1
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
- --------------------------------------------------------------------------
FORM 10-Q
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Quarterly Period Ended June 30, 2001
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
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Commission File Number 33-94670-01
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FARMERS GROUP, INC.
(Exact name of registrant as specified in its charter)
NEVADA
(State or other jurisdiction of
incorporation or organization)
95-0725935
(IRS Employer Identification No.)
4680 WILSHIRE BOULEVARD, LOS ANGELES, CALIFORNIA 90010
(Address of principal executive offices)(Zip Code)
(323) 932-3200
(Registrants telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has
been subject to such filing requirements for the past 90 days.
Yes /X/ No / /
Registrant's Common Stock outstanding on June 30, 2001 was 1,000 shares.
2
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FARMERS GROUP, INC.
AND SUBSIDIARIES
TABLE OF CONTENTS FORM 10-Q
FOR THE PERIOD ENDED JUNE 30, 2001
PART I. FINANCIAL INFORMATION PAGE
----
ITEM 1. Financial Statements (Unaudited)
Consolidated Balance Sheets - Assets
June 30, 2001 and December 31, 2000 4
Consolidated Balance Sheets - Liabilities and Stockholders'
Equity June 30, 2001 and December 31, 2000 5
Consolidated Statements of Income
Six Month Periods ended June 30, 2001 and
June 30, 2000 6
Consolidated Statements of Comprehensive Income
Six Month Periods ended June 30, 2001 and
June 30, 2000 7
Consolidated Statements of Income
Three Month Periods ended June 30, 2001 and
June 30, 2000 8
Consolidated Statements of Comprehensive Income
Three Month Periods ended June 30, 2001 and
June 30, 2000 9
Consolidated Statement of Stockholders' Equity
Six Month Period ended June 30, 2001 10
Consolidated Statement of Stockholders' Equity
Six Month Period ended June 30, 2000 11
Consolidated Statements of Cash Flows
Six Month Periods ended June 30, 2001 and
June 30, 2000 12
Notes to Interim Financial Statements 13
ITEM 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 20
ITEM 3. Quantitative and Qualitative Disclosures about Market Risks 26
PART II. OTHER INFORMATION 27
SIGNATURES 28
4
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
FARMERS GROUP, INC.
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands)
(Unaudited)
ASSETS
June 30, December 31,
2001 2000
------------- ------------
Current assets, excluding Insurance Subsidiaries:
Cash and cash equivalents $ 341,651 $ 132,245
Marketable securities, at market value 27,209 10,386
Accrued interest 21,331 41,995
Accounts receivable, principally from the P&C Group 43,388 36,052
Note receivable - affiliate 207,000 207,000
Deferred taxes 48,353 40,609
Prepaid expenses and other 16,117 15,437
------------- ------------
Total current assets 705,049 483,724
------------- ------------
Investments, excluding Insurance Subsidiaries:
Fixed maturities available-for-sale, at market value
(cost: $168,895 and $292,039) 163,661 291,795
Mortgage loans on real estate 63 92
Common stocks available-for-sale, at market value
(cost: $294,156 and $282,224) 239,126 242,066
Certificates of contribution and surplus notes of the
P&C Group 184,830 184,830
Real estate, at cost (net of accumulated depreciation:
$27,573 and $26,179) 64,649 69,699
Other investments 840 3,341
------------- ------------
653,169 791,823
------------- ------------
Other assets, excluding Insurance Subsidiaries:
Notes receivable - affiliates 345,000 345,000
Goodwill (net of accumulated amortization:
$750,550 and $720,528) 1,651,205 1,681,227
Attorney-in-fact relationships (net of accumulated
amortization: $534,075 and $512,712) 1,174,968 1,196,331
Other assets 266,180 255,174
------------- ------------
3,437,353 3,477,732
------------- ------------
Properties, plant and equipment, at cost: (net of accumulated
depreciation: $419,221 and $391,360) 447,192 438,371
------------- ------------
Investments of Insurance Subsidiaries:
Fixed maturities available-for-sale, at market value
(cost: $4,480,325 and $4,349,824) 4,540,767 4,365,338
Mortgage loans on real estate 33,155 36,984
Non-redeemable preferred stocks available-for-sale, at market
value (cost: $11,128 and $11,128) 11,805 11,500
Common stocks available-for-sale, at market value
(cost: $385,926 and $330,785) 333,899 293,407
Certificates of contribution and surplus notes of the P&C Group 502,500 502,500
Policy loans 226,322 218,162
Real estate, at cost (net of accumulated depreciation:
$30,751 and $29,369) 86,585 89,426
Joint ventures, at equity 3,315 4,651
S&P 500 call options, at fair value (cost: $33,146 and $29,696) 17,919 26,271
Other investments 9,411 5,279
------------- ------------
5,765,678 5,553,518
------------- ------------
Other assets of Insurance Subsidiaries:
Cash and cash equivalents 54,874 84,431
Marketable securities, at market value 10,000 9,997
Reinsurance premiums receivable - P&C Group 0 111,874
Accrued investment income 72,815 69,922
Deferred policy acquisition costs and value of life business
acquired 832,195 838,121
Securities lending collateral 41,856 436,744
Other assets 61,899 29,151
Assets held in Separate Account 34,239 8,423
------------- ------------
1,107,878 1,588,663
------------- ------------
Total assets $ 12,116,319 $ 12,333,831
============= ============
The accompanying notes are an integral part of these interim financial statements.
5
FARMERS GROUP, INC.
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands)
(Unaudited)
LIABILITIES AND STOCKHOLDERS' EQUITY
June 30, December 31,
2001 2000
------------ ------------
Current liabilities, excluding Insurance Subsidiaries:
Notes and accounts payable:
P&C Group $ 0 $ 481
Other 44,737 53,375
Accrued liabilities:
Profit sharing 28,507 58,242
Income taxes 127,715 115,223
Other 5,035 9,715
------------ ------------
Total current liabilities 205,994 237,036
------------ ------------
Other liabilities, excluding Insurance Subsidiaries:
Real estate mortgages payable 14 16
Non-current deferred taxes 543,761 551,097
Other 116,502 120,405
------------ ------------
660,277 671,518
------------ ------------
Liabilities of Insurance Subsidiaries:
Policy liabilities:
Future policy benefits 3,675,847 3,574,594
Claims 35,949 32,509
Policyholders dividends 8 3
Other policyholders funds 189,305 141,544
Death benefits payable 49,229 42,011
Provision for non-life losses and loss adjustment expenses 67,480 89,936
Income taxes (including deferred taxes: $88,900 and $97,267) 113,827 121,499
Unearned investment income 931 903
Reinsurance payable - P&C Group 137,289 185,742
Securities lending liability 41,856 436,744
Other liabilities 46,080 34,983
Liabilities related to Separate Account 34,239 8,423
------------ ------------
4,392,040 4,668,891
------------ ------------
Total liabilities 5,258,311 5,577,445
------------ ------------
Commitments and contingencies
Company obligated mandatorily redeemable preferred
securities of subsidiary trusts holding solely junior
subordinated debentures 500,000 500,000
------------ ------------
Stockholders' Equity:
Class A common stock, $1 par value per share; authorized, issued
and outstanding: as of June 30, 2001 - 450 shares, as of
December 31, 2000 - 500 shares 0.45 0.50
Class B common stock, $1 par value per share; authorized, issued
and outstanding: as of June 30, 2001 and
December 31, 2000 - 500 shares 0.50 0.50
Class C common stock, $1 par value per share; authorized, issued
and outstanding: as of June 30, 2001 - 50 shares 0.05 0.00
Additional capital 5,212,618 5,212,618
Accumulated other comprehensive loss (net of deferred
taxes: ($24,415) and ($23,946)) (45,342) (44,471)
Retained earnings 1,190,731 1,088,238
------------ ------------
Total stockholders' equity 6,358,008 6,256,386
------------ ------------
Total liabilities and stockholders' equity $ 12,116,319 $ 12,333,831
============ ============
The accompanying notes are an integral part of these interim financial statements.
