Torchmark, through its subsidiaries, owns or leases buildings that are used in the normal course of business. Liberty owns a 487,000 sq. ft. building at 2001 Third Avenue South, Birmingham, Alabama, which currently serves as Liberty's, UILIC's, and Torchmark's home office. Liberty leases approximately 150,000 sq. ft. of this building to unrelated tenants and has another 15,000 sq. ft. available for lease. Liberty also operates from 67 company-owned district office buildings used for agency sales personnel.
Globe owns a 300,000 sq. ft. office building at 204 North Robinson, Oklahoma City, Oklahoma, of which it occupies 85,647 sq. ft. as its home office and the balance is available for lease. Globe also owns a 330,000 sq. ft. office building complex at 14000 Quail Springs Parkway Plaza Boulevard, Oklahoma City and a 110,000 sq. ft. office building at 120 Robert S. Kerr Avenue, Oklahoma City, which are available for lease to other tenants.
American Income owns and is the sole occupant of an office building located at 1200 Wooded Acres Drive, Waco, Texas. The building is a two-story structure containing approximately 72,000 square feet of usable floor space. In addition, American Income leases office space in various cities throughout the United States.
Liberty, Globe and W&R also lease district office space for their agency sales personnel. All of the other Torchmark companies lease their office space in various cities in the U.S.
All centralized computer software support, information processing schedules and computer-readable data management requirements are supported by company specific policies and procedures which ensure that required information processing results are produced and distributed in a timely manner and provide for the copying, off-site physical storage and retention of significant company computer programs and business data files for backup purposes.
Net income for Torchmark in 1994 was $269 million, declining 9.7% from $298 million in 1993. On a per share basis, net income was $3.72, decreasing 7.2% from 1993 per share net income of $4.01. Per share earnings for 1993 rose 12.0% over 1992 earnings of $3.58 per share. Excluding the after-tax effect of realized investment gains and losses and the associated adjustment to deferred acquisition costs, per share earnings were $3.81 in 1994 compared to $3.94 in 1993, a decrease of 3.3%. The adjustment to deferred acquisition costs, which was $7.1 million of additional amortization before tax, was made because of an accounting rule requiring that deferred acquisition costs on interest- sensitive insurance products be amortized in accordance with expected gross profits. Since realized investment gains or losses on assets backing such products change profit expectations, the adjustment is required. The 1993 increase in per share earnings, excluding realized investment gains and losses, was 9.7% over 1992 adjusted per share earnings of $3.59.
Other operating expenses declined 7% in 1994 after having increased 3% in 1993. When comparing 1994 operating expenses to 1993, three items should be considered. Vesta expenses of $7.5 million should be excluded from 1993, American Income expenses of $1.2 million should be excluded from 1994, and goodwill amortization from the purchases of American Income and United Investors Management Company ("United Management") of $1.6 million and $1.9 million, respectively, should be excluded from 1994. After such adjustments are made, operating expenses declined 6% to $158 million in 1994. As a percentage of total revenues, operating expenses declined to 8.3% in 1994 from 8.5% in 1993, adjusting revenues for the previously-mentioned gains from the Vesta sale of $57 million and the large energy
property in the amount of $22 million, and adjusting expenses to exclude Vesta in 1993 and the new amortization of goodwill in 1994. Although operating expenses rose in 1993 over 1992 from $157 million to $170 million, a comparison of operating expenses as a percentage of revenues reveals they were level at 8.3%, adjusting for the one-time Vesta and energy gains but including Vesta operations. Interest expense rose 21% in 1993 to $67.3 million and then rose an additional 13.5% to $76.4 million in 1994, primarily as a result of $300 million in new debt issued during 1993, which caused average indebtedness to rise in both 1993 and 1994. These new issues were used mainly to fund the 1993 acquisition of the remaining shares of United Management. These debt issuances and the United Management transaction are discussed further as a part of the capital resources discussion found on page 29 of this report. Increased borrowings on Torchmark's line of credit and rising rates were also minor factors in the 1994 increase. The line of credit is discussed in more depth in the liquidity discussion found on page 28 of this report.
Health Insurance: Torchmark's individual health products include Medicare ----------------- Supplement insurance, cancer insurance, and other under-age 65 medical and hospitalization products. As a percentage of annualized individual health premium in force at December 31, 1994, Medicare Supplement accounted for 71%, cancer accounted for 14%, and other products accounted for 15%.
Cancer insurance annualized premium in force declined 3.4% to $106 million at year-end 1993 but rose 8% in 1994 to $114 million at year-end 1994. Sales of this product declined 45% in 1993 to $10 million and further declined 19% in 1994 to $8 million. Annualized premium in force for under age 65 health insurance stabilized in 1994, standing at $113 million at both year-end 1994 and 1993. Annualized premium in force for under age 65 declined 19% in 1993 from $141 million. Sales of a number of these products were discontinued in 1992 because of poor margins, causing the premium in force to decline in both 1992 and 1993.
