Globe leases a 30,300 square foot office area in the City Place Tower building located in downtown Oklahoma City, Oklahoma. Globe also leases 11,000 square feet at a nearby facility used for storage. Globe Marketing Services, a subsidiary of Globe, owns a 133,000 square foot facility in Oklahoma City which houses the Globe Life Direct Response operation.
American Income owns and is the sole occupant of an office building located in Waco, Texas. The two-floored building contains 70,000 square feet. American Income also has leased 10,800 square feet in a building across the street from the main office building. American Income Marketing Services, a subsidiary of American Income, owns a 43,000 square foot facility located in Waco, Texas, housing American Income’s direct response operation. American Income also leases office space throughout the United States to support its marketing operations.
Family Heritage owns 50% of a partnership that owns an approximate 66,000 square foot building in Broadview Heights, Ohio (a suburb of Cleveland), serving as Family Heritage’s headquarters. The partnership also leases a portion of the building to unrelated tenants.
Note: Certain balances were retrospectively adjusted to give effect to the discontinued continued operations presentation as described in Note 6-Discontinued Operations.
(1) Net investment income retrospectively adjusted to give effect to the adoption of new accounting guidance as described in Note 1- Significant Accounting Policies under the caption "Low-Income Housing Tax Credit Interests."
(2) At December 31, 2012, cash and invested assets included $615 million, total assets included $869 million, annualized life premium in force included $949 thousand, and annualized health premium in force included $188 million, representing the business acquired in the acquisition of Family Heritage in 2012.
(3) Includes Torchmark's 7.1% Junior Subordinated Debentures reported as "Due to affiliates" on the Consolidated Balance Sheet at year end 2011 in the amount of $123.7 million.
The tables in Note 14-Business Segments in the Notes to the Consolidated Financial Statements reconcile Torchmark’s revenues and expenses by segment to its major income statement line items for each of the years in the three-year period ended December 31, 2015. Additionally, this Note provides a summary of the profitability measures that demonstrates year-to-year comparability and which reconciles to net income. That summary is reproduced below from the Consolidated Financial Statements to present our overall operations in the manner that we use to manage the business.
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
Life Insurance. Life insurance is our largest insurance segment, with 2015 life premium representing 69% of total premium. Life underwriting income before other income and administrative expense represented 73% of the total in 2015. Additionally, investments supporting the reserves for life products produce the majority of excess investment income attributable to the investment segment.
Life insurance premium rose 5% to $2.1 billion in 2015 after having increased 4% in 2014 to $2.0 billion. Life insurance products are marketed through several distribution channels. Premium income by channel for each of the last three years is as follows:
We use three statistical measures as indicators of premium growth and sales over the near term: “annualized premium in force,” “net sales,” and “first-year collected premium.” Annualized premium in force is defined as the premium income that would be received over the following twelve months at any given date on all active policies if those policies remain in force throughout the twelve-month period. Annualized premium in force is an indicator of potential growth in premium revenue. Net sales is annualized premium issued, net of cancellations in the first thirty days after issue, except in the case of Globe Life Direct Response where net sales is annualized premium issued at the time the first full premium is paid after any introductory offer period has expired. We believe that net sales is a superior indicator of the rate of premium growth relative to annualized premium issued. First-year collected premium is defined as the premium collected during the reporting period for all policies in their first policy year. First-year collected premium takes lapses into account in the first year when lapses are more likely to occur, and thus is a useful indicator of how much new premium is expected to be added to premium income in the future.
Annualized life premium in force was $2.15 billion at December 31, 2015, an increase of 5% over $2.04 billion a year earlier. Annualized life premium in force was $1.96 billion at December 31, 2013.
The American Income Exclusive Agency has historically marketed primarily to members of labor unions. While labor unions are still the core market for this agency, American Income has diversified in recent years by focusing heavily on other affinity groups and referrals to help ensure sustainable growth. The life business of this agency is Torchmark’s highest-margin life business and it is the largest contributor to life premium of any distribution channel at 40% of Torchmark’s 2015 total. This group produced premium income of $831 million, an increase of 8% over the prior year total of $766 million, after having risen 7% in 2014. First-year collected premium was $156 million compared to $134 million in 2014, an increase of 16%. First-year collected premium rose 5% in 2014. Net sales increased 15% to $198 million in 2015 over the 2014 total of $172 million. Net sales increased 13% in 2014 over the 2013 total of $153 million. Sales growth in our captive agencies is generally dependent on growth in the size of the agency force. The American Income Agency's average agent count rose 11% to 6,529 for the year ended December 31, 2015 compared with 5,868 for the same period in 2014. The average agent count is based on the actual count at the end of each week during the period. The American Income Agency has been focusing on growing and strengthening middle management to support sustainable growth of the agency force. To accomplish this, we have placed an increased emphasis on agent training programs and financial incentives that appropriately reward agents at all levels for helping develop and train personnel. The agency continues to provide more home-office and webinar training programs. These programs are designed to provide each agent, from new recruits to top level managers, coaching and instruction specifically designed for each individual’s level of experience and responsibility.
has focused on driving traffic to the inbound call center. We continually introduce new initiatives in this unit in an attempt to increase response rates.
