Globe Life Inc (GL) 2006 Q2 法說會逐字稿

Good day everyone, and welcome to the Torchmark Corporation Second Quarter 2006 Earnings Release Conference Call. Please note that this call is being recorded and is also being simultaneously webcast. At this time, I will turn the conference over to the Chief Executive Officer, Mr. Mark McAndrew. Please go ahead, sir.

Thank you. Good morning everyone. Joining me this morning are Gary Coleman, our Chief Financial Officer; Larry Hutchison, our General Counsel; Rosemary Montgomery, our Chief Actuary; and Joyce Lane, our Vice President of Investor Relations. For those of you who've not seen our supplemental financial reports and would like to follow along, you can view them on our website at torchmarkcorp.com at the Investor Relations page.

Some of our comments, or answers to your questions may contain forward-looking statements that are provided for general guidance purposes only. Accordingly, please refer to our 2005 10-K which is on file with the SEC. Operating income before stock option expense for the second quarter was 125 million or $1.23 per share, an 8% increase compared to the $1.14 for the year ago quarter. Our return on equity was 15.8% for the quarter, and our book value was $31.20 per share.

In our life insurance operations, premium revenue grew 3% to $381 million, and underwriting margins grew 5% to $99 million. Life insurance net sales declined 7% for the quarter to 71 million, and life first year premiums were also down 7% to 53 million. In our Direct Response operation, life premiums grew 4% to $113 million, and life underwriting margins grew 2% to 28 million. Life first year premiums declined 4% to 19 million, and life net sales declined 2% to $31 million.

For the first six months of 2006, Direct Response life premiums [are] up 7%, in line with our expectations. We believe that fluctuation on our growth rates between the first and second quarters is a timing issue, caused primarily by an additional working day in the first quarter and one last working day in the second quarter versus last year. The net sales in Direct Response for the second quarter were less than expected.

During the quarter, we experienced an unexpected broad decline in our response rates. We suspect that these declines may be a result of higher energy prices, which have impacted the discretionary income of our target market. If these slower response rates continue during the second half of the year, they could offset the growth of new sales we previously projected. If sales do not improve, we continue to expect to see 6 to 7% growth in our premiums for the balance of the year.

At American Income, life premiums grew 7% to $102 million, and life underwriting margins were up 13% to $32 million. First year life premiums declined 4% to $18 million. Net life sales were down 1% from a year ago to 22 million, but were up 8% from the first quarter level. The producing agent count at the end of the quarter was 2,312, up 14% year-to-date, and up 8% from a year ago. New agent recruiting continued strong for the quarter, and it was up 21% from a year ago. We are on track at American Income to see renewed growth in sales during the second half of this year, and should see double-digit growth by the fourth quarter.

At Liberty National, life premiums were $76 million for the quarter, the same as a year ago. Life underwriting margins increased 4% to $19 million. Life first year premiums were flat at $9 million for the quarter, and net sales declined 10% from a year ago to $11 million, but were unchanged from the first quarter level. The major changes in compensation structure and minimum production requirements were implemented May 1st, with no big surprises.

Our producing agent count declined 5% for the quarter to 1,606, and is down 18% from a year ago. We've also seen 30% turnover in our district managers at Liberty National since the beginning of the year. This decline in agents and management turnover were expected, and consisted primarily of low-producing and unprofitable agents and managers. New agent recruiting was up 18% over the first quarter level, with May and June being the highest recruiting months year-to-date, even though we discontinued service [salaries] for new hires effective May 1st.

We continue to believe we are positioned to see improved long-term growth at Liberty National beginning in 2007. We also expect to see improving margins in the second half of 2006, as a result of the changes we made. Our current estimates are that we would add about $1.4 million in the third quarter, and $2.3 million in the fourth quarter this year, as a result of that compensation changes that were implemented.

In our Military operation, life premiums and underwriting margins both grew 2% to $51 million and $12 million respectively. First year premiums were down 36% to $4 million, and net sales declined 32% to $3 million, which followed a 34% drop in our producing agents. On the Health slide, premium revenue, excluding Part D, grew 1% to $255 million. Health underwriting margins also increased 1% to $45 million.

First year health premiums grew 26% to $45 million, and net sales were up 47% to $64 million. The growth in net sales was driven by 91% growth in our United American branch office operation. This distribution system now represents almost two thirds of our total health sales. The branch office producing agent count ended the quarter at 2,765, up 16% for the quarter and 44% from a year ago.

Our health sales have now reached a level which will grow our total health premiums and margins. At the current level of sales, we would expect total health premiums -- total health premium growth to accelerate to approximately 5% over the next year. Continued growth in new health sales, which we fully expect to see, should increase our total health premium above that 5% level.

Part D revenue for the quarter was $53 million. We saw a significant upturn in our new enrollees toward the end of the open enrollment period, and ended up with just over 200,000 confirmed enrollees. Our total enforced premium for Part D grew to $246 million at the end of the quarter, and we expect 2006 revenues to be in the range of $205 million to $215 million.

