Horace Mann Educators Corp (HMN) 2002 Q4 法說會逐字稿

Good morning, ladies and gentlemen, welcome to the Horace Mann Educators Corporation fourth quarter conference call. At this time all participants have been placed in a listen-only mode and the floor will be open for questions and comments following the presentation.

It is now my pleasure to turn the floor over to your house Mr. Dwayne Hollman. You may begin.

Good morning. Welcome to Horace Mann's fourth quarter earnings conference call. After market close we released our year-end earnings as well as financial statements as well as supplemental business segment. If you need a copy of the release it's available on our web site www.horacemann.com.

We'll cover our results for the fourth quarter and the year in our prepared remarks. The following senior management members will make presentations today and as usual it will be available for questions later in the conference call. Lou Lower, President and Chief Executive Officer. Pete Heckman, Executive Vice President, Chief Financial Officer. Doug Reynolds, Executive Vice President, Property and Casualty, George Zock, Executive Vice President, Service and Technology Operations and Financial Services. And Dan Jensen, Executive Vice President and Chief Marketing Officer.

The following discussion may contain forward-looking statements within the meaning of the United States securities laws our actual results may differ materially from those projected in the forward-looking statements. These statements are made based upon manage's current expectations and beliefs as of the date of this conference call. For a discussion of the risks that could affect actual results, please refer to the company's filings with the Securities and Exchange Commission and in the earnings press release issued yesterday. We undertake no obligation to publicly update or revise such forward-looking statements to reflect actual results or changes in the assumptions or other factors that could affect these statements.

As a reminder, this call is being recorded and is available live on our web site. An Internet replay will be available on our web site until March 7th, 2003.

Now I'll turn the call over to Lou Lower, who will share his views on the year, quarter outlook for '03.

Good morning and thanks for participating in our call. You just heard from Dwayne Hollman who just recently joined us as senior vice president reporting to Pete Heckman. His responsibilities at the company will include investor relations, investment management. Treasury, financial planning and analysis and corporate risk management. For those of you who may not have met him before, Dwayne comes to us from acceptance insurance companies in Omaha Nebraska where he was CFO for financial responsibilities for treasury reporting investor relations and property casualty operations. Prior to that he was VP finance and treasurer at high lands insurance group in Houston Texas. And before that served as an auditor AKPMG. We welcome him to this call and I know he's looking forward to working with all of you.

As you have seen in our earnings release we just reported net income of 33 cents and operating income of 30 cents for our fourth quarter. And on an operating basis, that brings the full year to $1.18, which in line with our guidance and a little better than consensus.

Dan, Doug and George are going to fill you in on the details of our marketing and business unit performance, but as a group we continue to feel very good about the progress that we've made. We're seeing our strategies and tactics gaining greater momentum and that's beginning to show up in reported financial results as well as impacting leading indicators of future performance in a very positive way.

We've told new the past that we were turning the corner on agents growth. The 922 we ended the year with represents the most significant annual agents growth the company has had in eight years.

We also told you our primary emphasis was on the quality of our agency force, not the absolute numbers.

And indeed our new recruiting selection standards coupled with enhanced training and education continue to drive-in creases in agents productivity. Just rolling the clock back a little bit. If you consider that we started the year 2000 with a little over 11 hundred agents who produced 185 million in total new annualized sales, in 2002 we began the year with 867 agents. That's 238 less. But they delivered 231 million in total new annualized sales, a 25 percent increase.

As you'll hear from Dan we fully expect to continue both trends, growth in agents and growth in productivity as we move forward.

Premiums written in contract deposits in our core lines were up nine percent for the quarter, excluding mass auto, thanks primarily to new annuity sales and property and casualty rate increases and that nine percent compares to about five percent in the first half and seven percent in the third quarter, for some healthy sequential improvement in revenues.

The pricing and underwriting activities that we've described to you in the past resulted in a 16 point improvement for the year in our property loss ratio, and while the reported improvement for voluntary auto loss ratio was less than that at two points for the year, current accident year results continue to be encouraging as you'll hear Doug describe.

Somewhat offsetting those favorable comparisons our annuity line has experienced both spread compression and fee reduction in our fixed and variable products respectively as a result of the difficult credit and stock market environments. On the other hand, the combination of our career agency force and our emerging independent agent distribution has delivered the company's best annuity year ever with a 12 percent increase in sales, coupled with continued improvements in persistency.

Our life business was comparable in operating earnings to 2001. But off from a sales perspective which we will be addressing over the course of this year through new products, enhanced range and improved service.

