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 September 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 September 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 SEPTEMBER 30, 2001
PART I. FINANCIAL INFORMATION PAGE
----
ITEM 1. Financial Statements (Unaudited)
Consolidated Balance Sheets Assets
September 30, 2001 and December 31, 2000 4
Consolidated Balance Sheets Liabilities and Stockholders'
Equity
September 30, 2001 and December 31, 2000 5
Consolidated Statements of Income
Nine Month Periods ended September 30, 2001 and
September 30, 2000 6
Consolidated Statements of Comprehensive Income
Nine Month Periods ended September 30, 2001 and
September 30, 2000 7
Consolidated Statements of Income
Three Month Periods ended September 30, 2001 and
September 30, 2000 8
Consolidated Statements of Comprehensive Income
Three Month Periods ended September 30, 2001 and
September 30, 2000 9
Consolidated Statement of Stockholders' Equity
Nine Month Period ended September 30, 2001 10
Consolidated Statements of Cash Flows
Nine Month Periods ended September 30, 2001 and
September 30, 2000 11
Notes to Interim Financial Statements 12
ITEM 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 20
ITEM 3. Quantitative and Qualitative Disclosures about Market Risks 27
PART II. OTHER INFORMATION 28
SIGNATURES 29
4
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
FARMERS GROUP, INC.
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands)
ASSETS
(Unaudited)
September 30, December 31,
2001 2000
------------- ------------
Current assets, excluding Insurance Subsidiaries:
Cash and cash equivalents $ 509,244 $ 132,245
Marketable securities, at market value
(cost: $27,294 and $10,386) 27,451 10,386
Accrued interest 21,177 41,995
Accounts receivable, principally from the P&C Group 106,548 36,052
Notes receivable affiliate 95,000 207,000
Deferred taxes 60,012 40,609
Prepaid expenses and other 21,112 15,437
------------- ------------
Total current assets 840,544 483,724
------------- ------------
Investments, excluding Insurance Subsidiaries:
Fixed maturities available-for-sale, at market value
(cost: $116,919 and $292,039) 115,087 291,795
Mortgage loans on real estate 49 92
Common stocks available-for-sale, at market value
(cost: $263,742 and $282,224) 206,338 242,066
Certificates of contribution and surplus notes of the P&C Group 546,830 184,830
Real estate, at cost (net of accumulated depreciation:
$45,015 and $26,179) 88,066 69,699
Other investments 0 3,341
------------- ------------
956,370 791,823
------------- ------------
Other assets, excluding Insurance Subsidiaries:
Notes receivable affiliates 250,000 345,000
Goodwill (net of accumulated amortization:
$765,561 and $720,528) 1,636,194 1,681,227
Attorney-in-fact relationships (net of accumulated amortization:
$544,757 and $512,712) 1,164,286 1,196,331
Other assets 269,286 255,174
------------- ------------
3,319,766 3,477,732
------------- ------------
Properties, plant and equipment, at cost: (net of accumulated
depreciation: $414,786 and $391,360) 414,108 438,371
------------- ------------
Investments of Insurance Subsidiaries:
Fixed maturities available-for-sale, at market value
(cost: $4,386,735 and $4,349,824) 4,548,724 4,365,338
Mortgage loans on real estate 31,396 36,984
Non-redeemable preferred stocks available-for-sale, at market
value (cost: $11,128 and $11,128) 12,003 11,500
Common stocks available-for-sale, at market value
(cost: $354,629 and $330,785) 288,129 293,407
Certificates of contribution and surplus notes of the P&C Group 490,500 502,500
Policy loans 228,670 218,162
Real estate, at cost (net of accumulated depreciation:
$31,135 and $29,369) 85,479 89,426
Joint ventures, at equity 3,235 4,651
S&P 500 call options, at fair value (cost: $37,219 and $29,696) 8,438 26,271
Other investments 14,341 5,279
------------- ------------
5,710,915 5,553,518
------------- ------------
Other assets of Insurance Subsidiaries:
Cash and cash equivalents 308,455 84,431
Marketable securities, at market value
(cost: $86,499 and $9,997) 86,787 9,997
Reinsurance premiums receivable P&C Group 13,109 111,874
Accrued investment income 67,866 69,922
Deferred policy acquisition costs and value of life business
acquired 815,483 838,121
Securities lending collateral 33,334 436,744
Other assets 84,373 29,151
Assets held in Separate Account 39,349 8,423
------------- ------------
1,448,756 1,588,663
------------- ------------
Total assets $ 12,690,459 $ 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)
LIABILITIES AND STOCKHOLDERS' EQUITY
(Unaudited)
September 30, December 31,
2001 2000
------------ ------------
Current liabilities, excluding Insurance Subsidiaries:
Notes and accounts payable:
P&C Group 362,000 481
Other 53,532 53,375
Accrued liabilities:
Profit sharing 45,100 58,242
Income taxes 205,252 115,223
Other 6,701 9,715
------------ ------------
Total current liabilities 672,585 237,036
------------ ------------
Other liabilities, excluding Insurance Subsidiaries:
Real estate mortgages payable 14 16
Non-current deferred taxes 539,254 551,097
Other 105,625 120,405
------------ ------------
644,893 671,518
------------ ------------
Liabilities of Insurance Subsidiaries:
Policy liabilities:
Future policy benefits 3,740,666 3,574,594
Claims 45,973 32,509
Policyholders dividends 10 3
Other policyholders funds 213,271 141,544
Death benefits payable 52,550 42,011
