Horace Mann Educators Corp (HMN) 2007 Q3 法說會逐字稿

Good morning. My name is Caretta and I will be your conference operator today. At this time I would like to welcome everyone to the Horace Mann Educators Corporation third-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, Mr. Dwayne Hallman, Senior Vice President of Finance. Sir, you may begin your conference.

Thank you. Good morning, everyone. Welcome to our third quarter 2007 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 will cover our results for the third quarter in our prepared remarks. The following senior management members will make presentations today and as usual will be available for questions later in the conference call.

Lou Lower, President and Chief Executive Officer; Pete Heckman, Executive Vice President and Chief Financial Officer; Doug Reynolds, Executive Vice President, Insurance Operations; Frank D'Ambra, Senior Vice President of Life & 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 or 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, assumptions or other factors that could affect these statements. As a reminder, this call is being recorded, and it is available live on our website. An Internet replay will be available on our website until December 3, 2007. Now we will 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 and losses of $0.42 per share for the quarter. That EPS result was equal to prior year and consistent with our expectations. Despite a benign hurricane season for the Continental US, we did experience significant levels of non-hurricane related catastrophe losses. This was an active quarter for other wind and hail events, which exceeded similar weather activity last year. However, the negative impact of weather on our property casualty results was more than offset by favorable results in life and annuity, helping to produce another solid quarter of profitability.

Turning now to individual segment highlights, third quarter auto unit sales came in below our expectations; similar to what we discussed last quarter, the decline from last year's strong sales performance and true new units was largely attributable to the fallout that our coastal risk reduction initiatives have had in Florida. In other states we are not immune to the competitive auto environment, while we've been able to maintain attractive pricing in our target educator market, the lack of shopping on the part of consumers presents challenges on the growth front.

Despite a quarterly decline, year-to-date sales growth in P&C, coupled with improving retention, has resulted in continuing PIF growth compared to prior year, led by growth in educator policies. That, in turn, has translated into written premium growth of 2% excluding the impact of the expiration of the NEA liability policy, which we discussed earlier. In addition to catastrophes, property casualty margins were pressured by a quarterly deterioration in property ex Cap margins, reduced favorable prior year development, and to a lesser extent, auto frequency. We continue to be pleased with the performance of our claims initiatives and the favorable impact they are having on auto severity control. But we do recognize the need as we move toward next year to take moderate level of rates where appropriate.

In our life and annuity segments pretax operating income continues to outperform prior year for the quarter and year-to-date; combining the two segments were up 26% for the year. As you may recall, annuity sales got off to a slow start in the first half. We've made up some lost ground in career agent sales this quarter, which increased 32% sequentially and 3% over prior year. Including the flow business, annuity deposits increased 10% compared to the third quarter of '06 with account values growing 8% over the last 12 months.

Spreads for the fixed business continue to improve while variable fee income has increased, as well. From a balance sheet perspective, property casualty reserves remain strong with continuing favorable prior year development, although at reduced levels in the quarter. The investment portfolio is performing as expected with minimal watchlist concerns and insignificant exposure to subprime and Alt-A mortgage issues. Ex FAS 115 average invested asset growth of just under 5% helped to drive the year-to-date increase of 7% in investment income. Our key financial ratios continue to strengthen, providing a strong capital base for future growth with book value per share ex FAS 115 up 14% year-over-year.

And speaking of capital, a month and a half ago we disclosed that our Board authorized a $50 million share repurchase program. No purchases were made between the time of approval in September and quarter end. The program I would characterize as being opportunistic in nature and at least through the end of the third quarter we have kept our powder dry given the uncertainties and volatility in the financial markets. And now for some further elaboration on the financial picture, here is Pete.

Thanks, Lou, and good morning. On balance, the third quarter was a good one for Horace Mann. Consolidated operating income of $0.42 per share was consistent with our expectations and with prior year. Property and casualty earnings were down in the quarter due to increased catastrophes and a lower level of favorable reserve development. Also the current accident year ex cat combined ratio was up about two points in the third quarter compared to prior year, primarily due to increased non catastrophe weather in the property line.

