GLOBE LIFE INC. - FORM 10-Q - November 7, 2017

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EX-32.1 - EXHIBIT 32.1 - GLOBE LIFE INC.tmk201710-qq3exhbit321.htm
EX-31.3 - EXHIBIT 31.3 - GLOBE LIFE INC.tmk201710-qq3exhibit313.htm
EX-31.2 - EXHIBIT 31.2 - GLOBE LIFE INC.tmk201710-qq3exhibit312.htm
EX-31.1 - EXHIBIT 31.1 - GLOBE LIFE INC.tmk201710-qq3exhibit311.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 September 30, 2017
 
 
¨
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
torchmarklogocolora01rgba18.jpg
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”, “smaller reporting company” and "emerging growth 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
 
¨
 
 
 
 
Emerging growth company
 
¨
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.
 
¨
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 October 31, 2017
 
 
Common Stock,
$1.00 Par Value
 
115,446,832
 


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)
 
September 30,
2017
 
December 31,
2016
Assets:

 
 
Investments:
 
 
 
Fixed maturities—available for sale, at fair value (amortized cost: 2017—$14,914,580; 2016—$14,188,050)
$
16,652,913

 
$
15,245,861

Policy loans
523,318

 
507,975

Other long-term investments
70,096

 
53,852

Short-term investments
65,482

 
72,040

Total investments
17,311,809

 
15,879,728

Cash
88,462

 
76,163

Accrued investment income
238,278

 
223,148

Other receivables
389,084

 
384,454

Deferred acquisition costs
3,911,800

 
3,783,158

Goodwill
441,591

 
441,591

Other assets
544,011

 
520,313

Assets related to discontinued operations
68,572

 
127,532

Total assets
$
22,993,607

 
$
21,436,087

Liabilities:
 
 
 
Future policy benefits
$
13,298,069

 
$
12,825,837

Unearned and advance premiums
61,536

 
64,017

Policy claims and other benefits payable
318,832

 
299,565

Other policyholders' funds
97,016

 
96,993

Total policy liabilities
13,775,453

 
13,286,412

Current and deferred income taxes payable
2,069,158

 
1,743,990

Other liabilities
492,175

 
413,760

Short-term debt
309,002

 
264,475

Long-term debt (estimated fair value: 2017—$1,243,232; 2016—$1,233,019)
1,130,806

 
1,133,165

Liabilities related to discontinued operations
49,328

 
27,424

Total liabilities
17,825,922

 
16,869,226

Commitments and Contingencies (Note 6)

 

Shareholders’ equity:
 
 
 
Preferred stock, par value $1 per share—Authorized 5,000,000 shares; outstanding: -0- in 2017 and 2016
—

 
—

Common stock, par value $1 per share—Authorized 320,000,000 shares; outstanding: (2017—127,218,183 issued, less 11,859,162 held in treasury and 2016—127,218,183 issued, less 9,187,075 held in treasury)
127,218

 
127,218

Additional paid-in capital
508,386

 
490,421

Accumulated other comprehensive income
1,039,302

 
577,574

Retained earnings
4,239,582

 
3,890,798

Treasury stock, at cost
(746,803
)
 
(519,150
)
Total shareholders’ equity
5,167,685

 
4,566,861

Total liabilities and shareholders’ equity
$
22,993,607

 
$
21,436,087


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 
 September 30,
 
Nine Months Ended 
 September 30,
 
2017
 
2016
 
2017
 
2016
Revenue:
 
 
 
 
 
 
 
Life premium
$
576,223

 
$
546,415

 
$
1,725,896

 
$
1,639,156

Health premium
242,991

 
236,987

 
730,557

 
709,936

Other premium
3

 
9

 
9

 
34

Total premium
819,217

 
783,411

 
2,456,462

 
2,349,126

Net investment income
213,872

 
202,720

 
634,930

 
601,415

Realized investment gains (losses)
12,595

 
3,482

 
6,142

 
7,780

Other income
331

 
160

 
1,140

 
963

Total revenue
1,046,015

 
989,773

 
3,098,674

 
2,959,284

 
 
 
 
 
 
 
 
Benefits and expenses:
 
 
 
 
 
 
 
Life policyholder benefits
386,445

 
369,546

 
1,168,383

 
1,101,748

Health policyholder benefits
155,774

 
153,351

 
470,104

 
459,387

Other policyholder benefits
9,000

 
9,255

 
26,923

 
27,475

Total policyholder benefits
551,219

 
532,152

 
1,665,410

 
1,588,610

Amortization of deferred acquisition costs
122,334

 
116,821

 
370,363

 
352,872

Commissions, premium taxes, and non-deferred acquisition costs
67,863

 
61,153

 
198,011

 
185,609

Other operating expense
63,019

 
57,805

 
187,788

 
173,080

Interest expense
20,970

 
20,381

 
62,825

 
62,860

Total benefits and expenses
825,405

 
788,312

 
2,484,397

 
2,363,031

 
 
 
 
 
 
 
 
Income before income taxes
220,610

 
201,461

 
614,277

 
596,253

Income taxes
(67,264
)
 
(59,551
)
 
(183,390
)
 
(181,475
)
Income from continuing operations
153,346

 
141,910

 
430,887

 
414,778

 
 
 
 
 
 
 
 
Income (loss) from discontinued operations, net of tax
(12
)
 
9,959

 
(3,739
)
 
(447
)
Net income
$
153,334

 
$
151,869

 
$
427,148

 
$
414,331

 
 
 
 
 
 
 
 
Basic net income (loss) per common share:
 
 
 

 
 
 
Continuing operations
$
1.32

 
$
1.19

 
$
3.69

 
$
3.44

Discontinued operations
—

 
0.08

 
(0.03
)
 
—

Total basic net income per common share
$
1.32

 
$
1.27

 
$
3.66

 
$
3.44

 
 
 
 
 
 
 
 
Diluted net income (loss) per common share:
 
 
 

 
 
 
Continuing operations
$
1.29

 
$
1.16

 
$
3.61

 
$
3.38

Discontinued operations
—

 
0.09

 
(0.03
)
 
—

Total diluted net income per common share
$
1.29

 
$
1.25

 
$
3.58

 
$
3.38

 
 
 
 
 
 
 
 
Dividends declared per common share
$
0.15

 
$
0.14

 
$
0.45

 
$
0.42






See accompanying Notes to Condensed Consolidated Financial Statements.

2

TORCHMARK CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
(Dollar amounts in thousands)
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2017
 
2016
 
2017
 
2016
Net income
$
153,334

 
$
151,869

 
$
427,148

 
$
414,331

 
 
 
 
 
 
 
 
Other comprehensive income (loss):
 
 
 
 
 
 
 
Unrealized investment gains (losses):
 
 
 
 
 
 
 
Unrealized gains (losses) on securities:
 
 
 
 
 
 
 
Unrealized holding gains (losses) arising during period
83,216

 
236,040

 
692,747

 
1,397,181

Reclassification adjustment for (gains) losses on securities included in net income
(12,910
)
 
(3,513
)
 
(13,264
)
 
(7,809
)
Reclassification adjustment for amortization of (discount) and premium
119

 
(927
)
 
(379
)
 
(3,495
)
Foreign exchange adjustment on securities recorded at fair value
1,173

 
(199
)
 
1,418

 
849

Unrealized gains (losses) on securities
71,598

 
231,401

 
680,522

 
1,386,726

Unrealized gains (losses) on other investments
473

 
1,685

 
3,544

 
3,568

Total unrealized investment gains (losses)
72,071

 
233,086


684,066


1,390,294

Less applicable tax (expense) benefit
(25,225
)
 
(81,583
)
 
(239,479
)
 
(486,573
)
Unrealized investment gains (losses), net of tax
46,846

 
151,503

 
444,587

 
903,721

 
 
 
 
 
 
 
 
Unrealized gains (losses) attributable to deferred acquisition costs
505

 
621

 
(992
)
 
(4,829
)
Less applicable tax (expense) benefit
(177
)
 
(216
)
 
347

 
1,691

Unrealized gains (losses) attributable to deferred acquisition costs, net of tax
328

 
405

 
(645
)
 
(3,138
)
 
 
 
 
 
 
 
 
Foreign exchange translation adjustments, other than securities
8,533

 
120

 
16,049

 
7,262

Less applicable tax (expense) benefit
(2,986
)
 
(16
)
 
(4,567
)
 
(2,454
)
Foreign exchange translation adjustments, other than securities, net of tax
5,547

 
104

 
11,482

 
4,808

 
 
 
 
 
 
 
 
Pension adjustments:
 
 
 
 
 
 
 
Amortization of pension costs
3,108

 
2,551

 
9,326

 
7,654

Experience gain (loss)
—

 
—

 
371

 
791

Pension adjustments
3,108

 
2,551

 
9,697

 
8,445

Less applicable tax (expense) benefit
(1,087
)
 
(894
)
 
(3,393
)
 
(2,957
)
Pension adjustments, net of tax
2,021

 
1,657

 
6,304

 
5,488

 
 
 
 
 
 
 
 
Other comprehensive income (loss)
54,742

 
153,669

 
461,728

 
910,879

Comprehensive income (loss)
$
208,076

 
$
305,538

 
$
888,876

 
$
1,325,210


See accompanying Notes to Condensed Consolidated Financial Statements.

3

TORCHMARK CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(Unaudited)
(Dollar amounts in thousands, except per share data)
 
 
Preferred Stock
 
Common Stock
 
Additional Paid-in Capital
 
Accumulated Other Comprehensive Income (Loss)
 
Retained Earnings
 
Treasury Stock
 
Total Shareholders’ Equity
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at January 1, 2016
 
$
—

 
$
130,218

 
$
482,284

 
$
231,947

 
$
3,614,369

 
$
(403,266
)
 
$
4,055,552

Comprehensive income (loss)
 

 

 

 
910,879

 
414,331

 

 
1,325,210

Common dividends declared ($0.42 per share)
 

 

 

 

 
(50,410
)
 

 
(50,410
)
Acquisition of treasury stock
 

 

 

 

 

 
(311,356
)
 
(311,356
)
Stock-based compensation
 

 

 
13,787

 

 
(2,224
)
 
8,771

 
20,334

Exercise of stock options
 

 

 


 

 
(42,040
)
 
89,093

 
47,053

Balance at September 30, 2016
 
$
—

 
$
130,218

 
$
496,071

 
$
1,142,826

 
$
3,934,026

 
$
(616,758
)
 
$
5,086,383

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Preferred Stock
 
Common Stock
 
Additional Paid-in Capital
 
Accumulated Other Comprehensive Income (Loss)
 
Retained Earnings
 
Treasury Stock
 
Total Shareholders’ Equity
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at January 1, 2017
 
$
—

 
$
127,218

 
$
490,421

 
$
577,574

 
$
3,890,798

 
$
(519,150
)
 
$
4,566,861

Comprehensive income (loss)
 

 

 

 
461,728

 
427,148

 

 
888,876

Common dividends declared ($0.45 per share)
 

 

 

 

 
(52,304
)
 

 
(52,304
)
Acquisition of treasury stock
 

 

 

 

 

 
(301,448
)
 
(301,448
)
Stock-based compensation
 

 

 
17,965

 

 
(606
)
 
7,450

 
24,809

Exercise of stock options
 

 

 


 

 
(25,454
)
 
66,345

 
40,891

Balance at September 30, 2017
 
$
—

 
$
127,218

 
$
508,386

 
$
1,039,302

 
$
4,239,582

 
$
(746,803
)
 
$
5,167,685















See accompanying Notes to Condensed Consolidated Financial Statements.

4

TORCHMARK CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(Dollar amounts in thousands)
 
Nine Months Ended September 30,
 
2017
 
2016
Cash provided from operating activities
$
1,085,842

 
$
971,926

 
 
 
 
Cash provided from (used for) investing activities:
 
 
 
Investments sold or matured:
 
 
 
Fixed maturities available for sale—sold
52,951

 
75,299

Fixed maturities available for sale—matured, called, and repaid
306,132

 
178,873

Other long-term investments
3,523

 
466

Total long-term investments sold or matured
362,606

 
254,638

Acquisition of investments:
 
 
 
Fixed maturities—available for sale
(1,042,705
)
 
(910,090
)
Other long-term investments
(16,775
)
 
(20,404
)
Total investments acquired
(1,059,480
)
 
(930,494
)
Net increase in policy loans
(15,343
)
 
(6,623
)
Net (increase) decrease in short-term investments
6,556

 
(11,138
)
Net change in payable or receivable for securities
—

 
94

Additions to property and equipment
(13,451
)
 
(10,138
)
Sale of other assets
18

 
767

Investment in low-income housing interests
(13,852
)
 
(16,126
)
Cash provided from (used for) investing activities
(732,946
)
 
(719,020
)
 
 
 
 
Cash provided from (used for) financing activities:
 
 
 
Issuance of common stock
40,891

 
47,053

Cash dividends paid to shareholders
(51,532
)
 
(50,258
)
Proceeds from issuance of debt
—

 
400,000

Payment for debt issuance costs
—

 
(9,638
)
Repayment of debt
(1,250
)
 
(250,000
)
Net borrowing (repayment) of commercial paper
42,652

 
25,266

Acquisition of treasury stock
(301,448
)
 
(311,356
)
Net receipts (payments) from deposit-type product
(65,912
)
 
(57,188
)
Cash provided from (used for) financing activities
(336,599
)
 
(206,121
)
 
 
 
 
Effect of foreign exchange rate changes on cash
(3,998
)
 
(3,268
)
Net increase (decrease) in cash
12,299

 
43,517

Cash at beginning of year
76,163

 
61,383

Cash at end of period
$
88,462

 
$
104,900










See accompanying Notes to Condensed Consolidated Financial Statements.