Provision for non-life losses and loss adjustment expenses 47,746 89,936
Income taxes (including deferred taxes: $96,199 and $97,267) 152,193 121,499
Unearned investment income 910 903
Reinsurance payable P&C Group 7,657 185,742
Securities lending liability 33,334 436,744
Other liabilities 125,642 34,983
Liabilities related to Separate Account 39,349 8,423
------------ ------------
4,459,301 4,668,891
------------ ------------
Total liabilities 5,776,779 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 September 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 September 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 September 30, 2001 50 shares 0.05 0.00
Additional capital 5,212,618 5,212,618
Accumulated other comprehensive income/(loss) (net of deferred
taxes: $2,208 and ($23,946)) 4,101 (44,471)
Retained earnings 1,196,960 1,088,238
------------ ------------
Total stockholders' equity 6,413,680 6,256,386
------------ ------------
Total liabilities and stockholders' equity $ 12,690,459 $ 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)
Nine month period
ended September 30,
------------------------
2001 2000
----------- -----------
Consolidated operating revenues $ 2,279,549 $ 2,560,580
=========== ===========
Management services to property and casualty
insurance companies; and other:
Operating revenues $ 1,256,988 $ 1,179,798
Operating expenses 704,089 665,826
----------- ----------
Operating income 552,899 513,972
Net investment income 59,983 100,408
Net realized gains 13,099 52,943
Impairment losses on investments (38,195) 0
Dividends on preferred securities of subsidiary trusts (31,553) (31,553)
----------- ----------
Income before provision for taxes 556,233 635,770
Provision for income taxes 229,704 259,718
----------- ----------
Management services income 326,529 376,052
----------- ----------
Insurance Subsidiaries:
Life and annuity premiums 201,787 168,013
Non-life reinsurance premiums 350,000 750,000
Life policy charges 162,991 161,090
Net investment income 279,104 262,590
Net realized gains 42,287 39,089
Impairment losses on investments (47,925) 0
----------- -----------
Total revenues 988,244 1,380,782
----------- -----------
Non-life losses and loss adjustment expenses 248,042 515,362
Life policyholders' benefits and charges 341,105 283,274
Non-life reinsurance commissions 93,208 215,903
General operating expenses 112,772 124,775
----------- -----------
Total operating expenses 795,127 1,139,314
----------- -----------
Income before provision for taxes 193,117 241,468
Provision for income taxes 62,424 83,007
----------- -----------
Insurance Subsidiaries income 130,693 158,461
----------- -----------
Consolidated net income $ 457,222 $ 534,513
=========== ===========
The accompanying notes are an integral part of these interim financial statements.
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FARMERS GROUP, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF
COMPREHENSIVE INCOME
(Amounts in thousands)
(Unaudited)
Nine month period
ended September 30,
------------------------
2001 2000
----------- -----------
Consolidated net income $ 457,222 $ 534,513
----------- -----------
Other comprehensive income/(loss), net of tax:
Net unrealized holding gains/(losses) on securities,
net of tax of $38,231 and ($8,569) 71,000 (15,912)
Change in effect of unrealized losses on other
insurance accounts, net of tax of ($12,077) and ($4,128) (22,428) (7,667)
----------- -----------
Other comprehensive income/(loss) 48,572 (23,579)
----------- -----------
Comprehensive income $ 505,794 $ 510,934
=========== ===========
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 September 30,
------------------------
2001 2000
----------- -----------
Consolidated operating revenues $ 701,087 $ 880,005
=========== ===========
Management services to property and casualty
insurance companies; and other:
Operating revenues $ 428,272 $ 407,681
Operating expenses 231,348 231,607
----------- -----------
Operating income 196,924 176,074
Net investment income 16,568 33,892
Net realized gains/(losses) (67) 16,215
Impairment losses on investments (38,195) 0
Dividends on preferred securities of subsidiary trusts (10,518) (10,518)
----------- -----------
Income before provision for taxes 164,712 215,663
Provision for income taxes 69,316 88,664
----------- -----------
Management services income 95,396 126,999
----------- -----------
Insurance Subsidiaries:
Life and annuity premiums 68,463 59,743
Non-life reinsurance premiums 50,000 250,000
Life policy charges 54,276 53,293
Net investment income 92,222 89,833
Net realized gains 13,167 19,455
Impairment losses on investments (39,630) 0
----------- -----------
Total revenues 238,498 472,324
----------- -----------
Non-life losses and loss adjustment expenses 35,296 186,399
Life policyholders' benefits and charges 117,055 98,176
Non-life reinsurance commissions 13,454 57,350
General operating expenses 34,839 40,662
----------- -----------
Total operating expenses 200,644 382,587
----------- -----------
Income before provision for taxes 37,854 89,737
Provision for income taxes 13,871 31,022
----------- -----------
Insurance Subsidiaries income 23,983 58,715
----------- -----------
Consolidated net income $ 119,379 $ 185,714
=========== ===========
The accompanying notes are an integral part of these interim financial statements.
