1
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
- --------------------------------------------------------------------------
FORM 10-Q
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Quarterly Period Ended September 30, 1999
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
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Commission File Number 33-94670-01
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FARMERS GROUP, INC.
(Exact name of registrant as specified in its charter)
NEVADA
(State or other jurisdiction of
incorporation or organization)
95-0725935
(IRS Employer Identification No.)
4680 WILSHIRE BOULEVARD, LOS ANGELES, CALIFORNIA 90010
(Address of principal executive offices)(Zip Code)
(323) 932-3200
(Registrants telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has
been subject to such filing requirements for the past 90 days.
Yes /X/ No / /
Registrant's Common Stock outstanding on September 30, 1999 was 1,000 shares.
2
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FARMERS GROUP, INC.
AND SUBSIDIARIES
TABLE OF CONTENTS FORM 10-Q
FOR THE PERIOD ENDED SEPTEMBER 30, 1999
PART I. FINANCIAL INFORMATION PAGE
----
ITEM 1. Financial Statements
Consolidated Balance Sheets - Assets
September 30, 1999 and December 31, 1998 4
Consolidated Balance Sheets - Liabilities and Stockholders'
Equity
September 30, 1999 and December 31, 1998 5
Consolidated Statements of Income
Nine Month Periods ended September 30, 1999 and
September 30, 1998 6
Consolidated Statements of Comprehensive Income
Nine Month Periods ended September 30, 1999 and
September 30, 1998 7
Consolidated Statements of Income
Three Month Periods ended September 30, 1999 and
September 30, 1998 8
Consolidated Statements of Comprehensive Income
Three Month Periods ended September 30, 1999 and
September 30, 1998 9
Consolidated Statement of Stockholders' Equity
Nine Month Period ended September 30, 1999 10
Consolidated Statement of Stockholders' Equity
Nine Month Period ended September 30, 1998 11
Consolidated Statements of Cash Flows
Nine Month Periods ended September 30, 1999 and
September 30, 1998 12
Notes to Interim Financial Statements 13
ITEM 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 19
ITEM 3. Quantitative and Qualitative Disclosures about Market Risks 27
PART II. OTHER INFORMATION 28
SIGNATURES 29
4
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
FARMERS GROUP, INC.
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands)
(Unaudited)
ASSETS
September 30, December 31,
1999 1998
------------- ------------
Current assets, excluding Insurance Subsidiaries:
Cash and cash equivalents $ 100,705 $ 253,828
Marketable securities, at market value 50,146 53,536
Accrued interest 20,751 32,542
Accounts receivable, principally from the P&C Group 60,141 35,271
Note receivable - affiliate 190,000 0
Deferred taxes 34,646 27,044
Prepaid expenses and other 31,502 22,126
------------- ------------
Total current assets 487,891 424,347
------------- ------------
Investments, excluding Insurance Subsidiaries:
Fixed maturities available-for-sale, at market value
(cost: $663,146 and $597,262) 661,621 608,539
Mortgage loans on real estate 159 196
Common stocks available-for-sale, at market value
(cost: $345,927 and $278,107) 357,631 354,465
Certificates of contribution of the P&C Group 23,330 34,380
Real estate, at cost (net of accumulated depreciation:
$29,724 and $32,363) 58,778 62,820
Joint ventures, at equity 840 840
------------- ------------
1,102,359 1,061,240
------------- ------------
Other assets, excluding Insurance Subsidiaries:
Notes receivable - affiliate 1,057,000 1,057,000
Goodwill (net of accumulated amortization:
$645,473 and $600,440) 1,756,282 1,801,315
Attorney-in-fact contracts (net of accumulated amortization:
$459,304 and $427,260) 1,249,739 1,281,783
Other assets 285,377 258,912
------------- ------------
4,348,398 4,399,010
------------- ------------
Properties, plant and equipment, at cost: (net of accumulated
depreciation: $313,978 and $293,425) 418,329 402,061
------------- ------------
Investments of Insurance Subsidiaries:
Fixed maturities available-for-sale, at market value
(cost: $4,418,645 and $4,178,305) 4,350,101 4,356,066
Mortgage loans on real estate 37,009 52,879
Non-redeemable preferred stocks available-for-sale, at market
value (cost: $1,153 and $1,153) 1,205 1,270
Common stocks available-for-sale, at market value
(cost: $124,582 and $98,399) 129,404 106,095
Surplus note of the P&C Group 119,000 119,000
Policy loans 196,802 185,211
Real estate, at cost (net of accumulated depreciation:
$27,477 and $28,366) 51,297 59,047
Joint ventures, at equity 7,899 8,456
S&P 500 call options, at fair value (cost: $17,376 and $11,305) 23,498 14,817
------------- ------------
4,916,215 4,902,841
------------- ------------
Other assets of Insurance Subsidiaries:
Cash and cash equivalents 57,357 73,724
Reinsurance premiums receivable - P&C Group 111,119 80,124
Accrued investment income 66,408 59,910
Deferred policy acquisition costs and value of life business
acquired 860,008 801,690
Securities lending collateral 262,126 461,801
Other assets 29,467 19,856
------------- ------------
1,386,485 1,497,105
------------- ------------
Total assets $ 12,659,677 $ 12,686,604
============= ============
The accompanying notes are an integral part of these interim financial statements.
5
FARMERS GROUP, INC.
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands)
(Unaudited)
LIABILITIES AND STOCKHOLDERS' EQUITY
September 30, December 31,
1999 1998
------------ ------------
Current liabilities, excluding Insurance Subsidiaries:
Notes and accounts payable:
P&C Group $ 7,231 $ 137
Other 37,846 28,420
Accrued liabilities:
Profit sharing 38,983 50,404
Income taxes 76,160 69,906
Other 12,582 30,724
------------ ------------
Total current liabilities 172,802 179,591
------------ ------------
Other liabilities, excluding Insurance Subsidiaries:
Real estate mortgages payable 23 25
Non-current deferred taxes 575,750 601,047
Other 168,605 136,135
------------ ------------
744,378 737,207
------------ ------------
Liabilities of Insurance Subsidiaries:
Policy liabilities:
Future policy benefits 3,348,597 3,184,248
Claims 31,013 26,177
Policyholder dividends 1 1
Other policyholders funds 77,239 57,357
Provision for non-life losses and loss adjustment expenses 102,093 105,944
Income taxes (including deferred taxes: $94,954 and $164,729) 105,670 168,618
Unearned investment income 967 971
Reinsurance payable - P&C Group 176,575 167,709
Securities lending liability 262,126 461,801
Other liabilities 82,523 62,573
------------ ------------
4,186,804 4,235,399
------------ ------------
Total liabilities 5,103,984 5,152,197
------------ ------------
Commitments and contingencies
Company obligated mandatorily redeemable preferred
securities of subsidiary trusts holding solely junior
subordinated debentures 500,000 500,000
------------ ------------
Stockholders' Equity:
Class A common stock, $1 par value per share; authorized, issued
and outstanding: as of September 30, 1999 and
December 31, 1998 - 500 shares 0.5 0.5
Class B common stock, $1 par value per share; authorized, issued
and outstanding: as of September 30, 1999 and
December 31, 1998 - 500 shares 0.5 0.5
Additional capital 5,212,618 5,212,618
Accumulated other comprehensive income/(loss) (net of deferred
taxes: ($13,657) and $77,897) (25,361) 144,742
Retained earnings 1,868,435 1,677,046
------------ ------------
Total stockholders' equity 7,055,693 7,034,407
------------ ------------
Total liabilities and stockholders' equity $ 12,659,677 $ 12,686,604
============ ============
The accompanying notes are an integral part of these interim financial statements.