As Pete is going to cover with you in some detail we completed the actions we deemed appropriate to maintain our balance sheet integrity, including meeting our commitments to the rating agencies. And as you'll recall, the second and third quarters were a rough time in the credit markets in general. And for Horace Mann in particular. Stress from fixed income holdings resulted in an after tax net loss of 32 million for the year, a directive to equity putting pressure on both our debt to capital ratio and our statutory leverage and RBC ratios. The actions we've taken have returned us to where we feel comfortable and have some breathing room as well.

While combined impact of those transactions is going to cost us approximately nine cents per share in 2003, they give us a solid foundation on which to continue to accelerate delivery of the Horace Mann value proposition.

Looking forward to 2003, we will continue to build out our distribution network focusing again foremost on quality.

There is still leverage for us in improved property and casualty underwriting margins, which should be a key driver of earnings growth over the course of the next two years, although normal level of catastrophe losses would obviously moderate that improvement somewhat.

We continue to see a generally favorable pricing environment for personal lines. And while there may be or will be selected regulatory challenges along the way, we are not in the gloom and doom camp. We'd also offer that prices but one of the levers we have to improve margin in this business although some of those other levers do take to longer to flow through. You're improvement is driven by external environment. We're not immune to geo political risks and its potential impact on both the equity and credit markets. How much future financial market volatility is already reflected in today's pricing levels is anyone's guess. But we do know with certainty, however, that lower interest rates, coupled with the credit losses we experienced in 2002, are going to have a full year impact in 2003. And that will produce a drag on investment income and create further spread compression in our life and annuity lines as George will discuss.

Having said all of that, our initial guidance for the year is an EPS range of $1.25 to $1.35 reflecting the elements of uncertainty we see in the environment and the nine cent impact per share of the capital transactions that we completed in the fourth quarter of '02. It also takes into account the significant changes we've embarked upon in our claims organization and the difficulty of forecasting with precision the timing of the emergence of all the benefits that we're pursuing. As and when those uncertainties abate, and as we book quarterly operating results through the course of the year, we will update our guidance as appropriate.

Now I'll turn it over to Pete for some additional commentary. .

Thanks, I character Horace Mann's fourth quarter as a relatively good one. Generally reflecting a continuation of the trends we saw in the third quarter.

In terms of the investment portfolio, after realizing 27 million and nine million dollars of after tax losses this year in the second and third quarters respectively, we realized a net gain of 1.6 million dollars after tax in the fourth quarter.

Impairment charges were 1.9 million dollars after tax. About half of which reflected additional charges on telecom securities that had been previously impaired.

Those charges were more than offset by net gains from portfolio sales transactions.

The credit environment seems to have at least stabilized somewhat. Unrealized gains in the portfolio grew by about 20 million dollars pretax in the fourth quarter, while we continued to make progress in reducing our issuer and (inaudible) concentrations towards our revised guidelines. In contrast to those positive balance sheet trends, investment income remains under pressure as a result of declining interest rates and the default and other credit issues that we experienced in the last half of 2002.

We also continued to experience favorable property and casualty loss trends for the current accident year in the fourth quarter. However, as was the case in the third quarter, we experienced further adverse development of prior years' reserves, totalling an additional $10 million after tax in the current quarter.

This development was primarily related to the auto lines in the 2000, and 2001 accident years.

For the full year of 2002, prior year reserve strengthening was 15 million dollars after tax and represented about four and a half points on the P and C combined ratio.

Ernst & Young performed an independent analysis of Horace Mann's P and C reserves as of 12/31/02 and concluded that the company's held reserves were slightly in excess of their select estimate. This degree of conservatism was consistent with their independent assessment at both June 30th, 2002 and December 31, 2001.

Expense trends continue to be consistent with what we've seen throughout the year. Of the seven and a half million dollar annual increase in GAAP operating expenses in 2002, 7.3 million was related to increased pension and employee incentive compensation expense.

These two items also accounted for about half of the 2.8 point year-to-date increase in the property casualty statutory expense ratio.

The third quarter 2.7 million after tax claims restructuring expense drove eight tenths of the increase in the ratio, with agents compensation in the North Carolina auto rate dispute escrow also contributing to the higher result.

During last quarter's call, I updated you on the actions we had been taking to reduce our financial leverage. At the end of 2001 and the first quarter of 2002, our debt to capital ratio, excluding unrealized gains, was in the 25 to 26 percent range.

