- ------------------------------------------------------------------------------- (1) Annualized life premium in force includes $144 million, and annualized health premium in force includes $37 million, representing the business acquired in the acquisition of American Income Life Insurance Company in 1994. (2) Annualized life premium in force includes $2.7 million, representing the business acquired in the acquisition of Sentinel American Life Insurance Company in 1991. (3) Annualized life premium in force includes $28.1 million, representing the business acquired in the acquisition of Family Service Life Insurance Company in 1990. (4) Includes accrued investment income. (5) Computed after deduction of preferred shareholders' equity.
In a comparison of 1994 results with those of 1993 and 1992, consideration should be given to a number of nonrecurring items. On November 3, 1994, Torchmark acquired American Income, and those results were consolidated with Torchmark's after the acquisition date. American Income added approximately $2.2 million to Torchmark's net income, after taking into account goodwill amortization and financing costs. The purchase was made at a total cost of $552 million. In November, 1993, Torchmark sold 73% of its interest in Vesta, which was Torchmark's wholly-owned property and casualty subsidiary prior to the sale, retaining an approximate 27% interest. Such interest was sold for proceeds of $161 million and a $57 million pretax gain from the sale was recognized. Results for 1993 included an $82 million pretax charge for nonoperating expenses, compared to $25.1 million for 1994 and $5.7 million for 1992. These charges relate to legal costs, guaranty assessments, and other contingencies which are discussed in more depth in "Item 3 - -Legal Proceedings" ------------------------- on page 14 of this report. The $25.1 million charge in 1994 was principally offset, however, by a reclassification of nonoperating expense to health benefits, since actual payments will be made in the form of health benefits. Two new accounting standards which dealt with postretirement benefits and accounting for income taxes were implemented in 1993, increasing 1993 earnings by $18.4 million. Enactment of corporate tax legislation in mid-1993, which increased tax rates from 34% to 35%, resulted in an additional charge to 1993 earnings of $9.4 million to adjust the deferred tax liability relating to prior years. It also caused an increase in 1994 and 1993 income taxes when compared to 1992.
Revenues declined 12% to $1.9 billion in 1994, after having increased 6.4% in 1993 to $2.2 billion. After excluding Vesta's revenues in 1993 and the above-mentioned gain on the sale of Vesta, the decline in 1994 revenues would have been 3.3%. Excluding Vesta, premium income for 1994 grew 1.4% or $19 million to $1.4 billion. Financial services revenues rose 1.4% in 1994 and 3.0% in 1993 primarily because of increased average assets under management. Energy operations revenues declined 39% to $64 million from $106 million after having risen 43% in 1993, because of the sale of a large producing property in late 1993. The $22 million gain from the property sale as well as its production revenues were included in 1993 revenues. Net investment income, which declined 2.7% in 1993, dropped $35 million or 9.5% in 1994. Two significant events caused the decline in net investment income in 1994 and, to a lesser extent, in 1993. First, capitalization of developmental costs in Torchmark's Black Warrior methane gas investment were phased out in 1993 and discontinued in 1994 as the project became operational, causing rising expense recognition while gas prices softened. Additionally, the low interest rate environment in 1993 and early 1994 caused an acceleration of GNMA repayments, requiring Torchmark to reinvest such funds at lower prevailing rates. A more in-depth discussion of each of Torchmark's segments and investment operations is found on pages 20 through 28 of this report.
Life Insurance: Torchmark's life insurance premium, including policy --------------- charges, increased 8.2% to $602 million in 1994, after having risen 2.0% to $556 million in 1993. Sales of life products were strong in 1994 with annualized life premium issued increasing 17% to $150 million in 1994. Approximately 57% of the growth in life premium issued was in the direct mail marketing area. Direct mail sales grew 34% in 1994 to $48 million. Annualized life premium in force rose to $797 million at December 31, 1994, growing 30% over the prior year-end amount of $613 million. Annualized life premium in force grew 4% in 1993 from $588 million. Annualized premium in force data includes amounts collected on certain interest-sensitive life products which are not recorded as premium income but exclude single premium income and policy charges.
