GLOBE LIFE INC. - FORM 10-Q - May 6, 2016

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EX-31.1 - EXHIBIT 31.1 - GLOBE LIFE INC.tmk201610-qq1exhibit311.htm
EX-31.2 - EXHIBIT 31.2 - GLOBE LIFE INC.tmk201610-qq1exhibit312.htm
EX-31.3 - EXHIBIT 31.3 - GLOBE LIFE INC.tmk201610-qq1exhibit313.htm
EX-32.1 - EXHIBIT 32.1 - GLOBE LIFE INC.tmk201610-qq1exhbit321.htm

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark one)
 
ý
Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 
For the quarterly period ended March 31, 2016
 
 
¨
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 1-8052
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, Texas
 
75070
(Address of principal executive offices)
 
(Zip Code)
Registrant’s telephone number, including area code (972) 569-4000
NONE
Former name, former address and former fiscal year, if changed since last report.

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    ý            No   ¨
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 during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes   ý            No   ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer
 
ý
  
Accelerated filer
 
¨
 
 
 
 
Non-accelerated filer
 
¨ (Do not check if a smaller reporting company)
  
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   ý
Indicate the number of shares outstanding for each of the issuer’s classes of common stock, as of the last practicable date.
 
CLASS
 
OUTSTANDING AT April 29, 2016
 
 
Common Stock,
$1.00 Par Value
 
120,650,716
 


INDEX
 
 
 
Page
 
 
 
 
Item 1.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
 
 
 
Item 1.
 
 
 
Item 1A.
 
 
 
Item 2.
 
 
 
Item 6.


PART I–FINANCIAL INFORMATION
Item 1.
Condensed Consolidated Financial Statements

TORCHMARK CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
(Dollar amounts in thousands)
 
March 31,
2016
 
December 31,
2015
Assets

 
 
Investments:



Fixed maturities, available for sale, at fair value (amortized cost: 2016–$13,489,492; 2015–$13,251,871)
$
14,459,605


$
13,758,024

Equity securities, at fair value (cost: 2016–$776; 2015–$776)
1,610


1,635

Policy loans
496,840


492,462

Other long-term investments
37,237


36,803

Short-term investments
144,671


54,766

Total investments
15,139,963

 
14,343,690

Cash
12,758


61,383

Accrued investment income
221,186


209,915

Other receivables
349,652


344,552

Deferred acquisition costs
3,656,449


3,617,135

Goodwill
441,591


441,591

Other assets
511,656


522,104

Assets held for sale
287,766


312,843

Total assets
$
20,621,021

 
$
19,853,213

Liabilities and Shareholders’ Equity



Liabilities:



Future policy benefits
$
12,394,378


$
12,245,811

Unearned and advance premiums
71,537


67,021

Policy claims and other benefits payable
269,198


272,898

Other policyholders’ funds
95,532


95,988

Total policy liabilities
12,830,645

 
12,681,718

Current and deferred income taxes payable
1,665,136


1,450,888

Other liabilities
382,821


380,158

Short-term debt
557,163


490,129

Long-term debt (fair value: 2016–$860,647; 2015–856,291)
743,953


743,733

Liabilities held for sale
49,560


51,035

Total liabilities
16,229,278

 
15,797,661

Commitments and Contingencies

 

Preferred stock, par value $1 per share–Authorized 5,000,000 shares; outstanding: -0- in 2016 and in 2015
—


—

Common stock, par value $1 per share–Authorized 320,000,000 shares; outstanding: (2016–130,218,183 issued, less 9,125,010 held in treasury and 2015–130,218,183 issued, less 7,848,231 held in treasury)
130,218


130,218

Additional paid-in capital
482,672


482,284

Accumulated other comprehensive income
535,475


231,947

Retained earnings
3,715,179


3,614,369

Treasury stock, at cost
(471,801
)

(403,266
)
Total shareholders’ equity
4,391,743

 
4,055,552

Total liabilities and shareholders’ equity
$
20,621,021

 
$
19,853,213

See accompanying Notes to Condensed Consolidated Financial Statements.

1

TORCHMARK CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(Dollar amounts in thousands except per share data)
 
 
Three Months Ended 
 March 31,
 
2016(1)
 
2015(2)
Revenue:
 
 
 
Life premium
$
544,151


$
513,342

Health premium
235,697


228,673

Other premium
12


41

Total premium
779,860

 
742,056

Net investment income
197,053


191,596

Realized investment gains
293


119

Other income
421


669

Total revenue
977,627

 
934,440

Benefits and expenses:
 
 
 
Life policyholder benefits
362,860


339,701

Health policyholder benefits
152,775


148,029

Other policyholder benefits
9,338


10,045

Total policyholder benefits
524,973

 
497,775

Amortization of deferred acquisition costs
118,806


110,660

Commissions, premium taxes, and non-deferred acquisition costs
61,602


57,105

Other operating expense
57,429


55,363

Interest expense
19,369


19,060

Total benefits and expenses
782,179

 
739,963

 
 
 
 
Income before income taxes
195,448

 
194,477

Income taxes
(61,874
)

(63,699
)
Income from continuing operations
133,574

 
130,778

 
 
 
 
Discontinued operations:





Income (loss) from discontinued operations, net of tax
(9,541
)

(9,130
)
Net income
$
124,033

 
$
121,648

 
 
 
 
Basic net income per share:
 
 
 
Continuing operations
$
1.10


$
1.03

Discontinued operations
(0.08
)

(0.07
)
Total basic net income per common share
$
1.02

 
$
0.96

 
 
 
 
Diluted net income per share:
 
 
 
Continuing operations
$
1.08


$
1.02

Discontinued operations
(0.07
)

(0.07
)
Total diluted net income per common share
$
1.01

 
$
0.95

 
 
 
 
Dividends declared per common share
$
0.14


$
0.14

(1) Due to the adoption of ASU 2016-09, certain balances related to excess tax benefits from stock compensation were adjusted prospectively as described in Note 2—New Accounting Standards.
(2) Certain prior year balances were adjusted to give effect to discontinued operations as described in Note 5—Discontinued Operations.
See accompanying Notes to Condensed Consolidated Financial Statements.

2

TORCHMARK CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited and in thousands)
 
 
Three Months Ended 
 March 31,
 
2016
 
2015
Net income
$
124,033

 
$
121,648

 
 
 
 
Other comprehensive income (loss):
 
 
 
 
 
 
 
Unrealized gains (losses) on securities:
 
 
 
Unrealized holding gains (losses) arising during period
465,157

 
266,582

Reclassification adjustment for (gains) losses on securities included in net income
(313
)
 
(119
)
Reclassification adjustment for amortization of (discount) and premium
(1,364
)
 
(1,672
)
Foreign exchange adjustment on securities recorded at fair value
455

 
(2,558
)
Unrealized gains (losses) on securities
463,935

 
262,233

Unrealized gains (losses) on other investments
658

 
1,143

Total unrealized investment gains (losses)
464,593

 
263,376

Less applicable (taxes) benefits
(162,589
)
 
(92,131
)
Unrealized investment gains (losses), net of tax
302,004

 
171,245

 
 
 
 
Unrealized gains (losses) attributable to deferred acquisition costs
(2,769
)
 
652

Less applicable (taxes) benefits
969

 
(228
)
Unrealized gains (losses) attributable to deferred acquisition costs, net of tax
(1,800
)
 
424

 
 
 
 
Foreign exchange translation adjustments, other than securities
1,760

 
(8,691
)
Less applicable (taxes) benefits
(540
)
 
2,729

Foreign exchange translation adjustments, other than securities, net of tax
1,220

 
(5,962
)
 
 
 
 
Pension adjustments
3,238

 
3,820

Less applicable (taxes) benefits
(1,134
)
 
(1,338
)
Pension adjustments, net of tax
2,104

 
2,482

 
 
 
 
Other comprehensive income (loss)
303,528

 
168,189

Comprehensive income (loss)
$
427,561

 
$
289,837

See accompanying Notes to Condensed Consolidated Financial Statements.

3

TORCHMARK CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited and in thousands)
 
Three Months Ended March 31,
 
2016(1) 
 
2015
Cash provided from operations
$
337,748

 
$
279,729

 
 
 
 
Cash provided from (used for) investment activities:
 
 
 
Investments sold or matured:
 
 
 
Fixed maturities available for sale—sold
14,331

 
11,444

Fixed maturities available for sale—matured, called, and repaid
44,622

 
127,554

Other long-term investments
8

 
51

Total long-term investments sold or matured
58,961

 
139,049

Acquisition of investments:
 
 
 
Fixed maturities—available for sale
(287,204
)
 
(291,798
)
Other long-term investments
(644
)
 
(19
)
Total investments acquired
(287,848
)
 
(291,817
)
Net increase in policy loans
(4,378
)
 
(2,608
)
Net (increase) decrease in short-term investments
(89,905
)
 
(76,006
)
Net change in payable or receivable for securities
2,990

 
—

Additions to property and equipment
(3,879
)
 
(6,080
)
Investment in low-income housing interests
(7,925
)
 
(6,865
)
Cash from (used for) investment activities
(331,984
)
 
(244,327
)
 
 
 
 
Cash provided from (used for) financing activities:
 
 
 
Issuance of common stock
3,763

 
11,823

Cash dividends paid to shareholders
(16,524
)
 
(16,210
)
Net borrowing (repayment) of commercial paper
66,899

 
20,523

Excess tax benefit from stock option exercises
—

 
4,952

Acquisition of treasury stock
(85,089
)
 
(110,619
)
Net receipts (payments) from deposit-type product
(17,641
)
 
(15,558
)
Cash provided from (used for) financing activities
(48,592
)
 
(105,089
)
 
 
 
 
Effect of foreign exchange rate changes on cash
(5,797
)
 
6,754

Net increase (decrease) in cash
(48,625
)
 
(62,933
)
Cash at beginning of year
61,383

 
66,019

Cash at end of period
$
12,758

 
$
3,086

(1) Due to the adoption of ASU 2016-09, the excess tax benefits from stock option exercises of $2 million for the quarter ended March 31, 2016 were presented as a component of operating activities in the same manner as other cash flows related to income taxes. See further discussion at Note 2—New Accounting Standards.



See accompanying Notes to Condensed Consolidated Financial Statements.

4
TORCHMARK CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(Dollar amounts in thousands except per share data)



Note 1—Significant Accounting Policies
Basis of Presentation: The accompanying condensed consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q. Therefore, they do not include all of the annual disclosures required by accounting principles generally accepted in the United States of America (GAAP). However, in the opinion of management, these statements include all adjustments, consisting of normal recurring adjustments, which are necessary for a fair presentation of the condensed consolidated financial position at March 31, 2016, and the condensed consolidated results of operations, comprehensive income, and cash flows for the periods ended March 31, 2016 and 2015. The interim period condensed consolidated financial statements should be read in conjunction with the Consolidated Financial Statements that are included in the Form 10-K filed with the Securities Exchange Commission (SEC) on February 26, 2016.
Note 2—New Accounting Standards

Accounting Pronouncements Adopted

ASU 2014-15: In August 2014, the FASB issued Accounting Standards Update No. 2014-15, Presentation of Financial Statements—Going Concern (Subtopic 205-40) (ASU 2014-15). This accounting standard requires management to perform interim and annual assessments of the entity's ability to continue its business operations within one year of the date of issuance of its financial statements. The Company must then provide certain disclosure if there is substantial doubt about its ability to continue as a going concern. As of January 1, 2016, the Company adopted this standard with no impact to the financial statements.
ASU 2016-09: In March 2016, the FASB issued Accounting Standards Update No. 2016-09, Compensation—Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting (ASU 2016-09) to simplify certain aspects of accounting for share-based payment award transactions including: (a) income tax consequences; (b) classification in the statement of cash flows; and (c) accounting for forfeitures.Torchmark elected to early adopt this standard as of January 1, 2016, as permitted. This new accounting standard primarily affects Torchmark's computations of net income and diluted shares outstanding and thus earnings per share.

While the intent of the adoption of this guidance is simplification, inherent changes in future share prices and volume of stock option exercises are expected to result in increased volatility in net income and earnings per share in future periods. As provided by the new standard, the adoption is prospective and thus will impact only 2016 and future periods.

Below is a listing of the effects of the adoption of this guidance:
•
Condensed consolidated statement of operations: The Company recorded $2 million in additional excess tax benefits as a component of income taxes, which resulted in an increase in net income as compared with the quarter ended March 31, 2015 when the excess tax benefits of $5 million were recorded as a component of additional paid-in capital on the balance sheet.
•
Weighted average diluted shares:The weighted average diluted shares outstanding were adjusted to exclude excess tax benefits from the assumed proceeds in the diluted shares calculation. This change resulted in diluted weighted average shares outstanding calculated of 123.3 million for the quarter ended March 31, 2016, as compared with 122.7 million as would have been calculated under the previous guidance.
•
Earnings per share: The adoption resulted in a $0.01 increase in earnings per share for the three months ended March 31, 2016.
•
Condensed consolidated statement of cash flows: The excess tax benefits related to share-based payments of $2 million were presented as a component of operating activities in the same manner as other cash flows related to income taxes. In prior years, the excess tax benefits were reclassified from operating activities to financing activities. The prior period amounts were not adjusted.


