0001193125-15-069449.txt : 20150227 0001193125-15-069449.hdr.sgml : 20150227 20150227153232 ACCESSION NUMBER: 0001193125-15-069449 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 15 CONFORMED PERIOD OF REPORT: 20141231 FILED AS OF DATE: 20150227 DATE AS OF CHANGE: 20150227 FILER: COMPANY DATA: COMPANY CONFORMED NAME: TORCHMARK CORP CENTRAL INDEX KEY: 0000320335 STANDARD INDUSTRIAL CLASSIFICATION: LIFE INSURANCE [6311] IRS NUMBER: 630780404 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 001-08052 FILM NUMBER: 15658084 BUSINESS ADDRESS: STREET 1: 3700 SOUTH STONEBRIDGE DRIVE CITY: MCKINNEY STATE: TX ZIP: 75070 BUSINESS PHONE: 972-569-4000 MAIL ADDRESS: STREET 1: 3700 SOUTH STONEBRIDGE DRIVE CITY: MCKINNEY STATE: TX ZIP: 75070 FORMER COMPANY: FORMER CONFORMED NAME: TORCHMARK CORP SAVINGS & INVESTMENT PLAN DATE OF NAME CHANGE: 19820825 FORMER COMPANY: FORMER CONFORMED NAME: LIBERTY NATIONAL INSURANCE HOLDING CO DATE OF NAME CHANGE: 19820701 10-K 1 d820030d10k.htm 10-K 10-K
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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, 2014

 

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   891027104   New York Stock Exchange
Common Stock, $1.00 par value per share   891027104   The International Stock Exchange, London, England

 

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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes  x      No   ¨    

 

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, 2014, the aggregate market value of the registrant’s common stock held by non-affiliates of the registrant was $7,156,116,413 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 February 13, 2015

Common Stock, $1.00 par value per share    127,107,471 shares

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Document

  

Parts Into Which Incorporated

Proxy Statement for the Annual Meeting of Stockholders to be
held April 30, 2015 (Proxy Statement)
   Part III


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Index to Financial Statements

TORCHMARK CORPORATION

INDEX

 

                Page  

PART I.

        
  

Item 1.

  

Business

       1   
  

Item 1A.

  

Risk Factors

       6   
  

Item 1B.

  

Unresolved Staff Comments

     12   
  

Item 2.

  

Properties

     12   
  

Item 3.

  

Legal Proceedings

     13   
  

Item 4.

  

Mine Safety Disclosures

     13   

PART II.

        
  

Item 5.

   Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities      14   
  

Item 6.

  

Selected Financial Data

     16   
  

Item 7.

   Management’s Discussion and Analysis of Financial Condition and Results of Operations      17   
  

Item 7A.

  

Quantitative and Qualitative Disclosures about Market Risk

     52   
  

Item 8.

  

Financial Statements and Supplementary Data

     53   
  

Item 9.

   Changes in and Disagreements with Accountants on Accounting and Financial Disclosure      108   
  

Item 9A.

  

Controls and Procedures

     108   
  

Item 9B.

  

Other Information

     108   

PART III.

        
  

Item 10.

  

Directors, Executive Officers, and Corporate Governance

     111   
  

Item 11.

  

Executive Compensation

     111   
  

Item 12.

   Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters      111   
  

Item 13.

   Certain Relationships and Related Transactions and Director Independence      111   
  

Item 14.

  

Principal Accountant Fees and Services

     111   

PART IV.

        
  

Item 15.

   Exhibits and Financial Statement Schedules      112   


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Index to Financial Statements

PART I

 

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 National), Globe Life And Accident Insurance Company (Globe), United American Insurance Company (United American), and Family Heritage Life Insurance Company of America (Family Heritage).

 

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

 

 
American Income Exclusive Agency  

American Income Life Insurance Company

Waco, Texas

  Individual life and supplemental health insurance marketed to union and credit union members.   6,434 producing agents in the U.S., Canada, and New Zealand.

 

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 mail, internet, television, magazine; nationwide.

 

Family Heritage Exclusive Agency  

Family Heritage Life Insurance Company of America

Cleveland, Ohio

  Supplemental limited-benefit health insurance to middle-income families.   785 captive agents in the U.S.

 

Liberty National Exclusive Agency  

Liberty National Life Insurance Company

McKinney, Texas

  Individual life and supplemental health insurance marketed to middle-income families.   1,498 producing agents in the U.S.

 

United American Independent Agency  

United American
Insurance Company

McKinney, Texas

  Medicare Supplement and Medicare Part D coverage to Medicare beneficiaries and, to a lesser extent, supplemental limited-benefit health coverage to people under age 65.   3,161 independent producing agents in the U.S.

 

Additional information concerning industry segments may be found in Management’s Discussion and Analysis and in Note 14—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.

 

     Annualized Premium in Force
(Amounts in thousands)
 
         2014              2013              2012      

Whole life:

        

Traditional

   $ 1,296,403       $ 1,235,904       $ 1,213,304   

Interest-sensitive

     54,490         58,549         63,290   

Term

     619,782         591,628         551,583   

Other

     73,870         69,320         66,840   
  

 

 

    

 

 

    

 

 

 
   $ 2,044,545       $ 1,955,401       $ 1,895,017   
  

 

 

    

 

 

    

 

 

 

 

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.

 

     Annualized Premium in Force
(Amounts in thousands)
 
         2014              2013              2012      

Direct response

   $ 721,261       $ 688,866       $ 659,026   

Exclusive agents:

        

American Income

     807,935         749,165         705,417   

Liberty National

     285,201         287,079         295,396   

Independent agents:

        

United American

     15,831         17,846         19,533   

Other

     214,317         212,445         215,645   
  

 

 

    

 

 

    

 

 

 
   $ 2,044,545       $ 1,955,401       $ 1,895,017   
  

 

 

    

 

 

    

 

 

 

 

Health Insurance

 

Torchmark offers supplemental limited-benefit health insurance products that include primarily cancer and accident plans. These policies are designed to supplement health coverage that applicants already own. Medicare Supplements are also offered to enrollees in the traditional fee-for-service Medicare program. Medicare Supplement plans are standardized by federal regulation and are designed to pay deductibles and co-payments not paid by Medicare. We also offer Medicare Part D prescription drug insurance.

 

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The following table presents supplemental health annualized premium in force information for the three years ended December 31, 2014 by product category.

 

    

Annualized Premium in Force

(Amounts in thousands)

 
         2014              2013              2012      
     Amount      % of
Total
     Amount      % of
Total
       Amount        % of
Total
 

Medicare Supplement

   $ 488,142         39       $ 435,788         36       $ 450,812         37   

Limited-benefit plans

     459,181         36         451,656         37         451,941         37   

Medicare Part D

     316,089         25         322,763         27         325,749         26   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total Health

   $ 1,263,412         100       $ 1,210,207         100       $ 1,228,502         100   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

The following table presents supplemental health annualized premium in force for the three years ended December 31, 2014 by marketing (distribution) method.

 

     Annualized Premium in Force
(Amounts in thousands)
 
         2014              2013              2012      

Direct response

   $ 72,659       $ 55,270       $ 60,206   

Exclusive agents:

        

Liberty National

     226,599         240,581         259,452   

American Income

     71,942         71,354         73,280   

Family Heritage

     217,742         201,054         187,979   

Independent agents:

        

United American

     358,381         319,185         321,836   
  

 

 

    

 

 

    

 

 

 
     947,323         887,444         902,753   

Medicare Part D

     316,089         322,763         325,749   
  

 

 

    

 

 

    

 

 

 
   $ 1,263,412       $ 1,210,207       $ 1,228,502   
  

 

 

    

 

 

    

 

 

 

 

Annuities

 

Annuity products include single-premium and flexible-premium deferred annuities. Annuities in each of the three years ending December 31, 2014 comprised less than 1% of premium.

 

Pricing

 

Premium rates for life and health insurance products are established using assumptions as to future mortality, morbidity, persistency, and expenses. These assumptions are based on Company experience and 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 annuity products and 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.

 

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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, pharmacy data, 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. The assumptions used in the calculation of Torchmark’s reserves are reported in Note 1—Significant Accounting Policies in the Notes to 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 97% of total investments at fair value at December 31, 2014. (See Note 4Investments in the Notes to 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.

 

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.

 

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Index to Financial Statements

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 to be placed 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 based on its proportional share of the premium in each state. Assessments are recoverable to a great extent as offsets against state premium taxes.

 

Medicare Part D.    The Medicare Part D program is regulated at the federal level by the Centers for Medicare and Medicaid Services (CMS). This agency periodically examines Torchmark’s participating subsidiaries.

 

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. Torchmark and its subsidiaries have registered as a holding company system pursuant to such legislation in Indiana, Nebraska, Ohio, 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 2014, Torchmark had 2,980 employees.

 

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Item 1A.    Risk Factors

 

Risks Related to Our Business

 

Product Marketplace and Operational Risks:

 

The insurance industry is a regulated industry, populated by many firms. We operate in the life and health insurance sectors of the insurance industry, each with its own set of risks.

 

The development and maintenance of our various distribution systems are critical to growth in product sales and profits.    Because our life and health 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. Adequate compensation that is competitive with other career opportunities and that also motivates producing agents to increase sales is critical. In direct response, continuous development of new offerings and cost efficiency are key. Less than optimum execution of these strategies may result in reduced sales and profits.

 

Economic conditions may materially adversely affect our business and results of operations. We serve primarily the middle-income market for individual protection life and health insurance and, as a result, we compete directly with alternative uses of a customer’s disposable income. If disposable income within this demographic group declines or the use of disposable income becomes more limited, as a result of a significant, sustained economic downturn or otherwise, then new sales of our insurance products could become more challenging, and our policyholders may choose to defer paying insurance premiums or stop paying insurance premiums altogether.

 

Variations in expected to actual rates of mortality, morbidity, and persistency could materially negatively affect our results of operations and financial condition.    We establish a liability for our policy reserves to pay future policyholder benefits and claims. These reserves do not represent an exact calculation of liability, but rather are actuarial estimates based on models that include many assumptions and projections which are inherently uncertain. The reserve computations involve the exercise of significant judgment with respect to levels of mortality, morbidity, and persistency as well as the timing of premium and benefit payments. Even though our actuaries continually test expected-to-actual results, actual levels that occur may differ significantly from the levels assumed when premium rates were first set. Accordingly, we cannot determine with precision the ultimate amounts of claims or benefits that we will pay or the timing of such payments. Significant variations from the levels assumed when policy reserves are first set could negatively affect our profit margins and income.

 

A ratings downgrade or other negative action by a rating agency could materially affect our business, financial condition and results of operations.    Various rating agencies review the financial performance and condition of insurers, including our insurance subsidiaries, and publish their financial strength ratings as indicators of an insurer’s ability to meet policyholder and contract holder obligations. These ratings are important to maintaining public confidence in our insurance products. A downgrade or other negative action by a rating agency with respect to the financial strength ratings of our insurance subsidiaries could negatively affect us in many ways, including the following: limiting or restricting the ability of our insurance subsidiaries to pay dividends to us and adversely affecting our ability to sell insurance products through our independent agencies.

 

Rating agencies also publish credit ratings for us. Credit ratings are indicators of a debt issuer’s ability to meet the terms of debt obligations in a timely manner. These ratings are important to our overall ability to access certain types of liquidity. Actual or anticipated downgrades in our credit ratings, or an announcement that our ratings are under further review for a downgrade, could potentially have a negative effect on our operations, by limiting our access to capital markets, increasing the cost of debt, impairing our ability to raise capital to refinance maturing debt obligations, limiting our capacity to support growth at our insurance subsidiaries, or making it more difficult to maintain or improve the current financial strength ratings of our insurance subsidiaries.

 

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Ratings reflect only the rating agency’s views and are not recommendations to buy, sell or hold our securities. Rating agencies assign ratings based upon several factors. While most of the factors relate to the rated company, some of the factors relate to the views of the rating agency, general economic conditions and circumstances outside the rated company’s control. In addition, rating agencies use various models and formulas to assess the strength of a rated company, and from time to time rating agencies have, in their discretion, altered the models. Changes to the models could impact the rating agencies’ judgment of the rating to be assigned to the rated company. There can be no assurance that current credit ratings will remain in effect for any given period of time or that such ratings will not be lowered, suspended or withdrawn entirely by the rating agencies, if in each rating agency’s judgment, circumstances so warrant. We cannot predict what actions the rating agencies may take, or what actions we may take in response to the actions of the rating agencies, which could negatively affect our business, financial condition and results of operations.

 

Reputational Risk:

 

Damage to the reputation of Torchmark or its subsidiaries could affect our ability to conduct business. Negative publicity published through traditional media, internet, social media, and other public forums could damage our reputation and adversely impact our agent recruiting efforts, the ability to market our products, and the persistency of our block of inforce policies.

 

Life Insurance Marketplace Risk:

 

Our life products are sold in selected niche markets. We are at risk should any of these markets diminish. We have two life distribution channels that focus on distinct market niches: labor union members and sales via direct response solicitation. Deterioration of our relationships with organized labor or adverse changes in the public’s receptivity to unsolicited direct response marketing could negatively affect this business.

 

Health Insurance Marketplace Risks:

 

The health insurance market is subject to substantial legislative scrutiny. Legislative changes could impact our Medicare Supplement, Medicare Part D, and other supplemental health businesses. The nature and timing of any such changes cannot be predicted and could have a material adverse effect on that business.

 

Competition in the health market can be significant. Sales of our health insurance products are subject to competition from other health insurance companies and alternative healthcare providers, such as those that provide alternatives to traditional Medicare to seniors. In addition, some insurers may be willing to significantly reduce their profit margins or under price new sales in order to gain market share. We choose not to compete for market share based on these terms. Accordingly, changes in the competitive landscape, including the pricing strategies employed by our competitors, could negatively impact the future sales of our health insurance products.

 

An inability to obtain timely and appropriate premium rate increases for the health insurance policies we sell due to regulatory delay could adversely affect our results of operations and financial condition.    A significant percentage of the health insurance premiums that our insurance subsidiaries earn is from Medicare Supplement insurance. Medicare Supplement insurance and the terms under which the premiums for such policies may be increased are highly regulated at both the state and federal level. As a result, it is characterized by lower profit margins than life insurance and requires strict administrative discipline and economies of scale for success. Because Medicare Supplement policies are coordinated with the federal Medicare program, which experiences health care inflation every year, annual premium rate increases for the Medicare Supplement policies are necessary. Obtaining timely rate increases is of critical importance to our success in this market. Accordingly, the inability of our insurance subsidiaries to obtain approval of premium rate increases in a timely manner from state insurance regulatory authorities in the future could adversely impact their profitability.

