XNYS:TMK Torchmark Corp Quarterly Report 10-Q Filing - 3/31/2012

Effective Date 3/31/2012

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Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

QUARTERLY REPORT UNDER SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For Quarter Ended March 31, 2012

Commission File Number 1-8052

 

TORCHMARK CORPORATION

(Exact name of registrant as specified in its charter)

 

 

DELAWARE   63-0780404
(State or other jurisdiction of incorporation or organization)   (I.R.S. Employer Identification No.)
 
3700 South Stonebridge Drive, McKinney, Texas   75070
Address of principal executive offices)   (Zip Code)

Registrant’s telephone number, including area code (972) 569-4000

NONE

Former name, former address and former fiscal year, if changed since last report.

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes   x             No   ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes   x             No   ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer   x    Accelerated filer   ¨
Non-accelerated filer   ¨   (Do not check if a smaller reporting company)    Smaller reporting company   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes   ¨             No   x

Indicate the number of shares outstanding for each of the issuer’s classes of common stock, as of the last practicable date.

 

                CLASS                 

 

        OUTSTANDING AT April 24, 2012        

Common Stock,

$1.00 Par Value

 

98,455,101

Index of Exhibits (Page 57).

Total number of pages included are 58.


Table of Contents

TORCHMARK CORPORATION

INDEX

 

             Page  

PART I.

  FINANCIAL INFORMATION   
  Item 1.   Financial Statements   
   

Consolidated Balance Sheets

     1     
   

Consolidated Statements of Operations

     2     
   

Consolidated Statements of Comprehensive Income

     3     
   

Consolidated Statements of Cash Flows

     4     
   

Notes to Consolidated Financial Statements

     5     
  Item 2.  

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     23     
  Item 3.  

Quantitative and Qualitative Disclosures about Market Risk

     54     
  Item 4.  

Controls and Procedures

     54     

PART II.

  OTHER INFORMATION   
  Item 1.  

Legal Proceedings

     55     
  Item 1A.  

Risk Factors

     56     
  Item 2.  

Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities

     56     
  Item 6.  

Exhibits

     57     


Table of Contents

PART I – FINANCIAL INFORMATION

 

Item 1. Financial Statements

TORCHMARK CORPORATION

CONSOLIDATED BALANCE SHEETS

(Dollar amounts in thousands except per share data)

 

     March 31,
2012
    December 31,
2011*
 
Assets    (Unaudited)     (As adjusted)  

Investments:

    

Fixed maturities, available for sale, at fair value (amortized cost: 2012 – $11,081,405; 2011 – $10,924,244)

   $ 11,954,840      $ 11,888,205   

Equity securities, at fair value (cost: 2012 – $14,875; 2011 – $14,875)

     17,134        17,056   

Policy loans

     404,559        400,914   

Other long-term investments

     25,113        26,167   

Short-term investments

     55,978        21,244   
  

 

 

   

 

 

 

Total investments

     12,457,624        12,353,586   

Cash

     78,302        84,113   

Accrued investment income

     199,474        192,325   

Other receivables

     264,429        253,549   

Deferred acquisition costs

     2,951,155        2,916,732   

Goodwill

     396,891        396,891   

Low-income housing interests

     273,382        280,955   

Other assets

     113,155        110,121   
  

 

 

   

 

 

 

Total assets

   $ 16,734,412      $ 16,588,272   
  

 

 

   

 

 

 

Liabilities and Shareholders' Equity

    

Liabilities:

    

Future policy benefits

   $ 9,704,961      $ 9,572,257   

Unearned and advance premiums

     74,475        69,539   

Policy claims and other benefits payable

     241,191        222,254   

Other policyholders' funds

     93,322        92,487   
  

 

 

   

 

 

 

Total policy liabilities

     10,113,949        9,956,537   

Current and deferred income taxes payable

     1,332,334        1,319,853   

Other liabilities

     313,853        312,417   

Short-term debt

     224,884        224,842   

Long-term debt (fair value: 2012 – $968,412; 2011 – $947,142)

     790,817        790,571   

Due to affiliates

     124,421        124,421   
  

 

 

   

 

 

 

Total liabilities

     12,900,258        12,728,641   

Shareholders' equity:

    

Preferred stock, par value $1 per share – Authorized 5,000,000 shares; outstanding: -0- in 2012 and in 2011

     0        0   

Common stock, par value $1 per share – Authorized 320,000,000 shares; outstanding: (2012 – 112,312,123 issued, less 12,986,698 held in treasury and 2011 – 112,312,123 issued, less 11,732,658 held in treasury)

     112,312        112,312   

Additional paid-in capital

     437,037        425,331   

Accumulated other comprehensive income (loss)

     501,290        549,916   

Retained earnings

     3,349,856        3,264,711   

Treasury stock, at cost

     (566,341     (492,639
  

 

 

   

 

 

 

Total shareholders' equity

     3,834,154        3,859,631   
  

 

 

   

 

 

 

Total liabilities and shareholders' equity

   $ 16,734,412      $ 16,588,272   
  

 

 

   

 

 

 

 

* Derived from audited financial statements. Additionally, 2011 balances have been retroactively adjusted to give effect to the adoption of new accounting guidance as described in Note F – Adoption of New Accounting Standard.

See accompanying Notes to Consolidated Financial Statements.

 

1


Table of Contents

TORCHMARK CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited and in thousands except per share data)

 

     Three Months Ended
March 31,
 
     2012     2011*  
           (As adjusted)  

Revenue:

    

Life premium

   $ 451,878      $ 430,657   

Health premium

     266,444        249,106   

Other premium

     153        138   
  

 

 

   

 

 

 

Total premium

     718,475        679,901   

Net investment income

     174,121        171,647   

Realized investment gains (losses)

     5,006        (22,723

Other income

     321        447   
  

 

 

   

 

 

 

Total revenue

     897,923        829,272   

Benefits and expenses:

    

Life policyholder benefits

     290,688        278,338   

Health policyholder benefits

     211,092        175,270   

Other policyholder benefits

     10,867        10,519   
  

 

 

   

 

 

 

Total policyholder benefits

     512,647        464,127   

Amortization of deferred acquisition costs

     96,498        92,463   

Commissions, premium taxes, and non-deferred acquisition costs

     50,756        55,518   

Other operating expense

     48,116        50,187   

Interest expense

     19,671        19,460   
  

 

 

   

 

 

 

Total benefits and expenses

     727,688        681,755   

Income from continuing operations before income taxes

     170,235        147,517   

Income taxes

     (51,558     (46,777
  

 

 

   

 

 

 

Income from continuing operations

     118,677        100,740   

Loss on disposal of discontinued operations, net of tax

     0        (599
  

 

 

   

 

 

 

Net income

   $ 118,677      $ 100,141   
  

 

 

   

 

 

 

Basic net income per share:

    

Continuing operations

   $ 1.19      $ 0.87   

Discontinued operations

     0.00        (0.01
  

 

 

   

 

 

 

Total basic net income per share

   $ 1.19      $ 0.86   
  

 

 

   

 

 

 

Diluted net income per share:

    

Continuing operations

   $ 1.17      $ 0.85   

Discontinued operations

     0.00        (0.01
  

 

 

   

 

 

 

Total diluted net income per share

   $ 1.17      $ 0.84   
  

 

 

   

 

 

 

Dividends declared per common share

   $ 0.12      $ 0.11   
  

 

 

   

 

 

 

* The 2011 balances have been retroactively adjusted to give effect to the adoption of new accounting guidance as described in Note F—Adoption of New Accounting Standard.

See accompanying Notes to Consolidated Financial Statements.

 

2


Table of Contents

TORCHMARK CORPORATION

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited and in thousands)

 

     Three Months Ended
March 31,
 
     2012     2011*  
           (As adjusted)  

Net income

   $ 118,677      $ 100,141   

Other comprehensive income (loss):

    

Unrealized gains (losses) on securities:

    

Unrealized holding gains (losses) arising during period

     (81,631     29,435   

Less: reclassification adjustment for (gains) losses on securities included in net income

     (5,050     22,728   

Less: reclassification adjustment for amortization of (discount) and premium

     (96     (1,142

Less: foreign exchange adjustment on securities marked to market

     (3,671     (3,166
  

 

 

   

 

 

 

Unrealized gains (losses) on securities

     (90,448     47,855   

Unrealized gains (losses) on deferred acquisition costs

     8,261        (1,395

Unrealized gains (losses) on other assets

     992        0   
  

 

 

   

 

 

 

Total unrealized gains (losses)

     (81,195     46,460   

Less applicable taxes

     28,419        (16,260
  

 

 

   

 

 

 

Unrealized gains (losses), net of tax

     (52,776     30,200   

Foreign exchange translation adjustments

     2,878        871   

Less applicable taxes

     (1,007     (303
  

 

 

   

 

 

 

Foreign exchange translation adjustments, net of tax

     1,871        568   

Amortization of pension costs

     3,506        3,042   

Less applicable taxes

     (1,227     (1,066
  

 

 

   

 

 

 

Amortization of pension costs, net of tax

     2,279        1,976   
  

 

 

   

 

 

 

Other comprehensive income (loss)

     (48,626     32,744   
  

 

 

   

 

 

 

Comprehensive income (loss)

   $ 70,051      $ 132,885   
  

 

 

   

 

 

 

 

* The 2011 balances have been retroactively adjusted to give effect to the adoption of new accounting guidance as described in Note F – Adoption of New Accounting Standard.

See accompanying Notes to Consolidated Financial Statements.

 

3


Table of Contents

TORCHMARK CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited and in thousands)

 

     Three Months Ended
March 31,
 
     2012     2011  

Cash provided from operations

   $ 284,047      $ 300,047   

Cash provided from (used for) investment activities:

    

Investments sold or matured:

    

Fixed maturities available for sale—sold

     55,033        15,052   

Fixed maturities available for sale—matured, called, and repaid

     29,441        103,149   

Other long-term investments

     502        535   
  

 

 

   

 

 

 

Total investments sold or matured

     84,976        118,736   

Investments acquired:

    

Fixed maturities

     (231,370     (231,217

Other long-term investments

     (3,655     (4,027
  

 

 

   

 

 

 

Total investments acquired

     (235,025     (235,244

Net (increase) decrease in short-term investments

     (34,734     (54,337

Net change in payable or receivable for securities

     11,423        2,833   

Disposition of properties

     19        37   

Additions to properties

     (479     (761

Investment in low-income housing interests

     (21,595     (6,861
  

 

 

   

 

 

 

Cash used for investment activities

     (195,415     (175,597

Cash provided from (used for) financing activities:

    

Proceeds from exercise of stock options

     94,439        45,171   

Net borrowings (repayments) of commercial paper

     42        1,560   

Excess tax benefit from stock option exercises

     9,273        5,665   

Acquisition of treasury stock

     (189,949     (235,913

Cash dividends paid to shareholders

     (12,087     (12,508

Net receipts (withdrawals) from deposit product operations

     6,415        (6,976
  

 

 

   

 

 

 

Cash provided by (used for) financing activities

     (91,867     (203,001

Effect of foreign exchange rate changes on cash

     (2,576     (3,455
  

 

 

   

 

 

 

Net increase (decrease) in cash

     (5,811     (82,006

Cash at beginning of year

     84,113        365,679   
  

 

 

   

 

 

 

Cash at end of period

   $ 78,302      $ 283,673   
  

 

 

   

 

 

 

See accompanying Notes to Consolidated Financial Statements.

