<PAGE> 1
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
- --------------------------------------------------------------------------
FORM 10-Q
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Quarterly Period Ended March 31, 1998
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
-------------------------------------
Commission File Number 33-94670-01
-------------------------------------
FARMERS GROUP, INC.
(Exact name of registrant as specified in its charter)
NEVADA
(State or other jurisdiction of
incorporation or organization)
95-0725935
(IRS Employer Identification No.)
4680 WILSHIRE BOULEVARD, LOS ANGELES, CALIFORNIA 90010
(Address of principal executive offices)(Zip Code)
(213) 932-3200
(Registrants telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has
been subject to such filing requirements for the past 90 days.
Yes /X/ No / /
Registrant's Common Stock outstanding on March 31, 1998 was 1,000 shares.
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FARMERS GROUP, INC.
AND SUBSIDIARIES
TABLE OF CONTENTS FORM 10-Q
FOR THE PERIOD ENDED MARCH 31, 1998
PART I. FINANCIAL INFORMATION PAGE
----
ITEM 1. Financial Statements
Consolidated Balance Sheets - Assets
March 31, 1998 and December 31, 1997 4
Consolidated Balance Sheets - Liabilities and Stockholder's
Equity
March 31, 1998 and December 31, 1997 5
Consolidated Statements of Income
Three Month Periods ended March 31, 1998 and
March 31, 1997 6
Consolidated Statements of Comprehensive Income
Three Month Periods ended March 31, 1998 and
March 31, 1997 7
Consolidated Statement of Stockholder's Equity
Three Month Period ended March 31, 1998 8
Consolidated Statement of Stockholder's Equity
Three Month Period ended March 31, 1997 9
Consolidated Statements of Cash Flows
Three Month Periods ended March 31, 1998 and
March 31, 1997 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 21
SIGNATURES 22
<PAGE> 4
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
FARMERS GROUP, INC.
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands)
(Unaudited)
ASSETS
<TABLE>
<CAPTION>
March 31, December 31,
1998 1997
------------- ------------
<S> <C> <C>
Current assets, excluding insurance subsidiaries:
Cash and cash equivalents $ 268,935 $ 506,273
Marketable securities, at market value 69,031 78,147
Accrued interest 36,265 43,849
Accounts receivable, principally from the P&C Group 37,671 34,804
Notes receivable - affiliate 137,000 137,000
Deferred taxes 28,695 28,925
Prepaid expenses and other 24,515 13,725
------------- ------------
Total current assets 602,112 842,723
------------- ------------
Investments, excluding insurance subsidiaries:
Fixed maturities available-for-sale, at market value
(cost: $646,752 and $482,355) 651,344 488,245
Mortgage loans on real estate 230 240
Common stocks available-for-sale, at market value
(cost: $329,521 and $322,741) 437,113 388,966
Certificates in surplus of Exchanges 684,380 684,380
Real estate, at cost (net of accumulated depreciation:
$25,456 and $29,212) 59,835 63,512
Joint ventures, at equity 4,825 4,825
------------- ------------
1,837,727 1,630,168
------------- ------------
Other assets, excluding insurance subsidiaries:
Notes receivable - affiliate 270,000 270,000
Goodwill (net of accumulated amortization:
$555,407 and $540,396) 1,846,348 1,861,359
Attorney-in-fact contracts (net of accumulated amortization:
$395,215 and $384,534) 1,313,828 1,324,509
Securities lending collateral 51,090 49,908
Other assets 297,295 297,602
------------- ------------
3,778,561 3,803,378
------------- ------------
Properties, plant and equipment, at cost: (net of accumulated
depreciation: $254,332 and $242,392) 442,622 450,880
------------- ------------
Investments of insurance subsidiaries:
Fixed maturities available-for-sale, at market value
(cost: $3,533,269 and $3,408,426) 3,676,632 3,555,148
Mortgage loans on real estate 85,340 89,903
Non-redeemable preferred stocks available-for-sale, at market
value (cost: $1,153 and $1,153) 1,284 1,227
Common stocks available-for-sale, at market value
(cost: $0 and $0) 0 120
Policy loans 170,753 165,894
Real estate, at cost (net of accumulated depreciation:
$19,906 and $19,306) 68,945 69,265
Joint ventures, at equity 9,594 9,515
Other investments, at market value (cost: $4.886 and $3,450) 6,347 3,299
------------- ------------
4,018,895 3,894,371
------------- ------------
Other assets of insurance subsidiaries:
Cash and cash equivalents 154,215 9,980
Marketable securities, at market value 14,239 50,069
Accounts receivable - P&C Group 106,738 0
Accrued investment income 53,684 52,017
Deferred taxes 616 0
Deferred policy acquisition costs and value of life business
acquired 798,219 798,725
Securities lending collateral 501,488 544,580
Other assets 26,099 40,542
------------- ------------
1,655,298 1,495,913
------------- ------------
Total assets $ 12,335,215 $ 12,117,433
============= ============
The accompanying notes are an integral part of these interim financial statements.
