As reported in Note 1-Significant Accounting Policies in the Notes to Consolidated Financial Statements under the caption Litigation and Tax Settlements, we have been involved in a number of litigation issues over the course of the three year period 2006 through 2008 in which we either received settlements net of expenses or incurred settlement losses and expenses. These issues resulted in after-tax charges of $770 thousand in 2008, $272 thousand in 2007, and an after-tax benefit of $7.4 million in 2006. Additionally, as described under the same caption of Note 1, we received tax settlements in each year in the amounts of $10.8 million in 2008, $1.1 million in 2007, and $11.6 million in 2006. All of these litigation and tax issues pertained to issues arising many years ago and are not considered by management to relate to our current operations. Legal expenses and litigation items pertaining to current operations are included in either insurance administrative expenses or parent expenses, as appropriate, in our segment analysis. As explained in Note 3-Investments under the caption Other-than-temporary impairments, we wrote down certain company-occupied property to fair value during 2008. The write down resulted in an after-tax charge of $1.4 million.
Index to Financial Statements Direct Response, primarily a life operation, also offers health insurance, which is predominantly Medicare Supplements sold directly to employer or union sponsored groups. In 2008, net health sales were $6 million, comprising less than 5% of Direct Response’s total life and health net sales. Direct Response health net sales and premium income have risen each year over the prior year. Net sales increased 7% in 2008 and 2% in 2007. Health premium rose 7% in both 2008 and 2007, increasing to $45 million in 2008.
Total Medicare Part D premium and health premium exclude $7.3 million in 2007 of risk-sharing premium paid to the CMS consistent with the Medicare Part D contract. In 2008, $122 thousand of risk-sharing premium was received. This risk-sharing amount is a portion of the excess or deficiency of actual over expected claims, and therefore we view this payment as a component of policyholder benefits in our segment analysis.
Declines in equity markets during 2008 have had a significant effect on the variable policyholder account balance, as they have resulted in declines in value in the underlying investments and increased policyholder withdrawals. The decline in the size of the annuity account balance has had a negative impact on annuity underwriting income. An analysis of underwriting income is as follows.
While the fixed annuity account balance has increased each year over the prior year, policy charges have remained steady and underwriting income has declined slightly each year. The stability in fixed annuity policy charges has resulted as the charges consist of surrender charges and are not based on account size. These charges have remained somewhat level in recent periods. A significant portion of fixed annuity profitability is derived from the spread of investment income exceeding contractual interest requirements, which can result in negative net policy obligations. However, this investment income spread has declined in each year, resulting in the decline in underwriting income.
Future Policy Benefits. Because of the long-term nature of insurance contracts, our insurance companies are liable for policy benefit payments that will be made in the future. The liability for future policy benefits is determined by standard actuarial procedures common to the life insurance industry. The accounting policies for determining this liability are disclosed in Note 1-Significant Accounting Policies in the Notes to Consolidated Financial Statements. A list of the significant assumptions used to calculate the liability for future policy benefits is reported in Note 5-Future Policy Benefit Reserves.
We have audited the accompanying consolidated balance sheets of Torchmark Corporation and subsidiaries (“Torchmark”) as of December 31, 2008 and 2007, and the related consolidated statements of operations, comprehensive income, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2008. Our audits also included the financial statement schedules listed in the Index at Item 15. These financial statements and financial statement schedules are the responsibility of Torchmark’s management. Our responsibility is to express an opinion on the financial statements and financial statement schedules based on our audits.
sensitive and deposit-balance type products, these assumptions are reviewed on a regular basis and are revised if actual experience differs significantly from original expectations. For all other products, amortization assumptions are generally not revised once established. Deferred acquisition costs are subject to periodic recoverability and loss recognition testing to determine if there is a premium deficiency. These tests ensure that the present value of future contract-related cash flows will support the capitalized deferred acquisition cost asset. These cash flows consist primarily of premium income, less benefits and expenses taking inflation into account. The present value of these cash flows, less the benefit reserve, is then compared with the unamortized deferred acquisition cost balance. In the event the estimated present value of net cash flows is less, the deficiency would be recognized by a charge to earnings and either a reduction of unamortized acquisition costs or an increase in the liability for future benefits, as described under the caption Future Policy Benefits.
annual impairment testing based on the procedures outlined in the Statement. Amortization of goodwill is not permitted. Torchmark tested its goodwill annually in each of the years 2006 through 2008. The tests involve assigning the Company’s carrying value to each of the components of Torchmark’s segments, including the portion of goodwill assigned to each component. The fair value of each component is measured against that component’s corresponding carrying value. Because the fair value exceeded the carrying value, including goodwill, of each component in each period, Torchmark’s goodwill was not impaired in any of the periods.
