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. The insurance marketing and underwriting operation is segmented by the types of insurance products offered: life, health, and annuity. 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 agencies, 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.

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



	Three Months Ended March 31, 2016
	Life			Health			Annuity			Investment			Other & Corporate			Adjustments				Consolidated
Revenue:
Premium	$	544,151		$	235,697		$	12												$	779,860
Net investment income										$	197,053									197,053
Other income													$	465		$	(44	)	(2)	421
Total revenue	544,151			235,697			12			197,053			465			(44		)		977,334
Expenses:
Policy benefits	362,860			152,775			9,338													524,973
Required interest on reserves	(142,011		)	(18,076		)	(13,092		)	173,179										—
Required interest on DAC	44,202			5,742			224			(50,168		)								—
Amortization of acquisition costs	94,539			22,365			1,902													118,806
Commissions, premium taxes, and non-deferred acquisition costs	40,261			21,376			9									(44		)	(2)	61,602
Insurance administrative expense ⁽¹⁾													48,468							48,468
Parent expense													2,026							2,026
Stock compensation expense													6,935							6,935
Interest expense										19,369										19,369
Total expenses	399,851			184,182			(1,619		)	142,380			57,429			(44		)		782,179
Subtotal	144,300			51,515			1,631			54,673			(56,964		)	—				195,155
Nonoperating items																—				—
Measure of segment profitability (pretax)	$	144,300		$	51,515		$	1,631		$	54,673		$	(56,964	)	$	—			195,155
Deduct applicable income taxes																				(61,771		)
Segment profits after tax																				133,384
Add back income taxes applicable to segment profitability																				61,771
Add (deduct) realized investment gains (losses)																				293
Pretax income per Consolidated Statements of Operations																				$	195,448

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

(2) Elimination of intersegment commission.

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



	Three Months Ended March 31, 2015
	Life			Health			Annuity			Investment			Other & Corporate			Adjustments				Consolidated
Revenue:
Premium	$	513,342		$	228,673		$	41												$	742,056
Net investment income										$	191,596									191,596
Other income													$	722		$	(53	)	(2)	669
Total revenue	513,342			228,673			41			191,596			722			(53		)		934,321
Expenses:
Policy benefits	339,701			148,029			10,045													497,775
Required interest on reserves	(136,185		)	(16,883		)	(13,369		)	166,437										—
Required interest on DAC	42,846			5,668			313			(48,827		)								—
Amortization of acquisition costs	88,528			20,184			1,948													110,660
Commissions, premium taxes, and non-deferred acquisition costs	37,049			20,098			11									(53		)	(2)	57,105
Insurance administrative expense⁽¹⁾													45,951							45,951
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			(1,052		)	136,670			55,363			(53		)		739,963
Subtotal	141,403			51,577			1,093			54,926			(54,641		)	—				194,358
Nonoperating items																—				—
Measure of segment profitability (pretax)	$	141,403		$	51,577		$	1,093		$	54,926		$	(54,641	)	$	—			194,358
Deduct applicable income taxes																				(63,657		)
Segment profits after tax																				130,701
Add back income taxes applicable to segment profitability																				63,657
Add (deduct) realized investment gains (losses)																				119
Pretax income per Consolidated Statements of Operations																				$	194,477

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

(2) Elimination of intersegment commission.

(3) Certain prior year balances were adjusted to give effect to discontinued operations as described in Note 5—Discontinued Operations.

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)
	2016			2015			Amount			%
Life insurance underwriting margin	$	144,300		$	141,403		$	2,897		2
Health insurance underwriting margin	51,515			51,577			(62		)	—
Annuity underwriting margin	1,631			1,093			538			49
Excess investment income	54,673			54,926			(253		)	—
Other and corporate:
Other income	465			722			(257		)	(36	)
Administrative expense	(48,468		)	(45,951		)	(2,517		)	5
Corporate and adjustments	(8,961		)	(9,412		)	451			(5	)
Pre-tax total	195,155			194,358			797			—
Applicable taxes	(61,771		)	(63,657		)	1,886			(3	)
After-tax total, before discontinued operations	133,384			130,701			2,683			2
Discontinued operations (after tax)⁽¹⁾	(9,541		)	(9,130		)	(411		)	5
After-tax total, after discontinued operations	123,843			121,571			2,272			2
Reconciling items, net of tax:
Realized gains (losses) - Investments	190			77			113
Net income	$	124,033		$	121,648		$	2,385		2

(1) Income (loss) from discontinued operations (after tax) is included for purpose of reconciling to net income.