SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For Quarter Ended March 31, 2004
Commission File Number 1-8052
TORCHMARK CORPORATION
(Exact name of registrant as specified in its charter)
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 by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).
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, 2004
Index of Exhibits (Page 45)
Total number of pages included are 46.
INDEX
PART I.
Consolidated Balance Sheets
Consolidated Statements of Operations
Consolidated Statements of Comprehensive Income
Consolidated Statement of Cash Flows
Notes to Consolidated Financial Statements
PART II.
PART I - FINANCIAL INFORMATION
CONSOLIDATED BALANCE SHEETS
(Dollar amounts in thousands except per share data)
Assets
Investments:
Fixed maturities, available for sale, at fair value (amortized cost: 2004 - $7,681,564; 2003 - $7,472,003)
Equity securities, at fair value (cost: 2004 - $ 53,937; 2003 - $49,074)
Mortgage loans, at cost (fair value: 2004 - $112,808; 2003 - $114,026)
Investment real estate, at depreciated cost
Policy loans
Other long-term investments, at fair value
Short-term investments
Total investments
Cash
Accrued investment income
Other receivables
Deferred acquisition costs
Value of insurance purchased
Property and equipment
Goodwill
Other assets
Separate account assets
Total assets
Liabilities and Shareholders’ Equity
Liabilities:
Future policy benefits
Unearned and advance premiums
Policy claims and other benefits payable
Other policyholders’ funds
Total policy liabilities
Accrued income taxes
Other liabilities
Short-term debt
Long-term debt (fair value: 2004 - $645,918; 2003 - $626,208)
Due to affiliates
Separate account liabilities
Total liabilities
Shareholders’ equity:
Preferred stock, par value $1 per share - Authorized 5,000,000 shares; outstanding: -0- in 2004 and in 2003
Common stock, par value $1 per share - Authorized 320,000,000 shares; outstanding: (2004 - 113,783,658 issued, less 1,926,639 held in treasury and 2003 - 113,783,658 issued, less 1,069,053 held in treasury)
Additional paid-in capital
Accumulated other comprehensive income (loss)
Retained earnings
Treasury stock, at cost
Total shareholders’ equity
Total liabilities and shareholders’ equity
See accompanying Notes to Consolidated Financial Statements.
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CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited and in thousands except per share data)
Three Months Ended
March 31,
Revenue:
Life premium
Health premium
Other premium
Total premium
Net investment income
Realized investment gains (losses)
Other income
Total revenue
Benefits and expenses:
Life policyholder benefits
Health policyholder benefits
Other policyholder benefits
Total policyholder benefits
Amortization of deferred acquisition costs
Commissions and premium taxes
Other operating expense
Interest expense
Total benefits and expenses
Income from operations before income taxes
Income taxes
Net income before cumulative effect of change in accounting principle
Cumulative effect of change in accounting principle (less applicable income tax benefit of $3,857)
Net income
Basic net income per share:
Cumulative effect of change in accounting principle (net of tax)
Diluted net income per share:
Dividends declared per common share
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CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited and in thousands)
Other comprehensive income (loss):
Unrealized gains (losses) on securities:
Unrealized holding gains (losses) arising during period
Less: reclassification adjustment for gains (losses) on securities included in net income
Less: reclassification adjustment for amortization of discount and premium
Less: foreign exchange adjustment on securities marked to market
Unrealized gains (losses) on securities
Unrealized gains (losses) on other investments
Unrealized gains (losses) adjustment to deferred acquisition costs
Foreign exchange translation adjustments
Other comprehensive income (loss), before tax
Income tax benefit (expense) related to other comprehensive income (loss)
Other comprehensive income (loss)
Comprehensive income
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CONSOLIDATED STATEMENTS OF CASH FLOWS
Cash provided from operations
Cash provided from (used for) investment activities:
Investments sold or matured:
Fixed maturities available for sale - sold
Fixed maturities available for sale - matured, called, and repaid
Other long-term investments
Total investments sold or matured
Investments acquired:
Fixed maturities
Total investments acquired
Net (increase) decrease in short-term investments
Net effect of change in payable or receivable for securities
Disposition of properties
Additions to properties
Cash provided from (used for) investment activities
Cash provided from (used for) financing activities:
Issuance of common stock
Additions to debt
Acquisition of treasury stock
Cash dividends paid to shareholders
Net receipts (withdrawals) from deposit product operations
Cash provided from (used for) financing activities
Net increase (decrease) in cash
Cash at beginning of year
Cash at end of period
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Note A—Accounting Policies
The accompanying 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 accounting principles generally accepted in the United States of America (GAAP). 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, 2004, and the consolidated results of operations, comprehensive income and cash flows for the periods ended March 31, 2004 and 2003. Certain prior period amounts have been reclassified to conform with current period presentations.
Note B—Earnings Per Share Giving Effect to Stock Options
Torchmark accounts for its employee stock options in accordance with Statement of Financial Accounting Standards (SFAS) No. 123–Accounting for Stock-Based Compensation as amended by SFAS 148–Accounting for Stock-Based Compensation—Transition which defines a “fair value method” of measuring and accounting for compensation expense from employee stock options. This standard also allows accounting for such options under the “intrinsic value method” in accordance with Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (APB 25) and related interpretations. If a company elects to use the intrinsic value method, then pro forma disclosures of earnings and earnings per share are required as if the fair value method of accounting were applied.
Torchmark accounts for stock options under the intrinsic value method as outlined in APB 25, whereby compensation expense is recognized only if the exercise price of the employee stock option is less than the market price of the underlying stock on the date of grant. As required by SFAS 123, Torchmark has computed the required pro forma earnings disclosures utilizing the fair value method. The fair value method requires the use of an option valuation model, such as the Black-Scholes option valuation model, to value employee stock options. Compensation expense is based on these values. The expense is then charged to pro forma earnings over the option vesting period.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS –CONTINUED
(UNAUDITED)
Note B—Earnings Per Share Giving Effect to Stock Options (continued)
Torchmark’s pro forma earnings information giving effect to stock option expense is presented in the following table.
Three Months
Ended March 31,
Net income as reported
After tax stock-based compensation, as reported
After tax effect of stock-based compensation, fair value method
Pro forma net income
Earnings per share:
Basic—as reported
Basic—pro forma
Diluted—as reported
Diluted—pro forma
Note C—Earnings Per Share
A reconciliation of basic and diluted weighted-average shares outstanding is as follows:
Basic weighted average shares outstanding
Weighted average dilutive options outstanding
Diluted weighted average shares outstanding
Antidilutive shares*
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Note C—Earnings Per Share (continued)
For the periods presented, pro forma income available to common shareholders for basic earnings per share is equivalent to pro forma income available to common shareholders for diluted earnings per share. Unless otherwise specified, earnings per share data is assumed to be on a diluted basis.
