Humana Inc (HUM) 2007 Q1 法說會逐字稿

Good day, Ladies and Gentlemen and welcome to the First Quarter 2007 KMG American Corporation Conference Call. My name is Dan and I'll be your operator for today. [OPERATOR INSTRUCTIONS]. I'd now like to turn the call over to Mr. Kenneth Kuk, CEO. Please proceed, sir.

Good morning. Welcome to KMG America's First Quarter 2007 Conference Call. With me this morning is Scott DeLong our CFO and 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 Form 10K for 2006 and Form 10Q that will be filed later this week. In light of these risks, actual results may differ materially from those expressed and 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.

Before Scott reviews our first quarter results, it's important that I review our strategies in response to the actions taken by rating agencies in late March, namely AM Best affirmed Kanawha's financial strength rating of A-, but revised its outlook from stable to negative. I'm sure that all of you are aware how important it is to our business that our AM Best A- rating be maintained. In an effort to preserve that rating, we have devised and are implementing a multiple track strategy to address the issues they raised, including a variety of backup contingencies. Our objective is to preserve, enhance and then maximize shareholder value.

Before I describe our strategies and the initiatives we are taking, I want to repeat how disappointed we were with AM Best's actions on our rating outlook. AM Best's concerns centered around our long term care concentration, statutory losses and our concentration of new business in the stop loss line. As you may know, long term care is a closed block that continues to perform respectively. Further, our statutory losses were projected to decline sharply and were expected to be eliminated over the next couple of years. And we had adequate capital in the interim. Finally, AM Best's concern about our concentrations of new business in the stop loss line was an issue that we had already identified and had taken steps to address. Regardless, they did retain our A- rating, while also assigning a negative outlook. While we do appreciate that the decision was their best judgment, the change in outlook has reverberations across our business and makes our tasks now more difficult.

An important part of our multiple track response is to develop strategies to deal with each rating agency concern with the expectation that we remain independent. However, the most attractive and practical track may be to seek a strategic or financial partner that would solidify our rating and foster a stable environment that would allow us to get back to executing our business plan. To that end, we retained Keefe, Bruyette and Woods to assist us in developing and reviewing strategic alternatives for the business and progress has been made. We've had preliminary interest from several firms and expect them to begin due diligence shortly.

Because book value represents one valuation metric, we believe there is an opportunity to create additional shareholder value from where the current share price resides. After giving effect to the first quarter charges that Scott will review in a moment, our book value at 3/31/07 was $8.26 per share. Because there is no guarantee we will be successful in identifying a partner at a value deemed acceptable by our Board, we have developed a strategy and a series of actions intended to address rating agency concerns should we remain independent.

It is not possible to describe all the plans in detail now, but I will say that we have limited ability to alter our strategy regarding long term care. The good news is GAAP reserving for that block of business was brought current at the time of the Kanawha acquisition. We have not solicited new long term care business in nearly two years. Rate increases continue to become effective and the block is performing well.

There are a range of strategies to deal with statutory losses. Some are operational and others are tactical, including the transfer of units within our organization's structure to obtain better statuary and tax treatment. To that end, we established a $6.5 million reserve against the deferred tax asset at the holding company. This is a non cash charge and the asset remains available should our tax position change. By eliminating the asset, we improved prospects for statutory losses, as well as a potential strategic transaction.

To address concerns about our stop loss concentration, to increase our flexibility and to improve the likelihood of maintaining our A- rating, we have taken a $6 million charge to strengthen reserves for the stop loss line of business. This charge should also give us an opportunity to more easily reduce our exposure to stop loss via reinsurance if we remain independent. In addition, we believe this charge could serve to increase our investment attractiveness, as well as the probability of a transaction should we determine not to remain independent.

