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 March 31, 1997
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
-------------------------------------
Commission File Number 33-94670-01
-------------------------------------
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)
(213) 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 March 31, 1997 was 1,000 shares.
2
[THIS PAGE INTENTIONALLY LEFT BLANK]
3
FARMERS GROUP, INC.
AND SUBSIDIARIES
TABLE OF CONTENTS FORM 10-Q
FOR THE PERIOD ENDED MARCH 31,1997
PART I. FINANCIAL INFORMATION PAGE
----
ITEM 1. Financial Statements
Consolidated Balance Sheets - Assets
March 31, 1997 and December 31, 1996 4
Consolidated Balance Sheets - Liabilities and Stockholder's
Equity
March 31, 1997 and December 31, 1996 5
Consolidated Statements of Income
Three Month Periods ended March 31, 1997 and
March 31, 1996 6
Consolidated Statement of Stockholder's Equity
Three Month Period ended March 31, 1997 7
Consolidated Statement of Stockholder's Equity
Three Month Period ended March 31, 1996 8
Consolidated Statements of Cash Flows
Three Month Periods ended March 31, 1997 and
March 31, 1996 9
Notes to Interim Financial Statements 10
ITEM 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 15
PART II. OTHER INFORMATION 20
SIGNATURES 21
4
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
FARMERS GROUP, INC.
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands)
(Unaudited)
ASSETS
March 31, December 31,
1997 1996
------------- ------------
Current assets, excluding life subsidiaries:
Cash and cash equivalents $ 401,479 $ 412,018
Marketable securities, at market value 146,355 118,253
Accrued interest 32,411 39,148
Accounts receivable, principally from the exchanges 31,871 28,641
Notes receivable - affiliate 135,000 135,000
Deferred taxes 33,585 35,003
Prepaid expenses and other 4,297 23,985
------------- ------------
Total current assets 784,998 792,048
------------- ------------
Investments, excluding life subsidiaries:
Fixed maturities available-for-sale, at market value
(cost: $220,898 and $182,474) 222,908 184,829
Non-redeemable preferred stocks available-for-sale,
at market value (cost: $18 and $18) 17 20
Common stocks available-for-sale, at market value
(cost: $278,836 and $250,421) 305,054 307,821
Certificates in surplus of exchanges 684,380 684,380
Real estate, at cost (net of accumulated depreciation:
$17,205 and $16,944) 45,137 45,358
Joint ventures, at equity 9,681 10,366
------------- ------------
1,267,177 1,232,774
------------- ------------
Other assets, excluding life subsidiaries:
Notes receivable - affiliate 272,000 272,000
Goodwill (net of accumulated amortization:
$495,363 and $480,352) 1,906,392 1,921,403
Attorney-in-fact contracts (net of accumulated amortization:
$352,489 and $341,808) 1,356,554 1,367,235
Other assets 359,930 357,104
------------- ------------
3,894,876 3,917,742
------------- ------------
Properties, plant and equipment, at cost: (net of accumulated
depreciation: $216,890 and $202,085) 444,543 447,636
------------- ------------
Investments of life subsidiaries:
Fixed maturities available-for-sale, at market value
(cost: $3,805,229 and $3,764,192) 3,815,985 3,854,126
Mortgage loans on real estate 118,311 122,635
Non-redeemable preferred stocks available-for-sale, at market
value (cost: $6,843 and $7,007) 6,375 6,308
Common stocks available-for-sale, at market value
(cost: $87,050 and $84,532) 103,876 103,887
Policy loans 191,200 187,285
Real estate, at cost (net of accumulated depreciation:
$16,991 and $16,824) 61,227 61,715
Joint ventures, at equity 11,493 11,971
------------- ------------
4,308,467 4,347,927
------------- ------------
Other assets of life subsidiaries:
Cash and cash equivalents 126,069 87,310
Accrued investment income 56,825 53,063
Deferred policy acquisition costs and value of life business
acquired 1,023,165 1,001,044
Other assets 225,732 252,667
Assets held in Separate Account 798,657 796,616
------------- ------------
2,230,448 2,190,700
------------- ------------
Total assets $ 12,930,509 $ 12,928,827
============= ============
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 STOCKHOLDER'S EQUITY
March 31, December 31,
1997 1996
------------- ------------
Current liabilities, excluding life subsidiaries:
Notes and accounts payable:
Exchanges $ 397 $ 8,234
Other 24,523 21,004
Accrued liabilities:
Profit sharing 13,901 52,690
Income taxes 93,491 29,831
