Assurant Inc (AIZ) 2004 Q1 法說會逐字稿

Welcome to the Assurant first quarter 2004 financial results conference call. At this time all participants have been placed on a listen-only mode and the floor will be open for questions following the presentation. I would now like to turn the call over to Mr. Larry Cains, Senior Vice President, Investor Relations. Please go ahead, sir.

Thank you.

Welcome to Assurant's 2004 first quarter earnings conference call. Joining me are Kerry Clayton, our President and Chief Executive Officer, and Rob Pollock, our Chief Financial Officer. Today's prepared remarks will last approximately 20 minutes, after which time we will open up the call to questions. Before we get underway I'd like to make the following remarks.

This morning we issued our press release announcing Assurant's first quarter 2004 financial results. The press release, as well as corresponding supplementary financial information, may be found on our website at www.Assurant.com.

Now a word about forward-looking statements. Some of the statements we may make during this call may contain forward-looking information. Our actual results may differ materially from such statements. We advise you to read the discussion of risks and uncertainties associated with our business and results of operations contained in our SEC filings which can be accessed from our website.

Additionally, this presentation will contain non-GAAP financial measures which we believe are meaningful in evaluating the company's performance. For detailed disclosures on non-GAAP metrics and their GAAP reconciliations please refer to the supplementary financial information posted on the Assurant website. Finally, all percentages in our press release and those that we will discuss on this call are calculated based on the actual numbers before rounding. Now I'd like to turn the call over to Kerry Clayton.

Thank you, Larry.

Good morning everyone and thank you for joining us today.

Assurant had a strong first quarter. We continued to benefit from our diversified business model and our focus on specialty insurance businesses. Our excellent results were driven by strong performance in our three largest businesses, Assurant Solutions, Assurant Health, and Assurant Employee Benefits. Let me give you some highlights.

First quarter 2004 net operating income of $87.5 million was up 14% over a year ago. We define net operating income as, net income before investment gains or losses and before after-tax effect of other unusual or infrequent items. The only unusual item for this reporting period was $2.3 million in after-tax expenses directly related to our IPO.

Turning to our businesses, in Assurant Solutions we saw strong profit growth and significant earned premium growth when compared to the first quarter of 2003. Assurant Solutions continues to experience strong growth in both its consumer protection and specialty property businesses. Assurant Solutions also benefited from the relatively mild winter weather.

In Assurant Health we continued to enjoy substantial growth in both profit and earned premiums. We also maintained an excellent combined ratio. Of particular note is our strength in the new consumer directed health savings accounts, or HSAs, which accounted for almost one quarter of our individual medical sales in the first quarter of 2004.

In Assurant Employee Benefits we had flat top-line growth but profitability was better. Loss ratios continued to improve in group disability, a trend we've been observing for several quarters. We also saw improvement in the overall expense ratio.

In Assurant Preneed, our most asset intensive business, profitability continues to be affected by spread compression resulting from the near record low interest rate environment. However, based on the trend of interest rate movements over the last four weeks, income in Preneed may pick up over the remainder of the year.

Now let me discuss generally some factors that may impact our performance for the balance of the year. Overall the low interest rate environment continues to be a factor in terms of anticipated investment income. Our current portfolio yield is still higher than the current new money rates. It looks as though interest rates are most likely headed up, but it's too soon to tell If rates do continue to rise, our portfolio yield should plateau sometime in the next few quarters. The strong first quarter GDP numbers recently released, as well as positive jobs report last week, indicate that the economy continues to improve which should benefit some of our businesses.

In Assurant Solutions new client activity is strong in both major business lines, specialty property, and consumer protection. So far in 2004 we've seen no catastrophe activity or unusual weather-related losses, including any from the recent fires in California. There's a seasonal effect in relation to our exposure to hurricanes and other natural disasters and these typically do not occur in the first quarter.

Assurant Health's growth in 2004 will be driven primarily by sales of individual medical coverage. HSA sales have accelerated since their introduction and we stand to benefit from their continued growth. Loss ratios remain favorable but we are seeing competitive pressures in the small group market. And although we are not yet seeing heightening competition in the individual market, we expect it to come.

In Assurant Employee Benefits we will continue to emphasize underwriting discipline in this highly competitive environment. This business would benefit overall from continued new job creation and the hiring of new employees by our customers. In addition, we will maintain our emphasis on voluntary products.

Lastly, Assurant Preneed would benefit greatly from any improvement in new money rates as most of the benefit would fall right to the bottom line. In the meantime we are diligently managing our expenses.

Now I'll turn it over to Rob to review our results in more detail.

Thank you.

As Kerry mentioned, our balanced growth reflects the merits of our specialized business model. The combined net operating income of our four businesses grew 16% to $96.5 million from $83.83 million on the same basis in 2003. Comparing the first quarter of 2004 with the first quarter of 2003, our net earned premiums increased 8% to $1.6 billion. Net investment income increased less than 2% to $153.8 million from $151.5 million. Although we had a 12% increase in total invested assets and cash and equivalents, the annualized yield on the portfolio continued to decline to 5.3 -- excuse me, 5.43% from 5.85% in the first quarter of 2003.

I'll now review the quarterly results of our operating segments starting with Assurant Solutions, our largest business. The combination of strong top-line growth in key product lines within Assurant Solutions and and improved combined ratio drove this segment's overall performance in the first quarter of 2004. Net operating income in the first quarter of 2004 increased almost 16% to $40.1 million. These positive operating results were driven by continued strength in both the consumer protection business, specifically the warranty and extended service contract product lines, and in the special properties solutions businesses primarily in creditor-placed homeowners lines.

