1
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
- --------------------------------------------------------------------------
FORM 10-Q
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Quarterly Period Ended June 30, 1997
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)
(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 June 30, 1997 was 1,000 shares.
2
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FARMERS GROUP, INC.
AND SUBSIDIARIES
TABLE OF CONTENTS FORM 10-Q
FOR THE PERIOD ENDED JUNE 30,1997
PART I. FINANCIAL INFORMATION PAGE
----
ITEM 1. Financial Statements
Consolidated Balance Sheets - Assets
June 30, 1997 and December 31, 1996 4
Consolidated Balance Sheets - Liabilities and Stockholder's
Equity
June 30, 1997 and December 31, 1996 5
Consolidated Statements of Income
Six Month Periods ended June 30, 1997 and
June 30, 1996 6
Consolidated Statements of Income
Three Month Periods ended June 30, 1997 and
June 30, 1996 7
Consolidated Statement of Stockholder's Equity
Six Month Period ended June 30, 1997 8
Consolidated Statement of Stockholder's Equity
Six Month Period ended June 30, 1996 9
Consolidated Statements of Cash Flows
Six Month Periods ended June 30, 1997 and
June 30, 1996 10
Notes to Interim Financial Statements 11
ITEM 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 16
PART II. OTHER INFORMATION 24
SIGNATURES 25
4
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
FARMERS GROUP, INC.
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands)
(Unaudited)
ASSETS
June 30, December 31,
1997 1996
------------- ------------
Current assets, excluding life insurance subsidiary:
Cash and cash equivalents $ 545,482 $ 412,018
Marketable securities, at market value 121,741 118,253
Accrued interest 45,018 39,148
Accounts receivable, principally from the exchanges 28,081 28,641
Notes receivable - affiliate 135,000 135,000
Deferred taxes 13,291 35,003
Prepaid expenses and other 11,186 23,985
------------- ------------
Total current assets 899,799 792,048
------------- ------------
Investments, excluding life insurance subsidiary:
Fixed maturities available-for-sale, at market value
(cost: $346,114 and $182,474) 350,673 184,829
Non-redeemable preferred stocks available-for-sale,
at market value (cost: $0 and $18) 0 20
Common stocks available-for-sale, at market value
(cost: $288,234 and $250,421) 353,018 307,821
Certificates in surplus of exchanges 684,380 684,380
Real estate, at cost (net of accumulated depreciation:
$17,451 and $16,944) 44,933 45,358
Joint ventures, at equity 8,405 10,366
------------- ------------
1,441,409 1,232,774
------------- ------------
Other assets, excluding life insurance subsidiary:
Notes receivable - affiliate 272,000 272,000
Goodwill (net of accumulated amortization:
$510,374 and $480,352) 1,891,381 1,921,403
Attorney-in-fact contracts (net of accumulated amortization:
$363,170 and $341,808) 1,345,873 1,367,235
Other assets 405,408 357,104
------------- ------------
3,914,662 3,917,742
------------- ------------
Properties, plant and equipment, at cost: (net of accumulated
depreciation: $217,345 and $202,085) 429,063 447,636
------------- ------------
Investments of life insurance subsidiary:
Fixed maturities available-for-sale, at market value
(cost: $3,261,972 and $3,764,192) 3,323,567 3,854,126
Mortgage loans on real estate 112,625 122,635
Non-redeemable preferred stocks available-for-sale, at market
value (cost: $1,153 and $7,007) 1,190 6,308
Common stocks available-for-sale, at market value
(cost: $45 and $84,532) 18 103,887
Policy loans 156,051 187,285
Real estate, at cost (net of accumulated depreciation:
$13,045 and $16,824) 69,153 61,715
Joint ventures, at equity 11,841 11,971
------------- ------------
3,674,445 4,347,927
------------- ------------
Other assets of life insurance subsidiary:
Cash and cash equivalents 22,842 87,310
Accrued investment income 49,284 53,063
