Torchmark, through its subsidiaries, owns or leases buildings that are used in the normal course of business. United American, through a joint venture with Torchmark, owns and occupies a 140,000 square foot facility located in McKinney, Texas (a north Dallas suburb). To facilitate the consolidation of Torchmark’s operations, we have constructed a 150,000 square foot addition to this building, which was substantially completed in December, 2007 and is now being occupied by United American.
The tables in Note 13-Business Segments 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 ending December 31, 2009. 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.
Summary of Operations: Net income declined $47 million or 10% in 2009 to $405 million. In 2008, net income declined $75 million or 14% to $452 million from $528 million. On a diluted per share basis, 2009 net income fell 5% to $4.88, while in 2008 per share net income declined 7% to $5.11. One major cause for the decline in both years was after-tax realized investment losses, due mostly to writedowns of fixed-maturity securities that were determined to be other-than-temporarily impaired. In 2009, after-tax realized investment losses reduced per share earnings $1.12, of which $1.27 per share related to other-than-temporary impairments of fixed maturities which were offset by $.15 of net gains. In 2008, after-tax losses accounted for $.79 per share, of which $.78 related to other-than-temporary impairments. In 2007, we had realized investment gains which added $.02 to per diluted share earnings, after other-than-temporary impairment writedowns of $.08 per share offset $.10 of other gains for the period. Another contributing factor to the declines in both years was in our health insurance segment, where intense competition in recent periods has resulted in significant declines in agent counts, which in turn has resulted in lower sales of new health products. Health underwriting margins declined $24 million or 12% in 2009 to $170 million, after having decreased $14 million or 7% in 2008.
Our annuity margins have fluctuated in recent periods. Our 2008 annuity underwriting loss was $6 million, compared with gains of $3 million in 2009 and $9 million in 2007. In 2008, significant declines
in equity markets caused variable policyholder account values to decline, guaranteed minimum death benefit costs to increase, policyholders to withdraw funds, and changes in actuarial assumptions all of which resulted in the underwriting losses. As equity markets improved during 2009, many of these factors abated somewhat and margins partially recovered. We do not emphasize this segment and discontinued the sale of variable annuities in 2008, only offering a fixed annuity product.
Total revenues declined 3% in 2009 to $3.22 billion. In 2008, total revenues declined 5% to $3.33 billion from $3.49 billion in 2007. Life premium rose $43 million in 2009 and $47 million in 2008. Net investment income rose $3 million in 2009 and $23 million in 2008. However, growth in revenues in both 2009 and 2008 were negatively affected by the aforementioned pretax realized investment losses and declines in health premium, described further under this caption.
As noted earlier, we no longer offer variable annuities. While we still offer fixed annuities, we do not emphasize sales of annuity products, favoring life insurance instead. See the caption Annuities for further discussion of the Annuity segment.
on our long-term debt rose $11 million. During the year we issued our $300 million 9 1/4% Senior Notes but repaid our $99 million 8 1/4% Senior Debentures, resulting in a higher balance of debt outstanding at a higher interest rate. However, this segment has benefited from lower short-term financing costs in each successive year, as these costs have declined primarily due to lower rates on our short-term debt. Prior to 2009, growth in total investment income has been somewhat negatively affected by Torchmark’s share repurchase program (described later under this caption), which has diverted cash that could have otherwise been used to acquire investments.
As mentioned earlier in this summary, we wrote down certain securities in each of the years 2007 through 2009, as these securities met our criteria for other-than-temporary impairment. The pretax impairment losses were $160 million, $106 million, and $11 million in 2009, 2008, and 2007, respectively. Please refer to Note 3-Investments in the Notes to Consolidated Financial Statements under the caption Other-than-temporary impairments and under the caption Realized Gains and Losses in this report for more information on these writedowns and our criteria for consideration of other-than-temporary impairment. Including the writedowns, we had total after-tax realized investment losses of $93 million in 2009 ($1.12 per share) and $70 million in 2008 ($.79 per share), compared with a $2 million gain in 2007 ($.02 per share). Realized investment gains and losses can vary significantly from period to period and may have a material positive or negative impact on net income. Under the caption Realized Gains and Losses in this report, we present a complete analysis and discussion of our realized gains and losses including the writedowns. Also, as explained in Note 13-Business Segments in the Notes to the Consolidated Financial Statements, we do not consider realized gains and losses to be a component of our core insurance operations or operating segments.
As reported in Note 1-Significant Accounting Policies in the Notes to Consolidated Financial Statements under the caption Litigation and Tax Settlements, we have been involved in a number of litigation issues over the course of the three year period 2007 through 2009 in which we either received settlements net of expenses or incurred settlement losses and expenses. These issues resulted in after-tax charges of $770 thousand in 2008 and $272 thousand in 2007. Additionally, as described under the same caption of Note 1, we received tax settlements in each year in the amounts of $2.9 million in 2009, $10.8 million in 2008, and $1.1 million in 2007. All of these litigation and tax issues pertained to issues arising many years ago and are not considered by management to relate to our current operations. Legal and litigation expenses pertaining to current operations are included in either insurance administrative expenses or parent expenses, as appropriate, in our segment analysis. Income from
Torchmark has in place an ongoing share repurchase program which began in 1986. With no specified authorization amount, we determine the amount of repurchases based on the amount of the Company’s excess cash flow, general market conditions, and other alternative uses. The majority of these purchases are made from excess operating cash flow when market prices are favorable. Additionally, when stock options are exercised, proceeds from these exercises and the tax benefit are used to repurchase additional shares on the open market to minimize dilution as a result of the option exercises. Due to economic conditions at the time, we temporarily suspended our share repurchase program in the first quarter of 2009. We may resume the program with a reaffirmation by the Board of Directors when share repurchases are determined to be the best use of cash. The following chart summarizes share purchase activity for each of the three years ended December 31, 2009.
The American Income Exclusive Agency focuses primarily on members of labor unions, but also on credit unions and other associations for its life insurance sales. It is a high profit margin business characterized by lower policy obligation ratios. Life premium for this agency rose 7% to $508 million in 2009, after having increased 8% in 2008. Net sales increased 18% in 2009 to $128 million from $108 million in 2008. Net sales rose 17% in 2008. First-year collected premium rose 17% in 2009 to $96 million, after having increased 11% in 2008. As in the case of all of Torchmark’s agency distribution systems, continued increases in product sales are largely dependent on increases in agent count. Growth in the agent count has contributed to the improvements in sales in this agency. The American Income agent count was 4,154 at December 31, 2009 compared with 3,085 a year earlier, an increase of 35%. The agent count rose 21% in 2008 from 2,545 at year end 2007. This agency continues to recruit new agents focusing on an incentive program to reward growth in both the recruiting of new agents and in the production of new business. Additionally, the systematic, centralized internet recruiting program has enhanced the recruiting of new agents.