6
FARMERS GROUP, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Amounts in thousands)
(Unaudited)
Six month period
ended June 30,
------------------------
2001 2000
----------- -----------
Consolidated operating revenues $ 1,578,462 $ 1,680,575
=========== ===========
Management services to property and casualty
insurance companies; and other:
Operating revenues $ 828,716 $ 772,117
Operating expenses 472,741 434,219
----------- ----------
Operating income 355,975 337,898
Net investment income 43,415 66,516
Net realized gains 13,166 36,728
Dividends on preferred securities of subsidiary trusts (21,035) (21,035)
----------- ----------
Income before provision for taxes 391,521 420,107
Provision for income taxes 160,388 171,054
----------- ----------
Management services income 231,133 249,053
----------- ----------
Insurance Subsidiaries:
Life and annuity premiums 133,324 108,270
Non-life reinsurance premiums 300,000 500,000
Life policy charges 108,715 107,797
Net investment income 186,882 172,757
Net realized gains 20,825 19,634
----------- -----------
Total revenues 749,746 908,458
----------- -----------
Non-life losses and loss adjustment expenses 212,746 328,963
Life policyholders' benefits and charges 224,050 185,098
Non-life reinsurance commissions 79,754 158,553
General operating expenses 77,933 84,113
----------- -----------
Total operating expenses 594,483 756,727
----------- -----------
Income before provision for taxes 155,263 151,731
Provision for income taxes 48,553 51,985
----------- -----------
Insurance Subsidiaries income 106,710 99,746
----------- -----------
Consolidated net income $ 337,843 $ 348,799
=========== ===========
The accompanying notes are an integral part of these interim financial statements.
7
FARMERS GROUP, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF
COMPREHENSIVE INCOME
(Amounts in thousands)
(Unaudited)
Six month period
ended June 30,
------------------------
2001 2000
----------- -----------
Consolidated net income $ 337,843 $ 348,799
----------- -----------
Other comprehensive loss, net of tax:
Net unrealized holding gains/(losses) on securities,
net of tax of $3,727 and ($21,704) 6,921 (40,308)
Change in effect of unrealized gains/(losses) on other
insurance accounts, net of tax of ($4,196) and $103 (7,792) 191
----------- -----------
Other comprehensive loss (871) (40,117)
----------- -----------
Comprehensive income $ 336,972 $ 308,682
=========== ===========
The accompanying notes are an integral part of these interim financial statements.
8
FARMERS GROUP, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Amounts in thousands)
(Unaudited)
Three month period
ended June 30,
------------------------
2001 2000
----------- -----------
Consolidated operating revenues $ 689,273 $ 855,443
=========== ===========
Management services to property and casualty
insurance companies; and other:
Operating revenues $ 413,642 $ 396,785
Operating expenses 236,337 227,598
----------- ----------
Operating income 177,305 169,187
Net investment income 22,480 32,566
Net realized gains 8,727 18,963
Dividends on preferred securities of subsidiary trusts (10,517) (10,517)
----------- ----------
Income before provision for taxes 197,995 210,199
Provision for income taxes 79,342 85,015
----------- ----------
Management services income 118,653 125,184
----------- ----------
Insurance Subsidiaries:
Life and annuity premiums 62,243 56,343
Non-life reinsurance premiums 50,000 250,000
Life policy charges 54,563 54,058
Net investment income 94,010 86,940
Net realized gains 14,815 11,317
----------- -----------
Total revenues 275,631 458,658
----------- -----------
Non-life losses and loss adjustment expenses 34,422 164,537
Life policyholders' benefits and charges 106,304 95,320
Non-life reinsurance commissions 14,328 79,212
General operating expenses 32,319 41,162
----------- -----------
Total operating expenses 187,373 380,231
----------- -----------
Income before provision for taxes 88,258 78,427
Provision for income taxes 25,578 26,894
----------- -----------
Insurance Subsidiaries income 62,680 51,533
----------- -----------
Consolidated net income $ 181,333 $ 176,717
=========== ===========
The accompanying notes are an integral part of these interim financial statements.
9
FARMERS GROUP, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF
COMPREHENSIVE INCOME
(Amounts in thousands)
(Unaudited)
Three month period
ended June 30,
------------------------
2001 2000
----------- -----------
Consolidated net income $ 181,333 $ 176,717
----------- -----------
Other comprehensive loss, net of tax:
Net unrealized holding losses on securities,
net of tax of ($3,810) and ($19,885) (7,077) (36,930)
Change in effect of unrealized gains on other
insurance accounts, net of tax of $3,155 and
$1,082 5,860 2,009
----------- -----------
Other comprehensive loss (1,217) (34,921)
----------- -----------
Comprehensive income $ 180,116 $ 141,796
=========== ===========
The accompanying notes are an integral part of these interim financial statements.
10
FARMERS GROUP, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
For the six month period ended June 30, 2001
(Amounts in thousands)
(Unaudited)
Accumulated Other Total
Common Additional Comprehensive Retained Stockholders'
Stock Capital Loss Earnings Equity
-------- ----------- ----------------- ------------ ------------
Balance, December 31, 2000 $ 1 $ 5,212,618 $ (44,471) $ 1,088,238 $ 6,256,386
Net income 337,843 337,843
Net unrealized holding gains on
securities, net of tax of
$3,727 6,921 6,921
Change in effect of unrealized
losses on other insurance
accounts, net of tax of ($4,196) (7,792) (7,792)
Cash dividends paid (235,350) (235,350)
-------- ----------- ---------------- ------------ ------------
Balance, June 30, 2001 $ 1 $ 5,212,618 $ (45,342) $ 1,190,731 $ 6,358,008
======== =========== ================ ============ ============
The accompanying notes are an integral part of these interim financial statements.
11
FARMERS GROUP, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
For the six month period ended June 30, 2000
(Amounts in thousands)
(Unaudited)
Accumulated Other Total
Common Additional Comprehensive Retained Stockholders'
Stock Capital Loss Earnings Equity
-------- ----------- ----------------- ------------ ------------
Balance, December 31, 1999 $ 1 $ 5,212,618 $ (33,999) $ 1,920,619 $ 7,099,239
Net income 348,799 348,799
Net unrealized holding losses on
securities, net of tax of
($21,704) (40,308) (40,308)
Change in effect of unrealized
gains on other insurance
accounts, net of tax of $103 191 191
Cash dividends declared and/or
paid (1,437,025) (1,437,025)
-------- ----------- ---------------- ------------ ------------
Balance, June 30, 2000 $ 1 $ 5,212,618 $ (74,116) $ 832,393 $ 5,970,896
======== =========== ================ ============ ============
The accompanying notes are an integral part of these interim financial statements.
12
FARMERS GROUP, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in thousands)
(Unaudited)
Six month period
ended June 30,
-----------------------
2001 2000
---------- ----------
Cash Flows from Operating Activities:
Consolidated net income $ 337,843 $ 348,799
Non-cash and operating activities adjustments:
Depreciation and amortization 84,615 81,970
Amortization of deferred policy acquisition costs and
value of life business acquired 50,299 56,951
Policy acquisition costs deferred (56,361) (51,079)
Life insurance policy liabilities 107,487 61,015
Provision for non-life losses and loss adjustment expenses (22,455) (22,947)
Universal life type contracts:
Deposits received 152,083 152,014
Withdrawals (136,780) (134,439)
Interest credited 40,516 37,135
Equity in earnings of joint ventures 489 10,163
Gains on sales of assets (37,049) (56,781)
Changes in assets and liabilities:
Current assets and liabilities (264) 58,878
Non-current assets and liabilities 5,695 (32,965)
Other, net 2,354 (557)
---------- -----------
Net cash provided by operating activities 528,472 508,157
---------- -----------
Cash Flows from Investing Activities:
Purchases of investments available-for-sale (1,444,652) (581,954)
Purchases of properties (43,018) (51,747)
Purchase of surplus notes of the P&C Group 0 (175,000)
Purchase of certificates of contribution of the P&C Group 0 (370,000)
Proceeds from sales and maturities of investments
available-for-sale 1,378,571 830,039
Proceeds from sales of properties 13,668 4,412
Proceeds from redemption of notes receivable - affiliate 0 175,000
Mortgage loan collections 3,858 2,724
Increase in policy loans (8,160) (8,955)
Other, net (3,031) (2,014)
---------- -----------
Net cash used in investing activities (102,764) (177,495)
---------- -----------
Cash Flows from Financing Activities:
Dividends paid to stockholders (235,350) (362,025)
Annuity contracts:
Deposits received 279,621 80,448
Withdrawals (316,334) (145,065)
Interest credited 26,206 38,407
Payment of long-term notes payable (2) (2)
---------- -----------
Net cash used in financing activities (245,859) (388,237)
---------- -----------
Increase/(Decrease) in cash and cash equivalents 179,849 (57,575)
Cash and cash equivalents - at beginning of year 216,676 313,500
---------- -----------
Cash and cash equivalents - at end of period $ 396,525 $ 255,925
========== ===========
The accompanying notes are an integral part of these interim financial statements.
