Horace Mann Educators Corp (HMN) 2006 Q3 法說會逐字稿

Good morning, my name is Denise, and I'll be your conference operator today. At this time I'd like to welcome everyone to the Horace Mann Educators Corporation Third Quarter Earnings Conference Call.

[OPERATOR INSTRUCTIONS]

It is now my pleasure to turn the floor over to your host, Mr. Dwayne Hallman, Senior Vice President of Finance. Sir, the floor is yours.

Good morning, everyone, and welcome to our third 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 the results of the third quarter in our prepared remarks.

The following senior management member 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 Annuity and Butch Joyner, Senior Vice President of Marketing.

The following discussion may contain forward-looking statements regarding Horace Mann and its operation. 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 4th, 2006. Now I'll turn the call over to Lou Lower for his comments.

Good morning, and thanks for joining us. As we reported yesterday Horace Mann recorded net income excluding realized capital gains of $0.42 per share for the quarter, $0.40 greater than prior year, which was adversely impacted by an unusually active hurricane season. This year's EPS result was ahead of both our expectations and the consensus that was put out following our earnings call last quarter. However, it is below current consensus expectations which were subsequently increased in response to the benign hurricane season. Unfortunately Horace Mann experienced a significant level of catastrophe losses which were non-hurricane related in the third quarter, frankly not that far off from what we expected in the quarter going into the hurricane season.

Nonetheless we're pleased with actual results for the quarter and first nine months and encouraged by continuing favorable underlying trends. And accordingly we are raising our guidance to a range of $1.90 to $2.05 for the year, the midpoint of which should produce an operating ROE ex-FAS 115 of approximately 15% with book value growth ex-FAS 115 of over 15% for the full year.

As you'll hear from Doug Property/Casualty results continue to benefit from pricing and underwriting initiative, transformation of our claims organization and excellent quality trends. At the same time we're reducing our coastal catastrophe exposure through new business restrictions, agent placement, non-renewals and price increases. Pretax income for both life and annuity in the quarter exceeded prior year and are consistent with the guidance we provided last quarter.

The fixed annuity squeeze between interest earned and credited appears to have bottomed out with a modest uptick in spreads in the quarter, account values are growing and variable fee income is increased, and we're fully expecting that those trends will continue. Most importantly the focus and resources we're now bringing to the company's overall growth continue to gain traction. Once again we're pleased with another quarter of positive sales results, particularly in new auto units, which were up 7% including a substantial 22% increase in pure new business.

As you'll recall the auto line with the consistent cash flow that renewal commissions provide to Asians is a critical foundational element to the success of our distribution growth strategy. But even with the significant focus we're bringing to bear on auto sales, sales in the life and annuity lines increased 6 and 2% respectively. And let me note that sales of all lines grew without any sacrifice to new business quality.

For example, in auto over 80% of new business for both the quarter and year-to-date is in the educator segment. As a result of positive continued sales momentum coupled with improving retention auto and property educator PIF continues to grow sequentially. Very importantly auto educator PIF has increased sequentially over the past six quarters and is up 4% over prior year.

That in turn is reducing the decline in property/casualty written premium which excluding the increased costs of our enhanced catastrophe reinsurance program is flattening, and looks like it should turn positive in the fourth quarter as those sales and retention trends continue. Property/casualty PIF growth is a key metric for future success affording our agents the opportunity to expand their operations and cross-sell all lines to an increasing number of customers. As you'll hear from Butch we are entering a very exciting period for the company and have kicked off the migration process to our Asian business model which is the growth engine of our future.

As we discussed last quarter it's designed to remove the capacity constraints inherent in the company's historical distribution model so we can significantly increase agent productivity, expand market penetration, and drive revenue growth. So all in all a solid quarter. Our team is very encouraged by what's been delivered so far this year to drive positive earnings with emerging growth trends and that in turn makes us bullish on our future growth prospects.

And now for some further elaborations here's Pete.

