A subsidiary of Globe owns a 112,000 square foot facility located in Oklahoma City, Oklahoma which houses the Globe direct response operation. During 2008, Globe sold two office buildings located in Oklahoma City. The first was a 300,000 square foot building in which Globe previously occupied 56,000 square feet as its home office with the remainder either leased or available for lease. After the sale, Globe continued to occupy 37,000 square feet under a lease expiring in April, 2011. The other sold building was vacant, and consisted of 80,000 square feet.
(1) Includes 7 3/4% Junior Subordinated Debentures reported as “Due to affiliates” on the Consolidated Balance Sheet at year end 2005 in the amount of $154.6 million. Also included at year ends 2006 through 2009 are Torchmark’s 7.1% Junior Subordinated Debentures in the amount of $123.7 million, which are also reported as “Due to affiliates” on the Consolidated Balance Sheets.
We market three primary health insurance products: under-age-65 limited-benefit health insurance, Medicare Supplement insurance, and the Medicare Part D prescription drug benefit. Health premium declined 10% in 2009 to $1.02 billion from $1.13 billion in 2008. Health premium declined 9% in 2008. The primary factor in the decreases in both years was the decline in agent count in our United American Branch Office during the year, our largest health producer. This agency has experienced intense competition, which has resulted in a significant decrease in new health sales and has negatively impacted premium income. This agency had historically focused on sales of our limited-benefit health product, as demand for this product had increased. Accordingly, premium from the limited-benefit product grew significantly in relation to Medicare Supplement premium in recent years. However, with the decline in the size of this Agency beginning in 2007, premium for the limited-benefit product has declined. Medicare Supplement remains our largest contributor to total health premium, but increased competition has also dampened sales of this product, resulting in premium declines in each successive year. It should be noted, however, that net sales for Medicare Supplement insurance rose in 2009 for the first time in several years. This was a result of the increase in group Medical Supplement sales. We also offer Medicare Part D insurance. As most of the country’s Part D enrollees selected a plan provider in 2006, we do not expect significant growth in our Part D business going forward. See the discussion under Health Insurance for a more detailed discussion of health insurance results.
As previously mentioned, the investment segment’s pretax profitability, or excess investment income, increased $4 million in 2008 but declined $31 million in 2009. Profitability in this segment is based on three major components: net investment income, required interest on net policy liabilities (interest applicable to and assigned to insurance products), and financing costs. In recent years, growth in net investment income has been restricted in relation to the growth in the size of our portfolio. One of the primary reasons that investment income has grown at a lower rate than mean invested assets has grown in recent years is that new investments have been made at yield rates lower than the yield rates earned on securities that matured or were otherwise disposed of. Another factor that has contributed to the relatively slower growth rate of investment income is the time lag between the date proceeds from maturities and dispositions are received and the date such proceeds are reinvested. During these lags, we have held cash at lower yields. Among the most important factors contributing to the relatively lower growth rate in investment income during 2009 is the fact that, due primarily to uncertainty about liquidity in the financial markets, we held significantly more cash and short term investments during 2009 than we did during 2008 and 2007. Additionally, in 2009, we sold a significant portion of higher-yielding but lower-rated fixed maturities and reinvested the proceeds in lower-yielding but higher-rated bonds in 2009 to improve our risk-adjusted return. This also contributed to reduced net investment income. The interest required on net policy liabilities is deducted from net investment income, and generally grows in conjunction with the insurance policy reserves that are supported by the invested assets. Financing costs, which consist of the interest required for debt service on our long and short-term debt, are also deducted from excess investment income. In 2009, interest expense
Torchmark’s current investment policy limits new investment acquisitions to investment-grade fixed maturities generally with longer maturities (often exceeding twenty years) that meet our quality and yield objectives. Approximately 92% of our invested assets at fair value consists of fixed maturities of which 94% was investment grade at December 31, 2009. The average quality rating of the portfolio was BBB+. The portfolio contains no securities backed by sub prime or Alt-A mortgages, no direct investment in residential mortgages, no counterparty risks, no credit default swaps, or derivative contracts. See the analysis of excess investment income and investment activities under the caption Investments in this report and Note 3-Investments in the Notes to Consolidated Statements of Operations for a more detailed discussion of this segment.
In each of the years 2007 through 2009, 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. A discussion of these items follows.
litigation settlements is included in other income. As explained in Note 3-Investments under the caption Other-than-temporary impairments, we wrote down certain company-occupied property to fair value during both 2009 and 2008. The write downs resulted in after-tax charges of $231 thousand in 2009 and $1.4 million in 2008.
Prior to 2007, Liberty began a program to dispose of its agency office buildings, replacing them with rental facilities. In 2007, 21 buildings were sold for proceeds of $6.4 million and a pretax gain of $4.3 million ($2.8 million after tax). The program began to wind down in 2008 as five buildings were sold for proceeds of $787 thousand and a pretax gain of $278 thousand ($181 thousand after tax). Because of the significant scale of this nonoperating activity, we have removed these amounts from our core results in 2008 and 2007. No buildings were sold in 2009. Five buildings remained to be sold at December 31, 2009.
Throughout 2009, we have been in the process of combining selected United American (UA) Exclusive Agency Branch Offices with the Liberty National Exclusive Agency. For this reason, all premium income and margin data will be reported on a combined basis in this report. However, we will continue to report sales data and agent counts separately.
Life insurance premium rose 3% to $1.7 billion in 2009 after having increased 3% in 2008 to $1.62 billion. Life insurance products are marketed through several distribution channels. Premium income by channel for each of the last three years is as follows:
Annualized life premium in force was $1.77 billion at December 31, 2009, an increase of 4% over $1.71 billion a year earlier. Annualized life premium in force was $1.67 billion at December 31, 2007.
Direct Response is one of our leading writers of life insurance. The Direct Response operation consists of two primary components: direct mail and insert media. Direct mail targets primarily young middle-income households with children. The juvenile life insurance policy is a key product. Not only is the juvenile market an important source of sales, but it also is a vehicle to reach the parents and grandparents of the juvenile policyholders. Parents and grandparents of these juvenile policyholders are more likely to respond favorably to a Direct Response solicitation for life coverage on themselves than is the general adult population. Also, both the juvenile policyholders and their parents are low acquisition- cost targets for sales of additional coverage over time. At this time, we believe that the Direct Response unit is the largest U.S. writer of juvenile direct mail life insurance. We expect that sales to this demographic group will continue as one of Direct Response’s premier markets.
The insert media area targets primarily the adult market. It involves placing insurance solicitations as advertising inserts into a variety of media, such as coupon packets, newspapers, bank statements, and billings. This media was historically placed by Direct Marketing and Advertising Distributors, Inc. (DMAD), previously an unrelated entity which we acquired and integrated their operations into ours during 2007. This acquisition allowed the Company to expand marketing opportunities through increased solicitation volume and also improve margins through cost savings in the insert media component.
$298 million for 2009, a 2% decrease compared with $304 million in 2008. Life premium for this agency declined 2% in 2008 from 2007. First-year collected premium on a combined basis rose 6% to $35 million in 2009, after having increased 8% in 2008.
We also offer life insurance through Other Agencies consisting of the United Investors Agency, the Military Agency, the United American Independent Agency, and other small miscellaneous sales agencies. The United Investors Agency is comprised of several independent agencies that concentrate on annuity business. United Investors represented 4% of Torchmark’s 2009 life premium income. The Military Agency consists of a nationwide independent agency whose sales force is comprised primarily of former military officers who have historically sold primarily to commissioned and noncommissioned military officers and their families. This business consists of whole-life products with term insurance riders. Military premium represented 12% of life premium. The United American Independent Agency represented less than 2% of Torchmark’s total life premium. This agency is focused on health insurance, with life sales being incidental.
