Humana Inc (HUM) 2007 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Second Quarter 2007 KMG America Corporation Earnings Conference Call. My name is Francis and I'll be your coordinator for today.

(OPERATOR INSTRUCTIONS)

I would now like to turn the call over to Mr. Kenneth Kuk, Chairman and Chief Executive Officer. Please proceed.

Good morning. Welcome to KMG America's Second Quarter 2007 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 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 and our Form 10-Q for the first quarter 2007 and Form 10-Q for the second quarter 2007 that will be filed later this week. In light of these risks, actual results may vary 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. We announced second quarter operating earnings this morning of $0.03 a share, which includes a couple of unusual items that Scott DeLong will speak to in a few minutes. Without those items operating earnings would have been $0.06 per share, which is in line with consensus estimates.

I would now like to update you on several operational items including the previously announced efforts to review strategic alternatives including the possible sale of the Company. We are being assisted in this effort by Keefe Bruyette & Woods which has managed a thorough comprehensive and disciplined process. We are currently in advanced negotiations and despite the recent volatility of the financial markets we remain optimistic about a successful conclusion to this process but there could be no assurance that this effort will result in a transaction.

I expect there will be questions about this subject during the Q&A portion of this call. I know you appreciate there are significant constraints on the level of detail I can provide regarding probability of a transaction, timing and so forth and I most likely will not be able to furnish more information at this time. As we stated when we announced our involvement in this process we will update when we either have entered into a definitive agreement with a third party or terminate the efforts to affiliate with a strategic partner.

Scott will comment in more detail on financial topics but I'd like to mention a couple of items. The long term care block continued to perform at satisfactory levels in the second quarter. As time passes and the block continues to perform, the anxiety that many of our constituents have expressed would be expected to subside. Rate increases and good claims management have allowed this block to keep producing earnings at acceptable levels.

Next, our sales organizations continue to perform well in spite of the recent ratings actions and disruptions resulting from our announcement that we are evaluating strategic alternatives. In spite of the hurdles in the second quarter we have continued to produce new voluntary and group premium at about the same levels as last year.

Overall sales results in the second quarter are below last year's levels, which is due to our decision to reduce the growth rate of our stop loss block which is identified by AM Best as an issue. Our sales organizations have done a commendable job of representing our Company and we are encouraged by the continued high level of support from the consultants and brokerage community. They like our product offerings, our strategy, our organization and our people. We currently have 17 sales reps in our large case sales organization which is down from 19 at the time of our last call in May. One rep took a position in sales management with a large firm that is reentering the voluntary market. The other was in a geographical market that does little voluntary business and he decided to return to his former employer because of our renewed focus on voluntary products.

The rest of our organization has experienced minimal turnover which demonstrates the dedication of our staff to KMG America and our strategy. The current uncertainty is not comfortable for most of our people but they have risen to the challenge. I'm anxious to get our Company positioned in a more favorable environment.

With that, I'll ask Scott to comment.

Good morning. Today, we reported operating income of $0.03 per share compared to operating income of $0.05 in the second quarter last year. As Ken mentioned, this result reflects two unusual items booked in the second quarter both of which are likely to be non-recurring. After excluding these items as Ken indicated recurring operating earnings matched the $0.06 analyst consensus estimate as reported by First Call.

I'll start with a discussion of the usual items. The first item relates to a deferred tax asset associated with the current second quarter tax losses of the holding company. Because of special federal income tax provisions relating to life insurance companies, our holding company is taxed separately from our life insurance company and the two tax returns cannot be consolidated until 2011. Last quarter you may recall we took a $6.5 million charge when we put up a valuation allowance against the full amount of the non-life deferred tax asset. In light of this strategic review underway during this past quarter, we postponed taking the actions necessary to reestablish a non-life deferred tax asset going forward. This item was worth about $400,000 after tax this quarter or about $0.02 per share. Looking ahead, if we were to remain independent we believe we can reestablish the deferred tax asset without the offsetting valuation allowance and avoid any further adverse financial effect. To do so, we need to change our corporate structure such that our third party administrator KHS, which is profitable and taxed as a non-life insurance company, is a direct subsidiary of the holding company. It is currently a subsidiary of the life insurance company and as a result, KHS taxable income cannot be consolidated with the tax losses of the holding company.