 

4


Table of Contents

TORCHMARK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

(Dollar amounts in thousands except per share data)

Note A—Accounting Policies

The accompanying consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q. Therefore, they do not include all of the annual disclosures required by accounting principles generally accepted in the United States of America (GAAP). However, in the opinion of management, these statements include all adjustments, consisting of normal recurring adjustments, which are necessary for a fair presentation of the consolidated financial position at March 31, 2012, and the consolidated results of operations, comprehensive income, and cash flows for the periods ended March 31, 2012 and 2011. The interim period consolidated financial statements should be read in conjunction with our Consolidated Financial Statements that are included in the Annual Report on Form 10K filed on February 28, 2012.

 

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Table of Contents

TORCHMARK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

(Dollar amounts in thousands except per share data)

 

Note B—Earnings Per Share

Torchmark declared a three-for-two stock split paid in the form of a 50% stock dividend on all of the Company’s outstanding common stock. On July 1, 2011, the payment date, holders of Torchmark common stock as of June 1, 2011 received one additional share of stock for every two shares held. All share and per share amounts have been adjusted to reflect this stock split for all periods presented in these consolidated financial statements.

A reconciliation of basic and diluted weighted-average shares outstanding is as follows:

 

     For the three months ended  
     March 31,  
     2012      2011  

Basic weighted average shares outstanding

     100,068,360         116,817,327   

Weighted average dilutive options outstanding

     1,191,932         2,196,825   
  

 

 

    

 

 

 

Diluted weighted average shares outstanding

     101,260,292         119,014,152   
  

 

 

    

 

 

 

Antidilutive shares*

     66,813         1,320,543   
  

 

 

    

 

 

 

*Antidilutive shares are excluded from the calculation of diluted earnings per share.

 

6


Table of Contents

TORCHMARK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

(Dollar amounts in thousands except per share data)

 

Note C—Postretirement Benefit Plans

The following tables present a summary of post-retirement benefit costs by component:

Components of Post-Retirement Benefit Costs

 

     Three Months ended March 31,  
     Pension Benefits     Other Benefits  
     2012     2011     2012      2011  

Service cost

   $ 2,691      $ 2,339      $ 124       $ 248   

Interest cost

     4,152        4,026        257         252   

Expected return on assets

     (4,120     (4,030     0         0   

Prior service cost

     516        519        0         0   

Net actuarial (gain)/loss

     2,966        2,395        0         (136
  

 

 

   

 

 

   

 

 

    

 

 

 

Net periodic benefit cost

   $ 6,205      $ 5,249      $ 381       $ 364   
  

 

 

   

 

 

   

 

 

    

 

 

 

 

7


Table of Contents

TORCHMARK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

(Dollar amounts in thousands except per share data)

Note C—Postretirement Benefit Plans (continued)

 

The following chart presents assets at fair value for the defined-benefit pension plans at March 31, 2012 and the prior-year end.

Pension Assets by Component

(Dollar amounts in thousands)

 

     March 31, 2012         December 31, 2011   
  

 

 

    

 

 

 
     Amount         %         Amount         %   
  

 

 

    

 

 

    

 

 

    

 

 

 

Corporate debt

   $ 158,279         59.9       $ 159,759         61.9   

Other fixed maturities

     335         0.1         348         0.1   

Equity securities

     87,580         33.2         79,459         30.8   

Short-term investments

     3,081         1.2         3,767         1.5   

Guaranteed annuity contract

     12,665         4.8         12,745         4.9   

Other

     2,236         0.8         1,989         0.8   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $     264,176         100.0       $     258,067         100.0   
  

 

 

    

 

 

    

 

 

    

 

 

 

The liability for the funded defined-benefit pension plans was $282 million at December 31, 2011. Contributions of $375 thousand were made to the qualified pension plans during the three months ended March 31, 2012. Torchmark plans to contribute an amount not to exceed $6 million for 2012 during the remainder of the year. With respect to the Company’s non-qualified supplemental retirement plan, life insurance policies on the lives of plan participants have been established with an unaffiliated carrier to fund a portion of the Company’s obligations under the plan. These policies, as well as investments deposited with an unaffiliated trustee, were previously placed in a Rabbi Trust to provide for payment of the plan obligations. At March 31, 2012, the combined value of the insurance policies and investments in the Rabbi Trust to support plan liabilities were $50 million, compared with $43 million at year end 2011. This plan is unqualified and therefore the value of the insurance policies and investments are not included in the chart of plan assets above. The liability for the unqualified pension plan was $50 million at December 31, 2011.

 

8


Table of Contents

TORCHMARK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

(Dollar amounts in thousands except per share data)

 

Note D—Investments

Portfolio Composition:

A summary of fixed maturities and equity securities available for sale by cost or amortized cost and estimated fair value at March 31, 2012 is as follows:

PORTFOLIO COMPOSITION AS OF MARCH 31, 2012

 

    
                                   
     Cost or
Amortized
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
    Fair Value      % of
Total Fixed
Maturities*
 

Fixed maturities available for sale:

             

Bonds:

             

U.S. Government direct, guaranteed, and government-sponsored enterprises

   $ 65,374       $ 831       $ (716   $ 65,489         1

States, municipalities, and political subdivisions

     1,212,410         127,401         (1,009     1,338,802         11   

Foreign governments

     22,390         1,081         0        23,471         0   

Corporates

     8,519,731         902,554         (111,946     9,310,339         78   

Collateralized debt obligations

     61,457         0         (32,676     28,781         0   

Other asset-backed securities

     37,222         2,856         (1,338     38,740         0   

Redeemable preferred stocks

     1,162,821         29,813         (43,416     1,149,218         10   
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

Total fixed maturities

     11,081,405         1,064,536         (191,101     11,954,840         100
             

 

 

 

Equity securities

     14,875         2,328         (69     17,134      
  

 

 

    

 

 

    

 

 

   

 

 

    

Total fixed maturities and equitysecurities

   $ 11,096,280       $ 1,066,864       $ (191,170   $ 11,971,974      
  

 

 

    

 

 

    

 

 

   

 

 

    

 

* At fair value

 

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Table of Contents

TORCHMARK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

(Dollar amounts in thousands except per share data)

Note D—Investments (continued)

 

A schedule of fixed maturities by contractual maturity date at March 31, 2012 is shown below on an amortized cost basis and on a fair value basis. Actual maturity dates could differ from contractual maturities due to call or prepayment provisions.

 

     Amortized
Cost
     Fair
Value
 

Fixed maturities available for sale:

     

Due in one year or less

   $ 73,875       $ 75,493   

Due from one to five years

     497,355         537,343   

Due from five to ten years

     698,562         770,036   

Due from ten to twenty years

     2,472,078         2,678,707   

Due after twenty years

     7,235,975         7,820,292   

Mortgage-backed and asset-backed securities

     103,560         72,969   
  

 

 

    

 

 

 
   $ 11,081,405       $ 11,954,840   
  

 

 

    

 

 

 

Selected information about sales of fixed maturities is as follows:

 

For the three months ended March 31,

 
     2012     2011  

Proceeds from sales

   $ 55,033      $ 56,197   

Gross realized gains

     5,162        161   

Gross realized losses

     (114     (22,934

 

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Table of Contents

TORCHMARK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

(Dollar amounts in thousands except per share data)

Note D—Investments (continued)

 

Fair Value Measurements:

The following table represents assets measured at fair value on a recurring basis:

FAIR VALUE MEASUREMENTS AT MARCH 31, 2012 USING:

 

Description

   Quoted Prices
in Active

Markets for
Identical
Assets
(Level 1)
    Significant
Other
Observable
Inputs (Level 2)
    Significant
Unobservable
Inputs (Level 3)
    Total Fair
Value
 

Fixed maturities available for sale:

        

Bonds:

        

U.S. Government direct, guaranteed, and government-sponsored enterprises

   $ 0      $ 65,489      $ 0      $ 65,489   

States, municipalities, and political subdivisions

     0        1,338,802        0        1,338,802   

Foreign governments

     0        23,471        0        23,471   

Corporates

     33,018        9,230,891        46,430        9,310,339   

Collateralized debt obligations

     0        0        28,781        28,781   

Other asset-backed securities

     0        38,740        0        38,740   

Redeemable preferred stocks

     221,249        927,969        0        1,149,218   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total fixed maturities

     254,267        11,625,362        75,211        11,954,840   

Equity securities

     16,331        64        739        17,134   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total fixed maturities and equity securities

   $ 270,598      $ 11,625,426      $ 75,950      $ 11,971,974   
  

 

 

   

 

 

   

 

 

   

 

 

 

Percent of total

     2.3     97.1     0.6     100.0
  

 

 

   

 

 

   

 

 

   

 

 

 

 

11


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TORCHMARK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

(Dollar amounts in thousands except per share data)

Note D—Investments (continued)

 

As of March 31, 2012, fair value measurements classified as Level 3 represented 0.6% of total fixed maturities and equity securities, compared with 0.4% at December 31, 2011.

Other-Than-Temporary Impairments:

There were no other-than-temporary impairments during the three-month periods ending March 31, 2012 or 2011.

Unrealized Loss Analysis:

The following table discloses unrealized investment losses by class of investment at March 31, 2012. Torchmark considers these investments not to be other-than-temporarily impaired.

 

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TORCHMARK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

(Dollar amounts in thousands except per share data)

Note D—Investments (continued)

 

ANALYSIS OF GROSS UNREALIZED INVESTMENT LOSSES

At March 31, 2012

 

     Less than     Twelve Months               
     Twelve Months     or Longer     Total  
     Fair      Unrealized     Fair      Unrealized     Fair      Unrealized  

Description of Securities

   Value      Loss     Value      Loss     Value      Loss  

Fixed maturities available for sale:

               

Bonds:

               

U.S. Government direct, guaranteed, and government-sponsored enterprises

   $ 46,509       $ (715   $ 33       $ (1   $ 46,542       $ (716

States, municipalities, and political subdivisions

     0         0        16,754         (1,009     16,754         (1,009

Foreign governments

     0         0        0         0        0         0   

Corporates

     790,774         (28,140     601,772         (83,806     1,392,546         (111,946

Collateralized debt obligations

     0         0        28,781         (32,676     28,781         (32,676

Other asset-backed securities

     0         0        7,122         (1,338     7,122         (1,338

Redeemable preferred stocks

     232,812         (4,762     352,613         (38,654     585,425         (43,416
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total fixed maturities

     1,070,095         (33,617     1,007,075         (157,484     2,077,170         (191,101

Equity securities

     64         (34     315         (35     379         (69
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total fixed maturities and equity securities

   $ 1,070,159       $ (33,651   $ 1,007,390       $ (157,519   $ 2,077,549       $ (191,170
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Additional information about investments in an unrealized loss position is as follows:

 

     Less than
Twelve
Months
     Twelve
Months
or Longer
     Total  

Number of issues (Cusip numbers) held:

        

As of March 31, 2012

     134         88         222   

As of December 31, 2011

     117         93         210   

 

13


Table of Contents

TORCHMARK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

(Dollar amounts in thousands except per share data)

Note D—Investments (continued)

 

Torchmark’s entire fixed-maturity and equity portfolio consisted of 1,369 issues at March 31, 2012 and 1,373 issues at December 31, 2011. The weighted average quality rating of all unrealized loss positions as of March 31, 2012 was BBB. Even though Torchmark’s fixed-maturity investments are available for sale, Torchmark’s management generally does not intend to sell and does not believe it will be required to sell any securities which are temporarily impaired until they mature due to the strong and stable cash flows generated by its insurance products.

