Horace Mann Educators Corp (HMN) 2003 Q1 法說會逐字稿

Good morning ladies and gentlemen and welcome to your Horace Mann Educators Corporation first quarter conference call. At this time, all participants have been placed on a listen-only mode, and the floor will be opened for questions and comments following the presentation. It is now my pleasure to hand the floor over to your host Mr. Dwayne Hallman, Senior Vice President of Finance. Sir you may begin.

Good morning and welcome to Horace Mann’s first quarter earnings release conference call. Yesterday after the market closed, we released our first quarter earnings, including financial statements, as well as supplemental business segment information. If you need a copy of the release, it is available on our website horacemann.com. We will cover our results for the first quarter in our prepared remarks. The following senior management members will make presentations today, and as usual will be available for questions later in the conference call -- Lou Lower, President and CEO, Pete Heckman, EVP and Chief Financial Officer, Doug Reynolds, EVP Property and Casualty, George Zock, EVP of Service and Technology Operations and Financial Services, and Dan Jensen, EVP and Chief Marketing Officer.

The following discussion may contain forward-looking statements within the meaning in the United States securities laws. Our actual results may differ materially from those projected in the forward-looking statements. These forward-looking statements are made based on management’s current expectations and beliefs as of the date of the published call. For discussion of the risks and uncertainties that could affect actual results, please refer to the company’s public filings with SEC and in the earnings press release issued yesterday. We undertake no obligation of publicly update or revise such forward-looking statements to reflect actual results or changes in assumptions or other factors that could affect these statements. The information provided today may include certain non-GAAP financial measures. The reconciliations to such measures to the comparable GAAP figures are included in the first quarter earnings release. As a reminder, this call is being recorded and is available live on our website. An internet replay will be available on our website until May 9, 2003. Now, we will turn the call over to Lou Lower who will share his views on the quarter.

Thank you Dwayne, and good morning everyone. Thanks for joining us. As you have seen in yesterday’s release, Horace Mann reported net income of 19 cents per share and operating earnings of 26 cents per share for the quarter. Positive accomplishments in our property casualty business for the period include continued success in obtaining rate increases, accelerating growth of earned premium, average premium increasing faster than current accident year loss cost, along with a calendar year combined ratio below a 100, despite higher weather-related losses than last year and a little over 3 points of adverse development of prior year auto loss reserves. While the full extent of our progress in reducing the combined ratio was diminished by prior year’s reserve strengthening that Doug is going to talk about in a few moments, we do feel very good about the improvements we are seeing both in the impacts of pricing on premium growth and our underwriting initiatives.

We are also confident that the changes being made to our claims operations are on track to deliver the improvements and severity LAE and service that we described to you last year. While property casualty policies and force are down in total, the decreases are coming from the non-educator book, while the higher quality educator book is now beginning to grow. Both key drivers, along with approved rate increases which will generate further growth and average premium will put us in a position to deliver our 2003 combined ratio objectives. As George will describe, the performance of the financial markets in the first quarter caused us to accelerate amortization of [TAC and VIC] and increase GMDB reserves in our annuity segment, as market performance fell short of our underlying assumptions. But apart from those charges, our combined life and annuity business is performing as we had anticipated going into the year. As you have seen, however, after-tax income from those segments was down compared to 2002, reflecting lower interest rates and the full impact of last year’s credit markets working their way to our income statement in the form of reduced investment income creating spread compression. But again, excluding the market related charges, results are not inconsistent with our expectations. On the distribution front, agent count is 5% ahead of where we were last year at this time.

Sales in total were down slightly for the quarter and as Dan will highlight that’s due in large part to lengthy school closings as a result of winter storms in key Horace Mann states, and similar preoccupation with economic uncertainty, and an increase in the percentage of finance agents in our field force. We have, however, seen the pace of agent sales pick up with favorable prior year comparisons as we entered the second quarter. Consistent with our overall strategy and value propositions, to meet a broader array of consumer financial needs we are rounding out the product portfolio that our agents can offer through two new additional marketing alliances. The first is with Jefferson Pilot for universal life and the second is with the American Funds for retail mutual funds. Those products roll outs are underway and will enable us to reach us to more educators while deepening our relationship with both new and existing clients, and that in turn should benefit both the growth and persistency of all of our product lines.