We continue to report an 80% expected loss ratio for the quarter, although our actual claim experience to-date has been significantly better than expected. If this favorable trend continues, we could see full year underwriting margins of 15%, versus the 9% reported in the first half of 2006. We would like to stress that there are still considerable uncertainties regarding our 2006 full year loss ratio. The third quarter will provide us with much greater insight, and should allow for some adjustment in our reported loss ratio for the next quarter.

Administrative expenses were 39.5 million for the quarter, up 7.5% from a year ago. Excluding expenses attributable to Part D, our administrative expenses would have been 38.1 million, a 3.5% increase. We expect the administrative expenses attributable to Part D to decline roughly $1 million during the second half of 2006.

I will now turn the call over to Gary Coleman, our Chief Financial Officer, for his comments on our investment operations.

Good morning. I want to spend a few minutes discussing investments and excess investment income, and to comment on share repurchases. First, the investments. Torchmark has $8.9 billion of bonds and amortized cost, which comprise 95% of invested assets. Investment-grade bonds total $8.2 billion with an average rating of A-, and below investment-grade bonds were $694 million with an average rating of BB-. Overall, the total portfolio is rated A- compared to BBB+ a year ago.

Regarding new investments, in the previous four quarters, we invested in a combination of long and short maturity bonds, investing long when we could find quality bonds yielding in excess of 6.5%. Due to the increase in the long-term interest rates, our second quarter bond acquisitions were all long-term. In the quarter, we invested $443 million with an annual effective yield of 6.98%, an average life of 24 years, and an average rating of A+. This compares to the yield of new investments of 5.9% in the second quarter of 2005, and 6.1% in the first quarter of this year.

As noted in our previous earning calls, the low investment yields in the last three years have had a negative impact on the portfolio. The average yield of the entire portfolio in the second quarter was 6.98%, 24 basis points lower than last year. However, by investing new money at the same yield earned on the portfolio during the quarter, we finally ended the turning of 12 consecutive quarters of investing at rates below the portfolio yield.

Now, I'll make a few comments about excess investment income, which was $79 million in the second quarter, $3 million less than a year ago. On a per-share basis, excess investment income increased 1%, which reflected the effect of our stock repurchase program. Looking at the components, net investment income was up $4 million or 3%, lower than the 6% increase in average investment assets due to the decline in the portfolio yield.

Offsetting the $4 million increase in investment income was a $7 million increase in the costs of the interest-bearing liabilities. Interest on the net policy liabilities was up $3 million or 4%, which was in line with the similar increase in the average liabilities. The remaining $4 million increase in the cost of the interest-bearing liabilities was due to higher financing costs. Of that, $2 million was due to the reduced benefits from the interest rates loss, $1 million resulted from higher rates paid on short term debt, and $800,000 was due to the senior notes and trust preferred securities issued late in the quarter.

Regarding the swaps, due to rising short term interest rates, the income from the swaps declined steadily in the last few years. As late as the second quarter of 2005, we had four swaps with a combined notional amount [of] face amount at $530 million. In the third quarter of 2005, we terminated two of them, holding $200 million of face amount. And in the second quarter of this year, we terminated the remaining two swaps, that had a combined face amount of $330 million.

Since their inception in late 2001, these four swaps provided $46 million of income. However, due to rising short-term interest rates, the income has declined dramatically in the last few years. We went ahead and terminated the swaps due to the likelihood that there semi-annual cash payments would become negative in the future. Now that we no longer have the swaps, our only exposure to floating-rate debt is a short-term commercial paper that totaled $115 million at June 30.

Now regarding the issuance of the securities mentioned above, late in the second quarter we borrowed $370 million. $250 million or 6.38% senior notes due 2016 and $120 million or 7.10% trust preferred securities due 2046. After issue expenses, the net proceeds were $362 million. $330 million we used to retire the 180 million or 6.25 senior notes that mature in December and for the likely call of the $150 million or 7.25% trust preferred in November. The other $32 million of proceeds will remain in investments, or possibly be used to reduce short-term debt.

We went ahead and issue the new securities, because of the concern over rising interest rates later in the year. From June 30, until the proceeds of the new securities are needed for the fourth quarter payoff, we will incur a net pre-tax costs of approximately $300,000, which is comprised of the interest expense on the new issues offset by the investment income on the related proceeds. Going forward, beginning in 2007, this refinancing will benefit excess investment income by about $900,000 a year pre-tax. For more information on Torchmark's debt, please see the related schedule in the financial report section of our website.

In summary, the lower long-term interest rates, and higher short-term rates have restricted excess investment income in the last two years. However, we're seeing improvement. We are investing money at higher rates and we reduced exposure to short-term floating-rate debt. We're encouraged most by the uptick in the long rates. With the strong and growing cash flow from our insurance operations, our long-term rates will provide a quickest way to reverse the trend of decline excess investment income.

Finally, I'd like to make just a few comments regarding our share repurchase program. So far this year, we spent $267 million to buy 4.7 million Torchmark shares. And this is comparable to the $237 million used to buy 4.4 million shares in the first half of 2005. We use our free cash flow with the holding company to fund our stock repurchases. Free cash flow, the previous year's statutory earnings of our subsidiaries, dividend into the holding company, less the dividend pay to the shareholders, and less the financing cost.