Torchmark’s balances related to bifurcated credit loss positions included in other comprehensive income were $22 million at March 31, 2012 and December 31, 2011, with no change to this balance during any period presented.

Note E—Income Taxes

The effective income tax rate differed from the expected 35% rate as shown below:

 

     Three months ended March 31,  
     2012     2011  
     Amount     %     Amount     %  

Expected income taxes

   $ 59,582        35.0      $ 51,631        35.0   

Increase (reduction) in income taxes resulting from:

        

Tax-exempt investment income

     (924     (0.5     (846     (0.6

Low-income housing investments

     (7,246     (4.3     (5,058     (3.4

Other

     146        0.1        1,050        0.7   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income tax expense

   $ 51,558        30.3      $ 46,777        31.7   
  

 

 

   

 

 

   

 

 

   

 

 

 

The effective income tax rate for the three month period ended March 31, 2012 differed from the effective income tax rate for the same period ended March 31, 2011 primarily as a result of the Company’s low-income housing tax credit investments.

 

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TORCHMARK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

(Dollar amounts in thousands except per share data)

 

Note F—Adoption of New Accounting Standard

The FASB has issued and Torchmark has adopted new guidance concerning policy acquisition costs (ASU 2010-26) as of January 1, 2012. This accounting guidance amends the accounting for costs associated with acquiring or renewing insurance contracts in order to address the diversity in practice surrounding the capitalization and deferral of these costs. As a result of this new standard, certain costs that have been deferred and amortized through deferred acquisition costs are no longer allowed to be deferred and are expensed as incurred. The new guidance limits the deferral of costs to those direct incremental costs related to the successful issuance of an insurance contract, and includes primarily sales commissions, policy issue, and underwriting costs for policies that are successfully issued. Previously, the Company was allowed to defer any cost that varied with and related to the production of new business. For Torchmark, the costs that are no longer deferrable primarily relate to agent distribution systems, and include such costs as training, recruiting, office space, and certain management and underwriting expenses.

Torchmark has adopted the new guidance retroactively, as permitted, meaning the deferred acquisition cost has been written down to a level as if the new guidance had been in effect in prior periods. The reduction in acquisition cost deferrals have caused commissions and expenses to increase. However, as a result of the retroactive writedown, the amortization of previously deferred costs decreased, offsetting the impact of the increased expenses. The method of amortization has not changed due to the adoption. The retroactive adoption of the standard caused the deferred acquisition cost asset to be reduced by $537 million at January 1, 2011 and $568 million at December 31, 2011, while stockholders’ equity was reduced by $349 million and $369 million at January 1, 2011 and December 31, 2011, respectively. Net income for the first quarter of 2011 was reduced by $5.4 million and 2011 first quarter earnings per diluted share were reduced by $0.05. The adoption of this guidance causes a delay in the recognition of underwriting profit on newly issued business, but not the ultimate profitability of that business. The adoption had no impact on Torchmark’s cash flows, liquidity, or the statutory earnings of its insurance subsidiaries.

The new guidance further limits the deferral of certain advertising costs associated with the Direct Response operation. Costs related to advertising are generally charged to expense as incurred. However, certain direct response advertising costs are capitalized when there is a reliable and demonstrated relationship between total costs and future benefits that is a direct result of incurring these costs. Direct Response advertising costs consist primarily of the production and distribution costs of direct mail advertising materials, and when capitalized are included as a component of deferred acquisition costs. They are amortized in the same manner as other deferred acquisition costs. Direct Response advertising costs charged to earnings and included in other operating expense were $4.2 million in the first three months of 2012, compared with $4.0 million in the same period of 2011. Capitalized advertising costs were $32.9 million at March 31, 2012, compared with $31.9 million at December 31, 2011.

 

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Table of Contents

TORCHMARK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

(Dollar amounts in thousands except per share data)

Note F—Adoption of New Accounting Standard (continued)

 

A roll forward presenting an analysis of the changes in the deferred acquisition costs balances for the 2012 and 2011 periods is as follows:

Deferred Acquisition Costs

 

     Three months ended  
     March 31,  
     2012     2011(1)  

Balance at beginning of year

   $ 2,916,732      $ 2,869,546   

Additions:

    

Deferred during period:

    

Commissions

     74,979        67,892   

Other expenses

     44,890        40,118   
  

 

 

   

 

 

 

Total deferred

     119,869        108,010   

Adjustment attributable to unrealized investment losses (2)

     8,262        0   

Foreign exchange adjustment

     2,790        954   
  

 

 

   

 

 

 

Total additions

     130,921        108,964   

Deductions:

    

Amortized during period

     (96,498     (92,463

Adjustment attributable to unrealized investment gains(2)

     0        (1,395
  

 

 

   

 

 

 

Total deductions

     (96,498     (93,858
  

 

 

   

 

 

 

Balance at end of period

   $ 2,951,155      $ 2,884,652   
  

 

 

   

 

 

 

 

  (1) The 2011 balances have been retroactively adjusted to give effect to the adoption of new accounting guidance.
  (2) Represents amounts pertaining to investments relating to universal life-type products.

NOTE G—Business Segments

Torchmark is comprised of life insurance companies which primarily market individual life and supplemental health insurance products through niche distribution systems to middle income Americans. To a limited extent, the Company also markets fixed annuities. Torchmark’s core operations are insurance marketing and underwriting, and management of its investments. Insurance marketing and underwriting is segmented by the types of insurance products offered: life, health, and annuity. Management’s measure of profitability for each insurance segment is insurance underwriting margin, which is underwriting income before other income and insurance administrative expenses. It represents the profit margin on insurance products before administrative expenses, and is calculated by deducting net policy obligations (claims incurred and change in reserves), commissions and other acquisition expenses from premium revenue. Torchmark further views the profitability of each insurance product segment by the marketing groups that distribute the products of that segment: direct response, independent, or captive/career agencies.

 

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Table of Contents

TORCHMARK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

(Dollar amounts in thousands except per share data)

Note G—Business Segments (continued)

 

The investment segment includes the management of the investment portfolio, debt, and cash flow. Management’s measure of profitability for this segment is excess investment income, which is the income earned on the investment portfolio less the interest credited on net policy liabilities and financing costs. Financing costs include the interest on Torchmark’s debt. Other income and insurance administrative expense are classified in a separate “Other” segment.

The required interest on net policy liabilities (benefit reserves less the deferred acquisition cost asset) is not credited to policyholder accounts. Instead, it is an actuarial assumption for discounting cash flows in the computation of benefit reserves and the amortization of the deferred acquisition cost asset. Required interest related to the net policy liabilities is not included in the various insurance underwriting segments but is shown in the investment segment as a reduction to net investment income. We believe this presentation facilitates a more meaningful analysis of the Company’s underwriting and investment performance as the underwriting results are based on premiums, claims and expenses and are not affected by unanticipated fluctuations in investment yields.

As noted, Torchmark’s “core operations” are insurance and investment management. The insurance segments issue policies for which premiums are collected for the eventual payment of policy benefits. In addition to policy benefits, operating expenses are incurred including acquisition costs, administrative expenses, and taxes. Because life and health contracts can be long term, premium receipts in excess of current expenses are invested. Investment activities, conducted by the investment segment, focus on seeking quality investments with a yield and term appropriate to support the insurance product obligations. These investments generally consist of fixed maturities, and, over the long term, the expected yields are taken into account when setting insurance premium rates and product profitability expectations. As a result, fixed maturities are generally held for long periods to support the liabilities, and Torchmark generally expects to hold investments until maturity. Dispositions of investments occur from time to time, generally as a result of credit concerns, calls by issuers, or other factors usually beyond the control of management.

Dispositions are sometimes required in order to maintain the Company’s investment policies and objectives. Investments are also occasionally written down as a result of other-than-temporary impairment. Torchmark does not actively trade investments. As a result, realized gains and losses from the disposition and write down of investments are generally incidental to operations and are not considered a material factor in insurance pricing or product profitability. While from time to time these realized gains and losses could be significant to net income in the period in which they occur, they have a limited effect on the yield of the total investment portfolio. Further, because the proceeds of the disposals are reinvested in the portfolio, the disposals have little effect on the size of the portfolio and the income from the reinvestments is included in net investment income. Therefore, management removes realized investment gains and losses from results of core operations when evaluating the performance of the Company. For this reason, these gains and losses are excluded from Torchmark’s operating segments.

 

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Table of Contents

TORCHMARK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

(Dollar amounts in thousands except per share data)

Note G—Business Segments (continued)

 

Torchmark accounts for its stock options and restricted stock under current accounting guidance requiring stock options and stock grants to be expensed based on fair value at the time of grant. Management considers stock compensation expense to be an expense of the Parent Company. Therefore, stock compensation expense is treated as a corporate expense in Torchmark’s segment analysis.

Torchmark provides coverage under the Medicare Part D prescription drug plan for Medicare beneficiaries. In accordance with GAAP, Part D premiums are recognized evenly throughout the year when they become due but benefit costs are recognized when the costs are incurred. Due to the design of the Part D product, premiums are evenly distributed throughout the year, but benefit costs are higher earlier in the year. As a result, under GAAP, benefit costs can exceed premiums in the first part of the year, but be less than premiums during the remainder of the year. In order to more closely match the benefit cost with the associated revenue for interim periods, Torchmark defers these excess benefits for segment reporting purposes. In addition, GAAP recognizes in each quarter a government risk-sharing premium adjustment consistent with the contract as if the quarter represented an entire contract period. These contract payments are based upon the experience of the full contract year, not the experience of interim periods. Therefore, these risk-sharing adjustments are removed in the segment analysis. For the entire year, Torchmark expects its benefit ratio to be in line with pricing and does not expect to receive any government risk-sharing premium. For the full year of 2011, the total premiums and benefits were the same under this alternative method as they were under GAAP and are expected to be so in 2012. The Company’s presentation results in the underwriting margin percentage of each interim period reflecting the expected margin percentage for the full year.

