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TMK > SEC Filings for TMK > Form 10-Q on 8-Nov-2012All Recent SEC Filings

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Form 10-Q for TORCHMARK CORP


8-Nov-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

Results of Operations

Acquisition. As disclosed in Note H-Acquisition, Torchmark acquired Family Heritage on November 1, 2012 for approximately $232 million. As noted, Family Heritage is a specialty insurer focused primarily on selling individual supplemental health insurance products through a captive agency force, consisting of approximately 1,200 agents. We were attracted to the company because it sells protection-oriented insurance to middle income families through a captive agency force that we believe we can help grow. We currently intend to operate the company as a stand-alone operation. We expect that the addition of this acquisition will be accretive to earnings and earnings per share in both 2012 and 2013, excluding the effects of acquisition costs of the transaction as described in Note G-Business Segments and Note H-Acquisition. These costs must be expensed in their entirety in 2012 under applicable accounting guidance. The transaction will have a minimal effect, if any, on our share repurchase program and the regulatory capital ratios of the insurance subsidiaries.

Debt Transactions. As discussed in Note I-Debt Transactions, we closed two separate debt issues on September 24, 2012 - a ten-year $300 million 3.8% Senior Note issue and a forty-year $125 million 5.875% Junior Subordinated Debt issue that is callable at par after five years. The Senior Notes were issued to provide approximately $200 million to fund the acquisition of Family Heritage and $94 million to pre-fund the eventual retirement of our August 2013 7 3/8% Senior Notes. As we wanted to fund the majority of the Family Heritage acquisition internally, the Parent Company issued $150 million of these Senior Notes to two of our insurance companies. The $125 million in Junior Subordinated Notes were issued to refinance our $120 million Trust Preferred Securities, which carried an interest rate of 7.1%. The Trust Preferred Securities were called on October 24, 2012.

The $150 million in the 3.8% Senior Notes owned by our insurance companies are eliminated in consolidation and thus are not treated as outstanding debt or as invested assets in our consolidated financial statements. Therefore, the issuance of these two instruments resulted in net additional proceeds to the Company of $268 million during September, 2012. After the older issues are retired, the addition of these new debt issues will result in a small increase in our debt to capitalization ratio and a reduction in interest cost. These issuances will have no material effect on our debt covenants.

Effect of New Accounting Standard. As discussed in Note F - Adoption of New Accounting Standard, Torchmark adopted ASU 2010-26, a new accounting rule concerning the deferral of policy acquisition costs. Note F describes the effect that this new guidance has on Torchmark. The new standard was adopted effective January 1, 2012, but was adopted retroactively, meaning that all prior periods give effect to the change as if we had always accounted for deferred acquisition costs under the new guidance. Therefore, the results for prior periods presented in this discussion have been restated as if the new rule had been in effect in those periods.


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Summary of Operations. Torchmark's operations are segmented into its insurance underwriting and investment operations as described in Note G-Business Segments. The measures of profitability described in Note G are useful in evaluating the performance of the segments and the marketing groups within each insurance segment, because each of our distribution units operates in a niche market. These measures enable management to view period-to-period trends, and to make informed decisions regarding future courses of action.

The tables in Note G-Business Segments demonstrate how the measures of profitability are determined. Those tables also reconcile our revenues and expenses by segment to major income statement line items for the nine-month periods ended September 30, 2012 and 2011. Additionally, a table in that note, Analysis of Profitability by Segment, provides a summary of the profitability measures that demonstrates year-to-year comparability and reconciles those measures to our net income. That summary represents our overall operations in the manner that management views the business, and is a basis of the following highlights discussion.

A discussion of operations by each segment follows later in this report. These discussions compare the first nine months of 2012 with the same period of 2011, unless otherwise noted. The following discussions are presented in the manner we view our operations, as described in Note G-Business Segments.

Highlights, comparing the first nine months of 2012 with the first nine months of 2011. Net income per diluted share increased 15% to $3.84 from $3.33. Included in net income in 2012 were realized investment gains of approximately $11 million after tax, or $.11 per share compared with $14 million or $.12 per share in 2011. Realized investment gains and losses are presented more fully under the caption Realized Gains and Losses in this report. Earnings in 2011 were also negatively affected by two non-operating charges, a charge for a state administrative matter in the estimated after tax amount of $3.9 million ($.03 per share) and the loss on sale of aviation equipment of $636 thousand after tax ($.01 per share).

We use three statistical measures as indicators of future premium growth:
"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 defined as annualized premium issued, net of cancellations in the first thirty days after issue, except for Direct Response, where net sales is annualized premium issued at the time the first full premium is paid after any introductory offer has expired. Annualized premium issued is the gross premium that would be received during the policies' first year in force,


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assuming that none of the policies lapsed or terminated. Although lapses and terminations will occur, we believe that net sales is a useful indicator of the rate of acceleration of premium growth. First-year collected premium is 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 policy 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.

