American Income owns and is the sole occupant of an office building located in Waco, Texas. The building is a two-story structure containing approximately 72,000 square feet of usable floor space. American Income also owns a 43,000 square foot facility located in Waco which houses a direct response operation.
(2) SFAS 115 is an accounting rule requiring fixed maturities to be revalued at fair value each period. The effect of SFAS 115 on equity per share reflects the amount added or (deducted) under SFAS 115 to produce GAAP Shareholders’ equity. Please see the explanation and discussion under the caption Capital Resources in Management’s Discussion and Analysis in this report concerning the effect this rule has on Torchmark’s equity.
Insurance Product Line Segments. As fully described in Note 15-Business Segments in the Notes to the Consolidated Financial Statements, the product line segments involve the marketing, underwriting and benefit administration of policies. Each product line is comprised of the various distribution units that market the insurance policies. Whether analyzing profitability of a segment as a whole, or the individual distribution units within the segment, the measure of profitability used by management is the underwriting margin, which is premium revenue reduced by policy benefit obligations and policy acquisition expenses. Underwriting margin is useful to management in evaluating the performance of the insurance product line segments and their underlying distribution units because each distribution unit tends to operate in a niche market offering insurance products designed for that niche. These measures enable management to view period-to-period trends and make informed decisions regarding future courses of action.
Under the caption Realized Gains and Losses in the report, Torchmark presents a complete analysis and discussion of its realized gains and losses. As also explained under that caption, Torchmark management does not consider realized gains and losses to be a component of its core insurance operations. However, they can have a material positive or negative impact on net income. In 2004, Torchmark had after-tax realized investment gains of $14 million compared with losses of $2 million in 2003 and losses of $25 million in 2002. Realized gains and losses in all periods were favorably impacted by the effects of Torchmark’s interest-rate swap derivatives, which, as explained in the following paragraph, are included in realized gains and losses. Writedowns of investments due to the deterioration in credit quality of certain investments had a negative impact in each period, particularly in 2002.
As also explained under the discussion of realized gains and losses, Torchmark views the benefit of the reduced interest cost resulting from the swap of its fixed-rate interest obligations to variable rates as a reduction in interest costs. In addition to the beneficial impact on earnings from this interest cost differential due to these swaps, GAAP rules also require that all derivatives (including Torchmark’s swaps) must be valued at market value with period-to-period changes reflected in earnings. In accordance with GAAP, these changes in value are treated as realized gains and losses. In 2003, the Securities and Exchange Commission informally interpreted the GAAP rules affecting the reporting of Torchmark’s swap instruments stating that all income and expenses related to non-hedged derivatives must be reported in the same line item as the required fair value adjustment. To comply with this interpretation, Torchmark reports the interest expense reduction on all of its swap derivatives in its Consolidated Statements of Operations as a realized investment gain, not as a reduction in interest expense. Torchmark continues to report this interest savings as a reduction in interest cost in its segment analysis and in its management’s discussion, as GAAP requires the segment disclosures to be as Torchmark manages its investment segment.
In 2004 and 2003, Torchmark’s net income was affected by certain significant, unusual, and nonrecurring items. Torchmark management does not view these items as components of its core operating results because they are not indicative of past performance or future prospects of the insurance operations. A discussion of these items follows.
Torchmark has in place an ongoing share repurchase program which began in 1986 and was reaffirmed at its July 29, 2004 Board of Director’s Meeting. With no specified authorization amount, management determines the amount of repurchases based on the amount of the Company’s excess cash
Life insurance. Life insurance is Torchmark’s largest insurance segment. Its premium is also growing at a greater rate than the other insurance segments. In 2004, life premium represented 56% of total premium, compared with 55% in 2003 and 54% in 2002. Life underwriting income before other income and administrative expense represented 65% of the total in 2004, compared with 65% in 2003 and 62% in 2002. Additionally, investments supporting the reserves for life products result in the majority of excess investment income attributable to the investment segment.
Torchmark management uses two statistical measures as indicators of premium growth and sales over the near term, “annualized premium in force” and “first-year collected premium.” Annualized premium in force is defined as the premium income that would be received over the next twelve months at any given date on all active policies if those policies remain in force throughout the period. Annualized premium in force is an indicator of growth in premium revenue. First-year collected premium is a measure of sales, and is defined as the premium collected during the reporting period for all policies in their first policy year. First-year collected premium takes lapses into account in the first year when lapses are more likely to occur, and thus is a useful indicator of how much new premium is expected to be added to premium in force due to new sales.
The Direct Response Group is Torchmark’s leading writer of life insurance. Marketing is conducted primarily through direct mail, but also through co-op mailings, television and consumer magazine advertising, and direct mail solicitations endorsed by groups, unions and associations. This group markets a line of life products primarily to juveniles, their parents, and other adults over age 50. The Direct Response operation accounted for almost 28% of Torchmark’s life insurance premium during 2004. Life premium rose 10% in 2004 and 11% in 2003. At December 31, 2004, life annualized premium in force was $443 million, which represented 29% of Torchmark’s total, the largest of any distribution group. Life insurance annualized premium in force rose 9% in 2004 after growing 13% in 2003.
Growth in premium income and annualized premium in force resulted from strong sales of Direct Response products in each period, as evidenced by the increases in first-year collections of 19% to $74 million in 2004 and 24% to $63 million in 2003. These increases in first-year collections were the largest of any life distribution group in either period. The growth in sales is largely attributable to this group’s focus on its juvenile life product. This product was recently recharacterized as a larger face-amount product with a higher annual premium, and has been a successful product for this market. Not only is the juvenile market an important source of sales, but it also is a vehicle to reach the parents and grandparents of the juvenile insureds. Parents and grandparents of juvenile policyholders are more likely to respond favorably to a solicitation by Direct Response for life coverage on themselves than is the general adult population. Also, both the juveniles and their parents are low-acquisition cost targets for sales of additional coverage over time. Torchmark expects that sales to the juvenile market and their parents will continue as one of this group’s premier markets. Management believes that the Direct Response Unit is the largest U.S. writer of juvenile direct response life insurance.
