American Income owns and is the sole occupant of an office building located at 1200 Wooded Acres Drive, Waco, Texas. The building is a two-story structure containing approximately 72,000 square feet of
Torchmark and its primary subsidiaries have significant information technology capabilities at their disposal. The corporation uses centralized mainframe computer systems, a corporate wide-area network, company-specific local-area networks, workstations, and personal computers to meet its ongoing information processing requirements. Torchmark and its primary subsidiaries also use data communications hardware and software to support their remote data communications networks, intranets, and internet-related telecommunications capabilities.
Torchmark's computer hardware, data communications equipment, and associated software programs are managed by the corporation's information technology staff. All of the corporation's computer hardware and software support, information processing schedules, and computer-readable data-management requirements are met through company-specific policies and procedures. These company-specific policies and procedures also provide for the off-site storage and retention of backup computer software, financial, and business data files.
The following information should be read in conjunction with Torchmark's Consolidated Financial Statements and related notes reported elsewhere in this Form 10-K:
1) Changing general economic conditions leading to unexpected changes in lapse rates and/or sales of Torchmark's policies;
3) Market trends in the senior-aged health care industry that provide alternatives to traditional Medicare, such as Health Maintenance Organizations and other managed care or private plans, and that could affect the sales of traditional Medicare Supplemental insurance;
11) Financial markets trends that affect sales of Torchmark's market- sensitive products; and
12) Reported amounts in the financial statements which are based on management's estimates and judgements which may differ from the actual amounts ultimately realized.
4) The effect of a required change in accounting principle which modified the accounting for an interest rate swap instrument, increasing net income in the after-tax amount of $16.1 million in 1999;
7) A tax incurred related to the spin off of Waddell & Reed, Inc. (Waddell & Reed) in 1999 in the amount of $1.1 million after tax.
The charge related to discontinued energy operations arose from litigation which was ongoing at the time of Torchmark's divestiture of energy activities in 1996. This litigation was settled during 2001 and resulted in the charge. More information concerning this matter is found in Note 18--Commitments and Contingencies beginning on page 73 of this report.
Reconciliation of Per Share Net Operating Income to Reported Net Income
Net realized investment losses in 2001 were $1.6 million after tax, compared with $3.5 million after-tax in 2000. Realized investment losses in 1999 in the after-tax amount of $72 million included a $41 million after-tax loss from the sale of real estate and a $19 million after-tax loss from the sale of fixed maturities. Realized losses in 1999 also included a $12 million after-tax loss from the reduction in value of Torchmark's interest rate swap.
Life insurance. Life insurance is Torchmark's largest segment in terms of revenue, with life premium representing 52% of total premium in 2001 and with life underwriting income before other income and administrative expense representing 59% of the total in 2001.
Direct Response marketing is conducted through direct mail, co-op mailings, television and consumer magazine advertising, and direct mail solicitations endorsed by groups, unions and associations. This group markets a line of life products primarily to juveniles, their parents, and other adults over age 50 with face amounts of around $13,500 on average. In addition to life insurance marketing, the Direct Response operation has promoted growth in some of Torchmark's agent-based distribution channels through marketing support. This support includes providing sales leads and assisting in agent recruiting and has contributed indirectly to the growth in premium in other Torchmark distribution agencies. The Direct Response operation is characterized by lower acquisition costs than Torchmark's agency-based marketing systems. It accounted for over 25% of Torchmark's life insurance premium during 2001. Direct Response life premium rose 8% in 2001 to $289 million. Direct Response life premium was $268 million in 2000, increasing 9% over 1999 premium of $246 million.
The American Income Exclusive Agency is a distribution system that focuses on members of labor unions, credit unions, and other associations for its life insurance sales. It is a high profit margin business characterized by lower policy obligation ratios. This agency was Torchmark's fastest growing agency during 2001, accounting for the largest growth in both life sales and annualized life premium in force among Torchmark's distribution methods. Annualized life premium in force was $266 million at year-end 2001, an increase of 8% over 2000 premium in force of $245 million. Annualized life premium in force rose 6% in 2000. Sales, in terms of annualized premium issued, rose 17% in 2001 to $66 million, compared with an increase of 5% in 2000 to $57 million. This increase was 1% in 1999. The turnaround in sales for this agency over the last three years was a result of the growth in the number of agents. Prior to and during early 1999, this agency had suffered significant declines in its agent count. At December 31, 1998, there were 1,222 American Income agents. However, changes in American Income's marketing organization were implemented in 1999 to reverse the decline in the number of agents. As a result, this agency has grown steadily since mid-1999. While an overall decline in agent count occurred in the year 1999 to 1,197 agents because of agent losses early in that year, the agent count rose 13% in 2000 to 1,352 agents and further grew 31% in 2001 to 1,768 agents. American Income's marketing organization continues to implement efforts to improve agent recruiting, retention, and productivity in order to increase the size of this agency. The American Income Agency contributed $247 million of life insurance premium during 2001, representing 22% of Torchmark's total. The 2001 premium increased 7% over 2000 premium of $231 million, which in turn rose 6% over the prior year.
Torchmark's Other life insurance distribution system consists of its Military Agency, United Investors Agency, and other small miscellaneous sales agencies. Torchmark's Military Agency consists of a nationwide independent agency whose sales force is comprised of former commissioned and noncommissioned military officers who sell exclusively to commissioned and noncommissioned military officers and their families. This business consists of whole life products with term insurance riders and is characterized by low lapse rates. The United Investors Agency is comprised of several independent agencies. Prior to 2001, United Investors' distribution was primarily through the sales representatives of a former Torchmark subsidiary, Waddell & Reed. Torchmark spun off Waddell & Reed in 1998, and United Investors terminated the Waddell & Reed agency contract in 2001. However, some Waddell & Reed agents have obtained personal appointments with United Investors in order to continue to sell United Investors' life products. Life premium income from the Other distribution category grew 8% to $245 million in 2001 and also 8% to $227 million in 2000. Life premium income from the Other group accounted for 21% of Torchmark's total life insurance premium income in the year 2001. Annualized life premium in force grew 5% in 2001 to $275 million, after having increased 8% to $262 million in 2000. A major factor in the growth of premium income and in-force premium relates to the high persistency associated with
In addition to life insurance sales, this distribution system has also engaged in the production of variable life collections. In 2001, collections were $34 million, compared with 2000 collections of $41 million, a decline of 18%. In 2000, these collections rose 28% over the prior year. Although variable life collections are not included in premium in force data, they are indicative of growth in the variable life account balance. Indirectly, they add to premium revenue through the policy account charges for insurance coverage and administration as the account balance grows. At December 31, 2001, the variable life account balance was $147 million. The following table summarizes selected variable life insurance information.
Health Insurance. Torchmark markets its supplemental health insurance products through a number of distribution channels. The following table indicates health insurance premium income by distribution method during each of the three years ended December 31, 2001.
Premium for the health insurance segment increased 11% to $1.01 billion in 2001, exceeding the $1 billion milestone in health premium income for the first time. Health premium grew 10% to $911 million in 2000 and 9% to $825 million in 1999. Annualized health premium in force grew 4% to $1.04 billion at December 31, 2001 over the previous year-end balance of $1.00 billion. Health premium in force rose 14% during 2000. Sales of health insurance, in terms of annualized premium issued, declined 16% in 2001 to $213 million, after having increased 31% in 2000 to $252 million. Health sales in 1999 rose 39% to $193 million. The fluctuations in health sales are largely attributable to Medicare Supplement sales in each period.
