<PAGE>
FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
QUARTERLY REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For Quarter Ended September 30,1998 Commission File Number 1-8052
TORCHMARK CORPORATION
(Exact name of registrant as specified in its charter)
DELAWARE 63-0780404
(State or other jurisdiction of (I.R.S Employer
incorporation or organization) Identification No.)
2001 3rd Avenue South, Birmingham, Alabama 35233
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (205) 325-4200
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 X No
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 OCTOBER 31, 1998
Common Stock, 140,264,983
$1.00 Par Value
Index of Exhibits (Page 28)
Total number of pages included are 29.
<PAGE>
TORCHMARK CORPORATION
INDEX
Page
----
Part 1. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheet 1
Consolidated Statement of Operations 2
Consolidated Statement of Comprehensive Income 4
Consolidated Statement of Cash Flow 5
Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis
of Financial Condition and Results of Operations 8
Part II. OTHER INFORMATION
Item 1. Legal Proceedings 27
Item 6. Exhibits and Reports on Form 8-K 28
<PAGE>
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
TORCHMARK CORPORATION
CONSOLIDATED BALANCE SHEET
(Amounts in thousands)
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
------------- ------------
<S> <C> <C>
Assets:
Investments:
Fixed maturities, available for sale, at fair
value (amortized cost: 1998 - $5,558,598;
1997 - $5,628,924) $ 5,859,953 $ 5,841,690
Equity securities, at fair value
(cost: 1998 - $2,255; 1997 - $3,284) 8,332 12,404
Mortgage loans, at cost (estimated fair value:
1998 - $104,321; 1997 - $79,096) 104,201 78,974
Investment real estate, at depreciated cost 180,722 167,297
Policy loans 229,206 221,703
Other long-term investments (at fair value) 28,818 64,433
Short-term investments 94,112 65,510
----------- -----------
Total investments 6,505,344 6,452,011
Cash 2,586 11,085
Investment in affiliates 44,904 102,305
Accrued investment income 98,789 100,392
Other receivables 128,230 116,506
Deferred acquisition costs 1,447,010 1,371,131
Value of insurance purchased 186,109 216,988
Property and equipment 37,838 37,100
Goodwill 417,677 426,732
Discontinued operations - Waddell & Reed 277,828 397,910
Other assets 19,411 19,049
Separate account assets 2,111,414 1,876,439
----------- -----------
Total assets $11,277,140 $11,127,648
=========== ===========
Liabilities and Shareholders' Equity:
Liabilities:
Future policy benefits $ 4,529,181 $ 5,023,763
Unearned and advance premiums 86,755 83,722
Policy claims and other benefits payable 193,022 228,754
Other policyholders' funds 81,342 82,224
----------- -----------
Total policy liabilities 4,890,300 5,418,463
Accrued income taxes 508,077 416,665
Short-term debt 348,042 347,152
Long-term debt (estimated fair value:
1998 - $442,845; 1997 - $607,471) 394,022 564,298
Other liabilities 202,204 378,696
Separate account liabilities 2,111,414 1,876,439
----------- -----------
Total liabilities 8,454,059 9,001,713
Minority interest in consolidated affiliate 100,935 0
Monthly income preferred securities (estimated
fair value: 1998 - $205,520; 1997 - $210,480) 193,244 193,199
Shareholders' equity:
Preferred stock 0 0
Common stock 147,801 143,220
Additional paid-in capital 610,193 187,731
Unrealized investment gains, net of tax 178,634 136,926
Retained earnings 1,818,693 1,699,409
Treasury stock, at cost (226,419) (234,550)
----------- -----------
Total shareholders' equity 2,528,902 1,932,736
----------- -----------
Total liabilities and shareholders' equity $11,277,140 $11,127,648
=========== ===========
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
-1-
<PAGE>
<TABLE>
<CAPTION>
TORCHMARK CORPORATION
CONSOLIDATED STATEMENT OF OPERATIONS
(Unaudited and in thousands except per share data)
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------- ------------------------
1998 1997 1998 1997
--------- --------- ---------- ----------
<S> <C> <C> <C> <C>
Revenue:
Life premium $241,212 $229,677 $ 718,534 $ 680,247
Health premium 188,166 182,995 567,457 555,284
Other premium 8,586 7,555 24,354 20,273
-------- -------- ---------- ----------
Total premium 437,964 420,227 1,310,345 1,255,804
Net investment income 112,165 108,862 349,846 315,900
Realized investment gains (losses) (39,750) (390) (44,777) (34,169)
Other income 892 101 1,937 751
-------- -------- ---------- ----------
Total revenue 511,271 528,800 1,617,351 1,538,286
Benefits and expenses:
Life policyholder benefits 156,503 148,820 470,119 443,475
Health policyholder benefits 119,753 117,173 360,114 348,003
Other policyholder benefits 8,961 13,318 33,834 40,711
-------- -------- ---------- ----------
Total policyholder benefits 285,217 279,311 864,067 832,189
Amortization of deferred acquisition costs 57,248 56,736 172,337 168,387
Commissions and premium taxes 36,439 34,331 107,904 104,840
Other operating expense 29,314 27,467 89,488 87,412
Amortization of goodwill 3,018 3,019 9,055 9,055
Interest expense 12,981 17,385 45,791 53,544
-------- -------- ---------- ----------
Total benefits and expenses 424,217 418,249 1,288,642 1,255,427
Income before income taxes, equity in earnings
of unconsolidated affiliates, discontinued
operations, and extraordinary item 87,054 110,551 328,709 282,859
Income taxes (27,532) (38,865) (117,238) (99,850)
Equity in earnings of Vesta (3,875) 4,496 383 12,180
Adjustment to carrying value of Vesta 0 0 (20,234) 0
Monthly income preferred securities dividend (2,494) (2,489) (7,433) (7,352)
-------- -------- ---------- ----------
Net income from continuing operations, before
extraordinary item 53,153 73,693 184,187 187,837
Discontinued operations of Waddell & Reed:
Income from operations (less applicable income tax of
$13,356, $12,193, $38,902, and $36,087, respectively;
and net of minority interest of $8,043, $0, $18,612,
and $0, respectively) 13,924 19,281 43,912 57,055
Loss on disposal (including income tax of $48,391) (52,531) 0 (52,531) 0
-------- -------- ---------- ---------
Net income before extraordinary items 14,546 92,974 175,568 244,892
Loss on redemption of debt, net of income tax
benefit of $2,672 0 0 (4,962) 0
-------- -------- ---------- ---------
Net Income $ 14,546 $ 92,974 $ 170,606 $ 244,892
======== ======== ========== ==========
</TABLE>
(Continued)
-2-
<PAGE>
<TABLE>
<CAPTION>
TORCHMARK CORPORATION
CONSOLIDATED STATEMENT OF OPERATIONS
(Unaudited and in thousands except per share data)
(Continued)
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ -----------------
1998 1997 1998 1997
------- ------ ------ ------
<S> <C> <C> <C> <C>
Basic earnings per share:
Income from continuing operations $ 0.38 $0.53 $ 1.31 $1.35
Discontinued operations of Waddell & Reed:
Income from operations 0.10 0.14 0.31 0.41
Loss on disposal (0.38) 0.00 (0.37) 0.00
------ ----- ------ -----
Net income before extraordinary item 0.10 0.67 1.25 1.76
Loss on redemption of debt 0.00 0.00 (0.03) 0.00
------ ----- ------ -----
Net income $ 0.10 $0.67 $ 1.22 $1.76
====== ===== ====== =====
Diluted earnings per share:
Net income from continuing operations $ 0.38 $0.52 $ 1.30 $1.33
Discontinued operations of Waddell & Reed:
Income from operations 0.10 0.14 0.31 0.40
Loss on disposal (0.38) 0.00 (0.37) 0.00
------ ----- ------ -----
Net income before extraordinary item 0.10 0.66 1.24 1.73
Loss on redemption of debt 0.00 0.00 (0.04) 0.00
------ ----- ------ -----
Net income $ 0.10 $0.66 $ 1.20 $1.73
====== ===== ====== =====
</TABLE>
See accompanying Notes to Consolidated Financial Statements
-3-
<PAGE>
TORCHMARK CORPORATION
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
(Unaudited and in thousands)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------- --------------------