The Liberty National Exclusive Agency markets individual and group life insurance to middle-income customers. Life premium income for this agency was $271 million in 2015, a slight decline from $272 million in 2014. Life premium income in 2013 totaled $276 million. Net sales increased 4% during 2015 to $36 million over the 2014 total of $34 million. Net sales in 2014 increased 11%. The increase in net sales during 2014 marked the first increase in several years, reflecting changes in structure of the agency that management has put in place in recent years. First-year collected premium increased 7% to $28 million during 2015 and was flat in 2014 compared to 2013 at $26 million.
The Other Agencies distribution channels offering life insurance include the Military Agency, the UA Independent Agency (which predominantly writes health insurance), and various smaller distribution channels. The Other Agencies contributed $224 million of life premium income, or 11% of Torchmark’s total in 2015, but contributed only 3% of net sales for the year.
increased primarily as a result of additional investments made to support our distribution channels which are expected to result in increased sales and premium income in future periods. The higher than expected claims in the Globe Life Direct Response Unit primarily relate to policies issued since 2011 where prescription information was used in the underwriting process for certain policies in order to improve the overall mortality of the policies written. To date, improvements in the actual mortality on such policies have been less than expected, causing an increase in our net policy obligations.
Health Insurance. Health insurance sold by Torchmark includes primarily Medicare Supplement insurance, critical illness coverage, accident coverage, and other limited-benefit supplemental health products. In this analysis, all health coverage plans other than Medicare Supplement are classified as limited-benefit plans.
The following table discloses first-year collected health premium by distribution method.
The Liberty National Exclusive Agency represented 23% of all Torchmark health premium income at $209 million in 2015. The Liberty Agency markets limited-benefit supplemental health products consisting primarily of critical illness insurance. Much of Liberty’s health business is now generated through work site marketing targeting small businesses of 10 to 25 employees. In 2015, health premium income in the Agency declined 6% from prior year premium of $222 million after declining 8% during 2014. Liberty’s health premium decline has been due primarily to its declining Medicare Supplement block.
As presented in the following table, Torchmark’s health insurance underwriting margin before other income and administrative expense increased 3% to $204 million in 2015, after an increase of 1% to $199 million in 2014. As a percentage of health premium, margins were down slightly to 22% in 2015, due to increased benefit ratios in the Direct Response and UA channels. The group business sold in 2014 was priced at higher benefit ratios.
While the fixed annuity account balance has been declining slightly year over year, underwriting income has increased each year over the prior year. Policy charges have actually declined slightly in each successive year. The majority of policy charges consist of surrender charges which are based on a function of account size and time lapsed since deposit. A considerable portion of fixed annuity profitability is derived from the spread of investment income exceeding contractual interest requirements, which can result in negative net policy obligations. In the three-year period, however, spreads tended to level as crediting rates reached guaranteed minimums.
Administrative expenses. Operating expenses are included in the Other and Corporate Segments and are classified into two categories: insurance administrative expenses and expenses of the parent company. The following table is an analysis of operating expenses for the three years ended December 31, 2015.
Investments. We manage our capital resources including investments, debt, and cash flow through the investment segment. Excess investment income represents the profit margin attributable to investment operations. It is the measure that we use to evaluate the performance of the investment segment as described in Note 14-Business Segments in the Notes to the Consolidated Financial Statements. It is defined as net investment income less both the required interest attributable to net policy liabilities and the interest cost associated with capital funding or “financing costs.”
We also view excess investment income per diluted share as an important and useful measure to evaluate the performance of the investment segment. It is defined as excess investment income divided by the total diluted weighted average shares outstanding, representing the contribution by the investment segment to the consolidated earnings per share of the Company. Since implementing our share repurchase program in 1986, we have used over $6.5 billion of cash flow to repurchase Torchmark shares after determining that the repurchases provided a greater return than other investment alternatives. Share repurchases reduce excess investment income because of the foregone earnings on the cash that would otherwise have been invested in interest-bearing assets, but they also reduce the number of shares outstanding. In order to put all capital resource uses on a comparable basis, we believe that excess investment income per diluted share is an appropriate measure of the investment segment.
(1) Net investment income has been retrospectively adjusted for ASU 2014-01 Investments-Equity Method and Joint Ventures: Accounting for Investments in Qualified Affordable Housing Projects; see additional information at Note 1-Significant Accounting Policies in the Notes to the Consolidated Financial Statements.
(2) Net of deferred acquisition costs, excluding the associated unrealized gains and losses thereon.
The largest component of excess investment income is net investment income, which rose 2% to $774 million in 2015. It increased 3% to $758 million in 2014 from $735 million in 2013. Growth in net investment income has generally been slower than growth in mean invested assets in recent years due to the declining interest rate environment. In 2015, fixed maturity yields averaged 5.84% on a tax-equivalent and effective-yield basis, compared with 5.91% in 2014 and 5.94% in 2013. Even though mean invested assets have increased each period, net investment income has grown at a slower pace as a result of the decline in average yields. The overall average portfolio yield decreased in the 2013
to 2015 periods as new money is being invested at lower prevailing yields, and from the result of reinvesting proceeds from bonds that matured or were called at yield rates less than the rates we earned on the bonds before they matured or were called. A significant amount of calls were a negative factor on net investment income in 2013, but calls and maturities were very limited in their affect in 2014 and 2015. During 2014 and 2015, the proceeds from all dispositions have been reinvested at yield rates closer to the yield rates on the disposed assets.
