XNYS:TMK Torchmark Corp Quarterly Report 10-Q Filing - 6/30/2012

Effective Date 6/30/2012

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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 June 30, 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 July 24, 2012        

Common Stock,

$1.00 Par Value

  95,398,698

Index of Exhibits (Page 59).

Total number of pages included are 60.


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

     24     
  Item 3.  

Quantitative and Qualitative Disclosures about Market Risk

     54     
  Item 4.  

Controls and Procedures

     55     

PART II.

  OTHER INFORMATION   
  Item 1.  

Legal Proceedings

     55     
  Item 1A.  

Risk Factors

     58     
  Item 2.  

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

     59     
  Item 6.  

Exhibits

     59     


Table of Contents

PART I – FINANCIAL INFORMATION

 

Item 1. Financial Statements

TORCHMARK CORPORATION

CONSOLIDATED BALANCE SHEETS

(Dollar amounts in thousands except per share data)

 

     June 30,
2012
    December 31,
2011*
 
Assets    (Unaudited)     (As adjusted)  

Investments:

    

Fixed maturities, available for sale, at fair value (amortized cost: 2012 – $11,075,086 ; 2011 – $10,924,244)

   $ 12,308,684      $ 11,888,205   

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

     16,820        17,056   

Policy loans

     410,801        400,914   

Other long-term investments

     25,510        26,167   

Short-term investments

     109,541        21,244   
  

 

 

   

 

 

 

Total investments

     12,871,356        12,353,586   

Cash

     70,666        84,113   

Accrued investment income

     193,445        192,325   

Other receivables

     308,585        253,549   

Deferred acquisition costs

     2,966,272        2,916,732   

Goodwill

     396,891        396,891   

Low-income housing interests

     264,664        280,955   

Other assets

     113,124        110,121   
  

 

 

   

 

 

 

Total assets

   $ 17,185,003      $ 16,588,272   
  

 

 

   

 

 

 

Liabilities and Shareholders’ Equity

    

Liabilities:

    

Future policy benefits

   $ 9,820,893      $ 9,572,257   

Unearned and advance premiums

     71,734        69,539   

Policy claims and other benefits payable

     221,652        222,254   

Other policyholders’ funds

     92,984        92,487   
  

 

 

   

 

 

 

Total policy liabilities

     10,207,263        9,956,537   

Current and deferred income taxes payable

     1,460,827        1,319,853   

Other liabilities

     283,936        312,417   

Short-term debt

     319,829        224,842   

Long-term debt (fair value: 2012 – $981,882 ; 2011 – $947,142)

     791,066        790,571   

Due to affiliates

     124,421        124,421   
  

 

 

   

 

 

 

Total liabilities

     13,187,342        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 16,938,875 held in treasury and 2011 – 112,312,123 issued, less 11,732,658 held in treasury)

     112,312        112,312   

Additional paid-in capital

     443,630        425,331   

Accumulated other comprehensive income (loss)

     734,379        549,916   

Retained earnings

     3,462,272        3,264,711   

Treasury stock, at cost

     (754,932     (492,639
  

 

 

   

 

 

 

Total shareholders’ equity

     3,997,661        3,859,631   
  

 

 

   

 

 

 

Total liabilities and shareholders’ equity

   $ 17,185,003      $ 16,588,272   
  

 

 

   

 

 

 

 

* Derived from audited financial statements. Additionally, 2011 balances have been retrospectively 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
June 30,
    Six Months Ended
June 30,
 
     2012     2011*     2012     2011*  
           (As adjusted)           (As adjusted)  

Revenue:

        

Life premium

   $ 450,950      $ 433,573      $ 902,828      $ 864,230   

Health premium

     254,506        238,617        520,950        487,723   

Other premium

     126        160        279        298   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total premium

     705,582        672,350        1,424,057        1,352,251   

Net investment income

     175,176        173,104        349,297        344,751   

Realized investment gains (losses)

     4,661        31,272        9,667        8,549   

Other income

     376        608        697        1,055   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total revenue

     885,795        877,334        1,783,718        1,706,606   

Benefits and expenses:

        

Life policyholder benefits

     292,784        277,848        583,472        556,186   

Health policyholder benefits

     181,037        166,423        392,129        341,693   

Other policyholder benefits

     10,986        10,423        21,853        20,942   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total policyholder benefits

     484,807        454,694        997,454        918,821   

Amortization of deferred acquisition costs

     96,601        91,664        193,099        184,127   

Commissions, premium taxes, and non-deferred acquisition costs

     50,600        55,999        101,356        111,517   

Other operating expense

     47,758        46,514        95,874        96,701   

Interest expense

     19,649        19,411        39,320        38,871   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total benefits and expenses

     699,415        668,282        1,427,103        1,350,037   

Income from continuing operations before income taxes

     186,380        209,052        356,615        356,569   

Income taxes

     (57,392     (66,271     (108,950     (113,048
  

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations

     128,988        142,781        247,665        243,521   

Loss on disposal of discontinued operations, net of tax

     0        0        0        (599
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income

   $ 128,988      $ 142,781      $ 247,665      $ 242,922   
  

 

 

   

 

 

   

 

 

   

 

 

 

Basic net income per share:

        

Continuing operations

   $ 1.33      $ 1.29      $ 2.51      $ 2.14   

Discontinued operations

     0.00        0.00        0.00        (0.01
  

 

 

   

 

 

   

 

 

   

 

 

 

Total basic net income per share

   $ 1.33      $ 1.29      $ 2.51      $ 2.13   
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted net income per share:

        

Continuing operations

   $ 1.32      $ 1.27      $ 2.48      $ 2.11   

Discontinued operations

     0.00        0.00        0.00        (0.01
  

 

 

   

 

 

   

 

 

   

 

 

 

Total diluted net income per share

   $ 1.32      $ 1.27      $ 2.48      $ 2.10   
  

 

 

   

 

 

   

 

 

   

 

 

 

Dividends declared per common share

   $ 0.15      $ 0.11      $ 0.30      $ 0.22   
  

 

 

   

 

 

   

 

 

   

 

 

 

* The 2011 balances have been retrospectively 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
June 30,
    Six Months Ended
June 30,
 
     2012     2011*     2012     2011*  
           (As adjusted)           (As adjusted)  

Net income

   $ 128,988      $ 142,781      $ 247,665      $ 242,922   

Other comprehensive income (loss):

        

Unrealized gains (losses) on securities:

        

Unrealized holding gains (losses) arising during period

     360,468        180,776        278,837        210,211   

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

     (4,659     (31,299     (9,709     (8,571

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

     (28     (532     (124     (1,674

Less: foreign exchange adjustment on securities marked to market

     4,068        1,549        397        (1,617
  

 

 

   

 

 

   

 

 

   

