UNITED STATES
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 June 30, 2011
Commission File Number 1-8052
TORCHMARK CORPORATION
(Exact name of registrant as specified in its charter)
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
Registrant’s telephone number, including area code (972) 569-4000
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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes ¨ No x
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 July 25, 2011
Index of Exhibits (Page 55).
Total number of pages included are 56.
INDEX
PART I. FINANCIAL INFORMATION
Item 1.
Consolidated Balance Sheets
Consolidated Statements of Operations
Consolidated Statements of Comprehensive Income
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements
Item 2.
Item 3.
Item 4.
PART II. OTHER INFORMATION
Item 1A.
Item 6.
PART I – FINANCIAL INFORMATION
Item 1. Financial Statements
CONSOLIDATED BALANCE SHEETS
(Dollar amounts in thousands except per share data)
Assets
Investments:
Fixed maturities, available for sale, at fair value (amortized cost: 2011 - $10,719,320 ; 2010 - $10,435,497)
Equity securities, at fair value (cost: 2011 - $14,875 ; 2010 - $14,875)
Policy loans
Other long-term investments
Short-term investments
Total investments
Cash
Accrued investment income
Other receivables
Deferred acquisition costs and value of insurance purchased
Goodwill
Other 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
Current and deferred income taxes payable
Other liabilities
Short-term debt
Long-term debt (fair value: 2011 - $951,894 ; 2010 - $933,336)
Due to affiliates
Total liabilities
Shareholders’ equity:
Preferred stock, par value $1 per share - Authorized 5,000,000 shares; outstanding: -0- in 2011 and in 2010
Common stock, par value $1 per share - Authorized 320,000,000 shares; outstanding: (2011 - 119,812,123 issued, less 14,414,264 held in treasury and 2010 - 119,812,123 issued, less 947,498 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)
Revenue:
Life premium
Health premium
Other premium
Total premium
Net investment income
Realized investment gains (losses)
Other-than-temporary impairments
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 continuing operations before income taxes
Income taxes
Income from continuing operations
Discontinued operations:
Income from discontinued operations, net of tax
Loss on disposal, net of tax
Income (loss) from discontinued operations
Net income
Basic net income per share:
Continuing operations
Discontinued operations
Total basic net income per share
Diluted net income per share:
Total 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 deferred acquisition costs
Unrealized gains (losses) on other assets
Total unrealized investment gains (losses)
Less applicable taxes
Unrealized gains (losses), net of tax
Foreign exchange translation adjustments
Foreign exchange translation adjustments, net of tax
Amortization of pension costs
Amortization of pension costs, net of tax
Other comprehensive income (loss)
Comprehensive income (loss)
See accompanying Notes to Consolidated Financial Statements
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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
Total investments sold or matured
Investments acquired:
Fixed maturities
Total investments acquired
Net increase in policy loans
Net change in short-term investments
Net change in payable or receivable for securities
Disposition of properties
Additions to properties
Investment in low-income housing interests
Cash used for investment activities
Cash provided from (used for) financing activities:
Proceeds from exercise of stock options
Repurchase of 9 1/4% Senior Notes
Net borrowings (repayments) of commercial paper
Tax benefit from stock option exercises
Acquisition of treasury stock
Cash dividends paid to shareholders
Net receipts (withdrawals) from deposit product operations
Cash provided by (used for) financing activities
Effect of foreign exchange rate changes on cash
Net increase (decrease) in cash
Cash at beginning of year (includes $847 of cash at December 31, 2009 included in assets of subsidiary held for sale)
Cash at end of period (includes $2,319 of cash at June 30, 2010 included in assets of subsidiary held for sale)
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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 annual 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 adjustments, which are necessary for a fair presentation of the consolidated financial position at June 30, 2011, and the consolidated results of operations, comprehensive income, and cash flows for the periods ended June 30, 2011 and 2010. The interim period consolidated financial statements should be read in conjunction with our Consolidated Financial Statements that are included in the Annual Report on Form 10K filed on February 28, 2011.
Torchmark reports the results of operations of a business as discontinued operations when the component is sold or expected to be sold, the operations and cash flows of the business have been or will be eliminated from the ongoing operations as a result of the disposal transaction, and Torchmark will not have any significant continuing involvement in the operations of the business after the disposal transaction. The results of discontinued operations are reported in discontinued operations in the Consolidated Statements of Operations for current and prior periods commencing in the period in which the business is either disposed of or is accounted for as a disposal group, including any gain or loss recognized on the sale or adjustment of the carrying amount to fair value less cost to sell.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—CONTINUED
Note B—Earnings Per Share
Torchmark declared a three for two stock split paid in the form of a 50% stock dividend on all of the Company’s outstanding common stock. The record date for the three for two stock split was the close of business on June 1, 2011. On July 1, 2011, the payment date, holders of Torchmark common stock as of the record date received one additional share of stock for every two shares held. The Company paid $123 thousand in cash to acquire 2,841 fractional shares as a result of the stock split. Upon completion of the transaction, Torchmark had 119,812,123 shares issued at a par value of $1 per share and 105,397,859 shares outstanding at the close of business on July 1, 2011. All share and per share amounts have been adjusted to reflect this stock split for all periods presented in these consolidated financial statements.
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—Postretirement Benefit Plans
The following tables present a summary of post-retirement benefit costs by component:
Components of Post-Retirement Benefit Costs
Service cost
Interest cost
Expected return on assets
Prior service cost
Net actuarial (gain)/loss
Net periodic benefit cost
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Note C—Postretirement Benefit Plans (continued)
The following chart presents assets at fair value for our defined-benefit pension plans at June 30, 2011 and the prior-year end.
Pension Assets by Component
(Dollar amounts in thousands)
Corporate debt
Other fixed maturities
Equity securities
Guaranteed annuity contract
Other
Total
The liability for the funded defined-benefit pension plans was $244 million at December 31, 2010. No contributions were made to the qualified pension plans during the six months ended June 30, 2011. Torchmark plans to contribute a range of $6 million to $12 million during the remainder of the year. Life insurance policies on the lives of plan participants have been established with an unaffiliated carrier for the Company’s supplemental retirement plan. Premiums for this coverage paid during both of the 2011 and 2010 periods were $1.7 million. During 2010, a Rabbi Trust was established to provide for the obligations under this supplemental retirement plan. The insurance policies, as well as an additional $21 million of cash, were placed in the Rabbi Trust. The cash was deposited with an unaffiliated trustee to be invested. A cash deposit of $5 million was added in the first quarter of 2011. The combined value of the insurance policies and investments was $40 million as of June 30, 2011, compared with $33 million at year end 2010. This plan is unqualified and therefore the value of the insurance policies and investments are not included in the chart above. The liability for the unqualified pension plan was $39 million at June 30, 2011 and $38 million at December 31, 2010.
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Note D—Investments
Portfolio Composition:
A summary of fixed maturities and equity securities available for sale by cost or amortized cost and estimated fair value at June 30, 2011 is as follows:
PORTFOLIO COMPOSITION AS OF JUNE 30, 2011
Fixed maturities available for sale:
Bonds:
U.S. Government direct, guaranteed, and government-sponsored enterprises
States, municipalities, and political subdivisions
Foreign governments
Corporates
Collateralized debt obligations
Other asset-backed securities
Redeemable preferred stocks
Total fixed maturities
Total fixed maturities and equity securities
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Note D—Investments (continued)
A schedule of fixed maturities by contractual maturity date at June 30, 2011 is shown below on an amortized cost basis and on a fair value basis. Actual maturity dates could differ from contractual maturities due to call or prepayment provisions.
