additional information regarding this segment.
FBL FINANCIAL GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Financial information concerning our operating segments is as follows:
Our investment in equity method investees and the related equity income are attributable to the life insurance segment. The exchange of our home office properties for Class A common stock described in Note 7 is attributable to the life insurance segment.
Transactions between segments are recorded at negotiated rates generally intended to be at levels commensurate with charges that would be assessed to unaffiliated parties. Interest expense and expenditures for long-lived assets were not significant during 2000, 1999 or 1998.
FBL FINANCIAL GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
15. KANSAS FARM BUREAU LIFE INSURANCE COMPANY ACQUISITION - SUBSEQUENT EVENT
On January 1, 2001, we acquired the assets and liabilities of Kansas Farm Bureau Life Insurance Company for $81.1 million. The acquisition will be accounted for using purchase accounting. Goodwill recorded in connection with the transaction will be amortized using the straight-line method over a 20-year period. A condensed statement of the assets and liabilities acquired as of January 1, 2001, is as follows (dollars in thousands - unaudited):
As consideration for the purchase, we issued 3,429,500 shares of Series C cumulative voting mandatorily redeemable preferred stock with an estimated fair value of $80.4 million. Each share of Series C preferred stock has a par value of $26.8404 and voting rights identical to that of Class A common stock. Dividends on the Series C preferred stock are payable quarterly at a rate equal to the common stock dividend per share then payable. The mandatory redemption is structured so that 49.5% of the Series C preferred stock will be redeemed at par value, or $45.6 million, on January 2, 2004 with the remaining 50.5% redeemed at par value, or $46.5 million, on January 3, 2006. In the event of a change in the control of the Company, at the option of the holder, each share of Series C preferred stock is convertible into one share of Class A common stock or redeemable for cash at par. The Series C preferred stock was issued at an $11.6 million discount to par. This discount will accrete to preferred stock dividends during the life of the securities using the effective interest method. Acquisition costs totaling $0.7 million have been deferred and are included as a component of goodwill.
16. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
Unaudited quarterly results of operations are as follows:
FBL FINANCIAL GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Earnings per common share for each quarter is computed independently of earnings per common share for the year. As a result, the sum of the quarterly earnings per common share amounts may not equal the earnings per common share for the year due primarily to transactions affecting the number of weighted average common shares outstanding in each quarter.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
None
PART III
The information required by Part III is hereby incorporated by reference from the Registrant's definitive proxy statement to be filed with the Commission pursuant to Regulation 14A within 120 days after December 31, 2000.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(a) 1. Financial Statements. See index to Financial Statements on page 29 for a list of financial statements included in this Report.
2. Financial Statement Schedules. The following financial statement schedules are included as part of this Report immediately following the signature page:
Schedule I -- Summary of Investments
Schedule II -- Condensed Financial Information of Registrant (Parent Company)
Schedule III -- Supplementary Insurance Information
Schedule IV -- Reinsurance
All other schedules are omitted, either because they are not applicable, not required, or because the information they contain is included elsewhere in the consolidated financial statements or notes.
3. Exhibits.
3 Restated Articles of Incorporation 3.1 Articles of Amendment -- Series A Cumulative Voting Preferred Stock 3.2 Articles of Amendment -- Series B Cumulative Voting Preferred Stock 3.3 Articles of Correction -- Series B Cumulative Voting Preferred Stock 3.4 Articles of Amendment -- Series C Voting Preferred Stock 23 Consent of Independent Auditors
(b) Reports on Form 8-K.
On January 12, 2001, a Form 8-K was filed in connection with the closing of the acquisition of Kansas Farm Bureau Life Insurance Company's assets and liabilities. Filed with the Form 8-K was the Articles of Amendment - Certificate of Designations Series C Voting Preferred Stock of FBL Financial Group, Inc.
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, this 13th day of March, 2001.
FBL Financial Group, Inc.
By: /s/ EDWARD M. WIEDERSTEIN -------------------------
Edward M. Wiederstein CHAIRMAN OF THE BOARD
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;
REPORT OF INDEPENDENT AUDITORS ON SCHEDULES
The Board of Directors and Stockholders FBL Financial Group, Inc.
We have audited the consolidated balance sheets of FBL Financial Group, Inc. as of December31, 2000 and 1999, and the related consolidated statements of income, changes in stockholders' equity and cash flows for each of the three years in the period ended December 31, 2000, and have issued our report thereon dated February 5, 2001 (included elsewhere in this Form 10-K). Our audits also included the financial statement schedules listed in Item 14(a) of this Form 10-K. These schedules are the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits.
In our opinion, the financial statement schedules referred to above, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein.
/s/ Ernst & Young LLP
Des Moines, Iowa February 5, 2001
SCHEDULE I - SUMMARY OF INVESTMENTS - OTHER THAN INVESTMENTS IN RELATED PARTIES FBL FINANCIAL GROUP, INC.
DECEMBER 31, 2000
(1) On the basis of cost adjusted for repayments and amortization of premiums and accrual of discounts for fixed maturities, other long-term investments and short-term investments; original cost for equity securities; unpaid principal balance for mortgage loans on real estate and policy loans, and original cost less accumulated depreciation for investment real estate.
(2) Amount not equal to cost (Column B) because of allowance for possible losses deducted from cost to determine reported amount.
(3) Amount not equal to cost (Column B) because other long-term investments include securities held by broker-dealer subsidiaries that carry securities at market value. Also, an allowance for possible losses is deducted from cost to determine reported amount.
SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT FBL FINANCIAL GROUP, INC. (PARENT COMPANY) CONDENSED BALANCE SHEETS (DOLLARS IN THOUSANDS)
See accompanying notes to condensed financial statements.
SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT (CONTINUED) FBL FINANCIAL GROUP, INC. (PARENT COMPANY) CONDENSED STATEMENTS OF INCOME (DOLLARS IN THOUSANDS)
See accompanying notes to condensed financial statements.
SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT (CONTINUED) FBL FINANCIAL GROUP, INC. (PARENT COMPANY) CONDENSED STATEMENTS OF CASH FLOWS (DOLLARS IN THOUSANDS)
See accompanying notes to condensed financial statements.
SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT (CONTINUED) FBL FINANCIAL GROUP, INC. (PARENT COMPANY) NOTES TO CONDENSED FINANCIAL STATEMENTS
DECEMBER 31, 2000
1. BASIS OF PRESENTATION
The accompanying condensed financial statements should be read in conjunction with the consolidated financial statements and notes thereto of FBL Financial Group, Inc.
In the parent company only financial statements, our investments in subsidiaries are stated at cost plus equity in undistributed earnings of subsidiaries since the date of acquisition and net unrealized gains/losses on the subsidiaries' investments classified as "available-for-sale" in accordance with SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities."
2. CASH DIVIDENDS FROM SUBSIDIARY
The parent company received cash dividends totaling $32.2 million in 2000, $29.9 million in 1999 and $13.6 million in 1998.
SCHEDULE III - SUPPLEMENTARY INSURANCE INFORMATION FBL FINANCIAL GROUP, INC.
(1) Net investment income is allocated to the segments based upon the investments held by the respective segment.
SCHEDULE IV - REINSURANCE FBL FINANCIAL GROUP, INC.