Torchmark, through its subsidiaries, owns or leases buildings that are used in the normal course of business. Liberty owns a 487,000 square foot building at 2001 Third Avenue South, Birmingham, Alabama which currently serves as Liberty's, UILIC's, and Torchmark's home office. Liberty leases approximately 160,000 square feet of this building to unrelated tenants and has another 5,000 square feet available for lease. Liberty also operates from 64 company- owned district office buildings used for agency sales personnel.
United American owns and occupies a 125,000 square foot home office building at 2909 North Buckner Boulevard, Dallas, Texas. United American has purchased a 20 acre site in the Stonebridge Ranch development in McKinney, Texas (a north Dallas suburb) and is currently constructing a new 140,000 square foot facility on that site into which its home office will be relocated in 1996. The current home office building on Buckner will be sold.
A Torchmark subsidiary, Torchmark Development Corporation ("TDC"), has completed two buildings consisting of 185,000 square feet and 90,000 square feet of office space within a 100 acre commercial development known as Liberty Park along Interstate 459 in Birmingham, Alabama. Approximately 250,000 square feet of this total office area is currently leased. A 25,000 square foot office building is currently under construction in this development and is scheduled for completion in the Spring of 1996. TDC also owns and manages a 70,000 square foot office and retail complex adjacent to Liberty Park of which approximately 60% is leased by an affiliated party. As a part of a joint venture with unaffiliated entities, TDC is also developing 2,800 contiguous acres as a planned community development.
In the fourth quarter of 1995, Torchmark decided to dispose of its coalbed methane gas development in the Black Warrior Basin of Alabama due to disappointments in production. During 1995, Torchmark experienced increased difficulties in obtaining significant gas production from the lower coal seams from this development, resulting in revisions to engineering estimates of reserves. Accordingly, the Black Warrior investment was written down to its estimated realizable value. The writedown amounted to an after-tax charge of $130 million, or $1.82 per share for 1995. Please refer to "Black Warrior Writedown" on page 24 of this report for more information.
Net income from continuing operations for 1995 was $272 million, increasing 3% over $264 million in 1994. On a per share basis, income from continuing operations was $3.80 in 1995, gaining 4% from $3.65. Net income was $143 million, or $2.00 per share in 1995, compared with $269 million or $3.72 per share in 1994. Excluding realized investment gains and losses and the associated adjustment to deferred acquisition costs, net income from continuing operations was $3.93 per share, rising 5% over the prior period amount of $3.74. In 1994, net income per share from continuing operations, excluding realized investment gains and the associated adjustment to deferred acquisition costs, rose 9% over $3.43 per share in 1993. The adjustment to deferred acquisition costs was made because of an accounting rule requiring that deferred acquisition costs on interest-sensitive insurance products be amortized in accordance with expected gross profits. Since realized investment gains or losses on assets backing such products change profit expectations, the adjustment is required. Realized investment losses for 1995 included a $15 million after-tax, or $.21 per share, writedown of an investment in Southwestern Life Corporation, which filed for Chapter 11 bankruptcy protection in the third quarter of 1995.
In a comparison of 1995 results with those of 1994, attention should be given to the acquisition of American Income on November 3, 1994 for total consideration of $552 million. American Income's results were consolidated with Torchmark's after the acquisition date, being included for a full year in 1995 for the first time. American Income added approximately $17 million to Torchmark's net income, after taking into account goodwill amortization and financing costs. In comparison with 1993, a number of nonrecurring items should be considered. (1) In November, 1993, Torchmark sold 73% of its interest in Vesta Insurance Group, Inc. ("Vesta"), which was a wholly-owned property and casualty subsidiary prior to the sale. Such interest was sold for proceeds of $161 million and a $57 million pretax gain from the sale was recognized as other income. Vesta's operations were consolidated with Torchmark's in 1993 prior to the sale. (2) Results for 1993 included an $82 million pretax charge for nonoperating expenses, compared with $25 million for 1994. These charges related to legal costs, guaranty assessments, and other contingencies, some of which are discussed in more depth in "Item 3 - -Legal Proceedings" on page 12 of this report. The $25 million charge in 1994 was offset, however, by a reclassification of nonoperating expense to health benefits, since actual payments will be made in the form of health benefits. (3) Two new accounting standards which dealt with postretirement benefits and income taxes were implemented in 1993, increasing earnings $18.4 million. (4) Corporate tax legislation was enacted in 1993 which increased tax rates from 34% to 35%, resulting in an additional charge to 1993 earnings of $9.4 million to adjust the deferred tax liability relating to prior years.