Due in one year or less
Due from one to five years
Due from five to ten years
Due from ten to twenty years
Due after twenty years
Mortgage-backed and asset-backed securities
Selected information about sales of fixed maturities is as follows:
Proceeds from sales
Gross realized gains
Gross realized losses
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Fair Value Measurements:
The following table represents assets measured at fair value on a recurring basis:
FAIR VALUE MEASUREMENTS AT JUNE 30, 2011 USING:
Description
U.S. Government direct, guaranteed,and government-sponsored enterprises
Percent of total
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS–CONTINUED
The great majority of fixed maturities are not actively traded and direct quotes are not generally available. Management therefore determines the fair values of these securities after consideration of data provided by third-party pricing services and independent broker/dealers. Over 99% of the fair value reported at June 30, 2011 was determined using data provided by third-party pricing services. Prices provided by third-party pricing services are not binding offers but are estimated exit values. They are based on observable market data inputs which can vary by security type. Such inputs include benchmark yields, available trades, broker/dealer quotes, issuer spreads, benchmark securities, bids, offers, and other market data. Where possible, these prices were corroborated against other independent sources. When corroborated prices produce small variations, the close correlation indicates observable inputs, and the median value is used. When corroborated prices present greater variations, additional analysis is required to determine which value is the most appropriate. When only one price is available, it is used if based on observable inputs and analysis confirms that it is appropriate. All fair value measurements based on prices determined with observable market data are reported as Level 1 or Level 2 measurements.
When third-party vendor prices are not available, the Company attempts to obtain at least three quotes from broker/dealers for each security. When at least three quotes are obtained, and the standard deviation of such quotes is less than 3%, (suggesting that the independent quotes were likely derived using similar observable inputs), the Company uses the median quote and classifies the measurement as Level 2. At June 30, 2011, there were no assets valued as Level 2 in this manner with broker quotes.
When the standard deviation is 3% or greater, or the Company cannot obtain three quotes, then additional information and management judgment are required to establish the fair value. The measurement is then classified as Level 3. The Company uses information and valuation techniques deemed appropriate for determining the point within the range of reasonable fair value estimates that is most representative of fair value under current market conditions.
As of June 30, 2011, fair value measurements classified as Level 3 represented less than 7 tenths of one percent of total fixed maturities and equity securities, compared with slightly less than 1% at December 31, 2010.
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Other-Than-Temporary Impairments:
During the six month periods of 2011 and 2010, the Company determined that certain of its holdings in fixed maturities were other-than-temporarily impaired, resulting in writedowns on those securities. Writedowns for other-than-temporary impairment are included in realized investment losses. On a pretax basis, the 2011 writedown was on bonds with a carrying amount of $20 thousand ($13 thousand after tax). The 2010 writedown included the complete write off of a CDO with a carrying amount of $1.7 million ($1.1 million after tax).
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Unrealized Loss Analysis:
The following table discloses unrealized investment losses by class of investment at June 30, 2011. Torchmark considers these investments not to be other-than-temporarily impaired.
ANALYSIS OF GROSS UNREALIZED INVESTMENT LOSSES
At June 30, 2011
Description of Securities
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Additional information about investments in an unrealized loss position is as follows:
Number of issues (Cusip numbers) held:
As of June 30, 2011
As of December 31, 2010
Torchmark’s entire fixed-maturity and equity portfolio consisted of 1,393 issues at June 30, 2011 and 1,430 issues at December 31, 2010. The weighted average quality rating of all unrealized loss positions as of June 30, 2011 was BBB+. Even though Torchmark’s fixed-maturity investments are available for sale, Torchmark’s management generally does not intend to sell and does not believe it will be required to sell any securities which are temporarily impaired until they mature due to the strong and stable cash flows generated by its insurance products.
Torchmark’s balances related to bifurcated credit loss positions included in other comprehensive income were $22 million at June 30, 2011 and December 31, 2010, with no change to this balance during any period presented.
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Note E—Income Taxes
The effective income tax rate differed from the expected 35% rate as shown below:
Expected income taxes
Increase (reduction) in income taxes resulting from:
Tax-exempt investment income
Low-income housing investments
Income tax expense
The effective income tax rate for the three and six month periods ended June 30, 2011 differed from the effective income tax rate for the same periods ended June 30, 2010 primarily as a result of the Company’s low-income housing tax credit investments.
Note F—Discontinued Operations
On December 31, 2010, Torchmark’s subsidiary, Liberty National Life Insurance Company (Liberty), sold its wholly-owned subsidiary, United Investors Life Insurance Company (United Investors), to an unaffiliated insurance carrier. United Investors markets primarily term and interest-sensitive life insurance, fixed annuities, and, prior to 2009, variable annuities. Consideration for the sale consisted of $343 million in cash at the closing, as well as final adjustment proceeds collected from the buyer of approximately $20 million during the first quarter of 2011. As a result of the sale, Torchmark’s consolidated financial statements are presented to reflect the operations of United Investors as discontinued operations for periods prior to the sale.
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Note G—Business Segments
Torchmark is comprised of life insurance companies which primarily market individual life and supplemental health insurance products through niche distribution systems to middle income Americans. To a limited extent, the Company also markets fixed annuities. Torchmark’s core operations are insurance marketing and underwriting, and management of its investments. Insurance marketing and underwriting is segmented by the types of insurance products offered: life, health, and annuity. Management’s measure of profitability for each insurance segment is insurance underwriting margin, which is 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 (claims incurred and change in reserves), commissions and other acquisition expenses from premium revenue. Torchmark further views the profitability of each insurance product segment by the marketing groups that distribute the products of that segment: direct response, independent, or captive/career agencies.
The investment segment includes the management of the investment portfolio, debt, and cash flow. Management’s measure of profitability for this segment is excess investment income, which is the income earned on the investment portfolio less the interest credited on net policy liabilities and financing costs. Financing costs include the interest on Torchmark’s debt. Other income and insurance administrative expense are classified in a separate “Other” segment.
As noted, Torchmark’s “core operations” are insurance and investment management. The insurance segments issue policies for which premiums are collected for the eventual payment of policy 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 and term appropriate to support the insurance product obligations. These investments generally consist of fixed maturities, and, over the long term, the 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, and Torchmark generally expects to hold investments until maturity. Dispositions of investments occur from time to time, generally as a result of credit concerns, calls by issuers, or other factors usually beyond the control of management.
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Note G—Business Segments (continued)
Dispositions are sometimes required in order to maintain the Company’s investment policies and objectives. Investments are also occasionally written down as a result of other-than-temporary impairment. Torchmark does not actively trade investments. As a result, realized gains and losses from the disposition and write down of investments are generally incidental to operations and are not considered a material factor in insurance pricing or product profitability. While from time to time these realized gains and losses could be significant to net income in the period in which they occur, they have a limited effect on the yield of the total investment portfolio. Further, because the proceeds of the disposals are reinvested in the portfolio, the disposals have little effect on the size of the portfolio and the income from the reinvestments is included in net investment income. Therefore, management removes realized investment gains and losses from results of core operations when evaluating the performance of the Company. For this reason, these gains and losses are excluded from Torchmark’s operating segments.
Torchmark accounts for its stock options and restricted stock under current accounting guidance requiring stock options and stock grants to be expensed based on fair value at the time of grant. Management considers stock compensation expense to be an expense of the Parent Company. Therefore, stock compensation expense is treated as a corporate expense in Torchmark’s segment analysis.
