Horace Mann Educators Corporation (HMN) Q2 2013 Earnings Report, Transcript and Summary

Good morning. My name is Julie, and I will be your conference operator today. At this time, I would like to welcome everyone to the Horace Mann Second Quarter 2013 Earnings Conference Call. [Operator Instructions] Mr. Ryan Greenier, you may begin your conference.

Thank you, Julie, and good morning, everyone. Welcome to Horace Mann's discussion of our second quarter results. Yesterday, we issued our earnings release and investor financial supplement. If you need a copy, you can find them on the Investors page of our website. Our speakers today are Pete Heckman, President and Chief Executive Officer; Dwayne Hallman, Executive Vice President and Chief Financial Officer; Marita Zuraitis, President and Chief Executive Officer-Elect; 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. Before turning it over to Pete, I want 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 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 on 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 close, Horace Mann reported a second quarter operating income of $0.39 per share, a solid result considering the elevated level of catastrophe losses in the quarter. Underlying earnings in all 3 segments of our multiline insurance platform met or exceeded our expectations. Excluding cats and another quarter of favorable prior years' reserve development, the underlying P&C combined ratio improved in both auto and property. The improvements reflected expanding margins from the rate actions we've taken over the past 18 months, as well as favorable non-cat weather in the quarter. Excluding DAC unlocking, annuity earnings were a bit better than we expected, with growth in assets under management offsetting a modest degree of spread compression. On a reported basis, annuity operating income included $1 million of pretax, or about $0.02 per share of negative DAC unlocking due to market performance and realized capital gains. Life segment earnings, while ahead of our expectations, were below prior year in the quarter, reflecting a more normalized level of mortality losses, as well as a slight decline in investment income. The quarter's solid earnings resulted in a 2% sequential increase in book value per share, excluding FAS 115 to $22.79. On a year-over-year basis, the increase was 11%. Now as I've done the last several quarters, let me comment briefly on how we're doing relative to our 4 key 2013 performance priorities. The first priority is to maintain the strong level of P&C new business sales we achieved last year, while further increasing our retention ratios. At the halfway point in the year, we remained very much on track. Auto new sales premiums were up 7% for both the quarter and 6 months, while property increased 5% and 11% over those same periods. And retention continues to improve. The 12-month auto renewal ratio has moved above 85%, while property is over 89%. Given our niche market focus, we monitor these metrics closely and believe policy retention to be a strong indicator of customer satisfaction. With that in mind, and as I've mentioned on recent calls, we continue to implement programs such as annual policy reviews and invest in infrastructure, including expanded staffing, training and service hours in our customer contact centers, along with enhancements to our P&C building capabilities, designed to improve our customer experience and, in turn, support our retention and cross-sale ratios. The second key priority this year is to make further progress toward our total P&C combined ratio goal of the mid-90s, with the next cat property combined ratio in the low to mid-70s and an auto combined in the high-90s. On a year-to-date basis, our total P&C reported combined ratio of 100.3% was higher than we'd like, in large part due to elevated catastrophe losses. However, on an underlying basis, the total combined was 92.3% through 6 months, a good result and almost 2 points better than prior year. The property component is solidly on track relative to our expectations. This quarter's auto results were encouraging and brought the year-to-date combined below 100%, but we still have work to do there. Meanwhile, we're on track with our 2013 REIT plan, which includes mid-single digit increases in auto and a low double-digit increase in property. The 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 up in the quarter, including a 5% increase in Horace Mann agency sales, and spreads on new business continued to exceed pricing targets. Meanwhile, assets under management increased 10% year-over-year and reached the $5 billion mark, so profitable growth continues in this very important segment of our business. Our final key priority in 2013 is to continue to aggressively grow our Horace Mann life business. Sales of proprietary life products were up approximately 30% for the quarter and on a year-to-date basis. And a few weeks ago, we introduced an electronic life new business application system, which was well received by the agency force. We expect that enhancement, as well as other related process improvements, to support continued strong sales momentum. In closing, the second quarter was another solid one for Horace Mann. Strong underlying combined ratios helped get our year-to-date property and casualty results closer to where we needed them to be; the combined annuity and life earnings exceeded our expectations; and growth and retention continued to trend favorably across all lines of business. Now, before turning it over to Dwayne, I wanted to mention that Marita Zuraitis and I had been working closely together since she came on board as Horace Mann's new President and CEO-Elect, a little over 2 months ago. The transition process is going well, and I know she'll be glad to share her initial thoughts with you during our upcoming Q&A session. But first, here's Dwayne Hallman to provide additional detail on our financial results. Dwayne?