Total premium income rose 6% in 2012 to $2.1 billion. Total net sales rose 22% to $372 million. After adjusting for the increased sales of Medicare Part D in 2012, largely caused by the addition of automatic enrollees discussed later in this report, net sales rose 5% to $303 million. First-year collected premium increased 42% to $348 million for the period. Excluding the increase in Part D first-year premium, the increase was 6%.

Life insurance premium income grew 5% to $1.4 billion. Life net sales increased 6% to $260 million, as three of our four distribution units experienced increases. First-year collected life premium rose 6% to $193 million. Life underwriting margins increased 11% to $381 million.

Health insurance premium income, excluding Medicare Part D, declined 5% to $527 million. Health net sales, excluding Part D, were flat at $43 million for the nine months, as a 5% increase in sales of Medicare Supplement policies were offset by declines in sales of limited-benefit health products. First-year collected health premium, excluding Part D, rose 7% to $46 million for the period. Health premium continued to be restrained by the run off of certain health products that we discontinued selling in 2010.

Our Medicare Part D prescription drug business is a component of the health insurance segment. In the manner we view our Medicare Part D business as described in Note G-Business Segments, policyholder premium was $234 million in 2012 compared with $148 million in 2011, an increase of 58%. This increase was due to the addition of a large number of low-income automatic enrollees into our Part D program in 2012.

As explained in Note G-Business Segments, differences in our estimate of interim results for Medicare Part D as we view this product for segment purposes and GAAP financial statement purposes resulted in a $12.3 million after-tax charge to earnings in 2012 ($.12 per share) and a $3.8 million charge in 2011 ($.03 per share). We expect our 2012 full year benefit ratios to be approximately the same as those for interim periods, as was the case in 2011 and prior years. For this reason, there should be no material difference in our segment versus financial statement reporting by year end 2012, as it relates to Medicare Part D. The increase in this adjustment in 2012 resulted from the addition of the automatic enrollees in Part D as noted above.

Excess investment income per diluted share increased 5% over 2011 to $1.83, while excess investment income declined 7% to $181 million. The increase in per share


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excess investment income in relation to the decline in dollar amount resulted from the significant number of shares purchased over the past twelve months, as discussed later in this report. Net investment income rose $6 million, or 1%. While our average investment portfolio at amortized cost grew 3%, the average effective yield on the fixed-maturity portfolio, which represented 93% of our investments at amortized cost, decreased to 6.42% in the 2012 period from 6.57% in the prior period. Excess investment income has been negatively affected by the low-interest-rate environment in financial markets during recent periods. Excess investment income declined despite the $6 million increase in net investment income, however, because of the $20 million or 7% increase in required interest on net insurance policy liabilities, as discussed under the caption Investments (excess investment income) later in this report. Financing costs also rose 1% in the period to $59 million.

In the first nine months of 2012, we invested new money in our fixed-maturity portfolio at an effective annual yield on new investments of 4.54%, compared with 5.79% in the same period of 2011. Our fixed maturity portfolio yield was 6.33% (as of September 30, 2012) and the portfolio had an average rating of BBB+. Approximately 94% of the portfolio at amortized cost was investment grade at September 30, 2012. Cash and short-term investments were $685 million at that date, compared with $105 million at December 31, 2011. The buildup in cash was due to the debt issuances in late September, 2012 in anticipation of the acquisition of Family Heritage and the October, 2012 call of our 7.1% Trust Preferreds mentioned above. In addition, we had $484 million proceeds from total security dispositions in the third quarter, including $465 million from securities called, a large portion of which was awaiting reinvestment.

The unrealized gain position in our fixed-maturity portfolio grew during the first nine months of 2012 from a net unrealized gain of $964 million at year end 2011 to a net unrealized gain position of $1.6 billion at September 30, 2012, primarily as a result of lower interest rates. The fixed-maturity portfolio contains no commercial mortgage-backed securities or securities backed by subprime or Alt-A mortgages (loans for which some of the typical documentation was not provided by the borrower). We are not a party to any counterparty risk, with no credit default swaps or other derivative contracts. We do not engage in securities lending, and have no direct exposure to European sovereign debt.

We have an on-going share repurchase program which began in 1986 and was reaffirmed by the Board of Directors at their August, 2012 meeting. With no specified authorization amount, we determine the amount of repurchases based on the amount of our excess cash flow, general market conditions, and other alternative uses. These purchases are made with excess cash flow. Share purchases are also made with the proceeds from option exercises by current and former employees, in order to reduce dilution. The following chart summarizes share purchases for the nine-month periods ended September 30, 2012 and 2011.