Torchmark provides coverage under the Medicare Part D prescription drug plan for Medicare beneficiaries. In accordance with GAAP, Part D premiums are recognized evenly throughout the year when they become due but benefit costs are recognized when the costs are incurred. Due to the design of the Part D product, premiums are evenly distributed throughout the year, but benefit costs are higher earlier in the year. As a result, under GAAP, benefit costs can exceed premiums in the first part of the year, but be less than premiums during the remainder of the year. In order to more closely match the benefit cost with the associated revenue for interim periods, Torchmark defers these excess benefits for segment reporting purposes. In addition, GAAP recognizes in each quarter a government risk-sharing premium adjustment consistent with the contract as if the quarter represented an entire contract period. These contract payments are based upon the experience of the full contract year, not the experience of interim periods. Therefore, these risk-sharing adjustments are removed in the segment analysis. For the entire year, Torchmark expects its benefit ratio to be in line with pricing and does not expect to receive any government risk-sharing premium. For the full year of 2010, the total premiums and benefits were the same under this alternative method as they were under GAAP and are expected to be so in 2011. The Company’s presentation results in the
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underwriting margin percentage of each interim period reflecting the expected margin percentage for the full year.
An analysis of the adjustments for the difference in the interim results as presented for segment purposes and GAAP for Medicare Part D is as follows:
Benefit costs deferred
Government risk-sharing premium adjustment
Pre-tax addition to segment interim period income
After tax amount
The decline in this adjustment was due to the addition of a small deductible for enrollees newly implemented in the Company’s 2011 plan.
During the first quarter of 2011, Torchmark sold aviation equipment for a pretax loss of $979 thousand ($636 thousand after tax). Also in the first quarter of 2011, Torchmark accrued an estimated liability for a state administrative settlement involving issues arising over many years in the pretax amount of $6 million ($3.9 million after tax). The actual amount of the settlement could differ from the amount accrued. Management removes items such as these that are related to prior periods or are one-time non-operating sales transactions when analyzing its ongoing core results.
The following tables total the components of Torchmark’s operating segments and reconcile these operating results to its pretax income and each significant line item in its Consolidated Statements of Operations.
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Reconciliation of Segment Operating Information to the Consolidated Statement of Operations
Premium
Expenses:
Policy benefits
Required interest on net reserves
Amortization of acquisition costs
Commissions and premium tax
Insurance administrative expense (3)
Parent expense
Stock compensation expense
Total expenses
Subtotal
Nonoperating items
Amortization of low-income housing
Measure of segment profitability (pretax)
Deduct applicable income taxes
Segment profits after tax
Add back income taxes applicable to segment profitability
Add (deduct) realized investment gains (losses)
Deduct Part D adjustment (1)
Deduct amortization of low-income housing (5)
Deduct estimated state administrative settlement expense (6)
Deduct loss on sale of equipment (7)
Pretax income from continuing operations per Consolidated Statement of Operations
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The following table summarizes the measures of segment profitability for comparison. It also reconciles segment profits to net income.
Analysis of Profitability by Segment
Life insurance
Health insurance
Annuity
Other:
Administrative expense
Investment
Corporate and adjustments
Pretax total
Applicable taxes
After-tax total, before discontinued operations
Discontinued operations (after tax)
Reconciling items, net of tax:
Realized gains (losses) - Investments
Realized gains (losses) - Discontinued operations
Loss on disposal of discontinued operations
Part D adjustment
Estimated state administrative settlement
Loss on sale of equipment
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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Results of Operations
Discontinued Operations. As discussed in Note F – Discontinued Operations, we sold our subsidiary United Investors Life Insurance Company (United Investors) on December 31, 2010. Because of the sale, United Investors’ financial results prior to the sale are excluded from this discussion.
Summary of Operations. Torchmark’s operations are segmented into its insurance underwriting and investment operations as described in Note G—Business Segments. The measures of profitability described in Note G are useful in evaluating the performance of the segments and the marketing groups within each insurance segment, because each of our distribution units operates in a niche market. These measures enable management to view period-to-period trends, and to make informed decisions regarding future courses of action.
The tables in Note G—Business Segments demonstrate how the measures of profitability are determined. Those tables also reconcile our revenues and expenses by segment to major income statement line items for the six-month periods ended June 30, 2011 and 2010. Additionally, a table in that note, Analysis of Profitability by Segment, provides a summary of the profitability measures that demonstrates year-to-year comparability and which reconciles those measures to our net income. That summary represents our overall operations in the manner that management views the business, and is a basis of the following highlights discussion.
A discussion of operations by each segment follows later in this report. These discussions compare the first six months of 2011 with the same period of 2010, unless otherwise noted. The following discussions are presented in the manner we view our operations, as described in Note G—Business Segments.
Highlights, comparing the first six months of 2011 with the first six months of 2010. Net income per diluted share increased 11% to $2.20 from $1.99. Net income from continuing operations was $255 million in 2011, compared with $235 in the prior year period, an increase of 8%. On a per share basis, net income from continuing operations rose 17% to $2.21 from $1.89. Included in net income from continuing operations in 2011 were realized investment gains of $5.6 million after tax or $.05 per share, compared with 2010 after-tax realized gains of $1.5 million, or $.01 per share. Realized investment gains and losses are discussed more fully under the caption Realized Gains and Losses in this report. Earnings in 2011 were also negatively affected by two non-operating charges, a charge for a state administrative matter in the estimated after tax amount of $3.9 million ($.03 per share) and the loss on sale of aviation equipment of $636 thousand after tax ($.01 per share).
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As explained in Note G—Business Segments, differences in our estimate of interim results for Medicare Part D as we view this product for segment purposes and GAAP financial statement purposes resulted in a $3.7 million after-tax charge to earnings in 2011 ($.03 per share) and a $11.1 million charge in 2010 ($.09 per share). We expect our 2011 full year benefit ratios to be approximately the same as those for interim periods, as was the case in 2010 and prior years. For this reason, there should be no differences in our segment versus financial statement reporting by year end 2011, as it relates to Medicare Part D.
We use three statistical measures as indicators of future premium growth: “annualized premium in force,” “net sales,” and “first-year collected premium.” Annualized premium in force is defined as the premium income that would be received over the following twelve months at any given date on all active policies if those policies remain in force throughout the twelve-month period. Annualized premium in force is an indicator of potential growth in premium revenue. Net sales is defined as annualized premium issued, net of cancellations in the first thirty days after issue, except for Direct Response, where net sales is annualized premium issued at the time the first full premium is paid after any introductory offer has expired. Annualized premium issued is the gross premium that would be received during the policies’ first year in force, assuming that none of the policies lapsed or terminated. Although lapses and terminations will occur, we believe that net sales is a useful indicator of the rate of acceleration of premium growth. First-year collected premium is the premium collected during the reporting period for all policies in their first policy year. First-year collected premium takes lapses into account in the first policy year when lapses are more likely to occur, and thus is a useful indicator of how much new premium is expected to be added to premium income in the future.
Total premium income increased 1% to $1.4 billion. Total net sales declined 9% to $203 million, as a result of agent losses, the discontinuation of certain products, and other factors discussed in depth later in this report. First-year collected premium declined 10% to $165 million for the period.
