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, 2013
Commission File Number 1-8052
TORCHMARK CORPORATION
(Exact name of registrant as specified in its charter)
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 26, 2013
Common Stock,
$1.00 Par Value
Index of Exhibits (Page 57).
Total number of pages included are 58.
INDEX
PART I. FINANCIAL INFORMATION
Item 1.
Item 2.
Item 3.
Item 4.
Item 1A.
Item 6.
PART I–FINANCIAL INFORMATION
CONSOLIDATED BALANCE SHEETS
(Dollar amounts in thousands except per share data)
Investments:
Fixed maturities, available for sale, at fair value (amortized cost: 2013–$12,210,939 ; 2012–$11,963,406)
Equity securities, at fair value (cost: 2013–$875 ; 2012–$14,875)
Policy loans
Other long-term investments
Short-term investments
Total investments
Cash
Accrued investment income
Other receivables
Deferred acquisition costs
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: 2013–$1,156,108 ; 2012–$1,191,320)
Total liabilities
Shareholders’ equity:
Preferred stock, par value $1 per share–Authorized 5,000,000 shares; outstanding: -0- in 2012 and in 2011
Common stock, par value $1 per share–Authorized 320,000,000 shares; outstanding: (2013–105,812,123 issued, less 14,218,532 held in treasury and 2012–105,812,123 issued, less 11,576,487 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.
1
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, premium taxes, and non-deferred acquisition costs
Other operating expense
Interest expense
Total benefits and expenses
Income before income taxes
Income taxes
Net income
Basic net income per share
Diluted net income per share
Dividends declared per common share
2
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 assets
Total unrealized gains (losses)
Less applicable taxes
Unrealized gains (losses), net of tax
Unrealized gains (losses) attributable to deferred acquisition costs
Unrealized gains (losses) attributable to deferred acquisition costs, 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)
3
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
Equities and other long-term investments
Total investments sold or matured
Investments acquired:
Fixed maturities
Total investments acquired
Net increase in policy loans
Net (increase) decrease 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
Net borrowings (repayments) of commercial paper
Excess 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
Cash at end of period
4
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Note A—Accounting Policies
The accompanying condensed 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, 2013, and the consolidated results of operations, comprehensive income, and cash flows for the periods ended June 30, 2013 and 2012. The interim period condensed consolidated financial statements should be read in conjunction with the Consolidated Financial Statements that are included in the Form 10-K filed on February 28, 2013.
Note B—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*
*Antidilutive shares are excluded from the calculation of diluted earnings per share.
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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 the defined-benefit pension plans at June 30, 2013 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 $358 million at June 30, 2013 and $353 million at December 31, 2012. No cash contributions were made to the qualified pension plans during the six months ended June 30, 2013. Torchmark plans to make cash contributions not to exceed $20 million during the remainder of 2013. With respect to the Company’s non-qualified supplemental retirement plan, life insurance policies on the lives of plan participants have been established with an unaffiliated carrier to fund a portion of the Company’s obligations under the plan. These policies, as well as investments deposited with an unaffiliated trustee, were previously placed in a Rabbi Trust to provide for payment of the plan obligations. At June 30, 2013, the combined value of the insurance policies and investments in the Rabbi Trust to support plan liabilities were $60 million, compared with $54 million at year end 2012. This plan is unqualified. Therefore, the value of the insurance policies and investments are recorded as other assets in the Consolidated Balance Sheets and are not included in the chart of plan assets above. The liability for the unqualified pension plan was $60 million at June 30, 2013 and $59 million at December 31, 2012.
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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, 2013 is as follows.
Portfolio Composition as of June 30, 2013
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, 2013 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.
For the six months ended June 30,
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, 2013 Using:
Description
Percent of total
As of June 30, 2013, fair value measurements classified as Level 3 represented 1.6% of total fixed maturities and equity securities, compared with 2.1% at December 31, 2012. The decrease in Level 3 investments since December 31, 2012 was due primarily to the reclassification of $82 million private placement corporate bonds as Level 2. The private placement corporate bonds were reclassified to Level 2 due to the availability of values for these securities from independent sources that were closely correlated with values obtained from third-parties and indicated the use of observable inputs in valuation models.
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Other-Than-Temporary Impairments:
During the six months ended June 30, 2013, Torchmark wrote down investment real estate in the amount of $2.7 million pre-tax ($1.7 million after tax) because of other-than-temporary impairment. There were no other-than-temporary impairments during the six-month period ended June 30, 2012.
Unrealized Loss Analysis:
The following table discloses unrealized investment losses by class of investment at June 30, 2013. Torchmark considers these investments not to be other-than-temporarily impaired.
Analysis of Gross Unrealized Investment Losses
At June 30, 2013
Description of Securities
States, municipalities and political subdivisions
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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, 2013
As of December 31, 2012
Torchmark’s entire fixed-maturity and equity portfolio consisted of 1,628 issues at June 30, 2013 and 1,630 issues at December 31, 2012. The weighted average quality rating of all unrealized loss positions as of June 30, 2013 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 before they recover due to the strong and stable cash flows generated by its insurance products.
Torchmark’s balances related to bifurcated credit loss positions included in accumulated other comprehensive income were $22 million at June 30, 2013 and December 31, 2012, with no change to this balance during the period.
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Note E—Supplemental Information about Changes to Accumulated Other Comprehensive Income
An analysis in the change in balance by component of Accumulated Other Comprehensive Income is as follows for the three months and six months ended June 30, 2013.
Components of Accumulated Other Comprehensive Income
Balance at April 1, 2013
Other comprehensive income (loss) before reclassifications
Reclassifications
Balance at June 30, 2013
Balance at January 1, 2013
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Note E—Supplemental Information about Changes to Accumulated Other Comprehensive Income (continued)
Reclassifications out of Accumulated Other Comprehensive Income are presented below for the three months and six months ended June 30, 2013.
Reclassification Adjustments
Component Line Item
Affected line items in the
Statement of Operations
Unrealized gains (losses) on available for sale assets:
Realized (gains) losses
Amortization of (discount) premium
Total before tax
Tax
Total after tax
Pension adjustments:
Amortization of prior service cost
Amortization of actuarial gain (loss)
Total reclassifications (after tax)
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NOTE F—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 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 required interest 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.
The majority of the Company’s required interest on net policy liabilities (benefit reserves less the deferred acquisition cost asset) is not credited to policyholder accounts. Instead, it is an actuarial assumption for discounting cash flows in the computation of benefit reserves and the amortization of the deferred acquisition cost asset. Required interest related to the net policy liabilities is not included in the various insurance underwriting segments but is shown in the investment segment as a reduction to net investment income. We believe this presentation facilitates a more meaningful analysis of the Company’s underwriting and investment performance as the underwriting results are based on premiums, claims, and expenses and are not affected by unanticipated fluctuations in investment yields.
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 current
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NOTE F—Business Segments (continued)
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.
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 generally 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,
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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 quarterly risk-sharing adjustments are removed in the segment analysis because the actual contract payments are based upon the experience of the full contract year, not the experience of interim periods. 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 2012, the total premiums and benefits were the same under this alternative method as they were under GAAP and are expected to be essentially the same in 2013. The Company’s presentation results in the 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
Torchmark has invested in various limited partnerships that provide investment returns through the provision of low-income housing tax credits and other related Federal income tax benefits to the Company. The investment returns from a portion of the interests are guaranteed by unrelated third-parties. Under GAAP, expenses associated with the amortization of the guaranteed interests are required to be reflected in income tax expense. In contrast, GAAP requires the expenses associated with the amortization of non-guaranteed interests to be reflected as a component of “Net investment income.” All of the investment returns from investing in these guaranteed and non-guaranteed limited partnerships interests are in the form of income tax benefits reflected in income tax expense. Management believes including the amortization
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expense associated with the non-guaranteed as well as the guaranteed interests in income tax expense provides a more appropriate matching of the expense with the related income. For this reason, amortization expense of the non-guaranteed interests is included in “Income taxes” and not “Net investment income” for segment reporting purposes.
During the second quarter of 2013, Torchmark incurred two non-operating charges: (1) a state guaranty fund assessment in the amount of $1.2 million ($751 thousand after tax) and (2) a legal settlement related to a non-insurance matter in the amount of $500 thousand ($325 thousand after tax). The assessment related to Torchmark’s share of state guaranty fund assessments resulting from events in years prior to 2012. While these items are included in “Other operating expense” in the 2013 Consolidated Statement of Operations, the Company removes items related to prior years and non-operating items such as these from its segment analysis because management does not view such expenses as part of its core insurance operating 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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Premium
Expenses:
Policy benefits
Required interest on:
Policy reserves
Amortization of acquisition costs
Insurance administrative expense (2)
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 (4)
Deduct Guaranty Fund Assessment (5)
Deduct legal settlement expense (6)
Pretax income from continuing operations per Consolidated Statement of Operations
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Reconciliation of Segment Operating Information to the Consolidated Statement of Operations
Insurance administrative expense (3)
Deduct amortization of low-income housing (5)
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Note F—Business Segments (continued)
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
Investment
Other and corporate:
Administrative expense
Corporate
Pretax total
Applicable taxes
Reconciling items, net of tax:
Realized gains (losses) - Investments
Part D adjustment
Guaranty Fund Assessment
Legal settlement expense
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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Results of Operations
Acquisition. On November 1, 2012, Torchmark acquired Family Heritage Life Insurance Company of America (Family Heritage), a specialty insurer focused primarily on selling individual supplemental health insurance products through a captive agency force. The results of Family Heritage subsequent to our acquisition are included in this discussion primarily within our health insurance segment.
Summary of Operations. Torchmark’s operations are segmented into its insurance underwriting and investment operations as described in Note F—Business Segments. The measures of profitability described in Note F 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 F—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, 2013 and 2012. 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 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 2013 with the same period of 2012, unless otherwise noted. The following discussions are presented in the manner we view our operations, as described in Note F—Business Segments.
Highlights, comparing the first six months of 2013 with the first six months of 2012. Net income per diluted share increased 9% to $2.70 from $2.48. Included in net income in 2013 were immaterial realized investment gains ($0 per share) compared with gains of $6 million or $.06 per share in 2012. Realized investment gains and losses are presented more fully under the caption Realized Gains and Losses in this report.
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
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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 rose 9% in 2013 to $1.5 billion. Total net sales declined 5% to $241 million. After removing the impact of sales of Medicare Part D, which increased significantly in 2012 as a result of the addition of automatic enrollees discussed later in this report, net sales rose 9% to $224 million. Additionally, if the net sales of Family Heritage were excluded, net sales would have declined 2% to $201 million. First-year collected premium was $219 million for the 2013 period compared with $226 million for the 2012 period. Excluding Part D, there was an increase in first year premium of 14%.
Life insurance premium income grew 5% to $946 million. Life net sales declined 1% to $176 million. First-year collected life premium rose 1% to $131 million. Life underwriting margins increased 7% to $269 million.