 

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Table of Contents

TORCHMARK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

(Dollar amounts in thousands except per share data)

Note G—Business Segments (continued)

 

An analysis of the adjustments for the difference in the interim results as presented for segment purposes and GAAP for Medicare Part D is as follows:

 

     Three Months Ended  
     March 31,  
     2012     2011  

Benefit costs deferred

   $ 31,614      $ 11,661   

Government risk-sharing premium adjustment

     (11,787     (7,871
  

 

 

   

 

 

 

Pre-tax addition to segment interim period income

   $ 19,827      $ 3,790   
  

 

 

   

 

 

 

After tax amount

   $ 12,888      $ 2,463   
  

 

 

   

 

 

 

Torchmark has invested in various limited partnerships that provide investment returns through the provision of low-income housing tax credits and other related Federal income tax benefits to the Company. The investment returns from a portion of the interests are guaranteed by unrelated third-parties. Under GAAP, expenses associated with the amortization of the guaranteed interests are required to be reflected in income tax expense. In contrast, GAAP requires the expenses associated with the amortization of non-guaranteed interests to be reflected as a component of “Net investment income.” All of the investment returns from investing in these guaranteed and non-guaranteed limited partnerships interests are in the form of income tax benefits reflected in income tax expense. Management believes including the amortization expense associated with the non-guaranteed as well as the guaranteed interest in income tax expense provides a more appropriate matching of the expense with the related income. For this reason, amortization expense of the non-guaranteed interests is included in “Income taxes” and not “Net investment income” for segment reporting purposes.

During the first quarter of 2011, Torchmark sold aviation equipment for a pretax loss of $979 thousand ($666 thousand after tax). Also in the first quarter of 2011, Torchmark accrued an estimated liability for a state administrative settlement involving issues arising over many years in the pretax amount of $6 million ($4.1 million after tax). Management removes items such as these that are related to prior periods or are one-time non-operating sales transactions when analyzing its segment profitability. As such, these items are presented as reconciling items to arrive at pre-tax income from continuing operations in the 2011 period.

The following tables total the components of Torchmark’s operating segments and reconcile these operating results to its pretax income and each significant line item in its Consolidated Statements of Operations.

 

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Table of Contents

TORCHMARK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

(Dollar amounts in thousands except per share data)

Note G—Business Segments (continued)

 

Reconciliation of Segment Operating Information to the Consolidated Statement of Operations

 

$000,000 $000,000 $000,000 $000,000 $000,000 $000,000 $000,000
    For the three months ended March 31, 2012  
    Life     Health     Annuity     Investment     Other &
Corporate
    Adjustments     Consolidated  

Revenue:

             

Premium

  $ 451,878      $ 254,657      $ 153          $ 11,787 (1)    $ 718,475   

Net investment income

        $ 179,648          (5,527 )(2,5)      174,121   

Other income

          $ 409        (88 )(4)      321   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenue

    451,878        254,657        153        179,648        409        6,172        892,917   

Expenses:

             

Policy benefits

    290,688        179,478        10,867            31,614 (1)      512,647   

Required interest on net reserves

    (118,413     (9,288     (14,692     142,393            0   

Amortization of acquisition costs

    118,507        20,948        3,086        (46,043         96,498   

Commissions, premium taxes, and non-deferred acquisition costs

    34,961        15,863        20            (88 )(4)      50,756   

Insurance administrative expense (3)

            40,570          40,570   

Parent expense

            1,921          1,921   

Stock compensation expense

            5,625          5,625   

Interest expense

          19,605          66 (2)      19,671   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total expenses

    325,743        207,001        (719     115,955        48,116        31,592        727,688   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Subtotal

    126,135        47,656        872        63,693        (47,707     (25,420     165,229   

Nonoperating items

              19,827 (1)      19,827   

Amortization of low-income housing

              5,593 (5)      5,593   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Measure of segment profitability (pretax)

  $ 126,135      $ 47,656      $ 872      $ 63,693      $ (47,707   $ 0        190,649   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

Deduct applicable income taxes

                (62,338
             

 

 

 

Segment profits after tax

                128,311   

Add back income taxes applicable to segment profitability

  

        62,338   

Add (deduct) realized investment gains (losses)

  

            5,006   

Deduct Part D adjustment (1)

                (19,827

Deduct amortization of low-income housing (5)

  

          (5,593
             

 

 

 

Pretax income from continuing operations per Consolidated Statement of Operations

  

  $ 170,235   
             

 

 

 
(1) Medicare Part D items adjusted to GAAP from the segment analysis, which matches expected benefits with policy premium.
(2) Reclassification of interest amount due to accounting rule requiring deconsolidation of Trust Preferred Securities. Management views the Trust Preferreds as consolidated debt.
(3) Administrative expense is not allocated to insurance segments.
(4) Elimination of intersegment commission.
(5) Amortization of low-income housing expense, considered a component of income tax expense in the segment analysis.

 

 

20


Table of Contents

TORCHMARK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

(Dollar amounts in thousands except per share data)

Note G—Business Segments (continued)

 

Reconciliation of Segment Operating Information to the Consolidated Statement of Operations*

 

$000,000 $000,000 $000,000 $000,000 $000,000 $000,000 $000,000
    For the three months ended March 31, 2011  
    Life     Health     Annuity     Investment     Other &
Corporate
    Adjustments     Consolidated  

Revenue:

             

Premium

  $ 430,657      $ 241,235      $ 138          $ 7,871 (1)    $ 679,901   

Net investment income

        $ 175,302          (3,655 )(2,5)      171,647   

Other income

          $ 543        (96 )(4)      447   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenue

    430,657        241,235        138        175,302        543        4,120        851,995   

Expenses:

             

Policy benefits

    278,338        163,609        10,519            11,661 (1)      464,127   

Required interest on net reserves

    (112,313     (9,017     (13,729     135,059            0   

Amortization of acquisition costs

    113,804        20,816        2,770        (44,927         92,463   

Commissions, premium taxes, and non-deferred acquisition costs

    39,108        16,486        20            (96 )(4)      55,518   

Insurance administrative
expense
(3)

            37,739        6,979 (6,7)      44,718   

Parent expense

            2,425          2,425   

Stock compensation expense

            3,044          3,044   

Interest expense

          19,394          66 (2)      19,460   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total expenses

    318,937        191,894        (420     109,526        43,208        18,610        681,755   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Subtotal

    111,720        49,341        558        65,776        (42,665     (14,490     170,240   

Nonoperating items

              10,769 (1,6,7)      10,769   

Amortization of low-income housing

              3,721 (5)      3,721   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Measure of segment profitability (pretax)

  $ 111,720      $ 49,341      $ 558      $ 65,776      $ (42,665   $ 0        184,730   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

Deduct applicable income taxes

  

              (61,320
             

 

 

 

Segment profits after tax

                123,410   

Add back income taxes applicable to segment profitability

  

          61,320   

Add (deduct) realized investment gains (losses)

  

            (22,723

Deduct Part D adjustment (1)

  

              (3,790

Deduct amortization of low-income housing (5)

  

            (3,721

Deduct estimated state administrative settlement expense (6)

  

          (6,000

Deduct loss on sale of equipment (7)

  

              (979
             

 

 

 

Pretax income from continuing operations per Consolidated Statement of Operations

  

    $ 147,517   
             

 

 

 

 

(1) Medicare Part D items adjusted to GAAP from the segment analysis, which matches expected benefits with policy premium.
(2) Reclassification of interest amount due to accounting rule requiring deconsolidation of Trust Preferred Securities. Management views the Trust Preferreds as consolidated debt.
(3) Administrative expense is not allocated to insurance segments.
(4) Elimination of intersegment commission.
(5) Amortization of low-income housing expense, considered a component of income tax expense in the segment analysis.
(6) Estimated state administrative settlement expense.
(7) Loss on sale of equipment.

 

* The 2011 balances have been retroactively adjusted to give effect to the adoption of new accounting guidance as described in Note F—Adoption of New Accounting Standard.

 

21


Table of Contents

TORCHMARK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

(Dollar amounts in thousands except per share data)

Note G—Business Segments (continued)

The following table summarizes the measures of segment profitability for comparison. It also reconciles segment profits to net income.

Analysis of Profitability by Segment

(Dollar amounts in thousands)

 

     Three months
ended March 31,
    Increase
(Decrease)
 
     2012     2011*     Amount     %  

Life insurance

   $ 126,135      $ 111,720      $ 14,415        13   

Health insurance

     47,656        49,341        (1,685     (3

Annuity

     872        558        314     

Investment

     63,693        65,776        (2,083     (3

Other:

        

Other income

     409        543        (134     (25

Administrative expense

     (40,570     (37,739     (2,831     8   

Corporate and adjustments

     (7,546     (5,469     (2,077     38   
  

 

 

   

 

 

   

 

 

   

Pretax total

     190,649        184,730        5,919        3   

Applicable taxes

     (62,338     (61,320     (1,018     2   
  

 

 

   

 

 

   

 

 

   

Total

     128,311        123,410        4,901        4   

Reconciling items, net of tax:

        

Realized gains (losses) - Investments

     3,254        (15,459     18,713     

Loss on disposal of discontinued operations

     0        (599     599     

Part D adjustment

     (12,888     (2,463     (10,425  

Estimated state administrative settlement

     0        (4,082     4,082     

Loss on sale of equipment

     0        (666     666     
  

 

 

   

 

 

   

 

 

   

Net income

   $ 118,677      $ 100,141      $ 18,536        19   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

* The 2011 balances have been retroactively adjusted to give effect to the adoption of new accounting guidance as described in Note FAdoption of New Accounting Standard.

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Results of Operations

As discussed in Note F – Adoption of New Accounting Standard, Torchmark adopted ASU 2010-26, a new accounting rule concerning the deferral of policy acquisition costs. Note F describes the effect that this new guidance has on Torchmark. The new standard was adopted effective January 1, 2012, but was adopted retroactively, meaning that all prior periods give effect to the change as if we had always accounted for deferred acquisition costs under the new guidance. Therefore, the results for prior periods presented in this discussion have been restated as if the new rule had been in effect in those periods.