Torchmark received an additional pre-tax litigation settlement, net of expenses, of $1.3 million in 2008 ($.9 million after tax) and $515 thousand in 2007 ($335 thousand after tax) from the WorldCom litigation noted above. Legal settlement costs in the amount of $2.5 million in 2008 ($1.6 million after tax) and $933 thousand in 2007 ($607 after tax) were expensed in those years relating to litigation issues arising in prior periods and concerning events occurring many years ago.
Postretirement Benefits: Torchmark adopted FASB Statement of Financial Accounting Standards (SFAS) No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, effective as of December 31, 2006. This Statement requires Torchmark to recognize the funded status of its postretirement benefit plans on its Consolidated Balance Sheets. Periodic gains and losses attributable to changes in plan assets and liabilities that are not recognized as components of net periodic benefit costs are to be recognized as components of other comprehensive income, net of tax. This Statement does not modify the procedures for measuring plan assets, liabilities, or net periodic benefit cost. The information required by this Statement is found in Note 9-Postretirement Benefits. Upon adoption of this Statement, “Accumulated other comprehensive income,” net of tax, was decreased $9 million.
Fair value measurements: Torchmark measures the fair value of its financial assets in accordance with SFAS 157. The hierarchy established by SFAS 157 consists of three levels to indicate the quality of the fair value measurements as described below:
The great majority of the Company’s fixed maturities are not actively traded and direct quotes are not generally available. Management therefore determines the fair values of these securities after consideration of data provided by third-party pricing services and independent broker/dealers. Over 97% of the fair value reported at December 31, 2008 was determined using data provided by third-party pricing services. Prices provided by third-party pricing services are not binding offers but are estimated exit values. They are based on observable market data inputs which can vary by security type. Such inputs include benchmark yields, available trades, broker/dealer quotes, issuer spreads, benchmark securities, bids, offers, and other market data. Where possible, these prices were corroborated against other independent sources. When third party vendor prices are not available, the Company attempts to obtain at least three quotes from broker/dealers for each security. When at least three quotes are
The following tables disclose unrealized investment losses by class of investment at December 31, 2008 and December 31, 2007. Torchmark considers these investments to be only temporarily impaired.
Certain employees, directors, and consultants have been granted fixed equity options to buy shares of Torchmark stock at the market value of the stock on the date of grant, under the provisions of the Torchmark stock option plans. The options are exercisable during the period commencing from the date they vest until expiring according to the terms of the grant. Options generally expire the earlier of employee termination or option contract term, which ranges from seven to eleven years. Employee and consultant stock options generally vest one-half in two years and one-half in three years. Formula-based director grants generally vest in six months. Stock options awarded in connection with compensation deferrals by certain directors and executives generally vest over a range of six to ten years. All options vest immediately upon the attainment of age 65, subject to a minimum vesting period of one year for employees or six months for directors. Torchmark generally issues shares for the exercise of stock options from treasury stock. The Company generally uses the proceeds from option exercises to buy shares of Torchmark common stock in the open market to reduce the dilution from option exercises.
Agent Receivables: Previously, Torchmark issued a guarantee to an unaffiliated third party, which purchased certain agents’ receivables of Torchmark’s wholly-owned subsidiary American Income Life Insurance Company (American Income). The guarantee covered all obligations and recovery of capital to the third party under the receivables purchase agreement up to a maximum amount of $95 million. Under the terms of the revolving purchase arrangement, the third party purchased the agents’ receivables and received the earned commissions as they were applied to the balance. The term of the guarantee corresponded with the purchase arrangement, which was annually renewable. Torchmark was liable to the extent that future commission collections were insufficient to repay the purchased amount. As of August 22, 2008, the agreement with the unaffiliated third-party was cancelled. Management expects that commission collections in 2009 will be sufficient to repay agent receivables purchased prior to the cancellation of the agreement. The guarantee will expire once all amounts due under the contact are collected.
Torchmark has in place a coinsurance agreement with First Command’s life subsidiary whereby Torchmark cedes back to First Command approximately 3% of the new life insurance business sold by
Torchmark also holds funds on behalf of Mr. Baxley as a part of an agreement established in 2006. Interest is paid to Baxley based on a variable rate computed as the average yield for Aa corporate bonds less fifty basis points, which was 6.2% at December 31, 2008. This account balance was $42 thousand at year end 2008 and $27 thousand at year end 2007.
The following is a summary of quarterly results for the two years ended December 31, 2008. The information is unaudited but includes all adjustments (consisting of normal accruals) which management considers necessary for a fair presentation of the results of operations for these periods.