Family Heritage owns 50% of a partnership that owns a 66,000 square foot building in Broadview Heights, Ohio (a suburb of Cleveland), serving as Family Heritage’s headquarters. The partnership also leases a portion of the building to unrelated tenants.
On December 22, 2017, the Tax Cuts and Jobs Act was enacted into law which revises corporate income tax rates from 35% to 21%, among other modifications. See further discussion of the tax reform implications in the Results of Operations. Excluding the effects of tax reform, net income, net income per diluted common share, shareholders' equity and shareholders' equity per diluted common share would have been $581 million, $4.88, $5.36 billion and $45.52, respectively.
How Torchmark Views Its Operations: Torchmark is the holding company for a group of insurance companies which market primarily individual life, and supplemental health insurance to middle income households throughout the United States. We view our operations by segments, which are the insurance product lines of life, health, and annuities, and the investment segment that supports the product lines. Segments are aligned based on their common characteristics, comparability of the profit margins, and management techniques used to operate each segment.
Insurance Product Line Segments. As fully explained in Note 14-Business Segments, the insurance product line segments involve the marketing, underwriting, and the administration of policies. Each product line is further segmented by the various distribution units that market the insurance policies. Each distribution unit operates in a niche market offering insurance products designed for that particular market. 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:
Net income as a return on equity (ROE) was 28.2%(1) and net operating income as a ROE, excluding net unrealized gains on the fixed maturity portfolio was 14.3%(1).
Total premium increased by 5% over the prior year. Life premium also increased by 5% for the year from $2.2 billion to $2.3 billion. Life underwriting margin also increased 5% from $574 million in 2016 to $604 million in 2017.
As further discussed below regarding Tax Legislation, excluding the tax reform adjustment, net income as a ROE and net operating income as a ROE would have been 11.7% and 14.4%, respectively. In 2017, the Company recorded a one-time adjustment of $874 million impacting net income. As the impact of the Tax Legislation was treated as a non-operating event, it was excluded from net operating income.
Net operating income from continuing operations rose each year over the prior year from $523 million in 2015 to $549 million in 2016 to $574 million in 2017. Net operating income is the consolidated total of segment profits after tax and as such is considered a non-GAAP measure. Net income is the most directly comparable GAAP measure. See Note 14-Business Segments for a discussion of the usefulness and purpose of this measure. We do not consider realized gains and losses to be a component of our core insurance operations or operating segments. Additionally, net income was affected by certain significant and unusual non-operating items in each of the years 2015 through 2017. We do not view these items as components of core operating results because they are not indicative of past performance or future prospects of the insurance operations. We remove items such as these that relate to prior periods or are non-operating items when evaluating the results of current operations, and therefore exclude such matters from our segment analysis for current periods.
The life insurance segment is our strongest segment and is the largest contributor to earnings in each year presented. This segment contributed $31 million in 2017 and $4 million in 2016 to the growth in our underwriting margin. Also contributing to growth in income in both years was our health insurance segment, which provided $9 million of additional margin in 2017 and $6 million in 2016.
Total revenues rose 6% in 2017 to $4.2 billion, or $221 million over the prior year total of $3.9 billion. Life premium rose 5% or $117 million in 2017 to $2.3 billion. Life premium increased $116 million in 2016 to $2.2 billion. Net investment income rose $41 million or 5% in 2017, and rose 4% or $33 million in 2016. Health premium increased 3% to $976 million in 2017 and contributed $29 million to 2017 revenue growth, after having gained 2% to $948 million in 2016. Health premium contributed $22 million to 2016 revenue growth.
Life insurance premium and underwriting margins have grown in each of the last three years ended December 31, 2017. The increase in life premium was driven by sales growth and improvements in persistency. While premium and underwriting margins grew, margin as a percent of premium remained flat in 2017 at 26%, after decreasing from 27% to 26% from 2015 to 2016. Net life sales increased in 2017 to $416 million. Net life sales were flat between 2015 and 2016. The life insurance segment is discussed further in this report under the caption Life Insurance.
The interest required on net policy liabilities is deducted from net investment income, and generally grows in conjunction with the net policy liabilities that are supported by the invested assets. The lower new-money yields resulting from the low interest rate environment noted above have compressed excess investment income as required interest has continued to grow at approximately the same rate that net policy liabilities have grown. Financing costs, which consist of the interest required for debt service on our long and short-term debt, are also deducted from net investment income. Financing costs in 2017 increased 1% to $85 million from $83 million in 2016. The additional interest expense resulted primarily from an increase in the cost of our short-term borrowings and, in lesser part, from the issuance of our new 5.275% Junior Subordinated Debt security thirty-six days before the repayment of our 5.875% Junior Subordinated Debt security.
Insurance administrative expenses were up 7.1% in 2017 when compared with the prior year period, and increased to 6.4% as a percentage of premium from 6.3% in 2016 and 6.2% in 2015. The increase in administrative expenses is primarily due to an increase in other employee costs and investments in information technology. Corporate and Other expenses were up primarily due to an increase in stock-based compensation expense, reflecting Torchmark's higher share price as compared with the same period a year ago, and recognition of a one-time increase in stock-based compensation expense due to the Tax Legislation.
Torchmark has in place an ongoing share repurchase program which began in 1986. With no specified authorization amount, we determine the amount of repurchases based on the amount of the excess cash flow at the Parent Company, general market conditions, and other alternative uses. The majority of these purchases are made from excess cash flow. Excess cash flow at the Parent Company is primarily comprised of dividends received from the insurance subsidiaries less interest expense paid on its debt, dividends paid to Torchmark shareholders, and other limited operating activities. Additionally, when stock options are exercised, proceeds from these exercises and the resulting tax benefit are used to repurchase additional shares on the open market to minimize dilution as a result of the option exercises. The Board of Directors has authorized the Company’s share repurchase program in amounts and with timing that management, in consultation with the Board, determines to be in the best interest of the Company and its shareholders. The following chart summarizes share purchase activity for each of the last three years.
Life insurance is our largest insurance segment, with 2017 life premium representing 70% of total premium. Life underwriting income before other income and administrative expense represented 72% of the total in 2017. Additionally, investments supporting the reserves for life products produce the majority of excess investment income attributable to the investment segment.
First-year collected premium 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 income in the future.