5
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 of Torchmark Corporation (Torchmark or alternatively, the Company) 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 September 30, 2017, and the condensed consolidated results of operations, comprehensive income, and cash flows for the periods ended September 30, 2017 and 2016. 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 27, 2017.
Note 2—New Accounting Standards
Accounting Pronouncements Not Yet Adopted
ASU 2016-01: In January 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2016-01, Financial Instruments—Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities, which primarily revises the classification and measurement of certain equity investments such that they will be measured at fair value through net income. Additionally, it eliminates the cost method for partnerships and joint ventures and requires these types of investments to be accounted for under the fair value through net income method or equity method. Lastly, the guidance will require certain disclosures associated with fair value of financial instruments. This standard will become effective for the Company beginning January 1, 2018. The adoption will not have a significant impact on the financial statements as we have limited ownership in equity investments and partnerships, representing less than 1% of total invested assets.
ASU 2016-02: In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842), which requires all lessees to report a right-of-use asset and a lease liability for leases with a term life greater than 12 months. Operating and financing leases will be recognized on the balance sheet going forward. Additional qualitative and quantitative disclosures will be required. This 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 does not expect the adoption to have a significant impact on the financial statements. Refer to the 2016 Form 10-K Note 15—Commitments and Contingencies for consideration of the noncancellable operating lease commitments. The Company does not have any lessor commitments.
ASU 2016-13: In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments to provide financial statement users with more decision-useful information about the expected credit losses on financial instruments as well as to change the loss impairment methodology for available-for-sale debt securities. This standard will become effective on January 1, 2020. The applicable section of the standard related to debt securities requires a prospective transition. The Company does not expect the adoption to have a significant impact on the financial statements as we have limited credit losses with respect to our available-for-sale portfolio.
ASU 2016-15: In August 2016, the FASB issued ASU No. 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments to provide uniformity in the classification of cash receipts and payments recorded in the statement of cash flows including debt prepayment or debt extinguishment costs, settlement of zero-coupon bonds, and proceeds from the settlement of insurance claims. This standard will become effective on January 1, 2018 and will not have a significant impact on the financial statements.
ASU 2016-16: In October 2016, the FASB issued ASU No. 2016-16, Income Taxes (Topic 740): Intra-Entity Transfer of Assets Other Than Inventory. This guidance was issued to improve the accounting for income tax consequences of intra-entity transfers of assets other than inventory by allowing the immediate recognition of the current and deferred income tax effects. Current guidance prohibits the recognition of current and deferred income taxes for an intra-entity transfer until the asset has been sold to an outside party. This new guidance should be applied on a modified retrospective

6
TORCHMARK CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(Dollar amounts in thousands, except per share data)

Note 2—New Accounting Standards (continued)


approach and will become effective on January 1, 2018. This adoption will not have a significant impact on the financial statements.
ASU 2017-04: In January 2017, the FASB issued ASU No. 2017-04, Intangibles—Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment. This guidance was issued to simplify the subsequent measurement of goodwill through the elimination of Step 2 from the goodwill impairment test which required a hypothetical purchase price allocation. It will become effective on January 1, 2020 and should be applied on a prospective basis. This adoption will not have a significant impact on the financial statements.
ASU 2017-07: In March 2017, the FASB issued ASU No. 2017-07, Compensation—Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost. This guidance was issued to simplify the reporting of pension costs by disaggregating the service-cost component from the other components of net benefit costs and reporting it separately on the income statement. The service-cost component is the only component of net benefit cost that will be eligible for capitalization. The guidance will become effective on January 1, 2018 with a retrospective transition method for separation of net benefit costs and a prospective transition method for the capitalization of service costs. The Company does not expect the adoption to have a significant impact on the financial statements as the change in pension capitalization should be less than 1% of Total Benefits and Expenses on the Consolidated Statement of Operations for the year.
ASU 2017-08: In March 2017, the FASB issued ASU No. 2017-08, Receivables—Nonrefundable Fees and Other Costs (Topic 310-20): Premium Amortization on Purchased Callable Debt Securities. This guidance was issued to shorten the amortization period for certain callable debt securities held at a premium. The guidance requires the premium to be amortized to the earliest call date. It will become effective on January 1, 2019 with early adoption permitted, including during interim periods. The adoption is to be applied on a modified retrospective basis through an adjustment to retained earnings. This adoption will not have a significant impact on the financial statements.
ASU 2017-09: In May 2017, the FASB issued ASU No. 2017-09, Compensation—Stock Compensation (Topic 718): Scope of Modification Accounting. This guidance was issued to provide clarity and guidance regarding changes to the terms or conditions of a share-based payment award that requires an entity to apply modification accounting. It will become effective on January 1, 2018 with early adoption permitted, including adoption in any interim periods. The Company does not expect the adoption to have a significant impact on the financial statements as modifications to stock compensation are infrequent.



7
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

An analysis of the change in balance by component of Accumulated Other Comprehensive Income is as follows for the three and nine month periods ended September 30, 2017 and 2016.

Components of Accumulated Other Comprehensive Income
 
 
Three Months Ended September 30, 2017
 
 
Available
for Sale
Assets
 
Deferred
Acquisition
Costs
 
Foreign
Exchange
 
Pension
Adjustments
 
Total
Balance at July 1, 2017
 
$
1,090,055

 
$
(7,655
)
 
$
10,902

 
$
(108,742
)
 
$
984,560

Other comprehensive income (loss) before reclassifications, net of tax
 
55,160

 
328

 
5,547

 
—

 
61,035

Reclassifications, net of tax
 
(8,314
)
 
—

 
—

 
2,021

 
(6,293
)
Other comprehensive income (loss)
 
46,846

 
328

 
5,547

 
2,021

 
54,742

Balance at September 30, 2017
 
$
1,136,901

 
$
(7,327
)
 
$
16,449

 
$
(106,721
)
 
$
1,039,302

 
 
 
 
 
 
 
 
 
 
 
 
 
Three Months Ended September 30, 2016
 
 
Available
for Sale
Assets
 
Deferred
Acquisition
Costs
 
Foreign
Exchange
 
Pension
Adjustments
 
Total
Balance at July 1, 2016
 
$
1,084,551

 
$
(8,658
)
 
$
8,331

 
$
(95,067
)
 
$
989,157

Other comprehensive income (loss) before reclassifications, net of tax
 
154,389

 
405

 
104

 
—

 
154,898

Reclassifications, net of tax
 
(2,886
)
 
—

 
—

 
1,657

 
(1,229
)
Other comprehensive income (loss)
 
151,503

 
405

 
104

 
1,657

 
153,669

Balance at September 30, 2016
 
$
1,236,054

 
$
(8,253
)
 
$
8,435

 
$
(93,410
)
 
$
1,142,826


 

8
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)



Components of Accumulated Other Comprehensive Income
 
 
Nine Months Ended September 30, 2017
 
 
Available
for Sale
Assets
 
Deferred
Acquisition
Costs
 
Foreign
Exchange
 
Pension
Adjustments
 
Total
Balance at January 1, 2017
 
$
692,314

 
$
(6,682
)
 
$
4,967

 
$
(113,025
)
 
$
577,574

Other comprehensive income (loss) before reclassifications, net of tax
 
453,455

 
(645
)
 
11,482

 
241

 
464,533

Reclassifications, net of tax
 
(8,868
)
 
—

 
—

 
6,063

 
(2,805
)
Other comprehensive income (loss)
 
444,587

 
(645
)
 
11,482

 
6,304

 
461,728

Balance at September 30, 2017
 
$
1,136,901

 
$
(7,327
)
 
$
16,449

 
$
(106,721
)
 
$
1,039,302

 
 
 
 
 
 
 
 
 
 
 
 
 
Nine Months Ended September 30, 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
 
911,069

 
(3,138
)
 
4,808

 
513

 
913,252

Reclassifications, net of tax
 
(7,348
)
 
—

 
—

 
4,975

 
(2,373
)
Other comprehensive income (loss)
 
903,721

 
(3,138
)
 
4,808

 
5,488

 
910,879

Balance at September 30, 2016
 
$
1,236,054

 
$
(8,253
)
 
$
8,435

 
$
(93,410
)
 
$
1,142,826

                                                                                                                                                           
Reclassifications out of Accumulated Other Comprehensive Income are presented below for the three and nine month periods ended September 30, 2017 and 2016.
Reclassification Adjustments
  
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
Affected line items in the
Statement of Operations
 
 
2017
 
2016
 
2017
 
2016
 
Unrealized investment gains (losses) on available for sale assets:
 
 
 
 
 
 
 
 
 
 
Realized (gains) losses
 
$
(12,910
)
 
$
(3,513
)
 
$
(13,264
)
 
$
(7,809
)
 
Realized gains (losses)
Amortization of (discount) premium
 
119

 
(927
)
 
(379
)
 
(3,495
)
 
Net investment income
Total before tax
 
(12,791
)
 
(4,440
)
 
(13,643
)
 
(11,304
)
 
 
Tax
 
4,477

 
1,554

 
4,775

 
3,956

 
Income taxes
Total after tax
 
(8,314
)
 
(2,886
)
 
(8,868
)
 
(7,348
)
 
 
Pension adjustments:
 
 
 
 
 
 
 
 
 
 
Amortization of prior service cost
 
118

 
120

 
356

 
360

 
Other operating expenses
Amortization of actuarial gain (loss)
 
2,990

 
2,431

 
8,970

 
7,294

 
Other operating expenses
Total before tax
 
3,108

 
2,551

 
9,326

 
7,654

 
 
Tax
 
(1,087
)
 
(894
)
 
(3,263
)
 
(2,679
)
 
Income taxes
Total after tax
 
2,021

 
1,657

 
6,063

 
4,975

 
 
Total reclassifications (after tax)
 
$
(6,293
)
 
$
(1,229
)
 
$
(2,805
)
 
$
(2,373
)
 
 


9
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 available for sale by cost or amortized cost and estimated fair value at September 30, 2017 is as follows:
Portfolio Composition as of September 30, 2017
 
Cost or
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair Value(1)
 
% of Total
Fixed
Maturities(2)
Fixed maturities available for sale:
 
 
 
 
 
 
 
 
 
U.S. Government direct, guaranteed, and government-sponsored enterprises
$
387,985

 
$
12,800

 
$
(1,098
)
 
$
399,687

 
2
States, municipalities, and political subdivisions
1,160,537

 
127,675

 
(108
)
 
1,288,104

 
8
Foreign governments
20,939

 
1,607

 
—

 
22,546

 
—
Corporates, by sector:
 
 
 
 
 
 
 
 
 
Financial
3,199,469

 
426,345

 
(25,880
)
 
3,599,934

 
22
Utilities
1,948,519

 
324,060

 
(2,655
)
 
2,269,924

 
14
Energy
1,602,054

 
185,296

 
(28,070
)
 
1,759,280

 
11
Other corporate sectors
6,025,262

 
666,120

 
(22,670
)
 
6,668,712

 
40
Total corporates
12,775,304

 
1,601,821

 
(79,275
)
 
14,297,850

 
87
Collateralized debt obligations
59,204

 
19,558

 
(8,994
)
 
69,768

 
—
Other asset-backed securities
145,224

 
5,018

 
(17
)
 
150,225

 
1
Redeemable preferred stocks, by sector:
 
 
 
 
 
 
 
 
 
Financial
336,822

 
60,159

 
(3,030
)
 
393,951

 
2
Utilities
28,565

 
2,333

 
(116
)
 
30,782

 
—
Total redeemable preferred stocks
365,387

 
62,492

 
(3,146
)
 
424,733

 
2
Total fixed maturities
$
14,914,580

 
$
1,830,971

 
$
(92,638
)
 
$
16,652,913

 
100
(1) Amounts reported on the balance sheet.
(2) At fair value.

A schedule of fixed maturities available for sale by contractual maturity date at September 30, 2017 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.
 