Other operating expenses rose $27 million in 1995 over the prior year or 23%. The inclusion of American Income's expenses for a full year accounted for $7 million of the increase. After adjusting for American Income and Vesta, 1994 expenses declined 10% from 1993. Increases in goodwill amortization, interest expense, and the MIPS dividend were caused by the American Income acquisition in 1994 and the United Management acquisition in 1993. The American Income purchase added $10 million and the United Management purchase added $3 million in annual goodwill amortization. Please refer to the following sections of this report for a more complete discussion of these purchases and the related financing costs: "Acquisition of American Income" on page 27, "Capital Resources" on page 27, and "Merger with United Management" on page 28.
Annualized life premium in force climbed 9% in 1995 to $869 million at December 31. Annualized life premium in force was $797 million at December 31, 1994, rising 30% over 1993 year end. The 1994 increase was 7% after adjusting for the inclusion for American Income's annualized life premium in force of $141 million at the acquisition date. Annualized premium in force data includes amounts collected on certain interest-sensitive life products which are not recorded as premium income but exclude single premium income and policy charges.
As a percentage of premium, insurance operating income has remained constant in both 1995 and 1994 over the prior period. Excluding American Income, insurance margins have remained stable with a slight increase in policy obligations offset by lower amortization of acquisition costs. A major factor in maintaining stable margins is improved persistency.
Improvements in persistency are beneficial to operating income margins because they lower the rate of amortization of acquisition costs and certain other expenses. In addition, improved persistency increases profits because the premium life is extended. Persistency improvements have resulted, at least in part, from revisions in agents' compensation formulas to encourage lower lapses. Improvements have also been attributable to the conversion of a large portion of agent-collected home service business to bank draft and direct billing premium, which have higher persistency. In fact, Torchmark will no longer sell agent-collected business starting in 1996. Agent-collected premium as a percentage of total home service premium was approximately 15% at year- end 1995, compared with 48% five years earlier.
Health premium was $751 million in 1995, falling 2% from $769 million in 1994. Health premium declined 4% in 1994. Annualized premium in force stood at $755 million at December 31, 1995, declining 7% from 1994 year-end premium in force of $808 million. Annualized health premium in force declined 2% in 1994. Sales of health insurance products in terms of annualized premium issued declined 15% to $103 million in 1995, after having declined 31% in 1994. These declines in sales resulted in the diminished base of annualized health premium in force.
The declines in sales of health annualized premium in both years were primarily due to decreases in Medicare Supplement product sales. Sales of Medicare Supplement insurance were $65 million in 1995, compared with $88 million in 1994. They declined 26% in 1995 and 36% in 1994. These sales declines caused annualized premium in force for Medicare Supplement to decrease from $601 million at year-end 1993 to $572 million at 1994 year end to $530 million at December 31, 1995. In the past few years, Torchmark has encountered considerable competition in the Medicare Supplement market with regard to price and "attained-age" pricing, whereby premium may be increased on a basis of increased age as well as increased medical costs. The increased price competition has had a negative impact on sales. Also, in recent years, there has been increased competition from health maintenance organizations in the Medicare Supplement market. Uncertainty has also been a factor negatively affecting sales. Particularly in 1993 and 1994, there was considerable uncertainty regarding various health care reforms proposed by both the Clinton Administration and Congress which had bearing on the Medicare Supplement market. Additionally, in recent years, this market has experienced a great deal of increased regulation including government mandated policy forms, a required minimum loss ratio of 65% on policies sold, and a required leveling of agents' commissions. The mandated loss ratio and leveling of commissions have put significant pressure on margins for Torchmark as well as the rest of the industry, thus discouraging sales.
Annuities: Torchmark's annuity products serve a wide range of markets, such as providing retirement income, funding prearranged funerals, and offering long-term tax-deferred growth opportunities. Annuities are sold on both a fixed and variable basis. Fixed annuity deposits are held and invested by Torchmark and are obligations of the company. Amounts deposited for variable annuities are invested at the policyholder's direction into his choice among nine W&R managed mutual funds which vary in degree of investment risk and return. A fixed investment account is also available as a variable annuity investment option. These investments for variable annuity deposits are reported as "Separate Account Assets" and the corresponding deposit balances for variable annuities are reported as "Separate Account Liabilities."
These charges were $19 million in 1995, gaining 37% over 1994 charges of $14 million, which in turn rose 47% over the prior year. Growth in these policy charges resulted from the increase in size of the annuity account balance over each of the prior years, the increase in the number of annuity contracts in force, and the cumulative effect of growth in sales over the past few years on which the sales charge is based. The allocated investment income, or the investment income earned in excess of policy requirements, also grew in each of the periods 1993 through 1995. These increases resulted from the growth in the fixed annuity deposit balances.
