Humana Inc (HUM) 2005 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the second quarter 2005 KMG America Corporation earnings conference call.

(OPERATOR INSTRUCTIONS)

I would now like to turn the call over to your host for today's presentation, Mr. Kenneth Kuk, chief executive officer. Please proceed, sir.

Good morning. Thank you for joining us and welcome to KMG America's second quarter conference call.

Before we begin, I want to mention that certain statements made during this call related to KMG America's future operations, performance, growth, plans, and expectations of future developments are forward-looking statements under Federal Securities laws. These statements are based on various assumptions and estimates that are subject to a number of risks and uncertainties. These risks are discussed in our second quarter earnings release issued this morning and our 10K to be filed later today. In light of these risks, actual results may differ materially from those expressed in any forward-looking statements made during this call and should be considered carefully.

During this call we will also be discussing certain non-GAAP financial measures, such as operating income and pro forma financial information, that we believe is useful for evaluating the performance of the business. This information should not be viewed in isolation or considered as a substitute for information prepared in accordance with GAAP. A reconciliation of the non-GAAP financial measures to the most comparable GAAP measures is contained in the earnings release.

I have several items to report on, starting with a few comments on earnings. We are very pleased with our second quarter earnings results for several reasons, even though they're below consensus estimates. We knew the absolute level of incremental costs associated with building the new KMA activity would be substantially higher in the second quarter than in the first, and they were, approximately $4 million compared to 2.4 million in the first quarter, and there was virtually no incremental new premium in the second quarter. Consequently, our modeling showed the second quarter earnings to be lower than the first.

As we've said repeatedly, we believe the new organization could be built while still producing positive earnings. And while claims and reserves can bounce around from quarter to quarter, we expect to have rapidly growing premiums starting the third quarter. This premium growth should be occurring while the pace of cost increases is slowing.

Additionally, we've picked a short end of the yield curve to invest excess cash in the near term. This is proving to be the right long term decision for KMG America as the upward pressure on short term rates should produce better returns than we would be receiving had we invested long in the second quarter. We continue to hold about $100 million, or roughly 20% of invested assets, in short term investments.

Finally, we are currently modeling 2006 and 2007 projections utilizing updated data in a far more refined process. We are trying to understand what we might reasonably expect our earnings growth trajectory to be. We have not changed our estimate of the long-term return prospects for KMA, but there have been changes in interest rate outlook, reinsurance strategies and other areas.

We have not given earnings guidance thus far, but certainly want to relay updated data when we're confident it's complete and accurate. The issue for us is when we achieve scale and stabilized ROEs in the mid teen range. Scott DeLong will have more details on the second quarter in a few minutes.

Some other important items. You'll recall we slowed sales rep hiring toward the end of the first quarter and well into the second quarter in order to better manage our costs, but we still added more high quality reps in the second quarter and now have 15, most of whom are already productive. Our objective was to have 15 or so reps going into the third quarter and 18 to 22 by 9/30. While it becomes increasingly difficult to hire reps as the year progresses because successful reps have their full year bonus achieved, we think there's little doubt recruiting objectives will be met and we continue to interview only the best.

Another important area is product development. We filed our new stop loss product in most states in May and have been actively selling it. Sales results are impressive. I'll have details in a minute. The new group life product was filed two to three weeks later than we expected. We clearly missed in July 1 business due to the delay, but it shouldn't be material to our full year results. The group life product has been in the market now for several weeks. Our other product work is progressing as planned.

While we didn't have a stop loss product available in all states in June, as of July 1, which means some of these sales will be reported in the third quarter, but as of July 1, actual sales of the stop loss product totaled $3.8 million, a very impressive result for the first month. And it wasn't the result of a couple of large cases, but rather many smaller cases. We're pushing group life right now and hope for similar success. We expect total annualized new sales to exceed $20 million in 2005 for this new activity, which is at least 50% greater than our original plan.