Life insurance premium income grew 4% to $864 million. Life net sales declined 4% to $167 million, as each of our distribution units experienced declines. First-year collected life premium declined 1% to $123 million. However, life underwriting margins increased 8% to $244 million, primarily as a result of lower claims.
Health insurance premium income, excluding Medicare Part D premium, declined 6% to $377 million. Health net sales, excluding Part D, declined 16% to $27 million and first-year collected health premium, excluding Part D, decreased 23% to $28 million. These declines resulted primarily from the discontinuance of sales of certain health products.
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Our Medicare Part D prescription drug business is a component of the health insurance segment. In the manner we view our Medicare Part D business as described in Note G—Business Segments, policyholder premium was $98 million in 2011 compared with $105 million in 2010, a decline of 7%. Underwriting income rose 2% to $10 million.
Excess investment income per diluted share increased 8% to $1.28, while excess investment income rose 1% to $148 million. Net investment income rose $14 million, or 4%. Our average investment portfolio at amortized cost grew 5%. The average effective yield on the fixed-maturity portfolio, which represents 96% of our investments, was 6.59% in the 2011 period, compared with 6.77% in the prior period. Excess investment income did not increase at the same rate as net investment income because of the $12 million or 8% increase in required interest on net insurance policy liabilities, exceeding the increase in net investment income. Financing costs also rose 3% in the period from $38 million to $39 million.
In the first six months of 2011, we invested new money in our fixed-maturity portfolio at an effective annual yield on new investments of 5.84%, compared with 6.07% in the same period of 2010. Our average fixed maturity portfolio yield was 6.55% (as of June 30, 2011) and had an average rating of A-. Over 93% of the portfolio at amortized cost was investment grade at June 30, 2011. Cash and short-term investments were $111 million at that date, compared with $582 million at December 31, 2010, as cash flow was generally either invested during the 2011 period or was used to buy Torchmark stock.
The unrealized gain position in our fixed-maturity portfolio improved from a net unrealized gain of $108 million at year end 2010 to a net gain position of $306 million at June 30, 2011, as a result of the sale of below-investment-grade bonds and improved financial markets. The fixed-maturity portfolio contains no commercial mortgage-backed securities or securities backed by subprime or Alt-A mortgages (loans for which some of the typical documentation was not provided by the borrower). We are not a party to any counterparty risk, with no credit default swaps or other derivative contracts. We do not engage in securities lending, and have no direct exposure to European sovereign debt.
We have an on-going share repurchase program which began in 1986 and was reaffirmed by the Board of Directors at their April, 2011 meeting. With no specified authorization amount, we determine the amount of repurchases based on the amount of our excess cash flow, general market conditions, and other alternative uses. These purchases are made with excess cash flow. Share purchases are also made with the proceeds from option exercises by current and former employees, in order to reduce dilution. The following chart summarizes share purchases for the six-month periods ended June 30, 2011 and 2010.
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ANALYSIS OF SHARE PURCHASES
(Amounts in thousands)
Purchases with:
Excess cash flow
Option exercise proceeds
Throughout the remainder of this discussion, share purchases will only refer to those made from excess cash flow.
A detailed discussion of our operations by component segment follows.
Life insurance, comparing the first six months of 2011 with the first six months of 2010. Life insurance is our predominant segment, representing 64% of premium income and 75% of insurance underwriting margin in the first six months of 2011. In addition, investments supporting the reserves for life business generate the majority of excess investment income attributable to the investment segment. Life insurance premium income increased 4% to $864 million. We have completed the combination of selected offices of our United American (UA) Exclusive Agency offices with the Liberty National Exclusive Agency. For this reason, all data will be reported on a combined basis in this report. The following table presents Torchmark’s life insurance premium by distribution method.
Life Insurance
Premium by Distribution Method
Direct Response
American Income Exclusive Agency
Liberty National Exclusive Agency
Other Agencies
Total Life Premium
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Net sales, defined earlier in this report as an indicator of new business production, declined 4% to $167 million. While all four of our distribution groups experienced declines over the prior year six months, second quarter 2011 sales of $86 million rose 5% over first quarter 2011 sales. An analysis of life net sales by distribution group is presented below.
Net Sales by Distribution Method
Total Life Net Sales
First-year collected life premium, defined earlier in this report, was $123 million in the 2011 period, declining 1%. First-year collected life premium by distribution group is presented in the table below.
First-Year Collected Premium by Distribution Method
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The Direct Response operation consists of two primary components: insert media and direct mail. Insert media, which targets primarily the adult market, involves placing insurance solicitations as inserts into a variety of media, such as coupon packets, newspapers, bank statements, and billings. Direct mail targets primarily young middle-income households with children. The juvenile life insurance policy is a key product. 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, who 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 juvenile policyholders and their parents are low acquisition-cost targets for sales of additional coverage over time.
Direct Response’s life premium income rose 5% to $302 million, representing 35% of Torchmark’s total life premium, the largest contribution to life premium of any distribution system. Net sales for this group of $73 million declined 2%, however. First-year collected premium of $46 million was flat with the prior year period.
The American Income Exclusive Agency markets primarily to members of labor unions, but also to credit unions and other associations. This agency produced premium income of $297 million, an increase of 8%. American Income is Torchmark’s fastest growing life insurance agency on the basis of premium growth. However, net sales declined 3% to $69 million, while first-year collected premium rose 1% to $56 million. Growth in sales in our captive agencies is highly dependent on growing the size of the agency force. The American Income agent count was 4,332 at June 30, 2011, a 3% increase from a year earlier (4,200), but an 11% increase over the count at December 31, 2010 (3,912). The American Income Agency continues to emphasize the recruiting and retention of new agents, focusing on an incentive program to reward growth in both recruiting and production.
The Liberty National Exclusive Agency markets primarily low-face-amount life insurance and supplemental health insurance. Life premium income for this agency was $146 million in the 2011 period, a 2% decline compared with $148 million in the 2010 period. First-year collected premium declined 8% to $16 million.
Net sales for this Agency declined 15% to $19 million. The Liberty Agency had 1,792 producing agents at June 30, 2011, compared with 2,252 a year earlier, a decline of 20%. The decrease in agent count is due to a number of factors, one of which was the closing of several offices which had poor production. The decrease was also a result of certain agent compensation issues which resulted in the departure of a number of the less productive agents. While these modifications caused a loss of agents, they resulted in improved first-year persistency and margins.
The Liberty Exclusive Agency agent counts have also decreased due to issues related to its health insurance business. Until recently, the agency’s health insurance marketing efforts had been focused on limited-benefit hospital-surgical plans. These limited-benefit hospital-surgical plans became less marketable due to healthcare reform
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developments. Sales of these limited-benefit hospital-surgical plans were discontinued after September, 2010. In response, the agency has shifted its marketing focus to a product mix more weighted towards life insurance and supplemental health insurance products (not affected by healthcare reform) that have higher margins and persistency. We believe this will increase the Agency’s profitability and stability in the long run. As is the case with all of our captive agency forces, growing the number of productive agents is critical to the growth in sales.
The Other Agencies distribution systems offering life insurance include the Military Agency, the UA Independent Agency (which predominantly writes health insurance), and various smaller distribution channels. The Other Agencies distribution group contributed $119 million of life premium income, or 14% of Torchmark’s total in the 2011 period, but contributed only 3% of net sales.