The third quarter generally reflected a continuation of the positive growth and underlying earnings trends we've been seeing over the last several quarters with all operating segments contributing. The annuity and life segments exceeded prior year in pretax income and excluding the impact of DAC unlocking are now both running ahead of 2005 on a year-to-date basis as well consistent with our expectations.

Our Property and Casualty combined ratios for the quarter and nine months are in the 88 to 89% range, excluding catastrophes and prior year's reserve releases also pretty much in line with expectations. Horace Mann like the rest of the industry did benefit from the relatively tame storm season in the Atlantic. However, we continued to experience a higher than normal level of non-hurricane catastrophes totally over $7 million or $0.10 per share in the third quarter. The majority of that amount was related to wind and hail in Minnesota which happens to be our fourth largest state in terms of P&C premiums.

Catastrophes in the quarter were 5.4% of earned premium and as Lou mentioned not that much below what we were expecting including hurricane losses. The favorable development of prior year's property and casualty reserves continued in the third quarter primarily related to the 2004 and 2005 accident years in the auto liability coverages with reserve re-estimates resulting in a $5 million benefit to pretax income.

Our outside actuarial firm performed a detailed review of our internal analysis during the quarter. They also refreshed their analysis of our 2005 hurricane reserves and did an independent review of the major auto coverages for the current accident year. Based on our work and their external perspective we believe our total held reserves to be in the upper quartile of Deloitte's range of estimates.

Our investment income growth rate continues to accelerate with an increase of more than 7% over prior year in the third quarter. Growth in our portfolio and an increase in portfolio yield are both contributing. Meanwhile credit quality continues to be extremely high and stable. And as Lou mentioned book value growth continues to be strong as well. Excluding FAS 115 book value per share increased nearly 13% over the last 12 months.

As disclosed in the press release and perhaps somewhat unlike many other companies Horace Mann currently has an unfunded gain in our pension and post-retirement benefit plans which we anticipate will increase book value about 1% when FAS 158 is implemented next quarter. So that impact in conjunction with our revised year-end guidance would point to a full-year 2006 increase in book value per share of approximately 15.5%.

As you saw we've increased our full-year estimate of net income excluding realized investment gains and losses to between $1.90 and $2.05 per share, up $0.10 driven by the more favorable than anticipated P&C reserve developments and the slightly better than expected catastrophe experience in the current quarter. The midpoint of our revised guidance range represents a 15% increase from the initial 2006 estimate which we provided back in February.

And while earnings trends remained favorable we were also pleased with the continued progress of our growth initiatives. Adjusting for both the third quarter 2005 reinsurance/reinstatement premiums associated with last year's hurricanes and the 2006 increase in seeded premiums related to our expanded catastrophe reinsurance program both consolidated and total P&C written premiums are only about 1% behind prior year and we've been steadily closing the gap over the last few quarters.

In terms of property and casualty PIF while educator policies have been increasing for several quarters in both our auto and property lines the current quarter saw the second consecutive sequential increase in total auto and total P&C policies in force and next quarter we are looking for both measures to exceed prior year.

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, and as Lou indicated I will provide a brief update on our Property and Casualty results. As in previous periods, our results have continued to perform as expected for the year with a number of positive trends continuing. Most notable is the continued policy growth of our educator auto business. In the quarter educator policies grew sequentially by 6,000 over second quarter results and over prior year by 16,000 or 4.3%. The auto retention ratio increased by 6/10ths of a point versus third quarter 2005 and marks sequential total auto policy growth for the second quarter in a row. And as Butch will discuss we once again posted sequential quarterly growth on true new auto business.

In our Property business line our educator policies grew slightly but our policies in force and the retention ratio were both negatively impacted as anticipated by our coastal risk reduction programs. The primary driver, of course, is the non-renewal program that is currently in place in Florida. As you saw in the news release we have continued to reflect strong underwriting combined ratios especially in our Property line of business. Our year-to-date Property and Casualty combined ratio excluding prior year development and catastrophes is running about 88%. While that is at a very good level it is up nearly a point from where we stood midway through the year.