Assurant Solutions first quarter 2004 net earned premiums grew almost 9% to $623 million from $572 million in the first quarter of 2003. Strong production in the warranty and extended service lines and growth in the creditor-placed and voluntary homeowners lines drove our top-line growth.

The new warranty and extended service contract agreement we signed with GE is ramping up nicely. Given the nature of extended service contracts, there's typically a lag in earned premiums. As such, we would expect this client's contribution to increase as the manufacturer's warranty ends and our coverage begins.

Premium growth was partially offset by lower investment income as well as by a reduction in fee income caused by the discontinuation of certain unprofitable membership programs during 2003. The first quarter of 2003 also included nonrecurring fee income for services performed on a one-time basis.

Loss and expense ratios were also better, leading to an overall improvement in the total combined ratio to 98% from 100% last year. Additionally, and similar to last year, the first quarter 2004 did not see any catastrophe losses or severe winter weather losses. Since catastrophe losses are unpredictable and generally occur in later quarters, the first quarter is not necessarily indicative of future results. In 2003, we experienced catastrophe losses of $30 million pretax, which were higher than our risk models forecasted. Natural catastrophes are impossible to predict, but we are forecasting lower catastrophe losses in 2004 in line with our modeled estimates.

Moving on to Assurant Health, our second largest business, we saw in the first quarter continued strong results. Net operating income grew almost 16% to $37 million from $32 million in the first quarter of 2003. Our performance in this business was driven by premium and membership increases, especially HSA sales and overall favorable loss ratio development.

Our individual sales continued to grow. We are particularly excited about our progress in HSA, health savings account, sales. HSAs are a good example of how we capitalize on our administrative skills to be quick to market. Last year, we anticipated that HSAs could be a large market opportunity, and we established plans to capitalize on them.

We benefited from our first mover advantage selling the very first HSA on January 1st. In fact, HSAs accounted for approximately 22% of our individual medical sales in the first quarter of 2004 and are continuing to grow. Net earned premiums in the first quarter of 2004 increased about 15% to $551 million from $477 million in the first quarter of 2003.

Individual health, especially HSAs, again drove our strong year-over-year growth. Overall membership grew about 12% to 1.16 million from 1.04 million at the end of the first quarter of 2003. Individual membership at the end of the quarter stood at 786,000 members, up about 15% from the first quarter of 2003, and up from the membership at year end. Individual continues to constitute the majority of Assurant Health's business based on net earned premiums.

Additionally, small group membership increased in the first quarter to 375,000 from 355,000 one year ago. This membership was flat versus year end. We are seeing more aggressive pricing from many competitors in small group, as Kerry mentioned earlier. The combined ratio for the most recent quarter was 93.1%, essential flat compared to 92.7 in the year-ago quarter. The increase in expense ratio is due to the higher commissions related to the strong growth in the individual business.

Turning to Assurant Employee Benefits, our focus continues to be on the pricing and underwriting discipline. Net operating income for the first quarter of 2004 improved to $13 million from $8 million in the first quarter of 2003, and was roughly flat versus the previous quarter's net operating income of $13 million.

Group life had favorable mortality experience and did not experience the spike in January mortality that we have historically seen in this business. Disability claims were lower, driving the improvement in the year-over-year loss ratio. The continuing improvement in the disability loss ratio was particularly noteworthy, declining two percentage points from last year. The overall expense ratio has also improved year-over-year. Net earned premiums in the first quarter of 2004 were almost flat at $318 million compared to $320 million in the first quarter of 2003. However, we have seen good sales activity in our voluntary lines.

These products that consumers like and an area in which we have been -- or an area in which we have been intently focused. Sales of these products increased over 20% versus the first quarter of last year. This strong growth was offset by a decline in true group, or employer-paid sales, where we continue to exercise pricing discipline in this highly competitive market.

Assurant Preneed, the market leading provider of prefunded funeral insurance, had net operating income in the first quarter of 2004 of $6 million compared to $9 million in the first quarter of 2003. To help improve profitability, we have taken several crediting rate reductions in 2003 and 2004 on both new policies and in-force policies where we have the ability to adjust rates. We have the ability to impact around 30% of our reserves by changing the credited rate. And we will be looking to take more actions if we determine they are necessary.

In addition, we continue to be extremely cost conscious in this business. Net earned premiums in Assurant Preneed for the first quarter were $133 million, basically flat compared to $134 million last year. The slight decline was due to the curtailment of certain nonprofitable marketing programs, as well as the reduction of crediting rates which affect sales primarily in the independent channel. If interest rates continue to increase as they have over recent weeks, we should see our portfolio yield plateau sometime in the next few quarters.

I'll briefly comment on our corporate and other segment. Corporate and other reported a net operating loss of $10.4 million, primarily related to costs of our being a public company, which ran higher in the first quarter than we anticipate for the rest of the year. The corporate line also had lower investment income. Amortization of deferred gains from businesses sold through reinsurance declined consistent with the runoff of these businesses. This number will be the same for the remaining three-quarters of 2004.

Interest expense and distributions on preferred securities of subsidiary trusts in the first quarter of 2004 declined by $11.2 million after tax, compared to the first quarter of 2003, as a result of less debt and lower rates. Interest is down significantly from the prior year due to refinancings that took place in December and early February. The first quarter 2004 interest expense is lower than our ongoing interest expense due to the lower rate on the short-term bridge loan financing that was outstanding during part of the period. We expect interest expense for the remainder of the year to be at a more normalized quarterly run rate of about $10 million after tax.