While net investment income in recent years has been negatively impacted by the factors discussed above, we would expect to see only modest declines in the average portfolio yield rate over the next few years. We anticipate that less than 2% of fixed maturities on average are expected to run off each year over the next five years and the average yield rate on assets acquired with the proceeds of dispositions is not expected to be significantly less than the yield rate earned on the assets prior to their disposal. Accordingly, we believe it is unlikely that dispositions will have a significant negative impact on net investment income and the growth rate of net investment income in the next few years.
Required interest on net insurance policy liabilities reduces net investment income as it is the amount of net investment income considered by management necessary to “fund” the required interest included in the insurance segments. As such, it is removed from the investment segment and applied to the insurance segments to offset the effect of the required interest from the insurance segments. As discussed in Note 14-Business Segments in the Notes to the Consolidated Financial Statements, management believes this provides a more meaningful analysis of the investment and insurance segments. Required interest is based on the actuarial interest assumptions used in discounting the benefit reserve liability and the amortization of deferred acquisition costs for our insurance policies in force. The great majority of our life and health insurance policies are fixed interest-rate protection policies, not investment products, and are accounted for under current accounting guidance for long-duration insurance products which mandates that interest rate assumptions for a particular block of business be “locked in” for the life of that block of business. Each calendar year, we set the discount rate to be used to calculate the benefit reserve liability and the amortization of the deferred acquisition cost asset for all insurance policies issued that year. That rate is based on the new money yields that we expect to earn on cash flow received in the future from policies of that issue year, and cannot be changed. The discount rate used for policies issued in the current year has no impact on the in force policies issued in prior years as the rates of all prior issue years are also locked in. As such, the overall discount rate for the entire in force block is a weighted average of the discount rates being used from all issue years. Changes in the overall weighted-average discount rate over time are caused by changes in the mix of the reserves and the deferred acquisition cost asset by issue year on the entire block of in force business. Business issued in the current year has very little impact on the overall weighted-average discount rate due to the size of our in force business.
Financing costs increased slightly from 2014 to 2015. The decrease of $4 million or 5% in 2014 was related to the maturity and repayment of our $94 million par amount 7.375% Notes during the third quarter of 2013. In 2015, interest on short-term debt increased primarily because of the increase in the weighted-average interest rate and the average balance on short-term debt. More information on our debt transactions are disclosed in the Financial Condition section of this report and in Note 11-Debt in the Notes to Consolidated Financial Statements.
During calendar years 2013 through 2015, Torchmark invested almost exclusively in fixed maturity securities, primarily in corporate bonds with longer-term maturities. The following table summarizes selected information for fixed maturity purchases for the last three years. The effective annual yield shown is the yield calculated to the potential termination date that produces the lowest yield, commonly referred to as the “worst call date.” For non-callable bonds, the worst-call date is always the maturity date. For callable bonds, the worst-call date is the call date that produces the lowest yield, typically the first call date.
We prefer to invest primarily in bonds that are not callable (on other than a make-whole basis) prior to maturity, but we periodically invest some funds in callable bonds when the incremental yield available on such bonds warrants doing so. For investments in callable bonds, the actual life of the investment will depend on whether the issuer calls the investment prior to the maturity date. Given our investments in callable bonds, the actual average life of our investments cannot be known at the time of the investment. However absent sales, 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.
Portfolio Composition. The composition of the investment portfolio at book value on December 31, 2015 was as follows:
Torchmark calculates the average life and duration of the fixed-maturity portfolio two ways:
At December 31, 2015, fixed maturities had a fair value of $13.8 billion, compared with $14.5 billion at December 31, 2014. The net unrealized gain position in the fixed maturity portfolio decreased from $1.7 billion at December 31, 2014 to $506 million at December 31, 2015, primarily as a result of an increase in market interest rates. The December 31, 2015 net unrealized gain consisted of gross unrealized gains of $1.1 billion offset by $564 million of gross unrealized losses, compared with the December 31, 2014 net unrealized gain which consisted of a gross unrealized gain of $1.7 billion and a gross unrealized loss of $79 million. As described in Note 4-Investments in the Notes to the Consolidated Financial Statements, the increase in gross unrealized losses was partially attributable to rising interest rates in the financial markets, but also resulted from deteriorating conditions in the energy and metals and mining sectors.
For more information about our fixed maturity portfolio by component at December 31, 2015 and 2014, including a discussion of other-than-temporary impairments, an analysis of unrealized investment losses and a schedule of maturities, see Note 4-Investments in the Notes to the Consolidated Financial Statements.
Our investment policy regarding fixed maturities is to acquire only investment-grade obligations. Thus, any increases in below investment-grade issues are a result of ratings downgrades of existing holdings. Our investment portfolio contains no securities backed by sub-prime or Alt-A mortgages (loans for which some of the typical documentation was not provided by the borrower). We have no direct investments in residential mortgages and we are not a party to any credit default swaps or other derivative contracts. We do not participate in securities lending, we have no off-balance sheet investments, and we have only an insignificant exposure to European sovereign debt consisting of $2 million in German government bonds at December 31, 2015. Our exposure to Puerto Rican obligations is insignificant.
Investments are occasionally sold or called, resulting in a realized gain or loss. These gains and losses generally occur only incidentally, usually as the result of bonds sold because of deterioration in investment quality of issuers or calls by the issuers. Investment losses are also caused by write downs due to impairments. We do not engage in trading investments for profit. Therefore, gains or losses which occur in protecting the portfolio or its yield, or which result from events that are beyond our control, are only secondary to our core insurance operations of providing insurance coverage to policyholders.