We continue to get a strong effort from Kanawha smaller case worksite sales unit following a significant reduction in its sales management structure in the second quarter. The structural changes caused some disruptions to sales efforts, but the management of the unit has responded positively. Our agency unit in the Carolinas continues to perform well nd will exceed its sales budget for the year. And Kanawha Health Services, our TPA, should show a 20% sales increase full year as well.

We have announced that we intend to discontinue writing long term care insurance in the near future and sell our senior market agency in Florida. This will have a negative impact on sales, but is the right decision for KMG America. We are negotiating a definitive agreement, as we speak, to sell this unit. The sale will not have a material impact on results. We expect to dispose of this unit in the third quarter or early in the fourth quarter at the latest.

Finally, there's been a flurry of activity on the ING suit, none of which has changed our opinion about the risks. After a one-day unsuccessful mediation session in late July, ING filed a motion to add two additional KMG America employees as defendants. Neither had any involvement in sales or the recruiting effort and neither has been employed by ING ReliaStar for several years. Neither had non-competes or non-solicit agreements in effect. Additionally, ING is now seeking injunctive relief when KMG America hasn't made an offer to one of their employees for about five months.

A hearing occurred last Tuesday and we expect a ruling this month. I repeat that following the hearing our attorneys have not changed their assessment of the rest. I can continue to report that the ING matter hasn't distracted us from our objective of building a first-class national group and Worksite company, but it is costing more to defend than we had expected.

In conclusion, KMG America is delivering as we said we would. We are moving forward on all fronts and I couldn't be happier with our progress. While our objectives are significant, I can't point to one area where we're coming up significantly short of our plan. Stated differently, we are near or ahead of plan on virtually every key area.

Now Scott will talk about the financials.

Good morning. Our earnings release went out earlier this morning and the 10Q will be filed later today. Let me start with a few words about our financial statement presentation in the press release.

First, as we noted last quarter, we provide 2004 results for our predecessor on a pro forma basis adjusted for the effects of purchase accounting. This is the only way we believe that comparisons between 2004 and 2005 can be meaningful. We plan to continue this approach throughout 2005.

Second, we compare this year's second quarter to both the first quarter and last year's second quarter. Because the financial results of our predecessor in 2004 do not reflect the new activity of KMG America, we believe the most meaningful comparison of the second quarter results will be to this year's first quarter.

Third, as we did in the first quarter, we have added extra lines to the income statement in order to separate the expenses of the Kanawha legacy business from the expenses relating to the build-out of our new sales and underwriting operation, the new corporate office, and the new costs associated with being a public company. This, too, facilitates period-to-period trend comparisons of the financial results of Kanawha's legacy business and helps you observe the earnings effects of our new activity. Starting next quarter we expect to start providing a full P&L for this new activity once more material premium revenues and benefit costs for this new activity are being recorded.

With this introduction, let me now get to second quarter results. Operating income was $0.03 per fully diluted share, below the analysts' consensus estimate of $0.06. This compares to $0.05 per share last quarter and $0.12 on a pro forma basis in the second quarter of 2004. We are pleased with this result because it reflects an improvement in the performance of Kanawha's legacy business of $0.15 per share for this quarter compared to $0.12 for both last quarter and on a pro forma basis for the second quarter in 2004.

As Ken said, we expected that overall earnings would decline from the $0.05 per share in the first quarter because we knew that, compared to the first quarter, we would be adding a lot more expense without adding much premium right away from this new activity. The improvement in Kanawha's legacy business was not enough to offset this expected ramp-up of expense, so earnings had to decline. I'll be talking about these expenses in more detail in a moment.

Next, I'm going to provide a little detail about the performance of Kanawha's legacy business. The improvement from $0.12 per share in the first quarter to $0.15 this quarter comes from several factors, including a 2.4% rise in premium revenue, which is about 10% annualized, a modest increase in investment income, as well as in fee and commission income, and improvement in the benefit ratio from 78% last quarter to 77% this quarter, and operating expenses that were flat.