Thanks, Pete, and good morning, everyone. Second quarter operating income was $0.39 per share, which was $0.23 better than the prior year. Improvement in operating income was primarily related to lower catastrophe losses, as well as improved underlying P&C results. P&C after-tax earnings of $4.1 million were $8.2 million higher than second quarter 2012. Historically, the second quarter has been a volatile catastrophe quarter for Horace Mann, and this year was no exception. Catastrophe losses of $22.5 million or 16.1% of earned premium, were higher than our expectations, but still $7 million lower than the prior year. The other significant contributor to higher earnings was the improved underlying combined ratio, which was 89% for the quarter. This was a 5.6-point improvement over the prior year. Auto improved 4.5 points to 97.1%, and property results were in the low-70s. For the first half of the year, the underlying P&C combined ratio was 92.3%, a 1.7-point improvement. Stronger non-cat property results were the primary driver, but importantly, the auto combined ratio improved 1 point. As we've said before, our auto results can be volatile quarter-to-quarter given seasonality and the size of our book. We are encouraged that the reported auto combined ratio for the first 6 months of the year is back below 100%. Annuity after-tax net income, excluding DAC unlocking, was $10 million, a 10% improvement over the prior year. Assets under management also increased 10% over the prior year, bolstered by strong deposits in sales, as well as financial market returns. The growth in assets helped offset the operating income impact of declining investment spreads. The year-to-date net interest spread of 1.98% declined 3 basis points from the prior quarter. This gradual decline is in line with what we expected and consistent with our full year earnings guidance. We anticipate the net interest spread to continue trending downward gradually over the remainder of the year. However, as was the case this quarter, we expect continued asset growth to offset the operating income impact of spread compression. Horace Mann agency sales have increased in each of the last 4 years, and deposits continue to grow steadily. And as Pete mentioned, we are comfortably above the pricing targets on new business and continue to see opportunities to grow our assets under management. Our life segment operating income was $5.6 million, down 8% from the prior year. The decline was primarily the result of a return to more normalized mortality levels. In addition, we saw some modest pressure on investment income due to lower interest rates. On a consolidated basis, after-tax net investment income was $52.1 million, modestly higher than the prior year quarter. Higher assets under management in the annuity segment were the primary contributor. During the second quarter, our new money reinvestment rate was about 4%, in line with what we assumed in our full year guidance. In regards to our investment portfolio, rising rates and wider credit spreads during the quarter resulted in a decrease on our net unrealized gain, which ended the quarter at $344 million. As a result, reported book value declined 13% on a sequential basis to $27.72, a 4.5% decline year-over-year. Net realized gains in the second quarter were $10 million after tax or $0.24 a share. We took advantage of gains taking opportunities and some short-dated corporates. The program worked marginally better than expected, as we were able to reinvest the proceeds at higher-than-anticipated levels, given the rise in rates towards the back end of the quarter. During the second quarter, we repurchased about 80,000 shares in an average price of $24.35. This brings the total number of shares repurchased under our current authorization at over 1.2 million and an average price of $17.40. We have $28.4 million remaining in our repurchase authorization, and we will continue to be in the market as opportunities present themselves. In summary, we are pleased with the first half of the year. This quarter's strong results, excluding catastrophes, moved us closer to our underlying P&C combined ratio goal. Annuity sales remain strong and the spread compression we are seeing is in line with our expectations and very manageable, and life operating income is on track as well. We are successfully executing our 2013 key priorities and anticipate that to continue in the second half of the year. Now I'll turn the call over to Ryan to start Q&A.

Thanks, Dwayne. Operator, please open the lines to begin the Q&A portion of the call.

[Operator Instructions] Your first question comes from the line of Robert Glasspiegel from Janney Capital.

Dwayne, you gave the same speech on annuities that you've been giving in the last 3 or 4 quarters, despite the fact that we have a 20% of S&P and -- or a little bit less than 20%, and long bond yields are up 70 basis points over the last quarter. Do those not have any impact on what your outlook is for this business over the next 12 to 18 months?

Bob, thanks for the question. I guess the speech, as you referred to, has really been around our spread compression and our expected decline in our spreads, which...

And your life annuity outlook for flat earnings.

