Globe Life Inc (GL) — Q2 2018 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 2017 10-K and 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 second quarter, net income was $184 million or $1.59 per share, compared to $140 million or $1.18 per share a year ago. Net operating income for the quarter was $175 million or $1.51 per share, a per share increase of 27% from a year ago. Excluding the impact of tax reform, we estimate that this growth would have been approximately 8%. On a GAAP reported basis, return on equity was 12.2% and book value per share was $48.44. Excluding unrealized gains and losses on fixed maturities, return on equity was 14.6% and book value per share grew 26% from a year ago to $42.08. In our life insurance operations, premium revenue increased 5% to $630 million and life underwriting margin was $161 million, up 9% from a year ago. Growth in underwriting margin exceeded premium growth due to higher margins at American Income and Direct Response. For the year, we expect life underwriting income to grow around 5% to 7%. On the health side, premium revenue grew 4% to $251 million, and health underwriting margin was up 8% to $60 million. Growth in underwriting margin exceeded premium growth due to higher margins at Family Heritage. For the year, we expect health underwriting income to grow around 6% to 8%. Administrative expenses were $55 million for the quarter, up 8% from a year ago and in line with our expectations. As a percentage of premium, administrative expenses were 6.5% compared to 6.3% a year ago. For the full year, we expect administrative expenses to be up 5% to 6% and around 6.5% of premium compared to 6.4% in 2017. 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 $270 million and life underwriting margin was up 11% to $89 million. Net life sales were $60 million, up 5%. The producing agent count for the second quarter was 7,064, up 1% from a year ago, and up 4% from the first quarter. The producing agent count at the end of the second quarter was 7,143. At Liberty National, life premiums were up 2% to $69 million, while life underwriting margin was down 7% to $17 million. Net life sales increased 9% to $13 million, and net health sales were $5 million, up 9% from the year-ago quarter. The sales increase was driven primarily by growth in agent count. The average producing agent count for the second quarter was 2,185, up 9% from a year ago, and up 5% compared to the first quarter. The producing agent count of Liberty National ended the quarter at 2,198. Our Direct Response operation at Globe Life, life premiums were up 3% to $209 million, and life underwriting margin increased 21% to $36 million. Net life sales were down 5% to $35 million. As we have discussed on previous calls, the sales decline is by design. We continue to refine and adjust our marketing programs in an effort to maximize the profitability of new sales. At Family Heritage, health premiums increased to 8% to $68 million and health underwriting margin increased 14% to $16 million. Health net sales grew 10% to $16 million. The average producing agent count for the second quarter was 1,052, up 2% from a year ago and up 6% from the first quarter. The producing agent count at the end of the quarter was 1,090. At United American General Agency, health premiums increased 3% to $94 million. Net health sales were $13 million, up 3% compared to the year-ago quarter. To complete my discussion on the market operations, I will now provide some projections. 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 7,300; Liberty National 2,200 to 2,400; Family Heritage 1,060 to 1,210. Approximate life net sales trends for the full year 2018 are expected to be as follows: American Income, 4% to 8% growth; Liberty National, 8% to 12% growth; Direct Response, 7% to 10% decline. Health net sales trends for the full year 2018 are expected to be as follows: Liberty National, 4% to 8% growth; Family Heritage, 5% to 9% growth; United American Individual Medicare supplement 10% to 10% growth. I will 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 defined as net investment income less required interest on net policy liabilities and debt was $60 million, a 3% decrease over the year-ago quarter. On a per share basis, reflecting the impact of our share repurchase program, excess investment income was flat. Year-to-date, excess investment was up 1% in dollar terms to the 4% per share. For the full year 2018, we expect excess investment income to grow by around 2%, which would result in a per share increase of 4% to 5%. Now regarding the portfolio, invested assets were $16.1 billion, including $15.4 billion of fixed maturities and amortized costs. Of the fixed maturities, $14.7 billion are investment grade, with an average rating of A-, and below investment grade bonds were $688 million compared to $672 million a year ago. The percentage of low investment grade bonds of fixed maturities is 4.5% compared to 4.6% a year ago, with a lower portfolio leverage of 3.2 times, the percentage of below investment grade bonds to equity, excluding net unrealized gains on fixed maturities is 14%. 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 $935 million approximately $732 million lower than a year ago due to primarily the changes in market interest rates. In the second quarter, we invested $182 million in investment-grade fixed maturities, primarily in industrials and financial sectors. We invested at an average yield of 5.16%, an average rating of BBB+, and an average life of 18 years. For the entire portfolio, the second quarter yield was 5.57%, down 11 basis points from the 5.68% yield in the second quarter of 2017. As of June 30, the portfolio yield was approximately 5.56%. At the midpoint of our guidance, we are assuming an average new money rate of around 5% for the remainder of the year. We would like to see higher interest rates going forward. Higher new money rates have a positive impact on operating income by driving up excess investment income. We are 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 GAAP or statutory balance sheet since we primarily sell non-interest sensitive protection products accounted for under FAS 60. While we would benefit from higher interest rates, Torchmark would continue to earn substantial excess investment income in an extended low interest rate environment. Now, I will turn the call back to Frank.