Deferred policy acquisition costs and value of life business
acquired 823,211 1.001,044
Securities lending collateral 679,117 221,216
Other assets 29,066 31,451
Assets held in Separate Account 778,043 796,616
------------- ------------
2,381,563 2,190,700
------------- ------------
Total assets $ 12,740,941 $ 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
June 30, December 31,
1997 1996
------------- ------------
Current liabilities, excluding life insurance subsidiary:
Notes and accounts payable:
Exchanges $ 629 $ 8,234
Other 40,368 21,004
Accrued liabilities:
Profit sharing 26,848 52,690
Income taxes 13,819 29,831
Other 12,443 18,474
------------ ------------
Total current liabilities 94,107 130,233
------------ ------------
Other liabilities, excluding life insurance subsidiary:
Real estate mortgages payable 157 217
Non-current deferred taxes 650,490 675,900
Other 236,685 251,315
------------ ------------
887,332 927,432
------------ ------------
Liabilities of life insurance subsidiary:
Policy liabilities:
Future policy benefits 2,910,091 3,474,862
Claims 24,409 32,732
Policyholder dividends 0 13,358
Other policyholder funds 61,544 70,816
Income taxes (including deferred taxes: $139,991 and $195,188) 143,664 194,222
Unearned investment income 1,092 2,302
Other liabilities 54,613 61,207
Securities lending liability 679,117 221,216
Liabilities related to Separate Account 778,043 796,616
------------ ------------
4,652,573 4,867,331
------------ ------------
Total liabilities 5,634,012 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 June 30, 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 $37,325
and $49,781) 73,652 92,104
Retained earnings 1,320,658 1,199,108
------------ ------------
Total stockholder's equity 6,606,929 6,503,831
------------ ------------
Total liabilities and stockholder's equity $ 12,740,941 $ 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)
Six month period
ended June 30,
------------------------
1997 1996
----------- -----------
Consolidated operating revenues $ 1,010,310 $ 998,785
=========== ===========
Management services to property and casualty
insurance companies; and other:
Operating revenues $ 649,538 $ 618,262
----------- -----------
Salaries and employee benefits 166,982 171,572
Buildings and equipment expenses 45,438 41,962
Amortization of AIF contracts and goodwill 51,384 51,384
General and administrative expenses 99,800 83,769
----------- ----------
Total operating expenses 363,604 348,687
----------- ----------
Operating income 285,934 269,575
Net investment income 70,403 54,289
Net realized gains 40,703 1,586
Gain on sale of subsidiaries 16,536 0
Dividends on preferred securities of subsidiary trusts (21,035) (21,035)
----------- ----------
Income before provision for taxes 392,541 304,415
Provision for income taxes 175,974 123,130
----------- ----------
Management services income 216,567 181,285
----------- ----------
Life subsidiaries:
Premiums 83,881 83,738
Policy charges 115,521 118,810
Investment income, net of expenses 152,765 156,268
Net realized gains 8,605 21,707
----------- -----------
Total revenues 360,772 380,523
----------- -----------
Policy benefits 69,677 73,440
Increase in liability for future policy benefits 6,247 5,548
Interest credited to policyholders 80,834 82,647
Amortization of deferred policy acquisition costs and
value of life business acquired 55,481 56,274
Commissions 10,106 10,599
General and administrative expenses 28,575 30,824
----------- -----------
Total operating expenses 250,920 259,332
----------- -----------
Income before provision for taxes 109,852 121,191
Provision for income taxes 36,269 40,487
----------- -----------
Life subsidiaries income 73,583 80,704
----------- -----------
Consolidated net income $ 290,150 $ 261,989
=========== ===========
The accompanying notes are an integral part of these interim financial statements.