Health insurance premium income, excluding Medicare Part D, rose 23% or $82 million to $440 million. The addition of Family Heritage accounted for $94 million of the additional premium in 2013. Health net sales, excluding Part D, rose 71% to $48 million for the six months, primarily as a result of the inclusion of Family Heritage health sales of $22 million. First-year collected health premium, excluding Part D, rose 67% to $50 million for the period. Again, the increase resulted primarily from the addition of Family Heritage health first-year premium of $18 million.
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 F—Business Segments, policyholder premium was $150 million in 2013 compared with $152 million in 2012, a decline of 2%. As discussed under the caption Health Insurance in this report, we expect a slight decline in Part D premium in the full year 2013.
As explained in Note F—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 $10 million after-tax charge to earnings in 2013 ($.10 per share) and a $14 million charge in 2012 ($.14 per share).
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We expect our 2013 full year benefit ratios to be approximately the same as those for interim periods, as was the case in 2012 and prior years. For this reason, there should be no difference in our segment versus financial statement reporting by year end 2013, as it relates to Medicare Part D. The decline in this adjustment in 2013 resulted primarily from an increase in the amount of government risk-sharing premium recognized in 2013 due to a change in plan design.
Excess investment income per diluted share decreased 8% in 2013 to $1.17 from $1.27, while the dollar amount of excess investment income declined 12% to $110 million. The lower decrease in per share excess investment income in relation to the decline in dollar amount resulted from share purchases over the past twelve months, as discussed later in this report. Net investment income rose $7 million, or 2%. While our average investment portfolio at amortized cost grew 10%, the average effective yield on the fixed-maturity portfolio, which represented 96% of our investments at amortized cost, decreased to 5.97% in the 2013 period from 6.46% in the prior period. This decrease was primarily due to lower new money rates and a large number of calls of bank-issued hybrid securities, as discussed under the caption Investments (excess investment income) later in this report. Excess investment income declined despite the $7 million increase in net investment income. This decline was caused by the $20 million, or 10%, increase in required interest on net insurance policy liabilities. Financing costs also rose 6% in the period to $42 million, as a result of increased debt outstanding in the 2013 period. Please refer to the discussion under Capital Resources for more information on debt and interest expense.
In the first six months of 2013, we invested new money in our fixed-maturity portfolio at an effective annual yield on new investments of 4.21%, compared with 4.64% in the same period of 2012. Our fixed maturity portfolio yield was 5.93% as of June 30, 2013 and the portfolio had an average rating of A-. Approximately 95% of the portfolio at amortized cost was investment grade at June 30, 2013. Cash and short-term investments were $148 million at that date, compared with $157 million at December 31, 2012.
The net unrealized gain position in our fixed-maturity portfolio declined from $1.6 billion at December 31, 2012 to $652 million during the first six months of 2013, largely due to an increase in market interest rates during the second quarter. 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 only insignificant exposure to European sovereign debt consisting of $11 million in German bonds.
Insurance administrative expenses rose 9% to $88 million, partially due to the addition of Family Heritage expenses. Increased pension costs were also a factor.
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We have an on-going share repurchase program which began in 1986 and was reaffirmed by the Board of Directors at their August, 2013 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, 2013 and 2012.
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 2013 with the first six months of 2012. Life insurance is our predominant segment, representing 62% of premium income and 69% of insurance underwriting margin in the first six months of 2013. 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 5% to $946 million. The following table presents Torchmark’s life insurance premium by distribution method.
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Life Insurance
Premium by Distribution Method
American Income Exclusive Agency
Direct Response
Liberty National Exclusive Agency
Other Agencies
Total Life Premium
Net sales, defined earlier in this report as an indicator of new business production, declined 1% to $176 million. While three of our four distribution groups had 1% or less declines in net sales over the prior year period, all three had sequential increases over the first quarter of 2013. An analysis of life net sales by distribution group is presented below.
Net Sales by Distribution Method
Total Life Net Sales
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First-year collected life premium, defined earlier in this report, was $131 million in the 2013 period, rising 1%. First-year collected life premium by distribution group is presented in the table below.
First-Year Collected Premium by Distribution Method
The American Income Exclusive Agency has historically marketed primarily to members of labor unions. While labor unions are still the premier market for this agency, American Income has diversified in recent years by focusing heavily on other affinity groups and referrals to help to ensure sustainable growth. The life business of this agency is Torchmark’s highest margin business and is the largest contributor to life premium of any of Torchmark’s distribution systems at 37% of Torchmark’s total life premium. This group produced premium income of $353 million, an increase of 9%. This agency is also our fastest growing life insurance agency on the basis of premium growth. First-year collected premium rose 4% to $65 million. However, net sales were flat at $78 million. Net sales for the second quarter of 2013 in this agency rose 8% over first quarter 2013 net sales. Increases in sales in our captive agencies are generally dependent on growth in the size of the agency force. The American Income agent count rose 4% to 5,540 at June 30, 2013 over the prior year (5,318). The count was also up 7% over the count at December 31, 2012 (5,176). The American Income Agency has been focusing on growing and strengthening middle management to support sustainable growth of the agency force. To accomplish this, we have placed an increased emphasis on agent training programs and financial incentives that appropriately reward agents at all levels for helping develop and train personnel. The agency has also begun providing more home-office and webinar training programs. These programs are designed to provide each agent, from new recruits to top level managers, coaching and instruction specifically designed for each individual’s level of experience and responsibilities.
The Direct Response Unit targets its market through a variety of direct-to-consumer marketing approaches which include direct mailings, insert media, internet, and inbound telephone calls. These different approaches support and complement one another in the unit’s efforts to reach the consumer. The Direct Response Unit’s growth has been fueled by constant innovation. In recent years, the internet and inbound call center production has grown rapidly as management has aggressively increased internet marketing activities and focused on driving traffic to the inbound call center. Direct Response focuses primarily on young and middle-income households with
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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 6% to $337 million, representing 36% of Torchmark’s total life premium in 2013. Net sales of $77 million for this group declined 1% due to declines in response rates, but increased 6% in the second quarter 2013 compared with the first quarter 2013. First-year collected premium fell 2% to $48 million.