Total health premium represented 38% of Torchmark’s total premium income in 2009. Excluding Part D premium, health premium represented 33% in 2009, compared with 37% in 2008 and 39% in 2007. Health underwriting margin, excluding Part D, accounted for 25% of the total in 2009, compared with 29% in 2008 and 30% in 2007. These declines in the health percentages are indicative of the growth in the premium and profitability of our life segment in relation to our health segment. Health results have also been negatively affected by increased competition in recent periods. The following table indicates health insurance premium income by distribution channel for each of the last three years.
other limited-benefit products. Medicare Supplement provides the greatest amount of health premium, representing 55% of non-Part D health premium in 2009. Because Medicare Supplement products are generally more persistent than the limited-benefit products, Medicare Supplement premium grew to 55% in relative proportion to limited-benefit premium in 2009 compared with 51% for the two prior years.
As previously mentioned under the caption Life Insurance, we have combined selected UA Exclusive Agency Branch Offices with the Liberty National Exclusive Agency. This combination has resulted in this Agency being Torchmark’s largest in terms of health premium income and net sales. In 2009, this Agency represented 46% of all Torchmark non-Part D income health premium at $389 million. The UA Branch has historically been Torchmark’s largest health distributor, marketing limited-benefit health products and Medicare Supplements. Liberty also markets limited-benefit products, concentrating on cancer insurance. In 2009, health premium income of $389 million in the combined Agency declined 18% from prior year premium of $476 million. Premium also fell 10% in 2008 from $528 million. First-year collected premium fell 62% to $33 million in 2009, after declining 36% a year earlier. As noted earlier, increased competition in the health insurance market has caused declines in agent counts particularly in the UA Branch Agency. The decline in agent counts has resulted in decreased new sales, translating into declines in premium. The UA Branch Office net sales for 2009 declined 75% from $72 million in 2008 to $18 million (of which $5 million was for sales of Liberty National products in 2009). In 2008, this Agency’s net sales fell 56%. As discussed under the caption Life Insurance, the UA Branch Office agent count has fallen significantly each year, 45% in 2008 to 1,651 agents and 56% in 2009 to 731 agents. These declines have negatively impacted net sales and premium growth. This effect has been more notable in Torchmark’s health segment as this Agency is a more prominent factor in our health operations. Also discussed under the Life Insurance caption are efforts designed to strengthen this Agency.
The UA Independent Agency is composed of independent agencies appointed with Torchmark whose size range from very large, multi-state organizations down to one-person offices. All of these agents generally sell for a number of insurance companies, of which 1,872 were active producing agents for Torchmark at December 31, 2009. This agency is our largest carrier of Medicare Supplement insurance, with $266 million or 58% of our Medicare Supplement premium income in 2009. This agency’s relative contribution to Torchmark’s total health sales has increased in each of the past three years. Net sales for this Agency rose 14% to $43 million in 2009. Medicare Supplement net sales of $30 million more than doubled in 2009 over net sales of $15 million in 2008 and almost doubled sales of $16 million in 2007. These increases in 2009 were due to increases in group Medicare Supplement sales. Total health premium income for the UA Independent Agency was $326 million in 2009, a 9% decline from 2008 premium of $357 million. Premium income declined 8% in 2008 from 2007. The declines in premium have resulted as new sales have not compensated for lapses.
Direct Response, primarily a life operation, also offers health insurance, which is predominantly Medicare Supplements sold directly to employer or union sponsored groups. In 2009, net health sales were $11 million, comprising approximately 8% of Direct Response’s total life and health net sales. Direct Response health net sales and premium income have risen each year over the prior year. Net sales increased 87% in 2009 and 7% in 2008. Health premium rose 3% in 2009 to $47 million and 7% in 2008.
We believe that the Medicare Part D program is a meaningful component to our health product offerings because of our experience with the senior-age market and with Medicare Supplements, the government assurances with regard to the risk-sharing agreements for participating insurers, the incremental income added to our health insurance margins, and the renewal of the business every year. 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, we do not expect significant growth in the Part D product in the near future, as most Medicare beneficiaries have already chosen a plan. Additionally, as with any government-sponsored program, the possibility of regulatory changes could change the outlook for this market.
Total Medicare Part D premium and health premium excludes $7.3 million in 2007 and $2.5 million in 2009 of risk-sharing premium paid to the CMS consistent with the Medicare Part D contract. In 2008, $122 thousand of risk-sharing premium was received, increasing premium. This risk-sharing amount is a portion of the excess or deficiency of actual over expected claims, and therefore we view this payment as a component of policyholder benefits in our segment analysis.
Annuities. Fixed annuity products are sold on a limited basis by our subsidiaries. Variable annuities were sold prior to 2008 but new sales were discontinued during that year. Annuities represented less than 1% of Torchmark’s 2009 premium revenue and underwriting income. We do not emphasize this segment.
Underwriting income on our variable business has been recently affected by two major factors other than policy charges. Our products contain guaranteed minimum death benefits providing a minimum death benefit regardless of policyholder account value upon death. For this reason, we provide a reserve for this benefit, the cost of which increases as the policyholder account value declines. Additionally, because of changes in the account balance size, we expect that future revenues and profits will also change accordingly. Therefore, the projections with regard to the deferred acquisition costs associated with this business are revised, resulting in a charge or credit to reflect this revision or “true-up” of the projections. Because equity markets declined significantly in the latter part of 2008, the guaranteed death benefit and the “true-up” related to deferred acquisition costs increased substantially in 2008, from $935 thousand in 2007 to $13.6 million. As a result of the partial recovery of the equity markets in 2009, the charge to underwriting income for the guaranteed death benefit reserve adjustment and “true-up” adjustment was reduced to $1.7 million. The variable annuity business is our only business where revenue and margins are significantly impacted by changes in equity markets.
As mentioned in Note 1-Significant Accounting Policies in the Notes to Consolidated Financial Statements, we settled litigation in prior periods relating to issues occurring many years ago, but incurred $2.5 million in legal costs in 2008 and $933 thousand in 2007. As previously noted, we do not consider the costs of settling litigation applicable to prior periods to be related to current insurance operations. Stock compensation expense declined in 2009, primarily as a result of the lower stock price caused by the severe market decline in 2009 and the effect it had on values at the time of our annual stock and stock option grants for 2009. Expense related to the new 2009 grants replaced the expense for costlier older grants that became fully vested. Stock compensation expense rose in 2008 because 2008 was the first year after adoption of the accounting rule requiring the expensing of stock options where we had three years of annual employee grants being expensed (2005, 2006 and 2008). The 2004 employee grant was fully vested in 2005 (before adoption) and there was no grant in 2007. New restricted stock grants in each of the three years 2006 through 2008, which generally vest over five years, have also contributed to the increases in 2008 and 2007 stock compensation expense. Management believes that stock compensation expense will increase slightly in 2010. As stated in Note 13-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. As described in Note 3-Investments under the caption Other-than-temporary impairments, we wrote down certain Company-occupied real estate because it met our criteria as described in that note for other-than-temporary impairment. As a result, we incurred a pretax charge of $2.1 million in 2008 and $355 thousand in 2009 which is included in Operating expenses in the Consolidated Statements of Operations in the respective year.