At one time, the primary competition for Medicare Supplement sales came from Medicare HMOs, the managed care alternative to traditional fee-for-service Medicare which eliminated the need for a supplemental policy. However, in the last few years, growing public dissatisfaction with managed care, increased medical cost inflation and increased Federal Government regulatory pressures on Medicare HMO's have caused a number of HMO's to withdraw from the market, reducing that competition. Other regulatory issues continue to affect the Medicare Supplement market. Medical cost inflation and changes to the Medicare program cause the need for annual rate increases, which generally require state insurance department approval. In addition, Congress and the Federal Administration have begun studying ways to restructure the Medicare program. Therefore, it is likely that changes will be made to the Medicare program at sometime in the future. However, it appears that there will continue to be an important role for private insurers in helping senior citizens cover their healthcare costs. As a result, Medicare Supplements should continue as a popular product for senior-age consumers.
Cancer insurance premium in force was flat in 2001 at $169 million, compared with 10% growth in 2000 and 6% growth in 1999. Sales of this product rose 7% in 2001 to $11 million after having declined in 2000 to $10 million from $11 million of 1999 sales. A portion of the growth in cancer annualized premium in force has been attributable to premium rate increases to offset increased health care costs. Cancer insurance products are sold primarily by the Liberty National Exclusive Agency. This agency represented 86% of Torchmark's total cancer annualized premium in force at December 31, 2001.
Health insurance underwriting income before other income and administrative expense rose 8% in 2001 to $173 million, after having increased 11% in 2000. As a percentage of premium, underwriting income before other income and administrative expense remained somewhat steady throughout the three-year period ending in 2001, rising slightly in 2000 and declining slightly in 2001. Medicare Supplement margins are restrained by the federally mandated minimum loss ratio of 65%. Cancer product obligation ratios have increased in recent years primarily due to higher loss ratios experienced on a closed block of business. Management has actively sought timely and adequate premium rate increases from regulatory authorities to offset these cost increases and to maintain margins on this business.
Annuities. Annuity products are marketed by Torchmark to service a variety of needs, including retirement income and long-term, tax-deferred growth opportunities. Prior to 2001, Torchmark's annuities were sold primarily by the Waddell & Reed sales force, which marketed United Investors annuities and other products under a marketing agreement. In 2000, this sales force collected 96% of Torchmark's total annuity collections. Effective April 30, 2001, Torchmark terminated the marketing agreement providing for the sale of Torchmark's variable annuities by the Waddell & Reed sales force. Waddell & Reed was a former subsidiary of Torchmark which was spun off in 1998 and is no longer affiliated. In addition to no longer marketing United Investors' products, Waddell & Reed has been replacing United Investors' products with those of another carrier. As a result, Torchmark has experienced declines in annuity sales and deposit balances. A successor underwriter to market the variable annuity products of United Investors was appointed effective May 1, 2001. While Torchmark is now distributing variable annuities through other broker-dealers, it does not expect to emphasize the growth of this product line in the future.
In addition to the annuities marketed by the United Investors Agency, a small amount of fixed annuities are sold by the United American Independent Agency and the Liberty National Agency.
Annuity premium is added to the annuity account balance as a deposit and is not reflected in income. Revenues on both fixed and variable annuities are derived from charges to the annuity account balances
The following table presents the annuity account balance at each year end and the annuity collections for each year for both fixed and variable annuities.
Collections of fixed annuity premium were $33 million in 2001, compared with $42 million in 2000, a 20% decrease. Fixed annuity premium collections declined 42% in 2000 from $72 million in 1999. The fixed annuity deposit balance declined 8% to $610 million at year-end 2001 from $662 million at year-end 2000. It declined 2% in the prior year from $677 million at year-end 1999. Torchmark has experienced weaker sales as a result of the reduced sales force and its reduced emphasis of these products. Lower interest rates have also been a factor in the reduced collections as alternative investments and other products have become more attractive.
Variable annuity collections declined 82% in 2001 to $112 million from $608 million in the prior year. Variable collections rose 55% from $393 million in 1999. The variable annuity account balance declined 34% in 2001 to $2.4 billion at December 31, 2001 from $3.6 billion at December 31, 2000. It increased 9% in 2000 from $3.3 billion at December 31, 1999. The introduction of a new product in 2000 had a positive influence on sales of variable annuities in spite of market weakness in that year. However, the loss of the Waddell & Reed sales force as well as weaker financial markets are believed to have been the primary cause of the decline in variable annuity sales in 2001, with replacement activity by Waddell & Reed and the weaker markets contributing greatly to the decline in the variable annuity deposit balance. Variable accounts are valued based on the market values of the underlying securities.
Annuity underwriting income before other income and administrative expense was $26 million in 2001, declining 17% from $31 million in 2000. The decline in 2001 is a result of the increased amortization of deferred acquisition costs caused by the increased surrender activity. Underwriting income rose 15% from $27 million in 1999. Policy charges have risen in each period, increasing 13% in 2001 and 29% in 2000. Growth in policy charges is primarily related to the growth in the size of the annuity account balance. Growth in deposit balances accounted for the growth in charges in 2000. However, in 2001, the decline in policy charges related to the asset balance were more than offset by increased surrender charges.
Net investment income grew 4% to $492 million in 2001. In 2000, net investment income increased 6% to $472 million after having declined 3% in 1999. On a tax-equivalent basis, in which the yield on tax-exempt securities is adjusted to produce a yield equivalent to the pretax yield on taxable securities, investment income rose 3% in 2001, after increasing 5% in 2000 and declining 3% in 1999. The 2001 increase was caused by the growth in mean invested assets, which rose 5% during the year to $6.9 billion. Mean invested assets are computed on the basis of book value. Average yield on the portfolio declined approximately 7 basis points during 2001 to 7.11%, as rates have generally declined on investments acquired during this period. This decline in yield partially offset the benefit to net investment income from the larger asset base. The 2000 increase in investment income resulted from a combination of the growth in mean invested assets and an increase in yield. Mean invested assets rose 4% to $6.6 billion in 2000 over the prior year. Higher interest rates in financial markets caused yields on the portfolio to rise 10 basis points in 2000 to 7.18%. New cash flow was invested primarily in taxable fixed maturities in both 2001 and 2000. The mean fixed maturity balance rose $381 million or 7% to $6.1 billion in 2000 and $253 million or 4% in 2001. The growth in mean invested assets was achieved in both 2001 and 2000 even though $303 million and $147 million were used to buy Torchmark stock in 2001 and 2000, respectively. Additionally, $95 million was used to pay down long and short-term debt in 2000.
Excess investment income increased 13% in 2001 after having increased 5% in both 2000 and 1999. Because of the effect of repurchases of Torchmark stock, excess investment income on a per share basis increased 15% in 2001 and 10% in 2000. The 2001 growth in excess investment income of $29 million was due in large part to the reductions in financing costs brought about through the lower interest rate environment and the call of the MIPS during the year. The increase in tax-equivalent investment income due to the growth in the invested asset base was also a contributing factor. The 5% increase in excess investment income in 2000 correlated closely with the change in tax-equivalent investment income for the same period.
