Good day everyone, welcome to the Torchmark fourth quarter 2015 earnings release conference call. Today's conference is being recorded. At this time, I'd 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. Please refer to our 2014 10-K and any subsequent Forms 10-Q on file with the SEC. I will now turn the call over to Gary Coleman.
Thank you, Mike, good morning, everyone. In the fourth quarter, net operating income from all operations was $131 million, or $1.05 per share, a per share increase of 5% from a year ago. During the fourth quarter, management determined that the Part D business met the criteria to be held for sale and is classified as discontinued operations. Net operating income from continuing operations, which excludes Part D, was $131 million, or $1.05 per share, up 6% on a per share basis from a year ago. Net income for the quarter was $133 million, or $1.07 per share, a 5% decline on a per share basis. The decline was due primarily to the fact that we had $11 million of tax-driven realized losses in the fourth quarter this year, compared to a gain of $5 million in the year ago quarter.
With fixed maturities at amortized cost, our return on equity as of December 31st was 14.5%, and our book value per share was $30.09, an 8% increase from a year ago. On a GAAP-reported basis with fixed maturities at market value, book value per share was $32.71, a decline of 10% from a year ago. In our life insurance operations, premium revenue grew 5.5% to $521 million, while life underwriting margins was $145 million, up 6.3% from a year ago. Net life sales increased 2% to $99 million. On the health side, premium revenue grew 5% to $235 million, and health underwriting margin was up $51 million, approximately the same as a year ago. Health sales declined 17% to $16 million due to declining group sales. Individual health sales were $38 million, up 20%.
Administrative expenses were $48 million for the quarter, up 9% from a year ago and in line with our expectations. As a percentage of premium from continuing operations, administrative expenses were 6.3% compared to 6.1% a year ago. The primary reasons for the increase in administrative expenses are higher information technology and pension costs. For the full year, administrative expenses were $186 million, or 6.2% of premium. In 2016, we expect administrative expenses to grow approximately 5% and to remain around 6.2% of premium. I will now turn the call over to Larry Hutchison for his comments on the marketing operations.
Thank you, Gary. I will now go over the results for each company. At American Income, life premiums were up 8% to $213 million, and life underwriting margin was up 10% to $69 million. Net life sales were $50 million, up 9%, due primarily to increased agent productivity. The average agent count for the fourth quarter was 6,590, up 4% over a year ago, but approximately the same as the third quarter. The producing agent count at the end of the fourth quarter was 6,552. We expect the producing agent count to be in the range of 6,600 to 6,800 at the end of 2016. Life sales for the full year 2015 grew 15%. We expect 5% to 7% life sales growth in 2016. In our direct response operation of Globe Life, life premiums are up 7% to $185 million. Life underwriting margin declined 2% to $37 million.
Net life sales were down 3% to $37 million. Life sales for the full year 2015 grew 4%. We expect life sales to be flat or down slightly in 2016. At Liberty National, life premiums were $67 million, approximately the same as the year-ago quarter. Life underwriting margin was $19 million, up 24%. Net life sales decreased 5% to $9 million. Net health sales decreased 4% to $5 million. The average producing agent count for the fourth quarter was 1,539, down 2% from a year ago and down 3% from the third quarter. The producing agent count at Liberty National end of the quarter was 1,478. We expect the producing agent count to be in a range of 1,550 to 1,625 at the end of 2016. Life net sales for the full year 2015 grew 4%.
Life net sales growth is expected to be within a range of 4% to 7% for the full year 2016. Health net sales for the full year 2015 grew 4%. Health net sales growth is expected to be within a range of 2% to 4% in 2016. At Family Heritage, health premiums increased 8% to $57 million. Health underwriting margin increased 2% to $11 million. Health net sales were up 2% to $12 million. The average producing agent count for the fourth quarter was 877, up 12% from a year ago, but down 3% from the third quarter. The producing agent count at the end of the quarter was 911. We expect the producing agent count to be in a range of 975 to 1,000 at the end of 2016. Health sales for the full year 2015 grew 70%.
We expect health sales growth to be in a range of 5%-9% for the full year 2016. At United American General Agency, health premiums increased 12% to $90 million. Net health sales declined from $51 million to $38 million. Individual sales grew 49% to $18 million, while group sales declined 47% to $21 million. Individual Medicare Supplement sales for the full year 2015 grew 36%. For the full year 2016, we expect growth in individual Medicare Supplement sales to be around 8%-10%. I'll now turn the call back to Gary.