7
FARMERS GROUP, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Amounts in thousands)
(Unaudited)
Three month period
ended June 30,
------------------------
1997 1996
----------- -----------
Consolidated operating revenues $ 495,364 $ 494,700
=========== ===========
Management services to property and casualty
insurance companies; and other:
Operating revenues $ 328,686 $ 311,677
----------- -----------
Salaries and employee benefits 83,662 84,336
Buildings and equipment expenses 23,140 21,378
Amortization of AIF contracts and goodwill 25,692 25,692
General and administrative expenses 50,721 39,951
----------- ----------
Total operating expenses 183,215 171,357
----------- ----------
Operating income 145,471 140,320
Net investment income 36,148 27,376
Net realized gains 10,268 777
Gain on sale of subsidiaries 16,536 0
Dividends on preferred securities of subsidiary trusts (10,517) (10,517)
----------- ----------
Income before provision for taxes 197,906 157,956
Provision for income taxes 79,282 63,680
----------- ----------
Management services income 118,624 94,276
----------- ----------
Life subsidiaries:
Premiums 38,922 41,212
Policy charges 52,334 60,090
Investment income, net of expenses 71,709 79,651
Net realized gains 3,713 2,070
----------- -----------
Total revenues 166,678 183,023
----------- -----------
Policy benefits 32,006 36,040
Increase in liability for future policy benefits 2,976 2,442
Interest credited to policyholders 37,573 41,858
Amortization of deferred policy acquisition costs and
value of life business acquired 22,855 28,482
Commissions 4,749 5,354
General and administrative expenses 11,950 15,774
----------- -----------
Total operating expenses 112,109 129,950
----------- -----------
Income before provision for taxes 54,569 53,073
Provision for income taxes 18,080 17,619
----------- -----------
Life subsidiaries income 36,489 35,454
----------- -----------
Consolidated net income $ 155,113 $ 129,730
=========== ===========
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 six month period ended June 30, 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 290,150 290,150
Change in net unrealized
gains/(losses) on
investments net
of tax of ($12,456) (18,452) (18,452)
Cash dividends paid (168,600) (168,600)
-------- ----------- ------------- ---------- ------------
Balance, June 30, 1997 $ 1 $ 5,212,618 $ 73,652 $1,320,658 $ 6,606,929
======== =========== ============= ========== ============
The accompanying notes are an integral part of these interim financial statements.
9
FARMERS GROUP, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDER'S EQUITY
For the six month period ended June 30, 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 261,989 261,989
Change in net unrealized
gains/(losses) on
investments net
of tax of ($43,694) (81,079) (81,079)
Cash dividends paid (149,950) (149,950)
-------- ------------ ------------- ---------- ------------
Balance, June 30, 1996 $ 1 $ 5,212,618 $ 43,883 $1,268,106 $ 6,524,608
======== ============ ============= ========== ============
The accompanying notes are an integral part of these interim financial statements.
10
FARMERS GROUP, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in thousands)
(Unaudited)
Six month period
ended June 30,
-----------------------
1997 1996
---------- ----------
Cash Flows from Operating Activities:
Consolidated net income $ 290,150 $ 261,989
Non-cash and operating activities adjustments:
Depreciation and amortization 85,104 69,039
Amortization of deferred policy acquisition costs and
value of life business acquired 55,481 56,274
Policy acquisition costs deferred (53,216) (66,195)
Life insurance policy liabilities 94,702 133,931
Equity in earnings of joint ventures 571 820
Gain on sales of assets (49,972) (24,111)
Gain on sale of subsidiaries (16,536) 0
Changes in assets and liabilities:
Current assets and liabilities (8,316) 12,186
Non-current assets and liabilities (72,701) (54,140)
Other, net (16,906) (6,109)
---------- -----------
Net cash provided by operating activities 308,361 383,684
---------- -----------
Cash Flows from Investing Activities:
Purchases of investments available-for-sale (947,134) (579,077)
Purchases of properties (57,241) (24,239)
Purchase of surplus certificates of the exchanges 0 (165,000)
Proceeds from sales and maturities of investments
available-for-sale 576,788 320,653
Proceeds from sales of properties 12,719 11,901
Proceeds from sale of subsidiaries 335,408 0
Mortgage loan collections 10,149 11,548
Other, net (1,394) 4,750
---------- -----------
Net cash used in investing activities (70,705) (419,464)
---------- -----------
Cash Flows from Financing Activities:
Dividends paid to stockholder (168,600) (149,950)
Payment of long-term notes payable (60) 0
Payment of real estate mortgages payable 0 (56)
Issuance cost of cumulative quarterly income preferred
securities 0 (409)
----------- -----------
Net cash used in financing activities (168,660) (150,415)
----------- -----------
Increase/(decrease) in cash and cash equivalents 68,996 (186,195)
Cash and cash equivalents - at beginning of year 499,328 913,006
---------- -----------
Cash and cash equivalents - at end of period $ 568,324 $ 726,811
========== ===========
The accompanying notes are an integral part of these interim financial statements.
11
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 June 30, 1997, the related consolidated
statements of income, stockholder's equity and cash flows for the six month
periods ended June 30, 1997 and June 30, 1996, and the consolidated statements
of income for the three months ended June 30, 1997 and June 30, 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
12
(collectively, the "P&C Group") and receives compensation based on a
percentage of earned premiums.
Prior to April 15, 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 April 15, 1997, upon receipt of regulatory approval, the Company sold
The Ohio State Life Insurance Company ("OSL") and Investors Guaranty Life
Insurance Company ("IGL") to Great Southern Life Insurance Company, a
subsidiary of Americo Life, Inc.. The sale of these subsidiaries resulted
in an estimated $16,536,000 gain and is reported on the "Gain on sale of
subsidiaries" line of the income statement. In addition, taxes associated with
the sale increased current year tax expense by an estimated $27,291,000 and are
reflected on the "Provision for income taxes" line. Both of these amounts are
reflected in the "Management services to property and casualty insurance
companies; and other" section of the Company's consolidated income statements
for the six month period ended June 30, 1997. The decision to sell these
subsidiaries was part of the Company's strategic plan to focus its life
insurance efforts on the growth of 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.
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.
This statement 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
13
Information by Nonpublic Enterprises". The Company does not expect the
adoption of this Statement to have a significant impact on its consolidated
financial statements.
In June 1997, the FASB released SFAS No. 130, "Reporting Comprehensive
Income". This Statement, effective for fiscal periods beginning after
December 15, 1997, establishes standards for reporting and displaying
comprehensive income and its components. This Statement requires that all
items that are required to be recognized under accounting standards as
components of comprehensive income be reported in a financial statement with
the same prominence as other financial statements. The Company does not
expect the adoption of this Statement to have a material impact on its
consolidated financial statements.
In June 1997, the FASB released SFAS No. 131, "Disclosures about Segments
of an Enterprise and Related Information". This Statement, effective for
financial statements of public enterprises issued for periods beginning after
December 15, 1997, establishes standards for reporting information about
operating segments in annual financial statements and requires the reporting
of selected information about operating segments in interim financial reports
issued to shareholders. It also establishes standards for related disclosures
about products and services, geographic areas, and major customers. This
Statement supersedes FASB Statement No. 14, "Financial Reporting for Segments
of a Business Enterprise" and amends FASB Statement No. 94, "Consolidation of
All Majority-Owned Subsidiaries". The Company does not expect the adoption of
this Statement to have a significant impact on its consolidated financial
statements.
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
14
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 June 30, 1997 and 1996, a total of 20,000,000 shares of QUIPS
were outstanding.
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 $608,281,000 and $580,002,000 for the
six month periods ended June 30, 1997 and June 30, 1996, respectively.
E. Related parties
As of June 30, 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 June 30,
1997 and June 30, 1996, was $11,617,000 and $10,320,000, respectively.
15
F. Sale of life insurance subsidiaries
On April 15, 1997, upon receipt of regulatory approval, the Company sold
OSL and IGL to Great Southern Life Insurance Company, a subsidiary of Americo
Life, Inc.. The contribution to net income of these subsidiaries for the six
month period ended June 30, 1997 was $5,909,000. The combined net assets of
these subsidiaries as of April 15, 1997 was $317,625,000. The sale of these
subsidiaries resulted in an estimated $16,536,000 gain and was recorded on the
"Gain on sale of subsidiaries" line of the income statement. In addition,
taxes associated with the sale increased current year tax expense by an
estimated $27,291,000 and are reflected on the "Provision for income taxes"
line. Both of these amounts are reflected in the "Management services to
property and casualty insurance companies; and other" section of the Company's
consolidated income statements for the six month period ended June 30, 1997.
G. 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 Insurance Insurance
Subsidiaries Subsidiaries Consolidated
------------ ------------ ------------
(Amounts in thousands)
Cash and cash equivalents -- December 31, 1995 $ 763,212 $ 149,794 $ 913,006
Activity through June 1996 (186,195)
---------
Cash and cash equivalents -- June 30, 1996 686,787 40,024 $ 726,811
=========
Cash and cash equivalents -- December 31, 1996 412,018 87,310 $ 499,328
Activity through June 1997 68,996
---------
Cash and cash equivalents -- June 30, 1997 545,482 22,842 $ 568,324
=========
Cash payments for interest were $1,073,000 and $8,568,000 for the six
month periods ended June 30, 1997 and June 30, 1996, respectively, while the
cash payment for dividends to the holders of the Company's QUIPS was
$21,035,000 and $10,518,000 for the six month periods ended June 30, 1997 and
June 30, 1996, respectively. In 1996, the second quarter dividend payment to
the holders of the Company's QUIPS, of $10,517,000, was made on July 1, 1996.