The Liberty National Exclusive Agency distribution system markets primarily to middle-income markets in several Southeastern states. Liberty’s life premium was flat in 2004 compared with 2003 at $304 million. In 2003, life premium grew 1% over the prior year. Annualized life premium in force was $318 million at December 31, 2004, declining 1% in 2004 after having risen 1% in 2003. Life premium sales for this agency, in terms of first-year collected premium, was flat in each of the years 2002 through 2004 at $40 million. Growth in sales and premium volume are highly dependent on growth in the agency force. Liberty had 1,775 agents at year end 2004, compared with 2,197 at year end 2003 and 2,203 at year end 2002. These counts represent a decrease of 19% in 2004 and were essentially flat in 2003.
Torchmark’s Other Agencies consist of the United Investors Agency, the United American Independent and Branch Office Agencies, and other small miscellaneous sales agencies. The United Investors Agency is comprised of several independent agencies that concentrate on annuity business. Prior to 2001, United Investors’ distribution was primarily through the sales representatives of a former Torchmark subsidiary that was spun off in 1998. United Investors terminated the agency contract with that organization in 2001. The loss of that sales group has had a negative impact on production in the United Investors Agency. The United American Independent and Branch Office Agencies combined represented approximately 40% of Other Agency premium in 2004, or 5% of the Torchmark total. Life premium for these agencies has been relatively flat for the past three years, because these two agencies focus on health insurance, with life sales being incidental.
Gross margins, as indicated by insurance underwriting margin before other income and administrative expense, rose 9% in both 2004 and 2003 over the respective prior year. As a percentage of life insurance premium, gross margins have increased each year. Improvements in life margins have resulted from several factors. The previously-mentioned changes in Liberty’s agent compensation system and premium collection method have contributed to notable increases in Liberty’s margins. Additionally, the percentage of American Income premium to total premium continues to grow, and that has caused life margins to increase because that agency’s margins are Torchmark’s highest at 30%. Direct Response margins have grown to above 25%, as it has emphasized sales of its juvenile policy, a higher-margin product.
Health Insurance. Torchmark markets its supplemental health insurance products through a number of distribution channels. Health premium represented 42% of Torchmark’s total premium income in 2004. Health underwriting margin accounted for 32% of the total. The following table indicates health insurance premium income by distribution channel for each of the last three years.
Health products sold by Torchmark insurance companies are all supplemental plans that include Medicare Supplements sold to enrollees in the federal Medicare program, as well as other limited-benefit plans including cancer and hospital-surgical plans sold to people under age 65. The table below presents Torchmark’s health insurance annualized premium in force by major product category at December 31, 2004 and for the two preceding years.
Health insurance underwriting margin before other income and administrative expense increased 6% in 2004 from $164 million to $175 million. In 2003, health underwriting income declined 2% from $167 million in 2002. As a percentage of premium, underwriting income before other income and administrative expense rose in 2004 to 16.6%, largely as a result of the reduced loss ratios in the previously-mentioned closed block of cancer business at Liberty. In recent years, this block of business has experienced high loss ratios even though frequent premium rate increases have been implemented. The high loss ratios have been a result of increased claim costs due to the additional benefits required in the class-action settlements. As a percentage of premium, health margin declined from 17.2% in 2001 to 16.4% in 2002 and to 15.9% in 2003, a downtrend primarily caused by the growing loss ratios of this block. The Company recently announced that it has reached an agreement with parties in a class-action lawsuit (Roberts v. Liberty National Life Insurance Company) related to this block of business. (See Part 1, Item 3 - Legal Proceedings), The settlement provides for claims incurred after the effective date of the settlement in early March 2005 to be paid on an actual incurred basis, rather than a billed basis, which management estimates will reduce benefits paid going forward. It also provides for a grandfathered period for certain claimants that will allow them to be paid at billed rates for one year. The settlement also requires Liberty to reduce premiums and to maintain an 85% claims loss ratio over the remaining life of the business. As a result, premiums are estimated to decline from about $70 million per year prior to the settlement to about $50 million in force when the settlement is fully phased in, assuming no lapsed policies. Prior to the settlement, Liberty has had a claims loss ratio above 100% on this block.
Annuity policy charges have declined in each period, as the average annuity account balance, upon which the majority of charges were based, has declined. Annuity underwriting margin before other income and administrative expenses rose 18% to $14 million in 2004, even though policy charges declined in 2004. The primary factor in this increase was the reduction in policy obligations resulting from the decline in guaranteed minimum death benefits from $5.0 million in 2003 to $2.8 million in 2004 due to higher equity markets in 2004 when compared with the prior year. A significant portion of product profitability of fixed annuities is derived from the spread of investment income earned versus contractual interest requirements credited to the policies. Because this interest spread exceeds policy benefit obligations, net policy obligations result in a negative balance and increase underwriting margin. Underwriting margins declined from $15 million in 2002 to $12 million in 2003. The 2003 decline resulted from the decline in the average annuity account balance even though the end of year balance rose 6% in 2003. Guaranteed minimum death benefits increased slightly in 2003 from $4.8 million.
The investment segment is responsible for the management of capital resources including investments, debt and cash flow. Excess investment income represents the profit margin attributable to investment operations. It is the measure that management uses to evaluate the performance of the investment segment as described in Note 15-Business Segments in the Notes to the Consolidated Financial Statements. It is defined as net investment income less both the interest credited to net policy liabilities and the interest cost associated with capital funding or “financing costs.” Management also views excess investment income per diluted share as an important and useful measure to evaluate the performance of the investment segment. It is defined as excess investment income divided by the total diluted weighted average shares outstanding, representing the contribution by the investment segment to the consolidated earnings per share of the Company. Since 1986, Torchmark has used over $2.5 billion of cash flow to repurchase Torchmark shares under its ongoing share repurchase program after determining that the repurchases provided a greater return than other investment alternatives. Share repurchases reduce excess investment income because of the foregone earnings on the cash that would otherwise have been invested in interest bearing assets, but they also reduce the number of shares outstanding. In order to put all capital resource uses on a comparable basis, management believes that excess investment income per diluted share is an appropriate measure of the investment segment.
