Good day, and welcome to Torchmark Corporation's fourth quarter 2012 earnings release conference call. Today's call is being recorded. For opening remarks and introductions, I would like to turn the call over to Mike Majors, Vice President of Investor Relations at Torchmark Corporation. Please go ahead, sir.
Thank you. Good morning, everyone. Joining me 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 2011 10-K and any subsequent Form 10-Q on file with the SEC. I will now turn the call over to Gary Coleman.
Thank you, Mike, and good morning, everyone. Net operating income for the fourth quarter was $127 million, or $1.33 per share, a per share increase of 10% from a year ago. Net income for the quarter was $151 million, or $1.58 per share, a 32% increase on a per share basis. With fixed maturities and amortized costs, our return on equity for 2012 was 15.5%, and our book value per share was $35.24, a 10% increase from a year ago. On a GAAP reported basis with fixed maturities and market value, book value per share grew 21% to $45.85. In our life insurance operations, premium revenue grew 5% to $452 million, and life underwriting margins increased 9% to $129 million. Net life sales increased 3% to $83 million.
On the health side, premium revenue, excluding Part D, increased 13% to $203 million, and health underwriting margin grew 10% to $45 million. Health sales increased 67% to $35 million. I will now turn the call over to Larry Hutchison for his comments on the insurance operations.
Thank you, Gary. First, let's discuss American Income. At American Income, life premiums were up 9% to $171 million, and life underwriting margin was also up 16% to $57 million. Net life sales increased 8% for the quarter to $40 million. The producing agent count at the end of the fourth quarter was 5,176, up 18% from a year ago, but down 5% during the quarter. We are very pleased overall with the progress made at American Income in 2012. The agent count decrease during the fourth quarter is not surprising, as American Income's agent count typically decreases in the fourth quarter. We also had increased terminations resulting from the big growth spurt we had in the early part of 2012. We're excited about the company's future prospects. We expect sales growth for 2013 to range from 10%-14%. Now, Direct Response.
In our Direct Response operation at Globe Life, life premiums were up 5% to $153 million, and life underwriting margin increased 6% to $34 million. Net life sales were down 4% to $32 million. However, for the year, life sales were up 3%. In addition, the business we wrote was more profitable. Response rates were lower than anticipated in the fourth quarter. We believe this is possibly due to the state of the economy. However, it is not unusual to have fluctuations like this from time to time in Direct Response. We are confident that our 2013 initiatives will help increase response rates in 2013, and we expect mid-single-digit sales growth in 2013. Now, Liberty National. At Liberty National, life premiums declined 2% to $69 million, while life underwriting margin was up 14% to $20 million.
Net life sales grew 3% to $9 million, while net health sales declined 12% to $4 million. The producing agent count at Liberty National ended the quarter at 1,419, up 6% from a year ago. We are pleased with the progress being made in turning around our producing agent counts and sales at Liberty National. We continue to work to change the culture of this agency. We are optimistic that agent growth will continue going forward and expect sales growth to range from 8%-12% for 2013. Family Heritage. Our results include two months of Family Heritage operations as we completed the acquisition on November the first. Health premiums were $30 million, and health net sales were $7 million. We're also excited about the growth potential of Family Heritage's health business. We intend to grow this agency through geographic expansion and implementation of our internet lead recruiting program.
For 2013, we expect premium income to range from $195 million-$205 million, with margins as a percentage of the health premium about 18%-19%. We expect health sales of approximately $50 million-$53 million in 2013, a growth rate of 5%-9% over 2012. Medicare Part D. Premium revenue for Medicare Part D grew 73% to $84 million, while the underwriting margin increased 49% to $10 million. Part D sales for the quarter fell 53% to $46 million due to the decrease in LIS in 2013. We don't expect as many new auto enrollees under the Low-Income Subsidy program in 2013 as we had in 2012. We won't have the type of sales and premium growth we had in 2012.
We expect a decrease of approximately 5%-7% in our Part D premiums for 2013, due primarily to price competition in the employer group market. I'll now turn the call back over to Gary.
Thanks, Larry. To complete the insurance operations, administrative expenses were $44.5 million for the quarter, 8% more than the year ago quarter. The increase is due primarily to the addition of Family Heritage and the 2012 expiration of a third-party agreement under which we received reimbursement for providing administrative services. For 2013, we expect a 6.5%-7.5% increase in administrative expenses, with most of the increase due to the acquisition of Family Heritage. However, as a % of premium, administrative expenses will be around the same level as 2012. Now I want to spend a few minutes discussing our investment operations. First, excess investment income. Excess investment income, which we define as net investment income less required interest on policy liabilities and debt, was $56 million, a decline of $8 million or 13%, 6% decline on a per share basis from the fourth quarter of 2011.
