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 Condensed Consolidated Statement of Operations



	Three Months Ended September 30, 2016
	Life			Health			Annuity			Investment			Other & Corporate			Adjustments				Consolidated
Revenue:
Premium	$	546,415		$	236,987		$	9												$	783,411
Net investment income										$	202,720									202,720
Other income													$	199		$	(39	)	(2)	160
Total revenue	546,415			236,987			9			202,720			199			(39		)		986,291
Expenses:
Policy benefits	369,546			153,351			9,255													532,152
Required interest on reserves	(145,295		)	(18,476		)	(12,761		)	176,532										—
Required interest on DAC	44,950			5,789			192			(50,931		)								—
Amortization of acquisition costs	93,496			22,643			682													116,821
Commissions, premium taxes, and non-deferred acquisition costs	40,577			20,604			11									(39		)	(2)	61,153
Insurance administrative expense ⁽¹⁾													49,248			257				49,505
Parent expense													1,955							1,955
Stock compensation expense													6,345							6,345
Interest expense										20,381										20,381
Total expenses	403,274			183,911			(2,621		)	145,982			57,548			218				788,312
Subtotal	143,141			53,076			2,630			56,738			(57,349		)	(257		)		197,979
Non-operating items																257				257
Measure of segment profitability (pretax)	$	143,141		$	53,076		$	2,630		$	56,738		$	(57,349	)	$	—			198,236
Deduct applicable income taxes																				(58,422		)
Segment profits after tax																				139,814
Add back income taxes applicable to segment profitability																				58,422
Add (deduct) realized investment gains (losses)																				3,482
Add (deduct) non-operating fees																				(257		)
Pretax income from continuing operations per Condensed Consolidated Statements of Operations																				$	201,461

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

(2) Elimination of intersegment commission.



	Three Months Ended September 30, 2015 ⁽³⁾
	Life			Health			Annuity			Investment			Other & Corporate			Adjustments				Consolidated
Revenue:
Premium	$	518,929		$	229,139		$	41												$	748,109
Net investment income										$	193,213									193,213
Other income													$	737		$	(45	)	(2)	692
Total revenue	518,929			229,139			41			193,213			737			(45		)		942,014
Expenses:
Policy benefits	342,196			149,312			9,648													501,156
Required interest on reserves	(138,649		)	(17,416		)	(13,328		)	169,393										—
Required interest on DAC	43,354			5,700			278			(49,332		)								—
Amortization of acquisition costs	88,376			20,934			2,333													111,643
Commissions, premium taxes, and non-deferred acquisition costs	39,552			20,402			9									(45		)	(2)	59,918
Insurance administrative expense⁽¹⁾													47,169							47,169
Parent expense													2,177							2,177
Stock compensation expense													6,836							6,836
Interest expense										19,246										19,246
Total expenses	374,829			178,932			(1,060		)	139,307			56,182			(45		)		748,145
Subtotal	144,100			50,207			1,101			53,906			(55,445		)	—				193,869
Non-operating items																—				—
Measure of segment profitability (pretax)	$	144,100		$	50,207		$	1,101		$	53,906		$	(55,445	)	$	—			193,869
Deduct applicable income taxes																				(63,352		)
Segment profits after tax																				130,517
Add back income taxes applicable to segment profitability																				63,352
Add (deduct) realized investment gains (losses)																				5,140
Pretax income from continuing operations per Condensed Consolidated Statements of Operations																				$	199,009

(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.



