Horace Mann Educators Corp (HMN) 2004 Q4 法說會逐字稿

Good morning and welcome to your Horace Mann Educators Fourth Quarter Earnings Release conference call. At this time, all participants have been placed on a listen-only mode and the floor will be open for questions following the presentation. It is now my pleasure to turn the floor over to your host, Mr. Dwayne Hallman. Sir, you may begin.

Good morning everyone, and welcome to Horace Mann's Fourth Quarter and Year-End Earnings Release conference call. Yesterday after the market closed, we released our earnings report including financial statements, as well as supplemental business segment information. If you need a copy of the release, it is available on our website under Investor Relations. Today we'll cover the results of the fourth quarter and year-end 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 chief executive officer; Pete Heckman, executive vice president and chief financial officer; Doug Reynolds, executive vice president - property and casualty; and Butch Joyner, senior vice president - marketing. Following the call, please feel free to contact me for any further clarification on our results.

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 forward-looking statements are made based on management's current expectation and belief as of the date of this conference call. For a discussion of the risk and uncertainties that could affect actual results, please refer to the Company's public filings with the SEC and in the earnings press release issued yesterday. We undertake no obligation to publicly update or advise such forward-looking statements to reflect actual results or changes and 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 the website until March 10, 2005. Now I'll turn the call over to Lou Lower for his comments.

Welcome, everybody, and thanks for joining us. Before we begin, I'm happy to introduce Frank D'Ambro (ph), who is the newest member of Horace Mann's management team. Frank will be leading our Life and Annuity operation. He brings a wealth of experience and a diverse background in insurance and financial services, including management Swiss Renivestors and GE Financial Insurance. Since he only started on February 1, we're going to let him off the hook today, but in the future, Frank will be reporting to you on Life and Annuity, allowing Pete Heckman to go back to wearing only one hat.

As you've read, Horace Mann's income before realized capital gains and losses of 54 cents for the quarter brought the full year to $1.04, excluding the dilution impact of CoCo accounting, which we adopted at year-end. That's the equivalent of $1.09 per share, clearly above both consensus, and the upper end of the earnings guidance range that we provided to you after our hurricane pre-announcement. You'll hear in both Pete and Doug's commentary that the drivers of that positive very historic guidance were ongoing favorable improvement trends in our property casualty segment in the fourth quarter. That coupled with continuing consistency and stability of P&C results allowed our internal and our independent actuarial reviews to read in more confidence and operational improvement in their year-end P&C reserve selections. As a result, our fourth quarter results contain favorable development of the 2004 accident year from prior quarters. Despite that favorable development, however, we have remained sufficiently conservative in our held reserves at year-end, appropriately reflecting the newness of the 2004 accident year.

As you'll hear from our team today, the quarter tracked the mainstream of our commentary throughout the past year, namely, continued improvement in our underlying P&C margins, significant improvement in loss adjustment expense with improving severity control from our claims redesign and reorganization, sales productivity and revenue gains in three of our four lines, while admittedly paying the price for our aggressive pricing and underwriting actions in reduced levels of auto sales and PIF. We also delivered greater fee income from the sale of our Partner Life products, asset growth and annuities, which crossed the $3 billion mark, and greater efficiency in our company-wide cost structure, which will certainly serve us well in the coming year.

All of the changes that we instituted in the management of our investments resulted in no impairments in our fixed income portfolio, and a minimal watch list. Elsewhere on the balance sheet, we feel very comfortable about our reserves for both P&C and life and annuity, including our current provision for hurricane losses. Let me just add that we are very proud of our claims team for their execution in closing over 99 percent of our hurricane claims. Despite the unprecedented frequency and severity of last year's four hurricanes, our capital increased nicely, benefiting all key capital ratios and improving the rating agency's outlook for the Company.

So all in all, we feel very good about the progress we have made and how the efforts of every Horace Mann employee over the past few years has seen the light of day in our reported results for 2004, and in our stock price performance, which was positive on both an absolute and relative basis. But that's history now, having restored margins, become more cost effective and improved the balance sheet, where do we go from here? We view 2004 as a transition year dedicated to turning the corner on auto and agent growth, while maintaining P&C margin adequacy, life and annuity sales momentum, and realizing continued benefits from disciplined expense controls.