Thanks, Gary. First, I want to spend a few minutes discussing our share repurchases and capital position. The parent company's excess cash flow, as we define it, results primarily from the dividend received by the parent from its subsidiaries, less the interest paid on debt and the dividends paid to Torchmark shareholders. We expect excess cash flow in 2018 to be around $325 million. Thus, including the assets on hand at the beginning of the year of $48 million, we currently expect to have around $375 million of cash and liquid assets available to the parent during the year. In the second quarter, we spent $88 million to buy 1 million Torchmark shares at an average price of $84.54. So far in July, we have spent $20 million to purchase 243,000 shares at an average price of $83. Thus, for the full year through today, we have spent $195 million of parent company cash to acquire approximately 2.3 million shares at an average price of $85.16. These purchases were made from the parent company's excess cash flow. As noted on previous calls, we will use our cash as efficiently as possible. If market conditions are favorable, we expect that share repurchases will continue to be a primary use of those funds. We also expect to retain approximately $50 million of parent assets at the end of 2018, absent the need to utilize any of these funds to support our insurance company operations. Now, regarding capital levels at our insurance subsidiaries. Our goal is to maintain capital at levels necessary to support our current ratings. For the past several years, that level has been around an NAIC RBC ratio of 325% on a consolidated basis. In light of the current tax reform legislation and proposed investments to the NAIC RBC factors, we are having discussions with the rating agencies to determine the appropriate target consolidated RBC for our insurance subsidiaries going forward. We will continue our dialogue with them over the next several months before making any final decisions. In June, the NAIC issued adjustments to certain RBC factors to reflect the reduction of the corporate income tax rate from 35% to 21%. These new factors will be effective for 2018. Taking into account these new factors, we have roughly estimated that our company action level RBC ratio for the year-end 2018 could be in the range of 275% to 285%. As previously noted, we have not yet finalized our target RBC ratio. However, if we were to set a target ratio of 300% to 325%, it would require a price point of $100 million to $225 million of additional capital. We understand that we may not be required to meet the appropriate target RBC ratio immediately, and we could be allowed to reach the target over a period of time. Given the fact it's actual form increases our GAAP tax lease substantially and thus lower our debt to capital ratio, we have additional borrowing capacity. Thus, we are confident that we can fund any amount to be contributed without a significant impact on our excess cash flow. Furthermore, any additional borrowings should not adversely impact earnings since the additional capital will be invested by the insurance companies in long-duration assets. Next, a few comments on our operations. With respect to our Direct Response operations, the underwriting margin as a percent of premium in the quarter was 17% compared to 15% in the year-ago quarter. This is primarily attributable to favorable claims in the second quarter of this year compared to higher than normal winter claims in the second quarter of 2017. On our last call, we estimated that the underwriting margin percentage for the full-year 2018 would be in the range of 15% to 17%. Now for the full-year 2018, we are estimating the underwriting margin percentage for Direct Response to be in the range of 16% to 18%. We are encouraged by the improved client experience and the fact that the underwriting margin percentage for the last four quarters has averaged 17%. We are obviously pleased with the underwriting income from Direct Response as it increases again. With respect to our stock compensation expense, we saw an increase during the quarter, primarily attributable to the decrease in the tax rate and excess tax benefits in 2018, as a result of the tax reform legislation. We are anticipating these expenses for the full year of 2018 to be in a range of $21 million to $23 million. Finally, with respect to our earnings guidance for 2018, we are projecting the net operating income per share will be in the range of $6.02 to $6.12 for the year ended December 31, 2018. The $6.07 midpoint of this guidance reflects a $0.07 increase over the prior quarter midpoint of $6, primarily attributable to the continued positive outlook for underwriting income, especially for our Direct Response channel. Those are my comments. I will now turn the call back to Larry.