Net income for the first quarter of 2012 was $1.6 million lower than it would have been under the previous accounting guidance, compared with $5.4 million in the 2011 quarter. The impact of adoption of the new accounting guidance on individual components of net income for each of the first quarters of 2012 and 2011 is shown below:

For the Quarter Ended March 31, 2012

(Dollar amounts in thousands)

 

     Prior to the
effects of
ASU 2010-26
    Adjustments
due to the
adoption of
ASU 2010-26
    As
Reported
 

Life insurance:

      

Amortization of deferred acquisition costs

   $ (132,357   $ 13,850      $ (118,507

Non-deferred commissions and premium taxes

     (20,278     0        (20,278

Non-deferred acquisition expenses

     0        (14,683     (14,683

Health insurance:

      

Amortization of deferred acquisition costs

     (31,101     10,153        (20,948

Non-deferred commissions and premium taxes

     (12,788     0        (12,788

Non-deferred acquisition expenses

     0        (3,075     (3,075

Required interest on net policy liabilities

     (87,675     (8,675     (96,350

Income Tax

       850     
    

 

 

   

Total impact of adoption (net of tax)

     $ (1,580  
    

 

 

   

 

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Table of Contents

For the Quarter Ended March 31, 2011

(Dollar amounts in thousands)

 

     As Previously
Reported
    Adjustments
due to the
adoption of
ASU 2010-26
    As
Restated
 

Life insurance:

      

Amortization of deferred acquisition costs

   $ (126,398   $ 12,594      $ (113,804

Non-deferred commissions and premium taxes

     (19,147     0        (19,147

Non-deferred acquisition expenses

     0        (19,961     (19,961

Health insurance:

      

Amortization of deferred acquisition costs

     (31,930     11,114        (20,816

Non-deferred commissions and premium taxes

     (12,827     0        (12,827

Non-deferred acquisition expenses

     0        (3,659     (3,659

Required interest on net policy liabilities

     (81,749     (8,383     (90,132

Income Tax

       2,903     
    

 

 

   

Total impact of adoption (net of tax)

     $ (5,392  
    

 

 

   

Summary of Operations. Torchmark’s operations are segmented into its insurance underwriting and investment operations as described in Note G—Business Segments. The measures of profitability described in Note G are useful in evaluating the performance of the segments and the marketing groups within each insurance segment, because each of our distribution units operates in a niche market. These measures enable management to view period-to-period trends, and to make informed decisions regarding future courses of action.

The tables in Note G—Business Segments demonstrate how the measures of profitability are determined. Those tables also reconcile our revenues and expenses by segment to major income statement line items for the three-month periods ended March 31, 2012 and 2011. Additionally, a table in that note, Analysis of Profitability by Segment, provides a summary of the profitability measures that demonstrates year-to-year comparability and reconciles those measures to our net income. That summary represents our overall operations in the manner that management views the business, and is a basis of the following highlights discussion.

A discussion of operations by each segment follows later in this report. These discussions compare the first three months of 2012 with the same period of 2011, unless otherwise noted. The following discussions are presented in the manner we view our operations, as described in Note G—Business Segments.

 

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Table of Contents

Highlights, comparing the first three months of 2012 with the first three months of 2011. Net income per diluted share increased 39% to $1.17 from $.84. Included in net income in 2012 were realized investment gains of $3 million after tax or $.03 per share, compared with 2011 after-tax realized losses of $15 million, or $.13 per share. Realized investment gains and losses are discussed more fully under the caption Realized Gains and Losses in this report. Earnings in 2011 were also negatively affected by two non-operating charges, a charge for a state administrative matter in the estimated after tax amount of $4.1 million ($.03 per share) and the loss on sale of aviation equipment of $666 thousand after tax ($.01 per share).

We use three statistical measures as indicators of future premium growth: “annualized premium in force,” “net sales,” and “first-year collected premium.” Annualized premium in force is defined as the premium income that would be received over the following twelve months at any given date on all active policies if those policies remain in force throughout the twelve-month period. Annualized premium in force is an indicator of potential growth in premium revenue. Net sales is defined as annualized premium issued, net of cancellations in the first thirty days after issue, except for Direct Response, where net sales is annualized premium issued at the time the first full premium is paid after any introductory offer has expired. Annualized premium issued is the gross premium that would be received during the policies’ first year in force, assuming that none of the policies lapsed or terminated. Although lapses and terminations will occur, we believe that net sales is a useful indicator of the rate of acceleration of premium growth. First-year collected premium is the premium collected during the reporting period for all policies in their first policy year. First-year collected premium takes lapses into account in the first policy year when lapses are more likely to occur, and thus is a useful indicator of how much new premium is expected to be added to premium income in the future.

Total premium income rose 6% in 2012 to $718 million. Excluding the government risk-sharing adjustment for Medicare Part D, premium income rose 5% to $707 million. Total net sales rose 25% to $128 million. After adjusting for the increased sales of Medicare Part D in 2012, largely affected by the addition of automatic enrollees discussed later in this report, net sales rose 8% to $103 million. First-year collected premium increased 33% to $110 million for the period. Excluding the increase in Part D first-year premium, the increase was 4%.

Life insurance premium income grew 5% to $452 million. Life net sales increased 9% to $88 million, as three of our four distribution units experienced increases. First-year collected life premium rose 5% to $65 million. Life underwriting margins increased 13% to $126 million.

 

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Table of Contents

Health insurance premium income, excluding Medicare Part D premium, declined 6% to $181 million. Health net sales, excluding Part D, increased 5% to $15 million for the three months, primarily as a result of sales of a new cancer product at Liberty. First-year collected health premium, excluding Part D, fell 2% to $14 million for the period. Health premium continued to be restrained by the discontinuance of sales of certain health products.

Our Medicare Part D prescription drug business is a component of the health insurance segment. In the manner we view our Medicare Part D business as described in Note G—Business Segments, policyholder premium was $74 million in 2012 compared with $49 million in 2011, an increase of 50%. This increase was due to the addition of a large number of low-income automatic enrollees into our Part D program in 2012.

As explained in Note G—Business Segments, differences in our estimate of interim results for Medicare Part D as we view this product for segment purposes and GAAP financial statement purposes resulted in a $12.9 million after-tax charge to earnings in 2012 ($.13 per share) and a $2.5 million charge in 2011 ($.02 per share). We expect our 2012 full year benefit ratios to be approximately the same as those for interim periods, as was the case in 2011 and prior years. For this reason, there should be no differences in our segment versus financial statement reporting by year end 2012, as it relates to Medicare Part D. The increase in this adjustment in 2012 resulted from the addition of the automatic enrollees in Part D as noted above.

Excess investment income per diluted share increased 15% to $.63, while excess investment income declined 3% to $64 million. The increase in per share excess investment income in relation to the dollar amount resulted from the significant number of shares purchased over the past twelve months, as discussed later in this report. Net investment income rose $4 million, or 2%. Our average investment portfolio at amortized cost also grew 2%. The average effective yield on the fixed-maturity portfolio, which represents 96% of our investments, was 6.47% in the 2012 period, compared with 6.62% in the prior period. Excess investment income has been negatively affected by the low-interest-rate environment in financial markets during recent periods. Excess investment income declined despite a 2% increase in net investment income, because of the $6 million or 7% increase in required interest on net insurance policy liabilities. Financing costs also rose 1% in the period to $20 million.

In the first three months of 2012, we invested new money in our fixed-maturity portfolio at an effective annual yield on new investments of 4.76%, compared with 5.99% in the same period of 2011. Our fixed maturity portfolio yield was 6.46% (as of March 31, 2012) and the portfolio had an average rating of A-. Over 93% of the portfolio at amortized cost was investment grade at March 31, 2012. Cash and short-term investments were $134 million at that date, compared with $105 million at December 31, 2011.

 

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Table of Contents

The unrealized gain position in our fixed-maturity portfolio declined during the first quarter of 2012 from a net unrealized gain of $964 million at year end 2011 to a net unrealized gain position of $874 million at March 31, 2012, as yield rates in the bond market rose slightly. The fixed-maturity portfolio contains no commercial mortgage-backed securities or securities backed by subprime or Alt-A mortgages (loans for which some of the typical documentation was not provided by the borrower). We are not a party to any counterparty risk, with no credit default swaps or other derivative contracts. We do not engage in securities lending, and have no direct exposure to European sovereign debt.

We have an on-going share repurchase program which began in 1986 and was reaffirmed by the Board of Directors at their April, 2011 meeting. With no specified authorization amount, we determine the amount of repurchases based on the amount of our excess cash flow, general market conditions, and other alternative uses. These purchases are made with excess cash flow. Share purchases are also made with the proceeds from option exercises by current and former employees, in order to reduce dilution. The following chart summarizes share purchases for the three-month periods ended March 31, 2012 and 2011.

ANALYSIS OF SHARE PURCHASES

(Amounts in thousands)

 

     For the three months ended March 31,  
     2012      2011  
     Shares      Amount      Average
Price
     Shares      Amount      Average
Price
 

Purchases with:

                 

Excess cash flow

     1,880       $ 89,809       $ 47.77         4,418       $ 186,847       $ 42.30   

Option exercise proceeds

     2,136         100,140         46.88         1,142         49,066         42.95   
  

 

 

    

 

 

       

 

 

    

 

 

    

Total

     4,016       $ 189,949       $ 47.30         5,560       $ 235,913       $ 42.43   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Throughout the remainder of this discussion, share purchases will only refer to those made from excess cash flow.

A detailed discussion of our operations by component segment follows.

Life insurance, comparing the first three months of 2012 with the first three months of 2011. Life insurance is our predominant segment, representing 64% of premium income and 72% of insurance underwriting margin in the first three months of 2012. In addition, investments supporting the reserves for life business generate the majority of excess investment income attributable to the investment segment. Life insurance premium income increased 5% to $452 million. The following table presents Torchmark’s life insurance premium by distribution method.

 

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Table of Contents

Life Insurance

Premium by Distribution Method

(Dollar amounts in thousands)

 

     Three months ended March 31,      Increase  
     2012      2011      (Decrease)  
     Amount      % of
Total
     Amount      % of
Total
     Amount     %  

Direct Response

   $ 161,282         36       $ 151,577         35       $ 9,705        6   

American Income Exclusive Agency

     160,505         35         146,115         34         14,390        10   

Liberty National Exclusive Agency

     71,529         16         73,143         17         (1,614     (2

Other Agencies

     58,562         13         59,822         14         (1,260     (2
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

Total Life Premium

   $ 451,878         100       $ 430,657         100       $ 21,221        5   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Net sales, defined earlier in this report as an indicator of new business production, rose 9% to $88 million. Three of our four distribution groups had increases in net sales over the prior year period. An analysis of life net sales by distribution group is presented below.

Life Insurance

Net Sales by Distribution Method

(Dollar amounts in thousands)

 

     Three months ended March 31,      Increase  
     2012      2011      (Decrease)  
     Amount      % of
Total
     Amount      % of
Total
     Amount     %  

Direct Response

   $ 39,368         45       $ 36,166         45       $ 3,202        9   

American Income Exclusive Agency

     38,589         44         32,865         40         5,724        17   

Liberty National Exclusive Agency

     7,401         8         9,443         12         (2,042     (22

Other Agencies

     2,770         3         2,636         3         134        5   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

Total Life Net Sales

   $ 88,128         100       $ 81,110         100       $ 7,018        9   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

First-year collected life premium, defined earlier in this report, was $65 million in the 2012 period, rising 5%. First-year collected life premium by distribution group is presented in the table below.