Other 34,688 18,474
------------ ------------
Total current liabilities 167,000 130,233
------------ ------------
Other liabilities, excluding life subsidiaries:
Real estate mortgages payable 217 217
Non-current deferred taxes 658,952 675,900
Other 231,812 251,315
------------ ------------
890,981 927,432
------------ ------------
Liabilities of life subsidiaries:
Policy liabilities:
Future policy benefits 3,518,970 3,474,862
Claims 32,413 32,732
Policyholder dividends 13,201 13,358
Other policyholder funds 70,401 70,816
Income taxes (including deferred taxes: $177,234 and $195,188) 195,490 194,222
Unearned investment income 2,244 2,302
Other liabilities 243,640 282,423
Liabilities related to Separate Account 798,657 796,616
------------ ------------
4,875,016 4,867,331
------------ ------------
Total liabilities 5,932,997 5,924,996
------------ ------------
Commitments and contingencies
Company obligated mandatorily redeemable preferred
securities of subsidiary trusts holding solely junior
subordinated debentures 500,000 500,000
------------ ------------
Stockholder's Equity:
Common stock, $1 par value per share; authorized, issued
and outstanding: as of March 31, 1997 and
December 31, 1996--1,000 shares 1 1
Additional capital 5,212,618 5,212,618
Unrealized gains (net of deferred taxes of $19,033
and $49,781) 35,048 92,104
Retained earnings 1,249,845 1,199,108
------------ ------------
Total stockholder's equity 6,497,512 6,503,831
------------ ------------
Total liabilities and stockholder's equity $ 12,930,509 $ 12,928,827
============ ============
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)
Three month period
ended March 31,
------------------------
1997 1996
----------- -----------
Consolidated operating revenues $ 514,946 $ 504,085
=========== ===========
Management services to property and casualty
insurance companies; and other:
Operating revenues $ 320,852 $ 306,585
----------- -----------
Salaries and employee benefits 83,320 87,236
Buildings and equipment expenses 22,298 20,584
Amortization of AIF contracts and goodwill 25,692 25,692
General and administrative expenses 49,079 43,818
----------- ----------
Total operating expenses 180,389 177,330
----------- ----------
Operating income 140,463 129,255
Net investment income 34,255 26,913
Net realized gains 30,435 809
Dividends on preferred securities of subsidiary trusts (10,518) (10,518)
----------- ----------
Income before provision for taxes 194,635 146,459
Provision for income taxes 96,692 59,450
----------- ----------
Management services income 97,943 87,009
----------- ----------
Life subsidiaries:
Premiums 44,959 42,526
Policy charges 63,187 58,720
Investment income, net of expenses 81,056 76,617
Net realized gains 4,892 19,637
----------- -----------
Total revenues 194,094 197,500
----------- -----------
Policy benefits 37,671 37,400
Increase in liability for future policy benefits 3,271 3,106
Interest credited to policyholders 43,261 40,789
Amortization of deferred policy acquisition costs and
value of life business acquired 32,626 27,792
Commissions 5,357 5,245
General and administrative expenses 16,625 15,050
----------- -----------
Total operating expenses 138,811 129,382
----------- -----------
Income before provision for taxes 55,283 68,118
Provision for income taxes 18,189 22,868
----------- -----------
Life subsidiaries income 37,094 45,250
----------- -----------
Consolidated net income $ 135,037 $ 132,259
=========== ===========
The accompanying notes are an integral part of these interim financial statements.
7
FARMERS GROUP, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDER'S EQUITY
For the three month period ended March 31, 1997
(Amounts in thousands)
(Unaudited)
Net Unrealized Total
Common Additional Gains/(Losses) Retained Stockholder's
Stock Capital On Investments Earnings Equity
-------- ----------- ------------- ---------- ------------
Balance, December 31, 1996 $ 1 $ 5,212,618 $ 92,104 $1,199,108 $ 6,503,831
Net income 135,037 135,037
Change in net unrealized
gains/(losses) on
investments net
of tax of ($30,748) (57,056) (57,056)
Cash dividends paid (84,300) (84,300)
-------- ----------- ------------- ---------- ------------
Balance, March 31, 1997 $ 1 $ 5,212,618 $ 35,048 $1,249,845 $ 6,497,512
======== =========== ============= ========== ============
The accompanying notes are an integral part of these interim financial statements.