6
FARMERS GROUP, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Amounts in thousands)
(Unaudited)
Nine month period
ended September 30,
------------------------
1999 1998
----------- -----------
Consolidated operating revenues $ 2,439,878 $ 2,286,713
=========== ===========
Management services to property and casualty
insurance companies; and other:
Operating revenues $ 1,116,267 $ 1,015,816
----------- -----------
Operating expenses 609,794 598,528
Merger related expenses 244 20,532
----------- -----------
Total expenses 610,038 619,060
----------- -----------
Operating income 506,229 396,756
Net investment income 84,915 104,039
Net realized gains 62,672 17,977
Dividends on preferred securities of subsidiary trusts (31,553) (31,553)
----------- -----------
Income before provision for taxes 622,263 487,219
Provision for income taxes 255,808 198,455
----------- -----------
Management services income 366,455 288,764
----------- -----------
Insurance Subsidiaries:
Life premiums 155,440 129,225
Non-life reinsurance premiums 750,000 750,104
Life policy charges 157,731 154,643
Investment income, net of expenses 247,525 226,918
Net realized gains 12,915 10,007
----------- -----------
Total revenues 1,323,611 1,270,897
----------- -----------
Non-life losses and loss adjustment expenses 494,769 491,271
Life policyholders' benefits and charges 258,615 228,298
Non-life reinsurance commissions 236,490 239,974
General operating expenses 122,425 113,822
----------- -----------
Total operating expenses 1,112,299 1,073,365
----------- -----------
Income before provision for taxes 211,312 197,532
Provision for income taxes 71,178 70,202
----------- -----------
Insurance Subsidiaries income 140,134 127,330
----------- -----------
Consolidated net income $ 506,589 $ 416,094
=========== ===========
The accompanying notes are an integral part of these interim financial statements.
7
FARMERS GROUP, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF
COMPREHENSIVE INCOME
(Amounts in thousands)
(Unaudited)
Nine month period
ended September 30,
------------------------
1999 1998
----------- -----------
Consolidated net income $ 506,589 $ 416,094
----------- -----------
Other comprehensive income/(loss), net of tax:
Unrealized holding gains/(losses) on securities:
Unrealized holding gains/(losses) arising during the period,
net of tax of ($92,355) and $15,896 (171,590) 29,582
Less: reclassification adjustment for gains
included in net income, net of tax of ($21,387)
and ($4,728) (39,719) (8,780)
----------- -----------
Net unrealized holding gains/(losses) on securities,
net of tax of ($113,742) and $11,168 (211,309) 20,802
Change in effect of unrealized gains/(losses) on other
insurance accounts, net of tax of $22,188 and ($2,612) 41,206 (4,850)
----------- -----------
Other comprehensive income/(loss) (170,103) 15,952
----------- -----------
Comprehensive income $ 336,486 $ 432,046
=========== ===========
The accompanying notes are an integral part of these interim financial statements.
8
FARMERS GROUP, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Amounts in thousands)
(Unaudited)
Three month period
ended September 30,
------------------------
1999 1998
----------- -----------
Consolidated operating revenues $ 813,141 $ 774,354
=========== ===========
Management services to property and casualty
insurance companies; and other:
Operating revenues $ 375,177 $ 343,904
----------- -----------
Operating expenses 207,551 229,108
Merger related expenses 0 20,532
----------- -----------
Total expenses 207,551 249,640
----------- -----------
Operating income 167,626 94,264
Net investment income 27,546 27,065
Net realized gains/(losses) 28,833 (552)
Dividends on preferred securities of subsidiary trusts (10,518) (10,518)
----------- -----------
Income before provision for taxes 213,487 110,259
Provision for income taxes 89,145 47,329
----------- -----------
Management services income 124,342 62,930
----------- -----------
Insurance Subsidiaries:
Life premiums 51,536 44,993
Non-life reinsurance premiums 250,000 250,104
Life policy charges 52,919 51,588
Investment income, net of expenses 83,191 80,369
Net realized gains 318 3,396
----------- -----------
Total revenues 437,964 430,450
----------- -----------
Non-life losses and loss adjustment expenses 166,098 160,525
Life policyholders' benefits and charges 84,558 79,195
Non-life reinsurance commissions 77,652 83,220
General operating expenses 42,282 38,893
----------- -----------
Total operating expenses 370,590 361,833
----------- -----------
Income before provision for taxes 67,374 68,617
Provision for income taxes 22,818 23,965
----------- -----------
Insurance Subsidiaries income 44,556 44,652
----------- -----------
Consolidated net income $ 168,898 $ 107,582
=========== ===========
The accompanying notes are an integral part of these interim financial statements.
9
FARMERS GROUP, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF
COMPREHENSIVE INCOME
(Amounts in thousands)
(Unaudited)
Three month period
ended September 30,
------------------------
1999 1998
----------- -----------
Consolidated net income $ 168,898 $ 107,582
----------- -----------
Other comprehensive loss, net of tax:
Unrealized holding gains/(losses) on securities:
Unrealized holding gains/(losses) arising during the
period, net of tax of ($33,243) and $3,190 (61,734) 5,935
Less: reclassification adjustment for gains
included in net income, net of tax of ($10,456)
and ($2,969) (19,418) (5,514)
----------- -----------
Net unrealized holding gains/(losses) on securities,
net of tax of ($43,699) and $221 (81,152) 421
Change in effect of unrealized gains/(losses) on other
insurance accounts, net of tax of $5,357 and
($2,470) 9,948 (4,587)
----------- -----------
Other comprehensive loss (71,204) (4,166)
----------- -----------
Comprehensive income $ 97,694 $ 103,416
=========== ===========
The accompanying notes are an integral part of these interim financial statements.
10
FARMERS GROUP, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
For the nine month period ended September 30, 1999
(Amounts in thousands)
(Unaudited)
Accumulated Other Total
Common Additional Comprehensive Retained Stockholders'
Stock Capital Income/(Loss) Earnings Equity
-------- ----------- ----------------- ------------ ------------
Balance, December 31, 1998 $ 1 $ 5,212,618 $ 144,742 $ 1,677,046 $ 7,034,407
Net income 506,589 506,589
Unrealized holding losses
arising during the period,
net of tax of ($92,355) (171,590) (171,590)
Reclassification adjustment
for gains included in net
income, net of tax of ($21,387) (39,719) (39,719)
Change in effect of unrealized
gains on other insurance
accounts, net of tax of $22,188 41,206 41,206
Cash dividends paid (315,200) (315,200)
-------- ----------- ---------------- ------------ ------------
Balance, September 30, 1999 $ 1 $ 5,212,618 $ (25,361) $ 1,868,435 $ 7,055,693
======== =========== ================ ============ ============
The accompanying notes are an integral part of these interim financial statements.
11
FARMERS GROUP, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
For the nine month period ended September 30, 1998
(Amounts in thousands)
(Unaudited)
Accumulated Other Total
Common Additional Comprehensive Retained Stockholders'
Stock Capital Income Earnings Equity
-------- ----------- ----------------- ------------ ------------
Balance, December 31, 1997 $ 1 $ 5,212,618 $ 113,549 $ 1,455,406 $ 6,781,574
Net income 416,094 416,094
Unrealized holding gains
arising during the period,
net of tax of $15,896 29,582 29,582
Reclassification adjustment
for gains included in net
income, net of tax of ($4,728) (8,780) (8,780)
Change in effect of unrealized
losses on other insurance
accounts, net of tax of ($2,612) (4,850) (4,850)
Cash dividends paid (266,400) (266,400)
-------- ----------- ---------------- ------------ ------------
Balance, September 30, 1998 $ 1 $ 5,212,618 $ 129,501 $ 1,605,100 $ 6,947,220
======== =========== ================ ============ ============
The accompanying notes are an integral part of these interim financial statements.