</TABLE>
<PAGE> 5
FARMERS GROUP, INC.
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands)
(Unaudited)
LIABILITIES AND STOCKHOLDER'S EQUITY
<TABLE>
<CAPTION>
March 31, December 31,
1998 1997
------------- ------------
<S> <C> <C>
Current liabilities, excluding insurance subsidiaries:
Notes and accounts payable:
P&C Group $ 166 $ 2,478
Other 32,755 28,204
Accrued liabilities:
Profit sharing 12,608 51,067
Income taxes 122,286 82,279
Other 7,037 12,245
------------ ------------
Total current liabilities 174,852 176,273
------------ ------------
Other liabilities, excluding insurance subsidiaries:
Real estate mortgages payable 92 92
Non-current deferred taxes 649,606 643,910
Securities lending liability 51,090 49,908
Other 136,667 131,056
------------ ------------
837,455 824,966
------------ ------------
Liabilities of insurance subsidiaries:
Policy liabilities:
Future policy benefits 3,043,971 3,010,162
Claims 23,495 22,156
Other policyholder funds 59,842 60,072
Provision for non-life losses and loss adjustment expenses 100,622 0
Income taxes (including deferred taxes: $148,951 and $153,006) 169,946 148,868
Unearned investment income 1,053 1,016
Securities lending liability 501,488 544,580
Other liabilities 51,898 47,766
------------ ------------
3,952,315 3,834,620
------------ ------------
Total liabilities 4,964,622 4,835,859
------------ ------------
Commitments and contingencies
Company obligated mandatorily redeemable preferred
securities of subsidiary trusts holding solely junior
subordinated debentures 500,000 500,000
------------ ------------
Stockholder's Equity:
Common stock, $1 par value per share; authorized, issued
and outstanding: as of March 31, 1998 and
December 31, 1997--1,000 shares 1 1
Additional capital 5,212,618 5,212,618
Accumulated other comprehensive income (net of deferred
taxes: of $73,620 and $61,193) 136,656 113,549
Retained earnings 1,521,318 1,455,406
------------ ------------
Total stockholder's equity 6,870,593 6,781,574
------------ ------------
Total liabilities and stockholder's equity $ 12,335,215 $ 12,117,433
============ ============
The accompanying notes are an integral part of these interim financial statements.
</TABLE>
<PAGE> 6
FARMERS GROUP, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Amounts in thousands)
(Unaudited)
<TABLE>
<CAPTION>
Three month period
ended March 31,
------------------------
1998 1997
----------- -----------
<S> <C> <C>
Consolidated operating revenues $ 753,148 $ 514,946
=========== ===========
Management services to property and casualty
insurance companies; and other:
Operating revenues $ 335,539 $ 320,852
Operating expenses 183,649 180,389
----------- ----------
Operating income 151,890 140,463
Net investment income 39,800 34,255
Net realized gains 9,813 30,435
Dividends on preferred securities of subsidiary trusts (10,518) (10,518)
----------- ----------
Income before provision for taxes 190,985 194,635
Provision for income taxes 76,826 96,692
----------- ----------
Management services income 114,159 97,943
----------- ----------
Insurance subsidiaries:
Life premiums 41,092 44,959
Non-life reinsurance premiums 250,000 0
Life policy charges 51,419 63,187
Investment income, net of expenses 71,498 81,056
Net realized gains 3,600 4,892
----------- -----------
Total revenues 417,609 194,094
----------- -----------
Non-life losses and loss adjustment expenses 176,623 0
Life policyholders' benefits and charges 72,626 84,203
Non-life reinsurance commissions 67,127 0
General operating expenses 37,028 54,532
----------- -----------
Total operating expenses 353,404 138,735
----------- -----------
Income before provision for taxes 64,205 55,359
Provision for income taxes 23,652 18,265
----------- -----------
Insurance subsidiaries income 40,553 37,094
----------- -----------
Consolidated net income $ 154,712 $ 135,037
=========== ===========
The accompanying notes are an integral part of these interim financial statements.
