Globe leases a 30,300 square foot office area in the City Place Tower building located in downtown Oklahoma City, Oklahoma. Globe also leases 11,000 square feet at a nearby facility used for storage. Globe Marketing Services, a subsidiary of Globe, owns a 133,000 square foot facility in Oklahoma City which houses the Globe direct response operation.
At December 31, 2012, cash and invested assets included $615 million, total assets included $869 million, annualized life premium in force included $949 thousand, and annualized health premium in force included $188 million, representing the business acquired in the acquisition of Family Heritage in 2012.
(3) There is an accounting rule (ASC 320-10-35-1) requiring available-for-sale fixed maturities to be revalued at fair value each period. The effect of this rule on diluted equity per share reflects the amount added or (deducted) under this rule to produce GAAP Shareholders’ equity per share. Please see the explanation and discussion under the caption Capital Resources in Management’s Discussion and Analysis in this report concerning the effect this rule has on Torchmark’s equity.
(4) Outstanding shares and per share amounts have been retrospectively adjusted for the three-for-two-stock split effective July 1, 2014.
How Torchmark Views Its Operations: Torchmark is the holding company for a group of insurance companies which market primarily individual life and supplemental health insurance, and to a limited extent annuities, to middle income households throughout the United States. We view our operations by segments, which are the insurance product lines of life, health, Medicare Part D, and annuities, and the investment segment that supports the product lines. Segments are aligned based on their common characteristics, comparability of the profit margins, and management techniques used to operate each segment. As described in Note 14-Business Segments in the Notes to Consolidated Financial Statements, we reorganized our segment structure to separate our Medicare Part D health insurance business from our other health insurance activities as a stand-alone segment, because management determined that Part D meets the criteria of a distinct segment under accounting guidance. Prior period results have been retrospectively adjusted for comparability.
** See the discussion of Realized Gains and Losses in this report.
Summary of Operations: Net income was $543 million in 2014, compared with $528 million in 2013. Net income declined slightly in 2013 from $529 million in 2012. On a diluted per share basis, 2014 net income rose 8% to $4.09 after a 5% increase in 2013. Net income per diluted share in 2013 rose to $3.79 from $3.60 in 2012. The per-share results have exceeded the growth in dollar amounts due to our share repurchase program. Also, each year’s per share net income was affected by realized investment gains, which were $0.12, $0.03, and $0.17 in 2014, 2013 and 2012, respectively. More information concerning realized investment gains and losses can be found under the caption Realized Gains and Losses in this report where there is a more complete discussion. Also, as explained in Note 14-Business Segments in the Notes to the Consolidated Financial Statements, we do not consider realized gains and losses to be a component of our core insurance operations or operating segments. Additionally, we do not consider non-operating items which are not related to the current ongoing reporting performance of our segments as indicated in the chart above to be part of our segment operating income.
Life insurance premium and underwriting margins have grown steadily in each of the three years ending December 31. The increase in life premium was driven by sales growth and improvements in persistency. While premium and underwriting margins grew, margin as a percent of premium fell slightly in 2014 to 28%, after increasing from 28% to 29% from 2012 to 2013. These fluctuations were due primarily to changes in mortality. Net life sales increased 12% in 2014 to $378 million after decreasing 1% in 2013. The life insurance segment is discussed further in this report under the caption Life Insurance.
We also market Medicare Part D prescription drug insurance. Our Medicare Part D premium rose 16% in 2014 to $348 million, compared with $300 million in 2013 and $318 million in 2012. The higher premiums in both 2014 and 2012 were due to higher levels of low-income auto-enrollees in our plans for those years. Due to increased competition in the 2013 plan year, we experienced a decrease in 2013 Part D premium. Medicare Part D margins were negatively impacted in 2014, however, by several factors, including two high cost Hepatitis C drugs, the coverage of which was mandated by the Center for Medicare and Medicaid Services (CMS) in early 2014, well after our 2014 pricing was finalized, new taxes under the Affordable Care Act, and other higher drug costs due to rebate restructuring. As a percentage of premium, margins fell from 12% in 2013 to 8% in 2014. For the 2015 plan year, we will have a significantly lower number of auto-enrollees which should reduce our exposure to Hepatitis C drug claims, because approximately 85% of these claims in 2014 were related to auto-enrollees. For more information on our Medicare Part D business, please refer to our discussion under the caption Medicare Part D.
Index to Financial Statements We do not currently market annuities. See the caption Annuities for discussion of the Annuity segment.
The interest required on net policy liabilities is deducted from net investment income, and generally grows in conjunction with the net policy liabilities that are supported by the invested assets. The lower new-money yields resulting from the low-interest-rate environment noted above have compressed excess investment income as required interest has continued to grow at approximately the same rate that net policy liabilities have grown. We have implemented certain strategies to offset this effect, including increasing premium rates on sales of new products as discussed under the caption Investments. Financing costs, which consist of the interest required for debt service on our long and short-term debt, are also deducted from net investment income. Financing costs in 2013 were stable at $80 million, but declined 5% in 2014. The 2014 decline resulted from the maturity and repayment in 2013 of our $94.5 million principal amount 7 3/8% Notes.
In each of the years 2012 through 2014, net income was affected by certain significant, unusual, and nonrecurring nonoperating items. We do not view these items as components of core operating results because they are not indicative of past performance or future prospects of the insurance operations. As reported in Note 1-Significant Accounting Policies in the Notes to Consolidated Financial Statements
Option proceeds were unusually high in 2012 due to option holders exercising several years of option grants that expired in 2012.
Index to Financial Statements The table below discloses first-year collected life premium by distribution channel.
The Direct Response Unit offers adult and juvenile life insurance through a variety of direct-to-consumer marketing approaches, which include direct mailings, insert media, and electronic media. These different approaches support and complement one another in the unit’s efforts to reach the consumer. The Direct Response Unit’s growth has been fueled by constant innovation. In recent years, electronic media production has grown rapidly as management has aggressively increased marketing activities related to internet and mobile technology, and has focused on driving traffic to the inbound call center.
