Globe Life Inc (GL) — Q4 2017 Earnings Call Transcript

Thank you. Good morning everyone. Joining the call today are Gary Coleman and Larry Hutchinson, 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 2016 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'll now turn the call over to Gary Coleman.

Thank you, Mike and good morning everyone. In the fourth quarter, net income was $1.27 billion or $8.71 per share, compared to $135 million or $1.12 per share a year ago. The increase is due primarily to the reduction of the parity contracts liabilities, resulting from the tax legislation passed late in 2017. While we view tax reform as being very beneficial to Torchmark and its shareholders in the long run, the positive impact of the new lower tax rates on current taxes paid will be largely offset by the expanded tax base over the next several years. Frank will discuss this in more detail in his comments. Without the impact of tax reform, net income for the fourth quarter would have been $153 million or $1.30 per share. Net operating income from continuing operations for the quarter was $147 million or $1.24 per share, a per share increase of 8% from a year ago. On a GAAP reported basis, return on equity as of December 31 was 28.2% and book value per share was $52.95. Excluding unrealized gains and losses on fixed maturities and the impact of tax reform, return on equity was 14.4%, and book value per share was $34.68, an 8% increase from a year ago. In our life insurance operations, premium revenue increased 6% to $581 million and life underwriting margin was $160 million, up 12% from a year ago. Growth in underwriting margin exceeded the premium growth, due primarily to favorable results in direct response and to a lesser extent, American Income. In 2018, we expect life underwriting income to grow around 4% to 5%. On the health side, premium revenue grew 3% to $246 million, while health underwriting margin was up 4% to $55 million. In 2018, we expect health underwriting income to grow around 3% to 5%. Administrative expenses were $55 million for the quarter, up 9% from a year ago and in line with our expectations. As a percentage of premium from continuing operations, administrative expenses were 6.6% compared to 6.4% a year ago. For the full year, administrative expenses were $211 million or 6.4% of premium. In 2018, we expect administrative expenses to grow approximately 6%, and to remain around 6.5% of premium. I will now turn the call over to Larry for his comments on the marketing operations.

Thank you, Gary. At American Income, life premiums were up 9% to $258 million and life underwriting margin was up 14% to $86 million. Net life sales were $56 million, up 7% due primarily to higher agent productivity. The average producing agent count for the fourth quarter was 6,959, up 1% from a year ago and down 3% from the third quarter. The producing agent count at the end of the fourth quarter was 6,880. Life sales for the full year 2017 grew 6%. At Liberty National, life premiums were up 2% to $69 million, while life underwriting margin was down 3% to $18 million. Net life sales increased 19% to $12 million, while net health sales were $6 million, up 21% from the year-ago quarter. The sales increase was driven primarily by growth in agent count and worksite activity. The average producing agent count for the fourth quarter was 2,112, up 19% from a year ago, but down 1% compared to the third quarter. The producing agent count at Liberty National ended the quarter at 2,106. Life net sales for the full year 2017 grew 17%. Health net sales for the full year 2017 grew 5%. In our Direct Response operation at Globe Life, life premiums were up 4% to $199 million. Net life sales were down 15% to $29 million. For the full year of 2017, life sales declined 10%. As we have discussed on previous calls, the sales decline is intentional. We have made operational changes designed to improve profitability in certain segments. Our primary marketing focus is to grow overall new business profits by maximizing margin dollars rather than emphasizing sales levels or margins as a percentage of premium. We are pleased with the increase in profit margins. At Family Heritage, health premiums increased 8% to $65 million and health underwriting margin increased 9% to $15 million. Health net sales grew 12% to $15 million. The average producing agent count for the fourth quarter was 1,026, up 8% from a year ago and approximately the same as the third quarter. The producing agent count at the end of the quarter was 1,076. Health sales for the full year 2017 grew 10%. At United American General Agency, health premiums increased 3% to $92 million. Net health sales were $28 million, up 17% compared to the year ago quarter, due to increases in both the group and individual Medicare supplement units. To complete my discussion for the market operations, I'll now provide some forward-looking information. We expect the producing agent count for each agency at the end of 2018 to be in the following ranges; American Income, 7,000 to 7,400; Liberty National, 2,300 to 2,500; Family Heritage, 1,125 to 1,185. Approximate life net sales trends for the full year 2018 are expected to be as follows; American Income, 6% to 10% growth; Liberty National, 11% to 15% growth; Direct Response, 1% to 9% decline. Health net sales trends for the full year 2018 are expected to be as follows; Liberty National, 1% to 5% growth; Family Heritage, 3% to 7% growth; United American Individual Medicare supplement, 4% to 8% growth. I'll now turn the call back to Gary.

