Horace Mann Educators Corp (HMN) 2007 Q1 法說會逐字稿

Good morning, my name is Elsa, and I'll be your conference operator today. at this time I would like to welcome everyone to the Horace Mann Educators Corp. first 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) It is now my pleasure to turn the floor over to your host, Mr. Dwayne Hallman. Sir, you may begin your conference.

Thank you. Good morning everyone, and welcome to our first quarter 2007 earnings conference call. Yesterday after the market closed we released our earnings report, including financial statement as well as supplemental business segment information. If you need a copy of the release, it is available at our website under investor relations.

Today we'll cover the results for the first quarter in our prepared remarks. The following senior management members will make presentation today, and as usual, we'll be available for questions later in the conference call; Louis Lower, President and Chief Executive Officer; Pete Heckman, Executive Vice President and Chief Financial Officer; Doug Reynolds, Executive Vice President Insurance Operations; Frank [Diambra], Senior Vice President of Life and Annuity; and Butch Joyner, Senior Vice President of Marketing.

The following discussions 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 June 7, 2007. Now I'll turn the call over to Louis Lower for his comments.

Welcome everyone, and thanks for joining our call. Horace Mann's earnings are off to a solid in line start for 2007, continuing the positive results we delivered throughout 2006, with net income before capital gains of $0.47 per share, we are tracking our expectations while being slightly ahead of consensus.

In property/casualty, our key initiatives continue to deliver as intended, our current accident year ex cap loss ratio was approximately equal to prior year, and expected increase in the expense ratio and higher reinsurance costs were more than offset by favorable prior year reserve development and somewhat lower caps compared to prior year. All in all, the reported combined ratio of 89.5 was slightly better than our expectations and a quality start to the year.

Pre-tax operating income for life and annuity combined was comparable to the first quarter of last year, as annuity account values continue to grow with continued improvements in spreads and fee income. We do expect to see favorable prior year comparisons going forward.

Auto sales lead the growth story with a healthy 24% increase in new auto sales units to new policy holders. That result, coupled with continued improvements in retention, delivered another quarter of sequential auto PIF growth. Our continued focus on, and success in our core educator market delivered core educator auto PIF growth of 6% year-over-year, which now represents about three-quarters of our in force auto business.

Average auto premium written has declined modestly, but it is important for you to know that that's a function of the improvements in the quality of our book, it's not indicative of reaching for growth or operating in an irrational pricing environment. Because of that average premium decline, overall PIF growth has not yet translated into positive premium growth, however the rate of decline has moderated over the last few quarters to virtually flat written premium results this quarter compare favorably to the decreases we've experienced over the past nine quarters. And we certainly project that turn around to continue and turn positive for combined voluntary auto and property written premium by the end of the year.

Elsewhere on the sales front, property sales units increased 12% with life premium up slightly. On the other hand, annuity disappointed with a 13% decrease, most of that decrease was attributable to roll over business, which had a disproportionate negative impact on the sales of partner products.

Most importantly for our long term growth prospects, the roll out of the agency business model is on schedule and on track, with early results meeting or exceeding our expectations. I've asked Butch to provide you with some additional perspective and elaboration on what we're seeing as positive leading indicators of success, and while it's still early in the transition, what you'll hear should help you gain an appreciation of the potential and power of this key initiative.

From a balance sheet perspective, property casualty reserves remain strong, stable and consistent, key investment portfolios performing as expected, with minimal watch list concerns and no credit related write downs. Investment asset growth of 7.5% helped to drive investment income growth of 9.4%, we continue to improve all of our key capital ratios and produce book value growth pre-FAS115of 16% year-over-year while delivering a 15% operating return on equity, again pre-FAS115.

So in summary, our leadership team feels very good about producing another quarter of solid performance that has established a strong foundation for the full year from both an earnings and growth perspective.

