Globe Life Inc (GL) 2003 Q1 法說會逐字稿

Good day, everyone, and welcome to the Torchmark Corporation's first quarter 2003 earnings 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 to the call. Joining us from our operating companies this morning are Mark McAndrew who is the CEO of American Income, Globe Life and United American. Mark also just recently was promoted to Chairman of Insurance Operations within Torchmark.

In addition, Tony McWhorter, CEO of Liberty National and United Investors; Gary Coleman, Torchmark Chief Financial Officer; Larry Hutchison, General Counsel; and Joyce Lane, vice president, investor relations.

For those of you who have not seen our supplemental financial reports and would like to do so, you can view them on our web site, www.torchmarkcorp.com at the investor relations page. Select financial reports from the menu. These reports also include the GAAP disclosures and reconciliations required by the SEC regulation "G" (ph).

Some of our comments or answers to your questions this morning 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-K (ph) for the year ended December 31, 2002, which is on file with the SEC and a matter of public record.

So much for this the surgeon general warning.

We've had a good quarter. Our operating income for the quarter was $110 million or 93 cents per share, an increase of 9 percent over the 85 cents in the first quarter of last year. Return on equity was 16.5 percent and we ended the quarter with a book value just in excess of $23. Our debt to capital ratio is 25.4 percent, treating our preferred stock as debt.

I'll now turn and talk about our operations.

First, with respect to life insurance. Our sales were in line with expectations, and our premiums and our margins exceeded expectations. Total sales for the quarter increased 14 percent to $88 million. American income sales increased 18 percent to $22.9 million, and we ended the quarter with 2,054 producing agents, an increase of almost 80 agents since year end.

American Income continues to be our fastest growing life operation and also our highest margin operation, both in terms of dollars and as a percentage of premium. Our direct response operation had an outstanding quarter with sales increasing 28 percent to $37.5 million. In addition, direct response packaging and postage expenses remained low at 51 cents per dollar of sales compared to 58 cents in the first quarter of last year.

With respect to our remaining life distribution systems, sales were $27.6 million, down 5 percent for the quarter. Total life premium income increased 7 percent to just over $320 million with double digit increases in our American income, direct response and military operations which represent three of our four major life distribution systems. Life underwriting margins increased 9 percent to $79.3 million. Our policy obligations and our acquisition expenses as a percentage of revenue were in line with expectations.

As of the end of the quarter, we had not been informed of any military fatalities directly resulting from the war with Iraq. We did set aside an additional $250,000 of claim reserve. Since the end of the quarter, there have been three fatalities reported, with total benefits of $264,000.

Turning to health insurance, sales were below expectations, but premiums and margins were in line. Total sales for the quarter declined 3 percent to 48.3 million. United American General Agency sales increased 4 percent to $23.9 million due to continuing strong sales in the nonmed supp market, although med supp sales declined 30 percent to $8.3 million, about what we've been running for the last several quarters, our other health sales increased 41 percent to $15.6 million.

With respect to the branch office, United American branch office operation, sales declined 16 percent to $16.6 million. Branch office producing agents numbered 1,275 at the end of the quarter, basically unchanged from year end. Although sales were less than what we had hoped for or expected for the quarter, we do expect improvement as the year progresses. Health insurance premium income and underwriting margins were $262 million and $42.6 million respectively, slightly down from last year.

With respect to our annuity business, the margins declined 41 percent to $2.2 million, but was in line with expectations or guessstimates as of year end. Given that there has been some recovery in the market recently and hopefully margins won't decline from the current level as the year progresses.

Our administrative expenses increased 7 percent to $33.5 million, but we're in line with expectations for the quarter, excluding the fact our pension costs were about $800,000 more than we anticipated.

Gary Coleman will provide additional information on our pension costs later in this presentation.

Both net investment income and excess investment income exceeded expectations. Excess investment income increased 8 percent to $79 million and on a per share basis, which reflects our share program, excess investment income increased 13 percent to 67 cents per share. For the quarter, we acquired investment-grade bonds with an annual effective yield of right at 7 1/2 percent. But by the end of the quarter, such yields were no longer available, which explains why at the end of the quarter we had roughly $125 million in short-term investments that are sitting in our companies. Given the current bond markets, we expect, at least for the time being, lower yields on our investments in the fixed maturities.