Operating income in all the segments was flat or up after removing the expenses of the new activity, with earnings in the worksite segment up very nicely from 1 million in the first quarter to 1.8 million pretax in the second quarter.

One item you might be wondering about is the benefit ratio for the long-term care block reported in the senior segment, which has been trending upward for two quarters after a very good result in the fourth quarter of last year. As we discussed in the press release, some of the increase is due to newly opened claims and some comes from the predictable rise from the aging of the block, combined with steadily decreasing new sales in recent years. These new sales start out with a much lower benefit ratio than what we see on policies that have been on the books a few years because of the level premium nature of these long-term policies. Countering this effect, however, are the premium rate increases that have already been approved but have not been fully reflected in current results. We will continue to file for additional rate increases, including another one in all states later this year. Finally, the nature of this product, combined with the relative small size of Kanawha's in force block, can lead to considerable quarter to quarter fluctuation in these benefit ratios.

I'll make one final point about taxes this quarter on the Kanawha legacy business. We are showing a 24% effective tax rate for the current quarter and 31% for six months. You will find a brief explanation in the press release. While I can't speak with certainty on this because a full year result will depend on the amount and mix of taxable income, our best guess at this time is that the tax benefit that gives rise to the low tax rate on our GAAP financials will not reverse in the second half of the year and we should have an effective tax rate for the full year approximately equal to the rate you see for the first six months. We don't see much of a benefit, if any, carrying over to future years, however.

I'll talk next about the ramp-up of expenses associated with the new KMG America activity. These expenses are expected and most are required to effectively implement our business plan. We incurred a total of 4 million of this type of expense in the second quarter, up from 2.4 million in the first quarter and 1.1 million in the fourth quarter last year. These expenses reduced after-tax operating income in the second quarter by $0.12 per share, up from $0.07 in the first quarter.

The quarter over quarter increase in these expenses of 1.7 million is composed of about 60% related to new personnel hired in the second quarter and 40% related to attorneys fees and Sarbanes-Oxley related costs. These incremental expenses will continue to rise throughout this year as we hire sales reps, underwriters and other support personnel, and the expense outlay for Sarbanes-Oxley continues to rise through next February. And legal fees related to the ING suit will likely continue at a high level well into next year. However, starting in the third quarter and accelerating into the fourth quarter, we should start seeing increased revenues from product sales through our new sales channel.

I'd like to talk next about the current impact on investment income from continuing low interest rates, as well as the outlook for the next year or two. Recall that we have no spread managed products currently, so increases and decreases in investment income due to portfolio yield changes fall directly to the bottom line. That's a good thing when rates rise, but makes for difficult earnings conditions when rates fall or remain low.

We provide some average portfolio yields in the press release for each of the three quarters we show financial statement data. These calculations of average yields are not perfect, but they are indicative. By looking at the difference between the PGAAP and HGAAP yields for the second quarter of 2004, you can see that the yield hair cut from marking the investment portfolio to market on the purchase date and amortizing the $18 million of capital gains over the remaining term to maturity is about 40 basis points.

You will recall we said at the time of the IPO that the Kanawha investment strategy as a privately owned company was not entirely suited to public company ownership as a portion of the portfolio generated low operating income while being geared to a total return strategy. By reallocating about 20% of that portfolio into high quality public and private assets, we believe we can add 25 to 50 basis points of yield over time. Therefore, we should be able to replace most or all of the 40 basis point mark-to-market reduction.

If we use the 10-year treasury rate as a benchmark, we believe we can add 100 to 115 basis points of yield, depending on the spreads over treasuries available to us among the various targeted asset types. The issue for us right now is we don't know when 10 year rates will rise close to 5%, which we view as our hurdle rate, although it seems clear that the Fed expects to continue to push up the short end of the yield curve.

