Torchmark, through its subsidiaries, owns or leases buildings that are used in the normal course of business. Liberty owns a 487,000 square foot building at 2001 Third Avenue South, Birmingham, Alabama which currently serves as Liberty's, UILIC's, and Torchmark's home office. Liberty leases approximately 160,000 square feet of this building to unrelated tenants. Liberty also operates from 60 company-owned district office buildings used for agency sales personnel.
W&R owns and occupies a 116,000 square foot office building utilized as its corporate headquarters located in United Investors Park, a commercial development at 6300 Lamar Avenue, Shawnee Mission, Kansas.
A Torchmark subsidiary, Torchmark Development Corporation ("TDC"), as a part of a joint venture with unaffiliated entities, is developing 3,300 acres as a planned community development known as Liberty Park, which is located along Interstate 459 in Birmingham, Alabama.
All centralized computer software support, information processing schedules and computer-readable data management requirements are supported by company- specific policies and procedures which ensure that required information processing results are produced and distributed in a timely manner. These policies and procedures provide for the copying, off-site physical storage and retention of significant company computer programs and business data files for backup purposes.
Torchmark has been in the process of modifying its computer system and applications for the year 2000. It is expected that the project will be substantially completed during 1998 and that final testing will be conducted in 1999. Torchmark is utilizing primarily internal staff for this conversion but is also using outside consultants where necessary. The cost of this project, which is immaterial to Torchmark, has been and will be expensed in each period in which it incurred.
As a part of its activities, Torchmark is engaged electronically with third- party financial institutions and other various organizations which may have computer systems which are not year 2000 compliant. To the degree possible, Torchmark is verifying that these third party business systems are currently compliant or are in the process of becoming compliant. To the extent these systems are not compliant, there is no assurance that the potential interruptions or cost to Torchmark may not be significant.
During 1997, the FASB issued Statement 128, Earnings per Share, which requires all companies to report earnings per share on both a basic and diluted basis. Per share net income and net operating income described herein are reported as basic earnings per share unless specifically designated otherwise. Diluted earnings per share takes into account Torchmark's outstanding stock options and treats them as if they had been exercised and converted to shares outstanding, with the proceeds from
Torchmark's revenues in 1996 gained 7% over 1995 revenues of $2.07 billion. Again, life insurance premium income was the largest contributor to revenue growth, rising 11% and accounting for $83 million of the $138 million in revenue growth. Financial services revenues gained 21%, comprising 23% of Torchmark's total revenue growth in 1996. Other operating expenses as a percentage of total revenues continue to decline. These expense ratios were 6.95% in 1997, 6.99% in 1996, and 7.04% in 1995. Lower litigation costs at Liberty, Torchmark's Alabama insurance subsidiary, have aided this decline. In 1997, expenses include a one-time $6.8 million charge related to system outsourcing in the asset management operations. The components of Torchmark's revenues and operations are described in more detail in the discussion of segments and investments found on pages 17 through 28 of this report.
Insurance operating income is the pretax income of Torchmark's insurance segment, exclusive of realized investment gains and losses and the related adjustment to deferred acquisition costs. Insurance operating income is comprised of underwriting income and excess investment income, which is the income from investment operations less the interest cost attributable to net policy liabilities. The following table is a summary of Torchmark's insurance operating income.
Following is a discussion of each of Torchmark's major product groups and a discussion of Torchmark's distribution channels.
The increase in life insurance issued by direct response in 1997 was a result of several expanded programs, including the expansion of the program that solicits sales from previous inquirers who did not buy. Also, co-op mailings were expanded.
The direct response operation is also testing new markets to increase future sales. For example, the sale of policies with higher face amounts was tested in early 1998 with favorable results.
The United American independent and captive agencies represent about 6% of Torchmark's life premium on a combined basis. The exclusive agency had 16% growth in premium in 1997 to $18 million, but had 47% growth in premium in 1996. The independent agency experienced a premium increase of 10% in 1997 with premium of $37 million. Premium from this agency rose 18% in 1996.
