Torchmark, through its subsidiaries, owns or leases buildings that are used in the normal course of business. Liberty owns a 487,000 square foot building at 2001 Third Avenue South, Birmingham, Alabama which currently serves as Liberty's, UILIC's, and Torchmark's home office. Liberty leases approximately 160,000 square feet of this building to unrelated tenants. Liberty also operates from 61 company-owned district office buildings used for agency sales personnel.
Globe owns a 300,000 square foot office building at 204 North Robinson, Oklahoma City, Oklahoma, of which it occupies 56,138 square feet as its home office and the balance is available for lease. Globe also owns a 330,000 square foot office building complex at 14000 Quail Springs Parkway Plaza Boulevard, Oklahoma City, Oklahoma, and an 80,000 square foot office building at 120 Robert S. Kerr Avenue, Oklahoma City, which are available for lease to other tenants.
In 1996, United American relocated to a new home office building. United American owns and is the sole occupant of this 140,000 square foot facility, located in the Stonebridge Ranch development in McKinney, Texas (a North Dallas suburb). The former home office building on Buckner Boulevard in Dallas, Texas is under contract to be sold.
American Income owns and is the sole occupant of an office building located at 1200 Wooded Acres Drive, Waco, Texas. The building is a two story structure containing approximately 72,000 square feet of usable floor space. In addition, American Income leases office space in various cities throughout the United States.
Torchmark and its primary subsidiaries have significant automated information processing capabilities, supported by centralized computer systems. Torchmark also uses personal computers to support the user-specific information processing needs of its professional and administrative staffs.
In a comparison of 1996 and 1995 results with those of 1994, attention should be given to the acquisition of American Income on November 3, 1994 for total consideration of $552 million. American Income's results were consolidated with Torchmark's after the acquisition date, being included for a full year in 1995 for the first time. American Income added approximately $17 million and $22 million to Torchmark's 1995 and 1996 net income, respectively, after taking into account goodwill amortization and financing costs.
Operating expenses, as a percentage of total revenues, were stable at 7% in both 1996 and 1995. This expense ratio increased from 6.3% in 1994. The higher expense ratios in 1995 and 1996 are related to increased legal and litigation costs at Liberty. In 1995, the increases in goodwill amortization, interest expense, and the MIPS dividend were the result of financing the American Income acquisition in late 1994. Please refer to the following sections of this report for a more complete discussion of this purchase
and the related financing costs: "Acquisition of American Income" on page 30, and "Capital Resources" on page 28. Interest expense declined 9% in 1996 due to debt paydowns. For a more complete discussion of Torchmark's debt, please see the "Capital Resources" discussion.
Life insurance premium is Torchmark's largest component of revenue, representing 39% of total revenue and 53% of total premium. In 1995, Torchmark's life annualized premium in force at year end exceeded its health premium for the first time since 1982. In 1996, the gap between life and health premium increased, as annualized life premium in force grew to 56% of total as opposed to health premium's 44%. Torchmark has emphasized increases in sales of life insurance product lines relative to health and other insurance products because profit margins for life insurance are superior. Additionally, assets backing the higher reserves required for life products provide the potential for Torchmark to increase investment income. Profit margins for life insurance operations, as measured by insurance operating income as a percentage of premium, have approximated 29% in each of the three years presented. By contrast, health margins have not exceeded 16% during the same three years.
The Liberty National Agency distribution system accounted for the most life insurance premium income in each of the three years presented, with 1996 premium representing 33% of Torchmark's total life premium. Annualized life premium in force grew from $297 million at year-end 1995 to $299 million at the end of 1996. Life premium sales, in terms of annualized premium issued, declined 6% during 1996 to $45 million. During the past two years, this agency has completed the transition from a debit-style renewal premium collection system to a direct bill or bank-draft collection system. At the beginning of 1996, debit or home collection sales were discontinued. Under the new system, agents spend more time developing new customers. As expected, a number of agents did not make the transition. During the two year period, the agency force declined 31% to 1,750 agents. However, life insurance production only declined 12%, which is evidence of the strength of the existing sales force. In the fourth quarter of 1996, emphasis was placed on hiring and training new agents under the new system. The agency expects a growth in the number of productive agents, and in turn, growth in sales and in force.
