Business Segments

Torchmark is comprised of life insurance companies which primarily market individual life and supplemental health insurance products through niche distribution channels to middle income Americans. Torchmark’s core operations are insurance marketing and underwriting, and management of its investments. The insurance marketing and underwriting operation is segmented by the types of insurance products offered: life, health, Medicare Part D, and annuity. Premium income for Medicare Part D health insurance is included with the premium for other health products in the Condensed Consolidated Statements of Operations. Annuity revenue is classified as “Other premium.” Management’s measure of profitability for each insurance segment is insurance underwriting margin, which is underwriting income before other income and insurance administrative expenses. It represents the profit margin on insurance products before administrative expenses, and is calculated by deducting net policy obligations (claims incurred and change in reserves), commissions and other acquisition expenses from premium revenue. Torchmark further views the profitability of each insurance product segment by the marketing groups that distribute the products of that segment: direct response, independent agencies, or captive agencies.

Torchmark’s management prefers to evaluate the performance of its underwriting and investment activities separately, rather than allocating investment income to the underwriting results. As such, the investment function is presented as a stand-alone segment.

The investment segment includes the management of the investment portfolio, debt, and cash flow. Management’s measure of profitability for this segment is excess investment income, which is the income earned on the investment portfolio less the required interest on net policy liabilities and financing costs. Financing costs include the interest on Torchmark’s debt. Other income and insurance administrative expense are classified in a separate “Other” segment.

The majority of the Company’s required interest on net policy liabilities (benefit reserves less the deferred acquisition cost asset) is not credited to policyholder accounts. Instead, it is an actuarial assumption for discounting cash flows in the computation of benefit reserves and the amortization of the deferred acquisition cost asset. Investment income required to fund the required interest on net policy liabilities is removed from the investment segment and applied to the insurance segments to eliminate the effect of the required interest from the insurance segments. As a result, the investment segment measures net investment income against the required interest on net policy liabilities and financing costs, while the insurance segments simply measure premiums against benefits and expenses. We believe this presentation facilitates a more meaningful analysis of the Company’s underwriting and investment performance as the underwriting results are based on premiums, claims, and expenses and are not affected by unanticipated fluctuations in investment yields.

As noted, Torchmark’s “core operations” are insurance and investment management. The insurance segments issue policies for which premiums are collected for the eventual payment of policy benefits. In addition to policy benefits, operating expenses are incurred including acquisition costs, administrative expenses, and taxes. Because life and health contracts can be long term, premium receipts in excess of current expenses are invested. Investment activities, conducted by the investment segment, focus on seeking quality investments with a yield and term appropriate to support the insurance product obligations. These investments generally consist of fixed maturities, and, over the long term, the expected yields are taken into account when setting insurance premium rates and product profitability expectations. As a result, fixed maturities are generally held for long periods to support the liabilities, and Torchmark generally expects to hold investments until maturity. Dispositions of investments occur from time to time, generally as a result of credit concerns, calls by issuers, or other factors usually beyond the control of management.

Dispositions are sometimes required in order to maintain the Company’s investment policies and objectives. Investments are also occasionally written down as a result of other-than-temporary impairment. Torchmark does not actively trade investments. As a result, realized gains and losses from the disposition and write down of investments are generally incidental to operations and are not considered a material factor in insurance pricing or product profitability. While from time to time these realized gains and losses could be significant to net income in the period in which they occur, they generally have a limited effect on the yield of the total investment portfolio. Further, because the proceeds of the disposals are reinvested in the portfolio, the disposals have little effect on the size of the portfolio and the income from the reinvestments is included in net investment income. Therefore, management removes realized investment gains and losses from results of core operations when evaluating the performance of the Company. For this reason, these gains and losses are excluded from Torchmark’s operating segments.

Torchmark accounts for its stock options and restricted stock under current accounting guidance requiring stock options and stock grants to be expensed based on fair value at the time of grant. Management considers stock compensation expense to be an expense of the Parent Company. Therefore, stock compensation expense is treated as a corporate expense in Torchmark’s segment analysis.