 

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Investment Risks:

 

Our investments are subject to market and credit risks.    Our invested assets are subject to the customary risks of defaults, downgrades, and changes in market values. Substantially all of our investment portfolio consists of fixed-maturity and short-term investments. A significant portion of our fixed-maturity investments is comprised of corporate bonds, exposing us to the risk that individual corporate issuers will not have the ability to make required interest or principal payments on the investment. Factors that may affect both market and credit risks include interest rate levels, financial market performance, disruptions in credit markets, general economic conditions, legislative changes, particular circumstances affecting the businesses or industries of each issuer, and other factors beyond our control. Additionally, because the majority of our investments are longer-term fixed maturities that we typically hold until maturity, significant increases in interest rates, widening of credit spreads, or inactive markets associated with market downturns could cause a material temporary decline in the fair value of our fixed investment portfolio, even with regard to performing assets. These declines could cause a material increase in unrealized losses in our investment portfolio. Significant unrealized losses can substantially reduce our capital position and shareholders’ equity. It is possible that our investment in certain of these securities with unrealized losses may experience a default event and that a portion or all of that unrealized loss may not be recoverable. In that case, the unrealized loss will be realized, at which point we would take an impairment charge, reducing our net income.

 

Difficulties in the business of particular issuers or in industries in which we hold investments could cause significant downgrades, delinquencies and defaults in our investment portfolio, potentially resulting in lower net investment income and increased realized and unrealized investment losses.     A default by an issuer could result in a significant other-than-temporary impairment of that investment, causing us to write the investment down and take a charge against net income. The risk of default is higher for bonds with longer-term maturities, which we acquire in order to match our long-term insurance obligations. We attempt to reduce this risk by purchasing only investment grade securities and by carefully evaluating an issuer before entering into an investment. We cannot be assured that any particular issuer, regardless of industry, will be able to make required interest and principal payments, on a timely basis or at all. Material other-than-temporary impairments could reduce our statutory surplus, leading to lower risk-based capital ratios, potential downgrades of our ratings by rating agencies and a potential reduction of future dividend capacity from our insurance subsidiaries. While we intend to hold our investments until maturity, a severe increase in defaults could cause us to suffer a significant decrease in investment income or principal repayments, resulting in substantial realized losses from the writedowns of impaired investments. Current net income would be negatively impacted by the writedowns, and prospective net income would be adversely impacted by the loss of future interest income.

 

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 discount rates used to calculate the net policy liabilities. While we attempt to manage our investments to preserve the excess investment income spread, we provide 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 our investment income, as reinvestment of the proceeds would likely be at lower rates.

 

Liquidity Risks:

 

Our liquidity to fund operations is substantially dependent on funds available, primarily dividends, from our insurance subsidiaries.    As a holding company with no direct operations, our principal asset is the capital stock of our insurance subsidiaries, which periodically declare and distribute dividends on their capital stock. Moreover, our liquidity, including our ability to pay our operating expenses and to make principal and interest payments on debt securities or other indebtedness owed by us, as well as our ability to pay dividends on our common stock or any preferred stock, depends significantly upon the surplus and earnings of our insurance subsidiaries and the ability of these subsidiaries to pay dividends or to advance or repay funds to us. Other sources of liquidity also include a variety of short-term and long-term instruments, including our credit facility, commercial paper, long-term debt, intercompany financing, and reinsurance.

 

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The principal sources of our insurance subsidiaries’ liquidity are insurance premiums, as well as investment income, maturities, repayments, and other cash flow from our investment portfolio. Our insurance 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 us, including laws establishing minimum solvency and liquidity thresholds. For example, in the states where our companies are domiciled, 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 prior year statutory net income, excluding capital gains, on an annual noncumulative basis or 10% of prior year statutory surplus without regulatory approval. Accordingly, impairments in invested assets or a disruption in our insurance subsidiaries’ operations that reduces their capital or cash flow could limit or disallow payment of dividends to us, a principal source of our cash flow.

 

We can give no assurance that more stringent restrictions will not be adopted from time to time by states in which our insurance subsidiaries are domiciled, which could, under certain circumstances, significantly reduce dividends or other amounts paid to us by our subsidiaries. Although we do not anticipate changes, changes in these laws could constrain the ability of our subsidiaries to pay dividends or to advance or repay funds to us in sufficient amounts and at times necessary to meet our debt obligations and corporate expenses. Additionally, the inability of our insurance subsidiaries to obtain approval of premium rate increases in a timely manner from state insurance regulatory authorities could adversely impact their profitability, and thus their ability to declare and distribute dividends to us. Limitations on the flow of dividends from our subsidiaries could limit our ability to service and repay debt or to pay dividends on our capital stock.

 

Adverse capital and credit market conditions may significantly affect our ability to meet liquidity needs or access capital, as well as affect our cost of capital.     Should credit spreads widen in the future, the interest rate on any new debt obligation we may issue could increase, and our net income could be reduced. If the credit and capital markets were to experience significant disruption, uncertainty, and instability, these conditions could adversely affect our access to capital. Such market conditions may limit our ability to replace maturing liabilities (in a timely manner or at all) and/or access the capital necessary to grow our business.

 

In the unlikely event that current resources do not satisfy our needs, we may have to seek additional financing or raise capital. The availability of additional financing or capital will depend on a variety of factors such as market conditions, the general availability of credit or capital, the volume of trading activities, the overall availability of credit to the insurance industry, and our credit ratings and credit capacity. Additionally, customers, lenders, or investors could develop a negative perception of our long- or short-term financial prospects if we incur large investment losses or if the level of our business activity decreases due to a market downturn. Our access to funds may also be impaired if regulatory authorities or rating agencies take negative actions against us. Our internal sources of liquidity may prove to be insufficient, and, in such case, we may not be able to successfully obtain additional financing on favorable terms, or at all. As such, we may be forced to delay raising capital, issue shorter term securities than we prefer, or bear an unattractive cost of capital which could decrease our profitability and significantly reduce our financial flexibility. Therefore, as a result, our results of operations, financial condition, and cash flows could be materially negatively affected by disruptions in the financial markets.

 

Regulatory Risks:

 

Our businesses are heavily regulated, and changes in regulation may reduce our profitability and growth.    Insurance companies, including our insurance subsidiaries, are subject to extensive supervision and regulation in the states in which we do business. The primary purpose of this supervision and regulation is the protection of our policyholders, not our investors. State agencies have broad administrative power over numerous aspects of our business, including premium rates and other terms and conditions that we can include in the insurance policies offered by our insurance subsidiaries, marketing practices, advertising, licensing agents, policy forms, capital adequacy, solvency, reserves, and permitted investments. Also, regulatory authorities have relatively broad discretion to grant, renew, or initiate procedures to revoke licenses or approvals. The insurance laws, regulations and policies currently affecting Torchmark and its insurance subsidiaries may change at any time, possibly having an adverse effect on our business. Should these changes to our business occur, we may be unable to maintain all

 

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required licenses and approvals, and our business may not fully comply with the wide variety of applicable laws and regulations or the relevant authority’s interpretation of the laws and regulations, which may change from time to time. If we do not have the requisite licenses and approvals or do not comply with applicable regulatory requirements, the insurance regulatory authorities could preclude or temporarily suspend us from carrying on some or all of our activities or impose substantial fines.

 

We cannot predict the timing or substance of any future regulatory initiatives. In recent years, there has been increased scrutiny of insurance companies, including our insurance subsidiaries, by insurance regulatory authorities, which has included more extensive examinations and more detailed review of disclosure documents. These regulatory authorities may bring regulatory or other legal actions against us if, in their view, our practices, or those of our agents or employees, are improper. These actions can result in substantial fines, penalties, or prohibitions or restrictions on our business activities and could have a material adverse effect on our business, results of operations, or financial condition. Additionally, changes in the overall legal or regulatory environment may, even absent any particular regulatory authority’s interpretation of an issue changing, cause us to change our views regarding the actions that we need to take from a legal or regulatory risk management perspective, thus necessitating changes to our practices that may, in some cases, limit our ability to grow, impact regulatory capital requirements, or otherwise negatively impact the profitability of our business.

 

Currently, the U.S. federal government does not directly regulate the business of insurance. However, the Dodd-Frank Wall Street Record and Consumer Protection Act of 2010 establishes a Federal Insurance Office (FIO) within the Department of the Treasury, and the Patient Protection and Affordable Care Act (Affordable Care Act) created the Center for Consumer Information and Insurance Oversight (CCIIO), originally established under the Department of Health and Human Services and subsequently transferred to the Centers for Medicare and Medicaid Services (CMS). The creation of these insurance regulatory offices may indicate that the federal government intends to play a larger role in the direct regulation of the insurance industry. We cannot predict what impact, if any, the FIO and CCIIO, as well as any other proposals for federal regulation of insurance could have on our business, results of operations, or financial condition. We also cannot predict what impact actions taken by CMS, as the regulator of our Medicare Part D business, could have on our business, results of operations, or financial condition.

 

Changes in U.S. federal income tax law could increase our tax costs.    Changes to the Internal Revenue Code, administrative rulings, or court decisions affecting the insurance industry, including the products it offers, could increase our effective tax rate and lower our net income, or negatively effect our ability to sell some of our products.

 

Changes in accounting standards issued by accounting standard-setting bodies may affect our financial statements, reduce our reported profitability, and change the timing of profit recognition.    Our financial statements are subject to the application of accounting principles generally accepted in the United States of America (GAAP), which principles are periodically revised and/or expanded. Accordingly, from time to time, we are required to adopt new or revised accounting standards or guidance issued by recognized authoritative bodies. It is possible that future accounting standards that we are required to adopt could change the current accounting treatment that we apply to our consolidated financial statements and that such changes could have a material adverse effect on our financial condition and results of operations. Further, standard setters have a full agenda of unissued topics under review at any given time, any of which have the potential to negatively impact our profitability.

 

If we fail to comply with restrictions on patient privacy and information security, including taking steps to ensure that our business associates who obtain access to sensitive patient information maintain its confidentiality, our reputation and business operations could be materially adversely affected.    The collection, maintenance, use, disclosure and disposal of individually identifiable data by our insurance subsidiaries are regulated at the international, federal and state levels. These laws and rules are subject to change by legislation or administrative or judicial interpretation. Various state laws address the use and disclosure of individually identifiable health data to the extent they are more restrictive than those contained in the privacy and security provisions in the federal Gramm-Leach-Bliley Act of 1999 (GLBA) and in the Health Insurance Portability and Accountability Act of 1996 (HIPAA). HIPAA also requires that we impose privacy and security requirements on our business associates (as that term is defined in the HIPAA regulations). Noncompliance with any privacy laws or

 

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any security breach involving the misappropriation, loss or other unauthorized disclosure of sensitive or confidential information, whether by us or by one of our business associates, could have a material adverse effect on our business, reputation and results of operations and could include material fines and penalties, various forms of damages, consent orders regarding our privacy and security practices, adverse actions against our licenses to do business and injunctive relief.

 

Litigation Risk:

 

Litigation could result in substantial judgments against us or our subsidiaries.    We are, and in the future may be, subject to litigation in the ordinary course of business. Some of these proceedings have been brought on behalf of various alleged classes of complainants, and, in certain of these matters, the plaintiffs are seeking large and/or indeterminate amounts, including punitive or exemplary damages. Members of our management and legal teams review litigation on a quarterly and annual basis. However, the outcome of any such litigation cannot be predicted with certainty. A number of civil jury verdicts have been returned against insurers in the jurisdictions in which Torchmark and its insurance subsidiaries do 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 in which we operate, juries have substantial discretion in awarding punitive damages. This discretion creates the potential for unpredictable material adverse judgments in any given punitive damages suit.

 

Our pending and future litigation could adversely affect us because of the costs of defending these cases, the costs of settlement or judgments against us, or changes in our operations that could result from litigation. Substantial legal liability in these or future legal actions could also have a material financial effect or cause significant harm to our reputation, which, in turn, could materially harm our business and our business prospects.

 

Catastrophic Event Risk:

 

Our business is subject to the risk of the occurrence of catastrophic events.    Our insurance policies are issued to and held by a large number of policyholders throughout the United States in relatively low-face amounts. Accordingly, it is unlikely that a large portion of our policyholder base would be affected by a single natural disaster. However, our insurance operations could be exposed to the risk of catastrophic mortality or morbidity, caused by events such as a pandemic, hurricane, earthquake, or man-made catastrophes, including acts of terrorism or war, which may produce significant claims in larger areas, especially those that are heavily populated. Claims resulting from natural or man-made catastrophic events could cause substantial volatility in our financial results for any fiscal quarter or year and could materially reduce our profitability or harm our financial condition.

 

Information Security and Technology Risk:

 

A network security breach, the introduction of malware in our computing environment, a disaster, or other unanticipated event could affect the computer systems of Torchmark or its subsidiaries, and could damage our business and adversely affect our financial condition and results of operations. Despite our implementation of cyber security measures to protect our hardware, software, data, and networks from attack, damage, or unauthorized access, our computing environment could be subject to physical and electronic break-ins and similar disruptions from unauthorized tampering with our systems.

 

We retain confidential information in our computer systems. Anyone who is able to circumvent our cyber security measures and penetrate our computer systems could access, view, misappropriate, alter or delete information in the systems, including personally identifiable customer information and proprietary business information. In addition, an increasing number of states require that customers be notified of unauthorized access, use, or disclosure of their information. Any compromise of the security of our computer systems that results in an inappropriate access, use, or disclosure of personally identifiable customer information could damage our reputation in the marketplace, deter people from purchasing our products, subject us to significant civil and criminal liability, and require us to incur significant technical, legal and other expenses.

 

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In the event of a disaster, such as a natural catastrophe, an industrial accident, a blackout, or a terrorist attack or war, our computer systems may be inaccessible to our employees or customers for a period of time. Even if our employees are able to report to work, they may be unable to perform their duties for an extended period of time if our data or systems are disabled or destroyed and if existing contingency plans cannot function as designed.

 

Item 1B.    Unresolved Staff Comments

 

As of December 31, 2014, Torchmark had no unresolved staff comments.

 

Item 2.    Properties

 

Torchmark, through its subsidiaries, owns or leases buildings that are used in the normal course of business. Torchmark owns and occupies a 300,000 square foot facility in McKinney, Texas (a north Dallas suburb). This facility is Torchmark’s corporate headquarters and also houses the operations of a subsidiary, United American, as well as the operations of other subsidiaries. In addition, United American leases 5,000 square feet of space in Omaha, Nebraska and, through a subsidiary, leases 2,500 square feet in an office area in Syracuse, New York.

 

Liberty National, though headquartered in McKinney, Texas, operates its main activities out of a 24,000 square foot facility leased in Hoover, Alabama (a Birmingham suburb). An 8,000 square foot facility is leased for storage in Pelham, Alabama, close to the Hoover facility.

 

Globe leases a 30,300 square foot office area in the City Place Tower building located in downtown Oklahoma City, Oklahoma. Globe also leases 11,000 square feet at a nearby facility used for storage. Globe Marketing Services, a subsidiary of Globe, owns a 133,000 square foot facility 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 two-floored building contains 70,000 square feet. American Income also has leased 8,100 square feet in a building across the street from the main office building. American Income Marketing Services, a subsidiary of American Income, owns a 43,000 square foot facility located in Waco, Texas, housing American Income’s direct response operation. American Income also leases office space throughout the United States to support its marketing operations.

