Globe owns a 300,000 square foot office building at 204 N. Robinson, Oklahoma City, of which Globe occupies 56,000 square feet as its home office and the remaining space is either leased or available for lease. Globe also owns an 80,000 square foot office building at 120 Robert S. Kerr Avenue, Oklahoma City, which is available for lease. Further, Globe owns a 112,000 square foot facility located at 133 NW 122 Street in Oklahoma City which houses the Direct Response operation.
4) Adverse levels of mortality, morbidity, and utilization of healthcare services relative to Torchmark's assumptions;
6) Interest rate changes that adversely affect product sales and/or investment portfolio yield;
On November 6, 1998, Torchmark distributed its remaining 64% investment in Waddell & Reed through a tax-free spin-off to Torchmark shareholders. Each Torchmark shareholder of record on October 23, 1998 received a total of .3018 Waddell & Reed shares per Torchmark share. After the spin-off, Torchmark retained no further ownership interest in Waddell & Reed. As a result of the transaction, Torchmark incurred $54 million in expenses related to the spin- off, the majority of which was $50 million of corporate Federal income tax resulting from the distribution of a portion of the policyholder surplus account of a Torchmark life subsidiary.
Torchmark has accounted for the spin-off of Waddell & Reed as a disposal of a segment. Accordingly, Torchmark's financial statements for 1998 and all prior periods were modified to present the net assets and operating results of Waddell & Reed as discontinued operations of the disposed segment. The $54 million expense of the spin-off is included in discontinued operations under the caption "Loss on Disposal." The distribution of the Waddell & Reed shares resulted in a reduction in Torchmark's shareholders' equity in the approximate amount of $174 million, consisting of the equity in Waddell & Reed, net of the 36% minority interest. Torchmark's share of Waddell & Reed's earnings for 1998 was $48 million after reduction for the minority interest during the period subsequent to the initial public offering but before the spin-off.
Sale of Family Service. On June 1, 1998, Torchmark sold Family Service, a preneed funeral insurer, to an unaffiliated insurance carrier. Consideration for the sale was $140 million in cash. Torchmark recorded a pretax realized loss on the sale of approximately $14 million, but incurred a tax expense on the transaction of $9 million for a total after-tax loss of $23 million. In connection with the sale, Torchmark agreed to continue to service the policies in force of Family Service for five years from the sale date for a fee of $2 million per year plus certain variable processing costs. Through May, 1998, Family Service contributed $25 million in revenues and $5.8 million in pretax income. Invested assets were $778 million and total assets were $828 million at the date of the sale.
2) Net income or loss from the discontinued operations of Waddell & Reed, including the $54 million nonrecurring expenses of the spin-off;
5) A one-time gain on the sale of equipment (included in other income) in the after-tax amount of $3.3 million in 1999; and
6) The effect of a 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.
Additionally, in 1999, Torchmark entered into a life insurance marketing arrangement with a third party, discussed more fully under the caption Life Insurance on page 21 of this report. This agreement contained certain cash guarantees to the third party which would not be recoverable by Torchmark based on test marketing results. Accordingly, Torchmark recorded a nonrecurring after-tax operating charge of $13 million, or $.10 per diluted share in 1999. Because this was an unusual one-time charge, net operating income has been presented before the charge for comparability.
Net realized investment losses in 2000 were $3.5 million after-tax. Gross losses from investments were partially offset by an after-tax gain in the amount of $4.9 million from the increase in value of Torchmark's interest rate swap relating to its MIPS, as discussed under the caption Capital Resources on page 34 of this report. The majority of the 2000 realized losses resulted from the sale of fixed maturities. See the discussion under the caption Investments beginning on page 29 of this report for more information on invested assets.
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.
Realized investment losses in 1998, which were $51 million net of tax, included a $23 million after-tax loss from the sale of Family Service, a $24 million after-tax loss on the writedown of Torchmark's Vesta holdings, and a $3 million after-tax loss from the sale of a portion of the Vesta holdings.
Torchmark reports basic and diluted earnings per share. Basic earnings per share are based on average shares outstanding during the period. Diluted earnings per share assume the exercise of Torchmark's employee stock options for which the exercise price was lower than the market price during the year and their impact on shares outstanding. Diluted earnings per share differ from basic earnings per share in that they are influenced by changes in the market price of Torchmark stock and the number of options as well as the number of shares outstanding. Unless otherwise indicated, all references to per share data in this report are on the basis of diluted shares.