Now, before my final comments with respect to the quarter and the year, we'd like to provide some additional details as to what's happening within some of our operations. First, I'd like to call upon Mark McAndrew to talk about our direct response operation in Oklahoma City.

Mark?

Thanks, C.B.

In order to understand where we are in direct response, I need to give a brief history. Our direct response operation began in 1964, selling $5,000 and $10,000 life insurance policies on children. This remained the primary product we sold in direct response for the next 25 years. With an average annual premium of $30, we needed close to 30 percent gross underwriting margin to achieve an acceptable return on our investment.

In the 1990s, the growth in our direct response operation was fueled by sales of life insurance to adults, primarily over age 50. With an average annual premium in excess of $200 on these policies, we could achieve an acceptable return on investment with a gross underwriting margin of approximately 20 percent. As this adult business became a larger piece or a total premium, we saw our direct response margins gradually decline from 30 percent plus to the 24 percent we reported in 2002. And unfortunately, as our adult business grew, our sales on children declined.

10 years ago, in 1993, we issued 423,000 new life insurance policies on children. By 2000, that number had shrunk to 235,000. It was within 2000 that we decided to refocus our efforts to grow this juvenile market. That year, we conducted extensive tests on products, rates and packaging. As a result, we've seen our juvenile sales increase to 439,000 new policies last year and expect over 500,000 new sales this year.

We're also continuing to refine cross selling capability to parents for juvenile insureds. This is very profitable for us, and recent tests have shown very positive results. Because of this shift in product mix, the business we've written in the past year and a half has a 29 percent projected gross underwriting margin. Going forward, I expect to see 20 percent growth in new direct response sales this year and additional double-digit growth in sales next year. Premium revenues should accelerate from the current 10 percent growth and we should see a very gradual increase in underwriting margins as a percentage of premium.

As I've been telling C.B. for the past year, direct response operation is in the best shape it's ever been in and we're very optimistic about its future.

Good, Mark.

Last year our sales in direct response were a little over $123 million. And only two months ago, we were projecting those sales to increase to about $138 million. I think, given Mark's comments of 20 percent growth in sales this year, I believe that takes us up to around $147 million which is quite an improvement.

Next, we've made some changes in our selling practices or habits at Liberty National. We're implementing those, and I'd like Tony McWhorter to discuss that this morning.

Tony?

Good morning.

During the past few months at Liberty National we've analyzed various aspects of our sales with the idea of improving the quality of business that we write. We found that when the initial application for insurance is taken, if that first premium payment is made with cash as opposed to a customer check, then our experience indicates we will see much lower persistency from that cash sale. I'm sure the lower persistency of cash business is due to the lower income level of those customers that deal only in cash. And because an early lapse carries with it a chargeback of agent commissions, we also know that the low persistency cash business has a negative impact on agent earnings and therefore agent retention. And overall, that kind of business has hampered our efforts to grow Liberty National

In order to enhance the quality of business that we write, we've taken the step of accepting new sales only when the customer can pay the initial application fee with a check. This way, the customer demonstrates that he or she does have a checking account and is not operating on a cash-only basis which, again, might be indicative of someone in the lower income level.

While this will clearly be a move that will enhance the quality of business that we do write, what's not clear at the present time is the overall expect effect on sales during the short run. We may see a temporary effect on sales as we focus our efforts towards writing business that is more persistent. But as for the longer term impact, we should see a larger increase in the in force premium at Liberty National than we've seen lately because of the new sales being more persistent.

C.B.?

Mark, any additional comments on that?

Well, again, my involvement at Liberty's been pretty limited up until recently, but just from what I've seen in the last month, I'm very encouraged and I feel confident that going forward we will see accelerated growth in Liberty.

I'll add to that by saying when we left the debit business some half a dozen years ago, we refused to accept any more debit production. What we apparently failed to do was to leave the low income business. And I've said in the conferences that we've had in New York or with shareholders, our target market are household incomes between $25,000 and $75,000. We realize at Liberty National we have been issuing business in households that have incomes less than those amounts and we just have to leave that market. The lapse rates are too high. It results in higher amortization of (inaudible) expenses and also anti-selection on the mortality side. This is a good improvement. It may cause some temporary decline in sales but I think it won't be long lasting.