 

 

 

Unrealized gains (losses) on securities

     359,849        150,494        269,401        198,349   

Unrealized gains (losses) on deferred acquisition costs

     (1,691     (4,604     6,570        (5,999

Unrealized gains (losses) on other assets

     23        (220     1,015        (220
  

 

 

   

 

 

   

 

 

   

 

 

 

Total unrealized gains (losses)

     358,181        145,670        276,986        192,130   

Less applicable taxes

     (125,365     (50,986     (96,946     (67,246
  

 

 

   

 

 

   

 

 

   

 

 

 

Unrealized gains (losses), net of tax

     232,816        94,684        180,040        124,884   

Foreign exchange translation adjustments

     (2,966     1,356        (88     2,227   

Less applicable taxes

     896        (474     (111     (777
  

 

 

   

 

 

   

 

 

   

 

 

 

Foreign exchange translation adjustments, net of tax

     (2,070     882        (199     1,450   

Amortization of pension costs

     3,603        3,042        7,109        6,084   

Less applicable taxes

     (1,260     (1,063     (2,487     (2,129
  

 

 

   

 

 

   

 

 

   

 

 

 

Amortization of pension costs, net of tax

     2,343        1,979        4,622        3,955   
  

 

 

   

 

 

   

 

 

   

 

 

 

Other comprehensive income (loss)

     233,089        97,545        184,463        130,289   
  

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive income (loss)

   $ 362,077      $ 240,326      $ 432,128      $ 373,211   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

* The 2011 balances have been retrospectively 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)

 

     Six Months Ended
June 30,
 
     2012     2011  

Cash provided from operations

   $ 447,131      $ 452,733   

Cash provided from (used for) investment activities:

    

Investments sold or matured:

    

Fixed maturities available for sale—sold

     131,027        126,523   

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

     155,637        301,010   

Other long-term investments

     631        14,650   
  

 

 

   

 

 

 

Total investments sold or matured

     287,295        442,183   

Investments acquired:

    

Fixed maturities

     (429,747     (696,940

Other long-term investments

     (1,077     0   
  

 

 

   

 

 

 

Total investments acquired

     (430,824     (696,940

Net increase in policy loans

     (9,887     (9,218

Net (increase) decrease in short-term investments

     (88,297     196,272   

Net change in payable or receivable for securities

     36,812        2,832   

Disposition of properties

     57        2,755   

Additions to properties

     (2,681     (1,399

Investment in low-income housing interests

     (48,359     (22,836
  

 

 

   

 

 

 

Cash used for investment activities

     (255,884     (86,351

Cash provided from (used for) financing activities:

    

Proceeds from exercise of stock options

     103,275        54,499   

Net borrowings (repayments) of commercial paper

     94,987        980   

Excess tax benefit from stock option exercises

     10,254        6,924   

Acquisition of treasury stock

     (389,643     (664,344

Cash dividends paid to shareholders

     (26,985     (24,788

Net receipts (withdrawals) from deposit product operations

     5,091        (13,747
  

 

 

   

 

 

 

Cash provided by (used for) financing activities

     (203,021     (640,476

Effect of foreign exchange rate changes on cash

     (1,673     (1,355
  

 

 

   

 

 

 

Net increase (decrease) in cash

     (13,447     (275,449

Cash at beginning of year

     84,113        365,679   
  

 

 

   

 

 

 

Cash at end of period

   $ 70,666      $ 90,230   
  

 

 

   

 

 

 

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 June 30, 2012, and the consolidated results of operations, comprehensive income, and cash flows for the periods ended June 30, 2012 and 2011. The interim period consolidated financial statements should be read in conjunction with the Consolidated Financial Statements that are included in Exhibit 99.1 of Form 8-K filed on June 29, 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

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

 

     For the three months ended
June 30,
       For the six months ended
June 30,
 
     2012      2011        2012      2011  

Basic weighted average shares outstanding

     96,896,301         111,010,134           98,482,330         113,897,688   

Weighted average dilutive options outstanding

     929,700         1,821,074           1,200,550         1,824,323   
  

 

 

    

 

 

      

 

 

    

 

 

 

Diluted weighted average shares outstanding

     97,826,001         112,831,208           99,682,880         115,722,011   
  

 

 

    

 

 

      

 

 

    

 

 

 

Antidilutive shares *

     160,000         1,075,248           113,407         1,144,232   
  

 

 

    

 

 

      

 

 

    

 

 

 

* 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 June 30  
     Pension Benefits     Other Benefits  
     2012     2011     2012      2011  

Service cost

   $ 2,690      $ 2,339      $ 120       $ 218   

Interest cost

     4,145        4,025        256         250   

Expected return on assets

     (4,117     (3,896     0         0   

Prior service cost

     515        518        0         0   

Net actuarial (gain)/loss

     2,992        2,395        0         (268
  

 

 

   

 

 

   

 

 

    

 

 

 

Net periodic benefit cost

   $ 6,225      $ 5,381      $ 376       $ 200   
  

 

 

   

 

 

   

 

 

    

 

 

 

 

     Six Months ended June 30,  
     Pension Benefits     Other Benefits  
     2012     2011     2012      2011  

Service cost

   $ 5,381      $ 4,678      $ 244       $ 466   

Interest cost

     8,297        8,051        513         502   

Expected return on assets

     (8,237     (7,926     0         0   

Prior service cost

     1,031        1,037        0         0   

Net actuarial (gain)/loss

     5,958        4,790        0         (404
  

 

 

   

 

 

   

 

 

    

 

 

 

Net periodic benefit cost

   $ 12,430      $ 10,630      $ 757       $ 564   
  

 

 

   

 

 

   

 

 

    

 

 

 

 

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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 June 30, 2012 and the prior-year end.

Pension Assets by Component

(Dollar amounts in thousands)

 

     June 30, 2012         December 31, 2011   
  

 

 

    

 

 

 
     Amount         %         Amount         %   
  

 

 

    

 

 

    

 

 

    

 

 

 

Corporate debt

   $ 158,293         58.1       $ 159,759         61.9   

Other fixed maturities

     340         0.1         348         0.1   

Equity securities

     89,698         32.8         79,459         30.8   

Short-term investments

     10,385         3.8         3,767         1.5   

Guaranteed annuity contract

     12,633         4.6         12,745         4.9   

Other

     1,707         0.6         1,989         0.8   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $     273,056         100.0       $     258,067         100.0   
  

 

 

    

 

 

    

 

 

    

 

 

 

The liability for the funded defined-benefit pension plans was $282 million at December 31, 2011. Cash contributions of $6 million were made to the qualified pension plans during the six months ended June 30, 2012. Torchmark does not plan to make any further cash contributions during the remainder of 2012. 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 June 30, 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.