The second item relates to an error identified late in July affecting one of the reinsurance treaties in our acquired business segment. There apparently was an incorrect entry placed in the monthly net settlement spreadsheet going back to 2001 which has caused reinsurance coverage we have collected to be overstated by a small amount every month since. While there are offsets in our favor that have not yet been fully quantified, we believe that once our analysis is complete, we will agree to a net settlement to our reinsurance partner.

Moving on to our insurance operating results the Kanawha legacy business produced operating income of $0.16 after tax in the second quarter excluding the unusual reinsurance item I described earlier,the same as in the second quarter last year. The long term care business reported in the senior segment contributed $0.10 per share this quarter compared to $0.08 on a pro forma basis a year ago. The improvement in long term care earnings this year comes from increased earned premium from rate increases approved in 2006, and reduced incurred claims in this year's quarter compared to last year's satisfactory level. Relative to the most recent set of rate filings in late 2005 and 2006, we have received approvals on 72% of our total premiums in force, which represents an average increase of 13% or about $5 million per year of additional premium and there are additional pending rate increases that we expect to be approved at some point.

Excluding the effect of the unusual reinsurance item discussed earlier, the performance of the acquired segment improved to essentially breakeven this year from a $0.02 per share loss on a pro forma basis in the second quarter a year ago. Long-term care in the acquired segment business consists of closed blocks that are in gradual runoff. Offsetting these improvements in the Kanawha legacy business was a decline in income contributed by the legacy worksite segment, with after tax earnings falling from $0.07 in the second quarter last year to $0.03 this year primarily from a 5% year-over-year drop in earned premium, accompanied by a modest increase in the policyholder benefit ratio from 70% last year to 75% this year. We continue to actively market worksite products through our smaller employer Specialty Worksite channel, so we do expect earned premium in the legacy worksite channel to increase over time unlike the decline we observed in this quarter.

Operating losses from the newer large case activity declined slightly from $0.11 after tax in the second quarter last year to $0.10 this year excluding the impact of evaluation allowance against the deferred tax asset discussed earlier. The improvement results from increasing margin contributions from continued growth and premium revenue from sales of voluntary benefit products. Earned premium from these products in this year's second quarter was $3.4 million compared to $1.1 million a year ago. Largely offsetting this improvement was the continuing impact of more conservative loss reserving on stop loss business implemented last quarter. Assuming stop loss claims experience continues as expected, earnings this year will continue to be reduced compared to 2006, but performance in 2008 should be much better. More conservative pricing commencing with sales and renewals on and after April 1 this year should also contribute to expected improvement in stop loss performance going forward. Along this line I would note that for our July 1 stop loss renewals this year we obtained an average rate increase of over 30% while retaining about two thirds of the business. This bodes well for improved earnings for the balance of 2007 and 2008 on this block of business.

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

We are now available for questions.

Ladies and gentlemen (OPERATOR INSTRUCTIONS).

Your first question comes from the line of Randy Binner of FBR. Please proceed.

Good morning, everyone.

Good morning.

I just -- can -- I think you said you lost two reps in the quarter. Is that right?

That's correct.

Okay great. And then I'm just going to roll through a few questions here. Scott, the investment yield jumped up in the quarter and I think part of that was due to some invested proceeds from the debt raise.

Can you just comment on the higher investment yield we saw from the portfolio and how sustainable that is?

Well there's really nothing non-sustainable about second quarter yield. I mean as we all know rates available for new investments increased at least during part of that quarter and we captured some of that.

If you're comparing to last year or excuse me, the last quarter when I think it was 15 basis points or so lower that result was I'll say artificially deflated because of the way we calculate investment yield which is investment income divided by average assets.

We had the trust preferred offering that increased invested assets very late in the quarter which just that simple math produced a slightly distorted and understated investment yield.

So while the yield improved in the second quarter versus the first quarter it wasn't quite as much as it appears on paper.

Okay. And then just staying on the investment side of the balance sheet. Subprime exposure.

Can you just give us a quick update on -- I know that it's minimal but maybe put a couple of numbers around where actual exposures are? What the ratings are of those traunches et cetera?

Well Randy, I didn't bring that data in with me. We have very minimal exposure. Just a few million dollars of invested assets that relate to subprime mortgages and actually to I should say residential mortgages.

As I recall nothing relative to subprime mortgages other than I think we have some corporate debt in the name of Countryside.

