Good day everyone, welcome to the Torchmark Corporation fourth quarter 2016 earnings release conference call. Today's conference is being recorded. For opening remarks and introductions, I would like to turn the conference over to Mike Majors, VP of Investor Relations. Please go ahead, sir.
Thank you. Good morning, everyone. Joining the call today are Gary Coleman and Larry Hutchison, our Co-Chief Executive Officers, Frank Svoboda, our Chief Financial Officer, and Brian Mitchell, our General Counsel. Some of our comments or answers to your questions may contain forward-looking statements that are provided for general guidance purposes only. Accordingly, please refer to our 2015 10-K and any subsequent Forms 10-Q on file with the SEC. Some of our comments may also contain non-GAAP measures. Please see our earnings release and website for a discussion of these terms and reconciliations to GAAP measures. I will now turn the call over to Gary Coleman.
Thank you, Mike, good morning, everyone. In the fourth quarter, net income was $135 million, or $1.12 per share, a 5% increase on a per share basis. Net operating income from continuing operations for the quarter was $139 million, or $1.15 per share, a per share increase of 10% from a year ago. On a GAAP reported basis, return on equity as of December 31st was 12%, and book value per share was $37.76. Excluding unrealized gains and losses on fixed maturities, return on equity was 14.6%, and book value per share was $32.13, a 7% increase from a year ago. In our life insurance operations, premium revenue grew 6% to $550 million, while life underwriting margin was $143 million, down 1% from a year ago. The decline in underwriting margin is due primarily to the decline in the direct response margins.
In 2017, we expect life underwriting income to grow around 1%-3%. Net life sales were $99 million, approximately the same as the year-ago quarter. On the health side, premium revenue grew 1% to $238 million, and health underwriting margin was up 4% to $53 million. In 2017, we expect health underwriting income to remain relatively flat. Health sales in total were $47 million, down 21% from a year ago. Individual health sales were $37 million, down 4%. Administrative expenses were $50 million for the quarter, up 6% from a year ago and in line with our expectations. As a percentage of premium from continuing operations, administrative expenses were 6.4% compared to 6.3% a year ago. For the full year, administrative expenses were $197 million, or 6.3% of premium. In 2017, we expect administrative expenses to grow approximately 5% and to remain around 6.3% of premium.
I will now turn the call over to Larry Hutchison for his comments on the marketing operations.
Thank you, Gary. At American Income, life premiums were up 11% to $236 million, and life underwriting margin was up 10% to $75 million. Net life sales were $52 million, up 3%, due primarily to increased agent count. The average agent count for the fourth quarter was 6,874, up 4% from a year ago and down 2% from the third quarter. The producing agent count at the end of the fourth quarter was 6,870. We expect the producing agent count to be in a range of 7,100 to 7,400 at the end of 2017. Life sales for the full year 2016 grew 6%. We expect 6%-10% life sales growth in 2017. At Liberty National, life premiums were $67 million, approximately the same as the year-ago quarter, while life underwriting margin was $19 million, down 4%.
Net life sales increased 15% to $10 million, while net health sales were $5 million, approximately the same as the year-ago quarter. The life sales increase was driven primarily by improvements in agent count. The average producing agent count for the fourth quarter was 1,781, up 16% from a year ago and down 1% compared to the third quarter. The producing agent count of Liberty National ended the quarter at 1,758. We expect the producing agent count to be in a range of 1,800 to 2,000 at the end of 2017. Life net sales for the full year 2016 grew 12%. Life net sales growth is expected to be within a range of 8%-12% for the full year 2017. Health net sales for the full year 2016 grew 8%. Health net sales growth in 2017 is expected to be within a range of 5%-9%.