Turning to the balance sheet, our financial positions remains very strong. At March 31st, total assets were $23.7 billion, and total invested assets and cash and equivalents were $11.9 billion. In the first quarter 2004, we had net realized after-tax gains of approximately $9.2 million, compared to the net realized after-tax losses of $ 3.3 million in the first quarter of 2003. In the first quarter of 2004, we recorded other than temporary impairments of $500,000 after tax, compared to $7.6 million after tax in the first quarter of 2003.

Our overall shareholders' equity at March 31st, 2004, was $3.5 billion. Annualized pro forma return on average equity, based on net operating income and excluding accumulated other comprehensive income from equity, was 11.3%. Our pro forma book value per share at the end of the quarter was $22.04. Again, excluding accumulated other comprehensive income and using actual shares outstanding.

Now I'll turn it back to Kerry to open the floor up for questions.

Okay, thanks, Rob. Operator, we're ready for questions.

Thank you. The floor is now open for questions. If you would like to ask a question please press star followed by 1 on your touch-tone phone. If at any point your question has been answered, you may remove yourself from the queue by pressing the pound key. We do ask that while you pose your question, please pick up your handset to provide optimum sound quality.

Our first question is coming from Nancy Benacci with Key/McDonald.

Thank you . Good morning. Congratulations on a good first quarter. I wanted to talk a little bit more on the solutions side. Could you go through a bit of what happened on the manufactured housing side in terms of what type of loss ratio you saw there?

Sure. Bear with me for a minute, Nancy. I mean, I think there's two important things on the manufactured housing side to bear in mind. That is, the shipment of new units continues to decline in this business. We think it is sometime this year we'll reach a lull, but that's going to cause, you know, a continued shrinking in the top line until that business bottoms out.

On the loss ratio side I think the loss ratio ran quite consistent with where we thought it would. We didn't see anything out of the ordinary in that business, and was quite in line with our pricing estimates on the business.

The improvement in the loss ratio in the quarter was really more from the other line as opposed to manufactured housing?

I think that is correct. I think that, you know, there were little pieces all over the place, but I don't think it stood out just in the -- that segment.

In terms of the solutions business, you indicated some new contracts coming in. GE we're not going to see the real benefit to the bottom line for awhile. Can you clarify any more potential new contracts that are coming in there?

Well two, things. First of all, one thing to just understand is a lot of our growth in the first quarter is really as a result of contracts that were landed in late 2002 and in 2003. Okay?

Because there is a lag between landing a client and really getting them up and running on our systems and our seeing the production. So we, you know, I think that we had a number of notable lands in both 2002 and 3 that contributed to our results. I say the - probably the biggest one in the specialty property area was OCWEN.

And in terms of then, as you look at the pipeline that you have in place for '04 that should benefit the rest of '04 and into '05, GE is obviously the big one, they're starting to come through. Are there other ones that you can clarify for us?

Not at this time, but I would say that we have a -- several client relationships under development, and when, you know, when they're finally inked we'll be prepared to talk about them, but until they are we are going to stay silent on that issue.

Can you give us an update on the State Farm contract?

That contract is -- it will be renegotiated in June. We do not expect any problems with that. We have a great relationship with State Farm. Their business is growing still with us. We're heavily intertwined with them in terms of systems linkages, special underwriting processes that we've developed for their agents, so we don't anticipate any difficulty. Certainly have not received any indications other than, you know, everyone's excited about the growing relationship there.

Then just a general question in terms of reserving. Were there any significant reserving changes within the quarter at all in any of the divisions?

No.

No.

And then just a quick one on Preneed. We saw obviously some new movement in the Preneed market which you talked about on your last call. Have you seen any changes coming since that has happened with Forethought and what you anticipate going forward?

Actually, we haven't seen any changes as a result of the impending change in ownership of Forethought. We've competed with them for years, and we expect to continue to compete and capitalize on any opportunities that may develop as a result of that.

Thanks very much.

Thank you, Nancy.

Thank you.

Our next question is coming from Charles Gates with Credit Suisse First Boston.

Good morning.

Hey, Charlie.

What was an example of an unprofitable membership program in solutions that you elected to sever?

Good question, Charlie. We were experimenting last year with something called tag sale programs. Tag sale programs basically come about from -- they can be television commercials or call-in's for certain product where you then try and tag a second sell in on top of that original sale, so this would be some other product where the telemarketer would then try and direct them into one of our products.

That was an experiment we tried last year. We found that to not be successful because of the cost of marketing the program were just too high. So we discontinued whole tag program. And it could cover a variety of different membership programs that we were offering, and our conclusion was that this was just something we couldn't make money at.

I would say, you know, we're always experimenting with new ideas, products, marketing arrangements, so forth. Of course, they don't all work, and, you know, this particular one shows up because of being, you know, in a different line on our financials. That is, in fee income rather than in premiums, where, you know, where the numbers wouldn't particularly show up. But it's certainly in the nature of our specialty businesses to have constant experimentation and improvement going on.

Would you think that the $27 million would be a possible run rate for that account?

I'm sorry, I --.

would you think that that would be a possible run rate going forward, for that account?

Oh, for the fee income line?

Yes, sir.

In solutions?

Yes, sir.

We're not really working on those kinds of projections, or you know, providing those kind of projections, Charlie. But there are other things within fee income that would cause us, you know, like the (INAUDIBLE) to believe that we will see some growth there.

Okay. My second question.

In response to, I believe, Nancy's -- one of Nancy's questions, you made reference to something called -- I'm going to ruin the name, OCWEN. What is OCWEN, and what is the service that you were providing for OCWEN. And how do you spell it?

Well, I'm gonna try. OCWEN is actually a publicly traded company. OCWEN Financial, OCWEN.

O-C-W-E-N.

Correct.