Margins have improved in each of the years considered. As a percentage of premium, insurance operating income for health insurance grew from 11.2% in 1992 to 13.2% in 1993 to 15.6% in 1994, representing an increase of 18% in both 1993 and 1994 over the prior year. There were two primary reasons for this improvement. First, the amortization of acquisition costs declined in each period due to improved persistency. The improvements were caused at least in part by the requirement in many states to level agents' commissions on Medicare Supplement products instead of paying a larger first-year commission. This leveling of commissions has encouraged persistency through the payment of a higher renewal commission. It has also encouraged persistency through the payment of a lower first-year commission, which discourages replacement. Additionally, policy obligations for health products as a percentage of premium declined .7% in 1993 and 1.4% in 1994. These declines were a result of the decline in lower margin non-Medicare business in 1993 and in 1994, as well as favorable experience in certain Medicare and other non-Medicare blocks of business. Not included in the above 1994 presentation of health results was a one-time increase in health benefits resulting primarily from the reclassification described on page 19.
Annuities: Torchmark's annuity products serve a wide range of markets, such ---------- as providing retirement income, funding prearranged funerals, and offering long-term tax deferred growth opportunities. Annuity products are sold on both a fixed and a variable basis. The premium is accounted for as a deposit and is not reflected in income. Amounts deposited for variable annuities are invested at the policyholder's direction into his choice among nine W&R managed mutual funds which vary in degree of risk and return. These investments are reported as Separate Account Assets and the corresponding deposit balances for variable annuities are reported as Separate Account Liabilities.
Fixed annuity deposits are added to policy reserves and the funds collected are invested by Torchmark. Revenues on fixed and variable annuity products are derived from charges to the annuity account balances for insurance risk, administration, and surrender, depending on the contract's structure. Variable accounts are also charged an investment management fee and a sales charge. Torchmark profits to the extent these policy charges exceed actual costs and to the extent actual investment income exceeds the investment income which is credited to policyholders on fixed annuities.
Asset management fees rose 10% in 1994 to $71 million, after having risen 14% in 1993 to $64 million. Growth in management fees in both periods was caused by the increase in average mutual fund and institutional assets under management, to which the fees correlate. The 1994 growth in average assets under management resulted from additional product sales. This growth was achieved even though financial markets weakened somewhat during the year as a result of rising interest rates. The 1993 increase in assets under management resulted largely from the stronger financial markets experienced in 1993 over prior periods as well as from additional product sales. Average assets under management grew 9% over the prior year. Assets under management were $14.5 billion at both December 31, 1993 and 1994, and $12.1 billion at December 31, 1992.
United Funds, for which commission revenue is earned at the point of sale, and increases in sales of the Waddell & Reed Funds, for which distribution revenues are deferred and earned subsequent to the point of sale. Waddell & Reed Funds' distribution fees are derived from an annual asset-based charge. In addition, the maximum sales charge on the United Funds was reduced in August, 1993 to improve their competitive position. This reduction in revenue was partially offset by an increased annual fee.
Energy operations revenues for 1993 included a one-time gain from the sale of an offshore producing property in the amount of $22 million. Excluding this gain, energy revenues declined 23% from $84 million in 1993 to $64 million in 1994. In 1993, revenues excluding the one-time gain rose 13% over 1992. Profitability in energy operations improved in each of the years 1992 through 1994, with recurring pretax income rising from $10.5 million in 1992 to $11.3 million in 1993 and to $11.9 million in 1994, an increase of 8% in 1993 and 5% in 1994.
Torchmark is presently evaluating various alternatives concerning the possible sale of Torch Energy.
Investment operations: Net investment income declined 9.5% in 1994 to $330 ---------------------- million from $365 million in 1993, after adjustment for Vesta's investment income. It declined 2.7% in 1993 (including Vesta). The three main factors causing the 1994 decrease were increased losses in energy investment income, accelerated GNMA repayments which caused increased acquisition of lower yielding securities, and increased investment in municipal securities which involve lower pretax yields. These factors also affected the decline in 1993 net investment income to a lesser extent. Additionally, the low yields available in 1993 on new investments for Torchmark's cash flow negatively affected 1993 and 1994 investment income growth.
The decline in interest rates during 1993 encouraged refinancing of mortgages, causing increased GNMA prepayments in 1993 and early 1994. These funds were reinvested at lower prevailing rates, causing a reduction in Torchmark's investment income in both 1993 and 1994. It is estimated that GNMA repayments reduced investments income $26.4 million in 1994 and $10.3 million in 1993, resulting in an after-tax decline of $.24 per share in 1994 and $.09 per share in 1993. Because of rising interest rates in 1994, however, refinancings have declined and Torchmark has been able to invest repayments as well as new cash flow in slightly higher yielding securities, reversing this trend. Torchmark has also reduced its exposure to GNMA's during 1994, decreasing the portfolio from $2.05 billion at year-end 1993 to $1.72 billion at year-end 1994.