Offsetting the prior year comparison in P&C were some excellent quarterly earning results in our annuity and life segments. With income in both of those lines of business well above prior year and better than our expectations. Expanded investment margins in both segments, as well as double-digit growth in annuity contract charges and favorable life mortality were the key drivers. Premium growth was positive in the quarter and continued to gain momentum. Consolidated premiums written and contract deposits were up about 1% on a reported basis versus prior year, but up approximately 4.5% adjusted for the expiration of the NEA professional liability policy in the current period.

Similarly, reported P&C premiums written were down almost 4% in the third quarter but increased 2.2% on a comparable basis, excluding the impact of the EPL policy. Expense management results have also been positive, although prior year comparisons were favorably impacted by a bonus accrual adjustment in the current period and the litigation settlement charge incurred in the third quarter of last year. We expect a normal seasonal uptick in our fourth quarter expenses, but the year end ratios should remain relatively comparable to full-year 2000 levels.

And finally, in terms of the investment portfolio, total net investment income is running slightly ahead of our expectations with increases of about 5% in the quarter and 7% year-to-date. The portfolio quality remains high with a double A- overall rating. As I mentioned last quarter, our subprime Alt-A exposure is insignificant, comprised primarily of two $5 million AAA rated securities, with a total unrealized loss of $1.2 million at September 30th. The small realized capital loss in the quarter reflected a $300,000 impairment of two fixed income securities of a single issuer in the paper industry.

And now, let me turn it over to Doug Reynolds for more detail on our P&C results.

Good morning. Let's start with the combined ratio and some of the drivers behind it. The total combined ratio in the quarter was 96.7, up 5.5 points over prior year third quarter. And looking at the calendar year results, the major driver was less favorable prior year development and more catastrophes. These two items account for about 3 of the 5.5 point difference. Total catastrophe costs of $10.3 million were about $3 million more than last year's third quarter.

In addition to the ISO recognized catastrophic events, late summer weather, namely wind and hail activity in the Midwest, drove up our non catastrophe costs in the quarter. Year-to-date the calendar combined ratio was up 3.5 points with an increase of just under 3 points on an accident year basis. Looking at the two major lines, our current accident year and auto, excluding catastrophes was better by 0.5 point for the quarter but up about 2 points on a year-to-date basis compared to prior periods. Overall, we have continued to control severities in virtually all coverages. However, frequency is higher than what was expected on a year-to-date basis.

We continue to improve the quality and distribution of our P&C policies in force. Our percent educator, percent of business in preferred underwriting tiers and the percent of tri-line business continues to increase. The percent of our customers using electronic funds transfer and our unique auto payroll deduction program are also increasing. Voluntary auto policies are up almost 1% or about 4000 units from a year ago. Auto educator policies in force increased almost 5% or about 18,000 compared to a year ago. Continued favorable retention ratio results and improvement up 3/10 over prior year supports our positive policy growth.

Turning to property, accident year combined ratio excluding catastrophes, is up a little more than 9 points for the quarter and up about 5 points year-to-date. Although the overall accident year combined ratio and normal catastrophes is still very good, it is higher than expectations. The primary driver has been much more active weather patterns, producing high levels of non catastrophe losses. Frequencies, excluding catastrophes, are up approximately 15% in the quarter and about 7% on a year-to-date basis. Severity showed increases in the quarter but is down on a year-over-year basis.

Property policies are up slightly, 4/10 of a percent, or about 1000 over prior year. This includes the impact of our coastal reduction policy and specifically reducing approximately 2000 Florida policies over the past year. We are beginning the next phase of Florida nonrenewals targeting an additional reduction of 20% of our Florida properties over the next year. To support our Florida agents we have partnered with another Florida domicile property company and are working with other carriers to provide outlets for property business to assist in our exposure reduction programs while allowing our agents to meet the needs of their clients.

From both a pricing and product perspective we continually look for ways to differentiate Horace Mann from the competition in the educator community. We now have our pricing program designed for the educator market, the educator segmentation model approved in 30 states representing 70% of our countrywide auto premium. The continued expansion of our auto payroll deduction program is a top priority. This quarter, about 11% of our true new auto units were written on payroll.

We are also introducing identity theft resolution services as an endorsement to our property policy this quarter, and we are providing this product to educators at no additional cost. And now, let me turn it over to Frank D'Ambra for his comments on life and annuity.