As described in Note 4-Investments under the caption Other-than-temporary impairments, we have not incurred any write downs in our fixed maturity portfolio as a result of other-than-temporary impairment for the years 2013 through 2015. During 2013, we sold investment real estate for an after-tax loss of $1.9 million, of which $1.7 million had been written down due to other-than-temporary impairment earlier in that year.
In summary, Torchmark expects to have readily available funds for 2016 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, additional borrowings on our short-term credit facility, and intercompany borrowing.
Consolidated Liquidity. Consolidated net cash inflows provided from operations were $1.1 billion in 2015, compared with $880 million in 2014 and $1.1 billion in 2013. In addition to cash inflows from operations, our companies received proceeds from maturities, calls, and repayments of fixed maturities in the amount of $376 million in 2015, compared with $273 million in 2014 and $494 million in 2013.
Our cash and short-term investments were $116 million at year-end 2015 and $82 million at year-end 2014. 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 $13.8 billion at December 31, 2015. 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.
The following table presents information about future payments under our contractual obligations for the selected periods as of December 31, 2015.
Pension obligations are primarily liabilities in trust funds that are calculated in accordance with the terms of the pension plans. They are offset by invested assets in the trusts, which are funded through periodic contributions by Torchmark in a manner which will provide for the settlement of the obligations as they become due. Therefore, our obligations are offset by those assets when reported on Torchmark’s Consolidated Balance Sheets. At December 31, 2015, these pension obligations were $477 million, but there were also assets of $308 million in the pension entities. The schedule of pension benefit payments covers ten years and is based on the same assumptions used to measure the pension obligations, except there is no interest assumption because the payments are undiscounted. There are also obligations for benefits other than pensions with a liability of $22 million. Please refer to Note 9-Postretirement Benefits in the Notes to Consolidated Financial Statements for more information on pension obligations.
Our insurance subsidiaries generally target a capital ratio of 325% of Company action level 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, 2015, our insurance subsidiaries in the aggregate had RBC ratios of approximately 320%. Should we experience impairments and/or ratings downgrades within its fixed maturity portfolio in the future, the ratio could fall below targeted levels. In such a case, management believes more than sufficient liquidity exists at the Parent Company to make additional contributions as necessary to maintain the targeted ratio.
year. Please refer to the description of our share repurchase program under the caption Summary of Operations in this report.
Torchmark has continually increased the quarterly dividend on its common shares over the past three years. In the first quarter of 2013, it was increased to $0.1133 per share from $0.10 per share. In the first quarter of 2014, it was raised to $0.1267 per share. Finally, in the first quarter of 2015, dividends were raised to $0.135 per share.
Shareholders’ equity was $4.1 billion at December 31, 2015, compared with $4.7 billion at December 31, 2014. During the twelve months since December 31, 2014, shareholders’ equity was reduced by the $359 million in share purchases under the repurchase program, $60 million to offset the dilution from stock option exercises, and $750 million of after-tax unrealized losses in the fixed maturity portfolio. However, it was increased by $527 million of net income.
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.
FASB guidance provides for 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 the accounting rule which permits us to account for changes in our available-for-sale bond portfolio through other comprehensive income, the guidance 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.
Torchmark’s ratio of earnings before interest and taxes to interest requirements (times interest earned) was 11.0 times in 2015, compared with 11.3 times in 2014 and 10.4 times in 2013 (as adjusted for discontinued operations and the adoption of ASU 2014-01 Investments-Equity Method and Joint Ventures: Accounting for Investments in Qualified Affordable Housing Projects). This times-interest-earned ratio is computed by dividing interest expense into the sum of pre-tax income from continuing operations and interest expense. A discussion of our interest expense is included in the discussion of financing costs under the caption Investments in this report.
Financial Strength Ratings. The financial strength of our major insurance subsidiaries is rated by Standard & Poor’s and A. M. Best. The following chart presents these ratings for our five largest insurance subsidiaries at December 31, 2015.
Deferred Acquisition Costs: Certain costs of acquiring new business are deferred and recorded as an asset. Deferred acquisition costs consist primarily of sales commissions and other underwriting costs related to the successful issuance of a new insurance contract as indicated in Note 1-Significant Accounting Policies under the caption Deferred Acquisition Costs in the Notes to Consolidated Financial Statements. Additionally, the cost of acquiring blocks of insurance business or insurance business through the purchase of other companies, known as the value of insurance purchased, is included in deferred acquisition costs. Our policies for accounting for deferred acquisition costs and the associated amortization are reported under the same caption in Note 1.
Approximately 99% of our recorded amounts for deferred acquisition costs at December 31, 2015 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, 2015.
Valuation of Fixed Maturities: We hold a substantial investment in high-quality fixed maturities to provide for the funding of our future policy contractual obligations over long periods of time. While these securities are generally expected to
Defined benefit pension plans: We maintain funded defined benefit plans covering most full-time employees. We also have unfunded nonqualified defined benefit plans covering certain key and other employees. Our obligations under these plans are determined actuarially based on specified actuarial assumptions. In accordance with GAAP, an expense is recorded each year as these pension obligations grow due to the increase in the service period of employees and the interest cost associated with the passage of time. These obligations are offset, at least in part, by the growth in value of the assets in the funded plans. At December 31, 2015, our gross liability under these funded plans was $477 million, but was offset by assets of $308 million.