Torchmark has emphasized increased sales in life insurance product lines relative to health and other insurance products because profit margins are superior. Additionally, assets backing the higher reserves required for life products allow Torchmark to increase investment income. Profit margin for life insurance, as measured by insurance operating income as a percentage of premium, was in excess of 29% in both 1994 and 1993, improving over 27.9% in 1992. One factor in the improvement over 1992 was increased persistency. Persistency improvements have resulted, at least in part, from revisions in agents' compensation formulas to encourage persistency. Lower lapses have also been attributable to the conversion of a large portion of agent-collected home service business to bank draft premium, which has higher persistency. The proportion of bank draft premium to total home service premium increased from 69% in 1992 to 78% in 1993 to 81% in 1994. Improvements in persistency reduce the amortization of acquisition expenses and positively affect overall profitability margins but may cause some increases in the ratio of policy obligations to premium.
The primary cause of the increase in the ratio of policy obligations to premium in 1994 was higher mortality when compared to 1993. Fluctuations in mortality are normal, however, and such increase is not indicative of a pattern. The above presentation of life insurance results excludes a $22.8 million benefit in 1994 from the re-evaluation of reserving assumptions on a block of burial reserves. A review of assumptions regarding mortality, interest and inflation pressures on burial costs indicated that sufficient experience existed to support a change in the level of reserves held on this block. Torchmark will continue to monitor the reserving assumptions for this block on an annual basis to ensure that reserves are sufficient to meet contractual liabilities. Had this item been included, the 1994 ratio of policy obligations to premium would have been reduced and overall margin would have been increased 3.8%.
Health premium was $769 million in 1994, declining 4% over premium of $800 million in 1993. Health premium increased slightly in 1993 over the prior year. Annualized health premium in force stood at $808 million at December 31, 1994, decreasing 2% from 1994 premium in force of $823 million. Year-end 1993 annualized health premium in force declined 1% from the December 31, 1992 amount of $832 million. The declines in health premium in force resulted from falling sales of most health products. Sales of health insurance products in terms of annualized premium issued declined 31% to $121 million in 1994 after having declined 22% to $176 million in 1993.
The declines in premium sales in both years and the 1994 decline in premium in force are primarily attributable to Torchmark's Medicare Supplement product. Annualized premium in force for this product rose from $581 million at year-end 1992 to $601 million for year-end 1993, but fell 5% to $572 million in 1994. In terms of annualized premium issued, sales of Medicare Supplement insurance declined 13% to $136 million in 1993 and further declined 36% in 1994 to $88 million. Throughout all of 1993 and most of 1994, there was considerable uncertainty regarding various health care reforms proposed by both the Clinton Administration and Congress which had bearing on the Medicare Supplement market. Additionally, this market has also experienced a great deal of regulatory change in recent years, including increased government regulation in the form of mandated policy forms, a required minimum 65% loss ratio on products sold, and a required leveling of agents' commissions. The mandated loss ratio and policy forms have put significant pressure on margins for Torchmark as well as the rest of the industry, discouraging sales. Torchmark has also encountered considerable competition in this market with regard to price and "attained-age" pricing, whereby premium may be increased on a basis of increased age as well as increased medical costs. This increased competition has negatively affected sales.
Torchmark intends to continue its efforts to increase Medicare Supplement production. It is seeking approval in certain key states to sell the "attained-age" policy in order to compete more effectively and expects to receive approval in these states during 1995. Additionally, Torchmark plans to market a new group Medicare Supplement product and a variety of other new life and health products directed at the senior citizen market.
Variable annuity collections declined from $214 million in 1993 to $196 million in 1994, the first year of lower year-over-year collections since these products were introduced in 1987. The rapid growth experienced in variable annuities prior to 1994 resulted from increased customer interest in these investment-type products, due at least in part to stronger financial markets. Weaker financial markets in 1994 are thought to have caused decreased demand. Sales of fixed annuities have declined in each year in large part because of the increased interest in variable annuities. Although sales declined in 1994, the combined annuity account balance grew 14% in 1994 over the prior year end to $1.4 billion.