As Pete is going to cover, net income was adversely impacted by the impairment of a CDL security identified during the process of consolidating our investment grade income portfolio, fixed income portfolio with one institutional money manager. Despite the impairments in the quarter, the pre-tax unrealized gain in our investment portfolio has increased to a $150m compared to a $132m at year end, and our capital ratios remained well within our commitments to the rating agencies. So despite some noise in the first quarter, the impact of weather and a somewhat anemic financial market environment, we are confirming our operating income guidance range for the year of a $1.25 to a $1.35 based on the fundamental momentum of our operations and resulting underlying earnings growth. And now here is Pete.

Thanks Lou. Although we did have some noise in our first quarter results, the underlying trends in our P&C business continued to improve, while on the annuity and life sides of the business, I think we are coping with the financial market volatility reasonably well and feel good about the diversity that our multi-line platform provides us. And although we expect investment income to remain under some pressure, we are obviously encouraged by the recent improvement in the market and credit environments. I wanted to comment briefly on a just a couple of items this morning before turning it over to Doug, George, and Dan to cover the operational details.

First off, as you saw in our release, we realized investment losses of $3.1m after-tax in the quarter. We impaired four fixed income securities in the total amount of $4m after-tax with portfolio trading activity resulting in a net gain of just under a $1m. With regard to the impairments, $2m was split about equally among three issuers, two airlines NorthWest and Delta and Union Provident, the insurance carrier. I might add that those two airlines represent the only remaining exposure we have to that sector in our portfolio with the total market value being at $3.7m. The other $2m of after-tax impairment was related to one of our collateralized debt securities. The CDO portfolio is comprised of 11 investment grade securities with a book value of $88m, just under 3% of our total investment portfolio. Nine of the issues were transferred during the quarter to Blackrock Inc. (ph) as a result of our decision to consolidate the management of our investment grade, fixed income portfolio with one money manager. Blackrock’s comprehensive appraisal and evaluation of those assets resulted in the one CDO impairment recorded in the current quarter.

In terms of the overall credit environment, while individual names will no doubt continue to experience credit deterioration over the course of the year and industry segments or sub-segments may come under some pressure, we’ve observed over the last six months a degree of stability returning to the credit market and to our investment portfolio. In terms of the total portfolio, as Lou mentioned, we ended March with a net unrealized gain position of a $150m pretax, up about $20m from December 31st and $40m from the end of September. Of particular significance is the fact that the portfolio contained only $21m pretax of gross unrealized losses at the end of the current quarter with over 40% of that amount attributable to four securities -- Ford, Royal Caribbean and two of our CDOs. This is less than half the level of gross losses in the portfolio six months ago. So, again we have every reason to believe that the worst is behind us.

I also wanted to comment on property and casualty reserves. In total P&C reserves at March 31st remained adequate to slightly conservative. Based on Ernst & Young’s detailed review of the company’s actuarial analysis, the degree of conservatism was determined to be consistent with their independent analysis performed at year-end, where held reserves was slightly in excess of E & Y's select estimate. Reflected in the quarter was $2.8m after-tax of adverse development in prior year's reserves, which was basically in our voluntary auto line. 2.5 of the $2.8m strengthening reflected re-estimates of ultimate losses for claims from accidents years 2001, 2000 and '99 and prior with the amounts spread pretty evenly across those periods. As Doug will discuss in more detail, the changes we have been making in our claims organization over the last year or so, new management, improved processes, and the recent consolidation of our field offices which was completed in the first quarter, although not without some road bumps along the way, have resulted in an improved claims handling and overall claims management, including an updated assessment of reserves on some of our older cases as occurred in our current quarter. So with that lead in, let me turn it over to Doug Reynolds to review our Property and Casualty results

Thanks Pete. In the first quarter of 2003, we continued to improve our overall results for Property and Casualty. For the first time in two years, we are reporting a combined ratio of below 100 at 99.5, and this includes 3.3 points for prior year's reserves strengthening. Compared to last year's first quarter, the winter weather was more severe in certain areas of the U.S. This unfavorable weather impacted our results in a few of our key states which included North and South Carolina, Pennsylvania, Maine, and Alaska. Even with the reserves strengthening and the difficult weather, our result was better than prior year and better than our expectations for the quarter. Total combined ratio, adjusted for prior year's reserves and catastrophe losses was about 5.4 over prior year. Before any adjustments compared to the prior year first quarter, our expense ratio was 2 points higher, loss adjustment expense about 2 points lower, and tier loss ratio of about 1 point lower. The expense ratio, although up over prior years, due to the North Carolina escrow underwriting investigations and commissions, we did experience slight improvements over the fourth quarter of 2002 and we are at expected levels.