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                          Analysis of Share Purchases

                             (Amounts in thousands)



                                            For the nine months ended September 30,
                                          2012                                   2011
                                                     Average                                 Average
                           Shares       Amount        Price        Shares       Amount        Price
Purchases with:
Excess cash flow             6,635     $ 318,227     $  47.96       17,238     $ 720,446     $  41.79
Option exercise proceeds     3,091       147,872        47.84        1,631        70,053        42.94

Total                        9,726     $ 466,099     $  47.92       18,869     $ 790,499     $  41.89

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

A detailed discussion of our operations by component segment follows.

Life insurance, comparing the first nine months of 2012 with the first nine months of 2011. Life insurance is our predominant segment, representing 64% of premium income and 72% of insurance underwriting margin in the first nine months of 2012. In addition, investments supporting the reserves for life business generate the majority of excess investment income attributable to the investment segment. Life insurance premium income increased 5% to $1.4 billion. The following table presents Torchmark's life insurance premium by distribution method.

                                 Life Insurance

                         Premium by Distribution Method

                         (Dollar amounts in thousands)



                                                  Nine months ended September 30,                   Increase
                                                  2012                       2011                  (Decrease)
                                                          % of                       % of
                                           Amount        Total        Amount        Total       Amount        %
American Income Exclusive Agency         $   492,381         36     $   451,054         35     $ 41,327         9
Direct Response                              476,888         35         447,500         34       29,388         7
Liberty National Exclusive Agency            212,552         16         217,560         17       (5,008 )      (2 )
Other Agencies                               174,706         13         178,043         14       (3,337 )      (2 )


Total Life Premium                       $ 1,356,527        100     $ 1,294,157        100     $ 62,370         5

Net sales, defined earlier in this report as an indicator of new business production, rose 6% to $260 million. Three of our four distribution groups had increases in net sales over the prior year period. An analysis of life net sales by distribution group is presented below.


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                                 Life Insurance

                        Net Sales by Distribution Method

                         (Dollar amounts in thousands)



                                                 Nine months ended September 30,                  Increase
                                                  2012                      2011                 (Decrease)
                                                          % of                     % of
                                            Amount       Total       Amount       Total       Amount         %
American Income Exclusive Agency          $  119,049         46     $ 105,273         43     $ 13,776         13
Direct Response                              109,055         42       103,497         42        5,558          5
Liberty National Exclusive Agency             23,743          9        28,005         12       (4,262 )      (15 )
Other Agencies                                 8,355          3         7,784          3          571          7


Total Life Net Sales                      $  260,202        100     $ 244,559        100     $ 15,643          6

First-year collected life premium, defined earlier in this report, was $193 million in the 2012 period, rising 6%. First-year collected life premium by distribution group is presented in the table below.

                                 Life Insurance

              First-Year Collected Premium by Distribution Method

                         (Dollar amounts in thousands)



                                                 Nine months ended September 30,                  Increase
                                                  2012                      2011                 (Decrease)
                                                          % of                     % of
                                            Amount       Total       Amount       Total       Amount         %
American Income Exclusive Agency          $   94,031         49     $  83,972         46     $ 10,059         12
Direct Response                               71,755         37        67,495         37        4,260          6
Liberty National Exclusive Agency             20,154         10        24,086         13       (3,932 )      (16 )
Other Agencies                                 7,136          4         7,153          4          (17 )        0


Total                                     $  193,076        100     $ 182,706        100     $ 10,370          6

The American Income Exclusive Agency markets primarily to members of labor unions, but also to credit unions and other associations. This agency is the largest contributor to life premium of any of Torchmark's distribution systems at 36% of Torchmark's total life premium. This group produced premium income of $492 million, an increase of 9%. This agency is also our fastest growing life insurance agency on the basis of premium growth and sales. Net sales rose 13% to $119 million, while first-year collected premium rose 12% to $94 million. Increases in sales in our captive agencies are highly dependent on growth in the size of the agency force. The American Income agent count rose 23% to 5,472 at September 30, 2012 over the prior year (4,448). The count was also up 25% over the count at December 31, 2011 (4,381). The American Income Agency has been focusing on growing and strengthening middle management to support the growth of the agency force.


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The Direct Response operation consists of two primary components: insert media and direct mail. Insert media, which targets primarily the adult market, involves placing insurance solicitations as inserts into a variety of media, such as coupon packets, newspapers, bank statements, and billings. Direct mail targets primarily young lower-middle and middle-income households with children. The juvenile life insurance policy is a key product. Not only is the juvenile market an important source of sales, but it also is a vehicle to reach the parents and grandparents of the juvenile policyholders, 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.

Direct Response's life premium income rose 7% to $477 million, representing 35% of Torchmark's total life premium in 2012. Net sales for this group of $109 million increased 5%. First-year collected premium gained 6% to $72 million.

