During 1999, Torchmark sold the majority of its investment real estate holdings for total consideration of $123 million. These sold investments included its TMK Income Properties limited partnership and its joint venture investment in Liberty Park, a planned community in Birmingham, Alabama. As of December 31, 2000, Torchmark retained $15 million of investment real estate, which included $7 million of properties that were partially occupied by Torchmark subsidiaries and $7 million of undeveloped land in Liberty Park.
(1) Net income from continuing operations, excluding realized investment gains (losses), the related adjustment to deferred acquisition costs, equity in Vesta earnings for periods prior to 1999, a one-time gain on the sale of equipment, and the nonrecurring charge. (2) Annualized life premium in force excludes $5.3 million representing the Family Service business sold in 1998.
5) The inability of Torchmark to obtain timely and appropriate premium rate increases for health insurance;
9) The customer response to new products and marketing initiatives; and
10) Financial markets trends that adversely affect sales of Torchmark's market-sensitive products.
The following is a discussion of Torchmark's operations for the three years ended December 31, 2000. In the analysis and comparison of Torchmark's operating results for 1999 and 2000 with 1998, two divestitures that occurred in 1998 should be taken into account:
Divestiture of Waddell & Reed. In March, 1998, Waddell & Reed, Torchmark's asset management subsidiary, completed an initial public offering of approximately 24 million shares of its common stock. The offering represented approximately 36% of Waddell & Reed's shares. Net proceeds from the offering were approximately $516 million after underwriters' fees and expenses. Waddell & Reed used $481 million of the proceeds to repay existing notes owed to Torchmark and other Torchmark subsidiaries and retained the remaining $35 million. Torchmark's $481 million proceeds from the note repayments were invested or used to pay down debt. (See the discussion on Investments on page 29, Liquidity on page 33, and Capital Resources on page 33 of this report.) The initial public offering resulted in a $426 million gain which was added to Torchmark's additional paid-in capital. Torchmark retained the remaining 64% of the Waddell & Reed stock.
Summary of Operating Results. Torchmark's management computes a classification of income called "net operating income." Torchmark's management focuses on net operating income in evaluating the operating performance of the company. It differs from net income as reported in the financial statements in that it excludes unusual and nonrecurring income or loss items and nonoperating items which distort operating trends. It also excludes discontinued operations.
3) Torchmark's pro rata share of the income or losses related to Vesta in 1998;
4) The nonrecurring loss from the redemption by Torchmark of its debt in 1998 in the amount of $5 million net of tax and the gain from redemption of debt in 2000 of $.2 million net of tax;
Torchmark's revenues in 2000 were $2.52 billion, a 13% increase over 1999 revenues of $2.23 billion. Revenues rose 3% in 1999 over 1998 revenues of $2.16 billion. After adjustment for realized investment gains and losses in each year, revenues grew 8% to $2.52 billion in 2000 from $2.33 billion in 1999. They also increased 5% in 1999 over the prior year. Total premium rose $162 million, or 9%, to $2.05 billion in 2000. Total premium increased 7% in 1999 to $1.88 billion. Life insurance premium grew 6% in 2000 to $1.08 billion, an increase of $64 million. Health premium in 2000 rose 10% to $911 million, an increase of $86 million. Net investment income increased $25 million, or 6%, in 2000 to $472 million. Life premium increased 6% to $1.02 billion and health premium grew 9% to $825 million in 1999. Net investment income declined 3% in 1999 to $447 million, due primarily to the sale of Family Service.
Other operating expenses, which consist of insurance administrative expenses and expenses of the parent company, were $121 million in 2000, compared with $115 million in 1999 and $117 million in 1998. Other operating expenses as a percentage of revenues, excluding realized gains and losses, declined in each period and were 4.8% in 2000, 4.9% in 1999, and 5.3% in 1998. The components of Torchmark's revenues and operations are described in more detail in the discussion of Insurance and Investment segments found on pages 21 through 32 of this report.
The following table is a summary of Torchmark's net operating income. Insurance underwriting income is defined by Torchmark management as premium income less net policy obligations, commissions, acquisition expenses, and insurance administrative expenses plus other income. Excess investment income is defined as tax-equivalent net investment income reduced by the interest credited to net policy liabilities and financing costs. Financing costs include the interest on Torchmark's debt and the net cost of the Monthly Income Preferred Securities ("MIPS").
Because Family Service was sold on June 1, 1998, information for 1998 in the following discussions of Torchmark's life insurance operations exclude Family Service for comparability.
Life insurance products are marketed through a variety of distribution channels. The following table presents life insurance premium by distribution method during each of the three years ended December 31, 2000.
Annualized premium sold by the Direct Response operation was $113 million in 2000, increasing 18% over 1999 sales of $96 million, due in part to a higher average premium per policy issued. Sales in 1999 rose 3% over 1998 sales of $94 million. Sales growth in 1999 had declined from 1998 due in part to the withdrawal from the under-age 40 adult direct mail market because of unfavorable financial results from that market. Direct mail sales to ages 40 to 50 were interrupted for part of the year while those products were repriced to improve their financial results. The annualized life premium issued by the Direct Response group represented 39% of Torchmark's total life sales in 2000. Direct Response annualized life premium in force rose 8% to $306 million at December 31, 2000 from $283 million a year earlier. At December 31, 2000, Direct Response life annualized premium in force was 26% of Torchmark's total, second only to that of the Liberty National Exclusive Agency. Direct Response life insurance annualized premium in force grew 9% in 1999.