September 30, 2017
 
Amortized
Cost
 
Fair Value
Fixed maturities available for sale:
 
 
 
Due in one year or less
$
140,702

 
$
143,863

Due after one year through five years
660,487

 
705,847

Due after five years through ten years
1,430,894

 
1,604,091

Due after ten years through twenty years
4,397,807

 
5,084,516

Due after twenty years
8,079,191

 
8,893,450

Mortgage-backed and asset-backed securities
205,499

 
221,146

 
$
14,914,580

 
$
16,652,913


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

Note 4—Investments (continued)

Selected information about sales of fixed maturities available for sale is as follows.
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2017
 
2016
 
2017
 
2016
Proceeds from sales
$
52,951

 
$
24,000

 
$
52,951

 
$
75,299

Gross realized gains
4,851

 
2,577

 
4,851

 
6,133

Gross realized losses
—

 
—

 
—

 
(214
)

Fair Value Measurements:
The following table represents the fair value of fixed maturities available for sale measured on a recurring basis.
Fair Value Measurements at September 30, 2017 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
Bonds:
 
 
 
 
 
 
 
 
U.S. Government direct, guaranteed, and government-sponsored enterprises
 
$
—

 
$
399,687

 
$
—

 
$
399,687

States, municipalities, and political subdivisions
 
39,100

 
1,249,004

 
—

 
1,288,104

Foreign governments
 
—

 
22,546

 
—

 
22,546

Corporates, by sector:
 


 


 


 


Financial
 
—

 
3,537,728

 
62,206

 
3,599,934

Utilities
 
—

 
2,114,600

 
155,324

 
2,269,924

Energy
 
—

 
1,717,538

 
41,742

 
1,759,280

Other corporate sectors
 
3,225

 
6,340,276

 
325,211

 
6,668,712

Total corporates
 
3,225

 
13,710,142

 
584,483

 
14,297,850

Collateralized debt obligations
 
—

 
—

 
69,768

 
69,768

Other asset-backed securities
 
—

 
135,842

 
14,383

 
150,225

Redeemable preferred stocks, by sector:
 


 


 


 


Financial
 
—

 
393,951

 
—

 
393,951

Utilities
 
—

 
30,782

 
—

 
30,782

Total redeemable preferred stocks
 
—

 
424,733

 
—

 
424,733

Total fixed maturities
 
$
42,325

 
$
15,941,954

 
$
668,634

 
$
16,652,913

Percent of total
 
0.3
%
 
95.7
%
 
4.0
%
 
100.0
%



11
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)
 
Nine Months Ended September 30, 2017
 
Asset-
Backed
Securities
 
Collateralized
Debt
Obligations
 
Corporates(1)
 
Total
Balance at January 1, 2017
$
—

 
$
63,503

 
$
559,600

 
$
623,103

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

 
—

 
—

 
—

Included in other comprehensive income
595

 
7,787

 
10,614

 
18,996

Acquisitions
14,000

 
—

 
21,666

 
35,666

Sales
—

 
—

 
—

 
—

Amortization
—

 
3,705

 
14

 
3,719

Other(2)
(212
)
 
(5,227
)
 
(7,411
)
 
(12,850
)
Transfers in and/or out of Level 3(3)
—

 
—

 
—

 
—

Balance at September 30, 2017
$
14,383

 
$
69,768

 
$
584,483

 
$
668,634

Percent of total fixed maturities
0.1
%
 
0.4
%
 
3.5
%
 
4.0
%
 
 
 
 
 
 
 
 
 
Nine Months Ended September 30, 2016
 
Asset-
Backed
Securities
 
Collateralized
Debt
Obligations
 
Corporates(1)
 
Total
Balance at January 1, 2016
$
—

 
$
70,382

 
$
530,806

 
$
601,188

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

 
—

 
788

 
788

Included in other comprehensive income
—

 
(3,879
)
 
33,365

 
29,486

Acquisitions
—

 
—

 
33,662

 
33,662

Sales
—

 
—

 
—

 
—

Amortization
—

 
3,511

 
14

 
3,525

Other(2)
—

 
(6,732
)
 
(10,882
)
 
(17,614
)
Transfers in and/or out of Level 3(3)
—

 
—

 
—

 
—

Balance at September 30, 2016
$
—

 
$
63,282

 
$
587,753

 
$
651,035

Percent of total fixed maturities
—
%
 
0.4
%
 
3.7
%
 
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.


12
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:

In accordance with the other-than-temporary impairment (OTTI) policy, the Company evaluated its fixed maturities available for sale in an unrealized loss position to determine if there was any impairment for the quarter. Gross unrealized losses may fluctuate quarter over quarter due to adverse factors in the market that affect our holdings, such as changes in the interest rates or credit spreads. While the Company holds securities that may be in an unrealized loss position from time to time, Torchmark has the ability and intent to hold these investments to recovery. Additionally, Torchmark does not expect to be required to sell any of its securities due to the strong cash flows generated by its insurance operations.

For the nine months ended September 30, 2017, the Company recorded $245 thousand ($159 thousand, net of tax) in OTTI. For the comparable period in 2016, the Company concluded that there were no other-than-temporary impairments.

Unrealized Loss Analysis:

The following table discloses information about fixed maturities available for sale in an unrealized loss position.
 
 
Less than
Twelve
Months
 
Twelve
Months
or Longer
 
Total
Number of issues (CUSIP numbers) held:
 
 
 
 
 
 
As of September 30, 2017
 
151

 
109

 
260

As of December 31, 2016
 
407

 
94

 
501


Torchmark’s entire fixed maturity portfolio consisted of 1,514 issues at September 30, 2017 and 1,565 issues at December 31, 2016. The weighted average quality rating of all unrealized loss positions as of September 30, 2017 was BBB compared with BBB+ as of December 31, 2016.

13
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 fixed maturities available for sale at September 30, 2017 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 September 30, 2017
 
 
 
Less than
Twelve Months
 
Twelve Months
or Longer
 
Total
Description of Securities
 
Fair Value
 
Unrealized
Loss
 
Fair Value
 
Unrealized
Loss
 
Fair Value
 
Unrealized
Loss
Investment grade securities:
 
 
 
 
 
 
 
 
 
 
 
 
Bonds:
 
 
 
 
 
 
 
 
 
 
 
 
U.S. Government direct, guaranteed, and government-sponsored enterprises
 
$
97,370

 
$
(610
)
 
$
5,422

 
$
(488
)
 
$
102,792

 
$
(1,098
)
States, municipalities and political subdivisions
 
10,115

 
(70
)
 
691

 
(2
)
 
10,806

 
(72
)

 
 
 
 
 
 
 
 
 
 
 
 
Corporates, by sector:
 
 
 
 
 
 
 
 
 
 
 
 
Financial
 
94,944

 
(1,024
)
 
65,729

 
(2,271
)
 
160,673

 
(3,295
)
Utilities
 
101,687

 
(1,643
)
 
40,075

 
(1,012
)
 
141,762

 
(2,655
)
Energy
 
37,009

 
(512
)
 
93,841

 
(6,555
)
 
130,850

 
(7,067
)
Other corporate sectors
 
369,323

 
(6,254
)
 
247,324

 
(11,047
)
 
616,647

 
(17,301
)
Total corporates
 
602,963

 
(9,433
)
 
446,969

 
(20,885
)
 
1,049,932

 
(30,318
)
Other asset-backed securities
 
9,983

 
(17
)
 
—

 
—

 
9,983

 
(17
)
Redeemable preferred stocks, by sector:
 
 
 
 
 
 
 
 
 
 
 
 
Utilities
 
5,947

 
(116
)
 
—

 
—

 
5,947

 
(116
)
Total redeemable preferred stocks
 
5,947

 
(116
)
 
—

 
—

 
5,947

 
(116
)
Total investment grade securities
 
726,378

 
(10,246
)
 
453,082

 
(21,375
)
 
1,179,460

 
(31,621
)
Below investment grade securities:
 
 
 
 
 
 
 
 
 
 
 
 
Bonds:
 
 
 
 
 
 
 
 
 
 
 
 
States, municipalities and political subdivisions
 
269

 
(36
)
 
—

 
—

 
269

 
(36
)
Corporates, by sector:
 


 


 


 


 
 
 
 
Financial
 
—

 
—

 
83,164

 
(22,585
)
 
83,164

 
(22,585
)
Energy
 
—

 
—

 
78,721

 
(21,003
)
 
78,721

 
(21,003
)
Other corporate sectors
 
—

 
—

 
45,330

 
(5,369
)
 
45,330

 
(5,369
)
Total corporates
 
—

 
—

 
207,215

 
(48,957
)
 
207,215

 
(48,957
)
Collateralized debt obligations
 
—

 
—

 
11,006

 
(8,994
)
 
11,006

 
(8,994
)
Redeemable preferred stocks, by sector:
 
 
 
 
 
 
 
 
 
 
 
 
Financial
 
—

 
—

 
24,080

 
(3,030
)
 
24,080

 
(3,030
)
Total redeemable preferred stocks
 
—

 
—

 
24,080

 
(3,030
)
 
24,080

 
(3,030
)
Total below investment grade securities
 
269

 
(36
)
 
242,301

 
(60,981
)
 
242,570

 
(61,017
)
Total fixed maturities
 
$
726,647

 
$
(10,282
)
 
$
695,383

 
$
(82,356
)
 
$
1,422,030

 
$
(92,638
)




14
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 Prescription Drug Plan business as a discontinued operation. Historically, the business was a reportable segment. Effective July 1, 2016, Torchmark sold its Medicare Part D Prescription Drug Plan business to an unaffiliated third party.

The sale resulted in a net gain of $1.8 million ($1.2 million net of tax) in 2016. The operating results from discontinued operations are reflected in income for the nine months ended September 30, 2017. The remaining assets and liabilities reflected on the Torchmark balance sheet related to discontinued operations are receivables and payables associated with the 2016 and prior plan years that are expected to be settled in the ordinary course of business during 2017 and 2018.

The net assets related to discontinued operations at September 30, 2017 and December 31, 2016 were as follows:
 
September 30,
2017
 
December 31,
2016
Assets:
 
 
 
Due premiums
$
3,945

 
$
8,840

Other receivables(1)
64,627

 
118,692

Total assets related to discontinued operations
68,572

 
127,532


 
 
 
Liabilities:
 
 
 
Risk sharing payable
9,065

 
8,374

Current and deferred income taxes payable
1,630

 
3,820

Other(2)
38,633

 
15,230

Total liabilities related to discontinued operations
49,328

 
27,424


 
 
 
Net assets
$
19,244

 
$
100,108

(1) At September 30, 2017, other receivables included $65 million from the Centers for Medicare and Medicaid Services (CMS). At December 31, 2016, other receivables included $50 million from the Centers for Medicare and Medicaid Services (CMS) and $69 million from drug manufacturer rebates.
(2) At September 30, 2017, the balance included $35.8 million due to CMS. At December 31, 2016, the balance included a $3.6 million contingent purchase price reserve.

15
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 and nine months ended September 30, 2017 and 2016 was as follows:
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2017
 
2016
 
2017
 
2016
Revenue:
 
 
 
 

 

Health premium
$
(48
)
 
$
53,632

 
$
(343
)
 
$
165,105


 
 
 
 

 

Benefits and expenses:
 
 
 
 

 

Health policyholder benefits
(115
)
 
33,331

 
3,817

 
146,683

Amortization of deferred acquisition costs
—

 
1,018

 
—

 
2,958

Commissions, premium taxes, and non-deferred acquisition expenses
53

 
3,352

 
783

 
12,253

Other operating expense
32

 
1,222

 
809

 
4,512

Total benefits and expenses
(30
)
 
38,923

 
5,409

 
166,406


 
 
 
 

 

Income (loss) before income taxes for discontinued operations
(18
)
 
14,709

 
(5,752
)
 
(1,301
)
Gain from sale of discontinued operations
—

 
613

 
—

 
613

Income tax benefit (expense)
6

 
(5,363
)
 
2,013

 
241

Income (loss) from discontinued operations
$
(12
)
 
$
9,959

 
$
(3,739
)
 
$
(447
)

Operating cash flows of the discontinued operations for the nine months ended September 30, 2017 and 2016 were as follows:
 
Nine Months Ended 
 September 30,
 
2017
 
2016
Net cash provided from (used for) discontinued operations
$
77,125

 
$
82,565


Note 6—Commitments and Contingencies

Litigation:

Torchmark and its subsidiaries, in common with the insurance industry in general, are subject to litigation, involving various matters where we are either the defendant or the plaintiff. Torchmark subsidiaries are also 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. In each of these matters, based upon information presently available, management does not believe that such litigation or audits will have a material adverse effect on Torchmark’s financial condition, future operating results or liquidity.

As previously reported, litigation was filed on February 10, 2015 against Torchmark subsidiary, Globe Life And Accident Insurance Company (Globe) in Oklahoma County, Oklahoma District Court (Proctor v. Globe Life And Accident Insurance Company, Case No. CJ-2015-838) asserting claims for breach of the implied covenants of good faith and fair dealing and for false representation, deceit and conversion in connection with Globe’s denial of plaintiff’s claim on a life insurance policy for non-payment of premium. Plaintiff, who had alleged that Globe had improperly retained 12 monthly premium payments on a policy that was treated as lapsed or not returned to in-force status, seeks actual and punitive damages, prejudgment interest, attorney fees, costs and other relief. Plaintiff subsequently amended his

16
TORCHMARK CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(Dollar amounts in thousands, except per share data)

Note 6—Commitments and Contingencies (continued)


complaint to add allegations of conversion and civil theft on behalf of a purported class of Globe’s U.S. policyholders who had paid premiums retained by Globe when their policies were lapsed and not reinstated at the time of the premium payments. Globe removed the case to the U.S. District Court for the Western District of Oklahoma (Case No. 15-CV-0070-M) on July 10, 2015 and filed a Motion to Dismiss on July 17, 2015. The Court denied plaintiff’s Motion to Remand back to state court on October 26, 2015, but allowed the plaintiff to amend the complaint to assert a putative class action in federal court. Plaintiff filed a Motion for Class Certification on September 23, 2016. Globe filed a Response in Opposition on November 4, 2016. The Court denied plaintiff’s Motion for Class Certification on August 18, 2017.

With respect to current litigation, at this time management believes that the possibility of a material judgment adverse to Torchmark is remote, and no estimate of range can be made for loss contingencies that are at least reasonably possible but not accrued.

Guaranty Fund Assessment:

In 2017, the Commonwealth Court of Pennsylvania issued orders placing Penn Treaty Network America Insurance Company (Penn Treaty) and affiliate American Network Insurance Company (ANIC) in liquidation due to financial difficulties. In such instances, the various state guaranty fund associations employ funding mechanisms, through assessments to their member companies, to cover the obligations of the insolvent entities. Consequently, the Company continues to receive guaranty fund assessments from the state associations related to these companies. The Company has projected its share of the ultimate assessments from these insolvencies based on assumptions about future events and its market share of premiums by state. The total estimated assessment for Torchmark's subsidiaries is approximately $10 million of which $1.4 million is estimated to be unrecoverable. We are anticipating the remaining amount of the assessments to be recovered through premium tax credits.