Annuity policy charges, which are included in other premium in the financial statements, climbed 47% to $13.9 million, after having risen 8% in 1993 to $9.5 million. The large increase in policy charges in 1994 was attributable to the increase in size of the variable annuity account balance over the prior year, the increase in the number of variable annuity contracts in force, and the cumulative effect of growth in sales over the past few years on which the sales charge is based. Allocated investment income, or investment income earned in excess of policy requirements, was $8.6 million in 1994, a slight increase over 1993, due to the increase in deposit balance size for fixed annuities. Insurance operating income for the annuity line has grown in each of the years 1992 through 1994, increasing 19% to $14 million in 1994 and also 19% to $11.9 million in 1993. Profitability margins as measured by the mean reserve have been relatively stable, declining slightly in 1993 but increasing slightly in 1994.
- -------- *Financial services revenue includes $25.9 million in 1994, $26.2 million in 1993, and $19.7 million in 1992 representing revenues from other Torchmark segments which are eliminated in consolidation.
Financial services: Torchmark's financial services revenues increased 1% in ------------------- 1994 to $165 million from the prior-year amount of $164 million, which reflected a 7% increase over 1992. Financial services revenue consists of commission revenue derived primarily from the sale of mutual funds and other investment products, insurance, and annuity products by the W&R sales representatives. It is also comprised of asset management and service fees for mutual fund management and administration. Financial services revenues were comprised of the following at December 31, 1994: asset management fees 43%, commissions 44%, and service fees 13%.
Commission revenue from sales of investment products, which include mutual funds and variable annuity products, represented 82% of total commission revenue. The remaining source of commission revenue was from insurance product sales. Commissions from the sale of insurance products and variable annuity products are derived primarily from UILIC, and are eliminated in consolidation. Investment product commissions declined 10% to $59 million, after having risen 2% in 1993 to $66 million. Investment product sales were $1.18 billion in 1994, decreasing 5% over 1993 sales of $1.24 billion. Sales of these products climbed 10% in 1993 from $1.13 billion. Investment product sales for 1994 consisted of United Funds (75%), variable annuities (16%), and Waddell & Reed Funds (9%). Sales of the United Funds declined 5% to $939 million in 1993, and further declined 6% in 1994 to $881 million. On the other hand, sales of the Waddell & Reed Funds, which were introduced in 1992 as a deferred-load product to give investors five new mutual funds as additional investment alternatives, almost tripled to $94 million in 1993 and grew another 13% in 1994 to $107 million. W&R sales of variable annuities declined 6% in 1994 to $192 million, after experiencing a 74% increase in 1993 to $204 million. Growth in 1993 commission revenue for investment products was less than the growth in sales and the decline in 1994 commission revenue was greater than the decline in sales. These effects in both years were caused by declines in the sales of the
Commissions and selling expenses as a percentage of commission revenue were stable at 91% in both 1993 and 1992, but declined to 86% in 1994. The 1994 decline resulted from an increase in the 12-b service fee which offsets certain direct expenses. Margin improvement for financial services operations was mainly caused by a larger proportion of asset management fees to revenues than commissions to revenues in each year over the prior year. The asset management fees have a significantly higher profit margin than commission revenues.
The component of energy operations which has grown the most in the past two years was product marketing activities. These activities involve selling certain energy products which were acquired through purchase agreements with affiliated and unaffiliated parties. Net product revenues are computed after deducting the costs of the production sold from the gross marketing revenues. Net product marketing revenues grew 94% in 1994 after having gained 29% in 1993. These activities were the largest contributor to recurring energy profits in both 1993 and 1994, adding $5.5 million to pre-tax operating income in 1993 and $11.3 million in 1994.
Although producing properties were another source of energy operation profits in 1992 and 1993, production activity declined due to the sale of the previously-mentioned offshore property. Production revenues are derived from Torch Energy's participation, as a working interest owner, in properties purchased for certain institutional clients as well as drilling and workover activities in directly-owned properties. Prior to 1994, production activities generally were centered around offshore producing properties acquired from Placid Oil Company ("Placid") in 1991. These properties were sold in late 1993, resulting in the previously-mentioned $22 million gain. Depletion and direct expenses are related to production activities and declined as production declined. The interest expense reported for energy operations is also associated with producing activities, because of the cost of financing properties. The sharp decline in 1994 interest expense resulted from the 1993 property sale, although replacement properties were acquired in the amount of $24 million in 1994.
