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.

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.

Discontinued Operations: As described in Note 3-Discontinued Operations in the Notes to the Consolidated Financial Statements, we sold our subsidiary United Investors Life Insurance Company (United Investors) as of December 31, 2010. Because of the sale, United Investors' financial results are excluded from this discussion since those operations were discontinued.

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, 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.

Insurance Product Line Segments. As fully described in Note 14-Business Segments in the Notes to the Consolidated Financial Statements, the 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-Business Segments 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, 2012. 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.

                      Analysis of Profitability by Segment

                         (Dollar amounts in thousands)



                                                                                              2012                      2011
                                               2012            2011            2010          Change          %         Change          %
Life insurance underwriting margin          $  509,476      $  460,963      $  430,262      $  48,513         11      $  30,701          7
Health insurance underwriting margin           197,341         188,990         198,966          8,351          4         (9,976 )       (5 )
Annuity underwriting margin                      3,465           2,345           1,348          1,120         48            997
Other insurance:
Other income                                     1,898           2,507           2,834           (609 )      (24 )         (327 )      (12 )
Administrative expense                        (165,405 )      (159,109 )      (155,615 )       (6,296 )        4         (3,494 )        2
Excess investment income                       236,644         258,986         265,245        (22,342 )       (9 )       (6,259 )       (2 )
Corporate and adjustments                      (29,827 )       (22,647 )       (20,657 )       (7,180 )       32         (1,990 )       10

Pre-tax total                                  753,592         732,035         722,383         21,557          3          9,652          1
Applicable taxes                              (246,945 )      (238,335 )      (242,558 )       (8,610 )        4          4,223         (2 )

After-tax total, before discontinued
operations                                     506,647         493,700         479,825         12,947          3         13,875          3
Discontinued operations (after tax)                  0               0          27,932              0                   (27,932 )

Total                                          506,647         493,700         507,757         12,947          3        (14,057 )       (3 )
Realized gains (losses)-investments
(after tax)*                                    24,591          16,838          24,270          7,753                    (7,432 )
Realized gains (losses)-discontinued
operations (after tax)*                              0               0           1,852              0                    (1,852 )
Loss on disposal of discontinued
operations (after tax)                               0            (455 )       (35,013 )          455                    34,558
Acquisition expense-Family Heritage
(after tax)                                     (1,914 )             0               0         (1,914 )                       0
Cost of legal settlements (after tax)                0          (7,800 )             0          7,800                    (7,800 )
State administrative settlement (after
tax)                                                 0          (4,486 )             0          4,486                    (4,486 )
Loss on sale of equipment (after tax)                0            (636 )             0            636                      (636 )

Net income                                  $  529,324      $  497,161      $  498,866      $  32,163          6      $ (1,705)          0

* 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 rose 6% to $529 million in 2012 from $497 million in 2011. It had declined slightly in 2011 from $499 million in 2010. On a diluted per share basis, 2012 net income rose 19% to $5.41 after a 12% increase in 2011 to $4.53 from net income of $4.05 in 2010. The per-share results have exceeded the growth in dollar amounts due to our share repurchase program. Results in 2010 include a $35 million after-tax loss on the disposal of United Investors, representing $.28 per diluted share. Also, each year's per share net income was affected by realized investment gains, which were $0.25, $0.15, and $0.20 in 2012, 2011, and 2010, 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 to be part of our segment operating income.

As shown in the above chart, after-tax segment results of operations, before discontinued operations, rose each year over the prior year from $480 million in 2010 to $494 million in 2011 to $507 million in 2012. The primary contributor to the growth in both 2011 and 2012 was the underwriting margin in our life insurance segment, in which margins rose $31 million in 2011 and $49 million in 2012. The life insurance segment is our strongest segment and is the largest contributor to earnings in each year presented. Also contributing to growth in 2012 income was our health insurance segment, which provided $8 million of additional margin after a decline of $10 million in 2011. The 2012 improvement was largely due to the increased volume in our Medicare Part D program while the 2011 decline was a result of the discontinuance of sales of certain limited-benefit health products in late 2010 due to healthcare reform. Both 2012 and 2011 have been impacted negatively by declines in excess investment income, the measure of profitability of our investment segment. These declines in excess investment income have resulted from the continuing low interest rate environment which has pressured investment yields and spreads on policy benefit requirements, discussed more fully under the caption Investments in this report.

