Business Segments

Torchmark is comprised of life insurance companies which primarily market individual life and supplemental health insurance products through niche distribution channels to middle income Americans. Torchmark’s core operations are insurance marketing and underwriting, and management of its investments. Insurance marketing and underwriting is segmented by the types of insurance products offered: life, health, Medicare Part D, and annuity. Premium income for Medicare Part D health insurance is included with the premium for other health products in the Condensed Consolidated Statements of Operations. Annuity revenue is classified as “Other premium.” Management’s measure of profitability for each insurance segment is insurance underwriting margin, which is underwriting income before other income and insurance administrative expenses. It represents the profit margin on insurance products before administrative expenses, and is calculated by deducting net policy obligations (claims incurred and change in reserves), commissions and other acquisition expenses from premium revenue. Torchmark further views the profitability of each insurance product segment by the marketing groups that distribute the products of that segment: direct response, independent, or captive agencies.

Torchmark’s management prefers to evaluate the performance of its underwriting and investment activities separately, rather than allocating investment income to the underwriting results. As such, the investment function is presented as a stand-alone segment.

The investment segment includes the management of the investment portfolio, debt, and cash flow. Management’s measure of profitability for this segment is excess investment income, which is the income earned on the investment portfolio less the required interest on net policy liabilities and financing costs. Financing costs include the interest on Torchmark’s debt. Other income and insurance administrative expense are classified in a separate “Other” segment.

The majority of the Company’s required interest on net policy liabilities (benefit reserves less the deferred acquisition cost asset) is not credited to policyholder accounts. Instead, it is an actuarial assumption for discounting cash flows in the computation of benefit reserves and the amortization of the deferred acquisition cost asset. Investment income required to fund the required interest on net policy liabilities is removed from the investment segment and applied to the insurance segments to eliminate the effect of the required interest from the insurance segments. As a result, the investment segment measures net investment income against the required interest on net policy liabilities and financing costs, while the insurance segments simply measure premiums against benefits and expenses. We believe this presentation facilitates a more meaningful analysis of the Company’s underwriting and investment performance as the underwriting results are based on premiums, claims, and expenses and are not affected by unanticipated fluctuations in investment yields.

As noted, Torchmark’s “core operations” are insurance and investment management. The insurance segments issue policies for which premiums are collected for the eventual payment of policy benefits. In addition to policy benefits, operating expenses are incurred including acquisition costs, administrative expenses, and taxes. Because life and health contracts can be long term, premium receipts in excess of current expenses are invested. Investment activities, conducted by the investment segment, focus on seeking quality investments with a yield and term appropriate to support the insurance product obligations. These investments generally consist of fixed maturities, and, over the long term, the expected yields are taken into account when setting insurance premium rates and product profitability expectations. As a result, fixed maturities are generally held for long periods to support the liabilities, and Torchmark generally expects to hold investments until maturity. Dispositions of investments occur from time to time, generally as a result of credit concerns, calls by issuers, or other factors usually beyond the control of management.

Dispositions are sometimes required in order to maintain the Company’s investment policies and objectives. Investments are also occasionally written down as a result of other-than-temporary impairment. Torchmark does not actively trade investments. As a result, realized gains and losses from the disposition and write down of investments are generally incidental to operations and are not considered a material factor in insurance pricing or product profitability. While from time to time these realized gains and losses could be significant to net income in the period in which they occur, they generally have a limited effect on the yield of the total investment portfolio. Further, because the proceeds of the disposals are reinvested in the portfolio, the disposals have little effect on the size of the portfolio and the income from the reinvestments is included in net investment income. Therefore, management removes realized investment gains and losses from results of core operations when evaluating the performance of the Company. For this reason, these gains and losses are excluded from Torchmark’s operating segments.

Torchmark accounts for its stock options and restricted stock under current accounting guidance requiring stock options and stock grants to be expensed based on fair value at the time of grant. Management considers stock compensation expense to be an expense of the Parent Company. Therefore, stock compensation expense is treated as a corporate expense in Torchmark’s segment analysis.