The American Income Exclusive Agency is a distribution system that focuses on members of labor unions, credit unions, and other associations for its life insurance sales. It is a high profit margin business characterized by lower policy obligation ratios. At December 31, 2000, premium from this system accounted for 21% of Torchmark's total life premium. In 2000, American Income's premium rose 6% to $231 million, after a 6% increase in 1999 to $217 million. Annualized life premium in force was $245 million at year-end 2000, an increase of 6% over 1999 premium in force of $231 million. Annualized life premium in force rose 7% in 1999. Sales, in terms of annualized premium issued, were $57 million in 2000, compared with $54 million in both 1999 and 1998. These sales represented a 5% increase in 2000, compared with a 1% increase in 1999 and a 3% decrease in 1998. The turnaround in sales for this agency was a result of the growth in the number of agents. An 8% decline in agent count was experienced in 1998 to 1,222 agents at December 31, 1998, and a further decline in the first half of 1999 resulted in 1,160 agents at June 30, 1999. However, changes in American Income's marketing organization were implemented in 1999 to reverse the decline in the number of agents. As a result, the American Income Agency had 1,197 agents at year-end 1999 and 1,352 agents at year-end 2000, representing a 3% increase in the second half of 1999 and a 13% increase in agency size in 2000. American Income's marketing organization continues to implement efforts to improve agent recruiting, retention, and productivity in order to increase the size of this Agency.
The United American Independent and Exclusive Agencies together represented about 6% of Torchmark's total life premium in 2000. On a combined basis, life premium rose 9% to $62 million in 2000 after a 2% increase in 1999 from $56 million to $57 million. Annualized life premium issued in 2000 was $30 million, increasing 63% over 1999 issues of $19 million. The United American Independent Agency represented Torchmark's largest growth on a percentage basis of any component agency in life premium income and life sales in 2000. Life premium income rose 13% to $42 million and life sales gained 93% to $26 million.
Torchmark's Other life insurance distribution system consists of its Military Agency, United Investors Agency, and other small miscellaneous sales agencies. Torchmark's Military Agency consists of a nationwide independent agency whose sales force is comprised of former commissioned and noncommissioned military officers who sell exclusively to commissioned and noncommissioned military officers and their families. This business consists of whole life products with term insurance riders and is characterized by low lapse rates. The United Investors Agency is comprised of several independent agencies, including the sales representatives of Waddell & Reed. Life premium income from the Other distribution category grew 8% to $227 million in 2000 and 9% to $210 million in 1999. Life premium income from the Other group accounted for 21% of Torchmark's total life insurance premium income. Annualized life premium in force grew 8% in 2000 to $262 million, after having increased 8% to $243 million in 1999. A major factor in the growth of premium income and in-force premium relates to the high persistency associated with the Military business. Annualized premium sold during 2000 in the Other distribution category was $37 million, flat with both 1999 and 1998 sales which were also $37 million in each year.
In addition to the growth in life insurance sales, this agency has also increased production of variable life collections. In 2000, collections were $41 million, representing a 28% increase over 1999 collections of $32 million. In 1999, these collections rose 77%. Although variable life collections are not included in premium in force data, they are indicative of growth in the variable life account balance. Indirectly, they add to premium revenue through the policy account charges for insurance coverage and administration as the account balance grows. At December 31, 2000, the variable life account balance was $158 million, rising 14% over the prior year end.
In the third quarter of 1999, Reader's Digest Association and Torchmark entered into an agreement to market Torchmark life insurance products to certain Reader's Digest customers. These products were marketed through Torchmark's Direct Response operation, and required Torchmark to guarantee specified compensation to Reader's Digest, regardless of marketing success. Test marketing began in the fourth quarter of 1999. The less than favorable results from these tests indicated that it would be unlikely that Torchmark would recover the full amount of compensation guaranteed to Reader's Digest under the terms of the agreement. As a result, Torchmark recorded a nonrecurring operating charge of $21 million in the fourth quarter of 1999. This charge represented $13 million after tax or $.10 per diluted share. Torchmark has maintained its relationship with Reader's Digest and has used its subscriber lists in selective marketing of Torchmark insurance products and intends to continue to do so. However, Torchmark will only incur its normal solicitation costs on future business and will have no further costs related to the guaranteed compensation.
Premium for the health insurance segment increased 10% to $911 million in 2000 over 1999 and 9% to $825 million in 1999. Annualized health premium in force grew 14% to $1.00 billion at December 31, 2000 over the previous year- end balance of $884 million. Health premium in force rose 11% during 1999. Sales of health insurance, in terms of annualized premium issued, were $252 million in 2000, increasing 31% over 1999 sales of $193 million. Sales in 1999 rose 39% over the prior year. Sales for 2000 marked the third consecutive year of 30% or more growth in health insurance sales. Sales of health insurance have accelerated greatly in these years due to increases in sales of Medicare Supplement policies.
