Globe Life Inc (GL) 2002 Q2 法說會逐字稿

Please stand by. Good day everyone, and welcome to the Torchmark Corporation second quarter 2002 earning's release conference call. Please note that this call is being recorded, and is also being simultaneously Webcast. At this time, I would like to turn the call over to the Chairman of the Board, and Chief Executive Officer, Mr. C.B. Hudson. Please go ahead sir.

Thank you. Good morning everybody, and welcome. Joining us this morning from our operating companies are Mark McAndrew, CEO of Global Life, United American and American Income, Tony McWhorter, CEO of Liberty National and United Investors. Also joining us this morning are Gary Coleman, Chief Financial Officer, Larry Hutchison, General Counsel, and , Vice President, Investor Relations.

Excuse me. For those of you that have seen our supplemental financial reports, and would like to follow along as I discuss some of the details, you can view the financials on our Website, www.torchmarkcorp.com at the investors relation page. See financial reports from the menu. Some of our comments or answers to your questions may contain forward-looking statements that are provided for general guidance purposes only. Accordingly you are referred to the company's cautionary statement regarding forward-looking statements contained in our SEC Form 10-Q for the quarter ended March 31st, 2002, which is on file with the SEC and a matter of public record.

Our operating income for the quarter was $106 million, or 87 cents per share, an increase of nine percent over the 80 cents in the second quarter of last year. In order to keep things on an apples to apples basis, we've adjusted last year's earnings to exclude amortization of goodwill. Return on equity was almost 17 percent, and we ended the quarter with a book value just under $21. Our debt to capital ratio was 26 percent, treating our trust preferred as debt.

I'm going to review the operations for the quarter, and then ask Gary Coleman to make some comments on our bond portfolio. Then I'll summarize the results for the quarter and provide some guidance for the full year 2002. First turning to our life insurance operations. Total annualized premium sales for the quarter increased 17 percent to $88 million, roughly $10 million more than the first quarter of this year. American Income sales increased 62 percent, to 25 million, and we ended the quarter with 1,952 producing agents. About 400 more agents than at the end of the second quarter last year, and a little over 200 more agents than the end of the first quarter this year.

Direct Response sales increased six percent to 31 million. Our Direct Response acquisition costs were $37 million for the first six months and declined to 62 cents per one dollar of annualized premium issue. This compares to 96 cents, 74 cents, and 71 cents for the years 1999, 2000, and 2001, respectively, and reflects our commitment to produce higher-profit-margin business in our direct mail operation.

With respect to the remaining life distribution systems, sales were over $31 million, up six percent from a year ago. Total life premiums - total life premium income increased six percent to $307 million with double-digit increases in our military and American Income operations.

Excuse me. Life Underwriting margins increased four percent to 72.9 million and were lower than we expected for the quarter due to higher claims in our United American General Agency, our Direct Response, and Liberty National operations. We reviewed the claims for the quarter and found that in almost all durations - in other words, claims in the first year, second year, third year, clear out to 15 years and longer - were higher than we expected. Therefore, we don't see any evidence of adverse underwriting, it's just a higher claim quarter.

Partially off setting these higher claims was a return to normalcy in our military policy obligations for the quarter. We stated last quarter that we expected military claims to be somewhat higher this year because of the increased activity since 9/11, however, this didn't occur in the second quarter.

Turning to health insurance, annualized premium sales for the quarter increased six percent to 53 million. United American General Agency sales increased 42 percent to 23 million due to strong sales from the non-med supp market. Although med supp sales declined 30 percent to eight million, other health insurance sales almost tripled to 15 million.

With respect to the United American branch office operation, sales declined 31 percent to 19 million. We ended the first quarter with 1,499 producing agents and we thought we had hit bottom. We were wrong. We ended the second quarter with 1,379 producing agents. By and large we are through the med supp rate increase season that negatively impacts the attitude of our branch office sales force. Nonetheless, the recovery in the branch office system will be slower than we'd like and we expect only modest increase in sales for the balance of the year.