On a per share basis, Torchmark's net operating income before nonrecurring charge grew 12% in 2000 and 11% in 1999. In dollar amounts, Torchmark's net operating income before nonrecurring charge rose 7% in 2000 after a 5% increase in 1999. Per share growth exceeded growth in the dollar amounts as a result of share buybacks in both periods. Contributing to the growth in net operating income were gains in insurance underwriting income and excess investment income. Insurance underwriting income grew 7% in 2000 to $356 million. Excluding Family Service in 1998, insurance underwriting income rose 5% in 1999 to $333 million. Excess investment income also grew in both 2000 and 1999. The 2000 increase of 5% in excess investment income was a result of the 5% growth in net investment income. Excess investment income increased in 1999 because of lower policy requirements and lower financing costs in 1999. Torchmark's core operations are segmented into insurance underwriting operations and investment operations. Insurance underwriting activities are further segmented into life insurance, health insurance, and annuity product groups. A detailed discussion of each of Torchmark's segments follows.
Life insurance. Life insurance is Torchmark's largest segment, with life premium representing 53% of total premium and with life underwriting income before other income, administrative expense, and nonrecurring charge, representing 59% of the total.
Direct Response marketing is conducted through direct mail, co-op mailings, television and consumer magazine advertising, and direct mail solicitations endorsed by groups, unions and associations. It markets a line of life products primarily to juveniles, their parents, and other adults over age 50 with face amounts of around $10 thousand on average. The Direct Response operation is characterized by lower acquisition costs than Torchmark's agency- based marketing systems. It accounted for almost 25% of Torchmark's life insurance premium during 2000. In each of the three years 1998 through 2000, the Direct Response distribution center had Torchmark's highest growth in life insurance premium in dollar amount. Direct Response life premium was $268 million in 2000, increasing 9% over 1999 premium of $246 million. Direct Response life premium in 1999 grew 11% over 1998 premium of $221 million.
The Liberty National Exclusive Agency distribution system represented Torchmark's largest contribution to life insurance premium income in each of the three years presented, with 2000 premium of $294 million representing 27% of Torchmark's total life premium. The annualized life premium in force of the Liberty Agency was $312 million at year-end 2000, compared with $307 million and $298 million at year-ends 1999 and 1998, respectively. Life premium sales, in terms of annualized premium issued, grew 4% during 2000 to $54 million, compared with 13% growth in 1999. Sales growth in the Liberty Agency is largely attributable to growth in the number of agents. Liberty's agent count increased from 1,750 agents at year-end 1997 to 1,829 agents at year-end 1998, an increase of 5%. They further increased 4% to 1,902 at year-end 1999 and 7% to 2,032 at year end 2000. Ongoing agent recruitment efforts and training programs, which help to improve agent retention, have been responsible for the growth in this Agency. Management believes that the continued recruiting of new agents and the retention of productive agents are critical to the continued growth of sales in controlled agency distribution systems.
Life insurance gross margins have been presented in the above table to remove the effect of Family Service underwriting income in 1998 and the 1999 nonrecurring charge, which distort comparisons. Excluding these items, gross margins, as indicated by insurance underwriting income before other income and administrative expense, increased 3% in 2000 to $271 million after having risen 4% in 1999 to $263 million. As a percentage of life insurance premium, life insurance gross margins were 26% in both 1999 and 1998, but were 25% in 2000. One factor in the 1% decline in 2000 is the reduction in underwriting income margins for Direct Response. As a percentage of premium, Direct Response underwriting income was 26.3% in 2000, compared with 27.9% a year earlier. Additionally, an increase in policy obligation ratios was experienced in the Other Category in the first half of 2000, which appears to have been a short-term aberration. Fluctuations in obligation ratios are normal in the life insurance industry.
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, 2000.
Health products sold by Torchmark insurance companies include Medicare Supplement, cancer, long-term care, and other under-age-65 limited-benefit supplemental medical and hospitalization products. As a percentage of annualized health premium in force at December 31, 2000, Medicare Supplement accounted for 73% and cancer 17%. The table below presents Torchmark's health insurance annualized premium in force by major product category at December 31, 2000 and for the two preceding years.