 

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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

Portfolio Composition:

A summary of fixed maturities and equity securities available for sale by cost or amortized cost and estimated fair value at June 30, 2012 is as follows:

PORTFOLIO COMPOSITION AS OF JUNE 30, 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

   $ 29,677       $ 1,473       $ (9   $ 31,141         1

States, municipalities, and political subdivisions

     1,213,004         160,016         (415     1,372,605         11   

Foreign governments

     21,738         1,135         0        22,873         0   

Corporates

     8,593,737         1,193,283         (89,954     9,697,066         79   

Collateralized debt obligations

     62,495         0         (32,538     29,957         0   

Other asset-backed securities

     37,000         2,665         (1,275     38,390         0   

Redeemable preferred stocks

     1,117,435         32,878         (33,661     1,116,652         9   
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

Total fixed maturities

     11,075,086         1,391,450         (157,852     12,308,684         100
             

 

 

 

Equity securities

     14,875         1,999         (54     16,820      
  

 

 

    

 

 

    

 

 

   

 

 

    

Total fixed maturities and equity securities

   $ 11,089,961       $ 1,393,449       $ (157,906   $ 12,325,504      
  

 

 

    

 

 

    

 

 

   

 

 

    

 

* 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 June 30, 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

   $ 76,832       $ 79,363   

Due from one to five years

     465,380         500,769   

Due from five to ten years

     708,106         792,598   

Due from ten to twenty years

     2,504,770         2,800,162   

Due after twenty years

     7,215,861         8,062,238   

Mortgage-backed and asset-backed securities

     104,137         73,554   
  

 

 

    

 

 

 
   $ 11,075,086       $ 12,308,684   
  

 

 

    

 

 

 

Selected information about sales of fixed maturities is as follows:

 

For the six months ended June 30,

 
     2012     2011  

Proceeds from sales

   $ 133,079      $ 126,523   

Gross realized gains

     8,862        11,084   

Gross realized losses

     (240     (24,323

 

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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 JUNE 30, 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      $ 31,141      $ 0      $ 31,141   

States, municipalities, and political subdivisions

     0        1,372,605        0        1,372,605   

Foreign governments

     0        22,873        0        22,873   

Corporates

     43,498        9,614,687        38,881        9,697,066   

Collateralized debt obligations

     0        0        29,957        29,957   

Other asset-backed securities

     0        31,238        7,152        38,390   

Redeemable preferred stocks

     192,653        923,999        0        1,116,652   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total fixed maturities

     236,151        11,996,543        75,990        12,308,684   

Equity securities

     15,995        86        739        16,820   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total fixed maturities and equity securities

   $ 252,146      $ 11,996,629      $ 76,729      $ 12,325,504   
  

 

 

   

 

 

   

 

 

   

 

 

 

Percent of total

     2.1     97.3     0.6     100.0
  

 

 

   

 

 

   

 

 

   

 

 

 

 

11


Table of Contents

TORCHMARK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

(Dollar amounts in thousands except per share data)

Note D—Investments (continued)

 

As of June 30, 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 six months ending June 30, 2012. In the prior year period, Torchmark recorded an other-than-temporary impairment of $20 thousand ($13 thousand after tax).

 

12


Table of Contents

TORCHMARK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

(Dollar amounts in thousands except per share data)

Note D—Investments (continued)

 

Unrealized Loss Analysis:

The following table discloses unrealized investment losses by class of investment at June 30, 2012. Torchmark considers these investments not to be other-than-temporarily impaired.

ANALYSIS OF GROSS UNREALIZED INVESTMENT LOSSES

At June 30, 2012

 

     Less than
Twelve Months
    Twelve Months
or Longer
    Total  

Description of Securities

   Fair
Value
     Unrealized
Loss
    Fair
Value
     Unrealized
Loss
    Fair
Value
     Unrealized
Loss
 

Fixed maturities available for sale:

               

Bonds:

               

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

   $ 5,236       $ (8   $ 31       $ (1   $ 5,267       $ (9

States, municipalities, and political subdivisions

     0         0        17,550         (415     17,550         (415

Foreign governments

     0         0        0         0        0         0   

Corporates

     245,694         (7,047     631,148         (82,907     876,842         (89,954

Collateralized debt obligations

     0         0        29,957         (32,538     29,957         (32,538

Other asset-backed securities

     8,260         (22     7,152         (1,253     15,412         (1,275

Redeemable preferred stocks

     130,419         (1,789     334,511         (31,872     464,930         (33,661
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total fixed maturities

     389,609         (8,866     1,020,349         (148,986     1,409,958         (157,852

Equity securities

     86         (13     309         (41     395         (54
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total fixed maturities and equity securities

   $ 389,695       $ (8,879   $ 1,020,658       $ (149,027   $ 1,410,353       $ (157,906
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

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 June 30, 2012

     87         96         183   

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 1,360 issues at June 30, 2012 and 1,373 issues at December 31, 2011. The weighted average quality rating of all unrealized loss positions as of June 30, 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 June 30, 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 June 30,     Six months ended June 30  
     2012     2011     2012     2011  
     Amount     %     Amount     %     Amount     %     Amount     %  

Expected income taxes

   $ 65,233        35.0      $ 73,168        35.0      $ 124,815        35.0      $ 124,799        35.0   

Increase (reduction) in income taxes resulting from:

                

Tax-exempt investment income

     (869     (0.5     (847     (0.4     (1,737     (0.5     (1,693     (0.5

Low-income housing investments

     (7,332     (3.9     (5,060     (2.4     (14,578     (4.1     (10,118     (2.8

Other

     360        0.2        (990     (0.5     450        0.1        60        0.0   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income tax expense

   $ 57,392        30.8      $ 66,271        31.7      $ 108,950        30.5      $ 113,048        31.7   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

The effective income tax rate for the three and six month periods ended June 30, 2012 differed from the effective income tax rate for the same periods ended June 30, 2011 primarily as a result of the Company’s low-income housing tax credit investments.

 

14


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

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 six months of 2011 was reduced by $12 million and 2011 first six months earnings per diluted share were reduced by $0.10. 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 $8.2 million in the first six months of 2012, compared with $7.3 million in the same period of 2011. Capitalized advertising costs were $1.02 billion at June 30, 2012, compared with $1.00 billion 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

 

     Six months ended
June 30,
 
     2012     2011(1)  

Balance at beginning of year

   $ 2,916,732      $ 2,869,546   

Additions:

    

Deferred during period:

    

Commissions

     151,360        139,699   

Other expenses

     84,632        79,290   
  

 

 

   

 

 

 

Total deferred

     235,992        218,989   

Adjustment attributable to unrealized investment losses (2)

     6,571        0   

Foreign exchange adjustment

     76        1,667   
  

 

 

   

 

 

 

Total additions

     242,639        220,656   

Deductions:

    

Amortized during period

     (193,099     (184,127

Adjustment attributable to unrealized investment gains (2)

     0        (5,999
  

 

 

   

 

 

 

Total deductions

     (193,099     (190,126
  

 

 

   

 

 

 

Balance at end of period

   $ 2,966,272      $ 2,900,076   
  

 

 

   

 

 

 

 

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

 

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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

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 agencies.

