Horace Mann Educators Corporation (HMN) Q1 2013 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by, and welcome to the Horace Mann First Quarter 2013 Earnings Conference Call. [Operator Instructions] Thank you. I would now like to turn the conference over to Mr. Ryan Greenier. Sir, you may begin.

Thank you, Racquel, and good morning, everyone. Welcome to Horace Mann's discussion of our first quarter results. Yesterday, we issued our earnings release, including financial statements, as well as supplemental business segment 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 want to note that our presentation today includes forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. The company cautions investors that any forward-looking statements include risks and uncertainties and are 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. The actual results may differ materially due to a variety of factors, which are described in our press release and SEC filings. In our prepared remarks, we may use some non-GAAP financial measures. Reconciliations of these measures to the most comparable GAAP measures are available in the supplemental sections of our press release. I'll now turn the call over to Pete Heckman.

Good morning, everyone, and welcome to our call. Before commenting on Horace Mann's first quarter earnings, I wanted to acknowledge the most important of the 2 press releases that went out after the markets closed yesterday when we announced Marita Zuraitis as our new President and Chief Executive Officer-Elect. Marita is a 30-year veteran of the property, casualty industry with both commercial and personal lines experience. She comes to us from the Hanover Group where we she was a member of the executive leadership team and ran their $3-billion P&C business since joining them in 2004. Prior to that, she held senior leadership positions with The St. Paul/Travelers Companies and USF&G. Marita will be working closely with me, our senior management team and the board over the next several months as she transitions to the President and CEO position. As she gains a deeper understanding of Horace Mann's niche market, our product offerings and our business model, Marita will be able to leverage her considerable leadership and team-building experience and have a very positive impact on the company. We have an experienced senior management team in place at Horace Mann, have aggressive but realistic goals and the appropriate strategies to achieve them, and our operating and financial results have been solid. We're excited to welcome Marita to the Horace Mann team to help us further enhance the service we provide to our educator customers and profitably grow the business. She'll be starting in a couple of weeks and will be joining me on next quarter's call, so you'll be able to hear her thoughts on the company and how her transition is going at that time. Now let me move on to first quarter earnings. After yesterday's market closed, Horace Mann reported operating income of $0.55 per share for the quarter, a good start to the year. In total, operating earnings were consistent with our expectations. For P&C, our combined ratio of 97% reflected solid underlying property results, which offset some deterioration in auto margins. Excluding DAC unlocking, annuity earnings were in line with expectations, as higher assets under management more than offset some compression in net interest spread. On a reported basis, annuity earnings benefited from $0.03 of DAC unlocking. In the life segment, we saw a return to more normal levels of mortality consistent with our full year earnings guidance. Horace Mann agency sales continue to be strong, and the growth rate in property and casualty written premium ticked up a little bit. This quarter, solid earnings resulted in a 2% sequential increase in book value per share, excluding FAS 115 to $22.38. On a year-over-year basis, this measure was about 10%. We continue to return capital to shareholders in the first quarter, both in the form of a dividend increase, as well as opportunistic share repurchases. This was our fifth consecutive double-digit dividend increase and reflects not only our strong capital position but also confidence in our future earnings power. Now let me give you a brief update on how we are doing relative to the 4 key 2013 performance priorities we established on last quarter's call. Our first priority is to maintain the high level of P&C new business sales we achieved last year and further increase our retention ratios. And we are off to a reasonably good start here. True new auto sales unit were modestly higher in the first quarter compared to prior year, and we had a 7% increase in new property units. Efforts to improve retention, such as initiatives to increase the number of customers on automatic payroll deduction and electronic funds transfer, as well as proactive agent communications in advance of rate increases, have contributed to a nearly 2-point improvement over the last 12 months in the auto retention ratio, which ended the quarter at 85%. And we've added additional programs, including an annual customer policy review process, which we kicked off recently, to help sustain this improved retention level. Our second priority is to make further progress toward our total P&C combined ratio goal of the mid-90s. We plan to get there with a non-cap property combined ratio in the low to mid-70s and an auto combined in the high 90s. Our total underlying combined ratio was 95.4%, which, given the seasonality of the first quarter, is a pretty good result. When we look at the components here, we are reasonably satisfied with our property results but still have more work to do in auto. Importantly, we are on track with our 2013 rate plan in both lines, which include mid-single-digit rate increases for auto and double-digit increases for property. Our third priority for 2013 is to continue to grow our retirement annuity business while maintaining spreads on new sales at or above pricing targets. Total annuity sales were down 3% in the quarter, reflecting a decline in independent agents sales. However, Horace Mann agency sales were up by 5%, and spreads on new business exceeded pricing targets. As we move through 2013, we expect sales comparisons to prior year to continue to be somewhat challenging given the fact that 2012 was the fourth consecutive year of record annuity sales. Our final key priority in 2013 is to continue to aggressively grow our Horace Mann life business, and sales in the first quarter were up 28%. We successfully introduced our new cash value term product in February, which is an attractively priced mortality product that also builds cash value. And in the second quarter, we will be rolling out a new electronic application system. This will enable agents to take and submit an application in real time, a nice enhancement and one that we expect will help maintain our sales growth momentum. Now before I turn it over to Dwayne, if you wouldn't mind indulging me for just a minute, I'd like to acknowledge some recognition that Horace Mann received recently, one award and one nomination. First, we are pleased to have been selected in 2013 as one of Forbes' Top 100 Most Trustworthy Companies. This award is given to companies that consistently demonstrate transparent and conservative accounting practices and solid corporate governance. Now it's not like we're doing anything differently in this regard, but it certainly is gratifying to be recognized for our long-standing financial conservatism, transparency and governance practices. Second, we are honored to be a finalist for one of the Halo Awards sponsored by the Cause Marketing Forum. Our selection validates the success of our cause base marketing approach and strategic partnership with DonorsChoose.org. We are now in the third full year of this program, and Horace Mann and our agents have donated more than $1.7 million in the schools we serve, which, along with another $43 million from citizen philanthropists and other organizations, has funded over 81,000 classroom projects benefiting more than 3.7 million students. While these 2 items are not directly related to our quarterly results, they do provide some insight into what's important to us and how we go about doing our business at Horace Mann. Turning back to our financial results. The first quarter represented a solid start for 2013. While we have some work to do in auto, our underlying property results were good and the annuity and life segments are performing as expected. And with that, I'll turn the call over to Dwayne for some additional detail on our results. Dwayne?