Life insurance premium rose 5% to $2.3 billion in 2017 after having increased 6% in 2016 to $2.2 billion. Life insurance products are marketed through several distribution channels. Premium income by distribution channel for each of the last three years is as follows:
The American Income Exclusive Agency has historically marketed primarily to members of labor unions. While labor unions are still the core market for this agency, American Income has diversified in recent years by focusing heavily on other affinity groups, third party internet vendor leads, and referrals to help ensure sustainable growth. This agency is Torchmark’s largest contributor to life premium of any distribution channel at 43% of Torchmark’s 2017 total. This group produced premium income of $999 million, an increase of 9% over the prior year total of $913 million, after having risen 10% in 2016. First-year collected premium was $183 million compared to $174 million in 2016, an increase of 5%. First-year collected premium rose 11% in 2016. Net sales increased 6% to $223 million in 2017 over the 2016 total of $210 million. Net sales increased 6% in 2016 over the 2015 total of $198 million. Sales growth in our captive agencies is generally dependent on growth in the size of the agency force. The American Income Agency's average agent count rose 4% to 6,962 in 2017. The average producing agent count is based on the actual count at the end of each week during the period.
The Globe Life Direct Response unit offers adult and juvenile life insurance through a variety of direct-to-consumer marketing approaches, which include direct mailings, insert media, and electronic media. These different approaches support and complement one another in the unit’s efforts to reach the consumer. The Globe Life Direct Response
While the juvenile market is an important source of sales, it also is a vehicle to reach the parents and grandparents of juvenile policyholders, who are more likely to respond favorably to a Globe Life Direct Response solicitation for life coverage on themselves than is the general adult population. Also, both juvenile policyholders and their parents are low acquisition-cost targets for sales of additional coverage over time.
The Liberty National Exclusive Agency markets individual and group life insurance to middle-income customers. Life premium income for this agency was $275 million in 2017, an increase of 2% from $270 million in 2016. Life premium income in 2015 totaled $271 million. Net sales increased 17% during 2017 to $47 million over the 2016 total of $40 million. Net sales in 2016 increased 12%. The continued increases in net sales reflect changes in structure of the agency that were put in place several years ago. Middle management has also grown within the agency which will help continue this growth. First-year collected premium increased 14% to $33 million during 2017 and increased 6% in 2016 to $29 million.
The Other Agencies distribution channels offering life insurance include the Military Agency, the UA Independent Agency (which predominantly writes health insurance), and various smaller distribution channels. The Other Agencies contributed $220 million of life premium income, or 10% of Torchmark’s total in 2017, but contributed only 2% of net sales for the year.
Health premium accounted for 30% of our total premium in 2017, while the health underwriting margin accounted for 26% of total underwriting margin, reflective of the lower underwriting margin as a percent of premium for health compared with life insurance. As noted under the caption Life Insurance, we have emphasized life insurance sales relative to health, due to life’s superior profitability and its greater contribution to excess investment income.
Other distribution. Certain of our other distribution channels market health products, although their main emphasis is on life insurance. On a combined basis, they accounted for 17% of health premium in 2017 and 16% in 2016. The American Income Exclusive Agency primarily markets accident plans. The Direct Response group markets primarily Medicare Supplements to employer or union-sponsored groups. Direct Response added $6 million of Medicare Supplement net sales in 2017 and 2016 and $5 million in 2015.
In 2016 and 2015, the Affordable Care Act (ACA) imposed an annual fee to health insurance issuers offering commercial health insurance as well as another fee for premium stabilization. These fees totaled $621 thousand and $1.2 million in 2016 and 2015, respectively. There were no fees for 2017.
Annuities. Our fixed annuity balances at the end of 2017 and 2016 were $1.25 billion and $1.29 billion, respectively. Underwriting income was $10.6 million, $9.4 million, and $4.6 million for the three years ended December 31, 2017, respectively.
While the fixed annuity account balance has been declining slightly year over year, underwriting income has increased each year over the prior year. The significant increase in underwriting income in 2016 was primarily due to a slowdown in amortization as assumptions were adjusted to reflect longer retention of the annuity block than previously estimated as a result of the continuing low interest rate environment. Policy charges have actually declined slightly in each successive year. The majority of policy charges consist of surrender charges which are based on a function of account size and time lapsed since deposit. A considerable portion of fixed annuity profitability is derived from the spread of investment income exceeding contractual interest requirements, which can result in negative net policy obligations. We do not currently market annuity products, favoring instead protection-oriented life and health insurance products. Therefore, we do not expect that annuities will be a significant portion of our business or marketing strategy going forward.
Administrative expenses. Operating expenses are included in the Corporate and Other segment and are classified into two categories: insurance administrative expenses and expenses of the Parent Company. The following table is an analysis of operating expenses for the three years ended December 31, 2017.
Insurance administrative expenses were up 7.1% in 2017 when compared with the prior year after increasing 5.6% during 2016. As a percentage of total premium, insurance administrative expenses increased to 6.4% in 2017 from 6.3% in 2016 and 6.2% 2015. Total operating expenses increased 10.9% in 2017, after increasing 3.7% in 2016. The increase in other employee costs was due primarily to higher pension expense driven by lower interest rates.
The increase in information technology costs was due to investments that will enhance our customer experience, expand our data analytics capabilities, modernize our systems in order to improve our ability to react quickly to future changes, and bolster our information security programs.
The increase in stock-based compensation expense was primarily due to higher expense associated with equity awards, reflecting Torchmark's higher share price and higher stock option values as compared with the same period a year ago. The increase also reflects a one-time increase in stock-based compensation expense due to the effects of the Tax Legislation as previously discussed.
We also view excess investment income per diluted common 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 implementing our share repurchase program in 1986, we have used $7.1 billion of excess cash flow at the Parent Company to repurchase Torchmark shares after determining that the repurchases provided a greater return than other investment alternatives. If we had not used this excess cash to repurchase shares, but had instead invested it in interest-bearing assets, we would have earned more investment income and had more shares outstanding. In order to put all capital resource uses on a comparable basis, we believe that excess investment income per diluted share is an appropriate measure of the investment segment.
Excess investment income increased $15 million or 7% during 2017 after increasing 2% during 2016. The rate of growth was higher in 2017 than in 2016, in part, because excess investment income during 2016 was negatively impacted by an increase in financing costs attributable to the early refinancing of our 6.375% Senior Notes as is discussed below in the discussion of our financing costs. In addition, the growth rate in 2017 was positively impacted by the investment of positive cash flows relating to the collection in 2016 and 2017 of various receivables that had accumulated in prior years in the Medicare Part D business.
Excess investment income per diluted common share increased 10% during 2017 after increasing 6% during 2016. Excess investment income per diluted common share generally increases at a faster pace than excess investment income because the number of diluted shares outstanding generally decreases from year to year as a result of our share repurchase program.
Financing costs increased $1 million or 1% from 2016 to 2017. In 2017, interest on short-term debt increased because of the increase in the weighted-average interest rate on such debt. Financing costs also increased $7 million or 9% from 2015 to 2016 due primarily to the additional interest expense on our funded debt associated with the issuance of a 6.125% Junior Subordinated Debt security seventy days before the maturity and repayment of the 6.375% Senior Notes. More information on our debt transactions are disclosed in the Financial Condition section of this report and in Note 11-Debt.