Annualized premium in force for other health products declined 2% in 1997 to $102 million, after declining 8% in 1996. Sales increased in 1997, however, with annualized premium issued rising 26% to $31 million. A large factor in the 1997 sales increase is increased issue of a limited-benefit hospital- surgical product sold by the United American Independent Agency.
Annuities. Annuity products are marketed by Torchmark to service a variety of needs, including retirement income and long-term tax-deferred growth opportunities. Annuities are sold on both a fixed and variable basis. Fixed- annuity deposits are held and invested by Torchmark and are obligations of the company. Variable-annuity deposits are invested at the policyholder's direction into his choice among a variety of mutual funds managed by W&R, which vary in degree of investment risk and return. A fixed- annuity investment account is also available as a variable annuity investment option. Investments pertaining to variable-annuity deposits are reported as "Separate Account Assets" and the corresponding deposit balances for variable annuities are reported as "Separate Account Liabilities."
Premium collections on fixed annuities were $89 million in 1997, compared with $87 million in 1996 and $133 million in 1995. The 1996 decline in fixed collections resulted from a $21 million decline in collections by the United American general agency that markets to bank customers. These collections were $76 million in 1995, a record year. Also, in 1996 Torchmark's collections on preneed annuities declined $19 million. The sale of preneed products was discontinued in late 1995. The fixed annuity balance rose in each of the periods presented, primarily because of the additional collections.
Variable annuity collections were flat in 1997 when compared with 1996 at $247 million, but grew 31% in 1996 over 1995 collections of $189 million. The strength in financial market conditions in both 1996 and 1997 has had a positive influence on collections. However, it is believed lower capital gains rates implemented by Congress during 1997 may have been a negative factor in 1997 variable annuity sales. Torchmark's variable annuities are issued by UILIC and are sold by W&R sales representatives. Under a marketing agreement, Torchmark will continue to market its variable annuities through the W&R sales force subsequent to the planned spin-off of W&R. (See Initial Public Offering and Planned Spin-off of Asset Management Segment on page 30 of this report.) Torchmark also plans to market variable annuities through its direct response distribution system in 1998.
The variable account balance has climbed rapidly since 1995, rising 31% in 1996 to $1.4 billion at December 31, 1996, and 32% in 1997 to $1.8 billion at year-end 1997. A strong financial market in both 1996 and 1997 was the major factor in the rise in variable account values in those years. Variable accounts are valued based on the market values of the underlying securities. The additional collections in each year also added to the balances.
Financial services revenues rose 10% to $240 million in 1997, compared with 1996 revenues of $217 million. These revenues grew 21% in 1996 from 1995 revenues of $180 million. Financial services revenues presented in Torchmark's consolidated financial statements will not correspond to total revenues for the financial services segment presented above in the Summary of Results table because certain revenues as presented in the table are derived from other Torchmark subsidiaries and are eliminated in consolidation.
Distribution revenues are derived from the sales of both investment and insurance products and accounted for 37% of total asset management revenues. Investment product commissions represented 85% of total distribution revenues in 1997. Investment products consist of two different mutual fund groups, the W&R Funds and the United Funds. The United Funds have a front-load sales charge while the W&R Funds have a contingent deferred or back-load charge. The W&R Funds also charge a Rule 12b-1 distribution fee based on a percentage of assets under management. The commissions from insurance products and variable annuities are primarily received from Torchmark insurance subsidiaries, and are eliminated in consolidation. W&R and Torchmark have agreed that W&R will continue to market the variable annuities and insurance products of certain Torchmark insurance companies subsequent to the announced spin-off. See Initial Public Offering and Planned Spin-off of Asset Management Segment on page 30 of this report. Investment product commissions rose 5% to $76 million in 1997, after having increased 26% to $72 million in 1996. Investment product collections increased 1% in 1997 and were $1.5 billion during both 1996 and 1997. Investment product sales in 1996 climbed 27% from $1.2 billion. In 1997, sales of the United Funds in terms of mutual fund collections were $1.1 billion, rising 7% from 1996 sales of $1.0 billion. These sales rose 22% in 1996. The W&R Funds experienced a decline in 1997 sales of 23% to $176 million, but had a 44% increase in 1996 sales volume. Insurance product commission revenues were level in each year 1995 through 1997 at $14 million.