 

Family Heritage owns 50% of a partnership that owns an approximate 66,000 square foot building in Broadview Heights, Ohio (a suburb of Cleveland), serving as Family Heritage’s headquarters. The partnership also leases a portion of the building to unrelated tenants.

 

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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. Torchmark’s management recognizes that large punitive damage awards bearing little or no relation to actual damages continue to be awarded by juries in jurisdictions in which Torchmark and its subsidiaries have substantial business, creating the potential for unpredictable material adverse judgments in any given punitive damage suit.

 

As previously reported, Torchmark subsidiaries are currently the subject of audits regarding the identification, reporting and escheatment of unclaimed property arising from life insurance policies and a limited number of annuity contracts. These audits are being conducted by private entities that have contracted with forty-seven states through their respective Departments of Revenue, and have not resulted in any financial assessment from any state nor indicated any liability. The audits are wide-ranging and seek large amounts of data regarding claims handling, procedures, and payments of contract benefits arising from unreported death claims. Amounts that could be payable to insurance beneficiaries and to the states for the escheatment of abandoned property represent insurance liabilities and are included in the Company’s estimate of policy benefits under the caption “Total policy liabilities” on the Consolidated Balance Sheets. No estimate of range can be made for loss contingencies related to possible administrative penalties or amounts that could be payable to the states for the escheatment of abandoned property at this time.

 

Item 4.    Mine Safety Disclosures.

 

Not Applicable.

 

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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 2,996 shareholders of record on December 31, 2014, excluding shareholder accounts held in nominee form. The market prices and cash dividends paid by calendar quarter for the past two years are presented in the following table. Per share amounts have been retrospectively adjusted for the three-for-two stock split effective July 1, 2014.

 

           2014
Market Price
     Dividends
Per Share
 

Quarter

         High      Low     

1                

     $ 53.51       $ 48.37       $ .1133   

2                

       55.07         50.97         .1267   

3                

       55.68         52.37         .1267   

4                

       55.42         50.32         .1267   

Year-end closing price

  $ 54.17            
           2013
Market Price
     Dividends
Per Share
 

Quarter

         High      Low     

1                

     $ 39.87       $ 35.03       $ .1000   

2                

       43.81         38.76         .1133   

3                

       48.65         43.89         .1133   

4                

       52.35         47.11         .1133   

Year-end closing price

  $ 52.10            

 

(c)   Purchases of Certain Equity Securities by the Issuer and Others for the Fourth Quarter 2014

 

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, 2014

     811,046       $ 52.02         811,046      

November 1-30, 2014

     607,000         53.45         607,000      

December 1-31, 2014

     608,448         53.55         608,448      

 

On August 6, 2014, 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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(e)   Performance Graph

 

LOGO

 

 

      *   $100 invested on 12/31/09 in stock or index, including reinvestment of dividends. Fiscal year ending December 31.

 

Copyright© 2015 S&P, a division of The McGraw-Hill Companies Inc. All rights reserved.

 

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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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,   2014     2013     2012     2011           2010        

Premium revenue:

         

Life

  $ 1,966,300      $ 1,885,332      $ 1,808,524      $  1,726,244      $ 1,663,699   

Health

    1,242,720        1,166,410        1,047,379        929,466        987,421   

Other

    400        532        559        608        638   

Total

    3,209,420        3,052,274        2,856,462        2,656,318        2,651,758   

Net investment income

    729,207        709,743        693,644        693,028        676,364   

Realized investment gains (losses)

    23,548        7,990        37,833        25,904        37,340   

Total revenue

    3,964,296        3,771,938        3,589,516        3,377,401        3,367,632   

Income from continuing operations

    542,939        528,472        529,324        497,616        504,095   

Income from discontinued operations

    0        0        0        0        29,784   

Loss on disposal, net of tax

    0        0        0        (455     (35,013

Net income

    542,939        528,472        529,324        497,161        498,866   

Per common share:

         

Basic earnings:

         

Income from continuing operations(4)

    4.15        3.84        3.65        3.06        2.75   

Income (loss) from discontinued operations(4)

    0.00        0.00        0.00        0.00        (0.02

Net income(4)

    4.15        3.84        3.65        3.06        2.73   

Diluted earnings:

         

Income from continuing operations(4)

    4.09        3.79        3.60        3.02        2.73   

Income (loss) from discontinued operations(4)

    0.00        0.00        0.00        0.00        (0.03

Net income(4)

    4.09        3.79        3.60        3.02        2.70   

Cash dividends declared(4)

    0.51        0.45        0.40        0.31        0.27   

Cash dividends paid(4)

    0.49        0.44        0.38        0.30        0.27   

Basic average shares outstanding(4)

    130,722        137,647        144,921        162,417        183,014   

Diluted average shares outstanding(4)

    132,640        139,564        146,848        164,723        184,685   
As of December 31,   2014     2013     2012     2011           2010        

Cash and invested assets(1)

  $ 15,058,996      $ 13,456,944      $ 14,155,919      $  12,437,699      $ 11,563,656   

Total assets(1)

    20,214,730        18,191,744        18,776,910        16,588,272        15,622,973   

Short-term debt

    238,398        229,070        319,043        224,842        198,875   

Long-term debt(2)

    992,130        990,865        989,686        914,282        913,354   

Shareholders’ equity

    4,697,466        3,776,342        4,361,786        3,859,631        3,667,329   

Per diluted share(4)

    36.19        27.66        30.56        25.27        20.24   

Effect of fixed maturity revaluation on diluted equity per share(3,4)

    8.28        1.81        7.07        3.96        0.37   

Annualized premium in force:

         

Life(1)

    2,044,545        1,955,401        1,895,017        1,813,705        1,753,046   

Health(1)

    1,263,412        1,210,207        1,228,502        1,016,393        973,625   

Total

    3,307,957        3,165,608        3,123,519        2,830,098        2,726,671   

Basic shares outstanding(4)

    127,930        134,252        141,353        150,869        178,297   

Diluted shares outstanding(4)

    129,812        136,537        142,707        152,712        181,222   
(1)   At December 31, 2012, cash and invested assets included $615 million, total assets included $869 million, annualized life premium in force included $949 thousand, and annualized health premium in force included $188 million, representing the business acquired in the acquisition of Family Heritage in 2012.
(2) Includes Torchmark’s 7.1% Junior Subordinated Debentures reported as “Due to affiliates” on the Consolidated Balance Sheets at year ends 2010 through 2011 in the amount of $123.7 million.
(3) There is an accounting rule (ASC 320-10-35-1) requiring available-for-sale fixed maturities to be revalued at fair value each period. The effect of this rule on diluted equity per share reflects the amount added or (deducted) under this rule 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.
(4) Outstanding shares and per share amounts have been retrospectively adjusted for the three-for-two-stock split effective July 1, 2014.

 

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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 insurance product lines of life, health, Medicare Part D, 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. As described in Note 14—Business Segments in the Notes to Consolidated Financial Statements, we reorganized our segment structure to separate our Medicare Part D health insurance business from our other health insurance activities as a stand-alone segment, because management determined that Part D meets the criteria of a distinct segment under accounting guidance. Prior period results have been retrospectively adjusted for comparability.

 

Insurance Product Line Segments.    As fully explained in Note 14, the insurance product line segments involve the marketing, underwriting, and the 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:

    Required interest on net policy liabilities

    Financing costs

 

The tables in Note 14 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, 2014. 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.

 

Acquisition:    On November 1, 2012, we acquired Family Heritage, a previously privately-held supplemental health insurance carrier. Information about this acquisition can be found in Note 6—Acquisition in the Notes to Consolidated Financial Statements. The results of Family Heritage subsequent to our acquisition are included in this discussion within our health insurance segment.

 

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Analysis of Profitability by Segment

(Dollar amounts in thousands)

 

    2014     2013     2012     2014
Change
    %     2013
Change
    %  

Life insurance underwriting margin

  $ 556,489      $ 545,059      $ 509,476      $ 11,430        2      $ 35,583        7   

Health insurance underwriting margin*

    199,319        196,507        163,984        2,812        1        32,523        20   

Medicare Part D underwriting margin*

    27,266        35,300        33,357        (8,034     (23     1,943        6   

Annuity underwriting margin

    4,312        3,939        3,465        373        9        474        14   

Excess investment income

    225,091        218,826        236,644        6,265        3        (17,818     (8

Other insurance:

             

Other income

    2,354        2,208        1,898        146        7        310        16   

Administrative expense

    (179,955     (178,898     (165,405     (1,057     1        (13,493     8   

Corporate and adjustments

    (40,362     (34,137     (29,827     (6,225     18        (4,310     14   
 

 

 

   

 

 

   

 

 

   

 

 

     

 

 

   

Pre-tax total

    794,514        788,804        753,592        5,710        1        35,212        5   

Applicable taxes

    (260,046     (258,137     (246,945     (1,909     1        (11,192     5   
 

 

 

   

 

 

   

 

 

   

 

 

     

 

 

   

Total

    534,468        530,667        506,647        3,801        1        24,020        5   

Realized gains (losses)—investments (after tax)**

    15,306        3,965        24,591        11,341          (20,626  

Acquisition expense—Family Heritage (after tax)

    0        0        (1,914     0          1,914     

Family Heritage acquisition finalization adjustments (after tax)

    0        522        0        (522       522     

Legal settlement expenses (after tax)

    (1,519     (5,931     0        4,412          (5,931  

Guaranty Fund assessment (after tax)

    0        (751     0        751          (751  

Administrative settlements (after tax)

    (5,316     0        0        (5,316       0     
 

 

 

   

 

 

   

 

 

   

 

 

     

 

 

   

Net income

  $ 542,939      $ 528,472      $ 529,324      $ 14,467        3      $ (852)        0   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

* Retrospectively adjusted to give effect to the reorganization of segments described in Note 14 in the Notes to Consolidated Financial Statements.
** 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 was $543 million in 2014, compared with $528 million in 2013. Net income declined slightly in 2013 from $529 million in 2012. On a diluted per share basis, 2014 net income rose 8% to $4.09 after a 5% increase in 2013. Net income per diluted share in 2013 rose to $3.79 from $3.60 in 2012. The per-share results have exceeded the growth in dollar amounts due to our share repurchase program. Also, each year’s per share net income was affected by realized investment gains, which were $0.12, $0.03, and $0.17 in 2014, 2013 and 2012, respectively. More information concerning realized investment gains and losses can be found under the caption Realized Gains and Losses in this report where there is a more complete discussion. Also, as explained in Note 14—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. Additionally, we do not consider non-operating items which are not related to the current ongoing reporting performance of our segments as indicated in the chart above to be part of our segment operating income.

 

As shown in the above chart, after-tax segment results of operations rose each year over the prior year from $507 million in 2012 to $531 million in 2013 to $534 million in 2014. The primary contributor to the growth in both 2014 and 2013 was the underwriting margin in our life insurance segment, in which margins rose $11 million in 2014 and $36 million in 2013. The life insurance segment is our strongest segment and is the largest contributor to earnings in each year presented. Also contributing to growth in income in both years was our health insurance segment, which provided $3 million of additional margin in 2014 and $33 million in 2013. The 2013 larger increase in health margin was primarily due to the inclusion of Family Heritage’s health business for a full year since its acquisition in late 2012. Family Heritage accounted for $32 million of the increase in 2013 margin. Margins for the Medicare Part D segment declined 23% in 2014 to $27 million, primarily due to two costly Hepatitis C drugs which were not required to be covered until well after our 2014 pricing was finalized, as discussed more fully later in this report.

 

Excess investment income, the measure of profitability of our investment segment, increased to $225 million or 3% over the prior year amount of $219 million. This was the first time in four years the dollar

 

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amount of excess investment income exceeded the prior year’s amount. In 2013, excess investment income declined 8%. Although interest rates rebounded slightly during the first half of 2014, the low interest rate environment continued to pressure investment yields and spreads related to required interest on net policy liabilities throughout the three-year period. Excess investment income has also been hampered by a lag in government reimbursement of Medicare Part D costs. The effects of the low-interest-rate environment and the impact of the Part D business on investment income is discussed more fully later in this report under the caption Investments.

 

The inclusion of Family Heritage’s administrative expenses for a full year for the first time added $8 million of additional administrative expense in 2013. In addition, in both 2014 and 2013, there were increases in stock compensation expense which negatively affected the results during the year. Stock compensation increased $7 million in 2014 and $4 million in 2013. These increases in stock compensation expense resulted primarily from the increase in the value of Torchmark’s stock rather than an increase in the number of grants.

 

Total revenues rose 5% in 2014 to $3.96 billion, after having risen 5% in 2013 to $3.77 billion. Life premium rose 4% or $81 million in 2014 to $1.97 billion. Life premium increased $77 million in 2013 to $1.89 billion. Net investment income rose $16 million in 2013, and rose 3% or $19 million in 2014. Health premium increased 7% to $1.24 billion in 2014 and contributed $76 million to 2014 revenue growth, after having gained 11% to $1.17 billion in 2013. Health premium contributed $119 million to 2013 revenue growth.

 

Life insurance premium and underwriting margins have grown steadily in each of the three years ending December 31. The increase in life premium was driven by sales growth and improvements in persistency. While premium and underwriting margins grew, margin as a percent of premium fell slightly in 2014 to 28%, after increasing from 28% to 29% from 2012 to 2013. These fluctuations were due primarily to changes in mortality. Net life sales increased 12% in 2014 to $378 million after decreasing 1% in 2013. The life insurance segment is discussed further in this report under the caption Life Insurance.

 

With regard to health insurance, we primarily market Medicare Supplement insurance, other limited-benefit products including cancer, and accident and health products. As noted earlier, 2013 and 2014 health premiums were positively affected by the inclusion of Family Heritage’s health premium for the full years. The inclusion of Family Heritage also caused our limited-benefit health premium, which is their primary focus, to exceed our Medicare Supplement premium in 2013 for the first time in several years. Prior to 2013, Medicare Supplement was our largest contributor to total health premium. Limited-benefit health continued to exceed Medicare Supplement in 2014. Limited-benefit health premium was $446 million in 2014, compared with $447 million in 2013. Limited-benefit premium increased 50% over 2012 limited-benefit health premium of $298 million, a result of the inclusion of Family Heritage’s business. Medicare Supplement premium was $423 million in 2014, increasing over the prior year’s premium for the first time in many years, as lapses exceeded new sales in prior year periods. Medicare Supplement premium was $417 million in 2013 and $432 million in 2012. The increase in 2014 premium resulted from sales in 2014 to certain large groups. Health margins have remained somewhat stable as a percentage of premium throughout the three-year period. See the discussion under Health Insurance for a more detailed discussion of health insurance results.