Summary of Results
Premium and policy charges
Net policy obligations
Commissions and acquisition expense
Insurance underwriting income before other income and administrative expense
Life insurance underwriting income before insurance administrative expense was $244 million, increasing 8%. This growth in underwriting income was caused primarily by premium growth but also by improved mortality. As a percentage of premium, underwriting income rose from 27% to 28% in 2011. This increase was primarily a result of the improved policy obligation ratios, particularly in the Liberty and Military Agencies.
In 2011, we implemented several initiatives designed to further improve life insurance lapse ratios. Based on initial results, we expect this program to increase conservation of life in-force premium.
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Health insurance, comparing the first six months of 2011 with the first six months of 2010. Health premium accounted for 36% of our total premium in the 2011 period, while the health underwriting margin accounted for 25% of total underwriting margin, reflective of the lower underwriting margin as a percent of premium for health compared with life insurance. Health insurance sold by Torchmark includes primarily Medicare Supplement and Medicare Part D prescription drug coverage to enrollees in the federal Medicare program, along with limited-benefit cancer and accident coverage. All health coverage plans other than Medicare Supplement and Medicare Part D are classified here as limited-benefit plans. Medicare Part D business is shown as a separate health component and will be discussed separately in the analysis of the health segment.
As explained in Note G—Business Segments, management does not view the government risk-sharing premium for Medicare Part D as a component of premium income. Excluding this risk-sharing premium, health insurance premium for the 2011 period was $475 million, declining 6%. A reconciliation between segment reporting for Medicare Part D and GAAP is presented in the chart in Note G—Business Segments, and those differences are fully discussed in that note.
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The table below is an analysis of our health premium by distribution method.
Health Insurance
United American Independent Agency
Limited-benefit plans
Medicare Supplement
Total Health Premium (Before Part D)
Total (Before Part D)
Medicare Part D*
Total Health Premium*
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Presented below is a table of health net sales by distribution method.
Total Net Sales (Before Part D)
Total Net Sales *
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The following table presents health insurance first-year collected premium by distribution method.
Total First-Year Collected Premium (Before Part D)
Total First-Year Collected Premium*
Health insurance, excluding Medicare Part D. As noted under the caption Life Insurance, we have emphasized life insurance sales relative to health, due to life’s superior profitability and its greater contribution to excess investment income. With regard to health insurance, agent turnover has increased due to the Company’s decision to deemphasize the marketing of certain limited-benefit products. Declines in these agent counts have resulted in lower net sales, which in turn have pressured premium growth. Health premium, excluding Part D premium, fell 6% to $377 million in the 2011 period. Medicare Supplement premium declined 2% to $227 million, while
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other limited-benefit health premium dropped 11% to $150 million. Medicare Supplement provides Torchmark with the greatest amount of health premium, representing 60% of non-Part D health premium for the 2011 period, compared with 58% a year earlier.
Health net sales excluding Part D declined 16% to $27 million. Medicare Supplement net sales declined 8% to $15 million in the 2011 period. Limited-benefit net sales declined 23% to $13 million. The decline in limited-benefit health net sales was due in part to our discontinuance of the sale of a number of these products affected by healthcare reform. Health first-year collected premium declined 23%.
The UA Independent Agency consists of independent agencies appointed with Torchmark who may also sell for other companies. The UA Independent Agency was Torchmark’s largest health agency in terms of non-Part D premium income and net sales. Premium income was $158 million, representing 42% of Torchmark’s total non-Part D health premium. Net sales were $12 million, representing 44% of Torchmark’s non-Part D health sales. This agency is also Torchmark’s largest producer of Medicare Supplement insurance, with Medicare Supplement premium of $138 million. This Agency represents approximately 61% of all Torchmark Medicare Supplement premium and 78% of Medicare Supplement net sales. Net sales of Medicare Supplement products rose 6% in 2011 to $11 million. However, total health premium for this Agency declined 3% from the prior year as a result of the decline in limited-benefit plan premium.
The Liberty National Exclusive Agency markets Medicare Supplements and limited-benefit health products including cancer insurance. This Agency represented 40% of Torchmark’s non-Part D income health premium at $151 million in the 2011 six months. Net sales in this Agency declined 5% in the 2011 six months, but rose 10% in the second quarter of 2011 compared with the second quarter of 2010 and 40% over the first quarter of 2011. Second quarter 2011 increases in net sales were due in large part to sales of a new cancer insurance product.
Discussed under theLife Insurance caption, we noted the 20% decline in agent counts at Liberty over the prior twelve months. A primary factor in those declines was the discontinuance of the sales of certain health products after September, 2010. These declines in agent counts have had a negative effect on premium income and first-year collected premium. In the 2011 period, health premium income in the Liberty Agency declined 12% from the prior year premium of $173 million. First-year collected premium declined 36% to $6 million.
Other agencies. Certain of our other distribution channels market health products, although their main emphasis is on life insurance. On a combined basis, they accounted for 18% of health premium excluding Part D in the 2011 period and 17% in the same period of 2010. The American Income Exclusive Agency markets a variety of limited-benefit plans, primarily accident. The Direct Response group markets primarily Medicare Supplements to employer or union-sponsored groups. Direct Response is
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also involved in marketing Medicare Part D. On a combined basis, the health net sales of these agencies declined 23%, from $11 million in 2010 to $8 million in 2011. The Medicare Supplements sold by Direct Response are generally group products and are expected to fluctuate from period to period.
Medicare Part D. Coverage under Torchmark’s Medicare Part D prescription drug plan for Medicare beneficiaries is marketed through our UA Independent Agency and our Direct Response unit. As described in Note G—Business Segments, we report our Medicare Part D business for segment analysis purposes as we view the business, in which expected full-year benefits are matched with the related premium income which is received evenly throughout the policy year. At this time, we have expensed benefits based on our expected benefit ratio of approximately 84% for the entire 2011 contract year compared with 82% for the full year 2010. In 2011, we do not expect to benefit as much from drug rebate payments from the pharmacy benefits manager as we have in prior years. We describe the differences between the segment analysis and the GAAP operating results in Note G. Due to the design of the Medicare prescription drug product, claims are expected to be heaviest early in the calendar year. Management believes that the use of the full-year loss ratio is an appropriate measure for interim results, and also that these reporting differences will arise only on an interim basis and will be eliminated at the end of a full year, as they were in the full year of 2010.
Medicare Part D premium was $98 million in 2011, compared with $105 million in 2010, after removal of the risk-sharing adjustment in both periods. This represents a decline in premium of 7%. Medicare Part D underwriting results are presented in the following chart. The adjustments which reconcile Part D results in accordance with our health segment analysis to Part D GAAP results are presented in the charts in Note G—Business Segments.
Medicare Part D
Summary of Medicare Part D Results
The number of enrollees in our Medicare Part D coverage declined 9% in the 2011 plan year compared with 2010, due to a decline in group sales and the discontinuance of one of our individual plans. The Medicare Part D plan is a government-sponsored program. Therefore, regulatory changes could alter the outlook for this market.
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The following table presents underwriting margin data for health insurance.
Underwriting income for health insurance declined 3% or $3 million to $81 million, largely as a result of the 6% decline in health premium. As a percentage of health premium, underwriting margins were stable at 17%. However, excluding Part D, health underwriting margins rose 1% to 19% in 2011, as our more persistent Medicare Supplement business has become a greater proportion of our health insurance in force when compared with our limited-benefit product.
Annuities. Annuities represent an insignificant part of our business. As described in Note F—Discontinued Operations, we sold our subsidiary United Investors, which prior to the sale was our carrier of variable annuities and a primary carrier of fixed annuities. As a result of the sale, we disposed of 37% of our annuity deposit balances at December 31, 2010, including all variable annuities. For this reason, annuities are not expected to be a significant portion of our marketing strategy going forward.