Commissions and selling expenses are the direct expenses associated with producing distribution revenue. They consist of the commissions, bonuses, and other compensation paid to the sales force as well as other marketing and promotional costs. These expenses correlate closely with distribution revenues.
Other expenses, as a percentage of revenues, grew from 14% in 1996 to 17% in 1997. This increase was due primarily to a one-time charge in 1997 in the amount of $6.8 million which was largely related to the outsourcing of some data processing services and the discontinuance of internally-developed systems. Had this charge not been incurred, 1997 expenses would have been 14% of revenues, margins would have been 53%, and pretax income would have been $129 million.
Subsequent to the first quarter of 1997, interest rates declined steadily throughout the remainder of the year. Investments during 1997 of $1.66 billion were made at a tax-equivalent yield of 7.29%. This compares with investments of $1.08 billion in 1996 acquired at a tax-equivalent yield of 7.12%. Acquisitions during 1995, which were increased by several sale programs, totaled $1.87 billion. The average life of 1997 acquisitions was 13.3 years as compared with 7.8 years in the previous year and 13.4 years in 1995. Torchmark varies its maturity selection based on a number of factors including the prevailing yield curve.
Holdings of mortgage-backed securities continue to decline as a percentage of the portfolio, due to repayments of mortgage-backs and acquisitions of other types of fixed income investments. The holdings of mortgage-backed securities represented 24% of the fixed-income portfolio at year-end 1997, as compared with 25% at year-end 1996 and 30% at year-end 1995.
Torchmark considers its fixed-income portfolio available for sale. Therefore, it is valued at market and is subject to fluctuations as interest rates change. Falling rates during 1997 propelled the value of the fixed- income portfolio higher during the year. At year-end 1997, the portfolio had an unrealized gain of $213 million, compared with $63 million at year-end 1996 and $226 million at year-end 1995. During 1997, the portfolio yield declined slightly to 7.49% at year-end 1997, compared with 7.55% at year-end 1996 and 7.66% at year-end 1995. With the purchase of longer maturities in 1997, the average life of the portfolio increased slightly to 8.0 years at year-end 1997, compared with 7.8 years at year-end 1996 and 8.8 years at year-end 1995.
ANALYSIS OF EXCESS INVESTMENT INCOME AND RELATED ITEMS (Dollar amounts in millions)
Torchmark's insurance and asset management operations generate positive cash flows in excess of its immediate needs. Cash flows provided from operations, including net cash provided from Torchmark's deposit-type insurance and annuity products, were $568 million in 1997, rising 10% over $517 million in 1996. Operating cash flows for 1996 increased 8% over 1995 cash flows of $478 million. In addition to operating cash flows, Torchmark received $514 million of investment maturities and repayments in 1997, further enhancing total positive cash flow. Such repayments were $347 million in 1996 and $351 million in 1995. Cash flows in excess of immediate requirements are used to build an investment base to fund future requirements.
Liquidity of the parent company is affected by the ability of the subsidiaries to pay dividends. Dividends are paid by subsidiaries to the parent in order to meet its dividend payments on common and preferred stock, interest and principal repayment requirements on parent-company debt, and operating expenses of the parent company. Dividends from insurance subsidiaries of Torchmark are limited to the greater of statutory net gain from operations, excluding capital gains and losses, on an annual noncumulative basis or 10% of surplus, in the absence of special approval, and distributions are not permitted in excess of statutory net worth. Subsidiaries are also subject to certain minimum capital requirements. Although these restrictions exist, dividend availability from subsidiaries has been and is expected to be more than adequate for parent- company operations. During 1998, a maximum amount of $333 million will be available to Torchmark from insurance subsidiaries without regulatory approval.
