Horace Mann Educators Corporation (HMN) Q4 2012 Earnings Report, Transcript and Summary

Good morning, my name is Patrick, and I will be your conference operator today. At this time, I would like to welcome everyone to the Fourth Quarter and Full Year 2012 Earnings Conference Call. [Operator Instructions] I would now like to turn the call over to the Vice President of Investor Relations, Mr. Ryan Greenier, to begin the conference. Sir?

Thank you, Patrick, and good morning, everyone. Welcome to our advanced discussion our fourth quarter results. Yesterday, we issued our earnings release including financial statements, as well as supplemental business information. If you need a copy of the release you can find it on the Investors Page of our website. Our speakers today are Pete Heckman, President and Chief Executive Officer; and Dwayne Hallman, Executive Vice President and Chief Financial Officer; Steve Cardinal, Executive Vice President of Marketing; Matt Sharpe, Executive Vice President of Annuity and Life; and Tom Wilkinson, Executive Vice President of Property and Casualty, are also available for the question-and-answer session that follows our prepared comments. Before turning it over to Pete, I wanted to note that our presentation today includes forward-looking statements as defined in the Private Securities Legislation Reform Act of 1995. The company cautions investors that any forward-looking statements include risks and uncertainties and is not a guarantee of future performance. These forward-looking statements are based on management's current expectations and we assume no obligation to update them. Actual results may differ materially from those projected in the forward-looking statements due to a variety of factors. These factors are described in our press release and SEC filings. In our prepared remarks, we may use some non-GAAP financial measures. A reconciliation of these measures to the most comparable GAAP measures are available in the supplemental sections of our press release. And now I'll turn the call over to Pete Heckman.