5
TORCHMARK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(Dollar amounts in thousands except per share data)

Note 2—New Accounting Standards (continued)


Accounting Pronouncements Not Yet Adopted
ASU 2016-02: In February 2016, the FASB issued Accounting Standards Update No. 2016-02, Leases (Topic 842), (ASU 2016-02) which requires all lessees to report a right-of-use asset and a lease liability for most leases. For lessors, the standard modifies the classification criteria and the accounting for sales-type and direct financing leases. The standard will become effective for the Company beginning January 1, 2019 and will require recognizing and measuring leases at the beginning of the earliest period presented using a modified retrospective approach. Early adoption is permitted. The Company is currently evaluating the standard to determine its impact.

Note 3—Supplemental Information about Changes to Accumulated Other Comprehensive Income

An analysis of the change in balance by component of Accumulated Other Comprehensive Income is as follows for the three month periods ended March 31, 2016 and 2015.
Components of Accumulated Other Comprehensive Income
 
 
Three Months Ended March 31, 2016
 
 
Available for
Sale Assets
 
Deferred
Acquisition
Costs
 
Foreign
Exchange
 
Pension
Adjustments
 
Total
Balance at January 1, 2016
 
$
332,333

 
$
(5,115
)
 
$
3,627

 
$
(98,898
)
 
$
231,947

Other comprehensive income (loss) before reclassifications, net of tax
 
303,094

 
(1,800
)
 
1,220

 
445

 
302,959

Reclassifications, net of tax
 
(1,090
)
 
—

 
—

 
1,659

 
569

Other comprehensive income (loss)
 
302,004

 
(1,800
)
 
1,220

 
2,104

 
303,528

Balance at March 31, 2016
 
$
634,337

 
$
(6,915
)
 
$
4,847

 
$
(96,794
)
 
$
535,475

 
 
 
 
 
 
 
 
 
 
 
 
 
Three Months Ended March 31, 2015
 
 
Available
for Sale
Assets
 
Deferred
Acquisition
Costs
 
Foreign
Exchange
 
Pension
Adjustments
 
Total
Balance at January 1, 2015
 
$
1,090,273

 
$
(10,758
)
 
$
17,386

 
$
(99,449
)
 
$
997,452

Other comprehensive income (loss) before reclassifications, net of tax
 
172,409

 
424

 
(5,962
)
 
117

 
166,988

Reclassifications, net of tax
 
(1,164
)
 
—

 
—

 
2,365

 
1,201

Other comprehensive income (loss)
 
171,245

 
424

 
(5,962
)
 
2,482

 
168,189

Balance at March 31, 2015
 
$
1,261,518

 
$
(10,334
)
 
$
11,424

 
$
(96,967
)
 
$
1,165,641



6

TORCHMARK CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(Dollar amounts in thousands except per share data)

Note 3—Supplemental Information about Changes to Accumulated Other Comprehensive Income (continued)



Reclassifications out of Accumulated Other Comprehensive Income are presented below for the three month periods ended March 31, 2016 and 2015.
Reclassification Adjustments
  
 
Three Months Ended 
 March 31,
 
Affected line items in the
Statement of Operations
 
 
2016
 
2015
 
Unrealized investment gains (losses) on available for sale assets:
 
 
 
 
 
 
Realized (gains) losses
 
$
(313
)
 
$
(119
)
 
Realized investment gains (losses)
Amortization of (discount) premium
 
(1,364
)
 
(1,672
)
 
Net investment income
Total before tax
 
(1,677
)
 
(1,791
)
 
 
Tax
 
587

 
627

 
Income Taxes
Total after tax
 
(1,090
)
 
(1,164
)
 
 
Pension adjustments:
 
 
 
 
 
 
Amortization of prior service cost
 
120

 
81

 
Other operating expenses
Amortization of actuarial gain (loss)
 
2,432

 
3,557

 
Other operating expenses
Total before tax
 
2,552

 
3,638

 
 
Tax
 
(893
)
 
(1,273
)
 
Income Taxes
Total after tax
 
1,659

 
2,365

 
 
Total reclassifications (after tax)
 
$
569

 
$
1,201

 
 


7
TORCHMARK CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(Dollar amounts in thousands except per share data)


Note 4—Investments
Portfolio Composition:
A summary of fixed maturities and equity securities available for sale by cost or amortized cost and estimated fair value at March 31, 2016 is as follows:
Portfolio Composition as of March 31, 2016
 
Cost or
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair Value(1)
 
% of Total
Fixed
Maturities(2)
Fixed maturities available for sale:
 
 
 
 
 
 
 
 
 
Bonds:
 
 
 
 
 
 
 
 
 
U.S. Government direct, guaranteed, and government-sponsored enterprises
$
371,811


$
13,985


$
(1,422
)

$
384,374


3
States, municipalities, and political subdivisions
1,281,548


156,149


(318
)

1,437,379


10
Foreign governments
21,338


2,037


—


23,375


—
Corporates, by sector:













Financial
2,731,785


301,713


(60,705
)

2,972,793


21
Utilities
1,981,725


292,523


(20,505
)

2,253,743


16
Energy
1,569,187


54,215


(182,124
)

1,441,278


10
Other corporate sectors
5,040,267


477,927


(113,580
)

5,404,614


37
Total corporates
11,322,964


1,126,378


(376,914
)

12,072,428


84
Collateralized debt obligations
62,370


14,169


(11,047
)

65,492


—
Other asset-backed securities
18,471


793


—


19,264


—
Redeemable preferred stocks, by sector:













Financial
382,357


48,911


(4,163
)

427,105


3
Utilities
28,633


1,555


—


30,188


—
Total redeemable preferred stocks
410,990


50,466


(4,163
)

457,293


3
Total fixed maturities
13,489,492


1,363,977


(393,864
)

14,459,605


100
Equity securities
776


834


—


1,610



Total fixed maturities and equity securities
$
13,490,268


$
1,364,811


$
(393,864
)

$
14,461,215



(1) Amounts reported on the balance sheet.
(2) At fair value.


8
TORCHMARK CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(Dollar amounts in thousands except per share data)

Note 4—Investments (continued)

A schedule of fixed maturities by contractual maturity date at March 31, 2016 is shown below on an amortized cost basis and on a fair value basis. Actual maturity dates could differ from contractual maturities due to call or prepayment provisions.
 
Amortized
Cost
 
Fair Value
Fixed maturities available for sale:
 
 
 
Due in one year or less
$
45,343

 
$
45,953

Due from one to five years
586,187

 
631,214

Due from five to ten years
1,049,319

 
1,148,015

Due from ten to twenty years
3,939,736

 
4,356,812

Due after twenty years
7,786,358

 
8,190,986

Mortgage-backed and asset-backed securities
82,549

 
86,625

 
$
13,489,492

 
$
14,459,605

Selected information about sales of fixed maturities is as follows.
Three Months Ended March 31, 2016
 
2016
 
2015
Proceeds from sales
$
14,331

 
$
11,444

Gross realized gains
495

 
84

Gross realized losses
(214
)
 
—


9
TORCHMARK CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(Dollar amounts in thousands except per share data)

Note 4—Investments (continued)

Fair Value Measurements:
The following table represents the fair value of assets measured on a recurring basis.
Fair Value Measurements at March 31, 2016 Using:
Description
 
Quoted Prices
in Active
Markets for
Identical
Assets
(Level 1)
 
Significant
Other
Observable
Inputs (Level 2)
 
Significant
Unobservable
Inputs (Level 3)
 
Total Fair
Value
Fixed maturities available for sale:
 
 
 
 
 
 
 
 
Bonds:
 
 
 
 
 
 
 
 
U.S. Government direct, guaranteed, and government-sponsored enterprises
 
$
8


$
384,366


$
—


$
384,374

States, municipalities, and political subdivisions
 
—


1,437,379


—


1,437,379

Foreign governments
 
—


23,375


—


23,375

Corporates, by sector:
 











Financial
 
—


2,910,620


62,173


2,972,793

Utilities
 
22,221


2,094,747


136,775


2,253,743

Energy
 
—


1,413,980


27,298


1,441,278

Other corporate sectors
 
—


5,076,059


328,555


5,404,614

Total corporates
 
22,221


11,495,406


554,801


12,072,428

Collateralized debt obligations
 
—


—


65,492


65,492

Other asset-backed securities
 
—


19,264


—


19,264

Redeemable preferred stocks, by sector:
 











Financial
 
10,244


416,861


—


427,105

Utilities
 
—


30,188


—


30,188

Total redeemable preferred stocks
 
10,244


447,049


—


457,293

Total fixed maturities
 
32,473


13,806,839


620,293


14,459,605

Equity securities
 
733


7


870


1,610

Total fixed maturities and equity securities
 
$
33,206


$
13,806,846


$
621,163


$
14,461,215

Percent of total
 
0.2
%
 
95.5
%
 
4.3
%
 
100
%

10
TORCHMARK CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(Dollar amounts in thousands except per share data)

Note 4—Investments (continued)

The following table represents an analysis of changes in fair value measurements using significant unobservable inputs (Level 3).
Analysis of Changes in Fair Value Measurements Using
Significant Unobservable Inputs (Level 3)
 
 
Three Months Ended March 31, 2016
 
Collateralized
Debt
Obligations
 
Corporates(1)
 
Equities
 
Total
Balance at January 1, 2016
$
70,382

 
$
530,806

 
$
870

 
$
602,058

Total gains or losses:
 
 
 
 
 
 
 
Included in realized gains/losses
—

 
—

 
—

 
—

Included in other comprehensive income
(3,598
)
 
9,568

 
—

 
5,970

Acquisitions
—

 
15,800

 
—

 
15,800

Sales
—

 
—

 
—

 
—

Amortization
1,334

 
4

 
—

 
1,338

Other(2)
(2,626
)
 
(1,377
)
 
—

 
(4,003
)
Transfers in and/or out of Level 3(3)
—

 
—

 
—

 
—

Balance at March 31, 2016
$
65,492

 
$
554,801

 
$
870

 
$
621,163

Percent of total fixed maturity and equity securities
0.5
%
 
3.8
%
 
—
%
 
4.3
%
 
 
 
 
 
 
 
 
 
Three Months Ended March 31, 2015
 
Collateralized
Debt
Obligations
 
Corporates(1)
 
Equities
 
Total
Balance at January 1, 2015
$
63,232

 
$
512,714

 
$
833

 
$
576,779

Total gains or losses:
 
 
 
 
 
 
 
Included in realized gains/losses
—

 
—

 
—

 
—

Included in other comprehensive income
13,556

 
8,626

 
—

 
22,182

Acquisitions
—

 
8,000

 
—

 
8,000

Sales
—

 
—

 
—

 
—

Amortization
1,410

 
4

 
—

 
1,414

Other(2)
(3,644
)
 
(1,331
)
 
—

 
(4,975
)
Transfers in and/or out of Level 3(3)
—

 
—

 
—

 
—

Balance at March 31, 2015
$
74,554

 
$
528,013

 
$
833

 
$
603,400

Percent of total fixed maturity and equity securities
0.5
%
 
3.6
%
 
—
%
 
4.1
%
(1) Includes redeemable preferred stocks.
(2) Includes capitalized interest, foreign exchange adjustments, and principal repayments.
(3) Considered to be transferred at the end of the period. Transfers into Level 3 occur when observable inputs are no longer available. Transfers out of Level 3 occur when observable inputs become available.


11
TORCHMARK CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(Dollar amounts in thousands except per share data)

Note 4—Investments (continued)

Other-Than-Temporary Impairments:

Based on the Company's evaluation of its fixed maturities in an unrealized loss position in accordance with the OTTI policy, the Company concluded that there were no other-than-temporary impairments during the three-month periods ended March 31, 2016 and 2015, respectively.

As of quarter end 2016, previously written down securities remaining in the portfolio were carried at a fair value of $57 million, or less than 1% of the fair value of the fixed maturity portfolio. Torchmark is continuously monitoring the market conditions impacting its portfolio, including holdings negatively impacted by recent low prices for oil and other commodities. While adverse market conditions for an extended duration could lead to some ratings downgrades among these holdings, Torchmark has the ability and intent to hold these investments to recovery, and does not expect to be required to sell any of its securities.

Unrealized Loss Analysis:

The following table discloses information about investments in an unrealized loss position.
 
 
Less than
Twelve
Months
 
Twelve
Months
or Longer
 
Total
Number of issues (CUSIP numbers) held:
 
 
 
 
 
 
As of March 31, 2016
 
171

 
148

 
319

As of December 31, 2015
 
480

 
75

 
555

Torchmark’s entire fixed-maturity and equity portfolio consisted of 1,572 issues at March 31, 2016 and 1,568 issues at December 31, 2015. The weighted average quality rating of all unrealized loss positions as of March 31, 2016 was BBB.

