10-K 1 d10k.htm 10-K 10-K
Table of Contents
Index to Financial Statements

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

 

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

 

For the fiscal year ended December 31, 2007

 

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from                              to                             

 

Commission file number: 001-08052

 

TORCHMARK CORPORATION

(Exact name of registrant as specified in its charter)

 

Delaware   63-0780404
(State or other jurisdiction of
incorporation or organization)
  (I.R.S. Employer
Identification No.)
3700 South Stonebridge Drive, McKinney, TX   75070
(Address of principal executive offices)   (Zip Code)

 

972-569-4000

(Registrant’s telephone number, including area code)

 

None

(Former name, former address and former fiscal year, if changed since last report)

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class


 

CUSIP


 

Name of each exchange on
which registered


Common Stock, $1.00 par value per share   891927104   New York Stock Exchange
    The International Stock Exchange, London, England
7.10% Trust Originated Preferred Securities   89102W208   New York Stock Exchange

 

Securities registered pursuant to Section 12(g) of the Act:     None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes  x      No  ¨    

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes  ¨      No  x    

 

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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer       x

   Accelerated filer   ¨

Non-accelerated filer         ¨

   Smaller reporting company   ¨

(Do not check if a smaller reporting company)

   

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes  ¨      No  x

 

As of June 30, 2007, the aggregate market value of the registrant’s common stock held by non-affiliates of the registrant was $6,284,476,586 based on the closing sale price as reported on the New York Stock Exchange.

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

Class


  

Outstanding at January 31, 2008


Common Stock, $1.00 par value per share    90,969,385 shares

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Document


  

Parts Into Which Incorporated


Proxy Statement for the Annual Meeting of Stockholders to
be held April 24, 2008 (Proxy Statement)
   Part III


Table of Contents
Index to Financial Statements

TORCHMARK CORPORATION

INDEX

 

               Page

PART I.

              
    

Item 1.

  

Business

     1
    

Item 1.A.

  

Risk Factors

     5
    

Item 1.B.

  

Unresolved Staff Comments

     8
    

Item 2.

  

Properties

     9
    

Item 3.

  

Legal Proceedings

     9
    

Item 4.

  

Submission of Matters to a Vote of Security Holders

   12

PART II.

              
    

Item 5.

   Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities   

12

    

Item 6.

  

Selected Financial Data

   14
    

Item 7.

   Management’s Discussion and Analysis of Financial Condition and Results of Operations   

15

    

Item 7.A.

  

Quantitative and Qualitative Disclosures about Market Risk

   49
    

Item 8.

  

Financial Statements and Supplementary Data

   50
    

Item 9.

   Changes in and Disagreements with Accountants on Accounting and Financial Disclosure   

102

    

Item 9.A.

  

Controls and Procedures

   102
    

Item 9.B.

  

Other Information

   102

PART III.

              
    

Item 10.

  

Directors, Executive Officers, and Corporate Governance

   105
    

Item 11.

  

Executive Compensation

   105
    

Item 12.

   Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters   

105

    

Item 13.

   Certain Relationships and Related Transactions and Director Independence   

105

    

Item 14.

  

Principal Accountant Fees and Services

   105

PART IV.

              
    

Item 15.

   Exhibits and Financial Statement Schedules    106


Table of Contents
Index to Financial Statements

PART 1

 

Item 1.    Business

 

Torchmark Corporation (Torchmark) is an insurance holding company incorporated in Delaware in 1979. Its primary subsidiaries are American Income Life Insurance Company (American Income), Liberty National Life Insurance Company (Liberty), Globe Life And Accident Insurance Company (Globe), United American Insurance Company (United American), and United Investors Life Insurance Company (United Investors).

 

Torchmark’s website is: www.torchmarkcorp.com. Torchmark makes available free of charge through its website, its annual report on Form 10-K, its quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports as soon as reasonably practicable after they have been electronically filed with or furnished to the Securities and Exchange Commission.

 

The following table presents Torchmark’s business by primary marketing distribution method.

 

Primary
Distribution Method
  Company   Products and Target Markets   Distribution

 
Direct Response  

Globe Life And Accident Insurance Company

Oklahoma City, Oklahoma

  Individual life and supplemental health insurance including juvenile and senior life coverage, Medicare Supplement, and Medicare Part D marketed to middle-income Americans.   Direct response, mail, television, magazine; nationwide.

Liberty National Exclusive Agency  

Liberty National Life Insurance Company

Birmingham, Alabama

  Individual life and supplemental health insurance marketed to middle-income families.   2,060 producing agents; 130 district offices primarily in the Southeastern U.S.

American Income Exclusive Agency  

American Income Life Insurance Company

Waco, Texas

  Individual life and supplemental health insurance marketed to union and credit union members.   2,545 producing agents in the U.S., Canada, and New Zealand.

United American Independent Agency and Branch Office Agency  

United American
Insurance Company

McKinney, Texas

  Limited-benefit supplemental health coverage to people under age 65, Medicare Supplement and Medicare Part D coverage to Medicare beneficiaries and, to a lesser extent, life insurance.   3,439 independent producing agents in the U.S. and Canada; 2,979 exclusive producing agents in 155 branch offices.

 

Additional information concerning industry segments may be found in Management’s Discussion and Analysis and in Note 13—Business Segments in the Notes to the Consolidated Financial Statements.

 

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Insurance

 

Life Insurance

 

Torchmark’s insurance subsidiaries write a variety of nonparticipating ordinary life insurance products. These include traditional and interest sensitive whole-life insurance, term life insurance, and other life insurance. The following table presents selected information about Torchmark’s life products.

 

     (Amounts in thousands)
     Annualized Premium in Force

     2007

   2006

   2005

Whole life:

                    

Traditional

   $ 975,475    $ 934,553    $ 911,444

Interest-sensitive

     118,701      123,802      128,409

Term

     525,279      506,921      492,409

Other

     53,410      50,211      45,373
    

  

  

     $ 1,672,865    $ 1,615,487    $ 1,577,635
    

  

  

 

The distribution methods for life insurance products include sales by direct response, exclusive agents and independent agents. These methods are described in more depth in the Distribution Method chart earlier in this report. The following table presents life annualized premium in force by distribution method.

 

     (Amounts in thousands)
     Annualized Premium in Force

     2007

   2006

   2005

Direct response

   $ 530,137    $ 496,772    $ 472,733

Exclusive Agents:

                    

American Income

     469,486      430,598      403,333

Liberty National

     304,584      311,975      318,435

United American

     18,140      16,710      17,315

Independent Agents:

                    

United American

     34,758      39,613      44,819

Other

     315,760      319,819      321,000
    

  

  

     $ 1,672,865    $ 1,615,487    $ 1,577,635
    

  

  

 

Health Insurance

 

Torchmark offers supplemental limited-benefit health insurance products that include hospital/surgical plans, cancer, and accident plans sold to individuals under age 65. These policies are designed to supplement health coverage that applicants already own or to provide affordable, limited-benefit coverage to individuals without access to more comprehensive coverage. Medicare Supplements are also offered to enrollees in the traditional fee-for-service Medicare program. All Medicare Supplement plans are standardized by federal regulation and are designed to pay deductibles and co-payments not paid by Medicare. We also began offering Medicare Part D prescription drug insurance in 2006.

 

Health plans are offered through the Company’s exclusive and independent agents and direct response, with the United American agencies being the leading writers in the three-year period ended December 31, 2007, selling predominantly hospital/surgical plans. As shown in the charts below, net sales of limited-benefit plans exceeded net sales of Medicare Supplements in all years of the three-year-period ended December 31, 2007, but Medicare Supplement premium in force exceeded that of limited-benefit plans during 2006 and 2005. At December 31, 2007, limited-benefit health premium in force exceeded Medicare Supplement for the first time since Torchmark’s formation. These data reflect the change in product mix being sold from predominantly Medicare Supplements in prior years to predominantly limited-benefit plans in the more current periods.

 

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The following table presents health insurance net sales information for the three years ended December 31, 2007 by product category. Net sales for Medicare Part D represent only new first-time enrollees.

 

     (Amounts in thousands)

 

Net Sales


     2007

   2006

   2005

     Amount

   % of
Total


   Amount

   % of
Total


   Amount

   % of
Total


Limited-benefit plans

   $ 207,467    75    $ 209,258    40    $ 146,193    79

Medicare Supplement

     31,902    11      33,980    7      39,328    21

Medicare Part D

     37,913    14      278,023    53      -0-    -0-
    

  
  

  
  

  

Total Health

   $ 277,282    100    $ 521,261    100    $ 185,521    100
    

  
  

  
  

  

 

The following table presents supplemental health annualized premium information for the three years ended December 31, 2007 by product category.

     (Amounts in thousands)

 

Annualized Premium in Force


     2007

   2006

   2005

     Amount

   % of
Total

   Amount

   % of
Total


   Amount

   % of
Total


Limited-benefit plans

   $ 519,994    42    $ 508,112    39    $ 434,742    42

Medicare Supplement

     518,205    42      550,750    43      591,668    58

Medicare Part D

     195,685    16      234,219    18      -0-    -0-
    

  
  

  
  

  

Total Health

   $ 1,233,884    100    $ 1,293,081    100    $ 1,026,410    100
    

  
  

  
  

  

 

The number of health policies in force (excluding Medicare Part D) was 1.56 million, 1.60 million, and 1.60 million at December 31, 2007, 2006, and 2005, respectively. Medicare Part D enrollees at December 31, 2006 were approximately 189 thousand to begin the 2007 plan year, but are expected to decline slightly for the 2008 plan year.

 

The following table presents supplemental health annualized premium in force for the three years ended December 31, 2007 by marketing (distribution) method.

 

     (Amounts in thousands)
     Annualized Premium in Force

     2007

   2006

   2005

Direct response

   $ 44,708    $ 41,996    $ 39,446

Exclusive agents:

                    

United American

     395,773      385,505      337,175

Liberty National

     140,802      148,817      145,341

American Income

     67,976      63,810      60,747

Independent agents:

                    

United American

     388,940      418,734      443,701
    

  

  

       1,038,199      1,058,862      1,026,410

Medicare Part D

     195,685      234,219      -0-
    

  

  

     $ 1,233,884    $ 1,293,081    $ 1,026,410
    

  

  

 

Annuities

 

Annuity products offered include single-premium deferred annuities, flexible-premium deferred annuities, and variable annuities. In recent years Torchmark has deemphasized the marketing of annuity products. Annuities in 2007 comprise less than 1% of premium income and less than 2% of insurance underwriting margin.

 

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Pricing

 

Premium rates for life and health insurance products are established using assumptions as to future mortality, morbidity, persistency, and expenses, all of which are generally based on Company experience and on projected investment earnings. Revenues for individual life and health insurance products are primarily derived from premium income, and, to a lesser extent, through policy charges to the policyholder account values on certain individual life products. Profitability is affected to the extent actual experience deviates from the assumptions made in pricing and to the extent investment income varies from that which is required for policy reserves.

 

Collections for annuity products and certain life products are not recognized as revenues but are added to policyholder account values. Revenues from these products are derived from charges to the account balances for insurance risk and administrative costs. Profits are earned to the extent these revenues exceed actual costs. Profits are also earned from investment income on the deposits invested in excess of the amounts credited to policyholder accounts.

 

Underwriting

 

The underwriting standards of each Torchmark insurance subsidiary are established by management. Each subsidiary uses information from the application and, in some cases, telephone interviews with applicants, inspection reports, doctors’ statements and/or medical examinations to determine whether a policy should be issued in accordance with the application, with a different rating, with a rider, with reduced coverage or rejected.

 

Reserves

 

The life insurance policy reserves reflected in Torchmark’s financial statements as future policy benefits are calculated based on generally accepted accounting principles (GAAP). These reserves, with premiums to be received in the future and the interest thereon compounded annually at assumed rates, must be sufficient to cover policy and contract obligations as they mature. Generally, the mortality and persistency assumptions used in the calculations of reserves are based on Company experience. Similar reserves are held on most of the health policies written by Torchmark’s insurance subsidiaries, since these policies generally are issued on a guaranteed-renewable basis. A list of the assumptions used in the calculation of Torchmark’s reserves are reported in the financial statements (See Note 5Future Policy Benefit Reserves in the Notes to the Consolidated Financial Statements). Reserves for annuity products and certain life products consist of the policyholders’ account values and are increased by policyholder deposits and interest credited and are decreased by policy charges and benefit payments.

 

Investments

 

The nature, quality, and percentage mix of insurance company investments are regulated by state laws. The investments of Torchmark insurance subsidiaries consist predominantly of high-quality, investment-grade securities. Fixed maturities represented 94% of total investments at December 31, 2007. (See Note 3Investments in the Notes to the Consolidated Financial Statements and Management’s Discussion and Analysis.)

 

Competition

 

Torchmark competes with other insurance carriers through policyholder service, price, product design, and sales efforts. While there are insurance companies competing with Torchmark, no individual company dominates any of Torchmark’s life or health markets.

 

Torchmark’s health insurance products compete with, in addition to the products of other health insurance carriers, health maintenance organizations, preferred provider organizations, and other health care-related institutions which provide medical benefits based on contractual agreements.

 

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Management believes Torchmark companies operate at lower policy acquisition and administrative expense levels than peer companies. This allows Torchmark to have competitive rates while maintaining higher underwriting margins.

 

Regulation

 

Insurance.    Insurance companies are subject to regulation and supervision in the states in which they do business. The laws of the various states establish agencies with broad administrative and supervisory powers which include, among other things, granting and revoking licenses to transact business, regulating trade practices, licensing agents, approving policy forms, approving certain premium rates, setting minimum reserve and loss ratio requirements, determining the form and content of required financial statements, and prescribing the type and amount of investments permitted. They are also required to file detailed annual reports with supervisory agencies, and records of their business are subject to examination at any time. Under the rules of the National Association of Insurance Commissioners (NAIC), insurance companies are examined periodically by one or more of the supervisory agencies.

 

Risk Based Capital. The NAIC requires a risk based capital formula be applied to all life and health insurers. The risk based capital formula is a threshold formula rather than a target capital formula. It is designed only to identify companies that require regulatory attention and is not to be used to rate or rank companies that are adequately capitalized. All Torchmark insurance subsidiaries are more than adequately capitalized under the risk based capital formula.

 

Guaranty Assessments. State guaranty laws provide for assessments from insurance companies into a fund which is used, in the event of failure or insolvency of an insurance company, to fulfill the obligations of that company to its policyholders. The amount which a company is assessed is determined according to the extent of these unsatisfied obligations in each state. Assessments are recoverable to a great extent as offsets against state premium taxes.

 

Holding Company.    States have enacted legislation requiring registration and periodic reporting by insurance companies domiciled within their respective jurisdictions that control or are controlled by other corporations so as to constitute a holding company system. At December 31, 2007, Torchmark and its subsidiaries have registered as a holding company system pursuant to such legislation in Alabama, Indiana, Missouri, Nebraska, and New York.

 

Insurance holding company system statutes and regulations impose various limitations on investments in subsidiaries, and may require prior regulatory approval for material transactions between insurers and affiliates and for the payment of certain dividends and other distributions.

 

Personnel

 

At the end of 2007, Torchmark had 2,354 employees and 1,242 licensed employees under sales contracts.

 

Item 1A.    Risk Factors

 

Product Marketplace and Operational Risks:

 

The insurance industry is a mature, regulated industry, populated by many firms. Torchmark operates in the life and health insurance sections of the insurance industry, each with its own set of risks.

 

Life Insurance Marketplace Risk:

 

The life insurance industry is highly competitive and could limit Torchmark’s ability to gain or maintain market share.    Competition by product price and for market share is generally strong in the life insurance industry, but is less so in Torchmark’s life insurance niche markets. In recent years, most life insurers have targeted the smaller, highly competitive, higher-income market by offering asset accumulation products. Torchmark’s market has remained the middle income market, offering individually-sold protection life insurance, which is less competitive because the market is larger with fewer competing insurers and with less price sensitivity than the higher income, asset accumulation marketplace.

 

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Torchmark’s life insurance markets are subject to risks of general economic conditions.     Because Torchmark serves the middle income market for individual protection life insurance, competition is primarily from alternative uses of the customer’s disposable income. In times of economic downturns that affect employment levels, potential customers may be less likely to buy policies and policyholders may fail to pay premiums.

 

Torchmark’s life products are sold in selected niche markets. The Company is at risk should any of these markets diminish.    Torchmark has two life distribution channels that focus on distinct market niches: labor union members and sales via direct response distribution. The contraction of the size of either market could adversely affect sales. In recent years, labor union membership has grown little and has declined as a percentage of employed workers; however, Torchmark’s union-member policyholders are still a small portion of total union membership, indicating that sales growth can continue for some time without growth in total union membership. Most of the Company’s direct response business is either through direct mail solicitation or inserted into other mail media for distribution. Significant adverse changes in postage cost or the acceptance of unsolicited marketing mail by consumers could negatively affect this business.

 

The development and maintenance of Torchmark’s various distribution systems are critical to growth in product sales.    Because the Company’s life insurance sales are primarily made to individuals, rather than groups, and the face amounts sold are lower than that of policies sold in the higher income market, the development, maintenance and retention of adequate numbers of producing agents and direct response systems to support growth of sales in this market are critical. For agents, adequate compensation that is competitive with other employment opportunities, and that also motivates them to increase sales is very important. In direct response, continuous development of new offerings and cost efficiency are key. Less than optimum execution of these strategies will in time lead to less than optimum growth in sales and ultimately in profits.

 

Health Insurance marketplace risk:

 

Congress could make changes to the Medicare program which could impact Torchmark’s Medicare Supplement and Medicare Part D prescription drug insurance business.    Medicare Supplement insurance constitutes a significant portion of Torchmark’s in force health insurance business. Because of increasing medical cost inflation and concerns about the solvency of the Medicare program, it is possible that changes will be made to the Medicare program by Congress in the future. These changes could have either a positive or negative effect on that business. In 2006, Congress first provided prescription drug coverage (Medicare Part D) to Medicare beneficiaries. Changes are likely to be made to the program over the next several years as the acceptance and costs of the program become clear. Some of these changes might adversely affect Torchmark’s ability to profit from its Medicare Part D sales or the level of risk involved.

 

Torchmark’s Medicare Supplement business could be negatively affected by alternative healthcare providers.    The Medicare Supplement business is impacted by market trends in the senior-aged health care industry that provide alternatives to traditional Medicare, such as health maintenance organizations (HMOs) and other managed care or private plans. The success of these alternative businesses could negatively affect the sales and premium growth of traditional Medicare supplement insurance.

 

Torchmark’s Medicare Supplement business is subject to intense competition primarily on the basis of price which could restrict future sales.    In recent years, price competition in the traditional Medicare supplement market has been significant, characterized by some insurers who have been willing to earn very small profit margins or to under price new sales in order to gain market share. Torchmark believes these practices are not in the best interest of the Company or consumers and has elected not to compete on those terms, which has negatively affected sales. Should these industry practices continue, it is likely that Torchmark’s sales of this health product will remain depressed.

 

Torchmark’s health business is at risk in the event of government-sponsored under-age-65 health insurance.    Currently, Torchmark’s leading health sales are from limited benefit products sold to people under age 65. These products are in demand when buyers are either self employed or their

 

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Index to Financial Statements

employers offer limited or no health insurance to employees. If in the future the government offers comprehensive health care to people under age 65, demand for this product would likely decline. However, any government plan might provide beneficial opportunities if the plan includes the insurance industry as providers. Given the high cost and political challenges of such a program, Torchmark believes this is a low-level risk in the foreseeable future.

 

General Operating Risk:

 

Changes in mortality, economic conditions, or other market conditions could significantly affect our operation and profitability.    The Company’s insurance contracts are affected by the levels of mortality, morbidity, persistency, and healthcare utilization that we experience. The resulting levels that occur may differ significantly from the levels assumed when premium rates were first set. Significant variations in these levels could negatively affect profit margins and income. However, the Company’s actuaries continually test expected to actual results.