As previously mentioned, we have combined selected UA Exclusive Agency Branch Offices with the Liberty National Exclusive Agency. The Liberty National Agency has historically marketed life insurance to middle-income customers primarily in the Southeast. The UA Branch Office Agency has historically emphasized health products, but is now changing its focus for newly recruited agents to market Liberty National’s life and health products. In addition, due to ongoing cuts in Medicare Advantage funding and changes to the competitive environment in the Medicare Supplement market, we have also recently renewed our emphasis on Medicare Supplement sales. Life premium income for this combined agency was
Liberty National’s net sales declined 5% to $46 million in 2009, after having increased 31% a year earlier. The Liberty Agency had 1,740 producing agents at December 31, 2009, compared with 3,369 a year earlier, a decline of 48%. The agent count at Liberty had increased 40% in 2008 from 2,410. The 2009 decrease in agent count was due primarily to agent compensation issues. A two-tier bonus threshold proved more difficult for producing agents to meet than anticipated. Management reverted to a level bonus threshold during the third quarter of 2009. In addition, due to deteriorating first year persistency rates on business written over the past several quarters, management modified compensation incentives in the third quarter of 2009 to place more emphasis on retention. This has resulted in the departure of some of the weaker agents. Management expects the counts to increase in 2010.
The UA Branch Office Agency produced net sales of $9.2 million in 2009 of Liberty National’s life products. As noted earlier, this Agency traditionally focused on health product sales. Due to intense competition in recent periods in the health insurance market, the UA Branch has experienced sharp declines in agent count. The UA Branch Office Agency had 731 producing agents at December 31, 2009, compared with 1,651 agents a year earlier, a decline of 56%. The count declined 45% in 2008 from 2,979 agents.
As is the case with all of our captive agency forces, growing the number of productive agents is critical to the growth in sales. As mentioned above, we have shifted the emphasis in the UA Branch Office Agency to life and health products currently marketed by Liberty National agents, as well as a renewed focus on Medicare Supplement products. These products are priced to achieve higher profit margins and have better persistency than the UA Branch’s limited-benefit health insurance. This Agency will continue to offer the current product portfolio, but the majority of our financial incentives will be used to encourage new agents to sell the Liberty National product line along with the renewed focus on UA Medicare Supplement products. We believe this will improve the stability and profitability of the UA Branch Office Agency.
Total Medicare Part D premium and health premium exclude $7.3 million in 2007 and $2.5 million in 2009 of risk-sharing premium paid to the Centers for Medicare and Medicaid Services consistent with the Medicare Part D contract. In 2008, $122 thousand of risk-sharing premium was received, increasing premium. This risk-sharing amount is a portion of the excess or deficiency of actual over expected claims, and therefore we view this payment as a component of policyholder benefits in our segment analysis.
We market supplemental health insurance products through a number of distribution channels with the United American agencies being our market leaders. The following table presents net sales by distribution method for the last three years.
Health insurance, excluding Medicare Part D. As noted under the caption Life Insurance, we have emphasized life insurance sales relative to health, due to life’s superior margins and other benefits. Our health distribution groups have also encountered increased competition in recent periods. The increased competition has led to losses in agents in our UA Branch Office and Independent Agencies. Agent turnover has increased as lower premium, lower margin products offered by competitors have provided agents with products that are easier to sell. Declines in these agent counts have resulted in lower net sales, which in turn have pressured premium growth. Health premium, excluding Part D premium, fell 12% to $837 million in 2009, after declining 8% in 2008. Medicare Supplement premium declined 6% to $458 million in 2009, compared with a 7% decline in 2008. Other limited-benefit health premium dropped 18% in 2009 to $378 million, after a decline of 9% in 2008. Net sales, excluding Medicare Part D, declined 30% to $97 million in 2009. Net sales fell 42% in 2008 to $139 million. Medicare Supplement net sales rose 64% in 2009, however, while other health net sales declined 54%. In 2008, both Medicare Supplement and other health net sales declined, Medicare Supplement declined 14% and other limited-benefit health fell 46%. First year collected premium also declined significantly in both 2009 and 2008.
While new sales of our limited-benefit health products have been stronger than our Medicare Supplement plans, Medicare Supplement net sales have been gaining in recent periods in relation to
Liberty’s health net sales were relatively flat in 2009, but rose 22% to $12 million in 2008 on sales of limited-benefit health products, primarily cancer. Liberty’s net sales as a portion of total non-Part D health net sales rose from 4% in 2007 to 9% in 2008 to 13% in 2009.
The American Income Exclusive Agency, also predominantly a life insurance distribution channel, is our third largest health insurance distributor based on 2009 premium collected. Its health plans are comprised of various limited-benefit plans for which approximately 69% of the agency’s 2009 health premium was from accident policies. Sales of the health plans by this agency are generally made in conjunction with a life policy being sold to the same customer.
Health premium at this agency rose 2% in 2009 to $75 million, after having increased 4% to $73 million in 2008. Net health sales were $13 million in 2009, compared with $12 million in 2008 and $11 million in 2007. Net health sales comprised less than 10% of the American Income Agency’s total net sales in 2009.
Medicare Part D. Torchmark, through its subsidiary United American, began offering insurance coverage under the government’s Medicare Part D plan as of January 1, 2006. The Medicare Part D plan
The following tables present underwriting margin data for health insurance for each of the last three years.
Torchmark’s health insurance underwriting margin before other income and administrative expense declined 12% in 2009 to $170 million. Health margin declined 7% to $195 million in 2008 from $208 million in 2007. As a percentage of premium income, margins were stable in all periods at approximately 17%.
A significant portion of fixed annuity profitability is derived from the spread of investment income exceeding contractual interest requirements. This spread sometimes results in negative net policy obligations.
