FORM 10-Q SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For Quarter Ended March 31, 1999 Commission File Number 1-8052 TORCHMARK CORPORATION (Exact name of registrant as specified in its charter) DELAWARE 63-0780404 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 2001 3rd Avenue South, Birmingham, Alabama 35233 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code (205) 325-4200 NONE Former name, former address and former fiscal year, if changed since last report. Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No Indicate the number of shares outstanding for each of the issuer's classes of common stock, as of the last practicable date. CLASS OUTSTANDING AT APRIL 30, 1999 Common Stock, 133,362,708 $1.00 Par Value Index of Exhibits (Page 27) Total number of pages included are 28.
TORCHMARK CORPORATION INDEX Part I. FINANCIAL INFORMATION Page Item 1. Financial Statements ---- Consolidated Balance Sheet 1 Consolidated Statement of Operations 2 Consolidated Statement of Comprehensive Income 3 Consolidated Statement of Cash Flow 4 Notes to Consolidated Financial Statements 5 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 8 Part II. OTHER INFORMATION Item 1. Legal Proceedings 24 Item 6. Exhibits and Reports on Form 8-K 27
PART I - FINANCIAL INFORMATION Item 1. Financial Statements TORCHMARK CORPORATION CONSOLIDATED BALANCE SHEET (Amounts in thousands) <TABLE> <CAPTION> March 31, December 31, Assets: 1999 1998 ----------- ----------- (Unaudited) <S> <C> <C> Investments: Fixed maturities, available for sale, at fair value (amortized cost: 1999 - $5,603,257; 1998 - $5,519,772) $ 5,720,078 $ 5,768,447 Equity securities, at fair value (cost: 1999 - $33,766; 1998 - $2,256) 31,428 9,843 Mortgage loans, at cost (estimated fair value: 1999 - $124,960; 1998 - $124,191) 124,841 124,072 Investment real estate, at depreciated cost 164,477 164,644 Policy loans 234,776 233,765 Other long-term investments (at fair value) 34,440 35,976 Short-term investments 36,311 75,844 ----------- ----------- Total investments 6,346,351 6,412,591 Cash 8,415 4,920 Investment in unconsolidated subsidiaries - 31,510 Accrued investment income 102,748 99,279 Other receivables 132,894 130,279 Deferred acquisition costs 1,559,006 1,502,511 Value of insurance purchased 165,476 170,640 Property and equipment 38,903 39,080 Goodwill 411,639 414,658 Other assets 17,475 18,298 Separate account assets 2,526,989 2,425,262 ----------- ----------- Total assets $11,309,896 $11,249,028 =========== =========== Liabilities and Shareholders' Equity: Liabilities: Future policy benefits $ 4,655,033 $ 4,595,567 Unearned and advance premiums 87,456 85,923 Policy claims and other benefits payable 202,685 194,965 Other policyholders' funds 81,711 81,568 ----------- ----------- Total policy liabilities 5,026,885 4,958,023 Accrued income taxes 448,990 511,311 Short-term debt 412,948 355,392 Long-term debt (estimated fair value: 1999 - $421,759; 1998 - $430,431) 376,741 383,422 Other liabilities 189,194 162,831 Separate account liabilities 2,526,989 2,425,262 ----------- ----------- Total liabilities 8,981,747 8,796,241 Monthly income preferred securities (estimated fair value: 1999 - $203,520; 1998 - $205,040) 193,275 193,259 Shareholders' equity: Preferred stock 0 0 Common stock 147,801 147,801 Additional paid-in capital 611,843 610,925 Accumulated other comprehensive income 58,187 144,501 Retained earnings 1,778,550 1,707,933 Treasury stock, at cost (461,507) (351,632) ----------- ----------- Total shareholders' equity 2,134,874 2,259,528 ----------- ----------- Total liabilities and shareholders' equity $11,309,896 $11,249,028 =========== =========== </TABLE> See accompanying Notes to Consolidated Financial Statements. 1
TORCHMARK CORPORATION CONSOLIDATED STATEMENT OF OPERATIONS (Unaudited and in thousands except per share data) <TABLE> <CAPTION> Three Months Ended March 31, -------------------------- 1999 1998 -------- -------- <S> <C> <C> Revenue: Life premium $251,341 $236,211 Health premium 203,042 189,811 Other premium 8,381 6,995 -------- -------- Total premium 462,764 433,017 Net investment income 111,396 119,800 Realized investment gains (losses) (2,477) (3,173) Other income 466 388 -------- -------- Total revenue 572,149 550,032 Benefits and expenses: Life policyholder benefits 162,922 154,013 Health policyholder benefits 131,653 119,840 Other policyholder benefits 8,871 13,171 -------- -------- Total policyholder benefits 303,446 287,024 Amortization of deferred acquisition costs 59,570 57,334 Commissions and premium taxes 34,632 35,805 Other operating expense 29,226 30,714 Amortization of goodwill 3,018 3,018 Interest expense 12,576 18,338 -------- -------- Total benefits and expenses 442,468 432,233 Income before income taxes and equity in earnings of Vesta 129,681 117,799 Income taxes (44,028) (41,434) Equity in earnings of Vesta 0 4,258 Monthly income preferred securities dividend (2,289) (2,471) -------- -------- Net income from continuing operations 83,364 78,152 Discontinued operations of Waddell & Reed - Income from operations 0 14,766 -------- -------- Net income $ 83,364 $ 92,918 ======== ======== Basic earnings per share: Net income from continuing operations $ 0.62 $ 0.56 Discontinued operations of Waddell & Reed - Income from operations 0.00 0.10 -------- -------- Net income $ 0.62 $ 0.66 ======== ======== Diluted earnings per share: Net income from continuing operations $ 0.61 $ 0.55 Discontinued operations of Waddell & Reed - Income from operations 0.00 0.11 -------- -------- Net income $ 0.61 $ 0.66 ======== ======== </TABLE> See accompanying Notes to Consolidated Financial Statements. 2
TORCHMARK CORPORATION CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME (Unaudited and in thousands) <TABLE> <CAPTION> Three Months Ended March 31, ------------------------ 1999 1998 --------- --------- <S> <C> <C> Net income $ 83,364 $ 92,918 Other comprehensive income: Unrealized gains (losses) on securities: Unrealized holding gains (losses) arising during period (145,238) 5,406 Less: reclassification adjustment for (gains) losses on securities included in net income 2,461 2,156 Less: reclassification adjustment for amortization of discount and premium (237) (1,000) Less: foreign exchange adjustment on securities marked to market (560) - --------- --------- Unrealized gains (losses) on securities (143,574) 6,562 Unrealized gains (losses) on other investments 32 3,099 Unrealized gains (losses) on deferred acquisition costs 10,703 (140) Foreign exchange translation adjustments 623 198 --------- --------- Other comprehensive income (loss), before tax (132,216) 9,719 Income (tax) benefit related to other comprehensive income (loss) 45,902 (3,292) --------- --------- Other comprehensive income (loss) (86,314) 6,427 --------- --------- Comprehensive income $ (2,950) $ 99,345 ========= ========= </TABLE> See accompanying Notes to Consolidated Financial Statements. 3