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FARMERS GROUP, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF
COMPREHENSIVE INCOME
(Amounts in thousands)
(Unaudited)
Three month period
ended September 30,
------------------------
2001 2000
----------- -----------
Consolidated net income $ 119,379 $ 185,714
----------- -----------
Other comprehensive income, net of tax:
Net unrealized holding gains on securities,
net of tax of $34,504 and $13,135 64,079 24,396
Change in effect of unrealized losses on other
insurance accounts, net of tax of ($7,881) and
($4,231) (14,636) (7,858)
----------- -----------
Other comprehensive income 49,443 16,538
----------- -----------
Comprehensive income $ 168,822 $ 202,252
=========== ===========
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 nine month period ended September 30, 2001
(Amounts in thousands)
(Unaudited)
Accumulated Other Total
Common Additional Comprehensive Retained Stockholders'
Stock Capital Income/(Loss) Earnings Equity
-------- ----------- ----------------- ------------ ------------
Balance, December 31, 2000 $ 1 $ 5,212,618 $ (44,471) $ 1,088,238 $ 6,256,386
Net income 457,222 457,222
Net unrealized holding gains on
securities, net of tax of
$38,231 71,000 71,000
Change in effect of unrealized
losses on other insurance
accounts, net of tax of
($12,077) (22,428) (22,428)
Cash dividends paid (348,500) (348,500)
-------- ----------- ---------------- ------------ ------------
Balance, September 30, 2001 $ 1 $ 5,212,618 $ 4,101 $ 1,196,960 $ 6,413,680
======== =========== ================ ============ ============
The accompanying notes are an integral part of these interim financial statements.
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FARMERS GROUP, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in thousands)
(Unaudited)
Nine month period
ended September 30,
-----------------------
2001 2000
---------- ----------
Cash Flows from Operating Activities:
Consolidated net income $ 457,222 $ 534,514
Non-cash and operating activities adjustments:
Depreciation and amortization 128,586 123,659
Amortization of deferred policy acquisition costs and
value of life business acquired 72,113 83,770
Policy acquisition costs deferred (83,980) (76,637)
Life insurance policy liabilities 169,716 104,467
Provision for non-life losses and loss adjustment expenses (42,190) (7,540)
Universal life type contracts:
Deposits received 227,573 227,083
Withdrawals (203,963) (199,290)
Interest credited 60,897 56,252
Equity in earnings of joint ventures 750 738
Gains on sales of assets (69,325) (92,746)
Impairment losses on investments 86,120 0
Changes in assets and liabilities:
Current assets and liabilities 10,439 7,140
Non-current assets and liabilities (28,399) (79,967)
Other, net (4,038) 13,197
---------- -----------
Net cash provided by operating activities 781,521 694,640
---------- -----------
Cash Flows from Investing Activities:
Purchases of investments available-for-sale (1,949,135) (815,894)
Purchases of properties (60,335) (88,676)
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 1,955,838 1,521,491
Proceeds from sales of properties 23,831 7,882
Proceeds from redemption of notes receivable affiliate 207,000 175,000
Mortgage loan collections 5,632 3,305
Increase in policy loans (10,508) (12,809)
Other, net (1,706) (3,015)
---------- -----------
Net cash provided by investing activities 170,617 242,284
---------- -----------
Cash Flows from Financing Activities:
Dividends paid to stockholders (348,500) (362,025)
Annuity contracts:
Deposits received 315,058 111,284
Withdrawals (355,227) (195,928)
Interest credited 37,556 53,652
Payment of long-term notes payable (2) (2)
---------- -----------
Net cash used in financing activities (351,115) (393,019)
---------- -----------
Increase in cash and cash equivalents 601,023 543,905
Cash and cash equivalents at beginning of year 216,676 313,500
---------- -----------
Cash and cash equivalents at end of period $ 817,699 $ 857,405
========== ===========
The accompanying notes are an integral part of these interim financial statements.
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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 September 30, 2001, the
related consolidated statements of income, comprehensive income, stockholders'
equity and cash flows for the nine month period ended September 30, 2001 and
the consolidated statement of income, comprehensive income and cash flows for
the nine month period ended September 30, 2000, as well as the consolidated
statements of income and comprehensive income for the three month periods ended
September 30, 2001 and September 30, 2000, have been prepared in accordance
with accounting principles generally accepted in the United States of America
("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 with multiple reinsurers. As a result of this new agreement, the
monthly premiums assumed by Farmers Re decreased 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
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APD line of business. This treaty, which can be 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 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.
Additionally, on August 15, 2001, Farmers Re and the P&C Group commuted
$100,797,000 of losses and loss adjustment expenses due to the cancellation of
the original APD reinsurance agreement. As a result, Farmers Re paid the P&C
Group $100,797,000 of losses and loss adjustment expenses and $1,036,000 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
14
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.
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.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets". This Statement addresses
financial accounting and reporting for the impairment of long-lived assets and
for long-lived assets to be disposed of. This Statement supersedes SFAS No.
121, "Accounting for the Impairment of Long Lived Assets and for Long-Lived
assets to Be Disposed Of". However, this Statement retains the fundamental
provisions of SFAS No. 121 for a) recognition and measurement of the impairment
of long-lived assets to be held and used and b) measurement of long-lived
assets to be disposed of by sale. This Statement also supersedes the
accounting and reporting provisions of APB Opinion No. 30, "Reporting the
Results of Operations Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions", for segments of a business to be disposed of. However, this
Statement retains the requirements of APB Opinion No. 30 to report discontinued
operations separately from continuing operations and extends that reporting to
a component of an entity that either has been disposed of or is classified as
held for sale. The provisions of this Statement are effective for financial
statements issued for fiscal years beginning after December 15, 2001, and
interim periods within those fiscal years, with early application encouraged.
