Torchmark, through its subsidiaries, owns or leases buildings that are used in the normal course of business. Liberty owns a 487,000 square foot building at 2001 Third Avenue South, Birmingham, Alabama which currently serves as Liberty's, UILIC's, and Torchmark's home office. Liberty leases approximately 160,000 square feet of this building to unrelated tenants. Liberty also operates from 59 company-owned district office buildings used for agency sales personnel.
United American owns and is the sole occupant of a 140,000 square foot facility, located in the Stonebridge Ranch development in McKinney, Texas (a North Dallas suburb).
Globe owns a 300,000 square foot office building at 204 North Robinson, Oklahoma City, of which Globe occupies 56,000 square feet as its home office and the remaining space is either leased or available for lease. Globe also owns an 80,000 square foot office building at 120 Robert S. Kerr Avenue, Oklahoma City, which is available for lease. Further, Globe owns a 112,000 foot facility located at 133 NW 122 Street in Oklahoma City which houses the Direct Response operation.
Liberty and Globe 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.
2) Changes in governmental regulations (particularly those impacting taxes and changes to the Federal Medicare program that would affect Medicare Supplement insurance);
10) The inability of Torchmark to achieve the anticipated levels of administrative and operational efficiencies;
In the analysis and comparison of Torchmark's operating results with prior periods, two divestitures that occurred in 1998 should be taken into account:
Torchmark has accounted for the spin-off of Waddell & Reed as a disposal of a segment. Accordingly, Torchmark's financial statements for 1998 and all prior periods have been modified to present the net assets and operating results of Waddell & Reed as discontinued operations of the disposed segment. The $54 million expense of the spin-off is included in discontinued operations under the caption "Loss on Disposal." The distribution of the Waddell & Reed shares resulted in a reduction in Torchmark's shareholders' equity in the approximate amount of $174 million, consisting of the equity in Waddell & Reed, net of the 36% minority interest.
2) Torchmark's pro rata share of Vesta Insurance Group's ("Vesta's") adjustment to its equity as a result of the accounting irregularities and earnings restatement reported by Vesta in the second quarter of 1998, amounting to a $13 million loss after tax;
5) The nonrecurring loss from the redemption by Torchmark of its debt in the second quarter of 1998, in the amount of $5 million net of tax.
Net operating income is then further divided into three categories: continuing insurance operations, discontinued operations, and Torchmark's equity in the earnings of Vesta. Continuing insurance operations consists of the operations of Torchmark's insurance subsidiaries and corporate activities. The operations of this group is reflective of Torchmark's operations after the Waddell & Reed spin-off. Discontinued operations include the discontinued asset management activities of Waddell & Reed.
A reconciliation of net operating income from continuing insurance operations to net income on a per diluted share basis is as follows:
Other operating expenses have declined in both 1998 and 1997 from the respective prior year. They declined from $120 million in 1997 to $117 million in 1998. In 1997, expenses declined $6 million or 5%, primarily due to a reduction in litigation expense. As a percentage of revenues, excluding realized gains and losses, other operating expenses declined in each period and were 5.3% in 1998, 5.6% in 1997, and 6.2% in 1996. Other operating expenses consist of insurance administrative expenses and expenses of the parent company. The components of Torchmark's revenues and operations are described in more detail in the discussion of Insurance and Investment segments found on pages 20 through 30 of this report.
The following table is a summary of Torchmark's continuing insurance net operating income. Net underwriting income is defined by Torchmark management as premium income less net policy obligations, commissions, acquisition expenses, and insurance administrative expenses. Excess investment income is defined as tax equivalent net investment income reduced by the interest credited to
Direct Response marketing is conducted through direct mail, co-op mailings, television and consumer magazine advertising, and direct mail solicitations endorsed by groups, unions and associations. It markets a line of primarily life products to juveniles and adults with face amounts of less than $10 thousand on average. The Direct Response operation is a profitable distribution channel for Torchmark characterized by lower acquisition costs than Torchmark's agency-based marketing systems. Direct Response life operations have grown rapidly since the early 1990's when new direct distribution media and target markets were added. Prior to that time, the primary product was a direct mail juvenile life product. In both 1997 and 1998, this distribution center had Torchmark's highest growth in life insurance premium in dollar amount and accounted for over 23% of Torchmark's life insurance premium during 1998. Direct Response premium was $221 million in 1998, increasing 13% over 1997 premium of $195 million. Direct Response life premium in 1997 grew 14% over 1996 premium of $172 million.