Torchmark's other three distribution channels each experienced premium growth in 1996. The United Investors Exclusive Agency, made up of W&R sales representatives, recorded premium income of $74 million, increasing 6% over 1995. Premium for the United American Exclusive Agency rose 47% to $16 million. Annualized premium sold was $11 million in 1996, gaining 17%. The United American Independent Agency had life premium income growth of 19% to $33 million, and sales growth of 11% to $18 million. The United Investors Agency represents 9% of Torchmark's life premium, while the two United American Agencies represent 6%.
One major factor in maintaining stable operating income margins in the life insurance business is improved persistency. Persistency is beneficial to margins because it lowers the rate of amortization of acquisition costs, and increases profits because the premium life is extended. Persistency improvements have resulted, at least in part, from previously-mentioned changes in the Liberty National Agency marketing system, including revisions in agents' compensation formulas to encourage lower lapses and changing the premium collection method from agent-collected to bank draft and direct bill methods which are characterized by higher persistency. Another contributing factor to improved persistency in life business is a higher proportion of premium from the military distribution system, which has an extremely low lapse rate.
Even though improvements in persistency have occurred in Torchmark's major life insurance lines, acquisition cost ratios rose in each of the years reported. In a comparison of 1996 and 1995 ratios with 1994, the American income purchase must be taken into account. While American Income's life business is very profitable and has a total insurance operating income margin similar to other Torchmark products, it is characterized by lower policy obligations and higher amortization of acquisition costs. The higher acquisition cost ratio is a result of the higher amortization of the value of insurance purchased relative to deferred acquisition costs. Torchmark's discontinuance of active marketing of pre-need funeral insurance has caused the amortization of acquisition cost on this business to increase relative to premium, although the impact on total margins are more than offset by a reduction in policy benefits ratios.
The following chart demonstrates the smaller declines over the past three years for Medicare Supplement annualized premium sales and in force:
The leveling of Medicare Supplement sales as compared to the prior year is due in part to $4 million annualized premium sold through Direct response, a distribution system not previously marketing this product. In addition to higher sales than the previous year, 1996 Medicare Supplement in force benefited from premium rate increases implemented during the year, the first increase in three years.
In recent years, declines in Medicare Supplement premium issued and premium in force were the result of 1990 regulatory requirements that reduced allowable agents commissions on new sales, as well as uncertainties regarding health care reform by the Clinton Administration and Congress. Further, regulatory standardization of policy benefits to 10 standardized plans increased competition because consumers now see these products as a "commodity", differentiated only by price. Increased competition by Health Maintenance Organizations that substitute for traditional Medicare also have dampened sales.
Torchmark is using several strategies to maintain sales of new policies and the persistency of existing in force Medicare Supplement policies. Torchmark's premium rate increases year to year have been less than certain competitors, making Torchmark's rates more price competitive. In addition, new markets such as employer and association groups, and distribution methods such as Direct response are being tested.
As a percentage of premium, insurance operating income for Torchmark's health insurance was stable, approximating 16% in each of the three years considered. While policy obligations as a percentage of premium have risen each year, these increases have been more than offset by the declines in amortization of acquisition costs and commissions. The decline in the amortization of acquisition costs ratio has been caused by improvements in persistency in Torchmark's health business. Excluded from the above presentation of health results in 1994 is a $30 million charge for cancer policy benefits resulting from a reclassification of non-operating expense to health benefits, since actual payments will be made in the form of health benefits.
Annuity premium collections increased 4% in 1996 to $335 million over the prior year. Annuity collections rose 35% to $323 million in 1995. Fixed annuity premium collections declined 35% in 1996 to $87 million from $133 million in 1995, after having risen over three times 1994 collections of $43 million. The 1995 increase was caused by the entry of a United American general agency in the fourth quarter of 1994 that markets to bank customers. These sales generated $76 million in 1995 collections. In 1996, however, these sales declined to $55 million. Additionally, Torchmark's preneed annuity collections declined $19 million in 1996, contributing to the decline in 1996 fixed annuity collections.
The variable annuity account balance also gained 31% over the 1995 period, standing at $1.4 billion at December 31, 1996. The deposit account balance is positively affected by additional deposits resulting from heightened investor interest and by the accounts being valued based on the higher market values of the underlying investments.
requirements, also grew in each of the periods 1994 through 1996. These increases resulted from the growth in the fixed annuity deposit balances.