Good morning, everyone, and welcome to our call. After yesterday's market closed, Horace Mann reported fourth quarter operating income of $0.67 per share, which was only slightly below the record quarterly EPS we recorded a year ago. Full year operating income was $2.08 per share. Underlying earnings continued to be strong across all 3 segments of our multiline insurance platform. Cat losses in the quarter were minimal as we do not write business in New York or New Jersey. In addition, fourth quarter earnings benefited from the favorable prior year P&C reserve development, positive DAC unlocking in our annuity segment and favorable mortality in our life business. Each of those items was well above our expectations in both the current quarter and for the full year. In addition to strong bottom line results, the broad-based increases in new business sales and policy retention over the last several quarters continued in the fourth quarter. We are pleased with the solid earnings we've delivered to our shareholders in 2012. Horace Mann's book value per share, excluding FAS 115, increased 11% year-over-year. And in December, we announced our fourth consecutive, double-digit dividend increase. Our dividend has tripled since the financial crisis and is up more than 50% from precrisis levels. This track record reflects our strong capital position, as well as confidence in our future earnings power. Going forward, the Board will be moving our annual review of dividend and other capital management actions from December to March so that actual year-end results can be taken into consideration. This change will be made starting with next month's Board meeting. Now last year around this time, I outlined the 5 key performance priorities that Horace Mann would be focusing on in 2012. As you might expect, given my commentary on the last 3 earnings calls and our results this quarter, my end-of-year report is a very positive one. Horace Mann's agency force recorded double-digit sales increases in all 4 lines of business in 2012 and we grew our agency count for the fourth consecutive year. In the auto line, successful implementation of state-specific pricing, underwriting and marketing programs resulted in a 20% increase in true new unit sales. Retention was up 1.7 points, benefiting from the continued focus on expanding the number of multiline customers and the utilization of automatic payment plans. Meanwhile, the increase in both new sales and retention resulted in the stabilization of our auto PIF counts. In property, while we still have long ways to go, we continued to make progress on the underlying combined ratio, which improved more than 2 points in 2012 to end the year at 75.9%. Our retirement annuity business recorded its fourth consecutive year of record sales and assets under management increased 10%. This was a no small part due to the nearly 8,000 State Teachers Retirement Seminars conducted by our agencies in 2012. In addition to strong sales, annuity net interest margins were better than expected as a result of higher-than-anticipated reinvestment rates, prudent crediting rate management and new business spreads that were well above our pricing targets. And finally, sales of Horace Mann manufactured life products were up 40% from the prior year, consistent with our strategic commitment to grow our underwritten mortality-based business. This increase was supported by a number of improvements in our new business application and underwriting process during 2012. Our strong performance relative to these key 2012 priorities contributed significantly to an outstanding full year operating EPS of $2.08. But as I mentioned earlier, we also benefited from a number of items, which were considerably more favorable than we would have normally expected. Dwayne will take you through those details in just a moment. We anticipate 2013 operating earnings to be between $1.75 and $1.95 per share. This estimate reflects improved underlying P&C underwriting results offset by a reduced level of favorable P&C reserve development and a return to normal mortality and DAC unlocking. It also reflects the investment of $3 million to $4 million of our excess capital or roughly $0.05 per share in customer service and infrastructure improvements. These investments are being made to enhance our overall customer experience and to support further improvement in our already strong policy retention and cross sale ratios. Dwayne will also provide a reconciliation of our earnings guidance for you, but before he does, I'd like to lay out the 4 key performance priorities we'll be focusing on in 2013. Our first priority is to maintain the current high level of P&C new business sales and further increase our retention ratios. We will continue the state specific growth initiatives from 2012 and we'll launch additional customer contact programs, which we expect to contribute to further improvement in the retention. At the same time, we will continue to focus on achieving an appropriate growth profit balance, which leads to the second key priority for 2013, which is to make further progress toward our total P&C combined ratio goal of the mid-90s by improving both the auto and the underlying property profit margins. Our 2013 auto rate plan includes targeted increases averaging in the mid-single digits. In property, we're targeting double digits. These rate actions, combined with those taken in 2012, should result in improved margins and expanding premium growth. Our third priority for 2013 is to continue to grow our retirement annuity business while maintaining spreads on new sales at/or above our pricing targets. And finally, we plan to continue aggressively growing our life insurance business and are, once again, targeting double-digit growth in sales of Horace Mann manufactured products. To help sustain the strong growth momentum in this line, we are in the process of introducing a cash value term product, which has received strong initial feedback from our agency force, and we also plan to introduce an electronic new business application and submission system in the third quarter. So in addition to our underlying company-wide focus on improving the customer experience, those are the 4 key priorities for 2013. As we did last year, we plan to update our progress relative to these priorities on subsequent quarterly calls. In that regard, I believe Horace Mann is entering 2013 from a position of strength with positive sustainable momentum and we're looking forward to another good year. Now, let me turn it over to Dwayne for more detail on both our results and our earnings guidance. Dwayne?