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

First on Direct Response, on the updated margin expectations, as we look beyond 2018, at this point would you expect the margins to continue to gradually move back up or as we think about that as something that would be more stable at this point?

Good morning, Ryan. At this point in time with the information that we have, we do anticipate the margins to stay in that 16% to 18% range. As always, we won't give guidance one year after, but looking forward we know that the new business we are putting on the books has a slightly higher underwriting margin than that, but it will take some time for that to bleed into the results.

And then last quarter you've indicated interest in Gerber Life. As the sale process has continued to move forward, is that still a property that you're interested in acquiring and looking at?

Frank, why don’t you take that question?

Certainly, Ryan. In accordance with our corporate policy, we are not addressing or taking any questions regarding any possible transactions prior to a formal announcement, if and when such an announcement is made.

So just on the potential acquisition, how do you think about your capacity to do a deal? And how large of a deal could you do without really tapping into or without really issuing equity, just using that and actually maybe using some of the capital capacity within your subsidiaries?

Just in general terms with respect to any large transactions or potential acquisitions, of course, any analysis we would do would have to stand on its own as far as merits are concerned. We do look and we anticipate that by the end of the year, we will have around $700 million of debt capacity just to stay within some of the guidelines established by the rating agencies to keep our current ratings. I think as we noted on the last call, in connection with the acquisition, we would be able to probably go over the guidelines they established as long as we would have a plan to get back underneath those, using some of the cash flows from any acquired entity to get ourselves within our appropriate debt to capital ratio. So, that’s probably the extent of what we can do without having to issue some type of equity or without at least having to partner with somebody on some type of transaction.

And then on your margins overall in the life business are pretty good this quarter. But Liberty, the margin in the last couple of quarters has been weaker than they used to be, I think in the 24% to 25% range recently versus 27% plus in the past. Is there anything specific going on in terms of claims trends just normal possibly in the benefits ratio?

Jimmy, the underwriting margin in the second quarter was 24.5%. We were lower in that first quarter because we had a high claims quarter, but we expect declines to even out. But even then, I think our margin will be in the 24% to 25% range for the year, and last year it was at 26%. The reason for the lower margin is that the amortization is a little bit higher because the volume of new business we put on the books in recent years has a higher amortization rate than the older business running off. It's not a huge difference; it's a gradual trend. Last year, amortization was at 31%, and it will be just below 32% for this year. That along with the fact that our non-referred acquisition expenses are a little higher, just over 6% now, versus 5% last year, and that's due to the additional technology costs improving our agency operations. But that shouldn't go higher, so getting back to it, we aren't in the 26% range where we were last year; I think we're more in the 24% to 25% range going forward.

And then just lastly on expectation for Direct Response sales, I think you mentioned that for this year you expect an 8% to 12% drop. You were down 11% year-to-date but were down only 5% in 2Q. So, are you expecting results to get worse from 2Q in the second half? Or is your guidance somewhat conservative?

The guidance is we'll be down 7% to 10% for the entire year 2018. We don’t expect the sales to get weaker, but lower volumes in the second half of the year in terms of the Direct Response. So I think that will be early 2019, when we start to see positive sales growth in the Direct Response channel.

