Table of Contents. Letter to Shareholders...1. Significant Figures...2. Financial Highlights...3. Financial Bar Graphs...4-5

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2 Table of Contents Letter to Shareholders Significant Figures Financial Highlights Financial Bar Graphs Independent Auditor s Report Financial Statements Statutory Balance Sheets Statutory Statements of Operations and Changes in Unassigned Surplus Statutory Statements of Cash Flows Notes to Financial Statements - Statutory Basis Note 1 Nature of Operations and Summary of Significant Accounting Practices Note 2 Pension Plan, Post-Retirement Benefits, 401 (k) Savings Plan, and Deferred Compensation Note 3 Affiliated Entity Transactions Note 4 Investments Note 5 Fair Value Measurement Note 6 Annuity Actuarial Reserves and Deposit Liabilities by Withdrawal Characteristics Note 7 Life and Health Reserves Note 8 Federal Income Taxes Note 9 Capital and Surplus and Dividends Inner Circle Club Members Board of Directors, Officers, and Advisors Vision, Mission, and Values

3 To Our Shareholders The operating results for 2016 and the financial statements for the year are included in this Annual Shareholder Report and reflect marked improvement over the prior year. Premium income grew in 2016 over the 2015 total, driven primarily by our life insurance lines of business. This increase results from our strategic effort to grow the life segments of our insurance writings. The results for the year 2016 reflect increased life premiums, which in turn increases the actuarial reserve liabilities, resulting in a net income before realized capital gains (net of tax) of $1,495,100, or $0.09 per share, which is a significant improvement over The net loss after net realized capital gains, net of tax, was $973,218, or $0.06 per share for the year, compared to net loss after realized capital gains of $1,291,272, or $0.07 per share last year. Premium is up in several major product lines for the year, compared to 2015, as reported in the February 3, 2017 letter to shareholders. Total premium income increased by 3.1 percent, to $222,532,308. The largest growth in premium was seen in the following lines of business: ordinary life, Medicare supplement, pre-need life, and universal life. These increases in premiums were partially offset by increased policy reserves, acquisition expenses, and operating expenses. The low interest rate environment has significantly impacted our investment earnings which support our life and annuity products. Recently, the Federal Open Market Committee raised the target range for the federal funds rate by a 0.25 percentage point. As the Federal Reserve continues to squeeze monetary policy, we will closely monitor our investment returns and product rates. Investment income excluding capital gains increased to $56,186,018 in 2016, reflecting growth of 2.8 percent over last year. This increase reflects premium dollars that have been invested in the growing bond portfolio and an increase in gains released from our Interest Maintenance Reserve. Our bond portfolio is comprised of high quality holdings, 99.8 percent of which are investment grade. As of December 31, 2016, assets were $1,459,574,027, an increase of $65,974,587, or 4.7 percent over December 31, Total capital and surplus grew by $4,407,128 during the year and stands at $124,564,238 at December 31, 2016, reflecting our strong financial position. Book value per share rose to $7.30 at December 31, 2016, an increase of 3.7 percent when compared to $7.04 at December 31, Our commitment to investing in our people and advancing technology will enable us to serve our agents and policyholders for many years to come as their life insurance company of choice. In these rapidly changing times, the Company remains dedicated to our mission of providing financial protection and peace of mind for our policyholders by offering quality insurance products through independent agents. In all we do, we are dedicated to going Beyond the expected. We are sincerely thankful for the continued support of our shareholders, agents, and employees. SCOTT A. MARTIN Chairman of the Board, President, and Chief Executive Officer 1

4 Significant Figures Life Insurance in Force CHANGE Ordinary $15,651,158,000 $14,838,246, % Credit 943,438, ,546, % Group 570,384, ,390, % Total Life Insurance in Force 17,164,980,000 16,222,182, % Assets 1,459,574,027 1,393,599, % Policy Reserves 1,134,929,776 1,074,353, % Premium Income 222,532, ,738, % Payments to Policyholders and Beneficiaries 154,673, ,228, % Investment Income 56,186,018 54,654, % Net Rate of Return on Investments 4.12% 4.21% -2.1% Net Income (Loss) Before Realized Capital Gains 1,495,100 (1,750,781) % Net Income (Loss) (973,218) (1,291,272) +24.6% Net Income (Loss) Before Realized Capital Gains Per Share 0.09 (0.10) % Realized Capital Gains Per Share (0.15) % Net Income (Loss) Per Share (0.06) (0.07) +14.3% Book Value Per Share % Premium Income By Product Line Amount % of Total Amount % of Total Ordinary Life $ 71,362,517 32% $ 64,862,550 30% Annuity 14,434,867 7% 15,310,547 7% Pre-Need Life and Annuity 44,376,676 20% 42,731,086 20% Group Life and Health 40,458,056 18% 45,341,484 21% Group Annuity 3,331,370 1% 3,088,368 1% Medicare Supplement 29,762,092 13% 25,768,759 12% Credit Life and Health 18,806,730 9% 18,635,545 9% Total $222,532, % $215,738, % 2