HEALTH INSURANCE Annualized Premium in Force by Product (Dollar amounts in thousands)
Medicare Supplement insurance is sold primarily by the United American Exclusive Agency and the United American Independent Agency. Health sales in both agencies have grown significantly in the past three years. The United American Exclusive Agency is Torchmark's fastest growing agency in terms of health premium sales. The Exclusive Agency sold $145 million in annualized health premium in 2000, a 41% increase over the prior year. Health sales for this Agency rose 60% in 1999 to $103 million after having increased 62% in 1998. This Agency accounted for $60 million of the $86 million in health premium growth in 2000, or 69%, adding primarily Medicare Supplement premium. It also was instrumental in the growth of health annualized premium in force in both 2000 and 1999, accounting for $79 million of the $120 million growth in 2000 and adding $58 million to health premium in force in 1999. This Agency represented 31% of Torchmark's annualized health premium in force at December 31, 2000, compared with 26% one year earlier and 22% two years ago. The United American Exclusive Agency has grown very rapidly in recent years. At December 31, 2000, there were 3,661 agents, compared with 2,354 agents at year-end 1999 and 1,752 agents at year-end 1998. This represents an increase in Agency size of 56% in 2000 and 34% in 1999.
The United American Independent Agency continues to represent the largest amount of Torchmark's health premium in force and is also growing rapidly. The Agency's $467 million of annualized health premium in force at December 31, 2000, of which $436 million was Medicare Supplement premium in force, was 46% of Torchmark's total health premium in force. Health sales by the United American Independent Agency, in terms of annualized premium issued, were $85 million in 2000, a 25% increase over 1999. Sales rose 35% to $68 million in 1999.
Medicare Supplement policies are highly regulated at both the federal and state levels with standardized benefit plans, limits on first year agent compensation, and mandated minimum loss ratios. However, they remain a popular supplemental health policy with the country's large and growing group of Medicare beneficiaries. About 85% of all Medicare beneficiaries have Medicare Supplements to cover at least some of the deductibles and coinsurance for which the federal Medicare program does not pay. During the last few years, Torchmark has focused on developing its United American Exclusive Agency to serve this market. Use of targeted marketing support and increased agent recruiting have led to increased sales. Because of loss ratio regulation, underwriting margins on Medicare Supplements are less than on Torchmark's life business. However, due to United American's low cost, service-oriented customer service and claims administration, as well as its economies of scale, it is a profitable line of business.
Annualized premium in force for other health products grew 7% in 2000 to $106 million, after rising 1% in 1999 to $100 million. Other health sales rose 38% in 2000 to $41 million, after having increased 13% in 1999.
Annuities. Annuity products are marketed by Torchmark to service a variety of needs, including retirement income and long-term, tax-deferred growth opportunities. Torchmark's annuities are sold almost entirely by the United Investors Agency, a component of Torchmark's Other distribution category. This Agency consists of the Waddell & Reed sales force which markets United Investors annuities and other products under a marketing agreement. In 2000, this Agency collected $622 million of Torchmark's total $650 million in annuity collections, or 96%. The United Investors Agency accounted for almost 99% of total annuity policy charges in 2000. Annuities are also marketed by the United American Independent Agency, which collected $24 million in annuity deposits in 2000, compared with $56 million in 1999.
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. Variable annuity deposits are invested at the policyholder's direction into his choice among a variety of mutual funds, which vary in degree of investment risk and return. A fixed annuity investment account is also available as a variable annuity investment option. Investments pertaining to variable annuity deposits are reported as "Separate Account Assets" and the corresponding deposit balances for variable annuities are reported as "Separate Account Liabilities."
Annuity underwriting income excluding Family Service and before other income and administrative expense has grown steadily throughout each of the years 1998 through 2000. This underwriting income was $31 million in 2000 and $27 million in 1999, each representing a 15% increase over the prior year. Policy charges have also grown in each period, rising 29% in 2000 and 22% in 1999. Growth in policy charges is primarily related to the growth in the size of the account balance, but is also attributable to the increase in the number of annuity contracts in force and the cumulative effect of the growth in sales over the past few years upon which the sales charge is based.
Investments. The following table summarizes Torchmark's investment income and excess investment income.
Excess investment income increased 5% in both 2000 and 1999. Because of the effect of repurchases of Torchmark stock, excess investment income on a per share basis increased 10% in both 2000 and 1999. The 5% increase in 2000 correlated closely with the change in tax-equivalent investment income for the same period. While the 1998 sale of Family Service caused a reduction in 1999 investment income when compared with 1998, it had little effect on the excess investment income comparison in 1999 with 1998. The reduction in required interest on Family Service's policy liabilities offset the loss in investment income. The 1999 increase in excess investment income resulted primarily from decreased financing costs, due to debt paydowns.
While yields as measured by returns on U.S. Treasury securities fell substantially during 2000, corporate spreads widened and afforded investors the opportunity to increase nominal and effective returns. New investments in fixed-maturity securities, which totaled $1.1 billion in 2000, $2.1 billion in 1999, and $1.8 billion in 1998, were made at an effective compounded yield of 8.07% in 2000, compared with an effective compounded yield of 7.54% in 1999 and 7.26% in 1998. These yields equate to nominal yields on acquisition of 7.87%, 7.38%, and 7.13%, respectively, for 2000, 1999, and 1998. The size of acquisitions in the current year is not comparable with the prior year since 1999 included proceeds from tax motivated bond sales and from the sale of real estate.