Thanks, Doug, and good morning. As Lou indicated, we have seen continued improvement in career agent annuity sales during the first nine months. Total third-quarter sales met our expectations, though year-to-date comparisons are still impacted by the slow start and an anticipated decline in independent agent sales as a result of our narrowing their focus to 403-B and qualified sales. Total annuity sales decreased by 1 million in the third quarter and 12 million for the nine months, the bulk of which is attributable to reduced single deposit business. However, total annuity deposits year-to-date grew by 7%, driven by an increase in recurring deposits which is a key benefit of our 403-B market focus.

Our total policy count continues to grow slowly with cash value retention in the 91 to 92% range. Total annuity assets under management increased by more than 8% compared to a year ago with fixed annuity assets increasing 4% and variable annuity assets assisted by strong market performance increasing nearly 14%. Third quarter pretax income for the annuity segment was $7.8 million, up $3.2 million compared to the prior year exceeding our expectations. Quarterly earnings benefited primarily from improving interest margins and increased contract charges and fees, as well as a small contribution from favorable DAC and VIF unlocking. For the nine months pretax income of $20 million represented a $6 million increase over 2006 with the drivers being improved interest margins and increased contract charges and fees.

Turning to the life segment, third quarter individual life sales were flat with 2006, and total sales for the first nine months were comparable to those experienced last year. Third quarter and year-to-date premiums in contract deposits for Horace Mann proprietary products were also comparable. In terms of the bottom line, life pretax income for the quarter was $8.4 million, up $2.4 million compared to the prior year exceeding our expectations. Quarterly earnings benefited from increased investment income and favorable mortality experience. For the nine months pretax income of $19.6 million was a $2.6 million increase over 2006 reflecting growth in investment income and favorable mortality experience.

As you would expect, the new 403-B regulations are currently being digested by the marketplace. During the interim period between regulation issuance and the mandatory compliance date of January 1, 2009, school districts may choose to place a hold on participant transfers and some have already done so. Such action could temporarily depress single deposit sales while concurrently increasing retention for firms in the 403-B market. The decision to place a hold on transfers is made on a district to district basis. If a hold is imposed, it lasts until the district lists the hold or implements their plan documents, whichever comes first.

We are working with each of our school districts to secure approval to permit participant transfers in advance of plan implementation to benefit participating educators, as well as minimize the impact on our annuity sales. Given the economics of the annuity business, a short-term decline in single deposit sales would have little impact on our income expectations. And now to discuss the marketing results and progress on the ABM initiative is Butch Joyner.

Thank you Frank, and good morning to everyone. I would like to begin my discussions this morning by framing the third quarter as one of challenge and opportunity. The challenge is clearly reflected in the decline we realized on our auto and property insurance sales as compared to the prior year's third quarter. The opportunities, however, are manifested in the strengthening sales of our financial services lines, as well as the continued success with the implementation of our Agency Business Model or ABM.

First, let's turn to property and casualty sales. Combined auto sales, new and add car units were off by 6% in the quarter compared against the third quarter 2006. This reflects in part the general softening of the auto insurance marketplace. Of greater impact, however, is the effect coastal underwriting actions have had on property and casualty sales. To illustrate the impact of these actions, consider the effect in the Florida market where significant coastal actions have occurred.

On a total auto unit basis about one-half of the 6% decrease in third quarter occurred in the state of Florida. Looking at the all-important measure of new auto customers to Horace Mann, about three-fourths of the deficit is attributable to the Florida market. In spite of the impact that Florida has had on a year-to-date basis, auto and property sales are up modestly over prior year levels. For the first nine months total auto units are up 2% with sales to new auto customers increasing 3%. Property unit sales have grown similarly by 2%. When we exclude the impact of properties risk mitigation actions in Florida, our total auto unit sales climbed 4% through the first nine months with sales to new auto policyholders gaining 6%. Property units excluding Florida are up 8% year-to-date.

On the financial services side of the house, the third quarter demonstrated an uptick in annuity sales by the Horace Mann agent distribution channel. While we reported sales declines by captive agents in the first two quarters of 2007, the third quarter showed a 3% increase over the prior year. This is particularly encouraging given the decreased opportunities in 2007 from state retirement programs that allow teachers to privatize a portion of their retirement funds in 2006. These programs contributed to a significant growth in rollover annuity sales for us last year. When combined with Horace Mann annuity sales by independent agents, total annuity sales premiums still lagged by 2% during the quarter and 8% for the first nine months.