</TABLE>
<PAGE> 7
FARMERS GROUP, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF
COMPREHENSIVE INCOME
(Amounts in thousands)
(Unaudited)
<TABLE>
<CAPTION>
Three month period
ended March 31,
------------------------
1998 1997
----------- -----------
<S> <C> <C>
Consolidated net income $ 154,712 $ 135,037
=========== ===========
Other comprehensive income, net of tax:
Unrealized holding gains/(losses) on securities:
Unrealized holding gains arising during the period,
net of tax of $12,350 $ 22,963 $
Less: reclassification adjustment for losses
included in net income, net of tax of $772 1,434
----------- -----------
Net unrealized holding gains/(losses) on securities,
net of tax of $13,122 and ($39,716) 24,397 (73,712)
Change in effect of unrealized gains/(losses) on other
insurance accounts, net of tax of ($695) and
$8,968 (1,290) 16,656
----------- -----------
Other comprehensive income 23,107 (57,056)
----------- -----------
Comprehensive income $ 177,819 $ 77,981
=========== ===========
The accompanying notes are an integral part of these interim financial statements.
</TABLE>
<PAGE> 8
FARMERS GROUP, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDER'S EQUITY
For the three month period ended March 31, 1998
(Amounts in thousands)
(Unaudited)
<TABLE>
<CAPTION>
Accumulated Other Total
Common Additional Comprehensive Retained Stockholder's
Stock Capital Income Earnings Equity
-------- ----------- ----------------- ------------ ------------
<S> <C> <C> <C> <C> <C>
Balance, December 31, 1997 $ 1 $ 5,212,618 $ 113,549 $1,455,406 $ 6,781,574
Net income 154,712 154,712
Unrealized holding gains
arising during the period,
net of tax of $12,350 22,963 22,963
Reclassification adjustment
for losses included in net
income, net of tax of $772 1,434 1,434
Change in effect of unrealized
losses on other insurance
accounts, net of tax of ($695) (1,290) (1,290)
Cash dividends paid (88,800) (88,800)
-------- ----------- ---------------- ---------- -------------
Balance, March 31, 1998 $ 1 $ 5,212,618 $ 136,656 $1,521,318 $ 6,870,593
======== =========== ================ ========== =============
The accompanying notes are an integral part of these interim financial statements.
</TABLE>
<PAGE> 9
FARMERS GROUP, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDER'S EQUITY
For the three month period ended March 31, 1997
(Amounts in thousands)
(Unaudited)
<TABLE>
<CAPTION>
Accumulated Other Total
Common Additional Comprehensive Retained Stockholder's
Stock Capital Income Earnings Equity
-------- ------------ ----------------- ---------- -------------
<S> <C> <C> <C> <C> <C>
Balance, December 31, 1996 $ 1 $ 5,212,618 $ 92,104 $ 1,199,108 $ 6,503,831
Net income 135,037 135,037
Change in other comprehensive
income, net of tax of
($30,748) (57,056) (57,056)
Cash dividends paid (84,300) (84,300)
-------- ------------ --------------- ---------- ------------
Balance, March 31, 1997 $ 1 $ 5,212,618 $ 35,048 $1,249,845 $ 6,497,512
======== ============ =============== ========== ============
The accompanying notes are an integral part of these interim financial statements.