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Operating expenses, comparing the first six months of 2011 with the first six months of 2010. Operating expenses consist of insurance administrative expenses and parent company expenses. Also included is stock compensation expense, which is viewed by us as a parent company expense. Insurance administrative expenses relate to premium income for a given period; therefore, we measure those expenses as a percentage of premium income. Total expenses are measured as a percentage of total revenues. An analysis of operating expenses is shown below.
Operating Expenses Selected Information
Insurance administrative expenses:
Salaries
Other employee costs
Other administrative costs
Legal expense - insurance
Medicare Part D direct administrative expense
Total insurance administrative expenses
Parent company expense
Total operating expenses, per Consolidated Statements of Operations
Increase (decrease) over prior year
Total operating expenses:
Insurance administrative expenses increased 2% when compared with the prior year period, primarily as a result of $3 million in increased litigation costs, net of recoveries, and a $1 million increase in salary expense. These increases were offset somewhat by a decline in other employee costs, as employee health costs were greater in 2010 than in 2011. Total operating expense rose 10% in 2011 primarily because of two non-recurring items. There was a charge during the period relating to a state administrative issue concerning events occurring over a period of many prior years in the pre-tax amount of $6 million. The Company does not consider items related to prior periods in its evaluation of current operating results. In addition, the Company sold aviation equipment at a loss of $979 thousand. Sales of such equipment are infrequent and are not considered part of Torchmark’s ongoing insurance operations.
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Investments (excess investment income), comparing the first six months of 2011 with the first six months of 2010. We manage our capital resources including investments, debt, and cash flow through the investment segment. Excess investment income represents the profit margin attributable to investment operations. It is the measure that we use to evaluate the performance of the investment segment as described in Note G—Business Segments in the Notes to the Consolidated Financial Statements. It is defined as net investment income less the interest credited to net policy liabilities and the interest cost associated with capital funding or “financing costs.” We also view excess investment income per diluted share as an important and useful measure to evaluate the performance of the investment segment. It is defined as excess investment income divided by the total diluted weighted average shares outstanding, representing the contribution by the investment segment to the consolidated earnings per share of the Company. Since implementing our share repurchase program in 1986, we have used $4.8 billion of cash flow to repurchase Torchmark shares 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, we believe that excess investment income per diluted share is an appropriate measure of the investment segment.
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The following table summarizes Torchmark’s investment income, excess investment income, and excess investment income per diluted share.
Excess Investment Income
Net investment income *
Required interest on net insurance policy liabilities
Financing costs:
Interest on funded debt
Interest on short-term debt
Total financing costs
Excess investment income
Excess investment income per diluted share
Mean invested assets (at amortized cost)
Average net insurance policy liabilities **
Average debt and preferred securities (at amortized cost)
As shown in the above table, excess investment income for the 2011 period increased $2 million or 1% to $148 million. The 8% per-share increase exceeded the 1% growth in excess investment income as a result of share purchases over the past 12 months. The 4% growth in net investment income correlated with the 5% growth in average invested assets (at amortized cost) year over year. Even though yields in the fixed-maturity portfolio were lower in the 2011 six months, we held significantly more lower-yielding short-term securities in 2010.
Partially offsetting the increase in net investment income, required interest on net insurance policy liabilities increased $12 million or 8% to $165 million. The increase in required interest is slightly above the 7% change in average net interest-bearing insurance policy liabilities.
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Financing costs rose 3% to $39 million, primarily due to an increase in interest on short-term debt. Short-term interest expense rose $1.3 million, primarily as a result of an increase in fees related to our bank line and letters of credit. More information concerning short-term debt can be found in the Liquidity section of this report under the caption Short-term borrowings.
Excess investment income benefits from increases in long-term rates available on new investments and decreases in short-term borrowing rates. Of these two factors, higher investment rates have the greater impact because the amount of cash that we invest is significantly greater than the amount that we borrow at short-term rates. Therefore, Torchmark would benefit if rates, especially long-term rates, were to rise.
Investments (acquisitions), comparing the first six months of 2011 with the first six months of 2010. Torchmark’s investment policy calls for investing almost exclusively in fixed maturities that are investment grade and meet our quality and yield objectives. We generally prefer to invest in securities with longer maturities because they more closely match the long-term nature of our policy liabilities. We believe this strategy is appropriate because our cash flows are generally stable and predictable. If such longer-term securities do not meet our quality and yield objectives, new money is invested in shorter-term fixed maturities.
The following table summarizes selected information for fixed-maturity purchases. The effective annual yield shown is the yield calculated to the “worst call date.” For noncallable bonds, the worst-call date is always the maturity date. For callable bonds, the worst-call date is the call date that produces the lowest yield (or the maturity date, if the yield calculated to the maturity date is lower than the yield calculated to each call date).
Fixed Maturity Acquisitions Selected Information
(Dollar amounts in millions)
Cost of acquisitions:
Investment-grade corporate securities
Taxable municipals
Total fixed-maturity acquisitions
Effective annual yield *
Average life, in years to:
Next call
Maturity
Average rating
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During the first six months of 2011, we acquired $697 million of fixed maturities with an average effective yield of 5.84% and an average rating of A-. This compares with $952 million of fixed maturities with an average yield of 6.07% and an average rating of A- acquired during the same period of 2010. We acquired primarily corporate bonds in both periods, with securities spanning a diversified range of issuers, industry sectors, and geographical regions. All of these securities were investment grade.
Investments (portfolio composition). The composition of the investment portfolio at book value on June 30, 2011 was as follows:
Invested Assets At June 30, 2011
Fixed maturities(at amortized cost)
Equities (at cost)
Mortgage loans
Investment real estate
Approximately 96% of our investments at book value are in a diversified fixed-maturity portfolio. Policy loans, which are secured by policy cash values, make up an additional 3%. The remaining balance is comprised of other investments including equity securities, mortgage loans, and other long-term investments. Because fixed maturities represent such a significant portion of our investment portfolio, the remainder of the discussion of portfolio composition will focus on fixed maturities.
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Fixed Maturities.The following table summarizes certain information about our fixed-maturity portfolio by component at June 30, 2011.
Fixed Maturities by Component
Redeemable preferred stock
Municipals
Government-sponsored enterprises
Governments & agencies
Residential mortgage-backed*
At June 30, 2011, fixed maturities had a fair value of $11.0 billion, compared with $10.5 billion at December 31, 2010.The net unrealized gain position in the fixed-maturity portfolio improved from a net gain of $108 million at December 31, 2010 to a net gain of $306 million at June 30, 2011, due to a tightening in credit spreads.
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Investments in fixed-maturity securities are diversified over a wide range of industry sectors. The following table summarizes certain information about our fixed-maturity portfolio by sector at June 30, 2011:
Fixed Maturities by Sector
Financial - Life/Health/PC Insurance
Financial - Bank
Financial - Financial Guarantor
Financial - Insurance Broker
Financial - Other
Subtotal Financial
Utilities
Government (US, municipal, and foreign)
Mortgage-backed Securities
Energy
Consumer, Non-cyclical
Consumer, Cyclical
Communications
Basic Materials
Transportation
Other Industrials
At June 30, 2011, approximately 50% of the fixed-maturity assets at amortized cost (49% at fair value) were in the financial and utility sectors. The balance of the portfolio is spread among 263 issuers in a wide variety of sectors.