Cash payments for income taxes were $229,309,000 and $196,552,000 for the six
month periods ended June 30, 1997 and June 30, 1996, respectively.
Net cash proceeds from the sale of OSL and IGL amounted to an estimated
$335,408,000 and were in consideration primarily for the following:
Investments $ 808,208,000
Deferred policy acquisition cost and value of 182,472,000
life business acquired
Life insurance policy liabilities (690,426,000)
16
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 June 30, 1997 Compared to Three Months Ended June
30, 1996
Management Services to Property and Casualty Insurance Companies; and Other
Operating Revenues. Operating revenues increased from $311.7 million for
the three months ended June 30, 1996 to $328.7 million for the three months
ended June 30, 1997, an increase of $17.0 million, or 5.5%. Operating revenues
primarily consist of management fees paid to the Company as a percentage of
gross premiums earned by the P&C Group. Such premiums increased from $2,365.0
million in the second quarter of 1996 to $2,515.7 million in the second
quarter of 1997 due primarily to policy growth in Personal Lines business as
a result of stricter enforcement of the California mandatory auto insurance
law and the P&C Group's re-entry into the California homeowners' market.
Partially offsetting these increases is the fact that, in recognition of
expense savings realized as a result of improved operating efficiencies,
the Farmers Preferred Auto Management fee rate was reduced by 0.45% effective
November 1, 1996. This resulted in a $6.4 million reduction in management fees
in the second quarter of 1997 from what such fees would have been using the
second quarter 1996 rates. As the Company continues to benefit from improved
operating efficiencies, it may further reduce management fee rates in the
future.
17
Total Operating Expenses.
Salaries and Employee Benefits. Salaries and employee benefits
decreased from $84.3 million for the three months ended June 30, 1996 to
$83.7 million for the three months ended June 30, 1997, a decrease of
$0.6 million, or 0.7%, primarily due to a reduction in employee complement
resulting from staffing efficiencies realized from the use of technology.
Buildings and Equipment Expenses. Buildings and equipment expenses
increased from $21.4 million for the three months ended June 30, 1996 to
$23.1 million for the three months ended June 30, 1997, an increase of
$1.7 million, or 7.9%. This increase was primarily due to higher
amortization expense associated with 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 June 30, 1997 and June 30, 1996.
General and Administrative Expenses. General and administrative
expenses increased from $40.0 million for the three months ended June
30, 1996 to $50.7 million for the three months ended June 30, 1997, an
increase of $10.7 million, or 26.8%. This increase was due substantially
to higher advertising expenses (due to the fact that the 1997 media
advertising campaign began in January, whereas, the 1996 campaign did not
begin until August) and higher expenses attributable to increased business
levels.
Net Investment Income. Net investment income increased from $27.4
million for the three months ended June 30, 1996 to $36.1 million for the
three months ended June 30, 1997 primarily due to higher yield rates in 1997
and a larger invested asset base as a result of the net cash generated by
the sale of OSL and IGL and the common stock received as part of a dividend
FNWL paid to Farmers Group, Inc. in December 1996.
Net Realized Gains. Net realized gains increased from $0.8 million for
the three months ended June 30, 1996 to $10.3 million for the three months
ended June 30, 1997 due substantially to gains realized from restructuring
the Company's equity portfolio.
Gain on sale of subsidiaries. The estimated gain on the sale of OSL and
IGL, on April 15, 1997, amounted to $16.5 million.
Dividends on Preferred Securities of Subsidiary Trusts. Dividend expense
for the three months ended June 30, 1997 and June 30, 1996 was $10.5 million.
Provision for Income Taxes. Provision for income taxes increased from
$63.7 million for the three months ended June 30, 1996 to $79.3 million for
the three months ended June 30, 1997, an increase of $15.6 million, or 24.5%.
This increase was attributable to the increase in
18
pretax operating income between years and an estimated $6.3 million of
additional taxes recorded in the second quarter of 1997 associated with the
sale of OSL and IGL.
Management Services Income. As a result of the foregoing, management
services income increased from $94.3 million for the three months ended June
30, 1996 to $118.6 million for the three months ended June 30, 1997, an
increase of $24.3 million, or 25.8%.
Life Subsidiaries
On April 15, 1997, OSL and IGL were sold to Great Southern Life
Insurance Company, a subsidiary of Americo Life, Inc.. The contribution to
net income from OSL and IGL was $0.6 million for the three months ended June
30, 1997 and $2.5 million for the three months ended June 30, 1996. The
following commentary addresses the results of the Company's remaining life
subsidiary, FNWL.