All of these results are in line with our expectations and are reflected in our 2003 combined ratio target of 96 to 98.

The actions taken and our continued focus on underwriting, claims redesign, and pricing are all contributors in driving improved results. And voluntary auto continues to show improvement as a result of our overall quality actions and rate changes. Including the reserve adjustment, our loss ratio was about equal to prior year quarter even with the rather sever weather we experienced. After adjusting for reserve developments and catastrophes, we are almost 6 points lower than prior year's quarter. As we have covered in past calls, we have been implementing massive changes within our claim department. There are four pillars which support this change -- development of claims best practices, taking advantage of early opportunities to improve results, development of the new claims technology platform which is scheduled to commence in the second quarter of 2003, and physical reorganization of our home office and field plan function. Each of these four areas is continuing to be addressed and they are coming together to form our claim operation of the future.

During the fourth quarter, we continued to improve processes and identified opportunities where further action was needed. During the first quarter by way of example, we have seen improvements in litigation control and a decrease in the number of claims being handled by independent adjusters. Our consolidation of claims offices was a huge undertaking that although started in the fourth quarter, also carried over into the first quarter of 2003. This process was a consolidation of 17 branch offices into six regional claims offices. The six regional claims offices also physically relocated into new facilities. At the same time, we were installing new phone systems, relocating our current technology platforms, installing a number of new managers, and reviewing all files and pending files from the consolidated offices. During this process we identified situations where we needed strengthening, such as 2001 in prior auto liability losses that were mentioned in our earnings release. As we have moved through the first quarter, we have been able to substantially reduce our pending and gain far greater control over the entire claim process. Overall, we continue to be on target with implementing our claims redesign efforts.

Our other new business results continue to reflect high levels of educators approaching almost 70%, while also increasing the number of customers selecting easy pay options. Our rate pursuit activities continue to drive benefits. We have continued to see improvement in fewer pleasure rated vehicles and our percentage of better tiered business also continues to improve. Our average earned and written premium is up about 6% for auto, and we achieved approximately 7% in approved rate changes for the quarter. Regarding renewals, although down slightly in policies in force, our educator retention has improved 2%. Property results continue to reflect steady improvement. Our loss ratio, compared to prior year, was down 4.5 points even including about 6 points this year from the impact of catastrophes.

The catastrophes also contributed to higher loss adjustment expenses. On the operating expense side much of the increase over prior year is due to the inspection program that was implemented around midyear 2002. For the quarter, our average written premium was up 16% and average earned increased 13% with our average rate increases at almost 20%. As with auto, our retention of educator business increased the price approximately 0.6% for the first quarter. Our trends on new business continue with two-third being issued in our best three tiers while increasing our percent educator and decreasing the amount of business written at less than 100,000 in value. Overall our property business continues to reflect solid improvement. In total, I was pleased with the results for the first quarter. We basically were within our expectations for auto and property and based on the progress we have made at our product management and claim redesign, I expect to see continued improvement in our combined ratio for our stated target for the year. And now let me turn it over to George Zock.

Thanks Doug. First, a few comments on the life segment. First quarter 2003 pretax earnings were comparable to the first quarter 2002, slightly worse mortality and lower earned premiums were offset by a lower level of expenses in 2003 compared to the first quarter of 2002. Included in expenses is a favorable impact of $200,000 due to back-end locking in the first quarter of '03 versus no life segment on locking adjustment in the first quarter of 2002. Compared to the fourth quarter of 2002, life segment pretax earnings are down $2.4m. The decline is primarily due to death claims for the first quarter 2003, being $2m higher than the fourth quarter of 2002. Fourth quarter 2002 death claims were unusually low, while first quarter 2003, were only slightly higher than expected. In addition, net investments income declined $300,000 in the fourth quarter of 2002.