Financial Services. Torchmark's financial services operations consist of the marketing of 23 mutual funds, including the United Group and the W & R Group of funds through exclusive financial planners. These representatives also market a variety of insurance products of Torchmark subsidiaries. Financial services operations also involve the management of mutual fund portfolios, the management of institutional portfolios, and the servicing of customer accounts. Revenues are derived from commissions from the sale of investment and insurance products, fees for management of investment asset portfolios, and fees for servicing the accounts.
Financial services revenues rose 21% to $221 million in 1996 compared with 1995 revenues of $183 million. These revenues grew 9% in 1995 from 1994 revenues of $167 million. Financial services revenues presented in Torchmark's consolidated financial statements will not correspond to total revenues for the financial services segment presented below in the Summary of Results table because certain revenues are eliminated in consolidation.
Asset management fees of $103 million in 1996 were the largest component of financial services revenues, representing 47% of 1996 segment revenues. Asset management fees grew 20% in 1996, after having gained 22% to $86 million in 1995. Increases in these fees have occurred due to the daily growth in mutual fund assets and institutional assets under management, on which asset management fees are based. Average assets under management rose 17% in 1996 and 14% in 1995. Growth in average assets under management in 1995 and 1996 resulted from two factors. First, strength in the financial markets caused increases in the values of fund securities. Secondly, new net investment product sales and reinvested dividends in each period contributed to asset growth. Total assets under management were $18.9 billion at December 31, 1996, an increase over the prior year end of 3%. Total assets under management were $18.3 billion at December 31, 1995 and $14.5 billion at December 31, 1994, rising 26% in 1995. Mutual fund assets under management rose 14% in 1996 to $17.2 billion at year-end 1996. Asset management fees grew at a higher rate than assets under management in 1996 primarily because of a change in the type of assets under management. The total increase in assets under management for the period of $.6 billion was the result of a $2.1 billion increase in mutual fund assets partially offset by a $1.5 billion decrease in institutional assets. The mutual fund assets that were added have a higher management fee rate than the institutional assets that were lost.
Services fees grew 21% in 1996, after rising 6% in 1995. Service fees are charged based on the number of accounts serviced. The number of accounts serviced was 1.31 million at December 31, 1996, an increase of 7%. Accounts serviced were 1.22 million at year-end 1995 and 1.15 million at year-end 1994. The 1996 fees grew at a rate greater than the number of accounts because of an increase in fees.
Pretax income for Torchmark's financial services operations has grown very rapidly, rising 20% to $113 million in 1996. This growth follows a 12% increase in 1995 to $94 million and a 15% increase in 1994 to $84 million. As a percentage of total financial services revenues, pretax income rose above 51% in 1995 and remained comparable in 1996. The 1995 margin improvement resulted from a greater percentage of financial services revenues coming from asset management fees. Asset management fees have a significantly greater profit margin than commissions and service fees. The proportion of asset management fees to total revenues remained constant in 1996, contributing to the flat margin ratios. While other expenses as a percentage of revenues declined, asset management fees were up about 17% over 1995.
The overall level of interest rates rose sharply during the first half of 1996, then retracted approximately one-half of the advance by year end. In this environment, Torchmark's investment program continued to emphasize investment grade, call-protected corporate securities. New investment acquisitions of fixed income securities totaled $1.08 billion, compared with 1995 acquisitions of $1.87 billion. Acquisitions in 1995, however, were inflated by several sales programs implemented to reduce exposure to prepayments on mortgage-backed securities. During 1996, acquisitions were made at an average yield of 7.12% and an average life of 7.8 years compared with 7.28% and 13.4 years, respectively, for 1995. While there were no significant sales of GNMA holdings as in the past several
Torchmark's fixed maturity portfolio is subject to market risk caused by changes in interest rates in financial markets. Because this portfolio is classified as available for sale, it is valued at market. While the portfolio is sensitive to market fluctuations, these temporary changes in market value have no bearing on the ultimate proceeds at maturity. Torchmark limits its market risk by maintaining a high quality portfolio with a relatively short average life.
The moderate increase in rates in 1996 caused the unrealized gain of the fixed income portfolio to decline. At December 31, 1996, the market value of fixed income investments exceeded book value by $63 million, compared with an unrealized gain of $226 million at the end of 1995 and an unrealized loss of $242 million at year-end 1994. Despite the fluctuation in market values, the portfolio yield remained relatively stable at 7.55%, compared with 7.66% at year-end 1995 and 7.73% at year-end 1994. With shorter maturity acquisitions, the average life of the bond portfolio decreased from 8.8 years at year-end 1995 to 7.8 years currently. At year end, an estimated 38% of the fixed income portfolio will maturity within five years, and 80% will mature within 10 years. This compares with estimates of 38% and 76%, respectively, at year-end 1995.