During 2001, Torchmark adopted a new accounting principle, Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interest in Securitized Financial Assets (EITF 99-20), which changed the method of accounting for certain of its asset-backed securities. As a result of the requirements of the new principle, Torchmark wrote these investments down $41 million, or $27 million net of tax, which has been reported as a change in accounting principle. Future impairment of these assets will be reported as realized investment losses. Subsequent to the adoption of the new rule, an additional impairment loss of $1.6 million after tax was recorded. Additionally, certain of the asset-based securities were sold during 2001 for proceeds of $40 million at a loss of $170 thousand after tax. At year-end 2001, $20 million at market value of asset-backed securities were held subject to EITF 99-20. For more information on this new accounting rule, see Note 15-- Changes in Accounting Principles in the Notes to Consolidated Financial Statements on page 68 of this report.
The "yield curve" represents the difference between long and short-term rates on government securities of different maturities. When the curve is "flat" or "inverted", higher returns on new investments are generally available with shorter maturities. When the curve is "positive", longer maturities must be sought to obtain higher returns. In 2000, when the yield curve was relatively flat, higher returns were possible in spite of a shortening of maturities. During 2001, the slightly inverted yield curve which opened the year was replaced with a positively sloping yield curve by year end. In this environment, attaining desired yields on permanent investments required the extension of maturities. For this reason, Torchmark made acquisitions with longer maturities in 2001. The average life of 2001 purchases was 13.8 years, compared with 7.7 years in 2000 and 14.9 years in 1999. In 2001, new investments in fixed maturities totaled $1.5 billion, compared with $1.1 billion in 2000 and $2.1 billion in 1999. Acquisitions in 2001 were made at an effective compounded yield of 7.49%,compared with an effective compounded yield of 8.07% in 2000 and 7.54% in 1999. These yields equate to nominal yields on acquisition of 7.35%, 7.87% and 7.38%, respectively, for 2001, 2000, and 1999. The amount of fixed maturity acquisitions varied by year, primarily due to tax-motivated sales activity in all years and particularly the investment of the $124 million proceeds from the sale of real estate holdings in 1999.
Even though the average life of new investments increased significantly in 2001, the average life of the entire portfolio remained rather stable. The average life of the portfolio was 12.0 years at year-end 2001, 11.8 years at year-end 2000, and 12.7 years at year-end 1999.
Portfolio adjustments taken during 2001 resulted in sufficient realized tax gains to enable Torchmark to offset completely its tax loss carry-forward which originated in 1999 and carried through to 2001. Sales of fixed maturities for tax and other purposes in 2001 resulted in a pre-tax realized loss of $7 million. However, realized gains, principally through the change in value of Torchmark's fixed to floating swaps, reduced the net loss to $2 million. In 2000, $12 million of capital losses were offset by a $8 million gain on the swap and other investments. In 1999, losses of fixed maturities were $30 million. However, these losses were compounded by an $18 million reduction in swap value and a $63 million loss on the sale of real estate for a total realized investment loss of $111 million.
The following table illustrates the market risk sensitivity of Torchmark's interest-rate sensitive fixed-maturity portfolio at December 31, 2001 and December 31, 2000. This table measures the effect of a change in interest rates (as represented by the U.S. Treasury curve) on the fair value of Torchmark's fixed-maturity portfolio. The data is prepared through a model which incorporates various assumptions and estimates to measure the change in fair value arising from an immediate and sustained change in interest rates in increments of 100 basis points. It takes into account the effect that special option features such as call options, put options, and unscheduled repayments could have on the portfolio, given the changes in rates. The valuation of these option features is dependent upon assumptions about future interest rate volatility that are based on past performance.
Torchmark's insurance operations generate positive cash flows in excess of its immediate needs. Cash flows provided from operations were $662 million in 2001, compared with $533 million in 2000 and $512 million in 1999. In addition to operating cash flows, Torchmark received $263 million in investment maturities and repayments during 2001, adding to available cash flows. Such repayments were $226 million in 2000 and $413 million in 1999. Cash flows in excess of immediate requirements are used to build an investment base to fund future requirements. Available cash flows are also used to repay debt, to buy Torchmark shares, to pay shareholder dividends, and other corporate uses. While Torchmark's cash flows have historically been positive and very strong, a reduction in cash flow could negatively affect liquidity.
The carrying value of the funded debt was $536 million at December 31, 2001, compared with $366 million a year earlier.
Torchmark issued $180 million principal amount of 6 1/4% Senior Notes in December, 2001. These notes will mature on December 15, 2006 and may not be redeemed prior to maturity. There is no sinking fund requirement. Interest is payable semi-annually on June 15 and December 15. These notes are unsecured and rank equally with Torchmark's other unsecured indebtedness. Proceeds from the issuance, after underwriter's discount and expenses of the offering, were approximately $178 million. Proceeds were used initially to pay down short- term debt.
In connection with this issuance, Torchmark entered into a five-year swap agreement with an unaffiliated party to swap the 6 1/4% fixed rate payment obligation for a floating rate obligation. The floating rate is based on the six-month LIBOR and resets every six months. At December 31, 2001, the floating rate was 3.11%. This swap derivative qualifies as a hedge under accounting rules. Therefore, changes in its market value will be substantially offset by changes in the value of the debt security. Torchmark's derivative instruments are classified as Other Invested Assets.
In 2000, all of the debt previously acquired by insurance subsidiaries was acquired from those subsidiaries by the parent company. Additionally, another $4.6 million principal amount of the 7 7/8% Notes and $2.0 million principal amount of the 7 3/8% Notes were acquired by Torchmark in 2000 at a cost of $4.2 million and $1.9 million, respectively. The redemption of this debt in 2000 resulted in an after-tax gain of $202 thousand. In 2001, $8.1 million par value of the 7 7/8% Notes was acquired by Torchmark at a cost of $8.3 million, resulting in an after-tax loss of $277 thousand.
The two offerings resulted in proceeds to the Capital Trusts of $145 million, after underwriters' discount and issue expenses. The Capital Trusts in turn used the proceeds to buy 7 3/4% Junior Subordinated Debentures from Torchmark in like amount. Torchmark used these proceeds to redeem its remaining outstanding 9.18% MIPS in the approximate amount of $110 million, with the remaining proceeds used to pay down short-term debt. The MIPS were redeemed November 30, 2001.
The MIPS were originally issued in 1994 at a redemption amount of $200 million with a monthly dividend based on an annual rate of 9.18%. The MIPS were redeemable at Torchmark's option at any time after September 30, 1999 at the full redemption amount of $25 per share. Torchmark elected to redeem the MIPS in full during 2001 in three transactions which resulted in an after-tax loss on redemption of $4.3 million. Funds to repay $110 million of the principal amount were derived from the issuance of the trust preferred securities in November, 2001, while the remaining $90 million balance was redeemed using corporate cash flow or by short-term borrowings earlier in the year.
Torchmark continues to make share purchases from time to time under its share repurchase program in the open market when market conditions are favorable. In 2001, Torchmark acquired 7.8 million shares on the open market at a cost of $303 million. Torchmark purchased 6.1 million shares at a cost of $147 million in 2000 and 6.7 million shares at a cost of $222 million in 1999. Torchmark plans to continue to make share purchases when prices are attractive. Share purchases could have a favorable impact on earnings per share and return on equity but could cause a reduction in book value per share.
In each of the years 2001, 2000 and 1999, Torchmark executed stock option exercise and restoration programs in which Torchmark employees and directors exercised vested stock options and received a reduced number of new options at the current market price. While these programs resulted in the issuance of new shares, a substantial portion of the new shares were sold immediately by the participants in the open market to cover the cost of the purchased shares and the related minimum taxes. As a result of these restoration programs, management's ownership interest increased, and Torchmark received a significant current tax benefit from the exercise of the options. The 2000 program was conducted for two executives not able to participate in the 1999 program. The following table presents key information about the programs.