Right, right. But the spreads are declining. Yes, rates did pop up, in relative terms, slightly during the end of the last quarter and end of July, but keep in mind the current yield on the portfolio is still quite a bit above our reinvestment rate. So as we continue to put money to work, especially on our older blocks of business, that's still below our current portfolio yields, so we would expect the spreads to continue to decline. Now on the new business coming in, we're at or exceeding our spread targets, so it certainly helps mitigate some of the spread compression. But until the reinvestment rate starts to increase in a slow and more material level, I think you'll continue to see the spread compression through the rest of the year.

Obviously, we're going to have spread compression, but the guidance was for flat life and annuity earnings, which you have revised, and I would have thought that up 19% S&P and investing new money at 70 basis points might allow you to be able to grow the business, grow earnings.

Yes, I mean, Bob -- and generally, you're correct. But as we mentioned, the growth in assets is helping offset the spread compression, so keeping it relatively flat. Yes, in regards to the S&P, fee income is up, but as we stay at these levels, I think you'll see the fee income have more of an impact in the third and fourth quarter, if we didn't have any pullback there. But generally, it's in line with our expectations and we wouldn't expect any material jump in life or annuity earnings.

Well, you obviously know more about what's going than I do with your company, but I'll take the over on your guidance. Let's see, on auto underwriting, how excited should we be about? We turned the corner, or is this just a volatile positive quarter and we need more data?

Bob, this is Tom Wilkinson. I would say a little bit of both in what you just said. We had a good quarter. We're feeling pretty good about the quarter. But as you mentioned and as Dwayne mentioned, with our size and our seasonality, we do have volatility from quarter-to-quarter, and when you look at the last 2 quarters put together and year-to-date, we got the auto underwriting combined ratio back down below 100%, 99%, 1 point better than last year. It's in our range. We feel pretty good about the loss trends. We still feel pretty positive about our rate targets in the mid-single digit area. We've done that now for 18 months now, and retention is still looking pretty good, production is still looking pretty good. So we're feeling good. We feel like we got momentum on our side, we're just kind of a -- the seasonality and the volatility is still a little bit of an issue for us.

Okay, my last question is for Marita. I know you're going to -- it's way too early to give a lot of strategy and operation observations, but what surprised you as you've gone out to visit the field and get to know Horace Mann, either positively or negatively, versus what your expectations was coming in to join the company?

Bob, thanks for the question. You're right. It really has been a little over 2 months, so it's way too early to get specific. But I have spent a fair amount of time getting to know Horace Mann in general, and really understanding the unique customer niche that we have. And what I've learned so far is really what I thought coming in. We have a very attractive customer base, and our unique value proposition, being able to provide P&C, annuity and life together, really tailored to the needs of educators is a pretty compelling value proposition to that customer base. I have also spent a fair amount of time with the agency plant across the country, and what's really obvious to me is that our top agents are very impressive. They've got penetration numbers and cross-sell numbers that really far exceed the industry benchmarks that are out there. And I clearly think we'll be able to leverage this success and be able to replicate it going forward. And finally, what I'd say is that Pete and his team have done a really good job building a solid foundation that I clearly think we can build on going forward. So I wouldn't say any surprises. I'd say more of a confirmation of why I took the job in the first place.

[Operator Instructions] Your next question comes from the line of Vincent DeAugustino from KBW. Vincent M. DeAugustino - Keefe, Bruyette, & Woods, Inc., Research Division: I guess the first one up is a bit of a competitive landscape one. So over the last few years, we've seen competitors try to emulate progressive, and kind of what I'm referring to here is increased reliance on technology, maybe just a little less client touch and a more scalable platform with -- leading on price. And so with Travelers' auto comments earlier this week, that kind of echoed that trend. And I guess, the first question is, is with mid-single digit auto rate increase planned for auto in '13, how should we think about retention in an environment where we're potentially going to see increased rate competition? Just because so far it's not just been Travelers that have kind of made those comments about direction of where their rates will be heading. But if we see more of that, just with more players getting competitive on auto, how do you feel about your rate strategy in terms of impact on retention and top line growth?