I agree.

The next subject, as I mentioned earlier, our pension costs. We're about $800,000 higher than we expected a few months ago. And I'd like to call upon Gary to address those pension expenses.

OK.

The primary reason for the increase was an $825,000 increase in our pension expense. For our funded defined benefit plans, which have total liabilities of $141 million, we project that total costs for the year of $5.1 million, which is $3.3 million higher than the $1.8 million that we expensed in 2002, the increase in 2003 is due to changing various assumptions, including the discount rate and the earnings rate. Partially offsetting the higher pension costs will be a reduction in the costs of processing Medicare claims. We anticipate that these expenses will be reduced by approximately $1.1 million from 2002 levels and those savings will occur in the second through the fourth quarters.

Now, we'd also like to discuss our fixed maturities. As shown on page 11, the schedule entitled and fixed maturities, Torchmark has $7 million of fixed maturities to amortized costs which comprises 92 percent of our investment portfolio. These assets are carried on the balance sheet at their market value of $7.4 million. The $423 million excess of market value over cost is comprised of $554 million of unrealized gains and $131 million of unrealized losses. Investment grade bonds make up 90 percent of the fixed maturity portfolio and have an average rating of A-3 A-minus.

The low investment grade bonds are $722 million at amortized costs and have an average rate of B-1 B-plus. At 10.3 percent of the fixed portfolio and 9.4 percent total invested assets below investment grade bonds are up slightly from the 9.5 percent and 8.8 percent respectively at the end of 2002. We have not acquired any below investment grade bonds since early 2002 and during the first quarter of this year we sold $16 million of these bonds and wrote down another $10 million. However, this was not enough to offset the downgrades which were $92 million during the quarter.

Due to the nature of our policy liabilities, we will continue to invest our money in investment grade corporate fixed maturities. During the quarter we purchased $271 million in securities yielding 7.5 percent with an average rating of BBB and an average maturity of 22 years. At March 31, 95 percent of the fix matured portfolio was in corporate securities. We have only $200 million of asset-backed securities of which over half of those are seasoned Ginnie Maes (ph) with little prepayment risks, and we have less than $30 million of private placements. As mentioned above, fixed maturities comprise 92 percent of our invested assets and as we continue to emphasize those investments, that percentage should increase in the future.

Thank you, Gary.

Just want to emphasize, the gains that we have in that bond portfolio, as Gary said, were $554 million and the unrealized loss was $131, which gives us a net gain of $422 million. That's the highest net gain that we've had in the last 10 years in our portfolio. And I think it puts us in a good position in the event of any bonds that should go bad.

As you may have heard last week, we had some disappointing news with respect to our Waddell and Reed (ph) litigation and I'd like to call up on Larry Hutchison to provide some insight into that.

Larry?

Yes.

Last week, the Alabama Supreme Court reversed the $50 million verdict the jury returned in favor of United Investors in 2002. In the 51-page opinion, the court found two of United Investor claims should not have been submitted to the jury and we're obviously disappointed with the ruling. However, at this point we're considering our option for a possible rehearing before the Alabama Supreme Court. On remand, United Investors will pursue its claims for actual punitive damages at the trial court level. Because this is ongoing litigation, we're not going to discuss the specifics of each claim at this time, but we will see further activity as weigh we go forward.

C.B?

Thank you.

During our last conference call, we provided earnings per share guidance for 2003. I said that our best guess was about $3.78 per share, excluding any benefits from our share repurchase program. This figure translated into about $448 million of operating earnings divided by $118.6 million shares that were outstanding at the time. Our $110 million of operating earnings in the quarter was higher than our expectation, which is particularly pleasing in light of the fact that there was some loss of investment income as a result of our stock repurchase program that involved $2.2 million shares during the quarter at a total cost of $77 million.

We haven't revised our projections, and if we do it at all, it would be much later in the year. Therefore, our guidance remains unchanged. But I will say that we had a good quarter and that our expectations for the year are certainly no less than they were two months ago.

Those are our comments this morning and now we'll open it up for questions and answers.

Vickie (ph), can you handle that?