We have introduced certain new initiatives to increase response rates in this unit. These initiatives include lower premium rates and offerings of higher face amounts on the adult products.
TheLiberty National Exclusive Agency markets life insurance to middle-income customers. Life premium income for this agency was $139 million in the 2013 period, a 2% decline compared with $142 million in the 2012 period. First-year collected premium declined 4% to $13 million.
Net sales for the Liberty Agency declined 1% to $15 million, but rose 15% in the quarter over first quarter 2013 net sales. Liberty had 1,283 producing agents at June 30, 2013, compared with 1,355 a year earlier, a decline of 5%. The agent count has declined 10% since December 31, 2012, when it stood at 1,419. Our long term plans to grow this agency involve expansion from small-town markets in the southeast to more densely populated areas with larger pools of potential agent recruits and customers. We opened four new offices in larger metropolitan areas during the second quarter and believe this will help reverse the recent decline in agent count and create long term agency growth.
We have changed the cost structure of this agency to a more commission-driven model, which has increased the profitability of new sales. Margins in the Liberty Agency were $36.7 million in 2013, compared with $35.1 million in 2012, an increase of 5% even as premium declined. As a percentage of premium they were 26% in 2013 versus 25% in 2012.
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 $117 million of life premium income, or 12% of Torchmark’s total in the 2013 period, but contributed only 3% of net sales.
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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 $269 million, increasing 7%. Increases in margin were due in large part to growth in premium income. Margin was also benefitted by a decreased rate of amortization of deferred acquisition costs due to improved persistency resulting from our conservation program and an increase in the deferral of internet-related direct response acquisition costs. As a percentage of premium, underwriting income was 28% in both periods.
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Health insurance, comparing the first six months of 2013 with the first six months of 2012. Health insurance sold by Torchmark includes primarily Medicare Supplement and Medicare Part D prescription drug coverage, cancer coverage, accident coverage, and other limited-benefit supplemental health products. All health coverage plans other than Medicare Supplement and 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 F—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 2013 period was $590 million, increasing 16%. A reconciliation between segment reporting for Medicare Part D and GAAP is presented in the chart in Note F—Business Segments, and those differences are fully discussed in that note. An analysis of the component of changes in our health premium income is as follows:
Reported health premium*
Part D risk sharing adjustment
Premium per segment analysis*
Including Part D health premium, health premium accounted for 38% of our total premium in the 2013 period, while the health underwriting margin accounted for 30% of total underwriting margin, reflective of the lower underwriting margin as a percent of premium for health compared with life insurance. 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.
Total health premium income rose 16% to $590 million. However, included in the 2013 quarter was $94 million of Family Heritage health premium. Excluding Family Heritage, health premium declined from $510 million in 2012 to $496 million in 2013.
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The following table is an analysis of our health premium by distribution method.
Health Insurance
United American Independent Agency
Limited-benefit plans
Medicare Supplement
Family Heritage Agency
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*
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Health insurance, excluding Medicare Part D. As noted earlier, health premium, excluding Part D premium, rose 23% to $440 million in the 2013 period. However, if the premium of Family Heritage were removed for comparability, health premium would have declined 3%. Medicare Supplement premium declined 2% to $215 million, while other limited-benefit health premium increased 63% to $225 million, including $94 million of Family Heritage premium. Because of the addition of Family Heritage, limited-benefit premium now provides Torchmark with the greatest amount of non-Part D health premium, representing 51% of such premium for the 2013 period, compared with only 39% a year earlier.
Health net sales, excluding Part D, increased 71% to $48 million, as a result of the inclusion of Family Heritage’s sales. Otherwise, sales would have declined 8%, as net sales for Medicare Supplement and limited-benefit products declined. Medicare Supplement net sales decreased 4% to $15 million in the 2013 period. Limited-benefit net sales, excluding Family Heritage, declined 12% to $11 million. Non-Part D health first-year collected premium rose 67% to $50 million. However, excluding Family Heritage first-year collected premium, first-year collected premium rose 5% to $31 million.
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. Premium income was $154 million, representing 35% of Torchmark’s total non-Part D health premium. Net sales were $13 million, or 28% of Torchmark’s non-Part D health sales. This agency is also Torchmark’s largest producer of Medicare Supplement insurance, with Medicare Supplement premium income of $140 million. UA Independent represents approximately 65% of all Torchmark Medicare Supplement premium and 85% of Medicare Supplement net sales. Medicare Supplement premium in this agency rose 2% and total health premium rose 1%. However, net sales of these products declined 2% in 2013.
The Family Heritage Agency was acquired in Torchmark’s acquisition of Family Heritage on November 1, 2012. This agency markets primarily limited-benefit supplemental health insurance in non-urban areas. Most of their policies include a cash-back feature, such as a return of premium whereby any excess of premiums over claims paid is returned to the policyholder at the end of a specified period stated within the insurance policy. Management expects to grow this agency through geographic expansion and incorporation of Torchmark’s recruiting programs. This agency contributed $94 million in health premium income during the six-month period of 2013, representing 21% of Torchmark’s total. Annualized health premium in force at June 30, 2013 was $195 million. Net sales for this group were $22 million in the 2013 six months. The producing agent count was 744 agents at June, 2013 compared with 702 at December, 2012.
