Seth Weiss, the Senior U.S. Life Insurance Analyst, pleased to kick off the life portion of our conference and introduce Gary Coleman and Larry Hutchison, Co-CEOs of Torchmark. Torchmark focuses on providing protection-oriented life and supplemental health insurance products to the low to middle class. Gary and Larry took on the Co-CEO roles in mid-2012. Prior to their current roles, Gary served as CFO, and Larry served as General Counsel. In those roles, they both worked very closely together, and they each have over 25 years of experience with the company. I'm going to turn over to Larry just to read some forward-looking comments, and then we will get into our Q&A.
Seth, before we get started, we're required to say that some of our comments to answers or answers to questions may contain forward-looking statements that are provided for general guidance purposes only. Accordingly, please refer to our 2012 10-K and any subsequent forms 10-Q on file with the SEC.
Thanks, Larry. I think maybe the best place to start is on capital distribution. Thinking about the Torchmark model, that's one bit that's a differentiator of the company. Over the last six years, you've distributed about $2.5 billion to shareholders, which is about 85% of net earnings. This is one of the highest and most consistent payout ratios among your peer group. Perhaps you could start talking about the business model that allows for such strong capital distribution and how it's a differentiator relative to your peers.
Sure. We do believe that Torchmark's business model is different from its peers in five areas: distribution, product strategy, profit margins, cash flows, and capital requirements. We utilize controlled distribution to sell our protection products to the middle-income market. We think using controlled distribution allows us to be more cost-efficient. Primarily through our union relationships and Direct Response, we're able to access those segments of the market with little competition. Our products are protection oriented. They're not directly affected by either the equity or the credit markets. Our life products have high underwriting margins. The key to those higher margins is our ability to control our costs to acquire business and to administer it. We have strong cash flows because our products have high profit margins, and we have long-term revenue streams. With respect to capital requirements, our low-risk products result in lower risk-based capital requirements.
This allows us to maximize the use of our cash flows through an active capital management program.
Seth, I would add that with that high cash flow, consistent cash flow that we have and the low capital requirements, it allows us to not only cover all the capital needs each year of selling new business, but there's plenty of cash left over that we then distribute up to Torchmark. The only obligations really at a Torchmark level are interest on our debt and our dividends to shareholders. It gives us a great deal of cash that we can then use. We've used it, as you know, primarily for share repurchase over the past few years. That cash is available for acquisitions or other alternatives. It's a real strength, not only the size of excess cash flow, but the consistency of it.
If we think about that flexibility on cash, particularly after the run-up the group's had in 2013, Torchmark's now trading near about two times book value, like AOCI. Maybe you could help walk us through your consideration for stock value when you think about repurchase decisions and what some of the alternatives are to share repurchase when thinking about those cash flows.
Well, if we thought the stock was fully valued, we wouldn't use the money to buy stock. We would find another use for it. We're committed to distributing cash to our shareholders, it might be we would switch to special dividends or something like that. Even with the recent run-up, we look at PE price to book. We're not at the historical highs for Torchmark. We're still below that. We're always looking. We calculate what we think an intrinsic value of the stock is, and we talk to others to determine where we stand versus current price to what we think full value is. We're not there yet. If we ever do get there, though, we recognize that buying at greater than full value would be dilutive to shareholders, we would stop.
Thinking about some of the alternatives, 2012, I believe you made the acquisition of Family Heritage. M&A is obviously an alternative to share buyback. How do you think about M&A, and what businesses would you want to be in?
Well, we would like to do acquisitions, and we've looked pretty hard the last few years. We did make the acquisition of Family Heritage at the end of 2012. The problem is we're pretty selective in the type of company we're looking for. We're looking for a company that fits well in our business model, and that's selling protection insurance to the middle-income market through controlled distribution. There's just not many of those kind of companies out there that are available. Family Heritage was like that, and they fit well within the Torchmark Company. We're not closed to health. Family Heritage is a health company, but we prefer life insurance because they have higher profit margins, and there's less regulation and less competition. We'll continue to look, and when something comes available, we'll go after it.