 

We also market Medicare Part D prescription drug insurance. Our Medicare Part D premium rose 16% in 2014 to $348 million, compared with $300 million in 2013 and $318 million in 2012. The higher premiums in both 2014 and 2012 were due to higher levels of low-income auto-enrollees in our plans for those years. Due to increased competition in the 2013 plan year, we experienced a decrease in 2013 Part D premium. Medicare Part D margins were negatively impacted in 2014, however, by several factors, including two high cost Hepatitis C drugs, the coverage of which was mandated by the Center for Medicare and Medicaid Services (CMS) in early 2014, well after our 2014 pricing was finalized, new taxes under the Affordable Care Act, and other higher drug costs due to rebate restructuring. As a percentage of premium, margins fell from 12% in 2013 to 8% in 2014. For the 2015 plan year, we will have a significantly lower number of auto-enrollees which should reduce our exposure to Hepatitis C drug claims, because approximately 85% of these claims in 2014 were related to auto-enrollees. For more information on our Medicare Part D business, please refer to our discussion under the caption Medicare Part D.

 

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We do not currently market annuities. See the caption Annuities for discussion of the Annuity segment.

 

The investment segment’s pretax profitability, or excess investment income, is based on three major components: net investment income, required interest on net policy liabilities (interest applicable to insurance products), and financing costs. In 2014, net investment income rose 3%, compared with 2% in 2013. As we view our segments, net investment income rose 3% in both periods. At the same time, our investment portfolio grew 3% and 9% in 2014 and 2013, respectively. In recent years, net investment income has not grown as fast as the portfolio. One reason that investment income has grown at a lower rate than mean invested assets has grown in recent years is that new investments have been made at yield rates lower than the yield rates earned on securities that matured or were otherwise disposed of. Also, there is sometimes a lag between the time when proceeds from maturities and dispositions are received and when the proceeds are reinvested, during which the funds are held in cash. Growth in total investment income is also somewhat 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. In 2014, net investment income was negatively impacted by events affecting our Medicare Part D business. Under the program, we are required to cover certain claim costs in the current period that are the federal government’s responsibility, but are not reimbursed until late in the next calendar year. This delay in reimbursement substantially reduced our funds available for investment in 2014, with the result of reduced investment income in 2014 and 2015.

 

The interest required on net policy liabilities is deducted from net investment income, and generally grows in conjunction with the net policy liabilities that are supported by the invested assets. The lower new-money yields resulting from the low-interest-rate environment noted above have compressed excess investment income as required interest has continued to grow at approximately the same rate that net policy liabilities have grown. We have implemented certain strategies to offset this effect, including increasing premium rates on sales of new products as discussed under the caption Investments. Financing costs, which consist of the interest required for debt service on our long and short-term debt, are also deducted from net investment income. Financing costs in 2013 were stable at $80 million, but declined 5% in 2014. The 2014 decline resulted from the maturity and repayment in 2013 of our $94.5 million principal amount 7 3/8% Notes.

 

Torchmark’s current investment policy regarding fixed maturities limits new fixed maturity acquisitions to investment-grade securities generally with longer maturities (often exceeding twenty years) that meet our quality and yield objectives. Approximately 97% of our invested assets at fair value consist of fixed maturities of which 96% were investment grade at December 31, 2014. The average quality rating of the portfolio was A-. The portfolio contains no securities backed by sub prime or Alt-A mortgages, no direct investment in residential mortgages, no counterparty risks, no credit default swaps, or other derivative contracts. See the analysis of excess investment income and investment activities under the caption Investments in this report and Note 4—Investments in the Notes to Consolidated Statements of Operations for a more detailed discussion of this segment.

 

In 2012 and 2013, we engaged in a debt restructuring program which resulted in a reduction in financing costs. We issued two new debt offerings during 2012: our $300 million principal amount 3.8% Senior Notes due 2022 and our $125 million principal amount 5.875% Junior Subordinated Debentures due 2052, both issued in September. Proceeds from the Senior Notes were $297 million, but $150 million were purchased by our insurance subsidiaries and were eliminated in consolidation. Proceeds from this offering provided funding for the retirement of our 7 3/8% Senior Notes, which matured and were repaid in August, 2013, and for the acquisition of Family Heritage in November, 2012. The $121 million net proceeds from the Subordinated Debentures were used to fund the call of our $120 million principal amount 7.1% Trust Originated Preferred Securities in October, 2012. More information on these transactions can be found in Note 6—Acquisition and Note 11—Debt in the Notes to Consolidated Financial Statements and in our discussion of Capital Resources in this report.

 

In each of the years 2012 through 2014, 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. As reported in Note 1—Significant Accounting Policies in the Notes to Consolidated Financial Statements

 

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under the caption Settlements, we were involved in certain issues in which we incurred settlement losses and expenses. In connection with the 2012 purchase of Family Heritage, as described in Note 6Acquisition, we incurred $2.9 million of acquisition-related expenses ($1.9 million after tax). During 2013, Torchmark incurred a state guaranty fund assessment in the amount of $1.2 million ($751 thousand after tax), resulting from events in years prior to 2012. Also in 2013, we resolved a legal matter related to a non-insurance issue in the amount of $500 thousand ($325 thousand after tax), and settled additional litigation related to prior years in the amount of $8.6 million ($5.6 million after tax). During 2014, Torchmark accrued for certain litigation matters 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 $1.3 million ($853 thousand after tax) in settlement of litigation regarding investments. Also in 2014, the Company recorded $8.2 million in administrative settlements ($5.3 million after tax) related to benefits paid for deaths occurring in prior years where claims were not filed. All of these items have been expensed in the Consolidated Statements of Operations. However, as described in Note 1, we remove items such as these that relate to prior periods or are non-operating items when evaluating the results of current operations, and therefore exclude such matters from our segment analysis for current periods.

 

Torchmark has in place an ongoing share repurchase program which began in 1986. 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. 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 Board of Directors has authorized the Company’s share repurchase program in amounts and with timing that management, in consultation with the Board, determines to be in the best interest of the Company and its shareholders. The following chart summarizes share purchase activity for each of the three years ended December 31, 2014.

 

Analysis of Share Purchases

(Amounts in thousands)

 

     2014      2013*      2012*  

Purchases

   Shares      Amount      Shares      Amount      Shares      Amount  

Excess cash flow and borrowings

     7,155       $ 375,042         8,280       $ 360,001         11,219       $ 360,490   

Option proceeds

     1,394         74,266         2,789         122,263         6,438         209,675   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

     8,549       $ 449,308         11,069       $ 482,264         17,657       $ 570,165   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

*   Share purchases for the years 2013 and 2012 have been retrospectively adjusted for the three-for-two stock split effective July 1, 2014.

 

Option proceeds were unusually high in 2012 due to option holders exercising several years of option grants that expired in 2012.

 

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

 

A discussion of each of Torchmark’s segments follows. The following discussions are presented in the manner we view our operations, as described in Note 14—Business Segments.

 

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Life Insurance.    Life insurance is our largest insurance segment, with 2014 life premium representing 62% of total premium. Life underwriting income before other income and administrative expense represented 71% of the total in 2014. Additionally, investments supporting the reserves for life products produce the majority of excess investment income attributable to the investment segment.

 

Life insurance premium rose 4% to $1.97 billion in 2014 after having increased 4% in 2013 to $1.89 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)

 

     2014     2013     2012  
     Amount      % of
Total
    Amount      % of
Total
    Amount      % of
Total
 

American Income Exclusive Agency

   $ 766,458         39   $ 715,366         38   $ 663,696         37

Direct Response

     702,023         36        663,544         35        630,111         35   

Liberty National Exclusive Agency

     272,265         14        275,980         15        281,723         15   

Other Agencies

     225,554         11        230,442         12        232,994         13   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 
   $ 1,966,300         100   $ 1,885,332         100   $ 1,808,524         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 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 $2.04 billion at December 31, 2014, an increase of 5% over $1.96 billion a year earlier. Annualized life premium in force was $1.90 billion at December 31, 2012.

 

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)

 

     2014     2013     2012  
     Amount      % of
Total
    Amount      % of
Total
    Amount      % of
Total
 

American Income Exclusive Agency

   $ 172,271         45   $ 152,646         45   $ 158,609         46

Direct Response

     158,089         42        144,363         43        140,928         41   

Liberty National Exclusive Agency

     34,402         9        31,050         9        32,296         10   

Other Agencies

     13,492         4        11,000         3        11,331         3   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 
   $ 378,254         100   $ 339,059         100   $ 343,164         100
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

 

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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)

 

     2014     2013     2012  
     Amount      % of
Total
    Amount      % of
Total
    Amount      % of
Total
 

American Income Exclusive Agency

   $ 134,202         50   $ 127,978         50   $ 126,223         49

Direct Response

     100,287         37        93,089         36        93,374         37   

Liberty National Exclusive Agency

     25,777         9        25,580         10        26,533         10   

Other Agencies

     10,473         4        9,962         4        9,660         4   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 
   $ 270,739         100   $ 256,609         100   $ 255,790         100
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

 

The American Income Exclusive Agency has historically focused primarily on marketing to members of labor unions. While the labor union market is still the backbone of American Income’s business, the agency has diversified in recent years by focusing heavily on other affinity groups and referrals to help to ensure sustainable growth. It is Torchmark’s highest margin business. The American Income Agency was also the largest contributor to life premium and net sales of any Torchmark distribution method in 2014. Life premium for this agency rose 7% to $766 million, after having risen 8% in 2013. Net sales rose 13% in 2014 to $172 million, after having declined 4% in 2013. Net sales rose 12% in 2012. The average face amount of policies issued in 2014 was approximately $30 thousand. As is the case with all of Torchmark’s agency distribution systems, continued increases in product sales are largely dependent on increases in agent count. The American Income agent count was 6,434 at December 31, 2014 compared with 5,302 a year earlier, an increase of 21%. The agent count increased 2% in 2013 and 18% in 2012. The average agent count for 2014 was 5,868. The average agent count is based on the actual count at the end of each week during the year. Management’s primary objective is to grow middle management in the agency to help ensure sustainable growth. This is being achieved through an increased emphasis on agent training programs and financial incentives that appropriately reward agents at all levels for helping develop and train personnel. We have also begun providing more home-office and webinar training programs. These programs are designed to provide each agent, from new recruits to top level managers, coaching and instruction specifically designed for each individual’s level of experience and responsibilities. We believe that these initiatives will continue to promote enthusiasm in the field and will drive increases in agent retention and sales activity.

 

The Direct Response Unit offers adult and juvenile life insurance through a variety of direct-to-consumer marketing approaches, which include direct mailings, insert media, and electronic media. These different approaches support and complement one another in the unit’s efforts to reach the consumer. The Direct Response Unit’s growth has been fueled by constant innovation. In recent years, electronic media production has grown rapidly as management has aggressively increased marketing activities related to internet and mobile technology, and has focused on driving traffic to the inbound call center.

 

While the juvenile market is an important source of sales, it also is a vehicle to reach the parents and grandparents of the juvenile policyholders, who are more likely to respond favorably to a Direct Response solicitation for life coverage on themselves than is the general adult population. Also, both the juvenile policyholders and their parents are low acquisition-cost targets for sales of additional coverage over time.

 

The Direct Response operation accounted for 36% of our life insurance premium during 2014, increasing 6% over 2013 premium. Life premium for this unit rose 5% in 2013 and 6% in 2012. Net sales rose 10% to $158 million in 2014 after a 2% increase in 2013, due to growth in electronic media activity. First-year collected premium increased 8% to $100 million in 2014 and was flat in 2013 compared to 2012. The average face amount of policies issued in 2014 was approximately $17 thousand.

 

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The Liberty National Exclusive Agency markets individual and group life insurance to middle-income customers. Life premium income for this agency was $272 million in 2014, a 1% decrease compared with $276 million in 2013. Life premium declined 2% in 2013 from 2012. First year collected premium increased 1% in 2014, however, after having declined 4% in 2013. The average face amount of life policies issued in 2014 was approximately $23 thousand.

 

The Liberty National Agency’s net sales rose 11% to $34 million in 2014, after having declined 4% a year earlier. The increase in net sales during 2014 marks the first increase in several years, reflecting changes in structure of the agency that management has put in place in recent years. As is the case with all of our agencies, sales are driven by the size of the agent force. The Liberty agency had 1,498 producing agents at December 31, 2014 compared with 1,430 a year earlier, an increase of 5%. The producing agent count increased 1% during 2013 from 1,419. The average agent count for 2014 was 1,505. Agent counts declined during the fourth quarter of 2014 as the agency focused somewhat less on recruiting, due to the increased emphasis on annual worksite renewals.

 

Our long term plans to grow this agency involve expansion from small-town markets in the southeast to more densely populated areas with larger pools of potential agent recruits and customers. We believe that expansion of this Agency’s presence into more heavily populated, less-penetrated areas will help create long term agency growth. Additionally, a prospecting training program has helped to improve the ability of agents to develop new worksite marketing business.

 

We also offer life insurance through Other Agencies consisting of the Military Agency, the United American Independent Agency, and other small sales agencies. The Military Agency consists of a nationwide independent agency whose sales force is comprised primarily of former military officers who sell primarily to commissioned and noncommissioned military officers and their families. This business consists of whole-life products with term insurance riders. Military premium represented 9% of life premium at December 31, 2014. The United American Independent Agency represented approximately 1% of Torchmark’s total life premium at that date, as their sales of Torchmark products consist primarily of health insurance.

 

LIFE INSURANCE

Summary of Results

(Dollar amounts in thousands)

 

     2014     2013     2012  
     Amount     % of
Premium
    Amount     % of
Premium
    Amount     % of
Premium
 

Premium and policy charges

   $ 1,966,300        100   $ 1,885,332        100   $ 1,808,524        100

Policy obligations

     1,293,384        66        1,227,857        65        1,172,020        65   

Required interest on reserves

     (530,192     (27     (508,236     (27     (483,892     (27
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net policy obligations

     763,192        39        719,621        38        688,128        38   

Commissions, premium taxes, and non-deferred acquisition expenses

     143,174        7        131,721        7        137,115        8   

Amortization of acquisition costs

     503,445        26        488,931        26        473,805        26   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total expense

     1,409,811        72        1,340,273        71        1,299,048        72   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Insurance underwriting margin before other income and administrative expenses

   $ 556,489        28   $ 545,059        29   $ 509,476        28
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

Gross margins, as indicated by insurance underwriting margin before other income and administrative expense, rose 2% in 2014 and 7% in 2013. The margin increased to $556 million in 2014 after rising to $545 million in 2013. The steady growth in premium contributed to margin growth in all periods. As a percentage of premium, however, an increase in policy obligations resulted in a slightly lower margin in 2014. Policy obligations fluctuate from period to period as a result of mortality. In both 2013 and 2014, percentage margins were positively affected by our conservation program and the permitted increases in the deferrals of our internet-related direct response acquisition costs.

 

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Health Insurance.    Health insurance sold by Torchmark includes primarily Medicare Supplement coverage to enrollees in the federal Medicare program, cancer coverage, accident coverage, and other limited-benefit supplemental health products. As discussed in Note 14—Business Segments in the Notes to Consolidated Financial Statements, Medicare Part D is now reported as a separate Torchmark segment and is no longer included in the discussion of Torchmark’s other health products. See the discussion of Medicare Part D later in this report. In this discussion of health business, all health coverage plans other than Medicare Supplement are classified here as limited-benefit plans.

