A subsidiary of Globe owns a 112,000 square foot facility located in Oklahoma City, Oklahoma which houses the Globe direct response operation. This subsidiary has also leased an additional 25,000 square feet on a temporary basis while a 21,000 square foot addition to its facility is constructed. The addition is scheduled to be completed in late 2012, at which time the leased space will be vacated. Globe also currently leases 37,000 square feet of space for its home office activities in downtown Oklahoma City.
American Income owns and is the sole occupant of an office building located in Waco, Texas. The building is a two-story structure containing approximately 72,000 square feet of usable floor space. American Income also owns a 43,000 square foot facility located in Waco which houses the American Income direct response operation.
(1) Includes Torchmark’s 7.1% Junior Subordinated Debentures reported as “Due to affiliates” on the Consolidated Balance Sheets at year ends 2007 through 2011 in the amount of $123.7 million.
Summary of Operations: Net income increased slightly from $517 million to $518 million in 2011. It rose 28% or $112 million in 2010, largely as a result of after-tax realized investment gains of $24 million in 2010, compared with losses of $85 million after tax in 2009. The 2009 losses included $94 million of write downs of fixed maturities which were determined to be other-than-temporarily impaired. Realized investment gains were $17 million in 2011. On a diluted per share basis, 2011 net income increased 12% to $4.72, after an increase in 2010 of 29% to $4.20.The above-mentioned after-tax realized investment gains added $.15 to 2011 net income per diluted share and $.20 per share in 2010, while the 2009 loss reduced net income $.69 per share of which the impairment writedowns accounted for $.76 of the loss. More information concerning realized investment gains and losses can be found under the caption Realized Gains and Losses in this report where there is a more complete discussion. Also, as explained in Note 14-Business Segments in the Notes to the Consolidated Financial Statements, we do not consider realized gains and losses to be a component of our core insurance operations or operating segments. Also included in 2010 results is a $35 million after tax loss on the disposal of United Investors, representing $.28 per diluted share.
While life insurance premium has grown steadily in each of the three years ending December 31, 2011, margins as a percentage of premium rose in 2011 to 28% from 27% in 2010 and 2009. Segment profits for life insurance were not only positively affected by the premium growth, but also by improvements in mortality and persistency in both periods. Life net sales declined 1% in 2011 to $325 million but rose 1% in 2010 to $330 million. Life insurance segment results are discussed further in this report under the caption Life Insurance.
We primarily market two health insurance products: Medicare Supplement insurance and the Medicare Part D prescription drug benefit. We also market limited-benefit cancer and accident health products and prior to September, 2010, an under-age-65 limited-benefit hospital-surgical product. Health premium declined 6% in 2011 to $929 million from $987 million in 2010. Health premium declined 3% in 2010. The decreases in both years were caused primarily by the de-emphasis and discontinuance of sales in 2010 of our limited-benefit hospital-surgical health product. Declines in agent counts in the distribution units that market our health products were another negative factor. These factors have caused reductions in net sales of health products which have in turn pressured premium growth. Medicare Supplement remains our largest contributor to total health premium, but increased competition has also dampened sales of this product in recent years, resulting in premium declines in each successive year. Our Medicare Part D premium declined 6% in 2011, after having increased 14% in 2010. However, enrollees into our Medicare Part D program for the plan year 2012 were 225 thousand, an increase of 56% over the 2011 enrollees. Therefore, we expect premium growth in 2012 at approximately the same rate. See the discussion under Health Insurance for a more detailed discussion of health insurance results.
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 had the effect of compressing excess investment income as required interest has grown. We have implemented certain strategies to offset this effect, including lowering the discount rate going forward and increasing premium rates on sales of new products. 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 2011 were $78 million, an increase of 3% over $75 million in 2010. This increase was primarily a result of increased charges related to our letters of credit facility. In 2010, financing costs increased 8% as interest expense on our long-term debt rose $9 million or 13%. As noted earlier, in 2009 we issued our $300 million 9 1/4% Senior Notes but repaid our $99 million 8 1/4% Senior Debentures, resulting in a higher balance of debt outstanding at a higher interest rate in 2010.
In each of the years 2011 and 2009, income from continuing operations was affected by certain significant, unusual, and nonrecurring nonoperating items. 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. As reported in Note 1-Significant Accounting Policies in the Notes to Consolidated Financial Statements under the caption Settlements, we have been involved in certain issues in 2011 or 2009 in which we either received settlements or incurred settlement losses and expenses. In 2011, we settled a state administrative matter in the pretax amount of $6.9 million ($4.5 million after tax) and accrued an estimated liability for a litigation settlement expected to settle in early 2012 in the pretax amount of $12.0 million ($7.8 million after tax). Both of these issues involved matters arising many years ago. Additionally, as described under the same caption of Note 1, we received a tax settlement in the amount of $2.9 million in 2009. The tax settlement primarily involved the results of prior year examinations. The state administrative settlement and the litigation accrual are included in “Other operating expense” and the tax settlement is an adjustment to “Income taxes” in the Consolidated Statements of Operations. However, as described in Note 1, we remove items such as these that are concerned with prior periods when evaluating the results of current operations, and therefore exclude such matters from our segment analysis for current periods.
purchases are made from excess operating cash flow when market prices are favorable. Additionally, when stock options are exercised, proceeds from these exercises and the tax benefit are used to repurchase additional shares on the open market to minimize dilution as a result of the option exercises. Due to poor economic conditions, we temporarily suspended our share repurchase program in the first quarter of 2009. However, in the first quarter of 2010, the Board of Directors reactivated 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. The following chart summarizes share purchase activity for each of the three years ended December 31, 2011, retroactively restated for the three-for-two stock split described in Note 1-Significant Accounting Policies in the Notes to Consolidated Financial Statements.
Option proceeds increased significantly in 2011 due to optionholders exercising several years of option grants that are due to expire in 2012.
Life insurance premium rose 4% to $1.73 billion in 2011 after having increased 5% in 2010 to $1.66 billion. Life insurance products are marketed through several distribution channels. Premium income by channel for each of the last three years is as follows:
Annualized life premium in force was $1.81 billion at December 31, 2011, an increase of 3% over $1.75 billion a year earlier. Annualized life premium in force was $1.69 billion at December 31, 2009.
