UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark one)
ý	Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
	For the quarterly period ended March 31, 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 April 28, 2017
	Common Stock, $1.00 Par Value		116,982,255

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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 Equity		4
	Condensed Consolidated Statements of Cash Flows		5
	Notes to Condensed Consolidated Financial Statements		6
	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		18
	Note 9—Earnings Per Share		19
	Note 10—Business Segments		19
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		24
Item 3.	Quantitative and Qualitative Disclosures about Market Risk		45
Item 4.	Controls and Procedures		45
PART II. OTHER INFORMATION
Item 1.	Legal Proceedings		46
Item 1A.	Risk Factors		46
Item 2.	Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities		46
Item 6.	Exhibits		46

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PART I–FINANCIAL INFORMATION

Item 1.	Condensed Consolidated Financial Statements

TORCHMARK CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

(Dollar amounts in thousands)

	March 31, 2017				December 31, 2016
Assets:
Investments:
Fixed maturities—available for sale, at fair value (amortized cost: 2017—$14,602,250; 2016—$14,188,050)	$	15,874,131			$	15,245,861
Policy loans	510,574				507,975
Other long-term investments	53,741				53,852
Short-term investments	120,990				72,040
Total investments	16,559,436				15,879,728
Cash	61,754				76,163
Accrued investment income	235,120				223,148
Other receivables	370,306				384,454
Deferred acquisition costs	3,821,718				3,783,158
Goodwill	441,591				441,591
Other assets	513,706				520,313
Assets related to discontinued operations	83,345				127,532
Total assets	$	22,086,976			$	21,436,087
Liabilities:
Future policy benefits	$	12,972,517			$	12,825,837
Unearned and advance premiums	70,022				64,017
Policy claims and other benefits payable	301,944				299,565
Other policyholders' funds	97,015				96,993
Total policy liabilities	13,441,498				13,286,412
Current and deferred income taxes payable	1,864,015				1,743,990
Other liabilities	563,102				413,760
Short-term debt	327,019				264,475
Long-term debt (estimated fair value: 2017—$1,244,283; 2016—$1,233,019)	1,132,791				1,133,165
Liabilities related to discontinued operations	13,724				27,424
Total liabilities	17,342,149				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 in 2016	—				—
Common stock, par value $1 per share—Authorized 320,000,000 shares; outstanding: (2017—127,218,183 issued, less 9,951,143 held in treasury and 2016—127,218,183 issued, less 9,187,075 held in treasury)	127,218				127,218
Additional paid-in capital	491,772				490,421
Accumulated other comprehensive income	722,865				577,574
Retained earnings	3,994,665				3,890,798
Treasury stock, at cost	(591,693		)		(519,150		)
Total shareholders’ equity	4,744,827				4,566,861
Total liabilities and shareholders’ equity	$	22,086,976			$	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   March 31,
	2017				2016
Revenue:
Life premium	$	575,837			$	544,151
Health premium	244,791				235,697
Other premium	3				12
Total premium	820,631				779,860
Net investment income	208,282				197,053
Realized investment gains (losses)	(5,748		)		293
Other income	416				421
Total revenue	1,023,581				977,627
Benefits and expenses:
Life policyholder benefits	391,079				362,860
Health policyholder benefits	157,751				152,775
Other policyholder benefits	8,946				9,338
Total policyholder benefits	557,776				524,973
Amortization of deferred acquisition costs	125,908				118,806
Commissions, premium taxes, and non-deferred acquisition costs	65,116				61,602
Other operating expense	62,341				57,429
Interest expense	20,699				19,369
Total benefits and expenses	831,840				782,179
Income before income taxes	191,741				195,448
Income taxes	(54,563		)		(61,874		)
Income from continuing operations	137,178				133,574
Income (loss) from discontinued operations, net of tax	(3,637		)		(9,541		)
Net income	$	133,541			$	124,033
Basic net income (loss) per common share:
Continuing operations	$	1.16			$	1.10
Discontinued operations	(0.03		)		(0.08		)
Total basic net income per common share	$	1.13			$	1.02
Diluted net income (loss) per common share:
Continuing operations	$	1.14			$	1.08
Discontinued operations	(0.03		)		(0.07		)
Total diluted net income per common share	$	1.11			$	1.01
Dividends declared per common share	$	0.15			$	0.14

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   March 31,
	2017				2016
Net income	$	133,541			$	124,033
Other comprehensive income (loss):
Unrealized investment gains (losses):
Unrealized gains (losses) on securities:
Unrealized holding gains (losses) arising during period	215,527				465,157
Reclassification adjustment for (gains) losses on securities included in net income	(1,035		)		(313		)
Reclassification adjustment for amortization of (discount) and premium	(437		)		(1,364		)
Foreign exchange adjustment on securities recorded at fair value	15				455
Unrealized gains (losses) on securities	214,070				463,935
Unrealized gains (losses) on other investments	996				658
Total unrealized investment gains (losses)	215,066				464,593
Less applicable tax (expense) benefit	(75,323		)		(162,589		)
Unrealized investment gains (losses), net of tax	139,743				302,004
Unrealized gains (losses) attributable to deferred acquisition costs	(770		)		(2,769		)
Less applicable tax (expense) benefit	270				969
Unrealized gains (losses) attributable to deferred acquisition costs, net of tax	(500		)		(1,800		)
Foreign exchange translation adjustments, other than securities	4,214				1,760
Less applicable tax (expense) benefit	(428		)		(540		)
Foreign exchange translation adjustments, other than securities, net of tax	3,786				1,220
Pension adjustments:
Amortization of pension costs	3,109				2,552
Experience gain (loss)	371				686
Pension adjustments	3,480				3,238
Less applicable tax (expense) benefit	(1,218		)		(1,134		)
Pension adjustments, net of tax	2,262				2,104
Other comprehensive income (loss)	145,291				303,528
Comprehensive income (loss)	$	278,832			$	427,561