Torchmark's emphasis on fixed maturity bonds, which represented 90% of invested assets at 1996 year end, caused percentage holdings of other type investments to vary widely with latest industry averages prepared by the American Council of Life Insurance.
The quality of fixed income holdings remains very high, with 95% rated investment grade by Standard & Poor's and the NAIC.
Liquidity. Liquidity pertains to Torchmark's ability to meet on demand the cash commitments required by its business operations and financial obligations. Torchmark's liquidity is obtained from three sources: its positive cash flow from operations, its portfolio of short-term investments, and its line of credit facility.
Torchmark's insurance and asset management operations generate positive cash flows in excess of its immediate needs. Cash flows provided from operations, including deposit-product operations, were $517 million in 1996, compared with $478 million in 1995, an increase of 8%. Operating cash flows grew 42% in 1995 over 1994 cash flows of $337 million. The 1995 increase was primarily caused by increased deposit-product sales in 1995 and a one-time $48 million tax settlement paid in 1994 related to prior periods. In addition to operating cash flows, Torchmark received $347 million of investment maturities and repayments in 1996, further enhancing total positive cash flow. Such repayments were $351 million in 1995 and $796 million in 1994. Cash flows in excess of immediate requirements are used to build an investment base to fund future requirements.
Torchmark's cash and short-term investments were $103 million at December 31, 1996, compared with $86 million at year-end 1995. These liquid assets represented approximately 1% of total assets at December 31, 1996, the same as at the end of the previous year. In addition to Torchmark's liquid assets, Torchmark has a portfolio of marketable fixed and equity securities which are available for sale should the need arise. These securities had a value of $5.3 billion at December 31, 1996.
Torchmark has in place a line of credit facility with a group of lenders which allows unsecured borrowings up to a specified maximum amount. The maximum amount was increased during 1996 to $600 million at December 31, 1996. Interest is charged at variable rates for borrowings. This line of credit is further designated as a backup credit line for a commercial paper program not to exceed $600 million, whereby Torchmark may borrow from either the credit line or issue commercial paper at any time but may not borrow in excess of a total of $600 million on the combined facilities. At December 31, 1996, $41 million in commercial paper was outstanding and there were no borrowings on the line of credit. A facility fee is charged on the entire $600 million balance. In accordance with the agreements, Torchmark is subject to certain covenants regarding capitalization and earnings. At December 31, 1996, Torchmark was in full compliance with these covenants.
Liquidity of the parent company is affected by the ability of the subsidiaries to pay dividends. Dividends are paid by subsidiaries to the parent in order to meet its dividend payments on common and preferred stock, interest and principal repayment requirements on parent company debt, and operating expenses of the parent company. Dividends from insurance subsidiaries of Torchmark are limited to the greater of statutory net gain from operations on an annual noncumulative basis or 10% of surplus, in the absence of special approval, and distributions are not permitted in excess of statutory net worth. Subsidiaries are also subject to certain minimum capital requirements. Although these restrictions exist, dividend availability from subsidiaries has been and is expected to be more than adequate for parent company operations. During 1997, a maximum amount of $275 million will be available to Torchmark from insurance subsidiaries without regulatory approval.
In connection with the American Income purchase in November, 1994, Torchmark issued eight million shares or $200 million face amount Cumulative Monthly Income Preferred Securities, Series A ("MIPS") in October, 1994. The MIPS were issued at an annual dividend rate of 9.18%. They are subject to a mandatory redemption in full at September 30, 2024, although Torchmark may elect to extend the MIPS for up to an additional 20 years if certain conditions are met. They are redeemable at Torchmark's option at any time after September 30, 1999. While Torchmark is obligated to pay dividends at a fixed rate of 9.18%, Torchmark subsequently entered into a ten-year interest-rate swap agreement with an unaffiliated party to reduce financing costs. The swap agreement calls for Torchmark to pay a variable rate on the $200 million face amount in exchange for payment of the fixed dividend. Torchmark is at risk on this instrument for higher financing costs to the extent interest rates rise during the remaining term. This risk is limited, however, by a five-year interest- rate cap which Torchmark acquired in conjunction with the swap agreement that insures the variable rate cannot exceed 10.39%. At December 31, 1996, the variable rate was 6.95%. During 1996, Torchmark's after-tax dividend cost for the MIPS was $9.7 million, compared with $11.9 million that would have been incurred without the swap and cap transactions. Torchmark's after-tax cost in 1995 was $10.3 million, saving $1.6 million.