The American Income Exclusive Agency focuses primarily on members of labor unions, but also on credit unions and other associations as well as referrals from new customers for its life insurance sales. It is Torchmark’s highest profit margin business. The American Income Agency was also the largest contributor to life premium and net sales of any Torchmark distribution method in 2011. Life premium for this agency rose 8% to $608 million in 2011, after having increased 10% in 2010. Net sales increased 3% in 2011 to $142 million, after having risen 8% in 2010. Net sales rose 18% in 2009. First-year collected premium rose 2% in 2011 to $113 million, after having increased 16% in 2010. The average face amount of policies issued in 2011 was approximately $34 thousand. As in the case of all of Torchmark’s agency distribution systems, continued increases in product sales are largely
dependent on increases in agent count. The American Income agent count was 4,381 at December 31, 2011 compared with 3,912 a year earlier, an increase of 12%. However, the agent count had declined 6% in 2010 from 4,154 a year earlier. This agency continues to recruit new agents focusing on an incentive program to reward growth in both the recruiting of new agents and in the production of new business. Additionally, the systematic, centralized internet recruiting program has enhanced the recruitment of new agents.
The Liberty National Exclusive Agency markets primarily life insurance and supplemental health insurance, focusing primarily on middle-income customers. Life premium income for this agency was $288 million in 2011, a 2% decrease compared with $295 million in 2010. Life premium for this agency declined 1% in 2010 from 2009. First-year collected premium declined 10% to $31 million in 2011, after having also declined 1% in 2010. The average face amount of policies issued in 2011 was approximately $25 thousand.
We also offer life insurance through Other Agencies consisting of the Military Agency, the United American Independent Agency, and other small miscellaneous sales agencies. The Military Agency consists of a nationwide independent agency whose sales force is comprised primarily of former military officers who have historically sold primarily to commissioned and noncommissioned military officers and their families. This business consists of whole-life products with term insurance riders. Military premium represented 11% of life premium at December 31, 2011. The United American Independent Agency represented approximately 1% of Torchmark’s total life premium at that date. This agency is focused on health insurance, with life sales being incidental.
Gross margins, as indicated by insurance underwriting margin before other income and administrative expense, rose 7% in both 2011 and 2010. The margin increased to $486 million in 2011 after rising to $455 million in 2010. As a percentage of life insurance premium, the 2011 margin rose to 28%. In the two prior years, margins were stable at 27%. Margin growth in all periods was primarily the result of premium growth. Improved mortality was also a factor in 2011.
Health Insurance. Health insurance sold by Torchmark includes primarily Medicare Supplement and Part D prescription drug coverage to enrollees in the federal Medicare program, cancer coverage, and accident coverage. All health coverage plans other than Medicare Supplement and Part D are classified here as limited-benefit plans. For several years, our primary health insurance product had been limited-benefit hospital/surgical plans. However, as previously discussed under the caption Life Insurance, these plans became subject to intense competition which resulted in decreasing agent counts, most notably in the Liberty National Exclusive Agency but also in the UA Independent Agency. In addition, these plans became less marketable due to healthcare reform developments. These factors contributed to the Company’s decisions to discontinue the marketing of these limited-benefit hospital/surgical products after September, 2010. We do continue to market the limited-benefit cancer and accident products. Since 2009, Medicare Supplement sales have exceeded those of the limited-benefit products, and represented 59% of health net sales exclusive of Medicare Part D in 2011. Medicare Supplement sales have been stronger than limited-benefit sales due in part to changes in agent counts in our health distribution groups discussed below.
Total Medicare Part D premium and health premium exclude $1.0 million in 2011, $516 thousand in 2010, and $2.5 million in 2009 of risk-sharing premium paid to the Centers for Medicare and Medicaid Services consistent with the Medicare Part D contract. This risk-sharing amount is a portion of the excess or deficiency of actual over expected claims, and therefore we view this payment as a component of policyholder benefits in our segment analysis.
The UA Independent Agency is Torchmark’s largest in terms of health premium income. This Agency is composed of independent agencies appointed with Torchmark whose size range from very large, multi-state organizations down to one-person offices. All of these agents generally sell for a number of insurance companies. Torchmark had 1,447 active producing agents at December 31, 2011 compared with 1,406 a year earlier. This agency is our largest distributor of non-Part D health insurance in terms of health net sales, representing 51% in 2011. This Agency is also our largest producer of Medicare Supplement insurance, with $270 million or 61% of our Medicare Supplement premium income in 2011. Net sales for this Agency increased 2% to $33 million in 2011, after having declined 25% in 2010 from $43 million in 2009. The greater amount of net sales in 2009 were due to increases in group Medicare Supplement sales. Group Medicare Supplement sales fluctuate greatly from period to period and do not indicate a trend. Total health premium income for the UA Independent Agency was $306 million in 2011, a 3% decline from 2010 premium of $315 million. Premium income also declined 4% in 2010. These declines in premium have resulted as new sales have not compensated for lapses.
The American Income Exclusive Agency, predominantly a life insurance distribution channel, is our third largest health insurance distributor based on premium income. Its health plans are comprised of various limited-benefit plans. Approximately 69% of the agency’s 2011 health premium was from accident policies. Sales of the plans by this Agency are generally made in conjunction with a life policy being sold to the same customer.
Medicare Part D. Torchmark, through its subsidiary United American, offers coverage under the government’s Medicare Part D plan. The Medicare Part D plan is a stand-alone prescription drug plan for Medicare beneficiaries. Part D is regulated and partially funded by the Centers for Medicare and Medicaid Services (CMS) for participating private insurers like United American. Under Part D, private carriers are the primary insurers, while CMS provides significant premium subsidies and reinsurance. Total Medicare Part D premium was $197 million in 2011, compared with $209 million in 2010, a decline of 6%. Part D premium rose 14% in 2010. Changes in Part D premium generally result from changes in the number of
Our fixed annuity balances at the end of 2011, 2010, and 2009, were $1.29 billion, $1.24 billion, and $959 million, respectively. Underwriting income was $2.3 million, $1.3 million, and $3.2 thousand in each of the years 2011, 2010, and 2009, respectively.
While the fixed annuity account balance has increased each year over the prior year, policy charges and underwriting income have fluctuated only modestly. The stability in fixed annuity policy charges has resulted as the charges consist primarily of surrender charges and are not based on account size. These charges have remained somewhat level in recent periods. 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. In each of the years presented, the spreads for fixed annuities increased over the prior year as a result of credited rate reductions on the inforce annuities. Furthermore, spreads were increased by the introduction of a new annuity form on Liberty National paper in mid-2009. The amortization of deferred acquisition costs also rose as these costs are amortized in relation to gross profits.
As mentioned in Note 1-Significant Accounting Policies in the Notes to Consolidated Financial Statements, we incurred two settlement expense issues in 2011 that related to events occurring many years ago: the settlement of a state administrative issue of $7 million and a litigation issue in the estimated amount of $12 million. In addition to these two items, we recorded two nonrecurring charges. In 2011, we sold aviation equipment at a loss of $979 thousand and in 2009, we wrote down Company-occupied real estate that was other-than-temporarily impaired in the amount of $355 thousand. While these nonrecurring expenses were included in “Operating expenses” for the respective year in the Consolidated Statements of Operations in accordance with accounting guidance, they are considered as non-operating expenses by management.