Until recently the primary competition for Medicare Supplement sales had come from Medicare health maintenance organizations (HMO's), the managed care alternative to traditional fee-for-service Medicare which eliminated the need for a supplemental policy. However, in the last few years, growing public dissatisfaction with managed care, increased medical cost inflation and increased Federal Government regulatory pressures on Medicare HMO's have caused an increasing number of HMO's to withdraw from the market, reducing that competition. Other regulatory issues continue to affect the Medicare Supplement market. Medical cost inflation and changes to the Medicare program cause the need for annual rate increases, which generally require state insurance department approval. In addition, Congress and the Federal Administration have begun studying ways to 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 rose 10% in 2000 to $169 million, compared with 6% growth in 1999. Sales of this product declined in 2000 to $10 million from $11 million in sales in 1999. Sales in 1998 were also $10 million. 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, 2000.
Health insurance underwriting income before other income and administrative expense rose 11% in 2000 to $161 million, after having increased 4% in 1999. As a percentage of premium, underwriting income before other income and administrative expense remained steady at approximately 18% throughout the three-year period ending in 2000. Medicare Supplement margins are restrained by the federally mandated minimum loss ratio of 65% and by competition. 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. As a result, margins on cancer business improved slightly in 2000. Torchmark continues to seek such rate increases to maintain margins on this business.
Collections of fixed annuity premium were $42 million in 2000, compared with $72 million in 1999, a 42% decrease. Fixed annuity premium collections rose 11% in 1999 from $65 million in 1998. Management believes that the interest- rate environment is one factor in the sales of fixed annuities. As rates fall, alternative investments including variable annuities become more attractive. In 1999, as interest rates increased, fixed annuities became more desirable relative to alternative investments. Even though rates continued to rise in 2000, a decline in fixed annuity sales resulted from the loss of a key independent agent from the United American Independent Agency. This decline is expected to be temporary as management is in the process of redirecting annuity sales efforts in this Agency. The fixed annuity deposit balance declined 2% in 2000 to $662 million at year end. It rose 5% in the prior year from $647 million at year-end 1998 to $677 million at the end of 1999.
Net investment income increased 6% to $472 million in 2000. In 1999, net investment income declined 3% to $447 million after rising 7% to $460 million in 1998. 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 gained 5% in 2000, after declining 3% in 1999 and rising 7% in 1998. 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, computed based on book value, rose 4% to $6.6 billion in 2000 over the prior year, as new cash flow was invested primarily in taxable fixed maturities. The mean fixed maturity balance rose $381 million or 7% to $6.1 billion for 2000. The 2000 growth in mean invested assets was achieved even though $147 million was used to buy Torchmark stock and $95 million was used to pay down long and short-term debt. Higher interest rates in financial markets caused yields on the fixed maturity portfolio to rise 8 basis points in 2000 to 7.47%. The 1999 decline in investment income was a result of the sale of Family Service in the second quarter of 1998 and repurchases of Torchmark stock since late 1998. The Family Service sale resulted in the investment of approximately $140 million proceeds, producing an additional $10 million of investment income in 1999, compared with incremental investment income of $6 million in 1998. However, the 1998 tax- equivalent net investment income also included $22 million earned on Family Service assets which were not included in 1999. Mean invested assets were flat in 1999, as the growth in 1999 invested assets from reinvested cash flows was essentially offset by the loss of Family Service's $778 million in invested assets when compared with the prior year.
During 1999, Torchmark entered into two transactions to dispose of the majority of its investment real estate. Total consideration for the combined transactions was $123 million of which $111 million was cash. The real estate dispositions resulted in an after-tax loss of $41 million. After the sales, Torchmark retained $16 million in investment real estate, of which $8 million was represented by properties partially occupied by Torchmark subsidiaries. At December 31, 2000, Torchmark held $15 million in investment real estate.
Portfolio adjustments resulting in $8 million in after-tax capital losses were taken in 2000. These losses were partially offset, however, by a $5 million after-tax gain from the increase in market value of the interest-rate swap associated with Torchmark's MIPS, discussed in more depth under the caption Capital Resources found on page 34 of this discussion. In 1999, in addition to the real estate capital losses, Torchmark also generated $19 million in after-tax losses during 1999 from the planned sale of fixed maturities. These losses allowed Torchmark to carry back and recover capital gains taxes paid in prior years. Realized losses in 1999 also included a $12 million after-tax loss from the interest-rate swap on Torchmark's MIPS.