With the "flat" yield curve available much of the year, higher returns were possible in spite of a shortening of maturities. The average life of 2000 acquisitions was 7.7 years, compared with 14.9 years in 1999 and 20.7 years in 1998. Purchases of fixed-maturity investments with shorter maturities caused the average life of the portfolio to decline to 11.8 years at year end 2000, compared with 12.7 years at year-end 1999 but above the year-end 1998 level of 8.8 years.
With 2000 acquisitions made at yields in excess of the portfolio average, the nominal portfolio yield increased to 7.47%, compared with 7.39% during 1999 and 7.42% in 1998. Emphasis continues to be on marketable, medium quality investments. Approximately 92% of invested assets are fixed-maturity securities, and 94% of these holdings are classified as investment grade by the rating agencies. The NAIC considers 95% of the portfolio investment grade. The portfolio is highly marketable, although its value fluctuates with changes in interest rates. At year end 2000, the unrealized loss of $236 million compares with an unrealized loss of $275 million at the end of 1999 and an unrealized gain of $249 million at the end of 1998. Distribution of maturities is as follows:
With an emphasis on fixed-maturity investments, the percentage of holdings in other types of securities is inconsistent with industry data. The following table presents Torchmark's components of invested assets compared with the latest industry data:
The actual interest rate risk to Torchmark is reduced because the effect that changes in rates have on assets is offset by the effect they have on insurance liabilities and on debt. Interest assumptions are used to compute the majority of Torchmark's insurance liabilities. These insurance liabilities, net of deferred acquisition costs, were $3.2 billion and debt was $.7 million at December 31, 2000, compared with fixed-maturity investments of $6.2 billion at amortized cost at the same date. Because of the long-term nature of insurance liabilities, temporary changes in value caused by rate fluctuations have little bearing on ultimate obligations. Insurance liabilities and debt are not marked to market.
Market risk is managed in a manner consistent with Torchmark's investment objectives. Torchmark seeks to maintain a portfolio of high-quality fixed- maturity assets that may be sold in response to changing market conditions. A significant change in the level of interest rates, changes in credit quality of individual securities, or changes in the relative values of a security or asset sector are the primary factors that influence such sales. Occasionally, the need to raise cash for various operating commitments may also necessitate the sale of a security. Volatility in the value of Torchmark's fixed-maturity holdings is reduced by maintaining a relatively short-term portfolio, 20% of which matures within five years and 64% of which matures within ten years. Also, the portfolio and market conditions are constantly evaluated for appropriate action.
The following table illustrates the market risk sensitivity of Torchmark's interest-rate sensitive fixed-maturity portfolio at December 31, 2000 and December 31, 1999. This table measures the effect of a change in interest rates (as represented by the U.S. Treasury curve) on the fair value of Torchmark's fixed-maturity portfolio. The data is prepared through a model that measures the change in fair value arising from an immediate and sustained change in interest rates in increments of 100 basis points. It takes into account the effect that special option features such as call options, put options, and unscheduled repayments would have on the portfolio, given the changes in rates. The valuation of these option features is dependent upon assumptions about future interest rate volatility that are based on past performance.
Liquidity. Liquidity pertains to an institution's ability to meet on demand the cash commitments required by its business operations and financial obligations. Torchmark has very strong liquidity, as evidenced by its three sources of liquidity: its positive cash flow from operations, its portfolio of marketable securities, and its line of credit facility.
Torchmark's cash and short-term investments were $136 million at December 31, 2000, compared with $115 million at year-end 1999. In addition to these highly 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 $6.0 billion at December 31, 2000.
Torchmark has a line of credit facility with a group of lenders which allows unsecured borrowings up to a specified maximum amount. The maximum amount on this facility was $600 million at December 31, 2000. Interest is charged at variable rates for borrowings. This line of credit is further designated as a backup credit line for a commercial paper program not to exceed $600 million, whereby Torchmark may borrow from either the credit line or issue commercial paper at any time but may not borrow in excess of a total of $600 million on the combined facilities. At December 31, 2000, $331 million in face amount of commercial paper was outstanding and there were no borrowings on the line of credit. A fee is charged on the entire $600 million facility. In accordance with the agreements, Torchmark is subject to certain covenants regarding capitalization and earnings. At December 31, 2000, Torchmark was in full compliance with these covenants.
In 2000, all of the debt previously acquired by insurance subsidiaries was acquired from those subsidiaries by the parent company. Additionally, another $4.6 million principal amount of the 7 7/8% Notes and $2.0 million principal amount of the 7 3/8% Notes were acquired by Torchmark in 2000 at a cost of $4.2 million and $1.9 million, respectively. The redemption of this debt in 2000 resulted in an after-tax gain of $202 thousand.
Effective January 1, 1999, Torchmark changed its method of accounting for the swap agreement to recognize changes in its fair value, net of tax, as realized investment gains or losses. This method of accounting for such instruments was believed to be preferable under the guidance established by Statement of Financial Accounting Standards No. 80, Accounting for Futures Contracts ("SFAS 80") and the Securities and Exchange Commission. Previously, Torchmark accounted for the swap using hedge accounting under SFAS 80. The after-tax cumulative effect of the change at January 1, 1999 was $16.1 million (net of income taxes of $8.7 million). The effect of the change on the twelve months ended December 31, 1999 was to increase realized losses by $11.7 million ($.09 per diluted share), excluding the cumulative effect of the change in accounting principle. Market value of the swap, which is included as a component of Other Invested Assets, was $14.3 million and $6.7 million at December 31, 2000 and 1999, respectively.