Torch Energy and its subsidiaries are also involved in asset management and well operations. Assets under management were $1.2 billion at year-end 1992 and 1993, and $1.3 billion at year-end 1994. A total of 7,500 wells were operated at December 31, 1994, compared to 1,200 at year-end 1993 and 1,800 at year-end 1992.
Torchmark's energy investments, which were valued at $331 million at December 31, 1994 and $346 million at the same date in 1993, resulted in a loss of $24 million in 1994, compared to a loss of $4 million in 1993 and a gain of $15 million in 1992. While lower gas prices were a factor in the decline in both years, the primary cause for the decrease in earnings in both years was the completion during 1993 of the Black Warrior Basin development in Alabama. This development, for which Torchmark had a total investment of $235 million at December 31, 1994, involves wells which produce methane gas from coal seam formations. Prior to 1993, during the development process, development costs including interest were capitalized. As wells were dewatered and production of gas was phased in during 1993, capitalization of costs was phased out. There was no capitalization in 1994. Therefore, rising costs were recognized during a period of time when gas prices were trending lower. The effect of the capitalization of costs resulted in a $12 million, or $.17 per share, reduction in net investment income between 1993 and 1994. Earnings from the production of methane gas in the Black Warrior Basin development are primarily derived from Federal income tax credits available estimated to be $1.00 per thousand cubic feet of gas produced for 1994 and will continue through 2003. Torchmark's tax credits are reported as a reduction of income tax expense and do not increase investment income. Credits were recognized in the amounts of $8.0 million in 1994, $10.5 million in 1993, and $2.9 million in 1992.
Torchmark made fixed-maturity acquisitions at an average tax-equivalent yield of 7.27% in 1994 compared to 6.71% in 1993 and 7.75% in 1992. Principal components of 1994 acquisitions were noncallable corporate obligations, mortgage-backed securities, and to a lesser degree, insured municipal bonds.
The rise in interest rates in 1994 caused the market value of Torchmark's fixed-maturity investments to decline, resulting in a $248 million decline in shareholders' equity, net of related taxes and deferred acquisition costs. At December 31, 1994, the book value of Torchmark's fixed maturities was $4.6 billion, compared to $4.4 billion at year-end 1993. At December 31, 1994, book value exceeded market by $242 million, compared to an excess of market over book at year-end 1993 of $192 million. Torchmark's fixed-maturities are reported at market value because they have been designated "available for sale."
- -------- (1) Latest data available from the American Council of Life Insurance
Torchmark's investment strategy continues to concentrate on high quality, medium-term, fixed income securities. At 1994 year-end, government or government-guaranteed securities totalled $2.05 billion, approximately 46% of the bond and short-term portfolio. This represents a decrease from 61% at year-end 1993 due to a reduction in holdings of GNMA securities. Despite the reduction, a substantial portion of the fixed-income portfolio was represented by U.S. Government obligations. The quality of Torchmark's portfolio is evidenced by the fact that rating agencies rated 61.3% of the fixed income portfolio "AAA" and 98.8% were considered to be investment grade.
Torchmark's mortgage-backed holdings have resulted in a bond portfolio which provides substantial cash flow but one in which the principal repayments are impacted by interest rate changes. As indicated
Because of rising rates in 1994, the average life of the investment portfolio was extended as a result of a reduction in expected prepayments of mortgage-backed holdings and the acquisition of longer-term securities. At December 31, 1994, the average life of Torchmark's investment portfolio was estimated to be 8.0 years, compared with 6.0 years at year-end 1993 and 6.1 years at year-end 1992. The year-end duration of the portfolio increased to 5.2 years from 4.2 years at year-end 1993.
On November 3, 1994, Torchmark acquired American Income for a total cash purchase price of approximately $552 million. American Income sells life insurance to union and credit union members through exclusive agents. The addition of American Income's quality line of products and low-cost operation fits well with Torchmark's strategy of growing life insurance operations in niche markets. The results of operations of American Income were consolidated with those of Torchmark after the purchase date, adding $33.1 million to Torchmark's 1994 revenues and $2.2 million or $.03 per share to net income, after deduction of charges for goodwill amortization and the cost of funds for the purchase. Funds for the purchase were provided through a $200 million preferred stock offering which is discussed in more detail in the capital resources section found on page 29 of this report, a $175 million bridge loan from a group of banks, the sale of investments available for sale, and internal cash flow.