The basic service we're providing here, Charlie, is the forced placed mortgage hazard insurance. This is a portfolio we landed in 2003, setting up on the system last year and into this year. That, in essence, we will do all the loan tracking of their mortgage loans, just like we do with many of our other clients, and in situations where we find the mortgage holder has not maintained insurance coverage, we will go through a notification process and if they are unable to provide evidence that they've kept insurance in force we will force-place a policy upon them. Okay, so it's very consistent with what we're doing with many of our other clients there.

My final question at this time. Both of you made reference, I believe, to more aggressive competition in small group health cases.

Correct.

Could you elaborate on that competition, how you see that competition evolving?

Well, I think these small group marketplace is a competitive market. There's many players in that market. Including, you know, practically everyone who's in the large group or HMO market. The competition seems to sort of ebb and flow over time depending on the profitability of the larger group business. That is -- we're opportunistic in that business. We will only write business if we can write it profitably, and from time to time we do see more competition which cuts into, you know, our own production.

Again, it's different than the individual business where there are many fewer competitors and more specialized expertise required. I mean, that said, we are able to write the small group business. We have a lot of distribution that reaches it, and we're happy to write it when we can do so profitably.

I think that, you know, on the -- number of the managed care players, Charlie, are struggling for top-line growth. At those times we see them often turn to the small group end of things as a potential opportunity to generate growth. And so, you know, we're seeing it from, for instance, like a company like Aetna, who seems to have a stronger emphasis on that small end of the marketplace today. In addition, it's all the usual competitors we see in this space, people like the Anthem, the Blues, Principal. There's a number of people we'll see in competition in this marketplace.

Thank you.

Uh-huh.

Thank you. Our next question is coming from Bill Wilt with Morgan Stanley.

Hi, good morning. I'll follow-up on the healthcare sector first.

You talked about having a first mover advantage in the sale of the health savings accounts. I wonder if you could elaborate on that and, I guess, specifically speak to whether that is a sustainable competitive advantage that would you have? And maybe with that, taking it a step further, talk about the competitive pressures in the individual marketplace, vis-a-vis the small group sector in health.

Yeah, I think the -- you know, the health savings accounts, you know, were something that we became, you know, aware of sort of growing interest in last year. We are, you know, plugged into the political process on the health front through our trade organizations and our own activities.

We have processing expertise, you know, we were one of the leading writers of the old medical savings accounts which never became a major product. But, you know, took processing expertise, and we also believe that the consumer directed effort is, you know, one of the ways in which healthcare can perhaps be brought under control in a larger context. So we certainly push for those products. Those capabilities, worked with members of Congress and so forth, you know, in that end. In fact, obviously on a contrived basis we arranged to actually sell the first one at a minute after midnight on January 1st. And, in fact, two of our insureds have been at White House functions that have been promoting healthcare.

What we like about HSAs is that, you know, they're basically a wrapper, a supplement to a high deductible medical plan. And we like the high deductible plans, we have our best experience on the higher deductible plans. We believe that they encourage greater involvement by the insured, so we think it's a good public policy as well. So we had all the capabilities, we were ready to go, we were ready to market the plans and so forth, and, you know, we've really not even begun to market the HSAs to our existing book of business, which we will be doing as they come up from -- for renewal. I think -- go ahead, Rob. ¶

I was just going to point ¶ out a couple other things. First, to sell it in that individual market, it's a bit of a complicated sale. We have a sales force that's trained to do that.

There's a lot of discussion on is this concept going to migrate to the larger case group market, and, you know, if it does, everyone's going to be in there. The question is are we going to be able to move people from current deductible-type plans to plans that will qualify. All the big healthcare players are interested in this.

You know, your question is the question we're asking ourselves, Bill, on what can we do to maintain our leadership position here? And is it sustainable? We think, particularly in the individual market, a lot of that is around distribution and around administrative capability to execute. But we know that that won't stay there forever, so we're looking to find other ways to extend our leadership position.

Thanks for that. Now, do you charge a fee for the assets under management in health savings account, and I wonder, how, if at all, the sale or the supplement of health savings accounts on existing individual insureds would, you know, would that impact either the top or bottom line?

Yeah, it's all a good question.

At this time, you know, we are crediting interest to those accounts, and we have options that are both kind of fixed rate and, you know, they can also put the money in, you know, other investment options. That's an area where we're looking at a little bit. You know, I'd say that going forward, that's a big question, of how exactly is that going to work, are you going to charge for it. We don't -- you know, we're not looking to make money, if you will, on the asset management side of things. We're looking at it as a vehicle to control healthcare, which is our primary focus.

That being said, we're in extensive discussions with a variety of different asset managers and I would say potential distribution sources for us focused on that issue.

Okay. Thanks for that.

And one more, if I could, switching gears to solutions. I wonder, in the fourth place homeowner's insurance (force-placed ) if you're seeing any pressures, I guess I'm thinking as the profitability of the homeowners product in the traditional insurance market, has that improved? And it has been improving for many quarters now.

I wonder if you're seeing any signs where you're basically seeing a lower incidence of people losing their -- call it traditional homeowner's insurance and getting, then, kicked into your program. Is there any noticeable change in the frequency of customers coming to you because they've lost their traditional homeowner's insurance, or is that not a correlation that you've seen?

That's a very good question, and it's something we monitor regularly, Bill, and, you know, in the first quarter we did not see any different placement rates in our portfolio than we've seen over the last several years. So the answer is, no, we have not seen any changes as a result of changes in the underlying voluntary market.

That's great. Thank you.

Uh-huh.

Thank you. The next question is coming from Ed Spehar with Merrill Lynch.

Thank you. Good morning. I had a few questions.