Short-term debt consists of Torchmark's commercial paper outstanding. The commercial paper balance outstanding at December 31, 2000 was $329 million at carrying value, compared with a balance of $418 million a year earlier. The commercial paper borrowing balance fluctuates based on Torchmark's current cash needs.
Shareholders' equity rose 10% to $2.20 billion at December 31, 2000. Shareholders' equity declined 12% in 1999, from $2.26 billion at year-end 1998 to $1.99 billion at year-end 1999. The 2000 increase of $209 million in shareholders' equity resulted primarily from the addition of earnings, less the payment of dividends and $147 million of share purchases during the year. The 1999 decrease was impacted by the decrease in the value of the fixed- maturity portfolio due to increases in interest rates in the financial markets. Book value per share was $17.43 at 2000 year end, compared with $15.10 at year-end 1999. After adjusting for the impact on shareholders' equity for security value fluctuations due to changes in interest rates in financial markets, shareholders' equity rose from $2.15 billion at year-end 1999 to $2.34 billion at year-end 2000. Book value per share was $18.53 at year-end 2000, an increase of 14% over $16.32 at year-end 1999. Return on common shareholders' equity was 16.3% in 2000, compared with 16.2% in 1999. The return-on-equity ratios exclude the mark up or down of shareholders' equity for changes in security values caused by fluctuations in market interest rates. They are also computed on a basis of net operating income before nonrecurring charge, as defined on page 17 through 18 of this report.
In the fourth quarter of 1998, Torchmark announced its intention to dispose of its holdings in Vesta and to sell Vesta shares under satisfactory terms. In December, 1998, Torchmark sold 680 thousand Vesta shares at a price of $4.75 per share, recording a loss of $3 million after tax. In 1999, Vesta filed a registration statement with the Securities and Exchange Commission for the public offering of its shares held by Torchmark. To facilitate the registration of Vesta shares, Torchmark re-acquired the previously sold 680 thousand shares at a price of $5 per share. On November 5, 1999, the registration statement was filed by Vesta to offer all of Torchmark's holdings in Vesta.
Litigation. Torchmark and its subsidiaries continue to be named as parties to pending or threatened litigation, most of which involves 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 may have the potential for significant adverse results. Bespeaking caution is the fact that it is impossible to predict the extent of punitive damages that may be awarded if liability is found in any given case, since punitive damages in Alabama are based upon the compensatory damages (including mental anguish) awarded and the discretion of the jury in awarding compensatory damages is not precisely defined. 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. Based upon information presently available, and in light of legal and other factual defenses available to Torchmark and its subsidiaries, contingent liabilities arising from threatened and pending litigation are not presently considered by management to be material.
This Statement establishes standards for the accounting and reporting of derivative instruments. It requires that all derivatives be recognized as assets or liabilities on the balance sheet and be measured at fair value. Changes in the values of derivatives for the reporting period are reflected as adjustments to earnings through realized gains and losses. If certain conditions are met, a derivative may be designated as a hedge against exposure to market risks of other instruments or commitments, cash flow risks, or foreign currency risks. If a derivative is classified as a hedge, the adjustment to earnings is offset by a corresponding change in the value of the item hedged. Hedging relationships may be designated anew upon adoption of this statement.
To the Board of Directors and Shareholders of Torchmark Corporation Birmingham, Alabama
Business: Torchmark Corporation ("Torchmark") through its subsidiaries provides a variety of life and health insurance products and annuities to a broad base of customers.
Basis of Presentation: The accompanying financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America ("GAAP"). The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Realized investment gains and losses and investment income attributable to separate accounts are credited to the separate accounts and have no effect on Torchmark's net income. Investment income attributable to all other insurance policies and products is included in Torchmark's net investment income. Net investment income for the years ended December 31, 2000, 1999, and 1998, included $305.4 million, $287.7 million, and $296.7 million, respectively, which was allocable to policyholder reserves or accounts. Realized investment gains and losses are not allocable to insurance policyholders' liabilities.
respectively. Other premium includes annuity policy charges for the years ended December 31, 2000, 1999, and 1998, of $52.2 million, $40.5 million, and $33.5 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.
Property and Equipment: Property and equipment is reported at cost less allowances for depreciation. Depreciation is recorded primarily on the straight line method over the estimated useful lives of these assets which range from two to ten years for equipment and five to forty years for buildings and improvements. Ordinary maintenance and repairs are charged to income as incurred.
Reclassifications: Certain amounts in the financial statements presented have been reclassified from amounts previously reported in order to be comparable between years. These reclassifications have no effect on previously reported shareholders' equity or net income during the periods involved.
Proceeds from sales of fixed maturities available for sale were $629 million in 2000, $1.24 billion in 1999, and $758 million in 1998. Gross gains realized on those sales were $8.2 million in 2000, $4.3 million in 1999, and $6.1 million in 1998. Gross losses were $10.7 million in 2000, $36.5 million in 1999, and $20.1 million in 1998. Proceeds from sales of equity securities available for sale were $39.7 million in 2000, $260 thousand in 1999, and -0- in 1998. Gross gains realized on those sales were $6.5 million in 2000, $215 thousand in 1999, and -0- in 1998. Gross losses were $3.2 million in 2000, -0- in 1999, and -0- in 1998.