Thank you. For those of you joining us by telephone, to ask a question, you may do so by pressing the star key followed by the digit one on your touch tone telephone. If you are using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. We will proceed in the order you signal us and take as many questions as time permits. Once again, please press star one to ask a question.

Our first question will come from Nigel Dally of Morgan Stanley.

Thank you. Good morning.

First question, just on (inaudible) investment income. Are you investing in investment grade debt (ph)? The average yield 7 and a half percent, seems high. Just hoping we can get some details on where you're investing those cash flows, what sort of bonds.

And second, just on pensions. You said you changed the discount and earnings rates, just wanted to get the details there.

All right. On the investments, Nigel. After the call, if you would like to see a report of the individual bonds that we acquired in the quarter, be glad to provide it to you.

I did say that by the end of the first quarter, the bond market was much different than it was through the quarter, and currently, we're looking at investments that are probably below 7 percent going forward; hopefully that won't last forever. I'm not worried about it for the short haul.

And are the bonds you're purchasing now going to be a bit shorter duration or are you likely to continue investing it around the 20-year duration mark?

They won't be short duration. They may not be as long as we've done so in the past. We're just kind of undecided on that. Obviously, with that $125 million sitting in the short-term investments, we haven't come to any final conclusions.

OK.

On the pension side, Gary, would you like to take that?

Yes. Nigel, we haven't finalized all the assumptions. As you probably saw in our annual report that we dropped the discount raid to 7.25 to 6.75 . We will change the earnings (inaudible). It'll be somewhere between 8.75 and 9.25 that we used last year, but also looking at mortality assumptions and so on.

But as I mentioned before, the total liabilities are only $140 million, although we haven't finalized all the assumptions. I feel comfortable that the expense is going to be around $5 million, $5.2 million dollar market.

That's great. Thank you.

Our next question will come from David Lewis with SunTrust Robinson Humphrey.

Good morning.

C.B., you didn't talk much about the Medicare supplement side, maybe you can give us a little guidance. I think your comment was that you would look for that business to kind of stabilize and maybe show improvement in the latter part of the year. And I know your comment in the piece here about the fact that you're not putting in as strong a rate increase as in previous years, maybe give us some guidance here. Where do you think it's stabilizing? Are you looking to restructure any of the products to make it more affordable?

Mark?

Well, sure.

There's several things there. As C.B. mentioned, we talked about on the last conference call, one of the things we're looking for is to try to get a new standardized plan that does allow for some cost-sharing that would be more affordable. If we can get that done in the next year, that will have an immediate impact on our Medicare supplement sales.

In the meantime, we are kind of a flat point. We're about the same level we were in the third quarter of last year. I think we'll see some improvement as the year goes along. but I don't expect to see anything dramatic unless we can get a new standardized plan. Although on the group side, we did -- we were awarded the contract on Bethlehem Steel retirees which should throw in $5 to $10 million of sales this quarter and we're getting very close on another very large group, which hopefully the second half of the year can produce an excess of $20 million of sales ,but that hasn't been finalized. We really can't disclose that yet.

But the individual Medicare supplement sales, we'll see some improvement as the year goes along but it won't be dramatic.

C.B., just a quick question. You gave us, at year end, that excess investment income should probably grow at about 10 percent, and it's running a little quicker than that. Do you have a little more enthusiasm on that line?

Well, again, the quarter exceeded our expectations at 13 percent growth on a per share basis. On the other hand, again, yields are lower and we're generating an enormous amount of cash and we're probably going to be looking at yields for the time being, no doubt about it, below 7 percent annual effective yield. So haven't revised estimates, how much that will impact our overall investment income, I just can't answer that.

But as I said, we're pleased with the quarter in all areas of operation or at least in the life in the investment side. And we think the year's going to be better or as good as we thought it was going to be three months ago.

Great, thanks very much.

Our next question will come from Michelle Giordano with JP Morgan.

Good morning.

I was wondering if you could give us a little bit more color on the downgrades in the below investment grade portfolio in terms of which industries that came in and what you're going to try and do to reduce the exposure to the below investment grade bonds, and, you know, what your target is and when you intend to get there?

And then secondly, on the direct operations, you know, if you annualize what you did in the quarter which was fairly extraordinary, you get about $150 million of sales for the full year. Was there anything unusual in the first quarter that's not likely to recur in the direct response on the life insurance side?