In 2005, free cash flow was $300 million, and we purchased 5.6 million shares. In 2006, we expect the free cash flow to be at least $320 million. With our debt at an appropriate level, and as long as the stock is valued, [and such] repurchases provide a superior return over other alternatives, we expect that the stock repurchases will once again be the best use of our free cash flow.

Those are my comments. I'll now turn it back to Mark.

Thank you, Gary. As we stated in our earnings release we are raising our earnings guidance for the balance of 2006. Our previous guidance was $4.90, to $5 per share, which excluded a projected stock option expense of $0.04 per share.

Due to the better-than-expected experience of Medicare Part D, higher yields on our new investments, higher than projected net health sales, and improving margins at Liberty National, we are raising our guidance to $5 to $5.60 per share before stock option expense, which represents a 9% to 10% increase over our 2006 earnings per share.

Those are my comments. I'll now open the call up for questions.

[OPERATOR INSTRUCTIONS]

Our first question comes from Jimmy Bhullar of JP Morgan.

Hi, thank you. I just have a couple of questions. First on Part D, I think, Mark you mentioned that your actual underwriting margins have been closer to 15%, you had assumed about 9% in the first half results. What are you assuming for the revised guidance? Are you assuming that underwriting margins will be at the level you have seen in the first half, or is [there] assumption a little bit conservative so that there might be some room for upside?

Well, again Jimmy, that we were given a range, and there is still some uncertainty where our loss ratio will end up on the Part D. Right now our best estimate is that our actual loss ratio will end up somewhere in the low 70's. But the thing you have to keep in mind -- that anything down to 74% loss ratio, we basically get to keep the additional margin. Anything less than 74%, we have to refund most of that back to CMS or Medicare. So the difference between a 70% and a 74% actual loss ratio really is going to affect our margin very little. It would actually affected less than a point. So we are expecting -- right now our best estimate is we are going to come in somewhere around that 74% loss ratio.

Okay. And then on -- just on the Liberty National, your agent count was down I think about 88 agents. What's in those numbers? How many people left, and what was the actual growth? And or, what was the actually hiring activity, could you give us a better breakdown of that?

Well, I can give you a little better breakdown. We -- I don't -- we were losing agents basically throughout the first five months -- four months of the year, because we made the announcement of the changes back in January. So we didn't see -- we lost I think we terminated roughly 100 agents right around May 1st for low production. We reached our low point really about the first week of June. We got down as low as looks like 1546 agents. So we started to see that turnaround already, and we expect to see growth going forward. The new agent recruiting in May and June, I was very encouraged with.

Okay. And finally, as you had spoken in the past about restructuring American Income or you're adding agents to existing territories. Where do you stand in terms of that? Are you doing more of that or that on hold? If you could just speak a little bit about it?

Now we are continuing that again I think it's going take some time to get that done nationally. But we are continuing to expand that.

Are you halfway through the territories -- ?

No, we are not anywhere close to that, Jimmy. Right now, we've really just done it in three major metropolitan areas, which we expect to do three or four more here the balance of the year. So-- but we are getting -- seeing some benefit from it, because we're doing it in places where we are not seeing the growth that we feel like we need.

Okay. Thank you.

Our next question comes from David Lewis of SunTrust Robinson Humphrey.

Good morning. Thank you. Mark, A couple questions also on the Part D. You did 5 million of underwriting profit. If you end up with a 74% loss ratio, will you make the full adjustment in the third quarter, [or you] spread it out between the third and fourth? And with the administrative cost reduction, where do you think the underwriting margin would ultimately come in from the second half?

Well, again, the underwriting margin -- if we end up at a 74% loss ratio, we will have a full-year underwriting margin of about 15%. We wouldn't -- there are still some the significant uncertainties there. If you look at the information we put out on our website, we -- our actual loss ratio for the first quarter was 103%, and then that declined to 88% in the second quarter.

But we're projecting that our estimates are going to decline to 66% in the third quarter and 44% in the fourth quarter. That's still a big uncertainty, whether they will decline that far. We don't believe they're going to get quite that low at this point, but we still expect to see for the full-year, really somewhere between 85% and 90% would be my best estimate of where we think our actually expected loss ratio will end up, which gets us to about that 74% loss ratio.

Okay.

So I would expect for the full year -- right now, our best estimate for the full year, we will end up with a 15% underwriting margin, but it will be spread -- most of it, you'll probably see in the fourth quarter. You'll see more in the fourth than you would in the third.

Okay. And with some of the changes Medicare is going to make on the program, as you go into 2007, [where] you can revert to your original assumptions or would you keep something closer to the 74% loss ratio, if everything held as the trend you see now?

Well, for next year, we've already done our pricing. We have had to file that with CMS, and we have assumed better experience for next year. So we are still -- we price this product at an estimated 76% loss ratio at the beginning of the year, and that's basically where we are pricing for the next year. We'll use the same target loss ratio.

And that target loss ratio would give you an underwriting margin of what, 13%?