Finally I want to make sure that you're all aware of an important organizational change we announced in mid April. Effective May 1 Doug Reynolds has become Executive Vice President of Insurance Operations. In that roll he will continue his responsibilities for property/casualty, and strategic plan implementation, while assuming additional accountabilities for life and annuity, plus our client services organization, which handles processing and customer service for all lines of business. This new structure is going to enable us to better align business operations, to direct our resources more effectively and efficiently, to drive growth across all lines of business, and to take ease of doing business to the next level for our customers and agents with an approved service model. Now here's Pete Heckman for some further elaboration.

Thanks Lou, and good morning. The first quarter reflected a continuation of deposited growth and underlying earnings trends we've been seeing over the last several reporting periods. In property and casualty, catastrophe losses in the first quarter were relatively light, similar to the last couple of years. The current accident year loss ratio was comparable to prior year, but slightly above our expectations.

However, we also experienced a higher level of favorable reserve development in the quarter, driven by better than expected 2005 and 2006 accident year frequency trends in both homeowners and the auto physical damage coverages.

The expense ratio of 24.5%, while a point or so above last year's first quarter, was comparable to the full year 2006 results and was consistent with our expectations. And so with a combined ratio of under 90, and the continued growth in auto new business and PIF, it was another positive quarter for our P&C business.

In the annuity and life segments, excluding the impact of [DAC] and VIF on locking, pre-tax income exceeded prior year and was consistent with our expectations. The negative annuity on locking recorded in the current quarter was due to a higher than assumed level of realized capital gains.

Investment income, for the second quarter in a row, grew by over 9% compared to prior year. In addition to the growth in assets, our portfolio yield continued to increase modestly, which in turn has allowed the spreads for our interest sensitive annuity and life products to begin expanding somewhat, nice to see after an extended period of spread compression. Meanwhile, the credit quality of our investment portfolio continues to be extremely high and stable.

Finally, in terms of the balance sheet, we continue to grow capital, building book value and improving our leverage ratios. And, consistent with our disclosure last quarter, we provided notice a few weeks ago to the remaining holders of our senior convertible notes, of our intention to call those securities effective the middle of this month. That should further reduce our debt to total capital ratio by nearly three points, to below 23%, a level last recorded by the company about 10 years ago.

With that let me turn it over to Doug Reynolds, who will provide more detail on our P&C results.

Thanks Pete, and good morning. As Lou and Pete stated, our first quarter results were very solid, and fully in line with our expectations. Both auto and property had good results for the quarter, delivering a solid combined ratio of 89.5, with auto calendar year combined ratio at 93.6 and property at 78.3. The property and casualty combined ratio, excluding catastrophes and prior year development, was 91.9, up about 1.5 points over prior year quarter, with the expense ratio driving a major portion of this increase.

In the quarter our auto accident year loss and LAE ratio was flat to prior year. On property, the current accident year loss ratio and LAE ratio, excluding catastrophes and the increased cost of reinsurance, was about a point lower than prior year.

Although the property and casualty expense ratio is higher than prior year, the increase is consistent with our expectations, and is primarily driven by our continued investment in strategic initiatives, including the agency business model.

During the quarter we did experience frequency increases in both auto and property, primarily due to the winter weather patterns in the Midwest. Our overall combined severity trends continued to remain very favorable.

Our auto policy count once again increased sequentially, and continued the growth pattern that began in the second quarter of 2006. Our year-over-year growth in total auto policies in force is about 7,000, with auto educator policy growth over 20,000. Our total property policies in force remain level, but also featured positive growth in educator policies.

In addition to the policy growth, our auto and property retention rates improved once again in the first quarter and are both up a half point over March of 2006.

We have continued to reduce our coastal exposure as a percentage of our total property business. We have reached agreement with a Florida domicile company that allows our agents to have an outlet for their property business. We continue to work with other potential partners to further reduce our number of Florida policies.

The quality of business in both auto and property has remained excellent, our percent educator lower tier business and those selecting payroll deduction have continued to increase. Overall, a good start to the year with results that were within our expected ranges. And now let me turn it over to Frank Diambra for his commentary on life and annuity.