We are enthusiastic about Liberty National's prospects. Life premiums grew on a year-over-year basis in both the first quarter and the fourth quarter of 2016. The last time we had year-over-year growth for a quarter was in 2004. While the fourth quarter growth was slight, it is an indicator of the positive effect of the changes that have been made at this agency. We expect to see consistent life premium growth at Liberty National going forward. I would like to make one more comment regarding American Income and Liberty National. Roger Smith, who oversees both of these agencies, announced he will retire at the end of the year. Roger's contributed greatly to the growth at American Income and the turnaround at Liberty National. Over the past several years, Roger has developed talented leaders at both American Income and Liberty National.
Steven K. Greer, the President of American Income Agency Division, will succeed Roger Smith at American Income. Steve has served in his current capacity for over a year and was an SGA for American Income for 12 years prior to that. Steven J. DiChiaro, President of the Liberty National Agency Division, will succeed Roger Smith at Liberty National. Steve has served in his current capacity for over 5 years and was an SGA at American Income before that. Roger Smith will serve in an advisory capacity for both agencies after his retirement. Direct Response. In our Direct Response operation at Globe Life, life premiums were up 4% to $192 million. Life underwriting margin declined 21% to $29 million. Net life sales were down 7% to $34 million. For the full year 2016, life sales declined 9%, due primarily to decreases in circulation designed to improve profitability in certain segments.
We expect life sales to be down 4.5%-9.5% in 2017 as we continue those efforts. At Family Heritage, health premiums increased 7% to $61 million, while health underwriting margin increased 26% to $14 million. Health net sales grew 8% to $13 million. The average producing agent count for the fourth quarter was 947, up 8% from a year ago and down 4% from the third quarter. The producing agent count at the end of the quarter was 909. We expect the producing agent count to be in a range of 950-1,050 at the end of 2017. Health sales for the full year 2016 grew 2%. We expect health sales growth to be in a range from 3%-7% in 2017. At United American General Agency, health premiums declined 2% to $89 million.
Net health sales were $24 million, down 38% compared to the year ago quarter. Individual Medicare Supplement sales for the full year 2016 declined 3%. In 2017, we expect growth in individual Medicare Supplement sales to be approximately 5%. I will now turn the call back to Gary Coleman.
I'll spend a few minutes discussing our investment operations. Talk about excess investment income. Excess investment income, which we define as net investment income less required interest on policy liabilities and debt, was $58 million, an 8% increase over the year ago quarter. On a per share basis, reflecting the impact of our share repurchase program, excess investment income was up 12%. In 2017, we expect excess investment income to grow by about 6%-8%. On a per share basis, we should see an increase of about 9%-11%. Regarding the investment portfolio, invested assets were $14.8 billion, including $14.2 billion of fixed maturities at amortized cost. Of the fixed maturities, $13.4 billion are investment grade with an average rating of A minus, and below investment grade bonds are $751 million compared to $640 million a year ago.
The percentage of below investment grade bonds to fixed maturities is 5.3% compared to 4.8% a year ago. The increase in below investment grade bonds is due primarily to downgrades of securities in the energy and metals and mining sectors that occurred early in 2016. However, due to the increase in the underlying commodity prices, the current market value of these securities are significantly higher than at the time of the downgrades. With a portfolio leverage of 3.7 times, the percentage of below investment grade bonds to equity, excluding net unrealized gains on fixed maturities, is 19%. Overall, the total portfolio is rated high triple B plus, just slightly under the A minus of a year ago. In addition, we have net unrealized gains in the fixed maturity portfolio of $1.1 billion, approximately $550 million higher than a year ago.
Regarding investment yield, in the fourth quarter, we invested $607 million in investment-grade fixed maturities, primarily in the industrial sectors. We invested at an average yield of 4.58%, an average rating of triple B plus, and an average life of 26 years. For the entire portfolio, fourth quarter yield was 5.75%, down six basis points from the 5.81% yield in the fourth quarter of 2015. At December 31st, the portfolio yield was approximately 5.74%. For 2017, the midpoint of our current guidance assumes an increasing new money yield throughout the year, averaging 4.80% for the full year. We are encouraged by the prospect of higher interest rates. Higher new money rates will 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 the income statement but not the balance sheet. Since we primarily sell non-interest sensitive protection products that counter for under FAS 60, we don't see a reasonable scenario that would require us to write off the DAC or put up additional GAAP reserves due to interest rate fluctuations. In addition, we do not foresee a negative impact on our statutory balance sheet. While we would benefit from higher interest rates, Torchmark would continue to earn a substantial excess investment income in an extended low interest rate environment. Now I'll turn the call over to Frank Svoboda.