I want to spend a few minutes discussing our investment operations. First, excess investment income. Excess investment income, which we define as net investment income plus acquired interest on policy loan liabilities and debt, was $54 million compared to $55 million in fourth quarter of 2014. On a per share basis, reflecting the impact of our share repurchase program, excess investment income was flat. As discussed on previous calls, the Part D segment has had a negative impact on excess investment income due to negative cash flows that occur during the year, including the long delay in receiving reimbursements from CMS for excess claims made by the company. The impact of the lost investment income from the delayed receipt of reimbursements is reflected in income from continuing operations rather than discontinued operations in accordance with applicable accounting rules.
In 2015, Part D had a negative impact on excess investment income of approximately $8 million. In 2016, we expect excess investment income to grow by about 1%-3%. However, on a per share basis, we should see an increase of about 6%-8%. At the midpoint of our 2016 guidance, we're expecting a drag on excess investment income from Part D of approximately $8 million-$9 million. Regarding the investment portfolio, invested assets were $13.8 billion, including $13.3 billion of fixed maturities and amortized cost. Excuse me. Of the fixed maturities, $12.6 billion were investment grade with an average rating of A minus, and below investment-grade bonds were $640 million compared to $561 million a year ago. The percentage of below investment-grade bonds to fixed maturities was 4.8%, compared to 4.4% a year ago.
With a portfolio leverage of 3.6 times, the percentage of below investment-grade bonds to equity, excluding net unrealized gains on fixed maturities, is 17%. Overall, the total portfolio is rated A minus, same as a year ago. In addition, we have net unrealized gains in the fixed maturity portfolio of $506 million, approximately $4 million-$8 million less than at the end of the third quarter. To complete the investment portfolio discussion, I'd like to address our $1.6 billion of fixed maturities in the energy sector. As a result of spreads widening in the fourth quarter, the net unrealized loss of our energy portfolio increased by $142 million to a total of $165 million as of December 31st. However, we believe the risk of realizing any losses in the foreseeable future is minimal for the following reasons: $1.5 billion or 94% of our energy holdings are investment grade.
Only $123 million or 9% of our energy holdings are in the oilfield service and drilling sector. Approximately 70% of these bonds are investment grade. Also, based on the consensus of expert views, our investment department believes that oil is more likely to increase to $45 or $50 a barrel during the next 12 to 24 months than to remain at current levels. We believe the companies in our portfolio can continue to operate for a very long time with oil prices at $45 to $50 a barrel. Even if oil remains around $30 a barrel for the next 12 to 24 months, we would not expect to have any defaults during that period.
The companies we have invested in have a variety of options that they can utilize to avoid default, including, but not limited to, reducing distributions to partners, drawing on lines of credit, and reducing exploration activities. We do believe that there could be further downgrades which could pressure our RBC ratio. That doesn't mean we would have to suspend or materially impact our stock buyback program. Frank will address this in more detail when he discusses capital. To investment yield. In the fourth quarter, we invested $341 million in investment-grade asset securities, primarily in the industrial sector. We invested at an average yield of 5%, an average rating of A-minus, and an average life of 26 years. For the entire portfolio, the fourth quarter yield was 5.81%, down eight basis points from the 5.89% yield in the fourth quarter of 2014.
At December 31st, the portfolio yield was approximately 5.83%. The midpoint of our current guidance for 2016 assumes increasing money yields throughout the year, averaging 5.25% for the full year. We continue to hope for higher interest rates. As discussed on previous analyst calls, rising new money rates will have a positive impact on operating income by driving up excess investment income. We're not concerned about potential unrealized losses that are interest rate driven reflected on the balance sheet because we do not expect to convert them to realized losses. We have the intent and, more important, the ability to hold our investments to maturity. If rates don't rise, a continued low interest rate environment will impact our income statement, but not the balance sheet.
If we primarily sell non-interest sensitive packaged products accounted for under FAS 60, we don't see a reasonable scenario that would require us to write off DAC or to put up additional GAAP reserves due to interest rate fluctuations. In addition, we do not foresee a negative impact on our statutory balance sheet. While we would benefit from higher interest rates, Torchmark would continue to earn substantial excess investment income in an extended low interest rate environment. 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. In the fourth quarter, we spent $83 million to buy 1.4 million Torchmark shares at an average price of $58.68. For the full year, we spent $359 million of parent company cash to acquire 6.3 million shares at an average price of $56.99. The parent ended the year with liquid assets of $46 million. In addition to these liquid assets, the parent will generate additional free cash flow during the remainder of 2016. Free cash flow results primarily from the dividends received by the parent from the subsidiaries, plus the interest paid on debt and the dividends paid to Torchmark shareholders. While our 2015 statutory earnings have not yet been finalized, we expect free cash flow in 2016 to be in the range of $320 million-$330 million.