First, Rob, I was wondering, you mentioned a few things that, I guess pluses and maybe some minuses in this quarter? I'm wondering if we could just talk about what kind of an earnings impact we might have seen from some of these things if we're trying to think about a normalized run rate. You had mentioned group rate mortality being a little better than what is typical. You mentioned no cats or real severe weather loss.

A couple comments you made on the corporate line. I was wondering if it's possible to put any numbers on those item so we can think about what adjustments we might want to make.

Okay, sure. Let me just maybe start with a general comment, which is obviously our results were better in the first quarter and perhaps the issue you're getting at, Ed, is, gee, is this kind of one-time, or is this something I should look at as continuing. And, you know, I think our feeling right now is to look at this as one-time. All right? Until we see more experience unfold. All right?

Let me go through some of the things in particular that you cited related to catastrophes in general. I think the point we're really trying to get across there is we do not experience catastrophes on any kind of seasonal base in the first quarter. We've not seen them historically. So traditionally our first quarter results have been a little better just because of that in the solutions segment, and we see those catastrophes show up in the second and third quarter. I think that's just - could you understand of a putting you guys on alert or notification that no catastrophes in the first quarter, last year $30 million pretax. That all came in the second, third, and fourth quarts. I think our forecasted model for this year is a lower number than that, and you're going see if they run according to our model, those numbers come through in the second, third, quarters primarily, maybe a little bit in the fourth quarter. Okay?

On the corporate line lots of things going on. Let me highlight a few and see if these help. One of the things we had to do is purchase our own D&O insurance. That cost us about a million dollars this year.

This quarter.

Excuse me this quarter. Thank you, Larry.

We had a number of filing fees with the SEC, the rating agencies, that was about half a million dollars this quarter. We had costs associated with Investor Relations, marketing, some branding things. That was about $3 million this quarter.

And as we've mentioned to you before, we have a long-term incentive compensation plan, stock appreciation rights plan. That is valued based on our actual stock price at the end of the quarter. That was more than we had probably anticipated would have occurred, and that was about two and a half million dollars, Ed. Okay?

So those are some of the items that caused that difference in the corporate line. Hopefully that gives you a better color for what those differences were.

That's very helpful. Now, does that -- of those expenses, though, the D&O is that a one-time?

No, D&O will be every quarter.

So the only thing that's really -- the number you would consider to be maybe one-time would probably be the filing fees?

No, I guess I like that -- depending on where our stock price is at the end of the a quarter, for instance, I believe our stock price is down from where it was at 3/31, and the way stock appreciation rights are valued is, basically to look at the actual price and use that to calculate our expense.

So the fact that the expense goes down -- excuse me, the price of the stock goes down says we're going to have a positive impact from that if we were to close the books today.

I think we had two to three million of extra expenses in this quarter related to, you know, our name change, you know, initial branding expenses, those sort of things above what we, you know, would expect for the balance of the year, you know, in the corporate line, so there's probably an extra two or three million of expenses in the first quarter versus sort of a run rate. Somewhat similar number is the, you know, the lesser amount of interest expense we had in the quarter. So if you, you know, if you put those three sort of nonbusiness unit things together, you know, you probably got a decent run rate, you know, for the quarter.

I just comment also on the solutions, that one of the things that tends to happen, sort of the -- what you might call the non catastrophic loss ratio in the first quarter often tends to be higher just because sort of normal losses that relate to winter weather. You know, the house damage from busted pipes and stuff like that. And I think the milder winter weather that we had in most of the country, you know, caused that normal sort of run rate in the first quarter to be a little lower, you know, than -- that is, the losses to be a little lower than we would expect. And so that that solutions number in the first quarter is a little higher than, you know, what you might call a normalized pre-catastrophe number.

Just very quickly a couple of broad questions, when you look at -- when you look at the mix that your health business is heading in, and you talk about a 3 combined ratio this quarter, how would you think about the range of where the combined ratio may be given the mix you have today versus what we've seen historically?

And then interest rates obviously rates have gone up a lot since -- I think since this last call, up pretty -- since your last call, up pretty significantly, and I'm wondering how you're feeling about earnings impact, even if rates just sort of stay where they are, and any comments at all about share buyback?

Well, you covered the gamut of a lot of things. Let's see if we can go through each of those.

First the mix of the health business. I think as we mentioned at last year end, our actual to expected loss ratios are running below our price targets. We saw no deterioration, if you will, in our loss ratios in the first quarter. All right? And we are hoping that our risk management techniques combined with a continued movement toward HSAs and high deductible plans will help us, because as Kerry mentioned, our high deductible experience has been more favorable than the block in general. Okay?

Yes.

If we move to interest rates --.

Can I just add, the combined ratios tend to be, you know, quite similar between individual and group. There's a different mix of loss ratio and expense ratio, but the mix doesn't really, in itself, change combined ratio. So, you know, I mean, I think overall we would expect to see individual, you know, grow at a faster rate than group. But the -- the group will be probably somewhat more uneven because it's a more opportunistic line for us, where the individual -- we've been intending to get good growth on a much more consistent basis.

Yeah, Kerry, I guess that's my question. Not so much the expected average combined ratio, but the volatility around that average, individual versus group.

Well, the group historically has been a little more volatile, but -- you know, than the individual, but, frankly, I wouldn't expect to see too much more volatility in the combined ratio, but you see more volatility in the production amounts, in the actual premium production in group than in individual.

I guess just a couple other points on that, to think about, is, gee, what causes that volatility, Ed, is it caused by pricing, okay, in other words, we're seeing pricing pressure in small group. Okay? Same kind of claim rate, if you will, but less premiums. That can lead to volatility.