Note D—Changes in Accounting Standards
Guaranteed Minimum Policy Benefits. The American Institute of Certified Public Accountants issued Statement of Position 03-1, Accounting and Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration Contracts and for Separate Accounts (SOP 03-1), which was adopted by Torchmark on January 1, 2004. This Statement covers various aspects of accounting for nontraditional product features in order to increase uniformity in practice. The primary issue in the Statement affecting Torchmark is the accounting for liabilities for certain guaranteed minimum policy benefits on Torchmark’s variable annuities. Upon adoption, Torchmark recorded a charge in the amount of $11.0 million before tax ($7.2 million after tax) to reflect the additional liability to recognize these benefits. This charge was reported as a cumulative effect of a change in accounting principle.
Subsequent to adoption, Torchmark does not expect the provision for guaranteed minimum policy benefits to have a material impact on its operations. However, the liability for guaranteed minimum policy benefits is highly dependent on the performance of financial markets, whereby poor market performance in the future could increase Torchmark’s obligations for such benefits.
Deconsolidation. In January 2003, the Financial Accounting Standards Board (FASB) issued FASB Interpretation 46 (FIN 46), Consolidation of Variable Interest Entities, which Torchmark adopted in 2003 with no impact to the consolidated financial statements. In December, 2003, the FASB revised FIN 46 (FIN46R) and deferred its adoption for variable interest entities (VIE’s) that meet certain criteria until the first quarter of 2004. FIN46R clarified the definition of a variable interest such that only the holder of a variable interest can ever be the VIE’s primary beneficiary. Only primary beneficiaries are permitted to consolidate VIE’s. Therefore, FIN46R does not permit consolidation of VIE’s in which a company has voting control but is not the primary beneficiary. The trusts that are liable for Torchmark’s Trust Preferred Securities meet the definition of VIE’s. Under FIN46R, Torchmark does not have a variable interest in the trusts and therefore cannot be the
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Note D—Changes in Accounting Standards (continued)
entity’s primary beneficiary. For this reason, Torchmark may no longer consolidate the trusts, even though Torchmark is the sole owner of the voting equity of these entities.
Torchmark adopted FIN46R effective January 1, 2004. Prior periods are restated for comparability. As a result of the deconsolidation that this standard requires, Torchmark will no longer report the Trust Preferred Securities as long-term debt but will instead report its 7 ¾% Junior Subordinated Debentures due 2041 to the trust entities as “Due to Affiliates.” The amount of this debt was $155 million at March 31, 2004, $10 million greater than the balance that would have been reported as Trust Preferred Securities. Deconsolidation requires that the $4.6 million additional debt due to the trust entities be reported and offset by an asset, included in “Other Receivables,” of a like amount representing Torchmark’s interest in the trusts. Also, the unamortized issue expenses of the Trust Preferreds of $5.5 million still remain in long-term debt. The additional interest expense on this debt exceeds the Trust Preferred distributions by $90 thousand in the three-month periods ending March 31, 2004 and 2003, which is offset by $90 thousand of investment income to Torchmark in like amount representing dividends from the trusts.
Note E—Postretirement Benefit Plans
Components of Post-Retirement Benefit Costs
Service cost - benefits earned during the period
Interest cost on benefit obligation
Expected return on assets
Amortization of prior service cost
Recognition of net actuarial (gain)/loss
Net periodic pension cost
At December 31, 2003, Torchmark estimated that it would contribute to the pension plans an amount not to exceed $20 million during 2004. As of March 31, 2004, no contributions have been made. Torchmark continues to anticipate contributing an amount not to exceed $20 million during the remainder of 2004.
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Note F—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 the investment segment, which manages the Company’s investment portfolio, debt, and cash flow. The measure of profitability for insurance segments is insurance underwriting margin. It represents the profit margin on insurance products before administrative expenses, and is calculated by deducting net policy obligations, commissions, and acquisition expenses from premium revenue. The measure of profitability for the investment segment is excess investment income, which is the income earned on the investment portfolio in excess of net policy requirements and financing costs associated with Torchmark’s debt. Other income and the unallocated insurance administrative expense are classified in a separate “Other” segment.
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Note F—Business Segments (continued)
Reconciliation of Segment Operating Information to the Consolidated Statement of Operations
Other &
Corporate(1)
Premium
Expenses
Policy benefits
Required interest on reserves
Amortization of acquisition costs
Commissions and premium tax
Required interest on acquisition costs
Insurance administrative expense(3)
Parent expense(1)
Financing costs:
Debt
Benefit from interest rate swaps
Total expenses
Measure of segment profitability
Deduct applicable income taxes
Segment profits after tax
Add back income taxes applicable to segment profitability
Remove benefit from interest rate swaps (included in realized investment gains)
Add realized investment gains (losses)
Pretax income per income statement
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Revenue
Parent expenses(1)
Remove benefit from interest rate swaps (included in realized investment losses)
Deduct realized investment losses
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The table below summarizes the measures of segment profitability for comparison. It also reconciles segment profits to net income.
Analysis of Profitability by Segment
(Dollar amounts in thousands)
Three months
ended March 31,
Life insurance
Health insurance
Annuity
Other insurance:
Administrative expense
Investment
Corporate
Pre-tax total
Applicable taxes
After-tax total
Remove benefit from interest rate swaps (after tax) from Investment Segment
Realized gains (losses) (after-tax)*
Change in accounting principle (after-tax)
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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:
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Results of Operations
Summary of Operations. Torchmark consists of a group of life insurance companies which market primarily individual life and supplemental health insurance products but also market annuities to a limited extent. Torchmark’s operations are segmented into its insurance underwriting and investment operations as described in Note F—Business Segments. Torchmark’s segments consist of its insurance segments: life, health, annuity, and other; the investment segment; and the corporate segment. The insurance segments are responsible for marketing, underwriting, and administering their respective insurance products. The investment segment is responsible for managing Torchmark’s investments, debt, and cash flow. The measure of profitability for insurance segments is insurance underwriting income before other income and insurance administrative expenses. It represents the profit margin on insurance products before administrative expenses, and is calculated by deducting net policy obligations, commissions, and acquisition expenses from premium revenue. The measure of profitability for the investment segment is excess investment income, which is the income earned on the investment portfolio in excess of net policy requirements and financing costs associated with Torchmark’s debt. Other income and the unallocated insurance administrative expense are classified in a separate “Other Insurance” segment. Torchmark further views its insurance segments operations by marketing group—either direct response, independent, or captive/career agencies, which distributes the products of that segment. Profitability of these marketing groups is also measured in the same manner as the overall segment is measured. The designated measures of profitability are highly useful to management in evaluating the performance of the segments and the underlying marketing groups within each insurance segment, because each of Torchmark’s distribution units tend to operate in a niche market offering insurance products designed for that niche. These measures enable management to view period-to-period trends, and make informed decisions regarding future courses of action.
Torchmark considers its “core operations” to be its insurance operations and the associated investment activities to provide a yield to support those products. The insurance segments market and write business for which premiums are collected for the eventual payment of benefits. In addition to policy benefits, operating expenses are incurred including acquisition costs, administrative expenses, and taxes. Because life and health contracts can be long term, premium receipts in excess of current expenses are invested. Investment activities, conducted by the investment segment, focus on seeking quality investments with a yield appropriate to support the insurance product obligations. Torchmark does not engage in trading investments for profit, and generally holds investments over long periods. Realized gains and losses in the portfolio, which can have a significant positive or negative effect on net income, are not considered to be part of core operating results. They are generally caused by investment sales for factors beyond the control of management, as investments are expected to be held to full term. They are not considered in the determination of insurance premium pricing or product profitability, and are not a component of segment operating results. Please refer to the discussion of Realized Gains and Losses in this report.