At the end of June, 2002, following our convertible notes issuance and exacerbated by the investment losses we had incurred in the second quarter, that ratio rose to 33.5 percent. In the third and fourth quarters, we completed a series of debt repurchase transactions, culminating with the previously announced repurchase of 27 million dollars carrying value of our convertible notes in exchange for 1.8 million shares of Horace Mann stock on December 10th. As a result our December 31st, 2002 debt to capital ratio was reduced to 24.4 percent. Comfortably below our target level and consistent with our rating agency commitments.

A second capital transaction which was also announced on December 10th was concentrated in the fourth quarter was a financial reinsurance transaction between Horace Mann Life Insurance Company and Sun Life Reinsurance Company. As a result of this transaction, the statutory surplus of Horace Mann Life was increased by approximately 32 million dollars.

Thereby reducing the operating leverage and correspondingly increasing the risk-based capital ratio of that entity to levels consistent with our historical target ranges and with rating agency expectations.

I'm pleased to say we've returned our leverage and capital ratios and overall balance sheet to a position as strong or stronger than what we have had in the last few years.

The cost of these transactions to Horace Mann translates to approximately nine cents in terms of 2003 per share operating earnings. About six cents resulting from the dilution caused by the additional shares outstanding, and three cents reflecting the fees and the associated lost investment income of the reinsurance transaction.

Which leads me to the subject of our operating earnings guidance for 2003.

As Lou mentioned our initial projection calls for a range of $1.25 to $1.35 per share. In property casualty I would peg the normalized 2002 combined ratio at just under 100, with the adverse impact of prior year reserve development being offset by favorable catastrophe and noncatastrophe weather we experienced in the year. In 2003 we're looking for a two to four point improvement from that level. We anticipate investment income generally and annuity and life segment results as a whole to partially offset the expanded P and C margin improvement. Pressure on investment income will continue through all segments in 2003 as we experience a full year's impact from the adverse credit environment that was only felt for half of 2002.

We anticipate continued annuity margin compression in '03 as a result of the lower interest rates and market valuation pressures, while on the life segment, in addition to investment income pressures, we're looking for mortality to be a little less favorable than we experienced in 2002.

Looking at 2003 from more of a high level view, if we were to adjust the 2002 operating EPS of $1.18 for the impact of the capital transactions we completed in the fourth quarter, that would yield a result of approximately $1.10.

Using the $1.30 mid point of '03 guidance range, that will translate into an adjusted 18 percent annual increase.

This is above the 12 to 15 percent annual earnings growth we've been targeting over the long-term but feel it's warranted in light of the favorable trends we're seeing in the P and C business.

To reiterate what Lou said, there are considerable unknowns in the external environment these days. As we move through the year, 2003, and get a better feel for how the assumptions underlying our projections are playing out, we will update our guidance and potentially tighten the range as appropriate.

Now let me turn it over to Doug Reynolds who will provide you with more details on our property casualty results.

Thanks, Pete. In the fourth quarter we continued to see improvements in the underlying quality of our book of business. Even with some tough weather in our key states we were able to achieve good results on both auto and property. Catastrophe losses to impact comparisons in the third quarter by 3.6 million and year-to-date basis .five million both after tax but still better than expectations for the year.

Total property casualty loss and lost adjustment expense results for the fourth quarter after adjusting for catastrophes and prior year strengthening was about 13 points better than 2001 and eight points lower on a year-to-date basis. As in prior quarters we continue to be impacted by a higher expense ratio and loss adjustment expense.

Total combined ratio impact for these two areas was 1.3 points for the quarter, almost four points year-to-date. As Pete indicated, our total reserve position alliance with our external actuarial consulting firm of BMY inclusive of prior year strengthening. The overall quality of our book of business continues to reflect improvements as a result of the many changes that have been implemented throughout the year.

One of the key drivers of future results is our claims restructure. During the fourth quarter, we continued to move towards a fully redesigned claims organization. We have successfully consolidated our claims offices from 16 branch locations to six regional claims offices. All six offices have relocated to new office space installed new phone systems and are close to being fully staffed.

And we're still on target for implementation of our new claims system in the second quarter of 2003.

Our voluntary automobile business has continued to reflect solid results based on the underwriting changes, pricing

segmentation, rate actions, proper pursuit mechanisms, claims focus and needs-based selling techniques. The fourth quarter loss and loss adjustment expense ratio after adjusting for catastrophes in prior year reserve changes was six points lower than prior year and over three points lower on a year-to-date basis.