The actuarial assumptions used in determining our obligations for pensions include employee mortality and turnover, retirement age, the expected return on plan assets, projected salary increases, and the discount rate at which future obligations could be settled. These assumptions have an important effect on the pension obligation. A decrease in the discount rate or rate of return on plan assets will cause an increase in the pension obligation. A decrease in projected salary increases will cause a decrease in this obligation. Small changes in assumptions may cause significant differences in reported results for these plans. For example, a sensitivity analysis is presented below for the impact of change in the discount rate and the long-term rate of return on assets assumed on our defined benefit pension plans expense for the year 2015 and projected benefit obligation as of December 31, 2015.
The criteria used to determine the primary assumptions are discussed in Note 9-Postretirement Benefits in the Notes to Consolidated Financial Statements. While we have used our best efforts to determine the most reliable assumptions, given the information available from company experience, economic data, independent consultants and other sources, we cannot be certain that actual results will be the same as expected. The assumptions are reviewed annually and revised, if necessary, based on more current information available to us. Note 9 also contains information about pension plan assets, investment policies, and other related data.
8) Levels of administrative and operational efficiencies that differ from our assumptions;
Consolidated Statements of Comprehensive Income for each of the three years in the period ended December 31, 2015
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, 2015, based on the criteria established in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 26, 2016 expressed an unqualified opinion on Torchmark’s internal control over financial reporting.
(1) Certain balances were adjusted to give effect to discontinued operations as described in Note 1-Significant Accounting Policies.
(1) Certain balances were adjusted to give effect to discontinued operations and the adoption of new accounting guidance as described in Note 1- Significant Accounting Policies under the caption "Low-Income Housing Tax Credit Interests."
When a component of Torchmark’s business is expected to be sold during the ensuing year, Torchmark considers whether the criteria of ASC 205-20, Discontinued Operations, have been met, which includes evaluating if the disposal of a component represents a strategic shift that has, or will have, a major effect on the Company. If the disposal meets the criteria for discontinued operations, the assets and liabilities of components held for sale are segregated and are recorded in the Consolidated Balance Sheets as assets held for sale and liabilities held for sale for all periods presented. If the carrying amount of the business exceeds its estimated fair value, a loss is recognized. The results of operations for the component held for sale are reported in "Income from discontinued operations, net of tax" in the Consolidated Statements of Operations for current and prior periods. Discontinued operations are reported commencing in the period in which the business is either disposed of or meets the accounting criteria for discontinued operations, including any gain or loss recognized on the sale or adjustment of the carrying amount to the estimated fair value less cost to sell. As discussed in further detail in Note 6-Discontinued Operations, Torchmark has classified one of its operating segments, Medicare Part D, as held for sale and it is reflected as a discontinued operation for the year ended December 31, 2015. As this business has been classified as held for sale and its operations are discontinued, the financial results of this business are excluded from Torchmark's continuing operations and the Notes to the Consolidated Financial Statements, other than Note 2-Statutory Accounting and Note 6-Discontinued Operations.
carried at unpaid principal balances. Investments in real estate, included in “Other long-term investments,” are reported at cost less allowances for depreciation. Depreciation is calculated on the straight-line method. Investments in limited partnerships, also included in "Other long-term investments," are accounted for using the cost method of accounting as Torchmark's partnership interest is minor since Torchmark lacks the ability to exercise significant influence over the partnership's operating and financial policies. The Company considers its cost method investments for impairment when the carrying value of such investments exceeds the net asset value (“NAV”). Short-term investments include investments in interest-bearing time deposits with original maturities of twelve months or less.
Fair Value Measurements, Other Financial Instruments: Fair values for cash, short-term investments, short-term debt, receivables and payables approximate carrying value. Policy loans are an integral part of Torchmark’s subsidiaries’ life insurance policies in force and their fair values cannot be valued separately and apart from the insurance contracts. The fair values of Torchmark’s long-term debt issues are based on the same methodology as investments in fixed maturities. Because observable inputs were available for these debt securities at December 31, 2015, they were classified as Level 2 in the valuation hierarchy. The fair value for each debt instrument as of December 31, 2015 is disclosed in Note 11-Debt. As described in Note 9-Postretirement Benefits, Torchmark maintains an unqualified supplemental retirement plan. Therefore the assets which support the liability for this plan are considered general assets of the Company. These assets consist of the cash value of corporate-owned life insurance policies and exchange traded funds (ETFs). The fair value of the insurance cash values approximates carrying value. Fair values for the ETFs are derived from direct quotes and are considered Level 1 in the valuation hierarchy.
Impairment of Investments: Torchmark’s portfolio of fixed maturities fluctuates in value due to changes in interest rates in the financial markets as well as other factors. Fluctuations caused by market interest rate changes have little bearing on whether or not the investment will be ultimately recoverable. Therefore, Torchmark considers these declines in value resulting from changes in market interest rates to be temporary. In certain circumstances, however, Torchmark determines that the decline in the value of a security is other-than-temporary and writes the book value of the security down to its fair value, realizing an investment loss. The evaluation of Torchmark’s securities for other-than-temporary
The Company’s ability and intent to hold the security until anticipated recovery
Other Receivables: Other receivables consist primarily of agent debit balances, which represent commissions advanced to insurance agents. These balances are repaid to the Company over time as the premiums are collected by the Company and agents' commissions on such premiums are retained. The balance was $334 million and $313 million at December 31, 2015 and 2014, respectively. Management believes these balances are recoverable as they are less than the estimated present value of future commissions.