12
TORCHMARK CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(Dollar amounts in thousands except per share data)

Note 4—Investments (continued)

The following table discloses unrealized investment losses by class and major sector of investments at March 31, 2016 for the period of time in a loss position. Torchmark considers these investments to be only temporarily impaired.
Analysis of Gross Unrealized Investment Losses
At March 31, 2016
 
 
 
Less than
Twelve Months
 
Twelve Months
or Longer
 
Total
Description of Securities
 
Fair Value
 
Unrealized
Loss
 
Fair Value
 
Unrealized
Loss
 
Fair Value
 
Unrealized
Loss
Fixed maturities available for sale:
 
 
 
 
 
 
 
 
 
 
 
 
Investment grade securities:
 
 
 
 
 
 
 
 
 
 
 
 
Bonds:
 
 
 
 
 
 
 
 
 
 
 
 
U.S. Government direct, guaranteed, and government-sponsored enterprises
 
$
1,653


$
(1
)

$
44,002


$
(1,421
)

$
45,655

 
$
(1,422
)
States, municipalities and political subdivisions
 
5,226


(14
)

11,843


(60
)

17,069

 
(74
)
Corporates, by sector:
 












 
 
 
Financial
 
210,987


(9,112
)

103,332


(9,463
)

314,319

 
(18,575
)
Utilities
 
79,078


(10,368
)

90,495


(10,137
)

169,573

 
(20,505
)
Energy
 
581,465


(81,129
)

162,373


(45,263
)

743,838

 
(126,392
)
Other corporate sectors
 
471,242


(28,872
)

476,466


(25,555
)

947,708

 
(54,427
)
Total corporates
 
1,342,772

 
(129,481
)
 
832,666

 
(90,418
)
 
2,175,438

 
(219,899
)
Redeemable preferred stocks, by sector:
 












 
 
 
Financial
 
23,565


(343
)

—


—


23,565

 
(343
)
Total redeemable preferred stocks
 
23,565

 
(343
)
 
—

 
—

 
23,565

 
(343
)
Total investment grade securities
 
1,373,216

 
(129,839
)
 
888,511

 
(91,899
)
 
2,261,727

 
(221,738
)
Below investment grade securities:
 












 
 
 
Bonds:
 












 
 
 
States, municipalities and political subdivisions
 
—


—


310


(244
)

310

 
(244
)
Corporates, by sector:
 












 
 
 
Financial
 
—


—


63,652


(42,130
)

63,652

 
(42,130
)
Energy
 
27,193


(6,449
)

81,174


(49,283
)

108,367

 
(55,732
)
Other corporate sectors
 
113,767


(22,808
)

111,801


(36,345
)

225,568

 
(59,153
)
Total corporates
 
140,960

 
(29,257
)
 
256,627

 
(127,758
)
 
397,587

 
(157,015
)
Collateralized debt obligations
 
—


—


8,953


(11,047
)

8,953

 
(11,047
)
Redeemable preferred stocks, by sector:
 












 
 
 
Financial
 
—


—


23,329


(3,820
)

23,329

 
(3,820
)
Total redeemable preferred stocks
 
—

 
—

 
23,329

 
(3,820
)
 
23,329

 
(3,820
)
Total below investment grade securities
 
140,960

 
(29,257
)
 
289,219

 
(142,869
)
 
430,179

 
(172,126
)
Total fixed maturities
 
$
1,514,176

 
$
(159,096
)
 
$
1,177,730

 
$
(234,768
)
 
$
2,691,906

 
$
(393,864
)


13
TORCHMARK CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(Dollar amounts in thousands except per share data)


Note 5—Discontinued Operations

At December 31, 2015, Torchmark met the criteria to account for its Medicare Part D business as a discontinued operation and expects the business to be sold during 2016. Historically, the business was a reportable segment. However, Torchmark no longer emphasizes its Medicare Part D business due to declining margins, increased risks, higher drug costs, and increased administrative and compliance costs. Management believes this sale will allow the Company to better focus on its core protection life and health insurance businesses as well as provide additional capital to invest.

The net assets held for sale at March 31, 2016 and December 31, 2015 were as follows:

 
March 31, 2016
 
December 31, 2015
Assets:



Due premiums
$
5,084


$
8,041

Other receivables(1)
265,818


287,765

Deferred acquisition costs
16,864


17,037

Total assets held for sale
287,766


312,843





Liabilities:



Unearned and advance premiums
3,559


806

Policy claims and other benefits payable
11,010


12,309

Risk sharing payable
26,754


23,837

Current and deferred income taxes payable
8,466


13,604

Other
(229
)

479

Total liabilities held for sale
49,560


51,035





Net assets
$
238,206


$
261,808

(1) At March 31, 2016, receivables included $195 million from Centers for Medicare and Medicaid Services (CMS) and $71 million from drug manufacturer rebates. At December 31, 2015, the comparable amounts were $193 million and $95 million, respectively.

14

TORCHMARK CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(Dollar amounts in thousands except per share data)

Note 5—Discontinued Operations (continued)


Income from discontinued operations for the three months ended March 31, 2016 and 2015 was as follows:
 
Three Months Ended March 31,
 
2016
 
2015
Revenue:



Health premium
$
54,699


$
88,092





Benefits and expenses:



Health policyholder benefits
61,481


94,122

Amortization of deferred acquisition costs
1,008


603

Commissions, premium taxes, and non-deferred acquisition expenses
5,109


6,163

Other operating expense
1,780


1,249

Total benefits and expenses
69,378


102,137





Income (loss) before income taxes for discontinued operations
(14,679
)

(14,045
)
Income taxes
5,138


4,915

Income (loss) from discontinued operations
$
(9,541
)

$
(9,130
)

Operating cash flows of the discontinued operations for the three months ended March 31, 2016 and 2015 were as follows:
 
Three Months Ended March 31,
 
2016
 
2015
Net cash provided from (used for) discontinued operations
$
14,061

 
$
(37,955
)

Note 6—Income Taxes

The effective income tax differed from the expected 35% rate as shown below:
 
Three Months Ended March 31,
 
2016

%

2015

%
Expected income taxes
$
68,407


35.0


$
68,067


35.0

Increase (reduction) in income taxes resulting from:







Low income housing investments
(4,828
)

(2.4
)

(4,723
)

(2.4
)
Share-based awards
(1,972
)
 
(1.0
)
 
—

 
—

Other
267


0.1


355


0.2

Income tax expense from continuing operations
$
61,874

 
31.7

 
$
63,699

 
32.8


The effective income tax rate for the three months ended March 31, 2016 differed from the effective income tax rate for the same period ended March 31, 2015 primarily as a result of the Company adopting ASU 2016-09 as of January 1, 2016. As a result of the adoption, the excess tax benefits related to share-based awards are now recorded through income tax expense rather than additional paid-in capital. See Note 2—New Accounting Standards for further discussion.

15
TORCHMARK CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(Dollar amounts in thousands except per share data)


Note 7—Debt Transactions
On April 5, 2016, Torchmark completed the issuance and sale of $300 million in aggregate principal of Torchmark’s 6.125% Junior Subordinated Debentures due 2056. The debentures were sold pursuant to Torchmark’s shelf registration statement on Form S-3, filed September 25, 2015. The net proceeds from the sale of the debentures were $290 million, after giving effect to the underwriting discount and estimated expenses of the offering of the debentures. Torchmark intends to use the net proceeds from the offering of the debentures to repay the $250 million outstanding principal, plus accrued interest, on the 6.375% Senior Notes due June 15, 2016, and for general corporate purposes.

Note 8—Postretirement Benefit Plans
The following tables present a summary of post-retirement benefit costs by component.
Components of Post-Retirement Benefit Costs
 
 
Three Months Ended March 31,
 
Pension Benefits
 
Other Benefits
 
2016
 
2015
 
2016
 
2015
Service cost
$
3,894

 
$
3,990

 
$
—

 
$
—

Interest cost
5,432

 
5,003

 
212

 
203

Expected return on assets
(5,782
)
 
(5,323
)
 
—

 
—

Amortization:
 
 
 
 
 
 
 
Prior service cost
120

 
81

 
—

 
—

Actuarial (gain) loss
2,424

 
3,534

 
8

 
23

Direct recognition of expense
—

 
—

 
34

 
176

Net periodic benefit cost
$
6,088

 
$
7,285

 
$
254

 
$
402

 
The following table presents assets at fair value for the defined-benefit pension plans at March 31, 2016 and the prior-year end.
Pension Assets by Component
 
March 31, 2016
 
December 31, 2015
 
Amount
 
%
 
Amount
 
%
Corporate debt
$
149,670

 
49
 
$
146,381

 
47
Other fixed maturities
655

 
—
 
270

 
—
Equity securities
120,717

 
39
 
123,428

 
40
Short-term investments
13,273

 
4
 
15,593

 
5
Guaranteed annuity contract
17,209

 
6
 
17,082

 
6
Other
5,571

 
2
 
4,842

 
2
Total
$
307,095

 
100
 
$
307,596

 
100
The liability for the funded defined-benefit pension plans was $408 million at March 31, 2016 and $406 million at December 31, 2015. No cash contributions were made to the qualified pension plans during the three months ended March 31, 2016. Torchmark expects to make cash contributions to these plans during 2016 in an amount not to exceed $20 million. With respect to the Company’s non-qualified supplemental retirement plan, life insurance policies on the lives of plan participants have been established with an unaffiliated carrier to fund a portion of the Company’s obligations under the plan. These policies, as well as investments deposited with an unaffiliated trustee, were previously placed in a Rabbi Trust to provide for payment of the plan obligations. At March 31, 2016, the combined value of the insurance policies and investments in the Rabbi Trust to support plan liabilities were $81 million, compared with $79 million at

16

TORCHMARK CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(Dollar amounts in thousands except per share data)

Note 8—Postretirement Benefits (continued)

year-end 2015. Since this plan is non-qualified, the values of the insurance policies and investments are recorded as other assets in the Condensed Consolidated Balance Sheets and are not included in the chart of plan assets above. The liability for the non-qualified pension plan was $68 million at March 31, 2016 and $67 million at December 31, 2015.
 
Note 9—Earnings Per Share
A reconciliation of basic and diluted weighted-average shares outstanding is as follows:
 
For the Three Months Ended 
 March 31,
 
2016
 
2015
Basic weighted average shares outstanding
121,480,805

 
127,121,101

Weighted average dilutive options outstanding
1,831,938

 
1,465,751

Diluted weighted average shares outstanding
123,312,743

 
128,586,852

Antidilutive shares
1,489,562

 
605,188


As discussed earlier in Note 2—New Accounting Standards, the Company adopted ASU 2016-09 on January 1, 2016. The adoption resulted in an adjustment to the weighted average diluted shares outstanding to exclude excess tax benefits from the assumed proceeds in the diluted shares calculation. This change has been applied prospectively and resulted in diluted weighted average shares outstanding of 123.3 million for the quarter ended March 31, 2016, as compared with 122.7 million as would have been calculated under the previous guidance.


Note 10—Business Segments
Torchmark is comprised of life insurance companies which primarily market individual life and supplemental health insurance products through niche distribution channels to middle income Americans. Torchmark’s core operations are insurance marketing and underwriting, and management of its investments. The insurance marketing and underwriting operation is segmented by the types of insurance products offered: life, health, and annuity. Annuity revenue is classified as “Other premium.” Management’s measure of profitability for each insurance segment is insurance underwriting margin, which is underwriting income before other income and insurance administrative expenses. It represents the profit margin on insurance products before administrative expenses, and is calculated by deducting net policy obligations (claims incurred and change in reserves), commissions and other acquisition expenses from premium revenue. Torchmark further views the profitability of each insurance product segment by the marketing groups that distribute the products of that segment: direct response, independent agencies, or captive agencies.
Torchmark’s management prefers to evaluate the performance of its underwriting and investment activities separately, rather than allocating investment income to the underwriting results. As such, the investment function is presented as a stand-alone segment.
The investment segment includes the management of the investment portfolio, debt, and cash flow. Management’s measure of profitability for this segment is excess investment income, which is the income earned on the investment portfolio less the required interest on net policy liabilities and financing costs. Financing costs include the interest on Torchmark’s debt. Other income and insurance administrative expense are classified in a separate Other segment.
The majority of the Company’s required interest on net policy liabilities (benefit reserves less the deferred acquisition cost asset) is not credited to policyholder accounts. Instead, it is an actuarial assumption for discounting cash flows in the computation of benefit reserves and the amortization of the deferred acquisition cost asset. Investment income required to fund the required interest on net policy liabilities is removed from the investment segment and applied to the insurance segments to eliminate the effect of the required interest from the insurance segments. As a result, the investment segment measures net investment income against the required interest on net policy liabilities and financing costs, while the insurance segments simply measure premiums against benefits and expenses. We believe this

17
TORCHMARK CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(Dollar amounts in thousands except per share data)

Note 10—Business Segments (continued)

presentation facilitates a more meaningful analysis of the Company’s underwriting and investment performance as the underwriting results are based on premiums, claims, and expenses and are not affected by unanticipated fluctuations in investment yields.
 
As noted, Torchmark’s “core operations” are insurance and investment management. The insurance segments issue policies for which premiums are collected for the eventual payment of policy benefits. In addition to policy benefits, operating expenses are incurred including acquisition costs, administrative expenses, and taxes. Because life and health contracts can be long term, premium receipts in excess of current expenses are invested. Investment activities, conducted by the investment segment, focus on seeking quality investments with a yield and term appropriate to support the insurance product obligations. These investments generally consist of fixed maturities, and, over the long term, the expected yields are taken into account when setting insurance premium rates and product profitability expectations. As a result, fixed maturities are generally held for long periods to support the liabilities, and Torchmark generally expects to hold investments until maturity. Dispositions of investments occur from time to time, generally as a result of credit concerns, calls by issuers, or other factors usually beyond the control of management.

