Horace Mann Educators Corp (HMN) 2005 Q2 法說會逐字稿

Good morning and welcome to the Horace Mann Educators Second 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 this call over to your host, Mr. Dwayne Hallman. Sir, you may begin.

Good morning, everyone, and welcome to our Second Quarter 2005 Earnings Conference Call. Yesterday, after the market closed, we released our earnings report, including financial statements, as well 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 our results for the second 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 Chief Executive Officer, Pete Heckman, Executive Vice President and Chief Financial Officer, Doug Reynolds, Executive Vice President, Property Casualty, Frank D'ambra, Senior Vice President of Life and Annuities, and Butch Joyner, Senior Vice President of Marketing.

The following discussion may contain forward-looking statements regarding Horace Mann and its operations. Our actual results may differ materially from these projected in the forward-looking statements. These forward-looking statements are made based on management's current expectations and beliefs as of the date and time of this call.

For discussions of risks 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 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 September 5, 2005.

Now I'll turn the call over to Lou Lower for his comments.

Good morning, and thanks for joining us. As we announced yesterday, Horace Mann delivered a strong second quarter, with net income before realized gains of $0.65 a share. That's an increase of 51% over the prior year and above the consensus of $0.44 per share. And just to remind you, per share data now includes additional dilution from the new [Co Co] Accounting Convention, the impact of which was approximately $0.06 per share at operating income for the second quarter of 2005.

As we reported, second quarter results were bolstered by favorable catastrophe experience and the release of a contingent federal income tax liability. But more importantly, our positive earning results are attributable to consistent, underlying profit margins and continuing improvements in our property casualty segment. Favorable variances and current accident year results are the direct result of pricing and underwriting actions, transformation of our claims organization, outstanding quality trends in our book of business, as well as favorable frequency trends. All of those factors worked together to deliver a very healthy combined ratio of 84.3 for the quarter.

As we discussed last quarter, with financial stability and profitability in place, our focus now is directed at growing our P&C book of business through a combination of increased new business and improved retention of the in-force, while maintaining acceptable levels of profitability.

The first leg of the growth equation is to expand our agency force. And for the first time in 7 quarters, our agent count, which now stands at 837, has increased both over prior year and sequentially. We do anticipate continued growth over the balance of the year, but at a more moderate pace, so that we ensure continued quality hires with improved retention of our sales force.

The second leg of the growth equation is raising agent auto productivity. Heightened sales focus, and the positive influence of our product management organization are starting to bring our agents back to the auto market in an environment which now has stability and consistency in terms of pricing, underwriting, and claims handling. While second quarter auto sales were still below last year's levels, the gap to prior year is closing month by month. Total auto PIF decreased year-over-year, but appears to be bottoming out, while our Educator PIF has increased sequentially with improving retention. We are encouraged by those emerging trends and are deploying a broad list of critical initiatives to increase their momentum to realize the full potential of our franchise.

Sales and earnings year-to-date in the annuity line are off last year's pace as we, along with the industry, face a very challenging interest rate environment. Low [inaudible] fluid interest rates, an ever flattening yield curve, and tight credit spreads continue to work against new fixed annuity sales, as well as [inaudible] spreads. While we've just recently seen some positive sales activity, we have no intention of sacrificing our pricing discipline to drive volume.

Other highlights of the call today include positive life segment earnings and continued solid, companywide expense control discipline. From a balance sheet perspective, we continue to feel very good about the strength, stability, and consistency of our P&C reserves. Investments remain well diversified and high quality, with no impairments during the quarter. Our key capital ratios continue to improve on both the GAAP and SAP bases, at both operating and holding company levels. Book value increased 26% year over year, in part driven by the impact of lower interest rates on unrealized gains. Excluding that impact, pre-FAS-115 book value increased 13% compared to last June 30.

All in all, the results reflect our solid financial conditions, attractive property casualty margin, leading indicators of future personal lines growth, and growing distribution power. As a result, we remain confident about our prospects for the future and are increasing our guidance for the year by $0.25 to a range of $1.82 to $1.90, the midpoint of which equates to an operating ROE ex-FAS-115 of approximately 16%.

And now here's Pete with some additional information on the second quarter financials.