The relative attractiveness of tax-exempt securities improved in late 1993 because of the increase in corporate tax rates. While pretax returns on tax- exempt securities are lower than taxables, net after-tax returns are higher. Torchmark's holdings in tax-exempt securities represented 13.6% of total investments at December 31, 1994, compared to 11% at year-end 1993 and 1.7% at year-end 1992. Tax-equivalent investment income, excluding energy income and Vesta, was $370 million in 1994, compared to $376 million in 1993 and $374 million in 1992.
Torchmark's investments are very high quality and are primarily in U.S. Government or U.S. Government-backed securities and other investment-grade bonds. Torchmark's emphasis on such investments varies significantly with the insurance industry, which is demonstrated in the following table at December 31, 1994 including information provided by the American Council of Life Insurance:
Liquidity: Torchmark's high level of liquidity is represented by its strong ---------- positive cash flow, its liquid assets, and the availability of a line of credit facility and a commercial paper program. As is typical of established life insurance companies, Torchmark generates cash flow from premium, investment, and other income generally well in excess of its immediate needs for policy obligations, expenses, and other requirements. Additionally, because of the nature of the life insurance business, cash flow is also quite stable and predictable.
Cash and short-term investments were $116 million at December 31, 1994, compared to $237 million at December 31, 1993. These liquid assets represented 1.4% of total assets at December 31, 1994, compared to 3.1% at the prior year end. In addition to Torchmark's liquid assets, Torchmark has marketable fixed and equity securities with a value of $4.4 billion at December 31, 1994, which are available for sale should the need arise.
At year-end 1994, Torchmark had in place a line of credit facility with a group of banks which allowed borrowings up to $400 million. This line of credit agreement was entered into in December, 1994 and
Torchmark's long-term debt stood at $793 million at December 31, 1994, compared to $792 million at December 31, 1993. Torchmark's major debt issues outstanding at both December 31, 1994 and December 31, 1993 consisted of the following: (1) 8 5/8% Sinking Fund Debentures due 2017, $200 million principal amount; (2) 9 5/8% Senior Notes due 1998, $200 million principal amount; (3) 8 1/4% Senior Debentures due 2009, $100 million principal amount; (4) 7 7/8% Notes due 2023, $200 million principal amount; and (5) 7 3/8% Notes due 2013, $100 million principal amount. The latter two issues were issued in 1993, proceeds of which were used primarily to fund the United Management purchase. All major debt issues were carried at a balance of $791 million at December 31, 1994, after deducting the unamortized discount, compared to $790 million at December 31, 1993.
During 1994, Torchmark's short-term debt rose to $255 million at December 31, 1994 from $107 million at year-end 1993. Torchmark increased its line of credit borrowings from $107 million to $250 million during 1994. Also, at year-end 1994, there was an additional $5 million outstanding in energy short- term debt.
In 1994, Torchmark acquired 1.5 million shares of its common stock on the open market at an aggregate cost of $59 million. While Torchmark is not actively acquiring shares of its common stock at the current time, it may do so from time to time at favorable prices. Torchmark acquired 850 thousand shares at a cost of $42 million in 1993 and 4.2 million shares at a cost of $158 million in 1992.
Also, the class action litigation in Alabama over an exchange of Liberty's cancer policies continued in 1994. Although in May, 1994, a settlement was approved involving both equitable and monetary relief, valued by the court at $55 million, the appeal from the trial court's final approval is pending before the Alabama Supreme Court. Final briefs in the case were submitted to the Court in February, 1995. It is impossible to determine when a ruling will be issued.
We have audited the consolidated financial statements of Torchmark Corporation and subsidiaries as listed in item 8 and the supporting schedules as listed in Item 14(a). These financial statements and financial statement schedules are the responsibility of Torchmark's management. Our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audits.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Torchmark Corporation and subsidiaries at December 31, 1994 and 1993, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1994, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.
Principles of Consolidation: The financial statements include the results of --------------------------- Torchmark Corporation ("Torchmark") and its wholly-owned subsidiaries and United Investors Management Company ("United Management"). United Management was approximately 83% owned through October 1, 1993 at which time Torchmark acquired all of the publicly held shares. Torchmark deducts the interests of minority shareholders from its shareholders' equity and operating results. Subsidiaries which are not majority-owned are reported on the equity method. All significant intercompany accounts and transactions have been eliminated in consolidation.
Investments. Torchmark adopted the provisions of SFAS 115 at December 31, ----------- 1993. This standard prescribes the accounting for investments in debt and equity securities. Also at December 31, 1993, Torchmark elected to classify all of its fixed maturity investments, which include bonds and redeemable preferred stocks, as available for sale. The Standard requires that investments classified as available for sale be carried at market value with unrealized gains and losses, net of deferred taxes, reflected directly in shareholders' equity.