Gary, on the bonds?

OK. On the below investment grade bonds, about half the downgrades were in the utilities area this past quarter. As far as what our goal is, you know, again, we're not buying any and we are selling those bonds and we'll look to sell more. We don't have a target that we're working at. But by the fact that we will be selling bonds, and also a lot of the projections seem to show that downgrades will lessen as the year goes on and if that will happen that will help a whole lot in helping us reduce this portfolio.

The other half of the downgrades were, you know, broadly speaking, in which groups?

Oh, there were some, I think, in the petroleum, and it was pretty much spread throughout the portfolio.

Michelle, I'll just add to that. Again, we are not going to inquire below investment grade bonds, but we're not going to be kick quick to sell them just because they're been downgraded. We've looked at some of the bonds we've got there and we're inclined to held hold them, some others we'll be inclined to sell. Do it all on a tax efficient basis whenever we take a realized loss, we will sell a bond and realize gains and remain in a tax neutral position. We've done that now for the last three or four years.

But there's some opportunity, I think, in that below investment grade. Again, not that we're going to acquire any, but we're not necessarily going to sell everything.

Mark, on the direct response?

Well, OK. It's kind of an unusual thing, but historically, the first quarter's always been our best response rates; never exactly understood why. But on the other hand, December, we do very little in December because during the holidays, historically, it's been our lowest response. So actually in December we do very few mailings. so we do more than normal in January. So the first quarter is historically a little -- little better than the subsequent quarters but I think we can come very close to that $150 million for the year.

Thank you.

Moving on, we will hear from Vanessa Wilson with Deutsche Bank.

Thank you, good morning.

Good morning.

C.B., on the mixed shift in the health business to the supplemental products, could you talk a little bit about the margins and persistency of those newer products versus your enforce Medigap (ph) products?

Well, the margin per dollar premium (ph) income on the underage health business, the non-Medicare supp business is a little higher than the med supp. That's the good news. The bad news, the business has higher lapse rates than the med supp so it has a shorter lifetime.

All said, we make more dollars over the life of the business on med supp than we do underage, but it's not a giant difference. Again, these are supplemental products. And there's a need out there today, as I've explained in the past, the cutbacks in employer group plans and also the elimination of major medical insurance, there's just a need for supplemental health. But the little higher dollar margin per -- higher margin per dollar premium income, but a little shorter life than med supp.

Do you think you can sustain the very attractive sales growth that you had in the last two quarters, the fourth quarter and the first quarter, were real nice double digits in those products?

Mark?

Well, I expect to, particularly in the branch office. Again, there's 42 million Americans with no health insurance at all, and that's really a market we're pursuing. So I expect to see very good sales growth in that, the balance of this year.

And so, C.B., with the lower level of rate increases in the Medicare supplement products this year, how should we think about the margins for health?

I would think they would basically stay the same. I think around the 18 percent in the overall general agency operations and around 15 percent, 16 percent in the branch office operations. I don't see any reason to think those numbers are going to change; certainly not going to go up.

I'll add that we are very close to -- and Larry, I may ask you to explain this -- to receiving authorization to expand our PPO program with respect to part A of Medicare. This is a program where the hospitals waive all or a portion of the Part A deductible. When we receive that letter, we're prepared to expand immensely the number of hospitals that we have under contract that will waive those deductibles or partially waive those deductibles. That won't increase the margins in this business, but it will -- it will have an impact on future rate increases.

Larry?

Therefore, what we're seeking is an advisory opinion from the Office of Inspector General. We've been working on this for approximately a year. I think we're very close to getting the final approval, and we expect to get that in the next 30 days. What it lets us do is offer this and we have the assurance from the inspector general that they've signed off on this program.

We currently have several million dollars a year of Part A deductibles that are waived or partially waived. With this letter our arrangement with PPOs will expand immensely, I believe, and we'll have a much larger number of hospitals signed up. And this is an advantage that we think we, United American, have that other companies don't have. We'll see how that goes.

Thank you very much.

Yes.

Once again, please press star one on your touch tone telephone to ask a question. If you find that your question has been answered, you may remove yourself by pressing the pound key.