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The Liberty National Exclusive Agency represented 29% of all Torchmark non-Part D health premium income at $125 million in 2013. The Liberty Agency markets limited-benefit health supplemental products consisting primarily of cancer insurance. Much of Liberty’s health business is now generated through worksite marketing targeting small businesses of 10 to 25 employees. In 2013, health premium income in the Agency declined 8% from prior year premium of $136 million. Liberty’s health premium decline has been due primarily to the runoff of a block of discontinued hospital-surgical products and the declining Medicare Supplement block resulting from reduced sales of Medicare Supplement products by this agency in recent years.
Other distribution. Certain of our other distribution channels market health products, although their main emphasis is on life insurance. On a combined basis, they accounted for 15% of health premium excluding Part D in the 2013 period. 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 also involved in marketing Medicare Part D. On a combined basis, the health net sales of these agencies excluding Part D declined 18%, from $7.3 million in 2012 to $6.0 million in 2013.
Medicare Part D. Coverage under Torchmark’s Medicare Part D prescription drug plan for Medicare beneficiaries is provided through United American. The Medicare Part D plan is a stand-alone prescription drug plan for Medicare beneficiaries which is regulated and partially funded by the Centers for Medicare and Medicaid Services (CMS) for participating private insurers. These products are marketed through our Direct Response unit and to groups through our UA Independent Agency. As described in Note F—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 2013 contract year, the same as it was for the full year 2012. We describe the differences between the segment analysis and the GAAP operating results in Note F. 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 2012.
Medicare Part D premium was $150 million in 2013, compared with $152 million in 2012, after removal of the risk-sharing adjustment in both periods. This represents a decrease in premium of 2%. Growth in premium in 2012 resulted from a new lower-cost Part D plan which qualified us to receive a large number of low-income automatic enrollees and to grow our own individual sales. However, we anticipate a slight decline
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in Part D premium for the full year 2013. Due to intensified price competition for the 2013 plan year, we did not qualify for as many new auto-enrollees in 2013 as we did in 2012, and thus we expect to have a lower average number of enrollees for 2013 than we had in 2012.
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 F—Business Segments.
Medicare Part D
Summary of Medicare Part D Results
Since the Medicare Part D plan is a government-sponsored program, 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 rose to $116 million or 21% in 2013. Family Heritage accounted for $18 million or 19% of the 21% increase. Medicare Part D underwriting income was flat at $16 million, while non-Part D health underwriting income, including Family Heritage’s added supplemental-health business, gained $20 million or 25% to $100 million in the period. As a percentage of health premium, underwriting margins rose 1% to 20%, primarily as a result of an improved claim ratio at American Income.
Annuities. While we do underwrite annuities, they represent an insignificant part of our business and are not expected to be important to our marketing strategy going forward.
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Operating expenses, comparing the first six months of 2013 with the first six months of 2012. 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
Total insurance administrative expenses
Parent company expense
Total operating expenses, perConsolidated Statements of Operations
Increase (decrease) over prior year
Total operating expenses:
Insurance administrative expenses increased $8 million or 9% in 2013 when compared with the prior year period. Of the $8 million increase, $5 million was due to the addition of Family Heritage’s administration expense. As a percentage of total premium, insurance administrative expenses rose slightly from 5.6% to 5.7%. Total operating expenses rose 12% in 2013. In 2013, employee costs increased 20%, primarily as a result of increased pension benefit costs. Stock compensation expense rose 15% to $13 million, primarily as a result of an increase in the market price of Torchmark stock in 2012 and 2013, which caused higher grant prices for restricted stock and options. As described in Note F in the Consolidated Financial Statements, we recorded two non-operating charges during the 2013 six months, a state guaranty fund assessment and a legal settlement involving a non-insurance matter.
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Investments (excess investment income), comparing the first six months of 2013 with the first six months of 2012. 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 F—Business Segments in the Notes to the Consolidated Financial Statements. It is defined as net investment income less the required interest on 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 $5.6 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.
The following table summarizes Torchmark’s investment income, excess investment income, and excess investment income per diluted share.
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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
Average 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 2013 period declined 12% to $110 million. Excess investment income has been pressured in recent periods as a result of the impact of lower interest rates on net investment income coupled with the increase in required interest on net policy liabilities discussed later under this caption. However, excess investment income per share only declined by 8% as a result of our share purchases over the past 12 months. Net investment income rose $7 million or 2% in 2013, while average invested assets (with fixed maturities at amortized cost) rose 10% year over year. In the 2013 six months, fixed maturity yields averaged 5.97% on a tax-equivalent and effective-yield basis, compared with 6.46% a year earlier. This was primarily a result of new money being invested during the period at rates lower than the average portfolio yield. While Family Heritage added $11 million to net investment income during 2013, its lower-yielding portfolio contributed to the decline in the average fixed-maturity yield.
Another factor negatively affecting net investment income was calls of fixed-maturity securities. During late 2012 and the first half of 2013, we had an unusually large number of these calls, including $467 million of bank-issued hybrid securities. Fixed maturity securities are more likely to be called in a declining interest-rate environment, as these callable securities can usually be refinanced at lower prevailing rates. In addition to bonds with scheduled call dates, our portfolio includes bank-issued
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hybrid securities with provisions allowing the security to be called in the event of a change in capital treatment. Many banks chose to call their hybrid securities in 2012, and to a lesser extent in 2013, because the Dodd-Frank Act phases out the partial equity credit historically allowed for these securities. Of our $12.2 billion fixed maturity portfolio at amortized cost as of June 30, 2013, we held $134 million book value of bank hybrid securities with a weighted average yield of 6.87% that were callable without a make-whole provision and $113 million of other fixed maturity securities with a weighted average yield of 6.64% that were callable solely at the discretion of the issuer but that had not been called at June 30, 2013. In addition, we also held $270 million book value of non-bank hybrid securities with a weighted average yield of 5.45% that become callable solely at the discretion of the issuer on various scheduled dates during the next three years. Many factors can be involved in an issuer’s decision to call a bond. Therefore, it is difficult to predict whether or not a bond will be called in the future, and, if so, when it will be called. If these bonds were to be called, there would be a reduction in future net investment income as long as the average yield on called securities exceeds prevailing new money rates. Approximately 66% of the bank hybrid securities were rated below-investment-grade. If called, both the ratio of below-investment-grade securities to our investment portfolio and statutory required capital would also decrease.