Note 7—Liability for Unpaid Claims

Activity in the liability for unpaid health claims is summarized as follows:
 
Nine Months Ended 
 September 30,
 
2017
 
2016
Balance at beginning of period
$
143,128

 
$
137,120

Incurred related to:

 

Current year
393,747

 
388,998

Prior years
(10,745
)
 
(5,710
)
Total incurred
383,002

 
383,288

Paid related to:

 

Current year
279,563

 
275,388

Prior years
103,010

 
102,435

Total paid
382,573

 
377,823

Balance at end of period
$
143,557

 
$
142,585

 
Below is the reconciliation of the liability for "Policy claims and other benefits payable" in the Condensed Consolidated Balance Sheets.

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

Note 7—Liability for Unpaid Claims (continued)


 
September 30,
2017
 
December 31, 2016
Policy claims and other benefits payable:

 

Short-duration contracts
$
23,193

 
$
26,721

Insurance lines other than short duration—health
120,364

 
116,407

Insurance lines other than short duration—life
175,275

 
156,437

Total policy claims and other benefits payable
$
318,832

 
$
299,565



Short-Duration Contracts

Although Torchmark primarily sells long-duration contracts for both life and health, the Company also has a limited amount of group health products that qualify as short-duration contracts in accordance with the applicable guidance.

The below table illustrates the total incurred but not reported liabilities plus expected development on reported claims for short-duration products over the last five years. Claim frequency is determined by duration and incurred date.
 
As of September 30, 2017
Accident Year
Total of incurred-but-not-reported liabilities plus expected development on reported claims
2013
$
—

2014
1

2015
46

2016
1,022

2017
22,124

Total
$
23,193



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


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 September 30,
 
Pension Benefits
 
Other Benefits
 
2017
 
2016
 
2017
 
2016
Service cost
$
4,486

 
$
3,894

 
$
—

 
$
—

Interest cost
5,552

 
5,430

 
249

 
212

Expected return on assets
(5,900
)
 
(5,782
)
 
—

 
—

Amortization:
 
 
 
 
 
 
 
Prior service cost
118

 
120

 
—

 
—

Actuarial (gain) loss
2,952

 
2,423

 
38

 
8

Direct recognition of expense
—

 
—

 
111

 
45

Net periodic benefit cost
$
7,208

 
$
6,085

 
$
398

 
$
265

 
 
 
 
 
 
 
 
 
Nine Months Ended September 30,
 
Pension Benefits
 
Other Benefits
 
2017
 
2016
 
2017
 
2016
Service cost
$
13,457

 
$
11,682

 
$
—

 
$
—

Interest cost
16,653

 
16,294

 
749

 
636

Expected return on assets
(17,697
)
 
(17,346
)
 
—

 
—

Amortization:
 
 
 
 
 
 
 
Prior service cost
356

 
360

 
—

 
—

Actuarial (gain)/loss
8,855

 
7,270

 
115

 
24

Direct recognition of expense
—

 
—

 
323

 
99

Net periodic benefit cost
$
21,624

 
$
18,260

 
$
1,187

 
$
759

 
The following table presents assets at fair value for the defined-benefit pension plans at September 30, 2017 and December 31, 2016.
Pension Assets by Component
 
September 30, 2017
 
December 31, 2016
 
Amount
 
%
 
Amount
 
%
Corporate bonds
$
172,587

 
47
 
$
160,036

 
49
Exchange traded fund(1)
153,824

 
42
 
134,771

 
41
Other bonds
259

 
—
 
258

 
—
Guaranteed annuity contract(2)
21,163

 
6
 
18,997

 
6
Short-term investments
12,676

 
4
 
7,391

 
2
Other
5,118

 
1
 
7,418

 
2
Total
$
365,627

 
100
 
$
328,871

 
100
(1)
A fund including marketable securities that mirror the S&P 500 index.
(2)
Representing a guaranteed annuity contract issued by Torchmark's subsidiary, American Income Life Insurance Company, to fund the obligations of the American Income Pension Plan.


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

Note 8—Postretirement Benefits (continued)

The following table presents liabilities for the defined-benefit pension plans at September 30, 2017 and December 31, 2016.
Pension Liability
 
September 30,
2017
 
December 31, 2016
Funded defined benefit pension
$
475,927

 
$
449,613

SERP(1) (Active)
77,223

 
74,687

SERP(1) (Closed)
2,827

 
3,222

Pension Benefit Obligation
$
555,977

 
$
527,522

(1)
Supplemental executive retirement plan (SERP).
During the nine months ended September 30, 2017, the Company made $19 million in cash contributions to the qualified pension plans. Torchmark will not make any additional cash contributions in 2017.
With respect to the Company’s active nonqualified noncontributory SERP, life insurance policies on the lives of plan participants have been established with an unaffiliated carrier to provide for a portion of the Company’s obligations under the plan. These policies along with investments deposited with an unaffiliated trustee were previously placed in a Rabbi Trust to provide for the payment of the plan obligations. At September 30, 2017, the combined value of the insurance policies and investments in the Rabbi Trust to support plan liabilities were $94 million, compared with $86 million at December 31, 2016. Since this plan is nonqualified and therefore is treated as unfunded, 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.
 
Note 9—Earnings Per Share
A reconciliation of basic and diluted weighted-average shares outstanding is as follows:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
Basic weighted average shares outstanding
115,921,134

 
119,480,642

 
116,772,652

 
120,476,813

Weighted average dilutive options outstanding
2,521,815

 
2,430,121

 
2,540,955

 
2,209,739

Diluted weighted average shares outstanding
118,442,949

 
121,910,763

 
119,313,607

 
122,686,552

Antidilutive shares
—

 
—

 
1,174,469

 
—


Note 10—Business Segments
Torchmark's reportable segments are based on the insurance product lines it markets and administers: life insurance, health insurance, and annuities. These major product lines are set out as reportable segments because of the common characteristics of products within these categories, comparability of margins, and the similarity in regulatory environment and management techniques. Torchmark's chief operating decision makers evaluate the overall performance of the operations of the Company in accordance with these segments.
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.

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

Note 10—Business Segments (continued)

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 net policy benefits and expenses. Management believes this 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. However, dispositions of investments occur from time to time, generally for reasons such as credit concerns, calls by issuers, or other factors.

Since Torchmark does not actively trade investments, 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.
As discussed in Note 6—Commitments and Contingencies, the Company received an assessment from various state guaranty fund associations for the liquidation of Penn Treaty and its affiliate. The total estimated assessment for Torchmark's subsidiaries is approximately $10 million of which $1.4 million is estimated to be unrecoverable. We are anticipating the remaining amount of the assessments to be recovered through premium tax credits. The assessment expenses were considered a non-operational event and therefore were excluded from the core underwriting operations of the Company.

21
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 Condensed Consolidated Statement of Operations
 
Three Months Ended September 30, 2017
 
Life
 
Health
 
Annuity
 
Investment
 
Other &
Corporate
 
Adjustments
 
 
Consolidated
Revenue:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Premium
$
576,223

 
$
242,991

 
$
3

 
 
 
 
 
 
 
 
$
819,217

Net investment income
 
 
 
 
 
 
$
213,872

 
 
 
 
 
 
213,872

Other income
 
 
 
 
 
 
 
 
$
361

 
$
(30
)
 
(2)
331

    Total revenue
576,223

 
242,991

 
3

 
213,872

 
361

 
(30
)
 
 
1,033,420

Expenses:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Policy benefits
386,445

 
155,774

 
9,000

 
 
 
 
 


 

551,219

Required interest on reserves
(152,862
)
 
(19,617
)
 
(12,433
)
 
184,912

 
 
 
 
 
 
—

Required interest on DAC
46,893

 
5,881

 
172

 
(52,946
)
 
 
 
 
 
 
—

Amortization of acquisition costs
98,268

 
23,458

 
608

 
 
 
 
 
 
 
 
122,334

Commissions, premium taxes, and non-deferred acquisition costs
44,748

 
21,746

 
7

 
 
 
 
 
1,362

 
(2,3)
67,863

Insurance administrative expense(1)
 
 
 
 
 
 
 
 
52,426

 


 

52,426

Parent expense
 
 
 
 
 
 
 
 
2,330

 
 
 
 
2,330

Stock compensation expense
 
 
 
 
 
 
 
 
8,263

 
 
 
 
8,263

Interest expense
 
 
 
 
 
 
20,970

 
 
 
 
 
 
20,970

Total expenses
423,492

 
187,242

 
(2,646
)
 
152,936

 
63,019

 
1,362

 
 
825,405

Subtotal
152,731

 
55,749

 
2,649

 
60,936

 
(62,658
)
 
(1,392
)
 
 
208,015

Non-operating items
 
 
 
 
 
 
 
 
 
 
1,392

 
(3)
1,392

Measure of segment profitability (pretax)
$
152,731

 
$
55,749

 
$
2,649

 
$
60,936

 
$
(62,658
)
 
$
—

 
 
209,407

Deduct applicable income taxes
 
 
(63,342
)
Segment profits after tax
 
 
146,065

Add back income taxes applicable to segment profitability
 
 
63,342

Add (deduct) realized investment gains (losses)
 
   
12,595

Add (deduct) guaranty fund assessments(3)
 
 
(1,392
)
Pretax income from continuing operations per Condensed Consolidated Statements of Operations
 
   
$
220,610


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



22
TORCHMARK CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(Dollar amounts in thousands, except per share data)

Note 10—Business Segments (continued)

 
Three Months Ended September 30, 2016
 
Life
 
Health
 
Annuity
 
Investment
 
Other &
Corporate
 
Adjustments
 
 
Consolidated
Revenue:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Premium
$
546,415

 
$
236,987

 
$
9

 
 
 
 
 
 
 
 
$
783,411

Net investment income
 
 
 
 
 
 
$
202,720

 
 
 
 
 
 
202,720

Other income
 
 
 
 
 
 
 
 
$
199

 
$
(39
)
 
(2)
160

Total revenue
546,415

 
236,987

 
9


202,720

 
199

 
(39
)
 
 
986,291

Expenses:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Policy benefits
369,546

 
153,351

 
9,255

 
 
 
 
 
 
 
 
532,152

Required interest on reserves
(145,295
)
 
(18,476
)
 
(12,761
)
 
176,532

 
 
 
 
 
 
—

Required interest on DAC
44,950

 
5,789

 
192

 
(50,931
)
 
 
 
 
 
 
—

Amortization of acquisition costs
93,496

 
22,643

 
682

 
 
 
 
 
 
 
 
116,821

Commissions, premium taxes, and non-deferred acquisition costs
40,577

 
20,604

 
11

 
 
 
 
 
(39
)
 
(2)
61,153

Insurance administrative expense(1)
 
 
 
 
 
 
 
 
49,248

 
257

 
 
49,505

Parent expense
 
 
 
 
 
 
 
 
1,955

 
 
 
 
1,955

Stock compensation expense
 
 
 
 
 
 
 
 
6,345

 
 
 
 
6,345

Interest expense
 
 
 
 
 
 
20,381

 
 
 
 
 
 
20,381

Total expenses
403,274

 
183,911

 
(2,621
)
 
145,982

 
57,548

 
218

 
 
788,312

Subtotal
143,141

 
53,076

 
2,630

 
56,738

 
(57,349
)
 
(257
)
 
 
197,979

Non-operating items
 
 
 
 
 
 
 
 
 
 
257

 
 
257

Measure of segment profitability (pretax)
$
143,141

 
$
53,076

 
$
2,630

 
$
56,738

 
$
(57,349
)
 
$
—

 
 
198,236

Deduct applicable income taxes
 
 
(58,422
)
Segment profits after tax
 
 
139,814

Add back income taxes applicable to segment profitability
 
 
58,422

Add (deduct) realized investment gains (losses)
 
   
3,482

Add (deduct) non-operating fees
 
 
(257
)
Pretax income from continuing operations per Condensed Consolidated Statements of Operations
 
   
$
201,461


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


23
TORCHMARK CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(Dollar amounts in thousands, except per share data)

Note 10—Business Segments (continued)

 
Nine Months Ended September 30, 2017
 
Life
 
Health
 
Annuity
 
Investment
 
Other &
Corporate
 
Adjustments
 
  
Consolidated
Revenue:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Premium
$
1,725,896

 
$
730,557

 
$
9

 

 

 


 

$
2,456,462

Net investment income

 

 

 
$
634,930

 

 


 

634,930

Other income

 

 

 

 
$
1,239

 
$
(99
)
 
(2)
1,140

    Total revenue
1,725,896

 
730,557

 
9

 
634,930

 
1,239

 
(99
)
 

3,092,532

Expenses:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Policy benefits
1,166,289

 
470,104

 
26,923

 

 

 
2,094

 
(3)
1,665,410

Required interest on reserves
(452,339
)
 
(57,859
)
 
(37,245
)
 
547,443

 

 

 

—

Required interest on DAC
139,042

 
17,530

 
524

 
(157,096
)
 

 

 

—

Amortization of acquisition costs
296,646

 
71,801

 
1,916

 

 

 

 

370,363

Commissions, premium taxes, and non-deferred acquisition costs
132,094

 
64,599

 
25

 


 


 
1,293

 
(2,4)
198,011

Insurance administrative expense(1)


 


 


 


 
155,751

 


 

155,751

Parent expense


 


 


 


 
7,228

 


 

7,228

Stock compensation expense


 


 


 


 
24,809

 


 

24,809

Interest expense


 


 


 
62,825

 


 


 

62,825

Total expenses
1,281,732

 
566,175

 
(7,857
)
 
453,172

 
187,788

 
3,387

 
 
2,484,397

Subtotal
444,164

 
164,382

 
7,866

 
181,758

 
(186,549
)
 
(3,486
)
 
 
608,135

Non-operating items
 
 
 
 
 
 
 
 
 
 
3,486

 
(3,4)
3,486

Measure of segment profitability (pretax)
$
444,164

 
$
164,382

 
$
7,866

 
$
181,758

 
$
(186,549
)
 
$
—

 
 
611,621

Deduct applicable income taxes
 
 
(184,703
)
Segment profits after tax
 
 
426,918

Add back income taxes applicable to segment profitability
 
 
184,703

Add (deduct) realized investment gains (losses)
 
   
6,142

Add (deduct) administrative settlements(3)
 
 
(2,094
)
Add (deduct) guaranty fund assessments (4)
 
 
(1,392
)
Pretax income from continuing operations per Condensed Consolidated Statements of Operations
 
   
$
614,277


(1) Administrative expense is not allocated to insurance segments.
(2) Elimination of intersegment commission.
(3) Administrative settlements.
(4) Guaranty fund assessments.




