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TMK > SEC Filings for TMK > Form 10-K on 28-Feb-2014All Recent SEC Filings

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Annual Report

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.


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.

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


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


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, 2013. 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.

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                      Analysis of Profitability by Segment

                         (Dollar amounts in thousands)

                                                                                             2013                     2012
                                              2013            2012            2011          Change         %         Change          %
Life insurance underwriting margin         $  545,059      $  509,476      $  460,963      $  35,583         7      $  48,513         11
Health insurance underwriting margin          231,807         197,341         188,990         34,466        17          8,351          4
Annuity underwriting margin                     3,939           3,465           2,345            474        14          1,120         48
Excess investment income                      218,826         236,644         258,986        (17,818 )      (8 )      (22,342 )       (9 )
Other insurance:
Other income                                    2,208           1,898           2,507            310        16           (609 )      (24 )
Administrative expense                       (178,898 )      (165,405 )      (159,109 )      (13,493 )       8         (6,296 )        4
Corporate and adjustments                     (34,137 )       (29,827 )       (22,647 )       (4,310 )      14         (7,180 )       32

Pre-tax total                                 788,804         753,592         732,035         35,212         5         21,557          3
Applicable taxes                             (258,137 )      (246,945 )      (238,335 )      (11,192 )       5         (8,610 )        4

Total                                         530,667         506,647         493,700         24,020         5         12,947          3
Realized gains (losses)-investments
(after tax)*                                    3,965          24,591          16,838        (20,626 )                  7,753
Loss on disposal of discontinued
operations (after tax)                              0               0            (455 )            0                      455
Acquisition expense and
adjustments-Family Heritage (after tax)           522          (1,914 )             0          2,436                   (1,914 )
Legal settlement expenses (after tax)          (5,931 )             0          (7,800 )       (5,931 )                  7,800
Guaranty Fund assessment (after tax)             (751 )             0               0           (751 )                      0
State administrative settlement (after
tax)                                                0               0          (4,486 )            0                    4,486
Loss on sale of equipment (after tax)               0               0            (636 )            0                      636

Net income                                 $  528,472      $  529,324      $  497,161      $   (852)         0      $  32,163          6

* 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 $528 million in 2013, compared with $529 million in 2012. Net income increased 6% in 2012 from $497 million in 2011. On a diluted per share basis, 2013 net income rose 5% to $5.68 after a 19% increase in 2012. Net income per diluted share in 2012 rose to $5.41 from $4.53 in 2011. 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 $.04, $0.25, and $0.15 in 2013, 2012, and 2011, 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 $494 million in 2011 to $507 million in 2012 to $531 million in 2013. The primary contributor to the growth in both 2013 and 2012 was the underwriting margin in our life insurance segment, in which margins rose $36 million in 2013 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 income in both years was our health insurance segment, which provided $34 million of additional margin in 2013 and $8 million in 2012. The 2013 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. The 2012 improvement was largely due to the increased volume in our Medicare Part D program. Both of the years 2013 and 2012 have been negatively impacted 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 related to required interest on net policy liabilities, discussed more fully under the caption Investments in this report. Especially in 2012, the impact of the lower interest-rate environment increased as an unusual number of calls, resulting

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from a new regulation affecting bank hybrid securities, caused us to replace these higher yielding securities with securities at lower yields. 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 2013 and 2012, there were increases in stock compensation expense which negatively affected the results during the year. Stock compensation increased $4 million in 2013 and $7 million in 2012. These increases 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 5% in 2013 to $3.77 billion, after having risen 6% in 2012 to $3.59 billion. Life premium rose 4% or $77 million in 2013 to $1.89 billion. Life premium increased $82 million in 2012 to $1.81 billion. Net investment income was essentially flat at $694 million in 2012, but rose 2% or $16 million in 2013. Health premium increased 11% to $1.17 billion in 2013 and contributed $119 million to 2013 revenue growth, after having gained 13% to $1.05 billion in 2012. Health premium contributed $117 million to 2012 revenue growth.

While life insurance premium has grown steadily in each of the three years ending December 31, 2013, margins as a percentage of premium have risen even more, rising in 2013 to 29% from 28% in 2012 and 27% in 2011. Segment profits for life insurance were not only positively affected by the premium growth, but also by improvements in persistency in both periods and reductions in non-deferred acquisition costs. Life net sales declined 1% in 2013 to $339 million, but increased 6% in 2012 to $343 million. Life insurance segment results are discussed further in this report under the caption Life Insurance.