The auto line was the main contributor to that uptick as we continued to take a somewhat conservative approach with our current accident year reserves based on an increase in our physical damage pure premium that came through in the third quarter. On the Property side of our business we continue to achieve excellent underlying results running the combined ratio excluding Cats and prior year development in the low 70s. As with auto it is better to view the results on a 12-month moving basis to obtain a true picture of how the book is performing.

As you know we did not experience any hurricane-related losses in the quarter. However, we did have large catastrophe loss due to hail and tornadoes in Minnesota, one of our largest states. It is due to the many smaller catastrophes such as the one that we have -- such as the ones we have had around the country during the year that led us to purchase the aggregate coverage as a component of our catastrophe reinsurance program. Overall, for both lines of business we continue to see both frequency and severity performing well within our expectations. The overall quality of our new business continues to reflect the focus on the educator along with our better tiered business.

In addition, the introduction of ESM as well as other discount programs has continued to gain traction. The tri-line discounts that we introduced in 2005 has driven a doubling of the number of educator households with more than three lines of business. Our number of educator households with two or more lines of business has also grown to almost 50% of our households.

The auto payroll deduction process that was expanded in 2006 has resulted in a substantial increase in the number of auto new business customers that are utilizing this option. Each of these programs drive higher retention and better overall long-term loss results. Our catastrophe management programs are also moving forward. As covered in last quarter's call, we have started our second non-renewal program in Florida and will non-renew approximately 2,500 of the targeted 5,000 policies by year end.

In Louisiana, we placed our non-renewal program on hold as discussions with the state insurance department continue. From a claims perspective, we have continued to drive improved customer satisfaction results and successfully launched Claims Desktop in the quarter. Claims Desktop will assist us in both effectiveness and efficiency of our claims handling. Overall we achieved solid results in the quarter which exceeded our expectations.

And now, let me turn it over to Frank D'Ambra for his commentary on Life and Annuity.

Thanks, Doug, and good morning. We are continuing to see positive sales results from the release earlier this year of our new fixed and variable annuity offerings and our new suite of term and whole life products. Total Annuity sales in the third quarter increased by 2% and increased by 3% for the first nine months. This was driven by third quarter and year-to-date gains of 2% and 5% respectively in our career channel offset in part by somewhat lower sales in our independent agent channel where the flat yield curve continues to impact sales of fixed annuity products.

Our single deposit or rollover business which includes partner sales, increased by 4% for the quarter and was up 8% for the first nine months. This was partially offset by a decrease in our recurring deposit business. Our policy account increase for the 2% rate with cash value retention remaining in the 91 to 94% range. Total Annuity assets under management grew 7.5% with fixed annuity assets increasing 6% and variable annuity assets aided by increased deposits and market performance growing over 9%.

The third quarter pretax income for the annuity segment was 4.6 million compared to 4 million the prior year. For the first nine months pretax income of 14 million reflected a $2.2 million versus the prior year. Earnings for the quarter benefited from increased interest margin and charges and fees that were offset in part by increased expenses and unfavorable change in the DAC -- DIF unlocking.

Turning to the Life segment, third quarter sales remained solid building on the strong results reported in the prior two quarters. Third quarter sales increased 6% including a 10% in the sale of Horace Mann proprietary products. For the first nine months sales of Horace Mann products increased 23%. Partner product sales increased 2% for the quarter but are down 1% for the year. Continued sluggish UL sales have dampened the effect of robust BUL Sales.

Third quarter Life premiums and contract deposits for the Horace Mann proprietary products were flat with last year while the year-to-date comparison show the slight decline. This improvement over past quarters as a result of the ongoing success of our new products and stable retention. Looking at the bottom line third quarter pretax income was 6 million versus 4.4 million from the prior year. This increase was attributable to increases in investment income and lower expenses offset by slightly higher claims. For the first nine months pretax income was even with the prior year. Year-to-date lower claims and expenses are offset by additions to Life reserves.