13
FARMERS GROUP, INC.
AND SUBSIDIARIES
NOTES TO INTERIM FINANCIAL STATEMENTS
(Unaudited)
A. Basis of presentation and summary of significant accounting policies
The accompanying consolidated balance sheet of Farmers Group, Inc. ("FGI")
and its subsidiaries (together, the "Company") as of June 30, 2001, the related
consolidated statements of income, comprehensive income, stockholders' equity
and cash flows for the six month periods ended June 30, 2001 and June 30, 2000,
and the consolidated statements of income and comprehensive income for the
three month periods ended June 30, 2001 and June 30, 2000, have been prepared
in accordance with accounting principles generally accepted in the United
States ("GAAP") for interim periods and are unaudited. However, in
management's opinion, the consolidated financial statements include all
adjustments (consisting of only normal recurring adjustments) necessary for a
fair presentation of results for such interim periods. These statements do not
include all of the information and footnotes required by GAAP for complete
financial statements and should be read in conjunction with the consolidated
balance sheets of the Company as of December 31, 2000 and 1999, and the related
consolidated statements of income, comprehensive income, stockholders' equity,
and cash flows for each of the three years in the period ended December 31,
2000.
Interim results are not necessarily indicative of results for the full
year. All material inter-company transactions have been eliminated. Certain
amounts applicable to prior years have been reclassified to conform with the
2001 presentation.
The preparation of the Company's financial statements in conformity with
GAAP requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and the disclosure of contingent
assets and liabilities at the date of the financial statements as well as the
reported amounts of revenues and expenses during the reporting periods. Actual
results could differ from those estimates.
The Company is attorney-in-fact ("AIF") for three inter-insurance
exchanges: Farmers Insurance Exchange, Fire Insurance Exchange and Truck
Insurance Exchange (collectively the "Exchanges"), which operate in the
property and casualty insurance industry. On March 7, 2000, the Exchanges
acquired Foremost Corporation of America and its subsidiaries ("Foremost"),
a prominent writer of insurance for manufactured homes, recreational vehicles
and other specialty lines. Each policyholder of the Exchanges appoints the
Company as the exclusive AIF to provide management services. For such
services, the Company earns management fees based on a percentage of gross
premiums earned by the Exchanges, their respective subsidiaries, Farmers Texas
County Mutual Insurance Company, Foremost County Mutual Insurance Company and
Foremost Lloyds of Texas (collectively the "P&C Group"). The P&C Group is
owned by the policyholders of the Exchanges, Farmers Texas County Mutual
Insurance Company and Foremost County Mutual Insurance Company as well as the
underwriters of Foremost Lloyds of Texas. Accordingly, the Company has no
ownership interest in the P&C Group.
Farmers New World Life Insurance Company ("Farmers Life"), a Washington
based insurance company, is a wholly owned subsidiary of the Company. Farmers
Life markets a broad line of individual life insurance products, including
universal life, term life and whole life insurance, structured settlement and
annuity products, predominately flexible premium deferred annuities, as well as
variable universal life insurance and variable annuity products. These
products are sold directly by the P&C Group's agents.
Farmers Reinsurance Company ("Farmers Re"), a wholly owned subsidiary of
the Company, reinsures a percentage of the auto physical damage business
("APD") written by the P&C Group. Effective April 1, 2001, the APD reinsurance
agreement between Farmers Re and the P&C Group which had been in force since
January 1998 was cancelled and replaced with a similar APD reinsurance
agreement supported by multiple reinsurers. As a result of this new
agreement, the monthly premiums assumed by Farmers Re decreases from
$83.3 million to $16.7 million. Farmers Re continues to assume a quota share
percentage of ultimate net losses sustained by the P&C Group in its APD line
of business. This treaty, which will remain in effect until terminated by
either party, also provides for the P&C Group to receive a ceding
commission of 18% of premiums with additional experience commissions that
depend
14
on loss experience. This experience commission arrangement limits
Farmers Re's potential underwriting gain on the assumed business to 2.5% of
premiums assumed.
On March 31, 2001, Farmers Re and the P&C Group commuted $89,936,000 of
losses and loss adjustment expenses associated with the 2000 accident year.
As a result, in May 2001, Farmers Re paid the P&C Group $89,936,000 of losses
and loss adjustment expenses and $8,766,000 of accrued interest in settlement
of this commutation.
References to the "Insurance Subsidiaries" within the consolidated
financial statements are to Farmers Life and Farmers Re.
In December 1988, B.A.T Industries p.l.c. ("B.A.T"), acquired 100%
ownership of the Company through its wholly owned subsidiary BATUS Financial
Services. Immediately thereafter, BATUS Financial Services was merged into
FGI. The acquisition was accounted for as a purchase and, accordingly, the
acquired assets and liabilities were recorded in the Company's consolidated
balance sheets based on their estimated fair values at December 31, 1988.
In September 1998, the financial businesses of B.A.T, which included the
Company, were merged with Zurich Insurance Company ("ZIC"). The businesses of
ZIC and the financial services businesses of B.A.T were transferred to Zurich
Group Holding ("ZGH"), formerly known as Zurich Financial Services, a Swiss
company with headquarters in Zurich, Switzerland. This merger was accounted
for by ZGH as a pooling of interests under International Accounting Standards.
As a result of a unification of the holding structure of the Zurich
Financial Services Group in October 2000, Zurich Financial Services was renamed
Zurich Group Holding, as noted above, and a new group holding company, Zurich
Financial Services, was formed. As such, references to "Zurich" are to the new
group holding company, Zurich Financial Services.
In 1998, the Financial Accounting Standards Board ("FASB") released
Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for
Derivative Instruments and Hedging Activities". This Statement establishes
accounting and reporting standards for derivative instruments (including
certain derivative instruments embedded in other contracts) and for hedging
activities. SFAS No.133 requires that an entity recognize all derivatives as
either assets or liabilities in the statement of financial position and measure
those instruments at market value. Subsequently, in June 1999, the FASB
released SFAS No. 137, "Deferral of the Effective Date of FASB Statement No.
133", which deferred the effective date of SFAS No. 133 to fiscal years
beginning after June 15, 2000. Finally, in June 2000, the FASB released SFAS
No. 138, "Accounting for Certain Derivative Instruments and Certain Hedging
Activities". This Statement amends the accounting and reporting standards of
SFAS No. 133 for the following items: normal purchases and normal sales
exception, interest rate risk, recognized foreign-currency-denominated debt
instruments and intercompany derivatives. This Statement also amends SFAS No.
133 for certain provisions related to the implementation guidance arising from
the Derivative Implementation Group process. SFAS No. 133, No. 137, and No.138
are effective for financial statements issued by the Company for periods ending
after December 31, 2000. The adoption of these Statements did not have a
material impact on the Company's consolidated financial statements.
In September 2000, the FASB issued SFAS No. 140, "Accounting for Transfers
and Servicing of Financial Assets and Extinguishments of Liabilities". This
Statement revises accounting standards for securitizations and other transfers
of financial assets and collateral. SFAS No. 140 replaces SFAS No. 125,
"Accounting for Transfers and Servicing of Financial Assets and Extinguishments
of Liabilities", and rescinds SFAS No. 127, "Deferral of the Effective Date of
Certain Provisions of FASB Statement No. 125". This Statement, which is
required to be applied prospectively with certain exceptions, is effective for
transfers and servicing of financial assets and extinguishments of liabilities
occurring after March 31, 2001. Additionally, this Statement is effective for
recognition and reclassification of collateral and for disclosures relating to
securitization transactions and collateral for fiscal years ending after
December 15, 2000. The adoption of this Statement did not have a material
impact on the Company's consolidated financial statements.
15
In June 2001, the FASB issued SFAS No. 141, "Business Combinations". This
Statement, effective for all business combinations initiated after June 30,
2001, establishes standards for accounting and reporting business combinations.
It requires that all business combinations be accounted for by the purchase
method and prohibits the pooling of interest method of accounting except for
transactions initiated before July 1, 2001. This Statement supersedes
Accounting Principles Board ("APB") Opinion No. 16, "Business Combinations",
and FASB Statement No. 38, "Accounting for Preacquisition Contingencies of
Purchased Enterprises". The adoption of this Statement did not have a
material impact on the Company's consolidated financial statements.