TORCHMARK CORPORATION CONSOLIDATED STATEMENT OF CASH FLOW (Unaudited and in thousands) <TABLE> <CAPTION> Three Months Ended March 31, -------------------------- 1999 1998 --------- --------- <S> <C> <C> Cash provided from operations $ 121,954 $ 116,186 Cash provided from (used for) investment activities: Investments sold or matured: Fixed maturities available for sale - sold 146,719 51,565 Fixed maturities available for sale - matured, called, and repaid 97,806 101,139 Other long-term investments 3,620 3,849 --------- --------- Total investments sold or matured 248,145 156,553 Investments acquired: Fixed maturities (331,470) (545,571) Other long-term investments (4,114) (29,381) --------- --------- Total investments acquired (335,584) (574,952) Net decrease (increase) in short-term investments 39,536 (99,992) Disposition of properties 23 241 Additions to properties (1,141) (613) --------- --------- Cash used for investment activities (49,021) (518,763) Cash provided from (used for) financing activities: Issuance of common stock 901 2,046 Proceeds from W&R public offering 0 516,138 Offering proceeds retained by Waddell & Reed 0 (35,251) Additions to debt 57,630 0 Repayments of debt (6,783) (82,236) Acquisition of treasury stock (111,494) 0 Cash dividends paid to shareholders (12,327) (20,957) Net receipts from deposit product operations 2,635 12,394 --------- --------- Cash used for financing activities (69,438) 392,134 Net increase (decrease) in cash 3,495 (10,443) Cash at beginning of year 4,920 11,085 --------- --------- Cash at end of period $ 8,415 $ 642 ========= ========= </TABLE> See accompanying Notes to Consolidated Financial Statements. 4
TORCHMARK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(UNAUDITED) Note A - Accounting Policies The accompanying unaudited consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q. Therefore, they do not include all of the disclosures required by generally accepted accounting principles. However, in the opinion of management, these statements include all adjustments, consisting of normal recurring accruals, which are necessary for a fair presentation of the consolidated financial position at March 31, 1999, and the consolidated results of operations for the periods ended March 31, 1999 and 1998. 5
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)--CONTINUED Note B - Business Segments Torchmark's segments are based on the insurance product lines it markets and administers: life insurance, health insurance, and annuities. There is also an investment segment, which manages the investment portfolio, debt, and cash flow for the insurance segments and the corporate function. The measure of profitability for insurance segments is underwriting income before other income and administrative expenses. It represents the gross profit margin on insurance products before administrative expenses and is calculated by deducting net policy obligations, acquisition expenses, and commissions from premium revenue. The measure of profitability for the investment segment is excess investment income, which represents the income earned on the investment portfolio in excess of net policy requirements and financing costs associated with debt and Torchmark's monthly income preferred securities (MIPS). The tables below set forth revenue (excluding realized investment losses) and measure of profitability by segment as well as reconciliations from the total measures of profitability to pretax operating income for the three-month periods ended March 31, 1999 and March 31, 1998, respectively. Selected Segment Information (Amounts in thousands) <TABLE> <CAPTION> Three months ended March 31, 1999 ------------------------------------------------------------------------------------------------- Life Health Annuity Investment Other Adjustments Consolidated -------- -------- -------- ---------- ------- ----------- ------------ <S> <C> <C> <C> <C> <C> <C> <C> Revenue: Premium $251,341 $203,042 $ 8,381 $462,764 Net investment income $114,152 $(2,756) 111,396 Other income $945 (479) 466 Intersegment revenue - required interest on net policy obligations 33,470 1,565 8,439 (43,474) 0 -------- -------- -------- ------- ---- ------- -------- Total revenue* $284,811 $204,607 $ 16,820 $70,678 $945 $(3,235) $574,626 ======== ======== ======== ======= ==== ======= ======== Measure of profitability: Underwriting income before other income and administrative expense $ 66,965 $ 35,910 $ 5,236 $108,111 Excess investment income $54,580 54,580 -------- -------- -------- ------- ---- ------- -------- Total measure of profitability $ 66,965 $ 35,910 $ 5,236 $54,580 $ 0 $ 0 $162,691 ======== ======== ======== ======= ==== ======= ======== </TABLE> * excludes realized investment gains (losses) 6
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)--CONTINUED Selected Segment Information (Amounts in thousands) <TABLE> <CAPTION> Three months ended March 31, 1998 ------------------------------------------------------------------------------------------------- Life Health Annuity Investment Other Adjustments Consolidated -------- -------- -------- ---------- ------- ----------- ------------ <S> <C> <C> <C> <C> <C> <C> <C> Revenue: Premium $236,211 $189,811 $ 6,995 $433,017 Net investment income $122,475 $(2,675) 119,800 Other income $944 (556) 388 Intersegment revenue - required interest on net policy obligations 36,456 2,470 14,404 (53,330) 0 -------- -------- ------- ------- ---- ------- -------- Total revenue* $272,667 $192,281 $21,399 $69,145 $944 $(3,231) $553,205 ======== ======== ======= ======= ==== ======= ======== Measure of profitability: Underwriting income before other income and administrative expense $ 64,255 $ 35,881 $ 4,941 $105,077 Excess investment income $47,005 47,005 -------- -------- ------- ------- ---- ------- -------- Total measure of profitability $ 64,255 $ 35,881 $ 4,941 $47,005 $ 0 $ 0 $152,082 ======== ======== ======= ======= ==== ======= ======== </TABLE> Reconciliation of Measure of Profitability to Pretax Operating Income (Amounts in thousands) For the three months ended March 31, -------------------------- 1999 1998 -------- -------- Total measure of profitablity $162,691 $152,082 Administrative expense (26,532) (26,769) Parent expense (2,694) (3,394) Tax equivalent adjustment (2,756) (2,675) Other income adjustment 945 944 Goodwill amortization (3,018) (3,018) -------- -------- Operating income before taxes* $128,636 $117,170 ======== ======== - ------------ *excludes realized investment gains (losses) 7