Excess investment income rose 4% in 2004 to $331 million. It increased 9% in 2003 and 16% in 2002. Excess investment income per diluted share increased 7% in 2004 to $2.95 per share from $2.75 per share. It increased 14% in 2003 and 21% in 2002. Growth in excess investment income is impacted by increases in investment income due to the growth in the portfolio and changes in rates available in financial markets. It is also affected by crediting rates on policy liabilities and changes in Torchmark’s borrowing costs. Additionally, share purchases in recent periods have caused excess investment income per share to grow faster than excess investment income.
Included in the Consolidated Statements of Operations as a realized investment gain under the caption “Realized investment gains (losses)”. See Derivatives in Note 1-Significant Accounting Policies in the Notes to Consolidated Financial Statements.
Torchmark’s investment strategy is to maintain a positive spread between yields on investments and the Company’s required yield on policy and financing costs. It is this positive spread that results in excess investment income. At the same time, Torchmark desires to invest predominately in investment-grade quality corporate fixed maturities. In prolonged periods of low interest rates, maintaining sufficient spread while limiting new investments to high quality becomes more challenging. Because Torchmark’s policy liabilities are very long-term in nature with predominantly fixed crediting rates, a low-rate environment must exist for a considerable period of time before any meaningful negative impact will be made on the spread. Nevertheless, Torchmark has addressed this issue in the recent periods of declining rates by lengthening maturities of new investment purchases to maximize the yield and revising the crediting rates on various products.
The chart below presents selected information about Torchmark’s fixed-maturity acquisitions in the years 2002 through 2004. Investment-grade corporate securities include both bonds and trust-preferred securities (classified as redeemable preferred stocks) with a diversity of issuers and industry sectors. Both yield and average life calculations on new purchases on noncallable bonds are based on the maturity date. In the case of callable bonds, the average life is based on the call date or maturity date, whichever produces the lowest yield (“yield to worst”).
As rates have declined in recent periods, Torchmark has attempted to maximize yield on new investments by lengthening maturities as shown above. Management believes that the long-term, fixed-rate characteristics of its policy liabilities do not result in negative asset and liability matching. In years prior to 2003, Torchmark was able to maintain yields in excess of 7.25% on new acquisitions of investment-grade bonds. In 2003 and in 2004, however, yields at this level were unavailable for investment-grade bonds due to the lower interest-rate environment. As a result, new money was invested at an average effective yield of 6.47% in 2004 and 6.55% in 2003. In addition to the investment of new cash flow, the lower-yield environment during this period also impacted Torchmark as calls by issuers of securities have accelerated. Issuers are more likely to call bonds when rates are low because they can refinance them at a lower cost. These calls cause Torchmark to replace higher-yielding bonds with those available at lower prevailing yields. For the 2003-2004 period, bonds at a book value of $796 million were called yielding an average of 7.2%.
As long as the current yields on new fixed maturity acquisitions remain at or below those of the 2003-2004 period, the overall yield on the investment portfolio will slowly decline as will investment income and excess investment income. Torchmark has taken steps to minimize the potential impact of lower rates: maximizing the yield on investment-grade fixed maturity acquisitions by lengthening the life of acquisitions, reducing crediting rates on certain policy liabilities, and using interest rate swap agreements to offset some of its fixed rate debt. Management believes its strategy to mitigate the lower interest rate environment is appropriate, and with the sizeable annual cash flow generated from operations, the Company will be well positioned when investment interest rates eventually rebound.
Torchmark’s emphasis has been on bond investments over investments in equities, mortgages, or real estate. Therefore, the relative percentage of Torchmark’s investments by type continues to vary from industry norms. The following table presents a comparison of Torchmark’s components of invested assets at amortized cost as of December 31, 2004 with the latest industry data.
For an analysis of Torchmark’s fixed-maturity portfolio by component at December 31, 2004 and 2003, see Note 3-Investments in the Notes to Consolidated Financial Statements.
* A measure of the price sensitivity of a fixed-income security to a particular change in interest rates.
At the end of both 2004 and 2003, the fixed-maturity portfolio had a gross unrealized gain of $670 million. Gross unrealized losses on fixed maturities were $21 million at December 31, 2004, compared with $39 million a year earlier.
Otherwise, no individual industry represented 2% or more of Torchmark’s corporate fixed maturities.
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. Unrealized changes in value caused by changes in interest rates are significant to Torchmark’s investment portfolio because its fixed-maturity holdings at amortized cost represent approximately 94% of total investments and 59% of its total assets. 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 fair value under SFAS 115.
Market risk is managed in a manner consistent with Torchmark’s investment objectives. Torchmark seeks to maintain a portfolio of high-quality, fixed-maturity assets that are available for sale. However, it is Torchmark’s primary objective to hold securities to maturity. Torchmark’s strong operating cash flow and stable, long-term policy liabilities decrease the likelihood of needing to sell fixed investments for operating liquidity. Some sales may be made to preserve capital due to changes in credit quality of individual securities or for certain business purposes. While the lengthening of the fixed-maturity portfolio can result in more period-to-period volatility in the fair value of the portfolio, Torchmark’s objective to generally hold securities to maturity to provide for its long-term liabilities minimizes any real impact of interest-rate changes on the Company. The Company expects 35% of the fixed portfolio to be repaid (including calls) within five years and 51% within ten years.
No derivative instruments are used to manage Torchmark’s exposure to market risk in the investment portfolio. Interest-rate swap instruments have been entered into by Torchmark in connection with its trust preferred stock and certain of its debt issues as discussed in Note 12-Debt in the Notes to the Consolidated Financial Statements and under the caption Capital Resources in this report.
The following table illustrates the market risk sensitivity of Torchmark’s interest-rate sensitive fixed-maturity portfolio at December 31, 2004 and 2003. This table measures the effect of a change in interest rates (as represented by the U.S. Treasury curve) on the fair value of Torchmark’s fixed-maturity portfolio. The data are prepared through a model which incorporates various assumptions and estimates to measure the change in fair value arising from an immediate and sustained change in interest rates in increments of 100 basis points. It takes into account the effect that special option features such as call options, put options, and unscheduled repayments could have on the portfolio, given the changes in rates. The valuation of these option features is dependent upon assumptions about future interest rate volatility that are based on past performance.
