Welcome to Assurant's fourth quarter 2012 earnings conference call and webcast. At this time, all participants have been placed in a listen-only mode, and the floor will be open for your questions following management's prepared remarks. If you'd like to ask a question at that time, please press star one on your touch-tone phone. If at any point your question has been answered, you may remove yourself from the queue by pressing the pound key. We ask that you please pick up your handset to allow optimal sound quality. Lastly, if you should require operator assistance, please press the star and zero. It is now my pleasure to turn the floor over to Francesca Luthi, Senior Vice President, Investor Relations. You may begin.
Thank you, Kevin. Good morning, everyone. We look forward to discussing our fourth quarter and full year 2012 results with you today. Joining me for Assurant's conference call are Rob Pollock, our President and Chief Executive Officer, Mike Peninger, our Chief Financial Officer, and Chris Pagano, our Chief Investment Officer and Treasurer. Yesterday afternoon, we issued a news release announcing our fourth quarter and full year 2012 results. Both the release and corresponding financial supplement are available at assurant.com. All prior period financial information presented in the release, in the financial supplement, and on this call reflects the new accounting guidance for deferred acquisition costs, which the company adopted as of January 1st, 2012. We'll start today's call with brief remarks from Rob and Mike, with Chris participating in the Q&A session.
Some of the statements we make on today's call may be forward-looking, and actual results may differ materially from those projected in these statements. Additional information on factors that could cause actual results to differ materially from those projected can be found in yesterday's news release, as well as in our SEC reports, including our 2011 Form 10-K, third quarter 2012 Form 10-Q, and upcoming 2012 Form 10-K, each as filed with the SEC. Today's call will also contain non-GAAP financial measures, which we believe are meaningful in evaluating the company's performance. For more details on these measures, the most comparable GAAP measures, and a reconciliation of the two, please refer to the news release and financial supplement posted at assurant.com. I will turn the call over to Rob.
Thanks, Francesca. Good morning, everyone. In 2012, we accelerated growth in the specialty areas we are targeting for expansion and aligned resources to best support these growth opportunities for the future. We also prudently managed our capital. Our strong balance sheet continues to provide great flexibility. We did this in a year when our results were significantly affected by Superstorm Sandy. As we start the new year, we are well positioned to grow profitably. I'll highlight our three key metrics, discuss capital flows, and offer some comments on our progress at each business. Mike will talk about specific results for each of our segments. Operating return on equity, excluding accumulated other comprehensive income, or AOCI, was 10.4% for the year. This includes $163 million of after-tax catastrophe losses.
Book value per diluted share, excluding AOCI, increased by 13.8% for the year, reflecting a combination of our earnings and repurchase activity. Revenue, defined as net earned premium and fee income, increased by 2.4% in 2012, driven by strong contributions from Specialty Property and Solutions. Turning to capital management, we secured $580 million in dividends from our operating companies. This was about $40 million more than the operating income from our businesses in 2012. We returned $472 million to shareholders through stock repurchases and common dividends. Since our IPO in 2004, we've increased our dividend every year. During the fourth quarter, we did not implement a new share repurchase program because of Sandy. It was the largest flood event our business has experienced. By the time we were able to report an estimate of total losses, we'd entered our earnings blackout period.
Despite this interruption, we did buy almost 11 million shares in 2012, representing about 12% of our shares outstanding at the end of 2011. We continue to view our stock as attractively priced and repurchases as a prudent use of capital. Now, I'll turn to the businesses. Assurant Solutions expanded in several targeted areas. In 2012, our net earned premiums from service contracts increased by over $120 million. Our domestic vehicle service contract business was a primary driver as we continue to benefit from the rebound in auto sales that started in mid-2009. We further strengthened our position in Latin America, a key market for Solutions. In the fourth quarter, we signed a 10-year agreement for service contracts with Novo Mundo, one of the largest retailers in Brazil, with more than 180 stores.
At the same time, we continued the phased rollout of our Telefonica partnership and are now servicing their mobile customers across five countries in Latin America. In addition, we recently expanded our relationship with Sprint by launching a mobile device protection program for Sprint's wholesale network partners. Solutions' sales pipeline is robust, and the business is very focused on achieving its 14% ROE goal in 2014. At Assurant Specialty Property, we made tremendous strides in 2012. The investments we've made to better serve homeowners and clients from loan tracking all the way through claims adjudication were evident in our response to Sandy. Our employees quickly brought relief to our policyholders impacted by the storm. The swift deployment of our frontline team ensured that claims were processed and paid quickly. Focusing on customer service and supporting our clients helped us further expand our lender placed business in 2012.