Thanks Doug, and good morning everyone. Financial product sales for the first quarter, particularly annuity, were lower than expected. The primary factor was a decrease in single deposit sales as several special state programs, which enabled educators to accumulate transferable lump sum retirement dollars, wound down. Total annuity sales in the first quarter decreased by 13%. Our single deposit, or roll over business, which includes partner sales, decreased by 14% for the quarter, and our recurring deposit business decreased 9%. While total career sales were down 23%, mainly due to the drop in single premium and partner sales, independent agent sales increased 37%.

Total policy count increased 1.2% with cash value retention in the 91% to 93% range. Total annuity assets under management grew 6.8% with fixed annuity assets increasing 6% and variable annuity assets, aided by positive market performance, growing over 8%.

First quarter pre-tax income for the annuity segment was $4.9 million compared to $5.6 million for the prior year. Earnings for the quarter benefited from increased interest margin and charges and fees, but were more than offset by an unfavorable change in DAC and VIF. Excluding the DAC/VIF impact, first quarter results were in line with our expectations.

Turning to the life segment, first quarter sales were comparable to those experienced last year for both Horace Mann's proprietary and partner products. First quarter life premiums and contract deposits were down 3% compared with last year.

Looking at the bottom line, first quarter pre-tax income was up slightly when compared to the prior year. Increases in investment income and lower expenses were reduced by higher mortality. This result was in line with our first quarter expectations.

We have multiple initiatives underway to improve the annuity sales results. First, we have identified additional state program opportunities that we will act on in 2007; second, we developed and launched in late 2006 an advanced retirement sales and education program to help drive annuity sales. Prior to the back to school selling season, most of our top annuity agents will have completed this program.

With these actions and additional opportunities under consideration, we remain confident that we will achieve our fully year profit objectives and positive year-over-year sales comparisons. And now to discuss the marketing results and the status of the agency business model is Butch Joyner.

Thanks Frank. This morning I'll share additional details on the continued progress of the Agency Business Model, or ABM. As Lou stated, there are solid indications of early success as our agents transition to the new model.

Before I get to those details, let's look at the sales results for the quarter. After a slow start in auto sales last year, momentum began building in the second quarter of 2006 and has continued into the new year. For the quarter, new auto sales units increased by 19% over the first quarter of 2006. This includes a solid increase of 24% in auto unit sales to new auto customers. These increases were in line with our expectations. The continued strong sales results in new auto units holds additional significance since, as we've discussed with you before, the auto book is the foundation for the new Agency Business Model.

On the property side, new sales units also showed solid results with an increase of 12% in the first quarter compared to the first quarter of 2006. The positive results continued in life sales with new premiums also showing an increase when compared to the prior year.

The annuity line disappointed, however, with a sales decrease of 13% in new sales premium in a first quarter-to-quarter comparison. Last year, particularly in the first quarter, we had an influx of lump sum deposits from a few states that had instituted programs allowing educators the opportunity to privatize a portion of their teacher retirement funds. These were states where we have good market penetration and agents with a successful history in annuity sales.

The same opportunity does not exist this year, at least not in as great a magnitude. We do, however, expect to cut into this deficit over the rest of the year to bring sales back in line with expectations and (inaudible) is now producing solid annuity results for the year.

Agent count at the end of the first quarter was virtually flat when compared to the number of agents at the end of the first quarter of 2006. However, the number of licensed product specialists grew from 117 at the end of 2006 to 163 at the end of the first quarter. These licensed specialists employed by our agents, work primarily on the property and casualty side off the business and played a notable role in the increase of new auto sales in the first quarter of the year.

Throughout the remainder of 2007, we'll focus on growing both the agent count and the number of licensed specialists, continuing to increase our total points of distribution.