 

Torchmark’s ability to pay dividends or service any of its debt or preferred securities is limited by the amounts its subsidiaries are able to pay to the holding company.    Torchmark’s insurance company subsidiaries, its principal sources of cash flow, periodically declare and distribute dividends on their common and preferred stock held by Torchmark, the holding company. Torchmark’s ability to pay dividends on its common stock, principal and interest on any debt security, or dividends on any preferred stock security is affected by the ability of its subsidiaries to pay the holding company these dividends. The insurance company subsidiaries are subject to various state statutory and regulatory restrictions, applicable to insurance companies, that limit the amount of cash dividends, loans, and advances that those subsidiaries may pay to the holding company. For example, under certain state insurance laws, an insurance company generally may pay dividends only out of its unassigned surplus as reflected in its statutory financial statements filed in that state. Additionally, dividends paid by insurance subsidiaries are generally limited to the greater of statutory net gain from operations, excluding capital gains and losses, or 10% of statutory surplus without regulatory approval.

 

Torchmark can give no assurance that more stringent restrictions will not be adopted from time to time by states in which its insurance subsidiaries are domiciled, which could, under certain circumstances, significantly reduce dividends or other amounts paid to Torchmark by its subsidiaries. Additionally, the inability to obtain approval of the previously mentioned premium rate increases in a timely manner from state insurance regulatory authorities could adversely impact the profitability, and thus the ability of Torchmark’s insurance subsidiaries to declare and distribute dividends.

 

A ratings downgrade could negatively affect Torchmark’s ability to compete.    Ratings are a factor in Torchmark’s competitive position. Rating organizations periodically review the financial performance and condition of insurers, including the Company’s insurance subsidiaries. While ratings are less important in the middle-income market than in markets focused on higher incomes or the group market, a downgrade in the ratings of Torchmark’s insurance subsidiaries could slightly affect the ability of the subsidiaries to market their products.

 

Rating organizations assign ratings based upon several factors. While most of the considered factors relate to the rated company, some of the factors relate to general economic conditions and circumstances outside of the Company’s control.

 

Investment Risk:

 

The Company’s investments are subject to market risks.    Torchmark’s invested assets are subject to the customary risks of defaults, downgrades, and changes in market values. Factors that may affect these risks include interest rate levels, financial market performance, and general economic conditions, as well as particular circumstances affecting the businesses or industries of individual issuers. Some of these factors could result in write-downs of individual investments. Significant increases in interest rates could cause a material temporary decline in the fair value of the fixed investment portfolio, reflecting unrealized fair value losses. This risk is mitigated by Torchmark’s operating strategy to generally hold investments to maturity recognizing the long-term nature of the life policy reserve liabilities supported by investments and by Torchmark’s strong operating cash flow that greatly diminishes the need to liquidate investments prior to maturity.

 

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A decline in interest rates could negatively affect income.    Declines in interest rates expose insurance companies to the risk of not earning anticipated spreads between the interest rate earned on investments and the rates credited to the net policy liabilities. While Torchmark attempts to manage its investments to preserve the excess investment income spread, the Company can give no assurance that a significant and persistent decline in interest rates will not materially affect such spreads.

 

Significant decreases in interest rates could result in calls by issuers of investments, where such features are available to issuers. These calls could result in a decline in the Company’s investment income as reinvestment of the proceeds would likely be at lower rates.

 

Regulatory risk:

 

Regulatory changes could adversely affect our business.    Insurance companies are subject to government regulation in each of the states in which they conduct business. State agencies have broad administrative power over many aspects of the insurance business, which may include premium rates, marketing practices, advertising, licensing agents, policy forms, capital adequacy, and permitted investments. Government regulators are concerned primarily with the protection of policyholders rather than our shareholders. Insurance laws, regulations, and policies currently affecting Torchmark and its subsidiaries may change at any time, possibly having an adverse effect on its business. Furthermore, the Company cannot predict the timing or form of any future regulatory initiatives.

 

Changes in taxation could negatively affect our income.    Changes in the way the insurance industry is taxed or increases in tax rates could increase the Company’s tax burden and negatively affect its income.

 

Litigation risk:

 

Litigation could result in substantial judgments against the Company or its subsidiaries.    A number of civil jury verdicts have been returned against insurers in the jurisdictions in which Torchmark does business involving the insurers’ sales practices, alleged agent misconduct, failure to properly supervise agents, and other matters. These lawsuits have resulted in the award of substantial judgments against insurers that are disproportionate to the actual damages, including material amounts of punitive damages. In some states, including Alabama and Mississippi, juries have substantial discretion in awarding punitive damages. This discretion creates the potential for unpredictable material adverse judgments in any given punitive damages suit. Torchmark, like other insurers, is involved in this type of litigation from time to time in the ordinary course of business. The outcome of any such litigation cannot be predicted with certainty.

 

Natural disaster risk:

 

Torchmark’s business is subject to risk of a catastrophic event.    The marketplaces of Torchmark’s major subsidiaries are national in scope. Because the Company’s insurance policies in force are relatively low-face amounts issued to large numbers of policyholders throughout the country, the likelihood that a large portion of the Company’s policyholder base would be affected by a natural disaster is not likely. As a result, it is unlikely that even a major natural disaster covering hundreds of miles would disrupt the marketing and premium collection in more than a small portion of Torchmark’s markets. In addition, the administration of the four leading subsidiaries is conducted in three distant locations that allow the company to take advantage of those distances to plan back-up administrative support for any one of the subsidiaries in the event of disaster. The Company also has outside contracts for off-site backup information systems and record keeping in the event of a disaster.

 

Item 1B.    Unresolved Staff Comments

 

As of December 31, 2007, Torchmark had no unresolved staff comments.

 

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Index to Financial Statements

Item 2.    Properties

 

Torchmark, through its subsidiaries, owns or leases buildings that are used in the normal course of business. United American, through a joint venture with Torchmark, owns and occupies a 140,000 square foot facility located in McKinney, Texas (a north Dallas suburb). To facilitate the consolidation of Torchmark’s operations, we have constructed a 150,000 square foot addition to this building, which was substantially completed in December, 2007 and is now being occupied by United American.

 

Liberty owns a 487,000 square foot building in Birmingham, Alabama which currently serves as Liberty’s and United Investors’ home office. Approximately 134,000 square feet of this building is leased or available for lease to unrelated tenants by Liberty. Liberty also operates from 9 company-owned district offices used for agency sales personnel. Liberty is currently in the process of selling its remaining company-owned office buildings, opting instead to operate from leased facilities. A total of 21 buildings were sold in each of the years 2007 and 2006.

 

Globe owns a 300,000 square foot office building in Oklahoma City, Oklahoma of which Globe occupies 56,000 square feet as its home office and the remaining space is either leased or available for lease. Globe also owns an 80,000 square foot office building in Oklahoma City. Further, a Globe subsidiary owns a 112,000 square foot facility located in Oklahoma City which houses the Globe direct response operation.

 

American Income owns and is the sole occupant of an office building located in Waco, Texas. The building is a two-story structure containing approximately 72,000 square feet of usable floor space. American Income also owns a 43,000 square foot facility located in Waco which houses the American Income direct response operation.

 

Liberty and United American also lease district office space for their agency sales personnel.

 

Item 3.    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 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 continue to occur bearing little or no relation to actual damages 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 Forms 10-K and 10-Q, Liberty and Torchmark were parties to purported class action litigation filed in the Circuit Court of Choctaw County, Alabama on behalf of all persons who currently or in the past were insured under Liberty cancer policies which were no longer being marketed, regardless of whether the policies remained in force or lapsed (Roberts v. Liberty National Life Insurance Company, Case No. CV-2002-009-B). These cases were based on allegations of breach of contract in the implementation of premium rate increases, misrepresentation regarding the premium rate increases, fraud and suppression concerning the closed block of business and unjust enrichment. On December 30, 2003, the Alabama Supreme Court issued an opinion granting Liberty’s and Torchmark’s petition for a writ of mandamus, concluding that the Choctaw Circuit Court did not have subject matter jurisdiction and ordering that Circuit Court to dismiss the action. The plaintiffs then filed their purported class action litigation against Liberty and Torchmark in the Circuit Court of Barbour County, Alabama on December 30, 2003 (Roberts v. Liberty National Life Insurance Company, Civil Action No. CV-03-0137).

 

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Index to Financial Statements

On April 16, 2004 the parties filed a written Stipulation of Agreement of Compromise and Settlement with the Barbour County, Alabama Circuit Court seeking potential settlement of the Roberts case. A fairness hearing on the potential settlement was held by the Barbour County Circuit Court with briefs received on certain issues, materials relating to objections to the proposed settlement submitted to the Court-appointed independent special master, objectors to the potential settlement heard and a report of the Court-appointed independent actuary received on certain issues thereafter.

 

On November 22, 2004, the Court entered an order and final judgment in Roberts whereby the Court consolidated Roberts with Robertson v. Liberty National Life Insurance Company, CV-92-021 (previously reported in Forms 10-K and 10-Q) for purposes of the Roberts Stipulation of Settlement and certified the Roberts class as a new subclass of the class previously certified by that Court in Robertson. The Court approved the Stipulation and Settlement and ordered and enjoined Liberty to perform its obligations under the Stipulation. The Court dismissed plaintiffs’ claims, released the defendants, enjoined Roberts subclass members from any further prosecution of released claims and retained continuing jurisdiction of all matters relating to the Roberts settlement. In an order issued February 1, 2005, the Court denied the objectors’ motion to alter, amend or vacate its earlier final judgment on class settlement and certification. The companies proceeded to implement the settlement terms. On March 10, 2005, the Roberts plaintiffs filed notice of appeal to the Alabama Supreme Court.

 

In an opinion issued on September 29, 2006, the Alabama Supreme Court voided the Barbour County Circuit Court’s final judgment and dismissed the Roberts appeal. The Supreme Court held that the Barbour County Court lacked subject-matter jurisdiction in Roberts to certify the Roberts class as a subclass of the Robertson class and to enter a final judgment approving the settlement since Roberts was filed as an independent class action collaterally attacking Robertson rather than being filed in Robertson under the Barbour County Court’s reserved continuing jurisdiction over that case. On October 23, 2006, Liberty filed a petition with the Barbour County Circuit Court under its continuing jurisdiction in Robertson for clarification, or in the alternative, to amend the Robertson final judgment. Liberty sought an order from the Circuit Court declaring that Liberty pay benefits to Robertson class members based upon the amounts accepted by providers in full payment of charges. A hearing was held on Liberty’s petition on March 13, 2007.

 

On March 30, 2007, the Barbour County Circuit Court issued an order denying Liberty’s petition for clarification and/or modification of Robertson, holding that Liberty’s policies did not state that they will pay “actual charges” accepted by providers. On April 8, 2007, the Court issued an order granting a motion to intervene and establishing a subclass in Robertson comprised of Liberty cancer policyholders who are now or have within the past six years, undergone cancer treatment and filed benefit claims under the policies in question. Liberty filed a motion with the Barbour County Circuit Court to certify for an interlocutory appeal that Court’s order on Liberty’s petition for clarification in Robertson on April 17, 2007. An appellate mediation of these issues was conducted on August 9, 2007. On October 16, 2007, the Alabama Supreme Court entered orders, based upon the conclusion by the parties of the appellate mediation, staying the proceedings for a writ of mandamus, reinstating the cases on the appellate docket, and remanding the cases to the Barbour County Circuit Court to implement the parties’ settlement agreement. A fairness hearing on the proposed settlement agreement was held by the Barbour County Circuit Court on January 15, 2008.

 

United American has been named as a defendant in previously-reported purported class action litigation filed on September 16, 2004, in the Circuit Court of Saline County, Arkansas on behalf of the Arkansas purchasers of association group health insurance policies or certificates issued by United American through Heartland Alliance of America Association and Farm & Ranch Healthcare, Inc. (Smith and Ivie v. Collingsworth, et al., CV2004-742-2). The plaintiffs assert claims for fraudulent concealment, breach of contract, common law liability for non-disclosure, breach of fiduciary duties, civil conspiracy, unjust enrichment, violation of the Arkansas Deceptive Trade Practices Act, and violation of Arkansas law and the rules and regulations of the Arkansas Insurance Department. Declaratory, injunctive and equitable relief, as well as actual and punitive damages are sought by the plaintiffs.

 

On September 7, 2005, the plaintiffs amended their complaint to assert a nation wide class, defined as all United American insureds who simultaneously purchased both an individual Hospital and Surgical

 

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Index to Financial Statements

Expense health insurance policy and an individual supplemental term life insurance policy from Farm & Ranch through Heartland. Defendants removed this litigation to the United States District Court for the Western District of Arkansas (No. 4:05-cv-1382) but that Court remanded the litigation back to state court on plaintiffs’ motion. Discovery is proceeding.

 

As previously reported, United American was named as a defendant in purported class action litigation filed on January 7, 2005, in the District Court of Starr County, Texas on behalf of the purchasers of association group health insurance policies or certificates issued by United American through Heartland Alliance of America and Farm & Ranch Healthcare, Inc. (Rodriguez v. Burdine, et al, DC-05-8). The plaintiffs asserted claims of civil conspiracy, conversion and theft, violations of the Texas Insurance and Administrative Codes, breach of fiduciary duties, fraud and gross negligence and breach of contract as well as filing a members representative action on behalf of all the members of the Heartland Association. The plaintiffs alleged excessive and unauthorized association dues payments that the defendants have collected from policyholders. A declaratory judgment, monetary damages, imposition of a constructive trust, equitable forfeiture and attorney’s fees were sought by the plaintiffs. A class certification hearing was held August 31, 2006, at which time the Court considered and approved a proposed settlement agreement between the parties. A fairness hearing was conducted on October 5, 2006 and the judgment and related orders were entered without issues. The final settlement was concluded on November 9, 2006.

 

On February 17, 2005, named defendant Martha Burdine filed an amended answer and a complaint (the cross complaint) against various other defendants including United American (the cross defendants) on behalf of a purported class of former agents and managers of those cross defendants (the cross plaintiffs). These cross plaintiffs asserted a pattern of contract breaches and misconduct by the cross defendants including claims for breach of contract, intentional and negligent misrepresentation, fraud, negligence, breach of duties of trustees, trespass to chattels, conversion, intentional interference with a business relationship and intentional interference with a valid business expectancy. The cross plaintiffs sought actual, punitive and exemplary damages, attorneys’ fees and costs and other legal and equitable relief. Upon the conclusion of the Rodriguez settlement, only the cross claims filed by Martha Burdine remained outstanding. The parties agreed to dismiss these cross claims with prejudice on August 29, 2007.

 

On July 26, 2007, previously-reported purported class action litigation for a class comprised only of Texas citizens was filed against United American in the state District Court of Falls County, Texas (Neuman v. United American Insurance Company, Case No. 36593). Plaintiffs assert that the UA Partners program is a fraudulent scheme presented by United American to prospective insureds when they apply for insurance as a discount product and service program and the fee for this program is built into the insurance premium. They allege that United American has been unjustly enriched as a result of the UA Partners program and initially had sued for money had and received and attorneys fees. On January 28, 2008, plaintiffs amended their complaint to allege breach of contract and unfair business practices prohibited by the Texas Insurance Code in connection with the UA Partners program and now seek actual and additional statutory damages.

 

On January 18, 2008, purported class action litigation was filed against Liberty in the U.S. District Court for the Southern District of Florida (Joseph v. Liberty National Life Insurance Company, Case No. 08-20117 CIV – Martinez) on behalf of all black Haitian-Americans who reside in Florida (including both naturalized and alien persons) and who have or have had an ownership interest in life insurance policies sold by Liberty where it is alleged that Liberty issued and administered such policies on a discriminatory basis because of their race and Haitian ancestry, ethnicity or national origin. The plaintiffs allege an intentional plan on behalf of Liberty to discriminate against the black Haitian-American community in the formation, performance and termination of life insurance contracts in violation of 42 U.S.C. §1981 and §1982 by target marketing and underwriting inquiries regarding whether the applicant for insurance was Haitian, had traveled to Haiti in the past or planned to do so at any time in the future and, based upon such information, either denying the application or issuing a substandard policy or in some instances it is alleged, refusing to pay death benefits on issued policies. The plaintiffs seek unspecified compensatory damages in excess of $75,000, punitive damages, injunctive relief, attorneys’ fees and other relief.

 

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Index to Financial Statements

Item 4.    Submission of Matters to a Vote of Security Holders

 

No matter was submitted to a vote of shareholders, through the solicitation of proxies or otherwise, during the fourth quarter of 2007.

 

PART II

 

Item 5.    Market for Registrant’s Common Equity,

Related Stockholder Matters and Issuer Purchases of Equity Securities

 

(a)   Market Price of and Dividends on the Registrant’s Common Equity and Related Stockholder Matters

 

The principal market in which Torchmark’s common stock is traded is the New York Stock Exchange. There were 5,106 shareholders of record on December 31, 2007, excluding shareholder accounts held in nominee form. The market prices and cash dividends paid by calendar quarter for the past two years are as follows:

 

         2007
Market Price

   Dividends
Per Share


Quarter


       High

   Low

  

1                

         $ 66.87    $ 62.83    $ .13

2                

           70.32      64.48      .13

3                

           68.14      59.39      .13

4                

           65.16      58.78      .13

Year-end closing price

  $ 60.53                     
         2006
Market Price


   Dividends
Per Share


Quarter


       High

   Low

  

1                

         $ 57.79    $ 54.25    $ .11

2                

           61.01      56.43      .11

3                

           63.42      59.75      .13

4                

           64.23      61.68      .13

Year-end closing price

  $ 63.76                     

 

(c)   Purchases of Certain Equity Securities by the Issuer and Others for the Fourth Quarter 2007

 

Period


   (a) Total Number
of Shares
Purchased


   (b) Average
Price Paid
Per Share


   (c) Total Number of
Shares Purchased
as Part of Publicly
Announced Plans
or Programs


   (d) Maximum Number
of Shares (or
Approximate Dollar
Amount) that May
Yet Be Purchased
Under the Plans or
Programs


October 1-31, 2007

   32,002    $ 64.45    32,002     

November 1-30, 2007

   5,000      60.18    5,000     

December 1-31, 2007

   28,779      61.20    28,779     

 

On July 26, 2007, Torchmark’s Board reaffirmed its continued authorization of the Company’s stock repurchase program in amounts and with timing that management, in consultation with the Board, determined to be in the best interest of the Company. The program has no defined expiration date or maximum shares to be purchased.

 

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Index to Financial Statements
e)   Performance Graph

 

LOGO

 

 
  *   $100 invested on 12/31/02 in stock or index-including reinvestment of dividends. Fiscal year ending December 31.

 

Copyright © 2008, Standard & Poor’s, a division of The McGraw-Hill Companies, Inc. All rights reserved.

www.researchdatagroup.com/S&P.htm

 

The line graph shown above compares Torchmark’s cumulative total return on its common stock with the cumulative total returns of the Standard and Poor’s 500 Stock Index (S&P 500) and the Standard and Poor’s Life & Health Insurance Index (S&P Life & Health Insurance). Torchmark is one of the companies whose stock is included within both the S&P 500 and the S&P Life & Health Insurance Index.