 

Health premium represented 27% of Torchmark’s total premium income in 2014, compared with 28% in 2013 and 26% in 2012. Health underwriting margin accounted for 25% of the total in 2014, compared with 25% in 2013 and 23% in 2012. Health results in 2014 and 2013 were positively affected by the late 2012 addition of Family Heritage. Family Heritage added $205 million and $191 million of health premium in 2014 and 2013, respectively, compared with $30 million in 2012. 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)

 

     2014     2013     2012  
     Amount      % of
Total
    Amount      % of
Total
    Amount      % of
Total
 

United American Independent Agency

               

Limited-benefit plans

   $ 19,028         $ 24,173         $ 26,377      

Medicare Supplement

     286,340           274,125           272,382      
  

 

 

      

 

 

      

 

 

    
     305,368         35     298,298         35     298,759         41

Liberty National Exclusive Agency

               

Limited-benefit plans

     143,722           152,415           162,607      

Medicare Supplement

     78,295           88,849           100,928      
  

 

 

      

 

 

      

 

 

    
     222,017         25        241,264         28        263,535         36   

American Income Exclusive Agency

               

Limited-benefit plans

     78,244           78,862           78,957      

Medicare Supplement

     478           573           683      
  

 

 

      

 

 

      

 

 

    
     78,722         9        79,435         9        79,640         11   

Family Heritage Exclusive Agency

               

Limited-benefit plans

     204,667           190,923           30,119      

Medicare Supplement

     0           0           0      
  

 

 

      

 

 

      

 

 

    
     204,667         24        190,923         22        30,119         4   

Direct Response

               

Limited-benefit plans

     805           313           341      

Medicare Supplement

     57,861           53,585           57,625      
  

 

 

      

 

 

      

 

 

    
     58,666         7        53,898         6        57,966         8   

Total Premium

               

Limited-benefit plans

     446,466         51        446,686         52        298,401         41   

Medicare Supplement

     422,974         49        417,132         48        431,618         59   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total Premium

   $ 869,440         100   $ 863,818         100   $ 730,019         100
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

 

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Index to Financial Statements

We market supplemental health insurance products through a number of distribution channels. 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)

 

     2014     2013     2012  
     Amount      % of
Total
    Amount      % of
Total
    Amount      % of
Total
 

United American Independent Agency

               

Limited-benefit plans

   $ 873         $ 916         $ 989      

Medicare Supplement

     82,971           40,512           41,218      
  

 

 

      

 

 

      

 

 

    
     83,844         46     41,428         38     42,207         54

Liberty National Exclusive Agency

               

Limited-benefit plans

     17,084           13,906           14,274      

Medicare Supplement

     299           394           818      
  

 

 

      

 

 

      

 

 

    
     17,383         10        14,300         13        15,092         19   

American Income Exclusive Agency

               

Limited-benefit plans

     9,162           6,985           8,695      

Medicare Supplement

     0           0           0      
  

 

 

      

 

 

      

 

 

    
     9,162         5        6,985         6        8,695         11   

Family Heritage Exclusive Agency

               

Limited-benefit plans

     47,102           43,520           7,441      

Medicare Supplement

     0           0           0      
  

 

 

      

 

 

      

 

 

    
     47,102         26        43,520         39        7,441         10   

Direct Response

               

Limited-benefit plans

     6           591           727      

Medicare Supplement

     23,099           3,685           3,876      
  

 

 

      

 

 

      

 

 

    
     23,105         13        4,276         4        4,603         6   

Total Net Sales

               

Limited-benefit plans

     74,227         41        65,918         60        32,126         41   

Medicare Supplement

     106,369         59        44,591         40        45,912         59   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total Net Sales

   $ 180,596         100   $ 110,509         100   $ 78,038         100
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

 

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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)

 

     2014     2013     2012  
     Amount      % of
Total
    Amount     % of
Total
    Amount     % of
Total
 

United American Independent Agency

             

Limited-benefit plans

   $ 710         $ 795        $ 838     

Medicare Supplement

     49,519           38,399          33,176     
  

 

 

      

 

 

     

 

 

   
     50,229         42     39,194        39     34,014        50

Liberty National Exclusive Agency

             

Limited-benefit plans

     13,132           12,010          13,105     

Medicare Supplement

     306           558          1,127     
  

 

 

      

 

 

     

 

 

   
     13,438         11        12,568        12        14,232        21   

American Income Exclusive Agency

             

Limited-benefit plans

     9,500           8,957          10,364     

Medicare Supplement

     0           0          0     
  

 

 

      

 

 

     

 

 

   
     9,500         8        8,957        9        10,364        15   

Family Heritage Exclusive Agency

             

Limited-benefit plans

     36,392           36,340          5,710     

Medicare Supplement

     0           0          0     
  

 

 

      

 

 

     

 

 

   
     36,392         31        36,340        36        5,710        8   

Direct Response

             

Limited-benefit plans

     143           544          623     

Medicare Supplement

     9,196           3,310          3,714     
  

 

 

      

 

 

     

 

 

   
     9,339         8        3,854        4        4,337        6   

Total First-Year Collected Premium

             

Limited-benefit plans

     59,877         50        58,646        58        30,640        45   

Medicare Supplement

     59,021         50        42,267        42        38,017        55   
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

   $ 118,898         100   $ 100,913        100   $ 68,657        100
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

Health premium, rose 1% to $869 million in 2014, after having increased 18% in 2013 to $864 million. However, if the premium of Family Heritage were removed for comparability in 2013 and 2012, health premium would have declined 4% in 2013. The decline in 2013 premium resulted primarily from a run-off of a block of discontinued hospital-surgical plans. This runoff had been ongoing for a number of years. In 2014, this runoff is thought to have substantially run its course. Net sales increased 63% in 2014 to $181 million, after having increased 42% in 2013. The 2014 increase was caused by the more than double growth in Medicare Supplement sales. These sales occurred in both the United American Independent Agency and in the Direct Response Group. These increases were primarily the result of strong group sales of Medicare Supplement which can vary significantly from period to period. The 2013 increase was primarily a result of the acquisition of Family Heritage, which contributed $44 million to the growth in 2013 compared with $7 million in 2012. First-year collected premium increased 18% in 2014 and 47% in 2013, as a result of the increased sales in both 2014 and 2013, and the addition of Family Heritage first-year premium for a full year in 2013 for the first time.

 

The addition of Family Heritage’s sales and premium from limited-benefit products has resulted in limited-benefit health premium exceeding Medicare Supplement premium income in 2013 for the first time in several years and continuing to lead in premium in 2014. However, due to increased Medicare Supplement group sales, Medicare Supplement net sales exceeded limited-benefit net sales in 2014. Limited-benefit premium represented 51% of total health premium in 2014 and 52% in 2013, but represented 41% in 2012. However, as noted above, Medicare Supplement sales rose 139% to $106

 

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Index to Financial Statements

million in 2014 due to the high group sales, which represented 59% of net health sales in 2014. Medicare Supplement sales were 40% of the total in 2013 and 59% in 2012. As mentioned previously, group Medicare Supplement sales fluctuate significantly from period to period.

 

We do not expect recent health care reform activity to have a significant impact on our operations. We don’t sell any products subject to the Affordable Care Act, and don’t believe that consumer demand for the types of supplemental health products we sell will be diminished. While we will be subject to certain federal taxes on a small portion of our existing health business going forward, we don’t expect the amount of these taxes to be material.

 

The UA Independent Agency is Torchmark’s largest in terms of health premium income, producing 35% of health premium in 2014. This Agency is composed of independent agencies appointed with Torchmark whose sizes range from very large, multi-state organizations down to one-person offices. All of these agents generally sell for a number of insurance companies. Torchmark had 3,161 active producing agents at December 31, 2014 compared with 2,414 a year earlier. This Agency is our largest producer of Medicare Supplement insurance, with $286 million or 68% of our Medicare Supplement premium income in 2014. Net sales for this Agency were $84 million in 2014, consisting almost entirely of Medicare Supplement business. These net sales were more than double the net sales of $41 million in 2013. In 2013, they had declined 2%. Total health premium income for the UA Independent Agency was $305 million in 2014, an increase of 2% from $298 million in 2013. Premium income had declined very slightly in 2013.

 

The Family Heritage Exclusive Agency was acquired by Torchmark’s acquisition of Family Heritage on November 1, 2012 as discussed in Note 6—Acquisition in the Notes to Consolidated Financial Statements. This agency markets primarily limited-benefit supplemental health insurance in non-urban areas. Most of their policies include a cash-back feature, such as a return-of-premium, whereby any excess of premiums over claims paid is returned to the policyholder at the end of a specified period stated within the insurance policy. The Family Heritage Agency is our largest agency in terms of limited-benefit health net sales, adding $47 million in net sales in 2014, compared with $44 million in 2013, an increase of 8%. This agency’s $205 million in health premium income during 2014 represented 24% of Torchmark’s total. Premium in 2014 increased 7% over 2013 premium of $191 million. The producing agent count was 785 agents at December 31, 2014, compared with 695 agents at December 31, 2013. The average agent count for 2014 was 740. The agent count was 702 at December 31, 2012. Management expects to grow this agency going forward through geographic expansion and incorporation of Torchmark’s recruiting programs.

 

The Liberty National Exclusive Agency represented 25% of all Torchmark health premium income at $222 million in 2014. The Liberty Agency markets limited-benefit health supplemental products consisting primarily of cancer insurance. Much of the Liberty’s health business is now generated through worksite marketing which targets small businesses of 10 to 25 employees. In 2014, health premium income in the Agency declined 8% from prior year premium of $241 million, after also declining 8% in 2013. These premium declines were due primarily to the runoff of a block of discontinued hospital-surgical business as well as an earlier restructuring of this Agency to a variable-cost, commission-driven model. The Liberty Agency experienced growth in net health sales in 2014 of 22% to $17 million. The agent count at Liberty was 1,498 at 2014 year end, an increase of 5% over year end 2013 and 6% over year end 2012.

 

The American Income Exclusive Agency, predominantly a life insurance distribution channel, was our fourth largest health insurance distributor based on premium income in 2014. Its health plans are comprised of various limited-benefit plans. Approximately 68% of the agency’s 2014 health premium was from accident policies. Sales of the plans by this Agency are generally made in conjunction with a life policy being sold to the same customer.

 

Health premium at this agency was $79 million in both 2014 and 2013. In 2013, it had declined slightly from $80 million. However, health net sales rose 31% in 2014 to $9 million, after falling 20% in 2013 to $7 million. Because this agency focuses on life products, health net sales comprised only 5% of the American Income Agency’s total net sales in 2014.

 

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Direct Response, primarily a life operation, also offers health insurance, which is predominantly Medicare Supplements sold directly to employer or union sponsored groups. In 2014, net health sales were $23 million, compared with $4 million in 2013 and $5 million in 2012. The large increase in Direct Response net sales in 2014 was due to the addition of a large Medicare Supplement group, which is not indicative of a trend. In 2014, health net sales for this group represented approximately 13% of Direct Response’s total life and health net sales. Direct Response health premium income was $59 million in 2014, increasing 9% over 2013 premium of $54 million. Health premium declined 7% in 2013.

 

As presented in the following table, Torchmark’s health insurance underwriting margin before other income and administrative expense increased 1% to $199 million in 2014, after an increase of 20% to $197 million in 2013. Family Heritage contributed $32 million of the $33 million 2013 increase. As a percentage of premium income, margins were 23% in both 2014 and 2013 as compared with 22% in 2012.

 

HEALTH INSURANCE

Summary of Results

(Dollar amounts in thousands)

 

     2014     2013     2012  
     Amount     % of
Premium
    Amount     % of
Premium
    Amount     % of
Premium
 

Premium

   $ 869,440        100   $ 863,818        100   $ 730,019        100

Policy obligations

     559,817        64        558,982        65        472,988        65   

Required interest on reserves

     (64,401     (7     (59,858     (7     (40,963     (6
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net policy obligations

     495,416        57        499,124        58        432,025        59   

Commissions, premium taxes, and non-deferred acquisition expenses

     79,475        9        75,895        9        52,625        8   

Amortization of acquisition costs

     95,230        11        92,292        10        81,385        11   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total expense

     670,121        77        667,311        77        566,035        78   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Insurance underwriting income before other income and administrative expense

   $ 199,319        23   $ 196,507        23   $ 163,984        22
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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Medicare Part D.    Torchmark, through its subsidiary United American, offers coverage under the government’s Medicare Part D plan. The Medicare Part D plan is a stand-alone prescription drug plan for Medicare beneficiaries. Part D is regulated and partially funded by CMS for participating private insurers like United American. Under Part D, private carriers are the primary insurers, while CMS provides significant premium subsidies and reinsurance. Our Medicare Part D product is sold through the Direct Response operation and to groups through the UA Independent Agency.

 

Medicare Part D

Selected Financial Information

(Dollar amounts in thousands)

 

     2014      2013      2012  
     Amount      Amount      Amount  

Premium(1)

   $ 347,805       $ 300,008       $ 317,764   

Net sales(2)

     186,170         78,698         114,489   

First-year collected premium(3)

     94,982         66,209         153,509   

 

(1)   Total Medicare Part D premium excludes $25.5 million and $2.6 million of risk-sharing premium received in 2014 and 2013, respectively, and $404 thousand in 2012 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.
(2)   Net sales for Medicare Part D represents only new first-time enrollees.
(3)   First-year collected premium for Medicare Part D represents only premium collected within the first twelve months from new first-time enrollees.

 

Total Medicare Part D premium was $348 million in 2014, compared with $300 million in 2013 and $318 million in 2012. Part D net sales were $186 million in 2014, compared with $79 million in 2013 and $114 million in 2012. The unusual increase in 2014 net sales was due to the addition in 2014 of the auto-enrollees as noted below. We count only sales to new first-time enrollees in net sales, and the majority of premium income is from previous enrollees. Total enrollees in the program were 269 thousand at the beginning of the 2014 plan year, 254 thousand at the beginning of the 2013 plan year, and 215 thousand at the beginning of the 2012 plan year.

 

Changes in Part D premium generally result from changes in the number of enrollees, which are heavily influenced by new sales. In 2012, the Company issued a new lower cost Part D plan allowing us to pick up a large number of auto-enrollees in 21 regions with resulting higher sales. In 2013, due to intensified price competition, we qualified for new low-income auto-enrollees in only 7 regions but were able to keep prior year auto-enrollees in 14 regions and maintain our presence in 21 regions. In 2014, Torchmark qualified to receive new Part D auto-enrollees in 15 regions and also qualified to retain prior year auto-enrollees in 8 regions, for a total of 23 regions. These variations in the number of new auto-enrollees caused the changes in Part D net sales, premium, and enrollee counts, including the large increases in 2014 and the declines in 2013. The 2013 decline was also influenced by the loss of several employer group Part D cases at the end of 2012.