Thanks, Pete, and good morning, everyone. First quarter operating income was $0.55 per share, which included $0.03 of positive DAC unlocking in our annuity segment. Excluding the DAC unlocking, operating income of $0.52 was generally consistent with management's overall expectations but lower than the prior year, primarily due to a higher combined ratio in property and casualty. Property and casualty after-tax earnings of $10.2 million were $3 million lower compared to the first quarter of 2012. Catastrophe losses were in line with expectations at 4.2% of earned premium. 2.4 points of favorable prior year's reserve development was modestly lower than the first quarter of last year. The total P&C underlying combined ratio was 95.4%, which included a strong property component in the mid-70s. This helped mitigate some of the increase in the auto loss ratio, which, as Pete mentioned, was above our expectations for the quarter. The increase was primarily driven by lower anticipated current accident year salvage and subrogation recovery as compared to the assumptions used in the first quarter of 2012. This reduced level is consistent with declines in salvage values experienced throughout 2012 as a result of a supply glut in the salvage and parts marketplace, which was exacerbated in late 2012 as a result of events related to Superstorm Sandy. Our recovery assumption in the first quarter of 2013 is generally in line with the levels we established for the fourth quarter of 2012 and anticipate the stabilization in salvage values for the remainder of the year. Top line trends remain solid with written premiums of $132 million, up over 3% from the prior year, and Tom and his team are successfully implementing the P&C rate plan. Turning to our annuity segment. After-tax income, excluding DAC unlocking, was approximately $10 million, slightly higher than in prior year. Increased assets under management in the quarter helped offset the operating income impact of the decline in investment spreads. The first quarter net interest spread of 2.01%, while down 10 basis points from the prior year, was slightly above our expectations. Importantly, we remain above our pricing targets for the new annuity business and continue to pursue opportunities to grow our assets under management. Our life segment after-tax operating income was $4.3 million, down almost $1 million from the prior year. During the quarter, mortality returned to a more normalized level compared to the favorable experience throughout 2012. Turning to investments. After-tax net investment income was $52 million, more than 2% higher than the prior year. The majority of the increase was driven by higher annuity assets under management. This quarter's income continue to benefit from the modest allocation to alternative investments that we added throughout 2012. The reinvestment rate in the quarter was in line with the 4% assumption used in our full year guidance. We ended the quarter in a net unrealized gain position of about $640 million, a slight decline from year end. Reported book value ended the quarter at $31.81, a 16% increase year-over-year driven by strong operating results and an increase in unrealized gains in the investment portfolio. Book value per share, excluding unrealized gains, grew 10% to $22.38 per share. As Pete mentioned, we were active in our buyback program during the quarter, taking advantage of market volatility. We repurchased almost 90,000 shares this quarter at an average price of $20.53. Since we began the program in the fourth quarter of 2011, we have repurchased almost 1.2 million shares at an average price of $16.89 per share. We have $30.4 million remaining under the share buyback authorization, and we'll continue to be opportunistic in our approach to further repurchases. Overall, we are pleased with the solid start to the year. First quarter earnings were in line with our expectations. We also made good progress on all 4 of our key priorities for 2013. Before I turn the call over to Ryan, I want to mention that we plan to post a financial supplement on the Investors page of our website after this morning's call. I think you'll find the format of the supplement easy to work with, and we welcome your feedback. Going forward, it is our intention to issue the supplement in tandem with our earnings release, which is typically the evening before the earnings call. And now let's move to the question-and-answer session. Ryan?

