The Daily Warren Buffett Stock is TMK. Berkshire Hathaway owns 2,823,879 shares. As of Dec 31,2007, this represents 0.25% percent of portfolio.
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), Globe Life And Accident Insurance Company (Globe), United American Insurance Company (United American), and United Investors Life Insurance Company (United Investors).
Torchmarkâ€™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.
Torchmarkâ€™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 Torchmarkâ€™s life products.
Torchmark offers supplemental limited-benefit health insurance products that include hospital/surgical plans, cancer, and accident plans sold to individuals under age 65. These policies are designed to supplement health coverage that applicants already own or to provide affordable, limited-benefit coverage to individuals without access to more comprehensive coverage. Medicare Supplements are also offered to enrollees in the traditional fee-for-service Medicare program. All Medicare Supplement plans are standardized by federal regulation and are designed to pay deductibles and co-payments not paid by Medicare. We also began offering Medicare Part D prescription drug insurance in 2006.
Health plans are offered through the Companyâ€™s exclusive and independent agents and direct response, with the United American agencies being the leading writers in the three-year period ended December 31, 2007, selling predominantly hospital/surgical plans. As shown in the charts below, net sales of limited-benefit plans exceeded net sales of Medicare Supplements in all years of the three-year-period ended December 31, 2007, but Medicare Supplement premium in force exceeded that of limited-benefit plans during 2006 and 2005. At December 31, 2007, limited-benefit health premium in force exceeded Medicare Supplement for the first time since Torchmarkâ€™s formation. These data reflect the change in product mix being sold from predominantly Medicare Supplements in prior years to predominantly limited-benefit plans in the more current periods.
The number of health policies in force (excluding Medicare Part D) was 1.56 million, 1.60 million, and 1.60 million at December 31, 2007, 2006, and 2005, respectively. Medicare Part D enrollees at December 31, 2006 were approximately 189 thousand to begin the 2007 plan year, but are expected to decline slightly for the 2008 plan year.
Annuity products offered include single-premium deferred annuities, flexible-premium deferred annuities, and variable annuities. In recent years Torchmark has deemphasized the marketing of annuity products. Annuities in 2007 comprise less than 1% of premium income and less than 2% of insurance underwriting margin.
Premium rates for life and health insurance products are established using assumptions as to future mortality, morbidity, persistency, and expenses, all of which are generally based on Company experience and on 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 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.
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, doctorsâ€™ 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.
The life insurance policy reserves reflected in Torchmarkâ€™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 Torchmarkâ€™s insurance subsidiaries, since these policies generally are issued on a guaranteed-renewable basis. A list of the assumptions used in the calculation of Torchmarkâ€™s reserves are reported in the financial statements ( See Note 5 â€” Future Policy Benefit Reserves in the Notes to the Consolidated Financial Statements). Reserves for annuity products and certain life products consist of the policyholdersâ€™ account values and are increased by policyholder deposits and interest credited and are decreased by policy charges and benefit payments.
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 94% of total investments at December 31, 2007. ( See Note 3 â€” Investments in the Notes to the Consolidated Financial Statements and Managementâ€™s Discussion and Analysis. )
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 Torchmarkâ€™s life or health markets.
Torchmarkâ€™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.
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 subject to examination at any time. Under the rules of the National Association of Insurance Commissioners (NAIC), insurance companies are examined periodically by one or more of the supervisory agencies.
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 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 determined according to the extent of these unsatisfied obligations in each state. Assessments are recoverable to a great extent as offsets against state premium taxes.
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. At December 31, 2007, Torchmark and its subsidiaries have registered as a holding company system pursuant to such legislation in Alabama, Indiana, Missouri, Nebraska, 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 2007, Torchmark had 2,354 employees and 1,242 licensed employees under sales contracts.
Charles E. Adair (age 60) has been a director since April 2003. His term expires in 2010. He is also a director of Performance Food Group, Inc., Tech Data Corporation, and PSS World Medical, Inc. Principal Occupation: Partner, Cordova Ventures, Montgomery, Alabama, a venture capital management company since December 1993.
David L. Boren (age 66) has been a director of the Company since April 1996. His term expires in 2009. He is also a director of AMR Corporation, Hiland Partners, L.P. and Texas Instruments, Inc. Principal occupation: President of The University of Oklahoma, Norman, Oklahoma since November 1994.
M. Jane Buchan (age 44) has been a director of the Company since October 2005. Her term expires in 2009. Principal Occupation: Chief Executive Officer and Managing Director of Pacific Alternative Asset Management Company, LLC, Irvine, California, an institutional fund of funds for pension plans of corporations, state governments and foreign retirement trusts, since March 2000.
Robert W. Ingram (age 59) has been a director of the Company since October 2005. His term expires in 2009. Principal Occupation: Senior Associate Dean and Ross-Culverhouse Professor of Accounting in Culverhouse College of Commerce, University of Alabama, Tuscaloosa, Alabama since August 2004. (Director, Culverhouse School of Accountancy, University of Alabama, 2002â€”2004).