Thinking about sort of the payout ratio and what's required for normal organic growth. If I think about the last couple of years, since 2008, EPS has grown at a very strong clip. Operating earnings have been mostly flat, and this has obviously been a difficult operating environment in terms of economic weakness, low interest rates. In a more normal environment, what do you view as a normalized organic growth rate?
Well, if you take a look at the last three years, I think we've grown earnings per share at an average annual rate of 11%. If you look at just the dollars of operating income, we've grown at an annual rate between 3% and 4%. We've been really hurt by the lower interest rates. In that period of time, our excess investment income declined on an annual basis about 6%. It was offset by the fact that we increased our underwriting income around 7.5% annually during that three-year period. There were some unusual items there, the acquisition, Family Heritage, and there was some restructuring and non-deferred acquisition costs, that kind of thing.
Going forward, I would still say that operating earnings on just a pure dollar basis will still grow between 3% and 4%, but the components are going to change with the fact that the new money rates are higher. Instead of a decline in excess investment income, we should see increases in excess investment income of 5% to 6% going forward, and our underwriting increases will go back to more of a 3% to 4% growth rate.
In terms of an improved interest rate environment, is there a level where the rate levels turn into a tailwind from the headwind that we're at right now?
Well, I think we're there. One thing about Torchmark, we don't have interest-sensitive products, and so the higher the interest rates, the better for us. Right now in our guidance for 2014, we're assuming that we're going to invest at 5.5%. Although that sounds really high when you compare it to we invested at 4.7% in 2013, and as low as 4.3% in 2012, being at 5.5 makes a big difference. Where we've seen the decline in excess investment income because of lower rates in the last three years, we're going to see that reverse. Even in those years, even with declining rates, we're still growing investment income, but we were growing at a much smaller rate than the growth in assets.
What's going to happen in 2014 and going forward, we're going to grow the investment income at about the same rate we're growing the assets. That's going to turn a decline in excess investment income into 2014, we'll have a positive of 5% to 6%. It's a great improvement, but we would like for the rates to continue to go up, and the sooner, the better.
Maybe just to close the loop on the investment income piece. Part of the pressures over the last couple of years were calls on some hybrid preferred. If we think out over the next call it five years, is there anything else on the horizon that we need to be watching for in terms of run off the portfolio that could cause for some near-term volatility in the investment income line?
No, as a matter of fact, our maturities looking out over the next five years, average about 2% of the portfolio a year. The yield rates on the bonds coming out of the portfolio is now closer to the new money rate that we've seen. If we keep investing at 5.5% over the next five years, we're going to see the portfolio yield stabilize instead of decline. To show you how bad it was in the last five years, our portfolio yield has declined from over 100 basis points, from 698 to 590. Investing at 5.5%, we would expect five years from now, it'll be maybe 8-10 basis points lower, but it won't be the big decline we've had.
That's helpful. Maybe transitioning away from the investment side to more so the operations side and thinking about sales. Since your underwriting results tend to be so stable, there's a lot of focus on sales, which can be lumpy in general. If we look at premium growth, it's a very smooth line. Maybe you could talk a little bit about persistency trends that you've seen the last several years in your in-force business and actions you're taking to keep that in-force and persistency high.
We've been selling the same protection products, especially our life products, for over 30 years, as long as I've been at Torchmark. We have a great deal of history in terms of persistency and lapse rates. There's very little change from year to year. We've always had our agents. We've always incentivized them to reinstate policies that have lapsed. One thing we've done, I think it's 3 years ago in our home office, we put together a group and implemented procedures that whenever somebody lapses a policy, we contact them, we try to get them back in a paying status. We just had never done that before. By making a concerted effort to do it, we've seen a real improvement. For example, in 2013, 15% of the business that lapsed, we were able to get reinstated through this home office effort.