The following table summarizes Torchmark’s tax-effected realized gains (losses) by component for each of the years in the three-year period ended December 31, 2004.
In each year, Torchmark wrote down several individual holdings to estimated fair value as a result of other-than-temporary impairment. The impaired securities met some or all of Torchmark’s criteria for other-than-temporary impairment as discussed in Note 3-Investments in the Notes to Consolidated Financial Statements and in its Critical Accounting Policies in this report. Pretax charges for these impairments were $6 million in 2004, $15 million in 2003, and $93 million in 2002. Of the issuers of bonds written down in 2002 through 2004, the bonds of 3 issuers were still held at December 31, 2004 at a fair value of $57 million and a recorded book value of $34 million.
Liquidity. Liquidity provides Torchmark with the ability to meet on demand the cash commitments required by its business operations and financial obligations. Torchmark’s liquidity is derived from three sources: positive cash flow from operations, a portfolio of marketable securities, and a line of credit facility.
Torchmark’s cash and short-term investments were $99 million at year-end 2004 and $64 million at year-end 2003. Additionally, Torchmark has a portfolio of marketable fixed and equity securities that are available for sale in the event of an unexpected need. These securities had a fair value of $8.8 billion at December 31, 2004. However, Torchmark’s strong cash flows from operations, investment maturities, and credit line availability make any need to sell securities for liquidity unlikely.
Off-Balance Sheet Arrangements. As fully described and discussed in Note 12-Debt in the Notes to the Consolidated Financial Statements and under the subcaption Funded Debt, Torchmark has outstanding $150 million (par amount) 7 3/4% Trust Preferred Securities. The Capital Trusts which are liable for these securities are the legal entities which are responsible for the securities and facilitate the payment of dividends to shareholders. They are off-balance sheet arrangements which Torchmark is required to deconsolidate in accordance with GAAP rules. Deconsolidation is necessary because they are considered to be variable interest entities in which Torchmark has no variable interest and is therefore not the primary beneficiary of the entity, even though it owns all of the entity’s voting equity. While these liabilities are not on Torchmark’s balance sheet, they are represented by Torchmark’s 7 3/4% Junior Subordinated Debentures due to the trusts. These Junior Subordinated Debentures are a Torchmark
liability of $155 million par and book value at December 31, 2004 and are indicated as a capital resource to Torchmark under the caption Capital Resources in this report. The 7 3/4% preferred dividends due to the preferred shareholders are funded by Torchmark’s 7 3/4% interest payment on its debt to the trusts. As described in Note 16-Commitments and Contingencies in the Notes to Consolidated Financial Statements, Torchmark has guaranteed the performance of the Capital Trusts to meet its financial obligations to the Trust Preferred shareholders.
As of December 31, 2004, Torchmark had no other significant unconsolidated affiliates and no guarantees of the obligations of third-party entities. All of Torchmark’s guarantees, other than the Trust Preferred guarantee, were guarantees of the performance of consolidated subsidiaries, as disclosed in Note 16-Commitments and Contingencies. All of Torchmark’s derivative instruments were recorded at fair value on the balance sheet.
Interest on debt is based on Torchmark’s fixed contractual obligations. As certain debt instruments have related swaps which exchange fixed obligations to those based on floating rates, Torchmark’s actual interest cost may be greater or lesser than presented. At December 31, 2004, Torchmark had in place swaps with a notional amount of $529 million on its $692 million of long-term debt. More information about Torchmark’s swaps is found in Note 12-Debt in the Notes to Consolidated Financial Statements.
These are remaining fixed payments due under insurance contracts where benefit payments began on or before December 31, 2004. Unlike the liability on the Consolidated Balance Sheet, which is discounted, the scheduled amounts are undiscounted and will sum to an amount greater than the discounted liability.
A comparison of the estimated insurance revenue (premiums and investment income) to the estimated insurance obligations follows:
Capital Resources. Torchmark’s capital structure consists of short-term debt (the commercial paper facility described in Note 12-Debt in the Notes to Consolidated Financial Statements), long-term funded debt, Junior Subordinated Debentures supporting its trust preferred securities, and shareholders’ equity. The Junior Subordinated Debentures are payable to Torchmark’s Capital Trusts which are liable for its Trust Preferred Securities. In accordance with GAAP, these instruments are included in “Due to affiliates” on the Consolidated Balance Sheet. An analysis of long-term debt issues outstanding is as follows at December 31, 2004.
Unamortized issue expenses incurred upon issuance of the Trust Preferred Securities.
Market value of the Trust Preferred Securities which are obligations of the unconsolidated capital trusts.
The carrying value of the funded debt was $695 million at December 31, 2004, compared with $698 million a year earlier. See Note 12-Debt in the Notes to Consolidated Financial Statements for information concerning funded debt. In connection with these instruments, Torchmark had in place four interest-rate swap agreements at December 31, 2004, but also had another swap agreement which expired in September, 2004. These agreements exchange Torchmark’s fixed-rate obligations on the debt instruments to floating rates. Information about these swaps is also found in the debt note.
Torchmark maintains a significant available-for-sale fixed-maturity portfolio to support its insurance policyholders’ liabilities. Torchmark is required by an accounting rule (SFAS 115) to revalue this portfolio to fair market value at the end of each accounting period. The period-to-period changes in fair value, net of their associated impact on deferred acquisition costs and income tax, are reflected directly in shareholders’ equity. Changes in the fair value of the portfolio result from changes in interest rates in financial markets. While SFAS 115 requires invested assets to be revalued, accounting rules do not permit interest-bearing insurance policy liabilities to be valued at fair value in a consistent manner. Due to the size of Torchmark’s policy liabilities in relation to its shareholders’ equity, this inconsistency in measurement usually has a material impact in the reported value of shareholders’ equity. If these liabilities were revalued in the same manner as the assets, the effect on equity would be largely offset. Fluctuations in interest rates cause undue volatility in the period-to-period presentation of Torchmark’s shareholders’ equity, capital structure, and financial ratios which would be essentially removed if interest- bearing liabilities were valued in the same manner as assets. For this reason, Torchmark’s management, credit rating agencies, lenders, many industry analysts, and certain other financial statement users prefer to remove the effect of SFAS 115 when analyzing Torchmark’s balance sheet, capital structure, and financial ratios.