Leading the other distribution channels, annualized premium sold by the Direct Response operation was $94 million in 1998, rising 18% over 1997 sales of $79 million. The 1997 sales increased 28% over 1996 sales of $62 million. Direct Response life annualized premium in force rose 12% to $260 million at December 31, 1998 from $233 million a year earlier. At December 31, 1998, Direct Response life annualized premium in force was second only to that of the Liberty National Exclusive Agency. Direct Response life insurance annualized premium in force grew 15% in 1997.
The United American Independent and Exclusive Agencies represented about 6% of total life premium in 1998. On a combined basis, life premium rose 1% to $56 million in 1998. Premium for these agencies increased 12% in 1997 to $55 million.
Health insurance premium increased 3% to $760 million in 1998 over 1997 premium of $739 million. In 1997, health premium rose 1% over 1996 premium. However, 1997 was the first year since 1993 that Torchmark recorded a year- over-year increase in premium for this segment. Annualized health premium in force grew 5% to $797 million at December 31, 1998 over the previous year-end balance of $762 million. Health premium in force rose 2% during 1997. Sales of health premium, in terms of annualized premium issued, were $139 million in 1998, increasing 30% over 1997 sales of $107 million. Sales in 1997 grew 6% over the prior year. Sales of health insurance have accelerated greatly in the past two years due to increases in sales of Medicare Supplement policies. Prior to 1997, Torchmark had not experienced year-over-year sales growth in health insurance for five years.
Health products sold by Torchmark insurance companies include Medicare Supplement, cancer, long-term care, and other under-age-65 limited-benefit supplemental medical and hospitalization products. As a percentage of annualized health premium in force at December 31, 1998, Medicare Supplement accounted for 69%, cancer 18%, and other health products 13%. Medicare Supplement and cancer annualized premium in force was $554 million and $145 million, respectively, at December 31, 1998.
Medicare Supplement insurance is sold primarily by the United American Exclusive Agency and the United American Independent Agency. While health sales in both Agencies have grown in the past three years, sales by the Exclusive Agency exceeded the health sales of the Independent Agency in 1998. This Agency sold $64 million in annualized health premium in 1998, a 62% gain over the prior year. Health sales of $40 million in 1997 rose 26% over 1996 sales. This Agency accounted for $18 million of the $20 million in health premium growth in 1998. It also was instrumental in health annualized premium growth in both 1998 and 1997, accounting for $31 million of the $35 million growth during 1998 in in-force premium and adding $11 million to annualized health premium in force in 1997. One factor in the growth in Medicare Supplement sales in the United American Exclusive Agency is the targeted marketing support provided by the Direct Response operation.
The United American Independent Agency continues to represent the largest amount of Torchmark's health premium in force. The Agency's $426 million of annualized health premium in force at December 31, 1998, of which $399 million was Medicare Supplement premium in force, was 54% of Torchmark's total health premium in force. Medicare Supplement sales by the United American Independent Agency were $38 million in 1998, a 47% increase over 1997. In spite of increased Medicare Supplement sales, Medicare Supplement annualized premium in force for the United American Independent Agency remained level at year-end 1998 compared with year-end 1997. This occurred because recent years' increases in sales resulting in additions to in force policies have been offset by normal lapses occurring in the large, aging block of in force Medicare Supplement policies.
Until recently the primary competition for Medicare Supplement sales had come from Medicare health maintenance organizations (HMO's), the managed care alternative to traditional fee-for-service Medicare which eliminated the need for a supplemental policy. However, in the last few years, growing public dissatisfaction with managed care, increased medical cost inflation and increased federal government regulatory pressures on Medicare HMO's have caused an increasing number of HMO's to withdraw from the market, reducing that competition. Other regulatory issues continue to affect the Medicare Supplement market. Medical cost inflation and changes to the Medicare program cause the need for annual rate increases, which generally require state insurance department approval. In addition, Congress and the Federal Administration have begun studying ways to finance the Medicare program in
Cancer insurance premium in force grew 5% in 1998 to $145 million, compared with 15% growth in 1997. Sales of this product declined 5% from 1997 sales of $11 million to $10 million. Sales in 1996 were also $11 million. Growth in cancer annualized premium in force has been attributable in large part to premium rate increases to offset increased health care costs. Cancer insurance products are sold primarily by the Liberty National Exclusive Agency. This Agency represented 85% of Torchmark's total cancer annualized premium in force at December 31, 1998.
