Humana Inc (HUM) 2006 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Third Quarter KMG America Corporation Earnings Conference Call. My name is Danielle, and I will be your coordinator for today.

[OPERATOR INSTRUCTIONS]

As a reminder, this call is being recorded for replay purposes. I would now like to turn the presentation over to your host for today's call, Mr. Kenneth Kuk, Chairman and CEO. Please proceed, sir.

Good morning. Welcome to KMG America's Third Quarter 2006 Conference Call. I have with me this morning Scott DeLong, our CFO; Jim Nelson, our General Counsel; and, Tom Sass who is in charge of Operations. Before we begin, I want to mention that certain statements made during this call relating 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 Third Quarter Form 10-Q to be issued tomorrow and our Form 10-KA for 2006. 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. KMG America assumes no obligation to publicly update or revise any forward-looking statements.

KMG America reported third quarter operating results this morning of $0.10 per share. These results are consistent with internal projections and better than analysts' consensus estimates of $0.08 per share. Scott will describe several unusual items, some of which contribute positively to earnings and some negatively. But the trend of rapidly increasing sales, premium growth and reduced losses on our new large case business is evident.

I'll make a few comments on our large case sales activity. Including a small block of voluntary business, sales rose from 8.2 million in the second quarter to 12.8 million in the third. We are now aggressively pursuing January 1 renewal business, and are optimistic that we will begin 2007 with a significantly increased premium base compared to January 2006.

In addition, the quality and diversity of cases has consistently improved throughout the year. The number of sales representatives remains stable at 21. It appears productivity per rep will be somewhat under 3 million for full year 2006, but it should be within an acceptable range for the objective.

KMG America continues to gain more traction in the market place. The flow of new cases is increasing nicely, and the product mix is becoming more balanced with improved numbers of group and voluntary quotes. We are having success with multiple product sales which is a key piece of our strategy. I expect January renewals to include significantly improved numbers of group cases. All of this is more confirmation of the quality of KMG America's sales, administration and underwriting operation.

Product development continues to progress nicely. We have filed several new voluntary products this year. For the most part, product approvals are being received on a timely basis, with the exception of disability approvals in the key states of California and Minnesota. This has hampered our group product sales results somewhat; however, most of you are aware we have been emphasizing voluntary products because of the more certain margin results associated with individual products which have filed rates.

Operationally, long term care claims retreated nicely in the third quarter after being up in the second quarter. There is an industry-wide concern over long term care claims, so we are happy to report that our book continues to perform at a reasonable level. Also, you'll see that the expected efficiencies associated with premium growth are being realized, and we added reserves to our stop loss block as we transitioned to actual claims from formula reserving.

Finally, before I turn it over to Scott, I'll say a couple of things about the ING litigation, not because it's material, but because many of you are interested. In the third quarter we received another very favorable ruling, this one from Minnesota State Appeals Court. Incredibly, however, discovery continues. We have an assigned date for a Summary Judgment hearing in January, and we expect to be successful. And remember, we filed a Rule 11 Motion seeking reimbursement for costs. As time and rulings pass, we are increasingly optimistic about the outcome.

Now, I'll ask Scott to comment more detail about the financial results.

Good morning. Our operating income of $0.10 per fully diluted share compares with $0.05 last quarter and $0.06 in the third quarter a year ago. The operating income per share this quarter breaks down into $0.19 for the Kanawha legacy business versus $0.16 last quarter, and a loss of $0.09 for the new large case activity this quarter versus the $0.11 loss last quarter. This means the earnings trends in both the legacy business and new large case activity were favorable this quarter.

Before I get into a brief earnings discussion, let me make note of the change in format of our earnings release this quarter, along with the introduction of a new statistical supplement on our company website, which went live with the earnings press release this morning. These format changes accomplish two important objectives. Number one, shorten and simplify the press release with a focus on two key elements of our operating performance, the underlying earnings stability and strength of Kanawha's legacy business and the revenue and earnings trajectory of the new large case activity.

And number two, present a new normalized earnings measure to identify and remove unusual or temporary items in each quarter, to help analysts and investors focus on underlying earnings trends. Normalized earnings for the current and all prior quarters are now available on the new statistical supplement. Earnings presented on this basis are subjective but you can look through the details and form your own opinion.

There were a number of unusual items in the current quarter results, both favorable and unfavorable, but in our view, normalized earnings for the quarter were consistent in total with a $0.10 operating earnings number. These earnings items include the following. One, a reimbursement from our D&O underwriters for certain prior and current period ING litigation expenses amounting to $0.02 per share, roughly half of this relates to prior periods with the other half for the current quarter.