</TABLE>
<PAGE> 10
FARMERS GROUP, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in thousands)
(Unaudited)
<TABLE>
<CAPTION>
Three month period
ended March 31,
-----------------------
1998 1997
---------- ----------
<S> <C> <C>
Cash Flows from Operating Activities:
Consolidated net income $ 154,712 $ 135,037
Non-cash and operating activities adjustments:
Depreciation and amortization 46,774 42,626
Amortization of deferred policy acquisition costs and
value of life business acquired 21,560 32,626
Policy acquisition costs deferred (23,039) (29,124)
Life insurance policy liabilities 6,126 4,878
Provision for non-life losses and loss adjustment expenses 100,622 0
Universal life type contracts:
Deposits received 74,932 73,941
Withdrawals (60,003) (58,953)
Interest credited 16,359 15,015
Equity in earnings of joint ventures (576) (808)
Gain on sales of assets (13,025) (35,518)
Changes in assets and liabilities:
Current assets and liabilities (86,371) 38,357
Non-current assets and liabilities 20,205 4,906
Other, net (11,363) (3,080)
---------- -----------
Net cash provided by operating activities 246,913 219,903
---------- -----------
Cash Flows from Investing Activities:
Purchases of investments available-for-sale (432,169) (363,284)
Purchases of properties (14,367) (14,311)
Proceeds from sales and maturities of investments
available-for-sale 178,499 261,104
Proceeds from sales of properties 6,371 2,608
Mortgage loan collections 3,801 4,324
Increase in policy loans (4,859) (3,915)
Other, net 14,004 (2,245)
----------- ------------
Net cash used in investing activities (248,720) (115,719)
----------- ------------
Cash Flows from Financing Activities:
Dividends paid to stockholder (88,800) (84,300)
Annuity contracts:
Deposits received 29,758 26,970
Withdrawals (53,598) (38,281)
Interest credited 21,344 19,647
---------- -----------
Net cash used in financing activities (91,296) (75,964)
---------- -----------
Increase/(decrease) in cash and cash equivalents (93,103) 28,220
Cash and cash equivalents - at beginning of year 516,253 499,328
---------- -----------
Cash and cash equivalents - at end of period $ 423,150 $ 527,548
========== ===========
The accompanying notes are an integral part of these interim financial statements.
</TABLE>
<PAGE> 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.
("FGI") and its subsidiaries (together, the "Company") as of March 31, 1998,
the related consolidated statements of income, comprehensive income,
stockholder's equity and cash flows for the three month periods ended March
31, 1998 and March 31, 1997, 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, 1997
and 1996, 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, 1997.
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
1998 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.
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 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 earned
premiums.
Prior to April 15, 1997, the Company's life insurance operations were
conducted by three wholly owned life insurance subsidiaries: Farmers New
World Life Insurance Company ("Farmers Life"), The Ohio State Life Insurance
Company ("OSL") and Investors Guaranty Life Insurance Company ("IGL"). On
April 15, 1997, FGI 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 three month period ended March 31, 1997 was $4,826,000,
and the combined net assets of these subsidiaries as of March 31, 1997 was
$334,242,000.
In December 1997, Farmers Reinsurance Company ("Farmers Re"), a property
and casualty insurance subsidiary of FGI, was formed and licensed to conduct
business. In January 1998, Farmers Re entered into a quota share reinsurance
treaty with Farmers Insurance
<PAGE> 12
Exchange under which it reinsures a percentage of the auto physical damage
business written by the P&C Group.
As a result of the foregoing, references to the "Insurance Subsidiaries"
within the 1998 financial statements are to Farmers Life and Farmers
Re, whereas, references to the "Insurance Subsidiaries" within the 1997
statement of income, comprehensive income and cash flows are to Farmers
Life, OSL and IGL.
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.
On December 22, 1997, a definitive agreement was reached to merge B.A.T
Industries' Financial Services Businesses ("BAFS") and FGI with Zurich
Insurance Company ("Zurich"). Completion of the merger is subject to
regulatory consents, tax clearances and the approval of the shareholders of
B.A.T and Zurich, and is expected to be finalized in late 1998. Under the
agreement, the businesses of Zurich, BAFS and FGI will be transferred to
Zurich Financial Services, a new Swiss company with headquarters in Zurich.
In February 1997, the Financial Accounting Standards Board ("FASB")
released Statement of Financial Accounting Standards ("SFAS") No. 128,
"Earnings per Share". This Statement, effective for financial statements
issued for periods ending after December 15, 1997, established 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 1998, the Company adopted SFAS No. 129, "Disclosure of Information
about Capital Structure". This Statement, effective for financial statements
issued for periods ending after December 15, 1997, established standards for
disclosing information about an entity's capital structure. This Statement
eliminated the exemption of nonpublic entities from certain disclosure
requirements of Accounting Principles Board Opinion No. 15, "Earnings Per
Share", as provided by SFAS No. 21, "Suspension of the Reporting of Earnings
per Share and Segment Information by Nonpublic Enterprises". The adoption of
this Statement did not have a material impact on the Company's consolidated
financial statements.