5 Financial Highlights Market Price Premium Income Per Share Investment Income Per Share (.02) (.05).27 (.10).09 (A)(C) Earnings Per Share.14 (.32) (.14) (.15) (D) Realized Capital Gains (Losses) Per Share (.16) (.07) (.06) (A)(B) Earnings Per Share Dividends Declared Per Share (A) Tangible Book Value Per Share 17,068 17,068 17,068 17,068 17,068 17,068 17,068 17,068 17,068 17,068 Common Shares Outstanding (000) % Price to Book Value Year End P/E Ratio Year End Dividend Yield (%) 120, , , , , , , , , ,564 Net Worth ($000) % Profits Retained to Common Equity % Cash Dividends to Net Profit (A) The statutory basis of accounting applies (used for reporting to the respective Insurance Departments). (B) Includes realized capital gains (losses). (C) Excludes realized capital gains (losses). (D) The statutory basis of accounting requires that unrealized capital losses on investments that are determined to be other than temporary declines in value must be reclassified to be realized capital losses. In 2016, 2009, and 2008, realized capital losses of $(0.17), $(0.41), and $(0.34) per share, respectively, are considered to be other than temporary declines in value and are charged to earnings. 3

6 Premium Income (In Millions) 76,036, Life Insurance In Force (In Millions) 7, , , , , , , , , , , , , , , , , , , , , , , 17, ,

7 Cash and Invested Assets (In 9 Millions) , , , , , , , Investment Income (In 03 Millions)

8 INDEPENDENT AUDITOR S REPORT ON THE FINANCIAL STATEMENTS To the Board of Directors and Shareholders Pekin Life Insurance Company Pekin, Illinois We have audited the accompanying financial statements of Pekin Life Insurance Company (the Company), which are comprised of the statutory balance sheets as of December 31, 2016 and 2015, and the related statutory statements of operations, changes in unassigned surplus, and cash flows for the years then ended, and the related notes to the statutory financial statements. Management s Responsibilities for the Statutory Financial Statements Management is responsible for the preparation and fair presentation of these financial statements in accordance with the accounting practices prescribed or permitted by the Illinois Department of Insurance. Management is also responsible for the design, implementation, and maintenance of internal control relevant to the preparation and fair presentation of financial statements that are free from material misstatement, whether due to fraud or error. Auditor s Responsibility Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free from material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements. The procedures selected depend on the auditor s judgment, including the assessment of the risks of material misstatement of the financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the Company s preparation and fair presentation of the financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company s internal control. Accordingly, we express no such opinion. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of significant accounting estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinions. 6

9 Basis for Adverse Opinion on U.S. Generally Accepted Accounting Principles As described in Note 1 to the financial statements, the financial statements are prepared by the Company in accordance with accounting practices prescribed or permitted by the Illinois Department of Insurance, which is a basis of accounting other than accounting principles generally accepted in the United States of America, to meet the requirements of the state of Illinois. The effects on the statutory financial statements of the variances between the statutory basis of accounting described in Note 1 and accounting principles generally accepted in the United States of America, have not been determined but are presumed to be material. Adverse Opinion on U.S. Generally Accepted Accounting Principles In our opinion, because of the significance of the matter discussed in the Basis for Adverse Opinion on U.S. Generally Accepted Accounting Principles paragraph, the financial statements referred to above do not present fairly, in accordance with accounting principles generally accepted in the United States of America, the financial position of the Company as of December 31, 2016 and 2015, and the results of its operations and its cash flows for the years then ended. Opinion on Regulatory Basis of Accounting In our opinion, the statutory financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2016 and 2015, and the results of its operations, changes in unassigned surplus, and its cash flows for the years then ended, in accordance with the accounting practices prescribed or permitted by the Illinois Department of Insurance described in Note 1. Madison, Wisconsin March 17, 2017 Strohm Ballweg, LLP 7

10 Statutory Balance Sheets December 31, 2016 and Admitted Assets: Bonds $ 1,290,044,244 $ 1,239,524,463 Common Stocks 15,484,569 14,640,552 Mortgage Loans 32,238,947 16,487,414 Real Estate Occupied by the Company, Net of Depreciation 288, ,127 Cash and Short-Term Investments 17,236,634 13,689,240 Contract Loans 16,210,696 15,396,115 Securities Lending Reinvested Collateral Assets 39,599,356 46,537,674 Receivables for Securities 8,732 1,154,196 Total Cash and Invested Assets 1,411,112,025 1,347,818,781 Life and Health Premiums Due and Unpaid 1,091,920 2,192,400 Life Premiums Deferred 22,797,640 21,000,568 Investment Income Accrued 11,891,464 11,392,598 Amounts Recoverable from Reinsurers 462, ,426 Current Federal Income Tax Recoverable 234,751 1,816,166 Net Deferred Tax Asset 9,971,289 9,014,791 Post-Retirement Asset 1,912,426 - Other Assets 100, ,710 Total Admitted Assets $ 1,459,574,027 $ 1,393,599,440 Liabilities: Aggregate Reserve for Contracts: Life $ 709,276,636 $ 651,098,338 Annuity 399,447, ,944,424 Health 26,205,263 25,310,870 Total Aggregate Reserve for Contracts 1,134,929,776 1,074,353,632 Contract Claims: Life 11,862,990 9,721,854 Health 9,404,504 11,835,163 Total Contract Claims 21,267,494 21,557,017 Other Policy Liabilities: Premium Received in Advance 1,656,587 1,588,502 Policyholders' Dividends 14,705 16,894 Deposit Administration Contracts 57,267,583 50,954,469 Other Deposit-Type Contracts 17,562,724 16,995,210 Total Other Policy Liabilities 76,501,599 69,555,075 Interest Maintenance Reserve 29,415,531 25,913,945 Expenses and Taxes Accrued 5,631,149 4,856,118 Amounts Withheld or Retained 1,279,424 1,255,950 Asset Valuation Reserve 7,702,982 8,300,415 Due to Parent 1,300,841 2,110,124 Drafts Outstanding 3,230,221 3,504,489 Payable for Securities Lending 39,599,356 46,537,674 Pension Benefit Obligations 4,300,390 6,635,816 Post-Retirement Benefit Obligations 5,554,861 5,952,662 Other Liabilities 4,296,165 2,909,413 Total Liabilities 1,335,009,789 1,273,442,330 Capital and Surplus: Capital Stock, Par Value $1.25; 22,000,000 Shares Authorized; Shares Issued - 17,600,000; and Shares Outstanding - 17,068,023 22,000,000 22,000,000 Paid-In Surplus 900, ,000 Special Surplus Funds - 198,103 Unassigned Surplus 105,933, ,328,611 Treasury Stock, Shares at Cost, 531,977 in 2016 and 2015 (4,269,604) (4,269,604) Total Capital and Surplus 124,564, ,157,110 Total Liabilities, Capital and Surplus $ 1,459,574,027 $ 1,393,599,440 The accompanying notes are an integral part of the financial statements. 8