Sales in the lifeline of business gained momentum in the third quarter with target sales premium increasing by 9% over third quarter 2006, and we are now up 4% for the year. As reported, we have experienced a reduction in our agent count. We ended the third quarter with 797 agents, down 4% compared to the same point in time one year ago. This is due in part to reduction in hires resulting from an increased emphasis on quality and building readiness for the new agency business model. This strategy is bearing fruit as evidenced by the auto unit productivity of agents who are in their first 24 months. Auto productivity for these new agents in 2007 is 23% greater than their company peers in 2006, and while our agent count has declined an increasing number of agents are employing license support, expanding our points of distribution. By the end of September 228 licensed producers were employed by agents. This represents a 22% increase during the third quarter 2007 and nearly doubles the number of licensed producers since January first.

As we continue the transition to our new Agency Business Model, we expect that over the intermediate term the agent count will continue to decline marginally, while our total points of distribution increased as a result of the growing number of licensed producers supporting those agents who adopt the new model.

So now let me update you on the progress we've made with implementing ABM. As I previously described, ABM is about a new approach to distribution, making it far more entrepreneurial. Part of the strategy calls for moving agents into outside offices supported by license support staff. And we continue to gain momentum on this thrust. Agents increasingly realize the benefits to their sales operations under the new model through significant sales lift and increasing revenues.

Through September 121 agents or 15% of the sales force have completed the agent business school. Of these agents more than 60% have fully implemented the model by securing commercial office space and employing license support staff. As a group, these agents have experienced a marked lift in their sales levels in all lines over their prior year sales levels. Of particular note is the increase in sales of agents who have graduated from the agent business school when compared to those agents who have yet to attend the school. By years end we expect 25% of the agency force to have graduated from the agent business school with another 25% scheduled to attend in 2008.

While we are still in the early stages of the implementation of ABM, the results are well in line with our expectations. We anticipate the Agency Business Model to gain even greater traction as more agents attend the school and migrate into the model. With that, I will turn it back over to Dwayne.

Thanks, Butch. And that concludes our prepared remarks. Caretta, please move to the question-and-answer session.

(OPERATOR INSTRUCTIONS) Bob Glasspiegel, Langen McAlenney.

Good morning. I guess your decision to try to be opportunistic on share repurchase is getting rewarded today. Is there any sort of -- with the stock down over 10% -- is there any restriction on you buying back stock on day of reporting?

(multiple speakers) Bob, no.

So you could be buying today if you chose to?

Yes, that's correct.

California, you gave us a sort of we feel comfortable for now sort of commentary. What are your claims on the fires todate, and you said I guess it won't be material with what you know, as of today. But maybe give us some information on --.

Yes, I think first off we are obviously being a little careful with it because it is still early in the process. We have people out there on the ground from our claims standpoint. We are into all areas; some of that will depend, at this point there has been one catastrophe named the Witch Fire. We fully expect some of the other fires to also be named as catastrophes. And the other part of our reason behind that is, as you know a couple years ago we strengthened our reinsurance program around catastrophes by adding an aggregate of loss coverage for catastrophes. And based on what we've had so far this year, we are close to moving in and being able to utilize that coverage.

Can you remind me the details on that?

Yes, it basically for any cat loss it covers once you cross the $21 million mark, the next $19 million comes under the catastrophe egg, and it goes from dollar one on a cat loss but caps out at $10 million per catastrophe. So if we are at the $21 million mark and we have a $10 million catastrophe, the aggregate would kick in and cover that full $10 million.

What is your retention on that layer?

$21 million.

No, on the $10 million.

5%.

Okay. And no numbers on claim count at this point?

No, well, we obviously have some. But it is not something we want to share today. They do continue to come in, although I will tell you that they have been slow. Certainly from this standpoint, if you recall from fires a few years ago, we would be seeing substantially less from a claim count. But as I said, I've got to have the caution that it is still early in the process. But it is fairly slow in developing at this point.

You said the auto frequency was up and prices are flat. Are we going to just sit and wait to see whether this is a trend that continues before we start to reflect increased frequency of pricing?

No, actually the pricing is on the auto side is up a couple points this year. We would obviously be taking more in the pricing area as we move through the rest of this year and into 2008, and we've already begun that process. I will tell you that in the future as in the past, it is a little bit more focused on the non educated than the educator. But no, we would not be waiting for that to happen.