If you look at the average portfolio yield for the second quarter of 2005 in the press release, you see that we earned about 4.7%, at least 130 basis points short of our initial target yield. This cost us about 1.2 million in after-tax earnings for the quarter, or $0.06 a share. This shortfall is due to two factors. First, we have remained very short and liquid throughout the first seven months of this year because rates have remained low. We started the year with about 130 million of cash and equivalents and we still have approximately 100 million of cash equivalents and short maturity investments of two to three years where we have parked funds temporarily pending higher interest rates.

Second, we have been cautious about investing in our targeted private asset classes. This is because the long funding lag, combined with the volatility and uncertainty of where rates might be 90 to 120 days out, makes investment commitment decisions difficult. In light of this, we are very much shorter and more liquid at this point of the year than we had thought at the time of the IPO, but we believe this is right where we ought to be in light of current conditions. It is costing us near term earnings, but is giving us the flexibility to wait for the right investments in order to improve longer-term earnings.

All in all, we are very satisfied with our current earnings performance, especially given the current interest rate environment. The important thing, we think, is that we are getting our new sales and underwriting organization in place earlier than we thought and the quality of the newly recruited personnel is every bit as good, if not better, than we had planned. Key products are getting developed, filed and approved. We are positioned for strong revenue and earnings growth in 2006.

With that, I'll turn it back to Ken.

We're open to questions now.

(OPERATOR INSTRUCTIONS)

Your first question comes from the line of David Lewis of SunTrust Robinson Humphrey. Please proceed.

Can we talk a little more about sales, Ken? I think you indicated $20 million was your target for full year 2005. How would you see that breaking out between group life and the stop loss and are there any other product introductions expected here for the balance of the year?

I would expect slightly over half of sales this year to be stop loss sales. The remainder will be made up of group life plus we are selling some of the Kanawha voluntary product. Those sales will accelerate in the last half of the year for a couple of reasons. I'm talking about the voluntary product.

Number one, we've had some technology connections that we had to get in place and I think they are substantially done right now. And there is probably more activity in the second half of the year than in the first in the voluntary business. So I think that's the breakdown, David.

And no additional product offerings in the second half?

We will have several additional products that will be available, most of which we're targeting for January 1 renewals. But we will have a disability product available. We expect to have a voluntary universal life product available. We're not projecting any substantial sales in '05 from those products. As I said, they're mostly being readied for the January 1 renewal.

Okay. And for Scott, can you give us your new legal cost outlook? I think it was, if I recall, $1 million was kind of expected over the next six to 12 months?

We've been advised by counsel not to talk about where we are, where we expect to be, but they are somewhat higher than what we had originally thought when we indicated -- I think we had indicated $0.5 million at one point.

Okay. And Scott again on the investment income outlook, $0.06 a share negative impact versus the original expectations, if rates went to 5% between now and year end on the 10 year treasury, would you be able to put that 100 million to work here, say on January 1, and then we would not have that negative $0.06 per share quarterly impact?

David, this is Ken Kuk. The answer to that question is yes, we could. We are quickly evolving, though, to the point where to invest on the yield curve is becoming more important than ever. We can pick up 20 basis points or something like that by going out 10 years versus two years.

So the next big decision we will have is where on the yield curve to invest, even if long-term rates do rise. The consensus opinion is that the Fed is going to raise the discount rate one more time and I've seen indications from some very informed people that it could be three more. If that happens, the long-term rates absolutely have to go up or we're going to have an inverted yield curve, at which point we would stay short. So this is still rather fluid. The one thing I can say is our asset managers have indicated that within a two to three week period they would expect us to get fully invested, if we gave them the okay today.

David, this is Scott. Let me just add to that. The 6% target yield would be on the $100 million or so I noted available for permanent investment. We would still have close to $500 million already invested with rates embedded. Higher interest rates won't impact that immediately; it would take some time for those cash flows out of those existing investments to be reinvested at higher rates.

Your next question comes from the line of Tom Gallagher of Credit Suisse First Boston. Please proceed.