Shareholders' equity rose 13% to $2.50 billion at December 31, 2001. Shareholders' equity increased 10% in 2000, from $1.99 billion at year-end 1999 to $2.20 billion at year-end 2000. Book value per share was $20.32 at 2001 year end, compared with $17.43 at year-end 2000. After adjusting for the impact on shareholders' equity for security value fluctuations due to changes in interest rates in financial markets, shareholders' equity rose from $2.15 billion at year-end 1999 to $2.34 billion at year-end 2000 to $2.50 billion at year-end 2001. Book value per share was $20.32 at year-end 2001, an increase of 10% over $18.53 at year-end 2000. Book value per share rose 14% in 2000 from $16.32 at year-end 1999. The increases in adjusted book value and book value per share in each period resulted primarily from the addition of earnings and were achieved in spite of the Torchmark share purchases of $303 million in 2001 and $147 million in 2000. Return on common shareholders' equity was 16.1% in 2001, compared with 16.3% in 2000 and 16.2% in 1999. The return-on-equity ratios exclude the mark up or down of shareholders' equity for changes in security values caused by fluctuations in market interest rates. They are also computed on a basis of net operating income before nonrecurring charge, as defined on page 18 of this report.
Credit Ratings. Torchmark's debt instruments and capital securities are rated as to quality by various rating agencies. The chart below presents selected ratings as of December 31, 2001.
- -------- * May be increased or reduced by the effect of interest-rate swaps.
Litigation. Torchmark and its subsidiaries continue to be named as parties to pending or threatened litigation, most of which involves punitive damage claims based upon allegations of agent misconduct at Liberty in Alabama. Such punitive damage claims are tried in Alabama state courts where any punitive damage litigation may have the potential for significant adverse results. Bespeaking caution is the fact that it is impossible to predict the extent of punitive damages that may be awarded if liability is found in any given case, since punitive damages in Alabama are based upon the compensatory damages (including mental anguish) awarded and the discretion of the jury in awarding compensatory damages is not precisely defined. It is thus difficult to predict with certainty the liability of Torchmark or its subsidiaries in any given case because of the unpredictable nature of this type of litigation. Based upon information presently available, and in light of legal and other factual defenses available to Torchmark and its subsidiaries, contingent liabilities arising from threatened and pending litigation are not presently considered by management to be material. For more information concerning litigation, please refer to Note 18--Commitments and Contingencies in the Notes to Consolidated Financial Statements beginning on page 74.
First Command. Lamar C. Smith, elected a director of Torchmark in October 1999, is an officer, director and 15% owner of First Command Financial Services, Inc. (First Command), which receives commissions as the Military Agency distribution system for selling certain life insurance products offered by Torchmark's insurance subsidiaries. These commissions were $48.2 million in 2001, $43.5 million in 2000, and $39.2 million in 1999.
During 2001, Torchmark entered into a coinsurance agreement with First Command whereby Torchmark cedes back to First Command approximately 5% of the new life insurance business sold by First Command on behalf of Torchmark's insurance subsidiaries. Under the terms of this agreement, First Command pays Torchmark expense allowances equal to 5.5% of all premium collected and an additional 2.9% of first year premium. First Command reimburses Torchmark for premium taxes. Also under the agreement, Torchmark provides First Command certain administrative, accounting, and investment management services. Premium ceded in 2001 was $108 thousand. At December 31, 2001, life insurance ceded was $47 million and annualized ceded premium was $398 thousand.
transaction was $10 million after tax. At the time of the transaction, Mr. Richey was a one-third investor in Elgin Development Company. His total investment in Elgin Development was approximately $1.5 million. The outstanding balance of the collateralized note with Elgin Development Company, which is included in fixed maturities, was $10.5 million at December 31, 2001.
Additionally, Liberty loaned Mr. Baxley's wife $883 thousand secured by a mortgage on a building sold to her in 1997. Interest is charged at a rate of 7.7%. Scheduled cash payments are made to Liberty to amortize the loan over thirty years. However, there is a balloon payment due at the end of ten years (2007) in the amount of $712 thousand less a credit of $18 thousand if all payments are made timely. To date, all payments have been timely. At December 31, 2001, the outstanding balance of this loan was $824 thousand.
Goodwill and Other Intangible Assets (SFAS No. 142) changes the way business combinations and goodwill are accounted for. SFAS No. 142 changes the accounting for goodwill and certain other intangible assets from an amortization method to an impairment method. Accordingly, amortization of goodwill, including goodwill recorded in past business combinations, will cease upon adoption of that Statement. Goodwill will be tested annually for impairment based on the specific requirements outlined by SFAS No. 142.
Torchmark adopted SFAS No. 142 on January 1, 2002. While Torchmark is currently assessing the impact of SFAS No. 142 on its financial statements, it does not appear that goodwill is impaired. At December 31, 2001, Torchmark's goodwill was $378 million and annual goodwill amortization expense was approximately $12 million. The goodwill balance will be frozen and not amortized. Torchmark's insurance intangibles are subject to recoverability testing under previously issued accounting rules. There are no other significant intangible assets.
Accounting for the Impairment of Disposal of Long-Lived Assets (SFAS No. 144) is effective for Torchmark beginning January 1, 2002. It requires one accounting model be used for long-lived assets to be disposed of and broadens the presentation of discontinued operations to include more disposal transactions. It retains previous requirements regarding the impairment of long-lived assets. It is not anticipated that this Statement will have a material impact on Torchmark.
Future Policy Benefits. Because of the long-term nature of insurance contracts, Torchmark's insurance companies are liable for policy benefit payments many years into the future. The liability for future policy benefits represents estimates of the present value of Torchmark's insurance subsidiaries' expected benefit payments, net of the related present value of future net premium collections. It is determined by standard actuarial procedures, using assumptions as to mortality (life expectancy), morbidity (health expectancy), persistency, and interest rates, which are based on Torchmark's subsidiaries' previous experience with similar products. For the majority of Torchmark's insurance products, the assumptions used were those considered to be appropriate at the time the policies were issued. An additional provision is made on most products to allow for possible adverse deviation from the assumptions assumed. For insurance products considered to be interest-sensitive or deposit-balance type products, the assumptions are monitored on a regular basis and modified when it is determined that actual experience is different from that previously assumed. While management and company actuaries have used their best judgment in determining the assumptions and in calculating the liability for future policy benefits, there is no assurance that the estimate of the liabilities reflected in the financial statements represents Torchmark's ultimate obligation. Additionally, significantly different assumptions could result in materially different reported amounts. A complete list of the assumptions used to calculate the liability for future policy benefits is reported in Note 7--Future Policy Benefits Reserves in the Notes to Consolidated Financial Statements found on page 59 of this report.