Thanks, Pete, and good morning, everyone. Fourth quarter operating income of $0.67 per share benefited from relatively low cat losses, stronger-than-expected prior year reserve development, $0.04 a positive DAC unlocking and $0.04 of favorable earnings in life, primarily related to mortality. Offsetting these positive items was $0.05 of expenses related to CEO and other incentive compensation. Adjusted for these items, fourth quarter earnings would have been $0.50 to $0.55 per share at the top end of our guidance range. On a full year basis, operating income of $2.08 per share also benefited from a number of items that weren't included in our original guidance. Prior year P&C reserves continued to develop favorably. However the level of releases in 2012, was higher than we expected. Favorable mortality in our life segment contributed $0.07. Strong equity markets and improved annuity persistency resulted in positive DAC unlocking of $0.07. Adjusted for these items, normalized 2012 earnings would have been in the $1.85 range. Pretax net investment income of $77 million was up over 3% from the prior year quarter, primarily related to the annuity segment. Our reinvestment rate in the quarter was around 4.2%, which was ahead of expectations. We continue to find opportunities to put money to work at attractive, risk-adjusted yields without venturing into asset classes or individual securities inconsistent with our conservative investment philosophy. That said, we did enhance our annuity portfolio returns during 2012 by adding a modest allocation to alternative investments, which helped mitigate what would have otherwise been a declining interest spread in the second half of the year. On a full year basis, the average spread in annuity was 211 basis points. Without the alternative investments, the average net spread would have been around 200 basis points. Reported book value ended the year at $31.65 per share, a 19% increase year-over-year driven by solid operating results and an increase in unrealized gains in the investment portfolio. The continued combination of low treasury yields and tightening spreads resulted in a net unrealized gain of $650 million at year end. Book value excluding net unrealized gains grew 11% to end the year at $21.93 per share. In terms of our capital position, we generated roughly $90 million of statutory operating income and $25 million of additional excess capital in 2012. While RBC ratios aren't final, our initial estimates have been comfortably above our targets. The P&C ratio is estimated at 550%, with a premium-to-surplus ratio of 1.35, while life company RBC should end the year around 470%. During the quarter, we repurchased 115,000 common shares, utilizing an additional $2 million of our authorization. We now have $32 million remaining. When we originally authorized our share repurchase program in December of 2011, Horace Mann stock was trading around $13 per share or 65% of book value, excluding net unrealized investment gains. The Board authorized the program in light of our excess capital position and a clearly undervalued stock price. While the strong price appreciation of our stock during 2012 was welcomed, it has reduced the relative desirability of share repurchases and has tipped the scale somewhat in favor of dividends as a means of returning capital to shareholders. With that said, however, we will continue to be opportunistic in our share repurchases and are well-positioned to capitalize on any market dislocation. As Pete mentioned, our outlook for 2013 operating earnings is $1.75 to $1.95 per share. We expect underlying results to improve in property and casualty, offset by a reduction in favorable pricing reserve development, a reversion to model mortality experience in our life operations, no benefit from DAC unlocking and $0.05 of spend on customer experience and infrastructure investments. Let me break down our 2013 outlook by segment and provide some additional color behind our assumptions. In property/casualty, we expect written premium to grow 2% to 3%, which reflects a 2013 rate plan of mid-single-digit increases in auto and a double-digit increase in property. We expect those rates, coupled with 20 [indiscernible] pricing actions to outpace loss costs and contribute to about a 2-point improvement in the underlying P&C loss ratio in 2013. We anticipate this improvement will be offset by a reduced level of favorable prior year reserve development, as well as a modest increase in the expense ratio. So all in, on a reported basis, we expect the P&C combined ratio to basically be flat with 2012 results. In annuity, after adjusting 2012 for the $0.07 benefit from DAC unlocking, we anticipate operating earnings to be relatively stable in 2013, as growth in annuity assets is expected to offset a decline in spreads. Using a 4% reinvestment rate assumption, we expect the full year average in net interest spread in 2013 to be in the low-190 basis point range. And finally, in our life segment, we're anticipating a return to model mortality along with the modestly lower portfolio yield in 2013, which should result in about a $5 million to $6 million after-tax decline in operating earnings. As you'll see, our consolidated 2013 operating earnings guidance is generally in line with 2012 results after adjusting for the favorable items we just discussed. So to summarize, 2012 was a solid year for Horace Mann. We saw a broad-based increases in new business sales and policy retention, as well as improvement in the underlying earnings across all 3 segments of our multiline insurance platform. Moving into 2013, we are well-positioned to capitalize on the strong momentum while reinvesting in our business to set the stage for continued profitable growth. Now, I'll turn the call over to Ryan to begin the Q&A session.

Thanks, Dwayne. Patrick, we're ready.

[Operator Instructions] Our first question comes from the line of Bob Glasspiegel.

On the projections, it seems like a few years ago you were saying you would target a 12% to 14% ROE with a 92 to 94 combined ratio. Now, I think you're talking more about getting it to 95 a year from now. Is that from the original goal? Or is that still where you were 2 to 3 years ago?

Yes, Bob, this is Pete, good morning. Yes, we still look at our franchise as being able to deliver in the low teens, as you say, ROE, and that would have include P&C combined ratio in the mid-90s. As you know, over the last couple of years, it's been a very competitive market and we have and continue to try to balance growth and profit. So we've made some progress on the underlying combined in 2012, and are targeting additional progress in '13. And we'll continue to move down toward the mid-90s, but again, we need to balance growth with profit appropriately.

