Horace Mann Educators Corporation (HMN) Q1 2012 Earnings Report, Transcript and Summary

Good morning. My name is Tasha, and I will be your conference operator today. At this time, I would like to welcome everyone to the Horace Mann Educator First Quarter 2012 Earnings Call. [Operator Instructions] Mr. Dwayne Hallman you may begin your conference.

Good morning, everyone, and welcome to our first quarter earnings conference call. Yesterday, we released our earnings reports, including financial statements, as well as supplemental business segment information. If you need a copy of the release, it is available on the Investor's page of our website. This morning, we'll cover our results for the first quarter in our prepared remarks. The following management members and I will provide commentary and be available for questions: Pete Heckman, President and Chief Executive Officer; Tom Wilkinson, Executive Vice President, Property and Casualty; Matt Sharpe, Executive Vice President, Annuity and Life; and Steve Cardinal, Executive Vice President, Marketing. The following discussion may contain forward-looking statements regarding Horace Mann and its anticipated or expected results of operations. Our actual results may differ materially from those projected in the forward-looking statements. These forward-looking statements are made based on management's current expectations and beliefs as of the date and time of this call. For a discussion of the risks and uncertainties that could affect the actual results, please refer to the company's public filings with the SEC and in the earnings press release issued yesterday. We undertake no obligation to publicly update or revise such forward-looking statements to reflect the actual results or changes in assumptions or other factors that could affect these statements. Also, in our prepared remarks and responses to questions, we may make mention of non-GAAP financial measures. Reconciliations of such non-GAAP financial measures are available on the Investor page of our website. Finally, this call is being recorded and will be available on our website until May 25, 2012. Now I'll turn the call over to Pete.

Thanks, Dwayne. Good morning, everyone, and welcome to our call. After yesterday's market close, Horace Mann reported first quarter operating income of $0.64 per share, which was up 21% over the same period last year. Our earnings growth was broad-based in the quarter, as all 3 segments of our multi-line insurance operation recorded an increase in income compared to prior year. In P&C, our property insurance underwriting results benefited from of a lower level of catastrophe and Florida sinkhole losses in the quarter, which helped to offset an increase in the Auto loss ratio. And both of our Financial Services business segments posted double-digit earnings gains with the positive Annuity results driven by increased interest margins and strong financial market's performance. Now before the management team provides more detail on our financial and business segment operating results, I'd like to offer an initial first quarter assessment of the key performance priorities that we established for 2012. As I mentioned during last quarter's call, there are 5 of them, 4 which are focused on sustaining the momentum and strong underlying business results we achieved last year. First, in terms of the agency force, while we are targeting another modest increase in the overall agent count, our primary focus this year is on further increasing the productivity of our agents. And we're definitely off to a good start in the first quarter, with new business sales up significantly across all of our product lines. Number two, with regard to the Auto line, we're focusing on continuing the sales momentum we generated in the second half of last year. And while prior-year comparisons will become tougher as the years progresses, we're definitely encouraged with our strong start in true new Auto sales this year. Similarly, Auto retention trends have continued to improve with sequential renewal ratio increases noted in each of the last 6 months. So our key leading indicators of growth in this line of business remain headed in the right direction. As I mentioned a year ago, however, we are absolutely committed to achieving profitable growth in our Auto business, so we'll be keeping a close eye on the underlying combined ratio, which popped up over 100 in the first quarter, to ensure we maintain an acceptable growth-profit balance. Our third priority is to continue focusing on property profitability in order to maintain the favorable underlying margins we achieved at the end of 2011. For the first quarter, the underlying combined ratio of 77% in Property was well below prior year and generally in line with our targeted level. The fourth and final carryover priority from last year is to leverage the strong growth trends we've enjoyed over the last few years in our Retirement Annuity business while effectively managing the profit margin in the current interest rate environment. Here, I think our 9% sales growth, keeping in mind that record sales levels were achieved in each of the last 3 years along with a strong double-digit increase in both reported and underlying earnings in this segment, is clear evidence of continued strong performance relative to this priority. And finally, our fifth priority that we formally established at the end of last year was to achieve a double-digit growth in sales of Horace Mann Manufactured Life products with the strategic objective of growing our underwritten mortality-based business over the long term. While this will be an ongoing, multi-faceted process that builds over time, we're pleased with the 24% increase in the proprietary life product sales we generated out of the gate in 2012. So all in all, a strong first quarter for Horace Mann and a good start to the year. And now let me turn it over to Dwayne for some additional detail on our financial results.