 

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Table of Contents

Life Insurance

First-Year Collected Premium by Distribution Method

(Dollar amounts in thousands)

 

     Three months ended March 31,      Increase  
     2012      2011      (Decrease)  
     Amount      % of
Total
     Amount      % of
Total
     Amount     %  

Direct Response

   $ 24,955         38       $ 23,450         38         1,505        6   

American Income Exclusive Agency

     30,441         47         27,298         44         3,143        12   

Liberty National Exclusive Agency

     6,945         11         8,298         14         (1,353     (16

Other Agencies

     2,396         4         2,405         4         (9     0   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

Total

   $ 64,737         100       $ 61,451         100       $ 3,286        5   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

The Direct Response operation consists of two primary components: insert media and direct mail. Insert media, which targets primarily the adult market, involves placing insurance solicitations as inserts into a variety of media, such as coupon packets, newspapers, bank statements, and billings. Direct mail targets primarily young lower-middle and middle-income households with children. The juvenile life insurance policy is a key product. Not only is the juvenile market an important source of sales, but it also is a vehicle to reach the parents and grandparents of the juvenile policyholders, who are more likely to respond favorably to a Direct Response solicitation for life coverage on themselves than is the general adult population. Also, both the juvenile policyholders and their parents are low acquisition-cost targets for sales of additional coverage over time.

Direct Response’s life premium income rose 6% to $161 million. The Direct Response group is the largest contributor to life premium of any of Torchmark’s distribution systems, representing 36% of Torchmark’s total life premium. Net sales for this group of $39 million increased 9%. First-year collected premium gained 6% to $25 million.

The American Income Exclusive Agency markets primarily to members of labor unions, but also to credit unions and other associations. This agency produced premium income of $161 million, an increase of 10%. American Income represents 35% of Torchmark’s total life premium. This agency is also our fastest growing life insurance agency on the basis of premium growth. Net sales grew 17% to $39 million, while first-year collected premium rose 12% to $30 million. Increases in sales in our captive agencies are highly dependent on growth in the size of the agency force. The American Income agent count rose 26% to 5,104 at March 31, 2012 over the prior year (4,039). The count was also up 17% over the count at December 31, 2011 (4,381). The American Income Agency has been focusing on growing and strengthening middle management to support the growth of the agency force.

 

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Table of Contents

The Liberty National Exclusive Agency markets primarily life insurance and supplemental health insurance, focusing primarily on middle-income customers. Life premium income for this agency was $72 million in the 2012 period, a 2% decline compared with $73 million in the 2011 period. First-year collected premium declined 16% to $7 million.

Net sales for the Liberty Agency declined 22% to $7 million. Liberty had 1,276 producing agents at March 31, 2012, compared with 1,844 a year earlier, a decline of 31%. The agent count declined 5% since December 31, 2011, when it stood at 1,345. However, the agent count steadily increased during the last half of the first quarter of 2012 after reaching a low of 1,228 agents in the middle of February. The decrease in agent count over the prior twelve months is due to a number of factors, one of which was the closing of several offices which had poor production. Decreases were also a result of certain agent compensation issues which resulted in the departure of a number of the less productive agents. While these modifications caused a loss of agents, they resulted in improved persistency and margins, and have contributed to Torchmark’s overall improvement in life insurance margins. Additionally, we have changed the cost structure of this agency to a more commission-driven model, which we believe will also increase the profitability of new sales.

The Other Agencies distribution systems offering life insurance include the Military Agency, the UA Independent Agency (which predominantly writes health insurance), and various smaller distribution channels. The Other Agencies distribution group contributed $59 million of life premium income, or 13% of Torchmark’s total in the 2012 period, but contributed only 3% of net sales.

Life Insurance

Summary of Results

(Dollar amounts in thousands)

 

     Three months ended March 31,         
     2012      2011      Increase  
     Amount      % of
Premium
     Amount      % of
Premium
     Amount      %  

Premium and policy charges

   $ 451,878         100       $ 430,657         100       $ 21,221         5   

Net policy obligations

     172,275         38         166,025         39         6,250         4   

Commissions and acquisition expense*

     153,468         34         152,912         35         556         0   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

Insurance underwriting income before other income and administrative expense

   $ 126,135         28       $ 111,720         26       $ 14,415         13   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

* 2011 expense has been restated as a result of the adoption of new accounting guidance as described in Note FAdoption of New Accounting Standard. The restatement resulted in a reduction in the amortization of acquisition expense of $13 million and the addition of non-deferred acquisition expense of $20 million, for a net reduction in margin of $7 million in 2011.

 

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Table of Contents

Reported margins for our life insurance business have been negatively affected by the adopted accounting rule described in Note F which was adopted for all periods presented and has the effect of delaying the recognition of profitability on our insurance products. The recognition is delayed because we are no longer allowed to capitalize certain acquisition costs which were deferrable under previous accounting guidance. These costs that we no longer defer are included in the chart above under the caption “Commissions and acquisition expense” and were $14.7 million in 2012 and $20.0 million in 2011. While the recognition of profits are now delayed, ultimate profitability on our business is not affected by the change in accounting.

Life insurance underwriting income before insurance administrative expense was $126 million, increasing 13%. As a percentage of premium, underwriting income rose from 26% to 28% in 2012. Growth in underwriting income was caused partially by premium growth but also by reductions in certain acquisition expenses. There was also a slight improvement in the obligation ratio in 2012.

In 2011, we implemented several initiatives designed to further improve life insurance lapse ratios. Based on initial results, we continue to expect this program to increase conservation of life in-force premium.

Health insurance, comparing the first three months of 2012 with the first three months of 2011. Health premium accounted for 36% of our total premium in the 2012 period, while the health underwriting margin accounted for 27% of total underwriting margin, reflective of the lower underwriting margin as a percent of premium for health compared with life insurance. Health insurance sold by Torchmark includes primarily Medicare Supplement and Medicare Part D prescription drug coverage to enrollees in the federal Medicare program, along with limited-benefit cancer and accident coverage. All health coverage plans other than Medicare Supplement and Medicare Part D are classified here as limited-benefit plans. Medicare Part D business is shown as a separate health component and will be discussed separately in the analysis of the health segment.

As explained in Note G—Business Segments, management does not view the government risk-sharing premium for Medicare Part D as a component of premium income. Excluding this risk-sharing premium, health insurance premium for the 2012 period was $255 million, increasing 6%. A reconciliation between segment reporting for Medicare Part D and GAAP is presented in the chart in Note G—Business Segments, and those differences are fully discussed in that note.

 

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Table of Contents

The table below is an analysis of our health premium by distribution method.

Health Insurance

Premium by Distribution Method

(Dollar amounts in thousands)

 

     Three months ended March 31,      Increase  
     2012      2011      (Decrease)  
     Amount      % of
Total
     Amount      % of
Total
     Amount     %  

United American Independent Agency

                

Limited-benefit plans

   $ 8,351          $ 10,740          $ (2,389     (22

Medicare Supplement

     68,202            69,397            (1,195     (2
  

 

 

       

 

 

       

 

 

   
     76,553         42         80,137         42         (3,584     (4

Liberty National Exclusive Agency

                

Limited-benefit plans

     42,616            46,501            (3,885     (8

Medicare Supplement

     26,955            30,977            (4,022     (13
  

 

 

       

 

 

       

 

 

   
     69,571         39         77,478         40         (7,907     (10

American Income Exclusive Agency

                

Limited-benefit plans

     19,706            19,310            396        2   

Medicare Supplement

     177            197            (20     (10
  

 

 

       

 

 

       

 

 

   
     19,883         11         19,507         10         376        2   

Direct Response

                

Limited-benefit plans

     96            106            (10     (9

Medicare Supplement

     14,493            14,556            (63     0   
  

 

 

       

 

 

       

 

 

   
     14,589         8         14,662         8         (73     0   

Total Health Premium (Before Part D)

                

Limited-benefit plans

     70,769         39         76,657         40         (5,888     (8

Medicare Supplement

     109,827         61         115,127         60         (5,300     (5
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

Total (Before Part D)

     180,596         100         191,784         100         (11,188     (6
     

 

 

       

 

 

      

Medicare Part D*

     74,061            49,451            24,610        50   
  

 

 

       

 

 

       

 

 

   

Total Health Premium*

   $ 254,657          $ 241,235          $ 13,422        6   
  

 

 

       

 

 

       

 

 

   

 

 

 

 

* Total Medicare Part D premium and health premium exclude the risk-sharing premiums of $11.8 million in 2012 and $7.9 million in 2011 receivable from the Centers for Medicare and Medicaid Services consistent with the Medicare Part D contract. This risk-sharing amount is a portion of the excess or deficiency of actual over expected claims, and therefore we view this payment as a component of policyholder benefits in our segment analysis.

 

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Presented below is a table of health net sales by distribution method.

Health Insurance

Net Sales by Distribution Method

(Dollar amounts in thousands)

 

     Three months ended March 31,      Increase  
     2012      2011      (Decrease)  
     Amount      % of
Total
     Amount      % of
Total
     Amount     %  

United American Independent Agency

                

Limited-benefit plans

   $ 230          $ 249          $ (19     (8

Medicare Supplement

     7,607            6,871            736        11   
  

 

 

       

 

 

       

 

 

   
     7,837         52         7,120         50         717        10   

Liberty National Exclusive Agency

                

Limited-benefit plans

     3,247            2,415            832        34   

Medicare Supplement

     210            556            (346     (62
  

 

 

       

 

 

       

 

 

   
     3,457         23         2,971         21         486        16   

American Income Exclusive Agency

                

Limited-benefit plans

     2,185            2,499            (314     (13

Medicare Supplement

     0            0            0        0   
  

 

 

       

 

 

       

 

 

   
     2,185         14         2,499         17         (314     (13

Direct Response

                

Limited-benefit plans

     72            25            47        188   

Medicare Supplement

     1,512            1,673            (161     (10
  

 

 

       

 

 

       

 

 

   
     1,584         11         1,698         12         (114     (7

Total Net Sales (Before Part D)

                

Limited-benefit plans

     5,734         38         5,188         36         546        11   

Medicare Supplement

     9,329         62         9,100         64         229        3   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

Total (Before Part D)

     15,063         100         14,288         100         775        5   
     

 

 

       

 

 

      

Medicare Part D*

     25,076            7,491            17,585        235   
  

 

 

       

 

 

       

 

 

   

Total Net Sales *

   $ 40,139          $ 21,779          $ 18,360        84   
  

 

 

       

 

 

       

 

 

   

 

 

 

 

* Net sales for Medicare Part D represents only new first-time enrollees.

 

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The following table presents health insurance first-year collected premium by distribution method.