Annualized premium in force for other health products declined 4% in 1998 to $98 million, after declining 2% in 1997. Other health sales declined 15% in 1998 to $26 million. Sales increased in 1997, however, with annualized premium issued rising 26% to $31 million. A large factor in the 1997 sales increase was the increased issue of a limited-benefit hospital-surgical product sold by the United American Independent Agency. With the resurgence of Medicare Supplement sales opportunities, the emphasis of the United American Independent Agency during 1998 returned to Medicare Supplement and less on other health products. As a result, sales and annualized premium in force by this agency of other health products declined as compared with 1997.
Health insurance underwriting income before other income and administrative expense declined 1% in 1998 to $139 million, after having declined 4% in 1997. As a percentage of premium, underwriting income before other income and administrative expense declined 1% in the years 1998 and 1997 from the prior year, respectively. Margins have lagged premium growth because of higher obligation costs. Medicare Supplement margins are restrained by the Federally mandated minimum loss ratio of 65% and by competition. Cancer obligation ratios have increased in each year because of healthcare inflationary pressures. To the extent management is able to obtain timely and adequate premium rate increases from regulatory authorities to offset these cost increases, margins may be stabilized on cancer business. Torchmark continues to seek such rate increases.
Annuity premium is added to the annuity account balance as a deposit and is not reflected in income. Revenues on both fixed and variable annuities are derived from charges to the annuity account balances for insurance risk, administration, and surrender, depending on the structure of the contract. Variable accounts are also charged an investment fee and a sales charge. Torchmark benefits to the extent these policy charges exceed actual costs and to the extent actual investment income exceeds the investment income which is credited to fixed annuity policyholders.
Collections of fixed annuity premium were $65 million in 1998, compared with $77 million in 1997, a decline of 16%. Management believes that the low- interest environment in 1997 and 1998 has been a factor in the reduced sales of fixed annuities, as variable annuities and alternative investments have grown more attractive. Fixed annuity collections were $72 million in 1996. The fixed annuity deposit balance increased 6% in 1998 to $647 million at year end. It rose 7% in the prior period from $572 million at year-end 1996 to $611 million at the end of 1997.
The variable account balance has experienced rapid growth in recent years, rising 31% in 1996 to $1.4 billion at December 31, 1996, 32% in 1997 to $1.8 billion at year-end 1997, and 29% to $2.3 billion at the end of 1998. Strong financial markets in all of these periods contributed greatly to the growth. Variable accounts are valued based on the market values of the underlying securities. The additional collections in each year also added to the balances.
Annuity underwriting income before other income and administrative expense has grown steadily throughout each of the years 1996 through 1998, increasing 22% to $24 million in 1998 and 17% to $19 million in 1997 over the respective prior year. Policy charges have also grown in each period, rising 22% in 1998 to $34 million and 30% in 1997 to $27 million. Growth in policy charges is primarily related to the growth in the size of the account balance, but is also attributable to the increase in the number of annuity contracts in force and the cumulative effect of the growth in sales over the past few years upon which the sales charge is based.
The increases in excess investment income were greater than the growth in net investment income, however. In 1998, excess investment income increased 44% to $206 million. The $63 million increase in 1998 in excess investment income resulted primarily from the proceeds of the Waddell & Reed offering which provided Torchmark with $481 million in additional funds to invest or to apply to outstanding debt. There was also $7 million of interest income on an internal financing with Waddell & Reed included in 1998 income. Also in 1998, Torchmark essentially refinanced $380 million principal amount of its long- term debt with either short-term debt or lower-yielding investments sales, saving an average of 350 basis points in 1998 financing costs. The Family Services disposition had minimal impact on the change in excess investment income. The loss of Family's investment portfolio did result in a loss of net investment income, but this loss was offset by the reduction in required interest caused by the disposition of net policy obligations and the receipt of $140 million in proceeds from the sale which were added to investments.
In 1997, the 21% growth in excess investment income resulted primarily from the greater growth in average invested assets relative to the growth in net policy liabilities. Also, financing costs declined 2% during the period as a result of debt paydowns.
U. S. Treasury rates continued a downward trend in 1998. The rates on corporate and municipal securities did not decline to the same extent as treasuries, resulting in a "spread widening." For this reason, Torchmark was able to continue its fixed-maturity acquisition program relatively unchanged. Excluding Family Service, which was sold during 1998, acquisitions totaled $1.8 billion, compared with $1.7 billion for 1997. New fixed-maturity holdings were acquired at an average yield of 7.13% in 1998, compared with 7.29% for 1997 and 7.12% in 1996. The estimated average maturity of 1998 acquisitions was 20.7 years, compared with 13.3 years in 1997 and 7.8 years in 1996. Torchmark varies the maturities of its new investments based on a number of factors, including the level of rates and the slope of the prevailing yield curve in order to maximize investment value and return.