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 required interest 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 majority of the Company’s 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

 

17


Table of Contents

TORCHMARK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

(Dollar amounts in thousands except per share data)

Note G—Business Segments (continued)

 

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.

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

 

18


Table of Contents

TORCHMARK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

(Dollar amounts in thousands except per share data)

Note G—Business Segments (continued)

 

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.

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:

 

     Six Months Ended  
     June 30,  
     2012     2011  

Benefit costs deferred

   $ 32,640      $ 17,903   

Government risk-sharing premium adjustment

     (11,274     (12,248
  

 

 

   

 

 

 

Pre-tax addition to segment interim period income

   $ 21,366      $ 5,655   
  

 

 

   

 

 

 

After tax amount

   $ 13,888      $ 3,676   
  

 

 

   

 

 

 

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.

 

19


Table of Contents

TORCHMARK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

(Dollar amounts in thousands except per share data)

Note G—Business Segments (continued)

 

During the first quarter of 2011, Torchmark sold aviation equipment for a pretax loss of $979 thousand ($636 thousand after tax). Also during the first six months 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 ($3.9 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.

 

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

 

    For the six months ended June 30, 2012  
    Life     Health     Annuity     Investment     Other &
Corporate
    Adjustments     Consolidated  

Revenue:

             

Premium

  $ 902,828      $ 509,676      $ 279          $ 11,274 (1)    $ 1,424,057   

Net investment income

        $ 360,329          (11,032 )(2,5)      349,297   

Other income

          $ 865        (168 )(4)      697   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenue

    902,828        509,676        279        360,329        865        74        1,774,051   

Expenses:

             

Policy benefits

    583,472        359,489        21,853            32,640 (1)      997,454   

Required interest on:

             

Policy reserves

    (238,656     (18,700     (29,766     287,122            0   

Deferred acquisition costs

    81,814        9,196        1,177        (92,187         0   

Amortization of acquisition costs

    155,649        32,243        5,207              193,099   

Commissions, premium taxes, and non-deferred acquisition costs

    70,254        31,234        36            (168 )(4)      101,356   

Insurance administrative expense (3)

            80,427          80,427   

Parent expense

            4,210          4,210   

Stock compensation expense

            11,237          11,237   

Interest expense

          39,188          132 (2)      39,320   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total expenses

    652,533        413,462        (1,493     234,123        95,874        32,604        1,427,103   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Subtotal

    250,295        96,214        1,772        126,206        (95,009     (32,530     346,948   

Nonoperating items

              21,366 (1)      21,366   

Amortization of low-income housing

              11,164 (5)      11,164   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Measure of segment profitability (pretax)

  $ 250,295      $ 96,214      $ 1,772      $ 126,206      $ (95,009   $ 0        379,478   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

Deduct applicable income taxes

                (124,209
             

 

 

 

Segment profits after tax

  

    255,269   

Add back income taxes applicable to segment profitability

  

    124,209   

Add (deduct) realized investment gains (losses)

  

    9,667   

Deduct Part D adjustment (1)

  

    (21,366

Deduct amortization of low-income housing (5)

  

    (11,164
             

 

 

 

Pretax income from continuing operations per Consolidated Statement of Operations

  

  $ 356,615   
             

 

 

 

 

(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.

 

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)

 

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

 

     For the six months ended June 30, 2011  
     Life     Health     Annuity     Investment     Other &
Corporate
    Adjustments     Consolidated  

Revenue:

              

Premium

   $ 864,230      $ 475,475      $ 298          $ 12,248 (1)    $ 1,352,251   

Net investment income

         $ 352,060          (7,309 )(2.5)      344,751   

Other income

           $ 1,240        (185 )(4)      1,055   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenue

     864,230        475,475        298        352,060        1,240        4,754        1,698,057   

Expenses:

              

Policy benefits

     556,186        323,790        20,942            17,903 (1)      918,821   

Required interest on:

              

Policy reserves

     (226,155     (18,245     (27,705     272,105            0   

Deferred acquisitions costs

     79,152        9,565        1,339        (90,056         0   

Amortization of acquisition costs

     148,004        31,601        4,522              184,127   

Commissions, premium taxes, and non-deferred acquisition costs

     78,901        32,767        34            (185 )(4)      111,517   

Insurance administrative expense (3)

             77,909        6,979 (6.7)      84,888   

Parent expense

             4,811          4,811   

Stock compensation expense

             7,002          7,002   

Interest expense

           38,739          132 (2)      38,871   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total expenses

     636,088        379,478        (868     220,788        89,722        24,829        1,350,037   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Subtotal

     228,142        95,997        1,166        131,272        (88,482     (20,075     348,020   

Nonoperating items

               12,634 (1,6,7)      12,634   

Amortization of low-income housing

               7,441 (5)      7,441   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

Measure of segment profitability (pretax)

   $ 228,142      $ 95,997      $ 1,166      $ 131,272      $ (88,482   $ 0        368,095   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

Deduct applicable income taxes

                 (121,919
              

 

 

 

Segment profits after tax

                 246,176   

 

Add back income taxes applicable to segment profitability

     121,919   

Add (deduct) realized investment gains (losses)

     8,549   

Deduct Part D adjustment (1)

     (5,655

Deduct amortization of low-income housing (5)

     (7,441

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

   $ 356,569   
  

 

 

 

 

(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.

 

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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)

 

     Six months ended
June 30,
    Increase
(Decrease)
 
     2012     2011*     Amount     %  

Life insurance

   $ 250,295      $ 228,142        22,153        10   

Health insurance

     96,214        95,997        217     

Annuity

     1,772        1,166        606     

Investment

     126,206        131,272        (5,066     (4

Other:

        

Other income

     865        1,240        (375     (30

Administrative expense

     (80,427     (77,909     (2,518     3   

Corporate and adjustments

     (15,447     (11,813     (3,634     31   
  

 

 

   

 

 

   

 

 

   

Pretax total

     379,478        368,095        11,383        3   

Applicable taxes

     (124,209     (121,919     (2,290     2   
  

 

 

   

 

 

   

 

 

   

Total

     255,269        246,176        9,093        4   

Reconciling items, net of tax:

        

Realized gains (losses)–Investments

     6,284        5,557        727     

Loss on disposal of discontinued operations

     0        (599     599     

Part D adjustment

     (13,888     (3,676     (10,212  

Estimated state administrative settlement

     0        (3,900     3,900     

Loss on sale of equipment

     0        (636     636     
  

 

 

   

 

 

   

 

 

   

Net income

   $ 247,665      $ 242,922      $ 4,743        2   
  

 

 

   

 

 

   

 

 

   

 

* 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.