Financial services revenues climbed 9% to $152 million for the year 1995 from the prior year amount of $139 million. These revenues grew 1% in 1994. Asset management fees of $86 million in 1995 were the largest component of financial services revenues, gaining 22% over 1994 fees of $71 million. Asset management fees grew 10% in 1994 over 1993. Increases in these fees have occurred due to the growth in average mutual fund assets and institutional assets under management, on which asset management fees are based. Average assets under management rose 14% in 1995 and 10% in 1994. Growth in average assets under management resulted from added investment product sales in both the 1995 and 1994 periods. Additionally, 1995 asset growth was boosted by the strength in the financial markets. Assets under management were $18.3 billion at December 31, 1995 and $14.5 billion at December 31, 1994, rising 26% in 1995. The 1994 increase in assets under management was less than 1%.
Energy: As previously discussed on page 17 of this report, Torchmark intends to dispose of its energy operations and has classified such operations as discontinued operations in the financial statements. These energy operations involved the management of proven producing oil and gas properties for both Torchmark affiliates and unrelated parties by Torch Energy. Energy operations also included drilling of developmental wells, acquisition of properties and facilities, and marketing of oil and gas products by Torch Energy. They also involved the extraction and production of energy products through direct energy investments.
As a result of these events, a review was made for impairment under the provisions of SFAS 121. In accordance with the requirements of SFAS 121 and in view of Torchmark's desire to dispose of Black Warrior, Torchmark wrote down its investment to its estimated net realizable value, resulting in an after- tax charge of $130 million, or $1.82 per share in 1995. Net realizable value was determined using a discounted cash flow model. Even though gas prices improved in 1995, the significant decline in proved reserves resulted in the impairment of Black Warrior's estimated net realizable value.
Investments: Because Torchmark's Black Warrior coalbed methane investment and certain other energy investments are included in the disposed energy segment, these investments and the associated investment income are presented in the financial statements as discontinued operations. Therefore, all previously-reported amounts of invested assets and investment income have been reclassified accordingly.
Net investment income increased 10% to $382 million in 1995, after having experienced a 6% decline from $368 million in 1993 to $348 million in 1994. In comparison of net investment income between these three periods, the acquisition of American Income and the disposition of Vesta must be taken into account. After adjusting for the effect of the American Income acquisition, 1995 net investment income rose 3% from $344 million in 1994 to $354 million. When excluding the effect of both transactions, 1994 investment income declined 4% from $357 million in 1993.
In addition to the larger invested asset base caused by the American Income purchase, the increase in 1995 income over the prior year was also caused by certain other factors. First, nonrecurring investment income was received in the fourth quarter of 1995 on passive energy investments retained by Torchmark in the amount of $4.3 million from a legal settlement. Additionally, there was a slight improvement in yield on the portfolio.
In 1995, a persistent easing of inflationary expectations helped create a significant bond market rally which more than offset the weakness of 1994. Yields available on fixed investments declined throughout the year, falling approximately 200 basis points when measured by the ten and thirty-year Treasury bond. In this environment, Torchmark emphasized the acquisition of call-protected corporate bonds, while continuing to reduce mortgage-backed investments and municipal holdings. During 1995, investment acquisitions in the amount of $1.87 billion were made at an average yield of 7.28%, compared with acquisitions of $1.29 billion yielding 7.13% in 1994. Corporate obligations represented 84% of total 1995 new purchases. The increased acquisition activity in 1995 resulted from (1) the inclusion of American Income's investment operations for the full year of 1995; and, (2) the reinvestment of proceeds from two sale programs executed during 1995 designed to lessen exposure to mortgage-backed holdings.
With the decrease in GNMA holdings, the percentage of government and government-guaranteed holdings within Torchmark's fixed-income portfolio continued to decline. This percentage was 29% at year-end 1995, 47% at year- end 1994, and 59% at year-end 1993. Torchmark's preference for quality is demonstrated, however, by the fact that at December 31, 1995, 43% of the fixed income holdings were rated "AAA" by rating agencies and 96% were considered to be investment grade.
Repayment of investment assets is a function of both maturity and the changing interest rate environment. The reduction in cash flow which resulted from GNMA sales during the year was more than offset by the acquisition of shorter maturity corporate bonds and the increased probability of early calls as rates declined. Accordingly, at year-end 1995, an estimated 37% of the fixed maturity portfolio should repay within five years, compared with 30% at year-end 1994 and 46% at year-end 1993. The following table is a presentation of the percentages of Torchmark's fixed investment portfolio by estimated maturity.