Another thing that can lead to the is just does something fundamentally go on in the cost of medical care. We monitor that very closely. We have more underwriting screens if you will on the individual side than we have on small group, so, you know, I think we have a bit better protection on the individual than we have on small group, but we're pretty good at the small group as well.

As Kerry pointed out, we are, you know, we will let the top line vary. I want to jump to the interest rate question. Because there's a couple different things going on. One, yeah, new money rates are up over where they have been. They're still below our portfolio yields, so, you know, on the one side we've got pressure of money -- or, you know, dollars that are invested today, maturing and rolling over at slightly lower interest rates than they were probably previously invested at. But it's better today than it was three months ago. That's the good news there.

Second, we pointed out that we've had quite a growth in basically cash flow from the existing business. That can help our investment income.

And third, on the Preneed line in particular, you know, we have portions of this business with money being able to reinvest where if rates go up it will enure to us, and that is the case in much of our investment income. There's only a segment where it's linked. So we are in a position to benefit, with you it's a compilation -- or a complicated calculation based on which of the assets are rolling over and what the yields are in those particular assets.

What is your new money ¶ yield?

Well, the -- that's a good ¶ question. I don't have it particularly, but if you look at the ten-year treasury, you know, I think when we issued our debt, the ten-year was at 4.11. It fell to in the 3.70s, I believe, and I believe as of yesterday it might have been closer to hl 4.80. So there's obviously been a lot of movement. We earn a spread on top of the 10-year. It's a function of the benchmark portfolio constructed for each of the four separate businesses. So it really depends on which business we're looking at, Ed, what the asset mix is we have there. But I think the whole point is, higher rates are good news for us. Okay?

I want to bounce to share buyback. We're doing a lot of research around share buyback. We want to understand how this is done in the best manner we can. I'd point out that, you know, I think that share buyback, you know, right now is unlikely until fortis sells its remaining shares. That could change based on research we find out, but I think that's kind of our position today.

But again we're in a research phase to just understand how this works and to make sure that we are following all the -- you know, the appropriate rules associated with share buyback. Obviously we're also looking at other things as we've mentioned as well which if we see opportunities to do acquisitions, that would be another consideration. I don't think we'd consider right now, based on the environment, you know, pay down debt, but all of those are things at our disposal to deal with any excess capital we might generate.

Thank you.

Thank you. Our next question is coming from Adam Klauber with Cochran.

Good morning.

Hi, Adam.

In solutions if you exclude the positive impact of a light winter quarter, did margins still improve year-over-year?

I think that that's a tough question, Adam, so I'm going to give something you kind of off the top of my head. I think they were driven by our revenue increase. Okay?

More than, you know, huge underwriting -- part of that underwriting was a result of mix of business shift to the special property from the other segment. So I'd attribute most of it to the fact that we've gotten top-line growth. There was a little improvement in the basic underwriting margin as well, but it's those two pieces.

So far in the second quarter have we seen much in the way of catastrophic or weather losses?

None.

Okay.

That would exclude anything that might have happened last night.

As far as the health segment, what's the margin impact of greater HSA sales some is that positive to the margin?

We believe it is. The reason we believe it is, is that our loss ratio experience on the higher deductible plans has historically been better, and all these HSAs are written with high deductible plans. That would be point one.

You know, one of the things, and it's early in the process, but we think that the whole HSA concept could have quite a change in what our persistency experience is on the business. This is a learning for us, and we're going to be monitoring that intently to understand how does persistency change when someone has an HSA established on their account. It's obviously too early to say on any of that, but we think that fundamentally this could improve the persistency of our business as a result of HSAs, which would be good news.

Okay. Last question.

When does your reinsurance program come up for the property? Has that been renegotiated already, and what do you expect from the cost side? Do you expect to save money this year versus last year?

One, I think it is just in ¶ the process of being finalized. No, it's going to cost us a little more, largely as a result of our block -- our exposures have grown, largely around, really, all our specialty property businesses having more business in force than they had a year ago at this time.

Thank you very much.

Uh-huh.

Thank you. Our next question is coming from David Lewis with SunTrust Robinson.

Good morning. Thank you. To follow up on Ed's question on the repurchase program to start with, is there a possibility you can negotiate something with fortis as you build cash to potentially do a direct repurchase from them? Is that something you'd consider?

It's certainly something we'd consider. I think, you know, we're locked up until close to the end of August, so we have could you understand of put this in the study phase.

I would say by the, you know, next quarter's call, you know, we should have, you know, more definitive news on, you know, this subject. I know it's one of interest, and we have not made it top priority just because of the lockup anyway. So I think we'll have more information on that in August, I guess it will be.

All right. Thank you.

Two more quick questions. A little broader.

First, can you give us any indication on what's actually happening with the pricing both on the individual and group from your side, as you kind of look back to the first quarter? Are we still getting reasonable rate increases?

Absolutely. Again, we are very disciplined to get the price we think we need. I guess the way I'd characterize that is we've seen a slowdown in production as a result of that in the small group, but individual, our production remains strong.

Can you give us any actual pricing figures?

I can't, but, you know, we are trending at a certain rate that is quite high, you know, I'd say, you know, base plan over plan years our medical trend is in the high teens, but then, of course, people buy down the plan of benefits that they choose to get the overall rate increase down. That could be a deductible shift. They could change their prescription contract. They could change their out-of-pockets, coinsurance, all those things. That's a trend we've seen for a long time in terms of how individuals and small groups deal with the rise in medical costs.

So probably fair to say at the end of the day you're still getting a double-digit rate increase?

Those would be your words.