In 1999, Torchmark disposed of most of its investment real estate. In the second quarter of 1999, efforts to dispose of these properties revealed that the carrying value of the real estate exceeded its estimated realizable value. For this reason Torchmark wrote down its investment real estate portfolio to its estimated realizable value as of June 30, 1999. This write down resulted in a pretax loss of $64 million, or $41 million after tax. The majority of the investment real estate was sold in two transactions in the latter half of 1999 for total consideration of $123 million, of which $111 million was in cash and the remainder in a ten-year collateralized note. After the sales, Torchmark retained $16.4 million in investment real estate, of which $8 million was included with properties partially occupied by Torchmark subsidiaries. At December 31, 2000, Torchmark owned $15.5 million in investment real estate, of which $7.1 million was included with properties partially occupied by Torchmark subsidiaries.
In 2000, 1999, and 1998, deferred income tax expense was incurred because of certain differences between net operating income before income taxes as reported on the consolidated statement of operations and taxable income as reported on Torchmark's income tax returns. As explained in Note 1, these differences caused the financial statement book values of some assets and liabilities to be different from their respective tax bases.
The excess benefit pension plan provides the benefits that an employee would have otherwise received from a defined benefit pension plan in the absence of the Internal Revenue Code's limitation on benefits payable under a qualified plan. Although this plan is unfunded, pension cost is determined in a similar manner as for the funded plans. Liability for the excess benefit plan was $4.6 million and $4.7 million at December 31, 2000 and 1999, respectively.
Torchmark adopted FASB Statement No. 132, Employers' Disclosures about Pensions and Other Postretirement Benefits, that was effective for year-end 1998. In accordance with this Standard, the following table presents a reconciliation from the beginning to the end of the year of the benefit obligation and plan assets. This table also presents a reconciliation of the plans' funded status with the amounts recognized on Torchmark's balance sheet.
For retired employees over age sixty-five, Torchmark does not provide postretirement benefits other than pensions. Torchmark does provide a portion of the cost for health insurance benefits for employees who retired before February 1, 1993 and before age sixty-five, covering them until they reach age sixty-five. Eligibility for this benefit was generally achieved at age fifty- five with at least fifteen years of service. This subsidy is minimal to retired employees who did not retire before February 1, 1993. This plan is unfunded.
The weighted average discount rate used in determining the accumulated postretirement benefit obligation was 7.5% in 2000 and 7.15% in 1999.
The amount of debt that becomes due during each of the next five years is: 2001, $329,148, and 2002-2005, $0.
The Notes, due May 15, 2023, were issued in May, 1993 in the principal amount of $200 million. Proceeds of the issue, net of issue costs, were $196 million. Interest is payable on May 15 and November 15 of each year at a rate of 7 7/8%. In 1998 and 1999, $10.8 million and $7.6 million principal amount were purchased in the open market at a cost of $10.6 million and $7.9 million respectively by Torchmark subsidiary companies, which in turn sold them to the parent company in 2000 for $16.6 million. An additional $4.6 million principal amount was purchased by the parent company in the open market at a cost of $4.2 million. An after-tax gain on the redemption of debt of $166 thousand was recorded in the fourth quarter of 2000. These notes are not callable prior to maturity and have equal priority with other Torchmark unsecured indebtedness.
Torchmark also had $200 million principal amount 9 5/8% Senior Notes which matured on May 1, 1998. The principal amount with accrued interest was repaid from additional commercial paper borrowings.
In October, 1994, Torchmark, through its wholly-owned finance subsidiary, Torchmark Capital L.L.C., completed a public offering of eight million shares of 9.18% MIPS at a face amount of $200 million. The securities 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 have been redeemable at Torchmark's option since September 30, 1999. Torchmark subsequently entered into a ten-year 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. In a related transaction, Torchmark purchased a five-year cap on the swap agreement that expired on September 30, 1999. The variable interest rate was 8.03% at December 31, 2000 and 7.00% at December 31, 1999. The swap is accounted for as a free-standing derivative and is marked to market value at the end of each accounting period. The market value of the swap agreement was a benefit of $14.3 million at December 31, 2000 and $6.7 million at December 31, 1999. Torchmark changed its method of accounting for this swap agreement during 1999. Refer to Note 15--Change in Accounting Principle below for more information on this change in accounting principle.
Torchmark has in place a swap agreement with an unaffiliated party whereby Torchmark pays a variable dividend rate on its $200 million face amount outstanding MIPS in exchange for payment of a 9.18% fixed dividend. Effective January 1, 1999, Torchmark changed its method of accounting for this swap agreement to recognize changes in its fair value, net of tax, as realized investment gains or losses. This method of accounting for such instruments is believed to be preferable under the guidance established by Statement of Financial Accounting Standards No. 80, "Accounting for Futures Contracts ("SFAS 80") and the Securities and Exchange Commission. Previously, Torchmark accounted for the swap using hedge accounting under SFAS 80. The after-tax cumulative effect of the change at January 1, 1999 of $16.1 million (net of income taxes of $8.7 million) is included in income for the twelve months ended December 31, 1999. The effect of the change on the twelve months ended December 31, 1999 was to increase realized losses by $11.7 million ($.09 per diluted share) excluding the cumulative effect of the change in accounting principle. The pro forma effect of the retroactive application of the new accounting method to the twelve month period ended December 31, 1998 would be to increase net income by $4.4 million ($.03 per diluted share).