Torchmark's cash flow has been strong and more than adequate to meet current needs. Cash provided from operations, including cash provided from deposit- product operations, was $370 million in 1994, compared to $488 million in 1993 and $554 million in 1992. In addition, Torchmark received $838 billion in 1994, $1.16 billion in 1993, and $808 million in 1992 from scheduled investment maturities as well as unscheduled GNMA and other principal repayments. Cash flow from operations and investment repayments in excess of debt service and shareholder dividends are generally invested to enhance return.
replaced a then existing $250 million credit line and the previously-mentioned $175 million bridge loan associated with the American Income purchase. The $400 million credit line is further designed as a backup credit line for a commercial paper program not to exceed $400 million, whereby Torchmark may borrow from either the credit line or issue commercial paper at any time but may not borrow in excess of a total of $400 million on the combined facilities. At December 31, 1994, $250 million was borrowed on the line of credit and no commercial paper was outstanding. A facility fee is charged on the entire $400 million balance. In accordance with the agreements, Torchmark is subject to certain covenants regarding capitalization and earnings. At December 31, 1994, Torchmark was in full compliance with these covenants.
Capital Resources: On October 11, 1994, a wholly-owned finance subsidiary of ------------------ Torchmark issued 8 million shares or $200 million face amount Cumulative Monthly Income Preferred Securities, Series A ("MIPS") at an annual dividend rate of 9.18%. These securities were issued pursuant to a registration with the Securities and Exchange Commission in January, 1994. The MIPS are subject to a mandatory redemption in full at September 30, 2024, although Torchmark may elect to extend the MIPS for up to an additional 20 years if certain conditions are met. They are redeemable at Torchmark's option after September 30, 1999. While obligated to pay dividends at a fixed rate of 9.18%, Torchmark subsequently entered into a ten-year interest-rate swap agreement with an unaffiliated party whereby Torchmark agreed to pay a variable rate on the $200 million face amount in exchange for payment of the fixed dividend. Additionally, Torchmark acquired a five-year interest-rate cap on the swap agreement that insures the variable rate cannot exceed 10.39%. At December 31, 1994, the variable rate was 7.0%. Net proceeds from the issue, which were $193 million after issue expenses, were used to acquire American Income.
In March, 1994, Torchmark acquired the remaining outstanding shares of its adjustable-rate preferred stock at its face amount of $47 million. Prior to 1994, Torchmark had acquired $53 million face amount of this stock on the open market at an aggregate cost of $48 million. These shares were retired immediately.
Shareholders' equity was $1.2 billion at December 31, 1994, a decrease of 12% when compared to the $1.4 billion at December 31, 1993. Book value per share was $17.37 at December 31, 1994, compared to $18.80 at December 31 1993. After adjusting the fixed-maturity portfolio to remove the market value fluctuation required by accounting rules, book value was $19.31 at year-end 1994, compared to $17.29 at year-end 1993, an increase of 12%. Return on common shareholders' equity was 21% in 1994, compared to 24% in 1993. Total debt as a percentage of total capitalization was 40% at December 31, 1994, compared to 41% at December 31, 1993, with the MIPS counted as equity and excluding the mark up or down of fixed investments. The multiple of earnings before interest and taxes to interest requirements was 5.9 for 1994, compared to 7.5 for 1993 and 8.0 for 1992.
Litigation: Torchmark and its subsidiaries continue to be named as parties ----------- to pending or threatened litigation, most of which involve punitive damage claims based upon allegations of agent misconduct at Liberty in Alabama. Such punitive damage claims are tried in Alabama state courts where any punitive damage litigation has the potential for significant adverse results. It is impossible to predict the extent of punitive damages that may be awarded if liability is found in any given case, since the amount of punitive damages in Alabama is left largely to the discretion of the jury in each case. While provision has been made in the financial statements for litigation costs, it is thus difficult to predict with certainty the liability of Torchmark or its subsidiaries in any given case because of the unpredictable nature of this type of litigation.