We would now expect reimbursements for most of our future legal costs to continue as long as this lawsuit continues. With this new development, it now appears that this lawsuit will be even less consequential as it progresses to its conclusion. Two, a one-time accrual amounting to $0.02 per share for indemnification of previously reported losses from former shareholders of Kanawha under the terms of the purchase agreement.

And three, an offset to these favorable adjustments of $0.02 per share for an addition to stop loss reserves on business we wrote in 2005. This quarter, we began a transition to actual claims-based reserves from formula driven reserves as our stop loss matures. Our current expectation for 2007 and beyond is that future loss ratios for the 2005 cases that were renewed this year, as well as for the stop loss business that had been written in 2006, a significantly larger block business I would add, will be lower.

Notwithstanding these unusual items, the $0.05 earnings improvement this quarter from the $0.05 recorded last quarter, comes in large part from improved claims experience and Kanawha's legacy business, especially in the senior and acquired business segments, as well as from earned premium growth in the new large case activity.

The benefit ratio for the Kanawha legacy business this quarter was 75% compared to 82% last quarter. Virtually offsetting this improvement was accelerated amortization of deferred acquisition costs in the third quarter stemming from lapses of a number of legacy worksite cases. Indicative of a favorable trend, the expense ratio continues to decline even after adjusting out the unusual items this quarter, falling from 50% last quarter to 47% this quarter after adjustment. This means that premiums and fees are growing faster than expenses, indicative of the economies of scale .

We are reporting operating returns on average equity for the first time this quarter. You will find the details in the statistical supplement. The annualized ROE was about 4.5% in the third quarter, on both the reported and normalized basis for KMG America as a whole, which is an improvement from the second quarter on both measures. For the Kanawha legacy business only, return on average equity in the third quarter was 9.7% on a reported basis, up from 8.2% in the second quarter. On a normalized basis, the ROE for the Kanawha legacy business at nearly 9% was also up compared to the second quarter.

Finally, we continue to be comfortable with the $0.28 to $0.32 full year EPS guidance announced last quarter. With that, I'll turn it back to Ken for the Q&A session.

We're available to take questions now.

Thank you.

[OPERATOR INSTRUCTIONS]

Your first question will come from the line of David Lewis with SunTrust Robinson Humphrey. Please proceed.

Thank you, and good morning. Congratulations on a solid quarter.

Thank you.

Ken, can you talk a little bit about the quote activity? what you're seeing on pricing? how active you are, what prospects you think you'll ultimately see on January 1 renewals?

I will ask Tom Sass to join me in this answer, but the level of activity continues to improve very significantly, both in voluntary group and stop loss as well. We are not prepared to say what we would expect the total level of activity on January 1 because there's still a lot of uncertainty. There's still a substantial amount of time before January 1. But we are seeing good margins on voluntary. Our stop loss margins, I suspect, are improving, but still not to the level that we would hope they would get to, and group margins are showing signs of improvement as well. I'd ask Tom Sass to comment or say anything that he might have on this question.

We've continued to see just increasing proposal activity both on the voluntary and on the group side, and again, the combined cross-selling quotes are what's really promising. Activity continues to pick up, and we've very encouraged by what we've seen and what might be the results for January 1.

That's helpful. And, if I look at just the third quarter voluntary benefit sales, they actually declined sequentially, do you think that's more seasonally related or just kind of the repositioning of the product? I guess I would have anticipated that to be up. Excluding the block.

Excluding the block, they were up very substantially. I don't think that there's any trend relative to a voluntary -- it typically grows towards the end of the year. Fourth quarter should be quite strong in voluntary. First quarter is usually the lightest. But there's nothing in our numbers in the third quarter that ought to be indicative of a trend, other than we continue to see increasing number of cases, and we obviously will have substantially increased premium in that line going into 2007.

Okay. And lastly for me right now, could you give us any more details on the small, voluntary benefit term life block purchase? You know, what kind of margin did you price that for on an ROE basis? Any other details you can provide?

As you are aware, David, we're not aggressively pursuing blocks of business and this is not a normal block. The underwriter of this business was exiting. We had significant overlap in distribution. We would be in the market place picking up this business on a rather consistent basis over several quarters. We felt the economics that we were able to put together by buying them in bulk were every bit as good as we would see if we were renewing or pursuing the business directly.