Market Risk Sensitivity. Market risk is the risk that the value of a security will change because of a change in market conditions. Torchmark's primary exposure to market risk is interest rate risk, which is the risk that a change in a security's value could occur because of a change in interest rates. This risk is significant to Torchmark's investment portfolio because its fixed-maturity holdings amount to 92% of total investments. The effects of interest rate fluctuations on fixed investments are reflected on an after-tax basis in Torchmark's shareholders' equity because these investments are marked to market.
No derivative instruments are used to manage Torchmark's exposure to market risk in the investment portfolio. An interest-rate swap instrument was entered into by Torchmark in connection with its MIPS as discussed in the Notes to the Consolidated Financial Statements on page 65 of this report and in Capital Resources on page 34 of this report. A cap instrument was also previously entered into to protect Torchmark from the market risk on an increase in rates associated with the swap on this security. This cap expired during 1999.
Torchmark's insurance operations generate positive cash flows in excess of its immediate needs. Cash flows provided from operations were $533 million in 2000, compared with $512 million in 1999 and $389 million in 1998. In addition to operating cash flows, Torchmark received $226 million in investment maturities and repayments during 2000, adding to available cash flows. Such repayments were $413 million in 1999 and $474 million in 1998. Cash flows in excess of immediate requirements are used to build an investment base to fund future requirements.
Capital Resources. Torchmark's capital structure consists of long and short- term debt, MIPS, and shareholders' equity. Torchmark's debt is primarily its funded debt and its commercial paper facility. An analysis of Torchmark's funded debt outstanding at year-ends 2000 and 1999 on the basis of par value was as follows:
During 1998, Torchmark received approximately $481 million in intercompany note repayments from Waddell & Reed as a result of their initial public offering. Torchmark utilized a portion of these funds to pay down funded debt. It also took advantage of the lower interest rate environment in 1998 to refinance existing funded debt at lower short-term rates. In early 1998, Torchmark repaid $20 million principal amount on its 8 5/8% Sinking Fund Debentures due in 2017, of which $8 million was a mandatory redemption and $12 million was an optional repayment under the terms of the agreement. On April 1, 1998, Torchmark called the remaining $160 million principal balance of this debt at the prevailing call price of 103.76, or $166 million. A loss on the redemption of debt was recorded in the second quarter of 1998 in the after-tax amount of $5 million, representing the difference between the total call price and the carrying value of $158 million. In addition to the call, Torchmark's 9 5/8% Senior Notes, principal amount $200 million, matured on May 1, 1998. Torchmark borrowed on its commercial paper facility to repay the Sinking Fund Debentures that were called and to repay its Senior Notes upon maturity with accrued interest, in the combined amount of $377 million.
The MIPS were issued in November, 1994 at a redemption amount of $200 million with 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 currently redeemable at Torchmark's option at any time. While Torchmark is obligated to pay dividends at a fixed rate of 9.18%, Torchmark has in place a ten-year interest-rate swap agreement with an unaffiliated party. 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 by the other party. The swap expires in 2004. Torchmark is at risk on this instrument for higher financing costs to the extent interest rates rise during the remaining term. At December 31, 2000, the variable rate was 8.0%. During 2000, Torchmark's after-tax dividend cost for the MIPS was $10.3 million, compared with $11.9 million that would have been incurred without the swap. Torchmark's after-tax cost in 1999 was $9.2 million and in 1998 was $9.8 million, saving $2.7 million and $2.1 million in each of those years, respectively.
During July, 1999, Torchmark filed a Form S-3 Registration Statement with the Securities and Exchange Commission for the shelf registration of capital securities in an aggregate face amount of $300 million. Proceeds from the issuance of any such capital securities could be used for the possible purchase of Torchmark securities, for working capital, for the repayment of debt, for acquisitions, or for any other general corporate purpose or business opportunity. As of December 31, 2000, no capital securities have been issued under this Registration Statement.
Torchmark has made share purchases from time to time under its share repurchase program on the open market when market conditions were favorable. Torchmark purchased 6.1 million shares on the open market at a cost of $147 million in 2000 and 6.7 million shares at a cost of $222 million in 1999. Purchases of 3.4 million shares were made in 1998 at a cost of $126 million, subsequent to the Waddell & Reed spin off. Torchmark will continue to make share purchases under its share repurchase program when prices are attractive. Share purchases could have a favorable impact on earnings per share and return on equity.