Investments. We manage our capital resources including investments, debt, and cash flow through the investment segment. Excess investment income represents the profit margin attributable to investment operations. It is the measure that we use to evaluate the performance of the investment segment as described in Note 13-Business Segments in the Notes to the Consolidated Financial Statements. It is defined as net investment income less both the interest credited to net policy liabilities and the interest cost associated with capital funding or “financing costs.” We also view excess investment income per diluted share as an important and useful measure to evaluate the performance of the investment segment. It is defined as excess investment income divided by the total diluted weighted average shares outstanding, representing the contribution by the investment segment to the consolidated earnings per share of the Company. Since implementing our share repurchase program in 1986, we have used $4.0 billion of cash flow to repurchase Torchmark shares after determining that the repurchases provided a greater return than other investment alternatives. Share repurchases reduce excess investment income because of the foregone earnings on the cash that would otherwise have been invested in interest-bearing assets, but they also reduce the number of shares outstanding. In order to put all capital resource uses on a comparable basis, we believe that excess investment income per diluted share is an appropriate measure of the investment segment.
The largest component of excess investment income is net investment income, which rose 1% to $675 million in 2009. It increased 3.5% to $671 million in 2008 from $649 million in 2007. As presented in the following chart, the growth in net investment income in all periods was not as great as the growth in mean invested assets.
Financing costs rose $7 million or 11% in 2009. They declined $4 million or 6% in 2008. The 2009 increase in financing costs reflects the issuance in June 2009 of $300 million principal amount 9 ¼% Senior Notes due in 2019 and the maturity in August 2009 of $99 million principal amount 8 ¼% Senior Debentures. Short-term interest expense was $4 million lower in 2009, as a result of significantly lower interest rates when compared with 2008. The 2008 decline resulted from a decrease in short-term interest rates during 2008, as well as a 4% decline in our average commercial paper balance for the year to $229 million.
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. We believe this strategy is appropriate because our cash flows are generally stable and predictable. If such longer-term securities do not meet our quality and yield objectives, new money is invested short-term, generally with maturities less than five years. During calendar years 2007 through 2009, Torchmark invested almost exclusively in fixed-maturity securities. Investments were primarily made in corporate securities, although some municipal bonds were acquired in 2007 and 2009. There were virtually no below-investment-grade securities acquired and the average rating of investments acquired in each year was A. Investment-grade corporate securities include both bonds and trust-preferred securities (which are classified as redeemable preferred stocks) with a diversity of issuers and industry sectors.
We prefer to invest primarily in bonds that are not callable (on other than a make-whole basis) prior to maturity, but we periodically invest some funds in callable bonds when the incremental yield available on such bonds warrants doing so. For investments in callable bonds, the actual life of the investment will depend on whether or not (and if so, when) the issuer calls the investment prior to the maturity date. Given our investments in callable bonds, the actual average life of our investments can not be known at the time of the investment. However, the average life will not be less than the average life to next call and will not exceed the average life to maturity. Data for both of these average life measures is provided in the above chart.
During 2007 and 2008, we invested considerable funds in fixed-maturity securities (bonds, trust preferred securities, and redeemable preferred stocks) with longer scheduled maturity dates, often exceeding 30 years. In virtually all cases, such securities have a scheduled maturity date and are callable many years prior to the scheduled maturity date. Because of the changing investment environment later in 2009, we were able to achieve our yield and quality objectives with investments in securities with somewhat shorter average lives and maturities. As a result, the average life of funds invested during 2009 (to both next call and maturity) was somewhat lower than that of investments during 2007 and 2008.
Portfolio Analysis. Because Torchmark has recently invested almost exclusively in fixed-maturity securities, the relative percentage of our assets invested in various types of investments varies from industry norms. The following table presents a comparison of Torchmark’s components of invested assets at amortized cost as of December 31, 2009 with the latest industry data.
At December 31, 2009, fixed maturities had a fair value of $9.7 billion, compared with $7.8 billion at December 31, 2008. Net unrealized losses on fixed maturities declined from $1.8 billion at December 31, 2008 to $456 million at December 31, 2009. Approximately 74% of our fixed maturity assets at December 31, 2009 at amortized cost were corporate bonds and 14% were redeemable preferred stocks. This compares with 78% corporate bonds and 15% redeemable preferred stocks at year end 2008. At December 31, 2009, less than 2% of the assets at amortized cost were residential and commercial mortgage-backed securities, other asset-backed securities, and collateralized debt obligations (CDOs). The $55 million of CDOs at amortized cost made up less than 1% of the assets and are backed primarily by trust preferred securities issued by banks and insurance companies. The $22 million of mortgage-backed securities are rated AAA. For more information about our fixed-maturity portfolio by component at December 31, 2009 and 2008, including an analysis of unrealized investment losses and a schedule of maturities, see Note 3-Investments in the Notes to Consolidated Financial Statements.
The following table presents the relative percentage of our fixed maturities by industry sector at December 31, 2009.
Also at December 31, 2009, we held investments issued by five different monoline insurers. In our opinion, our investments in three of these monoline insurers ($9 million amortized cost and $10 million fair value) were other-than-temporarily impaired and our investments in two monoline insurers ($83 million amortized cost and $37 million fair value) were not other-than-temporarily impaired. We collected and analyzed a significant amount of information to form opinions about the reasons for the severity of our impairments, including the illiquidity of some of our holdings (and its impact on fair values), the expected future experience in the mortgage market, and the reasonable expectation of the receipt of all future contractual interest and principal payments for these investments. We reviewed news and information about the economy and the mortgage market in general and about the issuers of our investments. We reviewed and analyzed financial statements and had discussions with sell-side and independent credit analysts who follow this sector, certain regulators, and members of the management teams of some of the issuers of our investments. While there is a possibility that future experience in the mortgage markets will differ from our current expectations, we believe there is ample evidence to support our conclusions.
An analysis of the fixed-maturity portfolio by a composite rating at December 31, 2009 is shown in the table below.
Realized gains and losses can be significant in relation to the earnings from core insurance operations, and as a result, can have a material positive or negative impact on net income. The significant fluctuations caused by gains and losses can cause the period-to-period trends of net income not to be indicative of historical core operating results nor predictive of the future trends of core operations. Accordingly, they have no bearing on core insurance operations or segment results as we view operations. For these reasons, and in line with industry practice, we remove the effects of realized gains and losses when evaluating overall insurance operating results.
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, 2009.
Additionally, as described in Note 3, we wrote down a real estate investment to fair value in 2008, resulting in a loss of $1.1 million ($718 thousand after tax). We wrote down an additional $205 thousand ($133 thousand after tax) in 2009 on this investment.
An additional source of parent company liquidity is a line of credit facility with a group of lenders which allows unsecured borrowings and stand-by letters of credit up to $600 million. As of December 31, 2009, we had available $167 million under this facility. For a detailed discussion of this line of credit facility, see the Commercial Paper section of Note 10-Debt in the Notes to Consolidated Financial Statements.
During the first half of 2009 until early June, Torchmark qualified for and participated in the Commercial Paper Funding Facility (CPFF), a facility created by the Federal Reserve Board to purchase commercial paper from eligible issuers. One condition of participation was that we maintain our commercial paper credit ratings. As of June 5, 2009, one agency downgraded our commercial paper facility by one notch. As a result, we no longer qualified to issue commercial paper in the CPFF after that date. However, the Company has been able to issue commercial paper in the public market since that time at a considerably lower cost than through the government program. We issued over one billion dollars of commercial paper during the second half of 2009 at an average yield of 0.6%, compared with an average yield of 1.7% during the first half of 2009 which was primarily issued under the CPFF. The downgrade has not had an impact on our ability to access public commercial paper markets.
In summary, Torchmark expects to have readily available funds for 2010 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.
Our cash and short-term investments were $590 million at year-end 2009 and $177 million at year-end 2008. 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 $9.7 billion at December 31, 2009. However, our strong cash flows from operations, investment maturities, and credit line availability make any need to sell securities for liquidity unlikely.