8
FARMERS GROUP, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDER'S EQUITY
For the three month period ended March 31, 1996
(Amounts in thousands)
(Unaudited)
Net Unrealized Total
Common Additional Gains/(Losses) Retained Stockholder's
Stock Capital On Investments Earnings Equity
-------- ------------ ------------- ---------- -------------
Balance, December 31, 1995 $ 1 $ 5,212,618 $ 124,962 $ 1,156,067 $ 6,493,648
Net income 132,259 132,259
Change in net unrealized
gains/(losses) on
investments net
of tax of ($29,857) (55,419) (55,419)
Cash dividends paid (74,975) (74,975)
-------- ------------ ------------- ---------- ------------
Balance, March 31, 1996 $ 1 $ 5,212,618 $ 69,543 $1,213,351 $ 6,495,513
======== ============ ============= ========== ============
The accompanying notes are an integral part of these interim financial statements.
9
FARMERS GROUP, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in thousands)
(Unaudited)
Three month period
ended March 31,
-----------------------
1997 1996
---------- ----------
Cash Flows from Operating Activities:
Consolidated net income $ 135,037 $ 132,259
Non-cash and operating activities adjustments:
Depreciation and amortization 42,626 34,442
Amortization of deferred policy acquisition costs and
value of life business acquired 32,626 27,792
Policy acquisition costs deferred (29,124) (31,638)
Life insurance policy liabilities 43,217 66,236
Equity in earnings of joint ventures 206 378
Gain on sales of assets (35,518) (20,558)
Changes in assets and liabilities:
Current assets and liabilities 38,357 64,022
Non-current assets and liabilities 991 (15,647)
Other, net (4,094) (2,483)
---------- -----------
Net cash provided by operating activities 224,324 254,803
---------- -----------
Cash Flows from Investing Activities:
Purchases of investments available-for-sale (363,284) (333,475)
Purchases of properties (14,311) (11,812)
Proceeds from sales and maturities of investments
available-for-sale 261,104 183,339
Proceeds from sales of properties 2,608 6,747
Mortgage loan collections 4,324 3,639
Other, net (2,245) 2,559
---------- -----------
Net cash used in investing activities (111,804) (149,003)
---------- -----------
Cash Flows from Financing Activities:
Dividends paid to stockholder (84,300) (74,975)
Issuance cost of cumulative quarterly income preferred
securities 0 (409)
----------- -----------
Net cash used in financing activities (84,300) (75,384)
----------- -----------
Increase/(decrease) in cash and cash equivalents 28,220 30,416
Cash and cash equivalents - at beginning of year 499,328 913,006
---------- -----------
Cash and cash equivalents - at end of period $ 527,548 $ 943,422
========== ===========
The accompanying notes are an integral part of these interim financial statements.
10
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. and
subsidiaries (the "Company") as of March 31, 1997, the related consolidated
statements of income, stockholder's equity and cash flows for the three month
periods ended March 31, 1997 and March 31, 1996, have been prepared in
accordance with generally accepted accounting principles ("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 generally accepted accounting principles for complete
financial statements and should be read in conjunction with the consolidated
balance sheets of the Company as of December 31, 1996 and 1995, and the
related consolidated statements of income, stockholder's equity, and cash
flows for each of the three years in the period ended December 31, 1996.
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
1997 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 disclosure of contingent assets
and liabilities at the date of the financial statements as well as the
reported amounts of revenues and expenses during the reporting periods.
Actual results could differ from those estimates.
In December 1988, BATUS Inc. ("BATUS"), a subsidiary of B.A.T Industries
p.l.c. ("B.A.T"), acquired 100% ownership of the Company for $5,212,619,000 in
cash, including related expenses, through its wholly owned subsidiary BATUS
Financial Services. Immediately thereafter, BATUS Financial Services was
merged into Farmers Group, Inc.. The acquisition was accounted for as a
purchase and, accordingly, the acquired assets and liabilities were recorded
in the Company's consolidated balance sheets based on their estimated fair
values at December 31, 1988. In January 1990, ownership of the Company was
transferred to South Western Nominees Limited, a subsidiary of B.A.T.