Health Insurance

First-Year Collected Premium by Distribution Method

(Dollar amounts in thousands)

 

     Three months ended March 31,      Increase  
     2012      2011      (Decrease)  
     Amount      % of
Total
     Amount      % of
Total
     Amount     %  

United American Independent Agency

                

Limited-benefit plans

   $ 209          $ 669          $ (460     (69

Medicare Supplement

     6,608            6,345            263        4   
  

 

 

       

 

 

       

 

 

   
     6,817         48         7,014         49         (197     (3

Liberty National Exclusive Agency

                

Limited-benefit plans

     3,338            2,243            1,095        49   

Medicare Supplement

     332            684            (352     (51
  

 

 

       

 

 

       

 

 

   
     3,670         26         2,927         20         743        25   

American Income Exclusive Agency

                

Limited-benefit plans

     2,482            2,867            (385     (13

Medicare Supplement

     0            0            0        0   
  

 

 

       

 

 

       

 

 

   
     2,482         18         2,867         20         (385     (13

Direct Response

                

Limited-benefit plans

     168            98            70        71   

Medicare Supplement

     955            1,490            (535     (36
  

 

 

       

 

 

       

 

 

   
     1,123         8         1,588         11         (465     (29

Total First-Year Collected Premium (Before Part D)

                

Limited-benefit plans

     6,197         44         5,877         41         320        5   

Medicare Supplement

     7,895         56         8,519         59         (624     (7
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

Total (Before Part D)

     14,092         100         14,396         100         (304     (2
     

 

 

       

 

 

      

Medicare Part D*

     31,510            7,190            24,320        338   
  

 

 

       

 

 

       

 

 

   

Total First-Year Collected Premium*

   $ 45,602          $ 21,586          $ 24,016        111   
  

 

 

       

 

 

       

 

 

   

 

 

 

 

* First-year collected premium for Medicare Part D represents only premium collected from new first-time enrollees in their first policy year.

Health insurance, excluding Medicare Part D. As noted under the caption Life Insurance, we have emphasized life insurance sales relative to health, due to life’s superior profitability and its greater contribution to excess investment income. Health premium, excluding Part D premium, fell 6% to $181 million in the 2012 period. Medicare Supplement premium declined 5% to $110 million, while other limited-benefit health premium decreased 8% to $71 million. Medicare Supplement provides Torchmark with the greatest amount of health premium, representing 61% of non-Part D health premium for the 2012 period, compared with 60% a year earlier.

 

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Health net sales excluding Part D increased 5% to $15 million. Medicare Supplement net sales rose 3% to $9 million in the 2012 period. Limited-benefit net sales increased 11% to $6 million. The increase in limited-benefit health net sales was due in large part to cancer insurance sales at Liberty. Non-Part D health first-year collected premium declined 2%.

The UA Independent Agency consists of independent agencies appointed with Torchmark who may also sell for other companies. The UA Independent Agency was Torchmark’s largest health agency in terms of non-Part D premium income and net sales. Premium income was $77 million, representing 42% of Torchmark’s total non-Part D health premium. Net sales were $8 million, representing 52% of Torchmark’s non-Part D health sales. This agency is also Torchmark’s largest producer of Medicare Supplement insurance, with Medicare Supplement premium income of $68 million. This agency represents approximately 62% of all Torchmark Medicare Supplement premium and 82% of Medicare Supplement net sales. Net sales of Medicare Supplement products in this agency rose 11% in 2012 to $8 million. However, total health premium declined 4% from the prior year.

The Liberty National Exclusive Agency markets Medicare Supplements and limited-benefit health products including cancer insurance. This agency represented 39% of Torchmark’s non-Part D health premium income at $70 million in the 2012 three months. Net sales in this agency rose 16% in the 2012 period, due in large part to sales of a new cancer insurance product.

Discussed under the Life Insurance caption, we noted the 31% decline in agent counts at Liberty over the prior twelve months. Declines in agent counts have had a negative effect on premium income and first-year collected premium. In the 2012 period, health premium income in the Liberty Agency declined 10% from the prior year premium of $77 million. However, first-year collected premium rose 25% to $4 million, due to the cancer sales.

Other distribution. Certain of our other distribution channels market health products, although their main emphasis is on life insurance. On a combined basis, they accounted for 19% of health premium excluding Part D in the 2012 period. The American Income Exclusive Agency markets a variety of limited-benefit plans, primarily accident. The Direct Response group markets primarily Medicare Supplements to employer or union-sponsored groups. Direct Response is also involved in marketing Medicare Part D. On a combined basis, the health net sales of these agencies declined 10%, from $4.2 million in 2011 to $3.8 million in 2012.

Medicare Part D. Coverage under Torchmark’s Medicare Part D prescription drug plan for Medicare beneficiaries is marketed through our Direct Response unit and to groups through our UA Independent Agency. As described in Note G—Business Segments, we report our Medicare Part D business for segment analysis purposes as we view the business, in which expected full-year benefits are matched with the related premium income which is received evenly throughout the policy year. At this time, we

 

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have expensed benefits based on our expected benefit ratio of approximately 84% for the entire 2012 contract year compared with 82% for the full year 2011. We describe the differences between the segment analysis and the GAAP operating results in Note G. Due to the design of the Medicare prescription drug product, claims are expected to be heaviest early in the calendar year. Management believes that the use of the full-year loss ratio is an appropriate measure for interim results, and also that these reporting differences will arise only on an interim basis and will be eliminated at the end of a full year, as they were in the full year of 2011.

Medicare Part D premium was $74 million in 2012, compared with $49 million in 2011, after removal of the risk-sharing adjustment in both periods. This represents an increase in premium of 50%. Growth in premium in 2012 resulted from a new lower-cost Part D plan which qualified us to receive a large number of low-income automatic enrollees and to grow our own individual sales. The new product is priced to achieve the same underwriting margin as our existing products. At this time, we cannot predict our level of participation in the low-income automatic enrollee Part D program going forward beyond 2012.

Medicare Part D underwriting results are presented in the following chart. The adjustments which reconcile Part D results in accordance with our health segment analysis to Part D GAAP results are presented in the charts in Note G—Business Segments.

Medicare Part D

Summary of Medicare Part D Results

(Dollar amounts in thousands)

 

     Three months ended March 31,  
     2012     2011  
     Per
Segment
Analysis
     GAAP     Per
Segment
Analysis
     GAAP  

Insurance underwriting income before other income and administrative expense

   $ 7,905       $ (11,922   $ 5,128       $ 1,338   
  

 

 

    

 

 

   

 

 

    

 

 

 

The Medicare Part D plan is a government-sponsored program. Therefore, regulatory changes could alter the outlook for this market.

 

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The following table presents underwriting margin data for health insurance.

Health Insurance

Summary of Results

(Dollar amounts in thousands)

 

     Three months ended March 31, 2012  
     Health *      % of
Premium
     Medicare
Part D
     % of
Premium
     Total
Health
     % of
Premium
 

Premium and policy charges

   $ 180,596         100       $ 74,061         100       $ 254,657         100   

Net policy obligations

     108,223         60         61,967         84         170,190         67   

Commissions and acquisition expense

     32,622         18         4,189         5         36,811         14   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Insurance underwriting income before other income and administrative expense

   $ 39,751         22       $ 7,905         11       $ 47,656         19   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

     Three months ended March 31, 2011  
     Health *      % of
Premium
     Medicare
Part D
     % of
Premium
     Total
Health
     % of
Premium
 

Premium and policy charges

   $ 191,784         100       $ 49,451         100       $ 241,235         100   

Net policy obligations

     112,826         59         41,766         85         154,592         64   

Commissions and acquisition expense**

     34,745         18         2,557         5         37,302         16   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Insurance underwriting income before other income and administrative expense

   $ 44,213         23       $ 5,128         10       $ 49,341         20   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

* Health other than Medicare Part D.
** 2011 expense has been restated as a result of the adoption of new accounting guidance as described in Note F Adoption of New Accounting Standard. The restatement resulted in a reduction in the amortization of acquisition expense of $11.1 million and the addition of non-deferred acquisition expense of $3.7 million in 2011.

Underwriting income for health insurance declined 3% or $2 million to $48 million. As a percentage of health premium, underwriting margins declined from 20% to 19%. Underwriting margins (excluding Part D) of $40 million also declined 10% in 2012 primarily due to the decrease in premium. Margins for Medicare Part D increased 54% in 2012 as a result of the previously-mentioned increased volume of business, as premium rose 50%.

 

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As discussed under the caption Life Insurance, reported underwriting margins have been affected by the newly adopted accounting standard which has limited the deferral of product acquisition costs. Health margins for 2011 restated for the new guidance benefited, as the increase in non-deferred acquisition expenses caused by the new accounting of $4 million was less than the decrease in amortization expense of $11 million (from $32 million to $21 million). As noted earlier, the new guidance only affects the timing of the recognition of product profitability, and has no effect on ultimate profitability.

Annuities. While we do underwrite annuities, they represent an insignificant part of our business and are not expected to be important to our marketing strategy going forward.

Operating expenses, comparing the first three months of 2012 with the first three months of 2011. Operating expenses consist of insurance administrative expenses and parent company expenses. Also included is stock compensation expense, which is viewed by us as a parent company expense. Insurance administrative expenses relate to premium income for a given period; therefore, we measure those expenses as a percentage of premium income. Total expenses are measured as a percentage of total revenues. An analysis of operating expenses is shown below.

 

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Operating Expenses Selected Information

(Dollar amounts in thousands)

 

     Three months ended March 31,  
     2012      2011  
     Amount     % of
Premium
     Amount     % of
Premium
 

Insurance administrative expenses:

         

Salaries

   $ 19,061        2.7       $ 18,512        2.7   

Other employee costs

     7,251        1.0         7,413        1.1   

Other administrative costs

     12,598        1.7         9,777        1.5   

Legal expense - insurance

     1,660        0.2         2,037        0.3   
  

 

 

   

 

 

    

 

 

   

 

 

 

Total insurance administrative expenses

     40,570        5.6         37,739        5.6   
    

 

 

      

 

 

 

Parent company expense

     1,921           2,425     

Stock compensation expense

     5,625           3,044     

Estimated state administrative settlement

     0           6,000     

Loss on sale of equipment

     0           979     
  

 

 

      

 

 

   

Total operating expenses, per Consolidated Statements of Operations

   $ 48,116         $ 50,187     
  

 

 

      

 

 

   

Insurance administrative expenses:

         

Increase (decrease) over prior year

     7.5        1.8  

Total operating expenses:

         

Increase (decrease) over prior year

     (4.1 )%         17.6  

Insurance administrative expenses increased 7.5% when compared with the prior year period, primarily as a result of $2.8 million in increased administrative costs. Of this amount, $1.4 million of the increase resulted from the loss of a contract fee for insurance policy service. Total operating expenses declined 4% in 2012, primarily because of two 2011 non-recurring expense items. There was a charge during the period relating to a state administrative issue concerning events occurring over a period of many prior years in the pre-tax amount of $6 million. The Company does not consider items related to prior periods in its evaluation of current operating results. In addition, the Company sold aviation equipment at a loss of $979 thousand. Sales of such equipment are infrequent and are not considered part of Torchmark’s ongoing insurance operations. Stock compensation expense has increased primarily as a result of increases in the market price of Torchmark stock in 2012.