Given the competitive environment described in the pronouncements that you've heard from other companies, what we're pursuing along the growth dimension in auto is certainly not without its challenges. Like others, our favorable P&C results will reduce our ability to increase rates in some states. So looking forward, auto new business unit growth is clearly critical to drive revenue and in turn future earnings growth.

As you are going to hear from both Doug and Butch, we are deploying a series of both short- and medium-term initiatives to power up our agents in the auto line and to increase overall agent growth. The combination of a more robust and sophisticated pricing model, a product management organization focused on local markets, a new agent compensation program to support more auto growth, a strengthened field organization, and improve ease of doing business is designed to make that happen. In addition, the time-out that we called last year to improve our overall agent retention and the quality and productivity of new agents has paid off. Having stabilized total agent count over the last two quarters now, we're optimistic about our agency force growth prospects going forward.

We'll not be immune to the industry trends of increased price competition, regulatory constraints and frequency trends that may put pressure on the personal line sector. While it will take time for our auto and agent growth initiative to take hold, our continuing company-wide expense control focus will help us to continue to have favorable expense ratios. Additional improvement opportunities in our claims operation, particularly in severity control, should help counter competitive and regulatory pressures on loss ratios. At the same time, we certainly intend to maintain the positive momentum that we've achieved in the growth of life and annuity, which will continue to play a vital role in our growth strategies as we reach out to and retain more educators.

So put all that together and our earning guidance for net income excluding realized capital gains and losses for 2005 is a range of $1.65 to $1.75 pre-CoCo accounting, and $1.55 to $1.65 after CoCo. The midpoint of that range should deliver book value growth of 11 to 13 percent, and an ROE of 13 to 15 percent, along with further improvement in capital ratios at both the operating and holding company levels. While we view accomplishing those results to be a positive achievement, the transition that we're going to be going through over the course of this year will build a solid foundation for continued profitable growth in the years ahead. And now for the financial overview, we'll turn to Pete Heckman.

Thanks, Lou. Before commenting on fourth quarter and 2004 earnings, and in the event some members of the audience are not familiar with FASB's EITF related to convertible securities, I wanted to provide a little detail on the nature of this new accounting that went into effect for fourth quarter reporting. The EITF basically eliminated the ability to use contingent conversion accounting or, in other words, the ability to exclude the amount of equivalent common shares associated with the bond issues conversion option in a diluted EPS calculation for contingently convertible bonds, sometimes referred to as CoCos, with share-only settlement provisions. The EITF applies to our convertible notes issued in 2002, as well as to many other convertible bond issuers. The specific adjustments that apply to Horace Mann's diluted EPS calculations in 2004 year-end are described in footnote A on page 1 of the numerical exhibits accompanying the press release. Since the new accounting does not have a true economic impact, and since the dilution is relatively insignificant for Horace Mann in the 5 percent range, we chose not to spend real money and go through the process of reissuing or converting our bonds with modified settlement provisions. Most other companies that we are aware of that are similarly affected have reached the same conclusion.

For those of you already up to speed on this issue, including those we consulted with a few months ago, who confirmed the appropriateness of our approach here, I apologize for the repetition. For the others on the call this morning, I hope this helps you understand the references in the press release, as well as any comments Lou or I make today that refer to EPS results before CoCo or after CoCo.

So, getting back on track, fourth quarter net income excluding net realized investment gains was 54 cents per share, 57 cents before CoCo, above the first call consensus of 42 cents and significantly better than 2003 fourth quarter earnings of 22 cents. There was a fair amount of noise in the fourth quarter results, including some tax accrual revisions that had a favorable impact on earnings. Even adjusting for those items, however, full year net income excluding net realized investment gains of $1.04, or $1.09 before CoCo, exceeded our post-hurricane expectations for the year, driven by the continuing strong underlying property and casualty results. Doug will provide more detail on those results in just a moment, but I did want to point out that in light of the unusual level of catastrophe losses experienced in 2004, including hurricane-related reserve strengthening in the fourth quarter, and the amount of prior year's reserve strengthening which occurred in 2003, we have provided again this quarter an exhibit in the press release which we believe will be helpful in understanding the underlying P&C trends. That exhibit also contains information that provides a more meaningful comparison of property and casualty premiums between the two years, adjusting for the adverse impact in 2004 of certain reinsurance transactions and accruals for premium refunds.