Realized Gains and Losses. Our life and health insurance companies collect premium income from policyholders for the eventual payment of policyholder benefits, sometimes paid many years or even decades in the future. Because benefits are expected to be paid in future periods, premium receipts in excess of current expenses are invested to provide for these obligations. For this reason, we hold a significant investment portfolio as a part of our core insurance operations. This portfolio consists primarily of high-quality fixed maturities containing an adequate yield to provide for the cost of carrying these long-term insurance product obligations. As a result, fixed maturities are generally held for
Despite our intent to hold fixed maturity investments for a long period of time, investments are occasionally sold or called, resulting in a realized gain or loss. These gains and losses generally occur only incidentally, usually as the result of bonds sold because of deterioration in investment quality of issuers or calls by the issuers. Investment losses are also caused by write downs due to impairments. We do not engage in trading investments for profit. Therefore, gains or losses which occur in protecting the portfolio or its yield, or which result from events that are beyond our control, are only secondary to our core insurance operations of providing insurance coverage to policyholders.
As described in Note 4-Investments under the caption Other-than-temporary impairments, the Company recorded $245 thousand ($159 thousand, net of tax) in security write-downs. We did not incur any write downs in our fixed maturity portfolio as a result of other-than-temporary impairment for the years 2015 and 2016.
During calendar years 2015 through 2017, Torchmark invested almost exclusively in fixed maturity securities, primarily in corporate bonds with longer-term maturities. The following table summarizes selected information for fixed maturity purchases for the last three years. The effective annual yield shown is the yield calculated to the potential termination date that produces the lowest yield, commonly referred to as the “worst call date.” For non-callable bonds, the worst-call date is always the maturity date. For callable bonds, the worst-call date is the call date that produces the lowest yield, typically the first call date.
We prefer to invest primarily in bonds that are not callable (on other than a make-whole basis) prior to maturity, but we periodically invest some funds in callable bonds when the incremental yield available on such bonds warrants doing so. For investments in callable bonds, the actual life of the investment will depend on whether the issuer calls the investment prior to the maturity date. Given our investments in callable bonds, the actual average life of our investments cannot be known at the time of the investment. Absent sales, however, the average life will not be less than the average life to next call and will not exceed the average life to maturity. Data for both of these average life measures is provided in the above chart.
based on the next call date which is the next call date for callable bonds and the maturity date for noncallable bonds, and
Credit Risk Sensitivity. The following tables summarize certain information about the major corporate sectors and security types held in our fixed maturity portfolio at December 31, 2017 and 2016.
At December 31, 2017, fixed maturities had a fair value of $17.0 billion, compared with $15.2 billion at December 31, 2016. The net unrealized gain position in the fixed maturity portfolio increased from $1.1 billion at December 31, 2016 to $2.0 billion at December 31, 2017, primarily as a result of a decrease in credit spreads. The December 31, 2017 net unrealized gain consisted of gross unrealized gains of $2.1 billion offset by $83 million of gross unrealized losses, compared with the December 31, 2016 net unrealized gain which consisted of a gross unrealized gain of $1.3 billion and a gross unrealized loss of $216 million.
The net unrealized gain of the fixed maturity portfolio increased $916 million from December 31, 2016. The financial, utility, energy, and basic materials sectors experienced increases of $237 million, $132 million, $117 million, and $117 million respectively, in net unrealized gains from December 31, 2016 to December 31, 2017. The fair value of the entire portfolio increased 11% for the period. Over the past year, oil and many other commodity prices have increased meaningfully to the benefit of our holdings in the energy and basic materials sectors. While a sustained period of low prices might lead to some downgrades in ratings, we do not currently anticipate any losses from defaults or write-downs in the foreseeable future.
For more information about our fixed maturity portfolio by component at December 31, 2017 and 2016, including a discussion of other-than-temporary impairments, an analysis of unrealized investment losses and a schedule of maturities, see Note 4-Investments.
Market Risk Sensitivity. Torchmark’s investment securities are exposed to interest rate risk, meaning the effect of changes in financial market interest rates on the current fair value of the company’s investment portfolio. Since 95% of the book value of our investments is attributable to fixed maturity investments (and virtually all of these investments are fixed-rate investments), the portfolio is highly subject to market risk. Declines in market interest rates generally result in the fair value of the investment portfolio rising and increases in interest rates cause the fair value to decline. Under normal market conditions, we do not expect to realize these unrealized gains and losses because we have the ability and the intent to hold these investments to maturity. The long-term nature of our insurance policy liabilities and strong cash-flow operating position substantially mitigate any future need to liquidate portions of the portfolio. The increase or decrease in the fair value of insurance liabilities and debt due to increases or decreases in market interest rates largely offsets the impact of rates on the investment portfolio. However, as is permitted by GAAP, these liabilities are not recorded at fair value.
Insurance Subsidiary Liquidity. The operations of our insurance subsidiaries have historically generated substantial cash inflows in excess of immediate cash needs. Sources of cash flows for the insurance subsidiaries include primarily premium and investment income. Cash outflows from operations include policy benefit payments, commissions, administrative expenses, and taxes. The funds to provide for policy benefits, the majority of which are paid in future periods, are invested primarily in long-term fixed maturities to meet these long-term obligations. In addition to investment income, maturities and scheduled repayments in the investment portfolio are sources of cash. Excess cash available from the insurance subsidiaries’ operations is generally distributed as a dividend to the Parent Company, subject to regulatory restriction. The dividends are generally paid in amounts equal to the subsidiaries’ prior year statutory net income excluding realized capital gains. While the leading source of the excess cash is investment income, due to our high underwriting margins and effective expense control, a significant portion of the excess cash also comes from underwriting income.
Parent Company cash flow in excess of its operating requirements is available for other corporate purposes, such as insurance subsidiary capital or financing needs, strategic acquisitions, additional shareholder dividends, or share repurchases. In 2018, it is expected that the Parent Company will receive approximately $450 million in dividends and transfers from subsidiaries and that approximately $320 to $330 million will be available as excess cash flow. Certain restrictions exist on the payment of these dividends. For more information on the restrictions on the payment of dividends by subsidiaries, see the Restrictions section of Note 12-Shareholders’ Equity. Although these restrictions exist, dividend availability from subsidiaries historically has been more than sufficient for the cash flow needs of the Parent Company.
Consolidated Liquidity. Consolidated net cash inflows provided from continuing operations were $1.4 billion in 2017, compared with $1.2 billion in 2016 and $1.1 billion in 2015. In addition to cash inflows from operations, our companies received proceeds from maturities, calls, and repayments of fixed maturities in the amount of $489 million in 2017, compared with $236 million in 2016 and $376 million in 2015.
securities had a fair value of $17.0 billion at December 31, 2017. However, our strong cash flows from operations, investment maturities, and the availability of our credit line make any need to sell securities for liquidity unlikely.
