(1) Net operating income is defined on pages 16-18 of this report. It also excludes the nonrecurring charge described in (3) below.
(3) The nonrecurring charge relates to a 1999 marketing agreement whereby Torchmark guaranteed compensation to another party, regardless of Torchmark’s marketing success. Unfavorable results indicated that the full amount of guaranteed compensation was not recoverable. As a result, Torchmark recorded a charge in an after-tax amount of $13 million, or $.10 per share. The relationship with the counterparty was terminated in 2002.
Cautionary Statements. Torchmark cautions readers regarding certain forward-looking statements contained in the following discussion and elsewhere in this document, and in any other statements made by, or on behalf of Torchmark whether or not in future filings with the Securities and Exchange Commission. Any statement that is not a historical fact, or that might otherwise be considered an opinion or projection concerning Torchmark or its business, whether express or implied, is meant as and should be considered a forward-looking statement. Such statements represent management’s opinions concerning future operations, strategies, financial results or other developments.
1) Changing general economic conditions leading to unexpected changes in lapse rates and/or sales of Torchmark’s policies as well as levels of mortality, morbidity and utilization of healthcare services that differ from Torchmark’s assumptions;
These designated measures of profitability are highly useful to management in evaluating the performance of the segments and the underlying marketing groups within each insurance segment. These measures enable management to view period-to-period trends which are helpful in the determination of future courses of action to be taken. Since net operating income is basically a composite of the results of these operating units, it is a valuable aid to management and to investors in evaluating total corporate trends and performance. Net operating income and other measurements of segment profitability, along with associated ratios, are also used in determining a portion of executive management compensation.
Net operating income differs from net income as reported on the income statement because it excludes certain nonoperating items, nonrecurring items, and discontinued operations which must be recorded in the GAAP income statement. These nonoperating items sometimes cause distorted comparisons with prior year results if only net income is considered and financial statements are not taken as a whole.
The differences between net income as reported in Torchmark’s financial statements and net operating income are as follows:
2) The loss from the redemption by Torchmark of its Monthly Income Preferred Securities (MIPS) in the amount of $4.3 million net of tax in 2001;
The effect of adoption of a new accounting standard which does not permit the amortization of goodwill after 2001.
follows: 2002, $18 million; 2001, $5 million; and 2000, $8 million. During 2002, Torchmark wrote down $89 million in fixed maturities due to impairments. For more information regarding these writedowns and Torchmark’s policies for evaluating other-than-temporary impairments, see the discussions of Investments on page 28 of this report and Critical Accounting Policies on page 41.
The charge related to previously discontinued energy operations arose from litigation which was ongoing at the time of Torchmark’s divestiture of energy activities in 1996. This litigation was settled during 2001 and resulted in the charge. More information concerning this matter is found in Note 18-Commitments and Contingencies beginning on page 75 of this report.
The change in accounting principle is discussed in Note 11-Change in Accounting Principle in the Notes to Consolidated Financial Statements on page 65 of this report.
A reconciliation of net operating income to net income in total and on a per diluted share basis is as follows:
On a per share basis, Torchmark’s net operating income grew 9% in both 2002 and 2001, to $3.51 in 2002 and $3.21 in 2001. Torchmark’s net operating income rose 5% in 2002 to $424 million and 7% in 2001 to $405 million. Per share growth exceeded growth in total net operating income for both periods as a result of share buybacks. Insurance underwriting income grew 3% in 2001 to $368 million but declined 2% to $359 million in 2002. A complete discussion of Torchmark’s insurance operations is found in the discussions of insurance segments beginning on page 19 of this report. Excess investment income grew in both periods. The 13% increase in 2001 excess investment income was due primarily to the decrease in financing costs resulting from the lower interest rate environment in 2001 and debt refinancings during the year. Excess investment income rose an additional 15% in 2002 as a result of the continued benefit from the lower-interest environment and its favorable impact on financing costs from Torchmark’s interest rate swaps. Refer to the discussion of Investments on page 28 and Capital Resources on page 34 of this report.
Torchmark’s total revenues were $2.74 billion in 2002, a 1% increase over 2001 revenues of $2.71 billion. Revenues rose 8% in 2001 over 2000 revenues of $2.52 billion. After adjustment for realized investment losses in each year, revenues grew 3% to $2.80 billion in 2002 from $2.71 billion in 2001. They increased 7% in 2001 over the prior year. Total premium rose 3% to $2.28 billion in 2002. Total premium increased 8% in 2001 to $2.22 billion. Life insurance premium grew 7% in 2002 to $1.22 billion, an increase of $76 million. Health premium in 2002 rose 1% to $1.02 billion. Net investment income increased $27 million, or 5%, in 2002 to $519 million. Life premium increased 6% to $1.14 billion and health premium grew 11% to $1.01 billion in 2001. Net investment income rose 4% in 2001 to $492 million.
Other operating expenses were $135 million in 2002, compared with $129 million in 2001 and $121 million in 2000. These expenses as a percentage of revenues, excluding realized losses, were 4.8% in each of the years 2002, 2001 and 2000. The largest component of other operating expenses, insurance administrative expenses, were $125 million in 2002, increasing 5% over 2001 expenses of
Life insurance. Life insurance is Torchmark’s largest segment. In 2002, life premium represented 54% of total premium, and life underwriting income before other income and administrative expense represented 62% of the total.
The table below sets forth annualized life insurance premium issued and in force information for each of the last three years.
Direct Response annualized life premium in force rose 10% to $357 million at December 31, 2002 from $326 million a year earlier. At December 31, 2002, Direct Response life annualized premium in force was 27% of Torchmark’s total, the largest of any component distribution group. Direct Response life insurance annualized premium in force grew 7% in 2001 from $306 million.
Sales of life insurance in terms of annualized premium issued by Direct Response were $123 million in 2002, an increase of 10%. Sales declined slightly in 2001 to $112 million from $113 million in 2000. In early 2001, Torchmark discontinued certain products in the Direct Response market in order to focus on sales of more profitable business. The discontinuance of sales of these products resulted in the flattening of 2001 sales. The annualized life premium issued by Direct Response represented 37% of Torchmark’s total life sales in 2002.
The Liberty National Exclusive Agency distribution system markets primarily to middle-income markets in several Southeastern states. Liberty’s life premium rose 2% in 2002 to $302 million, representing 25% of Torchmark’s total life premium. Life premium in 2001 was $297 million, an increase of 1% over the prior year. The annualized life premium in force at the Liberty Agency was $319 million at year-end 2002, compared with $315 million and $312 million at year-ends 2001 and 2000, respectively. Liberty represented 24% of Torchmark’s total life annualized premium in force at December 31, 2002, compared with 25% a year earlier. Life premium sales for this agency, in terms of annualized premium issued, grew 3% during 2002 to $56 million, compared with 2% growth in 2001. Sales growth in the Liberty Agency is largely attributable to growth in the number of agents. Liberty’s agent count rose 2% to 2,203 at year-end 2002, after having increased 6% in 2001 to 2,162. Management believes that the continued recruiting of new agents and the retention of productive agents are critical to the continued growth of sales in controlled agency distribution systems.