Joseph L. Lanier, Jr. (age 76) has been a director of the Company since 1980. His term expires in 2010. He is also a director of Flowers Foods and Alliance One International, Inc. Principal occupation: Retired textile executive. (Chairman of the Board of Dan River Incorporated, Danville, Virginia, a textile manufacturer, November 1989-August 2006; Chief Executive Officer of Dan River Incorporated November 1989-February 2005).
Mark S. McAndrew (age 54) has been a director of the Company since July 1998. Principal occupation: Chairman since February 2006 and Chief Executive Officer since August 2005 of the Company. (Chairman of Insurance Operations of the Company, February 2003-August 2005; Executive Vice President of the Company, September 1999-February 2003; Chief Executive Officer September 1999-August 2005 and President October 1991-August 2005 of Globe; President October 1991-July 2004 and Chief Executive Officer September 1999-July 2004 of United American; President and Chief Executive Officer of American Income, September 1999-December 2003.)
Lloyd W. Newton (age 65) has been a director of the Company since April 2006. His term expires in 2010. He is also a director of Goodrich Corporation and Sonocco Products Company. Principal Occupation: Consultant. (Executive Vice President Military Engines of Pratt & Whitney, a manufacturer of aircraft engines, gas turbines and space propulsion systems, Hartford, Connecticut August 2000-March 2006).
Sam R. Perry (age 73) has been a director of the Company since October 2004. Principal occupation: Attorney in Private Practice, Austin, Texas since October 2004. (Shareholder and Of Counsel at Sneed Vine & Perry P.C., Austin, Texas December 2003-September 2004; Shareholder, Officer and Director of Sneed Vine & Perry, P.C. June 1961-December 2003.)
Lamar C. Smith (age 60) has been a director of the Company since October 1999. Principal Occupation: Retired financial services executive. (Chairman January 1992-January 2007 and Chief Executive Officer 1990-April 2007 of First Command Financial Services, Inc., Fort Worth, Texas, a financial services company providing insurance, mutual funds and banking services to current and former commissioned and non-commissioned military officers; Chairman of First Command Bank, a subsidiary of First Command Financial Services, Inc., May 2007 - September 2007).
Paul J. Zucconi (age 67) has been a director of the Company since July 2002. His term expires in 2009. He is also a director of Titanium Metals Corporation and Affirmative Insurance Holdings, Inc. Principal occupation: Business Consultant, Plano, Texas, since January 2001.
MANAGEMENT DISCUSSION FROM LATEST 10K
RESULTS OF OPERATIONS
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, to middle income households throughout the United States. We view our operations by segments, which are the major insurance product lines of life, health, 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.
Insurance Product Line Segments. As fully described in Note 13 â€” Business Segments in the Notes to the Consolidated Financial Statements, the product line segments involve the marketing, underwriting, and benefit 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.
Torchmarkâ€™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 increased 2% or $9 million to $528 million in 2007, and 5% or $23 million to $519 million in 2006. The life insurance segment contributed $20 million to pretax growth in the 2007 margin, the largest contributor. Life insurance margin growth in 2007 resulted from both premium growth and favorable mortality. Also adding to 2007 pretax earnings growth was the investment segment, from which excess investment income rose $5 million or 2%. It had declined in both of the previous two years. Excess investment income in 2007 was positively affected by lower financing costs on our debt as a result of the refinancing of two debt issues in 2006. The primary contributor to growth in 2006 earnings was the health insurance segment, as we first offered Medicare Part D for coverage beginning January 1, 2006. Our Medicare Part D product accounted for $26 million of the $30 million growth in health margins. The life insurance segment also added $16 million to our $28 million growth in pretax earnings in 2006. Excess investment income declined in both 2006 and 2005, as it was compressed by a flattened yield curve and as significant amounts of cash have been used to repurchase Torchmark shares.
Total revenues rose 2% in 2007 to $3.49 billion. In 2006, total revenues increased 9% to $3.42 billion from $3.13 billion in 2005. Growth in life premium of $46 million and net investment income of $20 million accounted for the growth in 2007 revenues. The 2006 revenue increase was primarily the result of the $212 million of premium added from Medicare Part D. Growth in life premium and net investment income also contributed to 2006 revenue growth.
Life insurance premium has grown steadily in each of the three years ending December 31, 2007, rising 3% in 2007 to $1.6 billion and 4% in 2006. Margins as a percentage of premium have also increased slightly each year to 27% of premium in 2007 from 26% in 2005 and 2006. While premium and margin percentage growth have resulted in increases in the total life insurance segmentâ€™s contribution to pretax earnings, sales volumes have declined slightly each year. Life insurance segment results are discussed further under the caption Life Insurance.