Okay. And so with the Countrywide -- you mean Countrywide, right?

Sorry.

I guess you're going to see a mark-to-market on that at the end of this quarter, but is that the only comment worthy thing there and approximately now much is that?

I don't have the exact amount of exposure on Countrywide, but out investment limits are very restrictive so it would -- I'm certain would be less than $2 million, but I don't have the exact number. I can get that to you.

Okay, we'll follow-up. That's -- we'll follow-up on that later. Moving on.

You know you commented and maybe this is a better question for Ken on the long term care book continuing to perform well.

Conseco had a large long term care charge they came out with last night and they have accelerated -- accelerating prior year's loss development going on there. Is there -- what's your read on that?

That's a lot of business that was written in the '90s so I don't know geographically and time wise how much those circles overlap and so if you give color on that and just how you think that might upset some of your constituents perceptions of the long term care block?

Well I really can't comment on Conseco's exposure. They had a series of charges that we've had -- that they've had to take. I will comment though on our performance. We follow this very closely.

It's necessary to have good claims data for purposes of supporting your rate filings and we've been proactive on that but just looking at the actual to expected loss ratios in our book of business for the first half of this year versus last year which was very good Florida, which everybody is concerned about for the first half of this year we had an expected or actual expected ratio of 81% compared to about 101% last year which we felt very happy about.

That's Florida. That's been the one pocket of concern that we've had making up roughly a third of our overall book.

Again in the first half of this year an 81% actual to expected loss ratio very good and then nationwide that loss ratio -- actual to expected loss ratio was at 64% for the first half of this year compared to 72% last year and it's been under a hundred percent I believe every year we've been in the business certainly based on the data I'm looking at right now back to 2003 for sure and it's been trending down each year.

So I don't know what the issue is with Conseco but we're very pleased with the performance of our book.

I would comment that this is one single block of business that was originated by our own agency. We have and acquired blocks of business form other places.

It was underwritten to very disciplined standards from the very beginning and it has performed nicely now for many years. We did a very thorough review of the block. In 2004, became very comfortable with it.

We watched that block perform for a couple of years prior to that as we were working on due diligence and so forth and we now have seen it perform coming on three years with incredible stability and I think the people that had paid attention to this will come to a conclusion that there is something basically different about this than many of the blocks that are owned by other organizations.

Okay, great. All those comments are really helpful. So I mean has there been any further dialogue with Best in any regard or any kind of milestone set?

We stay in continuous communication with AM Best so yes there has been dialogue.

Okay. Anything quantifiable or is it just general updates?

General updates, they pay very close attention. I think they do quite a nice job following us so there is really nothing for us to update you on.

Okay, fair enough. One last question and I'll drop back.

The statutory capital of Kanawha. Do you have up -- Scott, do you have an updated number of what that is, statutory surplus from Kanawha at mid-year? I just have a year end '06 number.

Well, we put an $18 million infusion in during the second quarter from the trust preferred offering. The statutory capital as of June 30 is a little over $70 million.

Okay.

The way we like to look at that though is in terms of the AM Best BCAR ratio because that's one of the drivers of their rating.

Yes.

And our BCAR ratio on June 30 was over 140%.

Okay.

And that's just at the life company just counting the capital there if you incorporate the capital available to it in the holding company then it jumps up to around 180% and the threshold for an A minus rating is 130% so we're in good shape there.

And just a follow-up on that.

Is there another significant pool of statutory capital for KMG America overall beyond that at Kanawha beyond the $70 million?

Yes. The holding company capital, the $35 million that we raised in March, plus a small amount of additional capital that we had at that time remaining from the IPO is all available to the life insurance company.

Now as I said we put $18 million of that in March at the end, or excuse me -- at the end of June so there's close to $20 million remaining in the holding company. That explains the difference between the 140 plus and the 180% --

Right.

-- ratio.

Right exactly and so that's -- I mean again the $20 million that the holding company has is essentially the same as statutory surplus from a regulatory point of view or a statutory point of view?

That's right.

All right. That's all very helpful. Thank you.

(OPERATOR INSTRUCTIONS).

And there are no further questions at this time. I'd like to turn the call back over to Mr. Ken Kuk for any final or closing remarks.

Thank you for joining the call this morning. We look forward to updating you on the status of our review of alternatives in the near future. Thank you.

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