1998 1997 1998 1997
-------- --------- -------- --------
<S> <C> <C> <C> <C>
Net income $ 14,546 $ 92,974 $170,606 $244,892
Other comprehensive income:
Unrealized gains (losses) on securities:
Unrealized holding gains arising during period 81,759 94,412 114,714 75,691
Less: reclassification adjustment for (gains) losses
on securities included in net income (1,460) (3,515) (553) 23,392
Less: reclassification adjustment for amortization of
discount and premium (573) (1,571) (2,507) (1,931)
Less: foreign exchange adjustment on securities
marked to market 692 246 1,595 600
Less: unrealized gains of Family Service at date of sale 0 0 (28,315) 0
-------- --------- -------- --------
Unrealized gains (losses) on securities 80,418 89,572 84,934 97,752
Unrealized gains (losses) on other investments (1,103) (2830) (10,435) 6,527
Unrealized gains (losses) on deferred acquisition costs (6,569) (8,704) (8,210) (9,649)
Foreign exchange translation adjustments (1,167) (37) (2,027) (538)
-------- --------- -------- --------
Other comprehensive income, before tax 71,579 83,661 64,262 94,092
Income tax effect (25,126) (29,703) (22,554) (33,428)
-------- --------- -------- --------
Other comprehensive income 46,453 53,958 41,708 60,664
-------- --------- -------- --------
Comprehensive income $ 60,999 $146,932 $212,314 $305,556
======== ========= ======== ========
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
-4-
<PAGE>
TORCHMARK CORPORATION
CONSOLIDATED STATEMENT OF CASH FLOW
(Amounts in thousands)
<TABLE>
<CAPTION>
Nine Months Ended
September 30
----------------------------
1998 1997
----------- -----------
<S> <C> <C>
Cash provided from operations $ 279,085 $ 343,144
Cash provided from (used for) investment activities:
Investments sold or matured:
Fixed maturities available for sale - sold 509,138 689,602
Fixed maturities available for sale - matured, called, and repaid 361,977 329,254
Other long-term investments 56,049 67,741
----------- -----------
Total investments sold or matured 927,164 1,086,597
Investments acquired:
Fixed maturities (1,541,007) (1,275,542)
Other long-term investments (72,847) (69,155)
----------- -----------
Total investments acquired (1,613,854) (1,344,697)
Net decrease (increase) in short-term investments (37,434) (65,456)
Payments related to sale of discontinued energy operations 0 (15,021)
Dividends from Waddell & Reed 11,210 52,977
Dividends to Waddell & Reed 0 (26,000)
Repayment of note to Waddell & Reed (1,390) 0
Money borrowed from Waddell & Reed 0 40,820
Money loaned to affiliates 0 (790)
Disposition of properties 1,129 579
Additions to properties (3,892) (4,563)
----------- -----------
Cash used for investment activities (717,067) (275,554)
Cash provided from (used for) financing activities:
Issuance of common stock 3,564 88,517
Proceeds from Waddell & Reed public offering 516,014 0
IPO proceeds retained by Waddell & Reed (35,251) 0
Proceeds from sale of Family Service 140,388 0
Additions to debt 209,079 38,696
Repayments of debt (380,291) (20,132)
Acquisition of treasury stock 0 (178,618)
Cash dividends paid to shareholders (63,744) (60,048)
Net receipts from deposit product operations 39,724 63,915
----------- -----------
Cash used for financing activities 429,483 (67,670)
Net increase (decrease) in cash (8,499) (80)
Cash at beginning of year 11,085 2,516
----------- -----------
Cash at end of period $ 2,586 $ 2,436
=========== ===========
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
-5-
<PAGE>
TORCHMARK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note A - Accounting Policies
The accompanying unaudited consolidated financial statements have been
prepared in accordance with the instructions to Form 10-Q. Therefore, they do
not include all of the disclosures required by generally accepted accounting
principles. However, in the opinion of management, these statements include all
adjustments, consisting of normal recurring accruals, which are necessary for a
fair presentation of the consolidated financial position at September 30, 1998,
and the consolidated results of operations for the periods ended September 30,
1998 and 1997.
Note B - Spin-Off of Subsidiary
Waddell & Reed, Torchmark's asset management subsidiary, completed an
initial public offering in March, 1998 of approximately 24 million shares of its
common stock. The offering represented approximately 36% of Waddell & Reed's
shares. On November 6, 1998, Torchmark distributed its remaining 64% investment
in Waddell & Reed through a tax-free spin-off to Torchmark shareholders, whereby
each shareholder of record on October 23, 1998 received a total of .3018
Waddell & Reed shares per Torchmark share. After the spin-off, Torchmark
retained no further ownership interest in Waddell & Reed.
Torchmark has accounted for the spin-off of Waddell & Reed as a disposal of
a segment. Accordingly, Torchmark's financial statements for 1998 and all prior
periods have been modified to present the net assets and operating results of
Waddell & Reed as discontinued operations of the disposed segment.
Additionally, as a part of the transaction, Torchmark incurred $53 million in
expense related to the spin-off which is also included in discontinued
operations. The majority of the expense was $50 million of corporate Federal
income tax resulting from the distribution of a portion of the policyholder
surplus account of a Torchmark life subsidiary. The distribution of the Waddell
& Reed shares resulted in a reduction in Torchmark's shareholders' equity in the
approximate amount of $177 million, consisting of the equity of Waddell & Reed
net of the minority interest.
Note C - Investment in Vesta Insurance Group
On November 6, 1998, Torchmark entered into an agreement to sell
approximately 1.8 million shares of Vesta common stock to an unaffiliated
insurance carrier (acquirer) at a price of $7.42 per Vesta share. The
transaction is subject to regulatory approval. Torchmark currently owns 5.13
6
<PAGE>
million shares of Vesta, representing approximately 27.8% of Vesta's outstanding
shares. The transaction will reduce Torchmark's ownership in Vesta to
approximately 12% after giving effect to other Vesta equity transactions
involving the acquirer. In addition, Torchmark will vacate the two Vesta board
seats it now occupies. Torchmark presently plans to sell its remaining shares in
the future.
In view of the terms of the agreement, Torchmark has determined that the
estimated fair value of its holding in Vesta shares is substantially less than
Torchmark's carrying value for those shares. As a result, Torchmark has
adjusted the value of its investment in Vesta common stock to estimated net
realizable value, effective September 30, 1998. The adjustment produces an
after-tax nonoperating realized loss of $24.0 million ($0.17 per Torchmark
diluted share). The adjustment reduces the carrying value of Torchmark's
holdings in Vesta to $7.42 per Vesta share for the 1.8 million shares to be
sold, and to $9.50 per Vesta share for the remaining 3.3 million shares. The
$9.50 amount used to determine the estimated net realizable value for the
remaining shares was the closing market value of Vesta stock on the New York
Stock Exchange on November 6, 1998. After the adjustment to estimated net
realizable value, Torchmark's book value of Vesta was $45 million at September
30, 1998.
Torchmark previously accounted for its investment in Vesta on the equity
method. Because of the agreement to sell the Vesta shares, the resulting
writedown, and the vacating of the board seats, Torchmark will discontinue
equity-method accounting. It will account for Vesta on the cost method in future
periods, adjusting its book value to market value each period and recording only
dividend income.