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The tables in Note F—Business Segments demonstrate how the measures of profitability are determined. Those tables also reconcile Torchmark’s revenues and expenses by segment to its major income statement line items for the three-month periods ended March 31, 2004 and 2003. Additionally, this Note provides a summary of the profitability measures that demonstrates year-to-year comparability and which reconciles to Torchmark’s net income. That summary is reproduced below from the Consolidated Financial Statements to present Torchmark’s overall operations in the manner that management uses to manage the business.
A discussion of operations by each of Torchmark’s segments follows later in this report. The segment discussions are then followed by a discussion of realized investment gains and losses.
Highlights.Torchmark’s first year collected premium for life and health business rose 14% in the 2004 quarter compared with the prior year. Reflective of recent sales, first year collected premium is the premium collected during the period for policies in their first year and is considered by Torchmark as the best indicator of future premium growth. Life insurance premium income and margins rose 7% in the 2004 quarter. Three of Torchmark’s four major life distribution groups had double digit growth in life premium income and first-year collected life premium when compared with the prior-year quarter. Health premium rose 3%, but first year health premium collected increased 19%, as sales efforts have emphasized supplemental health products other than Medicare Supplement. First year collections on these other health products rose 51% in the quarter.
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Excess investment income rose 5% to $82 million for the quarter, 9% on a per share basis. This growth was achieved even though new investments were made at a yield of 6.3% in the 2004 quarter, compared with 7.5% in the prior year period. Average invested assets grew 8% to $8.2 billion (with fixed maturities at amortized cost). The growth in invested assets in excess of income is reflective of the effect of lower interest rates on the portfolio. Total assets rose 10%, GAAP Shareholders equity increased 16% to $3.4 billion, and GAAP book value per share rose 18% to $29.88. Purchases of 1.2 million shares at a cost of $61 million were made during the quarter under Torchmark’s Share Repurchase program. However, the impact of the purchases on diluted shares was largely offset by the effect of the increase in Torchmark’s share price on the dilution computation. A detailed discussion of Torchmark’s operations follows.
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Life insurance. Life insurance is Torchmark’s predominant segment, representing 55% of premium income and 64% of insurance underwriting margin in the first quarter of 2004. In addition, investments supporting the reserves for life business generate the majority of excess investment income attributable to the investment segment. Torchmark’s life insurance premium income increased 7% to $343 million in the first quarter of 2004. The following table presents Torchmark’s life insurance premium and policy charges by distribution method.
Life Insurance
Premium Income by Distribution Method
Direct Response
American Income Exclusive Agency
Liberty National Exclusive Agency
Military
Other Agencies
Total life premium
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Production of new life and health business is reflected by first-year collected premium. First-year collected life premium of $59 million in the 2004 quarter rose 10% over the prior-year period. An analysis of first-year collected life premium is presented in the table below.
First Year Collected Premium
Total
Torchmark’s Direct Response operation is conducted primarily through direct mail, but also through co-op mailings, direct mail, and television solicitations endorsed by groups, unions and associations. Direct Response’s life premium of $95 million in the 2004
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quarter represented 28% of Torchmark’s total life premium, the largest percentage contribution of any Torchmark distribution system. First-year collected premium of $18 million increased 22%, the largest percentage increase of the life distribution channels. These increases have resulted largely from revisions to Direct Response policies sold in the juvenile market in recent periods, whereby more profitable larger-face products have been marketed. Not only did these changes produce improved margins, but resulted in the reopening of certain juvenile markets where the previous product had become unprofitable.
Sales of direct response life insurance to the juvenile market have long been a major market for Torchmark’s Direct Response channel. Not only is the juvenile market an important source of sales, but it also is a vehicle to reach the parents and grandparents of the juvenile policyholders. Parents and grandparents are more likely to respond favorably to a Direct Response solicitation for life coverage on themselves than is the general adult population. Also, both the juveniles and their parents are low-acquisition cost targets for sales of additional coverage over time. Given the success of the change in product offering to the juvenile market and the parents, sales to this demographic group will continue as one of Direct Response’s premier markets.
The American Income Agency markets to members of labor unions, credit unions, and other associations. This agency produced premium income of $84 million in the 2004 three-month period, an increase of 13% over the same 2003 period. This growth in life premium income was the strongest in both percentage and dollar amount of any Torchmark life insurance distribution method. American Income life premium represented 25% of Torchmark’s total life premium during the 2004 quarter. First-year collected premium, rose 13% in the 2004 quarter to $19 million, the highest percentage increase of any distribution group in terms of dollar amount collected. Growth in sales of the American Income Agency has traditionally been attributable to the growth in the number of agents. American Income had 2,054 agents at March 31, 2003 and 2,291 at year-end 2003. The agent count fell to 2,027 at March 31, 2004, however. During 2003, American Income changed its compensation package to agents to improve the quality of business and to improve margins. Not only did these changes cause the loss of some agents who had been writing lower quality business, but they also had the unintended result of a disruption in recruiting activities. In March of 2004, certain of these changes were rolled back with the anticipation that agent growth will return and sales volume will increase.
The Liberty National Agency markets life insurance to middle-income customers in several Southeastern states. It represented 22% of Torchmark’s life premium income in the 2004 quarter. Life premium was $77 million, increasing 1% over the 2003 quarter. First-year collected
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premium was essentially flat for the period at $10.3 million in both periods. Sales in the Liberty group declined throughout the latter part of 2003, because it stopped accepting the initial premium with the application in the form of cash, a type of business prone to higher lapse rates. This type of sale had accounted for 25% of Liberty’s life sales prior to the change. The lower life sales from this change appear to have been temporary, as first-year collected premium for the first quarter of 2004 rose 6% over fourth quarter 2003 first-year premium. Liberty’s total agent count declined 13% over the prior year to 1,898. The count of renewal agents, those agents that have been with Liberty for more than one year, declined 5% to 877 from one year ago, but rose 2% since year-end 2003. Renewal agents are generally higher producers than first-year agents. Liberty has recently restructured its bonus system to not only reward production, but also to encourage recruiting and retention of productive agents.
Torchmark’s Military Agency is an independent agency comprised of former military officers who sell exclusively to military officers and their families. Life premium in the Military Agency at $45 million represents 13% of Torchmark’s life premium, and rose 12% in the 2004 quarter. First-year premium collections for this agency rose 14% to $7 million in the 2004 quarter. Margins in this distribution group fell to 21% from 23% a year ago, in part due to the hostilities in Iraq, as benefits of $531 thousand were attributable to that conflict during the 2004 quarter.
Torchmark’s Other Distribution systems offering life insurance include United Investors and various minor distribution channels. The Other Distribution group contributed $42 million of life premium to Torchmark, or 12% of Torchmark’s total. This distribution group has diminished in importance to Torchmark as the other four primary groups have grown.