Dispositions are sometimes required in order to maintain the Company’s investment policies and objectives. Investments are also occasionally written down as a result of other-than-temporary impairment. Torchmark does not actively trade investments. As a result, realized gains and losses from the disposition and write down of investments are generally incidental to operations and are not considered a material factor in insurance pricing or product profitability. While from time to time these realized gains and losses could be significant to net income in the period in which they occur, they generally have a limited effect on the yield of the total investment portfolio. Further, because the proceeds of the disposals are reinvested in the portfolio, the disposals have little effect on the size of the portfolio and the income from the reinvestments is included in net investment income. Therefore, management removes realized investment gains and losses from results of core operations when evaluating the performance of the Company. For this reason, these gains and losses are excluded from Torchmark’s operating segments.
Torchmark accounts for its stock options and restricted stock under current accounting guidance requiring stock options and stock grants to be expensed based on fair value at the time of grant. Management considers stock compensation expense to be an expense of the Parent Company. Therefore, stock compensation expense is treated as a corporate expense in Torchmark’s segment analysis.


18
TORCHMARK CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(Dollar amounts in thousands except per share data)

Note 10—Business Segments (continued)

The following tables set forth a reconciliation of Torchmark’s revenues and operations by segment to its pretax income and each significant line item in its Condensed Consolidated Statements of Operations.
 
Reconciliation of Segment Operating Information to the Consolidated Statement of Operations
 
Three Months Ended March 31, 2016
 
Life
 
Health
 
Annuity
 
Investment
 
Other &
Corporate
 
Adjustments
 
  
 
Consolidated
Revenue:















Premium
$
544,151


$
235,697


$
12











$
779,860

Net investment income






$
197,053









197,053

Other income








$
465


$
(44
)

(2)

421

    Total revenue
544,151

 
235,697

 
12

 
197,053

 
465

 
(44
)



977,334

Expenses:














 
Policy benefits
362,860


152,775


9,338











524,973

Required interest on reserves
(142,011
)

(18,076
)

(13,092
)

173,179








—

Required interest on DAC
44,202


5,742


224


(50,168
)







—

Amortization of acquisition costs
94,539


22,365


1,902










118,806

Commissions, premium taxes, and non-deferred acquisition costs
40,261


21,376


9








(44
)

(2)

61,602

Insurance administrative expense (1)












48,468







48,468

Parent expense












2,026







2,026

Stock compensation expense












6,935







6,935

Interest expense









19,369










19,369

Total expenses
399,851

 
184,182

 
(1,619
)

142,380

 
57,429

 
(44
)
 
 
 
782,179

Subtotal
144,300

 
51,515

 
1,631

 
54,673

 
(56,964
)
 
—

 
 
 
195,155

Nonoperating items
 
 
 
 
 
 
 
 
 
 
—

 
 
 
—

Measure of segment profitability (pretax)
$
144,300

 
$
51,515

 
$
1,631

 
$
54,673

 
$
(56,964
)
 
$
—

 
 
 
195,155

Deduct applicable income taxes
 
 
 
(61,771
)
Segment profits after tax
 
 
 
133,384

Add back income taxes applicable to segment profitability
 
 
 
61,771

Add (deduct) realized investment gains (losses)
 
   
 
293

Pretax income per Consolidated Statements of Operations
 
   
 
$
195,448


(1) Administrative expense is not allocated to insurance segments.
(2) Elimination of intersegment commission.


19
TORCHMARK CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(Dollar amounts in thousands except per share data)

Note 10—Business Segments (continued)

Reconciliation of Segment Operating Information to the Condensed Consolidated Statement of Operations
 
Three Months Ended March 31, 2015
 
Life

Health

Annuity

Investment

Other &
Corporate

Adjustments

 

Consolidated
Revenue:















Premium
$
513,342


$
228,673


$
41













$
742,056

Net investment income









$
191,596










191,596

Other income












$
722


$
(53
)

(2)

669

Total revenue
513,342

 
228,673

 
41

 
191,596

 
722

 
(53
)
 
 

934,321

Expenses:




















 
Policy benefits
339,701


148,029


10,045













497,775

Required interest on reserves
(136,185
)

(16,883
)

(13,369
)

166,437










—

Required interest on DAC
42,846


5,668


313


(48,827
)









—

Amortization of acquisition costs
88,528


20,184


1,948













110,660

Commissions, premium taxes, and non-deferred acquisition costs
37,049


20,098


11








(53
)

(2)

57,105

Insurance administrative expense (1)












45,951







45,951

Parent expense












2,173







2,173

Stock compensation expense












7,239







7,239

Interest expense









19,060










19,060

Total expenses
371,939

 
177,096

 
(1,052
)

136,670

 
55,363

 
(53
)
 
 
 
739,963

Subtotal
141,403

 
51,577

 
1,093

 
54,926

 
(54,641
)
 
—

 
 
 
194,358

Nonoperating items
 
 
 
 
 
 
 
 
 
 
—

 
 
 
—

Measure of segment profitability (pretax)
$
141,403

 
$
51,577

 
$
1,093

 
$
54,926

 
$
(54,641
)
 
$
—

 
 
 
194,358

Deduct applicable income taxes
 
 
 
(63,657
)
Segment profits after tax
 
 
 
130,701

Add back income taxes applicable to segment profitability
 
 
 
63,657

Add (deduct) realized investment gains (losses)
 
  
 
119

Pretax income per Consolidated Statements of Operations
 
  
 
$
194,477


(1) Administrative expense is not allocated to insurance segments.
(2) Elimination of intersegment commission.
(3) Certain prior year balances were adjusted to give effect to discontinued operations as described in Note 5—Discontinued Operations.




20
TORCHMARK CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(Dollar amounts in thousands except per share data)

Note 10—Business Segments (continued)

The following table summarizes the measures of segment profitability for comparison. It also reconciles segment profits to net income.
Analysis of Profitability by Segment
 
Three Months Ended March 31,
 
Increase (Decrease)
 
2016
 
2015
 
Amount
 
%
Life insurance underwriting margin
$
144,300


$
141,403


$
2,897

 
2

Health insurance underwriting margin
51,515


51,577


(62
)
 
—

Annuity underwriting margin
1,631


1,093


538

 
49

Excess investment income
54,673


54,926


(253
)
 
—

Other and corporate:




 
 
 
Other income
465


722


(257
)
 
(36
)
Administrative expense
(48,468
)

(45,951
)

(2,517
)
 
5

Corporate and adjustments
(8,961
)

(9,412
)

451

 
(5
)
Pre-tax total
195,155

 
194,358

 
797

 
—

Applicable taxes
(61,771
)

(63,657
)

1,886

 
(3
)
After-tax total, before discontinued operations
133,384

 
130,701

 
2,683

 
2

Discontinued operations (after tax)(1)
(9,541
)

(9,130
)

(411
)
 
5

After-tax total, after discontinued operations
123,843

 
121,571

 
2,272

 
2

Reconciling items, net of tax:




 
 
 
Realized gains (losses) - Investments
190


77


113

 
 
Net income
$
124,033

 
$
121,648

 
$
2,385

 
2


(1) Income (loss) from discontinued operations (after tax) is included for purpose of reconciling to net income.

21

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Results of Operations
Summary of Operations. Torchmark’s operations are segmented into its insurance underwriting and investment operations as described in Note 10—Business Segments. The measures of profitability described in Note 10—Business Segments are useful in evaluating the performance of the segments and the marketing groups within each insurance segment, because each of our distribution channels 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 10—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 three month periods ended March 31, 2016 and 2015. 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 three months of 2016 with the same period of 2015, unless otherwise noted. The following discussions are presented in the manner we view our operations, as described in Note 10—Business Segments.
Highlights, comparing the first three months of 2016 with the first three months of 2015. Net income per diluted share increased 6% to $1.01 from $0.95. Included in net income in 2016 were after-tax realized investment gains of $190 thousand compared with gains of $77 thousand in 2015. Realized investment gains and losses are presented more fully under the caption Realized Gains and Losses in this report.
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 Globe Life 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, 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 5% in 2016 to $780 million. Total net sales were flat at $136 million when compared with the same period in 2015. First-year collected premium was $113 million for the 2016 period, compared with $110 million for the 2015 period. The increase in first-year collected premium is primarily the result of prior year life insurance sales growth in the American Income Exclusive Agency.
Life insurance premium income grew 6% to $544 million. Life net sales were flat at $104 million when compared with the same period in 2015. First-year collected life premium grew 7% during the first three months of 2016 to $79 million over the same period in 2015 of $74 million. Life underwriting margin as a percent of premium was down to 27% as a result of higher than expected Globe Life Direct Response policy obligations and additional costs of supporting certain distribution channels. Underwriting income increased to $144 million for the first three months of 2016 compared with $141 million for the same period in 2015.
Health insurance premium income increased 3% to $236 million over the prior year total of $229 million. Health net sales fell 1% to $32 million for the three month period, primarily as a result of a 3% decrease in Medicare Supplement sales. First-year collected health premium fell 7% to $34 million. Health margins declined to 22%, with underwriting income of $52 million for the first three months of 2016, due to increased acquisition costs.


22

Insurance administrative expenses were up 5.5% in 2016 when compared with the prior year period. The increase in administrative expenses is primarily due to investments in information technology that will standardize and streamline operations and enhance the customer experience.
Excess investment income is defined as net investment income less the required interest on net policy liabilities and the interest cost associated with capital funding or “financing costs”. Excess investment income per diluted share increased 2% in 2016 to $0.44 from $0.43, while the dollar amount of excess investment income was flat at $55 million. The increase in per share excess investment income in relation to the flat dollar amount resulted from share purchases over the period, as discussed later in this report. Net investment income rose $5 million or 3% to $197 million, slightly below the 4% growth in our average investment portfolio at amortized cost. The average effective yield on the fixed-maturity portfolio, which represented 95% of our investments at amortized cost, decreased to 5.83% in the 2016 period from 5.87% in the prior period. Required interest rose 5% or $5 million to $123 million, in line with growth in average net policy liabilities. Financing costs were $19 million in both periods. Please refer to the discussion under Capital Resources for more information on debt and interest expense.
In the first three months of 2016, we invested new money in our fixed-maturity portfolio at an effective annual yield on new investments of 5.03%, compared with 4.47% in the same period of 2015, with an average rating of BBB+, and an average life of twenty six years. Approximately 94% of the portfolio at amortized cost was investment grade at March 31, 2016. Cash and short-term investments were $157 million at that date, compared with $116 million at December 31, 2015.
The net unrealized gain position in our fixed-maturity portfolio grew from $506 million at December 31, 2015 to $970 million during the first three months of 2016, primarily due to a decrease in Treasury rates during 2016. The fixed-maturity portfolio contains no commercial mortgage-backed securities. We have no direct investments in residential mortgages, nor are we a party to any derivative contracts, including credit default swaps. We do not participate in securities lending, we have no off-balance sheet investments, and we have only insignificant exposures to European Sovereign debt consisting of $2 million of German government bonds. Our exposure to Puerto Rican obligations at March 31, 2016 was less than $600 thousand.
We have an on-going share repurchase program which began in 1986 which is reviewed quarterly and is reaffirmed by the Board of Directors on an annual basis. The program was reaffirmed on August 5, 2015. 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 at the Parent 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 three month periods ended March 31, 2016 and 2015.
Analysis of Share Purchases
(Amounts in thousands, except per share amounts) 
 
Three Months Ended March 31,
 
2016
 
2015
 
Shares

Amount

Average
Price

Shares

Amount

Average
Price
Purchases with:











Excess cash flow
1,503


$
80,057


$
53.26


1,692


$
90,011


$
53.20

Option exercise proceeds
95


5,032


53.08


387


20,608


53.33

Total
1,598


$
85,089


$
53.25


2,079


$
110,619


$
53.22

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



23

A detailed discussion of our operations by component segment follows.
Life insurance, comparing the first three months of 2016 with the first three months of 2015. Life insurance is our predominant segment, representing 70% of premium income and 73% of insurance underwriting margin in the first three months of 2016. 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 6% to $544 million. The following table presents Torchmark’s life insurance premium by distribution channel.
Life Insurance
Premium
(Dollar amounts in thousands)
 
Three Months Ended March 31,

Increase
 
2016

2015

(Decrease)
 
Amount

% of
Total

Amount

% of
Total

Amount

%
American Income Exclusive Agency
$
220,402

 
41
 
$
202,041

 
39
 
$
18,361

 
9

Globe Life Direct Response
200,001

 
37
 
187,407

 
37
 
12,594

 
7

Liberty National Exclusive Agency
67,892

 
12
 
67,803

 
13
 
89

 
—

Other Agencies
55,856

 
10
 
56,091

 
11
 
(235
)
 
—

Total Life Premium
$
544,151

 
100
 
$
513,342

 
100
 
$
30,809

 
6

Net sales, defined earlier in this report as an indicator of new business production, were flat at $104 million. An analysis of life net sales by distribution channel is presented below.
Life Insurance
Net Sales
(Dollar amounts in thousands)
 
Three Months Ended March 31,

Increase
 
2016
 
2015
 
(Decrease)
 