In the fourth quarter, we have received approved rate increases in excess of seven percent.

Our average earned premium can, excluding Massachusetts, grew at six percent for the year and slightly above that for the quarter. The overall pure premium improved by approximately seven and a half percent and six percent for the fourth quarter and year-to-date respectively.

The key new business quality measurements also reflect ongoing improvement. Our best experience tiers continue to improve in the fourth quarter and in these tiers the year we increase our percentage of new business by almost 30 percent.

Our property business has sustained the improvements that were beginning to show in prior quarters. In 2002, the combined ratio was improved by about 15 points over 2001.

After adjusting for catastrophe and prior year reserve adjustments our year over year improvement for loss and loss adjustment ratio was 18 points and 29 points for the fourth quarter.

The positive trends shown in the first three-quarters continued as we realized the benefits of reinspections revised 81 writing guidelines, product enhancements, pricing segmentation and improved rate increases. For the quarter our improved rate increases exceeded 20 percent. As a result of all of these activities, our average written premium grew 14 percent for 2002 and 17 percent in the fourth quarter.

On the loss side, our unadjusted pure premium improved approximately 10 percent for the year and was up about one percent in the fourth quarter.

The expense and loss adjustment expense, although having a smaller impact in the first quarter versus year-to-date, are continuing to put pressure on the combined ratio P

As we implement and leverage changes in our claims area. We will see the loss adjustment expense ratio improve.

We anticipate the expense ratio overall will improve in 2003, however, we will still incur expense pressure due to the North Carolina rate dispute and increase in our agent compensation and continued investments in the business such as reinspection programs.

Our overall rate of growth and expenses is targeted to be less than the expected revenue growth.

In 2003, as I indicated in our last call, we expect to achieve profitable combined ratios for both auto and property. Nod to achieve a totaled combined ratio on the 96 to 98 range of 2003, we will continue to drive claims improvements, expense controls, product enhancements and rate changes.

And although, to a lesser degree than the annuity and life side of the house, our total earnings in 2003 also will be impacted by declines in investment income.

A wild card in all of this will be the achievement of rate changes. Although we believe the environment will become more difficult as we move through 2003, we still expect to be able to achieve our targets.

And now I'd like to turn the call over to George Zock.

Thanks. First few comments on life cycle. Improvements were better than the first quarters of 2002 due to better mortality. We experienced slightly better mortality also compared to the fourth quarter of 2001. Current quarter pretax earnings were below the fourth quarter of last year. Due to an unfavorable DAC unlocking adjustment of 500,000 pretax, 300,000 after tax, resulting from net realized investment gains in the quarter.

Year-to-date pretax results reflect a favorable DAC unlocking adjustment of 500,000, again 300,000 after tax. Resulting from net realized investment losses for the year.

Now on to the annuity segment.

My annuity comments today will focus on annuity earnings in the fourth quarter and year-to-date, a high level look at 2003 for the life and annuity segments, and then I'll provide some additional information on the guaranteed minimum death benefit reserve and deferred acquisition costs and value of business enforce amortization.

First annuity earnings. Current quarter pretax earnings of 6.7 million dollars compares to 8.6 million in the fourth quarter of 2001.

Compared to the fourth quarter of 2001, the fixed margin is

down 1.3 million. Variable fees and other contract charges are down 200,000.

Expenses, including the amortization of intangibles, are up 1.1 million, 200,000 of which is due to unlocking of DAC itself. Improved mortality and the reduction in liability were contracts on pay outs total 700,000 favorable in the quarter.

Year-to-date annuity pretax operating earnings of 23.2 million compares to 30.7 for 2001.

The decline is due to an increase in expense of 4.3 million, including amortization of intangibles. Also mortality losses in 2002 of 800,000, compared to mortality gains of 2001 of 900,000.

That's an unfavorable variance of 1.7 million between years and declines in the interest margin of 500,000 and a decline in variable fees and contract charges of one million dollars. Included in the expense increase is a reduction in favorable unlocking in 2002 of 800,000.

As we look forward for the annuity and life business segments, we'll experience a full year's impact of the 2002 financial market difficulties on investment income, as well as variable fees and fixed interest margin.

That, combined with the continued low interest rate environment, and less favorable mortality experience in the life lines, will result in a decline in pretax earnings in both segments in 2003 versus 2002.

Now some additional information on the deferred acquisition costs and value of business enforce amortization and the guaranteed minimum death benefit reserve.

First DAC and SIP. We (inaudible) revert to go the mean approach with a maximum rate of 12 percent.