Because Torchmark's investment program is based upon high quality fixed maturity bonds, Torchmark's percentage ownership of other types of investments varies significantly from other companies in the industry. The following table presents Torchmark's holdings by asset type as of December 31, 1995 as contrasted with the industry averages prepared by the American Council of Life Insurance.
Cash and short-term investments were $86 million at December 31, 1995, compared with $120 million at year-end 1994. These liquid assets represented approximately 1% of total assets at December 31, 1995, compared with 1.5% at the end of the previous year. In addition to Torchmark's liquid assets, Torchmark has a portfolio of marketable fixed and equity securities which are available for sale should the need arise. These securities had a value of $5.2 billion at December 31, 1995.
Liquidity of the parent company is affected by the ability of the subsidiaries to pay dividends. Dividends are paid by subsidiaries to the parent in order to meet its dividend payments on common and preferred stock, interest and principal repayment requirements on parent company debt, and operating expenses of the parent company. Dividends from insurance subsidiaries of Torchmark are limited to the greater of statutory net gain from operations on an annual noncumulative basis or 10% of surplus, in the absence of special approval, and distributions are not permitted in excess of statutory net worth. Subsidiaries are also subject to certain minimum capital requirements. Although these restrictions exist, dividend availability from subsidiaries has been and is expected to be more than adequate for parent company operations. At December 31, 1995, a maximum amount of $237 million was available to Torchmark from insurance subsidiaries without regulatory approval.
In connection with the American Income purchase in November, 1994, Torchmark issued eight million shares or $200 million face amount Cumulative Monthly Income Preferred Securities, Series A ("MIPS") in October, 1994. The MIPS were issued at an annual dividend rate of 9.18%. They are subject to a mandatory redemption in full at September 30, 2024, although Torchmark may elect to extend the MIPS for up to an additional 20 years if certain conditions are met. They are redeemable at Torchmark's option at any time after September 30, 1999. While Torchmark is obligated to pay dividends at a fixed rate of 9.18%, Torchmark subsequently entered into a ten-year interest-rate swap agreement with an unaffiliated party whereby Torchmark agreed to pay a variable rate on the $200 million face amount in exchange for payment of the fixed dividend. Additionally, Torchmark acquired a five-year interest-rate cap on the swap agreement that insures the variable rate cannot exceed 10.39%. At December 31, 1995, the variable rate was 5.86%. During 1995, Torchmark's after-tax dividend cost for the MIPS was $10.3 million, compared with $11.9 million that would have been incurred without the swap and cap transactions.
Shareholders' equity rose to $1.59 billion at December 31, 1995, an increase of 28% from December 31, 1994 shareholders' equity of $1.24 billion. Book value per share was $22.17 at 1995 year end, compared with $17.37 and $18.80 at year-ends 1994 and 1993, respectively. After adjusting for the impact of interest-rate fluctuations on shareholders' equity required by accounting rules, book value per share was $20.33 at year-end 1995, an increase of 5% over $19.31 at year-end 1994. Comparative book value per share was $17.29 at year-end 1993. Return from continuing operations on common shareholders' equity was 18.5% in 1995, compared with 19.7% in 1994, declining in large part due to the growth in shareholders' equity. The return on equity ratio excludes the mark up or down of shareholders' equity for changes in interest rates required by accounting rules. Total debt as a percentage of total capitalization was 37% at December 31, 1995, with the MIPS counted as equity and excluding the effect of the above-mentioned accounting rule. This debt to capitalization ratio was 40% at year-end 1994 and 41% at year-end 1993. Torchmark's multiple of earnings before interest, taxes, and discontinued operations to interest requirements was 6.3 for 1995, compared with 6.2 in 1994 and 7.7 in 1993.
Acquisition of American Income: On November 3, 1994, Torchmark acquired American Income for a total cash purchase price of approximately $552 million. American Income sells life insurance to union and credit union members through exclusive agents. The addition of American Income's quality line of products and low-cost operation fits well with Torchmark's strategy of growing life insurance operations in niche markets. The results of operations of American Income were consolidated with those of Torchmark after the purchase date. Funds for the purchase were provided through a $200 million preferred stock offering which is discussed in more detail in the capital resources section above, a $175 million bridge loan from a group of banks, the sale of investments available for sale, and internal cash flow.
Restructure: Torchmark is exploring a strategic restructuring for the purpose of enhancing shareholder value. Many alternatives will be examined. One alternative includes the possibility that Torchmark could be divided into separate publicly-traded operating companies. Because there are many complex tax, accounting, business, operational, and capital issues to be resolved, should such a restructuring be undertaken, it is unknown at this time what the ultimate form of this restructuring might take .
