Horace Mann Educators Corporation (HMN) Q4 2017 Earnings Report, Transcript and Summary

Greetings, and welcome to the Horace Mann Fourth Quarter and Full Year 2017 Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation [Operator Instructions]. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Mr. Ryan Greenier, Vice President of Investor Relations. Thank you sir, you may begin.

Thank you, Kristine, and good morning everyone. Welcome to Horace Mann's discussion of our fourth quarter and full year 2017 results. Yesterday, we issued our earnings release and inventor financial supplement and copies are available on our Inventor’s page of our Web site. Our speakers today are Marita Zuraitis, President and Chief Executive Officer and Bret Conklin, Executive Vice President and Chief Financial Officer. Bill Caldwell, Executive Vice President of Property and Casualty; Bret Benham, Executive Vice President, Life and Retirement; and Matt Sharp, Executive Vice President of Strategy and Business Development are also available for the question-and-answer session that follows our prepared comments. Before turning it over to Marita, 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 inventors that any forward-looking statements include risks and uncertainties and are not 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 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 measures. Reconciliations of these measures to the most comparable GAAP measure are available in the supplemental sections of our press release. And now, I'll turn the call over to Marita Zuraitis.

Thanks Ryan. Good morning everyone and welcome to our call. Yesterday evening, we reported fourth quarter core earnings of $0.65 and full year 2017 earnings of $1.74 per diluted share, excluding the favorable impact of tax reform. These results underscore our positive momentum as we move into 2018. I am very pleased with our results, particularly in a year largely defined by record level catastrophe losses and industry disruption in the retirement space. For a second consecutive quarter, our auto loss ratio improved significantly over prior year. In the fourth quarter, the auto loss ratio of 77.5 was more than 5 points better than the prior year. This is the result of rate actions combined with weather that was somewhat more favorable compared to our typical fourth quarter experience. Due to this strong result, we were able to achieve 1 point year-over-year improvement in our underlying auto combined ratio and we expect continued improvement in 2018. And while many in the industry experienced another quarter of significant catastrophe impacts, our cat losses of 2.2 points were relatively small. For example, the California wildfire losses in the fourth quarter were about $1 million, significantly lower than our market share would indicate. This strong result was due to our stringent wildfire underwriting protocol that utilizes multiple risk assessment tools. 2016 and 2017 were two of the heaviest catastrophe years in recent history for the PNC industry with multiple firms estimating more than $100 billion in losses in 2017 alone. And for both of these two years, our property results were solidly profitable. We did have higher catastrophe costs than our historic averages but our conservative underwriting standards, use of partner carriers for risks that exceed our underwriting appetite and a continued focus on profitability, resulted in a full year property reported combined ratio of 97. The Retirement and Life segments continue to provide steady consistent returns. In retirement, we finished the year in line with prior year in impressive fee given the amount of disruption in the industry. We rolled out our new department of labor compliant product suite and an open architectural mutual fund platform. We built the tools to provide a solution based sales process that is consistent across the agency for us. And we trained our agents to deliver a customized holistic plan to help customers achieve their financial goals. Unlike many competitors, we took a consistent approach across all types of retirement savings accounts, a strategy that we believe is in the best interest of our customers and provides a clear competitive advantage as the industry continues to evolve. Life earnings continue to consistent year-over-year. We saw an increase in mortality cost in the fourth quarter. However, the full year finished in line with historical trends. We continue to grow our Life business at a double digit sales rate. Over the last four years, we've made significant investments to modernize our Company's products, distribution and infrastructure. As we head into 2018, I am confident that we have laid the necessary foundation to fully leverage our strategic position to realize profitable growth. We have a robust relative product suite that meets the needs of our educator customers. We are also in the process of key infrastructure improvements to support greater volumes of business and provide an enhanced customer experience. And we have made good progress on improving distribution to develop multi-channel options that allow educators to interact with us the way they choose. The strategic decisions we have made to improve profitability and ROE are beginning to share results. More than two years ago, we saw an increase in auto loss trends and acted accordingly with rate increases and profitability improvement initiatives. As the trends continue to emerge, it was clear we didn't take enough rate, and we responded more aggressively with additional rate actions and tighter underwriting standards, particularly in geographies that saw the most pressure and this approach is working. Since the midpoint of 2017, our auto loss ratio has improved by 2.2 points with the corresponding 60 basis point increase in ROE. We believe we are now solidly ahead of loss cost trends, and expect another 2 to 2.5 points of underlying auto loss ratio improvement in 2018. The passage of the U.S. tax reform and jobs act of 2017 is another tailwind. As a result of the re-measurement of our deferred tax liability, our net income for 2017 increased by $99 million, roughly equal to one year of core earnings. The onetime benefit resulted in corresponding increase of $2.43 in our book value, which ended the year at $30.73 per diluted share. We will also see lower ongoing tax expense going forward. This gives us additional flexibility as we continue to invest in our business with a goal of accelerating profitable growth. Reinvesting in our business is not new for us. We’ve been deploying earnings to improve our product distribution and infrastructure over the past four years. We work to improve business efficiencies through systems modernizations, created new platforms for fee revenue and have grown and optimized our product set. These efforts have created a solid foundation that we can now build upon. As we look to leverage these achievements, it was the right time to dedicate a small team to focus on opportunities that could accelerate profitable growth while also deepening our reach into the educator market. Matt Sharpe work closely with me on many of our successful strategic initiatives, such as modernizing our Life operations and creating a differentiated approach to retirement that leverages our multiline business model. I am confident that by dedicating more focus to business development efforts, we will be able to more efficiently identify and act upon opportunities to accelerate profitable growth. We have focused on three areas; increasing scale by finding hunks and chunks of educator business, further diversifying our product portfolio to increase share of customer wallet and optimizing our position by prioritizing growth of more capital efficient offerings, like our fee based retirement products. In order to do that, we need to define the seasoned executive who could seamlessly takeover the execution of our Life and Retirement strategy. Bret Benham has decades of experience driving strong results in the exact areas that we see our biggest opportunities. As Senior Vice President of Retirement at Meredith, he was instrumental in building out an institutional channel and as President and CEO of TIAA-CREF Life Insurance Company, he drove profitable growth and operational efficiencies in their Life business. We’re happy to have him and officially welcome him on board. Before turning the call over to Bret Conklin, I want to highlight an additional initiative that we’re focused on for 2018, corporate social responsibility. As the mission centric company, we’ve always aim to have a positive impact on our communities, but we have never quantified the sum of those efforts until now. We plan to publish our first corporate social responsibility report, which is aligned to GRI reporting standards. This will be released on our Web site later this week. And I am really proud of the many positive impacts we have had on our community, and I look forward to sharing more success in the future. In closing, I am optimistic about what's to come in 2018. We have spent the last few years modernizing our products, strengthening our distribution, and improving our infrastructure. We are clearly on track to ROE improvement and sustained earnings growth. We have a solid foundation, the right strategy, the right people, and positive momentum. As we strengthen our focus on execution and take advantage of what we’ve built, I am excited to see what we can accomplish with all of the pieces in place. And with that, I'll turn the call over to Bret.