In June 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible
Assets". This Statement addresses financial accounting and reporting for
intangible assets acquired individually or with a group of other assets (but
not those acquired in a business combination) at acquisition. This Statement
also addresses financial accounting and reporting for goodwill and other
intangible assets subsequent to their acquisition. Upon adoption of this
Statement, goodwill and other intangible assets that are determined to have an
indefinite useful life will no longer be amortized. Instead, goodwill will be
tested for impairment on an annual basis and intangible assets with indefinite
useful lives will be evaluated each reporting period to determine whether an
indefinite useful life is still supported. Any intangible asset that is
determined to have a finite useful life shall be amortized over this period and
its useful life shall be evaluated each reporting period to determine whether
revisions to the remaining amortization period are warranted. This Statement
is effective for financial statements issued for fiscal years beginning after
December 15, 2001 and supersedes APB Opinion No. 17, "Intangible Assets".
Early application is permitted for entities with fiscal years beginning after
March 15, 2001, provided that the first interim financial statements have not
previously been issued. This Statement is required to be applied at the
beginning of an entity's fiscal year and to be applied to all goodwill and
other intangible assets recognized in its financial statements at that date.
The Company is currently assessing but has not yet determined the impact of
SFAS No. 142 on its consolidated financial statements.
In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations". This Statement, effective for fiscal years beginning
after June 15, 2002, establishes the standard to record the fair value of a
liability for an asset retirement obligation in the period in which it is
incurred. The Company does not expect the adoption of this Statement to have
a material impact on its consolidated financial statements.
B. Capital structure
As of June 30, 2001, the Company had three classes of common stock - Class
A Common Stock (the "Class A Shares"), Class B Common Stock (the "Class B
Shares") and Class C Common Stock (the "Class C Shares"). Prior to a
recapitalization of the Company's capital structure which occurred in
connection with a private placement of an aggregate of $1,125,000,000 of
securities by six Zurich RegCaPS Funding Trusts on February 9, 2001, the
Company had 500 shares of Class A Common Stock, par value $1.00 per share, and
500 shares of Class B Common Stock, par value $1.00 per share. All Class A
Shares were wholly owned by ZGH and all Class B Shares were wholly owned by
Allied Zurich Holdings Limited, an affiliated company created during the
restructuring of B.A.T.
Subsequently, on February 9, 2001, in connection with the private
placement of the $1,125,000,000 of securities, ZGH exchanged 50 Class A Shares
for 50 shares of Class C Common Stock, par value $1.00 per share. The Class C
Shares were issued in six series (C-1 through C-6). ZGH subsequently
contributed each respective series of the Class C Shares to one of six Zurich
RegCaPS Funding Limited Partnerships (collectively, the "Partnerships"), which
are controlled by ZIC. As a result, upon completion of the recapitalization,
450 Class A Shares were owned by ZGH, 500 Class B Shares were owned by Allied
Zurich Holdings Limited and 50 Class C Shares were owned by the Partnerships.
The holders of the Class A Shares are entitled to 1.0694444 votes per
share and the holders of Class B Shares are entitled to .1111111 of a vote per
share (each subject to adjustment in the event of any stock dividend, stock
split, stock distribution or combination with respect to any shares of capital
stock of the Company) upon the election of directors and on all other matters
upon which stockholders generally are entitled to vote. In the event of a
liquidation, dissolution or winding up of the Company, the holders of Class A
Shares are entitled to share equally and ratably with the holders of Class C
Shares in the assets of the Company, if any, remaining after payment of all
16
liabilities of the Company and the Class C Share liquidation preference, to
the exclusion of the holders of Class B Shares.
Subject to the rights of the holders of Class C Shares, the holders of
Class A Shares and the holders of Class B Shares shall be entitled to receive
dividends, when and if declared by the Board of Directors, out of funds legally
available therefor.
The holders of Class C Shares are entitled to 0.375 of a vote per share
upon the election of directors and on all other matters upon which stockholders
generally are entitled to vote. However, at no time shall the aggregate voting
power of the Class C Shares be greater than 3.375% of the total voting power of
the Company. Upon any dissolution, liquidation or winding up of the Company,
after payment of the liabilities of the Company and the expenses of such
dissolution, liquidation or winding up, the holders of Class C Shares will be
entitled to receive in the aggregate out of the assets of the Company, before
any payment or distribution is made to the holders of Class A Shares or Class B
Shares, $1,125,000,000 in liquidation preference (the "Class C Liquidation
Preference"). To the extent the amount available for distribution upon
liquidation, dissolution or winding up exceeds the Class C Liquidation
Preference, the holders of Class C Shares are entitled to receive 7.4503311%
(as adjusted from time to time based upon the percentage of the Company's fair
market value represented by the Class C Shares at the time of such adjustment)
of the aggregate amount available for payment of distributions on liquidation
with respect to the Company's common stock. Amounts payable on the Class C
Shares in connection with the liquidation of the Company in excess of the Class
C Liquidation Preference are payable on a pari passu basis with the holders of
the Class A Shares and any other shares that rank junior to the Class C Shares
with respect to payments upon liquidation.
The holders of Class C Shares are entitled to receive non-cumulative
dividends when, as and if declared by the Board of Directors out of funds
legally available therefor. No cash dividends may be declared or paid on any
Class A Shares, Class B Shares or any other shares of common stock that rank
junior to the Class C Shares with respect to payment of dividends, unless (i)
full dividends have been declared for payment on the Class C Shares in an
amount at least equal to the greater of (A) the dividends payable or set apart
during the dividend period during which such cash dividends are paid at the
respective Class C Share indicative rate (as defined in the Certificates of
Designations of Class C-1 through Class C-6 Shares) or (B) 7.4503311% (as
adjusted as set forth above) of the amount of dividends paid or set apart for
payment by the Company on its common shares (including the Class C Shares)
during any relevant dividend period, (ii) the Partnerships have set apart or
paid the full amount of cash remittances (the "RegCaPS Payments") payable to
the holders of the regulatory capital preferred securities (the "RegCaPS")
issued by the Partnerships during any RegCaPS Payments period, (iii) the six
Zurich RegCaPS Funding LLCs (collectively, the "LLC") who hold the RegCaPS,
have set apart or paid certain cash payments during any LLC payment period on
the LLC preferred interests issued by each LLC, and (iv) such dividend does not
cause the net worth of the Company to be less than $3 billion (as adjusted from
time to time).
C. Material contingencies
The Company is a party to numerous lawsuits arising from its normal
business activities. These actions are in various stages of discovery and
development, and some seek punitive as well as compensatory damages. In the
opinion of management, the Company has not engaged in any conduct which should
warrant the award of any material punitive or compensatory damages. The
Company intends to vigorously defend its position in each case, and management
believes that, while it is not possible to predict the outcome of such matters
with absolute certainty, ultimate disposition of these proceedings should not
have a material adverse effect on the Company's consolidated results of
operations or financial position.
D. Company Obligated Mandatorily Redeemable Preferred Securities of
Subsidiary Trusts Holding Solely Junior Subordinated Debentures
In 1995, Farmers Group Capital and Farmers Group Capital II (the
"Subsidiary Trusts"), consolidated wholly owned subsidiaries of Farmers Group,
Inc., issued $410 million of 8.45% Cumulative Quarterly Income Preferred
Securities ("QUIPS"), Series A and $90 million of 8.25% QUIPS, Series B,
respectively. In connection with the
17
Subsidiary Trusts' issuance of the QUIPS and the related purchase by Farmers
Group, Inc. of all of the Subsidiary Trusts' Common Securities ("Common
Securities"), Farmers Group, Inc. issued to Farmers Group Capital $422,680,399
principal amount of its 8.45% Junior Subordinated Debentures, Series A due on
December 31, 2025, (the "Junior Subordinated Debentures, Series A") and issued
to Farmers Group Capital II $92,783,505 principal amount of its 8.25% Junior
Subordinated Debentures, Series B due on December 31, 2025 (the "Junior
Subordinated Debentures, Series B" and, together with the Junior Subordinated
Debentures, Series A, the "Junior Subordinated Debentures"). The sole assets
of Farmers Group Capital are the Junior Subordinated Debentures, Series A.