Our current DAC and BIS balances for the annuity line represent four percent of account values. While an actuarial rule of thumb will not work under all market conditions I want to give you an idea of the idea of the sensitivity to market decline there's a lot of parts to the DAC and (inaudible) including funds performance persistencies business realized gains and losses but generally if all other assumptions are met a one percent deviation from the targeted market performance would impact pretax earnings approximately 150,000 dollars. Moving on to the minimum guaranteed death benefit reserve. The total GAAP reserve for guaranteed minimum death benefits at the end of 2002 was 800,000 dollars.

That's down 200,000 from the third quarter 2002 due to market performance in the fourth quarter.

The comparable statutory reserve is now at 1.6 million.

The company has a relatively low exposure to guaranteed minimum death benefits, as 24 percent of contract values have no guarantee.

71 percent of contract values have only return of premium guarantee. And the remaining five percent of contract values have a guarantee of premium at an annual interest rate of between three to five percent.

The aggregate in the money death benefit under the guaranteed death benefit provision totaled 115 million at the end of December. Again, to give you an idea of the sensitivity to market decline, a rough rule of thumb for the impact on the guaranteed minimum death benefit reserve is that for each one point of negative performance, the guaranteed minimum death benefit reserve will increase approximately $60,000 pretax.

Now Dan Jensen our chief marketing officer.

As we ramp up 2002, it's truly been a unique year full of challenges and opportunities. I'd like to start by taking a moment to outline the key drivers for growing our top line. It starts with a number and quality of recruits on the cast of agent side. We had 84 recruits for the quarter and 293 for the year compared to 73 and 247 from the year prior. An increase of 15 percent and 19 percent for the quarter and year.

Next, the recruits need to stay with you. First year agent retention ended the year at 90.4 percent up above one and a half percent from 2001.

In addition to bringing on and retaining new agents, it's important that we retain and grow the productivity of existing agents. Overall, agent retention ended the year at 80 percent, up eight points from 2001.

Contributing to that increase in retention were gains in productivity with overall agent productivity up from 253 thousand in 2001 to 269,000 in 2002, an increase of seven percent. This increase came despite the proportion of agents who were on their first two years with us growing from 36 percent at the end of 2001 to 42 percent at the end of 2002. These new agents have much more productivity than do experienced agents. Productivity of agents with five or more years grew from 297 thousand in 2001 to 348,000 in 2002 or a 17 percent interest. The total number of agents grew from 867 to 922 a gain of six percent. As Lou mentioned this is the largest gain in eight years ago. The difference is that these gains are coming with increased productivity. Another factor on growing the top line is the emerges ofg distribution. With more than $10 million in production in 2002 and high expectations for 2003, I said agent influence on the top line will continue to grow. We ended 2002 with 167 independent agent and 23 broker dealers under contract. Putting together increased number of recruits, agent retention, agent productivity and independent agent total sales increased from 226 million in 2001 to 247 million in 2002. This increase came despite a decrease of 25 agents in the average number of agents in 2002 as compared to 2001. As you recall 2001 went from 978 down to 867 agents and 2002 we've gone from 667 agents up from 922 agents. Due to top line comparison fourth quarter sales were up one percent while model sales for the year were up 13 percent. Sales for the quarter and year were down two percent and eight percent respectively. Annuity sales were 40 million for the quarter and 140 million for the year an increase of 17 percent and 12 percent compared to a year earlier. Both of these results are all time records for Horace Mann.

For the quarter and year, life sales decreased just over 15 percent compared to 2001, with renewed emphasis on life and new products scheduled to be released for the field I would expect these numbers to improve in 2003.

As well as increasing sales in agents we made significant progress in increasing quality numbers. The percent of our households that are educators increased three points in 2002. And looking at new business, the percentage of educators running more than ten points higher than the overall book of business. Another block of business that has significantly better than average retention is the auto business that customers pay via electronic funds transfer or EFT. The percent of auto business that is paid by EFT has increased from 15 percent to 20 percent in 2002.

Last but definitely not least was our high priority (inaudible) initiative. As you may recall we're expanding into counties with large educators and minimal Horace Mann presence. In 2002 we added 22 counties to the initial 14 counties from 2001. Our plan this year was to hire 75 agents in these counties and we ended the year with 109 agent hires. Not only did we significantly surpass expectation but these agents have shown significantly higher retention rate than do new agent population as a whole. Now I'll turn it back over to Dwayne.