During the fourth quarter conference call we indicated that 2002 health sales would likely decline about 10 percent. Last quarter we stated the decline might be no more than five percent. Now we think the decline for the year will be in the one- to two-percent range. So overall we are improving.

Total health premiums were 255 million, basically unchanged from last year. Health insurance underwriting margins declined five percent to 42.5 million. The decline was due to lower percentage of premium margins in our branch office operation and to the continuing problem that we're experiencing with out cancer class action business.

With respect to the branch office operation, the decline was due to increased amortization of acquisitions expenses. As I've said before, we've increased our expenses in the branch office operation to support a larger sales force than we currently have. Furthermore, the rate increases and the loss of Asians have adversely affected resistance of the business. We are reducing cost, but at a lesser rate than the decline in sales. Nonetheless we expect to branch office margins, health insurance margins to remain at around the 15 percent level.

With respect to the Liberty National Cancer Business, we continue to implement rate increases. In addition we've initiated litigation against healthcare providers in Alabama for what we allege are illegally excessive billings unrelated to the actual incurred charges. If we are successful in this litigation, our customers will benefit from rate decreases and Liberty National will benefit from lower claims. However, litigation is a slow and uncertain process and we'll keep you informed as we go along.

Turning to the annuity business, as expected our margins declined 36 percent to 4.4 million. Although some of the decline was due to market conditions, most of the decline was due to what replacement activity, which is not subsided despite our successful lawsuit against .

The $50 million verdict, which has now been appealed is bearing interest at the rate of 12 percent per annum. Furthermore, the judge did not grant injunctive relief from our continuing replacements. Instead he said that we could seek remedy in the courts, and that is precisely what we'll do.

With respect to the $50 million and the interest thereon, we have not nor will we book any of these sums until the money is actually in hand.

Administrative expenses increased two percent to $30.2 million, but as a percentage of premium was 5.3 percent, the same as in the second quarter of last year.

Turning to our investment operations, excess investment income increased 16 percent to 72.7 million. On a per share basis, which we believe is more meaningful view of the subject in light of our share repurchased program, excess investment income increased 20 percent to 60 cents per share. Our excess investment income would have been higher were it not for the fact that we eliminated the accrual of investment income on several bonds that are severally distressed. The accrual eliminated was $2.8 million. With respect to these bonds, we will not accrue investment income in the future, but will book interest payments if and when received.

Before I sum up the results for the quarter and provide guidance for the year, I'd like to turn it over to Gary Coleman for some additional comments regarding our bond portfolio. Gary.

OK. Regarding the bond portfolio, in the second quarter we identified several bonds who's value we feel is permanently impaired and wrote those bonds down to our estimate of their realizable value. As shown on page 13 of our supplemental reports, the schedule entitled "Fixed Maturity", these bonds had a book value before write-down of $110 million or 1.7 percent of our bond portfolio. Write-down total of $83 million, 54 million after tax, and reduced their book value to $27 million. The annual income on these bonds is a little over $8 million. As C. B. mentioned, we did not accrue any income as of June 30. Had we done so investment income would have been higher by $2.8 million. This amount includes a reversal of $900,000 of income that was accrued in the first quarter.

After the write-down, fixed maturities that amortized costs now total $6.7 billion, and have an average rating of A3 A minus. Our below investment grade bonds are 611 million, or nine percent at fixed maturities, and have an average rating of B1 B plus.

As we have previously discussed, we terminated our relationship with an investment firm that managed a high-yield portfolio for us. Going forward, we won't buy below investment grade bonds, and any increase in our below investment grade bond portfolio will be due to bond downgrades. Finally, the June 30 comparison of market value and amortized costs for the fixed maturity portfolio was favorable. The market value was higher by $63 million. C.B.?

All right. In summary, we had a good quarter, with operation earnings growing nine percent to 87 cents per share. We achieved this in spite of somewhat higher, abnormally higher life claims and the assumed loss of 2.8 million of investment income. During the quarter we repurchased two million shares of our stock, and through the first six months we have repurchased over three million shares. And given the current market conditions, it's likely that we will purchase additional shares in the second half of the year.