Thanks, Pete. Horace Mann recorded first quarter operating income of $0.64 per share, which was $0.11 per share ahead of prior year, the difference primarily driven by expanded annuity investment margins; lower mortality costs in the life segment, and improvement in property-casualty results, including favorable prior-year's reserve development; and reduced levels of catastrophe and sinkhole losses. First quarter earnings were above our expectations and analyst consensus in total. The underlying book value per share, excluding net unrealized gains, increased 2.6% sequentially and 6% over prior year. With relative stabilization in the credit markets, including continued low treasury yields and tight spreads, the net unrealized gains were $462 million at the end of March, up marginally from year-end 2011 but an increase of $282 million from the prior March, driving reported book value to $27.37 per share, up 26% compared to a year ago. Pretax net investment income was up 7% in the quarter versus prior year, with Annuity and Life segments experiencing growth of 12% and 1%, respectively, while the Property and Casualty segment experienced a decline of 3%. The Annuity segment increase reflects growth in the portfolio as well as a decrease in average cash and short-term balances, the combination of which resulted in a 17% increase and the net interest margin over prior year. Our fixed annuity spread was 211 bps in the first quarter, up 9 bps from full year 2011, which was slightly favorable to our expectations. Looking forward, we would expect a modest decrease in spreads over the remainder of the year, consistent with our full year 2012 current earnings guidance. The decline in Property Casualty segment investment income compared to the prior-year quarter reflects the cash outflows over the last 12 months due to the high level of catastrophe losses experienced during 2011. We reported a small net realized investment gain for the quarter with no impairment write-downs. However, the current quarter did include some rebalancing, reflecting a slight bias towards shortening the duration in Annuity and Life portfolios, as well as strategic sales in our CMBS portfolio as the market presented a unique opportunity at the end of the quarter to trade lower-rated securities in the asset class. Net unrealized gain or loss balances generally remained consistent across all asset classes compared to year end, reflecting narrowing credit spreads, somewhat offset by higher treasury yields. The one exception was our CMBS portfolio, which after the quarter's disposals, now reflects a net unrealized gain position of $1.8 million. Regarding our current stock repurchase program. We bought back 200,000 shares during the quarter at an average price of $16.65, for a total at $3.3 million. Under the program, we've repurchased 355,000 shares and have remaining authorization of $44.6 million. Our repurchase program is purely opportunistic in nature, taking into account such items as price-to-book ratio, trading volumes, current-year actual results and macroeconomic factors. Lastly, we adopted the new accounting guidance related to deferrable policy acquisition cost effective January 1, 2012. The impact on beginning book value was $31.6 million after tax or approximately $0.80 per share, which was slightly favorable to our previous disclosures. Going forward, the impact of lower expense deferrals and amortization on operating earnings compared to prior periods is expected to be minimal and is reflected in the earnings guidance we provided in our last call. So to sum up the quarter, we're encouraged by the start of 2012 and the overall reported results, demonstrating the strength and benefits of our truly multi-line footprint. And now to review the current results and trends in our P&C business, I'll turn it over to Tom.

Thanks, Dwayne, and good morning. Today, I will summarize our Property and Casualty and profitability and growth results for the first quarter. Starting with profitability, we posted a 95% total P&C combined ratio in the quarter, which was equal to last year's first quarter. Total catastrophe cost from the 6 cat events were just under $6 million, $2 million less than last year. We had a favorable impact of prior-year reserve reestimates in the quarter of $4 million, an increase of $1.3 million when compared to prior-year same time frame. Our accident year combined ratio, excluding cats, was 93.6%, 2.4 points above 2011 first quarter. Our overall combined ratio for the quarter was 98.8%. When excluding cats and the impact of prior years, it was 102%, both ratios up 7 to 8 points above prior year. The increase was driven by a spike in injury losses in the quarter, predominantly increased bodily injury loss frequency. Given the size of our book, results in these coverages can be volatile from quarter-to-quarter. And as always, we will continue to monitor our experience to maintain results within our profitability target. Property combined ratio was 87.2%, an improvement of almost 15 points compared to prior year. Excluding cats and the impact of prior years, we posted a combined ratio of about 77%, almost 8 points better than last year. We are experiencing the favorable results from our profitability initiatives from the last couple of years, our underwriting programs have contributed to reduce non-cat losses, the Florida exposure management program has virtually eliminated sinkhole losses and we are earning the effects of aggressive rate actions. Now for a look at our top line results through the first quarter. Total P&C premium was down about 1% to prior year, with Auto down 3% and Property posting a 4% increase. We continue to implement additional state- and market-specific Auto new business growth initiatives. And we are off to a good start this year, with first quarter true new Auto units increasing about 40% above last year's first quarter. Additionally, we have been introducing national initiatives to improve policyholder retention. With the recent introduction of Auto electronic delivery and continued enhancements to our easy pay EFT process and to our Auto school payroll deduct program, we are seeing increases in the number of customers making automatic premium payments, which should favorably impact policyholder retention. In the quarter, our Auto retention on a 6-months trailing basis was above prior year by 6/10 of a point after posting declines in both 2010 and 2011. We ended the first quarter with 723,000 total P&C policies in force, 2,000 below year end, representing the smallest sequential PIF decline in the last 2 years. One final note about Auto retention. You may have noticed that we have added an additional policy renewal rate measure on Page 4 of the financial highlights in the earnings release. It is labeled Automobile 12 months, and it is the measure of retention on an annual basis of our entire Auto policyholder base. The other Auto measure, Automobile 6 months, measures the renewal rate every 6 months instead of annually, and it doesn't include the Auto policies we have on Auto payroll deduct, which have annual terms. This segment of our business, while relatively small, is one of our fastest-growing segments with our highest retention ratio and should be included in our measure of policyholder retention. This year, we will continue to display both measures. Next year, we'll only display the Automobile 12 months annual renewal rate. In summary, we're off to a good start in 2012. We see continued improvement in the profitability of our Property line, and we will be monitoring Auto injury loss results closely. Our expectation is to continue to be, for a total P&C combined ratio, in the 96% to 98% range, with Auto running in the high 90s and Property in the low 90s. And we are encouraged by the progress of our Auto growth initiatives in the first quarter. Now I would like to turn it over to Matt for his commentary on Annuity and Life results.