Effectively what the consumer sees after plan changes and so forth. Again, in the individual market, with the high deductible plan, you know, it's much easier for somebody who's got a $2,000 deductible to up to the 2500 than your typical group plan that may have adds 200 deductible going to 300, which seems like a big deal. So the individuals do massage their plan, you know, quite readily to keep the rate increase in something that's personally palatable for them.

I understand. When I used to cover American Banker, shifting to solutions, seemed to me there was clearly a lag on the revenue side excluding the ability to bring on new accounts, but just kind of the existing account new business clearly a lag with an economic rebound or slowdown. And now that we're apparently seeing a rebound do you think you're seeing some of that benefit in the existing account or do you think it's still on the come maybe out six months?

Well, that's a good question. I think I'd start with we know that there are. When you land a new account, okay, there is a lot of installation of costs associated with the new account, and then depending on the coverage sold, it can take awhile to get the thing up to a full production capability. That will vary depending on what kind of coverage. For instance, if it is an extended service contract, we can have that up-front cost of installation and then we're not actually earning any premiums until a warranty expires. So, you know, it really becomes a function of which coverage we sold, but indeed there is a lag, and, you know, I think that maybe what we would hope for is the rebound in the economy could make, you know, the purchase of our number of -- a number of our products even higher than they've been in the past.

I think we're already seeing it in the extended warranty business, the service contract business. That's the one that's more directly hooked to consumer spending and, you know, retail sales and so forth. But our businesses are driven by a lot of different trends, and they're not all driven directly by the economy, which also gives us, you know, stability when the economy goes down. But I think you're right in that we are seeing it in extended service contracts, you know, I think already in, you know, for example, I don't think we're seeing it in the manufactured housing market, but that, you know, that could turn soon based on, you know, employment improvements, and we might see that growth coming again if we get the growth in economic -- employment growth and economic growth over the balance of the year.

That's helpful. Just a final question.

We talked about a lot of moving parts in the quarter, and kind of be helpful, if you were, say, comfortable with the mean forecast of 249 for this year prior to the quarter and you beat expectations by a nickel. Would you be opposed with people just adjusting the quarter and kind of maintaining their outlook for the balance of the year?

Really to have leave that for you guys to judge.

I thought I'd try. ¶ Thanks.

Thanks, David.

Thank you. Our final question is coming from Steven Schwartz with Raymond James & Associates.

Good morning everybody. Better to be lucky than good, I guess. Couple questions. I want to follow up on the one-timers. First I want to do that.

One-timers that Ed was talking about. You went over to corporate side. You seemed to leave alone the favorable group life mortality and how much that may have helped your earnings, and as well, Rob, you had a -- you mentioned favorable loss development in health. Me, in individual health to me that tends to mean a reserve release. Did that happen?

Well, it's a complicated question. I guess that first of all, on the health side, I just want to start with actual to expected loss ratios, particularly on individual but group as well, ran better than we expected. Okay?

Now, you know, I hear your point on the reserves, and I guess you can think about it two ways. One is, we had reserves set up at year end. We now think we don't need as many -- you know, based on claim payment patterns perhaps we didn't need to reserve to that level. So, gee that would sound like there could have been a reserve release. But then the question is, well, what were the reserves set up at the end of the current quarter? Okay.

And if you look at our historical pattern in the health business we've consistently had more reserve established than needed, and our basis for setting those reserves has not changed. Okay?

All right, Rob. Let me paraphrase you. You would say that, yes, you released some reserves, your belief, however, based on past experience, is that reserves you set up for the current accident year are in line with the past, and basically you've wound up even?

That is a good way to put it.

With medical claims, I mean, you know, they run off very quickly, you know, you don't have the long tail that you have with, you know, some casualty lines, so, you know, the run I don't have of claims at the end of the year, you know, is largely done, not completely, of course, but you've seen the bulk of it by the end of, you know, three months later.

So it's -- I think you said it correctly, but, you know, it's not so much when you release reserves, you know, you pay claims out of those reserves, and, you know, it's largely done at the end of the day you either had more or less than you needed, and we don't like to have less, so --.

Okay. And then on the mortality and group life?

Yeah, I think on the mortality and group life, we had very unfavorable experience in the first quarter of last year, very unfavorable. We had quite an improvement in that this year, all right, saying that we still expect that our first quarter mortality in group life will probably be a bit higher than we will experience over the remaining quarters. And that's just a seasonal impact we've always seen. Last year it was particularly acute. I don't know if it was related to, you know, flu, whatever it was. We had a lot of death claims in the first quarter, particularly January.

There is, you know, statistically there is a spike in death claims in January. There's a seasonal pattern, low points in the summer, and, you know, it's highest in January, and, you know, so we normally expect that. I'd say we had a normal quarter for group life losses this year, and, you know, we did not have sort of the abnormal spike that we have seen, you know, I would say not infrequently in the past.

Okay. So group life mortality, then, was pretty much normal. It was just a lot better than last year.

Correct.

Okay. And then just a couple of theory questions.

On HSAs, do you have a sense of how much that is -- that is cannibalizing the current market vis-a-vis bringing new people in, and then margins clearly you've indicated you think are going to be better on HSAs. Is premium better? I mean, does it all even out, if everything was to turn over, in theory?

Okay. Those are all good questions.

First, on the cannibalization, in essence we rolled all our old medical savings accounts over to HSAs, but we have not gone to any of our existing clients and offered them an HSA option. We're studying that, how should that be done, et cetera. We're trying to really get at the fundamental issue is, is this bringing in a new group of buyers that wasn't there previously. We don't know yet, Steven. We're studying that intently. But, you know, your comment on the cannibalization, I guess our feeling on it is, if all this stuff moved to an HSA, we would like that.