Torchmark provides coverage under the Medicare Part D prescription drug plan for Medicare beneficiaries. In accordance with GAAP, Part D premiums are recognized evenly throughout the year when they become due but benefit costs are recognized when the costs are incurred. Due to the design of the Part D product, premiums are evenly distributed throughout the year, but benefit costs are higher earlier in the year. As a result, under GAAP, benefit costs can exceed premiums in the first part of the year, but be less than premiums during the remainder of the year. In order to more closely match the benefit cost with the associated revenue for interim periods, Torchmark defers these excess benefits for segment reporting purposes. In addition, GAAP recognizes in each quarter a government risk-sharing premium adjustment consistent with the contract as if the quarter represented an entire contract period. These quarterly risk-sharing adjustments are removed in the segment analysis because the actual contract payments are based upon the experience of the full contract year, not the experience of interim periods. Torchmark expects its benefit ratio to be in line with pricing. Total premiums less total benefits will be the same for segment reporting purposes as they will be under GAAP for the full calendar year. The Company’s presentation results in the underwriting margin percentage in interim periods reflecting the expected margin percentage for the full year. These interim adjustments do not impact the full year results.

An analysis of the adjustments for the difference in the interim results as presented for segment purposes and GAAP for Medicare Part D is as follows:



	Six Months Ended June 30,
	2015			2014
Benefit costs deferred	$	47,335		$	60,899
Government risk-sharing premium adjustment	(16,470		)	(35,131		)
Pre-tax addition to segment interim period income	$	30,865		$	25,768
After tax amount	$	20,062		$	16,749

Additionally, management does not view the risk-sharing premium for Medicare Part D as a component of premium income, and accordingly adjusts health premium income in its segment analysis. A reconciliation of health premium included in the segment analysis with health premium as reported in the Condensed Consolidated Statements of Operations is presented in the following table.



	Six Months Ended June 30,
	2015		2014		% Change
Premium per segment analysis:
Medicare Part D premium	$	154,705	$	167,990	(8	)
Other health premium	461,082		434,533		6
Part D risk-sharing adjustment	16,470		35,131		(53	)
Health premium per Condensed Consolidated Statements of Operations	$	632,257	$	637,654	(1	)

During the first six months of 2014, Torchmark accrued for certain litigation cases in the net amount of $3.7 million ($2.4 million after tax) that were not directly related to its insurance operations. Additionally, Torchmark received $1.3 million ($853 thousand after tax) in settlement of litigation regarding investments. Also in the second quarter of 2014, the Company recorded $3.1 million in administrative settlements ($2.0 million after tax) related to benefits paid for deaths occurring in prior years where claims had not been filed. These administrative settlements were the result of the Company's program of matching policyholder information against the Social Security death master file and obtaining due proof of loss. These administrative settlements were included in "Policyholder benefits" in the Consolidated Statements of Operations in 2014. Torchmark removes these segment analysis amounts that do not relate to its core insurance operations.

The following tables set forth a reconciliation of Torchmark’s revenues and operations by segment to its pretax income and each significant line item in its Condensed Consolidated Statements of Operations.

Reconciliation of Segment Operating Information to the Consolidated Statement of Operations



	For the Six Months Ended June 30, 2015
	Life			Health			Medicare Part D		Annuity			Investment			Other & Corporate			Adjustments				Consolidated
Revenue:
Premium	$	1,033,380		$	461,082		$	154,705	$	78								$	16,470		⁽¹⁾	$	1,665,715
Net investment income												$	386,419									386,419
Other income															$	1,464		(104		)	⁽³⁾	1,360
Total revenue	1,033,380			461,082			154,705		78			386,419			1,464			16,366				2,053,494
Expenses:
Policy benefits	687,065			299,227			130,764		19,799									47,335			⁽¹⁾	1,184,190
Required interest on:
Policy reserves	(273,615		)	(34,034		)			(26,756		)	334,405										—
Deferred acquisition costs	85,985			11,358			446		607			(98,396		)								—
Amortization of acquisition costs	177,265			40,924			1,769		4,209													224,167
Commissions, premium taxes, and non-deferred acquisition costs	75,900			40,418			11,049		23									(104		)	⁽³⁾	127,286
Insurance administrative expense (2)															94,063							94,063
Parent expense															4,485							4,485
Stock compensation expense															15,041							15,041
Interest expense												38,174										38,174
Total expenses	752,600			357,893			144,028		(2,118		)	274,183			113,589			47,231				1,687,406
Subtotal	280,780			103,189			10,677		2,196			112,236			(112,125		)	(30,865		)		366,088
Nonoperating items																		30,865			⁽¹⁾	30,865
Measure of segment profitability (pretax)	$	280,780		$	103,189		$	10,677	$	2,196		$	112,236		$	(112,125	)	$	—			396,953
Deduct applicable income taxes																						(129,909		)
Segment profits after tax																						267,044
Add back income taxes applicable to segment profitability																						129,909
Add (deduct) realized investment gains (losses)																						2,732
Deduct Part D adjustment (1)																						(30,865		)
Pretax income per Condensed Consolidated Statement of Operations																						$	368,820


(1)	Medicare Part D items adjusted to GAAP from the segment analysis, which matches expected benefits with policy premium.