The provisions of this statement generally are to be applied prospectively.
The Company does not expect the adoption of this Statement to have a material
impact on its consolidated financial statements.
15
B. Capital structure
As of September 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
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
16
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 Subsidiary Trusts' issuance of the QUIPS
and the related purchase by Farmers Group, Inc. of all of the Subsidiary
Trusts' Common Securities ("Common Securities"), Farmers Group, Inc. issued to
Farmers Group Capital $422,680,399 principal amount of its 8.45% Junior
Subordinated Debentures, Series A due on December 31, 2025, (the "Junior
Subordinated Debentures, Series A") and issued to Farmers Group Capital II
$92,783,505 principal amount of its 8.25% Junior Subordinated Debentures,
Series B due on December 31, 2025 (the "Junior Subordinated Debentures, Series
B" and, together with the Junior Subordinated Debentures, Series A, the "Junior
Subordinated Debentures"). The sole assets of Farmers Group Capital are the
Junior Subordinated Debentures, Series A. The sole assets of Farmers Group
Capital II are the Junior Subordinated Debentures, Series B. In addition,
these arrangements are governed by various agreements between Farmers Group,
Inc. and the Subsidiary Trusts (the Guarantee Agreements, the Trust Agreements,
the Expense Agreements, the Indentures and the Junior Subordinated Debentures)
which considered together constitute a full and unconditional guarantee by
Farmers Group, Inc. of the Subsidiary Trusts' obligations under the Preferred
Securities.
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 September 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
$1,177,440,000 and $1,108,411,000 for the nine month periods ended September
30,2001 and September 30, 2000, respectively.
17
F. Related parties
As of September 30, 2001, the Company held a $250,000,000 note receivable
from ZGA US Limited ("ZGAUS"), a subsidiary of Zurich, formerly known as Orange
Stone (Delaware) Holdings Limited. The Company loaned $250,000,000 to ZGAUS 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 and for each of the nine month periods ended September
30, 2001 and September 30, 2000 totaled $14,063,000.
In addition, as of September 30, 2001, the Company held $95,000,000 of
notes receivable from Zurich (UKISA) Limited ("UKISA"), a subsidiary of Zurich.
The Company originally 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.
Also, 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. Finally, on September 3, 2001, the Company received
$214,625,000 from UKISA in settlement of a $207,000,000 note receivable and
$7,625,000 of accrued interest. This note had a maturity date of September 3,
2001 and a coupon rate of 5.48%.
As a result, as of September 30, 2001, the Company held $95,000,000 of
notes receivable from UKISA each with a maturity date of September 2002. The
$95,000,000 notes receivable are fixed rate short-term notes with coupon rates
as follows: $25,000,000 at a coupon rate of 6.80% and $70,000,000 at a coupon
rate of 5.67%. Interest on the UKISA notes is paid semi-annually and for the
nine month periods ended September 30, 2001 and September 30, 2000 totaled
$12,461,000 and $39,048,000, respectively.
G. Certificates of contribution and surplus note of the P&C Group
Effective September 27, 2001, the Company redeemed one-half of the
$175,000,000 surplus notes of the P&C Group which were obtained in March 2000
as a result of the assignment of the matured surplus notes of the P&C Group
from Eagle Star (see Note F). In addition, effective September 27, 2001, the
Company redeemed a $119,000,000 surplus note of the P&C Group bearing interest
at 6.10% annually and maturing in October 2001. Finally, effective September
27, 2001, the Company purchased $556,500,000 of certificates of contribution
of the P&C Group which mature in September 2006.
As a result, at September 30, 2001, the Company held the following
certificates of contribution and surplus notes of the P&C Group:
An $87,500,000 surplus note, issued in March 2000, bearing interest at
8.50% annually.
$370,000,000 of certificates of contribution, issued in March 2000,
bearing interest at 7.85% annually.
$556,500,000 of certificates of contribution issued in September 2001.
Miscellaneous other certificates of contribution totaling $23,330,050
which bear interest at various rates.
Conditions governing repayment of these amounts are outlined in the
certificates of contribution and the surplus note. Generally, repayment may be
made only when the surplus balance of the issuer reaches a certain
18
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 September 2000 543,905
-----------
Cash and cash equivalents -- September 30, 2000 823,556 33,849 $ 857,405
===========
Cash and cash equivalents -- December 31, 2000 $ 132,245 $ 84,431 $ 216,676
Activity through September 2001 601,023
-----------
Cash and cash equivalents -- September 30, 2001 509,244 308,455 $ 817,699
===========
Cash payments for interest were $1,807,000 and $1,726,000 for the nine
month periods ended September 30, 2001 and September 30, 2000, respectively,
while the cash payment for dividends to the holders of the Company's QUIPS was
$31,553,000 for each of the nine month periods ended September 30, 2001 and
September 30, 2000. Cash payments for income taxes were $229,037,000 and
$302,345,000 for the nine month periods ended September 30, 2001 and September
30, 2000, respectively.
On September 3, 2001, the Company received $214,625,000 from UKISA in
settlement of a $207,000,000 note receivable and $7,265,000 of accrued interest
(see Note F). Also 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 $1,177,440,000 and $1,108,411,000 for the nine month
periods ended September 30, 2001 and September 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.
19
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 nine month periods ended September 30, 2001 and
September 30, 2000.