The Company is attorney-in-fact for three inter-insurance exchanges:
Farmers Insurance Exchange, Fire Insurance Exchange and Truck Insurance
Exchange (collectively, the "Exchanges"), which operate in the property and
casualty insurance industry. As attorney-in-fact, Farmers Group, Inc., or its
subsidiaries, as applicable, manages the affairs of the Exchanges, their
respective subsidiaries and Farmers Texas County Mutual Insurance
Company
11
(collectively, the "P&C Group") and receives compensation based on a
percentage of earned premiums.
As of March 31,1997, the Company's life insurance operations were
conducted by three wholly owned subsidiaries, Farmers New World Life Insurance
Company, The Ohio State Life Insurance Company and Investors Guaranty Life
Insurance Company (the "Life Subsidiaries"). They market a broad line of
individual life insurance products, including universal life, term life and
whole life insurance, and annuity products, predominately flexible premium
deferred annuities. On January 23, 1997, the Company announced an agreement
to sell The Ohio State Life Insurance Company ("OSL") and Investors Guaranty
Life Insurance Company ("IGL") to Great Southern Life Insurance Company, a
subsidiary of Americo Life, Inc.. This decision is part of the Company's
strategic plan to focus its life insurance efforts on the growth of Farmers
New World Life Insurance Company ("FNWL"), by far its largest insurance
company, whose products and services are sold directly by the Company's
agents. This sale was completed on April 15, 1997, upon receipt of regulatory
approval (see Note G).
In 1997, the Company adopted Financial Accounting Standards Board ("FASB")
Statement of Financial Accounting Standards ("SFAS") No. 125, "Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities". This Statement establishes accounting and reporting standards
for transfers and servicing of financial assets and extinguishments of
liabilities based on a consistent application of a financial-components
approach that focuses on the issue of control. This Statement was amended by
SFAS No. 127, "The Deferral of the Effective Date of Certain Provisions of
FASB Statement No. 125", which delays for one year the effective date of the
provisions that apply to certain transactions. These transactions include
repurchase agreements, dollar-rolls, securities lending, secured borrowings
and collateral. The adoption of these Statements did not have a material
impact on the Company's consolidated financial statements.
In February 1997, the FASB released SFAS No. 128, "Earnings per Share".
This Statement, effective for financial statements issued for periods ending
after December 15, 1997, establishes standards for computing and presenting
earnings per share and applies to entities with publicly held common stock or
potential common stock. The Company does not have any publicly held common
stock and, therefore, is not subject to the requirements of this Statement.
In February 1997, the FASB released SFAS No. 129, "Disclosure of
Information about Capital Structure". This Statement, effective for financial
statements issued for periods ending after December 15, 1997, establishes
standards for disclosing information about an entity's capital structure. It
eliminates the exemption of nonpublic entities from certain disclosure
requirements of Accounting Principles Board Opinion No. 15, "Earnings Per
Share", as provided by SFAS No. 21, "Suspension of the Reporting of Earnings
per Share and Segment Information by Nonpublic Enterprises". The Company does
not expect the adoption of this Statement to have a significant impact on its
consolidated financial statements.
12
B. 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.
C. 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. The QUIPS are subject to mandatory
redemption upon repayment of the Junior Subordinated Debentures at maturity,
or upon their earlier redemption, at a redemption price of $25 per Preferred
Security, plus accrued and unpaid distributions thereon to the date fixed for
redemption. Farmers Group, Inc. will have the option at any time on or after
September 27, 2000 to redeem, in whole or part, the Junior Subordinated
Debentures.
As of March 31, 1997 and 1996, a total of 20,000,000 shares of QUIPS
were outstanding.
13
D. Management fees
As attorney-in-fact, the Company, or its subsidiaries, as applicable,
manages the affairs of the P&C Group and receives management fees for the
services rendered to the Exchanges. As a result, the Company received
management fees from the Exchanges of $300,574,000 and $287,628,000 for the
three month periods ended March 31, 1997 and March 31, 1996, respectively.
E. Related parties
As of March 31, 1997, the Company had $407,000,000 in notes receivable
related to loans made to B.A.T Capital Corporation, a subsidiary of B.A.T.