 

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Index to Financial Statements

Item 6.    Selected Financial Data

 

The following information should be read in conjunction with Torchmark’s Consolidated Financial Statements and related notes reported elsewhere in this Form 10-K:

 

(Amounts in thousands except per share and percentage data)

 

Year ended December 31,          2007      

    2006

    2005

   2004

   2003

 

Premium revenue:

                                      

Life

   $ 1,569,964     $ 1,524,267     $ 1,468,288    $ 1,395,490    $ 1,310,373  

Health

     1,236,797       1,237,532       1,014,857      1,048,666      1,034,031  

Other

     20,470       22,914       24,929      27,744      31,379  

Total

     2,827,231       2,784,713       2,508,074      2,471,900      2,375,783  

Net investment income

     648,826       628,746       603,068      577,035      557,670  

Realized investment gains (losses)

     2,734       (10,767 )     280      22,216      (3,274 )

Total revenue

     3,486,697       3,421,178       3,125,910      3,071,542      2,930,998  

Net income before cumulative effect of change in accounting principle

     527,535       518,631       495,390      475,718      430,141  

Net income

     527,535       518,631       495,390      468,555      430,141  

Per common share:

                                      

Basic earnings:

                                      

Net income before cumulative effect of change in accounting principle

     5.59       5.20       4.73      4.32      3.75  

Net income

     5.59       5.20       4.73      4.26      3.75  

Diluted earnings:

                                      

Net income before cumulative effect of change in accounting principle

     5.50       5.13       4.68      4.25      3.73  

Net income

     5.50       5.13       4.68      4.19      3.73  

Cash dividends declared

     0.52       0.50       0.44      0.44      0.40  

Cash dividends paid

     0.52       0.48       0.44      0.44      0.38  

Basic average shares outstanding

     94,317       99,733       104,735      110,106      114,837  

Diluted average shares outstanding

     95,846       101,112       105,751      111,908      115,377  
As of December 31,    2007

    2006

    2005

   2004

   2003

 

Cash and invested assets

   $ 9,792,297     $   9,719,988     $ 9,410,695    $ 9,243,090    $ 8,702,398  

Total assets

     15,241,428       14,980,355       14,768,903      14,252,184      13,465,525  

Short-term debt

     202,058       169,736       381,505      170,354      182,448  

Long-term debt(1)

     721,723       721,248       507,902      694,685      698,042  

Shareholders’ equity

     3,324,627       3,459,193       3,432,768      3,419,844      3,240,099  

Per diluted share

     35.60       34.68       32.91      31.07      28.45  

Effect of SFAS 115 on diluted equity per share(2)

     (0.66 )     1.43       2.50      3.62      3.39  

Annualized premium in force:

                                      

Life

     1,672,865       1,615,487       1,577,635      1,523,335      1,449,290  

Health

     1,233,884       1,293,081       1,026,410      1,056,451      1,064,428  

Total

     2,906,749       2,908,568       2,604,045      2,579,786      2,513,718  

Basic shares outstanding

     92,175       98,115       103,569      107,944      112,715  

Diluted shares outstanding

     93,383       99,755       104,303      110,075      113,887  

(1)

Includes 7 3/4% Junior Subordinated Debentures reported as “Due to affiliates” on the Consolidated Balance Sheets at each year end 2003 through 2005 in the amount of $154.6 million. Also included at year end 2006 and 2007 are Torchmark’s 7.1% Junior Subordinated Debentures in the amount of $123.7 million, which are also reported as “Due to affiliates” on the Consolidated Balance Sheet.

(2) SFAS 115 is an accounting rule requiring fixed maturities to be revalued at fair value each period. The effect of SFAS 115 on diluted equity per share reflects the amount added or (deducted) under SFAS 115 to produce GAAP Shareholders’ equity per share. Please see the explanation and discussion under the caption Capital Resources in Management’s Discussion and Analysis in this report concerning the effect this rule has on Torchmark’s equity.

 

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Item 7.    Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

The following discussion should be read in conjunction with the Selected Financial Data and Torchmark’s Consolidated Financial Statements and Notes thereto appearing elsewhere in this report.

 

RESULTS OF OPERATIONS

 

How Torchmark Views Its Operations:    Torchmark is the holding company for a group of insurance companies which market primarily individual life and supplemental health insurance, and to a limited extent annuities, to middle income households throughout the United States. We view our operations by segments, which are the major insurance product lines of life, health, and annuities, and the investment segment that supports the product lines. Segments are aligned based on their common characteristics, comparability of the profit margins, and management techniques used to operate each segment.

 

Insurance Product Line Segments.    As fully described in Note 13Business Segments in the Notes to the Consolidated Financial Statements, the product line segments involve the marketing, underwriting, and benefit administration of policies. Each product line is further segmented by the various distribution units that market the insurance policies. Each distribution unit operates in a niche market offering insurance products designed for that particular market. Whether analyzing profitability of a segment as a whole, or the individual distribution units within the segment, the measure of profitability used by management is the underwriting margin, which is:

 

Premium revenue

Less:

    Policy obligations

    Policy acquisition costs and commissions

 

Investment Segment.    The investment segment involves the management of our capital resources, including investments and the management of corporate debt and liquidity. Our measure of profitability for the investment segment is excess investment income, which is:

 

Net investment income

Less:

    Interest credited to net policy liabilities

    Financing costs

 

The tables in Note 13Business Segments reconcile Torchmark’s revenues and expenses by segment to its major income statement line items for each of the years in the three-year period ending December 31, 2007. Additionally, this Note provides a summary of the profitability measures that demonstrates year-to-year comparability and which reconciles to net income. That summary is reproduced below from the Consolidated Financial Statements to present our overall operations in the manner that we use to manage the business.

 

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Analysis of Profitability by Segment

(Dollar amounts in thousands)

 

         2007    

    2006

    2005

    2007
Change

    %

    2006
Change


    %

 

Life insurance underwriting margin

   $ 417,038     $ 397,444     $ 381,648     $ 19,594     5     $ 15,796     4  

Health insurance underwriting margin

     208,254       206,694       177,179       1,560     1       29,515     17  

Annuity underwriting margin

     9,337       11,915       12,580       (2,578 )   (22 )     (665 )   (5 )

Other insurance:

                                                    

Other income

     4,313       4,024       2,366       289     7       1,658     70  

Administrative expense

     (154,552 )     (155,331 )     (147,681 )     779     (1 )     (7,650 )   5  

Excess investment income

     323,762       318,763       324,238       4,999     2       (5,475 )   (2 )

Corporate and adjustments

     (17,921 )     (14,437 )     (9,660 )     (3,484 )   24       (4,777 )   49  
    


 


 


 


       


     

Pre-tax total

     790,231       769,072       740,670       21,159     3       28,402     4  

Applicable taxes

     (268,118 )     (264,716 )     (255,165 )     (3,402 )   1       (9,551 )   4  
    


 


 


 


       


     

After-tax total

     522,113       504,356       485,505       17,757     4       18,851     4  

Remove benefit from interest-rate swaps (after tax) from Investment Segment

     -0-       (319 )     (4,805 )     319             4,486        

Realized gains (losses) (after tax)*

     1,777       (7,254 )     25       9,031             (7,279 )      

Gain on sale of agency buildings, net of tax

     2,768       2,816       -0-       (48 )           2,816        

Tax settlements (after tax)

     1,149       11,607       15,989       (10,458 )           (4,382 )      

Net proceeds (cost) from legal settlements (after tax)

     (272 )     7,425       (955 )     (7,697 )           8,380        

Retiring executive option term extension (after tax)

     -0-       -0-       (369 )     -0-             369        
    


 


 


 


 

 


     

Net income

   $ 527,535     $ 518,631     $ 495,390     $ 8,904     2     $ 23,241     5  
    


 


 


 


 

 


 


* See the discussion of Realized Gains and Losses in this report.

 

Torchmark’s operations on a segment-by-segment basis are discussed in depth under the appropriate captions following in this report.

 

Summary of Operations:    Net income increased 2% or $9 million to $528 million in 2007, and 5% or $23 million to $519 million in 2006. The life insurance segment contributed $20 million to pretax growth in the 2007 margin, the largest contributor. Life insurance margin growth in 2007 resulted from both premium growth and favorable mortality. Also adding to 2007 pretax earnings growth was the investment segment, from which excess investment income rose $5 million or 2%. It had declined in both of the previous two years. Excess investment income in 2007 was positively affected by lower financing costs on our debt as a result of the refinancing of two debt issues in 2006. The primary contributor to growth in 2006 earnings was the health insurance segment, as we first offered Medicare Part D for coverage beginning January 1, 2006. Our Medicare Part D product accounted for $26 million of the $30 million growth in health margins. The life insurance segment also added $16 million to our $28 million growth in pretax earnings in 2006. Excess investment income declined in both 2006 and 2005, as it was compressed by a flattened yield curve and as significant amounts of cash have been used to repurchase Torchmark shares.

 

Total revenues rose 2% in 2007 to $3.49 billion. In 2006, total revenues increased 9% to $3.42 billion from $3.13 billion in 2005. Growth in life premium of $46 million and net investment income of $20 million accounted for the growth in 2007 revenues. The 2006 revenue increase was primarily the result of the $212 million of premium added from Medicare Part D. Growth in life premium and net investment income also contributed to 2006 revenue growth.

 

Life insurance premium has grown steadily in each of the three years ending December 31, 2007, rising 3% in 2007 to $1.6 billion and 4% in 2006. Margins as a percentage of premium have also increased slightly each year to 27% of premium in 2007 from 26% in 2005 and 2006. While premium and margin percentage growth have resulted in increases in the total life insurance segment’s contribution to pretax earnings, sales volumes have declined slightly each year. Life insurance segment results are discussed further under the caption Life Insurance.

 

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Health premium was flat in 2007 compared with 2006 at $1.2 billion. However, it rose 22% or $223 million in 2006 from $1.0 billion in 2005, but $212 million of the growth came from Medicare Part D premium which was offered for the first time in 2006. Since the majority of the Country’s Part D enrollees selected a plan in 2006, we do not expect significant growth in our Part D business going forward. Medicare Supplement has historically accounted for the largest portion of our health premium. Over the past few years, however, increased competition in the Medicare Supplement business has continued to dampen health sales, and has resulted in declines in the premium from this product each year. At the same time, net sales of our under-age-65 limited-benefit health products have grown significantly over the past few years, as demand for these products continues to increase. As a result, premium from the limited-benefit health products are expected to overtake Medicare Supplement premium in 2008. See the discussion under Health Insurance for a more detailed discussion of health insurance results.

 

While we still offer annuities, we do not plan to emphasize annuity products, favoring life insurance instead. See the caption Annuities for further discussion.

 

As previously mentioned, the investment segment’s pretax profitability, or excess investment income, increased $5 million or 2% in 2007, after having declined 2% in each of the last two years. The investment segment’s 2007 income was positively affected by a decline in our interest expense on debt, due to the refinancing of the two funded debt issues noted below. However, growth in total investment income has been negatively affected by Torchmark’s share repurchase program (described later under this caption), which has diverted cash that could have otherwise been used to acquire investments. Management believes that the acquisition of Torchmark stock at favorable prices provides a superior return on available cash. Additionally, the lower long-term interest rates available for new investments during the past three years have caused our average portfolio yield to decline in each successive year, restricting growth in net investment income and excess investment income. At the same time, short-term rates have risen and stayed at higher levels during the three-year period, negatively affecting excess investment income. During 2005 and continuing through mid-2006, short-term rates rose with no meaningful change in long-term rates. The rising short-term rates caused short-term financing costs to increase and the income spread on Torchmark’s fixed-to-variable interest-rate swaps to narrow. Because of the diminished profitability of these swaps, all of the swaps were disposed of by June, 2006. See the analysis of excess investment income and investment activities under the caption Investments for a more detailed discussion.

 

During the second quarter of 2006, we issued two new debt securities in separate public offerings: (1) our 7.1% Trust Preferred Securities, redemption amount $120 million and (2) our 6 3/ 8% Senior Notes, par value $250 million. These offerings essentially provided funding for the repayment of two existing debt instruments in the fourth quarter of 2006: (1) the call of our 7¾% Trust Preferred Securities at a redemption price of $150 million and (2) the maturity of our 6¼% Senior Notes, par value $180 million. More information on these transactions can be found in Note 10—Debt in the Notes to Consolidated Financial Statements and in our discussion of Capital Resources in this report.

 

We had $2 million of after-tax realized investment gains in 2007, compared with after-tax realized investment losses of $7 million in 2006. There was an immaterial amount of after-tax realized investment gains in 2005. Realized investment gains and losses can vary significantly from period to period and may have a material positive or negative impact on net income. Under the caption Realized Gains and Losses in this report, we present a complete analysis and discussion of our realized gains and losses. Also, as explained in Note 13—Business Segments in the Notes to the Consolidated Financial Statements, we do not consider realized gains and losses to be a component of our core insurance operations or operating segments.

 

In each of the years 2005 through 2007, net income was affected by certain significant, unusual, and nonrecurring nonoperating items. We do not view these items as components of core operating results because they are not indicative of past performance or future prospects of the insurance operations. A discussion of these items follows.

 

In 2005, we recorded an after-tax charge of $955 thousand ($1.5 million pretax) pertaining to litigation. This litigation involved net settlements after expenses primarily in three significant legal matters: our subsidiary Liberty’s race-distinct mortality/dual-pricing litigation, its class-action cancer case, and the

 

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Waddell & Reed litigation. All of the settlements of these cases relate to litigation arising many years ago and are not relevant to current operations. Of this pre-tax amount, $13.5 million is recorded as “Other income” and $15 million is recorded as “Other operating expense” in the 2005 Consolidated Statement of Operations. For more information on these litigation items, see Note 14—Commitments and Contingencies in the Notes to Consolidated Financial Statements. Also in 2005, we recorded a $16 million settlement benefit from an Internal Revenue Service examination covering several years. This tax settlement reduced tax expense. More information on this tax settlement is provided in Note 8—Income Taxes in the Notes to the Consolidated Financial Statements. Additionally, a noncash after-tax charge of $369 thousand was recorded as a result of the extension in the term of a previously granted stock option for a senior officer upon retirement. The option extension expense was recorded as administrative expense in the 2005 Consolidated Statement of Operations.

 

In 2006, we received four litigation and tax settlements, two of which were concerned with issues related to a subsidiary and an investment disposed of several years ago, a third involving our investment in Worldcom, Inc. bonds (Worldcom), which was held and sold in prior years, and a fourth concerning Federal income tax issues arising from examinations of prior years. The first settlement, involving the disposed subsidiary, resulted in state income tax refunds of $6.7 million net of expenses ($4.3 million net of tax) which were received and reported above as a tax settlement. The second settlement involving the investment resulted in proceeds of $5.1 million net of expenses ($3.3 million net of tax) and is included in the table above as a legal settlement. In the third settlement, we received $6.3 million ($4.1 million after tax) in connection with our Worldcom class-action litigation for recovery of a portion of investment losses. This item is included in the table above as a litigation settlement. The Federal income tax settlement resulted in benefits due us of $7.4 million, included as tax settlements in the table above. The two litigation settlements were included in “Other income” and the two tax settlements reduced “Income taxes” in the 2006 Consolidated Statement of Operations. All four of these cases involved litigation or issues arising years ago and are not considered by management to relate to our current operations.

 

Additionally in 2006, Liberty began a program to dispose of its agency office buildings, replacing them with rental facilities. In 2006, 21 buildings were sold for gross proceeds of $6.7 million and a pre-tax gain of $4.8 million. Because of the significant scale of this nonoperating item, we have removed $4.3 million ($2.8 million after tax) from our core results representing the gain from the sales.

 

Liberty’s program to dispose of its agency office buildings continued in 2007. As a result, 21 additional buildings were sold for proceeds of $6.4 million and a pre-tax gain of $4.3 million ($2.8 million after tax). Also in 2007, additional legal costs or settlements from litigation relating to prior periods were recorded. We received an additional $515 thousand ($334 thousand after tax) in settlement proceeds from the Worldcom litigation discussed above. We also incurred additional costs relating to Liberty National’s race-distinct pricing litigation that was settled in 2005 and was also discussed above. These costs were $933 thousand ($606 thousand after tax). Additionally, in 2007, we recorded a Federal income tax benefit of $1.1 million relating primarily to settlements of prior year examinations, presented as “Tax settlements” in the table above. This item reduced “Income Taxes” in the 2007 Consolidated Statement of Operations. See Note 8 for more information on this settlement.

 

We redomesticated two of our insurance subsidiaries, United American and Globe, to the state of Nebraska in 2007. This redomestication will benefit us going forward by reducing premium tax rates in these companies. We plan to redomesticate other subsidiaries to Nebraska in the future.

 

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Torchmark has in place an ongoing share repurchase program which began in 1986 and was reaffirmed at its July 26, 2007 Board of Director’s meeting. With no specified authorization amount, we determine the amount of repurchases based on the amount of the Company’s excess cash flow, general market conditions, and other alternative uses. The majority of these purchases are made from excess operating cash flow when market prices are favorable. Additionally, when stock options are exercised, proceeds from these exercises and the tax benefit are used to repurchase additional shares on the open market to minimize dilution as a result of the option exercises. The following chart summarizes share purchase activity for each of the three years ended December 31, 2007.

 

Analysis of Share Purchases

(Amounts in thousands)

 

     2007

   2006

   2005

Purchases


   Shares

   Amount

   Shares

   Amount

   Shares

   Amount

Excess cash flow and borrowings

   6,150    $ 402,116    5,575    $ 320,425    5,647    $ 300,134

Option proceeds*

   766      49,675    415      24,436    4,655      254,812
    
  

  
  

  
  

Total

   6,916    $ 451,791    5,990    $ 344,861    10,302    $ 554,946
    
  

  
  

  
  


* In 2005, 4.5 million shares at a cost of $248 million related to the option restoration program more fully discussed under the caption Capital Resources.

 

Throughout the remainder of this discussion, share purchases refer only to those made from excess cash flow.

 

A discussion of each of Torchmark’s segments follows.

 

Life Insurance.    Life insurance is our largest insurance segment, with 2007 life premium representing 55% of total premium. Life underwriting income before other income and administrative expense represented 66% of the total in 2007. Additionally, investments supporting the reserves for life products result in the majority of excess investment income attributable to the investment segment.

 

Life insurance premium rose 3% to $1.57 billion in 2007 after having increased 4% in 2006 to $1.52 billion. Life insurance products are marketed through several distribution channels. Premium income by channel for each of the last three years is as follows.

 

LIFE INSURANCE

Premium by Distribution Method

(Dollar amounts in thousands)

 

     2007

    2006

    2005

 
     Amount

   % of
Total


    Amount

   % of
Total


    Amount

   % of
Total


 

Direct Response

   $ 484,176    31 %   $ 457,159    30 %   $ 424,037    29 %

American Income Exclusive Agency

     440,164    28       409,188    27       380,365    26  

Liberty National Exclusive Agency

     293,936    19       300,933    20       302,747    21  

Other Agencies

     351,688    22       356,987    23       361,139    24  
    

  

 

  

 

  

     $ 1,569,964    100 %   $ 1,524,267    100 %   $ 1,468,288    100 %
    

  

 

  

 

  

 

We use three statistical measures as indicators of premium growth and sales over the near term: “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

 

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given date on all active policies if those policies remain in force throughout the twelve-month period. Annualized premium in force is an indicator of potential growth in premium revenue. Net sales is annualized premium issued, net of cancellations in the first thirty days after issue, except in the case of Direct Response where net sales is annualized premium issued at the time the first full premium is paid after any introductory offer period has expired. We believe that net sales is a superior indicator of the rate of premium growth relative to annualized premium issued. First-year collected premium is defined as 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 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.

 

Annualized life premium in force was $1.67 billion at December 31, 2007, an increase of 4% over $1.62 billion a year earlier. Annualized life premium in force was $1.58 billion at December 31, 2005.

 

The following table shows net sales information for each of the last three years by distribution method.