The Liberty National Exclusive Agency markets primarily life insurance and supplemental health insurance, focusing primarily on middle-income customers. Life premium income for this agency was $213 million in the 2012 period, a 2% decline compared with $218 million in the 2011 period. First-year collected premium declined 16% to $20 million.

Net sales for the Liberty Agency declined 15% to $24 million. However, Liberty's net life sales rose sequentially over each of the past two quarters, increasing 3% over second quarter 2012. Liberty had 1,401 producing agents at September 30, 2012, compared with 1,578 a year earlier, a decline of 11%. However, the agent count has risen 4% since December 31, 2011, when it stood at 1,345, and has risen 3% over the prior quarter. Decreases in agent counts prior to 2012 have had a negative effect on premium growth in this agency. The past declines were due to a number of factors, including the closing of several offices which had poor production as well as certain agent compensation issues which resulted in the departure of a number of the less productive agents. While these factors caused a loss of agents, they have resulted in improved persistency and margins, and have contributed to Torchmark's overall improvement in life insurance margins. Additionally, we have changed the cost structure of this agency to a more commission-driven model, which we believe will also increase the profitability of new sales.

The Other Agencies distribution systems offering life insurance include the Military Agency, the UA Independent Agency (which predominantly writes health insurance), and various smaller distribution channels. The Other Agencies distribution group contributed $175 million of life premium income, or 13% of Torchmark's total in the 2012 period, but contributed only 3% of net sales.


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                                 Life Insurance

                               Summary of Results

                         (Dollar amounts in thousands)



                                                 Nine months ended September 30,
                                               2012                          2011                    Increase
                                                       % of                          % of
                                       Amount         Premium        Amount         Premium       Amount       %
Premium and policy charges           $ 1,356,527           100     $ 1,294,157           100     $ 62,370        5
Net policy obligations                   518,863            38         494,906            38       23,957        5
Commissions and acquisition
expense *                                457,075            34         456,039            35        1,036        0

Insurance underwriting income
before other income and
administrative expense               $   380,589            28     $   343,212            27     $ 37,377       11

* 2011 expense has been retrospectively adjusted as a result of the adoption of new accounting guidance as described in Note F - Adoption of New Accounting Standard. The restatement resulted in a reduction in the amortization of acquisition expense of $38 million and the addition of non-deferred acquisition expense of $60 million, for a net reduction in margin of $22 million in 2011.

Reported margins for our life insurance business have been negatively affected by the adopted accounting rule described in Note F which was adopted for all periods presented and has the effect of delaying the recognition of profitability on our insurance products. The recognition is delayed because we are no longer allowed to capitalize certain acquisition costs which were deferrable under previous accounting guidance. These costs that we no longer defer are included in the chart above under the caption "Commissions and acquisition expense" and were $42 million in 2012 and $60 million in 2011. While the recognition of profits is now delayed, ultimate profitability on our business is not affected by the change in accounting.

Life insurance underwriting income before insurance administrative expense was $381 million, increasing 11%. As a percentage of premium, underwriting income rose from 27% to 28% in 2012. Growth in underwriting income was caused partially by premium growth but also by reductions in certain acquisition expenses.

In 2011, we implemented several initiatives designed to further improve life insurance lapse ratios. This program has been very successful and has continued to grow. We anticipate that it will conserve approximately $31 million of additional annualized life premium during 2012.

Health insurance, comparing the first nine months of 2012 with the first nine months of 2011. Health premium accounted for 36% of our total premium in the 2012 period, while the health underwriting margin accounted for 27% of total underwriting margin, reflective of the lower underwriting margin as a percent of premium for health compared with life insurance. Health insurance sold by Torchmark includes


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primarily Medicare Supplement and Medicare Part D prescription drug coverage to enrollees in the federal Medicare program, along with limited-benefit cancer and accident coverage. All health coverage plans other than Medicare Supplement and Medicare Part D are classified here as limited-benefit plans. Medicare Part D business is shown as a separate health component and will be discussed separately in the analysis of the health segment.

As explained in Note G-Business Segments, management does not view the government risk-sharing premium for Medicare Part D as a component of premium income. Excluding this risk-sharing premium, health insurance premium for the 2012 period was $761 million, increasing 8%. A reconciliation between segment reporting for Medicare Part D and GAAP is presented in the chart in Note G-Business Segments, and those differences are fully discussed in that note.


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The table below is an analysis of our health premium by distribution method.

Health Insurance

Premium by Distribution Method

(Dollar amounts in thousands)

                                                 Nine months ended September 30,                   Increase
                                                  2012                      2011                  (Decrease)
                                                          % of                     % of
                                            Amount       Total       Amount       Total       Amount          %
. . .
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