Thanks, Marita and good morning everyone. Fourth quarter core earnings of $0.65 were $0.13 below prior year, mostly attributable to 5 point improvement in underlying auto loss ratio. Full year results of $1.74 were $0.23 below prior year, primarily due to a high level of adverse non-cat weather in the first half of the year. When looking at full year results, it’s really a tail of two halves. While our first half was heavily impacted by weather, the underlying auto improvement in the second half help drive strong earnings growth. A $1.34 of our full year earnings came in the second half of the year. We except the positive trends we saw in the second half of the year to continue in 2018. Since we introduced our initiative to drive ROE improvement in the third quarter, we’ve improved ROE by 60 basis points. We aim to further increase ROE in 2018 by improving our auto loss ratio another 2 to 2.5 points. In addition, continued focus on expense discipline and growing our fee-based retirement product will also result in higher ROEs over time. For 2018, we are forecasting core earnings between $2.10 and $2.30 per diluted share. This reflects continued improvement in the P&C line led by auto, Retirement and Life results that are largely in line with 2017, and continued investments in strategic initiatives that will drive future profitable growth. In PNC, we are forecasting net written premium to increase by 4% to 6%, largely attributable to rate increases. From a profitability perspective, we are seeing continued stabilization in loss trends in the mid-single digit range. Our 2018 rate plan assumes high-single digit auto rate increases and mid-single digit increases in property. These rate actions coupled with those implemented in 2017, should lead to 2 to 2.5 point improvement in the auto underlying loss ratio and a 1 to 1.5 point improvement in the property underlying loss ratio. These targets assume more normalized weather compared to the previous two years as does our cat load assumption of 6 to 7 points. From a growth perspective, we anticipate that we'll be generally flat in 2018. Despite the rate actions we’ve taken to improve in profitability, we're pleased that our retention levels and overall market share is stable. We are seeing new business growth emerged in geographies that need PNC profitability targets. And as we continue to take steps to address other less profitable market, we would expect our new business growth rate to accelerate overtime. Although, we plan to see continued growth in our retirement assets under management, we expect segment earnings to be largely in line with 2017. This is primarily due to lower net investment income, which leads to spread pressure on our fixed annuity block of business. Our investment returns have benefitted from strong prepayment activity over the past few years, including a meaningful spike this December as borrowers look to maximize their tax benefits relative to the tax reform changes. As a result, we expect a measurable drop in prepayment activity compared to the $40 million we received in 2017. We are forecasting $6 million less of prepayment activity in 2018, which equates to the roughly $0.10 impact per diluted share. In addition to prepayments, alternative returns have also been a solid contributor to the investment portfolio performance. We have about $275 million of limited partnership and alternative investments, and our investments in this asset class have historically produced about 5.5% annual return. This return may seems somewhat lower than what other companies earned on their alternative portfolio, but it is reflective of the type of relatively conservative risk profile of our alternative investments. We focus on funds and investment types that provide good asset diversification, such as real estate debt, corporate mezzanine debt, structure credit, private equity, infrastructure and long historic funds. While returns can be volatile quarter-to-quarter on an annual basis, 2017 returns are similar to what we would expect in 2018. In our fixed maturity portfolio, we are taking steps to improve the credit quality of our portfolio as we are late in the credit cycle. We have been actively reducing high yield exposure, as well as underweighting retail and consumer discretionary sectors. Spreads continue to tighten across many asset classes and for some higher risk assets, we do not feel spreads or to measure it with the risk assumed. The combination of tighter spreads and our desire to move the portfolio up in credit quality will likely result in a lower reinvestment rate versus what we achieved in 2017. As a result, we are targeting a new money rate of 3.5% in the coming year. Clearly, these factors create some negative drain on our portfolio yield and equates to an additional $0.10 per diluted share. However, in the long run, we believe this will serve us well in the event of a correction consistent with many of our previous portfolio decisions. In summary, the combination of tighter spreads and the lower reinvestment rate, as well as the expectation of lower prepayment and our actions to improve the overall quality of the portfolio will result in a 20 to 30 basis point decline in the annualized earned pretax net investment yield over the course of 2018. For the fixed annuity business specifically, we would expect the net interest spread to decline to around 170. In Life, we expect earnings of $16 million to $18 million, which is largely flat to 2017 due to a modest increase in mortality cost. We continue to see the Life segment as an area of significant opportunity and plan to continue to grow the business in the double digit. The tax reform changes clearly had favorable impacts going forward. We estimate our total effective tax rate for 2018 will be between 15% to 18%, which has an ongoing earnings benefit of about $0.25 per diluted share. As Marita said earlier, we continue to budget for strategic initiatives and investments that are accretive to sustain profitable growth. Overall, we see 2018 as the year of strong earnings growth, continued ROE improvement and new opportunities to profitably grow our company. We’re in a strong position to do so because we have aligned our strategic decisions with our company’s mission in mind, to take care of educators. By providing them with the products they need delivered in the way they choose with trusted advisors who have the best interest in mind, we can achieve our vision to be the company of choice for the educator community. Thanks. And now I'll turn it over to Ryan to start the Q&A.

Thanks, Bret. Kristine, please open up the line to begin the Q&A portion of the call.