In 1998, the Company adopted SFAS No. 130, "Reporting Comprehensive
Income". This Statement, effective for fiscal periods beginning after
December 15, 1997, established standards for reporting and displaying
comprehensive income and its components. This Statement mandated 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. As a result of adopting
this Statement, the components of comprehensive income are now stated in the
consolidated statements of comprehensive income. The adoption of this
Statement did not have a material impact on the Company's consolidated
financial statements.
<PAGE> 13
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, established standards for reporting information about
operating segments in annual financial statements and required the reporting
of selected information about operating segments in interim financial reports
issued to shareholders. It also established standards for related disclosures
about products and services, geographic areas, and major customers. This
Statement superseded FASB Statement No. 14, "Financial Reporting for Segments
of a Business Enterprise" and amended FASB Statement No. 94, "Consolidation of
All Majority-Owned Subsidiaries". As this Statement need not be applied to
the interim financial statements in the initial year of its application, the
Company will adopt SFAS No. 131 beginning with its December 31, 1998 annual
financial statements. The Company does not expect the adoption of this
Statement to have a material impact on its consolidated financial statements.
In March 1998, the American Institute of Certified Public Accountants
issued Statement of Position ("SOP") No. 98-1, "Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use". This SOP,
effective for financial statements issued for periods beginning after December
15, 1998, applies to all nongovernmental entities and establishes the rules
for capitalizing or expensing internally used software. The Company does not
expect the adoption of this Statement 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.
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
<PAGE> 14
Subordinated Debentures) which considered together constitute a full and
unconditional guarantee by Farmers Group, Inc. of the Subsidiary
Trusts' obligations under the Preferred Securities.
Under certain circumstances, the Junior Subordinated Debentures may be
distributed to holders of the QUIPS and holders of the Common Securities in
liquidation of the Subsidiary Trusts. The QUIPS are subject to mandatory
redemption upon repayment of the Junior Subordinated Debentures at maturity,
or upon their earlier redemption, at a redemption price of $25 per Preferred
Security, plus accrued and unpaid distributions thereon to the date fixed for
redemption. Farmers Group, Inc. will have the option at any time on or after
September 27, 2000 to redeem, in whole or part, the Junior Subordinated
Debentures.
As of March 31, 1998 and 1997, 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 to the P&C Group. As a result, the Company received
management fees from the P&C Group of $314,287,000 and $300,574,000 for the
three month periods ended March 31, 1998 and March 31, 1997, respectively.
E. Related parties
As of March 31, 1998, 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:
$137,000,000 in October 1998, $135,000,000 in October 1999, and $135,000,000
in October 2000. Interest on these notes is paid semi-annually at coupon
rates of 5.35%, 6.68%, and 6.33%, respectively. On October 7, 1997, a four
year $135,000,000 note with an interest rate of 5.10% matured and the
$135,000,000 note maturing in October 2000 was subsequently issued at an
interest rate of 6.33%. Income earned on the notes outstanding for the three
month periods ended March 31, 1998 and March 31,1997 was $6,223,000 and
$5,808,000, respectively.
F. Supplemental cash flow information
For financial statement purposes, the Company considers all investments
with original maturities of 90 days or less as cash equivalents. Following is
a reconciliation of the individual balance sheet cash and cash equivalent
totals to the consolidated cash flow total:
<TABLE>
<CAPTION>
Excluding
Insurance Insurance
Subsidiaries Subsidiaries Consolidated
------------ ------------ ------------
(Amounts in thousands)
<S> <C> <C> <C>
Cash and cash equivalents -- December 31, 1996 $ 412,018 $ 87,310 $ 499,328
Activity through March 1997 28,220
---------
Cash and cash equivalents -- March 31, 1997 401,479 126,069 $ 527,548
=========
Cash and cash equivalents -- December 31, 1997 506,273 9,980 $ 516,253
Activity through March 1998 (93,103)
---------
Cash and cash equivalents -- March 31, 1998 268,935 154,215 $ 423,150
=========
</TABLE>
<PAGE> 15
Cash payments for interest were $1,179,000 and $1,375,000 for the three
month periods ended March 31, 1998 and March 31, 1997, respectively, while the
cash payment for dividends to the holders of the Company's QUIPS was
$10,518,000 for both three month periods ended March 31, 1998 and March 31,
1997. Cash payments for income taxes were $46,794,000 and $34,516,000 for the
three month periods ended March 31, 1998 and March 31, 1997, respectively.