While the fixed annuity account balance has increased each year over the prior year, policy charges and underwriting income have fluctuated only modestly. The stability in fixed annuity policy charges has resulted as the charges consist of surrender charges and are not based on account size. These charges have remained somewhat level in recent periods. A considerable portion of fixed annuity profitability is derived from the spread of investment income exceeding contractual interest requirements, which can result in negative net policy obligations. In 2009, investment income for fixed annuities increased as a result of the assignment of higher-yielding new investments to this product as older lower-yielding investments matured and rolled off over time. As the income has grown at a greater rate than the fund balance, the spread has widened. The amortization of deferred acquisition costs also rose as these costs are amortized in relation to gross profits.
Insurance administrative expenses declined 3% in 2009, after having risen 3% in 2008. As a percentage of premium, they declined to 5.7% in 2009, after having risen from 5.5% in 2007 to 5.8% in 2008. In 2009, increases in salaries were more than offset by declines in other administrative costs and other employee costs. As a result of the effort to achieve greater consistency in expense classification among our subsidiaries, we deferred $12 million more of deferrable administrative expense to acquisition expense in 2009 compared with 2008. These reductions in administrative expense were partially offset by increases in pension and other employee benefit costs during the period. The additional deferred costs will increase the amortization of acquisition costs in future periods. The 2008 increase was primarily a result of higher salary expenses, pension costs, and other costs such as postage and property taxes. The 2008 increases were partially offset by lower legal expenses and Medicare Part D administrative expense. Management believes that pension cost will stabilize in 2010, because of the partial recovery in financial markets.
Parent company expense was lower in 2009 than in the two prior periods. Included in 2008 and 2007 expenses were charges in the amount of $2.9 million in 2008 and $1.6 million in 2007 for expenses incurred related to potential acquisition bids that were not successful.
* Deconsolidation of trusts liable for Trust Preferred Securities required by accounting guidance. See Note 10-Debt in the Notes to Consolidated Financial Statements.
Excess investment income decreased $31 million or 9% in 2009 over the prior year. Excess investment income rose $4 million or 1% in 2008. On a per diluted share basis, 2009 excess investment income declined 4% to $3.58. Share purchases caused the decline in per share excess investment income in 2009 to be less than the decline in total excess investment income and the increase in per share excess investment income to be greater than the increase in total excess investment income in 2007 and 2008. Per share excess investment income increased 10% in 2008 and 7% in 2007.
Revised from previously reported to exclude the unrealized gains and losses on deferred acquisition costs.
(1) See Principles of Consolidation in Note 1-Significant Accounting Policies in the Notes to Consolidated Financial Statements for an explanation of deconsolidation.
The following table summarizes selected information for fixed-maturity purchases. The effective annual yield shown in the table is the yield calculated to the potential termination date that produces the lowest yield. This date is commonly known as the “worst call date.” Two different average life calculations are shown, average life to the next call date and average life to the maturity date.
New cash flow available to us for investment has been affected by issuer calls as a result of the low-interest environment experienced during the past three years, especially 2007. Issuers are more likely to call bonds when rates are low because they often can refinance them at a lower cost. Calls increase funds available for investment, but they can have a negative impact on investment income if the proceeds from the calls are reinvested in bonds that have lower yields than that of the bonds that were called. Issuer calls were $181 million in 2009, $238 million in 2008, and $848 million in 2007. The 2007 level of calls was unusual, and contributed to the significant increase in funds invested in that year. The higher level of acquisitions in 2009 was primarily due to the additional cash flow available from the special sales transactions noted below.
Sales transactions. As disclosed in Note 3-Investments, the Company sold $758 million of fixed maturities at amortized cost in the third quarter of 2009, including $315 million of below- investment-grade securities. The market value for some of these securities increased significantly during the period to a level where, even though the sales price was less than amortized cost, management determined that better risk-adjusted returns could be achieved by selling rather than continuing to hold the securities. Other securities were sold at prices that produced gains to offset these losses for tax purposes. Due in large part to selling below-investment-grade securities and reinvesting the proceeds in investment-grade securities, below-investment-grade securities as a percentage of total fixed maturities at amortized cost declined from 13% at June 30, 2009 to 8% at December 31, 2009. The reduction in below-investment-grade securities had a positive impact on the risk-based capital position of our insurance subsidiaries.
At December 31, 2009, approximately 93% of our investments at book value were in a diversified fixed-maturity portfolio. Policy loans, which are secured by policy cash values, made up an additional 4%. The remaining balance was comprised of other investments including equity securities, mortgage loans, and other long-term and short-term investments.
Because fixed maturities represent such a significant portion of our investment portfolio, the remainder of the discussion of portfolio composition will focus on fixed maturities. An analysis of our fixed-maturity portfolio by component at December 31, 2009 and December 31, 2008 is as follows:
The increase in effective duration during 2009 was due in large part to significantly lower discount rates implied by the increase in the market value of the portfolio, which increases sensitivity to changes in rates.
At December 31, 2009, approximately 38% of the fixed maturity assets at amortized cost (34% at fair value) were in the financial sector, including 17% in life and health or property casualty insurance companies and 16% in banks at amortized cost. Financial guarantors, mortgage insurers, and insurance brokers comprised approximately 2% of the portfolio. After financials, the next largest sector was utilities, which comprised 14% of the portfolio at amortized cost. The balance of the portfolio is spread among 266 issuers in a wide variety of sectors. As previously noted, gross unrealized losses were $723 million at December 31, 2009, declining from $1.9 billion a year earlier. Approximately 60% of the decrease in net unrealized loss was attributable to improvements in valuations in non-financial sectors since year-end 2008 and 40% was due to a partial recovery in the net unrealized loss position of our financial holdings. As discussed in Note 3-Investments, we believe much of the unrealized losses in recent periods were attributable to illiquidity in the financial markets. We expect to recover the full book value of our investments in impaired securities.
As shown in the table above, the ratio of gross unrealized losses to book value was greater than 50% for our investments in CDOs and the financial guarantor/mortgage insurer (monoline insurer) sectors. We evaluated each of the impaired securities in these and all other sectors to determine whether or not any of
the impairments were other-than-temporary. Certain information about our evaluation of the impaired securities in the CDO and monoline insurer sectors is provided in the following paragraphs.
At December 31, 2009, we held investments in five different CDOs. In our opinion, our investments in four of these CDOs ($34 million amortized cost and $13 million fair value) were other-than-temporarily impaired and our investment in one CDO ($21 million amortized cost and $5 million fair value) was not other-than-temporarily impaired. In reaching this conclusion, we reviewed and discussed with the collateral managers for each of these CDOs the current status of the collateral underlying our investments, the credit events (defaults and deferrals in underlying collateral) experienced to date, and the possibility of future credit events. We calculated expected future cash flows using assumptions for expected future credit events that reflect actual historical experience and expected future experience. We reviewed the actual versus expected cash flows received to date and the impact that potential future credit events would have on our expected future cash flows. We calculated the magnitude of future credit events that could be experienced without negatively impacting the recovery of our investment and our expected yield rate. While there is a possibility that future credit events will exceed our current expectations, we believe there is ample evidence to support our conclusions.