Amount
 
% of
Total
 
Amount
 
% of
Total
 
Amount
 
%
American Income Exclusive Agency
$
50,240

 
48
 
$
47,144

 
46
 
$
3,096

 
7

Globe Life Direct Response
41,155

 
40
 
44,813

 
43
 
(3,658
)
 
(8
)
Liberty National Exclusive Agency
9,451

 
9
 
8,546

 
8
 
905

 
11

Other Agencies
3,000

 
3
 
3,392

 
3
 
(392
)
 
(12
)
Total Life Net Sales
$
103,846

 
100
 
$
103,895

 
100
 
$
(49
)
 
—

First-year collected life premium, defined earlier in this report, was $79 million in the 2016 period, rising 7%. First-year collected life premium by distribution channel is presented in the table below. 
Life Insurance
First-Year Collected Premium
(Dollar amounts in thousands)
 
Three Months Ended March 31,

Increase
 
2016

2015

(Decrease)
 
Amount

% of
Total

Amount

% of
Total

Amount

%
American Income Exclusive Agency
$
41,955

 
53
 
$
37,049

 
50
 
$
4,906

 
13

Globe Life Direct Response
26,959

 
34
 
27,080

 
37
 
(121
)
 
—

Liberty National Exclusive Agency
7,050

 
9
 
6,550

 
9
 
500

 
8

Other Agencies
2,967

 
4
 
2,933

 
4
 
34

 
1

Total
$
78,931

 
100
 
$
73,612

 
100
 
$
5,319

 
7



24

The American Income Exclusive Agency has historically marketed primarily to members of labor unions. While labor unions are still the core market for this agency, American Income has diversified in recent years by focusing heavily on other affinity groups and referrals to help ensure sustainable growth. The life business of this agency is Torchmark’s highest-margin life business and it is the largest contributor to life premium of any distribution channel at 41% of Torchmark’s total. This group produced premium income of $220 million, an increase of 9%. First-year collected premium was $42 million, an increase of 13%. Net sales rose 7% to $50 million. Sales growth in our captive agencies is generally dependent on growth in the size of the agency force. The American Income Agency's average agent count decreased 2% to 6,206 for the three months ended March 31, 2016 compared with 6,317 for the same period in 2015. The average agent count is based on the actual count at the end of each week during the period. Sales increased despite the decline in agent count due to increased agent productivity. The American Income Agency has been focusing on growing and strengthening middle management to support sustainable growth of the agency force. To accomplish this, we have placed an increased emphasis on agent training programs and financial incentives that appropriately reward agents at all levels for helping develop and train personnel. The agency continues to provide 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 responsibility.
The Globe Life 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 Globe Life Direct Response channel’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. We continually introduce new initiatives in this unit in an attempt to increase response rates.
While the juvenile market is an important source of sales, it also is a vehicle to reach the parents and grandparents of juvenile policyholders, who are more likely to respond favorably to a Globe Life Direct Response solicitation for life coverage on themselves than is the general adult population. Also, both juvenile policyholders and their parents are low acquisition-cost targets for sales of additional coverage over time.
Globe Life Direct Response’s life premium income rose 7% to $200 million, representing 37% of Torchmark’s total life premium in the first three months of 2016. Net sales of $41 million for this group decreased 8%. The sales decline was expected as we reduced insert media circulation to eliminate less profitable segments. First-year collected premium was $27 million for both periods.
The Liberty National Exclusive Agency markets individual and group life insurance to middle-income customers. Life premium income for this agency was $68 million in the 2016 and 2015 periods. First-year collected premium increased 8% to $7 million.
Net sales for the Liberty National Agency increased 11% to $9 million. This is the largest percentage increase of any of Torchmark's distributions channels.The Liberty average agent count increased 5% to 1,542 for the three months ended March 31, 2016 compared with 1,464 for the same period in 2015. We continue to execute our long term plan to grow this agency through expansion from small-town markets in the southeast to more densely populated areas with larger pools of potential agent recruits and customers. Expansion of this agency’s presence into more heavily populated, less-penetrated areas will help create long term agency growth. Additionally, our prospecting training program has helped to improve the ability of agents to develop new worksite marketing business.
The Other Agencies distribution channels primarily include independent agencies selling predominately life insurance. The Other Agencies contributed $56 million of life premium income, or 10% of Torchmark’s total in the first three months of 2016, but contributed only 3% of net sales for the period.

25

Life Insurance
Summary of Results
(Dollar amounts in thousands)
 
 
Three Months Ended March 31,

Increase
 
2016

2015

(Decrease)
 
Amount

% of
Premium

Amount

% of
Premium

Amount

%
Premium and policy charges
$
544,151

 
100
 
$
513,342

 
100
 
$
30,809

 
6
Net policy obligations
220,849

 
40
 
203,516

 
39
 
17,333

 
9
Commissions and acquisition expense
179,002

 
33
 
168,423

 
33
 
10,579

 
6
Insurance underwriting income before other income and administrative expense
$
144,300

 
27
 
$
141,403

 
28
 
$
2,897

 
2
Life insurance underwriting income before insurance administrative expense was $144 million in the first three months of 2016 compared with $141 million for the same period in 2015. As a percentage of premium, underwriting margins declined to 27% from 28%. The decrease in underwriting margin as a percentage of premium was due to higher Globe Life Direct Response policy obligations. The higher claims in the Globe Life Direct Response Unit primarily relate to policies issued since 2011 where additional prescription information was used in the underwriting process for certain business in order to improve the overall mortality. To date, improvements in actual mortality have been less than expected, causing higher than expected net policy obligations.
Health insurance, comparing the first three months of 2016 with the first three months of 2015. Health insurance sold by Torchmark includes primarily Medicare Supplement insurance, critical illness coverage, accident coverage, and other limited-benefit supplemental health products. In this analysis, all health coverage plans other than Medicare Supplement are classified as limited-benefit plans.
Health premium accounted for 30% of our total premium in the 2016 period, while the health underwriting margin accounted for 26% of total underwriting margin, reflective of the lower underwriting margin as a percent of premium for health compared with life insurance. As noted under the caption Life Insurance, we have emphasized life insurance sales relative to health, due to life’s superior profitability and its greater contribution to excess investment income.

Health premium increased 3% to $236 million in the 2016 period. Medicare Supplement premium increased 4% to $119 million, while other limited-benefit health premium increased 2% to $117 million.
Health net sales decreased 1% to $32 million. Medicare Supplement net sales decreased 3% to $13 million in 2016. Group sales can vary significantly from period to period. Limited-benefit net sales were flat at $18 million. Health first-year collected premium fell 7% to $34 million, due to a high level of group sales in the third and fourth quarter 2014.


26


The following table is an analysis of our health premium by distribution channel.

Health Insurance
Premium
(Dollar amounts in thousands)
 
Three Months Ended March 31,

Increase
 
2016

2015

(Decrease)
 
Amount

% of
Total

Amount

% of
Total

Amount

%
United American Independent Agency
 
 
 
 
 
 
 
 
 
 
 
Limited-benefit plans
$
3,330

 
 
 
$
4,275

 
 
 
$
(945
)
 
(22
)
Medicare Supplement
84,720

 
 
 
78,897

 
 
 
5,823

 
7

 
88,050

 
37
 
83,172

 
36
 
4,878

 
6

Family Heritage Agency
 
 
 
 
 
 
 
 
 
 
 
Limited-benefit plans
57,317

 
 
 
53,549

 
 
 
3,768

 
7

Medicare Supplement
—

 
 
 
—

 
 
 
—

 
—

 
57,317

 
24
 
53,549

 
23
 
3,768

 
7

Liberty National Exclusive Agency
 
 
 
 
 
 
 
 
 
 
 
Limited-benefit plans
35,550

 
 
 
36,135

 
 
 
(585
)
 
(2
)
Medicare Supplement
16,322

 
 
 
17,845

 
 
 
(1,523
)
 
(9
)
 
51,872

 
22
 
53,980

 
24
 
(2,108
)
 
(4
)
American Income Exclusive Agency
 
 
 
 
 
 
 
 
 
 
 
Limited-benefit plans
20,156

 
 
 
19,815

 
 
 
341

 
2

Medicare Supplement
78

 
 
 
97

 
 
 
(19
)
 
(20
)
 
20,234

 
9
 
19,912

 
9
 
322

 
2

Direct Response
 
 
 
 
 
 
 
 
 
 
 
Limited-benefit plans
177

 
 
 
263

 
 
 
(86
)
 
(33
)
Medicare Supplement
18,047

 
 
 
17,797

 
 
 
250

 
1

 
18,224

 
8
 
18,060

 
8
 
164

 
1

Total Health Premium
 
 
 
 
 
 
 
 
 
 
 
Limited-benefit plans
116,530

 
49
 
114,037

 
50
 
2,493

 
2

Medicare Supplement
119,167

 
51
 
114,636

 
50
 
4,531

 
4

Total
$
235,697

 
100
 
$
228,673

 
100
 
$
7,024

 
3


27

Presented below is a table of health net sales by distribution channel.
Health Insurance
Net Sales
(Dollar amounts in thousands)
 
Three Months Ended March 31,

Increase
 
2016

2015

(Decrease)
 
Amount

% of
Total

Amount

% of
Total

Amount

%
United American Independent Agency
 
 
 
 
 
 
 
 
 
 
 
Limited-benefit plans
$
174

 
 
 
$
204

 
 
 
$
(30
)
 
(15
)
Medicare Supplement
11,885

 
 
 
12,066

 
 
 
(181
)
 
(2
)
 
12,059

 
38
 
12,270

 
38
 
(211
)
 
(2
)
Family Heritage Agency
 
 
 
 
 
 
 
 
 
 
 
Limited-benefit plans
10,629

 
 
 
11,675

 
 
 
(1,046
)
 
(9
)
Medicare Supplement
—

 
 
 
—

 
 
 
—

 
—

 
10,629

 
33
 
11,675

 
36
 
(1,046
)
 
(9
)
Liberty National Exclusive Agency
 
 
 
 
 
 
 
 
 
 
 
Limited-benefit plans
4,846

 
 
 
4,036

 
 
 
810

 
20

Medicare Supplement
1

 
 
 
40

 
 
 
(39
)
 
(98
)
 
4,847

 
15
 
4,076

 
12
 
771

 
19

American Income Exclusive Agency
 
 
 
 
 
 
 
 
 
 
 
Limited-benefit plans
2,821

 
 
 
2,567

 
 
 
254

 
10

Medicare Supplement
—

 
 
 
—

 
 
 
—

 
—

 
2,821

 
9
 
2,567

 
8
 
254

 
10

Direct Response
 
 
 
 
 
 
 
 
 
 
 
Limited-benefit plans
—

 
 
 
—

 
 
 
—

 
—

Medicare Supplement
1,572

 
 
 
1,809

 
 
 
(237
)
 
(13
)
 
1,572

 
5
 
1,809

 
6
 
(237
)
 
(13
)
Total Net Sales
 
 
 
 
 
 
 
 
 
 
 
Limited-benefit plans
18,470

 
58
 
18,482

 
57
 
(12
)
 
—

Medicare Supplement
13,458

 
42
 
13,915

 
43
 
(457
)
 
(3
)
Total
$
31,928

 
100
 
$
32,397

 
100
 
$
(469
)
 
(1
)

28

The following table presents health insurance first-year collected premium by distribution channel.
Health Insurance
First-Year Collected Premium
(Dollar amounts in thousands)
 
Three Months Ended March 31,

Increase
 
2016

2015

(Decrease)
 
Amount

% of
Total

Amount

% of
Total

Amount

%
United American Independent Agency
 
 
 
 
 
 
 
 
 
 
 
Limited-benefit plans
$
163

 
 
 
$
171

 
 
 
$
(8
)
 
(5
)
Medicare Supplement
15,557

 
 
 
14,996

 
 
 
561

 
4

 
15,720

 
47

 
15,167

 
42

 
553

 
4

Family Heritage Agency
 
 
 
 
 
 
 
 
 
 
 
Limited-benefit plans
9,873

 
 
 
9,507

 
 
 
366

 
4

Medicare Supplement
—

 
 
 
—

 
 
 
—

 
—

 
9,873

 
29

 
9,507

 
27

 
366

 
4

Liberty National Exclusive Agency
 
 
 
 
 
 
 
 
 
 
 
Limited-benefit plans
3,831

 
 
 
3,443

 
 
 
388

 
11

Medicare Supplement
1

 
 
 
59

 
 
 
(58
)
 
(98
)
 
3,832

 
12

 
3,502

 
10

 
330

 
9

American Income Exclusive Agency
 
 
 
 
 
 
 
 
 
 
 
Limited-benefit plans
3,100

 
 
 
2,616

 
 
 
484

 
19

Medicare Supplement
—

 
 
 
—

 
 
 
—

 
—

 
3,100

 
9

 
2,616

 
7

 
484

 
19

Direct Response
 
 
 
 
 
 
 
 
 
 
 
Limited-benefit plans
—

 
 
 
—

 
 
 
—

 
—

Medicare Supplement
1,074

 
 
 
5,168

 
 
 
(4,094
)
 
(79
)
 
1,074

 
3

 
5,168

 
14

 
(4,094
)
 
