Globe Life Inc (GL) — Q3 2019 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 2018 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 a 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 $202 million or $1.82 per share, compared to $179 million or $1.55 per share a year ago. Net operating income for the quarter was $192 million or $1.73 per share, a per-share increase of 9% from a year ago. On a GAAP-reported basis, return on equity as of September 30th was 12% and book value per share was $65.96. Excluding unrealized gains and losses on fixed maturities, return on equity was 14.7% and book value per share grew 10% to $47.58. In our life insurance operations, premium revenue increased 4% to $631 million, and life underwriting margin was $181 million, up 8% from a year ago. Growth in underwriting margin exceeded premium growth due to higher margin percentages in all our distribution channels. For the year, we expect life underwriting income to grow around 7% to 8%. On the health side, premium revenue grew 5% to $269 million, and health underwriting margin was up 1% to $61 million. Growth in premium exceeded underwriting margin growth, primarily due to lower margin percentage at United American. For the year, we expect health underwriting income to grow around 3% to 4%. Administrative expenses were $61 million for the quarter, up 8.5% from a year ago. As a percentage of premium, administrative expenses were 6.7%, compared to 6.5% a year ago. For the full year, we expect administrative expenses to grow approximately 6% and to be around 6.6% to 6.7% of premium, compared to 6.5% in 2018. I'll now turn the call over to Larry for his comments on the marketing operations.