Information regarding the Company's reportable operating segments follows:
Nine month period ended September 30, 2001
------------------------------------------------------------------------------------------------------------------
GAAP historical basis PGAAP adjustments Consolidated
------------------------------------------------------ ----------------------------------------------
Management Life Management Life PGAAP
services insurance Reinsurance Total services insurance Total basis
- ------------------------------------------------------ --------------------------------------------- ------------
(Amounts in thousands)
<C
Revenues $1,256,988 $ 639,455 (a) $ 383,791 (a) $2,280,234 $ 0 $ (685) $ (685) $2,279,549
Investment
income 60,595 262,916 32,767 356,278 (612) (685) (1,297) 354,981
Investment
expenses 0 (10,362) (5,532) (15,894) 0 0 0 (15,894)
Net realized
gains/(losses) 14,125 34,855 7,432 56,412 (1,026) 0 (1,026) 55,386
Impairment
losses on
investments (38,195) (40,157) (7,768) (86,120) 0 0 0 (86,120)
Dividends on
preferred
securities of
subsidiary
trusts (31,553) 0 0 (31,553) 0 0 0 (31,553)
Income before
provision for
taxes 641,739 163,631 35,443 840,813 (85,506) (5,957) (91,463) 749,350
Provision for
income taxes 250,876 59,855 11,042 321,773 (21,172) (8,473) (29,645) 292,128
Depreciation and
amortization 46,854 69,987 0 116,841 78,321 (b) 5,537 (c) 83,858 200,699
- -----------------------
(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 ($32.0 million) and goodwill ($45.0 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.
Nine month period ended September 30, 2000
- ------------------------------------------------------------------------------------------------------------------
GAAP historical basis PGAAP adjustments Consolidated
------------------------------------------------------ ----------------------------------------------
Management Life Management Life PGAAP
services insurance Reinsurance Total services insurance Total basis
- ------------------------------------------------------ --------------------------------------------- ------------
(Amounts in thousands)
<C
Revenues $1,179,798 $ 603,474 (a) $ 777,996 (a) $2,561,268 $ 0 $ (688) $ (688) $2,560,580
Investment
income 105,017 249,075 32,103 386,195 (465) (688) (1,153) 385,042
Investment
expenses (4,144) (9,099) (8,801) (22,044) 0 0 0 (22,044)
Net realized
gains 52,943 34,395 4,694 92,032 0 0 0 92,032
Dividends on
preferred
securities of
subsidiary
trusts (31,553) 0 0 (31,553) 0 0 0 (31,553)
Income before
provision for
taxes 716,566 201,488 46,537 964,591 (80,796) (6,557) (87,353) 877,238
Provision for
income taxes 273,424 71,334 14,475 359,233 (13,706) (2,802) (16,508) 342,725
Depreciation and
amortization 42,703 80,393 0 123,096 78,197 (b) 6,137 (c) 84,334 207,430
- -----------------------
(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 ($32.0 million) and goodwill ($45.0 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
J. Notes and accounts payable P&C Group
Notes and accounts payable consist of a liability to the P&C Group for the
purchase of certificates of contribution of the P&C Group (see Note G).
K. Impairment losses on investments
The Company regularly reviews its investment portfolio to determine
whether declines in the value of investments are other than temporary as
defined by SFAS 115, "Accounting for Certain Investments in Debt and Equity
Securities". The Company's review for declines in value includes reviewing
historical and forecasted financial information as well as reviewing the market
performance of similar types of investments. As a result of the Company's
review, the Company determined that some of its investments had declines in
value that were other than temporary as of September 30, 2001 due to
unfavorable market and economic conditions as well as the events of September
11, 2001, which exacerbated the declines in value. Accordingly, as of
September 30, 2001, the Company has recorded $86,120,000 of impairment losses
on investments, primarily in the equity portfolios. Impairment losses were
recorded for each reporting segment and, as of September 30, 2001, amounted to
$38,195,000, $7,768,000, and $40,157,000 for the Management services, Farmers
Re, and Farmers Life segments, respectively.
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 a
prominent writer of manufactured homes, 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 can be terminated by
either party, also provides for the P&C Group to receive a provisional ceding
commission of 18% of
21
premiums. This experience commission arrangement limits Farmers Re's potential
underwriting gain on the assumed business to 2.5% of premiums assumed.
Impairment of investments
The Company regularly reviews its investment portfolio to determine
whether declines in the value of investments are other than temporary as
defined by SFAS 115, "Accounting for Certain Investments in Debt and Equity
Securities". The Company's review for declines in value includes reviewing
historical and forecasted financial information as well as reviewing the market
performance of similar types of investments. As a result of the Company's
review, the Company determined that some of its investments had declines in
value that were other than temporary as of September 30, 2001 due to
unfavorable market and economic conditions as well as the events of September
11, 2001, which exacerbated the declines in value. Accordingly, as of September
30, 2001, the Company has recorded $86.1 million of impairment losses on
investments, primarily in the equity portfolios. Impairment losses were
recorded for each reporting segment and, as of September 30, 2001, amounted to
$38.2 million, $7.8 million, and $40.1 million for the Management services,
Farmers Re, and Farmers Life segments, respectively.
Three Months Ended September 30, 2001 Compared to Three Months Ended
September 30, 2000
Management Services to Property and Casualty Insurance Companies; and Other
Operating Revenues. Operating revenues increased from $407.7 million for
the three months ended September 30, 2000 to $428.3 million for the three
months ended September 30, 2001, an increase of $20.6 million, or 5.1%.
