ITEM 1. BUSINESS
Overview
The following discussion includes the operations of Farm Family Holdings, Inc. ("Farm Family Holdings"), a Delaware corporation incorporated in 1996, and its wholly owned subsidiaries, (collectively referred to as the "Company"). The primary subsidiary of Farm Family Holdings is Farm Family Casualty Insurance Company ("Farm Family Casualty"). The operations of the Company are also closely related with those of its affiliates, Farm Family Life Insurance Company ("Farm Family Life") and Farm Family Life's wholly owned subsidiary, United Farm Family Insurance Company ("United Farm Family").
On July 26, 1996, Farm Family Mutual Insurance Company ("Farm Family Mutual") converted from a mutual property and casualty insurance company to a stockholder owned property and casualty insurance company and became a wholly owned subsidiary of Farm Family Holdings pursuant to a plan of Reorganization and Conversion (the "Plan"). In addition, Farm Family Mutual was renamed Farm Family Casualty Insurance Company. As part of the Plan, Farm Family Holdings was formed and the Farm Family Mutual policyholders received approximately 2,237,000 shares of Farm Family Holding's common stock and $11,735,000 in cash in exchange for their membership interest in Farm Family Mutual.
On July 23, 1996, Farm Family Holdings made an initial public offering of its common stock at a price of $16.00 per share. Farm Family Holdings received net proceeds of $41,453,000 for approximately 2,786,000 shares sold in the initial public offering. In addition, Farm Family Holdings received $3,427,000 for approximately 214,000 shares purchased by policyholders of Farm Family Mutual in a subscription offering. In addition, pursuant to the Plan, holders of Farm Family Mutual debt could elect to exchange their debt instruments for shares of common stock or cash. As a result, there were 17,000 common shares and $1,107,000 in cash exchanged for debt with an outstanding principal amount of $1,371,000.
Farm Family Casualty is a specialized property and casualty insurer of farms, agribusiness, other generally related businesses and residents of rural and suburban communities principally in the Northeastern United States. Farm Family Casualty provides property and casualty insurance coverages to members of the state Farm Bureau(R) organizations in New York, New Jersey, Delaware, West Virginia and all of the New England states, (collectively the "Farm Bureaus"). Membership in a state or county Farm Bureau organization is a prerequisite for voluntary insurance coverage, except for employees of the Company and its affiliates.
Farm Family Casualty markets its insurance products through more than 200 Farm Family agents and field managers who are located in the rural and suburban communities it serves. These agents generally sell insurance products primarily for Farm Family Casualty and Farm Family Life. The Company believes that the distinctive focus of the Company and its agents on meeting the specialized insurance needs of rural communities has provided the Company with the knowledge and experience to adapt to changes in the demographics of its markets and in the nature of agricultural related businesses. In addition to insuring those engaged in agricultural pursuits such as dairy, vegetable and fruit farming, the Company insures a wide range of other businesses related to agriculture, such as distributors of agricultural products, horse breeding and training facilities, landscapers, nurseries, florists, wineries and growers of specialty products. The Company also offers businessowners products for certain retail and contractor businesses and for owners of apartment and office buildings, as well as a homeowners product.
The Company's principal strategy is to maintain its focus on meeting the specialized insurance needs of northeastern rural and suburban communities. The Company's flagship product, the Special Farm Package, is a flexible policy that can be adapted to meet the needs of a variety of agricultural and agricultural related businesses. As evidenced by its introduction of businessowners products in 1990, the Company also seeks to leverage its local reputation, agency force, knowledge and experience to expand its product offerings to a wider variety of customers in the rural and suburban communities in which it currently operates. In addition, the Company will continue to seek to facilitate and expedite sales, underwriting and policy administration functions through the use of local service centers and computer networking communications with the home office.
Farm Family Holdings entered into an Option Purchase Agreement with the shareholders of Farm Family Life (the "Selling Shareholders") pursuant to which
Farm Family Holdings has, for a two-year period which commenced on July 26, 1996, the option to acquire Farm Family Life subject to certain conditions. On February 26, 1998, the Board of Directors of Farm Family Holdings approved the exercise of the option to acquire Farm Family Life and it's wholly owned subsidiary, United Farm Family. Under the terms of the Option Purchase Agreement, Farm Family Holdings will pay an exercise price of $37.5 million to acquire Farm Family Life, consisting of $31.5 million of common stock of Farm Family Holdings (the "Common Stock"), and $6 million stated value of 6-1/8% voting preferred stock of Farm Family Holdings (the "Series A Preferred Stock"). The actual number of shares of Common Stock and Series A Preferred Stock issued to the Selling Shareholders will be equal to approximately $31.5 million and approximately $6 million respectively, divided by the average closing price of the Common Stock on the New York Stock Exchange, Inc. during the 20 trading days preceding the third business day prior to the closing of the acquisition. The proposed acquisition of Farm Family Life is subject to the approval of the shareholders of Farm Family Holdings and receipt of all required government approvals. Management expects that the acquisition of Farm Family Life will be brought to the shareholders of Farm Family Holdings for their approval in 1998.
Related Party Transactions
The Company was organized through the efforts of certain Farm Bureaus, and its relationship with the Farm Bureaus in its ten state region continues to be a fundamental aspect of its business (see "Relationship with Farm Bureaus"). Many of the directors of the Company are also directors or executive officers of the Farm Bureaus and the Selling Shareholders of Farm Family Life under the Option Purchase Agreement.
The Company is a party to Membership List Purchase Agreements with each of the state Farm Bureaus in the ten states in which it conducts business. Pursuant to each Membership List Purchase Agreement, Farm Bureau membership lists are provided to the Company on an exclusive basis for the purpose of marketing its insurance products. The Membership List Purchase Agreements are for six years commencing on January 1, 1996. For the years ended December 31, 1997 and 1996, the Company paid a total of $600,000 and $571,000, respectively, to the Farm Bureaus pursuant to the Membership List Purchase Agreements. For the year ended December 31, 1995 the Company paid $547,000 to the Farm Bureaus under substantially similar Membership List Purchase Agreements in effect for 1995.
The operations of the Company are closely related with those of its affiliates, Farm Family Life and United Farm Family. The affiliated companies operate under similar Boards of Directors and have similar senior management. In addition, the affiliated companies share home office facilities, data processing equipment, certain personnel and other operational expenses.
The Company and Farm Family Life are parties to an Amended and Restated Expense Sharing Agreement, effective as of February 14, 1996 (the "Expense Sharing Agreement"), pursuant to which shared expenses for goods, services and facilities are allocated between the Company and Farm Family Life. Under the Expense Sharing Agreement, expenses are allocated in accordance with applicable provisions of the New York Insurance Law and regulations promulgated thereunder. Direct expenses are charged as incurred to the Company and Farm Family Life, as applicable, at cost. In 1995, the parties shared expenses under a similar expense sharing agreement. For each of the years ended December 31, 1997 and 1996, 67% and 65%, respectively, of aggregate operating expenses totaling $29.4 million and $30.7 million, respectively, were allocated to the Company, under the Expense Sharing Agreement. For the year ended December 31, 1995, 61% of aggregate operating expenses totaling $26.7 million was allocated to the Company under a similar expense sharing arrangement.
The Company and Farm Family Life are parties to a Lease Agreement dated July 1, 1988, as amended by Amendment to Lease Agreement, effective January 1, 1994, as so amended, (the "Lease Agreement") pursuant to which the Company leases home office space in Glenmont, New York from Farm Family Life. Annual rent under the Lease Agreement was approximately $760,000, $712,000, and $687,000 for each of the years ended December 31, 1997, 1996, and 1995, respectively.
The Company and United Farm Family are parties to a service agreement dated July 25, 1988 (the "Service Agreement") pursuant to which the Company provides United Farm Family with certain administrative and special services necessary for its operations, including, but not limited to, claims management, underwriting, accounting, tax and auditing, investment management, and functional support services. In addition, the Company provides United Farm Family with certain personnel, property, equipment and facilities for its operations. For each of the years ended December 31, 1997, 1996, and 1995, Farm Family Casualty charged United Farm Family approximately $0.5 million, $0.7 million, and $0.8 million, respectively, in direct and allocated expenses and
overhead under the Service Agreement.
Prior to January 1, 1998, the Company's reinsurance program included reinsurance agreements with United Farm Family. In accordance with the provisions of these reinsurance agreements, premiums earned, losses, and expenses ceded by the Company to United Farm Family were as follows:
The Company terminated all reinsurance agreements with United Farm Family effective December 31, 1997. However, United Farm Family retains liability for covered losses arising from occurrences prior to the termination date. Effective January 1, 1998, the Company's retention on a per risk basis will increase from $100,000 to $300,000 and all reinsurance coverage will be provided solely by non-affiliated reinsurers.
Products
The Company offers a variety of property and casualty insurance products primarily designed to meet the unique insurance needs of its agricultural clients and the general insurance needs of the rural and suburban communities in which it does business. Many policyholders have more than one policy with the Company, most commonly, a property policy (such as a Special Farm Package or homeowners policy) and an automobile policy.
The following table sets forth by product the direct premiums written by the Company for the periods indicated:
*Includes $6.3 million of assigned risk automobile for personal automobile and $0.7 million of assigned risk automobile for commercial automobile
Personal Automobile. Personal automobile is the Company's largest product. The Company's industry standard policies are generally marketed in conjunction with its other products, such as the Special Farm Package, the businessowners policy or the homeowners policy.
Special Farm Package. The Special Farm Package, developed in 1980, is a flexible, multi-line package of insurance coverages which the Company regards as its "flagship" product. As a result of its flexible features, this product can be adapted to meet the needs of a variety of agricultural and related businesses. The Special Farm Package policy combines personal, farm and business
property and liability insurance for the farm owner, as well as owners of other agricultural related businesses, such as horse breeding and training facilities, nurseries, wineries and greenhouses.
In October 1997, the Company began marketing the Country Estate program, a specialized version of the Special Farm Package. The Country Estate program covers rural residents where agricultural exposures are present, but agribusiness is not the main source of income for the household.
Commercial Automobile. Commercial automobile is the Company's third largest product. The Company's industry standard policies are generally marketed in conjunction with the Special Farm Package or the businessowners policy.
Workers' Compensation. The Company generally does not seek to market or write its workers' compensation policy apart from a Special Farm Package or a businessowners policy.
Businessowners. The Company's businessowners product (based on the industry standard policy form) is designed to meet the needs of small businesses within its rural and suburban markets. This product is marketed to two distinct groups: (i) "mercantile businessowners" with property based risks, including apartment and office building owners and small to medium-sized retail businesses, such as florists and farm markets and (ii) small, established artisan contractors principally serving the agricultural community.
Special Home Package and Homeowners Policy. The Company's homeowners policy, introduced in 1989, is a standard homeowners multi-peril policy for the rural and suburban homeowner. Increasingly, the homeowners policy is being sold to provide coverage for the insured's principal residence, while the Special Home Package is used by the Company to insure rural-based, tenant occupied residences. Like the Special Farm Package, the Special Home Package combines personal and commercial property and liability coverages, and contains flexible features which also allow it to be adapted to meet the needs of a variety of customers.
Umbrella Liability. The Company writes commercial and personal line excess liability policies covering business, farm and personal liabilities of its policyholders in excess of amounts covered under Special Farm Package, homeowners, businessowners and automobile policies. Such policies are available with limits of $1.0 million to $5.0 million. The Company does not generally seek to market its excess liability policies unless it also writes an underlying liability policy.
Commercial General Liability. The Company writes an industry standard commercial general liability policy which is generally marketed in connection with the Special Farm Package or, as an accommodation to policyholders in connection with the commercial automobile policy. The commercial general liability policy is generally not written apart from these other policies. The policy is usually written by the Company for unique business situations, such as horse breeding and training facilities and certain landscaper risks, which do not meet the criteria for liability coverage under a businessowners or Special Farm Package policy. The policy insures businesses against third party liability from accidents occurring on their premises or arising out of their operations or products. Most of the Company's products liability line is written as part of the commercial general liability product.
Pollution. The Company writes a small number of pollution liability policies covering specified farm risks on a "claims-made" basis. The policy insures against losses incurred from third party liability, including bodily injury and property damages, for pollution incidents, such as those caused from pesticides, fertilizers, herbicides and manure piles. An "extended reporting period" option is available under certain circumstances which allows for claim reporting after the policy expiration. As of December 31, 1997, the Company had approximately 222 pollution policies in force.
Marketing
The following table sets forth the Company's direct written premiums by state for the periods indicated:
As of December 31, 1997, the Company marketed its property and casualty insurance products in its ten state region through approximately 189 primarily exclusive agents, 13 independent agents and 12 field managers. Many of the Company's agents are established residents of the rural and suburban communities in which they operate and often have specific prior experience in agricultural related businesses. Almost all of the Company's agents market and write the full range of its products. In addition to marketing the Company's property and casualty insurance products, the agency force also markets life insurance products for Farm Family Life. In 1997, agent compensation was comprised entirely of commissions, office expense allowances and incentive bonuses.