Litigation: Torchmark and its subsidiaries continue to be named as parties to pending or threatened litigation, most of which involve punitive damage claims based upon allegations of agent misconduct at Liberty in Alabama. Such punitive damage claims are tried in Alabama state courts where any punitive damage litigation has the potential for significant adverse results. It is impossible to predict the extent of punitive damages that may be awarded if liability is found in any given case, since the amount of punitive damages in Alabama is left largely to the discretion of the jury in each case. It is thus difficult to predict with certainty the liability of Torchmark or its subsidiaries in any given case because of the unpredictable nature of this type of litigation.
Merger with United Management: On October 1, 1993, Torchmark acquired the approximately 16% of United Management that it did not already own through the payment of $31.25 per share in cash for the remaining outstanding shares. Accordingly, United Management was merged into Torchmark. Including share purchases made in 1993, the total amount of consideration paid to the remaining United Management shareholders was approximately $230 million.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Torchmark Corporation and subsidiaries at December 31, 1995 and 1994, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1995, in conformity with generally accepted accounting principles. Also, in our opinion, the related 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.
Recognition of Premium Revenue and Related Expenses: Premiums for insurance contracts which are not defined as universal life-type according to SFAS 97 are recognized as revenue over the premium-paying period of the policy. Profits for limited-payment life insurance contracts as defined by SFAS 97 are recognized over the contract period. Premiums for universal life-type and annuity contracts are added to the policy account value, and revenues for such products are recognized as charges to the policy account value for mortality, administration, and surrenders (retrospective deposit method). Variable annuity products are also assessed an investment management fee and a sales charge. Life premium
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) (DOLLAR AMOUNTS IN THOUSANDS EXCEPT PER SHARE DATA) NOTE 1--SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) includes policy charges of $72.7 million, $74.2 million, and $76.2 million for the years ended December 31, 1995, 1994 and 1993, respectively. Other premium includes annuity policy charges for the years ended December 31, 1995, 1994, and 1993 of $19.0 million, $13.9 million, and $9.5 million, respectively. Profits are also earned to the extent that investment income exceeds policy requirements. The related benefits and expenses are matched with revenues by means of the provision of future policy benefits and the amortization of deferred acquisition costs in a manner which recognizes profits as they are earned over the same period.
measured. It also requires that long-lived assets and intangibles to be disposed of be reported at the lower of carrying amount or fair value less cost to sell. Except for the writedown of the energy investment described in Note 8, the adoption of this statement had no material impact on Torchmark's operations or financial position.
Litigation: Torchmark and its subsidiaries continue to be named as parties to legal proceedings. Because much of Torchmark's litigation is sought in Alabama, a jurisdiction known for excessive punitive damage verdicts bearing little or no relationship to actual damages, the ultimate outcome of any particular action cannot be predicted. It is reasonably possible that changes in the expected outcome of these matters could occur in the near term, but such changes should not be material to Torchmark's reported results or financial condition.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) (DOLLAR AMOUNTS IN THOUSANDS EXCEPT PER SHARE DATA) NOTE 3--INVESTMENT OPERATIONS (CONTINUED) A summary of fixed maturities available for sale and equity securities by amortized cost and estimated market value at December 31, 1995 and 1994 is as follows:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) (DOLLAR AMOUNTS IN THOUSANDS EXCEPT PER SHARE DATA) NOTE 3--INVESTMENT OPERATIONS (CONTINUED)
Derivative investments are immaterial to Torchmark at December 31, 1995. Torchmark's total carrying value of these investments was $23.9 million and $24.5 million at December 31, 1995 and 1994, respectively. Torchmark has no off-balance sheet exposure in connection with these investments.
Depreciation expense on property used in the business was $5.7 million, $7.6 million, and $7.3 million in each of the years 1995, 1994, and 1993, respectively.
In November, 1993, Torchmark sold approximately 73% of Vesta Insurance Group, Inc. ("Vesta"), Torchmark's holding company for its property and casualty insurance operations. The sale was made through an initial public offering of common stock for net proceeds of $161 million for a pretax gain of $57.2 million. Torchmark maintains a 27% interest in Vesta and accounts for its investment on the equity method, recording its investment as an unconsolidated subsidiary. In connection with the public offering, Torchmark loaned Vesta $28 million at an interest rate of 6.1% for a term of five years, which was outstanding at both December 31, 1994 and 1993. In July, 1995, this note was repaid in full.