This is actually Craig Siegenthaler stepping in for Tom today. But my question deals with sales reps. From my notes, I have approximately eight to 10 reps were hired in Q1, another five in Q2, and then I guess you highlighted to get the 18 to 22 before September 30th, that's another three to seven. Are there -- are you planning on making any additional hires in Q4? And I also wanted to hear your expectations with regard to sales rep hirings for '06 and '07.

This is Ken Kuk. We have stated that we expect to have 22 reps productive and in the marketplace in the fourth quarter. So if we get to 18 reps by the end of the third quarter, and I would expect we'll probably have more than that, we would expect to round out this year's hiring of 22 reps early in the fourth quarter. Next year the plan I believe is to add an additional 18 reps.

And...

And if I could just add this additional thought, we have flexibility relative to the '06 plan to add more or fewer reps based upon how the earnings are evolving and what our expectations are for '06 and what we want '07 and '08 to look like. So we clearly have latitude to increase or lower that number. We've done modeling with as few as five or six reps hired next year and of course we've done modeling with the full 18. So we clearly have latitude to hire more or fewer reps next year.

With that said, one of the things that has become apparent to us, it's a lot easier to hire reps in February than it is in September. And if we do hire reps next year we probably -- or whatever number of reps we're hiring next year, we would want to hire early in the year so that we have good production from them later on in the year. So we will decide on what that number is going to be probably sometime in the middle of the fourth quarter after we get our modeling done and then we will aggressively pursue whatever that number is for '06 early in the year.

Second question deals with the benefit ratio. You had very strong improvement there in the worksite segment. Do you see this improving a little bit further or do you think it's going to get flat-lined from here?

The worksite -- this is Scott DeLong. The worksite is composed of not only Kanawha's legacy worksite sales channel and related production, but a number of other pieces of business, both sold by the career agency force as well as some other products sold in the past not currently sold, like Medicare supplement. So there is quite a potpourri of blocks of business and associated benefit rates.

One of the things that impacts these benefit ratios -- which recall our incurred claims plus change in reserve divided by premiums earned. One of the things that impacts that is how much new business you've got flowing in because these are level premium products payable over long periods of time, assuming they remain in force, and as the block ages, just by the aging of the policyholders you see the benefit ratios increase. So the more sales we have, the lower that benefit ratio is, at least relative to the true worksite activity. We expect continuing solid sales that rise year over year, so you have to take all of that into account.

Now, as we said, and we didn't say about worksite, but we said in terms of the acquired blocks we had worksite -- or the benefit ratios probably a little bit better than we would expect based on our forecast. I hesitate to say pricing because in many cases we've adjusted the reserve base so it no longer reflects pricing. But what we currently expect the acquired blocks were a bit better, the senior segment and the long-term care was a bit worse. On balance, they came in pretty close. So again, lots of volatility quarter to quarter. We don't see any particular reason for things to shift in the third quarter, fourth quarter relative to where they've been in the first half of this year.

Your next question comes from the line of Stewart Johnson of Friedman, Billings, Ramsey. Please proceed.

The new business results, sales expenses and so forth, were largely in line with what I was expecting. I was very happy to see that. What I'm concerned about and I'd like to get a little more information on is this long-term care business and the higher than expected claims. It looks like there are two things you're doing that will hopefully address this. One is the price increases you said you're going to put in place starting later this year. And then also you mentioned you're going to be selling off the business. Can you give us some more details on both of those issues, the pricing and this sale that Ken mentioned earlier?

This is Scott DeLong. First, one thing I'd like to clarify, we are selling the agency that has produced long term care for Kanawha. We do not intend to sell the block of business; we intend to actively manage that block. It's about $40 million-plus of annualized premium. And active management means both periodic, probably every other year or so including this year, filed rate increases on the in force business, which we've been successful in the past in getting and continue to expect to be successful, as well as continuing perhaps even more intensive claims management relative to newly arising claims. So wanted to make sure you understood it's not our intent at this time to sell the in force block simply to see the agency that produces that business.