These notes are fixed rate medium-term notes with maturity dates as
follows: $135,000,000 in October 1997, $137,000,000 in October 1998, and
$135,000,000 in October 1999. Interest on these notes is paid semi-annually
at coupon rates of 5.10%, 5.35%, and 6.68%, respectively. On October 7, 1996,
a three year $135,000,000 note with an interest rate of 4.76% matured and the
$135,000,000 note maturing in October 1999 was subsequently issued at an
interest rate of 6.68%. Income earned on the notes outstanding as of March 31,
1997 and March 31, 1996, was $5,808,000 and $5,160,000, respectively.
F. Supplemental cash flow information
For financial statement purposes, the Company considers all investments
with original maturities of 90 days or less as cash equivalents. Following is
a reconciliation of the individual balance sheet cash and cash equivalent
totals to the consolidated cash flow total.
Excluding
Life Life
Subsidiaries Subsidiaries Consolidated
------------ ------------ ------------
(Amounts in thousands)
Cash and cash equivalents -- December 31, 1995 $ 763,212 $ 149,794 $ 913,006
Activity through March 1996 30,416
---------
Cash and cash equivalents -- March 31, 1996 874,057 69,365 $ 943,422
=========
Cash and cash equivalents -- December 31, 1996 412,018 87,310 $ 499,328
Activity through March 1997 28,220
---------
Cash and cash equivalents -- March 31, 1997 401,479 126,069 $ 527,548
=========
Cash payments for interest were $1,375,000 and $8,532,000 for the three
month periods ended March 31, 1997 and March 31, 1996, respectively, while the
cash payment for dividends to the holders of the Company's QUIPS was
$10,518,000 for the three month period ended March 31, 1997. In 1996, the
first quarter dividend payment to the holders of the Company's QUIPS, of
$10,518,000, was made on April 1, 1996. Cash payments for income taxes were
$34,516,000 and $13,647,000 for the three month periods ended March 31, 1997
and March 31, 1996, respectively.
14
G. Subsequent events
On January 23, 1997, the Company announced an agreement to sell OSL and
IGL to Great Southern Life Insurance Company, a subsidiary of Americo Life,
Inc.. This sale was completed on April 15, 1997, upon receipt of regulatory
approval. The contribution to net income of these subsidiaries for the three
month period ended March 31, 1997 was $4,826,002. The combined net assets of
these subsidiaries as of March 31, 1997 was $334,242,070. The sale of these
subsidiaries is expected to have an immaterial impact on operating income.
On an after-tax basis, this sale is estimated to result in a $21,003,000 loss
and is reflected on the "Provision for income taxes" line in the "Management
services to property and casualty insurance companies; and other" section of
the Company's consolidated income statement for the three month period ended
March 31, 1997.
15
ITEM 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
General
The Company is engaged in the management of property and casualty
insurance companies and the underwriting of life insurance and annuity
products. The Company does not own any property and casualty insurers, but
rather serves as the manager of the P&C Group. The Company receives management
fees primarily based on the gross premiums earned by the P&C Group. Revenues
and expenses relating to both of these principal business activities are
reflected in the Company's Consolidated Financial Statements prepared in
accordance with GAAP, which differs from the statutory accounting practices
("SAP"), which the Life Subsidiaries are required to use for regulatory
reporting purposes.
The Company underwrites life insurance and annuity products through its
life insurance subsidiaries. Revenues attributable to traditional life
insurance products, such as whole life or term insurance contracts, are
classified as premiums as they become due. Future benefits are associated
with such premiums (through increases in liabilities for future policy
benefits), and prior period capitalized costs are amortized (through
amortization of Deferred Policy Acquisition Costs ("DAC")) so that profits are
generally recognized over the same period as revenue income. Revenues
attributable to Universal Life ("UL") 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 UL and annuity policies include interest
credited to policyholders on policy balances as well as benefit claims
incurred in excess of policy account balances.
Three Months Ended March 31, 1997 Compared to Three Months Ended
March 31, 1996
Management Services to Property and Casualty Insurance Companies; and Other
Operating Revenues. Operating revenues increased from $306.6 million for
the three months ended March 31, 1996 to $320.9 million for the three months
ended March 31, 1997, an increase of $14.3 million, or 4.7%. 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 $2,318.9 million in the first quarter of 1996 to $2,465.6 million in the
first quarter of 1997 due primarily to higher average premium levels across
all major lines of business and an increase in the number of policies-in-
force. Partially offsetting these increases is the fact that, in recognition
of expense savings realized as a result of improved operating efficiencies,
the Farmers Preferred Auto Management fee rate was reduced by 0.45% effective
November 1, 1996. This resulted in a $6.3 million reduction in management
fees in 1997 from what such fees would have been using the first quarter 1996
rates. As the Company continues to benefit from improved operating
efficiencies, it may further reduce management fee rates in the future.