Health premium was flat in 2007 compared with 2006 at $1.2 billion. However, it rose 22% or $223 million in 2006 from $1.0 billion in 2005, but $212 million of the growth came from Medicare Part D premium which was offered for the first time in 2006. Since the majority of the Countryâ€™s Part D enrollees selected a plan in 2006, we do not expect significant growth in our Part D business going forward. Medicare Supplement has historically accounted for the largest portion of our health premium. Over the past few years, however, increased competition in the Medicare Supplement business has continued to dampen health sales, and has resulted in declines in the premium from this product each year. At the same time, net sales of our under-age-65 limited-benefit health products have grown significantly over the past few years, as demand for these products continues to increase. As a result, premium from the limited-benefit health products are expected to overtake Medicare Supplement premium in 2008. See the discussion under Health Insurance for a more detailed discussion of health insurance results.
While we still offer annuities, we do not plan to emphasize annuity products, favoring life insurance instead. See the caption Annuities for further discussion.
As previously mentioned, the investment segmentâ€™s pretax profitability, or excess investment income, increased $5 million or 2% in 2007, after having declined 2% in each of the last two years. The investment segmentâ€™s 2007 income was positively affected by a decline in our interest expense on debt, due to the refinancing of the two funded debt issues noted below. However, growth in total investment income has been negatively affected by Torchmarkâ€™s share repurchase program (described later under this caption), which has diverted cash that could have otherwise been used to acquire investments. Management believes that the acquisition of Torchmark stock at favorable prices provides a superior return on available cash. Additionally, the lower long-term interest rates available for new investments during the past three years have caused our average portfolio yield to decline in each successive year, restricting growth in net investment income and excess investment income. At the same time, short-term rates have risen and stayed at higher levels during the three-year period, negatively affecting excess investment income. During 2005 and continuing through mid-2006, short-term rates rose with no meaningful change in long-term rates. The rising short-term rates caused short-term financing costs to increase and the income spread on Torchmarkâ€™s fixed-to-variable interest-rate swaps to narrow. Because of the diminished profitability of these swaps, all of the swaps were disposed of by June, 2006. See the analysis of excess investment income and investment activities under the caption Investments for a more detailed discussion.
During the second quarter of 2006, we issued two new debt securities in separate public offerings: (1) our 7.1% Trust Preferred Securities, redemption amount $120 million and (2) our 6 3 / 8 % Senior Notes, par value $250 million. These offerings essentially provided funding for the repayment of two existing debt instruments in the fourth quarter of 2006: (1) the call of our 7Âľ% Trust Preferred Securities at a redemption price of $150 million and (2) the maturity of our 6ÂĽ% Senior Notes, par value $180 million. More information on these transactions can be found in Note 10â€”Debt in the Notes to Consolidated Financial Statements and in our discussion of Capital Resources in this report.
We had $2 million of after-tax realized investment gains in 2007, compared with after-tax realized investment losses of $7 million in 2006. There was an immaterial amount of after-tax realized investment gains in 2005. Realized investment gains and losses can vary significantly from period to period and may have a material positive or negative impact on net income. Under the caption Realized Gains and Losses in this report, we present a complete analysis and discussion of our realized gains and losses. Also, as explained in Note 13â€”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.
In each of the years 2005 through 2007, 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. A discussion of these items follows.
In 2005, we recorded an after-tax charge of $955 thousand ($1.5 million pretax) pertaining to litigation. This litigation involved net settlements after expenses primarily in three significant legal matters: our subsidiary Libertyâ€™s race-distinct mortality/dual-pricing litigation, its class-action cancer case, and the Waddell & Reed litigation. All of the settlements of these cases relate to litigation arising many years ago and are not relevant to current operations. Of this pre-tax amount, $13.5 million is recorded as â€śOther incomeâ€ť and $15 million is recorded as â€śOther operating expenseâ€ť in the 2005 Consolidated Statement of Operations . For more information on these litigation items, see Note 14â€”Commitments and Contingencies in the Notes to Consolidated Financial Statements . Also in 2005, we recorded a $16 million settlement benefit from an Internal Revenue Service examination covering several years. This tax settlement reduced tax expense. More information on this tax settlement is provided in Note 8â€”Income Taxes in the Notes to the Consolidated Financial Statements . Additionally, a noncash after-tax charge of $369 thousand was recorded as a result of the extension in the term of a previously granted stock option for a senior officer upon retirement. The option extension expense was recorded as administrative expense in the 2005 Consolidated Statement of Operations .
