The investment segment’s pretax profitability, or excess investment income, is based on three major components: net investment income, required interest on net policy liabilities (interest applicable to insurance products), and financing costs. In 2014, net investment income rose 3%, compared with 2% in 2013. As we view our segments, net investment income rose 3% in both periods. At the same time, our investment portfolio grew 3% and 9% in 2014 and 2013, respectively. In recent years, net investment income has not grown as fast as the portfolio. One reason that investment income has grown at a lower rate than mean invested assets has grown in recent years is that new investments have been made at yield rates lower than the yield rates earned on securities that matured or were otherwise disposed of. Also, there is sometimes a lag between the time when proceeds from maturities and dispositions are received and when the proceeds are reinvested, during which the funds are held in cash. Growth in total investment income is also somewhat negatively affected by Torchmark’s share repurchase program (described later under this caption), which has diverted cash that could have otherwise been used to acquire investments. In 2014, net investment income was negatively impacted by events affecting our Medicare Part D business. Under the program, we are required to cover certain claim costs in the current period that are the federal government’s responsibility, but are not reimbursed until late in the next calendar year. This delay in reimbursement substantially reduced our funds available for investment in 2014, with the result of reduced investment income in 2014 and 2015.
As described in Note 1-Significant Accounting Policies in the Notes to Consolidated Financial Statements, we described certain litigation matters that were incurred in the years 2014 and 2013 that were not directly related to our ongoing core insurance operations. Management does not consider these litigation matters to be part of insurance administration expense, but instead considers them to be non-operating expenses. Also during 2013, Torchmark recorded an additional non-operating charge involving a state guaranty fund assessment in the amount of $1.2 million, resulting from events in years prior to 2012. We incurred expenses of $2.9 million related to the acquisition of Family Heritage in late 2012 as described in Note 6-Acquisition in the Notes to Consolidated Financial Statements. While all of these non-operating expenses were included in “Operating expenses” for the respective year in the Consolidated Statements of Operations in accordance with accounting guidance, they are removed by management from consideration when evaluating segment operating results.
In response to the lower interest rates, we raised the premium rates for new business on major life products in early 2012 and again in late 2013. The increased premium provides additional margin on these policies to help offset higher mandatory cash values and the possible future reductions in excess investment income. Despite these increases in premium rates, we have continued to see growth in net sales.
Index to Financial Statements An analysis of the fixed-maturity portfolio by a composite rating at December 31, 2014 is shown in the table below. The composite rating for each security, other than private-placement securities managed by a third party, is the average of the security’s ratings as assigned by Moody’s Investor Service, Standard & Poor’s, Fitch Ratings, and Dominion Bond Rating Service, LTD. The ratings assigned by these four nationally recognized statistical rating organizations are evenly weighted when calculating the average. Included in the chart below are private placement fixed-maturity holdings of $497 million at amortized cost ($513 million at fair value) for which the ratings were assigned by the third-party manager.
Consolidated Liquidity. Consolidated net cash inflows provided from operations were $865 million in 2014, compared with $1.1 billion in 2013 and $943 million in 2012. In addition to cash inflows from operations, our companies have received $160 million in investment calls and tenders and $113 million
As also discussed in Note 11, we issued $125 million principal amount of our 5.875% Junior Subordinated Debentures due 2052 in a September, 2012 public offering. This issue resulted in net proceeds after issue expenses of $121 million, and were used to redeem our 7.1% Trust Originated Preferred Securities in the amount of $120 million plus accrued dividends for a total cost of $121 million.
Litigation. Torchmark and its subsidiaries are subject to being named as parties to pending or threatened litigation, much of which involves punitive damage claims based upon allegations of agent misconduct at the insurance subsidiaries. Such punitive damage claims may have the potential for significant adverse results since Torchmark and its subsidiaries operate in jurisdictions where large punitive damage awards bearing little or no relation to actual damages continue to be awarded. This bespeaks caution since it is impossible to predict the likelihood or extent of punitive damages that may be awarded if liability is found in any given case. 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 us to be material. For more information concerning litigation, please refer to Note 15-Commitments and Contingencies in the Notes to the Consolidated Financial Statements.
The new guidance is effective for Torchmark beginning January 1, 2015, with early adoption permitted. The guidance continues to permit the effective-yield method for investments held as of the date of adoption. Adoption is required on a retrospective basis. Torchmark does not expect that adoption will have a material impact on the consolidated financial statements.
During the two-month period commencing on the purchase date of November 1, 2012 and ending December 31, 2012, Family Heritage had revenues of $33 million and net income of $3.1 million included in Torchmark’s 2012 Consolidated Statement of Operations.
Pension Plans: Torchmark has noncontributory retirement benefit plans and contributory savings plans which cover substantially all employees. There are also two nonqualified, noncontributory supplemental benefit pension plans which cover a limited number of employees. The total cost of these retirement plans charged to operations was as follows:
The portion of other comprehensive income that is expected to be reflected in pension expense in 2015 is as follows:
All employee options vest immediately upon retirement on or after the attainment of age 65, upon death, or disability. 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.
Restricted stock units outstanding at each of the year ends 2014, 2013, and 2012 were 98,039, 85,717, and 79,907, respectively. Restricted stock units are only available to directors, and are not converted to shares until the director’s retirement, death, or disability. There were no unvested director restricted shares outstanding at the end of any of the years 2012 through 2014. Director restricted stock and restricted stock units are generally granted on the first working day of the year and vest in six months. Dividend equivalents are earned on restricted stock units only. They are granted in the form of additional restricted stock units and vest immediately upon grant.
The measure of profitability established by the chief operating decision maker for insurance segments is underwriting margin before other income and administrative expenses, in accordance with the manner the segments are managed. It essentially represents gross profit margin on insurance products before insurance administrative expenses and consists of premium, less net policy obligations, acquisition expenses, and commissions. Interest credited to net policy liabilities (reserves less deferred acquisition costs) is reflected as a component of the Investment segment in order to match this cost to the investment earnings from the assets supporting the net policy liabilities.