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)														303,528				124,033								427,561
Common dividends declared ($0.14 per share)																		(16,979		)						(16,979		)
Acquisition of treasury stock																						(85,089		)		(85,089		)
Stock-based compensation										388								(2,224		)		8,771				6,935
Exercise of stock options																		(4,020		)		7,783				3,763
Balance at March 31, 2016		$	—			$	130,218			$	482,672			$	535,475			$	3,715,179			$	(471,801	)		$	4,391,743
		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)														145,291				133,541								278,832
Common dividends declared ($0.15 per share)																		(17,567		)						(17,567		)
Acquisition of treasury stock																						(113,719		)		(113,719		)
Stock-based compensation										1,351								(606		)		7,450				8,195
Exercise of stock options																		(11,501		)		33,726				22,225
Balance at March 31, 2017		$	—			$	127,218			$	491,772			$	722,865			$	3,994,665			$	(591,693	)		$	4,744,827

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)

	Three Months Ended March 31,
	2017				2016
Cash provided from operating activities	$	460,756			$	340,738
Cash provided from (used for) investing activities:
Investments sold or matured:
Fixed maturities available for sale—sold	—				14,331
Fixed maturities available for sale—matured, called, and repaid	108,899				44,622
Other long-term investments	3,071				8
Total long-term investments sold or matured	111,970				58,961
Acquisition of investments:
Fixed maturities—available for sale	(461,324		)		(287,204		)
Other long-term investments	—				(644		)
Total investments acquired	(461,324		)		(287,848		)
Net increase in policy loans	(2,599		)		(4,378		)
Net (increase) decrease in short-term investments	(48,950		)		(89,905		)
Additions to property and equipment	(3,978		)		(3,879		)
Sale of other assets	18				—
Investment in low-income housing interests	(5,875		)		(7,925		)
Cash provided from (used for) investing activities	(410,738		)		(334,974		)
Cash provided from (used for) financing activities:
Issuance of common stock	22,225				3,763
Cash dividends paid to shareholders	(16,503		)		(16,524		)
Net borrowing (repayment) of commercial paper	61,919				66,899
Acquisition of treasury stock	(113,719		)		(85,089		)
Net receipts (payments) from deposit-type product	(21,174		)		(17,641		)
Cash provided from (used for) financing activities	(67,252		)		(48,592		)
Effect of foreign exchange rate changes on cash	2,825				(5,797		)
Net increase (decrease) in cash	(14,409		)		(48,625		)
Cash at beginning of year	76,163				61,383
Cash at end of period	$	61,754			$	12,758

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 March 31, 2017, and the condensed consolidated results of operations, comprehensive income, and cash flows for the periods ended March 31, 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 FASB issued Accounting Standards Update No. 2016-01, Financial Instrument—Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities, which revises the classification and measurement of certain equity investments such that they are measured at fair value through net income. The standard will become effective for the Company beginning January 1, 2018 and early adoption is permitted. The Company does not expect the adoption to have a significant impact on the financial statements.

ASU 2016-02: In February 2016, the FASB issued Accounting Standards Update No. 2016-02, Leases (Topic 842), which requires all lessees to report a right-of-use asset and a lease liability for most leases. For lessors, the standard modifies the classification criteria and the accounting for sales-type and direct financing leases. The standard will become effective for the Company beginning January 1, 2019 and will require recognizing and measuring leases at the beginning of the earliest period presented using a modified retrospective approach. Early adoption is permitted. The Company 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 non-cancellable operating lease commitments.

ASU 2016-13: In June 2016, the FASB issued Accounting Standards Update 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.

ASU 2016-15: In August 2016, the FASB issued Accounting Standards Update 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. The Company is currently evaluating the standard to determine its impact.

ASU 2016-16: In October 2016, the FASB issued Accounting Standards Update 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 approach and will become effective on January 1, 2018. The Company does not expect the adoption to have a significant impact on the financial statements.

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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)

ASU 2017-04: In January 2017, the FASB issued Accounting Standards Update 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. It will become effective on January 1, 2020 and should be applied on a prospective basis. The Company does not expect the adoption to have a significant impact on the financial statements.

ASU 2017-07: In March 2017, the FASB issued Accounting Standards Update 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 is currently evaluating the standard to determine its impact.

ASU 2017-08: In March 2017, the FASB issued Accounting Standards Update 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. The Company is currently evaluating the standard to determine its impact.

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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 month periods ended March 31, 2017 and 2016.

