Horace Mann Educators Corp (HMN) 2005 Q3 法說會逐字稿

Good morning, ladies and gentlemen. My name is Melissa, and I'll be your conference facilitator today. At this time I would like to welcome everyone to the Horace Mann Educators' Third Quarter Earnings Conference Call. [OPERATOR INSTRUCTIONS.] Thank you.

It is now my pleasure to turn the floor over to your host, Dwayne Hallman, Senior Vice President of Finance. Sir, you may begin your conference.

Good morning, everyone, and welcome to our Third 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 the results for the third 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 and Casualty; [Frank D'ambra][ph], Senior Vice President of Life and Annuity; and Butch Joyner, Senior Vice President of Marketing. Following the call, please feel free to contact me for further clarification of our results.

The following discussion may contain forward-looking statements regarding Horace Mann and its operations. Our actual results may differ materially from those projected in the forward-looking statements. These forward-looking statements are made based on management's current expectations and beliefs as of the date and time of this 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 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 5, 2005.

Now, I will turn the call over to Lou Lower for his comments.

Good morning, everyone. Thanks for joining us. As you're well aware, the past quarter was unprecedented in terms of the magnitude of catastrophic damage impacting the insurance industry and its customers. Despite the level of losses, we feel good about what we've accomplished at Horace Mann.

But first and foremost, our hearts go out to the human suffering caused by the devastation, and once again, we're very proud of the response of our entire claims organization. They are working under adverse and trying circumstances but successfully delivering our financial protection as quickly, compassionately, and equitably as possible to help restore the lives of our customers. That work, obviously, continues beyond the third quarter, and we have every confidence that our redesigned claims organization will perform to the same very high standards of service it delivered last year.

Despite the significant impact of third quarter cats to our financial results, we were able to absorb those events and still produce positive earnings for the quarter. Our net income before capital gains of $0.02 per share was, in fact, an improvement over the loss of $0.37 per share we recorded last year, thanks in no small part to strong underlying [10C][ph] profitability.

We've certainly been handsomely rewarded by the positive financial contributions of the key quality indicators we've set out to improve several years ago. Both educator business and business from our preferred underwriting tiers continues to increase as a percentage of both new and in-force policies. Those quality trends, coupled with the continued progress and the transformation of our claims organization, are driving very solid P&C margins with combined ratios, excluding cash and excluding prior-year development on a year-to-date basis better than last year.

As we discussed earlier in the year, we're transitioning our focus in 2005 from P&C margin expansion to profitable unit growth. The initiatives we've previously discussed are beginning to gain traction and produce our best quarter of the year from a growth perspective. Over the first half of the year, we narrowed the gap to prior year in auto sales with each passing month. That momentum continued into the third quarter, the gap closed, and auto unit sales passed into positive territory with a 3% increase to last year's quarter.

We're encouraged to see several other important and leading indicators of growth emerging as well.

Our agent count continues on its growth path, up 6% from last year's level. We're also realizing continued improvements in retention as more of the educator, higher quality, and multi-line business stays with us. Total PIF count is still below last year, but it's bottoming out, and more importantly, educator PIF continues to grow sequentially.

Year-to-date sales in the annuity line are off last year's record pace as we, along with the industry, faced a very challenging interest rate environment with low absolute interest rates, an ever-flattening yield curve, and tight credit spreads. Having said that, the quarter continued this year's pattern of sequential annuity sales and asset growth, with account values up 10% to prior year.

Despite that positive momentum, we will not sacrifice our pricing discipline to drive volume. As you'll hear, there are quite a few moving parts to life and annuity pretax earnings for both the quarter and year; however, in total through nine months, we are tracking our expectations.

From a balance sheet perspective, reserves are strong and developing favorably. Investments are well diversified and have continued high quality. Our key capital ratios are stronger now, both at operating and holding company levels than at year end 2004, and pre-FAS-115 book value per share has increased 16% over prior year, with improving return on equity.

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

Thanks, Lou, and good morning. Horace Mann's earnings in the third quarter were impacted by many of the same factors that have been in play over recent quarters and prior year. For the most part, that's good news. The one notable exception, of course, was catastrophes. Similar to last year, though not quite to the same magnitude, Horace Mann, along with the industry, incurred a significant level of catastrophe-related losses in the third quarter, primarily due to Katrina and other hurricanes that hit the Gulf Coast.

Estimated losses and loss adjustment expenses in the quarter related to catastrophes were $35.5 million pretax. This amount includes a $1.8 million assessment from the Florida Citizens Property Insurance Corporation related to the 2004 hurricane losses in that state. We also incurred approximately $9 million in catastrophe reinsurance reinstatement premiums, which brought our total pretax catastrophe costs to a little over $44 million in the current quarter, consistent with the estimate we pre-announced three weeks ago.

On a side note, I wanted to point out that beginning this quarter, we are no longer providing in the numerical exhibit attached to the press release adjusted P&C ratio and premium growth rate calculations that exclude catastrophes in order to stay clear of providing any non-GAAP measures. We have provided the raw data, including the impact of catastrophes on the combined ratio. But going forward, you'll need to calculate the adjustments required to get at the underlying premium growth, loss ratio, and expense ratio trends. In doing so this quarter, you'll note that the favorable underlying trends we've seen in our P&C business over the last two-plus years continued in the current period, with [ex-cat] combined ratios of 83 to 84% for the both the quarter and year-to-date.

In addition to positive current accident year results, prior year's reserves continued to develop favorably, benefiting the third quarter and year-to-date combined ratios by approximately 4.5 and 2 points, respectively.

As we disclosed in our pre-announcement, third quarter earnings were also favorably impacted by a reduction of approximately $6.4 million in federal income tax expense as a result of closing tax years 1998 through 2001 and eliminating the contingent tax liability related to those years. Of that total amount, about $3.6 million benefited annuity segment net income in the current quarter, with the remaining $2.8 million credited to corporate and other.

As you may recall, last quarter's earnings similarly benefited from a reduction of approximately $2.7 million in federal income tax expense, all of which was recorded in the corporate and other segment as a result of closing tax years 1996 and 1997.

And just to reiterate Lou's comment on life and annuity, I would again note that pretax income for these two segments, while somewhat volatile quarter to quarter, was comparable to prior year through nine months, excluding DAC unlocking and change in GMDB reserves, and was consistent with our expectations.

So in conclusion, and in spite of the significant catastrophe losses experienced, we are encouraged by the fact that Horace Mann recorded a third quarter profit; that book value per share, excluding FAS-115, declined less than 1% sequentially and increased 16% over prior year; that operating ROE, excluding FAS-115, improved to 16%; and that both statutory capital growth and operating leverage improvements in our P&C business have been substantial since the end of last year.

Our third quarter operating income EPS of $0.02 per share, while below the First Call Consensus, was consistent with our expectations and with the full-year guidance we provided. With operating EPS at $1.20 per share through nine months, our $1.70 to $1.80 guidance would imply a fourth quarter of between $0.50 and $0.60 per share, which is right in line with the average earnings recorded in the first two quarters of the year.

So with that, let me turn it over to Doug Reynolds for his comments on property and casualty. Doug?

Thanks, Pete, and good morning. The third quarter of 2005 proved to be as challenging as the third quarter we experienced in 2004, with multiple catastrophic events occurring in each year. Although these unfortunate events occurred two years in a row, they gave us the opportunity to once again show our responsiveness, compassion, and value to our clients.

As was covered in our press release, we posted net after-tax catastrophe costs of almost $29 million as a result of the multiple catastrophes. For the quarter, our combined ratio, excluding catastrophes, was 83.5%, 4 points better than prior year. On a year-to-date basis for 2005, excluding catastrophes, we are approximately 6 points lower than 2004.

The effects for prior year's favorable experience is 4.8 points and almost 2 points for the quarter and year-to-date, respectively. As in previous quarters, both auto and property continued with strong underlying performance. The auto and combined ratio for the quarter of 84.6%, excluding catastrophes, is over 7 points better than 2004 and 4.6 points better on a year-to-date basis at 88.8%. Our property book of business also continues to reflect the positive improvements we have made over the past few years as the combined ratio, excluding catastrophes, for the quarter was 77.1% and year-to-date, 68.5%.

For both lines of business, our expenses continue to stay in line with expectations. The improvement in the quality of our book of business is the driver of our continued success. We continue to focus on the educator, and for the quarter, 78% of our auto and new business was in our target market, along with continued increases in our preferred tiers.

As mentioned last quarter, we are increasing our focus on educator household retention to support our growth objectives. We are piloting touch point programs to expand our relationship with our educator clients. While still early, we are seeing indications of improved retention for our educator clientele.

In the third quarter, educator policies in force increased sequentially for both auto and property for the second quarter in a row. In support of educator new business growth, we implemented our educator segmentation model in the state of Virginia during the quarter. This model provides significantly expanded price points and segmentation opportunities to achieve profitable growth. Early indications of results are positive, and we will introduce the model in Colorado during the fourth quarter. In 2006, we will expand implementation to additional states.

Average premium and pure premium are consistent with prior quarters and with our expectations. Average premium in auto for the quarter was about flat to prior year, as we continue improving the mix of our new and in-force book of business. For property, our average written premium continues to run above the prior year.

As you would expect, the hurricanes, especially Katrina, have proven to be a claims handling challenge. Although Katrina was the single largest event, we are also handling other significant storms of Dennis, Rita, and the hailstorms in Minneapolis as [straight] third quarter events, and most recently, Wilma. For all the storms, our primary mission is taking care of our customers and responding to their needs. Although there are areas of New Orleans that we still cannot enter to inspect damage, we have closed over 50% of the claims from Katrina.

Overall, we had a good quarter, with strong results in both auto and property. At the same time, we once again had a chance to show our customers our care and empathy through very difficult times.

And now, let me turn it over to Frank [D'ambra] for his comments on life and annuity. Frank.

Thanks, Doug, and good morning. As Lou indicated earlier, the annuity market continues to be growth challenged. However, unlike the first two quarters of 2005, which experienced a decline in sales as compared to 2004, third quarter total annuity sales increased 6%.

Third quarter sales benefited from a 7% gain in single or rollover deposits, while our core scheduled recurring premium deposit business was flat. For the first nine months of 2005, total annuity sales were down 5% from last year's record pace. Our single deposit or rollover business continues to lag 2004 by 8%, partially offset by a recurring deposit business, which has grown by 7%. We continue to grow our policy count at a 3% annual rate, with strong cash value retention in the range of 93 to 95%.

Total annuity assets continue to show healthy growth. For the period ending September 30, 2005, total annuity assets under management grew year over year by 10%, with fixed annuity assets increasing 8.3% and variable assets increasing 12.7%.

Third quarter pretax income for the annuity segment of $4 million represents a slight gain over third quarter 2004, with increased contract charges and fees and favorable DAC and DIP unlocking offsetting decreased interest margins. For the nine months, pretax income for the annuity line was $11.8 million, a decline of $1.6 million from the prior-year period. Unfavorable DAC and DIP unlocking and decreased interest margins were partially offset by increased contract charges and lower operating expenses. Excluding the impact of DAC unlocking and one-time items, earnings were up marginally.

Sales of life products in the quarter were down 19% versus 2004, with Horace Mann products down 12% and partner products down 24%. For the nine months, sales were down 13%. As we discussed in the second quarter call, the downturn in partner sales and the overall decline in sales is due to a decline in universal life. Having identified the critical service and marketing issues impacting sales, we are working with our partner to implement programs designed to reverse the recent sales trend in universal life.

Third quarter premiums, which represent Horace Mann products only, were down 3% compared to the third quarter of 2004 and were down 2.7% year-over-year for the first nine months. As we discussed in our last call, we are planning to launch a new series of term and whole life products in the first quarter of 2006, and we remain on track to meet that timetable. We expect these products to produce very favorable results for the sale of Horace Mann-manufactured life products.

Pretax income for the life segment decreased in the third quarter from a year ago by $3 million, or 40%. Earnings were impacted by a reduction in earned premiums, increased operating expenses, lower partner fees, and higher interest credited. For the nine months, earnings decreased slightly by $200,000. Prior credited interest, lower interest income, and higher claims were offset by favorable DAC unlocking and operating expenses.

During the February call, we indicated that after adjusting from locking and one-time events, annuity earnings would be slightly above 2004 and life earnings would fall between 2003 and 2004's final numbers. The results through the first nine months of 2005 are in line with those expectations.

And now, I will turn the call over to Butch Joyner, Senior VP of Marketing, for his comments.

Thanks, Frank, and good morning. In the third quarter, our focus [intended] on two priorities -- growing our agency force and increasing our agents' auto productivity. I am pleased to report the progress made in the first half of the year continued, and we have built added momentum to our efforts.

Let me start my comments with agent growth. The Horace Mann agency force now has three consecutive quarters of growth, and as I've said in previous calls, we expect the growth to continue in the coming quarter, although at more moderate levels.

Here's what it looks like. Compared to last September, we grew our agency force by just over 6%, ending the quarter with 849 agents. That includes an increase in the number of experienced agents, those agents with more than two years' experience, of almost 13%. That growth, the growth of experienced agents, is driven by a 10-point improvement in our base force retention.

As Lou mentioned, thanks to improving auto agent productivity, auto unit sales passed into positive territory. In the third quarter, we increased the sale of new auto units by 3% over the same period of a year ago. As mentioned in our last call, agents are becoming more aggressive and confident in the marketing of the quality of our auto business in the educator market. Their efforts are supported by the more stabilized pricing environment and additional marketing support we've placed behind them. As a result, we're closing the gap with last year's sales numbers.

New property unit sales increased by 4% and premium by 5% in the third quarter compared to the previous year. This growth ties back to our new auto sales results, and by concentrating marketing efforts on the educator business.

And there's more positive news. In the third quarter, sales from all lines increased by 2% compared to the third quarter of last year. In fact, the third quarter represented our best sales quarter since the third quarter of 2003.

On a year-to-date basis, total new sales premium decreased 5%, career agent sales dipped 3%, and independent agent sales are down 16%. The majority of the decrease lies in the annuity line of business, or more specifically, the single premium annuity, which continues to be affected by the current interest rate environment. However, in the third quarter, annuity sales increased by over 5.5% as teachers returned to school and make regularly scheduled deposits into their annuities.

In spite of challenges, I remain optimistic and encouraged by the progress made in agency force growth, continued new auto sales growth, and overall sales growth in the quarter. And the overall progress made in the third quarter places us in a position for positive results through the remainder of 2005 and then carrying that momentum into the new year.

Now, back to Dwayne.

Thank you, Butch. And that concludes our remarks. Melissa, please move to the question/answer session.

Thank you. [OPERATOR INSTRUCTIONS.]

Your first question is coming from Bob Glasspiegel with Langen McAlenney.

Good morning. This is Bob Glasspiegel from Langen McAlenney. It seems like your commentary sort of indicates the last two years' exposure to hurricane losses is more a function of bad luck than bad underwriting or insufficient purchases of reinsurance. Are you rethinking at all your property book in the light of last two years' experience? Is there a reinsurance strategy that you might conceive of looking at that more carefully going forward?

Yes, Bob, this is Doug Reynolds. A couple things. One is we actually, on the coastal, the hurricane exposure, started a process over a year ago, actually before the four storms of last year, to reduce the exposure in Florida. And one of the things that we have just about completed was a non-renewal of about 3,200 risks that were coastal exposure in Florida, and we're continuing to analyze that state to probably reduce exposure even a little bit more down there, as well as really embarking on an analysis of the other coastal states and looking at our exposure to see where we have opportunities to either limit it, limit new business writing, or reduce it, reduce our policies in force in those states. So, we do have an active program that's in place to take a look at that and really try and reduce the total insured value along the coast where we have -- where we think we'd have more than we should.

The second thing is on the reinsurance side, we're continuing to evaluate that and look at a couple different options around expanding the top end, reviewing aggregates, and anything that -- and the cost related to that.

So, those would be the two things that we're doing to try and address it, both from a policy reduction, as well as a little bit of a different reinsurance program.

Your '04 guidance of $0.50 to $0.60, it fully incorporates everything you know about Wilma? Or is this sort of Wilma's too early to tell and it's a potential risk factor on that projection?

I'm sorry; yes, it's a little bit too early to tell. What we did have in our projection for the fourth quarter was what we would typically expect in the four quarter, which really is around the 3.5 to 4% premium impact.

3.5 to 4 points of cat losses in Q4 in aggregate?

Right. Right.

So, that would have Wilma then being sort of less than a quarter of last year's third quarter Florida hit for you guys.

Well, we'd certainly have Wilma being less than any one of the four storms last year, and again, as we're going through that, we need a little bit more time, but that would -- I would certainly think that that would be the case.

Because the RIMS data suggests it's going to be equal to some of those last year. So maybe I'm looking at different macro things than you guys are from a bottoms-up perspective, but --.

Yes, I think as we look at our -- where we have our policies in force down there, it hit fairly south in the state, as you know. Our policies would not be -- we do not have significant exposure around the Miami area. As you get into the Palm Beach area, we've got a little bit more, so like I said, it's a little bit too early to tell. I think last year, Jean was probably the smallest storm, but at this juncture, we don't expect it to be that -- to that degree.

Thank you very much.

Hello?

Thank you. Your next question is coming from Dan Farrell with Fox-Pitt, Kelton.

Hi, good morning. Just a couple questions. Firstly, I apologize if I missed this, but can you just comment on the trends that you're seeing so far, the frequency and severity, in the auto business?

Yes, in the -- I didn't make a comment on those separately. The frequency on the auto business, we're continuing to see that trend down slightly, and the severities are staying -- overall, are staying pretty flat.

Okay. Okay, great. And then, just on the reserve release in the quarter, can you just -- what were the years that that was coming out of, and then just give a little more color on the underlying drivers of the release.

Yes, the 6 million approximately of reserve releases were predominantly coming out of the '04 and '03 accident years, and most of the $6 million was out of the auto liability coverages.

Okay. Thanks, guys.

[OPERATOR INSTRUCTIONS.]

Your next question is coming from Alain Karaoglan with Deutsche Bank.

Good morning. I have three questions. The first one is with respect to your pricing on the P&C side, what are you assuming in terms of future trends in frequency and severity when you're pricing your business?

On the auto side, we would be really using a flat trend on the frequency, and on the severity side, we would expect it to go up, but we would expect to beat -- to be lower than inflationary impacts.

Okay. And what sort of price increases you're putting through on personal auto?

Well, at this juncture, in the most recent quarter, we actually had auto decreases in a few states. And, really, our approach is -- has been to look and segment the educator versus the non-educator. And our educator business is running -- performs substantially better than the non-educator, so where we have opportunities, we are actually taking rate reductions in those markets but maintaining the margins that we want. And we are continuing to more aggressively price the non-educator.

And you mentioned that you were looking at your exposure for cats of Florida and other region and thinking about reinsurance. Are you thinking, also, about your earthquake exposure and what to do about that? I mean are there lessons from these cats to be drawn and to be applied to any cat exposure that a company may have? And if you could remind us, what's your reinsurance program currently in place?

Okay. One is, yes, we are looking at -- we're actually looking at all of the catastrophe exposure. Our primary topic right now is in regard to the hurricanes, but we are looking at the earthquake. We've done a number of things to strengthen our position in regards to the earthquake coverage, but that is something that we are looking at.

Secondly, on the reinsurance program, it -- excluding Florida, because you have the Florida -- well, Hurricane Catastrophe Fund, our attachment point is $10 million, and then we have reinsurance up to the $80 million level, and we retain 5% above on the 10 to $80 million. And in Florida, we would have the same attachment point of $10 million, but then the Florida Catastrophe Fund would kick in right around the $15 million. So, in Florida, we would have a top end at about $130 million.

Okay. And the last comment is, Pete, on the disclosure, not giving the cats disclosure. I would ask if you could reconsider that. Other companies are giving that, and there's additional disclosure they'd give or disclaimers that they give. I would be happy to share that with you, so I would ask you reconsider that because it's better that you do it and give us the right number as opposed that we do it and get it always wrong. But thank you very much.

Thank you.

Operator. Thank you. There appear to be no further questions. I would like to turn the floor back over to Mr. Hallman for any closing remarks.

Thanks again for joining us today, and we look forward to visiting with you at the end of the year.

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