Investments in equity securities, which include common and nonredeemable preferred stocks, are reported at market value. Policy loans are carried at unpaid principal balances. Mortgage loans are carried at amortized cost. Investments in real estate are reported at cost less allowances for depreciation, which are calculated on the straight line method. Short-term investments include investments in certificates of deposit and other interest- bearing time deposits with original maturities within three months. Other long-term investments consist primarily of investments in mutual funds managed by a Torchmark subsidiary. They are carried at market value. If an investment becomes permanently impaired, such impairment is treated as a realized loss and the investment is adjusted to net realizable value.
Realized investment gains and losses and investment income attributable to separate accounts are credited to the separate accounts and have no effect on Torchmark's net income. Investment income attributable to other policyholders is included in Torchmark's net investment income. Net investment income for the years ended December 31, 1994, 1993 and 1992 included $240.7 million, $229.5 million, and $221.2 million, respectively, which was allocable to policyholder reserves or accounts. Realized investment gains and losses are not allocable to policyholders.
Determination of Fair Values of Financial Instruments: Fair value for cash, ----------------------------------------------------- short-term investments, receivables and payables approximates carrying value. Fair values for investment securities are based on quoted market prices, where available. Otherwise, fair values are based on quoted market prices of comparable instruments. Mortgages are valued using discounted cash flows. The carrying amounts of short-term borrowings approximate their fair value. Substantially all of Torchmark's long-term debt is valued based on quoted market prices.
Cash: Cash consists of balances on hand and on deposit in banks and ---- financial institutions. Overdrafts arising from the overnight investment of funds offset cash balances on hand and on deposit.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) (DOLLAR AMOUNTS IN THOUSANDS EXCEPT PER SHARE DATA) NOTE 1--SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) policy charges of $74.2 million, $76.2 million, and $79.8 million for the years ended December 31, 1994, 1993 and 1992, respectively. Other premium includes annuity policy charges for the years ended December 31, 1994, 1993, and 1992 of $13.9 million, $9.5 million, and $8.8 million, respectively. Profits are also earned to the extent that investment income exceeds policy requirements. The related benefits and expenses are matched with revenues by means of the provision of future policy benefits and the amortization of deferred acquisition costs in a manner which recognizes profits as they are earned over the same period.
Deferred Acquisition Costs and Value of Insurance Purchased: The costs of ----------------------------------------------------------- acquiring new insurance business are deferred. Such costs consist of sales commissions, underwriting expenses, and certain other selling expenses. The costs of acquiring new business through the purchase of other companies and blocks of insurance business are also deferred.
Income Taxes: Income taxes are accounted for under the asset and liability ------------ method in accordance with SFAS 109. Under the asset and liability method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Under Statement 109, the effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
Effective January 1, 1993, Torchmark adopted SFAS 109 and has reported the cumulative effect of that change in the method of accounting for income taxes in the 1993 consolidated statement of operations. Prior years' financial statements have not been restated to reflect Statement 109's provisions.
Prior to the adoption of SFAS 109, income taxes were accounted for under APB Opinion 11, which required the deferred method. Under this method, deferred income taxes were recognized for revenue and expense items that were reported in different years for financial reporting purposes and income tax purposes using the tax rate applicable for the year of the calculation. Deferred taxes were not adjusted for subsequent changes in tax rates.
Reclassification: Certain amounts in the financial statements presented have ---------------- been reclassified from amounts previously reported in order to be comparable between years. These reclassifications have no effect on previously reported shareholders' equity or net income during the periods involved.
Litigation: Provision has been made for litigation in the financial ---------- statements. Torchmark reports litigation costs as operating expenses except for large and unusual awards for actual and punitive damages, which are reported as nonoperating expense.
Earnings Per Share: Earnings available to holders of common stock are ------------------ computed after deducting dividends on the Adjustable Rate Cumulative Preferred Stock. Primary earnings per share are then calculated by dividing the earnings available to holders of common stock by the weighted average number of common shares outstanding during the period. The weighted average numbers of common shares outstanding for each period are as follows: 1994--72,095,657, 1993-- 73,501,654, 1992--73,236,849.
The excess, if any, of shareholders' equity of the insurance subsidiaries on a GAAP basis over that determined on a statutory basis is not available for distribution to Torchmark without regulatory approval.
A schedule of fixed maturities by contractual maturity at December 31, 1994 is shown below on an amortized cost basis and on a market value basis. Actual maturities could differ from contractual maturities due to call or prepayment provisions.
Torchmark had $26.3 million and $22.0 million in investment real estate at December 31, 1994 and 1993, respectively, which was nonincome producing during the previous twelve months. These properties included primarily construction in process and land. Fixed investments and mortgage loans which were nonincome producing during the previous twelve months were $0.6 million, and $.4 million at December 31, 1994 and 1993, respectively.
Derivative investments are immaterial to Torchmark at December 31, 1994. Torchmark's total carrying value of these investments was $26.5 million at December 31, 1994 and Torchmark has no off-balance sheet exposure in connection with these investments.
