Humana Inc (HUM) 2006 Q4 法說會逐字稿

Good day, ladies and gentlemen and welcome to the KMG America Corporation Fourth Quarter 2006 Earnings Conference Call. My name is Tanya and I'll be your coordinator for today.

[OPERATOR INSTRUCTIONS]

I would now like to turn the call over to your host for today's call, Mr. Kenneth Kuk, Chairman, President, and CEO. Please proceed.

Good morning. Welcome to KMG America's Fourth Quarter 2006 Conference Call. I have with me this morning Scott DeLong, our CFO; Jim Nelson, our General Counsel; and, Tom Sass, who's in charge of Operations.

Before I begin, I want to mention that certain statements made during this call relating to KMG America's future operations, performance, growth plans, and expectation 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 Form 10-K for 2006. In light of these risks, actual results may differ materially from those expressed in any forward-looking statement made during this call and should be considered carefully. KMG America assumes no obligation to publicly update or revise any forward-looking statements.

I know that you have seen KMG America's Fourth Quarter Earnings Results of $0.11 per share operating, $0.13 net, and full year 2006 operating income of $0.31 per share and 33 net. Both the quarter and full year results represent increases of over 50% versus prior year comparable periods and both quarterly numbers are better than analysts consensus expectations. Scott DeLong will discuss in more detail in a few minutes.

I have information on several other operating areas that I'd like to share with you. In January, we released sales results of $45 million for full year 2006 and 30 million for January 2007. We are particularly pleased with January's sales which were roughly double January 2006 levels. Approximately 80% of January sales were in the stop loss line. As you are aware, our objective is to achieve a balance of roughly one-third in stop loss, group and voluntary. We did, in fact, produce one-third of total sales in the voluntary line in 2006. But the remaining two thirds was over-balanced to stop loss and that trend continued in January. Our sales organization is heavily focused on group and voluntary products to achieve the desired product mix for full year 2007.

As I believe most of you area aware, stop-loss margins seem to be improving, but still are not at pricing expectations. We are hopeful the markets will continue to firm over the next several quarters. In the meantime, we are building a valuable book of business of stop loss business and developing excellent broker relationships.

The number of sales representatives is down by two, at 19. Both have left KMG America since January 1. Corporate human resource policy restricts my ability to disclose the reasons for the two departures. Productivity per rep in 2006 after an initial start-up period for new hires, was almost exactly 2,500,000. This is slightly under our objective of 3 million per rep.

With January's strong start, we expect productivity per rep to be in excess of 3.5 million in 2007. Our modeling shows that we gained far more leverage by improving rep productivity than by hiring more reps. Consequently, our focus in 2007 will be to give more support to existing reps in hopes of improving productivity.

We believe we can produce better short-term results and still accomplish longer term objectives by adding reps more aggressively as margins improve. So with the departures, we would expect the number of reps in 2007 not to increase significantly above 2006 year end levels.

Regarding 2007 earnings estimates. There's a wide range with the consensus of $0.51 per share. We are comfortable with the consensus estimate. Although our confidence level is obviously higher at the lower end of the range.

After increasing earnings by 55% in 2006, the 2007 consensus estimate would represent another very substantial increase of over 50%. One final point before I ask Scott to comment and I'd like to add that this is very important. We do not give quarterly guidance but we have seen a recurring pattern over the last several years of first and second quarter earnings being significantly lower than the third and fourth quarter results. This is largely due to skewing of long-term care policy anniversary dates toward the first half of the year which accelerates policy reserve increases. This seasonality will reduce as long term care becomes a diminishing portion of total liabilities, but our modeling suggests this phenomenon will occur again in 2007. Another contributing factor is the trend toward more voluntary sales in the last half of the year, which increases revenue. We have fully incorporated this seasonality into our 2007 budgets and re-forecasts. Now I'll have Scott discuss the numbers.

Good morning. Our operating income of $0.11 per fully diluted share compares favorably with the analysts' consensus estimate for the quarter of $0.10 as well as with the $0.10 we reported last quarter and the $0.07 for the fourth quarter a year ago.

Additionally, we reported net income this quarter of $0.13, $0.02 higher than operating income. The $0.02 reflects the gain from the sale of a small business unrelated to the insurance operations of KMG America in which we had held a 15% minority interest for a number of years.

The operating income per share this quarter improved to $0.26 for the Kanawha legacy business versus $0.19 last quarter, and the improvement was partially offset by higher losses for the new large case activity.