Short-term debt was $41 million at year-end 1996, compared with $189 million at the end of the previous year. Torchmark repaid $148 million principal amount on this debt in 1996, with funds from internal cash flow. Torchmark paid down a net of $61 million on the credit facility during 1995.
(2) Monetization of Vesta stock (see discussion below under Other items).
(3) Complete the sale of the energy related discontinued operations (see discussion below under Other Items).
Acquisition of American Income. On November 3, 1994, Torchmark acquired American Income for a total cash purchase price of approximately $552 million. American Income sells life insurance to union, credit union, and other association members through exclusive agents. The results of operations of American Income were consolidated with those of Torchmark after the purchase date. Funds for the purchase were provided through a $200 million preferred security offering which is discussed in more detail in the capital resources section above, a $175 million bridge loan from a group of banks, the sale of investments available for sale, and internal cash flow.
Also, the cancer policy class action litigation in Alabama continued in 1996. In February 1996, the Alabama Supreme Court issued a notice overruling a petition for rehearing of its decision affirming the trial court's final approval of the May 1994 settlement of this litigation. Certain intervenors then filed a petition for writ of certiorari to the U.S. Supreme Court, which granted certiorari in October 1996. Oral arguments were heard on the intervenors' petition in January 1997. On March 3, 1997, the U.S. Supreme Court dismissed, as improvidently granted, the writ of certiorari it had previously granted, effectively ending direct appeals of the cancer policy class action settlement.
Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities (FASB Statement No. 125) is effective for transactions occurring after December 31, 1996, applied prospectively. Earlier or retrospective application is not permitted. This statement provides accounting and reporting standards for transfers and servicing of financial assets and extinguishments of liabilities, based on the concept of control. The adoption of this standard will have no material impact on Torchmark's financial condition or results.
We have audited the consolidated financial statements of Torchmark Corporation and subsidiaries as listed in Item 8 and the supporting schedules as listed in Item 14(a). These financial statements and financial statement schedules are the responsibility of Torchmark's management. Our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audits.
Birmingham, Alabama January 31, 1997, except for Note 16, which is as of March 11, 1997
TORCHMARK CORPORATION CONSOLIDATED STATEMENT OF OPERATIONS (AMOUNTS IN THOUSANDS EXCEPT PER SHARE DATA)
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 shareholders' equity. 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 shareholders' equity. Policy loans are carried at unpaid principal balances. Mortgage loans are carried at amortized cost. Investments in real estate are reported at cost less allowances for depreciation, which are calculated on the straight line method. Short-term investments include investments in certificates of deposit and other interest-bearing time deposits with original maturities within three months. Other long-term investments consist of investments in mutual funds managed by a Torchmark subsidiary. They are carried at fair value. Other long- term investments also include passive energy limited-partnership investments which are valued at partnership equity. If an investment becomes permanently impaired, such impairment is treated as a realized loss and the investment is adjusted to net realizable value.
Determination of Fair Values of Financial Instruments: Fair value for cash, short-term investments, short-term debt, receivables and payables approximates carrying value. Fair values for investment securities are based on quoted market prices, where available. Otherwise, fair values are based on quoted market prices of comparable instruments. Mortgages are valued using discounted cash flows. Substantially all of Torchmark's long-term debt, including the monthly income preferred securities, is valued based on quoted market prices.
Recognition of Premium Revenue and Related Expenses: Premiums for insurance contracts which are not defined as universal life-type according to SFAS 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 $72.8 million, $72.7 million, and $74.2 million for the years ended December 31, 1996, 1995 and 1994, respectively. Other premium includes annuity policy charges for the
Property and Equipment: Property and equipment is reported at cost less allowances for depreciation. Depreciation is recorded primarily on the straight line method over the estimated useful lives of these assets which range from two to twenty years for equipment and two to forty years for buildings and improvements. Ordinary maintenance and repairs are charged to income as incurred.