At December 31, 2009, our internal rating for a security was determined as the average of the security’s rating from four nationally recognized rating agencies. The ratings from each agency are evenly weighted when calculating the average, and the average is rounded to the nearest rating when it is between two ratings. In prior years, the average was rounded down to the next lower rating when it was between two ratings. The ratings methodology was changed in 2009 to more accurately reflect the average ratings of the securities and to make ratings by category be more consistent with the statutory ratings which are instrumental in determining the regulatory required capital for our insurance subsidiaries. Under the new rating methodology, below-investment-grade bonds would have been 6% of the fixed-maturity portfolio at December 31, 2008 at amortized cost, compared with 7% based on the prior rating methodology.
The portfolio has a weighted average quality rating of BBB+ based on amortized cost. Approximately 92% of the portfolio at amortized cost was considered investment grade. 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, nor do we have any counterparty risks as we are not a party to any credit default swaps or other derivative contracts. We do not participate in securities lending. There are no off-balance sheet investments, as all investments are reported on our Consolidated Balance Sheets. At December 31, 2009, we had $18 million at fair value ($55 million book value) invested in CDOs, for which the composite rating at that date was CC. The collateral underlying these CDOs is primarily trust preferred securities issued by banks and insurance companies, but no sub-prime or Alt-A mortgages are included in the collateral.
The following table illustrates the market risk sensitivity of our interest-rate sensitive fixed-maturity portfolio at December 31, 2009 and 2008. This table measures the effect of a change in interest rates (as represented by the U.S. Treasury curve) on the fair value of the fixed-maturity portfolio. The data measures the change in fair value arising from an immediate and sustained change in interest rates in increments of 100 basis points.
Because our investment portfolio is large and diverse, investments are occasionally sold or called, resulting in a realized gain or loss. These gains and losses occur only incidentally, usually as the result of sales because of deterioration in investment quality of issuers or calls by the issuers. Investment losses are also caused by writedowns due to impairments. We do not engage in trading investments for profit. Therefore, gains or losses which occur in protecting the portfolio or its yield, or which result from events that are beyond our control, are only secondary to our core insurance operations of providing insurance coverage to policyholders.
As described in Note 3-Investments under the caption Other-than temporary impairments in the Notes to Consolidated Financial Statements, we wrote certain securities down to fair value during each year 2007 through 2009 as a result of other-than-temporary impairment. The impaired securities met our criteria for other-than-temporary impairment as discussed in Note 3 and in our Critical Accounting Policies in this report. The writedowns resulted in pretax charges of $160 million in 2009 ($105 million after tax), $106 million in 2008 ($69 million after tax), and $11 million in 2007 ($7 million after tax). The 2009 charge included $83 million on CDOs ($55 million after tax) and $36 million on monoline financial guarantors and mortgage insurers ($23 million after tax). The remaining writedowns in 2009 were from losses on a variety of corporate bonds. In 2008, the significant bonds written down were Lehman Brothers bonds of $74 million pretax ($48 million after tax) and Washington Mutual bonds of $19 million pretax ($12 million after tax). Other writedowns in 2008 included perpetual preferred stocks of Federal National Mortgage Association and certain non-financial securities. Impairment losses on fixed maturities in 2007 were related to non-financial institution holdings.
The operations of our insurance subsidiaries have historically generated positive cash flows in excess of our immediate needs. Sources of cash flows for the insurance subsidiaries include primarily premium and investment income. Cash outflows from operations include policy benefit payments, commissions, administrative expenses, and taxes.
Consolidated Liquidity. Consolidated net cash inflows provided from operations were $976 million in 2009, compared with $731 million in 2008, and $850 million in 2007. In addition to cash inflows from operations, our companies have received $243 million in investment calls and tenders and $518 million of scheduled maturities or repayments during 2009. Maturities, tenders, and calls totaled $581 million in 2008 and $1.3 billion in 2007.
(1) Funded debt is itemized in Note 10-Debt in the Notes to Consolidated Financial Statements and includes short-term commercial paper.
(5) Future insurance obligations consist primarily of estimated future contingent benefit payments on policies in force and separate account obligations at December 31, 2009. These estimated payments were computed using assumptions for future mortality, morbidity and persistency. The actual amount and timing of such payments may differ significantly from the estimated amounts shown. Management believes that the assets supporting the liability of $9.1 billion at December 31, 2009, along with future premiums and investment income, will be sufficient to fund all future insurance obligations.
temporary impairments taken. Because of the large volume of ratings downgrades and impairments, these items have had a significant negative effect on the subsidiaries’ regulatory capital. The subsidiaries generally target a capital ratio of at least 300% of required regulatory capital under Risk-Based Capital (RBC), a formula designed by insurance regulatory authorities to monitor the adequacy of capital. The 300% 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. RBC has been favorably impacted by these capital contributions and the sales of below-investment-grade securities discussed under the caption Investments-Sales Transactions in this report. At December 31, 2009, our insurance subsidiaries in the aggregate had RBC ratios in excess of 350%. Should we experience additional impairments and ratings downgrades in the future and the ratio falls below 300%, management could utilize cash on hand at the Parent Company to make additional contributions as necessary to maintain the ratios at or above 300%.
Due to its strong liquidity and capital position, Torchmark has no intent at this point in time to issue equity, and, in fact, has recently declared an increase in its dividend on it common stock from $.14 to $.15 per share each quarter. As noted under the caption Highlights in this report, we suspended our share repurchase program indefinitely in March, 2009 due to general economic conditions at that time. Reactivation of this program is subject to Board approval. No share purchases have been made since March, 2009. However, we did acquire 2 million shares at a cost of $47 million ($22.78 per share) in the first quarter of 2009 under the program. Share purchases in 2008 and 2007 were more significant, as we acquired 8 million shares for $427 million in 2008 and 6 million shares in 2007 for $402 million under the program. Please refer to the description of our share repurchase program under the caption Highlights in this report.