Thanks Lou, and good morning. As Lou just mentioned, Horace Mann recorded another excellent quarter in terms of underlying earnings. On top of that, and similar to last year, we experienced an unusually low level of catastrophe losses in the second quarter. And the receipt of a federal income tax refund in the current quarter generated increased earnings of approximately $0.08 per diluted share.

The tax item had two components. The first was a release of the contingent tax liability associated with 2 tax years that are now closed, which was recorded as a $2.7 million reduction in federal income tax expense in the corporate and other segment. The second was the receipt of $1.4 million pre-tax of tax refund interest, which was recorded as other income across all business segments, with about $900,000 of that $1.4 million benefiting the annuity line of business.

In terms of operating results, excluding the tax benefit and the impact of DAC unlocking, underlying annuity and life segment earnings were consistent with our expectations through 6 months. And with the total combined ratio in the 84 to 85% range, P&C underwriting results continued to be very favorable and consistent -- once again, the real strength of the quarter. Catastrophe costs were worth only about 2 points on the combined ratio in the second quarter, while favorable prior year reserve development resulted in a 1 point benefit.

With regard to property casualty reserves, BMT performed a complete, independent review of our reserves as of June 30, consistent with past practice. Our degree of confidence in our reserving process and level of reserves has increased steadily over the last few quarters. Still, we remain somewhat cautious, with our held reserves at 6-30-05 toward the high end of VMT's range, similar to our position at year end.

Total net investment income in the second quarter, and year-to-date, was generally consistent with our expectations, and slightly ahead of prior year, in spite of significantly lower prepayment income in the current period. We realized pretax capital gains of $4.3 million in the quarter, had no impairment write-downs, and our watch list remains minimal.

In terms of our capital structure, we completed two rather significant transactions in the second quarter. We replaced our expiring, 1 year, $35 million bank line with a 4 year, $100 million credit facility, which, by the way, ended up being oversubscribed. We also issued $75 million of 10 year senior notes, with a 6.05% coupon, using the proceeds to retire the remainder of our 2006 senior notes and repay the outstanding balance on the expiring bank line. With these transactions, we substantially increased our financial flexibility and refinanced existing debt at a lower rate. And throughout the process, we were very encouraged by the receptivity of the capital markets to the Horace Mann name.

And finally, as you saw in the press release, and as Lou just mentioned, we raised our 2005 year end estimate of net income before realized investment gains and losses by $0.25 to between $1.80 and $1.90 per diluted share. This increase reflects the strong underlying results we've experienced in the first half of the year, along with the second quarter tax benefit, while remaining cautious with regard to what some feel will be a difficult hurricane season. We'll obviously know a lot more at the end of the third quarter, and if appropriate, we'll update our outlook at that time.

Now let me turn it over to Doug Reynolds for his comments on property and casualty.

Thanks, Pete, and good morning, everyone. The second quarter of 2005 continued the trend of solid quarterly results for property and casualty in both our auto and property lines. For the quarter, we posted a total combined ratio of 82.2%, excluding catastrophes, a near 7 point improvement over prior year. On the same basis, our 2005 year-to-date combined ratio of 83.7% also improved by more than 7 points, and more importantly, reflects a 3 point improvement over 2004 full year results.

Within the specific lines of business, voluntary auto, again ex-catastrophe, achieved a combined ratio of 91% for the quarter, a solid improvement over second quarter 2004, and about equal to our first quarter 2005 results. Similar trends, excluding catastrophes, also held true in property, but we had a combined ratio of 59.5%, some 17 points better than last year's second quarter. In a comparison to 2004 full year, it's a 12 point improvement.

As regards premium and loss trends in the second quarter, we experienced, not unexpectedly, a slight decrease on our auto average written premium versus a slight increase on the year-to-date basis. Our property average risk premium continued to increase in the quarter, but at a slowing pace. The good news is, the trends in both lines are mainly attributable to the ever improving quality of our business, as we write and retain more educators within the lower priced, better quality tiers. As you might guess, with all the rate activity and other changes implemented over the past few years, we see far less need for rate increases.

On the loss side, our average earned premium continues to outpace paid pure premium trends as our frequencies and severities continue to perform well within expectations. As we have discussed in the past, retention improvements, especially within the Educator segment, is a key opportunity that has our attention and focus. In the second quarter, auto Educator policies in force increased sequentially for the first time since the second half of 2003. This positive result was driven by both increased new business sales, as well as an increase in the retention ratio for this segment.

As part of this effort, during the second quarter, we began piloting several client retention based initiatives to broaden our relationship with Educator clients, as well as to keep us in closer touch. Additionally, the quality of our renewal business continues to improve, as an increasing percentage of our business is Educator and placed into our better experienced tiers. In addition to the auto retention improvements, we also achieved an increase in the number of Educator property policies, along with an increase in the retention ratio.

On new business quality, we note continued strength as we write in excess of 70% Educator for both auto and property. In our preferred tiers, we also exceeded 65% for the quarter in both lines. During the quarter, we began sending out renewals to customers in the first state introduced to our new, more sophisticated pricing model. We plan to introduce one additional state this year and another state in 2006. The pricing model, called Educator Segmentation Model, or ESM, provides greater rating flexibility through the use of many more price points, while providing even greater focus on the Educator marketplace.

Overall, we had a strong quarter. We are pleased with the continued, positive, underlying loss trends, and more importantly, the consistency of our results from month to month. In addition, the increase in both auto and property Educator households, and for auto, for the first time in over 6 quarters, is an extremely positive sign.

And now, let me turn it over to our Senior Vice President of Life and Annuity, Frank D'ambra.

Thanks, Doug, and good morning. As Lou stated earlier, the overall market for annuity sales remains a difficult one for the industry and our Company. This is reflected in the modest decline in total annuity sales for the second quarter of 2005 when compared to the second quarter of 2004. However, on a positive note, second quarter 2005 sales improved over the first quarter of 2005. When measured sequentially, second quarter sales were up 8% over the first quarter, bolstered by a 22% gain in single or rollover deposits. And we continue to see positive results in our core scheduled recurring premium deposit system. Sales were up 10% for the first 6 months of 2005, as compared to 2004. We continue to grow our policy count at a 3% annual rate and benefit from increased contribution levels from current customers.

I want to reiterate one point we made earlier, and that is while we are committed to growing the annuity line as rapidly as possible on a profitable basis, we will not alter our pricing discipline in this regard.

For the period ending June 30, 2005, total annuity assets under management grew year over year by 8.6%, with fixed annuity assets increasing 8.8%, and variable assets growing by 8.3%. During the first quarter earnings call, we announced that effective February 1, we started selling a new partner product, the Equity Index Annuity Series from Jefferson Pilot. Initially, we anticipated 2005 sales of $4 million. In the second quarter, we sold $3 million, and the current sales pace continues to exceed our expectations. I believe this result reflects the inherent and growing strength of our distribution system when it is equipped with a competitive, customer desired product.

Second quarter pretax income for the annuity segment of $4.4 million represents a modest gain over the second quarter of 2004. Increased contract charges and fees, lower mortality and benefit costs, and tax refund interest offset unfavorable DAC and DIP unlocking. For the 6 months, pretax income for the annuity line was $7.8 million, a decline of $1.9 million from the prior year period. Unfavorable DAC and DIP unlocking and decreased interest margins were partially offset by lower operating expenses. Excluding the impact of DAC unlocking and one-time items, earnings were up slightly.

Sales of life products in the quarter were down 14% versus 2004, with Horace Mann products down 12% and partner products down 16%. For the 6 months, sales were down 10%. The downturn in partner sales is due solely to a decline in Universal Life. In concert with our partner, we have identified and are working to address customer service and marketing support issues, which we believe are dampening sales.

Second quarter total life premiums, which consist of Horace Mann products only, were flat when compared to the second quarter of 2004 and were down 2.5% year over year for the first 6 months. The second quarter comparisons improved over the first quarter comparisons and premiums declined by 5%.

Pretax income for the life segment increased in the second quarter from a year ago by $2.6 million, or 52%, and by $2.8 million, or 28.6%, for the first 6 months. Earnings benefited from lower operating expenses and favorable DAC unlocking.

Looking forward, we are on track to launch a new series of term and whole life products, as well as significant enhancements to our variable annuity products, in the first quarter of 2006. The life products will be Horace Mann's first new offerings in several years. These products were developed with significant voice of the customer input, and have been well received in field previews. We continue to monitor the market and regulatory environment, as well as work closely with sales and marketing, to identify and act on solution opportunities. By doing so, we can ensure that we fulfill our mission of being the Educator's lifetime financial partner and realize the full potential of the Horace Mann franchise.

Thank you, and here's Butch Joyner, Senior Vice President of Marketing.

Thank you, Frank. As Lou mentioned, the first half of the year focused on growing our agency force and increasing our agents' auto productivity. Although challenges remain in these critical areas, I am pleased to report that we are encouraged by the progress made in the first half, as the momentum we built in the first 3 months carried into the second quarter. With that said, let's look at agent growth.

As Lou pointed out a few minutes ago, our agent count grew to 837. That represents a 4% increase compared to last June. Inside of that growth, we saw increases in the number of experienced agents, which underscored stability in our sales force, as well as an increase in base force retention, reflecting on our improving ability to attract and retain quality hires. We anticipate continued growth in our agency force for the balance of the year, albeit more moderate than the first 2 quarters.

The second part of the growth equation is agent auto productivity. As a reminder, we view auto productivity as the gateway that provides a solid financial base on which to build a successful, professional franchise. So, on the productivity side, we're encouraged by the number of agents who are electing to get back to aggressively marketing the auto line of business. They realize that the pricing environment for the Company and the industry has stabilized. They are confident in our competitiveness within our target market, and they welcome the additional marketing support and promotion developed for this business line.

As stated last quarter, we're making progress in building momentum, but there's still much to accomplish. For example, new sales auto premium decreased by 1% for the second quarter and 4% for the first half of 2005. But remember, we were looking at an 8% decrease in the first quarter, as compared to a year ago. More importantly, the second quarter of 2005 saw a 9% increase in the number of Educator auto new business units over the same period in 2004, underscoring Doug's comments about our efforts to attract and retain more Educators. So as you can see, we're continuing to close the gap.

Moving beyond agent growth and auto productivity, let me say a few words about overall sales activity. We experienced a 3% decrease in sales for the second quarter and a 9% decrease for the year. Total new sales premium for career agents in the second quarter was virtually flat, while sales in the independent agency channels were down 23%. These results are attributable, almost entirely, to the annuity line of business, specifically in the single premium business. This is the result of low levels of interest in a flat yield curve environment. While single premium business is down, our scheduled premium business has increased 10% for the 6 months.

I'll repeat that I'm encouraged by the progress made in the second quarter. The agent count continues to grow. Auto sales grew stronger in each month of the quarter, and new sales premium showed momentum, exceeding the first quarter of 2005 in all lines of business. While we are not where we want to be, the progress made in the second quarter positions us for continued, positive achievement through the balance of the year.

Thank you, and now back to Dwayne.

Thank you. And that concludes our prepared remarks. [Denaro], please move to the question answer session.

Thank you, sir. The floor is now open for questions. [OPERATOR INSTRUCTIONS] The first question comes from Bob Glasspiegel from Langen and McAlenney. Please pose your question, sir.

Good morning. A quick few questions. I was wondering if you could explain what was behind the increase in expense ratio in the quarter? Second question is the reinstatement premium. The third is, I didn't understand -- you said that the Educator's market was 70% of new business, but 65% in your preferred. Does that mean 5% were not preferred Educators?

Okay. Those are the three?

Yes.

Okay. This is Doug Reynolds. Let me address a couple of the items. First, on the expense ratio, really, I think there's probably a couple of things there. One is, obviously, the premiums are down a little bit, which is having a negative impact on the ratio overall. I think second thing, it fluctuates from quarter to quarter, and we had a few carryover benefits in the first quarter. And I think when we look at it on a year-to-date basis, we're still projecting us to run in the mid-22 range, which is really our target.

On the last question that you asked, in regards to the Educator, two separate things. One is, for our new business, over 70% in both auto and property are Educator.

Right.

On the quality tiers, that was for the entire new business book, so that would have included both Educator and non-Educator that were exceeding 65% in our top three quality tiers.

Okay. So some of the teachers would have been non-quality tiers?

Sure, some of the Educators would have been in our higher priced tiers.

Got you.

So, Bob, we would -- just to add to that, when they're in those higher priced tiers, we still believe that we've got the right price for the right risk.

Right.

So it's not that it's unprofitable business.

Got you.

Bob, I think your last question, or one of your questions, was reinstatement of premium in the quarter. I think that relates to the hurricanes in 2004. As we've seen some additional supplemental development through the first part of the year, we have triggered some reinstatement premiums in our [inaudible], so we're still within our expectations of overall hurricane reserves -- no impact there.

If you'd let me, one last question. If the premiums continue to contract, and I know that's not your game plan, you want to grow, but if your premiums continue to correct and your capital ratio is improved dramatically, does buyback become a viable option before too long?

That would certainly be something that we would consider, but having said that, our focus is on growing the business and putting the capital to work to facilitate that growth. But obviously, we, like others in the industry, if excess capital starts building, need to consider the prospect of share repurchase.

But you're at least a couple quarters away from that as a viable thought?

Absolutely.

Thank you.

Thank you. Our next question comes from Dan Farrell from Fox-Pitt, Kelton. Please pose your question.

Good morning.

Morning

A couple of questions. First, can you talk a little bit more about your efforts to improve the productivity per agent? Is it focused really more on their marketing, providing them product? Is it tweaking the compensation incentives? Can you just give a little more detail around that?

I think our -- This is Butch Joyner. The focus on increasing agent productivity would fall under a couple of areas. The major area is increasing the auto productivity, which we are seeing our agents approaching much more aggressively than in the past. We've done some re-training in the area. But the major factor, I think, is more and more of our agents are adding support help, enhancing their office operation, which helps drive productivity. And we would also expect increasing productivity in the annuity line of business.

Let me just maybe add a little bit to that. Yes, we do have agents -- we're trying to transition our agency force from single person operations to agents who have outside offices, support personnel, and solicitors. So the things that we've already put in place to facilitate that, we've revised our renewal commission schedules in auto; we've restructured our field organization to provide more support at the font line; improved the ease of doing business in the auto line, both for our customers and agents. Doug, in the past, has talked about our product management organization, which links the folks in the property casualty organization to developing opportunities for growth at a local market level working with Butch's field organization, streamlined the submission process of auto business, and provided greater marketing support. And then, things that are rolling out to further enhance that growth would include the Educator Segmentation Model that Doug mentioned, auto skills training that Butch mentioned, and a new property casualty front end to make the whole quoting, submission, and issuance policy process easier for our agents.

Okay. That's helpful. One other question. Can you talk a little bit more about the DAC adjustments, both on the life and the annuity, both this quarter -- and then just review what the underlying assumptions are in your DAC modeling?

On the annuity side, most of the DAC adjustments stem from capital gains that we took that were above and beyond what we anticipated for the year. I think we paid 10 -- $5 million, and so far, we've taken about $7.8 million, and that $5 million was spread out evenly over the course of the year. So if we don't take any additional gains on the annuity side, we would expect to get part of that back over the balance of the year.

On the life side, in one of our blocks of business we did have policy reserve release, and that's affected things. And in terms of the other adjustments we make, we look at things, for example, the expense assumptions that we have built in to the product, and we look at the actual experience we have against those, and those account for some adjustments. And as we look at the experience we're having in the block itself, there can be adjustments from quarter to quarter. At this point, I don't anything's occurred that's outside of what we were expecting at this point.

Okay. On the annuity book -- ?

Yes.

On the annuity book, what's the market return assumptions and surrender assumptions?

On the variable annuities, market return assumption is 9%.

Okay.

And our surrender assumptions on that -- we have what we call a cash persistency number, and our cash persistency number on that is between 93 and 94%.

Okay. Great. Thank you.

You're welcome.

[OPERATOR INSTRUCTIONS] Our next question comes from Alain Karaoglan from Deutsche Bank. Please pose your question.

Good morning. I have a couple of questions. The first one relates to your statutory capital position. What is your statutory surplus on the property casualty side, and what is it on the life side, as of June?

Alain, on the life side, adjusted capital and surplus is approximately $240 million, and on the P&C business, ending capital and surplus is around $280 million.

And what was your risk-based capital ratio on the life side at year end 2004?

It was a little over 400%, I think 430 range somewhere.

Okay. And in terms of the dollar amount of the impact of the [inaudible] unlocking on the life side, I may have missed that. What was the dollar amount?

The actual dollar amount on that was approximately $600,000.

Thank you very much.

And, Alain, that was a year-to-date number.

Yes.

Thank you. At this time I'm showing no further questions from the phone lines. I'd like to turn the call back over to Mr. Dwayne Hallman for any closing statement or comments.

Thank you for your time and attention today, and we look forward to speaking to you after the end of the next quarter. Have a good day.

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