In 1997, the Company established a wholly owned subsidiary, Farm Family Financial Services, Inc. Through this subsidiary, and its affiliation with a national broker-dealer, the Company's agents can make available financial services and products. Many agents are in the process of obtaining a securities license so they can offer these products to their clients.
The Company emphasizes personal contact between its agents and the policyholders. The Company believes that its name recognition, policyholder loyalty and policyholder satisfaction with agent and claims relationships are the principal sources of new customer referrals, cross-selling of additional insurance products and policyholder retention. In addition, the Company believes that its relationship with the Farm Bureaus in its target markets promotes the Company's name recognition and new customer referrals among Farm Bureau members (see " Relationship with Farm Bureaus").
Relationship with Farm Bureaus
The Company was organized through the efforts of certain Farm Bureaus, and its relationship with the Farm Bureaus in its ten state region continues to be a fundamental aspect of its business. These Farm Bureaus are affiliated with the American Farm Bureau Federation, the nation's largest general farm organization with over four million members, which has traditionally sought to advance the interests of the agricultural community. The Company was established in 1955 through the efforts of certain Farm Bureaus to provide property and casualty insurance for Farm Bureau members in the Northeast. Substantially all of the directors of the Company are associated with Farm Bureau organizations in the Northeast. The Company has the exclusive endorsement of the Farm Bureaus to market property and casualty insurance in the ten states in which it operates.
The endorsement of the Farm Bureaus generally means that the Farm Bureaus provide the Company with the right to utilize their membership lists and authorize the use of their name and service marks in connection with the marketing of the Company's products. In exchange for these rights, the Company pays to each of the Farm Bureaus an annual fee of $7.50 per Farm Bureau member, pursuant to agreements with each Farm Bureau (the "Membership List Purchase Agreements"). The current term of each Membership List Purchase Agreement is six
years, commencing on January 1, 1996. Pursuant to the Membership List Purchase Agreements, the Farm Bureaus may not endorse the products of other property and casualty insurers within the Company's ten state region. Farm Family Life has entered into similar membership list purchase agreements with each of the Farm Bureaus.
Underwriting
The Company seeks to write its commercial and personal lines risks by evaluating loss experience and underwriting profitability with consistently applied standards. The Company maintains information on all aspects of its business which is routinely reviewed by the Company's staff of underwriters in relationship to product line profitability. The Company's underwriters generally specialize by agency territory. Specific information is monitored with regard to individual insureds which is used to assist the Company in making decisions about policy renewals or modifications.
The Company concentrates on its established major product lines (personal and commercial auto, Special Farm Package, businessowners and homeowners policies). It generally does not pursue the development of products with risk profiles with which it is not familiar, nor does it, typically, actively market its automobile, workers' compensation or general liability policies except to policyholders who may also purchase its Special Farm Package, businessowners or homeowners products. The Company believes its extensive knowledge of local markets in its region is a key element in its underwriting process.
Claims
Claims on insurance policies written are usually investigated and settled by one of the Company's staff claims adjusters, located in nine field offices. The Company's claims philosophy emphasizes timely investigation, evaluation and settlement of claims, while maintaining adequate reserves and controlling claim adjustment expenses. The claims philosophy is designed to support the Company's marketing efforts by providing agents and policyholders with prompt service.
Claims settlement authority levels are established for each adjuster and claims manager based upon the employee's ability and level of experience. Claims are reported directly to the claims department, located at a field office or through the central claim reporting unit at the home office. Specialized units exist at the home office for no-fault automobile and workers' compensation claims, as well as subrogation and large, litigated or certain other claims. The Company also has on staff a special investigator to investigate suspected insurance fraud, including arson. The claims department is responsible for reviewing all claims, obtaining necessary documentation, estimating the loss reserves and resolving the claims. Claims for New York private passenger assigned risk business are handled by outside claim adjusting firms which specialize in this line of business.
Reinsurance
Reinsurance Ceded
The Company's reinsurance arrangements are generally placed with non-affiliated reinsurers through reinsurance brokers. In addition, through December 31, 1997, certain reinsurance coverages were also placed directly with United Farm Family (see "Related Party Transactions"). Prior to January 1, 1998, the largest net per risk exposure retained by the Company on any one individual property or casualty risk was $100,000. Property and casualty risks in excess of $100,000 were covered on an excess of loss basis up to $300,000 per risk by United Farm Family, prior to January 1, 1998. Effective January 1, 1998, the largest net per risk exposure retained by the Company on any one individual property or casualty risk is $300,000. Per risk property losses in excess of $300,000 but less than $4 million are reinsured on an excess of loss basis by unaffiliated reinsurers. Casualty losses per risk in excess of $300,000 but less than $1 million (which is generally the maximum limit of liability written by the Company's casualty insurance policies, other than workers' compensation and umbrella liability policies) are covered on an excess of loss basis by unaffiliated reinsurers. Clash coverage provided by unaffiliated reinsurers covers casualty losses, including workers' compensation, in excess of $1 million but less than $5 million. In addition, workers' compensation claims, on a per occurrence basis with a $600,000 per person limit, in excess of $3 million but less than $10 million are separately reinsured on an excess of loss basis by an unaffiliated reinsurer. Prior to January 1, 1998, the Company reinsured 95% of its umbrella liability losses (including a 5% quota share participation by United Farm Family) under $1 million per loss on a quota share basis and 100% of umbrella liability losses in excess of $1 million up to $5 million per loss with unaffiliated reinsurers. Effective January 1, 1998, umbrella losses per occurrence in excess of $300,000 but less than $2 million are covered on an
excess of loss basis with unaffiliated reinsurers. In addition, the Company reinsures 100% of its umbrella liability losses in excess of $2 million up to $5 million per loss with unaffiliated reinsurers. Facultative coverage is available for property risks in excess of $4 million per risk, casualty risks in excess of $1 million, and umbrella losses in excess of $5 million.
The Company's property catastrophe reinsurance provides for recovery of 95% of the losses over $6 million up to a maximum of $51 million per occurrence and approximately 79% of the losses between $3 million and $6 million per occurrence. The Company retains the first $3 million of losses per occurrence under its property catastrophe program. Prior to January 1, 1998, United Farm Family was a participant in Farm Family's property catastrophe reinsurance program and assumed 2% of losses per occurrence between $11 million and $51 million and approximately 16% of losses between $3 million and $6 million.
The insolvency or inability of any reinsurer to meet its obligations to the Company could have a material adverse effect on the results of operations or financial condition of the Company. As of December 31, 1997, more than 95% of the Company's reinsurance program was provided by reinsurers which were rated "A-" (Excellent) or above by A.M. Best Company, Inc. ("A.M. Best").
The Company terminated all reinsurance agreements with United Farm Family effective December 31, 1997. However, United Farm Family retains liability for covered losses arising from occurrences prior to the termination date. Effective January 1, 1998, all reinsurance agreements will be provided solely by non-affiliated reinsurers. Consequently, the Company's net retention on all risks will increase from $100,000 to $300,000 for the 1998 year. In addition, the Company purchased an aggregate stop loss which provides $12.5 million of coverage excess of 66% loss ratio for the 1998 year.
Reinsurance Assumed
The Company assumes voluntary reinsurance covering primarily property, property catastrophe and casualty risks located outside of the Northeast. The Company believes that, among other benefits, its assumed reinsurance arrangements balance to a limited extent the geographic concentration of its risks in the Northeast. The Company also assumed an insignificant amount of reinsurance covering substandard automobile policies from United Farm Family through December 31, 1997. For the year ended December 31, 1997, the Company earned premiums of $7.0 million under various voluntary proportional and non-proportional reinsurance agreements. In addition, the Company has a retrocessional reinsurance program covering the Company's assumed business, which is placed with unaffiliated reinsurers and provides for recovery of 95% of losses over $1 million up to a maximum of $4 million per occurrence and 75% of losses over $4 million up to a maximum of $6 million.
Loss and Loss Adjustment Expense ("LAE") Reserves
The Company's reserve for losses is an estimate of the unpaid amount, as of December 31, of the losses incurred in both the current year and all prior years. The LAE reserve is an estimate of the unpaid expenses required to settle losses incurred in both the current year and all prior years. The Company is required to maintain reserves for payment of estimated loss and LAE for both reported claims and claims which have been incurred but not yet reported. The ultimate liability incurred by the company may be different from current reserve estimates.
Adjustments in aggregate reserves, if any, are reflected in the operating results of the period during which such adjustments are made. Although claims for which reserves are established may not be paid for many years, reserves for losses and LAE are not discounted, except for certain lifetime workers' compensation indemnity reserves where the reserves are discounted at 3.5%.
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The following table provides a reconciliation of beginning and ending loss and LAE reserve balances of the Company for each of the years in the three year period ended December 31, 1997.
Reconciliation of Liability for Loss and Loss Adjustment Expenses
Analysis of Loss and Loss Adjustment Expense Development
The following table reflects the development of losses and loss adjustment expenses for the periods indicated at the end of that year and each subsequent year. Each calendar year-end reserve includes the estimated unpaid liabilities for that accident year and for all prior accident years. The data presented under the caption "Cumulative Amount of Reserves Paid Through" show the cumulative amounts paid related to the reserve as of the end of each subsequent year. The data presented under the caption "Reserves, Net, Reestimated as of" show the original recorded reserve as adjusted as of the end of each subsequent year to reflect the cumulative amounts paid and all other facts and circumstances discovered during each such year. The line "Cumulative Redundancy (Deficiency)" reflects the difference between the latest reestimated reserve amount and the reserve amount as originally established.
In evaluating the information in the table below, it should be noted that each amount includes the effects of all changes in amounts of prior periods. For example, if a loss determined in 1996 to be $150,000 was first reserved in 1988 at $100,000, the $50,000 deficiency (actual loss minus original estimate) would be included in the cumulative deficiency in each of the years 1989 through 1995 shown below. This table presents development data by calendar year and does not relate the data to the year in which the accident actually occurred. Conditions and trends that have affected the development of these reserves in the past may not necessarily recur in the future.
The following table sets forth the development of loss and loss adjustment expenses reserves of the Company for the ten-year period ended December 31, 1997:
Prior to 1990, the Company had a history of cumulative deficiencies in reserving for losses and LAE. These deficiencies were primarily caused by the underestimation of reserves for workers' compensation, automobile and other liability claims. In 1991, the Company reviewed and revised its process for estimating reserves for losses and LAE, and in recent years the Company has generally experienced overall redundancies. The redundancies at December 31, 1997 of $14.9 million, $7.8 million and $4.0 million for the December 31, 1994, 1995 and 1996 reserves, respectively, were primarily attributable to favorable development of IBNR and case reserves for personal automobile, commercial automobile, automobile physical damage, and workers' compensation claims.
The Company believes that its reserves at December 31, 1997 are adequate. Conditions and trends that have historically affected the Company's claims may not necessarily occur in the future. Accordingly, it would not be appropriate to extrapolate future deficiencies or redundancies based on the results set forth above. Future adjustments to loss reserves and LAE that are unanticipated by the Company could have a material adverse impact upon the Company's financial condition and results of operations.
Investments
An important component of the operating results of the Company has been the return on invested assets. The Company's investment objective is to maximize current yield while maintaining safety of capital together with adequate liquidity for its insurance operations. Since 1995, the Company has significantly reduced its holdings of non-investment grade fixed maturity securities and improved the overall credit quality of its invested assets.
At December 31, 1997, the Company had cash and invested assets with an aggregate carrying value of $286.3 million. The Company primarily invests in high quality fixed maturity securities and to a lesser extent, equity securities. At December 31, 1997, 93.6% of the Company's total cash and invested assets consisted of fixed maturities, 4.0 % consisted of cash and short-term investments, 1.6% consisted of equity securities, and the remainder consisted of mortgage loans and other invested assets.
Prior to September 1, 1997, the Company exclusively managed its invested assets internally. During 1997, the Company retained the services of a professional asset management firm, specializing in the management of investments for insurance companies, to supplement its internal capabilities and improve upon the management of its invested assets. Investment activities are subject to oversight by management of the Company as well as an Investment Committee of the Board of Directors.
The Company actively manages and monitors its exposure to credit risk. Invested assets are reviewed regularly for credit quality. Investments which have experienced payment delinquencies, adverse changes in credit ratings or deterioration in the financial condition of the borrower, or which have otherwise been identified as having potential adverse credit implications are placed on a credit watch report. Securities placed on the credit watch list are reviewed by management and the investment committee on a regular basis. At December 31, 1997, the Company had identified eight securities, with an aggregate carrying value of $9.9 million on the credit watch report. None of these securities were considered non-performing or in default. In addition, Farm Family Casualty's holdings of NAIC Class 3 through 6 bonds, generally considered non-investment grade, were $8.4 million or 3.1% of its fixed maturity portfolio, at December 31, 1997. Due to uncertainties in the economic environment, however, it is possible that the quality of investments currently held in Farm Family Casualty's investment portfolio may change.
The average duration and average maturity of the Company's fixed maturity investments as of December 31, 1997 were approximately 4.2 and 9.5 years, respectively. As a result, the market value of the Company's investments may fluctuate significantly in response to changes in interest rates. In addition, the Company may also be likely to experience investment losses to the extent its liquidity needs require the disposition of fixed maturity securities in unfavorable interest rate environments.