So if we're thinking about third and fourth quarters and the benefit ratio that we saw in the second quarter, you would expect that to continue for the entire senior segment or not?

Well, as I've said, it bounces around. And remember last year in the fourth quarter we had quite a low benefit ratio; I think around 80% or so. So when you open a new claim, these are -- the loss reserve you set up is quite high, so the impact of newly arising claims can be material comparing one quarter to the next.

The point I was trying to make is we have approved premium rate increases already in effect, but we haven't observed the full benefit of that because the rate increases will go into effect on the following policy anniversary and then it takes a full 12 months to get all of that rate increase into the -- in house. So it's about a two-year implementation period before a rate, once approved, is fully in place.

And so you are expecting to see some of that benefit come through towards the end of this year, meaning you've requested the price increases previously?

Yes.

Okay, great. And then the only other question I have has to do with the new business that you put on. You had mentioned that it is not a result of one or two large sales, but rather from a number of smaller sales, which is a good thing. Are those sales spread across your sales reps? Was there one rep responsible for most of the business? Can you give us a little more detail on where within the organization the sales came from?

This is Ken Kuk. We have gotten production, I believe, from 10 reps already and the largest production was I think just over $1 million. So it really is coming from a broad group; there's not one or two reps that are -- that have written all the business, it is coming from a group of at least 10.

And of course in the third quarter, as the new hires are on onboard for a while, we'll be seeing more business from other reps. We will give you more data next quarter because we should have information that will help you conclude whether or not we're achieving or have likelihood of achieving that 3 million or so annualized new premium per rep and we think that there ought to be adequate data after the third quarter to start giving you some indication of that.

Okay. And then just one follow-up question on this long-term care thing. I don't mean to beat a dead horse, but am I right to look at this as an ongoing issue or do you view it more as a one quarter blip?

We are not troubled by the behavior of the long-term care block at all. Now, it's hard for you or for me to draw conclusions just looking at this benefit ratio one quarter to the next because there's so much going on inside there that impacts that measure but doesn't truly indicate whether things are going well or not so well, this natural aging that I talked about being one.

And as I said, last year we had a very good fourth quarter, so except for the one piece of our business that's in south Florida that the whole industry has had claims issues with, we're very happy with everything else, which is about 70% of the block. I mean the benefit ratios have consistently been well below our pricing expectations, so we're not overly concerned about it.

Okay, and it sounds like you're focused on Florida as kind of the central issue, which is not really news in the industry. We've heard that from others.

Right.

Your next question is a follow-up from the line of David Lewis of SunTrust Robinson Humphrey. Please proceed.

I don't know if you guys answered Stewart's question on average rate increases on the senior book. Can you give us any general feel there and when you might go for another round?

I'm not equipped to have real good information for you on the average rate increases. Let me put it this way; in every state other than Florida we've gotten everything that we've asked for. In Florida the regulators require full credibility in terms of the size of your block of business and your historical claims activity before they will give you 100% of your indicated required rate increase.

So we've been getting in the past maybe a third to a half of what we've -- what our studies indicate we need. But with the continuing aging of that block, we are generating more credibility and we should have a relatively easier time getting the full amount that we request. But as I said, in other states it has not bee a problem; they've granted us the entire rate increase that we filed for.

And what percentage of that book is in Florida, Scott?

30% of it is in south Florida. There's also additional amounts in other parts of Florida. I don't have that, but all of the other locations in Florida have been performing very satisfactorily.

Okay, that's helpful. And going back to the tax rate, you said the NOLs would be largely gone by the end of this year, so does that mean for '06 and '07 we probably look at something in the 35, 35.5% range?

This is Scott DeLong again. That's absolutely right. Now, we could have some carryover into 2006 if the taxable income that drives us isn't as high as it now looks like it would be. But if everything proceeds as we now expect, we should have the loss carry-forwards used up at the end of the year.