In June, 1998, Vesta announced that (a) an investigation of accounting
irregularities that occurred during the fourth quarter of 1997 and the first
quarter of 1998 would result in an aggregate $14 million net after-tax reduction
in previously reported net income, and, in addition, that (b) it would restate
its historical financial statements for the period of 1993 through the first
quarter of 1998, reflecting reductions in reported net after-tax earnings of $49
million for the period of 1993 through 1997 and $10 million for the first
quarter of 1998. To reflect its pro rata share of Vesta's cumulative reported
financial corrections, Torchmark recorded a pre-tax charge of $20 million ($13
million after tax) or $.09 per diluted share in the second quarter of 1998.
Additionally, Vesta is now subject to numerous class action lawsuits in state
and federal courts filed subsequent to such announcements.
Torchmark had recorded its equity in Vesta's earnings in the quarter that
Vesta reported those earnings. In the third quarter of 1998, Vesta reported its
second quarter 1998 earnings and Torchmark recorded its equity in those earnings
as a loss of $3.9 million.
7
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OPERATING RESULTS
Cautionary statements. Torchmark cautions readers regarding certain
forward-looking statements contained in the following discussion and elsewhere
in this document, and in any other statements made by, or on behalf of Torchmark
whether or not in future filings with the Securities and Exchange Commission.
Any statement that is not a historical fact, or that might otherwise be
considered an opinion or projection concerning Torchmark or its business,
whether express or implied, is meant as and should be considered a forward-
looking statement. Such statements represent management's opinions concerning
future operations, strategies, financial results or other developments.
Forward-looking statements are based upon estimates and assumptions that
are subject to significant business, economic and competitive uncertainties,
many of which are beyond Torchmark's control. If these estimates or assumptions
prove to be incorrect, the actual results of Torchmark may differ materially
from the forward-looking statements made on the basis of such estimates or
assumptions. Whether or not actual results differ materially from forward-
looking statements may depend on numerous foreseeable and unforeseeable events
or developments, which may be national in scope, related to the insurance
industry generally, or applicable to Torchmark specifically. Such events or
developments could include, but are not necessarily limited to:
1) Deteriorating general economic conditions leading to increased lapses
and/or decreased sales of Torchmark's policies;
2) Changes in governmental regulations (particularly those impacting taxes
and mandates for health insurance products);
3) Financial markets trends that adversely affect sales of Torchmark's
market-sensitive products;
4) Interest rate changes that adversely affect product sales and/or
investment portfolio yield;
5) Increased pricing competition;
6) Adverse regulatory developments;
7) Adverse litigation results;
8) Adverse Year 2000 compliance results; and
9) Developments involving Vesta Insurance Group, Inc., described more fully
elsewhere in this document under the caption "Transactions involving
Vesta Insurance Group" on page 21 of this report.
8
<PAGE>
Divestiture of Waddell & Reed. Waddell & Reed, Torchmark's asset
management subsidiary, completed an initial public offering in March, 1998 of
approximately 24 million shares of its common stock. The offering represented
approximately 36% of Waddell & Reed's shares. On November 6, 1998, Torchmark
distributed its remaining 64% investment in Waddell & Reed through a tax-free
spin-off to Torchmark shareholders, whereby each shareholder of record on
October 23, 1998 received a total of .3018 Waddell & Reed shares per Torchmark
share. After the spin-off, Torchmark retained no further ownership interest in
Waddell & Reed.
Torchmark has accounted for the spin-off of Waddell & Reed as a disposal of
a segment. Accordingly, Torchmark's financial statements for 1998 and all prior
periods have been modified to present the net assets and operating results of
Waddell & Reed as discontinued operations of the disposed segment.
Additionally, as a part of the transaction, Torchmark incurred $53 million in
expense related to the spin-off which is also included in discontinued
operations. The majority of the expense was $50 million of corporate Federal
income tax resulting from the distribution of a portion of the policyholder
surplus account of a Torchmark life subsidiary. The distribution of the Waddell
& Reed shares resulted in a reduction in Torchmark's shareholders' equity in the
approximate amount of $177 million, consisting of the equity of Waddell & Reed
net of the minority interest.
Torchmark's share of Waddell & Reed's earnings for the first nine months of
1998 was $44 million after reduction for the minority interest. This compares
with $57 million during the first nine months of 1997 when Torchmark owned 100%
of Waddell & Reed for the entire period.
9
<PAGE>
Operating Results. The following table presents earnings and earnings per
share data for Torchmark.
Earnings and Earnings Per Share
(Dollar amounts in thousands, except for per share data)
<TABLE>
<CAPTION>
For the nine months ended
September 30,
------------------------------------ %
1998 1997 Change
------------ ------------ ------------
<S> <C> <C> <C>
Net operating income from continuing
insurance operations:
Amount $239,904 $210,176 14.1
Per Share:
Basic 1.71 1.51 13.2
Diluted 1.69 1.49 13.4
Net operating income - all operations:
Amount 283,816 267,231 6.2
Per Share:
Basic 2.02 1.92 5.2
Diluted 2.00 1.89 5.8
Net income from continuing operations:
Amount 184,187 187,837 (1.9)
Per Share:
Basic 1.31 1.35 (3.0)
Diluted 1.30 1.33 (2.3)
Net income:
Amount 170,606 244,892 (30.3)
Per Share:
Basic 1.22 1.76 (30.7)
Diluted 1.20 1.73 (30.6)
</TABLE>
Torchmark's operating results have been divided into two components. The
first component is Torchmark's continuing insurance operations which includes
the operations of its insurance subsidiaries and corporate activities. The
operations of this insurance group will constitute Torchmark's total operations
after the spin-off. The other component is its discontinued asset management
activities conducted by Waddell & Reed.
While Torchmark reports net income in accordance with accounting rules, it
also computes "net operating income." Net operating income is the measure of
income Torchmark's management focuses on to evaluate the performance of the
operations of the company. It excludes unusual and nonrecurring income or loss
items which distort operating trends. For the nine month periods ended
10
<PAGE>
September 30, 1998 and 1997, the following items were excluded from net income
in order to compute net operating income:
1) Realized investment gains and losses and the related adjustment to
deferred acquisition costs, net of tax;
2) Torchmark's pro rata share of Vesta Insurance Group's (Vesta's)
adjustment to its equity as a result of the accounting irregularities and
earnings restatement reported by Vesta in the second quarter of 1998,
amounting to $13 million after tax;
3) The nonrecurring expenses of the spin-off of $53 million after tax; and
4) The nonrecurring loss from the redemption by Torchmark of its debt in the
second quarter of 1998, in the amount of $5 million net of tax.
Realized investment losses, net of tax, were $43 million in the 1998 nine
months and $22 million in the year earlier period. The 1998 loss includes a $23
million after-tax loss from the sale of Family Service Life Insurance Company
completed in the second quarter and a $24 million after-tax loss on the
writedown of Vesta in the third quarter. Losses in 1997 were primarily a result
of intentional sales of fixed-maturity investments at a loss to offset current
and prior year taxable gains.
Also in accordance with accounting rules, Torchmark reports earnings per
share data as basic and diluted. Basic earnings per share are based on average
shares outstanding during the period. Diluted earnings per share assume the
exercise of Torchmark employee stock options and their impact on shares
outstanding. Diluted earnings per share differ from basic earnings per share in
that they are influenced by changes in the market price of Torchmark stock and
the number of options as well as the number of shares outstanding.
Operating revenues, or revenues excluding realized investment gains and
losses, rose 6% to $1.67 billion in the first nine months of 1998. Total
premium increased 4% to $1.31 billion and net investment income rose 12% to $353
million in the 1998 period. Torchmark's operating expense increased 2% to $89
million in 1998, but as a percentage of operating revenues it declined from 5.6%
in 1997 to 5.4% in 1998.