The ROE profile of the business, like I said, is consistent with what we would normally see on voluntary business, maybe slightly better. There's an earn out provision that allows us to not incur any significant loss at all. If the block performs properly, there will be earn out payments, but they're not significant either.

That's helpful. Thank you.

Your next question will come from the line of Mike Grasher with Piper Jaffray. Please proceed.

Good morning, gentlemen. I wanted to ask about the TPA business. It looks like margins fell a little bit and assets moved lower. Anything in particular we should make note of here?

This is Scott DeLong. Let me address that second question about the assets. There were, I think the number is about $4 million of assets, that had historically resided in that block. These were assets that were just normal investments. Because of the way the performance of that block presents itself on a statutory basis, we felt it was advantageous to move the assets from the TPA directly into the life insurance company which we did in the third quarter, and that accounts for the reduction in assets.

And the margins on the business overall?

We had one rather significant client that laid off a large percentage of their workforce which caused some revenue reduction from that account. Sales activity for the year is up over last year, so we would view that as a one time event. However, I have to say that that will continue into 2007, as well because those reductions will continue.

Reductions will continue to impact --?

The revenue of the TPA.

Okay. All right, thanks very much.

Your next question will come from the line of Stewart Johnson with FBR. Please proceed.

Good morning. I have a question regarding the reimbursement for your legal expenses, and I'm wondering if it's something that you're expecting going forward? Is there a chance you may use some of that to do some more recruiting on the sales side?

Well, I think [they're] independent activities quite honestly, Stewart. We would expect to have a significant percentage of our costs reimbursed going forward. We will continue to make the decision about rep hiring independent of that based upon other appearances on our P&L and so forth. But we would expect to start hiring again in the first quarter of '07 under any scenario.

Okay. And then the next question relates to the worksite business. The life block that you acquired, you've mentioned that there was some overlap on the distribution side? Is there a chance that you could use those relationships in the now relationships with the individuals that hold these life policies, to go back to businesses and sell some group product?

Absolutely. It's a key piece of the strategy.

Okay. And then my last question relates to the disability income in the voluntary benefit products. It looks like it's dropped off from the levels in the prior three quarters. Was there something kind of in the market that steered you away from that, or do you expect it to bounce back going forward?

I'm not prepared to answer that, Stewart. I'm going to have to get back to you. I don't think that there's anything going on in the market place relative to the voluntary that should have impacted that number.

Okay. Maybe I could sneak one last question in. I'm just thinking about sales in the fourth quarter. Obviously it's a big quarter for the annual renewals and so forth. You're in a better position with products in the market than you were last year. Can you give us any guidelines on how we should think about sales, maybe relating them to either this third quarter or the second quarter sales?

The actual level of sales in the fourth quarter will be less than the third quarter. The bulk of sales in the fourth quarter are voluntary. There's not a lot of group activity. Some stop loss. But the bulk of our efforts now are focused on January 1.

Okay, so we'll see that in the first quarter then?

That's right. We will announce January 1 renewals sales results early in the first quarter. That will not be a [first] quarter conference call number. We'll announce that earlier.

The process of kind of lining up those group sales that you'll sign as of January 1 is going on right now. What are your reps saying to you about the reception of the products, and specifically, steering away from the stop loss insurance? Are you seeing interest in the other products as well?

Absolutely. Interest in all three product categories continues to grow as evidenced by the number of quotes. The reception that we're getting in the market place has just been tremendous -- it continues to be. Again, it speaks to the quality of our sales management, our sales organization and the administrative performance that we have demonstrated. The issue for us is not the flow of transactions, but the issue is to pick those that have an appropriate margin.

As I said in the past, sales can be whatever we want them to be. We see so many transactions. But we want to be prudent and pick those that offer us the best opportunity to produce a good bottom line result. But our products, the product menu, the product mix, the three groups of products offered together, are absolutely being accepted in the market place.

Okay, that's it. Thank you, very much.

[OPERATOR INSTRUCTIONS]

Your next question will come from the line of Craig Siegenthaler with Credit Suisse. Please proceed.

Hi, good morning. Just a couple of questions here. The first one. The 900,000 in one time item related to the 2005 stop loss claims. Was this an adverse reserve development, or is this a result of a change in formulas?

Well, as we transition from formula to actual claims reserving, we just have to accept that there is some volatility that occurs in claims on a continuous basis for all carriers and it's exaggerated for us because of our size. We obviously do these calculations every quarter.

We completed the same set of calculations at the end of the second quarter. At that point, if we would have started the transition, it would have had a positive impact on earnings in the second quarter. We had a couple of claims in the third quarter that caused that to change, so we moved to start that transition in the third quarter. I would ask Scott to make a comment about the specifics relative to that reserve.