Off-Balance Sheet Arrangements. As fully described and discussed in Note 10-Debt in the Notes to the Consolidated Financial Statements and under the subcaption Funded Debt, Torchmark had outstanding $120 million (par amount) 7.1% Trust Preferred Securities at both December 31, 2009 and 2008. The capital trust liable for these securities is the legal entity which is responsible for the securities and facilitates the payment of dividends to shareholders. The trust is an off-balance sheet arrangement which we are required to deconsolidate in accordance with GAAP rules. Deconsolidation is required because the capital trust is considered to be a variable interest entity in which we have no variable interest. Therefore Torchmark is not the primary beneficiary of the entity, even though we own all of the entity’s voting equity and have guaranteed the entity’s performance. While these liabilities are not on our Consolidated Balance Sheets, they are represented by Torchmark’s 7.1% Junior Subordinated Debentures due to the trust. These Junior Subordinated Debentures were a Torchmark liability of $124 million par and book value at both December 31, 2009 and 2008. These securities are indicated as a capital resource to us under the caption Capital Resources in this report. The 7.1% preferred dividends due to the preferred shareholders are funded by our 7.1% interest payment on our debt to the trusts. As described in Note 14-Commitments and Contingencies in the Notes to Consolidated Financial Statements, we have guaranteed the performance of the capital trust to meet its financial obligations to the Trust Preferred shareholders.
As a part of its above-mentioned credit facility, Torchmark has outstanding $200 million in stand-by letters of credit. However, these letters are issued among our subsidiaries and have no impact on company obligations as a whole.
As of December 31, 2009, we had no other significant unconsolidated affiliates and no guarantees of the obligations of third-party entities other than as described above. All of our guarantees, other than the Trust Preferred guarantee, were guarantees of the performance of consolidated subsidiaries, as disclosed in Note 14-Commitments and Contingencies.
The following table presents information about future payments under our contractual obligations for the selected periods as of December 31, 2009.
(3) Pension obligations are primarily liabilities in trust funds that are calculated in accordance with the terms of the pension plans. They are offset by invested assets in the trusts, which are funded through periodic contributions by Torchmark in a manner which will provide for the settlement of the obligations as they become due. Therefore, our obligations are offset by those assets when reported on Torchmark’s Consolidated Balance Sheets. At December 31, 2009, these pension obligations were $242 million, but there were also assets of $212 million in the pension entities. The schedule of pension benefit payments covers ten years and is based on the same assumptions used to measure the pension obligations, except there is no interest assumption because the payments are undiscounted. Please refer to Note 9-Postretirement Benefits in the Notes to Consolidated Financial Statements for more information on pension obligations.
Capital Resources. Torchmark’s capital structure consists of short-term debt (the commercial paper facility described in Note 10-Debt in the Notes to Consolidated Financial Statements), long-term funded debt, Junior Subordinated Debentures supporting its Trust Preferred Securities, and shareholders’ equity. The Junior Subordinated Debentures are payable to Torchmark’s Capital Trust III which is liable for its Trust Preferred Securities. In accordance with GAAP, these instruments are included in “Due to affiliates” on the Consolidated Balance Sheets. A complete analysis and description of long-term debt issues outstanding is presented in Note 10-Debt in the Notes to Consolidated Financial Statements.
The carrying value of the funded debt was $920 million at December 31, 2009, compared with $722 million a year earlier. Our 8 1/4 % Senior Debentures matured and were repaid in August, 2009 at a redemption amount of $99 million plus accrued interest. At year end 2008, they were classified as short-term debt because they were due within a year. As a result, reported long-term debt at December 31, 2008 was $499 million.
As fully explained in Note 10-Debt in the Notes to Consolidated Financial Statements, in June of 2009 we issued $300 million principal amount of 9¼% Senior Notes due in 2019 for proceeds of $296 million. As noted above, a portion of these proceeds were used to repay the $99 million due upon the August, 2009 maturity of our 8¼% Senior Debentures. Of the $197 million balance of the proceeds, $175 million was contributed to our insurance subsidiaries in 2009. The subsidiaries then in turn invested these funds in investment-grade corporate bonds and municipal bonds. The capital contributions were made as a result of our desire to maintain subsidiary regulatory capital at levels adequate to meet the requirements of rating agencies.
** Includes Torchmark’s 7.1% Junior Subordinated Debentures in 2009, 2008, and 2007 in the amount of $124 million.
*** Torchmark’s debt covenants require that the effect of the accounting rule requiring revaluation be removed to determine this ratio.
Effective in 2008, the FASB issued new guidance, offering an option which, if elected, would permit us to value our interest-bearing policy liabilities and debt at fair value in our Consolidated Balance Sheets. However, unlike current accounting rules which permit us to account for changes in our available-for-sale bond portfolio through other comprehensive income, the new rule requires such changes to be recorded in earnings. Because both the size and duration of the investment portfolio do not match those attributes of our policyholder liabilities and debt, the impact on earnings could be very significant and volatile, causing reported earnings not to be reflective of core results. Therefore, we have not elected this option.
($.9 billion after tax). Torchmark’s ratio of earnings before interest and taxes to interest requirements (times interest earned) was 9.7 times in 2009, compared with 11.5 times in 2008 and 12.8 times in 2007. A discussion of our interest expense is included in the discussion of financing costs under the caption Investments in this report.
Credit Ratings. The credit quality of Torchmark’s debt instruments and capital securities are rated by various rating agencies. In 2008, Moody’s affirmed our credit ratings. In 2009, however, they modified their outlook on our Senior Debt from stable to negative. They cited their expectation of rising asset losses as well as tighter liquidity and reduced financial flexibility. In 2008, Standard & Poor’s affirmed all credit ratings on Torchmark and its subsidiaries. However, it revised its outlook to negative from stable for the Company. Standard & Poor’s cited our increased risk within our investment portfolio which had experienced significant unrealized losses concentrated in the financial sector. They also noted that our share repurchase program has reduced our capitalization, but that we were still well within a level adequate to support their rating. During 2007, Standard & Poor’s lowered its credit rating on Torchmark’s outstanding debt from A+ to A, and lowered the rating of its preferred stock from A- to BBB+. The credit rating change was attributed to weaker agent productivity, recruiting, and retention, as well as changes in direct response strategy, all of which have contributed to lower new sales. During 2009, A.M. Best affirmed our funded debt rating at a-, but downgraded our preferred stock from bbb+ to bbb. They also revised their outlook to negative on the funded debt. Also in 2009, Fitch downgraded our Senior Debt from A to BBB+ (two notches), our preferred stock from A- to BBB (two notches), and our commercial paper from to (one notch). Fitch stated that the downgrades were a result of the weakness in the statutory capital position of Torchmark’s insurance subsidiaries brought on by the ratings downgrades of fixed maturity securities held in the subsidiaries’ investment portfolios. They also expressed concern with the level of intercompany financing by the Parent Company from the subsidiaries, the ongoing exposure to financial market turmoil, and the expectation of continued investment deterioration going forward. Fitch had previously revised its outlook to negative from stable in 2008 and maintained the negative outlook in 2009. The chart below presents Torchmark’s credit ratings as of December 31, 2009.
In January, 2010, Fitch further downgraded our preferred stock one notch to BBB-. At that time, Fitch downgraded over 200 hybrid securities issued by insurance industry entities, as their assessments of these securities in our industry changed.
Fair Value Disclosures: New guidance has been issued concerning disclosures about the fair value of financial assets. This guidance will require us to separately disclose transfers in and out of Level 1 and Level 2 in the fair value hierarchy as we currently only disclose transfers in and out of Level 3. The point at which the transfer is recognized must be disclosed. All purchases, sales, issuances, and settlements of Level 3 assets must be reported on a gross basis, contrary to our previous permitted practice of reporting on a net basis. A more detailed disclosure of classes of investments will be required, although Torchmark currently complies with the required level of detail. Valuation techniques for Level 2 and Level 3 assets must be fully disclosed. The new guidance will be effective for Torchmark beginning January 1, 2010, except for the detail breakout (gross up) of Level 3 assets which is effective beginning January 1, 2011. Prior period comparisons are not required in the initial adoption periods. Early adoption is permitted.