11
<PAGE>
INSURANCE OPERATIONS
The following table is a summary of Torchmark's insurance operations. Net
underwriting income is premium income less net policy obligations, commissions,
acquisition expenses, and insurance administrative expenses. Excess investment
income is tax equivalent net investment income reduced by the interest credited
to net policy liabilities, less the financing cost of Torchmark's debt and
Monthly Income Preferred Securities (MIPS).
Summary of Insurance Net Operating Income
(Dollar amounts in thousands)
<TABLE>
<CAPTION>
Nine months
Ended September 30, Increase
------------------------------- -------------------------
1998 1997 Amount %
------------ ------------ ------------ ---------
<S> <C> <C> <C> <C>
Insurance underwriting income before
other income and administrative
expense:
Life $ 189,803 $ 183,066 $ 6,737 4
Health 104,691 106,874 (2,183) (2)
Annuity 16,909 14,153 2,756 19
------------ ------------ ------------
Total 311,403 304,093 7,310 2
Other income 3,581 2,396 1,185 49
Insurance administrative expense (78,145) (77,252) (893) 1
------------ ------------ ------------
Net underwriting income 236,839 229,237 7,602 3
Excess investment income 152,259 103,461 48,798 47
Corporate expense and other (26,664) (14,600) (12,064) 83
Income taxes (122,530) (107,922) (14,608) 14
------------ ------------ ------------
Insurance net operating income $ 239,904 $ 210,176 $ 29,728 14
</TABLE>
12
<PAGE>
Life insurance. Torchmark's life insurance premium income rose 6% to $719
million in the first nine months of 1998, from $680 million in the same nine-
month period last year. The following table presents Torchmark's life insurance
premium and policy charges by distribution method.
Life Insurance
Premium by Distribution Method
(Dollar amounts in thousands)
<TABLE>
<CAPTION>
Nine months ended September 30,
--------------------------------------------------------
1998 1997 Increase
---------------------------- ------------------------ -------------------
% of % of
Amount Total Amount Total Amount %
----------- ------------- ------------ --------- ----------- ----
<S> <C> <C> <C> <C> <C> <C>
Liberty National Exclusive Agency $ 211,501 29 $ 210,933 31 $ 568 0
United American Independent Agency 27,841 4 27,436 4 405 1
United American Exclusive Agency 14,112 2 13,699 2 413 3
Direct Response 165,591 23 145,716 21 19,875 14
American Income Exclusive Agency 152,476 21 141,877 21 10,599 7
Military Independent Agency 67,980 9 58,612 9 9,368 16
United Investors Exclusive Agency 60,820 9 58,330 9 2,490 4
Other 18,213 3 23,643 3 (5,430) (23)
----------- ------- ------------ ------ ------------
Total Premium $ 718,534 100 $ 680,246 100 $38,288 6
</TABLE>
13
<PAGE>
Annualized life premium in force was $1.05 billion at September 30, 1998,
growing 5% over $995 million in force a year earlier. Life insurance sales, in
terms of annualized premium issued, were $183 million in the 1998 nine-month
period, increasing 6% over 1997 same-period sales of $173 million. The
following table presents Torchmark's life insurance sales and in force data by
distribution method.
Life Insurance
Annualized Premium Sales and In Force
(Dollar amounts in thousands)
<TABLE>
<CAPTION>
Sales In Force
----------------------------------------------- -----------------------------------------------
Nine months
Ended September 30, Increase At September 30, Increase
------------------------ --------------------- ------------------------ ------------------
1998 1997 Amount % 1998 1997 Amount %
------------ ----------- ----------- ----- ----------- ----------- ----------- -----
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Liberty Exclusive Agency $ 33,052 $ 31,869 $ 1,183 4 $ 297,718 $ 298,064 $ (346) 0
UA Independent Agency 6,669 12,033 (5,364) (45) 40,947 42,354 (1,407) (3)
UA Exclusive Agency 4,088 5,362 (1,274) (24) 21,487 21,174 313 1
Direct Response 70,384 58,812 11,572 20 254,759 226,387 28,372 13
American Income Agency 41,546 41,732 (186) 0 214,312 200,455 13,857 7
Military Agency 12,898 11,828 1,070 9 96,087 83,113 12,974 16
UI Exclusive Agency 10,929 7,635 3,294 43 96,212 87,936 8,276 9
Other Distribution 3,243 3,630 (387) (11) 26,843 35,272 (8,429) (24)
------------ ----------- ----------- --------------- ----------- ------------
Total Life $ 182,809 $ 172,901 $ 9,908 6 $ 1,048,365 $ 994,755 $ 53,610 5
</TABLE>
Torchmark's Direct Response operation is conducted through direct mail,
co-op mailings, television and consumer magazine advertising, and direct mail
solicitations endorsed by groups, unions and associations. In the 1998 nine
months, this distribution method generated $70 million in annualized premium
issued, compared with $59 million in the same period of 1997, an increase of
20%. Direct Response annualized premium in force rose 13% over the prior year
to $255 million at September 30, 1998, and premium income grew 14% to $166
million in the 1998 period. The $20 million growth in Direct Response premium
income was Torchmark's largest premium income gain in terms of dollar amount.
In addition to sales and premium growth, the Direct Response operation provides
support to other Torchmark marketing agencies by providing sales leads.
Torchmark's Military Agency produced the greatest percentage increase in
premium income at 16% to $68 million. It also recorded a 9% increase in
annualized premium issued of $12.9 million during the 1998 period. This agency
consists of former military officers who sell exclusively to military officers
and their families.
The Liberty National Exclusive Agency distribution system represented the
largest component of life premium at 29% or $212 million in the 1998 nine-month
14
<PAGE>
period. Life insurance sales for this agency grew 4% to $33 million of
annualized premium issued in the 1998 period.
The American Income Agency produced sales of $42 million in annualized life
premium in the current period. Premium income increased 7% to $152 million.
This distribution system focuses on members of labor unions, credit unions, and
other associations.
The United Investors Exclusive Agency had the largest percentage increase
in sales for Torchmark life insurance operations at 43%. Annualized premium
issued rose to $11 million. Annualized life premium in force gained 9% to $96
million. These products are marketed through the Waddell & Reed sales force.
Sales of life insurance by the United American Independent and Exclusive
Agencies declined 38% in the 1998 nine months on a combined basis. The decline
in sales was attributable to Torchmark's emphasis in health insurance sales over
life insurance sales in these agencies and to improvements in the Medicare
Supplement market.
Life Insurance
Summary of Results
(Dollar amounts in thousands)
<TABLE>
<CAPTION>
Nine months ended September 30,
----------------------------------------------------
1998 1997 Increase
------------------------- ----------------------- -----------------
% to % to
Amount Total Amount Total Amount %
------------ ------- ----------- ------ -------- -----
<S> <C> <C> <C> <C> <C> <C>
Premium and policy charges $ 718,534 100 $ 680,246 100 $ 8,288 6
Net policy obligations 300,765 42 278,429 41 22,336 8
Commissions and
acquisition expense 227,966 32 218,751 32 9,215 4
------------ ----------- -------
Insurance underwriting income before
other income and administrative
expenses $ 189,803 26 $ 183,066 27 $ 6,737 4
</TABLE>
Life insurance underwriting income before administrative expenses was $190
million in the first nine months of 1998, growing 4% over the same period in
1997. As a percentage of premium, underwriting income declined from 27% in 1997
to 26% in 1998. There was a slight increase in mortality in 1998, as indicated
by the increase in benefit ratios, which occurred in both the Liberty National
and Direct Response areas. Fluctuations in mortality are expected in the life
insurance business and are not indicative of a trend.