Thanks, Gary. First, I want to spend a few minutes discussing our share repurchases and capital position. In the fourth quarter, we spent $71 million to buy 1.0 million Torchmark shares at an average price of $68.60. For the full year, we spent $311 million of parent company cash to acquire 5.2 million shares at an average price of $59.78. So far in 2017, we have spent $19 million to purchase 257,000 shares. The parent ended the year with liquid assets of about $45 million. In addition to these liquid assets, the parent will generate additional free cash flow in 2017. The parent company's free cash flow, as we define it, results primarily from the dividends received by the parent from the subsidiaries, less the interest paid on debt and of the dividends paid to Torchmark shareholders.
While our 2016 statutory earnings have not yet been finalized, we expect free cash flow in 2017 to be in the range of $325 million-$335 million. Thus, including the assets on hand at the beginning of the year, we currently expect to have around $370 million-$380 million of cash and liquid assets available to the parent during the year. This level of free cash flow in 2017 is slightly higher than 2016, primarily due to the net proceeds received in 2016 from the sale of our Medicare Part D business. 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 2017, absent the need to utilize any of these funds to support our insurance company operations. Now, regarding RBC at our insurance subsidiaries. We currently plan to maintain our capital at the level necessary to retain our current ratings. For the past several years, that level has been around an NAIC RBC ratio of 325% on a consolidated basis. This ratio is lower than some peer companies, but it's sufficient for our companies in light of our consistent statutory earnings and the relatively lower risk of our policy liabilities and our ratings. Although we have not finalized our 2016 statutory financial statements, we expect that our consolidated RBC percentage at December 31, 2016 will be around 325%. We do not anticipate any changes to our targeted RBC levels in 2017.
Next, a few comments to provide an update on our Direct Response operations. During 2016, the growth in total life underwriting income lagged behind the growth in premium due to higher than expected policy obligations in our Direct Response operations. As discussed on previous calls, this is attributable to higher than originally expected claims relating to policies issued in calendar years 2000 through 2007 and 2011 through 2015. During the fourth quarter, claims emerged as anticipated and policy obligations were in the range we expected for the fourth quarter and consistent with those reported for the third quarter. In addition, at 16.5% of premiums, the underwriting margin for the full year 2016 fell within the 16%-17% range we expected.
Looking forward, and as indicated on the last call, we anticipate that the underwriting margin for 2017 will decline slightly and be in the range of 14%-16% of premium for the full year. Now with regard to the recognition of excess tax benefits on equity compensation. As we previously discussed in the first quarter of 2016, the company adopted a new accounting standard relating to the treatment of excess tax benefits on a prospective basis. This new accounting standard primarily causes excess tax benefits to be recognized through earnings and affects Torchmark's computations of net income, diluted shares outstanding, and earnings per share. In the fourth quarter, the reduction in expense related to the adoption of the standard caused earnings per share from continuing operations to increase $0.04. During the full year 2016, earnings per share increased $0.13.
While several factors influence the amount of excess tax benefits, we anticipate that the excess tax benefits recognized in 2017 will be slightly less than 2016, and that stock option expense as reflected in net operating income will be in the range of $2 million-$4 million for the year, compared to a benefit of $1.5 million in 2016, a negative swing of $3.5 million-$5.5 million. Finally, with respect to our earnings guidance for 2017, we are projecting net operating income from continuing operations per share to be in the range of $4.57-$4.77. The $4.67 midpoint of this range reflects a $0.03 decrease from the midpoint of our previous guidance.