 

As presented in the following table, margins decreased 23% in 2014 to $27 million, even though premium rose 16%. Premiums were increased for the year 2014 to cover higher anticipated non-deferred acquisition expenses. As such, we expected significantly lower obligation ratios in 2014. However, due primarily to unexpected costs related to two Hepatitis C drugs, the coverage of which was mandated by CMS Administration early in 2014, well after our 2014 pricing was finalized, the obligation ratios for 2014 increased from 82% to 83%. Non-deferred acquisition cost ratios were significantly higher, as planned in our pricing, due to (1) new taxes imposed by the Affordable Care Act, (2) higher costs related to a change in the structure of drug rebates, and (3) higher costs related to the increased volume of enrollees. As a percentage of premium, underwriting margin for 2014 fell to 8%, compared with 12% for 2013. In 2013, margins increased 6% to $35 million, even though premium declined 6%. As a percentage of premium, margins rose from 10% to 12%. The benefit ratio declined 2%, as a result of lower claims experience in the group market in 2013. Group Part D claims tend to fluctuate from year to year.

 

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Medicare Part D

Summary of Results

(Dollar amounts in thousands)

 

     2014     2013     2012  
     Amount      % of
Premium
    Amount      % of
Premium
    Amount      % of
Premium
 

Premium(1)

   $ 347,805         100   $ 300,008         100   $ 317,764         100

Policy obligations

     290,341         83        247,496         82        266,957         84   

Commissions, premium taxes, and non-deferred acquisition expenses

     26,613         8        14,027         5        14,498         5   

Amortization of acquisition costs

     3,585         1        3,185         1        2,952         1   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total expense

     320,539         92        264,708         88        284,407         90   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Insurance underwriting income before other income and administrative expense

   $ 27,266         8   $ 35,300         12   $ 33,357         10
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

 

(1)   Total Medicare Part D premium excludes $25.5 million and $2.6 million of risk-sharing premium received in 2014 and 2013 respectively, and $404 thousand in 2012 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.

 

For 2015, we do not expect Hepatitis C claims to have the same negative impact on margins that they had in 2014, as our 2015 pricing reflects the cost of these drugs. In addition, we will have significantly less auto-enrollees in 2015. Auto-enrollees accounted for approximately 85% of our 2014 Hepatitis C claims.

 

Total enrollees in the program were 249 thousand at the beginning of the 2015 plan year, compared with 269 thousand in 2014. We expect that Part D margins will be flat to slightly lower in 2015, based on a preliminary analysis of the risk scores and claims history of our 2015 enrollees.

 

We participate in the Medicare Part D program because it complements our Medicare Supplement products, it provides us with incremental income, we have extensive experience with the senior-age market, and the government assurances with regard to the risk-sharing agreements for participating insurers limit our risk. Additionally, due to our experience with service to the senior-age market and the use of our existing Direct Response marketing system, entry to this business required little new investment. However, as with any government-sponsored program, the possibility of regulatory changes could change the outlook for this market.

 

Annuities.    Our fixed annuity balances at the end of 2014, 2013, and 2012 were $1.36 billion, $1.38 billion, and $1.35 billion, respectively. Underwriting income was $4.3 million, $3.9 million, and $3.5 million in each of the respective years.

 

While the fixed annuity account balance has remained relatively stable each year over the prior year, underwriting income has increased each year over the prior year. Policy charges have actually declined slightly in each successive year. The majority of policy charges consist of surrender charges which are not based on account size. A considerable portion of fixed annuity profitability is derived from the spread of investment income exceeding contractual interest requirements, which can result in negative net policy obligations. In the three-year period, however, spreads tended to level as crediting rates reached guaranteed minimums.

 

We do not currently market annuity products, favoring instead protection-oriented life and health insurance products. Therefore, we do not expect that annuities will be a significant portion of our business or marketing strategy going forward.

 

 

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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, 2014.

 

Operating Expenses Selected Information

(Dollar amounts in thousands)

 

     2014     2013     2012  
     Amount     % of
Premium
    Amount     % of
Premium
    Amount     % of
Premium
 

Insurance administrative expenses:

            

Salaries

   $ 83,625        2.6   $ 82,739        2.7   $ 77,137        2.7

Non-salary employee costs

     28,095        0.9        33,589        1.1        28,344        1.0   

Other administrative expense

     57,717        1.8        52,757        1.8        51,228        1.8   

Legal expense—insurance

     10,518        0.3        9,813        0.3        8,696        0.3   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total insurance administrative expenses

     179,955        5.6     178,898        5.9     165,405        5.8
    

 

 

     

 

 

     

 

 

 

Parent company expense

     8,159          8,495          8,222     

Stock compensation expense

     32,203          25,642          21,605     

Litigation settlements

     2,337          500          0     

State Guaranty Fund Assessment

     0          1,155          0     

Acquisition expenses of Family Heritage

     0          0          2,944     
  

 

 

     

 

 

     

 

 

   

Total operating expenses, per
Consolidated Statements of
Operations

   $ 222,654        $ 214,690        $ 198,176     
  

 

 

     

 

 

     

 

 

   

Insurance administrative expenses:

            

Increase (decrease) over prior year

     0.6       8.2       4.0  

Total operating expenses:

            

Increase (decrease) over prior year

     3.7       8.3       (1.7 )%   

 

Insurance administrative expenses rose 1% in 2014, after having increased 8% in 2013. As a percentage of premium, they increased .1% in 2013 to 5.9%, but declined .3% in 2014 to 5.6%. The inclusion of Family Heritage’s administrative expenses accounted for $8.1 million of the $13.5 million increase in total administrative expense in 2013. Non-salary employee costs increased 19% in 2013 but fell back 16% in 2014, close to 2012 levels. These fluctuations were caused in large part by adjustments to pension expenses primarily due to changes in interest rates in the financial markets. Stock compensation expense has risen in each successive year as the value of Torchmark stock has increased, resulting in higher values for grants of stock and options, as well as positive Company performance that caused an increase in the expense related to performance share grants. As stated in Note 14—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.

 

As described in Note 1—Significant Accounting Policies in the Notes to Consolidated Financial Statements, we described certain litigation matters that were incurred in the years 2014 and 2013 that were not directly related to our ongoing core insurance operations. Management does not consider these litigation matters to be part of insurance administration expense, but instead considers them to be non-operating expenses. Also during 2013, Torchmark recorded an additional non-operating charge involving a state guaranty fund assessment in the amount of $1.2 million, resulting from events in years prior to 2012. We incurred expenses of $2.9 million related to the acquisition of Family Heritage in late 2012 as described in Note 6—Acquisition in the Notes to Consolidated Financial Statements. While all of these non-operating expenses were included in “Operating expenses” for the respective year in the Consolidated Statements of Operations in accordance with accounting guidance, they are removed by management from consideration when evaluating segment operating results.

 

 

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Investments.    We manage our capital resources including investments, debt, and cash flow through the investment segment. Excess investment income represents the profit margin attributable to investment operations. It is the measure that we use to evaluate the performance of the investment segment as described in Note 14—Business Segments in the Notes to the Consolidated Financial Statements. It is defined as net investment income less both the required interest attributable 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 over $6.1 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)

 

     2014     2013     2012  

Net investment income

   $ 729,207      $ 709,743      $ 693,644   

Reclassification of low income housing expense(1)

     29,079        24,907        22,488   

Reclassification of interest amount due to deconsolidation(2)

     0        0        (214
  

 

 

   

 

 

   

 

 

 

Adjusted net investment income (per segment analysis)

     758,286        734,650        715,918   

Interest on net insurance policy liabilities:

      

Interest on reserves

     (649,848     (625,388     (584,148

Interest on deferred acquisition costs

     192,779        190,025        185,172   
  

 

 

   

 

 

   

 

 

 

Net required interest

     (457,069     (435,363     (398,976

Financing costs

     (76,126     (80,461     (80,298
  

 

 

   

 

 

   

 

 

 

Excess investment income

   $ 225,091      $ 218,826      $ 236,644   
  

 

 

   

 

 

   

 

 

 

Excess investment income per diluted share(3)

   $ 1.70      $ 1.57      $ 1.61   
  

 

 

   

 

 

   

 

 

 

Mean invested assets (at amortized cost)

   $ 13,278,028      $ 12,838,010      $ 11,750,059   

Average net insurance policy liabilities(4)

     8,227,741        7,840,078        7,093,560   

Average debt and preferred securities (at amortized cost)

     1,287,740        1,321,102        1,248,427   

 

(1)   Reclassified amortization of non-guaranteed low-income housing interests included in “Net investment income” in the Consolidated Statements of Operations but recorded in “Income taxes” in the segment analysis. See Note 1—Significant Accounting Policies in the Notes to Consolidated Financial Statements under the caption Low-Income Housing Tax Credit Interests for an explanation.
(2) Deconsolidation of trusts liable for Trust Preferred Securities required by accounting guidance. See Note 11—Debt in the Notes to Consolidated Financial Statements.
(3) Per share amounts for 2013 and 2012 have been retrospectively adjusted for the three-for-two stock split effective July 1, 2014.
(4) Net of deferred acquisition costs, excluding the associated unrealized gains and losses thereon.

 

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Excess investment income increased $6 million or 3% in 2014 over the prior year. Excess investment income declined $18 million or 8% in 2013. Excess investment income has been pressured over the past three years as a result of the impact of lower interest rates on net investment income coupled with the increase in required interest on net policy liabilities discussed later under this caption. On a per diluted share basis, excess investment income increased 8% to $1.70 in 2014. Excess investment income declined 2% to $1.57 per share in 2013, after having risen 3% in the prior year. The greater increase in 2014 per-share amounts, as well as the smaller decline in 2013 relative to the changes in dollar amounts for excess investment income are a result of share repurchases.

 

The largest component of excess investment income is net investment income, as adjusted for the segment analysis, which rose 3% to $758 million in 2014. It increased 3% to $735 million in 2013 from $716 million in 2012. The inclusion of Family Heritage, acquired in late 2012, added $21 million of net investment income in 2013 compared with $3 million in 2012, accounting for the majority of the 2013 increase. However, growth in net investment income has generally been slower than growth in mean invested assets in recent years due to the declining interest rate environment. In 2014, fixed maturity yields averaged 5.91% on a tax-equivalent and effective-yield basis, compared with 5.94% in 2013 and 6.35% in 2012. Even though mean invested assets have increased each period, net investment income has grown at a slower pace as a result of the decline in average yields. In a declining rate environment, the overall portfolio yield will decrease as new money is invested at lower prevailing yields. The reduction in the average yields has primarily been the result of reinvesting proceeds from bonds that matured or were called at yield rates less than the rates we earned on the bonds before they matured or were called. While Family Heritage added incrementally to net investment income during 2014 and 2013, its lower-yielding portfolio has also contributed to the decline in the average fixed-maturity yield.

 

A major factor negatively affecting net investment income, especially in 2012 and 2013, was calls of fixed-maturity securities. During 2012, and to a lesser extent in 2013, we had an unusually large number of these calls, including $339 million of bank-issued hybrid securities in 2012 and $129 million in 2013. Fixed maturity securities are more likely to be called in a declining interest-rate environment, as these callable securities can often be refinanced at lower prevailing rates. In 2014, however, call activity has been more limited. We believe that it is unlikely that calls would have a material negative impact on investment income in the foreseeable future if our callable investments were called and the proceeds from those calls were reinvested at expected future new money rates. During 2014, the proceeds from all dispositions have been reinvested at yield rates closer to the yield rates on the disposed assets.

 

Net investment income has also been negatively affected in 2014 by the CMS requirement for us to pay certain Medicare Part D claims costs during the current period that are ultimately the responsibility of the government, but are not reimbursed until the following year. Because Part D claims have been unusually high in 2014, due to the approval of new Hepatitis C drugs discussed earlier in this report and higher overall drug costs, we have incurred extensive upfront costs that will not be reimbursed by CMS until late 2015. This delay in reimbursement has caused a delay in cash flows available for new investments that resulted in a loss of approximately $5 million of pre-tax net investment income in 2014, and will cause us to lose approximately $4 million of additional investment income in 2015. Please refer to Note 10¯Supplemental Disclosures of Cash Flow Information in the Notes to Consolidated Financial Statements.

 

Presented in the following chart is the growth in net investment income compared with the growth in mean invested assets.

 

     2014     2013     2012  

Growth in net investment income

     3.2     2.6     1.3

Growth in mean invested assets (at amortized cost)

     3.4        9.3        4.4   

 

While net investment income in recent years has been negatively impacted by the factors discussed above, we would expect to see only modest declines in the average portfolio yield rate over the next few years compared with the larger declines in recent years. We anticipate that less than 2% of fixed maturities

 

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on average are expected to run off each year over the next five years. Overall, we are encouraged that the prospect of additional significant calls seems to be behind us and expected maturities should have lower yields than in the past.

 

Excess investment income is reduced by the required interest on net insurance policy liabilities because we consider these amounts to be components of the profitability of our insurance segments. Required interest is based on the actuarial interest assumptions used in discounting the benefit reserve liability and the amortization of deferred acquisition costs for our insurance policies in force. The great majority of our life and health insurance policies are fixed interest-rate protection policies, not investment products, and are accounted for under current accounting guidance for long-duration insurance products (formerly SFAS 60, now incorporated into ASC 944-20-05). This guidance mandates that interest rate assumptions be “locked in” for the life of that block of business. Each calendar year, we set the assumed discount rate to be used to calculate the benefit reserve liability and the deferred acquisition cost asset for all insurance policies issued that year. That rate is based on the new money yields that we expect to earn on the premiums received in the future from policies of that issue year, and cannot be changed except in the event of a premium deficiency. The discount rate used for policies issued in the current year has no impact on the in force policies issued in prior years as the rates of all prior issue years are also locked in. As such, the overall discount rate for the entire in force block is a weighted average of the discount rates being used from all issue years. Changes in the overall weighted-average discount rate over time are caused by changes in the mix of the in force business by issue year.

 

Because actuarial discount rates are locked in for life on essentially all of our business, benefit reserves and deferred acquisition costs are not affected by interest rate fluctuations unless a loss recognition event occurs. Due to the strength of our underwriting margins and the current positive spread between the yield on our investment portfolio and the weighted-average discount rate of our in force block, we don’t expect an extended low-interest-rate environment to cause a loss recognition event.

 

Information about interest on policy liabilities is shown in the following table.

 

Required Interest on Net Insurance Policy Liabilities

(Dollar amounts in millions)

 

     Required
Interest
    Average Net
Insurance
Policy  Liabilities
    Average
Discount
Rate
 

2014

      

Life and Health

   $ 395.9      $ 6,888.9        5.75

Annuity

     61.2        1,338.8        4.57   
  

 

 

   

 

 

   

Total

     457.1        8,227.7        5.56   

Increase in 2014

     4.99     4.94  

2013

      

Life and Health

   $ 372.4      $ 6,516.9        5.71

Annuity

     63.0        1,323.2        4.76   
  

 

 

   

 

 

   

Total

     435.4        7,840.1        5.55   

Increase in 2013

     9.12     10.52  

2012

      

Life and Health

   $ 335.0      $ 5,820.1        5.76

Annuity

     64.0        1,273.5        5.03   
  

 

 

   

 

 

   

Total

     399.0        7,093.6        5.62   

Increase in 2012

     7.71     6.64  

 

The combined weighted average discount rate decreased in 2013 due to the inclusion of Family Heritage for a full year.