Torchmark’s Military Agency consists of a nationwide independent agency whose sales force is comprised of former commissioned and noncommissioned military officers who sell exclusively to commissioned and noncommissioned military officers and their families. This business consists of whole- life products with term insurance riders and is characterized by low lapse rates. The Military Agency represented approximately 12% of Torchmark’s life premium in 2002 and life premium in force at December 31, 2002. Premium rose 11% in 2002 to $149 million, after an increase of 13% to $133 million in 2001. Annualized premium in force grew 12% to $159 million at year-end 2002, compared to an increase of 12% in the prior year. A major factor in the growth of premium income and premium in force in the Military Agency is the high persistency associated with military business. Annualized premium issued increased 11% to $23 million in 2002, after having advanced 7% to $21 million in 2001.
In addition to life insurance sales, this distribution system has also engaged in the production of variable life collections. In 2002, collections were $30 million, compared with 2001 collections of $34 million, a decline of 11%. In 2001, these collections had previously declined 18% from the prior year. Although variable life collections are not included in premium in force data, they are included in the variable life account balance. Indirectly, they add to premium revenue through charges to the variable life account balance for insurance coverage and administration. The account balance is affected by fluctuations in financial markets. Because equity markets were weak in 2002 and 2001, the variable life account balance was negatively impacted in both periods. At December 31, 2002, the variable life account balance was $119 million, declining 19% from the prior-year balance of $147 million. The following table summarizes selected variable life insurance information.
Gross margins, as indicated by insurance underwriting income before other income and administrative expense, rose 5% in both 2002 and 2001 over the respective prior year. Margins grew from $271 million in 2000 to $283 million in 2001 and to $298 million in 2002. As a percentage of life insurance premium, life insurance gross margins were 25% in both 2001 and 2000, but declined slightly to 24.4% in 2002. There was a slight increase in mortality in 2002 compared with the previous two years.
Premium for the health insurance segment increased 1% to $1.02 billion in 2002. It rose 11% to $1.01 billion in 2001 and 10% to $911 million in 2000. Annualized health premium in force declined 1% to $1.03 billion at December 31, 2002 over the previous year-end balance of $1.04 billion. Health premium in force rose 4% in 2001 and 14% during 2000. Sales of health insurance, in terms of annualized premium issued, declined 5% in 2002 to $202 million. In 2001, health sales declined 16% from $252 million to $213 million. The declines in health sales were attributable to declines in Medicare Supplement sales in both periods.
Medicare Supplement sales, in terms of annualized premium issued, fell 37% in 2002 to $99 million from $159 million in 2001. In 2001, Medicare Supplement sales were down 21% from $201 million the prior year. There were three major factors which contributed to these declines. First, sales in recent years prior to 2001 were positively affected by the involuntary terminations of Medicare HMO members, which resulted in the disenrollees returning to traditional Medicare and Medicare Supplements. In 2000, the number of disenrollees reached an unprecedented level. In 2001, however, these terminations were approximately half of those of the prior year. In 2002, terminations continued to decline. The second factor was that Medicare Supplement sales faced increased premium rate pressure from competition in some markets. Torchmark implemented premium rate increases on its Medicare Supplement policies on a more timely basis than some competitors during these periods. Management believes that these competitive pressures will subside as competitors obtain necessary rate increases. Torchmark plans to seek lower rate increases in 2003 than in recent years on this business which may improve its competitive position. Third, in addition to the increased competition, the number of producing agents at the United American Branch Office Agency declined in 2001 as agents in some markets left for easier sales at those competitors whose Medicare Supplement products were priced lower than Torchmark’s. Prior to 2001, this agency had experienced rapid growth in appointed agents, which contributed greatly to the growth in sales in these periods.
Medicare Supplement policies are highly regulated at both the federal and state levels with standardized benefit plans, limits on first year agent compensation, and mandated minimum loss ratios. However, they remain a popular supplemental health policy with the country’s large and growing group of Medicare beneficiaries. About 85% of all Medicare beneficiaries have Medicare Supplements to cover at least some portion of the deductibles and coinsurance for which the federal Medicare program does not pay. Because of loss ratio regulation, underwriting margins on Medicare Supplements are lower than those on Torchmark’s life business. However, due to United American’s low cost, service-oriented customer service and claims administration, as well as its economies of scale, it is a profitable line of business.
Medicare Supplement insurance is sold primarily by the United American Branch Office Agency and the United American Independent Agency. Medicare Supplement sales in both agencies have declined in both 2001 and 2002 as a result of the decline in HMO disenrollees, the increased competition, and the loss in the number of agents. At the end of 2001, the number of producing agents was 1,644 and declined to 1,280 at year-end 2002. In terms of annualized health premium issued, health sales for the Branch Office Agency were $75 million in 2002, declining 35% from sales of $116 million in 2001. Health sales in 2001 declined 20% from sales of $145 million in 2000. The Independent Agency sold $85 million, $74 million, and $96 million in each of the years 2000, 2001, and 2002, respectively. This represents a decline of 14% in 2001 but an increase of 31% in 2002. While Medicare Supplement sales in this agency declined in 2002, increases in sales of other limited-benefit health products, as discussed below, have more than offset the declines.
Cancer insurance premium in force rose 2% in 2002 to $173 million. It was flat in 2001 with premium in force of $169 million in both 2001 and 2000. Sales of this product were up 9% in 2002 to $12 million. Sales rose 7% in 2001 to $11 million from $10 million. A portion of the growth in cancer annualized premium in force has been attributable to premium rate increases to offset increased health care costs. Cancer insurance products are sold primarily by the Liberty National Exclusive Agency. This agency represented 85% of Torchmark’s total cancer annualized premium in force at December 31, 2002.
Sales of other limited-benefit health products more than doubled in 2002, increasing from $44 million in 2001 to $91 million in 2002. Sales of these products previously increased 7% in 2001 over the prior year. Annualized premium in force for other health products grew 28% in 2002 to $144 million, after rising 6% in 2001 to $112 million. The United American agencies have offered limited benefit plans for many years. The majority of the recent increases in sales were written by the United American Independent Agency. Most of the plans being written are limited benefit hospital and surgical plans that are lower cost alternatives to individual major medical plans, or that are bought to supplement employer-sponsored group health plans. Increased demand for these plans is the result of the growing unavailability of individual major medical plans and decreased coverage offered by employers. Because of the limits on maximum benefits and other limits, these type plans are less subject to high rate increases that have been experienced in major medical type plans. From a regulatory standpoint, these type plans generally require lower minimum loss ratios than Medicare Supplements, but they do experience slightly higher lapse rates.
Annuity premium is added to the annuity account balance as a deposit and is not reflected in income. Revenues on both fixed and variable annuities are derived from charges to the annuity account balances for insurance risk, administration, and surrender, depending on the structure of the contract. Variable accounts are also charged an investment fee and a sales charge. Torchmark benefits to the extent these policy charges exceed actual costs and, on fixed annuity policies, to the extent actual investment income exceeds the investment income which is credited to the policy.