As of December 31, 2017, we had no unconsolidated affiliates and no guarantees of the obligations of third party entities. All of our guarantees were guarantees of the performance of consolidated subsidiaries, as disclosed in Note 15-Commitments and Contingencies.
The following table presents information about future payments under our contractual obligations for the selected periods as of December 31, 2017.
Future insurance obligations consist primarily of estimated future contingent benefit payments on policies in force at December 31, 2017. These estimated payments were computed using assumptions for future mortality, morbidity and persistency. The actual amount and timing of such payments may differ significantly from the estimated amounts shown. Management believes that the assets supporting the liability of $13.4 billion at December 31, 2017, along with future premiums and investment income, will be sufficient to fund all future insurance obligations.
Capital Resources. Torchmark’s capital structure consists of short-term debt (the commercial paper facility described in Note 11-Debt and the current maturity of funded debt), long-term funded debt, and shareholders’ equity. A complete analysis and description of long-term debt issues outstanding is presented in Note 11.
Debt: The carrying value of the long-term debt was $1.1 billion at December 31, 2017, the same as a year earlier.
On April 5, 2016, Torchmark completed the issuance and sale of $300 million aggregate principal amount of Torchmark’s 6.125% Junior Subordinated Debentures due 2056. The debentures were sold pursuant to Torchmark’s shelf registration statement on Form S-3, filed September 25, 2015. The net proceeds from the sale of the debentures were $290 million, after giving effect to the underwriting discount and estimated expenses of the offering of the debentures. Torchmark used the net proceeds from the offering of the debentures to repay the $250 million outstanding principal amount plus accrued interest of $8 million on its 6.375% Senior Notes that were due June 15, 2016. The remaining proceeds were used for general corporate purposes.
Subsidiary Capital: For the past several years, our insurance subsidiaries have targeted a capital ratio of approximately 325% of Company Action Level regulatory capital under Risk-Based Capital (RBC) standards, a formula designed by insurance regulatory authorities to monitor the adequacy of capital. At December 31, 2017, our insurance subsidiaries had an aggregate RBC ratio of 314%, a decrease in the ratio from the prior year of 324% due to the reduction in deferred tax assets as a result of the Tax Legislation previously discussed in the Results of Operations in this report. Should the NAIC adjust the RBC factors in 2018, as expected, to take into account the lower tax rate, we would expect a further reduction in our consolidated RBC ratio for the year ending December 31, 2018. At this time, target RBC levels for 2018 are yet to be determined pending discussion with regulators and rating agencies. Management believes more than sufficient liquidity exists at the Parent Company to make additional contributions as necessary to maintain the targeted ratio.
Torchmark has continually increased the quarterly dividend on its common shares over the past three years. In the first quarter of 2015, it was increased to $0.135 per share from $0.1267 per share. In the first quarter of 2016, it was raised to $0.14 per share. Finally, in the first quarter of 2017, dividends were raised to $0.15 per share.
Shareholders’ equity was $6.2 billion at December 31, 2017, compared with $4.6 billion at December 31, 2016, a $1.7 billion or 36% increase. During the twelve months since December 31, 2016, shareholders’ equity was reduced by $325 million in share purchases under the repurchase program and $88 million to offset the dilution from stock option exercises. However, it was increased by $1.5 billion of net income, $874 million of which was attributed to a tax adjustment as a result of the Tax Legislation and $870 million of after-tax unrealized gains, of which $275 million was attributed to a tax adjustment as a result of the Tax Legislation.
Due to the size of our policy liabilities in relation to our shareholders’ equity, this inconsistency in measurement usually has a material impact on the reported value of shareholders’ equity. If these liabilities were revalued in the same manner
Financial Strength Ratings. The financial strength of our major insurance subsidiaries is rated by Standard & Poor’s and A. M. Best. The following chart presents these ratings for our five largest insurance subsidiaries at December 31, 2017.
A.M. Best states that it assigns an A+ (Superior) rating to insurance companies that have, in its opinion, a superior ability to meet their ongoing insurance obligations.
During the fourth quarter of 2017, S&P reviewed our operations and financial outlook. Based on their review, they confirmed our "AA-" financial strength ratings at our insurance subsidiaries and Torchmark Corporation's senior debt "A" credit rating.
Litigation. Torchmark and its subsidiaries are subject to being named as parties to pending or threatened litigation, much of which involves punitive damage claims based upon allegations of agent misconduct at the insurance subsidiaries. Such punitive damage claims may have the potential for significant adverse results since Torchmark and its subsidiaries operate in jurisdictions where large punitive damage awards bearing little or no relation to actual damages continue to be awarded. This bespeaks caution since it is impossible to predict the likelihood or extent of punitive damages that may be awarded if liability is found in any given case. 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 us to be material. For more information concerning litigation, please refer to Note 15-Commitments and Contingencies .
Approximately 87% of our liabilities for future policy benefits at December 31, 2017 were traditional insurance liabilities where the liability is determined as the present value of future benefits less the present value of the portion of the gross premium required to pay for such benefits. The assumptions used in estimating the future benefits for this portion of business are set at the time of contract issue. These assumptions are “locked in” and are not revised for the lifetime of the contracts, except where there is a premium deficiency, as defined in Note 1-Significant Accounting Policies under the caption Future Policy Benefits. Otherwise, variability in the accrual of policy reserve liabilities after policy issuance is caused only by variability of the inventory of in force policies. Torchmark did not have a premium deficiency event for its traditional business during the three years ended December 31, 2017.
Deferred Acquisition Costs: Certain costs of acquiring new business are deferred and recorded as an asset. Deferred acquisition costs consist primarily of sales commissions and other underwriting costs related to the successful issuance of a new insurance contract as indicated in Note 1-Significant Accounting Policies under the caption Deferred Acquisition Costs in the Notes to Consolidated Financial Statements. Additionally, the cost of acquiring blocks of insurance business or insurance business through the purchase of other companies, known as the value of insurance purchased, is included in deferred acquisition costs. Our policies for accounting for deferred acquisition costs and the associated amortization are reported under the same caption in Note 1-Significant Accounting Policies.
Less than 1% of deferred acquisition costs pertain to deposit business for which deferred acquisition costs are amortized over the estimated lives of the contracts in proportion to actual and estimated future gross profits. These contracts are not subject to lock-in. The assumptions must be updated when actual experience or other evidence suggests that earlier estimates should be revised. Revisions related to our deposit business assets have not had a material impact on the amortization of deferred acquisition costs during the three years ended December 31, 2017.
Valuation of Fixed Maturities: We hold a substantial investment in high-quality fixed maturities to provide for the funding of our future policy contractual obligations over long periods of time. While these securities are generally expected to be held to maturity, they are classified as available for sale and are sold from time to time, primarily to manage risk.