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Cautionary statements. Torchmark cautions readers regarding certain forward-looking statements contained in the following discussion and elsewhere in this document, and in any other statements made by, or on behalf of Torchmark whether or not in future filings with the Securities and Exchange Commission. Any statement that is not a historical fact, or that might otherwise be considered an opinion or projection concerning Torchmark or its business, whether express or implied, is meant as and should be considered a forward- looking statement. Such statements represent management's opinions concerning future operations, strategies, financial results or other developments. Forward-looking statements are based upon estimates and assumptions that are subject to significant business, economic and competitive uncertainties, many of which are beyond Torchmark's control. If these estimates or assumptions prove to be incorrect, the actual results of Torchmark may differ materially from the forward-looking statements made on the basis of such estimates or assumptions. Whether or not actual results differ materially from forward- looking statements may depend on numerous foreseeable and unforeseeable events or developments, which may be national in scope, related to the insurance industry generally, or applicable to Torchmark specifically. Such events or developments could include, but are not necessarily limited to: 1) Deteriorating general economic conditions leading to increased lapses and/or decreased sales of Torchmark's policies; 2) Regulatory developments, including changes in governmental regulations (particularly those impacting taxes and changes to the Federal Medicare program that would affect Medicare Supplement insurance); 3) Financial markets trends that adversely affect sales of Torchmark's market-sensitive products; 4) Interest rate changes that adversely affect product sales and/or investment portfolio yield; 5) Increased pricing competition; 6) Adverse litigation results; 7) Adverse Year 2000 compliance results; 8) Developments involving Vesta Insurance Group, Inc., ("Vesta"); 9) The inability of Torchmark to achieve the anticipated levels of administrative and operational efficiencies; 10) The customer response to new products and marketing initiatives; 11) Adverse levels of mortality, morbidity, and utilization of healthcare services relative to Torchmark's assumptions; and 12) The inability of Torchmark to obtain timely and appropriate premium rate increases. 8
Results of Operations Divestitures. In the analysis and comparison of Torchmark's operating results with the prior period, the divestitures of Waddell & Reed and Family Service in 1998 should be taken into account. Waddell & Reed, formerly a wholly- owned asset management subsidiary of Torchmark, completed an initial public offering in March, 1998 of approximately 36% of its shares. Offering proceeds to Torchmark were $481 million, net of amounts retained by Waddell & Reed. In November, 1998 Torchmark distributed to its shareholders the remaining 64% of the Waddell & Reed shares through a tax-free spin-off. As a result of this spin- off, Torchmark retained no further ownership interest in Waddell & Reed. The divestiture of Waddell & Reed was accounted for as the disposal of a segment. Therefore, Torchmark's share of the operating results of Waddell & Reed prior to its divestiture are included in discontinued operations of the disposed segment. Family Service is a preneed funeral insurer which was a wholly-owned subsidiary of Torchmark. It was sold on June 1, 1998 for $140 million in cash. Family Service's operations are included with Torchmark's until the date of sale. However, in the following discussion of operating segments, the insurance operating results of Family Service have been removed from Torchmark's ongoing insurance operations for comparability. Operating Results. Torchmark management computes a classification of income called "net operating income from continuing operations." Net operating income from continuing operations is the measure of income Torchmark's management focuses on to evaluate the performance of the operations of the company. It excludes unusual and nonrecurring income or loss items which distort operating trends. The following items were excluded from net income in order to compute net operating income from continuing operations: 1) Realized investment gains and losses and the related adjustment to deferred acquisition costs, net of tax; 2) The net income from the discontinued operations of Waddell & Reed; and 3) Torchmark's pro rata share of the income or losses related to Vesta. 9
The following table presents earnings and earnings per share data for Torchmark. Earnings and Earnings Per Share (Dollar amounts in thousands, except for per share data) For the three months ended March 31, -------------------------- % 1999 1998 Change ------- ------- ------ Net operating income from continuing operations: Amount $84,974 $77,446 9.7 Per Share: Basic 0.63 0.55 14.5 Diluted 0.62 0.55 12.7 Net income: Amount 83,364 92,918 (10.3) Per Share: Basic 0.62 0.66 (6.1) Diluted 0.61 0.66 (7.6) Operating revenues, or revenues excluding realized investment gains and losses, rose 4% to $575 million in the first quarter of 1999. Total premium increased 7% to $463 million and net investment income declined 7% to $111 million in the 1999 quarter. Torchmark's operating expense declined 5% to $29 million in 1999 in spite of the revenue growth. As a result, operating expense as a percentage of operating revenues decreased from 5.6% in 1998 to 5.1% in 1999. 10