Impairments: Torchmark adopted the provisions of SFAS 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of, effective at the issuance of the standard in March, 1995. This standard requires that certain long-lived assets used in Torchmark's business as well as certain intangible assets 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 the writedown of the energy investment described in Note 7, the adoption of this statement had no material impact on Torchmark's operations or financial position for the years ended December 31, 1996 and 1995.
A schedule of fixed maturities by contractual maturity at December 31, 1996 is shown below on an amortized cost basis and on a market value basis. Actual maturities could differ from contractual maturities due to call or prepayment provisions.
Proceeds from sales of fixed maturities available for sale were $487 million in 1996, $1.18 billion in 1995, and $583 million in 1994. Gross gains realized on those sales were $8.7 million in 1996, $13.4 million in 1995, and $14.6 million in 1994. Gross losses were $5.3 million in 1996, $13.5 million in 1995, and $20.8 million in 1994.
Derivative investments were immaterial to Torchmark at December 31, 1996. These investments consist of interest-only and principal-only collateralized mortgage obligations and a foreign currency trading account. Torchmark's total carrying value of these investments was $26.3 million and $23.9 million at December 31, 1996 and 1995, respectively. Torchmark has no off-balance sheet exposure in connection with these investments.
In addition to previously transferred securities, warrants, and Section 29 energy-related tax credits, which approximated $112 million at closing, Torchmark received subordinated debt and notes totaling $32.5 million along with $15.5 million in cash. After closing costs and retained liabilities, Torchmark recorded a pretax loss of $23 million and an after-tax loss of $7 million from the sale, or $.10 per share.
A summary of the assumptions used in determining the liability for future policy benefits at December 31, 1996 is as follows:
The overall average interest assumption for determining the liability for future life and health insurance benefits in 1996 was 6.3%.
Health benefits for 1994 include a $30 million charge resulting from a reclassification of nonoperating expense to health benefits, since actual payments will be made in the form of health benefits.
Income tax expense attributable to income from continuing operations consists of:
In 1996, 1995, and 1994, deferred income tax expense was incurred because of the difference between net operating income before income taxes as reported on the consolidated statement of operations and taxable income as reported on Torchmark's income tax returns. As explained in Note 1, this difference caused the financial statement book values of some assets and liabilities to be different from their respective tax bases.
Torchmark has not recognized a deferred tax liability for the undistributed earnings of its wholly-owned subsidiaries because such earnings are remitted to Torchmark on a tax-free basis. A deferred tax liability will be recognized in the future if the remittance of such earnings becomes taxable to Torchmark. In addition, Torchmark has not recognized a deferred tax liability of approximately $60 million that arose prior to 1984 on temporary differences related to the policyholders' surplus accounts in the life insurance subsidiaries. A current tax expense will be recognized in the future if and when these amounts are distributed.
The weighted average assumed discount rates used in determining the actuarial benefit obligations were 7.5% in 1996 and 7.25% in 1995. The rate of assumed compensation increase was 4.5% in 1996 and 4.25% in 1995 and the expected long-term rate of return on plan assets was 9.25% in 1996 and 8.0% in 1995.
For retired employees over age sixty-five, Torchmark does not provide postretirement benefits other than pensions. Torchmark does provide a portion of the cost for health insurance benefits for employees who retired before February 1, 1993 and before age sixty-five, covering them until they reach age sixty-five. Eligibility for this benefit was generally achieved at age fifty- five with at least fifteen years of service. This subsidy is minimal to employees who did not retire before February 1, 1993. This plan is unfunded.
For measurement purposes, a 7.5% to 10.0% annual rate of increase in a per capita cost of covered healthcare benefits was assumed for 1996. These rates were assumed to decrease gradually to ranges of 4.5% to 6.5% by the year 2005. The health care cost trend rate assumption has a significant effect on the amounts reported. To illustrate, increasing the health care cost trend by one percentage point in each year would increase the accumulated postretirement benefit obligation as of December 31, 1996 by $1.3 million and would increase the net periodic postretirement cost for the year ended December 31, 1996 by approximately $425 thousand.
The weighted average discount rate used in determining the accumulated postretirement benefit obligation was 7.5% in 1996 and 7.0% to 8.0% in 1995.
The amount of debt that becomes due during each of the next five years is: 1997, $40.9 million; 1998, $200.1 million; 1999, $150 thousand; 2000, $-0-; and 2001, $-0-.