Advertising Costs: Costs related to advertising are generally charged to expense as incurred. However, certain Globe Life Direct Response advertising costs are capitalized when there is a reliable and demonstrated relationship between total costs and future benefits that is a direct result of incurring these costs. Globe Life Direct Response advertising costs consist primarily of the production and distribution costs of direct mail advertising materials, and when capitalized are included as a component of deferred acquisition costs. They are amortized in the same manner as other deferred acquisition costs. Globe Life Direct Response advertising costs charged to earnings and included in other operating expense were $10 million, $8 million, and $6 million in 2015, 2014, and 2013, respectively. Capitalized advertising costs included within deferred acquisition costs were $1.21 billion at December 31, 2015 and $1.15 billion at December 31, 2014.
Property and Equipment: Property and equipment, included in “Other assets,” is reported at cost less allowances for depreciation. Depreciation is recorded primarily on the straight line method over the estimated useful lives of these assets which range from three to 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 certain events and circumstances become evident that the fair value of the asset is less than its carrying amount. Original cost of property and equipment was $175 million at December 31, 2015 and $139 million at December 31, 2014. Accumulated depreciation was $92 million at year end 2015 and $85 million at the end of 2014. Depreciation expense was $8.0 million in 2015, $7.4 million in 2014, and $6.4 million in 2013. During 2013, Liberty National Life Insurance Company (Liberty National), a Torchmark subsidiary, sold real estate for a loss of $265 thousand after a previous write-down for other-than-temporary impairment of $2.7 million earlier in the year. The sale of this property eliminated substantially all asbestos-related liability for Torchmark.
Income Taxes: Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement book values and tax bases of assets and liabilities. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. More information concerning income taxes is provided in Note 8-Income Taxes.
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 $19 million, $21 million, and $22 million for the years ended December 31, 2015, 2014, and 2013, 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.
The fair value method requires the use of an option valuation model to value employee stock options. Torchmark has elected to use the Black-Scholes valuation model for option expensing. A summary of assumptions for options granted in each of the three years 2013 through 2015 is as follows:
The expected term is generally derived from Company experience. However, expected terms are determined based on the simplified method as permitted under the ASC 718 Stock Compensation topic when company experience is insufficient. The Torchmark Corporation 2011 Incentive Plan replaced all previous plans and allows for option grants for employees with a ten-year contractual term which vest over five years in addition to seven-year grants which vest over three years as permitted by the previous plans. Director grants vest over six months. The Company has sufficient experience with seven-year grants that vest in three years, but insufficient historical experience with five-year vesting. Therefore, Torchmark has used the simplified method to determine the expected term for the ten-year grants with five-year vesting and will do so until adequate experience is developed. Volatility and risk-free interest rates are assumed over a period of time consistent with the expected term of the option. Volatility is measured on a historical basis. Monthly data points are utilized to derive volatility for periods greater than three years. Expected dividend yield is based on current dividend yield held constant over the expected term. Once the fair value of an option has been determined, it is amortized on a straight-line basis over the employee’s service period for that grant (from the grant date to the date the grant is fully vested). Expenses for restricted stock and restricted stock units are based on the grant-date fair value allocated on a straight-line basis over the service period. Performance share expense is recognized based on management’s estimate of the probability of meeting the metrics identified in the performance share award agreement, assigned to each service period as these estimates develop.
Financial Instruments: The FASB issued Accounting Standards Update No. 2016-01 Financial Instruments-Overall: Recognition and Measurement of Financial Assets and Financial Liabilities (ASU 2016-01). The guidance addresses certain aspects of recognition, measurement, presentation and disclosure of financial instruments. In particular, this guidance requires equity investments to be measured at fair value with changes in fair value recognized in net income rather than other comprehensive income, and changes the presentation of certain fair value changes for financial liabilities. ASU 2016-01 will be effective for Torchmark on January 1, 2018. As Torchmark's equity securities portfolio is insignificant in comparison to its investment portfolio, the Company does not anticipate the guidance to have a material impact on its operating results.
Leases: The FASB issued Accounting Standards Update No. 2016-02 Leases (ASU 2016-02). This new guidance states that leases classified as operating leases under current accounting guidance will be recognized on the balance sheet as lease assets and lease liabilities when the company is the lessee. ASU 2016-02 will be effective for Torchmark on January 1, 2019 and is required to be presented using a modified retrospective approach. Torchmark is currently evaluating the impact that this guidance will have on the consolidated financial statements.
As discussed in Note 1-Significant Accounting Policies, net investment income was retrospectively adjusted to give effect to the adoption of ASU 2014-01 for all periods presented.
The private placement fixed maturities are valued based on the contractual cash flows discounted by a yield determined as a treasury benchmark adjusted for a credit spread. The credit spread is developed from observable indices for similar public fixed maturities and unobservable indices for private fixed maturities for corresponding credit ratings. However, the credit ratings for the private placements are considered unobservable inputs, as they are assigned by the third party investment manager based on a quantitative and qualitative assessment of the credit underwritten. A higher (lower) credit rating would result in a higher (lower) valuation. For more information regarding valuation procedures, please refer to Note 1-Significant Accounting Policies under the caption Fair Value Measurements, Investments in Securities.