That would be correct. If we end up with a 76% loss ratio next year, it should give us about a 13% underwriting margin.

Okay. Great. Thanks, very much.

Our next question comes from Yaron Shashoua of Fox-Pitt, Kelton.

Good morning. Thank you. Just a couple of quick questions. The first one is Part D, I just kind of went over a couple of the loss ratio numbers, going into the first, second, third and fourth quarter. Can you -- could you please explain the pattern of these loss ratios in Part D, please?

Well, again, a lot of it has to do with the benefit design that -- basically, people have first dollar coverage up to $2,250 of claims. And then, basically, until they hit $3,600 of out-of-pocket, they have no coverage. That's what referred to as a doughnut hole. So we fully expected -- in fact, in the first quarter, we expected to see 137% loss ratio, and we only saw 103%.

So what's happening is people are not -- the playing to experience was better, but they are not hitting that doughnut hole as fast. So well, a loss ratio is coming down, it's not coming down as quickly as what our initial projections were. So if you look -- again, our actual-to-expected claims were 75% in the first quarter. They were 89% in the second quarter.

So we continue to expect those claims to -- the loss ratio to come down the balance of the year. And we have looked at the detail of our claims and tried to make some projections of when people are going to hit that doughnut hole. So our best estimate right now, again, is that our total loss ratio for the year will be somewhere in the low 70s.

Okay. The second question is on the health side for the UA Branch. Over the past four quarters, this distribution channel had shown strong year-over-year sales growth. Just wondering what is the primary driver for this growth, and also do expect it to continue into the second half '06 and '07? And can you please actually describe a particular product that's driving this growth? I believe it's a limited benefit product. I just want to know if you can just kind of go over in detail?

Well, we'd be happy to. If you'd like to, we can send you product brochures, which give you the specifics of the product. It is a limited benefit product, but it's a combination of things that are driving the branch office sales growth. One, we are opening up new offices. We expect to open roughly 20% additional offices this year versus last year.

Our new agent recruiting is very strong, but a lot of it is driven by the product that we introduced early part of last year that has -- it is a limited benefit product, but it has pretty broad benefits. I believe you can get up to $4,000 a day, while you're hospital confined. And it has a number of benefits within there. They all have internal limits, and we are comfortable with the product. But there is a strong demand for it right now. But we'd be happy to send you product brochure, if you'd like.

And you expect that demand to continue into '06 and '07 -- end of '06 into '07?

It's going to be difficult to continue 91% growth, but we do fully expect to see strong growth for the foreseeable future in that distribution system.

Great. Thank you, very much.

Our next question comes from Bob Glasspiegel of Langen McAlenney.

Good morning. Just one question on Med D, and one question on sales. You haven't changed your 9% margin assumption year-to-date, but implicit in your [share of] earnings guidance was a little bump, or sort of -- I assume a better second half margins, starting to bleed in. But it sounds like you're not assuming all the way up to 15, so we're somewhere between 9 and 15 for the year. Is that a fair characterization of what you're trying to tell us?

We're pretty confident it's going to be something above the 9. Yes. It could be as high as 15. And again, that's why we have given a range in our guidance. The big question mark we have is the Part D ultimate loss ratio. So that is why we've given a $0.06 range. It could still fluctuate considerably. We're pretty confident we are going to have more than 9% margin for the full year. And again, right now, our best estimate is that it's going to be somewhere around right around that 15%.

So at 15%, it would be adding like $0.15 to $0.20 a share, incrementally the share, correct, on that premium that you gave us?

Well -- okay.

Just taking the most optimistic, -- read of -- if everything goes -- ?

Well, as we end up, we should end up with some around 210 million of revenue. If we have a 15% underwriting margin -- that is $31.5 million. So that -- again, that's before administrative expenses.

Before administrative expense.

So that would be roughly $20 million after-tax. So, yes, that's a significant contribution to earnings per share. And most of that, we will see in the second half of the year.

Okay. And just trying to read body language, we've gone from hoping that fixes at Liberty National and American Income on sales activity, that would work to actually giving a [shot clock] for when you think their going to work. Is that a fair statement that you are a little bit more confident that these fixes are going to pay off [inaudible] a quarter ago?

I think that's true. American Income in particular -- the last eight months of last year we saw a decline in our agent count of American Income. So unfortunately, the first quarter really the first four months of this year, we were just catching up to where we were a year ago. I think at the end of April, our agent count was up 3%.

At the end of May it was 5%, and by the end of June it was up 8% from a year ago numbers. And if I look at the new business just coming in the door at American income, June numbers were very -- they were a 10% increase over June of last year. So I feel good about where American Income is at. Liberty National -- and I think there was some concern that as major changes we made, that we might see it implode, which didn't happen.

We did see some turnover, which we fully expected. But I'm very encouraged by the recruiting numbers there. That they are actually very strong right now, and we are starting to see the agent count, it hit the flow in the first of June and we're starting to see some growth there. So, I feel much better about where Liberty National is at, then I did a quarter ago.

So mission accomplished at American Income, but not quite there [at] Liberty?