The Sinking Fund Debentures, due March 1, 2017, are carried at $200 million principal amount less unamortized issue expenses and bear interest at 8 5/8%, payable on March 1 and September 1. A sinking fund provides for mandatory repayment at par of not less than $8 million principal amount per year from March 1, 1998 through March 1, 2016. At Torchmark's option, an additional $12 million principal amount per year may be redeemed at par according to the same schedule. The option to make such additional repayments is not cumulative and if not availed of in any year will terminate. Furthermore, Torchmark may, at its option, redeem the entire issue at prices ranging from 104.59% to 100.0% of par, subject to certain restrictions. The Sinking Fund Debentures have equal priority with other Torchmark unsecured indebtedness.
The Notes, due August 1, 2013, were issued in July, 1993 in the principal amount of $100 million for net proceeds of $98 million. Interest is payable on February 1 and August 1 of each year at a rate of 7 3/8%. These notes are not redeemable prior to maturity and have equal priority with other Torchmark unsecured indebtedness.
Torchmark has entered into revolving credit agreements with a group of lenders under which it may borrow on an unsecured basis up to $600 million. One-third of the commitment matures October 23, 1997 and the balance matures October 24, 2001. Borrowings, pro rata under each facility, are at interest rates selected by Torchmark based on either the corporate base rate or the Eurodollar rate at the time of borrowings. At December 31, 1996 and December 31, 1995 there were no borrowings under the revolving credit agreements. The revolving credit agreements are designed to back up a commercial paper program which began in 1995. The short-term borrowings under the revolving credit agreements and in the commercial paper market averaged $103 million during 1996, and were made at an average yield of 5.42%. At December 31, 1996, commercial paper was outstanding in the face amount of $41.0 million. Torchmark is subject to certain covenants for the revolving credit agreements regarding capitalization and earnings, for which it was in compliance at December 31, 1996, and pays a facility fee based on size of the lines.
In October, 1994, Torchmark, through its wholly-owned finance subsidiary, Torchmark Capital L.L.C., completed a public offering of eight million shares of 9.18% MIPS at a face amount of $200 million. The securities are subject to a mandatory redemption in full at September 30, 2024, although Torchmark may elect to extend the MIPS for up to an additional 20 years if certain conditions are met. They are redeemable at Torchmark's option after September 30, 1999. Torchmark subsequently entered into a ten-year swap agreement with an unaffiliated party whereby Torchmark agreed to pay a variable rate on the $200 million face amount in exchange for payment of the fixed dividend. In a related transaction, Torchmark purchased a five-year cap on the swap agreement that insures that the variable rate cannot exceed 10.39% through September 30, 1999. The interest rate was 6.95% at December 31, 1996 and 7.25% at December 31, 1995. Torchmark pays a yearly fee of $860 thousand for the cap agreement. The market value of the swap agreement was a benefit of $14.7 million at December 31, 1996 and a benefit of $26.5 million at December 31, 1995. The market value of the cap agreement, net of the present value of future annual payments, was an obligation of $1.3 million at December 31, 1996 and an obligation of $2.1 million at December 31, 1995. Except as otherwise described in "Note 3--Investments" on page 43 of this report, Torchmark is a party to no other derivative instruments as defined by SFAS 119.
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 on an annual noncumulative basis in the absence of special approval. Additionally, insurance companies are not permitted to distribute the excess of shareholders' equity as determined on a GAAP basis over that determined on a statutory basis. In 1997, $275 million will be available to Torchmark for dividends from insurance subsidiaries in compliance with statutory regulations without prior regulatory approval.
Certain employees and directors have been granted options to buy shares of Torchmark stock generally at the market value of the stock on the date of grant under the provisions of the Torchmark Corporation 1987 Stock Incentive Plan ("1987 Option Plan"). The options are exercisable during the period commencing from three months to three years after grant until expiring ten years or ten years and two days after grant. Employee stock options granted under the 1987 Option Plan generally vest one-half in two years and one-half in three years. Director grants generally vest in six months. At December 31, 1996, approximately 11.4 million shares were authorized for grants of options under this plan. In October, 1993, Torchmark implemented a policy to issue shares for the exercise of stock options out of treasury stock.
In accordance with SFAS 123, 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 1996 and 1995.
A summary of Torchmark's stock option activity, and related information for the years ended December 31, 1996 and 1995 follows:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) (DOLLAR AMOUNTS IN THOUSANDS EXCEPT PER SHARE DATA) NOTE 16--COMMITMENTS AND CONTINGENCIES
Collateral Requirements: Torchmark requires collateral for investments in instruments where collateral is available and is typically required because of the nature of the investment. Since the majority of Torchmark's investments are in government, government-secured, or corporate securities, the requirement for collateral is rare. Torchmark's mortgages are secured by collateral.