Excess investment income is reduced by the required interest on net insurance policy liabilities, because we consider these amounts to be components of the profitability of our insurance segments. Required interest is based on the actuarial interest assumptions used in discounting the benefit reserve liability and the amortization of deferred acquisition costs for our insurance policies in force. Essentially all of our life and health insurance policies are fixed interest-rate protection policies, not investment products, and are accounted for under current accounting guidance for long-duration insurance products (formerly SFAS 60, now incorporated into ASC 944-20-05), which mandates that interest rate assumptions be “locked in” for the life of that block of business. Each calendar year, we set the discount rate to be used to calculate the benefit reserve liability and the deferred acquisition cost asset for all insurance policies issued that year. That rate is based on the new money yields that we expect to earn on premiums received in the future from policies of that issue year, and cannot be changed.
The discount rate used for policies issued in the current year has no impact on the in force policies issued in prior years as the rates of all prior issue years are also locked in. As such, the overall discount rate for the entire in force block is a weighted average of the discount rates being used from all issue years. Changes in the overall weighted-average discount rate over time are caused by changes in the mix of the reserves and the deferred acquisition cost asset by issue year on the entire block of in force business. Business issued in the current year has very little impact on the overall weighted-average discount rate due to the size of our in force business.
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Required interest on net insurance policy liabilities increased $20 million or 10% to $215 million. The increase in required interest was slightly lower than the 12% growth in average net interest-bearing insurance policy liabilities, primarily due to the impact of Family Heritage.
Financing costs rose 6% or $2.5 million to $42 million, as a result of a $2.7 million increase in additional interest from the funded debt restructuring that occurred in late 2012. Because our $94 million 7 3/8% Notes mature in August, 2013, interest on funded debt after that date will decline. More information concerning debt can be found in the Capital Resources section of this report.
As previously mentioned, excess investment income is pressured when growth in income from the portfolio is less than growth of the required interest related to net policy liabilities and financing costs, such as we have experienced in recent periods. In an extended low-interest-rate environment, the portfolio yield will tend to decline as we invest new money at lower long-term rates. We believe, however, that any decline would be relatively slow, as only 2% to 3% of fixed maturities on average are expected to run off each year over the next five years. This run off assumes the call of the bank hybrids previously discussed.
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. Even a sudden, significant increase in interest rates would be beneficial because Torchmark has very little disintermediation risk. Also, we are not concerned with potential interest-rate driven unrealized losses in our fixed maturity portfolio because we have the intent, and more importantly, the ability to hold our fixed maturities to maturity.
In response to the lower interest rates and their negative impact on margins, we raised the premium rates for new business on major life products in 2012. The increased premium provides additional margin to help offset the possible future reductions in excess investment income and have not had a detrimental impact on sales.
Because actuarial discount rates are locked in for life on essentially all of our business, benefit reserves and deferred acquisition costs are not affected by changes in investment yields unless a loss recognition event occurs. Due to the strength of our underwriting margins and the current positive spread between the yield on our investment portfolio and the weighted-average discount rate of our in force block, we do not expect that an extended low-interest-rate environment will cause a loss recognition event for Torchmark.
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Investments (acquisitions), comparing the first six months of 2013 with the first six months of 2012. 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 available longer-term securities do not meet our quality and yield objectives, new money is generally 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 non-callable 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
Total fixed-maturity acquisitions
Effective annual yield *
Average life, in years to:
Next call
Maturity
Average rating
Acquisitions in both periods consisted primarily of corporate bonds, with securities spanning a diversified range of issuers, industry sectors, and geographical regions. All of the acquired securities were investment grade.
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Investments (portfolio composition). The composition of the investment portfolio at book value on June 30, 2013 was as follows:
Invested Assets At June 30, 2013
% ofTotal
Fixed maturities(at amortized cost)
Equities (at cost)
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 approximately 3% of our investments. We also have insignificant investments in equity securities 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.
Fixed Maturities. The following table summarizes certain information about our fixed-maturity portfolio by component at June 30, 2013.
Fixed Maturities by Component
Redeemable preferred stock
Municipals
Government-sponsored enterprises
Governments & agencies
Residential mortgage-backed*
At June 30, 2013, fixed maturities had a fair value of $12.9 billion, compared with $13.5 billion at December 31, 2012. The net unrealized gain position in the fixed-maturity portfolio declined from a net gain of $1.6 billion at December 31, 2012 to a net gain of $652 million at June 30, 2013, as a result of an increase in market interest rates. While our June 30, 2013 net unrealized gain of $652 million consisted of gross unrealized gains of $973 million offset by $321 million of gross unrealized losses, our December, 2012 net unrealized gain consisted of a gross unrealized gain of $1.7 billion and gross unrealized loss of $89 million.
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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, 2013.