Very good. And two final questions. Once, can you talk about the sales rep responses out there in the marketplace, going out, trying to promote a fairly new name, and whether there's been any headwinds that they're facing that you're aware of?

And then two, I'm going to put you on the spot regarding your 2006 and 2007 outlook. I know you haven't done the work yet, but the mean estimate is $1.14. Given your comments of some higher expenses, lower investment income, I would assume that that number probably should be a little south of there. Is that accurate?

This is Scott. I will handle that first one. We are not -- we're not in a position to give guidance on 2006. As you've heard us say before, we don't feel at this stage in our evolution that we ought to be doing that. We will be, in lieu of that at some later point in time, and I think Ken intends to speak to this in closing, we'll be providing some important data on the key financial indicators that will not be earnings guidance per se, but will enable you to understand what we're thinking in terms of where earnings are headed. And you can incorporate that into your models if you see fit.

David, Ken Kuk. Regarding your first question, the reception that we have gotten in the marketplace is astonishing even to me. We had an open house for our western operation a couple of weeks ago. I was there. The attendants from the brokerage community and the benefits consultant community was absolutely incredible, 60, 70 people there that headed down after work and struggled with traffic to get there; the energy and enthusiasm of that group was spectacular.

It's an indication to me that we have put together an exceedingly strong sales organization that's got an incredible amount of credibility. The sales management is absolutely second to none and the quality of our reps is exceptional. And there's evidence of that every time I interact with the brokerage community or any broker or consultant. And for a small company like KMG America to have that kind of credibility in the marketplace is very impressive to me.

With that said, we expected that we would have certain cases that we couldn't quote on because we're a new name and maybe some employers wouldn't want to deal with a new name. We have seen very little of that. I won't say we haven't seen any of it, but I would say we've seen less than we anticipated.

And the sales results, the immediate sales results on that stop loss product, $4 million the first month that it's available, is equally impressive. So just in total, we just couldn't be happier with the reception that we've gotten.

That's very helpful. And one just last question. You brought up the stop loss. Doesn't the stop loss have a lower targeted benefit ratio so therefore, as that part of the business grows, you might see the overall benefit ratio decline modestly?

I think that's right. Additionally, stop loss is a shorter-term product and profits emerge more quickly and there's a shorter period between the time these things are available in the market and the time the transaction closes. And that was the reason that the first product we put up was stop loss.

David, this is Scott DeLong. Let me add to that. In general, it's not just stop loss, but all of the new core group, group life, disability, et cetera. All of those products, as they become more material in the mix, have lower pricing benefit ratios, or loss ratios, than the voluntary products that have higher acquisition costs and other costs associated with them. So it isn't just stop loss. It's all of these true or core group products, as they come into the mix will drive down the overall benefit ratio.

Your next question comes from the line of Jim Agah of Millennium Partners. Please proceed.

I wanted to just clarify a couple of things you'd said earlier on the call and then ask you a follow-up question or two. You mentioned -- I thought I heard you say that group life filings were a bit late so you missed some renewals. Can you go into that a little more?

We expected to have the group life product filed in early June and because of the product -- some product changes that we made, we were about two or three weeks late. And consequently we missed some premium that would have been available on July 1. Not meaningful for the year, maybe 1 million of premium, maybe 2 million of premium max, so not hugely meaningful. And we're in the marketplace now selling the product.

Okay. And then the 20 million-plus of new sales that you alluded to earlier and gave a little bit more detail on, how did -- you said that's about double your original expectation?

I said it's up 50%. I think the original...

Up 50% from your original expectation?

Yes. Our original model I think was in the low teens, 13 million...

Okay.

...I think was the number.

And then what about the product mix? Is that consistent or has that changed as well?

I think the product mix is very consistent with what we expected. We had stop loss in there rather substantial and we knew that was going to be our first product.

Okay. I also heard some comments about -- I'm not clear. I heard that you made a sales management change and there was some disruption in the quarter. What were you alluding to?