Collections of fixed annuity premium almost doubled in 2002 at $65 million, compared with $33 million in 2001. Fixed annuity premium collections declined 20% in 2001 from $42 million in 2000. The fixed annuity deposit balance rose 3% to $628 million at year-end 2002 from $610 million at year-end 2001. This increase reversed the decline of 8% in 2001 to $610 million at year end from $662 million at year-end 2000. During 2000 and 2001, Torchmark had experienced weaker sales as a result of the reduced sales force and its reduced emphasis of annuity products. In 2002, weaker financial markets caused increased customer interest in fixed annuities and resulted in some transfers of variable annuity customers to fixed products.
Annuity underwriting income before other income and administrative expense declined from $26 million in 2001 to $15 million in 2002. It declined 17% from $31 million in 2000. The declines in annuity underwriting income resulted from the declines in the annuity account balance in each period. Policy charges rose 13% in 2001 to $60 million before dropping 35% in 2002 to $39 million. Policy charges are generally based on the size of the annuity account balance. In 2001, policy charges increased despite declining account balances because of surrender charges generated by the Waddell & Reed replacement activity. However, the replacements caused an increase in the amortization of deferred acquisition costs which reduced 2001 underwriting income. The reduced variable annuity sales and replacement activity continued in 2002 and, along with the weaker financial markets, resulted in the lower variable annuity account size and overall lower annuity underwriting income.
It is Torchmark’s investment strategy to maintain a positive spread between yields on new investments and the company’s required yield on policy and financing costs. To accomplish this, the company invests new cash primarily in corporate investment-grade quality fixed-maturity bonds. In periods of lower than historically normal interest rates, such as experienced in recent years, Torchmark maintained its yield spread by purchasing longer maturities. Because the majority of Torchmark’s liabilities are its policy liabilities, which have fixed interest rates and are very long-term, Torchmark does not experience negative asset and liability matching by extending investment maturities. Torchmark’s 2002 investment results indicate this strategy is effective even in periods of low rates, but the company expects to benefit as rates eventually rebound. Funds generated annually from insurance operations as well as those from the investment portfolio exceed the total of floating rate liabilities, and reinvestment at higher rates should result in a positive benefit to excess investment income.
At the close of 2002, the fixed-maturity portfolio had a tax-equivalent book yield of 7.43%, virtually the same as the 7.44% portfolio yield of the previous year and slightly less than 7.50% at the end of 2000. The portfolio average life increased to 9.6 years at year-end 2002, compared with 9.4 years at the end of 2001. Both yield and average life calculations are based on the maturity date, or for callable bonds, the call or the maturity date whichever produces the lowest yield (yield to worst).
The distribution of expected maturities at December 31 of the indicated year is as follows:
With emphasis on bond investments over investments in equities, mortgages, or real estate, the relative percentage of Torchmark’s investments by type continues to vary from industry data. The following table presents Torchmark’s components of invested assets at amortized cost as of December 31, 2002 with the latest industry data.
Market Risk Sensitivity. Market risk is the risk that the value of a security will change because of a change in market conditions. Torchmark’s primary exposure to market risk is interest rate risk, which is the risk that a change in a security’s value could occur because of a change in interest rates. This risk is significant to Torchmark’s investment portfolio because its fixed-maturity holdings amount to 92% of total investments. The effects of interest rate fluctuations on fixed investments are reflected on an after-tax basis in Torchmark’s shareholders’ equity because these investments are marked to market value under SFAS 115.
No derivative instruments are used to manage Torchmark’s exposure to market risk in the investment portfolio. Interest-rate swap instruments have been entered into by Torchmark in connection with its preferred stock and certain debt issues as discussed in the Notes to the Consolidated Financial Statements on page 70 of this report and in Capital Resources beginning on page 34 of this report.
Torchmark’s cash and short-term investments were $80 million at year-end 2002 and $138 million at year-end 2001. In addition to these highly liquid assets, Torchmark has a portfolio of marketable fixed and equity securities that are available for sale should the need arise. These securities had a value of $7.2 billion at December 31, 2002.
Torchmark has in place a line of credit facility with a group of lenders which allows unsecured borrowings and stand-by letters of credit up to $625 million. The facility is split into two parts: a $325 million 364-day tranche maturing November 27, 2003, and a $300 million five-year tranche maturing November 30, 2006. The company has the ability to request up to $200 million in letters of credit to be issued against the $300 million five-year tranche. Under either tranche, interest is charged at variable rates. The line of credit is further designated as a back-up credit line for a commercial paper program not to exceed $600 million, whereby Torchmark may borrow from either the credit line or issue commercial paper at any time. Commercial paper borrowings and letters of credit on a combined basis may not exceed $625 million. At December 31, 2002, $202 million face amount of commercial paper was outstanding, $170 million letters of credit were issued, and there were no borrowings under the line of credit. A facility fee is charged on the entire $625 million facility. The facility does not contain any ratings-based acceleration triggers which would require early repayment. In accordance with the agreements, Torchmark is subject to certain covenants regarding capitalization and earnings. At December 31, 2002, Torchmark was in full compliance with these covenants.
Capital Resources. In the use of financial measures and ratios to evaluate its use of capital resources, Torchmark’s management adjusts shareholders’ equity to remove the effect caused by changes in the interest rates in the financial markets. Torchmark has a large available-for-sale fixed- maturity portfolio and is required by an accounting rule (SFAS 115) to revalue the portfolio to fair market value at the end of each accounting period. These changes in value, net of tax, are reflected directly in shareholders’ equity. Because the size of Torchmark’s fixed maturity portfolio is very large relative to shareholders’ equity, and because small changes in interest rates can cause huge swings in market value, Torchmark’s shareholders’ equity as reported in accordance with GAAP can be volatile. This volatility can distort the measure of Torchmark’s capital structure, as the short-term changes in the value of its fixed-maturity investment portfolio have little bearing on its long-term ongoing insurance business. For this reason, this interest-based market adjustment is removed from shareholders’ equity and related
ratios to provide management and investors a clearer picture of Torchmark’s shareholders’ equity. A reconciliation of shareholders’ equity excluding SFAS 115 with shareholders’ equity is as follows:
Torchmark issued $180 million principal amount of 6 1/4% Senior Notes in December, 2001. These notes will mature on December 15, 2006 and may not be redeemed prior to maturity. There is no sinking fund requirement. Interest is payable semi-annually on June 15 and December 15. These notes are unsecured and rank equally with Torchmark’s other unsecured indebtedness. Proceeds from the issuance, after underwriters’ discount and expenses of the offering, were approximately $178 million. Proceeds were used initially to pay down short-term debt.
