NOTE G—Business Segments

Torchmark is comprised of life insurance companies which primarily market individual life and supplemental health insurance products through niche distribution systems to middle income Americans. To a limited extent, the Company also markets fixed annuities. Torchmark’s core operations are insurance marketing and underwriting, and management of its investments. Insurance marketing and underwriting is segmented by the types of insurance products offered: life, health, and annuity. 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, or captive agencies.

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. Required interest related to the net policy liabilities is not included in the various insurance underwriting segments but is shown in the investment segment as a reduction to net investment income. 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 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 contract payments are based upon the experience of the full contract year, not the experience of interim periods. Therefore, these risk-sharing adjustments are removed in the segment analysis. For the entire year, Torchmark expects its benefit ratio to be in line with pricing and does not expect to receive any government risk-sharing premium. For the full year of 2011, the total premiums and benefits were the same under this alternative method as they were under GAAP and are expected to be essentially the same in 2012. The Company’s presentation results in the underwriting margin percentage of each interim period reflecting the expected margin percentage for the full year.

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:


	Nine months ended
	September 30,
	2012			2011
Benefit costs deferred	$	25,047		$	11,211
Government risk-sharing premium adjustment		(6,125	)		(5,374	)

Pre-tax addition to segment interim period income	$	18,922		$	5,837

After tax amount	$	12,299		$	3,794

Torchmark has invested in various limited partnerships that provide investment returns through the provision of low-income housing tax credits and other related Federal income tax benefits to the Company. The investment returns from a portion of the interests are guaranteed by unrelated third-parties. Under GAAP, expenses associated with the amortization of the guaranteed interests are required to be reflected in income tax expense. In contrast, GAAP requires the expenses associated with the amortization of non-guaranteed interests to be reflected as a component of “Net investment income.” All of the investment returns from investing in these guaranteed and non-guaranteed limited partnerships interests are in the form of income tax benefits reflected in income tax expense. Management believes including the amortization expense associated with the non-guaranteed as well as the guaranteed interest in income tax expense provides a more appropriate matching of the expense with the related income. For this reason, amortization expense of the non-guaranteed interests is included in “Income taxes” and not “Net investment income” for segment reporting purposes.

As discussed in Note H—Acquisition, Torchmark incurred $615 thousand of expenses ($400 thousand after tax) in connection with an acquisition which closed on November 1, 2012. Additionally, during the first quarter of 2011, Torchmark sold aviation equipment for a pretax loss of $979 thousand ($636 thousand after tax). Also during the first nine months of 2011, Torchmark accrued an estimated liability for a state administrative settlement involving issues arising over many years in the pretax amount of $6 million ($3.9 million after tax). Management removes items such as these that are related to prior periods or are one-time non-operating transactions when analyzing its segment profitability. As such, these items are presented as reconciling items to arrive at pre-tax income from continuing operations in the 2011 period.

The following tables total the components of Torchmark’s operating segments and reconcile these operating results to its pretax income and each significant line item in its Consolidated Statements of Operations.

Reconciliation of Segment Operating Information to the Consolidated Statement of Operations


	For the nine months ended September 30, 2012
	Life			Health			Annuity			Investment			Other & Corporate			Adjustments			Consolidated
Revenue:
Premium	$	1,356,527		$	760,825		$	440								$	6,125	⁽¹⁾	$	2,123,917
Net investment income										$	535,325						(16,628	)^(2,5)		518,697
Other income													$	1,501			(247	)⁽⁴⁾		1,254

Total revenue		1,356,527			760,825			440			535,325			1,501			(10,750	)		2,643,868

Expenses:
Policy benefits		879,317			539,212			32,997									25,047	⁽¹⁾		1,476,573
Required interest on:
Policy reserves		(360,454	)		(28,242	)		(44,690	)		433,386									0
Deferred acquisition costs		122,453			13,710			1,721			(137,884	)								0
Amortization of acquisition costs		231,926			47,536			7,653												287,115
Commissions, premium taxes, and non-deferred acquisition costs		102,696			45,752			53									(247	)⁽⁴⁾		148,254
Insurance administrative expense ⁽³⁾														120,942						120,942
Parent expense														6,203			615	⁽⁶⁾		6,818
Stock compensation expense														16,547						16,547
Interest expense											58,965						198	⁽²⁾		59,163

Total expenses		975,938			617,968			(2,266	)		354,467			143,692			25,613			2,115,412

Subtotal		380,589			142,857			2,706			180,858			(142,191	)		(36,363	)		528,456
Nonoperating items																	19,537	^(1,6)		19,537
Amortization of low-income housing																	16,826	⁽⁵⁾		16,826

Measure of segment profitability (pretax)	$	380,589		$	142,857		$	2,706		$	180,858		$	(142,191	)	$	0			564,819

Deduct applicable income taxes																				(184,800	)

Segment profits after tax																				380,019
Add back income taxes applicable to segment profitability																				184,800
Add (deduct) realized investment gains (losses)																				16,950
Deduct Part D adjustment ⁽¹⁾																				(18,922	)
Deduct amortization of low-income housing ⁽⁵⁾																				(16,826	)
Deduct Family Heritage Life acquisition expense ⁽⁶⁾																				(615	)

Pretax income from continuing operations per Consolidated Statement of Operations																			$	545,406

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

(2)	Reclassification of interest amount due to accounting rule requiring deconsolidation of Trust Preferred Securities. Management views the Trust Preferreds as consolidated debt.