Excess investment income declined $5 million or 2% in 2011 from the prior year. Excess investment income rose $21 million or 8% in 2010. On a per diluted share basis, excess investment income rose 10% to $2.66 per share in 2011, after having risen 9% in the prior year. The favorable increases in the per share amounts relative to the changes in dollar amounts for excess investment income are a result of share purchases.
Growth in net investment income generally correlates somewhat with the growth in mean invested assets at amortized cost. With the exception of the years 2009 and 2010, growth in investment income has slightly lagged the growth in mean assets for several years. One of the primary reasons that investment income has grown at a lower rate than the growth in mean invested assets in recent years is due to the low-interest-rate environment during that period. As a result, new investments have been made at yield rates lower than the yield rates earned on securities that matured or were otherwise disposed of. Another factor that has contributed to the relatively slower growth rate of investment income is the time lag between the date proceeds from maturities and dispositions are received and the date such proceeds are reinvested. During these lags, we have held cash at lower yields. During 2009, because of the uncertainty about liquidity in the financial markets, we held significantly more cash and short-term investments than in other years. Holding this larger balance of low-yielding securities in 2009 resulted in the extremely low growth rate in income in that year, and also affected the higher growth rate in 2010 as these lower yielding cash balances were invested in 2010. The trend of lags in growth in net investment income in relation to the growth in mean invested assets is expected to continue until yields on suitable new investments exceed the portfolio yield.
Excess investment income is also impacted by financing costs. Financing costs for the investment segment primarily consist of interest on our various debt instruments and are deducted from excess investment income. The table below reconciles interest expense per the Consolidated Statements of Operations to financing costs.
However, growth in our excess investment income decreases when growth in income from the portfolio is less than that of the interest required by policy liabilities and financing costs, such as we have experienced in recent periods. In an extended low-interest-rate environment, the portfolio yield will tend to decline as we invest new money at lower long-term rates. We believe, however, the decline would be relatively slow, as only 2% to 3% of fixed maturities on average are expected to run off each year over the next five years. We also believe that the deferred acquisition costs and benefit reserve balances on our life and health business would not be impacted by an extended low-interest-rate environment. While these balances for annuities could be affected, the impact would be immaterial.
In response to the lower interest rates, we raised the new business premium rates on certain life products. The increased premiums will provide additional margin on these policies to help offset the possible future reductions in excess investment income and are not expected to have a detrimental impact on sales.
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 can not be known at the time of the investment. 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. The average life of funds invested in 2009 (to both next call and maturity) was lower than that of funds invested during 2011 and 2010 due to actions taken for statutory capital management purposes and the limited availability of longer term investments.
During the three years 2009 through 2011, we have invested primarily in investment-grade corporate bonds. Purchases in 2011 were almost entirely in these corporates. During 2009 and 2010, we acquired a significant amount of taxable municipal bonds, primarily Build America Bonds authorized by the American Recovery and Retirement Act of 2009. The investments in these municipal bonds consisted almost exclusively of general obligation bonds and revenue bonds for essential services. In assessing the creditworthiness of these bonds, we took into account a number of factors, including the geographic location of the municipalities.
but they can have a negative impact on investment income if the proceeds from the calls are reinvested in bonds that have lower yields than that of the bonds that were called. Issuer calls were $187 million in 2011, $109 million in 2010, and $181 million in 2009. The higher level of acquisitions in 2009 was primarily due to the additional cash flow available from the special sales transactions noted below.
Sales transactions. During 2009, the Company sold $703 million of fixed maturities at amortized cost, including $293 million of below- investment-grade securities. The market value for some of these securities increased significantly during the period to a level where, even though the sales price was less than amortized cost, management determined that better risk-adjusted returns could be achieved by selling rather than continuing to hold the securities. Other securities were sold at prices that produced gains to offset these losses for tax purposes. Due in large part to selling below-investment-grade securities and reinvesting the proceeds in investment-grade securities, below-investment-grade securities declined significantly as a percentage of total fixed maturities at year end 2009. The reduction in below-investment-grade securities had a positive impact on the risk-based capital position of our insurance subsidiaries at that date and thereafter.
At December 31, 2011, approximately 95% of our investments at book value were in a diversified fixed-maturity portfolio. Policy loans, which are secured by policy cash values, made up an additional 4%. The remaining balance was comprised of other investments including equity securities, mortgage loans, and other long-term and short-term investments.
At December 31, 2011, fixed maturities had a fair value of $11.9 billion, compared with $10.5 billion at December 31, 2010. At December 31, 2011, fixed maturities were in a $964 million net unrealized gain position compared with an unrealized gain position of $108 million at December 31, 2010. Approximately 77% of our fixed maturity assets at December 31, 2011 at amortized cost were corporate bonds and 11% were redeemable preferred stocks. This compares with 74% corporate bonds and 13% redeemable preferred stocks at year end 2010. On a combined basis, residential mortgage-backed securities, other asset-backed securities, and collateralized debt obligations (CDOs) were less than 2% of the assets at amortized cost at December 31, 2011. The $60 million of CDOs at amortized cost made up less than 0.6% of the assets and are backed primarily by trust preferred securities issued by banks and insurance companies. The $14 million of residential mortgage-backed securities are rated AAA. For more information about our fixed-maturity portfolio by component at December 31, 2011 and 2010, including an analysis of unrealized investment losses and a schedule of maturities, see Note 4-Investments in the Notes to Consolidated Financial Statements.
Due to the strong and stable cash flows generated by its insurance products, Torchmark has the ability to hold securities with temporary unrealized losses until recovery. Even though these fixed maturity investments are available for sale, Torchmark generally expects and intends to hold to maturity any securities which are temporarily impaired.
At December 31, 2011, approximately 32% of the fixed maturity assets at amortized cost (31% at fair value) were in the financial sector, including 16% in life and health or property casualty insurance companies and 12% in banks at amortized cost. Financial guarantors, mortgage insurers, and insurance brokers comprised approximately 4% of the portfolio. After financials, the next largest sector was utilities, which comprised 16% of the portfolio at amortized cost. The balance of the portfolio is spread among 262 issuers in a wide variety of sectors. As previously noted, gross unrealized losses were $239 million at December 31, 2011, declining from $368 million a year earlier. The portfolio was in a net unrealized gain position of $964 million at December 31, 2011.