On November 15, 1999, Torchmark executed a stock option exercise and restoration program through which 80 Torchmark directors and employees exercised vested stock options and received a reduced number of replacement options at the current market price. This program resulted in the issuance of 1.8 million shares, but over 1.3 million of the new shares were immediately sold by the directors and employees through the open market to cover the cost of the purchased shares and the related taxes. A similar option exercise and restoration program was conducted on December 20, 2000 for two executives not able to participate in the 1999 program. Under the 2000 program, 433 thousand shares were issued but 283 thousand shares were sold to pay the exercise price and taxes. As a result of both of these restoration programs, management's ownership interest increased, and Torchmark received a significant current tax benefit from the exercise of the options.
Management believes that Statement 133 will have an immaterial impact on Torchmark's financial statements. Other than the interest rate swap on its MIPs, which is a free-standing derivative currently carried at fair market value, Torchmark's use of derivatives is limited.
Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities (FASB Statement No. 140) provides accounting and reporting standards for transfer and servicing of financial assets and extinguishments of liabilities. It replaces FASB Statement No. 125, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. While it revises certain of the provisions of that statement, it carries over most of Statement No. 125's provisions without reconsideration. Statement No. 140 also requires certain disclosures.
We have audited the accompanying consolidated balance sheets of Torchmark Corporation and subsidiaries as of December 31, 2000 and 1999, and the related consolidated statements of operations, comprehensive income, shareholders' equity, and cash flow for the years then ended. Our audit also included the financial statement schedules listed in the Index at Item 14 as of and for the years ended December 31, 2000 and 1999. 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.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Torchmark Corporation and subsidiaries as of December 31, 2000 and 1999, and the results of their operations and their cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly in all material respects the information set forth therein.
We conducted our audit in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements and financial statement schedules are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the results of operations and cash flows of Torchmark Corporation and subsidiaries for the year ended December 31, 1998, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.
Birmingham, Alabama January 29, 1999, except for Note 18 which is as of February 10, 1999
Gains and losses realized on the disposition of investments are recognized as revenues and are determined on a specific identification basis.
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 $71.4 million, $71.9 million, and $71.7 million for the years ended December 31, 2000, 1999, and 1998,
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 real estate in 1999, as discussed in Note 3--Investments on page 54 of this report, and Torchmark's writedown of its investment in Vesta Insurance Group ("Vesta") in 1998, as discussed in Note 20--Related Party Transactions on page 81 of this report, there were no significant impairments in the three years ending 2000.
Earnings Per Share: Torchmark presents basic and diluted earnings per share ("EPS") on the face of the income statement and a reconciliation of basic EPS to diluted EPS. Basic EPS is computed by dividing income available to common stockholders by the weighted average common shares outstanding for the period. Weighted average common shares outstanding for each period are as follows: 2000--128,089,235, 1999--133,197,023, 1998--139,998,671. Diluted EPS is calculated by adding to shares outstanding the additional net effect of potentially dilutive securities or contracts which could be exercised or converted into common shares. Weighted average diluted shares outstanding for each period are as follows: 2000--128,353,404, 1999--133,985,943, 1998-- 141,351,912.
A summary of fixed maturities available for sale and equity securities by amortized cost and estimated fair value at December 31, 2000 and 1999 is as follows:
A schedule of fixed maturities by contractual maturity at December 31, 2000 is shown below on an amortized cost basis and on a fair value basis. Actual maturities could differ from contractual maturities due to call or prepayment provisions.
Torchmark had $6.7 million and $7.0 million in investment real estate at December 31, 2000 and 1999, respectively, which was nonincome producing during the previous twelve months. These properties consisted primarily of undeveloped land. Torchmark had $3.4 million and $118 thousand in nonincome producing mortgages as of December 31, 2000 and 1999, respectively. As of year-end 2000, Torchmark had $410 thousand in nonincome producing fixed maturities. There were no other long-term investments which were nonincome producing at December 31, 2000.
Depreciation expense on property used in the business was $6.3 million, $5.6 million, and $4.2 million in each of the years 2000, 1999, and 1998, respectively.
Torchmark accounted for the spin-off of Waddell & Reed as a disposal of a segment. Accordingly, Torchmark's financial statements for 1998 and all prior periods have been modified to present the net assets and operating results of Waddell & Reed as discontinued operations of the disposed segment. The $54 million expense of the spin-off is included in discontinued operations under the caption "Loss on Disposal." The distribution of the Waddell & Reed shares resulted in a reduction in Torchmark's shareholders' equity in the approximate amount of $174 million, consisting of the equity in Waddell & Reed net of the 36% minority Interest.