Merger with United Management: On October 1, 1993, Torchmark acquired the ------------------------------ approximately 16% of United Management that it did not already own through the payment of $31.25 per share in cash for the remaining outstanding shares. Accordingly, United Management was merged into Torchmark. Including share purchases made in 1993, the total amount of consideration paid to the remaining United Management shareholders was approximately $230 million.
Divestiture of Vesta Insurance Group: During 1993, Torchmark announced that ------------------------------------- it was considering a public offering of shares of common stock of its wholly- owned subsidiary, Vesta Insurance Group, Inc. ("Vesta"), which was at that time the holding company for Torchmark's property and casualty operations. On November 11, 1993, Vesta sold 9 million shares of common stock in a public offering of which 6.8 million shares were owned by Torchmark prior to the sale and 2.2 million were newly issued shares. Torchmark's 6.8 million shares were sold for $25 per share less expenses, amounting to proceeds of approximately $161 million and resulting in a $57 million pretax gain. After the transaction, Torchmark continued to own 3.4 million shares of Vesta outstanding common stock or approximately 27% of the company. Torchmark also loaned Vesta $28 million in December, 1993, which continued to be outstanding at December 31, 1994.
As discussed in Notes 1 and 10 to the consolidated financial statements, Torchmark changed its method of accounting for income taxes to adopt the provisions of the Financial Accounting Standards Board's Statement of Financial Accounting Standards (Statement) No. 109, Accounting for Income Taxes, in 1993. As discussed in Note 1, Torchmark adopted the provisions of the Financial Accounting Standards Board's Statement No. 115, Accounting for Certain Investments in Debt and Equity Securities at December 31, 1993. Also, as discussed in Note 11, Torchmark adopted the provisions of the Financial Accounting Standards Board's Statement No. 106, Employers' Accounting for Postretirement Benefits Other than Pensions, in 1993.
Basis of Presentation: The accompanying financial statements have been --------------------- prepared in conformity with generally accepted accounting principles ("GAAP").
Recognition of Premium Revenue and Related Expenses: Premiums for insurance --------------------------------------------------- contracts which are not defined as universal life-type according to SFAS 97 are recognized as revenue over the premium-paying period of the policy. Profits for limited-payment life insurance contracts as defined by SFAS 97 are recognized over the contract period. Premiums for universal life-type and annuity contracts are added to the policy account value, and revenues for such products are recognized as charges to the policy account value for mortality, administration, and surrenders (retrospective deposit method). Variable annuity products are also assessed an investment management fee and a sales charge. Life premium includes
Future Policy Benefits: The liability for future policy benefits for ---------------------- universal life-type products according to SFAS 97 is represented by policy account value. The liability for future policy benefits for all other life and health products is provided on the net level premium method based on estimated investment yields, mortality, morbidity, persistency and other assumptions which were appropriate at the time the policies were issued. Assumptions used are based on Torchmark's experience as adjusted to provide for possible adverse deviation. These estimates are periodically reviewed and compared with actual experience. If it is determined future experience will probably differ significantly from that previously assumed, the estimates are revised.
Property and Equipment: Property and equipment is reported at cost less ---------------------- allowances for depreciation. Depreciation is recorded primarily on the straight line method over the estimated useful lives of these assets which range from two to twenty years for equipment and two to forty years for buildings and improvements. Ordinary maintenance and repairs are charged to income as incurred.
Energy: Torchmark uses the successful-efforts method of accounting for its ------ energy operations. All costs associated with property acquisitions and development of proved oil and gas reserves are capitalized. Capitalized costs are amortized by the unit-of-production method based on estimated proved oil and gas reserves. All costs relating to production activities are charged to income as incurred. Energy properties owned by Torchmark's energy subsidiaries are accounted for as "properties" and revenue therefrom is accounted for as "energy operations revenues." Investments in oil and gas properties by Torchmark's insurance subsidiaries are accounted for as "investments" and income therefrom is accounted for as "investment income."
Treasury Stock: Torchmark accounts for purchases of treasury stock on the -------------- cost method.
Stock Split: On August 19, 1992, Torchmark distributed one share for every ----------- two shares owned by shareholders on record as of August 5, 1992 in the form of a stock dividend. The dividend was accounted for as a stock split. All prior- year share and per share data have been restated to give effect for this split.