We report this portfolio at fair value. Fair value is the price that we would expect to receive upon sale of the asset in an orderly transaction. The fair value of the fixed maturity portfolio is primarily affected by changes in interest rates in financial markets, having a greater impact on longer-term maturities. Because of the size of our fixed maturity portfolio, small changes in rates can have a significant effect on the portfolio and the reported financial position of the Company. This impact is disclosed in 100 basis point increments under the caption Market Risk Sensitivity in this report. However, as discussed under the caption Financial Condition in this report, we believe these unrealized fluctuations in value have no meaningful impact on our actual financial condition and, as such, we remove them from consideration when viewing our financial position and financial ratios.
At times, the values of our fixed maturities can also be affected by illiquidity in the financial markets. Illiquidity would contribute to a spread widening, and accordingly unrealized losses, on many securities that we would expect to be fully recoverable. Even though our fixed maturity portfolio is available for sale, we have the ability and intent to hold the securities until maturity as a result of our strong and stable cash flows generated from our insurance products. Considerable information concerning the policies, procedures, classification levels, and other relevant data concerning the valuation of our fixed maturity investments is presented in Note 1-Significant Accounting Policies and in Note 4-Investments under the captions Fair Value Measurements in both notes.
The criteria used to determine the primary assumptions are discussed in Note 9-Postretirement Benefits. While we have used our best efforts to determine the most reliable assumptions, given the information available from company experience, economic data, independent consultants and other sources, we cannot be certain that actual results will be the same as expected. The assumptions are reviewed annually and revised, if necessary, based on more current information available to us. Note 9-Postretirement Benefits also contains information about pension plan assets, investment policies, and other related data.
We have audited the accompanying consolidated balance sheets of Torchmark Corporation and subsidiaries (the “Company”) as of December 31, 2017 and 2016, 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, 2017, and the related notes and the schedules listed in the Index at Item 15 (collectively referred to as the “financial statements”). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2017 and 2016, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2017, in conformity with accounting principles generally accepted in the United States of America.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company’s internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 26, 2018, expressed an unqualified opinion on the Company’s internal control over financial reporting.
Level 2 -fair values are based on inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. Level 2 inputs include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability, or inputs that can otherwise be corroborated by observable market data.
Level 3- fair values are based on inputs that are considered unobservable where there is little, if any, market activity for the asset or liability as of the measurement date. In this circumstance, the Company has to rely on values derived by independent brokers or internally-developed assumptions. Unobservable inputs are developed based on the best information available to the Company which may include the Company’s own data or bid and ask prices in the dealer market.
The fair values for each class of security and by valuation hierarchy level are indicated in Note 4-Investments under the caption Fair value measurements and Note 9-Postretirement Benefits under the caption Pension Plans.
Fair Value Measurements, Other Financial Instruments: Fair values for cash, short-term investments, short-term debt, mortgage participations, receivables and payables approximate carrying value. Policy loans are an integral part of Torchmark’s subsidiaries’ life insurance policies in force and their fair values cannot be valued separately and apart from the insurance contracts. The fair values of Torchmark’s long-term debt issues are based on the same methodology as investments in fixed maturities. At December 31, 2017, observable inputs were available for these debt securities and as such were classified as Level 2 in the valuation hierarchy. The fair value for each debt instrument as of December 31, 2017 is disclosed in Note 11-Debt. As described in Note 9-Postretirement Benefits, Torchmark maintains a nonqualified supplemental retirement plan. Therefore the assets which support the liability for this plan are considered general assets of the Company. These assets consist of the cash value of corporate-owned life insurance policies (COLI) and exchange traded funds (ETFs). The fair value of the insurance cash values approximates carrying value. Fair values for the ETFs are derived from direct quotes and are considered Level 1 in the valuation hierarchy.
and evaluated. The determination that an impairment is other-than-temporary is highly subjective and involves the careful consideration of many factors. Among the factors considered are:
Current accounting guidance is such that if an entity intends to sell or if it is more likely than not that it will be required to sell an impaired security prior to recovery of its cost basis, the security is to be considered other-than-temporarily impaired and the full amount of impairment must be charged to earnings. Otherwise, losses on fixed maturities which are other-than-temporarily impaired are separated into two categories, the portion of loss which is considered credit loss and the portion of loss which is due to other factors. The credit loss portion is charged to earnings while the loss due to other factors is charged to other comprehensive income. The credit loss portion of an impairment is determined as the difference between the security’s amortized cost and the present value of expected future cash flows discounted at the security’s original effective yield rate. The temporary portion is the difference between this present value of expected future cash flows and fair value (as discounted by a market yield). The expected cash flows are determined using judgment and the best information available to the Company. Inputs used to derive expected cash flows include expected default rates, current levels of subordination, and loan-to-collateral value ratios.
DAC and VOBA are amortized in a systematic manner which matches these costs with the associated revenues. Policies other than universal life-type policies are amortized with interest over the estimated premium-paying period of the policies in a manner which charges each year’s operations in proportion to the receipt of premium income. Universal life-type policies are amortized with interest in proportion to estimated gross profits. The assumptions used to amortize acquisition costs with regard to interest, mortality, morbidity, and persistency are consistent with those used to estimate the liability for future policy benefits. For interest-sensitive and deposit-balance type products, these assumptions are reviewed on a regular basis and are revised if actual experience differs significantly from original expectations. For all other products, amortization assumptions are generally not revised once established.
DAC are subject to periodic recoverability and loss recognition testing to determine if there is a premium deficiency. These tests evaluate whether the present value of future contract-related cash flows will support the capitalized DAC asset. These cash flows consist primarily of premium income, less benefits and expenses taking inflation into account. The present value of these cash flows, less the benefit reserve, is then compared with the unamortized deferred acquisition cost balance. In the event the estimated present value of net cash flows is less, the deficiency would be recognized by a charge to earnings and either a reduction of unamortized acquisition costs or an increase in the liability for future benefits, as described under the caption Future Policy Benefits.
Advertising Costs: Costs related to advertising are generally charged to expense as incurred. However, certain Globe Life Direct Response advertising costs are capitalized when there is a reliable and demonstrated relationship between total costs and future benefits that is a direct result of incurring these costs. Globe Life Direct Response advertising costs consist primarily of the production and distribution costs of direct mail advertising materials, and when capitalized are included as a component of DAC. They are amortized in the same manner as other DAC. Globe Life Direct Response advertising costs charged to earnings and included in other operating expense were $9.3 million, $9.3 million, and $9.7 million in 2017, 2016, and 2015, respectively. At December 31, 2017, unamortized capitalized advertising costs included within DAC were $1.28 billion at December 31, 2017 and $1.25 billion at December 31, 2016.