Fixed maturity investments continued to represent 91% of investment assets at year-end 1998, which causes the percentage holdings of other type investments to vary from industry averages. The following table presents Torchmark's components of invested assets compared with the latest industry data:
- -------- (1) Latest data available from the American Council of Life Insurance.
Market risk is managed in a manner consistent with Torchmark's investment objectives. Torchmark seeks to maintain a portfolio of high-quality fixed- maturity assets that may be sold in response to changing market conditions. A significant change in the level of interest rates, changes in credit quality of individual securities, or changes in the relative values of a security or asset sector are the primary factors that influence such sales. Occasionally, the need to raise cash for various operating commitments may also necessitate the sale of a security. Volatility in the value of Torchmark's fixed-income holdings is reduced by maintaining a relatively short-term portfolio, of which 63% matures within ten years. Also, the portfolio and market conditions are constantly evaluated for appropriate action.
No derivative instruments are used to manage Torchmark's exposure to market risk in the investment portfolio. A swap instrument was entered into to allow Torchmark to participate in the downward trend in interest rates in connection with its MIPS as discussed in the Notes to the Consolidated Financial Statement on page 63 of this report and in Capital Resources on page 32 of this report. A cap instrument was also entered into to protect Torchmark from the market risk on an increase in rates associated with the swap on this security.
The liability for Torchmark's insurance policy obligations is computed using interest assumptions, some of which are contractually guaranteed. A reduction in market interest rates of a permanent nature could cause investment return to fall below amounts guaranteed. Torchmark's insurance companies participate in the cash flow testing procedures imposed by statutory insurance regulations, the purpose of which is to insure that such liabilities are adequate to meet the company's obligations under a variety of interest rate scenarios. It has been determined from those procedures that Torchmark's insurance policy liabilities, when considered in light of the assets held with respect to such liabilities and the investment income expected to be received on such assets, are adequate to meet the obligations and expenses of Torchmark's insurance activities in all but the most extreme circumstances.
Liquidity. Liquidity pertains to an institution's ability to meet on demand the cash commitments required by its business operations and financial obligations. Torchmark is highly liquid, as evidenced by its three sources of liquidity: its positive cash flow from operations, its portfolio of marketable securities, and its line of credit facility.
Liquidity of the parent company is affected by the ability of the subsidiaries to pay dividends. Dividends are paid by subsidiaries to the parent in order to meet its dividend payments on common and preferred stock, interest and principal repayment requirements on parent-company debt, and operating expenses of the parent company. Dividends from insurance subsidiaries of Torchmark are limited to the greater of statutory net gain from operations, excluding capital gains and losses, on an annual noncumulative basis or 10% of surplus, in the absence of special approval, and distributions are not permitted in excess of statutory net worth. Subsidiaries are also subject to certain minimum capital requirements. Although these restrictions exist, dividend availability from subsidiaries has been and is expected to be more than adequate for parent- company operations. During 1999, a maximum amount of $258 million will be available to Torchmark from insurance subsidiaries without regulatory approval.
Torchmark reduced its shareholder cash dividend paid in the fourth quarter of 1998 to $.13 per share from $.15 paid in the previous four quarters. The fourth quarter 1998 dividend was paid prior to the spin-off of Waddell & Reed. Because the dividend Waddell & Reed pays on its shares represents approximately $.04 per Torchmark share, Torchmark's quarterly dividend is expected to be $.09 per share each quarter in 1999.
Torchmark resumed its share buyback program in November, 1998 after completion of the Waddell & Reed spin-off. Purchases of 3.4 million shares were made on the open market during November and December of 1998 at a cost of $126 million. Funds for these purchases were derived primarily from the sale of investments. During 1997, Torchmark acquired 5.2 million shares at a cost of $183 million. Share purchases of 4.6 million shares were made in 1996 for $107 million. Torchmark will continue to make share purchases under its share repurchase program on the open market when prices are attractive. Share purchases have a favorable impact on earnings per share and return on equity, but negatively affect book value per share.