Total Revenues. Total revenues increased from $146.9 million for the
three months ended June 30, 1996 to $160.6 million for the three months ended
June 30, 1997, an increase of $13.7 million, or 9.3%.
Premiums. Premiums increased $3.7 million for the three months ended
June 30, 1997, or 10.9%, over the three months ended June 30, 1996. This
increase was due to growth in renewal and first year business. The
increase in renewal premiums is attributable to 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 sales of Premier Whole Life products.
Policy Charges. Policy charges increased $3.3 million for the three
months ended June 30, 1997, or 7.1%, over the three months ended June 30,
1996, reflecting continued growth in universal life-type insurance in-
force.
Investment Income. Net investment income increased $4.1 million for
the three months ended June 30, 1997, or 6.3%, over the three months ended
June 30, 1996 due to higher bond interest income resulting primarily from
a higher invested asset base.
Net Realized Gains. Net realized gains increased $2.6 million,
from $1.1 million for the three months ended June 30, 1996 to $3.7 million
for the three months ended June 30, 1997 due to an increase in bond sales,
partially offset by the absence of common stock gains in 1997 due to the
fact that FNWL's common stock portfolio was transferred to Farmers Group,
Inc. in December 1996 as part of the dividend.
Total Operating Expenses. Total operating expenses increased from $97.5
million for the three months ended June 30, 1996 to $106.9 million for the
three months ended June 30, 1997, an increase of $9.4 million, or 9.6%.
Policyholders' Benefits. Policyholders' benefits expense increased
from $61.8 million for the three months ended June 30, 1996 to $69.7
million for the three months ended June 30, 1997, an increase of $7.9
million, or 12.8%. Policy benefits, which consist primarily of death
and surrender benefits on life products, increased $5.3 million over
June 30, 1996 to $30.3
19
million, due to an increase in insurance in-force. Increase in liability
for future benefits expense increased from $2.6 million for the three
months ended June 30, 1996 to $3.1 million for the three months ended
June 30, 1997 due to fewer terminations on older whole life business
carrying higher reserves. Interest credited to policyholders, which
represents the amount credited under universal life-type contracts and
deferred annuities for policyholder funds on deposit, increased from
$34.2 million for the three months ended June 30, 1996 to $36.3 million
for the three months ended June 30, 1997, or 6.1%, reflecting growth in
universal life-type insurance in-force and an increase in annuity funds
on deposit.
Amortization of DAC and Value of Life Business Acquired.
Amortization expense increased from $21.0 million for the three months
ended June 30, 1996 to $21.7 million for the three months ended June 30,
1997, or 3.3%. This increase reflects the continued growth in universal
life-type and traditional business.
Commissions. Commissions were $4.6 million for the three months
ended June 30, 1996 and June 30, 1997.
General and Administrative Expenses. General and administrative
expenses increased from $10.1 million for the three months ended June 30,
1996 to $10.9 million for the three months ended June 30, 1997, or 7.9%.
This increase resulted mainly from higher salaries and benefits expenses
and higher audit and legal fees.
Provision for Income Taxes. Provision for income taxes increased from
$16.4 million for the three months ended June 30, 1996 to $17.8 million for
the three months ended June 30, 1997, an increase of $1.4 million, due to an
increase in pretax operating income.
Life Subsidiary Income. As a result of the foregoing, FNWL's income
increased from $33.0 million for the three months ended June 30, 1996 to
$35.9 million for the three months ended June 30, 1997, an increase of $2.9
million, or 8.8%.
Consolidated Net Income
Consolidated net income of the Company increased from $129.7 million for
the three months ended June 30, 1996 to $155.1 million for the three months
ended June 30,1997, an increase of $25.4 million, or 19.6%.
Six Months Ended June 30, 1997 Compared to Six Months Ended June 30, 1996
Management Services to Property and Casualty Insurance Companies; and Other
Operating Revenues. Operating revenues increased from $618.3 million
for the six months ended June 30, 1996 to $649.5 million for the six months
ended June 30, 1997, an increase of $31.2 million, or 5.0%. This growth
reflects higher gross premiums earned by the P&C Group which increased
from $4,683.9 million in the first six months of 1996 to $4,981.2 million
in the first six months of 1997 due primarily to policy growth in
Personal Lines business. Partially offsetting these increases is the
0.45% reduction in the Farmers Preferred Auto Management fee
20
rate which resulted in a $12.7 million reduction in management fees in 1997
from what such fees would have been using 1996 rates.