Now I'll give you some guidance for the full calendar year of 2002, and again, it's for the full calendar and not just the second half. For the year we expect life sales to grow about 15 percent, and health sales to decline in the one to two percent range, substantially less than we were projecting in the last two quarters. Our life premium income is expected to increase in the seven to eight percent range, and our health premiums will likely increase less than two percent.

Life underwriting margins are expected to grow for the year in the six to seven percent range, and health margins to decline for the year in the two percent range. With respect to the annuity margins, it's difficult to predict, but our best guess is that the total margin for the year will be around $15.8 million, roughly $9 million less than in 2001. For the year administrative expenses are expected to increase about five percent, included in these expenses are litigation expenses.

In 2001, our litigation costs were $3.1 million, which is what they were in the first half of this year. Because of the race based litigation, and our proactive position with regard to the Liberty National cancer business and continued variable annuity replacements, litigation costs will probably be about the same dollar amount in the second half of the year as they were in the first half.

Primarily because of the loss of margins in the annuity business, and the higher litigation expenses, underwriting income will likely be flat or down slightly from 2001. With respect to excess investment income, we expect the growth rate in dollars to be about 15 percent, and this assumes, as Gary stated, no investment income from the bonds for which we took the $83 million pre-tax write-down. And that was $2.8 million in the quarter, and another three million that won't be coming in, or unlikely to come in the second half of the year.

Therefore, in conclusion, and making no assumption as to the second half stock repurchases, we believe earnings per share for the year will be in the 350 to 352 range, up nine to ten percent from the 321 reported in 2001. Those are my comments this morning. Now , we'll open it up for question and answers.

Thank you. If you'd like to ask a question today please press the star key, followed by the digit one, on your touch-tone telephone. We will proceed in the order that you signal and we will take as many questions as time permits. Again, to ask a question it's star-one on your telephone.

And we'll hear first from David with SunTrust Robinson Humphrey.

Please go ahead, sir.

Hi. Actually, it's for David this morning.

First question, can you quantify your adverse mortality in the second quarter?

Well, as I stated in my comments, in the General Agency and the - and the Direct Response and - what was the other category ...

Liberty.

... yeah, Liberty National, if you'll look at the - well, we were up basically one to one-and-a-half percent at Liberty National and the Direct Response operation. You can take that as a percentage of premiums. And we were up you can call it like five points in the General Agency operation.

So it - I don't have a dollar amount, , but just look at the policy obligation ratios for those three distribution systems and you can - you can see roughly what it was, several million dollars.

OK, thank you. That's helpful.

And then any guidance on how low acquisition costs can go on the Direct Response side from your impressive recent declines over the last few years?

?

I really wouldn't expect them to go much below the level they're at today. But I think we've gotten them to a level where now we can see growth - renewed growth in our sales. But I think we've gotten them overall about as low as we can realistically get them. And we're also - at that level we're very happy with the margins that we're generating.

Right. OK.

, we're producing business at this level and it could be higher than this. But the point is we dramatically cut those costs.

Right.

We're putting business on the books that are providing in excess of a 20 percent return on our investment and should provide margins, underwriting margins, in the 30-percent range, well above what our overall block of business is producing right now.

OK, thank you very much.

Our next question will come from with Deutsche Bank.

Thank you, good morning. Could you give us a feel for how you're feeling about your overall investment portfolio? Do you have a watch list? You know, has the number of trouble spots for you increased or do you see it sort of working its way through the system?

Well, , I'll make a few comments and then can add to them.

Worldcom we just don't - those things can come up and hit you ...

Yeah.

... and you don't anticipate them.

But separate from fraud, separate from something that all of us get surprised by, how are you seeing your defaults developing?

Well, you're seeing the ones that we've - that we've had. We've had a great run the last several years, there haven't been any defaults. We think we've got a good bond portfolio. We're out of the high-yield emerging market area, as said. We've terminated that relationship. But we've got roughly 600 million below investment-grade. I'm not concerned about those bonds.