Now, let's talk about the Agency Business Model. 25 agents completed the Agency Business School in the first quarter of 2007. This brings the total number of agents to have completed the school to 59 since its inception in October of 2006. About 75% of our field managers have completed the school. As described in earlier calls, the school's (inaudible) an operational blueprint for the management of an outside office, training on how to fully leverage support staffs and licensed specialists and personalized business operating, marketing and financial plans. These are integral parts of the transition from a single person solo operation to a more entrepreneurial growth oriented agency.

Even though it's early in the transition to the ABM model, the results are not only meeting but exceeding our expectations. Agents who have completed the Agency Business School have outperformed the agents who have not attended the school when comparing the percent of increase in sales in the first quarter of 2007 to the same period in 2006. And they're doing so in all lines of business and by significant margins.

We see a similar trend in cross selling. Again, it's early in the transition but our ABM agents are experiencing a decrease in the number of one-line households and an increase in those households with three or more lines of business since completing their training. These leading indicators of success demonstrate the potential and power of the Agency Business Model when fully implemented.

By the end of the year, our current game plan calls for approximately 25% of our agents to have completed the school. The balance of our field managers are scheduled to complete the school in the second quarter of this year.

14% of our agents now have a base of operation in outside offices with licensed support staff. This group was a major contributor to the 20% increase in average auto unit productivity experienced in the first quarter of 2007. The leading indicators of this key initiative are validating the Agency Business Model's potential. As implementation continues, we expect to steadily grow premium with more points of distribution, enhance our agents' customer and policy retention and build a better brand and distribution [credits] in the educator market.

Now back to Dwayne.

Thanks Butch. And that concludes our prepared remarks. Please move to the question and answer session.

(OPERATOR INSTRUCTIONS)

Our first question is coming from Bob Glasspiegel with Langen McAlenney. Please go ahead.

Good morning everyone. A couple of questions; starting off, you didn't update guidance. Is that just because first quarter's out of the box? And, it sounded like we had a few things better than expected but no change in your overall guidance?

No change in the guidance and Bob, I just think it'd be premature at this point in time to do anything.

Right. Butch, a question for you; are we done calling the agency count? When do we start to see the aggregate numbers start to grow?

Our intentions are to continue to grow the agency force throughout 2007 with not only emphasis on our growing our agency count but also the licensed specialists to increase our total points of distribution.

What sort of growth would you be pleased with?

In agent count?

Yes.

I would look at some type of improvement in the 2% to 3% increase in agency count.

From where we are net today, or from - just to make sure I've got the right benchmark.

From the year-end count

Okay. Are we done buying [Co-Cos] back? The shares outstanding went up sequentially.

Yes, Bob, we're through buying them on the market, if you will. But as I said, we have notified the remaining holders that we will be calling them. The effective date of that, I believe, is May 14th. So, by the next quarter-end, we'll have no more Co-Co dilution in play in our financial results.

And what's the share equivalent left to buy; have left to retire?

Well, right now, I think it's on the first footnote of the first page of the data. Diluted shares were increased by the Co-Co dilution about 1.2 million and our income was increased by Co-Co interest of about $200,000. Now, that'll go away at the end of the quarter but, obviously, for the year, we'll still have a diminishing effect of dilution. But for the second half of the year, they'll be pretty much gone.

Got you on that. Where are we on capital? I mean, I admire your desire to keep gunpowder available to grow the business, which, obviously, would be your first goal. But, in light of the current environment, I would think, you know, top line growth in excess of the current run rate will be a challenge. If that's the case, when does buyback and/or dividends become the way to go?

The way we look at what's happening in the pace of the business and auto sales and PIF growth, we wouldn't agree with the if clause that you had. We do see that we will grow, turn positive in the combination of auto and property written premium by the end of the year and, you know, look forward to seeing good growth in 2008.

So, we continue to believe that that's happening. We think we're on track to make that happen. And so, using our capital, which I would admit, Bob, is we are building excess capital relative to where we are today, but using that capital to fund growth in the future is our primary priority, which as you've indicated, it should be.