For the year ended December 31, 1997, compared with the prior year, the amortized cost of the Company's cash and invested assets increased 15.3% to $274.9 million, primarily as a result of the cash flow from the Company's operations. For the years ended December 31, 1997, 1996 and 1995, the Company's net investment income, average cash and invested assets and return on average cash and invested assets were as follows:
The reduction in the return on average cash and invested assets during 1997 is primarily attributable to an overall reduction in the prevailing interest rate environment during 1996 and 1997 compared to earlier years, as well as an increase in the Company's investment in tax exempt investments which should improve the Company's after tax investment returns.
The following table sets forth certain information concerning the Company's investments:
- ------------ (1) Fixed maturities (bonds, redeemable preferred stocks and mortgage-backed securities) and equity securities in the Available for Sale Portfolio are carried at market value in the consolidated financial statements of the Company. Mortgage loans, cash and short-term investments and other invested assets are carried at cost, which approximates market value.
(2) Fixed maturities in the Held to Maturity Portfolio are carried at amortized cost.
(3) The Company primarily obtains market value information through the pricing service offered by Interactive Data Corporation. Market values are also obtained, to a lesser extent, from various brokers who provide price quotes.
The Company's investments in fixed maturity securities are composed primarily of intermediate-term, investment grade securities. The table below contains additional information concerning the investment ratings of the Company's fixed maturity investments at December 31, 1997.
(1) The ratings set forth in this table are based on the ratings, if any, assigned by Standard & Poor's Corporation ("S&P"). If S&P's ratings were unavailable, the equivalent ratings supplied by Moody's Investors Services, Inc., Fitch Investors Service, Inc. or the NAIC were used where available. The percentage of securities that were not assigned a rating by S&P at December 31, 1997 was 3.8%.
(2) Fixed maturities in the Available for Sale Portfolio are carried at market value in the consolidated financial statements of the Company.
(3) Fixed maturities in the Held to Maturity Portfolio are carried at amortized cost.
(4) Represents percent of market value for classification as a percent of total for each portfolio.
The table below sets forth the maturity profile of the Company's fixed maturity investments as of December 31, 1997:
(1) Fixed maturities in the Available for Sale portfolio are carried at market value in the consolidated financial statements of the Company. Fixed maturities in the Held to Maturity portfolio are carried at amortized cost.
(2) The Company obtains market value information primarily through the pricing service offered by Interactive Data Corporation. Market values are also obtained, to a lesser extent, from various brokers who provide price quotes
Information Services
The Company's automated information processing capabilities are supported by centralized computer systems and a network of personal computers linking agents, claims offices and service centers with the Company's home office data center and information services division. This network enables field employees and agents to work directly with clients in response to service questions and policy transactions. A specialized client information system containing policy and claim information for each customer's portfolio is utilized by the Company's agents to monitor policy activity. Also, personalized summaries of material events affecting each agent's policies are updated daily on the network and forwarded to agents. Substantially all of the Company's information services equipment, including the centralized computer systems and computer network, is owned by Farm Family Life. Information systems equipment expenses are shared by the Company and Farm Family Life pursuant to the Expense Sharing Agreement (see "Related Party Transactions").
Many of the Company's existing computer programs use only two digits to identify a year in the date field. These programs were designed and developed without considering the impact of the upcoming change in the century. If not corrected, many of these computer applications could fail or create erroneous results by or at the Year 2000. The Year 2000 issue affects virtually all companies and organizations . Therefore, the Company must also coordinate with other entities with which it interacts to ensure these entities are also addressing the Year 2000 issue. If not successfully addressed, the Year 2000 issue could have material adverse consequences on the Company. The Company has an on-going, enterprise-wide project to address its Year 2000 issue. During 1998, the Company will perform system-wide testing to support its plan of having policy administration systems Year 2000 compliant by December 31, 1998. Year 2000 work on remaining systems will continue through 1999. In addition, the Company has contacted other entities on which it relies to process and support its business. The Company will react to their plans to achieve Year 2000 compliance and will adjust operations as required. The Company believes it will successfully address its Year 2000 issue without material adverse consequences to the Company. However, there can be no assurance that other entities with which the Company interacts will achieve
Year 2000 compliance or that the failure by such entities to achieve Year 2000 compliance would not have a material adverse effect on the Company.
A.M. Best Rating
A.M. Best, which rates insurance companies based on factors of concern to policyholders, currently assigns a Best's Rating of "A" (Excellent), its third highest rating category, to Farm Family Casualty. A.M. Best assigns "A" or "A-" ratings to companies which, in its opinion, have demonstrated excellent overall performance when compared to the standards established by A.M. Best. Companies rated "A" or "A-" have a strong ability to meet their obligations to policyholders over a long period of time. In evaluating a company's financial and operating performance, A.M. Best reviews the company's profitability, leverage and liquidity, as well as the company's book of business, the adequacy and soundness of its reinsurance, the quality and estimated market value of its assets, the adequacy of its loss reserves, the adequacy of its surplus, its capital structure, the experience and competency of its management and its market presence. No assurance can be given that A.M. Best will not downgrade the Company's current rating in the future.
Competition
The property and casualty insurance market is highly competitive. The Company competes with stock insurance companies, mutual insurance companies, local cooperatives and other underwriting organizations. Certain of these competitors have substantially greater financial, technical and operating resources than the Company. The Company's ability to compete successfully in its principal markets is dependent upon a number of factors, many of which (including market and competitive conditions) are outside the Company's control. Many of the lines of insurance written by the Company are subject to significant price competition. Some companies may offer insurance at lower premium rates through the use of salaried personnel or other methods, rather than agents paid on a commission basis, as the Company does. In addition to price, competition in the lines of business written by the Company is based on the quality of the products, quality and speed of service (including claims service), financial strength, ratings, distribution systems and technical expertise.
Seasonality
Although the insurance business generally is not seasonal, losses and loss adjustment expenses tend to be higher for periods of severe or inclement weather.
Employees
The Company shares most of its employees with Farm Family Life. As of December 31, 1997, the total number of full time employees of the Company and Farm Family Life was 391 employees in aggregate, of which 286 were employed in the home office. Based on annual time studies, 66% of total employee expenses, including salary expense, is currently allocated to the Company and 34% is allocated to Farm Family Life and United Farm Family (see "Certain Relationships and Related Transactions"). None of these employees are covered by a collective bargaining agreement, and the Company believes that its employee relations are good.
Effect of Regulation
General
The Company is regulated by government agencies in the states in which it does business. Such regulation usually includes (i) regulating premium rates and policy forms, (ii) setting minimum capital and surplus requirements, (iii) regulating guaranty fund assessments and residual markets, (iv) licensing companies, adjusters and agents, (v) approving accounting methods and methods of setting statutory loss and expense reserves, (vi) setting requirements for and limiting the types and amounts of investments, (vii) establishing requirements for the filing of annual statements and other financial reports, (viii) conducting periodic statutory examinations of the affairs of insurance companies, (ix) approving proposed changes in control and (x) limiting the amount of dividends that may be paid without prior regulatory approval.
Insurance companies are also affected by a variety of state and federal legislative and regulatory measures and judicial decisions that define and extend the risks and benefits for which insurance is sought and provided. These include redefinitions of risk exposure in areas such as products liability, environmental damage and workers' compensation. Certain state insurance departments and legislatures may prevent premium rates for some classes of
insureds from reflecting the level of risk assumed by the insurer for those classes. Several states place restrictions on the ability of insurers to discontinue or withdraw from some lines of insurance. Such developments may adversely affect the profitability of various lines of insurance.
Risk-Based Capital
State insurance departments have adopted a methodology developed by the NAIC for assessing the adequacy of statutory surplus of property and casualty insurers which includes a risk-based capital formula that attempts to measure statutory capital and surplus needs based on the risks in a company's mix of products and investment portfolio. The formula is designed to allow state insurance regulators to identify potential inadequately capitalized companies. Under the formula, a company determines its "risk-based capital" ("RBC") by taking into account certain risks related to the insurer's assets (including risks related to its investment portfolio and ceded reinsurance) and the insurer's liabilities (including underwriting risks related to the nature and experience of its insurance business). The risk-based capital rules provide for different levels of regulatory attention depending on the ratio of a company's total adjusted capital to its "authorized control level" of RBC. Based on calculations made by the Company, the risk-based capital level for the Company exceeds a level that would trigger regulatory attention. At December 31, 1997, the Company's total adjusted capital was $94.6 million, and the threshold requiring the least regulatory attention was $27.7 million.
NAIC-IRIS Ratios
The NAIC's Insurance Regulatory Information System ("IRIS") was developed by a committee of state insurance regulators and is primarily intended to assist state insurance departments in executing their statutory mandates to oversee the financial condition of insurance companies operating in their respective states. IRIS identifies 12 ratios for the property and casualty insurance industry and specifies a range of "usual values" for each ratio. Departure from the "usual value" range on four or more ratios may lead to increased regulatory oversight from individual state insurance commissioners. The Company did not have any ratios which varied from the "usual value" range in 1997, 1996 or 1995.
Risk Factors
In addition to the normal risks of business, the Company is subject to significant risk factors, including but not limited to: (i) the inherent uncertainty in the process of establishing property-liability loss reserves, including reserves for the cost of pollution claims, and the fact that ultimate losses could materially exceed established loss reserves and have a material adverse effect on results of operations and financial condition; (ii) the potential material adverse impact on its financial condition, results of operations and cash flow of losses arising out of catastrophes; (iii) the insolvency or inability of any reinsurer to meet its obligations to Farm Family Casualty may have a material adverse effect on the business and results of operations of the Company; (iv) the need for Farm Family Casualty to maintain appropriate levels of statutory capital and surplus, particularly in light of continuing scrutiny by rating organizations and state insurance regulatory authorities, and to maintain acceptable financial strength and claims-paying ability ratings; (v) the fact that there can be no assurance that Farm Family Casualty will be able to maintain its current A.M. Best rating and that the Company's business and results of operations could be materially adversely affected by a rating downgrade; (vi) the fact that the property and casualty market is highly competitive and certain of its competitors may have substantially greater financial, technical and operating resources than the Company; (vii) the extensive regulation and supervision to which Farm Family Casualty is subject, various regulatory initiatives that may affect the Company, and regulatory and other legal actions involving the Company; (viii) Farm Family Holdings' primary reliance, as a holding company, on dividends and other payments from Farm Family Casualty for funds to meet its obligations, and regulatory restrictions on Farm Family Casualty to pay such dividends; (ix) the inherent uncertainty in the economic environment may cause the quality of the investments currently held in the Company's investment portfolio to change; (x) the impact on the revenues and profitability of the Company from prevailing economic, regulatory, demographic and other conditions in New York, New Jersey and the other states in which the company operates; (xi) the fact that since a substantial portion of the Company's business is concentrated in a relatively small number of states, a significant change in or the termination of the Company's relationship with the Farm Bureaus in certain of these states could have a materially adverse effect on the Company's results of operations and financial condition; and (xii) the Company has experienced, and can be expected in the future to experience, storm and weather related losses which may have a material adverse impact on the Company's results of operations, financial condition and cash flow.
Safe Harbor Statement under The Private Securities Litigation Reform Act of 1995
With the exception of historical information, the matters discussed or incorporated by reference in this Report on Form 10-K are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 that are based on management's current knowledge, expectations, estimates, beliefs and assumptions. The forward-looking statements in this Report on Form 10-K include, but are not limited to, statements with respect to Farm Family Holdings' potential acquisition of Farm Family Life, the impact of the potential acquisition of Farm Family Life on the earnings and shareholder value of Farm Family Holdings, statements regarding the Company's ability to successfully address its Year 2000 issue, statements regarding the Company's dividend policy, statements regarding the Company's plans to redeem its outstanding Surplus Notes, statements regarding the Company's ability to adapt to changes in the demographics of its markets and in the nature of agricultural related businesses, statements regarding the ability of the Company's reinsurance arrangements to balance the geographical concentrations of the Company's risks, statements regarding the Company's investment objectives and expected rates of return, statements regarding the adequacy of the Company's reserves, capital resources and other financial items, statements of the plans and objectives of the Company or its management, statements of future economic performance and assumptions underlying statements regarding the Company or its business. Readers are hereby cautioned that certain events or circumstances could cause actual results to differ materially from those estimated, projected, or predicted. The forward-looking statements in this Report on Form 10-K are not guarantees of future performance and are subject to a number of important risks and uncertainties, many of which are outside the Company's control, that could cause actual results to differ materially. These risks and uncertainties include, but are not limited to, the results of operations of the Company and Farm Family Life, fluctuations in the market value of shares of Farm Family Holdings' common stock, the satisfaction of the closing conditions set forth in the Option Purchase Agreement (which conditions include, but are not limited to, the approval of Farm Family Holdings' shareholders and receipt of all required governmental approvals), factors relating to the Company's ability to successfully address its Year 2000 issue, the potential recision of the New York Insurance Department's conditional approval to redeem the Company's Surplus Notes, exposure to catastrophic loss, geographic concentration of loss exposure, general economic conditions and conditions specific to the property and casualty insurance industry including its cyclical nature, regulatory changes and conditions, rating agency policies and practices, competitive factors, claims development and the impact thereof on loss reserves and the Company's reserving policy, the adequacy of the Company's reinsurance programs, developments in the securities markets and the impact thereof on the Company's investment portfolio and other risk factors listed from time to time in the Company's Securities and Exchange Commission Filings. Accordingly, there can be no assurance that the actual results will conform to the forward-looking statements in this Report on Form 10-K.