Including the $46 million available from assets on hand at the beginning of the year, we currently expect to have $366 million-$376 million of cash and liquid assets available to the parent during the year. This level of free cash flow in 2016 is lower than recent years due to lower distributable statutory earnings at our subsidiaries in 2015. As we've discussed on prior calls, a key driver of the lower earnings is higher commission and acquisition expenses associated with the higher levels of sales growth we have experienced in 2014 and 2015, coupled with lower growth rates in investment income due to lower new money yields and adverse bond cash flows. Another significant driver of the lower earnings is higher federal income tax expense in 2015 as compared to 2014.
At this time, we anticipate that statutory earnings in 2016 will be approximately the same as 2015 as the profits from recent sales start to emerge, the incremental impact of new sales lessens, and the growth in investment income improves. As noted before, 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-$60 million of assets at the parent company absent the need to utilize any of these funds to support our insurance company operations. Regarding RBC at our insurance subsidiaries. We currently plan to maintain our capital at the level necessary to retain our current ratings. For the last three years, that level has been around an NAIC RBC ratio of 325% on a consolidated basis.
This ratio is lower than some peer companies, is sufficient for our companies in light of our consistent statutory earnings, the relatively lower risk of our policy liabilities, and our ratings. Although we have not finalized our 2015 statutory financial statements, we expect that the RBC percentage at December 31st, 2015, will be around the 325% consolidated target. We do not anticipate any changes to our targeted RBC levels in 2016. Our investment department has reviewed multiple scenarios of downgrades within our fixed maturity holdings, including those in the energy sector. To put the findings into context, as a rule of thumb, downgrades of around $100 million in statutory book value would reduce our RBC ratio by approximately two percentage points and require around $9 million of additional capital to retain a 325% RBC level.
Using this rule of thumb, to the extent additional downgrades do occur in 2016, we are comfortable that we would be able to fund the additional capital requirements with available assets on hand and other sources of liquidity available to Torchmark without having to suspend or reduce the amount available for buybacks. A few comments to provide an update on our Medicare Part D operations. Management has committed to a plan to sell the Part D business and expect it to be sold before the end of the year. We have met the criteria to account for the business as held for sale, and the result of the Part D operations will be reflected within discontinued operations in our financial statements.
We have previously said, we originally decided to participate in the Medicare Part D program back in 2006 because most of the underwriting risk was covered by the government, we believed it would complement our Medicare Supplement business. Over the years, the Part D business has been good for Torchmark as it has provided over $259 million of underwriting margin since 2006. This business has been changing rapidly over the past few years, and the earnings have become much more volatile. Increased competition, industry consolidation, preferred networks have reduced overall margins and made it more difficult for smaller players to compete in this market. While we are still generating profits from the Part D operations, those profits have been shrinking in recent years due to higher drug costs and increased administrative and compliance costs.
We believe this trend will likely continue, perhaps could even turn into significant losses in the future as drug costs, especially those on specialty drugs, continue to escalate. We have already seen regulatory changes that have shifted costs from the government to carriers, and it appears likely that more cost shifting is to come. The risks and the administrative and compliance costs associated with the business are much greater than they once were, and the business now demands an increasingly disproportionate amount of time and focus given its level of earnings. Looking forward, we prefer to focus our attention on our core life insurance businesses and our other lines of health business that produce more predictable, stable margins. We've previously indicated that we view this business opportunistically and that we would review it on a yearly basis.
While the Part D business has been a good opportunity to this point, we no longer believe it is a business that makes sense for Torchmark going forward, therefore, it is the right time to exit the business. We have included on our website a final operating summary for the discontinued operations. Over the year, we earned $10.8 million, or $0.09 per share after tax. This amount was lower than we had anticipated on the last call due to higher-than-expected claims in the fourth quarter as a result of higher drug costs. To the extent we were to hold the business for the full year 2016, we estimate that our after-tax earnings would be in the range of $5 million to $9 million.
As noted on our previous calls, the profits from the Part D business are further reduced by lost investment income that results from having to finance substantial cash outflows during the year, including amounts paid upfront on behalf of the government that won't get repaid to us until the following year. These outflows are generally represented by the significant receivable balances that are included in the assets held for sale line of our consolidated balance sheet. The opportunity cost of not being able to timely invest the receivable balances is included in our continuing operations as required by the applicable accounting rules. However, to reflect what management considers to be a better reflection of earnings from the Part D operations, we have included on our website a schedule showing the pro forma income from discontinued operation that includes an estimate of the after-tax cost of the foregone investment income.