Note H—Acquisition

On July 31, 2012, Torchmark signed a definitive agreement to acquire Family Heritage Life Insurance Company of America (Family Heritage), a privately-held supplemental health insurance provider. The purchase price will be approximately $218.5 million, subject to closing adjustments. The transaction will be funded internally with cash from Torchmark’s insurance subsidiaries and is expected to close early in the fourth quarter of 2012. Family Heritage was founded in 1989 and is headquartered in Cleveland, Ohio. It is a specialty insurer focused primarily on selling protection-oriented individual supplemental health insurance products through a captive agency force.

 

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Table of Contents

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

Results of Operations

Acquisition. As disclosed in Note H—Acquisition, Torchmark signed a definitive agreement to acquire Family Heritage for approximately $218.5 million, subject to closing adjustments. As noted, Family Heritage is a specialty insurer focused primarily on selling individual supplemental health insurance products through a captive agency force. We expect that the addition of this acquisition will be accretive to earnings and earnings per share. We expect the transaction to have a minimal effect, if any, on our share repurchase program and the regulatory capital ratios of the insurance subsidiaries.

Family Heritage has approximately 1,200 captive sales agents, over 223,000 policies in force, and is licensed in all 50 states except New York. Direct written premium in 2011 was $162 million. We believe that Family Heritage with its emphasis on selling protection-oriented individual supplemental health insurance to middle-income families is an excellent fit with Torchmark’s existing business.

Effect of New Accounting Standard. 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.

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 six-month periods ended June 30, 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.

 

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Table of Contents

A discussion of operations by each segment follows later in this report. These discussions compare the first six 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.

Highlights, comparing the first six months of 2012 with the first six months of 2011. Net income per diluted share increased 18% to $2.48 from $2.10. Included in net income in both 2012 and 2011 were realized investment gains of approximately $6 million after tax, or $.06 per share in 2012 compared with $.05 per share in 2011. Realized investment gains and losses are presented 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 $3.9 million ($.03 per share) and the loss on sale of aviation equipment of $636 thousand after tax ($.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 5% in 2012 to $1.4 billion. Total net sales rose 24% to $252 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 6% to $205 million. First-year collected premium increased 36% to $226 million for the period. Excluding the increase in Part D first-year premium, the increase was 5%.

Life insurance premium income grew 4% to $903 million. Life net sales increased 6% to $177 million, as three of our four distribution units experienced increases. First-year collected life premium rose 5% to $129 million. Life underwriting margins increased 10% to $250 million.

 

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Table of Contents

Health insurance premium income, excluding Medicare Part D, declined 5% to $358 million. Health net sales, excluding Part D, increased 3% to $28 million for the six months, as a result of increased sales of Medicare Supplement policies and sales of a new cancer product at Liberty. First-year collected health premium, excluding Part D, rose 4% to $30 million for the period. Health premium continued to be restrained by the decline in the in force balance of certain health products that we discontinued selling in 2010.

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 $152 million in 2012 compared with $98 million in 2011, an increase of 55%. 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 $13.9 million after-tax charge to earnings in 2012 ($.14 per share) and a $3.7 million charge in 2011 ($.03 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 12% to $1.27, while excess investment income declined 4% to $126 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 $8 million, or 2%. Our average investment portfolio at amortized cost grew 3%. The average effective yield on the fixed-maturity portfolio, which represents 95% of our investments at amortized cost, was 6.46% in the 2012 period, compared with 6.59% 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 the $8 million increase in net investment income, because of the $13 million or 7% increase in required interest on net insurance policy liabilities, as discussed under the caption Investments (excess investment income) later in this report. Financing costs also rose 1% in the period to $39 million.

In the first six months of 2012, we invested new money in our fixed-maturity portfolio at an effective annual yield on new investments of 4.64%, compared with 5.84% in the same period of 2011. Our fixed maturity portfolio yield was 6.42% (as of June 30, 2012) and the portfolio had an average rating of BBB+. Over 93% of the portfolio at amortized cost was investment grade at June 30, 2012. Cash and short-term investments were $180 million at that date, compared with $105 million at December 31, 2011.

 

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The unrealized gain position in our fixed-maturity portfolio grew during the first six months of 2012 from a net unrealized gain of $964 million at year end 2011 to a net unrealized gain position of $1.2 billion at June 30, 2012, primarily as a result of lower interest rates. 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 August, 2012 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 six-month periods ended June 30, 2012 and 2011.

ANALYSIS OF SHARE PURCHASES

(Amounts in thousands)

 

     For the six months ended June 30,  
     2012      2011  
     Shares      Amount      Average
Price
     Shares      Amount      Average
Price
 

Purchases with:

                 

Excess cash flow

     5,761       $ 273,840       $ 47.53         13,989       $ 602,247       $ 43.05   

Option exercise proceeds

     2,461         115,803         47.06         1,436         62,097         43.25   
  

 

 

    

 

 

       

 

 

    

 

 

    

Total

     8,222       $ 389,643       $ 47.39         15,425       $ 664,344       $ 43.07   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

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 six months of 2012 with the first six months of 2011. Life insurance is our predominant segment, representing 64% of premium income and 72% of insurance underwriting margin in the first six 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 4% to $903 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)

 

     Six months ended June 30,      Increase  
     2012      2011      (Decrease)  
     Amount      % of
Total
     Amount      % of
Total
     Amount     %  

American Income Exclusive Agency

   $ 324,884         36       $ 297,008         34       $ 27,876        9   

Direct Response

     318,954         35         302,232         35         16,722        6   

Liberty National Exclusive Agency

     142,441         16         145,669         17         (3,228     (2

Other Agencies

     116,549         13         119,321         14         (2,772     (2
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

Total Life Premium

   $ 902,828         100       $ 864,230         100       $ 38,598        4   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Net sales, defined earlier in this report as an indicator of new business production, rose 6% to $177 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)

 

     Six months ended June 30,      Increase  
     2012      2011      (Decrease)  
     Amount      % of
Total
     Amount      % of
Total
     Amount     %  

American Income Exclusive Agency

   $ 78,467         44       $ 69,025         41       $ 9,442        14   

Direct Response

     77,623         44         72,907         44         4,716        6   

Liberty National Exclusive Agency

     15,446         9         19,215         12         (3,769     (20

Other Agencies

     5,546         3         5,482         3         64        1   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

Total Life Net Sales

   $ 177,082         100       $ 166,629         100       $ 10,453        6   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

First-year collected life premium, defined earlier in this report, was $129 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)