Summary of Results
Premium and policy charges
Net policy obligations
Commissions and acquisition expense
Insurance underwriting margin
Life insurance underwriting income before insurance administrative expenses was $85 million in the first quarter of 2004, increasing 7% over the same period of 2003. As a percentage of life premium, underwriting income remained steady at 25% in both periods.
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Health insurance. Torchmark’s health products are supplemental health plans that include Medicare Supplements sold to Medicare enrollees as well as other limited-benefit plans including cancer and hospital-surgical plans sold to customers under age 65. In the first quarter of 2004, Torchmark’s health insurance premium accounted for 44% of total premium, and health insurance underwriting margin accounted for 34% of the total underwriting margin. Health insurance premium income increased 3% to $270 million when comparing the first quarter of 2004 with the same period of 2003. The table below is an analysis of Torchmark’s health premium by distribution method.
Health Insurance
United American Independent Agency
United American Branch Office Agency
Total health premium
The table below is a presentation of health insurance first-year collected premium by distribution method. First-year collected premium is believed by Torchmark to be indicative of future premium growth.
First Year Collected Premium by Distribution
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The following table is an additional presentation of first-year collected health premium by product type.
First Year Collected Premium by Product
Other limited-benefit plans
Medicare Supplement
Cancer
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Other limited-benefit hospital-surgical policies are becoming the more prominent component of Torchmark’s health business, as this group represented almost 20% of annualized health premium in force at March 31, 2004, compared with 15% one year ago. Annualized premium in force is a statistic commonly used by the insurance industry. It is a measure of expected premium income to be collected in the next twelve months on active policies, assuming all policies remain in force for that year. Historically, Torchmark’s predominant health insurance product has been Medicare Supplemental insurance, which comprises 63% of Torchmark’s total $1.08 billion health annualized premium in force at March 31, 2004. A year ago, Medicare Supplement annualized premium in force was $711 million, or 68% of all health insurance in force.
Medicare Supplement first-year collected premium was 37% of health collections in the 2004 quarter, compared with first-year collections of 56% for other limited-benefit hospital-surgical health products. These percentages contrast with 50% Medicare Supplement and 43% other hospital-surgical products in the 2003 quarter, reflecting a change in product mix in Torchmark’s health insurance business.
The United American Branch Office and Independent agencies are the predominant distributors of Torchmark’s health products. These agencies accounted for $205 million or 76% of 2004 health premium income. In recent periods, Medicare Supplement sales have not been the predominant health product being sold by these two agencies as their focus has shifted to distributing other limited-benefit hospital/surgical policies. Medicare Supplement sales have been under pressure for the last several years from increased price competition. Accordingly, these agencies have expanded their product lines as increased consumer demand for these type products has resulted from the growing unavailability of individual major medical plans and decreased coverage offered by employers. Margins on the hospital/surgical products are higher than those of Medicare Supplement, as the Medicare plans have higher mandated loss ratios, but persistency on the Medicare product is superior.
Medicare Supplements will continue to be a major health product offering of Torchmark. Medicare beneficiaries represent a large and growing group of potential customers. It continues to be a profitable line of business to Torchmark. While price
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competition has been a factor, price pressures have moderated as Torchmark’s premium rate increases have declined to annual percentages in the mid-single digits.
Cancer business is produced primarily by the Liberty National Agency. Approximately half of Liberty’s health premium income was from a closed block of cancer business. Significant rate increases to offset deteriorating margins on this block of business have contributed to the growth in cancer premium in force. First-year collected cancer premium rose 25% from $2.2 million in the 2003 quarter to $2.8 million in the 2004 quarter, indicative of the growth in new business.
The following table presents underwriting margin data for health insurance.
Underwriting margins for health insurance increased 6% to $45 million in the first three months of 2004 from the year-ago period. As a percentage of health premium, underwriting margins rose to 17% in the 2004 period from 16% in the 2003 period. The health margin increase resulted from the improvement in the net policy obligations of the previously-mentioned closed block of Liberty National cancer policies. Despite the semi-annual rate increases over the past several years, this block has experienced a high loss ratio (claim/premium) impacting health underwriting margins. The Company recently announced that it has reached a proposed agreement with parties in a class-action lawsuit (Roberts v. Liberty National Life Insurance Company) related to this block of business (see Part II, Item 1—Legal Proceedings), by which it is hoped that margin pressures on this business will be stabilized.
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Annuities. Torchmark markets both fixed and variable annuities. Torchmark measures the monetary volume of its inventory of annuity products and annuity sales on the basis of “deposit balance” and “collections,” respectively. Annuity collections are the deposits or annuity premium received from a customer, either as a new sale or as an addition to an existing deposit balance. Collections are not accounted for as revenue but are added to the deposit balance. The deposit balance is the liability due to customers for Torchmark’s annuities and is a measure of the size of the annuity inventory upon which annuity revenue is based. The variable annuity deposit balance is included in “Separate account liabilities” on Torchmark’s Balance Sheet. The fixed annuity balance is a component of Torchmark’s “Future policy benefits.” The deposit balance is increased by collections and interest credits, but is reduced by withdrawals and by the policy charge assessments that are revenue to Torchmark. The variable account balance is additionally increased or decreased by market growth or declines in the investments in the underlying funds. The following table presents collection and deposit balance information about Torchmark’s annuities.
Annuities
Collections and Deposit Balances
Increase
(Decrease)
Fixed
Variable
Fixed annuity collections were up 23% in the first three months of 2004 to $32 million. Fixed annuities on deposit with Torchmark at March 31, 2004 rose 14% to $752 million. The increase in the fixed annuity balance is due primarily to production in the United American Independent Agency through arrangements with banks. This agency added approximately $97 million to the fixed account balance.
Collections of variable annuities were $5 million in the first three months of 2004, a 71% increase over variable collections of $3 million in the same period of 2003. The variable annuity balance was $1.5 billion at March 31, 2004, compared with $1.5 billion at December 31, 2003 and $1.4 billion one year ago.
As previously disclosed, United Investors and Waddell & Reed, Torchmark’s former annuity distributor, have engaged in litigation regarding a compensation dispute and Waddell & Reed’s replacement of the United Investors variable annuities. On March 17, 2004, a trial jury in the Jefferson County Alabama Circuit Court awarded UILIC verdicts of $15 million against Waddell & Reed Financial, Inc., $15 million against Waddell & Reed, Inc., and $15 million against Waddell & Reed Financial Services, Inc. on UILIC’s remaining
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claims in the Alabama litigation. Defendants have filed post judgment motions with the Circuit Court to set aside or reduce the verdicts. This litigation has been discussed in detail in prior years’ Forms 10-K and 10-Q as well as in Item 1—Legal Proceedings in this Form 10-Q.
While Torchmark continues to sell annuity products, it does not expect to emphasize this product line in the future.
The following table presents underwriting margin results for Torchmark’s annuities.