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 $2,889.1 million in the third quarter of 2000 to $3,115.1
million in the third quarter of 2001, an increase of $226.0 million, or 7.8%,
due to continued growth in all lines of business mainly as a result of rate
increases.
Operating Expenses.
Salaries and Employee Benefits. Salaries and employee benefits
increased from $105.3 million for the three months ended September 30,
2000 to $107.4 million for the three months ended September 30, 2001, an
increase of $2.1 million, or 2.0%, due primarily to an increase in
employee benefits expenses.
Buildings and Equipment Expenses. Buildings and equipment expenses
increased from $26.0 million for the three months ended September 30, 2000
to $27.6 million for the three months ended September 30, 2001, an
increase of $1.6 million, or 6.2% due primarily to growth in the
mainframe capacity.
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 September 30, 2001 and
September 30, 2000.
General and Administrative Expenses. General and administrative
expenses decreased from $74.6 million for the three months ended September
30, 2000 to $70.7 million for the three months ended September 30, 2001, a
decrease of $3.9 million, or 5.2%. This decrease was primarily due to a
decrease in expenses related to a project to implement a new financial
accounting and reporting system for the Company and the P&C Group.
Net Investment Income. Net investment income decreased from $33.9 million
for the three months ended September 30, 2000 to $16.6 million for the three
months ended September 30, 2001, a decrease of $17.3 million, or 51.0%. This
decrease was due mainly to a decrease in the average invested asset base
resulting from the fact that a sizeable 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 and
lower investment yields.
22
Net Realized Gains/(Losses). Net realized gains/(losses) decreased $16.3
million, from a $16.2 million gain for the three months ended September 30,
2000 to a $0.1 million loss for the three months ended September 30, 2001, due
primarily to unfavorable market conditions experienced during the three month
period ended September 30, 2001, as well as a loss of flexibility that resulted
from the $1,075.0 million special dividend paid in October 2000.
Impairment Losses on Investments. Impairment losses on investments were
$38.2 million for the three months ended September 30, 2001.
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 September 30, 2001 and September 30, 2000.
Provision for Income Taxes. Provision for income taxes decreased from
$88.7 million for the three months ended September 30, 2000 to $69.3 million
for the three months ended September 30, 2001, a decrease of $19.4 million, or
21.9%, due mainly to a decrease in pretax income between periods.
Management Services Income. As a result of the foregoing, management
services income decreased from $127.0 million for the three months ended
September 30, 2000 to $95.4 million for the three months ended September 30,
2001, a decrease of $31.6 million, or 24.9%.
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 September 30, 2000 to $50.0 million for the three
months ended September 30, 2001. Losses and loss adjustment expenses incurred
under these treaties were $35.3 million for the three months ended September
30, 2001 and $186.4 million for the three months ended September 30, 2000 and
non-life reinsurance commissions were $13.5 million for the three months ended
September 30, 2001 and $57.3 million for the three months ended September 30,
2000. Income before taxes decreased $8.9 million from $15.1 million for the
three months ended September 30, 2000 to $6.2 million for the three months
ended September 30, 2001 due primarily to the decrease in underwriting gain
between periods resulting from the new reinsurance agreement and the $7.8
million of impairment losses on investments recorded in 2001. For the three
month periods ended September 30, 2001 and September 30, 2000, Farmers Re's
contribution to net income was $4.5 million and $10.3 million, respectively.
Farmers Life
Total Revenues. Total revenues decreased from $213.4 million for the three
months ended September 30, 2000 to $183.4 million for the three months ended
September 30, 2001, a decrease of $30.0 million, or 14.1%.
Life and Annuity Premiums. Life and annuity premiums increased
$8.7 million for the three months ended September 30, 2001, or 14.6%, over
the three months ended September 30, 2000. This increase was due
primarily to an 83.6% increase in structured settlement with life
contingencies premiums over the three month period ended September 30,
2001.
Life Policy Charges. Life policy charges increased $1.0 million for
the three months ended September 30, 2001, or 1.9%, over the three months
ended September 30, 2000, reflecting growth in universal life-type
insurance in-force.
Net Investment Income. Net investment income increased $1.2 million
for the three months ended September 30, 2001, or 1.4%, over the three
months ended September 30, 2000. The increase was due to an increase in
average invested assets.
23
Net Realized Gains. Net realized gains decreased by $9.0 million,
from $18.4 million for the three months ended September 30, 2000 to $9.4
million for the three months ended September 30, 2001 due to unfavorable
market conditions
Impairment Losses on Investments. Impairment losses on investments
were $31.9 million for the three months ended September 30, 2001.
Total Operating Expenses. Total operating expenses increased from $138.7
million for the three months ended September 30, 2000 to $151.8 million for the
three months ended September 30, 2001, an increase of $13.1 million, or 9.4%.
Life Policyholders' Benefits and Charges. Life policyholders'
benefits expense and charges increased $19.0 million for the three months
ended September 30, 2001, or 19.4%, over the three months ended September
30, 2000.