Deferred Acquisition Costs and Value of Insurance Purchased. The costs of acquiring new business are generally deferred and recorded as an asset on the balance sheet. Deferred acquisition costs consist primarily of sales commissions and the other underwriting costs of new insurance sales. Additionally, the costs of acquiring blocks of insurance from other companies or through the acquisition of other companies are also deferred and recorded as assets under the caption "Value of Insurance Purchased." Deferred acquisition costs are amortized with interest in a systematic manner which matches these costs against the associated revenues. The assumptions used to amortize acquisition costs with regard to interest, mortality, morbidity, and persistency are consistent with those used to estimate the liability for future policy benefits. For interest-sensitive and deposit-balance type products, these assumptions are reviewed on a regular basis and are revised if actual experience differs significantly from original expectations. Deferred acquisition costs are subject to periodic recoverability and loss recognition testing. These tests ensure that the present value of future contract-related cash flows will support the capitalized deferred acquisition cost balance. These cash flows consist primarily of premium income, less maintenance expenses taking inflation into account. The present value of these cash flows, less the benefit reserve, is then compared with the unamortized deferred acquisition cost balance. In the event the asset balance is greater, this deficiency is charged to expense as a component of amortization and the asset balance is reduced to the recoverable amount. For more information about accounting for deferred acquisition costs see Note 1--Significant Accounting Policies and Note 5--Deferred Acquisition Costs in the Notes to Consolidated Financial Statements on pages 51 and 58 of this report, respectively.
Policy Claims and Other Benefits Payable. This liability consists of known benefits currently payable and an estimate of claims currently expected to be payable but which have not been submitted. The estimate of unsubmitted claims is based on prior experience. Torchmark management makes an estimate after careful evaluation of all information available to the company. However, there is no certainty the stated liability for claims and other benefits, including the estimate of unsubmitted claims, will be Torchmark's ultimate obligations.
Revenue Recognition. Premium income for Torchmark's subsidiaries' insurance contracts is generally recognized as the premium is collected. However, in accordance with generally accepted accounting principles, revenue on limited- payment contracts and universal life-type contracts (deposit balance products) are recognized differently. Revenues on limited-payment contracts are recognized over the contract period. Premium for deposit balance products, such as Torchmark's annuity and interest-sensitive life policies, is added to the policy account value. The policy account value (or deposit balance) is a Torchmark liability. This deposit balance is then charged a fee for the cost of insurance, administration, surrender, and certain other charges which are recognized as revenue in the period the fees are charged to the policyholder. In each case, benefits and expenses are matched against revenues in a manner by which they are incurred as the revenues are earned.
Investment income is reported as revenue by Torchmark when it is earned less investment expenses. The investment activities of Torchmark are integral to its insurance operations. Because life and health insurance claims and benefits may not be paid until many years into the future, the accumulation of cash flows from premium receipts are invested. Anticipated yields earned on investments are reflected in premium rates, contract liabilities, and other product contract features. These yield assumptions are implied in the interest required on Torchmark's net insurance liabilities (future policy benefits less deferred acquisition costs) and contractual interest obligations in its insurance and annuity products. Torchmark benefits to the extent actual net investment income exceeds the required interest on net insurance liabilities and the interest on its debt. During 2001, the yield on the investment portfolio exceeded the weighted-average contractual interest requirement by 125 basis points. Torchmark will continue to be required to provide for future contractual obligations in the event of a decline in investment yield. For more information concerning revenue recognition, investment accounting, and interest sensitivity, please refer to Note 1--Significant Accounting Policies on page 50, Note 3--Investments beginning on page 54 in the Notes to Consolidated Financial Statements and discussions under the captions Annuities on page 27, Investments on page 29, and Market Risk Sensitivity on page 31 of this report.
We have audited the accompanying consolidated balance sheets of Torchmark Corporation and subsidiaries as of December 31, 2001 and 2000, and the related consolidated statements of operations, comprehensive income, shareholders' equity, and cash flow for each of the three years in the period ended December 31, 2001. Our audits also included the financial statement schedules listed in the Index at Item 14. 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.
TORCHMARK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollar amounts in thousands except per share data)
Basis of Presentation: The accompanying financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (GAAP). The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Principles of Consolidation: The financial statements include the results of Torchmark and its wholly-owned subsidiaries. Subsidiaries which are not majority-owned are reported on the equity method. All significant intercompany accounts and transactions have been eliminated in consolidation.
Investments: Torchmark classifies all of its fixed maturity investments, which include bonds and redeemable preferred stocks, as available for sale. Investments classified as available for sale are carried at fair value with unrealized gains and losses, net of deferred taxes, reflected directly in other accumulated comprehensive income. Investments in equity securities, which include common and nonredeemable preferred stocks, are reported at fair value with unrealized gains and losses, net of deferred taxes, reflected directly in other accumulated comprehensive income. Policy loans are carried at unpaid principal balances. Mortgage loans are carried at amortized cost. Investments in real estate are reported at cost less allowances for depreciation, which are calculated on the straight line method. Short-term investments include investments in certificates of deposit and other interest- bearing time deposits with original maturities within twelve months. If an investment becomes permanently impaired, such impairment is treated as a realized loss and the investment is adjusted to fair market value.
Recognition of Premium Revenue and Related Expenses: Premiums for insurance contracts which are not defined as universal life-type according to Statement of Financial Accounting Standards (SFAS) No. 97 are recognized as revenue over the premium-paying period of the policy. Profits for limited-payment life insurance contracts as defined by SFAS 97 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 annuity products are also assessed an investment management fee and a sales charge. Life premium includes policy charges of $71.3 million, $71.4 million, and $71.9 million for the years ended December 31, 2001, 2000, and 1999, respectively. Other premium includes annuity policy charges for the years ended December 31, 2001,
2000, and 1999, of $59.5 million, $52.2 million, and $40.5 million, respectively. Profits are also earned to the extent that investment income exceeds policy requirements. The related benefits and expenses are matched with revenues by means of the provision of future policy benefits and the amortization of deferred acquisition costs in a manner which recognizes profits as they are earned over the same period.
Future Policy Benefits: The liability for future policy benefits for universal life-type products according to SFAS 97 is represented by policy account value. The liability for future policy benefits for all other life and health products is provided on the net level premium method based on estimated investment yields, mortality, morbidity, persistency and other assumptions which were appropriate at the time the policies were issued. Assumptions used are based on Torchmark's experience as adjusted to provide for possible adverse deviation. These estimates are periodically reviewed and compared with actual experience. If it is determined future experience will probably differ significantly from that previously assumed, the estimates are revised.
Deferred acquisition costs, including the value of life insurance purchased, for policies other than universal life-type policies, are amortized with interest over the estimated premium-paying period of the policies in a manner which charges each year's operations in proportion to the receipt of premium income. For limited-payment contracts, acquisition costs are amortized over the contract period. For universal life-type policies, acquisition costs are amortized with interest in proportion to estimated gross profits. The assumptions used as to interest, persistency, morbidity and mortality are consistent with those used in computing the liability for future policy benefits and expenses. If it is determined that future experience will probably differ significantly from that previously assumed, the estimates are revised. Deferred acquisition costs are adjusted to reflect the amounts associated with realized and unrealized investment gains and losses pertaining to universal life-type products.
Impairments: Torchmark accounts for impairments in accordance with the provisions of SFAS 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of. This standard requires that certain long-lived assets used in Torchmark's business as well as certain intangible assets, including goodwill, be reviewed for impairment when circumstances indicate that these assets may not be recoverable, and further provides how such impairment shall be determined and measured. It also requires that long- lived assets and intangibles to be disposed of be reported at the lower of carrying amount or fair value less cost to sell. Except for Torchmark's writedown of asset-backed securities in 2001, as discussed in Note 15--Changes in Accounting Principles on page 68 of this report, and the writedown of real estate in 1999, as discussed in Note 3--Investments on page 56 of this report, there were no significant impairments in the three years ending 2001.