Components of Accumulated Other Comprehensive Income

    

		Three Months Ended March 31, 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		140,700				(500		)		3,786				241				144,227
Reclassifications, net of tax		(957		)		—				—				2,021				1,064
Other comprehensive income (loss)		139,743				(500		)		3,786				2,262				145,291
Balance at March 31, 2017		$	832,057			$	(7,182	)		$	8,753			$	(110,763	)		$	722,865
		Three Months Ended March 31, 2016
		Available for Sale Assets				Deferred Acquisition Costs				Foreign Exchange				Pension Adjustments				Total
Balance at January 1, 2016		$	332,333			$	(5,115	)		$	3,627			$	(98,898	)		$	231,947
Other comprehensive income (loss) before reclassifications, net of tax		303,094				(1,800		)		1,220				445				302,959
Reclassifications, net of tax		(1,090		)		—				—				1,659				569
Other comprehensive income (loss)		302,004				(1,800		)		1,220				2,104				303,528
Balance at March 31, 2016		$	634,337			$	(6,915	)		$	4,847			$	(96,794	)		$	535,475

                                                                                                                                                           

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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)

Reclassifications out of Accumulated Other Comprehensive Income are presented below for the three month periods ended March 31, 2017 and 2016.

Reclassification Adjustments

		Three Months Ended   March 31,								Affected line items in the Statement of Operations
		2017				2016
Unrealized investment gains (losses) on available for sale assets:
Realized (gains) losses		$	(1,035	)		$	(313	)		Realized gains (losses)
Amortization of (discount) premium		(437		)		(1,364		)		Net investment income
Total before tax		(1,472		)		(1,677		)
Tax		515				587				Income taxes
Total after tax		(957		)		(1,090		)
Pension adjustments:
Amortization of prior service cost		119				120				Other operating expenses
Amortization of actuarial gain (loss)		2,990				2,432				Other operating expenses
Total before tax		3,109				2,552
Tax		(1,088		)		(893		)		Income taxes
Total after tax		2,021				1,659
Total reclassifications (after tax)		$	1,064			$	569

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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 March 31, 2017 is as follows:

Portfolio Composition as of March 31, 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	$	385,755			$	1,830			$	(6,424	)		$	381,161			3
States, municipalities, and political subdivisions	1,184,062				120,066				(1,029		)		1,303,099				8
Foreign governments	20,066				1,466				(8		)		21,524				—
Corporates, by sector:
Financial	3,137,495				331,704				(34,260		)		3,434,939				21
Utilities	1,896,115				268,397				(9,842		)		2,154,670				14
Energy	1,589,982				145,310				(31,320		)		1,703,972				11
Other corporate sectors	5,824,044				494,335				(59,618		)		6,258,761				39
Total corporates	12,447,636				1,239,746				(135,040		)		13,552,342				85
Collateralized debt obligations	59,976				17,515				(9,648		)		67,843				—
Other asset-backed securities	104,476				1,072				(361		)		105,187				1
Redeemable preferred stocks, by sector:
Financial	371,691				48,325				(7,011		)		413,005				3
Utilities	28,588				1,628				(246		)		29,970				—
Total redeemable preferred stocks	400,279				49,953				(7,257		)		442,975				3
Total fixed maturities	$	14,602,250			$	1,431,648			$	(159,767	)		$	15,874,131			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 March 31, 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.

	March 31, 2017
	Amortized Cost				Fair Value
Fixed maturities available for sale:
Due in one year or less	$	88,952			$	91,746
Due from one to five years	628,487				675,601
Due from five to ten years	1,335,053				1,474,252
Due from ten to twenty years	4,256,853				4,794,890
Due after twenty years	8,127,226				8,663,281
Mortgage-backed and asset-backed securities	165,679				174,361
	$	14,602,250			$	15,874,131

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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 March 31,
	2017				2016
Proceeds from sales	$	—			$	14,331
Gross realized gains	—				495
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 March 31, 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		$	4			$	381,157			$	—			$	381,161
States, municipalities, and political subdivisions		—				1,303,099				—				1,303,099
Foreign governments		—				21,524				—				21,524
Corporates, by sector:
Financial		—				3,372,832				62,107				3,434,939
Utilities		—				2,000,220				154,450				2,154,670
Energy		—				1,663,113				40,859				1,703,972
Other corporate sectors		—				5,930,189				328,572				6,258,761
Total corporates		—				12,966,354				585,988				13,552,342
Collateralized debt obligations		—				—				67,843				67,843
Other asset-backed securities		—				91,187				14,000				105,187
Redeemable preferred stocks, by sector:
Financial		—				413,005				—				413,005
Utilities		—				29,970				—				29,970
Total redeemable preferred stocks		—				442,975				—				442,975
Total fixed maturities		$	4			$	15,206,296			$	667,831			$	15,874,131
Percent of total		—		%		95.8		%		4.2		%		100.0		%

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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 represents an analysis of changes in fair value measurements using significant unobservable inputs (Level 3).