<PAGE> 16
ITEM 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
General
The Company's principal activities are providing management services to
the property and casualty insurance companies, underwriting of life insurance
and annuity products, and providing reinsurance coverage to the P&C Group.
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 Farmers Life and Farmers Re are required to use
for regulatory reporting purposes.
The Company underwrites life insurance and annuity products through
Farmers Life. 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 Deferred Policy
Acquisition Costs ("DAC")) so that profits are generally recognized over
the same period as revenue income. Revenues attributable to Universal Life
("UL") products consist of policy charges for the cost of insurance, policy
administration charges, surrender charges, and investment income on assets
allocated to support policyholder account balances on deposit. Revenues for
deferred annuity products consist of surrender charges and investment income
on assets allocated to support policyholder account balances. Expenses on
UL and annuity policies include interest credited to policyholders on policy
balances as well as benefit claims incurred in excess of policy account
balances.
Three Months Ended March 31, 1998 Compared to Three Months Ended March
31, 1997
Management Services to Property and Casualty Insurance Companies; and Other
Operating Revenues. Operating revenues increased from $320.9 million for
the three months ended March 31, 1997 to $335.5 million for the three months
ended March 31, 1998, an increase of $14.6 million, or 4.5%. 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 $2,467.4 million in the first quarter of 1997 to $2,542.3 million in the
first quarter of 1998 due primarily to policy growth within the Auto and Fire
lines of business despite increasingly competitive market conditions.
Operating Expenses. Operating expenses as a percentage of operating
revenues decreased from 56.2% for the three months ended March 31, 1997 to
54.7% for the three months ended March 31, 1998, a decrease of 1.5%. Although
operating expenses were higher by 1.8%, this was significantly less than the
4.5% increase in operating revenues.
Salaries and Employee Benefits. Salaries and employee benefits
increased from $83.3 million for the three months ended March 31, 1997 to
$84.3 million for the three months ended March 31, 1998, an increase of
$1.0 million, or 1.2%.
<PAGE> 17
Buildings and Equipment Expenses. Buildings and equipment expenses
increased from $22.3 million for the three months ended March 31, 1997
to $26.3 million for the three months ended March 31, 1998, an increase
of $4.0 million, or 17.9%. 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. 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
March 31, 1998 and March 31, 1997.
General and Administrative Expenses. General and administrative
expenses decreased from $49.1 million for the three months ended March
31, 1997 to $47.3 million for the three months ended March 31, 1998, a
decrease of $1.8 million, or 3.7%. This decrease was due substantially
to lower advertising expenses.
Net Investment Income. Net investment income increased from $34.3
million for the three months ended March 31, 1997 to $39.8 million for the
three months ended March 31, 1998 due to a larger asset base which
resulted primarily from the reinvestment of the proceeds received from the
sale of OSL and IGL.
Net Realized Gains. Net realized gains decreased from $30.4 million for
the three months ended March 31, 1997 to $9.8 million for the three months
ended March 31, 1998 due to the fact that significant gains were realized in
1997 in connection with restructuring the equities portfolio.
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 March 31, 1998 and March 31, 1997.
Provision for Income Taxes. Provision for income taxes decreased from
$96.7 million for the three months ended March 31, 1997 to $76.8 million for
the three months ended March 31, 1998, a decrease of $19.9 million, or 20.6%.
This decrease was substantially attributable to the $21.0 million of taxes
that were recorded in 1997 related to the sale of OSL and IGL.
Management Services Income. As a result of the foregoing, management
services income increased from $97.9 million for the three months ended March
31, 1997 to $114.2 million for the three months ended March 31, 1998, an
increase of $16.3 million, or 16.6%.