Thank you. We will now be conducting a question-and-answer session [Operator Instructions]. Our first question comes from the line of Bob Glasspiegel with Janney. Please proceed with your question.

I was wondering if you could clarify your flat Life and annuity outlook that’s after tax, so that would be a decent decline on the pretax basis given the tax rate coming down in those two segments?

That would be correct, Bob, all driven by the decline in net investment income, but the numbers that we provided were after tax, correct.

Do you have Life and/or annuity tax rate, because PC -- what your profitability associated there…

Yes, we actually included a new page in the Investor Presentation. I believe it’s on page 38 where you can pick up the various ranges by segment, but for Life, which would traditionally be about 35% effective rate. You could probably use a range of 18% to 21%. And as it relates to the retirement segment what would normally be a 30% effective rate pretax reform that will be in the 17% to 20% range.

So you didn’t talk about Life pretax earnings going down. Is it the same investment income assumption or did you like building a cushion for Q1 mortality for the flu, et cetera?

No, it's strictly the lion shares related to the decline in net investment income.

And, no early read on January mortality?

No, no early read.

Okay….

But not being anything significantly out of line with model trends.

Are you seeing any pushback on rates from any regulators on the tax reform, California Commission has made some public comments. But what's your general read on your ability to get your -- at least at high-single digit rate of your target?

Our target rate plan for 2018 is high-single digits. We're already halfway there from a filing perspective half of our rate is already been filed and approved. And we're following the communications from the various deal-wise and the consumer advocates, but the reality is the industry is still at the highly unprofitable situation right now. So I expect that will be in overtime but we still have ways to go as an industry to get profitable. So we haven't seen any pressure yet.

And California, just specifically where I think the cushion has been most visible here over 100 there, or…

I said it last year in this we don't have the numbers for the industry for this year yet, but last year California was 109 for the industry. We're typically better than the industry by 3 to 5 points, and that's during California's loss over still above 100. But we just had a rate filing approved that's effective in March for 6.8%. So our rates are already in the bag for 2018 for California.

The rate approved was what amount?

6.8%.

6.8%, I thought I heard 28%. 6.8%, I could process that. Thank you very much.

And Bob, even though there has been some discussion as to whether or not the department could go back on prior approved rate increases even if we factored in the new effect of tax, we could actuarially justify the rate increase that we filed. And that's what typically will happen. Companies will begin to put a new tax rate in their filings. So what comes out of the machine will be lower than what it was before that tax rate, but even in California, we can justify what we filed and what we got approved.

And you got approved when, what was the date in California?

Mid-March, March 15th or 16th…

But I mean when did they give you the approval?

Early January.

[Operator Instructions] Our next question comes from the line of Christopher Campbell with KBW. Please proceed with your questions.

Just a few questions on the '18 guidance. My first one was on the P&C expense ratio. I know last night's release and then the earnings script didn't include an explicit assumption here. And if I go back to last couple of years with the investments that you're making in the business, it's been about 27.5%. Is that still a good overall expense ratio assumption, or should we be thinking about this any differently?

With respect to expense ratio, I think I even mentioned on the third quarter earnings call that on a go forward basis, you probably need to bring that down to 27% instead of the 27.5% on a go-forward basis. And we're still doing the balance between strategic and non-strategic initiatives. But we ended both this year and last year around 27%, so I would lower that by 0.5% on a go forward basis.

We included a separate slide, a new slide, on page 17 of our Investor Presentation that summarizes all of the guidance points that were made in either the press release or the commentary. We thought it would just be easier for everybody to get it all at one place.

And then finally, I know the guidance excludes any potential reserve releases. But if I’m thinking about the amount of rate that Horace Mann is putting through its auto book and did last year, coupled with if you’re assuming more moderate more soft inflation with frequency concerns aside. That you would have a potential that you could be building up some auto redundancies that that probability is increased a little bit. And then just even going back to Horace Mann’s history, our model is back 08’, so I can speak to then, consistent positive or consistent favorable releases in the book. So how should we think about any potential upside to guidance? And what's your cadence in terms of just reserve reviews on that line or the PNC book in total?