As shown in the table above, the ratio of gross unrealized losses to book value was approximately 50% for our investments in CDOs. As previously noted, CDOs represented less than 0.6% of our fixed maturity investments at December 31, 2011. We evaluated each of the impaired securities in this and all other sectors to determine whether or not any of the impairments were other-than-temporary. Our portfolio consisted of five CDO investments at December 31, 2011, in which three were carried at a value of $0, one was considered only temporarily impaired, and one was previously considered other-than-temporarily impaired.
Investments are occasionally sold or called, resulting in a realized gain or loss. These gains and losses occur only incidentally, usually as the result of sales because of deterioration in investment quality of issuers or calls by the issuers. Investment losses are also caused by writedowns 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 in the Notes to Consolidated Financial Statements, we wrote certain securities down to fair value during each year 2009 through 2011 as a result of other-than-temporary impairment. The impaired securities met our criteria for other-than-temporary impairment as discussed in Note 4 and in our Critical Accounting Policies in this report. The writedowns resulted in pretax charges of $20 thousand in 2011 ($13 thousand after tax), $5 million in 2010 ($3 million after tax), and $143 million in 2009 ($94 million after tax). The 2009 charge included $83 million on CDOs ($55 million after tax) and $24 million on monoline financial guarantors and mortgage insurers ($16 million after tax). The remaining writedowns in 2009 were from losses on a variety of corporate bonds. In 2010, we acquired $7.3 million book value of our 9 1/4% Senior Notes at a cost of $8.9 million, resulting in an after-tax loss on debt redemption of $1.1 million.
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. The leading source of the excess cash is investment income. However, due to our high underwriting margins and effective expense control, a significant portion of the excess cash comes from underwriting income.
The following table presents certain information about our short-term borrowings, all of which was commercial paper.
In summary, Torchmark expects to have readily available funds for 2012 and the foreseeable future to conduct its operations and to maintain target capital ratios in the insurance subsidiaries through internally generated cash flow and the credit facility. In the unlikely event that more liquidity is needed, the Company could generate additional funds through multiple sources including, but not limited to, the issuance of additional debt, a short-term credit facility, and intercompany borrowing.
Our cash and short-term investments were $105 million at year-end 2011 and $582 million at year-end 2010. Included in cash at December 31, 2010 was the $343 million of proceeds received from the sale of United Investors on that date. Additionally, we have a portfolio of marketable fixed and equity securities that are available for sale in the event of an unexpected need. These securities had a fair value of $11.9 billion at December 31, 2011. 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.
Off-Balance Sheet Arrangements. As described in Note 11-Debt in the Notes to the Consolidated Financial Statements and under the subcaption Funded Debt, Torchmark had outstanding $120 million (par amount) 7.1% Trust Preferred Securities at both December 31, 2011 and 2010. The capital trust liable for these securities is the legal entity which is responsible for the securities and facilitates the payment of dividends to shareholders. As described in Note 15-Commitments and Contingencies in the Notes to Consolidated Financial Statements, we have guaranteed the performance of the capital trust to meet its financial obligations to the Trust Preferred shareholders. The trust is an off-balance sheet arrangement which we are required to deconsolidate in accordance with GAAP rules, because the capital trust is considered to be a variable interest entity in which we have no variable interest. While these liabilities are not on our Consolidated Balance Sheets, they are represented by Torchmark’s 7.1% Junior Subordinated Debentures due to the trust in the amount of $124 million which is on our balance sheets at both December 31, 2011 and 2010. The 7.1% preferred dividends due to the preferred shareholders are funded by our 7.1% interest payment on our debt to the trusts.
As a part of its above-mentioned credit facility, Torchmark had outstanding $198 million in stand-by letters of credit at December 31, 2011. However, these letters are issued among our subsidiaries and have no impact on company obligations as a whole.
As of December 31, 2011, we had no other significant unconsolidated affiliates and no guarantees of the obligations of third-party entities other than as described above. All of our guarantees, other than the Trust Preferred guarantee, 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, 2011.
(4) Future insurance obligations consist primarily of estimated future contingent benefit payments on policies in force at December 31, 2011. 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 $9.6 billion at December 31, 2011, along with future premiums and investment income, will be sufficient to fund all future insurance obligations.
The carrying value of the funded debt was $914 million at December 31, 2011, compared with $913 million a year earlier. As fully explained in Note 11-Debt, we issued $300 million principal amount of 9¼% Senior Notes due in 2019 in June of 2009 for proceeds of $296 million. A portion of these proceeds were used to repay the $99 million due upon the August, 2009 maturity of our 8¼% Senior Debentures. In addition, we also used $175 million to strengthen the capital position of certain of our insurance subsidiaries in 2009 in the form of capital contributions and surplus notes. The regulatory capital positions of these subsidiaries had been negatively affected by rating-agency downgrades of bonds in their investment portfolios. The subsidiaries in turn invested these funds in investment-grade fixed maturities.
Our insurance subsidiaries generally target a capital ratio of at least 325% of required regulatory capital under Risk-Based Capital (RBC), a formula designed by insurance regulatory authorities to monitor the adequacy of capital. The 325% target is considered sufficient for the subsidiaries because of their strong reliable cash flows, the relatively low risk of their product mix, and because that ratio is in line with rating agency expectations for Torchmark. At December 31, 2011, our insurance subsidiaries in the aggregate had RBC ratios of approximately 336%. Should we experience additional impairments and ratings downgrades in the future that cause the ratio to fall below 325%, management has more than sufficient liquidity at the Parent Company to make additional contributions as necessary to maintain the ratios at or above 325%.
*** Torchmark’s debt covenants require that the effect of the accounting rule requiring revaluation be removed to determine this ratio. This ratio is computed by dividing total debt by the sum of debt and shareholders’ equity.
Previously, the FASB issued guidance which offered an option which, if elected, would permit us to value our interest-bearing policy liabilities and debt at fair value in our Consolidated Balance Sheets. However, unlike current accounting rules which permit us to account for changes in our available-for-sale bond portfolio through other comprehensive income, the new rule requires such changes to be recorded in earnings. Because both the size and duration of the investment portfolio do not match those attributes of our policyholder liabilities and debt, the impact on earnings could be very significant and volatile, causing reported earnings not to be reflective of core results. Therefore, we have not elected this option.
During the three year period ended December 31, 2011, each of the rating agencies revised the outlook for Torchmark from stable to negative and then back to stable. Reasons cited for the negative outlook included increased risk in our investment portfolio, tighter liquidity, and reduced financial flexibility. Reasons cited for the revision back to a stable outlook included improved financial flexibility, increased capital levels at the insurance subsidiaries, the decrease in unrealized losses, and strong operating performance.
A.M. Best states that it assigns an A+ (Superior) rating to those companies which, in its opinion, have demonstrated superior overall performance when compared to the norms of the life/health insurance industry. A+ (Superior) companies have a superior ability to meet their obligations to policyholders over a long period of time.