Now, I would like to report on how the benefits market has responded to the negative outlook on our A- rating. No doubt, our 19 sales representatives face a more difficult job. We have lost a couple cases that we expected to be awarded, but we don't believe we've been precluded from bidding on any cases. We continue to feel strong support from the broker and consultant community and our reps have been very engaged in protecting what we have created. Unfortunately, we have spent time addressing the ratings situation when we could have been soliciting new business. Nevertheless, our team remains committed, in spite of the recent hurdles and we believe we can continue to successfully compete in the benefits market.

Late last Friday the ING lawsuit was settled. Terms cannot be disclosed, other than to comply with SEC reporting requirements. And because we have not yet settled with our D&O carrier, any liability to KMA cannot be determined. In a ruling in late April, only 3 of 12 claims survived summary judgment. The remaining claims were to be tried beginning June 11th. I can say that the total settlement was significantly less than the expected legal fees from now through the June 11th trial. A by-product of the settlement is that uncertainty is removed when seeking a strategic partner.

Finally, before I ask Scott to comment on first quarter results, I wanted to address earnings guidance. Because of all the uncertainties, we feel it best not to offer any guidance until we have a clearer view of the strategic track we will pursue.

With that, I'll hand the call to Scott DeLong. Scott?

Good morning. We reported an operating loss of $0.42 per diluted share as a result of two charges in the first quarter, compared to operating income of $0.11 the last quarter and $0.06 in the first quarter of last year. Operating income was $0.05 per share after excluding these charges. And I'll start out by discussing the two charges.

First, we have established a non cash valuation allowance of $6.5 million to offset the deferred tax asset relating to holding company net operating losses incurred since the IPO in late December, 2004. We are required to file both a life insurance company tax return for Kanawha Insurance Company and a non-life insurance company tax returns for both our holding company and our profitable TPA. Currently, we are not able to consolidate any of these tax returns and will not be able to consolidate the holding company with Kanawha's tax return until 2011.

In light of this and recent developments, we concluded it would be prudent to establish the valuation allowance against the holding company deferred tax asset. Subject to other actions we expect to take later this year, we believe we will be able to tax effect all operating results starting again next quarter. And we should have greater flexibility addressing the issue AM Best raised regarding statutory earnings, while substantially improving our chances of deducting expenses on the holding company tax return in the future.

Second, we took a charge of $6 million this quarter for increased stop loss claims and reserves, applicable to essentially all premiums earned since our first case was sold in June of 2005. Our experience has been that it takes four or more quarters after a stop loss case is written before a clear picture emerges regarding claims. As is typical of industry practice, we're setting expected loss ratios for premiums earned on new books of business without actual claims experience. We use pricing assumptions at the time of the sale of a new stop loss case to guide us, a bit under half of the charge this quarter applies to older business written in 2005 and early 2006 that has now developed unfavorably to original pricing expectations. While some of the unfavorable claims data began to emerge late last year and guided our reserving in the fourth quarter, this new data came to our attention very late in the first quarter. As a result of this new data, we have concluded that it would be prudent to increase the estimated loss ratios on newer cases before we have fully developed claims experience so a bit more than the $6 million charge applies to estimated loss ratios on premiums earned on newer cases with limited claims history to date.

This translates to a loss ratio of about 92% on a direct basis on this newer business, as compared to about 77% last quarter. This refinement should reduce the likelihood of negative earnings impacts from claim reserve adjustments should future claims history track to our past experience. Additionally, these actions should give us increased flexibility in managing the current book of stop loss business.

The Kanawha Legacy business produced operating income of $0.12 versus $0.26 last quarter and $0.16 in the first quarter of 2006. While the senior segment with our long term care business continues to perform very well, earnings are down from last quarter when we had a benefit we discussed then. The benefits ratio on long term care in the first quarter was 72%, compared to 59% last quarter when we had that benefit, but compares favorably to the average of 75% over the first eight quarters since the IPO. And I would add that just last week we were notified that a recent filing for a 10% rate increase on certain long term care policy forms in our second larges state was approved, which will increase annualized premiums by about $500,000.