In 2006, we received four litigation and tax settlements, two of which were concerned with issues related to a subsidiary and an investment disposed of several years ago, a third involving our investment in Worldcom, Inc. bonds (Worldcom), which was held and sold in prior years, and a fourth concerning Federal income tax issues arising from examinations of prior years. The first settlement, involving the disposed subsidiary, resulted in state income tax refunds of $6.7 million net of expenses ($4.3 million net of tax) which were received and reported above as a tax settlement. The second settlement involving the investment resulted in proceeds of $5.1 million net of expenses ($3.3 million net of tax) and is included in the table above as a legal settlement. In the third settlement, we received $6.3 million ($4.1 million after tax) in connection with our Worldcom class-action litigation for recovery of a portion of investment losses. This item is included in the table above as a litigation settlement. The Federal income tax settlement resulted in benefits due us of $7.4 million, included as tax settlements in the table above. The two litigation settlements were included in â€śOther incomeâ€ť and the two tax settlements reduced â€śIncome taxesâ€ť in the 2006 Consolidated Statement of Operations . All four of these cases involved litigation or issues arising years ago and are not considered by management to relate to our current operations.
Additionally in 2006, Liberty began a program to dispose of its agency office buildings, replacing them with rental facilities. In 2006, 21 buildings were sold for gross proceeds of $6.7 million and a pre-tax gain of $4.8 million. Because of the significant scale of this nonoperating item, we have removed $4.3 million ($2.8 million after tax) from our core results representing the gain from the sales.
Libertyâ€™s program to dispose of its agency office buildings continued in 2007. As a result, 21 additional buildings were sold for proceeds of $6.4 million and a pre-tax gain of $4.3 million ($2.8 million after tax). Also in 2007, additional legal costs or settlements from litigation relating to prior periods were recorded. We received an additional $515 thousand ($334 thousand after tax) in settlement proceeds from the Worldcom litigation discussed above. We also incurred additional costs relating to Liberty Nationalâ€™s race-distinct pricing litigation that was settled in 2005 and was also discussed above. These costs were $933 thousand ($606 thousand after tax). Additionally, in 2007, we recorded a Federal income tax benefit of $1.1 million relating primarily to settlements of prior year examinations, presented as â€śTax settlementsâ€ť in the table above. This item reduced â€śIncome Taxesâ€ť in the 2007 Consolidated Statement of Operations . See Note 8 for more information on this settlement.
We redomesticated two of our insurance subsidiaries, United American and Globe, to the state of Nebraska in 2007. This redomestication will benefit us going forward by reducing premium tax rates in these companies. We plan to redomesticate other subsidiaries to Nebraska in the future.
Torchmark has in place an ongoing share repurchase program which began in 1986 and was reaffirmed at its July 26, 2007 Board of Directorâ€™s meeting. With no specified authorization amount, we determine the amount of repurchases based on the amount of the Companyâ€™s excess cash flow, general market conditions, and other alternative uses. The majority of these purchases are made from excess operating cash flow when market prices are favorable. 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 following chart summarizes share purchase activity for each of the three years ended December 31, 2007.
Life Insurance. Life insurance is our largest insurance segment, with 2007 life premium representing 55% of total premium. Life underwriting income before other income and administrative expense represented 66% of the total in 2007. Additionally, investments supporting the reserves for life products result in the majority of excess investment income attributable to the investment segment.
Life insurance premium rose 3% to $1.57 billion in 2007 after having increased 4% in 2006 to $1.52 billion. Life insurance products are marketed through several distribution channels. Premium income by channel for each of the last three years is as follows.
We use three statistical measures as indicators of premium growth and sales over the near term: â€śannualized premium in force,â€ť â€śnet sales,â€ť and â€śfirst-year collected premium.â€ť 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 $1.67 billion at December 31, 2007, an increase of 4% over $1.62 billion a year earlier. Annualized life premium in force was $1.58 billion at December 31, 2005.
Direct Response is our leading writer of life insurance. The Direct Response operation consists of two primary components: direct mail and insert media. Direct mail targets primarily young middle-income households with children. The juvenile life insurance policy is a key product. Not only is the juvenile market an important source of sales, but it also is a vehicle to reach the parents and grandparents of the juvenile policyholders. Parents and grandparents of these juvenile policyholders 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. At this time, we believe that the Direct Response unit is the largest U.S. writer of juvenile direct mail life insurance. We expect that sales to this demographic group will continue as one of Direct Responseâ€™s premier markets.
Insert media, which targets primarily the adult market, involves placing insurance solicitations as advertising inserts into a variety of media, such as coupon packets, newspapers, bank statements, and billings. This media was historically placed by Direct Marketing and Advertising Distributors, Inc. (DMAD), previously an unrelated entity with which we have had a business relationship for fifteen years. We acquired DMAD in January, 2007 for $47 million, and integrated their operations during 2007. This acquisition allows the Company to expand marketing opportunities through increased solicitation volume and also improve margins through cost savings in the insert media component. Over the period of our relationship with DMAD, the insert media component has grown to the point that it now represents over half of Direct Response net sales. However, in the last half of 2006, DMAD substantially reduced insert media solicitations resulting in declines in reported net sales in the first half of 2007. Net sales from insert media are generated four to seven months following the initial sales solicitation. We believe that the DMAD purchase will favorably impact Direct Response sales going forward.