However, there were a few unusual items in the current quarter results, both favorable and unfavorable, that were offsetting in total but affected the third to fourth quarter trend line in both the Kanawha legacy and the new large case activity segments of our business.

These unusual items include the following.

Number one -- prepayment of the $14 million seller note balance at a discount in late December. The one time addition to revenue in the corporate and other segment was about $0.025 per share.

Number two -- a one-time gain in the senior segment of about $0.025 after tax resulting from a combination of correcting a misalignment of some long term care reserve factors and a correction to the persistency adjustment in the amortization of VOBA.

And number three -- an offset to these favorable adjustments of about $0.05 per share after tax in the work site segment for an addition to stop loss claims costs on business we wrote primarily in 2006.

As we noted last quarter, we are transitioning to actual claims-based reserves from formula-driven reserves as our stop loss book matures and we continue to accumulate credible claims data. We believe our current loss reserving is appropriate for our existing book of inforc business based on claims data available to us at the time we closed our books in January.

We intend to establish preliminary loss ratios for business written in 2007 based on this recent claims data which should reduce the likelihood of additions of similar magnitude to loss reserves in the future. And our internal budgets and plans conform to a more conservative projected loss ratio for stop loss business sold or renewed on January 1, 2007 and later.

Notwithstanding these unusual items, earnings this quarter in the Kanawha legacy business were very good. Earnings from the long-term care block reported in the senior segment were strong, based in part, on the one-time items I noted above but also from improved investment income and premium growth coming from rate increases approved and implemented earlier in the year.

Earnings in the legacy work site segment were up from the third quarter, due in part to reduced VOBA amortization, reflecting very favorable persistency compared to the third quarter and earnings declined in the acquired business segment, compared from third quarter resulted from less favorable claims experience and partially offset the other favorable earnings trends.

Operating loses related to the new large case activity were up on the fourth quarter due in large part to the additional stop loss claim reserves mentioned above. The gain from the discounted prepayment of the seller note was more than offset by increased legal fees and year-end accruals for broker and sales rep incentive bonus payments.

While net earned premiums appears to be down from 9.8 million in the third quarter to 8.8 million in the fourth quarter, premium is actually up 24% in the fourth quarter when a one time reserve transfer of $2.7 million related to an acquisition of a small block of worksite life insurance is removed from third quarter premium.

Operating returns on average equity in the fourth quarter reached 12.6% for the Kanawha legacy business and 4.8% overall, compared to 9.7% and 4.4%, respectively, in the third quarter. The ROE for the Kanawha legacy business was almost 11% if the unusual items in the senior segment mentioned earlier are removed, still very good compared to the strong result in the third quarter. You will find the ROE details in the statistical supplement that we published on our website.

We introduced normalized earnings, a non-GAAP measure, in the statistical supplement last quarter. While the concept requires a fair amount of judgment to apply, we believe it is a useful way to identify underlying earnings trends and establish a run rate that can be used as a starting point to forecast earnings, bearing in mind historical quarterly earnings pattern in the Kanawha legacy business Ken noted earlier.

Using the adjustments which are fully documented in the statistical supplement, we calculated normalized earnings of $0.12 for the quarter composed of $0.22 for the legacy business and a loss of $0.10 for the new large case activity.

We invite you to review the rationale for our adjustments and form your own conclusion. With that, I'll turn it back to Ken for the Q&A session.

We're now available to take questions.

[OPERATOR INSTRUCTIONS] Your first question comes from the line of Stewart Johnson of FBR. Please proceed.

Good morning. I have a couple questions. One is focused on the productivity expectations that you mentioned on the call. Maybe you could give us some ideas of what you're doing to improve the productivity of the 19 sales people that you have on board and expect to have on board at the end of the year.

And then, secondly, could you give us an update on where things stand in California. Are there any additional approvals, whatever, that need to fall in place there? And then, finally, on the stop loss business, when you mentioned pricing expectations. Would you give us an idea of what you would be looking for in terms of ROE on that business? Thanks.

Stewart, this is Kenneth Kuk. I'll answer the question regarding productivity. Our reps are, for the most part, in one-person offices and they are required to do an awful lot of administrative work themselves, which removes them from the marketplace for a percentage of their time.

One of the ways that we are going to improve productivity is to instead of hiring more reps, add more support people so that our reps have more time to be in the marketplace doing what they do best and do very well.

