Horace Mann Educators Corp (HMN) 2003 Q3 法說會逐字稿

Good morning, and welcome to the Horace Mann third-quarter earnings release conference call. At this time, all participants have been placed on a listen-only mode, and the floor will be opened for questions following the presentation. I will now like to turn this over to your host, Mr. Dwayne Hallman. Sir, you may begin.

Good morning, and welcome to Horace Mann's third-quarter earnings release conference call. Yesterday, after the market closed, we released our first third-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. As a reminder, on Monday of this week, we announced that our third-quarter and year-end results would be impacted by efforts (ph), prior year's development and strengthening of property-and-casualty claims reserves. On Tuesday, we hosted a conference call and discussed the reserving actions taken in the third quarter. In case you missed it, an Internet replay of the conference call is available on our website. Today, we will cover the results of the third quarter and 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. Louis Lower, the President and Chief Executive Officer, Pete Heckman, Executive Vice President and Chief Financial Officer, Doug Reynolds, Executive Vice President, Property and Casualty, George Zock, Executive Vice President, Service and Technology Operation and Financial Services, Dan Jensen, Executive Vice President and Chief Marketing Officer.

The following discussion may contain quarter 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 forward-looking statements are made based on management's current expectation and beliefs as of the date of this conference call. For a discussion of the risks and uncertainties that could affect actual results, please refer to the Company's public 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 assumptions or other factors that could affect these statements. 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 December 1st. Now I will turn the call over to Louis Lower for his comments.

Well, good morning, everyone. Thanks for joining us. As Dwayne noted, earlier this week we issued an earnings warning with revised guidance and held a conference call to go into detail about the property-casualty reserving actions that we have taken in the third quarter. And our intent today is not to repeat that explanation, but for anyone who missed the call, it is available on replay. So our focus today is going to be on the balance of the third-quarter results. However, I did want to reiterate one -- that the change in our estimate of reserves is a direct result of changes we are making in the process and management in our claims organization, which have more fully revealed deficiencies in historic practices and resulting deficiencies in case reserves and IB&R. And it's that catch-up that is reflected in our third-quarter actuarial calculations. Two, given our frustration with prior-year, adverse development, we have engaged Deloitte & Touche to conduct a detailed review of the Company's claims handling practices and their integration with our reserving practices to include providing their perspective on the adverse development experience, identifying its causes and possible implications for the future. And three, rather than waiting for the results of their work, we have established a level of reserves such that if the adverse development of the third quarter repeated itself in the fourth quarter, we should be okay.

Despite the negative and very frustrating reoccurrence of adverse, prior-year development, we are seeing other results that confirm to us that the Horace Mann consumer franchise is healthy, and that our initiatives continue to move us in the right direction. On the marketing front, you may recall that total sales were down slightly in the first quarter and then increased by the modestly in the second quarter with what we then described as emerging momentum. That momentum has accelerated in the current quarter, with a 34 percent increase over prior year. While annuities led the way with a 52 percent increase through our combined independent and career agent channels, all core lines participated with healthy increases, as you'll hear from Dan.

So while we had a weak sales start to the year, total sales year to date, have increased 12 percent, with about two-thirds of that dollar growth driven by increasing levels of activity in our independent channels. In property-casualty, you'll note that our total PIF is relatively flat. But if you break the segments apart, there is a different picture. Educator PIF in the auto line has increased in each of the last six quarters, up 15,000 units over that period, with one-third of that growth coming in the third quarter. The offset to the growth has been a decrease in the non-educator book and property units, driven by the pricing and underwriting actions that we have purposely taken to reduce exposure to those segments. We view that segment distribution shift as a favorable trend for our future. At the same time, more of our new business is coming from the preferred underwriting tiers, and those shifts, in combination with tightened (ph) underwriting criteria, are showing up in improving frequency and renewal ratios. And Doug is going to elaborate on those trends and share even more property-casualty metrics that are developing favorably. As George is going to report, annuity met our expectations -- our earnings expectations for the quarter and year to date. Although we continue to feel the challenges of spread compression in our fixed-annuity block, we are, however, beginning to benefit from equity market performance through our M&E fees. All in all, while the developments on the reserve front are a setback and highly frustrating for all of us, they don't change our view of the vision and strategy we have put in place. The positive trends we are seeing elsewhere encourages us. The steps we are taking will realize the full value of Horace Mann's franchise potential. And now, Pete is going to provide you his financial perspective, including guidance, capital ratios and investments.