Additional information about investments in an unrealized loss position is as follows:
Torchmark’s entire fixed-maturity and equity portfolio consisted of 1,568 issues at December 31, 2015 and 1,604 issues at December 31, 2014. The weighted-average quality rating of all unrealized loss positions was BBB+ for both 2015 and 2014. The weighted-average quality ratings are based on amortized cost.
Corporate debt securities and redeemable preferred stocks represent 82% of Torchmark's investment portfolio. These investments are spread across a wide range of industries. Below are the ten largest industry concentrations held in the corporate portfolio of corporate debt securities and redeemable preferred stocks at December 31, 2015, based on fair value:
At December 31, 2015, Torchmark met the criteria to account for its Medicare Part D business as a discontinued operation and expects the business to be sold during 2016. Historically, the business was a reportable segment. However, Torchmark no longer emphasizes its Medicare Part D business due to declining margins, increased risks, higher drug costs, and increased administrative and compliance costs. Management believes this sale will allow the Company to better focus on its core protection life and health insurance businesses as well as provide additional capital to invest.
Torchmark’s tax liability is adjusted to include a provision for uncertain tax positions taken or expected to be taken in a tax return. However, during the years 2013 through 2015, Torchmark did not have any uncertain tax positions which resulted in unrecognized tax benefits.
Cost for the defined benefit pension plans has been calculated on the projected unit credit actuarial cost method. All plan measurements for the defined benefit plans are as of December 31 of the respective year. The defined benefit pension plans covering the majority of employees are qualified and funded. Contributions are made to funded pension plans subject to minimums required by regulation and maximums allowed for tax purposes. Defined benefit plan contributions were $15.5 million in 2015, $14.6 million in 2014, and $10.3 million in 2013. Torchmark estimates as of December 31, 2015 that it will contribute an amount not to exceed $20 million to these plans in 2016. The actual amount of contribution may be different from this estimate.
Plan assets in the funded plans consist primarily of investments in marketable fixed maturities and equity securities and are valued at fair value. Torchmark measures the fair value of its financial assets, including the assets in its benefit plans, in accordance with accounting guidance which establishes a hierarchy for asset values and provides a methodology for the measurement of value. Please refer to Note 1-Significant Accounting Policies under the caption Fair Value Measurements, Investments in Securities for a complete discussion of valuation procedures. The following table presents the assets of Torchmark’s defined benefit pension plans for the years ended December 31, 2015 and 2014.
Allowed investments are limited to equities, fixed maturities, and short-term investments (invested cash). The assets are to be invested in a mix of equity and fixed income investments that best serve the objectives of the pension plan. Factors to be considered in determining the asset mix include funded status, annual pension expense, annual pension contributions, and balance sheet liability. Equities include common and preferred stocks, securities convertible into equities, mutual funds that invest in equities, and other equity-related investments. Equities must be listed on major exchanges and adequate market liquidity is required. Fixed maturities consist of marketable debt securities rated investment grade at purchase by a major rating agency. Short-term investments include fixed maturities with maturities
less than one year and invested cash. Short-term investments in commercial paper must be rated at least A-2 by Standard & Poor’s with the issuer rated investment grade. Invested cash is limited to banks rated A or higher. Investments outside of the aforementioned list are not permitted, except by prior approval of the Plan’s Trustees. At December 31, 2015, there were no restricted investments contained in the portfolio. Plan contributions have been invested primarily in fixed maturity and equity securities during the three years ended December 31, 2015.
(1) Includes amortization of postretirement benefits other than pensions of $120 thousand in 2015, $2 thousand in 2014, and $224 thousand in 2013.
The portion of other comprehensive income that is expected to be reflected in pension expense in 2016 is as follows:
The accumulated benefit obligation (ABO) for Torchmark’s funded defined benefit pension plans was $371 million and $374 million at December 31, 2015 and 2014, respectively. In the unfunded plans, the ABO was $63 million at December 31, 2015 and 2014.
(1) The net loss for benefit plans other than pensions reduces other comprehensive income.
All securities other than the Junior Subordinated Debentures have equal priority with one another.
Quarterly payments on the 15th of March, June, September, and December.
Torchmark's 6.375% Senior Notes, in the principal amount of $250 million, will mature on June 15, 2016. The Company plans to refinance these notes in 2016.
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
There were no anti-dilutive shares as of December 31, 2015, 2014, or 2013. Income available to common shareholders for basic earnings per share is equivalent to income available to common shareholders for diluted earnings per share.
(1) Plan allows for grant of options such that each grant reduces shares available for grant in a range from 0.85 share to 1 share.
The following table summarizes information about stock options outstanding at December 31, 2015.
No equity awards were cash settled during the three years ended December 31, 2015.
An analysis of option activity for each of the three years ended December 31, 2015 is as follows:
Restricted stock grants consist of time-vested grants, restricted stock units, and performance shares. Time-vested restricted stock is available to both senior executives and directors. The employee grants generally vest over five years and the director grants vest over six months. Restricted stock units are available only to directors. They vest over six months and are not converted to shares until the directors’ retirement, death, or disability. Director restricted stock and restricted stock units are generally granted on the first work day of the year. Performance shares are granted to a limited number of senior executives. Performance shares have a three year contract life and are not settled in shares until the termination of the three-year contract period. While the grant specifies a stated target number of shares, the determination of the actual settlement in shares will be based on the achievement of certain performance objectives of Torchmark over the respective three-year contract periods. The actual shares could be distributed in a range from 0 to 359 thousand shares for the 2015 grants, 0 to 359 thousand shares for the 2014 grants, and 0 to 295 thousand shares for the 2013 grants. Certain executive restricted stock and performance share grants contain terms related to age that could accelerate vesting.