Thank you, Gary. I'm going to go through the results of each of our distribution channels. I'll start by saying we were especially pleased with the year-to-date agent count growth we've seen across all three of our exclusive agencies. At American Income, life premiums were up 7% to $293 million, and life underwriting margin was up 9% to $100 million. Net life sales were $60 million, up 9%. The sales growth was driven primarily by agent count growth. The average producing agent count for the third quarter was 7,578, up 7% from the year-ago quarter and up 3% from the second quarter. The producing agent count at the end of the third quarter was 7,770. At Liberty National, life premiums were up 2% to $72 million, and the underwriting margin was up 12% to $19 million. Net life sales increased 12% to $13 million, and the net health sales were $6 million, up 8% from the year-ago quarter. The sales growth was driven primarily by agent count growth. The average producing agent count for the third quarter was 2,398, up 10% from the year-ago quarter and up 5% from the second quarter. The producing agent count at Liberty National ended the quarter at 2,421. At our Direct Response operation at Globe Life, life premiums were up 2% to $212 million, and life underwriting margin increased 5% to $41 million. Net life sales were $30 million, down 1% from the year-ago quarter. Year-to-date, sales were down 1% due primarily to a decrease in juvenile life insurance mailing volume. At Family Heritage, health premiums increased 7% to $74 million, and health underwriting margin increased 12% to $19 million. Net health sales were up 9% to $18 million due to an increase in both agent count and agent productivity. The average producing agent count for the third quarter was 1,135, up 5% from both the year-ago quarter and the second quarter. The producing agent count at the end of the quarter was 1,236. At United American General Agency, health premiums increased 8% to $103 million, while margins declined 10% to $14 million. Net health sales were $16 million, up 25% compared to the year-ago quarter. To complete my discussion on marketing operations, I will now provide some projections. We expect the producing agent count for each agency to be in the following ranges for the full year 2019: American Income, 7,350 to 7,450; Liberty National, 2,300 to 2,400; Family Heritage, 1,210 to 1,230. Approximate net life sales are expected to be as follows: American Income for the full year 2019, 6% to 7% growth; for 2020, 5% to 9% growth; Liberty National for the full year 2019, 8% to 10% growth; for 2020, 6% to 10% growth; Direct Response for the full year 2019 down 2% to flat; for 2020, down 3% to 1% growth. Approximate net health sales are expected to be as follows: Liberty National for the full year 2019, 7% to 9% growth; for 2020, 6% to 10% growth; Family Heritage for the full year 2019, 5% to 7% growth; for 2020, 5% to 9% growth; United American individual Medicare Supplement for the full year 2019, 8% to 12% growth; for 2020, relatively flat. 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 define as net investment income less required interest on net policy liabilities and debt, was $65 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 increased 7%. For the full year, we expect excess investment income to grow by about 5%, which would result in a per-share increase of around 8.5%. Regarding the investment portfolio, investment assets are $17.2 billion, including $16.2 billion of fixed maturities and amortized cost. Of the fixed maturities, $15.6 billion are investment grade with an average rating of A minus. Below investment-grade bonds are $623 million compared to $682 million a year ago. The percentage of below investment-grade bonds to fixed maturities is 3.8% compared to 4.4% a year ago. This is the lowest this ratio has been in the last 20 years. Overall, the total portfolio is rated A minus compared to BBB plus a year ago. This is the first time the overall portfolio rating has been A minus since 2016. Bonds rated BBB are 56% of the fixed maturity portfolio as compared to 58% at the end of 2018. While this ratio is higher relative to our peers, we have no exposure to higher risk assets such as derivatives or equities and little exposure to commercial mortgages in asset-backed securities. We believe BBB securities provide us the best risk-adjusted, capital-adjusted returns due in large part to our unique ability to hold securities to maturity regardless of fluctuations in interest rates or equity markets. Finally, we have net unrealized gains in the fixed maturity portfolio of $2.6 billion, $638 million higher than the previous quarter, due primarily to changes in market interest rates. Regarding investment yield, in the third quarter, we invested $409 million in investment-grade fixed maturities, primarily in the financial, industrial, and municipal sectors. We invested at an average yield of 4.12%, an average rating of A, and an average life of 29 years. For the entire portfolio, the third quarter yield was 5.47%, down 9 basis points from the 5.56% yield in the third quarter of 2018. As of September 30, the portfolio yield was approximately 5.45%. At the midpoint of our guidance, we are assuming a new money rate of around 4% in the fourth quarter and a weighted average rate of 4.25% in 2020. At these new money rates, we expect the annual yield on the portfolio to be around 5.49% in 2019 and 5.38% in 2020. While we would like to see higher interest rates going forward, Globe Life can thrive in a lower-for-longer interest rate environment. Extended low interest rates will not impact the GAAP or statutory balance sheets under the current accounting rules since we sell non-interest sensitive protection products. While net investment income, to a lesser extent pinched expense, will be impacted in a continuing low interest rate environment, investment income will still grow; it just won't grow at the same rate as the invested assets. Fortunately, the impact of lower new money rates on our investment income is somewhat limited as we expect to have an average turnover of less than 2% per year in our investment portfolio over the next four years. 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. The parent began the year with liquid assets of $41 million. In addition, as is the norm for Globe Life, the parent will generate excess cash flow in 2019. The parent company's excess cash flow, as we define it, results primarily from the dividends received by the parent from its subsidiaries less the interest paid on debt and the dividends paid to Globe Life's shareholders. We anticipate our excess cash flow in 2019 to be approximately $375 million. Thus, including the assets on hand at the beginning of the year, we currently expect to have around $415 million available to the parent during the year. As discussed on our prior calls, we accelerated the repurchases of $25 million of Globe Life stock into December 2018 with commercial paper and parent cash. We have utilized $15 million of the 2019 excess cash flow to reduce the commercial paper for those repurchases, leaving approximately $400 million available to the parent, including the $50 million of liquid assets we normally retain at the parent. In the third quarter, we spent $83 million to buy 933,000 Globe Life shares at an average price of $89.26. So far in October, we have spent $25 million to purchase 265,000 shares at an average price of $93.50. Thus, for the full year through today, we have spent $282 million of parent company cash to acquire more than 3.3 million shares at an average price of $86.33. Taking into account the $282 million spent year-to-date, we now have around $118 million of available cash, of which $50 million will be retained at the parent, leaving approximately $68 million for use in the remainder of the fourth quarter. Looking forward to 2020, we preliminarily estimate that the excess cash flow available to the parent will be in the range of $365 million to $385 million. As noted on previous calls, we will use our cash as efficiently as possible. If market conditions are favorable and absent alternatives with higher value to our shareholders, we expect that share repurchases will continue to be a primary use of those funds. Now, regarding capital levels at our insurance subsidiaries. Our goal is to maintain capital at levels necessary to support our current ratings. As discussed on our previous calls, Globe Life intends to target a consolidated company action level RBC ratio in the range of 300% to 320% for 2019. Finally, with respect to our earnings guidance for 2019 and 2020. Our third quarter earnings were slightly higher than we anticipated, primarily due to favorable life claim fluctuations during the quarter, plus a one-time $1.2 million consent fee received on the forced exchange of one of our bond holdings. As a result, we are now projecting net operating income per share will be in the range of $6.71 to $6.77 for the year ended December 31, 2019, a $0.02 increase at the $6.74 midpoint of this range over the prior quarter midpoint of $6.72. For 2020, we are projecting the net operating income per share will be in the range of $7 to $7.30, a 6% increase at the midpoint from 2019. Growth will be impeded in 2020 due to the lower interest rate environment, which we currently expect to continue through 2020. 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.

I have a couple of questions. First, regarding Direct Response. It appears that your margins are beginning to recover. To what degree do you believe this is due to the recent changes in pricing and marketing, and do you see the margins reported in the third quarter as sustainable in Direct Response? Additionally, on sales in Direct Response, you previously anticipated an improvement by late 2019. Do you still forecast that sales will turn positive in the fourth quarter, and what is your outlook for 2020?