The following table is a summary of Torchmark's net operating income from continuing operations by component. Net underwriting income is premium income less net policy obligations, commissions, acquisition expenses, and insurance administrative expenses. Excess investment income is tax equivalent net investment income reduced by the interest credited to net policy liabilities, and the financing cost of Torchmark's debt and MIPS. Summary of Net Operating Income from Continuing Operations (Dollar amounts in thousands) <TABLE> <CAPTION> Three months Ended March 31, Increase --------------------- ------------------ 1999 1998 Amount % -------- -------- -------- ---- <S> <C> <C> <C> <C> Insurance underwriting income before other income and administrative expense: Life $ 66,965 $ 62,937 $ 4,028 6 Health 35,910 35,881 29 0 Annuity 5,236 4,878 358 7 -------- -------- -------- Total 108,111 103,696 4,415 4 Other income 945 944 1 0 Administrative expense (26,532) (26,170) (362) 1 -------- -------- -------- Insurance underwriting income excluding Family Service 82,524 78,470 4,054 5 Insurance underwriting income - Family Service 0 782 (782) (100) Excess investment income 54,580 47,005 7,575 16 Corporate expense (2,694) (3,394) 700 (21) Goodwill amortization (3,018) (3,018) 0 0 Tax equivalency adjustment (2,756) (2,675) (81) 3 -------- -------- -------- Pretax insurance net operating income 128,636 117,170 11,466 10 Income tax (43,662) (39,724) (3,938) 10 -------- -------- -------- Net operating income from continuing operations $ 84,974 $ 77,446 $ 7,528 10 ======== ======== Net operating income from continuing operations per diluted share $ 0.62 $ 0.55 13 ======== ======== </TABLE> A discussion of Torchmark's operations by segment follows. 11
Life insurance. Torchmark's life insurance premium income rose 7% to $251 million in the first three months of 1999. The following table presents Torchmark's life insurance premium and policy charges by distribution channel. Life Insurance Premium by Distribution Method (Dollar amounts in thousands) <TABLE> <CAPTION> Three months ended March 31, -------------------------------------------------------- 1999 1998 Increase ----------------------- ---------------------- -------------------- % of % of Amount Total Amount Total Amount % ------ ----- ------ ----- ------ --- <S> <C> <C> <C> <C> <C> <C> Liberty National Exclusive Agency $ 70,849 28 $ 70,654 30 $ 195 0 Direct Response 61,146 24 53,377 23 7,769 15 American Income Exclusive Agency 52,891 21 49,889 21 3,002 6 Military Independent Agency 25,034 10 21,816 9 3,218 15 United Investors Agency 22,034 9 19,620 9 2,414 12 United American Independent Agency 9,288 4 9,365 4 (77) (1) United American Exclusive Agency 4,782 2 4,623 2 159 3 Other 5,317 2 5,301 2 16 0 -------- --- -------- --- ------- Total life premium excluding Family Service 251,341 100 234,645 100 16,696 7 Family Service 0 1,566 (1,566) -------- -------- ------- Total life premium including Family Service $251,341 $236,211 $15,130 6 </TABLE> 12
Annualized life premium in force was $1.08 billion at March 31, 1999, rising 6% over $1.02 billion in force a year earlier. Life insurance sales, in terms of annualized premium issued, were $65 million in the 1999 three-month period, increasing 10% over 1998 same-period sales of $59 million. The following table presents Torchmark's life insurance sales and in force data by distribution method. <TABLE> <CAPTION> Life Insurance Annualized Premium Sales and In Force (Dollar amounts in thousands) Sales In Force --------------------------------------- ---------------------------------------- Three months Ended March 31, Increase At March 31, Increase ------------------- -------------- --------------------- --------------- 1999 1998 Amount % 1999 1998 Amount % ------- ------- -------- --- ------ ------ -------- --- <S> <C> <C> <C> <C> <C> <C> <C> <C> Direct Response $27,057 $24,178 $2,879 12 $269,338 $242,330 $27,008 11 Liberty Exclusive Agency 12,565 10,439 2,126 20 299,057 298,184 873 0 AI Exclusive Agency 12,415 12,882 (467) (4) 218,931 206,245 12,686 6 Military Independent Agency 4,310 4,263 47 1 102,013 89,518 12,495 14 United Investors Agency 3,460 2,943 517 18 102,543 89,760 12,783 14 UA Independent Agency 2,727 2,157 570 26 41,066 41,752 (686) (2) UA Exclusive Agency 1,278 1,324 (46) (3) 21,316 20,888 428 2 Other Distribution 1,267 775 492 63 26,808 26,719 89 0 ------- ------- ------ ---------- ---------- ------- Total Life excluding Family Service 65,079 58,961 6,118 10 1,081,072 1,015,396 65,676 6 Family Service 0 0 0 0 0 5,813 (5,813) ------- ------- ------ ---------- ---------- ------- Total life including Family Service $65,079 $58,961 $6,118 10 $1,081,072 $1,021,209 $59,863 6 </TABLE> Torchmark's Direct Response operation is conducted through direct mail, co- op mailings, television and consumer magazine advertising, and direct mail solicitations endorsed by groups, unions and associations. Direct Response generated $27 million in annualized premium issued in the first quarter of 1999, compared with $24 million in the same period of 1998, an increase of 12%. Annualized premium in force for this distribution method rose 11% over the prior year to $269 million at March 31, 1999, and premium income grew 15% to $61 million in the 1999 first quarter. The $8 million growth in Direct Response premium income and the $27 million increase in annualized premium in force were the largest increases of any Torchmark distribution channel, respectively, in terms of dollar amount. In addition to sales and premium growth, the Direct Response operation provides support to other Torchmark marketing agencies by providing sales leads and agent recruiting, which has contributed indirectly to premium growth in those agencies. 13
The Liberty National Exclusive Agency distribution system represented the largest component of life premium at 28% or $71 million in the 1999 three-month period. Life insurance sales for this agency grew 20% to $13 million of annualized premium issued in the 1999 period. A primary factor in the growth in sales was the increase in the number of Liberty agents, which was 1,825 at March 31, 1999, compared with 1,773 a year earlier. Torchmark's Military Agency produced the greatest percentage increase in premium income at 15% to $25 million. It also recorded a 14% increase in annualized life premium in force which was $102 million at March 31, 1999. Military Agency sales rose 1% to $4.3 million in the 1999 period. This agency consists of former military officers who sell exclusively to military officers and their families. The American Income Agency focuses on members of labor unions, credit unions, and other associations. This agency produced premium income of $53 million in the 1999 quarter, an increase of 6%. While life sales were down 4% to $12 million for the period, annualized life premium in force rose 6% to $219 million at 1999 quarter end. The decline in sales is reflective of the decline in the number of agents which was 1,160 at March 31, 1999, down 218 from a year earlier. Management has begun restructuring the agency to focus on recruiting and retaining new agents. The United Investors Exclusive Agency had the largest percentage growth in annualized life premium in force for Torchmark life insurance operations at 14%. Annualized premium in force was $103 million at March 31, 1999. Annualized life premium issued rose 18% to $3.5 million. United Investors' products are marketed primarily through the Waddell & Reed sales force, as well as other Torchmark distribution channels. 14