I want to spend a few minutes discussing our investment operations. First, excess investment income. Excess investment income, which we define as net investment income less required interest on net policy liabilities and debt, was $58 million, a 1% decrease over the year ago quarter. The decrease is due in part to the negative carry from the earlier refinancing of a debt issue. On a per share basis, reflecting the impact of our share repurchase program, excess investment income was up 2%. In 2018, we expect excess investment income to grow around 3%. However, on a per share basis, we expect the increase to be around 6% to 7%. In our investment portfolio, invested assets were $15.8 billion, including $15 billion of fixed maturities at amortized cost. Out of the fixed maturities, $14.3 billion are investment grade, with an average rating of A- and below investment grade bonds were $702 million compared to $751 million a year ago. The percentage of low investment grade bonds of fixed maturities is 4.7%, compared to 5.3% a year ago. And with a portfolio leverage of 3.2 times, the percentage of below investment grade bonds to equity, excluding net unrealized gains on fixed maturities, is 15%. Overall, the total portfolio is rated BBB+, the same as the year ago quarter. In addition, we have net unrealized gains in the fixed maturity portfolio of $2 billion, approximately $916 million higher than a year ago. Regarding investment yield. In the fourth quarter, we invested $262 million in investment grade fixed maturities, primarily in industrial sectors. We invested at an average yield of 4.36%, an average rating of BBB+, and an average life of 25 years. For the entire portfolio, the fourth quarter yield was 5.61%, down 14 basis points from the 5.75% yield in the fourth quarter of 2016. As of December 31st, the portfolio yield was approximately 5.60%. For 2018, the midpoint of our current guidance assumes an increasing new money yield throughout the year, averaging 4.75% for the full year. We are encouraged by the prospect of higher long-term interest rates. Higher new money rates will have a positive impact on operating income by driving up excess investment income. We're not concerned about potential unrealized losses that are interest rate-driven, since we would not expect to realize them. We have the intent, and more importantly, the ability to hold our investments to maturity. However, if rates don't rise, a continued low interest rate environment will impact our income statement, but not the balance sheet. Since we primarily sell non-interest sensitive protection products accounted for under FAS 60, we don't see a reasonable scenario that would require us to write off DAC or to put up additional GAAP reserves due to interest rate fluctuations. In addition, we do not foresee a negative impact on our statutory balance sheet. While we would definitely benefit from higher interest rates, Torchmark would continue to earn substantial investment income in an extended low interest rate environment. Now, I will turn the call over to Frank.