24
TORCHMARK CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(Dollar amounts in thousands, except per share data)

Note 10—Business Segments (continued)

 
Nine Months Ended September 30, 2016
 
Life
 
Health
 
Annuity
 
Investment
 
Other &
Corporate
 
Adjustments
 
 
Consolidated
Revenue:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Premium
$
1,639,156

 
$
709,936

 
$
34

 
 
 
 
 
 
 

$
2,349,126

Net investment income


 


 


 
$
601,415

 
 
 
 
 

601,415

Other income


 


 


 


 
$
1,086

 
$
(123
)
 
(2)
963

Total revenue
1,639,156

 
709,936

 
34

 
601,415

 
1,086

 
(123
)
 
 
2,951,504

Expenses:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Policy benefits
1,101,748

 
459,387

 
27,475

 


 


 


 

1,588,610

Required interest on reserves
(430,931
)
 
(54,803
)
 
(38,359
)
 
524,093

 


 


 

—

Required interest on DAC
133,628

 
17,297

 
621

 
(151,546
)
 


 


 

—

Amortization of acquisition costs
281,698

 
67,110

 
4,064

 


 


 


 

352,872

Commissions, premium taxes, and non-deferred acquisition costs
121,968

 
63,733

 
31

 


 


 
(123
)
 
(2)
185,609

Insurance administrative expense (1)


 


 


 


 
146,129

 
257

 

146,386

Parent expense


 


 


 


 
6,360

 


 

6,360

Stock compensation expense


 


 


 


 
20,334

 


 

20,334

Interest expense


 


 


 
62,860

 


 


 

62,860

Total expenses
1,208,111

 
552,724

 
(6,168
)

435,407

 
172,823

 
134

 
 
2,363,031

Subtotal
431,045

 
157,212

 
6,202

 
166,008

 
(171,737
)
 
(257
)
 
 
588,473

Non-operating items
 
 
 
 
 
 
 
 
 
 
257

 
 
257

Measure of segment profitability (pretax)
$
431,045

 
$
157,212

 
$
6,202

 
$
166,008

 
$
(171,737
)
 
$
—

 
 
588,730

Deduct applicable income taxes
 
 
(178,842
)
Segment profits after tax
 
 
409,888

Add back income taxes applicable to segment profitability
 
 
178,842

Add (deduct) realized investment gains (losses)
 
  
7,780

Add (deduct) non-operating fees
 
 
(257
)
Pretax income from continuing operations per Condensed Consolidated Statements of Operations
 
  
$
596,253


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





25
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 
 September 30,
 
Nine Months Ended 
 September 30,
 
2017
 
2016
 
2017
 
2016
Life insurance underwriting margin
$
152,731

 
$
143,141

 
$
444,164

 
$
431,045

Health insurance underwriting margin
55,749

 
53,076

 
164,382

 
157,212

Annuity underwriting margin
2,649

 
2,630

 
7,866

 
6,202

Excess investment income
60,936

 
56,738

 
181,758

 
166,008

Other insurance:
 
 
 
 
 
 
 
Other income
361

 
199

 
1,239

 
1,086

Administrative expense
(52,426
)
 
(49,248
)
 
(155,751
)
 
(146,129
)
Corporate and adjustments
(10,593
)
 
(8,300
)
 
(32,037
)
 
(26,694
)
Segment profits before tax
209,407

 
198,236

 
611,621

 
588,730

Applicable taxes
(63,342
)
 
(58,422
)
 
(184,703
)
 
(178,842
)
Segment profits after tax
146,065

 
139,814

 
426,918

 
409,888

Discontinued operations (after tax)
(12
)
 
9,959

 
(3,739
)
 
(447
)
After-tax total, after discontinued operations
146,053

 
149,773

 
423,179

 
409,441


 
 
 
 
 
 
 
Realized gains (losses)—investments (after tax)
8,186

 
2,263

 
6,235

 
5,057

Administrative settlements (after tax)
—

 
—

 
(1,361
)
 
—

Guaranty fund assessments (after tax)
(905
)
 
—

 
(905
)
 
—

Non-operating fees (after tax)
—

 
(167
)
 
—

 
(167
)
Net income
$
153,334

 
$
151,869

 
$
427,148

 
$
414,331

                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        


26

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 in the Notes to the Condensed Consolidated Financial Statements. The measures of profitability 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. Insurance underwriting margin consists of premium less policy obligations, commissions and other acquisition expenses. 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 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 and nine month periods ended September 30, 2017 and 2016. Additionally, a table in that note, Analysis of Profitability by Segment, provides a summary of 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.
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(1), 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. 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.
A discussion of operations by each segment follows later in this report. These discussions compare the first nine months of 2017 with the same period of 2016, unless otherwise noted. The following discussions are presented in the manner we view our operations, as described in Note 10.













(1) 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.

27

Highlights, comparing the first nine months of 2017 with the first nine months of 2016.
Net income per diluted common share increased 6% to $3.58 from $3.38. Included in net income were after-tax realized gains of $6.2 million in 2017 compared with gains of $5.1 million for the same period in 2016. Realized gains and losses are presented more fully under the caption Realized Gains and Losses in this report. Net operating income from continuing operations is the consolidated total of segment profits after tax and as such is considered a non-GAAP measure. Net operating income from continuing operations increased 4% or $17 million to $427 million for the nine months ended September 30, 2017 compared with $410 million for the same 2016 period.
Total premium income rose 5% in 2017 to $2.5 billion. Total net sales increased 2% to $420 million, when compared with the same period in 2016. First-year collected premium was $339 million for the 2017 period, compared with $340 million for the 2016 period.
Life insurance premium income grew 5% to $1.7 billion. Life net sales increased 1% when compared with the same period in 2016. First-year collected life premium grew 1% during the first nine months of 2017 to $239 million over the same period in 2016. Life underwriting margin as a percentage of premium was flat at 26%. Underwriting income increased 3% to $444 million when compared with the same period in 2016.
Health insurance premium income increased 3% to $731 million over the prior year total of $710 million. Health net sales rose 6% to $104 million for the nine month period. First-year collected health premium fell 4% to $100 million. Health margins increased to 23% from 22% a year earlier. Underwriting income increased 5% to $164 million for the first nine months of 2017.
Insurance administrative expenses were up 6.6% in 2017 when compared with the prior year period. These expenses were 6.3% as a percentage of premium during the first nine months of 2017 compared with 6.2% a year earlier. The increase in administrative expenses was primarily due to an increase in other employee costs and investments in information technology.
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 common share is an important measure to management. Refer to the Excess Investment Income section of this report for further details. Excess investment income per common share increased 13% in 2017 to $1.52 from $1.35 in the same period last year, while the dollar amount of excess investment income increased 9% to $182 million. Net investment income rose $34 million or 6% to $635 million in 2017, below the 7% growth in our average investment portfolio at amortized cost. The average effective yield earned on the fixed maturity portfolio, which represented 96% of our investments at amortized cost, decreased to 5.68% in the 2017 period from 5.80% in the prior period. Required interest rose 5% or $18 million to $390 million, in line with the growth in average net policy liabilities. Financing costs were flat at $63 million. Please refer to the discussion under Capital Resources for more information on debt and interest expense.
In the first nine months of 2017, we invested new money in fixed maturity securities at an effective annual yield of 4.74%, compared with 4.73% in the same period of 2016. These new investments had an average rating of BBB+ and an average life to maturity of twenty-four years. Approximately 96% of the fixed-maturity portfolio at amortized cost was investment grade at September 30, 2017. Cash and short-term investments were $154 million at that date, compared with $148 million at December 31, 2016.
The net unrealized gain position in our fixed maturity portfolio grew from $1.1 billion at December 31, 2016 to $1.7 billion at September 30, 2017 due primarily to changes in market interest rates.

28

Share Repurchases. We have an on-going share repurchase program which began in 1986 that is reviewed quarterly and is reaffirmed by the Board of Directors on an annual basis. The program was reaffirmed on August 7, 2017. 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 Company with excess cash flow. Excess cash flow is primarily made up of cash received from the insurance subsidiaries less dividends paid to shareholders and interest paid on our debt. See further discussion in the Capital Resources section below. Share purchases are also made with the proceeds from option exercises by current and former employees in order to reduce dilution. The following chart summarizes share purchases for the nine month periods ended September 30, 2017 and 2016.

Analysis of Share Purchases
(Amounts in thousands, except per share data) 

 
Nine Months Ended September 30,
 
2017
 
2016
 
Shares
 
Amount
 
Average
Price
 
Shares
 
Amount
 
Average
Price
Purchases with:

 

 

 

 

 

Excess cash flow at the Parent Company
3,176

 
$
242,841

 
$
76.46

 
4,170

 
$
240,108

 
$
57.58

Option exercise proceeds
760

 
58,607

 
77.16

 
1,180

 
71,248

 
60.38

Total
3,936

 
$
301,448

 
$
76.59

 
5,350

 
$
311,356

 
$
58.20

Throughout the remainder of this discussion, share purchases will only refer to those made from excess cash flow.
A detailed discussion of our operations by component segment follows.
Life insurance, comparing the first nine months of 2017 with the first nine months of 2016. Life insurance is our predominant segment, representing 70% of premium income and 72% of insurance underwriting margin in the first nine months of 2017. In addition, investments supporting the reserves for life business generate the majority of excess investment income attributable to the investment segment.
The following table presents the summary of results for life insurance.
Life Insurance
Summary of Results
(Dollar amounts in thousands)
 
 
Nine Months Ended September 30,
 
Increase
 
2017
 
2016
 
(Decrease)
 
Amount
 
% of
Premium
 
Amount
 
% of
Premium
 
Amount
 
%
Premium and policy charges
$
1,725,896

 
100
 
$
1,639,156

 
100
 
$
86,740

 
5
Net policy obligations
713,950

 
41
 
670,817

 
41
 
43,133

 
6
Commissions and acquisition expense
567,782

 
33
 
537,294

 
33
 
30,488

 
6
Insurance underwriting income before other income and administrative expense
$
444,164

 
26
 
$
431,045

 
26
 
$
13,119

 
3


29

The following table presents Torchmark’s life insurance premium by distribution channel.
Life Insurance
Premium
(Dollar amounts in thousands)
 
Nine Months Ended September 30,
 
Increase
 
2017
 
2016
 
(Decrease)
 
Amount
 
% of
Total
 
Amount
 
% of
Total
 
Amount

%
American Income Exclusive Agency
$
741,392

 
43
 
$
677,702

 
41
 
$
63,690

 
9

Globe Life Direct Response
613,568

 
35
 
591,084

 
36
 
22,484

 
4

Liberty National Exclusive Agency
205,775

 
12
 
203,040

 
13
 
2,735

 
1

Other Agencies
165,161

 
10
 
167,330

 
10
 
(2,169
)
 
(1
)
Total
$
1,725,896

 
100
 
$
1,639,156

 
100
 
$
86,740

 
5

Net sales, an indicator of new business production, increased 1% to $316 million when compared with the same period in 2016. An analysis of life net sales by distribution channel is presented below.
Life Insurance
Net Sales
(Dollar amounts in thousands)
 
Nine Months Ended September 30,

Increase
 
2017
 
2016
 
(Decrease)
 
Amount
 
% of
Total
 
Amount
 
% of
Total
 
Amount
 
%
American Income Exclusive Agency
$
167,478

 
53
 
$
157,949

 
50
 
$
9,529

 
6

Globe Life Direct Response
106,652

 
34
 
116,224

 
37
 
(9,572
)
 
(8
)
Liberty National Exclusive Agency
34,609

 
11
 
29,856

 
10
 
4,753

 
16

Other Agencies
7,501

 
2
 
9,063

 
3
 
(1,562
)
 
(17
)
Total
$
316,240

 
100
 
$
313,092

 
100
 
$
3,148

 
1

First-year collected life premium, defined earlier in this report, was $239 million in the 2017 period, rising 1% over the same period in 2016. First-year collected life premium by distribution channel is presented in the table below. 
Life Insurance
First-Year Collected Premium
(Dollar amounts in thousands)
 
Nine Months Ended September 30,

Increase
 
2017

2016

(Decrease)
 
Amount

% of
Total

Amount

% of
Total

Amount

%
American Income Exclusive Agency
$
135,935

 
57
 
$
129,878

 
55
 
$
6,057

 
5

Globe Life Direct Response
70,989

 
30
 
75,784

 
32
 
(4,795
)
 
(6
)
Liberty National Exclusive Agency
24,587

 
10
 
21,707

 
9
 
2,880

 
13

Other Agencies
7,325

 
3
 
8,801

 
4
 
(1,476
)
 