The AA financial strength rating category is assigned by Standard & Poor’s Corporation to those insurers which have very strong financial security characteristics, differing only slightly from those rated higher. The minus sign (-) shows the relative standing within the major rating category.
Comprehensive Income (ASU 2011-05). Under this guidance, the components of comprehensive income must be presented as either 1) a continuous statement (including the components of net income) or 2) as two separate but consecutive statements (an income statement followed by a comprehensive income statement). This guidance is effective for us in interim and annual periods beginning in 2012. Because we already present comprehensive income as contemplated by the second alternative, this guidance should not result in any change.
Fair Value Measurement and Disclosure (ASU 2011-04). The primary purpose of this new guidance is to converge the measurement criteria and disclosures of fair value in U.S. GAAP with those of International Accounting Standards. The measurement principles are generally consistent with current U.S. GAAP and are not expected to have a material impact on our financial statements. The guidance will require additional disclosures, including expanded disclosures for fair value measurements categorized in Level 3 of the fair value hierarchy and a requirement to disclose the level in the fair value hierarchy of items whose fair value is disclosed but not measured at fair value on the balance sheet. The guidance is effective for us in calendar 2012, with early adoption prohibited.
Future Policy Benefits. Because of the long-term nature of insurance contracts, our insurance companies are liable for policy benefit payments that will be made in the future. The liability for future policy benefits is determined by standard actuarial procedures common to the life insurance industry. The accounting policies for determining this liability are disclosed in Note 1-Significant Accounting Policies in the Notes to Consolidated Financial Statements. A list of the significant assumptions used to calculate the liability for future policy benefits is reported in Note 6-Future Policy Benefit Reserves.
Approximately 98% of our recorded amounts for deferred acquisition costs at December 31, 2011 were related to traditional products and are being amortized over the premium-paying period in proportion to the present value of actual historic and estimated future gross premiums. The projection assumptions for this business are set at the time of contract issue. These assumptions are “locked-in” at that time and, except where there is a loss recognition issue, are not revised for the lifetime of the contracts. Absent a premium deficiency, variability in amortization after policy issuance is caused only by variability in premium volume. We have not recorded a deferred acquisition cost loss recognition event for assets related to this business for any period in the three years ended December 31, 2011.
The remaining 2% 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. As noted earlier in this report, our variable annuity block was disposed of as of December 31, 2010. 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, 2011.
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 4-Investments under the caption Fair Value Measurements.
Impairment of Investments. We continually monitor our investment portfolio for investments that have become impaired in value, where fair value has declined below carrying value. While the values of the investments in our portfolio constantly fluctuate due to market conditions, an other-than-temporary impairment charge is recorded only when a security has experienced a decline in fair market value which is deemed to be other than temporary. The policies and procedures that we use to evaluate and account for impairments of investments are disclosed in Note 1-Significant Accounting Policies and Note 4-Investments in the Notes to Consolidated Financial Statements and the discussions under the captions Investments and Realized Gains and Losses in this report. While every effort is made to make the best estimate of status and value with the information available regarding an other-than-temporary impairment, it is difficult to predict the future prospects of a distressed or impaired security.
Readers are also directed to consider other risks and uncertainties described in our other documents on file with the Securities and Exchange Commission.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Torchmark’s internal control over financial reporting as of December 31, 2011, based on the criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 28, 2012 expressed an unqualified opinion on Torchmark’s internal control over financial reporting.
Per share amounts have been retroactively adjusted for stock split described in Note 1.
Amounts have been retroactively adjusted for stock split described in Note 1.
Torchmark accounts for its variable interest entities under accounting guidance which clarifies the definition of a variable interest and the instructions for consolidating variable interest entities (VIE’s). Only primary beneficiaries are required or allowed to consolidate VIE’s. Therefore, a company may have voting control of a VIE, but if it is not the primary beneficiary of the VIE, it is not permitted to consolidate the VIE. The trust that is liable for Torchmark’s Trust Preferred Securities meets the definition of a VIE. However, Torchmark is not the primary beneficiary of this entity because its interest is not variable. Therefore, Torchmark is not permitted to consolidate its interest, even though it owns 100% of the voting equity of the trust and guarantees its performance. For this reason, Torchmark reports its 7.1% Junior Subordinated Debentures due to the trust as “Due to affiliates” each period at its carrying value. However, Torchmark views the Trust Preferred Securities as it does any other debt offering and consolidates the trust in its segment analysis because GAAP requires that the segment analysis be reported as management views its operations and financial condition.
When a component of Torchmark’s business is sold or expected to be sold during the ensuing year, Torchmark reports the assets and liabilities of the component as assets and liabilities of subsidiaries held for sale. Assets or liabilities of subsidiaries held for sale are segregated and are recorded in the Consolidated Balance Sheets at the lower of the carrying amount or estimated fair value less cost to sell. If the carrying amount of the business exceeds its estimated fair value, a loss is recognized. Torchmark reports the results of operations of a business as discontinued operations when the component is sold or expected to be sold, the operations and cash flows of the business have been or will be eliminated from the ongoing operations as a result of the disposal transaction, and Torchmark will not have any significant continuing involvement in the operations of the business after the disposal transaction. The results of discontinued operations are reported in discontinued operations in the Consolidated Statements of Operations for current and prior periods commencing in the period in which the business is either disposed of or is accounted for as a disposal group, including any gain or loss recognized on the sale or adjustment of the carrying amount to fair value less cost to sell. Major components of the income from
Fair Value Measurements: Fair values for cash, short-term investments, short-term debt, receivables and payables approximate carrying value. Fair values for long-term debt investments, equity securities, and certain other assets are determined in accordance with specific accounting guidance. Fair values are based on quoted market prices, where available. Otherwise, fair values are based on quoted market prices of comparable instruments in active markets, quotes in inactive markets, or other observable criteria. For specific information regarding Torchmark’s measurements and procedures in valuing financial instruments, please see Note 4-Investments under the caption Fair value measurements. The fair values of Torchmark’s long-term debt issues, along with the trust preferred securities, are based on quoted market prices. Mortgage loans are valued at discounted cash flows.
Impairment of Investments: Torchmark evaluates securities for other-than-temporary impairment as described in Note 4-Investments under the caption Other-than-temporary-impairments. If a security is determined to be other-than-temporarily impaired, the cost basis of the security is written down to fair value and is treated as a realized loss. The written-down security will be amortized and revenue recognized in accordance with estimated future cash flows.