Thanks, Tom, and good morning. I'll spend the next few minutes going over the profitability and growth results for the Annuity and Life segments. Starting with the earnings for our Annuity segment. We continue to see solid increases in account values and margins. Fixed account values increased 11% compared to a year ago, and the associated net interest margin improved 17% compared to a year ago, reflecting management of both the investment portfolio and crediting rates. The resulting net interest spread was 211 basis points on an annualized basis for the quarter, an increase of 9 basis points compared to the prior year. The variable account balances decreased slightly over the prior year. Our Annuity liabilities remain extremely stable, positive net fund flows continued in the quarter and total account value persistency of 94.5% over the last 12 months was up nearly one point compared to prior year. Strong market performance had a positive impact on both the valuation of deferred policy acquisition costs and the level of guaranteed minimum debt benefit reserves for the quarter, and was the main driver of the $2.6 million positive impact from DAC unlocking. Annuity pretax income for the quarter was $17.3 million, representing an increase of 37% to over prior year. Excluding the valuation of deferred policy acquisition costs and the change in the GMDB reserve, the underlying pretax income increased 24% over prior year. Annuity sales results for the quarter were up 9% driven by single premium and rollover business, while total contract deposits received for the quarter were down slightly. Turning to the Life segment. Pretax income for the quarter was $8.1 million, an increase of 23% over prior year mainly due to lower mortality costs. Life premium and contract deposits, which consist only of Horace Mann products, were up 1% compared to prior year. Horace Mann Life sales for the quarter increased 24%. Our Life persistency for the quarter remained consistently strong at 95.4%. In closing, it was a solid quarter for both Annuity and Life sales and a continuation of strong underlying earnings in both lines of business. And with that, let me turn it over to Steve for his comments on distribution and sales.

Thanks, Matt, and good morning. I'll provide an update on our sales and marketing programs. From a sales perspective, positive momentum in all lines of business carried into the first quarter. We saw a continued strength in the sales of Auto, Annuity and Life insurance lines and also saw our Property sales improve over prior year's first quarter. Looking line by line, our true new Auto units sales, which represent business from brand-new Horace Mann customers, increased approximately 40% for the quarter compared to the same period last year. Our total Auto units, which include add cars or additional units from existing Horace Mann customers, increased 21% during the quarter. We are confident that the programs initiated early last year, which positively impacted sales results starting in the third quarter, will enable us to sustain these higher levels of production in 2012. However, we would expect our favorable prior-year comparisons to moderate in the second half of the year. Following Auto, Property sales increased 13% compared to the first quarter of 2011. And moving to Annuity, sales were once again strong, up 9% in the quarter compared to the same period last year. The increases comprised of a 9% increase in single premium and retirement rollover sales and a 6% increase in flex sales. Single premium and rollover sales have been strong for several quarters. And finally, Life Insurance. Horace Mann Life product sales increased in the first quarter compared to last year. And as mentioned last quarter, we introduced initiatives designed to support the sales of our Horace Mann branded life products. The result, an encouraging 24% in the quarter compared to the same time last year. From a staffing perspective, on March 31, total agency force decreased by 18 from the end of 2011, which is consistent with a seasonal pattern of prior years. The majority of terminations continue to come from our lowest-producing agents. And as Pete mentioned, we are targeting another modest growth in agents for the full year. Additionally, we anticipate continued improvement in our agency force productivity as the primary driver of increased sales levels. We have a number of indicators that our sales momentum will continue based upon activities in the marketplace. The marketing and education program investments we continue to make are having a positive impact on our sales results. For example, our state teacher retirement seminars increased dramatically, as have other group presentation, all received positive reaction, especially in our newer school district marketing programs. In summary, we are pleased with the results and encouraged by the momentum that carried into the first quarter of 2012. We are confident and optimistic that the marketing programs we've initiated will continue to yield favorable results. Thank you, and now back to Dwayne.