11 Statutory Statements of Operations and Changes in Unassigned Surplus Years Ended December 31, 2016 and Income: Life Premiums $ 125,779,777 $ 117,545,223 Annuity Considerations 19,924,260 20,615,663 Health Premiums 76,828,271 77,577,453 Net Investment Income 56,186,018 54,654,393 Total Income 278,718, ,392,732 Deductions: Benefits to Policyholders and Beneficiaries: Life 67,308,690 60,758,606 Annuity 33,428,907 36,002,767 Health 53,935,768 58,467,210 Total Benefits to Policyholders and Beneficiaries 154,673, ,228,583 Additions to Policy Reserves: Life 58,178,298 56,920,575 Annuity 1,503,458 (339,577) Health 894, ,678 Total Additions to Policy Reserves 60,576,148 57,243,676 Expenses: Commissions and Service Fees 25,352,146 23,250,143 General Insurance Expenses 31,077,804 31,100,645 Taxes, Licenses and Fees 5,277,137 4,618,262 Total Expenses 61,707,087 58,969,050 Total Deductions 276,956, ,441,309 Income (Loss) Before Federal Income Tax Expense and Net Realized Capital Gains 1,761,726 (1,048,577) Federal Income Tax Expense 266, ,204 Income (Loss) Before Net Realized Capital Gains, Net of Tax 1,495,100 (1,750,781) Net Realized Capital Gains (Loss) (2,468,318) 459,509 Net Loss $ (973,218) $ (1,291,272) Net Income (Loss) Before Net Realized Capital Gains Per Share $ 0.09 $ (0.10) Net Realized Capital Gains (Loss), Net of Income Taxes Per Share (0.15) 0.03 Net Loss Per Share $ (0.06) $ (0.07) Shares Outstanding 17,068,023 17,068,023 Unassigned Surplus: Unassigned Surplus - Beginning of Year $ 101,328,611 $ 101,488,114 Changes in Unassigned Surplus: Net Loss (973,218) (1,291,272) Net Unrealized Capital Gains (Losses) 372,814 (712,734) Asset Valuation Reserve 597,433 (550,519) Net Deferred Tax Asset 6,275, ,547 Non-Admitted Assets (5,540,947) (463,920) Provision for Reinsurance (20,473) 9,711 Pension Benefit Obligations 1,954, ,925 Post-Retirement Benefit Obligations 1,912,426 2,710,304 ACA Fee Assessment 198,103 16,176 Shareholder Dividends - Cash ($0.01 and $0.04 per share) (170,680) (682,721) Net Increase (Decrease) 4,605,231 (159,503) Unassigned Surplus - End of Year $ 105,933,842 $ 101,328,611 The accompanying notes are an integral part of the financial statements. 9

12 Statutory Statements of Cash Flows Years Ended December 31, 2016 and 2015 Cash from Operations: Premiums Collected, Net of Reinsurance Net Investment Income Miscellaneous Income Total Cash Received Benefits and Loss Related Payments Commissions, Expenses Paid, and Other Deductions Dividends Paid to Policyholders Federal Income Taxes Paid Total Cash Disbursed Net Cash from Operations $ 222,605,040 $ 215,243,759 54,145,147 54,121, ,782 1,616, ,505, ,981, ,150, ,310,833 62,988,187 60,414,267 15,106 17,430 2,553,966 7,302, ,707, ,045,492 56,798,649 48,936,409 Cash from Investments: Proceeds from Investments Sold, Matured, or Repaid: Bonds Stocks Mortgage Loans Miscellaneous Total Investment Proceeds Cost of Investments Acquired: Bonds 270,745, ,161,986 7,579,781 8,161, , ,527 8,083, ,106, ,444, ,069, ,026,353 7,736,380 8,356,459 Stocks Mortgage Loans 16,449,070 16,608,944 Real Estate - 62,308 Miscellaneous - 8,367,098 Total Investments Acquired Net Increase (Decrease) in Contract Loans Net Cash from Investments 339,254, ,421, ,581 (1,062,442) (52,962,747) (66,913,986) Cash from Financing and Miscellaneous Sources: Dividends to Shareholders Net Deposits on Deposit-Type Contracts Other Cash Provided (Applied) Net Cash from Financing and Miscellaneous Sources Net Change in Cash and Short-Term Investments Cash and Short-Term Investments at Beginning of Year Cash and Short-Term Investments at End of Year (170,680) (682,721) 6,880,628 (978,575) (6,998,456) 8,131,190 (288,508) 6,469,894 3,547,394 (11,507,683) 13,689,240 25,196,923 $ 17,236,634 $ 13,689,240 The accompanying notes are an integral part of the financial statements. 10

13 1. Nature of Operations and Summary of Significant Accounting Practices Pekin Life Insurance Company (Company) is a life and accident and health insurance company domiciled in the State of Illinois that operates in 21 states across the nation. The Company sells insurance primarily through independent agents. Insurance products primarily include ordinary life, group health, Medicare Supplement, credit life and health, annuities, and pre-need life. The Company continually evaluates its products to ensure ongoing alignment with corporate objectives. As a result of this evaluation process, the Company decided to exit the Fully Insured Group Market by year end 2017 (which represents $38,299,964 and $43,509,098 of health premiums for the years ending December 31, 2016 and 2015, respectively). The Company will continue to offer Group Life, Dental and Short-term Disability as well as Voluntary products. The Company also plans to expand its Self-Funded book of business. The accompanying financial statements have been prepared in conformity with accounting practices prescribed or permitted by the Illinois Department of Insurance (statutory accounting practices). Prescribed statutory accounting practices include those practices denoted in the National Association of Insurance Commissioners (NAIC) Accounting Practices and Procedures Manual as well as state laws, regulations, and general administrative rules. Permitted statutory accounting practices encompass all accounting practices not so prescribed when such practices are approved by the insurance department of the insurer s state of domicile. The Company does not use any permitted practices. Accounting Estimates The preparation of statutory financial statements requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. Estimates that are particularly susceptible to significant change in the near term relate to: 1) the estimated life, annuity, and health insurance contract reserves, 2) the assumptions regarding the other than temporary impairment analysis of the investment portfolio, 3) the assumptions, including the discount rate, used to determine the benefit obligations for the defined benefit pension plan and other postretirement benefit plan, and 4) the amount of deferred tax assets expected to be realized in future years. Summary of Significant Differences Between Statutory Accounting and GAAP A description of the significant accounting practices used by the Company and significant variances from accounting principles generally accepted in the United States of America (GAAP) are as follows: A. Investments Bonds and stocks are valued in accordance with rules prescribed by the NAIC, whereby bonds eligible for amortization under such rules are stated at amortized cost. The Company uses a modified scientific method for amortizing bonds. Common stocks are carried at fair market value. Loan-backed securities (mortgage-backed and asset-backed securities) are stated at amortized cost using a prospective basis. The prospective approach recognizes, through the recalculation of the effective yield to be applied to future periods, the effects of all cash flows whose amounts differ from those estimated earlier. Changes in amortization and amortized cost will occur in future periods. Assumptions for loan-backed securities are updated on a quarterly basis. Agency pass-through and collateralized mortgage obligations use the threemonth generic prepayment speed assumption. Non-agency collateralized mortgage obligations and asset-backed securities are updated using projected principal payment windows. 11

14 Investment income is recorded when earned. Realized gains and losses on sale or maturity of investments are determined on the basis of specific identification. Aggregate unrealized capital gains and losses are credited or charged directly to unassigned surplus without income tax effect. Unrealized capital losses on investments that are determined to be other than temporary declines in value must be recognized as realized capital losses. The Company reviews its investment portfolio on a periodic basis to determine other than temporary declines in value. In evaluating whether a decline in value is other than temporary, management considers several factors including, but not limited to: 1) the Company s ability and intent to retain the security for a sufficient amount of time for it to recover, 2) the extent and duration of the decline in value, 3) the probability of collecting all cash flows according to contractual terms in effect at acquisition or restructuring, 4) relevant industry conditions and trends, and 5) the financial condition and current and future business prospects of the issuer. Under GAAP, equity securities that have readily determinable fair values and debt securities would be classified into three categories: held-to-maturity, trading, and available-for-sale. Held-to-maturity securities would be reported at amortized cost. Trading securities would be reported at fair value, with unrealized gains and losses included in earnings. Available-forsale securities would be reported at fair value, with unrealized gains and losses, net of applicable taxes, reported as a separate component of unassigned surplus. Mortgage loans and contract loans are stated at the aggregate of unpaid loan balances, which approximate fair value. The stated value of contract loans are not in excess of cash surrender values of related policies. The investment in the Company s wholly owned subsidiary is accounted for using the statutory equity method in which undistributed earnings are reported as unrealized gains and losses; under GAAP, the financial statements of the subsidiary would be consolidated with those of the Company. The asset valuation reserve (AVR) is maintained as prescribed by the NAIC for the purpose of stabilizing surplus against fluctuations in the market values of invested assets. The AVR is reported as a liability and changes are charged or credited directly to unassigned surplus. The AVR would not be required under GAAP. The interest maintenance reserve (IMR) is maintained as prescribed by the NAIC to defer realized capital gains and losses which result from changes in interest rates for fixed income securities and to amortize these capital gains and losses into investment income over the remaining life of the investments sold, rather than reflecting the gains or losses in the year of sale. Under GAAP, realized capital gains and losses would not be deferred, amortized, or combined with investment income. An occupancy rental charge on home office real estate owned is recorded as investment income and as offsetting rental expense; under GAAP, no such rental charge would be recognized. B. Non-Admitted Assets Certain assets, designated as non-admitted assets are excluded from the balance sheet, and the net change in such assets is charged or credited directly to unassigned surplus. Under GAAP, such assets would be included in the balance sheet and the net change in such assets would be recognized as a component of net income. C. Policy Reserves and Claim Reserves Policy reserves on life insurance are based on statutory mortality and interest rate requirements and are computed using principally net level and modified preliminary term methods with interest rates ranging primarily from 2.25 percent to 6.0 percent. The use of a modified reserve basis partially offsets the effect of immediately expensing policy acquisition costs. Policy reserves on annuities are based on statutory mortality and interest 12

