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 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 for reasons such as credit concerns, calls by issuers, or other factors.

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, as discussed in Note 4—Investments. 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.

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

Reconciliation of Segment Operating Information to the Consolidated Statement of Operations



	Three Months Ended June 30, 2016
	Life			Health			Annuity			Investment			Other & Corporate			Adjustments				Consolidated
Revenue:
Premium	$	548,590		$	237,252		$	13												$	785,855
Net investment income										$	201,642									201,642
Other income													$	422		$	(40	)	(2)	382
Total revenue	548,590			237,252			13			201,642			422			(40		)		987,879
Expenses:
Policy benefits	369,342			153,261			8,882													531,485
Required interest on reserves	(143,625		)	(18,251		)	(12,506		)	174,382										—
Required interest on DAC	44,476			5,766			205			(50,447		)								—
Amortization of acquisition costs	93,663			22,102			1,480													117,245
Commissions, premium taxes, and non-deferred acquisition costs	41,130			21,753			11									(40		)	(2)	62,854
Insurance administrative expense ⁽¹⁾													48,413							48,413
Parent expense													2,379							2,379
Stock compensation expense													7,054							7,054
Interest expense										23,110										23,110
Total expenses	404,986			184,631			(1,928		)	147,045			57,846			(40		)		792,540
Subtotal	143,604			52,621			1,941			54,597			(57,424		)	—				195,339
Nonoperating items																—				—
Measure of segment profitability (pretax)	$	143,604		$	52,621		$	1,941		$	54,597		$	(57,424	)	$	—			195,339
Deduct applicable income taxes																				(58,649		)
Segment profits after tax																				136,690
Add back income taxes applicable to segment profitability																				58,649
Add (deduct) realized investment gains (losses)																				4,005
Pretax income per Consolidated Statements of Operations																				$	199,344

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

(2) Elimination of intersegment commission.



	Three Months Ended June 30, 2015 ⁽³⁾
	Life			Health			Annuity			Investment			Other & Corporate			Adjustments				Consolidated
Revenue:
Premium	$	520,038		$	232,409		$	37												$	752,484
Net investment income										$	194,823									194,823
Other income													$	742		$	(51	)	(2)	691
Total revenue	520,038			232,409			37			194,823			742			(51		)		947,998
Expenses:
Policy benefits	347,364			151,198			9,754													508,316
Required interest on reserves	(137,430		)	(17,151		)	(13,387		)	167,968										—
Required interest on DAC	43,139			5,690			294			(49,123		)								—
Amortization of acquisition costs	88,737			20,740			2,261													111,738
Commissions, premium taxes, and non-deferred acquisition costs	38,851			20,320			12									(51		)	(2)	59,132
Insurance administrative expense⁽¹⁾													45,474							45,474
Parent expense													2,312							2,312
Stock compensation expense													7,802							7,802
Interest expense										19,114										19,114
Total expenses	380,661			180,797			(1,066		)	137,959			55,588			(51		)		753,888
Subtotal	139,377			51,612			1,103			56,864			(54,846		)	—				194,110
Nonoperating items																—				—
Measure of segment profitability (pretax)	$	139,377		$	51,612		$	1,103		$	56,864		$	(54,846	)	$	—			194,110
Deduct applicable income taxes																				(63,282		)
Segment profits after tax																				130,828
Add back income taxes applicable to segment profitability																				63,282
Add (deduct) realized investment gains (losses)																				2,613
Pretax income per Consolidated Statements of Operations																				$	196,723

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

(2) Elimination of intersegment commission.

(3) Certain prior year balances were adjusted to give effect to discontinued operations as described in Note 5—Discontinued Operations.