As previously mentioned, Torchmark’s Board reaffirmed its continued authorization of the Company’s stock repurchase program in 2004 in amounts and timing that management, in consultation with the Board, determined to be in the best interest of the Company. Torchmark has repurchased its common
The financial strength of Torchmark’s major insurance subsidiaries are also rated by Standard & Poor’s and A.M. Best. Standard and Poor’s lowered the insurance financial strength rating of United Investors to A+ from AA, noting that United Investors was no longer a strategic subsidiary to Torchmark. Also during 2003, A. M. Best upgraded American Income’s insurance financial strength rating to A+ (Superior) from A (Excellent). The following chart presents these ratings for Torchmark’s five largest insurance subsidiaries at December 31, 2004.
Litigation. Torchmark and its subsidiaries continue to be named as parties to pending or threatened litigation, much of which involves punitive damage claims based upon allegations of agent misconduct at Liberty in Alabama. Such punitive damage claims are tried in Alabama state courts where any punitive damage litigation may have the potential for significant adverse results since punitive damages in Alabama are based upon the compensatory damages (including mental anguish) awarded and the discretion of the jury in awarding compensatory damages is not precisely defined. Additionally, it should be noted that Torchmark subsidiaries actively market insurance in the State of Mississippi, a jurisdiction which is nationally recognized for large punitive damage verdicts. Bespeaking caution is the fact that it is impossible to predict the likelihood or extent of punitive damages that may be awarded if liability is found in any given case. It is thus difficult to predict with certainty the liability of Torchmark or its subsidiaries in any given case because of the unpredictable nature of this type of litigation. Based upon information presently available, and in light of legal and other factual defenses available to Torchmark and its subsidiaries, contingent liabilities arising from threatened and pending litigation are not presently considered by management to be material. For more information concerning litigation, please refer to Note 16-Commitments and Contingencies in the Notes to the Consolidated Financial Statements.
Information regarding related party transactions is found in Note 17 - Related Party Transactions in the Notes to Consolidated Financial Statements.
Stock Option Expensing: Stock options have been granted to executives, employees, consultants, and directors as a form of compensation to provide motivation and to align the interests of these groups with the same interests of shareholders. Because they are generally granted at the fair value of Torchmark stock at the date of grant, the value of these options increases as the value of Torchmark stock increases. The cost of these options is in the dilution caused by the exercise of the options, as the grantees’ ownership of the Company grows in relation to existing shareholders. This cost has historically been reflected in per share earnings in the financial statements through the increased dilution.
While restatement of prior periods is permitted, the Statement also permits a “modified prospective” method of adoption, whereby the expense of all unvested options as of July 1, 2005 and options granted after July 1, 2005 are expensed in accordance with the Statement after that date. Torchmark will elect the modified prospective method of adoption.
The “fair value” assigned to option grants is derived from complex option pricing models using subjective assumptions such as price volatility and expected term. Considerable judgment is sometimes
produce the liability for claims and other benefits, including the estimate of unsubmitted claims, are the most appropriate under the circumstances. However, there is no certainty that the resulting stated liability will be Torchmark’s ultimate obligation.
While every effort is made to make the best estimate of status and value with the information available regarding an other-than-temporary impairment, it is difficult to predict the ultimate recoverable amount of a distressed or impaired security.
2) Federal and state legislative and regulatory developments, particularly those impacting taxes and changes to the federal Medicare program that would affect Medicare Supplement insurance;
4) Interest rate changes that affect product sales and/or investment portfolio yield;
9) The inability of Torchmark to obtain timely and appropriate premium rate increases for health insurance policies due to regulatory delay;
11) Reported amounts in the financial statements which are based on management’s estimates and judgments which may differ from the actual amounts ultimately realized.
Consolidated Statements of Operations for each of the three years in the period ended December 31, 2004
Consolidated Statements of Comprehensive Income for each of the three years in the period ended December 31, 2004
We have audited the accompanying consolidated balance sheets of Torchmark Corporation and subsidiaries (“Torchmark”) as of December 31, 2004 and 2003, and the related consolidated statements of operations, comprehensive income, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2004. Our audits also included the financial statement schedules listed in the Index at Item 15. These financial statements and financial statement schedules are the responsibility of Torchmark’s management. Our responsibility is to express an opinion on the financial statements and financial statement schedules based on our audits.
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, 2004 and 2003, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2004, 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.
Gains and losses realized on the disposition of investments are determined on a specific identification basis. Realized investment gains and losses and investment income attributable to separate accounts are credited to the separate accounts and have no effect on Torchmark’s net income. Investment income attributable to all other insurance policies and products is included in Torchmark’s net investment income. Net investment income for the years ended December 31, 2004, 2003, and 2002, included $370 million, $351 million, and $332 million, respectively, which was allocable to policyholder reserves or accounts. Realized investment gains and losses are not allocated to insurance policyholders’ liabilities.
Impairment of Investments: In March, 2004, the Emerging Issues Task Force reached a consensus concerning Issue 03-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments (EITF 03-1). It calls for evaluation of all of Torchmark’s fixed-maturity and equity investments for other-than-temporary impairment each reporting period using a three-step approach. First, evaluate if the investment is impaired (fair value is less than cost or amortized cost). Second, determine whether the impairment is other-than-temporary. While specific steps are outlined, this step requires considerable evidence-based judgment as to the ultimate recoverability of amounts due, taking into account the severity and duration of the impairment. An assessment of the ability and intent to hold the security to
recovery is also a factor. In the event there is an other-than-temporary impairment, the third step involves a writedown of the cost basis of the security to fair value, which becomes the new cost basis. EITF 03-1 also calls for certain disclosures.
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
Stock Options: Torchmark accounts for its employee stock options in accordance with SFAS 123-Accounting for Stock-Based Compensation as amended by SFAS 148-Accounting for Stock-Based Compensation-Transition which defines a “fair value method” of measuring and accounting for compensation expense from 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.