I think it's going to take a little more time at Liberty, just -- because we did turnover so many of our managers.

Right.

Although, most of those people have now been replaced, it takes some time to get those people up to speak. So, I'm still not going to project any significant growth at Liberty National and sales for the balance of this year. I think that's hopefully little on the conservative side, but I think we're in good shape for '07.

Thank you, very much.

[OPERATOR INSTRUCTIONS]

Our next question comes from Joan Zief with Goldman Sachs.

Thank you. Good morning.

Good morning.

You mentioned under -- for your direct response that you thought the response rate was under pressure, because of discretionary income being pressured by higher energy prices, higher gas prices. And I guess my question is, considering you actually target this middle-to-lower-middle income economic strata for many of your products, would you expect that if gas prices and oil prices and inflation continued to be an issue, that your sales across more than just one distribution channel could be affected?

I don't really look for it to affect our agent sales. We're going to a little higher demographic there than what we probably are in a direct response. And I don't want to be overly negative on a direct response. We do have some good things going there. Our direct mail juvenile sales are up 19% year to date. Although, we -- based upon assumptions we made earlier in the year and some of the models we did, we expected it closer to 30% growth in the quarter. So that number is very good, although it's not as good as what we actually expected.

Our sales to parents are down 5% year to date, which isn't too surprising, because that's -- our juvenile sales, last year we're down, and sales to parents will follow what happens to your juvenile sales. So we know that number will improve over the next 12 months. So it's not doom and gloom, its just -- we had a disappointing response rate in the second quarter. So we're just being a little less optimistic then we were three months ago.

All right. My next question is, on the premiums for Medicare Part D. Given all of the issues that you talked about, [so] changing pricing going forward, but then the potential for you new policy's being sold next year, what type of sales and premium growth are you thinking about for 2007?

Well, that's a big question, and that -- there is only a six week open enrollment period at the end of this year from November 15th to the through January 1st versus we had a six months open enrollment last year. Again, I think roughly the number I saw was 39 million of the 44 million people have enrolled in the plan. We don't know how many of those peoples will switch, during either to us or away from us in that six week open enrollment period.

I don't believe we're going to see, we're going to lose a significant number of people, but we really don't know how many people we're going to enroll during our open enrollment. The other thing it's a big question mark is, although we only had 14,000, roughly -- or maybe it was down to 12 of the [auto assigns] the low income, people we don't have any idea how many of those we will be assigned next year.

We did filed a second product at a lower premium rate with lesser benefits, to hopefully pickup a few more of those people, but we just have no idea at this point how many of those we might receive. So I can't really give you much guidance for 2007 yet, but the thing about this year that we'll know on January 1 versus May 15th how many enrollees we will have for next year.

This is Rosemary Montgomery. I would like to add that we should have some better information on the auto assigned in September, since that's one we will find our. I think CMS will release the average nationwide prices then for all the other plans, so I think we'll have better information then on the auto assigns.

Okay.

But then, my other question does relate to your guidance. You talked about a lot of things that were working better than your previous guidance had assumed. You talked about the Medicare Part D, which could be as much as what ever it is, as much as $0.08 incrementally. You also gave us the cost saves at Liberty National that I suspect part of this cost saves must have been better than you thought.

You talked about investment income, you talked about health sales, and I guess just try to sort of understand, what is the critical drivers of all of these variables, what provides the really the biggest swing, which could provide potentially even more upside than your guidance implies, and what could be disappointing to bring you down to the low end of the guidance?

Again, I think the single biggest variable there is the ultimate loss ratio on Part D. So we don't have a lot of upside there. I mean if it's anything below 74, we have to get most of that back. So I mean if it ended up at 69, we still figured instead of the 74% loss ratio we'd have a 73.1% loss ratio.

So you're basically saying that a lot of the -- the better earnings, assuming that you do not end up with an 80% loss ratio, then what you are basically saying is a lot of the positive of the upside to the guidance are technically they tend to results, and there is not a lot of risks.

Again the biggest -- there is not a lot of risk. We think that the improvements in margins of Liberty National are roughly 2.5 cents, and we don't see a lot of risk there. The only real question mark, the reason why we still have that big of a range is the Part D ultimate loss ratio. And that is still a significant question mark. Could it be 76? It could. I mean there was a possibility that it could end up at 76 and not 74.

Okay.

I think the big unknown with that loss ratio, also is the fact that the people that enrolled so close to May 15, were very, very healthy people, at least that's what we're seeing so far. So instead of seeing the latter enrollees increase our cost, which was what we actually expected it's actually going the other way. But that experience is -- you know there is not much there. We've got one to two months that we are dealing with. I think that's really one of the biggest unknowns that we have.

Thanks. Thank you, so much.

And our next question comes from Steven Schwartz of Raymond James & Associates.

Hi. Just a follow-up a lot of the questions were asked, but a question actually for Rosemary. Rosemary, it's my understanding see if I get this right, that was on as a lot of the people in May who came in before the end of the enrollment period were healthier. So in effect, it's a timing type of deal going on here to some extent, that there are not using the benefits as fast as you thought. They may still get to the doughnut hole, their ultimate -- the ultimate benefit ratio on those people might be the same, but the timing of the type of accounting that you're using really creates phenomenon. Is that fair?