In November, 2001, Torchmark established two Capital Trusts which in turn sold trust preferred securities in a public offering. Capital Trust I sold 5 million shares and Capital Trust II sold 1 million shares. The trust preferreds sold in the two offerings have identical terms. Each offering consisted of 7 3/4% trust preferreds at a liquidation amount of $25 per security, resulting in an aggregate liquidation amount of $150 million. They are redeemable at Torchmark’s option in part or whole at any time on or
In conjunction with the offering of the trust preferred securities, Torchmark entered into a ten-year swap agreement to replace the 7 3/4% fixed-distribution obligation with a floating rate payment. The floating rate is based on the three-month LIBOR and resets each quarter when the distributions are made. The trust preferred swap rate is set in arrears each quarter. Therefore it is estimated at the end of each accounting period. At December 31, 2002, the variable rate was 3.6%. This swap derivative does not qualify as a hedge for accounting purposes and is carried on the consolidated balance sheet at fair market value. At December 31, 2002, this swap was valued at a gain of $16 million before tax. Torchmark’s net operating income was increased $3.7 million in 2002 as a result of the swap.
The MIPS were originally issued in 1994 at a redemption amount of $200 million with a monthly dividend based on an annual rate of 9.18%. The MIPS were redeemable at Torchmark’s option at any time after September 30, 1999 at the full redemption amount of $25 per share. Torchmark elected to redeem the MIPS in full during 2001 in three transactions which resulted in an after-tax loss on redemption of $4.3 million. Funds to repay $110 million of the principal amount were derived from the issuance of the trust preferred securities in November, 2001, while the remaining $90 million balance was redeemed using corporate cash flow or by short-term borrowings earlier in the year.
Torchmark has a swap agreement, originally entered into when the MIPS were issued, to exchange a monthly fixed payment based on an annual rate of 9.18% for a floating rate based on the one-month LIBOR rate on a notional amount of $200 million. While the MIPS have been redeemed, the swap is still in place and does not expire until September 30, 2004. At December 31, 2002, Torchmark was obligated to pay at a floating rate of 2.83% on this agreement, while collecting at a rate of 9.18%. Torchmark’s net operating income benefited $7.7 million in 2002, $4.6 million in 2001, and $1.6 million in 2000 because of this swap agreement. At December 31, 2002, this swap was carried at its fair market value of $21 million.
investment losses were excluded, this coverage ratio would have been 23.6 in 2002 and 14.6 in 2001. Torchmark’s interest expense declined 36% in 2002 to $29 million and 18% to $44.5 million in 2001. The 2002 decline in interest expense was caused primarily by the lower rates in financial markets that resulted in a benefit from the three interest rate swaps and in reduced interest cost on short-term debt. The 2001 decline also resulted from much lower interest rates in financial markets and a reduction in average debt outstanding.
In each of the years 2001 and 2000, Torchmark executed stock option exercise and restoration programs whereby Torchmark employees and directors exercised vested stock options and received a reduced number of new options at the current market price. While these programs resulted in the issuance of new shares, a substantial portion of the new shares were sold immediately by the participants in the open market to cover the cost of the purchased shares and the related minimum taxes. As a result of these restoration programs, management’s ownership interest increased, and Torchmark received a current tax benefit from the exercise of the options. The following table presents key information about the programs.
Credit Ratings. The credit quality of Torchmark’s debt instruments and capital securities are by various rating agencies. The chart below presents selected ratings as of December 31, 2002.
The financial strength of Torchmark’s major insurance subsidiaries are also rated by Standard & Poor’s and A.M. Best. The following chart presents these ratings for Torchmark’s five largest insurance subsidiaries at December 31, 2002.
The AA rating is assigned by Standard & Poor’s Corporation to those companies who offer excellent financial security on an absolute and relative basis and whose capacity to meet policyholders’ obligations is overwhelming under a variety of economic and underwriting conditions.
Contractual Commitments. A schedule of Torchmark’s scheduled contractual commitments for the next five years at December 31, 2002 is as follows.
MidFirst Bank. Torchmark has engaged MidFirst Bank as the servicing agent for a portion of Torchmark’s subsidiaries’ commercial mortgages portfolios. George J. Records, a Torchmark director, is an officer, director, and 38.3% beneficial owner of Midland Financial Co., the parent corporation of MidFirst Bank. Fees paid for these services were $118 thousand in 2002, $109 thousand in 2001, and $106 thousand in 2000.
Future Policy Benefits. Because of the long-term nature of insurance contracts, Torchmark’s insurance companies are liable for policy benefit payments that will be made in the future. The liability for future policy benefits represents estimates of the present value of Torchmark’s insurance subsidiaries’ expected benefit payments, net of the related present value of future net premium collections. It is determined by standard actuarial procedures common to the life insurance industry, using assumptions as to mortality (life expectancy), morbidity (health expectancy), persistency, and interest rates, which are based on Torchmark’s previous experience with similar products. For the majority of Torchmark’s insurance products, the assumptions used were those considered to be appropriate at the time the policies were issued. An additional provision is made on most products to allow for possible adverse deviation from the assumptions assumed. For insurance products considered to be interest-sensitive or deposit-balance type products, the assumptions are monitored on a regular basis and modified when it is determined that actual experience is different from that previously assumed. While management and company actuaries have used their best judgment in determining the assumptions and in calculating the liability for future policy benefits, there is no assurance that the estimate of the liabilities reflected in the financial statements represents Torchmark’s ultimate obligation. Additionally, significantly different assumptions could result in materially different reported amounts. A complete list of the assumptions used to calculate the liability for future policy benefits is reported in Note 7-Future Policy Benefits Reserves in the Notes to Consolidated Financial Statements found on page 62 of this report.
Revenue Recognition. Premium income for Torchmark’s subsidiaries’ insurance contracts is generally recognized as the premium is collected. However, in accordance with GAAP, revenue on limited-payment contracts and universal life-type contracts (deposit balance products) are recognized differently. Revenues on limited-payment contracts are recognized over the contract period. Premium for deposit balance products, such as Torchmark’s annuity and interest-sensitive life policies, is added to the policy account value. The policy account value (or deposit balance) is a Torchmark liability. This deposit balance is then charged a fee for the cost of insurance, administration, surrender, and certain other charges which are recognized as revenue in the period the fees are charged to the policyholder. In each
case, benefits and expenses are matched with revenues in a manner by which they are incurred as the revenues are earned.
The determination that a security is permanently impaired is highly subjective. Many factors are taken into account including:
in certain assumptions may cause material differences in reported results. While management has used its best efforts to determine the most reliable assumptions, given the information available from company experience, economic data, independent consultants and other sources, no assurance can be given that actual results will be the same as expected. Torchmark’s discount rate, rate of return on assets, and projected salary increase assumptions are disclosed in Note 12-Postretirement Benefits in the Notes to Consolidated Financial Statements on page 66 of this report.