(1) Estimated additional share grants expected due to achievement of performance criteria.
A final determination for the 2012 performance share grants was made as of December 31, 2014 to be 211 thousand shares, as those shares were settled on January 27, 2015. Likewise, a final settlement was determined for the 2013 grants as of December 31, 2015 to be 159 thousand shares, and the shares were settled on February 24, 2016.
Due to the nature of the life insurance industry, Torchmark has no individual or group which would be considered a major customer. Substantially all of Torchmark’s business is conducted in the United States.
Torchmark holds a sizeable investment portfolio to support its insurance liabilities, the yield from which is used to offset policy benefit, acquisition, administrative and tax expenses. This yield or investment income is taken into account when establishing premium rates and profitability expectations of its insurance products. In holding such a portfolio, investments are sold, called, or written down from time to time, resulting in a realized gain or loss. These gains or losses generally occur as a result of disposition due to issuer calls, compliance with Company investment policies, or other reasons often beyond management’s control. Unlike investment income, realized gains and losses are incidental to insurance operations, and only overall yields are considered when setting premium rates or insurance product profitability expectations. While these gains and losses are not relevant to segment profitability or core operating results, they can have a material positive or negative result on net income. For these reasons, management removes realized investment gains and losses when it views its segment operations.
During 2014, Torchmark accrued for certain litigation matters in the net amount of $3.7 million ($2.4 million after tax) that were not directly related to its insurance operations. Additionally, Torchmark received $1.3 million ($853 thousand after tax) in settlement of litigation regarding investments. Also in 2014, the Company recorded $8.2 million in administrative settlements ($5.3 million after tax) related to benefits paid for deaths occurring in prior years where claims had not been filed. These administrative settlements were included in “Policyholder benefits” in the Consolidated Statements of Operations in 2014.
During 2013, Torchmark incurred four non-operating charges: (1) a state guaranty fund assessment in the amount of $1.2 million ($751 thousand after tax), resulting from events in years prior to 2013, (2) a legal settlement related to a non-insurance matter in the amount of $500 thousand ($325 thousand after tax), (3) the settlement of a litigation matter related to prior years in the amount of $8.6 million ($5.6 million after tax) and (4) a one-time adjustment related to the finalization of accounting for the acquisition of the insurance assets and liabilities of Family Heritage. The Family Heritage acquisition closed on November 1, 2012. This adjustment increased 2013 after-tax earnings in the amount of $522 thousand. Management removes items that are related to prior periods when evaluating the operating results of current periods. Management also removes non-operating items unrelated to its core insurance activities when evaluating those results. Therefore, these items are excluded in its presentation of segment results, because accounting guidance requires that operating segment results be presented as management views its business. With the exception of the administrative settlements in the paragraph above, all of these items are included in “Other operating expense” in the Consolidated Statements of Operations for the appropriate year.
(6) Retrospectively adjusted to give effect to the adoption of ASU 2014-01 as described in Note 1-Significant Accounting Policies.
(1) Income from discontinued operations (after tax) is included for purposes of reconciling to net income.
Liabilities for each segment are reported also on a specific identification basis similar to the assets. The insurance segments' liabilities contain future policy benefits, unearned and advance premiums, and policy claims and other benefits payable. Other policyholders' funds are included in Other. Debt represents both short and long term. Current and deferred income taxes payable is also included in Other.
Reinsurance: Insurance affiliates of Torchmark reinsure that portion of insurance risk which is in excess of their retention limits. Retention limits for ordinary life insurance range up to $2.0 million per life. Life insurance ceded represented 0.4% of total life insurance in force at December 31, 2015. Insurance ceded on life and accident and health products represented 0.3% of premium income for 2015. Torchmark would be liable for the reinsured risks ceded to other companies to the extent that such reinsuring companies are unable to meet their obligations.
Insurance affiliates also assume insurance risks of other companies. Life reinsurance assumed represented 2.1% of life insurance in force at December 31, 2015 and reinsurance assumed on life and accident and health products represented 0.8% of premium income for 2015.
Rental expense for operating leases for each of the three years ended December 31, 2015 is as follows:
Low-Income Housing Tax Credit Interests: As described in Note 1-Significant Accounting Policies, Torchmark had $306 million invested in entities which provide certain tax benefits at December 31, 2015. As of December 31, 2015, Torchmark remained obligated under these commitments as follows:
Guarantees: At December 31, 2015, Torchmark had in place four guarantee agreements, of which were either parent company guarantees of subsidiary obligations to a third party, or parent company guarantees of obligations between wholly-owned subsidiaries. As of December 31, 2015, Torchmark had no liability with respect to these guarantees.
Equipment leases: Torchmark has guaranteed performance of certain subsidiaries as lessees under three leasing arrangements which include two for aviation equipment and one for computer software, furniture, and equipment. One aviation lease expires in August 2022 and the second expires in September 2024. The office equipment lease expires in December 2017. At December 31, 2015, total remaining undiscounted payments under the leases were approximately $19 million. The 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.
(1) Certain balances were adjusted to give effect to discontinued operations and the adoption of new accounting guidance as described in Note 1-Significant Accounting Policies.