There are no family relationships among any of such officers nor are there any arrangements or understandings between any person pursuant to which he/she was elected as an officer. All officers serve at the pleasure of the Board of Directors, but subject to the foregoing, are elected for terms of approximately one year until the next Annual Meeting of the Company.
All the Executive Officers of the Registrant have been employed by the Registrant or its Subsidiary in various executive or administrative capacities for at least five years, except for the following:
Mr. Walsh has served as Executive Vice President - Finance & Treasurer of Farm Family Holdings since December 1996 and Executive Vice President - Finance & Treasurer of Farm Family Casualty since April 1997, as Executive Vice President Finance of Farm Family Casualty from December 1996 to April 1997, and as Treasurer of Farm Family Holdings from October 1996 to December 1996. Mr. Walsh was Senior Vice President - Finance of Farm Family Casualty from March 1996 to December 1996, and was previously Director of Corporate Development for Farm Family Casualty from August 1995 to March 1996. Previously, Mr. Walsh was Vice President, Finance & Chief Financial Officer with MPW Industrial Services, Inc., Columbus, OH, from April 1994 to August 1995, Corporate Controller of NSC Corporation, Methuen, MA from July 1992 to April 1994 and Senior Manager at KPMG Peat Marwick from July 1983 to July 1992. Mr. Walsh currently serves as a director of MPW Industrial Services Group, Inc.
ITEM 2.
ITEM 2. PROPERTIES
The Company currently leases space for its home office in Glenmont, New York from Farm Family Life. The lease agreement provides for Farm Family Casualty to pay Farm Family Life an annual rental of approximately $760,000. The lease expires on December 31, 1998. See "Related Party Transactions".
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
The Company is subject to litigation in the normal course of business. Based upon information presently available to it, management believes that resolution of these legal actions will not have a material adverse effect on the Company's consolidated results of operations and financial condition. However, given the uncertainties attendant to litigation, there can be no assurance that the Company's consolidated results of operations and financial condition will not be materially adversely affected by any threatened or pending litigation.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
PART II
ITEM 5.
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
The Company's common stock is traded on the New York Stock Exchange. There were approximately 29,139 registered holders of the Company's common stock at March 2, 1998. The Company currently intends to retain any earnings in order to develop its business and support its operations, and, as such, does not anticipate that it will pay any dividends to stockholders in the foreseeable future. The declaration of dividends in the future is at the discretion of the Board of Directors of the Company, subject to certain regulatory constraints and will depend upon, among other things, the Company's results of operations, financial condition, cash requirements, future prospects and other factors.
The high and low New York Stock Exchange closing market prices for the Company's common stock for each quarter since the Company's initial public offering on July 26, 1996, at a price of $16 per share, were as follows:
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth certain consolidated financial data of the Company and its subsidiaries prior to and after the reorganization pursuant to the Plan that took place during 1996. The consolidated statement of income data set forth below for the years ended December 31, 1997, 1996, 1995, 1994 and 1993 and the consolidated balance sheet data as of December 31, 1997, 1996, 1995 and 1994 are derived from the consolidated financial statements of the Company which have been audited by Coopers & Lybrand L.L.P, independent auditors. The consolidated balance sheet data as of December 31, 1993 was derived from the unaudited consolidated financial statements of the Company. The Company believes that such unaudited financial data fairly reflect the consolidated financial condition of the Company as of December 31, 1993. This data should be read in conjunction with Item 7
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The "Management's Discussion and Analysis of Financial Condition and Results of Operations" on pages 12 - 18 of the Annual Report is incorporated herein by reference.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The consolidated financial statements of the Company, including the accompanying notes to the consolidated financial statements and Report of Independent Accountants on pages 19 - 38 of the Annual Report are incorporated herein by reference.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
There were no disagreements with the Company's independent auditors.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Certain information regarding directors of the Company located in the Proxy Statement under the caption "Item 1 - Election of Directors" is incorporated herein by reference .
Information regarding executive officers of the Company in Item 1 of Part 1 of this Report under the caption "Executive Officers of the Registrant" is incorporated herein by reference.
Information required by Item 405 of Regulation S-K of the Securities Exchange Act of 1934 located in the Proxy Statement under the caption "Section 16(a) Beneficial Ownership Reporting Compliance" is incorporated herein by reference.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
Information regarding executive compensation located in the Proxy Statement under the captions "Item 1 - Election of Directors - Compensation of Directors", "Executive Compensation - Summary Compensation Table, Options, Severance Plan, Pension Benefits, Change of Control Arrangements and Compensation Committee Interlocks and Insider Participation" is incorporated herein by reference.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information regarding security ownership of certain beneficial owners and management located in the Proxy Statement under the caption "Stock Ownership of Management and Certain Beneficial Owners" is incorporated herein by reference.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information regarding certain relationships and related transactions located in the Proxy Statement under the caption "Certain Relationships and Related Transactions" is incorporated herein by reference.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) 1 and 2 An "Index to Financial Statements and Financial Statement Schedules" has been filed as a part of this Report beginning on page S-1 hereof.
(a) 3 Exhibits:
An "Exhibit Index" has been filed as a part of this Report beginning on page E-Index hereof and is incorporated herein by reference.
(b) Reports on Form 8-K:
On October 16, 1997, a Report on Form 8-K was filed regarding a press release announcing the beginning of an Odd-Lot Shareowner Program which provided all stockholders owning fewer than 100 shares of common stock of the Company with convenient means of selling their shares in the open market at a reduced brokerage fees and without any cost to the Company.
On October 29, 1997, a Report on Form 8-K was filed regarding a press release announcing the Company's operating results for the three month period and the nine month period ended September 30, 1997
On December 16, 1997, a Report on Form 8-K was filed regarding a press release announcing that a committee of its independent directors and a committee representing the shareholders of Farm Family Life have negotiated the proposed exercise price, and a revision of the form of consideration to be paid, under the Option Purchase Agreement pursuant to which Farm Family Holdings, Inc. has an option to acquire Farm Family Life.
Pursuant to the requirements of Section 13 or 15(d) 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.
FARM FAMILY HOLDINGS, INC.
By: /s/ Philip P. Weber ----------------------------- Philip P. Weber, President March 25, 1998
SIGNATURES
Pursuant to the requirements of Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
FARM FAMILY HOLDINGS, INC. AND SUBSIDIARIES INDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES Year Ended December 31, 1997
The following consolidated financial statements, notes thereto and related information of Farm Family Holdings, Inc. and Subsidiaries are incorporated herein by reference to the Company's Annual Report.
Page in Annual Report
Consolidated Statements of Income 19
Consolidated Balance Sheets 20
Consolidated Statements of Stockholders' Equity 21
Statements of Consolidated Cash Flows 22
Notes to Consolidated Financial Statements 23
Report of Independent Accountants 38
The following additional financial statement schedules are furnished herewith pursuant to the requirements of Form 10-K.
Page
Report of Independent Accountants S-2
Schedule I Summary of Investments - Other than Investments in Related Parties S-3
Schedule II Condensed Financial Information of the Registrant S-4
Schedule IV Reinsurance S-8
Schedule VI Supplemental Information Concerning Property - Casualty Insurance Operations S-9
S-1
Report of Independent Accountants
To the Shareholders and Board of Directors of Farm Family Holdings, Inc.
Our report on the consolidated financial statements of Farm Family Holdings, Inc. and Subsidiaries has been incorporated by reference in this Form 10-K from page 38 of the 1997 Annual Report to Shareholders of Farm Family Holdings, Inc. and Subsidiaries. In connection with our audits of such financial statements, we have also audited the related financial statement schedules listed in the index on page S-1 of this Form 10-K
In our opinion, the financial statement schedules referred to above, when considered in relation to the basic financial statements taken as a whole, present fairly, in all material respects, the information required to be included therein.
Coopers & Lybrand L.L.P.
Albany, New York February 13, 1998
S-2
FARM FAMILY HOLDINGS, INC. AND SUBSIDIARIES SCHEDULE 1 - SUMMARY OF INVESTMENTS OTHER THAN INVESTMENTS IN RELATED PARTIES DECEMBER 31, 1997
S-3
FARM FAMILY HOLDINGS, INC. AND SUBSIDIARIES SCHEDULE II CONDENSED FINANCIAL INFORMATION OF REGISTRANT STATEMENTS OF OPERATIONS
S-4
FARM FAMILY HOLDINGS, INC. AND SUBSIDIARIES SCHEDULE II CONDENSED FINANCIAL INFORMATION OF REGISTRANT BALANCE SHEETS ($ in Thousands)
S-5
S-6
FARM FAMILY HOLDINGS, INC. AND SUBSIDIARIES SCHEDULE II CONDENSED FINANCIAL INFORMATION OF REGISTRANT NOTES TO CONDENSED FINANCIAL INFORMATION ($ in Thousands)
Basis of Presentation
The financial statements of the registrant should be read in conjunction with the Consolidated Financial Statements and notes thereto included in the Farm Family Holdings, Inc. 1997 Annual Report.
The accompanying condensed financial information includes the accounts of Farm Family Holdings, Inc. Farm Family Holdings, Inc. was incorporated on February 14, 1996.
S-7
FARM FAMILY HOLDINGS, INC. AND SUBSIDIARIES SCHEDULE IV REINSURANCE ($ in Thousands)
S-8
FARM FAMILY HOLDINGS, INC. AND SUBSIDIARIES SCHEDULE VI SUPPLEMENTAL INFORMATION CONCERNING CONSOLIDATED PROPERTY-CASUALTY INSURANCE OPERATIONS ($ in Thousands)
S-9
E-2
Exhibit 10.4
Termination Addendum
to the
Underlying Multi-Line Per Risk Reinsurance Contract Effective: January 1, 1995
issued to
Farm Family Casualty Insurance Company Glenmont, New York (hereinafter referred to as the "Company")
and to the
Interests and Liabilities Agreement
of
United Farm Family Insurance Company Glenmont, New York (hereinafter referred to as the "Subscribing Reinsurer")
attached thereto
It Is Hereby Agreed that this Contract and the Interests and Liabilities Agreement under which the Subscribing Reinsurer has a 100% share in the interests and liabilities of the "Reinsurer" shall be terminated on December 31, 1997, with respect to losses occurring after that date as respects Coverage A of Article V and losses arising out of occurrences commencing after that date as respects Coverage B of Article V.
In Witness Whereof, the parties hereto by their respective duly authorized representatives have executed this Addendum as of the dates undermentioned at:
Glenmont, New York, this _______ day of ___________________________________ 199___.
- ----------------------------------------------------- Farm Family Casualty Insurance Company
Glenmont, New York, this _______ day of __________________________199___.
- ----------------------------------------------------- United Farm Family Insurance Company
E-3
Exhibit 10.5
Termination Addendum
to the
Umbrella Quota Share Reinsurance Contract Effective: January 1, 1995
issued to
Farm Family Casualty Insurance Company Glenmont, New York (hereinafter referred to as the "Company")
and to the
Interests and Liabilities Agreement
of
United Farm Family Insurance Company Glenmont, New York (hereinafter referred to as "United Farm Family")
attached thereto
It Is Hereby Agreed that this Contract and the Interests and Liabilities Agreement under which United Farm Family has a 5.0% part of the Company's 10.0% retention of its net liability on Coverage A business subject hereto shall be terminated at 12:01 a.m., January 1, 1998.
It Is Further Agreed that United Farm Family shall return to the Company its 5.0% share of the ceded unearned Coverage A premium in force at 12:01 a.m., January 1, 1998 (less commission allowed thereon), as promptly as possible after that date. In consideration thereof, United Farm Family shall have no liability hereunder with respect to losses arising out of occurrences commencing at or after the effective time and date of termination.
In Witness Whereof, the parties hereto by their respective duly authorized representatives have executed this Addendum as of the dates undermentioned at:
Glenmont, New York, this _______ day of ___________________________________ 199___.
- ----------------------------------------------------- Farm Family Casualty Insurance Company
Glenmont, New York, this ________ day of ___________________________________ 199___.
- ----------------------------------------------------- United Farm Family Insurance Company
E-4
Termination Addendum
to the
Umbrella Quota Share Reinsurance Contract Effective: January 1, 1995
issued to
Farm Family Casualty Insurance Company Glenmont, New York (hereinafter referred to as the "Company")
and to the
Interests and Liabilities Agreement
of
Continental Casualty Company Chicago, Illinois (hereinafter referred to as the "Subscribing Reinsurer")
attached thereto
It Is Hereby Agreed that this Contract and the Interests and Liabilities Agreement under which the Subscribing Reinsurer has a 27.5% share in the interests and liabilities of the "Reinsurer" shall be terminated at 12:01 a.m., January 1, 1998.