The amount of interest accrued on the unamortized balance of value of insurance purchased was $11.7 million, $10.8 million, and $12.7 million for the years ended December 31, 1994, 1993 and 1992, respectively. The average interest accrual rates used for the years ended December 31, 1994, 1993 and 1992 were 7.72%, 7.57% and 7.81%, respectively. The estimated amount of the unamortized balance at December 31, 1994 to be amortized during each of the next five years is: 1995, $29.3 million; 1996, $25.9 million; 1997, $22.9 million; 1998, $19.4 million; and 1999, $17.8 million.
In November, 1993, Torchmark sold approximately 73% of Vesta Insurance Group, Inc. ("Vesta"), Torchmark's holding company for its property and casualty insurance operations. The sale was made through an initial public offering of common stock for net proceeds of $161 million for a pretax gain of $57.2 million. Torchmark maintains a 27% interest in Vesta and accounts for its investment on the equity method, recording its investment as an unconsolidated subsidiary. In connection with the public offering, Torchmark loaned Vesta $28 million at an interest rate of 6.1 % for a term of five years, which was outstanding at both December 31, 1994 and 1993.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) (DOLLAR AMOUNTS IN THOUSANDS EXCEPT PER SHARE DATA) NOTE 8--FUTURE POLICY BENEFIT RESERVES
A summary of the assumptions used in determining the liability for future policy benefits at December 31, 1994 is as follows:
For individual life, the mortality tables used are various statutory mortality tables and modifications of: 1950-54 Select and Ultimate Table 1954-68 Industrial Experience Table 1955-60 Ordinary Experience Table 1965-70 Select and Ultimate Table 1955-60 Inter-Company Table 1970 United States Life Table 1979-81 United States Life Table 1975-80 Select and Ultimate Table X-18 Ultimate Table
Health benefits include a $30 million charge for 1994 resulting from a reclassification of nonoperating expense to health benefits, since actual payments will be made in the form of health benefits.
Torchmark and its eligible subsidiaries file a life-nonlife consolidated federal income tax return. Famlico and Sentinel file a separate federal income tax return and will not be eligible to join the consolidated return group until 1996 and 1997, respectively. American Income and its parent, Trust Life Insurance Company, will file a separate federal income tax return and will not be eligible to join the consolidated return group until 2000.
As discussed in Note 1, Torchmark adopted Statement 109 on January 1, 1993. The cumulative effect of this change in accounting for income taxes is a $26.1 million addition to net income for the year ended December 31, 1993. This amount is included in the cumulative effect of changes in accounting principles line on the consolidated statement of operations.
Income tax expense before the cumulative effect of the change in accounting principles and adjustments to shareholders' equity is summarized as follows:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) (DOLLAR AMOUNTS IN THOUSANDS EXCEPT PER SHARE DATA) NOTE 10--INCOME TAXES (CONTINUED)
Pension Plans: Torchmark has retirement benefit plans and savings plans ------------- which cover substantially all employees. There is also a nonqualified excess benefit plan which covers certain employees. The total cost of these retirement plans charged to operations was as follows:
Cost for the defined benefit pension plans has been calculated on the projected unit credit actuarial cost method. Contributions are made to the pension plans subject to minimums required by regulation and maximums allowed for tax purposes. Accrued pension expense in excess of amounts contributed has been recorded as a liability in the financial statements and was $11.8 million and $12.4 million at December 31, 1994 and 1993, respectively. The plans are organized as trust funds whose assets consist primarily of investments in marketable long-term fixed maturities and equity securities which are valued at market.
The weighted average assumed discount rates used in determining the actuarial benefit obligations were 8.0% in 1994 and 7.25% in 1993. The rate of assumed compensation increase was 5.0% in 1994 and 1993 and the expected long- term rate of return on plan assets was 8.0% in 1994 and 1993.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) (DOLLAR AMOUNTS IN THOUSANDS EXCEPT PER SHARE DATA) NOTE 11--POSTRETIREMENT BENEFITS (CONTINUED)
Post Retirement Benefit Plans Other Than Pensions; Torchmark provides ------------------------------------------------- postretirement life insurance benefits for most retired employees, and also provides additional postretirement life insurance benefits for certain key employees. The majority of the life insurance benefits are accrued over the working lives of active employees.
For measurement purposes, a 11% to 13% annual rate of increase in a per capita cost of covered health care benefits was assumed for 1994; the rate was assumed to decrease gradually to 4.5% by the year 2008 and remain at that level thereafter. The health care cost trend rate assumption has a significant effect on the amounts reported. To illustrate, increasing the health care cost trend by one percentage point in each year would increase the accumulated postretirement benefit obligation as of December 31, 1994 by $3.1 million and would increase the net periodic postretirement cost for the year ended December 31, 1994 by approximately $486 thousand.