As we are in the midst of discussions with multiple parties regarding a purchase, we are unable to discuss the timing, potential value, or other details of the sale. We do anticipate that the assets held for sale on our balance sheet will be fully recovered and do not believe the consummation of the sale will have a material impact on our income from continuing operations. Any such impact on earnings is included in the range of earnings guidance provided. With respect to our guidance for 2016, on our last call, we indicated a preliminary range of $4.25-$4.55 for our 2016 net operating earnings per share, with a midpoint of $4.40. Excluding the effect of the discontinued Part D operations, the midpoint would have been $4.35. We now estimate that our earnings from continued operations will be in the range of $4.28-$4.48.
A 6.1% growth at the midpoint over our 2015 earnings from continued operations. A schedule providing prior year earnings per share for continued operations only, and our revised 2016 earnings per share guidance has been placed on our website. Those are my comments. I will now turn the call back to Larry.
Thank you, Frank. Those are our comments. We're now open the call up for questions.
Thank you. If you would like to ask a question, please do so by pressing star one on your touch-tone phone. Please make sure your mute function is turned off to allow your signal to reach our equipment. Again, it's star one to ask a question. We'll take our first question today from Yaron Kinar with Deutsche Bank.
Good morning, everybody, thanks for taking my call. I wanted to start with the last point on the revised guidance, the recent increase in the midpoint. Looking at the different parts of the guidance with the granularity that you offer, it seems like your expected sales actually come down a bit from your prior guidance. Expenses maybe going up a little bit, headcounts maybe a little weaker. Where's the positive offset coming from? Where are you expecting to out earn your previous guidance?
Yeah, I think in looking at the increase at the midpoint, we really have an improved outlook on net life and underwriting margin, underwriting income overall. There's a slight margin improvement at Liberty National, given the favorable claims experience that we had in Q4. Really the really favorable sales that we had at American Income, as well as just better expectations with respect to some of our premium at direct response really impact the 2016 guidance. You need to remember that some of the reduced sales guidance with respect to 2016 really don't impact the 2016 premiums as much as they will premiums looking out past that.
Okay. That's helpful. You had talked about expecting new money yields going up a bit over the course of 2016, or at least that being one of your underlying assumptions. What's that based on, data? Is it spread widening? Is it opportunities you see in the market?
It's a little bit of both. We're expecting, this is from our investments department canvassing all reports and coming up with a consensus, take the Treasury rate to all those declines so far in January, and expect it to gradually increase during the year. Spreads we're pretty much expecting to stay where they were towards the end of 2015.
Okay. Then one quick final question. Is there any capital impact from the sale of the Part D business?
Yeah, there will be eventually some of the capital freed up. We do have to carry some RBC on that business. We would estimate we'd probably carry, we don't have a final RBC for 2015 done yet with respect to that business, but we would expect it to be somewhere maybe in that $60 million-$70 million of capital ultimately would be hold on that business. We would see that capital being freed up over the course of 2016, then partially and then more fully over the course of 2017.
The expectation would be then that'd be deployed in 2017, 2018?
Yeah, there's always the possibility that we would be able to deploy that capital or be able to distribute some of that excess capital. We'd really have to be able to see what the capital situation looks like at that point in time. It probably really wouldn't be fully available, if you will, until the 2017, 2018 timeframe.
Got it. Thank you very much.
We'll take our next question from Jimmy Bhullar with JPMorgan.
Hi. Good morning. First question just on available resources for buybacks in 2016. I think, Frank, you mentioned free cash available with the liquidity on hand will be $366 million-$376 million. If I assume roughly $70 million for dividends and also put in the cushion that you're going to hold of $50 million-$60 million, implies buybacks of about $250 million in 2016. Is that a fair assumption?
No, I think as I indicated, I think the free cash flow that was available for buybacks that we see for 2016 should be in that range of $320 million to $330 million.
Okay, got it. Yeah, because I was taking out the dividends, the number you gave were post dividends.
Yeah. That's correct.
As we think about from 2016 to 2017, given I think you mentioned in your remarks that such dividends will be somewhat stable or flat. That number shouldn't change that much in 2017, right?
That's correct.
The proceeds from the sale, whenever that happens, are those going into the sub or would those come directly to the whole? I realize the capital freed is going to stay with the sub and might not be dividends up, but what about the proceeds? Where would those go?