Insurance Subsidiaries
In December 1997, Farmers Re, a property and casualty insurance
subsidiary of FGI, was formed and licensed to conduct business. In January
1998, Farmers Re entered into a quota share reinsurance treaty with Farmers
Insurance Exchange under which it reinsures a percentage of the auto physical
damage business written by the P&C Group. As a result, through March 31,
1998, Farmers Re assumed $250.0 million of premiums, incurred $176.6 million
of non-life losses and loss adjustment expenses and incurred $67.1 million of
non-life reinsurance
<PAGE> 18
commissions. For the first three months of 1998, Farmers Re contributed $6.9
million to income before taxes and $4.5 million to net income.
On April 15, 1997, OSL and IGL were sold to Great Southern Life Insurance
Company, a subsidiary of Americo Life, Inc.. As a result, there was no
contribution to net income from OSL or IGL for the three months ended March 31,
1998, compared to a $4.8 million contribution to net income from OSL and IGL
for the three months ended March 31, 1997. The following commentary addresses
the results of the Company's remaining life insurance subsidiary, Farmers Life.
Total Revenues. Total revenues increased from $154.7 million for the
three months ended March 31, 1997 to $166.9 million for the three months
ended March 31, 1998, an increase of $12.2 million, or 7.9%.
Life Premiums. Life premiums increased $3.9 million for the three
months ended March 31, 1998, or 10.5%, over the three months ended March
31, 1997. This increase was due to a 12.8% growth in the average volume
of insurance in-force which was driven by sales of the Premier Whole Life
("PWL") and Farmers Premier 20 Year Term ("FP20") products.
Life Policy Charges. Life policy charges increased $1.7 million for
the three months ended March 31, 1998, or 3.4%, over the three months
ended March 31, 1997, reflecting a 3.6% growth in universal life-type
insurance in-force.
Investment Income. Net investment income increased $4.7 million for
the three months ended March 31, 1998, or 7.1%, over the three months
ended March 31, 1997. The increase was due to higher bond interest
income resulting from a higher invested asset base as the universal life
and annuity fund accounts increased 12.7% and 1.7%, respectively.
Net Realized Gains. Net realized gains increased by $1.9 million,
from $1.7 million for the three months ended March 31, 1997 to $3.6
million for the three months ended March 31, 1998. This increase was due
to higher gains realized on bond sales.
Total Operating Expenses. Total operating expenses increased from $106.5
million for the three months ended March 31, 1997 to $109.6 million for the
three months ended March 31, 1998, an increase of $3.1 million, or 2.9%.
Life Policyholders' Benefits and Charges. Life policyholders'
benefits expense and charges increased from $67.1 million for the
three months ended March 31, 1997 to $72.6 million for the three months
ended March 31, 1998, an increase of $5.5 million, or 8.2%.
Policy benefits. Policy benefits, which consist primarily of
death and surrender benefits on life products, increased $3.2
million for the three months ended March 31, 1998, to $30.7 million,
due to a 6.7% growth in the volume of 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 $4.0 million
for the three months ended March 31, 1997 to $4.8 million for
the three months ended March 31, 1998. This increase was
primarily attributable to lower terminations on older whole life
business which carry higher future benefit provisions coupled with
increased sales of the FP20 and PWL products.
<PAGE> 19
Interest credited to policyholders. Interest credited to
policyholders, which represents the amount credited under universal
life-type contracts and deferred annuities to policyholder funds on
deposit, increased from $35.6 million for the three months ended
March 31, 1997 to $37.1 million for the three months ended March 31,
1998, or 4.2%, reflecting the 12.7% and 1.7% growth in universal
life and annuity fund balances.
General Operating Expenses. General operating expenses decreased
from $39.4 million for the three months ended March 31, 1997 to
$37.0 million for the three months ended March 31, 1998, a decrease of
$2.4 million, or 6.1%.
Amortization of DAC and Value of Life Business Acquired.
Amortization expense decreased from $24.5 million for the three months
ended March 31, 1997 to $21.6 million for the three months ended March
31, 1998 due to higher death claims experience on the universal life
product and lower terminations on the traditional life products.
Commissions. Commissions increased from $4.6 million for the
three months ended March 31, 1997 to $4.7 million for the three
months ended March 31, 1998.