16
Total Operating Expenses. Total operating expenses as a percentage of
operating revenues decreased from 57.8% for the three months ended March 31,
1996 to 56.2% for the three months ended March 31, 1997, a decrease of 1.6%.
Specifically, labor costs (salaries and employee benefits) decreased from
28.5% of operating revenues for the three months ended March 31, 1996 to 26.0%
of operating revenues for the three months ended March 31, 1997 as the Company
continued to benefit from staffing efficiencies and the use of information
technology.
Salaries and Employee Benefits. Salaries and employee benefits
decreased from $87.2 million for the three months ended March 31, 1996 to
$83.3 million for the three months ended March 31, 1997, a decrease of
$3.9 million, or 4.5%, primarily due to a reduction in employee complement.
Buildings and Equipment Expenses. Buildings and equipment expenses
increased from $20.6 million for the three months ended March 31, 1996 to
$22.3 million for the three months ended March 31, 1997, an increase of
$1.7 million, or 8.3%. This increase was primarily due to the
amortization of information technology systems software.
Amortization of Attorney-In-Fact Contracts and Goodwill. Purchase
accounting entries related to the acquisition of the Company by B.A.T
Industries p.l.c. in December 1988 include goodwill (capitalized at $2.4
billion) and the value of the attorney-in-fact contracts 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 March 31, 1997 and March 31, 1996.
General and Administrative Expenses. General and administrative
expenses increased from $43.8 million for the three months ended March
31, 1996 to $49.1 million for the three months ended March 31, 1997, an
increase of $5.3 million, or 12.1%. This increase was attributable to
increased levels of business activity.
Net Investment Income. Net investment income increased from $26.9
million for the three months ended March 31, 1996 to $34.3 million for the
three months ended March 31, 1997 primarily due to a larger invested asset
base and higher yield rates in 1997.
Net Realized Gains. Net realized gains increased from $0.8 million for
the three months ended March 31, 1996 to $30.4 million for the three months
ended March 31, 1997. This increase was primarily attributable to gains
realized from the partial sale of the common stock portfolio received as part
of an extraordinary dividend FNWL paid to Farmers Group, Inc. ("FGI") in
December 1996.
Dividends on Preferred Securities of Subsidiary Trusts. Dividend expense
for the three months ended March 31, 1997 and March 31, 1996 was $10.5 million.
Provision for Income Taxes. Provision for income taxes increased from
$59.5 million for the three months ended March 31, 1996 to $96.8 million for
the three months ended March 31, 1997, an increase of $37.3 million, or 62.7%.
This increase was attributable to the increase in
17
pretax operating income between years and the estimated $21.0 million of
entries associated with the sale of OSL and IGL (see Note G).
Management Services Income. As a result of the foregoing, management
services income increased from $87.0 million for the three months ended March
31, 1996 to $97.9 million for the three months ended March 31, 1997, an
increase of $10.9 million, or 12.5%.
Life Subsidiaries
Total Revenues. Total revenues decreased from $197.5 million for the three
months ended March 31, 1996 to $194.1 million for the three months ended March
31, 1997, a decrease of $3.4 million, or 1.7%.
Premiums. Premiums increased $2.4 million for the three months
ended March 31, 1997, or 5.7%, over the three months ended March 31,
1996. This increase was due to growth in renewal and first year business.
The increase in renewal premiums is attributable to an 11.1% growth in
traditional life insurance in-force resulting from improved persistency
and an increase in average policy size. The higher first year premiums
are due primarily to growth in the Premier Whole Life ("PWL") product.
Policy Charges. Policy charges increased $4.5 million for the three
months ended March 31, 1997, or 7.7%, over the three months ended March
31, 1996, reflecting continued growth in universal life-type insurance
in-force.
Investment Income. Net investment income increased $4.4 million for
the three months ended March 31, 1997, or 5.7%, over the three months
ended March 31, 1996 due to higher bond interest income resulting
primarily from a higher invested asset base.
Net Realized Gains. Net realized gains decreased by $14.7 million,
from $19.6 million for the three months ended March 31, 1996 to $4.9
million for the three months ended March 31, 1997. This decrease was
substantially due to the fact that FNWL's common stock portfolio was
transferred to FGI as part of the extraordinary dividend paid to FGI in
December 1996.