Turning now to reserves. Based on our review of December 31, 2004 property and casualty claims reserves, and reflecting a re-estimate of 2004 accident year ultimate losses, we released approximately $13 million of reserves in the fourth quarter related to claims which occurred in the first three quarters of the year. Prior year's reserve development unbalance continued to be consistent with our expectations with the $3.8 millions of strengthening in the quarter related to a single claim that occurred over 10 years ago. Based on additional payments and claim development in the fourth quarter, we also increased our estimate of net reserves and reinstatement premiums related to Hurricanes Charley, Frances, Ivan and Jeanne by $11 million. This reflected more refined lost estimates by storm, along with a higher level of supplemental payments on closed claims than had been anticipated in our prior estimate.

Relative to the independent year-end review performed by D&T, Horace Mann's held reserves at 12/31/04 were toward the high end of Deloitte's range, primarily related to the auto liability coverages for the 2004 accident year.

While we're on the balance sheet, as Lou mentioned in his remarks and in spite of the unprecedented level of catastrophe losses during the year, Horace Mann's shareholder's equity and book value per share increased 8 percent in 2004, and ROE ended the year in double figures. As a result, both GAAP and statutory leverage ratios were improved compared to year-end 2003, which contributed to Moody's and S&P upgrading our ratings outlook in the fourth quarter.

Moving on to Investments. We realized net capital gains of approximately $3 million pre-tax in the fourth quarter, and $12 million year-to-date. There were no write-downs or impairments in the fixed income portfolio during the year, and our credit watch list had only one security trading below 90 percent of book value at December 31. Pre-tax investment income increased just over 3.5 percent in both the fourth quarter and full year.

Looking ahead to 2005, as far as investment income is concerned, due to the impact of hurricane claim payments on invested assets and our expectation for a substantially reduced level of prepayment income, we would expect total investment income to increase only modestly over 2004, perhaps in the 1 to 2 percent range, with property and casualty investment income expected to fall below prior year.

Finally, our guidance for 2005 net income excluding realized investment gains and losses of $1.55 to $1.65 equates to $1.65 to 75, excluding the CoCo adjustment. Our guidance is predicated on continued strong underlying property and casualty results with normal catastrophes and stable annuity and life segment earnings in total compared to 2004. As Lou indicated, achieving those results would drive a very attractive 13 to 15 percent pre-FAS 115 operating ROE, and a growth in pre-FAS 115 book value in the 11 to 13 percent range. With that, let me turn it over to Doug Reynolds, to review property and casualty.

Thanks, Pete. Good morning, everyone. As Lou indicated, I'm going to take you through the property and casualty results for the quarter and the year, also providing some context of our expectations for 2005. As you have already seen, property and casualty enjoyed excellent results in both the quarter and the year. While the unprecedented Florida hurricane activity impacted our bottom line, the underlying results for our core business continued to improve.

Let me highlight a few numbers to illustrate my point. In the quarter, we delivered a combined ratio of 88.2 percent, and for the year 100.5. When you exclude the effects of the catastrophes in any prior year's reserve development, we posted very attractive combined ratios of 77.2 for the quarter, and 86.4 for the year. And, as a reminder, we typically would add about 3-1/2 to 4 points to our combined ratio as a catastrophe load. To give you an idea of how far we've come as an improvement over prior year excluding catastrophes and any prior year reserve development of 15 points for the quarter and 9 points for the year. Because of the 2004 accident year favorable development reported in the fourth quarter, the better barometer of our progress is the year-over-year results. With improvements across the board in both auto and property, including positive progress on PR premium, loss adjustment expense, and total expenses.

Individual lines also performed extremely well in the fourth quarter and for the year. Again, excluding the impact of catastrophes and any prior year's reserve changes, the 2004 year-end combined ratios improved by almost 7 points for auto and nearly 15 points for property compared to 2003. At normal catastrophes, 2004 saw our property business achieve a low 80s combined ratio and auto posted a combined ratio below 92.

As I said in past calls, there have been a number of factors that have contributed to improve the quality of our business. Over the past three years, our combined property and casualty accident year loss and LAE results at normal catastrophes have improved by 13 points. Looking at the components over that three-year period, auto improved almost 10 points, and property improved approximately 24 points. We have also continued to improve our book of business by writing a larger percentage of our business from our primary target market, the educator, as well as in our most profitable tiers for both auto and property.

Of equal importance, we continue to experience improvements in our claims operation in loss adjustment expense, severity control, and agent and customer satisfaction. Our new organization allowed us to respond quickly and professionally to the four hurricanes in Florida, and we are now over 99 percent closed for all claims generated, and we have received letters of thanks from many of our customers for the empathy and professionalism we showed in responding to their needs. One of the key goals of ACE is to drive process improvements wherever possible.

In the fourth quarter we changed our process for first notice of loss, eliminating a vendor from the process, and we began taking claim reports directly from our customers in each of our six claims offices. We are already seeing a benefit from this change through higher customer satisfaction, quicker settlement times, and more accurate initial information. We believe this process will continue to show improvement as we move through 2005.

While 2004 was a year for us to focus on rate adequacy and further improvement of our margins, our rate increase activity slowed in the fourth quarter. Auto final rate changes in the quarter were about 2.5 percent, and property approximately 8 percent. We are pleased with the progress we've made and the underlying results we've achieved. However, new challenges are in the forefront for 2005.

First and foremost, we need to grow our automobile business. As we move to 2005, we expect to see growth over prior year for new business. As new business increases, we will need to grow in auto policies in force for 2006. At the same time, we want to make our agents more successful by increasing their average productivity. In a few minutes, Butch will share with you several marketing strategies designed to drive growth. Additionally, we have developed other complimentary strategies to drive growth over both the short and long term. For example, we continue to move forward with the development of our Educator Segmentation Model, a tool to differentiate our business from competitors who don't focus on this market. It employs a more surgical approach to pricing, favoring our targeted business. We are on track for filing in the first quarter of 2005, and expect to implement additional states prior to the end of the year.

Product management is another method of operating we are using to help drive growth while maintaining margins. This structure and how we utilize it will have a more immediate impact on sales by bringing more focus and discipline to our partnership with marketing. Currently, product management is in place in six key states, and our product managers are working closely with our field organization to identify opportunities to grow our presence in the educator market, while addressing any loss challenges.

Looking forward to 2005, we expect the combined ratio for both auto and property to increase slightly to a level in the low 90s at average catastrophes and with a slight decrease in total premiums. There are a number of factors that will drive this result. As our results would indicate, we will experience a slow-down in our rate activity. Auto will experience a number of carefully selected rate reductions. Few pricing changes will occur on the property side. In both lines, price changes will be targeted to favor our educator market and preferred risk. Overall, we expect about a 1 percent reduction in auto rate levels and property rates will be flat. However, in those areas where we experience loss pressures, we will continue to take aggressive action to improve margins. We also expect increases in auto and property frequencies, where they return to more normal [inaudible]. For both auto and property, severities will increase, but we are planning on levels that are below inflation as we continue to drive improvements through our ACE claims initiatives.

Overall, we expect 2005 to be another solid year for earnings as we continue our expense control initiatives, drive continued improvements in claims, and manage the margins of our business while driving auto new business growth. As we move through the year, we also expect to gain some traction with agent productivity increases as we balance our top line growth with bottom line results. And now, let me turn it back to Pete Heckman for an update on our life and annuity business.

Thanks, Doug. Just a few brief comments on life and annuity. First, with regard to the life segment, while premiums and contract deposits showed modest declines in both the fourth quarter and 12 months compared to 2003, life sales continued to be strong, driven by the success of our Universal Life partner product manufactured by Jefferson Pilot, total life sales in 2004 were up 27 percent in the quarter, and 23 percent year-to-date. In terms of the bottom line, fourth quarter 2004 life segment pre-tax earnings of 5.5 million, while below prior year on a reported basis was nearly $1 million above fourth quarter of 2003, excluding the favorable impact of DAC unlocking in the prior period. Year-to-date, life earnings were well ahead of prior year, up 19 percent, excluding the impact of unlocking due to the expected increase in fee income from partner product sales, and the unanticipated benefits from favorable mortality and unusually strong group insurance results, which we commented on last quarter.

Looking ahead and assuming a return to normal mortality and group results, we would expect 2005 life segment pre-tax income to fall somewhere between the 2003 and 2004 levels, adjusting for the impact of DAC unlocking.

In our annuity segment, December 31 total cash values grew by 11 percent over prior year. That increase was evenly balanced between the fixed and variable components, each generating double-digit growth over 2003. The 12 percent increase in variable annuity cash value was driven by both market appreciation and positive net funds growth. Total contracts in force grew by 4 percent, and cash value retention remained strong in the 93 to 95 percent range. Annuity segment pre-tax income of $3 million in the fourth quarter was adversely impacted by DAK and PIF unlocking as revised interest rate and [inaudible] assumptions more than offset the positive impact of market appreciation experience in the quarter. Excluding the impact of unlocking and change in guaranteed minimum death benefit reserves, 2004 annuity pre-tax income exceeded the prior year by approximately 15 percent of the quarter, and 12 percent for the full year, driven by increased contract fees and investment income prepayments.

Looking to 2005, we would expect annuity earnings to be slightly above the 2004 level, excluding unlocking, with growth and assets and contract fees offsetting spread compression, and the anticipated reduction in prepayment income. And now I'll turn it over to our senior VP of marketing, Butch Joyner.

Thanks, Pete, and good morning. Our sales in the fourth quarter followed the summer pattern of sales in the first three quarters of the year; that is, outstanding sales results in three lines and one line in transition. For 2004, total sales increased a respectful 8 percent over the prior year. Career agent sales rose 11 percent over 2003, and career agent productivity increased by 21 percent compared to the 2003 time frame. I am proud to say that this is fifth consecutive year for increased agent productivity. In fact, we have doubled our agent productivity in the past five years. So let's get behind some of the factors driving this increased productivity.

Let's begin with Life. Life sales are solid for the quarter and the year. Fourth quarter sales increased 27 percent over results of a year ago. For the year, Life sales also posted double-digit results, rising 23 percent over 2003. These results were driven by the more fully developed relationship with our partner companies and the continued implementation of our new selling system solutions. The momentum that began earlier in the year on annuity sales continued in the fourth quarter. Again, we enjoyed double digit sales growth 2004 annuity sales increasing by 19 percent for the full year over 2003. Of note are the full year career agent sales results, which showed an 11 percent increase in the quarter, and a 26 percent increase for the full year.

On the independent agent side of the equation, annuity sales for the full year were flat to the previous year. However, independent agent sales increased in their volume of qualified business in the quarter as we continued to shift the emphasis of the distribution channel to the educator market. As reported in the third quarter column, we fully expected this shift to have a short-term effect on sales growth in this sector. The good news is that on a going-forward basis, we anticipate continued growth from both independent and Horace Mann agents.

On the Property and Casualty side of our business, property new sales premium for 2004 grew by a more modest 2 percent over 2003. Auto new sales premium, however, was down by 14 percent for the same time period.

We spent the past two years focusing on returning acceptable margins to our auto business, but now it's time to grow, and I can assure you that auto growth has our full attention and we're taking aggressive actions to boost sales. For example, our mid-agent compensation program introduced at the beginning of this year provides agents with additional financial motivation to increase new business sales through improved commissions. Additionally, larger renewal opportunities designed to improve the retention of in-force business are available to agents with demonstrated new business growth. We believe that by tying new business growth and retention together, we can create a win-win for the agent, as well as the Company. Increased renewals will also allow them to invest in their own operations, such as hiring support staff, which improves their productivity.

We've also changed the compensation structures of our field managers, giving them added skin in the game for both auto growth and auto staffing, enhancing their opportunities for financial growth. As part of our new strength in field organization, we have created a new position in each marketing region, a property and casualty specialist, to assist in training and developing agents in the best practices of their high producing peers. All the changes and initiatives we've taken both in marketing and property and casualty represent an integrated effort designed to deliver results in our auto book. It is a total team effort, and working together we have a plan that we believe in and, more importantly, have the confidence and a facility to produce results.

As Lou mentioned, we have stabilized the total agent count over the past two quarters, while growing the number of experienced agents by 6 percent this past year. Growth in experienced agents defined as those with more than two years of selling experience, is an important measure, as they are our most productive agent group. In an earlier call, we reported on a new agent retention program introduced at the beginning of 2004. This program included fewer planned hires, better selection, longer pre-contract training, and hiring in preferred territories. These efforts contributed to a 13-point improvement in the retention of our 2004 hires, compared to the retention of 2003 hires in the corresponding years. At the same time, the 2004 hires increased their productivity levels by 19 percent over the 2003 hires.

Looking at this year, we anticipate growing our sales force by increasing our new hires while maintaining and improving upon the hiring practices that created the positive 2004 results. That, coupled with our restructured field organization, an organization with positions created to focus on agent growth and development, will be a key factor in both increased recruiting activity and improved retention of agents.

Going forward we remain optimistic. We have every intention of following up a successful 2004 with a clear focus on the challenge of increasing auto sales and growing our agency force, while maintaining the momentum we have filled in our lines. Thank you, and now back to Dwayne.

Thanks, Butch. That concludes our prepared remarks. Ian, please move to the question and answer session.

Thank you. The floor is now open for questions. (OPERATOR INSTRUCTIONS) Our first question comes from Mark Finkelstein with Cochran Carolina.

Hi, good morning. I have a couple of questions. In the PIF decline of 5 percent, do you know roughly how much that was between educator and non-educators?

Not an exact number. This is Doug Reynolds. I wouldn't have an exact number, but the trend was continued as the decline was predominantly made up of the non-educator market.

Okay.

Mark, it would also be weighted towards the less desirable underwriting tiers as well.

Okay, perfect. And on the -- I just want to make sure I understand your comments regarding the 13 million of favorable development on the 2004 first three quarters, I guess accident quarters. You mentioned that -- you referenced the Deloitte report and that you were still at the higher end of their range. Was that after the 13 million release, or was it before that and kind of where is it at year-end based on their analysis?

Those comments all were after our release of reserves. So after our results were finalized, which included the 13 million '04 accident year release, Deloitte did an independent study and with that release we still remain toward the high end of their range, mainly still in the '04 accident year, which, as Lou mentioned, is the appropriate place that we feel to be somewhat conservative, given the newness of that year, and also since the predominance of that conservatism is in the longer tail of auto liability lines.

Okay. And then, I guess to follow up on that. The 3.8 million of adverse development related to 2003 prior year, that related entirely to one claim, or was there any leakage on kind of the most recent couple of years based on some of the claims issues?

No, absolutely no leakage on anything other than the one claim that I mentioned.

Okay, perfect. And then my last question. Just to get a feel, how much in fee income did you get in the quarter from the partner products/UL distributed or manufactured by Jefferson Pilot, just to get a feel for what that nominal number is?

We got 3.1 million for the year, probably a little more than 25 percent of that in the fourth quarter, I think, would be a reasonable estimate.

Okay. And is that -- that's the amount that is retained by Horace Mann versus -- do you have any payments that you have to make out to agents or whatever, or is that kind of your piece?

Yes, we do have some bonus commission and override source of payments that reduce that somewhat, so it's not totally to our bottom line.

Okay. And how much would you expect that to be out of the 3.1, just an approximation?

Maybe half or so.

Okay. So 1.5 million is kind of the net piece to you for the year. Okay.

Roughly, yes.

That covers my questions. Thank you.

(OPERATOR INSTRUCTIONS) There appear to be no further questions. I'd like to turn it back over to Mr. Hallman for any closing remarks.

Thank you for your participating on the call this morning. We look forward to visiting with you at the end of the first quarter. 1000738

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