Business Segments

Torchmark's reportable segments are based on the insurance product lines it markets and administers: life insurance, health insurance, and annuities. These major product lines are set out as reportable segments because of the common characteristics of products within these categories, comparability of margins, and the similarity in regulatory environment and management techniques. Torchmark's chief operating decision makers evaluate the overall performance of the operations of the Company in accordance with these segments.

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 net policy benefits and expenses. Management believes 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. However, dispositions of investments occur from time to time, generally for reasons such as credit concerns, calls by issuers, or other factors.

Since Torchmark does not actively trade investments, 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 Condensed Consolidated Statement of Operations



	Three Months Ended March 31, 2018
	Life			Health			Annuity			Investment			Corporate & Other			Adjustments				Consolidated
Revenue:
Premium	$	598,303		$	251,798		$	5												$	850,106
Net investment income										$	218,084									218,084
Other income													$	323		$	(28	)	(2)	295
Total revenue	598,303			251,798			5			218,084			323			(28		)		1,068,485
Expenses:
Policy benefits	400,581			160,619			8,689													569,889
Required interest on reserves	(156,214		)	(20,404		)	(12,017		)	188,635										—
Required interest on DAC	47,944			6,013			153			(54,110		)								—
Amortization of acquisition costs	103,777			25,257			586													129,620
Commissions, premium taxes, and non-deferred acquisition costs	47,394			22,265			8									(28		)	(2)	69,639
Insurance administrative expense⁽¹⁾													55,472							55,472
Parent expense													2,292							2,292
Stock-based compensation expense													9,060							9,060
Interest expense										21,622										21,622
Total expenses	443,482			193,750			(2,581		)	156,147			66,824			(28		)		857,594
Subtotal	154,821			58,048			2,586			61,937			(66,501		)	—				210,891
Non-operating items																—				—
Measure of segment profitability (pretax)	$	154,821		$	58,048		$	2,586		$	61,937		$	(66,501	)	$	—			210,891
Deduct applicable income taxes																				(38,721		)
Net operating income																				172,170
Add back income taxes applicable to segment profitability																				38,721
Add (deduct) realized investment gains (losses)																				1,951
Income before income taxes per Condensed Consolidated Statements of Operations																				$	212,842

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

(2) Elimination of intersegment commission.



	Three Months Ended March 31, 2017
	Life			Health			Annuity			Investment			Corporate & Other			Adjustments				Consolidated
Revenue:
Premium	$	575,837		$	244,791		$	3												$	820,631
Net investment income										$	208,282									208,282
Other income													$	451		$	(35	)	(2)	416
Total revenue	575,837			244,791			3			208,282			451			(35		)		1,029,329
Expenses:
Policy benefits	391,079			157,751			8,946													557,776
Required interest on reserves	(148,825		)	(18,975		)	(12,418		)	180,218										—
Required interest on DAC	45,936			5,809			178			(51,923		)								—
Amortization of acquisition costs	99,905			25,327			676													125,908
Commissions, premium taxes, and non-deferred acquisition costs	43,638			21,502			11									(35		)	(2)	65,116
Insurance administrative expense⁽¹⁾													51,913							51,913
Parent expense													2,233							2,233
Stock-based compensation expense													8,195							8,195
Interest expense										20,699										20,699
Total expenses	431,733			191,414			(2,607		)	148,994			62,341			(35		)		831,840
Subtotal	144,104			53,377			2,610			59,288			(61,890		)	—				197,489
Non-operating items																—				—
Measure of segment profitability (pretax)	$	144,104		$	53,377		$	2,610		$	59,288		$	(61,890	)	$	—			197,489
Deduct applicable income taxes																				(58,818		)
Net operating income																				138,671
Add back income taxes applicable to segment profitability																				58,818
Add (deduct) realized investment gains (losses)																				(5,748		)
Income before income taxes per Condensed Consolidated Statements of Operations																				$	191,741

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

(2) Elimination of intersegment commission.