Analysis of Changes in Fair Value Measurements Using

Significant Unobservable Inputs (Level 3)

	Three Months Ended March 31, 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	—				5,090				6,275				11,365
Acquisitions	14,000				—				21,666				35,666
Sales	—				—				—				—
Amortization	—				1,249				4				1,253
Other(2)	—				(1,999		)		(1,557		)		(3,556		)
Transfers in and/or out of Level 3(3)	—				—				—				—
Balance at March 31, 2017	$	14,000			$	67,843			$	585,988			$	667,831
Percent of total fixed maturities	0.1		%		0.4		%		3.7		%		4.2		%
	Three Months Ended March 31, 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	—				—				—				—
Included in other comprehensive income	—				(3,598		)		9,568				5,970
Acquisitions	—				—				15,800				15,800
Sales	—				—				—				—
Amortization	—				1,334				4				1,338
Other(2)	—				(2,626		)		(1,377		)		(4,003		)
Transfers in and/or out of Level 3(3)	—				—				—				—
Balance at March 31, 2016	$	—			$	65,492			$	554,801			$	620,293
Percent of total fixed maturities	—		%		0.5		%		3.8		%		4.3		%

(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:

Based on the Company's evaluation of its fixed maturities available for sale in an unrealized loss position in accordance with the other-than-temporary impairment (OTTI) policy, the Company concluded that there were no other-than-temporary impairments during the three month periods ended March 31, 2017 and 2016. Torchmark is continuously monitoring the market conditions impacting its portfolio. Additionally, Torchmark has the ability and intent to hold these investments to recovery, and does not expect to be required to sell any of its securities.

Unrealized Loss Analysis:

The following table discloses information about 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 March 31, 2017		346			87			433
As of December 31, 2016		407			94			501

Torchmark’s entire fixed maturity portfolio consisted of 1,535 issues at March 31, 2017 and 1,565 issues at December 31, 2016. The weighted average quality rating of all unrealized loss positions as of March 31, 2017 was BBB+.

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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 March 31, 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 March 31, 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		$	243,425			$	(5,865	)		$	1,441			$	(559	)		$	244,866			$	(6,424	)
States, municipalities and political subdivisions		30,822				(779		)		668				(32		)		31,490				(811		)
Foreign governments		2,187				(8		)		—				—				2,187				(8		)
Corporates, by sector:
Financial		335,653				(7,863		)		80,362				(3,632		)		416,015				(11,495		)
Utilities		246,001				(7,937		)		16,675				(1,905		)		262,676				(9,842		)
Energy		57,535				(955		)		141,685				(12,049		)		199,220				(13,004		)
Other corporate sectors		1,301,093				(46,268		)		70,324				(5,124		)		1,371,417				(51,392		)
Total corporates		1,940,282				(63,023		)		309,046				(22,710		)		2,249,328				(85,733		)
Other asset-backed securities		24,580				(361		)		—				—				24,580				(361		)
Redeemable preferred stocks, by sector:
Financial		23,985				(6		)		—				—				23,985				(6		)
Utilities		5,842				(246		)		—				—				5,842				(246		)
Total redeemable preferred stocks		29,827				(252		)		—				—				29,827				(252		)
Total investment grade securities		2,271,123				(70,288		)		311,155				(23,301		)		2,582,278				(93,589		)
Below investment grade securities:
Bonds:
States, municipalities and political subdivisions		—				—				333				(218		)		333				(218		)
Corporates, by sector:
Financial		—				—				82,995				(22,765		)		82,995				(22,765		)
Energy		10,563				(123		)		88,907				(18,193		)		99,470				(18,316		)
Other corporate sectors		—				—				115,418				(8,226		)		115,418				(8,226		)
Total corporates		10,563				(123		)		287,320				(49,184		)		297,883				(49,307		)
Collateralized debt obligations		—				—				10,351				(9,648		)		10,351				(9,648		)
Redeemable preferred stocks, by sector:
Financial		10,000				—				20,119				(7,005		)		30,119				(7,005		)
Total redeemable preferred stocks		10,000				—				20,119				(7,005		)		30,119				(7,005		)
Total below investment grade securities		20,563				(123		)		318,123				(66,055		)		338,686				(66,178		)
Total fixed maturities		$	2,291,686			$	(70,411	)		$	629,278			$	(89,356	)		$	2,920,964			$	(159,767	)

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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 as of March 31, 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 March 31, 2017 and December 31, 2016 were as follows:

	March 31, 2017				December 31, 2016
Assets:
Due premiums	$	3,945			$	8,840
Other receivables(1)	79,400				118,692
Total assets related to discontinued operations	83,345				127,532
Liabilities:
Risk sharing payable	8,528				8,374
Current and deferred income taxes payable	3,128				3,820
Other(2)	2,068				15,230
Total liabilities related to discontinued operations	13,724				27,424
Net assets	$	69,621			$	100,108

(1) At March 31, 2017, receivables included $65 million from the Centers for Medicare and Medicaid Services (CMS) and $14 million from drug manufacturer rebates. At December 31, 2016, the comparable amounts were $50 million and $69 million, respectively.

(2) Balance at December 31, 2016 includes $3.6 million representing a contingent purchase price reserve.