Surely I can't say there isn't going to be more problems. Likely there will be for anybody who holds bonds. But we feel pretty good about our bond portfolio. And actually, if you put it in perspective, this was the worst write-down we've ever incurred. It was roughly what, 45 cents a share off of the - of our book value. That's not the end of the world. I can't imagine that we'll ever have another quarter like this, although it's possible. But we feel good about it. The main thing is we're out of the higher risk bonds. We'll only be purchasing investment grade going forward.

Gary, any addition comments?

Yeah, we monitor you know, the bonds as an ongoing basis. And we have investment guidelines within the company to try to, we have limits based on how much we'll invest with certain issuers. As far as what we're concerned with, as you can see from the write-down, the telecommunications bonds, we still have 370 million in the telecommunications area. Out of that 370 million, 62 million of those are below investment grade. So far those look OK, but you know, we were surprised by WorldCom. We could be surprised by some of those. But that's the one sector that, you know, that we are a little concerned with. Otherwise, I think we're in pretty shape.

OK, so C.B. if I could just say back to you what I think I heard from you. It sounds like this really flushed through a lot of problems this quarter. This was a peak quarter in some ways.

Oh, I hope so. Again, I can't anticipate WorldCom, but we've laid it out on the line here. These bonds, we've written them down dramatically to a market value. We don't get subjective about writing it more or less, and we've taken the most conservative approach on investment income. We assume zero going forward, though, unless we get the money we won't accrue anything.

OK, and then if I could just switch over to your annuities. Could you give us some sense of how much you have up against that block, and what is the level of asset at the end of June 30 and how did that compare to March 31?

, can you?

Well I don't have, I don't have the figures, certainly they're available and we can send them to you. We have increased the amortization though in the face of the increased replacement activity. So, you know, we feel like that we're writing off the as we need to as long as the replacement activity continues.

Let's see , I think I've got here the, excuse me, we've got $117 million of associated with the United Investors Annuity business. So that includes both the variable annuity and fixed annuity.

And then how much assets did we lose from the first quarter?

?

Let's see. The, I've got it right here. The change in the asset portfolio in the first quarter was about $300 million. Again, that's partially due to replacement activity and partially due to market action.

OK, and that's the second quarter delta.

Second quarter of 2000, 2002.

OK, thank you very much.

OK.

And now we'll move on to with Merrill Lynch.

Good morning. I have a few questions.

Hi .

First of all, I was wondering if we could talk a little bit about the competitive environment in Medicare supplement, if there's anything going on that makes you feel better or worse about that business?

And also in American Income you've put on a lot of business and I was wondering if you could talk a little bit about why you're comfortable that you're getting the margin you need in that business.

Third, on direct response margins, you're putting on business at a very high marginal returns, and I'm wondering how quickly do you think we'll see, assuming that mortality gets back and claims levels get back to normal, how quickly do you think we're going to see that margin show up in your financial statements.

And then if you'll allow me just one last one? Is there any change in your thoughts on the free cash for this year? You were pretty aggressive buying back stock in the second quarter. Is that the kind of level we can see, we could expect to see in the second half of the year? On a quarterly basis? Thanks.

Thank you . That's a, I think there were four questions there. Mark, the competitiveness on the Med sup and the American Income.

OK. As far as Medicare supplement, we're seeing in some states a little better competitive environment, but it's still, I still believe it'll be next year before we see that really turn around. We have, and are taking some steps to long-term try to make our Medicare supplement a little more price competitive. Such as we've changed our underwriting to be more in line with our competition, which long-term will have a positive impact there. But I really, , is I think it'll be sometime next year before we really see that situation improve.

As far as American Income, we're very comfortable with the margins. Basically the, we're selling the same products that we, that American Income has sold for years, and the persistency, everything about it, we have an awful lot of experience at. We're very comfortable with those margins. So it's not like it's anything new, it's basically the same products that they've had for years.