The sole assets of Farmers Group Capital II are the Junior Subordinated
Debentures, Series B. In addition, these arrangements are governed by various
agreements between Farmers Group, Inc. and the Subsidiary Trusts (the
Guarantee Agreements, the Trust Agreements, the Expense Agreements, the
Indentures and Junior Subordinated Debentures) which considered together
constitute a full and unconditional guarantee by Farmers Group, Inc. of the
Subsidiary Trusts' obligations under the Preferred Securities.
Under certain circumstances, the Junior Subordinated Debentures may be
distributed to holders of the QUIPS and holders of the Common Securities in
liquidation of the Subsidiary Trusts. As of September 27, 2000, Farmers Group,
Inc. had the option to redeem, in whole or in part, the Junior Subordinated
Debentures. The QUIPS are subject to mandatory redemption upon repayment of
the Junior Subordinated Debentures at maturity, or upon their earlier
redemption, at a redemption price of $25 per Preferred Security, plus accrued
and unpaid distributions thereon to the date fixed for redemption.
As of June 30, 2001 and 2000, a total of 20,000,000 shares of QUIPS were
outstanding.
E. Management fees
As AIF, the Company, provides management services to the non-claims side of
the P&C Group and receives management fees for the services rendered. As a
result, the Company received management fees from the P&C Group of $777,489,000
and $726,386,000 for the six month periods ended June 30, 2001 and June 30,
2000, respectively.
F. Related parties
As of June 30, 2001, the Company held a $250,000,000 note receivable from
Orange Stone (Delaware) Holdings Limited ("OSDH"), a subsidiary of Zurich. The
Company loaned $250,000,000 to OSDH on December 15, 1999 and, in return,
received a medium-term note with a 7.50% fixed interest rate that matures on
December 15, 2004. Interest on this note is paid semi-annually. Income earned
on this note totaled $9,375,000 in each of the six month periods ended June 30,
2001 and June 30, 2000.
In addition, as of June 30, 2001, the Company held $302,000,000 of notes
receivable from Zurich (UKISA) Limited ("UKISA"), a subsidiary of Zurich. The
Company purchased $1,057,000,000 of notes from UKISA on September 3, 1998.
Subsequently, on March 1, 2000, Eagle Star Life Assurance Company Limited
("Eagle Star"), also an affiliate of Zurich, assigned $175,000,000 of matured
surplus notes of the P&C Group to the Company and, in return, the Company
reduced the outstanding balance of the notes receivable from UKISA by
$175,000,000. Additionally, on September 3, 2000, $25,000,000 of the notes
receivable from UKISA, bearing interest at a coupon rate of 5.44% with an
original maturity date of September 3, 2000, were renewed for medium-term
notes with a 6.80% fixed interest rate maturing in September 2002.
Finally, on October 23, 2000, to help fund the payment of a $1,075,000,000
special dividend associated with the Zurich capital structure unification in
October 2000, the Company sold $580,000,000 of notes receivable from UKISA to
ZIC for par value. As a result, as of June 30, 2001, the Company held
$302,000,000 of notes receivable from UKISA with the following amounts,
maturity dates and coupon rates: $207,000,000 maturing in September 2001 at a
coupon rate of 5.48% and $95,000,000 maturing in September 2002, $25,000,000
of which is at a coupon rate of 6.80% and $70,000,000 of which is at a coupon
rate of 5.67%. Interest on the UKISA notes is paid semi-annually and for the
six month periods ended June 30, 2001 and June 30, 2000 totaled $9,058,000 and
$26,543,000, respectively.
18
G. Certificates of contribution and surplus notes of the P&C Group
As of June 30, 2001, the Company held $175,000,000 of surplus notes of the
P&C Group. These notes bear interest at 8.50% annually and mature in March
2005. These notes were obtained in March 2000 with the assignment of the
$175,000,000 of matured surplus notes of the P&C Group from Eagle Star
(see Note F).
Additionally, as of June 30, 2001, the Company held $370,000,000 of
certificates of contribution of the P&C Group bearing interest at 7.85%
annually. These certificates of contribution of the P&C Group were purchased
on March 7, 2000 to help fund the Exchanges' acquisition of Foremost.
Furthermore, the Company continued to hold $23,330,000 of miscellaneous other
certificates of contribution of the P&C Group, which bear interest at various
rates, and a $119,000,000 surplus note of the P&C Group, which bears interest
at 6.10% annually.
Conditions governing repayment of these amounts are outlined in the
certificates of contribution and the surplus notes. Generally, repayment may
be made only when the surplus balance of the issuer reaches a certain specified
level, and then only after approval is granted by the issuer's governing Board
and the appropriate state insurance regulatory department.
H. Supplemental cash flow information
For financial statement purposes, the Company considers all investments
with original maturities of 90 days or less as cash equivalents. Following is
a reconciliation of the balance sheet cash and cash equivalent totals to the
consolidated cash flow total:
Excluding
Insurance Insurance
Subsidiaries Subsidiaries Consolidated
------------ ------------ ------------
(Amounts in thousands)
Cash and cash equivalents -- December 31, 1999 $ 217,466 $ 96,034 $ 313,500
Activity through June 2000 (57,575)
-----------
Cash and cash equivalents -- June 30, 2000 212,757 43,168 $ 255,925
===========
Cash and cash equivalents -- December 31, 2000 $ 132,245 $ 84,431 $ 216,676
Activity through June 2001 179,849
-----------
Cash and cash equivalents -- June 30, 2001 341,651 54,874 $ 396,525
===========
Cash payments for interest were $1,795,000 and $1,678,000 for the six
month periods ended June 30, 2001 and June 30, 2000, respectively, while the
cash payment for dividends to the holders of the Company's QUIPS was
$21,035,000 for each of the six month periods ended June 30, 2001 and June 30,
2000. Cash payments for income taxes were $218,969,000 and $190,935,000 for
the six month periods ended June 30, 2001 and June 30, 2000, respectively.
On March 7, 2000, the Company purchased $370,000,000 of certificates of
contribution of the P&C Group to help fund the Exchanges' acquisition of
Foremost (see Note G).
I. Operating segments
The Company's principal activities are the provision of management
services to the P&C Group and the ownership and operation of the life and
reinsurance subsidiaries. These activities are managed separately as each
offers a unique set of services. As a result, the Company is comprised of the
following three reportable operating segments as defined in SFAS No. 131,
"Disclosures about Segments of an Enterprise and Related Information": the
management services segment, the life insurance segment and the reinsurance
segment.
As AIF, the management services segment is primarily responsible for
providing management services to the P&C Group. Management fees earned from
the P&C Group totaled $777,489,000 and $726,386,000 for the six
19
month periods ended June 30, 2001 and June 30, 2000, respectively. The life
insurance segment provides individual life insurance products, including
universal life, term life and whole life insurance and structured settlement
and annuity products, as well as variable universal life and annuity products.
Finally, the reinsurance segment provides reinsurance coverage to a percentage
of the auto physical damage business written by the P&C Group.
The basis of accounting used by the Company's management in evaluating
segment performance and determining how resources should be allocated is
referred to as the Company's GAAP historical basis, which excludes
the effects of the purchase accounting ("PGAAP") adjustments related to the
acquisition of the Company by B.A.T in December 1988 (see Note A). This
differs from the basis used in preparing the Company's financial statements
included in the SEC Form 10-K and 10-Q reports, which incorporates the effects
of these adjustments.
The Company accounts for intersegment transactions as if they were to
third parties and, as such, records the transactions at current market prices.
There were no intersegment revenues among the Company's three reportable
operating segments for the six month periods ended June 30, 2001 and June 30,
2000.
Information regarding the Company's reportable operating segments
follows:
Six month period ended June 30, 2001
---------------------------------------------------------------------------------------
- ------------------
GAAP historical basis PGAAP adjustments
Consolidated
------------------------------------------------------ -------------------------------
- ------
Management Life Management Life
PGAAP
services insurance Reinsurance Total services insurance
Total basis
------------------------------------------------------ -------------------------------
- ------ -----------
(Amounts in thousands)
Revenues $ 828,716 $ 428,376 (a) $ 321,826 (a) $1,578,918 $ 0 $ (456) $
(456) $1,578,462
Investment
income 43,723 176,664 22,311 242,698 (308) (456)
(764) 241,934
Investment
expenses 0 (7,431) (4,206) (11,637) 0 0
0 (11,637)
Net realized
gains/(losses) 14,192 17,104 3,721 35,017 (1,026) 0
(1,026) 33,991
Dividends
on preferred
securities of
subsidiary
trusts (21,035) 0 0 (21,035) 0 0
0 (21,035)
Income before
provision for
taxes 446,369 130,044 29,222 605,635 (54,848) (4,003)
(58,851) 546,784
Provision for
income taxes 173,690 46,938 9,261 229,889 (13,302) (7,646)
(20,948) 208,941
Depreciation and
amortization 30,208 48,853 0 79,061 52,130 (b) 3,723 (c)
55,853 134,914
- -----------------------
(a) Revenues for the insurance operating segments include net investment
income and net realized gains/(losses).