Like Lou, I don't plan to retrace a lot of the ground we already covered on the call last Tuesday, related to the reserving actions we took in the third quarter. We will certainly be glad to entertain any follow-up questions you may have on that topic during the Q&A session. Third-quarter results obviously included a fair amount of noise. But I would suggest that underlying or normalized earnings were generally consistent with our expectations. As you saw in our release, third-quarter earnings per share, excluding net realized investment gains, was a loss of 44 cents. There were two to three notable items that adversely affected that result.

First, of course, was the 57 cents of prior years' development and strengthening of property casualty reserves, which we have discussed previously. An additional item, which was noted in the release, was a significant drop in our 2003 annual, estimated tax rate, which was reflected in the quarter in light of the sizable P&C net loss recorded. That change has an adverse impact on the third-quarter income of approximately 12 cents per share. So taking those two items into account, adjusted third-quarter income before realized gains, would be about 25 cents per share. Adjusting further for higher than expected catastrophe losses and life mortality, yield-to-normalized third-quarter earnings of about 27 or 28 cents per share, excluding realized investment gains -- which lines up pretty well with our expectations. With regard to our full-year 2003 earnings guidance, the revised range of 30 to 40 cents per share, reflects a 60 cent reduction from our prior estimate, which approximates the impact of the third-quarter P&C reserve charges. Given our September, year-to-date results, the revised guidance range implies a fourth quarter of 46 to 56 cents per share, excluding realized gains and losses. At first blush, I acknowledge that appears a bit aggressive. However, we would expect fourth-quarter income to benefit from the third-quarter change in the annual effective tax rate by approximately 15 cents per share, in effect, more or less offsetting the adverse impact this item had in the third quarter. So the adjusted or normalize fourth-quarter estimate, excluding the expected tax rate benefit, would be approximately 31 to 41 cents per share, once again, excluding realized investment gains or losses. While we would characterize this is a very reasonable estimate, I would point out that it assumes a normal level of catastrophe and weather-related losses. It also does not include any P&C reserve actions that may result from the Deloitte claims and reserving studies that is anticipated to conclude in January.

I apologize for that level of detail on the earnings, particularly on the tax piece. But, hopefully, it provided some clarity around how we view the last half of the year. Now, before turning it over to Doug, I would like to comment briefly on our capital situation and the investment results. As I mentioned during the Q&A session earlier this week, we don't expect the actions we've taken or the results we have experienced this quarter to have a significant, adverse impact on capital adequacy. As of September 30th, our holding company, debt-to-total capital ratio, excluding unrealized gains, ticked up a bit from the end of June and now stands at 25.2 percent, consistent with the level we've been targeting and managing to for quite some time. Based on our updated earnings guidance, we would expect the ratio to be at or below that level at year-end. Similarly, we're comfortable we can manage the year-end leverage ratios of our insurance subsidiaries to the levels we have historically targeted, without having to raise additional capital.

With regard to our investment portfolio, we continue to observe an improving credit markets. Coupled with the aggressive approach to loss recognition and valuation we took during the down cycle, this reinforces our belief that those issues are pretty much behind us. In the third quarter, we did take an additional $1.2 million impairment on one of our asset-backed securities, but this was more than offset by a modest level of portfolio gains. Nearly half of those gains related to the restructuring our high-yield bond portfolio, as that portfolio was transitioned to our new high-yield manager. Total net investment income in the third quarter was off about 5 percent versus prior year. But on a sequential basis was comparable to second quarter, consistent in total with our expectation of this leveling over the latter part of the year. That concludes my remarks this morning, and now let me to turn it over to Doug for his comments on Property-Casualty.

Thanks, Peter. As indicated in our call this past Tuesday, we again found it necessary to address prior years' adverse development. As previously announced, our property and casualty-held reserves have been raised to $308 million. This action reflects 30 million of adverse development for prior years and additional 8 million for current accident year. We feel these actions more accurately reflect the proper level of reserves necessary to settle these claims. Last quartered, we announced what we believe was a conservative increase in reserves for prior years. However, we saw continued unfavorable development in the third quarter, as our new claims organization has intensified our efforts to bring older claim files up-to-date with appropriate case reserves, investigation and evaluation. This has accelerated recognition of shortcomings in our past practices. We remain confident that we are putting the right processes and structure in place with our ongoing claim reorganization. We are continuing to deploy our advanced claim environment, which will automate our claims processes and improve efficiency and accuracy. We have early proof that this process works in our strategy for handling accessories. Despite the fact that our catastrophe losses are three times the amount we had in third quarter of 2002, we have already settled over 90 percent of our claims from Isabel. We accomplished this without disrupting our claims service for claims not associated with the hurricane.

Our new claims processes are improving settlement rates. Our direct repair program has gotten off to a very impressive start. More of our claims are being handled by employee adjusters, rather than independent appraisers. And our loss adjustment expenses, after adjusting for development, are below prior year levels. In previous quarterly calls, we have spoken about our claims office consolidation, and our need to provide our adjusters with better tools. This process is moving forward, and frankly, we expect this automation to help us avoid future reserve issues. Our new claims processing platform has been successfully implemented in our pilot office. We will deploy this automation in the remaining five regional claim offices over the next several months.

We have engaged Deloitte & Touche to conduct a review of the Company's claim processes and reserving practices. D&T will review our claim case reserve practices, as well as our actuarial reserving process. We have checkpoint meetings scheduled with D&T during the fourth quarter of this year, with a project completion date of January 2004. Our advance claim environment, which includes such advances as expert systems to access liability, medical expenses and litigation controls, will assist us in improving severity and expenses. These enhancements give our adjusters additional tools to help them properly evaluate current and past claims during the evaluation and settlement process. Additionally, these enhancements will allow us to quickly act upon opportunities identified by D&T.

So why are we confident in the underlying profitability our business? Key indicators, like improvements in our claim-closure rates, declining loss frequency and improving auto-policy retention rate, are all positive. Excluding claim-restructure charges, our expense ratio is about even to prior year. Written premiums are up 7 percent for voluntary auto and homeowners in the quarter. Our average rate filing for the quarter was 4.8 percent inn auto, and it is about 8 percent for the year, excluding the North Carolina and Colorado reductions. Property changes were 9.4 percent for the quarter, which include the 18 percent rate rollback that was mandated in Texas. Our auto rate need (ph) will be impacted by prior year's development we have reported. We are measuring the impact but feel our rate indications will increase by a few points once our reserve position is fully included in our pricing.

Here is some additional information regarding our key indicators. We ended last year with an 87.7 retention rate in auto, and this year were at 89.1. Retention in our educator book is 7 points higher than our non-educator business. We have further examined the business leaving us. Auto business, in our most-profitable credit tiers, represents 60 percent of our in-force (ph) business -- but only 31 percent of the business leaving us. Business in our least-profitable credit tiers represents 20 percent of our in-force business -- but 34 percent of those departing. Some of this improvement is due to an increase in the number of science (ph) (indiscernible) -paying premiums automatically -- the monthly electronic funds transfer. From year-end 2002, we have increased the number of clients paying via EFT from 19.7 percent to 23 percent of our in-force business. New business is selecting EFT 1/3rd of the time. Handling checks and money orders is an expensive way of collecting premiums. Plus, we know that are retention rate for EFT is higher than those policies paid by check. We have plans to increase both EFT and credit card payments activities significantly over the next few months.

We're making very good progress in addressing our primary market -- educators. Just three years ago, educators represented less than 50 percent of our new auto business. This year it is 68 percent. This is being driven by competitive pricing in the educator market, specific educator products, contract benefits focusing on educators, and agent compensation that rewards our field force for addressing the educator market. Even more important, our educator loss ratios are at least 20 percent better than the loss ratios of our business outside our primary market. It is for this reason that we believe we will be able to stay competitive in our target market, even with the increase rate need. Our auto, new business quality continues to improve. As we target growth in our more profitable segments, we are on pace to increase production by 13 percent in our most profitable credit-score business. Property has some equally impressive key indicators. Our educator PIF is up approximately .5 point, versus a non-educator reduction of over 6 percent from year-end 2002. The average value of homes we insure has increased with nearly half of the homes we insure in the most profitable segment over 150,000. PIF for this segment is up 11 percent over year-end 2002. Property new business has increased 10 percent in our most profitable credit tiers. Catastrophes for the quarter were 5.7 million pretax, primarily from hurricane Isabel. Despite the impact of the storms, our homeowner combined ratio for the quarter was 98.2 percent, excluding any prior-year reserve adjustments.

Let's look at some additional key indicators for 2003 compared to third quarter 2002. In auto, average, earned premiums is up nearly 5 percent. Frequency is down over 5 percent, and our policies in-force for voluntary auto has increased by approximately 1,000 units. For property, average earned premium is up nearly 14 percent. Frequency is down double digits. And our loss ratio, excluding catastrophe, has declined over 14 points third quarter of 2003 versus 2002. We expect that our property policies in-force to decline. And we have had 2 percent decline in units, with more than half of that coming from the volatile Texas and Michigan markets.

A telling indicator of our improved underwriting results is our accident-year loss ratios, excluding LAE. Our 2003 auto accident-year loss ratio is 2 points lower than 2002 and 5.7 points lower than 2001. In property, our 2003 accident-year loss ratio at third quarter, excluding LAE, is about 4 point lower than 2002 and over 18 points lower than 2001. We do face challenges, such as driving our general expense and LAE ratios lower. Our claims process is improving, and will advance even more rapidly in coming months. We must work harder to achieve rate adequacy, while further segmenting our market pricing. We have updated our loss development, tax factors to make sure our pricing is consistent with our recent loss trends. We will stay aggressive with our rate filing actions. Our pricing model will have several changes regarding multi-line clients, youthful classes and drivers per car, to better segment our pricing. We will give primary focus on our larger states to leverage their size to drive the growth and profitability we are committed to. We're fully committed to putting the adverse development challenges behind us, while driving improved loss results with controlled topline growth. And now, I would like to turn it over to George.

Thanks, John. First a few comments on the Life segment. Third-quarter 2003, pretax earnings were below third quarter 2002 by $3.5 million. Compared to the third quarter 2002, we have currently experienced a decline in investment income of $1.5 million, due to the difficult credit environment in 2002 and the lower interest rate environment over the last couple of years. Expenses were up about $1 million over third quarter 2002, primarily due to favorable deferred-acquisition cost, DAC, unlocking adjustment in the third quarter of 2002. Mortality was up about $1 million over the third quarter 2002. The third-quarter 2003 pretax earnings were also lower than second quarter 2003 by $2.5 million, mainly due to less favorable mortality of 1.6 million and lower investment income of $600,000.

Now the annuity segment -- current-quarter pretax earnings of 4.2 million are 1.9 million higher than third quarter 2002. The change is primarily due to DAC and guaranteed minimum death-benefit charges being $3 million lower versus the third quarter of 2002. We also had favorable fees of 400,000 and a decrease of $1 million resulting from spread compression and a non-recurring expense of 400,000 in the third quarter of 2003. Variable cash value on deposit grew 26 percent over the previous year, primarily due to the equity market performance. Our third-quarter 2003 pretax operating earnings of 4.2 million, after unlocking adjustments in DAC and value-business-in-force -- VIF (ph) -- were lower than the annuity segment, pretax earnings estimates given at our last conference call of $4.5 to $5 million pretax per quarter. Again, the third quarter reflected a non-recurring expense of 400,000. Assuming a normal or expected mortality environment, a normal or expected market performance, and no additional bond defaults, we again anticipate to be in the $4.5 to $5 million range in the fourth quarter, and that's pretax.

Now I will review, as I've done in previous quarters, some additional information on deferred-acquisition costs and value-business-in-force amortization and the guaranteed minimum death-benefit reserve. First, DAC and VIF -- the Company amortizes DAC and VIF utilizing a 10 percent reversion of mean approach, with a 200 basis point corridor around the mean. Our current DAC and VIF balances for the annuity line represent 4 percent of account value. While an exact rule of thumb will not work under all market conditions, I will again give you an idea of the sensitivity of the amortization-to-market decline. There are a lot of moving parts to the DAC and VIF calculation, including fund performance, fixed-margin persistency, realized investment gains and losses. But as a general of rule of thumb, if all other assumptions are met, a 1 percent deviation from the targeted market performance would impact pretax earnings approximately $150,000.

Moving on to the guaranteed minimum death-benefit reserve -- the total debt reserve for guaranteed minimum death-benefit at the end of September '03 is $.5 million. That's down 100,000 from the second quarter 2003. The comparable statutory reserve is 900,000. The Company has a relatively low exposure to guaranteed minimum death-benefits, as approximately 25 percent of contract values have no guarantee. Approximately 70 percent of contract values have only a return of premium guarantee. And the remaining 5 percent of contract values have a guarantee of premium at an annual interest rate of between 3 and 5 percent. The total aggregate, in-the-money, death benefit under the guaranteed minimum death-benefit provision totaled $55 million at the end of September. And that compares to $74 million at the end of last June. 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 reserves is that for each one point of negative market performance, the guaranteed minimum death-benefit reserve would increase approximately $100,000. Positive market performance will begin to have a smaller impact on the favorable change in reserve, due to the decline in the number of contracts requiring a death-benefit reserve. Now I will turn it over to Dan Jensen.

Thanks, George. Third quarter continued our favorable, prior-year comparisons in agent count. We ended the third quarter with 899 agents, up 3 percent from last September. The growth in agents was helped by better-than-expected recruiting results and hurt by lower new agent retention. The number of recruits for the first half of the year is up 12 percent, compared to the same time last year. On a year-to-date basis, compared to last year, new agent retention is down 4.5 points and experienced agent retention is flat, with overall retention down 3 points. On a rolling, twelve-month basis compared to last year, first-year agent retention is down 2 points and overall agent retention is down 1 point. While year-to-date, the average career agent productivity was flat compared to first nine months of 2002, primarily due to a down first quarter of '03, we saw career agent productivity start to gain momentum in the second quarter and average career agent productivity for the third quarter was up 8 percent compared to the same period last year. Combining the increased productivity and growth in career agents, career agent sales for the third quarter were up 12 percent compared to the third quarter last year. Year-to-date sales for career agents is up 4 percent for the same period last year.

Driving the growth in the third-quarter, career-agent sales were increases in all four core lines. In the third quarter, auto, property, annuity and life sales were up 9 percent, 23 percent, 13 percent and 15 percent, respectively, compared to the same period last year. Independent agent sales of our annuity products for the third quarter were up significantly compared to third quarter last year. Year-to-date independent agent sales of $21 million were nearly three times the production for the first nine months of 2002 and double last year's year-end total production. We currently have 433 independent agents appointed with Horace Mann at the end of the third quarter. This is up from 322 at the end of the second quarter. Combining the strong independent-agent sales and the strong third-quarter, career-agent sales, total sales for all lines in the third quarter and year-to-date were up 34 percent and 12 percent, respectively, compared to the same periods last year. In summary, on the career side, we are growing the number of agents, while improving agent productivity, the quality of new businesses is continuing to improve and on the independent-agent front, we have seen a real pickup in sales and are ahead of own expectations. Overall, it looks like it will be a strong finish to 2003. And now I will turn it back over to Dwayne.

Thank you. That concludes our prepared remarks. Crystal, please move forward to the question-and-answer session.

Thank you. The floor is now open for questions. (OPERATOR INSTRUCTIONS) Our first question comes from Alison Jacobowitz. Ma'm, please state your affiliation.

Hi, with Merrill Lynch. I have a couple of questions. I'm sorry if I missed it, but in the annuity segment, when you gave the -- your estimate, the 4.5 to 5 million, is that -- I just want to make sure, is it pre- or post-tax?

Alison, that's pretax.

It is pretax. So the 3 percent tax rate then would get applied to that, as well?

Well, that's the total effective rate for the entire book of business. So I think the answer is 35 percent. Anything different from what is in our year-end estimate in our guidance range -- any variance to that would be taxed at 35 percent. So that would be the difference you would take in our estimate. But that 15 cents pick-up in the fourth quarter is basically going to be there, given our guidance range.

Okay. And then I didn't hear it -- did you gave a similar estimate for your Life operation?

Alison, the life earnings year-to-date through September -- a good range would be annualizing that number.

And then I don't have the equity breakout. Do know what -- off the top of your head -- the ROE is running for the annuity operations?

The low-double digits.

And then one last question, please -- the California fire -- have you any estimation of the effect on you?

Alison, no. This is Doug Reynolds. No, at this point, we don't have any estimation as to the effect. We've obviously received some calls. But until things settle down there -- out there -- it's going to be a little bit difficult to fully evaluate what type of impact that has had us.

Do you have any off top of your head -- just your share of that area? I know it's not a direct correlation but --?

Well, our market share for the state is about 2/10ths of a percent. But in that -- in those areas, it would run a little bit higher than the full-state market share simply because we don't have very much business in some of the major metropolitan areas.

Okay. Thank you.

Thank you our next question comes from Stephan Petersen. Please state your affiliation.

Cochran Caronia Securities. Good morning. I'm just wondering, Doug, we've been seeing some of the other personal-lines companies start to scale back on the requested rate increases. And I'm wondering -- it sounds like you guys are still going to try to push a bit additional rate going forward. I'm wondering if that may be creating head wind for you guys in '04? And, secondarily, do you do much benchmarking as regards Allstate, State Farm and some of the other big personals-line companies?

A couple of things. On the rate change front, we will have to obviously continue at the levels -- and actually a little bit higher overall than what we were in 2003. I think one of the things that we do have is the results on the educator side of our business is very favorable. So, we will be able to continue to go after our target market. As far as benchmarking to the other companies, we do look at some of the fast-track and some of financial combined ratios. And we basically look at that a number of ways. But obviously, Allstate and Progressive on the auto side are running some pretty good combined ratios. When we benchmark it against other companies, that larger companies, our combined ratio on the auto accident year would still be running slightly below what those totals would be.

Okay. So do you think your rates still lag relative to those carriers?

Well, I would say that as far as the rate change effect -- what we're going to have to get for approvals, certainly for an Allstate and a Progressive, I would expect our rate filings to be higher than theirs. As far as the marketplace overall, like I said, we are right about what the -- a little bit below what the P&C market would be running. So although we're going to have to be a little bit higher than what we had previously anticipated because of the prior-year development, I don't think it will put us completely out of touch with what other companies are doing. And as I want to reiterate, our opportunity in the educator markets would continue based on what we're seeing for much better results.

Okay. Terrific. Mr. Jensen, I was wondering if you to give me the experienced agent count at the end of the third quarter?

Yes, one second let me --

And then the other question I had, is if you could talk a little bit about how the independent agent build-out is either continuing or starting to slow at this point. And the appointments you've made there. And lastly, a little bit about the accounting initiatives that you undertook about a year and a half ago in terms of targeting? And I guess what I'm looking for is where your agent growth is and in what parts of the country are we seeing the biggest pick-up?

Sure. And in the three parts. First, on the experienced-agents side, we are sitting right at 498 experienced agents out of the 899 agents. So the percentage of agents that are financed is obviously up fairly significantly, which is having an impact -- it makes it (technical difficulty) more difficult to grow, improve retention and grow productivity, even though we are still having gains in those areas. On the independent agent front, in the beginning of the fourth quarter, as we are going forward, we are still seeing continued improvement in that. We have actually had a gain every month in terms of actual, independent agent production. We are weeding through our contracts to get rid of non-performers, at the same time as we're bringing on a fairly strong amount of new producers, as well. And on the third part, with high-priority markets, it is absolutely our focus going forward. We have identified -- there is 16 core markets that is where focus is and that is where our hiring plans are going forward. I mean, it's where our growth is coming from. It's where our growth is going to be in '04 as well.

Just a quick follow-up on the independents. Are you pretty close to feeling you are done building out that particular distribution channel? It sounds as though your sort of built it out, and now you're looking to primarily just weed out the non-performers? Or do you see that accelerating into next year in terms of growth?

I absolutely see it accelerating into '04. We have a focus both on the producers that we have currently that we're working with -- some very large agencies that will be kind of strategic partners. And we absolutely expect that to accelerate significantly going forward.

And then one last quick follow-up on -- this is sort of the first back-to-school season where you have had a real significant independent agency distribution force in place. I believe last year, it was sort of still under construction. Can you provide us any color in terms of whether or not there are any administrative headaches? Are things moving fairly smoothly? Are you seeing the kind of -- obviously, you are seeing growth -- but is that growth coming from a couple of key independent agents or is that growth nicely spread out throughout the distribution channel?

It is fairly spread out. And in terms of impact between the two distributions, we've really -- it really hasn't materialized. I'm not saying there isn't an occasional, individual case where somebody runs into somebody. But I have to say, for the most part, we're not having channel conflict or concerns there.

Okay. Terrific. Thank you.

Thank you. Our next question comes from Bob Glasspiegel. Please state your affiliation.

Good morning from Langen McAlenney. I know you gave some of these figures. Did you give the accident-year, combined ratios for auto for nine months versus a year ago?

No, I gave the accident-year loss ratio improvement over prior year -- which was the couple points.

That was quarter or year -- can you give me the absolute numbers, please? Or just give me the reserve development in each year and I can do the calcs.

Yes, the '03 September year-to-date, auto-accident year would be around the ninety six seven.

And that compares to you said 98.7? 2 points?

For '02? (multiple speakers)

You said 2 points better?

Yes, well, that was on a loss ratio. It's actually -- the '02 would have been closer to the hundred mark for accident year with everything on a combined ratio basis.

Okay. What sort of ROE do you get at 96.7 combined?

It's up in the high teens. Glass(ph)

Okay. I would love to see that worked out off-line.

Well, again, our -- we manage our premium-to-surplus ratio at about the 2.5 to 1 level, which is one of the things that is driving that.

And what's your yield on the portfolio?

Well, you know, that's kind of a current yield basis.

Right. So you're getting sort of 7.5 percent under (ph) rate in ROE. And that would imply that you're getting 6 percent after-tax or something to get to the mid-teens. Let me follow-up a little bit of that off-line. Premiums written decelerated to 2 percent from 8 percent. And now you're going to push rates a little higher. Is it fair to say that '04 is going to be a rebuilding year and look for premiums to be flat to down or --?

No. One of the things that is driving that reduced rate of the premium growth is the adjustment we made in our involuntary auto line. You probably noticed that on one of the attachments.

Right.

That amounted to about $6 million. And it dampened the third-quarter percent increase in both written and earned premium by about 4.5 points. That was the one-time adjustment to true-up (ph) our facility business to align with the way we are accounting for that business now, which is basically to record actual results we receive from the facilities on a one-quarter lag basis. So we view that adjustment as being just a one-time adjustment to get us to our accounting practice. So I would view the run rate, again, of premium increase about 5 percent in the quarter and -- (Multiple Speakers)

That you contract going forward by pushing more rate in an environment that is probably less receptive for rates. (Multiple Speakers) I assume you are saying you want the pif (ph). I mean, you are willing to accept the pif (ph), the decline to get the rates rate (ph).

Of course, we're going to be focusing on educator PIF (ph), and that has been increasing and we would expect that to continue.

So are you a bit -- I mean, two years ago, I thought you gave a presentation that you really wanted to expand beyond the educator's niche. Is this a 180 to sort of go back to your base at this point?

Well, I think a presentation a couple of years ago was we wanted to expand within the educator niche -- not expand outside of it. So this does not reflect a change in our direction.

So, Bob, what we were talking about there is the Company, historically, have primarily been a NEA member, K-12 marketing organization. our agents have drifted into the mass market, unfortunately. So we have steered them back to the educator market. But we have expanded our target beyond just members of the NEA, although there are very important constituency for us, to non-NEA members, private teachers, junior colleges, some community colleges, where our business model is transportable.

Okay. The last question -- do you view the sort of change in your actuarial accounting firm sort of as -- it -- as far as major changes that you're going to take -- or is there some management changes or more stringent operational changes necessary?

Well, whatever comes out of the D&T study -- if they have recommendations about organizational changes, we will certainly make those. If they have recommendations about claims practices and disintegration with reserving in practices, we will do that. We don't -- you know, we just have to sort of suspend judgment here for awhile, and look at what they come up with and review it and makes changes that might be needed. But I have to say that within our claims organization, there are a very significant number of people in the former claims organization who are no longer with us as we have strengthened our claims team.

Okay. Well, some presentation or -- by those people -- by the news claims department at some point would be, I think, a value to us.

Good. We will provide you that update. Well, I know we have talked about doing special topics before, and I think we can certainly accommodate that as we go into '04.

Thank you very much.

Crystal, before we go onto the next question I would like to clarify a response I made to Alison with regard to tax rate on the annuity segment.

This Peter Heckman. Alison and others, we would expect the marginal tax rate in the fourth quarter for both the annuity and life segments to be somewhere around the 32 to 35 percent level. The overall consolidated, effective tax rate of down to the 3 percent or so level -- really the difference would all be in the P&C segments. Thanks, Crystal. You can bring the next question on.

Thank you. We have a question coming from Jeff Tremblay (ph). Please state your affiliation.

Credit Suisse First Boston. Good morning. Dan, I think you mentioned that your retention rate on new recruits was trending down. Did I get this right?

Yes, we had saw -- we saw a year-to-date decline of 4.5 points. But on a rolling, twelve-month basis, it was a decline of about 2 points.

Were you surprised by the decline?

A little bit. We had a significant increase in the number of recruits, and were concerned a little bit with the quality. And we are addressing and have already put in place a significant new agent retention program going forward that will have an impact both at the end of this year and all of next year.

And what do you think has caused this decline?

I really thought it was probably driven by the volume of new recruits being brought on.

Okay. Have you done any analysis in terms of regions where you had a lower retention rate? Don't know if that is regions where your independent agents were more active or maybe you had too many recruits in the same regions?

Yes, and it does go along the lines with where we have had a significant increase in the number of recruits in a specific region. We really don't see any correlation to the independent-agents side (indiscernible).

Okay. And then on a different topic. Can you give us an update on your discussions with school boards-- whether you're seeking any new school board announcements -- endorsements similar to what you had with Chicago last year?

Yes. Actually, that is something that we are always involved in. We do requests for proposals to hundreds of -- literally hundreds of RFP's every year. So it is something that is always an ongoing basis. Chicago was kind of unique because it was really the first, large independent one. But I would point out that Chicago, which is really great business and the volume is strong, has actually been surpassed by some of our other independent producers. So we already had, in a quieter way, been moving forward throughout the independent side, acquiring new schools.

Okay. Thank you.

Thank you, our final question comes from Alain Karaoglan. Please state your affiliation.

Good morning. Alain Karaoglan with Deutsche Bank. A few questions. The first one, Pete, could you give -- you may have mentioned it -- with respect to the life insurance company, what's your capital and RBC level?

Hang on a second, Alain.

And I will ask the same thing on the P&C side.

Okay. At September 30, our P&C statutory surplus is 192 million and our -- on the life side -- 232. 232 million on the life side. RBC ratios -- and, again, I'm kind of quoting from memory here -- but it was fairly high at year end on the life side. I think it's a little over 400 percent. On the P&C side, it was down somewhere around 310 or 315 -- something like that. Again, with our belief and intention to manage those subsidiary leverage ratios consistent with as we have passed, we would expect to be able to be over 300 percent in RBC in both segments at the end of this year.

Okay. And with respect to the taxes -- the geography of the tax benefit -- you mentioned what it should be on the life side. Would there be any benefit at (indiscernible) the total would be at the corporate level or in the property-casualty operations?

It really is going to be in the property-casualty operations.

Okay. And then last question is really from running the Company point of view, Lou, in terms of some of what's happening now, it seems to be a little bit self-inflicted. And I have a couple of questions related to that. If we look at Horace Mann, historically, from 1985 to 1998, we had probably one year of adverse reserve development in 1986. And the combined ratio was 116 and dropped to 97. In 1998, the medical trends had an inflection point. And I could see the trends coming up instead of down, as they were for most of the 1990's, where the Company had significant reserve redundancies. So, you could see some adverse reserve development. Are you looking at either the compensation of the agents -- you changed it a couple of years ago -- or the change in the claims process as having led to these reserve deficiencies? -- because of the history of the Company having been redundant for many of these years. And the reason I'm asking that is if I look at the career agents as a percentage of the total agents -- they are 54 - 55 percent today -- in 2001, it was 64 percent. So it seems we're not keeping the most experienced agents that we want to keep that would be the best at driving the business. So could you talk a little bit about the compensation? If you're thinking of changing anything, putting more profit bonuses? Or on the claims process, in terms of what we did wrong to achieve that result?

Just a couple of comments. I guess I would tell you that the claims practices and policies that have caused this issue have been with the Company and date back for many, many years and would date back through that -- certainly through that entire period that you're talking about. So it's not the -- it's the new practices that we are putting in place that are correcting practices in the past that led to the situation that we are in. So it's not the new claims organization that's creating the problem. It's the new claims organization and it's the people, the leadership, the policies and practices that are unearthing, revealing the full extent of the problem and causing us to increase case reserves and IB&Rs. So this isn't a case where we ought to be shooting messenger in the new claims organization.

So how do -- sorry, just to interrupt -- how do we explain the reserve redundancy of the Company for so many years? Doesn't that suggest that on the IB&R side, the actuarial process adjusted for the deficiencies in the claims practices?

I guess I would just say that for the four (ph) prior claims practices were hidden by the reserve redundancies.

Okay.

With respect to the agent piece, we did change agent compensation. We did not diminish the compensation that is tied to profitability of the business. We did increase compensation tied to being in the educator marketplace and driving multi-line sales. So I don't think compensation has had anything to do with the deterioration of results. And in fact, the results that we have uncovered existed in the past under the old compensation. In terms of the mix of new agents to old agents, we did have to route out a lot of the career agents who were non-productive, as you may recall. We do have a lot of new agents. But we think with our underwriting guidelines and pricing that it is not the agents that are driving the problem here.

Okay. And you had some prior goals in terms of achieving certain combined ratios. Do you have an update on that with respect to personal auto and homeowners?

Well, the goals that we had stated before would still be the same. Obviously, the challenge in meeting them as quickly is a little bit larger. At that point, it was to try and run our P&C business in 94 - 95 combined ratio. But, obviously, we would have expected to not have the prior development that we have experienced this year. So that will just make achieving that goal a little bit more difficult. But it is still a target that we are attempting to run our business in.

Do you have a time-frame by which you think you can achieve it?

Well, at this point that would not be -- until we really go through what we are looking to achieve for '04 -- would be the time that I would just as soon talk about that.

Okay. Thank you.

I will turn the floor back over to Mr. Hallman for any closing comments.

Thank you, Crystal. We appreciate your participation on the call this morning. Have a good day.

Thank you. This does conclude today's teleconference. Please disconnect your line, and have a wonderful weekend.