What we have come to refer to, probably unfairly, as the Kanawha worksite legacy unit. In other words, the original Kanawha worksite unit had developed a rather substantial sales management infrastructure and we made the determination in the second quarter that a more efficient way to go was to eliminate most of that management layer, which we did.

And it was disruptive, but the management team in Kanawha on this matter, and quite honestly everything that we work with them on, has just responded very positively. We have reduced the sales objective for this unit. The profitability is not impacted significantly because we took out a significant layer of expense by eliminating that management level.

Okay. That's good. That's good clarity. I think what David was trying to get to was not necessarily getting guidance on '06 or '07, but maybe what would be more -- even more important is to kind of go through your projections, if you will, as to when the operating leverage can turn positive.

This is Ken Kuk again. We have had incredible success on every important measurement that is important to our long-term success. We've had -- with a couple of exceptions we've had interest income, investment income that's going to be different. Could turn out to be better, but at this point, I would say probably not. And we are incurring some expenses that we didn't expect to incur.

We're working on all of this and the quality of our model now is improved so much from the original acquisition model and the IPO model, with all the work that we've done on our budgeting and re-forecasting, that we are probably going to be in a position within the next 30, 45 days to speak more definitively on this. But we just don't have '06 and '07 done and it would just be premature for us to say how it's likely to look because, quite honestly, we don't know.

No, I understand. I understand your frustration. It's frustrating as a shareholder, but we're taking a long-term view.

Just on the frustration. If you detect a frustration in my voice, you shouldn't have because everything that matters is going exceedingly well. We haven't translated that to a new bottom line yet.

I understand, Ken. Good. Let me keep going, if you don't mind.

Sure.

The increase in expenses, I think you guys said it was 60% new employee related, 40% roughly from Sarb-Ox and other costs. The ING defense costs are in the new employees costs, right?

No, they were in that 40% bucket.

Okay, okay.

That was Scott DeLong speaking, by the way.

Your next question comes from the line of Felice Gelman of Sunova Capital. Please proceed.

Just in terms of the stop loss pricing on the -- I'm just wondering what your pricing is looking like relative to competition and where do you feel you have an advantage?

This is Tom Sass. Our pricing right now is -- well, we've developed a new pricing model and so we're out there and we are fine-tuning it and we're staying on top of our pricing very, very closely. Just to give you some idea, a little background, we've received about 450 stop loss quotes, so it's not like we have had very few quotes and we sold a lot of them.

Got you.

There's not a lot of pricing pressure on us on each and every case. So of the 450, I think we've quoted on 279, roughly. And of those quotes, we've sold 9 (ph). So we've got about a 3% close ratio, which is pretty much norm in the industry; I think they're running 2 to 5%. So as we watch our cases, we watch our pricing, we see our close ratios, we're very much following the industry norms.

At this point in time we're pricing competitively, but we're taking the position, because of our sales force that we've hired and they have such good relationships with not only TPAs but also a lot of brokers who focus on stop loss, we're able to get business without having to, I'll just call it buy business at all. But it's a competitive market out there.

There are no further questions at this time.

Okay, I've got a couple of closing comments and some of this is repetitive. But today we've given guidance only on sales and when we expect to achieve scale, which is roughly 30 months following the IPO. We've given no earnings guidance and, as I said, we'll be able to give updated information on key indicators sometime in the fourth quarter if we expect any meaningful deviation from the sales or scale guidance that we've given previously.

Additionally, we'd expect to have an investor conference in New York right after the first of the year. At that point we would be in a position to discuss long-term strategy in more detail and potential results.

But, as I said, we couldn't be happier with all the important pieces that are coming together for KMG America. Sales, product development, hiring, integration of Kanawha, Kanawha's administrative capability and so forth are all on target. And, as I said, the reception that we've received in the marketplace just couldn't be better.

Thank you for joining us this morning and thank you for your continued support of KMG America.

This concludes today's presentation. You may now disconnect. Thank you and have a great day.