I'll add to Mark's comments on the Med sup , we are, as he said, looking at our underwriting trying to improve our underwriting. The competition effects us. One thing we won't do is we won't reduce the margins and our pricing of our product. Med sup is already the lowest profit margin business that we write in Torchmark. And to reduce margins would just be unacceptable. American Income, we have fixed cost in that distribution system. Those fixed costs although increasing, are not increasing anywhere as fast as the production is.

You've seen a little up tick in the margins on the business, I'm not projecting that that's going to go up anymore. But because of fixed costs that are substantially less than the roughly $100 million production this year versus I think 65 million last year, we are producing higher margin of business. And we're quite comfortable with it. On the Direct Response margin, I know that we are producing higher margin business today. We did last year, and we did the year before, than we did in the prior years.

And I keep expecting those margins to show up. We're running our lapse rates on older business are a little higher and we've had some higher claims, policy obligations on older business. That will level out. Unlike health insurance, when you have rate increases, you have continuing anti-selection as you've seen in our cancer business. Those lapses will stabilize and the loss ratio, the claims loss ratio will also stabilize. So the margins are going to improve in the Direct Response. I know they are.

I've been thinking every quarter we would see it. We haven't. I'll sure be looking hard for it no later than next year, but I'm just going to wait and let it happen. I'm comfortable that it will happen. As far as free cash, Gary, would like to address that?

Sure. As we had mentioned earlier, or previously, that we, our free cash flow for this year is going to be around $190 million, and we did spend 120 million through the first six months on share repurchases, that would leave around 70 million of free cash available for the rest of the year. In addition, under our short-term borrowings we have ample capacity there to borrow more.

As to whether we'll buy at the same level through the second half of the year, I don't think I could say that. You know, we will be all likelihood buying shares but we have to keep in mind the ratings and other things in determining how much we can buy.

OK, thank you. If I could just follow-up, one question on the margins, the changes in the med supp. When you talk about changing the underwriting to be more in line with competition but at the same time saying you're not going to give up margin, could you expand a little bit on what you mean by that?

Well, it - take extremes. If there was no underwriting at all our rates would be dramatically higher than if we took extreme underwriting measures. So to the extent that we can underwrite the business better and get a better risk it will reduce the amount of premium that we would have to collect from our customers, our on-going customers, and still keep the same margins.

If I can interrupt just a second, C.B.

, basically last fall we did a study of looking at our underwriting versus our primary competitors. We found between 15 and 20 percent of the business we were accepting would not be accepted by our competitors. We, beginning of this year, changed our underwriting to be more in line. It has a - it's had a direct impact on our sales because we're now no longer taking some of these poorer risks. And we know that going forward it will have a positive impact on our claims and, as a result, on our premium rates. But we haven't - it'll really be next year and coming years where we'll see the benefit of that.

Where the - where it also can benefit you, , is it might reduce the amount of the rate increases going forward. And to the extent rate increases are lower persistency is higher.

OK, thank you.

And once again, if you would like to ask a question you may press star-one on your telephone.

And next we'll hear from with Dresdner Kleinwort Wasserstein.

Good morning. First a question on the growth in health sales. Can you just remind us what are the other major health products you're selling aside from med supp and what was really the big reason for the change in the quarter?

And then also a question on your decision to discontinue the relationship with the firm who was managing your high-yield portfolio. Can you just comment on whether or not you're likely to be liquidating some of that portfolio at a faster rate than you would have previously, given that you no longer have that relationship with the high-yield manager?

All right, , would you ...

OK.

... med supp versus other health?

OK. On our non-Medicare supplement sales it's - we have a variety of products. We have some cancer products. But most of what we're selling are not major medical, but we have some fairly broad-benefit health products. But they have numerous limits within the product. For example, it may pay $400 a day while you're in the hospital, and it'll pay scheduled benefits for different surgeries.