Total Operating Expenses. Total operating expenses as a percentage of
operating revenues decreased from 56.4% for the six months ended June 30, 1996
to 56.0% for the six months ended June 30, 1997, a decrease of 0.4%.
Specifically, labor costs (salaries and employee benefits) decreased from
27.8% of operating revenues for the six months ended June 30, 1996 to 25.7% of
operating revenues for the six months ended June 30, 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 $171.6 million for the six months ended June 30, 1996 to
$167.0 million for the six months ended June 30, 1997, a decrease of
$4.6 million, or 2.7%, primarily due to a reduction in employee
complement.
Buildings and Equipment Expenses. Buildings and equipment expenses
increased from $42.0 million for the six months ended June 30, 1996 to
$45.4 million for the six months ended June 30, 1997, an increase of $3.4
million, or 8.1%. This increase was primarily due to higher amortization
expense associated with 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 $51.4 million in each of the six month periods
ended June 30, 1997 and June 30, 1996.
General and Administrative Expenses. General and administrative
expenses increased from $83.8 million for the six months ended June 30,
1996 to $99.8 million for the six months ended June 30, 1997, an increase
of $16.0 million, or 19.1%. This increase was primarily due to higher
advertising expenses (due to the fact that the 1997 media advertising
campaign began in January, whereas, the 1996 campaign did not begin until
August) and higher expenses attributable to increased business levels.
Net Investment Income. Net investment income increased from $54.3 million
for the six months ended June 30, 1996 to $70.4 million for the six months
ended June 30, 1997 primarily due to higher yield rates in 1997 and a larger
invested asset base as a result of the net cash generated by the sale of OSL
and IGL and the common stock received as part of the dividend FNWL paid to
Farmers Group, Inc. in December 1996.
Net Realized Gains. Net realized gains increased from $1.6 million for
the six months ended June 30, 1996 to $40.7 million for the six months ended
June 30, 1997 due primarily to gains realized from restructuring the Company's
equity portfolio.
Gain on sale of subsidiaries. The estimated gain on the sale of OSL and
IGL, on April 15, 1997, amounted to $16.5 million for the six months ended
June 30, 1997.
21
Dividends on Preferred Securities of Subsidiary Trusts. Dividend expense
for the six months ended June 30, 1997 and June 30, 1996 was $21.0 million.
Provision for Income Taxes. Provision for income taxes increased from
$123.1 million for the six months ended June 30, 1996 to $175.9 million for
the six months ended June 30, 1997, an increase of $52.8 million, or 43.0%.
This increase was attributable to the increase in pretax operating income
between years and an estimated $27.3 million of taxes associated with the sale
of OSL and IGL.
Management Services Income. As a result of the foregoing, management
services income increased from $181.3 million for the six months ended June
30, 1996 to $216.6 million for the six months ended June 30, 1997, an increase
of $35.3 million, or 19.5%.
Life Subsidiaries
On April 15, 1997, OSL and IGL were sold to Great Southern Life Insurance
Company, a subsidiary of Americo Life, Inc.. The contribution to net income
from OSL and IGL was $5.5 million for the six months ended June 30, 1997 and
$9.0 million for the six months ended June 30, 1996. The following commentary
addresses the results of the Company's remaining life subsidiary, FNWL.
Total Revenues. Total revenues increased from $303.4 million for the six
months ended June 30, 1996 to $315.3 million for the six months ended June 30,
1997, an increase of $11.9 million, or 3.9%.
Premiums. Premiums increased $6.9 million for the six months ended
June 30, 1997, or 10.2%, over the six months ended June 30, 1996. This
increase was due to growth in renewal and first year business. The
increase in renewal premiums is attributable to an 11.7% 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 sales of Premier Whole Life products.
Policy Charges. Policy charges increased $7.2 million for the six
months ended June 30, 1997, or 7.8%, over the six months ended June 30,
1996, reflecting continued growth in universal life-type insurance in-
force.
Investment Income. Net investment income increased $8.4 million for
the six months ended June 30, 1997, or 6.6%, over the six months ended
June 30, 1996 due to higher bond interest income resulting primarily from
a higher invested asset base.