The Financial Accounting Standards Board (FASB) issued SFAS No. 142, Goodwill and Other Intangible Assets, which is effective on January 1, 2002. SFAS No. 142 changes the accounting for goodwill and certain other intangible assets from an amortization method to an impairment method. Accordingly, amortization of goodwill, including goodwill recorded in past business combinations, will cease upon adoption of that Statement. Goodwill will be tested annually for impairment based on the specific requirements outlined by SFAS No. 142. Torchmark adopted SFAS No. 142 on January 1, 2002. While Torchmark is currently assessing the impact of SFAS No. 142 on its consolidated financial statements, it does not appear that goodwill is impaired. Because of the requirements of this Statement, Torchmark's goodwill will be frozen at the December 2001 balance and not amortized. At December 31, 2001, Torchmark's goodwill was $378 million and previous annual goodwill amortization expense was approximately $12 million.
Reclassifications: Certain amounts in the consolidated financial statements presented have been reclassified from amounts previously reported in order to be comparable between years. These reclassifications have no effect on previously reported shareholders' equity or net income during the periods involved.
Proceeds from sales of fixed maturities available for sale were $881 million in 2001, $629 million in 2000, and $1.24 billion in 1999. Gross gains realized on those sales were $20.6 million in 2001, $8.2 million in 2000 and $4.3 million in 1999. Gross losses were $21.4 million in 2001, $10.7 million in 2000, and $36.5 million in 1999. There were no sales of equity securities available for sale during 2001. Proceeds from sales of equity securities available for sale were $39.7 million in 2000 and $260 thousand in 1999. Gross gains realized on those sales were $6.5 million in 2000 and $215 thousand in 1999. Gross losses were $3.2 million in 2000 and -0- in 1999.
In 1999, Torchmark disposed of most of its investment real estate. In the second quarter of 1999, efforts to dispose of these properties revealed that the carrying value of the real estate exceeded its estimated realizable value. For this reason Torchmark wrote down its investment real estate portfolio to its estimated realizable value as of June 30, 1999. This write down resulted in a pretax loss of $64 million, or $41 million after tax. The majority of the investment real estate was sold in two transactions in the latter half of 1999 for total consideration of $123 million, of which $111 million was in cash and the remainder in a ten-year collateralized note. After the sales, Torchmark retained $16.4 million in investment real estate, of which $8 million was included with properties partially occupied by Torchmark subsidiaries. At December 31, 2001, Torchmark owned $14.1 million in investment real estate, of which $7.5 million was included with properties partially occupied by Torchmark subsidiaries.
A summary of the assumptions used in determining the liability for future policy benefits at December 31, 2001 is as follows:
The overall average interest assumption for determining the liability for future life and health insurance benefits in 2001 was 6.1%.
The excess benefit pension plan provides the benefits that an employee would have otherwise received from a defined benefit pension plan in the absence of the Internal Revenue Code's limitation on benefits payable under a qualified plan. Although this plan is unfunded, pension cost is determined in a similar manner as for the funded plans. Liability for the excess benefit plan was $5.4 million and $4.6 million at December 31, 2001 and 2000, respectively.
In accordance with FASB Statement No. 132, Employers' Disclosures about Pensions and Other Postretirement Benefits, the following table presents a reconciliation from the beginning to the end of the year of the benefit obligation and plan assets. This table also presents a reconciliation of the plans' funded status with the amounts recognized on Torchmark's consolidated balance sheet.
Postretirement Benefit Plans Other Than Pensions: Torchmark provides postretirement life insurance benefits for most retired employees, and also provides additional postretirement life insurance benefits for certain key employees. The majority of the life insurance benefits are accrued over the working lives of active employees.
For measurement purposes, a 7.5% annual rate of increase in per capita cost of covered healthcare benefits was assumed for 2001. The health care cost trend rate assumption has a significant effect on the amounts reported, as illustrated in the following table which presents the effect of a one percentage point increase and decrease on the service and interest cost components and the benefit obligation:
The amount of debt that becomes due during each of the next five years is: 2002--$204,037, 2003--$0, 2004--$0, 2005--$0, and 2006--$180,000.
The Senior Notes, due December 16, 2006, were issued in December, 2001 in the principal amount of $180 million for net proceeds of $178 million. Interest is payable on June 15 and December 15 of each year at a rate of 6 1/4%. The notes are unsecured, may not be redeemed prior to maturity, and have no sinking fund requirement. These notes have equal priority with other Torchmark unsecured indebtedness.
In connection with this issuance, Torchmark entered into a five-year swap agreement with an unaffiliated party to swap the 6 1/4% fixed rate payment obligation for a floating rate obligation. The floating rate is based on the six-month LIBOR plus 120.5 basis points and resets every six months. At December 31, 2001, this rate was 3.11%. This swap derivative qualifies as a hedge under accounting rules. Therefore, changes in its fair market value will be substantially offset by changes in the fair market value of the debt security. Torchmark's derivative instruments are classified as Other Invested Assets.
variable rates for each tranche. In addition, Torchmark can request up to $200 million letters of credit to be issued against the $300 million five-year tranche. The line of credit is further designated as a back-up credit line for a commercial paper program, which cannot exceed $600 million. Torchmark may borrow from the credit facility or issue commercial paper, with total commercial paper outstanding not to exceed $600 million. At December 31, 2001, Torchmark had $204 million face amount of commercial paper outstanding, $168 million of letters of credit issued, and no borrowings under the line of credit. During 2001, the short term borrowings under the combined facilities averaged approximately $311 million, and were made at an average yield of 3.9%. The facility does not have a ratings-based acceleration trigger which would require early payment. A facility fee is charged for the entire $625 million facility, at a rate of 9 basis points for the 364-day tranch and 11 basis points for the five-year tranch. For letters of credit issued, there is an issuance fee of 29 basis points and a fronting fee of 5 basis points. Additionally, if borrowings on both the line of credit and letters of credit exceed 33% of the total $625 million facility, there is a usage fee of 10 basis points. During 2001, Torchmark's usage of the facility was below this threshold and no usage fee was required. Torchmark is subject to certain covenants for the agreements regarding capitalization and earnings, for which it was in compliance at December 31, 2001.
Interest in the amount of $284 thousand was capitalized during 1999. There was no capitalized interest in 2000 or 2001.
In November 2001, Torchmark established two Capital Trusts, which in turn sold trust preferred securities (trust preferreds) in separate public offerings. Capital Trust I sold 5 million shares while Capital Trust II sold 1 million shares at a combined face amount of $150 million. Both trust preferreds pay a quarterly dividend at an annual 7 3/4% rate which is equivalent to an annual rate of $1.9375 per share. All dividends are cumulative. The trust preferreds are subject to a mandatory redemption on November 2, 2041, but Torchmark has the option to redeem in part or whole the securities on or after November 2, 2006. All payments by the Capital Trusts regarding the trust preferreds are guaranteed by Torchmark. The Capital Trusts are wholly-owned consolidated subsidiaries of Torchmark. The two offerings resulted in net proceeds of $145 million to the Capital Trusts. The Capital Trusts in turn used the proceeds to buy 7 3/4% Junior Subordinated Debentures from Torchmark in like amount. Torchmark used these proceeds to redeem its outstanding 9.18% monthly income preferred securities in 2001 in the approximate amount of $110 million, with the remaining proceeds used to pay down short-term debt. In a related transaction, Torchmark entered into a ten year swap agreement to exchange a variable rate payment for the 7 3/4% fixed dividend obligation. The variable rate is based on the three-month LIBOR plus 221 basis points and resets each quarter when payments are made. The variable rate was 4.10% at December 31, 2001. The swap derivative does not qualify as a hedge for accounting purposes and will be carried on the balance sheet at fair market value. The swap had a fair value of zero at December 31, 2001.