12
FARMERS GROUP, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in thousands)
(Unaudited)
Nine month period
ended September 30,
-----------------------
1999 1998
---------- ----------
Cash Flows from Operating Activities:
Consolidated net income $ 506,589 $ 416,094
Non-cash and operating activities adjustments:
Depreciation and amortization 120,956 141,205
Amortization of deferred policy acquisition costs and
value of life business acquired 78,198 67,759
Policy acquisition costs deferred (73,122) (71,746)
Life insurance policy liabilities 63,455 21,311
Provision for non-life losses and loss adjustment expenses (3,851) 105,251
Universal life type contracts:
Deposits received 226,359 223,394
Withdrawals (189,591) (180,274)
Interest credited 53,167 50,285
Equity in earnings of joint ventures (6,262) (1,039)
Gain on sales of assets (76,278) (28,197)
Changes in assets and liabilities:
Current assets and liabilities (34,702) 34,533
Non-current assets and liabilities (38,481) 62,598
Other, net 8,291 (32,095)
---------- ----------
Net cash provided by operating activities 634,728 809,079
---------- ----------
Cash Flows from Investing Activities:
Purchases of investments available-for-sale (1,621,967) (1,257,063)
Purchases of properties (35,253) (34,963)
Purchase of notes receivable - affiliate (190,000) (1,057,000)
Purchase of surplus note of the P&C Group 0 (119,000)
Proceeds from sales and maturities of investments
available-for-sale 1,282,914 656,622
Proceeds from sales of properties 24,259 20,143
Proceeds from redemption of certificates of contribution
of the P&C Group 11,050 650,000
Proceeds from redemption of notes receivable - affiliate 0 407,000
Mortgage loan collections 17,081 24,058
Increase in policy loans (11,591) (14,848)
Other, net (1,187) 3,250
---------- ----------
Net cash used in investing activities (524,694) (721,801)
---------- ----------
Cash Flows from Financing Activities:
Dividends paid to stockholders (315,200) (266,400)
Annuity contracts:
Deposits received 121,572 107,341
Withdrawals (149,600) (164,283)
Interest credited 63,706 58,577
Payment of long-term notes payable (2) (66)
---------- ----------
Net cash used in financing activities (279,524) (264,831)
---------- ----------
Decrease in cash and cash equivalents (169,490) (177,553)
Cash and cash equivalents - at beginning of year 327,552 516,253
---------- ----------
Cash and cash equivalents - at end of period $ 158,062 $ 338,700
========== ==========
The accompanying notes are an integral part of these interim financial statements.
13
FARMERS GROUP, INC.
AND SUBSIDIARIES
NOTES TO INTERIM FINANCIAL STATEMENTS
(Unaudited)
A. Basis of presentation and summary of significant accounting policies
The accompanying consolidated balance sheet of Farmers Group, Inc.
("FGI") and its subsidiaries (together, the "Company") as of September 30,
1999, the related consolidated statements of income, comprehensive income,
stockholders' equity and cash flows for the nine month periods ended September
30, 1999 and September 30, 1998, and the consolidated statements of income and
comprehensive income for the three month periods ended September 30, 1999 and
September 30, 1998, 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 GAAP for complete
financial statements and should be read in conjunction with the consolidated
balance sheets of the Company as of December 31, 1998 and 1997, and the related
consolidated statements of income, comprehensive income, stockholders' equity,
and cash flows for each of the three years in the period ended December 31,
1998.
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
1999 presentation.
The preparation of the Company's financial statements in conformity with
GAAP requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and the disclosure of contingent
assets and liabilities at the date of the financial statements as well as the
reported amounts of revenues and expenses during the reporting periods. Actual
results could differ from those estimates.
The Company is attorney-in-fact ("AIF") for three inter-insurance
exchanges: Farmers Insurance Exchange, Fire Insurance Exchange and Truck
Insurance Exchange (collectively the "Exchanges"), which operate in the
property and casualty insurance industry. As AIF, FGI, or its subsidiaries, as
applicable, provides certain management services to the Exchanges, their
respective subsidiaries and Farmers Texas County Mutual Insurance Company
(collectively the "P&C Group") and receives compensation based on a percentage
of gross premiums earned. The P&C Group is owned by the policyholders of the
Exchanges and Farmers Texas County Mutual Insurance Company. Accordingly, the
Company has no ownership interest in the P&C Group.
Farmers New World Life Insurance Company ("Farmers Life"), a Washington
based insurance company, is a wholly owned subsidiary of the Company. Farmers
Life markets a broad line of individual life insurance products, including
universal life, term life and whole life insurance and structured settlement
and annuity products, predominately flexible premium deferred annuities. These
products and services are sold directly by the P&C Group's agents.
Farmers Reinsurance Company ("Farmers Re"), a wholly owned subsidiary of
the Company, reinsures a percentage of the auto physical damage business
written by the P&C Group. Under a quota share reinsurance treaty, Farmers Re
assumes monthly premiums of $83,333,000 and a quota share percentage of
ultimate net losses sustained by the P&C Group in its auto physical damage
lines of business. This treaty also provides for the P&C Group to receive a
provisional ceding commission of 20% of premiums with additional experience
commissions that depend on loss experience. This experience commission
arrangement limits Farmers Re's potential underwriting gain on the assumed
business to 2.5% of premiums assumed. On March 31, 1999, Farmers Re and the
P&C Group commuted $105,944,000 of losses and loss adjustment expenses
associated with the 1998 accident year. As a result, on May 14, 1999, Farmers
Re paid the P&C Group $105,944,000 of losses and loss adjustment expenses and
$8,205,000 of accrued interest in settlement of this commutation.
14
References to the "Insurance Subsidiaries" within the consolidated
financial statements are to Farmers Life and Farmers Re.
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.
In September 1998, B.A.T's Financial Services Businesses, which included
the Company, were merged with Zurich Insurance Company ("Zurich"). The
businesses of Zurich and B.A.T's Financial Services Businesses were transferred
to Zurich Financial Services ("ZFS"), a new Swiss company with headquarters in
Zurich. As a result, each two shares of the Company's prior outstanding stock
were recapitalized into one share of Class A Common Stock, par value $1.00 per
share ("Ordinary Shares"), and one share of Class B Common Stock, par value
$1.00 per share ("Income Shares"). Under the merger agreement, all Ordinary
Shares became wholly owned by ZFS and all Income Shares became wholly owned by
Allied Zurich Holdings Limited, an affiliated company created during the
restructuring of B.A.T. This merger was accounted for by ZFS as a pooling of
interests and, therefore, no purchase accounting adjustments were made to the
Company's assets and liabilities.
In 1999, the Company adopted Statement of Position ("SOP") No. 98-1,
"Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use". This SOP applies to all nongovernmental entities and
establishes the rules for capitalizing or expensing internally developed
software.
In 1999, the Company adopted SOP No. 98-5, "Reporting on the Costs of
Start Up Activities". This SOP addresses the recording of costs associated
with a one-time activity, such as opening a new facility, introducing a new
product or service, conducting business in a new territory or conducting
business with a new class of customer.
In June 1999, the Financial Accounting Standards Board ("FASB") released
Statement of Financial Accounting Standards ("SFAS") No. 137, "Deferral of the
Effective Date of FASB Statement No. 133", which defers the effective date of
SFAS No. 133 to fiscal years beginning after June 15, 2000. In 1998, the FASB
released SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities". This Statement establishes accounting and reporting standards for
derivative instruments (including certain derivative instruments embedded in
other contracts) and for hedging activities. SFAS No. 133 requires that an
entity recognize all derivatives as either assets or liabilities in the
statement of financial position and measure those instruments at market value.