Policy Benefits. Policy benefits, which consist primarily of
death and surrender benefits on life products, increased $5.3 million
for the three months ended September 30, 2001, to $41.5 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 $21.4 million for the three
months ended September 30, 2000 to $29.9 million for the three months
ended September 30, 2001. This increase was primarily attributable to
an 83.6% 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 $40.5 million for the three months ended
September 30, 2000 to $45.7 million for the three months ended
September 30, 2001, an increase of $5.2 million, or 12.8%. This
increase reflects a growth in the universal life, structured
settlements with life contingencies and fixed annuity fund balances.
General Operating Expenses. General operating expenses decreased from
$40.6 million for the three months ended September 30, 2000 to $34.7
million for the three months ended September 30, 2001, a decrease of $5.9
million, or 14.5%.
Amortization of DAC and Value of Life Business Acquired.
Amortization expense decreased from $26.8 million for the three months
ended September 30, 2000 to $21.8 million for the three months ended
September 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 $1.0 million for
the three months ended September 30, 2000 to $0.1 million for the
three months ended September 30, 2001, due to a 50.4% growth in
reinsurance activity.
General and Administrative Expenses. General and administrative
expenses remained constant at $12.8 million for the three months ended
September 30, 2000 and for the three months ended September 30, 2001.
Provision for Income Taxes. Provision for income taxes decreased from
$26.3 million for the three months ended September 30, 2000 to $12.1 million
for the three months ended September 30, 2001.
24
Farmers Life Income. As a result of the foregoing, Farmers Life income
decreased from $48.4 million for the three months ended September 30, 2000 to
$19.5 million for the three months ended September 30, 2001, a decrease of
$28.9 million, or 59.7%.
Consolidated Net Income
Consolidated net income of the Company decreased from $185.7 million for
the three months ended September 30, 2000 to $119.4 million for the three
months ended September 30, 2001, a decrease of $66.3 million, or 35.7%.
Nine Months Ended September 30, 2001 Compared to Nine Months Ended
September 30, 2000
Management Services to Property and Casualty Insurance Companies; and Other
Operating Revenues. Operating revenues increased from $1,179.8 million
for the nine months ended September 30, 2000 to $1,257.0 million for the nine
months ended September 30, 2001, an increase of $77.2 million, or 6.5%. This
growth reflects higher gross premiums earned by the P&C Group, which increased
from $8,475.2 million in the first nine months of 2000 to $9,129.6 million in
the first nine 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 $306.1 million for the nine months ended September 30, 2000
to $317.4 million for the nine months ended September 30, 2001, an
increase of $11.3 million, or 3.7%, 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 $76.2 million for the nine months ended September 30, 2000
to $79.0 million for the nine months ended September 30, 2001, an increase
of $2.8 million, or 3.7%, 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.
Amortization of Attorney-In-Fact Relationships and Goodwill.
Amortization expense was $77.1 million in each of the nine month periods
ended September 30, 2001 and September 30, 2000.
General and Administrative Expenses. General and administrative
expenses increased from $206.3 million for the nine months ended
September 30, 2000 to $230.6 million for the nine months ended
September 30, 2001, an increase of $24.3 million, or 11.8%. 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 $100.4
million for the nine months ended September 30, 2000 to $60.0 million for the
nine months ended September 30, 2001, a decrease of $40.4 million, or 40.2%.
This decrease was due mainly to 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 and
lower investment yields.
Net Realized Gains. Net realized gains decreased $39.8 million, from
$52.9 million for the nine months ended September 30, 2000 to $13.1 million for
the nine months ended September 30, 2001, due primarily to unfavorable market
conditions experienced during the nine month period ended September 30, 2001
as well as a loss of flexibility that resulted from the $1,075.0 million
special dividend paid in October 2000.
25
Impairment Losses on Investments. Impairment losses on investments were
$38.2 million for the nine months ended September 30, 2001.
Dividends on Preferred Securities of Subsidiary Trusts. Dividend expense
was $31.6 million in each of the nine month periods ended September 30, 2001
and September 30, 2000.
Provision for Income Taxes. Provision for income taxes decreased from
$259.7 million for the nine months ended September 30, 2000 to $229.7 million
for the nine months ended September 30, 2001, a decrease of $30.0 million, or
11.6%, due mainly to a decrease in pretax income between periods.
Management Services Income. As a result of the foregoing, management
services income decreased from $376.1 million for the nine months ended
September 30, 2000 to $326.5 million for the nine months ended September 30,
2001, a decrease of $49.6 million, or 13.2%.
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 $750.0 million for the
nine month period ended September 30, 2000 to $350.0 million for the nine
months ended September 30, 2001. Losses and loss adjustment expenses incurred
under these treaties were $248.0 million for the nine months ended September 30,
2001 and $515.4 million for the nine months ended September 30, 2000 and
non-life reinsurance commissions were $93.2 million for the nine months ended
September 30, 2001 and $215.9 million for the nine months ended September 30,
2000. Income before taxes decreased $11.1 million from $46.5 million for the
nine months ended September 30, 2000 to $35.4 million for the nine months ended
September 30, 2001 due primarily to the decrease in underwriting gain between
periods resulting from the new reinsurance agreement and the $7.8 million of
impairment losses on investments recorded in 2001. For the nine month
periods ended September 30, 2001 and September 30, 2000, Farmers Re's
contribution to net income was $24.4 million and $32.0 million, respectively.
Farmers Life
Total Revenues. Total revenues increased from $602.8 million for the nine
months ended September 30, 2000 to $611.4 million for the nine months ended
September 30, 2001, an increase of $8.6 million, or 1.4%.