Torchmark’s statutory financial statements are presented on the basis of accounting practices prescribed by the insurance department of the state of domicile of each insurance subsidiary. All states have adopted the National Association of Insurance Commissioners’ (NAIC) statutory accounting practices (“NAIC SAP”) as the basis for statutory accounting. However, certain states have retained the prescribed practices of their respective insurance code or administrative code which can differ from NAIC SAP. There are no significant differences between NAIC SAP and the accounting practices prescribed by the state of domicile for Torchmark’s life insurance companies that affect statutory surplus except as noted in the chart below.
Carrying value of affiliated preferred stock limited to 2% of prior year admitted assets
A summary of fixed maturities available for sale and equity securities by cost or amortized cost and estimated fair value at December 31, 2004 and 2003 is as follows:
A schedule of fixed maturities by contractual maturity at December 31, 2004 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’s portfolio of fixed maturities fluctuates in value based on interest rates in financial markets and other economic factors. These fluctuations caused by market rate changes have little bearing on whether or not the investment will be ultimately recoverable. Therefore, Torchmark considers these declines in value as temporary even in periods exceeding one year. In certain circumstances, however, it may become apparent that the principal of an investment may not be recoverable, generally due to factors specific to an individual issuer and not market interest rates. In this event, Torchmark classifies such investments as other-than-temporarily impaired and writes the investment down to fair value, realizing an investment loss. The determination that a security is other-than-temporarily impaired is highly subjective and involves the careful consideration of many factors. These factors include:
The following tables disclose unrealized investment losses by class of investment at December 31, 2004 and December 31, 2003. Torchmark considers these investments to be only temporarily impaired.
Torchmark had $6.6 million in investment real estate at December 31, 2004, which was nonincome producing during the previous twelve months. These properties consisted primarily of undeveloped land. Torchmark had $8.8 million in nonincome producing mortgages as of December 31, 2004. Torchmark had no nonincome producing fixed maturities or other long-term investments during the twelve months ended December 31, 2004.
During 2002, Torchmark wrote down a portion of its investment real estate portfolio to net realizable value. The write down resulted in a pretax loss of $3.6 million, or $2.4 million after tax. At December 31, 2004, Torchmark owned $13.7 million in investment real estate, of which $6.5 million was included with properties partially occupied by Torchmark subsidiaries.
Depreciation expense on property and equipment used in the business was $4.1 million, $4.1 million, and $4.5 million, in each of the years 2004, 2003, and 2002, respectively.
The amount of interest accrued on the unamortized balance of value of insurance purchased was $4.8 million, $5.5 million, and $6.6 million, for the years ended December 31, 2004, 2003, and 2002, respectively. The average interest rates used for the years ended December 31, 2004, 2003, and 2002, were 5.7%, 5.7%, and 6.1%, respectively. The estimated amortization, net of interest accrued, on the unamortized balance at December 31, 2004 during each of the next five years is: 2005, $10.7 million; 2006, $9.1 million; 2007, $7.7 million; 2008, $6.6 million; and 2009, $5.6 million.
Guaranteed minimum death benefits of variable annuity products provide contractual guarantees in the event of death of the contract holder (or in some cases the annuitant). These benefits provide at least a return of the total deposits made to the contract, adjusted for withdrawals. Under certain conditions, they also provide that the benefit will not be less than the highest contract value on certain specified anniversaries, adjusted for additional deposits and withdrawals after those anniversaries. Torchmark does not offer other types of guaranteed minimum policy benefits, such as minimum accumulation or income benefits.
A summary of the assumptions used in determining the liability for future policy benefits at December 31, 2004 is as follows:
For individual health, the morbidity assumptions are based on either Torchmark’s experience or the assumptions used in calculating statutory reserves.
Activity in the liability for unpaid health claims is summarized as follows:
The liability for unpaid health claims is included with “Policy claims and other benefits payable” on the Consolidated Balance Sheet.
* The interest cost reductions resulting from the cash settlements of Torchmark’s interest-rate swaps are netted against realized investment losses.
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 $10 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 it becomes probable that all or a portion of the policyholders’ surplus accounts will become taxable.
Torchmark has net operating loss carryforwards of approximately $8.7 million at December 31, 2004 of which $185 thousand expire in 2008; $3.9 million expire in 2020; and $4.6 million expire in 2021. A valuation allowance is to be provided when it is more likely than not that deferred tax assets will not be realized by the company. No valuation allowance has been recorded relating to Torchmark’s deferred tax assets since, in management’s judgment, Torchmark will more likely than not have sufficient taxable income in future periods to fully realize its existing deferred tax assets.
Pension Plans: Torchmark has noncontributory retirement benefit plans and contributory savings plans which cover substantially all employees. There is also a nonqualified, noncontributory excess benefit pension plan which covers certain employees. The total cost of these retirement plans charged to operations was as follows:
The excess benefit pension plan provides the benefits that an employee would have otherwise received from a defined benefit pension plan in the absence of the Internal Revenue Code’s limitation on benefits payable under a qualified plan. This plan is limited to a select group of employees and was closed as of December 31, 1994. Although this plan is unfunded, pension cost is determined in the same manner as for the funded plans. Liability for the excess benefit plan was $5.8 million at December 31, 2004 and $5.6 million at December 31, 2003.
The accumulated benefit obligations (ABO) for Torchmark’s defined benefit pension plans were $165.2 million and $150.4 million at December 31, 2004 and 2003, respectively. Plan assets exceeded the ABO in all of Torchmark’s funded pension plans at both December 31, 2004 and 2003. In the unfunded plans, the ABO was $9.9 million at December 31, 2004 and $9.3 million at December 31, 2003.
On an aggregate basis, the accumulated post-retirement benefit obligation for the post-retirement plans other than pensions were $13.0 million and $12.5 million at December 31, 2004 and, 2003, respectively. The table below presents the assumptions used to determine the liabilities and costs of Torchmark’s post-retirement benefit plans other than pensions.
Junior Subordinated Debentures included in “Due to affiliates” on the Consolidated Balance Sheet.