In the two-step quantitative analysis, the Company utilizes two approaches, income and market, to determine the fair value of each reporting unit. In the income approach, judgment and assumptions are used in developing the projected cash flows for the reporting units, and such estimates are subject to change. The Company also exercises judgment in the determination of the discount rate as management believes this to be appropriate for the risk associated with the cash flow expectations. In the market approach, the Company utilizes the share price and a control premium based
Torchmark tested its goodwill annually as of June 30th in each of the years 2015 through 2017. Torchmark’s goodwill was not impaired in any of those periods.
Low-Income Housing Tax Credit Interests: Torchmark invests in limited partnerships that provide low-income housing tax credits and other related federal income tax benefits to Torchmark. The carrying value of Torchmark’s investment in these entities was $228 million and $280 million at December 31, 2017 and 2016, respectively and was included in "Other assets" on the Consolidated Balance Sheets. As of December 31, 2017, Torchmark was obligated under future commitments of $34 million, which are recorded in "Other liabilities". For guaranteed investments acquired prior to January 1, 2015, the Company utilizes the effective-yield method of amortization while the proportional method of amortization is utilized for all non-guaranteed as well as guaranteed investments acquired on or after January 1, 2015. All amortization expense is recorded in "Income tax benefit (expense)" on the Consolidated Statements of Operations.
Property and Equipment: Property and equipment, included in “Other assets,” is reported at cost less allowances for depreciation. Depreciation is recorded primarily on the straight line method over the estimated useful lives of these assets which range from three to five years for equipment and ten to forty years for buildings and improvements. Ordinary maintenance and repairs are charged to income as incurred. Impairments, if any, are recorded when certain events and circumstances become evident that the fair value of the asset is less than its carrying amount. Original cost of property and equipment was $217 million at December 31, 2017 and $196 million at December 31, 2016. Accumulated depreciation was $109 million at year end 2017 and $99 million at the end of 2016. Depreciation expense was $10.5 million in 2017, $9.8 million in 2016, and $8.0 million in 2015. Internally generated software costs are expensed as incurred in the preliminary project phase and post-implementation phase, and will be capitalized during the application development stage.
Treasury Stock: Torchmark accounts for purchases of treasury stock on the cost method. Issuance of treasury stock is accounted for using the weighted-average cost method. More information is found in Note 12-Shareholders' Equity.
Stock-Based Compensation: Torchmark accounts for stock-based compensation by recognizing an expense in the financial statements based on the “fair value method.” The fair value method requires that a fair value be assigned to a stock option or other stock grant on its grant date and that this value be amortized over the grantees’ service period.
ASU 2018-02: In February 2018, the FASB issued ASU No. 2018-02, Income Statement-Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income (AOCI). This guidance was issued to allow the reclassification of taxes from AOCI to retained earnings as a result of the reduction in corporate income tax rates due to Tax Legislation. Current accounting requires the effect of changes in tax rates used to measure deferred tax assets and liabilities to be reported in net income as of the date of enactment even though deferred taxes were previously recognized in AOCI (stranded taxes). This guidance, however, allows a company to elect to reclassify the stranded taxes in AOCI to retained earnings and is effective for years beginning after December 15, 2018, with early adoption permitted. The Company elected to early adopt this guidance resulting in a reclassification of $252 million from AOCI to retained earnings for the period ended December 31, 2017. See Consolidated Statements of Shareholders' Equity and Note 3-Supplemental Information about Changes to Accumulated Other Comprehensive Income.
ASU 2016-02: In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842), which requires all lessees to report a right-of-use asset and a lease liability for leases with a term life greater than 12 months. Operating and financing leases will be recognized on the balance sheet going forward. Additional qualitative and quantitative disclosures will be required. This standard will become effective for the Company beginning January 1, 2019 and will require recognizing and measuring leases at the beginning of the earliest period presented using a modified retrospective approach. Early adoption is permitted. The Company does not expect the adoption to have a significant impact on the financial statements. Refer to Note 15-Commitments and Contingencies for consideration of the noncancelable operating lease commitments. The Company is not a lessor.
ASU 2016-13: In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments to provide financial statement users with more decision-useful information about the expected credit losses on financial instruments as well as to change the loss impairment methodology for available-for-sale debt securities by use of an allowance rather than a direct write-down. This standard will become effective on January 1, 2020. The applicable section of the standard related to debt securities requires a prospective transition. The Company does not expect the adoption to have a significant impact on the financial statements as we have limited credit losses with respect to our available-for-sale portfolio.
ASU 2016-15: In August 2016, the FASB issued ASU No. 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments to provide uniformity in the classification of cash receipts and payments recorded in the statement of cash flows including debt prepayment or debt extinguishment costs, settlement of zero-coupon bonds, and proceeds from the settlement of insurance claims. This standard became effective on January 1, 2018 and will not have a significant impact to the classification on our Statement of Cash Flows.
The excess, if any, of shareholder’s equity of the insurance subsidiaries on a GAAP basis over that determined on a statutory basis is not available for distribution by the insurance subsidiaries to Torchmark without regulatory approval. Insurance subsidiaries’ statutory capital and surplus necessary to satisfy regulatory requirements in the aggregate was $458 million at December 31, 2017. More information on the restrictions on the payment of dividends can be found in Note 12-Shareholders’ Equity.
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. While all states have adopted the National Association of Insurance Commissioners’ (NAIC) statutory accounting practices (NAIC SAP) as the basis for statutory accounting, certain states have retained prescribed practices of their respective insurance code or administrative code which can differ from NAIC SAP. For Torchmark’s life insurance companies, there are no significant differences between NAIC SAP and the accounting practices prescribed by the states of domicile.
A summary of fixed maturities available for sale by cost or amortized cost and estimated fair value at December 31, 2017 and 2016 is as follows:
(2) There were no transfers in or out of Level 3 during the three years ended 2017.
Acquisitions of Level 3 investments in each of the years 2015 through 2017 are comprised of private-placement fixed maturities managed by an unaffiliated third-party.
As of year end 2017, previously written down securities remaining in the portfolio were carried at a fair value of $59 million, or less than 0.4% of the fair value of the fixed maturity portfolio. Torchmark is continuously monitoring the market conditions impacting its portfolio. While adverse market conditions for an extended duration could lead to some ratings downgrades in certain sectors, Torchmark has the ability and intent to hold these investments to recovery, and does not intend to sell or expect to be required to sell any of its securities in such a position.
Unrealized gains/loss analysis: The following tables disclose gross unrealized investment losses by class and major sector of investments at December 31, 2017 and December 31, 2016 for the respective periods of time in a loss position. Torchmark considers these investments to be only temporarily impaired.