Proceeds from sales of fixed maturities available for sale were $583 million in 1994 and $246 million in 1993. Gross gains realized on those sales were $14.6 million in 1994 and $8.3 million in 1993. Gross losses were $20.8 million in 1994 and $176 thousand in 1993. Proceeds from sales of fixed investments held to maturity were $58 million in 1993 and $403 million in 1992. Gross gains realized on those sales were $2.6 million in 1993 and $8.6 million in 1992. Gross losses on those sales were $138 thousand in 1993 and $1.7 million in 1992. The 1993 sales of fixed investments held to maturity were made for various reasons including changes in regulatory requirements, credit deterioration, and sales within 90 days of maturity.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) (DOLLAR AMOUNTS IN THOUSANDS EXCEPT PER SHARE DATA) NOTE 5--DEFERRED ACQUISITION COSTS AND VALUE OF INSURANCE PURCHASED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) (DOLLAR AMOUNTS IN THOUSANDS EXCEPT PER SHARE DATA) NOTE 7--ACQUISITIONS
On October 1, 1993, the United Management public shareholders approved Torchmark's offer to acquire the remaining approximately 17% of United Management which it did not already own for cash consideration of $31.25 per share. The transaction was completed for a total purchase price of $234 million resulting in goodwill of $126 million which will be amortized over approximately 40 years on a straight line basis. All other purchase accounting adjustments were immaterial.
For health, the morbidity assumptions are based on either Torchmark's experience or the assumptions used in calculating statutory reserves.
The overall average interest assumption for determining the liability for future life and health insurance benefits in 1994 was 6.0%.
The liability for unpaid health claims is included with "Policy claims and other benefits payable" on the Balance Sheet.
The effective income tax rate differed from the expected 35% rate in 1994 and 1993 and 34% rate in 1992 as shown below:
For the year ended December 31, 1992, deferred income tax expense of $16,062 resulted from timing differences in the recognition of revenue and expense for financial reporting versus income tax reporting. The sources and tax effect of those timing differences are presented below:
The valuation allowance for deferred tax assets as of January 1, 1994 was $- 0-. The net change in the total valuation allowance for the year ended December 31, 1993 was an increase of $2.1 million. Subsequently recognized tax benefits of $2.1 million relating to the valuation allowance for deferred tax assets as of December 31, 1994 will be allocated to goodwill.
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 $3.2 million and $1.5 million as of December 31, 1994 and 1993, respectively.
The weighted average discount rate used in determining the accumulated postretirement benefit obligation was 8.00%.
Torch Energy Advisors Incorporated ("Torch Energy"), a wholly-owned subsidiary of Torchmark, also maintains a line of credit agreement which at December 31, 1994 allowed borrowings up to $50 million. The interest rate is charged at variable rates and is based on the prime or Libor rates, and a commitment fee is charged for the unused balance. The agreement matures on January 1, 1996 and is secured by any assets acquired with the funds and by the approximately 1.5 million shares of Nuevo common stock owned by Torch Energy. There was $5 million outstanding on this line of credit at December 31, 1994.
Net proceeds from the MIPS offering of approximately $193 million were loaned from Torchmark Capital to Torchmark to provide part of the financing of the acquisition of American Income Holding, Inc. The carrying value of the MIPS at December 31, 1994 was $193 million.
Adjustable Rate Preferred Stock: One million shares of adjustable rate ------------------------------- preferred stock were issued in 1983 at an issue price of $100 per share. During 1992, Torchmark acquired 338 thousand shares of this preferred stock at a cost of $31.5 million, representing a redemption value of $33.7 million. Prior to 1992, Torchmark acquired 192 thousand shares at a cost of $16.3 million or a redemption value of $19.2 million. These shares were reported as treasury stock and had a total cost basis of $47.8 million and a total redemption value of $52.9 million. During 1994, Torchmark acquired the remaining 470 thousand shares at a cost of $100 per share plus accrued dividends. The acquisition was completed at an aggregate price of $47 million. The preferred treasury stock was immediately retired.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) (DOLLAR AMOUNTS IN THOUSANDS EXCEPT PER SHARE DATA) NOTE 14--SHAREHOLDERS' EQUITY (CONTINUED) A summary of option activity in terms of shares is as follows:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) (DOLLAR AMOUNTS IN THOUSANDS EXCEPT PER SHARE DATA) NOTE 14--SHAREHOLDERS' EQUITY (CONTINUED)
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 from operations 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 1995, $213 million will be available to Torchmark for dividends from insurance subsidiaries in compliance with statutory regulations without prior regulatory approval.