Total Operating Expenses. Total operating expenses increased from $129.4
million for the three months ended March 31, 1996 to $138.8 million for the
three months ended March 31, 1997, an increase of $9.4 million, or 7.3%.
Policyholders' Benefits. Policyholders' benefits expense increased
from $81.3 million for the three months ended March 31, 1996 to $84.2
million for the three months ended March 31, 1997, an increase of $2.9
million, or 3.6%. Policy benefits, which consist primarily of death and
surrender benefits on life products, increased $0.3 million over March
31, 1996 to $37.7 million, due to an increase in average insurance-in-
force. Increase in liability for future benefits expense increased from
$3.1 million for the three months ended March 31, 1996 to $3.2 million
for the three months ended March 31, 1997 due to increases in PWL and
other traditional product premiums. Interest credited to policyholders,
which represents the amount
18
credited under universal life-type contracts and deferred annuities for
policyholder funds on deposit, increased from $40.8 million for the three
months ended March 31, 1996 to $43.3 million for the three months ended
March 31, 1997, or 6.1%, reflecting a 5.7% growth in universal life-type
insurance in-force and a 4.9% increase in annuity funds on deposit.
Amortization of DAC and Value of Life Business Acquired. Amortization
expense increased from $27.8 million for the three months ended March 31,
1996 to $32.6 million for the three months ended March 31, 1997, or 17.3%.
This increase reflects the continued growth in universal life-type and
traditional business.
Commissions. Commissions increased from $5.2 million for the three
months ended March 31, 1996 to $5.3 million for the three months ended
March 31, 1997, or 1.9%, reflecting increased renewal premiums from
traditional and universal life products.
General and Administrative Expenses. General and administrative
expenses increased from $15.1 million for the three months ended March 31,
1996 to $16.7 million for the three months ended March 31, 1997, or
10.6%. This increase resulted mainly from higher audit and legal fees,
premium taxes and contract values paid to terminated agents and district
managers.
Provision for Income Taxes. Provision for income taxes decreased from
$22.8 million for the three months ended March 31, 1996 to $18.2 million for
the three months ended March 31, 1997, a decrease of $4.6 million due to a
decrease in pretax operating income.
Life Subsidiaries Income. As a result of the foregoing, Life Subsidiaries
income decreased from $45.3 million for the three months ended March 31, 1996
to $37.1 million for the three months ended March 31, 1997, a decrease of $8.2
million, or 18.1%.
Consolidated Net Income
Consolidated net income of the Company increased from $132.3 million for
the three months ended March 31, 1996 to $135.0 million for the three months
ended March 31,1997, an increase of $2.7 million, or 2.0%.
Liquidity and Capital Resources
As of March 31, 1997 and March 31, 1996, the Company held cash and cash
equivalents of $527.5 million and $943.4 million, respectively. In addition,
as of March 31, 1997, 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 decreased from $254.8 million
for the three months ended March 31, 1996 to $224.3 million for the three
months ended March 31, 1997, a decrease in cash of $30.5 million, or 12.0%.
This decrease in cash was principally due to a decrease in the volume of new
FNWL annuity business.
19
Net cash used in investing activities decreased from $149.0 million for
the three months ended March 31, 1996 to $111.8 million for the three months
ended March 31, 1997, an increase in cash of $37.2 million, or 25.0%. This
increase in cash resulted primarily from a $77.8 million increase in proceeds
received from sales and maturities of investments available-for-sale offset
in part by a $29.8 million increase in purchases of investments available-for-
sale.
Net cash used in financing activities increased from $75.4 million for
the three months ended March 31, 1996 to $84.3 million for the three months
ended March 31, 1997, or 11.8%. This decrease in cash was the result of an
$8.9 million increase in dividends paid to the Company's stockholder.
20
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 Reports on Form 8-K.
(a) Exhibits.
27. Financial Data Schedule
(b) Reports on Form 8-K. None.
21
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)
May 9, 1997 /s/ Martin D. Feinstein
---------------------------------------------
Date Martin D. Feinstein
President and
Chief Executive Officer
May 9, 1997 /s/ Anthony L.R. Clark
---------------------------------------------
Date Anthony L.R. Clark
Senior Vice President and
Chief Financial Officer