The remaining portion of liabilities for future policy benefits pertains to business accounted for as deposit business, whereby the recorded liability is the fund balance attributable to the benefit of policyholders as determined by the policy contract at the financial statement date. Accordingly, there are no assumptions used to determine the future policy benefit liability for deposit business.
Approximately 95% of our recorded amounts for deferred acquisition costs at December 31, 2009 were related to traditional products and are being amortized over the premium-paying period in proportion to the present value of actual historic and estimated future gross premiums. The projection assumptions for this business are set at the time of contract issue. These assumptions are “locked-in” at that time and, except where there is a loss recognition issue, are not revised for the lifetime of the contracts. Absent a premium deficiency, variability in amortization after policy issuance is caused only by variability in premium volume. We have not recorded a deferred acquisition cost loss recognition event for assets related to this business for any period in the three years ended December 31, 2009.
Policy Claims and Other Benefits Payable. This liability consists of known benefits currently payable and an estimate of claims that have been incurred but not yet reported to us. The estimate of unreported claims is based on prior experience and is made after careful evaluation of all information available to us. However, the factors upon which these estimates are based can be subject to change from historical patterns. Factors involved include the litigation environment, regulatory mandates, and the introduction of
We have audited the accompanying consolidated balance sheets of Torchmark Corporation and subsidiaries (“Torchmark”) as of December 31, 2009 and 2008, and the related consolidated statements of operations, comprehensive income, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2009. Our audits also included the financial statement schedules listed in the Index at Item 15. These financial statements and financial statement schedules are the responsibility of Torchmark’s management. Our responsibility is to express an opinion on the financial statements and financial statement schedules based on our audits.
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, 2009, based on the criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 26, 2010 expressed an unqualified opinion on Torchmark’s internal control over financial reporting.
Gains and losses realized on the disposition of investments are determined on a specific identification basis. Realized investment gains and losses and investment income attributable to separate accounts are credited to the separate accounts and have no effect on Torchmark’s net income. Investment income attributable to all other insurance policies and products is included in Torchmark’s net investment income. Net investment income for the years ended December 31, 2009, 2008, and 2007 included $516 million, $480 million, and $448 million, respectively, which was allocable to policyholder reserves or accounts. Realized investment gains and losses are not allocated to insurance policyholders’ liabilities.
Impairment of Investments: Torchmark evaluates securities for other-than-temporary impairment as described in Note 3-Investments under the caption Other-than-temporary-impairments. If a security is determined to be other-than-temporarily impaired, the cost basis of the security is written down to fair value and is treated as a realized loss. The written-down security will be amortized and revenue recognized in accordance with estimated future cash flows.
Torchmark elected to early adopt the amended guidance for the periods beginning January 1, 2009. Adoption resulted in no cumulative effect adjustment to opening retained earnings or to accumulated other comprehensive income as of January 1, 2009. Invested assets, total assets, and total shareholders’ equity were not affected by adoption. Application of the new guidance resulted in an after-tax increase in net income of $13.5 million in 2009, because the portion of other-than-temporary impairment loss related to factors other than credit was recorded in other comprehensive income instead of being reflected in net income. See Note 3-Investments under the caption Other-than-temporary impairments for a full discussion and disclosures related to other-than-temporary impairments.
Determination of Fair Values of Financial Instruments: Fair values for cash, short-term investments, short-term debt, receivables and payables approximate carrying value. Fair values for long-term debt instruments and equity securities are determined in accordance with specific accounting guidance. Fair values are based on quoted market prices, where available. Otherwise, fair values are based on quoted market prices of comparable instruments in active markets, quotes in inactive markets, or other observable
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). Variable life and annuity products are also assessed an investment management fee and a sales charge. Life premium includes policy charges of $46 million, $51 million, and $52 million for the years ended December 31, 2009, 2008, and 2007, respectively. Other premium includes annuity policy charges for the years ended December 31, 2009, 2008, and 2007, of $10 million, $14 million, and $20 million, respectively. 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.
Future Policy Benefits: The liability for future policy benefits for universal life-type products is represented by policy account value. The liability for future policy benefits for all other life and health products, approximately 72% of total future policy benefits, is provided on the net level premium method based on estimated investment yields, mortality, morbidity, persistency and other assumptions which were considered appropriate at the time the policies were issued. Assumptions used are based on Torchmark’s previous experience with similar products. Once established, assumptions for these products are generally not changed. An additional provision is made on most products to allow for possible adverse deviation from the assumptions. These estimates are periodically reviewed and compared with actual experience. If it is determined that existing contract liabilities, together with the present value of future gross premiums, will not be sufficient to cover the present value of future benefits and to recover unamortized acquisition costs, then a premium deficiency exists. Such a deficiency would be recognized immediately by a charge to earnings and either a reduction of unamortized acquisition costs or an increase in the liability for future policy benefits. From that point forward, the liability for future policy benefits would be based on the revised assumptions.
The liability for these minimum guarantees is determined each period end by estimating the expected value of death benefits in excess of the projected account balance using actuarial methods and assumptions including mortality, lapses, and interest. This excess benefit is then recognized ratably over the accumulation period based on total expected assessments. The Company regularly evaluates estimates used. If actual experience or other evidence suggests that earlier assumptions should be revised, Torchmark adjusts the additional liability balance with a related charge or credit to benefit expense. This liability was $1.1 million and $2.5 million at December 31, 2009 and 2008, respectively.
Torchmark adopted and implemented new accounting interpretive guidance relating to uncertain tax positions on January 1, 2007. This guidance was issued to clarify the accounting for income taxes by providing methodology for the financial statement recognition and measurement of uncertain income tax positions taken or expected to be taken in a tax return. More information concerning uncertain tax positions is provided in Note 8-Income Taxes.
Property and Equipment: Property and equipment, included in “Other assets,” 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 five to forty years for buildings and improvements. Ordinary maintenance and repairs are charged to income as incurred. Impairments, if any, are recorded when, based on events and circumstances, it becomes evident that the fair value of the asset is less than its carrying amount. Original cost of property and equipment was $112 million and $106 million at December 31, 2009 and 2008, respectively. Accumulated depreciation was $60 million at year end 2009 and $55 million at the end of 2008. Depreciation expense was $4.6 million in 2009, $5.0 million in 2008, and $4.3 million in 2007. During 2008, Torchmark completed the construction of an office building adjacent to the home office building of its subsidiary United American Insurance Company (United American) in McKinney, Texas. The Company spent approximately $23 million on the building and land, and approximately $3 million on equipment. Subsidiary Liberty National Life Insurance Company (Liberty) has sold the majority of its agency office buildings. In 2008, five offices were sold for proceeds of $787 thousand, recording a realized gain of $278 thousand before tax. In 2007, 21 buildings were sold for proceeds of $6.4 million, for a realized gain of $4.3 million. In 2008, Globe Life And Accident Insurance Company (Globe), a wholly-owned Torchmark subsidiary, sold two office buildings in Oklahoma City, Oklahoma for proceeds of $7.5 million, recording a gain on the sale of $2.6 million. No buildings were sold in 2009.