	Nine Months Ended September 30, 2016
	Life			Health			Annuity			Investment			Other & Corporate			Adjustments				Consolidated
Revenue:
Premium	$	1,639,156		$	709,936		$	34												$	2,349,126
Net investment income										$	601,415									601,415
Other income													$	1,086		$	(123	)	(2)	963
Total revenue	1,639,156			709,936			34			601,415			1,086			(123		)		2,951,504
Expenses:
Policy benefits	1,101,748			459,387			27,475													1,588,610
Required interest on reserves	(430,931		)	(54,803		)	(38,359		)	524,093										—
Required interest on DAC	133,628			17,297			621			(151,546		)								—
Amortization of acquisition costs	281,698			67,110			4,064													352,872
Commissions, premium taxes, and non-deferred acquisition costs	121,968			63,733			31									(123		)	(2)	185,609
Insurance administrative expense ⁽¹⁾													146,129			257				146,386
Parent expense													6,360							6,360
Stock compensation expense													20,334							20,334
Interest expense										62,860										62,860
Total expenses	1,208,111			552,724			(6,168		)	435,407			172,823			134				2,363,031
Subtotal	431,045			157,212			6,202			166,008			(171,737		)	(257		)		588,473
Non-operating items																257				257
Measure of segment profitability (pretax)	$	431,045		$	157,212		$	6,202		$	166,008		$	(171,737	)	$	—			588,730
Deduct applicable income taxes																				(178,842		)
Segment profits after tax																				409,888
Add back income taxes applicable to segment profitability																				178,842
Add (deduct) realized investment gains (losses)																				7,780
Add (deduct) non-operating fees																				(257		)
Pretax income from continuing operations per Condensed Consolidated Statements of Operations																				$	596,253

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

(2) Elimination of intersegment commission.



	Nine Months Ended September 30, 2015 ⁽³⁾
	Life			Health			Annuity			Investment			Other & Corporate			Adjustments				Consolidated
Revenue:
Premium	$	1,552,309		$	690,221		$	119												$	2,242,649
Net investment income										$	579,632									579,632
Other income													$	2,201		$	(149	)	(2)	2,052
Total revenue	1,552,309			690,221			119			579,632			2,201			(149		)		2,824,333
Expenses:
Policy benefits	1,029,261			448,539			29,447													1,507,247
Required interest on reserves	(412,264		)	(51,450		)	(40,084		)	503,798										—
Required interest on DAC	129,339			17,058			885			(147,282		)								—
Amortization of acquisition costs	265,641			61,858			6,542													334,041
Commissions, premium taxes, and non-deferred acquisition costs	115,452			60,820			32									(149		)	(2)	176,155
Insurance administrative expense⁽¹⁾													138,594							138,594
Parent expense													6,662							6,662
Stock compensation expense													21,877							21,877
Interest expense										57,420										57,420
Total expenses	1,127,429			536,825			(3,178		)	413,936			167,133			(149		)		2,241,996
Subtotal	424,880			153,396			3,297			165,696			(164,932		)	—				582,337
Non-operating items																—				—
Measure of segment profitability (pretax)	$	424,880		$	153,396		$	3,297		$	165,696		$	(164,932	)	$	—			582,337
Deduct applicable income taxes																				(190,291		)
Segment profits after tax																				392,046
Add back income taxes applicable to segment profitability																				190,291
Add (deduct) realized investment gains (losses)																				7,872
Pretax income from continuing operations per Condensed Consolidated Statements of Operations																				$	590,209

(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 September 30,						Nine Months Ended September 30,
	2016			2015			2016			2015
Life insurance underwriting margin	$	143,141		$	144,100		$	431,045		$	424,880
Health insurance underwriting margin	53,076			50,207			157,212			153,396
Annuity underwriting margin	2,630			1,101			6,202			3,297
Excess investment income	56,738			53,906			166,008			165,696
Other and corporate:
Other income	199			737			1,086			2,201
Administrative expense	(49,248		)	(47,169		)	(146,129		)	(138,594		)
Corporate and adjustments	(8,300		)	(9,013		)	(26,694		)	(28,539		)
Pre-tax total	198,236			193,869			588,730			582,337
Applicable taxes	(58,422		)	(63,352		)	(178,842		)	(190,291		)
After-tax total, from continuing operations	139,814			130,517			409,888			392,046
Discontinued operations (after tax)⁽¹⁾	9,959			11,528			(447		)	(3,019		)
After-tax total, after discontinued operations	149,773			142,045			409,441			389,027
Reconciling items, net of tax:
Realized gains (losses)	2,263			3,341			5,057			5,117
Non-operating fees	(167		)	—			(167		)	—
Net income	$	151,869		$	145,386		$	414,331		$	394,144

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