(17
)
Total
$
238,836

 
100
 
$
236,170

 
100
 
$
2,666

 
1


30

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 referrals and other affinity groups to help ensure sustainable growth. This agency is the largest contributor to life premium and underwriting margin of any distribution channel. This group produced premium income of $741 million, an increase of 9%. First-year collected premium was $136 million, an increase of 5%. Net sales rose 6% to $167 million. Sales growth in our exclusive agencies is generally dependent on growth in the size of the agency force. The American Income Exclusive Agency's average agent count increased 5% to 6,962 for the nine months ended September 30, 2017, compared with 6,603 for the same period in 2016. As is the case with all Torchmark agencies, the average agent count is based on the actual count at the end of each week during the period. The American Income Exclusive Agency has been focusing on growing and strengthening middle management to support sustainable growth of the agency force. To accomplish this, the agency has placed an increased emphasis on training and financial incentives that appropriately reward agents at all levels for helping develop and train its agents. These programs are designed to provide each agent, from new recruits to top level managers, coaching and instruction specifically designed for their level of experience and responsibility. We are also making considerable investments in information technology in support of the agency.
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 over the years has been fueled by constant innovation. In recent years, electronic media production has grown rapidly as management has increased marketing activities related to internet and mobile technology, and has focused on driving traffic to an 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 4% to $614 million, representing 35% of Torchmark’s total life premium in the first nine months of 2017. Net sales of $107 million for this group decreased 8%. First-year collected premium decreased 6% to $71 million. The underwriting margin, as a percent of premium, was 15.6%, up from 15.2% in the year-ago quarter. While higher claims will cause the underwriting margin to be lower for the full year 2017 as compared with 2016, the increase in the quarter was fully in line with our expectations. The sales and first-year collected premium declines were expected as we continue to refine our marketing efforts in a manner intended to optimize underwriting profits.
The Liberty National Exclusive Agency markets individual and group life insurance to middle-income customers. Life premium income for this agency was $206 million in the first nine months of 2017 compared with $203 million for the same period in 2016. First-year collected premium increased 13% to $25 million. Net sales for the Liberty National Agency increased 16% to $35 million. The increases in first-year collected premium and net sales are the largest percentage increases of any of Torchmark's life distribution channels.
The Liberty National average agent count increased 17% to 1,985 for the nine months ended September 30, 2017 compared with 1,693 for the same period in 2016. 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 predominantly life insurance. The Other Agencies contributed $165 million of life premium income, or 10% of Torchmark’s total in the first nine months of 2017, but contributed only 2% of net sales for the period.

31

Health insurance, comparing the first nine months of 2017 with the first nine months of 2016. 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 2017 period. Health underwriting margin accounted for 27% of total underwriting margin, reflective of the lower underwriting margin as a percentage 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.

The following table presents underwriting margin data for health insurance.
Health Insurance
Summary of Results
(Dollar amounts in thousands)
 
Nine Months Ended September 30,
 
Increase
 
2017
 
2016
 
(Decrease)
 
Amount
 
% of
Premium
 
Amount
 
% of
Premium
 
Amount
 
%
Premium and policy charges
$
730,557

 
100
 
$
709,936

 
100
 
$
20,621

 
3
Net policy obligations
412,245

 
56
 
404,584

 
57
 
7,661

 
2
Commissions and acquisition expense
153,930

 
21
 
148,140

 
21
 
5,790

 
4
Insurance underwriting income before other income and administrative expense
$
164,382

 
23
 
$
157,212

 
22
 
$
7,170

 
5


32


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

Health Insurance
Premium
(Dollar amounts in thousands)
 
Nine Months Ended September 30,

Increase
 
2017

2016

(Decrease)
 
Amount

% of
Total

Amount

% of
Total

Amount

%
United American Independent Agency
 
 
 
 
 
 
 
 
 
 
 
Limited-benefit plans
$
8,686

 
 
 
$
9,737

 
 
 
$
(1,051
)
 
(11
)
Medicare Supplement
263,904

 
 
 
256,572

 
 
 
7,332

 
3

 
272,590

 
37
 
266,309

 
38
 
6,281

 
2

Family Heritage Agency
 
 
 
 
 
 
 
 
 
 
 
Limited-benefit plans
188,350

 
 
 
175,538

 
 
 
12,812

 
7

Medicare Supplement
—

 
 
 
—

 
 
 
—

 
—

 
188,350

 
26
 
175,538

 
25
 
12,812

 
7

Liberty National Exclusive Agency
 
 
 
 
 
 
 
 
 
 
 
Limited-benefit plans
108,085

 
 
 
106,343

 
 
 
1,742

 
2

Medicare Supplement
39,988

 
 
 
46,080

 
 
 
(6,092
)
 
(13
)
 
148,073

 
20
 
152,423

 
21
 
(4,350
)
 
(3
)
American Income Exclusive Agency
 
 
 
 
 
 
 
 
 
 
 
Limited-benefit plans
66,077

 
 
 
62,477

 
 
 
3,600

 
6

Medicare Supplement
198

 
 
 
241

 
 
 
(43
)
 
(18
)
 
66,275

 
9
 
62,718

 
9
 
3,557

 
6

Direct Response
 
 
 
 
 
 
 
 
 
 
 
Limited-benefit plans
425

 
 
 
407

 
 
 
18

 
4

Medicare Supplement
54,844

 
 
 
52,541

 
 
 
2,303

 
4

 
55,269

 
8
 
52,948

 
7
 
2,321

 
4

Total Health Premium
 
 
 
 
 
 
 
 
 
 
 
Limited-benefit plans
371,623

 
51
 
354,502

 
50
 
17,121

 
5

Medicare Supplement
358,934

 
49
 
355,434

 
50
 
3,500

 
1

Total
$
730,557

 
100
 
$
709,936

 
100
 
$
20,621

 
3


33

Presented below is a table of health net sales by distribution channel.
Health Insurance
Net Sales
(Dollar amounts in thousands)
 
Nine Months Ended September 30,

Increase
 
2017

2016

(Decrease)
 
Amount

% of
Total

Amount

% of
Total

Amount

%
United American Independent Agency
 
 
 
 
 
 
 
 
 
 
 
Limited-benefit plans
$
388

 
 
 
$
428

 
 
 
$
(40
)
 
(9
)
Medicare Supplement
33,052

 
 
 
31,799

 
 
 
1,253

 
4

 
33,440

 
32
 
32,227

 
33
 
1,213

 
4

Family Heritage Agency
 
 
 
 
 
 
 
 
 
 
 
Limited-benefit plans
41,755

 
 
 
38,144

 
 
 
3,611

 
9

Medicare Supplement
—

 
 
 
—

 
 
 
—

 
—

 
41,755

 
40
 
38,144

 
39
 
3,611

 
9

Liberty National Exclusive Agency
 
 
 
 
 
 
 
 
 
 
 
Limited-benefit plans
14,558

 
 
 
14,665

 
 
 
(107
)
 
(1
)
Medicare Supplement
—

 
 
 
8

 
 
 
(8
)
 
(100
)
 
14,558

 
14
 
14,673

 
15
 
(115
)
 
(1
)
American Income Exclusive Agency
 
 
 
 
 
 
 
 
 
 
 
Limited-benefit plans
10,369

 
 
 
9,463

 
 
 
906

 
10

Medicare Supplement
—

 
 
 
—

 
 
 
—

 
—

 
10,369

 
10
 
9,463

 
9
 
906

 
10

Direct Response
 
 
 
 
 
 
 
 
 
 
 
Limited-benefit plans
—

 
 
 
—

 
 
 
—

 
—

Medicare Supplement
3,790

 
 
 
3,607

 
 
 
183

 
5

 
3,790

 
4
 
3,607

 
4
 
183

 
5

Total Net Sales
 
 
 
 
 
 
 
 
 
 
 
Limited-benefit plans
67,070

 
65
 
62,700

 
64
 
4,370

 
7

Medicare Supplement
36,842

 
35
 
35,414

 
36
 
1,428

 
4

Total
$
103,912

 
100
 
$
98,114

 
100
 
$
5,798

 
6


34

The following table presents health insurance first-year collected premium by distribution channel. Health first-year collected premium fell 4% to $100 million as a result of lower group sales in 2016. Group sales can vary significantly from period to period.
Health Insurance
First-Year Collected Premium
(Dollar amounts in thousands)
 
Nine Months Ended September 30,
 
Increase
 
2017

2016
 
(Decrease)
 
Amount

% of
Total

Amount

% of
Total
 
Amount

%
United American Independent Agency
 
 
 
 
 
 
 
 
 
 
 
Limited-benefit plans
$
344

 
 
 
$
433

 
 
 
$
(89
)
 
(21
)
Medicare Supplement
39,306

 
 
 
47,653

 
 
 
(8,347
)
 
(18
)
 
39,650

 
40

 
48,086

 
46

 
(8,436
)
 
(18
)
Family Heritage Agency
 
 
 
 
 
 
 
 
 
 
 
Limited-benefit plans
33,116

 
 
 
30,311

 
 
 
2,805

 
9

Medicare Supplement
—

 
 
 
—

 
 
 
—

 
—

 
33,116

 
33

 
30,311

 
29

 
2,805

 
9

Liberty National Exclusive Agency
 
 
 
 
 
 
 
 
 
 
 
Limited-benefit plans
12,256

 
 
 
11,946

 
 
 
310

 
3

Medicare Supplement
2

 
 
 
2

 
 
 
—

 
—

 
12,258

 
12

 
11,948

 
12

 
310

 
3

American Income Exclusive Agency
 
 
 
 
 
 
 
 
 
 
 
Limited-benefit plans
10,840

 
 
 
10,188

 
 
 
652

 
6

Medicare Supplement
—

 
 
 
—

 
 
 
—

 
—

 
10,840

 
11

 
10,188

 
10

 
652

 
6

Direct Response
 
 
 
 
 
 
 
 
 
 
 
Limited-benefit plans
—

 
 
 
—

 
 
 
—

 
—

Medicare Supplement
4,108

 
 
 
3,161

 
 
 
947

 
30

 
4,108

 
4

 
3,161

 
3

 
947

 
30

Total First-Year Collected Premium


 
 
 
 
 
 
 
 
 
 
Limited-benefit plans
56,556

 
57

 
52,878

 
51

 
3,678

 
7

Medicare Supplement
43,416

 
43

 
50,816

 
49

 
(7,400
)
 
(15
)
Total
$
99,972

 
100

 
$
103,694

 
100

 
$
(3,722
)
 
(4
)

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 $273 million, representing 37% of Torchmark’s total health premium. Net sales were $33 million, or 32% of Torchmark’s health sales. This agency primarily produces Medicare Supplement insurance, with Medicare Supplement premium income of $264 million. The UA Independent Agency represents approximately 74% of all Torchmark Medicare Supplement premium and 90% of Medicare Supplement net sales. Medicare Supplement premium in this agency rose 3%. Total health premium increased 2%. Net sales of the Medicare Supplement product increased 4% in 2017 as a result of an increase in group sales. First-year collected health premium fell 18% to $40 million, as a result of a high level of group sales in the fourth quarter of 2015 that positively affected the 2016 first-year collected premium.
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 by continuing the incorporation of Torchmark’s agent recruiting programs. The Family Heritage Agency contributed $42 million and $38 million in net sales in the nine months of 2017 and 2016, respectively.

35

Health premium income was $188 million for the nine month period of 2017, representing 26% of Torchmark’s health premium compared with $176 million or 25% of health premium in the prior year period. The average agent count was 984 for the nine months ended September 30, 2017 compared with 915 for the same period in 2016, an increase of 8%.
The Liberty National Exclusive Agency represented 20% of all Torchmark health premium income at $148 million in the nine months of 2017. 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 2017, health premium income in the Liberty Agency declined $4 million to $148 million from prior year premium. Liberty’s health premium decline is primarily due to its declining Medicare Supplement block as we are no longer selling these products from this agency.
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 2017 period. The American Income Exclusive Agency primarily markets accident plans. The Direct Response unit markets primarily Medicare Supplements to employer or union-sponsored groups. Direct Response added $4 million of Medicare Supplement net sales in 2017.
Annuities. Annuities represent an insignificant part of our business and are not expected to be an important part of our marketing strategy going forward.
Operating expenses, comparing the first nine months of 2017 with the first nine months of 2016. Operating expenses consist of insurance administrative expenses and Parent Company expenses. Also included is stock compensation expense, which is viewed by us as 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)
 
Nine Months Ended September 30,
 
2017
 
2016

Amount
 
% of
Premium
 
Amount
 
% of
Premium
Insurance administrative expenses:
 
 
 
 
 
 
 
Salaries
$
70,505

 
2.9
 
$
67,683

 
2.9
Other employee costs
25,320

 
1.0
 
21,834

 
0.9
Information technology costs
19,325

 
0.8
 
17,712

 
0.7
Legal costs
6,520

 
0.2
 
6,352

 
0.3
Other administrative costs
34,081

 
1.4
 
32,548

 
1.4
Total insurance administrative expenses
155,751

 
6.3
 
146,129

 
6.2
 
 
 
 
 
 
 
 
Parent company expense
7,228

 
 
 
6,360

 
 
Stock compensation expense
24,809

 
 
 
20,334

 
 
Non-operating fees
—

 
 
 
257

 
 
Total operating expenses, per Condensed Consolidated Statements of Operations
$
187,788

 
 
 
$
173,080

 
 
 
 
 
 
 
 
 
 
Insurance administrative expenses:
 
 
 
 
 
 
 
Increase (decrease) over prior year
6.6
%
 
 
 
5.4
%
 
 
Total operating expenses:
 
 
 
 
 
 
 
Increase (decrease) over prior year
8.5
%
 
 
 