General and Administrative Expenses. General and administrative
expenses increased from $10.3 million for the three months ended
March 31, 1997 to $10.7 million for the three months ended March 31,
1998, or 3.9%, due to higher employee benefit expenses and increased
premium taxes.
Provision for Income Taxes. Provision for income taxes increased from
$16.0 million for the three months ended March 31, 1997 to $21.2 million for
the three months ended March 31, 1998 due to higher pretax operating income.
Farmers Life Income. As a result of the foregoing, Farmers Life income
increased from $32.2 million for the three months ended March 31, 1997 to
$36.0 million for the three months ended March 31, 1998, an increase of $3.8
million, or 11.8%.
Consolidated Net Income
Consolidated net income of the Company increased from $135.0 million for
the three months ended March 31, 1997 to $154.7 million for the three months
ended March 31,1998, an increase of $19.7 million, or 14.6%.
Liquidity and Capital Resources
As of March 31, 1998 and March 31, 1997, the Company held cash and cash
equivalents of $423.2 million and $527.5 million, respectively. In addition,
as of March 31, 1998, the Company had available revolving credit facilities
enabling it to borrow up to $500.0 million in the event such a need should
arise.
Net cash provided by operating activities increased from $219.9 million
for the three months ended March 31, 1997 to $246.9 million for the three
months ended March 31, 1998, an increase in cash of $27.0 million, or 12.3%.
This increase was due to a $100.6
<PAGE> 20
million increase in the provision for non-life losses and loss adjustment
expenses held by Farmers Re and a $19.7 million increase in consolidated net
income. The above increases in cash were partially offset by an increase in
current assets due to a $106.7 million receivable from the P&C Group as a
result of the fact that Farmers Re began reinsuring the auto physical damage
business of the P&C Group in 1998.
Net cash used in investing activities increased from $115.7 million for
the three months ended March 31, 1997 to $248.7 million for the three months
ended March 31, 1998, a decrease in cash of $133.0 million, or 115.0%. This
decrease in cash resulted primarily from an $82.6 million decrease in proceeds
from sales and maturities of investments available-for-sale and a $68.9
million increase in purchases of investments available-for-sale.
Net cash used in financing activities increased from $76.0 million for
the three months ended March 31, 1997 to $91.3 million for the three months
ended March 31, 1998, an increase of $15.3 million, or 20.1%. This decrease
in cash is substantially the result of a $15.3 million increase in withdrawals
related to annuity contracts held by Farmers Life.
<PAGE> 21
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. None.
(b) Reports on Form 8-K. None
<PAGE> 22
FARMERS GROUP, INC.
AND SUBSIDIARIES
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of
1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned thereunto duly authorized.
Farmers Group, Inc.
(Registrant)
May 13, 1998 /s/ Martin D. Feinstein
---------------------------------------------
Date Martin D. Feinstein
Chairman of the Board,
President and Chief Executive Officer
May 13, 1998 /s/ Anthony L.R. Clark
---------------------------------------------
Date Anthony L.R. Clark
Senior Vice President and
Chief Financial Officer
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the
consolidated balance sheet of Farmers Group, Inc. and subsidiaries as of
March 31, 1998 and the related consolidated statements of income,
comprehensive income, stockholder's equity and cash flows for the three
month period ended March 31, 1998 (unaudited) and is qualified in its
entirety by reference to such financial statements.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> MAR-31-1998
<CASH> 423,150
<SECURITIES> 83,270
<RECEIVABLES> 0
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 931,604
<PP&E> 696,954
<DEPRECIATION> 254,332
<TOTAL-ASSETS> 12,335,215
<CURRENT-LIABILITIES> 276,527
<BONDS> 0
500,000
0
<COMMON> 1
<OTHER-SE> 6,870,592
<TOTAL-LIABILITY-AND-EQUITY> 12,335,215
<SALES> 0
<TOTAL-REVENUES> 753,148
<CGS> 0
<TOTAL-COSTS> 487,440
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 10,518
<INCOME-PRETAX> 255,190
<INCOME-TAX> 100,478
<INCOME-CONTINUING> 154,712
<DISCONTINUED> 0
<EXTRAORDINARY> 0
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<NET-INCOME> 154,712
<EPS-PRIMARY> 0
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</TABLE>