Insurance affiliates also assume insurance risks of other companies. Life reinsurance assumed represents less than 0.1% of life insurance in force at December 31, 1994 and reinsurance assumed on life and accident and health products represents 0.1% of premium income for 1994.
Moody's service or the equivalent NAIC designation). Par value of these investments was $29.8 million, amortized cost was $26.4 million, and market value was $25.5 million. While these investments could be subject to additional credit risk, such risk should generally be reflected in market value.
On October 25, 1993, a jury in the Circuit Court for Mobile County, Alabama rendered a one million dollar verdict ($1,000 actual damages) against Liberty in McAllister v. Liberty National Life Insurance Company, one of twenty-five ----------------------------------------------------- suits involving cancer policy exchanges which were filed prior to class certification in the Barbour County litigation and therefore were excluded from the Robertson class action. The McAllister decision was appealed to the ---------- Alabama Supreme Court. On February 25, 1995, the verdict was affirmed. A petition for rehearing has been filed by Liberty. Previously, another judge in the Mobile County Court had granted a summary judgment in favor of Liberty in another substantially similar suit in which no cancer claims had been submitted (Boswell v. Liberty National Life Insurance Company), which was -------------------------------------------------- appealed to the Alabama Supreme Court. On May 13, 1994, the Alabama Supreme Court reversed and remanded Boswell. The Court held the plaintiffs had alleged ------- injury or damages in the form of the additional policy premium payments and these allegations were sufficient to withstand a motion to dismiss the complaint. Following this order and pending a petition for rehearing, the Boswell case was settled. Excluding the McAllister case, no pre-class - ------- ---------- certification individual cancer exchange cases remain active, all having been settled or stayed.
As reported previously, a fairness hearing was held on January 20, 1994, in the Robertson cancer policy exchange class action. Prior to that hearing, --------- class members had been mailed notice of the hearing and the proposed settlement.
On July 5, 1994, certain intervenors in the Robertson litigation filed a --------- notice of appeal of the Order and Final Judgment approving class certification and the settlement with the Supreme Court of Alabama. The appeal is currently pending.
On March 17, 1994, litigation was filed against Liberty, a subsidiary of Torchmark, certain officers and present and former directors of Torchmark, and KPMG Peat Marwick LLP, independent public accountants of Torchmark and its subsidiaries, in the Circuit Court for Marion County, Alabama (Miles v. -------- Liberty National Life Insurance Company). The lawsuit asserts that it is - --------------------------------------- brought on behalf of a class composed of the shareholders of Torchmark. The complaint alleges a failure to timely and adequately report allegedly material contingent liabilities arising out of insurance policy litigation involving Liberty. Compensatory and punitive damages in an unspecified amount are sought.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) (DOLLAR AMOUNTS IN THOUSANDS EXCEPT PER SHARE DATA) NOTE 15--COMMITMENTS AND CONTINGENCIES (CONTINUED)
Also in July 1994, a purported class action (Bosarge v. Liberty National --------------------------- Life Insurance Company) was filed against Liberty and Torchmark in the Circuit - ---------------------- Court for Mobile County, Alabama which alleges that Liberty agents have made misrepresentations in connection with converting policyholder accounts to bank budget from other modes of premium payment. The lawsuit claims that agents have represented that insureds would receive additional "free insurance" if they changed to bank budget payment while charges for such "free insurance" were actually made through bank budget payments. Injunctive relief and unspecified actual and punitive damages are sought. No class has been certified and no proceedings of any materiality have occurred in this case. Liberty intends to vigorously defend this action.
Certain insurance company investments are managed by the asset management segment. Included in these investments are energy investments in the amount of $331 million and $346 million at December 31, 1994 and 1993, respectively. Additionally, the asset management segment markets certain insurance products for the insurance segment and manages the mutual funds for the insurance segment's variable products.
The following is a summary of quarterly results for the two years ended December 31, 1994. 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.