<TABLE> <CAPTION> Life Insurance Summary of Results (Dollar amounts in thousands) Three months ended March 31, --------------------------------------------- 1999 1998 Increase ----------------- -------------------- ----------------- % to % to Amount Total Amount Total Amount % ------ ----- ------ ----- ------ --- <S> <C> <C> <C> <C> <C> <C> Premium and policy charges $251,341 100 $234,645 100 $16,696 7 Net policy obligations 107,188 42 97,999 42 9,189 9 Commissions and acquisition expense 77,188 31 73,709 31 3,479 5 -------- -------- ------ Insurance underwriting income before other income and administrative expenses, excluding Family Service $66,965 27 $62,937 27 $ 4,028 6 Family Service insurance underwriting income before other income and administrative expense 0 1,318 (1,318) -------- -------- ------ Insurance underwriting income before other income and administrative expense $66,965 $64,255 $ 2,710 </TABLE> Life insurance underwriting income before administrative expenses excluding Family Service was $67 million in the first three months of 1999, growing 6% over the same period in 1998. As a percentage of premium, underwriting income was 27% in both periods. 15
Health insurance. Health insurance premium income rose 7% from $190 million in the first quarter of 1998 to $203 million in the same period of 1999. The table below is an analysis of Torchmark's health premium by distribution method. <TABLE> <CAPTION> Health Insurance Premium by Distribution Method (Dollar amounts in thousands) Three months ended March 31, ------------------------------------------------------- 1999 1998 Increase ------------------------- ------------------------ -------------------- % to % to Amount Total Amount Total Amount % ------ ----- ------ ----- ------ --- <S> <C> <C> <C> <C> <C> <C> United American Independent Agency $108,488 54 $107,224 56 $1,264 1 United American Exclusive Agency 44,755 22 35,242 19 9,513 27 Liberty National Exclusive Agency 35,293 17 33,649 18 1,644 5 American Income Exclusive Agency 11,600 6 11,437 6 163 1 Direct Response 2,906 1 2,259 1 647 29 -------- --- -------- --- ------- Total Premium $203,042 100 $189,811 100 $13,231 7 </TABLE> The table below is a presentation of health insurance sales and in force data. <TABLE> <CAPTION> Health Insurance Annualized Premium Sales and In Force (Dollar amounts in thousands) Sales In Force -------------------------------------- ----------------------------------------- Three months Ended March 31, Increase At March 31, Increase --------------- --------------- ------------------ --------------- 1999 1998 Amount % 1999 1998 Amount % ---- ---- ------ --- ---- ---- ------ --- <S> <C> <C> <C> <C> <C> <C> <C> <C> UA Exclusive Agency $23,629 $12,733 $10,896 86 $188,520 $148,097 $40,423 27 UA Independent Agency 16,056 11,631 4,425 38 432,597 433,963 (1,366) 0 Liberty Exclusive Agency 2,492 2,618 (126) (5) 143,110 136,447 6,663 5 AI Exclusive Agency 1,835 2,295 (460) (20) 44,235 43,739 496 1 Direct Response 1,703 1,871 (168) (9) 11,499 9,063 2,436 27 ------- ------- ------- -------- -------- ------- Total Premium $45,715 $31,148 $14,567 47 $819,961 $771,309 $48,652 6 </TABLE> 16
Annualized health insurance premium in force grew 6% to $820 million at March 31, 1999. Sales of health insurance, as measured by annualized premium issued, grew 47% to $46 million in the 1999 quarter. Medicare Supplement sales rose 70% in the 1999 period to $37 million, accounting for all of the growth in Torchmark's total health sales of $15 million. Medicare Supplement products are sold by Torchmark's United American Independent and Exclusive Agencies. Both of these agencies have experienced growth in agency size over the prior year. An additional factor in the increased Medicare Supplement sales was the support obtained from Torchmark's Direct Response operation in providing these agencies with leads and assistance in agent recruiting. Annualized Medicare Supplement premium in force was $578 million at March 31, 1999, rising 8% from a year earlier. Medicare Supplement represented 70% of total health premium in force at the end of the 1999 quarter, compared with 69% at the same date a year earlier. Cancer sales, produced primarily by the Liberty National Agency, were $2.5 million in the 1999 quarter, increasing 4% from the prior year quarter. Cancer annualized premium in force rose 6% to $145 million, primarily as a result of premium rate increases. Other health product sales declined 11% to $6.1 million in the 1999 period. The following table presents underwriting margin data for health insurance. Health Insurance Summary of Results (Dollar amounts in thousands) <TABLE> <CAPTION> Three months ended March 31, ----------------------------------------------------- 1999 1998 Increase -------------------- --------------------- --------------- % of % of Amount Total Amount Total Amount % ------ ----- ------ ----- ------ --- <S> <C> <C> <C> <C> <C> <C> Premium and policy charges $203,042 100 $189,811 100 $13,231 7 Net policy obligations 127,136 62 114,573 60 12,563 11 Commissions and acquisition expense 39,996 20 39,357 21 639 2 -------- -------- ------- Insurance underwriting income before other income and administrative expenses $35,910 18 $35,881 19 $ 29 0 </TABLE> Underwriting margins for health insurance, or underwriting income as a percentage of premium, declined from 19% in the first quarter of 1998 to 18% in the same period of 1999 as a result of a 2% increase in policy obligation ratios due primarily to an increasing 17
loss ratio on a block of Liberty National's cancer insurance. Premium rate increases are being sought to offset these cost increases. A major rate increase went into effect in May, 1999. Requests for additional increases in future periods are possible to address the decline in margins. In Torchmark's Medicare Supplement business, underwriting income as a percentage of premium is restrained by Federally mandated loss ratios and market competition. Annuities. The following table presents collection and balance information about Torchmark's annuities, excluding Family Service. Annuities Collections and Deposit Balances (Dollar amounts in thousands) <TABLE> <CAPTION> Collections Deposit Balances ------------------------------------------- ----------------------------------------- Three Months Ended March 31, Increase At March 31, Increase ---------------------- --------------- ----------------------- ---------------- 1999 1998 Amount % 1999 1998 Amount % ------- ------- ------- --- ---------- ---------- --------- --- <S> <C> <C> <C> <C> <C> <C> <C> <C> Fixed $11,115 $15,007 $(3,892) (26) $ 646,652 $ 859,942 $(213,290) (25) Variable 81,500 47,027 34,473 73 2,438,105 2,041,769 396,336 19 ------- ------- ------- ---------- ---------- --------- Total $92,615 $62,034 $30,581 49 $3,084,757 $2,901,711 $ 183,046 6 </TABLE> Annuities are sold on both a fixed and a variable basis. Fixed annuity collections were $11 million in the first three months of 1999, compared with $15 million collected in the prior period, a decline of 26%. Collections of variable annuities were over $81 million in the 1999 period, increasing 73% from variable collections of $47 million in the first quarter of 1998. Fixed annuities on deposit with Torchmark declined 25% to $647 million. The variable annuity balance on deposit rose 19% during the past twelve months. This balance was $2.4 billion at March 31, 1999, $2.3 billion at December 31, 1998, and $2.0 billion a year ago. The low interest environment which has resulted in strong financial markets in recent months has had a positive impact on the variable account balance and has been a major factor in increased variable annuity sales. On the other hand, as variable annuities and alternative investments have become more attractive, the fixed-annuity market has become more difficult. 18
The following table presents underwriting margin data for Torchmark's annuities. <TABLE> <CAPTION> Annuities Summary of Results (Dollar amounts in thousands) Three months Ended March 31, Increase ------------------------ -------------------------- 1999 1998 Amount % ------ ------ ------------- ---------- <S> <C> <C> <C> <C> Policy charges $ 8,381 $ 6,777 $1,604 24 Net policy obligations (1,097) (1,945) 848 (44) Commissions and acquisition expense 4,242 3,844 398 10 ------- ------- ------ --- Insurance underwriting income before other income and administrative expenses, excluding Family Service 5,236 4,878 358 7 Family Service 0 63 (63) ------- ------- ------ Insurance underwriting income before other income and administrative expense $5,236 $4,941 $295 </TABLE> Policy charges for annuities for the 1999 quarter were $8.4 million, compared with $6.8 million for the 1998 period, an increase of 24%. Policy charges are assessed against the annuity account balance periodically for insurance risk, sales, administration, and cash surrender. The increase in policy charges resulted from the growth in variable annuities over the prior- year period. Annuity underwriting income excluding Family Service improved 7% from $4.9 million in the 1998 period to $5.2 million in 1999. 19
Investment. The following table summarizes Torchmark's insurance companies' investment income and excess investment income. <TABLE> <CAPTION> Insurance Operations Excess Investment Income (Dollars in thousands) Three months Ended March 31, Increase ----------------------- ------------- 1999 1998 Amount % -------- -------- ------- --- <S> <C> <C> <C> <C> Net investment income $111,396 $119,800 $(8,404) (7) Tax equivalency adjustment 2,756 2,675 81 3 -------- -------- ------- -- Tax equivalent investment income 114,152 122,475 (8,323) (7) Required interest on net insurance policy liabilities (43,474) (53,330) 9,856 (18) Financing costs (16,098) (22,140) 6,042 (27) -------- -------- ------- -- Excess investment income $ 54,580 $ 47,005 $ 7,575 16 </TABLE> On a tax equivalent basis, net investment income from insurance operations was $114 million in the first quarter of 1999, declining 7% from $122 million during the same 1998 period. The 1998 amount includes $7 million in the first quarter on internal financing with Waddell & Reed related to the March, 1998 initial public offering. Also, 1998 investment income included $14 million attributable to Family Service on a tax-equivalent basis. Excess investment income is tax-equivalent net investment income reduced by the interest credited to net insurance policy liabilities and less Torchmark's financing costs. Financing costs include interest on debt and the pretax dividends on Torchmark's MIPS. Excess investment income for the 1999 first quarter rose 16% to $55 million from $47 million a year earlier. The increase resulted primarily from the reduction in Torchmark's borrowing cost due to the replacement of $360 million in long-term debt with short-term debt in the second quarter of 1998. Excess investment income also benefited from the increase in invested assets relative to net policy liabilities and a reduction in total debt. During the first quarter, Torchmark continued its program of acquiring primarily investment grade fixed maturity bonds. Purchases totaled $331 million, and had an average yield of 7.21%, equivalent to an effective compounded yield of 7.33%. For the first quarter of 1998, purchases, excluding Family Service, totaled $532 million with average and effective compounded yields of 7.24% and 7.38%, respectively. The fixed maturity 20
portfolio average yield was 7.40% during the first quarter, compared with 7.42% for the year 1998 and 7.47% for the year-ago quarter. At quarter end, the portfolio had an estimated average life of 10.3 years and an effective duration of 5.7 years. With the first quarter of 1999 increase in interest rates, the unrealized gain in the fixed-maturity portfolio decreased from $249 million at 1998 year end to $117 million at the end of March, 1999. The unrealized gain at the March, 1998 quarter end was $218 million. Volatility in carrying values should be expected as the maturity of the portfolio is lengthened and as interest rates fluctuate. The portfolio overall quality, however, remained high at an average quality rating of A and with less than 6% of holdings rated below investment grade. Financial Condition Liquidity. Torchmark's liquidity is represented by its positive cash flow, marketable investments, and the availability of a line of credit facility. Torchmark's insurance operations typically generate cash flows in excess of immediate requirements. Torchmark's net cash inflows from operations were $122 million in the first quarter of 1999, compared with $116 million in the same period of 1998, an increase of 5%. In addition to cash flows from operations, Torchmark received $102 million in investment maturities or repayments during the first quarter of 1999. Torchmark's cash and short-term investments were $45 million at the end of March, 1999, compared with $81 million of these assets at December 31, 1998. In addition to these liquid assets, Torchmark's entire portfolio of fixed-income and equity securities, in the approximate amount of $5.8 billion at market value on March 31, 1999, is available for