The Direct Response operation accounted for 36% of our life insurance premium during 2014, increasing 6% over 2013 premium. Life premium for this unit rose 5% in 2013 and 6% in 2012. Net sales rose 10% to $158 million in 2014 after a 2% increase in 2013, due to growth in electronic media activity. First-year collected premium increased 8% to $100 million in 2014 and was flat in 2013 compared to 2012. The average face amount of policies issued in 2014 was approximately $17 thousand.
Index to Financial Statements The Liberty National Exclusive Agency markets individual and group life insurance to middle-income customers. Life premium income for this agency was $272 million in 2014, a 1% decrease compared with $276 million in 2013. Life premium declined 2% in 2013 from 2012. First year collected premium increased 1% in 2014, however, after having declined 4% in 2013. The average face amount of life policies issued in 2014 was approximately $23 thousand.
The Liberty National Agency’s net sales rose 11% to $34 million in 2014, after having declined 4% a year earlier. The increase in net sales during 2014 marks the first increase in several years, reflecting changes in structure of the agency that management has put in place in recent years. As is the case with all of our agencies, sales are driven by the size of the agent force. The Liberty agency had 1,498 producing agents at December 31, 2014 compared with 1,430 a year earlier, an increase of 5%. The producing agent count increased 1% during 2013 from 1,419. The average agent count for 2014 was 1,505. Agent counts declined during the fourth quarter of 2014 as the agency focused somewhat less on recruiting, due to the increased emphasis on annual worksite renewals.
Our long term plans to grow this agency involve expansion from small-town markets in the southeast to more densely populated areas with larger pools of potential agent recruits and customers. We believe that expansion of this Agency’s presence into more heavily populated, less-penetrated areas will help create long term agency growth. Additionally, a prospecting training program has helped to improve the ability of agents to develop new worksite marketing business.
We also offer life insurance through Other Agencies consisting of the Military Agency, the United American Independent Agency, and other small sales agencies. The Military Agency consists of a nationwide independent agency whose sales force is comprised primarily of former military officers who sell primarily to commissioned and noncommissioned military officers and their families. This business consists of whole-life products with term insurance riders. Military premium represented 9% of life premium at December 31, 2014. The United American Independent Agency represented approximately 1% of Torchmark’s total life premium at that date, as their sales of Torchmark products consist primarily of health insurance.
The addition of Family Heritage’s sales and premium from limited-benefit products has resulted in limited-benefit health premium exceeding Medicare Supplement premium income in 2013 for the first time in several years and continuing to lead in premium in 2014. However, due to increased Medicare Supplement group sales, Medicare Supplement net sales exceeded limited-benefit net sales in 2014. Limited-benefit premium represented 51% of total health premium in 2014 and 52% in 2013, but represented 41% in 2012. However, as noted above, Medicare Supplement sales rose 139% to $106
million in 2014 due to the high group sales, which represented 59% of net health sales in 2014. Medicare Supplement sales were 40% of the total in 2013 and 59% in 2012. As mentioned previously, group Medicare Supplement sales fluctuate significantly from period to period.
We do not expect recent health care reform activity to have a significant impact on our operations. We don’t sell any products subject to the Affordable Care Act, and don’t believe that consumer demand for the types of supplemental health products we sell will be diminished. While we will be subject to certain federal taxes on a small portion of our existing health business going forward, we don’t expect the amount of these taxes to be material.
The American Income Exclusive Agency, predominantly a life insurance distribution channel, was our fourth largest health insurance distributor based on premium income in 2014. Its health plans are comprised of various limited-benefit plans. Approximately 68% of the agency’s 2014 health premium was from accident policies. Sales of the plans by this Agency are generally made in conjunction with a life policy being sold to the same customer.
Total Medicare Part D premium was $348 million in 2014, compared with $300 million in 2013 and $318 million in 2012. Part D net sales were $186 million in 2014, compared with $79 million in 2013 and $114 million in 2012. The unusual increase in 2014 net sales was due to the addition in 2014 of the auto-enrollees as noted below. We count only sales to new first-time enrollees in net sales, and the majority of premium income is from previous enrollees. Total enrollees in the program were 269 thousand at the beginning of the 2014 plan year, 254 thousand at the beginning of the 2013 plan year, and 215 thousand at the beginning of the 2012 plan year.
Total enrollees in the program were 249 thousand at the beginning of the 2015 plan year, compared with 269 thousand in 2014. We expect that Part D margins will be flat to slightly lower in 2015, based on a preliminary analysis of the risk scores and claims history of our 2015 enrollees.
We participate in the Medicare Part D program because it complements our Medicare Supplement products, it provides us with incremental income, we have extensive experience with the senior-age market, and the government assurances with regard to the risk-sharing agreements for participating insurers limit our risk. Additionally, due to our experience with service to the senior-age market and the use of our existing Direct Response marketing system, entry to this business required little new investment. However, as with any government-sponsored program, the possibility of regulatory changes could change the outlook for this market.
Annuities. Our fixed annuity balances at the end of 2014, 2013, and 2012 were $1.36 billion, $1.38 billion, and $1.35 billion, respectively. Underwriting income was $4.3 million, $3.9 million, and $3.5 million in each of the respective years.
Insurance administrative expenses rose 1% in 2014, after having increased 8% in 2013. As a percentage of premium, they increased .1% in 2013 to 5.9%, but declined .3% in 2014 to 5.6%. The inclusion of Family Heritage’s administrative expenses accounted for $8.1 million of the $13.5 million increase in total administrative expense in 2013. Non-salary employee costs increased 19% in 2013 but fell back 16% in 2014, close to 2012 levels. These fluctuations were caused in large part by adjustments to pension expenses primarily due to changes in interest rates in the financial markets. Stock compensation expense has risen in each successive year as the value of Torchmark stock has increased, resulting in higher values for grants of stock and options, as well as positive Company performance that caused an increase in the expense related to performance share grants. As stated in Note 14-Business Segments in the Notes to Consolidated Financial Statements, management views stock compensation expense as a corporate expense, and therefore treats it as a Parent Company expense.
(3) Per share amounts for 2013 and 2012 have been retrospectively adjusted for the three-for-two stock split effective July 1, 2014.
Presented in the following chart is the growth in net investment income compared with the growth in mean invested assets.