EITF 99-20 also sets forth specific new rules regarding the impairment of asset-backed securities. Future impairments, if any, are to be recognized as a component of realized investment losses. On initial application of this standard, impairments were recognized as a change in accounting principle. Reversals of impairment charges recognized subsequent to adoption of EITF 99- 20 are prohibited.
In accordance with this guidance, Torchmark evaluated the expected cash flows on its asset-backed securities under the new rules. As a result, Torchmark determined that these assets were impaired by $41 million, or $27 million after tax. This impairment charge was recorded as a cumulative effect of a change in accounting principle in the second quarter of 2001. Also, during 2001, Torchmark sold an additional $40 million of these securities after adjustment for the impairment. An additional impairment of $2.5 million was recognized in 2001 and is included in realized investment losses. Torchmark's total investment at fair value in asset-backed securities subject to the accounting guidance at December 31, 2001 was $20 million, or less than 1% of total investments.
Swap Agreements. Since 1994, Torchmark has had in place a swap agreement with an unaffiliated party whereby Torchmark pays a variable dividend rate on a $200 million face amount instrument in exchange for payment of a 9.18% fixed dividend. Effective January 1, 1999, Torchmark changed its method of accounting for this swap agreement to recognize changes in its fair value, net of tax, as realized investment gains or losses. This method of accounting for derivatives was believed to be preferable under the guidance established by Statement of Financial Accounting Standards No. 80, Accounting for Futures Contracts (SFAS 80) and the Securities and Exchange Commission. Previously, Torchmark accounted for the swap using hedge accounting under SFAS 80. The after-tax cumulative effect of the change at January 1, 1999 was a gain of $16.1 million (net of income taxes of $8.7 million) and is included in income for the twelve months ended December 31, 1999. The effect of the change on the twelve months ended December 31, 1999 was to increase realized losses by $11.7 million ($.09 per diluted share) excluding the cumulative effect of the change in accounting principle.
Share Data: A summary of preferred and common share activity is as follows:
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. These restrictions generally limit the payment of dividends by insurance subsidiaries to statutory net gain from operations before realized capital gains or losses on an annual noncumulative basis in the absence of special approval. Additionally, insurance companies are generally not permitted to distribute the excess of shareholders' equity as determined on a GAAP basis over that determined on a statutory basis. In 2002, $299 million will be available to Torchmark for dividends from insurance subsidiaries in compliance with statutory regulations without prior regulatory approval.
Certain employees, directors, and consultants have been granted options to buy shares of Torchmark stock, generally at the market value of the stock on the date of grant, under the provisions of the various Torchmark stock option plans. The options are exercisable during the period commencing from the date they vest until expiring ten years and two days or eleven years after grant. Employee and consultant stock options generally vest one-half in two years and one-half in three years. Formula-based director grants generally vest in six months. Grants in August, 2001 and November, 1999 vested immediately for all optionees other than those subject to SEC Section 16(a) reporting, whose options vest in six months. A grant in December, 2000 vested in six months. Stock options awarded in connection with compensation deferrals by certain directors and executives vest over ten years. Torchmark generally issues shares for the exercise of stock options out of treasury stock.
The fair value for Torchmark's employee stock options was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted average assumptions for 2001, 2000, and 1999:
Torchmark executed a stock option exercise and restoration program on August 9, 2001 and November 15, 1999 through which 122 and 80 Torchmark directors and employees, respectively, exercised vested stock options. These participants were granted a reduced number of new options at the respective current market price. The August 9, 2001 and November 15, 1999 programs resulted in the issuance of 4.0 million shares and 1.8 million shares, respectively, of which 3.5 million shares and 1.2 million shares, respectively, were immediately sold by the directors and employees through the open market to cover the cost of the purchased shares and related taxes. Another restoration program was effected on December 20, 2000 involving two employees who were not able to participate in the 1999 restoration program. They exercised vested options resulting in the issuance of 433 thousand shares, of which 283 thousand shares were sold by the employees to pay the exercise price and minimum withholding taxes. As a result of these restoration programs, management's ownership interest increased, and Torchmark received a significant current tax benefit from the exercise of the options.
A summary of Torchmark's stock option activity and related information for the years ended December 31, 2001, 2000, and 1999 follows:
The weighted average fair value of options granted during the years ended December 31, 2001, 2000, and 1999 were $13.00, $12.05, and $9.29, respectively.
The following table summarizes information about stock options outstanding at December 31, 2001:
Insurance affiliates also assume insurance risks of other companies. Life reinsurance assumed represents 2.2% of life insurance in force at December 31, 2001 and reinsurance assumed on life and accident and health products represents 1.7% of premium income for 2001.
Concentrations of Credit Risk: Torchmark maintains a highly diversified investment portfolio with limited concentration in any given region, industry, or economic characteristic. At December 31, 2001, the investment portfolio consisted of the following:
In connection with its line of credit facility with a group of lenders, Torchmark has guaranteed letters of credit of another wholly-owned subsidiary in the maximum amount of $200 million. At December 31, 2001, $168 million of letters of credit were issued.
Litigation: Torchmark and its subsidiaries continue to be named as parties to pending or threatened legal proceedings. These lawsuits involve tax matters, alleged breaches of contract, torts, including bad faith and fraud claims based on alleged wrongful or fraudulent acts of agents of Torchmark's subsidiaries, employment discrimination, and miscellaneous other causes of action. Many of these lawsuits involve claims for punitive damages in state courts of Alabama, a jurisdiction particularly recognized for its large punitive damage verdicts. A number of such actions involving Liberty also name Torchmark as a defendant. In 1999, Alabama enacted legislation limiting punitive damages in non-physical injury cases to the greater of $500,000 or three times compensatory damages. Since this legislation has not undergone scrutiny by appellate courts regarding its constitutionality and a jury's discretion regarding the amount of compensatory damages (including mental anguish) awarded in any given case is not precisely defined, the effect of this legislation on Torchmark's litigation remains unclear. Bespeaking caution is the fact that the likelihood or extent of a punitive damage award in any given case is currently impossible to predict. As of December 31, 2001, Liberty was a party to approximately 86 active lawsuits (including 9 employment related cases and excluding interpleaders and stayed cases), 62 of which were Alabama proceedings and 7 of which were Mississippi proceedings in which punitive damages were sought. Liberty faces trial settings in these cases on an on-going basis.
As previously reported, on March 15, 1999, Torchmark was named as a defendant in consolidated derivative securities class action litigation involving Vesta Insurance Group, Inc. filed in the U.S. District Court for the Northern District of Alabama (In re Vesta Insurance Group, Inc. Securities Litigation. Master File No. 98-AR-1407-S). The amended consolidated complaint in this litigation alleges violations of Section 10(b) of the Securities Exchange Act of 1934 by the defendants Vesta, certain present and former Vesta officers and directors, Vesta's former independent public accountants and Torchmark and of Section 20(a) of the Exchange Act by certain former Vesta officers and directors and Torchmark acting as "controlling persons" of Vesta in connection with certain accounting irregularities in Vesta's reported financial results and filed financial statements. Unspecified damages and equitable relief are sought on behalf of a purported class of purchasers of Vesta equity securities between June 2, 1995 and June 29, 1998. A class was certified in this litigation on October 25, 1999. In September, 2001, Torchmark filed a motion for summary judgment, which was denied by the District Court on January 10, 2002.