 

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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 presents the components of financing costs and reconciles interest expense per the Consolidated Statements of Operations.

 

Analysis of Financing Costs

(Amounts in thousands)

 

     2014      2013      2012  

Interest on funded debt

   $ 71,072       $ 75,136       $ 74,815   

Interest on short-term debt

     5,013         5,299         5,656   

Other

     41         26         41   
  

 

 

    

 

 

    

 

 

 

Interest expense per Consolidated Statements of Operations

     76,126         80,461         80,512   

Reclassification of interest due to deconsolidation (1)

     0         0         (214
  

 

 

    

 

 

    

 

 

 

Financing costs

   $ 76,126       $ 80,461       $ 80,298   
  

 

 

    

 

 

    

 

 

 

 

(1) See Principles of Consolidation in Note 1—Significant Accounting Policies in the Notes to Consolidated Financial Statements for an explanation of deconsolidation.

 

Financing costs decreased $4 million or 5% in 2014. They were essentially flat in 2013. The decrease in financing costs in 2014 was due to the maturity and repayment of our $94 million par amount $7.375% Notes during the third quarter of 2013. The increase in financing costs in 2013 reflects the increased interest expense from the issuance in September, 2012 of $300 million principal amount of our 3.8% Senior Notes due in 2022, $150 million of which is eliminated in consolidation. Also in September, 2012, we issued our 5.875% Junior Subordinated Debentures due 2052 for $125 million principal amount but called our $120 million 7.1% Trust Preferred Securities one month later. In both 2014 and 2013, interest on short-term debt declined primarily because of the reduction in the weighted-average interest rate on short-term debt. More information on our debt transactions are disclosed in the Financial Condition section of this report and in Note 11—Debt in the Notes to Consolidated Financial Statements.

 

As previously noted, growth rates in our excess investment income decline when growth in income from the portfolio is less than that of the interest required by policy liabilities and financing costs, such as we have experienced in recent periods. In an extended low-interest-rate environment, the portfolio yield will tend to decline as we invest new money at lower long-term rates. We believe, however, the decline would be relatively slow, as, on average, only 1% to 2% of fixed maturities are expected to run off each year over the next five years.

 

In response to the lower interest rates, we raised the premium rates for new business on major life products in early 2012 and again in late 2013. The increased premium provides additional margin on these policies to help offset higher mandatory cash values and the possible future reductions in excess investment income. Despite these increases in premium rates, we have continued to see growth in net sales.

 

Excess investment income benefits from increases in long-term rates available on new investments and decreases in short-term borrowing rates. Of these two factors, higher investment rates have the greater impact because the amount of cash that we invest is significantly greater than the amount that we borrow at short-term rates. Therefore, Torchmark would benefit if rates, especially long-term rates, were to rise.

 

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Investment Acquisitions.    Torchmark’s current investment policy calls for investing almost exclusively in investment-grade fixed maturities generally with long maturities (maturity date more than 20 years after acquisition date) that meet our quality and yield objectives. We generally prefer to invest in securities with longer maturities because they more closely match the long-term nature of our policy liabilities. Further, we believe this strategy is appropriate because our strong positive cash flows are generally stable and predictable. If such longer-term securities do not meet our quality and yield objectives, we consider investing in short-term securities, taking into consideration the slope of the yield curve and other factors at the time. During calendar years 2012 through 2014, Torchmark invested almost exclusively in fixed-maturity securities, primarily with longer-term maturities as presented in the chart below.

 

The following table summarizes selected information for fixed-maturity purchases. The effective annual yield shown in the table is the yield calculated to the potential termination date that produces the lowest yield. This date is commonly known as the “worst 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  
         2014         2013     2012  

Cost of acquisitions:

      

Investment-grade corporate securities

   $ 696.3      $ 1,113.2      $ 1,465.9   

Taxable municipal securities

     0        0        1.5   

Other investment-grade securities

     8.7        30.6        16.9   
  

 

 

   

 

 

   

 

 

 

Total fixed-maturity acquisitions

   $ 705.0      $ 1,143.8      $ 1,484.3   
  

 

 

   

 

 

   

 

 

 

Effective annual yield (one year compounded*)

     4.77     4.65     4.30

Average life (in years, to next call)

     22.9        26.0        25.6   

Average life (in years to maturity)

     23.4        26.5        26.7   

Average rating

     BBB+        BBB+        BBB+   

 

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

   

 

We prefer to invest primarily in bonds that are not callable (on other than a make-whole basis) prior to maturity, but 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 the issuer calls the investment prior to the maturity date. Given our investments in callable bonds, the actual average life of our investments cannot be known at the time of the investment. However, 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 the three years 2012 through 2014, we have invested almost entirely in investment-grade corporate bonds. Acquisitions in all three years have been primarily in industrial and utility bonds. New cash flow available for investment has been primarily provided through our insurance operations, but has also been affected by other factors. Issuer calls, as a result of the low-interest environment experienced during the past three years were an important factor, especially in 2012. Calls increase funds available for investment, but as noted earlier in this discussion, they can have a negative impact on investment income if the proceeds from the calls are reinvested in bonds that have lower yields than that of the bonds that were called. Issuer calls were $160 million in 2014, $344 million in 2013, and $650 million in 2012. The higher level of acquisitions in 2012 was primarily due to the additional funds available from the higher level of 2012 calls.

 

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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, 2014 with the latest industry data.

 

     Torchmark        
     Amount
(in millions)
     %     Industry %(1)  

Bonds

   $ 12,327         92     78

Preferred stock (redeemable and perpetual)(2)

     497         4        0   

Common stocks

     1         0        2   

Mortgage loans

     0         0        9   

Real estate

     0         0        0   

Policy loans

     472         3        4   

Other invested assets

     10         0        4   

Cash and short terms

     82         1        3   
  

 

 

    

 

 

   

 

 

 
   $ 13,389         100     100
  

 

 

    

 

 

   

 

 

 

 

(1)    Latest data available from the American Council of Life Insurance as of December 31, 2013.

(2)    Includes redeemable preferred of $497 million or 100% and perpetual preferred of $0 million.

       

       

 

Because fixed maturities represent such a significant portion of our investment portfolio, the remainder of the discussion of portfolio composition will focus on fixed maturities. An analysis of our fixed-maturity portfolio by component at December 31, 2014 and December 31, 2013 is as follows:

 

Fixed Maturities by Component

At December 31, 2014

(Dollar amounts in millions)

 

    Cost or
Amortized
Cost
    Gross
Unrealized
Gains
    Gross
Unrealized
Losses
    Fair
Value
    % of Total
Fixed Maturities
 
          Amortized
Cost
    Fair
Value
 

Corporates

  $ 10,566      $ 1,502      $ (61   $ 12,007        82     83

Redeemable preferred stock

    497        58        (5     550        4        4   

Municipals

    1,278        177        (1     1,454        10        10   

Government-sponsored enterprises

    291        5        (2     294        2        2   

Governments & agencies

    100        1        (1     100        1        1   

Residential mortgage-backed securities

    6        0        0        6        0        0   

Collateralized debt obligations

    68        4        (9     63        1        0   

Other asset-backed securities

    18        1        0        19        0        0   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total fixed maturities

  $ 12,824      $ 1,748      $ (79   $ 14,493        100     100
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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Fixed Maturities by Component

At December 31, 2013

(Dollar amounts in millions)

 

    Cost or
Amortized
Cost
    Gross
Unrealized
Gains
    Gross
Unrealized
Losses
    Fair
Value
    % of Total
Fixed Maturities
 
          Amortized
Cost
    Fair
Value
 

Corporates

  $ 10,134      $ 702      $ (300   $ 10,536        81     83

Redeemable preferred stock

    503        25        (14     514        4        4   

Municipals

    1,278        70        (13     1,335        10        10   

Government-sponsored enterprises

    347        0        (71     276        3        2   

Governments & agencies

    122        1        (5     118        1        1   

Residential mortgage-backed securities

    8        0        0        8        0        0   

Collateralized debt obligations

    66        0        (8     58        1        0   

Other asset-backed securities

    31        3        0        34        0        0   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total fixed maturities

  $ 12,489      $ 801      $ (411   $ 12,879        100     100
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

At December 31, 2014, fixed maturities had a fair value of $14.5 billion, compared with $12.9 billion at December 31, 2013. At December 31, 2014, fixed maturities were in a $1.7 billion net unrealized gain position compared with an unrealized gain position of $390 million at December 31, 2013. Approximately 82% of our fixed maturity assets at December 31, 2014 at amortized cost were corporate bonds and 4% were redeemable preferred stocks. This compares with 81% corporate bonds and 4% redeemable preferred stocks at year end 2013. On a combined basis, residential mortgage-backed securities, other asset-backed securities, and collateralized debt obligations (CDOs) were 1% of the assets at amortized cost at December 31, 2014. The $68 million of CDOs at amortized cost made up less than 0.6% of the assets and are backed primarily by trust preferred securities issued by banks and insurance companies. The $6 million of residential mortgage-backed securities are rated AAA. For more information about our fixed-maturity portfolio by component at December 31, 2014 and 2013, including an analysis of unrealized investment losses and a schedule of maturities, see Note 4—Investments in the Notes to Consolidated Financial Statements.

 

Due to the strong and stable cash flows generated by its insurance products, Torchmark has the ability to hold securities with temporary unrealized losses until recovery. Even though these fixed maturity investments are classified as available for sale, Torchmark generally expects and intends to hold to maturity any securities which are temporarily impaired.

 

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

 

Fixed Maturity Portfolio Selected Information

 

     At December 31,  
     2014     2013  

Average annual effective yield (1)

     5.89     5.91

Average life, in years, to:

    

Next call (2)

     17.8        18.3   

Maturity (2)

     20.5        21.5   

Effective duration to:

    

Next call (2), (3)

     10.9        10.4   

Maturity (2), (3)

     12.0        11.7   

 

(1)    Tax-equivalent basis, where 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.

        

 

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Credit Risk Sensitivity.    Credit risk relates to the level of uncertainty that a security’s issuer will maintain its ability to honor the terms of that security until maturity. Approximately 87% of our fixed-maturity holdings at book value are in corporate securities (including redeemable preferred and asset-backed securities). As we continue to invest in corporate bonds with relatively long maturities, we continually monitor credit risk. We mitigate this ongoing risk, in part, by acquiring only 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. We also seek to reduce credit risk by spreading investments over a large number of issuers and a wide range of industry sectors.

 

The following table presents the relative percentage of our fixed maturities by industry sector at December 31, 2014.

 

Fixed Maturities by Sector

At December 31, 2014

(Dollar amounts in millions)

 
    Cost or
Amortized
Cost
    Gross
Unrealized
Gains
    Gross
Unrealized
Losses
    Fair
Value
    % of Total
Fixed Maturities
 
          At
Amortized
Cost
    At
Fair
Value
 

Financial - Life/Health/PC
Insurance

  $ 1,819      $ 291      $ (3   $ 2,107        14     15

Financial - Bank

    683        94        (5     772        5        5   

Financial - Other

    633        92        (9     716        5        5   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total Financial

    3,135        477        (17     3,595        24        25   

Utilities

    2,183        379        (3     2,559        17        19   

Government

    1,669        183        (4     1,848        13        13   

Energy

    1,512        173        (22     1,663        12        11   

Basic Materials

    997        86        (7     1,076        8        7   

Other Industrials

    910        112        (7     1,015        7        7   

Consumer Non-cyclical

    848        125        (2     971        7        7   

Transportation

    559        80        (3     636        4        4   

Communications

    533        75        (4     604        4        4   

Consumer Cyclical

    404        54        (1     457        3        3   

Collateralized debt obligations

    68        4        (9     63        1        0   

Mortgage-backed securities

    6        0        0        6        0        0   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total Fixed Maturities

  $ 12,824      $ 1,748      $ (79   $ 14,493        100     100
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

At December 31, 2014, approximately 24% of the fixed maturity assets at amortized cost (25% at fair value) were in the financial sector, including 14% in life and health or property casualty insurance companies and 5% in banks. Financial guarantors, mortgage insurers, and insurance brokers comprised approximately 5% of the portfolio at amortized cost. After financials, the next largest sector was utilities, which comprised 17% of the portfolio at amortized cost. The balance of the portfolio is spread among 396 issuers in a wide variety of sectors.

 

Our energy sector investments accounted for 12% of fixed maturities at amortized cost as of December 31, 2014. While this sector has seen recent volatility, we believe the risk of losses in the foreseeable future is minimal. Over 98% of these holdings are investment grade, and the portfolio had a net unrealized gain of $151 million at year end 2014. Less than 8% of our holdings are in the oil field service and drilling area. While there may be some downgrades in this sector, we believe that our investments will be able to withstand lower energy prices for an extended duration.

 

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An analysis of the fixed-maturity portfolio by a composite rating at December 31, 2014 is shown in the table below. The composite rating for each security, other than private-placement securities managed by a third party, is the average of the security’s ratings as assigned by Moody’s Investor Service, Standard & Poor’s, Fitch Ratings, and Dominion Bond Rating Service, LTD. The ratings assigned by these four nationally recognized statistical rating organizations are evenly weighted when calculating the average. Included in the chart below are private placement fixed-maturity holdings of $497 million at amortized cost ($513 million at fair value) for which the ratings were assigned by the third-party manager.

 

Fixed Maturities by Rating

At December 31, 2014

(Dollar amounts in millions)

 

     Amortized
Cost
     %     Fair
Value
     %  

Investment grade:

          

AAA

   $ 688         5   $ 726         5

AA

     1,333         10        1,531         10   

A

     3,914         32        4,620         32   

BBB+

     2,429         19        2,763         19   

BBB

     2,833         22        3,153         22   

BBB-

     1,066         8        1,150         8   
  

 

 

    

 

 

   

 

 

    

 

 

 

Investment grade

     12,263         96        13,943         96   

Below investment grade:

          

BB

     331         2        334         2   

B

     118         1        109         1   

Below B

     112         1        107         1   
  

 

 

    

 

 

   

 

 

    

 

 

 

Below investment grade

     561         4        550         4   
  

 

 

    

 

 

   

 

 

    

 

 

 
   $ 12,824         100   $ 14,493         100
  

 

 

    

 

 

   

 

 

    

 

 

 

 

The portfolio has a weighted average quality rating of A- based on amortized cost. Approximately 96% of the portfolio at amortized cost was considered investment grade. Our investment portfolio contains no securities backed by sub-prime or Alt-A mortgages (loans for which some of the typical documentation was not provided by the borrower). We have no direct investments in residential mortgages, nor do we have any counterparty risks as we are not a party to any credit default swaps or other derivative contracts. We do not participate in securities lending. There are no off-balance sheet investments, as all investments are reported on our Consolidated Balance Sheets. Other than $9 million of German government bonds at amortized cost and fair value, we have no direct exposure to European sovereign debt.

