Globe Life Inc (GL) — Q3 2016 Earnings Call Transcript

Thank you. Good morning, everyone. Joining the call today are Gary Coleman and Larry Hutchison, our Co-Chief Executive Officers; Frank Svoboda, our Chief Financial Officer; and Brian Mitchell, our General Counsel. 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 2015 10-K and any subsequent forms 10-Q on file with the SEC. Some of our comments may also contain non-GAAP measures. Please see our earnings release and website for discussion of these terms and reconciliations to GAAP measures. I will now turn the call over to Gary Coleman.

Thank you, Mike, and good morning everyone. In the third quarter, net income was $152 million or $1.25 per share, a 9% increase on a per share basis. Net operating income from continuing operations for the quarter was $140 million or $1.58 per share, $0.03 higher than anticipated in our previous guidance due primarily to lower than expected after-tax stock compensation expense. On a GAAP reported basis, our return on equity as of September 30 was 12.0%, and book value per share was $41.94. Excluding unrealized gains on fixed maturities, our return on equity was 14.7%, and our book value per share was $31.86, an 8% increase from a year ago. In our life insurance operations, premium revenue grew 5% to $546 million, while life underwriting margin was $143 million, down 1% from a year ago. The decline in underwriting margin was due primarily to the decline in the direct response margin. For the full year, we expect life underwriting margin to be around 1% higher than 2015. Net life sales were $100 million, down 1% from the year ago quarter. On the health side, premium revenue grew 3% to $237 million, and health underwriting margin was up 6% to $53 million. For the full year, we expect health underwriting margin to grow approximately 2%. Health sales were $33 million the same as in the year ago quarter. However, individual health sales were $30 million, up 9%. Administrative expenses were $49 million for the quarter, up 4% from the year ago, and in line with our expectations. As a percentage of premium from continuing operations, administrative expenses were 6.3%, same as the year ago. For the full year, we expect administrative expenses will be around 6.2% to premium. I will now turn the call over to Larry Hutchison for his comments on the marketing operations.

Thank you, Gary. I’ll now review the results for each company. At American Income, life premiums were up 10% to $231 million, and life underwriting margin was up 11% to $74 million. Net life sales were $52 million, up 4% due primarily to increased agent count. The average agent count for the third quarter was 7,004, up 6% from a year ago and up 6% from the second quarter. The producing agent count at the end of the third quarter was 7,025. We expect the producing agent count to be in a range of 6,750 to 6,950 at the end of 2016. We expect 7% to 8% life sales growth for the full year 2016 and 6% to 10% in 2017. In our direct response operation at Globe Life, life premiums are up 4% to $192 million. Life underwriting margin declined 26% to $29 million. Net life sales were down 9% to $35 million due primarily to decreases in circulations. We expect life sales to be down 7% to 9% for the full year of 2016 and flat to down 5% in 2017. The further sales decline in 2017 reflects changes in marketing designed to increase the profitability of new sales. At Liberty National, life premiums were $67 million, down 1% from the year ago quarter, while life underwriting margin was $20 million, up 9%. Net life sales increased 11% to $10 million, while net health sales increased 3% to $5 million. The sales increases were driven primarily by improvements in agent count. The average producing agent count for the third quarter was 1,799, up 13% from a year ago and up 3% compared to the second quarter. The producing agent count at Liberty National ended the quarter at 1,785. We expect the producing agent count to be in a range of 1,700 to 1,800 at the end of 2016. Life net sales growth is expected to be within a range of 10% to 11% for the full year of 2016, and 7% to 11% in 2017. Health net sales growth is expected to be within a range of 7% to 9% for the full year of 2016, and 4% to 8% in 2017. We are very pleased with the progress in the turnaround at Liberty National. At Family Heritage, health premiums increased 7% to $16 million, while health underwriting margin increased 19% to $13 million. Health net sales grew 8% to $14 million. The average producing agent count for the third quarter was 986, up 9% from a year ago, and 6% from the second quarter. The producing agent count at the end of the quarter was 1,004. We expect the producing agent count to be in a range of 975 to 1,025 at the end of 2016. Health sales growth should be in a range of 2% to 4% for the full year 2016, and 3% to 7% for 2017. At United American General Agency, health premiums increased 5% to $88 million. Net health sales were $10 million, down 14% compared to the year ago quarter. Individual Medicare supplement sales grew 14% to $8 million, while group sales declined 57% to $2 million. For the full year of 2016, we expect growth in individual Medicare supplement sales to be around 7% to 9%. We expect sales growth in 2017 of 6% to 10%. I will now turn the call back to Gary.

