Greetings and welcome to the Horace Mann Fourth Quarter 2018 Earnings Call. At this time, all participants are in a listen only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Heather Wietzel, Vice President of Investor Relations.

Thank you, Sherry, and good morning, everyone. Welcome to Horace Mann’s discussion of our fourth quarter and full year 2018 results. Yesterday, we issued our earnings release and investor supplement, copies are available on the Investors page of our website, along with our investor presentation, which was posted this morning. 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, Property and Casualty; Bret Benham, Executive Vice President, Life and Retirement; and Ryan Greenier, Vice President, Corporate Finance are also available for the question-and-answer session that follows our prepared remarks. Before turning it over to Marita, I wanted 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 guarantees 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 use some non-GAAP measures. Reconciliation of these measures to the most comparable GAAP measures are available in the supplemental section of our press release. With that, I'll turn the call over to Marita.

Thanks, Heather. Good morning, everyone and welcome to our call. Yesterday evening we reported a fourth quarter core loss of $0.21 per diluted share, reflecting the Camp Fire's unprecedented level of losses, the challenging investment environment and transaction-related expenses. Underlying performance was solid, as we continue to make progress on our strategic initiatives. The Camp Fire accounted for the majority of the quarter's losses, with gross losses of about $150 million as we previously disclosed. The total financial impact was $38 million pre-tax, or $0.72 per share after-tax. This was not a typical wildfire and it was an unprecedented event for Horace Mann. Situations like this is why we have our conservative reinsurance program, which provides coverage for $25 million in losses up to $175 million. In fact, the Camp Fire was the first claim we've had against that program, since the equally unprecedented Hurricane Katrina in 2005. Even though our losses from the fire were not disproportionate to our employed market share, we're looking carefully at what we can learn from this type of event in the context of the growing frequency of more severe weather events. We are continually evaluating our aggregation management, underwriting standards and reinsurance strategy, to ensure our property line achieves profitability targets in the long term. Remember, in 2016 and 2017, even with elevated catastrophe losses, we achieved combined ratios below 100. Before moving from the Camp Fire, I want to take a moment to thank our claims professionals, our agents and our contact center personnel for their quick and compassionate response in taking care of our customers. We take the responsibility to our policyholders very seriously, and these representatives help us deliver when it matters most, for making wellness checks on every policyholder in the affected area regardless of claim status to delivering…

Thanks, Marita, and good morning, everyone. Marita described our view of our financial performance for 2018 and the fourth quarter and I'll reiterate. The results we're reporting do not represent the earnings potential of our business, nor do they capture the progress we're making on our strategic initiatives to drive profitable growth and return Horace Mann to a double-digit ROE. So what happened, it's been discussed all year and should be no surprise. Cat losses were nearly two and half times higher than what our modeling anticipated or what our historic average would imply. You can measure the impact of those losses in different ways, but one would be to say that, cats cost us over three points in ROE. In the fourth quarter, the Camp Fire alone accounted for $0.72 per share of $0.85 from catastrophe events, clearly making it the single most significant factor to the quarter and year. We're not ignoring the risk associated with heightened severity and frequency of severe weather, but we also know that the Camp Fire was the first event to reach our reinsurance pretension since Hurricane Katrina in 2005. In other words, it was unusual. In addition, in the fourth quarter, expenses associated with the two transactions we announced during the period to help drive long-term value had an $0.08 impact on core earnings. Further, DAC unlocking due to the volatile equity markets in the later part of the year had a $0.07 impact. I'll note that we've already recouped about half of that so far in the first quarter. Based on the progress, we did see on the key drivers of ROE going forward, underlying auto loss ratio improvement, fee income growth and continued expense discipline, we do expect 2019 to better reflect our earnings potential. ROE should be in the…

Thank you. Sherry, if you could queue for questions?

Yes. [Operator Instructions] Our first question is from Christopher Campbell with KBW. Please proceed with your question.

Yes. Hi. Good morning.

Good morning. Hey, Chris.