Thanks, Steve. That concludes our prepared remarks. Tasha, if you would please move to the question-and-answer session.

[Operator Instructions] And your first question comes from the line of Bob Glasspiegel with Langen McAlenney.

The commentary on Auto. I'm trying to figure out where you think we are in the environment. You're not the first to say that there were some events going on in the first quarter. But you seem to be tweaking a little bit your priorities from growing Auto to say, "Whoops, we better be careful in how we pursue growth in the current environment." And I'm not sure you were saying whether auto is going to be worse throughout the year. I thought you were hoping for it to be stable and get better next year. So what's going on in Auto? What's your strategy? And how should we think about how the results might be for the rest of the year?

This is Tom Wilkinson. Agree with you that we're hearing other people talk about Auto losses in the quarter rising up a little bit, and I think we saw the same thing. What we see is it's not really across the board through all coverages. It's pretty much in the injury coverages and BI frequency specifically. Given our size, we often have some volatility of results from quarter-to-quarter. And we're starting from that point that this is a -- just a little bit of volatility. Obviously, it's-- injury coverage is where a lot of money is, so we've got a lot of attention on it and as usual, we're going to keep an eye on it. We took our rate expectations -- we're not really changing our rate expectations, and at this point in time, we're not really changing our expectations for the full year combined ratio. The high-90s is the -- a number we mentioned on the last call and the number we mentioned fairly consistently. I think that it's going to be, right now anyways with our position in Property, which we think is pretty good and improving over the last few years, in running that into low 90s can balance out the high 90s in Auto for this year and possibly the next year.

The high-90s is all-in or that's underlying a -- I forget.

No, that's all-in.

So that's all-in combined. So are you -- your foot's on the gas pedal in Auto, you're tapping the brakes or you're slamming the brakes on. I mean what would be the right characterization?

This is Pete. Again, as we've said, when we started talking about the state-specific initiatives that we began to put in place in the second and third quarter last year and continue to do so, that we probably got a little bit ahead of ourselves in the latter part of 2010 with rate. So the attempt there was to do a better job of balancing growth and profit. I guess you would say in your vernacular, tapping the accelerator a little bit. But all along, and as we've said back the last couple of quarters and continue to say today, we are looking at a balance of growth and profit. We aren't looking to put new business on the books and lose money, be short-sighted in that way. So I guess I view this first quarter spike in primarily BI frequency. And the fact of the matter is, a fair amount of that occurred in the last month of the quarter. It's something we're certainly going to watch but something that is, at this point in time, not going to divert our attention from trying to maintain that balance. And I think the production levels have moved in the direction we want them to. So it will be a continuing effort to make sure that both the top and bottom line are in balance and our estimates for the full year, as Tom indicated, continue to be what our initial guidance was.

Okay. Last question on agent growth. Are you saying 50-50 you can grow it or from 75-25?

Bob, it's Steve Cardinal. We're pretty optimistic. It's not a key driver of our productivity this year. We're optimistic that we'll be growing. That's our target, to kind of grow this year. It was a handful last year, and I expect it's probably in that range again. Where we're losing our -- where our turnover is we still have a lot of this transformation of our agents. There was -- the agents that we're losing have been very -- have been low-productive agents so far. So we anticipate that continues. Our retention of the agents since we started the exclusive agent model in 2009, our goal there was to move that up towards the limmer [ph] averages of the multi-line agents, and we are trending at or above that, depending on which year of classes. And every year-- subsequent year, seems to be looking even better. So we're pretty comfortable with where we are from the stability and the ability to kind of grow that. At some point out in the future, we may look at growing that, growing the agent count differently. But right now, we've had so much work on our -- the programs and process to the marketing programs to generate activities in the marketplace. We've seen our quote volume spike. We're seeing the increase in the sales and productivities of all -- across all lines. So we're feeling pretty comfortable right now from where we're positioned in our agency force with what's going on and kind of all lines. And even at Tom's question, we're aware, where working with -- as we have to go through and take rates in the Auto line and have a dialogue with both our field folks and our pricings, and feel we've got a different strategy to go through this next part of the rate cycle, which we're well aware of differently than we did in the past and feel pretty good about our ability to grow that.

[Operator Instructions] At this time, there are no further questions.

All right. Thanks, Tasha, and thank you, everyone, for participating in our call this morning. If you have any further questions, please feel free to give me a call. Have a good day, everyone.

This concludes today's conference call. You may now disconnect.