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 from operations before realized capital gains or losses 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 2001, $240 million will be available to Torchmark for dividends from insurance subsidiaries in compliance with statutory regulations without prior regulatory approval.
On November 15, 1999, Torchmark executed a stock option exercise and restoration program through which 80 Torchmark directors and employees exercised vested stock options and received a reduced number of replacement options at current market price. This program resulted in the issuance of 1.8 million shares, of which 1.2 million shares were immediately sold by the directors and employees through the open market to cover the cost of the purchased shares and related taxes. Another restoration program was effected on December 20, 2000 involving two employees who were not able to participate in the 1999 restoration program. They exercised vested options for 433 thousand shares, resulting in the issuance of 433 thousand shares, of which 283 thousand shares were sold by the employee to pay the exercise price and minimum withholding taxes. As a result of these restoration programs, management's ownership interest increased, and Torchmark received a significant current tax benefit from the exercise of the options.
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 $2.5 million per life. Life insurance ceded represents less than 1.0% of total life insurance in force at December 31, 2000. Insurance ceded on life and accident and health products represents .7% of premium income for 2000. 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 represents 2.2% of life insurance in force at December 31, 2000 and reinsurance assumed on life and accident and health products represents 1.7% of premium income for 2000.
million, amortized cost was $393 million, and fair value was $302 million. While these investments could be subject to additional credit risk, such risk should generally be reflected in market value.
As previously reported, Dismukes v. Torchmark Corporation (Case No. CV-94- 1006-P-M), which was filed on December 30, 1994 in the U.S. District Court for the Northern District of Alabama, was the only remaining purported class action litigation brought by Torchmark shareholders alleging untimely and inadequate disclosure of material contingent liabilities arising out of insurance policy litigation involving Liberty. The U.S. District Court entered an order granting partial summary judgment on behalf of the defendants on April 16, 1996. Claims for damages based on Section 10b-5 of the Securities Exchange Act, on state securities laws and for common law fraud remained pending in the case following the U.S. District Court's 1996 order. On September 28, 2000, the District Court granted defendants' motions for summary judgment declaring plaintiffs claims as time-barred by the statute of limitations and denying class certification. Plaintiffs appealed the District Court's orders to the Eleventh Circuit Court of Appeals. On December 19, 2000, the Dismukes case was settled on an individual basis and the plaintiffs' appeal was dismissed.
As previously reported, Torchmark, its insurance subsidiaries Globe and United American, and certain Torchmark officers were named as defendants in purported class action litigation filed in the District Court of Oklahoma City, Oklahoma (Moore v. Torchmark Corporation, Case No. CJ-94-2784-65, subsequently amended and restyled Tabor v. Torchmark Corporation). This suit claims damages on
behalf of individual health policyholders who are alleged to have been induced to terminate such policies and to purchase Medicare Supplement and/or other insurance coverages. On February 6, 1998, the defendants renewed their motion to dismiss the class claims for failure to prosecute. The District Court, in an order dated April 2, 1998, allowed bifurcation of Tabor into Medicare Supplement policy claims and non-Medicare Supplement policy claims. The non- Medicare Supplement claims were stayed pending disposition of a related case involving the same plaintiffs filed in Mississippi while discovery was allowed to proceed on plaintiff's motion to certify a class of Medicare Supplement policyholders' claims. On August 23, 2000, the non-Medicare Supplement claims were dismissed with prejudice. Plaintiff's motion to certify a class of Medicare Supplement policyholders' claims remains pending.
American Income's employee benefit plans. The lawsuit alleged breach of fiduciary duty and wrongful denial of access to plan documents and other information under the Employee Retirement Income Security Act. Declaratory and injunctive relief together with restitution, disgorgement and statutory penalties were sought. On September 12, 2000, the District Court granted the defendants' motions for partial summary judgment and denied plaintiffs' motion for class certification with leave to renew plaintiffs' class certification motion if they provided the Court with information regarding additional benefit plans from which they had been improperly excluded. Subsequently, in September 2000, plaintiffs submitted additional information to the Court alleging additional benefit plans from which plaintiffs had been improperly excluded, and plaintiffs also filed a motion for reconsideration of the order granting defendants' motion for summary judgment with respect to American Income's defined benefit plan.
As previously reported, Liberty was served on October 28, 1999 with a subpoena from the Florida Department of Insurance in connection with that Department's investigation into Liberty's sales practices and disclosures in the State of Florida regarding industrial life insurance and low coverage life insurance policies. Liberty has also received similar subpoenas from the Alabama, Georgia, Kentucky, Texas, South Carolina and Minnesota Insurance Departments regarding its industrial life insurance and other low face-amount life insurance policies sold in those states. Specific inquiry is made into the historical use of race-based mortality, a practice discontinued by Liberty many years ago. Liberty has been and continues responding to these subpoenas in a timely fashion. In July 2000, the Florida and Georgia Insurance Departments issued cease and desist orders to all companies reporting premium income from industrial life insurance, including Liberty, stating that, to the extent that any company is currently collecting any race-based insurance premiums from Florida and Georgia residents, respectively, it immediately cease and desist from collecting any premium differential based on the race of the policyholders. On August 22, 2000, the Florida First District Court of Appeal issued an order staying the Florida Insurance Department's immediate final cease and desist order. At present, Liberty, as an Alabama domestic company, is being examined by representatives of the Alabama Department of Insurance with regard to issues parallel to those raised by the State of Florida.