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

(4)	Elimination of intersegment commission.

(5)	Amortization of low-income housing expense, considered a component of income tax expense in the segment analysis.

(6)	Family Heritage Life acquisition expense.

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


	For the nine months ended September 30, 2011
	Life			Health			Annuity			Investment			Other & Corporate			Adjustments			Consolidated
Revenue:
Premium	$	1,294,157		$	702,807		$	438								$	5,374	⁽¹⁾	$	2,002,776
Net investment income										$	528,902						(10,660	)^(2,5)		518,242
Other income													$	1,953			(273	)⁽⁴⁾		1,680

Total revenue		1,294,157			702,807			438			528,902			1,953			(5,559	)		2,522,698
Expenses:
Policy benefits		836,358			478,392			31,634									11,211	⁽¹⁾		1,357,595
Required interest on:
Policy reserves		(341,452	)		(27,521	)		(42,139	)		411,112									0
Deferred acquisitions costs		119,364			14,221			1,990			(135,575	)								0
Amortization of acquisition costs		220,269			46,722			7,035												274,026
Commissions, premium taxes, and non-deferred acquisition costs		116,406			48,998			53									(273	)⁽⁴⁾		165,184
Insurance administrative expense ⁽³⁾														117,796			6,979	^(6,7)		124,775
Parent expense														6,162						6,162
Stock compensation expense														11,032						11,032
Interest expense											58,183						198	⁽²⁾		58,381

Total expenses		950,945			560,812			(1,427	)		333,720			134,990			18,115			1,997,155

Subtotal		343,212			141,995			1,865			195,182			(133,037	)		(23,674	)		525,543
Nonoperating items																	12,816	^(1,6,7)		12,816
Amortization of low-income housing																	10,858	⁽⁵⁾		10,858

Measure of segment profitability (pretax)	$	343,212		$	141,995		$	1,865		$	195,182		$	(133,037	)	$	0			549,217

Deduct applicable income taxes																				(179,857	)

Segment profits after tax																				369,360


Add back income taxes applicable to segment profitability		179,857
Add (deduct) realized investment gains (losses)		21,149
Deduct Part D adjustment ⁽¹⁾		(5,837	)
Deduct amortization of low-income housing ⁽⁵⁾		(10,858	)
Deduct estimated state administrative settlement expense ⁽⁶⁾		(6,000	)
Deduct loss on sale of equipment ⁽⁷⁾		(979	)

Pretax income from continuing operations per Consolidated Statement of Operations	$	546,692

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

(2)	Reclassification of interest amount due to accounting rule requiring deconsolidation of Trust Preferred Securities. Management views the Trust Preferreds as consolidated debt.

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

(4)	Elimination of intersegment commission.

(5)	Amortization of low-income housing expense, considered a component of income tax expense in the segment analysis.

(6)	Estimated state administrative settlement expense.

(7)	Loss on sale of equipment.

*	The 2011 balances have been retroactively adjusted to give effect to the adoption of new accounting guidance as described in Note F—Adoption of New Accounting Standard.

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

Analysis of Profitability by Segment

(Dollar amounts in thousands)


	Nine months ended September 30,						Increase (Decrease)
	2012			2011*			Amount			%
Life insurance	$	380,589		$	343,212		$	37,377			11
Health insurance		142,857			141,995			862			1
Annuity		2,706			1,865			841
Investment		180,858			195,182			(14,324	)		(7	)
Other:
Other income		1,501			1,953			(452	)		(23	)
Administrative expense		(120,942	)		(117,796	)		(3,146	)		3
Corporate and adjustments		(22,750	)		(17,194	)		(5,556	)		32

Pretax total		564,819			549,217			15,602			3
Applicable taxes		(184,800	)		(179,857	)		(4,943	)		3

Total		380,019			369,360			10,659			3
Reconciling items, net of tax:
Realized gains (losses)–Investments		11,017			13,747			(2,730	)
Loss on disposal of discontinued operations		0			(455	)		455
Part D adjustment		(12,299	)		(3,794	)		(8,505	)
Estimated state administrative settlement		0			(3,900	)		3,900
Loss on sale of equipment		0			(636	)		636
Family Heritage acquisition expense		(400	)		0			(400	)

Net income	$	378,337		$	374,322		$	4,015			1

*	The 2011 balances have been retroactively adjusted to give effect to the adoption of new accounting guidance as described in Note F—Adoption of New Accounting Standard.