Index to Financial Statements Excess investment income is also impacted by financing costs. Financing costs for the investment segment primarily consist of interest on our various debt instruments and are deducted from excess investment income.
Financing costs decreased $4 million or 5% in 2014. They were essentially flat in 2013. The decrease in financing costs in 2014 was due to the maturity and repayment of our $94 million par amount $7.375% Notes during the third quarter of 2013. The increase in financing costs in 2013 reflects the increased interest expense from the issuance in September, 2012 of $300 million principal amount of our 3.8% Senior Notes due in 2022, $150 million of which is eliminated in consolidation. Also in September, 2012, we issued our 5.875% Junior Subordinated Debentures due 2052 for $125 million principal amount but called our $120 million 7.1% Trust Preferred Securities one month later. In both 2014 and 2013, interest on short-term debt declined primarily because of the reduction in the weighted-average interest rate on short-term debt. More information on our debt transactions are disclosed in the Financial Condition section of this report and in Note 11-Debt in the Notes to Consolidated Financial Statements.
As previously noted, growth rates in our excess investment income decline when growth in income from the portfolio is less than that of the interest required by policy liabilities and financing costs, such as we have experienced in recent periods. In an extended low-interest-rate environment, the portfolio yield will tend to decline as we invest new money at lower long-term rates. We believe, however, the decline would be relatively slow, as, on average, only 1% to 2% of fixed maturities are expected to run off each year over the next five years.
Excess investment income benefits from increases in long-term rates available on new investments and decreases in short-term borrowing rates. Of these two factors, higher investment rates have the greater impact because the amount of cash that we invest is significantly greater than the amount that we borrow at short-term rates. Therefore, Torchmark would benefit if rates, especially long-term rates, were to rise.
Index to Financial Statements Investment Acquisitions. Torchmark’s current investment policy calls for investing almost exclusively in investment-grade fixed maturities generally with long maturities (maturity date more than 20 years after acquisition date) that meet our quality and yield objectives. We generally prefer to invest in securities with longer maturities because they more closely match the long-term nature of our policy liabilities. Further, we believe this strategy is appropriate because our strong positive cash flows are generally stable and predictable. If such longer-term securities do not meet our quality and yield objectives, we consider investing in short-term securities, taking into consideration the slope of the yield curve and other factors at the time. During calendar years 2012 through 2014, Torchmark invested almost exclusively in fixed-maturity securities, primarily with longer-term maturities as presented in the chart below.
During the three years 2012 through 2014, we have invested almost entirely in investment-grade corporate bonds. Acquisitions in all three years have been primarily in industrial and utility bonds. New cash flow available for investment has been primarily provided through our insurance operations, but has also been affected by other factors. Issuer calls, as a result of the low-interest environment experienced during the past three years were an important factor, especially in 2012. Calls increase funds available for investment, but as noted earlier in this discussion, they can have a negative impact on investment income if the proceeds from the calls are reinvested in bonds that have lower yields than that of the bonds that were called. Issuer calls were $160 million in 2014, $344 million in 2013, and $650 million in 2012. The higher level of acquisitions in 2012 was primarily due to the additional funds available from the higher level of 2012 calls.
At December 31, 2014, fixed maturities had a fair value of $14.5 billion, compared with $12.9 billion at December 31, 2013. At December 31, 2014, fixed maturities were in a $1.7 billion net unrealized gain position compared with an unrealized gain position of $390 million at December 31, 2013. Approximately 82% of our fixed maturity assets at December 31, 2014 at amortized cost were corporate bonds and 4% were redeemable preferred stocks. This compares with 81% corporate bonds and 4% redeemable preferred stocks at year end 2013. On a combined basis, residential mortgage-backed securities, other asset-backed securities, and collateralized debt obligations (CDOs) were 1% of the assets at amortized cost at December 31, 2014. The $68 million of CDOs at amortized cost made up less than 0.6% of the assets and are backed primarily by trust preferred securities issued by banks and insurance companies. The $6 million of residential mortgage-backed securities are rated AAA. For more information about our fixed-maturity portfolio by component at December 31, 2014 and 2013, including an analysis of unrealized investment losses and a schedule of maturities, see Note 4-Investments in the Notes to Consolidated Financial Statements.
Due to the strong and stable cash flows generated by its insurance products, Torchmark has the ability to hold securities with temporary unrealized losses until recovery. Even though these fixed maturity investments are classified as available for sale, Torchmark generally expects and intends to hold to maturity any securities which are temporarily impaired.
At December 31, 2014, approximately 24% of the fixed maturity assets at amortized cost (25% at fair value) were in the financial sector, including 14% in life and health or property casualty insurance companies and 5% in banks. Financial guarantors, mortgage insurers, and insurance brokers comprised approximately 5% of the portfolio at amortized cost. After financials, the next largest sector was utilities, which comprised 17% of the portfolio at amortized cost. The balance of the portfolio is spread among 396 issuers in a wide variety of sectors.
Our current investment policy regarding fixed maturities is to acquire only investment-grade obligations. Thus, any increases in below investment-grade issues are a result of ratings downgrades of existing holdings.
The following table illustrates the market risk sensitivity of our interest-rate sensitive fixed-maturity portfolio at December 31, 2014 and 2013. This table measures the effect of a change in interest rates (as represented by the U.S. Treasury curve) on the fair value of the fixed-maturity portfolio. The data measures the change in fair value arising from an immediate and sustained change in interest rates in increments of 100 basis points.
Investments are occasionally sold or called, resulting in a realized gain or loss. These gains and losses generally occur only incidentally, usually as the result of sales because of deterioration in investment quality of issuers or calls by the issuers. Investment losses are also caused by writedowns due to impairments. We do not engage in trading investments for profit. Therefore, gains or losses which occur in protecting the portfolio or its yield, or which result from events that are beyond our control, are only secondary to our core insurance operations of providing insurance coverage to policyholders.
The following table summarizes our tax-effected realized gains (losses) by component for each of the years in the three-year period ended December 31, 2014.