 

LIFE INSURANCE

Net Sales by Distribution Method

(Dollar amounts in thousands)

 

     2007

    2006

    2005

 
     Amount

   % of
Total


    Amount

   % of
Total


    Amount

   % of
Total


 

Direct Response

   $ 114,232    43 %   $ 115,031    43 %   $ 112,240    41 %

American Income Exclusive Agency

     92,306    35       86,369    33       84,270    31  

Liberty National Exclusive Agency

     36,981    14       41,369    16       47,088    17  

Other Agencies

     20,727    8       22,728    8       31,368    11  
    

  

 

  

 

  

     $ 264,246    100 %   $ 265,497    100 %   $ 274,966    100 %
    

  

 

  

 

  

 

The table below discloses first-year collected life premium by distribution channel.

 

LIFE INSURANCE

First-Year Collected Premium by Distribution Method

(Dollar amounts in thousands)

 

     2007

    2006

    2005

 
     Amount

   % of
Total


    Amount

   % of
Total


    Amount

   % of
Total


 

Direct Response

   $ 76,043    38 %   $ 77,385    37 %   $ 76,746    35 %

American Income Exclusive Agency

     73,862    37       72,072    35       73,490    33  

Liberty National Exclusive Agency

     28,773    15       34,342    16       35,993    16  

Other Agencies

     18,980    10       25,269    12       35,704    16  
    

  

 

  

 

  

     $ 197,658    100 %   $ 209,068    100 %   $ 221,933    100 %
    

  

 

  

 

  

 

Direct Response is our leading writer of life insurance. The Direct Response operation consists of two primary components: direct mail and insert media. Direct mail targets primarily young middle-income households with children. The juvenile life insurance policy is a key product. Not only is the juvenile market an important source of sales, but it also is a vehicle to reach the parents and grandparents of the juvenile policyholders. Parents and grandparents of these juvenile policyholders 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. At this time, we believe that the Direct Response unit is the largest U.S. writer of juvenile direct mail life insurance. We expect that sales to this demographic group will continue as one of Direct Response’s premier markets.

 

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Insert media, which targets primarily the adult market, involves placing insurance solicitations as advertising inserts into a variety of media, such as coupon packets, newspapers, bank statements, and billings. This media was historically placed by Direct Marketing and Advertising Distributors, Inc. (DMAD), previously an unrelated entity with which we have had a business relationship for fifteen years. We acquired DMAD in January, 2007 for $47 million, and integrated their operations during 2007. This acquisition allows the Company to expand marketing opportunities through increased solicitation volume and also improve margins through cost savings in the insert media component. Over the period of our relationship with DMAD, the insert media component has grown to the point that it now represents over half of Direct Response net sales. However, in the last half of 2006, DMAD substantially reduced insert media solicitations resulting in declines in reported net sales in the first half of 2007. Net sales from insert media are generated four to seven months following the initial sales solicitation. We believe that the DMAD purchase will favorably impact Direct Response sales going forward.

 

The Direct Response operation accounted for 31% of our life insurance premium during 2007, the largest of any distribution group. Direct Response’s share of total life premium has risen steadily in each of the last three years as illustrated in the chart above. Life premium for this channel rose 6% in 2007 and 8% in 2006. Net sales declined 1% in 2007 to $114 million after having risen 2% in 2006 to $115 million. First-year collected premium declined 2% in 2007 to $76 million but grew 1% in 2006 to $77 million.

 

The American Income Exclusive Agency focuses primarily on members of labor unions, but also on credit unions and other associations for its life insurance sales. It is a high profit margin business characterized by lower policy obligation ratios. Life premium for this agency rose 8% to $440 million in 2007, after having increased 8% in 2006. Net sales increased 7% in 2007 to $92 million from $86 million in 2006. Net sales rose 2% in 2006. First-year collected premium rose 2% in 2007 to $74 million, after having decreased 2% in 2006. As in the case of all of Torchmark’s agency distribution systems, continued increases in product sales are largely dependent on increases in agent count. Growth in the agent count has contributed to the improvements in sales in this agency. Net sales, a lead indicator of new sales, rose in both years and first-year collected premium turned positive in 2007 after a decline in 2006. The American Income agent count was 2,545 at December 31, 2007 compared with 2,353 a year earlier, an increase of 8%. The agent count rose 16% in 2006 from 2,027 at year end 2005. This agency continues to recruit new agents focusing on an incentive program to reward growth in both the recruiting of new agents and in the production of new business. Additionally, the systematic, centralized internet recruiting program has enhanced the recruiting of new agents.

 

The Liberty National Exclusive Agency distribution system markets its life products to primarily middle-income customers in Southeastern states. Liberty’s life premium declined 2% in 2007 and 1% in 2006 compared with the respective prior year. Liberty’s life premium sales, in terms of net sales, were $37 million in 2007, representing a decrease of 11% in 2007. Net sales also decreased 12% in 2006. First-year collected premium declined 16% in 2007 to $29 million. First-year collected premium declined 5% in 2006.

 

Growth in the Liberty Agency’s sales and premium volume are highly dependent on building the size of its agency force. Liberty has implemented initiatives similar to those of American Income to recruit new agents, primarily through the use of the internet. The continued recruiting of new agents and the retention of productive agents are critical to growing the sales in controlled agency distribution systems. Liberty’s agent count rose 49% to 2,060 at December 31, 2007 from 1,381 a year earlier. This compared with a decline of 22% in 2006 and an increase of 9% in 2005. Most of the growth in the 2007 agent count occurred in the latter half of the year. As these new agents become trained and more seasoned, they should become more productive. Declines in net sales in both 2007 and 2006 were attributable primarily to the 2006 declines in agent count. In 2006, the Liberty National Agency began the reorganization of its marketing leadership and restructured its agent compensation system to provide greater reward to productive agents and to establish production minimums for agents. These changes led to terminations and resignations during 2006 of agents not meeting these production minimums. However, management believes that these changes will result in a more productive agency over the long term. Management also believes these changes are responsible for recent margin improvements. Increased sales from a larger and more productive agency force should lead to increased premium growth.

 

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We also offer life insurance through Other Agencies consisting of the United Investors Agency, the Military Agency, the United American Independent and Branch Office Agencies, and other small miscellaneous sales agencies. The United Investors Agency is comprised of several independent agencies that concentrate on annuity business. United Investors represents approximately 5% of Torchmark’s life premium income. The Military Agency consists of a nationwide independent agency whose sales force is comprised primarily of former military officers who have historically sold primarily to commissioned and noncommissioned military officers and their families. This business consists of whole-life products with term insurance riders. Military premium represents 13% of life premium. The United American Independent and Branch Office Agencies combined represented approximately 3% of Torchmark’s total life premium. Life premium income for these two agencies has declined for the past three years because they focus on health insurance, with life sales being incidental.

 

LIFE INSURANCE

Summary of Results

(Dollar amounts in thousands)

 

     2007

    2006

    2005

 
     Amount

    % of
Premium


    Amount

    % of
Premium


    Amount

    % of
Premium


 

Premium and policy charges

   $ 1,569,964     100 %   $ 1,524,267     100 %   $ 1,468,288     100 %

Policy obligations

     1,039,278     66       1,005,771     66       966,093     66  

Required interest on reserves

     (388,024 )   (25 )     (364,313 )   (24 )     (342,305 )   (23 )
    


 

 


 

 


 

Net policy obligations

     651,254     41       641,458     42       623,788     43  

Commissions and premium taxes

     72,291     5       76,859     5       76,278     5  

Amortization of acquisition costs

     429,381     27       408,506     27       386,574     26  
    


 

 


 

 


 

Total expense

     1,152,926     73       1,126,823     74       1,086,640     74  
    


 

 


 

 


 

Insurance underwriting margin before other income and administrative expenses

   $ 417,038     27 %   $ 397,444     26 %   $ 381,648     26 %
    


 

 


 

 


 

 

Gross margins, as indicated by insurance underwriting margin before other income and administrative expense, rose 5% in 2007 to $417 million after rising 4% in 2006 and 8% in 2005. As a percentage of life insurance premium, gross margins have increased slightly each year and were 27% in 2007. Improvements in life margins have resulted from several factors. Margin improvement in 2007 was primarily the result of premium growth, but favorable mortality was also a positive factor. This improvement in mortality is not expected to be a trend. In 2006, the previously-mentioned changes in Liberty’s agent compensation system contributed to increases in Liberty’s margins, as this new system has reduced acquisition costs at Liberty. Additionally, the proportion of American Income premium to total premium has grown each year, and that has caused life margins to increase because that agency’s margins are Torchmark’s highest, well exceeding 30% in all periods. Mortality improvement in the Military Agency was also a major factor in the 2006 improvement.

 

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Health Insurance.    Health products sold by Torchmark insurance companies consist of supplemental plans that include limited-benefit hospital/surgical plans, cancer, and accident plans sold to people under age 65. We also sell Medicare Supplements to enrollees in the federal Medicare program, as well as providing coverage under the Medicare Part D prescription drug program beginning January 1, 2006. Because Medicare Part D is a significant new health product and there is no comparative prior year data in 2005, Medicare Part D business will be shown as a separate health component and will be discussed separately in the analysis of the health segment. Health premium represented 44% of Torchmark’s total premium income in 2007. Excluding Part D premium, health premium represented 39% in 2007, compared with 40% in both 2006 and 2005. Health underwriting margin, excluding Part D, accounted for 30% of the total in 2007, compared with 31% of the total in both 2006 and 2005. These declines in the health percentages are indicative of the growth in the premium and profitability of our life segment in relation to our health segment. The following table indicates health insurance premium income by distribution channel for each of the last three years.

 

HEALTH INSURANCE

Premium by Distribution Method

(Dollar amounts in thousands)

 

     2007

    2006

    2005

 
     Amount

   % of
Total


    Amount

   % of
Total


    Amount

   % of
Total


 

United American Independent Agency

                                       

Limited-benefit plans

   $ 92,042          $ 102,163          $ 98,023       

Medicare Supplement

     296,368            316,527            343,650       
    

        

        

      
       388,410    38 %     418,690    41 %     441,673    43 %

United American Branch Office Agency

                                       

Limited-benefit plans

     203,577            153,944            94,731       

Medicare Supplement

     183,377            200,591            228,036       
    

        

        

      
       386,954    37       354,535    35       322,767    32  

Liberty National Exclusive Agency

                                       

Limited-benefit plans

     141,082            144,925            148,894       

Medicare Supplement

     84            99            126       
    

        

        

      
       141,166    14       145,024    14       149,020    15  

American Income Exclusive Agency

                                       

Limited-benefit plans

     69,268            65,588            61,797       

Medicare Supplement

     1,403            1,587            1,826       
    

        

        

      
       70,671    7       67,175    6       63,623    6  

Direct Response

                                       

Limited-benefit plans

     527            572            638       

Medicare Supplement

     41,811            39,154            37,136       
    

        

        

      
       42,338    4       39,726    4       37,774    4  

Total Premium (Before Part D)

                                       

Limited-benefit plans

     506,496    49       467,192    46       404,083    40  

Medicare Supplement

     523,043    51       557,958    54       610,774    60  
    

  

 

  

 

  

Total Premium (Before Part D)

     1,029,539    100 %     1,025,150    100 %     1,014,857    100 %
           

        

        

Medicare Part D*

     214,589            212,382            -0-       
    

        

        

      

Total Health Premium*

   $ 1,244,128          $ 1,237,532          $ 1,014,857       
    

        

        

      

*   Total Medicare Part D premium and health premium in 2007 exclude $7.3 million of risk-sharing premium paid to the Centers for Medicare and Medicaid Services consistent with the Medicare Part D contract. This risk-sharing amount is a portion of the excess or deficiency of actual over expected claims, and therefore we view this payment as a component of policyholder benefits in our segment analysis.

 

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We market supplemental health insurance products through a number of distribution channels with the two United American agencies being our market leaders. Over the past several years, we have placed greater emphasis on the sale of limited-benefit health insurance products rather than Medicare Supplement insurance as customer demand for the limited-benefit hospital/surgical plans has increased and price competition and lesser demand for Medicare Supplements has dampened sales of that product. While Medicare Supplement still remains our largest health product in terms of premium income, the premium from other limited-benefit health products have been growing rapidly. As shown in the chart above, Medicare Supplement premium represented 51% of total health premium (excluding Part D) in 2007, but has declined steadily as a percentage of total health premium in each successive year. Accordingly, limited-benefit health products have increased as a percentage of total health premium before Part D each year during the same period.

 

The following table presents net sales by distribution method for the last three years.

 

HEALTH INSURANCE

Net Sales by Distribution Method

(Dollar amounts in thousands)

 

     2007

    2006

    2005

 
     Amount

   % of
Total


    Amount

   % of
Total


    Amount

   % of
Total


 

United American Independent Agency

                                       

Limited-benefit plans

   $ 33,917          $ 38,651          $ 42,753       

Medicare Supplement

     16,381            16,278            15,813       
    

        

        

      
       50,298    21 %     54,929    23 %     58,566    32 %

United American Branch Office Agency

                                       

Limited-benefit plans

     151,924            146,711            78,137       

Medicare Supplement

     10,406            12,765            17,953       
    

        

        

      
       162,330    68       159,476    65       96,090    52  

Liberty National Exclusive Agency

                                       

Limited-benefit plans

     9,842            11,588            13,218       

Medicare Supplement

     130            216            330       
    

        

        

      
       9,972    4       11,804    5       13,548    7  

American Income Exclusive Agency

                                       

Limited-benefit plans

     11,307            11,685            11,347       

Medicare Supplement

     -0-            -0-            -0-       
    

        

        

      
       11,307    5       11,685    5       11,347    6  

Direct Response

                                       

Limited-benefit plans

     477            623            738       

Medicare Supplement

     4,985            4,721            5,232       
    

        

        

      
       5,462    2       5,344    2       5,970    3  

Total Net Sales (Before Part D)

                                       

Limited-benefit plans

     207,467    87       209,258    86       146,193    79  

Medicare Supplement

     31,902    13       33,980    14       39,328    21  
    

  

 

  

 

  

Total Net Sales (Before Part D)

     239,369    100 %     243,238    100 %     185,521    100 %
           

        

        

Medicare Part D*

     37,913            278,023            -0-       
    

        

        

      

Total Health Net Sales

   $ 277,282          $ 521,261          $ 185,521       
    

        

        

      

*   Net sales for Medicare Part D represents only new first-time enrollees.

 

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Table of Contents
Index to Financial Statements

The following table discloses first-year collected health premium by distribution method.

 

HEALTH INSURANCE

First-Year Collected Premium by Distribution Method

(Dollar amounts in thousands)

 

     2007

    2006

    2005

 
     Amount

   % of
Total


    Amount

   % of
Total


    Amount

   % of
Total


 

United American Independent Agency

                                       

Limited-benefit plans

   $ 27,055          $ 31,817          $ 34,498       

Medicare Supplement

     12,992            15,084            16,834       
    

        

        

      
       40,047    21 %     46,901    26 %     51,332    35 %

United American Branch Office Agency

                                       

Limited-benefit plans

     115,148            92,791            49,887       

Medicare Supplement

     10,238            14,131            17,129       
    

        

        

      
       125,386    66       106,922    59       67,016    45  

Liberty National Exclusive Agency

                                       

Limited-benefit plans

     8,180            9,756            9,547       

Medicare Supplement

     161            248            332       
    

        

        

      
       8,341    4       10,004    5       9,879    7  

American Income Exclusive Agency

                                       

Limited-benefit plans

     12,347            12,716            12,804       

Medicare Supplement

     -0-            -0-            -0-       
    

        

        

      
       12,347    6       12,716    7       12,804    9  

Direct Response

                                       

Limited-benefit plans

     470            697            136       

Medicare Supplement

     4,499            4,397            5,714       
    

        

        

      
       4,969    3       5,094    3       5,850    4  

Total First-Year Collected Premium (Before Part D)

                                       

Limited-benefit plans

     163,200    85       147,777    81       106,872    73  

Medicare Supplement

     27,890    15       33,860    19       40,009    27  
    

  

 

  

 

  

Total (Before Part D)

     191,090    100 %     181,637    100 %     146,881    100 %
           

        

        

Medicare Part D*

     53,269            212,382            -0-       
    

        

        

      

Total First-Year Collected Premium

   $ 244,359          $ 394,019          $ 146,881       
    

        

        

      

*   First-year collected premium for Medicare Part D represents only premium collected from new first-time enrollees in their first policy year. In 2006, all premium was first year.

 

The United American Branch Office and Independent Agencies.    As discussed above, the two United American Agencies have emphasized sales of individual supplemental limited-benefit health plans known generally as hospital/surgical plans for which demand has increased in recent years. These plans generally provide a per diem payment for each hospital inpatient day confined, a fixed-amount surgical schedule, out patient coverage, and other miscellaneous hospital-related charges. They also contain caps on total per-illness benefits. Consumer interest in these products has increased as a result of growing unavailability or lack of affordability of individual major-medical plans and decreased coverage offered by employers. Minimum regulatory loss ratios on these limited-benefit plans are generally lower than those of Medicare Supplement; however, the Medicare Supplement product has historically had slightly higher persistency rates, resulting in both products having approximately the same underwriting margin as a percentage of premium. Both of the United American agencies offer these limited-benefit plans.

 

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Index to Financial Statements

The United American Branch Office is an exclusive agency, meaning the agents in its 155 offices nationwide sell only for us. In recent years, this agency has been successful in building sales of limited-benefit plans to replace the decline in Medicare Supplement sales. Net sales of limited-benefit plans in 2007 were $152 million, rising 4%. In 2006, net sales rose 88% to $147 million. As a result, total health sales at the UA Branch Office were $162 million, a 2% increase over 2006, including the decline in Medicare Supplement sales. However, in 2006, total net health sales for this Agency increased 66%, as a result of the growth in limited-benefit sales. Total health premium rose 9% in 2007 to $387 million, compared with a 10% increase in 2006 to $355 million, taking the decline in the Medicare Supplement in force block into account. After growing very rapidly over the past few years, the producing agent count in the UA Branch office declined 1% as of December 31, 2007 to 2,979 from 3,015. In 2006, the producing agent count rose 39%, after growing 29% a year earlier. As is the case with all of our captive agencies, growing the agency size translates into increased sales and premium growth.

 

The United American Independent Agency is composed of independent agencies appointed with Torchmark whose size range from very large, multi-state organizations down to one-person offices. All of these agents generally sell for a number of insurance companies, of which 3,439 were active producing agents for Torchmark at December 31, 2007. Health premium for the UA Independent Agency declined 7% to $388 million in 2007, after declining 5% in 2006. The declines in premium are due to the decreases in Medicare Supplement premium. This block of business continues to decline as sales have not compensated for lapses. This agency’s contribution to Torchmark’s total health sales and premium has declined in each of the past three years. Even though net sales of limited-benefit products declined in each of the last three years, each year’s new sales have added to premium in force, resulting in the increases in limited-benefit premium. In the recent past, most of this agency’s health sales came from one large independent agency. In 2005, that leading agency’s recruiting and training program experienced a disruption that resulted in a decline in producing agents. The disruption resulted in a 32% drop in 2005 net sales. Sales from this agency have not recovered.

 

Liberty National Exclusive Agency, predominately a life insurance distribution channel, is the third largest writer of Torchmark health business based on premium collected. Cancer supplemental plans are the type of limited-benefit health products primarily produced by this agency. Liberty is our only distribution channel for which cancer insurance is its primary health product. Liberty’s health premium declined 3% in 2007 to $141 million after a 3% drop in 2006. The declines in premium have resulted from the settlement of a class-action lawsuit in early 2005 concerning a closed block of cancer business over the timing and size of the premium rate increases on this block. This block represented approximately half of Liberty’s cancer business in 2005 and approximately 37% at year end 2007. Prior to 2005, significant rate increases to offset deteriorating margins on this block were a continuing factor causing growth in health premium, but increasing claims continued to reduce underwriting margins. The settlement provided for reduced benefits paid going forward and further required Liberty to reduce premiums and to maintain an 85% claims loss ratio over the remaining life of the business.