Torchmark provides coverage under the Medicare Part D prescription drug plan for Medicare beneficiaries. In accordance with GAAP, Part D premiums are recognized evenly throughout the year when they become due but benefit costs are recognized when the costs are incurred. Due to the design of the Part D product, premiums are evenly distributed throughout the year, but benefit costs are higher earlier in the year. As a result, under GAAP, benefit costs can exceed premiums in the first part of the year, but be less than premiums during the remainder of the year. In order to more closely match the benefit cost with the associated revenue for interim periods, Torchmark defers these excess benefits for segment reporting purposes. In addition, GAAP recognizes in each quarter a government risk-sharing premium adjustment consistent with the contract as if the quarter represented an entire contract period. These quarterly risk-sharing adjustments are removed in the segment analysis because the actual contract payments are based upon the experience of the full contract year, not the experience of interim periods. Torchmark expects its benefit ratio to be in line with pricing. Total premiums less total benefits will be the same for segment reporting purposes as they will be under GAAP for the full calendar year. The Company’s presentation results in the underwriting margin percentage in interim periods reflecting the expected margin percentage for the full year. These interim adjustments do not impact the full year results.

An analysis of the adjustments for the difference in the interim results as presented for segment purposes and GAAP for Medicare Part D is as follows.



	Three months ended March 31,
	2015			2014
Benefit costs deferred	$	27,229		$	47,671
Government risk-sharing premium adjustment	(8,745		)	(27,395		)
Pre-tax addition to segment interim period income	$	18,484		$	20,276
After tax amount	$	12,015		$	13,179

Additionally, management does not view the risk-sharing premium for Medicare Part D as a component of premium income, and accordingly adjusts health premium income in its segment analysis. A reconciliation of health premium included in the segment analysis with health premium as reported in the Condensed Consolidated Statements of Operations is presented in the following table.



	Three months ended March 31,
	2015		2014		% Change
Premium per segment analysis:
Medicare Part D premium	$	79,347	$	83,033	(4	)
Other health premium	228,673		219,435		4
Part D risk-sharing adjustment	8,745		27,395		(68	)
Health premium per Condensed Consolidated Statements of Operations	$	316,765	$	329,863	(4	)

During the first three months of 2014, Torchmark accrued for certain litigation cases in the net amount of $3.7 million ($2.4 million after tax) that were not directly related to its insurance operations. Additionally, Torchmark received $1.2 million ($752 thousand after tax) in settlement of litigation regarding investments. Torchmark removes these segment analysis amounts that do not relate to its core insurance operations.

The following tables set forth a reconciliation of Torchmark’s revenues and operations by segment to its pretax income and each significant line item in its Condensed Consolidated Statements of Operations.

Reconciliation of Segment Operating Information to the Consolidated Statement of Operations



	For the three months ended March 31, 2015
	Life			Health			Medicare Part D		Annuity			Investment			Other & Corporate			Adjustments				Consolidated
Revenue:
Premium	$	513,342		$	228,673		$	79,347	$	41								$	8,745		⁽¹⁾	$	830,148
Net investment income												$	191,596									191,596
Other income															$	722		(53		)	⁽³⁾	669
Total revenue	513,342			228,673			79,347		41			191,596			722			8,692				1,022,413
Expenses:
Policy benefits	339,701			148,029			66,893		10,045									27,229			⁽¹⁾	591,897
Required interest on:
Policy reserves	(136,185		)	(16,883		)			(13,369		)	166,437										—
Deferred acquisition costs	42,846			5,668			214		313			(49,041		)								—
Amortization of acquisition costs	88,528			20,184			603		1,948													111,263
Commissions, premium taxes, and non-deferred acquisition costs	37,049			20,098			6,163		11									(53		)	⁽³⁾	63,268
Insurance administrative expense (2)															47,200							47,200
Parent expense															2,173							2,173
Stock compensation expense															7,239							7,239
Interest expense												19,060										19,060
Total expenses	371,939			177,096			73,873		(1,052		)	136,456			56,612			27,176				842,100
Subtotal	141,403			51,577			5,474		1,093			55,140			(55,890		)	(18,484		)		180,313
Nonoperating items																		18,484			⁽¹⁾	18,484
Measure of segment profitability (pretax)	$	141,403		$	51,577		$	5,474	$	1,093		$	55,140		$	(55,890	)	$	—			198,797
Deduct applicable income taxes																						(65,211		)
Segment profits after tax																						133,586
Add back income taxes applicable to segment profitability																						65,211
Add (deduct) realized investment gains (losses)																						119
Deduct Part D adjustment (1)																						(18,484		)
Pretax income per Condensed Consolidated Statement of Operations																						$	180,432


(1)	Medicare Part D items adjusted to GAAP from the segment analysis, which matches expected benefits with policy premium.