It Is Further Agreed that the Subscribing Reinsurer shall return to the Company its 27.5% share of the ceded unearned premium in force at 12:01 a.m., January 1, 1998 (less commission allowed thereon), as promptly as possible after that date. In consideration thereof, the Subscribing Reinsurer shall have no liability hereunder with respect to losses arising out of occurrences commencing at or after the effective time and date of termination.
In Witness Whereof, the parties hereto by their respective duly authorized representatives have executed this Addendum as of the dates undermentioned at:
Glenmont, New York, this _______ day of ___________________________________ 199___.
- ----------------------------------------------------- Farm Family Casualty Insurance Company
Chicago, Illinois, this _______ day of __________________________199___.
- ----------------------------------------------------- Continental Casualty Company
E-5
Termination Addendum
to the
Umbrella Quota Share Reinsurance Contract Effective: January 1, 1995
issued to
Farm Family Casualty Insurance Company Glenmont, New York (hereinafter referred to as the "Company")
and to the
Interests and Liabilities Agreement
of
Folksamerica Reinsurance Company New York, New York (hereinafter referred to as the "Subscribing Reinsurer")
attached thereto
It Is Hereby Agreed that this Contract and the Interests and Liabilities Agreement under which the Subscribing Reinsurer has a 12.5% share in the interests and liabilities of the "Reinsurer" shall be terminated at 12:01 a.m., January 1, 1998.
It Is Further Agreed that the Subscribing Reinsurer shall return to the Company its 12.5% share of the ceded unearned premium in force at 12:01 a.m., January 1, 1998 (less commission allowed thereon), as promptly as possible after that date. In consideration thereof, the Subscribing Reinsurer shall have no liability hereunder with respect to losses arising out of occurrences commencing at or after the effective time and date of termination.
In Witness Whereof, the parties hereto by their respective duly authorized representatives have executed this Addendum as of the dates undermentioned at:
Glenmont, New York, this _______ day of ___________________________________ 199___.
- ----------------------------------------------------- Farm Family Casualty Insurance Company
New York, New York, this _______ day of _________________________ 199___.
- ----------------------------------------------------- Folksamerica Reinsurance Company
E-6
Termination Addendum
to the
Umbrella Quota Share Reinsurance Contract Effective: January 1, 1995
issued to
Farm Family Casualty Insurance Company Glenmont, New York (hereinafter referred to as the "Company")
and to the
Interests and Liabilities Agreement
of
Kemper Reinsurance Company Long Grove, Illinois (hereinafter referred to as the "Subscribing Reinsurer")
attached thereto
It Is Hereby Agreed that this Contract and the Interests and Liabilities Agreement under which the Subscribing Reinsurer has a 27.5% share in the interests and liabilities of the "Reinsurer" shall be terminated at 12:01 a.m., January 1, 1998.
It Is Further Agreed that the Subscribing Reinsurer shall return to the Company its 27.5% share of the ceded unearned premium in force at 12:01 a.m., January 1, 1998 (less commission allowed thereon), as promptly as possible after that date. In consideration thereof, the Subscribing Reinsurer shall have no liability hereunder with respect to losses arising out of occurrences commencing at or after the effective time and date of termination.
In Witness Whereof, the parties hereto by their respective duly authorized representatives have executed this Addendum as of the dates undermentioned at:
Glenmont, New York, this _______ day of ___________________________________ 199___.
- ----------------------------------------------------- Farm Family Casualty Insurance Company
Long Grove, Illinois, this _______ day of _________________________199___.
- ----------------------------------------------------- Kemper Reinsurance Company
E-7
Termination Addendum
to the
Umbrella Quota Share Reinsurance Contract Effective: January 1, 1995
issued to
Farm Family Casualty Insurance Company Glenmont, New York (hereinafter referred to as the "Company")
and to the
Interests and Liabilities Agreement
of
Signet Star Reinsurance Company Wilmington, Delaware (hereinafter referred to as the "Subscribing Reinsurer")
attached thereto
It Is Hereby Agreed that this Contract and the Interests and Liabilities Agreement under which the Subscribing Reinsurer has a 32.5% share in the interests and liabilities of the "Reinsurer" shall be terminated at 12:01 a.m., January 1, 1998.
It Is Further Agreed that the Subscribing Reinsurer shall return to the Company its 32.5% share of the ceded unearned premium in force at 12:01 a.m., January 1, 1998 (less commission allowed thereon), as promptly as possible after that date. In consideration thereof, the Subscribing Reinsurer shall have no liability hereunder with respect to losses arising out of occurrences commencing at or after the effective time and date of termination.
In Witness Whereof, the parties hereto by their respective duly authorized representatives have executed this Addendum as of the dates undermentioned at:
Glenmont, New York, this _______ day of ___________________________________ 199___.
- ----------------------------------------------------- Farm Family Casualty Insurance Company
Florham Park, New Jersey, this _______ day of _______________________________ 199___.
- ----------------------------------------------------- Signet Star Reinsurance Company
E-8
Exhibit 13
Management's Discussion and Analysis of Financial Condition and Results of Operations.
General
Corporate Profile The following discussion and analysis of financial condition and results of operations includes the operations of Farm Family Holdings, Inc. ("Farm Family Holdings") and its wholly owned subsidiaries (collectively referred to as the "Company"). The primary subsidiary of Farm Family Holdings is Farm Family Casualty Insurance Company ("Farm Family Casualty"). The operations of the Company are also closely related with those of its affiliates, Farm Family Life Insurance Company ("Farm Family Life") and Farm Family Life's wholly owned subsidiary, United Farm Family Insurance Company ("United Farm Family").
Farm Family Farm Family Casualty is a specialized property and casualty insurer of farms, other generally related businesses and residents of rural and suburban communities principally in the Northeastern United States. Farm Family Casualty provides property and casualty insurance coverages to members of the state Farm Bureau(R) organizations in New York, New Jersey, Delaware, West Virginia and all of the New England states. Membership in a state Farm Bureau organization is a prerequisite for insurance coverage (except for employees of the Company and its affiliates). During 1997, the Company created Farm Family Financial Services, Inc., a wholly owned subsidiary. Farm Family Financial Services, Inc. entered into a mutually beneficial agreement with a national broker-dealer that allows the Company's agents to offer mutual funds and other securities products to their clients.
Farm Family Holdings entered into an Option Purchase Agreement with the shareholders of Farm Family Life pursuant to which Farm Family Holdings has, for a two-year period commencing on July 26, 1996, the option to acquire Farm Family Life subject to certain conditions. On February 26, 1998, the Board of Directors of Farm Family Holdings approved the exercise of the option to acquire Farm Family Life and its wholly owned subsidiary United Farm Family. Under the terms of the Option Purchase Agreement, Farm Family Holdings will pay an exercise price of $37.5 million to acquire Farm Family Life, consisting of $31.5 million of common stock of Farm Family Holdings, and $6 million stated value of 6-1/8% voting preferred stock of Farm Family Holdings. The proposed acquisition of Farm Family Life is subject to the approval of the shareholders of Farm Family Holdings and receipt of all required government approvals. Management expects that the acquisition of Farm Family Life will be brought to the shareholders of Farm Family Holdings for their approval in 1998.
1997 Financial Highlights The Company's operating earnings for the year ended December 31, 1997 increased $5.4 million to $15.0 million compared to $9.6 million in 1996. On a per share basis (diluted), operating earnings for 1997 were $2.84 compared to $2.42 in 1996. Operating earnings exclude realized investment gains (losses), extraordinary items, and the related taxes thereon. Premium revenue increased 14.1% during the year ended December 31, 1997 to $149.2 million from $130.8 million in 1996. In addition, the Company's GAAP combined ratio decreased to 97.2% in 1997 from 101.8% in 1996.
Operating Environment The Company's operating results are subject to significant fluctuations from period to period depending upon, among other factors, the frequency and severity of losses from weather related and other catastrophic events, the effect of competition and regulation on the pricing of products, changes in interest
E-9
rates, general economic conditions, tax laws and the regulatory environment. As a condition of its license to do business in various states, the Company is required to participate in a variety of mandatory residual market mechanisms (including mandatory pools) which provide certain insurance (most notably automobile insurance) to consumers who are otherwise unable to obtain such coverages from private insurers. In all such states, residual market premium rates are subject to the approval of the State Insurance Department. Residual market premium rates for automobile insurance have generally been inadequate. The amount of future losses or assessments from residual market mechanisms cannot be predicted with certainty and could have a material adverse effect on the Company's results of operations.
For the years ended December 31, 1997, 1996, and 1995, 36.5%, 38.6% and 39.1%, respectively, of the Company's direct written premiums were derived from policies written in New York and 26.3%, 22.6% and 20.8%, respectively, were derived from policies written in New Jersey. For these periods, no other state accounted for more than 10.0% of the Company's direct written premiums. As a result of the concentration of the Company's business in the states of New York and New Jersey, and more generally, in the Northeastern United States, the Company's results of operations may be significantly affected by weather conditions, catastrophic events and regulatory developments in these two states and in the Northeastern United States, generally.
Many of the Company's existing computer programs use only two digits to identify a year in the date field. These programs were designed and developed without considering the impact of the upcoming change in the century. If not corrected, many of these computer applications could fail or create erroneous results by or at the Year 2000. The Year 2000 issue affects virtually all companies and organizations . Therefore, the Company must also coordinate with other entities with which it interacts to ensure these entities are also addressing the Year 2000 issue. If not successfully addressed, the Year 2000 issue could have material adverse consequences on the Company. The Company has an on-going, enterprise-wide project to address its Year 2000 issue. During 1998, the Company will perform system-wide testing to support its plan of having policy administration systems Year 2000 compliant by December 31, 1998. Year 2000 work on remaining systems will continue through 1999. In addition, the Company has contacted other entities on which it relies to process and support its business. The Company will react to their plans to achieve Year 2000 compliance and will adjust operations as required. The Company believes it will successfully address its Year 2000 issue without material adverse consequences to the Company. However, there can be no assurance that other entities with which the Company interacts will achieve Year 2000 compliance or that the failure by such entities to achieve Year 2000 compliance would not have a material adverse effect on the Company.
Products The Special Farm Package is a flexible, multi-line package of insurance coverages which the Company regards as its "flagship" product. For the year ended December 31, 1997, 22.8% of the Company's total direct written premiums were derived from the Special Farm Package product.
The Company concentrates on its primary products: personal and commercial automobile, the Special Farm Package, businessowners, Special Home Package and homeowners policies. The Company underwrites its commercial and personal lines risks by evaluating historical loss experience, current prevailing market conditions, and product profitability with consistently applied standards. The adequacy of premium rates is affected mainly by the severity and frequency of claims and changes in the competitive, legal and regulatory environment in which the Company operates.
Expense Management During 1997, the Company continued the expense management initiatives it began
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during 1996. The goal of the Company's expense management initiatives is to continually review its cost structure and reduce or eliminate certain expenses. Additionally, the Company seeks to tie expenses to operating results so that expenses become increasingly more variable with the Company's profitability and less fixed or volume sensitive. As a result, portions of the compensation for agents, employees and management are influenced by the Company's operating results. These programs help to align the Company's interests more directly with those of its shareholders. As a result of these initiatives, as well as an increase in the Company's premium revenue at a greater rate than its expenses, the Company's underwriting expenses as a percentage of premium revenue were reduced during 1997 to 28% compared to 29.2% for 1996.
Future Application of Accounting Standards In June 1997, the Financial Accounting Standards Board issued Statement No. 130 "Comprehensive Income" ("Statement 130"), which establishes standards for the reporting and disclosure of comprehensive income and its components (revenues, expenses, gains and losses). Statement 130 requires that all items that are required to be recognized under accounting standards as components of comprehensive income be reported in a financial statement that is displayed with the same prominence as other financial statements. Statement 130 requires that an enterprise (a) classify items of other comprehensive income by their nature in a financial statement and (b) display the accumulated balance of other comprehensive income separately from retained earnings and additional paid-in capital in the equity section of a statement of financial position. Statement 130 is effective for the fiscal years beginning after December 15, 1997. The Company will adopt Statement 130 in 1998.
Results of Operations
The Year Ended December 31, 1997 Compared to the Year Ended December 31, 1996
Premiums Premium revenue increased $18.4 million, or 14.1%, during the year ended December 31, 1997 to $149.2 million from $130.8 million in 1996. The increase in premium revenue in 1997 resulted from an increase of $18.2 million in earned premiums on additional business directly written by the Company (principally in New Jersey and New York) and an increase of $3.7 million in earned premiums assumed by the Company, offset by an increase of $3.5 million in earned premium ceded to reinsurers. The $18.2 million increase in earned premiums on additional business directly written by the Company was primarily attributable to an increase of $15.8 million, or 13.4%, in earned premiums from the Company's primary products (personal and commercial automobile products other than assigned risk automobile business, the Special Farm Package, businessowners products, homeowners products, and Special Home Package), an increase of $1.0 million in earned premiums on workers' compensation business, an increase of $0.5 million in earned premium from assigned risk automobile business, and an increase of $0.9 million in earned premium from the Company's other products. Premiums earned on personal automobile policies in the state of New Jersey accounted for $6.5 million of the $18.2 million increase in earned premiums from the Company's primary products. The number of policies in force of the Company's primary products increased by 11.4% to approximately 127,000 in 1997 from approximately 114,000 in 1996 and the average premium earned for each such policy increased by 1.6% in 1997.