You moved up the growth guidance for health underwriting margins pretty materially for the year. So just hoping you can talk about the drivers of better outlook for that business?

Erik, it's the improved guidance; there really... we're experiencing a little better claims experience than we expected. And it's been two quarters now, and we expect that to continue for the year. And that's really not just one particular distribution; it's really across the board in terms of Family Heritage, the other health or American Income and Liberty National. So, we have increased our underwriting income estimate.

And your sales guidance for health was also pretty promising, I guess, should we expect premium growth to start to pick up there as well?

Within time here with some of that, but that will definitely flow through the additional premium growth, probably not impacting this particular year, maybe just a little bit of the year or the remainder of the year, but more in 2019.

Yes, Erik, last year health premiums grew 3%. I think if I'm right, the midpoint of our guidance we're expecting more of a 4% or a little bit higher increase in 2018.

And then just lastly, you mentioned in your discussion or your script that you have or are having ongoing discussions with the rating agencies. I know A.M. Best recently put Torchmark on a negative outlook and I realize your business is much rating sensitive than many others. But how important is it for you to maintain the A+ rating? And again, what actions would you contemplate to do this, if needed?

Well, we'd like to retain that rating, but A.M. Best's rating is not really new, considering our marketing operations. So it's... if we had to downgrade, I don’t know that that would be a big effort. We would like to retain that rating, but I think as Frank has mentioned, we have to work with A.M. Best and the other rating agencies. We feel like we have appropriate capital levels, and we need to work with them to make our case. Frank, do you have any comments?

I don’t really have anything more to add to what you said. We'll continue; we would like to maintain where we're at, but we'll continue to work with them. We do think there are reasonable arrangements for why target levels could be a bit less than 325%, and we'll make our case over the coming months.

I had a question about the recent Supreme Court ruling related to public labor unions and just around collective bargaining fees. And I guess there's been some speculation that it could lead to reductions in the membership of public sector labor unions. So the question I have for you guys is, when I think about Torchmark's earnings stream and sales, how much of it currently comes from unions? And is there any way for you to help us understand what portion comes from the public sector versus the private sector unions?

Let’s try to address what percentage comes from the public sector versus other unions, but currently, 30% of the new business we issued with American Income comes from the union relationships or union lists. And that percentage has only dropped or depending upon the referrals over the last 10 years. Our union relationships are important almost exclusively because of those referrals. The non-union members come from our union relationships. So, we’re hopeful that this will not have a major impact on the public unions. But we have relationships with all the international and local unions in the U.S., so I don't see this having any material impact on Torchmark.

And when I think about the enforce, if there were a greater than expected reduction in unions, would it... do you think it would affect persistency? And I guess specifically what I'm asking is, are the premiums paid by the union in some cases? Or are they paid by the individual, in which case maybe it would stay with them, even if they dropped out of the union?

The premiums are paid by the individuals, not the union. So, if there is a reduction in union members, it does have to do with the payment process.

I've got a couple of quick ones. One, Gary, I think you mentioned on excess investment income and the expectation that in dollar terms it would grow around 2% in 2018. I think in the first half of the year it's running at just about 1%. What’s the driver of the sort of acceleration? I know it's only modest. Is that just about new money yields being a bit better? Is it about cash flows being maybe stronger?

John, the new money would have a little bit of impact, but I think the big impact is that we have a bit of a timing difference on some non-fixed maturity income, limited partnership income we have, but it was a little lower in the second quarter and that should pick up. We should regain that in the second half of the year. I think that's the... and also the interest expense on the short-term debt is going to stabilize, we believe itself. I think it's a combination of those two things that would give us 2% to 3% growth.

And then, I know in American Income and Liberty, there has been a pretty sizeable correlation, of course, between agent count growth or producing agent talent growth and sales growth. Family Heritage though we saw a sizeable pick-up in sales growth than your agent count is growing at not nearly as quickly. What's happening there? It seems like productivity is certainly improving. Is there something on the product offering side that has changed? Or is there something on the demand side that you think has changed?