(2)	Administrative expense is not allocated to insurance segments.


(3)	Elimination of intersegment commission.

Reconciliation of Segment Operating Information to the Condensed Consolidated Statement of Operations *



	For the three months ended March 31, 2014
	Life			Health			Medicare Part D		Annuity			Investment			Other & Corporate			Adjustments				Consolidated
Revenue:
Premium	$	489,058		$	219,435		$	83,033	$	99								$	27,395		⁽¹⁾	$	819,020
Net investment income												$	188,051									188,051
Other income															$	544		(63		)	⁽³⁾	481
Total revenue	489,058			219,435			83,033		99			188,051			544			27,332				1,007,552
Expenses:
Policy benefits	320,176			141,786			66,261		10,623									47,671			⁽¹⁾	586,517
Required interest on:
Policy reserves	(130,511		)	(15,632		)			(13,791		)	159,934										—
Deferred acquisition costs	41,690			5,598			175		389			(47,852		)								—
Amortization of acquisition costs	83,600			18,608			705		1,820													104,733
Commissions, premium taxes, and non-deferred acquisition costs	33,484			19,618			6,326		13									(63		)	⁽³⁾	59,378
Insurance administrative expense (2)															44,211			2,493			⁽⁴⁾	46,704
Parent expense															1,743							1,743
Stock compensation expense															8,509							8,509
Interest expense												19,049										19,049
Total expenses	348,439			169,978			73,467		(946		)	131,131			54,463			50,101				826,633
Subtotal	140,619			49,457			9,566		1,045			56,920			(53,919		)	(22,769		)		180,919
Nonoperating items																		22,769			^(1,4)	22,769
Measure of segment profitability (pretax)	$	140,619		$	49,457		$	9,566	$	1,045		$	56,920		$	(53,919	)	$	—			203,688
Deduct applicable income taxes																						(66,835		)
Segment profits after tax																						136,853
Add back income taxes applicable to segment profitability																						66,835
Add (deduct) realized investment gains (losses)																						16,619
Deduct Part D adjustment (1)																						(20,276		)
Deduct legal settlement expenses (4)																						(2,493		)
Pretax income from continuing operations per Condensed Consolidated Statement of Operations																						$	197,538


(1)	Medicare Part D items adjusted to GAAP from the segment analysis, which matches expected benefits with policy premium.


(2)	Administrative expense is not allocated to insurance segments.


(3)	Elimination of intersegment commission.


(4)	Legal settlement expenses.


*	Retrospectively adjusted to give effect to the adoption of ASU 2014-01 as described in Note G-Adoption of New Accounting Standards.

The following table summarizes the measures of segment profitability for comparison. It also reconciles segment profits to net income.

Analysis of Profitability by Segment



	Three months ended March 31,						Increase (Decrease)
	2015			2014*			Amount			%
Life	$	141,403		$	140,619		$	784		1
Health	51,577			49,457			2,120			4
Medicare Part D	5,474			9,566			(4,092		)	(43	)
Annuity	1,093			1,045			48			5
Investment	55,140			56,920			(1,780		)	(3	)
Other and corporate:
Other income	722			544			178			33
Administrative expense	(47,200		)	(44,211		)	(2,989		)	7
Corporate	(9,412		)	(10,252		)	840			(8	)
Pretax total	198,797			203,688			(4,891		)	(2	)
Applicable taxes	(65,211		)	(66,835		)	1,624			(2	)
Total	133,586			136,853			(3,267		)	(2	)
Reconciling items, net of tax:
Realized gains (losses) - Investments	77			10,802			(10,725		)
Part D adjustment	(12,015		)	(13,179		)	1,164
Legal settlement expense	—			(1,620		)	1,620
Net income	$	121,648		$	132,856		$	(11,208	)	(8	)

* Retrospectively adjusted to give effect to the adoption of ASU 2014-01 as described in Note G-Adoption of New Accounting Standards.