This Statement amends SFAS No. 52, "Foreign Currency Translation" and SFAS No.
107, "Disclosures about Fair Value of Financial Instruments". It supersedes
SFAS No. 80, "Accounting for Futures Contracts", SFAS No. 105, "Disclosure of
Information about Financial Instruments with Off-Balance-Sheet Risk and
Financial Instruments with Concentrations of Credit Risk", and SFAS No. 119,
"Disclosure about Derivative Financial Instruments and Fair Value of Financial
Instruments". The Company does not expect the adoption of these Statements to
have a material 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.
15
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 September 30, 1999 and 1998, a total of 20,000,000 shares of QUIPS
were outstanding.
D. Management fees
As AIF, the Company, or its subsidiaries, as applicable, provides
management services to the P&C Group and receives management fees for the
services rendered. As a result, the Company received management fees from the
P&C Group of $1,050,507,000 and $950,787,000 for the nine month periods ended
September 30, 1999 and September 30, 1998, respectively.
E. Related Parties
On June 30, 1999, the Company loaned Centre Reinsurance Holdings (Delaware
II) Ltd., a subsidiary of ZFS, $190,000,000. In return, the Company received a
$190,000,000 note with an 8.75% fixed interest rate that matures on December
31, 1999. Interest is due at maturity and, through September 30, 1999,
interest earned on this note totaled $4,202,000.
In addition, as of September 30, 1999, the Company held $1,057,000,000 of
notes receivable from British American Financial Services (UK and
International), Ltd. ("BAFS"), a subsidiary of ZFS. The Company purchased the
notes from BAFS on September 3, 1998, using proceeds received in settlement of
$407,000,000 of B.A.T Capital Corporation notes and proceeds received from the
redemption of $650,000,000 of certificates of contribution of the P&C Group.
The $1,057,000,000 notes receivable are fixed rate medium-term notes with
maturity dates as follows: $200,000,000 in September 2000, $207,000,000 in
September 2001, $200,000,000 in September 2002, $200,000,000 in September 2003
and $250,000,000 in September 2004. Interest on these notes is paid semi-
annually at coupon rates of 5.44%, 5.48%, 5.67%, 5.71% and 5.78%, respectively.
Income earned on these notes was $44,575,000 and $4,761,000 for the nine month
periods ended September 30, 1999 and September 30, 1998, respectively.
16
F. Certificates of contribution and surplus note of the P&C Group
On April 7, 1999, the Company received $12,274,000 from the P&C Group for
the redemption of an $11,050,000 certificate of contribution issued on December
11, 1991 and for the payment of $1,224,000 of accrued interest. As of
September 30, 1999, the Company continued to hold miscellaneous other
certificates of contribution of the P&C Group totaling $23,330,000 which bear
interest at various rates. In addition, Farmers Life holds a $119,000,000
surplus note of the P&C Group which bears interest at 6.10% annually.
Conditions governing repayment of these amounts are outlined in the
certificates of contribution and the surplus note. Generally, repayment may be
made only when the surplus balance of the issuer reaches a certain specified
level, and then only after approval is granted by the issuer's governing Board
and the appropriate Department of Insurance.
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 balance sheet cash and cash equivalent totals to the
consolidated cash flow total:
Excluding
Insurance Insurance
Subsidiaries Subsidiaries Consolidated
------------ ------------ ------------
(Amounts in thousands)
Cash and cash equivalents -- December 31, 1997 $ 506,273 $ 9,980 $ 516,253
Activity through September 1998 (177,553)
------------
Cash and cash equivalents -- September 30, 1998 155,593 183,107 $ 338,700
============
Cash and cash equivalents -- December 31, 1998 $ 253,828 $ 73,724 $ 327,552
Activity through September 1999 (169,490)
------------
Cash and cash equivalents -- September 30, 1999 100,705 57,357 $ 158,062
============
Cash payments for interest were $1,543,000 and $2,544,000 for the nine
month periods ended September 30, 1999 and September 30, 1998, respectively,
while the cash payment for dividends to the holders of the Company's QUIPS was
$31,553,000 for each of the nine month periods ended September 30, 1999 and
September 30, 1998. Cash payments for income taxes were $325,884,000 and
$326,509,000 for the nine month periods ended September 30, 1999 and September
30, 1998, respectively.
H. Operating segments
The Company's principal activities are the provision of management
services to the P&C Group and the ownership and operation of the life and
reinsurance subsidiaries. These activities are managed separately as each
offers a unique set of services. As a result, the Company is comprised of the
following three reportable operating segments as defined in SFAS No. 131,
"Disclosures about Segments of an Enterprise and Related Information": the
management services segment, the life insurance segment and the reinsurance
segment.
The basis of accounting used by the Company's management in evaluating
segment performance and determining how resources should be allocated is
referred to as the Company's GAAP historical basis, which excludes the effects
of the purchase accounting ("PGAAP") adjustments related to the acquisition of
the Company by B.A.T in December 1988 (see Note A) and intersegment
adjustments. This differs from the basis used in preparing the Company's
financial statements included in the SEC Form 10-K and 10-Q reports, which
incorporates the effects of these adjustments.
17
The Company accounts for intersegment transactions as if they were to
third parties and, as such, records the transactions at current market prices.
As of September 30, 1999, the Company held intersegment loans among its three
reportable operating segments. The profit and loss effects of these loans
are reflected in the table below. There were no intersegment revenues among
the Company's three reportable operating segments for the nine month period
ended September 30, 1998.
Information regarding the Company's reportable operating segments follows:
Nine month period ended September 30, 1999
------------------------------------------------------------------------------------------------------------------
GAAP historical basis PGAAP and intersegment adjustments Consolidated
------------------------------------------------------ ---------------------------------------------
Management Life Management Life PGAAP
services insurance Reinsurance Total services insurance Reinsurance Total basis
------------------------------------------------------ --------------------------------------------- ------------
(Amounts in thousands)
Revenues $1,116,267 $ 553,864 (a) $ 770,790 (a) $2,440,921 $ 0 $ (1,043) $ 0 $ (1,043) $2,439,878
Investment
income 85,997 236,615 20,035 342,647 (1,082) (720) 0 (1,802) 340,845
Investment
expenses 0 (8,405) 0 (8,405) 0 0 0 0 (8,405)
Intersegment
interest
income/
(expense) (1,572)(b) 1,130 (b) 442 (b) 0 1,572 (c) (1,130)(c) (442)(c) 0 0
Net realized
gains/(losses) 66,504 12,483 755 79,742 (3,832) (323) 0 (4,155) 75,587
Dividends
on preferred
securities of
subsidiary
trusts (31,553) 0 0 (31,553) 0 0 0 0 (31,553)
Income before
provision for
taxes 705,948 (d) 200,663 (d) 39,814 (d) 946,425 (83,685)(e) (28,723)(e) (442)(e) (112,850) 833,575
Provision for
income taxes 270,599 (f) 70,389 (f) 11,469 (f) 352,457 (14,791)(g) (10,525)(g) (155)(g) (25,471) 326,986
Depreciation and
amortization 39,593 53,824 (h) 0 93,417 78,887 (i) 26,850 (j) 0 105,737 199,154
- -----------------------
(a) Revenues for the insurance operating segments include net investment
income and net realized gains/(losses).
(b) Amount reflects the interest income/(expense) associated with the
intersegment loans.