The amount of debt that becomes due during each of the next five years is: 2005-$0, 2006-$180.0, 2007-$0, 2008-$0, 2009-$99.4 and thereafter-$512.4.
In January, 2003, the FASB issued FASB Interpretation 46, Consolidation of Variable Interest Entities (FIN46), which Torchmark adopted in 2003 with no impact to the consolidated financial statements. In December, 2003, the FASB revised FIN 46 (FIN46R) and deferred its adoption for variable interest entities (VIE’s) that meet certain criteria until the first quarter of 2004. FIN46R clarified the definition of a variable interest and the determination of which holder is the VIE’s primary beneficiary. Only primary beneficiaries are permitted to consolidate VIE’s. Therefore, FIN46R does not permit consolidation of VIE’s
As a result of the deconsolidation that this standard requires, Torchmark no longer reports the trust preferreds as long-term debt but instead reports its 7 3/4% Junior Subordinated Debentures due 2041 to the trust entities as “Due to Affiliates.” The amount of this debt was $154.6 million at December 31, 2004, $4.6 million greater than the trust preferreds. Deconsolidation resulted in reporting $4.6 million of additional debt which is due to the trust entities and is offset by an asset, included in “Other Receivables,” of a like amount representing Torchmark’s equity interest in the trusts. Also, the unamortized issue expenses of the trust preferreds of $5.5 million still remain as a reduction of long-term debt. The additional interest expense on this debt exceeds the trust preferred distributions by $360 thousand in each of the years ended December 31, 2004, 2003, and 2002, which is offset by investment income to Torchmark in like amount representing dividends from the trusts.
Junior Subordinated Debentures is classified as “Due to affiliate” and is junior to other securities in priority of payment.
$200 million of Monthly Income Preferred Securities were redeemed in full in 2001, but the related swap was retained until expiration.
Commercial Paper: On November 18, 2004, Torchmark entered into a credit facility with a group of lenders which allows unsecured borrowings and stand-by letters of credit up to $600 million. The five-year facility matures on November 18, 2009. Interest is charged at variable rates. In addition, Torchmark can request up to $175 million letters of credit to be issued against the facility. The line of credit is further designated as a back-up credit line for a commercial paper program, which cannot exceed $600 million. Torchmark may borrow from the credit facility or issue commercial paper, with total borrowings and commercial paper outstanding not to exceed $600 million. At December 31, 2004, Torchmark had $171 million face amount ($170 million carrying amount) of commercial paper outstanding, $152 million of letters of credit issued, and no borrowings under the line of credit. During 2004, the short term borrowings under the combined facilities averaged approximately $173 million, and were made at an average yield of 1.54%. The facility does not have a ratings-based acceleration trigger which would require early payment. A facility fee is charged for the entire $600 million facility, at a rate of 8 basis points. For letters of credit issued, there is an issuance fee of 22 basis points and a fronting fee of 7.5 basis points. Additionally, if borrowings on both the line of credit and letters of credit exceed 50% of the total $600 million facility, there is a usage fee of 7.5 basis points. During 2004, Torchmark’s usage of the facility was below this threshold and no usage fee was required. Torchmark is subject to certain covenants for the agreements regarding capitalization and earnings, with which it was in compliance at December 31, 2004. Borrowings on this facility are reported as short-term debt on the Consolidated Balance Sheets.
Retirement of Treasury Stock: In 2004 and 2003, Torchmark retired 5 million and 13 million shares, respectively, of its treasury stock.
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. Stock options awarded in connection with compensation deferrals by certain directors and executives generally vest over ten years. Torchmark generally issues shares for the exercise of stock options from treasury stock.
The weighted average fair value of options as determined by the option pricing model granted during the years ended December 31, 2004, 2003, and 2002 were $11.83, $10.52, and $10.33, respectively.
A summary of Torchmark’s stock option activity and related information for the years ended December 31, 2004, 2003, and 2002 follows:
Torchmark’s segments are based on the insurance product lines it markets and administers: life insurance, health insurance, and annuities. These major product lines are set out as segments because of the common characteristics of products within these categories, comparability of margins, and the similarity in regulatory environment and management techniques. There is also an investment segment which manages the investment portfolio, debt, and cash flow for the insurance segments and the corporate function. Torchmark’s management evaluates the overall performance of the operations of the company in accordance with these segments.
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 Torchmark’s debt. 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 following tables set forth a reconciliation of Torchmark’s revenues and operations by segment to its major income statement line items.
Reclassification of interest amount due to FIN46R (accounting rule requiring deconsolidation of Trust Preferred Securities).
Insurance affiliates also assume insurance risks of other companies. Life reinsurance assumed represents 1.6% of life insurance in force at December 31, 2004 and reinsurance assumed on life and accident and health products represents .9% of premium income for 2004.
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 and equity investments are made in a wide range of industries. At December 31, 2004, 2% or more of the portfolio was invested in the following industries:
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 is in government, government-secured, or corporate securities, the requirement for collateral is rare. Torchmark’s mortgages are secured by the underlying real estate.
Letters of Credit: Torchmark has guaranteed letters of credit in connection with its credit facility with a group of banks. The letters of credit were issued by TMK Re, Ltd., a wholly-owned subsidiary, to secure TMK Re, Ltd.’s obligation for claims on certain policies reinsured by TMK Re, Ltd. that were sold by other Torchmark insurance companies. These letters of credit facilitate TMK Re, Ltd.’s ability to reinsure the business of Torchmark’s insurance carriers. The agreement is a five-year contract expiring in 2009. The maximum amount of letters of credit available is $175 million. Torchmark (parent company) would be liable to the extent that TMK Re, Ltd. does not pay the reinsured party. At December 31, 2004, $152 million of letters of credit were outstanding.
Agent Receivables: Torchmark issued a guarantee to an unaffiliated third party, which has purchased certain agents’ receivables of Torchmark’s wholly-owned subsidiary American Income Life Insurance Company. The guarantee covers all obligations and recovery of capital to the third party under the receivables purchase agreement up to a maximum amount of $100 million. Under the terms of the revolving purchase arrangement, the third party has purchased the agents’ receivables and receives the earned commissions as they are applied to the balance. The term of the guarantee corresponds with the purchase arrangement, which is annually renewable. Torchmark would be liable to the extent that future commission collections were insufficient to repay the purchased amount. As of December 31, 2004, the present value of future commissions substantially exceeded the purchased balance.