(b) Amount includes PGAAP adjustments associated with the amortization of the
AIF relationships ($21.4 million) and goodwill ($30.0 million).
(c) Amount includes PGAAP adjustments associated with the amortization of the
Value of Life Business Acquired ("VOLBA") asset and the reversal of
amortization associated with the pre-1988 deferred policy acquisition
costs ("DAC") asset.
Six month period ended June 30, 2000
---------------------------------------------------------------------------------------
- ------------------
GAAP historical basis PGAAP adjustments
Consolidated
------------------------------------------------------ -------------------------------
- ------
Management Life Management Life
PGAAP
services insurance Reinsurance Total services insurance
Total basis
------------------------------------------------------ -------------------------------
- ------ -----------
(Amounts in thousands)
Revenues $ 772,117 $ 389,850 (a) $ 519,067 (a) $1,681,034 $ 0 $ (459) $
(459) $1,680,575
Investment
income 66,826 163,251 15,413 245,490 (310) (459)
(769) 244,721
Investment
expenses 0 (5,448) 0 (5,448) 0 0
0 (5,448)
Net realized
gains/(losses) 36,728 15,980 3,654 56,362 0 0
0 56,362
Dividends
on preferred
securities of
subsidiary
trusts (21,035) 0 0 (21,035) 0 0
0 (21,035)
Income before
provision for
taxes 473,991 124,548 31,443 629,982 (53,884) (4,260)
(58,144) 571,838
Provision for
income taxes 180,199 44,121 9,707 234,027 (9,145) (1,843)
(10,988) 223,039
Depreciation and
amortization 28,084 54,726 0 82,810 52,131 (b) 3,980 (c)
56,111 138,921
- ----------------
(a) Revenues for the insurance operating segments include net investment
income and net realized gains/(losses).
(b) Amount includes PGAAP adjustments associated with the amortization of the
AIF relationships ($21.4 million) and goodwill ($30.0 million).
(c) Amount includes PGAAP adjustments associated with the amortization of the
VOLBA asset and the reversal of amortization associated with the pre-1988
DAC asset.
20
ITEM 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
General
The Company's principal activities are the provision of management
services to the P&C Group and the ownership and operation of the Insurance
Subsidiaries. Revenues and expenses relating to these principal business
activities are reflected in the Company's Consolidated Financial Statements
prepared in accordance with GAAP, which differs from statutory accounting
practices ("SAP"), which the Insurance Subsidiaries are required to use for
regulatory reporting purposes.
On March 7, 2000, the Exchanges acquired Foremost. Foremost is the
country's leading writer of manufactured homes and a prominent insurer of
recreational vehicles and other specialty lines. The Company provides
management services in respect of this business and receives compensation
based on a percentage of gross premiums earned.
Farmers Life, a wholly owned subsidiary of the Company, underwrites and
sells life insurance, structured settlement and annuity products as well as
variable universal life and variable annuity products. Revenues attributable
to traditional life insurance products, such as whole life or term life
contracts, as well as structured settlements with life contingencies are
classified as premiums as they become due. Future benefits are associated with
such premiums (through increases in liabilities for future policy benefits),
and prior period capitalized costs are amortized (through amortization of DAC)
so that profits are generally recognized over the same period as revenue
income. Revenues attributable to universal life, variable universal life and
variable annuity products consist of policy charges for the cost of insurance,
policy administration charges, surrender charges and investment income on
assets allocated to support policyholder account balances on deposit. Revenues
for deferred annuity products consist of surrender charges and investment
income on assets allocated to support policyholder account balances. Expenses
on universal life and annuity policies as well as on variable products include
interest credited to policyholders on policy balances as well as benefit claims
incurred in excess of policy account balances. Revenues attributable to
structured settlements without life contingencies consist of investment income
on assets allocated to support the policyholder benefits schedule and expenses
consist of interest credited to policyholders on policy balances.
Farmers Re, a wholly owned subsidiary of the Company, reinsures a
percentage of the auto physical damage business written by the P&C Group.
Effective April 1, 2001, the APD reinsurance agreement between Farmers Re and
the P&C Group which had been in force since January 1998 was cancelled and
replaced with a similar APD reinsurance agreement supported by multiple
reinsurers. As a result of this new agreement, the monthly premiums
assumed by Farmers Re decreases from $83.3 million to $16.7 million. Farmers
Re continues to assume a quota share percentage of ultimate net losses
sustained by the P&C Group in its APD line of business. This treaty, which
will remain in effect until terminated by either party, also provides for the
P&C Group to receive a provisional ceding commission of 18% of premiums. This
experience commission arrangement limits Farmers Re's potential underwriting
gain on the assumed business to 2.5% of premiums assumed.
Three Months Ended June 30, 2001 Compared to Three Months Ended June 30, 2000
Management Services to Property and Casualty Insurance Companies; and Other
Operating Revenues. Operating revenues increased from $396.8 million for
the three months ended June 30, 2000 to $413.6 million for the three months
ended June 30, 2001, an increase of $16.8 million, or 4.2%. Operating
revenues primarily consist of management fees paid to the Company as a
percentage of gross premiums earned by the P&C Group. Such premiums increased
from $2,851.5 million in the second quarter of 2000 to $3,034.4 million in the
second quarter of 2001, an increase of $182.9 million, or 6.4% due mainly to
continued growth in all lines of business.
21
Operating Expenses.
Salaries and Employee Benefits. Salaries and employee benefits
decreased from $104.1 million for the three months ended June 30, 2000 to
$99.0 million for the three months ended June 30, 2001, a decrease of
$5.1 million, or 4.9%, due primarily to a decrease in profit sharing
expenses.
Buildings and Equipment Expenses. Buildings and equipment expenses
decreased from $27.1 million for the three months ended June 30, 2000 to
$26.6 million for the three months ended June 30, 2001, a decrease of
$0.5 million, or 1.9%, due primarily to savings generated by renegotiated
lease contracts.
Amortization of Attorney-In-Fact Relationships and Goodwill.
Purchase accounting entries related to the acquisition of the Company by
B.A.T in December 1988 include goodwill (capitalized at $2.4 billion) and
the value of the AIF relationships of the P&C Group (capitalized at $1.7
billion). Amortization of these two items, which is being taken on a
straight-line basis over forty years, reduced pretax income by
approximately $25.7 million in each of the three month periods ended June
30, 2001 and June 30, 2000.
General and Administrative Expenses. General and administrative
expenses increased from $70.8 million for the three months ended June 30,
2000 to $85.1 million for the three months ended June 30, 2001, an
increase of $14.3 million, or 20.2%. This increase was primarily due to
increased levels of business activity between periods and increased
postage expense resulting from the recent privacy notice requirements
called for by the Gramm-Leach-Bliley Act.
Net Investment Income. Net investment income decreased from $32.6 million
for the three months ended June 30, 2000 to $22.5 million for the three months
ended June 30, 2001, a decrease of $10.1 million, or 31.0%. This decrease was
due mainly to lower investment yields and a decrease in the average invested
asset base resulting from the fact that a sizable portion of the investment
portfolio was liquidated to help fund the payment of the $1,075.0 million
special dividend associated with the Zurich capital structure unification in
October 2000 (see Note F).
Net Realized Gains. Net realized gains decreased $10.3 million, from
$19.0 million for the three months ended June 30, 2000 to $8.7 million for the
three months ended June 30, 2001, due primarily to unfavorable market
conditions experienced during the three month period ended June 30, 2001, and
the $1,075.0 million special dividend paid in 2000.
Dividends on Preferred Securities of Subsidiary Trusts. Dividend expense
related to the $500.0 million of QUIPS issued in 1995 was $10.5 million for the
three months ended June 30, 2001 and June 30, 2000.
Provision for Income Taxes. Provision for income taxes decreased from
$85.0 million for the three months ended June 30, 2000 to $79.3 million for the
three months ended June 30, 2001, a decrease of $5.7 million, or 6.7%, due
mainly to a decrease in pretax income between periods.