Torchmark makes cash contributions to the funded plans from time to time subject to mandatory required minimums and Internal Revenue Service allowed maximums for tax deductibility. These contributions were $7.2 million, $1.0 million, and $.6 million in each of the years 2002, 2001, and 2000, respectively. Assets in the funded plans are placed in a diversified mix of investments. At December 31, 2002 the composition of investments at fair value was as follows:
Consolidated Statements of Shareholders’ Equity for each of the three years in the period ended December 31, 2002
Investments: Torchmark classifies all of its fixed maturity investments, which include bonds and redeemable preferred stocks, as available for sale. Investments classified as available for sale are carried at fair value with unrealized gains and losses, net of deferred taxes, reflected directly in accumulated other comprehensive income. Investments in equity securities, which include common and nonredeemable preferred stocks, are reported at fair value with unrealized gains and losses, net of deferred taxes, reflected directly in accumulated other comprehensive income. Policy loans are carried at unpaid principal balances. Mortgage loans are carried at amortized cost. Investments in real estate are reported at cost less allowances for depreciation, which are calculated on the straight line method. Short-term investments include investments in certificates of deposit and other interest-bearing time deposits with original maturities within twelve months. If a decline in the fair market value of an investment is deemed other than temporary, such impairment is treated as a realized loss and the investment’s cost basis is adjusted to fair market value.
Determination of Fair Values of Financial Instruments: Fair value for cash, short-term investments, short-term debt, receivables and payables approximates carrying value. Fair values for investment securities are based on quoted market prices, where available. Otherwise, fair values are based on quoted market prices of comparable instruments. Mortgages are valued using discounted cash flows. Substantially all of Torchmark’s long-term debt, along with the trust preferred securities, is valued based on quoted market prices. Interest rate swaps are valued using discounted anticipated cash flows.
The pro forma effect of the adoption of SFAS 142 on reported earnings is as follows:
Earnings Per Share: Torchmark presents basic and diluted earnings per share (EPS) on the face of the income statement and a reconciliation of basic EPS to diluted EPS. Basic EPS is computed by dividing income available to common stockholders by the weighted average common shares outstanding for the period. Weighted average common shares outstanding for each period are as follows: 2002-120,258,685, 2001-125,134,535, and 2000-128,089,235. Diluted EPS is calculated by adding to shares outstanding the additional net effect of potentially dilutive securities or contracts, such as stock
options, which could be exercised or converted into common shares. Weighted average diluted shares outstanding for each period are as follows: 2002-120,669,115, 2001-125,860,869, and 2000-128,353,404. For more information on earnings per share, see Note 16-Shareholders’ Equity.
Torchmark has elected to account for its stock options under the intrinsic value method as outlined in APB 25, and has therefore computed the required pro forma earnings disclosures utilizing the fair value method. The fair value method requires the use of an option valuation model, such as the Black-Scholes option valuation model, to value employee stock options. Compensation expense is based on these values. The expense is then charged to pro forma earnings over the option vesting period. Under the intrinsic value method, compensation expense for Torchmark’s option grants is only recognized if the exercise price of the employee stock option is less than the market price of the underlying stock on the date of grant.
Insurance subsidiaries of Torchmark are required to file statutory financial statements with state insurance regulatory authorities. Accounting principles used to prepare these statutory financial statements differ from GAAP. Consolidated net income and shareholders’ equity on a statutory basis for the insurance subsidiaries were as follows:
The excess, if any, of shareholders’ equity of the insurance subsidiaries on a GAAP basis over that determined on a statutory basis is not available for distribution to Torchmark without regulatory approval.
A reconciliation of Torchmark’s life insurance subsidiaries’ statutory net income to Torchmark’s consolidated GAAP net income is as follows:
A schedule of fixed maturities by contractual maturity at December 31, 2002 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.
Torchmark had $2.2 million in investment real estate at December 31, 2002, which was nonincome producing during the previous twelve months. These properties consisted primarily of undeveloped land. Torchmark had $10.8 million in nonincome producing mortgages as of December 31, 2002. Torchmark had $473 thousand in nonincome producing fixed maturities during the twelve months ended December 31, 2002. There were no other long-term investments which were nonincome producing at December 31, 2002.
During 2002, Torchmark wrote down a portion of its investment real estate portfolio to net realizable value. The write down resulted in a pretax loss of $3.6 million, or $2.4 million after tax. At December 31, 2002, Torchmark owned $9.4 million in investment real estate, of which $7.0 million was included with properties partially occupied by Torchmark subsidiaries.
Depreciation expense on property and equipment used in the business was $4.5 million, $5.2 million, and $6.3 million in each of the years 2002, 2001, and 2000, respectively.
The amount of interest accrued on the unamortized balance of value of insurance purchased was $6.6 million, $7.7 million, and $9.1 million, for the years ended December 31, 2002, 2001, and 2000, respectively. The average interest rates used for the years ended December 31, 2002, 2001, and 2000, were 6.1%, 6.2%, and 6.4%, respectively. The estimated amortization, net of interest accrued, on the unamortized balance at December 31, 2002 during each of the next five years is: 2003, $11.0 million; 2004, $9.5 million; 2005, $8.2 million; 2006, $7.1 million; and 2007, $6.2 million.
Energy. In 1996, Torchmark divested itself of the majority of its energy operations, which was accounted for as the disposal of a segment. At the time of the disposition, there was pending litigation in which Torchmark was named as a party. This litigation was settled in 2001, resulting in an after-tax charge of $3.3 million which is reflected in discontinued operations.
A summary of the assumptions used in determining the liability for future policy benefits at December 31, 2002 is as follows:
At the end of each period, the liability for unpaid health claims includes an estimate of claims incurred but not yet reported to the Company. This estimate is based on historical trends. The difference between the estimate made at the end of each prior period and the actual experience is reflected above under the caption “Incurred related to: Prior year.”
In 2002, 2001, and 2000, deferred income tax expense was incurred because of certain differences between net income from continuing operations before income taxes as reported on the consolidated statement of operations and taxable income as reported on Torchmark’s income tax returns. As explained in Note 1, these differences caused the financial statement book values of some assets and liabilities to be different from their respective tax bases.
Torchmark has not recognized a deferred tax liability for the undistributed earnings of its wholly-owned subsidiaries because such earnings are remitted to Torchmark on a tax-free basis. A deferred tax liability will be recognized in the future if the remittance of such earnings becomes taxable to Torchmark. In addition, Torchmark has not recognized a deferred tax liability of approximately $10 million that arose prior to 1984 on temporary differences related to the policyholders’ surplus accounts in the life insurance subsidiaries. A current tax expense will be recognized in the future if and when these amounts are distributed.
Cost for the defined benefit pension plans has been calculated on the projected unit credit actuarial cost method. Contributions are made to the pension plans subject to minimums required by regulation and maximums allowed for tax purposes. The plans covering the majority of employees are organized as trust funds whose assets consist primarily of investments in marketable long-term fixed maturities and equity securities which are valued at fair market value.
The excess benefit pension plan provides the benefits that an employee would have otherwise received from a defined benefit pension plan in the absence of the Internal Revenue Code’s limitation on benefits payable under a qualified plan. Although this plan is unfunded, pension cost is determined in a similar manner as for the funded plans. Liability for the excess benefit plan was $5.4 million at both December 31, 2002 and 2001.