Through what the agents do, it was another 2%. We were able to save 17% of the business it lapsed. Some of that business will lapse as we go forward, but anytime you can save lapses, you can get back in force, it improves your persistency.
One thing I'll add to that is that in the agencies, we've also focused on increasing our persistency. Each agency has a personnel that's assigned full time to work on conservation, and we're seeing those improvements in each agency. Each of the agencies discovers best practices for conservation within the agency, that's shared among the Torchmark agencies, and we think we can grow that conservation as well as in the home office.
Another thing I would add is, one thing that's important about improving persistency is I don't think people realize the value of the in-force block that we have at Torchmark. As Larry mentioned earlier, we have high profit margins on the business, but we also have long revenue streams. One reason you don't see higher growth in underwriting income is the fact that in any one year, you can look at the premiums. For example, in 2013, the premiums on policies issued in 2013 only made up about 10% of our total premium income. The other 90% came from policies we sold in prior years. You have that big of a block of in-force, it is hard to grow underwriting income at a high rate. What we do is we grow it at a very consistent rate.
Thinking about those conservation efforts, that's something that doesn't really come up on the quarterly calls, and I think it's an interesting point. How much more progress do you think there is in terms of conservation and improvements in persistency, which is already pretty strong?
Well, as I mentioned from that home office group, we conserved 15% of the lapses in 2013. Our goal for the next couple of years is to get that up to just under 20%. After that, I don't know. It'll depend on us keep finding new ways to get to the policyholders and get to them back and help them reinstate the policy.
Part of that's a testing process. We're continually testing new means of conserving that business. There are constantly new ideas that come up of how to contact the policyholders that lapse, when to contact them. Use a little bit of the Globe methodology in that testing process to improve our conservation efforts.
Maybe a little bit further on the sales front. Torchmark's market position, pretty unique in terms of the focus on the mid-market, which has historically been a cohort that under-insures. If you think about strategies to improve penetration both of Torchmark and the industry in terms of that middle income segment, what are the strategies that you put forth?
First of all, we have done a lot of research in the middle income market, Gary and I look at other markets, and we come back to the middle income market because we know it's an underserved market. Our research tells us that 50% of consumers understand they don't have enough insurance, and most consumers don't have any life insurance at all. I'm talking about life insurance. In terms of penetration of the market, we've made a lot of moves to increase our penetration over the last five years at our American Income distribution. We have long relationships with our unions, and we continue to maintain those relationships. In addition to that, we've used those relationships to develop a referral program. Today, about 70% of the new business that we write at American Income comes from referrals versus the traditional union member.
We're seeing great success in that referral program to expand our footprint in that middle income market. There's such a Globe Life and Accident. Globe Life has been selling the same life insurance products for about 50 years. In that 50 years, they've developed a lot of expertise. They have economies of scale in controlling cost. More importantly, we have a lot of data, a lot of experience in selling those products. Through that, we know who to sell, when to sell, and where to sell those products in terms of the Direct Response. Globe has also used a lot of technology to change the company. Globe has really evolved from just a Direct Response company that uses the mail to where it now uses technology. When we look at our sales, about 40% of our new sales are now through electronic technology.
That would be the internet, other social media to reach our consumers. That is our fastest growing segment of Direct Response. We'll continue to explore that, and we see real opportunities for Globe Life in the electronic distribution.
Maybe on Globe Life, for those who may have missed the release, Torchmark just purchased the naming rights to the Texas Rangers Ballpark. It'll be called the Globe Life Ballpark in Arlington. Maybe you could just describe a little bit the thinking behind that deal and also why you decided to use the Globe Life brand name instead of using the Torchmark name.
We are really excited about this opportunity for Globe Life. When we looked at the Rangers and the demographics of their customers, their fans, they really match the demographics of Globe Life. It's a middle-income fan, and obviously Globe Life's in the middle-income market. Traditionally, Globe Life and the other Torchmark operating companies haven't had real name recognition. We see this as an opportunity, particularly in the Texas region, that is Globe's fastest growing state, to test and see the results from a branding opportunity. We know it's going to help the other agencies because I think there's an instant credibility.