15 requirements with interest rates ranging primarily from 3.50 percent to percent. Under GAAP, reserves would be based on mortality, lapse, withdrawal, and interest rate assumptions that are based on Company experience. Liabilities for accident and health policies include unearned premiums and additional reserves. The liability for future policy benefits and claims on life and health insurance products includes estimated unpaid claims that have been reported to the Company and claims incurred but not yet reported. Changes in estimates are reflected in current operations. D. Reinsurance The Company has long-standing reinsurance treaties in place for its life and health insurance business to reduce exposure to large losses. Although reinsurance does not relieve the Company of its legal liability to its policyholders, it provides a measure of protection against catastrophic losses and provides a means of risk reduction on individual losses. In order to maintain an appropriate balance between the cost of reinsurance and surplus growth, the Company periodically evaluates its retention levels correlated to specific types of life and health insurance policies. E. Premiums Premiums deferred and uncollected represent modal premiums, either due and uncollected or not yet due, where policy reserves have been provided on the assumption that the full modal premium for the current policy year has been collected. Also, where policy reserves have been provided on a continuous premium assumption, premiums uncollected are similarly defined. Premiums and annuity considerations are recognized as income over the premium paying period of the policies. Acquisition costs, such as commissions and other costs related to the new business, are expensed as incurred. Contracts that permit the insured to change the amount and timing of premium payments, such as universal life products, are recorded as revenue when received. Under GAAP, revenues would include only policy charges for the cost of insurance, contract initiation and administration, surrender charges, and other fees that have been assessed against contract account values, and benefits would represent the excess of benefits paid over the policy account value and interest credited to the account values. Additionally, acquisition costs under GAAP would be capitalized and amortized over the policy period. F. Cash and Short-Term Investments For purposes of reporting cash flows, the Company follows statutory accounting practices and considers cash in checking accounts, certain money market funds, and highly liquid debt instruments purchased with a remaining maturity of one year or less to be cash and shortterm investments. The Company occasionally has on deposit in a financial institution a balance in excess of amounts insured by the Federal Deposit Insurance Corporation (FDIC). On December 31, 2016, the Company held $4,792,199 in one financial institution in excess of the FDIC limit. The Company does not believe it is exposed to any significant credit risks on this account. G. Deferred Tax Assets Deferred income taxes are provided for differences between the financial statement and the tax bases of assets and liabilities and are reduced by a valuation allowance when it is more likely than not that some portion or all of the deferred tax assets would not be realized. Additionally, under statutory accounting practices, limitations are placed on the admissibility of deferred tax assets. All changes in ordinary deferred tax assets and liabilities are reported as changes in surplus, and state income taxes are not included in deferred tax calculations; under GAAP, there is no admissibility concept, changes in deferred tax assets and liabilities would be reported through operations and/or surplus depending on 13

16 their characteristics, and state income taxes would be included in the deferred tax calculation. H. Affordable Care Act Fee Assessment The Affordable Care Act (ACA) Section 9010 Assessment Moratorium, was adopted by the NAIC and became effective April 3, This guidance is intended to promote consistent reporting of the ACA 9010 Assessment in reporting periods 2016, 2017 and As a result of this updated guidance, the Company will not be required to accrue a monthly segregation of special surplus in 2016 for the 2016 data year to be paid in Under previous guidance in SSAP No. 106, ACA Section 9010 Assessment, health insurers were required to segregate the fee that would be paid in the subsequent year based on premium written in the data year on a monthly basis. The ACA fee assessment and the related impact to risk-based capital are shown below for the years ending December 31, 2016 and ACA Fee Assessment Payable for the Upcoming Year * $ - $ 198,103 ACA Fee Assessment Paid $ 172,823 $ 204,135 Premium Written Subject to ACA 9010 Assessment $ 39,073,804 $ 44,810,269 Total Adjusted Capital Before Surplus Adjustment $ 132,274,573 $ 128,465,972 Authorized Control Level Before Surplus Adjustment $ 13,243,946 $ 12,661,463 Total Adjusted Capital After Surplus Adjustment $ 132,274,573 $ 128,267,869 Authorized Control Level After Surplus Adjustment $ 13,243,946 $ 12,661,463 * Reflected in Special Surplus Funds I. Subsequent Events Subsequent events were evaluated through March 17, 2017, which is the date the financial statements were available to be issued. J. Other Treasury stock is recorded at cost and reported as a reduction of capital and surplus under both statutory accounting practices and GAAP. Statutory financial statements are prepared in a form using language and groupings substantially the same as the annual statement filed with the NAIC and state regulatory authorities which differ from the presentation and disclosure of financial statements presented under GAAP. Necessary reclassifications are made in prior period financial statements, whenever appropriate, to conform to the current presentation. 2. Pension Plan, Post-Retirement Benefits, 401(k) Savings Plan and Deferred Compensation Employee Pension Benefits The Company, its parent (The Farmers Automobile Insurance Association), and its affiliates participate in a trusteed non-contributory defined benefit pension plan for certain employees. Effective January 1, 2013, the Company and its affiliates adopted an amendment to freeze participation in the Plan for employees hired after January 1, The funding policy is to contribute annually an amount that represents the current cost of benefits expected to be earned in the current year offset by the expected asset return higher than the discount rate, but no more than the maximum amount that can be deducted for federal income tax purposes. Each affiliate is charged for its applicable share of such contributions based on a percent of projected benefit obligation. 14

