TORCHMARK CORPORATION
4th QUARTER 2005 CONFERENCE CALL
February 9, 2006
Corporation Participants
Mark McAndrew,
Chief Executive OfficerGary L. Coleman,
EVP and CFOLarry Hutchison,
EVP & General CounselJoyce Lane,
VP Investor RelationsMark McAndrew: Thank you. Good morning, everyone.
Joining me this morning are Gary Coleman, our Chief Financial Officer; Larry Hutchison, our General Counsel; and Joyce Lane, Vice President of Investor Relations.
For those of you who have not seen our supplemental financial reports and would like to follow along, you can view them on our website at torchmarkcorp.com at the Investor Relations page. Some of our comments or answers to your questions may contain forward-looking statements that are provided for general guidance purposes only. Accordingly, please refer to our 2004 10-K, which is on file with the SEC.
Operating income for the fourth quarter was $122 million, or $1.17 per share, an increase of 9% over the $1.07 in the fourth quarter of last year. Operating income for the year was $486 million or $4.59 per share, also a 9% increase over the $4.23 for 2004. At year-end, our book value was $30.41 and our return on equity was 15.9%.
In our life insurance operations (which generate over 2/3 of our underwriting margins), premium revenue increased 5% for the quarter to $369 million and underwriting margin rose 8% to $99 million. As a percentage of premiums, life underwriting margins were 27% for the quarter, up from 26% a year ago. Life first-year premiums declined 6% to $53 million while life insurance net sales declined 5% to just over $64 million.
In our Direct Response operation, life premiums and underwriting margins both grew at 9% for the quarter
to $106 million and $27 million, respectively. First year premiums were up 3% to $19 million and net sales grew by 1% to $26 million.
For the full year, Direct Response life sales grew by only 1.5% compared to higher than normal growth of 14% and 28% the previous two years. I am encouraged over recent developments in Direct Response and expect 2006 to see renewed growth in net life sales of at least 8% to 10%. While we have made improvements in our first quarter product offerings, we will not begin to see the benefit in our reported net sales (which reflect only policies that pay beyond the initial introductory offer) until sometime in the second quarter of 2006.
At American Income, life premiums grew 8% for the quarter to $97 million, while underwriting margins grew 13% to $31 million. Life first year premiums declined 5% to $18 million and life net sales fell 7% to $20 million. American Income’s producing agent count declined to 2,027, down 125 for the quarter and 63 for the full year. New agent recruiting declined 8% from the same quarter a year ago.
It was a disappointing year at American Income. At this time last year, I projected double-digit growth in both our producing agents and net sales for 2005. The problems at American Income turned out to be more complex than I had anticipated. We have been, and will continue, making the changes necessary to get American Income back on track. I have, however, learned my lesson and we will not be making projections at this time for 2006 concerning growth in producing agents or sales at American Income.
At Liberty National, life premiums for the quarter were $75 million, unchanged from a year ago. Life underwriting margins grew 3% to $22 million. Life first year premiums declined 5% to $9 million although life net sales grew by 8% for the quarter to $12 million. Liberty’s producing agent count stood at 1,781 at year-end, a drop of 54 for the quarter although still an increase of 143, or 9%, for the year.
I am very unhappy with Liberty’s performance for the second half of 2005. After experiencing rapid growth in our recruiting and producing agents during the first six months of 2005, we fell apart during the last six
months. There are no excuses – major changes are needed and will be made at Liberty National.
The first needed change has already occurred with the appointment of Andy King as President and Chief Marketing Officer of Liberty National. Andy has headed up our United American Branch Office operation for the past 10 years and is extremely talented.
During the first half of 2006, we will move Liberty National from what I consider to be a somewhat “socialistic” compensation system to a more “capitalistic” approach. All agency compensation will become performance based and those individuals who add to the growth and profitability of Liberty National will benefit. In turn, those who continue to be a drag on Liberty’s results will see their compensation decline.
We are raising the minimum production requirements for agents at Liberty. Due to the salaries and benefits currently provided to Liberty’s agents, approximately 25% of the sales force is not producing enough business for the Company to make a profit. This is unacceptable.
The changes being implemented will result in either growth in new sales, improved margins, or both. But due to the magnitude of these changes, I’m unable at this time to project Liberty’s agent growth or sales growth for 2006.
In our Military business, premiums grew 4% for the quarter to $50 million while underwriting margins declined 8% to $11 million. First year premiums declined 34% to $5 million and net sales fell 35% to $4 million.
Claims resulting from the hostilities in Iraq and Afghanistan totaled $1.1 million for the quarter with all of the deaths occurring in Iraq. This is an increase of $400,000 from the fourth quarter a year ago. We have also seen our first year lapse rates increase in the Military from 5% to the 7% – 8% range. While still excellent, this deterioration has a negative impact on underwriting margin. Net sales in the Military operation appear to have leveled off in the $3.5 to $4.0 million per quarter range and my current projection would be for that level to continue through 2006.
On the health side, premiums were down 4% from a year ago to $246 million for the quarter with
underwriting margins up 6% to $43 million. The increase in health underwriting margin is attributable to the lower loss ratios on Liberty National’s “class” cancer business as we previously reported. First year health premiums declined 4% to $38 million with net sales increasing 24% to $53 million.
85% of our new health sales are generated at our United American subsidiary – 59% coming from the Branch Office and 26% from our Independent Agency operations.
A bright spot for the quarter was our Branch Office operation. Health premiums grew 3% for the quarter to $81 million and underwriting margins grew 6% to $12 million. First year premiums grew 17% to $19 million and net health sales grew 62% to $31 million. We ended the quarter with 2,166 producing agents, up 29% for the year. We grew by twelve branch offices
during 2005, ending the year with 96. For 2006, I expect to see our agents and sales
to continue to grow at a very rapid pace. Premiums and underwriting margin will see accelerated growth during the year reaching double-digits during the second half of 2006.
The Independent Agency side of United American has seen less progress. Premiums for the quarter declined 7% and underwriting margins declined 11%. First year premiums declined 25% to $12 million and net health sales were down 17% for the quarter to $14 million.
In 2004, one large independent agency accounted for 55% of our health sales in this distribution system. In 2005, net sales from this agency fell 62% and now represent only 26% of the total. Excluding this one agency, net sales grew by 7% for the year and 17% for the last six months.
2006 will be difficult to project due to the high concentration of business in this one agency. While we hope they have begun to turn around, I’m estimating that sales in this distribution will be flat to modest single-digit growth in 2006.
We began enrollments for the new Medicare Prescription Drug program on November 15th with the first coverages effective on January 1st. As of January 31st,
we had 121,000 enrollees confirmed by CMS, including 14,000 dual eligible auto-enrollees.
While the pace has slowed somewhat since January 1st, we continue to see several thousand new enrollments per week and expect to see an upturn as the May 15th deadline approaches.
We currently expect to see 200,000 to 250,000 enrollments by May 15th with 2006 revenues in the $175 to $225 million dollar range. Assuming we achieve a 6% profit margin, the Medicare Part D program should contribute $.06 to .09 to 2006 earnings per share.
I will now turn the call over to Gary Coleman, our Chief Financial Officer, for his comments on our investment operations, followed by Larry Hutchison who will comment on the status of Liberty National’s race- based litigation.
Gary Coleman: Good morning.
I want to discuss our investments and excess investment income, and make a few comments on share repurchases.
First, investments.
Torchmark has $8.4 billion of bonds at amortized cost, which comprise 94% of invested assets. These assets are carried on the balance sheet at their market value, which reflects net unrealized gains of $425 million.
Investment grade bonds total $7.7 billion and have an average rating of A-. Below investment grade bonds are $671 million, same as a year ago, and have an average rating of BB-.
Overall, the total portfolio is rated BBB+, same as a year ago.
Regarding new investments. As begun in the second quarter, we continue to invest long when we can find bonds of a quality issuer with yields in excess of 6%; but otherwise we invest in short maturities. Since April, we invested almost $600 million; $424 million in short bonds yielding 5.2% and having an average maturity of five years, and $168 million in long bonds yielding 6.8%. In total, the average yield was 5.6% and the average life was just under ten years. This compares to the 6.5%
yield, and 24 year life of bonds that were purchased in 2004 and through the first quarter of 2005.
The lower investment yields continue to negatively impact the portfolio. The fourth quarter marks the eleventh consecutive quarter that we have invested new money at lower than the portfolio yield which has declined by little over 40 basis points during that period to now towards 7.0%. Contributing to this decline has been the reinvestment, at lower rates, of proceeds from called bonds. However, the calls have declined. In 2005, they averaged $55 million a quarter, compared to the $100 million a quarter we experienced in 2003 and 2004.
Now, I’ll make a few comments about excess investment income, which is our net investment income less the costs associated with the interest bearing net policy liabilities and debt.
Excess investment income was $80 million in the fourth quarter, $1 million less than a year ago. However, on a per share basis, excess investment income increased 4%, which reflects the effect of our
stock repurchase program. Looking at the components, net investment
income was up $6 million, or 4%; however, that was lower than the 5.6% increase in average invested assets due to the lower yields on new investments.
Offsetting the $6 million increase in investment income was the $7 million increase in the costs of the interest bearing liabilities.
Interest on the net policy liabilities was up $3 million, or 6%, and that was in line with a similar increase in the average liabilities.
The remaining $4 million increase in the costs of our interest bearing liabilities was higher financing costs. $2.7 million was due to the reduced benefits from the interest rate swaps, and $1.2 million resulted from higher rates paid on short-term debt.
Now regarding the swaps, due to the rising short-term interest rates, the benefits from the swaps has declined steadily the last few years. As late as the second quarter of 2005, we had four swaps with a combined notional amount, or you might say face amount of $530 million. In the third quarter, we terminated the two least profitable of the swaps that had a combined
face amount of $200 million and we did that due to the likelihood that their semi-annual cash payments would become negative in 2006. That leaves us with two swaps that have a combined face amount of $330 million; and one of those will expire in late 2006, at which time we will likely have just the one remaining swap of $150 million. Based on current rates and the reduced face amount of the swaps, it appears that the pre-tax benefits from the swaps in 2006 will be around $2 million, which is about $5.5 million less than we received in 2005. For more information on the terms of the swaps, please see the related schedule in the financial reports section of our website.
Overall, regarding the excess investment income, the lower long-term interest rates and the flattening yield curve continue to restrict it. Going forward, we will continue to buy investment grade corporate bonds, and as long as rates remain where they are today, we would expect to make significant investments in bonds with shorter maturities – probably around five years. And obviously, we aren’t happy with the lower yields, but where rates are today we still believe that this is the best strategy.
Now, I would like to make a few comments regarding our share repurchase program. As you know, Torchmark began its program in 1986, and has repurchased shares each year since then, except 1995. During that period, the Company has bought back 57% of its outstanding shares.
We use our excess cash flow at the holding company to fund stock repurchases. Excess cash flow is the previous year’s statutory earnings of our subsidiaries dividended up to the holding company less the dividends paid to shareholders and less financing costs. In 2005, our excess cash flow was $300 million, and we used that to repurchase 5.6 million shares. It is worth noting that, as recent as 2000, excess cash flow was only $135 million, indicating the strong growth of Torchmark’s cash flow.
Share repurchases had a positive impact on earnings per share. For example, if the 2005 cash flow had alternatively been invested in bonds, investment income would have been higher by about $8.8 million,
after tax, and net operating income would have come in at $4.50 a share. But with the buybacks, due to the reduction in the number of shares outstanding, actual net operating income per share was $.09 higher at $4.59.
In 2006, we expect free cash flow to be at least $320 million. With our debt at what we consider an appropriate level, and as long as the stock is valued such that repurchases provide a superior return over other investment alternatives, we expect that the stock repurchases will once again be the best use of our cash flow.
Those are my comments. I will now turn it over to Larry Hutchison.
Larry Hutchison: Thank you Gary. On February 3rd,
Torchmark filed an 8-K reporting the federal court’s preliminary approval of Liberty National’s class action relating to the pricing of insurance sold to African-American policyholders in the period prior to 1966. The settlement provides that Liberty National will enhance policy benefits under those plans by stated percentages. This enhancement relates to approximately 55,000 in-force policies and other policies on which claims were filed in the past. Additional relief in the form of a reinstatement procedure is granted to policyholders with lapsed or terminated coverages. Total benefits provided under the settlement are subject to a $6 million cap. Torchmark recorded a non-operating after-tax charge of $7.1 million in the fourth quarter for these benefits, related expected attorney’s fees, and other miscellaneous costs associated with the litigation. A fairness hearing is scheduled for March 31st. If the court gives final approval to the settlement following the fairness hearing, substantially all the class action issues related to the race distinct pricing litigation will be resolved. All that remain are certain individual mental anguish and punitive damage claims, previously asserted by approximately 2,000 individual plaintiffs. Liberty National did not include these claims in the settlement because the Company believes the claims will be barred by legal defenses. The Company will defend those claims if they are pursued in federal court. We are pleased with the settlement and
believe it is in the best interest of Liberty National and its policyholders.
In summary, the two most important facts about the settlement are first, total benefits of the settlement are capped at $6 million; and secondly, all class policyholders, whether past or present, are eligible for this relief.
Mark.
Mark McAndrew: Thank you Larry. Due to the
uncertainties involved in several of our distribution systems as well as the new Medicare Prescription Drug program, we did not give a precise earnings per share estimate for 2006. Also, unlike prior years, we included the impact of our ongoing stock repurchase program in our projection.
Our current projection for 2006 earnings per share is in the range of $4.90 to $5.00, not including a $.04 per share stock option expense. This represents growth of 7% to 9% over the $4.59 earnings per share for 2005.
The major components of our earnings per share projections are our underwriting income should be in the range of $443 to $453 million including the benefit from Medicare Part D.
Excess investment income should be in the range of $320 to $325 million assuming we continue our stock repurchase. This also assumes the $5.5 million reduction in benefit from our interest rate swaps as Gary previously mentioned.
Net operating income before stock option expense should be in the range of $495 to $504 million with an average of approximately 101 million outstanding diluted shares for the full year.
Those are my comments. Rebecca will now open it up for questions.
Jimmy Bhullar, J. P. Morgan: Hi. Thank you. I just
have a couple of questions. First, if you could speak about Liberty National. Give us some more details of some of the changes you are making? And what gives you assurance that you are not going to have a bunch of
people leave as you implement higher productivity requirements? And then also, Mark, on legal expenses, I think you had legal costs of about $5 million in ‘05. What is your outlook for ‘06 now that most of your outstanding issues have been settled?
Mark McAndrew: Well, I’ll let Larry make his projections
on the litigation expenses. At both American Income and Liberty National, many of the changes we are making have not been announced to our sales force so I am not at liberty to discuss some of those. But at Liberty National, one of the things is we don’t know how many agents will leave. As I mentioned, we are raising the minimum production standard. Those 25% of the agents that are basically unprofitable today are only producing about 5% of the business at Liberty. We have no idea. We are giving them 90 days to increase their production level to a level where the Company is at least making money. But we have no idea how many of those agents will increase that production or how many of those agents that will leave. Either way, the margins at Liberty National will improve the second half of this year. So if all of these agents increase production, we will see growth in new sales. If none of those agents increase their production, it could cost us 5% of the existing sales. But either way, the margins at Liberty National will improve as a result of that change.
Jimmy Bhullar: And what’s the timing on American
Income and Liberty National’s changes that you are implementing? Is that first quarter ’06 or.…?
Mark McAndrew: Most will occur in the second quarter,
definitely by mid-year.
Jimmy Bhullar: So we should see whatever impact on
sales I guess in the third quarter then?
Mark McAndrew: By the end of the second quarter we
should have a much better feel for what is going to happen at both Liberty and American Income.
Jimmy Bhullar: Okay.
Mark McAndrew: If you would like more details on
some of these changes, if you would like to call Joyce Lane after the conference call I’m available the rest of the day and I’ll be happy to discuss them in more detail.
Jimmy Bhullar: Okay, thank you.
Larry Hutchison: Mark, I think $4 to $5 million is a
reasonable estimate for legal expenses next year. The difference is we are a plaintiff currently in three lawsuits at Liberty National. It is much different being a plaintiff than a defendant. But I think that is a reasonable estimate of legal fees in the next twelve months.
Mark McAndrew: Okay.
Tom Gallagher, Credit Suisse First Boston: Good
morning. I first wanted to ask about the Part D guidance. So if I understand the numbers correctly, does your guidance assume you are going to have 200,000 to 250,000 enrollees by, I guess, the May 15th deadline? Is that basically the way we can kind of translate the $0.06 to $0.09. Would that translate into 200,000 to 250,000 enrollees?
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Mark McAndrew: We expect to see the 200,000 to
250,000. Now that is with an assumption that we will have a 6% profit margin on that business. But that is correct.
Tom Gallagher: Okay, and I just want to kind of trace to
those, how we get to those numbers. You had 121,000 signed up January 1st, and you said you had been running at several thousand per week. So…..
Mark McAndrew: We had 121,000 at the end of January
that were confirmed by CMS. Those are people that we
absolutely know, but we are continuing to enroll people every week. In fact, our total enrollment as of this morning was right at 150,000. A number of those have not yet been confirmed by CMS. The 121,000 that we reported were only the ones that had been confirmed by CMS as of the end of January.
Tom Gallagher: So then really to get to your guidance,
and I realize these are not hard numbers yet, you would need about an extra 50,000 enrollees by May 15th or so?
Mark McAndrew: Yes.
Tom Gallagher: Okay. And based on the trends you are
seeing right now, you are getting roughly 10,000 a month?
Mark McAndrew: We are currently enrolling in more
than that. That’s why the range is 200,000 to 250,000. Even though it has trailed off somewhat, I think the 200 is on the low end. I would hope it is closer to the 250,000,
but it should be somewhere in that range.
Tom Gallagher: Okay, and it sounds like the X factor
here is going to be is there a surge around the time of the
May 15th deadline. Is that kind of fair to say?
Mark McAndrew: Well, even without the surge, we
should see the 200. If we see a surge, it should be closer to the 250.
Tom Gallagher: Got it, okay. And is there any way of
knowing or any kind of leading indicator for whether there will be a surge?
Mark McAndrew: No, I don’t know what that would be.
Everything I have seen is there is still a lot of people out there in the surveys that CMS has put out, that are in no big hurry because they don’t have huge prescription expenses, but they know that they need and intend to enroll prior to May 15th.
Tom Gallagher: Got it, okay. And just a question on, I guess, the sales assumptions embedded in your guidance for health insurance premium growth. The health premium growth guidance is 0% to 2%. I was curious on what kind of sales results, ballpark, you would need to see to get to those numbers because I believe the medical product you have been selling is somewhat lower persistency than the Med supp.
Mark McAndrew: It is lower persistency, and actually if
anything, we’re probably a little conservative on the sales projections on the Branch Office in coming up with that assumption. If anything, we may do better than that.
Tom Gallagher: Okay, so you feel pretty good about the
0% to 2% premium growth guidance in light of what you’re seeing right now on the sales front?
Mark McAndrew: Yes.
Tom Gallagher: Okay, and I guess just the last question
I had is I guess just about American Income. I understood what you said about Liberty National, what the problems were and how you are addressing those. What are the real underlying problems at American Income and kind of what really has surprised you, disappointed you, and what are you doing there to really fix things?
Mark McAndrew: Well, again, if I could, I think it would
take me at least 15 to 30 minutes to explain in detail of what I see as the challenges at American Income and what we are doing to fix them. I really would prefer if you would call Joyce Lane sometime after the call, anytime today. We would be happy to take a little more time and explain it to you.
Tom Gallagher: Okay, I’ll do that. Thanks.
Mark McAndrew: Okay.
Bob Glasspiegel, Langen McAlenney: Good morning.
I’m going to go on some more questions on the D following Tom’s questions. If you do 220,000 and it works out to about $256 million in first-year sales, is that sort of a fair, rough number, $25 a month, although you won’t necessarily have them all for 12 months? But on the sales side…
Mark McAndrew: Again, I think the projections we are
making on revenue for 2006 is somewhere between
$175 and $225 million.
Bob Glasspiegel: Right.
Mark McAndrew: Yeah, see, the annualized premium
on that business will be higher that that. But again, some of those are effective February 1st, March, April, May, June. We will obviously see a few lapses during the course of the year, so the annual premium on those will
be higher than what the revenue projection is.
Bob Glasspiegel: I’m just thinking about ‘06, looking out
into ‘06, which you haven’t given guidance for – I mean ‘07, rather, which we’re all going to be modeling for, there’s going to be a decent number. It seems like the earnings contribution in ‘07 will be decent but higher than ‘06 because you’ll be earning those premiums for a full year and there should be some more sales in ‘07, correct?
Mark McAndrew: There will be another open
enrollment period at the end of 2006. I have no idea how many people we might enroll there, and we will constantly be enrolling people as they turn 65. Again, the nice thing about our Direct Response operation is we know who those people are so we will actively be soliciting the people as they turn 65 during the course of the year. But yes, next year if we have the same number of enrollees, we will see higher revenue because we will have them for the full twelve months.
Bob Glasspiegel: Okay, your $320 million of excess
cash flow, could you explore sort of the pieces? I mean, we’ve got just a rough sense of what the statutory earnings was in ‘05. I assume the tax gain, does that feed into statutory or not?
Gary Coleman: Well, that is primarily a non-cash gain,
the tax gain. That was liability that we set up that we pulled down.
Bob Glasspiegel: I got you.
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Gary Coleman: As far as the components of the cash
flow, our statutory earnings should be around $420 million. We haven’t finalized those yet, but that’s what it looks like they will be, somewhere around that level.
Bob Glasspiegel: How does that compare to ‘04?
Gary Coleman: That is about a 10% increase.
Bob Glasspiegel: Okay.
Gary Coleman: One thing, our interest costs on our debt
it will be a little bit higher. To get from the $420 to the $320 is $100 million of interest expense and the dividends to the shareholders.
Bob Glasspiegel: Okay. The buyback is sort of cut into
the increase in the dividends. That shouldn’t change much.
Gary Coleman: Yeah, it doesn’t change much. Three
years ago, the dividends were just under $50 million and
for next year they will probably be $46 to $47 million.
Bob Glasspiegel: Okay, and anything on the debt side
we should be considering prospectively?
Gary Coleman: Well, we’ve got $180 million, 6¼ debt,
that matures in December of ‘06. And in addition to that, we’ve got $150 of trust preferred securities that become callable in late November. Where rates are today, it looks like we’ll refinance both of those and we’ll refinance them into a combination of debt and similar trust preferred securities. That will have an impact because where rates are today it looks like our debt cost will be reduced on that $330 million by about 100 basis points. Also, as I mentioned earlier, by the end of ‘06, instead of having $530 million of swaps that we had throughout most of 2005, we’ll only have $150 million at the end of 2006. So the combination of both those should lead to an improvement. Just the refinancing itself should lead to maybe $2 million after-tax improvement in our financing costs in 2007.
______________________________________________ Bob Glasspiegel: I look forward to that. Thank you.
Jeff Schuman, Keefe, Bruyette, Woods: I guess I’d like
to come back to the Part D a little bit more. Can you give us a little bit of color on how the sales have emerged by customer? In other words, are these mostly brand new Torchmark customers or what extent have you gotten from Medicare cross sell? And then, have the sales actually come out almost entirely from Direct Response or has there been some contribution from the agent channels as well?
Mark McAndrew: We have actually derived these from a
number of sources. I should have those in front of me, but I can get them fairly quickly here. Most have come from Direct Response. I am trying to recall the numbers from a couple of weeks ago. We had a little over 30,000 of our existing customers, who we signed up through Direct Response. We have also had, I believe it’s right around 25,000 that our agents have signed up. The balance, other than the 14,000 auto enrollees, are people that we have signed up through our Direct Response operation that were not existing customers.
Jeff Schuman: Okay, and as the market has developed over the last couple of months, has your share been about what you expected? Better or worse? What has kind of surprised you plus or minus about the nature of the competition?
Mark McAndrew: I would have to say it is about where
we thought we would be. I believe a quarter ago we were looking at spending $8 to $10 million and hoped to sign up – well really, our target was to sign up 100,000 people. We actually spent $13 million in the fourth quarter, and we ended up at the end of January with 121,000. So it’s about what we anticipated and we will end up by May 15th – right now, we expect to spend about $18 million to sign up the 200,000 to 250,000 people, which is in line with the allowance we made for acquisition cost.
Jeff Schuman: And of the $13 million, how much of that
was capitalized?
Mark McAndrew: Right now, it has all been capitalized.
It will be spread – it will be gapped over the estimated life of that business, so none of that has been recognized in the fourth quarter, although on the administrative side we did add roughly 90 people on our customer service area, which is included in our administrative expenses for the quarter. But none of the acquisition expense, Direct Response expense, has been recognized at this point. It will start to be recognized in the first quarter.
Jeff Schuman: Okay, and lastly. Thinking about the
administrative expenses and the ramp up there, should we think of the earnings contribution through the course of the year pretty much following the premiums or will there be some higher sort of initial expenses that you need to recover as you go through the year?
Mark McAndrew: We will see some increase in our
administrative expenses because of the Part D. As I mentioned, we’ve added roughly 90 people thus far. But as a percentage of the revenue, the administrative
expenses for the Part D will be significantly less than what we have for overall business.
Jeff Schuman: Okay, so I’m trying to ask, if we assume
$0.06 to $0.09 contribution, should we model that as emerging in line with the developing premium or is there
anything funky we should consider in terms of time?
Mark McAndrew: No, we would expect to report level
margins as a percentage of revenue.
Jeff Schuman: Terrific. Thanks a lot.
Ed Spehar, Merrill Lynch: Good morning. I had a few
questions. First I guess, just one point of clarification. Gary, could you go over again the numbers that you gave us on the dollars invested? I think you said $424 million invested short, $168 million long. What period of time was that over?
Gary Coleman: That was started in May. Toward the
end of April when we made a decision that we wouldn’t go long on all or purchases as we had done in the last couple of years. And so those numbers I gave were really from May through the end of December.
Ed Spehar: Okay, and in terms of the outlook today, it
seems like new money yields should be a little bit more attractive here. Are you seeing any shift, even if it’s modest, toward longer versus shorter?
Gary Coleman: Yeah, we are and it is fairly modest
though. But we are seeing and we have, in the fourth quarter, we invested a little bit longer than we did say in the second and third quarters.
Ed Spehar: Okay, and then going back on the
distribution, first question on Liberty National. I guess when we talk about the 25% of the agents not covering their expenses, I am curious why there wasn’t a change or why this issue wasn’t addressed at the same time that
I thought you took a pretty close look at the agent profitability dynamics. I guess it was maybe a year ago when you eliminated some subsidies that had been paid. Why wouldn’t this have sort of fallen under that category of actions?
Mark McAndrew: Well, Ed, I really don’t have an
excuse there. I would have to say it is something I should have seen a year ago or two years ago. That is one of the benefits I am deriving from having Andrew King out there is he has the time and the energy and the ability to dig in a little deeper than unfortunately I had.
Ed Spehar: Okay, and then another related question is
why wouldn’t changes take place sooner than the second quarter of ‘06?
Mark McAndrew: Well, two things. On the raising of
minimum standards, in all fairness to the people that are there, we felt like 90 days to provide them a 90 day opportunity to meet those levels is fair. So we feel like doing that. On a number of the other changes, we are shooting for May 1st, simply because it is going to take us that long to get the programming done and be able to actually introduce those changes.
Ed Spehar: Okay, and then on American Income. I
know you said you don’t want to – it’s a long discussion, but I guess I’m curious, it seems like there must be at least one or two things to identify here. I guess when we think about Liberty National, this has been a problem for a while in terms of how do we get this distribution channel productive? But American Income had not been. So I am just wondering what is it…..
Mark McAndrew: I will try to give you as brief as I can
without getting into necessarily too much detail, but one of the big changes we made in our Branch Office operation at United American in the past year or so is we began opening new offices in cities that we already had offices. Where in the past we only had one office in Dallas and one in Cleveland. Now we have five in the
Dallas area and three in the Cleveland area and we have four in Orlando. At American Income, right now, we have exclusive territories for all of these SGAs who are field management people. In places we don’t have growth, we need more than one SGA there. Unfortunately, the SGA in the past has always controlled the lead generation from the local unions.
Well, we started in the second half of 2005 in New York and in Los Angeles. Places where we did not feel we were getting enough production, where now the individuals who go out and get the endorsements and get for the lead generation now report directly to the Company. Now we have been able to add a second SGA in that area, in both of those areas, and we’re seeing more lead generation and we are seeing growth in sales in those areas now that was not possible before. We can’t in a 30 day period. We have 140 people roughly out there who go out and get these local union endorsements for us to generate our leads there. We are not physically able to manage 140 of those people all at once. But during the course of 2006, we are going to gradually, especially in places where we are not getting growth, we are going to take that responsibility in house where we can add a second SGA and we control the lead generation. I guess that in a nutshell is the biggest single thing I see at American Income.
Ed Spehar: Okay, so that is really the change. It’s just
sort of the idea that now you are going to kind of leverage the Torchmark expertise on the lead generation side rather than funneling this through the distribution?
Mark McAndrew: Plus, in areas that we are not getting
growth, we need the ability to add a second SGA. We are also going to be making some changes in compensation at American Income but I’m just not at liberty yet, because they have not been announced, to really discuss those here.
Ed Spehar: Okay, and then just finally, just so I’m clear, on the Part D, the open enrollment that is only going to
occur, it will end at May 15th and then be open again in November?
Mark McAndrew: Yes. Right now the plan is it’s
supposed to end May 15th and it will open up again November 15th.
Ed Spehar: And obviously, if you are turning 65
throughout the year you can enroll in this plan?
Mark McAndrew: Yes.
Ed Spehar: What are the numbers of your customers,
do you know, that turn 65 every year?
Mark McAndrew: Oh, I don’t not know that number, Ed.
We could get that. But just, particularly in our Direct Response, we have a number of policyholders that are turning 65 every year. But I just do not have that number.
Ed Spehar: Okay, just one final quick one. On the
Medicare Part D margins, I think you had said 8% previously and you’re saying 6% now. Is 6% the long-term expectation or is there a reason to think that 6% goes to 8%?
Mark McAndrew: I guess we are being a little bit
conservative. We hope to make 8% but in our assumption we have assumed 6%. We don’t – again, we’re just starting into this and again, if our claims are higher than what we anticipate the first 2% we have to eat. Beyond that, Medicare is going to reimburse us for roughly 80% of the excess. So we are taking a little bit of a conservative approach here in our assumption. We still hope to make 8%, but we just have no idea at this point what that is going to turn out to be.
Ed Spehar: Okay, thank you very much.
Colin Devine, Citigroup: Good morning, Mark.
Mark McAndrew: Good morning.
Colin Devine: In looking at the situation you find yourself in, two-thirds of your earnings come off life insurance. And as I’m going down each distribution channel, United American, ten consecutive quarters of declines in the General Agency; the Branch Office, I think is the worst quarter they have ever put up, period. The direct business flat-lined in ‘05 and you know the list goes on. Liberty National is basically about the worst one in the last five years. This doesn’t seem to be just one product or one channel. Am I correct in saying that what you are faced with right now is the Company needs a major overhaul to get this turned around and this is going to be a multi-year process? Is that a fair conclusion?
Mark McAndrew: No, I don’t think it is a fair conclusion. If you are looking at it in total, right now, the Branch Office actually is doing very well. They never have been a life distribution system. They are primarily a health distribution system. The Direct Response, if I look there, I mean, again, if I look back historically, it has seen double-digit growth for the last twenty years. We had a relatively small growth in new sales in 2005. But I fully expect in 2006 and ‘07, I expect to see significant growth in our juvenile new sales in the Direct Response this year. Which, if we see that, following that, we see significant growth in ‘07 in our parent sales. I feel very good about where the Direct Response is right now.
We do have challenges at Liberty and American Income. Liberty has never been a major contributor to growth for the past 25 years. So it is not something that has recently significantly deteriorated. It has been basically flat for a long period of time. We believe we can improve upon that. American Income is probably the biggest challenge right now. We had four years of rapid growth. We are still seeing good growth in premiums and even with flat sales, we will continue to see nice growth in premiums at American Income where we had, I believe, 9% – let’s see, we had 8% growth in life premiums this year. Even with flat sales we will probably still see somewhere in the neighborhood of 7% growth in
premiums in ‘06. I think that can be turned around during the course of this year.
So no, I don’t think it’s a major, a multi-year overhaul. I hope by mid-year, we have a much brighter outlook on all those distribution systems. I am just not ready to make that today.
Colin Devine: Is the issue then that really lead in most
of your channels can pretty steady declines in sales, right? Not just for one quarter or year-over-year, but for the past couple of years. Do you view your problem as recruiting or the problem is the products you have been offering, or both?
Mark McAndrew: It’s not a product problem. In all of
our distribution systems, other than Direct Response, it has always been if we can grow our agents, we grow sales. In the years that we saw big growth at American Income, it was because agents were growing. The reason that the Branch Office is seeing good growth now is because they are getting good growth in recruiting.
The problems at American Income and Liberty National are recruiting problems. They are not product problems, and it’s not that we don’t have a lack of people to recruit. I know we have talked about this in past quarters. In 2004, from our internet source, we generated 426,000 potential applicants. People responded to our efforts. This past year, we generated over 1.6 million; four times as many, but yet our recruiting didn’t go up at American Income. That’s not because we have a lack of people who want to come to work. It is a motivation problem and it is a design of the compensation program. The difference is that we have in the Branch Office is those people are paid. We changed, I believe two, three years ago, where now they are paid a higher commission, the sales management, for new agents and they are veteran agents. And that is something that we are going to move to at both Liberty National and American Income during the first half of this year. And I think it will pay a dividend.
Colin Devine: Okay, thanks very much Mark.
Tamara Kravec, Bank of America Securities: Thank
you and good morning. Quick question. I know you cannot really quantify the compensation changes that are going to happen, but can you give us a sense quantifiably as to what kind of increase in productivity you are looking for? Is this going to be, you know, double what they had been doing or less than that?
Mark McAndrew: Particularly at Liberty National, if I
look at just the agents at Liberty National, I think between service salaries and payroll taxes, we spent almost $17 million in 2005. We are going to move from that. But if you look at raising the minimum standards, it’s the average. We are asking those 25% to basically double their sales. But again, that only represents roughly 5% of the total. So if they all do double their sales in the next three months, it will result in about 5% growth in new sales. If none of them grow their sales and they all end up leaving, we are going to see about a 5% reduction in our new sales as a result of that.
Tamara Kravec: Okay, but at the same time, your
salaries and comp will come down because the new people that you’re bringing in will supposedly be on the
new system, right?
Mark McAndrew: Well, if I look at those 25% of the
people that are below that profitability line, right now they are costing us in salaries and benefits between $4 and $5 million a year. So, either the production is going to come up to where we can justify that expense, or that
expense will go away.
Tamara Kravec: Okay, and then just conceptually do
you think the problem occurred as a result of the type of people that were hired in and recruited? So was it a problem at the beginning stage or was it a problem that they looked okay by resume and you brought them in and then after a while, you know, their productivity just kept on declining. So do you think it’s really fixing, because it seems like, you know, bringing in Mr. King that that’s
going to really, his focus at United American was on the internet lead recruiting aspect of it?
Mark McAndrew: There is no doubt moving Andy King
out there we will see an improvement in the recruiting and new agent hiring. As far as these people that are at that extremely low production level, this has been a long term problem. It is something that has gone on for years, so it’s not anything new. Some of those are veteran agents. Most of those would be more veteran agents. It has been accepted for a number of years, and it is something we’re changing. So it’s really not a new problem.
Tamara Kravec: Okay, so more cultural. And then my
other quick question was just on the acquisition of fixed maturities. It seems like you are going back and forth a little. In the third quarter you made acquisitions in the A+ category. Now you are kind of in the BBB+ in the fourth quarter, and you made about half the acquisitions there. Are you finding that you are having to stretch for yield? I mean, the yield was obviously higher on the acquisitions you made in the fourth quarter and what are your thoughts on that?
Gary Coleman: No, we weren’t stretching for yield. I
think what we saw and I mentioned when Ed asked, what we saw is that the rates did pick up a little bit, longer rates in the fourth quarter. We did invest, I think we had just about half of our investments in the fourth quarter were long bonds, where it was in the second and third quarters. This is probably a third of what our purchases were.
For most of the year, we purchased bonds in the A-, BBB+. Actually from April to June, I think it averaged out to an A rating and some of the longer bonds that we did buy were in the BBB+ range, and that is why that came out that way. But we’re not making a conscious effort to stretch for yield. What we are doing, those long bonds, we do a research and we think that it’s a quality credit, then we will go ahead and take the higher yield, but it has got to be in excess of 6.5 for us to do it. Otherwise, we will go short. Again, we think long-term
rates, at some point, we hope soon, will start going up. And the fact that we put so much short-term money, recently we’ll be in a position to take advantage of that.
Tamara Kravec: Okay, thank you.
Eric Berg, Lehman Brothers: Thank you and good
morning.
Mark McAndrew: Good morning Eric.
Eric Berg: Good morning to everyone, to Mark, to
everyone else. Two quick questions. First, and I will apologize, I joined the call a little late if you already covered this. I’m noticing in the supplementary financial material that net sales at LNL were actually up in the quarter significantly. Are you suggesting that that gives perhaps not a fair impression of what is going on?
Mark McAndrew: Well, they were up 8% versus a year
ago quarter. I would say the year-ago quarter was kind of the low point as a result of some of the changes we previously made so I am not overly excited about that. My disappointment there is more in the recruiting side. You know, the first half of the year we grew by several hundred agents. We have seen the agent count decline the second half of the year, which is not a good trend. If that continues, we will not continue to see that 8% growth. We have got to turn that around and get renewed growth in our agent count or we won’t continue to see the growth in the new sales. So, my disappointment is more in the recruiting efforts and the decline in the agent count the second half of the year.
Eric Berg: The second question relates to the Military.
It would seem to be a deteriorating situation rather than a stable one. I think we all understand, or certainly most of us understand what has happened there, the change in compensation in ‘04 leading to a sort of a exodus of agents. What are you doing as we speak or what have you done to try to stem the decline here?
Mark McAndrew: Well, again, that is a little bit of a frustrating situation and it is an independent agency. We are now trying to assist them and we are assisting them in trying to increase their recruiting using our internet resources. But we don’t control what they do. That’s why I am not going to project any growth there. We do believe that it has pretty much leveled off in that $3.5 to $4 million sales range, which is far less than what it was two years ago. We don’t expect to see any additional deterioration, but at this point I am not overly optimistic that we’re going to see any significant turnaround there in 2006.
Eric Berg: All right, thank you.
Mark McAndrew: I would, Eric, I would like to point out
it is by far the smallest of the distribution systems that we have. It’s relatively, if you look at it, is about 7.5% of our underwriting margins. So it’s not that it is not important to us and we want to see it grow, but the American Income, Liberty National and Direct Response are the three big life operations that will drive our growth.
Eric Berg: Yeah, they are the engines. Very clear.
Thank you.
Mark McAndrew: That’s our comments for today.
Thanks for joining us and we’ll see you in three months. Thank you.