The Direct Response operation accounted for 31% of our life insurance premium during 2007, the largest of any distribution group. Direct Responseâ€™s share of total life premium has risen steadily in each of the last three years as illustrated in the chart above. Life premium for this channel rose 6% in 2007 and 8% in 2006. Net sales declined 1% in 2007 to $114 million after having risen 2% in 2006 to $115 million. First-year collected premium declined 2% in 2007 to $76 million but grew 1% in 2006 to $77 million.
The American Income Exclusive Agency focuses primarily on members of labor unions, but also on credit unions and other associations for its life insurance sales. It is a high profit margin business characterized by lower policy obligation ratios. Life premium for this agency rose 8% to $440 million in 2007, after having increased 8% in 2006. Net sales increased 7% in 2007 to $92 million from $86 million in 2006. Net sales rose 2% in 2006. First-year collected premium rose 2% in 2007 to $74 million, after having decreased 2% in 2006. As in the case of all of Torchmarkâ€™s agency distribution systems, continued increases in product sales are largely dependent on increases in agent count. Growth in the agent count has contributed to the improvements in sales in this agency. Net sales, a lead indicator of new sales, rose in both years and first-year collected premium turned positive in 2007 after a decline in 2006. The American Income agent count was 2,545 at December 31, 2007 compared with 2,353 a year earlier, an increase of 8%. The agent count rose 16% in 2006 from 2,027 at year end 2005. This agency continues to recruit new agents focusing on an incentive program to reward growth in both the recruiting of new agents and in the production of new business. Additionally, the systematic, centralized internet recruiting program has enhanced the recruiting of new agents.
The Liberty National Exclusive Agency distribution system markets its life products to primarily middle-income customers in Southeastern states. Libertyâ€™s life premium declined 2% in 2007 and 1% in 2006 compared with the respective prior year. Libertyâ€™s life premium sales, in terms of net sales, were $37 million in 2007, representing a decrease of 11% in 2007. Net sales also decreased 12% in 2006. First-year collected premium declined 16% in 2007 to $29 million. First-year collected premium declined 5% in 2006.
Growth in the Liberty Agencyâ€™s sales and premium volume are highly dependent on building the size of its agency force. Liberty has implemented initiatives similar to those of American Income to recruit new agents, primarily through the use of the internet. The continued recruiting of new agents and the retention of productive agents are critical to growing the sales in controlled agency distribution systems. Libertyâ€™s agent count rose 49% to 2,060 at December 31, 2007 from 1,381 a year earlier. This compared with a decline of 22% in 2006 and an increase of 9% in 2005. Most of the growth in the 2007 agent count occurred in the latter half of the year. As these new agents become trained and more seasoned, they should become more productive. Declines in net sales in both 2007 and 2006 were attributable primarily to the 2006 declines in agent count. In 2006, the Liberty National Agency began the reorganization of its marketing leadership and restructured its agent compensation system to provide greater reward to productive agents and to establish production minimums for agents. These changes led to terminations and resignations during 2006 of agents not meeting these production minimums. However, management believes that these changes will result in a more productive agency over the long term. Management also believes these changes are responsible for recent margin improvements. Increased sales from a larger and more productive agency force should lead to increased premium growth.
We also offer life insurance through Other Agencies consisting of the United Investors Agency, the Military Agency, the United American Independent and Branch Office Agencies, and other small miscellaneous sales agencies. The United Investors Agency is comprised of several independent agencies that concentrate on annuity business. United Investors represents approximately 5% of Torchmarkâ€™s life premium income. The Military Agency consists of a nationwide independent agency whose sales force is comprised primarily of former military officers who have historically sold primarily to commissioned and noncommissioned military officers and their families. This business consists of whole-life products with term insurance riders. Military premium represents 13% of life premium. The United American Independent and Branch Office Agencies combined represented approximately 3% of Torchmarkâ€™s total life premium. Life premium income for these two agencies has declined for the past three years because they focus on health insurance, with life sales being incidental.
MANAGEMENT DISCUSSION FOR LATEST QUARTER
Summary of Operations . Torchmarkâ€™s operations are segmented into its insurance underwriting and investment operations as described in Note Dâ€”Business Segments . The measures of profitability described in Note D are useful in evaluating the performance of the segments and the marketing groups within each insurance segment, because each of our distribution units operates in a niche market. These measures enable management to view period-to-period trends, and to make informed decisions regarding future courses of action.
The tables in Note Dâ€”Business Segments demonstrate how the measures of profitability are determined. Those tables also reconcile our revenues and expenses by segment to major income statement line items for the nine-month periods ended September 30, 2007 and 2006. Additionally, this note provides a summary of the profitability measures that demonstrates year-to-year comparability and which reconciles those measures to our net income. That summary is reproduced below from the Consolidated Financial Statements to present our overall operations in the manner that management views the business.