Those go into the subsidiary.
When you talked about free capital, that did not obviously include any impact from proceeds, right? From the sales proceeds. Your direct response sales were weak, and I think you're expecting a flat or sort of flattish sales in 2016 off of just 4% growth in 2015. Can you talk about what's going on there, whether it's because of the market environment or is it more some of the changes that you're making given what's happened with your margins in that business?
Jimmy, as we discussed previously, we've experienced lower than expected profit margins associated with prescription drug underwriting changes. Our sales will be lower since we've now adjusted our marketing activities to eliminate the segments of unprofitable sales.
Okay. That's all I had. Thank you.
We'll take our next question from Erik Bass with Citi.
Hi, thank you. First, Frank, could you elaborate a little bit on your comment about if you do see ratings downgrade, you think that you could use some assets on hand or other measures to kind of plug the RBC impact? Can you expand on that a little bit?
Sure. As I indicated in my comments that we kind of looked and had that rule of thumb that roughly $100 million of downgrade would extrapolate into us probably needing about an additional $9 million of additional capital to retain the current RBC levels. Whether it be the cash that's available at the holding company or, say, from being able to access the capital markets, that we would have sources available to make for additional capital contribution to the company if we needed to. Just even using that rule of thumb, if we were to have around $500 million of downgrade, which is about half of the Triple B energy bonds that we have out there, that would really indicate that we would only need around $50 million of additional capital to retain our existing RBC levels.
Got it. Obviously, one option would be to just not dividend that out as well. I think, are you implying that you don't expect any change to the free cash flow patterns, or could the free cash flow be lower in that scenario?
Always a possibility, but we would always be looking at the opportunities and looking for the cheapest or most inexpensive way for our shareholders to fund that additional capital.
Got it. Thank you.
Erik, I was just going to say Frank is right. We would probably use a lower cost approach. If we're talking about $50 million, we could use the cash on hand, or we could borrow short term at a very low cost. That's a much lower cost than reducing the dividend, the amount we're dividending to the parent company.
Got it. That's helpful. Then just one question on direct response policy obligations. I think as a percentage of premiums, they're slightly above the 52% range that you're targeting for next year. Just any comments there, what gives you confidence that that kind of ratio will come down over the next year?
Yeah. That, you're right, that 52% was what we had there in Q4. For the year as a whole, we had the obligation percentage of around 51%, which was right at the top edge of what we had estimated for 2015. I think for 2016, we'd previously indicated we thought the policy obligations would be around that 52%. We'll probably move that up just slightly to somewhere in that 52.5% range is kind of what we'd anticipate for the policy obligations. We're still really seeing the overall margin percentage on the direct response business in 2016 being somewhere in that 19.5%-20% range.
Okay.
Pretty much what we had previously indicated. We haven't really seen a lot of change in that at this point.
Okay. Thank you.
We'll take our next question from Steven Schwartz with Raymond James.
Hey, good morning, everybody. First, just a couple, I guess, on Part D. It sounds maybe it's the nature of the Part D business, but it sounds to me from the conversation that just occurred with regards to when capital will be released, that you kind of will remain on the books and on the hook until current liabilities run off. In a sense, you're selling really the renewal rights. Is that an accurate way to think about it?
Well, we really would have responsibilities for the business up until the time of sales, unless there's some other arrangement with a buyer from that perspective. Of course, really can't get into any details of how that might work. I think the point was that from an RBC perspective, the way that the RBC rules work, if we sold it now or partway through the year, you don't get 100% deduction of that at the end of 2016. Some of that bleeds over into 2017. Of course, we are settling up even in 2017, just with respect to or potentially we could be settling up in 2017, on just receiving payments and again, just depending on how the sales process and what arrangements are worked out with the buyer.
Okay. Frank, I think you said that you thought the drag in 2016 from reimbursement patterns on Part D would hurt by about $8 million? Your excess investment income. Does that mean, looking at a 2017 model, just go back?
Correct.
Okay.
Let me modify that. In 2017, all that's assuming that we have the business for the better part of 2016. You have a little bit of drag in 2017, just pending the receipt, if you will, of the various receivables that we would anticipate at the end of 2016.
Okay. Larry, I apologize. I came a little bit late. Did you run through the sales expectations for the individual agencies already? If you did, I'll just check the transcript.
I did. I was going to go through it again.
I'll check the transcript. Let somebody else ask the question. That's all right.
Okay.
We'll go next to Randy Binner with FBR & Company.