The weighted average assumed discount rates used in determining the actuarial benefit obligations were 6.75%, 7.25%, and 7.50% in 2002, 2001, and 2000, respectively. The rate of assumed compensation increase was 4.50% in each of the years 2000 through 2002 and the expected long-term rate of return on plan assets was 9.25% in each of the same years. The discount and compensation increase rates are used to determine current year projected benefit obligations and subsequent year pension expense. The long-term rate of return is used to determine current year expense. Differences between assumptions and actual experience are included in actuarial gain or loss.
For retired employees over age sixty-five, Torchmark does not provide postretirement benefits other than pensions. Torchmark does provide a portion of the cost for health insurance benefits for certain employees who retired before February 1, 1993 and for certain employees that retired before age sixty-five, covering them until they reach age sixty-five. Eligibility for this benefit was generally achieved at age fifty-five with at least fifteen years of service. This subsidy is minimal to retired employees who did not retire before February 1, 1993. This plan is unfunded.
The weighted average discount rate used in determining the accumulated postretirement benefit obligation for plans other than pensions was 7.59% in 2002, 7.58% in 2001, and 7.55% in 2000.
The Notes, due May 15, 2023, were issued in May, 1993 in the principal amount of $200 million. Interest is payable on May 15 and November 15 of each year at a rate of 7 7/8%. In 2002, 2001, and 2000, Torchmark purchased principal amounts of $75 thousand, $8.1 million, and $4.6 million in the open market at a cost of $76 thousand, $8.3 million, and $4.2 million, respectively. After-tax losses on the redemption of debt of $2 thousand and $277 thousand were recorded during 2002 and 2001, respectively. An after-tax gain on the redemption of debt of $166 thousand was recorded in 2000. These notes are not callable prior to maturity and have equal priority with other Torchmark unsecured indebtedness.
During 2001, Torchmark used funds received from short-term borrowings and the issuance of the trust preferreds to redeem its 8 million shares of 9.18% MIPS for a total cost of $200 million plus accrued dividends. Torchmark recognized an after-tax loss of approximately $4.3 million during 2001 as a result of the redemption.
Acquisition of Common Shares: Torchmark shares are acquired from time to time through open market purchases under the Torchmark stock repurchase program when it is believed to be the best use of Torchmark’s funds and for future employee stock option exercises. Share repurchases under this program were 4.8 million shares at a cost of $182 million in 2002, 7.8 million shares at a cost of $303 million in 2001, and 6.1 million shares at a cost of $147 million in 2000.
Retirement of Treasury Stock: On May 11, 2001, Torchmark retired 21 million shares of its treasury stock. The retirement resulted in a decrease in common stock of $21 million, decrease in additional paid-in capital of $89 million, decrease in retained earnings of $527 million, and a decrease in treasury stock of $637 million.
A summary of Torchmark’s stock option activity and related information for the years ended December 31, 2002, 2001, and 2000 follows:
The weighted average fair value of options granted during the years ended December 31, 2002, 2001, and 2000 were $10.33, $13.00, and $12.05, respectively.
* Issued when the market price was $24.8125. Option price at that time (prior to the Waddell & Reed spin-off adjustment) was $18.61.
Leases: Torchmark leases office space and office equipment under a variety of operating lease arrangements. These leases contain various renewal options, purchase options, and escalation clauses. Rental expense for operating leases was $3.4 million in 2002, $3.2 million in 2001, and $3.3 million in 2000. Future minimum rental commitments required under operating leases having remaining noncancelable lease terms in excess of one year at December 31, 2002 are as follows: 2003, $2.1 million; 2004, $1.4 million; 2005, $962 thousand; 2006, $731 thousand; 2007, $614 thousand and in the aggregate, $7.2 million.
Concentrations of Credit Risk: Torchmark maintains a highly diversified investment portfolio with limited concentration in any given region, industry, or economic characteristic. At December 31, 2002, the investment portfolio consisted of the following:
Investments in municipal governments and corporations are made throughout the U.S. with no concentration in any given state. Most of the investments in foreign government securities are in Canadian government obligations. Corporate debt and equity investments are made in a wide range of industries. At December 31, 2002, 2% or more of the portfolio was invested in the following industries:
Otherwise, no individual industry represented 2% or more of Torchmark’s investments. At year-end 2002, 7% of invested assets was represented by fixed maturities rated below investment grade (BB or lower as rated by the Bloomberg Composite or the equivalent NAIC designation). Par value of these
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 is a one-year renewable contract expiring in 2006. The maximum amount of letters of credit available is $200 million. Torchmark (parent company) would be liable to the extent that TMK Re, Ltd. does not pay the reinsured party. At December 31, 2002, $161 million of letters of credit were outstanding.
the effect of this legislation on Torchmark’s litigation remains unclear. Additionally, it should be noted that Torchmark subsidiaries actively market insurance in the State of Mississippi, a jurisdiction which is recognized nationally for large punitive damage verdicts. Bespeaking caution is the fact that the likelihood or extent of a punitive damage award in any given case is currently impossible to predict. As of December 31, 2002, Liberty was a party to approximately 93 active lawsuits (including 9 employment related cases and excluding interpleaders and stayed cases), 69 of which were Alabama proceedings and 9 of which were Mississippi proceedings in which punitive damages were sought. Liberty faces trial settings in these cases on an on-going basis.
As previously reported, Liberty was served on October 28, 1999 with a subpoena from the Florida Department of Insurance in connection with that Department’s investigation into Liberty’s sales practices and disclosures in the State of Florida regarding industrial life insurance and low coverage life insurance policies. Liberty has also received similar subpoenas from the Alabama, Georgia, Kentucky, Texas, South Carolina and Minnesota Insurance Departments regarding its industrial life insurance and other low face-amount life insurance policies sold in those states. Specific inquiry is made into the historical use of race-distinct mortality in the design or pricing of industrial insurance, a practice believed to be actuarially sound, but nevertheless discontinued by Liberty many years ago. In 1988, Liberty endeavored to convert to paid-up status those policies utilizing race-distinct mortality that remained in premium-paying status at that time. Liberty has been and continues responding to these subpoenas in a timely fashion. In July 2000, the Florida and Georgia Insurance Departments issued cease and desist orders to all companies reporting premium income from industrial life insurance, including Liberty, stating that, to the extent that any company is currently collecting any race-distinct insurance premiums from Florida and Georgia residents, respectively, it immediately cease and desist from collecting any premium differential based on the race of the policyholders. Upon receiving the Georgia order, Liberty informed the Georgia Insurance Department that Liberty did not interpret the Georgia Department’s directive as a cease and desist order since it did not afford Liberty the opportunity for a mandatory or voluntarily requested hearing thereunder. On August 22, 2000, the Florida District Court of Appeals issued an order staying the Florida Insurance Department’s immediate final cease and desist order, pending appeals to the Florida Supreme Court. The Florida Supreme Court subsequently reversed and rendered the District Court of Appeals’ order, and thus declared the cease and desist order null and void. Liberty, as an Alabama domestic company, was examined by representatives of the Alabama Department of Insurance with regard to issues parallel to those raised by the State of Florida. By order dated January 28, 2002, the Alabama Department finalized a report of its examination of Liberty. The report has now been turned over to the Alabama Department’s Legal Division for further consideration.