In 2012, this pressure on excess investment income was increased as an unusual number of calls, resulting from a new regulation affecting bank hybrid securities, caused us to replace these higher yielding securities with securities at lower yields due to the current low-interest-rate environment. Also in 2012, there was a $7 million increase in stock compensation expense which negatively affected the results during the year. The increase in stock compensation expense resulted primarily from the increase in the value of Torchmark's stock and not from an increase in the number of grants.

Total revenues rose 6% in 2012 to $3.59 billion. They were flat in 2011 at $3.38 billion compared with $3.37 billion in 2010. Life premium rose 5% or $82 million in 2012 to $1.81 billion. Life premium increased $63 million in 2011 to $1.73 billion. Net investment income was essentially flat at $694 million in 2012, after rising 2% or $17 million in 2011. Health premium increased 13% to $1.05 billion in 2012 and contributed $117 million to 2012 revenue growth, but health premium negatively affected revenue growth in 2011 as discussed below.

While life insurance premium has grown steadily in each of the three years ending December 31, 2012, margins as a percentage of premium have risen even more, rising in 2012 to 28% from 27% in 2011 and 26% in 2010. Segment profits for life insurance were not only positively affected by the premium growth, but also by improvements in persistency in both periods. Life net sales increased 6% in 2012 to $343 million, but declined 1% in 2011 to $325 million. Life insurance segment results are discussed further in this report under the caption Life Insurance.

We primarily market Medicare Supplement insurance, Medicare Part D prescription drug insurance, limited-benefit cancer, and accident health products. Prior to September, 2010, we marketed an under-age-65 limited-benefit hospital-surgical product. Health premium increased $117 million or 13% in 2012, as a result of the addition of a large number of new low-income Medicare Part D auto-enrollees in the 2012 plan year. However, 2011 health premium declined 6% to $930 million as a result of the discontinuance of certain limited-benefit health products because of healthcare reform mentioned above. Medicare Supplement remains our largest contributor to total health premium, and we have experienced growth in net sales in this product in each successive year. Medicare Supplement premium was $432 million in 2012 but has declined slightly in each successive year as lapses have exceeded new sales. Our Medicare Part D premium rose 62% to $318 in 2012 as a result of the previously-noted addition of low-income auto-enrollees in the 2012 plan. Due to increased competition for the 2013 plan year, we expect a slight decrease in 2013 Part D premium. See the discussion under Health Insurance for a more detailed discussion of health insurance results.

We offer fixed annuities, but we do not emphasize sales of annuity products, favoring life insurance instead. With the sale of United Investors in 2010, we disposed of 37% of our annuity deposit balance. See the caption Annuities for further discussion of the Annuity segment.

As previously mentioned, the investment segment's pretax profitability, or excess investment income, declined in both 2012 and 2011. Profitability in this segment is based on three major components: net investment income, required interest on net policy liabilities (interest applicable to insurance products), and financing costs. In recent years, growth in net investment income has been restricted in relation to the growth in the size of our 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 has also been 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 2012, net investment income rose 1% while the portfolio (at amortized cost) grew 4%, as new money yields available have continued to decline.

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. We have implemented certain strategies to offset this effect, including lowering the discount rate on new business and 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 2012 increased 3% to $80 million, primarily as a result of two new debt offerings issued in the latter half of 2012 as described below. Financing costs also increased from $75 million in 2010 to $78 million in 2011, primarily a result of increased charges related to our letters of credit facility.

Torchmark's current investment policy limits new investment acquisitions to investment-grade fixed maturities generally with longer maturities (often exceeding twenty years) that meet our quality and yield objectives. Approximately 96% of our invested assets at fair value consist of fixed maturities of which 96% were investment grade at December 31, 2012. 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 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.