The RIS recently announced that the effective date of its proposed regulations for 403(b) programs will be postponed to no earlier than January 1st, 2008. Despite the delay in the effective date, we have already seen a handful of districts moving to modify their 403(b) programs in anticipation of these new regulations. We are therefore continuing to drive significant product and service initiatives, that will be implemented throughout the upcoming year. These initiatives will ensure that we deliver appropriate retirement solutions to school districts and their employees, and provide our agents with product offerings to capitalize on the changing environment. This will allow us to grow market share and fully leverage the increased capacity of the new agent business model.

And now to discuss the marketing results, and the status of the new agent business model is Butch Joyner.

Thanks, Frank, and good morning everyone. Before I share the latest details around our agent business model I'll start with sales results for both the third quarter and year-to-date. And with that said I'm pleased to report that sales on [inaudible] on the first half of the year accelerated further in the third quarter. New auto sales units for the quarter increased by 7% over the third quarter of 2005. That also represents a 3% increase over the solid results of the second quarter of this year and it was the best sales quarter for new auto units since the third quarter of 2003.

There's even better news behind these numbers. Auto unit sales to new customers increased 22% compared to the same quarter in 2005 and from a quality viewpoint over 80% of these new customers are educators. One other note on the quarter's auto production, agent auto unit productivity increased 10% compared to the same period in 2005. While we've intentionally focused on growing the auto book of business in order to build a foundation for our new agent business model our sales force has struck the right balance and increased financial services sales as well.

So let's take a look at that side of the business. Life sales increased by 6% in the third quarter and 8% for the first three quarters, compared to the same period of 2005. Partner product sales compared to the nine months of a year ago have been relatively flat while sales of Horace Mann Life products are up 23% through the first three quarters of the year. This is a reflection of the confidence our agency force has in the new products introduced earlier this year.

On the Annuity side new sales premium increased by 2% for the quarter and 3% for the first nine months compared to the same period in 2005. For the first nine months a 5% increase in Annuity sales by career agents was partially offset by a decline in independent agent sales resulting in a 3% increase I just mentioned.

And that's our positive sales picture, solid sales growth in new auto units combined with increases in new sales premium in both Life and Annuity. Moving onto agent count. Our total number of agents at the end of the third quarter was virtually the same as at the end of the first two quarters of this year. As you will recall, in the first quarter we reconstructed our agencies in Florida and Louisiana in response to our risk mitigation plans contributing to a decline in agent count. This action is the major contributor to the 2% decrease in agents compared to the same point in time a year ago and the decline from the end of 2005.

However, with more agents, the early adopters to the new business model employing licensed solicitors our points of distribution have grown each quarter this year. Now, let's talk about the new agent business model. Just a few weeks ago a group of 15 agents participated in the inaugural agent business school. As described in an earlier call, the school includes a detailed operational blueprint of best practices for the management of an outside office, training on how to fully leverage support staff and license solicitors, a personalized business plan and financial modeling to fully maximize the opportunity of an entrepreneurial agent-owned agency.

The reaction to the first school was enthusiastic building excitement and anticipation throughout the entire company. And that spirit continues to grow as we move from the developmental stage to the implementation of the model. This formal five-day program will continue in the fourth quarter as we bring additional agents through the school.

In 2007 we plan to increase the agent participation with approximately 25% of our agents completing the school by year end. These agents are our top producers who write a healthy percentage of our business and they're eager to write more. Over the next three years, the entire agency force will attend the agent business school. And in some point in 2007, we will begin hiring agents directly into the new model, allowing our newest agents to employ and staff with licensed personnel, expanding our points of distribution and freeing the agents from the constraints of a solo operation.

One other point, even as we roll out the new business model, a growing number of agents are electing to move to outside offices on their own, prior to officially converting to the new model, and they're employing support staff and licensed solicitors. At the end of the third quarter, the number of agents working in this environment grew to approximately 11% of our agency force adding more than 100 additional points of distribution.