Low-Income Housing Tax Credit Interests: As of December 31, 2009, Torchmark had $169 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 these entities was $138 million at December 31, 2008. The majority of the return on the investments has been guaranteed by unrelated third-parties and has been accounted for using the effective-yield method. The remaining investments are non-guaranteed and are accounted for using the amortized-cost method. The Federal income tax benefits accrued during the year, net of related amortization of the investment, are recorded in “Income tax expense.” The premium tax benefits, net of the related amortization, are recorded in “Net investment income.” At December 31, 2009, $149 million of the investment is included in “Other assets” with the remaining $20 million included in “Other invested assets.” At December 31, 2008, the comparable amounts were $106 million and $32 million, respectively. Any unpaid commitments to invest are recorded in “Other liabilities.”
Litigation and Tax Settlements: The Company recorded a $2.9 million tax settlement benefit in 2009 and a benefit of $1.1 million in 2007 primarily resulting from the favorable settlements of U.S. Federal income tax issues that related to prior tax years in both cases. The Company also recorded a $10.8 million settlement benefit in 2008 related to litigation that occurred in prior years as a result of the favorable resolution of litigation concerning tax liabilities asserted by Canadian tax authorities covering several years. More information on these tax settlements is provided in Note 8-Income Taxes.
Torchmark received an additional pre-tax litigation settlement, net of expenses, of $1.3 million in 2008 ($.9 million after tax) and $515 thousand in 2007 ($335 thousand after tax) from investment litigation. Legal settlement costs in the amount of $2.5 million in 2008 ($1.6 million after tax) and $933 thousand in 2007 ($607 after tax) were expensed in those years relating to litigation issues arising in prior periods and concerning events occurring many years ago.
The fair value method requires the use of an option valuation model to value employee stock options. Torchmark has elected to use the Black-Scholes valuation model for option expensing. A summary of assumptions for options granted in each of the three years 2007 through 2009 is as follows:
Earnings Per Share: Torchmark presents basic and diluted earnings per share (EPS) on the face of the Consolidated Statements of Operations. Basic EPS is computed by dividing income available to common shareholders by the weighted average common shares outstanding for the period. Diluted EPS is calculated by adding to shares outstanding the additional net effect of potentially dilutive securities or contracts, such as stock options, which could be exercised or converted into common shares. For more information on earnings per share, see Note 11-Shareholders’ Equity.
Non-controlling Interests: As of January 1, 2009, Torchmark also adopted new guidance relating to non-controlling interests (also known as minority interests). At this time, Torchmark has no non-controlling interests.
Codification: Torchmark adopted the new FASB Accounting Standards Codification as of July 1, 2009. This codification reorganizes and codifies all non-SEC GAAP, and supersedes all previously-issued non-SEC accounting and reporting standards. It also revised the hierarchy of GAAP. The codification is, as of the effective date, the source of all authoritative non-SEC GAAP. Upon adoption, the codification did not change any guidance, but only rearranged previously-issued guidance in a topical manner. On the effective date of codification, substantially all existing non-SEC accounting and reporting standards were superseded, and are no longer referenced by title in these financial statements.
The excess, if any, of shareholders’ equity of the insurance subsidiaries on a GAAP basis over that determined on a statutory basis is not available for distribution to Torchmark without regulatory approval. More information on the restrictions on the payment of dividends can be found in Note 11-Shareholders’ Equity.
A schedule of fixed maturities by contractual maturity at December 31, 2009 is shown below on an amortized cost basis and on a fair 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 $900.4 million in 2009, $123.7 million in 2008, and $313.6 million in 2007. Gross gains realized on those sales were $77.7 million in 2009, $2.9 million in 2008, and $1.6 million in 2007. Gross losses were $60.0 million in 2009, $3.4 million in 2008, and $4.7 million in 2007. Proceeds from sales of equity securities were $1.1 million in 2009 and $7.6 million in 2007. There were no equities sold in 2008. Gross gains realized on those sales were zero in both years. Gross losses realized on those sales were $862 thousand in 2009 and $2.2 million in 2007.
The great majority of the Company’s fixed maturities are not actively traded and direct quotes are not generally available. Management therefore determines the fair values of these securities after consideration of data provided by third-party pricing services and independent broker/dealers. Over 97% of the fair value reported at December 31, 2009 was determined using data provided by third-party pricing services. Prices provided by third-party pricing services are not binding offers but are estimated exit values. They are based on observable market data inputs which can vary by security type. Such inputs include benchmark yields, available trades, broker/dealer quotes, issuer spreads, benchmark securities, bids, offers, and other market data. Where possible, these prices were corroborated against other independent sources. 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.
When the standard deviation is 3% or greater, or the Company cannot obtain three quotes, then additional information and management judgment are required to establish the fair value. The measurement is then classified as Level 3. The Company uses information and valuation techniques deemed appropriate for determining the point within the range of reasonable fair value estimates that is most representative of fair value under current market conditions. As of December 31, 2009, fair value measurements classified as Level 3 represented 1% of total fixed maturities and equity securities.
The following tables represent the fair value of assets measured on a recurring basis at December 31, 2009 and 2008:
Inputs used to derive expected cash flows included expected default rates, current levels of subordination, and loan-to-collateral value ratios. Management has determined that the present value of future cash flows is a better measure of fair value due to limited observable market data and because the market for these securities is not active and does not reflect orderly transactions. The pre-tax writedown for other-than-temporary impairment on corporate bonds of $77 million was all credit related and was included in the charge to earnings.
As of year end 2009, previously written down securities remaining in the portfolio were carried at a fair value of $48 million. Otherwise, as of December 31, 2009, Torchmark has no information available to cause it to believe that any of its investments are other-than-temporarily impaired. Torchmark has the ability and intent to hold these investments to recovery, and does not intend to sell nor expects to be required to sell its other impaired securities.
During both 2009 and 2008, certain real estate holdings, measured on a nonrecurring basis, were written down because the carrying values of these properties were not expected to be recoverable. In 2008, the writedowns consisted of Company-occupied property in the amount of $2.1 million ($1.4 million after tax) and investment real estate in the amount of $1.1 million ($.7 million after tax). In 2009, additional writedowns in the amounts of $355 thousand ($231 thousand after tax) of Company-occupied real estate and $205 thousand ($133 thousand after tax) of investment real estate were taken on these same properties. The fair values in 2008 were determined based on recent sales of similar properties (Level 2 observable inputs). The 2009 fair value was determined based on a bid (Level 1). The losses on Company-occupied property were included in “Other operating expenses” and the losses on invested real estate were included as “Other-than-temporary impairments.”
Unrealized loss analysis. Net unrealized losses on fixed maturities increased from $103 million at December 31, 2007 to $1.8 billion at December 31, 2008 but declined to $456 million at December 31, 2009. The financial sector accounted for $468 million of the net losses, which were offset by $13 million of net gains in other sectors in 2009. At December 31, 2008, the financial sector accounted for 56% of the net unrealized losses. Based upon conditions experienced by companies in the bond market and the commercial paper market, management believes that much of the unrealized loss at December 31, 2008 and during the early part of 2009 was attributable to illiquidity in the financial market, which contributed to a spread widening, and accordingly increased unrealized losses, on many securities that management expects to be fully recoverable. Accordingly, as conditions in financial markets improved during 2009, unrealized losses in the portfolio have declined. Due to the strong and stable cash flows generated by its insurance products, Torchmark has the ability to hold these securities until recovery. Even though these fixed maturity investments are available for sale, Torchmark generally expects and intends to hold any securities which are temporarily impaired until they mature.
Torchmark had $9.5 million in fixed maturities at book value ($11.6 million at fair value) that were non-income producing during the twelve months ended December 31, 2009. Torchmark had $349 thousand in investment real estate at December 31, 2009 which was non-income producing during the previous twelve months. Torchmark did not have any other invested assets that were non-income producing during the twelve months ended December 31, 2009.