17 Post-Retirement Benefits In addition to providing pension benefits, the Company and its affiliates provide certain health care and life insurance benefits (post-retirement benefits) for retired employees. Employees hired prior to 2013 may become eligible for these benefits if they reach retirement age while working for the Company. Expected Cash Flows The Company and its affiliates expect to contribute $6,000,000 to the Pension Plan and $2,000,000 to the Post-Retirement Benefit Plan in The following benefit payments for the Company and its affiliates, which reflect expected cash flows for future service, as appropriate, are expected to be paid: Year Pension Benefits Post-Retirement Benefits 2017 $ 7,030,000 $ 1,367, ,857,000 1,475, ,486,000 1,579, ,839,000 1,694, ,919,000 1,787, ,380,000 10,416,000 Assets, Obligations, and Assumptions A summary of obligations and assumptions of the Pension and Post-Retirement Benefit Plans for the Company and its affiliates is as follows at December 31: Pension Benefits Post-Retirement Benefits C hange in Benefit Obligation: Benefit Obligation at Beginning of Year $ 102,308,574 $ 106,460,019 $ 43,959,445 $ 77,440,910 Service Cost 6,027,963 6,791,250 1,736,304 3,725,654 Interest C ost 4,368,011 4,280,603 2,100,663 3,435,297 Actuarial Loss (Gain) 11,168,376 (7,264,748) (1,414,947) (6,922,256) Benefits Paid (7,200,443) (7,958,550) (1,723,552) (2,530,489) Plan Amendment (31,189,671) C urtailment (16,843,958) Benefit Obligation at End of Year $ 99,828,523 $ 102,308,574 $ 44,657,913 $ 43,959,445 Benefit Obligation Allocable to the C ompany $ 19,568,335 $ 19,260,127 $ 8,708,395 $ 9,708,085 Accumulated Benefit Obligation 85,442,394 75,285,470 44,657,913 43,959,445 Effective December 21, 2016, the Company and its affiliates adopted Amendment No. 1 to freeze accrued benefits for all non-grandfathered participants. Non-grandfathered participants are participants who have not attained age 50 on or before December 31, 2017, and whose age and credited service as of December 31, 2017, does not equal or exceed 75. Changes to the pension plan to freeze accrued benefits for all non-grandfathered participants resulted in a net reduction of $16,843,958 in the 2016 pension benefit obligation. Additionally, Plan amendments in 2015 reduced the post-retirement obligation by $31,189,671. The post-retirement plan amendments include an employee group waiver plan (EGWP), deductibles, coinsurance percentages, co-pays, and out-of-pocket maximums. 15

18 A summary of the plan assets and funded status of the Pension and Post-Retirement Benefit Plans for the Company and its affiliates is as follows for the years ended December 31: Change in Plan Assets: Fair Value of Plan Assets at Beginning of Year Actual Return on Plan Assets Employer Contribution Benefits Paid Fair Value of Plan Assets at End of Year Pension Benefits Post-Retirement Benefits $ 67,044,084 $ 69,408,222 $ 23,384,381 $ 22,904,048 7,946,299 (505,588) 708, ,068 10,100,000 6,100,000 3,366,330 2,033,130 (7,200,443) (7,958,550) (1,480,399) (2,286,865) $ 77,889,940 $ 67,044,084 $ 25,979,284 $ 23,384,381 Plan Assets Allocable to the Company $ 15,267,945 $ 12,624,401 $ 5,065,960 $ 4,828,875 Funded Status: Recognized Liabilities Accrued Benefit Costs $ 8,224,630 $ 10,248,051 $ 24,952,716 $ 27,189,395 Liability for Benefits 13,713,953 22,399,082 (6,274,087) - Total Liabilities Recognized $ 21,938,583 $ 32,647,133 $ 18,678,629 $ 27,189,395 Unrecognized Liabilities $ - $ 2,617,357 $ - $ - For the years ended December 31, 2016 and 2015, the Company s portions of recognized liabilities were $4,300,390 and $6,635,816, respectively, for the Pension Plan and $5,554,861 and $5,952,662, respectively, for the Post-Retirement Benefit Plan. Additionally, the Company recognized a post-retirement asset in 2016 in the amount of $1,912,426. A summary of net periodic benefit cost of the Pension and Post-Retirement Benefit Plans for the Company and its affiliates is as follows for the years ended December 31: Components of Net Periodic Benefit Cost: Service Cost Net Periodic Benefit Cost Allocable to the Company Pension Benefits Post-Retirement Benefits $ 6,027,963 $ 6,791,250 $ 1,736,304 $ 3,725,654 4,368,011 4,280,603 2,100,663 3,435,297 Interest Cost Expected (Return) on Plan Assets (3,957,815) (4,488,386) (1,422,394) (1,472,276) Transition Obligation 113, , Net Losses 1,120,346 1,226, ,665 Prior Service Cost 32, ,564 (1,042,241) 2,777,591 Curtailment 371, Total Net Periodic Benefit Cost $ 8,076,579 $ 8,734,188 $ 1,372,804 $ 8,660,931 $ 2,228,695 $ 2,425,024 $ 283,484 $ 1,753,839 The net periodic benefit cost of the Pension and Other Post-Retirement Benefit Plans is measured on a seriatim basis that projects future benefit costs participant by participant based on demographic characteristics. The projected costs are discounted to a present value. 16