This decrease is due to a $0.05 reduction resulting from the higher current share price, which is causing the number of shares expected to be repurchased in 2017 to be lower than anticipated at the time of our last call. The negative effect of the higher share price is offset somewhat by a slightly improved outlook for underwriting and investment income. Much speculation exists that Congress will enact some type of tax reform in 2017. At this time, few details are known as to the direction that Congress will ultimately take, including what statutory rate might be agreed to and what, if any, changes to the tax base might occur. As such, we have not reflected any possible changes in the tax law in our 2017 earnings guidance, and our calculations assume that existing tax law will stay in effect through 2017. Those are my comments.
I will now turn the call back to Larry.
Those are our comments. We will now open the call up for questions.
Thank you. If you would like to ask a question, please signal by pressing *1 on your phone. Please make sure your mute function is turned off to allow your signal to reach our equipment. Again, that's *1 for any questions. We'll go first to Jimmy Bhullar with JPMorgan.
Hi. First, I had a question on the annuity business. You've had pretty strong underwriting income in each of the last two quarters. What really drove that? I'm assuming it's lower amortization and stuff, but what really drove it, and what's your expectation of sort of a more normalized ongoing earnings number for that business?
Yeah. Hi, Jimmy. You're right that the increased income from the annuity business relates to lower amortization. Really, we slowed down the amortization on that business due to that staying on the books longer due to the lower interest rate environment. Going forward, at really the midpoint of our guidance, we see annuity income probably being in that $10 million range, pretty similar to what we saw on a per-quarter basis to what we had in the fourth quarter.
Okay. I think you mentioned retaining $50 million of liquidity at the holding company. In the past, I thought it was $50-$60, not sure. Has there been a change, or is it still consistent with what you were planning before?
Generally consistent, I think, looking realistically, that we'd probably be at the lower end of that range, given our starting point, where we ended up in 2016, a little below $50 million, just really due to some timing of some items.
Okay. Then have the final numbers in terms of sales proceeds from the Part D block, do you have the final numbers on what you are expecting to get from the Part D sale?
The numbers aren't totally finalized until after the end of the first quarter.
Okay.
Right now we estimate that the proceeds will be around $18 million. It's subject to a little bit of adjustment still through the first quarter.
Just lastly, how do you think about the impact of the exit on your investment income? I'm assuming at some point down the road it should help your investment income. How do you think about how it affected this year, next year, and the year after?
As the exit of the business occurs, we will receive the various receivables that we have on the Part D business. We did see a pickup here in 2016 as we collected a significant portion of our CMS receivables here in 2016. As of the end of 2016, we still have around $100 million of net receivables from that business. We expect to probably get around $80 million of that in 2017, and that'll be fairly pro rata over the course of the year. It looks like there'll be a little bit of a tail on the final $20 or so million that we don't anticipate to receive from CMS until probably the end of 2018. There's some review processes that take a couple of years since we've exited the business.
Jimmy,
The more normal number, it'll take till 2019 to get to a more sort of normal number on investment income and no lag effect from this?
Ultimately, yes. There is a little bit of that drag that we're going to see here in 2017, probably around the $2 million-$3 million range of a net drag. Ultimately, it'll be cleaned up for the most part by the end of the year into 2019.
Jimmy, that's a comparison of, excuse me, the drag in 2016 was $9 million. We're going from $9 million to $2 million-$3 million.
Yes.
Of drag.
Thank you.
We will take our next question from Bob Glasspiegel with Janney.
Hi, good morning, Gary, Mike. Direct response margins were sort of flat sequentially, but you are guiding to sort of a further decline from the Q4 run rate into 2017. Have we turned the corner there, or is it still a little bit of marginal deterioration?