Policy charges
Underwriting margins rose 34% to $3.4 million in the 2004 quarter. The primary factor in this increase was the reduction in policy obligations resulting from the decline in guaranteed minimum death benefits from $1.4 million in the 2003 quarter to $.3 million in 2004. The decline in guaranteed minimum benefits paid was due to increases in the equity markets. Policy charges declined 6% in the 2004 period, even though the average overall account balance increased slightly, and is primarily attributable to the runoff of an older variable product with a deferred sales charge, as well as a reduction in surrender charges compared with 2003.
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Operating expense. Torchmark’s operating expense consists of its insurance administrative expense and its parent company expense. An analysis of these expenses and their relationship to revenues are disclosed in the table below.
Operating Expenses Selected Information
Insurance administrative expenses
Parent company expense
Total operating expenses
Insurance administrative expenses:
Increase over prior year
Expenses as percentage of premium
Total operating expenses:
Expenses as percentage of revenues*
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Investment. The following table summarizes Torchmark’s investment income and excess investment income.
Excess Investment Income
Required interest on net insurance policy liabilities
Trust Preferred Distribution
Interest rate swaps
Total financing costs
Excess investment income
Excess investment income per share
Excess investment income represents the profit margin attributable to the investment segment. It is defined as net investment income reduced by the interest credited to net insurance policy liabilities and Torchmark’s financing costs. Financing costs include interest on Torchmark’s debt and the difference between the fixed-rate and floating-rate payments on Torchmark’s swap instruments. Excess investment income per diluted share is the measure used by management to evaluate the performance of the investment segment. This segment is responsible for the management of capital resources including investments, debt, and cash flow. Since 1986, Torchmark has used over $2 billion of cash flow to repurchase Torchmark shares under its ongoing share repurchase program after determining that the repurchases provided a greater return than other investment alternatives. Share repurchases reduce excess investment income because of the foregone earnings on the cash that would otherwise have been invested in interest-bearing assets, but they also reduce the number of shares outstanding. In order to put all capital resource uses on a comparable basis, management believes that excess investment income per diluted share is the best measure of the investment segment.
Excess investment income for the 2004 three months rose 5% to $82 million over the same period of 2003. On a per share basis, excess investment income per share rose 9% in the 2004 period to $.72 from $.66.
The largest component of excess investment income is net investment income, which increased 5% to $142 million in the first quarter of 2004, compared with $135 million
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during the 2003 quarter. The increase resulted from the 8% growth in the investment portfolio (based on average invested assets). However, the effects of lower yields available in recent periods have partially offset the portfolio’s growth in investment income, as recent acquisitions at lower yields have impacted returns. Investments during the 2004 quarter were made at an effective annual yield of 6.3%, compared with 7.5% in the year-earlier quarter. Average invested assets, which include fixed maturities at amortized cost, were $8.2 billion in the 2004 first quarter, compared with $7.6 billion in the 2003 period. The $610 million increase in average invested assets over the prior-year period was achieved even though Torchmark used $210 million to repurchase Torchmark shares under its share repurchase program during the prior twelve months.
Financing costs declined 5% to $7.2 million in the 2004 period. This reduction was due to slightly lower interest rates compared with the prior period resulting in a slight increase in benefit on Torchmark’s swap instruments and lower interest cost on commercial paper borrowings.
Approximately 93% of Torchmark’s investments at fair market value are in a diversified fixed-maturity portfolio. The balance of investments is in mortgages (1.3%), short-terms (0.8%), policy loans, which are secured by policy cash values (3.2%), and other investments (1.4%). At March 31, 2004, fixed maturities had a fair value of $8.5 billion, compared with $8.1 billion at December 31, 2003 and $7.4 billion at March 31, 2003. An analysis of Torchmark’s fixed-maturity portfolio by component at March 31, 2004 is as follows.
Fixed Maturities by Component
(Dollar amounts in millions)
% of
FixedMaturities*
Fixed maturities available for sale:
Bonds:
U. S. Government direct obligations & agencies
GNMA pools
Other mortgage-backed securities
States, municipalities and political subdivisions
Foreign governments
Corporates
Asset-backed securities
Redeemable preferred stocks
Total fixed maturities
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Torchmark’s $8.5 billion fixed-maturity portfolio at fair market value had a net unrealized gain of $817 million at March 31, 2004. At the end of the first quarter last year, the $7.4 billion portfolio had a net unrealized gain of $423 million. At year-end 2003, the $8.1 billion portfolio had a net unrealized gain of $631 million. The improvement in market valuation of the portfolio at March 31, 2004 resulted primarily from the continued reduction in market interest rates and in yields on competing assets.
An analysis of the fixed-maturity portfolio by quality rating at March 31, 2004 is as follows.
Fixed Maturities by Rating*
AAA
AA
A
BBB
BB
B
Below B
The portfolio has an average quality rating of “BBB+.” Approximately 91% of the portfolio at amortized cost was considered investment grade.
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The majority of Torchmark’s fixed-maturity holdings are in corporate securities. Torchmark’s investments in corporate fixed maturities are highly diversified in a wide range of industry sectors. At fair value, the following table presents the highest ten percentage holdings of Torchmark’s corporate fixed maturities by industry sector at March 31, 2004.
Industry
Depository institutions
Electric, gas, sanitation services
Insurance carriers
Nondepository credit institutions (finance)
Communications
Chemicals & allied products
Transportation equipment
Oil & gas extraction
Food & kindred products
Petroleum refining & related industries
All other sectors *
During the first three months of 2004, Torchmark continued to make investments in investment-grade fixed-maturity corporate bonds and trust preferred securities (classified as redeemable preferred stocks) with a diversity of issuers and industry sectors. The chart below summarizes selected information for fixed maturity purchases. Both yield and average life calculations on new purchases of noncallable bonds are based on the maturity date. In the case of callable bonds, the average life is based on the call date or maturity date, whichever produces the lowest yield (“yield to worst”).
Fixed Maturity Acquisitions Selected Information
Cost of acquisitions:
Investment-grade corporate securities
Other investment-grade securities
Total fixed-maturity acquisitions
Average yield *
Effective annual yield *
Average life (in years, to worst call)
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While Torchmark had been able to maintain a yield in excess of 7.25% on new investments over the last several years, the recent decline in rates in financial markets has caused such yields to become unavailable for investment-grade corporate purchases. As a result, new money was invested at an average effective yield of 6.3% in the first quarter of 2004 compared with 7.5% in 2003. While the lower yields available to Torchmark are expected to reduce the increase in investment income in the near term, the impact of the lower rates on excess investment income and total net income is expected to be minimized. This is because Torchmark has been able to reduce the crediting rates on the majority of its interest-sensitive and annuity products. Additionally, the lower interest rate environment reduces the cost of Torchmark’s commercial paper borrowings and enhances the benefits from its interest rate swaps, further reducing financing costs and minimizing the impact of lower investment rates on income. In the event of an increase in rates, excess investment income will benefit as new acquisitions are made at higher yields. While higher rates will increase floating-rate financing costs, they only partially offset the benefit to Torchmark as incoming cash flows on an annual basis far exceed the amount of floating-rate debt.
Additional information concerning the fixed-maturity portfolio is as follows.