Family Heritage Life's largest state is the state of Texas. One of the issues we deal with in agent recruitment is when you're talking to a new agent, they say, "Well, I'm not sure who Family Heritage Life is." They're able to say, "Well, it's part of the Torchmark group, and it's a publicly traded company." Now, as they talk to prospective agents or even customers, they can say Family Heritage has a sister company called Globe Life. I'm sure you're aware of that. That's the naming partner with the Texas Rangers. We know there's an instant credibility. Within the Texas market and the surrounding states, we know there's going to be a lift because we're licensed to use the logo. We're going to be on the social media pages.
There's a lot of TV and radio advertising that comes with the naming rights. That's going to be a positive as there's a greater recognition of Globe Life. Outside that five-state area for the Rangers, we know the national telecast will be helpful because every visiting team on every pitch will see Globe Life behind home plate as they see each pitch. Then we'll be able to test to see how mailings, what the internet traffic is in each of those areas as we go forward. We really see this as a terrific opportunity for Globe Life and the other Torchmark companies. We didn't use Torchmark because within Torchmark doesn't reach its customers directly. All of our products are sold through the operating companies.
As Gary and I talked about this, we really thought it made more sense to use Globe Life than Torchmark because Torchmark is known in the investment community. Globe Life made the most sense among the Torchmark companies because it is a Direct Response company, and it benefits from internet traffic and other kinds of electronic communication.
Yeah, I would add that we, as I think Larry mentioned, for years have been trying to look at a way to increase the brand awareness of Globe Life. In doing so, the expenses, especially in television throughout the country, was really high, especially when you compare it to our Direct Response calls, which are very low premium. We could eat up the profit margins pretty quickly with high expense brand advertising. Despite, of course, the varying amounts of what this costs, this is going to be an inexpensive way of doing some brand identification for Globe. The Rangers have the largest television market in the five-state area that's assigned to them, and that is our biggest area in terms of sales for Direct Response. Also they play, of course, teams throughout the country, and games are played in Arlington when the Los Angeles Angels play there.
Los Angeles is a big area for Direct Response. When the Angels play there, they'll see Globe Life in the background, and the same for other visiting teams. We think it'll just help. When somebody gets an insert or a piece of mail from Globe Life or they go to the internet and see the name Globe Life, we think it'll help with the name recognition. All it takes is just a few more people to open that mail or look at those inserts or to go online to improve our response rates, which improves our profitability. The second part of that, as Larry mentioned, the television and radio spots we get along with this deal, that's where we can help with advertising for our agencies to help with recruiting and especially Family Heritage, as Larry mentioned.
We think this probably the most benefits Globe Life, it really benefits all our companies. I also agree with Larry. We've been contacted by other stadiums before. We've never done it because we could never see the value in it for Torchmark. I think with the increased use of electronic media in Direct Response, we finally seen there is a strategic reason to do it's not through Torchmark. It's getting that Globe Life name out.
As we test these results, we haven't ruled out other regional branding opportunities. As we see the actual results of Globe Life and the other companies, we consider national branding opportunities as well.
Should we think about a step up in other branding advertising initiatives, or should we think of this as sort of step one?
This is really step one. This is really a different approach for the Torchmark companies. In the past, Globe Life surely has been able to measure response rates, but it hasn't done branding per se. This is really a first step, but the value is this first step supports all the other initiatives with Globe Life. I mean, it fits perfectly with your direct mail campaigns, with your internet campaigns, and all the ways that Globe Life tries to reach that consumer without an agent is supported through this branding effort.
Just want to pause and see if we have any questions from the back, Ryan.
Not to harp on this, but are you going to run the expenses? It sounded like, A, that the published reports about what it's going to cost Torchmark or Globe Life for the naming rights may have been overstated, based on what I think you said earlier. The second question I had is follow-up to that. Would you run the expenses associated with the naming rights through the Globe Life segment or through the corporate segment?