Despite a shrinking overall mortgage loan inventory, we were able to increase the loans we tracked nearly three million to over 31 million loans in total. We're well-positioned to gain more as portfolios move between servicers in the months ahead. Our multifamily housing business, another target area, achieved double-digit revenue growth in 2012. Our Resident Bond products, which complement our renters insurance offerings, helped us cross-sell our products to existing clients and in turn to their residents. We're well positioned to capitalize on the trend of renting versus owning in the U.S. housing market. We're also pleased with our progress at Assurant Health. Despite a challenging fourth quarter, we grew sales for the third consecutive quarter. We completed the rollout of our network agreement with Aetna. With a more competitive product suite and a broader choice of network providers, we've experienced double-digit sales increases in many key Aetna markets.
We saw a pickup in small group sales that we believe reflect our improved competitive position. Those increases, combined with the continued success of our Affordable Choice and supplemental products, helped us grow the total number of insured lives by about 6% in 2012. We will evolve our strategy as new rules related to healthcare reform unfold. Currently, for example, we're evaluating our options and fine-tuning our strategy related to healthcare exchanges. While preliminary regulations were issued in November, many open questions remain related to timing and availability. As we adapt, we remain confident that our long history in the individual healthcare market and deep customer insights uniquely position us to succeed. Finally, we were pleased by our strong results at Assurant Employee Benefits. Several years ago, benefits strategically focused on voluntary and the shift of small business benefit plans from employer funded to employee paid offerings.
We responded by diversifying our product suite, enhancing our distribution, and rolling out easier to use enrollment and administrative platforms. In addition, we strengthened our dental network in 2012 with our United Concordia arrangement. We now offer the largest dental PPO network in many markets. The success of this approach is evident in our 2012 results. Voluntary drove about half of benefit sales and over a third of its premiums. While the economy still presents challenges for small businesses, we believe that our voluntary products and capabilities have us well positioned for success. Overall, we're pleased with our progress in 2012. We see many opportunities to focus on market segments where we can compete differently. Examples include mobile, multifamily housing, voluntary benefits, and affordable healthcare. Achieving steady improvements across all of our businesses is our focus in 2013.
With that, I'll turn to Mike for more detailed comments on the fourth quarter and the outlook for this year.
Thanks, Rob. I'll start with Solutions, where net operating income for the quarter reflected $28.1 million of previously disclosed charges for U.K. intangible impairments and workforce reductions primarily in our domestic credit and European operations. Absent these items and a non-recurring tax benefit of $3.5 million, net operating income declined in the quarter as weaker domestic results offset continued growth and favorable experience in Latin America. Several factors contributed to the decline in the U.S. The previously disclosed loss of a mobile client effective last October reduced net earned premiums by about $22 million in the quarter. Second, we incurred expenses of approximately $5 million in our mobile and vehicle services businesses to enhance our technology platform and support new business growth. Finally, we saw less favorable underwriting experience in our service contract business.
These factors increased our domestic combined ratio excluding disclosed items to 98.7% for the full year, above our long-term target of 98%. While quarterly experience can fluctuate, we expect the combined ratio to return to the target level in 2013. In 2012, we saw improved performance in our international operations led by Latin America. Absent disclosed items, European underwriting results also were better. Canadian results remained strong and we made additional progress in China. Overall, Solutions International combined ratio excluding the disclosed items was 102.4% for the year, a 160 basis point year-over-year improvement. In 2013, we expect an additional 100 to 200 basis point reduction primarily from profitable growth in Latin America and additional expense initiatives in Europe. Our pre-need business remains an important contributor to Solutions' overall results. Fee income increased more than 30%, and sales were up by 14% for the year.
These results reaffirm our strong relationship with SCI and the value of its broad funeral home network. Across Solutions, we expect modest increases in both net earned premiums and earnings excluding disclosed items in 2013. This will be driven by a combination of profitable growth and expense management initiatives. Looking ahead to 2014, Solutions continues to target a 14% ROE. Achieving this goal will require further progress in international, especially in Europe. Improved results in the U.K. during 2013 is a critical step. In the fourth quarter, our U.K. operating loss was about $4 million, excluding disclosed items. Based on the actions we've taken, we expect lower losses in the first half of the year, followed by a small profit in the second half of 2013. We believe we are on track to deliver on this commitment for the U.K. and to continue to improve our overall European results.
Fourth quarter earnings and Specialty Property were depressed by Sandy. Excluding the impact of the storm, results were strong. Revenue increased by 13% as our loan portfolio continued to grow. Fourth quarter and full-year results also benefited from better non-catastrophe loss experience, which is consistent with reported industry results. The growth in written premiums was driven by previously disclosed loan portfolio additions and approximately 650,000 of loans newly added in the fourth quarter. Prior coverage on about 200,000 of these loans was flat canceled, so they began producing premiums in the fourth quarter. An existing client acquired 300,000 more loans this January, which will increase premiums in the first half of this year, as prior coverage will also be flat canceled. As a result of the loan activity late last year, our placement rate in the fourth quarter increased to 2.87%.