I don't think it's really the timing of the accounting. We would have normally expected that somebody coming in April or May would have -- for the year had a very, very high loss ratio -- which would have driven our overall number up. As I said, the experience is very preliminary at this point, but we're actually seeing it go the other way, and these people are so healthy that they are just not having very many claims, yet of course, they do have a premium. So, that's really what's been helping us.

You take the June 1 effective dates, for our expected loss ratio on those people for the year was actually a 109%, because we did not think they would hit the doughnut hole soon enough to get a loss ratio below 100%. But our actual loss ratio in June -- for those June 1 release was only 73%. So they are far, far better than what we expected.

Again, that number could change a little bit because the experience is preliminary. But you know, I still think it's going to come in very favorable.

Okay. So you are thinking less of these people are going over the 12-month period, are going to be hitting the doughnut hole.

Well, really over the remainder of the year will be hitting the doughnut hole.

Right. Okay. All right. And then just kind of a [little] technical question, with the end of the enrollment period in Medicare Advantage, have you seen any changes in lapse rates and your Med Supp. block of business?

No the Med Supp. block of business is really held in quite well with the lapse experience. So, we really have not seen anything different there. No.

Okay. Great. Thanks.

[OPERATOR INSTRUCTIONS]

Our next question comes from Ed Spehar of Merrill Lynch.

Good morning, everyone.

Good morning, Ed.

A couple of questions. Mark, back to direct response, I know you were pretty optimistic about some things that you were doing there, and it sounds like you still are. But I'm wondering what was it that changed in sort of -- it seems late in the quarter in some ways that you think caused the sales to come in a little less than you would have expected?

Well, Ed, it's not so much of the sales this quarter were that much less than expected. But -- okay. Again, given a few numbers, the juvenile sales or direct mail portion of our juvenile sales, they are up 19% year-to-date, which is -- we really thought would be closer to 30%, particularly in the second quarter.

The parent sales are pretty much in line with our expectations. But the thing that -- our biggest challenge right now is a little over half of our sales come from outside our traditional direct mail solicitations. They are coming -- we get a little from TV, a little from the Internet, but roughly half of our sales are coming from what we call other insert media, which are the coupon packs or the newspaper inserts.

We were in like Chase Bank statements or AT&T billings. We do a lot of these other insert pieces. In fact, it was roughly a billion pieces a year. And it's a two-step process, where we put the insert in. The people sent us a response card. And then we send them a fulfillment package with an application. Then that's where we're seeing the biggest impact.

One, we can't be as selective there about who we are going out to. But the number of response cards we've gotten year-to-date are down 15% from a year ago. Now, the sales off of those response cards are only down 1%. We've made some significant improvements and getting more premium and more sales per response card.

But we were not expecting. We were expecting those response cards to be roughly the same as they were last year. And they have declined by 15%. We hope, and we are sure going to give priority to doing whatever we can to get those numbers up for the second half of the year. But that's the biggest single thing that's brought our expectations down.

Okay. That's helpful. And then I want to clarify something that you had said on direct response premium growth. Did you say without sales improvement that you'd have 6% to 7% premium growth in '06?

Yes.

And I mean in terms of thinking about '07, maybe a little bit less but not that much so.

I think that's fair assessment. If we continue to have flat sales, we will see a slow decline in that growth rate. But it will better then that -- the 4% we had this quarter, really is timing issue. So it would be a very slow decline. That 5 to 6% growth next year or even with flat sales would still be a reasonable estimate.

Okay. That's good, and then the final. The final question was in terms of the Med Part D, when you talk about -- it sounds like the prices that the premium rates in the product you filed as it sort of suggesting a 13% underwriting margin. How shall we think about, what the administrative expenses percentage would be?

Well our --.

Will [it be] less from this year or --?

Well, let us see. Our administrative expense for the second quarter was roughly $1.4 million. But we were still [during] the open enrollment period for part of that time. We expect our ongoing level of administrative expense to only be about $1 million a quarter.

Okay.

And [that] are directly to be attributable to Part D.

And maybe a little bit higher in the first quarter of '07, because of the --?

Probably more so the fourth quarter of this year, just because the open enrollment November 15 to January 1.

Right, okay.

So, we'll have to have additional people on the telephones, during the open enrollment period.

Okay, very good. Thank you, very much.

Our next question comes from Eric Berg of Lehman Brothers.

It's actually Eric Berg, at Lehman Brothers. Good morning to everyone.

Good morning, Eric.

So I have a few questions. First, with respect to Direct Response, I want to revisit this whole issue of fuel costs. In as much as the price of gas at the pump admittedly has had its, ups and downs, but has been significantly more expensive than it has been for a year now. Why do you think just -- are you suggesting that just now your customers are being affected by $3 a gallon gas? I mean was it not the case a year ago as well?

Well, again Eric, I hate to give subjective reasons there. We have nothing concrete, we really don't have anything concrete to know why those response rates were down in the second quarter. We like to think that our target market, there's roughly the same target that Wal-Mart is trying to reach.