(c) Amount reflects the adjustment, relating to interest income/(expense)
associated with the intersegment loans, necessary to present information
on a consolidated PGAAP basis.
(d) Amount includes interest income/(expense) associated with the
intersegment loans.
(e) Amount includes the adjustment related to intersegment interest
income/(expense) (refer to (c) above).
(f) Amount includes ($0.6 million), $0.4 million and $0.2 million associated
with the tax effect of intersegment interest income/(expense) relating to
the management services segment, the life insurance segment and the
reinsurance segment, respectively.
(g) Amount includes $0.6 million, ($0.4 million) and ($0.2 million)
associated with the tax effect of adjustments for intersegment interest
income/(expense) relating to the management services segment, the life
insurance segment and the reinsurance segment, respectively.
(h) Amount includes the historical basis amortization associated with the
deferred acquisition costs ("DAC") asset which included a $23.3 million
adjustment, reducing expense, due to favorable persistency experience on
the fixed universal life business.
(i) Amount includes PGAAP adjustments associated with the amortization of the
AIF contracts ($32.0 million) and goodwill ($45.0 million).
(j) Amount includes PGAAP adjustments associated with the amortization of the
Value of Life Business Acquired ("VOLBA") asset and the reversal of
amortization associated with the pre-1988 DAC asset. Included in this
amount are adjustments totaling $21.3 million, increasing expense, due to
unfavorable persistency experience on the pre-1988 business.
18
Nine month period ended September 30, 1998
------------------------------------------------------------------------------------------------------------------
GAAP historical basis PGAAP and intersegment adjustments Consolidated
------------------------------------------------------ ---------------------------------------------
Management Life Management Life PGAAP
services insurance Reinsurance Total services insurance Reinsurance Total basis
------------------------------------------------------ --------------------------------------------- ------------
(Amounts in thousands)
Revenues $1,015,816 $ 513,589 (a) $ 757,152 (a) $2,286,557 $ 0 $ 156 $ 0 $ 156 $2,286,713
Investment
income 104,702 229,642 6,910 341,254 (663) 156 0 (507) 340,747
Investment
expenses 0 (9,790) 0 (9,790) 0 0 0 0 (9,790)
Net realized
gains/(losses) 19,979 9,869 138 29,986 (2,002) 0 0 (2,002) 27,984
Dividends
on preferred
securities of
subsidiary
trusts (31,553) 0 0 (31,553) 0 0 0 0 (31,553)
Income before
provision for
taxes 570,405 170,158 25,740 766,303 (83,186) 1,634 0 (81,552) 684,751
Provision for
income taxes 213,062 60,797 9,027 282,886 (14,607) 378 0 (14,229) 268,657
Depreciation and
amortization 59,901 71,387 (b) 0 131,288 78,635 (c) (959)(d) 0 77,676 208,964
- -----------------------
(a) Revenues for the insurance operating segments include net investment
income and net realized gains/(losses).
(b) Amount includes the historical basis amortization associated with the DAC
asset.
(c) Amount includes PGAAP adjustments associated with the amortization of the
AIF contracts ($32.0 million) and goodwill ($45.0 million).
(d) Amount includes PGAAP adjustments associated with the amortization of the
VOLBA asset and the reversal of amortization associated with the pre-1988
DAC asset.
I. Subsequent events
On October 19, 1999, the Exchanges announced an agreement to acquire
Foremost Corporation of America ("Foremost") for approximately $812,000,000.
Foremost is the country's leading writer of manufactured homes and a prominent
insurer of recreational vehicles and other specialty lines. Subject to
regulatory approvals, this acquisition is expected to be completed during the
first quarter of 2000. The Company may purchase certificates of contribution
or surplus notes of the Exchanges to help fund this acquisition.
19
ITEM 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
General
The Company's principal activities are the provision of management
services to the P&C Group and the ownership and operation of the Insurance
Subsidiaries. Revenues and expenses relating to these principal business
activities are reflected in the Company's Consolidated Financial Statements
prepared in accordance with GAAP, which differs from statutory accounting
practices ("SAP"), which the Insurance Subsidiaries are required to use for
regulatory reporting purposes.
Effective January 1, 1999, the P&C Group began assuming all personal lines
business written by Zurich's subsidiary, Maryland Casualty Company ("MCC").
The Company provides management services in respect of this business and, as
with its services to the other P&C Group entities, receives compensation based
on a percentage of gross premiums earned.
Farmers Life, a wholly owned subsidiary of the Company, underwrites life
insurance, structured settlement and annuity products. Revenues attributable
to traditional life insurance products, such as whole life or term life
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 DAC) so that profits are generally recognized over the same
period as revenue income. Revenues attributable to universal life 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 attributable to structured
settlement products consist of investment income on assets allocated to support
the policyholder benefits schedule. Expenses on structured settlement products
include interest credited to policyholders on policy balances. Revenues for
deferred annuity products consist of surrender charges and investment income on
assets allocated to support policyholder account balances. Expenses on
universal life and annuity policies include interest credited to policyholders
on policy balances as well as benefit claims incurred in excess of policy
account balances.
Farmers Re, a wholly owned subsidiary of the Company, reinsures a
percentage of the auto physical damage business written by the P&C Group.
Under a quota share reinsurance treaty, Farmers Re assumes monthly premiums of
$83.3 million and a quota share percentage of ultimate net losses sustained by
the P&C Group in its auto physical damage lines of business. This treaty also
provides for the P&C Group to receive a provisional ceding commission of 20% of
premiums with additional experience commissions that depend on loss experience.
This experience commission arrangement limits Farmers Re's potential
underwriting gain on the assumed business to 2.5% of premiums assumed.
Three Months Ended September 30, 1999 Compared to Three Months Ended September
30, 1998
Management Services to Property and Casualty Insurance Companies; and Other
Operating Revenues. Operating revenues increased from $343.9 million for
the three months ended September 30, 1998 to $375.2 million for the three
months ended September 30, 1999, an increase of $31.3 million, or 9.1%.
Operating revenues primarily consist of management fees paid to the Company as
a percentage of gross premiums earned by the P&C Group. Such premiums
increased from $2,609.2 million in the third quarter of 1998 to $2,704.0
million in the third quarter of 1999 due primarily to the P&C Group assuming
personal lines business from MCC. Management fees earned on this assumed
business totaled $12.7 million for the third quarter of 1999. In addition,
management fees increased approximately $6.6 million between the three month
periods ended September 30, 1999 and September 30, 1998 due to the fact that
the management fee rates on all lines of business were increased 0.25%
effective January 1999. The Company is entitled to receive a management fee of
up to 20% (25% in the case of Fire Insurance Exchange) of the gross premiums
earned by the P&C Group. Through September 30, 1999, the average management
fee rate was 12.2%.
20
Operating Expenses. Operating expenses as a percentage of operating
revenues decreased from 66.6% in the third quarter of 1998 to 55.3% in the
third quarter of 1999, a decrease of 11.3 percentage points. This decrease is
due to the fact that $45.8 million of impaired assets were written-off in the
third quarter of 1998.
Salaries and Employee Benefits. Salaries and employee benefits
expense increased from $79.4 million for the three months ended September
30, 1998 to $96.1 million for the three months ended September 30, 1999,
an increase of $16.7 million, or 21.0%, due in large part to expenses
incurred in connection with providing management services to the personal
lines business previously managed by MCC.
Buildings and Equipment Expenses. Buildings and equipment expenses
decreased from $70.2 million for the three months ended September 30, 1998
to $24.1 million for the three months ended September 30, 1999, a decrease
of $46.1 million, or 65.7%. In 1998, $43.4 million of capitalized
software costs that were no longer deemed recoverable were written-off.