Is there a date that you're -- have we eliminated the date in the goal achievement publicly or --

We don't have a specific date or month or year or anything like that, Bob. We just --

You used to say 2 to 3 years 2 years ago, but -- so you sort of had a date before.

Yes, well, the market is dynamic, and we continue, as I say, to make progress toward it, and we feel comfortable that we're on the right track and we're going to get there in a reasonable amount of time.

Okay. Second question, I'm going to flip my third quarter question where I said, "Why aren't you declaring victory in auto where you had very strong underlying results." This quarter, I mean, your underlying auto was 106, maybe there's some seasonality in it, but I was wondering where are you in auto? There's a lot of reserve releases in auto for pretty high combined ratio a year, maybe we could talk through how that plays out?

Well, Bob, this is Tom Wilkinson. On the underlying side, we may recall our conversation in the third quarter, we do have significant seasonality in our business in the fourth quarter where the combined ratio historically shoots over 100%, and it did again this year. We're encouraged that it didn't go as high as it was last year, giving us the second quarter in a row where our underlying combined, this current accident year was better than what it was the prior accident year. In terms of overall levels of the full year accident year is still over 100. It's -- as Pete was saying, it's trending down. Our target for total P&C is to get the total bucket in the mid-90s range. We still think that to be competitive and to balance growth and profit, our auto target is going to be in the high-90s range. We feel -- we're not declaring victory yet. We feel good about it. We feel that we got the trends going in the right direction and we're effectively moving towards our target, while at the same time setting the stage for future policy growth.

You don't normally see that large of reserve release when you're pushing rates pretty hard, too. I mean, what there a positive in the quarter in the reserve picture that you saw?

Bob, this is Dwayne Hallman. Nothing in particular. Just in the quarter, we were seeing favorable returns throughout the year in the fourth quarter, kind of reaffirmed our belief of what we're seeing in the prior years. So our reserve releases from prior years were not just from 2011, there were some longer tail auto lines, especially in the liability component, was coming from '09 and '10 as well, but the underlying favorable trend did continue into the fourth quarter on those prior years.

Okay. My last question. I'll go back in the queue. I'm not sure I followed, your capital management meeting will be in March. Does that mean that we could have a possibility of another dividend increase pretty quickly, but you're not doing buyback with all the excess capital? Or was I misreading the body language?

Well, we are going to move the conversation or consideration around capital management including dividends to March. Again, we've done it historically in December, but feel it would be probably more in line with the competition or our peers, but also gives us a chance to see where the year ends up to make a more informed decision. So it will be on the agenda in March now, starting next month. And we will continue to have excess capital and discuss the best ways to deploy that to the shareholders or to invest it in the company. We're beginning to do some of the latter, as you heard this year and going forward, but it will be a topic that the Board will discuss next month.

Bob, It's Ryan. Actually, if you have any additional questions, we can continue to take them.

Okay. Pete, are you going to be attending in any of those retirement seminars any time soon?

Which one --

I'm not trying to push you off. I enjoy chatting with you, and enjoying an additional quality time with you, but maybe you can feed us in on how the search for your successor is progressing?

To your first comment Bob, I'd like to know, which ones you're going to because those will be the good ones that I'd want to attend as well. But to your point, we've had a search process. The Board has had a search process that's begun now for a little over a couple of months. It is making progress, but it's too soon to report anything. There's really nothing at this point to comment on. But certainly, we'll keep you and everybody up to speed as things move forward. As you know my retirement date is going to be at the end of the year, so the process has a reasonable amount of runway left, and the Board is going to be very careful and deliberate in choosing my successor.

And there are no further questions. I would now like to turn the call back over to Mr. Greenier, to close the call.

Thank you very much for your interest in today's call. If anyone has any further questions, I'm available, as always, and we look forward to meeting with you and talking with everyone soon. Thanks.

And this does conclude today's conference call. All lines may disconnect this time. Thank you.