Sequentially, excess investment income was up $1 million from the third quarter. Due to expected calls of hybrid securities and lower new money rates, we expect excess investment income in 2013 to decrease approximately 6.5%-7.5%. However, reflecting the impact of share repurchases, we expect 2013 excess investment income per share to be down 1%-2% compared to 2012. Now regarding the investment portfolio, invested assets are $12.5 billion, including $12 billion of fixed maturities at amortized cost. There is no exposure to European sovereign debt, and there are no commercial mortgage-backed securities or securities backed by subprime or Alt-A mortgages. As of fixed maturities, $11.4 billion are investment grade with an average rating of A-, and below investment grade bonds are $585 million compared to $685 million at the end of the third quarter and $701 million a year ago.
The percentage of below investment grade bonds to fixed maturities is 4.9% compared to 6.3% at September 30 and 6.4% a year ago. The $100 million decline in the fourth quarter is due primarily to calls and sales. With a portfolio leverage of 3.5 times, the percentage of fixed bonds to equity, excluding net unrealized gains on fixed maturities, is 17%, which is less than most of our peers. Overall, the total portfolio was rated A-, the same as a year ago. In addition, we have net unrealized gains in the fixed maturity portfolio of $1.6 billion compared to $964 million a year ago. Regarding investment yield, in the fourth quarter, we invested $729 million in investment-grade fixed maturities, primarily in the industrial and utility sectors.
The large amount of fourth quarter acquisitions was due to the reinvestment of proceeds from bonds called in the third quarter as well as bonds sold for tax purposes. In order to get the excess cash invested in a timely manner, we temporarily lowered our yield requirements, resulting in an average annual effective yield of 4.05%. However, I want to note that we did not lower our credit quality standards. If we had invested a normal amount of cash during the fourth quarter, our average annual effective yield would have been around 4.25%. As such, our guidance for 2013 assumes a new money rate of 4.25%. The average rating for fourth quarter acquisitions was BBB+, and the average life was 27 years. For the year, we invested $1.5 billion at an average yield of 4.3% and an average rating of BBB+.
For the entire portfolio, the fourth quarter yield was 6.2% compared to 6.52% in the fourth quarter of 2011. Excluding Family Heritage, the yield on the portfolio at December 31st is 6.19%. Including the Family Heritage portfolio of lower yielding government securities, the yield on the total portfolio at December 31st is 15 basis points lower or 6.04%. By the way, the addition of Family Heritage results in a similar 15 basis point reduction in the overall yield on the net policy liabilities at December 31st, reducing that yield to 5.52%. On the last call, we indicated that we still held approximately $300 million of bank hybrids that could be called. In the fourth quarter, $38 million were called, leaving $262 million of those securities in the portfolio at year-end.
Including $37 million that we assume will not be called this year, we have $225 million of hybrids that we expect to be called in 2013. Of this amount, we know for certain that $66 million will be called in the first quarter. For guidance purposes, we assume that the remaining $159 million will be called by the end of the first quarter. Assuming a 4.25% reinvestment rate, the lost annual income related to the $225 million of calls will be approximately $3.7 million after tax in 2013 and $4.4 million after tax on an annual basis going forward. On past analyst calls, we've discussed the current low interest rate environment and the impact of a lower for longer rate scenario. Our concern regarding the extended period of low interest rates continues to be the impact on earnings, not the balance sheet.
As long as we are in this low interest rate environment, the portfolio yield will continue to decline and thus pressure excess investment income. However, the decline will be slowed by the fact that on average, only 2%-3% of fixed maturities will run off each year over the next five years, and that assumes the call of the bank hybrids that we previously discussed. In the fourth quarter, we updated our stress test assuming a new money rate of 4.25% for the next five years, and determined that the portfolio yield at the end of 2017 would be around 5.55%. Assuming a 4% new money rate, the portfolio yield at the end of 2017 would only be around five basis points lower at 5.50%.
At these rates, we would earn a small spread on the policy liabilities while earning the full 550-555 basis points on our equity less the interest required to service debt. In either scenario, we would still generate substantial excess investment income. As I mentioned, an extended low interest rate environment impacts our income statement, but not the balance sheet. Since we sell non-interest sensitive protection 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. As a result of our cash flow testing indicate that our reserves are more than adequate to compensate for lower interest rates. Now I'll turn the call over to Frank to discuss share repurchases and capital.