 

     Six months ended June 30,      Increase  
     2012      2011      (Decrease)  
     Amount      % of
Total
     Amount      % of
Total
     Amount     %  

American Income Exclusive Agency

   $ 62,068         48       $ 55,541         45       $ 6,527        12   

Direct Response

     48,749         38         46,338         38         2,411        5   

Liberty National Exclusive Agency

     13,694         10         16,428         13         (2,734     (17

Other Agencies

     4,749         4         4,822         4         (73     (2
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

Total

   $ 129,260         100       $ 123,129         100       $ 6,131        5   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

The American Income Exclusive Agency markets primarily to members of labor unions, but also to credit unions and other associations. This agency is the largest contributor to life premium of any of Torchmark’s distribution systems at 36% of Torchmark’s total life premium. This group produced premium income of $325 million, an increase of 9%. This agency is also our fastest growing life insurance agency on the basis of premium growth. Net sales rose 14% to $78 million, while first-year collected premium rose 12% to $62 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 23% to 5,318 at June 30, 2012 over the prior year (4,332). The count was also up 21% 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.

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 $319 million, representing 35% of Torchmark’s total life premium in 2012. Net sales for this group of $78 million increased 6%. First-year collected premium gained 5% to $49 million.

 

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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 $142 million in the 2012 period, a 2% decline compared with $146 million in the 2011 period. First-year collected premium declined 17% to $14 million.

Net sales for the Liberty Agency declined 20% to $15 million. Liberty had 1,355 producing agents at June 30, 2012, compared with 1,792 a year earlier, a decline of 24%. However, the agent count rose 1% since December 31, 2011, when it stood at 1,345, and has risen 6% over the prior quarter. Decreases in agent counts prior to 2012 have been due to a number of factors, including the closing of several offices which had poor production as well as certain agent compensation issues which resulted in the departure of a number of the less productive agents. While these factors caused a loss of agents, they have 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 $117 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)

 

     Six months ended June 30,                
     2012      2011      Increase  
     Amount      % of
Premium
     Amount      % of
Premium
     Amount      %  

Premium and policy charges

   $ 902,828         100       $ 864,230         100       $ 38,598         4   

Net policy obligations

     344,816         38         330,031         38         14,785         4   

Commissions and acquisition expense *

     307,717         34         306,057         36         1,660         1   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

Insurance underwriting income before other income and administrative expense

   $ 250,295         28       $ 228,142         26       $ 22,153         10   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

*

2011 expense has been retrospectively adjusted 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 $25 million and the addition of non-deferred acquisition expense of $41 million, for a net reduction in margin of $16 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 $29 million in 2012 and $41 million in 2011. While the recognition of profits is now delayed, ultimate profitability on our business is not affected by the change in accounting.

Life insurance underwriting income before insurance administrative expense was $250 million, increasing 10%. 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.

In 2011, we implemented several initiatives designed to further improve life insurance lapse ratios. This program has been very successful and has continued to grow. We anticipate that it will conserve approximately $31 million of additional annualized life premium during 2012.

Health insurance, comparing the first six months of 2012 with the first six months of 2011. Health premium accounted for 36% of our total premium in the 2012 period, while the health underwriting margin accounted for 28% 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 $510 million, increasing 7%. 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)

 

     Six months ended June 30,      Increase  
     2012      2011      (Decrease)  
     Amount      % of
Total
     Amount      % of
Total
     Amount     %  

United American Independent Agency

                

Limited-benefit plans

   $ 15,479          $ 20,014          $ (4,535     (23

Medicare Supplement

     136,885            137,733            (848     (1
  

 

 

       

 

 

       

 

 

   
     152,364         43         157,747         42         (5,383     (3

Liberty National Exclusive Agency

                

Limited-benefit plans

     83,428            91,044            (7,616     (8

Medicare Supplement

     52,804            60,262            (7,458     (12
  

 

 

       

 

 

       

 

 

   
     136,232         38         151,306         40         (15,074     (10

American Income Exclusive Agency

                

Limited-benefit plans

     39,323            38,876            447        1   

Medicare Supplement

     356            415            (59     (14
  

 

 

       

 

 

       

 

 

   
     39,679         11         39,291         10         388        1   

Direct Response

                

Limited-benefit plans

     180            199            (19     (10

Medicare Supplement

     29,046            28,622            424        1   
  

 

 

       

 

 

       

 

 

   
     29,226         8         28,821         8         405        1   

Total Health Premium (Before Part D)

                

Limited-benefit plans

     138,410         39         150,133         40         (11,723     (8

Medicare Supplement

     219,091         61         227,032         60         (7,941     (3
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

Total (Before Part D)

     357,501         100         377,165         100         (19,664     (5
     

 

 

       

 

 

      

Medicare Part D *

     152,175            98,310            53,865        55   
  

 

 

       

 

 

       

 

 

   

Total Health Premium *

   $ 509,676          $ 475,475          $ 34,201        7   
  

 

 

       

 

 

       

 

 

   

 

 

 

 

* Total Medicare Part D premium and health premium exclude the risk-sharing premiums of $11.3 million in 2012 and $12.2 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)

 

     Six months ended June 30,      Increase  
     2012      2011      (Decrease)  
     Amount      % of
Total
     Amount      % of
Total
     Amount     %  

United American Independent Agency

                

Limited-benefit plans

   $ 462          $ 538          $ (76     (14

Medicare Supplement

     12,966            11,291            1,675        15   
  

 

 

       

 

 

       

 

 

   
     13,428         48         11,829         44         1,599        14   

Liberty National Exclusive Agency

                

Limited-benefit plans

     6,758            6,206            552        9   

Medicare Supplement

     373            933            (560     (60
  

 

 

       

 

 

       

 

 

   
     7,131         26         7,139         26         (8     0   

American Income Exclusive Agency

                

Limited-benefit plans

     4,432            5,084            (652     (13

Medicare Supplement

     0            0            0        0   
  

 

 

       

 

 

       

 

 

   
     4,432         16         5,084         19         (652     (13

Direct Response

                

Limited-benefit plans

     551            694            (143     (21

Medicare Supplement

     2,276            2,332            (56     (2
  

 

 

       

 

 

       

 

 

   
     2,827         10         3,026         11         (199     (7

Total Net Sales (Before Part D)

                

Limited-benefit plans

     12,203         44         12,522         46         (319     (3

Medicare Supplement

     15,615         56         14,556         54         1,059        7   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

Total (Before Part D)

     27,818         100         27,078         100         740        3   
     

 

 

       

 

 

      

Medicare Part D*

     47,255            9,677            37,578        388   
  

 

 

       

 

 

       

 

 

   

Total Net Sales*

   $ 75,073          $ 36,755          $ 38,318        104   
  

 