15
<PAGE>
Health insurance. Health insurance premium income was up 2% from $555
million in the first nine months of 1997 to $567 million in the same period of
1998. The table below is an analysis of Torchmark's health premium by
distribution method.
Health Insurance
Premium by Distribution Method
(Dollar amounts in thousands)
<TABLE>
<CAPTION>
Nine months ended September 30,
-------------------------------------------------
1998 1997 Increase
--------------------- ----------------------- ---------------------
% to % to
Amount Total Amount Total Amount %
----------- ------- ----------- -------- ------------ -----
<S> <C> <C> <C> <C> <C> <C>
Liberty National Exclusive Agency $ 101,237 18 $ 93,848 17 $ 7,389 8
United American Independent Agency 314,246 55 323,528 58 (9,282) (3)
United American Exclusive Agency 110,315 20 98,642 18 11,673 12
Direct Response 6,521 1 4,729 1 1,792 38
American Income Exclusive Agency 35,138 6 34,537 6 601 2
----------- ------ ----------- ------ -----------
Total Premium $ 567,457 100 $ 555,284 100 $ 12,173 2
</TABLE>
The table below is a presentation of health insurance sales and in force
data.
Health Insurance Annualized Premium Sales and In Force
(Dollar amounts in thousands)
<TABLE>
<CAPTION>
Sales In Force
-------------------------------------------------- --------------------------------------------
Nine months
Ended September 30, Increase At September 30, Increase
--------------------------- -------------------- -------------------------- ------------------
1998 1997 Amount % 1998 1997 Amount %
------------ ------------ ------------ ----- ------------ ----------- ------------- ---
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Liberty Exclusive Agency $ 8,561 $ 9,028 $ (467) (5) $ 146,552 $ 130,835 $ 15,717 12
UA Independent Agency 35,663 30,985 4,678 15 426,969 436,124 (9,155) (2)
UA Exclusive Agency 44,251 29,040 15,211 52 163,705 139,926 23,779 17
Direct Response 3,309 2,478 831 34 9,277 6,971 2,306 33
American Income Agency 7,152 7,633 (481) (6) 44,379 43,478 901 2
----------- ----------- ------------ ----------- ----------- -----------
Total Premium $ 98,936 $ 79,164 $ 19,772 25 $ 790,882 $ 757,334 $ 33,548 4
</TABLE>
Annualized health insurance premium in force grew 4% to $791 million at
September 30, 1998. Cancer annualized premium in force rose 13% to $147
16
<PAGE>
million, primarily as a result of premium rate increases at Liberty National.
Medicare Supplement annualized premium in force grew 4% to $544 million at
September 30, 1998 and represented 69% of health premium in force on that date.
Sales of health insurance, as measured by annualized premium issued, grew
$20 million or 25% to $99 million in the 1998 period. Medicare Supplement sales
rose 48% in the 1998 period to $71 million. Growth in Medicare Supplement
sales, which increased $23 million, accounted for the total increase in health
sales. Torchmark's Medicare Supplement products are sold by its United American
Independent and Exclusive Agencies. Both of these agencies have experienced
growth in agency size over the prior year. An additional factor in the
increased Medicare Supplement sales was the support obtained from Torchmark's
Direct Response operation in providing these agencies with leads. Cancer sales,
produced primarily by the Liberty National Agency, were $8 million in the 1998
nine months, unchanged from the prior period. Other health product sales
declined 11% to $20 million.
The following table presents underwriting margin data for health insurance.
Health Insurance
Summary of Results
(Dollar amounts in thousands)
<TABLE>
<CAPTION>
Nine months ended September 30,
------------------------------------------------------
1998 1997 Increase
---------------------------- -------------------- --------------------
% of % of
Amount Total Amount Total Amount %
----------- ------- ---------- ------- --------- ------
<S> <C> <C> <C> <C> <C> <C>
Premium $ 567,457 100 $ 555,284 100 $ 12,173 2
Net policy obligations 344,752 61 331,046 60 13,706 4
Commissons and
acquisition expense 118,014 21 117,364 21 650 1
----------- ----------- ----------
Insurance underwriting income before
other income and administrative
expenses $ 104,691 18 $ 106,874 19 $ (2,183) (2)
</TABLE>
Underwriting margins for health insurance, or underwriting income as a
percentage of premium, declined from 19% in the first nine months of 1997 to 18%
in the same period of 1998 as a result of a 1% increase in policy obligation
ratios. Health policy obligations rose 4% while premium rose 2%. Cancer
benefit increases have contributed to the increase in net policy obligations.
Premium rate increases are being sought to offset these cost increases.
Requests for additional increases in future periods are possible to address the
decline in margins. In Torchmark's Medicare Supplement business, underwriting
17
<PAGE>
income as a percentage of premium is restrained by Federally mandated loss
ratios and market competition. Both cancer and Medicare Supplement products are
profitable to Torchmark, and Torchmark continues to promote new sales for both
products.
Annuities. The following table presents collection and balance information
about Torchmark's annuities.
Annuities
Collections and Deposit Balances
(Dollar amounts in thousands)
<TABLE>
<CAPTION>
Collections Deposit Balances
------------------------------------------- --------------------------------------------------------
Nine Months
Ended September 30, Increase At September 30, Increase
------------------------ ----------------- ----------------------------- -----------------------
1998 1997 Amount % 1998 1997 Amount %
---------- ----------- ----------- --- ------------- ------------ -------------- ---
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Fixed $ 50,696 $ 70,535 $(19,839) (28) $ 640,343 $1,005,628 $ (365,285) (36)
Variable 204,472 172,992 31,480 18 2,044,492 1,776,853 267,639 15
---------- ----------- ----------- ------------- ------------ -------------
Total $255,168 $243,527 $ 11,641 5 $2,684,835 $2,782,481 $(97,646) (4)
</TABLE>
Annuities are sold on both a fixed and a variable basis. Fixed annuity
collections were $51 million in the first nine months of 1998, compared with
$71 million collected in the prior period, a decline of 28%. Collections of
variable annuities were $204 million in the 1998 period, rising 18% from
variable collections of $173 million in 1997. Fixed annuities on deposit with
Torchmark declined 36% to $640 million. The decline was caused by the sale of
Family Service, which had a block of fixed annuities in the amount of $396
million at April 30, 1998. Excluding Family Service, the fixed annuity balance
would have increased 5%. The variable annuity balance on deposit rose 15%
during the past twelve months. Strength in financial markets in the first half
of 1998 was a major factor in the growth during that period. The variable
annuity balance declined slightly in the third quarter of 1998 as markets became
more volatile. The variable annuity deposit balance was $2.0 billion at
September 30, 1998, $2.1 billion at June 30, 1998, and $1.8 billion a year ago.
18
<PAGE>
The following table presents underwriting margin data for Torchmark's
annuities.
Annuities
Summary of Results
(Dollar amounts in thousands)
Nine months
Ended September 30, Increase
-------------------- -------------
1998 1997 Amount %
-------------------- -------------
Policy charges $ 24,354 $ 20,273 $ 4,081 20
Net policy obligations (7,453) (8,544) 1,091 (13)
Commissions and
acquisition expense 14,898 14,664 234 2
-------------------- -------------
Insurance underwriting income before
other income and administrative
expenses $ 16,909 $ 14,153 $ 2,756 19
Policy charges for annuities for the 1998 nine months were $24 million,
compared with $20 million for the 1997 period, an increase of 20%. Policy
charges are assessed against the annuity account balance periodically for
insurance risk, sales, administration, and cash surrender. The increase in
policy charges resulted primarily from the growth in variable annuities over
the prior-year period. Annuity underwriting income improved 19% from $14 million
in the 1997 period to $17 million in 1998, consistent with the growth in policy
charges.