On July 3, 2000, the District Court issued an order in the Moore case granting in part and denying in part the plaintiffs’ motions. The District Court ordered the Moore plaintiffs to file an amended complaint setting forth their claims under 28 U.S.C. §§ 1981 and 1982 and, if such claims are timely, any state law claims for breach of contract related to the discontinuance of debit collections, and dismissed with prejudice all remaining state law claims of the plaintiffs as time-barred by the common law rule of repose. On July 14, 2000, plaintiffs filed their amended complaint with the District Court and Liberty filed a motion to alter or amend the District Court’s July order or, in the alternative, requested that the District Court certify for purposes of appeal the issue whether the state law doctrine of repose should be applied to and bar plaintiffs’ actions under 28 U.S.C. §§ 1981 and 1982. The District Court entered such an order on July 21, 2000 and stayed proceedings in Moore pending resolution of Liberty’s petition to the U.S. Circuit Court of Appeals for the Eleventh Circuit. Liberty filed a petition on July 30, 2000 with the Eleventh Circuit seeking that Court’s permission to appeal the portions of the District Court’s July order in Moore granting the plaintiffs the right to file the amended complaint. The Eleventh Circuit Court granted Liberty’s motion and agreed to consider Liberty’s arguments regarding the applicability of the state law of repose to actions under 28 U.S.C. §§ 1981 and 1982. Oral arguments were heard by the Eleventh Circuit Court on July 20, 2001. On September 28, 2001, the Eleventh Circuit Court ruled that the rule of repose was not a bar to the Moore claims in federal court and that there is no reverse pre-emption under the McCarrin Ferguson Act. Liberty filed a petition seeking an en banc rehearing in the Eleventh Circuit Court, which was subsequently denied. Liberty filed a petition for a writ of certiorari with the U.S. Supreme Court on February 21, 2002, which has been denied. The plaintiffs filed their motion for class certification in Moore with the District Court on December 20, 2002 and Liberty filed its opposition to this motion on February 3, 2003. .
Four individual cases with similar allegations to those in the Moore case which were filed against Liberty in various state Circuit Courts in Alabama remain pending and have been removed and/or transferred to the U.S. District Court for the Northern District of Alabama. The Moore case and all cases transferred to the Northern District of Alabama have been assigned to Judge U.W. Clemon, a noted former civil rights attorney. In the earliest filed of the individual state court actions, Walter Moore v. Liberty National Life Insurance Company (Circuit Court of Dallas County, Alabama, CV 00-306) the Court entered an order granting summary judgment in favor of Liberty based upon the doctrine of repose and has subsequently denied a motion to reconsider its dismissal of this case.
Hudson v. Liberty National Life Insurance Company, one of the four individual cases referenced above, was filed in the Circuit Court of Bullock County, Alabama on February 28, 2001 (Case No. CV 2001-25) and contains similar allegations to those in Moore. After denials by the Bullock Circuit Court of Liberty’s motion to dismiss and request that certain questions arising in the litigation be certified to the Alabama Supreme Court, Liberty sought a writ of mandamus on the certified questions issue from the Alabama Supreme Court. The Alabama Supreme Court agreed to hear Liberty’s petition for writ of mandamus seeking to have the Supreme Court direct the trial court to grant Liberty’s motion to dismiss or for a summary judgment or to certify for interlocutory appeal the Circuit Court’s denial of such motion. On January 18, 2002, the Alabama Supreme Court denied Liberty’s request for the writ of mandamus but noted that Liberty’s motion for summary judgment based on the rule of repose remained pending in the trial court and was ripe for adjudication. Upon remand, plaintiff amended his complaint to add causes of action under federal law and this case has been removed to federal court as discussed above.
In the fifth individual state court action, (Edwards v. Liberty National Life Insurance Company, Case No. CV 0005872), the trial court denied Liberty’s motion seeking a summary judgment based upon the rule of repose but indicated that it would reconsider that motion after discovery. Liberty filed a motion to alter or amend the trial court’s order, or in the alternative, for an interlocutory appeal. In September 2001, the trial court in that case vacated its earlier order and stayed the litigation pending resolution of the Hudson case, which is discussed above. On February 22, 2002, the trial court held a hearing regarding the stay in Edwards. The trial court permitted the plaintiffs very limited discovery.
There are a total of 16 race-distinct mortality cases pending in the U.S. District Court for the Northern District of Alabama (with two of such cases having been originally filed in the U.S. District Court for the Northern District of Georgia), including Sunday v. Liberty National Life Insurance Company, Case No. CV02-BE-0639-S), in which approximately 460 individuals assert that they had discriminatory insurance policies with Liberty. The Baldwin and Edwards cases remain pending in Alabama Circuit Courts. Plaintiffs’ attorneys have actively advertised for additional plaintiffs to join these suits or file additional suits.
On December 23, 2002, seventy individual plaintiffs filed an action against Liberty and certain of its sales agents in the Circuit Court of Holmes County, Mississippi (Thurmond v. Liberty National Life Insurance Company, Cause No.: 2002-517). The plaintiffs, all African Americans, assert claims of fraudulent and reckless misrepresentation, innocent misrepresentation, fraudulent concealment and suppression, breach of contract in the dismantling of Liberty’s debit collection system and racial discrimination under various sections of the Mississippi Code Annotated in connection with the marketing, sale and administration by Liberty of plaintiffs’ industrial low value whole life, accident and/or burial insurance policies. Actual and punitive damages in an unspecified amount, interest and costs are sought.
On December 27, 2002, individual litigation involving 120 separate plaintiffs with substantially similar allegations, was filed against Liberty in the Circuit Courts of Holmes County, Mississippi (Billingsley v. Liberty National Life Insurance Company, Civil Action No.: 2002-532), of Bolivar County, Mississippi (Hudson v. Liberty National Life Insurance Company, Civil Action No.: 2002-170) and of Leflore County, Mississippi (Teague v. Liberty National Life Insurance Company, Civil Action No.: 2002-0218-CICI). Plaintiffs in each action assert that Liberty and its sales agents marketed small value debit insurance policies at racially discriminatory rates to African Americans using racially discriminatory sales and administrative practices and collected premium payments which are alleged to be excessive and
On July 26, 2001, litigation was filed against Torchmark and three current members of Torchmark’s Board of Directors in the United States District Court for the District of Kansas (Waddell & Reed Financial, Inc. v. Torchmark Corporation, Civil Action No. 01-2372-KHV). Plaintiffs assert that defendants engaged in a scheme to control and injure Waddell & Reed Financial, Inc. (Waddell & Reed) after it was spun-off by Torchmark in November 1998, to interfere with the business relationship between a Waddell & Reed subsidiary, Waddell & Reed, Inc. (W&R) and a Torchmark subsidiary, United Investors, and to injure Waddell & Reed as well as asserting that one of the individual defendants sought to interfere with Waddell & Reed’s relationship with the United Group of Mutual Funds. The litigation alleges RICO violations, breaches of fiduciary duty by the three individual defendants, knowing participation in such breaches of fiduciary duty by Torchmark and intentional interference with prospective business relations in connection with the relationship between W&R and United Investors. Plaintiffs seek actual, punitive and treble damages, interest, fees and costs under RICO of $29 million, $13.4 million plus punitive damages, interest and costs on the intentional interference allegations and a total of $58 million on the remaining two counts.