 

       

 

 

       

 

 

   

 

 

 

 

* 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)

 

     Six months ended June 30,      Increase  
     2012      2011      (Decrease)  
     Amount      % of
Total
     Amount      % of
Total
     Amount     %  

United American Independent Agency

                

Limited-benefit plans

   $ 420          $ 1,074          $ (654     (61

Medicare Supplement

     14,449            13,098            1,351        10   
  

 

 

       

 

 

       

 

 

   
     14,869         50         14,172         50         697        5   

Liberty National Exclusive Agency

                

Limited-benefit plans

     6,856            4,579            2,277        50   

Medicare Supplement

     632            1,235            (603     (49
  

 

 

       

 

 

       

 

 

   
     7,488         25         5,814         20         1,674        29   

American Income Exclusive Agency

                

Limited-benefit plans

     4,990            5,827            (837     (14

Medicare Supplement

     0            0            0        0   
  

 

 

       

 

 

       

 

 

   
     4,990         17         5,827         21         (837     (14

Direct Response

                

Limited-benefit plans

     330            230            100        43   

Medicare Supplement

     1,882            2,391            (509     (21
  

 

 

       

 

 

       

 

 

   
     2,212         8         2,621         9         (409     (16

Total First-Year Collected Premium (Before Part D)

                

Limited-benefit plans

     12,596         43         11,710         41         886        8   

Medicare Supplement

     16,963         57         16,724         59         239        1   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

Total (Before Part D)

     29,559         100         28,434         100         1,125        4   
     

 

 

       

 

 

      

Medicare Part D*

     66,902            13,903            52,999        381   
  

 

 

       

 

 

       

 

 

   

Total First-Year Collected Premium*

   $ 96,461          $ 42,337          $ 54,124        128   
  

 

 

       

 

 

       

 

 

   

 

 

 

 

* 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 5% to $358 million in the 2012 period. Medicare Supplement premium declined 3% to $219 million, while other limited-benefit health premium decreased 8% to $138 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 3% to $28 million. Medicare Supplement net sales rose 7% to $16 million in the 2012 period. Limited-benefit net sales decreased 3% to $12 million. Non-Part D health first-year collected premium rose 4%.

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 $152 million, representing 43% of Torchmark’s total non-Part D health premium. Net sales were $13 million, or 48% 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 $137 million. This agency represents approximately 62% of all Torchmark Medicare Supplement premium and 83% of Medicare Supplement net sales. Net sales of Medicare Supplement products in this agency rose 15% in 2012. While Medicare Supplement premium declined 1%, total health premium declined 3% from the prior year period.

The Liberty National Exclusive Agency markets Medicare Supplement products and limited-benefit health products including cancer insurance. This agency represented 38% of Torchmark’s non-Part D health premium income at $136 million in the 2012 six months. Net health sales in this agency were flat in the 2012 period at $7 million. However, limited-benefit product sales rose 9%.

Discussed under the Life Insurance caption, we noted the 24% decline in agent counts at Liberty over the prior twelve months. Declines in agent counts have also had a negative effect on health net sales and premium income. In the 2012 period, health premium income in the Liberty Agency declined 10% from the prior year premium of $151 million. However, first-year collected premium rose 29% to $7.5 million, due to the increase in 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 $8.1 million in 2011 to $7.3 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

 

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premium income which is received evenly throughout the policy year. At this time, we 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 $152 million in 2012, compared with $98 million in 2011, after removal of the risk-sharing adjustment in both periods. This represents an increase in premium of 55%. 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. Because of the structure of this government program, we will not know our level of participation in the low-income automatic enrollee Part D program for 2013 until later in the third quarter of 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)

 

     Six months ended June 30,  
     2012     2011  
     Per
Segment
Analysis
     GAAP     Per
Segment
Analysis
     GAAP  

Insurance underwriting income before other income and administrative expense

   $ 16,121       $ (5,245   $ 10,730       $ 5,075   
  

 

 

    

 

 

   

 

 

    

 

 

 

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)

 

     Six months ended June 30, 2012  
     Health*      % of
Premium
     Medicare
Part D
     % of
Premium
     Total
Health
     % of
Premium
 

Premium and policy charges

   $ 357,501         100       $ 152,175         100       $ 509,676         100   

Net policy obligations

     212,505         60         128,284         84         340,789         67   

Commissions and acquisition expense

     64,903         18         7,770         5         72,673         14   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Insurance underwriting income before other income and administrative expense

   $ 80,093         22       $ 16,121         11       $ 96,214         19   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     Six months ended June 30, 2011  
     Health*      % of
Premium
     Medicare
Part D
     % of
Premium
     Total
Health
     % of
Premium
 

Premium and policy charges

   $ 377,165         100       $ 98,310         100       $ 475,475         100   

Net policy obligations

     223,006         59         82,539         84         305,545         64   

Commissions and acquisition expense**

     68,892         18         5,041         5         73,933         16   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Insurance underwriting income before other income and administrative expense

   $ 85,267         23       $ 10,730         11       $ 95,997         20   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
                 

 

* Health other than Medicare Part D.
** 2011 expense has been retrospectively adjusted 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 $22.1 million and the addition of non-deferred acquisition expense of $7.4 million in 2011.

Underwriting income for health insurance rose slightly to $96 million. Medicare Part D underwriting income was up $5 million or 50%, while non-Part D health underwriting income declined $5 million or 6% to $80 million in the period. The 2012 decline in health margins (excluding Part D) was primarily the result of the decline in premium income. The increased underwriting income for Medicare Part D in 2012 was a result of the previously-mentioned increased volume of business, correlating closely with the premium increase of 55%. As a percentage of health premium, underwriting margins declined from 20% to 19%, due to the greater proportion of Medicare Part D business in 2012.

 

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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 that were retrospectively adjusted for the new accounting guidance were positively benefited, as the increase in non-deferred acquisition expenses caused by the new rules of $7 million was less than the decrease in amortization expense of $22 million (from $63 million to $41 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 six months of 2012 with the first six 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.