Other people in the Direct Response industry are talking about that affecting their sales. We don't have anything concrete there to really we know. We do know that we saw a decline in our response rates during the quarter, and at this point, we are not sure when they will come back up. So I can't -- it's really a very subjective thing as to why they are down.

Okay. Let me move on. I want to revisit your comments about American Income. I'm certainly am aware, from your news release and your comments that the agent count is up both sequentially and year-over-year. I think the percentage year-over-year gain is quite healthy 8, 10% whatever the precise number was. But in the end, the sales are not really going anywhere. There are flat.

Can you revisit for us or elaborate on, if you have many more agents than you used to, but they are producing -- but the numbers are just not coming in the way I think we'd all like to see in terms of sales growth, what's the basis for your positiveness?

Okay. Well again, when you say that their not -- their flat with a year ago. But again, the last eight months of last year, we saw an agent decline. In fact we saw an 8% decline in our agent count the last eight months of last year. So the second quarter last year was our peak sales quarter, because it was our peak agent count. And what happened the first quarter of this year, the growth that we had was just getting this back to even with last year.

Again, at the end of April, our agent count at Americana Income was only up 3% from a year ago. Now we're up 8% from a year ago. And again if I look at just the June sales, the business coming into the door is not net issued number that we've reported, but the new sales are coming up. We did see 10% growth in our June sales at American Income.

So I'm optimistic that -- and the sales, if you look at our second quarter sales versus our first quarter sales, they were up. The think that we saw declined in the second -- in the third and fourth quarter. Last year I do not expect -- I expect to see those sales continue to move upward in the second half of this year, where they decline in the second half of last year.

Essentially, you're saying it's a comparison issue that sales last year?

And again it was we saw a decline in our agent count in the second half of last year. And we saw decline in our sales in the second half of last year, which we think we've reversed. And I do not expect -- I expect to see continued growth in the agent count in the second half of this year, and continued growth in sales.

If I can move on to Liberty. You talked -- one of the reasons I think you said that you're increasing your guidance for your EPS is -- relates to margins at Liberty. But it looks to me from the fiscal supplement, from your supplementary material that margins in the June quarter both on the life and health side were flat. They were clearly up year-over-year, pardon me, year-to-date, year-over-year, but they were flat in the quarter. What is happening with margins if they were -- are margins really improving if they were flat in the quarter?

Well, again the changes we're not implemented until May 1st. And they had very little impact on the second quarter numbers. For example, we're eliminating all management salaries, the middle managers, as well as the district manager salaries at Liberty National. But there are coming down over time.

The sales manager, the middle managers' salaries are going down to $20 a week until they are gone. The district managers' salaries are going down $25 a week until they are gone. That's going to take six or eight months for all of those savings to be recognized. That's why we expect right now about 1 million for benefit in the third quarter and 2.3 million benefit in the fourth quarter. And actually that number will increase a little more in '07. From those numbers -- but we saw very little impact in the second quarter.

Last question relates to Part D. Am I right when I conclude that the cost you have been surprised by claims experienced to-date, but as well because you planed to book at least preliminary for '07, a loss ratio consistent with what you're now expecting for the full year, across the 74% to 75%. That you think this surprise was not an anomaly, but is going to be sort of the way things work prospectively? I hope the question was clear.

I think it is. Yes, it definitely was a surprise this year. We now have at least some experience to make better projections for next year, and as Rosemary said, the biggest surprise we had with how healthy the later enrollees were.

The May 1 and June 1 enrollees appeared to be substantially betters than the January 1 enrollees. Next year we'll have the benefit of those people for the full year instead of just seven months or eight months. So we do expect to see better experience for the full year of 2007. And we've used -- we think reasonable assumption on our pricing for next year.

Yes. I don't think it's an anomaly at all, I think it's really just been a learning process. And when we have to price for 2007, we did take into account that favorable experience that we were seeing. It was -- we didn't have a lot of months of experience at the time, but we did take that into account. So it's really hard to say at this point what 2007 will show. We'll have to look at what the full results for 2006 and compare them to our pricing. But I definitely don't see that as an anomaly at all.

Thank you.

Our next question comes from Mark Finkelstein of Cochran Caronia Waller.

Hi. Good morning. A couple of questions here. Just going back to Part D, the second product that you're introducing for 2007, just to clarify is that directed specifically at the [duals] and are you filing that in all regions?

We are filing it in all regions, and it is intended to try to pick up more of the dual eligibles. We basically did not load any acquisition expense into it, and it has the basic package of benefits. And it has a narrower formulary than what our current product has. So it is -- we have filed it specifically to try to pick up more of those. But we really have no idea whether we will or not at this point.

And did you file it with a lower margin assumption on it, or is it consistent with the other products?

You want to answer that Rosemary?

I believe it's consistent.

Okay. Just moving on, a fundamental question on the health side. Explosive growth in the limited benefit plan at the branch, yet considerably lower growth, almost flattish in the independent channel on that product. Can talk just talk a little bit about, I guess, and obviously it's a very different distributions. But just why is the growth of the independent channel on that product not picking up, and are you doing anything to try and kind of grow that product in that channel, given success of the branch?