19
<PAGE>
Investment. The following table summarizes Torchmark's insurance companies'
investment income and excess investment income.
<TABLE>
<CAPTION>
Insurance Operations
Excess Investment Income
(Dollars in thousands)
Nine months
Ended September 30, Increase
----------------------- -------------------
1998 1997 Amount %
---- ---- ------ -----
<S> <C> <C> <C> <C>
Net investment income $349,846 $315,900 $33,946 11
Tax equivalency adjustment 8,371 7,220 1,151 16
--------- -------- -------
Tax equivalent investment income 358,217 323,120 35,097 11
Required interest on net insurance
policy liabilities (148,732) (156,675) 7,943 (5)
Financing costs (57,226) (64,854) 7,628 (12)
--------- --------- -------
Excess investment income $152,259 $101,591 $50,668 50
</TABLE>
On a tax equivalent basis, net investment income from insurance operations
was $358 million during the first nine months of 1998, an increase of 11% over
$323 million during the same 1997 period. The 1998 amount includes $7 million
in the first quarter on internal financing with Waddell & Reed related to the
March, 1998 initial public offering.
The increase in investment income resulted from the increase in mean
invested assets over the prior period. Mean invested assets at amortized cost
increased 9% to $6.6 billion during the 1998 nine months from $6.0 billion a
year earlier. The increase in mean invested assets was primarily caused by the
proceeds received from the Waddell & Reed initial public offering and was also
impacted by the accumulation of life reserves and reinvestment of cash flow.
Excess investment income is tax-equivalent net investment income reduced by
interest credited to net insurance policy liabilities, less financing costs.
Excess investment income for the nine months ended September 30, 1998 was $152
million, compared with $102 million for the prior nine months. This 50%
increase was caused by four factors:
1) The Waddell & Reed transaction, in which $481 million in additional
funds were available, allowing Torchmark to invest $399 million in new
investments at an average yield of 6.92% and pay down $82 million in
short-term debt;
20
<PAGE>
2) The refinancing of long-term debt with short-term debt, saving an average
of 350 basis points in financing costs; and
3) The inclusion of $7 million interest on internal financing with Waddell &
Reed.
Measured by U.S. Treasury yields, rates continued to fall throughout the
first nine months of 1998, but uncertainties in financial markets caused spread
widening, a reduced new issue calendar, and extreme volatility in bond prices,
especially in emerging market debt. In this environment, 1998 fixed-maturity
acquisitions excluding Family Service totalled $1.46 billion and were made at an
average yield of 7.12% and an average maturity of 20.4 years. This compares
with fixed maturity acquisitions during the comparable 1997 period of $1.27
billion at an average yield of 7.29% and an average maturity of 10.7 years.
With new fixed income investments being made at yields below the average
year-end 1997 portfolio yield of 7.49%, the portfolio yield for the nine months
ending September, 1998 was 7.41%. At quarter end, the portfolio had an average
life of 8.4 years and an effective duration of 5.5 years, compared with an
average life of 8.0 years and a duration of 5.1 years at year-end 1997.
Torchmark's investments continue to emphasize investment-quality fixed-maturity
obligations, with only 11% of acquisitions and 6% of holdings below investment
grade.
With the decline in interest rates, the unrealized gain in the fixed-
maturity portfolio increased from $213 million at 1997 year end to $301 million
at the end of September, 1998. This increase occurred in spite of the
elimination of $24 million in unrealized gains by virtue of the Family Service
sale. Other comprehensive income resulting from security value fluctuations on
a pretax basis was income in 1998 of $115 million, compared with a loss of $76
million in 1997.
TRANSACTIONS INVOLVING VESTA INSURANCE GROUP
On November 6, 1998, Torchmark entered into an agreement to sell
approximately 1.8 million shares of Vesta common stock to an unaffiliated
insurance carrier (acquirer) at a price of $7.42 per Vesta share. The
transaction is subject to regulatory approval. Torchmark currently owns 5.13
million shares of Vesta, representing approximately 27.8% of Vesta's outstanding
shares. The transaction will reduce Torchmark's ownership in Vesta to
approximately 12% after giving effect to other Vesta equity transactions
involving the acquirer. In addition, Torchmark will vacate the two Vesta board
seats it now occupies. Torchmark presently plans to sell its remaining shares in
the future.
In view of the terms of the agreement, Torchmark has determined that the
estimated fair value of its holding in Vesta shares is substantially less than
Torchmark's carrying value for those shares. As a result, Torchmark has adjusted
the value of its investment in Vesta common stock to estimated net realizable
value,
21
<PAGE>
effective September 30, 1998. The adjustment produces an after-tax nonoperating
realized loss of $24.0 million ($0.17 per Torchmark diluted share). The
adjustment reduces the carrying value of Torchmark's holdings in Vesta to $7.42
per Vesta share for the 1.8 million shares to be sold, and to $9.50 per Vesta
share for the remaining 3.3 million shares. The $9.50 amount used to determine
the estimated net realizable value for the remaining shares was the closing
market value of Vesta stock on the New York Stock Exchange on November 6, 1998.
After the adjustment to estimated net realizable value, Torchmark's book value
of Vesta was $45 million at September 30, 1998. The effects of this writedown
were reported subsequent to Torchmark's announcement of earnings for the third
quarter of 1998 through its press release dated October 22, 1998.
Torchmark previously accounted for its investment in Vesta on the equity
method. Because of the agreement to sell the Vesta shares, the resulting
writedown, and the vacating of the board seats, Torchmark will discontinue
equity-method accounting. It will account for Vesta on the cost method in future
periods, adjusting its book value to market value each period and recording only
dividend income.
In June, 1998, Vesta announced that (a) an investigation of accounting
irregularities that occurred during the fourth quarter of 1997 and the first
quarter of 1998 would result in an aggregate $14 million net after-tax reduction
in previously reported net income, and, in addition, that (b) it would restate
its historical financial statements for the period of 1993 through the first
quarter of 1998, reflecting reductions in reported net after-tax earnings of $49
million for the period of 1993 through 1997 and $10 million for the first
quarter of 1998. To reflect its pro rata share of Vesta's cumulative reported
financial corrections, Torchmark recorded a pre-tax charge of $20 million ($13
million after tax) or $.09 per diluted share in the second quarter of 1998.
Additionally, Vesta is now subject to numerous class action lawsuits in state
and federal courts filed subsequent to such announcements.
Torchmark had recorded its equity in Vesta's earnings in the quarter that
Vesta reported those earnings. In the third quarter of 1998, Vesta reported its
second quarter 1998 earnings and Torchmark recorded its equity in those earnings
as a loss of $3.9 million.
22
<PAGE>
SALE OF FAMILY SERVICE
On June 1, 1998, Torchmark sold Family Service to an unaffiliated
insurance carrier. Family Service, which was acquired in 1990, is an insurer of
pre-need funeral policies but has not issued any new policies since 1995.
Consideration for the sale was $140 million in cash. Torchmark recorded a
pretax realized loss on the sale of approximately $14 million, but incurred a
tax expense on the transaction of $9 million. In connection with the sale,
Torchmark will continue to service the policies in force of Family Service for
the next five years for a fee of $2 million per year plus certain variable
processing costs. Through May, 1998, Family Service contributed $25 million in
revenues and $5.8 million in pretax income. Invested assets were $778 million
and total assets were $828 million at the date of sale.
FINANCIAL CONDITION
Liquidity. Torchmark's liquidity is indicated by its positive cash flow,
marketable investments, and the availability of a line of credit facility.
Torchmark's insurance and asset-management operations typically generate cash
flows in excess of immediate requirements. Torchmark's net cash inflows from
operations were $279 million in the first nine months of 1998, compared with
$343 million in the same period of 1997. In addition to cash flows from
operations, Torchmark received $362 million in investment maturities or
repayments during the first half of 1998.
Torchmark's cash and short-term investments were $97 million at the end of
September, 1998, compared with $77 million of these assets at December 31,
1997. Cash and short-term investments represented approximately 1% of total
assets at end of the third quarter of 1998. In addition, Torchmark's entire
portfolio of fixed-income and equity securities, in the amount of $5.9 billion
at market value on September 30, 1998, is available for sale.
Torchmark has in place a line of credit facility, which is also designed as
a backup credit line for a commercial paper program. This program provides
credit up to a maximum amount of $600 million, and permits Torchmark to borrow
from either the credit line or issue commercial paper at any time up to the
combined facility maximum of $600 million. Terms of the facility permit
borrowing up to the maximum amount at variable interest rates. Torchmark is
subject to certain covenants regarding capitalization and earnings, with which
Torchmark was in full compliance at September 30, 1998. At that date, Torchmark
had commercial paper outstanding in the amount of $348 million and no
borrowings on the line of credit. At December 31, 1997, $139 million in
commercial paper was outstanding.
23
<PAGE>
Capital resources. In 1998, Torchmark utilized a portion of funds received
from the Waddell & Reed initial public offering to pay down funded debt. It has
also taken advantage of the lower interest rate environment to refinance
existing debt at lower rates. In early 1998, Torchmark repaid $20 million
principal amount on its 8 5/8% Sinking Fund Debentures due in 2017, of which $8
million was a mandatory redemption and $12 million was an optional repayment
under the terms of the agreement. On April 1, 1998, Torchmark called the
remaining $160 million principal balance of this debt at the prevailing call
price of 103.76, or $166 million. A loss on the redemption of debt was
recorded in the second quarter of 1998 in the after-tax amount of $5 million,
representing the difference between the total call price and the carrying value
of $158 million. Additionally, Torchmark's 9 5/8% Senior Notes, principal
amount $200 million, matured on May 1, 1998. Torchmark borrowed on its
commercial paper facility to repay the Sinking Fund Debentures that were called
and to repay its Senior Notes upon maturity with accrued interest, in the
combined amount of $377 million. Additionally, in October, 1998, Torchmark
acquired $10.8 million of its 7 7/8% notes due 2023 in the open market at a cost
of $10.6 million.
Torchmark's total debt outstanding was $742 million at September 30, 1998,
compared with $911 million at December 31, 1997 and $852 million at September
30, 1997. Debt as a percentage of total capitalization was 23% at September 30,
1998, counting the MIPS as equity and excluding the effects of fluctuations in
security values based on changes in interest rates in the financial markets. The
debt to capitalization ratio was 31% at year-end 1997 and 31% at September 30,
1997. Interest coverage was 8.2 times for the 1998 nine months, compared with
6.3 times for the prior-year period, excluding discontinued operations.
Torchmark's shareholders' equity was $2.53 billion at September 30, 1998,
compared with $1.93 billion at 1997 year end and $1.83 billion one year ago.
The September 30, 1998 shareholders' equity was increased by the $516 million
proceeds from the W&R offering, but was also reduced by the $90 million of
minority interests at the time of the offering representing the 36% of W&R that
Torchmark no longer owns. Book value per share was $18.03 at quarter end,
compared with $13.80 at year-end 1997 and $13.08 a year earlier. After adjusting
shareholders' equity to remove the effects of interest-rate fluctuations on the
security portfolio on an after-tax basis, shareholders' equity was $2.35 billion
at September 30, 1998, compared with $1.81 billion at 1997 year end and $1.74
billion a year ago. On a per share basis, book value was $16.76 at the end of
September, 1998, compared with $12.90 at year-end 1997 and $12.42 at September
30, 1997. The annualized return on common equity, excluding the effects of
securities at market value and realized investment gains and losses, declined to
17.2% for the 1998 nine-month period from 21.2% for the same 1997 period. This
decline was a result of the increased equity due to the W&R initial public
offering. There have been no share purchases through October, 1998.
24
<PAGE>
Torchmark intends to reactivate its common share repurchase program
subsequent to the spin-off of Waddell & Reed. Purchases will be made from time
to time in the open market when prices are attractive. Torchmark plans to use
primarily internally generated funds for these purchases but could also use
short-term borrowings. In present market conditions, share purchases will be
accretive to both per share earnings and return on equity.
YEAR 2000 COMPLIANCE
The new millennium poses a significant concern to all businesses which use
computer systems or electronic data in their operations. This concern arises
because these organizations have been processing computer systems and programs
that cannot always identify a proper date. For many years, programs were written
using a two digit code to represent a year. At the beginning of the year 2000,
more digits are needed to accurately determine the date in these programs.
Without addressing this issue, many computer programs could fail or produce
erroneous results. Additionally, companies which are electronically engaged
with other businesses or which rely on other businesses for services are exposed
to risk of failure by the electronic devices and computer systems of those other
entities to the extent they are not Year 2000 compliant. The potential of
failure of these systems creates considerable uncertainty and could potentially
adversely affect the ongoing operations and stability of a business.
Torchmark is exposed to these risks should its computer systems fail due to
date-related problems. Torchmark is also reliant on a number of third party
businesses and governmental agencies in which it either interacts
electronically or depends upon for services in the conduct of its business.
These institutions include but are not limited to banks, financial
institutions, telecommunication companies, utilities, mail delivery
organizations, and a variety of governmental agencies. Should Torchmark's
computer systems or the systems of its third-party business partners not be
compliant, Torchmark may be exposed to considerable and material risks,
including business interruption, loss of revenue, increased expense, loss of
policyholders, and litigation.
To reduce its business risk to an acceptable level, Torchmark has
established a project plan to insure that the company's business-critical
computer systems will be Year 2000 compliant. This plan also addresses third-
party compliance issues. Under the direction of executive management,
objectives and timetables have been set forth to achieve compliance in each
geographic location where Torchmark operates. Progress toward achieving those
objectives is constantly monitored. Torchmark currently expects the entire
project, including testing, to be completed during 1999.
As of September 30, 1998, Torchmark is on schedule to meet all of its Year
2000 compliance requirements. All known required software changes have been
completed, and the related testing is in process with plans for completion in
25
<PAGE>
1999. With regard to third party concerns, Torchmark has in process the
following procedures:
1) Torchmark is confirming, with its software vendors, the Year 2000
readiness of its purchased software packages because Torchmark has
purchased software packages on all of its computer platforms;
2) Torchmark is verifying the Year 2000 compliance status of its financial
business partners' computer and data communications systems to insure
readiness, including data interface testing with third parties; and
3) All of Torchmark's electronic operational systems (telephones, security,
utility, environmental) are being evaluated for Year 2000 compliance.
While Torchmark is making every effort to verify the compliance of third
parties, no assurances as to the compliance of their computer systems can be
given.
Torchmark has used primarily its own employees to complete its Year 2000
project. Other than completion of software testing, all significant Year 2000
project milestones for internal computer systems have been completed.
Confirmation of third party compliance and electronic data interface testing
with third parties is continuing with completion expected during 1999. Torchmark
has spent $4.5 million on its Year 2000 project activities to date, including
internal programming costs, outside contractors, and replacement costs. These
costs have been expensed as incurred. Total project cost is expected to be
approximately $6 million.
In early 1999, Torchmark will address any unresolved Year 2000 concerns for
its internally-supported computer systems and programs. It will also continue
working with its financial business partners and other third parties to identify
any Year 2000-related issues that could negatively impact Torchmark's
operational capabilities.
Year 2000 contingency plans will be performed in response to identified
risks. In the event a system failure is detected, a plan will be developed in a
timely manner to resolve the problem and to reduce the risk to an acceptable
level.