On November 3, 1994, Torchmark acquired all of the outstanding common stock of American Income Holding, Inc., whose primary operating subsidiary is American Income Life Insurance Company ("American Income") for $35 per share or a total purchase price of $552 million, including expenses. American Income is a life insurance company which sells individual supplemental life and fixed-benefit accident and health insurance through labor union locals, credit unions, and other employment related associations. The purchase was financed with a combination of internal funds, sales of securities, bank borrowings, and the issuance by a finance subsidiary of 9.18% Cumulative Monthly Income Preferred Securities, Series A ("MIPS"). The transaction resulted in goodwill of approximately $403 million which will be amortized on a straight line basis over 40 years. The acquisition was accounted for as a purchase, and the results of operations since the acquisition date have been consolidated.
The table below presents supplemental pro forma information for 1994 and 1993 as if the American Income acquisition were made at January 1, 1993 at the same purchase price, based on estimates and assumptions considered appropriate:
During 1995, Torchmark decided to dispose of Torch Energy Advisors Incorporated ("Torch Energy"), its energy management subsidiary. At year end 1995, Torchmark was negotiating to sell Torch Energy to an unaffiliated party. Also in 1995, Torchmark decided to dispose of its coalbed methane gas development in the Black Warrior basin of Alabama due to disappointments in production. Torchmark intends to sell this development, and implemented a plan to dispose of this investment in the fourth quarter of 1995. In view of the proposed sale of the Black Warrior investment, and in accordance with the provisions of SFAS 121, Torchmark wrote this investment down to its estimated net realizable value, resulting in an after-tax charge of $130 million or $1.82 per share. Since, on a combined basis, the activities of Torch Energy and the Black Warrior investment represent Torchmark's energy management and development activities, the disposition of these operations qualify for disposal of a segment
accounting treatment. Therefore, Torchmark has modified the presentation in its financial statements for 1995 and all prior periods to set forth separately the net assets and results attributable to the discontinued energy segment as discontinued operations.
The overall average interest assumption for determining the liability for future life and health insurance benefits in 1995 was 6.3%.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) (DOLLAR AMOUNTS IN THOUSANDS EXCEPT PER SHARE DATA) NOTE 11--INCOME TAXES
As discussed in Note 1, Torchmark adopted Statement 109 on January 1, 1993. The cumulative effect of this change in accounting for income taxes was a $26.1 million addition to net income for the year ended December 31, 1993. This amount is included in the cumulative effect of changes in accounting principles line on the consolidated statement of operations.
The effective income tax rate differed from the expected 35% rate in 1995, 1994, and 1993 as shown below:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) (DOLLAR AMOUNTS IN THOUSANDS EXCEPT PER SHARE DATA) NOTE 11--INCOME TAXES (CONTINUED)
The significant components of deferred income tax expense before the cumulative effect of the change in accounting principles and adjustments to shareholders' equity are as follows:
Pension Plans: Torchmark has retirement benefit plans and savings plans which cover substantially all employees. There is also a nonqualified excess benefit plan which covers certain employees. The total cost of these retirement plans charged to operations was as follows:
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. Accrued pension expense in excess of amounts contributed has been recorded as a liability in the financial statements and was $9.5 million and $11.8 million at December 31, 1995 and 1994, respectively. The plans are organized as trust funds whose assets consist primarily of investments in marketable long-term fixed maturities and equity securities which are valued at market.
A reconciliation of the funded status of the defined benefit plans with Torchmark's pension liability was as follows:
The weighted average assumed discount rates used in determining the actuarial benefit obligations were 7.25% in 1995 and 8.0% in 1994. The rate of assumed compensation increase was 4.25% in 1995 and 5.0% in 1994 and the expected long-term rate of return on plan assets was 8.0% in 1995 and 1994.
The following table sets forth the plans' combined benefit obligation with the amount shown in Torchmark's balance sheet:
For measurement purposes, a 11% to 14% annual rate of increase in a per capita cost of covered health care benefits was assumed for 1995; the rate was assumed to decrease gradually to 4.5% by the year 2008 and remain at that level thereafter. The health care cost trend rate assumption has a significant effect on the amounts reported. To illustrate, increasing the health care cost trend by one percentage point in each year would increase the accumulated postretirement benefit obligation as of December 31, 1995 by $855 million and would increase the net periodic postretirement cost for the year ended December 31, 1995 by approximately $146 thousand.
Torchmark has entered into revolving credit agreements with a group of lenders under which it may borrow on an unsecured basis up to $400 million. One-half of the commitment matures December 3, 1996 and the balance matures December 6, 1999. Borrowings, pro rata under each facility, are at interest rates selected by Torchmark based on either the prime rate or the Eurodollar rate at the time of borrowings. At December 31, 1994, borrowings totalled $250 million and were made at an average rate of 6.40%. There were no borrowings outstanding at December 31, 1995. The revolving credit agreements are designed to back up a commercial paper program which began in March, 1995. The short- term borrowings under the revolving credit agreements and in the commercial paper market averaged $221 million during 1995, and were made at an average yield of 5.97%. At December 31, 1995, commercial paper was outstanding in the face amount of $190.4 million. Torchmark is subject to certain covenants for the revolving credit agreements regarding capitalization and earnings, for which it was in compliance at December 31, 1995, and pays a facility fee based on size of the lines.