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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 (continued)

Income from discontinued operations for the three months ended March 31, 2017 and 2016 was as follows:

	Three Months Ended   March 31,
	2017				2016
Revenue:
Health premium	$	(224	)		$	54,699
Benefits and expenses:
Health policyholder benefits	4,184				61,481
Amortization of deferred acquisition costs	—				1,008
Commissions, premium taxes, and non-deferred acquisition expenses	576				5,109
Other operating expense	611				1,780
Total benefits and expenses	5,371				69,378
Income (loss) before income taxes for discontinued operations	(5,595		)		(14,679		)
Income tax benefit (expense)	1,958				5,138
Income (loss) from discontinued operations	$	(3,637	)		$	(9,541	)

Operating cash flows of the discontinued operations for the three months ended March 31, 2017 and 2016 were as follows:

	Three Months Ended   March 31,
	2017				2016
Net cash provided from (used for) discontinued operations	$	26,850			$	14,061

Note 6—Commitments and Contingencies

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.

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.

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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

Activity in the liability for unpaid health claims is summarized as follows:

	Three Months Ended March 31,
	2017				2016
Balance at beginning of period	$	143,128			$	137,120
Incurred related to:
Current year	135,377				126,897
Prior years	(4,024		)		(316		)
Total incurred	131,353				126,581
Paid related to:
Current year	54,241				52,621
Prior years	77,555				76,421
Total paid	131,796				129,042
Balance at end of period	$	142,685			$	134,659

 

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

	March 31, 2017				December 31, 2016
Policy claims and other benefits payable:
Short-duration contracts	$	24,341			$	26,721
Insurance lines other than short duration—health	118,344				116,407
Insurance lines other than short duration—life	159,259				156,437
Total policy claims and other benefits payable	$	301,944			$	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 March 31, 2017
Accident Year	Total of incurred-but-not-reported liabilities plus expected development on reported claims
2013	$	—
2014	7
2015	210
2016	6,174
2017	17,950
Total	$	24,341

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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 March 31,
	Pension Benefits								Other Benefits
	2017				2016				2017				2016
Service cost	$	4,487			$	3,894			$	—			$	—
Interest cost	5,550				5,432				250				212
Expected return on assets	(5,899		)		(5,782		)		—				—
Amortization:
Prior service cost	119				120				—				—
Actuarial (gain)/loss	2,951				2,424				39				8
Direct recognition of expense	—				—				96				34
Net periodic benefit cost	$	7,208			$	6,088			$	385			$	254

 

The following table presents assets at fair value for the defined-benefit pension plans at March 31, 2017 and the prior-year end.

Pension Assets by Component

	March 31, 2017						December 31, 2016
	Amount				%		Amount				%
Corporate bonds	$	160,254			48		$	160,036			49
Exchange traded fund(1)	142,902				42		134,771				41
Other bonds	260				—		258				—
Guaranteed annuity contract(2)	19,126				6		18,997				6
Short-term investments	11,336				3		7,391				2
Other	3,075				1		7,418				2
Total	$	336,953			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.

Pension Liability

	March 31, 2017				December 31, 2016
Funded defined benefit pension	$	460,475			$	449,613
SERP(1) (Active)	75,533				74,687
SERP(1) (Closed)	2,864				3,222
Pension Benefit Obligation	$	538,872			$	527,522

(1)	Supplemental executive retirement plan (SERP).

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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)

As noted in the table above, the liability for the funded defined-benefit pension plans was $460 million at March 31, 2017 and $450 million at December 31, 2016. During the three months ended March 31, 2017, the Company made no cash contributions to the qualified pension plans. Torchmark expects to make total cash contributions to these plans during 2017 in an amount not to exceed $20 million.

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 March 31, 2017, the combined value of the insurance policies and investments in the Rabbi Trust to support plan liabilities were $88 million, compared with $86 million at year end 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. The liability for the active non-qualified pension plan was $76 million at March 31, 2017 and $75 million at December 31, 2016.

 

Note 9—Earnings Per Share

A reconciliation of basic and diluted weighted-average shares outstanding is as follows:

	Three Months Ended March 31,
	2017			2016
Basic weighted average shares outstanding	117,770,474			121,480,805
Weighted average dilutive options outstanding	2,659,242			1,831,938
Diluted weighted average shares outstanding	120,429,716			123,312,743
Antidilutive shares	625,855			1,489,562

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.

Annuity revenue is classified as “Other premium.” Management’s measure of profitability for each insurance segment is insurance underwriting margin, which is underwriting income before other income and insurance administrative expenses. It represents the profit margin on insurance products before administrative expenses, and is calculated by deducting net policy obligations (claims incurred and change in reserves), commissions and other acquisition expenses from premium revenue. Torchmark further views the profitability of each insurance product segment by the marketing groups that distribute the products of that segment: direct response, independent agencies, or captive agencies.

Torchmark’s management prefers to evaluate the performance of its underwriting and investment activities separately, rather than allocating investment income to the underwriting results. As such, the investment function is presented as a stand-alone segment. The investment segment includes the management of the investment portfolio, debt, and cash flow. Management’s measure of profitability for this segment is excess investment income, which is the income earned on the investment portfolio less the required interest on net policy liabilities and financing costs. Financing costs include the interest on Torchmark’s debt. Other income and insurance administrative expense are classified in a separate Other segment.

The majority of the Company’s required interest on net policy liabilities (benefit reserves less the deferred acquisition cost asset) is not credited to policyholder accounts. Instead, it is an actuarial assumption for discounting cash flows in the computation of benefit reserves and the amortization of the deferred acquisition cost asset. Investment income required to fund the required interest on net policy liabilities is removed from the investment segment and applied to

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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 insurance segments to eliminate the effect of the required interest from the insurance segments. As a result, the investment segment measures net investment income against the required interest on net policy liabilities and financing costs, while the insurance segments simply measure premiums against benefits and expenses. 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.