I will spend the next few minutes discussing our investment operations, first, the excess investment income. Excess investment income, which we define as net investment income that’s acquired in for some policy liabilities and debt was $57 million, a 5% increase over the year ago quarter. On a per share basis, reflecting the impact of our share repurchase program, excess investment income was up 9%. For the full year 2016, we expect excess investment income to grow by approximately 2%. However, on a per share basis, we should see an increase of approximately 6%. Now, regarding the investment portfolio, investment assets were $14.6 billion, including $13.9 billion of fixed maturities and amortized costs. At the fixed maturities, $13.2 million are investment grade with an average rating of A minus, and below investment grade bonds are $753 million compared to $568 million a year ago. The percentage of below investment grade bonds to fixed maturities is 5.4% compared to 4.3% a year ago. The increase in below investment grade bonds is due primarily to downgrades at securities in the energy, metals, and mining sectors in previous quarters. However, due to increases in underlying commodity prices, the current market values of these securities are significantly higher than at the time of the downgrades. With a portfolio leverage of 3.6 times, the percentage of below investment grade bonds to equity, excluding net unrealized gains on fixed maturities, is 19%. Overall, the total portfolio is rated A minus, same as the year ago. In addition, we have net unrealized gains in the fixed maturities portfolio of $1.9 billion, approximately $1 billion higher than a year ago. To complete the discussion of the investment portfolio, I'd like to give an update on our $1.6 billion of fixed maturities in the energy sector. At September 30, we had a net unrealized gain of $90 million compared to an unrealized loss of $165 million at the end of 2015, an improvement of $255 million. The average rating of the energy fixed maturities is BBB with 90% of the holdings being investment grade. Now, investment yield, in the third quarter, we invested $275 million in investment-grade fixed maturities, primarily in industrial sectors. We invested at an average yield of 4.40%, an average rating of BBB, and an average life of 25 years. For the entire portfolio, the third quarter yield was 5.77%, down 4 basis points from the 5.81% yield in the third quarter of 2015. At September 30, the portfolio yield was approximately 5.76%. At the midpoint of our guidance, we assume the new money rate of 4.45% in the fourth quarter, and a weighted average rate of 4.65% in 2017. The low and declining interest rate environment continues to be an issue. However, our concern regarding the extended period of lower interest rates is the impact on the income statement, not the balance sheet. As long as we’re in this interest rate environment, the portfolio yield will continue to decline and place downward pressure on the growth of investment income. However, this decline will be lessened by the fact that on average only about 2% of our fixed maturity portfolio will run off each year over the next five years. Torchmark would continue to earn the substantial excess investment income in an extended low interest rate environment. As I mentioned earlier, lower interest rates negatively impact the income statement but not the balance sheet. Since we primarily sell non-interest sensitive protection products that account for under FAS 60, we don’t see a reasonable scenario that would require us to write off DAC or put up additional GAAP reserves due to interest rate fluctuations. In addition, we do not foresee a negative impact on our statutory balance sheet as our cash flow test results indicate that our reserves are more than adequate to compensate for lower interest rates. As we have said before, Torchmark can thrive in either a low or high interest rate environment. Now, I’ll turn the call over to Frank.

Thanks, Gary. First, I want to spend a few minutes discussing our share repurchases and capital position. In the third quarter, we spent $77 million to buy 1.2 million Torchmark shares at an average price of $62.65. So far in October, we have used $16.4 million to purchase 255,000 shares. For the full year, through today, we have spent $256 million of parent company cash to acquire more than 4.4 million shares at an average price of $57.96. These are being made from the parent’s free cash flows. The parent company’s free cash flows, as we define it, result primarily from the dividend received by the parent from their subsidiaries less the interest paid on debt and the dividends paid to Torchmark’s shareholders. We expect free cash flow in 2016 to be around $320 million. We have $256 million spent on share repurchases. Thus far, we can expect to have around $64 million available for the remainder of the year from our free cash flow, plus other assets available at the parent. As noted on previous calls, we will use our cash as efficiently as possible. If market conditions are favorable, we expect the share repurchases will continue to be a primary use of those funds. We also expect to retain approximately $50 million to $60 million of parent assets at the end of 2016. For 2017, we preliminarily estimate that the free cash flow available to the parent will be in the range of $325 million to $335 million. Now, regarding RBC at our insurance subsidiaries. We currently plan to maintain our capital at the level necessary to retain our current ratings. For the past several years, that level has been around an NAIC RBC ratio of 325% on a consolidated basis. This ratio is lower than some peer companies but is sufficient for our Company in light of our consistent statutory earnings and the relatively lower risk of our policy liabilities, and our ratings. As we discussed on the last call, we do not calculate RBC on a quarterly basis. However, we estimated that because of lower than expected capital levels as of year-end 2015 plus downgrades in our investment portfolio during this year, we would need around $60 million of additional capital to return to a 325% RBC level. As we also discussed, we believe this shortfall may be somewhat temporary, and thus we may choose to maintain an RBC ratio slightly below 325% for 2016. With the combination of proceeds from our second quarter debt issuances, capital we generated from the sale of our Medicare Part D business, and potential upgrades in our investment portfolio, we are comfortable with our ability to meet responsible RBC levels for 2016, and to meet our targeted 325% RBC ratio no later than the end of 2017, without having to utilize any of our free cash flow for capital contribution.

Thank you, Frank. For 2016, we expect our net operating income from continuing operations to be within a range of $4.43 per share to $4.49 per share, an 8% increase over 2015 at the midpoint. For 2017, we estimate that our net operating income per share will be within a range of $4.55 per share to $4.85 per share, a 5% increase at the mid-point of the guidance. Those are our comments. We will now open the call up for questions.

My first question is on the direct response business. Obviously, margins have gotten worse over time. And it seems like generally have been worse than what you have been expecting. So, what’s the likelihood that results could deteriorate further in 2017, beyond what you’re assuming?

Well, 2017 lower sales are expected. As we continue our work to identify the appropriate balance of sales and profitability. We are confident that any marketing adjustments, which result in lower sales would have been made to improve profitability. We do have better information to make our market decisions in 2017.

Jimmy, with respect to the margins, I think as we said, we would anticipate the margins in 2017 to be in that 14% to 16% range. With the additional claims experience that we have and just some better information regarding the root causes of what’s really giving rise to some of these higher claims, especially in the 2011-2015 block, we feel a lot better clearly with respect to looking at these long-term trends and how this is going to trend out for us. And clearly some of these blocks will get a little bit smaller and run off a little bit; any misses that we might have will have less of an impact going forward. But I think while some quarterly fluctuations could always impact, I think we feel pretty good with that estimate for next year.

I would just say, 2017 sales levels are a reflection of testing that we completed in 2016 and 2017. And so those sales will put a greater emphasis on restoring essential levels of profitability in certain segments. The sales could be higher or lower, depending on the results of those tests.

Go ahead, Jimmy.

And then what are you assuming for stock options expense next year, and that’s embedded in next year’s guidance, because that number has obviously moved around the market as the stock prices have moved?

So overall, Jimmy, the stock expense is at the midpoint of our guidance. We estimate that it would be around $1 million to $1.5 million per quarter.

What are some factors that you think would lead you to the high end or the low end of your EPS guidance range for 2017, aside from the stock option expense and the direct response margins?

Jimmy, for 2017, some of the real sensitivities are obviously some money raised, especially earlier in the year, and for the remainder of ’14 could have some impact on that. And then AIL margins, I mean it’s a big enough block of business that if there were some fluctuations in the claims that we have in 2017. If you move about half of a percentage point in their margin ends up being probably $0.03 worth of earnings, and then just generally on the buyback. Obviously, our expectations of free cash flow for next year looking out our projections. We’d really only have statutory earnings completed through June 30th at this point in time. So the extent that that moves if that were to change significantly, something were to happen between now and the end of the year, our stock price would have fluctuated, and that would also have some impact.

As you look at the edges of the range, and I think as we’ve talked about in prior years. The bottom end of that range really assumes that you have at the lower end of the margins for each of the distributions then you have some lower interest rates. And so you have a lot of things going and get you at the upper end and have basically at the upper end of those ranges.

Jimmy, I would like to elaborate on the underwriting income, particularly the life underwriting income. There have been challenges with direct response. If we exclude direct response, our remaining underwriting income over the past two years shows that premiums have increased by 5% to 6% and margins have risen by 6% to 7%. We anticipate that these margins will remain stable. Therefore, I believe the main variables affecting us are direct response and interest rates.

I joined a little bit late, so I apologize if this has already been discussed. Can you provide an update on your sales outlook for 2017 across the various distribution platforms? Additionally, regarding your 2017 guidance, how much new capital do you expect to deploy, and at the midpoint of your range, what yield are you anticipating from those new investments?

John, I’ll address the sales projections, first for 2017. At American Income, we’re projecting net sales growth for 2017 in the range 6% to 10%. At Liberty National, the net life sales should increase 7% to 11%. The net health sales should increase 4% to 6%. At Family Heritage, we’re predicting 3% to 7% increase in health sales. In direct response, we think the sales will be flat to decrease by 5%. In the United American General Agency individual Medicare settlement sales, we projected sales growth of 6% to 10%.

John, as far as our investments for next year, we’re expecting to invest just under $1 billion for the year. And we expect the rates to increase slightly as we go through the year. The weighted average rate that we’re assuming for ’17 is 4.65%.

And then I think Frank, you had mentioned that free cash flow expected to be generated for 2016 was about $320 million. I don’t think there is any change to that relative to what you’ve talked about over the last couple of quarters. Did you mention 2017 your expectations, and do we see some benefit, I think, from proceeds from the Medicare sale?

For 2017, what I indicated was around $325 million to $335 million. And there will be embedded in that probably around $10 million to $15 million of after-tax proceeds from the sale of Part D that is helping with that to some degree.

And the expectation was, Frank, that the RBC ratio would recover to or toward at least 325% target by the end of ‘17?

Yes, we’re comfortable that we will be at or above the 325% by the end of ‘17.

Is that primarily based on the expectation that you will retain a bit more of your statutory earnings throughout the year?

No, it’s actually the combination of using some of the debt proceeds that we have had to probably make some capital contributions between the remainder of this year and into 2017. We have mentioned in the previous call that there is some capital that will be freed up from the Part D sales, likely between $15 million to $20 million this year and another $50 million or so next year. So, it's really the combination of those factors that will be driving it.

I wanted to circle back on direct response. I know in the beginning of the year you mentioned that some of the elevated expenses, and elevated loss ratios, driven by the 2011 through 2014. Now it sounds like some of 2015 isn’t there as well. I just wanted to see if that is in fact the case and what you are seeing in terms of how 2016 is developing for that business?

What we’re really seeing the higher claims, in this particular year, is some increased mortality in just certain geographic and demographic segments of our business. And most of that does relate to 2011. And we are seeing a little bit of that already in the 2015 accident year. We’ve really seen a spike in claims this year. Then we found was we have seen the spike in claims earlier, the first half of this year. And that was giving rise to some of our elevated guidance in the claims last quarter. We really did not anticipate those claims to continue on here for the remainder of the second half of the year. But we have continued to see higher claims in these particular segments of our business here in the third quarter. And so at this point in time, we do anticipate that they’ll continue on through the remainder of the year.

And then in the 2017 guidance, does that incorporate the ’16 continuing to develop, and how do you think about the pricing and getting in line in 2017?

So, for the most part, looking at our expectations of the policy obligations for 2017, we are anticipating that the claim level that we’ve seeing here in 2016, for the most part, continue on into ‘17. And then as we’re taking all this emerging experience and we’re working that into our pricing expectations as well as our GAAP expectations really from this point going forward. So, for the remainder of 2016 and then also will be taken into account for 2017 business.

And then as we think about mortality more broadly this quarter in some of the other segments in AI, etc. How do they compare versus either typical seasonality in the third quarter?

No we did see some favorable claims experience really at American Income, primarily in American Income, Liberty National, and our military businesses. All of those just had very good claims experience for the quarter.

I would say that American Income showed a slight improvement, but it was very consistent overall. The most notable improvement has been in Liberty National, where we have seen a favorable trend throughout the year. Policy obligations for Liberty have remained at 36.5% for the last four quarters, and it was just above 38% this time. We are pleased with this progress, and it seems to be continuing.

I would say looking forward to 2017. For 2016, at Liberty followed by Gary’s comments, we expect the policy obligations somewhere in that 36% to 37% range, maybe not quite that good in 2017, maybe closer to a little over 37%, something in that range, 37% to 38%.

A couple of questions on the free cash flow numbers that you gave, I got a little confused whether the Part D proceeds were inclusive additives. And specifically for next year, is the 50 million on top of the 325% in the 325% to 335%, or is it part of the whole that you’re going to get back to your 325% RBC? Or could some of that be used for buyback potentially?

The $50 million, Bob, is really more a function of dropping RBC levels. And so when offline using that time frame, so it’s really being able to get for the most part being able to get back to the 325% level. The free cash flow in 2017 being in the 325% to 335% range, that really is based upon the distribution of our statutory earnings from 2016. And embedded in a portion of that statutory earnings from 2016 are the after-tax proceeds of the sale of the Part D.

So the 325% to 335% includes the 50 million in proceeds?

Has the proceeds....

But not the RBC freed up?

That is correct.

Now, I got you. And then the RBC that’s freed up, that’s worth 50 million next year. Is that going to be used for the whole? There are two 325s, we’re talking about the RBC, all of 325? Or can some of that be used for buyback on top of the free cash flow?

Right now, Bob, our projections are looking. It looks like it will be more used to fill the RBC hole, more so than being available to be able to distribute that in excess of normal statutory earnings.

So some of it’s for buyback, but not the majority, is what you’re saying?

I would say that we’re not really anticipating being able to distribute out any of the $50 million of capital that we’re freeing up from the sale.

Administrative expense this year has been a little bit heavy for IT expenses. Does it continue with the same rate next year, incrementally? Or could it grow a little bit slower than the revenues?

It's going to be about the same. That type of growth will be about the same as we have for revenues. So this year or for the quarter it was, administrative expenses were 6.3% of premium, but they should end the year at 6.2%. And we’re projecting for next year that it's going to be 6.2% to 6.3% of premiums. So, there is simply growth in the administrative expense, but it's going to match the growth in the premium.

The tax rate was a little low this quarter as it was last quarter. Was that the option element floating through? Or is there something else going on in the tax rate?

The tax rate was down, really start of last quarter, where there were some of the non-deductible expenses. But we’ve had, ACA as an example of that. We’re really lower than we’ve had in some of the prior quarters. And so if those become reduced, that reduces the tax rate. It really doesn’t have anything to do with the excess tax benefit on the stock options as that’s being on our operating summary netted against the stock option expense.

Is this the new good run rate, or was it unusually low?

No. I think for the most part, we’re really looking at that 32% from an operating tax perspective, it was 32% to 32.8%, somewhere in there 32.7%, somewhere in there, continuing on into 2017.

My question is on the cash flow numbers and your projection of cash flow, and if we look a couple of years ago, you had generally guided to cash flow numbers in the $360 million to $370 million range. And that number has obviously come down over the last couple of years, more like $320 million, if we take out the proceeds from Part D sales this year. I know that there's several things going on with Direct Response and timing of the CMS reimbursements. I was just hoping you could walk us through why we've had to step-down in free cash flow? And if it's something that we should think of as more temporary, or if this is a new run rate that we may grow slightly off of in the future.

I believe the decrease in statutory earnings from 2015 to 2016 is primarily due to the drop in free cash flow from $360 million to $320 million this year. This decline was influenced by several factors, including increased direct response claims and a reduction in the Part D margin over time. Higher direct response claims particularly affected our statutory earnings, accounting for about a third of the decline, which also reflects strong sales we've experienced in recent years. As we continue to grow sales at rates of 8%, 9%, or 10%, it creates a significant amount of first-year statutory strength. Over time, the processes generated from these sales begin to positively affect statutory earnings. Additionally, we've seen increases in IT and administrative expenses and fluctuations in the tax rate. Looking ahead to 2017, I anticipate that direct response will continue to impact our earnings, but I wouldn't expect a substantial difference in statutory earnings from current levels.

All right. Thank you for joining us this morning. Those are our comments. And we'll talk to you again next quarter.