3.6
%
 
 
Insurance administrative expenses of $156 million were up 6.6% in 2017 when compared with the prior year period of $146 million. As a percentage of total premium, insurance administrative expenses were 6.3% in 2017 compared with 6.2% in 2016. The increase in other employee costs was due primarily to higher pension expense driven by lower interest rates. The increase in information technology costs was due to investments that will enhance our customer

36

experience, improve our data analytics capabilities, improve our ability to react quickly to future changes and bolster our information security programs.
The increase in stock compensation expense was primarily due to higher expense associated with equity awards, reflecting Torchmark's higher share price as compared with the same period a year ago.
Investments (excess investment income), comparing the first nine months of 2017 with the first nine months of 2016. 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. 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 common 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 $7.0 billion of cash flow to repurchase Torchmark shares (average split-adjusted price per diluted common share of $15.90) 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.
The following table summarizes Torchmark’s investment income, excess investment income, and excess investment income per diluted common share.
Excess Investment Income
(Dollar amounts in thousands)
 
Nine Months Ended 
 September 30,
 
Increase
(Decrease)
 
2017
 
2016
 
Amount
 
%
Net investment income
$
634,930

 
$
601,415

 
$
33,515

 
6

Interest on net insurance policy liabilities:
 
 
 
 
 
 
 
Interest on reserves
(547,443
)
 
(524,093
)
 
(23,350
)
 
4

Interest on deferred acquisition costs
157,096

 
151,546

 
5,550

 
4

Net required interest
(390,347
)
 
(372,547
)
 
(17,800
)
 
5

Financing costs
(62,825
)
 
(62,860
)
 
35

 
—

Excess investment income
$
181,758

 
$
166,008

 
$
15,750

 
9

 
 
 
 
 
 
 
 
Excess investment income per diluted share
$
1.52

 
$
1.35

 
$
0.17

 
13

 
 
 
 
 
 
 
 
Average invested assets (at amortized cost)
$
15,275,412

 
$
14,339,950

 
$
935,462

 
7

Average net insurance policy liabilities(1)
9,306,010

 
8,896,284

 
409,726

 
5

Average debt and preferred securities (at amortized cost)
1,471,616

 
1,361,234

 
110,382

 
8

(1) Interest bearing policy liabilities, net of deferred acquisition costs and excluding the attributed unrealized gains and losses thereon.

Excess investment income for the 2017 period increased 9% to $182 million when compared to $166 million in the same period in 2016. The increase in excess investment income is primarily attributed to flat interest expense and an increase in net investment income due to the decline in the negative impact of delays of receiving Medicare Part D reimbursements. On a per diluted common share basis, excess investment income increased 13%, higher than the percentage increase in the dollar amount of excess investment income as a result of our share repurchase program.
Net investment income increased $34 million or 6% in 2017, below the 7% increase in average invested assets (with fixed maturities at amortized cost) over the same period last year. Net investment income has been negatively impacted

37

during recent years by low interest rates on new investments and the turnover of higher-yielding assets in the portfolio. As such, growth in net investment income has been slower than the growth in mean invested assets in recent years. The effective annual yield earned on the fixed maturity portfolio was 5.68% in the first nine months of 2017, compared with 5.80% a year earlier. The decrease in the overall portfolio yield during recent periods is due primarily to investing at lower yield rates than the overall portfolio yield rates and reinvesting at yield rates lower than disposition yield rates. We currently expect that the average annual 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.
Should interest rates rise, especially long-term rates, Torchmark's net investment income would benefit due to higher interest rates on new purchases. While such a rise in interest rates could adversely affect the fair value of the fixed maturities portfolio, we could withstand an increase in interest rates of approximately 90 to 95 basis points before the net unrealized gains on our fixed maturity portfolio as of September 30, 2017 would be eliminated. 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 since it is the amount of net investment income considered by management necessary to “fund” net insurance policy liabilities, which is the net of the benefit reserve liability and deferred acquisition cost asset. As such, it is removed from the investment segment and applied to the insurance segments to offset the effect of the interest required by 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 to discount the benefit reserve liability and to amortize the 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. Each calendar year, we set the discount rate to be used to calculate the benefit reserve liability and 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 $18 million or 5% to $390 million, in line with the growth in average net interest-bearing insurance policy liabilities.
Financing costs on our debt were flat in the first nine months of 2017 at $63 million.
More information concerning debt can be found in the Capital Resources section of this report.
Analysis of Financing Costs
(Dollar amounts in thousands)
 
Nine Months Ended 
 September 30,
 
Increase
(Decrease)
 
2017
 
2016
 
Amount
 
%
Interest on funded debt
$
55,089

 
$
57,647

 
$
(2,558
)
 
(4
)
Interest on term loan
1,706

 
536

 
1,170

 
*

Interest on short term debt
6,026

 
4,674

 
1,352

 
29

Other
4

 
3

 
1

 
33

Financing costs
$
62,825

 
$
62,860

 
$
(35
)
 
—

*Percent change is not meaningful.


38

Investments (acquisitions), comparing the first nine months of 2017 with the first nine months of 2016. Torchmark’s investment policy calls for investing primarily in investment grade fixed maturities that meet our quality and yield objectives. We generally prefer to invest in securities with longer maturities because they more closely match the long-term nature of our policy liabilities. 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)
 
 
Nine Months Ended 
 September 30,
 
2017
 
2016
Cost of acquisitions(1):

 

Corporate securities
$
1,046,773

 
$
910,085

Other
5,932

 
15,737

Total fixed maturity acquisitions
$
1,052,705

 
$
925,822

 
 
 
 
Effective annual yield(2)
4.74
%
 
4.73
%
Average life (in years, to next call)
22.8

 
24.1

Average life (in years, to maturity)
23.7

 
24.8

Average rating
BBB+

 
BBB+


(1) Total fixed maturity acquisitions include unsettled trades of $10.0 million in 2017 and $15.7 million in 2016.
(2) Tax-equivalent basis, where 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.
Investments (portfolio composition). The composition of the investment portfolio at book value on September 30, 2017 was as follows:
Invested Assets at September 30, 2017
(Dollar amounts in thousands)
 

Amount

% of
Total
Fixed maturities (at amortized cost)
$
14,914,580

 
96
Policy loans
523,318

 
3
Other long-term investments(1)
69,592

 
1
Short-term investments
65,482

 
—
Total
$
15,572,972

 
100
(1) Includes equities available for sale at amortized cost.
Approximately 96% of our investments at book value are in a diversified fixed-maturity portfolio, the same percentage as at year end. Policy loans, which are secured by policy cash values, make up approximately 3% 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.

39

Fixed Maturities. The following table summarizes certain information about the major corporate sectors and security types held in our fixed maturity portfolio at September 30, 2017.

Fixed Maturities by Sector
At September 30, 2017
(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
$
58,294

$
2,842

$
(3,381
)
$
57,755

 
$
2,003,179

$
319,173

$
(4,544
)
$
2,317,808

 
13
14
 
Banks
31,035

624

(3,030
)
28,629

 
739,517

107,348

(3,191
)
843,674

 
5
5
 
Other financial
74,955

—

(19,204
)
55,751

 
793,595

59,983

(21,175
)
832,403

 
5
5
 
Total financial
164,284

3,466

(25,615
)
142,135

 
3,536,291

486,504

(28,910
)
3,993,885

 
23
24
 
Utilities
 
 
 
 
 
 
 
 
 
 
 
 
 
Electric
20,713

1,239

—

21,952

 
1,469,534

275,245

(2,332
)
1,742,447

 
10
11
 
Gas and water
—

—

—

—

 
507,550

51,148

(439
)
558,259

 
3
3
 
Total utilities
20,713

1,239

—

21,952

 
1,977,084

326,393

(2,771
)
2,300,706

 
13
14
 
Industrial - Energy
 
 
 
 
 
 
 
 
 
 
 
 
 
Pipelines
40,598

531

(2,250
)
38,879

 
865,245

100,340

(5,289
)
960,296

 
6
6
 
Exploration and production
28,918

777

—

29,695

 
531,485

61,007

(4,023
)
588,469

 
4
4
 
Oil field services
33,871

—

(4,568
)
29,303

 
83,730

9,127

(4,568
)
88,289

 
1
1
 
Refiner
—

—

—

—

 
67,012

14,611

(5
)
81,618

 
—
—
 
Driller
54,582

211

(14,185
)
40,608

 
54,582

211

(14,185
)
40,608

 
—
—
 
Total energy
157,969

1,519

(21,003
)
138,485

 
1,602,054

185,296

(28,070
)
1,759,280

 
11
11
 
Industrial - Basic materials
 
 
 
 
 
 
 
 
 
 
 
 
 
Chemicals
—

—

—

—

 
541,902

45,379

(497
)
586,784

 
4
4
 
Metals and mining
68,073

7,831

—

75,904

 
390,213

74,145

—

464,358

 
3
3
 
Forestry products and paper
—

—

—

—

 
112,311

15,338

—

127,649

 
1
1
 
Total basic materials
68,073

7,831

—

75,904

 
1,044,426

134,862

(497
)
1,178,791

 
8
8
 
Industrial - Consumer, non-cyclical
—

—

—

—

 
1,770,933

168,731

(7,462
)
1,932,202

 
11
11
 
Other industrials
47,204

2,792

(29
)
49,967

 
1,357,486

164,785

(2,430
)
1,519,841

 
9
9
 
Industrial -
Transportation
26,572

387

(246
)
26,713

 
551,533

77,257

(614
)
628,176

 
4
4
 
Other corporate sectors
116,459

4,920

(5,094
)
116,285

 
1,300,884

120,485

(11,667
)
1,409,702

 
9
8
 
Total corporates
601,274

22,154

(51,987
)
571,441

 
13,140,691

1,664,313

(82,421
)
14,722,583

 
88
89
 
Other fixed maturities:
 
 
 
 
 
 
 
 
 
 
 
 
 
Government (U.S., municipal, and foreign)
306

—

(36
)
270

 
1,568,390

142,000

(1,205
)
1,709,185

 
11
10
 
Collateralized debt obligations
59,204

19,558

(8,994
)
69,768

 
59,204

19,558

(8,994
)
69,768

 
—
—
 
Other asset-backed securities
—

—

—

—

 
144,701

4,967

(17
)
149,651

 
1
1
 
Mortgage-backed securities(1)
—

—

—

—

 
1,594

133

(1
)
1,726

 
—
—
 
Total fixed maturities
$
660,784

$
41,712

$
(61,017
)
$
641,479

 
$
14,914,580

$
1,830,971

$
(92,638
)
$
16,652,913

 
100
100
(1) Includes GNMA's.


40

At September 30, 2017, fixed maturities had a fair value of $16.7 billion, compared with $15.2 billion at December 31, 2016. The net unrealized gain position in the fixed-maturity portfolio increased from $1.1 billion at December 31, 2016 to $1.7 billion at September 30, 2017. The September 30, 2017 net unrealized gain consisted of gross unrealized gains of $1.8 billion offset by $93 million of gross unrealized losses, compared with the December 31, 2016 net unrealized gain which consisted of a gross unrealized gain of $1.3 billion and a gross unrealized loss of $216 million.
Corporate securities, which consist of bonds and redeemable preferred stocks, were the largest component of the fixed maturity portfolio, representing 88% of amortized cost and 89% of fair value. The remainder of the portfolio is invested primarily in securities issued by the U.S. government and U.S. municipalities. The Company holds insignificant amounts in foreign government bonds, collateralized debt obligations, asset-backed securities, and agency mortgage-backed securities. Corporate securities are diversified over a variety of industry sectors and issuers; the total fixed maturity portfolio consisted of 600 issuers. The net unrealized gain of the fixed maturity portfolio increased $681 million from December 31, 2016.
An analysis of the fixed maturity portfolio at September 30, 2017 by a composite quality rating is shown in the table below. The composite quality 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. The composite quality rating is created using a methodology developed by Torchmark Corporation using ratings from the various rating agencies noted above (It should be noted that the composite quality rating is not a Standard & Poor's credit rating. Standard and Poor's does not sponsor, endorse or promote the composite quality rating and shall not be liable for any use of the composite quality rating.) Included in the chart below are private placement fixed maturity holdings of $593 million at amortized cost ($615 million at fair value). The ratings for these holdings were assigned by the third party managers of those securities.

Fixed Maturities by Rating
(Dollar amounts in thousands)
 
 
September 30, 2017

Amortized
Cost
 
%
 
Fair
Value
 
%
Investment grade:
 
 
 
 
 
 
 
AAA
$
647,007

 
4
 
$
681,920

 
4
AA
1,261,049

 
9
 
1,418,391

 
9
A
4,023,931

 
27
 
4,727,798

 
28
BBB+
3,493,852

 
23
 
3,886,434

 
23
BBB
3,201,975

 
22
 
3,531,015

 
21
BBB-
1,625,982

 
11
 
1,765,876

 
11
Investment grade
14,253,796

 
96
 
16,011,434

 
96
Below investment grade:
 
 
 
 
 
 
 
BB
362,855

 
2
 
351,691

 
2
B
161,422

 
1
 
140,346

 
1
Below B
136,507

 
1
 
149,442

 
1
Below investment grade
660,784

 
4
 
641,479

 
4

$
14,914,580

 
100
 
$
16,652,913

 
100
Of the $14.9 billion of fixed maturities at amortized cost as of September 30, 2017, $14.3 billion or 96% were investment grade with an average rating of A-. Below-investment-grade bonds were $661 million with an average rating of B+. Below-investment-grade bonds at amortized cost were 16% of our shareholders’ equity, excluding the effect of unrealized gains and losses on fixed maturities as of September 30, 2017. Overall, the total portfolio was rated BBB+ based on amortized cost, the same as at the end of 2016.