As previously reported, Dismukes v. Torchmark Corporation (Case No. CV-94- 1006-P-M), which was filed on December 30, 1994 and is presently pending in the U.S. District Court for the Northern District of Alabama, is the only remaining purported class action litigation brought by Torchmark shareholders alleging untimely and inadequate disclosure of material contingent liabilities arising out of insurance policy litigation involving Liberty. The U.S. District Court entered an order granting partial summary judgment on behalf of the defendants on April 16, 1996. Claims for damages based on Section 10b-5 of the Securities Exchange Act, on state securities laws and for common law fraud remain pending in the case.
A purported class action was filed on August 8, 1995, against Liberty in the Circuit Court of Jefferson County, Alabama on behalf of Liberty cancer policyholders eligible for Medicare who submitted claims during an approximately two month period in 1993 (Adkins v. Liberty National Life Insurance Company, Case No. CV-95-5634). Beginning in September 1993, in reliance on federal law concerning the amount health care providers could collect from Medicare eligible individuals, Liberty limited the payment of benefits to such individuals to the amounts collectible by the providers under federal law. In November, 1993 Liberty discontinued this practice and recalculated and repaid all claims in full as it had prior to September 1993 together with interest. Nearly two years after this refund, the Adkins case was filed. The claims made in Adkins are identical to the individual claims in Allen v. Liberty National Life Insurance Company (Case No. CV-94-3634), an individual case reversed and remanded by the Alabama Supreme Court on March 7, 1997 after an appeal regarding the remitted verdict of $2.7 million. A class certification order, which does not address the merits of the litigation, was entered by the Court in Adkins on July 26, 1996. Liberty filed a petition for writ of mandamus or prohibition with the Alabama Supreme Court in August 1996 asserting abuse of discretion by the trial court in certifying the Adkins class. The Alabama Supreme Court has stayed further proceedings as to the class issues in Adkins pending its ruling on the propriety of class certification.
In November 1993, an attorney (purporting to represent the funeral director class) filed a petition in the District Court seeking "alternative relief" under the final judgment. This petition was voluntarily withdrawn on November 8, 1995, by petitioners. On February 23, 1996, Liberty filed a petition with the District Court requesting that it order certain contract funeral directors to comply with their obligations under the Final Judgment in Battle and their funeral service contracts. A petition was filed on April 8, 1996 on behalf of a group of funeral directors seeking to modify the 1978 decree in Battle in light of changed economic circumstances. Liberty is actively opposing this petition.
It has been previously reported that the Company, its subsidiaries United American and Globe and certain individual corporate officers are parties to purported class action litigation filed April 5, 1996 in the U.S. District Court for the Northern District of Georgia (Crichlow v. Torchmark Corporation, Case No.: 4:96-CV 0086-HLM). The complaint alleged RICCO violations, fraud, breach of contract, conspiracy, violations of the Oklahoma Consumer Protection Act and breach of the duty of good faith and fair dealing on behalf of all persons who purchased, at any time between 1987 and the present, certain hospitalization and surgical insurance policies issued by Globe and United American. The plaintiffs asserted that they purchased these policies and subsequently incurred improper claim denials, wrongful recision and "rate-ups" and post-claim underwriting. On December 4, 1996, the U.S. District Court dismissed the RICCO counts, the Oklahoma Consumer Protection Act and contract counts as to certain defendants and ordered plaintiffs to file an amended complaint. On December 23, 1996, the plaintiffs filed the amended complaint as ordered, alleging breach of contract, fraud, conspiracy and breach of the duty of good faith and fair dealing on behalf of a purported class of persons who purchased Globe, but not United American, policies from 1987 to the present. Defendants have filed motions to dismiss and for partial summary judgment.
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. It should be noted, however, that the frequency of large punitive damage awards bearing little or no relation to actual damages awarded by juries in jurisdictions in which Torchmark has substantial business, particularly in Alabama, continues to increase universally, creating the potential for unpredictable material adverse judgments in any given punitive damage suit.
Certain insurance company investments are managed by the asset management segment. Additionally, the asset management segment markets certain insurance products for the insurance segment and manages the mutual funds for the insurance segment's variable products.