Where most of the growth in those sales are actually coming from a large agency who sells primarily to people in rural markets. They have found a niche that in rural areas there are large numbers of uninsured people and part of the reason for the growth is most of the individual major medical companies have exited the business. They're really are not many more options out there as far as an individual buying a major medical product. So it's basically come down to our products are the best alternative, but they are products that we've had at United American for years, some of them we've had for 20 years. We're very comfortable with the pricing on them. But they're kind of the best alternative out there in the market right now.

Is it safe to say in that type of product that there's going to be greater claims volatility than there is on your Medicare Sup Business.

I don't think so . As said, we've been, these aren't new products that we've put out on the market. The products that we've been selling for years, and I haven't, only when you make mistakes like in a major medical, do you have great deal of claim volatility. And we have so much experience in Medicare and we stay on top, we have smooth loss ratios there by and large, and I think the same will be true on the other health businesses.

And we, it's a rare occasion actually on those products where we need a rate increase. The rate increases are few and far between.

As far as the high yield, we made the decision that the risk, wasn't worth the reward and it was just a mathematical calculation that we did some time back and we decided to get out of that market. Gary, as far as what we we've got on the books, how much have we reduced our holdings in those, what I call, high yield emerging markets. Do you have the number?

Well, we in the last year-and-a-half, we have reduced through sales of about $45 million. We have reduced that portfolio. You will see though our total investment great bonds have increased in the last year and that's due primarily to the downgrades. But yes, we have already started selling some of the bonds out of that portfolio that was managed by the high yield manager and probably continue to do so.

OK, thanks.

Yes, .

Our next question will come from with .

I think my question was answered on the health side. Thank you.

Thank you. And one final reminder if you do have a question, please press star-one now. We'll hear next from with Goldman Sachs.

Hi. Good morning. Couple of quick questions. First being if you could just kind of remind us and maybe run through kind of the terms of this interest rate swap, and maybe review for us what you guys are paying, what you're receiving and kind of the sensitivity to a potential increase in short-term rates?

And then you've mentioned in the past, obviously, you just discussed the fact that you're getting out of high yield securities, but you've mentioned in the past that you're going out a little bit further on the yield curve to maintain yield in your portfolio. Is that still your strategy? If so, how far out are you going? And are you also maintaining yield by switching to different asset classes like perhaps mortgages or mortgage-backed securities.

First Gary, on the interest rate swaps?

we have three swaps and there's a $200 million swap, that's LIBOR plus 139 basis points, 150 million swaps at LIBOR plus 221, and then 180 million, that's LIBOR plus 121. The rates that we paid on those in the second quarter were between three and four percent. And the rates today is, they're still about that same level. In total if you add those up, that's a little over 500 million that's swapped and when you add in our short-term debt, that's about another 200 million. That's $700 million that is variable rate. But the rates have been pretty consistent this year, and where we stand today is pretty much what we paid in the second quarter.

OK

on the, on the yield curve, we have gone longer on our bonds, and I'm comfortable in doing that, as long as we are able to obtain yields well in excess of 700 basis points, and we're still doing that. One other comment on the, on the, on the swaps. As I pointed out before, we've intentionally positioned ourselves so that we would, really would prefer interest rates to go up. The cash that we have, that we generate at Torchmark in the course of the year, and the maturities that we have in our bond portfolio, allows us far more cash to invest to overcome any rise in interest rates that we have on our variable debt.

And that's intentional planning on our part. So we would prefer interest rates to go up instead of go down. If that happens, anything dramatically happened there, yes, well the dollars that we have to invest come in over a course of a year, and it would hurt us a little bit initially, but we would benefit from it in the long run. As far as what our investments will be going forward, I've had about all the CBOs and CMOs that I care to ever see in life. We're not interested in mortgages, the yields aren't high enough in spite of this write-down that we've taken in the, in corporate bonds. We will be, I can almost say with certainty, exclusively a corporate bond purchaser of investment grade quality.

OK, great. Thank you.

And at this time we have no further questions. So Mr. Hudson, I'll turn the conference back over to you for any additional or closing comments.

I thank you for joining us this morning, and have a good day. See you next quarter.

That will conclude today's conference call. Thank you everyone for your participation.