Shareholders’ equity was $3.4 billion at December 31, 2009, compared with $2.2 billion at December 31, 2008. During the twelve months since December 31, 2008, shareholders’ equity was reduced by the $47 million in share purchases but has been increased by a reduction of $819 million of net unrealized losses after tax in the fixed maturity portfolio as conditions in financial markets have improved. As explained in Note 3-Investments-unrealized loss analysis, unrealized losses in 2008 and early 2009 have resulted primarily from illiquidity in the financial markets in recent periods as a result of general economic conditions.
We plan to use excess cash as efficiently as possible in the future but we will be cautious in doing so. Excess cash flow could be used for share repurchases, acquisitions, increases in shareholder dividends, investment in fixed maturities, or repayment of short-term debt. We will determine the best use of excess cash after ensuring that desired capital levels are maintained in our companies. As mentioned previously, our share repurchase program was suspended in the first quarter of 2009 due to general economic conditions at the time. The program could be resumed with approval by the Board of Directors if share repurchases are determined to be the best use of excess cash.
Historically, management has felt that share purchases have been beneficial to the Company. We believe that Torchmark share purchases at favorable prices add incrementally to per share earnings and to return on equity, and are an excellent way to increase total shareholder value. As noted earlier in this report, we acquired over 2 million shares at a cost of $47 million in 2009 with excess cash flow. In 2008, a much more significant purchase of 7.6 million shares at a cost of $427 million was made. In 2008, if the free cash flow used for the repurchase of our common stock had alternatively been invested in corporate bonds, an estimated $11 million of additional investment income, after tax, would have resulted and net income per diluted share would have declined 9% to $4.99. Because share purchases were made, actual net income per share was $5.11, a lesser decline of 7%. The majority of purchased shares are retired each year.
As discussed earlier in this report, the fixed maturity portfolio incurred $1.8 billion in net unrealized investment losses in 2008 ($1.1 billion after tax and adjustments of deferred acquisition costs). These unrealized losses are believed by management to have been brought on by widening credit spreads in financial markets, and were the primary factor in the decline in our shareholders’ equity in 2008. In 2009, as conditions in financial markets have begun to improve, unrealized losses have declined $1.3 billion
The financial strength of our major insurance subsidiaries are also rated by Standard & Poor’s and A.M. Best. In 2009, A.M. Best affirmed the ratings of our insurance subsidiaries. In 2007, Standard & Poor’s lowered its financial strength rating of United Investors to A from A+ and the ratings of Liberty, Globe, United American and American Income from AA to AA-, as a result of an expected lag in new business sales in the short term. The following chart presents these ratings for our five largest insurance subsidiaries at December 31, 2009.
The FASB has issued new accounting guidance potentially applicable to Torchmark, effective in future periods:
Transfers of Financial Assets: This guidance, effective for Torchmark as of January 1, 2010, amends previous guidance concerning transfers of financial assets to disallow the use of qualifying special purpose entities. Such entities are required to be evaluated for consolidation. Torchmark has no such entities and does not expect any impact from adoption.
Variable Interest Entities: This new guidance, effective for Torchmark as of January 1, 2010, amends previous guidance concerning variable interest entities, modifying the determination of the primary beneficiary, and requiring ongoing assessment of primary beneficiary status of the variable interest entity for consolidation purposes. At present, the adoption of this guidance will have no effect on Torchmark. While the trust that holds Torchmark’s 7.1% Trust Preferred Securities is a variable interest entity, and Torchmark has 100% voting control, Torchmark is not the primary beneficiary. Therefore, we will not consolidate the trust under the new guidance, following the same treatment as in current practice.
Approximately 72% of our liabilities for future policy benefits at December 31, 2009 were traditional insurance liabilities whereby the liability is determined as the present value of future benefits less the present value of the portion of the gross premium required to pay for such benefits. The assumptions used in estimating the future benefits for this portion of business are set at the time of contract issue. These assumptions are “locked in” and are not revised for the lifetime of the contracts, except where there is a premium deficiency, as defined in Note 1-Significant Accounting Policies in the Notes to Consolidated Financial Statements under the caption Future Policy Benefits. Otherwise, variability in the accrual of policy reserve liabilities after policy issuance is caused only by variability of the inventory of in force policies. A premium deficiency event for Torchmark’s traditional business is very rare, and did not occur during the three years ended December 31, 2009.
Deferred Acquisition Costs and Value of Insurance Purchased. The costs of acquiring new business are generally deferred and recorded as an asset. Deferred acquisition costs consist primarily of sales commissions and other underwriting costs of new insurance sales. Additionally, the costs of acquiring blocks of insurance from other companies or through the acquisition of other companies are also deferred and recorded as assets under the caption “Value of Insurance Purchased” as indicated in Note 4-Deferred Acquisition Costs and Value of Insurance Purchased in the Notes to Consolidated Financial Statements. Our policies for accounting for deferred acquisition costs and the associated amortization are reported in Note 1-Significant Accounting Policies in the Notes to Consolidated Financial Statements.
The remaining portion of deferred acquisition costs pertain to deposit business for which deferred acquisition costs are amortized over the estimated lives of the contracts in proportion to actual and estimated future gross profits. These contracts are not subject to lock-in. The assumptions must be updated when actual experience or other evidence suggests that earlier estimates should be revised. With the exception of variable annuities, as discussed earlier in this report, revisions related to our deposit business assets have not had a material impact on the amortization of deferred acquisition costs during the three years ended December 31, 2009. The variable annuity block could sustain further increases in the level of amortization if equity markets were to decline. Amortization for deposit business is not expected to have a material impact on operations for the foreseeable future.
Revenue Recognition. Premium income from our subsidiaries’ insurance contracts is generally recognized as the premium is due. However, in accordance with GAAP, revenues 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 our 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.
captions Investments and Realized Gains and Losses in this report. While every effort is made to make the best estimate of status and value with the information available regarding an other-than-temporary impairment, it is difficult to predict the future prospects of a distressed or impaired security.
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, 2009, our net liability under these plans was $30 million.
We caution readers regarding certain forward-looking statements contained in the foregoing discussion and elsewhere in this document, and in any other statements made by us or on our behalf 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 us or our business, whether express or implied, is meant as and should be considered a forward-looking statement. Such statements represent our opinions concerning future operations, strategies, financial results or other developments.
Consolidated Statements of Operations for each of the three years in the period ended December 31,
Consolidated Statements of Comprehensive Income for each of the three years in the period ended December 31, 2009
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Torchmark Corporation and subsidiaries as of December 31, 2009 and 2008, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2009, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.