(79
)
Total First-Year Collected Premium


 
 
 
 
 
 
 
 
 
 
Limited-benefit plans
16,967

 
50

 
15,737

 
44

 
1,230

 
8

Medicare Supplement
16,632

 
50

 
20,223

 
56

 
(3,591
)
 
(18
)
Total
$
33,599

 
100

 
$
35,960

 
100

 
$
(2,361
)
 
(7
)

A discussion of health operations by distribution channel follows:
The UA Independent Agency consists of independent agencies appointed with Torchmark who may also sell for other companies. The UA Independent Agency was Torchmark’s largest health agency in terms of health premium income. Premium income was $88 million, representing 37% of Torchmark’s total health premium. Net sales were $12 million, or 38% of Torchmark’s health sales. This agency is Torchmark’s largest producer of Medicare Supplement insurance, with Medicare Supplement premium income of $85 million. The UA Independent Agency represents approximately 71% of all Torchmark Medicare Supplement premium and 88% of Medicare Supplement net sales. Medicare Supplement premium in this agency rose 7%. Total health premium also increased 6%. Net sales of the Medicare Supplement product decreased 2% in 2016; individual sales were up 2%, but group sales declined 10%. As noted earlier, Group Medicare Supplement sales have historically fluctuated from period to period.
The Family Heritage Agency primarily markets 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. Management expects to grow this agency through geographic expansion and continuing incorporation of Torchmark’s recruiting programs. The Family Heritage Agency contributed $11 million in net sales in the three months of 2016, compared with $12 million for the same period in 2015, a decrease of 9%. Health premium income was $57 million for the three month period of 2016, representing 24% of Torchmark’s health premium. This compared with $54 million or 23% of

29

health premium in the prior year period. The average agent count was 827 for the three months ended March 31, 2016, compared with 784 for the same period in 2015, an increase of 5%.
The Liberty National Exclusive Agency represented 22% of all Torchmark health premium income at $52 million in the three months of 2016. The Liberty Agency markets limited-benefit health supplemental products consisting primarily of critical illness insurance. Much of Liberty’s health business is now generated through worksite marketing targeting small businesses of 10 to 25 employees. In 2016, health premium income in the Liberty Agency declined $2 million to $52 million from prior year premium total of $54 million. Liberty’s health premium decline has been due primarily to its declining Medicare Supplement block.
Other distribution. Certain of our other distribution channels market health products, although their main emphasis is on life insurance. On a combined basis, they accounted for 17% of health premium in the 2016 period. The American Income Exclusive Agency primarily markets accident plans. The Direct Response group markets primarily Medicare Supplements to employer or union-sponsored groups. Direct Response added $2 million of Medicare Supplement net sales in 2016.

The following table presents underwriting margin data for health insurance.
Health Insurance
Summary of Results
(Dollar amounts in thousands)
 
Three Months Ended March 31,

Increase
 
2016

2015

(Decrease)
 
Amount

% of
Premium

Amount

% of
Premium

Amount

%
Premium and policy charges
$
235,697


100

$
228,673


100

$
7,024


3

Net policy obligations
134,699


57

131,146


57

3,553


3

Commissions and acquisition expense
49,483


21

45,950


20

3,533


8

Insurance underwriting income before other income and administrative expense
$
51,515


22

$
51,577


23

$
(62
)

—

Underwriting income for health insurance totaled $52 million in 2016, flat when compared to the same period in 2015. As a percentage of health premium, underwriting margins were down slightly to 22%, due to increased acquisition costs.
Annuities. Annuities represent an insignificant part of our business and are not expected to be an important part of our marketing strategy going forward.


30

Operating expenses, comparing the first three months of 2016 with the first three months of 2015. Operating expenses consist of insurance administrative expenses and parent company expenses. Also included is stock compensation expense, which is viewed by us as a parent company expense. Insurance administrative expenses relate to premium income for a given period; therefore, we measure those expenses as a percentage of premium income. Total expenses are measured as a percentage of total revenues. An analysis of operating expenses is shown below.
Operating Expenses Selected Information
(Dollar amounts in thousands)
 
Three Months Ended March 31,
 
2016

2015

Amount

% of
Premium

Amount

% of
Premium
Insurance administrative expenses:







Salaries
$
22,379


2.9

$
21,389


2.9
Other employee costs
7,924


1.0

8,214


1.1
Information technology costs
5,226

 
0.7
 
3,580

 
0.5
Legal costs
1,982


0.2

2,092


0.3
Other administrative costs
10,957


1.4

10,676


1.4
Total insurance administrative expenses
48,468


6.2

45,951


6.2
 
 
 
 
 
 
 
 
Parent company expense
2,026




2,173



Stock compensation expense
6,935




7,239



Total operating expenses, per Condensed Consolidated Statements of Operations
$
57,429




$
55,363



 
 
 
 
 
 
 
 
Insurance administrative expenses:







Increase (decrease) over prior year
5.5
%



6.3
 %


Total operating expenses:







Increase (decrease) over prior year
3.7
%



(1.1
)%


Insurance administrative expenses were up 5.5% in 2016 when compared with the prior year period. As a percentage of total premium, insurance administrative expenses were 6.2% in 2016, unchanged from the same period last year. Total operating expenses increased 3.7%. The increase in administrative expenses is primarily due to investments in information technology that will standardize and streamline operations and enhance the customer experience. The decline in stock compensation expense was primarily due to lower expense associated with restricted stock awards.
Investments (excess investment income), comparing the first three months of 2016 with the first three months of 2015. 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 10—Business Segments in the Notes to the Condensed Consolidated Financial Statements. It is defined as net investment income less the required interest on 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 $6.5 billion of cash flow to repurchase Torchmark shares (average split-adjusted price per share of $15.06) 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.

31

The following table summarizes Torchmark’s investment income, excess investment income, and excess investment income per diluted share.
Excess Investment Income
(Dollar amounts in thousands)
 
Three Months Ended March 31,

Increase
(Decrease)
 
2016

2015

Amount

%
Net investment income
$
197,053


$
191,596


$
5,457


3

Required interest on net insurance policy liabilities
(123,011
)

(117,610
)

(5,401
)

5

Financing costs:







Interest on funded debt
(17,822
)

(17,786
)

(36
)

—

Interest on short-term debt
(1,547
)

(1,274
)

(273
)

21

Total financing costs
(19,369
)

(19,060
)

(309
)

2

Excess investment income
$
54,673


$
54,926


$
(253
)

—

Excess investment income per diluted share
$
0.44


$
0.43


$
0.01


2

 
 
 
 
 
 
 
 
Average invested assets (at amortized cost)
$
14,050,732


$
13,553,190


$
497,542


4

Average net insurance policy liabilities (1)
8,792,062


8,444,320


347,742


4

Average debt and preferred securities (at amortized cost)
1,338,451


1,299,419


39,032


3

(1) Net of deferred acquisition costs, excluding the attributed unrealized gains and losses thereon.

Excess investment income for the 2016 period was flat at $55 million when compared with the same period in 2015. On a per share basis, excess investment income increased 2% as a result of our share repurchases over the past 12 months. Excess investment income has been negatively impacted during recent years by low interest rates and the turnover of higher yielding assets in the portfolio as well as certain aspects of Medicare Part D as discussed below.
Net investment income rose $5 million or 3% in 2016, slightly below the 4% increase in average invested assets (with fixed maturities at amortized cost) over the same period last year. The effective annual yield on the fixed maturity portfolio was 5.83% in the first three months of 2016, compared with 5.87% a year earlier. The reduction in the average portfolio yield rate was primarily a result of lower new money yield rates and reinvesting proceeds from bonds that were called in 2016 at yield rates less than the rates we earned on the bonds before they were called. We currently expect that the average turnover of fixed maturity assets during the next five years will not exceed 1% to 2% of the portfolio and that this turnover will not have a material negative impact on investment income.
Net investment income has also been negatively affected in 2016 by the CMS requirement for us to cover Medicare Part D claim costs in the current period that are ultimately the responsibility of the government, but are not reimbursed until the following year. We incurred extensive upfront costs in 2015 that will not be reimbursed by CMS until November 2016, and will continue to front additional significant costs in 2016 that will not be reimbursed until 2017. We also experience delays from the time certain claims are paid until related drug rebates are received from various pharmaceutical companies. These delays cause a lag in the timing of investable cash flows that result in lower investment income than would have been earned absent the delays. Due to these delays, our net investment income was reduced by approximately $3 million in the first three months of 2016, and we expect net investment income to be reduced by approximately $6 million for the remainder of 2016.
Should long-term interest rates rise, especially long-term rates, Torchmark would benefit due to higher net investment income on new purchases. We could withstand an increase in interest rates of approximately 55 to 65 basis points before the net unrealized gains on our fixed maturity portfolio as of March 31, 2016 would be eliminated (assuming there were no credit related valuation declines). Should interest rates increase further than that, we would not be concerned with potential interest-rate driven unrealized losses in our fixed maturity portfolio because we have the intent and, more importantly, the ability to hold our fixed maturities to maturity.
Required interest on net insurance policy liabilities reduces net investment income as it is the amount of net investment income considered by management necessary to “fund” the required interest included in the insurance segments. As such, it is removed from the investment segment and applied to the insurance segments to offset the

32

effect of the required interest from the insurance segments. As discussed in Note 10—Business Segments, management believes this provides a more meaningful analysis of the investment and 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 which mandates that interest rate assumptions for a particular block of business be “locked in” for the life of that block of business. Each calendar year, we set the discount rate to be used to calculate the benefit reserve liability and the amortization of 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 cash flow received in the future from policies of that issue year, and cannot be changed. 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 reserves and the deferred acquisition cost asset by issue year on the entire block of in force business. Business issued in the current year has very little impact on the overall weighted-average discount rate due to the size of our in force business.
Required interest on net insurance policy liabilities increased $5 million or 5% to $123 million, in line with the growth in average net interest-bearing insurance policy liabilities.
Financing costs on our debt increased 2% to $19 million. More information concerning debt can be found in the Capital Resources section of this report.
Investments (acquisitions), comparing the first three months of 2016 with the first three months of 2015. Torchmark’s investment policy calls for investing in fixed maturities that are investment grade and 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. We believe this strategy is appropriate because our cash flows from operations and invested assets are positive, stable and predictable. If longer-term securities that meet our quality and yield objectives are not available, we do not relax our quality objectives, but instead, consider investing in shorter or lower yielding securities, taking into consideration the slope of the yield curve and other factors.
The following table summarizes selected information for fixed-maturity purchases. The effective annual yield shown is the yield calculated to the “worst call date.” For non-callable bonds, the worst-call date is always the maturity date. For callable bonds, the worst-call date is the call date that produces the lowest yield (or the maturity date, if the yield calculated to the maturity date is lower than the yield calculated to each call date).

Fixed Maturity Acquisitions Selected Information
(Dollar amounts in thousands)
 
 
Three Months Ended March 31,
 
2016

2015
Cost of acquisitions:



Investment-grade corporate securities
$
278,713


$
277,378

Other
8,491


14,420

Total fixed-maturity acquisitions
$
287,204


$
291,798

Effective annual yield(1)
5.03
%
 
4.47
%
Average life, in years to:
 
 
 
Next call
25.6

 
28.0

Maturity
25.9

 
28.8

Average rating
BBB+

 
BBB+


(1) One-year compounded yield on a tax-equivalent basis. The yield on tax-exempt securities is adjusted to produce a yield equivalent to the pretax yield on taxable securities.
Acquisitions in both periods consisted primarily of corporate bonds, with securities spanning a diversified range of issuers, industry sectors, and geographical regions. All of the acquired securities were investment grade.

33

Investments (portfolio composition). The composition of the investment portfolio at book value on March 31, 2016 was as follows:
Invested Assets At March 31, 2016
(Dollar amounts in thousands)
 

Amount

% of
Total
Fixed maturities(at amortized cost)
$
13,489,492

 
95
Equities (at cost)
776

 
—
Policy loans
496,840

 
4
Other long-term investments
37,237

 
—
Short-term investments
144,671

 
1
Total
$
14,169,016

 
100
Approximately 95% of our investments at book value are in a diversified fixed-maturity portfolio. Policy loans, which are secured by policy cash values, make up approximately 4% of our investments. We also have insignificant investments in equity securities and other long-term investments. 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.