As noted earlier, 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 due 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 2011, income from continuing operations 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 under the caption Settlements, we were involved in certain issues in which we incurred settlement losses and expenses. We settled a state administrative matter in the pretax amount of $6.9 million ($4.5 million after tax) and accrued an estimated liability for a litigation amount which settled in early 2012 in the pretax amount of $12.0 million ($7.8 million after tax). Both of these issues involved matters arising many years ago. Additionally, in connection with the 2012 purchase of Family Heritage as described in Note 6-Acquisition, we incurred $2.9 million of acquisition-related expenses ($1.9 million after tax). The state administrative settlement, the litigation accrual, and the acquisition expenses are included in "Other operating expense" 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 when market prices are favorable. 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. Due to poor economic conditions, we temporarily suspended our share repurchase program in the first quarter of 2009. However, in the first quarter of 2010, the Board of Directors reactivated 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, 2012.

                          Analysis of Share Purchases

                             (Amounts in thousands)



                                              2012                       2011                       2010
Purchases                             Shares       Amount        Shares       Amount       Shares      Amount
Excess cash flow and borrowings         7,479     $ 360,490       18,901     $ 787,697       5,707       $203,566
Option proceeds                         4,292       209,675        4,380       184,859       1,074         42,440

Total                                  11,771     $ 570,165       23,281     $ 972,556       6,781       $246,006

Option proceeds increased significantly in 2011 and 2012 due to optionholders 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.

Life Insurance. Life insurance is our largest insurance segment, with 2012 life premium representing 63% of total premium. Life underwriting income before other income and administrative expense represented 72% of the total in 2012. Additionally, investments supporting the reserves for life products produce the majority of excess investment income attributable to the investment segment.

Life insurance premium rose 5% to $1.81 billion in 2012 after having increased 4% in 2011 to $1.73 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)



                                        2012                         2011                         2010
                                                 % of                         % of                         % of
                                 Amount         Total         Amount         Total         Amount         Total
American Income Exclusive
Agency                         $   663,696          37 %    $   607,914          35 %    $   560,649          34 %
Direct Response                    630,111          35          593,650          34          566,604          34
Liberty National Exclusive
Agency                             281,723          15          288,308          17          294,587          18
Other Agencies                     232,994          13          236,372          14          241,859          14

                               $ 1,808,524         100 %    $ 1,726,244         100 %    $ 1,663,699         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 $1.90 billion at December 31, 2012, an increase of 4% over $1.81 billion a year earlier. Annualized life premium in force was $1.75 billion at December 31, 2010.

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)



                                             2012                        2011                        2010
                                                     % of                        % of                        % of
                                      Amount        Total         Amount        Total         Amount        Total
American Income Exclusive Agency     $ 158,609          46 %     $ 141,793          44 %     $ 137,554          42 %
Direct Response                        140,928          41         136,663          42         136,653          41
Liberty National Exclusive Agency       32,296          10          36,338          11          44,763          14
Other Agencies                          11,331           3          10,404           3          10,561           3

                                     $ 343,164         100 %     $ 325,198         100 %     $ 329,531         100 %

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)



                                             2012                        2011                        2010
                                                     % of                        % of                        % of
                                      Amount        Total         Amount        Total         Amount        Total
American Income Exclusive Agency     $ 126,223          49 %     $ 113,151          46 %     $ 110,751          45 %
Direct Response                         93,374          37          88,962          37          89,542          37
Liberty National Exclusive Agency       26,533          10          31,296          13          34,845          14
Other Agencies                           9,660           4           9,413           4          10,364           4

                                     $ 255,790         100 %     $ 242,822         100 %     $ 245,502         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 2012. Life premium for this agency rose 9% to $664 million, after having risen 8% in 2011. Net sales increased 12% in 2012 after having risen 3% in 2011. Net sales rose 8% in 2010. The average face amount of policies issued in 2012 was approximately $33 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 5,176 at December 31, 2012 compared with 4,381 a year earlier, an increase of 18%. The agent count increased 12% in 2011. 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. In 2011, we began 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 his or her level of experience and responsibilities.

The Direct Response Unit reaches the market through a variety of . . .