Torchmark repaid $550 thousand of principal on the Senior Debentures in 1996 under the terms of a put provision. In 1997, Torchmark repaid $20 million principal amount on its 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. Torchmark intends to repay another $20 million on this indebtedness in the first quarter of 1998, and has notified its transfer agent of its intent to call the remaining $160 million principal balance of this debt on April 1, 1998 at the prevailing call price of $103.76, or $166 million. Additionally, Torchmark's 9 5/8% Senior Notes, principal amount $200 million, are due on May 1, 1998. Torchmark plans to use operating cash flow, borrowings under the line of credit, and funds from the initial public offering of the asset management segment to repay these debt issues. See Initial Public Offering and Planned Spin-off of the Asset Management Segment on page 30 of this report.
During 1997, Torchmark acquired 5.2 million shares of its common stock on the open market at a cost of $183 million in conjunction with its ongoing share repurchase program. Share purchases of 4.6 million shares were made in 1996 for $107 million. No shares were acquired in 1995.
Shareholders' equity increased 19% to $1.93 billion at December 31, 1997, over December 31, 1996 shareholders' equity of $1.63 billion. Book value per share was $13.80 at 1997 year end, compared with $11.69 at year-end 1996. After adjusting for the impact of interest-rate fluctuations on shareholders' equity required by accounting rules, book value per share was $12.90 at year- end 1997, an increase of 13% over $11.42 at year-end 1996. Return on common shareholders' equity was 21.2% in 1997, compared with 20.5% in 1996, even though average shareholders' equity increased. The return on equity ratios exclude the mark up or down of shareholders' equity for changes in market interest rates required by accounting rules. They also exclude discontinued operations and realized investment gains and losses.
W&R contributed $244 million in revenues and $122 million to Torchmark's pretax income in 1997. At December 31, 1997, its assets were $447 million and shareholders' equity was $250 million before giving effect to a $480 million dividend to Torchmark. As a result of the spin-off, Torchmark's debt-to- capitalization ratio should be improved and its interest coverage ratio minimally affected. As more fully discussed in the notes to the financial statements, the spin-off, if and when completed, will result in a current tax expense of approximately $50 million.
$32.5 million along with $15.5 million in cash. After closing costs and retained liabilities, Torchmark recorded a pre-tax loss of $23 million and an after-tax loss of $7 million from the sale, or $.05 per share.
Year 2000 Compliance. Existing computer programs of many businesses were developed with a two-digit year identification without consideration of the upcoming change in century or millenium in the year 2000. Without addressing this issue, many computer programs could fail or produce erroneous results, creating considerable uncertainty and potentially adversely affecting the operations of a business.
Torchmark has been in the process of modifying its computer system and applications for the year 2000. It is expected that the project will be substantially completed during 1998 and that final testing will be conducted in 1999. Torchmark is utilizing primarily internal staff for this conversion but is also using outside consultants where necessary. The cost of this project, which is immaterial to Torchmark, is expensed as incurred.
Reporting Comprehensive Income (FASB Statement No. 130) is effective for fiscal years beginning after December 15, 1997. Reclassification of prior periods for comparative financial statements is required.
This document establishes standards for presentation of comprehensive income, a concept of income which, in addition to net income, includes all changes in the equity of a company other than contributions from or distributions to shareholders. Comprehensive income is to be categorized into certain components, each of which is to be displayed prominently in Torchmark's basic financial statements.
The most significant aspect of this Statement on Torchmark is the separate disclosure of the change in the unrealized gain or loss on its fixed investments as a component of comprehensive income, rather than as a direct adjustment of shareholders' equity.
The new disclosures required by this Statement will not be significantly different from Torchmark's current segment disclosures because current segments as reported reflect the same operating data and results utilized by management in evaluating the performance of Torchmark's business. Torchmark will, however, be required to report additional segment information in its interim financial statements.