A discussion of operations by each segment follows later in this report. These discussions compare the first nine months of 2007 with the same period of 2006, unless otherwise noted .
Highlights, comparing the first nine months of 2007 with the first nine months of 2006. Net income per diluted share increased 11% to $4.09. Included in net income are after-tax realized investment gains of $.06 per share in 2007 compared with net losses of $.04 per share in 2006. One component of investment losses in 2006 was the valuation adjustment on interest-rate swaps, which increased 2006 investment losses by $.03 per share, but had no impact on 2007 earnings per share as all swaps were disposed of in 2006.
We use two statistical measures as indicators of product sales: â€śnet salesâ€ť and â€śfirst-year collected premium.â€ť Net sales is defined as annualized premium issued, net of cancellations in the first thirty 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 has expired. Annualized premium issued is the gross premium expected to be received during the policiesâ€™ first year in force, assuming no lapses or terminations during the year. We believe that net sales is a useful indicator of the rate of acceleration of premium growth. First-year collected premium is 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 policy 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.
Total premium income rose 2% to $2.1 billion. Total net sales, excluding Medicare Part D net sales, declined 2% to $376 million. Also excluding Part D, first-year collected premium rose 1% to $295 million for the nine months. Because net sales and first-year collected premium refer only to new product sales, these statistical measures for Medicare Part D are somewhat skewed, because the program began in 2006. All enrollees in 2006 were considered sales whereas only new enrollees were counted in 2007. We do not expect a large amount of growth in enrollees going forward after the first year.
Life insurance premium income grew 3% to $1.2 billion. Life net sales declined 4% to $196 million and first-year collected life premium declined 7% to $149 million. Life underwriting margins increased 5% to $309 million, as a result of the 3% premium growth and a temporary improvement in mortality. In early 2007, we completed our purchase of the assets of Direct Marketing and Advertising Distributors, Inc. (DMAD) for $47 million, which we believe will result in increased distribution opportunities and reduced per unit acquisition costs for the insert media component of the Direct Response group.
Health insurance premium income, excluding Medicare Part D premium, rose 1% to $777 million. Health net sales, excluding Part D, rose 1% to $180 million, reflective of increased supplemental limited-benefit product sales but partially offset by weaker Medicare Supplement sales. First-year collected health premium, excluding Part D, rose 10% to $146 million.
Our Medicare Part D prescription drug business is a component of the health insurance segment. A reconciliation between how management views Medicare Part D business and GAAP is found under the caption Medicare Part D in this report. In the manner we view our Medicare Part D business as described above, policyholder premium was $162 million in 2007, an increase of 4%. Underwriting income rose 2% to $17 million in the 2007 nine months. In the 2006 plan year, enrollees had until May 15, 2006 to enter the program. However, in the 2007 plan year, all enrollees had to sign up by December 31, 2006, a factor in the increased premium and underwriting income in the first half of 2007.
Excess investment income per diluted share increased 7% to $2.52, as excess investment income increased 2% or $5 million to $244 million in the period. Net investment income increased 4% or $17 million, but was largely offset by a $15 million increase in interest cost on net insurance policy liabilities. Investment income was also impacted by our additional investment in 2007 of $256 million in tax-exempt fixed maturities, which reduced net investment income but also effectively reduced taxes. Financing costs declined primarily due to the completion of our restructuring of debt in the 2006 period. (For more information, refer to the discussion under the caption Investments (excess investment income)).
Excess investment income continues to be restricted as short-term financing costs remain high while long-term yields available for investment have not increased significantly, resulting in a limited spread between long and short-term rates. Because new investments of suitable quality have only been available at lower rates, we continue to invest at yields below our portfolio average, causing the average to decline. For the 2007 nine months, the effective annual yield on new investments was 6.72%, compared with an average portfolio yield of 6.96% (at September 30, 2007). The fixed-maturity portfolio at fair value accounted for 94% of total investments at September 30, 2007.
We acquired 6.9 million shares of the Companyâ€™s common stock in the open market at a cost of $448 million ($65.35 average price per share) during the 2007 nine months. Of the $448 million, $401 million was from excess operating cash flow, which was used to repurchase 6.1 million shares, and $47 million was from the cash received from stock option exercises by current and former employees. Proceeds from these option exercises were used to repurchase 717 thousand shares in order to reduce dilution from the exercises. We have an on-going share repurchase program which began in 1986 and was reaffirmed at the July 26, 2007 Board of Directorsâ€™ meeting. With no specified authorization amount, we determine the amount of repurchases based on the amount of our excess cash flow, general market conditions, and other alternative uses.
A detailed discussion of our operations by component segment follows.