On June 1, 1998, Torchmark sold Family Service to an unaffiliated insurance carrier. Family Service, which was acquired in 1990, is a preneed funeral insurer. Consideration for the sale was $140 million in cash. Torchmark recorded a pretax realized loss on the sale of approximately $14 million, but incurred a tax expense on the transaction of $9 million. In connection with the sale, Torchmark will continue to service the policies in force of Family Service for the next five years for a fee of $2 million per year plus certain variable processing costs. Through May, 1998, Family Service contributed $25 million in revenues and $5.8 million in pretax income. Invested assets were $778 million and total assets were $828 million at the date of the sale.
The following table summarizes Torchmark's noncash transactions, which are not reflected on the Statement of Cash Flow:
A summary of the assumptions used in determining the liability for future policy benefits at December 31, 2000 is as follows:
1950-54 Select and Ultimate Table 1954-58 Industrial Experience Table 1955-60 Ordinary Experience Table 1965-70 Select and Ultimate Table 1955-60 Inter-Company Table 1970 United States Life Table 1975-80 Select and Ultimate Table X-18 Ultimate Table
The overall average interest assumption for determining the liability for future life and health insurance benefits in 2000 was 6.1%.
As more fully discussed in Note 6, Torchmark completed the spin-off of its asset management segment in 1998, which resulted in a distribution of the policyholder surplus account of a Torchmark life insurance subsidiary. This caused a current tax expense of $50 million.
Torchmark accrues expense for the defined contribution plans based on a percentage of the employees' contributions. The plans are funded by the employee contributions and a Torchmark contribution equal to the amount of accrued expense. Plan contributions are both mandatory and discretionary, depending on the terms of the plan.
The weighted average assumed discount rates used in determining the actuarial benefit obligations were 7.5% in both 2000 and 1999. The rate of assumed compensation increase was 4.5% in both 2000 and 1999 and the expected long-term rate of return on plan assets was 9.2% in both 2000 and 1999.
The components of net periodic postretirement benefit cost for plans other than pensions are as follows:
For measurement purposes, a range of 7.0% to 10.0% annual rate of increase in per capita cost of covered healthcare benefits was assumed for 2000. These rates grade to ranges of 4.5% to 5.5% by the year 2010. 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:
Torchmark has entered into a revolving credit agreement with a group of lenders under which it may borrow on an unsecured basis up to $600 million. The commitment matures October 22, 2002. Borrowings are at interest rates selected by Torchmark based on either the corporate base rate or the Eurodollar rate at the time of borrowing. At December 31, 2000 and December 31, 1999 there were no borrowings under the revolving credit agreement. The revolving credit agreement is also designed to back up a commercial paper program. The short-term borrowings under the revolving credit agreements and in the commercial paper market averaged $370 million during 2000, and were made at an average yield of 6.32%. At December 31, 2000, commercial paper was outstanding in the face amount of $331 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, 2000, and pays a facility fee based on size of the line. Including fees, the average borrowing cost during 2000 was 6.47%.
In the first quarter of 1998, Torchmark repaid $20 million principal amount of its 8 5/8% Sinking Fund Debentures due March 1, 2017, through a sinking fund payment of which $8 million was mandatory and $12 million was elective under the terms of the issue. The remaining $160 million principal amount was called by Torchmark on April 1, 1998, at a prevailing call price of 103.76, or $166 million. An after-tax loss on the redemption of debt of $5 million was recorded in the second quarter of 1998. These payments were made from additional commercial paper borrowings.
Interest in the amount of $0, $284 thousand, and $2.4 million was capitalized during 2000, 1999, and 1998, respectively.
Acquisition of Common Shares: Torchmark shares are acquired from time to time through open market purchases under the Torchmark stock repurchase program when it is believed to be the best use of Torchmark's funds and for future employee stock option exercises. Share repurchases under this program were 6.1 million shares at a cost of $147 million in 2000, 6.7 million shares at a cost of $222 million in 1999, and 3.4 million shares at a cost of $126 million in 1998.
Options outstanding considered to be anti-dilutive totaled 7,497,546, 5,013,990, and -0- as of December 31, 2000, 1999, and 1998, respectively, and are excluded from the calculation of diluted earnings per share. Income available to common shareholders for basic earnings per share is equivalent to income available to common shareholders for diluted earnings per share.