Jimmy, first of all, the Direct Response margin was at 19.5% in the third quarter. That was a little bit higher than expected. And we think for the year that there’ll be between 18% and 18.5%, that's for 2019. And as far as 2020, our preliminary guidance there is that we will still be at around the 18% level. We talked about a couple of years ago that that's where we thought we would get today, 18% where we'd get to. We're there now, and we think it's going to be stable.

Yes. One thing I would like to add is that we are pleased to see a real stabilization in the policy obligation percentage at around 54%. I agree with Gary that we expect that 18% to remain around that level moving forward. One factor in Q3 that worked in our favor was a slight fluctuation in our amortization of acquisition costs due to updating some models, and we also benefited from favorable persistency. However, we do not expect that trend to continue into Q4, which will likely differ a bit from what we observed in Q3.

Jimmy, I think you also have a question about fourth quarter sales in Direct Response. We are expecting to have lower sales in the fourth quarter. This is due to the lower juvenile mailing volumes in the third quarter. The decline has been due to the weaker than expected juvenile response rates.

Okay. And then, for Gary or Frank, how much insight do you have on the changes in accounting for long-duration contracts? Obviously, that's been delayed by a year. But, how do you think your book value and/or future earnings would be affected by it?

Yes. Jimmy, we continue to work through the implementation of that new guidance. We are pleased to see that it won't be standard for another year just to give us more time. I think the industry as well to really make sure we understand what the implications are. We do have some ideas on directionally, yet at this point in time, still working through a lot of the details. So there's not a lot of detail to share. One thing we would say is that at the current interest levels, we do anticipate that the reserves would have to increase, resulting in a negative impact on the overall equity. Some adjustments will be made. A certain portion of that will be included in other comprehensive income, but as for the exact amounts and what that will look like, we really don't have anything to share at this point in time.

The first question is about the health margins, which were 100 basis points lower year-over-year due to decreased Medicare Supplement margins at United American. Will these margins come under pressure from rising medical inflation for MedSup products? Do you believe we're at a level where they will remain stable?

Well, Andrew, we have seen an uptick in clients this year. Our expectation now is that going forward, the policy obligations, say in 2020, will be in the range of 65% to 66%. It’s early. When we give our guidance in the fourth quarter call, I think we'll have a better feel for that.

Okay. And then, what was driving the strong health sales growth at United American and Family Heritage in the quarter? It was pretty robust.

United American, the growth was driven primarily by the individual business. In the individual business, market conditions are favorable from a pricing standpoint at this time. We also had strong growth from some of our larger agencies. At Family Heritage, the sales growth is driven by a rise in agent counts and greater productivity.

Okay. Lastly, regarding the new money yields, it was notable that you reported a new money yield of 4.1% this quarter, especially since last quarter it was 5%. I understand that interest rates fell significantly, but could you provide some insight into why there was such a sharp decrease quarter-over-quarter?

Well, Andrew, the biggest factor there was the drop in the treasury rates during the quarter. Additionally, the quality of the bonds purchased in the third quarter was a little higher than we had in the second quarter. But the big part of it was that the treasury rates had dropped by 60 basis points.

Yes. I think you said a little earlier that it's going to be 4.25% is your projection next year for the new money rates. Is that right? Do you expect a little rise in treasury?

Yes.

Yes. You do?

Yes. In this scenario, we expect slightly higher treasury rates by the end of the year. That 4.25% was a weighted average rate, starting lower in the first part of the year; however, we think it will increase slightly as we move through the year.

I just wanted to touch on life underwriting margins more broadly. It looks like they came in better than your expectations across almost all of the segments this quarter. I know you touched on Direct Response, but was this just a particularly favorable quarter for mortality experience at American Income than Liberty, or is there something else that led to the improvement? And what are you assuming for life margins across the other businesses in 2020?

Erik, you're right. Across the board, we did have better mortality than expected. I think the bigger surprise was Liberty. In that one, we're thinking maybe a fluctuation because of the policy obligation there, the ratio there, 33.7 is lower than we've seen in quite some time. At American Income, we saw improvement there, but we think that we see improvement in mortality over the last several quarters at American Income. The impact on the margin has been the underwriting margin going from 33% to 33.6%. That doesn't sound like a big change; however, on a $1 billion in premiums, it does make quite a bit of change for our growth in earnings. The margins for this quarter were over 28% for the overall life business. We think that's going to revert back, and we're looking for underwriting margin for the full year to be around 27.9%, right at 28%. Our early thoughts on 2020 are that we’ll still be in that same range. What we have seen is increased or improved mortality, especially at American Income and also Direct Response over the last couple of years; we don't think we'll see improvement going forward, but we think we'll maintain the profit margins and where we are for this year. So, again, we think we'll be right around 28% for the year, and we think that that will hold in 2020 as well.