 

Net health sales in the Liberty agency for 2007 declined 16% to $10 million, compared with 2006 net health sales of $12 million. Net health sales were $14 million in 2005. One factor in the decline in health sales at Liberty has been the increased emphasis on selling the higher-margin life products. Another issue had been the decline in agent counts in recent periods, as a result of a change in the agent compensation system in 2006 to improve persistency and margins. However, as a result of recruiting and training initiatives, the agent count rose from 1,381 at year end 2006 to 2,060 at year end 2007, an increase of 49%.

 

American Income Exclusive Agency, also predominately a life insurance distribution channel, is our fourth largest health insurance distributor based on 2007 premium collected. Its health plans are comprised of various limited-benefit plans for which almost two thirds of the agency’s 2007 health premium was from accident policies. Sales of the health plans by this agency are generally made in conjunction with a life policy being sold to the same customer.

 

Health premium at this agency for 2007 increased 5% to $71 million, while 2006 premium of $67 million increased 6% over 2005. Net health sales were $11.3 million in 2007, compared with $11.7 million in 2006 and $11.3 million in 2005. Net health sales comprised only 11% of the American Income Agency’s total net sales in 2007.

 

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Index to Financial Statements

Direct Response, primarily a life operation, also offers health insurance, which is predominantly Medicare Supplements sold directly to employer or union sponsored groups. In 2007, net health sales were $5 million, comprising only 5% of Direct Response’s total life and health net sales. These net sales rose 2% in 2007, but declined 10% in 2006. Health premium in 2007 for this group rose 7% to $42 million. Health premium in 2006 was $40 million, a 5% increase.

 

Medicare Part D.      Torchmark, through its subsidiary United American, began offering insurance coverage under the government’s Medicare Part D plan as of January 1, 2006. The Medicare Part D plan is a stand-alone prescription drug plan for Medicare beneficiaries. Part D is regulated and partially funded by the Centers for Medicare and Medicaid Services (CMS) for participating private insurers like United American, unlike the traditional Medicare program for hospital and doctor services, where CMS is the primary insurer and private Medicare Supplement insurers are secondary insurers. The program generally calls for CMS to pay approximately two thirds of the premium with the insured Medicare beneficiary paying one third of the premium. Total Medicare Part D premium was $215 million in 2007, compared with $212 million in 2006. Enrollment for all Part D coverages ends on December 31 of the previous year, except for enrollees who reach age 65 in the current year. At December, 2006, United American had approximately 189 thousand enrollees for the 2007 Part D plan. Although final enrollment has not been confirmed, we expect a decline in enrollees for the 2008 plan year. Our Medicare Part D product is sold primarily through the Direct Response operation, but is also sold by the two UA agencies. Part D net sales were $38 million in 2007 compared with $278 million in 2006, as we count only sales to new first-time enrollees in net sales. The majority of 2007 premium income was from previous enrollees.

 

We believe that the Medicare Part D program is an excellent addition to our health product offerings because of our experience with the senior-age market and with Medicare Supplements, the government assurances with regard to the risk-sharing agreements for participating insurers, the incremental income added to our health insurance margins, and the renewal of the business every year. Our experience with service to the senior-age market and use of our Direct Response marketing system required little new investment to enter this business. As previously mentioned, we view the Medicare Part D product separately from our other health products because of its significance and because there are no prior year comparisons with 2005.

 

We do not expect significant growth in the Part D product in the near future, as most Medicare beneficiaries enrolled in a plan in 2006. Additionally, as with any government-sponsored program, the possibility of regulatory changes could change the outlook for this market.

 

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Table of Contents
Index to Financial Statements

The following tables present underwriting margin data for health insurance for each of the last three years.

 

HEALTH INSURANCE

Summary of Results

(Dollar amounts in thousands)

 

    2007

 
    Health*

    % of
Premium


    Medicare
Part D

  % of
Premium


    Total
Health

    % of
Premium


 

Premium**

  $ 1,029,539     100 %   $ 214,589   100 %   $ 1,244,128     100 %

Policy obligations**

    671,158     65       171,274   80       842,432     68  

Required interest on reserves

    (28,065 )   (3 )     -0-   -0-       (28,065 )   (3 )
   


 

 

 

 


 

Net policy obligations

    643,093     62       171,274   80       814,367     65  

Commissions and premium taxes

    70,362     7       13,891   7       84,253     7  

Amortization of acquisition costs

    131,998     13       5,256   2       137,254     11  
   


 

 

 

 


 

Total expense

    845,453     82       190,421   89       1,035,874     83  
   


 

 

 

 


 

Insurance underwriting income before other income and administrative expenses

  $ 184,086     18 %   $ 24,168   11 %   $ 208,254     17 %
   


 

 

 

 


 

    2006

 
    Health*

    % of
Premium


    Medicare
Part D

  % of
Premium


    Total
Health

    % of
Premium


 

Premium

  $ 1,025,150     100 %   $ 212,382   100 %   $ 1,237,532     100 %

Policy obligations

    670,560     65       163,457   77       834,017     67  

Required interest on reserves

    (24,662 )   (2 )     -0-   -0-       (24,662 )   (2 )
   


 

 

 

 


 

Net policy obligations

    645,898     63       163,457   77       809,355     65  

Commissions and premium taxes

    71,040     7       16,990   8       88,030     7  

Amortization of acquisition costs

    127,081     12       6,372   3       133,453     11  
   


 

 

 

 


 

Total expense

    844,019     82       186,819   88       1,030,838     83  
   


 

 

 

 


 

Insurance underwriting income before other income and administrative expenses

  $ 181,131     18 %   $ 25,563   12 %   $ 206,694     17 %
   


 

 

 

 


 

    2005

 
    Health*

    % of
Premium


    Medicare
Part D

  % of
Premium


    Total
Health

    % of
Premium


 

Premium

  $ 1,014,857     100 %               $ 1,014,857     100 %

Policy obligations

    668,205     66                   668,205     66  

Required interest on reserves

    (20,879 )   (2 )                 (20,879 )   (2 )
   


 

 

 

 


 

Net policy obligations

    647,326     64                   647,326     64  

Commissions and premium taxes

    74,484     7                   74,484     7  

Amortization of acquisition costs

    115,868     12                   115,868     12  
   


 

 

 

 


 

Total expense

    837,678     83                   837,678     83  
   


 

 

 

 


 

Insurance underwriting income before other income and administrative expenses

  $ 177,179     17 %               $ 177,179     17 %
   


 

 

 

 


 


*   Health other than Medicare Part D.
**   Total Medicare Part D premium and health premium in 2007 exclude $7.3 million of risk-sharing premium paid to CMS consistent with the Medicare Part D contract. This risk-sharing amount is a portion of the excess or deficiency of actual over expected claims, and therefore we view this payment as a component of policyholder benefits in our segment analysis.

 

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Torchmark’s health insurance underwriting margin excluding Part D before other income and administrative expense increased 2% in 2007 to $184 million from $181 million. In 2006, margin also rose 2%. As a percentage of premium, underwriting margin increased from 17.7% in 2006 to 17.9% in 2007, after having risen from 17.5% in 2005. These increases were primarily the result of the reduced loss ratios in the previously-mentioned closed block of cancer business at Liberty and improvements in American Income’s loss ratios, especially in 2006. Liberty’s health margins increased $6 million or 20% in 2007, or 24% of health premium. They also rose $3 million to $29 million in 2006, representing 20% of premium. American Income’s margins rose $3 million to $24 million in 2006 and $2 million to $26 million in 2007, 36% of premium in both periods.

 

Annuities.    Fixed and variable annuity products are sold on a limited basis by our subsidiaries. Annuities represented 1% of Torchmark’s 2007 premium revenue and less than 2% of insurance underwriting margin. We no longer emphasize this segment.

 

ANNUITIES

Summary of Results

(Dollar amounts in thousands)

 

     2007

    2006

    2005

 

Policy charges

   $ 20,470     $ 22,914     $ 24,929  

Policy obligations

     28,049       23,743       26,888  

Required interest on reserves

     (31,666 )     (28,318 )     (30,092 )
    


 


 


Net policy obligations

     (3,617 )     (4,575 )     (3,204 )

Commissions and premium taxes

     119       88       49  

Amortization of acquisition costs

     14,631       15,486       15,504  
    


 


 


Total expense

     11,133       10,999       12,349  
    


 


 


Insurance underwriting margin before other income and administrative expenses

   $ 9,337     $ 11,915     $ 12,580  
    


 


 


 

Annuities generate earnings from periodic policy fees and charges based on the average account balances, reduced by net policy obligations and acquisition costs. For fixed annuities, net required interest on reserves is the required interest credited to the accounts and is offset by investment income.

 

For the three periods shown in the chart above, account balances declined, resulting in reductions in policy fees and charges. Accordingly, insurance underwriting margin for annuities (before other income and administrative expenses) declined in each period and was $9.3 million in 2007. As a percentage of policy charges, margins rose slightly in 2006 to 52% but fell to 46% in 2007. The 2007 decline in margins resulted from increased acquisition costs ratios due to the unlocking of deferred acquisition costs related to guaranteed minimum death benefit business. We expect higher amortization of acquisition costs going forward. In all three periods, investment income earned exceeded required interest credited to fixed accounts. A significant portion of annuity profitability is derived from the spread of investment income exceeding contractual interest requirements. This spread results in negative net policy obligations.

 

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Index to Financial Statements

Administrative expenses.    Operating expenses are included in the Other and Corporate Segments and are classified into two categories: insurance administrative expenses and expenses of the parent company. The following table is an analysis of operating expenses for the three years ended December 31, 2007.

 

Operating Expenses Selected Information

(Dollar amounts in thousands)

 

     2007

    2006

    2005

 
     Amount

    % of
Prem.


    Amount

    % of
Prem.


    Amount

    % of
Prem.


 

Insurance administrative expenses:

                                          

Salaries

   $ 66,799     2.4 %   $ 66,031     2.4 %   $ 64,339     2.6 %

Other employee costs

     28,709     1.0       31,300     1.1       27,953     1.1  

Other administrative expense

     44,260     1.6       45,951     1.7       41,878     1.7  

Legal expense

     11,513     0.4       6,634     0.2       13,511     0.5  

Medicare Part D direct administrative expense

     3,271     0.1       5,415     0.2       -0-     -0-  
    


 

 


 

 


 

Total insurance administrative expenses

     154,552     5.5 %     155,331     5.6 %     147,681     5.9 %
            

         

         

Parent company expense

     9,815             7,862             9,660        

Stock compensation expense

     8,106             6,575             -0-        

Expenses related to settlement of prior period litigation

     933             -0-             14,950        

Option term extension expense for retiring executive

     -0-             -0-             568        
    


       


       


     

Total operating expenses, per Consolidated Statements of Operations

   $ 173,406           $ 169,768           $ 172,859        
    


       


       


     

Insurance administrative expenses:

                                          

Increase (decrease) over prior year

     (.5 )%           5.2 %           4.3 %      

Total operating expenses:

                                          

Increase (decrease) over prior year

     2.1 %           (1.8 )%           14.3 %      

 

Insurance administrative expenses as a percentage of premium declined to 5.5% in 2007 from 5.6% in 2006 and 5.9% in 2005. The decline in the 2007 ratio occurred even though legal expense rose $4.9 million. A major factor in this increase was the affirmation of an earlier jury verdict in insurance claim litigation in the amount of $1.9 million. The increase in legal expense was offset by declines in employee costs other than salaries, and in a $2.1 million decline in Medicare Part D direct administrative expense. One factor in the decline in insurance administrative expense resulted from the previously-mentioned changes implemented in Liberty’s agent compensation system. These changes resulted in reductions in agent salaries and related employee costs of approximately $2.8 million in 2007 compared with the prior period. Management believes that these salary reductions could be replaced by higher deferred acquisition costs going forward, as the compensation system changes emphasize a commission-based agent compensation system rather than salaries. Commissions on new product sales are deferred and amortized over the premium-paying life of the business. The Medicare Part D administrative costs were lower in 2007 because open enrollment was still in effect in 2006 until May 15, causing us to incur additional administrative expense in that year. Open enrollment for the 2007 plan year was closed on December 31, 2006. The 2006 ratio of expense to premium also declined even after including the $5 million of Medicare Part D administrative expense for the first time in 2006. Decreased legal costs were a primary factor, as several ongoing issues were resolved in 2005 and 2006.

 

Parent company expense rose $2.0 million or 25% in 2007. Included in 2007 expense is a one-time charge in the amount of $1.6 million for expenses incurred related to an acquisition bid that was not successful.

 

 

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Index to Financial Statements

As noted in the Summary of Operations in this discussion, we settled litigation in connection with Liberty’s race-distinct mortality dual/pricing litigation and its class-action cancer case in 2005. Settlement charges and expenses for both cases were recorded in 2005 in the amount of $15 million and additional expenses of $933 thousand were recorded in 2007. Both of these cases arose many years ago. As previously noted, we do not consider the costs of settling litigation applicable to prior periods to be related to current insurance operations. Stock compensation expense rose due to a higher fair value assigned to recent grants (primarily as a result of the increase in the Torchmark stock price), and due to restricted stock granted in late 2006 and mid-2007 for the first time in several years. As stated in Note 13—Business Segments in the Notes to Consolidated Financial Statements, management views stock compensation expense as a corporate expense, and therefore treats it as a Parent Company expense.

 

Investments.    The investment segment is responsible for the management of capital resources including investments, debt and cash flow. 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 13—Business Segments in the Notes to the Consolidated Financial Statements. It is defined as net investment income less both the interest credited to net policy liabilities and the interest cost associated with capital funding or “financing costs.” We also view excess investment income per diluted share as an important and useful measure to evaluate the performance of the investment segment. It is defined as excess investment income divided by the total diluted weighted average shares outstanding, representing the contribution by the investment segment to the consolidated earnings per share of the Company. Since implementing our share repurchase program in 1986, we have used $3.6 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.

 

Excess Investment Income. The following table summarizes Torchmark’s investment income and excess investment income.

 

Analysis of Excess Investment Income

(Dollar amounts in thousands except for per share data)

 

     2007

    2006

    2005

 

Net investment income

   $ 648,826     $ 628,746     $ 603,068  

Reclassification of interest amount due to deconsolidation*

     (264 )     (454 )     (360 )
    


 


 


Adjusted investment income (per segment analysis)

     648,562       628,292       602,708  

Interest credited to net insurance policy liabilities:

                        

Interest on reserves

     (447,755 )     (417,293 )     (393,276 )

Interest on deferred acquisition costs

     190,255       179,955       167,987  
    


 


 


Net required

     (257,500 )     (237,338 )     (225,289 )

Financing costs

     (67,300 )     (72,191 )     (53,181 )
    


 


 


Excess investment income

   $ 323,762     $ 318,763     $ 324,238  
    


 


 


Excess investment income per diluted share

   $ 3.38     $ 3.15     $ 3.07  
    


 


 


Mean invested assets (at amortized cost)

   $ 9,775,769     $ 9,324,024     $ 8,810,584  

Average net insurance policy liabilities

     4,828,161       4,496,561       4,303,655  

Average debt and preferred securities (at amortized cost)

     919,936       1,005,561       892,971  

* Deconsolidation of trusts liable for Trust Preferred Securities required by accounting rule FIN46R. See—Note 10—Debt in the Notes to Consolidated Financial Statements.

 

 

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Excess investment income increased $5 million or 2% in 2007 over the prior year. Excess investment income declined 2% in both 2006 and 2005. On a per diluted share basis, 2007 excess investment income rose 7% to $3.38. Per share excess investment income increased 3% in 2006 and 4% in 2005.

 

The largest component of excess investment income is net investment income, which rose 3% to $649 million in 2007. It increased 4% to $628 million in 2006 from $603 million in 2005. As presented in the following chart, the growth in net investment income in both periods was not as great as the growth in mean invested assets.

 

     2007

    2006

    2005

 

Growth in net investment income

   3.2 %   4.2 %   4.5 %

Growth in mean invested assets (at amortized cost)

   4.8     5.8     5.5  

 

The lower growth in income is reflective of new investments made each year at long-term yields lower than the portfolio’s average yield, resulting from the lower rates available in financial markets in recent years. In 2007, we purchased $256 million of tax-exempt municipal securities. This was another factor in limiting the growth of net investment income relative to average assets, as the yields available on municipal bonds are lower, but produce significant tax savings. Also contributing to the lower growth in yields in recent years were calls on fixed maturity securities in the portfolio, as the yield on the reinvestment of the proceeds was below that of the called securities. Given the sizeable annual cash flow from our operations, we expect mean invested assets to continue to grow, but as long as rates available for new investments do not exceed our portfolio yield, the rate of growth of investment income will be under pressure. More detailed information about investment acquisitions follows under this caption.

 

Excess investment income is reduced by interest credited to net insurance policy liabilities and the interest paid on corporate debt. Information about interest credited to policy liabilities is shown in the following table.

 

Interest Credited to Net Insurance Policy Liabilities

(Dollar amounts in millions)

 

     Interest
Credited


    Average Net
Insurance
Policy Liabilities


    Average
Crediting
Rate


 

2007

                      

Life and Health

   $ 223.3     $ 4,127.8     5.41 %

Annuity

     34.2       700.4     4.88  
    


 


     

Total

     257.5       4,828.2     5.33  

Increase in 2007

     8 %     7 %      

2006

                      

Life and Health

   $ 206.3     $ 3,857.8     5.35 %

Annuity

     31.0       638.8     4.85  
    


 


     

Total

     237.3       4,496.6     5.28  

Increase in 2006

     5 %     4 %      

2005

                      

Life and Health

   $ 193.0     $ 3,635.4     5.31 %

Annuity

     32.3       668.3     4.84  
    


 


     

Total

     225.3       4,303.7     5.23  

Increase in 2005

     6 %     6 %      

 

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The average interest crediting rate has risen in each of the last three years. In 2001, as part of our normal review of policy reserve assumptions, we increased the interest rate assumption 100 basis points (1%) on policies issued after January 1, 2001. As this group of policies becomes a larger proportion of our business, the average crediting rate will continue to increase. For more specific information on life and health crediting rates, please refer to Note 5—Future Policy Benefit Reserves in the Notes to Consolidated Financial Statements.

 

Excess investment income is also impacted by financing costs. Financing costs for the investment segment primarily consist of interest on our various debt instruments and are deducted from excess investment income. The table below reconciles interest expense per the Consolidated Statements of Operations to financing costs.

 

Reconciliation of Interest Expense to Financing Costs

(Amounts in thousands)

 

     2007

    2006

    2005

 

Interest expense per Consolidated Statements of Operations

   $ 67,564     $ 73,136     $ 60,934  

Reclassification of interest due to deconsolidation(1)

     (264 )     (454 )     (360 )

Benefit from interest-rate swaps(2)

     -0-       (491 )     (7,393 )
    


 


 


Financing costs

   $ 67,300     $ 72,191     $ 53,181  
    


 


 



(1) See Principals of Consolidation in Note 1—Significant Accounting Policies in the Notes to Consolidated Financial Statements. for an explanation of deconsolidation.
(2) Included in the Consolidated Statements of Operations as a realized investment gain under the caption “Realized investment gains (losses)”. See Derivatives in Note 1.

 

The table below presents the components of financing costs.