Exclusive of this write-off, buildings and equipment expenses were $2.7
million lower between periods due primarily to lower information
technology systems software amortization expense in 1999. This decrease
in expense was offset in part by $2.3 million of expenses incurred in
connection with providing management services to the personal lines
business previously managed by MCC.
Amortization of Attorney-In-Fact Contracts and Goodwill. Purchase
accounting entries related to the acquisition of the Company by B.A.T in
December 1988 include goodwill (capitalized at $2.4 billion) and the value
of the AIF 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 September 30, 1999 and
September 30, 1998.
General and Administrative Expenses. General and administrative
expenses increased from $53.9 million for the three months ended September
30, 1998 to $61.7 million for the three months ended September 30, 1999,
an increase of $7.8 million, or 14.5%. This increase is due substantially
to $5.5 million of expenses incurred in connection with providing
management services to the personal lines business previously managed by
MCC.
Merger Related Expenses. Expenses incurred by the Company as a result of
the merger between B.A.T's Financial Services Businesses and Zurich amounted to
$20.5 million in the three month period ended September 30, 1998. There were
no merger related expenses in the three month period ended September 30, 1999.
Net Investment Income. Net investment income increased from $27.1 million
for the three months ended September 30, 1998 to $27.5 million for the three
months ended September 30, 1999, an increase of $0.4 million, or 1.5%, due
substantially to a higher invested asset base.
Net Realized Gains/(Losses). Net realized gains increased $29.4 million,
from a $0.6 million loss for the three months ended September 30, 1998 to a
$28.8 million gain for the three months ended September 30, 1999, due primarily
to gains recognized on sales of common stock.
Dividends on Preferred Securities of Subsidiary Trusts. Dividend expense
related to the $500.0 million of QUIPS issued in 1995 was $10.5 million for the
three months ended September 30, 1999 and September 30, 1998.
Provision for Income Taxes. Provision for income taxes increased from
$47.3 million for the three months ended September 30, 1998 to $89.1 million
for the three months ended September 30, 1999, an increase of $41.8 million, or
88.4%, due mainly to an increase in pretax income between periods.
Management Services Income. As a result of the foregoing, management
services income increased from $62.9 million for the three months ended
September 30, 1998 to $124.3 million for the three months ended September 30,
1999, an increase of $61.4 million, or 97.6%. Exclusive of the merger related
expenses and the write-off of impaired assets in 1998, management services
income increased $20.0 million, or 19.2%, between periods.
21
Insurance Subsidiaries
Farmers Re
Under the quota share reinsurance treaty, Farmers Re assumed $250.0
million of premiums in the three month period ended September 30, 1999 and
$250.1 million of premiums in the three month period ended September 30, 1998.
Losses and loss adjustment expenses incurred under this treaty were $166.1
million for the three months ended September 30, 1999 and $160.5 million for
the three months ended September 30, 1998 and non-life reinsurance commissions
were $77.7 million for the three months ended September 30, 1999 and $83.2
million for the three months ended September 30, 1998. Income before taxes
increased $3.3 million from $9.5 million for the three months ended September
30, 1998 to $12.8 million for the three months ended September 30, 1999 due
primarily to increased investment income as a result of a higher invested asset
base. For the three month periods ended September 30, 1999, and September 30,
1998, Farmers Re's contribution to net income was $9.0 million and $6.2
million, respectively.
Farmers Life
Total Revenues. Total revenues increased from $177.2 million for the
three months ended September 30, 1998 to $181.3 million for the three months
ended September 30, 1999, an increase of $4.1 million, or 2.3%.
Life and Annuity Premiums. Life premiums increased $6.5 million for
the three months ended September 30, 1999, or 14.4%, over the three
months ended September 30, 1998. This increase was due to growth in the
average volume of traditional life insurance in-force coupled with
Farmers Life entering the structured settlements with life contingencies
market in January 1999.
Life Policy Charges. Life policy charges increased $1.3 million for
the three months ended September 30, 1999, or 2.5%, over the three months
ended September 30, 1998, reflecting a growth in universal life-type
insurance in-force.
Investment Income. Net investment income decreased $0.7 million for
the three months ended September 30, 1999, or 0.9%, from the three months
ended September 30, 1998 as a result of lower bond interest income.
Net Realized Gains. Net realized gains decreased by $3.0 million,
from $3.4 million for the three months ended September 30, 1998 to $0.4
million for the three months ended September 30, 1999. This decrease was
due to lower gains realized on bond sales.
Total Operating Expenses. Total operating expenses increased from $118.1
million for the three months ended September 30, 1998 to $126.8 million for
the three months ended September 30, 1999, an increase of $8.7 million, or
7.4%.
Life Policyholders' Benefits and Charges. Life policyholders'
benefits and charges increased from $79.2 million for the three months
ended September 30, 1998 to $84.5 million for the three months ended
September 30, 1999, an increase of $5.3 million, or 6.7%.
Policy benefits. Policy benefits, which consist primarily of
death and surrender benefits on life products, decreased $2.5
million, from $35.0 million for the three months ended September 30,
1998 to $32.5 million for the three months ended September 30, 1999,
due to better mortality experience in the current period.
Increase in liability for future benefits. Increase in
liability for future benefits expense increased from $6.4 million
for the three months ended September 30, 1998 to $12.5 million for
the three months ended September 30, 1999. This increase was
primarily attributable to higher traditional life
22
insurance in-force volumes and the fact that Farmers Life entered the
structured settlements with life contingencies market.
Interest credited to policyholders. Interest credited to
policyholders, which represents the amount credited to policyholder
funds on deposit under universal life-type contracts and deferred
annuities, increased from $37.8 million for the three months ended
September 30, 1998 to $39.5 million for the three months ended
September 30, 1999, or 4.5%, reflecting the growth in the universal
life and annuity fund balances.
General Operating Expenses. General operating expenses increased
from $38.9 million for the three months ended September 30, 1998 to $42.3
million for the three months ended September 30, 1999, an increase of
$3.4 million, or 8.7%.
Amortization of DAC and Value of Life Business Acquired.
Amortization expense increased from $23.9 million for the three
months ended September 30, 1998 to $28.2 million for the three
months ended September 30, 1999 due to differences in the mix of
business in-force between periods.
Commissions. Commissions expense decreased from $4.7 million
for the three months ended September 30, 1998 to $2.5 million for the
three months ended September 30, 1999, or 46.8% due to higher
reinsurance activity.
General and Administrative Expenses. General and
administrative expenses increased from $10.3 million for the three
months ended September 30, 1998 to $11.6 million for the three
months ended September 30, 1999, or 12.6%, due to higher employee
benefit expenses and legal fees.
Provision for Income Taxes. Provision for income taxes decreased from
$20.6 million for the three months ended September 30, 1998 to $18.9 million
for the three months ended September 30, 1999, a decrease of $1.7 million, or
8.3%, due to a decrease in pretax operating income.
Farmers Life Income. As a result of the foregoing, Farmers Life income
decreased from $38.5 million for the three months ended September 30, 1998 to
$35.6 million for the three months ended September 30, 1999, a decrease of
$2.9 million, or 7.5%.
Consolidated Net Income
Consolidated net income of the Company increased from $107.6 million for
the three months ended September 30, 1998 to $168.9 million for the three
months ended September 30, 1999, an increase of $61.3 million, or 57.0%. This
increase was due primarily to the merger related expenses and the write-off of
impaired assets in September 1998. Exclusive of these two items, consolidated
net income increased $19.9 million, or 13.4%, between periods.