While this is very high by historical standards, it's important to note that absent the impact of the new loan portfolios, the rate would have remained consistent with the third quarter. We expect placement rates in the near term to fluctuate, reflecting the state of the housing market and the changing composition of our tracked loan portfolio. Over time, we continue to expect placement rates to decline. As a percentage of our portfolio exposed to hurricanes grows, we continue to manage risk prudently. In January, we placed about 60% of our total 2013 reinsurance program at rates comparable to last year's program. We'll provide an update on the completed program in June. The impact of our next generation product continues. Feedback from clients is positive in the 14 states where it's already available.
By the end of the second quarter, we expect to implement it in 14 more states and we'll continue the rollout to other states through the end of this year. On the regulatory front, our discussions with the New York State Department of Financial Services continue. We do not have new information to share at this time. In Florida, we've had discussions with the Office of Insurance Regulation to introduce the features of our new next generation product and now expect to file in the first quarter. On the federal front, the Consumer Financial Protection Bureau published its mortgage servicing guidelines in January. These were in line with Dodd-Frank and largely consistent with our current practices. There's been speculation about potential new arrangements for Fannie Mae. No changes have been announced.
We continue to believe that in addition to our new product, we have the capabilities, expertise, and infrastructure to offer solutions to the Government-Sponsored Entities as they work to control the costs of their programs. We'll provide you an updated view of the business once these regulatory matters are resolved. In the meantime, we continue to believe that returns for the business will be attractive, albeit lower, in the future. For 2013, we expect Specialty Properties revenue to increase slightly from 2012 due to growth in our lender-placed portfolio and multifamily housing. Our overall results will continue to be influenced by placement rate trends, premium rate changes, loan portfolio activity, client renewals, and catastrophe losses. We expect our expense ratio to remain approximately level with 2012 as we continue to improve efficiency while further improving client and customer service.
At Health, changes in the minimum loss ratio rebate liability significantly affected fourth quarter net operating income. Due to favorable loss experience on certain blocks of business, we increased our MLR rebate accrual in the fourth quarter. The accrual reduced our net operating income by $9.7 million after tax. In contrast, we made a refinement to the MLR calculation that increased net operating income by about $4.4 million in the fourth quarter of 2011. Several other factors contributed to the drop in net operating income for the quarter. Net earned premiums declined, reflecting the continued shift to lower premium products in our individual business and fewer small group insured lives. As we have priced business with the MLR targets in mind, loss ratios are beginning to move up. Throughout 2012, Health continued to tightly manage expenses and reduce its capital. General expenses excluding commissions declined by 11% in 2012.
Due to the low capital intensity of the business, Health also was able to contribute approximately $160 million of dividends to corporate in 2012. In 2013, our loss ratio should continue to trend up toward MLR targets. Our effective tax rate will remain elevated due to limitations imposed by healthcare reform on the deductibility of compensation and certain other payments. We'll continue to look for opportunities to further reduce our cost structure to offset these pressures. The rate of reductions will be slower than in the past. Recent sales momentum is encouraging. We expect a continued increase in the total number of insured lives in 2013, although the market remains very dynamic. Taking all these factors into account, along with the absence of the substantial 2012 real estate investment income, we expect a decline in Health's earnings in 2013.
Nevertheless, we remain optimistic that our relentless focus on creating affordable solutions for our consumers will allow us to take advantage of the potentially large market opportunity created by healthcare reform. Employee benefits posted strong results for the fourth quarter. Net operating income increased 18% over the same period in 2011 due to favorable results across major product lines. Dental experience was especially strong, and disability incidents and recovery rates remained relatively stable throughout the year. Our results also demonstrated growing momentum in the voluntary benefits space. In order to provide greater insight into our progress, we are now showing voluntary net earned premiums and sales in our financial supplement. Continuing our efforts to focus resources, we sold a small subsidiary of benefits that provides disability advocacy services during the fourth quarter.
This sale will reduce both fee income and expenses by approximately $8 million per year, but will not impact net operating income. Overall, we expect 2013 revenues at benefits to be roughly level with 2012, as the continued strength of our voluntary offerings are tempered by limited growth prospects for traditional employer-paid coverage. We plan to lower our reserve discount rate for new long-term disability claims incurred in 2013 by 50 basis points to 4.25%. This will have about a $4 million bottom-line impact. The new discount rate, combined with lower investment income, will lead to a reduction in segment profitability in 2013. To partially offset these pressures, benefits continues to closely manage its expenses and capital. Moving to corporate matters, our capital position is strong. We ended the quarter with approximately $530 million in deployable capital in addition to our $250 million buffer.