Many of these lawsuits involve claims for punitive damages in state courts of Alabama and Mississippi. Torchmark’s management recognizes that large punitive damage awards continue to occur bearing little or no relation to actual damages awarded by juries in jurisdictions in which Torchmark has substantial business, particularly Alabama and Mississippi, creating the potential for unpredictable material adverse judgments in any given punitive damage suit. As of December 31, 2004, Liberty was a party to approximately 70 active lawsuits (which included no employment-related cases and excluded interpleaders), 57 of which were Alabama proceedings and 9 of which were Mississippi proceedings in which punitive damages were sought.
On February 17, 2005, named defendant Martha Burdine filed an amended answer and a complaint (the cross complaint) against various other defendants including United American (the cross defendants) on behalf of a purported class of former agents and managers of those cross defendants (the cross plaintiffs). These cross plaintiffs assert a pattern of contract breaches and misconduct by the cross defendants including claims for breach of contract, intentional and negligent misrepresentation, fraud, negligence, breach of duties of trustees, trespass to chattels, conversion, intentional interference with a business relationship and intentional interference with a valid business expectancy. The cross plaintiffs seek actual, punitive and exemplary damages, attorneys’ fees and costs and other legal and equitable relief.
As previously reported in Form 10-Q, purported class action litigation was filed against United American Insurance company in the Circuit Court of Duval County, Florida (Moore v. United American Insurance Company, Case No. 16-2003-CA-001955-XXX-MA, Division CV-E), on March 13, 2003. The plaintiff, representing a class with in excess of 8,000 members, asserts that the annual additional fee that United American charges him and its other Medicare Supplement insurance policyholders for electronic processing of claims is a premium charge subject to filing with and approval by the State of Florida’s Department of Financial Services (formerly the Department of Insurance) and that such charge has never been filed by United American with and approved by the Department. The plaintiff alleges claims for breach of contract and the implied covenant of good faith and fair dealing as well as for declaratory relief. Compensatory damages including the refund of all premium charges found to be illegal, a declaratory judgment, interest, costs, and attorney’s fees are sought.
receives commissions as the Military Agency distribution system for selling certain life insurance products offered by Torchmark’s insurance subsidiaries. These commissions were $67.0 million in 2004, $59.4 million in 2003, and $52.6 million in 2002. Torchmark held balances due from these agents of $17.0 million at year-end 2004 and $16.8 million at year-end 2003.
The collateral loan bears interest at the rate of 7.0%. First Command is making fixed monthly payments which are scheduled to repay the loan by May, 2010. First Command has the right to make additional, unscheduled payments. At year end 2004, the outstanding balance was $11.1 million, compared with $12.7 million at year end 2003. The loan is collateralized by real estate and a parking garage in Fort Worth, Texas. The property was appraised by an independent firm in 2002 at $17.6 million.
Mr. Richey was a 25% investor in Stonegate Realty Company, LLC, the parent company of Elgin Development Company until December 31, 2003, at which time he became a 50% investor. Until December 31, 2003, he was also a one-third investor in Stonegate Management Company, LLC, which, in turn, is a 50% owner of Commercial Real Estate Services. As of December 31, 2003, he became a two-thirds investor in Stonegate Management. Commercial Real Estate Services manages certain of Torchmark’s company-occupied and investment real estate properties along with those of other clients. Fees paid by Torchmark subsidiaries for these management and maintenance services were $702 thousand in 2004, $683 thousand in 2003, and $750 thousand in 2002. Lease rentals paid by Torchmark subsidiaries were $261 thousand, $261 thousand, and $260 thousand in 2004, 2003, and 2002, respectively.
Director life insurance. Torchmark annually pays premiums on three life insurance policies for R. K. Richey, currently a director and formerly Chairman and Chief Executive Officer of Torchmark. Life insurance premiums paid for Mr. Richey were $58 thousand in each of the years 2002 through 2004.
Executive share purchases. On January 3, 2005, two grantor-retained annuity trusts for the benefit of the adult sons of C. B. Hudson, Chief Executive Officer of Torchmark, and of which trusts he serves as trustee, sold 41,470 shares of Torchmark common stock in a privately-negotiated transaction to Torchmark for $2.4 million. The purchases (20,735 shares from each of the trusts) were made at the average of the high and low prices of Torchmark stock on January 3, 2005 ($57.045 per share).
MidFirst Bank. Torchmark has engaged MidFirst Bank as the servicing agent for a portion of Torchmark’s subsidiaries’ commercial mortgages portfolios. George J. Records, a Torchmark director, was an officer, director, and 38.3% beneficial owner of Midland Financial Co., the parent corporation of MidFirst Bank until December 31, 2003. After that date, he was no longer a beneficial owner. Fees paid for these services were $90 thousand in 2004, $110 thousand in 2003, and $118 thousand in 2002.
In the fourth quarter of 2003, a reserve in the pretax amount of $5 million was established on certain mortgages that met Torchmark’s criteria for impairment. These mortgages were originated and serviced by MidFirst. In the fourth quarter of 2004, Torchmark’s subsidiary Liberty sold its participation interests in certain mortgages back to MidFirst Bank in two transactions. The first transaction was completed in October, 2004 for proceeds of $57.3 million with a carrying value of $56.2 million, and the second was effected in December, 2004 for $17.1 million proceeds and a carrying value of $19.5 million. Because of Mr. Record’s relationship, the Board of Directors of Torchmark, with Mr. Records recusing himself, reviewed and approved the first transaction. Both of the transactions were also reviewed and approved by the Liberty National Board of Directors on which Mr. Records does not serve. Torchmark obtained opinions from an independent third party valuation firm experienced in valuing commercial loans that the purchase price on each transaction was within a reasonable and acceptable range.
Torchmark customarily grants options to certain consultants for their services in addition to their fees. Mr. Baxley has received Torchmark options in the past.
The following is a summary of quarterly results for the two years ended December 31, 2004. 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.