Net Investment Income Net investment income increased $2.1 million, or 13.3%, to $18.1 million for the year ended December 31, 1997 from $16.0 million in 1996. The increase in net investment income was primarily the result of an increase in cash and invested assets (at amortized cost) of approximately $36.4 million, or 15.3%. The increase in average cash and invested assets was primarily attributable to the
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investment of available operating cash flows during 1997. The return realized on the Company's cash and invested assets was 7.0% in 1997 and 7.5% in 1996.
Net Realized Investment Gains (Losses) Net realized investment gains were $5.4 million for the year ended December 31, 1997 compared to a loss of $0.6 million in 1996. The increase in realized investment gains was primarily attributable a realized gain on the sale of a common stock investment in 1997.
Losses and Loss Adjustment Expenses Losses and loss adjustment expenses increased $8.3 million, or 8.8%, to $103.3 million for the year ended December 31, 1997 from $95.0 million in 1996. The increase in losses and loss adjustment expenses was primarily attributable to the overall growth in the Company's business. Loss and loss adjustment expenses were 69.2% of premium revenue in 1997 compared to 72.6% of premium revenue in 1996. Losses and loss adjustment expenses believed to be weather related aggregated $5.2 million in 1997 compared to $10.6 million in 1996.
Underwriting Expenses Underwriting expenses increased $3.6 million, or 9.5%, to $41.8 million for the year ended December 31, 1997 from $38.2 million for the same period in 1996. For the year ended December 31, 1997, underwriting expenses were 28.0% of premium revenue compared to 29.2% in 1996. The reduction in the Company's underwriting expense ratio was primarily attributable to a smaller relative increase in overhead expenses than in premium revenue for the period and the Company's continued expense management initiatives which began in 1996.
Federal Income Tax Expense Federal income tax expense increased $6.0 million to $9.7 million in 1997 from $3.7 million in 1996. Federal income tax expense was 34.5% of income before federal income taxes in 1997 compared to 30.3% in 1996. The increase in income tax expense was primarily the result of the Company's increased premium volume and favorable operating results during 1997.
Net Income Net income increased $11.6 million to $18.5 million in 1997 from $6.9 million in 1996 primarily as a result of the foregoing factors and the impact of $1.5 million of expenses related to the demutualization of the Company which the Company has identified as an extraordinary item in 1996, as well as the implementation of a voluntary early retirement program which resulted in a one time charge to earnings of $0.8 million net of tax in the last quarter of 1996.
The Year Ended December 31, 1996 Compared to the Year Ended December 31, 1995
Premiums Premium revenue increased $13.9 million, or 11.8%, during the year ended December 31, 1996 to $130.8 million from $116.9 million in 1995. The increase in premium revenue in 1996 resulted from an increase of $11.1 million in earned premiums on additional business directly written by the Company (principally in New York and New Jersey) and an increase of $2.4 million in earned premiums retained by the Company and not ceded to reinsurers, in addition to an increase of $0.4 million in earned premiums assumed. The $11.1 million increase in earned premiums on additional business directly written by the Company was primarily attributable to an increase of $9.9 million, or 9.2%, in earned premiums from the Company's primary products (personal and commercial automobile products other than assigned risk business, the Special Farm Package, businessowners products, homeowners products, and Special Home Package) and to an increase of $0.7 million in earned premiums on workers' compensation business. The number of
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policies in force related to the Company's primary products increased by 8.6% to approximately 114,000 in 1996 from approximately 105,000 in 1995 and the average premium earned for each such policy increased by 0.6% in 1996. The $2.4 million increase in earned premiums retained by the Company was primarily the result of a change in the terms of certain of the Company's reinsurance agreements pursuant to which the earned premiums ceded by the Company were reduced.
Net Investment Income Net investment income increased $1.6 million, or 11.3%, to $15.9 million for the year ended December 31, 1996 from $14.3 million in 1995. The increase in net investment income was primarily the result of an increase in cash and invested assets (at amortized cost) of approximately $34.7 million, or 17.7%. The increase in average cash and invested assets was primarily attributable to the net proceeds of $31.0 million from Farm Family Holdings' initial public offering received in July 1996. The return realized on the Company's cash and invested assets was 7.5% in 1996 and 7.6% in 1995.
Net Realized Investment Gains (Losses) Net realized investment losses were $0.6 million for the year ended December 31, 1996 compared to a gain of $0.9 million in 1995.
Losses and Loss Adjustment Expenses Losses and loss adjustment expenses increased $11.8 million, or 14.2%, to $95.0 million for the year ended December 31, 1996 from $83.2 million in 1995. The increase in losses and loss adjustment expenses was primarily attributable to the overall growth in the Company's business, as well as the frequency of weather related losses in the Northeastern United States during the three months ended March 31, 1996. Loss and loss adjustment expenses were 72.6% of premium revenue in 1996 compared to 71.1% of premium revenue in 1995. Losses and loss adjustment expenses believed to be weather related aggregated $10.6 million in 1996 compared to $5.2 million in 1995.
Underwriting Expenses Underwriting expenses increased $3.3 million, or 9.3%, to $38.2 million for the year ended December 31, 1996 from $34.9 million for the same period in 1995. For the year ended December 31, 1996, underwriting expenses were 29.2% of premium revenue compared to 29.8% in 1995. The reduction in the Company's underwriting expense ratio was primarily attributable to a smaller relative increase in overhead expenses than in premium revenue for the period.
Federal Income Tax Expense Federal income tax expense decreased $1.3 million to $3.7 million in 1996 from $5.0 million in 1995. Federal income tax expense was 30.3% of income before federal income taxes in 1996 compared to 34.2% in 1995. The decrease in the Company's effective federal income tax rate was primarily attributable to an increase in tax exempt interest income in 1996.
Net Income Net income decreased $2.7 million to $6.9 million in 1996 from $9.6 million in 1995 primarily as a result of the foregoing factors and the impact of $1.5 million of expenses related to the demutualization of the Company which the Company has identified as an extraordinary item in 1996, as well as the implementation of a voluntary early retirement program which resulted in a one time charge to earnings of $0.8 million net of tax in the last quarter of 1996.
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Liquidity and Capital Resources
Historically, the principal sources of the Company's cash flow have been premiums, investment income, maturing investments, and proceeds from sales of invested assets. In addition to the need for cash flow to meet operating expenses, the liquidity requirements of the Company relate primarily to the payment of losses and loss adjustment expenses. The liquidity requirements of the Company vary because of the uncertainties regarding the settlement dates for liabilities for unpaid claims and because of the potential for large losses, either individually or in the aggregate.
At December 31, 1997, the Company's cash and invested assets, at amortized cost, was $274.9 million, a $36.4 million increase from 1996. The increase is primarily the result of the investment of operating cash flows. During 1997, the Company continued to invest primarily in investment grade fixed maturities to maintain the overall quality of its investment portfolio. Fixed maturity securities, at amortized cost, rated as investment grade by the National Association of Insurance Commissioners was $248.9 million, or 96.5% of its fixed maturity portfolio, at December 31, 1997 compared to $217.7 million, or 97.2% of its fixed maturity portfolio, at December 31, 1996. High yield corporate bonds constituted most of the non-investment grade securities held by the Company as of December 31, 1997 and 1996. The Company also increased its investments, at amortized cost, in tax exempt bonds from $21.6 million in 1996 to $31.7 million in 1997. The mortgage-backed securities held by the Company as of December 31, 1997 were primarily GNMA, FNMA, and Federal Home Loan Mortgage Corp. pass-through securities. The Company currently has no investments in such derivative financial instruments as futures, forward, swap, or option contracts, or other financial instruments with similar characteristics. The market value of the Company's fixed maturity investments is subject to fluctuations directly attributable to prevailing rates of interest as well as other factors. As of December 31, 1997 and 1996, the aggregate market value of the Company's fixed maturity investments exceeded the aggregate amortized cost of such investments by $10.6 million and $5.2 million, respectively.
The Company has in place unsecured lines of credit with two banks under which it may borrow up to $12.0 million. At December 31, 1997, no amounts were outstanding on the lines of credit each of which has an annual interest rate equal to such bank's prime rate. In addition, the Company's reinsurance intermediary has extended to the Company a "Rapid Recovery Facility" under which the Company, at its option, can receive cash advances of up to $7.7 million within 48 hours of experiencing a catastrophic loss. There is no interest rate associated with this facility. The Company did not utilize this facility in 1997, 1996 or 1995.
In addition, the Company had notes payable outstanding consisting of $0.3 million of debentures and $1.0 million of subordinated surplus certificates (collectively "the Surplus Notes"). The Surplus Notes bear interest at the rate of eight percent per annum, have no maturity date, and principal and interest are repayable only with the approval of the Insurance Department of the State of New York. Interest expense incurred by the Company on the Surplus Notes for the years ended December 31, 1997, 1996 and 1995 was $102,000, $167,000 and $216,000, respectively. The Company has received conditional approval from the Insurance Department of the State of New York to redeem all of the Surplus Notes outstanding, and plans to do so effective April 1, 1998. Principal and accrued interest on the Surplus Notes as of April 1, 1998 will be approximately $1.4 million.
Net cash provided by operating activities was $31.4 million, $11.8 million, and $16.4 million during the years ended December 31, 1997, 1996, and 1995, respectively. The increase in net cash provided by operating activities in 1997 was primarily attributable to the increase in premiums collected, interest and dividends received, and a reduction in losses paid relative to the increase in premiums collected. The decrease in cash provided by operating activities in 1996 compared to 1995 was primarily attributable to the decrease in net income
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which included the impact of $1.5 million of expenses related to the demutualization of the Company which the Company has identified as an extraordinary item during 1996.
Net cash used in investing activities was $29.6 million, $41.1 million, and $18.5 million during the years ended December 31, 1997, 1996, and 1995, respectively. The decrease in net cash used in investing activities in 1997 resulted primarily from an increase in investment collections from fixed maturities available for sale and proceeds from sales of equity securities. The increase in net cash used in investing activities in 1996 resulted primarily from a reduction in proceeds on the maturities and sales of fixed maturities and the investment of the net proceeds from the Company's initial public offering.
Net cash provided by financing activities for the year ended December 31, 1996 of $30.9 million was the result of the Company's initial public offering of its common stock on July 23, 1996. The Company received net proceeds of $41.5 million for approximately 2,786,000 shares sold in the initial public offering, including the underwriters' over-allotment, as well as $3.4 million for approximately 214,000 shares sold in a subscription offering to policyholders. The Company made payments of $11.7 million to policyholders in exchange for their membership interest in Farm Family Mutual Insurance Company and $1.1 million to holders of Farm Family Mutual Insurance Company debt pursuant to the Plan of Reorganization and Conversion. In addition, the net proceeds were utilized to pay certain expenses associated with the initial public offering of $1.1 million. Subsequent to the initial public offering, Farm Family Holdings made an $18.0 million capital contribution to Farm Family Casualty.
Effective December 31, 1997, the Company revised its reinsurance program. The Company's reinsurance agreement with its affiliate, United Farm Family, was terminated effective December 31, 1997. As a result, the Company's retention per claim under its current reinsurance program will increase from $100,000 to $300,000 in 1998. In addition, the Company entered into an agreement which provides reinsurance protection within certain dollar limits for losses in excess of a predetermined ratio of losses to earned premiums. This agreement covers all direct and assumed voluntary business as well as mandatory residual market mechanisms. The Company's reinsurance program is structured to partially mitigate the impact of large or unusual losses as well as the aggregation of smaller, more frequent losses on liquidity and operating results.
The New York Insurance Law regulates the distribution of dividends and other payments to Farm Family Holdings by Farm Family Casualty. As of December 31, 1997, the maximum amount of dividends that can be paid by Farm Family Casualty without the prior approval of the New York State Insurance Department is $1.9 million. Such restrictions or any subsequently imposed restrictions may in the future affect the liquidity of Farm Family Holdings. The Company believes that its liquidity and capital resources are adequate for the coming year.
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1. Summary of Significant Accounting Policies
Basis of Presentation:
The accompanying consolidated financial statements have been prepared in conformity with generally accepted accounting principles and include the accounts of Farm Family Holdings, Inc. ("Farm Family Holdings") and its wholly owned subsidiaries (collectively referred to as the "Company"). The primary subsidiary of Farm Family Holdings is Farm Family Casualty Insurance Company ("Farm Family Casualty"). All significant intercompany balances and transactions have been eliminated. The preparation of financial statements in accordance with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
The Company provides property and casualty insurance coverages to members of the state Farm Bureau(R) organizations in New York, New Jersey, Delaware, West Virginia and all of the New England states. Membership in the state Farm Bureau organizations is a prerequisite for voluntary insurance coverage, except for employees of the Company and its affiliates.