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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 March 31, 2017
	Life				Health				Annuity				Investment				Other & Corporate				Adjustments					Consolidated
Revenue:
Premium	$	575,837			$	244,791			$	3																$	820,631
Net investment income													$	208,282												208,282
Other income																	$	451			$	(35	)		(2)	416
Total revenue	575,837				244,791				3				208,282				451				(35		)			1,029,329
Expenses:
Policy benefits	391,079				157,751				8,946																	557,776
Required interest on reserves	(148,825		)		(18,975		)		(12,418		)		180,218													—
Required interest on DAC	45,936				5,809				178				(51,923		)											—
Amortization of acquisition costs	99,905				25,327				676																	125,908
Commissions, premium taxes, and non-deferred acquisition costs	43,638				21,502				11												(35		)		(2)	65,116
Insurance administrative expense (1)																	51,913									51,913
Parent expense																	2,233									2,233
Stock compensation expense																	8,195									8,195
Interest expense													20,699													20,699
Total expenses	431,733				191,414				(2,607		)		148,994				62,341				(35		)			831,840
Subtotal	144,104				53,377				2,610				59,288				(61,890		)		—					197,489
Non-operating items																					—					—
Measure of segment profitability (pretax)	$	144,104			$	53,377			$	2,610			$	59,288			$	(61,890	)		$	—				197,489
Deduct applicable income taxes																										(58,818		)
Segment profits after tax																										138,671
Add back income taxes applicable to segment profitability																										58,818
Add (deduct) realized investment gains (losses)																										(5,748		)
Pretax income from continuing operations per Condensed Consolidated Statements of Operations																										$	191,741

(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)

	Three Months Ended March 31, 2016
	Life				Health				Annuity				Investment				Other & Corporate				Adjustments					Consolidated
Revenue:
Premium	$	544,151			$	235,697			$	12																$	779,860
Net investment income													$	197,053												197,053
Other income																	$	465			$	(44	)		(2)	421
Total revenue	544,151				235,697				12				197,053				465				(44		)			977,334
Expenses:
Policy benefits	362,860				152,775				9,338																	524,973
Required interest on reserves	(142,011		)		(18,076		)		(13,092		)		173,179													—
Required interest on DAC	44,202				5,742				224				(50,168		)											—
Amortization of acquisition costs	94,539				22,365				1,902																	118,806
Commissions, premium taxes, and non-deferred acquisition costs	40,261				21,376				9												(44		)		(2)	61,602
Insurance administrative expense (1)																	48,468									48,468
Parent expense																	2,026									2,026
Stock compensation expense																	6,935									6,935
Interest expense													19,369													19,369
Total expenses	399,851				184,182				(1,619		)		142,380				57,429				(44		)			782,179
Subtotal	144,300				51,515				1,631				54,673				(56,964		)		—					195,155
Non-operating items																					—					—
Measure of segment profitability (pretax)	$	144,300			$	51,515			$	1,631			$	54,673			$	(56,964	)		$	—				195,155
Deduct applicable income taxes																										(61,771		)
Segment profits after tax																										133,384
Add back income taxes applicable to segment profitability																										61,771
Add (deduct) realized investment gains (losses)																										293
Pretax income from continuing operations per Condensed Consolidated Statements of Operations																										$	195,448

(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)

The following table summarizes the measures of segment profitability for comparison. It also reconciles segment profits to net income.

Analysis of Profitability by Segment

	Three Months Ended   March 31,
	2017				2016
Life insurance underwriting margin	$	144,104			$	144,300
Health insurance underwriting margin	53,377				51,515
Annuity underwriting margin	2,610				1,631
Excess investment income	59,288				54,673
Other insurance:
Other income	451				465
Administrative expense	(51,913		)		(48,468		)
Corporate and adjustments	(10,428		)		(8,961		)
Segment profits before tax	197,489				195,155
Applicable taxes	(58,818		)		(61,771		)
Segment profits after tax	138,671				133,384
Discontinued operations (after tax)	(3,637		)		(9,541		)
Net operating income	135,034				123,843
Reconciling items, net of tax:
Realized gains (losses)—investments (after tax)	(1,493		)		190
Net income	$	133,541			$	124,033

                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        

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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 period ended March 31, 2017 and 2016. Additionally, a table in that note, Analysis of Profitability by Segment, provides a summary of the profitability measures that demonstrates year-to-year comparability and reconciles those measures to our net income. That summary represents our overall operations in the manner that management views the business, and is a basis of the following highlights discussion.

We use three statistical measures as indicators of future premium growth: “annualized premium in force", "net sales", and “first-year collected premium.” Annualized premium in force is defined as the premium income that would be received over the following twelve months at any given date on all active policies if those policies remain in force throughout the twelve month period. Annualized premium in force is an indicator of potential growth in premium revenue. Net sales is defined as annualized premium issued, net of cancellations in the first thirty days after issue, except for Globe Life Direct Response, where net sales is annualized premium issued at the time the first full premium is paid after any introductory offer has expired. Annualized premium issued is the gross premium that would be received during the policies’ first year in force, assuming that none of the policies lapsed or terminated. Although lapses and terminations will occur, we believe that net sales is a useful indicator of the rate of acceleration of premium growth. First-year collected premium is the premium collected during the reporting period for all policies in their first policy year. First-year collected premium takes lapses into account in the first policy year when lapses are more likely to occur, and thus is a useful indicator of how much new premium is expected to be added to premium income in the future.