Fixed Maturity Portfolio Selected Information
Amortized cost (millions)
Gross unrealized gains (millions)
Gross unrealized losses (millions)
Fair market value (millions)
Average yield (tax-equivalent book basis)
Average life (in years, to maturity)
Effective duration (to worst call) *
Effective duration (to maturity)*
Torchmark calculates the average life and duration of the fixed maturity portfolio two ways: (1) based on the same date used to calculate the yield, which is the “worst call” date for callable bonds and the maturity date for all other bonds, and (2) based on the maturity date of all bonds, whether callable or not.
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The following tables disclose certain information about unrealized losses in Torchmark’s fixed-maturity portfolio at March 31, 2004.
Analyses of Gross Unrealized Investment Losses on Fixed Maturities
At March 31, 2004
(Amounts in millions)
Investment grade securities:
U.S. government and agency
Redeemable preferred stock
Non-investment grade securities:
States, municipals, & political subdivisions
Maturity distribution:
Due in one year or less
Due in more than 1 year through 5 years
Due in more than 5 years through 10 years
Due in more than 10 years through 20 years
Due in more than 20 years
Major sectors:
Electric, gas, water, sanitation services
Food stores
Municipal bonds
U.S. Government
Other
Realized Gains and Losses. Torchmark’s core business of providing insurance coverage requires it to maintain an investment portfolio to support its insurance liabilities. These insurance liabilities are often very long-term in nature, with the realization of profits from core insurance operations emerging over many years. The investments that support these liabilities consist primarily of fixed maturities, with yields expected to provide for the cost of carrying these insurance liabilities. These expected yields are taken into account when setting insurance premium rates and product profitability expectations. As a result, fixed maturities are generally held for long periods to support the liabilities, even though they are available for sale at any time.
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Because Torchmark holds a large and diverse investment portfolio, investments are sold or called from time to time, resulting in a realized gain or loss. These gains and losses occur only incidentally, and are usually the result of sales for tax reasons, deterioration in investment quality of issuers, or calls by the issuers. Torchmark does not engage in trading investments for profit. Therefore, gains or losses are only secondary to Torchmark’s core insurance operations of providing insurance coverage to policyholders.
Realized gains and losses can be significant in relation to the earnings from core insurance operations, and as a result, have a material positive or negative impact on net income. They are not considered in determining premium rates or product profitability of Torchmark’s insurance products, nor are they a component of ongoing investment income. Therefore, they have no bearing on core insurance operations or segment results as management views its operations, and could cause such results to not be indicative of the past or future performance of core operations. For these reasons, Torchmark management removes the effects of realized gains and losses when evaluating its overall insurance operations results.
The following table summarizes Torchmark’s tax-effected realized gains (losses) by component for each of the three-month periods ended March 31, 2004.
Analysis of Realized Gains (Losses)
(Dollar amounts in thousands, except for per share data)
Realized gains (losses), net of tax, from:
Investment sales
Writedown of fixed maturities
Writedown of other investments
Valuation of interest rate swap agreements
Cash from spread on interest rate swap agreements
In the first quarter of 2003, Torchmark wrote down certain fixed maturities to estimated fair value as a result of other-than-temporary impairment. Pretax charges for these impairments were $9.7 million ($6.3 million after-tax). There were no writedowns for impairment in the 2004 quarter.
Accounting rules require Torchmark to value its interest-rate swaps at their fair value at the end of each accounting period. The fair values of these instruments fluctuate with interest rates in financial markets and diminish with the passage of time so that their value
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is zero when they expire. Torchmark intends to hold its swaps until they expire. Therefore, while period-to-period fluctuations can be substantial, the value of the swaps and the cumulative unrealized gains and losses from marking the swaps to market value from inception will be zero when the swap agreements expire. Temporary unrealized changes in swap values are included as a component of “Realized Investment Losses” on the Consolidated Statement of Operations. This fair value adjustment for all swaps on a pretax basis was a positive $1.9 million in the three months of 2004, and a negative $2.0 million in the same period of 2003.
In September, 2003, the Securities and Exchange Commission informally interpreted SFAS 133, the GAAP rules concerning the reporting of nonhedged derivatives. Their interpretation concluded that all income and expenses related to a nonhedged derivative must be recorded in the same line item on the income statement that the adjustment to fair value is recorded. This interpretation was effective immediately with prior periods reclassified accordingly for comparability. This interpretation requires cash settlements in interest cost to be combined with the noncash unrealized fair value adjustment as a component of realized investment gains and losses. Torchmark’s pretax interest cost reduction from the cash settlement included in realized investment gains was a positive $6.7 million in 2004 and a positive $6.4 million 2003. Torchmark continues to reduce interest cost for this benefit in its segment analysis in accordance with GAAP because Torchmark views the benefit from lower interest rates as a reduction in its financing costs.
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Financial Condition
Liquidity. Torchmark’s liquidity is represented by its positive cash flow, a portfolio of marketable investments, and the availability of a line of credit facility. Torchmark’s insurance operations have historically generated cash flows well in excess of immediate requirements. Torchmark’s net cash inflows from operations were $214 million in the first three months of 2004, compared with $223 million in the same period of 2003. Additionally, Torchmark received $14 million from net deposit product collections in the first three months of 2004, compared with $40 million in the same period of 2003. Torchmark also received $140 million in investment maturities or repayments during the first three months of 2004.
Torchmark’s cash and short-term investments were $90 million at March 31, 2004, compared with $64 million at December 31, 2003 and $138 million at the end of March, 2003. In addition to these liquid assets, Torchmark’s entire portfolio of fixed-income and equity securities, in the approximate amount of $8.6 billion at fair value on March 31, 2004, is available for sale should any need arise. Substantially all of Torchmark’s fixed-income and equity securities are publicly traded.
Torchmark has in place a line of credit facility with a group of lenders that allows unsecured borrowings and stand-by letters of credit up to $625 million. The facility consists of two parts: a $325 million 364-day tranche maturing November 24, 2004 and a $300 million five-year tranche maturing November 30, 2006. The company has the ability to request up to $200 million in letters of credit to be issued against the $300 million five-year tranche. Under either tranche, interest is charged at variable rates. The line of credit is further designated as a back-up 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, with total commercial paper outstanding not to exceed $600 million. Commercial paper borrowings and letters of credit on a combined basis may not exceed $625 million. At March 31, 2004, Torchmark had $223 million face amount of commercial paper outstanding ($223 million book value), $159 million letters of credit issued, and there were no borrowings under the line of credit. A facility fee is charged on the entire $625 million facility. The facility has no ratings-based acceleration triggers which would require early repayment. In accordance with the agreements, Torchmark is subject to certain covenants regarding capitalization and interest coverage. At March 31, 2004, Torchmark was in full compliance with these covenants.
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Capital resources. Torchmark’s capital structure consists of short-term debt (the commercial paper facility described above), long-term funded debt, and shareholders’ equity. As described in Note D, Changes in Accounting Standards, effective January 1, 2004, Torchmark adopted the revised provisions of accounting rule FIN46R, which resulted in the deconsolidation of the trusts which are liable for Torchmark’s Trust Preferred Securities. As a result, Torchmark reports its 7 ¾% Junior Subordinated Debentures due 2041 as a “Due to Affiliate” in the amount of $155 million.