As previously reported, Liberty was served on October 28, 1999 with a subpoena from the Florida Department of Insurance in connection with that Department's investigation into Liberty's sales practices and disclosures in the State of Florida regarding industrial life insurance and low coverage life insurance policies. Liberty has also received similar subpoenas from the Alabama, Georgia, Kentucky, Texas, South Carolina and Minnesota Insurance Departments regarding its industrial life insurance and other low face-amount life insurance policies sold in those states. Specific inquiry is made into the historical use of race-based mortality, a practice discontinued by Liberty many years ago. In 1988, Liberty endeavored to convert to paid-up status those purely race-based policies that then remained in premium-paying status. Liberty has been and continues responding to these subpoenas in a timely fashion. In July 2000, the Florida and Georgia Insurance Departments issued cease and desist orders to all companies reporting premium income from industrial life insurance, including Liberty, stating that, to the extent that any company is currently collecting any race-based insurance premiums from Florida and Georgia residents, respectively, it immediately cease and desist from collecting any premium differential based on the race of the policyholders. Upon receiving the Georgia order, Liberty informed the Georgia Insurance Department that Liberty did not interpret the Georgia Department's directive as a cease and desist order since it did not afford Liberty the opportunity for a mandatory or voluntarily requested hearing thereunder. On August 22, 2000, the Florida District Court of Appeals issued an order staying the Florida Insurance Department's immediate final cease and desist order, pending appeals to the Florida Supreme Court. The Florida Supreme Court subsequently reversed and rendered the District Court of Appeals' order, and thus declared the cease and desist order null and void. Liberty, as an Alabama domestic company, was examined by representatives of the Alabama Department of Insurance with regard to issues parallel to those raised by the State of Florida. By order dated January 28, 2002, the Alabama Department finalized a report of its examination of LIberty. The report has now been turned over to the Alabama Department's Legal Division for further consideration.
judgment on the pleadings or in the alternative for summary judgment on January 27, 2000. On April 7, 2000, the District Court entered an order granting Liberty's motion for judgment on the pleadings and dismissing plaintiffs' claims under 42 U.S.C. (S) 1981 with prejudice as time-barred and dismissing their state law claims without prejudice to re-file in state court if desired. Plaintiffs subsequently filed motions with the District Court to reconsider its April 17, 2000 order and for permission to file an amended complaint adding similar claims under 24 U.S.C. (S) 1982. Liberty opposed this motion. On June 22, 2000, purported class action litigation with allegations comparable to those in the Moore case was filed against Liberty in the Circuit Court of Jefferson County, Alabama (Baldwin v. Liberty National Life Insurance Company, Case No. CV 00-684). The Baldwin case is currently stayed pending disposition of the Moore case.
On March 15, 2001, purported class action litigation was filed against Liberty in the United States District Court for the District of South Carolina (Hinton v. Liberty National Life Insurance Company, Civil Action No. 3-01- 68078 19), containing allegations largely similar to the Moore case filed in the Federal District Court for the Northern District of Alabama. Liberty was described in the suit as successor in interest of New South Life Insurance Company (New South), an insurer acquired out of receivership by an entity which was subsequently acquired by Peninsular Life Insurance Company (Peninsular). In 1985, Liberty reinsured a block of insurance business from Peninsular, including business formerly written by New South. Liberty has requested indemnification in the Hinton litigation from Peninsular and its successors in interest. Liberty sought a writ of mandamus in Hinton from the Fourth Circuit Court of Appeals as well as a change of venue to consolidate the Hinton case with the Moore case currently pending in Federal District Court in Alabama. Both the change in venue and the writ of mandamus were denied. However, the South Carolina District Court issued an order inviting the parties to resubmit a motion for change of venue. Liberty National filed such a motion to transfer the case to the U.S. District Court for the Northern District of Alabama, which was granted by the South Carolina District Court on February 12, 2002.
On September 28, 2001, a shareholder derivative action was filed in the Circuit Court of Jefferson County, Alabama against Torchmark, two unaffiliated limited liability companies, and three individual defendants (Bomar v. Torchmark Corporation, Case No. CV 0105981). The derivative action arises from
an October 1, 1999 transaction in which the three individual defendants (one of whom is a director and former Chairman of Torchmark and a second of whom is a former officer of a former real estate subsidiary of Torchmark) acting through two unaffiliated limited liability companies acquired the majority of the investment real estate of Torchmark together with other properties. Plaintiff alleges that, despite review and approval of the transaction by all independent and disinterested members of the Torchmark Board of Directors, the transaction was procedurally and substantively unfair to Torchmark and resulted from the breach of fiduciary duties of loyalty owed to Torchmark by two of the above described individual defendants and the knowing participation of the third individual defendant in the alleged breach of fiduciary duty. Establishment of a constructive trust for such assets for the benefit of Torchmark and its shareholders, an accounting for profits and unspecified compensatory and punitive damages are sought.
Torchmark markets its insurance products through a number of distribution channels, each of which sells the products of one or more of Torchmark's insurance segments. The tables below present segment premium revenue by each of Torchmark's marketing groups.
are managed. It essentially represents gross profit margin on insurance products before insurance administrative expenses and consists of premium, less net policy obligations, acquisition expenses, and commissions. It differs from GAAP pretax operating income before other income and administrative expense because interest credited to net policy liabilities (reserves less deferred acquisition costs and value of insurance purchased) is reflected as a component of the Investment segment in order to match this cost to the investment earnings from the assets supporting the net policy liabilities.
Torchmark has entered into two loan agreements with First Command, a construction loan agreement and a collateral loan agreement. The construction loan was entered into in 2001 and had an outstanding balance of $6.1 million at December 31, 2001. The loan was made at a rate of 7.55% and is collateralized by the construction of a four-story building in Fort Worth, Texas to be completed in late 2002. In addition to the office building as collateral, in the event of default, Torchmark has the right of offset to any commissions due First Command. The maximum amount of borrowing allowed on this loan is $22.5 million. Interest is added to the loan balance until the building is completed. The agreement calls for Torchmark to permanently finance the building with a fifteen-year mortgage at a rate of 2.25% over the ten year treasury rate at inception, but not less than 7%.
loan balance can never exceed 90% of the value of the collateral. The loan accumulated interest until December 31, 2001, after which it is to be repaid with a fixed payment amortizing the loan over fifteen years. The outstanding loan balance at December 31, 2001 was $22.9 million.
At the present time, Mr. Richey is a 25% investor in Stonegate Realty Company, LLC, the parent company of Elgin Development Company which in turn is a 50% owner of Commercial Real Estate Services. Commercial Real Estate Services manages certain of Torchmark's company-occupied and investment real estate properties along with those of other clients. Fees paid by Torchmark subsidiaries for these management and maintenance services were $757 thousand in 2001 and $750 thousand in 2000. Lease rentals paid by Torchmark subsidiaries were $261 thousand and $260 thousand in 2001 and 2000, respectively.
Baxley. William J. Baxley is a partner in the law firm of Baxley, Dillard, Dauphin & McKnight 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 were to be made in the form of legal services at customary rates to be applied against the outstanding balance which would amortize the loan with interest over nine years. 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. At December 31, 2001, the outstanding balance of this loan was $788 thousand.