Fixed Maturities by Sector
Financial - Life/Health/PC Insurance
Financial - Bank
Financial - Other
Subtotal Financial
Utilities
Energy
Government (US, municipal, and foreign)
Basic Materials
Consumer, Non-cyclical
Other Industrials
Communications
Transportation
Consumer, Cyclical
Mortgage-backed Securities
At June 30, 2013, approximately 44% of the fixed-maturity assets at amortized cost and fair value were in the financial and utility sectors. The balance of the portfolio is spread among 403 issuers in a wide variety of sectors. The financial sector had a net unrealized gain of $204 million at June 30, 2013, compared with a gain of $339 million at December 31, 2012. We expect our investment in temporarily impaired securities to be fully recoverable.
An analysis of the fixed-maturity portfolio at June 30, 2013 by a composite quality 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.
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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 $12.2 billion of fixed maturities at June 30, 2013, $11.6 billion or 95% at amortized cost were investment grade with an average rating of A-. Below-investment-grade bonds were $585 million with an average rating of B+ and were 5% of fixed maturities, the same as at the end of 2012. Below-investment-grade bonds at amortized cost were 17% of our shareholders’ equity, excluding the effect of unrealized gains and losses on fixed maturities as of June 30, 2013. Overall, the total portfolio was rated A- based on amortized cost, the same as at the end of 2012.
An analysis of the changes in our portfolio of below-investment-grade bonds at amortized cost during the first six months of 2013 is as follows:
Balance as of December 31, 2012
Downgrades by rating agencies
Upgrades by rating agencies
Disposals
Amortization and other
Balance as of June 30, 2013
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
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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, we have no off-balance sheet investments, and we have only insignificant exposure to European Sovereign debt consisting of $11 million in German bonds.
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 2013 with the first six months of 2012. As discussed inNote F—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, resulting in realized gains or losses. Because these dispositions and writedowns are outside the course of our normal operations, 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.
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
Real estate writedown*
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 Company. In the first six months of 2013, the Parent Company received $221 million of cash dividends from life insurance subsidiaries and $29 million of
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transfers from non-life subsidiaries. This compared with $229 million in 2012, including certain transfers. For the full year 2013, cash dividends from the life insurance subsidiaries are expected to total approximately $457 million and transfers from the non-life subsidiaries are expected to be $55 million.
Additional sources of liquidity for the Parent Company are cash, intercompany receivables, and a credit facility. At June 30, 2013, the Parent Company had $138 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 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 either borrow from 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 January 7, 2015. In accordance with the agreement, we are subject to certain covenants regarding capitalization and interest coverage with which we were in full compliance at June 30, 2013.
Included in short-term debt is the commercial paper outstanding, noted above, as well as the current maturity of long-term debt. At June 30, 2013, we had $94 million par value and carrying value of our 7 3/8% Notes due in August, 2013 classified as short-term debt. We intend to redeem these Notes with funds held at the Parent Company. The following table presents certain information about our commercial paper borrowings.
Short-term Borrowings - Commercial Paper
Balance at end of period (par value)
Annualized interest rate
Letters of credit outstanding
Remaining amount available under credit line
Average balance outstanding during period (par value)
Daily-weighted average interest rate*
Maximum daily amount outstanding during period (par value)
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Our balance of commercial paper outstanding at June 30, 2013 was $255 million, up approximately $30 million from the balance at the previous year end. We have had no difficulties in accessing the commercial paper market under this facility during the six-month periods ended June 30, 2013 and 2012.
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 $492 million in the first six months of 2013, compared with $447 million in the same period of 2012. In addition to cash inflows from operations, our companies have received $288 million in investment calls and tenders and $82 million in scheduled maturities or repayments during the 2013 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 $148 million at June 30, 2013, compared with $157 million at December 31, 2012 and $180 million at the end of June, 2012. In addition to these liquid assets, the entire $12.9 billion (fair value at June 30, 2013) 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 highly 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 regulatory capital under Risk-Based Capital (RBC), a measure established by insurance regulatory authorities to monitor the adequacy of capital. 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, 2012, our insurance subsidiaries had a consolidated RBC ratio of 347%. 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%.
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On a consolidated basis, Torchmark’s capital structure consists of short-term debt (comprised of the commercial paper outstanding discussed above and the current maturity of long-term debt issues), long-term funded debt, and shareholders’ equity. The outstanding long-term debt at book value was $990 million at June 30, 2013, the same as it was at December 31, 2012. An analysis of long-term debt issues outstanding is as follows at June 30, 2013.
Long Term Debt at June 30, 2013
Instrument
Senior Notes
Senior Notes(1)
Notes
Junior Subordinated Debentures
Junior Subordinated Debentures (2)
Total long-term debt
In addition to the long-term fund debt issues listed above, we have outstanding $94 million principal amount of our 7 3/8% Notes due in August, 2013. These notes have been reclassified as short-term debt because they mature within one year.
During the third quarter of 2012, we issued $300 million principal amount of our 3.8% Senior Notes and $125 million of our 5 7/8% Junior Subordinated Debentures. As a part of the offering of the 3.8% Senior Notes, $150 million principal amount were purchased by our insurance subsidiaries and were eliminated in consolidation. Proceeds from the Senior Notes provided a portion of the funding for the Family Heritage purchase in November, 2012. In the fourth quarter of 2012, we used the proceeds from the Junior Subordinated Debentures to call and redeem our 7.1% Trust Originated Preferred Securities in the principal amount of $120 million. Additionally, in the fourth quarter of 2012, we assumed $20 million principal amount of floating-rate Junior Subordinated Debentures as part of the acquisition price of Family Heritage. Interest is computed as the three-month LIBOR plus 330 basis points. These debt transactions in 2012 resulted in approximately $2.7 million in increased interest cost in the first six months of 2013.