 

Our current investment policy regarding fixed maturities is to acquire only investment-grade obligations. Thus, any increases in below investment-grade issues are a result of ratings downgrades of existing holdings.

 

An analysis of changes in below-investment grade fixed maturities at amortized cost is as follows.

 

     Year Ended
December  31,

2014
 
    
     (in $ millions)  

Balance at January 1

   $ 566   

Downgrades by rating agencies

     15   

Upgrades by rating agencies

     (20

Disposals

     (5

Write down of other-than-temporarily impaired securities

     0   

Amortization

     5   
  

 

 

 

Balance at December 31

   $ 561   
  

 

 

 

 

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Market Risk Sensitivity.    Torchmark’s financial securities are exposed to 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 96% of the book value of our investments is attributable to fixed-maturity investments (and virtually all of these investments are fixed-rate investments), the portfolio 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. Under normal market conditions, we do not expect to realize these unrealized gains and losses because we have the ability and generally the intent 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 offsets the impact of rates on the investment portfolio. However, as is permitted by GAAP, these liabilities are not recorded at fair value.

 

The following table illustrates the market risk sensitivity of our interest-rate sensitive fixed-maturity portfolio at December 31, 2014 and 2013. 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,

2014

  

At
December 31,

2013

-200

   $18,401    $16,205

-100

     16,287      14,412

   0

     14,493      12,879

 100

     12,961      11,562

 200

     11,645      10,423

 

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Realized Gains and Losses.    Our life and health insurance companies 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.

 

Investments are occasionally sold or called, resulting in a realized gain or loss. These gains and losses generally 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 our core insurance operations of providing insurance coverage to policyholders.

 

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 not to 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.

 

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, 2014.

 

Analysis of Realized Gains (Losses), Net of Tax

(Dollar amounts in thousands, except for per share data)

 

     Year Ended December 31,  
     2014      2013     2012  
     Amount     Per Share      Amount     Per Share*     Amount     Per Share*  

Fixed maturities:

             

Sales

   $ 10,209      $ 0.08       $ 3,015      $ 0.02      $ 24,943      $ 0.17   

Called or tendered

     4,851        0.04         5,525        0.04        5,830        0.04   

Writedowns**

     0        0.00         0        0.00        (3,640     (0.02

Loss on redemption of debt

     (168     0.00         0        0.00        (2,671     (0.02

Other

     414        0.00         (4,575     (0.03     129        0.00   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Total

   $ 15,306      $ 0.12       $ 3,965      $ 0.03      $ 24,591      $ 0.17   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

 

  *   Per share amounts for 2013 and 2012 have been retrospectively adjusted for the three-for-two stock split effective July 1, 2014.
  **   Written down due to other-than-temporary impairment.

 

As described in Note 4—Investments under the caption Other-than-temporary impairments in the Notes to Consolidated Financial Statements, we wrote certain securities down to fair value during 2012 as a result of other-than-temporary impairment. The impaired securities met our criteria for other-than-temporary impairment as discussed in Note 1—Significant Accounting Policies and in our Critical Accounting Policies in this report. The writedowns resulted in pretax charges of $5.6 million in 2012 ($3.6 million after tax). During 2013, we sold investment real estate for an after-tax loss of $1.9 million, of which $1.7 million had been written down due to other-than-temporary impairment earlier in the year. In 2012, we redeemed our 7.1% Trust Originated Preferred Securities, recording a loss on redemption of $4.1 million ($2.7 million after tax).

 

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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 primarily derived from three sources: positive cash flow from operations, a portfolio of marketable securities, and a line of credit facility.

 

Insurance Subsidiary Liquidity.    The operations of our insurance subsidiaries have historically generated substantial cash inflows in excess of immediate cash needs. Sources of cash flows for the insurance subsidiaries include primarily premium and investment income. Cash outflows from operations include policy benefit payments, commissions, administrative expenses, and taxes. The funds to provide for policy benefits, the majority of which are paid in future periods, are invested primarily in long-term fixed maturities to meet these long-term obligations. In addition to investment income, maturities and scheduled repayments in the investment portfolio are sources of cash. Excess cash available from the insurance subsidiaries’ operations is generally distributed as a dividend to the Parent Company, subject to regulatory restriction. The dividends are generally paid in amounts equal to the subsidiaries’ prior year statutory net income excluding realized capital gains. While the leading source of the excess cash is investment income, due to our high underwriting margins and effective expense control, a significant portion of the excess cash also comes from underwriting income.

 

Parent Company Liquidity.    Cash flows from the insurance subsidiaries are used to pay interest and principal repayments on Parent Company debt, operating expenses of the Parent, and Parent Company dividends to Torchmark shareholders. In 2014, the Parent received $479 million of cash dividends from its insurance subsidiaries, compared with $488 million in 2013 and $437 million in 2012. Including transfers from other subsidiaries and after paying debt obligations, shareholder dividends, and other expenses (but before share repurchases), Torchmark Parent had excess operating cash flow in 2014 of approximately $377 million, compared with $364 million in 2013. Parent Company cash flow in excess of its operating requirements is available for other corporate purposes, such as strategic acquisitions or share repurchases. In 2015, it is expected that the Parent Company will receive approximately $473 million in dividends from subsidiaries, and that an approximate range of $355 to $365 million will be available as excess cash flow. Certain restrictions exist on the payment of these dividends. For more information on the restrictions on the payment of dividends by subsidiaries, see the restrictions section of Note 12Shareholders’ Equity in the Notes to Consolidated Financial Statements. Although these restrictions exist, dividend availability from subsidiaries historically has been sufficient for the cash flow needs of the Parent Company. As additional liquidity, the Parent held $6 million of cash and short-term investments at December 31, 2014, compared with $8 million a year earlier. The Parent also had available a $50 million receivable from subsidiaries at 2014 year end.

 

Short-Term Borrowings. An additional source of parent company liquidity is a line of credit facility with a group of lenders which allows unsecured borrowings and stand-by letters of credit up to $750 million. In July 2014, Torchmark replaced a $600 million facility with this new agreement, as discussed in Note 11Debt in the Notes to Consolidated Financial Statements, under the caption Commercial Paper. The new facility, like the previous, is further designated as a back-up line of credit for a commercial paper program. As of December 31, 2014, we had available $314 million of additional borrowing capacity under this new facility, compared with $173 million a year earlier. There have been no difficulties in accessing the commercial paper market during the three years ended December 31, 2014. For detailed information about this new line of credit facility, please refer to Note 11Debt.

 

In summary, Torchmark expects to have readily available funds for 2015 and the foreseeable future to conduct its operations and to maintain target capital ratios in the insurance subsidiaries through internally generated cash flow and the credit facility. In the unlikely event that more liquidity is needed, the Company could generate additional funds through multiple sources including, but not limited to, the issuance of additional debt, a short-term credit facility, and intercompany borrowing.

 

Consolidated Liquidity. Consolidated net cash inflows provided from operations were $865 million in 2014, compared with $1.1 billion in 2013 and $943 million in 2012. In addition to cash inflows from operations, our companies have received $160 million in investment calls and tenders and $113 million

 

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of scheduled maturities or repayments during 2014. Maturities, tenders, and calls totaled $494 million in 2013 and $737 million in 2012.

 

Our cash and short-term investments were $82 million at year-end 2014 and $114 million at year-end 2013. 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 $14.5 billion at December 31, 2014. However, our strong cash flows from operations, investment maturities, and the availability of our credit line make any need to sell securities for liquidity unlikely.

 

Off-Balance Sheet Arrangements.    As a part of its above-mentioned credit facility, Torchmark had outstanding $198 million in stand-by letters of credit at December 31, 2014. However, these letters are issued among our subsidiaries, one of which is an offshore captive reinsurer, and have no impact on company obligations as a whole. Any future regulatory changes that restrict the use of off-shore captive reinsurers might require Torchmark to obtain third-party financing, which could cause an immaterial increase in financing costs.

 

As of December 31, 2014, we had no unconsolidated affiliates and no guarantees of the obligations of third-party entities. All of our guarantees were guarantees of the performance of consolidated subsidiaries, as disclosed in Note 15Commitments and Contingencies.

 

The following table presents information about future payments under our contractual obligations for the selected periods as of December 31, 2014.

 

(Amounts in millions)

 

    Actual
Liability
    Total
Payments
    Less than
One Year
    One to
Three Years
    Three to
Five Years
    More than
Five Years
 

Fixed and determinable:

           

Debt—principal(1)

  $ 1,231      $ 1,242      $ 238      $ 250      $ 293      $ 461   

Debt—interest(2)

    6        594        71        116        94        313   

Capital leases

    0        0        0        0        0        0   

Operating leases

    0        46        9        14        8        15   

Purchase obligations

    76        76        44        25        1        6   

Pension obligations(3)

    185        252        18        41        47        146   

Future insurance obligations(4)

    11,750        46,232        1,326        2,604        2,574        39,728   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

  $ 13,248      $ 48,442      $ 1,706      $ 3,050      $ 3,017      $ 40,669   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1)   Funded debt is itemized in Note 11—Debt in the Notes to Consolidated Financial Statements and includes short-term commercial paper.
(2)   Interest on debt is based on our fixed contractual obligations.
(3)   Pension obligations are primarily liabilities in trust funds that are calculated in accordance with the terms of the pension plans. They are offset by invested assets in the trusts, which are funded through periodic contributions by Torchmark in a manner which will provide for the settlement of the obligations as they become due. Therefore, our obligations are offset by those assets when reported on Torchmark’s Consolidated Balance Sheets. At December 31, 2014, these pension obligations were $477 million, but there were also assets of $323 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. There are also obligations for benefits other than pensions with a liability of $23 million. Please refer to Note 10Postretirement Benefits in the Notes to Consolidated Financial Statements for more information on pension obligations.
(4)   Future insurance obligations consist primarily of estimated future contingent benefit payments on policies in force at December 31, 2014. 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 $11.7 billion at December 31, 2014, along with future premiums and investment income, will be sufficient to fund all future insurance obligations.

 

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Capital Resources.    Torchmark’s capital structure consists of short-term debt (the commercial paper facility described in Note 11Debt in the Notes to Consolidated Financial Statements), long-term funded debt, and shareholders’ equity. A complete analysis and description of long-term debt issues outstanding is presented in Note 11.

 

The carrying value of the long-term funded debt was $992 million at December 31, 2014, compared with $991 million a year earlier. As fully explained in Note 11—Debt, we issued $300 million principal amount of 3.8% Senior Notes due in 2022 in September, 2012 for proceeds of $297 million in a public offering. However, $150 million of the offering was acquired by Torchmark insurance subsidiaries and was eliminated in consolidation, resulting in net proceeds after issue expenses to the consolidated group of $147 million. The majority of the $297 million proceeds received by the Parent were used to acquire Family Heritage as described in Note 6—Acquisition. The balance was invested and later used for the redemption of our $94.5 million principal amount 7 3/8% Notes that matured on August 1, 2013 and for other corporate purposes. The principal balance of the 7 3/8% Notes, along with accrued interest, was then repaid on its maturity date in the total amount of $97.5 million.

 

As also discussed in Note 11, we issued $125 million principal amount of our 5.875% Junior Subordinated Debentures due 2052 in a September, 2012 public offering. This issue resulted in net proceeds after issue expenses of $121 million, and were used to redeem our 7.1% Trust Originated Preferred Securities in the amount of $120 million plus accrued dividends for a total cost of $121 million.

 

Also noted in Note 11 was our assumption of $20 million of Trust Preferred Securities in connection with our acquisition of Family Heritage. These securities bear interest at a variable rate, the three-month LIBOR plus 330 basis points, which is reset each quarter. While these securities are callable by us at any time, we have no immediate plans to do so.

 

Our insurance subsidiaries generally target a capital ratio of at least 325% of required regulatory capital under Risk-Based Capital (RBC), a formula designed by insurance regulatory authorities to monitor the adequacy of capital. The 325% target is considered sufficient for the subsidiaries because of their strong reliable cash flows, the relatively low risk of their product mix, and because that ratio is in line with rating agency expectations for Torchmark. At December 31, 2014, our insurance subsidiaries in the aggregate had RBC ratios of approximately 326%. Should we experience additional impairments and/or ratings downgrades in the future that cause the ratio to fall below 325%, management has more than sufficient liquidity at the Parent Company to make additional contributions as necessary to maintain the ratios at or above 325%.

 

As noted under the caption Summary of Operations in this report, we have an ongoing share repurchase program. Under this program, we acquired 7 million shares at a cost of $375 million in 2014, 8 million shares at a cost of $360 million in 2013, and 11 million shares for $360 million in 2012. The majority of purchased shares are retired each year. Please refer to the description of our share repurchase program under the caption Summary of Operations in this report.

 

Torchmark has increased the quarterly dividend on its common shares over the past three years. In the first quarter of 2012, it was increased to $.10 per share from $.08 per share. In the first quarter of 2013, it was again raised to $.1133 per share. Then, in the first quarter of 2014, dividends were raised to $.1267 per share.

 

Shareholders’ equity was $4.7 billion at December 31, 2014, compared with $3.8 billion at December 31, 2013. During the twelve months since December 31, 2013, shareholders’ equity was reduced by the $375 million in share purchases under the repurchase program and another $74 million to offset the dilution from stock option exercises. However, it was increased by $827 million of after-tax unrealized gains in the fixed maturity portfolio and by the $543 million of net income.

 

We plan to use excess cash available at the Parent Company as efficiently as possible in the future. Possible uses of excess cash flow include, but are not limited to share repurchases, acquisitions, increases in shareholder dividends, investment in fixed maturities, or repayment of short-term debt. We will determine the best use of excess cash after ensuring that desired capital levels are maintained in our companies.

 

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We maintain a significant available-for-sale fixed-maturity portfolio to support our insurance policyholders’ liabilities. Current accounting guidance 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 can result from changes in interest rates and liquidity in financial markets. While invested assets are revalued, accounting rules do not permit interest-bearing insurance policy liabilities to be valued at fair value in a consistent manner as that of assets, with changes in value applied directly to shareholders’ equity. Due to the size of our policy liabilities in relation to our shareholders’ equity, this inconsistency in measurement usually has a material impact on 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. From time to time, the market value of our fixed maturity portfolio may be depressed as a result of bond market illiquidity which could result in a significant decrease in shareholders’ equity. Because of the long-term nature of our fixed maturities and liabilities and the strong cash flows generated by our insurance subsidiaries, we have the intent and ability to hold our securities to maturity. As such, we do not expect to incur losses due to fluctuations in market value of fixed maturities caused by interest rate changes and temporarily illiquid markets. Accordingly, our management, credit rating agencies, lenders, many industry analysts, and certain other financial statement users prefer to remove the effect of this accounting rule 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 this accounting guidance 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, 2014     At December 31, 2013     At December 31, 2012  
    GAAP     Effect of
Accounting
Rule
Requiring
Revaluation (1)
    GAAP     Effect of
Accounting
Rule
Requiring
Revaluation (1)
    GAAP     Effect of
Accounting
Rule
Requiring
Revaluation