Sure, we're trying to grow the channel. It is different. In that independent agencies we don't control, we can't. They are free to write for however many companies they choose to write for. And actually up until this quarter, we were seeing significant decline in the independent agency, because again if I go back two years ago, in that distribution system, 60% of our sales were coming out of one large general agency.

New sales had declined rapidly over the last two years. Their sales were basically flat, the second quarter versus the first quarter. So it look they have kind of hit a bottom level there. So the growth we're seeing is coming from other sources, which we've been seeing that growth for some time, it's just been offset by the decline in this one large general agency.

But the big question is why we're not seeing as bigger growth there is that we just don't control the general agency force. There is not that many independent agent out there that are in that market. And if they are, they're selling primarily major medical product that we are not willing to offer. So it's really just a difference in the basics of the distribution. We control our branch office people. Those are exclusive agents. So, we have more control over them.

Okay. And then just a, I mean, it come down lot lately. But First Command, the sequential decline in the agent in Canada. I know you're trying to work with First Command on trying to kind of restructure some comparable and there is some issue with annuity compensation --

Right.

...in effect [to you], but I guess how should we think about that distribution? Again, I think you lost 58 agents in a quarter. And is that -- is there hope there?

Well, again, it's a mutual fund compensation that declined, but there is really no new developments there. I will see the head of that distribution next weekend. I'm going to revisit with him. But right now, flat premiums is about the best we can hope for the balance of this year. And really right now, I don't see any reason to be optimistic for '07, any better than flat.

Okay. Thank you.

[OPERATOR INSTRUCTIONS]

We have a question from Tom Gallagher, Credit Suisse.

Hi. First question is just on total life insurance premium growth. If you had commented on that, I apologize I missed it. It was 3% this quarter I believe. Where do you see that going in light of your sales outlet?

Well, that's still a big question, a biggest challenge. The growth this quarter was a little light because of the direct response premiums. And again, I think that was a timing issue. But obviously, the growth for the next year is going to be impacted by what happens to our sales.

I felt good about where American Income is at. But realistically, for next year, right now, a 3% to 5% growth in life premiums next year is probably where we're going to end up. But we'll give more guidance down the road. We really haven't done a projection yet for next year. So when we put those numbers together, we'll be able to give you a better idea.

Okay. And then let's see on Part D, I know you -- there was some commentary about your -- I guess reflecting your better-than-expected experience in pricing this out for '07. Can you comment on what you actually did on pricing? I presume that means you lowered prices, and I also would presume competitors are doing the same, but can you give some commentary there?

Well, I am going to let Rosemary address, but actually Medicare is reducing their reimbursement rates for next year, so actually our prices that we are charging to the consumer will actually be up a little bit. Rosemary, do you want to comment?

Yes. I think that in terms of what we did for '07, as you say, Mark, we did increase the rates a little bit. But then, of course, CMS is going to be reimbursing us for next year. But I think that we really have fairly reflected the experience that we've been seeing to date in the pricing for next year.

And so if you combined the reduced reimbursement rates from CMS, plus your rate increase, is there a way for us to think about, I guess, kind of the net revenues that you'd be getting? Should they be going down per member or flat or --?

No, they will be going up a little bit per member.

Got it. Okay. And then just in terms of -- I don't know if there is a way to give a little better color on what's really going to drive the revenue growth here, because I presume that given that you now have a pretty sizeable base of customers, could you just probably gist on retaining them?

Can you talk a little bit about really what might drive growth here? Obviously, retention is a big issue, but are there any programs or strategies you have in place to other than that one other product that you mentioned to grow sales?

Well, it would be interesting to see again. We don't have a very big window this year six weeks. We do intend to vigorously try to enroll people during that six week period. I think that we've only signed up of our Medicare Supplement customers. We still have less than half of those people that are signed up for the Part D with us.

So that will be a big area of emphasis. And also we've learned a lot during our marketing efforts this year and actually our efforts toward the end of the open enrollment period were very successful. And we've been able to model that and we will doing some direct mail, marketing efforts during that open enrollment. We just -- it's impossible to say how many people were enrolled this point.

We obviously, won't enroll nearly as many as we did this past year, but could we see a 10% increase or more than that? We could. We just don't have a very good feel at this point. And then the other thing is the big question mark is the low income auto enrollees. We just don't - we'll know there as Rosemary said in September whether we'll see more of those for next year.

Yes. And I think that will be very interesting to see what happens with all of that. And I think that we've got a good product out there to compete with. As I said earlier, I think the profit margins are consistent, but of course we don't expect to have the acquisitions expense in that product that we would have had in the others. I think we've got a very competitive rate for that product.

Got it. Thanks.

And having no further questions, I'd like to turn the conference back over to Mr. McAndrew for any closing or final remarks.

Well, thank you for joining us this morning. Those are our comments, and we will see you again, talk to you again next quarter. Thank you.

We thank you for your participation. That does conclude today's conference and you may disconnect at this time.