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

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

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Table of Contents

INDEX

 

			Page
PART I. FINANCIAL INFORMATION
Item 1.	Condensed Consolidated Financial Statements
	Condensed Consolidated Balance Sheets		1
	Condensed Consolidated Statements of Operations		2
	Condensed Consolidated Statements of Comprehensive Income		3
	Condensed Consolidated Statements of Shareholders' Equity		4
	Condensed Consolidated Statements of Cash Flows		5
	Notes to Condensed Consolidated Financial Statements
	Note 1—Significant Accounting Policies		6
	Note 2—New Accounting Standards		6
	Note 3—Supplemental Information about Changes to Accumulated Other Comprehensive Income		8
	Note 4—Investments		10
	Note 5—Discontinued Operations		15
	Note 6—Commitments and Contingencies		16
	Note 7—Liability for Unpaid Claims		17
	Note 8—Postretirement Benefits Plans		19
	Note 9—Earnings Per Share		20
	Note 10—Business Segments		20
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		27
Item 3.	Quantitative and Qualitative Disclosures about Market Risk		48
Item 4.	Controls and Procedures		48
PART II. OTHER INFORMATION
Item 1.	Legal Proceedings		49
Item 1A.	Risk Factors		49
Item 2.	Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities		49
Item 6.	Exhibits		49

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Table of Contents

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.

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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.

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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.

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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.

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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.

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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

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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.

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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

 

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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	)

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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

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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		%

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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.

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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.

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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	)

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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.

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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

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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.

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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

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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.

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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.

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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.

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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.

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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.

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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: