Globe Life
Annual Report 2014

Plain-text annual report

2014 ANNUAL REPORT STOCK TR ANSFER AGENT AND SHAREHOLDER ASSISTANCE Wells Fargo Shareowner Services P.O. Box 64854 St. Paul, MN 55164-0854 or 1110 Centre Pointe Curve, Suite 101 Mendota Heights, MN 55120-4100 Toll-Free Number: (866) 557-8699 TDD: Hearing impaired can use a relay service Outside the U.S.: (651) 450-4064 Website: www.shareowneronline.com DIVIDEND REINVESTMENT for a dividend Torchmark maintains reinvestment plan all holders of its common stock. Under the plan, shareholders may reinvest all or part of their dividends in additional shares of common stock and may also make periodic additional cash payments of up to $3,000 toward the purchase of Torchmark stock. Participation is voluntary. More information on the plan may be obtained from the Stock Transfer Agent by calling toll-free (866) 557-8699 or by writing: Torchmark Corporation, c/o Wells Fargo Shareowner Services, P.O. Box 64874, St. Paul, MN 55164-0874 or 1110 Centre Pointe Curve, Suite 101, Mendota Heights, MN 55120-4100. AUTOMATIC DEPOSIT OF DIVIDENDS Automatic deposit of dividends is available to shareholders who wish to have their dividends directly deposited into the financial institution of their choice. Authorization forms may be obtained from the Stock Transfer Agent by calling toll-free (866) 557-8699. PRINCIPAL EXECUTIVE OFFICE 3700 South Stonebridge Drive McKinney, Texas 75070 (972) 569-4000 ANNUAL MEETING OF SHAREHOLDERS 10:00 a.m. CDT, Thursday, April 30, 2015 Corporate Headquarters 3700 South Stonebridge Drive McKinney, Texas 75070 The proceedings will be webcast live and in replay on the Investors page of the Torchmark Corporation website. The Company’s Annual Meeting will be conducted in accordance with its Shareholder Rights Policy. A copy of this policy can be obtained on the Company’s website, or by contacting the Corporate Secretary at the Torchmark Corporation headquarters address. INVESTOR RELATIONS Contact: Mike Majors Phone: (972) 569-3627 Fax: (972) 569-3282 E-Mail: tmkir@torchmarkcorp.com INDEPENDENT REGISTERED PUBLIC ACCOUNTANTS Deloitte & Touche LLP 2200 Ross Avenue Suite 1600 Dallas, Texas 75201 STOCK EXCHANGE LISTINGS New York Stock Exchange Symbol: TMK The London Stock Exchange, London, England INDENTURE TRUSTEE FOR 9 1/4%, 77/8%, 63/8%, AND 34/5% SENIOR NOTES AND 5 7/8% JUNIOR SUBORDINATED DEBENTURES The Bank of New York Mellon Trust Company, N.A. 601 Travis Street, 16th Floor Houston, TX 77002 Attention: Corporate Trust Administration Toll-Free Number: (800) 254-2826 Website: www.bnymellon.com/corporatetrust The 5 7/8% debentures trade through Depository Trust Company under global certificates listed on the New York Stock Exchange (NYSE Symbol TMKPRB). TORCHMARK CORPOR ATION WEBSITE On the home page at www.torchmarkcorp.com are links to the web pages of: y Company y Brands y Careers y Community y Investors y Contact The Investors page contains a menu with links to many topics of interest to investors and other interested third parties: y Annual Reports, 10-K and Proxy Statements y Calendar y News Releases y SEC Filings y XBRL y Financial Reports and Other Financial Information y Investor Contact Information y Calls and Meetings - Management Presentations - Conference Calls on the Web - Conference Call Replays and Transcripts - Annual Meeting of Shareholders y Stock Information - Stock Transfer Agent and Shareholder Assistance - Dividend Reinvestment - Automatic Deposit of Dividends y Corporate Governance - Shareholder Rights Policy - Code of Business Conduct and Ethics - Corporate By-laws - Code of Ethics for CEO and Senior Financial Officers - Corporate Governance Guidelines - Related Party Policy - Employee Complaint Procedure y Board of Directors - Members of the Board - Committees - Audit Committee - Compensation Committee - Governance and Nominating Committee - Executive Sessions - Director Qualification Standards - Director Independence Criteria - Director Resignation Policy · TORCHMARK CORPORATION· 1 Financial Highlights* In thousands, except percentage and per share amounts OPERATIONS: Total Premium Net Operating Income Annualized Life Premium In Force Annualized Health Premium In Force** Diluted Average Shares Outstanding Net Operating Income as a Return on Average Common Equity 2014 2013 % CHANGE $3,183,945 $3,049,690 534,468 2,044,545 947,323 132,640 530,667 1,955,401 887,444 139,564 14.9% 15.5% 4.4 0.7 4.6 6.7 (5.0) PER COMMON SHARE (ON A DILUTED BASIS): Net Operating Income Shareholders‘ Equity at Year End $4.03 27.91 $3.80 25.85 6.1 8.0 * Certain financial data differ from the comparable GAAP financial data. Reconciliations to GAAP financial data are presented on pages 14-15. ** Excludes Medicare Part D Note: All share and per share amounts presented on this page and the following letter have been retroactively adjusted for stock splits. 2· TORCHMARK CORPORATION· leTTeR TO sHAReHOldeRs* 2014 was another good year for Torchmark. Strong marketing efforts in each of our distribution channels led to double-digit net life and health sales growth, and return on equity was 14.9%, which is among the highest in our peer group. Torchmark’s success can be attributed in large part to several unique elements of our business model that differentiate us from other life insurers and have helped generate outstanding results in both good and bad economies over the years. These elements are discussed below: Market We operate in niches of the vastly underinsured middle-income market. Products We sell basic protection products that serve a significant consumer need and are not impacted by equity or credit market fluctuations. Controlled Distribution Our products are sold primarily through exclusive agencies and direct response marketing. Margins and Cash Flows Our control over administrative and acquisition costs helps generate high underwriting margins and facilitates the growth we’re seeing in our exclusive agencies. Our highly persistent block of inforce business produces very consistent, strong free cash flows year in and year out. Approximately 90% of our revenues each year come from inforce policies sold in prior years. Return of Excess Capital to Shareholders Torchmark consistently returns excess capital to its shareholders as a result of the substantial free cash flow generated each year. We have returned 77% of our net income to shareholders through share repurchases and dividends since 1986. * Certain financial data differ from the comparable GAAP financial data. Reconciliations to GAAP financial data are presented on pages 14-15. leTTeR TO sHAReHOldeRs · TORCHMARK CORPORATION· 3 Torchmark’s consistent growth in operating income per share and book value per share is demonstrated in the following charts. NET OPERATING INCOME PER SHARE* Compound Annual Growth Rate 10 Year – 7.9%, 5 Year – 9.8% $5.00 $4.00 $3.00 $2.00 $2.04* $2.22* $2.28 $4.03 $3.80 $3.45 $3.00 $2.75 $2.45 $2.53 $1.00 0 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 * Values prior to 2007 are not restated for the effect of accounting standards ASU 2010-26 due to lack of information. BOOK VALUE PER SHARE (EXCLUDING NET UNREALIZED GAINS OR LOSSES ON FIXED MATURITIES)* Compound Annual Growth Rate 10 Year – 8.6%, 5 Year – 9.3% $27.91 $25.85 $23.49 $21.31 $19.87 $17.88 $14.78* $14.77 $15.79 $13.51* $30.00 $25.00 $20.00 $15.00 $10.00 $5.00 0 2005 2006 2014 2009 * Values prior to 2007 are not retroactively adjusted for the effect of ASU 2010-26. 2008 2007 2010 2013 2012 2011 Torchmark has also long been among the leaders of its peers in return on equity. 4· TORCHMARK CORPORATION· leTTeR TO sHAReHOldeRs RETURN ON EQUITY (EXCLUDING NET UNREALIZED GAINS OR LOSSES ON FIXED MATURITIES)* 15.9%* 15.8%* 15.8%* 15.3%* 13.8%* 15.5% 15.5% 14.3%* 14.7% 14.9% 20% 15% 10% 5% 0 2005 2006 2014 2009 * Values prior to 2011 are not retroactively adjusted for the effect of ASU 2010-26. 2008 2007 2013 2012 2011 2010 Competition There has been a great deal of discussion concerning competition in the middle-income space. While we are aware of more activity by other insurers, we have not seen an adverse impact on our business. We will continue to maintain awareness and monitor competitive activity in our marketplace, but we don’t anticipate that competition will have a significant impact on our ability to grow our distribution channels and maintain our margins. As previously indicated, we operate in niches of the middle-income market in a very cost-efficient manner. In addition, we have more than fifty years of experience with many of our current products in this market. This experience, along with the tremendous amount of market data we have accumulated, provides us a significant advantage over potential competitors. We believe we are well positioned to meet any emerging competition and to grow our distribution channels in the future. In addition, the middle-income market is vastly underinsured with a real need for basic life insurance protection. We continue to see substantial opportunity in the middle-income marketplace, with or without increased competition. INsuRANCe OPeRATIONs dIsTRIBuTION CHANNels COMPONENTS OF NET OPERATING INCOME - 2014 ($ in millions, except per share data) 2007 Underwriting Income Excess Investment Income Tax and Parent Expenses Net Operating Income $610 225 (301) $534 Per share $4.60 1.70 (2.27) $4.03 income Underwriting represents premiums less policy benefits, acquisition costs, and administrative expenses. Due to our high profit margins, underwriting income generates a significant portion of our net operating income. Underwriting income was approximately 74% of pre-tax operating income in 2014. COMPONENTS OF UNDERWRITING INCOME - 2014 ($ in millions) Underwriting Margin Life Health Part D Other $ $556 199 27 5 as % of Premium 28.3% 22.9% 7.8% Administrative Expenses net of Other Income (177) 5.6% Underwriting Income $610 19.2% Torchmark operates through several distribution channels, each serving a particular niche. The following chart illustrates the relative sizes of our distribution channels. Total 787 24.7% HEALTH 2014 TOTAL UNDERWRITING MARGIN 23% 18% 36% 5% 3% 15% American Income Direct Response General Agency Liberty National Family Heritage Medicare Part D LIFE AND HEALTH NET SALES* ($ in millions) 2014 2013 % Increase LIFE American Income Direct Response Liberty National Other Distribution $172 158 34 14 $153 144 31 11 Total Life $378 $339 General Agency $84 $41 Family Heritage Direct Response Liberty National American Income 47 23 18 9 44 4 15 7 Total Health $181 $111 13 10 11 23 12 102 8 440 22 31 63 * Net sales is defined as annualized premium issued, net of cancellations in the first 30 days after issue, except for Direct Response where net sales is annualized premium issued at the time the first full premium is paid after any introductory offer period has expired. The health sales above do not include Medicare Part D. leTTeR TO sHAReHOldeRs · TORCHMARK CORPORATION· 5 AMeRICAN INCOMe lIFe American Income is the largest and most profitable of our distribution channels. As a union company with a unionized sales force, AIL enjoys a strong niche position due to its history and relationship with organized labor. Despite shrinking union membership levels over the past ten years, American Income’s producing agent count grew from 2,090 to over 6,400 from the end of 2004 to the end of 2014. While there is still significant opportunity within the union market, our emphasis on customer referrals and other affinity groups has expanded AIL’s marketing reach. Today, less than 30% of new sales come directly from union leads. AMERICAN INCOME - LIFE PREMIUM ($ in millions) 10-Year Compound Annual Growth Rate - 8.2% $766 $715 $664 sharp focus on recruiting and training, and a new senior life insurance product took hold in 2014 and should provide continued momentum in 2015. glOBe lIFe dIReCT ResPONse Direct Response is our second largest distribution channel. As shown in the following chart, life premiums have increased at a compound annual growth rate of 6.1% over the past ten years. Underwriting margins were consistently in a range of 23 to 25% during that period. DIRECT RESPONSE - LIFE PREMIUM ($ in millions) 10-Year Compound Annual Growth Rate - 6.1% $800 $700 $600 $500 $702 $664 $630 $567 $594 $537 $511 $484 $457 $608 $561 $400 $424 $508 $474 $440 $409 $380 $300 $200 $100 0 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 $800 $700 $600 $500 $400 $300 $200 $100 0 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 As can be seen in the previous chart, life premiums have grown steadily at a ten-year compound annual growth rate of 8.2%. During that same time, underwriting margins as a percentage of premiums ranged consistently from 31 to 33%. We are very optimistic regarding American Income’s long-term growth prospects. Net life sales grew 13% in 2014 as the agent count increased 21%. Changes in the agency compensation system, a 6· TORCHMARK CORPORATION· leTTeR TO sHAReHOldeRs Direct Response net life sales increased 10% in 2014, driven by an increase in electronic media activity. Electronic media primarily includes the Internet, mobile applications, social media, and inbound phone calls. The Direct Response unit began as a direct mail- only operation in the 1960s and was supplemented first by insert media in the 1990s, and then by electronic media in recent years. This evolution has been the result of a continual effort to expand our distribution footprint and find new ways to reach consumers in our marketplace. While we have historically enjoyed a competitive advantage in Direct Response due to the efficiencies of our state-of-the-art direct mail facilities, we maintain that advantage in the Internet era due to having more than 50 years of direct response marketing experience in the middle-income market and the tremendous amount of market data we have accumulated over that period. In addition, our direct mail, insert media, and electronic media operations are intertwined and support each other, providing a comprehensive marketing program that we don’t believe our competitors have. This multi-faceted approach gives consumers more ways to inquire and provides us with the ability to monetize those inquiries through multiple channels. If an initial inquiry doesn’t result in a sale, we continue to reach the consumer with additional solicitations. To further expand our consumer outreach, we continue to explore cost-beneficial branding opportunities to help provide enhanced credibility and drive additional traffic to each of our Direct Response channels. We fully expect continued innovation to sustain long-term growth in our Direct Response operations. Liberty has now opened 11 new offices in the last two years outside its traditional southeastern area. We believe continued expansion into more heavily populated areas is the key to Liberty’s growth. The strong growth in the number of middle managers in 2014 will help provide momentum and facilitate future expansion. We are very pleased with Liberty’s performance and to continued success. forward look FAMIly HeRITAge lIFe Family Heritage operates in a niche by selling supplemental health products with a unique return- of-premium feature in non-urban areas. Due to this return-of-premium feature, these products have a longer average life, higher margins and produce more investment income than other supplemental health products. Net health sales increased 8% in 2014, while the agent count increased 13%. Family Heritage’s continued transition to a culture that heavily emphasizes agent recruiting as well as sales has begun to take hold. We believe Family Heritage’s future prospects are very promising. lIBeRTy NATIONAl lIFe uNITed AMeRICAN Last year we reported on the structural changes that have been made over the past several years to convert Liberty from a fixed cost sales model to a variable cost model. This was a significant change from the way Liberty conducted business in the past, but was necessary to sustain long-term profitable growth. We began to see positive results from the transformation of Liberty in 2014. Life sales increased 11% and health sales increased 22% in 2014, due to growth in agent count and improvements in agent productivity. United American sells individual and group Medicare Supplement and Medicare Part D (Part D) products through independent agents and our Direct Response unit. As we’ve said many times, we view the Medicare Supplement and Part D businesses in an opportunistic manner. While our primary focus is on life insurance, we will take Medicare Supplement and Part D business so long as the margins are acceptable. leTTeR TO sHAReHOldeRs · TORCHMARK CORPORATION· 7 INVesTMeNT OPeRATIONs COMPONENTS OF NET OPERATING INCOME - 2014 ($ in millions, except per share data) Underwriting Income Excess Investment Income Tax and Parent Expenses Net Operating Income Per share $4.60 1.70 (2.27) $4.03 $610 225 (301) $534 Excess investment income is net investment income less the required interest on the net policy liabilities and the interest on our debt. Approximately 27% of pre-tax operating income was produced by excess investment income. EXCESS INVESTMENT INCOME - 2014 ($ in millions) Net Investment Income Required Interest on Net Policy Liabilities Interest on Debt Excess Investment Income $758 (457) (76) $225 In the last five years, declining interest rates have been a headwind. Early in 2014, we were encouraged by an increase in interest rates. However, subsequent declines in new-money income. yields have pressured Despite income this, excess increased in 2014 for the first time since 2010. We expect that excess investment income will soon begin to grow at about the same rate as our invested assets in the future. investment investment Our Medicare Supplement sales grew from $41 million in 2013 to $83 million in 2014. The increase was primarily due to the addition of an unusual number of large groups and a 39% increase in our individual Medicare Supplement sales. While our group Medicare Supplement business has grown significantly over the last several years, sales fluctuations from year to year can be significant due to the impact of large groups. Our Part D business provides only about 3% of our underwriting margin. However, this business produced some unexpected margin volatility in 2014 due primarily to the impact of new, very expensive hepatitis C drugs that were required to be covered by the Centers for Medicare and Medicaid Services in February 2014, well after our 2014 pricing was finalized. While the margins were less than we initially anticipated, Part D still generated $27 million of underwriting margin in 2014. We chose to participate in the Part D program for several reasons: • To complement and protect our existing Medicare Supplement business. We were concerned many consumers would prefer to have coverage with one carrier. For that reason, we also believed that having Part D would enhance the marketability of both our group and individual Medicare Supplement programs. • We knew that the exposure to underwriting losses was very minimal due to government- backed cost-sharing arrangements built into the design of the program. reinsurance and • This business requires relatively little capital on an ongoing basis. Moving forward, we will work to minimize Part D volatility. As such, we don’t expect Part D to become a significant part of our operations. 8· TORCHMARK CORPORATION· leTTeR TO sHAReHOldeRs INVESTMENT PORTFOLIO - DECEMBER 31, 2014 Invested Assets ($ in millions) BELOW INVESTMENT GRADE BONDS As a Percent of Fixed Maturities* $ % of Total 10.0% Fixed Maturities (at amortized cost) $12,824 96% Equities Policy Loans Other Investments Total 1 472 26 0 4 0 $13,323 100% We maintain a conservative investment approach. We invest long in fixed-rate securities (investment grade corporate bonds) because these investments best match our fixed-rate long-term liabilities. Despite the current low-rate environment, we do not intend to relax our credit standards. Because of our high underwriting margins, we don’t need to stretch for yield to generate operating income. There has been a significant amount of interest in energy sector investments due to recent declines in oil prices. We believe the risk of losses in our energy portfolio in the foreseeable future is minimal for the following reasons: • Over 96% of our energy holdings are investment grade. • Less than 10% of our energy portfolio is in the oil field services and drilling sectors. • Our energy portfolio has net unrealized gains of approximately $194 million. The energy portfolio information above is as of the end of February, 2015. We have thoroughly analyzed each of the investments in our energy portfolio and while we may see some downgrades, we believe that the companies we have invested in have the ability to withstand lower oil prices for an extended duration. 9.0% 8.0% 7.0% 6.0% 5.0% 4.0% 3.0% 2.0% 1.0% 0 8.0% 8.1% 8.1% 8.3% 7.5% 7.4% 6.4% 4.9% 4.5% 4.4% 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 * Excluding net unrealized gains and losses Our below investment grade (BIG) bonds make up 4.4% of our fixed maturity portfolio at amortized cost. This is the lowest concentration we’ve had since 1998. Because of our relatively low portfolio leverage, the ratio of BIG bonds to equity, excluding unrealized gains on fixed maturities, is only 15% - lower than most of our peers. Interest Rate Environment While low interest rates have a negative impact on our investment income, we are not concerned about an impact on our balance sheet should new money rates remain low for an extended period. The products we sell are not interest-sensitive and therefore are accounted for using interest rate assumptions that are locked in for the life of the business. Due to the high underwriting margins we generate, we don’t believe a reasonable scenario exists where we would have to increase reserves or write-off deferred acquisition costs due to an extended low interest rate environment. leTTeR TO sHAReHOldeRs · TORCHMARK CORPORATION· 9 We would like to see an increase in interest rates because of the positive effect that it would have on our investment income. We’re not concerned about the possibility of unrealized losses generated by significant rate increases, as we have the intent and more importantly, the ability, to hold our investments to maturity. FREE CASH FLOW ($ in Millions) $367* $364 $355 $377 $355 -$365 $353 $343 $340 $300 $281 $269 $400 $350 $300 $250 $200 $150 $100 $50 0 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 *Excludes $305 of free cash flow from the sale of United Investors. 2015 Estimate Free cash flow is the cash available to the parent company after fully funding all operating needs of the insurance subsidiaries, servicing debt, and paying shareholder dividends. As can be seen in the above chart, Torchmark consistently generates strong free cash flow due to our high underwriting margins and the high persistency of our inforce block. Free cash flow has grown from $1.09 per share at the end of 2004 to $2.83 per share at the end of 2014. If we include shareholder dividends, total distributable cash flow (free cash plus dividends) has grown from $1.29 per share to $3.32 per share over that same period. We carefully consider possible uses of the free cash including share repurchases, acquisitions or strategic alliances, increased dividends, debt reduction, and investment in corporate bonds. Historically, though, share repurchases have been the primary use of free cash flow. 10· TORCHMARK CORPORATION· leTTeR TO sHAReHOldeRs SHARE REPURCHASES Average Price No. of Shares (in 000’s) Total Spent (in millions) P/E Ratio† 2014 2013 2012 2011 2010 2009 2008 2007 2006 2005 $52.42 $43.48 $32.13 $27.78 $23.78 $10.12 $24.83 $29.06 $25.54 $23.62 7,155 8,280 11,219 28,347 8,560 4,613 17,185 13,837 12,544 12,706 $375 $360 $360 $788 $204 $47 $427 $402 $320 $300 13.0 11.4 9.3 9.3 8.7 4.0 10.1 12.7 11.5 11.6 † Values prior to 2007 are not restated for the effect of accounting standard ASU 2010-26 due to lack of information Since we began our share repurchase program in 1986, we have repurchased stock every year except 1995, the year after we acquired American Income. Over the last 29 years, we have spent $6.1 billion to repurchase 77% of the Company’s outstanding shares. We have returned approximately 77% of our net income to shareholders since 1986 in the form of share repurchases and dividends. As can be seen in the chart below, that percentage has been 83% over the last ten years. RETURN TO SHAREHOLDERS ($ in millions) Share Repurchases Dividends Paid (A) Total Cash Returned (B) Net Income (A)/(B) 2014 2013 2012 2011 2010 2009 2008 2007 2006 2005 $375 $360 $360 $788 $204 $47 $427 $402 $320 $300 $65 $61 $56 $49 $50 $47 $49 $50 $48 $46 $440 $421 $416 $837 $254 $94 $476 $452 $368 $346 $543 $528 $529 81% 80% 79% $497 168% $499 $383 $427 $497 $519 $495 51% 24% 111% 91% 71% 70% 83% 10-Year Total $4,104 $4,917 We remain committed to returning capital to our shareholders. In the absence of better alternatives, we will continue to achieve this through share repurchases and dividends. Conclusion We are more enthusiastic about our distribution channels than we have been in quite a few years and we believe the middle-income market we serve provides unlimited opportunity. Torchmark is competitively well positioned to deliver strong earnings growth and financial stability that should create substantial shareholder value for years to come, regardless of general economic conditions. Thank you for your investment in Torchmark. LARRY HUTCHISON Co-Chairman and Chief Executive Officer GARY COLEMAN Co-Chairman and Chief Executive Officer leTTeR TO sHAReHOldeRs· TORCHMARK CORPORATION· 11 Torchmark cautions you that this Letter to Shareholders may contain forward-looking statements within the meaning of the federal securities law. These prospective statements reflect management’s current expectations, but are not guarantees of future performance. Accordingly, please refer to Torchmark’s cautionary statement regarding forward-looking statements and the business environment in which the Company operates, contained in the Company’s Form 10-K for the period ended December 31, 2014, found on the following pages and on file with the Securities and Exchange Commission. Torchmark specifically disclaims any obligation to update or revise any forward-looking statement because of new information, future developments or otherwise. 12· TORCHMARK CORPORATION· leTTeR TO sHAReHOldeRs dIReCTORs CHARLES E. ADAIR Partner of Cordova Ventures Montgomery, Alabama MARILYN A. ALEXANDER Principal of Alexander and Friedman, LLC Laguna Beach, California DAVID L. BOREN President of the University of Oklahoma Norman, Oklahoma JANE M. BUCHAN Chief Executive Officer and Managing Director of Pacific Alternative Asset Management Company, LLC Irvine, California GARY L. COLEMAN Co-Chairman and Chief Executive Officer of Torchmark OFFICeRs GARY L. COLEMAN Co-Chairman and Chief Executive Officer LARRY M. HUTCHISON Co-Chairman and Chief Executive Officer ARVELIA M. BOWIE Vice President and Director of Human Resources JOHN T. DALY Corporate Actuary J. MATTHEW DARDEN Executive Vice President, Innovations and Business Development VERN D. HERBEL Executive Vice President and Chief Administrative Officer LARRY M. HUTCHISON Co-Chairman and Chief Executive Officer of Torchmark ROBERT W. INGRAM Retired Ross-Culverhouse Professor of Accounting in Culverhouse College of Commerce, University of Alabama Gulf Breeze, Florida LLOYD W. NEWTON Retired Executive Vice President Military Engines of Pratt & Whitney, Retired General, United States Air Force Lithia, Florida DARREN M. REBELEZ Former Executive Vice President and Chief Operating Officer of 7-Eleven, Inc. Irving, Texas LAMAR C. SMITH Retired Executive Chairman of Vista Machining Company, Retired Chief Executive Officer of First Command Financial Services, Inc. Fort Worth, Texas PAUL J. ZUCCONI Retired Partner of KPMG LLP Plano, Texas BEN W. LUTEK Executive Vice President and Chief Actuary W. MICHAEL PRESSLEY Executive Vice President and Chief Investment Officer MICHAEL C. MAJORS Vice President, Investor Relations SPENCER H. STONE Controller CAROL A. MCCOY Vice President, Associate Counsel and Corporate Secretary JAMES E. MCPARTLAND Executive Vice President and Chief Information Officer R. BRIAN MITCHELL Executive Vice President and General Counsel FRANK M. SVOBODA Executive Vice President and Chief Financial Officer GLENN D. WILLIAMS Executive Vice President and Chief Marketing Officer OFFICeRs OF suBsIdIARIes AMERICAN INCOME LIFE ROGER SMITH Chief Executive Officer and President GLOBE LIFE BILL E. LEAVELL President UNITED AMERICAN VERN D. HERBEL President and Chief Executive Officer FAMILY HERITAGE LIFE HOWARD L. LEWIS Chief Executive Officer KENNETH J. MATSON President LIBERTY NATIONAL LIFE ROGER SMITH Chief Executive Officer and President STEVEN J. DICHIARO Executive Vice President and Chief Agency Officer leTTeR TO sHAReHOldeRs · TORCHMARK CORPORATION· 13 OPeRATINg suMMARy Unaudited and in thousands except per share amounts TWELVE MONTHS ENDED DECEMBER 31, 2014 2013 % INCREASE (DECREASE) Underwriting Income Life: Premium Net policy obligations Non-deferred commissions and amortization Non-deferred acquisition expense Underwriting margin Health: Premium Net policy obligations Non-deferred commissions and amortization Non-deferred acquisition expense Underwriting margin Part D underwriting margin Annuity underwriting margin Total underwriting margin Other income Insurance administration expenses Underwriting income Excess Investment Income Net investment income Required interest on: Net policy liabilities: Policy reserves Deferred acquisition costs Debt Total excess investment income Corporate expenses Pre-tax operating income Income tax Net Operating Income before stock compensation expense Stock compensation expense, net of tax NET OPERATING INCOME Operating EPS on a diluted basis Diluted average shares outstanding Reconciliation of Net Operating Income to Net Income: Net operating income Non operating items, net of tax: Realized gains/(losses) - investments Guaranty Fund Assessment Administrative settlements Family Heritage Life acquisition expense and adjustments Legal settlement expenses Net Income EPS on a diluted basis $1,966,300 (763,192) (590,894) (55,725) 556,489 869,440 (495,416) (155,779) (18,926) 199,319 27,266 4,312 787,386 2,354 (179,955) 609,785 758,286 (649,848) 192,779 (76,126) 225,091 (8,159) 826,717 (271,317) 555,400 (20,932) $534,468 $4.03 132,640 $1,885,332 (719,621) (573,546) (47,106) 545,059 863,818 (499,124) (152,182) (16,005) 196,507 35,300 3,939 780,805 2,208 (178,898) 604,115 734,650 (625,388) 190,025 (80,461) 218,826 (8,495) 814,446 (267,112) 547,334 (16,667) $530,667 $3.80 139,564 4% 2% 1% 1% 1% 1% 3% 3% 2% 1% 6% $534,468 $530,667 15,306 0 (5,316) 0 (1,519) $542,939 $4.09 3,965 (751) 0 522 (5,931) $528,472 $3.79 The Operating Summary has been prepared in the manner Torchmark management uses to evaluate the operating results of the company. It differs from the Consolidated Statement of Operations found in the accompanying SEC Form 10-K. 14· TORCHMARK CORPORATION· OPeRATINg suMMARy CONdeNsed BAlANCe sHeeT Unaudited and in thousands except percentage and per share amounts AT DECEMBER 31, Assets: Fixed maturities at amortized cost* Cash and short-term investments Mortgages and real estate Other investments Deferred acquisition costs* Goodwill Other assets Total assets* Liabilities and shareholders’ equity: Policy liabilities Current and deferred income taxes payable* Short-term debt Long-term debt and trust preferred securities Other liabilities Shareholders’ equity, excluding ASC 320 *+ Total liabilities and shareholders’ equity Actual shares outstanding: Basic Diluted Book value (shareholders’ equity, excluding ASC 320) per diluted share Net operating income as a return on average equity, excluding ASC 320 Average equity, excluding ASC 320 Debt to capital ratio, excluding ASC 320 2014 12,823,612 81,901 203 483,832 3,488,332 441,591 1,242,362 18,561,833 12,130,353 1,218,751 238,398 992,130 359,118 3,623,083 18,561,833 127,930 129,812 27.91 14.9% 3,577,014 25.4% $ $ $ $ $ $ 2013 12,488,875 113,833 203 463,775 3,348,000 441,591 955,560 17,811,837 11,647,995 1,152,607 229,070 990,865 261,898 3,529,402 17,811,837 134,252 136,537 25.85 15.5% 3,422,983 25.7% $ $ $ $ $ $ Reconciliation of Torchmark management’s view of selected financial measures to comparable GAAP measures*: Shareholders’ equity, excluding fair value adjustments* $ 3,623,083 $ 3,529,402 Effect of fair value adjustments*: Increase fixed maturities Decrease deferred acquisition costs Current and deferred income taxes payable Shareholders’ equity* Other comparable GAAP measures: Fixed maturities Deferred acquisition costs Total assets Shareholders’ equity Current and deferred income taxes payable Book value (shareholders’ equity) per diluted share Net income as a return on average equity Average equity Debt to capital ratio 1,669,448 (16,551) (578,514) 4,697,466 14,493,060 3,471,781 20,214,730 4,697,466 1,797,265 36.19 12.5% 4,340,254 20.8% $ $ $ 390,258 (10,351) (132,967) 3,776,342 12,879,133 3,337,649 18,191,744 3,776,342 1,285,574 27.66 13.2% 4,008,378 24.4% $ $ $ *The Condensed Balance Sheet, Excluding ASC 320 has been prepared in the manner Torchmark management, industry analysts, rating agencies and financial institutions use to evaluate the financial position of the company. It differs from the Consolidated Balance Sheet found in the accompanying SEC Form 10-K. +Formerly known as FAS 115 CONdeNsed BAlANCe sHeeT · TORCHMARK CORPORATION· 15 16· TORCHMARK CORPORATION· UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K È ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2014 OR ‘ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to Commission file number: 001-08052 TORCHMARK CORPORATION (Exact name of registrant as specified in its charter) Delaware (State or other jurisdiction of incorporation or organization) 3700 South Stonebridge Drive, McKinney, TX (Address of principal executive offices) 63-0780404 (I.R.S. Employer Identification No.) 75070 (Zip Code) 972-569-4000 (Registrant’s telephone number, including area code) None (Former name, former address and former fiscal year, if changed since last report) Securities registered pursuant to Section 12(b) of the Act: Title of each class Common Stock, $1.00 par value per share Common Stock, $1.00 par value per share CUSIP 891027104 891027104 Name of each exchange on which registered New York Stock Exchange The International Stock Exchange, London, England Securities registered pursuant to Section 12(g) of the Act: None Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes È No ‘ Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes ‘ No È 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 È No ‘ Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ‘ Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes È No ‘ Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one): Large accelerated filer È ‘ Non-accelerated filer (Do not check if a smaller reporting company) ‘ Accelerated filer Smaller reporting company ‘ Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ‘ No È As of June 30, 2014, the aggregate market value of the registrant’s common stock held by non-affiliates of the registrant was $7,156,116,413 based on the closing sale price as reported on the New York Stock Exchange. Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date. Class Common Stock, $1.00 par value per share Outstanding at February 13, 2015 127,107,471 shares DOCUMENTS INCORPORATED BY REFERENCE Document Proxy Statement for the Annual Meeting of Stockholders to be held April 30, 2015 (Proxy Statement) Parts Into Which Incorporated Part III TORCHMARK CORPORATION INDEX Item 1. Business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Item 1A. Risk Factors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Item 1B. Unresolved Staff Comments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Item 2. Properties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Item 3. Legal Proceedings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Item 4. Mine Safety Disclosures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities . . . . . . . . . . . . . . . . . . . . . . . . . . Item 6. Selected Financial Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Item 7A. Quantitative and Qualitative Disclosures about Market Risk . . . . . . . . . . . . Item 8. Financial Statements and Supplementary Data . . . . . . . . . . . . . . . . . . . . . . Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Item 9A. Controls and Procedures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Item 9B. Other Information . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Item 10. Directors, Executive Officers, and Corporate Governance . . . . . . . . . . . . . Item 11. Executive Compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Item 13. Certain Relationships and Director Independence . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . and Related Transactions Item 14. Principal Accountant Fees and Services . . . . . . . . . . . . . . . . . . . . . . . . . . . . Page 1 6 12 12 13 13 14 16 17 52 53 108 108 108 111 111 111 111 111 Item 15. Exhibits and Financial Statement Schedules . . . . . . . . . . . . . . . . . . . . . . . . . 112 PART I. PART II. PART III. PART IV. PART I Item 1. Business Torchmark Corporation (Torchmark) is an insurance holding company incorporated in Delaware in 1979. Its primary subsidiaries are American Income Life Insurance Company (American Income), Liberty National Life Insurance Company (Liberty National), Globe Life And Accident Insurance Company (Globe), United American Insurance Company (United American), and Family Heritage Life Insurance Company of America (Family Heritage). Torchmark’s website is: www.torchmarkcorp.com. Torchmark makes available free of charge through its website, its annual report on Form 10-K, its quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports as soon as reasonably practicable after they have been electronically filed with or furnished to the Securities and Exchange Commission. The following table presents Torchmark’s business by primary marketing distribution method. Primary Distribution Method Company American Income Exclusive Agency Direct Response American Income Life Insurance Company Waco, Texas Globe Life And Accident Insurance Company Oklahoma City, Oklahoma Family Heritage Exclusive Agency Liberty National Exclusive Agency United American Independent Agency Family Heritage Life Insurance Company of America Cleveland, Ohio Liberty National Life Insurance Company McKinney, Texas United American Insurance Company McKinney, Texas Products and Target Markets Distribution Individual life and supplemental health insurance marketed to union and credit union members. 6,434 producing agents in the U.S., Canada, and New Zealand. Individual life and supplemental health insurance including juvenile and senior life coverage, Medicare Supplement, and Medicare Part D marketed to middle- income Americans. Direct mail, internet, television, magazine; nationwide. Supplemental limited-benefit health insurance to middle-income families. 785 captive agents in the U.S. Individual life and supplemental health insurance marketed to middle-income families. Medicare Supplement and Medicare Part D coverage to Medicare beneficiaries and, to a lesser extent, supplemental limited- benefit health coverage to people under age 65. 1,498 producing agents in the U.S. 3,161 independent producing agents in the U.S. Additional information concerning industry segments may be found in Management’s Discussion and Analysis and in Note 14—Business Segments in the Notes to the Consolidated Financial Statements. 1 Life Insurance Insurance Torchmark’s insurance subsidiaries write a variety of nonparticipating ordinary life insurance products. These include traditional and interest sensitive whole-life insurance, term life insurance, and other life insurance. The following table presents selected information about Torchmark’s life products. Annualized Premium in Force (Amounts in thousands) 2013 2014 2012 Whole life: Traditional . . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,296,403 $1,235,904 $1,213,304 63,290 Interest-sensitive . . . . . . . . . . . . . . . . . . . . . . . 551,583 Term . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 66,840 Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 54,490 619,782 73,870 58,549 591,628 69,320 $2,044,545 $1,955,401 $1,895,017 The distribution methods for life insurance products include sales by direct response, exclusive agents and independent agents. These methods are described in more depth in the Distribution Method chart earlier in this report. The following table presents life annualized premium in force by distribution method. Annualized Premium in Force (Amounts in thousands) 2013 2012 2014 Direct response . . . . . . . . . . . . . . . . . . . . . . . . . . $ 721,261 $ 688,866 $ 659,026 Exclusive agents: American Income . . . . . . . . . . . . . . . . . . . . . . Liberty National . . . . . . . . . . . . . . . . . . . . . . . . Independent agents: United American . . . . . . . . . . . . . . . . . . . . . . . Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 807,935 285,201 15,831 214,317 749,165 287,079 17,846 212,445 705,417 295,396 19,533 215,645 $2,044,545 $1,955,401 $1,895,017 Health Insurance Torchmark offers supplemental limited-benefit health insurance products that include primarily cancer and accident plans. These policies are designed to supplement health coverage that applicants already own. Medicare Supplements are also offered to enrollees in the traditional fee-for-service Medicare program. Medicare Supplement plans are standardized by federal regulation and are designed to pay deductibles and co-payments not paid by Medicare. We also offer Medicare Part D prescription drug insurance. 2 The following table presents supplemental health annualized premium in force information for the three years ended December 31, 2014 by product category. Annualized Premium in Force (Amounts in thousands) 2013 2014 2012 Amount $ 488,142 459,181 316,089 % of Total 39 36 25 Amount $ 435,788 451,656 322,763 % of Total 36 37 27 Amount $ 450,812 451,941 325,749 % of Total 37 37 26 Medicare Supplement . . . . . . . Limited-benefit plans . . . . . . . . Medicare Part D . . . . . . . . . . . . Total Health . . . . . . . . . . . $1,263,412 100 $1,210,207 100 $1,228,502 100 The following table presents supplemental health annualized premium in force for the three years ended December 31, 2014 by marketing (distribution) method. Annualized Premium in Force (Amounts in thousands) 2013 2014 2012 Direct response . . . . . . . . . . . . . . . . . . . . . . . . . . $ Exclusive agents: Liberty National . . . . . . . . . . . . . . . . . . . . . . . . American Income . . . . . . . . . . . . . . . . . . . . . . Family Heritage . . . . . . . . . . . . . . . . . . . . . . . . Independent agents: United American . . . . . . . . . . . . . . . . . . . . . . . Medicare Part D . . . . . . . . . . . . . . . . . . . . . . . . . 72,659 $ 55,270 $ 60,206 226,599 71,942 217,742 358,381 947,323 316,089 240,581 71,354 201,054 319,185 887,444 322,763 259,452 73,280 187,979 321,836 902,753 325,749 $1,263,412 $1,210,207 $1,228,502 Annuities Annuity products include single-premium and flexible-premium deferred annuities. Annuities in each of the three years ending December 31, 2014 comprised less than 1% of premium. Pricing Premium rates for life and health insurance products are established using assumptions as to future mortality, morbidity, persistency, and expenses. These assumptions are based on Company experience and projected investment earnings. Revenues for individual life and health insurance products are primarily derived from premium income, and, to a lesser extent, through policy charges to the policyholder account values on annuity products and certain individual life products. Profitability is affected to the extent actual experience deviates from the assumptions made in pricing and to the extent investment income varies from that which is required for policy reserves. Collections for annuity products and certain life products are not recognized as revenues but are added to policyholder account values. Revenues from these products are derived from charges to the account balances for insurance risk and administrative costs. Profits are earned to the extent these revenues exceed actual costs. Profits are also earned from investment income on the deposits invested in excess of the amounts credited to policyholder accounts. 3 Underwriting The underwriting standards of each Torchmark insurance subsidiary are established by management. Each subsidiary uses information from the application and, in some cases, telephone interviews with applicants, inspection reports, pharmacy data, doctors’ statements and/or medical examinations to determine whether a policy should be issued in accordance with the application, with a different rating, with a rider, with reduced coverage or rejected. Reserves The life insurance policy reserves reflected in Torchmark’s financial statements as future policy benefits are calculated based on generally accepted accounting principles (GAAP). These reserves, with premiums to be received in the future and the interest thereon compounded annually at assumed rates, must be sufficient to cover policy and contract obligations as they mature. Generally, the mortality and persistency assumptions used in the calculations of reserves are based on Company experience. Similar reserves are held on most of the health policies written by Torchmark’s insurance subsidiaries, since these policies generally are issued on a guaranteed-renewable basis. The assumptions used in the calculation of Torchmark’s reserves are reported in Note 1—Significant Accounting Policies in the Notes to Consolidated Financial Statements. Reserves for annuity products and certain life products consist of the policyholders’ account values and are increased by policyholder deposits and interest credited and are decreased by policy charges and benefit payments. Investments The nature, quality, and percentage mix of insurance company investments are regulated by state laws. The investments of Torchmark insurance subsidiaries consist predominantly of high-quality, investment-grade securities. Fixed maturities represented 97% of fair value at December 31, 2014. (See Note 4—Investments in the Notes to Consolidated Financial Statements and Management’s Discussion and Analysis.) investments at total Competition Torchmark competes with other insurance carriers through policyholder service, price, product design, and sales efforts. While there are insurance companies competing with Torchmark, no individual company dominates any of Torchmark’s life or health markets. Torchmark’s health insurance products compete with, in addition to the products of other health insurance carriers, health maintenance organizations, preferred provider organizations, and other health care-related institutions which provide medical benefits based on contractual agreements. Management believes Torchmark companies operate at lower policy acquisition and administrative expense levels than peer companies. This allows Torchmark to have competitive rates while maintaining higher underwriting margins. Regulation Insurance. Insurance companies are subject to regulation and supervision in the states in which they do business. The laws of the various states establish agencies with broad administrative and supervisory powers which include, among other things, granting and revoking licenses to transact business, regulating trade practices, licensing agents, approving policy forms, approving certain premium rates, setting minimum reserve and loss ratio requirements, determining the form and content of required financial statements, and prescribing the type and amount of investments permitted. They are also required to file detailed annual reports with supervisory agencies, and records of their business are Insurance subject Commissioners (NAIC), the supervisory agencies. insurance companies are examined periodically by one or more of to examination at any time. Under the National Association of the rules of 4 Risk Based Capital. The NAIC requires a risk based capital formula be applied to all life and health insurers. The risk based capital formula is a threshold formula rather than a target capital formula. It is designed only to identify companies that require regulatory attention and is not to be used to rate or rank companies that are adequately capitalized. All Torchmark insurance subsidiaries are more than adequately capitalized under the risk based capital formula. Guaranty Assessments. State guaranty laws provide for assessments from insurance companies to be placed into a fund which is used, in the event of failure or insolvency of an insurance company, to fulfill the obligations of that company to its policyholders. The amount which a company is assessed is based on its proportional share of the premium in each state. Assessments are recoverable to a great extent as offsets against state premium taxes. Medicare Part D. The Medicare Part D program is regulated at the federal level by the Centers for Medicare and Medicaid Services (CMS). This agency periodically examines Torchmark’s participating subsidiaries. Holding Company. States have enacted legislation requiring registration and periodic reporting by insurance companies domiciled within their respective jurisdictions that control or are controlled by other corporations so as to constitute a holding company system. Torchmark and its subsidiaries have registered as a holding company system pursuant to such legislation in Indiana, Nebraska, Ohio, and New York. Insurance holding company system statutes and regulations impose various limitations on investments in subsidiaries, and may require prior regulatory approval for material transactions between insurers and affiliates and for the payment of certain dividends and other distributions. At the end of 2014, Torchmark had 2,980 employees. Personnel 5 Item 1A. Risk Factors Risks Related to Our Business Product Marketplace and Operational Risks: The insurance industry is a regulated industry, populated by many firms. We operate in the life and health insurance sectors of the insurance industry, each with its own set of risks. The development and maintenance of our various distribution systems are critical to growth in product sales and profits. Because our life and health insurance sales are primarily made to individuals, rather than groups, and the face amounts sold are lower than that of policies sold in the higher income market, the development, maintenance, and retention of adequate numbers of producing agents and direct response systems to support growth of sales in this market are critical. Adequate compensation that is competitive with other career opportunities and that also motivates producing agents to increase sales is critical. In direct response, continuous development of new offerings and cost efficiency are key. Less than optimum execution of these strategies may result in reduced sales and profits. Economic conditions may materially adversely affect our business and results of operations. We serve primarily the middle-income market for individual protection life and health insurance and, as a result, we compete directly with alternative uses of a customer’s disposable income. If disposable income within this demographic group declines or the use of disposable income becomes more limited, as a result of a significant, sustained economic downturn or otherwise, then new sales of our insurance products could become more challenging, and our policyholders may choose to defer paying insurance premiums or stop paying insurance premiums altogether. Variations in expected to actual rates of mortality, morbidity, and persistency could materially negatively affect our results of operations and financial condition. We establish a liability for our policy reserves to pay future policyholder benefits and claims. These reserves do not represent an exact calculation of liability, but rather are actuarial estimates based on models that include many assumptions and projections which are inherently uncertain. The reserve computations involve the exercise of significant judgment with respect to levels of mortality, morbidity, and persistency as well as the timing of premium and benefit payments. Even though our actuaries continually test expected-to-actual results, actual levels that occur may differ significantly from the levels assumed when premium rates were first set. Accordingly, we cannot determine with precision the ultimate amounts of claims or benefits that we will pay or the timing of such payments. Significant variations from the levels assumed when policy reserves are first set could negatively affect our profit margins and income. A ratings downgrade or other negative action by a rating agency could materially affect our business, financial condition and results of operations. Various rating agencies review the financial performance and condition of insurers, including our insurance subsidiaries, and publish their financial strength ratings as indicators of an insurer’s ability to meet policyholder and contract holder obligations. These ratings are important to maintaining public confidence in our insurance products. A downgrade or other negative action by a rating agency with respect to the financial strength ratings of our insurance subsidiaries could negatively affect us in many ways, including the following: limiting or restricting the ability of our insurance subsidiaries to pay dividends to us and adversely affecting our ability to sell insurance products through our independent agencies. Rating agencies also publish credit ratings for us. Credit ratings are indicators of a debt issuer’s ability to meet the terms of debt obligations in a timely manner. These ratings are important to our overall ability to access certain types of liquidity. Actual or anticipated downgrades in our credit ratings, or an announcement that our ratings are under further review for a downgrade, could potentially have a negative effect on our operations, by limiting our access to capital markets, increasing the cost of debt, impairing our ability to raise capital to refinance maturing debt obligations, limiting our capacity to support growth at our insurance subsidiaries, or making it more difficult to maintain or improve the current financial strength ratings of our insurance subsidiaries. 6 Ratings reflect only the rating agency’s views and are not recommendations to buy, sell or hold our securities. Rating agencies assign ratings based upon several factors. While most of the factors relate to the rated company, some of the factors relate to the views of the rating agency, general economic conditions and circumstances outside the rated company’s control. In addition, rating agencies use various models and formulas to assess the strength of a rated company, and from time to time rating agencies have, in their discretion, altered the models. Changes to the models could impact the rating agencies’ judgment of the rating to be assigned to the rated company. There can be no assurance that current credit ratings will remain in effect for any given period of time or that such ratings will not be lowered, suspended or withdrawn entirely by the rating agencies, if in each rating agency’s judgment, circumstances so warrant. We cannot predict what actions the rating agencies may take, or what actions we may take in response to the actions of the rating agencies, which could negatively affect our business, financial condition and results of operations. Reputational Risk: Damage to the reputation of Torchmark or its subsidiaries could affect our ability to conduct business. Negative publicity published through traditional media, internet, social media, and other public forums could damage our reputation and adversely impact our agent recruiting efforts, the ability to market our products, and the persistency of our block of inforce policies. Life Insurance Marketplace Risk: Our life products are sold in selected niche markets. We are at risk should any of these markets diminish. We have two life distribution channels that focus on distinct market niches: labor union members and sales via direct response solicitation. Deterioration of our relationships with organized labor or adverse changes in the public’s receptivity to unsolicited direct response marketing could negatively affect this business. Health Insurance Marketplace Risks: The health insurance market is subject to substantial legislative scrutiny. Legislative changes could impact our Medicare Supplement, Medicare Part D, and other supplemental health businesses. The nature and timing of any such changes cannot be predicted and could have a material adverse effect on that business. Competition in the health market can be significant. Sales of our health insurance products are subject to competition from other health insurance companies and alternative healthcare providers, such as those that provide alternatives to traditional Medicare to seniors. In addition, some insurers may be willing to significantly reduce their profit margins or under price new sales in order to gain market share. We choose not to compete for market share based on these terms. Accordingly, changes in the competitive landscape, including the pricing strategies employed by our competitors, could negatively impact the future sales of our health insurance products. An inability to obtain timely and appropriate premium rate increases for the health insurance policies we sell due to regulatory delay could adversely affect our results of operations and financial condition. A significant percentage of the health insurance premiums that our insurance subsidiaries earn is from Medicare Supplement insurance. Medicare Supplement insurance and the terms under which the premiums for such policies may be increased are highly regulated at both the state and federal level. As a result, it is characterized by lower profit margins than life insurance and requires strict administrative discipline and economies of scale for success. Because Medicare Supplement policies are coordinated with the federal Medicare program, which experiences health care inflation every year, annual premium rate increases for the Medicare Supplement policies are necessary. Obtaining timely rate increases is of critical importance to our success in this market. Accordingly, the inability of our insurance subsidiaries to obtain approval of premium rate increases in a timely manner from state insurance regulatory authorities in the future could adversely impact their profitability. 7 Investment Risks: Our investments are subject to market and credit risks. Our invested assets are subject to the customary risks of defaults, downgrades, and changes in market values. Substantially all of our investment portfolio consists of fixed-maturity and short-term investments. A significant portion of our individual fixed-maturity investments is comprised of corporate bonds, exposing us to the risk that corporate issuers will not have the ability to make required interest or principal payments on the investment. Factors that may affect both market and credit risks include interest rate levels, financial market performance, disruptions in credit markets, general economic conditions, legislative changes, particular circumstances affecting the businesses or industries of each issuer, and other factors beyond our control. Additionally, because the majority of our investments are longer-term fixed maturities that we typically hold until maturity, significant increases in interest rates, widening of credit spreads, or inactive markets associated with market downturns could cause a material temporary decline in the fair value of our fixed investment portfolio, even with regard to performing assets. These declines could cause a increase in unrealized losses in our investment portfolio. Significant unrealized losses can material substantially reduce our capital position and shareholders’ equity. It is possible that our investment in certain of these securities with unrealized losses may experience a default event and that a portion or all of that unrealized loss may not be recoverable. In that case, the unrealized loss will be realized, at which point we would take an impairment charge, reducing our net income. Difficulties in the business of particular issuers or in industries in which we hold investments could cause significant downgrades, delinquencies and defaults in our investment portfolio, potentially resulting in lower net investment income and increased realized and unrealized investment losses. A default by an issuer could result in a significant other-than-temporary impairment of that investment, causing us to write the investment down and take a charge against net income. The risk of default is higher for bonds with longer-term maturities, which we acquire in order to match our long- term insurance obligations. We attempt to reduce this risk by purchasing only investment grade securities and by carefully evaluating an issuer before entering into an investment. We cannot be assured that any particular issuer, regardless of industry, will be able to make required interest and principal payments, on a timely basis or at all. Material other-than-temporary impairments could reduce our statutory surplus, leading to lower risk-based capital ratios, potential downgrades of our ratings by rating agencies and a potential reduction of future dividend capacity from our insurance subsidiaries. While we intend to hold our investments until maturity, a severe increase in defaults could cause us to suffer a significant decrease in investment income or principal repayments, resulting in substantial realized losses from the writedowns of income would be negatively impacted by the writedowns, and prospective net income would be adversely impacted by the loss of future interest income. impaired investments. Current net A decline in interest rates could negatively affect income. Declines in interest rates expose insurance companies to the risk of not earning anticipated spreads between the interest rate earned on investments and the discount rates used to calculate the net policy liabilities. While we attempt to manage our investments to preserve the excess investment income spread, we provide no assurance that a significant and persistent decline in interest rates will not materially affect such spreads. Significant decreases in interest rates could result in calls by issuers of investments, where such features are available to issuers. These calls could result in a decline in our investment income, as reinvestment of the proceeds would likely be at lower rates. Liquidity Risks: Our liquidity to fund operations is substantially dependent on funds available, primarily dividends, from our insurance subsidiaries. As a holding company with no direct operations, our principal asset is the capital stock of our insurance subsidiaries, which periodically declare and distribute dividends on their capital stock. Moreover, our liquidity, including our ability to pay our operating expenses and to make principal and interest payments on debt securities or other indebtedness owed by us, as well as our ability to pay dividends on our common stock or any preferred stock, depends significantly upon the surplus and earnings of our insurance subsidiaries and the ability of these subsidiaries to pay dividends or to advance or repay funds to us. Other sources of liquidity also include a variety of short- term and long-term instruments, long-term debt, intercompany financing, and reinsurance. facility, commercial paper, including our credit 8 The principal sources of our insurance subsidiaries’ liquidity are insurance premiums, as well as investment income, maturities, repayments, and other cash flow from our investment portfolio. Our insurance subsidiaries are subject to various state statutory and regulatory restrictions applicable to insurance companies that limit the amount of cash dividends, loans, and advances that those subsidiaries may pay to us, including laws establishing minimum solvency and liquidity thresholds. For example, in the states where our companies are domiciled, an insurance company generally may pay dividends only out of its unassigned surplus as reflected in its statutory financial statements filed in that state. Additionally, dividends paid by insurance subsidiaries are generally limited to the greater of prior year statutory net income, excluding capital gains, on an annual noncumulative basis or 10% of prior year statutory surplus without regulatory approval. Accordingly, impairments in invested assets or a disruption in our insurance subsidiaries’ operations that reduces their capital or cash flow could limit or disallow payment of dividends to us, a principal source of our cash flow. We can give no assurance that more stringent restrictions will not be adopted from time to time by states in which our insurance subsidiaries are domiciled, which could, under certain circumstances, significantly reduce dividends or other amounts paid to us by our subsidiaries. Although we do not anticipate changes, changes in these laws could constrain the ability of our subsidiaries to pay dividends or to advance or repay funds to us in sufficient amounts and at times necessary to meet our debt obligations and corporate expenses. Additionally, the inability of our insurance subsidiaries to obtain approval of premium rate increases in a timely manner from state insurance regulatory authorities could adversely impact their profitability, and thus their ability to declare and distribute dividends to us. Limitations on the flow of dividends from our subsidiaries could limit our ability to service and repay debt or to pay dividends on our capital stock. Adverse capital and credit market conditions may significantly affect our ability to meet liquidity needs or access capital, as well as affect our cost of capital. Should credit spreads widen in the future, the interest rate on any new debt obligation we may issue could increase, and our net income could be reduced. If the credit and capital markets were to experience significant disruption, uncertainty, and instability, these conditions could adversely affect our access to capital. Such market conditions may limit our ability to replace maturing liabilities (in a timely manner or at all) and/or access the capital necessary to grow our business. In the unlikely event that current resources do not satisfy our needs, we may have to seek additional financing or raise capital. The availability of additional financing or capital will depend on a variety of factors such as market conditions, the general availability of credit or capital, the volume of trading activities, the overall availability of credit to the insurance industry, and our credit ratings and credit capacity. Additionally, customers, lenders, or investors could develop a negative perception of our long- or short-term financial prospects if we incur large investment losses or if the level of our business activity decreases due to a market downturn. Our access to funds may also be impaired if regulatory authorities or rating agencies take negative actions against us. Our internal sources of liquidity may prove to be insufficient, and, in such case, we may not be able to successfully obtain additional financing on favorable terms, or at all. As such, we may be forced to delay raising capital, issue shorter term securities than we prefer, or bear an unattractive cost of capital which could decrease our profitability and significantly reduce our financial flexibility. Therefore, as a result, our results of operations, financial condition, and cash flows could be materially negatively affected by disruptions in the financial markets. Regulatory Risks: Insurance companies, including our insurance subsidiaries, are subject Our businesses are heavily regulated, and changes in regulation may reduce our profitability and growth. to extensive supervision and regulation in the states in which we do business. The primary purpose of this supervision and regulation is the protection of our policyholders, not our investors. State agencies have broad administrative power over numerous aspects of our business, including premium rates and other terms and conditions that we can include in the insurance policies offered by our insurance subsidiaries, marketing practices, advertising, licensing agents, policy forms, capital adequacy, solvency, reserves, and permitted investments. Also, regulatory authorities have relatively broad discretion to grant, renew, or initiate procedures to revoke licenses or approvals. The insurance laws, regulations and policies currently affecting Torchmark and its insurance subsidiaries may change at any time, possibly having an adverse effect on our business. Should these changes to our business occur, we may be unable to maintain all 9 required licenses and approvals, and our business may not fully comply with the wide variety of applicable laws and regulations or the relevant authority’s interpretation of the laws and regulations, which may change from time to time. If we do not have the requisite licenses and approvals or do not comply with applicable regulatory requirements, the insurance regulatory authorities could preclude or temporarily suspend us from carrying on some or all of our activities or impose substantial fines. We cannot predict the timing or substance of any future regulatory initiatives. In recent years, there has been increased scrutiny of insurance companies, including our insurance subsidiaries, by insurance regulatory authorities, which has included more extensive examinations and more detailed review of disclosure documents. These regulatory authorities may bring regulatory or other legal actions against us if, in their view, our practices, or those of our agents or employees, are improper. These actions can result in substantial fines, penalties, or prohibitions or restrictions on our business activities and could have a material adverse effect on our business, results of operations, or financial condition. Additionally, changes in the overall legal or regulatory environment may, even absent any particular regulatory authority’s interpretation of an issue changing, cause us to change our views regarding the actions that we need to take from a legal or regulatory risk management perspective, thus necessitating changes to our practices that may, in some cases, limit our ability to grow, impact regulatory capital requirements, or otherwise negatively impact the profitability of our business. the U.S. Currently, federal government does not directly regulate the business of insurance. However, the Dodd-Frank Wall Street Record and Consumer Protection Act of 2010 establishes a Federal Insurance Office (FIO) within the Department of the Treasury, and the Patient Protection and Affordable Care Act (Affordable Care Act) created the Center for Consumer Information and Insurance Oversight (CCIIO), originally established under the Department of Health and Human Services and subsequently transferred to the Centers for Medicare and Medicaid Services (CMS). The creation of these insurance regulatory offices may indicate that the federal government intends to play a larger role in the direct regulation of the insurance industry. We cannot predict what impact, if any, the FIO and CCIIO, as well as any other proposals for federal regulation of insurance could have on our business, results of operations, or financial condition. We also cannot predict what impact actions taken by CMS, as the regulator of our Medicare Part D business, could have on our business, results of operations, or financial condition. Changes in U.S. federal income tax law could increase our tax costs. Changes to the Internal Revenue Code, administrative rulings, or court decisions affecting the insurance industry, including the products it offers, could increase our effective tax rate and lower our net income, or negatively effect our ability to sell some of our products. Changes in accounting standards issued by accounting standard-setting bodies may affect our financial statements, reduce our reported profitability, and change the timing of profit recognition. Our financial statements are subject to the application of accounting principles generally accepted in the United States of America (GAAP), which principles are periodically revised and/or expanded. Accordingly, from time to time, we are required to adopt new or revised accounting standards or guidance issued by recognized authoritative bodies. It is possible that future accounting standards that we are required to adopt could change the current accounting treatment that we apply to our consolidated financial statements and that such changes could have a material adverse effect on our financial condition and results of operations. Further, standard setters have a full agenda of unissued topics under review at any given time, any of which have the potential to negatively impact our profitability. If we fail to comply with restrictions on patient privacy and information security, including taking steps to ensure that our business associates who obtain access to sensitive patient information maintain its confidentiality, our reputation and business operations could be materially adversely affected. The collection, maintenance, use, disclosure and disposal of individually identifiable data by our insurance subsidiaries are regulated at the international, federal and state levels. These laws and rules are subject to change by legislation or administrative or judicial interpretation. Various state laws address the use and disclosure of individually identifiable health data to the extent they are more restrictive than those contained in the privacy and security provisions in the federal Gramm- Leach-Bliley Act of 1999 (GLBA) and in the Health Insurance Portability and Accountability Act of 1996 (HIPAA). HIPAA also requires that we impose privacy and security requirements on our business associates (as that term is defined in the HIPAA regulations). Noncompliance with any privacy laws or 10 any security breach involving the misappropriation, loss or other unauthorized disclosure of sensitive or confidential information, whether by us or by one of our business associates, could have a material adverse effect on our business, reputation and results of operations and could include material fines and penalties, various forms of damages, consent orders regarding our privacy and security practices, adverse actions against our licenses to do business and injunctive relief. Litigation Risk: Litigation could result in substantial judgments against us or our subsidiaries. We are, and in the future may be, subject to litigation in the ordinary course of business. Some of these proceedings have been brought on behalf of various alleged classes of complainants, and, in certain of these matters, the plaintiffs are seeking large and/or indeterminate amounts, including punitive or exemplary damages. Members of our management and legal teams review litigation on a quarterly and annual basis. However, the outcome of any such litigation cannot be predicted with certainty. A number of civil jury verdicts have been returned against insurers in the jurisdictions in which Torchmark and its insurance subsidiaries do business involving the insurers’ sales practices, alleged agent misconduct, failure to properly supervise agents, and other matters. These lawsuits have resulted in the award of substantial judgments against insurers that are disproportionate to the actual damages, including material amounts of punitive damages. In some states in which we operate, juries have substantial discretion in awarding punitive damages. This for unpredictable material adverse judgments in any given punitive discretion creates the potential damages suit. Our pending and future litigation could adversely affect us because of the costs of defending these cases, the costs of settlement or judgments against us, or changes in our operations that could result from litigation. Substantial legal liability in these or future legal actions could also have a material financial effect or cause significant harm to our reputation, which, in turn, could materially harm our business and our business prospects. Catastrophic Event Risk: Our business is subject to the risk of the occurrence of catastrophic events. Our insurance policies are issued to and held by a large number of policyholders throughout the United States in relatively low-face amounts. Accordingly, it is unlikely that a large portion of our policyholder base would be affected by a single natural disaster. However, our insurance operations could be exposed to the risk of catastrophic mortality or morbidity, caused by events such as a pandemic, hurricane, earthquake, or man-made catastrophes, including acts of terrorism or war, which may produce significant claims in larger areas, especially those that are heavily populated. Claims resulting from natural or man-made catastrophic events could cause substantial volatility in our financial results for any fiscal quarter or year and could materially reduce our profitability or harm our financial condition. Information Security and Technology Risk: A network security breach, the introduction of malware in our computing environment, a disaster, or other unanticipated event could affect the computer systems of Torchmark or its subsidiaries, and could damage our business and adversely affect our financial condition and results of operations. Despite our implementation of cyber security measures to protect our hardware, software, data, and networks from attack, damage, or unauthorized access, our computing environment could be subject to physical and electronic break-ins and similar disruptions from unauthorized tampering with our systems. We retain confidential information in our computer systems. Anyone who is able to circumvent our cyber security measures and penetrate our computer systems could access, view, misappropriate, alter or delete information in the systems, including personally identifiable customer information and proprietary business information. In addition, an increasing number of states require that customers be notified of unauthorized access, use, or disclosure of their information. Any compromise of the security of our computer systems that results in an inappropriate access, use, or disclosure of personally identifiable customer information could damage our reputation in the marketplace, deter people from purchasing our products, subject us to significant civil and criminal liability, and require us to incur significant technical, legal and other expenses. 11 In the event of a disaster, such as a natural catastrophe, an industrial accident, a blackout, or a terrorist attack or war, our computer systems may be inaccessible to our employees or customers for a period of time. Even if our employees are able to report to work, they may be unable to perform their duties for an extended period of time if our data or systems are disabled or destroyed and if existing contingency plans cannot function as designed. Item 1B. Unresolved Staff Comments As of December 31, 2014, Torchmark had no unresolved staff comments. Item 2. Properties Torchmark, through its subsidiaries, owns or leases buildings that are used in the normal course of business. Torchmark owns and occupies a 300,000 square foot facility in McKinney, Texas (a north Dallas suburb). This facility is Torchmark’s corporate headquarters and also houses the operations of a subsidiary, United American, as well as the operations of other subsidiaries. In addition, United American leases 5,000 square feet of space in Omaha, Nebraska and, through a subsidiary, leases 2,500 square feet in an office area in Syracuse, New York. Liberty National, though headquartered in McKinney, Texas, operates its main activities out of a 24,000 square foot facility leased in Hoover, Alabama (a Birmingham suburb). An 8,000 square foot facility is leased for storage in Pelham, Alabama, close to the Hoover facility. Globe leases a 30,300 square foot office area in the City Place Tower building located in downtown Oklahoma City, Oklahoma. Globe also leases 11,000 square feet at a nearby facility used for storage. Globe Marketing Services, a subsidiary of Globe, owns a 133,000 square foot facility in Oklahoma City which houses the Globe direct response operation. American Income owns and is the sole occupant of an office building located in Waco, Texas. The two-floored building contains 70,000 square feet. American Income also has leased 8,100 square feet in a from the main office building. American Income Marketing Services, a building across the street subsidiary of American Income, owns a 43,000 square foot facility located in Waco, Texas, housing American Income’s direct response operation. American Income also leases office space throughout the United States to support its marketing operations. Family Heritage owns 50% of a partnership that owns an approximate 66,000 square foot building in Broadview Heights, Ohio (a suburb of Cleveland), serving as Family Heritage’s headquarters. The partnership also leases a portion of the building to unrelated tenants. 12 Item 3. Legal Proceedings Torchmark and its subsidiaries, in common with the insurance industry in general, are subject to litigation, including claims involving 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. Based upon information presently available, and in light of legal and other factual defenses available to Torchmark and its subsidiaries, management does not believe that such litigation will have a material adverse effect on Torchmark’s financial condition, future operating results or liquidity; however, assessing the eventual outcome of litigation necessarily involves forward-looking speculation as to judgments to be made by judges, juries and appellate courts in the future. This bespeaks caution, particularly in states with reputations for high punitive damage verdicts. Torchmark’s management recognizes that large punitive damage awards bearing little or no relation to actual damages continue to be awarded by juries in jurisdictions in which Torchmark and its subsidiaries have substantial business, creating the potential for unpredictable material adverse judgments in any given punitive damage suit. As previously reported, Torchmark subsidiaries are currently the subject of audits regarding the identification, reporting and escheatment of unclaimed property arising from life insurance policies and a limited number of annuity contracts. These audits are being conducted by private entities that have contracted with forty-seven states through their respective Departments of Revenue, and have not resulted in any financial assessment from any state nor indicated any liability. The audits are wide-ranging and seek large amounts of data regarding claims handling, procedures, and payments of contract benefits arising from unreported death claims. Amounts that could be payable to insurance beneficiaries and to the states for the escheatment of abandoned property represent insurance liabilities and are included in the Company’s estimate of policy benefits under the caption “Total policy liabilities” on the Consolidated Balance Sheets. No estimate of range can be made for loss contingencies related to possible administrative penalties or amounts that could be payable to the states for the escheatment of abandoned property at this time. Item 4. Mine Safety Disclosures. Not Applicable. 13 Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities PART II (a) Market Price of and Dividends on the Registrant’s Common Equity and Related Stockholder Matters The principal market in which Torchmark’s common stock is traded is the New York Stock Exchange. There were 2,996 shareholders of record on December 31, 2014, excluding shareholder accounts held in nominee form. The market prices and cash dividends paid by calendar quarter for the past two years are presented in the following table. Per share amounts have been retrospectively adjusted for the three-for- two stock split effective July 1, 2014. Quarter 1 2 3 4 Year-end closing price . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $54.17 Quarter 1 2 3 4 2014 Market Price Low High $53.51 $48.37 50.97 52.37 50.32 55.07 55.68 55.42 Dividends Per Share $.1133 .1267 .1267 .1267 2013 Market Price Low High $39.87 $35.03 38.76 43.89 47.11 43.81 48.65 52.35 Dividends Per Share $.1000 .1133 .1133 .1133 Year-end closing price . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $52.10 (c) Purchases of Certain Equity Securities by the Issuer and Others for the Fourth Quarter 2014 Period (a) Total Number of Shares Purchased (b) Average Price Paid Per Share (c) Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs (d) Maximum Number of Shares (or Approximate Dollar Amount) that May Yet Be Purchased Under the Plans or Programs October 1-31, 2014 . . . . . . . . . . . November 1-30, 2014 . . . . . . . . . December 1-31, 2014 . . . . . . . . . 811,046 607,000 608,448 $52.02 53.45 53.55 811,046 607,000 608,448 On August 6, 2014, Torchmark’s Board reaffirmed its continued authorization of the Company’s stock in consultation with the Board, repurchase program in amounts and with timing that management, determined to be in the best interest of the Company. The program has no defined expiration date or maximum shares to be purchased. 14 (e) Performance Graph COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN* Among Torchmark Corporation, the S&P 500 Index, and the S&P Life & Health Insurance Index $350 $300 $250 $200 $150 $100 $50 $0 12/09 12/10 12/11 12/12 12/13 12/14 Torchmark Corporation S&P 500 S&P Life & Health Insurance * $100 invested on 12/31/09 in stock or index, including reinvestment of dividends. Fiscal year ending December 31. Copyright© 2015 S&P, a division of The McGraw-Hill Companies Inc. All rights reserved. The line graph shown above compares Torchmark’s cumulative total return on its common stock with the cumulative total returns of the Standard and Poor’s 500 Stock Index (S&P 500) and the Standard and Poor’s Life & Health Insurance Index (S&P Life & Health Insurance). Torchmark is one of the companies whose stock is included within both the S&P 500 and the S&P Life & Health Insurance Index. 15 Item 6. Selected Financial Data The following information should be read in conjunction with Torchmark’s Consolidated Financial Statements and related notes reported elsewhere in this Form 10-K: (Amounts in thousands except per share and percentage data) Year ended December 31, 2014 2013 2012 2011 2010 Premium revenue: Life . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 1,966,300 $ 1,885,332 $ 1,808,524 $ 1,726,244 $ 1,663,699 987,421 Health . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . 638 2,651,758 Total . . . . . . . . . . . . . . . . . . . . . . . . . . . 676,364 Net investment income . . . . . . . . . . . . . . . . 37,340 Realized investment gains (losses) . . . . . . 3,367,632 Total revenue . . . . . . . . . . . . . . . . . . . . . . . 504,095 Income from continuing operations . . . . . . Income from discontinued operations . . . . 29,784 (35,013) Loss on disposal, net of tax . . . . . . . . . . . . 498,866 Net income . . . . . . . . . . . . . . . . . . . . . . . . . Per common share: Basic earnings: 929,466 608 2,656,318 693,028 25,904 3,377,401 497,616 0 (455) 497,161 1,047,379 559 2,856,462 693,644 37,833 3,589,516 529,324 0 0 529,324 1,242,720 400 3,209,420 729,207 23,548 3,964,296 542,939 0 0 542,939 1,166,410 532 3,052,274 709,743 7,990 3,771,938 528,472 0 0 528,472 Income from continuing operations(4) . Income (loss) from discontinued operations(4) . . . . . . . . . . . . . . . . . . . Net income(4) . . . . . . . . . . . . . . . . . . Diluted earnings: Income from continuing operations(4) . Income (loss) from discontinued operations(4) . . . . . . . . . . . . . . . . . . . Net income(4) . . . . . . . . . . . . . . . . . . Cash dividends declared(4) . . . . . . . . . . . Cash dividends paid(4) . . . . . . . . . . . . . . Basic average shares outstanding(4) . . . . . Diluted average shares outstanding(4) . . . . 4.15 0.00 4.15 4.09 0.00 4.09 0.51 0.49 130,722 132,640 3.84 0.00 3.84 3.79 0.00 3.79 0.45 0.44 137,647 139,564 3.65 0.00 3.65 3.60 0.00 3.60 0.40 0.38 144,921 146,848 3.06 0.00 3.06 3.02 0.00 3.02 0.31 0.30 162,417 164,723 2.75 (0.02) 2.73 2.73 (0.03) 2.70 0.27 0.27 183,014 184,685 As of December 31, 2014 2013 2012 2011 2010 Cash and invested assets(1) . . . . . . . . . . . . $15,058,996 $13,456,944 $14,155,919 $ 12,437,699 $11,563,656 Total assets(1) 15,622,973 . . . . . . . . . . . . . . . . . . . . . . . 198,875 Short-term debt . . . . . . . . . . . . . . . . . . . . . . Long-term debt(2) . . . . . . . . . . . . . . . . . . . . . 913,354 3,667,329 Shareholders’ equity . . . . . . . . . . . . . . . . . . 20.24 . . . . . . . . . . . . . . . . . 16,588,272 224,842 914,282 3,859,631 25.27 20,214,730 238,398 992,130 4,697,466 36.19 18,191,744 229,070 990,865 3,776,342 27.66 18,776,910 319,043 989,686 4,361,786 30.56 Per diluted share(4) Effect of fixed maturity revaluation on diluted equity per share(3,4) . . . . . . . . . 8.28 1.81 7.07 3.96 0.37 Annualized premium in force: Life(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . Health(1) . . . . . . . . . . . . . . . . . . . . . . . . . . Total . . . . . . . . . . . . . . . . . . . . . . . . . . . Basic shares outstanding(4) . . . . . . . . . . . . Diluted shares outstanding(4) . . . . . . . . . . . 2,044,545 1,263,412 3,307,957 127,930 129,812 1,955,401 1,210,207 3,165,608 134,252 136,537 1,895,017 1,228,502 3,123,519 141,353 142,707 1,813,705 1,016,393 2,830,098 150,869 152,712 1,753,046 973,625 2,726,671 178,297 181,222 (1) At December 31, 2012, cash and invested assets included $615 million, total assets included $869 million, annualized life premium in force included $949 thousand, and annualized health premium in force included $188 million, representing the business acquired in the acquisition of Family Heritage in 2012. Includes Torchmark’s 7.1% Junior Subordinated Debentures reported as “Due to affiliates” on the Consolidated Balance Sheets at year ends 2010 through 2011 in the amount of $123.7 million. (2) (3) There is an accounting rule (ASC 320-10-35-1) requiring available-for-sale fixed maturities to be revalued at fair value each period. The effect of this rule on diluted equity per share reflects the amount added or (deducted) under this rule to produce GAAP Shareholders’ equity per share. Please see the explanation and discussion under the caption Capital Resources in Management’s Discussion and Analysis in this report concerning the effect this rule has on Torchmark’s equity. (4) Outstanding shares and per share amounts have been retrospectively adjusted for the three-for-two-stock split effective July 1, 2014. 16 Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations The following discussion should be read in conjunction with the Selected Financial Data and Torchmark’s Consolidated Financial Statements and Notes thereto appearing elsewhere in this report. RESULTS OF OPERATIONS to middle income households throughout How Torchmark Views Its Operations: Torchmark is the holding company for a group of insurance companies which market primarily individual life and supplemental health insurance, and to a limited extent annuities, the United States. We view our operations by segments, which are the insurance product lines of life, health, Medicare Part D, and annuities, and the investment segment that supports the product lines. Segments are aligned based on their common characteristics, comparability of the profit margins, and management techniques used to operate each segment. As described in Note 14—Business Segments in the Notes to Consolidated Financial Statements, we reorganized our segment structure to separate our Medicare Part D health insurance business from our other health insurance activities as a stand-alone segment, because management determined that Part D meets the criteria of a distinct segment under accounting guidance. Prior period results have been retrospectively adjusted for comparability. Insurance Product Line Segments. As fully explained in Note 14, the insurance product line segments involve the marketing, underwriting, and the administration of policies. Each product line is further segmented by the various distribution units that market the insurance policies. Each distribution unit operates in a niche market offering insurance products designed for that particular market. Whether analyzing profitability of a segment as a whole, or the individual distribution units within the segment, the measure of profitability used by management is the underwriting margin, which is: Premium revenue Less: Policy obligations Policy acquisition costs and commissions Investment Segment. The investment segment involves the management of our capital resources, including investments and the management of corporate debt and liquidity. Our measure of profitability for the investment segment is excess investment income, which is: Net investment income Less: Required interest on net policy liabilities Financing costs line items for each of The tables in Note 14 reconcile Torchmark’s revenues and expenses by segment to its major income statement the years in the three-year period ending December 31, 2014. Additionally, this Note provides a summary of the profitability measures that demonstrates year-to-year comparability and which reconciles to net income. That summary is reproduced below from the Consolidated Financial Statements to present our overall operations in the manner that we use to manage the business. Acquisition: On November 1, 2012, we acquired Family Heritage, a previously privately-held supplemental health insurance carrier. this acquisition can be found in Note 6— Acquisition in the Notes to Consolidated Financial Statements. The results of Family Heritage subsequent to our acquisition are included in this discussion within our health insurance segment. Information about 17 Analysis of Profitability by Segment (Dollar amounts in thousands) 2014 2013 2012 Change % Change % 2014 2013 Life insurance underwriting margin . . . . . . . . . . . . . . . . . . . . . . . . . . $ 556,489 $ 545,059 $ 509,476 $11,430 2,812 Health insurance underwriting margin* . . . . . . . . . . . . . . . . . . . . . . (8,034) Medicare Part D underwriting margin* . . . . . . . . . . . . . . . . . . . . . . . 373 Annuity underwriting margin . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Excess investment income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6,265 Other insurance: 196,507 35,300 3,939 218,826 163,984 33,357 3,465 236,644 199,319 27,266 4,312 225,091 2 $ 35,583 1 (23) 9 3 7 32,523 20 6 474 14 (8) (17,818) 1,943 Other income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Administrative expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Corporate and adjustments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,354 (179,955) (40,362) 2,208 (178,898) (34,137) 1,898 (165,405) (29,827) 7 146 (1,057) 1 (6,225) 18 (13,493) 310 16 8 (4,310) 14 Pre-tax total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Applicable taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 794,514 (260,046) 788,804 (258,137) 753,592 (246,945) 5,710 (1,909) Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Realized gains (losses)—investments (after tax)** . . . . . . . . . . . . . Acquisition expense—Family Heritage (after tax) . . . . . . . . . . . . . . Family Heritage acquisition finalization adjustments (after tax) . . . Legal settlement expenses (after tax) . . . . . . . . . . . . . . . . . . . . . . . Guaranty Fund assessment (after tax) . . . . . . . . . . . . . . . . . . . . . . . Administrative settlements (after tax) . . . . . . . . . . . . . . . . . . . . . . . . 534,468 15,306 0 0 (1,519) 0 (5,316) 530,667 3,965 0 522 (5,931) (751) 0 506,647 24,591 (1,914) 0 0 0 0 3,801 11,341 0 (522) 4,412 751 (5,316) 1 1 1 5 5 5 35,212 (11,192) 24,020 (20,626) 1,914 522 (5,931) (751) 0 Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 542,939 $ 528,472 $ 529,324 $14,467 3 $ (852) 0 * Retrospectively adjusted to give effect to the reorganization of segments described in Note 14 in the Notes to Consolidated Financial Statements. ** See the discussion of Realized Gains and Losses in this report. Torchmark’s operations on a segment-by-segment basis are discussed in depth under the appropriate captions following in this report. Summary of Operations: Net income was $543 million in 2014, compared with $528 million in 2013. Net income declined slightly in 2013 from $529 million in 2012. On a diluted per share basis, 2014 net income rose 8% to $4.09 after a 5% increase in 2013. Net income per diluted share in 2013 rose to $3.79 from $3.60 in 2012. The per-share results have exceeded the growth in dollar amounts due to our share repurchase program. Also, each year’s per share net income was affected by realized investment gains, which were $0.12, $0.03, and $0.17 in 2014, 2013 and 2012, respectively. More information concerning realized investment gains and losses can be found under the caption Realized Gains and Losses in this report where there is a more complete discussion. Also, as explained in Note 14—Business Segments in the Notes to the Consolidated Financial Statements, we do not consider realized gains and losses to be a component of our core insurance operations or operating segments. Additionally, we do not consider non-operating items which are not related to the current ongoing reporting performance of our segments as indicated in the chart above to be part of our segment operating income. As shown in the above chart, after-tax segment results of operations rose each year over the prior year from $507 million in 2012 to $531 million in 2013 to $534 million in 2014. The primary contributor to the growth in both 2014 and 2013 was the underwriting margin in our life insurance segment, in which margins rose $11 million in 2014 and $36 million in 2013. The life insurance segment is our strongest segment and is the largest contributor to earnings in each year presented. Also contributing to growth in income in both years was our health insurance segment, which provided $3 million of additional margin in 2014 and $33 million in 2013. The 2013 larger increase in health margin was primarily due to the inclusion of Family Heritage’s health business for a full year since its acquisition in late 2012. Family Heritage accounted for $32 million of the increase in 2013 margin. Margins for the Medicare Part D segment declined 23% in 2014 to $27 million, primarily due to two costly Hepatitis C drugs which were not required to be covered until well after our 2014 pricing was finalized, as discussed more fully later in this report. Excess investment income, the measure of profitability of our investment segment, increased to $225 million or 3% over the prior year amount of $219 million. This was the first time in four years the dollar 18 amount of excess investment income exceeded the prior year’s amount. In 2013, excess investment income declined 8%. Although interest rates rebounded slightly during the first half of 2014, the low interest rate environment continued to pressure investment yields and spreads related to required interest on net policy liabilities throughout income has also been hampered by a lag in government reimbursement of Medicare Part D costs. The effects of the low- interest-rate environment and the impact of the Part D business on investment income is discussed more fully later in this report under the caption Investments. the three-year period. Excess investment The inclusion of Family Heritage’s administrative expenses for a full year for the first time added $8 million of additional administrative expense in 2013. In addition, in both 2014 and 2013, there were increases in stock compensation expense which negatively affected the results during the year. Stock compensation increased $7 million in 2014 and $4 million in 2013. These increases in stock compensation expense resulted primarily from the increase in the value of Torchmark’s stock rather than an increase in the number of grants. Total revenues rose 5% in 2014 to $3.96 billion, after having risen 5% in 2013 to $3.77 billion. Life premium rose 4% or $81 million in 2014 to $1.97 billion. Life premium increased $77 million in 2013 to $1.89 billion. Net investment income rose $16 million in 2013, and rose 3% or $19 million in 2014. Health premium increased 7% to $1.24 billion in 2014 and contributed $76 million to 2014 revenue growth, after having gained 11% to $1.17 billion in 2013. Health premium contributed $119 million to 2013 revenue growth. Life insurance premium and underwriting margins have grown steadily in each of the three years ending December 31. The increase in life premium was driven by sales growth and improvements in persistency. While premium and underwriting margins grew, margin as a percent of premium fell slightly in 2014 to 28%, after increasing from 28% to 29% from 2012 to 2013. These fluctuations were due primarily to changes in mortality. Net life sales increased 12% in 2014 to $378 million after decreasing 1% in 2013. The life insurance segment is discussed further in this report under the caption Life Insurance. With regard to health insurance, we primarily market Medicare Supplement insurance, other limited- benefit products including cancer, and accident and health products. As noted earlier, 2013 and 2014 health premiums were positively affected by the inclusion of Family Heritage’s health premium for the full years. The inclusion of Family Heritage also caused our limited-benefit health premium, which is their primary focus, to exceed our Medicare Supplement premium in 2013 for the first time in several years. Prior to 2013, Medicare Supplement was our largest contributor to total health premium. Limited-benefit health continued to exceed Medicare Supplement in 2014. Limited-benefit health premium was $446 million in 2014, compared with $447 million in 2013. Limited-benefit premium increased 50% over 2012 limited-benefit health premium of $298 million, a result of the inclusion of Family Heritage’s business. Medicare Supplement premium was $423 million in 2014, increasing over the prior year’s premium for the first time in many years, as lapses exceeded new sales in prior year periods. Medicare Supplement premium was $417 million in 2013 and $432 million in 2012. The increase in 2014 premium resulted from sales in 2014 to certain large groups. Health margins have remained somewhat stable as a percentage of premium throughout the three-year period. See the discussion under Health Insurance for a more detailed discussion of health insurance results. We also market Medicare Part D prescription drug insurance. Our Medicare Part D premium rose 16% in 2014 to $348 million, compared with $300 million in 2013 and $318 million in 2012. The higher premiums in both 2014 and 2012 were due to higher levels of low-income auto-enrollees in our plans for those years. Due to increased competition in the 2013 plan year, we experienced a decrease in 2013 Part D premium. Medicare Part D margins were negatively impacted in 2014, however, by several factors, including two high cost Hepatitis C drugs, the coverage of which was mandated by the Center for Medicare and Medicaid Services (CMS) in early 2014, well after our 2014 pricing was finalized, new taxes under the Affordable Care Act, and other higher drug costs due to rebate restructuring. As a percentage of premium, margins fell from 12% in 2013 to 8% in 2014. For the 2015 plan year, we will have a significantly lower number of auto-enrollees which should reduce our exposure to Hepatitis C drug claims, because approximately 85% of these claims in 2014 were related to auto-enrollees. For more information on our Medicare Part D business, please refer to our discussion under the caption Medicare Part D. 19 We do not currently market annuities. See the caption Annuities for discussion of the Annuity segment. investment The investment segment’s pretax profitability, or excess investment income, is based on three major components: net income, required interest on net policy liabilities (interest applicable to insurance products), and financing costs. In 2014, net investment income rose 3%, compared with 2% in 2013. As we view our segments, net investment income rose 3% in both periods. At the same time, our investment portfolio grew 3% and 9% in 2014 and 2013, respectively. In recent years, net investment income has not grown as fast as the portfolio. One reason that investment income has grown at a lower rate than mean invested assets has grown in recent years is that new investments have been made at yield rates lower than the yield rates earned on securities that matured or were otherwise disposed of. Also, there is sometimes a lag between the time when proceeds from maturities and dispositions are received and when the proceeds are reinvested, during which the funds are held in cash. Growth in total investment income is also somewhat negatively affected by Torchmark’s share repurchase program (described later under this caption), which has diverted cash that could have otherwise been used to acquire investments. In 2014, net investment income was negatively impacted by events affecting our Medicare Part D business. Under the program, we are required to cover certain claim costs in the current period that are the federal government’s responsibility, but are not reimbursed until late in the next calendar year. This delay in reimbursement substantially reduced our funds available for investment in 2014, with the result of reduced investment income in 2014 and 2015. The interest required on net policy liabilities is deducted from net investment income, and generally grows in conjunction with the net policy liabilities that are supported by the invested assets. The lower new- money yields resulting from the low-interest-rate environment noted above have compressed excess investment income as required interest has continued to grow at approximately the same rate that net policy liabilities have grown. We have implemented certain strategies to offset this effect, including increasing premium rates on sales of new products as discussed under the caption Investments. Financing costs, which consist of the interest required for debt service on our long and short-term debt, are also deducted from net investment income. Financing costs in 2013 were stable at $80 million, but declined 5% in 2014. The 2014 decline resulted from the maturity and repayment in 2013 of our $94.5 million principal amount 7 3⁄ 8% Notes. Torchmark’s current investment policy regarding fixed maturities limits new fixed maturity acquisitions to investment-grade securities generally with longer maturities (often exceeding twenty years) that meet our quality and yield objectives. Approximately 97% of our invested assets at fair value consist of fixed maturities of which 96% were investment grade at December 31, 2014. The average quality rating of the portfolio was A-. The portfolio contains no securities backed by sub prime or Alt-A mortgages, no direct investment in residential mortgages, no counterparty risks, no credit default swaps, or other derivative contracts. See the analysis of excess investment income and investment activities under the caption Investments in this report and Note 4—Investments in the Notes to Consolidated Statements of Operations for a more detailed discussion of this segment. In 2012 and 2013, we engaged in a debt restructuring program which resulted in a reduction in financing costs. We issued two new debt offerings during 2012: our $300 million principal amount 3.8% Senior Notes due 2022 and our $125 million principal amount 5.875% Junior Subordinated Debentures due 2052, both issued in September. Proceeds from the Senior Notes were $297 million, but $150 million were purchased by our insurance subsidiaries and were eliminated in consolidation. Proceeds from this offering provided funding for the retirement of our 7 3⁄ 8% Senior Notes, which matured and were repaid in August, 2013, and for the acquisition of Family Heritage in November, 2012. The $121 million net proceeds from the Subordinated Debentures were used to fund the call of our $120 million principal amount 7.1% Trust Originated Preferred Securities in October, 2012. More information on these transactions can be found in Note 6—Acquisition and Note 11—Debt in the Notes to Consolidated Financial Statements and in our discussion of Capital Resources in this report. In each of the years 2012 through 2014, net income was affected by certain significant, unusual, and nonrecurring nonoperating items. We do not view these items as components of core operating results because they are not indicative of past performance or future prospects of the insurance operations. As reported in Note 1—Significant Accounting Policies in the Notes to Consolidated Financial Statements 20 under the caption Settlements, we were involved in certain issues in which we incurred settlement losses and expenses. In connection with the 2012 purchase of Family Heritage, as described in Note 6— Acquisition, we incurred $2.9 million of acquisition-related expenses ($1.9 million after tax). During 2013, Torchmark incurred a state guaranty fund assessment in the amount of $1.2 million ($751 thousand after tax), resulting from events in years prior to 2012. Also in 2013, we resolved a legal matter related to a non-insurance issue in the amount of $500 thousand ($325 thousand after tax), and settled additional litigation related to prior years in the amount of $8.6 million ($5.6 million after tax). During 2014, Torchmark accrued for certain litigation matters in the net amount of $3.7 million ($2.4 million after tax) that were not directly related to its insurance operations. Additionally, Torchmark received $1.3 million ($853 thousand after tax) in settlement of litigation regarding investments. Also in 2014, the Company recorded $8.2 million in administrative settlements ($5.3 million after tax) related to benefits paid for deaths occurring in prior years where claims were not filed. All of these items have been expensed in the Consolidated Statements of Operations. However, as described in Note 1, we remove items such as these that relate to prior periods or are non-operating items when evaluating the results of current operations, and therefore exclude such matters from our segment analysis for current periods. Torchmark has in place an ongoing share repurchase program which began in 1986. With no specified authorization amount, we determine the amount of repurchases based on the amount of the Company’s excess cash flow, general market conditions, and other alternative uses. The majority of these purchases are made from excess operating cash flow. Additionally, when stock options are exercised, proceeds from these exercises and the tax benefit are used to repurchase additional shares on the open market to minimize dilution as a result of the option exercises. The Board of Directors has authorized the Company’s share repurchase program in amounts and with timing that management, in consultation with the Board, determines to be in the best interest of the Company and its shareholders. The following chart summarizes share purchase activity for each of the three years ended December 31, 2014. Analysis of Share Purchases (Amounts in thousands) Purchases 2014 2013* 2012* Shares Amount Shares Amount Shares Amount Excess cash flow and borrowings . . . . . . . . . . . . . . . . . Option proceeds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7,155 1,394 $375,042 74,266 8,280 $360,001 11,219 $360,490 209,675 2,789 122,263 6,438 Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8,549 $449,308 11,069 $482,264 17,657 $570,165 * Share purchases for the years 2013 and 2012 have been retrospectively adjusted for the three-for-two stock split effective July 1, 2014. Option proceeds were unusually high in 2012 due to option holders exercising several years of option grants that expired in 2012. Throughout the remainder of this discussion, share purchases refer only to those made from excess cash flow and borrowings. A discussion of each of Torchmark’s segments follows. The following discussions are presented in the manner we view our operations, as described in Note 14—Business Segments. 21 Life Insurance. Life insurance is our insurance segment, with 2014 life premium largest representing 62% of total premium. Life underwriting income before other income and administrative expense represented 71% of the total in 2014. Additionally, investments supporting the reserves for life products produce the majority of excess investment income attributable to the investment segment. Life insurance premium rose 4% to $1.97 billion in 2014 after having increased 4% in 2013 to $1.89 billion. Life insurance products are marketed through several distribution channels. Premium income by channel for each of the last three years is as follows: LIFE INSURANCE Premium by Distribution Method (Dollar amounts in thousands) American Income Exclusive Agency . . . . . . . Direct Response . . . . . . . . . . . . . . . . . . . . . . . Liberty National Exclusive Agency . . . . . . . . . Other Agencies . . . . . . . . . . . . . . . . . . . . . . . . 2014 2013 2012 Amount $ 766,458 702,023 272,265 225,554 % of Total Amount % of Total Amount 39% $ 715,366 663,544 36 275,980 14 230,442 11 38% $ 663,696 630,111 35 281,723 15 232,994 12 % of Total 37% 35 15 13 $1,966,300 100% $1,885,332 100% $1,808,524 100% We use three statistical measures as indicators of premium growth and sales over the near term: “annualized premium in force,” “net sales,” and “first-year collected premium.” Annualized premium in force is defined as the premium income that would be received over the following twelve months at any given date on all active policies if those policies remain in force throughout the twelve-month period. Annualized premium in force is an indicator of potential growth in premium revenue. Net sales is annualized premium issued, net of cancellations in the first thirty days after issue, except in the case of Direct Response where net sales is annualized premium issued at the time the first full premium is paid after any introductory offer period has expired. We believe that net sales is a superior indicator of the rate of premium growth relative to annualized premium issued. First-year collected premium is defined as the premium collected during the reporting period for all policies in their first policy year. First-year collected premium takes lapses into account in the first year when lapses are more likely to occur, and thus is a useful indicator of how much new premium is expected to be added to premium income in the future. Annualized life premium in force was $2.04 billion at December 31, 2014, an increase of 5% over $1.96 billion a year earlier. Annualized life premium in force was $1.90 billion at December 31, 2012. The following table shows net sales information for each of the last three years by distribution method. LIFE INSURANCE Net Sales by Distribution Method (Dollar amounts in thousands) American Income Exclusive Agency . . . . . . . . . . . . . Direct Response . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Liberty National Exclusive Agency . . . . . . . . . . . . . . . Other Agencies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2014 2013 2012 Amount $172,271 158,089 34,402 13,492 % of Total Amount % of Total Amount % of Total 45% $152,646 144,363 42 31,050 9 11,000 4 45% $158,609 140,928 43 32,296 9 11,331 3 46% 41 10 3 $378,254 100% $339,059 100% $343,164 100% 22 The table below discloses first-year collected life premium by distribution channel. LIFE INSURANCE First-Year Collected Premium by Distribution Method (Dollar amounts in thousands) American Income Exclusive Agency . . . . . . . . . . . . . Direct Response . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Liberty National Exclusive Agency . . . . . . . . . . . . . . . Other Agencies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2014 2013 2012 Amount $134,202 100,287 25,777 10,473 % of Total Amount % of Total Amount % of Total 50% $127,978 93,089 37 25,580 9 9,962 4 50% $126,223 93,374 36 26,533 10 9,660 4 49% 37 10 4 $270,739 100% $256,609 100% $255,790 100% The American Income Exclusive Agency has historically focused primarily on marketing to members of labor unions. While the labor union market is still the backbone of American Income’s business, the agency has diversified in recent years by focusing heavily on other affinity groups and referrals to help to ensure sustainable growth. It is Torchmark’s highest margin business. The American Income Agency was also the largest contributor to life premium and net sales of any Torchmark distribution method in 2014. Life premium for this agency rose 7% to $766 million, after having risen 8% in 2013. Net sales rose 13% in 2014 to $172 million, after having declined 4% in 2013. Net sales rose 12% in 2012. The average face amount of policies issued in 2014 was approximately $30 thousand. As is the case with all of Torchmark’s agency distribution systems, continued increases in product sales are largely dependent on increases in agent count. The American Income agent count was 6,434 at December 31, 2014 compared with 5,302 a year earlier, an increase of 21%. The agent count increased 2% in 2013 and 18% in 2012. The average agent count for 2014 was 5,868. The average agent count is based on the actual count at the end of each week during the year. Management’s primary objective is to grow middle management in the agency to help ensure sustainable growth. This is being achieved through an increased emphasis on agent training programs and financial incentives that appropriately reward agents at all levels for helping develop and train personnel. We have also begun providing more home-office and webinar training programs. These programs are designed to provide each agent, from new recruits to top level managers, coaching and instruction specifically designed for each individual’s level of experience and responsibilities. We believe that these initiatives will continue to promote enthusiasm in the field and will drive increases in agent retention and sales activity. The Direct Response Unit offers adult and juvenile life insurance through a variety of direct-to- consumer marketing approaches, which include direct mailings, insert media, and electronic media. These different approaches support and complement one another in the unit’s efforts to reach the consumer. The Direct Response Unit’s growth has been fueled by constant innovation. In recent years, electronic media production has grown rapidly as management has aggressively increased marketing activities related to internet and mobile technology, and has focused on driving traffic to the inbound call center. While the juvenile market is an important source of sales, it also is a vehicle to reach the parents and grandparents of the juvenile policyholders, who are more likely to respond favorably to a Direct Response solicitation for life coverage on themselves than is the general adult population. Also, both the juvenile policyholders and their parents are low acquisition-cost targets for sales of additional coverage over time. The Direct Response operation accounted for 36% of our life insurance premium during 2014, increasing 6% over 2013 premium. Life premium for this unit rose 5% in 2013 and 6% in 2012. Net sales rose 10% to $158 million in 2014 after a 2% increase in 2013, due to growth in electronic media activity. First-year collected premium increased 8% to $100 million in 2014 and was flat in 2013 compared to 2012. The average face amount of policies issued in 2014 was approximately $17 thousand. 23 The Liberty National Exclusive Agency markets individual and group life insurance to middle- income customers. Life premium income for this agency was $272 million in 2014, a 1% decrease compared with $276 million in 2013. Life premium declined 2% in 2013 from 2012. First year collected premium increased 1% in 2014, however, after having declined 4% in 2013. The average face amount of life policies issued in 2014 was approximately $23 thousand. The Liberty National Agency’s net sales rose 11% to $34 million in 2014, after having declined 4% a year earlier. The increase in net sales during 2014 marks the first increase in several years, reflecting changes in structure of the agency that management has put in place in recent years. As is the case with all of our agencies, sales are driven by the size of the agent force. The Liberty agency had 1,498 producing agents at December 31, 2014 compared with 1,430 a year earlier, an increase of 5%. The producing agent count increased 1% during 2013 from 1,419. The average agent count for 2014 was 1,505. Agent counts declined during the fourth quarter of 2014 as the agency focused somewhat less on recruiting, due to the increased emphasis on annual worksite renewals. Our long term plans to grow this agency involve expansion from small-town markets in the southeast to more densely populated areas with larger pools of potential agent recruits and customers. We believe that expansion of this Agency’s presence into more heavily populated, less-penetrated areas will help create long term agency growth. Additionally, a prospecting training program has helped to improve the ability of agents to develop new worksite marketing business. We also offer life insurance through Other Agencies consisting of the Military Agency, the United American Independent Agency, and other small sales agencies. The Military Agency consists of a nationwide independent agency whose sales force is comprised primarily of former military officers who sell primarily to commissioned and noncommissioned military officers and their families. This business consists of whole-life products with term insurance riders. Military premium represented 9% of life premium at December 31, 2014. The United American Independent Agency represented approximately 1% of Torchmark’s total life premium at that date, as their sales of Torchmark products consist primarily of health insurance. LIFE INSURANCE Summary of Results (Dollar amounts in thousands) 2014 2013 2012 Amount % of Premium Amount % of Premium Amount % of Premium Premium and policy charges . . . . . . . . . . . $1,966,300 100% $1,885,332 100% $1,808,524 100% Policy obligations . . . . . . . . . . . . . . . . . . . . . Required interest on reserves . . . . . . . . . . . 1,293,384 (530,192) 66 (27) 1,227,857 (508,236) 65 (27) 1,172,020 (483,892) 65 (27) Net policy obligations . . . . . . . . . . . . . . . . 763,192 Commissions, premium taxes, and non- deferred acquisition expenses . . . . . . . . Amortization of acquisition costs . . . . . . . . 143,174 503,445 Total expense . . . . . . . . . . . . . . . . . . . . . . 1,409,811 39 7 26 72 719,621 131,721 488,931 1,340,273 38 7 26 71 688,128 137,115 473,805 1,299,048 38 8 26 72 Insurance underwriting margin before other income and administrative expenses . . . . . . . . . . . . . . . . . . . . . . . . . $ 556,489 28% $ 545,059 29% $ 509,476 28% Gross margins, as indicated by insurance underwriting margin before other income and administrative expense, rose 2% in 2014 and 7% in 2013. The margin increased to $556 million in 2014 after rising to $545 million in 2013. The steady growth in premium contributed to margin growth in all periods. As a percentage of premium, however, an increase in policy obligations resulted in a slightly lower margin in 2014. Policy obligations fluctuate from period to period as a result of mortality. In both 2013 and 2014, percentage margins were positively affected by our conservation program and the permitted increases in the deferrals of our internet-related direct response acquisition costs. 24 Health Insurance. Health insurance sold by Torchmark includes primarily Medicare Supplement coverage to enrollees in the federal Medicare program, cancer coverage, accident coverage, and other limited-benefit supplemental health products. As discussed in Note 14—Business Segments in the Notes to Consolidated Financial Statements, Medicare Part D is now reported as a separate Torchmark segment and is no longer included in the discussion of Torchmark’s other health products. See the discussion of Medicare Part D later in this report. In this discussion of health business, all health coverage plans other than Medicare Supplement are classified here as limited-benefit plans. Health premium represented 27% of Torchmark’s total premium income in 2014, compared with 28% in 2013 and 26% in 2012. Health underwriting margin accounted for 25% of the total in 2014, compared with 25% in 2013 and 23% in 2012. Health results in 2014 and 2013 were positively affected by the late 2012 addition of Family Heritage. Family Heritage added $205 million and $191 million of health premium in 2014 and 2013, respectively, compared with $30 million in 2012. The following table indicates health insurance premium income by distribution channel for each of the last three years. HEALTH INSURANCE Premium by Distribution Method (Dollar amounts in thousands) 2014 2013 2012 Amount % of Total Amount % of Total Amount % of Total United American Independent Agency Limited-benefit plans . . . . . . . . . . . . . . . . . . . . . Medicare Supplement . . . . . . . . . . . . . . . . . . . . $ 19,028 286,340 $ 24,173 274,125 $ 26,377 272,382 305,368 35% 298,298 35% 298,759 41% Liberty National Exclusive Agency Limited-benefit plans . . . . . . . . . . . . . . . . . . . . . Medicare Supplement . . . . . . . . . . . . . . . . . . . . American Income Exclusive Agency Limited-benefit plans . . . . . . . . . . . . . . . . . . . . . Medicare Supplement . . . . . . . . . . . . . . . . . . . . Family Heritage Exclusive Agency Limited-benefit plans . . . . . . . . . . . . . . . . . . . . . Medicare Supplement . . . . . . . . . . . . . . . . . . . . Direct Response Limited-benefit plans . . . . . . . . . . . . . . . . . . . . . Medicare Supplement . . . . . . . . . . . . . . . . . . . . 143,722 78,295 222,017 78,244 478 78,722 204,667 0 204,667 805 57,861 58,666 Total Premium Limited-benefit plans . . . . . . . . . . . . . . . . . . . . . Medicare Supplement . . . . . . . . . . . . . . . . . . . . 446,466 422,974 152,415 88,849 241,264 78,862 573 79,435 190,923 0 190,923 313 53,585 53,898 446,686 417,132 25 9 24 7 51 49 162,607 100,928 263,535 78,957 683 79,640 30,119 0 30,119 341 57,625 57,966 298,401 431,618 28 9 22 6 52 48 36 11 4 8 41 59 Total Premium . . . . . . . . . . . . . . . . . . . . . . $869,440 100% $863,818 100% $730,019 100% 25 We market supplemental health insurance products through a number of distribution channels. The following table presents net sales by distribution method for the last three years. HEALTH INSURANCE Net Sales by Distribution Method (Dollar amounts in thousands) 2014 2013 2012 Amount % of Total Amount % of Total Amount % of Total United American Independent Agency Limited-benefit plans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Medicare Supplement $ 873 82,971 $ 916 40,512 $ 989 41,218 83,844 46% 41,428 38% 42,207 54% Liberty National Exclusive Agency Limited-benefit plans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Medicare Supplement American Income Exclusive Agency Limited-benefit plans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Medicare Supplement Family Heritage Exclusive Agency Limited-benefit plans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Medicare Supplement Direct Response Limited-benefit plans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Medicare Supplement 17,084 299 17,383 9,162 0 9,162 47,102 0 47,102 6 23,099 23,105 Total Net Sales Limited-benefit plans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Medicare Supplement 74,227 106,369 13,906 394 14,300 6,985 0 6,985 43,520 0 43,520 591 3,685 4,276 65,918 44,591 13 6 39 4 60 40 14,274 818 15,092 8,695 0 8,695 7,441 0 7,441 727 3,876 4,603 32,126 45,912 19 11 10 6 41 59 10 5 26 13 41 59 Total Net Sales . . . . . . . . . . . . . . . . . . . . . . $180,596 100% $110,509 100% $78,038 100% 26 The following table discloses first-year collected health premium by distribution method. HEALTH INSURANCE First-Year Collected Premium by Distribution Method (Dollar amounts in thousands) 2014 2013 2012 Amount % of Total Amount % of Total Amount % of Total United American Independent Agency Limited-benefit plans . . . . . . . . . . . . . . . . . . . . . . . . Medicare Supplement . . . . . . . . . . . . . . . . . . . . . . . $ 710 49,519 $ 795 38,399 $ 838 33,176 50,229 42% 39,194 39% 34,014 50% Liberty National Exclusive Agency Limited-benefit plans . . . . . . . . . . . . . . . . . . . . . . . . Medicare Supplement . . . . . . . . . . . . . . . . . . . . . . . American Income Exclusive Agency Limited-benefit plans . . . . . . . . . . . . . . . . . . . . . . . . Medicare Supplement . . . . . . . . . . . . . . . . . . . . . . . Family Heritage Exclusive Agency Limited-benefit plans . . . . . . . . . . . . . . . . . . . . . . . . Medicare Supplement . . . . . . . . . . . . . . . . . . . . . . . Direct Response Limited-benefit plans . . . . . . . . . . . . . . . . . . . . . . . . Medicare Supplement . . . . . . . . . . . . . . . . . . . . . . . 13,132 306 13,438 9,500 0 9,500 36,392 0 36,392 143 9,196 9,339 Total First-Year Collected Premium Limited-benefit plans . . . . . . . . . . . . . . . . . . . . . . . . Medicare Supplement . . . . . . . . . . . . . . . . . . . . . . . 59,877 59,021 12,010 558 13,105 1,127 11 12,568 12 14,232 21 8 8,957 0 8,957 36,340 0 31 36,340 36 544 3,310 3,854 58,646 42,267 4 58 42 8 50 50 10,364 0 9 10,364 15 5,710 0 5,710 623 3,714 4,337 30,640 38,017 8 6 45 55 Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $118,898 100% $100,913 100% $68,657 100% Health premium, rose 1% to $869 million in 2014, after having increased 18% in 2013 to $864 million. However, if the premium of Family Heritage were removed for comparability in 2013 and 2012, health premium would have declined 4% in 2013. The decline in 2013 premium resulted primarily from a run-off of a block of discontinued hospital-surgical plans. This runoff had been ongoing for a number of years. In 2014, this runoff is thought to have substantially run its course. Net sales increased 63% in 2014 to $181 million, after having increased 42% in 2013. The 2014 increase was caused by the more than double growth in Medicare Supplement sales. These sales occurred in both the United American Independent Agency and in the Direct Response Group. These increases were primarily the result of strong group sales of Medicare Supplement which can vary significantly from period to period. The 2013 increase was primarily a result of the acquisition of Family Heritage, which contributed $44 million to the growth in 2013 compared with $7 million in 2012. First-year collected premium increased 18% in 2014 and 47% in 2013, as a result of the increased sales in both 2014 and 2013, and the addition of Family Heritage first-year premium for a full year in 2013 for the first time. The addition of Family Heritage’s sales and premium from limited-benefit products has resulted in limited-benefit health premium exceeding Medicare Supplement premium income in 2013 for the first time in several years and continuing to lead in premium in 2014. However, due to increased Medicare Supplement group sales, Medicare Supplement net sales exceeded limited-benefit net sales in 2014. Limited-benefit premium represented 51% of total health premium in 2014 and 52% in 2013, but represented 41% in 2012. However, as noted above, Medicare Supplement sales rose 139% to $106 27 million in 2014 due to the high group sales, which represented 59% of net health sales in 2014. Medicare Supplement sales were 40% of the total in 2013 and 59% in 2012. As mentioned previously, group Medicare Supplement sales fluctuate significantly from period to period. We do not expect recent health care reform activity to have a significant impact on our operations. We don’t sell any products subject to the Affordable Care Act, and don’t believe that consumer demand for the types of supplemental health products we sell will be diminished. While we will be subject to certain federal taxes on a small portion of our existing health business going forward, we don’t expect the amount of these taxes to be material. The UA Independent Agency is Torchmark’s largest in terms of health premium income, producing 35% of health premium in 2014. This Agency is composed of independent agencies appointed with Torchmark whose sizes range from very large, multi-state organizations down to one-person offices. All of these agents generally sell for a number of insurance companies. Torchmark had 3,161 active producing agents at December 31, 2014 compared with 2,414 a year earlier. This Agency is our largest producer of Medicare Supplement insurance, with $286 million or 68% of our Medicare Supplement premium income in 2014. Net sales for this Agency were $84 million in 2014, consisting almost entirely of Medicare Supplement business. These net sales were more than double the net sales of $41 million in 2013. In they had declined 2%. Total health premium income for the UA Independent Agency was 2013, $305 million in 2014, an increase of 2% from $298 million in 2013. Premium income had declined very slightly in 2013. The Family Heritage Exclusive Agency was acquired by Torchmark’s acquisition of Family Heritage on November 1, 2012 as discussed in Note 6—Acquisition in the Notes to Consolidated Financial Statements. This agency markets primarily limited-benefit supplemental health insurance in non-urban areas. Most of their policies include a cash-back feature, such as a return-of-premium, whereby any excess of premiums over claims paid is returned to the policyholder at the end of a specified period stated within the insurance policy. The Family Heritage Agency is our largest agency in terms of limited-benefit health net sales, adding $47 million in net sales in 2014, compared with $44 million in 2013, an increase of 8%. This agency’s $205 million in health premium income during 2014 represented 24% of Torchmark’s total. Premium in 2014 increased 7% over 2013 premium of $191 million. The producing agent count was 785 agents at December 31, 2014, compared with 695 agents at December 31, 2013. The average agent count for 2014 was 740. The agent count was 702 at December 31, 2012. Management expects to grow this agency going forward through geographic expansion and incorporation of Torchmark’s recruiting programs. The Liberty National Exclusive Agency represented 25% of all Torchmark health premium income at $222 million in 2014. The Liberty Agency markets limited-benefit health supplemental products consisting primarily of cancer insurance. Much of the Liberty’s health business is now generated through worksite marketing which targets small businesses of 10 to 25 employees. In 2014, health premium income in the Agency declined 8% from prior year premium of $241 million, after also declining 8% in 2013. These premium declines were due primarily to the runoff of a block of discontinued hospital-surgical business as well as an earlier restructuring of this Agency to a variable-cost, commission-driven model. The Liberty Agency experienced growth in net health sales in 2014 of 22% to $17 million. The agent count at Liberty was 1,498 at 2014 year end, an increase of 5% over year end 2013 and 6% over year end 2012. The American Income Exclusive Agency, predominantly a life insurance distribution channel, was our fourth largest health insurance distributor based on premium income in 2014. Its health plans are comprised of various limited-benefit plans. Approximately 68% of the agency’s 2014 health premium was from accident policies. Sales of the plans by this Agency are generally made in conjunction with a life policy being sold to the same customer. Health premium at this agency was $79 million in both 2014 and 2013. In 2013, it had declined slightly from $80 million. However, health net sales rose 31% in 2014 to $9 million, after falling 20% in 2013 to $7 million. Because this agency focuses on life products, health net sales comprised only 5% of the American Income Agency’s total net sales in 2014. 28 Direct Response, primarily a life operation, also offers health insurance, which is predominantly Medicare Supplements sold directly to employer or union sponsored groups. In 2014, net health sales were $23 million, compared with $4 million in 2013 and $5 million in 2012. The large increase in Direct Response net sales in 2014 was due to the addition of a large Medicare Supplement group, which is not indicative of a trend. In 2014, health net sales for this group represented approximately 13% of Direct Response’s total life and health net sales. Direct Response health premium income was $59 million in 2014, increasing 9% over 2013 premium of $54 million. Health premium declined 7% in 2013. As presented in the following table, Torchmark’s health insurance underwriting margin before other income and administrative expense increased 1% to $199 million in 2014, after an increase of 20% to $197 million in 2013. Family Heritage contributed $32 million of the $33 million 2013 increase. As a percentage of premium income, margins were 23% in both 2014 and 2013 as compared with 22% in 2012. HEALTH INSURANCE Summary of Results (Dollar amounts in thousands) 2014 % of 2013 % of Amount Premium Amount Premium Amount 2012 % of Premium Premium . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $869,440 100% $863,818 100% $730,019 100% Policy obligations . . . . . . . . . . . . . . . . . . . . . . . . . Required interest on reserves . . . . . . . . . . . . . . . 559,817 (64,401) Net policy obligations . . . . . . . . . . . . . . . . . . . . Commissions, premium taxes, and non-deferred acquisition expenses . . . . . . . . . . . . . . . . . . . . . Amortization of acquisition costs . . . . . . . . . . . . . 495,416 79,475 95,230 Total expense . . . . . . . . . . . . . . . . . . . . . . . . . . 670,121 64 (7) 57 9 11 77 558,982 (59,858) 499,124 75,895 92,292 667,311 65 (7) 58 9 10 77 472,988 (40,963) 432,025 52,625 81,385 566,035 65 (6) 59 8 11 78 Insurance underwriting income before other income and administrative expense . . . . . . . . . $199,319 23% $196,507 23% $163,984 22% 29 Medicare Part D. Torchmark, through its subsidiary United American, offers coverage under the government’s Medicare Part D plan. The Medicare Part D plan is a stand-alone prescription drug plan for Medicare beneficiaries. Part D is regulated and partially funded by CMS for participating private insurers like United American. Under Part D, private carriers are the primary insurers, while CMS provides significant premium subsidies and reinsurance. Our Medicare Part D product is sold through the Direct Response operation and to groups through the UA Independent Agency. Medicare Part D Selected Financial Information (Dollar amounts in thousands) 2014 2013 2012 Amount Amount Amount Premium(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $347,805 $300,008 $317,764 Net sales(2) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 114,489 First-year collected premium(3) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 153,509 186,170 94,982 78,698 66,209 (1) Total Medicare Part D premium excludes $25.5 million and $2.6 million of risk-sharing premium received in 2014 and 2013, respectively, and $404 thousand in 2012 of risk-sharing premium paid to the Centers for Medicare and Medicaid Services consistent with the Medicare Part D contract. This risk-sharing amount is a portion of the excess or deficiency of actual over expected claims, and therefore we view this payment as a component of policyholder benefits in our segment analysis. (2) Net sales for Medicare Part D represents only new first-time enrollees. (3) First-year collected premium for Medicare Part D represents only premium collected within the first twelve months from new first-time enrollees. Total Medicare Part D premium was $348 million in 2014, compared with $300 million in 2013 and $318 million in 2012. Part D net sales were $186 million in 2014, compared with $79 million in 2013 and $114 million in 2012. The unusual increase in 2014 net sales was due to the addition in 2014 of the auto- enrollees as noted below. We count only sales to new first-time enrollees in net sales, and the majority of premium income is from previous enrollees. Total enrollees in the program were 269 thousand at the beginning of the 2014 plan year, 254 thousand at the beginning of the 2013 plan year, and 215 thousand at the beginning of the 2012 plan year. Changes in Part D premium generally result from changes in the number of enrollees, which are heavily influenced by new sales. In 2012, the Company issued a new lower cost Part D plan allowing us to pick up a large number of auto-enrollees in 21 regions with resulting higher sales. In 2013, due to intensified price competition, we qualified for new low-income auto-enrollees in only 7 regions but were able to keep prior year auto-enrollees in 14 regions and maintain our presence in 21 regions. In 2014, Torchmark qualified to receive new Part D auto-enrollees in 15 regions and also qualified to retain prior year auto-enrollees in 8 regions, for a total of 23 regions. These variations in the number of new auto- enrollees caused the changes in Part D net sales, premium, and enrollee counts, including the large increases in 2014 and the declines in 2013. The 2013 decline was also influenced by the loss of several employer group Part D cases at the end of 2012. As presented in the following table, margins decreased 23% in 2014 to $27 million, even though premium rose 16%. Premiums were increased for the year 2014 to cover higher anticipated non-deferred acquisition expenses. As such, we expected significantly lower obligation ratios in 2014. However, due primarily to unexpected costs related to two Hepatitis C drugs, the coverage of which was mandated by CMS Administration early in 2014, well after our 2014 pricing was finalized, the obligation ratios for 2014 increased from 82% to 83%. Non-deferred acquisition cost ratios were significantly higher, as planned in our pricing, due to (1) new taxes imposed by the Affordable Care Act, (2) higher costs related to a change in the structure of drug rebates, and (3) higher costs related to the increased volume of enrollees. As a percentage of premium, underwriting margin for 2014 fell to 8%, compared with 12% for 2013. In 2013, margins increased 6% to $35 million, even though premium declined 6%. As a percentage of premium, margins rose from 10% to 12%. The benefit ratio declined 2%, as a result of lower claims experience in the group market in 2013. Group Part D claims tend to fluctuate from year to year. 30 Medicare Part D Summary of Results (Dollar amounts in thousands) 2014 % of 2013 % of Amount Premium Amount Premium Amount 2012 % of Premium Premium(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $347,805 100% $300,008 100% $317,764 100% Policy obligations . . . . . . . . . . . . . . . . . . . . . . . . . 290,341 Commissions, premium taxes, and non-deferred acquisition expenses . . . . . . . . . . . . . . . . . . . . . Amortization of acquisition costs . . . . . . . . . . . . . 26,613 3,585 Total expense . . . . . . . . . . . . . . . . . . . . . . . . . . 320,539 83 8 1 92 247,496 14,027 3,185 264,708 82 5 1 88 266,957 14,498 2,952 284,407 84 5 1 90 Insurance underwriting income before other income and administrative expense . . . . . . . . . $ 27,266 8% $ 35,300 12% $ 33,357 10% (1) Total Medicare Part D premium excludes $25.5 million and $2.6 million of risk-sharing premium received in 2014 and 2013 respectively, and $404 thousand in 2012 of risk sharing premium paid to the Centers for Medicare and Medicaid Services consistent with the Medicare Part D contract. This risk-sharing amount is a portion of the excess or deficiency of actual over expected claims, and therefore we view this payment as a component of policyholder benefits in our segment analysis. For 2015, we do not expect Hepatitis C claims to have the same negative impact on margins that they had in 2014, as our 2015 pricing reflects the cost of In addition, we will have significantly less auto-enrollees in 2015. Auto-enrollees accounted for approximately 85% of our 2014 Hepatitis C claims. these drugs. Total enrollees in the program were 249 thousand at the beginning of the 2015 plan year, compared with 269 thousand in 2014. We expect that Part D margins will be flat to slightly lower in 2015, based on a preliminary analysis of the risk scores and claims history of our 2015 enrollees. We participate in the Medicare Part D program because it complements our Medicare Supplement products, it provides us with incremental income, we have extensive experience with the senior-age market, and the government assurances with regard to the risk-sharing agreements for participating insurers limit our risk. Additionally, due to our experience with service to the senior-age market and the use of our existing Direct Response marketing system, entry to this business required little new investment. However, as with any government-sponsored program, the possibility of regulatory changes could change the outlook for this market. Annuities. Our fixed annuity balances at the end of 2014, 2013, and 2012 were $1.36 billion, $1.38 billion, and $1.35 billion, respectively. Underwriting income was $4.3 million, $3.9 million, and $3.5 million in each of the respective years. While the fixed annuity account balance has remained relatively stable each year over the prior year, underwriting income has increased each year over the prior year. Policy charges have actually declined slightly in each successive year. The majority of policy charges consist of surrender charges which are not based on account size. A considerable portion of fixed annuity profitability is derived from the spread of investment income exceeding contractual interest requirements, which can result in negative net policy obligations. In the three-year period, however, spreads tended to level as crediting rates reached guaranteed minimums. We do not currently market annuity products, favoring instead protection-oriented life and health insurance products. Therefore, we do not expect that annuities will be a significant portion of our business or marketing strategy going forward. 31 Administrative expenses. Operating expenses are included in the Other and Corporate Segments and are classified into two categories: insurance administrative expenses and expenses of the parent company. The following table is an analysis of operating expenses for the three years ended December 31, 2014. Operating Expenses Selected Information (Dollar amounts in thousands) 2014 % of 2013 % of Amount Premium Amount Premium Amount 2012 % of Premium Insurance administrative expenses: Salaries . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 83,625 28,095 Non-salary employee costs . . . . . . . . . . . 57,717 Other administrative expense . . . . . . . . . 10,518 Legal expense—insurance . . . . . . . . . . . 2.6% $ 82,739 33,589 0.9 52,757 1.8 9,813 0.3 2.7% $ 77,137 28,344 1.1 51,228 1.8 8,696 0.3 2.7% 1.0 1.8 0.3 Total insurance administrative expenses . . . . . . . . . . . . . . . . . . . . . . . . 179,955 5.6% 178,898 5.9% 165,405 5.8% Parent company expense . . . . . . . . . . . . . . . . Stock compensation expense . . . . . . . . . . . . . Litigation settlements . . . . . . . . . . . . . . . . . . . . State Guaranty Fund Assessment . . . . . . . . . Acquisition expenses of Family Heritage . . . . 8,159 32,203 2,337 0 0 Total operating expenses, per Consolidated Statements of Operations . . . . . . . . . . . . . . . . . . . . . . $222,654 8,495 25,642 500 1,155 0 8,222 21,605 0 0 2,944 $214,690 $198,176 Insurance administrative expenses: Increase (decrease) over prior year . . . . 0.6% Total operating expenses: Increase (decrease) over prior year . . . . 3.7% 8.2% 8.3% 4.0% (1.7)% Insurance administrative expenses rose 1% in 2014, after having increased 8% in 2013. As a percentage of premium, they increased .1% in 2013 to 5.9%, but declined .3% in 2014 to 5.6%. The inclusion of Family Heritage’s administrative expenses accounted for $8.1 million of the $13.5 million increase in total administrative expense in 2013. Non-salary employee costs increased 19% in 2013 but fell back 16% in 2014, close to 2012 levels. These fluctuations were caused in large part by adjustments to pension expenses primarily due to changes in interest rates in the financial markets. Stock compensation expense has risen in each successive year as the value of Torchmark stock has increased, resulting in higher values for grants of stock and options, as well as positive Company performance that caused an increase in the expense related to performance share grants. As stated in Note 14—Business Segments in the Notes to Consolidated Financial Statements, management views stock compensation expense as a corporate expense, and therefore treats it as a Parent Company expense. As described in Note 1—Significant Accounting Policies in the Notes to Consolidated Financial Statements, we described certain litigation matters that were incurred in the years 2014 and 2013 that were not directly related to our ongoing core insurance operations. Management does not consider these litigation matters to be part of insurance administration expense, but instead considers them to be non- operating expenses. Also during 2013, Torchmark recorded an additional non-operating charge involving a state guaranty fund assessment in the amount of $1.2 million, resulting from events in years prior to 2012. We incurred expenses of $2.9 million related to the acquisition of Family Heritage in late 2012 as described in Note 6—Acquisition in the Notes to Consolidated Financial Statements. While all of these non-operating expenses were included in “Operating expenses” in the Consolidated Statements of Operations in accordance with accounting guidance, they are removed by management from consideration when evaluating segment operating results. the respective year for 32 Investments. We manage our capital resources including investments, debt, and cash flow through the investment segment. Excess investment income represents the profit margin attributable to investment operations. It is the measure that we use to evaluate the performance of the investment segment as described in Note 14—Business Segments in the Notes to the Consolidated Financial Statements. It is defined as net investment income less both the required interest attributable to net policy liabilities and the interest cost associated with capital funding or “financing costs.” We also view excess investment income per diluted share as an important and useful measure to evaluate the performance of the investment segment. It is defined as excess investment income divided by the total diluted weighted average shares outstanding, representing the contribution by the investment segment to the consolidated earnings per share of the Company. Since implementing our share repurchase program in 1986, we have used over $6.1 billion of cash flow to repurchase Torchmark shares after determining that the repurchases provided a greater return than other investment alternatives. Share repurchases reduce excess investment income because of the foregone earnings on the cash that would otherwise have been invested in interest-bearing assets, but they also reduce the number of shares outstanding. In order to put all capital resource uses on a comparable basis, we believe that excess investment income per diluted share is an appropriate measure of the investment segment. Excess Investment Income. The following table summarizes Torchmark’s investment income and excess investment income. Analysis of Excess Investment Income (Dollar amounts in thousands except for per share data) 2014 2013 2012 Net investment income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ Reclassification of low income housing expense(1) . . . . . . . . . . . . . . . . . . . Reclassification of interest amount due to deconsolidation(2) . . . . . . . . . . 729,207 $ 709,743 $ 29,079 0 24,907 0 Adjusted net investment income (per segment analysis) . . . . . . . . . . 758,286 734,650 693,644 22,488 (214) 715,918 Interest on net insurance policy liabilities: Interest on reserves . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Interest on deferred acquisition costs . . . . . . . . . . . . . . . . . . . . . . . . . (649,848) 192,779 (625,388) 190,025 (584,148) 185,172 Net required interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (457,069) (435,363) (398,976) Financing costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (76,126) (80,461) (80,298) Excess investment income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 225,091 $ 218,826 $ 236,644 Excess investment income per diluted share(3) . . . . . . . . . . . . . . . . . . . . . . $ 1.70 $ 1.57 $ 1.61 Mean invested assets (at amortized cost) . . . . . . . . . . . . . . . . . . . . . . . . . . $13,278,028 $12,838,010 $11,750,059 Average net insurance policy liabilities(4) . . . . . . . . . . . . . . . . . . . . . . . . . . . 7,093,560 1,248,427 Average debt and preferred securities (at amortized cost) . . . . . . . . . . . . 7,840,078 1,321,102 8,227,741 1,287,740 (1) Reclassified amortization of non-guaranteed low-income housing interests included in “Net income” in the Consolidated Statements of Operations but recorded in “Income taxes” in the segment analysis. See Note 1—Significant Accounting Policies in the Notes to Consolidated Financial Statements under the caption Low-Income Housing Tax Credit Interests for an explanation. investment (2) Deconsolidation of trusts liable for Trust Preferred Securities required by accounting guidance. See Note 11—Debt in the Notes to Consolidated Financial Statements. (3) Per share amounts for 2013 and 2012 have been retrospectively adjusted for the three-for-two stock split effective July 1, 2014. (4) Net of deferred acquisition costs, excluding the associated unrealized gains and losses thereon. 33 Excess investment income increased $6 million or 3% in 2014 over the prior year. Excess investment income declined $18 million or 8% in 2013. Excess investment income has been pressured over the past three years as a result of the impact of lower interest rates on net investment income coupled with the increase in required interest on net policy liabilities discussed later under this caption. On a per diluted share basis, excess investment income increased 8% to $1.70 in 2014. Excess investment income declined 2% to $1.57 per share in 2013, after having risen 3% in the prior year. The greater increase in 2014 per-share amounts, as well as the smaller decline in 2013 relative to the changes in dollar amounts for excess investment income are a result of share repurchases. The largest component of excess investment income is net investment income, as adjusted for the segment analysis, which rose 3% to $758 million in 2014. It increased 3% to $735 million in 2013 from $716 million in 2012. The inclusion of Family Heritage, acquired in late 2012, added $21 million of net investment income in 2013 compared with $3 million in 2012, accounting for the majority of the 2013 increase. However, growth in net investment income has generally been slower than growth in mean invested assets in recent years due to the declining interest rate environment. In 2014, fixed maturity yields averaged 5.91% on a tax-equivalent and effective-yield basis, compared with 5.94% in 2013 and 6.35% in 2012. Even though mean invested assets have increased each period, net investment income has grown at a slower pace as a result of the decline in average yields. In a declining rate environment, the overall portfolio yield will decrease as new money is invested at lower prevailing yields. The reduction in the average yields has primarily been the result of reinvesting proceeds from bonds that matured or were called at yield rates less than the rates we earned on the bonds before they matured or were called. While Family Heritage added incrementally to net investment income during 2014 and 2013, its lower-yielding portfolio has also contributed to the decline in the average fixed-maturity yield. A major factor negatively affecting net investment income, especially in 2012 and 2013, was calls of fixed-maturity securities. During 2012, and to a lesser extent in 2013, we had an unusually large number of these calls, including $339 million of bank-issued hybrid securities in 2012 and $129 million in 2013. Fixed maturity securities are more likely to be called in a declining interest-rate environment, as these callable securities can often be refinanced at lower prevailing rates. In 2014, however, call activity has been more limited. We believe that it is unlikely that calls would have a material negative impact on investment income in the foreseeable future if our callable investments were called and the proceeds from those calls were reinvested at expected future new money rates. During 2014, the proceeds from all dispositions have been reinvested at yield rates closer to the yield rates on the disposed assets. Net investment income has also been negatively affected in 2014 by the CMS requirement for us to pay certain Medicare Part D claims costs during the current period that are ultimately the responsibility of the government, but are not reimbursed until the following year. Because Part D claims have been unusually high in 2014, due to the approval of new Hepatitis C drugs discussed earlier in this report and higher overall drug costs, we have incurred extensive upfront costs that will not be reimbursed by CMS until late 2015. This delay in reimbursement has caused a delay in cash flows available for new investments that resulted in a loss of approximately $5 million of pre-tax net investment income in 2014, and will cause us to lose approximately $4 million of additional investment income in 2015. Please refer to Note 10¯Supplemental Disclosures of Cash Flow Information in the Notes to Consolidated Financial Statements. Presented in the following chart is the growth in net investment income compared with the growth in mean invested assets. Growth in net investment income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Growth in mean invested assets (at amortized cost) . . . . . . . . . . . . . . . . . . . . . 3.2% 2.6% 1.3% 9.3 3.4 4.4 2014 2013 2012 While net investment income in recent years has been negatively impacted by the factors discussed above, we would expect to see only modest declines in the average portfolio yield rate over the next few years compared with the larger declines in recent years. We anticipate that less than 2% of fixed maturities 34 on average are expected to run off each year over the next five years. Overall, we are encouraged that the prospect of additional significant calls seems to be behind us and expected maturities should have lower yields than in the past. Excess investment income is reduced by the required interest on net insurance policy liabilities because we consider these amounts to be components of the profitability of our insurance segments. Required interest is based on the actuarial interest assumptions used in discounting the benefit reserve liability and the amortization of deferred acquisition costs for our insurance policies in force. The great majority of our life and health insurance policies are fixed interest-rate protection policies, not investment products, and are accounted for under current accounting guidance for long-duration insurance products (formerly SFAS 60, now incorporated into ASC 944-20-05). This guidance mandates that interest rate assumptions be “locked in” for the life of that block of business. Each calendar year, we set the assumed discount rate to be used to calculate the benefit reserve liability and the deferred acquisition cost asset for all insurance policies issued that year. That rate is based on the new money yields that we expect to earn on the premiums received in the future from policies of that issue year, and cannot be changed except in the event of a premium deficiency. The discount rate used for policies issued in the current year has no impact on the in force policies issued in prior years as the rates of all prior issue years are also locked in. As such, the overall discount rate for the entire in force block is a weighted average of the discount rates being used from all issue years. Changes in the overall weighted-average discount rate over time are caused by changes in the mix of the in force business by issue year. Because actuarial discount rates are locked in for life on essentially all of our business, benefit reserves and deferred acquisition costs are not affected by interest rate fluctuations unless a loss recognition event occurs. Due to the strength of our underwriting margins and the current positive spread between the yield on our investment portfolio and the weighted-average discount rate of our in force block, we don’t expect an extended low-interest-rate environment to cause a loss recognition event. Information about interest on policy liabilities is shown in the following table. Required Interest on Net Insurance Policy Liabilities (Dollar amounts in millions) Required Interest Average Net Insurance Policy Liabilities Average Discount Rate 2014 Life and Health . . . . . . . . . . . . . . . . . . . . . . . . . . Annuity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $395.9 61.2 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total Increase in 2014 . . . . . . . . . . . . . . . . . . . . . . . . . 457.1 4.99% 2013 Life and Health . . . . . . . . . . . . . . . . . . . . . . . . . . Annuity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $372.4 63.0 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total Increase in 2013 . . . . . . . . . . . . . . . . . . . . . . . . . 435.4 9.12% 2012 Life and Health . . . . . . . . . . . . . . . . . . . . . . . . . . Annuity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $335.0 64.0 Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Increase in 2012 . . . . . . . . . . . . . . . . . . . . . . . . . 399.0 7.71% $6,888.9 1,338.8 8,227.7 4.94% $6,516.9 1,323.2 7,840.1 10.52% $5,820.1 1,273.5 7,093.6 6.64% 5.75% 4.57 5.56 5.71% 4.76 5.55 5.76% 5.03 5.62 The combined weighted average discount rate decreased in 2013 due to the inclusion of Family Heritage for a full year. 35 Excess investment income is also impacted by financing costs. Financing costs for the investment segment primarily consist of interest on our various debt instruments and are deducted from excess investment income. The table below presents the components of financing costs and reconciles interest expense per the Consolidated Statements of Operations. Analysis of Financing Costs (Amounts in thousands) 2014 2013 2012 Interest on funded debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $71,072 $75,136 $74,815 5,656 Interest on short-term debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other 5,013 41 5,299 26 Interest expense per Consolidated Statements of Operations . . . . . . . . . . . . . . . . . . . . Reclassification of interest due to deconsolidation (1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . 76,126 0 80,461 0 80,512 (214) Financing costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $76,126 $80,461 $80,298 (1) See Principles of Consolidation in Note 1—Significant Accounting Policies in the Notes to Consolidated Financial Statements for an explanation of deconsolidation. Financing costs decreased $4 million or 5% in 2014. They were essentially flat in 2013. The decrease in financing costs in 2014 was due to the maturity and repayment of our $94 million par amount $7.375% Notes during the third quarter of 2013. The increase in financing costs in 2013 reflects the increased interest expense from the issuance in September, 2012 of $300 million principal amount of our 3.8% Senior Notes due in 2022, $150 million of which is eliminated in consolidation. Also in September, 2012, we issued our 5.875% Junior Subordinated Debentures due 2052 for $125 million principal amount but called our $120 million 7.1% Trust Preferred Securities one month later. In both 2014 and 2013, interest on short-term debt declined primarily because of the reduction in the weighted-average interest transactions are disclosed in the Financial rate on short-term debt. More information on our debt Condition section of this report and in Note 11—Debt in the Notes to Consolidated Financial Statements. As previously noted, growth rates in our excess investment income decline when growth in income from the portfolio is less than that of the interest required by policy liabilities and financing costs, such as we have experienced in recent periods. In an extended low-interest-rate environment, the portfolio yield will tend to decline as we invest new money at lower long-term rates. We believe, however, the decline would be relatively slow, as, on average, only 1% to 2% of fixed maturities are expected to run off each year over the next five years. In response to the lower interest rates, we raised the premium rates for new business on major life products in early 2012 and again in late 2013. The increased premium provides additional margin on these policies to help offset higher mandatory cash values and the possible future reductions in excess investment income. Despite these increases in premium rates, we have continued to see growth in net sales. Excess investment income benefits from increases in long-term rates available on new investments and decreases in short-term borrowing rates. Of these two factors, higher investment rates have the greater impact because the amount of cash that we invest is significantly greater than the amount that we borrow at short-term rates. Therefore, Torchmark would benefit if rates, especially long-term rates, were to rise. 36 investment policy calls for Investment Acquisitions. Torchmark’s current investing almost exclusively in investment-grade fixed maturities generally with long maturities (maturity date more than 20 years after acquisition date) that meet our quality and yield objectives. We generally prefer to invest in securities with longer maturities because they more closely match the long-term nature of our policy liabilities. Further, we believe this strategy is appropriate because our strong positive cash flows are If such longer-term securities do not meet our quality and yield generally stable and predictable. objectives, we consider investing in short-term securities, taking into consideration the slope of the yield curve and other factors at the time. During calendar years 2012 through 2014, Torchmark invested almost exclusively in fixed-maturity securities, primarily with longer-term maturities as presented in the chart below. The following table summarizes selected information for fixed-maturity purchases. The effective annual yield shown in the table is the yield calculated to the potential termination date that produces the lowest yield. This date is commonly known as the “worst call date.” Two different average life calculations are shown, average life to the next call date and average life to the maturity date. Fixed Maturity Acquisitions Selected Information (Dollar amounts in millions) For the Year 2013 2014 2012 Cost of acquisitions: Investment-grade corporate securities . . . . . . . . . . . . . . . . . . Taxable municipal securities . . . . . . . . . . . . . . . . . . . . . . . . . . Other investment-grade securities . . . . . . . . . . . . . . . . . . . . . . $696.3 0 8.7 $1,113.2 $1,465.9 1.5 16.9 0 30.6 Total fixed-maturity acquisitions . . . . . . . . . . . . . . . . . . $705.0 $1,143.8 $1,484.3 Effective annual yield (one year compounded*) . . . . . . . . . . . . . Average life (in years, to next call) . . . . . . . . . . . . . . . . . . . . . . . . Average life (in years to maturity) . . . . . . . . . . . . . . . . . . . . . . . . Average rating . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.77% 22.9 23.4 BBB+ 4.65% 26.0 26.5 BBB+ 4.30% 25.6 26.7 BBB+ * Tax-equivalent basis, where the yield on tax-exempt securities is adjusted to produce a yield equivalent to the pretax yield on taxable securities. We prefer to invest primarily in bonds that are not callable (on other than a make-whole basis) prior to maturity, but we periodically invest some funds in callable bonds when the incremental yield available on such bonds warrants doing so. For investments in callable bonds, the actual life of the investment will depend on whether the issuer calls the investment prior to the maturity date. Given our investments in callable bonds, the actual average life of our investments cannot be known at the time of the investment. However, the average life will not be less than the average life to next call and will not exceed the average life to maturity. Data for both of these average life measures is provided in the above chart. During the three years 2012 through 2014, we have invested almost entirely in investment-grade corporate bonds. Acquisitions in all three years have been primarily in industrial and utility bonds. New cash flow available for investment has been primarily provided through our insurance operations, but has also been affected by other factors. Issuer calls, as a result of the low-interest environment experienced during the past three years were an important factor, especially in 2012. Calls increase funds available for investment, but as noted earlier in this discussion, they can have a negative impact on investment income if the proceeds from the calls are reinvested in bonds that have lower yields than that of the bonds that were called. Issuer calls were $160 million in 2014, $344 million in 2013, and $650 million in 2012. The higher level of acquisitions in 2012 was primarily due to the additional funds available from the higher level of 2012 calls. 37 Portfolio Analysis. Because Torchmark has recently invested almost exclusively in fixed-maturity securities, the relative percentage of our assets invested in various types of investments varies from industry norms. The following table presents a comparison of Torchmark’s components of invested assets at amortized cost as of December 31, 2014 with the latest industry data. Bonds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Preferred stock (redeemable and perpetual)(2) . . . . . . . . . . . . Common stocks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Mortgage loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Real estate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Policy loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other invested assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Cash and short terms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Torchmark Amount (in millions) % Industry %(1) $12,327 497 1 0 0 472 10 82 $13,389 92% 4 0 0 0 3 0 1 78% 0 2 9 0 4 4 3 100% 100% (1) Latest data available from the American Council of Life Insurance as of December 31, 2013. Includes redeemable preferred of $497 million or 100% and perpetual preferred of $0 million. (2) Because fixed maturities represent such a significant portion of our investment portfolio, the remainder of the discussion of portfolio composition will focus on fixed maturities. An analysis of our fixed-maturity portfolio by component at December 31, 2014 and December 31, 2013 is as follows: Fixed Maturities by Component At December 31, 2014 (Dollar amounts in millions) Cost or Amortized Cost Gross Unrealized Gains Gross Unrealized Losses % of Total Fixed Maturities Fair Value Amortized Cost Fair Value Corporates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $10,566 497 Redeemable preferred stock . . . . . . . . . . . . . . . 1,278 Municipals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 291 Government-sponsored enterprises . . . . . . . . . 100 Governments & agencies . . . . . . . . . . . . . . . . . Residential mortgage-backed securities . . . . . 6 68 Collateralized debt obligations . . . . . . . . . . . . . 18 Other asset-backed securities . . . . . . . . . . . . . Total fixed maturities . . . . . . . . . . . . . $12,824 $1,502 58 177 5 1 0 4 1 $1,748 $(61) (5) (1) (2) (1) 0 (9) 0 $(79) $12,007 550 1,454 294 100 6 63 19 $14,493 82% 4 10 2 1 0 1 0 83% 4 10 2 1 0 0 0 100% 100% 38 Fixed Maturities by Component At December 31, 2013 (Dollar amounts in millions) Cost or Amortized Cost Gross Unrealized Gains Gross Unrealized Losses % of Total Fixed Maturities Fair Value Amortized Cost Fair Value Corporates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $10,134 503 Redeemable preferred stock . . . . . . . . . . . . . . . 1,278 Municipals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 347 Government-sponsored enterprises . . . . . . . . . 122 Governments & agencies . . . . . . . . . . . . . . . . . Residential mortgage-backed securities . . . . . 8 66 Collateralized debt obligations . . . . . . . . . . . . . 31 Other asset-backed securities . . . . . . . . . . . . . Total fixed maturities . . . . . . . . . . . . . $12,489 $702 25 70 0 1 0 0 3 $801 $(300) (14) (13) (71) (5) 0 (8) 0 $(411) $10,536 514 1,335 276 118 8 58 34 $12,879 81% 4 10 3 1 0 1 0 83% 4 10 2 1 0 0 0 100% 100% At December 31, 2014, fixed maturities had a fair value of $14.5 billion, compared with $12.9 billion at December 31, 2013. At December 31, 2014, fixed maturities were in a $1.7 billion net unrealized gain position compared with an unrealized gain position of $390 million at December 31, 2013. Approximately 82% of our fixed maturity assets at December 31, 2014 at amortized cost were corporate bonds and 4% were redeemable preferred stocks. This compares with 81% corporate bonds and 4% redeemable preferred stocks at year end 2013. On a combined basis, residential mortgage-backed securities, other asset-backed securities, and collateralized debt obligations (CDOs) were 1% of the assets at amortized cost at December 31, 2014. The $68 million of CDOs at amortized cost made up less than 0.6% of the assets and are backed primarily by trust preferred securities issued by banks and insurance companies. The $6 million of residential mortgage-backed securities are rated AAA. For more information about our fixed-maturity portfolio by component at December 31, 2014 and 2013, including an analysis of unrealized investment losses and a schedule of maturities, see Note 4—Investments in the Notes to Consolidated Financial Statements. Due to the strong and stable cash flows generated by its insurance products, Torchmark has the ability to hold securities with temporary unrealized losses until recovery. Even though these fixed maturity investments are classified as available for sale, Torchmark generally expects and intends to hold to maturity any securities which are temporarily impaired. Additional information concerning the fixed-maturity portfolio is as follows. Fixed Maturity Portfolio Selected Information Average annual effective yield (1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Average life, in years, to: Next call (2) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Maturity (2) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Effective duration to: Next call (2), (3) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Maturity (2), (3) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . At December 31, 2014 2013 5.89% 5.91% 17.8 20.5 10.9 12.0 18.3 21.5 10.4 11.7 (1) Tax-equivalent basis, where the yield on tax-exempt securities is adjusted to produce a yield equivalent to the pretax yield on taxable securities. (2) Torchmark calculates the average life and duration of the fixed-maturity portfolio two ways: (a) based on the next call date which is the next call date for callable bonds and the maturity date for noncallable bonds, and (b) based on the maturity date of all bonds, whether callable or not. (3) Effective duration is a measure of the price sensitivity of a fixed-income security to a particular change in interest rates. 39 Credit Risk Sensitivity. Credit risk relates to the level of uncertainty that a security’s issuer will maintain its ability to honor the terms of that security until maturity. Approximately 87% of our fixed- maturity holdings at book value are in corporate securities (including redeemable preferred and asset- backed securities). As we continue to invest in corporate bonds with relatively long maturities, we continually monitor credit risk. We mitigate this ongoing risk, in part, by acquiring only investment-grade bonds and by analyzing the financial fundamentals of each prospective issuer. We continue to monitor the status of issuers on an ongoing basis. We also seek to reduce credit risk by spreading investments over a large number of issuers and a wide range of industry sectors. The following table presents the relative percentage of our fixed maturities by industry sector at December 31, 2014. Fixed Maturities by Sector At December 31, 2014 (Dollar amounts in millions) Cost or Amortized Cost Gross Unrealized Gains Gross Unrealized Losses Fair Value Financial - Life/Health/PC Insurance . . . . . . . . . . . . . . . . $ 1,819 683 633 Financial - Bank . . . . . . . . . . . . . Financial - Other . . . . . . . . . . . . $ 291 94 92 $ (3) (5) (9) $ 2,107 772 716 Total Financial . . . . . . . . 3,135 Utilities . . . . . . . . . . . . . . . . . . . . Government . . . . . . . . . . . . . . . . Energy . . . . . . . . . . . . . . . . . . . . Basic Materials . . . . . . . . . . . . . Other Industrials . . . . . . . . . . . . Consumer Non-cyclical . . . . . . . Transportation . . . . . . . . . . . . . . Communications . . . . . . . . . . . . . . . . . . . . . . Consumer Cyclical Collateralized debt obligations . . . . . . . . . . . . . . . Mortgage-backed securities . . . 2,183 1,669 1,512 997 910 848 559 533 404 68 6 477 379 183 173 86 112 125 80 75 54 4 0 (17) (3) (4) (22) (7) (7) (2) (3) (4) (1) (9) 0 3,595 2,559 1,848 1,663 1,076 1,015 971 636 604 457 63 6 % of Total Fixed Maturities At Amortized Cost At Fair Value 14% 15% 5 5 24 17 13 12 8 7 7 4 4 3 1 0 5 5 25 19 13 11 7 7 7 4 4 3 0 0 Total Fixed Maturities . . . $12,824 $1,748 $(79) $14,493 100% 100% At December 31, 2014, approximately 24% of the fixed maturity assets at amortized cost (25% at fair value) were in the financial sector, including 14% in life and health or property casualty insurance companies and 5% in banks. Financial guarantors, mortgage insurers, and insurance brokers comprised approximately 5% of the portfolio at amortized cost. After financials, the next largest sector was utilities, which comprised 17% of the portfolio at amortized cost. The balance of the portfolio is spread among 396 issuers in a wide variety of sectors. Our energy sector investments accounted for 12% of fixed maturities at amortized cost as of December 31, 2014. While this sector has seen recent volatility, we believe the risk of losses in the foreseeable future is minimal. Over 98% of these holdings are investment grade, and the portfolio had a net unrealized gain of $151 million at year end 2014. Less than 8% of our holdings are in the oil field service and drilling area. While there may be some downgrades in this sector, we believe that our investments will be able to withstand lower energy prices for an extended duration. 40 An analysis of the fixed-maturity portfolio by a composite rating at December 31, 2014 is shown in the table below. The composite rating for each security, other than private-placement securities managed by a third party, is the average of the security’s ratings as assigned by Moody’s Investor Service, Standard & Poor’s, Fitch Ratings, and Dominion Bond Rating Service, LTD. The ratings assigned by these four nationally recognized statistical rating organizations are evenly weighted when calculating the average. Included in the chart below are private placement fixed-maturity holdings of $497 million at amortized cost ($513 million at fair value) for which the ratings were assigned by the third-party manager. Fixed Maturities by Rating At December 31, 2014 (Dollar amounts in millions) Amortized Cost % Fair Value % Investment grade: AAA . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . AA . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . A . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . BBB+ . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . BBB . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . BBB- . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 688 1,333 3,914 2,429 2,833 1,066 Investment grade . . . . . . . . . . . . . . . . . . . . . . . . . . . 12,263 Below investment grade: BB . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . B . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Below B . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Below investment grade . . . . . . . . . . . . . . . . . . . . . . 331 118 112 561 5% $ 10 32 19 22 8 96 2 1 1 4 726 1,531 4,620 2,763 3,153 1,150 13,943 334 109 107 550 5% 10 32 19 22 8 96 2 1 1 4 $12,824 100% $14,493 100% The portfolio has a weighted average quality rating of A- based on amortized cost. Approximately the portfolio at amortized cost was considered investment grade. Our investment portfolio 96% of contains no securities backed by sub-prime or Alt-A mortgages (loans for which some of the typical documentation was not provided by the borrower). We have no direct investments in residential mortgages, nor do we have any counterparty risks as we are not a party to any credit default swaps or other derivative contracts. We do not participate in securities lending. There are no off-balance sheet investments, as all investments are reported on our Consolidated Balance Sheets. Other than $9 million of German government bonds at amortized cost and fair value, we have no direct exposure to European sovereign debt. Our current investment policy regarding fixed maturities is to acquire only investment-grade obligations. Thus, any increases in below investment-grade issues are a result of ratings downgrades of existing holdings. An analysis of changes in below-investment grade fixed maturities at amortized cost is as follows. Year Ended December 31, 2014 (in $ millions) Balance at January 1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Downgrades by rating agencies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Upgrades by rating agencies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Disposals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Write down of other-than-temporarily impaired securities . . . . . . . . . . . . . . . . Amortization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Balance at December 31 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $566 15 (20) (5) 0 5 $561 41 Market Risk Sensitivity. Torchmark’s financial securities are exposed to interest rate risk, meaning the effect of changes in financial market interest rates on the current fair value of the company’s investment portfolio. Since 96% of the book value of our investments is attributable to fixed-maturity investments (and virtually all of these investments are fixed-rate investments), the portfolio is highly subject to market risk. Declines in market interest rates generally result in the fair value of the investment portfolio exceeding the book value of the portfolio and increases in interest rates cause the fair value to decline below the book value. Under normal market conditions, we do not expect to realize these unrealized gains and losses because we have the ability and generally the intent to hold these investments to maturity. The long-term nature of our insurance policy liabilities and strong cash-flow operating position substantially mitigate any future need to liquidate portions of the portfolio. The increase or decrease in the fair value of insurance liabilities and debt due to increases or decreases in market interest rates largely offsets the impact of rates on the investment portfolio. However, as is permitted by GAAP, these liabilities are not recorded at fair value. The following table illustrates the market risk sensitivity of our interest-rate sensitive fixed-maturity portfolio at December 31, 2014 and 2013. This table measures the effect of a change in interest rates (as represented by the U.S. Treasury curve) on the fair value of the fixed-maturity portfolio. The data measures the change in fair value arising from an immediate and sustained change in interest rates in increments of 100 basis points. Market Value of Fixed Maturity Portfolio ($ millions) Change in Interest Rates (in basis points) At December 31, 2014 At December 31, 2013 -200 -100 0 100 200 $18,401 16,287 14,493 12,961 11,645 $16,205 14,412 12,879 11,562 10,423 42 Realized Gains and Losses. Our life and health insurance companies collect premium income from policyholders for the eventual payment of policyholder benefits, sometimes paid many years or even decades in the future. In addition to the payment of these benefits, we also incur acquisition costs, administrative expenses, and taxes as a part of insurance operations. Because benefits are expected to be paid in future periods, premium receipts in excess of current expenses are invested to provide for these obligations. For this reason, we hold a significant investment portfolio as a part of our core insurance operations. This portfolio consists primarily of high-quality fixed maturities containing an adequate yield to provide for the cost of carrying these long-term insurance product obligations. As a result, fixed maturities are generally held for long periods to support the liabilities. Expected yields on these investments are taken into account when setting insurance premium rates and product profitability expectations. Investments are occasionally sold or called, resulting in a realized gain or loss. These gains and losses generally occur only incidentally, usually as the result of sales because of deterioration in investment quality of issuers or calls by the issuers. Investment losses are also caused by writedowns due to impairments. We do not engage in trading investments for profit. Therefore, gains or losses which occur in protecting the portfolio or its yield, or which result from events that are beyond our control, are only secondary to our core insurance operations of providing insurance coverage to policyholders. Realized gains and losses can be significant in relation to the earnings from core insurance operations, and as a result, can have a material positive or negative impact on net income. The significant fluctuations caused by gains and losses can cause the period-to-period trends of net income not to be indicative of historical core operating results nor predictive of the future trends of core operations. they have no bearing on core insurance operations or segment results as we view Accordingly, operations. For these reasons, and in line with industry practice, we remove the effects of realized gains and losses when evaluating overall insurance operating results. The following table summarizes our tax-effected realized gains (losses) by component for each of the years in the three-year period ended December 31, 2014. Analysis of Realized Gains (Losses), Net of Tax (Dollar amounts in thousands, except for per share data) Year Ended December 31, 2014 2013 2012 Amount Per Share Amount Per Share* Amount Per Share* Fixed maturities: Sales . . . . . . . . . . . . . . . . . . . . . . . . $10,209 4,851 Called or tendered . . . . . . . . . . . . . 0 Writedowns** . . . . . . . . . . . . . . . . . (168) Loss on redemption of debt . . . . . . . . . 414 Other . . . . . . . . . . . . . . . . . . . . . . . . . . . Total . . . . . . . . . . . . . . . . . . . . $15,306 $0.08 0.04 0.00 0.00 0.00 $0.12 $3,015 5,525 0 0 (4,575) $0.02 0.04 0.00 0.00 (0.03) $24,943 5,830 (3,640) (2,671) 129 $0.17 0.04 (0.02) (0.02) 0.00 $3,965 $0.03 $24,591 $0.17 * Per share amounts for 2013 and 2012 have been retrospectively adjusted for the three-for-two stock split effective July 1, 2014. ** Written down due to other-than-temporary impairment. As described in Note 4—Investments under the caption Other-than-temporary impairments in the Notes to Consolidated Financial Statements, we wrote certain securities down to fair value during 2012 as a result of other-than-temporary impairment. The impaired securities met our criteria for other-than- temporary impairment as discussed in Note 1—Significant Accounting Policies and in our Critical Accounting Policies in this report. The writedowns resulted in pretax charges of $5.6 million in 2012 ($3.6 million after tax). During 2013, we sold investment real estate for an after-tax loss of $1.9 million, of which $1.7 million had been written down due to other-than-temporary impairment earlier in the year. In 2012, we redeemed our 7.1% Trust Originated Preferred Securities, recording a loss on redemption of $4.1 million ($2.7 million after tax). 43 FINANCIAL CONDITION Liquidity. Liquidity provides Torchmark with the ability to meet on demand the cash commitments required by its business operations and financial obligations. Our liquidity is primarily derived from three sources: positive cash flow from operations, a portfolio of marketable securities, and a line of credit facility. Insurance Subsidiary Liquidity. The operations of our insurance subsidiaries have historically generated substantial cash inflows in excess of immediate cash needs. Sources of cash flows for the insurance subsidiaries include primarily premium and investment income. Cash outflows from operations include policy benefit payments, commissions, administrative expenses, and taxes. The funds to provide for policy benefits, the majority of which are paid in future periods, are invested primarily in long-term fixed maturities to meet these long-term obligations. In addition to investment income, maturities and scheduled repayments in the investment portfolio are sources of cash. Excess cash available from the insurance subsidiaries’ operations is generally distributed as a dividend to the Parent Company, subject to regulatory restriction. The dividends are generally paid in amounts equal to the subsidiaries’ prior year statutory net income excluding realized capital gains. While the leading source of the excess cash is investment income, due to our high underwriting margins and effective expense control, a significant portion of the excess cash also comes from underwriting income. Parent Company Liquidity. Cash flows from the insurance subsidiaries are used to pay interest and principal repayments on Parent Company debt, operating expenses of the Parent, and Parent the Parent received $479 million of cash Company dividends to Torchmark shareholders. In 2014, dividends from its insurance subsidiaries, compared with $488 million in 2013 and $437 million in 2012. Including transfers from other subsidiaries and after paying debt obligations, shareholder dividends, and other expenses (but before share repurchases), Torchmark Parent had excess operating cash flow in 2014 of approximately $377 million, compared with $364 million in 2013. Parent Company cash flow in its operating requirements is available for other corporate purposes, such as strategic excess of acquisitions or share repurchases. the Parent Company will receive approximately $473 million in dividends from subsidiaries, and that an approximate range of $355 to $365 million will be available as excess cash flow. Certain restrictions exist on the payment of these dividends. For more information on the restrictions on the payment of dividends by subsidiaries, see the restrictions section of Note 12—Shareholders’ Equity in the Notes to Consolidated Financial Statements. Although these restrictions exist, dividend availability from subsidiaries historically has been sufficient for the cash flow needs of the Parent Company. As additional liquidity, the Parent held $6 million of cash and short-term investments at December 31, 2014, compared with $8 million a year earlier. The Parent also had available a $50 million receivable from subsidiaries at 2014 year end. is expected that In 2015, it Short-Term Borrowings. An additional source of parent company liquidity is a line of credit facility with a group of lenders which allows unsecured borrowings and stand-by letters of credit up to $750 million. In July 2014, Torchmark replaced a $600 million facility with this new agreement, as discussed in Note 11—Debt in the Notes to Consolidated Financial Statements, under the caption Commercial Paper. The new facility, like the previous, is further designated as a back-up line of credit for a commercial paper program. As of December 31, 2014, we had available $314 million of additional borrowing capacity under this new facility, compared with $173 million a year earlier. There have been no difficulties in accessing the commercial paper market during the three years ended December 31, 2014. For detailed information about this new line of credit facility, please refer to Note 11—Debt. In summary, Torchmark expects to have readily available funds for 2015 and the foreseeable future to conduct its operations and to maintain target capital ratios in the insurance subsidiaries through internally generated cash flow and the credit facility. In the unlikely event that more liquidity is needed, the Company could generate additional funds through multiple sources including, but not limited to, the issuance of additional debt, a short-term credit facility, and intercompany borrowing. Consolidated Liquidity. Consolidated net cash inflows provided from operations were $865 million in 2014, compared with $1.1 billion in 2013 and $943 million in 2012. In addition to cash inflows from operations, our companies have received $160 million in investment calls and tenders and $113 million 44 of scheduled maturities or repayments during 2014. Maturities, tenders, and calls totaled $494 million in 2013 and $737 million in 2012. Our cash and short-term investments were $82 million at year-end 2014 and $114 million at year-end 2013. Additionally, we have a portfolio of marketable fixed and equity securities that are available for sale in the event of an unexpected need. These securities had a fair value of $14.5 billion at December 31, 2014. However, our strong cash flows from operations, investment maturities, and the availability of our credit line make any need to sell securities for liquidity unlikely. Off-Balance Sheet Arrangements. As a part of its above-mentioned credit facility, Torchmark had outstanding $198 million in stand-by letters of credit at December 31, 2014. However, these letters are issued among our subsidiaries, one of which is an offshore captive reinsurer, and have no impact on company obligations as a whole. Any future regulatory changes that restrict the use of off-shore captive reinsurers might require Torchmark to obtain third-party financing, which could cause an immaterial increase in financing costs. As of December 31, 2014, we had no unconsolidated affiliates and no guarantees of the obligations the performance of consolidated of third-party entities. All of our guarantees were guarantees of subsidiaries, as disclosed in Note 15—Commitments and Contingencies. The following table presents information about future payments under our contractual obligations for the selected periods as of December 31, 2014. (Amounts in millions) Actual Liability Total Payments Less than One Year One to Three Years Three to Five Years More than Five Years Fixed and determinable: Debt—principal(1) . . . . . . . . . . . . . . . . . $ 1,231 Debt—interest(2) . . . . . . . . . . . . . . . . . . 6 0 Capital leases . . . . . . . . . . . . . . . . . . . 0 Operating leases . . . . . . . . . . . . . . . . . Purchase obligations . . . . . . . . . . . . . . 76 Pension obligations(3) 185 . . . . . . . . . . . . . Future insurance obligations(4) . . . . . . 11,750 $ 1,242 594 0 46 76 252 46,232 Total . . . . . . . . . . . . . . . . . . . . . . . . . $13,248 $48,442 $ 238 71 0 9 44 18 1,326 $1,706 $ 250 116 0 14 25 41 2,604 $3,050 $ 293 94 0 8 1 47 2,574 $3,017 $ 461 313 0 15 6 146 39,728 $40,669 (1) Funded debt is itemized in Note 11—Debt in the Notes to Consolidated Financial Statements and includes short-term commercial paper. Interest on debt is based on our fixed contractual obligations. (2) (3) Pension obligations are primarily liabilities in trust funds that are calculated in accordance with the terms of the pension plans. They are offset by invested assets in the trusts, which are funded through periodic contributions by Torchmark in a manner which will provide for the settlement of the obligations as they become due. Therefore, our obligations are offset by those assets when reported on Torchmark’s Consolidated Balance Sheets. At December 31, 2014, these pension obligations were $477 million, but there were also assets of $323 million in the pension entities. The schedule of pension benefit payments covers ten years and is based on the same assumptions used to measure the pension obligations, except there is no interest assumption because the payments are undiscounted. There are also obligations for benefits other than pensions with a liability of $23 million. Please refer to Note 10—Postretirement Benefits in the Notes to Consolidated Financial Statements for more information on pension obligations. (4) Future insurance obligations consist primarily of estimated future contingent benefit payments on policies in force at December 31, 2014. These estimated payments were computed using assumptions for future mortality, morbidity and persistency. The actual amount and timing of such payments may differ significantly from the estimated amounts shown. Management believes that the assets supporting the liability of $11.7 billion at December 31, 2014, along with future premiums and investment income, will be sufficient to fund all future insurance obligations. 45 Capital Resources. Torchmark’s capital structure consists of short-term debt (the commercial paper facility described in Note 11—Debt in the Notes to Consolidated Financial Statements), long-term funded debt, and shareholders’ equity. A complete analysis and description of long-term debt issues outstanding is presented in Note 11. The carrying value of the long-term funded debt was $992 million at December 31, 2014, compared with $991 million a year earlier. As fully explained in Note 11—Debt, we issued $300 million principal amount of 3.8% Senior Notes due in 2022 in September, 2012 for proceeds of $297 million in a public offering. However, $150 million of the offering was acquired by Torchmark insurance subsidiaries and was eliminated in consolidation, resulting in net proceeds after issue expenses to the consolidated group of $147 million. The majority of the $297 million proceeds received by the Parent were used to acquire Family Heritage as described in Note 6—Acquisition. The balance was invested and later used for the redemption of our $94.5 million principal amount 7 3⁄ 8% Notes that matured on August 1, 2013 and for other corporate purposes. The principal balance of the 7 3⁄ 8% Notes, along with accrued interest, was then repaid on its maturity date in the total amount of $97.5 million. As also discussed in Note 11, we issued $125 million principal amount of our 5.875% Junior Subordinated Debentures due 2052 in a September, 2012 public offering. This issue resulted in net proceeds after issue expenses of $121 million, and were used to redeem our 7.1% Trust Originated Preferred Securities in the amount of $120 million plus accrued dividends for a total cost of $121 million. Also noted in Note 11 was our assumption of $20 million of Trust Preferred Securities in connection with our acquisition of Family Heritage. These securities bear interest at a variable rate, the three-month LIBOR plus 330 basis points, which is reset each quarter. While these securities are callable by us at any time, we have no immediate plans to do so. Our insurance subsidiaries generally target a capital ratio of at least 325% of required regulatory capital under Risk-Based Capital (RBC), a formula designed by insurance regulatory authorities to monitor the adequacy of capital. The 325% target is considered sufficient for the subsidiaries because of their strong reliable cash flows, the relatively low risk of their product mix, and because that ratio is in line with rating agency expectations for Torchmark. At December 31, 2014, our insurance subsidiaries in the aggregate had RBC ratios of approximately 326%. Should we experience additional impairments and/or ratings downgrades in the future that cause the ratio to fall below 325%, management has more than sufficient liquidity at the Parent Company to make additional contributions as necessary to maintain the ratios at or above 325%. As noted under the caption Summary of Operations in this report, we have an ongoing share repurchase program. Under this program, we acquired 7 million shares at a cost of $375 million in 2014, 8 million shares at a cost of $360 million in 2013, and 11 million shares for $360 million in 2012. The majority of purchased shares are retired each year. Please refer to the description of our share repurchase program under the caption Summary of Operations in this report. Torchmark has increased the quarterly dividend on its common shares over the past three years. In the first quarter of 2012, it was increased to $.10 per share from $.08 per share. In the first quarter of 2013, it was again raised to $.1133 per share. Then, in the first quarter of 2014, dividends were raised to $.1267 per share. Shareholders’ equity was $4.7 billion at December 31, 2014, compared with $3.8 billion at December 31, 2013. During the twelve months since December 31, 2013, shareholders’ equity was reduced by the $375 million in share purchases under the repurchase program and another $74 million to offset the dilution from stock option exercises. However, it was increased by $827 million of after-tax unrealized gains in the fixed maturity portfolio and by the $543 million of net income. We plan to use excess cash available at the Parent Company as efficiently as possible in the future. limited to share repurchases, acquisitions, Possible uses of excess cash flow include, but are not increases in shareholder dividends, investment in fixed maturities, or repayment of short-term debt. We will determine the best use of excess cash after ensuring that desired capital levels are maintained in our companies. 46 We maintain a significant available-for-sale fixed-maturity portfolio to support our insurance policyholders’ liabilities. Current accounting guidance requires that we revalue our portfolio to fair market value at the end of each accounting period. The period-to-period changes in fair value, net of their associated impact on deferred acquisition costs and income tax, are reflected directly in shareholders’ equity. Changes in the fair value of the portfolio can result from changes in interest rates and liquidity in financial markets. While invested assets are revalued, accounting rules do not permit interest-bearing insurance policy liabilities to be valued at fair value in a consistent manner as that of assets, with changes in value applied directly to shareholders’ equity. Due to the size of our policy liabilities in relation to our shareholders’ equity, this inconsistency in measurement usually has a material impact on the reported value of shareholders’ equity. If these liabilities were revalued in the same manner as the assets, the effect on equity would be largely offset. Fluctuations in interest rates cause undue volatility in the period- to-period presentation of our shareholders’ equity, capital structure, and financial ratios which would be essentially removed if interest-bearing liabilities were valued in the same manner as assets. From time to time, the market value of our fixed maturity portfolio may be depressed as a result of bond market illiquidity which could result in a significant decrease in shareholders’ equity. Because of the long-term nature of our fixed maturities and liabilities and the strong cash flows generated by our insurance subsidiaries, we have the intent and ability to hold our securities to maturity. As such, we do not expect to incur losses due to fluctuations in market value of fixed maturities caused by interest rate changes and temporarily illiquid markets. Accordingly, our management, credit rating agencies, lenders, many industry analysts, and certain other financial statement users prefer to remove the effect of this accounting rule when analyzing our balance sheet, capital structure, and financial ratios. The following tables present selected data related to our capital resources. Additionally, the tables present the effect of this accounting guidance on relevant line items, so that investors and other financial statement users may determine its impact on Torchmark’s capital structure. Selected Financial Data At December 31, 2014 At December 31, 2013 At December 31, 2012 Effect of Accounting Rule Requiring Revaluation (1) GAAP Effect of Accounting Rule Requiring Revaluation (1) GAAP Effect of Accounting Rule Requiring Revaluation (1) GAAP Fixed maturities (millions) . . . . . . . . . . $ 14,493 Deferred acquisition costs (millions) (2) . . . . . . . . . . . . . . . . . . . . Total assets (millions) . . . . . . . . . . . . . Short-term debt (millions) . . . . . . . . . . Long-term debt (millions) . . . . . . . . . . Shareholders’ equity (millions) . . . . . . 3,472 20,215 238 992 4,697 $1,669 $ 12,879 $ 390 $ 13,541 $1,578 (16) 1,653 0 0 1,074 3,338 18,192 229 991 3,776 (10) 380 0 0 247 3,198 18,777 319 990 4,362 (25) 1,553 0 0 1,009 Book value per diluted share (3) . . . . . Debt to capitalization (4) . . . . . . . . . . . . 36.19 20.8% 8.28 (4.6)% 27.66 24.4% 1.81 (1.3)% 30.56 23.1% 7.07 (5.0)% Diluted shares outstanding (thousands) (3) . . . . . . . . . . . . . . . . . . 129,812 Actual shares outstanding (thousands) (3) . . . . . . . . . . . . . . . . . . 127,930 136,537 134,252 142,707 141,353 (1) Amount added to (deducted from) comprehensive income to produce the stated GAAP item (2) (3) Outstanding shares and per share amounts have been retrospectively adjusted for the three-for-two stock split effective July 1, Includes the value of insurance purchased 2014. (4) Torchmark’s debt covenants require that the effect of the accounting rule requiring revaluation be removed to determine this ratio. This ratio is computed by dividing total debt by the sum of debt and shareholders’ equity. FASB guidance provides for an option which, if elected, would permit us to value our interest-bearing policy liabilities and debt at fair value in our Consolidated Balance Sheets. However, unlike the accounting rule which permits us to account for changes in our available-for-sale bond portfolio through other comprehensive income, the guidance requires such changes to be recorded in earnings. Because 47 both the size and duration of the investment portfolio do not match those attributes of our policyholder liabilities and debt, the impact on earnings could be very significant and volatile, causing reported earnings not to be reflective of core results. Therefore, we have not elected this option. Torchmark’s ratio of earnings before interest and taxes to interest requirements (times interest earned) was 11.2 times in 2014, compared with 10.5 times in 2013 and 2012. This times-interest-earned ratio is computed by dividing interest expense into the sum of pre-tax income from continuing operations and interest expense. A discussion of our interest expense is included in the discussion of financing costs under the caption Investments in this report. Financial Strength Ratings. The financial strength of our major insurance subsidiaries is rated by Standard & Poor’s and A. M. Best. The following chart presents these ratings for our five largest insurance subsidiaries at December 31, 2014. Liberty . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Globe . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . United American . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . American Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Family Heritage . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . AA- AA- A+ AA- N/A A+ (Superior) A+ (Superior) A+ (Superior) A+ (Superior) A (Excellent) Standard & Poor’s A.M. Best A.M. Best states that it assigns an A+ (Superior) rating to those companies which, in its opinion, have demonstrated superior overall performance when compared to the norms of the life/health insurance industry. A+ (Superior) companies have a superior ability to meet their ongoing insurance obligations. Companies rated A (Excellent) are considered to have excellent ability to meet those obligations. The AA financial strength rating category is assigned by Standard & Poor’s Corporation (S&P) to those insurers which have very strong financial security characteristics, differing only slightly from those rated higher. An insurer rated A has strong financial security characteristics, but is somewhat more likely to be affected by adverse business conditions than are insurers with higher ratings. The plus sign (+) or minus sign (-) shows the relative standing within the major rating category. In August 2014, S&P updated its outlook on Torchmark’s capital position to a negative outlook. The revised outlook was due to a change in S&P’s view of certain internal components of Torchmark’s existing capital position rather than a change in the capital position itself. Management believes Torchmark’s regulatory capital position is currently as strong as it has been for many years and we expect our consolidated RBC ratio to remain at least 325% going forward. While we are currently evaluating multiple options to address S&P’s comments, we do not anticipate any change in our share repurchase program as a result of S&P’s action. OTHER ITEMS Litigation. Torchmark and its subsidiaries are subject to being named as parties to pending or threatened litigation, much of which involves punitive damage claims based upon allegations of agent misconduct at the insurance subsidiaries. Such punitive damage claims may have the potential for significant adverse results since Torchmark and its subsidiaries operate in jurisdictions where large punitive damage awards bearing little or no relation to actual damages continue to be awarded. This bespeaks caution since it is impossible to predict the likelihood or extent of punitive damages that may be awarded if liability is found in any given case. 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 us to be material. For more information concerning litigation, please refer to Note 15—Commitments and Contingencies in the Notes to the Consolidated Financial Statements. 48 CRITICAL ACCOUNTING POLICIES Future Policy Benefits. Because of the long-term nature of insurance contracts, our insurance companies are liable for policy benefit payments that will be made in the future. The liability for future policy benefits is determined by standard actuarial procedures common to the life insurance industry. The accounting policies for determining this liability are disclosed in Note 1—Significant Accounting Policies in the Notes to Consolidated Financial Statements. Approximately 84% of our liabilities for future policy benefits at December 31, 2014 were traditional insurance liabilities where the liability is determined as the present value of future benefits less the present value of the portion of the gross premium required to pay for such benefits. The assumptions used in estimating the future benefits for this portion of business are set at the time of contract issue. These assumptions are “locked in” and are not revised for the lifetime of the contracts, except where there is a premium deficiency, as defined in Note 1—Significant Accounting Policies in the Notes to Consolidated Financial Statements under the caption Future Policy Benefits. Otherwise, variability in the accrual of policy reserve liabilities after policy issuance is caused only by variability of the inventory of in force policies. Torchmark did not have a premium deficiency event for its traditional business during the three years ended December 31, 2014. The remaining portion of liabilities for future policy benefits pertains to business accounted for as deposit business, where the recorded liability is the fund balance attributable to the benefit of policyholders as determined by the policy contract at the financial statement date. Accordingly, there are no assumptions used to determine the future policy benefit liability for deposit business. Deferred Acquisition Costs. Certain costs of acquiring new business are deferred and recorded as an asset. Deferred acquisition costs eligible for deferral consist primarily of sales commissions and other underwriting costs related to the successful issuance of a new insurance contract as indicated in Note 1— Significant Accounting Policies under the caption Deferred Acquisition Costs in the Notes to Consolidated Financial Statements. Additionally, insurance business or insurance the cost of acquiring blocks of business through the purchase of other companies, known as the value of insurance purchased, is included in deferred acquisition costs. Our policies for accounting for deferred acquisition costs and the associated amortization are reported under the same caption in Note 1. Approximately 99% of our recorded amounts for deferred acquisition costs at December 31, 2014 were related to traditional products and are being amortized over the premium-paying period in proportion to the present value of actual historic and estimated future gross premiums. The projection assumptions for this business are set at the time of contract issue. These assumptions are “locked-in” at that time and, except where there is a loss recognition issue, are not revised for the lifetime of the contracts. Absent a premium deficiency, variability in amortization after policy issuance is caused only by variability in premium volume. We have not recorded a deferred acquisition cost loss recognition event for assets related to this business for any period in the three years ended December 31, 2014. The remaining 1% of deferred acquisition costs pertain to deposit business for which deferred acquisition costs are amortized over the estimated lives of the contracts in proportion to actual and estimated future gross profits. These contracts are not subject to lock-in. The assumptions must be updated when actual experience or other evidence suggests that earlier estimates should be revised. Revisions related to our deposit business assets have not had a material impact on the amortization of deferred acquisition costs during the three years ended December 31, 2014. Policy Claims and Other Benefits Payable. This liability consists of known benefits currently payable and an estimate of claims that have been incurred but not yet reported to us. The estimate of unreported claims is based on prior experience and is made after careful evaluation of all information available to us. However, the factors upon which these estimates are based can be subject to change from historical patterns. Factors involved include the litigation environment, regulatory mandates, and the introduction of policy types for which claim patterns are not well established, and medical trend rates and medical cost inflation as they affect our health claims. Changes in these estimates, if any, are reflected in the earnings of the period in which the adjustment is made. We believe that the estimates used to produce the liability for claims and other benefits, including the estimate of unsubmitted claims, are the most appropriate 49 under the circumstances. However, there is no certainty that the resulting stated liability will be our ultimate obligation. At this time, we do not expect any change in this estimate to have a material impact on earnings or financial position consistent with our historical experience. Valuation of Fixed Maturities. We hold a substantial investment in high-quality fixed maturities to provide for the funding of our future policy contractual obligations over long periods of time. While these securities are generally expected to be held to maturity, they are classified as available for sale and are sold from time to time, primarily to manage risk. We report this portfolio at fair value. Fair value is the price that we would expect to receive upon sale of the asset in an orderly transaction. The fair value of the fixed-maturity portfolio is primarily affected by changes in interest rates in financial markets, having a greater impact on longer-term maturities. Because of the size of our fixed-maturity portfolio, small changes in rates can have a significant effect on the portfolio and the reported financial position of the Company. This impact increments under the caption Market Risk Sensitivity in this report. However, as discussed under the caption Financial Condition in this report, we believe these unrealized fluctuations in value have no meaningful impact on our actual financial condition and, as such, we remove them from consideration when viewing our financial position and financial ratios. is disclosed in 100 basis point At times, the values of our fixed maturities can also be affected by illiquidity in the financial markets. Illiquidity would contribute to a spread widening, and accordingly unrealized losses, on many securities that we would expect to be fully recoverable. Even though our fixed maturity portfolio is available for sale, we have the ability and intent to hold the securities until maturity as a result of our strong and stable cash flows generated from our insurance products. Considerable information concerning the policies, procedures, classification levels, and other relevant data concerning the valuation of our fixed-maturity investments is presented in Note 1—Significant Accounting Policies and in Note 4—Investments under the captions Fair Value Measurements in both notes. Impairment of Investments. We continually monitor our investment portfolio for investments that have become impaired in value, where fair value has declined below carrying value. While the values of the investments in our portfolio constantly fluctuate due to market conditions, an other-than-temporary impairment charge is recorded only when a security has experienced a decline in fair market value which is deemed to be other than temporary. The policies and procedures that we use to evaluate and account for impairments of investments are disclosed in Note 1—Significant Accounting Policies in the Notes to Consolidated Financial Statements and the discussions under the captions Investments and Realized Gains and Losses in this report. While every effort is made to make the best estimate of status and value with the information available regarding an other-than-temporary impairment, it is difficult to predict the future prospects of a distressed or impaired security. Defined benefit pension plans. We maintain funded defined benefit plans covering most full-time employees. We also have unfunded nonqualified defined benefit plans covering certain key and other employees. Our obligations under these plans are determined actuarially based on specified actuarial assumptions. In accordance with GAAP, an expense is recorded each year as these pension obligations grow due to the increase in the service period of employees and the interest cost associated with the passage of time. These obligations are offset, at least in part, by the growth in value of the assets in the funded plans. At December 31, 2014, our gross liability under these funded plans was $403 million, but was offset by assets of $323 million. The actuarial assumptions used in determining our obligations for pensions include employee mortality and turnover, retirement age, the expected return on plan assets, projected salary increases, and the discount rate at which future obligations could be settled. These assumptions have an important effect on the pension obligation. A decrease in the discount rate or rate of return on plan assets will cause an increase in the pension obligation. A decrease in projected salary increases will cause a decrease in this obligation. Small changes in assumptions may cause significant differences in reported results for these plans. For example, a sensitivity analysis is presented below for the impact of change in the 50 discount rate and the long-term rate of return on assets assumed on our defined benefit pension plans expense for the year 2014 and projected benefit obligation as of December 31, 2014. Assumption % Change Impact on Expense Impact on Projected Benefit Obligation (Dollars in Thousands) Discount Rate (1): Increase . . . . . . . . . . . . . . . . . . . Decrease . . . . . . . . . . . . . . . . . . 0.25 (0.25) $(2,610) 2,754 $(19,809) 21,059 Expected Return (2): Increase . . . . . . . . . . . . . . . . . . . Decrease . . . . . . . . . . . . . . . . . . 0.25 (0.25) (758) 758 (1) The discount rate was 5.12% for 2014 expense and 4.23% for the projected benefit obligation at December 31, 2014 (2) The expected return rate assumed was 6.97% The Company determines mortality assumptions through the use of published mortality tables that reflect broad-based studies of mortality and published longevity improvement scales. During 2014, the Company revised the mortality assumptions based on an evaluation of a new mortality table and longevity scale released by the Society of Actuaries. The change in these assumptions added approximately $26 million to the projected benefit obligation as of December 31, 2014. The criteria used to determine the primary assumptions are discussed in Note 9—Postretirement Benefits in the Notes to Consolidated Financial Statements. While we have used our best efforts to determine the most reliable assumptions, given the information available from company experience, economic data, independent consultants and other sources, we cannot be certain that actual results will be the same as expected. The assumptions are reviewed annually and revised, if necessary, based on more current information available to us. Note 9 also contains information about pension plan assets, investment policies, and other related data. 51 CAUTIONARY STATEMENTS We caution readers regarding certain forward-looking statements contained in the foregoing discussion and elsewhere in this document, and in any other statements made by us or on our behalf 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 us or our business, whether express or implied, is meant as and should be considered a forward-looking statement. Such statements represent our 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 our control. If these estimates or assumptions prove to be incorrect, the actual results 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) Changes in lapse rates and/or sales of our insurance policies as well as levels of mortality, morbidity and utilization of healthcare services that differ from our assumptions; 2) Federal and state legislative and regulatory developments, particularly those impacting taxes and changes to the federal Medicare program that would affect Medicare Supplement and Medicare Part D insurance; 3) Market trends in the senior-aged health care industry that provide alternatives to traditional Medicare, such as health maintenance organizations (HMOs) and other managed care or private plans, and that could affect the sales of traditional Medicare Supplement insurance; 4) Interest rate changes that affect product sales and/or investment portfolio yield; 5) General economic, industry sector or individual debt issuers’ financial conditions that may affect the current market value of securities that we own, or that may impair issuers’ ability to pay interest due us on those securities; 6) Changes in pricing competition; 7) Litigation results; 8) Levels of administrative and operational efficiencies that differ from our assumptions; 9) Our inability to obtain timely and appropriate premium rate increases for health insurance policies due to regulatory delay; 10) The customer response to new products and marketing initiatives; and 11) Reported amounts in the financial statements which are based on our estimates and judgments which may differ from the actual amounts ultimately realized. Readers are also directed to consider other risks and uncertainties described in our other documents on file with the Securities and Exchange Commission. Item 7A. Quantitative and Qualitative Disclosures about Market Risk Information required by this item is found under the heading Market Risk Sensitivity in Item 7 beginning on page 42 of this report. 52 Item 8. Financial Statements and Supplementary Data Report of Independent Registered Public Accounting Firm . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Consolidated Financial Statements: Consolidated Balance Sheets at December 31, 2014 and 2013 . . . . . . . . . . . . . . . . . . . . . . . . . . . . Consolidated Statements of Operations for each of the three years in the period ended Page 54 55 December 31, 2014 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 56 Consolidated Statements of Comprehensive Income for each of the three years in the period ended December 31, 2014 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Consolidated Statements of Shareholders’ Equity for each of the three years in the period ended December 31, 2014 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Consolidated Statements of Cash Flows for each of the three years in the period ended December 31, 2014 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Notes to Consolidated Financial Statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 57 58 59 60 53 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Shareholders of Torchmark Corporation McKinney, Texas We have audited the accompanying consolidated balance sheets of Torchmark Corporation and subsidiaries (Torchmark) as of December 31, 2014 and 2013, and the related consolidated statements of operations, comprehensive income, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2014. Our audits also included the financial statement schedules listed in the Index at Item 15. These financial statements and financial statement schedules are the responsibility of Torchmark’s management. Our responsibility is to express an opinion on the financial statements and financial statement schedules based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. their operations and their cash flows for each of In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Torchmark Corporation and subsidiaries as of December 31, 2014 and 2013, and the results of the three years in the period ended December 31, 2014, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein. We have also audited, the Public Company Accounting Oversight Board (United States), Torchmark’s internal control over financial reporting as of December 31, 2014, based on the criteria established in Internal Control—Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 27, 2015 expressed an unqualified opinion on Torchmark’s internal control over financial reporting. in accordance with the standards of /s/ DELOITTE & TOUCHE LLP Dallas, Texas February 27, 2015 54 TORCHMARK CORPORATION CONSOLIDATED BALANCE SHEETS (Dollar amounts in thousands except per share data) December 31, 2014 2013 Assets: Investments: Fixed maturities—available for sale, at fair value (amortized cost: 2014—$12,823,612; 2013—$12,488,875) . . . . . . . . . . . . . . . . . . . . . . . . . $14,493,060 $12,879,133 1,884 448,887 13,207 76,890 Equity securities, at fair value (cost: 2014—$776; 2013—$875) . . . . . . . . . Policy loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other long-term investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Short-term investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,477 472,109 10,449 15,882 Total investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14,992,977 13,420,001 Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Accrued investment income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other receivables . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Deferred acquisition costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Goodwill . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 66,019 204,879 543,988 3,471,781 441,591 493,495 36,943 200,038 331,103 3,337,649 441,591 424,419 Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $20,214,730 $18,191,744 Liabilities: Future policy benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $11,750,495 $11,256,155 Unearned and advance premiums . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 74,174 223,380 Policy claims and other benefits payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 94,286 Other policyholders’ funds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 72,275 212,137 95,446 Total policy liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12,130,353 11,647,995 Current and deferred income taxes payable . . . . . . . . . . . . . . . . . . . . . . . . . . . Other liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Short-term debt Long-term debt (estimated fair value: 2014—$1,148,749; 1,797,265 359,118 238,398 1,285,574 261,898 229,070 2013—$1,131,391) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 992,130 990,865 Total liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15,517,264 14,415,402 Shareholders’ equity: Preferred stock, par value $1 per share—Authorized 5,000,000 shares; outstanding: 0 in 2014 and in 2013 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0 0 Common stock, par value $1 per share—Authorized 320,000,000 shares; outstanding: (2014—134,218,183 issued, less 6,287,907 held in treasury and 2013—151,218,183 issued, less 16,965,802 held in treasury)* . . . . . . Additional paid-in capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Accumulated other comprehensive income (loss) . . . . . . . . . . . . . . . . . . . . . . . Retained earnings* . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Treasury stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 134,218 457,613 997,452 3,376,846 (268,663) 151,218 462,058 210,981 3,495,533 (543,448) Total shareholders’ equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,697,466 3,776,342 Total liabilities and shareholders’ equity . . . . . . . . . . . . . . . . . . . . . . . . . $20,214,730 $18,191,744 * Amounts have been retrospectively adjusted for the stock split described in Note 1. See accompanying Notes to Consolidated Financial Statements. 55 TORCHMARK CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS (Amounts in thousands except per share data) Year Ended December 31, 2014 2013 2012 Revenue: Life premium . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,966,300 $1,885,332 $1,808,524 1,047,379 Health premium . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 559 Other premium . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,856,462 Total premium . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,166,410 532 3,052,274 1,242,720 400 3,209,420 Net investment income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Realized investment gains (losses) . . . . . . . . . . . . . . . . . . . . . . . . . Other-than-temporary impairments . . . . . . . . . . . . . . . . . . . . . . . . . Other income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 729,207 23,548 0 2,121 3,964,296 709,743 10,668 (2,678) 1,931 3,771,938 693,644 43,433 (5,600) 1,577 3,589,516 Benefits and expenses: Life policyholder benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Health policyholder benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other policyholder benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total policyholder benefits . . . . . . . . . . . . . . . . . . . . . . . . . . 1,301,562 875,633 42,005 2,219,200 1,227,857 817,687 43,302 2,088,846 1,172,020 739,541 44,121 1,955,682 Amortization of deferred acquisition costs . . . . . . . . . . . . . . . . . . . Commissions, premium taxes, and non-deferred acquisition expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other operating expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Interest expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total benefits and expenses . . . . . . . . . . . . . . . . . . . . . . . . . 418,772 403,389 385,167 249,076 222,654 76,126 3,185,828 221,426 214,690 80,461 3,008,812 203,986 198,176 80,512 2,823,523 Income before income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 778,468 763,126 765,993 Income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (236,669) Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 542,939 $ 528,472 $ 529,324 (234,654) (235,529) Basic net income per share* . . . . . . . . . . . . . . . . . . . . . . . . . $ 4.15 $ 3.84 $ Diluted net income per share* . . . . . . . . . . . . . . . . . . . . . . . $ 4.09 $ 3.79 $ 3.65 3.60 * Per share amounts have been retrospectively adjusted for the stock split described in Note 1. See accompanying Notes to Consolidated Financial Statements. 56 TORCHMARK CORPORATION CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Amounts in thousands) Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 542,939 $ 2014 Year Ended December 31, 2013 528,472 $ 529,324 2012 Other comprehensive income (loss): Unrealized investment gains (losses): Unrealized gains (losses) on securities: Unrealized holding gains (losses) arising during period . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,312,841 (1,166,332) 657,954 Reclassification adjustment for (gains) losses on securities included in net income . . . . . . . . . . . . . . . . . . Reclassification adjustment for amortization of (discount) premium . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Foreign exchange adjustment on securities recorded at (23,771) (13,138) (41,745) (8,621) (6,569) 462 fair value . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Unrealized gains (losses) on securities . . . . . . . . . . . . . . . . . . . (1,567) 1,278,882 (1,173) (1,187,212) (4,334) 612,337 Unrealized gains (losses) on other investments: Unrealized holding gains (losses) arising during period . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Reclassification adjustment for (gains) losses included in net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Unrealized gains (losses) on other investments . . . . . . . . . . . . Total unrealized investment gains (losses) . . . . . . . . . . . . 4,180 28 2,517 0 4,180 1,283,062 3,532 3,560 (1,183,652) 0 2,517 614,854 Less applicable taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . Unrealized gains (losses) on investments, net of tax . . . . . . . . . . (448,985) 834,077 415,481 (768,171) (215,194) 399,660 Unrealized gains (losses) attributable to deferred acquisition costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Less applicable taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Unrealized gains (losses) attributable to deferred acquisition (6,200) 2,170 14,906 (5,217) 7,234 (2,532) costs, net of tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (4,030) 9,689 4,702 Foreign exchange translation adjustments, other than securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Less applicable taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (10,770) 3,290 (2,962) 1,220 3,487 (1,118) Foreign exchange translation adjustments, other than securities, net of tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (7,480) (1,742) 2,369 Pension adjustments: Amortization of pension costs . . . . . . . . . . . . . . . . . . . . . . . . . . Plan amendments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Experience gain (loss) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Pension adjustments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Less applicable taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Pension adjustments, net of tax . . . . . . . . . . . . . . . . . . . . . . . . . . . 10,285 0 (65,817) (55,532) 19,436 (36,096) 18,366 0 52,296 70,662 (24,732) 45,930 14,799 (3,452) (59,613) (48,266) 16,894 (31,372) Other comprehensive income (loss) . . . . . . . . . . . . . . . . . . . . . . . . . 786,471 (714,294) 375,359 Comprehensive income (loss) . . . . . . . . . . . . . . . . . . . . . . $1,329,410 $ (185,822) $ 904,683 See accompanying Notes to Consolidated Financial Statements. 57 TORCHMARK CORPORATION CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY (Amounts in thousands except per share data) Preferred Stock Common Stock Additional Paid-in Capital Accumulated Other Comprehensive Income (Loss) Retained Earnings Treasury Stock Total Shareholders’ Equity Year Ended December 31, 2012 Balance at January 1, 2012 . . . . . . . . . . . $0 $168,468 $425,331 $ 549,916 $3,208,555 $(492,639) $3,859,631 Comprehensive income (loss) . . . . . . . . . Common dividends declared ($.40 a share)* . . . . . . . . . . . . . . . . . . . . . . . . . . Acquisition of treasury stock . . . . . . . . . . . Stock-based compensation . . . . . . . . . . . Exercise of stock options . . . . . . . . . . . . . Retirement of treasury stock* . . . . . . . . . . 375,359 529,324 (57,592) (570,165) 3,192 (51,322) 232,344 (278,533) 314,847 904,683 (57,592) (570,165) 21,605 203,624 0 18,413 22,602 (26,564) (9,750) Balance at December 31, 2012 . . . . . . 0 158,718 439,782 925,275 3,350,432 (512,421) 4,361,786 Year Ended December 31, 2013 Comprehensive income (loss) . . . . . . . . . Common dividends declared ($.45 a share)* . . . . . . . . . . . . . . . . . . . . . . . . . . Acquisition of treasury stock . . . . . . . . . . . Stock-based compensation . . . . . . . . . . . Exercise of stock options . . . . . . . . . . . . . Retirement of treasury stock* . . . . . . . . . . (714,294) 528,472 (61,991) 563 (482,264) 1,615 (25,195) 122,871 (296,748) 326,751 (185,822) (61,991) (482,264) 25,642 118,991 0 23,464 21,315 (22,503) (7,500) Balance at December 31, 2013 . . . . . . 0 151,218 462,058 210,981 3,495,533 (543,448) 3,776,342 Year Ended December 31, 2014 Comprehensive income (loss) . . . . . . . . . Common dividends declared ($.51 a share) . . . . . . . . . . . . . . . . . . . . . . . . . . . Acquisition of treasury stock . . . . . . . . . . . Stock-based compensation . . . . . . . . . . . Exercise of stock options . . . . . . . . . . . . . Retirement of treasury stock . . . . . . . . . . . 786,471 542,939 1,329,410 (65,998) (449,308) 526 78,934 (573,349) 644,633 362 (22,641) (65,998) (449,308) 32,203 74,817 0 31,315 18,524 (54,284) (17,000) Balance at December 31, 2014 . . . . . . $0 $134,218 $457,613 $ 997,452 $3,376,846 $(268,663) $4,697,466 * Dollar and per share amounts have been retrospectively adjusted to give effect to the stock split described in Note 1. See accompanying Notes to Consolidated Financial Statements. 58 TORCHMARK CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (Amounts in thousands) Year Ended December 31, 2013 2012 2014 Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 542,939 $ Adjustments to reconcile net income to cash provided from operations: 528,472 $ 529,324 Increase in future policy benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Increase (decrease) in other policy benefits . . . . . . . . . . . . . . . . . . . . . . . . . Deferral of policy acquisition costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Amortization of deferred policy acquisition costs . . . . . . . . . . . . . . . . . . . . . Change in current and deferred income taxes . . . . . . . . . . . . . . . . . . . . . . . Realized (gains) losses on sale of investments and properties . . . . . . . . . Change in other receivables . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 585,632 (11,982) (567,271) 418,772 98,711 (23,548) (163,522) (15,023) 578,217 (6,006) (524,263) 403,389 76,121 (7,990) 50,900 20,440 497,306 (8,115) (480,818) 385,167 122,538 (37,833) (89,677) 24,947 Cash provided from operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 864,708 1,119,280 942,839 Cash used for investment activities: Investments sold or matured: Fixed maturities available for sale—sold . . . . . . . . . . . . . . . . . . . . . . . . . . . . Fixed maturities available for sale—matured, called, and repaid . . . . . . . . Equity securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other long-term investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 109,024 273,223 700 795 133,463 493,885 14,000 1,333 345,601 736,900 0 9,458 Total investments sold or matured . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 383,742 642,681 1,091,959 Acquisition of investments: Fixed maturities—available for sale . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other long-term investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total investments acquired . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Acquisition of Family Heritage, net of cash acquired . . . . . . . . . . . . . . . . . . . . Net increase in policy loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net (increase) decrease in short-term investments . . . . . . . . . . . . . . . . . . . . . Net change in payable or receivable for securities . . . . . . . . . . . . . . . . . . . . . Additions to properties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Sales of properties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Investments in low-income housing interests . . . . . . . . . . . . . . . . . . . . . . . . . . (704,993) 0 (704,993) 0 (23,222) 61,008 0 (19,367) 8,752 (56,083) (1,143,840) (591) (1,431,690) (1,786) (1,144,431) 0 (24,837) 17,970 (43,987) (11,168) 570 (51,176) (1,433,476) (186,424) (23,130) (73,616) 3,647 (4,667) 56 (72,388) Cash used for investment activities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (350,163) (614,378) (698,039) Cash provided from (used for) financing activities: Issuance of common stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Cash dividends paid to shareholders . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Issuance of 3.8% Senior Notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Issuance of 5.875% Junior Subordinated Debentures . . . . . . . . . . . . . . . . . . Issue expenses of debt offerings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Repayment of 7.375% Notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Redemption of 7.1% Junior Subordinated Debentures . . . . . . . . . . . . . . . . . . Net borrowing (repayment) of commercial paper . . . . . . . . . . . . . . . . . . . . . . . Excess tax benefit from stock option exercises . . . . . . . . . . . . . . . . . . . . . . . . Acquisition of treasury stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net receipts (payments) from deposit-type product . . . . . . . . . . . . . . . . . . . . . 56,294 (65,006) 0 0 0 0 0 9,328 18,524 (449,308) (69,792) 97,816 (60,911) 0 0 0 (94,050) 0 3,983 21,315 (482,264) (21,808) 181,022 (55,527) 150,000 125,000 (7,101) 0 (123,711) 245 22,602 (570,165) 8,523 Cash provided from (used for) financing activities . . . . . . . . . . . . . . . . . . . . . . . . (499,960) (535,919) (269,112) Effect of foreign exchange rate changes on cash . . . . . . . . . . . . . . . . . . . . . . . . 14,491 6,250 1,909 Increase (decrease) in cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Cash at beginning of year 29,076 36,943 (24,767) 61,710 (22,403) 84,113 Cash at end of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 66,019 $ 36,943 $ 61,710 See accompanying Notes to Consolidated Financial Statements. 59 TORCHMARK CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollar amounts in thousands except per share data) Note 1—Significant Accounting Policies Business: Torchmark Corporation (Torchmark or alternatively, through its subsidiaries provides a variety of life and health insurance products and annuities to a broad base of customers. the Company) Basis of Presentation: The accompanying consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (GAAP), under guidance issued by the Financial Accounting Standards Board (FASB). The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Principles of Consolidation: The consolidated financial statements include the results of Torchmark and its wholly-owned subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation. When Torchmark acquires a subsidiary or a block of business, the assets acquired and the liabilities assumed are measured at fair value at the acquisition date. Any excess of acquisition cost over the fair value of net assets is recorded as goodwill. Expenses incurred to effect the acquisition are charged to earnings as of the acquisition date. Upon acquisition, the accounts and results of operations are consolidated as of and subsequent to the acquisition date. Torchmark accounts for its variable interest entities (VIE’s) under accounting guidance which clarifies the definition of a variable interest and the instructions for consolidating VIE’s. Only primary beneficiaries are required or allowed to consolidate VIE’s. Therefore, a company may have voting control of a VIE, but if it is not the primary beneficiary of the VIE, it is not permitted to consolidate the VIE. The trust that was liable for Torchmark’s 7.1% Trust Preferred Securities that were redeemed in October, 2012 met the definition of a VIE. However, Torchmark was not the primary beneficiary of this entity because its interest was not variable. Therefore, Torchmark was not permitted to consolidate its interest, even though it owned 100% of the voting equity of the trust and guaranteed its performance. For this reason, Torchmark reported its 7.1% Junior Subordinated Debentures due to the trust as “Due to affiliates” each period at its carrying value. However, Torchmark viewed the Trust Preferred Securities as it does any other debt offering and consolidated the trust in its segment analysis because GAAP requires that the segment analysis be reported as management views its operations and financial condition. More information about the redemption of these securities is disclosed in Note 11—Debt. Additionally, as further described under the caption Low-Income Housing Tax Credit Interests below in this note, Torchmark holds passive interests in limited partnerships which provide investment returns through the provision of tax benefits (principally from the transfer of Federal or state tax credits related to federal low-income housing). These interests are also considered to be VIEs. They are not consolidated because the Company has no power to control the activities that most significantly affect the economic performance of these entities and therefore the Company is not the primary beneficiary of any of these interests. Torchmark’s involvement is limited to its limited partnership interest in the entities. Torchmark has not provided any other financial support to the entities beyond its commitments to fund its limited partnership interests, and there are no arrangements or agreements with any of the interests to provide other financial support. The maximum loss exposure relative to these interests is limited to their carrying value. When a component of Torchmark’s business is sold or expected to be sold during the ensuing year, Torchmark reports the assets and liabilities of the component as assets and liabilities of subsidiaries held for sale. Assets or liabilities of subsidiaries held for sale are segregated and are recorded in the Consolidated Balance Sheets at the lower of the carrying amount or estimated fair value less cost to sell. If the carrying amount of the business exceeds its estimated fair value, a loss is recognized. Torchmark reports the results of operations of a business as discontinued operations when the component is sold or 60 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) (Dollar amounts in thousands except per share data) Note 1—Significant Accounting Policies (continued) expected to be sold, the operations and cash flows of the business have been or will be eliminated from the ongoing operations as a result of the disposal transaction, and Torchmark will not have any significant continuing involvement in the operations of the business after the disposal transaction. The results of discontinued operations are reported in discontinued operations in the Consolidated Statements of Operations for current and prior periods commencing in the period in which the business is either disposed of or is accounted for as a disposal group, including any gain or loss recognized on the sale or adjustment of the carrying amount to fair value less cost to sell. Investments: Torchmark classifies all of its fixed-maturity investments, which include bonds and redeemable preferred stocks, as available for sale. Investments classified as available for sale are carried at fair value with unrealized gains and losses, net of deferred taxes, reflected directly in accumulated other comprehensive income. Investments in equity securities, which include common and nonredeemable preferred stocks, are reported at fair value with unrealized gains and losses, net of deferred taxes, reflected directly in accumulated other comprehensive income. Policy loans are carried at unpaid principal balances. Mortgage loans, included in “Other long-term investments,” are carried at amortized cost. Investments in real estate, included in “Other long-term investments,” are reported at cost less allowances for depreciation. Depreciation is calculated on the straight-line method. Short-term investments include investments in interest-bearing time deposits with original maturities of twelve months or less. Gains and losses realized on the disposition of investments are determined on a specific identification basis. Income attributable to investments is included in Torchmark’s net investment income. Net income and realized investment gains and losses are not allocated to insurance policyholders’ liabilities. investment Fair Value Measurements, Investments in Securities: Torchmark measures the fair value of its fixed maturities and equity securities based on a hierarchy consisting of three levels which indicate the quality of the fair value measurements as described below: • • • Level 1 – fair values are based on quoted prices in active markets for identical assets or liabilities that the Company has the ability to access as of the measurement date. Level 2 – fair values are based on inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. Level 2 inputs include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability, or inputs that can otherwise be corroborated by observable market data. Level 3 – fair values are based on inputs that are considered unobservable where there is little, if any, market activity for the asset or liability as of the measurement date. In this circumstance, the Company has to rely on values derived by independent brokers or internally-developed assumptions. Unobservable inputs are developed based on the best information available to the Company which may include the Company’s own data or bid and ask prices in the dealer market. therefore determines the fair values of The great majority of the Company’s fixed maturities are not actively traded and direct quotes are not generally available. Management these securities after consideration of data provided by third-party pricing services and independent broker/dealers. Over 99% of the fair value reported at December 31, 2014 was determined using data provided by third-party pricing services. Prices provided by third-party pricing services are not binding offers but are estimated exit values. They are based on observable market data inputs which can vary by security type. Such inputs include benchmark yields, available trades, broker/dealer quotes, issuer spreads, benchmark securities, bids, offers, and other market data. Management reviews and analyzes all prices obtained to insure the reasonableness of the values, taking all available information into account. In addition, management corroborates the prices obtained from third-party sources against other independent sources. When 61 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) (Dollar amounts in thousands except per share data) Note 1—Significant Accounting Policies (continued) corroborated prices produce small variations, the close correlation indicates observable inputs, and the mean value is used. When corroborated prices present greater variations, additional analysis is required to determine which value is the most appropriate. When only one price is available, management evaluates observable inputs and performs additional analysis to confirm that the price is appropriate. All fair value measurements based on prices determined with observable market data are reported as Level 1 or Level 2 measurements. When third-party vendor prices are not available, the Company attempts to obtain at least three quotes from broker/dealers for each security. When at least three quotes are obtained, and the standard deviation of such quotes is less than 3%, (suggesting that the independent quotes were likely derived using similar observable inputs), the Company uses the mean quote and classifies the measurement as Level 2. At December 31, 2014 and 2013, there were no assets valued as Level 2 in this manner with broker quotes. When the standard deviation is 3% or greater, or the Company cannot obtain three quotes, then additional information and management judgment are required to establish the fair value. Further review is performed on the available quotes to determine if they can be corroborated within reasonable tolerance to any other observable evidence. If one of the quotes or the mean of the available quotes can be corroborated with other observable evidence, then the value is reported as Level 2. Otherwise, the value is classified as Level 3. The Company uses information and valuation techniques deemed appropriate for determining the point within the range of reasonable fair value estimates that is most representative of fair value under current market conditions. As of December 31, 2014 and 2013, fair value measurements classified as Level 3 represented 4.0% and 2.8%, respectively, of total fixed maturities and equity securities. Transfers between levels are recognized as of the end of the period of transfer. Beginning in 2012, Torchmark began investing in a portfolio of private placement bonds which are not actively traded. This portfolio is managed by a third party and was $497 million at amortized cost on December 31, 2014, compared with $313 million a year earlier. The portfolio manager provides valuations for the bonds based on a pricing matrix utilizing observable inputs, such as the benchmark treasury rate and published sector indices, and unobservable inputs such as an internally-developed credit rating. If the unobservable inputs can be closely corroborated with publicly available information, the fair values are classified as Level 2. If they cannot be corroborated, the fair values are classified as Level 3. As of December 31, 2014 and 2013, all private placements were classified as Level 3. The fair values for each class of security and by valuation hierarchy level are indicated in Note 4— Investments under the caption Fair value measurements. Fair Value Measurements, Other Financial Instruments: Fair values for cash, short-term investments, short-term debt, receivables and payables approximate carrying value. Policy loans are an integral part of Torchmark’s subsidiaries’ life insurance policies in force and cannot be valued separately. The fair values of Torchmark’s long-term debt issues are based on the same methodology as investments in fixed maturities. Because observable inputs were available for these debt securities at December 31, 2014, they were classified as Level 2 in the valuation hierarchy. The fair value for each debt instrument as of December 31, 2014 is disclosed in Note 11—Debt. As described in Note 9—Postretirement Benefits, Torchmark maintains an unqualified supplemental retirement plan. Because this plan is unfunded, the assets which support the liability for this plan are considered general assets of the Company. These assets consist of the cash value of corporate-owned life insurance policies and exchange traded funds (ETF’s). The fair value of the insurance cash values approximates carrying value. Fair values for the ETF’s are derived from direct quotes and are considered Level 1 in the valuation hierarchy. Impairment of Investments: Torchmark’s portfolio of fixed maturities fluctuates in value due to changes in interest rates in the financial markets as well as other factors. Fluctuations caused by market interest rate changes have little bearing on whether or not the investment will be ultimately recoverable. 62 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) (Dollar amounts in thousands except per share data) Note 1—Significant Accounting Policies (continued) Therefore, Torchmark considers these declines in value resulting from changes in market interest rates to be temporary. In certain circumstances, however, Torchmark determines that the decline in the value of a security is other-than-temporary and writes the book value of the security down to its fair value, realizing an investment loss. The evaluation of Torchmark’s securities for other-than-temporary impairments is a process that is undertaken at least quarterly and is overseen by a team of Company investment and accounting professionals. Each security which is impaired because the fair value is less than the cost or amortized cost is identified and evaluated. The determination that an impairment is other-than-temporary is highly subjective and involves the careful consideration of many factors. Among the factors considered are: • • • The length of time and extent to which the security has been impaired The reason(s) for the impairment The financial condition of the issuer and the near-term prospects for recovery in fair value of the security The Company’s ability and intent to hold the security until anticipated recovery • • Expected future cash flows In many cases, management believes it The relative weight given to each of these factors can change over time as facts and circumstances change. to prospective factors than to retrospective factors. Prospective factors that are given more weight include prospects for recovery, the Company’s ability and intent to hold the security until anticipated recovery, and expected future cash flows. is appropriate to give relatively more weight Among the facts and information considered in the process are: • Default on a required payment • • Issuer bankruptcy filings Financial statements of the issuer • Changes in credit ratings of the issuer • The value of underlying collateral • News and information included in press releases issued by the issuer • News and information reported in the media concerning the issuer • News and information published by or otherwise provided by credit analysts • Recent cash flows While all available information is taken into account, it is difficult to predict the ultimately recoverable amount of a distressed or impaired security. If a security is determined to be other-than-temporarily impaired, the cost basis of the security is written down to fair value and is treated as a realized loss in the period the determination is made. The written-down security will be amortized and revenue recognized in accordance with estimated future cash flows. Current accounting guidance is such that if an entity intends to sell or if it is more likely than not that it will be required to sell an impaired security prior to recovery of its cost basis, the security is to be impairment must be charged to considered other-than-temporarily impaired and the full amount of earnings. Otherwise, losses on fixed maturities which are other-than-temporarily impaired are separated into two categories, the portion of loss which is considered credit loss and the portion of loss which is due to other factors. The credit loss portion is charged to earnings while the loss due to other factors is 63 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) (Dollar amounts in thousands except per share data) Note 1—Significant Accounting Policies (continued) charged to other comprehensive income. The credit loss portion of an impairment is determined as the difference between the security’s amortized cost and the present value of expected future cash flows discounted at the security’s original effective yield rate. The temporary portion is the difference between this present value of expected future cash flows and fair value (as discounted by a market yield). The expected cash flows are determined using judgment and the best information available to the Company. Inputs used to derive expected cash flows include expected default rates, current levels of subordination, and loan-to-collateral value ratios. Management believes that the present value of future cash flows at the original effective yield is a better measure of valuation, because fair value determined by a discounted market yield is often based on limited observable market data, and the market for these securities is generally neither active nor orderly. Cash: Cash consists of balances on hand and on deposit in banks and financial institutions. Overdrafts arising from the overnight investment of funds offset cash balances on hand and on deposit. long- Recognition of Premium Revenue and Related Expenses: Premium income for traditional duration life and health insurance products is recognized when due from the policyholder. Premiums for short-duration health contracts are recognized as revenue over the contract period in proportion to the insurance protection provided. Profits for limited-payment life insurance contracts are recognized over the contract period. Premiums for universal life-type and annuity contracts are added to the policy account value, and revenues for such products are recognized as charges to the policy account value for mortality, administration, and surrenders (retrospective deposit method). Life premium includes policy charges of $21 million, $22 million, and $23 million for the years ended December 31, 2014, 2013, and 2012, respectively. Other premium consists of annuity policy charges in each year. Profits are also earned to the extent that investment income exceeds policy liability interest requirements. The related benefits and expenses are matched with revenues by means of the provision of future policy benefits and the amortization of deferred acquisition costs in a manner which recognizes profits as they are earned over the same period. Future Policy Benefits: The liability for future policy benefits for universal life-type products is represented by policy account value. The liability for future policy benefits for all other life and health products, approximately 84% of total future policy benefits, is determined on the net level premium method. This method provides for the present value of expected future benefit payments less the present value of expected future net premiums, based on estimated investment yields, mortality, morbidity, persistency and other assumptions which were considered appropriate at the time the policies were issued. For limited-payment contracts, a deferred profit liability is also recorded which causes profits to emerge over the life of the contract in proportion to policies in force. Assumptions used for traditional life and health insurance products are based primarily on Company experience. Assumptions for interest rates range from 2.5% to 7.0% for Torchmark’s insurance companies with an overall weighted average assumed rate of 5.7%. Mortality tables used for individual life insurance include various statutory tables and modifications of a variety of generally accepted actuarial tables. Morbidity assumptions for individual health are based on Company experience and industry data. Withdrawal and termination assumptions are based on Torchmark’s experience. Once established, assumptions for these products are generally not changed. An additional provision is made on most products to allow for possible adverse deviation from the assumptions. These estimates are periodically reviewed and compared with actual experience. If it is determined that existing contract liabilities, together with the present value of future gross premiums, will not be sufficient to cover the present value of future benefits and to recover unamortized deferred acquisition costs, then a premium deficiency exists. Such a deficiency would be recognized immediately by a charge to earnings and either a reduction of unamortized deferred acquisition costs or an increase in the liability for future policy benefits. From that point forward, the liability for future policy benefits would be based on the revised assumptions. 64 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) (Dollar amounts in thousands except per share data) Note 1—Significant Accounting Policies (continued) Deferred Acquisition Costs: Certain costs of acquiring new insurance business are deferred and recorded as an asset. These costs are essential for the acquisition of new insurance business and are directly related to the successful issuance of an insurance contract including sales commissions, policy issue costs, and underwriting costs. Additionally, deferred acquisition costs include the value of insurance purchased, which are the costs of acquiring blocks of insurance from other companies or through the acquisition of other companies. These costs represent the difference between the fair value of the contractual insurance assets acquired and liabilities assumed compared against the assets and liabilities for insurance contracts that the Company issues or holds measured in accordance with GAAP. Deferred acquisition costs and the value of insurance purchased are amortized in a systematic manner which life-type policies are matches these costs with the associated revenues. Policies other than universal amortized with interest over the estimated premium-paying period of the policies in a manner which charges each year’s operations in proportion to the receipt of premium income. Universal life-type policies are amortized with interest in proportion to estimated gross profits. The assumptions used to amortize acquisition costs with regard to interest, mortality, morbidity, and persistency are consistent with those used to estimate the liability for future policy benefits. For interest-sensitive and deposit-balance type products, these assumptions are reviewed on a regular basis and are revised if actual experience differs significantly from original expectations. For all other products, amortization assumptions are generally not revised once established. Deferred acquisition costs are subject to periodic recoverability and loss recognition testing to determine if there is a premium deficiency. These tests evaluate whether the present value of future contract-related cash flows will support the capitalized deferred acquisition cost asset. These cash flows consist primarily of premium income, less benefits and expenses taking inflation into account. The present value of these cash flows, less the benefit reserve, is then compared with the unamortized deferred acquisition cost balance. In the event the estimated present value of net cash flows is less, the deficiency would be recognized by a charge to earnings and either a reduction of unamortized acquisition costs or an increase in the liability for future benefits, as described under the caption Future Policy Benefits. Advertising Costs: Costs related to advertising are generally charged to expense as incurred. response advertising costs are capitalized when there is a reliable and However, certain direct demonstrated relationship between total costs and future benefits that is a direct result of incurring these costs. Torchmark’s Direct Response advertising costs consist primarily of the production and distribution costs of direct mail advertising materials, and when capitalized are included as a component of deferred acquisition costs. They are amortized in the same manner as other deferred acquisition costs. Direct response advertising costs charged to earnings and included in other operating expense were $8 million, $6 million, and $16 million in 2014, 2013, and 2012, respectively. Capitalized advertising costs included within deferred acquisition costs were $1.15 billion at December 31, 2014 and $1.09 billion at December 31, 2013. Policy Claims and Other Benefits Payable: Torchmark establishes a liability for known policy benefits payable and an estimate of claims that have been incurred but not yet reported to the Company. The estimate of unreported claims is based on prior experience. Torchmark makes an estimate after careful evaluation of all information available to the Company. However, there is no certainty the stated liability for claims and other benefits, including the estimate of unsubmitted claims, will be Torchmark’s ultimate obligation. Income Taxes: Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement book values and tax bases of assets and liabilities. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. More information concerning income taxes is provided in Note 8—Income Taxes. 65 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) (Dollar amounts in thousands except per share data) Note 1—Significant Accounting Policies (continued) Property and Equipment: Property and equipment, included in “Other assets,” is reported at cost less allowances for depreciation. Depreciation is recorded primarily on the straight line method over the estimated useful lives of these assets which range from three to ten years for equipment and five to forty years for buildings and improvements. Ordinary maintenance and repairs are charged to income as incurred. Impairments, if any, are recorded when, based on events and circumstances, it becomes evident that the fair value of the asset is less than its carrying amount. Original cost of property and equipment was $139 million at December 31, 2014 and $136 million at December 31, 2013. Accumulated depreciation was $85 million at year end 2014 and $85 million at the end of 2013. Depreciation expense was $7.4 million in 2014, $6.4 million in 2013, and $7.1 million in 2012. During 2013, Liberty National Life Insurance Company (Liberty National), a Torchmark subsidiary, sold real estate for a loss of $265 thousand after a previous write-down for other-than-temporary impairment of $2.7 million earlier in the year. The sale of this property eliminated substantially all asbestos-related liability for Torchmark. Low-Income Housing Tax Credit Interests: As of December 31, 2014, Torchmark had $318 million invested in limited partnerships that provide low-income housing tax credits and other related Federal income tax and state premium tax benefits to Torchmark. The carrying value of Torchmark’s investment in these entities was $290 million at December 31, 2013. As of December 31, 2014, Torchmark was obligated under future commitments of $76 million, which is included in the above carrying value. Interests for which the return has been guaranteed by unrelated third-parties are accounted for using the effective-yield method. The remaining interests are accounted for using the amortized-cost method. The Federal income benefits accrued during each of the years presented, net of the amortization associated with guaranteed interests, were recorded in “Income taxes.” Amortization associated with non- guaranteed interests and interests providing for state premium tax benefits was reflected as a component of “Net investment income.” All state premium tax benefits, net of the related amortization, were recorded in “Net investment income.” At December 31, 2014, $313 million associated with the Federal interests was included in “Other assets” with the remaining $5 million state-related interests included in “Other invested assets.” At December 31, 2013, the comparable amounts were $283 million and $7 million, respectively. Any unpaid commitments to invest are recorded in “Other liabilities.” In the segment analysis, the amortization associated with the non-guaranteed interests is reflected as a component of “Income tax expenses,” and not “Net investment income,” consistent with the treatment of the guaranteed interests. Management views this presentation as a more accurate matching of costs with the associated revenues with respect to the low-income housing interests. As described later in this note, under the caption Unadopted Accounting Policies, Torchmark will adopt new accounting guidance concerning its interests in low-income housing beginning in 2015. The new guidance will result in accounting for these items in a manner more consistent with the Company’s segment analysis. is subject to annual Goodwill: The excess cost of business acquired over the fair value of net assets acquired is reported as goodwill. Goodwill impairment testing based on certain procedures outlined by GAAP. These procedures include a qualitative assessment as to whether it is more likely than not that goodwill is impaired, and they also require consideration of a change in relevant events or circumstances that could possibly affect the valuation of a goodwill reporting unit. If it is determined that an impairment is likely, the procedures then involve measuring the carrying value of each reporting unit of Torchmark’s segments, the corresponding unit. If the carrying value of a unit including goodwill exceeds its estimated fair value, then the goodwill in that unit could potentially be impaired. In that event, further testing is required under the accounting guidance to determine the amount of impairment, if any. If there is an impairment in the goodwill of any reporting unit, it is written down and charged to earnings in the period of test. the estimated fair value of including the goodwill of that unit, against Torchmark has tested its goodwill annually in each of the years 2012 through 2014. These tests, performed in the second quarter each year, involved assigning carrying value by allocating the Company’s net assets to each of the reporting units of Torchmark’s segments, including the portion of 66 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) (Dollar amounts in thousands except per share data) Note 1—Significant Accounting Policies (continued) In 2012, the qualitative assessment was employed as permitted by goodwill assigned to the unit. accounting guidance. Based on the analyses as outlined in the guidance, it was determined that an impairment of goodwill was not likely. In both 2014 and 2013, the fair values of the various reporting units were developed. The fair value of each reporting unit was determined using discounted expected cash flows associated with that unit. Judgment and assumptions are used in developing the projected cash flows for the reporting units, and such estimates are subject to change. The Company also exercises judgment in the determination of the discount rate, which management believes to be appropriate for the risk associated with the cash flow expectations. The fair value of each reporting unit is then measured against that reporting unit’s corresponding carrying value. Because the estimated fair value substantially exceeded the carrying value, including goodwill, of each reporting unit in each period, Torchmark’s goodwill was not impaired in any of those periods. Treasury Stock: Torchmark accounts for purchases of treasury stock on the cost method. Issuance of treasury stock is accounted for using the weighted-average cost method. Postretirement Benefits: Torchmark accounts for its postretirement defined benefit plans by recognizing the funded status of those plans on its Consolidated Balance Sheets in accordance with accounting guidance. Periodic gains and losses attributable to changes in plan assets and liabilities that are not recognized as components of net periodic benefit costs are recognized as components of other comprehensive income, net of tax. More information concerning the accounting and disclosures for postretirement benefits is found in Note 9—Postretirement Benefits. Stock Compensation: Torchmark accounts for stock-based compensation by recognizing an expense in the financial statements based on the “fair value method.” The fair value method requires that a fair value be assigned to a stock option or other stock grant on its grant date and that this value be amortized over the grantees’ service period. The fair value method requires the use of an option valuation model to value employee stock options. Torchmark has elected to use the Black-Scholes valuation model for option expensing. A summary of assumptions for options granted in each of the three years 2012 through 2014 is as follows: Volatility factor . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Dividend yield . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Expected term (in years) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Risk-free rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2014 2013 2012 30.9% 38.5% 39.4% .89% 1.1% 1.0% 5.65 5.62 5.55 1.9% 1.1% 1.3% The expected term is generally derived from Company experience. However, expected terms are determined based on the simplified method as permitted by Staff Accounting Bulletins 107 and 110 when company experience is insufficient. The Torchmark Corporation 2011 Incentive Plan replaced all previous plans and allows for option grants with a ten-year contractual term which vest over five years in addition to seven-year grants which vest over three years as permitted by the previous plans. The Company has sufficient experience with seven-year grants that vest in three years, but insufficient historical experience with five-year vesting. Therefore, Torchmark has used the simplified method to determine the expected term for the ten-year grants with five-year vesting and will do so until adequate experience is developed. Volatility and risk-free interest rates are assumed over a period of time consistent with the expected term of the option. Volatility is measured on a historical basis. Monthly data points are utilized to derive volatility for periods greater than three years. Expected dividend yield is based on current dividend yield held constant over the expected term. Once the fair value of an option has been determined, it is amortized on a straight-line basis over the employee’s service period for that grant (from the grant date to the date the grant is fully vested). Expenses for restricted stock and restricted stock units are based on the grant-date fair value allocated on a straight-line basis over the service period. Performance share expense is recognized based on management’s estimate of the probability of meeting the metrics identified in the performance share award agreement, assigned to each service period as these estimates develop. 67 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) (Dollar amounts in thousands except per share data) Note 1—Significant Accounting Policies (continued) Torchmark management views all stock-based compensation expense as a corporate or Parent Company expense and, therefore, presents it as such in its segment analysis (See Note 14—Business Segments). It is included in “Other operating expense” in the Consolidated Statements of Operations. Stock Split: Torchmark declared a three-for-two stock split paid in the form of a 50% stock dividend on all of the Company’s outstanding common stock, having a record date of June 2, 2014. On July 1, 2014, the payment date, holders of Torchmark common stock received one additional share of stock for every two shares held. Upon completion of the transaction, Torchmark had 139,218,183 shares issued at a par value of $1 per share and 131,031,843 shares outstanding after giving effect to the purchase of $26 thousand in fractional shares on July 1, 2014. Shareholders’ equity component amounts as of December 31, 2013 were retrospectively adjusted to reflect this stock dividend. All share and per share amounts have been adjusted to reflect this stock split for all periods presented in these consolidated financial statements. Earnings Per Share: Torchmark presents basic and diluted earnings per share (EPS) on the face of the Consolidated Statements of Operations. Basic EPS is computed by dividing income available to common shareholders by the weighted average common shares outstanding for the period. Diluted EPS is calculated by adding to shares outstanding the additional net effect of potentially dilutive securities or contracts, such as stock options, which could be exercised or converted into common shares. For more information on earnings per share, see Note 12—Shareholders’ Equity. Unadopted Accounting Policies Low-income housing tax credits: The FASB has issued new accounting guidance, Investments- Equity Method and Joint Ventures: Accounting for Investments in Qualified Affordable Housing Projects (ASU 2014-01). This accounting guidance replaces the effective yield method of accounting with respect to investments in qualified affordable housing projects and, if certain conditions are present, provides for a new method of accounting. The new method of accounting allows an investor to amortize the cost of its investment based on the proportion of the tax credits/benefits received during the year to the total expected tax credits/benefits to be received over the life of the investment and will be recognized in the Consolidated Statements of Operations as a component of “Income tax expense.” Additional disclosures are required concerning investments in qualified affordable housing. The new guidance is effective for Torchmark beginning January 1, 2015, with early adoption permitted. The guidance continues to permit the effective-yield method for investments held as of the date of adoption. Adoption is required on a retrospective basis. Torchmark does not expect that adoption will have a material impact on the consolidated financial statements. Revenue recognition: The FASB issued Accounting Standard Update No. 2014-09 Revenue from Contracts with Customers (ASU 2014-09), to clarify the principles for recognizing revenue, to provide more consistency and comparability in revenue recognition practices, and to simplify recognition requirements along with other improvements. ASU 2014-09 will be effective for Torchmark beginning in calendar year 2017. The Company is currently evaluating this new guidance. Torchmark’s revenues consist of insurance premium and revenues related to financial instruments. These forms of revenue are not within the scope of ASC 2014-09 because they are addressed by other guidance. Therefore, Torchmark does not expect that the implementation of this guidance will result in any significant change in the manner the Company recognizes its revenue. Share-based performance awards: New accounting guidance has also been issued pertaining to share awards with performance targets. This standard, entitled Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could be Achieved After the Requisite Service Period (ASU 2014-12), is effective for Torchmark beginning in calendar year 2016, with early the adoption permitted. The new guidance provides that the Company must take into account 68 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) (Dollar amounts in thousands except per share data) Note 1—Significant Accounting Policies (continued) performance target in the recognition of compensation expense once the achievement of the performance target is probable. Torchmark has a limited number of such awards, but currently accounts for these items consistent with the new guidance. Therefore, no material impact is expected from adoption. Going concern: The FASB has issued Presentation of Financial Statements – Going Concern (Subtopic 205-40): Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern (ASU 2014-15). This new standard requires management to perform interim and annual assessments of the entity’s ability to continue its business operations within one year of the date of issuance of its financial statements. The Company must then provide certain disclosures if there is substantial doubt about its ability to continue as a going concern. ASU 2014-15 is effective for Torchmark for the year ended December 31, 2016 and for interim periods thereafter. Early adoption is permitted. Note 2—Statutory Accounting Life insurance subsidiaries of Torchmark are required to file statutory financial statements with state insurance regulatory authorities. Accounting principles used to prepare these statutory financial statements differ from GAAP. Consolidated net income and shareholders’ equity (capital and surplus) on a statutory basis for the insurance subsidiaries were as follows: Net Income Year Ended December 31, 2012 2013 2014 Shareholders’ Equity At December 31, 2013 2014 Life insurance subsidiaries . . . . . . . . . . . . . . $446,439 $572,509 $484,327 $1,262,624 $1,328,803 The excess, if any, of shareholder’s equity of the insurance subsidiaries on a GAAP basis over that determined on a statutory basis is not available for distribution by the insurance subsidiaries to Torchmark without regulatory approval. Insurance subsidiaries’ statutory capital and surplus necessary to satisfy regulatory requirements in the aggregate was $439 million at December 31, 2014. More information on the restrictions on the payment of dividends can be found in Note 12—Shareholders’ Equity. Torchmark’s statutory financial statements are presented on the basis of accounting practices prescribed by the insurance department of the state of domicile of each insurance subsidiary. All states have adopted the National Association of (NAIC) statutory accounting practices (NAIC SAP) as the basis for statutory accounting. However, certain states have retained the prescribed practices of their respective insurance code or administrative code which can differ from NAIC SAP. There are no significant differences between NAIC SAP and the accounting practices prescribed by the states of domicile for Torchmark’s life insurance companies that affect statutory surplus. Insurance Commissioners’ 69 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) (Dollar amounts in thousands except per share data) Note 3—Supplemental Information About Changes to Accumulated Other Comprehensive Income An analysis in the change in balance by component of Accumulated Other Comprehensive Income is as follows for the twelve months ended December 31, 2014 and 2013. Components of Accumulated Other Comprehensive Income For the twelve months ended December 31, 2013: Available for Sale Assets Deferred Acquisition Costs Foreign Exchange Pension Adjustments Total Balance at January 1, 2013 . . . . . . . . . . . $1,024,367 Other comprehensive income (loss) before reclassifications, net of tax . . . . Reclassifications, net of tax . . . . . . . . . . . (758,857) (9,314) Other comprehensive income (loss) . . . . (768,171) $(16,417) $26,608 $(109,283) $ 925,275 9,689 0 9,689 (1,742) 0 (1,742) 33,992 11,938 (716,918) 2,624 45,930 (714,294) Balance at December 31, 2013 . . . . . . . . 256,196 (6,728) 24,866 (63,353) 210,981 For the twelve months ended December 31, 2014: Other comprehensive income (loss) before reclassifications, net of tax . . . . Reclassifications, net of tax . . . . . . . . . . . 855,132 (21,055) (4,030) 0 (7,480) 0 (42,781) 6,685 800,841 (14,370) Other comprehensive income (loss) . . . . 834,077 (4,030) (7,480) (36,096) 786,471 Balance at December 31, 2014 . . . . . . . . $1,090,273 $(10,758) $17,386 $ (99,449) $ 997,452 Reclassifications out of Accumulated Other Comprehensive Income are presented below for the twelve months ended December 31, 2014 and 2013. Reclassification Adjustments Twelve months ended December 31, Component Line Item 2014 2013 Affected line items in the Statement of Operations Unrealized gains (losses) on available for sale assets: Realized (gains) losses . . . . . . . . . . . . . . . . . . Amortization of (discount) premium . . . . . . . . Total before tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . Tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total after tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (8,621) (32,392) 11,337 (21,055) (16,175) 6,861 (9,314) Income Taxes $(23,771) $ (9,606) Realized investment gains (losses) (6,569) Net investment income Pension adjustments: Amortization of prior service cost . . . . . . . . . . Amortization of actuarial (gain) loss . . . . . . . . Total before tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . Tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total after tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total reclassifications (after tax) . . . . . . . . . . . . . . . 2,113 8,172 10,285 (3,600) 6,685 2,276 Other operating expenses 16,090 Other operating expenses 18,366 (6,428) 11,938 $(14,370) $ 2,624 Income Taxes 70 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) (Dollar amounts in thousands except per share data) Note 4—Investments Portfolio Composition: A summary of fixed maturities available for sale and equity securities by cost or amortized cost and estimated fair value at December 31, 2014 and 2013 is as follows: 2014: Cost or Amortized Cost Gross Unrealized Gains Gross Unrealized Losses Fair Value Amount per the Balance Sheet % of Total Fixed Maturities* Fixed maturities available for sale: Bonds: U.S. Government direct, guaranteed, and government-sponsored enterprises . . . . . . . . . . . . . . . . . . . . $ States, municipalities, and political subdivisions . . . . . . . . . . . . . . . . . . . Foreign governments . . . . . . . . . . . . . Corporates . . . . . . . . . . . . . . . . . . . . . . Collateralized debt obligations . . . . . . Other asset-backed securities . . . . . . Redeemable preferred stocks . . . . . . . . 367,463 $ 5,561 $ (3,183) $ 369,841 $ 369,841 3% 1,278,429 25,824 10,565,620 67,876 21,424 496,976 177,052 1,350 1,501,212 4,165 1,104 57,626 (718) (1) (60,880) (8,809) 0 (5,031) 1,454,763 27,173 12,005,952 63,232 22,528 549,571 1,454,763 27,173 12,005,952 63,232 22,528 549,571 10 0 83 0 0 4 Total fixed maturities . . . . . . . . . . . . . . 12,823,612 1,748,070 (78,622) 14,493,060 14,493,060 100% Equity securities . . . . . . . . . . . . . . . . . . . . . 776 701 0 1,477 1,477 Total fixed maturities and equity securities . . . . . . . . . . . . . . . . . . . . . $12,824,388 $1,748,771 $(78,622) $14,494,537 $14,494,537 2013: Cost or Amortized Cost Gross Unrealized Gains Gross Unrealized Losses Fair Value Amount per the Balance Sheet % of Total Fixed Maturities* Fixed maturities available for sale: Bonds: U.S. Government direct, guaranteed, and government-sponsored enterprises . . . . . . . . . . . . . . . . . . . . $ States, municipalities, and political subdivisions . . . . . . . . . . . . . . . . . . . Foreign governments . . . . . . . . . . . . . Corporates . . . . . . . . . . . . . . . . . . . . . . Collateralized debt obligations . . . . . . Other asset-backed securities . . . . . . Redeemable preferred stocks . . . . . . . . 428,106 $ 362 $ (75,295) $ 353,173 $ 353,173 3% 1,278,434 43,811 10,133,868 66,173 35,568 502,915 69,817 411 702,867 0 2,699 25,064 (12,947) (67) (300,389) (7,968) (98) (14,198) 1,335,304 44,155 10,536,346 58,205 38,169 513,781 1,335,304 44,155 10,536,346 58,205 38,169 513,781 10 0 82 1 0 4 Total fixed maturities . . . . . . . . . . . . . . 12,488,875 801,220 (410,962) 12,879,133 12,879,133 100% Equity securities . . . . . . . . . . . . . . . . . . . . . 875 1,009 0 1,884 1,884 Total fixed maturities and equity securities . . . . . . . . . . . . . . . . . . . . . $12,489,750 $802,229 $(410,962) $12,881,017 $12,881,017 * At fair value 71 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) (Dollar amounts in thousands except per share data) Note 4—Investments (continued) A schedule of fixed maturities by contractual maturity at December 31, 2014 is shown below on an amortized cost basis and on a fair value basis. Actual maturities could differ from contractual maturities due to call or prepayment provisions. Fixed maturities available for sale: Due in one year or less . . . . . . . . . . . . . . . . . . . . . . . . . . Due from one to five years . . . . . . . . . . . . . . . . . . . . . . . Due from five to ten years . . . . . . . . . . . . . . . . . . . . . . . . Due from ten to twenty years . . . . . . . . . . . . . . . . . . . . . Due after twenty years . . . . . . . . . . . . . . . . . . . . . . . . . . . Mortgage-backed and asset-backed securities . . . . . . . Amortized Cost Fair Value $ 195,358 477,616 963,368 3,621,769 7,473,762 91,739 $12,823,612 $ 198,639 535,088 1,062,424 4,168,982 8,439,509 88,418 $14,493,060 Analysis of investment operations: Year Ended December 31, 2013 2014 2012 Net investment income is summarized as follows: Fixed maturities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 732,925 $ Equity securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Policy loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other long-term investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Short-term investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Less investment expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net investment income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 729,207 $ 8 35,015 1,508 75 769,531 (40,324) 709,756 323 33,471 1,281 138 744,969 (35,226) 709,743 $691,229 1,178 30,717 2,320 311 725,755 (32,111) $693,644 An analysis of realized gains (losses) from investments is as follows: Realized investment gains (losses): Fixed maturities: Sales and other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ Other-than-temporary impairments . . . . . . . . . . . . . . . . . . . . . . . . Equity securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Loss on redemption of debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Applicable tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Realized gains (losses) from investments, net of tax . . . . . . . . . . . . . . . . . $ 23,170 $ 0 601 (258) 35 23,548 (8,242) 15,306 $ 13,138 0 0 0 (5,148) 7,990 (4,025) 3,965 $ 47,345 (5,600) 0 (4,109) 197 37,833 (13,242) $ 24,591 An analysis of the net change in unrealized investment gains (losses) is as follows: $ (1,489) Equity securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 613,826 Fixed maturities available for sale . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 612,337 Net change in unrealized gains (losses) on securities . . . . . . . . . . . . . . . . Other investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,517 Net change in unrealized gains (losses) . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,283,062 $(1,183,652) $614,854 317 (1,187,529) (1,187,212) 3,560 1,279,190 1,278,882 4,180 (308) $ Additional information about securities sold is as follows: Fixed maturities: Proceeds from sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Gross realized gains . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Gross realized losses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $109,024 17,583 (1,879) $133,463 5,948 (1,310) $345,601 40,851 (2,477) At December 31, 2013 2014 2012 72 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) (Dollar amounts in thousands except per share data) Note 4—Investments (continued) Fair value measurements: The following tables represent the fair value of assets measured on a recurring basis at December 31, 2014 and 2013: Description Fixed maturities available for sale: . . . . . . . . . . . . . . . . . . . . Bonds: U.S. Government direct, guaranteed, and Fair Value Measurements at December 31, 2014 Using: Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Total Fair Value government-sponsored enterprises . . . . . . . . . $ 0 $ 369,841 $ 0 $ 369,841 States, municipalities, and political subdivisions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Foreign governments . . . . . . . . . . . . . . . . . . . . . . . Corporates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Collateralized debt obligations . . . . . . . . . . . . . . . Other asset-backed securities . . . . . . . . . . . . . . . . Redeemable preferred stocks . . . . . . . . . . . . . . . . . . . . 1,504 0 86,571 0 661 22,945 Total fixed maturities . . . . . . . . . . . . . . . . . . . . . . . Equity securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 111,681 664 1,453,259 27,173 11,406,667 0 21,867 526,626 13,805,433 0 0 0 512,714 63,232 0 0 575,946 833 1,454,763 27,173 12,005,952 63,232 22,528 549,571 14,493,060 1,477 Total fixed maturities and equity securities . . . . . $112,325 $13,805,433 $576,779 $14,494,537 Percentage of total . . . . . . . . . . . . . . . . . . . . . . . . . 0.8% 95.2% 4.0% 100.0% Description Fixed maturities available for sale: . . . . . . . . . . . . . . . . . . . . Bonds: U.S. Government direct, guaranteed, and Fair Value Measurements at December 31, 2013 Using: Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Total Fair Value government-sponsored enterprises . . . . . . . . . $ 0 $ 353,173 $ 0 $ 353,173 States, municipalities, and political subdivisions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Foreign governments . . . . . . . . . . . . . . . . . . . . . . . Corporates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Collateralized debt obligations . . . . . . . . . . . . . . . Other asset-backed securities . . . . . . . . . . . . . . . . Redeemable preferred stocks . . . . . . . . . . . . . . . . . . . . Total fixed maturities . . . . . . . . . . . . . . . . . . . . . . . Equity securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0 0 47,058 0 0 22,220 69,278 1,108 1,335,304 44,155 10,188,988 0 38,169 491,561 12,451,350 0 0 0 300,300 58,205 0 0 358,505 776 1,335,304 44,155 10,536,346 58,205 38,169 513,781 12,879,133 1,884 Total fixed maturities and equity securities . . . . . $ 70,386 $12,451,350 $359,281 $12,881,017 Percentage of total . . . . . . . . . . . . . . . . . . . . . . . . . 0.5% 96.7% 2.8% 100.0% 73 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) (Dollar amounts in thousands except per share data) Note 4—Investments (continued) The following table represents changes in assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3). Analysis of Changes in Fair Value Measurements Using Significant Unobservable Inputs (Level 3) Asset- backed securities $ 7,122 Collateralized debt Obligations $ 30,320 Corporates* $ 11,250 Equities $710 Total $ 49,402 0 1,482 Balance at January 1, 2012 . . . . . . . . . . . . . . . Total gains or losses: Included in realized gains/losses . . . Included in other comprehensive income . . . . . . . . . . . . . . . . . . . . . . Acquisitions . . . . . . . . . . . . . . . . . . . . . . . . Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Amortization . . . . . . . . . . . . . . . . . . . . . . . Other ** . . . . . . . . . . . . . . . . . . . . . . . . . . . Transfers into Level 3 . . . . . . . . . . . . . . . . Balance at December 31, 2012 . . . . . . . . . . . . Total gains or losses: Included in realized gains/losses . . . Included in other comprehensive income . . . . . . . . . Acquisitions . . . . . . . . . . . . . . . . . . . . . . . . Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Amortization . . . . . . . . . . . . . . . . . . . . . . . Other ** . . . . . . . . . . . . . . . . . . . . . . . . . . . Transfers out of Level 3 . . . . . . . . . . . . . . Balance at December 31, 2013 . . . . . . . . . . . . Total gains or losses: Included in realized gains/losses . . . Included in other comprehensive income . . . . . . . . . Acquisitions . . . . . . . . . . . . . . . . . . . . . . . . Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Amortization . . . . . . . . . . . . . . . . . . . . . . . Other ** . . . . . . . . . . . . . . . . . . . . . . . . . . . Transfers out of Level 3 . . . . . . . . . . . . . . Balance at December 31, 2014 . . . . . . . . . . . . 0 1,078 0 0 (219) 0 0 7,981 0 426 0 0 (57) 0 (8,350) 0 0 0 0 0 0 0 0 0 $ 3,600 183,676 (13,429) 699 0 43,794 231,072 0 (17,243) 129,755 0 5 (834) (42,455) 300,300 0 29 0 0 0 0 0 739 0 37 0 0 0 0 0 776 1,482 16,774 183,676 (13,429) 3,128 1,536 43,794 286,363 0 (6,697) 129,755 0 2,786 (2,121) (50,805) 359,281 12,067 0 0 2,648 1,536 0 46,571 0 10,083 0 0 2,838 (1,287) 0 58,205 15,924 1 0 15,925 3,323 0 (16,049) 5,519 (3,690) 0 $ 63,232 27,864 186,366 (1) 13 (1,829) 0 $512,714 57 0 0 0 0 0 $833 31,244 186,366 (16,050) 5,532 (5,519) 0 $576,779 * ** Includes redeemable preferred stocks Includes capitalized interest and foreign exchange adjustments. Acquisitions of Level 3 investments in 2014 and 2013 are comprised of private-placement fixed maturities managed by an unaffiliated third-party. Quantitative Information about Level 3 Fair Value Measurements As of December 31, 2014 Valuation Techniques Collateralized debt obligations . . . . . . . . $ 63,232 Discounted cash flows 512,714 Discounted cash flows 833 Third-party Other investments . . . . . . . . . . . . . . . . . . Private placement fixed maturities . . . . . Fair Value Unobservable Input Discount rate Credit rating Range Weighted Average 9-12.5% 11.9% BB+ to A+ BBB pricing without adjustment N/A N/A N/A $576,779 74 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) (Dollar amounts in thousands except per share data) Note 4—Investments (continued) The collateral underlying collateralized debt obligations for which fair values are reported as Level 3 consists primarily of trust preferred securities issued by banks and insurance companies. None of the collateral is subprime or Alt-A mortgages (loans for which the typical documentation was not provided by the borrower). Collateralized debt obligations are valued at the present value of expected future cash flows using an unobservable discount rate. Expected cash flows are determined by scheduling the projected repayment of the collateral assuming no future defaults, deferrals, or recoveries. The discount rate is risk-adjusted to take these items into account. A significant increase (decrease) in the discount rate will produce a significant decrease (increase) in fair value. Additionally, a significant increase (decrease) in the cash flow expectations would result in a significant increase (decrease) in fair value. The private placements are also valued based on discounted cash flows, resulting from the contractual cash flows discounted by a yield determined as a treasury benchmark adjusted for a credit spread. The credit spread is developed from observable indices for similar public fixed maturities and unobservable indices for private fixed maturities for corresponding credit ratings. However, the credit ratings for the private placements are considered unobservable inputs, as they are assigned by the third party investment manager based on a quantitative and qualitative assessment of the credit underwritten. A higher (lower) credit rating would result in a higher (lower) valuation. For more information regarding valuation procedures, please refer to Note 1 — Significant Accounting Policies under the caption Fair Value Measurements, Investments in Securities. The following table presents transfers in and out of each of the valuation levels of fair values. Level 1 . . . . . . . . Level 2 . . . . . . . . Level 3 . . . . . . . . In $36,468 0 0 2014 Out Net In 2013 Out Net In 2012 Out Net $ 0 (36,468) 0 $ 36,468 (36,468) 0 $19,416 50,805 0 $ 0 (19,416) (50,805) $ 19,416 31,389 (50,805) $48,536 0 43,794 $ 0 (92,330) 0 $ 48,536 (92,330) 43,794 Transfers into Level 2 from Level 3 result from the availability of observable market data when a security is valued at the end of a period. Transfers into Level 3 occur when there is a lack of observable market information. Transfers into Level 1 from Level 2 occur when direct quotes are available; transfers from Level 1 into Level 2 result when only observable market data and no direct quotes are available. Other-than-temporary impairments: Torchmark has determined that certain of its holdings in fixed maturity investments were other-than-temporarily impaired during the three years ended December 31, 2014. The following table presents the writedowns recorded due to these impairments in accordance with accounting guidance and whether the writedown was charged to earnings or other comprehensive income. Writedowns for Other-Than-Temporary Impairments 2014 2013 Net Income Other Comprehensive Income Net Income Other Comprehensive Income Corporate bonds (pre-tax) . . . . . . . . . After tax . . . . . . . . . . . . . . . . . . . . . . . . $0 $0 $0 $0 $0 $0 $0 $0 2012 Other Comprehensive Income $0 $0 Net Income $5,600 $3,640 As of year end 2014, previously written down securities remaining in the portfolio were carried at a fair value of $52 million. Otherwise, as of December 31, 2014, Torchmark has no information available to cause it to believe that any of its investments are other-than-temporarily impaired. Torchmark has the ability and intent to hold these investments to recovery, and does not intend to sell nor expects to be required to sell its other impaired securities. 75 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) (Dollar amounts in thousands except per share data) Note 4—Investments (continued) Unrealized gains/loss analysis: In 2013, increases in interest rates in financial markets caused the net unrealized gain balances to decline to $390 million at December 31, 2013 from $1.6 billion a year earlier. During 2014, interest rates declined resulting in an increase in net unrealized gains at December 31, 2014 to $1.7 billion. At December 31, 2014, investments in securities in the financial sector were in a $460 million net unrealized gain position. These investments in the financial sector represented 24% of the portfolio at amortized cost and 25% at fair value. This is compared with a net unrealized gain position of $180 million at the end of the prior year. Investments and securities in the other sectors had net unrealized gains of $1.2 billion at year end 2014 and $210 million at year end 2013. The following tables disclose gross unrealized investment losses by class of investment at December 31, 2014 and December 31, 2013 for the respective periods of time in a loss position. Torchmark considers these investments to be only temporarily impaired. ANALYSIS OF GROSS UNREALIZED INVESTMENT LOSSES At December 31, 2014 Description of Securities Fixed maturities available for sale: U.S. Government direct, guaranteed, and Less than Twelve Months Twelve Months or Longer Total Fair Value Unrealized Loss Fair Value Unrealized Loss Fair Value Unrealized Loss government-sponsored enterprises . . . . . . . . . . . . $ States, municipalities and political subdivisions . . . . Foreign governments . . . . . . . . . . . . . . . . . . . . . . . . . Corporates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Collateralized debt obligations . . . . . . . . . . . . . . . . . . Other asset-backed securities . . . . . . . . . . . . . . . . . . Redeemable preferred stocks . . . . . . . . . . . . . . . . . . 4,478 5,632 0 434,757 0 0 1,008 $ (7) $ 149,238 20,756 800 810,945 11,190 0 58,983 (206) 0 (17,491) 0 0 (1) $ (3,176) (512) (1) (43,389) (8,809) 0 (5,030) $ 153,716 26,388 800 1,245,702 11,190 0 59,991 $ (3,183) (718) (1) (60,880) (8,809) 0 (5,031) Total fixed maturities . . . . . . . . . . . . . . . . . . . . . . . . . . $445,875 $(17,705) $1,051,912 $(60,917) $1,497,787 $(78,622) ANALYSIS OF GROSS UNREALIZED INVESTMENT LOSSES At December 31, 2013 Description of Securities Fixed maturities available for sale: U.S. Government direct, guaranteed, and Less than Twelve Months Twelve Months or Longer Total Fair Value Unrealized Loss Fair Value Unrealized Loss Fair Value Unrealized Loss government-sponsored enterprises . . . . . . . . . . . . $ 242,144 $ (42,885) $ 87,977 $ (32,410) $ 330,121 $ (75,295) (12,947) (67) (300,389) (7,968) (98) (14,198) States, municipalities and political subdivisions . . . . Foreign governments . . . . . . . . . . . . . . . . . . . . . . . . . Corporates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Collateralized debt obligations . . . . . . . . . . . . . . . . . . Other asset-backed securities . . . . . . . . . . . . . . . . . . Redeemable preferred stocks . . . . . . . . . . . . . . . . . . 167,660 11,966 2,692,494 0 6,974 106,229 169,279 11,966 3,292,844 58,080 10,847 188,516 (12,807) (67) (196,139) 0 (26) (3,694) (140) 0 (104,250) (7,968) (72) (10,504) 1,619 0 600,350 58,080 3,873 82,287 Total fixed maturities . . . . . . . . . . . . . . . . . . . . . . . . . . $3,227,467 $(255,618) $834,186 $(155,344) $4,061,653 $(410,962) 76 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) (Dollar amounts in thousands except per share data) Note 4—Investments (continued) Additional information about investments in an unrealized loss position is as follows: Number of issues (Cusip numbers) held: As of December 31, 2014 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . As of December 31, 2013 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 80 462 173 130 Less than Twelve Months Twelve Months or Longer Total 253 592 Torchmark’s entire fixed-maturity and equity portfolio consisted of 1,604 issues at December 31, 2014 and 1,619 issues at December 31, 2013. The weighted-average quality rating of all unrealized loss positions as of December 31, 2014 was BBB+, compared with BBB+ a year earlier. The weighted- average quality ratings are based on amortized cost. Other investment information: Other long-term investments consist of the following: Investment real estate, at depreciated cost . . . . . . . . . . . . . . . . . Low-income housing interests . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 203 5,370 4,876 $ 203 7,589 5,415 Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $10,449 $13,207 December 31, 2014 2013 Accumulated depreciation on investment real estate was $1.7 million at both December 31, 2014 and December 31, 2013. Torchmark did not have any invested assets that were non-income producing during the twelve months ended December 31, 2014. Note 5—Deferred Acquisition Costs An analysis of deferred acquisition costs is as follows: Balance at beginning of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $3,337,649 $3,198,431 $2,916,732 2014 2013 2012 Additions: Deferred during period: Commissions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total deferred . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Value of insurance purchased during year Foreign exchange adjustment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Adjustment attributable to unrealized investment losses(1) . . . . . . . . . Total additions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 361,358 205,913 567,271 0 0 0 567,271 331,060 193,203 524,263 8,489 0 14,906 547,658 312,581 168,237 480,818 175,257 3,557 7,234 666,866 Deductions: Amortized during period . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Foreign exchange adjustment . . . . . . . . . Adjustment attributable to unrealized investment gains(1) Total deductions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (418,772) (8,167) (6,200) (433,139) (403,389) (5,051) 0 (408,440) (385,167) 0 0 (385,167) Balance at end of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $3,471,781 $3,337,649 $3,198,431 (1) Represents amounts pertaining to investments relating to universal life-type products. 77 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) (Dollar amounts in thousands except per share data) Note 6—Acquisition On November 1, 2012, Torchmark acquired all of the outstanding common stock of Family Heritage Life Insurance Company of America (Family Heritage), a privately-held supplemental health insurance provider. Family Heritage was founded in 1989 and is headquartered in Cleveland, Ohio. It is a specialty insurer focused primarily on selling protection-oriented individual supplemental health insurance products through a captive agency force. The purchase price was approximately $234 million, including post- closing adjustments and the assumption of $20 million par value of debt in the form of trust preferred securities issued by Family Heritage’s previous parent company ($20 million fair value at the purchase date). The balance of the purchase price of approximately $214 million was funded primarily with cash provided from borrowings as described in Note 11—Debt. There was approximately $27 million of cash acquired in the transaction. Acquisition expenses in connection with the transaction charged to Torchmark’s earnings in 2012 were $2.9 million ($1.9 million after tax). These costs were included as “Other operating expense” in the Consolidated Statement of Operations for 2012. In 2013, a one-time adjustment for the finalization of accounting for the insurance assets and liabilities for the Family Heritage acquisition was completed. The result of this adjustment was a $1.5 million increase in pretax income ($522 thousand after tax), due to the net effect of an increase in the policyholder benefit reserve of $8.5 million and a greater increase in the deferred acquisition asset of $10.0 million. During the two-month period commencing on the purchase date of November 1, 2012 and ending December 31, 2012, Family Heritage had revenues of $33 million and net income of $3.1 million included in Torchmark’s 2012 Consolidated Statement of Operations. The table below presents supplemental unaudited pro forma information for 2012 as if the Family Heritage acquisition were completed on January 1, 2011, based on estimates and assumptions considered appropriate: Revenues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net income per diluted share . . . . . . . . . . . . . . . . . . . . . . Year Ended December 31, 2012 $197,174 13,220 0.09 The supplemental unaudited pro forma information above is presented for informational purposes only and is not necessarily indicative of the results of operations that actually would have been achieved had the acquisition been consummated at that time, nor is it intended to be a projection of future results. 78 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) (Dollar amounts in thousands except per share data) Note 7—Liability for Unpaid Health Claims Activity in the liability for unpaid health claims is summarized as follows: Balance at beginning of year . . . . . . . . . . . . . . . . . . . . . . . . . . . Acquisition of Family Heritage . . . . . . . . . . . . . . . . . . . . . . . . . . Incurred related to: Current year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Prior years . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total incurred . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Paid related to: Current year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Prior years . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Year Ended December 31, 2012 2013 2014 $101,719 0 $104,870 0 $103,517 11,700 792,740 (23,106) 720,490 (11,594) 704,934 (17,531) 769,634 708,896 687,403 725,386 59,714 636,150 75,897 627,495 70,255 Total paid . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 785,100 712,047 697,750 Balance at end of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 86,253 $101,719 $104,870 At the end of each period, the liability for unpaid health claims includes an estimate of claims incurred but not yet reported to the Company. Such estimates are updated regularly based upon the Company’s most recent claims data with recognition of emerging experience trends. Because of the nature of the Company’s health business, the payment lags are relatively short and most claims are fully paid within a year from the time incurred. Fluctuations in claims experience can lead to either over- or under-estimation of the liability for any given year. The difference between the estimate made at the end of the prior period and the actual experience during the period is reflected above under the caption “Incurred related to: Prior years.” Claims paid in each of the years 2012 through 2014 were settled for amounts less than anticipated when estimated at the previous year end. The most significant component of these favorable variances was in Torchmark’s Medicare Part D business and, to a lesser extent, Torchmark’s UA Independent and Liberty National agencies. The Company’s estimates at each point have reflected the emerging data and trends. In the Medicare Part D channel, the Company is required to estimate claim discounts that will be received from drug manufacturers. In each of the years 2012 through 2014, the discounts from the drug manufacturers received in the current year but related to prior year claims were higher than anticipated when the claim liability was determined. The liability for unpaid health claims is included with “Policy claims and other benefits payable” on the Consolidated Balance Sheets. 79 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) (Dollar amounts in thousands except per share data) Note 8—Income Taxes The components of income taxes were as follows: Year Ended December 31, 2012 2013 2014 Income tax expense from continuing operations . . . . . . . . . . . . . . . . . . . $235,529 $ 234,654 $236,669 Shareholders’ equity: Other comprehensive income (loss) . . . . . . . . . . . . . . . . . . . . . . . . . . . Tax basis compensation expense (from the exercise of stock options and vesting of restricted stock awards) in excess of amounts recognized for financial reporting purposes . . . . . . . . . . . . . . . . . . . 424,089 (386,752) 201,950 (18,524) (21,314) (22,602) $641,094 $(173,412) $416,017 Income tax expense from continuing operations consists of: Year Ended December 31, 2012 2013 2014 Current income tax expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $147,486 $176,427 $161,332 75,337 Deferred income tax expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 88,043 58,227 $235,529 $234,654 $236,669 In each of the years 2012 through 2014, deferred income tax expense was incurred because of certain differences between net income before income taxes as reported on the Consolidated Statements of Operations and taxable income as reported on Torchmark’s income tax returns. As explained in Note 1—Significant Accounting Policies, these differences caused the financial statement book values of some assets and liabilities to be different from their respective tax bases. The effective income tax rate differed from the expected 35% rate as shown below: 2014 Year Ended December 31, % 2013 % 2012 % Expected income taxes . . . . . . . . . . . . . . . . . . . . . . . $272,464 35.0% $267,094 35.0% $268,098 35.0% Increase (reduction) in income taxes resulting from: Tax-exempt investment income . . . . . . . . . . . . . . $ (3,233) (36,442) Low income housing investments . . . . . . . . . . . . 2,740 Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (.4) (4.7) .4 (3,107) (32,417) 3,084 (.4) (4.2) .4 (3,506) (28,877) 954 (.4) (3.8) .1 Income tax expense . . . . . . . . . . . . . . . . . . . . . . . . . $235,529 30.3% $234,654 30.8% $236,669 30.9% 80 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) (Dollar amounts in thousands except per share data) Note 8—Income Taxes (continued) The tax effects of temporary differences that gave rise to significant portions of the deferred tax assets and deferred tax liabilities are presented below: Deferred tax assets: Fixed maturity investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ Carryover of tax losses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total gross deferred tax assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Deferred tax liabilities: December 31, 2014 2013 12,925 $ 3,036 15,961 16,868 11,415 28,283 Unrealized gains . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Employee and agent compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Deferred acquisition costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Future policy benefits, unearned and advance premiums, and policy claims . . . . . . . . . . Other liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 522,219 74,088 879,851 331,408 4,732 92,772 68,911 829,032 315,291 1,126 Total gross deferred tax liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,812,298 1,307,132 Net deferred tax liability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,796,337 $1,278,849 Torchmark and its subsidiaries, excluding Family Heritage, file a life-nonlife consolidated Federal income tax return on a separate company basis. income tax return. Family Heritage files its Federal Torchmark’s consolidated Federal income tax returns are routinely audited by the Internal Revenue Service (IRS). The IRS completed its examination of Torchmark’s 2008-2011 consolidated income tax returns during 2014 resulting in no impact on the company’s effective tax rate. The statutes of limitations for the assessment of additional tax are closed for all tax years prior to 2011 with respect to Torchmark’s consolidated and Family Heritage’s Federal income tax returns. Management believes that adequate provision has been made in the consolidated financial statements for any potential assessments that may result from current or future tax examinations and other tax-related matters for all open years. Torchmark has net operating loss carryforwards of approximately $8.7 million at December 31, 2014 which will begin to expire in 2032 if not otherwise used to offset future taxable income. A valuation allowance is to be provided when it is more likely than not that deferred tax assets will not be realized by the Company. No valuation allowance has been recorded relating to Torchmark’s deferred tax assets since, in management’s judgment, Torchmark will more likely than not have sufficient taxable income in future periods to fully realize its existing deferred tax assets. Torchmark’s tax liability is adjusted to include a provision for uncertain tax positions taken or expected to be taken in a tax return. However, during the years 2012 through 2014, Torchmark did not have any uncertain tax positions which resulted in unrecognized tax benefits. Torchmark’s continuing practice is to recognize interest and/or penalties related to income tax matters in income tax expense. The Company recognized interest income of $465 thousand, $0, and $56 thousand, net of Federal income tax benefits, in its Consolidated Statements of Operations for 2014, 2013, and 2012, respectively. The Company had no accrued interest or penalties at December 31, 2014 or 2013. 81 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) (Dollar amounts in thousands except per share data) Note 9—Postretirement Benefits Pension Plans: Torchmark has noncontributory retirement benefit plans and contributory savings plans which cover substantially all employees. There are also two nonqualified, noncontributory supplemental benefit pension plans which cover a limited number of employees. The total cost of these retirement plans charged to operations was as follows: Year Ended December 31, Defined Contribution Plans Defined Benefit Pension Plans 2014 . . . . . . . . . . . . . . . . . 2013 . . . . . . . . . . . . . . . . . 2012 . . . . . . . . . . . . . . . . . $3,078 3,373 3,668 $23,463 33,122 26,007 Torchmark accrues expense for the defined contribution plans based on a percentage of the employees’ contributions. The plans are funded by the employee contributions and a Torchmark contribution equal to the amount of accrued expense. Plan contributions are both mandatory and discretionary, depending on the terms of the plan. Cost for the defined benefit pension plans has been calculated on the projected unit credit actuarial cost method. All plan measurements for the defined benefit plans are as of December 31 of the respective year. The defined benefit pension plans covering the majority of employees are funded. Contributions are made to funded pension plans subject to minimums required by regulation and maximums allowed for tax purposes. Defined benefit plan contributions were $14.6 million in 2014, $10.3 million in 2013, and $8.2 million in 2012. Torchmark estimates as of December 31, 2014 that it will contribute an amount not to exceed $20 million to these plans in 2015. The actual amount of contribution may be different from this estimate. Torchmark has a Supplemental Executive Retirement Plan (SERP), which provides to a limited number of executives an additional supplemental defined pension benefit. The supplemental benefit is based on the participant’s qualified plan benefit without consideration to the regulatory limits on compensation and benefit payments applicable to qualified plans, except that eligible compensation is capped at $1 million. The SERP is unfunded. However, a Rabbi Trust has been established to support the liability for this plan. This trust consists of life insurance policies on the lives of plan participants with an unaffiliated insurance carrier as well as an investment account. The premiums paid for the insurance coverage were $2.2 million in 2014, $2.9 million in 2013, and $1.7 million in 2012. The cash value of these policies at December 31, 2014 was $24 million and was $22 million a year earlier. Investments in the investment account consist of exchange traded funds. Deposits of $6 million in 2013 and $5 million in in this trust. There were no deposits in 2014. As of 2012 were added to the investment account investments was the insurance policies and the trust the combined value of December 31, 2014, $74 million, compared with $66 million a year earlier. Because this plan is unqualified, the investments and the policyholder value of the insurance policies in the Rabbi Trust are not included as defined benefit plan assets but as assets of the Company. They are included with “Other Assets” in the Consolidated Balance Sheets. The liability for this SERP at December 31, 2014 was $71 million and was $58 million a year earlier. The Company has another small supplemental benefit pension plan which is limited to a very select group of employees and was closed as of December 31, 1994. It provides the full benefits that an employee would have otherwise received from a defined benefit plan in the absence of the limitation on benefits payable under a qualified plan. This plan is unfunded. Liability for this closed plan was $3 million at December 31, 2014 and December 31, 2013. Pension cost for both supplemental defined benefit plans is determined in the same manner as for the qualified defined benefit plans. Plan assets in the funded plans consist primarily of investments in marketable fixed maturities and equity securities and are valued at fair value. Torchmark measures the fair value of its financial assets, including the assets in its benefit plans, in accordance with accounting guidance which establishes a hierarchy for asset values and provides a methodology for the measurement of value. Please refer to 82 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) (Dollar amounts in thousands except per share data) Note 9—Postretirement Benefits (continued) Note 1—Significant Accounting Policies under the caption Fair Value Measurements, Investments in Securities for a complete discussion of valuation procedures. The following table presents the assets of Torchmark’s defined benefit pension plans for the years ended December 31, 2014 and 2013. Pension Assets by Component at December 31, 2014 Fair Value Determined by: Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Total Amount % to Total Equity securities: Financial . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Consumer, Cyclical Technology . . . . . . . . . . . . . . . . . . . . . . . Consumer, Non-Cyclical . . . . . . . . . . . . Energy . . . . . . . . . . . . . . . . . . . . . . . . . . Communications . . . . . . . . . . . . . . . . . . Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total equity securities . . . . . . . . . . . . . . . . Corporate bonds . . . . . . . . . . . . . . . . . . . . Other bonds . . . . . . . . . . . . . . . . . . . . . . . . Guaranteed annuity contract* . . . . . . . . . . Short-term investments . . . . . . . . . . . . . . . Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 45,790 26,542 16,965 11,665 10,192 9,322 7,092 127,568 9,038 4,156 $166,825 284 15,027 $ 45,790 26,542 16,965 11,665 10,192 9,322 7,092 127,568 166,825 284 15,027 9,038 4,156 14% 8 5 4 3 3 2 39 52 0 5 3 1 Grand Total . . . . . . . . . . . . . . . . . . . . . . . . $140,762 $182,136 $ 0 $322,898 100% * Annuity contract issued by a Torchmark subsidiary Pension Assets by Component at December 31, 2013 Fair Value Determined by: Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Total Amount % to Total Equity securities: Financial . . . . . . . . . . . . . . . . . . . . . . . . . Consumer, Cyclical . . . . . . . . . . . . . . . . Energy . . . . . . . . . . . . . . . . . . . . . . . . . . Consumer, Non-Cyclical . . . . . . . . . . . . Technology . . . . . . . . . . . . . . . . . . . . . . . Depository Institutions . . . . . . . . . . . . . . Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total equity securities . . . . . . . . . . . . . . . . Corporate bonds . . . . . . . . . . . . . . . . . . . . Other bonds . . . . . . . . . . . . . . . . . . . . . . . . Guaranteed annuity contract* . . . . . . . . . . Short-term investments . . . . . . . . . . . . . . . Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 35,807 17,915 13,816 13,187 13,055 10,523 10,153 114,456 0 13,318 1,667 $ 831 831 147,445 267 13,769 $ 35,807 17,915 13,816 13,187 13,055 10,523 10,984 115,287 147,445 267 13,769 13,318 1,667 12% 6 5 4 4 3 4 38 51 0 5 5 1 Grand Total . . . . . . . . . . . . . . . . . . . . . . . . $129,441 $162,312 $ 0 $291,753 100% * Annuity contract issued by a Torchmark subsidiary 83 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) (Dollar amounts in thousands except per share data) Note 9—Postretirement Benefits (continued) Torchmark’s investment objectives for its plan assets include preservation of capital, preservation of purchasing power, and long-term growth. Torchmark seeks to preserve capital through investments made in high quality securities with adequate diversification by issuer and industry sector to minimize risk. The portfolio is monitored continuously for changes in quality and diversification mix. The preservation of purchasing power is intended to be accomplished through asset growth, exclusive of contributions and withdrawals, in excess of the rate of inflation. Torchmark intends to maintain investments that when combined with future plan contributions will produce adequate long-term growth to provide for all plan obligations. The Company’s expectation for the portfolio is to achieve a compound total rate of return of 3% in excess of the inflation rate, to be reviewed on a three-year basis. It is also Torchmark’s objective that the portfolio’s investment return will meet or exceed the return of a balanced market index. The majority of the securities in the portfolio are highly marketable so that there will be adequate liquidity to meet projected payments. There are no specific policies calling for asset durations to match those of benefit obligations. Allowed investments are limited to equities, fixed maturities, and short-term investments (invested cash). There is also a guaranteed annuity contract issued by American Income Life Insurance Company to fund the obligations of the American Income Pension Plan. The assets are to be invested in a mix of equity and fixed income investments that best serve the objectives of the pension plan. Factors to be considered in determining the asset mix include funded status, annual pension expense, annual pension liability. Equities include common and preferred stocks, securities contributions, and balance sheet convertible into equities, mutual in equities, and other equity-related investments. funds that Equities must be listed on major exchanges and adequate market liquidity is required. Fixed maturities consist of marketable debt securities rated investment grade at purchase by a major rating agency. Short- term investments include fixed maturities with maturities less than one year and invested cash. Short- term investments in commercial paper must be rated at least A-2 by Standard & Poor’s with the issuer rated investment grade. Invested cash is limited to banks rated A or higher. Investments outside of the aforementioned list are not permitted, except by prior approval of the Plan’s Trustees. At December 31, 2014, there were no restricted investments contained in the portfolio. Plan contributions have been invested primarily in equity securities during the three years ended December 31, 2014. invest The investment portfolio is to be well diversified to avoid undue exposure to a single sector, industry, business, or security. The equity and fixed-maturity portfolios are not permitted to invest in any single issuer that would exceed 10% of total plan assets at the time of purchase. Torchmark does not employ any other special risk management techniques, such as derivatives, in managing the pension investment portfolio. 84 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) (Dollar amounts in thousands except per share data) Note 9—Postretirement Benefits (continued) The following table discloses the assumptions used to determine Torchmark’s pension liabilities and costs for the appropriate periods. The discount and compensation increase rates are used to determine current year projected benefit obligations and subsequent year pension expense. The long-term rate of return is used to determine current year expense. Differences between assumptions and actual experience are included in actuarial gain or loss. Weighted Average Pension Plan Assumptions For Benefit Obligations at December 31: 2014 2013 Discount Rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Rate of Compensation Increase . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.23% 5.12% 4.35 4.35 For Periodic Benefit Cost for the Year: 2014 2013 2012 Discount Rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Expected Long-Term Returns . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Rate of Compensation Increase . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5.12% 4.18% 5.09% 6.96 6.97 4.40 4.35 7.20 4.04 The discount rate is determined based on the expected duration of plan liabilities. A yield is then derived based on the current market yield of a hypothetical portfolio of higher-quality corporate bonds which match the liability duration. The rate of compensation increase is projected based on Company experience, modified as appropriate for future expectations. The expected long-term rate of return on plan assets is management’s best estimate of the average rate of earnings expected to be received on the assets invested in the plan over the benefit period. In determining this assumption, consideration is given to the historical rate of return earned on the assets, the projected returns over future periods, and the spread between the long-term rate of return on plan assets and the discount rate used to compute benefit obligations. Net periodic pension cost for the defined benefit plans by expense component was as follows: Year Ended December 31, 2012 2013 2014 Service cost—benefits earned during the period . . . . . . . . . . . Interest cost on projected benefit obligation . . . . . . . . . . . . . . . Expected return on assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net amortization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Recognition of actuarial loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 12,925 19,270 (19,031) 10,283 16 $ 14,984 17,043 (17,429) 18,143 381 $ 11,215 16,796 (17,114) 14,799 311 Net periodic pension cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 23,463 $ 33,122 $ 26,007 85 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) (Dollar amounts in thousands except per share data) Note 9—Postretirement Benefits (continued) An analysis of the impact on other comprehensive income (loss) concerning pensions and other postretirement benefits is as follows: Balance at January 1 . . . . . . . . . . . . Amortization of: Prior service cost . . . . . . . . . . . . . Net actuarial (gain) loss* . . . . . . . Total amortization* . . . . . . . . . . . . . . Plan amendments . . . . . . . . . . . . . . Experience gain(loss) . . . . . . . . . . . 2014 $ (97,467) 2013 $(168,129) 2012 $(119,863) 2,113 8,172 10,285 0 (65,817) 2,276 16,090 18,366 0 52,296 2,146 12,653 14,799 (3,452) (59,613) Balance at December 31 . . . . . . . . $(152,999) $ (97,467) $(168,129) * Includes amortization of postretirement benefits other than pensions of $2 thousand in 2014, $224 thousand in 2013, and $0 in 2012. The following table presents a reconciliation from the beginning to the end of the year of the projected benefit obligation and plan assets for pensions. This table also presents the amounts previously recognized as a component of accumulated other comprehensive income. Pension Benefits For the year ended December 31, 2014 2013 Changes in benefit obligation: Obligation at beginning of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 383,859 12,925 Service cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19,270 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Interest cost 78,487 Actuarial loss (gain) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (17,115) Benefits paid . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 477,426 Obligation at end of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $414,921 14,984 17,043 (45,258) (17,831) 383,859 Changes in plan assets: Fair value at beginning of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Return on assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Contributions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Benefits paid . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Fair value at end of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 291,753 33,641 14,619 (17,115) 322,898 277,641 21,613 10,330 (17,831) 291,753 Funded status at year end . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $(154,528) $ (92,106) Amounts recognized in accumulated other comprehensive income consist of: Net loss (gain) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 146,571 3,362 Prior service cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net amounts recognized at year end . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 149,933 $ 90,878 5,476 $ 96,354 The portion of other comprehensive income that is expected to be reflected in pension expense in 2015 is as follows: Amortization of prior service cost . . . . . . . . . . . . . . . . . . . . Amortization of net actuarial loss . . . . . . . . . . . . . . . . . . . . . Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 326 14,135 $14,461 86 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) (Dollar amounts in thousands except per share data) Note 9—Postretirement Benefits (continued) The accumulated benefit obligation (ABO) for Torchmark’s funded defined benefit pension plans was $374 million and $295 million at December 31, 2014 and 2013, respectively. In the unfunded plans, the ABO was $63 million and $52 million at December 31, 2014 and 2013, respectively. Torchmark has estimated its expected pension benefits to be paid over the next ten years as of December 31, 2014. These estimates use the same assumptions that measure the benefit obligation at December 31, 2014, taking estimated future employee service into account. Those estimated benefits are as follows: For the year(s) 2015 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2016 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2017 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2018 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2019 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2020-2024 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 17,103 18,335 20,055 21,274 22,557 135,663 Postretirement Benefit Plans Other Than Pensions: Torchmark provides a small postretirement life insurance benefit for most retired employees, and also provides additional postretirement life insurance benefits for certain key employees. The majority of the life insurance benefits are accrued over the working lives of active employees. Otherwise, Torchmark does not provide postretirement benefits other than pensions and the life insurance benefits described above. Torchmark’s post-retirement defined benefit plans other than pensions are not funded. Liabilities for these plans are measured as of December 31 for the appropriate year. The components of net periodic postretirement benefit cost for plans other than pensions are as follows: Year Ended December 31, 2013 2012 2014 Service cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Interest cost on benefit obligation . . . . . . . . . . . . . . . . . . . . Expected return on plan assets . . . . . . . . . . . . . . . . . . . . . Net amortization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Recognition of net actuarial (gain) loss . . . . . . . . . . . . . . . $ 0 646 0 2 (256) $ 354 1,030 0 224 0 $ 392 1,020 0 0 0 Net periodic postretirement benefit cost . . . . . . . . . . . . . . $ 392 $1,608 $1,412 87 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) (Dollar amounts in thousands except per share data) Note 9—Postretirement Benefits (continued) The following table presents a reconciliation of the benefit obligation and plan assets from the beginning to the end of the year. As these plans are unfunded, funded status is equivalent to the accrued benefit liability. Benefits Other Than Pensions For the year ended December 31, 2014 2013 Changes in benefit obligation: Obligation at beginning of year . . . . . . . . . . . . . . . . . . . . . . . . . . Service cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Interest cost Actuarial loss (gain) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Benefits paid . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Obligation at end of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Changes in plan assets: Fair value at beginning of year . . . . . . . . . . . . . . . . . . . . . . . . . . Return on assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Contributions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Benefits paid . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Fair value at end of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 20,860 0 646 1,700 (311) 22,895 0 0 311 (311) 0 $ 22,367 354 1,030 (2,475) (416) 20,860 0 0 416 (416) 0 Funded status at year end . . . . . . . . . . . . . . . . . . . . . . . . . . . . $(22,895) $(20,860) Amounts recognized in accumulated other comprehensive income: Net loss* . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net amounts recognized at year end . . . . . . . . . . . . . . . . . $ 3,066 $ 3,066 $ 1,113 $ 1,113 * The net loss for benefit plans other than pensions reduces other comprehensive income. The table below presents the assumptions used to determine the liabilities and costs of Torchmark’s post-retirement benefit plans other than pensions. Weighted Average Assumptions for Post-Retirement Benefit Plans Other Than Pensions For Benefit Obligations at December 31: Discount Rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.23% 5.12% 2014 2013 For Periodic Benefit Cost for the Year: Discount Rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5.12% 4.18% 5.09% 2014 2013 2012 Estimated Future Payments for Post-Retirement Benefit Plans Other Than Pensions For the year(s) 2015 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 2016 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2017 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2018 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2019 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2020-2024 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 994 1,117 1,301 1,503 1,655 10,659 88 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) (Dollar amounts in thousands except per share data) Note 10—Supplemental Disclosures of Cash Flow Information The following table summarizes Torchmark’s noncash transactions, which are not reflected on the Consolidated Statements of Cash Flows: Year Ended December 31, 2012 2013 2014 Stock-based compensation not involving cash . . . . . . . . . . . . . . . . $32,203 $25,642 $21,605 29,759 Commitments for low-income housing interests . . . . . . . . . . . . . . . 1,537 Capitalized investment income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20,000 Debt assumed to acquire Family Heritage . . . . . . . . . . . . . . . . . . . . 75,706 0 0 42,525 806 0 The following table summarizes certain amounts paid during the period: Year Ended December 31, 2012 2013 2014 Interest paid . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 77,066 $ 81,322 $77,686 89,061 Income taxes paid . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 112,935 139,091 In 2014, Torchmark’s receivables increased $164 million, reducing cash flows from operations. Of this amount, $154 million was due primarily to collections to be received in 2015 under the federal governments’ Medicare Part D risk-sharing and pass-through agreements, as well as contracted rebates from Part D drug providers. 89 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) (Dollar amounts in thousands except per share data) Note 11—Debt The following table presents information about the terms and outstanding balances of Torchmark’s debt. Description Selected Information about Debt Issues Annual Interest Rate Issue Date Periodic Interest Payments Due Outstanding Principal (Par Value) Outstanding Principal (Book Value) Outstanding Principal (Fair Value) Outstanding Principal (Book Value) As of December 31, 2014 2013 Notes, due 5/15/23(1)(2) Senior Notes, due 6/15/16(1)(3) Senior Notes, due 6/15/19(1)(3) Senior Notes, due 9/15/22(1)(3) Junior Subordinated . . . . . . . . . . . 7.875% 5/93 5/15 & 11/15 $ 165,612 $ 163,758 $ 210,112 $ 163,609 248,753 290,268 147,392 . . . . . 6.375% 6/06 6/15 & 12/15 . . . . . 9.250% 6/09 6/15 & 12/15 . . . . . 3.800% 9/12 3/15 & 9/15 249,236 290,618 147,648 250,000 292,647 150,000 268,395 370,569 154,673 Debentures due 12/15/52(4)(8) . . . . 5.875% 9/12 quarterly 125,000 120,870 125,000 120,843 Junior Subordinated Debentures due 3/15/36(4)(5) . . . . . 3.541%(9) (6) quarterly 20,000 20,000 20,000 20,000 Total funded debt . . . . . . . . . . . . . . . . . . . . . . . . . . . Commercial Paper(7) 1,003,259 238,450 992,130 238,398 1,148,749 238,398 990,865 229,070 Total debt . . . . . . . . . . . . . . . . . . $1,241,709 $1,230,528 $1,387,147 $1,219,935 (1) All securities other than the Junior Subordinated Debentures have equal priority with one another. (2) Not callable. (3) Callable subject to “make-whole” premium. (4) Quarterly payments on the 15th of March, June, Sept., and Dec. (5) Callable anytime. (6) Assumed upon November 1, 2012 acquisition of Family Heritage. (7) Classified as short-term debt. (8) Callable as of December 15, 2017. (9) Interest paid at 3 month LIBOR plus 330 basis points, resets each quarter. The amount of debt that becomes due during each of the next five years is: 2015—$238 million; 2016—$250 million; 2017—$0; 2018—$0; 2019—$293 million; and thereafter—$461 million. Funded debt: On September 24, 2012, Torchmark issued $300 million principal amount of 3.80% Senior Notes due 2022. Interest on the Senior Notes are payable semi-annually. As part of the offering, two of Torchmark’s insurance subsidiaries acquired a combined amount of $150 million par value of the Senior Notes. Proceeds from the issuance of this debt, net of underwriters’ discount and expenses, were $147 million with total proceeds to the Parent Company of approximately $297 million. The Senior Notes are redeemable by Torchmark in whole or in part at any time subject to a “make-whole” premium, whereby the Company would be required to pay the greater of the full principal amount of the notes or otherwise the present value of the remaining payment schedule of the notes discounted at a rate of interest equivalent to the rate of a United States Treasury security of comparable term plus a spread of 30 basis points. Torchmark used a portion of the net proceeds from the new Senior Note offering to fund the acquisition of Family Heritage as described in Note 6 - Acquisition. The Parent Company used the remaining proceeds to repay its $94 million principal amount 7 3⁄ 8% Notes that matured on August 1, 2013. Additionally, on September 24, 2012, Torchmark completed the public offering of its 5.875% Junior Subordinated Debentures due 2052 for an aggregate principal amount of $125 million. Proceeds from this offering were $121 million, net of underwriters’ discount and issue expenses. These debentures pay interest quarterly. The securities are redeemable on December 15, 2052, and are first callable in whole or in part by Torchmark on or after December 15, 2017. Expenses of $4.2 million related to the offering have been netted against long-term debt and will be amortized over the forty-year redemption period. Net proceeds were used to fund the redemption of Torchmark’s 7.1% Trust Preferred Securities discussed below. 90 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) (Dollar amounts in thousands except per share data) Note 11—Debt (continued) On October 24, 2012, Torchmark’s 7.1% Trust Originated Preferred Securities were redeemed in the amount of $120 million plus accrued dividends at a total cost of $121 million. These securities were originally issued in 2006 as preferred securities of Torchmark’s Capital Trust III, a deconsolidated variable interest entity. Upon redemption of III as well as the 7.1% Junior Subordinated Debentures due to that Trust in the amount of $124 million were liquidated. An after-tax loss of $2.7 million was recorded on this redemption in the fourth quarter of 2012 within “Realized investment gains (losses),” representing the write-off of the unamortized issue expenses. these securities, Capital Trust Capital Trust III, which held the Trust Preferred Securities, was a variable interest entity in which Torchmark was not the primary beneficiary. Therefore, Torchmark was prohibited by accounting rules from consolidating Capital Trust III even though it had 100% ownership, complete voting control, and had guaranteed the performance of the trust. Accordingly, prior to redemption, Torchmark carried its 7.1% Junior Subordinated Debentures due to Capital Trust III as a liability under the caption “Due to Affiliates” on its Consolidated Balance Sheets. Expenses related to the original offering reduced long-term debt and were amortized over the forty-year redemption period. In connection with the purchase of Family Heritage, Torchmark assumed $20 million par amount of Trust Preferred Securities that were liabilities of Family Heritage’s former parent. These securities, which are due March 15, 2036, had a fair value of $20 million on the November 1, 2012 purchase date and were carried at an amortized cost of $20 million at December 31, 2012. They bear interest at a variable rate paid quarterly, determined as the three-month LIBOR plus 330 basis points which is reset each quarter. They are callable by Torchmark at any time. Commercial Paper: As of July 16, 2014, Torchmark entered into a new credit facility with a group of lenders allowing for unsecured borrowings and stand-by letters of credit up to $750 million, replacing a previous facility that had a maximum limitation of $600 million. Up to $250 million in letters of credit can be issued against the new facility. The facility is further designated as a back-up credit line for a commercial paper program under which the Company may either borrow from the credit line or issue commercial paper at any time, with total commercial paper outstanding not to exceed the facility maximum, less any letters of credit issued. Interest is charged at variable rates. The facility has no ratings-based acceleration triggers which would require early repayment. The new facility terminates July to certain covenants regarding 16, 2019. capitalization, as was the case with the previous credit facility. As of December 31, 2014, and throughout the three-year period ended December 31, 2014, Torchmark was in full compliance with the appropriate covenants. Borrowings on the credit facilities are reported as short-term debt on the Consolidated Balance Sheets. A table presenting selected information concerning Torchmark’s short-term borrowings is presented below. In accordance with the agreement, Torchmark is subject Short-Term Borrowings At December 31, 2014 2013 Balance at end of period (at par value) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $238,450 $229,140 Annualized interest rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Letters of credit outstanding . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $198,000 $198,000 172,860 Remaining amount available under credit line . . . . . . . . . . . . . . . . . . . . . . . 313,550 .32% .30% Average balance outstanding during period . . . . . . . . . . . . . . Daily-weighted average interest rate (annualized) . . . . . . . . . Maximum daily amount outstanding during period . . . . . . . . . $296,246 $274,435 $250,401 .26% .33% .48% $343,000 $340,140 $385,000 For the Year Ended December 31, 2014 2013 2012 91 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) (Dollar amounts in thousands except per share data) Note 12—Shareholders’ Equity Share Data: A summary of preferred and common share activity is presented in the following chart. All share data in this Note has been retrospectively restated to give effect to the three-for-two stock split described in Note 1. Preferred Stock Common Stock Issued Treasury Stock Issued Treasury Stock 2012: Balance at January 1, 2012 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Grants of restricted stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Issuance of common stock due to exercise of stock options . . . . Treasury stock acquired . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Retirement of treasury stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Balance at December 31, 2012 . . . . . . . . . . . . . . . . . . . . . . . . . 2013: Grants of restricted stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Forfeitures and surrenders of restricted stock . . . . . . . . . . . . . . . Issuance of common stock due to exercise of stock options . . . . Issuance of common stock due to settlement of restricted stock units . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Treasury stock acquired . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Retirement of treasury stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Balance at December 31, 2013 . . . . . . . . . . . . . . . . . . . . . . . . . 2014: Grants of restricted stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Forfeitures of restricted stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Issuance of common stock due to exercise of stock options . . . . Treasury stock acquired . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Retirement of treasury stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Balance at December 31, 2014 . . . . . . . . . . . . . . . . . . . . . . . . . 0 0 0 0 0 0 0 0 168,468,183 (17,598,985) 104,580 8,036,235 (17,656,559) 9,750,000 158,718,183 (17,364,729) (9,750,000) 76,415 (37,359) 3,917,757 11,190 (11,069,076) 7,500,000 151,218,183 (16,965,802) (7,500,000) 19,041 (2,700) 2,210,349 (8,548,795) (17,000,000) 17,000,000 (6,287,907) 134,218,183 Acquisition of Common Shares: Torchmark shares are acquired from time to time through open market purchases under the Torchmark stock repurchase program when it is believed to be the best use of Torchmark’s excess cash flows. Share repurchases under this program were 7.2 million shares at a cost of $375 million in 2014, 8.3 million shares at a cost of $360 million in 2013, and 11.2 million shares at a cost of $360 million in 2012. When stock options are exercised, proceeds from the exercises are generally used to repurchase approximately the number of shares available with those funds in order to reduce dilution. Shares repurchased for dilution purposes were 1.4 million shares at a cost of $74 million in 2014, 2.8 million shares at a cost of $122 million in 2013, and 6.4 million shares at a cost of $210 million in 2012. Retirement of Treasury Stock: Torchmark retired 17.0 million shares of treasury stock in 2014, 7.5 million in 2013, and 9.8 million in 2012. Restrictions: Restrictions exist on the flow of funds to Torchmark from its insurance subsidiaries. Statutory regulations require life insurance subsidiaries to maintain certain minimum amounts of capital and surplus. Dividends from insurance subsidiaries of Torchmark are limited to the greater of prior year statutory net income excluding realized capital gains on an annual noncumulative basis, or 10% of prior year surplus, in the absence of special regulatory approval. Additionally, insurance company distributions are generally not permitted in excess of statutory surplus. Subsidiaries are also subject to certain minimum capital requirements. Subsidiaries of Torchmark paid cash dividends to the parent company in the amount of $479 million in 2014, $488 million in 2013, and $437 million in 2012. As of December 31, 2014, dividends and transfers from insurance subsidiaries to parent available to be paid in 2015 were limited to the amount of $438 million without regulatory approval, such that $825 million was considered restricted net assets of the subsidiaries. The Company believes that total dividends and transfers of $473 92 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) (Dollar amounts in thousands except per share data) Note 12—Shareholders’ Equity (continued) in 2015. Please refer to Schedule II. Condensed Financial million will be available to the parent Information of Registrant for more information about Torchmark’s transactions with its subsidiaries. While there are no legal restrictions on the payment of dividends to shareholders from Torchmark’s retained earnings, retained earnings as of December 31, 2014 were restricted by lenders’ covenants which require the Company to maintain and not distribute $2.6 billion from its total consolidated retained earnings of $3.4 billion. Earnings Per Share: A reconciliation of basic and diluted weighted-average shares outstanding used in the computation of basic and diluted earnings per share is as follows: Basic weighted average shares outstanding . . . . . . . . . . . . Weighted average dilutive options outstanding . . . . . . . . . . 130,721,738 1,918,506 137,646,885 1,916,900 144,921,299 1,926,283 Diluted weighted average shares outstanding . . . . . . . . . . . 132,640,244 139,563,785 146,847,582 2014 2013 2012 There were no anti-dilutive shares as of December 31, 2012, 2013, or 2014. Income available to to income available to common common shareholders for basic earnings per share is equivalent shareholders for diluted earnings per share. Note 13—Stock-Based Compensation Torchmark’s stock-based compensation consists of stock options, restricted stock, restricted stock units, and performance shares. Certain employees, directors, and consultants have been granted fixed equity options to buy shares of Torchmark stock at the market value of the stock on the date of grant, under the provisions of the Torchmark stock option plans. The options are exercisable during the period commencing from the date they vest until expiring according to the terms of the grant. Options generally expire the earlier of employee termination or option contract term, which ranges from seven to ten years. Options generally vest in accordance with the following schedule: Grants under the Torchmark Corporation 2011 Incentive Plan: Directors – vest in six months. Employees: Seven year grants – vest one half in two years, and one half in three years. Ten year grants – vest one fourth in two years, and one fourth in each of the next three years. Grants under all previous compensation plans: Directors – vest in six months. Employees – vest one half in two years, and one half in three years. All employee options vest immediately upon retirement on or after the attainment of age 65, upon death, or disability. Torchmark generally issues shares for the exercise of stock options from treasury stock. The Company generally uses the proceeds from option exercises to buy shares of Torchmark common stock in the open market to reduce the dilution from option exercises. As disclosed in Note 1—Significant Accounting Policies, Torchmark recorded a three-for-two stock split, effective as of July 1, 2014. As a result, share and per share data in this Note have been retrospectively adjusted to give effect to this split. During 2014, shareholders approved an amendment to the 2011 Incentive Plan allowing for an additional 6.3 million shares available for grant. 93 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) (Dollar amounts in thousands except per share data) Note 13—Stock-Based Compensation (continued) An analysis of shares available for grant is as follows: Balance at January 1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2011 Plan Amendment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Options expired and forfeited during year . . . . . . . . . . . . . . . . . . . Restricted stock expired and forfeited during year (counted as 3.1 options)* . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Options granted during year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Restricted stock, restricted stock units, and performance shares granted under the Torchmark Corporation 2011 Incentive Plan (counted as 3.1 options per grant)* . . . . . . . . . . . . . . . . . . Available for Grant 2013 2014 2012 4,368,753 6,300,000 3,488 6,804,452 0 128,109 9,149,013 0 8,775 31,620 (1,523,982) 9,625 (1,626,863) 0 (1,609,087) (721,286) (946,570) (744,249) Balance at December 31 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8,458,593 4,368,753 6,804,452 * Plan allows for grant of restricted stock such that each stock grant reduces 3.1 options available for grant A summary of stock compensation activity for each of the three years ended December 31, 2014 is presented below: 2014 2013 2012 Stock-based compensation expense recognized* . . . . . . . . . . . . . . . . . . . . . $32,203 $25,642 $ 21,605 7,562 Tax benefit recognized . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10.47 Weighted-average grant-date fair value of options granted . . . . . . . . . . . . . 80,781 Intrinsic value of options exercised . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 181,022 Cash received from options exercised . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29,307 Actual tax benefit received . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11,271 14.77 61,229 56,294 23,232 8,975 12.37 72,793 97,815 27,972 * No stock-based compensation expense was capitalized in any period. An analysis of option activity for each of the three years ended December 31, 2014 is as follows: 2014 2013 2012 Options Weighted Average Exercise Price Options Weighted Average Exercise Price Options Weighted Average Exercise Price Outstanding-beginning of year . . . . . . . . . . . . . . . . . 8,579,202 $27.84 10,998,206 $25.43 17,430,590 $23.61 Granted: 7-year term . . . . . . . . . . . 1,226,270 297,712 10-year term . . . . . . . . . Exercised . . . . . . . . . . . . . .(2,210,348) Expired and forfeited . . . . . (3,488) Adjustment due to 7/1/14 stock split . . . . . . . . . . . . (27) 50.70 50.69 25.47 40.05 n/a 1,361,700 265,162 (3,917,757) (128,109) 0 Outstanding-end of year . . 7,889,321 $32.91 8,579,202 37.62 37.40 24.97 32.33 0.00 $27.84 1,269,450 339,638 (8,031,572) (9,900) 0 10,998,206 30.73 30.33 22.55 29.75 0.00 $25.43 Exercisable at end of year . . . . . . . . . . . . . . . . . 3,809,415 $24.58 4,395,552 $22.95 6,392,726 $23.58 94 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) (Dollar amounts in thousands except per share data) Note 13—Stock-Based Compensation (continued) A summary of restricted stock and restricted stock units granted during each of the years in the three year period ended December 31, 2014 is presented in the table below. Restricted stock holders are entitled to dividends on the stock and holders of restricted stock units are entitled to dividend equivalents. Executive grants vest over five years and director grants vest over six months. Executives restricted stock: 2014 2013 2012 Shares . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 90,000 Price per share . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 50.69 $ 40.09 $ 30.75 Aggregate value . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 608 $ 2,353 $ 2,767 Percent vested as of 12/31/14 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12,000 58,695 0% 0% 40% Directors restricted stock: Shares . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14,580 Price per share . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 51.62 $ 35.45 $ 29.16 425 Aggregate value . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 100% Percent vested as of 12/31/14 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 533 $ 100% 363 $ 100% 15,045 7,041 Directors restricted stock units (including dividend equivalents): Shares . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15,496 Price per share . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 51.69 $ 35.99 $ 29.35 455 Aggregate value . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 100% Percent vested as of 12/31/14 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 612 $ 100% 637 $ 100% 12,322 16,998 Certain senior executives of the Company have been granted performance shares. On February 24 and March 4, 2014, grants were made of 179 thousand performance shares with grant prices ranging from $50.69 to $52.40 per share for an aggregate grant price of $9.2 million. On February 27, 2013, a grant was made of 148 thousand performance shares at a price of $37.40 per share for an aggregate grant price of $5.5 million. On February 21 and 22, 2012 grants were made of 120 thousand performance shares with grant prices ranging from $32.48 to $32.73 per share for an aggregate grant price of $3.9 million. Performance grants have a three year contract life, and they do not vest prior to the termination of the contract period. While the target distribution is 179 thousand, 148 thousand, and 120 thousand shares for the 2014, 2013, and 2012 grants, respectively, the determination of the actual settlement in shares will be based on the achievement of certain performance objectives of Torchmark over the respective three- year contract periods. The actual shares could be distributed in a range from 0 to 359 thousand shares for the 2014 grants and 0 to 295 thousand shares for the 2013 grants. A final determination for the 2012 grants has been made as of December 31, 2014 to be 211 thousand shares, as those shares became fully vested at January 27, 2015. The performance shareholders are not entitled to dividend equivalents, and are not entitled to dividend payments until vested and settled. 95 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) (Dollar amounts in thousands except per share data) Note 13—Stock-Based Compensation (continued) An analysis of unvested restricted stock is as follows: Executive Restricted Stock Executive Performance Shares Directors Restricted Stock Directors Restricted Stock Units Total 2012: Balance at January 1, 2012 . . . . . . . . . . . . Grants . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Restriction lapses . . . . . . . . . . . . . . . . . . . . Forfeitures . . . . . . . . . . . . . . . . . . . . . . . . . . 490,500 90,000 (112,950) 0 Balance at December 31, 2012 . . . . . . . 467,550 2013: Grants . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Additional performance shares* . . . . . . . . . Restriction lapses . . . . . . . . . . . . . . . . . . . . Forfeitures . . . . . . . . . . . . . . . . . . . . . . . . . . 58,695 0 (150,750) (31,050) Balance at December 31, 2013 . . . . . . . 344,445 0 120,000 0 0 120,000 147,750 94,800 0 0 362,550 2014: Grants . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Additional performance shares* . . . . . . . . . Restriction lapses . . . . . . . . . . . . . . . . . . . . Forfeitures . . . . . . . . . . . . . . . . . . . . . . . . . . 12,000 0 (90,315) (2,700) 179,250 22,060 0 (7,500) Balance at December 31, 2014 . . . . . . . 263,430 556,360 0 14,580 (14,580) 0 0 15,045 0 (15,045) 0 0 7,041 0 (7,041) 0 0 0 15,496 (15,496) 0 490,500 240,076 (143,026) 0 0 587,550 16,998 0 (16,998) 0 238,488 94,800 (182,793) (31,050) 0 706,995 12,322 0 (12,322) 0 210,613 22,060 (109,678) (10,200) 0 819,790 * Estimated additional share grants expected due to achievement of performance criteria. Restricted stock units outstanding at each of the year ends 2014, 2013, and 2012 were 98,039, 85,717, and 79,907, respectively. Restricted stock units are only available to directors, and are not converted to shares until the director’s retirement, death, or disability. There were no unvested director restricted shares outstanding at the end of any of the years 2012 through 2014. Director restricted stock and restricted stock units are generally granted on the first working day of the year and vest in six months. Dividend equivalents are earned on restricted stock units only. They are granted in the form of additional restricted stock units and vest immediately upon grant. An analysis of the weighted-average grant-date fair values of unvested restricted stock is as follows for the year 2014: Executive Restricted Stock Executive Performance Shares Directors Restricted Stock Directors Restricted Stock Units Grant-date fair value per share at January 1, 2014 . . . . . . Grants . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Estimated additional performance shares . . . . . . . . . . . . . . Restriction lapses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Forfeitures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Grant-date fair value per share at December 31, 2014 . . . $ 29.49 50.69 (25.37) 31.13 31.85 $34.58 51.41 41.93 50.69 40.07 $ 51.62 $ 51.62 (51.62) (51.62) 96 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) (Dollar amounts in thousands except per share data) Note 13—Stock-Based Compensation (continued) Additional information about Torchmark’s stock-based compensation as of December 31, 2014 and 2013 is as follows: Outstanding options: 2014 2013 Weighted-average remaining contractual term (in years) . . . . . . . . . . . . . . . . . . . . . Aggregate intrinsic value . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.34 $167,713 4.11 $208,152 Exercisable options: Weighted-average remaining contractual term (in years) . . . . . . . . . . . . . . . . . . . . . Aggregate intrinsic value . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.72 $112,724 2.49 $128,150 Unrecognized compensation* . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Weighted average period of expected recognition (in years)* . . . . . . . . . . . . . . . . . . . $ 38,809 0.91 $ 37,397 0.96 * Includes restricted stock Additional information concerning Torchmark’s unvested options is as follows at December 31: 2014 2013 Number of shares outstanding . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Weighted-average exercise price (per share) . . . . . . . . . . . . . . . . . . . . . $ Weighted-average remaining contractual term (in years) . . . . . . . . . . . Aggregate intrinsic value . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 4,079,906 40.69 $ 5.85 54,989 $ 4,183,650 32.98 5.81 80,002 Torchmark expects that substantially all unvested options will vest. The following table summarizes information about stock options outstanding at December 31, 2014. Range of Exercise Prices Number Outstanding $18.56 - $20.58 24.22 - 29.59 30.33 - 32.48 37.40 - 43.06 50.69 - 51.62 $18.56 - $51.62 1,719,209 1,698,264 1,335,555 1,614,112 1,522,181 7,889,321 Options Outstanding Options Exercisable Weighted- Average Remaining Contractual Life (Years) Weighted- Average Exercise Price 1.87 3.37 4.69 5.48 6.69 4.34 $18.17 29.31 30.54 37.58 50.70 $32.91 Number Exercisable 1,719,209 1,552,247 506,440 26,250 5,269 3,809,415 Weighted- Average Exercise Price $18.17 29.30 30.61 43.06 51.62 $24.58 No equity awards were cash settled during the three years ended December 31, 2014. Note 14—Business Segments Torchmark’s reportable segments are based on the insurance product lines it markets and administers: life insurance, health insurance, Medicare Part D, 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. There is also an investment segment which manages the investment portfolio, debt, and cash flow for the insurance segments and the corporate function. Torchmark’s chief operating decision maker evaluates the overall performance of the operations of the Company in accordance with these segments. 97 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) (Dollar amounts in thousands except per share data) Note 14—Business Segments (continued) Effective January 1, 2014, Torchmark reorganized its segment structure to separate its Medicare Part D health insurance business from its other health insurance activities as a stand-alone segment. Management has concluded that Medicare Part D meets the criteria of a distinct segment. Previously, Part D was included in the health segment. Prior periods’ segment results have been retrospectively adjusted for comparability. Premium income for Medicare Part D health insurance is included with the premium for other health products in the Consolidated Statements of Operations. Life insurance products include traditional and interest-sensitive whole life insurance as well as term life insurance. Health products are generally guaranteed-renewable and include Medicare Supplement, cancer, accident, long-term care, and limited-benefit hospital and surgical coverages. Medicare Part D includes prescription drug coverage for Medicare beneficiaries. Annuities include fixed-benefit contracts. Torchmark markets its insurance products through a number of distribution channels, each of which sells the products of one or more of Torchmark’s insurance segments. The tables below present segment premium revenue by each of Torchmark’s marketing groups. Torchmark Corporation Premium Income By Distribution Channel For the Year 2014 Life Health Medicare Part D % of Total Amount Annuity Distribution Channel United American Independent . . . . . . . . . . . . . $ Liberty National Exclusive . . . . . . . . . . . . . . . . American Income Exclusive . . . . . . . . . . . . . . Family Heritage Exclusive . . . . . . . . . . . . . . . . Direct Response . . . . . . . . . . . . . . . . . . . . . . . . Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Amount 16,582 272,265 766,458 1,595 702,023 207,377 % of Total Amount 1 $305,368 222,017 78,722 204,667 58,666 14 39 0 36 10 % of Total Amount 35 $ 55,397 25 6,431 9 24 7 285,977 $400 16 2 82 $1,966,300 100 $869,440 100 $347,805 100 $400 For the Year 2013 Life Health Medicare Part D % of Total Amount Annuity Distribution Channel United American Independent . . . . . . . . . . . . . $ Liberty National Exclusive . . . . . . . . . . . . . . . . American Income Exclusive . . . . . . . . . . . . . . Family Heritage Exclusive . . . . . . . . . . . . . . . . Direct Response . . . . . . . . . . . . . . . . . . . . . . . . Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Amount 19,742 275,980 715,366 1,006 663,544 209,694 % of Total Amount 1 $298,298 241,264 79,435 190,923 53,898 15 38 0 35 11 % of Total Amount 35 $ 41,455 28 7,361 9 22 6 251,192 $532 14 2 84 $1,885,332 100 $863,818 100 $300,008 100 $532 For the Year 2012 Life Health Medicare Part D % of Total Amount Annuity Distribution Channel United American Independent . . . . . . . . . . . . . $ Liberty National Exclusive . . . . . . . . . . . . . . . . American Income Exclusive . . . . . . . . . . . . . . Family Heritage Exclusive . . . . . . . . . . . . . . . . Direct Response . . . . . . . . . . . . . . . . . . . . . . . . Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Amount 21,127 281,723 663,696 130 630,111 211,737 % of Total Amount 1 $298,759 263,535 79,640 30,119 57,966 15 37 0 35 12 % of Total Amount 41 $ 64,021 36 8,533 11 4 8 245,210 $559 20 3 77 Total % of Total Amount 100 $ 377,747 500,713 845,180 206,262 1,046,666 207,377 % of Total 12 16 27 6 33 6 100 $3,183,945 100 Total % of Total Amount 100 $ 360,027 524,605 794,801 191,929 968,634 209,694 % of Total 12 17 26 6 32 7 100 $3,049,690 100 Total % of Total Amount 100 $ 384,466 553,791 743,336 30,249 933,287 211,737 % of Total 13 19 26 1 33 8 100 $2,856,866 100 $1,808,524 100 $730,019 100 $317,764 100 $559 98 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) (Dollar amounts in thousands except per share data) Note 14—Business Segments (continued) Because of the nature of the life insurance industry, Torchmark has no individual or group which would be considered a major customer. Substantially all of Torchmark’s business is conducted in the United States. The measure of profitability established by the chief operating decision maker for insurance segments is underwriting margin before other income and administrative expenses, in accordance with the manner the segments are managed. It essentially represents gross profit margin on insurance products before insurance administrative expenses and consists of premium, less net policy obligations, acquisition expenses, and commissions. Interest credited to net policy liabilities (reserves less deferred acquisition costs) is reflected as a component of the Investment segment in order to match this cost to the investment earnings from the assets supporting the net policy liabilities. The measure of profitability for the Investment segment is excess investment income, which represents the income earned on the investment portfolio in excess of net policy requirements and financing costs associated with Torchmark’s debt. Other than the above-mentioned interest allocations and an intersegment commission, there are no other intersegment revenues or expenses. Expenses directly attributable to corporate operations are included in the “Corporate” category. Stock-based compensation expense is considered a corporate expense by Torchmark management and is included in this category. All other unallocated revenues and expenses on a pretax basis, including insurance administrative expense, are included in the “Other” segment category. Torchmark holds a sizeable investment portfolio to support its insurance liabilities, the yield from which is used to offset policy benefit, acquisition, administrative and tax expenses. This yield or investment income is taken into account when establishing premium rates and profitability expectations of its insurance products. In holding such a portfolio, investments are sold, called, or written down from time to time, resulting in a realized gain or loss. These gains or losses generally occur as a result of disposition due to issuer calls, a downgrade in credit quality, compliance with Company investment policies, or other reasons often beyond management’s control. Unlike investment income, realized gains and losses are incidental to insurance operations, and only overall yields are considered when setting premium rates or insurance product profitability expectations. While these gains and losses are not relevant to segment profitability or core operating results, they can have a material positive or negative result on net income. For these reasons, management removes realized investment gains and losses when it views its segment operations. During 2014, Torchmark accrued for certain litigation matters in the net amount of $3.7 million ($2.4 million after tax) that were not directly related to its insurance operations. Additionally, Torchmark received $1.3 million ($853 thousand after tax) in settlement of litigation regarding investments. Also in 2014, the Company recorded $8.2 million in administrative settlements ($5.3 million after tax) related to benefits paid for deaths occurring in prior years where claims had not been filed. These administrative settlements were included in “Policyholder benefits” in the Consolidated Statements of Operations in 2014. During 2013, Torchmark incurred four non- operating charges: (1) a state guaranty fund assessment in the amount of $1.2 million ($751 thousand after tax), resulting from events in years prior to 2012, (2) a legal settlement related to a non-insurance matter in the amount of $500 thousand ($325 thousand after tax), (3) the settlement of a litigation matter related to prior years in the amount of $8.6 million ($5.6 million after tax) and (4) a one-time adjustment related to the finalization of accounting for the acquisition of the insurance assets and liabilities of Family Heritage. The Family Heritage acquisition closed on November 1, 2012. This adjustment increased after-tax earnings in the amount of $522 thousand. Management removes items that are related to prior periods when evaluating the operating results of current periods. Management also removes non-operating items unrelated to its core insurance activities when evaluating those results. Therefore, these items are excluded in its presentation of segment results, because accounting guidance requires that operating segment results be presented as management views its business. With the exception of the administrative settlements in the paragraph above, all of these items are included in “Other operating expense” in the Consolidated Statements of Operations for the appropriate year. 99 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) (Dollar amounts in thousands except per share data) Note 14—Business Segments (continued) The following tables set forth a reconciliation of Torchmark’s revenues and operations by segment to its information line items. See Note 1—Significant Accounting Policies for additional major income statement concerning reconciling items of segment profits to pretax income. Life Health Medicare Part D Annuity Investment Other Corporate Adjustments Consolidated For the year 2014 Revenue: Premium . . . . . . . . . . . . . . . . . . . . . . $1,966,300 $869,440 $347,805 $ Net investment income . . . . . . . . . . . Other income . . . . . . . . . . . . . . . . . . . 400 $ 758,286 Total revenue . . . . . . . . . . . . . . . 1,966,300 869,440 347,805 400 758,286 $ 2,354 2,354 Expenses: Policy benefits . . . . . . . . . . . . . . . . . . 1,293,384 559,817 290,341 Required interest on: 42,005 Policy reserves . . . . . . . . . . . . . . . Deferred acquisition costs . . . . . . Amortization of acquisition costs . . . Commissions, premium taxes, and non-deferred acquisition costs . . . Insurance administrative expense(2) . Parent expense . . . . . . . . . . . . . . . . . Stock compensation expense . . . . . Interest expense . . . . . . . . . . . . . . . . (530,192) 168,100 335,345 (64,401) 22,499 72,731 0 (55,255) 649,848 1,453 (192,779) 7,838 727 2,858 143,174 79,475 26,613 47 179,955 $ 8,159 32,203 76,126 $25,475(1) (29,079)(4) (233)(3) $3,209,420 729,207 2,121 (3,837) 3,940,748 33,653(1,6) 2,219,200 0 0 418,772 249,076 182,377 8,074 32,203 76,126 (233)(3) 2,422(5) (85)(5) Total expenses . . . . . . . . . . . . . 1,409,811 670,121 320,539 (3,912) 533,195 179,955 40,362 35,757 3,185,828 Subtotal . . . . . . . . . . . . . . . . . . . . . . . . . Nonoperating items . . . . . . . . . . . . . . Amortization of low-income housing . . . . . . . . . . . . . . . . . . . . . Measure of segment profitability 556,489 199,319 27,266 4,312 225,091 (177,601) (40,362) (39,594) 10,515(5,6) 754,920 10,515 29,079(4) 29,079 (pretax) . . . . . . . . . . . . . . . . . . . . $ 556,489 $199,319 $ 27,266 $ 4,312 $ 225,091 $(177,601) $(40,362) $ 0 794,514 Deduct applicable income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (260,046) Segment profits after tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 534,468 Add back income taxes applicable to segment profitability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Add (deduct) realized investment gains (losses) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Deduct Part D adjustments(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Deduct amortization of low-income housing(4) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Deduct legal settlement expenses(5) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Deduct administrative settlements(6) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 260,046 23,548 0 (29,079) (2,337) (8,178) Pretax income per Consolidated Statement of Operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 778,468 (1) Medicare Part D items adjusted to GAAP from the segment analysis, which matches expected benefits with policy premium. (2) Administrative expense is not allocated to insurance segments. (3) Elimination of intersegment commission. (4) Amortization of low-income housing expense, considered a component of income tax expense in the segment analysis. (5) Legal settlement expenses. (6) Administrative settlements. 100 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) (Dollar amounts in thousands except per share data) Note 14—Business Segments (continued) Life Health* Medicare Part D* Annuity Investment Other Corporate Adjustments Consolidated For the year 2013 Revenue: Premium . . . . . . . . . . . . . . . . . . . . . . . . . $1,885,332 $863,818 $300,008 $ Net investment income . . . . . . . . . . . . . Other income . . . . . . . . . . . . . . . . . . . . . 532 $ 734,650 Total revenue . . . . . . . . . . . . . . . . . 1,885,332 863,818 300,008 532 734,650 $ 2,208 2,208 Expenses: Policy benefits . . . . . . . . . . . . . . . . . . . . 1,227,857 558,982 247,496 Required interest on: 43,302 Policy reserves . . . . . . . . . . . . . . . . . Deferred acquisition costs . . . . . . . . Amortization of acquisition costs . . . . . Commissions, premium taxes, and non-deferred acquisition costs . . . . . Insurance administrative expense(2) . . . . Parent expense . . . . . . . . . . . . . . . . . . . Stock-based compensation expense . . . . . . . . . . . . . . . . . . . . . . . Interest expense . . . . . . . . . . . . . . . . . . (508,236) 164,981 323,950 (59,858) 22,568 69,724 0 (57,294) 625,388 1,811 (190,025) 8,714 665 2,520 131,721 75,895 14,027 60 178,898 $ 8,495 25,642 80,461 $2,584(1) (24,907)(4) (277)(3) $3,052,274 709,743 1,931 (22,600) 3,763,948 11,209(1,6) 2,088,846 (1,519)(7) (277)(3) 1,155(5) 500(6) 0 0 403,389 221,426 180,053 8,995 25,642 80,461 Total expenses . . . . . . . . . . . . . . . . 1,340,273 667,311 264,708 (3,407) 515,824 178,898 34,137 11,068 3,008,812 Subtotal . . . . . . . . . . . . . . . . . . . . . . . . . . . Non-operating items . . . . . . . . . . . . . . . Amortization of low-income housing interests . . . . . . . . . . . . . . . . . . . . . . . Measure of segment profitability 545,059 196,507 35,300 3,939 218,826 (176,690) (34,137) (33,668) 8,761(5,6,7) 755,136 8,761 24,907(4) 24,907 (pretax) . . . . . . . . . . . . . . . . . . . . . . $ 545,059 $196,507 $ 35,300 $ 3,939 $ 218,826 $(176,690) $(34,137) $ 0 788,804 Deduct applicable income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Segment profits after tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Add back income taxes applicable to segment profitability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Add (deduct) realized investment gains (losses) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Deduct Medicare Part D adjustments(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Deduct amortization of low-income housing(4) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Deduct Guaranty Fund Assessment(5) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Deduct legal settlement expenses(6) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Add Family Heritage Life acquisition adjustments(7) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (258,137) 530,667 258,137 7,990 0 (24,907) (1,155) (9,125) 1,519 Pretax income per Consolidated Statement of Operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 763,126 (1) Medicare Part D items adjusted to GAAP from the segment analysis, which matches expected benefits with policy premium. (2) Administrative expense is not allocated to insurance segments. (3) Elimination of intersegment commission. (4) Amortization of low-income housing interests. (5) Guaranty Fund Assessment. (6) Legal settlement expenses. (7) Family Heritage Life acquisition adjustments. * Retrospectively adjusted to give effect to the reorganization of segments described earlier in this Note. 101 Expenses: Policy benefits . . . . . . . . . . Required interest on: Policy reserves . . . . . . . Deferred acquisition costs . . . . . . . . . . . . . . Amortization of acquisition costs . . . . . . . . . . . . . . . . Commissions, premium taxes, and non-deferred acquisition costs . . . . . . Insurance administrative expense(3) . . . . . . . . . . . Parent expense . . . . . . . . . Stock-based compensation expense . . . . . . . . . . . . . Interest expense . . . . . . . . NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) (Dollar amounts in thousands except per share data) Note 14—Business Segments (continued) Life Health* Medicare Part D* Annuity Investment Other Corporate Adjustments Consolidated For the Year 2012 Revenue: Premium . . . . . . . . . . . . . . $1,808,524 $730,019 $317,764 $ Net investment income . . . Other income . . . . . . . . . . . 559 $ 715,918 Total revenue . . . . . . . 1,808,524 730,019 317,764 559 715,918 $ 1,898 1,898 1,172,020 472,988 266,957 44,121 (483,892) (40,963) 0 (59,293) 584,148 163,875 18,475 584 2,238 (185,172) 309,930 62,910 2,368 9,959 $ (404)(1) (22,274)(2)(5) (321)(4) $2,856,462 693,644 1,577 (22,999) 3,551,683 (404)(1) 1,955,682 0 0 385,167 137,115 52,625 14,498 69 (321)(4) 203,986 165,405 $ 8,222 2,944(6) 80,298 21,605 214(2) 165,405 11,166 21,605 80,512 Total expenses . . . . . 1,299,048 566,035 284,407 (2,906) 479,274 165,405 29,827 2,433 2,823,523 Sub total . . . . . . . . . . . . . . . . Non operating items . . . . . Amortization of low- income housing interests . . . . . . . . . . . . . Measure of segment 509,476 163,984 33,357 3,465 236,644 (163,507) (29,827) (25,432) 2,944(6) 728,160 2,944 22,488(5) 22,488 profitability (pretax) . . $ 509,476 $163,984 $ 33,357 $ 3,465 $ 236,644 $(163,507) $(29,827) $ 0 753,592 Deduct applicable income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Segment profits after tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Add back income taxes applicable to segment profitability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Add (deduct) realized investment gains (losses) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Deduct Medicare Part D adjustments(1) Deduct amortization of low-income housing(5) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Deduct Family Heritage Life acquisition expense(6) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (246,945) 506,647 246,945 37,833 0 (22,488) (2,944) Pretax income per the Consolidated Statement of Operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 765,993 (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. (3) Administrative expense is not allocated to insurance segments. (4) Elimination of intersegment commission. (5) Amortization of low-income housing interests. (6) Family Heritage Life acquisition expense. * Retrospectively adjusted to give effect to the reorganization of segments described earlier in this Note. 102 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) (Dollar amounts in thousands except per share data) Note 14—Business Segments (continued) The following table summarizes the measures of segment profitability as determined in the three preceding tables for comparison with prior periods. The table also reconciles segment profits to net income. Analysis of Profitability by Segment 2014 2013 2012 Change % Change % 2014 2013 Life insurance underwriting margin . . . . . . . . . . . . . . . . . . . . . . . . . . $ 556,489 $ 545,059 $ 509,476 $11,430 2,812 Health insurance underwriting margin* . . . . . . . . . . . . . . . . . . . . . . (8,034) Medicare Part D underwriting margin* . . . . . . . . . . . . . . . . . . . . . . . 373 Annuity underwriting margin . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Excess investment income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6,265 Other insurance: 199,319 27,266 4,312 225,091 196,507 35,300 3,939 218,826 163,984 33,357 3,465 236,644 2 $ 35,583 1 (23) 9 3 7 32,523 20 6 474 14 (8) (17,818) 1,943 Other income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Administrative expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Corporate and adjustments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,354 (179,955) (40,362) 2,208 (178,898) (34,137) 1,898 (165,405) (29,827) 7 146 (1,057) 1 (6,225) 18 (13,493) 310 16 8 (4,310) 14 Pre-tax total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Applicable taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 794,514 (260,046) 788,804 (258,137) 753,592 (246,945) 5,710 (1,909) Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Realized gains (losses)—investments (after tax) . . . . . . . . . . . . . . Acquisition expense—Family Heritage (after tax) . . . . . . . . . . . . . . Family Heritage acquisition finalization adjustments (after tax) . . . . . . . . . . . . . . . . . . . . . . . . . . Legal settlement expenses (after tax) Guaranty Fund assessment (after tax) . . . . . . . . . . . . . . . . . . . . . . . Administrative settlements (after tax) . . . . . . . . . . . . . . . . . . . . . . . . 