Thanks. I guess Steven Schwartz just asked my question, but I'm just trying to understand what it is exactly you're selling, and I guess the right way to think of it is mostly a renewal rights deal. Are there really standalone systems or are there distribution assets that would transfer with a business like this Part D business?
It really is. It's a sale of the contracts to be able to offer the Part D prescription drug coverage. To a certain degree, it is the renewal rights, if you want to think of them that way. There aren't any hard assets. We don't have any systems.
Right.
Those type of things that are infrastructure, if you will, that is being sold.
Just to follow up on an earlier question, too, I guess the lack of earnings impact has to do with the fact that this is just a short-tail business, so it kind of resolves itself over the next 12 months, and then someone would have the right to take the book from there if they wanted to.
That is correct.
Just touching on, and I apologize if I missed this, but did you all go through where you are getting new money yields right now on investment grade and below investment grade? I would also be interested if you are seeing stress or need for de-risking in any part of your investment portfolio outside of energy.
Well, Randy, as far as where we're placing our money, I mentioned it's primarily the industrial sector, and that's where it's been, as what we mentioned the last two or three quarters. Within that, it's mostly been in the consumer sector. In transportation, some of the other industrial sectors, we haven't really added to our energy exposure. As far as de-risking, we don't see, at this point, a need to sell any of our bonds. Again, let's talk about energy because that's what most people's concern is. We feel confident in the bonds that we have, and we expect them to be money good. We don't expect to sell any of those. In the last few years, we have, I think, done a good job of spreading the risk. We were a little overweight on financials a few years ago.
I think we're pleased with where we are with our distribution by sector.
Just on the yields, did you touch on where you're getting new money yields in investment grade? Is investment grade kind of A-minus? Is that the center point of the portfolio right now?
A-minus, BBB-plus.
What yield did you get in the fourth quarter there?
The fourth quarter, we were just a little under 5%, and I mentioned earlier that we'd had some tax treatment sales at the end of the year that actually pushed us a little bit under 5%. Had we not done that, I can't remember, but it seemed like it had been 5.10% or in that range. So far this quarter, we've invested a little over $100 million at 5.25%. Rates have, just in the last few weeks, have gone down. If we were investing money today, it'd probably be around 5%.
Perfect. Thanks a lot.
We'll go next to John Nadel with Piper Jaffray.
Hi, good morning. I have a couple of questions, one on the American Income agent counts. If I look 3Q to 4Q, kind of surprised by the decline. Maybe it's nothing more than some culling of underperformers at your end. I suspect that's really the answer for Liberty. Can you give us some color on that?
I think your question was American Income or was it Liberty?
Well, it's a question about American Income. I suspect because we typically see that kind of culling at Liberty in the fourth quarter. I don't think we tend to see as much in American Income. Maybe I'm wrong.
Okay, thank you. There's two reasons for the lower guidance. It's based in part on the lower recruiting numbers I've seen during the fourth quarter of 2015 and January of this year. Let's remember, 2016 follows two strong years of agency and sales growth at American Income. Over the two-year period, our agency grew by 23%. Based on our historical data, I just would expect slower growth here in 2016. I'll be in a better position to give that guidance into the second, certainly by the third quarter call, we'll have a better feel for the agent growth for 2016.
Okay.
The dip from the third quarter to the fourth quarter in the actual agent count, not producing, but I'm sorry, not the average producing agent count, but the actual quarter-end agent count. What was the-
If you look back-
-driver in that?
If you look back at that seasonal with the Thanksgiving and Christmas holidays.
Okay.
Within American Income, there's always a seasonal drop from third to fourth quarter.
The second question is that sensitivity that you provided on the $100 million roughly of downgrades is equating to roughly two points on risk-based capital. What is the downgrade there? Is it a one-notch downgrade, or is it an entire letter downgrade? Meaning, if we thought about $100 million of your BBB is going to BB's.
Generally, that's, again, kind of a rule of thumb in looking at different multiple scenarios, and kind of looking at just kind of what I hate to use the word averages, but just kind of what can be gleaned from taking a look at all those multiple scenarios, including taking a look at just some of the We did look at just at the BBBs, or maybe really more NAIC Class 2, and moving them down into Class 3. What if everybody goes down a notch. Those are included in those various scenarios we took a look at.
In that case, it would still stay within the NAIC 2 category, correct?
It would stay within the NAIC. There would be some that would go from NAIC to NAIC 3.
Two to three. Yep. Okay. All right.
It definitely did include the drop from two to three.