Well you asked about the methodology, and maybe I should comment on that. To date, we have not had adequate claims experience to drive lag studies to drive our IBNR calculation. Over time, as we get more experience and have information we can use to develop claim lags, we will be transitioning to that.

To date, though, we've been employing a -- what I'll call a "target loss ratio" approach, where the loss ratio has been derived from how we price the products. And we've added the difference between the target loss ratio calculated in incurred claims from paid claims to get the IBNR.

We are now beginning a transition to that actual claims-based reserving, which will probably take six to eight quarters to complete. We will always have some component of our incurred claims being derived by target loss ratios for the newest business on the books. The more mature business will have incurred claims determined by these lag studies.

Okay. And just my second question was, on the long term care improvement you saw in the loss ratios -- I was just wondering if this was a direct result of the Florida re-rates? And if so, I guess this is probably here to stay. And the follow up to that would be, did you get any re-rates passed in other states, because I know you did Florida in the second quarter? And I was just wondering if any other states are passed.

This is Scott DeLong. I would say that certainly the Florida approved rate increase helped although those really didn't go into effect until policy renewal dates around the first of September. So, it had a modest favorable contribution to third quarter results. I would say that the reduction in long term care claims this quarter, which was similar to what we saw in the first quarter, but different than what we saw in the second quarter, is simply the result of the ebbs and flows on open claims as prior claims fall off as new claims are added.

As you know, long term care is a low frequency, high severity situation and depending on the facts of the case on when you open a new claim file, you may put up a large reserve or you may put up a small one, depending on whether it's institutional care or home care or what the facts may be. So I think certainly the Florida rate approval helps and it will continue to help even more going forward. I don't believe we've had any additional approvals of previously-filed rate increases in other states, but we continue to respond to the questions that come back to us from the regulators in those states, and we fully expect to achieve the hope for rate changes on all of our pending rate filings.

Great. And real quickly, how many sales reps do you currently have?

21.

Okay. Thank you, very much guys.

21, by the way, is the same number we've had for the last couple of quarters.

Your next question is a follow up from the line of Mike Grasher with Piper Jaffray. Please proceed.

Ken, just a follow up question on the investment portfolio. I don't know if [you] discussed it or not, but it looks like the yield went down a little bit there.

Scott DeLong will answer that.

Yes, and I think we mentioned this in -- the last quarter, that because of the increase in market rates in some of our mortgage-backed securities, there was an adjustment of the prepayment fee that gave us a benefit in the second quarter. That benefit didn't repeat in the third quarter, we wouldn't have expected it to. And I think if you flush that out of the second quarter--

Got you.

you'll get something that is incrementally higher in the third quarter than it was in the second quarter.

Got you. Okay, thanks very much.

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

Thanks. Ken, can you talk a little bit about the average rate increases you are receiving on your renewed '05 stop loss coverages? And give us some sense of what percentage of that business terminated, when they saw those rate increases.

Tom Sass will answer that question.

Yes, David, we went out and offered renewals to all of our business and on the business that renewed, our average rate increases were in the high teens, which is actually above what Tillinghast has reported the industry average has been for the last couple of years. We feel pretty good about that.

We had several large claims as Ken indicated. That was isolated on a handful or small number of cases and we did lose several of the cases that were poor performers. So as we take a look at the business, the renewal increases in the business that's left, it gives us, we're encouraged by the results going forward on that 2005 business.

Okay. And how about as far as rate increases on the Florida long term care books?

This is Scott DeLong again. We had no new development to report this quarter on that, but last quarter we had indicated that on the conference call that within the same week we had received notification from Florida that they had approved our requested 11% rate increase.

Okay, and finally, probably for Ken. Can you give us any sense of range that you would anticipate adding new reps at in the first half of '07?

Yes, David, I would think that it would be probably about five new reps.

Okay, good. Thanks, very much.

We have not finished our budgeting for the year, and we haven't finalized it, but that's the preliminary number that we're including.

That's good. Thank you.

And there are no more questions in queue. I would now like to turn the call back over to Mr. Kenneth Kuk for closing remarks.

Thank you for joining us this morning, and thank you also for continuing to follow the progress of KMG America. We're satisfied with the quarter. We're very happy with the other indicators such as sales and so forth, and look forward to talking with you again in 90 days. Thank you.

Thank you for your participation in today's conference. You may now disconnect. Have a great day.