So that's the idea of some of the productivity measures that we're employing, and quite honestly, have been employing over the last several months to improve productivity. And if you just look at the first quarter, or the first month of the year with $30 million with 20 reps, they're already at a 1.5 million average productivity per rep and that's why we're pretty confident that the $3.5 million is very achievable.

Regarding California, there's nothing new the disability product which I think you're referring to. We still do not have approval in California for that product.

ROE question on stop loss.

I'm going to ask Tom Sass to join me on this, but let me start by noting that when we achieve full margins in our stop loss product, we would expect ROEs in the low 20s. So with that as a backdrop, I'll ask Tom to comment on current pricing.

We've taken a look at the '06 business that we've written and the '05 business and we've decided that we need to continually monitor that line but we're looking especially at how to get the margins up. We don't see anything really significantly problematic in the stop loss line.

We're working on pricing strategies for the renewals. We're also looking at some re-insurance adjustments that we can make in the contracts and that will increase performance and the returns in 2007 on the stop loss line.

One comment that I would add is that all the expense of producing sales is being covered currently so as we continue to sell and as margins improve in that stop loss line, that should go directly to the bottom line because all the costs associated with it are already being paid so we get good leverage on incremental sales and incremental margin, not only in the stop loss line but in the other lines as well.

I think that the reason I'm asking the question on the full margin to get -- you know, the low 20s certainly helps -- is, most investors in the life sector, when you think about ROEs, they're typically in the 12% range.

And the 12% would be far below the low 20s that you're talking about. So when you're talking about lower than expected margins, can you give us any idea of what you're earning now versus the full margin in the low 20s?

We're in a loss position on a fully loaded basis on our stop loss line. We don't have sufficient mass in order to produce a positive operating result. So we're in a negative position right now.

The point I was making a minute ago is that should move very quickly because all the costs are covered and the incremental margin will all go through to the bottom line so we think we get excellent leverage on incremental sales and incremental margin.

Now, relative to the 12%, we've indicated in the past that stop loss is a cyclical product, probably the only one that we have that has any cyclicality to it at all. And we have gone through a period of poor margins. I think everyone accepts, that has been the case for the last couple of years, but we see improvement and AM Best had a piece out several months ago that I think most of you are familiar with and indicated their opinion is that it is improving as well. Now I think that AM Best would say today that it's improving a little bit more slowly than they expected, but clearly, the margins are firming in this stop loss line.

That was my question specifically, when you say poor margins, currently, what are you talking about, versus the low 20s that you hope to get to?

Well, on a fully allocated basis, Stewart, clearly as Ken says, we're at a loss because that's apparent just from what we're showing for the new activity.

That's right.

So it's kind of difficult to answer that question because you know we have these costs that we haven't fully leveraged with new business yet because we haven't ramped up yet.

I guess I'm just looking more for a market core margin number but I can follow up with you on that. And then could you give us some concrete signs that you referenced in your press release that tell you the market is firming, heading into '07?

Stewart, this is Tom. We can see it, especially in some of the business we're getting in, some of the quote activity. There's certainly a number of carriers out there that are coming out with higher increases on some of their renewals. We're also seeing it in some of the new business pricing, so there's some definite signs out there that the market is beginning to firm a bit.

And, again, like Ken said, I don't think it's firming quite as rapidly as everyone maybe had hoped six months or a year ago, but there's certainly signs out there that there's a number of carriers that are starting to firm their pricing. In addition to that, we are seeing some consolidation out there in the marketplace, too, with the definitive agreement on the Hartford business --

Right.

-- and also the UHC purchasing of the Alliance block of business so we see that not only stop loss is very desirable out there, but I think it's a good indication that people are seeing maybe an uptick in pricing in that marketplace, so it's a good value to purchase those blocks of business.

Great, thank you very much.

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

Thank you, and good morning.

Good morning.

Can you give us a general idea of what your average stop loss rate increase was on January 1 and whether you think that kind of holds as you go through the year? And then in addition, kind of what persistency levels are you seeing on those renewals?

Yes, this is Tom again. I think it would be fair to say that in our business that we wrote in 2005, our lapses were a little bit higher than you'd normally expect in the business. We had a couple of groups in there that were somewhat problematic and we've talked about those, I believe, before, in our experience.

As we move through '06 though, especially our 1/1/07 renewals, persistency was very good, right at industry norms or even a little bit better so we are very, very pleased with that.