Vincent, this is Tom again. My thoughts on that are this is a -- even absent the Travelers' commentary, this is and has been a pretty competitive auto insurance market for the last couple of years. And during that period of time, there have been companies who have been more aggressive on rates and trying to get more competitive and try to gain share, and then there's been competitors who have strengthened profitability. And as we've talked about, we're trying to do both. We're trying to get our combined ratios in the range that we want them and grow at the same period of time. So, with that backdrop, and I kind of mentioned it already, we've been fairly successful in this very competitive market, getting new business growth and maintaining -- improving our retention and also maintaining it. And a lot of that, I think, has to do with our agency force and our customer base, our niche market, as well as our agency force and the fact that we have agents. It is high -- our model is more high-touch. The majority of our customers, over 80% of them, are cross-sold in the P&C line of business, which is good for the profitability of the customer, the company and also for the stickiness of the customer with us. Our business is very highly cross-sold between the financial services piece and the P&C side, probably twice the industry average, maybe almost twice the industry average. There's a pretty -- again, a sticky book, a pretty good customer. They're in touch with our agents. And they're the ones that are really helping us keep the customers, while growing, while we're taking these mid-single digit rates. I kind of think that's going to continue. It's still to be seen, whether -- you mentioned Travelers, how they enact their strategy. I guess, it sounds like they want to get more aggressive with rates, and we'll see how that plays out. But generally, we generally don't compete with them too much head-to-head. So I think, it's still -- I think the outlook is still favorable. We've got some pretty good momentum. We've got -- it's still hard work to keep it going, but that's our plan over the next -- this year and going forward. Vincent M. DeAugustino - Keefe, Bruyette, & Woods, Inc., Research Division: Okay, great. And just to lob one over to Marita and say welcome as well. As somebody that has embarked on margin improvement strategies and have been part of segmentation improvement initiatives, I'm just curious of your initial assessment. And maybe it's a little too early to tell, but just again, your assessment of Horace Mann's P&C pricing position from a rating and analytic standpoint? Just so, maybe from your experience at Hanover, maybe how the 2 -- and obviously, more of a focus on discussing Horace Mann, but just from a comparative standpoint, how do you feel about the need for any sort of upgrades from a technology or analytic standpoint from the Horace Mann side?

First, thanks for the welcome. It's good to hear your voice, and it's good to be here. I think Tom and his team have made a lot of progress. But I hope that I can bring my experience in this space to bear and help continue that improvement. I do think it's about balance. I do think that in the areas that you mention, there are some things that we can do to boost and continue that improvement, but I think we're off to a really good start. Vincent M. DeAugustino - Keefe, Bruyette, & Woods, Inc., Research Division: Okay, perfect. And just jumping to Matt real quick. And this is a little bit of a technical question, but the net transfers going the variable product and the fixed annuity product have slowed a little. And given the dynamic with the annuity deposit growth on variable side rebounding, I'm just curious of your thoughts on the potential for net transfers to pivot as well. And so far, this has been a relatively small drop in the bucket as flows go, but the reason I ask is if I'm recalling correctly, maybe about 1/3 of the assets under the variable wrap are allocated to the fixed account. So if I'm just looking at that nugget and wondering how likely it is that we see a rotation, I'd just be curious what the margin differences between $1 AUM invested in the VA product but that's sitting in the fixed account, versus $1 of AUM in the VA product that is in some underlying fund option.

The -- we have seen a bit of a change in the way the flows are going into the separate account back in 2011, and about 25% of our flows were going into the separate account. Today, about 35% on a year-to-date basis is going into the separate account. So we have seen a little bit of a shift. And that's a good thing for us. There's about a 200 basis points, between 100 and 200 basis point spread differential in terms of our ROEs for assets that are in the separate account versus assets that are in the fixed account. So that's a good thing, and we have seen the flows from the separate account into the fixed account as well, as you noted in the annuity roll-forward. So all of that's good news for us, and we hope that trend continues. Although, I might point out that historically, we haven't been -- we haven't had a large allocation towards the variable account or the separate account, because of the nature of our customer base. Vincent M. DeAugustino - Keefe, Bruyette, & Woods, Inc., Research Division: Okay, and then just the follow-up on Bob's question. Just with the concept of rising rates. As far as new product sales on the fixed side, has there been any change or would you expect there to be any change in -- a rise to the guaranteed minimum crediting rate for new sales?

Currently -- that's a great question, Vincent. Currently, on our best-selling product, the annual guarantee in rate now is 1.1%. So we're almost at the bottom. The ultimate guarantee's being between 1% and 1.5%, depending on which product line they're in. With the rate move, we expect to see an increase in our base rate for new sales going forward starting in August, and that just reflects our current purchase rates. But at that increase, we're still able to maintain the pricing spreads and have been maintaining our pricing spreads all the way through.

There are no further questions at this time. I will turn the call back over to the presenters.

Thank you. Thanks for joining us this morning on Horace Mann's Second Quarter Earnings Call. If there are any further questions, please don't hesitate to reach out to me. Thanks, and have a good morning.

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