We appreciate your attention this morning and that concludes our prepared remarks.

We can please move to the Q&A session.

The floor is now open for questions. If you do have a question, please press the numbers 1 followed by 4 on your touchtone telephone. To get out of line just dial the pound sign. We do ask that while you pose your question you pick up the handset to provide optimum sound quality. Once again, ladies and gentlemen, that's 1 followed by 4. Please hold while we poll for questions.

Thank you. Our first question is coming from Steven Peterson from Cochran Caronia securities

A couple quick questions. First one is for Dan. You mentioned that you had about ten million in production from your independent and broker dealer channel. I'm wondering if you might, if I might be able to pin you down a little bit in terms of what you're expecting for next year. Would you like to see that doubled? Should we expect it to triple? I mean do you have a sense yet of kind of the strength of growth there that we might see in 2003?

That's a tough question to get pinned down to. We do have kind of a feel there's strong growth. I hate to actually give a number. But it's not going to be the kind of growth that we're looking for on the captive agent side at all. We're looking for significantly increase in magnitude of growth.

Next general question concerns the P and C reserve strengthening. We've kind of gone -- we spent the year, did a little bit in the beginning and then third quarter you guys took 4.1 million and an additional 9.9 million for a total of 15.6.

How worried should we be that we're kind of seeing that trend pick up in terms of reserve strengthening and maybe you could talk a little bit about what got caught in the fourth quarter review that seemed to have gotten missed in the third quarter review?

This is Pete Heckman. We began to see some adverse prior year development really primarily in the third quarter. It was a relatively new trend at that time. E&Ys assessment and ours, although we were very consistent in terms of total reserves, , they were not seeing quite as much of it attributed to the development, development attributed to prior years as we were. So frankly our best estimate of the strengthening required at that time was a bit on the conservative side, perhaps, just because it was relatively new information.

As we moved into the fourth quarter, both the company and E&Ys assessment of total held reserves as well as the amount attributed to current accident year and prior year adverse development was pretty much on top of each other. So with two quarters of development and kind of confirmation, independently, between ENY and us, we basically moved to the indications of development in the fourth quarter.

As to what prior year development will occur going forward, I obviously can't tell you that. We think we've recognized all that was indicated the last half of the year. Certainly further adverse development could continue. On the other hand, as '02 flips into a prior year, and if that continues as favorably as it has been, that could somewhat offset it.

Just help me with some math then. If we back out both charges, what kind of a run rate would we be getting for the third and fourth quarter for total P and C combined? It's something in the low '90s for the fourth quarter. .

I guess what I would say as more instruct active is to look at the year-to-date adjusted for the prior reserve strengthening. And I think they were in the maybe 98 percent range.

Terrific. Thank you very much.

Thank you our next question is coming from Alison Jacobowitz from Merrill Lynch

Instead of fan addressed the question -- this is Jake Cohen, not Allison. For the full year, going a little bit further then, for the further year you were roughly at 98 more in an accident year basis, catastrophe losses were I guess a little bit light but seems your guidance next year one might suggest conservative given the price increases you've seen and hopefully expense ratio at least in the second half starts to drift down a little bit. I want to explore the guidance and why maybe it's not a little bit better even. Not that it's not bad. But you know what I'm saying.

This is Doug Reynolds I'll go from a property and casualty side. There's really a couple things. One is that we are making a lot of changes in our claims organization with the new technology and processes, et cetera. And although we're seeing some good early results that those things are starting to take hold, we also want to get some consistency behind those.

The other thing is that the rate environment is a little bit up in the air. As you know we've got a new commissioner in California. We've also got a Governor getting involved in Texas. And we're not sure how some of those things are going to roll out. We still think it will be a good market to take the rates that we need. But at the same time we also recognize that there could be some, probably a little bit more push back than there has been in 2002.

Then just one other follow up we had. Property and casualty investment income, the yield looked like it kind of jumped up from the third quarter, the average yield on average assets. I'm wondering kind of what's in there. Unless I'm just wrong with that presumption.

If you look at the pattern of quarterly investment income, and I'll give it to you after tax, that's shown on page four of the numerical exhibits attached to the press release. The fourth quarter '02 was 6.9 million. Third quarter '02 was 6.3. Second quarter was 6.7. So we had a little volatility sequentially with a tick up of 600,000 dollars after tax on the fourth quarter over the third. The fourth quarter, in property and casualty investment income is generally a strong seasonal quarter. If you look back to the third quarter of 2001, it was 7.2 million, and hopped up to 7.5 in the fourth quarter of 2001. So the tick up in the fourth quarter is a bit of seasonality, I'd say. Again, if you look at the percent declines for the quarter versus the year, you do see the continuing decline in investment income on the P and C side, similar to what you see on life and annuity.