We conducted our audits in accordance with generally accepted auditing standards. 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 audits provide a reasonable basis for our opinion.
Birmingham, Alabama February 2, 1998 except for Note 16 which is as of February 20, 1998 and Note 6 which is as of March 5, 1998
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 $72.3 million, $72.8 million, and $72.7 million for the years ended December 31, 1997, 1996, and 1995,
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) (DOLLAR AMOUNTS IN THOUSANDS EXCEPT PER SHARE DATA) NOTE 1--SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) respectively. Other premium includes annuity policy charges for the years ended December 31, 1997, 1996, and 1995 of $28.2 million, $22.4 million, and $19.0 million, respectively. Profits are also earned to the extent that investment income exceeds policy requirements. The related benefits and expenses are matched with revenues by means of the provision of future policy benefits and the amortization of deferred acquisition costs in a manner which recognizes profits as they are earned over the same period.
Impairments: Torchmark adopted the provisions of SFAS 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of, effective at the issuance of the standard in March, 1995. This standard requires that certain long-lived assets used in Torchmark's business as well as certain intangible assets be reviewed for impairment when circumstances indicate that these assets may not be recoverable, and further provides how such impairment shall be determined and measured. It also requires that long- lived assets and intangibles to be disposed of be reported at the lower of carrying amount or fair value less cost to sell. Except for the writedown of the energy investment described in Note 7, the adoption of this statement had no material impact on Torchmark's operations or financial position for the years ended December 31, 1997, 1996, and 1995.
A summary of fixed maturities available for sale and equity securities by amortized cost and estimated market value at December 31, 1997 and 1996 is as follows:
Proceeds from sales of fixed maturities available for sale were $745 million in 1997, $487 million in 1996, and $1.18 billion in 1995. Gross gains realized on those sales were $1.3 million in 1997, $8.7 million in 1996, and $13.4 million in 1995. Gross losses were $32.2 million in 1997, $5.3 million in 1996, and $13.5 million in 1995.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) (DOLLAR AMOUNTS IN THOUSANDS EXCEPT PER SHARE DATA) NOTE 4--PROPERTY AND EQUIPMENT
Depreciation expense on property used in the business was $5.9 million, $5.4 million, and $5.7 million, in each of the years 1997, 1996, and 1995, respectively.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) (DOLLAR AMOUNTS IN THOUSANDS EXCEPT PER SHARE DATA)
NOTE 6--INITIAL PUBLIC OFFERING AND PLANNED SPIN-OFF OF ASSET MANAGEMENT SEGMENT
In addition to previously transferred securities, warrants, and Section 29 energy-related tax credits, which approximated $112 million at closing, Torchmark received subordinated debt and notes totaling $32.5 million along with $15.5 million in cash. After closing costs and retained liabilities, Torchmark recorded a pretax loss of $23 million and an after-tax loss of $7 million from the sale, or $.05 per share.
The overall average interest assumption for determining the liability for future life and health insurance benefits in 1997 was 6.2%.
The valuation allowance for deferred tax assets as of December 31, 1997 and 1996 was $2.1 million. Subsequently recognized tax benefits of $2.1 million relating to the December 31, 1997 valuation allowance will be allocated to goodwill.
As more fully discussed in Note 6, Torchmark plans to spin off its asset management segment subject to market conditions, to receipt of a ruling from the IRS that the spin-off is a tax-free transaction, and to regulatory approval. The spin-off, if and when completed, will constitute the distribution of a portion of the policyholders' surplus account resulting in a tax expense of approximately $50 million.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) (DOLLAR AMOUNTS IN THOUSANDS EXCEPT PER SHARE DATA) NOTE 11--POSTRETIREMENT BENEFITS
The excess benefit pension plan provides the benefits that an employee would have otherwise received from a defined benefit pension plan in the absence of the Internal Revenue Code's limitation on benefits payable under a qualified plan. Although this plan is unfunded, pension cost is determined in a similar manner as for the funded plans. Liability for the excess benefit plan was $5.4 million and $4.8 million as of December 31, 1997 and 1996, respectively.