Defendants filed a motion to abstain or, in the alternative, to dismiss the Kansas District Court litigation on August 22, 2001, citing pending litigation filed in Jefferson County Alabama state circuit court by Torchmark and its subsidiary, United Investors against Waddell & Reed and W&R (United Investors Life Insurance Company v. Waddell & Reed Financial, Inc., et al, Case No. CV 00-2720), involving an alleged agreement dealing with existing in-force United Investors variable annuity business marketed by W&R as well as the prior dismissal by the Kansas District Court of litigation originally filed by W&R against United Investors in Kansas state court involving such variable annuity business. Defendant’s motion was denied but the Kansas District Court ruled that a judgment in the prior Alabama litigation would likely be res judicata as to the claims against Torchmark and one of the individual defendants in the current Kansas litigation. Trial of the Alabama state court litigation began February 19, 2002.
On March 19, 2002, a Jefferson County, Alabama Circuit Court jury awarded $50 million compensatory damages to Torchmark’s subsidiary United Investors in the Alabama state court litigation. United Investor’s claims in this litigation for additional injunctive relief prohibiting unlawful future policy replacements by W&R remained to be decided by the Circuit Court. Based upon the Alabama jury verdict, Torchmark filed a motion for summary judgment in the Kansas District Court.
On July 25, 2002, W&R filed notice of appeal to the Alabama Supreme Court of the Jefferson County Circuit Court’s order, which notice of appeal was supplemented on July 31, 2002 and the record of the same was certified to the Alabama Supreme Court in September, 2002. On October 25, 2002, the
Alabama Supreme Court affirmed the trial court’s judgment dismissing with prejudice all of W&R’s third party counterclaims against Torchmark and R.K. Richey. Oral arguments were heard by the Alabama Supreme Court on February 19, 2003 in W&R’s appeal from the jury verdict and trial court judgment against W&R on United Investors’ claims.
On October 16, 2001, defendant Torchmark filed a motion to dismiss and to stay discovery in the Bomar action, asserting plaintiff’s lack of standing, failure to make a legally-required demand on the Board of Directors of Torchmark and failure to comply with certain Alabama Rules of Civil Procedure. On October 17, 2001, the Board of Directors created a special litigation committee comprised of two independent, disinterested directors to review and make determinations and a report with regard to the transactions involved in such suit. Defendant Torchmark’s motion was amended on October 19, 2001 to include as further grounds for dismissal and stay the creation of that special litigation committee and the delegation of complete authority to said committee to review the transaction and determine whether prosecution of the Bomar action was in the interests of Torchmark and its shareholders and what action Torchmark should take with regard to the Bomar action. The committee, through its separately retained counsel, advised the Court that it concurred in Torchmark’s motions. A hearing on Torchmark’s amended motion to dismiss and stay discovery was held November 13, 2001 and on November 26, 2001, the Circuit Court issued an order staying all proceedings in Bomar for 150 days during which the special litigation committee was charged with investigating, reviewing and analyzing the asserted claims, completing its written report and filing the same with the Circuit Court. The special litigation committee began its interview process in February, 2002. On April 24, 2002, the plaintiff filed a motion to modify the stay so as to permit the filing of a second amended complaint, which sought to assert that the transaction violated a 1982 Torchmark Board of Directors resolution relating to conflicts of interest as well as the Alabama Insurance Holding Company System Regulatory Act; that the consideration received by Torchmark was unfairly low and was the result of two of the defendants’ violations of their fiduciary duty of loyalty to Torchmark; and that defendants concealed and suppressed material facts intentionally, knowingly and wantonly. The Circuit Court, on May 6, 2002, ordered the special litigation committee to also consider the allegations made in plaintiff’s second amended complaint (although the same was never formally filed with the Court). The Circuit Court granted the Committee extensions of time for the filing of its report until August 1, 2002. On July 31, 2002, the special litigation committee released and filed its written report with the Circuit Court.
Life insurance products include traditional and interest-sensitive whole life insurance as well as term life insurance. Health products are generally guaranteed-renewable and include Medicare Supplement, cancer, accident, long-term care, and limited hospital and surgical coverages. Annuities include both fixed-benefit and variable contracts. Variable contracts allow policyholders to choose from a variety of mutual funds in which to direct their deposits.
The measure of profitability for the investment segment is excess investment income, which represents the income earned on the investment portfolio in excess of net policy requirements and financing costs associated with debt and Torchmark’s preferred securities. The investment segment is measured on a tax-equivalent basis, equating the return on tax-exempt investments to the pretax return on taxable investments. Other than the above-mentioned interest allocations, there are no other intersegment revenues or expenses. Expenses directly attributable to corporate operations are included in the “Corporate” category. All other unallocated revenues and expenses on a pretax basis, including insurance administrative expense, are included in the “Other” segment category. The table below sets forth a reconciliation of Torchmark’s revenues and operations by segment to its major income statement line items.
Investment segment includes preferred dividends, net of swap benefit, on a pretax basis.
*** Investment segment includes preferred dividends, net of swap benefit, on a pretax basis
Assets for each segment are reported based on a specific identification basis. The insurance segments’ assets contain deferred acquisition costs, value of insurance purchased, and separate account assets. The investment segment includes the investment portfolio, cash, and accrued investment income. Goodwill is assigned to corporate operations. All other assets, representing less than 2% of total assets, are included in the other category. The table below reconciles segment assets to total assets as reported in the consolidated financial statements.
Torchmark has entered into two loan agreements with First Command, a construction loan agreement and a collateral loan agreement. The construction loan was entered into in 2001 and had an
outstanding balance of $19.4 million at December 31, 2002. The loan was made at a rate of 7.55% and is collateralized by a four-story building in Fort Worth, Texas. In addition to the office building as collateral, in the event of default, Torchmark has the right of offset to any commission due First Command. The maximum amount of borrowing allowed on this loan is $22.5 million. Interest is added to the loan balance until the building is completed. The agreement calls for Torchmark to permanently finance the building with a fifteen-year mortgage at a rate of 2.25% over the ten-year treasury rate at inception, but not less than 7%.
The following is a summary of quarterly results for the two years ended December 31, 2002. The information is unaudited but includes all adjustments (consisting of normal accruals) which management considers necessary for a fair presentation of the results of operations for these periods.
*Net operating income is defined on pages 16-18 of this report.