Net Realized Gains. Net realized gains decreased by $10.6 million,
from $16.0 million for the six months ended June 30, 1996 to $5.4 million
for the six months ended June 30, 1997. This decrease was substantially
due to the fact that FNWL's common stock portfolio was transferred to
Farmers Group, Inc. in December 1996 as part of the dividend.
22
Total Operating Expenses. Total operating expenses increased from $195.5
million for the six months ended June 30, 1996 to $213.5 million for the six
months ended June 30, 1997, an increase of $18.0 million, or 9.2%.
Policyholders' Benefits. Policyholders' benefits expense increased
from $125.0 million for the six months ended June 30, 1996 to $136.8
million for the six months ended June 30, 1997, an increase of $11.8
million, or 9.4%. Policy benefits increased $6.3 million over June 30,
1996 to $57.8 million, due to an increase in insurance-in-force. Increase
in liability for future benefits expense increased from $5.9 million for
the six months ended June 30, 1996 to $7.1 million for the six months
ended June 30, 1997 due to fewer terminations on older whole life
business carrying higher reserves. Interest credited to policyholders
increased from $67.6 million for the six months ended June 30, 1996 to
$71.9 million for the six months ended June 30, 1997, or 6.4%, reflecting
a 5.7% growth in universal life-type insurance in-force and a 4.8%
increase in annuity funds on deposit.
Amortization of DAC and Value of Life Business Acquired.
Amortization expense increased from $41.6 million for the six months
ended June 30, 1996 to $46.1 million for the six months ended June 30,
1997, or 10.8%. This increase reflects the continued growth in universal
life-type and traditional business.
Commissions. Commissions increased from $9.2 million for the six
months ended June 30, 1996 to $9.3 million for the six months ended June
30, 1997, or 1.1%.
General and Administrative Expenses. General and administrative
expenses increased from $19.7 million for the six months ended June 30,
1996 to $21.3 million for the six months ended June 30, 1997, or 8.1%.
This increase resulted mainly from higher salaries and benefits expenses
and higher audit and legal fees.
Provision for Income Taxes. Provision for income taxes decreased from
$36.2 million for the six months ended June 30, 1996 to $33.7 million for the
six months ended June 30, 1997, a decrease of $2.5 million, due to a decrease
in pretax operating income from reduced net realized gains.
Life Subsidiary Income. As a result of the foregoing, FNWL's income
decreased from $71.7 million for the six months ended June 30, 1996 to
$68.1 million for the six months ended June 30, 1997, a decrease of $3.6
million, or 5.0%.
Consolidated Net Income
Consolidated net income of the Company increased from $262.0 million for
the six months ended June 30, 1996 to $290.2 million for the six months ended
June 30, 1997, an increase of $28.2 million, or 10.8%.
23
Liquidity and Capital Resources
As of June 30, 1997 and June 30, 1996, the Company held cash and cash
equivalents of $568.3 million and $726.8 million, respectively. In addition,
as of June 30, 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 $75.3 million, or
19.6%, between years to $308.4 million for the six months ended June 30,
1997. This decrease in cash is principally due to a decrease in the volume
of new annuity business coupled with a decrease in non-current liabilities.
Net cash used in investing activities decreased $348.8 million, or
83.1%, between years to $70.7 million for the six months ended June 30,
1997. This increase in cash resulted primarily from a net increase in
proceeds from the sales of investments. In addition, cash increased between
years due to the purchase of $165.0 million of surplus certificates of the
Exchanges in June 1996.
Net cash used in financing activities increased from $150.4 million for
the six months ended June 30, 1996 to $168.7 million for the six months ended
June 30, 1997, or 12.2%. This decrease in cash is the result of an $18.7
million increase in dividends paid to the Company's stockholder.
24
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.
21 Subsidiaries of FGI.
(b) Reports on Form 8-K. None.
25
FARMERS GROUP, INC.
AND SUBSIDIARIES
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of
1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned thereunto duly authorized.
Farmers Group, Inc.
(Registrant)
August 14, 1997 /s/ Martin D. Feinstein
---------------------------------------------
Date Martin D. Feinstein
President and
Chief Executive Officer
August 14, 1997 /s/ Anthony L.R. Clark
---------------------------------------------
Date Anthony L.R. Clark
Senior Vice President and
Chief Financial Officer