The amount of debt that becomes due during each of the next five years is: 1995, $255 million; 1996, $123 thousand; 1997, $132 thousand; 1998, $200 million; and 1999, $150 thousand. Additionally, during the thirty-day period beginning June 15, 1996, senior debenture debt holders have the option to require Torchmark to repay $100 million.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) (DOLLAR AMOUNTS IN THOUSANDS EXCEPT PER SHARE DATA) NOTE 12--NOTES PAYABLE (CONTINUED)
Torchmark has entered into revolving credit agreements with a group of lenders under which it may borrow on an unsecured basis up to $400 million. One-half of the commitment matures December 5, 1995 and the balance matures December 6, 1999. Borrowings, pro rata under each facility, are at interest rates selected by Torchmark based on either the prime rate or the Eurodollar rate at the time of borrowing. At December 31, 1994, borrowings totalled $250 million and were made at an average rate of 6.40%. Torchmark is subject to certain covenants regarding capitalization and earnings, for which it was in compliance at December 31, 1994, and pays a facility fee based on size of the lines. The revolving credit agreements are designed to back up a commercial paper program with borrowings expected to begin in the first quarter of 1995.
Interest in the amount of $1.8 million, $10.5 million and $20.4 million was capitalized during 1994, 1993, 1992, respectively.
In October, 1994, Torchmark through its wholly-owned finance subsidiary, Torchmark Capital L.L.C., completed a public offering of eight million shares of 9.18% MIPS at a face amount of $200 million through an underwriting syndicate. The securities are subject to a mandatory redemption in full at September 30, 2024, although Torchmark may elect to extend the MIPS for up to an additional 20 years if certain conditions are met. They are redeemable at Torchmark's option after September 30, 1999. Torchmark subsequently entered into a ten-year swap agreement with an unaffiliated party whereby Torchmark agreed to pay a variable rate on the $200 million face amount in exchange for payment of the fixed dividend. In a related transaction, Torchmark purchased a five-year cap on the swap agreement that insures that the variable rate cannot exceed 10.39% through September 30, 1999. The interest rate was 7.02% at December 31, 1994. Torchmark pays a yearly fee of $860 thousand for the cap agreement. The market value of the swap agreement was an obligation of $4.1 million at December 31, 1994. The market value of the cap agreement, net of the present value of future annual payments, was a benefit of $517 thousand at December 31, 1994. Except as otherwise described in "Note 3--Investments" on page 42 of this report, Torchmark is a party to no other derivative instruments as defined by SFAS 119.
Share Data: A summary of preferred and common share activity is as follows: ----------
Stock Options: Under the provisions of the 1984 Torchmark Corporation Stock ------------- Option Plan ("1984 Option Plan") and the Torchmark Corporation 1987 Stock Incentive Plan ("1987 Option Plan"), certain employees and directors have been granted options to buy shares of Torchmark stock at the market value of the stock on the date of grant. In conjunction with the buyback of the minority interest of United Management, the United Investors Management Company 1986 Employee Stock Incentive Plan was amended to allow the granting of Torchmark stock options. The options are exercisable during the period commencing from three months to three years after grant until expiring ten years or ten years and two days after grant.
Reinsurance: Insurance affiliates of Torchmark reinsure that portion of ----------- insurance risk which is in excess of their retention limits. Retention limits for ordinary life insurance range up to $2 million per life. Life insurance ceded represents 1% of total life insurance in force at December 31, 1994. Insurance ceded on life and accident and health products represents 1.3% of premium income for 1994. Torchmark would be liable for the reinsured risks ceded to other companies to the extent that such reinsuring companies are unable to meet their obligations.
Leases: Torchmark leases office space and office equipment under a variety ------ of operating lease arrangements. These leases contain various renewal options, purchase options, and escalation clauses. Rental expense for operating leases was $7.9 million, $7.6 million, and $8.2 million for 1994, 1993, and 1992, respectively. Future minimum rental commitments required under operating leases having remaining noncancelable lease terms in excess of one year at December 31, 1994 are as follows: 1995, $5.8 million; 1996, $4.1 million; 1997, $3.0 million; 1998, $1.8 million; 1999, $199 thousand; and in the aggregate, $14.9 million.