(2)	Administrative expense is not allocated to insurance segments.


(3)	Elimination of intersegment commission.

Reconciliation of Segment Operating Information to the Condensed Consolidated Statement of Operations *



	For the Six Months Ended June 30, 2014
	Life			Health			Medicare Part D		Annuity			Investment			Other & Corporate			Adjustments				Consolidated
Revenue:
Premium	$	981,010		$	434,533		$	167,990	$	222								$	35,131		⁽¹⁾	$	1,618,886
Net investment income												$	377,981									377,981
Other income															$	1,266		(122		)	⁽³⁾	1,144
Total revenue	981,010			434,533			167,990		222			377,981			1,266			35,009				1,998,011
Expenses:
Policy benefits	641,311			280,140			135,233		21,084									63,956			^(1,5)	1,141,724
Required interest on:
Policy reserves	(262,328		)	(31,758		)			(27,616		)	321,702										—
Deferred acquisition costs	83,633			11,223			354		764			(95,974		)								—
Amortization of acquisition costs	167,991			36,072			1,377		3,854													209,294
Commissions, premium taxes, and non-deferred acquisition costs	69,068			39,611			12,815		26									(122		)	⁽³⁾	121,398
Insurance administrative expense (2)															89,573			2,337			⁽⁴⁾	91,910
Parent expense															4,045							4,045
Stock compensation expense															17,401							17,401
Interest expense												38,086										38,086
Total expenses	699,675			335,288			149,779		(1,888		)	263,814			111,019			66,171				1,623,858
Subtotal	281,335			99,245			18,211		2,110			114,167			(109,753		)	(31,162		)		374,153
Nonoperating items																		31,162			^(1,4,5)	31,162
Measure of segment profitability (pretax)	$	281,335		$	99,245		$	18,211	$	2,110		$	114,167		$	(109,753	)	$	—			405,315
Deduct applicable income taxes																						(132,458		)
Segment profits after tax																						272,857
Add back income taxes applicable to segment profitability																						132,458
Add (deduct) realized investment gains (losses)																						17,196
Deduct Part D adjustment (1)																						(25,768		)
Deduct legal settlement expenses (4)																						(2,337		)
Deduct administrative settlements (5)																						(3,057		)
Pretax income from continuing operations per Condensed Consolidated Statement of Operations																						$	391,349


(1)	Medicare Part D items adjusted to GAAP from the segment analysis, which matches expected benefits with policy premium.


(2)	Administrative expense is not allocated to insurance segments.


(3)	Elimination of intersegment commission.


(4)	Legal settlement expenses.


(5)	Administrative settlements.


*	Retrospectively adjusted to give effect to the adoption of ASU 2014-01 as described in Note G-Adoption of New Accounting Standards.

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

Analysis of Profitability by Segment



	Six Months Ended June 30,						Increase (Decrease)
	2015			2014*			Amount			%
Life	$	280,780		$	281,335		$	(555	)	—
Health	103,189			99,245			3,944			4
Medicare Part D	10,677			18,211			(7,534		)	(41	)
Annuity	2,196			2,110			86			4
Investment	112,236			114,167			(1,931		)	(2	)
Other and corporate:
Other income	1,464			1,266			198			16
Administrative expense	(94,063		)	(89,573		)	(4,490		)	5
Corporate	(19,526		)	(21,446		)	1,920			(9	)
Pretax total	396,953			405,315			(8,362		)	(2	)
Applicable taxes	(129,909		)	(132,458		)	2,549			(2	)
Total	267,044			272,857			(5,813		)	(2	)
Reconciling items, net of tax:
Realized gains (losses) - Investments	1,776			11,177			(9,401		)
Part D adjustment	(20,062		)	(16,749		)	(3,313		)
Administrative settlements	—			(1,987		)	1,987
Legal settlement expense	—			(1,519		)	1,519
Net income	$	248,758		$	263,779		$	(15,021	)	(6	)

* Retrospectively adjusted to give effect to the adoption of ASU 2014-01 as described in Note G-Adoption of New Accounting Standards.