Okay, that's helpful. Shoot, what was my last question? I'm sorry to do this to you. I guess my question is this. As you think about the level of buybacks here for 2016, and it seems for 2017, a similar level, in that $320 million-$330 million range. Is there some different approach to timing then that we should consider? There's been obviously moves in the market and moves in stock valuations. I'm curious, you kept the pace pretty consistent during 2015.
I don't like to tend to ask about these kinds of questions about pace, but I'm sure you guys are just as aware as most market participants are aware that there's a lot of speculation about Torchmark amongst maybe a few other companies as an interesting potential takeout candidate following some of the transactions that took place over the last year or two with Protective and Symetra and StanCorp. I'm curious how you think about the impact of that on your stock price and on your pace of buybacks.
I would say generally with respect to the pace of the buybacks is that we would continue, for the most part, to have those buybacks ratably throughout the course of the year. We would still think about having $87 million per quarter. Where you do think maybe there's some market opportunities, maybe that steps up just a little bit in kind of the near term. Obviously, we've had that from time to time where one quarter is a little bit more or less than the average, if you will. I don't see us varying from the overall strategy to any significant degree.
Okay. Is there any change as a result of Part D moving now into discontinued operations and essentially lack of sales at this point? Is there any change in the amount of new cash that you expect to be investing, the pattern that that looks like, 1Q to 2Q to 3Q, and obviously 4Q was a pretty high level of cash invested, and I assume that was in part driven by the receipt of cash from CMS?
Yeah, that's correct. Looking forward to within 2016, it will continue to have a drag throughout 2016. Tends to be a little bit more of a drag in the first three quarters of the year, a little bit more of that pop in the fourth quarter again.
Your expectations for what that receivable will look like or the cash received in the fourth quarter of 2016, how much is that?
We have around $75 million is what we would anticipate. In the fourth quarter of 2016, somewhere in that $75 million range is what we anticipate being a receivable from CMS.
Okay. Not nearly as big as the one from 2014 received the $2.5 billion.
That's correct. We do anticipate it going down.
Terrific. Thanks so much for all the help.
We'll take our next question from Seth Weiss with Bank of America Merrill Lynch.
Hi, thank you. Just wanted to follow up on the big decline in cash flow for 2016 relative to really the last three years. Could you help just walk through the drivers of that? I know a lot of it is sales driven, but if you could give us a little bit more granularity. I was a little surprised at the step down in cash flow.
Yeah. As I indicated, I think there's a couple of key drivers that all kind of work together to push that down. You do have the higher sales, and we've talked about you have higher sales, and in the first year of those sales, acquisition expenses exceed the amount of premiums coming in. So there is a drag on your statutory earnings from those. Then you start having positive statutory incomes in that second year after the sale. As you continue to, as we have the last couple of years, where we've had two really good years of continued sales and sales growth, that's just pulling down on the amount of statutory income. Now we anticipate those future profits from those sales just start really emerging, coming in the future here.
That's probably generating somewhere in that $15 million-$20 million of statutory drag in 2015 just by itself. In a lot of normal years, you'd have the decrease in investment income that would help offset that. Unfortunately, the last couple of years with the continuing drag that we have had largely from the Part D and then, of course, lower interest rates and to some degree the higher direct response claims, we've been having growth in that investment income of only around a 2% or probably about 2% level rather than at that 4% or so where our invested assets are growing at. That's weighing in on it. We have talked a little bit about, we had some higher acquisition or administrative costs, and this just inroads in 2015 from some of our IT and pension costs and that type of thing.
The way that the accounting rules work for federal income taxes, basically, you don't get quite the smoothing effect that you have on, for GAAP purposes. We just end up having some higher taxes in 2015 here than we did on a comparable basis with 2014.
Okay. There's obviously a lot of factors there. If we look back over the last three years, was there anything unusual and perhaps unsustainable that was contributing to cash flow, or would you think of the next few years as maybe the drag from higher sales and some of these other items that you've outlined as maybe keeping it unusually low for a couple of years?
Yeah, I think your latter comment. I don't see anything that was terribly unusual other than maybe the drags of some of the higher direct response costs and then the drag from Part D.
Great. Thank you.
We'll take our next question from Ryan Krueger with Keefe, Bruyette & Woods.
Hey, thanks. Good morning. A couple other follow-ups. In terms of the $60 million-$70 million of capital backing Part D, to the extent that it runs off, I guess it wouldn't come through, I don't think, as earnings. Would you view that, given that it would cause an increase in the RBC ratio as being able to be dividended up to the parent company in the following year?