19 Following are components of net periodic benefit cost as they related to unassigned surplus for the Company and its affiliates at December 31: Amounts in Unassigned Surplus Recognized as Pension Benefits Components of Net Periodic Benefit Cost: Items Not Yet Recognized from Prior Year $ 25,016,439 $ 29,437,934 $ (6,614,331) $ 33,731,644 Net Transition Obligation Recognized (485,651) (113,917) - - Net Prior Service Cost Arising During the Period (31,189,671) Net Prior Service Cost Recognized (32,423) (810,564) 1,042,241 (2,777,591) Net (Gain) Loss Arising During the Period (9,664,066) (2,270,774) (701,525) (6,184,048) Net (Gain) Loss Recognized (1,120,346) (1,226,240) (472) (194,665) Items Not Yet Recognized Current Year $ 13,713,953 $ 25,016,439 $ (6,274,087) $ (6,614,331) Amounts in Unassigned Surplus Expected to Be Recognized in the Next Fiscal Year as Components of Net Periodic Benefit Cost: Net Transition Obligation Recognized $ 20,981 $ 113,917 $ - $ - Net Prior Service Cost $ - $ 32,423 $ (1,042,241) $ (1,042,241) Net Recognized Losses $ 308,039 $ 1,120,346 $ - $ 472 Weighted average assumptions used to determine the projected benefit obligation are shown below at December 31: Pension Benefits Post-Retirement Benefits Amounts in Unassigned Surplus Not Yet Recognized as Components of Net Periodic Benefit Cost: Net Transition Obligation Recognized $ 83,924 $ 569,575 $ - $ - Net Prior Service Cost $ - $ 32,423 $ (9,974,247) $ (11,016,488) Net Recognized Losses $ 13,630,029 $ 24,414,441 $ 3,700,160 $ 4,402,157 Post-Retirement Benefits Discount Rate Rate of Compensation Increase 4.00% 4.39% 4.64% 4.86% 3.50% to 7.00% 3.50% to 7.00% N/A N/A Weighted average assumptions used to determine the net periodic benefit cost are shown below for the years ended December 31: Pension Benefits Post-Retirement Benefits Discount Rate 4.39% 4.09% 4.86% 4.49% Rate of Compensation Increase 3.50% to 7.00% 3.50% to 7.00% N/A N/A Expected Long-Term Rate of Return on Plan Assets 6.00% 6.50% 6.00% 6.50% The health care portion of the post-retirement benefit plan is contributory, with participants contributions adjusted annually as determined by the Company; the life insurance portion of the post-retirement benefit plan is noncontributory. The health care cost trend rate in 2016 was 17

20 8.31 percent, graded to 7.04 percent for one year, then graded to 4.50 percent by In 2015, the health care cost trend rate was 9.00 percent for one year, then 7.60 percent for one year, then 4.50 percent by Assumed health care cost trend rates have a significant effect on the amounts reported for the health care portion of the post-retirement benefit plan. A one-percentage-point change in assumed health care trend rates would have the following effects for the Company and its affiliates: One Percentage Point Increase One Percentage Point Decrease Effect on Total of Service and Interest C ost C omponents $ 906,372 $ (685,670) Effect on Post-Retirement Benefit Obligation $ 9,041,169 $ (6,984,807) During 2013, the Company and its affiliates adopted Statement of Statutory Accounting Principle No. 102, Accounting for Pensions, which requires the difference between the projected benefit obligation and the fair value of plan assets to be recorded on the statutory balance sheet. If the projected benefit obligation is greater than the fair value of plan assets, a liability is recorded. However, if the projected benefit obligation is less than the fair value of plan assets, a nonadmitted asset is recorded. In addition, non-vested participants are to be included in calculations such as the projected benefit obligation and net periodic pension cost. Although the Company and its affiliates elected to phase in the surplus impact over a period not to exceed ten years, the Company and its affiliates must continue to recognize a minimum amount of the transition liability that is at least equal to the amortization of the unrecognized items in effect at transition. At year-end 2016, the amount of the remaining surplus impact from the election of the transition deferral in SSAP No. 102 was fully recognized. The recognized surplus impact and remaining transition liability for the Pension Plan for the Company and its affiliates is as follows for the years ended December 31: Transition Liability at Beginning of Year $ 2,617,357 $ 8,607,844 Writedowns Recognized (2,617,357) (5,990,487) Remaining Transition Liability at End of Year $ - $ 2,617,357 Additionally, the Company and its affiliates adopted Statement of Statutory Accounting Principle No. 92, Accounting for Postretirement Benefits Other Than Pensions, which requires a liability, equal to the accumulated post-retirement benefit obligation, be established for vested and nonvested employees. Although the Company and its affiliates elected to phase in the surplus impact over a period not to exceed ten years, the Company and its affiliates must continue to recognize a minimum amount of the transition liability that is at least equal to the amortization of the unrecognized items in effect at transition. The surplus impact from the election of the transition deferral in SSAP No. 92 was fully recognized as of December 31,