As we look at profitability and everything, we're being cautious and we're being very careful on our renewals, trying to do a lot of different analysis so we go out to the marketplace on our renewals with many different options for our clients and try to do the fair and right thing compared to their experience and their plan designs and so forth. Our renewals have been wide ranging. On the better performing groups they're probably in the high teens. On the poor performing groups they can be anywhere 20 and 30%, so it's very, very wide ranging. I would say that our average increased on 1/1 was somewhere in the neighborhood of 20%.

Okay. I guess where I'm going with that, Tom or Scott, if you are getting the better renewals, because clearly you have to somewhat under price the business to pull it away from a competitor and then you try to kind of reprice it in to some degree and does that mean that the adverse claims development that we saw throughout 2006 as a stop loss will start to be diminished in '07 because of the rate increase of the existing book? I know you have the pressures of the new but I would think that, over time, that diminishes.

This is Scott, David. I think, very simply stated, we would say we certainly hope so. As I mentioned in my opening remarks, the reserve adjustments that were made in our fourth quarter financials we believe appropriately reflect all experience that we had to consider when we closed the books.

Furthermore, in terms of the internal projections that we've made that are reflected in the comments Ken gave relative to analysts consensus estimates for 2007, we have that current experience fully loaded into our model and into our thoughts on earnings guidance.

This is Tom. Maybe I'll just add quickly. Our block of business is growing but it's been quite small so it does have some volatility to it. So I would say that some of the stop loss reserve strengthening is probably more attributable to a handful of poor performing groups than it is really a problem with under pricing.

Scott, let me make sure I understand your statement. Are you indicating that you're 2007 guidance that Ken mentioned does not assume any further adverse development in stop loss or continues at some average level?

Well, what I was trying to say was you have an assumed loss ratio --

Right.

-- in those projections and, frankly, when we put new business on the books, before any paid claims experience develops, we also set an assumed loss ratio for the early quarters of financial reporting. What I'm trying to say is that we have taken all of the claims data that we had available to us and made those assumptions more conservative.

Okay. That's helpful. Just kind of one final thing. What type of revenue levels do you feel you need to get to to achieve profitability out of the new activity? I think that it's been pushed out a little bit from what our original assumptions were but you're continuing to move in the right direction. Is that, or can you give us some level?

I know, Scott, originally we talked about something, I believe it was in the 35% expense ratio range, which I guess I'm trying to get to the kind of revenue, or even a premium level, that would allow us to get close to break even. Have you thought of it from that perspective?

Well, I haven't thought about it from that perspective.

I don't want to put you on the spot. We can talk about that on the next call.

Well, we had, in terms of net earned premium on the new activity, and that's both the stop loss, the group life, as well as the voluntary benefit sales that the new sales organization produced, we had net earned premium of just under $30 million for all of 2006. And at that level we're still at a loss level.

With the $30 million or so of new premium we put on in January, now, some of that will leak away to the reinsurers but that's just the, let's say, about 40% of the sales for the full year. That $30 million or so of net earned premium for 2006 should be about three times that level for 2007. And at that level we would expect the operating losses to be far lower. Are they going to be positive? I guess I'm not prepared to say that right now.

But it would be hopeful that we'd turn that positive at some point in '08? Is that fair?

Yes.

Okay. And just one final question. Ken, I don't know if the Board has completed the 2007 incentive comp package but if they have, or can you give us any direction of what those targets might be, that would be helpful.

The makeup of the incentive plan is, and it's not quite final. We had a Board meeting last week and worked on it but it's not quite final. The makeup of the incentive plan is an absolute hurdle of earnings per share that creates an incentive pool and below that number the Board has discretion, but no obligation, to fund an incentive pool.

So the pool is funded based upon earnings per share and then there are longer term measurements that management has to achieve in order to participate in the pool. And those longer term measurements are things like sales, sales mix, product development, strategy in the market, and so forth.

And can you tell us what those sales, I guess the bottom threshold is? If you have $0.45 does that mean you get 20% of your bonus?

No, I can't disclose the threshold, the hurdle, but it's consistent with the Board expectation for what we should achieve in terms of earnings per share.

And while the number is not necessarily $0.51 a share, obviously the Board looks very closely at the earnings estimates that are out there in establishing our incentive plan so I hesitate, in fact, I don't think I can disclose, the hurdle number but there's good logic in the Board's position.

That's helpful. Thank you.

[OPERATOR INSTRUCTIONS] Your next question comes from the line of Mike Grasher of Piper Jaffray. Please proceed.

Good morning, gentlemen. Just a few questions here. A bit more, if you could provide a bit more perspective just in terms of what may have been a driver behind the sales in accident and health and life within the Kanawha legacy. Those numbers look to be up quite nicely in the quarter.