Short-term debt consists primarily of Torchmark's commercial paper outstanding but also includes the current maturity of long-term debt. The commercial paper balance outstanding at December 31, 1998 was $355 million at carrying value, compared with a balance of $139 million a year earlier. As previously noted, Torchmark essentially refinanced $360 million face amount of funded debt with additional short-term borrowings. These borrowings were offset somewhat by the use of $82 million in Waddell & Reed offering
Shareholders' equity increased 17% to $2.26 billion at December 31, 1998, over December 31, 1997 shareholders' equity of $1.93 billion. Growth in shareholders' equity was greatly impacted by the Waddell & Reed offering and spin-off in 1998. Proceeds from the March, 1998 offering added $516 million to Torchmark's shareholders' equity, but equity was reduced by $90 million of minority interest at the time of the offering representing the 36% of Waddell & Reed that Torchmark no longer owned. Additionally, the November, 1998 spin- off caused a reduction in Torchmark's equity of $174 million, representing its carrying value of Waddell & Reed at the time of the spin. Book value per share was $16.51 at 1998 year end, compared with $13.80 at year-end 1997. After adjusting for the impact on shareholders' equity for security value fluctuations due to changes in interest rates in financial markets, book value per share was $15.43 at year-end 1998, an increase of 20% over $12.90 at year- end 1997. Return on common shareholders' equity was 15.1% in 1998, compared with 18.2% in 1997. The return on equity ratios exclude the mark up or down of shareholders' equity for changes in security values caused by fluctuations in market interest rates. They also exclude all discontinued operations, equity in earnings of Vesta, and realized investment gains and losses.
During the fourth quarter of 1998, Torchmark announced it had entered into an agreement to sell approximately 1.8 million shares of Vesta common stock to an unaffiliated insurance carrier for $7.42 a share. In its fourth quarter Form 10Q, Torchmark reported its intent to sell its remaining Vesta shares and vacate the two Vesta board seats it occupied. In view of the pending transaction, Torchmark adjusted the carrying value of its holdings in Vesta to estimated net realizable value of $45 million, effective September 30, 1998. The adjustment produced an after-lax realized loss of $24 million or $.17 per Torchmark diluted share. Torchmark further reported that because of the agreement to sell the Vesta shares, the resulting writedown, and the vacating of the board seats, that Torchmark planned to discontinue equity-method accounting in accordance with accounting standards.
Subsequent to Vesta's June, 1998 announcement involving the accounting irregularities and the financial restatements, Torchmark recorded its equity in Vesta's earnings in the quarter that Vesta reported those earnings. As a result, Torchmark's equity in Vesta's reported earnings during 1998, including the restatements, was a pretax loss of $27 million. Torchmark carried Vesta at a value of $32 million at December 31, 1998.
Disposal of Energy Segment. On September 30, 1996, Torchmark completed the sale of its energy business segment including its energy asset management subsidiary, Torch Energy Advisors Incorporated ("TEAI"), and its Black Warrior coalbed methane investment. These operations, which were classified as discontinued operations in Torchmark's financial statements during the period prior to the sale, were sold to a TEAI management group. After the sale, Torchmark had no controlling ownership interest in any energy asset management organization.
Year 2000 Compliance. The new millennium poses a significant concern to all businesses which use computer systems or electronic data in their operations. This concern arises because these
2) Torchmark is verifying the Year 2000 compliance status of its financial business partners' computer and data communications systems to insure readiness, including data interface testing with third parties; and
Year 2000 contingency plans are being developed for critical risk areas. Management throughout the organization has established and documented a contingency plan for Torchmark's most critical systems and interfaces with business partners within each individual's responsibility. Such contingency plans include possible manual operation efforts, staff adjustments, outside services, and alternative procedures. These contingency plans will be maintained well into 2000.
Accounting for Derivative Instruments and Hedging Activities (FASB Statement No. 133) is effective for all fiscal quarters of all fiscal years beginning after June 15, 1999, with earlier application of all of the provisions of this statement encouraged. Early adoption of selective provisions is prohibited. Prior periods may not be restated for comparability.
This statement establishes standards for the accounting and reporting of derivative instruments. It requires that all derivatives be recognized as assets or liabilities on the balance sheet and be measured at fair value. Changes in the values of derivatives for the reporting period are reflected as adjustments to earnings through realized gains and losses. If certain conditions are met, a derivative may be designated as a hedge against exposure to market risks of other instruments or commitments, cash flow risks, or foreign currency risks. If a derivative is classified as a hedge, the adjustment to earnings is offset by a corresponding change in the value of the item hedged. Hedging relationships may be designated anew upon adoption of this statement.