A discussion of operations by each segment follows later in this report. These discussions compare the first three 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.

Highlights, comparing the first three months of 2017 with the first three months of 2016. Net income per diluted common share increased 10% to $1.11 from $1.01. Included in net income were after-tax realized losses of $1.5 million in 2017 compared with gains of $190 thousand 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 4.0% or $5.3 million to $139 million for the three months ended March 31, 2017 compared to $133 million for the same 2016 period.

Total premium income rose 5% in 2017 to $821 million. Total net sales increased 3% to $140 million, when compared with the same period in 2016. First-year collected premium was $112 million for the 2017 period, compared with $113 million for the 2016 period.

Life insurance premium income grew 6% to $576 million. Life net sales increased 2% when compared with the same period in 2016. First-year collected life premium grew 1% during the first three months of 2017 to $80 million over the same period in 2016. Life underwriting margin as a percentage of premium was down to 25% from 27% as a result of higher Globe Life Direct Response policy obligations. Underwriting income was flat at $144 million when compared with the same period in 2016.

Health insurance premium income increased 4% to $245 million over the prior year total of $236 million. Health net sales rose 6% to $34 million for the three month period. First-year collected health premium fell 4% to $32 million. Health margins were flat at 22%, with underwriting income of $53 million for the first three months of 2017.

Insurance administrative expenses were up 7.1% in 2017 when compared with the prior year period. These expenses were 6.3% as a percentage of premium during the first three months of 2017 compared with 6.2% a year earlier. The

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increase in administrative expenses was primarily due to investments in information technology that will enhance our customer experience, improve our data analytics capabilities, improve our ability to react quickly to future changes and bolster our information security programs.

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 11% in 2017 to $0.49 from $0.44 in the same period last year, while the dollar amount of excess investment income increased 8% to $59 million. Net investment income rose $11 million or 6% to $208 million in 2017, below the 8% growth in our average investment portfolio at amortized cost. The average effective yield on the fixed maturity portfolio, which represented 96% of our investments at amortized cost, decreased to 5.70% in the 2017 period from 5.83% in the prior period. Required interest rose 4% or $5 million to $128 million, in line with the growth in average net policy liabilities. Financing costs increased 7% to $21 million. Please refer to the discussion under Capital Resources for more information on debt and interest expense.

In the first three months of 2017, we invested new money in fixed maturity securities at an effective annual yield of 4.92%, compared with 5.03% in the same period of 2016. These new investments had an average rating of BBB+ and an average life to maturity of twenty-three years. Approximately 95% of the fixed-maturity portfolio at amortized cost was investment grade at March 31, 2017. Cash and short-term investments were $183 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 $1.3 billion during the first three months of 2017.

Share Repurchases. We have an on-going share repurchase program which began in 1986 which is reviewed quarterly and is reaffirmed by the Board of Directors on an annual basis. The program was reaffirmed on August 4, 2016. 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 three month periods ended March 31, 2017 and 2016.

Analysis of Share Purchases

(Dollar amounts in thousands, except per share data) 

	Three Months Ended March 31,
	2017											2016
	Shares			Amount				Average Price				Shares			Amount				Average Price
Purchases with:
Excess cash flow at the Parent Company	1,076			$	81,992			$	76.18			1,503			$	80,057			$	53.26
Option exercise proceeds	414			31,727				76.71				95			5,032				53.08
Total	1,490			$	113,719			$	76.33			1,598			$	85,089			$	53.25

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

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A detailed discussion of our operations by component segment follows.

Life insurance, comparing the first three months of 2017 with the first three months of 2016. Life insurance is our predominant segment, representing 70% of premium income and 72% of insurance underwriting margin in the first three months of 2017. In addition, investments supporting the reserves for life business generate the majority of excess investment income attributable to the investment segment. Life insurance premium income increased 6% to $576 million. The following table presents Torchmark’s life insurance premium by distribution channel.

Life Insurance

Premium

(Dollar amounts in thousands)

	Three Months Ended March 31,												Increase
	2017						2016						(Decrease)
	Amount				% of Total		Amount				% of Total		Amount				%
American Income Exclusive Agency	$	241,160			42		$	220,402			41		$	20,758			9
Globe Life Direct Response	210,417				36		200,001				37		10,416				5
Liberty National Exclusive Agency	68,732				12		67,892				12		840				1
Other Agencies	55,528				10		55,856				10		(328		)		(1	)
Total Life Premium	$	575,837			100		$	544,151			100		$	31,686			6

Net sales, an indicator of new business production, increased 2% to $106 million. An analysis of life net sales by distribution channel is presented below.