As Rob noted, following Sandy, we did not repurchase additional shares in the fourth quarter. Going forward, our capital deployment strategy remains the same. We expect to balance returning capital to shareholders with ongoing investments, both to support organic growth and in acquisitions. For 2013, we anticipate operating company dividends to approximately equal operating earnings. As always, dividends will be a function of growth in the business, rating agency or regulatory requirements, and investment performance. Despite low interest rates, our investment portfolio continued to perform well. Our conservative management and low asset turnover helped moderate the pace of the yield decline in our portfolio. However, yields will continue to decline absent changes in the macro environment. Overall, we're pleased with our 2012 results and progress in creating long-term value for our shareholders. With that, we'll ask the operator to open the call for questions.
The floor is now open for questions. At this time, if you have a question or comment, please press star one on your touch-tone phone. If at any point your question is answered, you may remove yourself from the queue by pressing the pound key. Again, we do ask that while you pose your question, you pick up your handset to provide optimal sound quality. Thank you. Our first question will come from the line of Christopher Giovanni with Goldman Sachs. Your line is open.
Morning, Chris.
Morning.
First question, in terms of the outlook for top-line at Property. You note slight increase, but you talk about a few potential factors around placement rates, premium rates. I'm curious if you factor in or what changes you factor in related to those with the slight uptick for top-line growth?
Yep. I'll start, and I'll let Mike add some color. Obviously, the movement in loan portfolios is driving our top-line growth, Chris, and as Mike pointed out, we already know we've got another portfolio coming in in the first quarter. I'll let Mike talk about the mechanics of how different portfolios can come in, but this is driving things. I think it fits in very well with our strategy of being aligned with market leaders. We think we're well positioned as portfolios continue to move around.
Despite that overall inventory of mortgage loans being down, we are growing. Mike, do you want to?
I'd just add a couple of things. We've announced several loan portfolio additions over the course of 2012, and then the ones that I mentioned coming in this quarter. When you get the flat cancel business, that sort of immediately comes onto your books and drives up written premiums in a particular quarter. Other portfolios, and we had some, I think, earlier in 2012, we had a 1 million loan portfolio and another 2 million, and those are coming in at renewal. Those gradually build up over time. We try to factor all those things going on and then make reasonable assumptions about the other factors that drive the growth.
There's just a great, as you know, variability depending on the portfolio, because some of the ones Mike mentioned had a placement rate about 1%. Obviously, higher quality loan portfolios placement rate on some of the others are quite a bit higher.
I just reiterate the growth in our placement rate was, as Rob said, driven by the changing composition.
Understood. The premium rate changes, does it contemplate anything beyond what we know from California?
Not specifically. As I said, we would certainly, if we get future things that would meaningfully impact our forecast, we'll give you an update.
They certainly reflect the new product we've rolled out that Mike mentioned, and we've certainly made assumptions on what might happen there related to servicers making decisions around deductibles or coverage amounts, Chris.
I guess, you've obviously been very successful getting costs out of the business. I guess I'm surprised that you kind of continue to see expense management opportunities in most of the segments in 2013. I wanted to see if you could maybe give us an update of the run rate cost reductions that you've taken out of the business to date and what the incremental opportunity could be here as we move forward.
I'll start, and maybe Rob can amplify if he wants, but I think it's sort of a business-by-business story, Chris, we're constantly working that. When at Assurant Health, for example, probably a notable example where we've been working at it for a couple of years, we got some of the easier things, then as you go farther, you get into more complicated changes like simplifying the systems environment, et cetera. In Assurant Specialty Property, they've had costs driven by the substantial growth that they've had to add staff to handle that and maintain the customer service levels. Now they're still getting that kind of growth, and to help dampen the impact of that, they're also investing in their systems and looking for opportunities to become more efficient. In Assurant Solutions, I think there they took some actions in the fourth quarter.
They continue to look for opportunities to streamline their business too. I think you really have to look at the expense story as a business-by-business one.
I think that's right. I guess what I'd add is that movement of resources to the important areas and away from things that, for instance, that domestic credit business. We know that business is going away. We took a lot of expenses out in the fourth quarter, okay? We want to make sure we're putting our resources on the best opportunities.
I think, I guess another couple of examples there is in Assurant Employee Benefits, for example, where they've essentially taken resources out of the traditional employer-paid business and moved them into the voluntary business. In Assurant Solutions, I commented on some of the expenses we incurred in the quarter to build out our technology platform in VSC and in mobile. We're trying to fund some of those things by, as Rob said, redeploying resources from other areas in the company, too.
Okay, last one. I guess last quarter and some prior quarters, you've given some insight into share repurchases through the first few weeks of the given quarter. Wondering if you could give us an update for 1Q to date.