Investments (excess investment income), comparing the first three months of 2012 with the first three months of 2011. We manage our capital resources including investments, debt, and cash flow through the investment segment. Excess investment income represents the profit margin attributable to investment operations. It is the measure that we use to evaluate the performance of the investment segment as described in Note GBusiness Segments in the Notes to the Consolidated Financial

 

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Statements. It is defined as net investment income less the required interest on net policy liabilities and the interest cost associated with capital funding or “financing costs.” We also view excess investment income per diluted share as an important and useful measure to evaluate the performance of the investment segment. It is defined as excess investment income divided by the total diluted weighted average shares outstanding, representing the contribution by the investment segment to the consolidated earnings per share of the Company. Since implementing our share repurchase program in 1986, we have used $5.1 billion of cash flow to repurchase Torchmark shares after determining that the repurchases provided a greater return than other investment alternatives. Share repurchases reduce excess investment income because of the foregone earnings on the cash that would otherwise have been invested in interest-bearing assets, but they also reduce the number of shares outstanding. In order to put all capital resource uses on a comparable basis, we believe that excess investment income per diluted share is an appropriate measure of the investment segment.

The following table summarizes Torchmark’s investment income, excess investment income, and excess investment income per diluted share.

Excess Investment Income

(Dollar amounts in thousands)

 

     Three months
ended March 31,
    Increase
(Decrease)
 
     2012     2011     Amount     %  

Net investment income *

   $ 179,648      $ 175,302      $ 4,346        2   

Required interest on net insurance policy liabilities

     (96,350     (90,132     (6,218     7   

Financing costs:

        

Interest on funded debt

     (18,122     (18,104     (18     0   

Interest on short-term debt

     (1,483     (1,290     (193     15   
  

 

 

   

 

 

   

 

 

   

Total financing costs

     (19,605     (19,394     (211     1   
  

 

 

   

 

 

   

 

 

   

Excess investment income

   $ 63,693      $ 65,776      $ (2,083     (3
  

 

 

   

 

 

   

 

 

   

Excess investment income per diluted share

   $ 0.63      $ 0.55      $ 0.08        15   
  

 

 

   

 

 

   

 

 

   

 

 

 

Average invested assets (at amortized cost)

   $ 11,477,696      $ 11,281,053      $ 196,643        2   

Average net insurance policy liabilities **

     6,868,964        6,513,828        355,136        5   

Average debt and preferred securities (at amortized cost)

     1,142,196        1,113,874        28,322        3   

 

* Net investment income per Torchmark’s segment analysis does not agree with Net investment income per the Consolidated Statements of Operations because management views the amortization of certain tax-advantaged low-income housing interests as an adjustment to increase tax expense while GAAP requires that it reduce net investment income, as presented in the Reconciliation in Note G - Business Segments. Additionally, management views our Trust Preferred Securities as consolidated debt, as also presented in Note G. GAAP requires those debt securities to be deconsolidated.
** Net of deferred acquisition costs, excluding the associated unrealized gains and losses thereon.

 

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As shown in the above table, excess investment income for the 2012 period declined 3% to $64 million, primarily as a result of the low-interest environment in recent periods. However, excess investment income per share rose 15% as a result of our share purchases over the past 12 months. Net investment income rose 2% in 2012, while average fixed maturities (at amortized cost) rose 5% year over year. In the 2012 three months, fixed maturity yields averaged 6.47% on a tax-equivalent basis, compared with 6.62% a year earlier. Even though yields in the fixed-maturity portfolio were lower in the 2012 three months, we held significantly more lower-yielding short-term securities in the 2011 first quarter, so that the average yield for the entire investment portfolio rose from 6.22% to 6.26% in 2012.

Offsetting the increase in net investment income, required interest on net insurance policy liabilities increased $6 million or 7% to $96 million. The increase in required interest was higher than the 5% growth in average net interest-bearing insurance policy liabilities, as a result of an increase in the weighted-average discount rate on the net policy liabilities.

Essentially all of our life and health insurance policies are fixed interest-rate protection policies, not investment products, and are accounted for under current accounting guidance (formerly SFAS 60), which mandates that interest rate assumptions be “locked in” for the life of that block of business. Each calendar year, we set the discount rate to be used to calculate the benefit reserves (liability) and deferred acquisition cost asset for all insurance policies issued that year. That rate is based on the new money yields that we expect to earn on premiums received in the future from policies of that issue year, and cannot be changed.

The discount rate used for policies issued in the current year has no impact on the inforce policies issued in prior years as the rates of all prior issue years are locked in. As such, the overall discount rate for the entire inforce block is a weighted average of the discount rates being used from all issue years. Changes in the overall weighted-average discount rate over time are caused by changes in the mix of the reserves and deferred acquisition cost asset by issue year on the entire block of inforce business. Business issued in the current year has very little impact on the overall weighted-average discount rate due to the size of our inforce business.

Financing costs rose 1% to $20 million, as a result of an increase in interest on short-term debt. Short-term interest expense rose $193 thousand, primarily as a result of an increase in fees related to our bank line and letters of credit. More information concerning short-term debt can be found in the Liquidity section of this report under the caption Short-term borrowings.

Excess investment income benefits from increases in long-term rates available on new investments and decreases in short-term borrowing rates. Of these two factors, higher investment rates have the greater impact because the amount of cash that we invest is significantly greater than the amount that we borrow at short-term rates. Therefore, Torchmark would benefit if rates, especially long-term rates, were to rise.

 

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However, excess investment income is pressured when growth in income from the portfolio is less than that of the interest required by net policy liabilities and financing costs, such as we have experienced in recent periods. In an extended low-interest-rate environment, the portfolio yield will tend to decline as we invest new money at lower long-term rates. We believe, however, that any decline would be relatively slow, as only 2% to 3% of fixed maturities on average are expected to run off each year over the next five years.

In response to the lower interest rates, we raised the new business premium rates on major life products. The increased premium will provide additional margin on these policies to help offset the possible future reductions in excess investment income and are not expected to have a detrimental impact on sales.

Because actuarial discount rates are locked in for life on essentially all of our business, benefit reserves and deferred acquisition costs are not affected by changes in investment yields unless a loss recognition event occurs. Due to the strength of our underwriting margins and the current positive spread between the yield on our investment portfolio and the weighted-average discount rate of our inforce block, we are confident that an extended low-interest-rate environment will not cause a loss recognition event.

Investments (acquisitions), comparing the first three months of 2012 with the first three months of 2011. Torchmark’s investment policy calls for investing almost exclusively in fixed maturities that are investment grade and meet our quality and yield objectives. We generally prefer to invest in securities with longer maturities because they more closely match the long-term nature of our policy liabilities. We believe this strategy is appropriate because our cash flows are generally stable and predictable. If available longer-term securities do not meet our quality and yield objectives, new money is invested in shorter-term fixed maturities.

 

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The following table summarizes selected information for fixed-maturity purchases. The effective annual yield shown is the yield calculated to the “worst call date.” For noncallable bonds, the worst-call date is always the maturity date. For callable bonds, the worst-call date is the call date that produces the lowest yield (or the maturity date, if the yield calculated to the maturity date is lower than the yield calculated to each call date).

Fixed Maturity Acquisitions Selected Information

(Dollar amounts in millions)

 

     For the three months ended
March 31,
 
     2012     2011  

Cost of acquisitions:

    

Investment-grade corporate securities

   $ 232      $ 260   

Taxable municipals

     0        5   
  

 

 

   

 

 

 

Total fixed-maturity acquisitions

   $ 232      $ 265   
  

 

 

   

 

 

 

Effective annual yield *

     4.76     5.99

Average life, in years to:

    

Next call

     29.7        27.1   

Maturity

     29.9        27.7   

Average rating

     A-        A-   

 

*   One-year compounded yield on a tax-equivalent basis, whereby the yield on tax-exempt securities is adjusted to produce a yield equivalent to the pretax yield on taxable securities.

      

Acquisitions in both periods consisted primarily of corporate bonds in both periods, with securities spanning a diversified range of issuers, industry sectors, and geographical regions. All of the acquired securities were investment grade.

Investments (portfolio composition). The composition of the investment portfolio at book value on March 31, 2012 was as follows:

Invested Assets At March 31, 2012

(Dollar amounts in millions)

 

     Amount      % of
Total
 

Fixed maturities (at amortized cost)

   $ 11,081         96

Equities (at cost)

     15         0   

Mortgage loans

     1         0   

Investment real estate

     3         0   

Policy loans

     405         4   

Other long-term investments

     21         0   

Short-term investments

     56         0   
  

 

 

    

 

 

 

Total

   $ 11,582         100
  

 

 

    

 

 

 

Approximately 96% of our investments at book value are in a diversified fixed-maturity portfolio. Policy loans, which are secured by policy cash values, make up less than 4% of our investments. We also have insignificant investments in equity securities, mortgage loans, and other long-term investments. Because fixed maturities represent such a significant portion of our investment portfolio, the remainder of the discussion of portfolio composition will focus on fixed maturities.

 

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Fixed Maturities. The following table summarizes certain information about our fixed-maturity portfolio by component at March 31, 2012

Fixed Maturities by Component

(Dollar amounts in millions)

 

     Cost or      Gross      Gross             % of Total Fixed Maturities  
     Amortized
Cost
     Unrealized
Gains
     Unrealized
Losses
     Fair
Value
     at Amortized
Cost
     at Fair
Value
 

Corporates

   $ 8,520       $ 902       $ (112)       $ 9,310         77         78   

Redeemable preferred stock

     1,163         30         (44)         1,149         11         10   

Municipals

     1,212         128         (1)         1,339         11         11   

Government-sponsored enterprises

     47            (1)         46            1   

Governments & agencies

     36         1            37            0   

Residential mortgage-backed*

     14         1            15            0   

Collateralized debt obligations

     61            (32)         29         1         0   

Other asset-backed securities

     28         3         (1)         30         0         0   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total fixed maturities

   $ 11,081       $ 1,065       $ (191)       $ 11,955         100         100   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

* Includes GNMA’s

At March 31, 2012, fixed maturities had a fair value of $12.0 billion, compared with $11.9 billion at December 31, 2011. The net unrealized gain position in the fixed-maturity portfolio decreased from a net gain of $964 million at December 31, 2011 to a net gain of $874 million at March 31, 2012.

Investments in fixed-maturity securities are diversified over a wide range of industry sectors. The following table summarizes certain information about our fixed-maturity portfolio by sector at March 31, 2012.

 

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Fixed Maturities by Sector

(Dollar amounts in millions)

 

     Cost or
Amortized
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
    Fair
Value
     % of Total Fixed Maturities  
                Amortized
Cost
    Fair
Value
 

Financial - Life/Health/PC Insurance

   $ 1,816       $ 97       $ (46   $ 1,867         16     16

Financial - Bank

     1,329         43         (46     1,326         12        11   

Financial - Other

     533         48         (15     566         5        5   
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Subtotal Financial

     3,678         188         (107     3,759         33        32   

Utilities

     1,837         256         (10     2,083         17        17   

Government (US, municipal, and foreign)

     1,295         129         (2     1,422         12        12   

Energy

     1,215         147         0        1,362         11        11   

Basic Materials

     745         82         (5     822         7        7   

Consumer, Non-cyclical

     550         83         (5     628         5        5   

Other Industrials

     509         52         (14     547         5        5   

Communications

     474         57         (10     521         4        4   

Consumer, Cyclical

     393         31         (6