Nine Months Ended September 30, 1999 Compared to Nine Months Ended September
30, 1998
Management Services to Property and Casualty Insurance Companies; and Other
Operating Revenues. Operating revenues increased from $1,015.8 million
for the nine months ended September 30, 1998 to $1,116.3 million for the nine
months ended September 30, 1999, an increase of $100.5 million, or 9.9%. This
growth reflects higher gross premiums earned by the P&C Group, which increased
from $7,718.5 million in the first nine months of 1998 to $8,094.1 million in
the first nine months of 1999, primarily as a result of the P&C Group assuming
personal lines business from MCC. Management fees earned on this assumed
business totaled $37.9 million for the nine months ended September 30, 1999.
In addition, management fees increased approximately $19.7 million between
years due to the 0.25% increase in the management fee rates.
23
Operating Expenses. Operating expenses as a percentage of operating
revenues decreased from 58.9% for the nine months ended September 30, 1998 to
54.6% for the nine months ended September 30, 1999, a decrease of 4.3
percentage points. This decrease is due to the fact that $45.8 million of
impaired assets were written-off in the third quarter of 1998.
Salaries and Employee Benefits. Salaries and employee benefits
expense increased from $247.2 million for the nine months ended September
30, 1998 to $277.9 million for the nine months ended September 30, 1999,
an increase of $30.7 million, or 12.4%, due primarily to $24.1 million of
expenses incurred in connection with providing management services to the
personal lines business previously managed by MCC.
Buildings and Equipment Expenses. Buildings and equipment expenses
decreased from $122.9 million for the nine months ended September 30,
1998 to $71.3 million for the nine months ended September 30, 1999, a
decrease of $51.6 million, or 42.0%. This decrease was due in large part
to the $43.4 million write-off of capitalized software costs in 1998.
Exclusive of this write-off, buildings and equipment expenses were $8.2
million lower between periods due primarily to lower information
technology systems software amortization expense in 1999. These decreases
in expense were offset in part by $5.5 million of expenses incurred in
connection with providing management services to the personal lines
business previously managed by MCC.
Amortization of Attorney-In-Fact Contracts and Goodwill.
Amortization expense was $77.1 million in each of the nine month periods
ended September 30, 1999 and September 30, 1998.
General and Administrative Expenses. General and administrative
expenses increased from $151.3 million for the nine months ended
September 30, 1998 to $183.5 million for the nine months ended September
30, 1999, an increase of $32.2 million, or 21.3%. This increase is due
substantially to $14.7 million of expenses incurred in connection with
providing management services to the personal lines business previously
managed by MCC and a $4.5 million increase in expenses resulting from
outsourcing the Company's investment portfolios in July 1998. The
remaining increase is primarily due to higher business levels.
Merger Related Expenses. Expenses incurred by the Company as a result
of the merger between B.A.T's Financial Services Businesses and Zurich
decreased from $20.5 million for the nine months ended September 30, 1998 to
$0.2 million for the nine months ended September 30, 1999.
Net Investment Income. Net investment income decreased from $104.0
million for the nine months ended September 30, 1998 to $84.9 million for the
nine months ended September 30, 1999, a decrease of $19.1 million, or 18.4%,
due substantially to lower investment yields.
Net Realized Gains. Net realized gains increased from $18.0 million for
the nine months ended September 30, 1998 to $62.7 million for the nine months
ended September 30, 1999, an increase of $44.7 million, due primarily to gains
recognized on sales of common stock.
Dividends on Preferred Securities of Subsidiary Trusts. Dividend expense
was $31.6 million in each of the nine month periods ended September 30, 1999
and September 30, 1998.
Provision for Income Taxes. Provision for income taxes increased from
$198.4 million for the nine months ended September 30, 1998 to $255.8 million
for the nine months ended September 30, 1999, an increase of $57.4 million, or
28.9%, due mainly to an increase in pretax operating income between periods.
Management Services Income. As a result of the foregoing, management
services income increased from $288.8 million for the nine months ended
September 30, 1998 to $366.5 million for the nine months ended September 30,
1999, an increase of $77.7 million, or 26.9%. Exclusive of the merger related
expenses and the write-off of impaired assets in 1998, management services
income increased $36.4 million, or 11.0%, between periods.
24
Insurance Subsidiaries
Farmers Re
Under the quota share reinsurance treaty, Farmers Re assumed $750.0
million of premiums in the nine month period ended September 30, 1999 and
$750.1 million of premiums in the nine month period ended September 30, 1998.
Losses and loss adjustment expenses incurred under this treaty were $494.8
million for the nine months ended September 30, 1999 and $491.3 million for
the nine months ended September 30, 1998 and non-life reinsurance commissions
were $236.5 million for the nine months ended September 30, 1999 and $240.0
million for the nine months ended September 30, 1998. Income before taxes
increased from $25.7 million for the nine months ended September 30, 1998 to
$39.4 million for the nine months ended September 30, 1999, an increase of
$13.7 million, or 53.3%, due primarily to increased investment income as a
result of a higher invested asset base. Farmers Re's contribution to net
income was $28.0 million for the nine month period ended September 30, 1999
and $16.7 million for the nine month period ended September 30, 1998.
Farmers Life
Total Revenues. Total revenues increased from $513.8 million for the
nine months ended September 30, 1998 to $552.8 million for the nine months
ended September 30, 1999, an increase of $39.0 million, or 7.6%.
Life and Annuity Premiums. Life premiums increased $26.2 million
for the nine months ended September 30, 1999, or 20.3%, over the nine
months ended September 30, 1998. This increase was due to a 14.3% growth
in the average volume of traditional insurance in-force coupled with
Farmers Life entering the structured settlements with life contingencies
market in January 1999.
Life Policy Charges. Life policy charges increased $3.0 million for
the nine months ended September 30, 1999, or 1.9%, over the nine months
ended September 30, 1998, reflecting a 2.2% growth in universal life-type
insurance in-force.
Investment Income. Net investment income increased $7.5 million for
the nine months ended September 30, 1999, or 3.4%, over the nine months
ended September 30, 1998. The increase was due to higher bond interest
income as a result of a higher invested asset base.
Net Realized Gains. Net realized gains increased by $2.3 million,
from $9.9 million for the nine months ended September 30, 1998 to $12.2
million for the nine months ended September 30, 1999. This increase was
due to higher gains realized on bond sales.
Total Operating Expenses. Total operating expenses increased from $342.0
million for the nine months ended September 30, 1998 to $380.8 million for the
nine months ended September 30, 1999, an increase of $38.8 million, or 11.3%.
Life Policyholders' Benefits and Charges. Life policyholders'
benefits expense and charges increased from $228.3 million for the nine
months ended September 30, 1998 to $258.6 million for the nine months
ended September 30, 1999, an increase of $30.3 million, or 13.3%.
Policy benefits. Policy benefits increased $3.6 million for
the nine months ended September 30, 1999 to $102.8 million due to a
6.6% growth in the volume of total life insurance in-force and an
increase in death benefits per thousand of volume of insurance
in-force.
Increase in liability for future benefits. Increase in
liability for future benefits expense increased from $16.7 million
for the nine months ended September 30, 1998 to $38.3 million for
the nine months ended September 30, 1999. This increase was
primarily attributable to higher volumes of traditional life
insurance in-force, particularly whole life, and the fact that
Farmers Life entered the structured settlements with life
contingencies market.
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Interest credited to policyholders. Interest credited to
policyholders increased from $112.4 million for the nine months
ended September 30, 1998 to $117.5 million for the nine months ended
September 30, 1999, or 4.5%, reflecting the growth in the universal
life and annuity fund balances.