And then we do also have to bear in mind that the rating agencies may have some tougher requirements than they've had in the past. But if, and we don't believe this, but if we were to not be able to turn the corner on growth, then, of course, we would have to do a little of what would be in the best interests of shareholders. But we don't think we're at that point right now.

In fact, we're very encouraged by everything that we're seeing and think we'll turn the corner this year and have a very good growth story on the written premium line in 2008.

I guess the when is the more operative. If it's four quarters, you know, after where you thought it would be, you've generated a year's worth of pretty significant excess capital that's clogging up your ROEs. But, you would quarrel with the fact that you have excess capital today; at least you're telling me the rating agencies would quarrel with my view?

No. I think we do have some excess capital today but we fully intend to put that to work.

Thank you very much.

Thank you. (OPERATOR INSTRUCTIONS)

Our next question is coming from Dan Farrell with FPK. Please go ahead.

Hi, good morning. A couple of questions and I apologize if you gave this but do you have the numbers, the percentage of educator PIF as a percentage of total PIFs for both auto and property?

Yes. Both of them are around, well, the total PIF is around the 70% level; a little bit higher at auto than the 70% but right around that range.

Okay. And then, just in terms of your [accident] year loss ratio, I mean, clearly, it seems like there was some impact, you said, from kind of a non-cap weather related frequency up tick. So, we wouldn't expect to see that trend going forward? Because there is some volatility from quarter-to-quarter.

Yes, well there definitely is some volatility from quarter-to-quarter based on our size of book and various weather patterns. And I would say that, from a frequency standpoint in the first quarter, certainly higher than 2006. Some of it was 2006 first quarter, as you recall, was a pretty good, very benign weather quarter, even with the weather slightly above what we would've expected for the quarter in our plans.

So, like I said, a little higher than last year; last year being the lower, it's impacted that comparison a little bit but not out of line with our expectations.

Okay and then, just on the life DAC. The increase, I think you said, was on the amortization - was primarily due to higher real life gains in the quarter. Are there any other changes to your DAC assumptions that are impacting the amortization? And how should we view the amortization rate, going forward there?

There's no other factors that are affecting it in the first quarter. We didn't change any of our assumptions there. It was strictly the capital gains that resulted in having a higher level of the amortization than we'd originally expected.

If the gains, going forward, are in line with what we expect, then you wouldn't expect to see that have a positive or a negative impact. But it just depends on what gains occur in the investment portfolio over the course of the year.

We don't have plans to necessarily take anything more at this point in time, but as opportunities come up, we've told our investment managers that they can - if there are opportunities for them taking that would have a positive income affect, they could do that.

Okay, great. Thanks guys.

Thank you. Our next question is coming from Mark Finkelstein, with Cochran Caronia. Please go ahead.

Hi, good morning. I apologize; I had to join the call late so if you addressed this, I'll come back and read the transcript. But, can you talk about, I guess, the regulatory changes occurring in the 43B market? And, some of the things that you're doing on the technology and the compliance side to be, I guess, compliant with that. And, ultimately, what is your opportunity, knowing that there's a substantial investment to, I guess, to be compliant and that there's going to be a limited number of slots that are available, likely coming out of this regulation?

The regulatory status is still a bit unclear at this point. I mean, the IRS has said that they intend to have the regulations issued by 6-30, with an effective date no sooner than 01-01-'08. But, we're not quite sure whether they're going to meet those objectives or not, at this point in time. And I don't think anyone is, at this particular juncture.

As far as the opportunities that it will create I think, given the number of payroll slots we have, given the positions that we have in the schools currently, I think we're very well positioned to take advantage of the changes as they come. Obviously the educational sector is our niche and that's what we're committed to and focused on. So we believe that we're going to be one of the companies that are going to be very well positioned to take advantage of it.