 

Analysis of Financing Costs

(Amounts in thousands)

 

     2007

    2006

    2005

 

Interest on funded debt

   $ 53,379     $ 63,585     $ 52,322  

Interest on short-term debt

     14,127       9,487       8,532  

Other

     58       64       80  

Reclassification of interest due to deconsolidation

     (264 )     (454 )     (360 )
    


 


 


Subtotal of interest expense

     67,300       72,682       60,574  

Benefit from interest-rate swaps

     -0-       (491 )     (7,393 )
    


 


 


Financing costs

   $ 67,300     $ 72,191     $ 53,181  
    


 


 


 

Financing costs declined $5 million or 7% in 2007. They increased 36% or $19 million in 2006. The primary factor in the 2007 decrease, as well as the 2006 increase in financing costs, was the refinancing in 2006 of two of our funded debt issues. Our 6¼% Senior Notes ($180 million principal amount) matured and our 7¾% Trust Preferred Securities ($150 million redemption value) were called in the fourth quarter of 2006. These repayments were essentially funded by the issuance of two new instruments in the second quarter of 2006, our 6 3/8% Senior Notes ($250 million principal amount) and our 7.1% Trust Preferred Securities ($120 million principal amount). Because the new issues were offered several months before the other securities were repaid, interest on funded debt increased $11 million. It should be noted, however, that we invested the proceeds of the new offerings and the investment income from those proceeds offset the increased financing costs, having little impact on excess investment income. Partially offsetting the decline in interest on funded debt in 2007 was an increase in interest on short-term debt. While higher short-term rates were a factor, the primary cause of the increase was a higher average balance of our commercial paper outstanding in 2007, which rose 43% to $238 million.

 

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Increased short-term rates were also a factor in the 2006 increase in financing costs, impacting us in two ways. Most notable was the effect that rising short rates had on our interest rate swaps, which we originally entered into to exchange our fixed-interest commitments for floating-rate commitments. In the low-interest environment experienced in the past several years, these swaps provided us with a considerable spread between our actual interest cost and what our fixed interest cost would have been. In 2004, short-term rates began to rise for the next two years, resulting in significant declines in the benefit of all of our swaps. Because of the possibility that continued rising short-term rates could cause our spreads to become negative, we disposed of all swap instruments as of the second quarter of 2006. Nevertheless, the reduction in positive spreads on settlements from the swaps caused financing costs to increase $7 million in 2006. As a result of the dispositions of the swaps, our only exposure to variable rates at December 31, 2007 was our commercial paper borrowing program, of which $202 million was outstanding. In addition to their impact on our swaps, rising short-term rates were also the primary factor in the $1 million increase in interest on our commercial paper borrowings in 2006. More information concerning the debt offerings, repayments, and swaps is disclosed in Note 10—Debt in the Notes to the Consolidated Financial Statements.

 

Investment Acquisitions.    During calendar years 2005 through 2007, Torchmark invested almost exclusively in investment-grade fixed-maturity securities. The following chart summarizes selected information for fixed maturity acquisitions in the years 2005 through 2007. Investment grade corporate securities include both bonds and trust-preferred securities (which are classified as redeemable preferred stocks) with a diversity of issuers and industry sectors. The effective annual yield shown is the yield calculated to the potential termination date that produces the lowest yield. This date is commonly known as the “worst call date.” For noncallable bonds, the worst call date is always the maturity date. For callable bonds, the worst call date is the call date that produces the lowest yield (or the maturity date, if the yield calculated to the maturity date is lower than the yield calculated to each call date). Two different average life calculations are shown, average life to the next call date and average life to the maturity date.

 

Fixed Maturity Acquisitions Selected Information

(Dollar amounts in millions)

 

     For the Year

 
     2007

    2006

    2005

 

Cost of acquisitions:

                        

Investment-grade corporate securities

   $ 1,767.8     $ 1,179.2     $ 787.4  

Tax-exempt municipal securities

     256.4       -0-       -0-  

Other investment-grade securities

     39.4       105.0       110.4  
    


 


 


Total fixed-maturity acquisitions

   $ 2,063.6     $ 1,284.2     $ 897.8  
    


 


 


Effective annual yield (one year compounded*)

     6.78 %     6.72 %     5.90 %

Average life (in years, to next call)

     19.6       13.8       14.6  

Average life (in years to maturity)

     32.6       24.0       16.4  

Average rating

     A       A       A-  

* Tax-equivalent basis, whereby the yield on tax-exempt securities is adjusted to produce a yield equivalent to the pretax yield on taxable securities.

  

 

When yields available on acceptable-quality long-term (maturity date more than 20 years after the acquisition date) securities are sufficient to meet our yield and spread objectives, we generally prefer to invest in such securities because they more closely match the long-term nature of our policy liabilities. During periods when we cannot invest in long-term securities that meet our objectives, we generally invest in shorter-term (maturity date less than 5 years after the acquisition date) securities. We prefer to invest primarily in bonds that are not callable (on other than a make-whole basis) prior to maturity. We periodically invest some funds in callable bonds when the incremental yield available on such bonds warrants doing so.

 

For investments in callable bonds, the actual life of the investment will depend on whether or not (and if so, when) the issuer calls the investment prior to the maturity date. Given our investments in callable

 

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bonds, the actual average life of our investments can not be known at the time of the investment. We do know that the average life will not be less than the average life to next call and will not exceed the average life to maturity. Data for both of these average life measures is provided in the above chart.

 

During 2005-2007, especially during 2005, there have been periods when yields available on acceptable-quality long-term non-callable securities did not meet our objectives. During such periods, we have invested in shorter-term securities. Some of these periods were characterized by relatively flat or inverted yield curves. During such periods, we did not have to give up much yield to invest in shorter-term securities, and we took on less credit risk than had we invested longer-term. Prior to 2007, we generally did not invest in securities with maturity dates more than 30 years after the acquisition date. During 2007, we invested some funds in hybrid securities (bonds, trust preferred securities and redeemable preferred stocks) with very long scheduled maturity dates, often exceeding 50 years. In virtually all cases, such hybrid securities are callable many years prior to the scheduled maturity date.

 

As shown in the chart above, the effective annual yield and average life to maturity on funds invested during 2005 is significantly lower than that of funds invested during 2006 and 2007. This difference is reflective of the fact that, consistent with the investment environment and strategy described above, we invested relatively more funds in lower yielding, shorter-term investments in 2005 than we did in 2006-2007. Due primarily to our investments in hybrid securities as described above, the average life of funds invested during 2007 (to both next call and maturity) is significantly higher than that of investments during 2005-2006. Given the long-term fixed-rate characteristics of our policy liabilities, we believe that investments with average lives in excess of 20 years are appropriate.

 

New cash flow available to us for investment was affected by issuer calls as a result of the low-interest environment experienced during the past three years. Issuers are more likely to call bonds when rates are low because they often can refinance them at a lower cost. Calls increase funds available for investment, but they can negatively affect portfolio yield if they cause us to replace higher-yielding bonds with those available at lower prevailing yields. Issuer calls were $848 million in 2007, $229 million in 2006, and $226 million in 2005.

 

As long as we continue our current investment strategy and the average yield on new investments is less than the average yield of the portfolio and of assets disposed of, the average yield on fixed maturity assets in the portfolio should decline. Because of the significant investable cash flow generated from investments and operations, Torchmark will benefit if yield rates available on new investments increase.

 

Portfolio Analysis.    Because Torchmark has recently invested almost exclusively in fixed-maturity securities, the relative percentage of our assets invested in various types of investments varies from industry norms. The following table presents a comparison of Torchmark’s components of invested assets at amortized cost as of December 31, 2007 with the latest industry data.

 

     Torchmark

    
     Amount
(in millions)


   %

   Industry %(1)

Bonds

   $ 8,021    81.3    75.6

Preferred stock (redeemable and perpetual)

     1,327    13.4    2.0

Common stocks

     1    0.0    2.8

Mortgage loans

     19    0.2    10.4

Real estate

     8    0.1    0.5

Policy loans

     344    3.5    3.9

Other invested assets

     42    0.4    3.2

Short terms

     111    1.1    1.6
    

  
  
     $ 9,873    100.0    100.0
    

  
  

(1) Latest data available from the American Council of Life Insurance.

 

For an analysis of our fixed-maturity portfolio by component at December 31, 2007 and 2006 and for a schedule of maturities, see Note 3Investments in the Notes to Consolidated Financial Statements.

 

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Additional information concerning the fixed-maturity portfolio is as follows.

 

Fixed Maturity Portfolio Selected Information

 

     At December 31,
2007


    At December 31,
2006


 

Average effective annual yield(1)

   6.96 %   7.02 %

Average life (in years, to next call)(2)

   14.0     10.6  

Average life (in years, to maturity)(2)

   20.7     16.5  

Effective duration (in years, to next call)(2,3)

   7.5     6.5  

Effective duration (in years, to maturity)(2,3)

   9.6     8.6  

(1)   Tax-equivalent basis, whereby the yield on tax-exempt securities is adjusted to produce a yield equivalent to the pretax yield on taxable securities.
(2)   Torchmark calculates the average life and duration of the fixed-maturity portfolio two ways: (a) based on the next call date which is the next call date for callable bonds and the maturity date for noncallable bonds, and (b) based on the maturity date of all bonds, whether callable or not.
(3)   Effective duration is a measure of the price sensitivity of a fixed-income security to a particular change in interest rates.

 

At the end of 2007 and 2006, the fixed-maturity portfolio had a gross unrealized gain of $247 million and $319 million, respectively. Gross unrealized losses on fixed maturities were $350 million at December 31, 2007, compared with $90 million a year earlier. Please see Note 3—Investments in the Notes to Consolidated Financial Statements for an analysis of unrealized investment losses.

 

Credit Risk Sensitivity. Credit risk is the level of certainty that a security’s issuer will maintain its ability to honor the terms of that security until maturity. As we continue to invest in corporate bonds with relatively long maturities, credit risk is a concern. We mitigate this ongoing risk, in part, by acquiring investment-grade bonds, and by analyzing the financial fundamentals of each prospective issuer. We continue to monitor the status of issuers on an ongoing basis. At December 31, 2007, approximately 94% of invested assets at fair value were held in fixed-maturity securities. The major rating agencies considered 92% of this portfolio to be investment grade. The average quality rating of the portfolio is A-. The table below demonstrates the credit rankings of Torchmark’s fixed-maturity portfolio at fair value as of December 31, 2007.

 

Rating


   Amounts
(in millions)


   %

AAA

   $ 751.3    8

AA

     472.3    5

A

     3,200.0    35

BBB

     4,099.9    44

BB

     525.9    6

B

     112.8    1

Less than B

     63.8    1

Not rated

     -0-    -0-
    

  
     $ 9,226.0    100
    

  

 

Our current 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.

 

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We additionally reduce credit risk by maintaining investments in a wide range of industry sectors. The following table presents the industry sectors that exceeded 2% of the corporate fixed-maturity portfolio at fair value at December 31, 2007.

 

Industry


   %

Insurance carriers

   21

Depository institutions

   13

Electric, gas, sanitation services

   12

Nondepository credit institutions (finance)

   8

Oil & gas extraction

   4

Communications

   4

Chemicals & allied products

   4

Food & kindred products

   2

Security & commodity brokers

   2

Transportation equipment

   2

Petroleum refining & related industries

   2

Media

   2

 

Otherwise, no individual industry represented more than 2% of Torchmark’s corporate fixed maturities.

 

We have no direct investment exposure to subprime or Alt-A mortgages (loans for which the credit score was acceptable but some of the typical documentation was not provided). We have no derivatives or any other off-balance sheet investment arrangements, as all of our investments are carried on our Consolidated Balance Sheets. We have $115 million at fair value ($132 million book value) invested in collateralized debt obligations (CDOs) for which the average Bloomberg Composite rating at December 31, 2007 was A. The collateral underlying these CDOs is primarily trust preferred securities issued by banks and insurance companies, and no subprime or Alt-A mortgages are included in the collateral.

 

Market Risk Sensitivity.    The primary market risk to which Torchmark’s financial securities are exposed is interest rate risk, meaning the effect of changes in financial market interest rates on the current fair value of the company’s investment portfolio. Since the portfolio is comprised 94% of fixed-maturity investments, it is highly subject to market risk. Declines in market interest rates generally result in the fair value of the investment portfolio exceeding the book value of the portfolio and increases in interest rates cause the fair value to decline below the book value. However, we do not expect to realize these unrealized gains and losses because it is generally our investment strategy to hold these investments to maturity. The long-term nature of our insurance policy liabilities and strong cash-flow operating position substantially mitigate any future need to liquidate portions of the portfolio. The increase or decrease in the fair value of insurance liabilities and debt due to increases or decreases in market interest rates largely offset the impact of rates on the investment portfolio. However, in accordance with GAAP, these liabilities are not marked to market.

 

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The following table illustrates the market risk sensitivity of our interest-rate sensitive fixed-maturity portfolio at December 31, 2007 and 2006. This table measures the effect of a change in interest rates (as represented by the U.S. Treasury curve) on the fair value of the fixed-maturity portfolio. The data measures the change in fair value arising from an immediate and sustained change in interest rates in increments of 100 basis points.

 

    

Market Value of
Fixed-Maturity Portfolio
($ millions)


Change in
Interest Rates
(in basis points)


  

At
December 31,
2007


  

At
December 31,
2006


-200

   $11,188    $10,777

-100

     10,132        9,901

      0

       9,226        9,127

 100

       8,445        8,439

 200

       7,765        7,837

 

Realized Gains and Losses.    Our life and health insurance carriers collect premium income from policyholders for the eventual payment of policyholder benefits, sometimes paid many years or even decades in the future. In addition to the payment of these benefits, we also incur acquisition costs, administrative expenses, and taxes as a part of insurance operations. Because benefits are expected to be paid in future periods, premium receipts in excess of current expenses are invested to provide for these obligations. For this reason, we hold a significant investment portfolio as a part of our core insurance operations. This portfolio consists primarily of high-quality fixed maturities containing an adequate yield to provide for the cost of carrying these long-term insurance product obligations. As a result, fixed maturities are generally held for long periods to support the liabilities. Expected yields on these investments are taken into account when setting insurance premium rates and product profitability expectations.

 

Because our investment portfolio is large and diverse, investments are occasionally sold or called, resulting in a realized gain or loss. These gains and losses occur only incidentally, usually as the result of sales because of deterioration in investment quality of issuers or calls by the issuers. Investment losses are also caused by writedowns due to impairments. We do not engage in trading investments for profit. Therefore, gains or losses which occur in protecting the portfolio or its yield, or which result from events that are beyond our control, are only secondary to the core insurance operation of providing insurance coverage to policyholders. Unlike investment income, realized gains and losses are not considered in determining premium rates or product profitability of our insurance products.

 

Realized gains and losses can be significant in relation to the earnings from core insurance operations, and as a result, can have a material positive or negative impact on net income. The significant fluctuations caused by gains and losses can cause the period-to-period trends of net income to not be indicative of historical core operating results nor predictive of the future trends of core operations. Accordingly, they have no bearing on core insurance operations or segment results as we view operations. For these reasons, and in line with industry practice, we remove the effects of realized gains and losses when evaluating overall insurance operating results.

 

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The following table summarizes our tax-effected realized gains (losses) by component for each of the years in the three-year period ended December 31, 2007.

 

Analysis of After-tax Realized Gains (Losses)

(Amounts in thousands, except for per share data)

 

     Year Ended December 31,

 
     2007

    2006

    2005

 
     Amount

    Per Share

    Amount

    Per Share

    Amount

    Per Share

 

Realized gains (losses), net of tax, from:

                                                

Investment sales and calls

   $ 9,075     $ .10     $ (787 )   $ (.01 )   $ 608     $ .01  

Loss on redemption of debt

     -0-       -0-       (3,830 )     (.04 )     -0-       -0-  

Writedown of fixed maturities

     (7,298 )     (.08 )     -0-       -0-       -0-       -0-  

Valuation of interest rate swaps

     -0-       -0-       (2,956 )     (.03 )     (5,388 )     (.05 )

Spread on interest rate swaps*

     -0-       -0-       319       .01       4,805       .04  
    


 


 


 


 


 


Total

   $ 1,777     $ .02     $ (7,254 )   $ (.07 )   $ 25     $ -0-  
    


 


 


 


 


 



*   The reduction in interest cost from swapping fixed-rate obligations to floating rate.

 

In 2007, we wrote down certain non-financial institution holdings to estimated fair value as a result of other-than-temporary impairment. The impaired securities met some or all of our criteria for other-than-temporary impairment as discussed in Note 3Investments in the Notes to Consolidated Financial Statements and in our Critical Accounting Policies in this report. The pretax charge for this impairment was $11 million ($7 million after tax). At the time of impairment, these securities were carried at a value of $48 million. Later during 2007, a portion of these securities were sold for proceeds of $19 million, with the remainder held at December 31, 2007 valued at $18 million.

 

As discussed in Note 10—Debt in the Notes to Consolidated Financial Statements, we redeemed our 7¾% Trust Preferred Securities in 2006, recording a pretax loss of $5.5 million ($3.6 million after tax). Additionally in 2006, we repurchased with the intent to retire $3.3 million principal amount of our 7 7/8% Notes, recording a pretax loss of $415 thousand ($270 thousand after tax).

 

In years prior to 2007, we entered into interest-rate swap agreements, swapping our fixed-rate commitments on our long-term debt for floating-rate commitments. Accounting rules required us to value our interest-rate swaps at their fair value at the end of each accounting period, recording changes as a component of “Realized investment gains (losses). Because the fair values of these instruments fluctuated with interest rates in financial markets and diminished with time, we never considered these fluctuations in managing ongoing operations. As explained earlier under the caption Investments, the outlook for short-term rate increases in late 2005 and the expectation of even greater short-term rate increases in 2006 could have caused the spreads on our swaps to become unprofitable in the future. Therefore, we sold two of our swaps in the third quarter of 2005 and the remaining two swaps in the second quarter of 2006, so that no swaps were held after June, 2006. Complete information on our swaps, including the accounting policies, is found in Note 1—Significant Accounting Policies and in Note 10—Debt in the Notes to Consolidated Financial Statements.

 

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FINANCIAL CONDITION

 

Liquidity.    Liquidity provides Torchmark with the ability to meet on demand the cash commitments required by its business operations and financial obligations. Our liquidity is derived from three sources: positive cash flow from operations, a portfolio of marketable securities, and a line of credit facility.

 

Our insurance operations have historically generated positive cash flows in excess of our immediate needs. Sources of cash flows from operations include primarily premium and investment income. Cash outflows from operations include policy benefit payments, commissions, administrative expenses, and taxes.

 

Operating cash inflows significantly exceed cash outflows primarily because life insurers, such as Torchmark, expect to pay the majority of their policyholder benefits in future periods, sometimes many years later. An actuarially computed reserve is carried in the financial statements for these future benefits. Earnings are charged for the increase in this reserve each period, but there is no corresponding cash outlay. Therefore, cash provided from operations is generally expected to exceed net income. Cash flows are also generated by the maturities and scheduled repayments of the investment portfolio. Cash flows in excess of immediate requirements are invested to fund future requirements. Available cash flows are also used to repay debt, to buy back Torchmark shares, to pay shareholder dividends, and for other corporate uses.

 

Cash flows provided from operations were $850 million in 2007, $865 million in 2006, and $858 million in 2005. In addition, we received $1.3 billion in investment maturities, repayments, and calls in 2007, adding to available cash flows. Such repayments were $606 million in 2006 and $473 million in 2005.

 

We have in place a line of credit facility with a group of lenders which allows unsecured borrowings and stand-by letters of credit up to $600 million. For a detailed discussion of this line of credit facility, see the commercial paper section of Note 10Debt in the Notes to Consolidated Financial Statements.

 

Our cash and short-term investments were $131 million at year-end 2007 and $173 million at year-end 2006. Additionally, we have a portfolio of marketable fixed and equity securities that are available for sale in the event of an unexpected need. These securities had a fair value of $9.2 billion at December 31, 2007. However, our strong cash flows from operations, investment maturities, and credit line availability make any need to sell securities for liquidity unlikely.

 

Liquidity of the parent company is affected by the ability of the subsidiaries to pay dividends. The parent receives dividends from subsidiaries in order to meet dividend payments on common and preferred stock, interest and principal repayment requirements on parent-company debt, and operating expenses of the parent company. For more information on the restrictions on the payment of dividends by subsidiaries, see the restrictions section of Note 11Shareholders’ Equity in the Notes to Consolidated Financial Statements. Although these restrictions exist, dividend availability from subsidiaries historically has substantially exceeded the cash flow needs for parent company operations.