Okay.

And the reason we'd like it is we just think it's going to help the persistency of the product.

The individual side, a lot of our business is already on high deductible plans, so, you know, this is kind of a wrapper. You put around it that makes it, you know, even, you know, even stickier in terms of, you know, the customer's experience with us and so forth. I think on the group side, if does it move into the group market, then you could see deductibles going up which would mean, you know, some reduction in premium on the medical insurance. Although, you know, like Rob said we have -- we haven't seen much movement on the group side so far.

Two more quickies. Small group. Would you say that's more competitive, less competitive, or about the same as of year end?

More.

More. Okay.

And the SCI relationship, looked like they actually had increasing premiums. Have they gotten their act together?

We're spending a lot of time with SCI. We -- first of all, we always think they've had their act together. Just a matter of where their relative priorities have focused, and we'ring an increasing focus on Preneed offerings. So we're encouraged by that.

Thanks a lot.

Thank you. Our next question is coming from Jukka Lipponen with KBW.

Good morning.

Good morning.

The couple of questions I guess. First of all, what's your excess capital position at the end of the quarter?

Well, I mean, we don't really disclose anything in terms of an excess capital position.

As we've mentioned earlier, we are -- we capitalize our businesses to the A.M. Best models, you know, we have a plan to diligently keep them capitalized there, and if there is excess capital, we will look to get it out. You know, our ordinary dividend capacity from statutory companies is about $300 million, and as I mentioned earlier, we're studying alternatives for use of this capital because, as we've mentioned to you folks previously, our capital requirements are in the $120, $130 million range. So obviously we will generating more capital than we have uses for in the near term.

A.M. Best is revising their capital adequacy model, and we have, you know, yet received, you know, our own calculations with their new parameters, but I think that's anticipated in the next few months. And that will help us refine a little bit more.

My next question, in terms of the pricing in group disability what are you seeing there, the current trends?

Actually, I think that we're seeing a hardening in the market a little bit which we are encouraged by. You know, it continues to be very competitive, but I think everybody is understanding that prices and disability probably need to be higher, if for no other reason than what's happened in the capital market with the decline in interest rates. So we are seeing, I'd say, a bit of tightening in the marketplace.

Okay. Last question.

Remind me of the deferred gains on the sale of the long-term care in the variable businesses, are you taxed on those on the current basis, or were they taxed up-front?

Well, they've already been taxed, you know, by the government, but there is deferred tax up on our balance sheet as an offset. So what comes through our financial statement is, you know, an after-tax number. After-tax accrual.

Thank you very much.

Uh-huh.

Thank you. Our final question is coming from Dan Johnson with Citadel.

Thank you very much. The question would be on the -- I guess three things.

One, the outlook on employee benefit sales. I heard what you said about the voluntary product, but I'm suspecting that will be a little while before that's driving the earnings. If you could just give us a little more insight on what you think the bigger part of the book will be doing for the rest of the year?

Okay. Do you have others, then, or --.

I do. I was going to ask about the prior period adjustments in the health. Sounds like it was touched on, if you'd quantify that.

On the HRA's, even though they may have potentially higher margins given the smaller premium wouldn't it be a bigger challenge to have the same sort of dollar contributions? Those are the three.

All good questions.

On employee benefit sales you're right we've had growth in the voluntary. It will take time for that to work its way through the financials. I think the big issue in employee benefits is, how will rebounding employment work its way through our existing book of business? Through most of the 90s we saw, if we analyzed our in-force insured employers we saw a slight growth, couple% every year in the number of people who were covered with them. That reversed in late -- well, probably in the 2000, 2001, 2002 time frame, continued into last year, where we saw the size of existing cases actually shrink. If we could get a stabilization or growth there, that would clearly help our top line revenues. That would be one point.

Second, we are looking to expand our sales force. Okay? And we need more people selling the product. We have plans in place to increase the number of people we have selling.

Okay.

If I jump in here, because, yeah, I want to go to HSAs, and really what I would -- I think your math is right, in terms of there's less premium, vis-a-vis our in-force block of business with an HSA sale, but I'd point out -- yeah, thank you.

Individual.

I was just going to point out, in general, on high deductible plans our loss ratios on an actual to expected basis in both individual and group are better than the block in general. So although you might experience some erosion in revenue, in essence you're also picking up some margin based on historical results. Okay?

So when all that works its way through it will depend on the plan they came from, but I'm not so sure we lose that much overall dollar margin. Last, on, you know, you talked about reserve developments, we publish that information annually, so, you know, we'll have that out again at year end 2004, so we don't publish the reserve developments quarterly but as we've mentioned there's been no change in our reserving policy, and I think you should all take comfort in that.

Could you remind us, then, what the development was in '03, if you have that handy?

I don't have it with me, but it was -- you will see that all our short run I don't have business demonstrated redundancy and that it was quite consistent on -- for the last several years.

Great. I'll get it out of the county. Thank you very much.

Thank you.

Thank you. I'd now like to turn the floor back over to the speakers for any further comments.

Okay, thank you.

I'd just like to summarize and say we're very pleased that our diversified business model and our focus on specialty insurance products is continuing to deliver strong he results. We are encouraged by the current macroeconomic view and interest rate trends. We remain focused on profitability. We always exercise underwriting discipline in our businesses, and we're not afraid to pull back from product lines where we see increased competition and where we can't get the returns that we need, we're a bottom line-focused company.

Thanks again for joining us today, and we look forward to updating you on our progress on our next call. Thank you.

Thank you. This does conclude today's teleconference. You may disconnect your lines at this time, and have a wonderful day.