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 September, 1997 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 vests 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.
Torchmark accounts for its employee stock options in accordance with SFAS 123 Accounting for Stock-Based Compensation, which defines a "fair value method" of measuring and accounting for employee stock options. This standard also allows accounting for such options under the "intrinsic value method" in accordance with Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees ("APB 25") and related interpretations. If a company elects to use the intrinsic value method, then pro forma disclosures of earnings and earnings per share are required as if the fair value method of accounting was applied. The effects of applying SFAS 123 in the pro forma disclosures are not necessarily indicative of future amounts.
Torchmark has elected to account for its stock options under the intrinsic value method as outlined in APB 25. The fair value method requires the use of an option valuation model, such as the Black-Scholes option valuation model, to value employee stock options, upon which compensation expense is based. The Black-Scholes option valuation model was not developed for use in valuing employee stock options. Instead, this model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because Torchmark's employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, it is management's opinion that the existing models do not provide a reliable measure of the fair value of its employee stock options. Under the intrinsic value method, compensation expense for Torchmark's option grants is only recognized if the exercise price of the employee stock option is less than the market price of the underlying stock on the date of grant.
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 2000, 1999, and 1998:
On November 6, 1998, in connection with its spin-off of Waddell & Reed, Torchmark adjusted the number and exercise price of its employee stock options so that the options' value after the spin would be equivalent to its value before the spin. Additionally, every eligible optionee was given the opportunity to elect to convert a portion of their Torchmark options into equivalent Waddell & Reed options in accordance with the same spin ratio that was applicable to all Torchmark shareholders. Also, employees of Waddell & Reed and directors were allowed to convert all of their Torchmark options into equivalent Waddell & Reed options. In every case, the employee or director maintained the same value after the spin-off as was held prior to the transaction.
A summary of Torchmark's stock option activity and related information for the years ended December 31, 2000, 1999, and 1998 follows:
The weighted average fair value of options granted during the years ended December 31, 2000, 1999, and 1998 were $12.05, $9.29, and $8.88, respectively.
Leases: Torchmark leases office space and office equipment under a variety of operating lease arrangements. These leases contain various renewal options, purchase options, and escalation clauses. Rental expense for operating leases was $3.3 million in 2000, $3.4 million in 1999, and $3.2 million in 1998. Future minimum rental commitments required under operating leases having remaining noncancelable lease terms in excess of one year at December 31, 2000 are as follows: 2001, $1.9 million; 2002, $1.5 million; 2003, $911 thousand; 2004, $431 thousand; 2005, $227 thousand and in the aggregate, $5.2 million.
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, 2000, the investment portfolio consisted of the following:
Investments in municipal governments and corporations are made throughout the U.S. with no concentration in any given state. Most of the investments in foreign government securities are in Canadian government obligations. Corporate debt investments are made in a wide range of industries. At December 31, 2000, 3% or more of the portfolio was invested in the following industries:
Guarantees: In the fourth quarter of 1999, Torchmark issued a full financial guaranty of all obligations, receivables, and recovery of capital on behalf of its subsidiaries American Income and AILIC Receivables Corporation up to $100 million. The guarantee was made to an unaffiliated third party as agent for the purchasers of certain agent receivables of American Income.
On August 25, 1995, a purported class action was filed against Torchmark, Globe, United American and certain officers of these companies in the United States District Court for the Western District of Missouri on behalf of all former agents of Globe (Smith v. Torchmark Corporation, Case No. :95-3304-CV- S-4). This action alleges that the defendants breached independent agent contracts with the plaintiffs by treating them as captive agents and engaged in a pattern of racketeering activity wrongfully denying income and renewal commissions to the agents, restricting insurance sales, mandating the purchase of worthless leads, terminating agents without cause and inducing the execution of independent agent contracts based on misrepresentations of fact. Monetary damages in an unspecified amount were sought. A plaintiff class was certified by the District Court on February 26, 1996, although the certification did not go to the merit of the allegations in the complaint. On December 31, 1996, the plaintiffs filed an amended complaint in Smith to allege violations of various provisions of the Employment Retirement Income Security Act of 1974. Extensive discovery was then conducted. In October 1998, defendants filed a motion to decertify the presently defined class in Smith. On March 23, 1999, the District Court granted defendants' motion to decertify the Smith class in part and decertified all but the ERISA claims of a more narrowly defined Smith class. In May 1999, the defendants filed motions to dismiss the claims certified by the Court's March 23, 1999 order. On December 14, 1999, the District Court granted defendants' motion for summary judgment. That Court denied a motion for reconsideration on January 21, 2000. Defendants filed a motion for summary judgment on the remaining individual claims in the Smith case on May 1, 2000 and this motion was granted by the District Court on January 4, 2001. The plaintiffs filed a notice of appeal shortly thereafter, which defendants have moved to dismiss as premature.