Life and Annuity Premiums. Life and annuity premiums increased $33.8
million for the nine months ended September 30, 2001, or 20.1%, over the
nine months ended September 30, 2000. This increase was due to a 22.2%
growth in the volume of traditional life insurance in-force, as well as a
129.0% increase in structured settlement with life contingencies premiums
over the nine months ended September 30, 2000.
Life Policy Charges. Life policy charges increased $1.9 million for
the nine months ended September 30, 2001, or 1.2%, over the nine months
ended September 30, 2000, reflecting a 1.7% growth in universal life-type
insurance in-force.
Net Investment Income. Net investment income increased $12.6 million
for the nine months ended September 30, 2001, or 5.3%, over the nine
months ended September 30, 2000. The increase was due to an increase in
average invested assets.
Net Realized Gains. Net realized gains increased by $0.5 million, or
1.2%, from $34.4 million for the nine months ended September 30, 2000 to
$34.9 million for the nine months ended September 30, 2001.
Impairment Losses on Investments. Impairment losses on investments
were $40.1 million for the nine months ended September 30, 2001.
26
Total Operating Expenses. Total operating expenses increased from $407.9
million for the nine months ended September 30, 2000 to $453.7 million for the
nine months ended September 30, 2001, an increase of $45.8 million, or 11.2%.
Life Policyholders' Benefits and Charges. Life policyholders'
benefits expense and charges increased from $283.3 million for the nine
months ended September 30, 2000 to $341.1 million for the nine months
ended September 30, 2001, an increase of $57.8 million, or 20.4%.
Policy Benefits. Policy benefits increased $14.6 million for
the nine months ended September 30, 2001 to $122.6 million, due to a
10.4% growth in the volume of life insurance in-force.
Increase in Liability for Future Benefits. Increase in
liability for future benefits expense increased from $54.1 million
for the nine months ended September 30, 2000 to $85.1 million for the
nine months ended September 30, 2001. This increase was primarily
attributable to a 129.0% increase in deposits for structured
settlement products.
Interest Credited to Policyholders. Interest credited to
policyholders increased from $121.2 million for the nine months ended
September 30, 2000 to $133.4 million for the nine months ended
September 30, 2001, an increase of $12.2 million, or 10.1%,
reflecting growth in the universal life, structured settlements with
life contingencies and fixed annuity fund balances.
General Operating Expenses. General operating expenses decreased
from $124.6 million for the nine months ended September 30, 2000 to $112.6
million for the nine months ended September 30, 2001, a decrease of $12.0
million, or 9.6%.
Amortization of DAC and VOLBA. Amortization expense decreased
from $83.8 million for the nine months ended September 30, 2000 to
$72.1 million for the nine months ended September 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 $3.7 million from
$3.6 million for the nine months ended September 30, 2000 to ($0.1)
million for the nine months ended September 30, 2001, due to a 51.0%
growth in reinsurance activity.
General and Administrative Expenses. General and administrative
expenses increased from $37.2 million for the nine months ended
September 30, 2000 to $40.6 million for the nine months ended
September 30, 2001, an increase of $3.4 million or 9.1%, due
primarily to business growth and new initiatives.
Provision for Income Taxes. Provision for income taxes decreased from
$68.5 million for the nine months ended September 30, 2000 to $51.4 million
for the nine months ended September 30, 2001.
Farmers Life Income. As a result of the foregoing, Farmers Life income
decreased from $126.4 million for the nine months ended September 30, 2000 to
$106.3 million for the nine months ended September 30, 2001, a decrease
of $20.1 million, or 15.9%.
27
Consolidated Net Income
Consolidated net income of the Company decreased from $534.5 million for
the nine months ended September 30, 2000 to $457.2 million for the nine months
ended September 30, 2001, a decrease of $77.3 million, or 14.5%.
Liquidity and Capital Resources
As of September 30, 2001 and September 30, 2000, the Company held cash
and cash equivalents of $817.7 million and $857.4 million, respectively. In
addition, as of September 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 $694.6 million
for the nine months ended September 30, 2000 to $781.5 million for the nine
months ended September 30, 2001, an increase of $86.9 million. This increase
in cash was due primarily to a $65.2 million increase in life insurance policy
liabilities. Although net income declined $77.3 million between years, this
was primarily a result of the $86.1 million of impairment losses recorded in
2001, which had no effect on cash.
Net cash provided by investing activities decreased $71.7 million between
periods to $170.6 million for the nine months ended September 30, 2001. This
decrease in cash was primarily due to a $1,133.2 million increase in purchases
of investments available-for-sale. Partially offsetting this decrease in cash
was a $545.0 million decrease in purchases of surplus notes and certificates
of contribution of the P&C Group and a $434.3 million increase in proceeds from
sales and maturities of investments available-for-sale.
Net cash used in financing activities decreased from $393.0 million for
the nine months ended September 30, 2000 to $351.1 million for the nine months
ended September 30, 2001, resulting in an increase in cash of $41.9 million.
This increase in cash was due primarily to a reduction in the net cash outflows
associated with annuity contracts between years.
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.
28
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.
29
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)
November 14, 2001 /s/ Martin D. Feinstein
---------------------------------------------
Date Martin D. Feinstein
Chairman of the Board,
President and Chief Executive Officer
November 14, 2001 /s/ Gerald E. Faulwell
---------------------------------------------
Date Gerald E. Faulwell
Senior Vice President,
Chief Financial Officer,
and Director