Sure. Let me just start. I'll turn it over to Chris, who can provide all the details. One of the big things is we mentioned we didn't implement a new repurchase program because we were blacked out, Chris. That blackout will remain in effect through sometime next week, I guess, just because of the earnings blackout. I think more important is to think about if you sit and look at our business, our businesses generate a lot of free cash flow. I think we have a history of prudent capital management. I'm going to let Chris talk a little bit about just how all that comes together.
I think, again, the fourth quarter situation notwithstanding, absolutely nothing's changed with our respect to capital management. We continue to execute on our priorities, capitalizing the existing businesses, looking to deploy capital in profitable growth opportunities, either organically or through acquisition, then return capital to shareholders, either through dividends or share repurchase. We continue to believe the shares are undervalued and that share repurchase is a prudent use of deployable capital. As we begin 2013, we feel very good about our ability to execute on those priorities. $530 million of deployable capital. As Mike mentioned, early estimates are that we will be able to dividend operating earnings up to the holding company throughout the course of the year.
Also the ability, if we need to on an opportunistic basis, access the debt markets in something in the $300 million-$400 million if that presented itself. We feel very good about our flexibility. Again, most importantly, long term, nothing's changed about our view on capital management and its role in creating long-term shareholder value.
Okay. Thanks so much.
We'll move next to the site of Jimmy Bhullar with J.P. Morgan. Your line is open.
Morning, Jimmy.
Hi, good morning. I had a couple of questions. First one on just the weak performance in the extended service contract business in the U.S. Can you give us some details on the causes of the weakness, whether it's concentrated to one product or a specific distributor, and the chances of it continuing. Then secondly, on capital deployment, do you expect any other uses for capital deployment other than share buybacks? If you are looking at deals, what type of hurdles they'd have to meet, given where your stock price is, I'd assume that deals would be unlikely. Maybe you could talk about that as well.
Sure. Just in general, then I'll let both Mike and Chris comment. We will have variability in results from quarter to quarter on the service contract business. We still expect to be at that 98% combined ratio next year. There's nothing there that we see as anything particularly problematic.
Yeah, I'd agree with that. We look at our experience sort of client by client in the service contract. We had a handful of clients that had, as Rob said, we saw some ticks up in their loss ratio. Part of managing this business is to look at the loss experience as it emerges and have regular dialogue with the clients and implement corrective actions when we see things going off track. That's sort of the process we're going through now.
On the capital deployment front, I think Chris summarized well that there's no difference in how we're looking at things. I'll let him expand on how we view our capital and deploy it.
Yeah, I think the key to capital deployment and the various uses of our deployable capital is discipline. We have certain targeted growth areas at each of the segments where we are looking at opportunities on a regular basis. We have specific hurdle rates by business, depending on the risk profile of the opportunity. Again, when the opportunities are not there, we are willing and have demonstrated the ability to, and the willingness to return capital to shareholders. We've returned about $1.5 billion over the last three years in the form of share repurchase, another $200 million of dividends. Again, I think that's an indication of our discipline here. We look at a lot of deals. The pipeline is active. We are regularly sourcing, having conversations about growth opportunities. Absent those opportunities meeting our financial requirements, we're going to return the capital to shareholders.
Okay, thank you.
Moving next to the side of John Nadel with Sterne Agee. John is open.
Morning. Hello, John.
Good morning, everybody. Rob, I want to start with maybe perhaps more of a strategic question for you around the lender-placed business. If I look at your full-year results in Specialty Property, that's clearly driven by the force-placed business. It was a very strong year. Even reflecting the higher catastrophe losses, your ROE was about 27%. My question is this: given all the various state and regulatory pressures, the focus around this business, have you considered trying to preempt some of these pressures by submitting proactively for premium rate reductions in conjunction with your next-generation product filings? Why not, instead of reacting, get out in front of this issue and show folks, if it's Fannie or if it's others, that you recognize that the returns are probably unsustainably too high, and you're willing to bring them down without someone forcing your hand?
Yep. Okay. I think first, John, rating is a state-by-state process, and it's based on, A, our experience and what we expect is going to be an indication of experience moving forward. I think that's quite important. Second, as Mike mentioned, we know that our risk profile is increasing, and we just look at our storm activity this year, where we're going to have severe but infrequent events, and we've got to make sure that our premiums reflect that. That being said, our next-generation product provides a lot of flexibility to allow premium rates to be lower, and that can come from a majority of different factors. Again, I go back to the other comment Mike made.
We understand that returns will be attractive in the business, but they're going to be lower, which I think is a reflection of the issue you've raised that we're trying to be responsive to. Saying all that, we have the capabilities and expertise that are winning business in a market that overall probably is declining. I think that's just indicative of the model we have.
Yeah. No question. Obviously, you've got some great relationships out there, Ocwen and others, so that makes a lot of sense. I guess related to that, Rob, have you guys specifically been at the table with Fannie Mae or Freddie or the FHA? FHFA, I think it is. Can you give us any color on those discussions, if at all?