sale should any need arise. Torchmark has in place a line of credit facility, which is also designed as a backup credit line for a commercial paper program. This program provides credit up to a maximum amount of $600 million, and permits Torchmark to borrow from either the credit line or issue commercial paper at any time up to the combined facility maximum of $600 million. Terms of the facility permit borrowing up to the maximum amount at variable interest rates. Torchmark is subject to certain covenants regarding capitalization and earnings, with which Torchmark was in full compliance at March 31, 1999. At that date, Torchmark had commercial paper outstanding in the face amount of $415 million and no borrowings on the line of credit. At December 31, 1998, $357 million face amount of commercial paper was outstanding. Capital resources. Torchmark's total debt outstanding was $790 million at March 31, 1999, compared with $739 million at December 31, 1998 and $829 million at March 31, 1998. Long-term debt was $377 million at March 31, 1999, decreasing from $383 million at December 31, 1998 and from $394 million at March 31, 1998. During the first quarter 21
of 1999, Torchmark acquired $4.0 million of its 7 3/8% notes due 2013 in the open market at a cost of $4.1 million and acquired $2.5 million of its 7 7/8% notes due 2023 in the market at a cost of $2.6 million. It also acquired $11 million of its 7 7/8% notes late in 1998. Debt as a percentage of total capitalization was 26% at March 31, 1999, counting the MIPS as equity and excluding the effects of fluctuations in security values based on changes in interest rates in the financial markets. The debt to capitalization ratio was 24% at year-end 1998 and 25% at March 31, 1998. Interest coverage was 11.3 times for the 1999 quarter, compared with 7.4 times for the prior-year quarter, increasing due to the debt paydowns. Torchmark continued to acquire its shares on the open market during the first quarter of 1999. Purchases of 3.4 million shares were made at a cost of $111 million during the quarter. Share purchases were primarily funded by the sale of investments but borrowings on the line of credit were also made. Torchmark intends to make additional purchases under its share repurchase program on the open market when prices are attractive. Torchmark's shareholders' equity was $2.13 billion at March 31, 1999, compared with $2.26 billion at 1998 year end and $2.44 billion one year ago. Book value per share was $15.99 at March 31, 1999, compared with $16.51 at year- end 1998 and $17.39 a year earlier. After adjusting shareholders' equity to remove the effects of interest-rate fluctuations on the security portfolio on an after-tax basis, shareholders' equity was $2.07 billion at March 31, 1999, compared with $2.11 billion at 1998 year end and $2.31 billion a year ago. On a per share basis, book value was $15.47 at the end of March, 1999, compared with $15.43 at year-end 1998 and $16.47 at March 31, 1998. The primary factor in the decline in adjusted shareholder equity for the 1999 quarter was the purchases of Torchmark shares. The decline in adjusted equity from a year earlier was impacted by the spin-off of Waddell & Reed, which accounted for a net reduction in equity of $174 million. The annualized return on common equity, excluding the effects of securities at market value, realized investment gains and losses, discontinued operations, and the earnings of Vesta, was 16.3% for the 1999 quarter. Return on equity for the same 1998 period was 14.6%. This increase was primarily a result of the share purchases. Vesta Insurance Group. Since 1993, Torchmark has held a passive investment in Vesta until December, 1998. This investment amounted to approximately 28% of the outstanding shares of Vesta. In December, 1998, Torchmark sold 680 thousand shares of Vesta, retaining 4.45 million Vesta shares or approximately 24% of the company at December 31, 1998 and March 31, 1999. During the first quarter of 1999, the two Torchmark directors who occupied seats on the Vesta Board of Directors resigned from those seats on the Vesta Board. It is Torchmark's intent to divest itself of Vesta and continue to sell Vesta shares under satisfactory terms. 22
Because of Torchmark's desire to reduce its investment in Vesta, the vacating of the board seats, and the absence of significant influence regarding Vesta, Torchmark has discontinued the equity method of accounting for its investment in Vesta and has included Vesta in equity securities on its March 31, 1999 balance sheet. Torchmark carried Vesta at a market value of $23 million at March 31, 1999. Vesta was carried at a value of $32 million at December 31, 1998. Year 2000 Compliance. As of May 1, 1999, Torchmark was on schedule to complete its corporate-wide Year 2000 compliance requirements. Business-critical testing has been completed. All non-critical computer software testing is scheduled to be completed during the third quarter of 1999. In addition, Torchmark is in the process of completing all of the verification and interface testing of its business-critical Year 2000 third-party interrelationships. Torchmark has also completed addressing its non-information technology Year 2000 concerns, which included correcting and replacing various systems. It is also finalizing its Year 2000 testing of its vendor supported computer software. Torchmark has used primarily its own employees to meet its Year 2000 project completion requirements. Through the end of first quarter 1999, Torchmark had spent approximately $5.5 million on its Year 2000 project, including Torchmark's internal computer hardware and software processing costs, internally-provided programming costs, the use of outside computer software contractors, the cost of testing its application software modifications, and all computer hardware and software replacement costs. These project costs have been expensed as they have been incurred. Total cost of the project is expected to be approximately $6 million at the time it is completed. Torchmark is establishing viable Year 2000 contingency plans for all business-critical areas. Management is currently in the process of developing and documenting Year 2000 contingency procedures throughout the corporation for its business-critical computer systems. Contingency procedures relating to critical third-party organizations have been completed. The contingency plans include possible manual operations, the use of outside staff, the redeployment of internal staff, and the implementation of alternative information processing procedures. 23