Statement 133 will have minimal impact on Torchmark's financial statements. Torchmark has negligible investments in derivative instruments, which are currently valued at fair value in its financial statements. Torchmark's use of derivatives for hedging purposes is very limited.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Torchmark Corporation and subsidiaries as of December 31, 1998 and 1997, and the results of their operations and their cash flows for each of the years in the three- year period ended December 31, 1998, 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.
Birmingham, Alabama January 29, 1999 except for Note 17 which is as of February 10, 1999
TORCHMARK CORPORATION CONSOLIDATED STATEMENT OF OPERATIONS--(Continued) (Amounts in thousands except per share data)
TORCHMARK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars amounts in thousands except per share data)
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.
Property and Equipment: Property and equipment is reported at cost less allowances for depreciation. Depreciation is recorded primarily on the straight line method over the estimated useful lives of these assets which range from two to ten years for equipment and two to forty years for buildings and improvements. Ordinary maintenance and repairs are charged to income as incurred.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) (Dollar amounts in thousands except per share data) Note 1--Significant Accounting Policies (continued)
Earnings Per Share: Torchmark adopted SFAS 128, "Earnings per share," effective year end 1997. This standard requires the dual presentation of basic and diluted earnings per share ("EPS") on the face of the income statement and a reconciliation of basic EPS to diluted EPS. As required by SFAS 128, all prior-period EPS data has been restated for comparability. Basic EPS is computed by dividing income available to common stockholders by the weighted average common shares outstanding for the period. Weighted average common shares outstanding for each period are as follows: 1998--139,998,671, 1997-- 139,202,354, 1996--142,459,783. Diluted EPS is calculated by adding to shares outstanding the additional net effect of potentially dilutive securities or contracts which could be exercised or converted into common shares. Weighted average diluted shares outstanding for each period are as follows: 1998-- 141,351,912, 1997--141,431,156, 1996--143,783,218.
During 1998, Liberty National Life Insurance Company paid an extraordinary dividend to Torchmark in the amount of $213 million.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) (Dollar amounts in thousands except per share data) Note 3--Investment Operations (continued)
A summary of fixed maturities available for sale and equity securities by amortized cost and estimated market value at December 31, 1998 and 1997 is as follows:
A schedule of fixed maturities by contractual maturity at December 31, 1998 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.
Proceeds from sales of fixed maturities available for sale were $758 million in 1998, $745 million in 1997, and $487 million in 1996. Gross gains realized on those sales were $6.1 million in 1998, $1.3 million in 1997, and $8.7 million in 1996. Gross losses were $20.1 million in 1998, $32.2 million in 1997, and $5.3 million in 1996.
Note 5--Deferred Acquisition Costs and Value of Insurance Purchased An analysis of deferred acquisition costs and the value of insurance purchased is as follows:
Torchmark has accounted for the spin-off of Waddell & Reed as a disposal of a segment. Accordingly, Torchmark's financial statements for 1998 and all prior periods have been modified to present the net assets and operating results of Waddell & Reed as discontinued operations of the disposed segment. The $54 million expense of the spin-off is included in discontinued operations under the caption "Loss on Disposal." The distribution of the Waddell & Reed shares resulted in a reduction in Torchmark's shareholders' equity in the approximate amount of $174 million, consisting of the equity in Waddell & Reed net of the 36% minority Interest.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) (Dollar amounts in thousands except per share data) Note 9--Future Policy Benefit Reserves
A summary of the assumptions used in determining the liability for future policy benefits at December 31, 1998 is as follows:
For individual health, the morbidity assumptions are based on either Torchmark's experience or the assumptions used in calculating statutory reserves.
The overall average interest assumption for determining the liability for future life and health insurance benefits in 1998 was 6.2%.
In 1998, 1997, and 1996, deferred income tax expense was incurred because of certain differences between net operating income before income taxes as reported on the consolidated statement of operations and taxable income as reported on Torchmark's income tax returns. As explained in Note 1, these differences caused the financial statement book values of some assets and liabilities to be different from their respective tax bases.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) (Dollar amounts in thousands except per share data) Note 12--Postretirement Benefits
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 $7.2 million and $5.0 million at December 31, 1998 and 1997, respectively. The plans covering the majority of employees 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 excess benefit pension plan provides the benefits that an employee would have otherwise received from a defined benefit pension plan in the absence of the Internal Revenue Code's limitation on benefits payable under a qualified plan. Although this plan is unfunded, pension cost is determined in a similar manner as for the funded plans. Liability for the excess benefit plan was $4.7 million and $5.4 million as of December 31, 1998 and 1997, respectively.