Adjustable Rate Preferred Stock: One million shares of adjustable rate preferred stock were issued in 1983 at an issue price of $100 per share. Prior to 1993, Torchmark acquired 530 thousand shares which were reported as treasury stock and had a total cost basis of $47.8 million and a total redemption value of $52.9 million. During 1994, Torchmark acquired the remaining 470 thousand shares at a cost of $100 per share plus accrued dividends. The acquisition was completed at an aggregate price of $47 million. The preferred treasury stock was immediately retired.
Stock Options: Under the provisions of the 1984 Torchmark Corporation Stock Option Plan ("1984 Option Plan") and the Torchmark Corporation 1987 Stock Incentive Plan ("1987 Option Plan"), certain employees and directors have been granted options to buy shares of Torchmark stock at the market value of the stock on the date of grant. In conjunction with the buyback of the minority interest of United Management, the United Investors Management Company 1986 Employee Stock Incentive Plan was amended to allow the granting of Torchmark stock options. The options are exercisable during the period commencing from three months to three years after grant until expiring ten years or ten years and two days after grant. In October, 1993, Torchmark implemented a policy to issue shares for the exercise of stock options out of treasury stock.
A summary of option activity in terms of shares is as follows:
Option information by exercise price is listed in the following table. Those options shown as granted on October 1, 1993 represent United Management options which were converted to Torchmark options in conjunction with the merger.
(1) Options to purchase 1,098,090 shares previously granted December 31, 1989 at $37.13 per share, 521,100 shares previously granted January 25, 1990 at $33.13 per share, and 389,870 shares originally granted August 1, 1990 at $33.88 per share were allowed by recipients to expire voluntarily and were reissued October 11, 1990 along with 675,200 additional shares at $25.63 per share. (2) Includes 173,650 shares granted under the United Investors Management Company 1986 Employee Stock Incentive Plan. (3) Issued from the United Investors Management Company 1986 Employee Stock incentive plan. (4) Options to purchase 37,777 shares previously granted at $36.61, options to purchase 301,881 shares previously granted at $43.50, options to purchase 22,905 shares previously granted at $46.56, and options to purchase 142,433 shares previously granted at $52.00 were repriced to $34.00 per share on December 16, 1994. The vesting schedules of these options did not change.
Restrictions: Restrictions exist on the flow of funds to Torchmark from its insurance subsidiaries. Statutory regulations require life insurance subsidiaries to maintain certain minimum amounts of capital and surplus. These restrictions generally limit the payment of dividends by insurance subsidiaries to statutory net gain on an annual noncumulative basis in the absence of special approval. Additionally, insurance companies are not permitted to distribute the excess of shareholders' equity as determined on a GAAP basis over that determined on a statutory basis. In 1996, $237 million will be available to Torchmark for dividends from insurance subsidiaries in compliance with statutory regulations without prior regulatory approval.
Restrictions on cash: A portion of the cash held in financial service subsidiaries that function as broker-dealers has been segregated for the benefit of customers in compliance with security regulations. This amount was $11.8 million at December 31, 1995 and $13.1 million at December 31, 1994.
Collateral Requirements: Torchmark requires collateral for investments in instruments where collateral is available and is typically required because of the nature of the investment. Since the majority of Torchmark's investments are in government, government-secured, or corporate securities, the requirement for collateral is rare. Torchmark's mortgages are secured by collateral, although new mortgages are no longer being acquired.
Litigation: Torchmark and its subsidiaries continue to be named as parties to pending or threatened legal proceedings. These lawsuits involve tax matters, alleged breaches of contract, torts, including bad faith and fraud claims based on alleged wrongful or fraudulent acts of agents of Torchmark's subsidiaries, employment discrimination, and miscellaneous other causes of action. Many of these lawsuits involve claims for punitive damages in state courts of Alabama, a jurisdiction particularly recognized for its large punitive damage verdicts. A number of such actions involving Liberty National Life Insurance Company ("Liberty") also name Torchmark as a defendant. As a practical matter, a jury's discretion regarding the amount of a punitive damage award is not limited by any clear, objective criteria under Alabama law. Accordingly, the likelihood or extent of a punitive damage award in any given case is virtually impossible to predict. Furthermore, the Alabama Supreme Court has recently ruled that one half of all punitive damage awards, after the deduction of attorneys fees, should go to the State of Alabama. This same ruling also provides for a bifurcated trial, with the first stage devoted to this issue of liability and the second stage relating to damages. The hearing on damages will enable the jury to hear evidence of the financial worth of the defendant. This potentially damaging evidence has not been previously admissible in Alabama courts. The Alabama Supreme Court has been asked to reconsider this ruling and this petition is still pending. As of December 31, 1995, Liberty was a party to approximately 185 active lawsuits (including 31 employment related cases and excluding interpleaders and stayed cases), more than 160 of which were Alabama proceedings in which punitive damages were sought. Liberty faces trial settings in these cases on an on- going basis.