PART II - OTHER INFORMATION Item 1. Legal Proceedings. 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 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. As of March 31, 1998, Liberty was a party to approximately 105 active lawsuits (including 16 employment related cases and excluding interpleaders and stayed cases), more than 91 of which were Alabama proceedings in which punitive damages were sought. Liberty faces trial settings in these cases on an on-going basis. 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. It should be noted, however, that large punitive damage awards bearing little or no relation to actual damages awarded by juries in jurisdictions in which Torchmark has substantial business, particularly in Alabama, continue to occur, creating the potential for unpredictable material adverse judgments in any given punitive damage suit. 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. The final such remaining case has now been dismissed by the Chambers County Circuit Court. In 1978, the United States District Court for the Northern District of Alabama entered a final judgment in Battle v. Liberty National Life Insurance ----------------------------------------- Company , et al (Case No. CV-70-H-752-S), class action litigation involving - --------------- Liberty, a class composed of all owners of funeral homes in Alabama and a class composed of all insureds (Alabama residents only) under burial or vault policies issued, assumed or reinsured by Liberty. The final judgment fixed the rights and obligations of Liberty and the funeral directors authorized to handle Liberty burial and vault policies as well as reforming the benefits available to the policyholders under the policies. Although class actions are inherently subject to subsequent collateral attack by absent class members, the Battle ------ decree remains in effect to date. A motion filed in February 1990 to challenge the final judgment under Federal Rule of Civil Procedure 60(b) was rejected by both the District Court in 1991 and the 24
Eleventh Circuit Court of Appeals in 1992 and a Writ of Certiorari was denied by the U.S. Supreme Court in 1993. In November 1993, an attorney (purporting to represent the funeral director class) filed a petition in the District Court seeking alternative relief under the final judgment. This petition was voluntarily withdrawn on November 8, 1995 by petitioners. On February 23, 1996, Liberty filed a petition with the District Court requesting that it order certain contract funeral directors to comply with their obligations under the Final Judgment in Battle and their ------ funeral service contracts. A petition was filed on April 8, 1996 on behalf of a group of funeral directors seeking to modify the 1978 decree in Battle in light ------ of changed economic circumstances. All parties made extensive submissions to the District Court and a hearing on the opposing petitions was held by the District Court on February 9, 1999. On March 8, 1999, the District Court entered an order granting Liberty's petition to enforce the obligations of contract funeral directors under their funeral service contracts and denying the funeral directors' petition for review of the Battle Final Judgment and alternative ------ relief. It has been previously reported that in July 1998, a jury in U.S. District Court in the Middle District of Florida recommended an aggregate total verdict amounting to $21.6 million against Liberty in Hipp v. Liberty National Life ----------------------------- Insurance Company (Case No. 95-1332-CIV-17A). This case, originally filed in - ----------------- 1995 in the Florida state court system, is a collective action under the Fair Labor Standards Act, alleging age discrimination by Liberty in violation of the Age Discrimination in Employment Act and the Florida Civil Rights Act. The plaintiffs, ten present or former Liberty district managers, sought damages for lost wages, loss of future earnings, lost health and retirement benefits and lost raises and expenses. Three of these plaintiffs, Florida residents, also sought compensatory and punitive damages allowable under Florida law. On November 20, 1998, the District Court remitted the $10 million punitive damage portion of the jury verdict to $0, thus reducing the total verdict to $11 million (including an advisory verdict of $3.2 million in front pay awards). Additional revised front pay submissions were made by the plaintiffs to the District Court in December 1998 and Liberty responded thereto in January 1999. On March 11, 1999, the District Court reduced the Hipp verdict to $7 million by ---- denying the plaintiffs front pay damages and remitting the punitive damages awarded to the Florida resident plaintiffs to the $100,000 limit allowable under Florida law. Liberty is awaiting the entry of a final judgment in the Hipp case ---- and thereafter will pursue all available post trial and appellate relief. On March 15, 1999, Torchmark was named as a defendant in consolidated derivative securities class action litigation involving Vesta Insurance Group, Inc. filed in the United States District Court for the Northern District of Alabama (In re Vesta Insurance Group, Inc. Securities Litigation, Master File -------------------------------------------------------- No. 98-AR-1407-S). The amended consolidated complaint in this litigation alleges violations of Section 10(b) of the Securities Exchange Act of 1934 by the defendants Vesta, certain present and former Vesta officers and directors, Vesta's former independent public accountants and Torchmark and of Section 20(a) of the Exchange Act by certain former Vesta officers and directors and 25
Torchmark acting as "controlling persons" of Vesta in connection with certain accounting irregularities in Vesta's reported financial results and filed financial statements. Unspecified damages and equitable relief are sought on behalf of a purported class of purchasers of Vesta equity securities between June 2, 1995 and June 29, 1998. No class has yet been certified in this litigation. 26
Item 6. Exhibits and Reports on Form 8-K (a) Exhibits (11) Statement re computation of per share earnings (27) Financial Data Schedule (b) Reports on Form 8-K No reports on Form 8-K were filed in the first quarter of 1999 27
SIGNATURES Pursuant to the requirement of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized. TORCHMARK CORPORATION Date: May 12, 1999 /s/ C. B. Hudson ------------------------------- C. B. Hudson, Chairman of the Board, President, and Chief Executive Officer Date: May 12, 1999 /s/ Gary L. Coleman ------------------------------- Gary L. Coleman, Vice President And Chief Accounting Officer 28