Recognition of Premium Revenue and Related Expenses: Premium income for traditional long-duration life and health insurance products is recognized when due from the policyholder. Premiums for short-duration health contracts are recognized as revenue over the contract period in proportion to the insurance protection provided. Profits for limited-payment life insurance contracts 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). Life premium includes policy charges of $24 million, $26 million, and $28 million for the years ended December 31, 2011, 2010, and 2009, respectively. Other premium consists of annuity policy charges in each year. Profits are also earned to the extent that investment income exceeds policy liability interest requirements. The related benefits and expenses are matched with revenues by means of the provision of future policy benefits and the amortization of deferred acquisition costs in a manner which recognizes profits as they are earned over the same period.
Deferred Acquisition Costs: The costs of acquiring new business are generally deferred and recorded as an asset. Deferred acquisition costs consist primarily of sales commissions and other underwriting costs of new insurance sales. Deferred acquisition costs 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. Limited-payment contracts are amortized over the contract period. 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. Deferred acquisition costs are subject to periodic recoverability and loss recognition testing to determine if there is a premium deficiency. These tests ensure that the present value of future contract-related cash flows will support the capitalized deferred acquisition cost 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.
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 two to ten years for equipment and five to forty years for buildings and improvements. Ordinary maintenance and repairs are charged to income as incurred. Impairments, if any, are recorded when, based on events and circumstances, it becomes evident that the fair value of the asset is less than its carrying amount. Original cost of property and equipment was $119 million at both December 31, 2011 and 2010. Accumulated depreciation was $71 million at year end 2011 and $65 million at the end of 2010. Depreciation expense was $6.8 million in 2011, $6.0 million in 2010, and $4.6 million in 2009.
Low-Income Housing Tax Credit Interests: As of December 31, 2011, Torchmark had $293 million invested in limited partnerships that provide low-income housing tax credits and other related Federal income tax and state premium tax benefits to Torchmark. The carrying value of Torchmark’s investment in these entities was $283 million at December 31, 2010. As of December 31, 2011, Torchmark was obligated under future commitments of $109 million, which amount is included in the above carrying value. Interests for which the return has been guaranteed by unrelated third-parties are accounted for using the effective-yield method. The remaining interests are accounted for using the amortized-cost method.
Torchmark has tested its goodwill annually in each of the years 2009 through 2011. These tests involved assigning carrying value by allocating the Company’s net assets to each of the reporting units of Torchmark’s segments, including the portion of goodwill assigned to the unit. The fair value of each reporting unit is determined using discounted expected cash flows associated with that unit. 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, which management believes to be appropriate for the risk associated with the cash flow expectations. The fair value of each reporting unit is then measured against that reporting unit’s corresponding carrying value. Because the estimated fair value exceeded the carrying value, including goodwill, of each reporting unit in each period, Torchmark’s goodwill was not impaired in any of those periods.
Settlements: During 2011, Torchmark settled a state administrative matter involving issues arising over a period of many years. The settlement resulted in a pre-tax charge of $6.9 million ($4.5 million after tax). Additionally in 2011, the Company accrued an estimated liability for settlement of an insurance litigation matter expected to settle in 2012. The liability for this litigation, which arose many years ago, was estimated to be $12.0 million pretax ($7.8 million after tax). Please refer to Note 15-Commitments and Contingencies in the Notes to Consolidated Financial Statements for a discussion of the litigation settlement. In 2009, Torchmark recorded a $2.9 million tax settlement primarily resulting from the favorable settlements of U.S. Federal income tax issues that related to prior tax years. More information on this tax settlement is provided in Note 8-Income Taxes. Management removes items that are related to prior periods when evaluating the operating results of current periods. Therefore, these items are excluded in its presentation of segment results as disclosed in Note 14-Business Segments, because accounting guidance requires that operating segment results be presented as management views its business.
Unadopted Accounting Guidance: The FASB has adopted new guidance concerning policy acquisition costs (ASU 2010-26). This accounting guidance amends the accounting for costs associated with acquiring or renewing insurance contracts in order to address the diversity in practice surrounding the capitalization and deferral of these costs. This guidance will be effective for Torchmark beginning January 1, 2012. As a result of this new standard, certain costs that have been deferred and amortized through deferred acquisition costs will no longer be allowed to be deferred and will be expensed as incurred. The new guidance limits the deferral of costs to those incremental costs related only to the successful issuance of an insurance contract. Previously, the Company was allowed to defer any cost that varied with and related to the production of new business. For Torchmark, these costs that are no longer deferrable primarily relate to our agent distribution systems, and include such costs as training, recruiting, office space, and certain management and underwriting expenses. The new guidance further limits the deferral of certain advertising costs associated with the Direct Response operation. Torchmark will adopt retroactively, meaning the deferred acquisition cost will be written down to a level as if the new guidance had been in effect in prior periods. Going forward, the reduction in deferrals will cause commissions and expenses to increase. However, as a result of the retroactive writedown, the amortization of previously deferred acquisition costs will decrease, greatly offsetting the impact of the increased expenses. The Company currently expects it to reduce the deferred acquisition cost asset approximately 16%, total assets approximately 3%, and shareholders’ equity approximately 10% at the time of adoption. Torchmark also expects it will reduce 2012 earnings and earnings per share less than 2%. The adoption of this guidance will delay the recognition of underwriting margin on newly issued business, but not the ultimate profitability of that business. It will have no impact on cash flows, liquidity, or statutory earnings.
A schedule of fixed maturities by contractual maturity at December 31, 2011 is shown below on an amortized cost basis and on a fair value basis. Actual maturities could differ from contractual maturities due to call or prepayment provisions.
Fair value measurements: Torchmark measures the fair value of its financial assets based on a hierarchy consisting of three levels which indicate the quality of the fair value measurements as described below:
The great majority of the Company’s fixed maturities are not actively traded and direct quotes are not generally available. Management therefore determines the fair values of these securities after consideration of data provided by third-party pricing services and independent broker/dealers. Over 99% of the fair value reported at December 31, 2011 was determined using data provided by third-party pricing services. Prices provided by third-party pricing services are not binding offers but are estimated exit values. They are based on observable market data inputs which can vary by security type. Such inputs include benchmark yields, available trades, broker/dealer quotes, issuer spreads, benchmark securities, bids, offers, and other market data. As part of the Company’s controls over pricing, management reviews and analyzes all prices obtained to insure the reasonableness of the values, taking all available information into account. One very important control is the corroboration of prices obtained from third-party sources against other independent sources. When corroborated prices produce small variations, the close correlation indicates observable inputs, and the median value is used. When corroborated prices present greater variations, additional analysis is required to determine which value is the most appropriate. When only one price is available, management evaluates observable inputs and performs additional analysis to confirm that the price is appropriate. All fair value measurements based on prices determined with observable market data are reported as Level 1 or Level 2 measurements.