The operations of the Company are closely related with those of its affiliates, Farm Family Life Insurance Company ("Farm Family Life") and Farm Family Life's wholly owned subsidiary, United Farm Family Insurance Company ("United Farm Family") (see Note 10). Farm Family Life is a stock life insurance company owned by the state Farm Bureau organizations of the ten states in which the Company operates. Farm Family Holdings has entered into an Option Purchase Agreement with the shareholders of Farm Family Life pursuant to which Farm Family Holdings has, for a two-year period commencing on July 26, 1996, the option to acquire Farm Family Life subject to certain conditions (See Note 15). The Company and Farm Family Life are affiliated by common management, shared agents and employees and similar Boards of Directors.
Investments:
Fixed maturities include bonds, redeemable preferred stocks and mortgage-backed securities. Investments in fixed maturities which the Company has both the ability and positive intent to hold to maturity are classified as held to maturity and carried at amortized cost. Investments classified as held to maturity on the Company's consolidated balance sheets consist primarily of private placements. Fixed maturities which may be sold prior to their contractual maturity are classified as available for sale and are carried at fair value on the Company's consolidated balance sheets. The difference between amortized cost and fair value of fixed maturities classified as available for sale, net of deferred income taxes, is reflected as a component of stockholders' equity.
Equity securities include common and non-redeemable preferred stocks which are carried at fair value. The difference between cost and fair value of equity securities, less deferred income taxes, is reflected as a component of stockholders' equity.
Mortgage loans are carried at their outstanding principal balance.
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The carrying values of all investments are reviewed on an ongoing basis. If this review indicates a decline in fair value below cost is other than temporary, the Company's carrying value in the investment is reduced to its estimated realizable value and a specific write-down is taken. Such write-downs are included in realized investment gains and losses.
Short-term investments are carried at cost which approximates fair value.
Investment income consists primarily of interest and dividends. Interest is recognized on an accrual basis and dividends are recorded on the ex-dividend date. Interest income on mortgage-backed securities is determined by the effective yield method based on estimated principal repayments. Realized investment gains and losses are determined on a specific identification basis.
Income Taxes:
The income tax provision is calculated under the liability method. Deferred income tax assets and liabilities are recorded based on the difference between the financial statement and tax bases of assets and liabilities and the enacted tax rates. The principal assets and liabilities giving rise to such differences are reserves for losses and loss adjustment expenses, unearned premiums, and deferred acquisition costs. Deferred income taxes also arise from unrealized investment gains or losses on equity securities and fixed maturities classified as available for sale.
Stock Compensation Plan:
Financial Accounting Standards Board Statement No. 123, "Accounting for Stock-Based Compensation" ("Statement 123") applies to all stock-based employee compensation plans (except employee stock ownership plans) in which an employer grants shares of its stock or other equity instruments to employees. Statement 123 permits a company to choose either the fair value or the intrinsic value based method of accounting as prescribed by Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25"), for its stock-based compensation plans. The Company has elected to account for its stock compensation plan using the intrinsic value based method as prescribed by APB 25.
Property-Liability Insurance Accounting:
Premiums are deferred and earned on a pro rata basis over the terms of the respective policies. Amounts paid for ceded reinsurance premiums are reported as prepaid reinsurance premiums and amortized over the remaining contract period in proportion to premium. Premiums receivable are recorded at cost less an allowance for doubtful accounts.
Policy acquisition costs that vary with and are primarily related to the production of business have been deferred. Deferred acquisition costs primarily consist of agents' compensation, premium taxes, and certain other underwriting expenses. Such deferred acquisition costs are amortized as premium revenue is recognized. Deferred acquisition costs are limited to their estimated realizable value, which gives effect to the premium to be earned, related investment income, and losses and loss adjustment expenses expected to be incurred as the premium is earned.
Reserves for losses and loss adjustment expenses represent estimates of the ultimate amounts necessary to settle reported losses and a provision for incurred but not reported claims of insured losses. The
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reserve estimates are based on known facts and circumstances, including the Company's experience with similar cases and historical trends involving reserving patterns, loss payments, pending levels of unpaid claims and product mix, as well as other factors including court decisions, economic conditions and public attitudes. The reserves for losses and loss adjustment expenses include case basis estimates of reported losses, estimates of incurred but not reported losses based upon prior experience adjusted for current trends, and estimates of losses to be paid under assumed reinsurance contracts. Estimated amounts of recoverable salvage and subrogation are deducted from the reserves for losses and loss adjustment expenses. The establishment of appropriate reserves, as well as related amounts recoverable under reinsurance contracts is an inherently uncertain process. Reserve estimates are regularly reviewed and updated, using the most current information available. Any resulting adjustments, which may be material, are reflected in current operations (see Note 7).
Net Income Per Share:
In 1997, the Financial Accounting Standards Board issued Statement No. 128, "Earnings Per Share" ("Statement 128"). Statement 128 replaced the calculation of primary and fully diluted earnings per share with basic and diluted earnings per share. Unlike primary earnings per share, basic earnings per share excludes any dilutive effects of options, warrants, and convertible securities. Diluted earnings per share is very similar to the previously reported fully diluted earnings per share. All earnings per share amounts for all periods presented conform to the Statement 128 requirements.
The following table presents a reconciliation of the numerators and denominators of the basic and diluted earnings per share computations.
The weighted average number of shares of common stock in 1996 and 1995 gives effect to the allocation of 3,000,000 shares of common stock to eligible policyholders on July 26, 1996 pursuant to Farm Family Casualty's conversion from a mutual company to a stockholder owned company.
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2. Plan of Reorganization and Conversion
On July 26, 1996, Farm Family Mutual Insurance Company ("Farm Family Mutual") converted from a mutual property and casualty insurance company to a stockholder owned property and casualty insurance company and changed its name to Farm Family Casualty Insurance Company. The conversion was made pursuant to a Plan of Reorganization and Conversion (the "Plan"). As part of the Plan, Farm Family Holdings was formed and the policyholders received approximately 2,237,000 shares of Farm Family Holdings common stock and $11,735,000 in cash in exchange for their membership interests in Farm Family Mutual.
On July 23, 1996, Farm Family Holdings made an initial public offering of its common stock at a price of $16 per share. Farm Family Holdings received net proceeds of $41,453,000 for 2,786,000 shares sold in the initial public offering. In addition, Farm Family Holdings received net proceeds of $3,427,000 for approximately 214,000 shares purchased by policyholders of Farm Family Mutual in a subscription offering.
As part of the Plan, holders of Farm Family Mutual debt (see Note 8) could elect to exchange their debt instruments for shares of stock or cash. As a result, there were 17,000 shares and $1,107,000 in cash exchanged for debt with an outstanding principal amount of $1,371,000 plus accrued interest thereon.
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3. Investments
The amortized cost, fair value and gross unrealized gains and losses of available for sale securities and held to maturity securities at December 31, 1997 and 1996 are as follows:
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The table below presents the amortized cost and fair value of fixed maturities at December 31, 1997, by contractual maturity. Actual maturities may differ from contractual maturities as a result of prepayments.
Unrealized investment gains and losses on fixed maturities classified as available for sale and equity securities included in stockholders' equity at December 31, 1997 are as follows:
The change in unrealized appreciation (depreciation) of investments included in stockholders' equity for the years ended December 31, 1997, 1996 and 1995 was as follows:
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The components of net investment income are as follows:
A summary of realized investment gains (losses), net, is as follows:
4. Fair Value of Financial Instruments
The estimated fair value of financial instruments has been determined using available market information and appropriate value methodologies. The estimated fair value of financial instruments is not necessarily indicative of the amounts the Company might pay or receive in actual market transactions. Potential taxes and other transaction costs have not been considered in estimating fair value. As a number of the Company's significant assets (including deferred acquisition costs, and deferred income taxes) and liabilities (including reserves for losses and loss adjustment expenses) are not considered financial instruments, the disclosures that follow do not reflect the fair value of the Company as a whole.
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The following table presents the carrying value and fair value of the Company's financial instruments at December 31, 1997 and 1996.
The following methods and assumptions were used in estimating the fair value disclosures for the financial instruments:
Fixed maturities and equity securities -- The fair value is based upon quoted market prices where available or from independent pricing services.
Mortgage loans -- The fair value is based on discounted cash flows using discount rates at which similar loans would be made to borrowers with similar characteristics.
Cash and Short-term Investments -- Due to their short-term, highly liquid nature, their carrying value approximates fair value.
Premiums Receivable, net; Accrued Investment Income and Other Assets; Receivable from Affiliates, net; and Accrued Expenses and Other Liabilities -- Due to their short-term nature, their carrying value approximates fair value.
Debt -- The fair value is based on discounted cash flows using current borrowing rates for similar debt arrangements.
5. Reinsurance
The Company assumes and cedes insurance to participate in the reinsurance market, to geographically diversify its exposure to catastrophic losses, limit maximum losses and minimize exposure on large risks (see Note 12). Reinsurance contracts do not relieve the Company from its obligations to policyholders as the primary insurer. The Company evaluates the financial condition of its reinsurers and monitors concentrations of credit risk arising from similar geographic regions, activities and economic characteristics of the reinsurers to minimize its exposure to significant losses from reinsurer insolvencies. Amounts recoverable are regularly evaluated by the Company and an allowance for uncollectible reinsurance is provided when collection is in doubt. At December 31, 1997 and 1996, the Company determined it was not necessary to provide an allowance for uncollectible reinsurance.
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The Company's reinsurance program also includes reinsurance agreements with United Farm Family (see Note 10).
The effects of reinsurance on premiums written and earned, and losses and loss adjustment expenses incurred, for the years indicated were as follows:
Effective December 31, 1997, the Company revised its reinsurance program. The Company's reinsurance agreement with its affiliate, United Farm Family, was terminated effective December 31, 1997. As a result, the Company's retention per claim under its current reinsurance program will increase from $100,000 to $300,000.
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6. Income Taxes
The components of the deferred income tax assets and liabilities at December 31, 1997 and 1996 are as follows:
There was no valuation allowance for deferred income tax assets as of December 31, 1997 or 1996. In assessing the realization of deferred tax assets, management considers whether it is more likely than not that the deferred tax assets will be realized. Management primarily considered the existence of taxable income in the carryback period in making this assessment and believes the benefits of the deductible differences recognized as of December 31, 1997 and 1996 will ultimately be realized.
The components of income tax expense (benefit) are as follows:
The Company paid income taxes of $9,962,000, $4,592,000, and $3,952,000 in 1997, 1996 and 1995 respectively.
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A reconciliation of the differences between the Company's effective tax rates and the United States federal income tax rates follows:
7. Reserves for Losses and Loss Adjustment Expenses
As described in Note 1, the Company establishes reserves for losses and loss adjustment expenses on reported and incurred but not reported claims of insured losses. The establishment of appropriate reserves for losses and loss adjustment expenses is an inherently uncertain process and the ultimate cost may vary materially from the recorded amounts. Reserve estimates are regularly reviewed and updated, using the most current information. Any resulting adjustments, which may be material, are reflected in current operations.
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The following table provides a reconciliation of beginning and ending liability balances for reserves for losses and loss adjustment expenses for the years ended December 31, 1997, 1996 and 1995.
The Company does not discount reserves for losses and loss adjustment expenses except for certain lifetime workers' compensation indemnity reserves it assumes from mandatory pools. The amount of such discounted reserves was $3,986,000 (net of a discount of $1,229,000), $4,184,000 (net of a discount of $1,185,000), and $4,754,000 (net of a discount of $1,192,000) for December 31, 1997, 1996 and 1995, respectively.
8. Debt
At December 31, 1997, debt consists of $293,000 of debentures and $975,000 of subordinated surplus certificates. The debentures and subordinated surplus certificates bear interest at the rate of 8% per annum, have no maturity date, and principal and interest are repayable only with the approval of the Insurance Department of the State of New York. No single holder holds more than 5% of the outstanding debentures or subordinated surplus certificates. The Company paid interest of $104,000, $279,000 and $217,000 for the years ended December 31, 1997, 1996 and 1995, respectively. The Company has received conditional approval from the Insurance Department of the State of New York to redeem all of the outstanding debentures and subordinated certificates
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and plans to do so effective April 1, 1998. Principal and accrued interest on the Surplus Notes, as of April 1, 1998 will be approximately $1,395,000.
At December 31, 1997, the Company had available lines of credit with two banks for $12,000,000. There were no amounts outstanding on these lines of credit at December 31, 1997.
9. Benefits Plans
Pension Plan: The Company and Farm Family Life sponsor a qualified multi-employer noncontributory defined benefit pension plan covering substantially all of the Company's and Farm Family Life's full-time employees who meet the eligibility requirements. Benefits under the pension plan are primarily based upon the employee's length of service and the employee's average compensation for certain periods during the last years of employment. The Company's funding policy for its defined benefit pension plan is to make annual contributions in accordance with accepted actuarial cost methods subject to regulatory funding limitations. Effective January 1, 1997, the Company and Farm Family Life froze benefits available through the defined benefit plan. In addition, the Company implemented a voluntary early retirement program in the fourth quarter of 1996 (see Note 14).