Thanks, Dwayne. Racquel, if you would like to compile questions?

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

The selection of Marita, I just want to focus on that initially. From my perspective, knowing her long time, it seems like a really good fit. Pete, what did you think the board saw in her that made her the best candidate?

Well, a variety of things, Bob, and I agree with you and the board certainly does as well. Marita has a pretty solid track record. That is well known in the industry, but really, primarily came down to a few things: leadership and management skills. I think Marita has proven that she's a team builder, works well in establishing and building and developing people. She, of course, has public company P&L experience, personal lines P&C experience, but a lot of what she was working on and accomplished at the Hanover was, in some way, similar to Horace Mann's strategy where she was trying to provide to their distribution channel and customers the breadth of products and services that a large company could bring to bear with the flexibility and adaptability and nimbleness, if you will, and service levels of the smaller company. And that's a lot about the differentiation and the focus on distribution that Horace Mann has here. So she'll bring a lot of new and complementary skills to the Horace Mann senior management team, and like you say, we're very pleased that she's joining us.

I think the original plan was you're going to possibly hang around until the end of the year. Is that still the plan? Or has that changed?

I think that's possibly the plan. As we mentioned in the release, I intend to be here for several months for the transition to make sure that it goes well and Marita has all she needs. And the exact amount of my time here, which could include being up to the end of the year is going to be determined by the board with input from Marita, but yes, I'm not leaving in the next few weeks.

Okay. On the auto side, how many points was the subro pressure?

Glass, this is Dwayne. The -- what's interesting on the salvage is if you look at our experience, as well as industry experience, the peak of the value, or the positive value occurred in the first, the end of '11, the first quarter of '12. So the 2 data points we're comparing, as I would say, is the high point over the last 4 years and in the first quarter of '13 as far both our numbers and industry is basically the low point. So with the increase in salvage and subro or the decrease in the anticipated recoveries, just in auto for the first quarter, about 1.5 points, and then the remaining part is obviously an increase in the expense ratio. But the level that we've established in the first quarter is generally consistent with year-end numbers. I guess the important thing here is although the auto loss result is still elevated above our expectations, as far that underlying piece is basically spot on year-over-year before salvage and subro and expenses.

Do you have to adjust rates further for this? Or you can get your plan...

That's a good question.

Yes, I think we can get it with our current pricing plan.

And Glass, during 2012, we saw the decline. So it was a -- that new run rate level off of the peaks of the end of '11 and '12 was somewhat already considered in Tom's strategy.

Yes, it was built into elevated rating -- elevated auto rate plan that we took the second half of 2012. You may recall it was higher than the first half rates, and then that continues into 2013.

Okay. On the annuity side, you weren't factoring in up 10% Q1 market in your plan, so I think you've sort have been leading to flat -- flattish earnings because of the DAC unlocking and margin pressure and spread compression. But let's say, getting a big market appreciation in Q1, which raised the sort of level of assets under management for the full year, does that sort of allow for an up year potentially as the market holds here?

In the plan, Bob, we assume a -- excuse me.

[indiscernible] the year or something [ph] .

We have a market assumption built into the plan, and the market expectation built into the plan was lower than the actual returns that we got in the current quarter. The...

But addition to it -- so can we get it all in Q1? That sort of raises the average assets for the whole year. So it's more than just getting -- if you assumed 8% for the year to get 10% in Q1, it's more than just...

Yes, it'll start our -- and that really, impacts the variable component of our annuity blocks, 40 blocks [ph] .

Right, which is 40 blocks [ph] .

Yes, 30 or so percent, with 70% being the fixed annuity. So you're right on that 30%. If the market basically remains flat for the remainder of the year, we'll be relatively close to our full year plan, but we will kind of have a little bit of a front-ended asset growth. On the 70%, the fixed side, again, the increase in assets there pretty much exactly offset the anticipated decline in spreads. So the total income off of the fixed block was about what we thought.

Okay. So a little bit of headwind -- yes, with tailwind, I mean, tailwind, tailwind.

Yes, a little bit [indiscernible] tailwind [indiscernible] .

On the -- but correct me if I'm wrong. As I recall, you normally get an erosion in agent count in Q1 and then build over the course of the year. So I assume you're still on plan for what your agent balance is going to be at the end of the year or do I have that wrong?

Yes, Bob, this is Steve Cardinal, and no. You're exactly right. We have a little bit of erosion in the first part of the year. We've done that the last few years. We think we're on track for a good -- another year, fifth year in a row of growing agency count again because that's what we've had. Agent retention's been very solid, and productivity is up so a lot of good indicators for us.

[Operator Instructions] There are no further questions at this time.

Thank you, Racquel. Thank you, everyone, for your interest and participation in today's call. Should you have any other questions, I'm available after the call. Thanks.

Thank you. Ladies and gentlemen, this concludes today's conference call. You may now disconnect. Have a wonderful day.