When the standard deviation is 3% or greater, or the Company cannot obtain three quotes, then additional information and management judgment are required to establish the fair value. The measurement is then classified as Level 3. The Company uses information and valuation techniques deemed appropriate for determining the point within the range of reasonable fair value estimates that is most representative of fair value under current market conditions. As of December 31, 2011 and 2010, fair value measurements classified as Level 3 represented 0.4% and 1.0%, respectively, of total fixed maturities and equity securities.
While all available information is taken into account, it is difficult to predict the ultimately recoverable amount of a distressed or impaired security.
As of year end 2011, previously written down securities remaining in the portfolio were carried at a fair value of $22.6 million. Otherwise, as of December 31, 2011, Torchmark has no information available to cause it to believe that any of its investments are other-than-temporarily impaired. Torchmark has the ability and intent to hold these investments to recovery, and does not intend to sell nor expects to be required to sell its other impaired securities.
Bifurcated credit losses result when there is an other-than-temporary impairment for which a portion of the loss is recognized in other comprehensive income. Torchmark’s balances related to bifurcated credit loss positions included in other comprehensive income were $22 million at December 31, 2011, December 31, 2010, and December 31, 2009. There was no change in this balance since December 31, 2009, the year the balance initially arose.
The estimated fair value of mortgage loans, based on discounted cash flows, was approximately $0.6 million at December 31, 2011 and $14.3 million at December 31, 2010. Accumulated depreciation on investment real estate was $1.8 million at both December 31, 2011 and 2010.
For individual life, the mortality tables used are various statutory mortality tables and modifications of:
Torchmark has net operating loss carryforwards of approximately $21 million at December 31, 2011 which will begin to expire in 2025 if not otherwise used to offset future taxable income. A valuation allowance is to be provided when it is more likely than not that deferred tax assets will not be realized by the Company. No valuation allowance has been recorded relating to Torchmark’s deferred tax assets since, in management’s judgment, Torchmark will more likely than not have sufficient taxable income in future periods to fully realize its existing deferred tax assets.
Torchmark’s tax liability is adjusted to include the provision for uncertain tax positions taken or expected to be taken in a tax return. A reconciliation of the beginning and ending amount of unrecognized tax benefits (excluding effects of accrued interest, net of Federal tax benefits) for the years 2009 through 2011 is as follows:
Torchmark has a Supplemental Executive Retirement Plan (SERP), which 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. The SERP is unfunded. However, life insurance policies on the lives of plan participants have been established for this plan with an unaffiliated insurance carrier. The premiums for this coverage paid in 2011 was $3.9 million and in 2010 was $1.7 million. The cash value of these policies at December 31, 2011 was $16 million and was $12 million a year earlier. Additionally, a Rabbi Trust was established for this plan in 2010 in the amount of $21 million to support the liability for this plan. An additional deposit of $5 million was added to this trust in 2011 and an investment account was established. As of December 31, 2011, the combined value of the insurance policies and the trust investments was $43 million. Because this plan is unqualified, the Rabbi Trust and the policyholder value of these policies are not included as defined benefit plan assets but as assets of the Company. The liability for this SERP at December 31, 2011 was $47 million and was $38 million a year earlier.
An analysis of the impact on other comprehensive income (loss) concerning pensions is as follows:
Torchmark has estimated its expected pension benefits to be paid over the next ten years as of December 31, 2011. These estimates use the same assumptions that measure the benefit obligation at December 31, 2011, taking estimated future employee service into account. Those estimated benefits are as follows:
The following table presents information about the terms and outstanding balances of Torchmark’s debt.
(1) All securities other than the Junior Subordinated Debentures have equal priority with one another.
The amount of debt that becomes due during each of the next five years is: 2012-$225 million; 2013-$94 million; 2014-$0; 2015-$0; 2016-$250 million and thereafter-$582 million.
Torchmark carries its 7.1% Junior Subordinated Debentures due to Trust III as a liability under the caption “Due to Affiliates” on its Consolidated Balance Sheets. Expenses related to the offering reduce long-term debt and are amortized over the forty-year redemption period.
On June 30, 2009, Torchmark issued $300 million principal amount of 9.25% Senior Notes due June 15, 2019. Interest on the Notes is payable semi-annually commencing on December 15, 2009. Proceeds from the issuance of this debt, net of expenses, were $296 million. The Notes are redeemable by Torchmark in whole or in part at any time subject to a “make-whole” premium, whereby the Company would be required to pay the greater of the full principal amount of the Notes or otherwise the present value of the remaining repayment schedule of the Notes discounted at a rate of interest equivalent to the rate of a United States Treasury security of comparable term plus a spread of 75 basis points. Torchmark used a portion of the net proceeds from this offering to repay its $99 million 8 1/4% Senior Debentures which matured on August 15, 2009 (plus accrued interest). Remaining funds were invested.
During 2010, Torchmark acquired $7.4 million par value of its 9 1/4% Senior Notes ($7.3 million book value) at a cost of $8.9 million. This repurchase resulted in a pre-tax loss of $1.6 million ($1.1 million after tax).
Acquisition of Common Shares: Torchmark shares are acquired from time to time through open market purchases under the Torchmark stock repurchase program when it is believed to be the best use of Torchmark’s excess cash flows. Torchmark suspended its share repurchase program temporarily from the first quarter of 2009 until the first quarter of 2010 because of uncertain economic conditions. Share repurchases under this program were 18.9 million shares at a cost of $788 million in 2011, 5.7 million shares at a cost of $204 million in 2010, and 3.1 million shares at a cost of $47 million in 2009. When stock options are exercised, proceeds from the exercises are generally used to repurchase approximately the number of shares available with those funds in order to reduce dilution. Shares repurchased for dilution purposes were 4.4 million shares at a cost of $185 million in 2011, 1.1 million shares at a cost of $42 million in 2010, and 30 thousand shares at a cost of $869 thousand in 2009.
Retirement of Treasury Stock: Torchmark retired 7.5 million shares of treasury stock in 2011, 6 million in 2010, and 3 million in 2009.
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. Dividends from insurance subsidiaries of Torchmark are limited to the greater of prior year statutory net income excluding realized capital gains on an annual noncumulative basis, or 10% of prior year surplus, in the absence of special regulatory approval. Additionally, insurance company distributions are generally not permitted in excess of statutory surplus. Subsidiaries are also subject to certain minimum capital requirements. In 2011, subsidiaries of Torchmark paid $769 million in dividends to the parent company, including $305 million available from the proceeds from the sale of United Investors. During 2012, a maximum amount of $470 million is expected to be available to Torchmark in dividends and transfers from subsidiaries without regulatory approval.