34

Fixed Maturities. The following table summarizes certain information about the major corporate sectors and security types held in our fixed-maturity portfolio at March 31, 2016.
Fixed Maturities by Sector
(Dollar amounts in thousands)
 

Below Investment Grade

Total FIxed Maturities

% of Total Fixed Maturities
 
 
Cost or
Amortized
Cost

Gross
Unrealized
Gains

Gross
Unrealized
Losses

Fair
Value

Cost or
Amortized
Cost

Gross
Unrealized
Gains

Gross
Unrealized
Losses

Fair
Value

At Amortized Cost
At Fair Value
 
 
Corporates:



















 

 


 
Financial


























 
Insurance - life, health, P&C
$
58,502


$
3,809


$
(9,132
)

$
53,179


$
1,960,200


$
230,340


$
(26,450
)

$
2,164,090


15
15
 
Banks
41,594


509


(3,820
)

38,283


634,864


75,622


(4,406
)

706,080


5
5
 
Other financial
74,954


—


(32,998
)

41,956


519,078


44,662


(34,012
)

529,728


3
4
 
Total financial
175,050


4,318


(45,950
)

133,418


3,114,142


350,624


(64,868
)

3,399,898


23
24
 
Utilities


























 
Electric
9,645


1,273


—


10,918


1,565,675


254,384


(16,348
)

1,803,711


12
12
 
Gas and water
—


—


—


—


444,683


39,694


(4,157
)

480,220


3
4
 
Total utilities
9,645


1,273


—


10,918


2,010,358


294,078


(20,505
)

2,283,931


15
16
 
Industrial - Energy


























 
Pipelines
45,413


—


(15,120
)

30,293


831,060


29,078


(90,696
)

769,442


6
5
 
Exploration and production
32,919


130


(5,993
)

27,056


532,405


14,534


(55,819
)

491,120


4
3
 
Oil field services
38,947


—


(9,568
)

29,379


87,973


4,730


(9,797
)

82,906


1
1
 
Refiner
—


—


—


—


63,049


5,873


(761
)

68,161


—
—
 
Driller
54,700


—


(25,051
)

29,649


54,700


—


(25,051
)

29,649


—
—
 
Total energy
171,979


130


(55,732
)

116,377


1,569,187


54,215


(182,124
)

1,441,278


12
10
 
Industrial - Basic materials


























 
Chemicals
—


—


—


—


522,802


27,510


(8,633
)

541,679


4
4
 
Metals and mining
107,138


—


(33,848
)

73,290


405,386


6,083


(52,073
)

359,396


3
2
 
Forestry products and paper
—


—


—


—


113,077


10,048


(1,403
)

121,722


1
1
 
Total basic materials
107,138


—


(33,848
)

73,290


1,041,265


43,641


(62,109
)

1,022,797


8
7
 
Industrial - Consumer, non-cyclical
13,424


1,548


—


14,972


1,236,239


134,170


(5,189
)

1,365,220


9
9
 
Other industrials
80,522


—


(12,297
)

68,225


1,108,935


128,679


(21,881
)

1,215,733


8
8
 
Industrial - Transportation
26,777


—


(5,611
)

21,166


566,643


62,024


(10,030
)

618,637


4
4
 
Other corporate sectors
123,812


1,739


(7,397
)

118,154


1,087,185


109,413


(14,371
)

1,182,227


8
8
 
Total corporates
708,347


9,008


(160,835
)

556,520


11,733,954


1,176,844


(381,077
)

12,529,721


87
87
 
Other fixed maturities:
























 
Government (U.S., municipal, and foreign)
554


—


(244
)

310


1,672,988


172,009


(1,739
)

1,843,258


13
13
 
Collateralized debt obligations
62,370


14,169


(11,047
)

65,492


62,370


14,169


(11,047
)

65,492


—
—
 
Other asset-backed securities
—


—


—


—


15,648


614


—


16,262


—
—
 
Mortgage-backed securities(1)
—


—


—


—


4,532


341


(1
)

4,872


—
—
 
Total fixed maturities
$
771,271


$
23,177


$
(172,126
)

$
622,322


$
13,489,492


$
1,363,977


$
(393,864
)

$
14,459,605


100
100
(1) Includes GNMA's.

35

At March 31, 2016, fixed maturities had a fair value of $14.5 billion, compared with $13.8 billion at December 31, 2015. The net unrealized gain position in the fixed-maturity portfolio increased from $506 million at December 31, 2015 to $970 million at March 31, 2016, primarily as a result of a decrease in Treasury rates. The March 31, 2016 net unrealized gain consisted of gross unrealized gains of $1.4 billion offset by $394 million of gross unrealized losses, compared with the December 31, 2015 net unrealized gain which consisted of a gross unrealized gain of $1.1 billion and a gross unrealized loss of $564 million.
Corporate securities, which consist of bonds and redeemable preferred stocks, were the largest component of the fixed maturity portfolio, representing 87% of amortized cost and 87% of fair value. The remainder of the portfolio is invested primarily in securities issued by the U.S. government, U.S. municipalities, and foreign governments. The Company holds insignificant amounts in collateralized debt obligations, asset-backed securities, and agency mortgage-backed securities. Corporate securities are diversified over a variety of industry sectors and issuers. At March 31, 2016, the financial, utility, and energy sectors represented approximately 23%, 15%, and 12%, respectively, of fixed maturities at amortized cost and 24%, 16%, and 10%, respectively, of fixed maturities at fair value. Otherwise, no single sector represented more than 10% of the corporate fixed maturity portfolio at either amortized cost or fair value. The total fixed maturity portfolio consists of 569 issuers, with 203 issuers within the financial, utility, and energy sectors.

The net unrealized gain of the fixed maturity portfolio increased $464 million from December 31, 2015. The financial, utility, energy and basic materials sectors experienced increases of $28 million, $78 million, $37 million, and $67 million, respectively, in net unrealized gains from December 31, 2015 to March 31, 2016. The fair values of the financial, utility, energy, and basic materials sectors increased approximately 3%, 4%, 3%, and 12%, respectively, while the fair value of the entire portfolio increased 5% for the period. The current low price of oil and other commodities has a negative impact on the operations of the companies whose bonds we hold in the energy and basic materials sectors. While a sustained period of low prices might lead to some downgrades in ratings, we don't expect to incur any losses from defaults in the foreseeable future.
An analysis of the fixed-maturity portfolio at March 31, 2016 by a composite quality rating is shown in the table below. The composite rating for each security 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.

Fixed Maturities by Rating
(Dollar amounts in thousands)
 
 
March 31, 2016

Amortized
Cost

%

Fair
Value

%
Investment grade:







AAA
$
667,043


5

$
711,845


5
AA
1,344,959


10

1,516,595


11
A
4,049,093


30

4,640,417


32
BBB+
2,588,579


19

2,819,085


19
BBB
2,717,382


20

2,844,582


20
BBB-
1,351,165


10

1,304,759


9
Investment grade
12,718,221


94

13,837,283


96
Below investment grade:







BB
468,688


4

363,033


2
B
185,792


1

138,022


1
Below B
116,791


1

121,267


1
Below investment grade
771,271


6

622,322


4

$
13,489,492


100

$
14,459,605


100
Of the $13.5 billion of fixed maturities at amortized cost as of March 31, 2016, $12.7 billion or 94% were investment grade with an average rating of A-. Below-investment-grade bonds were $771 million with an average rating of B+. Below-investment-grade bonds at amortized cost were 20% of our shareholders’ equity, excluding the effect of

36

unrealized gains and losses on fixed maturities as of March 31, 2016. Overall, the total portfolio was rated A- based on amortized cost, the same as at the end of 2015.
An analysis of the changes in our portfolio of below-investment-grade bonds at amortized cost during the first three months of 2016 is as follows:
Below-Investment-Grade Bonds
(Dollars amounts in thousands)
Balance as of December 31, 2015
$
640,150

Downgrades by rating agencies
161,524

Upgrades by rating agencies
(28,794
)
Disposals
(2,626
)
Amortization and other
1,017

Balance as of March 31, 2016
$
771,271


Our investment policy is to acquire only investment-grade obligations. Thus, any increases in below-investment-grade issues are a result of ratings downgrades of existing holdings. Our investment portfolio contains no commercial mortgage-backed securities. We have no direct investments in residential mortgages, nor do we have any counterparty risks as we are not a party to any derivative contracts, including credit default swaps. We do not participate in securities lending, we have no off-balance sheet investments, and we have only insignificant exposures to European Sovereign debt consisting of $2 million of German government bonds. Our exposure to Puerto Rican obligations at March 31, 2016 was less than $600 thousand.

Additional information concerning the fixed-maturity portfolio is as follows:
Fixed Maturity Portfolio Selected Information
 

March 31, 2016

December 31, 2015

March 31, 2015
Average annual effective yield (1)
5.81%

5.83%

5.86%
Average life, in years, to:





Next call (2)
17.9

17.8

17.9
Maturity (2)
20.5

20.3

20.5
Effective duration to:





Next call (2)(3)
10.5

10.2

11.1
Maturity (2)(3)
11.5

11.2

12.1

(1) Tax-equivalent basis. 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.
Realized Gains and Losses, comparing the first three months of 2016 with the first three months of 2015. As discussed in Note 10—Business Segments, our core business of providing insurance coverage requires us to maintain a large and diverse investment portfolio to support our insurance liabilities. From time to time, investments are disposed of or written down prior to maturity, resulting in realized gains or losses. Because these dispositions and writedowns are outside the course of our normal operations, management removes the effects of such gains and losses when evaluating its overall core operating results.

37

The following table summarizes our tax-effected realized gains (losses) by component.
Analysis of Realized Gains (Losses), Net of Tax
(Dollar amounts in thousands, except for per share data)
 
 
Three Months Ended March 31,
 
2016

2015
 
Amount

Per Share

Amount

Per Share
Fixed maturities and equities:







Investment sales
$
182


$
—


$
55


$
—

Investments called or tendered
21


—


22


—

Other
(13
)

—


—


—

Total
$
190


$
—


$
77


$
—



Financial Condition
Liquidity. Liquidity provides Torchmark with the ability to meet on demand the cash commitments required by our business operations and financial obligations. Our liquidity is evidenced by positive cash flow, a portfolio of marketable investments, and the availability of 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.
Parent Company liquidity. An important source of Parent Company liquidity is the dividends from the insurance subsidiaries noted above. These dividends are received throughout the year and are used by the Parent Company to pay dividends on common and preferred stock, interest and principal repayment requirements on Parent Company debt, and operating expenses of the Parent Company. In the first three months of 2016, the Parent Company received $96 million of cash dividends from subsidiaries, compared with $77 million in 2015. For the full year 2016, cash dividends from subsidiaries are expected to total approximately $420 million.
Additional sources of liquidity for the Parent Company are cash, intercompany receivables, and a credit facility. At March 31, 2016, the Parent Company had $66 million of invested cash and net intercompany receivables. The credit facility is discussed below.
Short-term borrowings. We have a credit facility with a group of lenders allowing for unsecured borrowings and stand-by letters of credit up to $750 million, which could be extended up to $1 billion. Up to $250 million in letters of credit can be issued against the facility. The facility is further designated as a back-up credit line for a commercial paper program under which we may either borrow from the credit line or issue commercial paper at any time, with total commercial paper outstanding not to exceed the facility maximum, less any letters of credit issued. Interest is charged at variable rates. The facility terminates in July 2019 and has no ratings-based acceleration triggers which would require early repayment. In accordance with the agreement, we are subject to certain covenants regarding capitalization. As of March 31, 2016, we were in full compliance with these covenants.


38

Included in short-term debt is the commercial paper outstanding, noted above, as well as the current maturity of long-term debt. At March 31, 2016, we had $250 million par value of our 6.375% Senior Notes due in June 15, 2016 classified as short-term debt.

The following table presents certain information about our commercial paper borrowings.
Short-term Borrowings - Credit Facility
(Dollar amounts in thousands)
 
 
At


March 31, 
 2016

December 31, 2015

March 31, 
 2015
Balance of commercial paper at end of period (par value)

$
307,576


$
240,544


$
259,000

Annualized interest rate

0.80
%

0.55
%

0.43
%
Letters of credit outstanding

$
177,000


$
177,000


$
198,000

Remaining amount available under credit line

265,424


332,456


293,000

 
 
Three Months Ended March 31,
 
 
2016
 
2015
Average balance of commercial paper outstanding during period (par value)
 
$
344,788


$
306,956

Daily-weighted average interest rate (annualized)
 
0.73
%

0.41
%
Maximum daily amount outstanding during period (par value)
 
$
412,676


$
356,500

Our balance of commercial paper outstanding at March 31, 2016 was $308 million compared with $241 million at the previous year end. We have had no difficulties in accessing the commercial paper market under this facility during the three-month periods ended March 31, 2016 and 2015.
In summary, Torchmark expects to have readily available funds for 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 Parent Company could generate additional funds through multiple sources including, but not limited to, the issuance of debt, an additional short-term credit facility, and intercompany borrowing.
Consolidated liquidity. Consolidated net cash inflows from operations were $338 million in the first three months of 2016, compared with $280 million in the same period of 2015. In addition to cash inflows from operations, our companies received proceeds from maturities, calls, and repayments of fixed maturities in the amount of $45 million during the 2016 period. As previously noted under the caption Short-term borrowings, we have in place a line of credit facility. The insurance companies have no additional outstanding credit facilities.
Cash and short term investments were $157 million at March 31, 2016, compared with $116 million at December 31, 2015. In addition to these liquid assets, the entire $14.5 billion (fair value at March 31, 2016) portfolio of fixed-income and equity securities is available for sale in the event of an unexpected need. Approximately 96% of our fixed-income and equity securities are publicly traded, freely tradable under SEC Rule 144, or qualified for resale under SEC Rule 144A . We generally expect to hold fixed-income securities to maturity, and even though these securities are classified as available for sale, we have the ability and intent to hold any securities which are temporarily impaired until they mature. Our strong cash flows from operations, investment maturities, and credit line availability make any need to sell securities for liquidity highly unlikely.
Capital Resources. Our insurance subsidiaries maintain capital at a level adequate to support their current operations and meet the requirements of the regulatory authorities and the rating agencies. Our insurance subsidiaries generally target a capital ratio of around 325% of Company Action Level required regulatory capital under Risk-Based Capital (RBC), a measure established by insurance regulatory authorities to monitor the adequacy of capital. The 325% target is considered sufficient because of our insurance companies’ strong reliable cash flows, the relatively low risk of their product mix, and because that ratio exceeds regulatory requirements and has been in line with rating agency expectations for Torchmark. As of December 31, 2015, our insurance subsidiaries had a consolidated RBC ratio of 317%. Although this was slightly below our targeted level of 325%, it was primarily due to lower Part D earnings and