On December 8, 1999, purported class action litigation was filed against Liberty in the United States District Court for the Northern District of Alabama (Moore v. Liberty National Life Insurance Company, Case No. CV-99-BU- 3262-S), on behalf of all African-Americans who have or have had at the time of policy termination an ownership interest in certain life insurance policies ($25,000 face amount or less) marketed by Liberty and certain of its former subsidiaries. The alleged class period covers virtually the entire twentieth century. Plaintiffs allege racial discrimination in Liberty's premium rates in violation of 42 U.S.C. (S) 1981, breach of fiduciary duty in sales and administrative practices, receipt of excessive and unreasonable premium payments by Liberty, improper hiring, supervision, retention and failure to monitor actions of officers, agents and employees, breach of contract in dismantling the debit premium collection system, fraudulent inducement and negligent misrepresentation. Unspecified compensatory and punitive damages are sought together with a declaratory judgment and equitable and/or injunctive relief, including establishment of a constructive trust for the benefit of class members. Defendants filed a motion for judgment on the pleadings or in the alternative for summary judgment on January 27, 2000. On April 7, 2000, the District Court entered an order granting Liberty's motion for judgment on the pleadings and dismissing plaintiffs' claims under 42 U.S.C. (S) 1981 with prejudice as time-barred and dismissing their state law claims without prejudice to re-file in state court if desired. Plaintiffs subsequently filed motions with the District Court to reconsider its April 17, 2000 order and for permission to file an amended complaint adding similar claims under 24 U.S.C. (S) 1982. Liberty opposed this motion. On June 22, 2000, purported class action litigation with allegations comparable to those in the Moore case was filed against Liberty in the Circuit Court of Jefferson County, Alabama (Baldwin v. Liberty National Life Insurance Company, Case No. CV-00-684). The Baldwin case is currently stayed pending disposition of the Moore case.
prejudice all remaining state law claims of the plaintiffs as time-barred by the common law rule of repose. On July 14, 2000, plaintiffs filed their amended complaint with the District Court and Liberty filed a motion to alter or amend the District Court's July order or, in the alternative, requested that the District Court certify for purposes of appeal the issue whether the state law doctrine of repose should be applied to and bar plaintiffs' actions under (S)(S) 1981 and 1982. The District Court entered such an order on July 21, 2000 and stayed proceedings in Moore pending resolution of Liberty's petition to the U.S. Circuit Court of Appeals for the Eleventh Circuit. Liberty filed a petition on July 30, 2000 with the Eleventh Circuit seeking that Court's permission to appeal the portions of the District Court's July order in Moore granting the plaintiffs the right to file the amended complaint. The Eleventh Circuit Court granted Liberty's motion and will consider Liberty's arguments regarding the applicability of the state law of repose to actions under (S)(S) 1981 and 1982. Five individual cases with similar allegations to those in the Moore case have been filed against Liberty in various Circuit Courts in the state of Alabama. In the earliest filed of these individual state court actions, Walter Moore v. Liberty National Life Insurance Company (Circuit Court of Dallas County, Alabama, CV-00-306) the Court has entered an order granting summary judgment in favor of Liberty based upon the doctrine of repose.
- ------- * Investment segment includes MIPS dividend on a pretax basis.
Transactions Regarding Vesta: From 1993 until disposition in 2000, Torchmark held a passive investment in Vesta, a property insurance carrier. Torchmark held 5.1 million shares of Vesta stock, or approximately 28% of the outstanding shares of Vesta, until December, 1998. Torchmark carried its investment in Vesta during this period on the equity method of accounting. In June, 1998, Vesta announced that (a) an investigation of accounting irregularities that occurred during the fourth quarter of 1997 and the first quarter of 1998 would result in an aggregate $14 million net after-tax reduction in previously reported net income, and, in addition, that (b) it would restate its historical financial statements for the period of 1993 through the first quarter of 1998, reflecting reductions in reported net after-tax earnings of $49 million for the period of 1993 through 1997 and $10 million for the first quarter of 1998. To reflect its pro rata share of Vesta's cumulative reported financial corrections, Torchmark recorded a pre- tax charge of $20 million ($13 million after tax) or $.09 per diluted share in the second quarter of 1998. As a result of the announcements relating to Vesta and the decline in value of Vesta stock, Vesta is currently subject to numerous class action lawsuits in state and Federal courts filed subsequent to such announcements.
On October 1, 1999, Torchmark sold the majority of its investment real estate in two transactions. One transaction involved sales to Elgin Development Company and other investors for total consideration of $97.4 million, of which $85 million was paid in cash and the remainder in a ten year collaterialized note. The Chairman of the Executive Committee of Torchmark is a 25% investor in Stonegate Realty Co., LLC, the parent company of Elgin Development Company. His investment in Elgin Development was approximately $1.5 million.