21 The retirement plan assets are held in a deposit administration contract and equity securities. The Trustees of the Farmers Automobile Insurance Association Retirement Plan maintain a deposit administration contract with the Company for pension benefits. The contract is a group annuity contract consisting of employer contributions with guaranteed interest, less annuities purchased, to provide benefit payments to retirees and lump sum benefits paid directly to participants. The fair value of the contract included in plan assets of the Company and its affiliates was $31,288,299 and $27,570,088 as of December 31, 2016 and 2015, respectively, or 40 and 41 percent of total plan assets. Equity securities comprise the remaining plan assets. At December 31, 2016 and 2015, equity securities, cash and cash equivalents amounted to $46,602,848 and $39,544,302, respectively, or 60 and 59 percent of total plan assets. The expected long-term rate of return on plan assets was selected based upon current market conditions, company experience, and future company expectations. The specific goal of the investment portfolio is to maintain a fully funded plan over time to ensure the benefit for the plan participants. New contributions are invested in equity securities until the amount in equities exceeds 45 percent of the plan s total assets. Additional amounts will be paid into the deposit administration contract, unless the equity portfolio falls under 45 percent. If the equity portfolio exceeds 60 percent of the plan s assets, part of the equity portfolio will be liquidated and proceeds moved into the deposit administration contract within a reasonable time frame. There are three return objectives. The primary benchmark is the projected annual rate of return used by the plan s actuary. The average annualized investment performance of the invested assets, net of investment-related expenses, should be equal to or in excess of this benchmark. The secondary (equity) benchmark is the percent total rate of return of a balanced portfolio comprised of a 70 percent weighting of the Standard & Poor s 500 Index and a 30 percent weighting of the Barclay s Government Corporate Index. The secondary (fixed income) benchmark is the weighted average rate of return of the Company s mortgage-backed securities portfolio less 0.75 percent which includes 0.25 percent for expenses and 0.50 percent for spread. All plan assets, in excess of those funds targeted for short-term cash flows needs, should be invested in a manner consistent with the basic principles of prudent long-term portfolio management. Derivatives, private placement securities, and commodity contracts are prohibited investment vehicles. The Trustees of the plan recognize the long-term nature of the majority of the plan s assets. The Farmers Automobile Insurance Association Retirement Plan maintains an account to partially fund health benefits provided to certain retirees and eligible dependents through a deposit administration contract with the Company. The permissible account funding was determined in accordance with generally recognized and accepted actuarial principles and practices, which are consistent with the Actuarial Standards of Practice. As of December 31, 2016 and 2015, the fair value of the contract was $25,979,284 and $23,384,380, respectively. Contributions of $3,366,330 and $2,033,130 were made in 2016 and 2015, respectively, into the deposit administration contract. The Company s share of the contribution was $633,870 and $452,778 in 2016 and 2015, respectively. The Company utilizes the following valuation techniques in determining the level, within the fair value hierarchy, of the Pension Plan and Post-Retirement Plan assets: Level 1 Quoted market prices reported on the active markets on which the individual stocks and money market funds are traded. Level 3 Principal valuation technique is discounted cash flows. Unobservable inputs are credit rate and payout date. 19

22 The following table sets forth by level, within the fair value hierarchy, the assets of the Pension Plan and Post-Retirement Plan at fair value as of December 31, 2016, for the Company and its affiliates: Assets at Fair Value as of December 31, 2016 Level 1 Level 2 Level 3 Total Pension Plan Assets: Equity Securities Consumer Discretionary $ 3,318,168 $ - $ - $ 3,318,168 Consumer Staples 4,714, ,714,288 Energy 5,106, ,106,500 Financials 9,716, ,716,607 Health Care 3,158, ,158,835 Industrials 5,541, ,541,795 Information Technology 5,384, ,384,500 Materials 1,078, ,078,830 Telecommunications 1,384, ,384,400 Utilities 7,034, ,034,236 Total Equity Securities $ 46,438,159 $ - $ - $ 46,438,159 Cash and Cash Equivalents 164, ,689 Deposit Administration C ontract ,288,299 31,288,299 Total Pension Plan Assets $ 46,602,848 $ - $ 31,288,299 $ 77,891,147 Post-Retirement Plan Assets: Deposit Administration C ontract $ - $ - $ 25,979,284 $ 25,979,284 Total Post-Retirement Plan Assets $ - $ - $ 25,979,284 $ 25,979,284 The following table sets forth by level, within the fair value hierarchy, the assets of the Pension Plan and Post-Retirement Plan at fair value as of December 31, 2015, for the Company and its affiliates: Assets at Fair Value as of December 31, 2015 Level 1 Level 2 Level 3 Total Pension Plan Assets: Equity Securities Consumer Discretionary $ 3,236,635 $ - $ - $ 3,236,635 Consumer Staples 4,180, ,180,128 Energy 3,466, ,466,615 Financials 7,218, ,218,278 Health Care 3,022, ,022,590 Industrials 4,984, ,984,570 Information Technology 4,299, ,299,612 Materials 968, ,060 Telecommunications 954, ,730 Utilities 6,887, ,887,894 Total Equity Securities $ 39,219,112 $ - $ - $ 39,219,112 Cash and Cash Equivalents 325, ,190 Deposit Administration C ontract ,570,088 27,570,088 Total Pension Plan Assets $ 39,544,302 $ - $ 27,570,088 $ 67,114,390 Post-Retirement Plan Assets: Deposit Administration C ontract $ - $ - $ 23,384,380 $ 23,384,380 Total Post-Retirement Plan Assets $ - $ - $ 23,384,380 $ 23,384,380 20