Torchmark has previously reported the entry of an Order and Final Judgment by the Circuit Court of Barbour County, Alabama in Robertson v. Liberty National Life Insurance Company (Case No. CV-92-021) approving a cancer policy class action settlement involving legal and equitable relief valued at a total of $55 million. The cost of this settlement increases over time as Liberty is prohibited from increasing the premium rates on this block of business for one year from final binding affirmance by the Alabama Supreme Court. This aspect of the settlement is expected to cost Torchmark an additional $2.5 million before tax in each quarter going forward until one year after final binding affirmance by the Alabama Supreme Court. In July 1994, certain intervenors in the Robertson litigation filed a notice of appeal of the Order and Final Judgment approving class certification and the settlement with the Supreme Court of Alabama. Oral argument on the appeal was held July 17, 1995 and on December 22, 1995, the Supreme Court unanimously affirmed the Robertson class action settlement. On February 16, 1996, the Alabama Supreme Court issued a notice overruling the petition for a rehearing in Robertson filed by certain intervenors.
In April 1994, the complaint in Miles was amended to add an additional shareholder plaintiff and to name Torchmark as a defendant. The Miles case was dismissed upon the joint motion of all parties in September 1995. A second similar action (Oakley v. Torchmark Corporation, Case No. CV-94-47), filed on August 16, 1994 in the Circuit Court for Bibb County, Alabama, was dismissed by the plaintiff without
Prior filings have reported that in July 1994, a purported class action alleging fraudulent and deceitful practices in premium billing and lapses of coverage on a payroll deduction insurance plan was filed in the Superior Court for Gordon County, Georgia against Liberty (Bryant v. Liberty National Life Insurance Company, Civil Action No. 28979). The complaint alleges actual damages in excess of $10 million and punitive damages of not less than $50 million as well as premium reimbursements. No class has been certified and no material proceedings have occurred in this case. Liberty removed this case to federal court, but the case has subsequently been remanded to the state court. Liberty intends to vigorously defend this action.
A purported class action was filed on August 8, 1995, against Liberty in the Circuit Court of Jefferson County, Alabama on behalf of Liberty cancer policyholders eligible for Medicare who submitted claims during the approximately two month period in 1993 described in the foregoing paragraph (Adkins v. Liberty National Life Insurance Company, Case No. CV-95-05634). The claims made in Adkins are identical to the individual claims in the Allen case above. More than 400 (and perhaps as many as 1,000) individuals appear to fit the proposed class definition in Adkins. Punitive damages and damages for mental anguish appear to be sought on behalf of the class. A class certification hearing is set in May 1996. The Company intends to oppose class certification and to vigorously defend the case.
Missouri on behalf of all former agents of Globe (Smith v. Torchmark Corporation, Case No.: 95-3304-CV-S-4). This action alleges that the defendants breached independent agent contracts with the plaintiffs by treating them as captive agents and engaged in a pattern of racketeering activity wrongfully denying income and renewal commissions to the agents, restricting insurance sales, mandating the purchase of worthless leads, terminating agents without cause and inducing the execution of independent contracts based on misrepresentations of fact. Monetary damages in an unspecified amount are sought. A plaintiff class was certified by the District Court on February 26, 1996, although the certification does not go to the merit of the allegations in the complaint. The companies intend to vigorously defend this action.
Torchmark operates primarily in two industry segments, insurance and asset management. Operations in the insurance industry involve the sale and administration of life insurance, health insurance and annuities. It also includes investment operations related to insurance segment investments. Operations in the asset management industry include the management, distribution, and servicing of various mutual funds. Torchmark markets its products in all fifty states.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) (DOLLAR AMOUNTS IN THOUSANDS EXCEPT PER SHARE DATA) NOTE 18--RELATED PARTY TRANSACTIONS
The following table summarizes Torchmark's noncash transactions, which are not reflected on the Statement of Cash Flow as required by GAAP: