Horace Mann Educators Corp (HMN) 2006 Q2 法說會逐字稿

Good morning, ladies and gentlemen. My name is Nelson, and I will be your conference facilitator today. At this time, I would like to welcome everyone to the Horace Mann Educators Corp. second quarter earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer period. [Operator Instructions]. Thank you. It is now my pleasure to turn the floor over to your host, Dwayne Hallman. Sir, you may begin your conference.

Good morning, everyone, and welcome to our second quarter 2006 earnings 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 our results for the second quarter and year to date 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 of Property and Casualty. Frank D'Ambra, Senior Vice President of Life and Annuity, 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 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 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 4, 2006.

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

Welcome to our call and thanks for joining us today. As you've read, Horace Mann reported net income before realized capital gains for the quarter of $0.59 a share, a key feels very good about the solid results generated in the quarter with continued positive trends and profitability coupled with building sales momentum. From a companywide profitability perspective, there are some moving features creating differences between current and prior year periods, but, as you'll hear from Pete, a normalized comparison of the quarter and six months would indicate results comparable to last year, which were excellent.

Both reported and normalized results exceeded our expectations and delivered book value growth FAS-115 of 4% sequentially and 7.5% since year end. From a P&C profitability perspective, the elements of success continue to be the benefits that we're realizing from pricing and underwriting actions, transformation of our claims organization, and excellent quality trends. Continued favorable launch trends, coupled with the ongoing benefits from improvements in our claim processes, led to reserve re-estimates which benefited the quarter. But even with the favorable development, P&C remain reserves near the high end of our range, while reported and underlying profitability measures continue to be very healthy. We're also making progress on reducing our catastrophe exposure for new business restrictions, agent placement, non-renewals, price increases, and a more comprehensive reinsurance program. And while we haven't yet been able to recover the significant increase in reinsurance costs in our pricing, the reinsurance program we've put in place this year should serve us well in reducing future earnings volatility.

Combined pre-tax income for life and annuity for the first half, while adversely impacted by equity market performance in the second quarter, is comparable to prior years and only slightly behind our expectations. Spread compression appears to have bottomed out, account values are growing, and fee income has increased, and we're anticipating that those trends will continue as we go forward.

We are particularly pleased with our sales results in the quarter, new auto units up 12%, including a 24% increase in tiered new business, annuity up 5%, while life including excess premium grew by 17%. And that growth was achieved, I want to emphasize, without any sacrifice to new business quality or pricing. Agent morale is very positive, their productivity is increasing, as are their incomes. Auto and property educator PIF continues to grow sequentially and is now above the same period levels of the last two years, thanks to strong sales and improving retention. That in turn is reducing the decline in property casualty written premium, which excluding the impact of reinsurance, is flattening and should turn positive in the second half as those sales and retention trends continue.

The focus in resources we're now dedicating to the growth side of the equation are beginning to pay off. But let me again emphasize that this will be profitable growth. We're just not going to sacrifice the financial gains and stability that we worked so hard to put in place, and the current quarter results certainly reflect that commitment with continuing improvements in our operating leverage ratio. Based on the positive results we've delivered and our favorable view of the future, we are increasing our guidance for the year by $0.15 to a new range of $1.80 to $1.95 per share, the midpoint of which should produce an operating ROE of between 14% and 15%.

And now, for some additional commentary on the financials, here's Pete.

Thanks, Lou, and good morning. Horace Mann recorded another quarter of solid earnings, with net income before realized investment gains and losses of $0.59 per share. That was below last year's $0.65 quarter, which included a non-recurring $0.08 per share income tax benefit, but was well ahead of both the First Call consensus and our expectations. As Lou mentioned, while our life and annuity income can be a bit volatile from quarter to quarter, the combined year-to-date earnings of those two segments was comparable to prior year, and only slightly below our expectations.

The real story in the quarter, and six months, for that matter, continues to be property-casualty, where favorable prior year reserve development and current year loss trends more than offset heavier-than-normal catastrophe losses. Cat costs were $8.8 million pre-tax in the quarter. $7 million was incurred as a result of 13 weather events in the period that were categorized as catastrophes, versus only five such events in the second quarter last year. The remaining $1.8 million was comprised of $1.4 million of adverse development related to catastrophes occurring in prior years, along with $400,000 of associated reinsurance reinstatement premiums. Year-to-date cat costs totaled $12 million, compared to only $4.5 million through June of last year.

The most significant earnings item in the quarter was the continuation of favorable P&C loss trends, resulting in reserve re-estimates for prior accident years which, excluding the adverse cat development, benefited second quarter earnings by $9.5 million pre-tax. That favorable development was primarily related to the 2005 and 2004 accident years. And, with compelling evidence in both the first and now the second quarter, that those trends have continued into 2006, we also reflected favorable reserve development related to the current accident year in the second quarter, as well.

Our outside actuarial consulting firm did a complete, independent review of our long tail lines at June 30 and also performed their normal detailed review of our analysis for all lines. Based on those combined analyses, we believe that our held reserves at the end of the second quarter continue to be at or near the high end of the reasonable range of estimates.

Clearly, a significant driver of the favorable loss trends that we, and the industry as a whole, have experienced over the last two quarters is the variety of external factors positively impacting frequency and severity. I think it's important to point out that at Horace Mann, we feel we're getting some extra lift from the improvements we've made in our claims organization over the last two to three years. Doug will comment further on some of the specifics, but it's good to see the hard work of a lot of folks across our claims organization showing up in the financial results. And we think those benefits still have some length left.

Looking at the current accident year, our six-month results excat are very positive, ahead of our expectations and comparable to the excellent first half we had last year. The voluntary auto loss ratio was 68%, almost a point lower than prior year. The equivalent current accident year excat property loss ratio stands at 50%. That's just a few points above an incredibly good 2005 result, with the variance almost entirely due to the increased cost of our expanded 2006 cat reinsurance program.

So we're obviously encouraged by the first half results, both the emerging growth trends and the continuing positive earnings momentum. I would characterize our increased for the year operating income guidance as appropriately conservative as we move into the heart of the hurricane season. But we certainly feel better this year as we enter the third quarter than we did in retrospect last year at this time given our current, more extensive reinsurance coverage. In any event, we'll know a lot more about where 2006 earnings are headed three months from now, at which point we'll update our outlook for you as appropriate.

So with that, let me turn it over to Doug Reynolds, who will take you through some of the details of our P&C results.

Good morning. Thanks, Pete. Let me start by providing you with the some context about our quarterly profit and casualty results. Simply stated, we had an excellent quarter based on three key measures--continued strong profit results in both auto and property, total auto policy force growth over the first quarter of this year, with continuing strong growth in our educator segment, and substantial growth over prior year for all the new business units.

Over the past few years, I detailed the actions we were taking to improve the quality of our business, our claim results, and the sophistication of our pricing models. These most recent results are the strongest evidence yet of success of all of our efforts. In the quarter, we posted solid financial results once again, with both auto and property continuing to perform well.

There were a number of items that impacted our calendar year results as compared to prior year. These included higher catastrophes impacting quarterly results as compared to prior year, excluding prior year development by about 3.5 points, and on a year-to-date basis, about 2.5 points. Positive prior year development in the quarter representing almost five points and about four points on a year-to-date basis. The added expense of reinsurance increased our combined ratio in each quarter by approximately two points. The last area that impacted results was our expense ratio, which increased just under two points for both quarter and year to date. Nevertheless, the underlying results continue to be quite strong, with improving frequency and severity that are trending under inflation.

On an accident year basis, after adjusting for the items already noted, the auto loss in LAE ratio has improved about a point over 2005 through the first six months of the year. Property accident year loss in LAE ratio has increased a couple points, excluding catastrophes and reinsurance increases. The positive prior year reserve development and the current accident year results are mainly attributable to the improving quality of the business written in our educator target market and the continued solid gains we are making with our advanced claims initiatives, or ACE.

As you will recall, ACE was introduced in 2002. It continues to mature, develop, and deliver consistent, favorable results. We have gained additional experience in implementing standardized claim processes at all claims locations, using the latest software and claim handling technologies. Although many of the programs were implemented over the past few years, it has taken time to fully embed all facets of our initiatives into the organization and realize the benefits. We have made tremendous gains in settlement times, pendings, and management, all components of the claim processes.

Although there have been external influences that have helped such as generally improving auto frequencies, we have also successfully managed two record years of catastrophe losses. The strong claim results that we have been able to achieve, having produced greater consistency of results with less variability, has allowed us to change the historical trend lines which have driven the positive prior and current accident year development. We are also continuing to invest in other improvements, such as claims desktop, that will add additional efficiency to the operation by aligning all software and processes into one application. And in addition to the pure claim process and operational improvements, we are also achieving solid customer loyalty gains. So overall, we are extremely pleased and proud of the claim improvements and results.

Another positive result we are driving is a substantial increase in our retention ratio. Over the past 12 months, we have increased our auto retention ratio by almost a point, and our educator auto household retention has increased by 1.3 points, June 2006 versus June 2005. This outstanding result is being shaped by a number of customer touch programs as well as the changing mix of our business. Auto policies in force, although down compared to a year ago, did well sequentially for the first time in well over two years. Our educator auto policy in force also continued impressive gains, increasing for the fifth quarter in a row. Year over year, educator auto policy in force growth was 3.5%. Property educator policies in force has followed the same trend as auto, achieving year-over-year growth up 3.3%. This is occurring, even as we take actions to reduce our coastal exposure and utilize partner companies for some of the smaller, non-core segments such as mobile home.

As I just mentioned, we've also continued to work on our catastrophe management programs. We have implemented new distance from coast acceptance guidelines from Texas, around Florida, and up the East Coast. We have started our second non-renewal program in Florida and will non-renew approximately 2,500 policies, or 10% of our policies in force, by end of 2006. We've also recently received approval for a 15% property rate increase in the state. In Louisiana, a non-renewal program is targeted to begin in the third quarter along with the implementation of a 10% statewide property rate increase. Although these actions will reduce our policy count and premiums, they also work to control future reinsurance costs while reducing earning volatility.

Finally, as Butch will discuss, we are also benefiting from excellent pure new business growth. Our new pricing approach via the educators segmentation model, or ESM, has now been implemented in ten states, representing a third of our auto premium, with three more states filed and awaiting final approval. In virtually all of these markets, we are experiencing new business production increases substantially above our countrywide average.

To wrap it up, we are extremely pleased with the results in the quarter, as well as with the positive emerging trends we are seeing in our claim results, policy in force growth, educator policy in force growth, retention ratios, pure new business growth, and our overall combined ratios.

Now let me turn it over to Frank D'Ambra for his comments on life and annuity.

Thanks, Doug, and good morning. During the first quarter call, I announced the completion of our new product launches in life and annuity, including the release of our new life cycle target maturity funds on May 1. As we will see in the results, these products are being embraced by our agents and customers, and we are building sales momentum as we enter the important back-to-school period.

Total annuity sales in the second quarter increased by 5% and increased by 4% for the first six months. This was driven by second quarter and first half gains of 5% and 7%, respectively, in our career channel, offset in part by lower sales in our independent agent channel, where the flat yield curve has had a greater impact on fixed annuity sales. Our single deposit, or rollover, business, which includes partner sales, most notably equity index annuities, increased by 7% for the quarter, and was up 10% for the six months. This was partially offset by a decrease in our referring deposit business. A policy could count through 2% with cash value retention continuing in the 91% to 94% range. Total annuity assets under management for six months increased by 7.4% over the 2005 period, with fixed annuity assets increasing 6.5% and variable annuity assets increasing 8.9%.

Looking at earnings, second quarter pre-tax income for the annuity segment was $3.8 million. This was a decrease from the second quarter of 2005, which was favorably impacted by $900,000 of tax refund interest. For the six months, pre-tax income of $9.4 million represented a $1.6 million increase, which was in line with our expectations. Earnings benefited from increased charges and fees, and favorable DAC and DIP unlocking offset by the tax refund interest.

Turning to the life segment, second quarter sales continued to build on the first quarter's strong results, increasing 17%, supported by a 34% increase in the sale of the Horace Mann proprietary products during the quarter, and a 29% increase for the six months. Importantly, our pending business remains strong as well. Partner product sales decreased 2% for the six months, with the universal life sales continuing to dampen total partner sales. Second quarter and first half life premiums and contract deposits for Horace Mann proprietary products declined by 4% and 3%, respectively. With the ongoing success of our new products and stable retention, we anticipate life premiums to show improvement in the second half of 2006.

Turning our attention to the bottom line, life earnings were slightly below our expectations. Pre-tax income for this segment declined in the second quarter versus a year ago, as increases in investment income were more than offset by additions to disabled life reserves. For the six months, increased investment income and lower claims were offset by increased interest credited and a change in the GAAP life reserves. For the balance of 2006 and into 2007, we are focusing on activities to drive the success for our new products, as well as continuing to develop new offerings in both retirement annuity and life products as we respond to educator needs and market change. In the annuity segment, this includes school district level products and services and response to forthcoming IRS 403(d) regulations, and on the life segment, proprietary single premium whole life and return of premium term products. With these initiatives, we expect to leverage our increasing educator customer base resulting from our increased auto sales, as well as the distribution power of the new agency business model initiative.

And now, to discuss the marketing results and progress on the ABM initiative, is Butch Joyner.

Thanks, Doug, and good morning. In last quarter's call, I acknowledged modest growth in the first quarter, but noticed that reserve momentum was building on the latter part of the quarter and expected the trend to continue. And today, I'm pleased to share with you more robust results for the second quarter. Starting with auto, new auto sales units showed double-digit improvement, increasing by 12% in the quarter, compared to the same period in 2005. This brings the increase in auto sales units to 7% for the first six months of 2006, compared to the first half of last year. The second quarter increase was fueled by an outstanding 24% growth in auto sales to new customers, with over 80% of these new customers being educators. These new to Horace Mann customers not only contributed to our growth in auto policies in force, but they will also provide our agents additional cross-selling opportunities for other lines of business.

Taking a look at the other lines of business, annuity sales increased 5% over the same quarter a year ago, with both career and independent agents contributing to the increase. For the first half of the year, a respectable 7% sales increase by career agents was partially offset by a decline in independent agent business, bringing the total annuity sales for the first six months of the year to a 4% increase. On the life side, target premium increased by 6% for the quarter and 8% for the first six months compared to the same periods in 2005. A major contributor to the solid growth in life sales was a vigorous 29% increase in sales of our Horace Mann products. You'll recall we rolled out new life products in the first quarter of this year, and the positive response to these products by agents and our customers continues. To make the life picture more complete, adding the partner products and total life sales to the double-digit gain with an increase of 17% in the quarter and 10% in the first half of the year. So overall, a solid sales quarter with positive trends continuing.

Moving to a view of our agency force, agent count at the end of the quarter totaled 835, showing little change from the end of the first quarter of one year ago. The number of experienced agents--agents with more than two years of service--continues to show growth over both of these measurement periods. Our experienced agents group has now shown year-to-year growth for nine consecutive quarters. The growth of experienced agents is important to top-line growth, as they are our most productive agents. As a reminder, I pointed out in the first quarter call that agent time and retention had been impacted in part by strategic actions taken in coastal risk mitigation areas, notably Louisiana and Florida. As for the rest of the country, agent retention continues at an improved level since we began the agent retention program two years ago. As you will recall, the retention program called for fewer planned hires while selectively identifying and hiring quality candidates.

Also in last quarter's call, I provided information on our new agent business model. This would advance our agents from their traditional one-person, in-home based operation to fully staffed professional agencies located in outside offices. The development of the new model is progressing as planned, and our agency force and sales management team is excited at the prospect and opportunities inherent in this new approach to serving our market. We will introduce the agent business model through a structured, tested program to our first group of agents and managers later this year. Over the next two years, we'll accelerate the rate at which we bring agents through the formalized program while making sure that our agents are prepared to be even more successful in the new model.

As we prepare to introduce the new model, a number of our agents are electing to move to outside offices on their own, employing support staff and licensed solicitors. This number grew in the second quarter, and these early adopters and their newly staffed offices played a key role in our 12% increase in agent dollar unit productivity in the second quarter compared to the same quarter of a year ago.

Looking over the next six months, we expect to steadily grow our agency force. In addition and equally important, we will see an increase in our points of distribution as more agents add life and support staff into [inaudible]. Overall, I'm quite pleased with the strength of the sales quarter and anticipate carrying this momentum into the second half of the year. Now back to Dwayne.

Thanks, Butch. And that concludes our prepared remarks. Nelson, if you would, please, move to the question-and-answer session.

Thank you. [Operator Instructions]. Our first question comes from Mark Finkelstein of Cochran Caronia.

Hey, good morning. I actually jumped on the call late, because another call came over, so if these have already been addressed, please, I'll just go back to the transcript. But first question, does the revised guidance range factor in anticipated federal reserve releases for the last two quarters of the year?

Mark, if continued favorable development occurs, we could certainly see some additional reserve impact, but at this point in time, we don't have anything substantial built into our revised guidance.

Okay, so the $1.80 to $1.95 assumes accident year result and normalized catastrophe load?

Yes.

Okay. And then, you probably did address this in your opening comments, but what are your average rate changes on currently, and how do you see this trending for the remainder of the year, on the auto book?

On, actually, both the auto book and the property book, the rate changes for the year are about flat, plus or minus a couple tenths of a point. And I would continue to expect that they happen on the auto side. Obviously, as we implement our educator segmentation model, there's substantial shifting around within the book of business, up and down, depending if it’s educator or non-educator, so we are addressing any positives or negatives that we would have on a state-by-state basis. On the property side, we are continuing to look at the reinsurance load and anticipate some of the expected costs for 2007 and load those into our rate request. But again, obviously, it's with the auto property sales on a state-by-state basis are very strong, and the opportunity to sometimes offset those increased reinsurance costs are reduced, just because of the outstanding combined loss ratios that we're running.

Okay. And then, just an overall question. Thinking about kind of growth on the P&C side, being in kind of a flattish range, the possibility very strong, how do you think about capital, and where do you kind of see yourself being at the end of the year, seeing a normal cat load, and I guess, what options does that give you and would be most attractive for you?

Well, we're firmly convinced, Mark, that we are turning the corner on the growth side. And our first objective with capital is to put that to work internally to generate organic growth within the company. Obviously, if capital continues to build to a level that was much greater than the organic growth, where we'd utilize that to consider other options, including share repurchase, but our first and primary objective at this point in time is to grow the company and turn the corner on the written premium side in property-casualty, both life and annuity business, and put that capital to work. So, if you're asking are we contemplating a share repurchase program in 2006, the answer to that, at least at this point, would be no. But is it an option that we'd think about in the future if we didn't successfully deploy the capital in our own business, the answer would be yes.

Okay, okay, that's very helpful. Thank you. Those are my questions.

Thank you. [Operator Instructions]. There appear to be no further questions at this time. I would like to now turn the floor back over to Mr. Hallman for closing remarks.

Thanks, Nelson. Thank you, everyone, for participating in our call this morning. We look forward to visiting with you next quarter. Have a good day.

Thank you. This does conclude today's Horace Mann Educators Corp. second quarter earnings conference call. You may now disconnect your lines, and have a wonderful day.