Management Services Income. As a result of the foregoing, management
services income decreased from $125.2 million for the three months ended June
30, 2000 to $118.6 million for the three months ended June 30, 2001, a decrease
of $6.6 million, or 5.3%.
Insurance Subsidiaries
Farmers Re
As a result of the new quota share reinsurance agreement, effective April
1, 2001, Farmers Re's assumed premiums decreased from $250.0 million for the
three month period ended June 30, 2000 to $50.0 million for the three month
ended June 30, 2001. Losses and loss adjustment expenses incurred under this
treaty were $34.4 million for the three months ended June 30, 2001 and $164.5
million for the three months ended June 30, 2000 and non-life reinsurance
commissions were $14.4 million for the three months ended June 30, 2001 and
$79.2 million for the
22
three months ended June 30, 2000. Income before taxes
decreased $1.3 million from $15.1 million for the three months ended June 30,
2000 to $13.8 million for the three months ended June 30, 2001 due primarily
to the decrease in underwriting gain between periods resulting from the new
reinsurance agreement. For the three month periods ended June 30, 2001 and
June 30, 2000, Farmers Re's contribution to net income was $9.5 million and
$10.5 million, respectively.
Farmers Life
Total Revenues. Total revenues increased from $199.7 million for the three
months ended June 30, 2000 to $212.9 million for the three months ended June
30, 2001, an increase of $13.2 million, or 6.6%.
Life and Annuity Premiums. Life and annuity premiums increased $5.9
million for the three months ended June 30, 2001, or 10.5%, over the three
months ended June 30, 2000. This increase was due to a 15.4% growth in
the volume of traditional life insurance in-force, as well as an 82.2%
increase in structured settlement with life contingencies premiums over
the three month period ended June 30, 2001.
Life Policy Charges. Life policy charges increased $0.5 million for
the three months ended June 30, 2001, or 0.9%, over the three months ended
June 30, 2000, reflecting growth in universal life-type insurance
in-force.
Net Investment Income. Net investment income increased $5.4 million
for the three months ended June 30, 2001, or 6.8%, over the three months
ended June 30, 2000. The increase was due to an increase in average
invested assets.
Net Realized Gains. Net realized gains increased by $1.4 million,
from $10.2 million for the three months ended June 30, 2000 to $11.6
million for the three months ended June 30, 2001 due to fixed income and
equity gains.
Total Operating Expenses. Total operating expenses increased from $136.4
million for the three months ended June 30, 2000 to $138.5 million for the
three months ended June 30, 2001, an increase of $2.1 million, or 1.5%.
Life Policyholders' Benefits and Charges. Life policyholders'
benefits expense and charges increased from $11.0 million for the three
months ended June 30, 2001, or 11.5%, over the three months ended June
30, 2000.
Policy Benefits. Policy benefits, which consist primarily of
death and surrender benefits on life products, increased $1.8 million
for the three months ended June 30, 2001, to $38.4 million, due to
growth in the volume of life insurance in-force.
Increase in Liability for Future Benefits. Increase in
liability for future benefits expense increased from $18.4 million
for the three months ended June 30, 2000 to $22.8 million for the
three months ended June 30, 2001. This increase was primarily
attributable to a 82.2% increase in deposits for structured
settlement products.
Interest Credited to Policyholders. Interest credited to
policyholders, which represents the amount credited to policyholder
funds on deposit under universal life-type contracts and deferred
annuities, increased from $40.3 million for the three months ended
June 30, 2000 to $45.1 million for the three months ended June 30,
2001, an increase of $4.8 million or 11.9%. This increase reflects
a growth in the universal life and fixed annuity fund balances.
General Operating Expenses. General operating expenses decreased
from $41.1 million for the three months ended June 30, 2000 to $32.2
million for the three months ended June 30, 2001, a decrease of $8.9
million, or $21.7%.
23
Amortization of DAC and Value of Life Business Acquired.
Amortization expense decreased from $27.3 million for the three
months ended June 30, 2000 to $20.6 million for the three months
ended June 30, 2001, due to favorable persistency on the Farmers
Flexible Universal Life ("FFUL") and Farmers Universal Life ("FUL")
product lines as well as differences in the mix of business.
Net Commissions. Net commissions decreased from $1.1 million
for the three months ended June 30, 2000 to ($0.5) million for the
three months ended June 30, 2001, due to a 55.1% growth in
reinsurance activity.
General and Administrative Expenses. General and administrative
expenses decreased from $12.7 million for the three months ended June
30, 2000 to $12.1 million, or 4.7%, for the three months ended June
30, 2001. This decrease was due largely to a premium tax refund from
California.
Provision for Income Taxes. Provision for income taxes decreased $22.3
million for the three months ended June 30, 2000 to $21.2 million for the three
months ended June 30, 2001.
Farmers Life Income. As a result of the foregoing, Farmers Life income
increased from $41.0 million for the three months ended June 30, 2000 to
$53.2 million for the three months ended June 30, 2001, an increase of $12.2
million, or 29.8%.
Consolidated Net Income
Consolidated net income of the Company increased from $176.7 million for
the three months ended June 30, 2000 to $181.3 million for the three months
ended June 30, 2001, an increase of $4.6 million, or 2.6%.
Six Months Ended June 30, 2001 Compared to Six Months Ended June 30, 2000
Management Services to Property and Casualty Insurance Companies; and Other
Operating Revenues. Operating revenues increased from $772.1 million for
the six months ended June 30, 2000 to $828.7 million for the six months ended
June 30, 2001, an increase of $56.6 million, or 7.3%. This growth reflects
higher gross premiums earned by the P&C Group, which increased from $5,586.1
million in the first six months of 2000 to $6,014.6 million in the first six
months of 2001 due mainly to continued growth in all lines of business. Also
contributing to the increase between periods was the fact that revenues earned
in connection with the provision of management services on the business the
P&C Group assumed from Foremost increased $12.0 million due to the fact that
the Foremost acquisition was not completed until March 2000.
Operating Expenses.
Salaries and Employee Benefits. Salaries and employee benefits
increased from $200.8 million for the six months ended June 30, 2000 to
$210.0 million for the six months ended June 30, 2001, an increase of $9.2
million, or 4.6%, due primarily to an increase in expenses incurred in
connection with providing management services to the business assumed from
Foremost.
Buildings and Equipment Expenses. Buildings and equipment expenses
increased from $50.2 million for the six months ended June 30, 2000 to
$51.4 million for the six months ended June 30, 2001, an increase of $1.2
million, or 2.4%, due to expenses incurred in connection with providing
management services to the business assumed from Foremost. This increase
in expense was partially offset by savings generated by renegotiated lease
contracts.
24
Amortization of Attorney-In-Fact Relationships and Goodwill.
Amortization expense was $51.4 million in each of the six month periods
ended June 30, 2001 and June 30, 2000.
General and Administrative Expenses. General and administrative
expenses increased from $131.7 million for the six months ended June 30,
2000 to $160.0 million for the six months ended June 30, 2001, an increase
of $28.3 million, or 21.5%. This increase was primarily due to increased
levels of business activity between periods, increased postage expense
resulting from the recent privacy notice requirements called for by the
Gramm-Leach-Bliley Act as well as an increase in expenses incurred in
connection with providing management services to the business assumed from
Foremost.
Net Investment Income. Net investment income decreased from $66.5 million
for the six months ended June 30, 2000 to $43.4 million for the six months
ended June 30, 2001, a decrease of $23.1 million, or 34.7%. This decrease was
due mainly to lower investment yields and a decrease in the average invested
asset base resulting from the fact that a sizable portion of the investment
portfolio was liquidated to help fund the payment of the $1,075.0 million
special dividend associated with the Zurich capital structure unification in
October 2000 (see Note F).
Net Realized Gains. Net realized gains decreased $23.5 million, from
$36.7 million for the six months ended June 30, 2000 to $13.2 million for the
six months ended June 30, 2001, due primarily to unfavorable market conditions
experienced during the six month period ended June 30, 2001, and the $1,075.0
million special dividend paid in 2000.
Dividends on Preferred Securities of Subsidiary Trusts. Dividend expense
was $21.0 million in each of the six month periods ended June 30, 2001 and June
30, 2000.
Provision for Income Taxes. Provision for income taxes decreased from
$171.1 million for the six months ended June 30, 2000 to $160.4 million for the
six months ended June 30, 2001, a decrease of $10.7 million, or 6.3%, due
mainly to an decrease in pretax income between periods.