With respect to what we've already done, we did launch an initiative early last year that we called 403B comply and compete. The first segment was to make the changes in our systems and in our service operations to allow us to assist school districts in complying with the format of the new regs. The second part, that we call compete, is designed to further enhance our services and provide additional product opportunities or offerings to customers, and that's well under way, and that will be delivered in a couple of phases over the course of this year. So we believe we will be very, very well positioned to take advantage of the opportunities that come out of these changes.

Okay, that's what I have, thank you.

You're welcome.

Thank you. Our next question is coming from David [Dusenberry] with [Dalton Greiner], please go ahead.

Good morning. I wanted to go back to the first questioner in terms of agent count. And then your training process that you've got going on, it seems like -- the question is really what kind of improvement in productivity of your existing agents do you think you could see as they go through this training process more than what's the raw growth in agent count. Can you quantify that for me in any way, in terms of improved productivity of agents coming out of this training process?

Yes, as far as the agent count that I mentioned earlier, our expectation is to grow the agency force in the 2% to 3% range throughout the year. We have a seasonal impact on staffing, normally in the first quarter, because that's the time of the year when you see retirements becoming affective, or promotions, so that has an impact on us, so that's not out of pattern.

As far as the agents that have been in the agent business school, we are measuring their (inaudible) carefully in several different areas, not only their increase in sales in the various lines of business, both over the same time period from a year ago, but also for their baseline results for the one year prior to attending the agent business school. And in addition to that, we also monitor the movement of agents from their base of operation to see that they are moving into offsite offices and getting the licensed support staff in place, and the product specialists which will do nothing but enhance the productivity of this group of agents.

So what is the improvement in productivity?

It varies by line of business, but all substantially higher than the agents who have not attended the school.

Dave I think at this point, since we're so early in the process and the transition and we don't have that many agents who have been through it, it would be premature to throw out a productivity gain number for you to multiply by the number of agents. But as we proceed over the course of this year and move from just early data to more seasoned data, we'll try to share that with you as we're comfortable. But we can actually count on that being multiplied through the whole sales organization.

Okay I guess what I'm reacting to is in your prepared remarks, Butch; you had said they're exceeding expectations, so there has to be some benchmark that you're using here that we could all latch on to. That's what I'm looking for.

I think in measuring the increase we have a level of productivity that we expect from our entire agency force and an amount in excess of that would come from our agents who are from the agency business model. So the expectation is, from those agents who have completed the school, is higher than what the expectation is of other agents.

Okay. And Frank if I could go to the 403B stuff, just run through it again. Just kind of, if you wouldn't mind, kind of what are the potential changes that could come about as part of this regulatory shift and how well are you positioned to take advantage of it.

When you say potential changes, are you talking about changes in the marketplace first? Is that what you want me to describe?

Yes.

The regs basically have the impact of putting the school in a plan sponsor role, not exactly equivalent to private industry, but much more like private industry than it is today. Schools then can respond in a number of different ways to these regs. They can still have a multi-provider environment if they choose. They can make a multi-provider work in a couple of different ways; one is to restrict school employees to using only the contract of a single provider, or one provider at any one point in time. The other is to engage third party administrators; the other is to go to a very limited offering of perhaps just a couple of different companies, kind of a one stop shop approach.

What we've done, and as I mentioned, we have a multistage process, the first was again to make the investments, to change our administrative systems to be able to insure our school district customers that we could help them meet the clients' requirements that are proposed in the regs, again they're not final just yet. And that project was actually completed last year. The second part of it was to expand our product offerings and continue to expand and develop our service offerings from an ease of doing business standpoint, etc., to make sure that we were in the very best possible position to compete in the open marketplace with whomever decided to stay or enter. And those projects are under way, the first measure deliverable from that process will occur in early August, and then there's a second phase that will be delivered in January.

So again we're very, very comfortable that we're going to be in a very good position there.

Great, thank you.

Thank you, at this time I'd like to turn the floor back over to you for any further or closing remarks.

Thank you for participating in our call this morning and we look forward to visiting with you next quarter. Have a good day.

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