Life insurance, comparing the first nine months of 2007 with the first nine months of 2006. Life insurance is our predominant segment, representing 55% of premium income and 65% of insurance underwriting margin in the first nine months of 2007. In addition, investments supporting the reserves for life business generate the majority of excess investment income attributable to the Investment segment. Life insurance premium income increased 3% to $1.2 billion. The following table presents Torchmark's life insurance premium by distribution method.
We view net sales as an indicator of new business production as defined earlier in this report. Our net sales of life insurance for the nine months declined 4% from the same period of the prior year. However, net sales rose 1% to $66 million in the third quarter of 2007 when compared with the prior year quarter. An analysis of life net sales by distribution group is presented below.
The Direct Response operation consists of two primary components, the direct mail component and the insert media component. The direct mail component targets primarily young middle-income households with children. The juvenile life insurance policy is a key product. Not only is the juvenile market an important source of sales, but it also is a vehicle to reach the parents and grandparents of the juvenile policyholders. Parents and grandparents of these juvenile policyholders 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. We expect that sales to this demographic group will continue as one of this groupâ€™s premier markets.
The insert media component, which targets primarily the adult market, involves placing our insurance solicitations as advertising inserts into a variety of media, such as coupon packets, newspapers, bank statements, and billings. This media was historically placed by DMAD, previously an unrelated entity with which we have had a relationship for fifteen years. Over this period, the insert media component of this operation has grown to the point that it now represents over half of Direct Response net sales. However, in the last half of 2006, DMAD substantially reduced insert media solicitations resulting in declines in reported net sales in the first half of 2007. Net sales from insert media are reported four to seven months following the initial sales solicitation. As noted in Note F â€“ Acquisitions , we acquired DMAD in January, 2007 for $47 million. We expect the additional control that this acquisition provides us will expand marketing opportunities while improving margins in the insert media component.
Direct Responseâ€™s life premium income rose 6% to $364 million, representing 31% of Torchmarkâ€™s total life premium, the largest contribution of any distribution system. Net sales of $85 million declined 4% and first-year collected premium of $57 million declined 3% over the prior year period due to the aforementioned decline in insert solicitations in the last half of 2006.
The American Income Exclusive Agency markets primarily to members of labor unions, but also to credit unions and other associations. This agency produced premium income of $327 million, an increase of 7%. Net sales increased 4% to $68 million while first-year collected premium rose 2% to $55 million. Growth in sales in our captive agencies is highly dependent on growing the size of the agency force. The American Income agent count was 2,616 at September 30, 2007 an all-time high for this agency. This count was 11% higher than at 2006 year end (2,353). The American Income agency continues to emphasize the recruiting of new agents, focusing on a systematic, centralized internet recruiting program, and an incentive program to reward growth in both recruiting and production. In mid-2007, revisions to this compensation system for first-year agents were made in an effort to further enhance productivity.
The Liberty National Exclusive Agency markets life insurance to middle-income customers primarily in the Southeast. Life premium income was $222 million, compared with $227 million in the 2006 period, a 2% decline. Both first-year collected premium and net sales declined 17% from the prior period. However, this agency has recently reversed a downward trend in size, as the agent count has begun to rise since year-end 2006. The Liberty Agency had 1,690 producing agents at September 30, 2007, compared with 1,381 at December 31, 2006, an increase of 22%. Liberty experienced a 22% decline in agent count during the year 2006 due to organizational changes implemented in that year. These changes involved reorganizing this agencyâ€™s marketing leadership and restructuring its agent compensation system to provide greater sales incentives and to establish production minimums for agents. These changes led to terminations and resignations during 2006 of agents not meeting these production minimums. While these changes led to a decline in agent count and sales in 2006, the changes have resulted in improved margins and lowered insurance administrative expenses which we expect to continue. Also, because this compensation system better rewards production, we believe that we will be better able to attract and retain productive agents and that these changes will result in a more productive agency over the long term. In October 2007, enhancements to Libertyâ€™s compensation system were made similar to those of American Incomeâ€™s in order to retain first-year agents and to further improve productivity.
The Other Agencies distribution systems offering life insurance include the Military Agency, the United American Independent and Branch Office Agencies (both of which predominately write health insurance), United Investors, and various minor distribution channels. The Other Agencies distribution group contributed $264 million of life premium income, or 22% of Torchmarkâ€™s total in the 2007 period, but contributed only 8% of net sales.
Life insurance underwriting income before insurance administrative expense was $309 million, increasing 5%. This margin growth was primarily the result of premium growth, but was also positively affected by favorable mortality in the Military Agency in the 2007 period. This improvement in mortality is not expected to be a trend. As a percentage of life premium, underwriting margin was stable at 26%.