Our next question will come from Jeff Schuman with KBW Investments.

Good morning.

Like to ask you about two areas. First of all, in capital, I was wondering if you could update us on your projection for excess cash flow generation or capital generation this year, share purchase, maybe risk based capital and leverage targets?

And then, secondly, with regard to the investment portfolio, you did note the downgrade activity, but also that the gross unrealized loss has actually improved a fair amount sequentially. I was wondering if you'd sort of decompose that for us? Was the downgrade activity offset by credit spread improvement in some areas or entirely due to interest rates?

Gary?

OK. As far as the cash flow, the (inaudible) the amount of stock we did in the first quarter. We've got about $160 million free cash available. We also had a $250 million available in our short-term credit lines. We have a lot of the liquidity there.

As far as our capital position, you mentioned RBC, the ratios of those companies (inaudible) percent, which is above industry level, at or above that level for the last couple of (inaudible). So from that standpoint our capital is well above the regulatory requirements and in line with our expectations.

As far as the unrealized losses, I don't have all the information to answer that question. It is due in large part to interest rates, but I don't know the breakdown.

OK, thank you.

I think I've emphasized in the conferences we've had, as well as 101 meetings, that we do generate a great deal of cash. In our life and health operations last year, life and health, excluding annuity and administrative expenses, the cash we generated was about $502 million to be invested. In the first quarter this year the cash was $138 million. So we're on schedule for a nice increase in cash. That's the good news. The bad news is, I wish these interest rates would go up a little bit. We'll just have to wait till that happens.

Next?

Our next question will come from Eric Berg with Lehman Brothers.

Thanks. Good morning.

Just a couple of quick questions. First, how are efforts going to get more and more business from your independent military agency, growing percentage of that business?

And second, help us understand -- I know we went over this last time, but I'd like to get sort of a progress report -- why, with respect to the health issue, that is the, you know, the Medicare supplement issue that is hurting sales, why it seems to be more pronounced in one of the United operations and less so in the other?

First, with respect to the military, that is an independent operation and we just work to get more of their production. That's how we've improved production over the years.

With that said, however, one of the -- that military agency writes business through about four different companies; Torchmark being one. One of the other companies had a -- I believe it was a 15 percent rate increase on their life products in early February, I believe. We think that will result in more production coming our way as the year progresses that will even add to the growth that we already expect in military operations. We'll just see how that materializes.

With respect to the med supps, Mark?

Well, I don't know that there's a dramatic -- both the independent, as well as our branch office operations, the Medicare supplement sales are down fairly significantly. Our independent agency operation shifted more to the non-Medicare supplement health products earlier than our branch office operation did, although now we're seeing good growth there in both of those. But both of those marketing organizations, Medicare supplement sales are down fairly significantly from where they were a couple of years ago.

Would you say -- Mark, just a quick follow-up -- would you say that in the branch office you are getting the effort to -- and you've already hinted at this but I'd like to get a firm -- the effort to effect a transition to the underage products are, you know, the -- the non-Medicare supplement is moving forward?

Yes, it's moving forward rather quickly. And I expect to see good growth there in the second half of this year, but the non-Medicare supplement sales, they are up significantly. I don't have a number in front of me, but they are increasing very strongly.

Thank you.

Moving on, our next question will come from Tom Gallagher from Legg Mason.

Good morning.

First question is, C.B., is your 10 percent growth in excess income target, is that potentially in jeopardy, you know, looking to what happened this quarter, if new money yield stayed below 7 percent? That's the first question.

Tom, I don't -- again, we haven't projected it out. I don't think if we spent the balance of this year investing at just below 7 percent that it's going to have a dramatic impact on the overall operations of the company. Certainly these declining interest rates make the repurchase of our stock all the more attractive. But I'm not looking for any material decline.

I really can't explain why the investment income was a few million dollars above what we've projected just two months ago, let alone a tough idea of projected outing for the next nine months.

OK. And then a question on Liberty National. I know you talked about transitioning that business to all checking account-based sales. Can you just comment on -- if we look at the sales number, I guess it was about 14 million this past quarter, looking at the life insurance side anyway -- can you give us an idea of how much of that sales number was already bank draft sales?