Remember, John, we talk to these guys all the time, okay? Because they're looking at how do programs work. We have capabilities. There's a lot of technical points around how these programs work.
We've been in, we've talked to them, talk to them regularly. We think we have that new program that we've talked about, our next generation product, that can respond to many of the issues being raised in the market.
Rob, does that next generation product, where there's a lot more flexibility to get the premium levels down. Is that premium levels down because deductibles might be higher? Or is that premium levels down because the actual rate online is down?
Well, the first is obviously the case that if they choose to have deductibles higher, things can change. They can change coverage amounts. Remember, in that next generation product, we're introducing some more sophistication, so there's different geographic ratings.
What that would imply is that there are some geographic areas things may go up a little, but others, they're going to go down. It's all dependent on the particulars, John.
Okay. Just separately, one quick one on the Health side. I recognize that the visibility remains cloudy around this business. Your outlook indicates we should expect that earnings are down in 2013 versus 2012 when we adjust 2012 for those real estate gains. Can you just clarify for us what the baseline 2012 earnings number is, and can you give us any help around order of magnitude decline?
I will let Mike talk a little. I want to go back to when healthcare reform was enacted, we changed our strategy, and what did we tell people? We said that fundamentally, we have a strategy. We think the strategy is a winning strategy that can deliver returns that will be attractive to shareholders when healthcare is fully implemented. Why? Because we believe this is a specialty business in the individual side of things, will continue to be, and that we have unique skills that we can bring to the table. Remember, as healthcare reform is implemented, there are different changes along the way that are going to cause bumpiness in the results. Mike, you want to just comment on that a little?
Yeah. I think, John, obviously, you take out the real estate income that we talked about. The fourth quarter-over-quarter, you had the mechanics of the MLR causing some noise. If you looked at the full year, it does not spread evenly. Part of the reason, again, one of the challenges in forecasting this is that our rebate liability is made up of a lot of separate calculations. We have talked about that before. You have credibility of experience that is always informing your calculations, too, so that can introduce a certain amount of volatility. We had an excellent year in 2012, too. Experience generally was pretty good. As we move forward, you have credibility changes in the formulas that are going to impact our results. You have upcoming changes around guarantee issue that go in at the beginning of 2014.
As we price for the MLR targets, that is going to drive our loss ratios up some, too. You have a lot of different things going on.
Just to be more clear, what's the 2012 baseline we should be thinking about there, Mike? Obviously, so many moving parts, but.
Yeah. I think primarily.
About $25 million, about $35 million? I'm just not sure.
It's primarily taking out the real estate income, John. That would be the main one.
Okay. One more quick one. I'm sorry. The 300,000 loans that are coming on in 1Q, can you give us a sense on the placement rate on that since it's a flat cancel?
I believe that'll be a placement rate that's relatively high.
Yeah, higher than the block in general.
We never know for sure, I think that one's going to be a little bit higher.
Higher than what? I'm sorry. Higher than the.
Than the block in general.
Got it.
One last one I'd add on healthcare that Mike's mentioned in the past is that the provisions, and Mike talked about this, around non-deductibility of expenses, John, will be another contributor to healthcare results being challenged next year.
That'll show up in the tax-
Exactly
tax rate for the segment.
Okay. Very helpful. Thank you for all the answers.
We'll go next to the site of Mark Finkelstein with Evercore Partners. Your line is open.
Good morning, Mark.
Good morning. Actually, I want to go back to one of John's questions. I guess maybe just on health. Is it possible to just give us a dollar value of the impact to health from purely the phase in our credibility feature changes that will go between 2012 and 2013?
Off the top of my head, no. Again, it's something we could look at. It's very complicated. Mike mentioned these 400 different calculations, and just in the fourth quarter, you get things moving over and under that target medical loss ratio can suddenly have you putting up a rebate that you hadn't anticipated.
Yeah, one of our challenges is this, we have business spread over the whole country. When you're doing all these separate rebate calculations, you don't have totally credible experience in very many of those cells. As experience builds, becomes more credible, then you can sort of factor that into your MLR calculation. Whether that experience is good or bad will determine the amount of the adjustment. There's just a lot of complexity under the covers here.
Okay. On Solutions, the 14% ROE target in 2014, which you still expect to achieve. My question is, does something more dramatic have to happen as you get later into 2013 or into 2014 on either the combined ratio improvement side or on the capital allocation? I am just trying to think about how you get there.
Yep. First, I would just go back and look at the progress we have made over the last several years, which the overall ROE has improved within Solutions, and we think we have outlined a pathway to get there. We have that combination of the growth. We have embedded business on the books that will earn out, that we think we have a line of sight on the profitability. That will be one. You are going to see us continue to manage expenses, would be a second way we will get there. Third, we are always looking for capital efficiency, and we will continue to try and do that. I think it is going to be all these different factors in combination helping us get there.