The weighted average assumed discount rates used in determining the actuarial benefit obligations was 7.0% in 1998 and 7.5% in 1997. The rate of assumed compensation increase was 4.0% in 1998 and 4.5% in 1997 while the expected long-term rate of return on plan assets was 9.22% in 1998 and 9.25% in 1997.
The components of net periodic postretirement benefit cost other than pensions is as follows:
The following table presents a reconciliation of the benefit obligation and plan assets from the beginning to the end of the year, also reconciling the funded status to the accrued benefit liability.
For measurement purposes, a 7.0% to 8.0% annual rate of increase in per capita cost of covered healthcare benefits was assumed for 1998. These rates grade to ranges of 4.5% to 5.5% by the year 2007. The health care cost trend rate assumption has a significant effect on the amounts reported, as illustrated in the following table which presents the effect of a one- percentage-point increase and decrease on the service and interest cost components and the benefit obligation:
The amount of debt that becomes due during each of the next five years is: 1999, $355,392, and 2000-2003, $0.
The 9 5/8% Senior Notes matured on May 1, 1998. The principal amount of $200 million with accrued interest was repaid from additional commercial paper borrowings.
The Notes, due May 15, 2023, were issued in May, 1993 in the principal amount of $200 million. Proceeds of the issue, net of issue costs, were $196 million. Interest is payable on May 15 and November 15 of each year at a rate of 7 7/8%. In October, 1998, $10.8 million principal amount were purchased in the open market at a cost of $10.6 million. These notes are not redeemable prior to maturity and have equal priority with other Torchmark unsecured indebtedness.
Torchmark has entered into a revolving credit agreement with a group of lenders under which it may borrow on an unsecured basis up to $600 million. The commitment matures October 22, 2002. Borrowings are at interest rates selected by Torchmark based on either the corporate base rate or the Eurodollar rate at the time of borrowings. At December 31, 1998 and December 31, 1997 there were no borrowings under the revolving credit agreement. The revolving credit agreement is also designed to back up a commercial paper program. The short-term borrowings under the revolving credit agreements and in the commercial paper market averaged $287 million during 1998, and were made at an average yield of 5.58%. At December 31, 1998, commercial paper was outstanding in the face amount of $357 million. Torchmark is subject to certain covenants for the revolving credit agreements regarding capitalization and earnings, for which it was in compliance at December 31, 1998, and pays a facility fee based on size of the line.
Interest in the amount of $2.4 million, $1.7 million, and $1.4 million was capitalized during 1998, 1997, and 1996, respectively.
Earnings Per Share: A reconciliation of basic and diluted weighted-average shares outstanding, in accordance with SFAS 128, is as follows:
Certain employees and directors have been granted options to buy shares of Torchmark stock generally at the market value of the stock on the date of grant under the provisions of the Torchmark Corporation 1987 Stock Incentive Plan ("1987 Option Plan"). The options are exercisable during the period commencing from the date they vest until expiring ten years or ten years and two days after grant. Employee stock options granted under the 1987 Option Plan generally vest one-half in two years and one-half in three years. Director grants generally vest in six months. A grant in September, 1997 vested immediately. Deferred executive and director grants vest over ten years. Torchmark generally issues shares for the exercise of stock options out of treasury stock.
Insurance affiliates also assume insurance risks of other companies. Life reinsurance assumed represents 2.5% of life insurance in force at December 31, 1998 and reinsurance assumed on life and accident and health products represents 1.8% of premium income for 1998.
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 $3.2 million in each of the years 1998, 1997, and 1996. Future minimum rental commitments required under operating leases having remaining noncancelable lease terms in excess of one year at December 31, 1998 are as follows: 1999, $2.0 million; 2000, $1.3 million; 2001, $639 thousand; 2002, $397 thousand; 2003, $197 thousand; and in the aggregate, $4.5 million.
As previously reported, Liberty has been subject to 76 individual cancer policy lawsuits pending in Alabama and Mississippi, which were stayed or otherwise held in abeyance pending final resolution of Robertson v. Liberty National Life Insurance Company (Case No. CV-92-021). Liberty filed motions to dismiss these lawsuits based upon the U.S. Supreme Court opinion issued in Robertson in March 1997. Only two of these individual cancer policy lawsuits remain, the other such suits having been dismissed.