39

fourth quarter downgrades greater than estimated. While we do not currently anticipate any significant changes to our targeted consolidated RBC level, should we believe that the RBC ratios of the insurance companies are being reduced due to downgrades in their investment portfolios that are temporary and that may reverse in the near future, we may choose to temporarily target a lower RBC ratio. We have available assets on hand and credit availability at the Parent Company to make additional contributions as necessary to maintain the targeted ratio. As discussed further in the next section below, the Parent Company will have approximately $40 million in additional proceeds from the $300 million debt offering in April at its disposal, if necessary, for additional capital or other financing needs of the insurance subsidiaries.
On a consolidated basis, Torchmark’s capital structure consists of short-term debt (comprised of the commercial paper outstanding discussed above and current maturities of funded debt), long-term funded debt, and shareholders’ equity. The outstanding long-term debt at book value was $744 million at March 31, 2016 and December 31, 2015. An analysis of long-term debt issues outstanding is as follows at March 31, 2016.
Long Term Debt at March 31, 2016
(Dollar amounts in thousands)
Instrument
Year
Due

Interest
Rate
 

Par
Value

Book
Value

Fair
Value
Senior Notes
2019

9.250
%
  

$
292,647


$
291,104


$
351,914

Senior Notes(1)
2022

3.800
%
  

150,000


147,981


153,233

Notes
2023

7.875
%
  

165,612


163,962


209,100

Junior Subordinated Debentures
2052

5.875
%
  

125,000


120,906


126,400

Junior Subordinated Debentures
2036

3.934
%
(2)

20,000


20,000


20,000

Total long-term debt





$
753,259


$
743,953


$
860,647

 
(1) An additional $150 million par value and book value is held by insurance subsidiaries that eliminates in consolidation.
(2) Interest paid at 3 month LIBOR plus 330 basis points, resets each quarter.
On April 5, 2016, Torchmark completed the issuance and sale of $300 million aggregate principal amount of Torchmark’s 6.125% Junior Subordinated Debentures due 2056. The debentures were sold pursuant to Torchmark’s shelf registration statement on Form S-3, filed September 25, 2015. The net proceeds from the sale of the debentures were $290 million, after giving effect to the underwriting discount and estimated expenses of the offering of the debentures. Torchmark intends to use the net proceeds from the offering of the debentures to repay the $250 million outstanding principal amount plus accrued interest on the 6.375% Senior Notes due June 15, 2016 and for general corporate purposes, including capital or other financing at our insurance subsidiaries if necessary. The Senior Notes are included in short-term debt.
As previously noted under the caption Results of Operations in this report, we acquired 1.5 million of our outstanding common shares under our share repurchase program during the first three months of 2016. These shares were acquired at a cost of $80 million (average of $53.26 per share), compared with purchases of 1.7 million shares at a cost of $90 million in the first three months of 2015.
On March 1, 2016, the Company announced that it had declared a quarterly dividend of $0.14 per share which was paid on April 29, 2016.
Shareholders’ equity was $4.4 billion at March 31, 2016. This compares with $4.1 billion at December 31, 2015 and $4.9 billion at March 31, 2015. During the three months since December 31, 2015, shareholders’ equity was increased by $300 million of after-tax unrealized gains in the fixed-maturity portfolio, as interest rates have decreased over the period. In addition, shareholders' equity was increased by net income of $124 million. Share purchases of $80 million noted above during the period reduced shareholders’ equity.
We are required by GAAP to revalue our available-for-sale fixed maturity portfolio to fair market value at the end of each accounting period. These changes, net of their associated impact on deferred acquisition costs and income tax, are reflected directly in shareholders’ equity.
While GAAP requires our fixed-maturity assets to be revalued, it does not permit interest-bearing insurance policy liabilities supported by those assets to be valued at fair value in a consistent manner, with changes in value applied directly to shareholders’ equity. However, due to the size of both the investment portfolio and our policy liabilities, this inconsistency in measurement can have a material impact on 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

40

intent and ability to hold our securities to maturity. As such, we do not expect to incur realized gains or losses due to fluctuations in the market value of fixed maturities caused by interest rate changes or losses caused by temporarily illiquid markets. Accordingly, management removes the effect of this rule when analyzing Torchmark’s balance sheet, capital structure, and financial ratios in order to provide a more consistent and meaningful portrayal of the Company’s financial position from period to period.
The following table presents selected data related to capital resources. Additionally, the table presents the effect of this GAAP requirement on relevant line items, so that investors and other financial statement users may determine its impact on our capital structure.
Selected Financial Data
(Dollar amounts in thousands, except for per share data)

At
 
March 31, 2016

December 31, 2015

March 31, 2015

GAAP

Effect of
Accounting
Rule
Requiring
Revaluation(1)

GAAP

Effect of
Accounting
Rule
Requiring
Revaluation(1)

GAAP

Effect of
Accounting
Rule
Requiring
Revaluation(1)
Fixed maturities
$
14,459,605

 
$
970,113

 
$
13,758,024

 
$
506,153

 
$
14,894,514

 
$
1,931,684

Deferred acquisition costs (2)
3,656,449

 
(10,638
)
 
3,617,135

 
(7,869
)
 
3,495,287

 
(15,899
)
Total assets
20,621,021

 
959,475

 
19,853,213

 
498,284

 
20,755,662

 
1,915,785

Short-term debt
557,163

 
—

 
490,129

 
—

 
258,921

 
—

Long-term debt
743,953

 
—

 
743,733

 
—

 
992,463

 
—

Shareholders' equity
4,391,743

 
623,659

 
4,055,552

 
323,885

 
4,883,628

 
1,245,260

 
 
 
 
 
 
 
 
 
 
 
 
Book value per diluted share
35.72

 
5.07

 
32.71

 
2.62

 
38.17

 
9.73

Debt to capitalization (3)
22.9
%
 
(2.8
)%
 
23.3
%
 
(1.5
)%
 
20.4
%
 
(5.2
)%
 
 
 
 
 
 
 
 
 
 
 
 
Diluted shares outstanding
122,954

 
 
 
123,996

 
 
 
127,935

 
 
Actual shares outstanding
121,093

 
 
 
122,370

 
 
 
126,502

 
 
 
(1) Amount added to (deducted from) comprehensive income to produce the stated GAAP item, per accounting rule ASC 320-10-35-1, formerly SFAS 115.
(2) Includes the value of insurance purchased.
(3) Torchmark’s debt covenants require that the effect of this accounting rule be removed to determine this ratio. This ratio is computed by dividing total debt by the sum of total debt and shareholders’ equity.
 
Interest coverage was 11.1 times in the 2016 three months, compared with 11.2 times in the 2015 period. Interest coverage is computed by dividing interest expense into the sum of pretax income and interest expense.


41

Cautionary Statements
We caution readers regarding certain forward-looking statements contained in the previous discussion and elsewhere in this document, and in any other statements made by, or on behalf of Torchmark whether or not in future filings with the Securities and Exchange Commission. Any statement that is not a historical fact or that might otherwise be considered an opinion or projection concerning Torchmark or its business, whether express or implied, is meant as and should be considered a forward-looking statement. Such statements represent management’s opinions concerning future operations, strategies, financial results or other developments. We specifically disclaim any obligation to update or revise any forward-looking statement because of new information, future developments, or otherwise.
Forward-looking statements are based upon estimates and assumptions that are subject to significant business, economic and competitive uncertainties, many of which are beyond our control. If these estimates or assumptions prove to be incorrect, the actual results of Torchmark may differ materially from the forward-looking statements made on the basis of such estimates or assumptions. Whether or not actual results differ materially from forward-looking statements may depend on numerous foreseeable and unforeseeable events or developments, which may be national in scope, related to the insurance industry generally, or applicable to Torchmark specifically. Such events or developments could include, but are not necessarily limited to:
 
1)
Changing general economic conditions leading to unexpected changes in lapse rates and/or sales of our policies, as well as levels of mortality, morbidity, and utilization of health care services that differ from Torchmark’s assumptions;
2)
Regulatory developments, including changes in governmental regulations (particularly those impacting taxes and changes to the Federal Medicare program that would affect Medicare Supplement and Medicare Part D insurance);
3)
Market trends in the senior-aged health care industry that provide alternatives to traditional Medicare (such as Health Maintenance Organizations and other managed care or private plans) and that could affect the sales of traditional Medicare Supplement insurance;
4)
Interest rate changes that affect product sales and/or investment portfolio yield;
5)
General economic, industry sector or individual debt issuers’ financial conditions that may affect the current market value of securities we own, or that may impair an issuer’s ability to make principal and/or interest payments due on those securities;
6)
Changes in pricing competition;
7)
Litigation results;
8)
Levels of administrative and operational efficiencies that differ from our assumptions;
9)
Our inability to obtain timely and appropriate premium rate increases for health insurance policies due to regulatory delay;
10)
The customer response to new products and marketing initiatives; and
11)
Reported amounts in the financial statements which are based on management’s estimates and judgments which may differ from the actual amounts ultimately realized.


42

Item 3. Quantitative and Qualitative Disclosures about Market Risk
There have been no quantitative or qualitative changes with respect to market risk exposure during the three months ended March 31, 2016.

Item 4. Controls and Procedures
Torchmark, under the direction of the Co-Chairmen and Chief Executive Officers and the Executive Vice President and Chief Financial Officer, has established disclosure controls and procedures that are designed to ensure that information required to be disclosed by Torchmark in the reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. The disclosure controls and procedures are also intended to ensure that such information is accumulated and communicated to Torchmark’s management, including the Co-Chairmen and Chief Executive Officers and the Executive Vice President and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosures.
As of the end of the fiscal quarter completed March 31, 2016, an evaluation was performed under the supervision and with the participation of Torchmark management, including the Co-Chairmen and Chief Executive Officers and the Executive Vice President and Chief Financial Officer, of Torchmark’s disclosure controls and procedures (as those terms are defined in Rule 13a-15(e) under the Securities Exchange Act of 1934). Based upon their evaluation, the Co-Chairmen and Chief Executive Officers and the Executive Vice President and Chief Financial Officer have concluded that Torchmark’s disclosure controls and procedures are effective as of the date of this Form 10-Q. In compliance with Section 302 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. §1350), each of these officers executed a Certification included as an exhibit to this Form 10-Q.
As of the date of this Form 10-Q for the quarter ended March 31, 2016, there have not been any changes in Torchmark’s internal control over financial reporting or in other factors that could significantly affect this control over financial reporting subsequent to the date of their evaluation which have materially affected, or are reasonably likely to materially affect, Torchmark’s internal control over financial reporting. No material weaknesses in such internal controls were identified in the evaluation and as a consequence, no corrective action was required to be taken.

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Part II – Other Information
Item 1. 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.

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 various 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. No estimate of range can be made at this time for loss contingencies related to possible administrative penalties or amounts that could be payable to the states for the escheatment of abandoned property.

Item 1A. Risk Factors
Torchmark has had no material changes to its risk factors.

Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities
    
(c)    Purchases of Certain Equity Securities by the Issuer and Others
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
January 1-31, 2016
 
812,999

 
$
54.35

 
812,999

 
 
February 1-29, 2016
 
467,440

 
50.72

 
467,440

 
 
March 1-31, 2016
 
317,486

 
54.16

 
317,486

 
 
At its August 5, 2015 meeting, the Board of Directors reaffirmed 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. The program has no defined expiration date or maximum shares to be repurchased.
Item 6. Exhibits
 
(a)
Exhibits
(31.1)
  
Rule 13a-14(a)/15d-14(a) Certification by Larry M. Hutchison
(31.2)
  
Rule 13a-14(a)/15d-14(a) Certification by Gary L. Coleman
(31.3)
  
Rule 13a-14(a)/15d-14(a) Certification by Frank M. Svoboda
(32.1)
  
Section 1350 Certification by Larry M. Hutchison, Gary L. Coleman, and Frank M. Svoboda
(101)
  
Interactive Data Files for the Torchmark Corporation Form 10-Q for the period ended March 31, 2016

44

SIGNATURES
Pursuant to the requirement of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized.
 
 
 
 
TORCHMARK CORPORATION
 
 
 
Date: May 6, 2016
 
 
/s/ Gary L. Coleman
 
 
 
Gary L. Coleman
 
 
 
Co-Chairman and Chief Executive Officer
 
 
 
Date: May 6, 2016
 
 
/s/ Larry M. Hutchison
 
 
 
Larry M. Hutchison
 
 
 
Co-Chairman and Chief Executive Officer
 
 
 
Date: May 6, 2016
 
 
/s/ Frank M. Svoboda
 
 
 
Frank M. Svoboda
 
 
 
Executive Vice President and Chief Financial Officer

45

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