General Operating Expenses. General operating expenses increased
from $113.7 million for the nine months ended September 30, 1998 to
$122.2 million for the nine months ended September 30, 1999, an increase
of $8.5 million, or 7.5%.
Amortization of DAC and Value of Life Business Acquired.
Amortization expense increased from $67.8 million for the nine
months ended September 30, 1998 to $78.2 million for the nine months
ended September 30, 1999 due to differences in the mix of business
in-force between periods.
In addition, adjustments were made to the fixed universal
product DAC asset and the VOLBA asset. DAC amortization expense was
reduced $23.3 million due to favorable persistency experience on the
fixed universal life business. This reduction in expense was
largely offset by a $21.3 million increase in VOLBA amortization
expense resulting from unfavorable persistency experience on the
pre-1988 business. The net impact of these adjustments was a $2.0
million reduction in amortization expense, which is reflected in the
$78.2 million mentioned above.
Commissions. Commissions expense decreased $2.3 million
between years, from $14.1 million for the nine months ended
September 30, 1998 to $11.8 million for the nine months ended
September 30, 1999 due to higher reinsurance activity.
General and Administrative Expenses. General and
administrative expenses increased from $31.8 million for the nine
months ended September 30, 1998 to $32.2 million for the nine months
ended September 30, 1999, or 1.3%.
Provision for Income Taxes. Provision for income taxes decreased from
$61.2 million for the nine months ended September 30, 1998 to $59.9 million
for the nine months ended September 30, 1999.
Farmers Life Income. As a result of the foregoing, Farmers Life income
increased from $110.6 million for the nine months ended September 30, 1998 to
$112.1 million for the nine months ended September 30, 1999, an increase of
$1.5 million, or 1.4%.
Consolidated Net Income
Consolidated net income of the Company increased from $416.1 million for
the nine months ended September 30, 1998 to $506.6 million for the nine months
ended September 30, 1999, an increase of $90.5 million, or 21.7%. This
increase was due in large part to the merger related expenses and the write-off
of impaired assets in September 1998. Exclusive of these two items,
consolidated net income increased $49.2 million, or 10.8%, between periods.
Year 2000 Issue
In 1995, the Company initiated a Year 2000 Project in order to prepare
for the information processing problems presented by the approach of the new
millennium. Significant efforts have been expended to gain a complete
understanding of Year 2000 implications and to develop a strategy to make the
Company's and the P&C Group's systems Year 2000 compliant. As of September 30,
1999, the Company has completed its remediation plans related to the Year 2000
Project. Although these plans have been completed, the Company continues to
monitor its preparedness for unforeseen Year 2000 issues that may impact its
operations. The costs associated with the Year 2000 Project have been expensed
as incurred, and, through September 30, 1999, the cumulative costs totaled
$23.0 million, of which $5.4 million was allocated to the P&C Group. Total
costs of the project are expected to be approximately $23.3 million, of which
approximately $5.5 million is expected to be allocated to the P&C Group.
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To remedy the Year 2000 issue, management devised a three-phase plan:
Phase I - "Awareness and Initial Impact Assessment". This phase was
completed in May 1996. During this phase, Year 2000 "Impact Assessment" was
performed using a mainframe analysis tool to determine which areas were at
risk.
Phase II - "Year 2000 Workpackage and Development Blueprint Project".
This phase was completed in November 1996 and consisted of creating a
comprehensive master plan which included establishing and prioritizing
clusters (groups of similar computer programs) and agreeing upon a definition
of what would be acceptable Year 2000 compliance. In addition, a timeframe
was established for the conversion, compliance testing and the implementation
of Year 2000 compliant programs into production.
Phase III - "Year 2000 Conversion and Implementation". This phase was
completed in July 1999. During this phase, the processes of converting,
implementing and testing these Year 2000 conversion programs were performed.
In addition, the Company evaluated its relationships with third parties
with which the Company has a direct and material relationship to determine
whether they are Year 2000 compliant. The Company sent out questionnaires and
warranty requests to all third party vendors and performed compliance testing
with all vendors to validate the vendors' claims regarding Year 2000
compliance. All compliance testing related to third party relationships has
been completed. However, it is not possible to state with certainty that the
operations of third parties will not be materially impacted in turn by other
parties with whom they themselves have a relationship.
The Year 2000 issue may not only affect the Company's information
technology ("IT") systems but also its non-IT systems. The Company has
assessed the readiness of its non-IT systems and, in the event of an
interruption of these systems, contingency plans have been established such
that no major disruptions will occur.
The Company's Year 2000 contingency plans were completed in June 1999.
These plans, which were tested across the enterprise in September of this year,
include contingency measures which will be followed in the event that certain
key vendors experience difficulties related to the Year 2000 issue. If new
information surfaces, the contingency plans will be reviewed to determine
whether they are adequate or if they need to be further enhanced. The
operations of the Company and the P&C Group are such that in the event all
electronic communications are down, the Company and the P&C Group could
continue to operate until an alternative communication source is acquired.
Liquidity and Capital Resources
As of September 30, 1999 and September 30, 1998, the Company held cash
and cash equivalents of $158.1 million and $338.7 million, respectively. In
addition, as of September 30, 1999, 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 $809.1 million
for the nine months ended September 30, 1998 to $634.7 million for the nine
months ended September 30, 1999, a decrease of $174.4 million, or 21.6%. This
decrease in cash was due to a $170.3 million decrease resulting from changes
in assets and liabilities and a $3.9 million decrease in the provision for
non-life losses and loss adjustment expenses in 1999 versus a $105.3 million
increase in the reserve in 1998. Partially offsetting these decreases in cash
was a $90.5 million increase in consolidated net income.
Net cash used in investing activities decreased from $721.8 million for
the nine months ended September 30, 1998 to $524.7 million for the nine months
ended September 30, 1999, an increase in cash of $197.1 million, or 27.3%.
This increase in cash is the result of the issuance of the $1,057.0 million
BAFS notes receivable and the $119.0 million surplus note in 1998 coupled with
a $626.3 million increase in proceeds received from sales and
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maturities of investments available-for-sale in 1999. Partially offsetting
these increases was the proceeds from the redemption of the $650.0 million
Exchange certificates of contribution and the $407.0 million B.A.T notes
receivable in 1998 coupled with a $364.9 million increase in purchases of
investments available-for-sale and the issuance of the $190.0 million loan to
Centre Reinsurance Holdings (Delaware II) Ltd. in 1999 (see Note E).
Net cash used in financing activities increased from $264.8 million for
the nine months ended September 30, 1998 to $279.5 million for the nine months
ended September 30, 1999, resulting in a decrease in cash of $14.7 million, or
5.6%, due to a $48.8 million increase in dividends paid to stockholders. This
decrease in cash was offset in part by higher cash flows from annuity
contracts in 1999.
ITEM 3. Quantitative and Qualitative Disclosures about Market Risks
The market risks associated with the Company's investment portfolios have
not changed materially from those disclosed at year-end 1998.
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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 - Incorporated by reference to the
corresponding Exhibit to FGI's Quarterly Report on
Form 10-Q for the quarterly period ended March 31, 1999.
(b) Reports on Form 8-K. None.
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FARMERS GROUP, INC.
AND SUBSIDIARIES
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of
1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned thereunto duly authorized.
Farmers Group, Inc.
(Registrant)
November 9, 1999 /s/ Martin D. Feinstein
---------------------------------------------
Date Martin D. Feinstein
Chairman of the Board,
President and Chief Executive Officer
November 9, 1999 /s/ Gerald E. Faulwell
---------------------------------------------
Date Gerald E. Faulwell
Senior Vice President and
Chief Financial Officer