As described in Note 4-Investments under the caption Other-than-temporary impairments in the Notes to Consolidated Financial Statements, we wrote certain securities down to fair value during 2012 as a result of other-than-temporary impairment. The impaired securities met our criteria for other-than-temporary impairment as discussed in Note 1-Significant Accounting Policies and in our Critical Accounting Policies in this report. The writedowns resulted in pretax charges of $5.6 million in 2012 ($3.6 million after tax). During 2013, we sold investment real estate for an after-tax loss of $1.9 million, of which $1.7 million had been written down due to other-than-temporary impairment earlier in the year. In 2012, we redeemed our 7.1% Trust Originated Preferred Securities, recording a loss on redemption of $4.1 million ($2.7 million after tax).
In summary, Torchmark expects to have readily available funds for 2015 and the foreseeable future to conduct its operations and to maintain target capital ratios in the insurance subsidiaries through internally generated cash flow and the credit facility. In the unlikely event that more liquidity is needed, the Company could generate additional funds through multiple sources including, but not limited to, the issuance of additional debt, a short-term credit facility, and intercompany borrowing.
of scheduled maturities or repayments during 2014. Maturities, tenders, and calls totaled $494 million in 2013 and $737 million in 2012.
Our cash and short-term investments were $82 million at year-end 2014 and $114 million at year-end 2013. Additionally, we have a portfolio of marketable fixed and equity securities that are available for sale in the event of an unexpected need. These securities had a fair value of $14.5 billion at December 31, 2014. However, our strong cash flows from operations, investment maturities, and the availability of our credit line make any need to sell securities for liquidity unlikely.
Index to Financial Statements Capital Resources. Torchmark’s capital structure consists of short-term debt (the commercial paper facility described in Note 11-Debt in the Notes to Consolidated Financial Statements), long-term funded debt, and shareholders’ equity. A complete analysis and description of long-term debt issues outstanding is presented in Note 11.
The carrying value of the long-term funded debt was $992 million at December 31, 2014, compared with $991 million a year earlier. As fully explained in Note 11-Debt, we issued $300 million principal amount of 3.8% Senior Notes due in 2022 in September, 2012 for proceeds of $297 million in a public offering. However, $150 million of the offering was acquired by Torchmark insurance subsidiaries and was eliminated in consolidation, resulting in net proceeds after issue expenses to the consolidated group of $147 million. The majority of the $297 million proceeds received by the Parent were used to acquire Family Heritage as described in Note 6-Acquisition. The balance was invested and later used for the redemption of our $94.5 million principal amount 7 3/8% Notes that matured on August 1, 2013 and for other corporate purposes. The principal balance of the 7 3/8% Notes, along with accrued interest, was then repaid on its maturity date in the total amount of $97.5 million.
As noted under the caption Summary of Operations in this report, we have an ongoing share repurchase program. Under this program, we acquired 7 million shares at a cost of $375 million in 2014, 8 million shares at a cost of $360 million in 2013, and 11 million shares for $360 million in 2012. The majority of purchased shares are retired each year. Please refer to the description of our share repurchase program under the caption Summary of Operations in this report.
Shareholders’ equity was $4.7 billion at December 31, 2014, compared with $3.8 billion at December 31, 2013. During the twelve months since December 31, 2013, shareholders’ equity was reduced by the $375 million in share purchases under the repurchase program and another $74 million to offset the dilution from stock option exercises. However, it was increased by $827 million of after-tax unrealized gains in the fixed maturity portfolio and by the $543 million of net income.
We plan to use excess cash available at the Parent Company as efficiently as possible in the future. Possible uses of excess cash flow include, but are not limited to share repurchases, acquisitions, increases in shareholder dividends, investment in fixed maturities, or repayment of short-term debt. We will determine the best use of excess cash after ensuring that desired capital levels are maintained in our companies.
FASB guidance provides for an option which, if elected, would permit us to value our interest-bearing policy liabilities and debt at fair value in our Consolidated Balance Sheets. However, unlike the accounting rule which permits us to account for changes in our available-for-sale bond portfolio through other comprehensive income, the guidance requires such changes to be recorded in earnings. Because
Torchmark’s ratio of earnings before interest and taxes to interest requirements (times interest earned) was 11.2 times in 2014, compared with 10.5 times in 2013 and 2012. This times-interest-earned ratio is computed by dividing interest expense into the sum of pre-tax income from continuing operations and interest expense. A discussion of our interest expense is included in the discussion of financing costs under the caption Investments in this report.
In August 2014, S&P updated its outlook on Torchmark’s capital position to a negative outlook. The revised outlook was due to a change in S&P’s view of certain internal components of Torchmark’s existing capital position rather than a change in the capital position itself. Management believes Torchmark’s regulatory capital position is currently as strong as it has been for many years and we expect our consolidated RBC ratio to remain at least 325% going forward. While we are currently evaluating multiple options to address S&P’s comments, we do not anticipate any change in our share repurchase program as a result of S&P’s action.
The remaining 1% of deferred acquisition costs pertain to deposit business for which deferred acquisition costs are amortized over the estimated lives of the contracts in proportion to actual and estimated future gross profits. These contracts are not subject to lock-in. The assumptions must be updated when actual experience or other evidence suggests that earlier estimates should be revised. Revisions related to our deposit business assets have not had a material impact on the amortization of deferred acquisition costs during the three years ended December 31, 2014.
Defined benefit pension plans. We maintain funded defined benefit plans covering most full-time employees. We also have unfunded nonqualified defined benefit plans covering certain key and other employees. Our obligations under these plans are determined actuarially based on specified actuarial assumptions. In accordance with GAAP, an expense is recorded each year as these pension obligations grow due to the increase in the service period of employees and the interest cost associated with the passage of time. These obligations are offset, at least in part, by the growth in value of the assets in the funded plans. At December 31, 2014, our gross liability under these funded plans was $403 million, but was offset by assets of $323 million.
The actuarial assumptions used in determining our obligations for pensions include employee mortality and turnover, retirement age, the expected return on plan assets, projected salary increases, and the discount rate at which future obligations could be settled. These assumptions have an important effect on the pension obligation. A decrease in the discount rate or rate of return on plan assets will cause an increase in the pension obligation. A decrease in projected salary increases will cause a decrease in this obligation. Small changes in assumptions may cause significant differences in reported results for these plans. For example, a sensitivity analysis is presented below for the impact of change in the
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Torchmark’s internal control over financial reporting as of December 31, 2014, based on the criteria established in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 27, 2015 expressed an unqualified opinion on Torchmark’s internal control over financial reporting.