26
<PAGE>
PART II - OTHER INFORMATION
Item 1. Legal Proceedings.
Torchmark and its subsidiaries continue to be named as parties to pending
or threatened legal proceedings. These lawsuits involve tax matters, alleged
breaches of contract, torts, including bad faith and fraud claims based on
alleged wrongful or fraudulent acts of agents of Torchmark's subsidiaries,
employment discrimination, and miscellaneous other causes of action. Many of
these lawsuits involve claims for punitive damages in state courts of Alabama, a
jurisdiction particularly recognized for its large punitive damage verdicts. A
number of such actions involving Liberty National Life Insurance Company also
name Torchmark as a defendant. As a practical matter, a jury's discretion
regarding the amount of a punitive damage award is not limited by any clear,
objective criteria under Alabama law. Accordingly, the likelihood or extent of
a punitive damage award in any given case is virtually impossible to predict.
As of September 30, 1998, Liberty National was a party to approximately 186
active lawsuits (including 29 employment related cases and excluding
interpleaders and stayed cases), 160 of which were Alabama proceedings in which
punitive damages were sought. Liberty National faces trial settings in these
cases on an on-going basis.
It has been previously reported that in June 1996, Liberty National had a
verdict for compensatory and punitive damages rendered against it by a jury in
the Circuit Court of Chambers County, Alabama in McQuiston v. Liberty National
-----------------------------
Life Insurance Company (CV-94-234). The McQuiston case was settled October 2,
- ---------------------- ---------
1998.
Based upon information presently available, and in light of legal and other
factual defenses available to Torchmark and its subsidiaries, contingent
liabilities arising from threatened and pending litigation are not presently
considered by management to be material. It should be noted, however, that
large punitive damage awards bearing little or no relation to actual damages
awarded by juries in jurisdictions in which Torchmark has substantial business,
particularly in Alabama, continue to occur, creating the potential for
unpredictable material adverse judgments in any given punitive damage suit.
27
<PAGE>
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
(11) Statement re computation of per share earnings
(27) Financial Data Schedule
(b) Reports on Form 8-K
No reports on Form 8-K were filed in the third quarter of 1998
28
<PAGE>
SIGNATURES
Pursuant to the requirement of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.
TORCHMARK CORPORATION
Date: November 11, 1998 /s/ C. B. Hudson
__________________________
C. B. Hudson, Chairman of the
Board, President, and Chief
Executive Officer
Date: November 11, 1998 /s/ Gary L. Coleman
__________________________
Gary L. Coleman, Vice President
And Chief Accounting Officer
29
<PAGE>
EXHIBIT 11
STATEMENT RE COMPUTATION OF PER SHARE EARNINGS.
TORCHMARK CORPORATION
COMPUTATION OF EARNINGS PER SHARE
THREE MONTHS ENDED SEPTEMBER 30,
1998 1997
------------ ------------
Net income from continuing operations 53,153,000 73,693,000
Discontinued operations of Waddell &
Reed:
Net income from operations 13,924,000 19,281,000
Loss on disposal (52,531,000) 0
------------ ------------
Net income before extraordinary items 14,546,000 92,974,000
Loss on redemption of debt 0 0
------------ ------------
Net income 14,546,000 92,974,000
============ ============
Basic weighted average shares and
common stock equivalents outstanding 140,262,269 138,475,521
Diluted weighted average shares and
common stock equivalents outstanding 141,485,008 141,290,584
Basic earnings per share:
Net income from continuing operations $ 0.38 $ 0.53
Discontinued operations of Waddell &
Reed:
Net income from operations $ 0.10 $ 0.14
Loss on disposal $ (0.38) $ 0.00
------------ ------------
Net income before extraordinary items $ 0.10 $ 0.67
Loss on redemption of debt $ 0.00 $ 0.00
------------ ------------
Net income $ 0.10 $ 0.67
============ ============
Diluted earnings per share:
Net income from continuing operations $ 0.38 $ 0.52
Discontinued operations of Waddell &
Reed:
Net income from operations $ 0.10 $ 0.14
Loss on disposal $ (0.38) $ 0.00
------------ ------------
Net income before extraordinary items $ 0.10 $ 0.66
Loss on redemption of debt $ 0.00 $ 0.00
------------ ------------
Net income $ 0.10 $ 0.66
============ ============
(Continued on following page)
<PAGE>
EXHIBIT 11. STATEMENT RE COMPUTATION OF PER SHARE EARNINGS.
TORCHMARK CORPORATION
COMPUTATION OF EARNINGS PER SHARE
(CONTINUED)
NINE MONTHS ENDED SEPTEMBER 30,
1998 1997
------------ ------------
Net income from continuing operations 184,187,000 187,837,000
Discontinued operations of Waddell &
Reed:
Net income from operations 43,912,000 57,055,000
Loss on disposal (52,531,000) 0
------------ ------------
Net income before extraordinary items 175,568,000 244,892,000
Loss on redemption of debt (4,962,000) 0
------------ ------------
Net income 170,606,000 244,892,000
============ ============
Basic weighted average shares and
common stock equivalents outstanding 140,242,436 138,921,044
Diluted weighted average shares and
common stock equivalents outstanding 141,664,915 141,381,805
Basic earnings per share:
Net income from continuing operations $ 1.31 $ 1.35
Discontinued operations of Waddell &
Reed:
Net income from operations $ 0.31 $ 0.41
Loss on disposal $ (0.37) $ 0.00
------------ ------------
Net income before extraordinary items $ 1.25 $ 1.76
Loss on redemption of debt $ (0.03) $ 0.00
------------ ------------
Net income $ 1.22 $ 1.76
============ ============
Diluted earnings per share:
Net income from continuing operations $ 1.30 $ 1.33
Discontinued operations of Waddell &
Reed:
Net income from operations $ 0.31 $ 0.40
Loss on disposal $ (0.37) $ 0.00
------------ ------------
Net income before extraordinary items $ 1.24 $ 1.73
Loss on redemption of debt $ (0.04) $ 0.00
------------ ------------
Net income $ 1.20 $ 1.73
============ ============
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 7
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<DEBT-HELD-FOR-SALE> 5,859,953
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 8,332
<MORTGAGE> 104,201
<REAL-ESTATE> 180,722
<TOTAL-INVEST> 6,505,344
<CASH> 2,586
<RECOVER-REINSURE> 0
<DEFERRED-ACQUISITION> 1,633,119
<TOTAL-ASSETS> 11,277,140
<POLICY-LOSSES> 4,529,181
<UNEARNED-PREMIUMS> 86,755
<POLICY-OTHER> 193,022
<POLICY-HOLDER-FUNDS> 81,342
<NOTES-PAYABLE> 742,064
193,244
0
<COMMON> 147,801
<OTHER-SE> 2,381,101
<TOTAL-LIABILITY-AND-EQUITY> 11,277,140
1,310,345
<INVESTMENT-INCOME> 349,846
<INVESTMENT-GAINS> (44,777)
<OTHER-INCOME> 1,937
<BENEFITS> 864,067
<UNDERWRITING-AMORTIZATION> 172,337
<UNDERWRITING-OTHER> 252,238
<INCOME-PRETAX> 328,709
<INCOME-TAX> 117,238
<INCOME-CONTINUING> 184,187
<DISCONTINUED> (8,619)
<EXTRAORDINARY> (4,962)
<CHANGES> 0
<NET-INCOME> 170,606
<EPS-PRIMARY> 1.22
<EPS-DILUTED> 1.20
<RESERVE-OPEN> 0
<PROVISION-CURRENT> 0
<PROVISION-PRIOR> 0
<PAYMENTS-CURRENT> 0
<PAYMENTS-PRIOR> 0
<RESERVE-CLOSE> 0
<CUMULATIVE-DEFICIENCY> 0
</TABLE>