Right. It does not come through as earnings, as you said. While it may be available as an extraordinary dividend to the extent that our capital levels would permit it, but it clearly would have to be something that would have to be approved by the regulators.
Okay, got it. What entity is this business in legally?
United American.
Got it. Okay. On the downgrade scenario, some of the other companies, the scenarios they've provided have even lower than the impact would look like it would be if you simply apply the RBC factors for C1 risk. You mentioned covariance and diversification offset. Maybe in your impact, it didn't seem like there was any sort of covariance offset. How should we think about that?
I think the impact of the covariance and some of the other offsets were taken into account, estimated to some degree within that overall rule of thumb that I provided.
All right. Last one. Can you just discuss how the impairment policy works? From a pricing standpoint, if you fully intend to hold the security to maturity, but the bond, let's say, is trading at $0.50 on the dollar for an extended period of time, is there anything that requires you to potentially impair that security if you still think it will pay off at par?
No, in answer to your question. The fact that it's just trading below book value in and of itself, even for an extended period of time, wouldn't require us to impair that security. We would have to take a look and evaluate that particular bond offering and determine, do we think it's money good? As long as we believe that we're going to collect the principal amount from that, in our particular case, we have the ability and the intent to hold those to maturity. As long as we believe and can demonstrate that we will be able to collect that at maturity, then we do not have to have an impairment under the accounting rules.
That includes both. That includes GAAP and statutory?
Correct.
Okay, thank you.
We'll take our next question from Bob Glasspiegel with Janney.
Good morning. What is behind the margin improvement in Liberty National in Q4? I think you said it was a factor behind your revised guidance for 2016.
Bob, it really is more of a timing issue there because if you are comparing the two quarters, the reason for the higher margin is that we had lower policy obligations in Q4 2015. As it turns out, Q4 2014 was our highest policy obligation quarter, and Q4 2015 was the lowest for the year 2015. If you look at it on a year-to-date basis, 2015 was 38% of premium versus 39% of premium the year before. It is pretty much the same. Our outlook for the coming year is that policy obligations will be around that 38% level and our margins will be somewhere to, I think at the midpoint it is about 26.5%, and that is a little bit lower than 2015, but a little bit higher than 2014.
You did not say that this recent increase was partially due to Liberty National margin assumptions for 2016 change?
Yeah, what I just indicated was that we just had a little bit of an improved outlook internally, with respect to where that margin was, could be from what we had back in the third quarter. I think we're anticipating our overall margin be somewhere in that 25%-27% range for the entire year 2016. That's just a slight improvement over where we just kind of thought it would've been back in October.
Nothing's changed with Liberty National Q3 to Q4. I misheard that for your outlook? Okay.
Between Q3 and Q4 guidance, we just had a slight increase in our expectation of the margins for 2016.
I thought you mentioned Liberty National in that, you didn't. You didn't mean to?
Yes.
Okay.
It was Liberty National.
Now I'm confused. Let me step back. Has Liberty National changed at all from Q3 to Q4?
For Liberty National, our outlook on the overall margin for 2016 increased slightly.
Okay. What's behind that?
Just a slightly better outlook as far as our net policy obligations.
Okay. What's the timing of the sale? How far along are you? Are there RFP out?
We really can't talk about it.
Whether there are RFP is what you can't say?
I think in my comments indicated that we're in the midst of discussions with multiple parties.
Okay. That's helpful. Appreciate it.
We'll take our next question from Eric Berg with RBC Capital Markets.
Thanks. Frank, I was hoping we could return to the question about the reduction in ratings in the energy portfolio. If the $100 million principal amount and the $9 million of incremental capital that would be required, is that the result of, again, in response to John Nadel's question, is that an analysis that looks at the impact of multiple scenarios for notching changes or just one notch? I was not clear on your response.
It's kind of an amalgamation of looking at multiple scenarios that our investment department took a look at.
Some of those scenarios would've looked at one-notch downgrades prior to the entire portfolio. We would've also looked within that range of scenarios, just drops from any NAIC from 2 to 3 for a certain amount of our portfolios. Obviously it is different if all of the downgrades go from one notch down to another notch. If it's all 2 to 3, we'll have some impact. As a general rule, we believe that this rule of thumb will hold or be fairly close.
Okay. Why don't I leave it there for now? Thanks very much.
Gentlemen, at this time, I'll turn the call back to you for any additional or closing remarks.
All right. Thanks for being with us. Those are our comments. We'll talk to you again next quarter.
Thank you. That does conclude today's conference. Thank you for your participation.