A summary of stock compensation activity for each of the years in the three years ended December 31, 2011 is presented below:
An analysis of option activity for each of the three years ended December 31, 2011 is as follows:
A summary of restricted stock and restricted stock units granted during each of the years in the three year period ended December 31, 2011 is presented in the table below. Restricted stock holders are entitled to dividends on the stock and holders of restricted stock units are entitled to dividend equivalents. Executive grants vest over five years and director grants vest over six months.
Restricted stock units outstanding at each of the year ends 2011, 2010, and 2009, were 42,938, 29,872, and 14,426, respectively. Restricted stock units are only available to directors, and are not converted to shares until the director’s retirement, death, or disability. There were no unvested director restricted shares outstanding at the end of any of the years 2009 through 2011. Director restricted stock and restricted stock units are generally granted on the first working day of the year and vest in six months. Dividend equivalents are earned on restricted stock units only. They are granted in the form of additional restricted stock units and vest immediately upon grant.
The following table summarizes information about stock options outstanding at December 31, 2011.
Low-Income Housing Tax Credit Interests: As described in Note 1, Torchmark has $293 million invested in entities which provide certain tax benefits. As of December 31, 2011, Torchmark remained obligated under these commitments for $109 million, of which $85 million is due in 2012, $21 million in 2013, $2 million in 2014, and $1 million thereafter.
Letters of Credit: Torchmark has guaranteed letters of credit in connection with its credit facility with a group of banks. The letters of credit were issued by TMK Re, Ltd., a wholly-owned subsidiary, to secure TMK Re, Ltd.’s obligation for claims on certain policies reinsured by TMK Re, Ltd. that were sold by other Torchmark insurance companies. These letters of credit facilitate TMK Re, Ltd.’s ability to reinsure the business of Torchmark’s insurance carriers. The agreement expires in 2015. The maximum amount of letters of credit available is $250 million. Torchmark (parent company) would be liable to the extent that TMK Re, Ltd. does not pay the reinsured party. At December 31, 2011, $198 million of letters of credit were outstanding.
Equipment leases: Torchmark has guaranteed performance of a subsidiary as lessee under two leasing arrangements for aviation equipment. One of the leases commenced in 2003 for a lease term of approximately 10 years and the other was entered into in 2009 also for 10 years. Torchmark has certain renewal and early termination options under the first lease. At December 31, 2011, total remaining undiscounted payments under the leases were approximately $8 million. Torchmark (parent company) would be responsible for any subsidiary obligation in the event the subsidiary did not make payments or otherwise perform under the terms of the lease.
As previously disclosed in filings with the Securities and Exchange Commission (SEC), United American was named as a defendant in purported class action litigation originally filed on September 16, 2004, in the Circuit Court of Saline County, Arkansas on behalf of the Arkansas purchasers of association group health insurance policies or certificates issued by United American through Heartland Alliance of America Association and Farm & Ranch Healthcare, Inc. (Smith and Ivie v. Collingsworth, et al., CV2004-742-2). The plaintiffs asserted claims for fraudulent concealment, breach of contract, common law liability for non-disclosure, breach of fiduciary duties, civil conspiracy, unjust enrichment, violation of the Arkansas Deceptive Trade Practices Act, and violation of Arkansas law and the rules and regulations of the Arkansas Insurance Department. Declaratory, injunctive and equitable relief, as well as actual and punitive damages were sought by the plaintiffs. On September 7, 2005, the plaintiffs amended their complaint to assert a nation-wide class, defined as all United American insureds who simultaneously purchased both an individual Hospital and Surgical Expense health insurance policy (Form HSXC) and an individual supplemental term life insurance policy (Form RT85) from Farm & Ranch through Heartland. Defendants removed this litigation to the United States District Court for the Western District of Arkansas (No. 4:05-cv-1382) but that Court remanded the litigation back to the state court on plaintiffs’ motion. On July 22, 2008, the plaintiffs filed a second amended complaint, asserting a class defined as “all persons who, between January 1998 and the present, were residents of Arkansas, California, Georgia, Louisiana or Texas, and purchased through Farm & Ranch: (1) a health insurance policy issued by United American known as Flexguard Plan, CS-1 Common Sense Plan, GSP Good Sense Plan, SHXC Surgical & Hospital Expense Policy, HSXC 7500 Hospital/Surgical Plan, MMXC Hospital/Surgical Plan, SMXC Surgical/Medical Expense Plan and/or SSXC Surgical Safeguard Expense Plan, and (ii) a membership in Heartland.” Plaintiffs assert claims for breach of contract, violation of Arkansas Deceptive Trade Practices Act and/or applicable consumer protection laws in other states, unjust enrichment, and common law fraud. Plaintiffs seek actual, compensatory, statutory and punitive damages, equitable and declaratory relief. On September 8, 2009, the Saline County Circuit Court granted the plaintiff’s motion certifying the class. On October 7, 2009, United American filed its notice of appeal of the class certification and subsequently filed its appellate brief on April 8, 2010. On December 2, 2010, the Arkansas Supreme Court affirmed the lower court’s decision to certify the class. On January 6, 2012, the parties agreed in
On March 15, 2011, purported class action litigation was filed against American Income and Torchmark in the District Court for the Northern District of Ohio (Fitzhugh v. American Income Life Insurance Company and Torchmark Corporation, Case No. 1:11-cv-00533). The plaintiff, a formerly independently contracted American Income agent, alleges that American Income intentionally misclassified its agents as independent contractors rather than as employees in order to escape minimum wage and overtime requirements of the Fair Labor Standards Act, as well as to avoid payroll taxes, workers compensation premiums and other benefits required to be provided by employers. Monetary damages in the amount of unpaid compensation plus liquidated damages and/or prejudgment interest as well as injunctive and/or declaratory relief is sought by the plaintiff on behalf of the purported class. On November 3, 2011, the Court granted American Income’s motion to compel arbitration and dismissed the case. Plaintiffs have appealed this decision.
Torchmark subsidiary, United American was named as defendant in purported class action litigation filed on May 31, 2011 in Cross County Arkansas Circuit Court (Kennedy v. United American Insurance Company (Case # CV-2011-84-5). In the litigation, filed on behalf of a proposed nationwide class of owners of certain limited hospital and surgical expense benefit policies from United American, the plaintiff alleged that United American breached the policy by failing and/or refusing to pay benefits for the total number of days an insured is confined to a hospital and by limiting payment to the number of days for which there are incurred hospital room charges rather than also including benefits for services and supplies. Claims for unjust enrichment, breach of contract, bad faith refusal to pay first party benefits, breach of the implied duty of good faith and fair dealing, bad faith, and violation of the Arkansas Deceptive Trade Practices Act were initially asserted. The plaintiff sought declaratory relief, restitution and/or monetary damages, punitive damages, costs and attorneys fees. In September 2011, the plaintiff dismissed all causes of action, except for the breach of contract claim.