At June 30, 2011, our net unrealized gain of $306 million consisted of gross unrealized gains of $545 million offset by $239 million of unrealized losses. This compares with a net unrealized gain of $108 million at December 31, 2010, consisting of a gross unrealized gain of $476 million and gross loss of $368 million. The financial sector had a net unrealized gain of $7 million at June 30, 2011, compared with a loss of $115 million at December 31, 2010. We expect our investment in temporarily impaired securities to be fully recoverable.
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An analysis of the fixed-maturity portfolio at June 30, 2011 by a composite rating is shown in the table below. The composite rating for each security is the average of the security’s ratings as assigned by Moody’s Investor Service, Standard & Poor’s, Fitch Ratings, and Dominion Bond Rating Service, LTD. The ratings assigned by these four nationally recognized statistical rating organizations are evenly weighted when calculating the average.
Fixed Maturities by Rating
Investment grade:
AAA
AA
A
BBB+
BBB
BBB-
Investment grade
Below investment grade:
BB
B
Below B
Below investment grade
Of the $10.7 billion of fixed maturities at June 30, 2011, $10.0 billion or 93% at amortized cost were investment grade with an average rating of A-. Below- investment -grade bonds were $721 million with an average rating of B+ and were 7% of fixed maturities, compared with 8% at the end of 2010. However, below-investment-grade bonds were only 20% of our shareholders’ equity as of June 30, 2011. Overall, the total portfolio was rated A- based on amortized cost, compared with BBB+ at the end of 2010. Our investment policy is to acquire only investment-grade obligations. Thus, any increases in below-investment-grade issues are a result of ratings downgrades of existing holdings. Our investment portfolio contains no commercial mortgage-backed securities or securities backed by sub-prime or Alt-A mortgages. We have no direct investments in residential mortgages, nor do we have any counterparty risks as we are not a party to any credit default swaps or other derivative contracts. We do not participate in securities lending. There are no off-balance sheet investments, as all investments are reported on our Consolidated Balance Sheets.
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An analysis of the changes in our portfolio of below-investment-grade bonds at amortized cost during the first six months of 2011 is as follows:
Balance as of December 31, 2010
Downgrades by rating agencies
Upgrades by rating agencies
Disposals
Balance as of June 30, 2011
Additional information concerning the fixed-maturity portfolio is as follows.
Fixed Maturity Portfolio Selected Information
Average annual effective yield (1)
Average life, in years, to:
Next call (2)
Maturity (2)
Effective duration to:
Next call (2), (3)
Maturity (2), (3)
Realized Gains and Losses, comparing the first six months of 2011 with the first six months of 2010. As discussed in Note G—Business Segments, our core business of providing insurance coverage requires us to maintain a large and diverse investment portfolio to support our insurance liabilities. From time to time, investments are disposed of or written down prior to maturity for reasons generally beyond the control of management, resulting in realized gains or losses. For this reason, management removes the effects of such gains and losses when evaluating its overall core operating results.
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The following table summarizes our tax-effected realized gains (losses) by component. As described in Note D—Investments, under the caption Other-Than-Temporary Impairments, we wrote certain securities down to fair value during 2011 and 2010 because we determined they were other-than-temporarily impaired.
Analysis of Realized Gains (Losses), Net of Tax
(Dollar amounts in thousands, except for per share data)
Fixed maturities and equities:
Investment sales
Investments called or tendered
Writedowns *
Loss on extinguishment of debt
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Financial Condition
Liquidity. Liquidity provides Torchmark with the ability to meet on demand the cash commitments required by our business operations and financial obligations. Our liquidity is evidenced by positive cash flow, a portfolio of marketable investments, and the availability of a line of credit facility.
Insurance subsidiary liquidity. The operations of our insurance subsidiaries have historically generated substantial cash inflows in excess of immediate cash needs. Sources of cash flows for the insurance subsidiaries include primarily premium and investment income. Cash outflows from operations include policy benefit payments, commissions, administrative expenses, and taxes. The funds to provide for policy benefits, the majority of which are paid in future periods, are invested primarily in long-term fixed maturities to meet these long-term obligations. In addition to investment income, maturities and scheduled repayments in the investment portfolio are sources of cash. Excess cash available from the insurance subsidiaries’ operations is generally distributed as a dividend to the parent company, subject to regulatory restriction. The dividends are generally paid in amounts equal to the subsidiaries’ prior year statutory net income excluding realized capital gains.
Parent Company liquidity. An important source of Parent Company liquidity is the dividends from the insurance subsidiaries noted above. These dividends are used by the Parent Company to pay dividends on common and preferred stock, interest and principal repayment requirements on Parent Company debt, and operating expenses of the Parent. In the first six months of 2011, the Parent Company received $549 million of dividends and transfers from the life insurance subsidiaries, including $305 million available from the proceeds from the sale of United Investors. For the full year 2011, dividends and transfers from the life insurance subsidiaries are expected to total approximately $768 million.
Additional sources of liquidity for the Parent Company are cash, intercompany receivables, and a credit facility. At June 30, 2011, the Parent Company had $87 million of invested cash and net intercompany receivables. The credit facility is discussed below under the caption“Short-term borrowings.”
Short-term borrowings. We have a credit facility that is in place with a group of lenders which allows for unsecured borrowings and stand-by letters of credit up to $600 million. The facility may be expanded by $200 million if certain conditions are met. Up to $250 million in letters of credit can be issued against the facility. The facility is further designated as a back-up credit line for a commercial paper program under which we may borrow from either the credit line or issue commercial paper at any time, with total commercial paper outstanding not to exceed the facility maximum, less any letters of credit issued. Interest is charged at variable rates. The facility has no ratings-based acceleration triggers which would require early repayment. The facility terminates on January 7, 2015. In accordance with the agreement, we are subject to certain
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covenants regarding capitalization and interest coverage with which we were in full compliance at June 30, 2011.
The following table presents certain information about our short-term borrowings, all of which was commercial paper at June 30, 2011 and December 31, 2010.
Short-term Borrowings - Commercial Paper
At end of period:
Balance
Annualized interest rate
Letters of credit outstanding
Remaining amount available under credit line
Average balance outstanding during period:
Daily-weighted average interest rate*
Maximum daily amount outstanding during period
There have been no difficulties in accessing the commercial paper market under this facility during the six-month periods ending June 30, 2011 and 2010.
In summary, Torchmark expects to have readily available funds for the foreseeable future to conduct its operations and to maintain target capital ratios in the insurance subsidiaries through internally generated cash flow and the credit facility. In the unlikely event that more liquidity is needed, the Company could generate additional funds through multiple sources including, but not limited to, the issuance of debt, an additional short-term credit facility, and intercompany borrowing.
Consolidated liquidity. Consolidated net cash inflows from operations were $453 million in the first six months of 2011, compared with $475 million in the same period of 2010. In addition to cash inflows from operations, our companies have received $161 million in investment calls and tenders and $140 million in scheduled maturities or repayments during the 2011 period. As previously noted under the caption Short-term borrowings, we have in place a line of credit facility. The insurance companies have no additional outstanding credit facilities.
Cash and short term investments were $111 million at June 30, 2011, compared with $582 million at December 31, 2010 and $274 million at the end of June, 2010. In
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addition to these liquid assets, the entire $11.0 billion (fair value at June 30, 2011) portfolio of fixed-income and equity securities is available for sale in the event of an unexpected need. Substantially all of our fixed-income and equity securities are publicly traded. We generally expect to hold fixed-income securities to maturity, and even though these securities are classified as available for sale, we have the ability and intent to hold any securities which are temporarily impaired until they mature. Our strong cash flows from operations, investment maturities, and credit line availability make any need to sell securities for liquidity unlikely.