41

An analysis of the changes in our portfolio of below-investment-grade bonds at amortized cost during the first nine months of 2017 is as follows:
Below-Investment-Grade Bonds
(Dollar amounts in thousands)
Balance as of December 31, 2016
$
751,144

Downgrades by rating agencies
—

Upgrades by rating agencies
(76,659
)
Disposals
(16,422
)
Amortization and other
2,721

Balance as of September 30, 2017
$
660,784


As noted earlier, our investment policy calls for investing primarily in fixed maturities that are investment grade and meet our quality and yield objectives. Thus, any increases in below-investment-grade issues are typically a result of ratings downgrades of existing holdings. Our investment portfolio does not contain counterparty risks as we are not a party to any derivatives contracts. We also do not participate in securities lending and we have no off-balance sheet investments.
Additional information concerning the fixed-maturity portfolio is as follows:
Fixed Maturity Portfolio Selected Information
 

September 30,
2017
 
December 31, 2016
 
September 30,
2016
Average annual effective yield(1)
5.63%
 
5.74%
 
5.76%
Average life, in years, to:
 
 
 
 
 
Next call(2)
17.4
 
17.6
 
17.6
Maturity(2)
19.2
 
19.8
 
19.9
Effective duration to:
 
 
 
 
 
Next call(2)(3)
10.7
 
10.4
 
10.8
Maturity(2)(3)
11.4
 
11.3
 
11.6

(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 nine months of 2017 with the first nine months of 2016. 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 write-downs are outside the course of our normal operations, management removes the effects of such gains and losses when evaluating its overall core operating results.

42

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 per share data)
 
 
Nine Months Ended September 30,
 
2017
 
2016
 
Amount
 
Per Share
 
Amount
 
Per Share
Fixed maturities:
 
 
 
 
 
 
 
Investment sales
$
3,153

 
$
0.02

 
$
3,847

 
$
0.03

Investments called or tendered
5,628

 
0.05

 
995

 
0.01

Investment writedowns (1)
(159
)
 
—

 
—

 
—

Other investments
(2,387
)
 
(0.02
)
 
215

 
—

Total
$
6,235

 
$
0.05

 
$
5,057

 
$
0.04


(1) Written down due to other-than-temporary impairment.
(1) Written down due to other-than-temporary impairment

Financial Condition
Liquidity. Liquidity provides Torchmark with the ability to meet on demand the cash commitments required to support our business operations and meet our financial obligations. Our liquidity is evidenced by consistent positive cash flow, a portfolio of marketable investments, and our 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 as they better match the long-term nature of these obligations. In addition to investment income, maturities and scheduled repayments in the investment portfolio are sources of cash. Excess cash available from the insurance subsidiaries’ operations is generally distributed as a dividend to the parent company, subject to regulatory restriction. The dividends are generally paid in amounts equal to the subsidiaries’ prior year statutory net income excluding realized capital gains. While the leading source of the excess cash is investment income, due to our high underwriting margins and effective expense control, a significant portion of the excess cash also comes from underwriting income.
Parent Company liquidity. 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 nine months of 2017, the Parent Company received $309 million of cash dividends from subsidiaries, compared with $273 million in 2016. The increase in cash dividends received from subsidiaries was primarily due to the timing of dividend payments. For the full year 2017, cash dividends from subsidiaries are expected to total approximately $452 million.
Additional sources of liquidity for the Parent Company are cash, intercompany receivables, intercompany borrowings, and a credit facility. At September 30, 2017, the Parent Company had $55 million of invested cash and net intercompany receivables. The credit facility is discussed below.

Credit Facility. We have a credit facility with a group of lenders allowing for unsecured revolving borrowings and stand-by letters of credit up to $750 million, which could be extended up to $1 billion. We may request the extension, however, it is not guaranteed. Up to $250 million in letters of credit can be issued against the facility. The facility serves as a back-up credit line for a commercial paper program under which we may issue commercial paper at any time, with total commercial paper outstanding not to exceed the facility maximum, less any letters of credit issued. Interest on the commercial paper program is charged at variable rates. This facility was amended in May 2016 to extend the maturity date of the facility to May 2021. The amendment also allowed for an additional $100 million term loan to be issued under the facility rate structure. The term loan was issued during 2016 and will be repaid in quarterly escalating installments with a balloon payment of $75 million due in May 2021. Interest on the term loan is computed and paid

43

monthly at 125 basis points plus 1 month LIBOR. In accordance with the agreement, we are subject to certain covenants regarding capitalization. As of September 30, 2017, we were in full compliance with those covenants.

Commercial paper outstanding and any amortization payments of the term loan due within one year are included in short-term debt. The remaining balance of the term loan is included in long-term debt.
The following table presents certain information about our commercial paper borrowings.
Credit Facility - Commercial Paper
(Dollar amounts in thousands)
 
 
At
 
 
September 30, 
 2017
 
December 31, 2016
 
September 30, 
 2016
Balance of commercial paper at end of period (par value)
 
$
305,800

 
$
262,850

 
$
266,000

Annualized interest rate
 
1.44
%
 
0.96
%
 
0.85
%
Letters of credit outstanding
 
$
177,000

 
$
177,000

 
$
177,000

Remaining amount available under credit line
 
267,200

 
310,150

 
307,000

 
 
Nine Months Ended 
 September 30,
 
 
2017
 
2016
Average balance of commercial paper outstanding during period (par value)
 
$
336,664

 
$
297,065

Daily-weighted average interest rate (annualized)
 
1.24
%
 
0.81
%
Maximum daily amount outstanding during period (par value)
 
$
455,912

 
$
412,676

Our balance of commercial paper outstanding at September 30, 2017 was $306 million compared with $263 million at the previous year end. We have had no difficulties in accessing the commercial paper market under this facility during the nine month periods ended September 30, 2017 and 2016.
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 continuing operations were $1 billion in the first nine months of 2017, compared with $889 million in the same period of 2016. The increase is primarily attributable to timing of cash disbursements and fluctuations in amounts recorded in other liabilities. In addition to cash inflows from operations, our companies received proceeds from maturities, calls, and repayments of fixed maturities available for sale in the amount of $306 million during the 2017 period. As previously noted under the caption Credit Facility, we have in place a line of credit facility. The insurance companies have no additional outstanding credit facilities.
Cash and short-term investments were $154 million at September 30, 2017, compared with $148 million at December 31, 2016. In addition to these liquid assets, the entire $16.7 billion (fair value at September 30, 2017) portfolio of fixed income securities is available for sale in the event of an unexpected need. Approximately 96% of our fixed income 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, on-going investment maturities, and credit line availability make any need to sell securities for liquidity highly unlikely.
Capital Resources. Management targets an aggregate capital ratio for its insurance subsidiaries of approximately 325% of Company action level regulatory capital under Risk-Based Capital (RBC), a formula designed by insurance regulatory authorities to monitor the adequacy of capital. The 325% target is considered sufficient for the subsidiaries because of their strong reliable cash flows, the relatively low risk of their product mix, and because that ratio is in line with rating agency expectations for Torchmark. At December 31, 2016, our insurance subsidiaries had an aggregate

44

RBC ratio of approximately 324%. Should we experience impairments and/or ratings downgrades within our fixed maturity portfolio in the future, the ratio could fall below targeted levels. In such a case, management believes more than sufficient liquidity exists at the Parent Company to make additional contributions as necessary to maintain the targeted ratio.
On a consolidated basis, Torchmark’s capital structure consists of short-term debt (comprised of the commercial paper outstanding discussed above, current maturities of the term loan, and current maturities of funded debt), long-term debt (comprised of long-term maturities of funded debt and long term maturities of the term loan), and shareholders’ equity.
The outstanding long-term debt at book value was $1.1 billion at September 30, 2017 and December 31, 2016. An analysis of debt issues outstanding is as follows at September 30, 2017.
Selected Information about Debt Issues
at September 30, 2017
(Dollar amounts in thousands)
Instrument
Year
Due
 
Interest
Rate
 
 
Par
Value
 
Book
Value
 
Fair
Value
Notes
2023
 
7.875%

 
$
165,612

 
$
164,236

 
$
198,786

Senior Notes
2019
 
9.250%

 
292,647

 
291,767

 
327,057

Senior Notes(1)
2022
 
3.800%

 
150,000

 
148,404

 
154,449

Junior Subordinated Debentures
2052
 
5.875%

 
125,000

 
120,954

 
126,700

Junior Subordinated Debentures
2036
 
4.620%
(2) 
 
20,000

 
20,000

 
20,000

Junior Subordinated Debentures
2056
 
6.125%

 
300,000

 
290,445

 
321,240

Term loan(3)
2021
 
2.489%
(4) 
 
98,750

 
98,750

 
98,750

 
 
 
 
 
 
1,152,009

 
1,134,556

 
1,246,982

Less current maturity of term loan(3)
 
 
 
 
 
3,750

 
3,750

 
3,750

Total long-term debt
 
 
 
 
 
1,148,259

 
1,130,806

 
1,243,232


 
 
 
 
 
 
 
 
 
 
Current maturity of term loan(3)
 
 
 
 
 
3,750

 
3,750

 
3,750

Commercial paper
 
 
 
 
 
305,800

 
305,252

 
305,252

Total short term debt
 
 
 
 
 
309,550

 
309,002

 
309,002


 
 
 
 
 
 
 
 
 
 
Total debt
 
 
 
 
 
$
1,457,809

 
$
1,439,808

 
$
1,552,234


(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.
(3) The current amount of the term loan due of $3.8 million is classified as short term debt.
(4) Interest paid at 1 month LIBOR plus 125 basis points, resets each month.

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 used the net proceeds from the offering of the Debentures primarily to repay the $250 million outstanding principal amount plus accrued interest of $8 million on its 6.375% Senior Notes that were due June 15, 2016.
As previously noted under the caption Results of Operations in this report, we acquired 3.2 million of our outstanding common shares under our share repurchase program during the first nine months of 2017. These shares were acquired at a cost of $243 million (average of $76.46 per share), compared with purchases of 4.2 million shares at a cost of $240 million (average of $57.58 per share) in the first nine months of 2016.
On August 28, 2017, the Company announced that it had declared a quarterly dividend of 0.15 per share. This dividend was paid on November 1, 2017.
Shareholders’ equity was $5.2 billion at September 30, 2017. This compares with $4.6 billion at December 31, 2016 and $5.1 billion at September 30, 2016. During the nine months since December 31, 2016, shareholders’ equity was

45

increased by $442 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 $427 million. Share purchases of $243 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 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 the GAAP requirement to revalue our fixed maturity assets on relevant 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 per share data)

At
 
September 30, 2017
 
December 31, 2016
 
September 30, 2016

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
$
16,652,913

 
$
1,738,333

 
$
15,245,861

 
$
1,057,811

 
$
15,837,700

 
$
1,893,233

Deferred acquisition costs(2)
3,911,800

 
(11,273
)
 
3,783,158

 
(10,281
)
 
3,739,526

 
(12,698
)
Total assets
22,993,607

 
1,727,060

 
21,436,087

 
1,047,530

 
22,077,031

 
1,880,535

Short-term debt
309,002

 
—

 
264,475

 
—

 
266,892

 
—

Long-term debt
1,130,806

 
—

 
1,133,165

 
—

 
1,133,544

 
—

Shareholders' equity
5,167,685

 
1,122,589

 
4,566,861

 
680,894

 
5,086,383

 
1,222,348

 
 
 
 
 
 
 
 
 
 
 
 
Book value per diluted share
43.78

 
9.51

 
37.76

 
5.63

 
41.94

 
10.08

Debt to capitalization(3)
21.8
%
 
(4.5
)%
 
23.4
%
 
(3.1
)%
 
21.6
%
 
(5.0
)%
 
 
 
 
 
 
 
 
 
 
 
 
Diluted shares outstanding
118,028

 
 
 
120,958

 
 
 
121,271

 
 
Actual shares outstanding
115,359

 
 
 
118,031

 
 
 
118,895

 
 
 
(1) Amount added to (deducted from) comprehensive income to produce the stated GAAP item, per accounting rule ASC 320-10-35-1.
(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 10.8 times in the first nine month of 2017, compared with 10.5 times in the 2016 period. Interest coverage is computed by dividing interest expense into the sum of pretax income and interest expense.

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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)
Economic and other 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);
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)
The ability to obtain timely and appropriate premium rate increases for health insurance policies from our regulators;
10)
The customer response to new products and marketing initiatives;
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; and
12)
Compromise by a malicious actor or other event that causes a loss of secure data from, or inaccessibility to, our computer and other information technology systems.


47

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 nine months ended September 30, 2017.
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 September 30, 2017, 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.
For the quarter ended September 30, 2017, 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.

48

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.

See further discussion of litigation and unclaimed property audits in Note 6—Commitments and Contingencies.

Item 1A. Risk Factors
Torchmark 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
July 1-31, 2017
 
148,621

 
$
78.04

 
148,621

 
 
August 1-31, 2017
 
775,262

 
77.79

 
775,262

 
 
September 1-30, 2017
 
337,147

 
76.48

 
337,147

 
 
At its August 7, 2017 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

49

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: November 7, 2017
 
 
/s/ Gary L. Coleman
 
 
 
Gary L. Coleman
 
 
 
Co-Chairman and Chief Executive Officer
 
 
 
Date: November 7, 2017
 
 
/s/ Larry M. Hutchison
 
 
 
Larry M. Hutchison
 
 
 
Co-Chairman and Chief Executive Officer
 
 
 
Date: November 7, 2017
 
 
/s/ Frank M. Svoboda
 
 
 
Frank M. Svoboda
 
 
 
Executive Vice President and Chief Financial Officer

50

GLOBE LIFE INC. Reports