Health insurance, comparing the first nine months of 2007 with the first nine months of 2006. Health premium accounted for 44% of our total premium in the 2007 period, while the health underwriting margin accounted for 33% of total underwriting margin, reflective of the lower underwriting margin as a percent of premium for health compared with life insurance. Our health products are supplemental health plans that include a variety of limited-benefit health plans including hospital/surgical, cancer and accident plans sold to customers under age 65, as well as Medicare Supplements sold to Medicare enrollees. Beginning January 1, 2006, we also began providing coverage under the Medicare Part D prescription plan. Because of the significant contribution to premium and underwriting income of our new Medicare Part D health product, Medicare Part D business will be shown as a separate health component and will be discussed separately in the analysis of the health segment.
Total health insurance premium for the 2007 period as viewed by management was $939 million, up 2%. Excluding Medicare Part D premium, health premium was $777 million, an increase of 1% over the prior period. A reconciliation between segment reporting for Part D and GAAP is discussed under the caption Medicare Part D in this report.
Health insurance, excluding Medicare Part D. In recent periods, we have emphasized the sale of limited-benefit health insurance products rather than Medicare Supplement insurance, as customer demand for the limited-benefit hospital/surgical plans has increased and price competition and decreased demand for Medicare Supplements have caused reduced sales of that product. Even though Medicare Supplement remains our dominant health product in terms of premium income, the contribution to premium of other health products has increased rapidly. Medicare Supplement represented 51% of total health premium income for the first nine months of 2007, compared with 55% a year earlier. In addition, net sales of limited-benefit plans were 89% of health sales in the 2007 period, compared with 86% in the 2006 period, reflecting the change in product mix in sales of health insurance business. Limited-benefit plan first-year collected premium accounted for 86% of collections, compared with 81% in the prior period.
The United American (UA) Branch Office and Independent Agencies are the predominant distributors of health products, primarily limited-benefit hospital/surgical plans. These agencies accounted for $586 million or 75% of our 2007 health premium income, exclusive of Part D premium. In recent periods, the focus of these agencies has been toward an increased emphasis on limited-benefit hospital/surgical policies sold to customers under age 65. Accordingly, these agencies have expanded their product lines as increased consumer demand for under-age-65 supplemental health products has resulted from the growth in the number of Americans without health insurance.
The UA Branch Office is a captive agency which focuses on sales of limited-benefit hospital/surgical plans. As is the case with all of our captive agency forces, growing the number of agents is critical to growth in sales. This agency has had ongoing recruiting initiatives, and as a result, this agency grew 13% over the prior year to 3,346 producing agents at September 30, 2007. As a result of the growth in this agency, net sales rose 9% over the prior year to $126 million and first-year collected premium increased 26% to $96 million, the highest percentage increases in new business of any Torchmark distribution group, life or health. Earlier this year, this agency surpassed the UA Independent Agency in annualized health premium in force for the first time, at $404 million. Emphasis on sales of limited-benefit hospital/surgical plans resulted in premium growth of 39% in these products in 2007 to $152 million, surpassing this agencyâ€™s Medicare Supplement premium ($139 million). However, the 9% decline in Medicare Supplement premium reduced the growth in total health premium at this distribution channel to 11%.
The UA Independent Agency consists of independent agencies appointed with Torchmark who also sell for other companies. The UA Independent Agency is Torchmarkâ€™s largest carrier of Medicare Supplement insurance, with Medicare Supplement premium of $225 million for the 2007 period, representing approximately 57% of all Torchmark Medicare Supplement premium. However, sales and premium of this Agency have declined over the prior period. In the first nine months of 2007, total net sales declined 17% to $34 million and total health premium fell 7% to $295 million, respectively.
Other agencies . Certain of our other distribution channels market health products, although their main emphasis is on life insurance. On a combined basis, they accounted for 25% of health premium in both periods. The Liberty National Exclusive Agency, which accounted for 14% of health premium, markets primarily limited-benefit cancer products. The American Income Exclusive Agency also markets a variety of limited-benefit plans, primarily accident. The Direct Response group markets primarily Medicare Supplements to employer or union-sponsored groups. Direct Response is also involved in marketing Medicare Part D.
Medicare Part D . Coverage under Torchmarkâ€™s Medicare Part D prescription drug plan for Medicare beneficiaries began January 1, 2006 and was offered again in 2007. Medicare Part D is marketed by Torchmark through our Direct Response organization and our UA Independent and Branch Agencies.
As described in Note Dâ€”Business Segments , we report our Medicare Part D business for segment analysis purposes as we view the business, in which expected full-year benefits are matched with the related premium income which is received evenly throughout the policy year. At this time, we have expensed benefits based on our expected benefit ratio of 80% for the 2007 contract year. This ratio was 77% for the full year 2006. Also described in Note D are the differences between the segment analysis and GAAP. Due to the design of the Medicare prescription drug product, claims are expected to be heaviest early in the calendar year. Management believes that the use of the full-year loss ratio is an appropriate measure for interim results, and also that these reporting differences will arise only on an interim basis and will be eliminated at the end of a full year, as they did in the full y