On November 6, 1998, Torchmark distributed its remaining 64% investment in Waddell & Reed through a tax-free spin-off to Torchmark shareholders. Each Torchmark shareholder of record on October 23, 1998 received a total of .3018 Waddell & Reed shares per Torchmark share. After the spin-off, Torchmark retained no further ownership interest in Waddell & Reed. As a result of the transaction, Torchmark incurred $54 million in expense related to the spin- off, the majority of which was $50 million of corporate Federal income tax resulting from the distribution of a portion of the policyholder surplus account of a Torchmark life subsidiary.
Sale of Family Service. On June 1, 1998, Torchmark sold Family Service to an unaffiliated insurance carrier. Family Service, which was acquired in 1990, is a preneed funeral insurer but has not issued any new policies since 1995. Consideration for the sale was $140 million in cash. Torchmark recorded a pretax realized loss on the sale of approximately $14 million, but incurred a tax expense on the transaction of $9 million for a total after-tax loss of $23 million. In connection with the sale, Torchmark will continue to service the policies in force of Family Service for the next five years for a fee of $2 million per year plus certain variable processing costs. During 1997, Family Service accounted for $57 million in revenues and $7.7 million in pretax income. Through May, 1998, Family Service contributed $25 million in revenues and $5.8 million in pretax income. Invested assets were $778 million and total assets were $828 million at the date of the sale.
3) The $54 million nonrecurring expenses of the Asset Management Operations (Waddell & Reed) spin-off;
Excess investment income represents the profit margin attributable to investment operations and cash flow management. It is defined as tax- equivalent investment income reduced by the interest cost credited to net policy liabilities and the interest cost associated with capital funding or "financing costs." Excess investment income is increased in a number of ways: an increase in investment yields over the rates credited to policyholders' liabilities or over the rates applicable to Torchmark debt, growth in assets in relation to policy liabilities and debt, and the efficient use of capital resources and cash flow.
Net investment income rose 7% to $460 million in 1998, compared with an increase of 7% to $429 million in 1997. On a tax-equivalent basis, in which the yield on tax-exempt securities is adjusted to produce a yield equivalent to the pretax yield on taxable securities, investment income also rose 7% in both 1998 and 1997. These increases in investment income resulted primarily from the growth in the invested asset base during each period. Mean invested assets increased 5% in 1998 and 8% in 1997. Asset growth in 1998 was caused primarily by the receipt of $481 million in proceeds from the Waddell & Reed offering in early 1998, offset somewhat by the sale of investments to repay debt and to buy Torchmark stock. The Family Service sale also negatively impacted 1998 net investment income due to the loss of approximately $778 million in invested assets at the date of the sale. Growth in 1997 excess investment income was due to the accumulation of the investments backing life reserves and the reinvestment of cash flow.
With lower yields on acquisitions, the fixed maturity portfolio yield declined to 7.42% at December 31, 1998, slightly below the year earlier level of 7.49% and 7.54% at year-end 1996. The average life of the portfolio increased to 8.8 years, compared with 8.0 years at year-end 1997 and 7.8 years at year-end 1996. At year-end 1998, duration was 5.7 years, compared with 5.1 years in 1997 and 5.0 years in 1996. Emphasis continues to be on marketable, high quality investments. Over 93% of the portfolio is considered by Standard and Poor's to be investment grade, while 95% is considered investment grade by the NAIC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) (Dollar amounts in thousands except per share data) Note 3--Investment Operations
- -------- (1)Represents amounts pertaining to investments relating to universal life- type products.
The fair value for Torchmark's employee stock options was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted average assumptions for 1998, 1997 and 1996:
It has been previously reported that Liberty was a party to 53 individual cases filed in Chambers County, Alabama involving allegations that an interest-sensitive life insurance policy would become paid-up or self- sustaining after a specified number of years. Only one of these cases remains pending with all others having been settled and dismissed by the Chambers County Circuit Court.
As of December 31, 1998, the terms of the agreement were not met by the unaffiliated insurance carrier and the contract to sell the Vesta shares expired. In the meantime, on December 29, 1998, Torchmark sold 680 thousand Vesta shares to another unrelated institution at a price of $4.75 per share. Torchmark realized a $2 million after-tax loss on the sale. The sale reduced Torchmark's ownership of Vesta to 4.45 million shares or approximately 24% of Vesta at December 31, 1998.