That's helpful. Thank you for the answers.

Our next question is coming from Seth Bower of Banc of America Securities

Could you give us a little more detail flavor on what you're seeing in some of the new markets that you're looking in, particularly in Chicago and some of the other areas?

What we're looking at, in terms of growth or in terms of -- I mean when I look at Chicago, public school system, we went in there, the beginning, second quarter of last year. We've seen significant growth up front and kind of a low level of production ever since. They produce and continue to produce I think excellent results there. In the other counties we are narrowing the focus and increasing our efforts because it's been such a successful program. I think we're going to continue to push heavily on that high priority market, specific counties. There's over 30 of them. There's some real good counties in San Diego and a couple in Arizona. They're all over the place. I'm not sure specifically what you're looking for. But we're seeing good growth in those counties.

Let me just add that if we look at the hiring that we're doing in those new counties, the agents are, from a productivity perspective, new agents there have a higher productivity than our average new agent. They're driving more educator business, more annuity line business. They're retention is better than our new agents across the country. So the focus we have in building a beach head in each of those counties is with home office support is paying off for us.

Okay. The other question I had was regarding the financial reinsurance. You indicated that for '03 the expected impact was about nine cents. Do you have any idea, can you give any guidance where that might be in '04 and beyond?

The financial reinsurance piece of the two capital transactions was about three cents. The other six cents was attributed to the dilution as a result of the additional 1.8 million shares that are out in float.

Those fees will generally decline as the years go out with generally a five-year term being the term of this agreement as the surplus will rate down as well over those five years to zero. So we should see a diminishing impact from fees, but loss investment income again should remain higher. In total, though, the three cents should diminish over the period of the contract.

I see. Thanks.

Our next question is coming from Alain Karaoglan from Deutsche Banc.

I have a few questions. On the combined ratio, I believe you mentioned a run rate for 2000 of around 100 percent.

Could you give us what that would be for the personal auto and homeowners lines as a run rate for 2000, and what was it for it in the fourth quarter and what do we expect it to be in 2003, for the two segments?

I'll have Doug take the first shot at that.

I'm trying to -- let me go to -- I'm going to go to the second part of the question first, as far as what we're looking at next year.

As I said before, our total combined ratio target that we're looking at is in the 96 to 98 range. And the automobile we would expect to be down in the lower end of that in the property towards the higher end of that range.

As we looked at the run rate for the automobile business, we're looking at something that's right about a 98 in 2002 and the property about a 101 for 2002.

And that's just a-adjusting for the prior year strengthening on a year-to-date basis. As we've said before, weather related losses, both CAT and non-CAT were favorable in the year and were not expected to repeat. If you look at a normal weather situation.

The 98 and 101 is not adjusted for normal CATS

No

In terms of the reserve editions you did in the quarter, was there anything in specific in terms of why, what is the reason for the trends that you're seeing, that led you to add to the reserves.

I guess one of the components that comes to mind is loss adjustment expense. As Doug has commented the last few quarters we saw some acceleration of ALAE expense, which are we believe we've contained now and have some actions in place to make some good gains going forward. But ALAE has been an issue and that did show up in prior year development as well. But again it was primarily focused on the auto line in the more recent last couple of years with ALAE being a big piece of it.

And if we look at the expense ratio, I mean a few years ago you were at 20 or slightly below. If we look at the full year, 2002, we're at 24.4. Is that where you think you'll be in 2003 and where do you think ultimately once you do whatever you want to do from an investment point of view, where do you think that ratio ought to be at to be competitive?

This is Doug Reynolds again. On the 2003. We would expect it to accrete down from where we ended 2002 at. But we're still dealing with a couple of issues, as Pete mentioned before, the North Carolina component, we've also got the piece around some of the agent compensation that we mentioned. And I would say that from a longer term standpoint we're definitely want to drive that down. I think we've got to be running in the mid 22 range, is really what I would say is a little bit of a longer term view at the expense ratio. And I want to add just the third that really is an impactor for us and it's really an investment in the business is the reinspection and the rate pursuit processes that we're undertaking. We did that in 2002. We'll be doing more of that in 2003, but we are getting the loss ratio improvements as a result of those investments. And we'll continue to see that as we move through 2003.