This is Bret Conklin again. I guess with respect to the reserved position itself, there is actually a schedule in the Inventor Presentation and with respect to where we are at in the independent actuarial reserve range were basically consistent in the upper half of their range, so we really haven’t moved out of our reserve position. I would say fair commentary that you made, the last two years have seen minimal reserve releases, I believe 16’ was about $7.5 million, the current year had about $2.7 million. Obviously, in our guidance estimate, it does not include any reserve releases. And obviously as that book of business on the auto gets more healthy, the likelihood that there would be perhaps some modest reserve, I think that’s a fair comment. But as is always the case, we will book it when we see it, but those loss ratios have been in excess of 100. We are getting the rate that you said and we’ll see what the loss cost due compare to the trends and like I said, we’ll book it if we see it.

I mean I think I would also add that the underlying issues that cause the industry miss in the first place haven’t gone away, increased miles driven the cost to repair, the effects of distracted driving. I mean we’ve all worked pretty hard as an industry to get the price to keep up with those lost trends, but those lost trends really haven’t gone away. And then the question is what else is out there. I mean we haven’t, as an industry, fully contemplated the effect of the legalization and decriminalization of Marijuana, how is that going to affect lost cost trends going forward. I mean, I feel really good about our improvement last year, getting a full point. I feel good about our guidance of another 2 to 2.5 points, but we’re going to stay ahead of this and not declare victory and make sure we stay ahead of these trends.

And then just dovetailing on that response Marita is that, I know there has been -- last couple of days, there has been market concerns about inflation potentially increasing. Can you give us some color on any inflationary trends you could be seeing in any of your auto or property claims cost and how would you be thinking about your current rate plan in the event inflation starts to accelerate in ’18?

Our loss trends for auto we're thinking mid-single digits. That's where the claims costs are going as there is an additional increase due to inflation, that will get baked into our models and will take more rate but we haven’t seen that. And again it's hard to proactively convince the regulator that inflation is coming and take rates in advance of that. But as we see it, we'll react just like frequency and clarity.

And I also wonder whether this is another place where our educator niche is helpful. I mean, our educators may see less of an inflationary trend on either auto or property. I mean, it tends to be a pretty tight segment of the population as far as the cars they drive and the types of homes they live in.

[Operator Instructions] Thank you. Our next question comes from the line of Gary Ransom with Dowling. Please proceed with your question.

On the spreads and retirement, you did mention how there was a spike in prepayments in the fourth quarter. But there has also been a general heightened level of that over the last several years of low interest rates. Have you incorporated the idea that interest rates will be moving higher into your 2018 guidance or that $6 million you mentioned, I am just trying to understand what's in that number?

I think in my prepared remarks, I shared that the actual prepayments that we've received in '17 were $14 million. That comes on $16 million of $11 million. The spike related to, and I'll just say for the fourth quarter, I think we received about $5.5 million of prepayment. So prepayments are lumpy, very hard to predict. Yes, they’ve continued for the last couple of years. But in light of the lumpiness, I would say we're trying to use average in our guidance and not assume too much. The reality is that we ended the year at 194 versus original plan, which we shared with you at the beginning, of '17 of 182. And that difference was primarily related to prepayments, as well as all investment returns. So, on a forward basis we've dropped that down to $8 million in our plan for '18. If it ends up more than that, yes, that's going to benefit our spread. But with rates going up, the spreads have been tightening. So we’re not really anticipating that lift. But yes, we are using a reduced amount of prepayments in '18.

On another subject, on tax reform, the long term implications of this. I'm really just asking for an opinion perhaps. But there is a lot of discussion about who gets it, whether it's the consumer overtime or whether the shareholders get the EBIT or maybe it’s the employee. And I wondered, Marita, if you had a view on what you think the final stickiness of that tax reform to shareholders might be?

I think you mentioned the buckets. I mean first when you think about employees, there obviously have been companies out there talking about returning some of this to employees in the way of bonus. And I would suspect that the majority of those companies don’t have an all employee bonus program where the employees could get to share in the results of the company, we do. I am proud of the fact that our employees have the ability to earn a bonus based on the results of the company, and it keeps all of our employees aligned with our goals and let them share in our success. So for us, we don’t need to announce a one-time employee bonus, because we have an ongoing all-the-time annual employee bonus. When I think about the other pieces, I do think over time, this helps the consumer as we talked about it gets dealt into our rate review process. It certainly begins to over time find its way to the consumer. But for us, I think it is a benefit to our shareholders where now we have more capital that we can put towards the growth efforts that we have been talking about for a while. It’s a very good time for us because we have built the product. We have modernized our systems and we have built better tools for our distributors to serve our customers better. So being able to deploy that capital and working with Matt in the work that we’re doing, I believe that we can take a good work that we’ve done in the individual customer-by-customer game and do it more in hunks and chunks and put that capital to use, which I think ultimately does help the shareholder in the way of improving our stock price and the overall value of the company.

Just following-on on tax implications. Have you thought about how you might restructure any of your portfolios either on the Life or the PC side, but maybe this is more for the PC side with the new tax law there, the switch and attractiveness of corporate versus munies?

I mean, we’re obviously looking at that. There is actually I think some tendency even on the Life side to look at tax exempts, but we’ll become more favorable under the tax law changes. But I guess at the end of the day, we will look for the best after tax yields on the portfolio. So it’s ongoing process in the investment portfolio to get the highest yields possible to benefit all of the segments. So yes, we look at that all the time.

Is there any -- would you be inclined to do any significant swapping over the course of the next few quarters or this is more of just a shift in strategy that you might use on new money coming in?

I would say it’s more maybe of a modest shift, but nothing in the next quarter or two of significance.

Our next question comes from the line of Sam Hofmann with Lincoln Square Capital. Please proceed with your questions.

I just had a question on the California insurance situation and what the impact you think will be on Horace Mann, the intention to pass on some of the tax savings to consumers?

I don’t know how that defers from the previous question. But California in 2016 around 109, I don’t have the 2017 numbers yet that’s an industry number so still unprofitable when you think about annual mileage new vehicles distracted driving, California has been at center of that. We tend to run 3 to 5 points better than industry and that's true in California too, the risk still above 100. So we're not to the point where the tax reform would impact our ability to get rates. And in fact our 2018 rate filing of 6.8% was already approved in March. And again, we're starting from above 100 so the ability for California to roll that back would be unlikely at this point just because of our profit position.

And what we were talking about earlier is even if we included the new tax rate in that filing, we could actuarially justify the rate need that we filed and we've got approved. I think what comes into play is for companies that when they build in the new tax rate, they can't justify the rate increase that they're looking for if they're particularly profitable in the state. I think the state is going to look closely at those rate filings. But because of where we sit in the state, even including the new tax rate in the filing, we certainly can justify the rate that we filed and have already gotten approved.

Do you have any visibility on other states that might follow similar policies?

I haven’t seen anybody release something official like California. But there are barriers that have profits and provisions in their filing requirements that could be impacted like that. But it's too sense to tell, I haven't heard anything outside of California.

And I would say that those states that are prior approval will require companies to include the new tax rate in their filing. And we'll look closely to make sure that folks aren't adding that to the profit margin and keeping the profit margin component consistent, but I think that's appropriate. And to an earlier question, that's where we'll see some of this tax benefit get to the consumer as that get passed us through in the rate filings. But as Bill said, when the industry is sitting where the industry is in auto, there is a long way to go before we can't justify the need for more rate in those filings.

So you don't see, on the competitive side also, you don't see any change in the competitive behavior of other insurers because it's not profitable enough based on tax reform, now that we’ve….

We do have a robust product management structure and we track what our competitors do. So we will see that as it unfolds. But so far I haven't seen that yet. And again, those companies are starting from an unprofitable position and we're ahead of the industry returning to -- before a lot of our competitors. So I don't expect that to be an issue…

Mr. Greeneir, it appears we have no further questions, at this time. I would now like to turn the floor back over to you for closing comments.

Thank you very much, Christine. And thanks to all for joining us this morning on the fourth quarter earnings call. If there are any further questions, don't hesitate to reach out to me. Thank you.

Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation and have a wonderful day.