Thank you, Gary. I would like to take a moment to talk about our share repurchases and capital position. In the fourth quarter, we spent $82 million to buy 950,000 Torchmark shares at an average price of $86.06. For the entirety of 2017, we spent $325 million from our parent company's cash to buy 4.1 million shares at an average price of $78.67. Thus far in 2018, we have spent $26.8 million to acquire 292,000 shares. These purchases are funded by the parent company's excess cash flow. The parent company ended the year with liquid assets totaling $48 million and we expect to generate more excess cash flow in 2018. This excess cash flow primarily comes from dividends received from our subsidiaries, minus the interest paid on debt and dividends given to Torchmark shareholders. While our statutory earnings for 2017 are still being finalized, we anticipate that excess cash flow for 2018 will be between $320 million and $330 million. Therefore, along with the assets available at the start of the year, we expect to have about $378 million to $380 million in cash and liquid assets available to the parent company throughout the year. As we have stated on previous calls, we will use our cash in the most efficient way possible. If market conditions are right, we plan to continue share repurchases as a primary use of these funds. Additionally, we expect to retain around $50 million in parent assets by the end of 2018 unless we need to use these funds for insurance company operations. Next, I want to comment on the new tax legislation. As you know, the Tax Cut and Jobs Act was signed into law on December 22nd, 2017. This legislation makes significant revisions to corporate income tax rates, lowering them from 35% to 21%, along with other changes to the Tax Law. Overall, this will provide significant long-term advantages for Torchmark since future business profits will be taxed at the lower rate, benefiting our long-term shareholders. The tax rate reduction required us to make a one-time adjustment to lower the deferred income tax liability recorded in our GAAP financial statements. This adjustment, along with other one-off adjustments, led to a non-recurring GAAP tax benefit of $874 million recorded in the fourth quarter, about $275 million of which relates to unrealized gains on fixed maturity investments. This entire $874 million adjustment is classified as a non-operating item, but it, as previously mentioned by Gary, has significantly increased our GAAP net income per share. The tax adjustment also raised our book value per share on December 31st, 2017, by $5.09, approximately 15%. Looking ahead, we expect our effective tax rate for operating income in 2018 to be between 19% and 20%, which should lead to an expected increase in net operating income of around 17%. Although the new tax rate will lower our GAAP tax expenses, cash taxes paid will not see a similar reduction in the short to intermediate term. On a cash tax basis, the lower rate will mostly be offset by provisions in the new legislation that limit tax deductions for policy reserves and acquisition costs. As a result, we do not foresee a substantial increase in statutory earnings from the lower rates. Furthermore, the lower tax rate will negatively affect our insurance company statutory capital by reducing deferred tax assets. Although we have not finalized our statutory filings for our insurance subsidiaries, we estimate a reduction in total statutory capital to be around $130 million to $140 million as of December 31st, 2017. In summary, while the GAAP tax rate is expected to decline by 12 to 13 basis points, cash taxes will only decrease slightly in the near term, and we might need to inject capital into our insurance subsidiaries over time to compensate for the reduced deferred tax assets. In the next months, we will further evaluate the short and long-term impacts of the new tax legislation on our operations. Now, regarding the capital levels at our insurance subsidiaries, we aim to maintain our capital at a level adequate to preserve our current ratings. For several years, that level has been around an NAIC RBC ratio of 325% on a consolidated basis. Although our 2017 statutory financial statements are not yet finalized, we expect our consolidated RBC ratio to be between 300% and 310% of the company action level RBC, reflecting a decline of about 30 basis points due to the reduced deferred tax assets we discussed. If the NAIC adjusts the RBC factors in 2018, as anticipated, to accommodate the lower tax rate, we expect an additional decrease of approximately 45 basis points in our RBC ratio by the end of December 2018. We are still in the early phases of determining an appropriate target RBC ratio for our insurance subsidiaries in 2018, considering the new tax legislation and will need to discuss this with our rating agencies and regulators. If we decide to make further capital contributions, we believe we can cover any required amounts without significantly affecting our excess cash flow. Next, I would like to provide an update on our Direct Response operations. In the fourth quarter, we observed growth in the Direct Response underwriting margin once again. The underwriting margin, as a percentage of premium, was 18.4%, an increase from 15.1% in the same quarter last year. This is due to higher-than-expected policy obligations in the fourth quarter of 2016 compared to lower policy obligations in the fourth quarter of 2017. Although the decrease in policy obligations was generally expected due to seasonality, overall, the underwriting margin percentage for the fourth quarter was at the higher end of our expectations. The underwriting margin percentage for all of 2017 was 15.6%, at the higher end of what we projected in prior calls. For 2018, we estimate that the underwriting margin percentage for Direct Response will be similar to 2017, falling within the range of 14.5% to 16.5%. We also anticipate that the underwriting margin percentage will be seasonally low in the first half of the year and higher in the second half. Finally, regarding our earnings guidance for 2018, we project that net operating income from continuing operations per share will range from $5.90 to $6.10 for the year ending December 31st, 2018. The midpoint of this guidance, $6 per share, represents a 24% increase compared to the 2017 earnings per share of $4.82. This increase is mainly due to the lower tax rate in 2018, offset by increased after-tax compensation expenses resulting from the lower tax benefits. We now expect our stock compensation expense to be between $18 million to $22 million, compared to around $5 million had there been no tax reform. Those are my comments, and now I will turn the call back to Larry.

Thank you, Frank. Those are our comments. We will now open the call up for questions.

Hi. I had a question, first on just the capital and cash flow. What are some of the actions that you're considering to replenish capital at the subs? And do you expect this to sort of affect share buybacks, especially if the rating agencies don't change their RBC thresholds?

Yes, Jimmy. Right now, we still need to figure out what we believe are the right target RBC levels for the organization in light of the changes in the tax rates. We haven't had significant discussions with the rating agencies about what we expect those levels to be. If we do need to inject additional capital to compensate for the lower deferred tax assets, we are considering doing that through debt financing rather than using our excess cash flows, but we still have to work through that.

Okay. And then on the Direct Response business, your margins improved. I think this is the third straight quarter that they improved and the magnitude of the improvement was higher this quarter than in the past few. Is that just because of the actions that you've been taken on limiting marketing and pricing? Or was there like an aberration or something else that helped the results this quarter?

Jimmy, regarding the impact on the fourth quarter, we found that the claims came in slightly lower than our expectations for the overall block. While we are observing higher profit margins on new business, the contribution to margin from that new business in the first year isn't substantial. Therefore, the increase in the fourth quarter is primarily driven by the lower claims.

Yes, part of that, Jimmy, is also just the seasonality. We really didn't expect the policy obligation percentage in the fourth quarter to be around that 55% or 56% range; it came in around 54%. So, it was really the low end of our expectations. However, we were anticipating improvement in the fourth quarter. Looking ahead to 2018, we expect some high seasonal clients in the first half of the year, which may lead to a slightly lower underwriting margin percentage in that period, but we anticipate it will rebound in the second half of the year.

Okay. And then just lastly, I don't know if you mentioned and I missed it, but what's the tax rate that you're embedding in your new EPS guidance?

Between 19% and 20%.

Okay. All right. Thank you.

Good morning, Torchmark, and thank you for the detailed discussion on taxes. I have a follow-up question regarding how the rating agencies and regulators would perceive a situation where your GAAP earnings and equity increase, but your GAAP taxes paid decrease over time, particularly in the short to intermediate term. Why would there be a need for more capital while all these positive changes are occurring? Are we assuming they only consider historical calculations, or do they engage in a more thoughtful analysis of how these factors interact?

Bob, we had many of the same questions. As Frank mentioned, we haven't yet discussed this with the rating agencies, but I believe this will be part of our conversation. Frank, do you have anything to add?

Yes, no. It's just kind of one of those funny anomalies of where the tax rate goes down, which should be good long-term benefit, but you have required additional capital. So, those are some of the questions that we'll have to get answered.

But you think there is a chance that logic would prevail, or you think the more likely scenario is that they blindly hold to their math calculations?

I think, Bob, for us, we don't have enough information to know. We haven't had discussions with them, so we'll just have to wait and see.

Okay. Thank you very much.

Hi. Can you discuss how much capacity you currently believe you have? I understand that tax reform led to a significant increase in GAAP book value. Could you provide insight into where the debt to capitalization ratio might go and your thoughts on debt capacity?

Our debt to capital ratio at the end of 2017 is expected to be just under 24%, and we anticipate that it will decrease to below 23% by the end of 2018. If we were to raise our debt to capital ratio back to the levels we've experienced over the past couple of years, around 26%, we would likely have about $300 million in capacity to maintain that ratio. Additionally, our discussions with the rating agencies generally allow for a higher threshold concerning our debt to capital ratio before they express significant concern, which would provide us with even more capacity if needed.

Got it. Is it correct that you did not assume any debt issuance in your EPS guidance for 2018?

That is correct.

Okay. The last question is regarding the free cash flow guidance of $320 million to $330 million for 2018. This is primarily based on the 2017 financials. If we extend this to the following year and consider changes in cash taxes, would you still anticipate a similar amount of free cash flow for 2019 as you expect for 2018?

Yes. With all things else being equal, from a statutory earnings perspective, looking forward a year, we really anticipate probably between $5 million and $10 million of lower cash taxes, solely because of the tax reform. So, we think it could be a slight uptick from that perspective and then obviously there are several other items in there that could affect the cash flow going forward. But we would expect it to be at that level or starting to tick up a little bit from there.

Good morning. I have a question regarding RBC. Given that you have performed fewer of the XXX transactions and engaged in statutory capital optimization, I understand the NICs are being assessed against a variety of options related to group capital calculation. If one of those strategies involves applying PBR to create a more equal framework for those who have utilized XXX and AXXX versus those who have not, how significant would the benefits be for your company? Specifically, what impact would this have on your surplus or reserves if PBR were utilized? I'm looking for rough estimates to understand if such an approach would resolve any challenges you face with RBC, particularly in regard to the optics of declining tax rates or tax reform.

Yes. The PBR that's come out, it's really more focused on some of the aggressive term insurance and the UL products and secondary guarantees. Products that we don't write. So, we have a few blocks of business where PBR will come into effect, but it is pretty minimal. And at this point in time, we really don't anticipate that PBR will have any real material impact on the amount of our statutory reserves.

Okay. And I guess, second question, just on the guide for 2018. The updated guide versus the guide you provided previously. I mean, there, could you highlight just if there are any other sort of adjustments, moving parts in there other than just the tax rate? And how to think about those?

Sure. Based on our previous guidance, we noticed an improvement on the health lines, which we are considering as we move into 2018. We expect the overall margins in the health sector to be similar to those in 2017, which reflects a slight improvement from our earlier expectations in October. The experience we had in the fourth quarter contributed to this outlook. However, this increase may be somewhat counterbalanced by higher administrative costs. Our pension expenses are anticipated to rise again in 2018, presenting a bit of a challenge. Additionally, short-term interest rates, which affect our short-term debt, will lead to higher interest expenses. Furthermore, given the recent rise in share prices, there will be some negative impact from our buyback program. Regarding stock option expenses, while the reduction in overall tax rates provided about $1 of additional earnings per share due to the rate change, the excess tax benefits we previously experienced are now offsetting our stock option expenses. We are facing a lower tax benefit along with decreased excess tax benefits, which explains the decline in the overall impact of the tax rate.

Okay. Thank you.

Hi. I wanted to follow-up on the tax rate. Is the primary reason for the tax rate being lower than on the statutory rate of 21%, just tax-preferred investments, like Build America Bonds or is there something else as well?

It's primarily low-income housing tax credit investments that we've made over the years.

Okay, and how should we think about the duration of those? Is that something that comes into play in your tax rate over the next two to three years? Or are they longer duration, so you shouldn't expect much of a change in the 2019 to 2020?

Yes, we continue to build the portfolio over the years, and these generally receive credits over a period of 10 to 12 years. There is a slight period where benefits may not be realized immediately, so there are still several years to consider in relation to those benefits.

Okay. Thank you.

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