Just the last two questions on the life side. Could you give us the spread on the fixed annuity business in 2002 and what is your RBC ratio and as of year-end?

The spread we experienced for 2002 on the fixed side is 212 for the year.

You expect that to compress in 2003?

Yes and all that is, it's the gross spread that the investment income for the line of business less the interest credited on the fixed annuity portfolio.

With regard to your RBC ratio question, we have not finalized that calculation for year-end 2002. I believe for the last few years both the life and P and C, RBC ratio were in the 350 percent range or thereabouts. And again although we haven't calculated the final ratio in '02, the financial reinsurance transaction we did on the life side was intended to return that RBC ratio into that same range.

Thank you very much.

Our next question is coming from Rob Mayton of Schneider Capital.

I had a couple of more questions on the guidance for '03. If I just take your '02 numbers and subtract the nine cents and then also subtract the prior year development, I'm getting something in the $1.64, $1.65 range. As you've spoken about the other categories, the P and C investment income and life and annuity are declining but if I look at where those were in '02 you'd have to in total those would have to decline about 20 percent from where they were in '02. And as that -- should I just think about that as a rough estimate for all three of those categories or is it more in some than others, or is there any other guidance you could give on that?

One piece that comes to mind that I didn't hear you think about was weather catastrophes and normal weather

I assume the normal weather is implicit in your 96 to 98 combined ratio expectation

That's correct, but as you adjusted '02 --

What I did was I plugged in the 97 combined to get to that $1.65.

The investment income piece, would certainly be under pressure at P and C as well and life and annuity. So I think you were asking about what to expect there and as you look at the quarterly trends in all three of our segments, investment income, you'll find that that is basically under pressure as well.

We also have again more shares outstanding which will again hair cut the EPS growth by nine cents, which I'm not sure you took into account.

If I may, I subtract the nine cents and then adjusted to get to the 97 combined. And I guess where I was going with that was obviously it's a very challenging environment in '03 on the life and annuity side. But I'm just wondering if you have a rough estimate of what type of an ROE those divisions would be generating in '03 and compare that to what your long-term target would be just to know how much below a normal or target level we would be in '03?

Next year looking at 10 to 12. That's below our long-term target of 12 to 15.

The overall ROE or just the life and annuity pieces?

Together.

Okay and that would probably be, the 10 to 12 would probably be two points lower on life and annuity and higher on P and C; is that fair?

That's a reasonable assumption

Okay. But long-term you would want both of those to be in the 12 to 15 or do you think the P and C is always going to run higher than the life and annuity.

I think as a general rule we would expect P and C to be above life and annuity

Okay. Thanks

To ask a question press the number 1 followed by 4. The next question is a follow-up coming from Steven Peterson from Cochran Caronia

I'll ask sort of a crystal ball question and maybe I could direct this at either Dan or Lou. I might ask you to respond to the Wall Street Journal article that was published yesterday concerning some of the tax favored proposals that are part of the current bush tax plan and the article implication was that there may be a little bit of competitive threat by some of the tax favored proposals to the annuity market. And I know the educator market is a bit unique, but I was wondering if you might be able to comment on the article and maybe your general thoughts about the bush proposals as regards to your sort of target educator market.

This is Lou. First of all I think you need to recognize it's just a proposal and there's going to be a lot of forces pushing and pulling before any changes come to pass. Some people are going to be winners and others who are losers in this. And there's going to be a lot of weighing in and lobbying in Washington. I think as you look at it you need to divide the impact analysis into qualified and nonqualified. In the qualified market, the proposal calls for ERSAs, which would either replace or consolidate 401(K)s and 403 Bs, but they still have to be employer-sponsored. It still would be funded with pretax dollars. You'd still need a payroll slot to access them and we don't really see any impact on our core annuity business which is 90 percent qualified. It would be replacing the plan with another plan. We think our agents are well positioned to market under those circumstances O the qualified side, which represents 10 percent of our business, whether you measure it by premium or policies, the proposal will create some dislocations to other carriers but I think depending on what's past, it could create opportunities for us to serve our educator clients in a more robust way. Those plans will allow folks to consolidate their assets and I think create an opportunity for us to increase the business that we do on the qualified side. But, again, it's just a proposal. We're going to be following the developments as they wind their way through various committees and go through the lobbying process. And frankly build plans to see it as an opportunity and grow with it

Terrific. Thank you.

I would like to turn the call over to Mr. Hollman for any closing comments.

Thank you for participating on the call this morning.

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