* Per share amounts have been retrospectively adjusted for the stock split described in Note 1.
* Dollar and per share amounts have been retrospectively adjusted to give effect to the stock split described in Note 1.
Torchmark accounts for its variable interest entities (VIE’s) under accounting guidance which clarifies the definition of a variable interest and the instructions for consolidating VIE’s. Only primary beneficiaries are required or allowed to consolidate VIE’s. Therefore, a company may have voting control of a VIE, but if it is not the primary beneficiary of the VIE, it is not permitted to consolidate the VIE. The trust that was liable for Torchmark’s 7.1% Trust Preferred Securities that were redeemed in October, 2012 met the definition of a VIE. However, Torchmark was not the primary beneficiary of this entity because its interest was not variable. Therefore, Torchmark was not permitted to consolidate its interest, even though it owned 100% of the voting equity of the trust and guaranteed its performance. For this reason, Torchmark reported its 7.1% Junior Subordinated Debentures due to the trust as “Due to affiliates” each period at its carrying value. However, Torchmark viewed the Trust Preferred Securities as it does any other debt offering and consolidated the trust in its segment analysis because GAAP requires that the segment analysis be reported as management views its operations and financial condition. More information about the redemption of these securities is disclosed in Note 11-Debt.
When a component of Torchmark’s business is sold or expected to be sold during the ensuing year, Torchmark reports the assets and liabilities of the component as assets and liabilities of subsidiaries held for sale. Assets or liabilities of subsidiaries held for sale are segregated and are recorded in the Consolidated Balance Sheets at the lower of the carrying amount or estimated fair value less cost to sell. If the carrying amount of the business exceeds its estimated fair value, a loss is recognized. Torchmark reports the results of operations of a business as discontinued operations when the component is sold or
Gains and losses realized on the disposition of investments are determined on a specific identification basis. Income attributable to investments is included in Torchmark’s net investment income. Net investment income and realized investment gains and losses are not allocated to insurance policyholders’ liabilities.
Level 3 - fair values are based on inputs that are considered unobservable where there is little, if any, market activity for the asset or liability as of the measurement date. In this circumstance, the Company has to rely on values derived by independent brokers or internally-developed assumptions. Unobservable inputs are developed based on the best information available to the Company which may include the Company’s own data or bid and ask prices in the dealer market.
corroborated prices produce small variations, the close correlation indicates observable inputs, and the mean value is used. When corroborated prices present greater variations, additional analysis is required to determine which value is the most appropriate. When only one price is available, management evaluates observable inputs and performs additional analysis to confirm that the price is appropriate. All fair value measurements based on prices determined with observable market data are reported as Level 1 or Level 2 measurements.
The fair values for each class of security and by valuation hierarchy level are indicated in Note 4-Investments under the caption Fair value measurements.
charged to other comprehensive income. The credit loss portion of an impairment is determined as the difference between the security’s amortized cost and the present value of expected future cash flows discounted at the security’s original effective yield rate. The temporary portion is the difference between this present value of expected future cash flows and fair value (as discounted by a market yield). The expected cash flows are determined using judgment and the best information available to the Company. Inputs used to derive expected cash flows include expected default rates, current levels of subordination, and loan-to-collateral value ratios. Management believes that the present value of future cash flows at the original effective yield is a better measure of valuation, because fair value determined by a discounted market yield is often based on limited observable market data, and the market for these securities is generally neither active nor orderly.
Recognition of Premium Revenue and Related Expenses: Premium income for traditional long-duration life and health insurance products is recognized when due from the policyholder. Premiums for short-duration health contracts are recognized as revenue over the contract period in proportion to the insurance protection provided. Profits for limited-payment life insurance contracts are recognized over the contract period. Premiums for universal life-type and annuity contracts are added to the policy account value, and revenues for such products are recognized as charges to the policy account value for mortality, administration, and surrenders (retrospective deposit method). Life premium includes policy charges of $21 million, $22 million, and $23 million for the years ended December 31, 2014, 2013, and 2012, respectively. Other premium consists of annuity policy charges in each year. Profits are also earned to the extent that investment income exceeds policy liability interest 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.
Low-Income Housing Tax Credit Interests: As of December 31, 2014, Torchmark had $318 million invested in limited partnerships that provide low-income housing tax credits and other related Federal income tax and state premium tax benefits to Torchmark. The carrying value of Torchmark’s investment in these entities was $290 million at December 31, 2013. As of December 31, 2014, Torchmark was obligated under future commitments of $76 million, which is included in the above carrying value. Interests for which the return has been guaranteed by unrelated third-parties are accounted for using the effective-yield method. The remaining interests are accounted for using the amortized-cost method.
As described later in this note, under the caption Unadopted Accounting Policies, Torchmark will adopt new accounting guidance concerning its interests in low-income housing beginning in 2015. The new guidance will result in accounting for these items in a manner more consistent with the Company’s segment analysis.
Torchmark has tested its goodwill annually in each of the years 2012 through 2014. These tests, performed in the second quarter each year, involved assigning carrying value by allocating the Company’s net assets to each of the reporting units of Torchmark’s segments, including the portion of
goodwill assigned to the unit. In 2012, the qualitative assessment was employed as permitted by accounting guidance. Based on the analyses as outlined in the guidance, it was determined that an impairment of goodwill was not likely. In both 2014 and 2013, the fair values of the various reporting units were developed. The fair value of each reporting unit was determined using discounted expected cash flows associated with that unit. Judgment and assumptions are used in developing the projected cash flows for the reporting units, and such estimates are subject to change. The Company also exercises judgment in the determination of the discount rate, which management believes to be appropriate for the risk associated with the cash flow expectations. The fair value of each reporting unit is then measured against that reporting unit’s corresponding carrying value. Because the estimated fair value substantially exceeded the carrying value, including goodwill, of each reporting unit in each period, Torchmark’s goodwill was not impaired in any of those periods.