I guess my first question is just kind of on the guidance. So if I'm looking at the overall original 2018 target on slide 16 of the deck, you guys have 7.6%. Now the core ROE expectation is 700 bps to 750 bps, which sounds like there's some net investment income issues. But it seems like you guys are still on track on the P&C core loss ratio improvement, which I know was like the overall target was about 500 bps to get you guys to double-digits. So I guess, just how should we think about, like when would we expect in terms of timing to get to double-digits at this point, excluding the extra 100 bps that you guys are expecting pre-synergy from NTA?

Yes. Chris, this is Bret. Let me just begin by saying that our opinion on our financial strategy and the value of our company hasn't changed one bit since what we've been talking about since we begun this ROE journey. We feel we have a very compelling value proposition and are very confident in its trajectory. And I think as we've said before that the return to a double-digit ROE it's a multi-journey. And obviously, in 2018, we were impacted by the outsized cats if you will compared to our historical averages. So when you look at that guidance that we're coming out with this year, yes, in fact that is below the guidance that we came out a year ago, mainly because of two items. I mean, we have factored in $10 million more in catastrophe losses bringing back cat load up to 7% to 7.5%, which is an increase from what we've estimated in prior years. And then also as we've talked about the lower net investment income of about $5 million to $6 million in total for the organization. So it's really those two items there that gets you to that drop in the guidance coming out this year versus what we did a year ago. And if you recall last year too, I believe we came out with guidance that was below where the Street has and it was all related to net investment income. I would also say that we tend to be conservative or cautious with our net investment income projections, and we did get back to basically flat net investment income for 2018. As you recall, when we went into 2018, we were basically projecting a decline of $10 million. But as we've disclosed and discussed with you throughout the year, we did benefit from increased prepayments. And as I said in my earlier remarks, we had over $16 million in prepayments, double what we actually anticipated, but we're taking that back down to $6 million. So if we get higher prepayments than what's in the plan, if we get a new money rate that exceeds the 4.5 that's baked into our new money rate curve, then perhaps we'll exceed the expectations. But I think we're somewhat cautious on the net investment income front, in light of the markets. And obviously, we are being impacted by the quality of our portfolio as well, making it up in quality.

I think that's right, Bret. And to put a finer point on it, when I think about the three levers we identified to drive ROE improvement. First, restoring auto profitability in the book and the fact that we're ahead of our initial plans on that and have already gotten the one that we talked about last year, the 2.5. We actually exceeded that with 2.6, more built into 2019. I feel very confident in us being even ahead of ourselves on that auto loss ratio improvement. When I think about fee income, really strong fee income growth from the Horace Mann general agency, but a 33% increase in retirement fee produces is a nice start to that lever that we identified and expenses holding relatively flat outside of the acquisition expenses. So when I look at those levers, I feel good about what we identified to improve ROE. And then I think about new levers that we didn't have when we talked about getting back to a double-digit ROE. With a full-point improvement with NTA right out of the block, before you even started thinking about cross-sell opportunities and cross synergies, and then the benefit that BCG brings to us in that employer space. We even have, I think more, levers that we didn't have when we identified our track to get back to a double-digit today than we had when we identified those levers.

Got it. And then you guys haven't quantified any expected ROE impact from BCG yet, correct?

Correct. The only thing that we've stated publicly is probably for a couple of years to be a non-contributor of any significance in the first couple of years.

Okay. Got it. And then just, I guess...

And the one thing Bret didn't mention was cats. And the only thing to know about cats is, your guess is going to be wrong, right? But we do know that the elevated cats we saw in 2016 and 2017 and to reiterate, with those elevated cats we still ended the year at a better than 100 combined in property in both of those years. Obviously, with the Camp Fire this year, unprecedented, we didn't. But feel good about the underlying performance of our property book, even when we have elevated cats. But when you take 2016, 2017 and now 2018 and update those more recent years, it's prudent to put more cats in the plan. But it's just a plan and it will be what it is. All we know that whatever number we pick, it's going to be wrong.

Got it. And then just kind of following on. That's a good point Marita. If I'm looking at just the core combined ratio ex cat and then prior year's development, like, going back in time to like 2008. It seems like you guys are pretty much like averaging about a 93%, but the cat loss ratio usually adds about, like, just on average, including the most recent year, that adds about 10%. So I guess I'm thinking, right, you guys are good in terms of a core combined ratio. But I guess the first question is, is the 700 to 750 bps far enough given your 10-year average is 10%? And then also, could this be an opportunity to buy more reinsurance to help better control this catastrophe cost so that, like, it's less of a drag on your overall combined ratio?

Yes. So, Chris, this is Bret, again. So the 7% to 7.5% and I'm going to maybe dovetail on Marita's prior comments, the last two years prior to 2018 our average cats were about $60 million prior and those were in the kind of a 9% to 10% cat load. But the prior five years averaged about $40 million. So here again, you're using the 10-year average, we're using more recent vintage. And here again, not assuming that there's going to be $100 million plus of cats next year here again, we took our cat estimate up. But we feel comfortable with the 7% to 7.5% because prior to that we were basically assuming more around the 6-ish range in the recent history probably in the last five years. So here again, it's a balancing act based on probably the more recent events. And Bill, I think can make a comment...

Yes, just a little bit more color on Property, we typically talk about Property as a low-90s combined target. We'll move that to high-80s given the elevated catastrophe. Obviously, we believe that our catastrophe costs are increasing we have to have better underlying performance. So we'll have more rate activity. We've implemented replacement cost calculation updates on our entire book which equates to another 1, 1.5 points of rate. So you'll see us react in that method as well. On the reinsurance side, we're always looking at it. As Bret said, this was our first reinsurance claim since 2005. It's harder to change our reinsurance program after we have the claim obviously, if we would have known this was happening it would be a great time to buy an aggregate. But to look back now to buy an aggregate cover the cost of that has gone up and it tends to be a cash drop at a certain point. But that said, we have a very diligent reinsurance program. We go to London and Bermuda every year and we're totally always evaluating what's in the marketplace. And when we see opportunities we tend to take them. We've improved it incrementally over time. But there's nothing available at a reasonable cost that would significantly improve our reinsurance position at this time.

Okay. Got it. That's very helpful. And then just one final one I think maybe this is for Bret. I guess, if you're targeting the $15 million to $20 million net income from NTA which I put it like maybe $0.36 to $0.48 run rate EPS in that first 12 months. I guess is there going to be -- because you guys are buying it at probably a significant premium to book. I forgot the actual, but it was like upper Qs in terms of the multiple. I guess, are there any initial thoughts on intangibles amortization? And whether you guys are going to treat those as operating or non-operating?

I think it's a little bit premature to have a discussion on the intangibles. But we're going to be – obviously, when we close the deal, we'll have that all hashed out and it would be reflect in our pro formas. But I'll save that for a future conversation.

Okay. Well, thanks to all the answers. Best of luck in 2019.

Thanks, Chris.

Thanks, Chris.

[Operator Instructions] Our next question is from Matt Carletti with JMP Securities. Please proceed with your question.

Yeah. Thanks, good morning.

Good morning.

Good morning.

Just few questions. Maybe just following on some of the P&C questions Chris had. Can you give us a little bit of color on the three or so points of expected improvement in the Property underlying loss ratio? Is that a function of pricing? Is that a function of -- some expectation of higher non-cat weather kind of normalizing? Is it a function of something else?

Good question. So, I'll unpack that for you because there are multiple pieces there. Some of that is simply the – I guess the reinstatement or reinstatement premium. So that naturally causes about one point of underlying improvement. There is one point of LAE that as we move-off of our guidewire transition that moves into the administration system. So remember underlying includes LAE systems cost. And then one point of natural underlying improvement, I'll call it given the rate and replacement cost actions that we're taking on the entire book.

Got you. Okay. That's very helpful. I guess, while we're on P&C maybe, can you talk a little bit about just – I mean, in the Camp Fire in particular but the past couple of wildfire seasons have been pretty unprecedented. What are some of the lessons learned? And are you changing anything on the underwriting side? Are you're pretty happy with kind of how you approach them and how you performed as just – when the events are that big you can't do much to fight them?

Yeah, happy would be a pretty strong word for our feelings of the Camp Fire.

Fair Enough

But, if I go back and look at the long-term wildfire history in California, just a reminder we have a pretty conservative approach. We use two tools to underwrite. The nature of our educator is that they cannot deliver those areas typically on the edge of the forest, where historically that's typically where the fires had happened. When we look back excluding the Camp Fire over the past four or five years, our total catastrophe wildfires were only $10 million. So that had proved effective over time. But that said, we look at the Camp Fire, certainly a different event unexpected event you had a utility with questionable infrastructure, on top of the wins, on top of a smaller city in Northern California, the entire city burnt. I did visit Paradise two days after the fire. The entire infrastructure was demolished including schools, hospitals, fast food restaurants things that typically don't burn. So certainly, a different from what we expect and even our reinsurance expect our book is run through a multiple – dozens of reinsurers every year and I don't think anybody was pricing for this type of risk. So as we take that information certainly we have learning's, we look for other areas that might be Paradise like. We've tightened our underwriting. We already have a rate filing in – at the Department of Insurance. We were unfortunate that we're working on it as the Camp Fire was occurring so we're a little bit ahead of the curve there. We expect that to be implemented in second quarter. So, again it's the combination of rate and underwriting. We've tightened our underwriting box in the entire state with what we call our fire land score, which is the tool that we use. So, certainly a lot of learning's and a lot of re-underwriting that will happen over the next few months and years.

Okay. Great. Thanks. And maybe just one more if I could. This is for Bret. You talked a bit about how you've improved the credit quality and investment portfolio taken the rate – average rating up a notch. Can you speak to the other side of that and give us some idea of typically there would be some cost or – investment yield that you're giving up currently for that less risky portfolio. Can you talk a little bit about how you view that, and if that's something that you can put a number on?

Sure. Sure. And a fair question. Obviously it's something we've been working on as I mentioned over the past 18-plus months. But quantifying that, I would say that, the impact of the staying up in credit quality is worth about $0.05 for the full year 2019. And given our current economic outlook, we think it's a very prudent trade that will serve us well as I said over the long term. I think it's also important to remember that 90% of our investment portfolio supports our L&R obligations, and that has a longer duration than a typical P&C portfolio personal lines. And it's really because of that that our portfolio yield remains higher than many of the P&C peers at 5.11% that I mentioned earlier in my prepared remarks. So I think our starting point if you will to begin with is higher than most. And we'll take a look at that. But I even remember in the -- you go back a few years if you pulled our Qs and Ks, there was nothing to apologize for what we did. As we've talked about too in the last credit cycle where things -- where we experienced pressure. So we feel -- the P&C pretax equivalent yield is 4.49%; Life, I think is 5.21% that kind of gets to the blended 5.11% rate. You've got different durations. But I think we just need to remind folks that $7.5 billion of the $8.5 billion portfolio supports the Life and Retirement segments. That's worth about $0.05 for...

But it seems like a pretty small price to pay for some added security.

You got it.

Anyway, thank you for the color and best of luck in 2019.

Thank you very much.

Ladies and gentlemen, we have reached the end of our question-and-answer session. I would like to turn the conference back over to Heather for closing comments.

Thank you, Sherry and thank you, everyone, for joining us today. We're fully aware it's a very busy reporting day today and tomorrow. But if you do want to follow up, I will be happy to help on the phone and chat through anything what's on your mind. And then finally if we don't get a chance to talk in the next few days, hopefully a bit we can see you in early March in Florida. So thank you again for joining us.

Thank you. This concludes today's conference. You may disconnect your lines at this time and thank you for your participation.