Life Insurance Net Sales (Dollar amounts in thousands)
	Three Months Ended March 31,												Increase
	2017						2016						(Decrease)
	Amount				% of Total		Amount				% of Total		Amount				%
American Income Exclusive Agency	$	53,397			51		$	50,240			48		$	3,157			6
Globe Life Direct Response	38,731				37		41,155				40		(2,424		)		(6	)
Liberty National Exclusive Agency	10,946				10		9,451				9		1,495				16
Other Agencies	2,583				2		3,000				3		(417		)		(14	)
Total Life Net Sales	$	105,657			100		$	103,846			100		$	1,811			2

First-year collected life premium, defined earlier in this report, was $80 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)
	Three Months Ended March 31,												Increase
	2017						2016						(Decrease)
	Amount				% of Total		Amount				% of Total		Amount				%
American Income Exclusive Agency	$	44,255			55		$	41,955			53		$	2,300			5
Globe Life Direct Response	25,169				32		26,959				34		(1,790		)		(7	)
Liberty National Exclusive Agency	7,934				10		7,050				9		884				13
Other Agencies	2,619				3		2,967				4		(348		)		(12	)
Total	$	79,977			100		$	78,931			100		$	1,046			1

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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. The life business of this agency is Torchmark’s highest margin life business and it is the largest contributor to life premium of any distribution channel at 42% of Torchmark’s total. This group produced premium income of $241 million, an increase of 9%. First-year collected premium was $44 million, an increase of 5%. Net sales rose 6% to $53 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 8% to 6,713 for the three months ended March 31, 2017 compared with 6,206 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 agent training programs and financial incentives that appropriately reward agents at all levels for helping develop and train its agents, including more home-office and webinar training programs. These programs are designed to provide each agent, from new recruits to top level managers, coaching and instruction specifically designed for their level of experience and responsibility. We are also making considerable investments in information technology in support of the agency, which are expected to enhance overall productivity of agents and improve agent retention.

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 aggressively increased marketing activities related to internet and mobile technology, and has focused on driving traffic to the inbound call center. We continually introduce new initiatives in this unit in an attempt to increase response rates.

While the juvenile market is an important source of sales, it also is a vehicle to reach the parents and grandparents of juvenile policyholders, who are more likely to respond favorably to a Globe Life Direct Response solicitation for life coverage on themselves than is the general adult population. Also, both juvenile policyholders and their parents are low acquisition-cost targets for sales of additional coverage over time.

Globe Life Direct Response’s life premium income rose 5% to $210 million, representing 36% of Torchmark’s total life premium in the first three months of 2017. Net sales of $39 million for this group decreased 6%. The sales decline was expected as we have refined our marketing efforts in a manner intended to optimize underwriting profits. First-year collected premium decreased 7% to $25 million.

The Liberty National Exclusive Agency markets individual and group life insurance to middle-income customers. Life premium income for this agency was $69 million in the first three months of 2017 compared with $68 million for the same period in 2016. First-year collected premium increased 13% to $8 million.Net sales for the Liberty National Agency increased 16% to $11 million. This is the largest percentage increase of any of Torchmark's distribution channels.

The Liberty National average agent count increased 18% to 1,820 for the three months ended March 31, 2017 compared with 1,542 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 $56 million of life premium income, or 10% of Torchmark’s total in the first three months of 2017, but contributed only 2% of net sales for the period.

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Life Insurance Summary of Results (Dollar amounts in thousands)
	Three Months Ended March 31,												Increase
	2017						2016						(Decrease)
	Amount				% of Premium		Amount				% of Premium		Amount				%
Premium and policy charges	$	575,837			100		$	544,151			100		$	31,686			6
Net policy obligations	242,254				42		220,849				40		21,405				10
Commissions and acquisition expense	189,479				33		179,002				33		10,477				6
Insurance underwriting income before other income and administrative expense	$	144,104			25		$	144,300			27		$	(196	)		—

Life insurance underwriting income before insurance administrative expense was $144 million in the first three months of 2017 and 2016. As a percentage of premium, underwriting margins declined to 25% from 27%. The decrease in underwriting margin as a percentage of premium was due to higher Globe Life Direct Response net policy obligations. The higher net policy obligations in the Globe Life Direct Response Unit primarily relate to policies issued in calendar years 2011 through 2015 where additional prescription drug information was used in the underwriting process with an expectation of improved mortality. To date, improvements in actual mortality have been less than originally expected.

Health insurance, comparing the first three months of 2017 with the first three 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.

Health premium increased 4% to $245 million in the 2017 period. Medicare Supplement premium increased 3% to $122 million, while other limited-benefit health premium increased 5% to $123 million.

Health net sales increased 6% to $34 million. Medicare Supplement net sales decreased 5% to $13 million in 2017. Limited-benefit net sales increased 14% to $21 million. Health first-year collected premium fell 4% to $32 million as a result of lower group sales in 2016. Group sales can vary significantly from period to period.

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

Health Insurance

Premium

(Dollar amounts in thousands)

	Three Months Ended March 31,												Increase
	2017						2016						(Decrease)
	Amount				% of Total		Amount				% of Total		Amount				%
United American Independent Agency
Limited-benefit plans	$	3,026					$	3,330					$	(304	)		(9	)
Medicare Supplement	89,230						84,720						4,510				5
	92,256				37		88,050				37		4,206				5
Family Heritage Agency
Limited-benefit plans	61,576						57,317						4,259				7
Medicare Supplement	—