Gross unrealized losses decreased from $216 million at year end 2016 to $83 million at year end 2017, a decrease of $133 million. The decrease in the gross unrealized losses from prior year was primarily attributable to the improved conditions during 2017 in the energy sector and broadly across all sectors.
Torchmark’s entire fixed maturity portfolio consisted of 1,502 issues at December 31, 2017 and 1,565 issues at December 31, 2016. The weighted-average quality rating of all unrealized loss positions at amortized cost was BBB- for 2017 and BBB+ for 2016.
(1) A mortgage participation is a legal right to a prorata interest in a mortgage loan.
Torchmark did not have any invested assets that were non-income producing during the twelve months ended December 31, 2017.
Concentrations of Credit Risk: Torchmark maintains a diversified investment portfolio with limited concentration in any given issuer. At December 31, 2017, the investment portfolio, at fair value, consisted of the following:
As of December 31, 2017, securities of state and municipal governments represented 7% of invested assets at fair value. Such investments are made throughout the U.S. At yearend 2017, the state and municipal bond portfolio at fair value was invested in securities issued within the following states: Texas (29%), Ohio (9%), Washington (8%), Illinois (7%), Michigan (5%), and Georgia (5%). Otherwise, there was no concentration within any given state greater than 5%.
Corporate debt securities and redeemable preferred stocks represent 85% of Torchmark's investment portfolio. These investments are spread across a wide range of industries. Below are the ten largest industry concentrations held in the corporate portfolio of corporate debt securities and redeemable preferred stocks at December 31, 2017, based on fair value:
At December 31, 2017, other receivables included $65 million from Centers for Medicare and Medicaid Services (CMS). At December 31, 2016, the comparable amounts were $50 million from CMS and $69 million from drug manufacturer rebates.
Income taxes paid related to discontinued operations for the three years ended December 31, 2017 were as follows:
At the end of each period, the liability for unpaid health claims includes an estimate of claims incurred but not yet reported to the Company. Such estimates are updated regularly based upon the Company’s most recent claims data with recognition of emerging experience trends. Because of the nature of the Company’s health business, the payment lags are relatively short and most claims are fully paid within a year from the time incurred. Fluctuations in claims experience can lead to either over or under estimation of the liability for any given year. The difference between the estimate made at the end of the prior period and the actual experience during the period is reflected above under the caption “Incurred related to: Prior years.”
The liability for unpaid health claims is included within “Policy claims and other benefits payable” in the Consolidated Balance Sheets.
This table illustrates the total cumulative paid claims and allocated claims for short-duration products over the last five years for the year ended December 31, 2017.
The cumulative paid claims for all years prior to 2017 are unaudited.
Below is the reconciliation of the net incurred and paid claims development tables to the liability for "Policy claims and other benefits payable" in the Consolidated Balance Sheets.
In each of the years 2015 through 2017, deferred income tax (benefit) expense was incurred because of certain differences between net income before income taxes as reported on the Consolidated Statements of Operations and taxable income as reported on Torchmark’s income tax returns. As explained in Note 1-Significant Accounting Policies, these differences caused the financial statement book values of some assets and liabilities to be different from their respective tax bases.
As discussed in Note 1-Significant Accounting Policies, due to the passage of the Tax Legislation before December 31, 2017, the Company recorded $877 million reduction in deferred income tax expense related to a one-time adjustment to reduce its net deferred tax liability as of December 22, 2017, as required by ASC 740 Income Taxes, due to the reduction in the income tax rate. This adjustment to the Company's net deferred tax liability included $252 million related to items included in AOCI.
Although many aspects of the Tax Legislation are not effective until 2018, the Company recorded a reasonable estimate for the tax reform adjustment in accordance with SAB 118. We will continue to analyze relevant information to complete our accounting for income taxes which may result in an adjustment to our estimate in 2018. The accounting is expected to be complete when the 2017 U.S. corporate income tax return is filed later in 2018.
Income Tax Return: Torchmark and its subsidiaries, excluding Family Heritage Life Insurance Company (Family Heritage), file a life-nonlife consolidated federal income tax return. Family Heritage files its federal income tax return on a separate company basis. The statutes of limitations for the Internal Revenue Service's examination and assessment of additional tax are closed for all tax years prior to 2014 with respect to Torchmark’s consolidated and Family Heritage’s federal income tax returns. Management believes that adequate provision has been made in the consolidated financial statements for any potential assessments that may result from current or future tax examinations and other tax-related matters for all open years.
Torchmark’s tax liability is adjusted to include a provision for uncertain tax positions taken or expected to be taken in a tax return. However, during the years 2015 through 2017, Torchmark did not have any uncertain tax positions which resulted in unrecognized tax benefits.
Torchmark has qualified noncontributory defined benefit pension plans and contributory savings plans which cover substantially all employees. There are also two nonqualified noncontributory supplemental executive retirement plans (SERPs) which cover a limited number of employees. The total cost of these retirement plans charged to operations was as follows:
Pension Plans: Cost for the defined benefit pension plans has been calculated on the projected unit credit actuarial cost method. All plan measurements for the defined benefit plans are as of December 31st of the respective year. The defined benefit pension plans covering the majority of employees are qualified and funded. Contributions are made to funded pension plans subject to minimums required by regulation and maximums allowed for tax purposes. Defined benefit plan contributions were $21.3 million in 2017, $15.8 million in 2016, and $15.5 million in 2015. Torchmark estimates as of December 31, 2017 that it will contribute an amount in the range of $30 million to $40 million to these plans in 2018. The actual amount of contribution may be different from this estimate.
Torchmark has two SERPs, one of which is active and provides to a limited number of executives an additional supplemental defined pension benefit. The supplemental benefit is based on the participant’s qualified plan benefit without consideration to the regulatory limits on compensation and benefit payments applicable to qualified plans, except that eligible compensation is capped at $1 million. This SERP is nonqualified and unfunded. However, a Rabbi Trust has been established to support the liability for this plan. This trust consists of life insurance policies on the lives of plan participants with an unaffiliated insurance carrier as well as an investment account.
Since this plan is nonqualified, the investments and the policyholder value of the insurance policies in the Rabbi Trust are not included as defined benefit plan assets, but rather assets of the Company. They are included in “Other Assets” in the Consolidated Balance Sheets.
The second supplemental benefit pension plan is limited to a very select group of employees and was closed as of December 31, 1994. It provides the full benefits that an employee would have otherwise received from a defined benefit plan in the absence of the limitation on benefits payable under a qualified plan. This plan is also nonqualified and unfunded. Pension cost for both supplemental defined benefit plans is determined in the same manner as for the qualified defined benefit plans.
The following table includes activity for the SERPs for the three years ended December 31, 2017.
The investment portfolio is to be well diversified to avoid undue exposure to a single sector, industry, business, or security. The equity and fixed maturity portfolios are not permitted to invest in any single issuer that would exceed 10% of total plan assets at the time of purchase. Torchmark does not employ any other special risk management techniques, such as derivatives, in managing the pension investment portfolio.
Torchmark's equity securities include an exchange traded fund that mirrors the S&P 500 index which better aligns with a passive approach rather than an actively managed portfolio. At December 31, 2017, there were no restricted investments contained in the portfolio. Plan contributions have been invested primarily in fixed maturity and equity securities during the three years ended December 31, 2017.
Includes amortization of postretirement benefits other than pensions of $155 thousand in 2017, $33 thousand in 2016, and $120 thousand in 2015.
The following table presents a reconciliation from the beginning to the end of the year of the projected benefit obligation and plan assets for pensions. This table also presents the amounts previously recognized as a component of accumulated other comprehensive income.
The portion of other comprehensive income that is expected to be reflected in pension expense in 2018 is as follows:
Torchmark has estimated its expected pension benefits to be paid over the next ten years as of December 31, 2017. These estimates use the same assumptions that measure the benefit obligation at December 31, 2016, taking estimated future employee service into account. Those estimated benefits are as follows:
Callable at any time on or after June15, 2021, and prior to this date upon the occurrence of a Tax Event or Rating Agency Event.
Funded debt: On November 17, 2017, Torchmark completed the issuance and sale of $125 million in aggregate principal of Torchmark’s 5.275% Junior Subordinated Debentures due 2057. The debentures were sold in a private placement pursuant to exemptions from the registration requirements of the Securities Act of 1933. The initial purchaser of the debentures was outside the United States. The net proceeds from the sale of the debentures were $123.3 million, after giving effect to the discount payable to the initial purchaser and expenses of the offering of the debentures. Torchmark used the net proceeds from the offering of the debentures to repay the $125 million outstanding principal, plus accrued interest of $143 thousand on the 5.875% Junior Subordinated Debentures on December 22, 2017. The Debentures were due December 15, 2052 and were callable beginning December 15, 2017.
Credit Facility: On May 17, 2016, Torchmark amended its credit facility to include, as a part of the facility, the issuance of a $100 million term loan and to extend the maturity date of the entire credit facility to May 2021. The facility is further designated as a back-up credit line for a commercial paper program under which the Company may either borrow from the credit line or issue commercial paper at any time, with total commercial paper outstanding not to exceed the facility maximum of $750 million, less any letters of credit issued. Interest is charged at variable rates. The term loan will be repaid on a redemption schedule which provides for quarterly installments that began June 30, 2017 that escalate each annual period with a balloon payment of $75 million due in May 2021. Interest on the term loan is computed and paid monthly at 125 basis points plus 1 Month LIBOR. In accordance with the agreement, Torchmark is subject to certain covenants regarding capitalization. As of December 31, 2017, the Company was in full compliance with these covenants.
Share Data: A summary of preferred and common share activity is presented in the following chart.
For the three years ended December 31, 2017, there were no anti-dilutive shares. Income available to common shareholders for basic earnings per share is equivalent to income available to common shareholders for diluted earnings per share.
Torchmark’s stock-based compensation consists of stock options, restricted stock, restricted stock units, and performance shares. Certain employees and directors have been granted fixed equity options to buy shares of Torchmark stock at the market value of the stock on the date of grant, under the provisions of the Torchmark stock option plans. The options are exercisable during the period commencing from the date they vest until expiring according to the terms of the grant. Options generally expire the earlier of employee termination or option contract term, which are either seven or ten year terms. Options generally vest in accordance with the following schedule:
All employee options vest immediately upon retirement on or after the attainment of age 65, upon death, or disability. Torchmark generally issues shares for the exercise of stock options from treasury stock. The Company generally uses
the proceeds from option exercises to buy shares of Torchmark common stock in the open market to reduce the dilution from option exercises.
A summary of stock compensation activity for each of the three years ended December 31, 2017 is presented below:
An analysis of option activity for each of the three years ended December 31, 2017 is as follows:
Additional information about Torchmark’s stock option activity as of December 31, 2017 and 2016 is as follows:
Selected stock option activity for the three years ended December 31, 2017 is presented below:
Restricted Stock: Restricted stock grants consist of time-vested grants, restricted stock units, and performance shares. Time-vested restricted stock is available to both senior executives and directors. The employee grants generally vest over five years and the director grants vest over six months. Restricted stock units are available only to directors. They vest over six months and are not converted to shares until the directors’ retirement, death, or disability. Director restricted
For the 2016 and 2017 performance share grants, actual shares that could be distributed range from 0 to 335 thousand for the 2016 grants and 0 to 306 thousand shares for the 2017 grants.
A summary of restricted stock grants for each of the years in the three-year period ended December 31, 2017 is presented in the table below.
An analysis of the weighted-average grant-date fair values per share of unvested restricted stock is as follows for the year 2017:
Torchmark is organized into four segments: life insurance, supplemental health insurance, annuities, and investments. We also have other administrative expenses reported in "Corporate & Other."
Torchmark’s reportable segments are based on the insurance product lines it markets and administers: life insurance, supplemental health insurance, and annuities. These major product lines are set out as reportable 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 chief operating decision makers evaluate the overall performance of the operations of the Company in accordance with these segments.
Torchmark markets its insurance products through a number of distribution channels, each of which sells the products of one or more of Torchmark’s insurance segments. The tables below present segment premium revenue by each of Torchmark’s distribution channels.
Recognition of a one-time increase in stock-based compensation expense due to Tax Legislation.
Insurance affiliates also assume insurance risks of other external companies. Life reinsurance assumed represented 1.8% of life insurance in force at December 31, 2017 and reinsurance assumed on life and accident and health products represented 0.7% of premium income for 2017.
Rental expense for operating leases for each of the three years ended December 31, 2017 is as follows:
On February 1, 2018, a putative class action litigation was filed against American Income Life Insurance Company in U.S. District Court for the Northern District of Texas, Dallas Division (Bruce v. American Income Life Insurance Company, et al., Case No. 3:18-cv-00258-G). The plaintiff, a former insurance sales agent of American Income who is suing on behalf of all current and former American Income sales agents contracted through State General Agent Stephen Jubrey’s agency office at any time since January 31, 2015 through the final disposition of this matter, asserts that such agents are employees rather than independent contractors as they are classified by American Income. He alleges failure to pay minimum wages, overtime wages and other applicable monies in accordance with the Fair Labor Standards Act. The plaintiff seeks, in a jury trial, actual and punitive damages, pre- and post-judgment interest, attorney fees, costs and other relief, including injunctive relief.
The following is an unaudited summary of quarterly results for the two years ended December 31, 2017. The information includes all adjustments (consisting of normal accruals) which management considers necessary for a fair presentation of the results of operations for these periods.