The weighted average assumed discount rates used in determining the actuarial benefit obligations were 7.5% in 1997 and 1996. The rate of assumed compensation increase was 4.5% in 1997 and 1996 and the expected long-term rate of return on plan assets was 9.25% in 1997 and 1996.
The weighted average discount rate used in determining the accumulated postretirement benefit obligation was 7.39% in 1997 and 7.5% in 1996.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) (DOLLAR AMOUNTS IN THOUSANDS EXCEPT PER SHARE DATA) NOTE 12--DEBT
The Sinking Fund Debentures, due March 1, 2017, are carried at remaining principal amount of $180 million less unamortized issue expenses and bear interest at 8 5/8%, payable on March 1 and September 1. A sinking fund provides for mandatory principal repayment at par of not less than $8 million per year each year during the twelve months preceding March 1, 1998 through March 1, 2016. At Torchmark's option, an additional $12 million principal amount per year may be redeemed at par according to the same schedule. The option to make such additional repayments is not cumulative and if not availed of in any year will terminate. Furthermore, Torchmark may, at its option, redeem the entire issue at prices ranging from 104.59% to 100.0% of par, subject to certain restrictions. The Sinking Fund Debentures have equal priority with other Torchmark unsecured indebtedness. During the third quarter of 1997, Torchmark repaid the mandatory $8 million principal amount and the optional $12 million principal amount. Torchmark intends to repay another $20 million, $8 million of which is mandatory, in the first quarter of 1998, and has notified its transfer agent of its intent to call the remaining $160 million principal balance of this debt on April 1, 1998 at the prevailing call price of 103.76% of par or $166 million.
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 5.2 million shares at a cost of $183 million in 1997, and 4.6 million shares at a cost of $107 million in 1996.
Restrictions: Restrictions exist on the flow of funds to Torchmark from its insurance subsidiaries. Statutory regulations require life insurance subsidiaries to maintain certain minimum amounts of capital and surplus. These restrictions generally limit the payment of dividends by insurance subsidiaries to statutory net gain on an annual noncumulative basis in the absence of special approval. Additionally, insurance companies are not permitted to distribute the excess of shareholders' equity as determined on a GAAP basis over that determined on a statutory basis. In 1998, $333 million will be available to Torchmark for dividends from insurance subsidiaries in compliance with statutory regulations without prior regulatory approval.
Weighted average options outstanding considered to be anti-dilutive under SFAS 128 totaled 742,472, 598,342 and 1,637,402 as of December 31,1997, 1996 and 1995, 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.
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. It 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 a 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 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 1997, 1996 and 1995:
A summary of Torchmark's stock option activity adjusted for the stock dividend, and related information for the years ended December 31, 1997, 1996, and 1995 follows:
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 $7.6 million, $7.0 million, and $6.3 million for 1997, 1996, and 1995, respectively. Future minimum rental commitments required under operating leases having remaining noncancelable lease terms in excess of one year at December 31, 1997 are as follows: 1998, $4.4 million; 1999, $3.0 million; 2000, $1.7 million; 2001, $586 thousand; 2002, $205 thousand; and in the aggregate, $9.9 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, 1997, the investment portfolio consisted of securities of the U.S. government or U.S. government-backed securities (18%); non government-guaranteed mortgage-backed securities (7%); short-term investments, which generally mature within one month (2%); securities of state and municipal governments (10%); securities of foreign governments (1%); and investment-grade corporate bonds (50%). The remainder of the portfolio was in real estate (3%), which is not considered a financial instrument according to GAAP; policy loans (3%), which are secured by the underlying insurance policy values; and equity securities, mortgages, noninvestment grade securities, and other long-term investments (6%). 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 equity and debt investments are made in a wide range of industries. At December 31, 1997, 1% or more of the portfolio was invested in the following industries: Financial services (18%); regulated utilities (6%); chemicals and allied products (5%); consumer goods (5%); transportation (5%); machinery and equipment (4%); manufacturing (3%); petroleum (2%); media/communications (2%); services (2%); retailing (2%); and asset-backed securities (1%). Otherwise, no individual industry represented 1% or more of Torchmark's investments. At year-end 1997, 4% of the carrying value of fixed maturities was rated below investment grade (BB or lower as rated by Standard & Poor's or the equivalent NAIC designation). Par value of these investments was $253.4 million, amortized cost was $255.3 million, and market value was $258.4 million. While these investments could be subject to additional credit risk, such risk should generally be reflected in market value.