Right. Okay. Maybe just on the expense side. Obviously, you are cutting expenses in Health pretty dramatically. You are cutting expenses in Solutions. I guess the expectation for corporate is actually a bigger loss rather than what you have been experiencing, and I am just kind of curious, can you just walk through the activities that are happening at the corporate segment that is driving a higher cost load vis-a-vis cutting expenses everywhere else? What are the investments and the activities that are occurring there that we should be thinking about?
Yeah. First, if you look at the numbers we have put out, I think the corporate level expenses are rather flat year-over-year, maybe up a couple million. Obviously, there is a number of things related to just being a public company. In addition to that, we are trying to fund some small incubation and growth initiatives such as Solar, et cetera, that we might bring out to others. I think that is really the driver of any increase, Mark, is really those investments to help fund the growth. We are trying to look at some different opportunities. Solar is one example that we have talked a bit about, but we are seeding certain amount of experiments around the company in each of the businesses to try to look for new opportunities in the market.
We think that's a prudent use of a relatively modest amount of capital to help fuel further future growth.
Okay. Maybe just one more, if I may. On Specialty Property outlook, you kind of suggested that expenses relatively flat or expense ratio, I think. I can't recall what you exactly said, but is there any kind of guidance or feel that we should get in terms of the average rate assumed in that guidance number between 2012 and 2013?
Well, that's kind of what we talked about in the prior question, Mark. The rate assumptions in the guidance are sort of state by state, reflecting experience, and then also combined with sort of expected growth in the loan portfolio.
No overall average, down five, down seven, down three, anything like that? No overall overriding kind of outlook?
No, it's going to be a function of where the policies show up.
Okay. All right. Thank you.
We'll go next to the site of Sean Dargan with Macquarie. Your line is open.
Thank you. Good morning. To follow up on John's question about your discussions with Fannie Mae. There have been press reports about a consortium. If there was a consortium with the attributes that have been talked about in the press, would that be something that you would want to join or would be able to join?
Well, first, we don't speculate. Again, I think our next generation product addresses a multitude of issues that can help any of the GSEs get to lower premiums if that's their choice, and the flexibility around that. Remember, the servicer is our client. We can provide the servicer with infinite flexibility on how they deal with that portfolio of theirs that can produce lower premiums on GSE loans, depending on the particulars.
Okay. Thank you. As a follow-up, last year you had given kind of a steady state estimate of placement rates, and as the housing market improves, I think the mortgage insurers have seen new notices of default come down 25%, 30% year-over-year. I'm just wondering where you think that steady state placement rate will shake out, because I think you said over time you do expect it to decrease.
Well, that's right. We do expect it to go down. I think what we looked at over time was returning to levels we'd seen in the 2006, 2007 timeframe. Again, that was our best thinking at the time. We also know, however, it's going to fluctuate. You can see that in the portfolios we've brought on the books. I think another important trend that we've tried to outline is we also think that placement rate is being impacted as voluntary carriers are leaving the more cat-prone areas. We don't have a full clear line of sight on that yet, but we're working on it and we know that our placement, as Mike mentioned, is going up in the more cat-prone areas. Thank you.
We'll go next to the line of Steven Schwartz with Raymond James & Associates. Your line is open.
Good morning, Steven. Good morning.
Hey, good morning. I want to return to Health, if I may, with a few questions.
Sure.
Thank you. The rebate, remind us, this is a catch-up for what periods, for what quarters?
The rebate is accrued for 2012 experience. At the end of the year, we're holding how much of the premium we earned in 2012 that we'll have to rebate.
Okay. With that, looking at Assurant Health, the loss ratio for the full year was around 74%. I guess my question is, I know there's going to be some difference between the GAAP MLR and your regulatory MLR, but I guess my question is once you get full credibility, maybe this is another way of asking John's question, but once you get the full credibility, where would that be if you had the full 80% MLR on a regulatory basis?
Yeah, I think we've talked about that being in the medium 70s or 75, 76, somewhere in that range. That's a function of we have business that, subject to the MLR guidelines, we have our affordable care products and some business that's not, so it's sort of a blended. I think you're going to see us move up into that 75, 76, 77 kind of range would be probably equating to the 80% MLR target.
Okay. I didn't realize that was the ultimate. I thought that was for this year. Then, if I may, your Affordable Choice product, is that MLR exempt?
By and large, yes. I think it is, yep.
Okay.
If you look at when we set the strategy up, we talked about the PPACA products, which are subject to the MLR and ones that aren't. We started from a very small base of the other products. We've had nice growth there, but still a small percentage of our overall block. That business is not subject to the MLR. I think that points out what Mike said, I think when he talked about that 75%-77%, that's on the Affordable Care Act products that are subject to the rebate.