The net pension expense for the plan is as follows:
The Company incurred no net periodic pension expense in 1997 due to the freezing of the plan. The Company's portion of net periodic pension expense, excluding the expense of the voluntary early retirement program, for the years ended December 31, 1996 and 1995 was $617,000 and $537,000, respectively. In addition, the Company's portion of the expense related to the voluntary early retirement program was $1,155,000 for 1996.
Assumptions used in the determination of pension obligations and assets were:
Since benefits under the plan were frozen as of January 1, 1997, the rate of increase in compensation levels assumption for 1997 is 0.00%.
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The following table summarizes the funded status of the pension plan:
Plan assets primarily consist of cash, U.S. government securities, municipal and corporate debt instruments, common stock mutual funds, and an insurance group annuity contract.
The accrued pension liability of the plan was as follows:
Incentive Savings Plans: The Company and Farm Family Life sponsor employee incentive savings plans which are qualified under Section 401 of the Internal Revenue Code. Under the provisions of these plans, employees may contribute up to 15% of their eligible compensation, with up to 6% being eligible for matching contributions from the Company. In 1997, the Company contributed to the plans a matching contribution of 50% of the first 6% of eligible compensation deferred by each eligible employee and as a percentage of each employee's eligible compensation, a regular contribution of 3%, a profit sharing contribution of 3% and a money purchase contribution of 3%. The profit sharing contribution and a portion of the matching contributions made by the Company in 1997 were discretionary. In 1997, the Company established a non-qualified unfunded supplemental plan for those employees whose compensation exceeds the Internal Revenue Code compensation limits for qualified plans. The Company's expense associated with the plans was $1,082,000, $182,000 and $138,000 in 1997, 1996 and 1995, respectively. In 1995 and 1996, the Company contributed 1% of eligible compensation (up to $240 per employee) to the plan for all eligible employees.
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Postretirement Benefits Other Than Pensions: The Company and Farm Family Life provide life insurance benefits for retired employees meeting certain age and length of service requirements. The Company's postretirement benefit plan is currently unfunded and noncontributory. Benefits under the postretirement benefit plan are provided by a group term life insurance policy.
Net periodic postretirement benefit expense for the years ended December 31, 1997, 1996, and 1995 included the following:
The Company's portion of net periodic postretirement benefit expense for the years ended December 31, 1997, 1996 and 1995 was $79,000, $88,000 and $66,000. The Company's portion of the voluntary early retirement program expense in 1996 was $22,000.
The following table presents the plan's accumulated postretirement benefit obligation as of December 31, 1997 and 1996 reconciled with the plan's funded status and the amount recognized in the Company's consolidated balance sheets:
The discount rate used to determine the accumulated postretirement benefit obligation was 7.0% at December 31, 1997 and 1996.
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Stock Compensation Plan:
In 1997, Farm Family Holdings adopted the Omnibus Securities Plan (the "Securities Plan"), under which up to 500,000 shares of common stock are available for award. Stock options granted under the Securities Plan may be either incentive stock options ("ISO's") or non-qualified stock options ("NQSO's"). For ISO's the option price may be no less than the fair market value on the date of the grant. For NQSO's, the option price may be no less than 85% of the fair market value on the date of grant. On April 22, 1997, 215,000 NQSO's were granted. These NQSO's may be exercised no earlier than July 26, 1999 and no later than April 22, 2007. These NQSO's vest annually in equal amounts over a three year period commencing December 13, 1996 and have an exercise price of $22.56 per share, the fair market value of the stock on the date of grant. The following table summarizes the status of the Securities Plan for the year ended December 31, 1997 and changes during the year of 1997:
The Company has elected to follow Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25") and related interpretations in accounting for the Securities Plan. Under APB 25, because the exercise price of the Company's stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recognized. If the Company had determined the compensation expense of the Securities Plan as prescribed by Financial Accounting Standards Board Statement No. 123, "Accounting for Stock-Based Compensation" ("Statement 123"), the Company's net income and earnings per share for the year ended 1997 would have been reduced to the pro forma amounts indicated below:
The fair value of the options granted in 1997 is estimated on the date of grant using the Black-Scholes option-pricing model and the following weighted-average assumptions: dividend yield of 0.0%, expected volatility of 22.79%, risk-free interest rate of 6.78%, and an expected life of six years. At December 31, 1997, the exercise price for options outstanding is $22.56, and the weighted-average contractual life of the outstanding options is 9.3 years.
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10. Related Party Transactions
The operations of the Company are closely related with those of Farm Family Life and Farm Family Life's wholly owned subsidiary, United Farm Family. The affiliated Companies operate under similar Boards of Directors and have similar senior management. The affiliated Companies share home office premises, branch office facilities, data processing equipment, certain personnel and other operational expenses. Expenses are shared based on each Company's estimated level of usage. The gross shared expenses and the Company's share of such expenses is summarized below:
Farm Family Life held $813,000 of the Company's debentures in 1994 and 1995. In July 1996, the Company repurchased the debentures owned by Farm Family Life for the principal amount of $813,000 plus accrued interest of $37,000. The Company incurred interest expense of $37,000 in 1996 and $65,000 in 1995 on the debentures held by Farm Family Life.
The Company's reinsurance program includes reinsurance agreements with United Farm Family. In accordance with the provisions of these reinsurance agreements, the Company recognized commission income of $63,000, $191,000, and $2,000 during the years ended December 31, 1997, 1996 and 1995, respectively. Effective December 31, 1997, the Company has terminated the reinsurance agreements with United Farm Family. A summary of the effect of the reinsurance agreements with United Farm Family on premiums written and earned is described in Note 5.
Receivable from affiliates represents amounts due from United Farm Family pursuant to a reinsurance agreement and amounts due from Farm Family Life and United Farm Family for shared expenses.
11. Dividends From Subsidiaries and Statutory Financial Information
Farm Family Casualty is restricted by law as to the amount of dividends it can pay without the approval of regulatory authorities. As of December 31, 1997, the maximum amount of dividends that can be paid by Farm Family Casualty without the prior approval of the New York State Insurance Department is $1.9 million.
Net income and surplus of Farm Family Casualty, as determined in accordance with statutory accounting practices are as follows:
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The National Association of Insurance Commissioners ("NAIC") requires insurance companies to calculate and report risk based capital information under a set of formulas which measure statutory capital and surplus needs based on a regulatory definition of the risks in a company's mix of products and its balance sheet. As of December 31, 1997, Farm Family Casualty's total capital exceeds the threshold level of regulatory action, as defined by the NAIC.
12. Commitments, Contingencies and Uncertainties
The Company is party to numerous legal actions arising in the normal course of business. Management believes that resolution of these legal actions will not have a material adverse effect on its consolidated financial condition. Catastrophes are an inherent risk in the property and casualty insurance industry and could produce significant adverse fluctuations in the Company's results of operations and financial condition. The Company is subject to a concentration of risk within the Northeastern United States. For the years ended December 31, 1997, 1996 and 1995, approximately 63%, 61% and 60%, respectively, of the Company's direct premiums were written in the states of New York and New Jersey. As a result of the concentration of the Company's business in the states of New York and New Jersey, and more generally in the Northeastern United States, the Company's results of operations may be significantly affected by weather conditions, catastrophic events and regulatory developments in these two states and in the Northeastern United States, despite the Company's reinsurance program designed to mitigate the impact of these factors.
As a condition of its license to do business in various states, the Company is required to participate in a variety of mandatory residual market mechanisms (including mandatory pools) which provide certain insurance (most notably automobile insurance) to consumers who are otherwise unable to obtain such coverages from private insurers. The amount of future losses and assessments from residual market mechanisms can not be predicted with certainty and could have a material adverse effect on the Company's future results of operations.
Pursuant to agreements between the Company and its agents and agency managers, subject to certain conditions including length of service and profitability, certain agents and agency managers are eligible to receive monthly extended earnings payments for a period of up to eight years subsequent to the termination of their association with the Company. Historically, such payments have been funded from commissions earned on the agent's or agency manager's book of business subsequent to the termination of the agent's association with the Company in accordance with the Company's agreement with the successor agents and agency managers. In the event that such commissions are insufficient to fund the extended earnings payments, the Company would be responsible for such payments. The aggregate outstanding amount of the extended earnings payments which former agents and agency managers are entitled to receive for a period of up to eight years subsequent to December 31, 1997 is $4,168,000.
The Company is a party to Membership List Purchase Agreements with each of the state Farm Bureaus in the ten states in which it conducts business. The Membership List Purchase Agreements are for six years commencing on January 1, 1996. For the years ended December 31, 1997 and 1996, the Company paid a total of $600,000 and $571,000, respectively, to the Farm Bureaus pursuant to the Membership List Purchase Agreements. For the year ended December 31, 1995 the Company paid $547,000 to the Farm Bureaus under substantially similar Membership List Purchase Agreements in effect for 1995.
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At December 31, 1997, the Company had $1,422,000 of outstanding letters of credit. These letters of credit are issued to insurance companies that Farm Family Casualty has assumed reinsurance from and are domiciled in states where Farm Family Casualty is not licensed or authorized as a reinsurer.
Many of the Company's existing computer programs use only two digits to identify a year in the date field. These programs were designed and developed without considering the impact of the upcoming change in the century. If not corrected, many of these computer applications could fail or create erroneous results by or at the Year 2000. The Year 2000 issue affects virtually all companies and organizations . Therefore, the Company must also coordinate with other entities with which it interacts to ensure these entities are also addressing the Year 2000 issue. If not successfully addressed, the Year 2000 issue could have material adverse consequences on the Company. The Company has an on-going, enterprise-wide project to address its Year 2000 issues. During 1998, the Company will perform system-wide testing to support its plan of having policy administration systems Year 2000 compliant by December 31, 1998. Year 2000 work on remaining systems will continue through 1999. In addition, the Company has contacted other entities on which it relies to process and support its business. The Company will react to their plans to achieve Year 2000 compliance and will adjust operations as required. The Company believes it will successfully address its Year 2000 issues without material adverse consequences to the Company. However, there can be no assurance that other entities with which the Company interacts will achieve Year 2000 compliance or that the failure by such entities to achieve Year 2000 compliance would not have a material adverse effect on the Company.
13. Unaudited Interim Financial Information
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14. Extraordinary Item and Non-Recurring Expenses
During 1996, the Company incurred expenses of $1,543,000 related to the demutualization of Farm Family Mutual which the Company has identified as an extraordinary item. These expenses consisted primarily of printing, postage, and legal costs.
Pursuant to the Statement of Financial Accounting Standards No. 87, "Employers' Accounting for Pensions", the Company recorded a non-recurring expense of $765,000 which is net of an income tax benefit of $412,000, for the Company's share of the costs of a voluntary early retirement program offered to certain eligible employees in 1996. Eligibility for the program was based on age and years of service. 15. Acquisition of Farm Family Life
Farm Family Holdings entered into an Option Purchase Agreement with the shareholders of Farm Family Life pursuant to which Farm Family Holdings has, for a two-year period commencing on July 26, 1996, the option to acquire Farm Family Life subject to certain conditions. On February 26, 1998, the Board of Directors of Farm Family Holdings approved the exercise of the option to acquire Farm Family Life and its wholly owned subsidiary United Farm Family. Under the terms of the Option Purchase Agreement, Farm Family Holdings will pay an exercise price of $37.5 million to acquire Farm Family Life, consisting of $31.5 million of common stock of Farm Family Holdings, and $6 million stated value of 6-1/8% voting preferred stock of Farm Family Holdings. The proposed acquisition of Farm Family Life is subject to the approval of the shareholders of Farm Family Holdings and receipt of all required governmental approvals. Management expects that the acquisition of Farm Family Life will be brought to the shareholders of Farm Family Holdings for their approval in 1998.
16. Future Application of Accounting Standards
In June 1997, the Financial Accounting Standards Board issued Statement No. 130 "Comprehensive Income", ("Statement 130") which establishes standards for the reporting and disclosure of comprehensive income and its components (revenues, expenses, gains and losses). Statement 130 requires that all items that are required to be recognized under accounting standards as components of comprehensive income be reported in a financial statement that is displayed with the same prominence as other financial statements. Statement 130 requires that an enterprise (a) classify items of other comprehensive income by their nature in a financial statement and (b) display the accumulated balance of other comprehensive income separately from retained earnings and additional paid-in capital in the equity section of a statement of financial position. Statement 130 is effective for the fiscal years beginning after December 15, 1997. The Company will adopt Statement 130 in 1998.
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Report of Independent Accountants
To the Shareholders and Board of Directors of Farm Family Holdings, Inc.
We have audited the accompanying consolidated balance sheets of Farm Family Holdings, Inc. and Subsidiaries as of December 31, 1997 and 1996, and the related consolidated statements of income, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1997. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Farm Family Holdings, Inc. and Subsidiaries as of December 31, 1997 and 1996, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1997 in conformity with generally accepted accounting principles.
Coopers & Lybrand L.L.P.
Albany, New York February 13, 1998, except for Note 15, as to which the date is February 26, 1998
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