With regard to health insurance, we primarily market Medicare Supplement insurance, Medicare Part D prescription drug insurance, other limited-benefit products including cancer, and accident and health products. As noted above, 2013 health premium was positively affected by the inclusion of Family Heritage's health premium for a full year. The 13% increase in 2012 health premium was a result of the addition of a large number of new low-income Medicare Part D auto-enrollees in the 2012 plan year. 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 premium was $447 million in 2013, increasing 50% over 2012 limited-benefit health premium of $298 million. This increase was a result of the inclusion of Family Heritage's business. Medicare Supplement premium was $417 million in 2013 but has declined slightly in each successive year from 2011 as lapses have exceeded new sales. Our Medicare Part D premium declined 6% in 2013 to $300 million after having risen 62% to $318 million in 2012. The 2012 increase was a result of the previously-noted addition of low-income auto-enrollees in the 2012 plan. Due to increased competition in the 2013 plan year, we experienced a decrease in 2013 Part D premium. For the 2014 Part D plan year, we were able to qualify for new auto-enrollees in 15 regions, compared with 7 in 2013. As a result, we expect growth in Part D sales and premium in 2014. See the discussion under Health Insurance for a more detailed discussion of health insurance results.

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

As previously mentioned, the investment segment's pretax profitability, or excess investment income, declined in both 2013 and 2012. 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, 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 2013, net investment income rose 2% (3% as in accordance with our segment analysis) while the portfolio (at amortized cost) grew 9%.

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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 increased 3% in 2012. The 2012 increase was primarily a result of two new debt offerings issued in the latter half of 2012 as described below.

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 96% of our invested assets at fair value consist of fixed maturities of which 96% were investment grade at December 31, 2013. 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.

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, 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 2011 through 2013, 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 under the caption Settlements, we were involved in certain issues in which we incurred settlement losses and expenses. In 2011, 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). 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). 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 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. 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

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Company and its shareholders. The following chart summarizes share purchase activity for each of the three years ended December 31, 2013.

                          Analysis of Share Purchases

                             (Amounts in thousands)

                                              2013                       2012                       2011
Purchases                             Shares       Amount        Shares       Amount        Shares       Amount
Excess cash flow and borrowings         5,520     $ 360,001        7,479     $ 360,490       18,901     $ 787,697
Option proceeds                         1,859       122,263        4,292       209,675        4,380       184,859

Total                                   7,379     $ 482,264       11,771     $ 570,165       23,281     $ 972,556

Option proceeds were unusually high in 2011 and 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.

Life Insurance. Life insurance is our largest insurance segment, with 2013 life premium representing 62% of total premium. Life underwriting income before other income and administrative expense represented 70% of the total in 2013. 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 $1.89 billion in 2013 after having increased 5% in 2012 to $1.81 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)

                                        2013                         2012                         2011
                                                 % of                         % of                         % of
                                 Amount         Total         Amount         Total         Amount         Total
American Income Exclusive
Agency                         $   715,366          38 %    $   663,696          37 %    $   607,914          35 %
Direct Response                    663,544          35          630,111          35          593,650          34
Liberty National Exclusive
Agency                             275,980          15          281,723          15          288,308          17
Other Agencies                     230,442          12          232,994          13          236,372          14

                               $ 1,885,332         100 %    $ 1,808,524         100 %    $ 1,726,244         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.

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Annualized life premium in force was $1.96 billion at December 31, 2013, an increase of 3% over $1.90 billion a year earlier. Annualized life premium in force was $1.81 billion at December 31, 2011.

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)

                                             2013                        2012                        2011
                                                     % of                        % of                        % of
                                      Amount        Total         Amount        Total         Amount        Total
American Income Exclusive Agency     $ 152,646          45 %     $ 158,609          46 %     $ 141,793          44 %
Direct Response                        144,363          43         140,928          41         136,663          42
Liberty National Exclusive Agency       31,050           9          32,296          10          36,338          11
Other Agencies                          11,000           3          11,331           3          10,404           3

                                     $ 339,059         100 %     $ 343,164         100 %     $ 325,198         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)

                                             2013                        2012                        2011
                                                     % of                        % of                        % of
                                      Amount        Total         Amount        Total         Amount        Total
American Income Exclusive Agency     $ 127,978          50 %     $ 126,223          49 %     $ 113,151          46 %
Direct Response                         93,089          36          93,374          37          88,962          37
Liberty National Exclusive Agency       25,580          10          26,533          10          31,296          13
Other Agencies                           9,962           4           9,660           4           9,413           4

                                     $ 256,609         100 %     $ 255,790         100 %     $ 242,822         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 2013. Life premium for this agency rose 8% to $715 million, after having risen 9% in 2012. Net sales declined 4% in 2013 to $153 million, after having risen 12% in 2012. Net sales rose 3% in 2011. The average face amount of policies issued in 2013 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 5,302 at December 31, 2013 compared with 5,176 a year earlier, an increase of 2%. The agent count increased 18% in 2012 and 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. 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. This agency has recently opened new offices in territories where there are existing offices, but . . .

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