Net earned premium for the Kanawha Legacy segments in total was down about 1.5% from the fourth quarter, due in part to increased lapses, but investment income and TPA earnings were up, while Legacy expenses were down slightly. We experienced less favorable claims in certain large Legacy worksite cases and assumption reassurance treaties in the Legacy worksite and acquired business segments compared to the fourth quarter and amortization of deferred acquisition costs and value of business acquired assets was up fairly significantly in the first quarter, due in part to the policy lapses which tend to increase in January on certain types of Legacy worksite business. These two factors reduced Legacy earnings per share by about $0.07 compared to last quarter.

Because of these charges, operating losses from the new large case activity were up in the first quarter to $0.54, compared to $0.15 last quarter and from $0.10 in the first quarter of last year. Excluding these charges, the operating loss this quarter was $0.07. Compared to the fourth quarter, new activity, net earned premium was up 80% to $15.8 million and expenses were down $.4 million, as a result of less litigation expense and incentive compensation accruals. While still smaller in volume compared to stop loss, growth in voluntary benefit in core group earned premium did add incrementally to margins in the first quarter.

With that, I'll turn it back to Ken for the Q and A session.

We will now take questions.

[OPERATOR INSTRUCTIONS] Your first question comes from the line of Craig Siegenthaler from Credit Suisse. Please proceed, sir.

Thanks. Just a few questions. First, how much cash do you currently have in the holding company? Is bank debt and total debt still around $14 million? And what is your current RBC? The second question is does AM Best have the minimum requirement for your RBC? Specifically, as your statutory capital levels have been falling while your risk based capital levels have been rising, that's your required base. At the current rate, when do you estimate that a capital infusion is needed to avoid a downgrade from AM Best?

This is Scott DeLong. I don't think I'll remember every single one of those questions, but I'll do the best I can.

First, you asked about cash at the holding company. As you know, we completed the offering of a trust preferred security during the first quarter and raised $35 million. Those funds remain in the holding company. We ended last year with about $6 million of additional cash in the holding company and while that's down just a little bit this quarter, it's still positive.

So, is that about $38 million, $37 million?

I don't have that number, but that sounds about right. And then you asked about debt. Yes, we have the $14 million of bank debt at the holding company and that's it. You asked about RBC. Well, relative to our risk based capital, relative to ratings, that's a multi-factor decision. Some are very objective criteria, others are more subjective. Capital adequacy is one of those. Relative to an A- rating, AM Best would say the minimum capital would be a ratio of 130%. Now, remember that's according to their proprietary formula; that's not the NAIC risk based capital formula. And we ended the year last year well in excess of that. And given the holding company capital that we have, we're still well in excess of that at the end of March 31.

Were there any other questions among that set?

You hit, I think, almost all of them. If I can just ask one more? In light of the long term care loss increase this quarter and I know it was favorable last quarter, I was just wondering how incidence is trending?

Claim incidence was maybe $100,000 or $200,000 worse pretax than last quarter, but still very favorable. I said, the benefit ratio, which is incurred claims but also takes into account policy reserves, was up versus last quarter when we had some one time effects that we discussed last quarter. But the 72% benefits ratio still compares very favorably to the average over the 8 preceding quarters since the IPO. Another metric that we track and we don't disclose in our Q or press release is just management type information, but we keep track of the ratio of actual claims to expected claims and where expected claims are as incorporated in product pricing. And for our book nationwide, that ratio has been well under 100% from inception. It actually improved considerably during 2006 and even in Florida that in most prior years has had an actual expected ratio in excess of 100%. In Florida in 2006 that was right around 100%. So, we keep saying and we have the data to back it up that the long term care portfolio continues to perform very well.

So, would you say the difference in the two benefits were cash payments, since it went by about $100,000 and not increases to reserves?

Well, the item that went up by $100,000 was incurred claims. And that is cash paid claims plus change in the case reserves for both pending and open claims.