534,468 15,306 0 0 (1,519) 0 (5,316) 530,667 3,965 0 522 (5,931) (751) 0 506,647 24,591 (1,914) 0 0 0 0 3,801 11,341 0 (522) 4,412 751 (5,316) 1 1 1 5 5 5 35,212 (11,192) 24,020 (20,626) 1,914 522 (5,931) (751) 0 Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 542,939 $ 528,472 $ 529,324 $14,467 3 $ (852) 0 * Retrospectively adjusted to give effect to the reorganization of segments described earlier in this Note. 103 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) (Dollar amounts in thousands except per share data) Note 14—Business Segments (continued) Assets for each segment are reported based on a specific identification basis. The insurance segments’ assets contain deferred acquisition costs (including the value of insurance purchased). The investment segment includes the investment portfolio, cash, and accrued investment income. Goodwill is assigned to the insurance segments at the time of purchase based on the excess of cost over the fair value of assets acquired for the benefit of that segment. All other assets are included in the Other category. The table below reconciles segment assets to total assets as reported in the consolidated financial statements. Assets by Segment Life Health Medicare Part D Annuity Investment Other Consolidated At December 31, 2014 Cash and invested assets . . . . . . . . . Accrued investment income . . . . . . . Deferred acquisition costs . . . . . . . . . Goodwill . . . . . . . . . . . . . . . . . . . . . . . Other assets . . . . . . . . . . . . . . . . . . . . $2,946,995 309,609 $493,880 131,982 $14,384 $16,522 $15,058,996 204,879 $15,058,996 204,879 3,471,781 441,591 1,037,483 $1,037,483 Total assets . . . . . . . . . . . . . . . . . . . . $3,256,604 $625,862 $14,384 $16.522 $15,263,875 $1,037,483 $20,214,730 Life Health Medicare Part D Annuity Investment Other Consolidated At December 31, 2013* Cash and invested assets . . . . . . . . . Accrued investment income . . . . . . . Deferred acquisition costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Goodwill Other assets . . . . . . . . . . . . . . . . . . . . $2,809,199 309,609 $485,527 131,982 $12,216 $30,707 $13,456,944 200,038 $13,456,944 200,038 3,337,649 441,591 755,522 $ 755,522 Total assets . . . . . . . . . . . . . . . . . . . . $3,118,808 $617,509 $12,216 $30,707 $13,656,982 $ 755,522 $18,191,744 Other Balances by Segment Future policy benefits . . . . . . . . . . . . . . . . . . . . Unearned and advance premium . . . . . . . . . . Policy claims and other benefits payable . . . . Debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . At December 31, 2014 Life Health $8,900,344 17,238 125,884 $1,489,963 54,465 128,265 Medicare Part D $ 572 (42,012) Annuity Investment Consolidated $1,360,188 $11,750,495 72,275 212,137 1,230,528 $1,230,528 Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $9,043,466 $1,672,693 $(41,440) $1,360,188 $1,230,528 $13,265,435 Future policy benefits . . . . . . . . . . . . . . . . . . . . Unearned and advance premium . . . . . . . . . . Policy claims and other benefits payable . . . . Debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . At December 31, 2013* Life Health $8,493,972 16,970 121,661 $1,384,365 54,248 116,559 Medicare Part D $ 2,956 (14,840) Annuity Investment Consolidated $1,377,818 $11,256,155 74,174 223,380 1,219,935 $1,219,935 Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $8,632,603 $1,555,172 $(11,884) $1,377,818 $1,219,935 $12,773,644 * Retrospectively adjusted to give effect to the reorganization of segments described earlier in this Note. 104 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) (Dollar amounts in thousands except per share data) Note 15—Commitments and Contingencies Reinsurance: Insurance affiliates of Torchmark reinsure that portion of insurance risk which is in excess of their retention limits. Retention limits for ordinary life insurance range up to $2.0 million per life. Life insurance ceded represented less than .1% of total life insurance in force at December 31, 2014. Insurance ceded on life and accident and health products represented .2% of premium income for 2014. Torchmark would be liable for the reinsured risks ceded to other companies to the extent that such reinsuring companies are unable to meet their obligations. Insurance affiliates also assume insurance risks of other companies. Life reinsurance assumed represented 2.2% of life insurance in force at December 31, 2014 and reinsurance assumed on life and accident and health products represented .8% of premium income for 2014. Leases: Torchmark leases office space and office equipment under a variety of operating lease arrangements. Rental expense for operating leases was $4.2 million in 2014, $4.1 million in 2013, and $3.6 million in 2012. Future minimum rental commitments required under operating leases having remaining noncancelable lease terms in excess of one year at December 31, 2014 were as follows: 2015, $9 million; 2016, $8 million; 2017, $7 million; 2018, $4 million; 2019, $4 million and in the aggregate, $46 million. Low-Income Housing Tax Credit Interests: As described in Note 1, Torchmark had $318 million invested in entities which provide certain tax benefits at December 31, 2014. As of December 31, 2014, Torchmark remained obligated under these commitments for $76 million, of which $44 million is due in 2015, $19 million in 2016, $6 million in 2017, and $7 million thereafter. Concentrations of Credit Risk: Torchmark maintains a diversified investment portfolio with limited concentration in any given issuer. At December 31, 2014, the investment portfolio, at fair value, consisted of the following: Investment-grade corporate securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Securities of state and municipal governments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Below-investment-grade securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Policy loans, which are secured by the underlying insurance policy values . . . . . . . . . . . . . . Government-sponsored enterprises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 81% 10 4 3 2 100% As of December 31, 2014, securities of state and municipal governments represented 10% of invested assets at fair value. Such investments are made throughout the U.S. At year-end 2014, 5% or more of the state and municipal bond portfolio at fair value was invested in securities issued within the following states: Texas (31%), Ohio (7%), Washington (7%), Illinois (6%), and Alabama (5%). Otherwise, there was no significant concentration within any given state. Corporate debt and equity investments are made in a wide range of industries. Below are the ten largest industry concentrations held in the corporate portfolio at December 31, 2014, based on fair value: Insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18% Electric utilities and services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17% 7% Pipelines . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6% Banks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5% Oil and gas extraction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5% Transportation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4% Chemicals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3% Mining . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3% Gas utilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3% REITs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 105 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) (Dollar amounts in thousands except per share data) Note 15—Commitments and Contingencies (continued) At year-end 2014, 4% of invested assets at fair value was represented by fixed maturities rated below investment grade (BB or lower as determined by the weighted average of available ratings from rating services). Par value of these investments was $635 million, amortized cost was $561 million, and fair value was $550 million. While these investments could be subject to additional credit risk, such risk should generally be reflected in their fair value. Guarantees: At December 31, 2014, Torchmark had in place three guarantee agreements, of which were either parent company guarantees of subsidiary obligations to a third party, or parent company guarantees of obligations between wholly-owned subsidiaries. As of December 31, 2014, Torchmark had no liability with respect to these guarantees. Letters of Credit: Torchmark has guaranteed letters of credit in connection with its credit facility with a group of banks as disclosed in Note 11. The letters of credit were issued by TMK Re, Ltd., a wholly-owned subsidiary, to secure TMK Re, Ltd.’s obligation for claims on certain policies reinsured by TMK Re, Ltd. that were sold by other Torchmark insurance companies. These letters of credit facilitate TMK Re, Ltd.’s ability to reinsure the business of Torchmark’s insurance carriers. The agreement expires in 2019. The maximum amount of letters of credit available is $250 million. Torchmark (parent company) would be liable to the extent that TMK Re, Ltd. does not pay the reinsured party. At December 31, 2014, $198 million of letters of credit were outstanding. Equipment leases: Torchmark has guaranteed performance of certain subsidiaries as lessees under three leasing arrangements, two for aviation equipment and the other for computer software and other furniture and equipment. One aviation lease expires in August, 2022, and the second expires in September, 2024. The other lease expires in December, 2017. At December 31, 2014, total remaining undiscounted payments under the leases were approximately $23 million. Torchmark (parent company) would be responsible for any subsidiary obligation in the event the subsidiary did not make payments or otherwise perform under the terms of the lease. Unclaimed Property Audits: Torchmark subsidiaries are currently the subject of audits regarding the identification, reporting, and escheatment of unclaimed property arising from life insurance policies and a limited number of annuity contracts. These audits are being conducted by private entities that have contracted with forty seven states through their respective Departments of Revenue, and have not resulted in any financial assessment from any state nor indicated any Company liability. These audits are wide-ranging, and seek large amounts of data regarding claims handling, procedures, and payments of contract benefits arising from unreported death claims. No estimate of range can be made at this time for loss contingencies related to possible administrative amounts or penalties that could be payable to the states for the escheatment of abandoned property. Litigation: Torchmark and its subsidiaries, in common with the insurance industry in general, are subject to litigation, including claims involving 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. Based upon information presently available, and in light of legal and other factual defenses available to Torchmark and its subsidiaries, management does not believe that such litigation will have a material adverse effect on Torchmark’s financial condition, future operating results or liquidity; however, assessing the eventual outcome of litigation necessarily involves forward-looking speculation as to judgments to be made by juries and appellate courts in the future. This bespeaks caution, particularly in states with judges, reputations for high punitive damage verdicts. Torchmark’s management recognizes that large punitive damage awards bearing little or no relation to actual damages continue to be awarded by juries in jurisdictions in which Torchmark and its subsidiaries have substantial business, creating the potential for unpredictable material adverse judgments in any given punitive damage suit. With respect to its current litigation, at this time management believes that the possibility of a material judgment adverse to Torchmark is remote, and no estimate of range can be made for loss contingencies that are at least reasonably possible but not accrued. 106 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) (Dollar amounts in thousands except per share data) Note 16—Selected Quarterly Data (Unaudited) The following is a summary of quarterly results for the two years ended December 31, 2014. The information is unaudited but includes all adjustments (consisting of normal accruals) which management considers necessary for a fair presentation of the results of operations for these periods. March 31, June 30, September 30, December 31, Three Months Ended 2014: Premium and policy charges . . . . . . . . . . . . . . . . Net investment income . . . . . . . . . . . . . . . . . . . . Realized investment gains (losses) . . . . . . . . . . Total revenues . . . . . . . . . . . . . . . . . . . . . . . . . . . Policy benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . Amortization of acquisition expenses . . . . . . . . . Pretax income . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Basic net income per common share* . . . . . . . . Diluted net income per common share* . . . . . . . 2013: Premium and policy charges . . . . . . . . . . . . . . . . Net investment income . . . . . . . . . . . . . . . . . . . . Realized investment gains (losses) . . . . . . . . . . Total revenues . . . . . . . . . . . . . . . . . . . . . . . . . . . Policy benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . Amortization of acquisition expenses . . . . . . . . . Pretax income . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Basic net income per common share* . . . . . . . . Diluted net income per common share* . . . . . . . $ 819,020 181,000 16,619 1,017,120 586,517 104,733 190,487 132,856 1.00 .98 $ 784,814 176,839 (3,907) 958,216 552,003 101,714 173,063 119,632 .85 .84 $799,866 182,877 577 983,983 555,207 104,561 186,758 130,923 1.00 .98 $765,851 177,964 5,913 950,339 524,499 102,488 192,784 133,901 .97 .96 $785,715 182,101 (1,483) 967,001 535,532 103,834 189,564 132,412 1.02 1.00 $750,998 176,656 4,459 932,789 516,783 98,444 190,850 132,122 .97 .95 $804,819 183,229 7,835 996,192 541,944 105,644 211,659 146,748 1.14 1.13 $750,611 178,284 1,525 930,594 495,561 100,743 206,429 142,817 1.06 1.04 * Per share amounts have been retrospectively adjusted for the stock split effective July 1, 2014. Basic and diluted net income per share by quarter may not add to per share income on a year-to-date basis due to share weighting and rounding. 107 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure No disagreements with accountants on any matter of accounting principles or practices or financial statement disclosure have been reported on a Form 8-K within the twenty-four months prior to the date of the most recent financial statements. Item 9A. Controls and Procedures Torchmark, under the direction of the Co-Chairmen and Chief Executive Officers and the Executive Vice President and Chief Financial Officer, has established disclosure controls and procedures that are designed to ensure that information required to be disclosed by Torchmark in the reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. The disclosure controls and procedures are also intended to ensure that such information is accumulated and communicated to Torchmark’s management, including the Co-Chairmen and Chief Executive Officers and the Executive Vice President and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosures. As of the end of the fiscal year completed December 31, 2014, an evaluation was performed under the supervision and with the participation of Torchmark management, including the Co-Chairmen and Chief Executive Officers and the Executive Vice President and Chief Financial Officer, of Torchmark’s disclosure controls and procedures (as those terms are defined in Rule 13a-15(e) under the Securities Exchange Act of 1934). Based upon their evaluation, the Co-Chairmen and Chief Executive Officers and the Executive Vice President and Chief Financial Officer have concluded that Torchmark’s disclosure controls and procedures are effective as of the date of this Form 10-K. In compliance with Section 302 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. § 1350), each of these officers executed a Certification included as an exhibit to this Form 10-K. As of the quarter ended December 31, 2014, there have not been any changes in Torchmark’s internal control over financial reporting or in other factors that could significantly affect this control over financial reporting subsequent to the date of their evaluation which have materially affected, or are reasonably likely to materially affect, Torchmark’s internal control over financial reporting. No material weaknesses in such internal controls were identified in the evaluation and as a consequence, no corrective action was required to be taken. There were no items required. Item 9B. Other Information 108 Management’s Report on Internal Control over Financial Reporting Management at Torchmark Corporation is responsible for establishing and maintaining adequate internal control over financial reporting for the Company and for assessing the effectiveness of internal control on an annual basis. As a framework for assessing internal control over financial reporting, the Company utilizes the criteria for effective internal control over financial reporting described in Internal Control—Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. There are inherent limitations in the effectiveness of any internal control, including the possibility of human error and the circumvention or overriding of controls. Accordingly, even effective internal controls can provide only reasonable assurance with respect to financial statement preparation. Further, because of changes in conditions, the effectiveness of internal control may vary over time. Management evaluated the Company’s internal control over financial reporting, and based on its assessment, determined that the Company’s internal control over financial reporting was effective as of December 31, 2014. The Company’s independent registered public accounting firm has issued an attestation report on the Company’s internal control over financial reporting as stated in their report which is included herein. /s/ Gary L. Coleman Gary L. Coleman Co-Chairman and Chief Executive Officer /s/ Larry M. Hutchison Larry M. Hutchison Co-Chairman and Chief Executive Officer /s/ Frank M. Svoboda Frank M. Svoboda Executive Vice President and Chief Financial Officer February 27, 2015 109 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Shareholders of Torchmark Corporation McKinney, Texas We have audited the internal control over financial reporting of Torchmark Corporation and subsidiaries (Torchmark) as of December 31, 2014, based on criteria established in Internal Control—Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Torchmark’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on Torchmark’s internal control over financial reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. included obtaining an understanding of the company’s principal executive and principal A company’s internal control over financial reporting is a process designed by, or under the supervision of, financial officers, or persons performing similar functions, and effected by the company’s board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of transactions are financial statements in accordance with generally recorded as necessary to permit preparation of accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. the company; (2) provide reasonable assurance that financial reporting and the preparation of the assets of Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, Torchmark maintained, in all material respects, effective internal control over financial reporting as of December 31, 2014, based on the criteria established in Internal Control—Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements and financial statement schedules as of and for the year ended December 31, 2014 of Torchmark and our report dated February 27, 2015 expressed an unqualified opinion on those financial statements and financial statement schedules. /s/ DELOITTE & TOUCHE LLP Dallas, Texas February 27, 2015 110 PART III Item 10. Directors, Executive Officers and Corporate Governance Information required by this item is incorporated by reference from the sections entitled “Election of Directors,” “Profiles of Director Nominees,” “Executive Officers,” “Audit Committee Report,” “Governance Guidelines and Codes of Ethics,” “Director Qualification Standards,” “Procedures for Director Nominations by Stockholders,” and “Section 16(a) Beneficial Ownership Reporting Compliance” in the Proxy Statement for the Annual Meeting of Stockholders to be held April 30, 2015 (the Proxy Statement), which is to be filed with the Securities and Exchange Commission (SEC). Item 11. Executive Compensation Information required by this item is incorporated by reference from the sections entitled “Compensation Discussion and Analysis”, “Compensation Committee Report”, “Summary Compensation Table”, “2014 Grants of Plan-based Awards”, “Outstanding Equity Awards at Fiscal Year End 2014”, “Option Exercises and Stock Vested during Fiscal Year Ended December 31, 2014”, “Pension Benefits at December 31, 2014”, “Potential Payments upon Termination or Change in Control”, “2014 Director Compensation”, “Payments to Directors” and “Compensation Committee Interlocks and Insider Participation” in the Proxy Statement, which is to be filed with the SEC. Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters (a) Equity Compensation Plan Information As of December 31, 2014 Number of securities to be issued upon exercise of outstanding options, warrants, and rights Weighted-average exercise price of outstanding options, warrants, and rights Number of securities remaining available for future issuance under equity compensation plans 7,889,321 $32.91 8,458,593 Plan Category Equity compensation plans approved by security holders . . . Equity compensation plans not approved by security holders . . . . . . . . . . Total . . . . . . . . . . . . . . 7,889,321 (b) Security ownership of certain beneficial owners: 0 0 $32.91 0 8,458,593 Information required by this item is incorporated by reference from the section entitled “Principal Stockholders” in the Proxy Statement, which is to be filed with the SEC. (c) Security ownership of management: Information required by this item is incorporated by reference from the section entitled “Stock Ownership” in the Proxy Statement, which is to be filed with the SEC. (d) Changes in control: Torchmark knows of no arrangements, including any pledges by any person of its securities, the operation of which may at a subsequent date result in a change of control. Item 13. Certain Relationships and Related Transactions and Director Independence Information required by this item is incorporated by reference from the sections entitled “Related Party Transaction Policy and Transactions” and “Director Independence Determinations” in the Proxy Statement, which is to be filed with the SEC. Item 14. Principal Accountant Fees and Services Information required by this Item is incorporated by reference from the section entitled “Principal Accounting Firm Fees” and “Pre-approval Policy” in the Proxy Statement, which is to be filed with the SEC. 111 PART IV Item 15. Exhibits and Financial Statement Schedules Index of documents filed as a part of this report: Page of this report Financial Statements: Torchmark Corporation and Subsidiaries: Report of Independent Registered Public Accounting Firm . . . . . . . . . . . . . . . . . . . . Consolidated Balance Sheets at December 31, 2014 and 2013 . . . . . . . . . . . . . . . Consolidated Statements of Operations for each of the three years in the period ended December 31, 2014 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Consolidated Statements of Comprehensive Income for each of the three years in the period ended December 31, 2014 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Consolidated Statements of Shareholders’ Equity for each of the three years in the period ended December 31, 2014 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Consolidated Statements of Cash Flows for each of the three years in the period ended December 31, 2014 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Notes to Consolidated Financial Statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Schedules Supporting Financial Statements for each of the three years in the period ended December 31, 2014: II. Condensed Financial Information of Registrant (Parent Company) . . . . . . . . . . . . . IV. Reinsurance (Consolidated) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 54 55 56 57 58 59 60 120 124 Schedules not referred to have been omitted as inapplicable or not required by Regulation S-X. 112 EXHIBITS Page of this Report 3.1 3.2 4.1 4.2 4.3 4.4 4.5 4.6 4.7 4.8 4.9 4.10 4.11 10.1 Restated Certificate of Incorporation of Torchmark Corporation, filed with the Delaware Secretary of State on April 30, 2010 (incorporated by reference from Exhibit 3.1.2 to Form 8-K dated May 5, 2010) Amended and Restated By-Laws of Torchmark Corporation, as amended April 20, 2012 (incorporated by reference from Exhibit 3.2 to Form 8-K dated April 24, 2012) Specimen Common Stock Certificate (incorporated by reference from Exhibit 4(a) to Form 10-K for the fiscal year ended December 31, 1989) Trust Indenture dated as of February 1, 1987 between Torchmark Corporation and Morgan Guaranty Trust Company of New York, as Trustee (incorporated by reference from Exhibit 4(b) to Form S-3 for $300,000,000 of Torchmark Corporation Debt Securities and Warrants (Registration No. 33-11816)) Junior Subordinated Indenture, dated November 2, 2001, between Torchmark the 7 3⁄4% Junior Corporation and The Bank of New York defining the rights of Subordinated Debentures (incorporated by reference from Exhibit 4.3 to Form 8-K dated November 2, 2001) Supplemental Indenture, dated as of December 14, 2001, between Torchmark, BankOne Trust Company, National Association and The Bank of New York, supplementing the Indenture Agreement dated February 1, 1987 (incorporated herein by reference to Exhibit 4(b) to Torchmark’s Registration Statement on Form S-3 (File No. 33-11716), and defining the rights of the 6 1⁄4% Senior Notes (incorporated by reference from Exhibit 4.1 to Form 8-K dated December 14, 2001) Second Supplemental Indenture dated as of June 23, 2006 between Torchmark Corporation, J.P. Morgan Trust Company, National Association and The Bank of New York Trust Company, N.A. (incorporated by reference from Exhibit 4.1 to Form 8-K filed June 23, 2006) Third Supplemental Indenture dated as of June 30, 2009 between Torchmark Corporation and The Bank of New York Mellon Trust Company, N.A. (incorporated by reference from Exhibit 4 to Form 10-Q for the quarter ended June 30, 2009) Fourth Supplemental Indenture dated as of September 24, 2012 between Torchmark Corporation and The Bank of New York Mellon Trust Company, N. A., as Trustee, supplementing the Indenture dated February 1, 1987 (incorporated by reference from Exhibit 4.2 to Form 8-K dated September 24, 2012) First Supplemental Indenture dated as of September 24, 2012, between Torchmark Corporation and The Bank of New York Mellon Trust Company, N. A., as Trustee, supplementing the Junior Subordinated Indenture dated November 2, 2001, (incorporated by reference from Exhibit 4.5 to Form 8-K dated September 24, 2012) Certificate and Declaration of Trust of SAFC Statutory Trust I dated February 16, 2006 (incorporated by reference from Exhibit 4.9 to Form 10-K for the fiscal year ended December 31, 2012) Amended and Restated Declaration of Trust of SAFC Statutory Trust I dated March 1, 2006 (incorporated by reference from Exhibit 4.10 to Form 10-K for the fiscal year ended December 31, 2012) Indenture dated as of March 1, 2006 for Fixed/Floating Rate Junior Subordinated Deferrable Interest Debentures due 2036 between Southwestern American Financial Corporation and Wilmington Trust Company (incorporated by reference from Exhibit 4.11 to Form 10-K for the fiscal year ended December 31, 2012) Torchmark Corporation and Affiliates Retired Lives Reserve Agreement, as amended, and Trust (incorporated by reference from Exhibit 10(b) to Form 10-K for the fiscal year ended December 31, 1991)* 113 Page of this Report 10.2 10.3 10.4 10.5 10.6 10.7 10.8 10.9 10.10 10.11 10.12 10.13 10.14 10.15 Capital Accumulation and Bonus Plan of Torchmark Corporation, as amended, (incorporated by reference from Exhibit 10(c) to Form 10-K for the fiscal year ended December 31, 1988)* Torchmark Corporation Supplementary Retirement Plan (incorporated by reference from Exhibit 10(c) to Form 10-K for the fiscal year ended December 31, 1992)* Amended and Restated Credit Agreement dated as of July 16, 2014 among Torchmark Corporation, as the Borrower, TMK Re, Ltd., as a Loan Party, Wells Fargo Bank, National Association, as Administrative Agent, Swing Line Lender, L/C Issuer and L/C Administrator and the other lenders party thereto (incorporated by reference from Exhibit 10.1 to Form 8-K dated July 21, 2014) Certified Copy of Resolution Regarding Director Retirement Benefit Program (incorporated by reference from Exhibit 10(e) to Form 10-K for the fiscal year ended December 31, 1999)* Torchmark Corporation Restated Deferred Compensation Plan for Directors, Advisory Directors, Directors Emeritus and Officers, as amended (incorporated by reference from Exhibit 10(e) to Form 10-K for the fiscal year ended December 31, 1992)* The Torchmark Corporation 1987 Stock Incentive Plan (incorporated by reference from Exhibit 10(f) to Form 10-K for the fiscal year ended December 31, 1998)* General Agency Contract between Liberty National Life Insurance Company and First Command Financial Services, Inc., (formerly known as Independent Research Agency For Life Insurance, Inc.) (incorporated by reference from Exhibit 10(i) to Form 10-K for the fiscal year ended December 31, 1990) Amendment to General Agency Contract between First Command Financial Services and Liberty National Life Insurance Company (incorporated by reference from Exhibit 10.1 to Form 10-Q for the First Quarter 2005)** Form of Deferred Compensation Agreement Between Torchmark Corporation or Subsidiary and Officer at the Level of Vice President or Above Eligible to Participate in the Torchmark Corporation and Affiliates Retired Lives Reserve Agreement and to Retire Prior to December 31, 1986 (incorporated by reference from Exhibit 10(k) to Form 10-K for the fiscal year ended December 31, 1991)* Form of Deferred Compensation Agreement between Torchmark Corporation or Subsidiary and Officer at the Level of Vice President or Above Eligible to Participate in the Torchmark Corporation and Affiliates Retired Lives Reserve Agreement and Not Eligible to Retire Prior to December 31, 1986 (incorporated by reference from Exhibit 10(l) to Form 10-K for the fiscal year ended December 31, 1991)* Form of Deferred Compensation Agreement Between Torchmark Corporation or Subsidiary and Officer at the Level of Vice President or Above Not Eligible to Participate in Torchmark Corporation and Affiliates Retired Lives Reserve Agreement (incorporated by reference from Exhibit 10(j) to Form 10-K for the fiscal year ended December 31, 1991)* Service Agreement, dated as of January 1, 1991, between Torchmark Corporation and Liberty National Life Insurance Company (prototype for agreements between Torchmark Corporation and other principal operating subsidiaries) (incorporated by reference from Exhibit 10(n) to Form 10-K for the fiscal year ended December 31, 1992) The Torchmark Corporation Amended and Restated Pension Plan (incorporated by reference from Exhibit 10.15 to Form 10-K for the fiscal year ended December 31, 2010)* Amendment Sixteen to the Torchmark Corporation Amended and Restated Pension Plan (as Restated Effective January 1, 2009) (incorporated by reference from Exhibit 10.16 to Form 10-K for the fiscal year ended December 31, 2012)* 114 Page of this Report 10.16 10.17 10.18 10.19 10.20 10.21 10.22 10.23 10.24 10.25 10.26 10.27 10.28 10.29 10.30 10.31 10.32 The Torchmark Corporation 1998 Stock Incentive Plan (incorporated by reference from Exhibit 10(n) to Form 10-K for the fiscal year ended December 31, 1998)* The Torchmark Corporation Savings and Investment Plan (amended and restated as of January 1, 2009)* (incorporated by reference from Exhibit 10.17 to Form 10-K for the fiscal year ended December 31, 2010) Torchmark Corporation 2013 Management Incentive Plan effective as of January 1, 2013 (incorporated by reference from Exhibit 10.1 to Form 8-K dated April 30, 2013)* Coinsurance and Servicing Agreement between Security Benefit Life Insurance Company and Liberty National Life Insurance Company, effective as of December 31, 1995 (incorporated by reference from Exhibit 10(u) to Form 10-K for the fiscal year ended December 31, 1995) Torchmark Corporation 1996 Non-Employee Director Stock Option Plan (incorporated by reference from Exhibit 10(w) to Form 10-K for the fiscal year ended December 31, 1996)* Torchmark Corporation 1996 Executive Deferred Compensation Stock Option Plan (incorporated by reference from Exhibit 10(x) to Form 10-K for the fiscal year ended December 31, 1996)* Form of Retirement Life Insurance Benefit Agreement ($1,995,000 face amount limit) (incorporated by reference from Exhibit 10(z) to Form 10-K for the fiscal year ended December 31, 2001)* Form of Retirement Life Insurance Benefit Agreement ($495,000 face amount limit) (incorporated by reference from Exhibit 10(aa) to Form 10-K for the fiscal year ended December 31, 2001)* Payments to Directors (incorporated by reference from Exhibit 10.1 to Form 10-Q for quarter ended September 30, 2014)* Form of Non-Formula Based Director Stock Option Agreement pursuant to Torchmark Corporation 2005 Non-Employee Director Incentive Plan (incorporated by reference from Exhibit 10.2 to Form 10-Q for the First Quarter 2005)* Form of Stock Option Agreement pursuant to Torchmark Corporation 2005 Incentive Plan (Section 16(a) (restoration)) (incorporated by reference from Exhibit 10.3 to Form 10-Q for the First Quarter 2005)* Form of Stock Option Agreement pursuant to Torchmark Corporation 2005 Incentive Plan (restoration general) (incorporated by reference from Exhibit 10.4 to Form 10-Q for the First Quarter 2005)* Form of Stock Option Agreement pursuant to Torchmark Corporation 2005 Incentive Plan (bonus) (incorporated by reference from Exhibit 10.36 to Form 10-K for the fiscal year ended December 31, 2005)* Form of Stock Option Agreement pursuant to Torchmark Corporation 2005 Incentive Plan (regular vesting) (incorporated by reference from Exhibit 10.37 to Form 10-K for the fiscal year ended December 31, 2005)* Torchmark Corporation 2005 Non-Employee Director Incentive Plan (incorporated by reference from Exhibit 10.1 to Form 8-K dated May 4, 2005)* Torchmark Corporation 2005 Stock Incentive Plan (incorporated by reference from Exhibit 10.2 to Form 8-K dated May 4, 2005)* Form of Deferred Compensation Stock Option Grant Agreement pursuant to the Torchmark Corporation 2005 Non-Employee Director Incentive Plan (incorporated by reference from Exhibit 10.3 to Form 8-K dated May 4, 2005)* 10.33 Torchmark Corporation Amended and Restated 2005 Incentive Plan (incorporated by reference from Exhibit 10.1 to Form 10-Q for quarter ended March 31, 2006)* 115 Page of this Report 10.34 10.35 10.36 10.37 10.38 10.39 10.40 10.41 10.42 10.43 10.44 10.45 10.46 10.47 10.48 10.49 10.50 Torchmark Corporation Amended and Restated 2005 Non-Employee Director Incentive Plan (incorporated by reference from Exhibit 10.2 to Form 10-Q for quarter ended March 31, 2006)* Form of Director Stock Option Issued under Torchmark Corporation Amended and Restated 2005 Non-Employee Director Incentive Plan (incorporated by reference from Exhibit 10.3 to Form 10-Q for quarter ended March 31, 2006)* Amendment One to Torchmark Corporation Supplementary Retirement Plan (incorporated by reference from Exhibit 10.4 to Form 10-Q for quarter ended March 31, 2006)* Torchmark Corporation Supplemental Executive Retirement Plan (incorporated by reference from Exhibit 10.1 to Form 8-K dated January 25, 2007)* Torchmark Corporation 2007 Long-Term Compensation Plan (incorporated by reference from Exhibit 99.1 to Form 8-K dated May 2, 2007)* Form of Stock Option Award Agreement under Torchmark Corporation 2007 Long-Term Compensation Plan (incorporated by reference from Exhibit 99.2 to Form 8-K dated May 2, 2007)* Form of Restricted Stock Award (Board grant) under Torchmark Corporation 2007 Long- Term Compensation Plan (incorporated by reference from Exhibit 99.3 to Form 8-K dated May 2, 2007)* Torchmark Corporation Non-Employee Director Compensation Plan, as amended and restated (incorporated by reference from Exhibit 10.1 to Form 8-K dated April 29, 2008)* Amendment No. 1 to the Torchmark Corporation Supplemental Executive Retirement Plan (incorporated by reference from Exhibit 10.53 to Form 10-K for the fiscal year ended December 31, 2007)* Amendment No. 2 to the Torchmark Corporation Supplemental Executive Retirement Plan (incorporated by reference from Exhibit 10.54 to Form 10-K for the fiscal year ended December 31, 2007)* Amendment No. 2 to the Torchmark Corporation Supplementary Retirement Plan (incorporated by reference from Exhibit 10.55 to Form 10-K for the fiscal year ended December 31, 2007)* Amendment No. 3 to the Torchmark Corporation Supplementary Retirement Plan (incorporated by reference from Exhibit 10.56 to Form 10-K for the fiscal year ended December 31, 2007)* Form of Restricted Stock Award Notice under Torchmark Corporation Non-Employee Director Compensation Plan (incorporated by reference from Exhibit 10.57 to Form 10-K for the fiscal year ended December 31, 2007)* Form of Restricted Stock Unit Award Notice under Torchmark Corporation Non-Employee Director Compensation Plan (incorporated by reference from Exhibit 10.58 to Form 10-K for the fiscal year ended December 31, 2007)* Form of Restricted Stock Award (Compensation Committee grant) under Torchmark Corporation 2007 Long-Term Compensation Plan (incorporated by reference from Exhibit 10.59 to Form 10-K for the fiscal year ended December 31, 2007)* Amendment Four to the Torchmark Corporation Supplementary Retirement Plan (incorporated by reference from Exhibit 10.52 to Form 10-K for the fiscal year ended December 31, 2008)* Amendment Three to the Torchmark Corporation Supplemental Executive Retirement Plan (incorporated by reference from Exhibit 10.53 to Form 10-K for the fiscal year ended December 31, 2008)* 116 Page of this Report 10.51 10.52 10.53 10.54 10.55 10.56 10.57 10.58 10.59 10.60 10.61 10.62 10.63 10.64 10.65 10.66 10.67 10.68 Amendment One to the Torchmark Corporation Restated Deferred Compensation Plan for Directors, Advisory Directors, Directors Emeritus and Officers (incorporated by reference from Exhibit 10.54 to Form 10-K for the fiscal year ended December 31, 2008)* Amendment Two to the Torchmark Corporation Restated Deferred Compensation Plan (incorporated by reference from Exhibit 10.55 to Form 10-K for the fiscal year ended December 31, 2008)* Amendment to the Torchmark Corporation 2007 Long-Term Compensation Plan (incorporated by reference from Exhibit 10.56 to Form 10-K for the fiscal year ended December 31, 2008)* Amendment Five to the Torchmark Corporation Savings and Investment Plan (amended and restated as of January 1, 2009) (incorporated by reference from Exhibit 10.54 to Form 10-K for the fiscal year ended December 31, 2011)* Amendment Six to the Torchmark Corporation Savings and Investment Plan (As Restated Effective January 1, 2009) (incorporated by reference from Exhibit 10.56 to Form 10-K for the fiscal year ended December 31, 2012)* Receivables Purchase Agreement dated as of December 31, 2008 among AILIC Receivables Corporation, American Income Life Insurance Company and TMK Re, Ltd. (incorporated by reference from Exhibit 10.1 to Form 8-K dated January 6, 2009) Amendment No.1 to Receivables Purchase Agreement dated as of December 31, 2008 among AILIC Receivables Corporation, American Income Life Insurance Company, and TMK Re, Ltd. (incorporated by reference to Exhibit 10.58 to Form 10-K for the fiscal year ended December 31, 2013) Torchmark Corporation Amended 2011 Non-Employee Director Compensation Plan (incorporated by reference from Exhibit 10.2 to Form 10-Q for the quarter ended September 30, 2014)* Form of Stock Option under Torchmark Corporation 2011 Non-Employee Director Compensation Plan (incorporated by reference from Exhibit 10.57 to Form 10-K for fiscal year ended December 31,2010)* Form of Restricted Stock Award Notice under Torchmark Corporation 2011 Non- Employee Director Compensation Plan (incorporated by reference from Exhibit 10.58 to Form 10-K for fiscal year ended December 31, 2010)* Form of Restricted Stock Unit Award Notice under Torchmark Corporation 2011 Non- Employee Director Compensation Plan (incorporated by reference from Exhibit 10.59 to Form 10-K for fiscal year ended December 31, 2010)* Torchmark Corporation 2011 Incentive Plan (incorporated by reference from Exhibit 10.1 to Form 8-K dated May 4, 2011)* Form of Restricted Stock Award (Executive) under Torchmark Corporation 2011 Incentive Plan (incorporated by reference from Exhibit 10.2 to Form 8-K dated May 4, 2011)* Form of Restricted Stock Award (Special) under Torchmark Corporation 2011 Incentive Plan (incorporated by reference from Exhibit 10.3 to Form 8-K dated May 4, 2011)* Form of Ten year Stock Option under Torchmark Corporation 2011 Incentive Plan (incorporated by reference from Exhibit 10.4 to Form 8-K dated May 4, 2011)* Form of Seven year Stock Option under Torchmark Corporation 2011 Incentive Plan (incorporated by reference from Exhibit 10.5 to Form 8-K dated May 4, 2011)* Form of Performance Share Award under Torchmark Corporation 2011 Incentive Plan (incorporated by reference from Exhibit 10.1 to Form 8-K dated February 27, 2012)* First Amendment reference from Exhibit 10.1 to Form 8-K dated April 29, 2014)* to Torchmark Corporation 2011 Incentive Plan (incorporated by 117 10.69 10.70 10.71 10.72 10.73 10.74 (11) (12) (20) (21) (23) (24) (31.1) (31.2) (31.3) (32.1) Form of Stock Option Grant Agreement (Special) pursuant to Torchmark Corporation 2011 Incentive Plan (incorporated by reference from Exhibit 10.1 to Form 8-K dated May 31, 2013)* Amendment to Restricted Stock Award Agreement of February 26, 2009 between Torchmark Corporation and Mark S. McAndrew (incorporated by reference from Exhibit 10.2 to Form 8-K dated May 31, 2013)* Amendment to Restricted Stock Award Agreement of February 25, 2010 between Torchmark Corporation and Mark S. McAndrew (incorporated by reference from Exhibit 10.3 to Form 8-K dated May 31, 2013)* to Restricted Stock Award Agreement of April 28, 2011 between Amendment Torchmark Corporation and Mark S. McAndrew (incorporated by reference from Exhibit 10.4 to Form 8-K dated May 31, 2013)* Consent and Acknowledgement of Amendment to Non-Qualified Stock Option Grant Agreement dated April 8, 2013 (incorporated by reference from Exhibit 10.1 to Form 8-K dated April 8, 2013)* Amendment Seventeen to Torchmark Corporation Amended and Restated Pension Plan (as Restated Effective January 1, 2009)* (incorporated by reference to Exhibit 10.76 to Form 10-K for fiscal year ended December 31, 2013) Statement re computation of per share earnings Statement re computation of ratios Proxy Statement for Annual Meeting of Stockholders to be held April 30, 2015*** Subsidiaries of the registrant Consent of Deloitte & Touche LLP Powers of attorney Rule 13a-14(a)/15d-14(a) Certification by Gary L. Coleman Rule 13a-14(a)/15d-14(a) Certification by Larry M. Hutchison Rule 13a-14(a)/15d-14(a) Certification by Frank M. Svoboda Section 1350 Certification by Gary L. Coleman, Larry M. Hutchison and Frank M. Svoboda Page of this Report 119 119 (101) Interactive Data File Compensatory plan or arrangement. * ** Certain portions of the exhibit have been omitted pursuant to a request for confidential treatment which was granted June 23, 2010 effective until May 9, 2015. The non-public information was filed separately with the Securities and Exchange Commission pursuant to Rule 24b-2 under the Securities Exchange Act of 1934, as amended. *** To be filed with the Securities and Exchange Commission within 120 days after the fiscal year ended December 31, 2014. 118 Exhibit 11. Statement re computation of per share earnings TORCHMARK CORPORATION COMPUTATION OF EARNINGS PER SHARE Twelve Months Ended December 31, 2013* 2014 2012* Net Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $542,939,000 $528,472,000 $529,324,000 Basic weighted average shares outstanding . . . . . . . Diluted weighted average shares outstanding . . . . . . 130,721,738 132,640,244 137,646,885 139,563,785 144,921,299 146,847,582 Basic net income per share . . . . . . . . . . . . . . . . . $ Diluted net income per share . . . . . . . . . . . . . . . . $ 4.15 $ 4.09 $ 3.84 $ 3.79 $ 3.65 3.60 * Shares and per share amounts have been retrospectively adjusted for the stock split effective July 1, 2014. Exhibit 21. Subsidiaries of the Registrant The following table lists subsidiaries of the registrant which meet the definition of “significant subsidiary” according to Regulation S-X: Company American Income Life Insurance Company Globe Life And Accident Insurance Company Liberty National Life Insurance Company United American Insurance Company State of Incorporation Indiana Nebraska Nebraska Name Under Which Company Does Business American Income Life Insurance Company Globe Life And Accident Insurance Company Liberty National Life Insurance Company Nebraska United American Insurance Company All other exhibits required by Regulation S-K are listed as to location in the “Index of documents filed as a part of this report” on pages 113 through 118 of this report. Exhibits not referred to have been omitted as inapplicable or not required. 119 TORCHMARK CORPORATION (PARENT COMPANY) SCHEDULE II. CONDENSED FINANCIAL INFORMATION OF REGISTRANT CONDENSED BALANCE SHEETS (Amounts in thousands) December 31, 2014 2013 Assets: Investments: Long-term investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Short-term investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 38,910 5,686 $ 34,816 8,415 Total investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Investment in affiliates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Due from affiliates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Taxes receivable from affiliates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 44,596 0 6,023,666 50,766 76,050 64,092 43,231 0 5,074,326 50,766 66,168 45,533 Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $6,259,170 $5,280,024 Liabilities and shareholders’ equity: Liabilities: Short-term debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Long-term debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Due to affiliates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 238,398 1,141,773 652 180,881 $ 229,070 1,140,469 652 133,491 Total liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,561,704 1,503,682 Shareholders’ equity: Preferred stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Common stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Additional paid-in capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Accumulated other comprehensive income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Retained earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Treasury stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 351 134,218 808,124 997,452 3,376,846 (619,525) 351 151,218 812,569 210,981 3,495,533 (894,310) Total shareholders’ equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,697,466 3,776,342 Total liabilities and shareholders’ equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $6,259,170 $5,280,024 See Notes to Condensed Financial Statements and accompanying Report of Independent Registered Public Accounting Firm. 120 TORCHMARK CORPORATION (PARENT COMPANY) SCHEDULE II. CONDENSED FINANCIAL INFORMATION OF REGISTRANT (continued) CONDENSED STATEMENTS OF OPERATIONS (Amounts in thousands) Year Ended December 31, 2013 2014 2012 Net investment income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Realized investment gains (losses) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ Total revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . General operating expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Reimbursements from affiliates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Interest expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22,259 4,767 27,026 53,235 (53,040) 79,366 $ 24,268 0 $ 22,968 (3,534) 24,268 19,434 53,255 (46,855) 84,273 49,549 (31,184) 81,145 Total expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 79,561 90,673 99,510 Operating income (loss) before income taxes and equity in earnings of affiliates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (52,535) (66,405) (80,076) Income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13,335 17,390 24,916 Net operating loss before equity in earnings of affiliates . . . . . . . . . . . . . . . . Equity in earnings of affiliates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (39,200) 582,139 (49,015) 577,487 (55,160) 584,484 Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 542,939 528,472 529,324 Other comprehensive income (loss): Attributable to Parent Company . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Attributable to affiliates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (28,680) 815,151 38,557 (752,851) (31,388) 406,747 Comprehensive income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,329,410 $(185,822) $904,683 See Notes to Condensed Financial Statements and accompanying Report of Independent Registered Public Accounting Firm. 121 TORCHMARK CORPORATION (PARENT COMPANY) SCHEDULE II. CONDENSED FINANCIAL INFORMATION OF REGISTRANT—(continued) CONDENSED STATEMENTS OF CASH FLOWS (Amounts in thousands) Year Ended December 31, 2013 2014 2012 Cash provided from (used for) operations before dividends from subsidiaries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Cash dividends from subsidiaries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ (21,358) 478,840 $ (54,213) 488,376 $ (5,652) 436,814 Cash provided from operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 457,482 434,163 431,162 Cash provided from (used for) investing activities: Disposition of investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net decrease (increase) in short-term investments . . . . . . . . . . . . . . . . . . Acquisition of Family Heritage . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Investment in other subsidiaries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Loaned money to affiliates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Repayments from affiliates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,064 2,729 0 0 (81,000) 81,000 Cash provided from (used for) investing activities . . . . . . . . . . . . . . . . . . . . . 7,793 Cash provided from (used for) financing activities: Issuance of 3.8% Senior Notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Issuance of 5.875% Junior Subordinated Debentures . . . . . . . . . . . . . . . . Issue expenses of debt offerings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Repayment of 7.375% Notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Redemption of 7.1% Junior Subordinated Debentures . . . . . . . . . . . . . . . Net issuance (repayment) of commercial paper . . . . . . . . . . . . . . . . . . . . . Issuance of stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Acquisitions of treasury stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Borrowed money from affiliate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Repayments to affiliates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net borrowings (to)/from affiliates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Excess tax benefit on stock option exercises . . . . . . . . . . . . . . . . . . . . . . . Payment of dividends . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0 0 0 0 0 9,328 56,294 (449,309) 168,000 (168,000) 0 6,688 (88,276) 514 (6,805) 0 0 0 0 (6,291) 0 0 0 (94,050) 0 3,983 97,677 (482,264) 0 0 120,000 10,963 (84,181) 3,955 (17,524) (213,747) (205) 0 0 (227,521) 300,000 125,000 (7,543) 0 (123,711) 245 181,022 (570,165) 0 0 (69,000) 12,209 (78,797) Cash provided from (used for) financing activities . . . . . . . . . . . . . . . . . . . . . (465,275) (427,872) (230,740) Net increase (decrease) in cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Cash balance at beginning of period . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Cash balance at end of period . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 0 0 0 $ 0 0 0 (27,099) 27,099 $ 0 See Notes to Condensed Financial Statements and accompanying Report of Independent Registered Public Accounting Firm. 122 TORCHMARK CORPORATION (PARENT COMPANY) NOTES TO CONDENSED FINANCIAL STATEMENTS (Amounts in thousands) Note A—Dividends from Subsidiaries Cash dividends paid to Torchmark from the subsidiaries were as follows: Dividends from subsidiaries . . . . . . . . . . . . . . . . . . . . . . . . . . . . $478,840 $488,376 $436,814 2014 2013 2012 Note B—Supplemental Disclosures of Cash Flow Information The following table summarizes noncash transactions, which are not reflected on the Condensed Statements of Cash Flows: Year Ended December 31, 2013 2014 2012 Stock-based compensation not involving cash . . . . . . . . Debt assumed to acquire Family Heritage . . . . . . . . . . . Dividend of subsidiary to Parent . . . . . . . . . . . . . . . . . . . . Dividend of subsidiary applied to loan balance . . . . . . . . $32,203 0 0 0 $ 25,642 0 1,246,557 72,000 $21,605 20,000 0 0 The following table summarizes certain amounts paid (received) during the period: Interest paid . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Income taxes received . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $77,663 25,581 $85,443 27,820 $76,833 29,251 Year Ended December 31, 2012 2013 2014 Note C—Preferred Stock As of December 31, 2014, Torchmark had 351 thousand shares of Cumulative Preferred Stock, Series A, issued and outstanding, of which 280 thousand shares were 6.50% Cumulative Preferred Stock, Series A, and 71 thousand shares were 7.15% Cumulative Preferred Stock, Series A (collectively, the “Series A Preferred Stock”). All issued and outstanding shares of Series A Preferred Stock were held by wholly-owned insurance subsidiaries. In the event of liquidation, the holders of the Series A Preferred Stock at the time outstanding would be entitled to receive a liquidating distribution out of the assets legally available to stockholders in the amount of $1 thousand per share or $351 million in the aggregate, plus any accrued and unpaid dividends, before any distribution is made to holders of Torchmark common stock. Holders of Series A Preferred Stock do not have any voting rights nor have rights to convert such shares into shares of any other class of Torchmark capital stock. See accompanying Report of Independent Registered Public Accounting Firm. 123 TORCHMARK CORPORATION SCHEDULE IV. REINSURANCE (CONSOLIDATED) (Amounts in thousands) Gross Amount Ceded to Other Companies(1) Assumed from Other Companies Net Amount Percentage of Amount Assumed to Net For the Year Ended December 31, 2014: Life insurance in force . . . . . . . . . . . . . . $160,455,963 $795,192 $3,658,511 $163,319,282 2.2% Premiums:(2) Life insurance . . . . . . . . . . . . . . . . . . . $ 1,924,605 1,245,671 Health insurance . . . . . . . . . . . . . . . . $ 4,614 2,951 Total premium . . . . . . . . . . . . . . . . $ 3,170,276 $ 7,565 $ $ 25,774 0 $ 1,945,765 1,242,720 25,774 $ 3,188,485 1.3% 0% .8% For the Year Ended December 31, 2013: Life insurance in force . . . . . . . . . . . . . . $154,488,511 $782,125 $3,882,237 $157,588,623 2.5% Premiums:(2) Life insurance . . . . . . . . . . . . . . . . . . . $ 1,841,425 1,169,534 Health insurance . . . . . . . . . . . . . . . . $ 4,645 3,124 Total premium . . . . . . . . . . . . . . . . $ 3,010,959 $ 7,769 $ $ 26,960 0 $ 1,863,740 1,166,410 26,960 $ 3,030,150 1.4% 0% .9% For the Year Ended December 31, 2012: Life insurance in force . . . . . . . . . . . . . . $150,107,614 $800,905 $4,138,180 $153,444,889 2.7% Premiums:(2) Life insurance . . . . . . . . . . . . . . . . . . . $ 1,762,640 1,049,608 Health insurance . . . . . . . . . . . . . . . . $ 7,592 2,229 Total premium . . . . . . . . . . . . . . . . $ 2,812,248 $ 9,821 $ $ 30,725 0 $ 1,785,773 1,047,379 30,725 $ 2,833,152 1.7% 0% 1.1% (1) No amounts have been netted against ceded premium (2) Excludes policy charges of $20,935, $22,124, and $23,310 in each of the years 2014, 2013, and 2012, respectively. See accompanying Report of Independent Registered Public Accounting Firm. 124 Pursuant to the requirements of Section 12 or 15(d) of the Securities Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. SIGNATURES By: By: By: TORCHMARK CORPORATION /s/ GARY L. COLEMAN Gary L. Coleman, Co-Chairman and Chief Executive Officer and Director /s/ LARRY M. HUTCHISON Larry M. Hutchison Co-Chairman and Chief Executive Officer and Director /s/ FRANK M. SVOBODA Frank M. Svoboda, Executive Vice President and Chief Financial Officer (Principal Accounting Officer) Date: February 27, 2015 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. By: By: By: By: /s/ LLOYD W. NEWTON * Lloyd W. Newton Director /s/ DARREN M. REBELEZ * Darren M. Rebelez Director /s/ LAMAR C. SMITH * Lamar C. Smith Director /s/ PAUL J. ZUCCONI * Paul J. Zucconi Director By: By: By: By: By: /s/ CHARLES E. ADAIR * Charles E. Adair Director /S/ MARILYN A. ALEXANDER * Marilyn A. Alexander Director /S/ DAVID L. BOREN * David L. Boren Director /s/ JANE M. BUCHAN * Jane M. Buchan Director /s/ ROBERT W. INGRAM * Robert W. Ingram Director Date: February 27, 2015 *By: /s/ FRANK M. SVOBODA Frank M. Svoboda Attorney-in-fact 125 [THIS PAGE INTENTIONALLY LEFT BLANK] 3700 S. Stonebridge Drive McKinney, Texas 75070 www.torchmarkcorp.com 

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