It has been previously reported that purported class action litigation was filed against Torchmark's subsidiary, American Income Life Insurance Company and certain of its employee benefit plans (Peet, et al. v. American Income Life Insurance Company, et al., Case No. C-99-2283) on May 18, 1999 in the U.S. District Court for the Northern District of California, which was subsequently transferred to the U.S. District Court for the Western District of Texas. Plaintiffs, individually and on behalf of all current and former public relations representatives of American Income, asserted that they had been improperly classified as independent contractors rather than employees and thus denied participation in certain of
On July 3, 2000, the District Court issued an order in the Moore case granting in part and denying in part the plaintiffs' motions. The District Court ordered the Moore plaintiffs to file an amended complaint setting forth their claims under 28 U.S.C. (S)(S) 1981 and 1982 and, if such claims are timely, any state law claims for breach of contract related to the discontinuance of debit collections, and dismissed with
It has been previously reported that on August 18, 2000, a jury in Barbour County, Alabama Circuit Court returned a verdict of $100,000 compensatory damages and $3.5 million in punitive damages against Torchmark's subsidiary, Liberty in Carter v. Liberty National Life Insurance Company (Civil Action No. CV-99-026). An individual lawsuit filed in March 1999, the Carter case involved allegations of fraud, misrepresentation, suppression and negligent/wanton agent hiring, training and supervision practices by Liberty in connection with the sale of an interest-sensitive life insurance policy. The plaintiff had asserted that the policy had been purchased based upon agent representations that it would become paid-up or self sustaining after a specified number of years. Liberty pursued available motions for post trial relief in this case and on February 15, 2001, the Circuit Court reduced the Carter verdict to $100,000 compensatory damages and $700,000 in punitive damages. Liberty will pursue additional appellate relief in the Carter case.
The measure of profitability established by management for insurance segments is underwriting income before other income and administrative expenses, in accordance with the manner the segments 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.
The measure of profitability for the investment segment is excess investment income, which represents the income earned on the investment portfolio in excess of net policy requirements and financing costs associated with debt and Torchmark's MIPS. The investment segment is measured on a tax-equivalent basis, equating the return on tax-exempt investments to the pretax return on taxable investments. Other than the above-mentioned interest allocations, there are no other intersegment revenues or expenses. Expenses directly attributable to corporate operations are included in the "Corporate" category. All other unallocated revenues and expenses on a pretax basis, including insurance administrative expense, are included in the "Other" segment category. The table below sets forth a reconciliation of Torchmark's revenues and operations by segment to its major income statement line items.
Assets for each segment are reported based on a specific identification basis. The insurance segments' assets contain deferred acquisition costs, value of insurance purchased, and separate account assets. The investment segment includes the investment portfolio, cash, and accrued investment income. Goodwill is assigned to corporate operations. All other assets, representing less than 2% of total assets, are included in the other category. The table below reconciles segment assets to total assets as reported in the consolidated financial statements.
During the first quarter of 1999, the two Torchmark directors who occupied seats on the Vesta Board of Directors resigned from those Vesta seats. Due to the vacating of the Vesta board seats and the absence of significant influence regarding Vesta, Torchmark discontinued the equity method of accounting for Vesta and has included Vesta in equity securities at market value subsequent to December 31, 1998. Torchmark carried Vesta at a value of $20 million at December 31, 1999.
Torchmark sold 3.75 million shares of Vesta during the second quarter of 2000. In early July, 2000, Torchmark sold the remaining 1.38 million shares of Vesta stock that it held. The sales provided proceeds of $33 million and resulted in an after-tax loss of $1.5 million. As of December 31, 2000, Torchmark no longer had any ownership interest in Vesta.
The following is a summary of quarterly results for the two years ended December 31, 2000. The information is unaudited but includes all adjustments (consisting of normal accruals) which management considers necessary for a fair presentation of the results of operations for these periods.