Well, about 65 percent of it was bank draft sales, has been bank draft sales. And about 25 percent of the business has been premium (ph) notice sales. And a substantial amount of the premium notice sales has been cash or money orders. And the analysis shows that that business has really extraordinarily high lapse rates and it's affected the overall consistency of Torchmark -- I mean of Liberty National which has been running about 45 percent first year. Whereas our pure bank draft business is running less than 30 percent first year lapse rates. We're just going to discontinue riding that horrendous persistency cash-related business. I think the agents will adapt. We may temporarily see a drop in sales, but I think it will recover well before the year ends.

That's my personal opinion.

Tony?

No, I agree with that, C.B.

We spent a fair amount of energy in the first quarter just talking about persistency and the effect on persistency with our field force. And, you know, while it may seem obvious, it always helps to sort of put those facts out in front of them periodically. And I think we've had very good acceptance of the need by our sales force to move to a higher persistent methods of payment. And any short-term effect we see, will be just that, we'll be short-term.

We've been recruiting agents at Liberty National. We're doing a fair job of recruiting agents, but we haven't seen a dramatic increase in agents and it's been baffling to us why this has happened.

Well, we think we've figured it out. We're training some agents. Too many agents to sell freedom premium notice business or cash business, and they just can't make any money at it, nor can we as a company. So we finally discovered what the problem is and now we've just got to solve it, and I think we will.

OK. And last question was on the Medicare supplement. Now that this represents less than 50 percent of your health insurance sales, will there be any issues down the road if sales keep going down here from an expense standpoint since you do have this very large infrastructure built up for that business? Can you just comment on that?

Well, in the G.A. (ph) side, it's really all percentage of premium expenses. In the branch side it is a little different; we have fixed expenses in our captive operation and we have been reducing those expenses. Certainly we've yet to reduce them to the level that they would have to be if we maintained this level of sales. But we're not terribly far from that, I don't believe. But the idea is to get that operation back in a growth mode.

Any additional comments there?

Excuse me.

Any additional comments (ph)?

No, I'd agree with that. Even though the Medicare supplemental sales may not go up in the near future, I think the non-Medicare sales will, and it will more than take care of the expense problem.

OK, thanks.

Our next question will come from Robert Glasspiegel with Langen McAlenney.

Good morning.

As I understood Gary's recap of the investment portfolio, my read was that you're very pleased with how the portfolio acted, even with the downgrades you're happy to have clipped (ph) the 7.50 percent yields, and the overall portfolio performed well even with the downgrade. Was that a correct read, Gary?

Yes.

OK. I was a little puzzled by the motivation for the relatively high cash position, relative to year end. Is that just trying to figure out what's going on or is that mainly agency driven or was that some other motivation?

No, I think Russ Tucker (ph) , our chief investment officer, has just had a hard time -- he hasn't been able to find fixed maturity investments yielding north of 7 percent. We've accumulated $125 million in the insurance companies. We've just got to get invested, which means we've got to make the decision, and we have, we're going to buy yielding assets below 7 percent.

So we'd expect that money to get worked in the second quarter?

Yes.

OK.

We're not going to sit around here with cash doing nothing.

Bob, that's exactly the reason. There's no other rating agency rates reason or anything else for having that money there.

OK. Litigation expenses in the quarter, do you have that?

Yes. Net litigation expense at Liberty for the quarter was a $1.232 million.

Versus?

$1.623, I think a year ago.

That's correct, C.B.

OK. And just finally on the administrative expenses, you suggested you were surprised by the pension in the quarter (inaudible) from guidance is -- are you saying we should settle for the 7 percent sort of growth in the quarter or can you cut some other things to bring it back down to sort of the four underline?

Our expenses will be less each of the remaining three-quarters of the year. The first quarter, excluding the pension which is going to be $800,000 a quarter...

But looks like it was (inaudible)

Because payroll tax, our expenses are always a little higher in the first quarter than they are in the subsequent quarters of the year, and that trend -- you'll see that as the year develops.

You're talking sequentially, I was talking more year over year. It was sort of up for X-pension (ph) year over year. Is that the sort of run rate or can you bring that down to offset the pension which is going to be with you for three more quarters?

Oh, I would look for our expenses for the year, excluding additional pension costs, to be something less than $124 million.

I got you.