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, included in “Other long-term investments,” are carried at amortized cost. 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. Short-term investments include investments in interest-bearing time deposits with original maturities of twelve months or less.
value. The provisions were applied prospectively. The adoption of this guidance had no material impact on Torchmark’s financial position or results of operations, as Torchmark’s assets and liabilities have historically been measured substantially in accordance with its provisions. This guidance was amended in April, 2009 by the FASB providing additional guidance for estimating the fair value of assets or liabilities when the level of transaction activity has decreased and for identifying when transactions are not orderly. The amended guidance was effective for interim and annual reporting periods ending after June 15, 2009, with early adoption permitted. It did not require disclosure for comparative periods ending prior to the period of initial adoption. Torchmark elected to early adopt the new guidance for the periods beginning January 1, 2009. There were no significant changes in valuation techniques to arrive at fair value as a result of the adoption, other than techniques used to value holdings in collateralized debt obligations (CDOs). CDOs were valued based on the present value of expected cash flows under the new guidance, rather than by considering broker quotes as determined previously. The use of the technique to determine fair value by the present value of expected cash flows resulted in an immaterial difference in fair value. Therefore, the impact of adoption of the revised guidance was not material to the investment portfolio. For specific information regarding Torchmark’s measurements and procedures in valuing financial instruments, please see Note 3-Investments under the caption Fair value measurements.
In April, 2009, the FASB also amended previous guidance concerning other-than-temporary impairments of debt securities and changed the presentation of other-than-temporary impairments in the financial statements. If an entity intends to sell or if it is more likely than not that it will be required to sell an impaired security prior to recovery of its cost basis, the security is to be considered other-than-temporarily impaired and the full amount of impairment must be charged to earnings. Otherwise, losses on securities which are other-than-temporarily impaired are separated into two categories, the portion of loss which is considered credit loss and the portion of loss which is due to other factors. The credit loss portion is charged to earnings while the loss due to other factors is charged to other comprehensive income, both charges net of tax. The revised guidance called for an opening cumulative effect adjustment to reclassify any unrecognized after-tax credit loss on each previously other-than-temporarily impaired security held at the beginning of the period of adoption as an adjustment to retained earnings and a corresponding adjustment to accumulated other comprehensive income. The revisions were effective for interim and annual periods ending after June 15, 2009, but early adoption was permitted for periods ending after March 15, 2009. Disclosures for earlier periods for comparative purposes were not required until the comparative periods end after initial adoption.
Separate Accounts: Separate accounts have been established in connection with Torchmark’s variable life and annuity businesses. The investments held for the benefit of contract holders (stated at fair value) are reported as “Separate account assets” and the corresponding deposit balance liabilities are reported as “Separate account liabilities.” The separate account investment portfolios and liabilities are segregated from Torchmark’s other assets and liabilities and these assets are invested in mutual funds of various unaffiliated mutual fund providers. Deposit collections, investment income, and realized and unrealized gains and losses on separate accounts accrue directly to the contract holders. Therefore, these items are added to the separate account balance and are not reflected in income. Fees are charged to the deposit balance for insurance risk, administration, and surrender. There is also a sales charge and an investment management fee. These fees and charges are included in premium revenues.
Guaranteed Minimum Policy Benefits: Torchmark’s variable annuity contracts generally provide contractual guarantees in the event of death of the contract holder to at least provide the return of the total deposits made to the contract, net of withdrawals. Under certain conditions, they also provide that the benefit will not be less than the highest contract value on certain specified anniversaries, adjusted for additional deposits and withdrawals after those anniversaries. Torchmark does not offer other types of guaranteed minimum policy benefits, such as minimum accumulation or income benefits.
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
Goodwill: The excess cost of businesses acquired over the fair value of their net assets is reported as goodwill. Goodwill is subject to annual impairment testing based on certain procedures outlined by GAAP. Amortization of goodwill is not permitted. Torchmark tested its goodwill annually in each of the years 2007 through 2009. The tests involve assigning the Company’s carrying value to each of the components of Torchmark’s segments, including the portion of goodwill assigned to each component. The
Postretirement Benefits: Torchmark accounts for its defined benefit pension plans by recognizing the funded status of its postretirement benefit plans on its Consolidated Balance Sheets in accordance with accounting guidance. Periodic gains and losses attributable to changes in plan assets and liabilities that are not recognized as components of net periodic benefit costs are recognized as components of other comprehensive income, net of tax. As of December 31, 2009, Torchmark adopted new accounting guidance requiring new disclosures about assets in its pension plans. The new disclosures include information about how investment decisions are made, categories of assets, information about how assets are valued, and concentrations of risk. More information concerning the accounting and disclosures for postretirement benefits is found in Note 9-Postretirement Benefits.
All of the above assumptions, with the exception of the expected term, are obtained from independent data services. The expected term is generally derived from Company experience. However, expected terms of grants made under the Torchmark Corporation 2005 Incentive Plan (2005 Plan) and the 2007 Long-Term Compensation Plan (2007 Plan), involving grants made in the years 2005 through 2009, were determined based on the simplified method as permitted by Staff Accounting Bulletins 107 and 110. This method was used because the 2005 and 2007 Plans limited grants to a maximum contract term of seven years, and Torchmark had no previous experience with seven-year contract terms. Prior to 2005, substantially all grants contained ten-year terms. Because a large portion of these grants vest over a three-year period, the Company did not have sufficient exercise history during 2009 or previous years to determine an appropriate expected term on these grants. 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 by the independent quote service 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).
A summary of fixed maturities available for sale and equity securities by cost or amortized cost and estimated fair value at December 31, 2009 and 2008 is as follows:
The collateral underlying collateralized debt obligations for which fair values are reported as Level 3 consists primarily of trust preferred securities issued by banks and insurance companies. None of the collateral is subprime or Alt-A mortgages (loans for which the typical documentation was not provided by the borrower). Of the change in the fair value of Level 3 assets still held at December 31, 2009, $86 million of realized investment losses was included as a charge to net income. At December 31, 2008, there was no such charge to earnings.
During 2008, the Company also determined that certain holdings in securities were other-than-temporarily impaired, resulting in writedowns in the amount of $106 million ($69 million after tax). The pretax writedown includes writedowns of $74 million for bonds issued by Lehman Brothers, $19 million for bonds issued by Washington Mutual, and $1.9 million for perpetual preferred stock issued by the Federal National Mortgage Association. All of these losses for other-than-temporary impairment were included in realized investment losses.