 

Off-Balance Sheet Arrangements.    As fully described and discussed in Note 10Debt in the Notes to the Consolidated Financial Statements and under the subcaption Funded Debt, Torchmark had outstanding $120 million (par amount) 7.1% Trust Preferred Securities at both December 31, 2007 and 2006. The Capital Trust liable for these securities is the legal entity which is responsible for the securities and facilitates the payment of dividends to shareholders. The trust is an off-balance sheet arrangement which we are required to deconsolidate in accordance with GAAP rules. Deconsolidation is required because the Capital Trust is considered to be a variable interest entity in which we have no variable interest. Therefore Torchmark is not the primary beneficiary of the entity, even though we own all of the entity’s voting equity and have guaranteed the entity’s performance. While these liabilities are not on our Consolidated Balance Sheets, they are represented by Torchmark’s 7.1% Junior Subordinated Debentures due to the trust. These Junior Subordinated Debentures were a Torchmark liability of $124 million par and book value at both December 31, 2007 and 2006. These securities are indicated as a capital resource to us under the caption Capital Resources in this report. The 7.1% preferred dividends

 

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Index to Financial Statements

due to the preferred shareholders are funded by our 7.1% interest payment on our debt to the trusts. As described in Note 14Commitments and Contingencies in the Notes to Consolidated Financial Statements, we have guaranteed the performance of the Capital Trust to meet its financial obligations to the Trust Preferred shareholders.

 

Pension obligations to our employees primarily are obligations of trust fund entities which are not reflected on our balance sheet. The obligations of these trusts are calculated in accordance with the terms of the pension plans. These trust entities hold assets which are funded through periodic contributions by Torchmark in a manner which will provide for the settlement of the pension obligations as they become due. The difference in our pension obligations and the fair value of the assets which fund those obligations are included on our Balance Sheets.

 

As of December 31, 2007, we had no other significant unconsolidated affiliates and no guarantees of the obligations of third-party entities other than as described above. All of our guarantees, other than the Trust Preferred guarantee, were guarantees of the performance of consolidated subsidiaries, as disclosed in Note 14Commitments and Contingencies.

 

The following table presents information about future payments under our contractual obligations for the selected periods as of December 31, 2007.

 

(Amounts in millions)

 

    Actual
Liability


  Total
Payments

  Less than
One Year

  One to
Three Years


  Four to
Five Years

  More than
Five Years


Fixed and determinable:

                                   

Long-term debt—principal

  $ 721   $ 733   $ -0-   $ 99   $ -0-   $ 634

Long-term debt—interest(1)

    9     726     53     95     89     489

Capital leases

    -0-     -0-     -0-     -0-     -0-     -0-

Operating leases

    -0-     12     3     4     3     2

Purchase obligations

    10     10     10     -0-     -0-     -0-

Pension obligations(2)

    54     138     12     21     26     79

Uncertain tax positions(3)

    15     15     6     9     -0-     -0-

Future insurance obligations(4)

    9,382     42,137     1,493     2,857     2,666     35,121
   

 

 

 

 

 

Total

  $ 10,191   $ 43,771   $ 1,577   $ 3,085   $ 2,784   $ 36,325
   

 

 

 

 

 


(1) Interest on debt is based on our fixed contractual obligations.
(2) Pension obligations are primarily liabilities in trust funds that are offset by invested assets funding the trusts. Therefore, our obligations are offset by those assets when reported on Torchmark’s Consolidated Balance Sheets. At December 31, 2007, these pension obligations were $224 million, but there were also assets of $170 million in the pension entities. The schedule of pension benefit payments covers ten years and is based on the same assumptions used to measure the pension obligations, except there is no interest assumption because the payments are undiscounted. Please refer to Note 9Postretirement Benefits in the Notes to Consolidated Financial Statements for more information on pension obligations.
(3) Uncertain tax positions include $8.6 million of tax liability and $6.5 million of accrued interest. See Note 8—Income Taxes in the Notes to Consolidated Financial Statements for more information.
(4) Future insurance obligations consist primarily of estimated future contingent benefit payments on policies in force and separate account obligations at December 31, 2007. These estimated payments were computed using assumptions for future mortality, morbidity and persistency. The actual amount and timing of such payments may differ significantly from the estimated amounts shown. Management believes that the assets supporting the liability of $9 billion at December 31, 2007, along with future premiums and investment income, will be sufficient to fund all future insurance obligations.

 

Capital Resources.    Torchmark’s capital structure consists of short-term debt (the commercial paper facility described in Note 10Debt in the Notes to Consolidated Financial Statements), long-term funded debt, Junior Subordinated Debentures supporting its trust preferred securities, and shareholders’ equity. The Junior Subordinated Debentures are payable to Torchmark’s Capital Trusts which are liable for its Trust Preferred Securities. In accordance with GAAP, these instruments are included in “Due to affiliates” on the Consolidated Balance Sheets. A complete analysis and description of long-term debt issues outstanding is presented in Note 10—Debt in the Notes to Consolidated Financial Statements.

 

 

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The carrying value of the funded debt was $722 million at December 31, 2007, compared with $721 million a year earlier. During the second quarter of 2006, we registered and issued two new security offerings: our 7.1% Trust Preferred Securities, offered through Torchmark Capital Trust III at a redemption value of $120 million less issue expenses, and our 6 3/8% Senior Notes issued for the principal amount of $250 million less issue expenses. In the fourth quarter of 2006, we redeemed our 7 3/4% Trust Preferred Securities and we repaid our 6 1/4% Senior Notes which matured. The Trust Preferreds were redeemed for $150 million plus accrued dividends and our Senior Notes were repaid in the principal amount of $180 million plus accrued interest. Specific information about the new securities offered and the securities repaid in 2006, including the uses of proceeds and sources of funding, is disclosed and discussed in Note 10—Debt in the Notes to Consolidated Financial Statements.

 

Over the past several years, we have entered into swap agreements to exchange the fixed-rate commitments on our funded debt for floating-rate commitments. During the low interest-rate environment in recent years, these swaps were very beneficial in reducing our interest cost, as discussed under the captions Investments (Excess investment income) and Realized Gains and Losses in this report. As short-term rates rose in 2005 and 2006 with no meaningful change in long-term rates, these swaps became less profitable. Because we believed that the swap settlements could have possibly become unprofitable, we disposed of these agreements during 2005 and 2006 and held no swap agreements after June 2006. Information about the history of our swaps is found in Note 10—Debt in the Notes to Consolidated Financial Statements under the caption Interest Rate Swaps.

 

In the second quarter of 2005, we executed a voluntary stock option exercise and restoration program in which 120 directors, employees and consultants exercised vested options in Torchmark’s common stock and received a lesser number of new options at the current market price. As a result, we issued 5.8 million new shares to the participants. However, a substantial number of the new shares were immediately sold through the open market by the participants to cover the option exercise price of their new shares and their related income taxes. As a result of the program, management’s ownership in Torchmark increased and the Company received a significant tax benefit from the exercise of the options. We received $213 million in proceeds for the exercise price and $37 million in tax benefits, both of which added to shareholder’s equity. However, as previously mentioned, we generally use the proceeds of option exercises to repurchase shares on the open market to reduce the dilution caused by option exercises. As a result, the total impact on shareholder’s equity and cash flow from the transaction was immaterial. More information on stock options and this program is found in Note 1—Significant Accounting Policies and in Note 12—Stock-Based Compensation in the Notes to Consolidated Financial Statements.

 

We believe that the most beneficial use of our excess cash flow could be a strategic acquisition. Absent an acquisition, we believe that the best use of excess cash is to buy Company stock. As previously mentioned, our Board reaffirmed its continued authorization of the stock repurchase program in July, 2007 in amounts and timing that management, in consultation with the Board, determined to be in the best interest of the Company. We have repurchased common stock every year since 1986, except for 1995, the year following the acquisition of American Income. Since the beginning of 1998, we have repurchased 52 million shares at a total cost of $2.3 billion, and have acquired no fewer than 3.4 million shares in any one year. We believe that Torchmark share purchases at favorable prices add incrementally to per share earnings, return on equity, and are an excellent way to increase total shareholder value. As noted earlier in this report, we acquired over 6.1 million shares at a cost of $402 million in 2007 with excess cash flow. If the free cash flow used for the repurchase of our common stock had alternatively been invested in corporate bonds, an estimated $11.0 million of additional investment income, after tax, would have resulted and net income per diluted share would have increased 6% to $5.42. Because share purchases were made, actual net income per share was $5.50, an increase of 7%. We intend to continue the repurchase of our common shares when prices are favorable. The majority of purchased shares are retired each year.

 

We maintain a significant available-for-sale fixed-maturity portfolio to support our insurance policyholders’ liabilities. Accounting rule (SFAS 115) requires that we revalue our portfolio to fair market value at the end of each accounting period. The period-to-period changes in fair value, net of their associated impact on deferred acquisition costs and income tax, are reflected directly in shareholders’ equity. Changes in the fair value of the portfolio result primarily from changes in interest rates in financial markets. While SFAS 115 requires invested assets to be revalued, accounting rules do not permit

 

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interest-bearing insurance policy liabilities to be valued at fair value in a consistent manner. Due to the size of our policy liabilities in relation to our shareholders’ equity, this inconsistency in measurement usually has a material impact in the reported value of shareholders’ equity. If these liabilities were revalued in the same manner as the assets, the effect on equity would be largely offset. Fluctuations in interest rates cause undue volatility in the period-to-period presentation of our shareholders’ equity, capital structure, and financial ratios which would be essentially removed if interest-bearing liabilities were valued in the same manner as assets. For this reason, our management, credit rating agencies, lenders, many industry analysts, and certain other financial statement users prefer to remove the effect of SFAS 115 when analyzing our balance sheet, capital structure, and financial ratios.

 

The following tables present selected data related to our capital resources. Additionally, the tables present the effect of SFAS 115 on relevant line items, so that investors and other financial statement users may determine its impact on Torchmark’s capital structure.

 

Selected Financial Data

 

     At December 31, 2007

    At December 31, 2006

    At December 31, 2005

 
     GAAP

    Effect of
SFAS 115*

    GAAP

    Effect of
SFAS 115*

    GAAP

    Effect of
SFAS 115*

 

Fixed maturities (millions)

   $ 9,226     $ (103 )   $ 9,127     $ 229     $ 8,837     $ 425  

Deferred acquisition costs (millions)

     3,159       8       2,956       (10 )     2,768       (23 )

Total assets (millions)

     15,241       (95 )     14,980       219       14,769       402  

Short-term debt (millions)

     202       -0-       170       -0-       382       -0-  

Long-term debt (millions) **

     722       -0-       721       -0-       508       -0-  

Shareholders’ equity (millions)

     3,325       (62 )     3,459       142       3,433       261  

Book value per diluted share

     35.60       (.66 )     34.68       1.43       32.91       2.50  

Debt to capitalization ***

     21.7 %     .3 %     20.5 %     (.7 )%     20.6 %     (1.3 )%

Diluted shares outstanding (thousands)

     93,383               99,755               104,303          

Actual shares outstanding (thousands)

     92,175               98,115               103,569          

* Amount added to (deducted from) comprehensive income to produce the stated GAAP item

**

Includes Torchmark’s 7.1% Junior Subordinated Debentures in both 2007 and 2006 in the amount of $124 million and its 7 3/4% Junior Subordinated Debentures in the amount of $155 million in 2005.

*** Torchmark’s debt covenants require that the effect of SFAS 115 be removed to determine this ratio.

 

As discussed under the caption New Unadopted Accounting Policies in this report, the FASB has issued a new Statement offering an option which, if elected, would permit us to value our interest-bearing policy liabilities and debt at fair value in our Consolidated Balance Sheets. However, unlike current accounting rules which permit us to account for changes in our available-for-sale bond portfolio through other comprehensive income, the new rule requires such changes to be recorded in earnings. Because both the size and duration of the investment portfolio do not match those attributes of our policyholder liabilities and debt, the impact on earnings could be very significant and volatile, causing reported earnings not to be reflective of core results. Therefore, we will not elect this option.

 

Torchmark’s ratio of earnings before interest and taxes to interest requirements (times interest earned) was 12.8 times in 2007, compared with 11.6 times in 2006, and 13.0 times in 2005. A discussion of our interest expense is included in the discussion of financing costs under the caption Investments in this report.

 

Credit Ratings.    The credit quality of Torchmark’s debt instruments and capital securities are rated by various rating agencies. During 2007, Standard & Poor’s lowered its credit rating on Torchmark’s outstanding debt from A+ to A, and lowered the rating of its preferred stock from A- to BBB+. The credit rating change was attributed to weaker agent productivity, recruiting, and retention, as well as changes in

 

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direct response strategy, all of which has contributed to lower new sales. During 2006, A.M. Best downgraded Torchmark’s funded debt one notch from a to a-, and its preferred stock from a- to bbb+. Moody’s downgraded our funded debt from A3 to Baa1, and our preferred stock from Baa1 to Baa2. Both downgrades were to reflect the “notching,” or widening of rating levels between the insurance companies and their parent company which has issued the debt. This notching is typical for these rating agencies as they rate other insurance companies. It does not reflect any change in the creditworthiness of the Company. The chart below presents Torchmark’s credit ratings as of December 31, 2007.

 

     Standard
& Poors


   Fitch

   Moody’s

   A.M.
Best


Commercial Paper

   A-1    F-1    P-2    AMB-1

Funded Debt

   A    A    Baa1    a-

Preferred Stock

   BBB+    A-    Baa2    bbb+

 

The financial strength of our major insurance subsidiaries are also rated by Standard & Poor’s and A.M. Best. In 2007, Standard & Poor’s lowered its financial strength rating of United Investors to A from A+ and the ratings of Liberty, Globe, United American and American Income from AA to AA-, as a result of an expected lag in new business sales in the short term. In 2006, A. M. Best lowered its financial strength rating of United Investors to A (Excellent) from A+ (Superior), as a result of Torchmark’s diminished emphasis of that subsidiary’s business. The following chart presents these ratings for our five largest insurance subsidiaries at December 31, 2007.

 

     Standard
& Poors


   A.M.
Best

Liberty

   AA-    A+ (Superior)

Globe

   AA-    A+ (Superior)

United Investors

   A    A (Excellent)

United American

   AA-    A+ (Superior)

American Income

   AA-    A+ (Superior)

 

A.M. Best states that it assigns A+ (Superior) ratings to those companies which, in its opinion, have demonstrated superior overall performance when compared to the norms of the life/health insurance industry. A+ (Superior) companies have a superior ability to meet their obligations to policyholders over a long period of time. The A.M. Best A (Excellent) rating is assigned to those companies which, in its opinion, have demonstrated excellent overall performance when compared to the norms of the life/health insurance industry. A (Excellent) companies have an excellent ability to meet their obligations to policyholders over a long period of time.

 

The AA financial strength rating category is assigned by Standard & Poor’s Corporation to those insurers which have very strong financial security characteristics, differing only slightly from those rated higher. The minus sign (-) shows the relative standing within the major rating category. The A rating is assigned to an insurer with strong financial security characteristics, somewhat more likely to be affected by adverse business conditions than insurers with higher ratings.

 

TRANSACTIONS WITH RELATED PARTIES

 

Information regarding related party transactions is found in Note 15—Related Party Transactions in the Notes to Consolidated Financial Statements.

 

OTHER ITEMS

 

Litigation.    Torchmark and its subsidiaries continue to be named as parties to pending or threatened litigation, much of which involves punitive damage claims based upon allegations of agent misconduct at Liberty in Alabama. Such punitive damage claims are tried in Alabama state courts where any punitive damage litigation may have the potential for significant adverse results since punitive damages in Alabama are based upon the compensatory damages (including mental anguish) awarded and the discretion of the jury in awarding compensatory damages is not precisely defined. Additionally, it should be noted that our subsidiaries actively market insurance in the State of Mississippi, a jurisdiction which is nationally recognized for large punitive damage verdicts. Bespeaking caution is the fact that it is impossible to predict the likelihood or extent of punitive damages that may be awarded if liability is found in any given case. It is thus difficult to predict with certainty the liability of Torchmark or its subsidiaries in any given case because of the unpredictable nature of this type of litigation. Based upon information

 

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presently available, and in light of legal and other factual defenses available to Torchmark and its subsidiaries, contingent liabilities arising from threatened and pending litigation are not presently considered by us to be material. For more information concerning litigation, please refer to Note 14Commitments and Contingencies in the Notes to the Consolidated Financial Statements.

 

NEW UNADOPTED ACCOUNTING RULES

 

The FASB has issued certain new standards applicable to Torchmark, effective in future periods:

 

Fair Value Measurements:    Statement No. 157, Fair Value Measurements (SFAS 157), clarifies the definition of fair value, establishes a single framework or a hierarchy for measuring fair value, and expands disclosures about fair value measurements. It does not change which assets or liabilities are measured at fair value. Accordingly, it is not expected to have a significant impact on Torchmark’s financial position. However, new disclosures of fair value measurement methodology and effects will be required. The Statement is effective for Torchmark in the calendar year and interim periods of 2008, with its provisions applied prospectively. Please refer to the discussion of Valuation of Fixed Maturities under the caption Critical Accounting Policies in this report for more information related to this new unadopted Statement.

 

Fair Value Option:    Statement No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (SFAS 159), was issued in February, 2007. This Statement permits entities to choose to measure certain financial assets and liabilities at fair value which are otherwise measured on a different basis in existing literature. Additional disclosures are required. If elected, it is effective as of January 1, 2008.

 

This Statement would provide us with the opportunity to carry our interest-bearing policy liabilities and debt as well as our invested assets at market value, with changes reflected in earnings. The size of this unrealized adjustment to earnings in relation to net income each period could be considerable and very volatile, causing our earnings not to be reflective of core results, historical patterns, or predictive of future earnings trends. Therefore, we will not elect to adopt this Statement.

 

Business Combinations:    Statement No. 141(R), Business Combinations (SFAS 141R), replaces the previous accounting guidance for the acquisition of other companies. It retains the purchase method of accounting and the current guidance with respect to the accounting for indefinite-lived intangibles and goodwill. However, the new Statement provides certain significant differences, most notably that all assets and liabilities (including contingent liabilities) are measured at their fair value as of the acquisition date rather than a cost allocation approach as previously required. Additionally, all expenses of the acquisition are charged off as incurred rather than capitalized. This Statement is effective for Torchmark as of January 1, 2009 in the event there is an acquisition dated subsequent to that date.

Noncontrolling Interests:    Statement No. 160, Noncontrolling Interests in Consolidated Financial Statements - an amendment of ARB No. 51 (SFAS 160), changes the accounting for noncontrolling interests (also known as minority interests). At this time, Torchmark has no noncontrolling interests.

 

CRITICAL ACCOUNTING POLICIES

 

Future Policy Benefits.    Because of the long-term nature of insurance contracts, our insurance companies are liable for policy benefit payments that will be made in the future. The liability for future policy benefits is determined by standard actuarial procedures common to the life insurance industry. The accounting policies for determining this liability are disclosed in Note 1Significant Accounting Policies in the Notes to Consolidated Financial Statements. A list of the significant assumptions used to calculate the liability for future policy benefits is reported in Note 5Future Policy Benefit Reserves.