And then, just moving to the health side. I guess, you gave some expectation around the United American margin. It looks like it would stabilize a bit. Is the reason that you're assuming flat sales that you're having to raise price a bit to reflect some of the experience?

I think it's given us strong growth in Medicare Supplement for 2019. It's really a tough comparable. Our Medicare Supplement sales in a market that's hard to predict. We use general agency distribution, and those market conditions have changed rapidly. Although we're giving that guidance to be flat, it's really truly to give any certainty to the guidance.

I have a couple of questions about the 2020 EPS guidance. Can you give us a sense of what your expectation is for admin expense growth in 2020?

Yes. Ryan, we're expecting around a 5% to 6% growth in administrative expenses.

Yes. I was just going to say that we really anticipate that percentage of premium to be about 6.7% that we're anticipating here for 2019.

I may have missed this, but could you also give the rough expectations for underwriting income growth for both life and health in 2020?

Well, for life, we're looking at 3% to 5% growth; and for the health insurance, we're looking at 4% to 6%.

On the Direct Response margins, you're now at about 18% to 19% for life underwriting margin. If we look back to 2011 through 2015, that margin percentage was in the 23% range. So, is there anything that's preventing you from getting back to that level?

Yes. At this point in time, as we are having to kind of recalibrate our thought process, taking into account the additional information we're getting on our underwriting and the results we had from that during that 2011 to 2014 timeframe, in the near term, we really think that it's going to continue to be in the 18% to 19% range. It's difficult to say over time as we work through testing and continuing changes, if we can get back to those levels. But in the near term, we think we'll be closer to this 18% and 19%.

And does it have anything to do with the IRRs on new products? Is that a consideration as well?

I don't think it's really the IRRs on the new products. The products are essentially the same. It's just getting the right mix of pricing and underwriting and working through all those to maximize the underwriting dollars and trying to get the right response rates and growth in sales, but at a price and a margin that we can ultimately grow underwriting dollars more so than focusing on the underwriting percentage.

Got it. And then, just real quick on American Income sales. So, you talked about some near-term pressure from just opening up new offices. I assume this kept middle management busy, just onboarding and training new agents. Given the results of the last couple of quarters, which were particularly good this quarter, are we starting to see a turnaround in sales? Is this headwind starting to abate?

I think we've had several factors in American Income that led to the industry growth. First, we had strong recruiting, with fewer terminations that was caused in part by the restructuring of compensation. Year-to-date, our recruiting is up 9%. Another important factor is that for this year, we got middle management growth of 9% year-to-date. As you stated, we have 13 new offices that opened since January 2018. Middle management and officers have been replaced now. We're starting to see recruiting activity in those 13 new offices. All those factors are at work and increasing the agent count at American Income.

My first question is about agent count and recruiting. It seems that some online distributors are aiming for higher growth rates and there is more discussion about a gig economy approach for agents. I would like to hear your perspective on that business model compared to yours, and what you're doing to address this situation. Are you feeling pressure from agents leaving for that kind of gig model? Any insights on what is helping you strengthen your agent recruiting would be appreciated.

To discuss the marketing generally, we operate in an underserved market. Typically, we're the only agent in that home, and so, there's not competition from other agents nor digital competition since this is a need that's filled. People aren't looking to buy life insurance; you're really explaining the need, and people buy insurance if they understand that need. So, I think there will be a place for life insurance agents as we go forward. We're selling smaller face policies, and there's not real competition in that part of the market because other agencies or other companies can't control expenses. Expense control is so important in writing lower face policies. So, for both expense control and for the market we serve, I think the agents fill an important issue in the market.

Got it. So, in the last couple of years, thinking now longer term, I mean, you're not seeing any signs that would lead you to believe in any way that there is shifting consumer preference for online purchasing versus in-home with an agent in person. Do you still feel like all the trends are still there for this to be the business model long term?

Yes. I think all the trends are there. We continue to grow the agency force. We continue to grow middle management and open offices. We haven't seen a change in persistency; our persistency and retention of agents remained unchanged. The short-term factors we discussed in earlier calls were the low unemployment rate, and we've dealt with that through research and compensation while really focusing on training and retention of our new agents. So, I’d say the long-term business model remains strong.

There are no major plans to change structure. First, from a legal structure, there are really no plans. We'll continue to have several companies operate under the Globe brand. As for our systems and back-office operations, we've consolidated those quite some time ago. What we're doing now is upgrading those systems, which will provide better service.

From a structural perspective, we don't have that many operating companies to begin with. As we have taken a look at and considered it along with the branding strategy, the cost of moving that, and working through changes with policyholders and transferring them through some type of merger wasn't worth the potential benefits we might achieve. We feel comfortable operating within the current legal structures we have while still achieving efficiencies through the overall consolidation of systems and working under the unified brand.

All right. Thank you for joining us this morning. Those are our comments. We will talk to you again next quarter.