Now the annuity segment. First quarter pretax earnings of $3.3m is below the first quarter 2002, primarily due to fixed interest margin compression of $1.7m [backed-invest] unlocking representing a charge that was $1.2m greater than last year. Reduction in variable margin and fees is $600,000 and adverse mortality of $400,000. And that includes an increase in the guaranteed minimum death benefit reserve of $200,000 in the first quarter of 2003. Specific interest margin was 185 basis points for the quarter. That's 50 basis point below the first quarter of 2002. The margin for the full year 2002 was 212 basis points. Additional reductions and interest credited on previous deposits was implemented April 1st, 2003 and new money rates will also be reduced again May 1, 2003. The adverse impact on first quarter 2003 pretax earnings from mortality, including in the increase in the guaranteed minimum death benefits reserve totaling $400,000 and the death unlocking which reflects the year-to-date, and that's due March 31st, impact of the equity market performance on a variable annuity product totaled $1m.

Between March 31st and now markets have recovered. Excluding these adjustments, first quarter 2003 operating earnings of $3.3m would have been $1.4m higher or $4.7m which would have been in line with our annuity segment earnings guidance given at our last conference call of $4.5-5m pretax per quarter. That guidance assumed a normal or expected mortality environment and a normal, or expected market performance, and that market performance would equate to a quarterly market appreciation of 2.25%. That's 9% on an annual rate and no additional bond to the form.

Now, I'll review as I did last quarter's some additional information on the deferred acquisition cost and value of business and poor standardization, and the guaranteed minimum death benefit reserve. The company amortizes [dack] and death utilizing a 10% reversion to the mean approach, with the maximum rate of 12%. Our current [dack] and death balances for the annuity line represent 4% of annuity account value. While an exact rule of thumb will not work under all market conditions, I want to give you an idea of the sensitivity of the amortization to market decline. There are a lot of moving parts to the [dack] and death calculation, including fund performance persistency, realized investment gains, and losses. But generally if all other assumptions are met, a 1% deviation from the targeted market performance would impact pre-tax earning approximately a $150,000.

Moving on to the guaranteed minimum death benefit reserve, the total GAAP reserves for guarantee of minimum death benefit at the end of March ‘03, was $1.1m, that’s up $200,000 from fourth quarter 2002. The comparable statutory reserve is $1.9m. The company has a relatively low exposure to guaranteed minimum death benefit, 24% of contract value have no guarantee. 71% of contract value has only return in premium guarantee, and remaining 5% of the contract value has the guarantee of premiums and an annual interest rate between 3-5%. The total aggregate in the money death benefit under the guaranteed minimum death benefit provision totaled $136m at the end of March and that compares to a $115m at the end of December '02. Again to you an idea of the sensitivity to market declines rough rule of thumb for the impact on the guaranteed minimum death benefit reserve is that for each point of negative market performance, the guaranteed minimum death benefit reserve will increase approximately $60,000-70,000. And now, I will turn it over to Dan.

Thank you, George. The first quarter of 2003 was both promising and challenging. The number of agent recruits in the first quarter was up 23% from 57 in 2002 to 70 in 2003. The agent retention in the first quarter fell 2% from 91% to 89% in 2003 versus 2002. This is largely a hanging issue as the number of the terminations for the last two quarters combined was actually down compared to a year earlier, even with the total number of agents up significantly. Speaking the total number of agents as of 3/31/03, there were 884 agents compared to 840 on 3/31/02, an increase of 5%. Finance agent retention dropped 3% while career agent retention remained flat. The increase in the total number of agents was offset by decline in agent productivity which was down 11% for the first quarter compared to the same period last year. The decline in productivity was largely driven by two factors. First was demonstrated by a significant decline in sales in the Southeast and Mid-Atlantic region due in large part to severe weather that occurred in that part of the United States in January and February. The second was a substantial shift in the percentage of the field force that is in the first two years. We call them financed agents. Financed agents have significantly lower productivity than career agents. The increase in financed agents in time will work their way to becoming more productive career agents.

Though productivity was down in the quarter, by the end of the quarter to the present we seem to be back on track. In spite of the decline in productivity in the quarter, total sales were down less than 1% compared to the first quarter last year, helped by $2.5m improvement by independent agent sales. The total number of independent agents grew from a 167 at year-end 2002 to 230 at the end of this quarter. Auto sales were down 3% for the quarter while property sales were up 14% compared to the same period last year. Annuity sales for the quarter were down 1% compared to the first quarter last year and first quarter life sales were down 5% compared to the same period last year. Again, April is shaping up to be a month where total sales will be ahead of last year and back on track.

As Lou mentioned earlier, we've expanded our partnership by adding Jefferson-Pilot. I am excited that our agents will sell their Universal Life portfolio, meeting an important need of clients with a top quality product. Jefferson-Pilot was the leading seller of Universal Life in the United States for 2002, and I expect that this partnership will have a positive impact on life sales activity for the rest of 2003 and beyond as well as bringing us closer to meeting the vision of our value proposition. We continue to make strong progress on improving the quality of new business that we are selling. Driven by our profile system, the percent of business coming from educators, the percent of business on electronic funds transfer, the percent of business rated pleasure and the percent of business that is cross sold all continue to improve. The high priority markets initiative continues to perform above expectations. We had 39 recruits in the first quarter of 2003 in these designated growth areas compared to our first quarter plan of 26. The recruits within these high priority markets continue to stay with us having, a retention rate of 91% compared to an 86% for all the financed agents in the field force. Our focus in 2003 and 2004 is to gain scale within these markets. And, now I'll turn it back over to the Dwayne.

Thank you for your attention this morning. If you joined the call late or you wish to replay our prepared remarks subsequent to the Q&A session, an Internet replay will be available through June 2, 2003, and a telephone replay will be available through May 9, 2003. Ricky, please go into the question-and-answer session.

Thank you the floor is now open for questions. If you do have a question or a comment you can press "1" followed "4" on your touchtone phone at this time. If at any point your question has been answered you may remove yourself from the queue by pressing the "" key. Once again, ladies and gentlemen that is "1" followed "4" on your touchtone phone at this time. Our first question comes from Stephan Peterson. Your line is live.

Good morning. Lou, real quick I had to step for just a second and I was wondering if guidance for the year remains at about $1.25-$1.35 for the year or that is being changed?

No, we are maintaining that based on the underlying momentum and trends that we see in the business. We did reconfirm that and you will also find that in the press release.

Okay, terrific. And Mr. Jenson, real quick can you just give me a quick update on the number of independent agency appointments?

Yes,–as I brought up, we have gone from a 167 at the year-end to 230 at the end of the quarter. So, that’s a significant increase.

Okay, terrific. Thank you very much.

Thank you, our next question comes from Seth Faler of Banc of America Securities.

Hi. Good morning, yeah, couple of questions. First on the annuities, you indicated that your spread level is currently at 180 basis points?

185.

185. Could talk a little bit about the trend that the you are seeing and I know it is hard to say but where we might except the run rate to end up for 2003?

Yes, it is tough to say but I can talk a little bit about the trends first. Last year we did about 212 stocks and that, for full year number 2002, that compares to our first quarter '02 number of about 235. So, the impact of the credited markets and our impact of bringing down the rates as quick as the investment earnings have dropped, has really narrowed those margins in the first quarter of last year 50 basis points and from a whole year last year going from 212 to 185, 27 basis points. We do have some room to continue to lower rates and with the current interest rate environment, we do anticipate those rates, the earned rates, going down and I think you are going to see some additional compression for the second 9 months of this year. I don't think as great as what we have seen over the last definitely with the last 12 months but even over the last 3 months.

All right. Okay. And on the new Asian front could you give us a little more color on where your focusing in terms of geography and which regions you are really targeting?

Well really on the high priority markets where we are focusing growing the new agents and that are where the educators are. If you remember way back when we rolled out of a couple of years ago there's 3,000 counties in the United States but a 150 counties represent 50% of all of the educators in the country and we are really focusing on those large educator populations. They are very diverse geographic areas from Fairfax to California to Illinois -- I mean they are pretty much spread throughout the United States but it’s where the educators are located.

Are there particular areas where you have seen significant success?

Absolutely. We have been in the high priority of markets -- the program as a whole has done a good job of bringing in and retaining recruits. Places like Maricopa county in Arizona would be one I’d really point to.

Okay. Thanks.

Thank you. Our next question comes from Alison Jacobowitz of Merrill Lynch.

It's actually Jay Cohen. I guess two questions, first of all your combined ratio target for the full year, is that fully loaded for cap, is that ex-weather?

No, this is Doug Reynolds, Jay. The target the 96-98 would be loaded for a normal cap catastrophe type year.

Okay. The first quarter caps, while generally worse than a year-ago, it just seems that for a typical quarter, it's not that unusual? Is that a fair characterization of that?

Yes. It was it is not unusual compared to historical but it was substantially lower than 2002 first quarter, or higher than 2002 first quarter.

Okay, so I guess for the combined ratio target, for you to hit it’s actually, the other assumption that you are probably making is no more adverse development. Is that a fair one?

That would be a fair assessment in the combined ratio targets of 96-98 and we would not be expecting to have any type of major reserve strengthening movement between now and end of the year.

Okay. Alright that's helpful. Thanks a lot.

Once again ladies and gentlemen as a reminder if you do have a question you may press the "1" followed "4" on your touch tone phones at this time. Our next question comes from Alan Karaoglan of Deutsche Bank Securities.

Yes. Good morning, a couple of questions just following up on Jay's question on the combined ratio of 96-98. The target for the year includes the adverse reserve development that happened in the first quarter?

Well, the restatement of the 96-98 was included at what he had to put up in the first quarter.

Okay. Could you give us a little bit more flavor as to, every quarter seems to adding to the reserves on the property casualty side, why is it taking so long to figuring it out because you have done extensive study and looked at it relatively granularly before. What is different this time around?

Yeah. I would say there’s really a couple of things going on and as we’ve gone through the year, last year we brought in a new chief actuary at the beginning of the year and really began a process of looking more and more at the reserves as well as having E & Y involved. And as we’ve gone through the year, we’ve just created a, I would call it, a more refined reserve analysis process which has certainly helped and has identified opportunities. I think the second thing and we knew this was going to happen or with certainly bring light to couple of issues is the whole claim redesign process. That was very a fairly large undertaking and it was intended to identify where there were weaknesses and strengthen those weaknesses. Whether it be through process, handling new files, control, pending, etc. So, as we went through some of the office consolidation that I mentioned at the end of the year, there were some things as we reviewed those past files that we have opportunity that we had to address and that's why as we’re sitting here through this first quarter, we’ve continued to feel better and better that we’re identifying the issues and that the claims reorganization was really about one of the last things that we knew we’re going to be going through where some things could pop out on it.

Okay and could you comment on the North Carolina environment? How do you view that and what is the outlook for you there?

Yeah. North Carolina is certainly a key state for us in the property and casualty sides. They have settled with the commissioner and with the bureau, One of the rate disputes and we’re escrowing for two rate disputes. So the one has been settled and we will be able to see the escrow for that rate dispute in July. However, the -- which is a benefit. The other side of it is that it includes the 15% rate reduction, which obviously is a not a benefit. We are continuing to look at what our options are in North Carolina as far as the making sure that we are controlling our loss results. We still feel that it’s a good market to do business in and we are happy that we one of the escrow -- one of the rate disputes has been settled. We expect the other one would be settled but I can’t -- as to what time period would that be, I don't know.

And the decrease in the 15% rate, are you going to able to keep your combined ratios and the targets you wish them to be?

Yeah. Actually the changes in the escrow, that was baked into our year end target at the 96-98. So we knew because one of the reason why we were escrowing the amounts of money that we were. So as I said even though we got a benefit with the escrow, the rate decrease does not quite equal that total escrow amount that we’re getting as a benefit.

And George, I just want to make sure I understood some of the value. You mentioned $4.5-5m pretax per quarter. Was that for the annuity business?

That's correct Alain, the annuity segment only.

And do you have a similar number for the life side?

The unusual items on the life side this time were the positives, back and locking of $200,000. So that would have been the only unusual item there in the first quarter results.

And was that at the pre-tax or after-tax?

That was a pre-tax item. I'm sorry, I should say pre-tax ahead every one of my numbers.

Okay. And sorry, last question. Pete, what was the capital in surplus of each of the life and P&C companies and what was the RBC of the life insurance company?

Alain, the statutory capital of both the P&C and the life companies are right around $220m or thereabouts and RBC ratios at the end of 2002 for P&C is 309% and for consolidated life segment is 429%.

Thank you.

Mr. Hallman, I am showing no further questions at this time.

Thank you for your participation this morning.

Thank you. This does conclude today's teleconference. Please disconnect your lines at this time and have a wonderful weekend.