Yeah, Bob, I think we do anticipate having a little bit of marginal deterioration in 2017, just as the 2002-2014 years related to the RX business that we primarily do on the RX business we have talked about in the past, as that really kind of goes through its maturity, if you will, in its higher years, and then starts to decline as an overall percentage of our premium. Looking past 2017, we really see it stabilizing for the most part in maybe that 14%-15% range. So there might be just a slight deterioration past 2017. But at this point in time, it is really difficult to determine exactly, until we see what impact the changes that we have made at the end of 2016 and on our 2017 sales will ultimately have.
Okay, thank you. And one quick follow-up on the guidance on new money rates for 2017 of 4.8%. How does that compare to what you are getting today? Do we need a further increase in rates to get there?
No. Excuse me, I'm battling a cold here. As I mentioned, we invested at 458 in the fourth quarter. So far this quarter, we're a little bit above where we thought we would be. We're in the high 480 range. What we contemplated is that first quarter would be around 470, and then it would graduate up toward the end of the year. It'd be just a little under 5%. When you average all that out, you get to the 480. We're a little ahead of the game through the first part of the first quarter, and of course, we hope that continues.
Okay, you said you're getting above 480 now?
Yeah, a little above 480 right now.
Okay. Appreciate it. Thank you.
As a reminder, if you would like to ask a question, please press *1. We'll go next to John Barnidge with Credit Suisse.
Hi. Thanks for taking the question. If I look at amortized cost of your invested assets, I'm thinking about the excess investment income calculation. I think you ended 2016 with about $14.2 billion. I know there's a bunch of different cash flows. How much do you think that should grow? Should we be thinking about that growing in that 2%-3% range annually, or do we get a bump up with some of these proceeds?
Okay. John, you're talking about the growth in the fixed maturity assets?
The $14.2 billion of invested assets in your excess investment income calc.
Yeah, I think we're looking at growth of 4% to 5% in the next two to three years.
Okay. Each year?
Yeah, each year, right.
Yeah. Okay, that's helpful. Then I have a, I guess this is more of a hypothetical question. I understand your guidance doesn't contemplate any changes in statutory tax rates. That seems sensible. Even if something happens, it doesn't feel like it's going to happen that soon. But hypothetically, if domestic tax rates, corporate tax rates fell from 35% to, I don't know, pick a number, 20% or 25% or even lower. Do you expect to be able to capture all that to the bottom line, or would you expect to sort of price new product sales differently, perhaps generate a faster pace of sales growth and still target a similar after-tax ROE, just recognizing that a greater proportion of your profit margin might come from a lower tax rate? You understand? I don't know if I'm phrasing that very well.
Yeah, I think, John, I understand, I believe, what your question is. It's really hard to say with respect to the impact that the sales might have. To be honest, we really haven't spent any time really thinking about how we might adjust the pricing at all with respect to changing the tax rates. We would clearly see, let's just say if tax rates were to decrease to 25%, we would expect there to be a decrease in the cash taxes we pay. At this point in time, we really don't know what changes they might make to the tax base to eat into that to some degree.
Understood.
We should end up having a benefit on the GAAP side, clearly. On the statutory side, it's a little bit more difficult to see exactly how that might materialize and how that might impact future cash flows, if you will.
Okay. It's more of a, I guess, a bit of a philosophical question, right? I suppose at the end of the day, lower corporate tax rates is intended to help the consumer and grow the economy faster. In that respect, I guess I'm wondering if you would target a higher ROE recognizing a lower tax rate, or if you would just look to pass along savings in the form of a lower premium rate to customers.
Well, John, in our businesses, the Direct Response would be an area we would consider that more than others because there's more price competitive there. In our agency operations, it's not that price competitive, so I think we would be careful about what we did to those premiums.
Okay, understood. All right, I'll take it offline with you. Thank you.
Gentlemen, we have no further questions at this time. I'll turn it back to you for any additional or closing remarks.
All right. Thank you for joining us this morning. Those are our comments, and we'll talk to you again next quarter.
Thank you. That does conclude today's conference. Thank you for your participation. You may now disconnect.