	Six Months Ended June 30, 2016
	Life			Health			Annuity			Investment			Other & Corporate			Adjustments				Consolidated
Revenue:
Premium	$	1,092,741		$	472,949		$	25												$	1,565,715
Net investment income										$	398,695									398,695
Other income													$	887		$	(84	)	(2)	803
Total revenue	1,092,741			472,949			25			398,695			887			(84		)		1,965,213
Expenses:
Policy benefits	732,202			306,036			18,220													1,056,458
Required interest on reserves	(285,636		)	(36,327		)	(25,598		)	347,561										—
Required interest on DAC	88,678			11,508			429			(100,615		)								—
Amortization of acquisition costs	188,202			44,467			3,382													236,051
Commissions, premium taxes, and non-deferred acquisition costs	81,391			43,129			20									(84		)	(2)	124,456
Insurance administrative expense ⁽¹⁾													96,881							96,881
Parent expense													4,405							4,405
Stock compensation expense													13,989							13,989
Interest expense										42,479										42,479
Total expenses	804,837			368,813			(3,547		)	289,425			115,275			(84		)		1,574,719
Subtotal	287,904			104,136			3,572			109,270			(114,388		)	—				390,494
Nonoperating items																—				—
Measure of segment profitability (pretax)	$	287,904		$	104,136		$	3,572		$	109,270		$	(114,388	)	$	—			390,494
Deduct applicable income taxes																				(120,420		)
Segment profits after tax																				270,074
Add back income taxes applicable to segment profitability																				120,420
Add (deduct) realized investment gains (losses)																				4,298
Pretax income per Consolidated Statements of Operations																				$	394,792

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

(2) Elimination of intersegment commission.



	Six Months Ended June 30, 2015 ⁽³⁾
	Life			Health			Annuity			Investment			Other & Corporate			Adjustments				Consolidated
Revenue:
Premium	$	1,033,380		$	461,082		$	78												$	1,494,540
Net investment income										$	386,419									386,419
Other income													$	1,464		$	(104	)	(2)	1,360
Total revenue	1,033,380			461,082			78			386,419			1,464			(104		)		1,882,319
Expenses:
Policy benefits	687,065			299,227			19,799													1,006,091
Required interest on reserves	(273,615		)	(34,034		)	(26,756		)	334,405										—
Required interest on DAC	85,985			11,358			607			(97,950		)								—
Amortization of acquisition costs	177,265			40,924			4,209													222,398
Commissions, premium taxes, and non-deferred acquisition costs	75,900			40,418			23									(104		)	(2)	116,237
Insurance administrative expense⁽¹⁾													91,425							91,425
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			(2,118		)	274,629			110,951			(104		)		1,493,851
Subtotal	280,780			103,189			2,196			111,790			(109,487		)	—				388,468
Nonoperating items																—				—
Measure of segment profitability (pretax)	$	280,780		$	103,189		$	2,196		$	111,790		$	(109,487	)	$	—			388,468
Deduct applicable income taxes																				(126,939		)
Segment profits after tax																				261,529
Add back income taxes applicable to segment profitability																				126,939
Add (deduct) realized investment gains (losses)																				2,732
Pretax income per Consolidated Statements of Operations																				$	391,200

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

(2) Elimination of intersegment commission.

(3) Certain prior year balances were adjusted to give effect to discontinued operations as described in Note 5—Discontinued Operations.

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 June 30,						Six Months Ended June 30,
	2016			2015			2016			2015
Life insurance underwriting margin	$	143,604		$	139,377		$	287,904		$	280,780
Health insurance underwriting margin	52,621			51,612			104,136			103,189
Annuity underwriting margin	1,941			1,103			3,572			2,196
Excess investment income	54,597			56,864			109,270			111,790
Other and corporate:
Other income	422			742			887			1,464
Administrative expense	(48,413		)	(45,474		)	(96,881		)	(91,425		)
Corporate and adjustments	(9,433		)	(10,114		)	(18,394		)	(19,526		)
Pre-tax total	195,339			194,110			390,494			388,468
Applicable taxes	(58,649		)	(63,282		)	(120,420		)	(126,939		)
After-tax total, before discontinued operations	136,690			130,828			270,074			261,529
Discontinued operations (after tax)⁽¹⁾	(865		)	(5,417		)	(10,406		)	(14,547		)
After-tax total, after discontinued operations	135,825			125,411			259,668			246,982
Reconciling items, net of tax:
Realized gains (losses) - Investments	2,604			1,699			2,794			1,776
Net income	$	138,429		$	127,110		$	262,462		$	248,758

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