Great. Thank you very much.

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

Thank you. Good morning. Ken, you touched on some of this but maybe a little more detail. Given the negative outlook from AM Best, maybe talk a little bit more about morale throughout the organization? And two, what your outlook is regarding sales rep retention? And then I guess finally, you mentioned that you may have lost a couple of cases due to the negative outlook. But in general, do you feel that the sales processes continue to be somewhat status quo?

Regarding your question about morale. It obviously has been a difficult time for all of us since the ratings announcement in the end of March. But in light of what we've been through, I have to say that I believe morale is better than I would have expected. I think we've done a good job of communicating the status to everyone so that everyone is fully informed. But more importantly, I think we have a very strong commitment from our sales reps, from the staff in Lancaster and from the people here in Minnetonka. So, I would say that the morale is better than we could hope for.

Regarding sales reps and really a continuation of that discussion, at the time of our last call we had 19 reps. We've had no hires since then. We've had no departures. I continue to feel very strong support from the reps. They've been fighting the marketplace, there's little doubt because competitors will use any advantage that they have, as you would expect. But the sales reps seem to be fully onboard, fully committed and they are indeed fighting the battle.

The issue relative to lost cases and what we're seeing in the marketplace is very, very difficult to quantify. We took action to reduce the flow of stop loss business by changing the reps comp arrangements in January, I believe. And we also have made a decision not to offer new stop loss without another product associated with it. So, the flow of quotes has changed rather significantly; an up-tick in non-stop loss quotes and a significant reduction in quotes on stop loss. With that said, we know it's a tougher battle in the marketplace; it's harder for our reps. And whereas before the action, I would have indicated that $3.5 million per rep was a very achievable number. Realistically we have to reduce that now I think to something in the area of $3 million, as an expectation. But we will see; we will monitor that.

That's helpful. Scott, in the text of the release there was a discussion about Kanawha Legacy lapse rates up a little bit. Is that some seasonality relative to the forth quarter, or does this relate to the negative outlook?

Oh, I don't think it relates to the negative outlook. That smaller employer agent sold worksite business isn't nearly as ratings sensitive as it is in the larger case market. I look at the lapse experience month by month and last summer we had an up tick. I'm not sure why, but we did. The fourth quarter was exceptionally good, as far as lapse experience. Of course that contributed to that nice fourth quarter result we had. And then I'm told that there is a tendency for worksite cases to, if they're going to change carriers, they do that effective January 1. So, we're not talking about individual policy by policy decisions, the lapse there, to stop their payroll deduction. We're talking about moving group cases, again the smaller worksite market from carrier A to carrier B. That's just a tendency to occur, if it's going to, on January 1.

Okay. And maybe back to you, Ken. Any new thoughts that you want to share regarding discussions with the rating agencies following your first quarter results?

We obviously have had interactions with both S&P and AM Best. There is no indication from AM Best of any follow-up action. It's my sense that they're comfortable with the negative outlook where they're at and where we're at. Obviously, there are no guarantees that they couldn't take action. They obviously have the latitude to do that at any time. But there clearly has been no indication of action on the part of AM Best.

S&P has indicated to us that if we do not affirm guidance for the rest of this year that they may very well take action. And we would not be surprised if they took action and lowered our rating to Triple B Plus from A-.

That's helpful. Thank you.

AT this time, there are no further questions in the queue. I would now like to turn the call back over to Mr. Kenneth Kuk for closing remarks.

Well, in closing, I can confirm that senior management remains totally engaged in the business and committed to securing the greatest possible outcome and return for KMG America shareholders. Like you, we have substantial equity interest in the Company. We are doing everything in our power to move the business forward and deliver value to all shareholders. We believe the KMG America platform has a very talented pool of employees and offers a range of products and competitive strengths. We are working tirelessly to execute on the business goals during this period of challenge and we appreciate your support and your confidence.

Thank you.

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