It has been previously reported that Torchmark, its subsidiaries United American and Globe and certain individual corporate officers are parties to purported class action litigation filed in April, 1996 in the U.S. District Court for the Northern District of Georgia (Crichlow v. Torchmark Corporation, Case No. 4:96-CV-0086-HLM) involving certain hospital and surgical insurance policies issued by Globe and United American. In September 1997, the U.S. District Court entered an order granting summary judgment against the plaintiffs on certain issues and denying national class certification, although indicating that plaintiffs could move for the certification of a state class of Georgia policyholders. Discovery then proceeded on the remaining claims for breach of contract and the duty of good faith arising from closure of the block of business and certain post-claim matters as well as fraud and conspiracy relating to pricing and delay in implementing rate increases. On June 17, 1998, the U.S. District Court entered an order which denied the plaintiffs' motion to certify a Georgia policyholders class, denied reconsideration of the previously entered motion for summary judgment on certain issues, denied reconsideration of the denial of national certification of a class of policyholders and severed and transferred claims of Mississippi policyholders to the U.S. District Court for the Northern District of Mississippi (Greco v. Torchmark Corporation, Case No. 1:98CV196-D-D). The U.S. District Court granted defendants' motion for summary judgment on all remaining issues in Crichlow on February 4, 1999. Plaintiffs in Greco have moved to certify a class of persons purchasing Globe hospital and surgical insurance policies in Mississippi. On February 1, 1999, defendants filed a motion for summary judgment in Greco.
Purported class action litigation was filed on January 2, 1996 against Torchmark, Torch Energy Advisors Incorporated, and certain Torch Energy subsidiaries and affiliated limited partnerships in the Circuit Court of Pickens County, Alabama (Pearson v. Torchmark Corporation, Case No. CV-95- 140). Plaintiff alleges improper payment of royalties and overriding royalties on coalbed methane gas produced and sold from wells in Robinson's Bend Coal Degasification Field, seeks certification of a class and claims unspecified compensatory and punitive damages on behalf of such class. On April 11, 1996, Torchmark's motion to change venue was granted and the case has been transferred to the Circuit Court of Tuscaloosa County, Alabama. Torchmark's motion to dismiss remains pending while discovery is proceeding. On February 10, 1999, the plaintiffs filed a request for a class certification hearing and to set a trial date for the Pearson case.
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. This petition was voluntarily withdrawn on November 8, 1995 by petitioners. On February 23, 1996, Liberty filed a petition with the District Court requesting that it order certain contract funeral directors to comply with their obligations under the Final Judgment in Battle and their funeral service contracts. A petition was filed on April 8, 1996 on behalf of a group of funeral directors seeking to modify the 1978 decree in Battle in light of changed economic circumstances. All parties made extensive submissions to the District Court and a hearing on the opposing petitions was held by the District Court on February 9, 1999.
Note 17--Commitments and Contingencies (continued) verdict to $0, thus reducing the total verdict to $11 million (including an advisory verdict of $3.2 million in front pay awards). Additional revised front pay submissions were made by the plaintiffs to the District Court in December 1998 and Liberty responded thereto in January 1999. Liberty is awaiting the entry of a final judgment in the Hipp case and thereafter will pursue all available post trial and appellate relief.
Assets for each segment are reported based on a specific identification basis. The insurance segments' assets contain deferred acquisition costs, value of insurance purchased, and separate account assets. The investment segment includes the investment portfolio, cash, and accrued investment income. Goodwill is assigned to corporate operations. All other assets, representing less than 2% of total assets, are included in the other category. The table below reconciles segment assets to total assets as reported in the financial statements.
During the fourth quarter of 1998, Torchmark announced it had entered into an agreement to sell approximately 1.8 million shares of Vesta common stock to an unaffiliated insurance carrier for $7.42 a share. In its fourth quarter Form 10Q, Torchmark reported its intent to sell its remaining Vesta shares and vacate the two Vesta board seats it occupied. In view of the pending transaction, Torchmark adjusted the carrying value of its holdings in Vesta to estimated net realizable value of $45 million, effective September 30, 1998. The adjustment produced an after-lax realized loss of $24 million or $.17 per Torchmark diluted share.
Subsequent to Vesta's June, 1998 announcement involving the accounting irregularities and the financial restatements, Torchmark recorded its equity in Vesta's earnings in the quarter that Vesta reported those earnings. As a result, Torchmark's equity in Vesta's reported earnings during 1998, including the restatements, was a pretax loss of $27 million. Torchmark carried Vesta at a value of $32 million at December 31, 1998, reflecting the previously taken writedown.
Torchmark leases office space to Vesta. Total rental income received from Vesta was $857 thousand, $585 thousand, and $508 thousand, for the years ended December 31, 1998, 1997 and 1996, respectively.