During 2007, the securities of five issuers met the other-than-temporary impairment criteria and were written down to fair value, resulting in a pre-tax loss of $11 million ($7 million after tax). After the write downs, these securities were valued at $36 million. In 2008, the securities of two of these issues were written down an additional $3.3 million ($2.2 after tax). All of the securities impaired during 2007 were subsequently sold for an aggregate after tax gain of $733 thousand.
The following tables disclose unrealized investment losses by class of investment at December 31, 2009 and December 31, 2008. Torchmark considers these investments to be only temporarily impaired.
Torchmark subsidiaries held 187 issues (CUSIP numbers) at December 31, 2009 that had been in an unrealized loss position for less than twelve months, compared with 373 issues a year earlier. Additionally, 285 and 330 issues had been in an unrealized loss position twelve months or longer at December 31, 2009 and 2008, respectively. Torchmark’s entire fixed-maturity and equity portfolio consisted of 1,657 issues at December 31, 2009 and 1,686 issues at December 31, 2008. The weighted average quality rating of all unrealized loss positions as of December 31, 2009 was BBB+.
The following table presents an analysis of the changes in Torchmark’s amounts related to credit loss positions for the year 2009.
Losses due to other-than-temporary impairment for which a portion was recognized in other comprehensive income.
The estimated fair value of mortgage loans, based on discounted cash flows, was approximately $15.2 million at December 31, 2009 and $18.0 million at December 31, 2008. Accumulated depreciation on investment real estate was $1.8 million at both December 31, 2009 and 2008.
The overall average interest assumption for determining the liability for future life and health insurance benefits in 2009 was 6.1%.
Claims paid in 2007 but incurred in 2006 and prior years were settled in 2007 for just $1.4 million less than anticipated in the Company’s estimate prepared for 2006 year-end reporting. However, claims paid in 2008 but incurred in 2007 and prior years were settled in 2008 for $23.9 million less than anticipated in the Company’s estimates at year-end 2007. Likewise, claims paid in 2009 but incurred in 2008 and prior years were settled in 2009 for $19.5 million less than what was anticipated at 2008 year-end. The most significant components of these favorable variances were in Torchmark’s UA Independent, UA Branch, and Medicare Part D distribution channels. During 2007, the Independent and Branch channels experienced a relatively high level of paid claims which resulted in an increased claim liability estimate at December 31, 2007. During 2008 and 2009, paid health claims have trended downwards and were settled more favorably than the original estimates. This resulted in reduced estimates of the claim liability for 2008 versus 2007, and again for 2009 versus 2008. The Company’s estimates at each point in time have reflected the emerging data and trends. In the Medicare Part D channel, the Company is required to estimate claim discounts that will be received from drug manufacturers. In each of the years 2008 and 2009, the discounts from the drug manufacturers received in the current year but related to prior year claims were higher than anticipated when the claim liability was determined.
In 2009, 2008, and 2007, deferred income tax expense was incurred because of certain differences between net income before income taxes as reported on the Consolidated Statements of Operations and taxable income as reported on Torchmark’s income tax returns. As explained in Note 1-Significant Accounting Policies, these differences caused the financial statement book values of some assets and liabilities to be different from their respective tax bases.
Torchmark’s Federal income tax returns are routinely audited by the Internal Revenue Service (IRS). During 2008, the IRS completed its examination of Torchmark’s 2003 and 2004 tax years. As a result, Torchmark recorded a $700 thousand tax benefit in 2008 to reflect the impact of the settlement. The IRS completed its examination of the Company’s 2005, 2006, and 2007 tax years during 2009. The Company recorded a $2.5 million tax benefit to reflect the results of the examination, including a reduction in its liability for uncertain tax positions relating to these years. The statutes of limitation for the assessments of additional tax are closed for all tax years prior to 2006. Management believes that adequate provision has been made in the financial statements for any potential assessments that may result from future tax examinations and other tax-related matters for all open tax years.
As noted in Note 1 - Significant Accounting Policies, effective January 1, 2007, Torchmark adopted new accounting guidance providing a methodology for the financial statement recognition and measurement of uncertain income tax positions taken or expected to be taken in a tax return. As a result of the adoption, Torchmark recognized a $2.3 million decrease to its liability for unrecognized tax benefits. This decrease was accounted for as an adjustment to the January 1, 2007 balance of “Retained earnings” on the Consolidated Balance Sheet. Including the cumulative effect decrease at January 1, 2007, Torchmark had approximately $12.3 million of total gross unrecognized tax benefits, excluding $6.0 million of accrued interest expense net of Federal tax benefits. If recognized in future periods, $1.2 million of the gross unrecognized tax benefits as of January 1, 2007 would have reduced the effective tax rate. The remaining $11.1 million related to timing differences which, if recognized, would have had no effect on the Company’s effective tax rate.
A reconciliation of the beginning and ending amount of unrecognized tax benefits (excluding effects of accrued interest, net of Federal tax benefits) for the years 2007 through 2009 is as follows:
Torchmark’s continuing practice is to recognize interest and/or penalties related to income tax matters in income tax expense. The Company recognized interest income of $1.7 million, $11.9 million, and $735 thousand, net of Federal income tax benefits, in its Consolidated Statements of Operations for 2009, 2008, and 2007, respectively. The Company had an accrued interest receivable of $3.9 million and $10.9 million, net of Federal income tax benefits, as of 2009 and 2008, respectively. The Company had no accrued penalties at December 31, 2009 or 2008.
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 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 million in 2009, $63 million in 2008, and $13 million in 2007. Torchmark estimates as of December 31, 2009 that it will contribute an amount not to exceed $20 million to these plans in 2010. The actual amount of contribution may be different from this estimate.
Plan assets in the funded plan 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 3-Investments under the caption Fair Value Measurements 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, 2009 and 2008.
Portfolio risk is managed through quality standards, diversification, and continuous monitoring. Equities must be listed on major exchanges and adequate market liquidity is required. Fixed maturities must be rated investment grade at purchase by a major rating agency. 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, 2009, there were no restricted investments contained in the portfolio.
The accumulated benefit obligation (ABO) for Torchmark’s funded defined benefit pension plans was $191 million and $184 million at December 31, 2009 and 2008, respectively. In the unfunded plans, the ABO was $27 million at December 31, 2009 and $24 million at December 31, 2008.