Something on the operating side, the products are basically the same but we've seen an increase in the percentage of agents submitting business. We've also seen an increase in the average premium submitted by our agents. The emphasis has been on ensuring Family Heritage maintains consistent production, and so the emphasis is resulting in an increase in the percentage of agents who are producing. Long-term, there's a close correlation between agent growth and production, John. In the short-run, really, its productivity has been a bigger driver for quarter-to-quarter.

And then the last one may be for Gary or Frank. What dialogue have you had to date with the rating agencies? I was interested in your comment, Frank, that it sounds like you think there might be an opportunity to sort of raise your risk-based capital level or recovery, if you will, the risk-based capital ratio over a long-term period of time than necessarily having to get there by year-end 2018. Is that something that you are just speculating? Or is that something that you've had some initial discussions with the rating agencies around?

Yes, so far John, we've had discussions with Moody's and obviously A.M. Best, and there have been indications from Moody's that they at least indicated the potential on a company-by-company basis. We've indicated that we would be outside of that realm. But at least if there were willingness to allow companies that come in below their target RBCs for their ratings, there would be some limited period of time that they would give to replace that capital, generally with consideration that, with the new tax law, this is considered to be a capital-favorable or at least a credit-favorable event. So, we believe that, but again, the companies would need to be making commitments and having some type of a plan to do so in order to receive a method of time. So, these still have in those indications.

And then at your current rating levels assuming they would downgrade, how much incremental borrowing capacity would you estimate Torchmark had?

Again, by the time we get to the end of the year, we would estimate that we'd have above $700 million.

Right, okay, so this $100 million to $225 million estimate really does not push you anywhere near your upper limit, if you will?

Yes, that’s the way we’re looking at it.

And from a cash flow coverage, you feel very comfortable with that too, I assume?

Absolutely, we currently have a cash flow coverage of about five times, which is above what the rating agencies look for us to have, and we feel really comfortable with that. We’ve also got some optimism knowing that our nine in a quarter debt that's coming due here in 2019. As we evaluate that, we'll obviously be able to refinance that at a lower rate, and that would give us some additional cushion, if you will, on those coverage ratios.

The outlook for Direct Response has since improved a little bit. Can you give us a little bit more color on whether it's pricing working its way through the system or just experience bottoming out? And how soon you think you can put your foot on the gas pedal on this one?

Bob, with respect to what's really driving the incremental guidance, there really is the claims settling in again in the second quarter, which gave us additional confidence regarding the claims expected to emerge for the remainder of 2018. In part, it's due to some changes we made overall to our marketing and underlying processes. At this point in time, most of those changes were made in 2017, so we’re not seeing a lot of experience from that. So, a lot of it is really just settling down with some of the claims from the 2011 to 2015 policy period. So, that gives us some added comfort. With respect to the sales volume...

Sales volume, what we’re seeing for 2018 is that our meeting inquiries have fully settled down to about 1% or 2%. Our main volume will be down another 2% or 3%. At the same time, our electronic inquiries were up 6% to 10% and circulation is up about 6% to 8%. When we look at our most recent analysis of the profitability of capital increases from 2016 to '17 in all states, we’re going to maximize total profits. We’re going to the previous phrase, and certain those face. Those reduced rates we implemented at the end of third quarter should result in a pickup in sales in the first or second quarter of next year. Any additional adjustments to rates will depend on future results. We’re really focused on maximizing total profits, not just trying to maximize the margin.

To summarize, the improvement is really based on lower claims. As we mentioned, we haven’t seen the full impact of the underwriting changes that we made in prices, but what we have seen from those so far is positive. We don’t give guidance past this year in sales, but we do believe sales, as Larry mentioned, will increase. We are really positive about Direct Response, and while we think the margin has reached the bottom low as anything, it will increase moving forward. We think we will see greater growth in underwriting income. After having two years where our underwriting income was declining, we are going to see growth this year and we think that growth will continue.

And just a follow-up on Frank's color on potential borrowing. I think what you’re saying is you can now invest your cost of debt or roughly match it with whatever you borrow, so the income impact from borrowing wouldn’t be material?

I do think that's correct, Bob.

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