I'm not sure what you're referring to, Mike.

If you look at your life sales 1088 over 448 year over year, I mean, is this just a matter of further penetration within the existing markets? Is it something that you spoke to earlier in terms of making the reps more productive, or is it again going back to product?

This is in the career channel of Kanawha. The number for the quarter was up, you're right. Year over year though, it was almost flat. And that is the unit that is not growing substantially. If you look at the life sales, year over year, 2.453 versus 2561, and we wouldn't expect a significant increase in that line. This is not an area where we're doing a significant amount of product development.

They do benefit from the product work that we're doing in our new large case area because they sell some of that product but there's nothing there that is, that I think would be insightful relative to the prospects for KMG America.

Okay, and then along the same lines within the core group on the new activity, the disability dropping sequentially. Was that more or less seasonality than anything else?

Well there's not enough there to develop in trends.

Okay.

We reinsure a substantial amount of that product and there's just not much there to develop a trend.

Okay. And then, in terms, you mentioned earlier about the productivity per rep and the efforts that you look to put in place. Just to clarify, those are efforts that you will be putting in place beginning in 1Q here or is it something that was in place during 4Q?

Well, we're working on it and the effect on sales will be relatively gradual. It's not something where we can add some support staff and then see in the ensuing quarter a significant change in productivity. It's just something that we've been working on.

And quite honestly, just because we've got an experienced group of reps and we're not adding a lot of new reps, productivity is going to go up just because they've been in the marketplace and will be gaining more and more traction. So it's a combination of things that we think will lead to productivity in '07 in excess of $3.5 million per rep.

Understood. And then, one final question. The assets in the acquired segment dropping some 20% understanding that this is expected to be a runoff in that, is that a fair run rate as we go forward? Sort of a 20% clip per year?

You know, I haven't thought of that year over year change in terms of run rate. It is declining. I would hesitate to say the assets are running off the books at 20% a year, but again, I admit I haven't really, really haven't focused on that rate of decline. But it will decline.

Okay. Fair enough. Thanks very much.

You have a follow up question from the line of David Lewis of SunTrust Robinson Humphrey. Please proceed.

Thank you. I have two questions. First, what does the interest rate benefit in 2007 due to the debt refinancing Scott. You can give us the absolute numbers if you want, or either way.

It's essentially flat.

So your cost, I guess, is the same, but your liability is now, what is it, 1 million less?

Right, as a result of that discount.

Right, okay. And secondly, probably for Ken. What's the response from brokers and employers regarding placing coverage through KMG America relative to maybe what it was a year ago and is the greatest consideration out there price or some other factors? And lastly, what's it going to take to start getting some multi-product sales?

We continue to become an accepted player in the market, competing with the big players. The key to that is the fact that we've been in the market for awhile, but also the credibility that we bring to the marketplace by the group of reps that we have in the marketplace. We will just continue to gain traction in that regard.

The fourth quarter of '06 was so totally different within our organization than the fourth quarter of '05 in terms of being established in the marketplace, being an accepted player, entered the quarter with normal background, almost a full suite of products, and that will just continue to improve. So the acceptance in the marketplace has just been excellent.

Relative to the multi-product sale, we continue to make progress there. This is not something that comes easy but we continue to make progress there. This year we will have a full year of a full product menu for voluntary and group and we will see how many of those stop loss relationships we can leverage and I'm sure that we will see a continuously increasing level of multi-product sales.

Very good. Thank you.

This is Scott DeLong. I'd like to get back to Mike on his question about the asset decline. You picked that number out of the statistical supplement. You'll notice that at the end of the statistical supplement that there's an appendix that shows the segment pro forma results.

Pro forma vis-à-vis the reserve reallocation that was put in place in mid 2006 so what you were looking at that showed the 20% decline was sort of an apples to apples or, you were comparing year end, apples to oranges, where the 2005 year end was pre-reserve reallocation and year end '06 was after. If you look at the pro forma reallocation of assets in that appendix you'll see that it was down, but nowhere near as much as the raw results would indicate.

I would add that our pro forma work on Kanawha shows a very, very, very gradual decline in earnings capability over an extended period of time. There just should be nothing abrupt about the decline in those earnings that we have as a support base from Kanawha.

There are no further questions at this time.

Okay. I will close by saying that we continue to make good steady progress. We're attempting to balance the short and long term objectives while focusing on satisfying all of our constituents. And we expect 2007 to be a continuation of that effort. Thank you.

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