The expected term is generally derived from Company experience. However, expected terms are determined based on the simplified method as permitted by Staff Accounting Bulletins 107 and 110 when company experience is insufficient. The Torchmark Corporation 2011 Incentive Plan replaced all previous plans and allows for option grants with a ten-year contractual term which vest over five years in addition to seven-year grants which vest over three years as permitted by the previous plans. The Company has sufficient experience with seven-year grants that vest in three years, but insufficient historical experience with five-year vesting. Therefore, Torchmark has used the simplified method to determine the expected term for the ten-year grants with five-year vesting and will do so until adequate experience is developed. Volatility and risk-free interest rates are assumed over a period of time consistent with the expected term of the option. Volatility is measured on a historical basis. Monthly data points are utilized to derive volatility for periods greater than three years. Expected dividend yield is based on current dividend yield held constant over the expected term. Once the fair value of an option has been determined, it is amortized on a straight-line basis over the employee’s service period for that grant (from the grant date to the date the grant is fully vested). Expenses for restricted stock and restricted stock units are based on the grant-date fair value allocated on a straight-line basis over the service period. Performance share expense is recognized based on management’s estimate of the probability of meeting the metrics identified in the performance share award agreement, assigned to each service period as these estimates develop.
Stock Split: Torchmark declared a three-for-two stock split paid in the form of a 50% stock dividend on all of the Company’s outstanding common stock, having a record date of June 2, 2014. On July 1, 2014, the payment date, holders of Torchmark common stock received one additional share of stock for every two shares held. Upon completion of the transaction, Torchmark had 139,218,183 shares issued at a par value of $1 per share and 131,031,843 shares outstanding after giving effect to the purchase of $26 thousand in fractional shares on July 1, 2014. Shareholders’ equity component amounts as of December 31, 2013 were retrospectively adjusted to reflect this stock dividend. All share and per share amounts have been adjusted to reflect this stock split for all periods presented in these consolidated financial statements.
Low-income housing tax credits: The FASB has issued new accounting guidance, Investments-Equity Method and Joint Ventures: Accounting for Investments in Qualified Affordable Housing Projects (ASU 2014-01). This accounting guidance replaces the effective yield method of accounting with respect to investments in qualified affordable housing projects and, if certain conditions are present, provides for a new method of accounting. The new method of accounting allows an investor to amortize the cost of its investment based on the proportion of the tax credits/benefits received during the year to the total expected tax credits/benefits to be received over the life of the investment and will be recognized in the Consolidated Statements of Operations as a component of “Income tax expense.” Additional disclosures are required concerning investments in qualified affordable housing.
Share-based performance awards: New accounting guidance has also been issued pertaining to share awards with performance targets. This standard, entitled Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could be Achieved After the Requisite Service Period (ASU 2014-12), is effective for Torchmark beginning in calendar year 2016, with early adoption permitted. The new guidance provides that the Company must take into account the
performance target in the recognition of compensation expense once the achievement of the performance target is probable. Torchmark has a limited number of such awards, but currently accounts for these items consistent with the new guidance. Therefore, no material impact is expected from adoption.
An analysis in the change in balance by component of Accumulated Other Comprehensive Income is as follows for the twelve months ended December 31, 2014 and 2013.
Reclassifications out of Accumulated Other Comprehensive Income are presented below for the twelve months ended December 31, 2014 and 2013.
Other-than-temporary impairments: Torchmark has determined that certain of its holdings in fixed maturity investments were other-than-temporarily impaired during the three years ended December 31, 2014. The following table presents the writedowns recorded due to these impairments in accordance with accounting guidance and whether the writedown was charged to earnings or other comprehensive income.
Unrealized gains/loss analysis: In 2013, increases in interest rates in financial markets caused the net unrealized gain balances to decline to $390 million at December 31, 2013 from $1.6 billion a year earlier. During 2014, interest rates declined resulting in an increase in net unrealized gains at December 31, 2014 to $1.7 billion. At December 31, 2014, investments in securities in the financial sector were in a $460 million net unrealized gain position. These investments in the financial sector represented 24% of the portfolio at amortized cost and 25% at fair value. This is compared with a net unrealized gain position of $180 million at the end of the prior year. Investments and securities in the other sectors had net unrealized gains of $1.2 billion at year end 2014 and $210 million at year end 2013. The following tables disclose gross unrealized investment losses by class of investment at December 31, 2014 and December 31, 2013 for the respective periods of time in a loss position. Torchmark considers these investments to be only temporarily impaired.
Torchmark’s entire fixed-maturity and equity portfolio consisted of 1,604 issues at December 31, 2014 and 1,619 issues at December 31, 2013. The weighted-average quality rating of all unrealized loss positions as of December 31, 2014 was BBB+, compared with BBB+ a year earlier. The weighted-average quality ratings are based on amortized cost.
The table below presents supplemental unaudited pro forma information for 2012 as if the Family Heritage acquisition were completed on January 1, 2011, based on estimates and assumptions considered appropriate:
The supplemental unaudited pro forma information above is presented for informational purposes only and is not necessarily indicative of the results of operations that actually would have been achieved had the acquisition been consummated at that time, nor is it intended to be a projection of future results.
Torchmark and its subsidiaries, excluding Family Heritage, file a life-nonlife consolidated Federal income tax return. Family Heritage files its Federal income tax return on a separate company basis. Torchmark’s consolidated Federal income tax returns are routinely audited by the Internal Revenue Service (IRS). The IRS completed its examination of Torchmark’s 2008-2011 consolidated income tax returns during 2014 resulting in no impact on the company’s effective tax rate. The statutes of limitations for the assessment of additional tax are closed for all tax years prior to 2011 with respect to Torchmark’s consolidated and Family Heritage’s Federal income tax returns. Management believes that adequate provision has been made in the consolidated financial statements for any potential assessments that may result from current or future tax examinations and other tax-related matters for all open years.
Torchmark has net operating loss carryforwards of approximately $8.7 million at December 31, 2014 which will begin to expire in 2032 if not otherwise used to offset future taxable income. A valuation allowance is to be provided when it is more likely than not that deferred tax assets will not be realized by the Company. No valuation allowance has been recorded relating to Torchmark’s deferred tax assets since, in management’s judgment, Torchmark will more likely than not have sufficient taxable income in future periods to fully realize its existing deferred tax assets.