Torchmark’s outstanding long-term debt at book value, including the Junior Subordinated Debentures, was $701 million at March 31, 2004. This compares with a total book value of $698 million at December 31, 2003. An analysis of long-term debt issues outstanding is as follows at March 31, 2004.
Long Term Debt at March 31, 2004
Instrument
Senior Debentures
Notes
Senior Notes
Issue expenses (1)
Total long-term debt
Junior Subordinated Debentures (2)
The carrying value of Torchmark’s 6.25% Senior Note is adjusted each period to reflect the change in fair value of a swap instrument which hedges the value of the note. This instrument increased the value of long-term debt by $15.1 million, $12.0 million, and $16.9 million at March 31, 2004, December 31, 2003, and March 31, 2003, respectively.
Torchmark acquired 1.2 million of its outstanding common shares on the open market at a cost of $61 million during the first three months of 2004 under its share repurchase program. If the $61 million free cash flow used for the repurchase of Torchmark common stock during the quarter had alternatively been invested in corporate bonds, an estimated $173 thousand of additional investment income, after-tax, would have resulted. Net Income for the quarter would have been $.98 per share, a 15% per share
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increase, compared with the year-ago quarter. Actual results including the buyback were $.99 per share, a 16% per share increase. Torchmark intends to continue the repurchase of its common shares when financial markets are favorable.
Diluted shares outstanding at March 31, 2004 were 113.8 million, compared with 113.9 million at December 31, 2003. Although purchases of 1.2 million shares were made during the first quarter of 2004, the impact on diluted shares outstanding was offset by 349 thousand shares issued for stock option exercises and the addition of approximately 840 thousand shares in the dilution computation due to the increase in Torchmark’s average share price during the quarter.
Shareholders’ equity was $3.40 billion at March 31, 2004. This compares with $3.24 billion at December 31, 2003 and $2.94 billion at March 31, 2003. The primary factors causing the growth in shareholders’ equity during the 2004 quarter were the addition of earnings of $112 million and unrealized gains of $107 million, offset by Torchmark share purchases of $61 million.
Torchmark is required by an accounting rule (SFAS 115) to revalue its available-for-sale fixed-maturity portfolio to fair market value at the end of each accounting period. These changes, net of their associated impact on deferred acquisition costs and income tax, are reflected directly in shareholders’ equity. Changes in the fair value of the portfolio result from changes in interest rates in financial markets. While SFAS 115 requires invested assets to be revalued, it does not permit interest-bearing insurance policy liabilities to be valued at fair value in a consistent manner. If these liabilities were revalued in the same manner as the assets, the effect on equity would be largely offset. The size of both Torchmark’s investment portfolio and its policy liabilities are quite large in relation to its shareholders’ equity. Therefore, this inconsistency in measurement usually has a material impact on the reported value of shareholders’ equity. Fluctuations in interest rates cause undue volatility in the period-to-period presentation of Torchmark’s shareholders’ equity, capital structure, and financial ratios which would be essentially removed if interest-bearing liabilities were valued in the same manner as assets. For this reason, Torchmark’s management, credit rating agencies, lenders, many industry analysts, and certain other financial statement users remove the effect of SFAS 115 when analyzing Torchmark’s balance sheet, capital structure, and financial ratios.
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The following tables present selected data related to Torchmark’s capital resources. Additionally, the tables present the effect of SFAS 115 on relevant line items, so that investors and other financial statement users may determine its impact on Torchmark’s capital structure.
Selected Financial Data
Fixed maturities (millions)
Deferred acquisition costs (millions) **
Total assets (millions)
Short-term debt (millions)
Long-term debt (millions)
Shareholders’ equity (millions)
Book value per diluted share
Debt to capitalization ***
Diluted shares outstanding (thousands)
Actual shares outstanding (thousands)
Torchmark’s interest coverage was 14.0 times in the 2004 quarter compared with 11.8 times in the same 2003 period. Had the reduction in interest cost from Torchmark’s swaps been treated as reduced interest expense instead of realized gains, coverage would have been 25.9 times in the first quarter of 2004 and 20.8 times in the same period of 2003.
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Pension assets: The following chart presents assets at fair value for Torchmark’s defined-benefit pension plans at March 31, 2004 and the prior year end.
Pension Assets by Component
Corporate debt
Other fixed maturities
Equity securities
Securities of Torchmark
Annuity contract issued by Torchmark
The liability for qualified defined-benefit pension plans was $165 million at December 31, 2003.
New Unadopted Accounting Rules
In March, 2004, the Emerging Issues Task Force reached a consensus concerning Issue 03-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments (EITF 03-1). This new accounting rule is effective for Torchmark beginning July 1, 2004. It calls for evaluation of substantially all of Torchmark’s fixed-maturity and equity investments for other-than-temporary impairment each reporting period using a three-step approach. First, consider if the investment is impaired (fair value is less than cost or amortized cost). Second, determine whether the impairment is other-than-temporary. While specific steps are outlined, this step requires considerable evidence-based judgment as to the ultimate recoverability of amounts due, taking into account the severity and duration of the impairment. An assessment of the ability and intent to hold the security to recovery is also a factor. In the event there is an other-than-temporary impairment, the third step involves a writedown of the cost basis of the security to fair value, which becomes the new cost basis. The adoption of these procedures will have no material impact for Torchmark as it already uses similar procedures to evaluate its investments for impairment.
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There have been no quantitative or qualitative changes with respect to market risk exposure during the three months ended March 31, 2004.
Torchmark, under the direction of the Chairman and Chief Executive Officer and the Executive Vice President and Chief Financial Officer, has established disclosure controls and procedures that are designed to ensure that information required to be disclosed by Torchmark in the reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. The disclosure controls and procedures are also intended to ensure that such information is accumulated and communicated to Torchmark’s management, including the Chairman and Chief Executive Officer and the Executive Vice President and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosures.
As of the end of the fiscal quarter completed March 31, 2004, an evaluation was performed under the supervision and with the participation of Torchmark management, including the Chairman and Chief Executive Officer and the Executive Vice President and Chief Financial Officer, of Torchmark’s disclosure controls and procedures (as those terms are defined in Rule 13a-15(e) under the Securities Exchange Act of 1934). Based upon their evaluation, the Chairman and Chief Executive Officer and the Executive Vice President and Chief Financial Officer have concluded that Torchmark’s disclosure controls and procedures are effective as of the date of this Form 10-Q. In compliance with Section 302 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. §1350), each of these officers executed a Certification included as an exhibit to this Form 10-Q.
As of the date of this Form 10-Q for the quarter ended March 31, 2004, there have not been any significant changes in Torchmark’s internal control over financial reporting or in other factors that could significantly affect this control over financial reporting subsequent to the date of their evaluation. No significant deficiencies or material weaknesses in such internal controls were identified in the evaluation and as a consequence, no corrective action was required to be taken.
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PART II – OTHER INFORMATION
Torchmark and its subsidiaries, in common with the insurance industry in general, are subject to litigation, including claims involving 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. A number of such actions involving Torchmark’s subsidiary Liberty also name Torchmark as a defendant. Based upon information presently available, and in light of legal and other factual defenses available to Torchmark and its subsidiaries, management does not believe that such litigation will have a material adverse effect on Torchmark’s financial condition, future operating results or liquidity, however, assessing the eventual outcome of litigation necessarily involves forward-looking speculation as to judgments to be made by judges, juries and appellate courts in the future. This bespeaks caution, particularly in states with reputations for high punitive damage verdicts such as Alabama and Mississippi.
Many of these lawsuits involve claims for punitive damages in state courts of Alabama and Mississippi, jurisdictions particularly recognized for their large punitive damage verdicts. Torchmark’s management recognizes that large punitive damage awards continue to occur bearing little or no relation to actual damages awarded by juries in jurisdictions in which Torchmark has substantial business, particularly Alabama and Mississippi, creating the potential for unpredictable material adverse judgments in any given punitive damage suit. As of March 31, 2004, Liberty was a party to approximately 90 active lawsuits (including 7 employment related cases and excluding interpleaders and stayed cases), 67 of which were Alabama proceedings and 11 of which were Mississippi proceedings in which punitive damages were sought.
As previously reported in Forms 10-K and 10-Q, beginning in October 1999, Liberty was served with subpoenas from the Departments of Insurance of several states (Florida, Alabama, Georgia, Kentucky, Texas, South Carolina and Minnesota) in connection with investigations into Liberty’s sales practices and disclosures regarding industrial and low face amount coverage life insurance policies, specifically the historical use of race-distinct mortality in the design or pricing of industrial insurance, a practice discontinued by Liberty years ago. Liberty responded to all of these subpoenas in a timely fashion.
Liberty is a party to a number of lawsuits (both a large number of lawsuits brought by individual plaintiffs and purported class action litigation with extremely broad class periods and relief sought) involving allegations of racially discriminatory pricing in the sale of insurance to African Americans. This litigation began with the filing on December 8, 1999 of Moore v Liberty National Life Insurance Company, Case No. CV-99-BU-3262-S in the United States District Court for the Northern District of Alabama. There are currently a total of 19 race-distinct mortality cases with in excess of 700 named plaintiffs, which have been
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consolidated in the Moore case that are pending in the U.S. District Court for the Northern District of Alabama (either originally filed with the Court or transferred to that Court), one pending case in Alabama Circuit Court (Baldwin v. Liberty National Life Insurance Company, Case No. CV 00-684), which is currently stayed pending disposition of the Moore case, and one individual, multi-plaintiff lawsuit which was originally filed in state court in Mississippi and subsequently transferred to U.S. District Court for the North District of Mississippi. The federal claims in Edwards v. Liberty National Life Insurance Company (Case No. CV0005872), which had been pending in Alabama Circuit Court were transferred to the U.S. District Court for the Northern District of Alabama on April 19, 2004. On March 5, 2004, Billingsley v. Liberty National Life Insurance Company (Civil Action No. 2002-532), a case originally filed in Mississippi state court and initially transferred to the U.S. District Court for the Northern District of Mississippi, was consolidated with the Moore case and transferred to the Northern District of Alabama.
The U.S. District Court for the Northern District of Alabama issued an order certifying a plaintiff class in the Moore case on March 31, 2004. Liberty has moved the Court to reconsider its class certification decision. Additional information regarding the race-distinct mortality/dual pricing litigation can be found in the Company’s prior Forms 10-K and Forms 10-Q.
As previously reported in Forms 10-K and Forms 10-Q, Torchmark and two current members of Torchmark’s Board of Directors remain defendants in litigation filed in the U.S. District Court for the District of Kansas by Waddell & Reed Financial, Inc. (Waddell & Reed) (Waddell & Reed Financial, Inc. v. Torchmark Corporation, Civil Action No. 01-2372-KHV). Torchmark’s subsidiary, United Investors Life Insurance Company (UILIC) is also a plaintiff in litigation in Circuit Court in Jefferson County, Alabama against Waddell & Reed and Waddell & Reed, Inc. (W&R) (United Investors Life Insurance Company v. Waddell & Reed Financial, Inc., Case No. CV 00-2720). On March 17, 2004, a trial jury in the Jefferson County Circuit Court awarded UILIC verdicts of $15 million against Waddell & Reed, $15 million against W&R and $15 million against Waddell & Reed Financial Services, Inc. on UILIC’s remaining claims in the Alabama litigation. Defendants have filed post judgment motions with the Circuit Court to set aside or reduce the verdicts. Additional information regarding the Kansas District Court litigation and the Alabama Circuit Court litigation can be found in the Company’s prior Forms 10-K and Forms 10-Q.
As previously reported in Form 10-K and Forms 10-Q, Liberty and Torchmark were parties to purported class action litigation filed in the Circuit Court of Choctaw County, Alabama on behalf of all persons who currently or in the past were insured under Liberty cancer policies which were no longer being marketed, regardless of whether the policies remained in force or lapsed (Roberts v. Liberty National Life Insurance Company, Case No. CV-2002-009-B). These cases were based on allegations of breach of contract in the implementation of premium rate increases, misrepresentation regarding the premium rate increases, fraud and suppression concerning the closed block of business and unjust enrichment. On December 30, 2003 the Alabama Supreme Court issued an opinion granting Liberty’s and Torchmark’s petition for a writ of mandamus, concluding that the
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Choctaw Circuit Court did not have subject matter jurisdiction and ordering that Circuit Court to dismiss the action. The plaintiffs then filed their purported class action litigation against Liberty and Torchmark in the Circuit Court of Barbour County, Alabama on December 30, 2003 (Roberts v. Liberty National Life Insurance Company, Civil Action No. CV2003 0137). On April 16, 2004 the parties filed a written Stipulation of Agreement of Compromise and Settlement with the Barbour County Alabama Circuit Court seeking potential settlement of the Roberts case. Additional information regarding the Roberts case can be found in the Company’s prior Form 10-K and Forms 10-Q.
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Period
(a) Total Numberof Shares
Purchased
(b) Average
Price Paid
Per Share
(c) Total Number of
Shares Purchased as Part
of Publicly Announced
Plans or Programs
(d) Maximum Number
of Shares (or
Approximate Dollar
Amount that May
Yet Be Purchased
Under the Plans or
Programs
January 1-31, 2004
February 1-29, 2004
March 1-31, 2004
On July 24, 2003, Torchmark’s Board reaffirmed its continued authorization of the Company’s stock repurchase program in amounts and with timing that management, in consultation with the Board, determined to be in the best interest of the Company. The program has no defined expiration date or maximum shares to be purchased.
46
A Form 8-K dated February 9, 2004 was filed in the first quarter of 2004 furnishing a press release announcing Torchmark Corporation’s fourth quarter and year end 2003 financial results. The Form 8-K contained no financial statements.
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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.
Date: May 6, 2004
/s/ C. B. Hudson
C. B. Hudson, Chairman of the
Board and Chief Executive Officer
/s/ Gary L. Coleman
Gary L. Coleman, Executive Vice
President and Chief Financial Officer
(Chief Accounting Officer)
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