Concentrations of Credit Risk: Torchmark maintains a highly-diversified ----------------------------- investment portfolio with limited concentration in any given region, industry, or economic characteristic. At December 31, 1994, the investment portfolio consisted of securities of the U.S. government or U.S. government-backed securities (39%); short-term investments, which generally mature within one month (2%); securities of state and municipal governments (14%); securities of foreign governments (2%); and investment-grade corporate bonds (27%). The remainder of the portfolio was in oil and gas investments (6%) and real estate (3%), which are not considered financial instruments according to GAAP; equity securities (1%); policy loans (4%), which are secured by the underlying insurance policy values; and mortgages, noninvestment grade corporate securities and other long-term investments (2%). Investments in municipal governments and corporations are made throughout the U.S. with no concentration in any given state. Substantially all investments in foreign government securities are in Canadian government obligations. Corporate equity and debt investments are made in a wide range of industries. At December 31, 1994, 1% or more of the portfolio was invested in the following industries or security types: Financial services (8%); regulated utilities (5%); nongovernment-guaranteed mortgage-backed securities (3%); chemicals (2%); petroleum (2%); transportation (2%); asset-backed securities (1%); foods (1%); and retailing (1%). Otherwise, no individual industry represented 1% or more of Torchmark's investments. At year-end 1994, less than 1% of the carrying value of fixed maturities was rated below investment grade (Ba or lower as rated by
Collateral Requirements: Torchmark requires collateral for investments in ----------------------- instruments where collateral is available and is typically required because of the nature of the investment. Since the majority of Torchmark's investments are in government, government-secured, or corporate securities, the requirement for collateral is rare. Torchmark's mortgages are secured by collateral, although new mortgages are no longer being acquired.
Litigation: Torchmark and its subsidiaries continue to be named as parties ---------- to pending or threatened legal proceedings. These suits involve tax matters, alleged breaches of contract, torts, including bad faith and fraud claims based on alleged wrongful or fraudulent acts of agents of Torchmark's subsidiaries, employment discrimination, and miscellaneous other causes of action. Many of these lawsuits involve claims for punitive damages. In particular, Torchmark's subsidiary Liberty is a party to a number of such actions which seek punitive damages in state courts of Alabama, a jurisdiction particularly recognized for its large punitive damage verdicts. Some of such actions involving Liberty also name Torchmark as a defendant. As a practical matter, a jury's discretion regarding the amount of a punitive damage award is virtually unlimited under Alabama law. Accordingly, the likelihood or extent of a punitive damage award in any given case is virtually impossible to predict. As of December 31, 1994, Liberty was a party to approximately 172 active lawsuits (excluding interpleaders and stayed cases), more than 120 of which were Alabama proceedings in which punitive damages were sought.
As previously reported, litigation was filed in May 1992 against Liberty in the Circuit Court for Barbour County, Alabama (Robertson v. Liberty National ----------------------------- Life Insurance Company). This suit was amended in October 1992 to include - ---------------------- claims on behalf of a class of Liberty policyholders alleging fraud in the exchange of certain cancer insurance policies. The complaint sought substantial equitable and injunctive relief and unspecified compensatory and punitive damages. A policyholder class was certified by the Barbour County Court in March 1993. Additionally, subsequent to the class certification, a number of individual lawsuits based on substantially the same allegations as in Robertson were filed by plaintiffs in Alabama, Georgia, Florida and --------- Mississippi. Four additional class action suits also based upon substantially the same allegations as in Robertson were filed in Mobile County, Alabama (Adair v. Liberty National Life Insurance Company and Lamey v. Liberty ------------------------------------------------ ---------------- National Life Insurance Company) and in Polk County, Florida (Howell v. - ------------------------------- --------- Liberty National Life Insurance Company and Scott v. Liberty National Life - --------------------------------------- ------------------------------ Insurance Company) after the class certification. Adair, Lamey, Howell and - ----------------- ----- ----- ------ Scott have been settled on an individual basis. - -----
On February 4, 1994, the Circuit Court for Barbour County, Alabama ruled that with a $16 million increase in the total value of the equitable and monetary relief contained in the proposed Robertson ---------
settlement (from approximately $39 million to $55 million in total value), the settlement would be fair and would be approved, provided that the parties to the litigation accepted the amended settlement within fourteen days of the issuance of the ruling. On February 17, 1994, the Court extended for two weeks the period for filing objections to or accepting the court's order conditionally approving the class action settlement. On February 22, 1994, the Court entered an order in the Robertson litigation, which delayed any final decision on the proposed class action settlement and various motions to modify it (including motions to delete Torchmark from the settlement release), pending certain specified discovery to be completed within 90 days from the date the order was entered. In the order, the Court directed limited additional discovery regarding whether Torchmark had any active involvement in the cancer policy exchanges. Pending completion of limited additional discovery, the Court reserved jurisdiction and extended the deadline for acceptance or rejection of the modifications set forth in the February 4, 1994, Order. On May 6, 1994, the Court entered an order in the Robertson litigation settling a hearing on May 19, 1994, on all outstanding motions in that case.
On May 26, 1994, the Barbour County Court entered an Order and Final Judgment in the Robertson litigation, making final the findings and conclusions of its February 4, 1994 Order. That Order has been accepted by the parties to the action. The discovery regarding the propriety of Torchmark's release by the settlement agreement was concluded prior to the entry of the Order and Final Judgment, and Torchmark was included in the release given on behalf of the class. The $55 million proposed amended settlement charge was provided for in Torchmark's 1993 financial reports.