Torchmark accrues expense for the defined contribution plans based on a percentage of the employees’ contributions. The plans are funded by the employee contributions and a Torchmark contribution equal to the amount of accrued expense. Plan contributions are both mandatory and discretionary, depending on the terms of the plan.
Cost for the defined benefit pension plans has been calculated on the projected unit credit actuarial cost method. All plan measurements for the defined benefit plans are as of December 31 of the respective year. The defined benefit pension plans covering the majority of employees are funded. Contributions are made to funded pension plans subject to minimums required by regulation and maximums allowed for tax purposes. Defined benefit plan contributions were $14.6 million in 2014, $10.3 million in 2013, and $8.2 million in 2012. Torchmark estimates as of December 31, 2014 that it will contribute an amount not to exceed $20 million to these plans in 2015. The actual amount of contribution may be different from this estimate.
The Company has another small supplemental benefit pension plan which is limited to a very select group of employees and was closed as of December 31, 1994. It provides the full benefits that an employee would have otherwise received from a defined benefit plan in the absence of the limitation on benefits payable under a qualified plan. This plan is unfunded. Liability for this closed plan was $3 million at December 31, 2014 and December 31, 2013. Pension cost for both supplemental defined benefit plans is determined in the same manner as for the qualified defined benefit plans.
Plan assets in the funded plans consist primarily of investments in marketable fixed maturities and equity securities and are valued at fair value. Torchmark measures the fair value of its financial assets, including the assets in its benefit plans, in accordance with accounting guidance which establishes a hierarchy for asset values and provides a methodology for the measurement of value. Please refer to
Allowed investments are limited to equities, fixed maturities, and short-term investments (invested cash). There is also a guaranteed annuity contract issued by American Income Life Insurance Company to fund the obligations of the American Income Pension Plan. The assets are to be invested in a mix of equity and fixed income investments that best serve the objectives of the pension plan. Factors to be considered in determining the asset mix include funded status, annual pension expense, annual pension contributions, and balance sheet liability. Equities include common and preferred stocks, securities convertible into equities, mutual funds that invest in equities, and other equity-related investments. Equities must be listed on major exchanges and adequate market liquidity is required. Fixed maturities consist of marketable debt securities rated investment grade at purchase by a major rating agency. Short-term investments include fixed maturities with maturities less than one year and invested cash. Short-term investments in commercial paper must be rated at least A-2 by Standard & Poor’s with the issuer rated investment grade. Invested cash is limited to banks rated A or higher. Investments outside of the aforementioned list are not permitted, except by prior approval of the Plan’s Trustees. At December 31, 2014, there were no restricted investments contained in the portfolio. Plan contributions have been invested primarily in equity securities during the three years ended December 31, 2014.
An analysis of the impact on other comprehensive income (loss) concerning pensions and other postretirement benefits is as follows:
Includes amortization of postretirement benefits other than pensions of $2 thousand in 2014, $224 thousand in 2013, and $0 in 2012.
The accumulated benefit obligation (ABO) for Torchmark’s funded defined benefit pension plans was $374 million and $295 million at December 31, 2014 and 2013, respectively. In the unfunded plans, the ABO was $63 million and $52 million at December 31, 2014 and 2013, respectively.
Torchmark has estimated its expected pension benefits to be paid over the next ten years as of December 31, 2014. These estimates use the same assumptions that measure the benefit obligation at December 31, 2014, taking estimated future employee service into account. Those estimated benefits are as follows:
In 2014, Torchmark’s receivables increased $164 million, reducing cash flows from operations. Of this amount, $154 million was due primarily to collections to be received in 2015 under the federal governments’ Medicare Part D risk-sharing and pass-through agreements, as well as contracted rebates from Part D drug providers.
The amount of debt that becomes due during each of the next five years is: 2015-$238 million; 2016-$250 million; 2017-$0; 2018-$0; 2019-$293 million; and thereafter-$461 million.
Funded debt: On September 24, 2012, Torchmark issued $300 million principal amount of 3.80% Senior Notes due 2022. Interest on the Senior Notes are payable semi-annually. As part of the offering, two of Torchmark’s insurance subsidiaries acquired a combined amount of $150 million par value of the Senior Notes. Proceeds from the issuance of this debt, net of underwriters’ discount and expenses, were $147 million with total proceeds to the Parent Company of approximately $297 million. The Senior Notes are redeemable by Torchmark in whole or in part at any time subject to a “make-whole” premium, whereby the Company would be required to pay the greater of the full principal amount of the notes or otherwise the present value of the remaining payment schedule of the notes discounted at a rate of interest equivalent to the rate of a United States Treasury security of comparable term plus a spread of 30 basis points. Torchmark used a portion of the net proceeds from the new Senior Note offering to fund the acquisition of Family Heritage as described in Note 6 - Acquisition. The Parent Company used the remaining proceeds to repay its $94 million principal amount 7 3/8% Notes that matured on August 1, 2013.
Additionally, on September 24, 2012, Torchmark completed the public offering of its 5.875% Junior Subordinated Debentures due 2052 for an aggregate principal amount of $125 million. Proceeds from this offering were $121 million, net of underwriters’ discount and issue expenses. These debentures pay interest quarterly. The securities are redeemable on December 15, 2052, and are first callable in whole or in part by Torchmark on or after December 15, 2017. Expenses of $4.2 million related to the offering have been netted against long-term debt and will be amortized over the forty-year redemption period. Net proceeds were used to fund the redemption of Torchmark’s 7.1% Trust Preferred Securities discussed below.
Acquisition of Common Shares: Torchmark shares are acquired from time to time through open market purchases under the Torchmark stock repurchase program when it is believed to be the best use of Torchmark’s excess cash flows. Share repurchases under this program were 7.2 million shares at a cost of $375 million in 2014, 8.3 million shares at a cost of $360 million in 2013, and 11.2 million shares at a cost of $360 million in 2012. When stock options are exercised, proceeds from the exercises are generally used to repurchase approximately the number of shares available with those funds in order to reduce dilution. Shares repurchased for dilution purposes were 1.4 million shares at a cost of $74 million in 2014, 2.8 million shares at a cost of $122 million in 2013, and 6.4 million shares at a cost of $210 million in 2012.