 

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Approximately 68% of our liabilities for future policy benefits at December 31, 2007 are accounted for under the provisions of Statement of Financial Accounting Standards No. 60, Accounting and Reporting by Insurance Enterprises (SFAS 60), under which the liability is the present value of future benefits less the present value of the portion of the gross premium required to pay for such benefits. The assumptions used in estimating the future benefits for this portion of business are set at the time of contract issue. Under SFAS 60, these assumptions are “locked in” and are not revised for the lifetime of the contracts, except where there is a premium deficiency, as defined in Note 1—Significant Accounting Policies in the Notes to Consolidated Financial Statements under the caption Future Policy Benefits. Otherwise, variability in the accrual of policy reserve liabilities after policy issuance is caused only by variability of the inventory of in force policies. A premium deficiency event for Torchmark’s SFAS 60 business is very rare, and did not occur during the three years ended December 31, 2007.

 

The remaining portion of liabilities for future policy benefits pertains to business reported under Statement of Financial Accounting Standards No. 97, Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments (SFAS 97). Under SFAS 97, the recorded liability is the fund balance attributable to the benefit of policyholders as determined by the policy contract at the financial statement date. Accordingly, there are no assumptions used in the determination of the SFAS 97 future policy benefit liability.

 

Deferred Acquisition Costs and Value of Insurance Purchased.    The costs of acquiring new business are generally deferred and recorded as an asset. Deferred acquisition costs consist primarily of sales commissions and other underwriting costs of new insurance sales. Additionally, the costs of acquiring blocks of insurance from other companies or through the acquisition of other companies are also deferred and recorded as assets under the caption “Value of Insurance Purchased” as indicated in Note 4Deferred Acquisition Costs and Value of Insurance Purchased in the Notes to Consolidated Financial Statements. Our policies for accounting for deferred acquisition costs and the associated amortization are reported in Note 1Significant Accounting Policies in the Notes to Consolidated Financial Statements.

 

Approximately 94% of our recorded amounts for deferred acquisition costs at December 31, 2007 are accounted for under the provisions of SFAS 60 for which deferred acquisition costs are amortized over the premium-paying period in proportion to the present value of actual historic and estimated future gross premiums. The projection assumptions for SFAS 60 business are set at the time of contract issue. Under SFAS 60, these assumptions are “locked-in” at that time and, except where there is a loss recognition issue, are not revised for the lifetime of the contracts. Absent a premium deficiency, variability in amortization after policy issuance is caused only by variability in premium volume. We have not recorded a deferred acquisition cost loss recognition event for our SFAS 60 assets for any period in the three years ended December 31, 2007.

 

The remaining portion of deferred acquisition costs pertain to business reported under SFAS 97 for which deferred acquisition costs are amortized over the estimated lives of the contracts in proportion to actual and estimated future gross profits. These contracts are not subject to lock-in. Under SFAS 97, the assumptions must be updated when actual experience or other evidence suggests that earlier estimates should be revised. For the three years ended December 31, 2007, revisions related to our SFAS 97 assets have not had a material impact on the amortization of deferred acquisition costs, and based on the nature of our operations, are not expected to have a material impact on operations for the foreseeable future.

 

Policy Claims and Other Benefits Payable.    This liability consists of known benefits currently payable and an estimate of claims that have been incurred but not yet reported to us. The estimate of unreported claims is based on prior experience and is made after careful evaluation of all information available to us. However, the factors upon which these estimates are based can be subject to change from historical patterns. Factors involved include medical trend rates and medical cost inflation, the litigation environment, regulatory mandates, and the introduction of policy types for which claim patterns are not well established. Changes in these estimates, if any, are reflected in the earnings of the period in which the adjustment is made. We believe that the estimates used to produce the liability for claims and other

 

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benefits, including the estimate of unsubmitted claims, are the most appropriate under the circumstances. However, there is no certainty that the resulting stated liability will be our ultimate obligation. At this time, we do not expect any change in estimate to have a material impact on earnings or financial position consistent with our historical experience.

 

Revenue Recognition.    Premium income from our subsidiaries’ insurance contracts is generally recognized as the premium is collected. However, in accordance with GAAP, revenue on limited-payment contracts and universal life-type contracts (deposit balance products) are recognized differently. Revenues on limited-payment contracts are recognized over the contract period. Premium for deposit balance products, such as our annuity and interest-sensitive life policies, is added to the policy account value. The policy account value (or deposit balance) is a Torchmark liability. This deposit balance is then charged a fee for the cost of insurance, administration, surrender, and certain other charges which are recognized as revenue in the period the fees are charged to the policyholder. In each case, benefits and expenses are matched with revenues in a manner by which they are incurred as the revenues are earned.

 

We report investment income as revenue, less investment expenses, when it is earned. Our investment activities are integral to our insurance operations. Because life and health insurance claims and benefits may not be paid until many years into the future, the accumulation of cash flows from premium receipts are invested. Anticipated yields earned on investments are reflected in premium rates, contract liabilities, and other product contract features. These yield assumptions are implied in the interest required on our net insurance liabilities (future policy benefits less deferred acquisition costs) and contractual interest obligations in our insurance and annuity products. For more information concerning revenue recognition, investment accounting, and interest sensitivity, please refer to Note 1Significant Accounting Policies and Note 3Investments in the Notes to Consolidated Financial Statements and discussions under the captions Annuities, Investments, and Market Risk Sensitivity in this report.

 

Valuation of Fixed Maturities: We hold a substantial investment in high-quality fixed maturities to provide for the funding of our future policy contractual obligations over long periods of time. While these securities are generally expected to be held to maturity, they are classified as available for sale and are sold from time to time, primarily to maintain our investment quality and diversification standards. We report this portfolio at fair value. Fair value is the price that we would expect to receive upon sale of the asset in an orderly transaction. The fair value of the fixed-maturity portfolio is primarily affected by changes in interest rates in financial markets, having a greater impact on longer-term maturities. Because of the size of our fixed-maturity portfolio, small changes in rates can have a significant effect on the portfolio and the reported financial position of the Company. This impact is disclosed in 100 basis point increments under the caption Market Risk Sensitivity in this report. However, as discussed under the caption Financial Condition in this report, we believe these unrealized fluctuations in value have no meaningful impact on our actual financial condition and, as such, we remove them from consideration when viewing our financial position and financial ratios.

 

The fair value of approximately 1.6% of our fixed-maturity portfolio is established by quoted prices for these assets in an active market, considered level 1 inputs in the hierarchy described by the recently issued but unadopted SFAS 157. The fair value of approximately 95.2% of the portfolio is determined by observable inputs other than direct quotes, considered as level 2 inputs by SFAS 157. These inputs generally include quoted closing market prices for similar assets in active markets, such quotes in inactive markets, or interest rates and yield curves observable under commonly quoted criteria. The remaining 3.2% of the portfolio is valued by unobservable inputs, or level 3 inputs in accordance with SFAS 157. Unobservable inputs include data for which there is limited market information causing us to rely on values derived by independent brokers or internally-developed assumptions. These values are established based on the best information available to us or the other parties.

 

Impairment of Investments.    We continually monitor our investment portfolio for investments that have become impaired in value, whereby fair value has declined below carrying value. While the values of the investments in our portfolio constantly fluctuate due to market conditions, an other than temporary impairment charge is recorded only when a security has experienced a decline in fair market value which is deemed other than temporary. The policies and procedures that we use to evaluate and account for impairments of investments are disclosed in Note 1Significant Accounting Policies and

 

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Note 3Investments in the Notes to Consolidated Financial Statements and the discussions under the captions Investments and Realized Gains and Losses in this report. While every effort is made to make the best estimate of status and value with the information available regarding an other-than-temporary impairment, it is difficult to predict the future prospects of a distressed or impaired security.

 

Defined benefit pension plans.    We maintain funded defined benefit plans covering most full-time employees. We also have unfunded nonqualified defined benefit plans covering certain key and other employees. Our obligations under these plans are determined actuarially based on specified actuarial assumptions. In accordance with GAAP, an expense is recorded each year as these pension obligations grow due to the increase in the service period of employees and the interest cost associated with the passage of time. These obligations are offset, at least in part, by the growth in value of the assets in the funded plans. At December 31, 2007, our net liability under these plans was $54 million.

 

The actuarial assumptions used in determining our obligations for pensions include employee mortality and turnover, retirement age, the expected return on plan assets, projected salary increases, and the discount rate at which future obligations could be settled. These assumptions have an important effect on the pension obligation. A decrease in the discount rate or rate of return on plan assets will cause an increase in the pension obligation. A decrease in projected salary increases will cause a decrease in this obligation. Small changes in assumptions may cause material differences in reported results for these plans. While we have used our best efforts to determine the most reliable assumptions, given the information available from company experience, economic data, independent consultants and other sources, we cannot assure that actual results will be the same as expected. Our discount rate, rate of return on assets, and projected salary increase assumptions are disclosed and the criteria used to determine those assumptions are discussed in Note 9Postretirement Benefits in the Notes to Consolidated Financial Statements. The assumptions are reviewed annually and revised, if necessary, based on more current information available to us. Note 9 also contains information about pension plan assets, investment policies, and other related data.

 

CAUTIONARY STATEMENTS

 

We caution readers regarding certain forward-looking statements contained in the foregoing discussion and elsewhere in this document, and in any other statements made by us or on our behalf 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 us or our business, whether express or implied, is meant as and should be considered a forward-looking statement. Such statements represent our opinions concerning future operations, strategies, financial results or other developments.

 

Forward-looking statements are based upon estimates and assumptions that are subject to significant business, economic and competitive uncertainties, many of which are beyond our control. If these estimates or assumptions prove to be incorrect, the actual results may differ materially from the forward-looking statements made on the basis of such estimates or assumptions. Whether or not actual results differ materially from forward-looking statements may depend on numerous foreseeable and unforeseeable events or developments, which may be national in scope, related to the insurance industry generally, or applicable to Torchmark specifically. Such events or developments could include, but are not necessarily limited to:

 

1) Changes in lapse rates and/or sales of our insurance policies as well as levels of mortality, morbidity and utilization of healthcare services that differ from our assumptions;

 

2) Federal and state legislative and regulatory developments, particularly those impacting taxes and changes to the federal Medicare program that would affect Medicare Supplement and Medicare Part D insurance;

 

3) Market trends in the senior-aged health care industry that provide alternatives to traditional Medicare, such as health maintenance organizations (HMOs) and other managed care or private plans, and that could affect the sales of traditional Medicare Supplement insurance;

 

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4) Interest rate changes that affect product sales and/or investment portfolio yield;

 

5) General economic, industry sector or individual debt issuers’ financial conditions that may affect the current market value of securities that we own, or that may impair issuers’ ability to pay interest due us on those securities;

 

6) Changes in pricing competition;

 

7) Litigation results;

 

8) Levels of administrative and operational efficiencies that differ from our assumptions;

 

9) Our inability to obtain timely and appropriate premium rate increases for health insurance policies due to regulatory delay;

 

10) The customer response to new products and marketing initiatives; and

 

11) Reported amounts in the financial statements which are based on our estimates and judgments which may differ from the actual amounts ultimately realized.

 

Readers are also directed to consider other risks and uncertainties described in our other documents on file with the Securities and Exchange Commission.

 

Item 7A.    Quantitative and Qualitative Disclosures about Market Risk

 

Information required by this item is found under the heading Market Risk Sensitivity in Item 7 beginning on page 37 of this report.

 

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Item 8.     Financial Statements and Supplementary Data

 

     Page

Report of Independent Registered Public Accounting Firm

   51

Consolidated Financial Statements:

    

Consolidated Balance Sheets at December 31, 2007 and 2006

   52

Consolidated Statements of Operations for each of the three years in the period ended December 31, 2007

   53

Consolidated Statements of Comprehensive Income for each of the three years in the period ended December 31, 2007

   54

Consolidated Statements of Shareholders’ Equity for each of the three years in the period ended December 31, 2007

   55

Consolidated Statements of Cash Flows for each of the three years in the period ended December 31, 2007

   56

Notes to Consolidated Financial Statements

   57

 

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

To the Board of Directors and Shareholders of

Torchmark Corporation

McKinney, Texas

 

We have audited the accompanying consolidated balance sheets of Torchmark Corporation and subsidiaries (“Torchmark”) as of December 31, 2007 and 2006, and the related consolidated statements of operations, comprehensive income, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2007. Our audits also included the financial statement schedules listed in the Index at Item 15. These financial statements and financial statement schedules are the responsibility of Torchmark’s management. Our responsibility is to express an opinion on the financial statements and financial statement schedules based on our audits.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Torchmark Corporation and subsidiaries as of December 31, 2007 and 2006, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2007, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.

 

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Torchmark’s internal control over financial reporting as of December 31, 2007, based on the criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 28, 2008 expressed an unqualified opinion on Torchmark’s internal control over financial reporting.

 

DELOITTE & TOUCHE LLP

 

Dallas, Texas

February 28, 2008

 

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TORCHMARK CORPORATION

CONSOLIDATED BALANCE SHEETS

(Dollar amounts in thousands except per share data)

 

    December 31,

 
    2007

    2006

 

Assets:

               

Investments:

               

Fixed maturities—available for sale, at fair value (amortized cost: 2007—$9,329,149; 2006—$8,897,401)

  $ 9,226,045     $ 9,126,784  

Equity securities, at fair value (cost: 2007—$18,776; 2006—$40,105)

    21,295       41,245  

Policy loans

    344,349       328,891  

Other long-term investments

    69,290       49,681  

Short-term investments

    111,220       156,671  
   


 


Total investments

    9,772,199       9,703,272  

Cash

    20,098       16,716  

Accrued investment income

    172,783       168,118  

Other receivables

    96,750       78,809  

Deferred acquisition costs and value of insurance purchased

    3,159,051       2,955,842  

Goodwill

    423,519       378,436  

Other assets

    173,833       180,540  

Separate account assets

    1,423,195       1,498,622  
   


 


Total assets

  $ 15,241,428     $ 14,980,355  
   


 


Liabilities:

               

Future policy benefits

  $ 7,958,983     $ 7,456,423  

Unearned and advance premiums

    86,714       88,039  

Policy claims and other benefits payable

    256,462       243,346  

Other policyholders’ funds

    89,958       90,671  
   


 


Total policy liabilities

    8,392,117       7,878,479  

Deferred and accrued income taxes

    966,008       1,010,618  

Other liabilities

    210,990       241,749  

Short-term debt

    202,058       169,736  

Long-term debt (estimated fair value: 2007—$655,543; 2006—$676,281)

    598,012       597,537  

Due to affiliates

    124,421       124,421  

Separate account liabilities

    1,423,195       1,498,622  
   


 


Total liabilities

    11,916,801       11,521,162  

Shareholders’ equity:

               

Preferred stock, par value $1 per share—Authorized 5,000,000 shares; outstanding:

-0- in 2007 and in 2006

    -0-       -0-  

Common stock, par value $1 per share—Authorized 320,000,000 shares; outstanding: (2007—94,874,748 issued, less 2,699,333 held in treasury and 2006—99,874,748 issued, less 1,760,121 held in treasury)

    94,875       99,875  

Additional paid-in capital

    481,228       492,333  

Accumulated other comprehensive income

    (80,938 )     140,097  

Retained earnings

    3,003,152       2,827,287  

Treasury stock

    (173,690 )     (100,399 )
   


 


Total shareholders’ equity

    3,324,627       3,459,193  
   


 


Total liabilities and shareholders’ equity

  $ 15,241,428     $ 14,980,355  
   


 


 

See accompanying Notes to Consolidated Financial Statements.

 

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TORCHMARK CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS

(Amounts in thousands except per share data)

 

     Year Ended December 31,

 
     2007

    2006

    2005

 

Revenue:

                        

Life premium

   $ 1,569,964     $ 1,524,267     $ 1,468,288  

Health premium

     1,236,797       1,237,532       1,014,857  

Other premium

     20,470       22,914       24,929  
    


 


 


Total premium

     2,827,231       2,784,713       2,508,074  

Net investment income

     648,826       628,746       603,068  

Realized investment gains (losses)

     2,734       (10,767 )     280  

Other income

     7,906       18,486       14,488  
    


 


 


Total revenue

     3,486,697       3,421,178       3,125,910  

Benefits and expenses:

                        

Life policyholder benefits

     1,039,278       1,005,771       966,093  

Health policyholder benefits

     835,101       834,017       668,205  

Other policyholder benefits

     28,049       23,743       26,888  
    


 


 


Total policyholder benefits

     1,902,428       1,863,531       1,661,186  

Amortization of deferred acquisition costs

     391,011       377,490       349,959  

Commissions and premium taxes

     155,483       163,683       149,451  

Other operating expense

     173,406       169,768       172,859  

Interest expense

     67,564       73,136       60,934  
    


 


 


Total benefits and expenses

     2,689,892       2,647,608       2,394,389  

Income before income taxes

     796,805       773,570       731,521  

Income taxes

     (269,270 )     (254,939 )     (236,131 )
    


 


 


Net income

   $ 527,535     $ 518,631     $ 495,390  
    


 


 


Basic net income per share

   $ 5.59     $ 5.20     $ 4.73  
    


 


 


Diluted net income per share

   $ 5.50     $ 5.13     $ 4.68  
    


 


 


Dividends declared per common share

   $ .52     $ .50     $ .44  
    


 


 


 

 

 

See accompanying Notes to Consolidated Financial Statements.

 

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TORCHMARK CORPORATION

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Amounts in thousands)

 

     Year Ended December 31,

 
     2007

    2006

    2005

 

Net income

   $ 527,535     $ 518,631     $ 495,390  

Other comprehensive income (loss):

                        

Unrealized investment gains (losses):

                        

Unrealized gains (losses) on securities:

                        

Unrealized holding gains (losses) arising during period

     (305,635 )     (208,344 )     (229,881 )

Reclassification adjustment for (gains) losses on securities included in net income

     (760 )     6,927       (778 )

Reclassification adjustment for amortization of (discount) and premium

     (7,572 )     4,615       4,768  

Foreign exchange adjustment on securities marked to market

     (17,141 )     68       (3,087 )
    


 


 


Unrealized gains (losses) on securities

     (331,108 )     (196,734 )     (228,978 )

Unrealized gains (losses) on other investments

     -0-       -0-       896  

Unrealized gains (losses), adjustment to deferred acquisition costs

     19,148       12,374       14,268  
    


 


 


Total unrealized investment gains (losses)

     (311,960 )     (184,360 )     (213,814 )

Less application taxes

     109,186       64,525       74,839  
    


 


 


Unrealized gains (losses), net of tax

     (202,774 )     (119,835 )     (138,975 )

Foreign exchange translation adjustments, other than securities, net of tax of $(3,244), $125, and $(1,155) during 2007, 2006, and 2005, respectively

     16,083       (237 )     2,143  

Pension adjustments:

                        

Adoption of Supplemental Executive Retirement Plan

     (15,419 )     -0-       -0-  

Amortization of pension costs

     2,692       -0-       -0-  

Experience gain (loss)

     (40,109 )     -0-       -0-  
    


 


 


Pension adjustments

     (52,836 )     -0-       -0-  

Less applicable taxes

     18,492       -0-       -0-  
    


 


 


Pension adjustments, net of tax

     (34,344 )     -0-       -0-  

Other comprehensive income (loss)

     (221,035 )     (120,072 )     (136,832 )
    


 


 


Comprehensive income

   $ 306,500     $ 398,559     $ 358,558  
    


 


 


 

See accompanying Notes to Consolidated Financial Statements.

 

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TORCHMARK CORPORATION

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

(Amounts in thousands except per share data)

 

    Preferred
Stock


  Common
Stock


    Additional
Paid-in
Capital


    Accumulated
Other
Comprehensive
Income (Loss)


    Retained
Earnings


    Treasury
Stock


    Total
Shareholders’
Equity


 

Year Ended December 31, 2005

                                               

Balance at January 1, 2005

  $ -0-   $ 108,784     $ 484,886     $ 405,916     $ 2,462,513     $ (42,255 )   $ 3,419,844  

Comprehensive income

                          (136,832 )     495,390               358,558  

Common dividends declared ($0.44 a share)

                                  (45,865 )             (45,865 )

Acquisition of treasury stock