Management Services Income. As a result of the foregoing, management
services income decreased from $249.1 million for the six months ended June 30,
2000 to $231.1 million for the six months nded June 30, 2001, a decrease of
$18.0 million, or 7.2%.
Insurance Subsidiaries
Farmers Re
As a result of the new quota share reinsurance agreement, effective April
1, 2001, Farmers Re's assumed premiums decreased from $500.0 million for the
six month period ended June 30, 2000 to $300.0 million for the six months ended
June 30, 2001. Losses and loss adjustment expenses incurred under this treaty
were $212.7 million for the six months ended June 30, 2001 and $329.0 million
for the six months ended June 30, 2000 and non-life reinsurance commissions
were $79.8 million for the six months ended June 30, 2001 and $158.6 million
for the six months ended June 30, 2000. Income before taxes decreased $2.2
million from $31.4 million for the six months ended June 30, 2000 to $29.2
million for the six months ended June 30, 2001 due primarily to the decrease in
underwriting gain between periods resulting from the new reinsurance agreement.
For the six month periods ended June 30, 2001 and June 30, 2000, Farmers Re's
contribution to net income was $20.0 million and $21.7 million, respectively.
Farmers Life
Total Revenues. Total revenues increased from $389.4 million for the six
months ended June 30, 2000 to $427.9 million for the six months ended June 30,
2001, an increase of $38.5 million, or 9.9%.
Life and Annuity Premiums. Life and annuity premiums increased $25.1
million for the six months ended June 30, 2001, or 23.1%, over the six
months ended June 30, 2000. This increase was due to a 24.3%
25
growth in the volume of traditional life insurance in-force, as well as a
168.2 % increase in structured settlement with life contingencies premiums
over the six months ended June 30, 2000.
Life Policy Charges. Life policy charges increased $0.9 million for
the six months ended June 30, 2001, or 0.9%, over the six months ended
June 30, 2000, reflecting a 1.4% growth in universal life-type insurance
in-force.
Net Investment Income. Net investment income increased $11.4 million
for the six months ended June 30, 2001, or 7.3%, over the six months ended
June 30, 2000. The increase was due to an increase in average invested
assets.
Net Realized Gains. Net realized gains increased by $1.1 million or
6.9%, from $16.0 million for the six months ended June 30, 2000 to $17.1
million for the six months ended June 30, 2001.
Total Operating Expenses. Total operating expenses increased from $269.1
million for the six months ended June 30, 2000 to $301.9 million for the six
months ended June 30, 2001, an increase of $32.8 million, or 12.2%.
Life Policyholders' Benefits and Charges. Life policyholders'
benefits expense and charges increased from $185.1 million for the six
months ended June 30, 2000 to $224.1 million for the six months ended
June 30, 2001, an increase of $39.0 million, or 21.1%.
Policy Benefits. Policy benefits increased $9.3 million for the
six months ended June 30, 2001 to $81.1 million, due to a 7.1% growth
in the volume of life insurance in-force.
Increase in Liability for Future Benefits. Increase in
liability for future benefits expense increased from $32.7 million
for the six months ended June 30, 2000 to $55.2 million for the six
months ended June 30, 2001. This increase was primarily attributable
to a 168.2% increase in deposits for structured settlement products.
Interest Credited to Policyholders. Interest credited to
policyholders increased from $80.6 million for the six months ended
June 30, 2000 to $87.8 million for the six months ended June 30,
2001, an increase of $7.2 million or 8.9%, reflecting growth in the
universal life and fixed annuity fund balances.
General Operating Expenses. General operating expenses decreased
from $84.0 million for the six months ended June 30, 2000 to $77.8 million
for the six months ended June 30, 2001, a decrease of $6.2 million, or
7.4%.
Amortization of DAC and VOLBA. Amortization expense decreased
from $57.0 million for the six months ended June 30, 2000 to $50.3
million for the six months ended June 30, 2001 due primarily to
favorable persistency on the FFUL and FUL product lines as well as
differences in the mix of business.
Net Commissions. Net commissions decreased $2.9 million from
$2.6 million for the six months ended June 30, 2000 to ($0.3) million
for the six months ended June 30, 2001, due to a 51.7% growth in
reinsurance activity.
General and Administrative Expenses. General and administrative
expenses increased from $24.4 million for the six months ended June
30, 2000 to $27.8 million for the six months ended June 30, 2001, an
increase of $3.4 million or 13.9%, due primarily to business growth
and new initiatives.
26
Provision for Income Taxes. Provision for income taxes decreased from
$42.3 million for the six months ended June 30, 2000 to $39.3 million for the
six months ended June 30, 2001.
Farmers Life Income. As a result of the foregoing, Farmers Life income
increased from $78.0 million for the six months ended June 30, 2000 to $86.7
million for the six months ended June 30, 2001, an increase of $8.7 million, or
11.2%.
Consolidated Net Income
Consolidated net income of the Company decreased from $348.8 million for
the six months ended June 30, 2000 to $337.8 million for the six months ended
June 30, 2001, a decrease of $11.0 million, or 3.2%.
Liquidity and Capital Resources
As of June 30, 2001 and June 30, 2000, the Company held cash and cash
equivalents of $396.5 million and $255.9 million, respectively. In addition,
as of June 30, 2001, the Company had available revolving credit facilities
enabling it to borrow up to $500.0 million in the event such a need should
arise.
Net cash provided by operating activities increased from $508.2 million
for the six months ended June 30, 2000 to $528.5 million for the six months
ended June 30, 2001, an increase of $20.3 million. This increase in cash was
due primarily to a $46.5 million increase in life insurance policy liabilities
and a $19.7 million increase resulting from gains on sales of assets.
Partially offsetting these increases in cash were a $20.5 million net decrease
resulting from changes in current and non-current assets and liabilities, an
$11.0 million decrease in consolidated net income as well as a $9.7 million
decrease in equity in earnings of joint ventures.
Net cash used in investing activities decreased from $177.5 million for
the six months ended June 30, 2000 to $102.8 million for the six months ended
June 30, 2001, an increase in cash of $74.7 million. This increase in cash was
the result of a $548.5 million increase in proceeds from sales and maturities
of investments available-for-sale and a $370.0 million increase resulting from
the purchase of certificates of contribution of the P&C Group in March 2000.
Partially offsetting these increases in cash was an $862.7 million increase in
purchases of investments available-for-sale.
Net cash used in financing activities decreased from $388.2 million for
the six months ended June 30, 2000 to $245.9 million for the six months ended
June 30, 2001, resulting in an increase in cash of $142.3 million. This
increase in cash was due primarily to a $126.7 million decrease in dividends
paid to stockholders coupled with higher cash flows from annuity contracts.
ITEM 3. Quantitative and Qualitative Disclosures about Market Risks
The market risks associated with the Company's investment portfolios have
not changed materially from those disclosed at year-end 2000.
27
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.
The Company is a party to numerous lawsuits arising from its normal
business activities. These actions are in various stages of discovery
and development, and some seek punitive as well as compensatory
damages. In the opinion of management, the Company has not engaged in
any conduct which should warrant the award of any material punitive or
compensatory damages. The Company intends to vigorously defend its
position in each case, and management believes that, while it is not
possible to predict the outcome of such matters with absolute
certainty, ultimate disposition of these proceedings should not have a
material adverse effect on the Company's consolidated results of
operations or financial position. In addition, the Company is, from
time to time, involved as a party to various governmental and
administrative proceedings.
Item 2. Changes in Securities. None.
Item 3. Defaults upon Senior Securities. None.
Item 4. Submission of Matters to a Vote of Security Holders. None.
Item 5. Other Information. None.
Item 6. Exhibits and Report on Form 8-K.
(a) Exhibits.
16. Letter regarding change in Certifying Accountant.
(b) Reports on Form 8-K.
On June 7, 2001, FGI filed a report on Form 8-K announcing a
change in its Certifying Accountant.
28
FARMERS GROUP, INC.
AND SUBSIDIARIES
SIGNATURES
Pursuant to the requirements 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.
Farmers Group, Inc.
(Registrant)
August 13, 2001 /s/ Martin D. Feinstein
---------------------------------------------
Date Martin D. Feinstein
Chairman of the Board,
President and Chief Executive Officer
August 13, 2001 /s/ Gerald E. Faulwell
---------------------------------------------
Date Gerald E. Faulwell
Senior Vice President,
Chief Financial Officer
and Director