Retirement of Treasury Stock: Torchmark retired 17.0 million shares of treasury stock in 2014, 7.5 million in 2013, and 9.8 million in 2012.
million will be available to the parent in 2015. Please refer to Schedule II. Condensed Financial Information of Registrant for more information about Torchmark’s transactions with its subsidiaries. While there are no legal restrictions on the payment of dividends to shareholders from Torchmark’s retained earnings, retained earnings as of December 31, 2014 were restricted by lenders’ covenants which require the Company to maintain and not distribute $2.6 billion from its total consolidated retained earnings of $3.4 billion.
As disclosed in Note 1-Significant Accounting Policies, Torchmark recorded a three-for-two stock split, effective as of July 1, 2014. As a result, share and per share data in this Note have been retrospectively adjusted to give effect to this split. During 2014, shareholders approved an amendment to the 2011 Incentive Plan allowing for an additional 6.3 million shares available for grant.
An analysis of option activity for each of the three years ended December 31, 2014 is as follows:
* Estimated additional share grants expected due to achievement of performance criteria.
The following table summarizes information about stock options outstanding at December 31, 2014.
No equity awards were cash settled during the three years ended December 31, 2014.
Torchmark’s reportable segments are based on the insurance product lines it markets and administers: life insurance, health insurance, Medicare Part D, and annuities. These major product lines are set out as reportable segments because of the common characteristics of products within these categories, comparability of margins, and the similarity in regulatory environment and management techniques. There is also an investment segment which manages the investment portfolio, debt, and cash flow for the insurance segments and the corporate function. Torchmark’s chief operating decision maker evaluates the overall performance of the operations of the Company in accordance with these segments.
Because of the nature of the life insurance industry, Torchmark has no individual or group which would be considered a major customer. Substantially all of Torchmark’s business is conducted in the United States.
During 2014, Torchmark accrued for certain litigation matters in the net amount of $3.7 million ($2.4 million after tax) that were not directly related to its insurance operations. Additionally, Torchmark received $1.3 million ($853 thousand after tax) in settlement of litigation regarding investments. Also in 2014, the Company recorded $8.2 million in administrative settlements ($5.3 million after tax) related to benefits paid for deaths occurring in prior years where claims had not been filed. These administrative settlements were included in “Policyholder benefits” in the Consolidated Statements of Operations in 2014. During 2013, Torchmark incurred four non-operating charges: (1) a state guaranty fund assessment in the amount of $1.2 million ($751 thousand after tax), resulting from events in years prior to 2012, (2) a legal settlement related to a non-insurance matter in the amount of $500 thousand ($325 thousand after tax), (3) the settlement of a litigation matter related to prior years in the amount of $8.6 million ($5.6 million after tax) and (4) a one-time adjustment related to the finalization of accounting for the acquisition of the insurance assets and liabilities of Family Heritage. The Family Heritage acquisition closed on November 1, 2012. This adjustment increased after-tax earnings in the amount of $522 thousand. Management removes items that are related to prior periods when evaluating the operating results of current periods. Management also removes non-operating items unrelated to its core insurance activities when evaluating those results. Therefore, these items are excluded in its presentation of segment results, because accounting guidance requires that operating segment results be presented as management views its business. With the exception of the administrative settlements in the paragraph above, all of these items are included in “Other operating expense” in the Consolidated Statements of Operations for the appropriate year.
Amortization of low-income housing expense, considered a component of income tax expense in the segment analysis.
Medicare Part D items adjusted to GAAP from the segment analysis, which matches expected benefits with policy premium.
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 $2.0 million per life. Life insurance ceded represented less than .1% of total life insurance in force at December 31, 2014. Insurance ceded on life and accident and health products represented .2% of premium income for 2014. 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.
Insurance affiliates also assume insurance risks of other companies. Life reinsurance assumed represented 2.2% of life insurance in force at December 31, 2014 and reinsurance assumed on life and accident and health products represented .8% of premium income for 2014.
Leases: Torchmark leases office space and office equipment under a variety of operating lease arrangements. Rental expense for operating leases was $4.2 million in 2014, $4.1 million in 2013, and $3.6 million in 2012. Future minimum rental commitments required under operating leases having remaining noncancelable lease terms in excess of one year at December 31, 2014 were as follows: 2015, $9 million; 2016, $8 million; 2017, $7 million; 2018, $4 million; 2019, $4 million and in the aggregate, $46 million.
Concentrations of Credit Risk: Torchmark maintains a diversified investment portfolio with limited concentration in any given issuer. At December 31, 2014, the investment portfolio, at fair value, consisted of the following:
Letters of Credit: Torchmark has guaranteed letters of credit in connection with its credit facility with a group of banks as disclosed in Note 11. The letters of credit were issued by TMK Re, Ltd., a wholly-owned subsidiary, to secure TMK Re, Ltd.’s obligation for claims on certain policies reinsured by TMK Re, Ltd. that were sold by other Torchmark insurance companies. These letters of credit facilitate TMK Re, Ltd.’s ability to reinsure the business of Torchmark’s insurance carriers. The agreement expires in 2019. The maximum amount of letters of credit available is $250 million. Torchmark (parent company) would be liable to the extent that TMK Re, Ltd. does not pay the reinsured party. At December 31, 2014, $198 million of letters of credit were outstanding.
Equipment leases: Torchmark has guaranteed performance of certain subsidiaries as lessees under three leasing arrangements, two for aviation equipment and the other for computer software and other furniture and equipment. One aviation lease expires in August, 2022, and the second expires in September, 2024. The other lease expires in December, 2017. At December 31, 2014, total remaining undiscounted payments under the leases were approximately $23 million. Torchmark (parent company) would be responsible for any subsidiary obligation in the event the subsidiary did not make payments or otherwise perform under the terms of the lease.
Per share amounts have been retrospectively adjusted for the stock split effective July 1, 2014. Basic and diluted net income per share by quarter may not add to per share income on a year-to-date basis due to share weighting and rounding.