Even though their productivity is well above the average agent they too will participate in one of the agent business schools over the next 15 months to further entrench best practices and productivity gains. Through the remainder of 2006 and throughout 2007 we expect to grow our agency force at a steady pace carefully selecting the placement of agents, and employing an improved onboarding process. The growth of our points of distribution, however, will continue at a much faster pace as more agents move into the new agent business model.

In summary our present strategies are producing the payoff we anticipate and the investment we're making in the new business model will help us sustain momentum in years ahead. And now here's Dwayne Hallman.

Thanks, Butch. At this time we'll be pleased to take your questions. Denise?

Thank you.

Thank you, Denise.

[OPERATOR INSTRUCTIONS]

Thank you, we have our first question coming from Dan Farrell of FPK. Please go ahead.

Good morning, guys.

Good morning, Dan.

You're clearly getting some very good momentum now in the educator marketplace, given all the strategic initiatives that you put through there. Can you just talk a little bit about the remaining book of non-educator business though? It continues to decline and I'm wondering just what your strategy is there? Do you see that continuing to decrease? Are you going to take some steps to try and stabilize that so that it's less of a drag on the total book?

Well really the -- yes obviously the educators we continue to write more new business on the Property/Casualty side and the retention is going up there. We are losing policies on the non-educator side. From our perspective what we're really trying to do now is we've reached what we would call the sweet spot as far as the percentage of our business that's educator business.

So what we're trying to do is really look at that -- at the marketplace and recognize that our agents not only deal with educators but there are some non-educators in the market and they get referrals etcetera. So there really are approaches one just to continue to price the non-educator as their experience dictates. And if we continue to run in that 75% educator, 25% non-educator we're very satisfied with that.

Okay thank you. And then, just one other thing. Actually on your combined ratio ex-Cats it's up this quarter versus what we've seen in the last few quarters and I realize there can be volatility on a quarterly basis but can you point to any trends either on frequency, severity in the quarter that may have shifted?

Well I wouldn't classify them as trends. I think obviously Dan as you pointed out the book you really have to look at a 12-month basis versus a quarter by quarter just because of the size we do get some volatility. In the quarter we did see some of the frequency go up on the -- especially on the physical damage side which was really the main driver behind it. And some of that was really at Midwest states so we saw a few of the states pick up probably as a result of the storm activity that occurred in that part of the country. But it's not -- like I said it's something that we saw. We saw it in the quarter a little bit out of pattern but not something that we would certainly expect to continue.

Okay great. Thank you, very much.

Thank you, our next question comes from Alain Karaoglan of Deutsche. Please go ahead.

Good morning.

Good morning.

I have several questions just following up on that question on the accident year loss ratio for the personal auto line excluding catastrophe and reserve development, if we look at it, it was around 72% this quarter versus 66% in the second. But it seems since the fourth quarter of last year it was 73% then the first quarter 71.8. Is it just something you've seen in this quarter or you've seen an uptick before that and why was the second quarter so low relatively speaking at 66% versus 72% is I did my numbers right?

Yes those numbers are accurate and it really gets right back into the same conversation which is around we just see volatility from a quarter-to-quarter basis. Sometimes that volatility is up higher and sometimes the volatility drives a lower loss result which is really what we've seen as we look on a quarter-by-quarter basis. As we're going forward obviously as we're writing the better quality business, the premium as you've seen, the average premium has shifted downward but we view that as a good thing because we're writing more educator in the better quality business.

So we're getting that a little bit as an offset on the loss side. And I think the other thing is that just inflationary factors tend to force up the loss ratio a little bit more, we're not taking rates and we're seeing that premium reduction. And again that's why I pointed out that the results are well within what our expectations have been on a quarter-by-quarter basis as we look at it over a moving 12-month for both frequency and severity.

But it seems, Doug, that 72 or slightly below 72, 71, 70 is more of what you've been having in the past four quarters on average because the first quarter and the fourth was at the higher level than the second. Is that fair?