An analysis of deferred acquisition costs and the value of insurance purchased is as follows:
(2) Amortization includes $2.5 million, $7.5 million, and $2.3 million in 2009, 2008, and 2007, respectively, from unlocking adjustments due to actuarial assumption revisions related to Torchmark’s variable annuity business.
The amount of interest accrued on the unamortized balance of value of insurance purchased was $2.1 million, $3.2 million, and $3.6 million for the years ended December 31, 2009, 2008, and 2007, respectively. The average interest rates used for the years ended December 31, 2009, 2008, and 2007 were 4.0%, 5.5%, and 5.7%, respectively. The estimated amortization, net of interest accrued, on the unamortized balance at December 31, 2009 during each of the next five years is: 2010, $4.9 million; 2011, $4.4 million; 2012, $4.0 million; 2013, $3.6 million; and 2014, $3.3 million.
A summary of the assumptions used in determining the liability for future policy benefits at December 31, 2009 is as follows:
At the end of each period, the liability for unpaid health claims includes an estimate of claims incurred but not yet reported to the Company. Such estimates are updated regularly based upon the Company’s most recent claims data with recognition of emerging experience trends. Because of the nature of the Company’s health business, the payment lags are relatively short and most claims are fully paid within a year from the time incurred. Fluctuations in claims experience can lead to either over- or under-estimation of the liability for any given year. The difference between the estimate made at the end of the prior period and the actual experience during the period is reflected above under the caption Incurred related to: Prior years.
Torchmark transacts business in Canada through a branch of one of its subsidiaries. For tax years prior to 2003, Canadian income tax authorities asserted that the branch carried on business in Canada through a permanent establishment and proposed additional taxes and interest. Torchmark challenged their assertion and litigated the issue before the Tax Court of Canada. In the second quarter of 2008, the Tax Court in Canada ruled in the Company’s favor and the Canadian tax authorities declined to appeal the Court’s decision. As a result, the Company recorded an $11.9 million tax benefit in 2008, including $5.4 million relating to the removal of amounts previously recorded by the Company for interest expense anticipated to be owed, net of Federal income tax, and $6.5 million relating to estimated interest income, net of Federal income tax, required to be paid by the Canadian tax authorities on amounts previously
Torchmark has net operating loss carryforwards of approximately $33.3 million at December 31, 2009 which will begin to expire in 2021 if not otherwise used to offset future taxable income. In addition, Torchmark has a net capital loss carryover of $36.8 million at December 31, 2009 of which $18.1 million will expire in 2010 if not otherwise utilized to offset capital gains. 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.
In January, 2007, Torchmark approved and implemented a new Supplemental Executive Retirement Plan (SERP), which provides to a limited number of executives an additional supplemental defined pension benefit. The supplemental benefit is based on the participant’s qualified plan benefit without consideration to the regulatory limits on compensation and benefit payments applicable to qualified plans, except that eligible compensation is capped at $1 million. The SERP is unfunded. However, life insurance policies on the lives of plan participants were established during 2009 for this plan with an unaffiliated insurance carrier. The premiums for this coverage paid in 2009 were $11 million. Because this plan is unqualified, the policyholder value of these policies is not included as defined benefit plan assets but as assets of the Company. The liability for this SERP at December 31, 2009 was $32 million and was $28 million a year earlier. Subsequent to December 31, 2009, the Company contributed an additional $21 million into a “Rabbi Trust” for this plan.
Torchmark’s investment objectives for its plan assets include preservation of capital, preservation of purchasing power, and long-term growth. Torchmark seeks to preserve capital through investments made in high quality securities with adequate diversification to minimize risk. The portfolio is monitored continuously for changes in quality and diversification mix. The preservation of purchasing power is intended to be accomplished through asset growth, exclusive of contributions and withdrawals, in excess of the rate of inflation. Torchmark intends to maintain investments that when combined with future plan
contributions will produce adequate long-term growth to provide for all plan obligations. It is also Torchmark’s objective that the portfolio’s investment return will meet or exceed the return of a balanced market index.
The portion of other comprehensive income that is expected to be reflected in pension expense in 2010 is as follows:
For measurement purposes of the healthcare benefits, a range of 7-10% annual rate of increase in per capita cost of covered healthcare benefits was assumed for the years 2007 through 2009. Torchmark has assumed that the health care cost trend rate will remain stable at the 7-10% range in future periods. This trend rate assumption could have a significant effect on the amounts reported. However, because participants substantially pay the cost of this benefit, a 1% increase or decrease in the health care cost trend rate is not expected to have a significant effect in the service and interest cost components.
(9) Classified as short-term debt. Senior debentures due 2009 were classified as short-term debt in 2008.
The amount of debt that becomes due during each of the next five years is: 2010-$233 million; 2011-$0; 2012-$0; 2013-$94 million; 2014-$0 and thereafter-$839 million.
Funded debt: During 2006, Torchmark established Torchmark Capital Trust III (Trust III) to facilitate the public offering of 4.8 million shares of $25 par value Trust Preferred Securities. Trust III completed the offering on June 8, 2006 for total proceeds of $120 million. It then exchanged $3.7 million of its common stock and the $120 million of proceeds from the offering for $123.7 million of Torchmark Junior Subordinated Debentures, due June 1, 2046. Trust III pays quarterly dividends on the Trust Preferred Securities at an annual rate of 7.1%, and receives quarterly payments at the same annual rate from Torchmark on the Junior Subordinated Debentures. All payments due to be paid by Trust III on the Trust Preferred Securities are guaranteed by Torchmark (see Note 14). The securities are redeemable on June 1, 2046, and first callable by Trust III on June 1, 2011.
Commercial Paper: In 2004, Torchmark entered into a credit facility with a group of lenders allowing unsecured borrowings and stand-by letters of credit up to $600 million. This agreement is set to terminate on August 31, 2011. Effective as of December 31, 2008, the Company has the ability to request up to $200 million in letters of credit to be issued against the facility. The credit facility is further designated as a back-up credit line for a commercial paper program, whereby Torchmark may borrow from either the credit line or issue commercial paper at any time, with total commercial paper outstanding not to exceed $600 million less any letters of credit issued. Interest is charged at variable rates. At December 31, 2009, Torchmark had $233 million face amount ($233 million carrying amount) of commercial paper outstanding, $200 million of letters of credit issued, and no borrowings under the line of credit. During 2009, the short term borrowings under the facility averaged approximately $251 million, and were made at an average yield of 1.10%, compared with an average balance of $229 million at an average yield of 3.5% a year earlier. The facility does not have a ratings-based acceleration trigger which would require early payment. A facility fee is charged for the entire $600 million facility at a rate of 10 basis points. For letters of credit issued, there is an issuance fee of 27.5 basis points. Additionally, if borrowings on both the line of credit and letters of credit exceed 50% of the total $600 million facility, there is a usage fee of 10 basis points. Torchmark is subject to certain covenants for the agreements regarding capitalization and earnings, with which it was in compliance at December 31, 2009 and throughout the three-year period ended December 31, 2009. Borrowings on this facility are reported as short-term debt on the Consolidated Balance Sheets.
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. Torchmark suspended its share repurchase program indefinitely during the first quarter of 2009. Share repurchases under this program were 2.1 million shares at a cost of $47 million in 2009, 7.6 million shares at a cost of $427 million in 2008, and 6.1 million shares at a cost of $402 million in 2007. 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 20 thousand shares at a cost of $869 thousand in 2009, 487 thousand shares at a cost of $29 million in 2008, and 767 thousand shares at a cost of $50 million in 2007.
Retirement of Treasury Stock: Torchmark retired 2 million shares of treasury stock in December, 2009, 9 million in 2008, and 5 million in 2007.