OK.

Next we will hear from Ed Spehar with Merrill Lynch.

Good morning, everyone.

I have a couple questions. I guess, first of all, Mark, you went through the direct response discussion in terms of targeting margins by type of business. I guess it sounds like you guys have spent some more time maybe breaking down the margin issue and direct response. And I'm wondering if you could give us any more specifics on -- given the mix of business that you're writing today, where they could go to and, you know, how long that might take.

It's my standard question every quarter.

It's C.B.'s standard question for the last 10 years.

Well, the margins are going to improve, Ed (ph). I've been saying that for two years, and I'm still saying it.

Overall on direct response for the quarter it was 24.7 percent margin in the fourth quarter it was 24.4, it was in the third quarter it was 24.1 and in the second quarter it was 22.9, so there's a nice, very subtle trend there. And we added to our claim reserves this quarter quite a bit. And I'm not sure at the moment if it's truly necessary, but we changed some internal practices that showed we had higher pending claims than we reporting earlier. So book we took that hit and we still had a 24.7 percent margin.

I believe, Ed, that the margins will improve as the years - as the year -- not years - progresses.

Well, I'd also say, Ed, you know, where we really make our money in the direct response is always -- it's selling the juvenile policy initially. And then. increasing those every time we do a billing, we -- well, not every time, but at least twice a year we offer to increase their coverage. And we have no acquisition costs when we increase that coverage. so that is very high margin business. And then, we also turn around and sell insurance to the parents which we get much higher response on and, again, have very low acquisition costs so it is very high margin business.

The fact that our juvenile sales have increased rather dramatically here the last two years, the parent sales and our up-sells (ph) and cross-sales (ph) will follow. and are following. And that's why I'm very optimistic going forward that the margins will -- we can maintain that 29 percent on new sales.

OK. And just to follow up, I guess, on the margin side, the American income business has been the fastest growing. The margin ticked down a little bit this quarter. Anything unusual there or is that just sort of normal volatility, should we still expect that 30 percent underwriting margin going forward?

I think so. It was actually 29.2 percent, and a year ago in the first quarter it was 29.6 percent. So basically, it's no change.

OK. And then, the final question is on the Medicare supplement sales. I guess, I'm wondering why you wouldn't be more optimistic about med supp sales in the second half of the year if we have yet to see sort of the benefit from your lower rate increases versus the competitors, why wouldn't that drive -- I guess I would have thought some pretty meaningful growth, potentially, in the second half of the year?

Mark?

Well, you know, I hope that's true, Ed. It's just, we don't have much control over our competitors, and I hope that turns out to be the case. I guess I'm being a little pessimistic there. But we don't really know exactly what kind of rate increases our competitors will have, so it's just really hard to say. I wish I could tell you more there. But you probably have as good a feel as we do.

The agent count in the branch is stabilized. I think I said it was 1,275. It's been that number now for, I believe, the last three quarters.

We're conservatively optimistic about improvement in the med supp sales and the sales as the year progresses, but we're far more excited about what's happening in the life operations, Ed. The direct response is great. The pure cash that we generated in the direct response in the first quarter was $35 million. That compares to $115 million for all of last year which was an improvement over the prior year.

This life insurance is a primary source of cash that fuels our investment operations. Again, be nice if interest rates would go up. We'll hope that that happens as time passes.

Final question on this. Is there a point where you have a better sense from rate filings, you know, state-by-state-by-state of what your competitors are doing? Is there any point where you might have more clarity on what type of rate actions they're taking?

Mark?

Oh, Ed, sure, by mid-year, most companies file around the first of the year for their current year rates. I think we do a little better job of getting approvals quicker. We really emphasize it.

Other companies, you know, they don't see their rate increases start coming through really till the second quarter. So by mid-year we should have a better feel, but right now it's kind of too early to tell what's going to happen there.

Thank you very much.

As a final reminder, if you would like to ask a question you may do so by pressing star one now.

Mr. Hudson, it appears there are no further questions at this time. We'll turn the conference back over to you for any additional or closing remarks.

All right, thank you.

Those are our comments this morning. Thank you very much for joining us, and we look forward to talking to you next quarter.

Good day.

That does conclude today's teleconference. Thank you and have a great day.