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 collateral.
punitive damage award in any given case is virtually impossible to predict. As of December 31, 1997, Liberty was a party to approximately 198 active lawsuits (including 28 employment related cases and excluding interpleaders and stayed cases), more than 170 of which were Alabama proceedings in which punitive damages were sought. Liberty faces trial settings in these cases on an on- going basis.
As previously reported, Torchmark, its insurance subsidiaries Globe and United American, and certain Torchmark officers were named as defendants in purported class action litigation filed in the District Court of Oklahoma County, Oklahoma (Moore v. Torchmark Corporation, Case No. CJ-94-2784-65, subsequently amended and restyled Tabor v. Torchmark Corporation). This suit claims damages on behalf of individual health policyholders who are alleged to have been induced to terminate such policies and to purchase Medicare Supplement and/or other insurance coverages. This case remains in the discovery proceeding status. On February 6, 1998, the defendants renewed their motion to dismiss the class claims for failure to prosecute.
As previously reported, a purported class action was filed in 1995 against Liberty in the Circuit Court of Jefferson County, Alabama on behalf of Liberty cancer policyholders eligible for Medicare who submitted claims during an approximate two month period in 1993 alleging improper payment practices (Adkins v. Liberty National Life Insurance Company, Case No. CV-95-5634). Liberty had discontinued the payment practices which were the subject of this litigation after two months in 1993 and recalculated and repaid all claims in full as it had prior to the two month period together with interest. In July, 1996, the Court entered a class certification order. Liberty subsequently filed a petition for writ of mandamus or prohibition with the Alabama Supreme Court asserting abuse of discretion by the trial court in certifying the Adkins class. The Alabama Supreme Court issued the writ of mandamus on August 19, 1996. In January, 1998, Liberty filed a motion for summary judgment and a motion to decertify the class in Adkins. On February 4, 1998, the Jefferson County Circuit Court granted Liberty's motion for summary judgment.
It has been previously reported that Torchmark, its subsidiaries United American and Globe and certain individual corporate officers are parties to purported class action litigation filed in April, 1996 in the U.S. District Court for the Northern District of Georgia (Crichlow v. Torchmark Corporation, Case No. 4:96-CV-0086-HLM) involving certain hospital and surgical insurance policies issued by Globe and United American. In September, 1997, the U.S. District Court entered an order granting summary judgment against the plaintiffs on certain issues and denying national class certification, although indicating that plaintiffs could move for certification of a state class of Georgia policyholders. In December 1997, plaintiffs moved for the certification of a state class of Georgia policyholders. Discovery is proceeding on the remaining claims for breach of contract and the duty of good faith arising from closure of the block of business and certain post claim matters as well as fraud and conspiracy relating to pricing and delay in implementing rate increases.
Investment in Related Parties: Other long-term investments include investment by Torchmark subsidiaries in the United Group of Mutual Funds and certain other funds for which Waddell & Reed, Inc. is sole advisor. These investments were $30.7 million and $30.3 million at December 31, 1997 and 1996, respectively. Investment income derived from these investments is included in net investment income.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) (DOLLAR AMOUNTS IN THOUSANDS EXCEPT PER SHARE DATA) NOTE 20--SELECTED QUARTERLY DATA (UNAUDITED)
The following is a summary of quarterly results for the two years ended December 31, 1997. 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.