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Shareholders’ equity was $3.8 billion at June 30, 2013. This compares with $4.4 billion at December, 31, 2012 and $4.0 billion at June 30, 2012. During the six months since December 31, 2012, shareholders’ equity was decreased by $246 million because of share purchases. Equity was also decreased by after-tax unrealized losses of $595 million in the fixed-maturity portfolio, as interest rates have risen over this period of time. Net income added $254 million over the same six-month period.
As previously noted under the caption Highlights in this report, we acquired 3.0 million of our outstanding common shares under our share repurchase program during the first six months of 2013. These shares were acquired at a cost of $180 million (average of $59.26 per share), compared with purchases of 5.8 million shares at a cost of $274 million in the first six months of 2012.
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 gains or losses due to fluctuations in the market value of fixed maturities caused by interest rate changes or losses caused by 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.
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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 (2)
Diluted shares outstanding (thousands)
Actual shares outstanding (thousands)
Interest coverage was 9.8 times in the 2013 six months, compared with 10.1 times in the 2012 period. Interest coverage is computed by dividing interest expense into the sum of pretax income and interest expense.
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
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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:
Changing general economic conditions leading to unexpected changes in lapse rates and/or sales of our policies, as well as levels of mortality, morbidity, and utilization of health care services that differ from Torchmark’s assumptions;
Regulatory developments, including changes in governmental regulations (particularly those impacting taxes and changes to the Federal Medicare program that would affect Medicare Supplement and Medicare Part D insurance);
Market trends in the senior-aged health care industry that provide alternatives to traditional Medicare (such as Health Maintenance Organizations and other managed care or private plans) and that could affect the sales of traditional Medicare Supplement insurance;
Interest rate changes that affect product sales and/or investment portfolio yield;
General economic, industry sector or individual debt issuers’ financial conditions that may affect the current market value of securities we own, or that may impair an issuer’s ability to make principal and/or interest payments due on those securities;
Changes in pricing competition;
Litigation results;
Levels of administrative and operational efficiencies that differ from our assumptions;
Our inability to obtain timely and appropriate premium rate increases for health insurance policies due to regulatory delay;
The customer response to new products and marketing initiatives; and
Reported amounts in the financial statements which are based on management’s estimates and judgments which may differ from the actual amounts ultimately realized.
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 six months ended June 30, 2013.
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Item 4. Controls and Procedures
Torchmark, under the direction of the Co-Chief Executive Officers 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 Co-Chief Executive Officers 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, 2013, an evaluation was performed under the supervision and with the participation of Torchmark management, including the Co-Chief Executive Officers 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 Co-Chief Executive Officers 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, 2013, 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 1. Legal Proceedings
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. 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
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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. Torchmark’s management recognizes that large punitive damage awards bearing little or no relation to actual damages continue to be awarded by juries in jurisdictions in which Torchmark and its subsidiaries have substantial business, particularly Alabama and Mississippi, creating the potential for unpredictable material adverse judgments in any given punitive damage suit.
As previously reported in filings with the SEC, Torchmark and its subsidiary, United American were named as defendants in purported class action litigation filed November 27, 2012 in U. S. District Court for the Southern District of California (Friedman, et al. v. Torchmark Corporation, et al., Case No. 12CV2837 IEGBGS). In the litigation, filed on behalf of a nationwide class of persons who had, within four years of the filing of the complaint, received any sales or solicitation telephone calls from Torchmark and United American to telephone numbers registered with the National Do Not Call Registry and who had not maintained a business relationship with the defendants within eighteen months of receiving defendants’ calls, plaintiff asserted violations of the Telephone Consumer Protection Act (47 U.S.C. 27 et seq.) by virtue of pre-recorded calls inviting the plaintiff to contact United American to attend a “recruiting webinar”. Monetary damages for each separate violation of TCPA were sought. On January 3, 2013, motions to dismiss were filed on behalf of Torchmark (not objected to by plaintiff) and United American (objected to by plaintiff). The Court granted Torchmark’s motion to dismiss on February 20, 2013 and United American’s motion to dismiss on April 16, 2013, with leave to the plaintiff to file an amended complaint against Untied American by May 7, 2013. Plaintiff filed an amended complaint on May 7, 2013, and on May 17, 2013, United American filed a motion to dismiss this amended complaint, which has been opposed by the plaintiff. The Court has not yet ruled on United American’s motion to dismiss.
Torchmark’s subsidiary, First United American Life Insurance Company was named as a defendant in litigation filed August 5, 2011 in New York Supreme Court, King’s County (Maimonides Medical Center v. First United American Life Insurance Company, Index No. 17935/2011). In the litigation, Maimonides, a New York not-for-profit hospital, alleged that First United American owes approximately $15 million in unpaid claims for medical services provided to six of First United American’s Medicare supplement insureds who have exhausted Medicare. Maimonides asserted that New York Insurance Law §3224-a (the “Prompt Pay Law”) mandates that once Medicare is exhausted, the Medicare supplement insurer must pay the provider’s billed amounts as opposed to the Medicare-approved amounts, which were the amounts paid by First United American. First United American filed a partial motion to dismiss based upon the lack of a private right of action under New York’s Prompt Pay Law in October 2011. The Court denied the motion to dismiss on February 22, 2012, holding that Maimonides
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could bring a private cause of action. First United American appealed this ruling to the Appellate Division in March 2012 and oral arguments on the appeal were held in May 2013. Mediation of this matter is scheduled on August 6, 2013.
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
Period
April 1-30, 2013
May 1-31, 2013
June 1-30, 2013
At its August 7, 2013 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.
Date: August 8, 2013
/s/ Larry M. Hutchison
Larry M. Hutchison
/s/ Gary L. Coleman
/s/ Frank M. Svoboda
Executive Vice President and Chief Financial Officer
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