Operating Expenses Selected Information

(Dollar amounts in thousands)

 

    Six months ended June 30,  
    2012     2011  
    Amount     % of
Premium
    Amount     % of
Premium
 

Insurance administrative expenses:

       

Salaries

  $ 37,620        2.6      $ 37,497        2.8   

Other employee costs

    14,150        1.0        15,218        1.1   

Other administrative costs

    24,674        1.7        20,646        1.5   

Legal expense—insurance

    3,983        0.3        4,548        0.4   
 

 

 

   

 

 

   

 

 

   

 

 

 

Total insurance administrative expenses

    80,427        5.6        77,909        5.8   
   

 

 

     

 

 

 

Parent company expense

    4,210          4,811     

Stock compensation expense

    11,237          7,002     

Estimated state administrative settlement

    0          6,000     

Loss on sale of equipment

    0          979     
 

 

 

     

 

 

   

Total operating expenses, per

       

Consolidated Statements of Operations

  $ 95,874        $ 96,701     
 

 

 

     

 

 

   

Insurance administrative expenses:

       

Increase (decrease) over prior year

    3.2       1.8  

Total operating expenses:

       

Increase (decrease) over prior year

    (0.9 )%        9.9  

 

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Insurance administrative expenses increased $2.5 million or 3% when compared with the prior year period, primarily as a result of the $2.6 million loss of a contract fee for insurance policy service that was in place in 2011. Total operating expenses declined 1% in 2012. The decline was primarily caused by 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. Partially offsetting the 2012 decrease was an increase in stock compensation expense in that year. This 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 six months of 2012 with the first six 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 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 $5.3 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.

 

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Table of Contents

Excess Investment Income

(Dollar amounts in thousands)

 

     Six months ended
June 30,
    Increase
(Decrease)
 
     2012     2011     Amount     %  

Net investment income*

   $ 360,329      $ 352,060      $ 8,269        2   

Required interest on net insurance policy liabilities

     (194,935     (182,049     (12,886     7   

Financing costs:

        

Interest on funded debt

     (36,248     (36,211     (37     0   

Interest on short-term debt

     (2,940     (2,528     (412     16   
  

 

 

   

 

 

   

 

 

   

Total financing costs

     (39,188     (38,739     (449     1   
  

 

 

   

 

 

   

 

 

   

Excess investment income

   $ 126,206      $ 131,272      $ (5,066     (4
  

 

 

   

 

 

   

 

 

   

Excess investment income per diluted share

   $ 1.27      $ 1.13      $ 0.14        12   
  

 

 

   

 

 

   

 

 

   

 

 

 

Average invested assets (at amortized cost)

   $ 11,542,693      $ 11,257,141      $ 285,552        3   

Average net insurance policy liabilities**

     6,924,837        6,567,008        357,829        5   

Average debt and preferred securities (at amortized cost)

     1,179,115        1,097,299        81,816        7   

 

* 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 GBusiness 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.

As shown in the above table, excess investment income for the 2012 period declined 4% to $126 million, primarily as a result of the effect of the low-interest environment on net investment income in recent periods and the increase in required interest on net policy liabilities as discussed below. However, excess investment income per share rose 12% as a result of our share purchases over the past 12 months. Net investment income rose $8 million or 2% in 2012, while average invested assets (with fixed maturities at amortized cost) rose 3% year over year. In the 2012 six months, fixed maturity yields averaged 6.46% on a tax-equivalent basis, compared with 6.59% a year earlier.

Offsetting the increase in net investment income, required interest on net insurance policy liabilities increased $13 million or 7% to $195 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, caused by changes in the mix of in force business as discussed below.

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

 

40


Table of Contents

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 reserve liability and the 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 in force 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 in force 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 the deferred acquisition cost asset by issue year on the entire block of in force business. Business issued in the current year has very little impact on the overall weighted-average discount rate due to the size of our in force business.

Financing costs rose 1% to $39 million, as a result of an increase in interest on short-term debt. Short-term interest expense rose $412 thousand, primarily as a result of the larger average balance of our commercial paper outstanding. 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.

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.

At the end of the second quarter we held approximately $708 million of trust preferred securities issued by banks. These securities are subject to provisions of the Dodd-Frank Act which will change the capital treatment of these bank-issued trust preferred securities beginning in 2013. Approximately $601 million of our trust preferred securities have provisions that allow them to be prematurely called without penalty in the event of a change in capital treatment of the security. These provisions do not explicitly state when the securities become callable. Some banks consider them callable once the Notice of Proposed Rulemaking regarding this change in capital treatment is published. However, we believe some banks consider them callable when the change in capital treatment actually occurs. The Notice of Proposed Rulemaking

 

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Table of Contents

was published July 5, 2012. We were notified in early July that $301 million of these securities with an average yield of 7.18% would be called during July and August. We expect the annual loss of interest income assuming reinvestment at around 4.25% to be approximately $6 million after tax.

We do not know how much, if any, of the remaining $300 million of these securities will be called later in 2012, but we expect most of them to be called by the end of 2013 due to the current interest rate environment. These securities have an average yield of 7.35%. If all of these additional securities were called, the annual lost investment income would be approximately $6 million after tax assuming a 4.25% reinvestment rate. The calls of all $601 million of these securities are assumed in the discussion above regarding the 2% to 3% run off of fixed maturities each year over the next five years.

The $601 million of trust preferred securities include approximately $260 million of below-investment-grade bonds. As such, the calls of these bonds should reduce the ratio of our below-investment-grade bonds to the total investment portfolio and reduce our required capital.

In response to the lower interest rates, we have raised the premium rates for new business 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 in force block, we expect that an extended low-interest-rate environment will not cause a loss recognition event.

Investments (acquisitions), comparing the first six months of 2012 with the first six 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 generally invested in shorter-term fixed maturities.

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).

 

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Table of Contents

Fixed Maturity Acquisitions Selected Information

(Dollar amounts in millions)

 

     For the six months
ended
June 30,
 
     2012     2011  

Cost of acquisitions:

    

Investment-grade corporate securities

   $ 424      $ 684   

Taxable municipals

     0        11   

Other

     5        2   
  

 

 

   

 

 

 

Total fixed-maturity acquisitions

   $ 429      $ 697   
  

 

 

   

 

 

 

Effective annual yield*

     4.64     5.84

Average life, in years to:

    

Next call

     28.3        26.9   

Maturity

     28.5        27.8   

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, 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 June 30, 2012 was as follows:

Invested Assets At June 30, 2012

(Dollar amounts in millions)

 

     Amount     

% of
Total

 

Fixed maturities(at amortized cost)

   $ 11,075         95

Equities (at cost)

     15         0   

Mortgage loans

     1         0   

Investment real estate

     3         0   

Policy loans

     411         4   

Other long-term investments

     21         0   

Short-term investments

     110         1   
  

 

 

    

 

 

 

Total

   $ 11,636         100
  

 

 

    

 

 

 

Approximately 95% 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 June 30, 2012.

Fixed Maturities by Component

(Dollar amounts in millions)

 

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

Corporates

   $ 8,594       $ 1,193       $ (90   $ 9,697         78         79   

Redeemable preferred stock

     1,118         33         (34     1,117         10         10   

Municipals

     1,213         160         0        1,373         11         11   

Government-sponsored enterprises

     12         1         0        13         0         0   

Governments & agencies

     35         1         0        36         0         0   

Residential mortgage-backed*

     13         1         0        14         0         0   

Collateralized debt obligations

     62         0         (33     29