Torchmark has estimated its expected pension benefits to be paid over the next ten years as of December 31, 2009. These estimates use the same assumptions that measure the benefit obligation at December 31, 2009, taking estimated future employee service into account. Those estimated benefits are as follows:
Torchmark carries its 7.1% Junior Subordinated Debentures due to Trust III as a liability under the caption “Due to Affiliates” on its Consolidated Balance Sheets. Expenses of $4.3 million related to the offering reduce long-term debt and are amortized over the forty-year redemption period.
Stock options to purchase 9.4 million shares, 3.5 million shares, and 432 thousand shares during the years 2009, 2008, and 2007, respectively, are considered to be anti-dilutive and are excluded from the calculation of diluted earnings per share. Income available to common shareholders for basic earnings per share is equivalent to income available to common shareholders for diluted earnings per share.
An analysis of option activity for each of the three years ended December 31, 2009 is as follows:
The following table summarizes information about stock options outstanding at December 31, 2009.
No equity awards were cash settled during the three years ended December 31, 2009.
(2) Reclassification of interest amount due to accounting rule requiring deconsolidation of Trust Preferred Securities.
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 .9% of total life insurance in force at December 31, 2009. Insurance ceded on life and accident and health products represented .4% of premium income for 2009. 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 1.3% of life insurance in force at December 31, 2009 and reinsurance assumed on life and accident and health products represented .7% of premium income for 2009.
Leases: Torchmark leases office space and office equipment under a variety of operating lease arrangements. Rental expense for operating leases was $4.9 million in 2009, $5.1 million in 2008, and $6.0 million in 2007. Future minimum rental commitments required under operating leases having remaining noncancelable lease terms in excess of one year at December 31, 2009 were as follows: 2010, $4.1 million; 2011, $2.5 million; 2012, $2.1 million; 2013, $1.9 million; 2014, $1.1 million; and in the aggregate, $16.6 million.
At year-end 2009, 6% of invested assets was represented by fixed maturities rated below investment grade (BB or lower as determined by the weighted average of available ratings from rating services. Par value of these investments was $1.1 billion, amortized cost was $824 million, and fair value was $585 million. While these investments could be subject to additional credit risk, such risk should generally be reflected in market value of the securities.
Letters of Credit: Torchmark has guaranteed letters of credit in connection with its credit facility with a group of banks. The letters of credit were issued by TMK Re, Ltd., a wholly-owned subsidiary, to secure TMK Re, Ltd.’s obligation for claims on certain policies reinsured by TMK Re, Ltd. that were sold by other Torchmark insurance companies. These letters of credit facilitate TMK Re, Ltd.’s ability to reinsure the business of Torchmark’s insurance carriers. The agreement expires in 2011. 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, 2009, $200 million of letters of credit were outstanding.
Equipment leases: Torchmark has guaranteed performance of two subsidiaries as lessees under three leasing arrangements for aviation equipment. Two of the leases commenced in 2003 for lease terms of approximately 10 years and the other was entered into in 2009 also for 10 years. Lessees have certain renewal and early termination options under the first two leases, however. At December 31, 2009, total remaining undiscounted payments under the leases were approximately $12.2 million. Torchmark (parent company) would be responsible for any subsidiary obligation in the event the subsidiary did not make payments or otherwise perform under the terms of the lease.
known as Flexguard Plan, CS-1 Common Sense Plan, GSP Good Sense Plan, SHXC Surgical & Hospital Expense Policy, HSXC 7500 Hospital/Surgical Plan, MMXC Hospital/Surgical Plan, SMXC Surgical/Medical Expense Plan and/or SSXC Surgical Safeguard Expense Plan, and (ii) a membership in Heartland.” Plaintiffs assert claims for breach of contract, violation of Arkansas Deceptive Trade Practices Act and/or applicable consumer protection laws in other states, unjust enrichment, and common law fraud. Plaintiffs seek actual, compensatory, statutory and punitive damages, equitable and declaratory relief. On September 8, 2009, the Saline County Circuit Court granted the plaintiff’s motion certifying the class. On October 7, 2009, United American filed its notice of appeal of the class certification. Discovery is continuing.
Liberty National was a party to previously-reported litigation filed in the U.S. District Court for the Southern District of Florida by and on behalf of black Haitian-Americans residing in Florida, who had or have had an ownership interest in life insurance policies sold by Liberty National, which alleged that Liberty National had issued and administered such policies on a discriminatory basis because of their race and Haitian ancestry, ethnicity or national origin (Max Joseph, et al v. Liberty National Life Insurance Company, Case No. 08-20117 CIV-Martinez and Marlene Joseph v. Liberty National Life Insurance Company, Case No. 08-1:08-cv-22580). In May 2009, Marlene Joseph was settled by the parties with no appeals taken and in July 2009, the U.S. Circuit Court of Appeals for the Eleventh Circuit dismissed the appeal of a summary judgment granted to Liberty National by the two remaining individual Max Joseph plaintiffs for lack of jurisdiction as untimely filed.
First Command. Lamar C. Smith, a director of Torchmark, served as Chief Executive Officer of First Command Financial Services, Inc. (First Command), a corporation 100% owned by the First Command Employee Stock Ownership Plan (First Command ESOP) until May 1, 2007 and thereafter as Chairman of First Command Bank, a subsidiary of First Command, until his retirement from First Command September 30, 2007. Mr. Smith was a beneficiary of the First Command ESOP although he had no ability to vote the stock of First Command that is held by the First Command ESOP, which is independently trusteed. First Command receives commissions as the Military Agency distribution system for selling certain life insurance products offered by Torchmark’s insurance subsidiaries. These commissions were $45.3 million in 2007.
Torchmark has in place a coinsurance agreement with First Command’s life subsidiary whereby Torchmark cedes back to First Command approximately 3% of the new life insurance business sold by First Command on behalf of Torchmark’s insurance subsidiaries. Under the terms of this agreement, First Command pays Torchmark a maintenance expense allowance equal to 5.5% of all premium collected and an issue allowance of 2.9% of first year premium collected. Torchmark is also reimbursed for actual commissions, premium taxes, and claims paid on the business ceded to First Command. Also under the agreement, Torchmark provides First Command certain administrative, accounting, and investment management services. Premium ceded was $2.7 million in 2007.
Torchmark customarily grants options to certain consultants for their services in addition to their fees. Mr. Baxley received Torchmark options in each of the years 2007 through 2009.
The following is a summary of quarterly results for the two years ended December 31, 2009. 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.