Okay. The Affordable Choice plans that you sell will have that lower.
Potentially.
Will have the total MLR.
Potentially. It depends on the mix. Yeah. Our reported overall loss ratio is going to be a blend of MLR products and non-MLR products.
Okay. That's what I wanted to know. Thank you.
We'll go next to the site of Mark Hughes with SunTrust. Your line is open.
Good morning, Mark. Thank you.
Good morning. The placement rate on the new 300,000 loan block, how does that compare to the 650,000 that you brought on this quarter or fourth quarter?
I don't think we have full line of sight on the 300,000 we're adding yet, Mark. We do think, as we said earlier, it's going to be higher than the block's average. It's not like we've had a couple of portfolios that have had placement rates that are more like the one percenters or something. This is going to be higher than that.
Yeah. With the 650, did you say that 200,000 of those were flat canceled?
Correct.
Within the 300,000 loans, how many of those are going to be flat canceled?
Those are going to be flat canceled as well.
All of them.
That'll impact our premiums start depending on exactly the date of the flat cancel type thing.
Right. Actually a higher number of flat cancels in this new block.
Yeah, right. Once we take over the business, it will all come flat cancel.
Right. Then you mentioned a couple of times portfolios passing between servicers in the months ahead. Is that to say there's a lot of visibility you've got for incremental pickups?
Exactly. In other words, if you look over the course of 2012, we won some portfolios through RFP. Our alignment with leaders has really helped us. If we look at the general trend that's gone on, and put this in perspective. In the 2008, 2009 timeframe, a movement from specialty to money center bank. We're seeing a movement away from money center bank to specialty servicer, our alignment with the leaders has us positioned as those movements occur.
Do you still go through the RFP process in those cases?
Not when it's just a loan portfolio that the servicing rights might be purchased by another servicer.
Yeah. Okay. Thank you very much.
We'll take our final question from the site of Seth Weiss with Bank of America Merrill Lynch. Your line is open.
Good morning, Seth.
Good morning. I have a question on free cash flow emergence going forward, specifically within health and specialty property. I know that the health dividend was $160 in 2012, and you mentioned capital efficiencies in that business. Maybe help us think about how we could think about that for 2013. Then specialty property, I know that the long-term visibility is a little bit less since the placement rates fluctuate around. Can you let us know how to think about capital release in that business, maybe as it relates to the total risk in force coming down as placement rates come down over the next few years?
Let me start, and then maybe Mike can comment on property. On the health side, an important thing to remember there is, first, on all these business, we capitalize to AM Best ratios. Because of where our health business was and the evolution, we didn't take any dividends for several years, even though we made money. This year, if you look at the money we took out, we took out several years' worth of earnings as a result of that, because it had been sitting there, and the rating agencies were comfortable with the progress we made, that that made sense. Mike, you want to talk about how to think about capital on the property side? In property, we've talked about the capital in the business or the equity being in that 50%-55% of premium.
One of the drivers of the capital requirements is the premium. If premium were to moderate, capital potentially can come out, although it has to be due to changes in exposure. That's what fundamentally, premium is sort of viewed as a surrogate for exposure. As exposure is reduced, then we can take the capital out of the business.
Okay, understood. If we think about it that way, the next generation product also will have a little bit of capital benefit as that exposure comes down with reductions in premium related to that, right?
Correct.
Great, thanks. Just one mechanical follow-up on Specialty Property and loans tracked. If we look at the 31.2 million loans tracked, that encompasses just the 200,000 that were flat canceled. There'll be 450 on top of that, which will emerge over time, right?
No, I think the full 650 go into the loan count the way we do the calculation. Right. I think that what's not in that 31.2 is the ones that are going to be added in the first quarter. Right. That's not in, but there's also, if you're trying to reconcile, you've got attrition in the existing portfolio. We start with the 30.8 or whatever it was. We add 650, and then we get some attrition, and that's how we end up at whatever, 31.2 or something.
I see. Just out of curiosity, because I know you've added a bunch of new portfolios over the last 12 months, is there a way to think about the gap between those that are still rolling on as the renewal process occurs?
Well, the loans go onto the system. That's what we're tracking. It's policies related to those loans that come on over time. It's really the placements that are going to occur on the loans. Right. Which is a good point you're driving at, that we will still have a pickup in some placements on some of the portfolios that were flat canceled.
I see. Great. Thanks a lot.
Thanks for joining us this morning. We encourage you to reach out to Francesca and Suzanne with additional questions. We look forward on updating you on our progress during the first quarter conference call on April 25th.
Thank you. This does conclude today's teleconference. Please disconnect your lines at this time and have a wonderful day.