I would also point out that the frequencies are up obviously a little bit more than we expected on the auto side as we were expecting it to remain relatively flat in 2007. But we also are seeing good controls around our severity results, so that is mitigating some of the frequency increase that we are seeing. And on an accident year basis we are right where we would have expected to be.

Last question. Recruitment. I thought last call or press release you said that you hoped to grow for the year and now it looks like you are backtracking on that. What has been the sort of biggest impediment at growing your force?

I think a couple challenges that we've given our field managers is one, to place a high degree of emphasis on quality of new hires. And our new hires are down slightly, but as you heard in my commentary, the productivity of these new hires is up substantially over hires from the past. And secondly, we want to hire agents that can transition into the new model, and that is a different profile than the agents that we've hired in the past. But at the same time, we've seen a rapid growth in the number of licensed producers and to the point that today we actually have a larger number of licensed appointed sales people with Horace Mann.

That's a good answer. Thank you very much.

Dan Farrell, Fox-Pitt, Kelton.

Can you just talk a little bit about the DAC adjustment that you had in the quarter? How much was that?

The net effect for the quarter was about $300,000.

Okay, so pretty small then.

Yes, minimal.

And then I apologize if you mentioned this in your remarks, but could you just go over the spread numbers again, what the annuity spread numbers were versus past quarters?

The overall spread that we are realizing on our assets is improved over the course of this year by about 15 or 20 basis points. And that is a reflection of rates moving higher, as well as all the new business we are selling, we are getting our price for spreads in those sales. So that is contributing to the improvement. The actual number at this point in time is at 141 basis points.

Okay, great. Thanks. And then just one last question. You gave some of the sales numbers ex the risk mitigation changes that you made. Can you just split what the premium number would have been on a gross basis ex that?

I don't have that available. I have to get back with you on that number.

Great. That's all. Thank you.

(OPERATOR INSTRUCTIONS) Rohan Pai, Banc of America Securities.

Good morning. First question has to do with the P&C insurance expense ratio. It seems to have declined both year-over-year slightly and also sequentially. Is there anything seasonal in this, or was any kind of initiatives that were put into place?

In my comments I indicated that we did have some favorable prior year comparisons primarily driven by litigation charge that we took in the last year's third quarter. So the prior year comparison is something that is somewhat artificial. We traditionally have an uptick seasonally in our expenses in the fourth quarter, so we would expect to see an expense ratio in P&C a little bit higher in the fourth quarter than it has been running. But as I said in my comments, we are generally not expecting the ratios to be much above the full year 2006 levels.

Okay. Thank you. And second question had to do again with the fixed annuity margin. It seems up, it is the second consecutive quarter. And you mentioned that this higher pricing and improved rates. What are your expectations going forward for the margins in this business?

There are two elements that contribute to that obviously. One is the overall yields that we are generating from our portfolio, and then the second element is the new business that we are selling at the price for margins. We're going to continue to sell at price for margins. So as we do that and that becomes a larger component of the block, that will help drive an improvement in the overall yields for the block as a whole. As far as the yields that we are getting in the marketplace, those have improved over the course of the year, and although they have kind of plateaued I think at the moment. So as we see some of the investments we have that mature rolloff and maybe get invested at slightly improved yields, that will help us. So we are looking for some, I would say modest improvement in that number going forward over the intermediate-term.

And I guess the final question has to do with the premium growth expectations. How do we model in the loss of the EPL policy? What is the impact going forward? I think this quarter there was an adjustment. Will we see a decline in future quarters, or is that a onetime type of a thing?

The way we had booked that premium was we booked all of the written premium at the renewal date, which is in the month of September. So September of '06 would have had approximately $8.5 million written premium for that policy, which is not in the third quarter '07 numbers. The premium, that premium is earned then ratably over twelve months but the written impact is all onetime.

Okay, so it is I guess in future quarters it would be a more normalized type of --?

Yes.

Thanks for the answers.

There are no further questions in the queue. I will turn the floor over to Mr. Hallman for closing remarks.

Thank you for your time and attention today, and we look forward to speaking with you again at the end of the next quarter. Have a great day.

Thank you. This concludes today's Horace Mann Educators Corporation third quarter earnings conference call. You may now disconnect, and have a wonderful day.