Yes, without question the first quarter and the third quarter were higher than the second and that's why as I indicated to sort of look at it on an annual basis. We get a much better view of how the book is performing and we sort of use that as -- are we consistently achieving what we expect.

In terms of the catastrophes that happened this quarter on the Property book, and in fact in the second quarter you had 22 points of Cat. In the first you had eight points of Cat on the Property book. Is that in line with your expectation, or is it more than you would think it would be, and are you doing something in terms of deductible or policies? I recall years ago you also had some catastrophes in Minnesota that hurt you.

Yes, and actually there's a few things -- and the non-hurricane catastrophe is certainly higher than what we've been running in past years. We've implemented a number of programs over the last couple of years that were geared towards increasing deductibles, taking the rate changes, reviewing inflation [guard], revamping and revising our reinsurance program, which one of the things, as you know, for 2006 was the acquisition of an aggregate coverage that kicks in at the 20 million mark which we're not quite there yet. And I think the other as you look at the overall property book, the underlying loss ratios continued to perform extremely well and it's a result of all those actions that we have taken.

Okay on the investment income on Property/Casualty the stacks rate seems to have gone up to 18% from 15. Was there anything usual this quarter?

Alain, this quarter compared to last year we had a little less weighting in municipal bonds than we had in prior quarters so that kind of gets the gap between pretax and after tax heading in the direction you're seeing there.

So should we expect 18% going forward?

I think that's reasonable.

Okay, and what was the retention on personal auto -- the retention rate, sorry?

Well it was up about six-tenths of a point. I think that's in the release, the number. One of the things I guess probably is a better way to answer that is that as we look at this we track the auto educator household retention and we've indicated in the past that that's in the 90% range on a 12-month moving so that's about what we've had.

And last question what is your, and I may have missed in the press release, what is your P&C surplus and the Life surplus and you have now $37 million at the holding company. Any thoughts on capital management or share buybacks?

Let me answer the question about capital management and share buyback, Alain. Obviously our first priority for the capital that we have, the excess capital that we have is to support new business growth. And we do think as we go into 2007 that the positive sales trends that we're seeing in auto and other lines will continue and accelerate as more and more of our agents are in the new agent business model.

We also need to be mindful from a capital perspective of possible increases in capital requirements on the part of the rating agencies so we don't want to -- certainly wouldn't want to put ourselves in a weakened position there. Actually we'd like to strengthen that somewhat but beyond that to the extent that we don't need the capital for those two purposes we do have conversations between management and the Board of Directors about the deployment of excess capital and we won't be doing anything this year.

Nothing is planned for this year, but we'll consider whether it's appropriate and beneficial to the shareholders to take some action next year. That's a thing that we do as a standard operating procedure in our discussions with the Board, and we'll evaluate that when we've completed our full business plans and financial plans for the next two years, and have discussions with the Board to determine what the appropriate capital management strategy is.

Alain, just a little bit of quantitative response to your question, at the end of the third quarter our P&C capital and surplus was a little over 300 million and that was up from about 270 million at the end of 2005. Correspondingly the premium to surplus ratio has come down from a little over 2:1 at the end of last year to a little under 1.8:1.0 this year so clearly trending in a range where we could be looking for some alternatives. RBC ratio is just under 400 on the P&C side. As far as Life goes at the end of the third quarter we're up around 260 million in [staff] surplus, up from about 245 at the end of prior year and our Life RBC ratio continues to be above 400.

To what I think is your final question in your longer list of questions, the cash that you see at the holding company level is being held to retire what's left of the outstanding convertible securities.

Great, thank you very much.

Thank you, gentlemen there appear to be no further questions at this time, so I'd like to turn the floor back to you for any closing remarks.

Thank you for your participation this morning. We look forward to visiting with you on the year-end results. Have a good day.

Thank you this does conclude today's Horace Mann Educators Corporation conference call. You may now disconnect your lines and have a wonderful day.