Well, hang on. Part of that question is, don't believe everything you've read about the cost of those naming rights. There've been reports that we've read that range from $50 million-$100 million. While we've agreed to the ranges, we won't disclose the amount, we can say it's less than the $50 million-$100 million that's been reported. Gary, do you want to cover the accounting treatment?
Yeah. Also, I'd add to that over the 10-year period, that the cost will be less than one half of 1% of Torchmark's operating earnings. It's really not a big cost. As far as where the cost, the cost will determine what the benefits we're getting, we'll allocate the cost that way. I think Globe will get a fair amount of it, but the agencies will also get some of that too. As I mentioned, we'll do some of the advertising through them, it'll be split among the companies.
Gary, I've talked to the CEOs of each of the other operating companies, and by the other operating companies besides Direct Response, they do see real benefit in this, that they can recruit with this. They can have production contests. The cost will be allocated according to the use among the Torchmark companies.
I guess just to, if I can follow up with that, we shouldn't expect to see a pickup on the expense or a deterioration of the margins, at least in year one, associated with higher advertising expenses?
No. When I think about the expenses associated with this is much like other campaigns or initiatives we talk about at Globe Life, I don't see this as a campaign or initiative that is significantly more of an investment expense than those other initiatives.
When I mentioned the less than one half of 1% of operating earnings, I was just talking about the cost. There's no benefits projected into that. It really should be less than that.
Thanks. Maybe just turning to the other business segments. You've had a successful turnaround in Lincoln National. I'm sorry, Liberty National.
Liberty National. Yeah, we ain't worked on Lincoln yet.
Successful turnaround with Liberty National. We've seen some modest margin improvements in the other segments. Where should we think about margins leveling off, and what other actions are there left to take at the operating companies?
Let's talk about Liberty National first. At Liberty National, we are pleased with the progress we're making. We opened six new offices at Liberty National in 2013. We expect to open another five offices at Liberty National in 2014. Our long-term goal at Liberty National is to open offices outside of the Southeast. That strategy is paying off. We expect to see our margins at or near the same levels that we've seen in 2013 and what we'll see in 2014.
Those margins are high for industry levels. I don't know that we can increase those much. We'll maintain those margins.
The balance there is to maintain the margins, at the same time expand our operation throughout the U.S. with Liberty National.
Maybe if there are more questions from the audience, we could. Just on the supplemental health business, which you commented early on that you like the margins in life businesses in terms of where you would seek acquisitions, obviously you're opportunistic. Given that you increased supplemental health with Family Heritage, how does the Affordable Care Act and the sort of evolving nature of healthcare change the operations and perhaps affect the economics of that business?
I'd just reiterate that our focus is on life insurance. 70% of our underwriting income comes from life insurance. That remains our primary focus. That said, Family Heritage really resembles life insurance more than health insurance. They sell a return of premium product, and the margins on that business are much like life insurance, really more so than health insurance. That said, we like Part D. We like Medicare Supplement. It's an opportunistic business, though, Seth. It's hard to project long range what that growth will be because we're going to maintain our profit margins, and we'll increase market share if we can maintain those margins. Part of the reason it's difficult to predict is that part of those margins are dependent upon what other insurers are willing to do in either Part D or Medicare Supplement.
If they're going to reduce their margins below an acceptable level to Torchmark, we'll write less of that business. If we see an acceptable margin, we can expand that. That is the one distribution that we write through a general agency business, so it's fairly easy to either expand or contract that business.
With our other supplemental insurance, Liberty and some of the other companies with dread disease type products, those aren't affected by Obamacare. We expect to be able to continue to sell those.
The supplemental products with the, particularly with Liberty National, are really an addition to the life insurance. About 50% of our distribution of Liberty National is through the workplace. In the workplace, you're offering life insurance and those supplemental health insurance products. It's really a complement to the life insurance sales at Liberty National Life Insurance Company.
Okay, great. I think we're going to end it there. Let's thank Gary and Larry again for their time.