Restrictions: Restrictions exist on the flow of funds to Torchmark from its insurance subsidiaries. Statutory regulations require life insurance subsidiaries to maintain certain minimum amounts of capital and surplus. Dividends from insurance subsidiaries of Torchmark are limited to the greater of prior year statutory net gain from operations not including realized capital gains on an annual noncumulative basis, or 10% of prior year surplus, in the absence of special regulatory approval. Additionally, insurance company distributions are generally not permitted in excess of statutory surplus. Subsidiaries are also subject to certain minimum capital requirements. In 2009, subsidiaries of Torchmark paid $355 million in dividends to the parent company. During 2010, a maximum amount of $360 million is expected to be available to Torchmark from subsidiaries without regulatory approval.
A summary of stock compensation activity for each of the years in the three years ended December 31, 2009 is presented below:
Additional information about Torchmark’s stock-based compensation as of December 31, 2009 and 2008 is as follows:
Assets for each segment are reported based on a specific identification basis. The insurance segments’ assets contain deferred acquisition costs (including the value of insurance purchased) and separate account assets. The investment segment includes the investment portfolio, cash, and accrued investment income. Goodwill is assigned to the insurance segments at the time of purchase based on the excess of cost over the fair value of assets acquired for the benefit of that segment. 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 consolidated financial statements.
Low-Income Housing Tax Credit Interests: As described in Note 1, Torchmark has invested $169 million in entities which provide certain tax benefits. As of December 31, 2009, Torchmark remained obligated under these commitments for $38 million, of which $28 million is due in 2010, $7 million in 2011, and $3 million in 2012.
Concentrations of Credit Risk: Torchmark maintains a diversified investment portfolio with limited concentration in any given issuer. At December 31, 2009, the investment portfolio, at fair value, consisted of the following:
As of December 31, 2009, securities of state and municipal governments represented 10% of invested assets at fair value. Such investments are made throughout the U.S. At year-end 2009, 5% or more of the state and municipal bond portfolio at fair value was invested in securities issued within the following states: Texas (31%), Washington (8%), Illinois (7%), Ohio (6%), Alabama (6%), and Pennsylvania (5%). Otherwise, there was no significant concentration within any given state.
Corporate debt and equity investments are made in a wide range of industries. Below are the ten largest industry concentrations held in the corporate portfolio at December 31, 2009, based on fair value:
Guarantees: At December 31, 2009, Torchmark had in place six guarantee agreements, all of which were either parent company guarantees of subsidiary obligations to a third party, or parent company guarantees of obligations between wholly-owned subsidiaries. As of December 31, 2009, Torchmark had no liability with respect to these guarantees.
Agent Receivables: In 2009, Torchmark issued a guarantee to TMK Re, Ltd., which purchased certain agents’ receivables of Torchmark’s wholly-owned subsidiary Liberty National Life Insurance Company (Liberty). The guarantee covered all obligations and recovery of capital to the third party under the receivables purchase agreement up to a maximum amount of $25 million. Under the terms of the purchase arrangement, TMK Re, Ltd. purchased the agents’ receivables and received the earned commissions as they were applied to the balance. The term of the guarantee expires on December 31, 2010, but is annually renewable. Torchmark is liable to the extent that future commission collections are insufficient to repay the purchased amount.
Previously, Torchmark issued a guarantee to an unaffiliated third party, which purchased certain agents’ receivables of Torchmark’s wholly-owned subsidiary American Income Life Insurance Company (American Income). The guarantee covered all obligations and recovery of capital to the third party under the receivables purchase agreement up to a maximum amount of $125 million. Under the terms of the revolving purchase arrangement, the third party purchased the agents’ receivables and received the earned commissions as they were applied to the balance. The term of the guarantee corresponded with the purchase arrangement, which was annually renewable. Torchmark was liable to the extent that future commission collections were insufficient to repay the purchased amount. As of August 22, 2008, the agreement with the unaffiliated third party was cancelled. All amounts were repaid to the third party under this arrangement by year end 2008.
As previously disclosed in filings with the Securities and Exchange Commission (SEC), United American has been named as a defendant in purported class action litigation originally filed on September 16, 2004, in the Circuit Court of Saline County, Arkansas on behalf of the Arkansas purchasers of association group health insurance policies or certificates issued by United American through Heartland Alliance of America Association and Farm & Ranch Healthcare, Inc. (Smith and Ivie v. Collingsworth, et al., CV2004-742-2). The plaintiffs asserted claims for fraudulent concealment, breach of contract, common law liability for non-disclosure, breach of fiduciary duties, civil conspiracy, unjust enrichment, violation of the Arkansas Deceptive Trade Practices Act, and violation of Arkansas law and the rules and regulations of the Arkansas Insurance Department. Declaratory, injunctive and equitable relief, as well as actual and punitive damages were sought by the plaintiffs. On September 7, 2005, the plaintiffs amended their complaint to assert a nation-wide class, defined as all United American insureds who simultaneously purchased both an individual Hospital and Surgical Expense health insurance policy (Form HSXC) and an individual supplemental term life insurance policy (Form RT85) from Farm & Ranch through Heartland. Defendants removed this litigation to the United States District Court for the Western District of Arkansas (No. 4:05-cv-1382) but that Court remanded the litigation back to the state court on plaintiffs’ motion. On July 22, 2008, the plaintiffs filed a second amended complaint, asserting a class defined as “all persons who, between January 1998 and the present, were residents of Arkansas, California, Georgia, Louisiana or Texas, and purchased through Farm & Ranch: (1) a health insurance policy issued by United American
On September 23, 2009, purported class action litigation was filed against American Income Life Insurance Company in the Superior Court of San Bernardino County, California (Hoover v. American Income Life Insurance Company, Case No. CIVRS 910758). The plaintiffs, former insurance sales agents of American Income who are suing on behalf of all current and former American Income sales agents in California for the four year period prior to the filing of this litigation, assert that American Income’s agents are employees, not independent contractors as they are classified by American Income. They allege failure to indemnify and reimburse for business expenses as well as failure to pay all wages due upon termination in violation of the California Labor Code; failure to pay minimum wages in violation of the California Industrial Welfare Commission Wage Order No. 4-2001, originally and as amended; and unfair business practices in violation of the California Business and Professions Code §§17200, et seq. They seek, in a jury trial, reimbursement for business expenses and indemnification for losses, payment of minimum wages for their training periods, payment of moneys due immediately upon termination under the California Labor Code, disgorgement of profits resulting from unfair and unlawful business practices, and injunctive relief granting employee status to all American Income’s California agents. On October 29, 2009, American Income filed a motion seeking to remove this litigation from the Superior Court in San Bernadino County to the U.S. District Court for the Central District of California, Eastern Division. The U.S. District Court remanded the case without prejudice to the Superior Court and denied American Income’s motion to dismiss on December 15, 2009. On January 19, 2010, American Income filed a motion to dismiss which is scheduled for hearing on March 16, 2010. Discovery has commenced.
Baxley. William J. Baxley is a partner in the law firm of Baxley, Dillard, Dauphin, McKnight & James which performs legal services for Torchmark and certain of its subsidiaries. In 1997, Mr. Baxley was loaned $668 thousand on an unsecured basis at a rate of 6.02%. Repayments are made in the form of legal services at customary rates and are applied against the outstanding balance, amortizing the loan with interest over its remaining term. In October, 2001, the terms of the loan were revised and an additional amount of $395 thousand was loaned to Baxley. The interest rate was revised to 5.6% and the term of the loan was extended until July, 2013. The loan is being repaid in accordance with its amortization schedule and all payments are current. At December 31, 2009 and 2008, the outstanding balance of this loan was $296 thousand and $371 thousand, respectively.