Capital Resources. Our insurance subsidiaries maintain capital at a level adequate to support their current operations and meet the requirements of the regulatory authorities and the rating agencies. Our insurance subsidiaries generally target a capital ratio of around 325% of company action level required capital under Risk-Based Capital (RBC), a measure established by insurance regulatory authorities to monitor the adequacy of capital. Company action level is a level of capital that is calculated using formulas established by the National Association of Insurance Commissioners. The 325% target is considered sufficient because of the insurance companies’ strong reliable cash flows, the relatively low risk of their product mix, and because that ratio exceeds regulatory requirements and is in line with rating agency expectations for Torchmark. As of December 31, 2010, our insurance subsidiaries had a consolidated RBC ratio of 421%. In the event of a decline in the RBC ratios of the insurance companies due to ratings downgrades in the investment portfolios, impairments, or other circumstances, we have available cash on hand and credit availability at the Parent Company to make additional contributions as necessary to maintain the ratio at or above 325%.
On a consolidated basis, Torchmark’s capital structure consists of short-term debt (comprised of the commercial paper outstanding discussed above), long-term funded debt, and shareholders’ equity. The outstanding long-term debt at book value, including our Junior Subordinated Debentures, was $914 million at June 30, 2011, compared with $913 million at December 31, 2010. An analysis of long-term debt issues outstanding is as follows at June 30, 2011.
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Long Term Debt at March 31, 2011
Instrument
Notes
Senior Notes
Issue expenses (1)
Total long-term debt
Junior Subordinated Debentures (2)
Shareholders’ equity was $3.8 billion at June 30, 2011.This compares with $4.0 billion at December, 31, 2010 and $3.9 billion at June 30, 2010.During the twelve months since June 30, 2010, shareholders’ equity was decreased by $833 million because of share purchases.However, shareholders’ equity has also been increased by unrealized gains of $81 million after tax in the fixed-maturity portfolio, as financial markets have improved over this period of time.Net income added over the same twelve-month period was $524 million.
As previously noted under the caption Highlights in this report, we acquired 14 million of our outstanding common shares under our share repurchase program during the first six months of 2011.These shares were acquired at a cost of $602 million ($43.05 per share), compared with purchases of 2 million shares at a cost of $75 million in the first six months of 2010.
We are required by GAAP to revalue our 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.
While GAAP requires our fixed-maturity assets to be revalued, it does not permit interest-bearing insurance policy liabilities supported by those assets to be valued at fair value in a consistent manner, with changes in value applied directly to shareholders’ equity. However, due to the size of both the investment portfolio and our policy liabilities, this inconsistency in measurement can have a material impact on shareholders’ equity.Because of the long-term nature of our fixed maturities and liabilities and the strong cash flows generated by our insurance subsidiaries, we have the intent and ability to hold our securities to maturity.As such, we do not expect to incur realized losses due to fluctuations in market value of fixed maturities caused by
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interest rate changes and temporarily illiquid markets.Accordingly, management removes the effect of this rule when analyzing Torchmark’s balance sheet, capital structure, and financial ratios in order to provide a more consistent and meaningful portrayal of the Company’s financial position from period to period.
The following table presents selected data related to capital resources.Additionally, the table presents the effect of this GAAP requirement on relevant line items, so that investors and other financial statement users may determine its impact on our capital structure.
Selected Financial Data
Fixed maturities (millions)
Deferred acquisition costs (millions) **
Assets of discontinued operations
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)
Interest coverage was 10.6 times in the 2011 six months, compared with 10.4 times in the 2010 period.Interest coverage is computed by dividing interest expense into the sum of pretax income and interest expense.
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New Unadopted Accounting Rules
The FASB has issued new accounting guidance potentially applicable to Torchmark, effective in future periods.
Comprehensive Income (ASU 2011-05). Under this guidance, the components of comprehensive income must be presented as either 1) a continuous statement (including the components of net income) or 2) as two separate but consecutive statements (an income statement followed by a comprehensive income statement).This guidance is effective for us in interim and annual periods beginning in 2012.Because we already present comprehensive income as contemplated by the second alternative, this guidance should not result in any change.
Fair Value Measurement and Disclosure (ASU 2011-04). The primary purpose of this new guidance is to converge the measurement criteria and disclosures of fair value in U.S. GAAP with those of International Accounting Standards.The measurement principles are generally consistent with current U.S. GAAP and are not expected to have a material impact on our financial statements.The guidance will require additional disclosures, including expanded disclosures for fair value measurements categorized in Level 3 of the fair value hierarchy and a requirement to disclose the level in the fair value hierarchy of items whose fair value is disclosed but not measured at fair value on the balance sheet. The guidance is effective for us in calendar 2012, with early adoption prohibited.
Cautionary Statements
We caution readers regarding certain forward-looking statements contained in the previous 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.We specifically disclaim any obligation to update or revise any forward-looking statement because of new information, future developments, or otherwise.
Forward-looking statements are based upon estimates and assumptions that are subject to significant business, economic and competitive uncertainties, many of which are beyond our 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
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the insurance industry generally, or applicable to Torchmark specifically.Such events or developments could include, but are not necessarily limited to:
Item 3. Quantitative and Qualitative Disclosures about Market Risk
There have been no quantitative or qualitative changes with respect to market risk exposure during the three months ended June 30, 2011.
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Item 4. Controls and Procedures
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 June 30, 2011, 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 June 30, 2011, there have not been any 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 which have materially affected, or are reasonably likely to materially affect, Torchmark’s internal control over financial reporting.No material weaknesses in such internal controls were identified in the evaluation and as a consequence, no corrective action was required to be taken.
Part II – Other Information
Item 1A. Risk Factors
Torchmark has had no material changes to its risk factors.
Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities
During the three months ended June 30, 2011, Torchmark issued 167,250 shares of restricted stock (as adjusted to reflect Torchmark’s three for two stock split) to certain of its senior executives under the Torchmark Corporation 2011 Incentive Plan (the “Plan”), valued in the aggregate amount of $7.4 million. Because Torchmark had not yet filed its registration statement on Form S-8 with respect to the Plan, it issued the shares in reliance on an exemption from registration contained in Section
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4(2) of the Securities Act of 1933, as amended (the “Securities Act”), or the common law “no sale” exemption for non-contributory issuances to employees.Such shares have not been registered under the Securities Act, or any state securities laws, and may not be offered or sold in the United States absent registration or an applicable exemption from registration requirements.This Quarterly Report on Form 10-Q does not constitute an offer to sell, or a solicitation of an officer to buy, any security and shall not constitute an offer, solicitation or sale in any jurisdiction in which such offering would be unlawful.
Period
April 1-30, 2011
May 1-31, 2011
June 1-30, 2011
All share information presented above reflects Torchmark’s three for two stock split.
At its April 28, 2011 meeting, the Board of Directors reaffirmed the Company’s share repurchase program in amounts and with timing that management, in consultation with the Board, determines to be in the best interest of the Company.The program has no defined expiration date or maximum shares to be repurchased.
Item 6. Exhibits
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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.
Gary L. Coleman, Executive Vice
President and Chief Financial Officer
(Principal Accounting Officer)
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