Purported class action litigation was filed in December 1993, against Liberty in the Circuit Court for Mobile County, Alabama asserting fraud and misrepresentation in connection with exclusionary provisions of accident and hospital accident policies sold to persons holding multiple accident policies (Cofield v. Liberty National Life Insurance Company). A hearing on class -------------------------------------------------- certification in Cofield has been postponed and has not been rescheduled.
In April 1994, the complaint in Miles was amended to add an additional shareholder plaintiff and to name Torchmark as a defendant. A second similar action (Oakley v. Torchmark Corporation) was filed on August 16, 1994 in the ------------------------------- Circuit Court for Bibb County, Alabama, but plaintiff has moved to dismiss that action without prejudice. Thereafter, a third such action was filed in the United States District Court for the Southern District of Alabama (Dismukes v. Torchmark Corporation), all of which seek punitive damages. The --------------------------------- Dismukes case was subsequently transferred to the United States District Court - -------- for the Northern District of Alabama. No class has been certified in any of these cases, all of which seek punitive damages. Torchmark, Liberty and the individual defendants intend to vigorously defend these actions.
Torchmark, its insurance subsidiaries Globe and United American, and certain Torchmark officers were named as defendants in litigation filed April 22, 1994 as a purported class action in the District Court of Oklahoma County, Oklahoma (Moore v. Torchmark Corporation). The suit claims damages on behalf of ------------------------------ individual health policyholders who are alleged to have been induced to terminate such policies and to purchase Medicare Supplement and/or other insurance coverages. The complaint seeks actual and punitive damages for each class member in excess of $10,000. Subsequent to the filing of this case, one of the plaintiffs was dismissed and the named plaintiff died. The complaint has been amended to include
new plaintiffs purporting to represent the class. No class has been certified, however, and a motion to dismiss has been filed by the defendants, who intend to vigorously defend the action.
In July 1994, a purported class action alleging fraudulent and deceitful practices in premium billing and lapses of coverage on a payroll deduction insurance plan was filed in the Superior Court for Gordon County, Georgia against Liberty (Bryant v. Liberty National Life Insurance Company). The ------------------------------------------------- complaint alleges actual damages in excess of $10 million and punitive damages of not less than $50 million as well as premium reimbursements. No class has been certified and no proceedings of any materiality have occurred in this case. Liberty has removed this case to federal court. Additionally, Liberty had filed a declaratory judgment action essentially seeking an accounting in this matter in the U.S. District Court for the Northern District of Georgia on the same day Bryant was filed. Liberty intends to vigorously defend the Bryant ------ ------ action.
In 1978, the United States District Court for the Northern District of Alabama entered a final judgment in Battle v. Liberty National Life Insurance ----------------------------------------- Company, et al., class action litigation involving Liberty, a class composed - -------------- of all owners of funeral homes in Alabama and a class composed of all insureds (Alabama residents only) under burial or vault policies issued, assumed or reinsured by Liberty. The final judgment fixed the rights and obligations of Liberty and the funeral directors authorized to handle Liberty burial and vault policies as well as reforming the benefits available to the policyholders under the policies. It remains in effect to date. A motion was filed to challenge the final judgment under Federal Rule of Civil Procedure 60(b), in February of 1990, but the final judgment was upheld and the Rule 60(b) challenge was rejected by both the District Court and the Eleventh Circuit Court of Appeals.
In November, 1993, an attorney (purporting to represent the funeral director class) filed a petition in the District Court seeking "alternative relief" under the final judgment. The relief sought is unclear, but includes a request that the District Court rule that the final judgment no longer has prospective application. Liberty has filed discovery requests seeking the identity of the funeral directors involved in the petition and information and materials necessary to evaluate the funeral directors' allegations and to clarify the relief sought.
Provision has been made in the financial statements for certain anticipated litigation costs. Based upon information presently available, and in light of legal and other defenses available to Torchmark and its subsidiaries, contingent liabilities arising from threatened and pending litigation are not considered material. It should be noted, however, that the frequency of large punitive damage awards bearing little or no relation to actual damages awarded by juries in jurisdictions in which Torchmark has substantial business, particularly Alabama, continues to increase universally.
Torchmark operates primarily in two industry segments, insurance and asset management. Operations in the insurance industry involve the sale and administration of life insurance, health insurance and annuities. It also includes investment operations related to insurance segment investments. Operations in the asset management industry include the management, distribution, and servicing of various mutual funds, the management of energy properties, the direct ownership of energy properties, and other energy related activities.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) (DOLLAR AMOUNTS IN THOUSANDS EXCEPT PER SHARE DATA) NOTE 17--RELATED PARTY TRANSACTIONS
Investment in Related Parties: Other long-term investments include ------------------------------ investment by Torchmark subsidiaries in the United Group of Mutual Funds and certain other funds for which Waddell & Reed, Inc. is sole advisor. These investments were $24.4 million and $26.2 million at December 31, 1994 and 1993, respectively. Investment income derived from these investments is included in net investment income.