Thanks, Gary. I want to spend a few minutes discussing our share repurchases and capital position. First, regarding share repurchases and parent company assets. In the fourth quarter, we spent $42 million to buy 844,000 Torchmark shares. For the full year, we have spent $360.5 million of parent company cash to acquire 7.5 million shares. The parent ended the year with liquid assets of $147 million, including $94 million that has been invested to be used for the redemption of our senior notes that mature on August 1st, 2013, or at an earlier time if opportunities to repurchase the notes become available. This leaves the parent with $53 million of liquid assets available for other corporate needs. In addition to these liquid assets, the parent will generate additional free cash flow in 2013.
Free cash flow results primarily from the dividends received by the parent from the subsidiaries, less the interest paid on debt and the dividends paid to Torchmark shareholders. While our 2012 statutory earnings have not yet been finalized, and assuming shareholder dividends remain at the current level, we expect free cash flow in 2013 to be in the range of $355 million-$365 million. Thus, including the $53 million available from assets on hand, we will have approximately $408 million-$418 million of cash and liquid assets available to the parent during the year. To date, in 2013, we have used $17.7 million of this cash to buy 330,000 Torchmark shares. As noted before, we'll 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 liquid assets at the parent company. Now, regarding RBC at our insurance subsidiaries. We plan to maintain our capital at the level necessary to retain our current ratings. In the last two years, that level has been around an NAIC RBC ratio of 325%. This ratio is lower than some peer companies, but 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 haven't finalized our 2012 statutory financial statements, we expect that the RBC at December 31st, 2012, will be in the range of 330%-340%. Now, before I turn the call back to Larry, I would like to briefly discuss the purchase of Family Heritage Life Insurance Company.
On November 1st, we closed on the purchase of all the outstanding stock of Family Heritage, a privately held supplemental health insurance provider. The base purchase price of $218.5 million was paid for with $150 million of internal funds from our life insurance companies and $68.5 million of additional debt, including the assumption of $20 million of trust preferred securities issued by Family Heritage's parent. Final closing and post-closing adjustments of approximately $15.5 million were paid with proceeds from a post-closing dividend from Family Heritage. The company added $0.02 per share to Torchmark's net operating income in 2012, net of the after-tax incremental financing cost of 3.8% on the $218.5 million purchase price. We anticipate that the company will add between $0.16 and $0.20 per share to 2013 operating earnings after financing costs.
Since we anticipate being able to take dividend distributions out of the company to fund the additional interest charges at the parent, we do not believe the acquisition will have a material impact on Torchmark's share buyback program. Those are my comments. I will now turn the call back to Larry.
Thank you, Frank. For 2013, we expect our net operating income will be within a range of $5.45 per share to $5.75 per share. The decrease in guidance is due primarily to the fact we are repurchasing shares at a higher price than we originally anticipated, and also due to the losses in employer group Part D cases because of increased competition. Those are our comments. We will now open the call up for questions.
Thank you. For those of you joining us by telephone, please press star one to ask a question. If you're using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. Once again, that is star one if you have a question. We'll take our first question from Jimmy Bhullar with J.P. Morgan.
Hi, thank you. Good morning. I had a question first on the Direct Response business. Sales have actually slowed for each of the past three quarters, I think you mentioned that maybe response rates are lower just given the economy. Given what the trends have been recently, how comfortable are you that you could actually do your mid-single-digit sales growth target? The economy is certainly not changing much, unless the economy changes. Then secondly, just on the Liberty National business, the margins on the life side were very strong this quarter, you had several initiatives going on to improve the margins there. What's your expectation? Do you expect a further improvement from here?
I'll address the Direct Response sales first, Jimmy. We have confidence that the Direct Response rates will come up in the second quarter of this year. We currently have initiatives regarding our adult products. We also are testing different initiatives with packaging. We think each of those will have a positive effect on our response rates as we go forward.
Jimmy, on Liberty National, for the quarter, we had an underwriting margin of 29% versus 25% last year.
Yeah.
That was a little high because we had a lower claim month or lower claim quarter. For the year, the underwriting margin was 26% versus 22% for last year, and the primary difference there is the fact that we lowered the non-deferred acquisition expenses by the changes we made in the agency system there. On a go-forward basis, the margin won't be 29%, it's going to be at the 26% or a little above the 26% range.
Okay. Then just one more on Family Heritage. If you could just talk about how the results, you gave some guidance, but how the results have been versus your expectations and any pleasant or unpleasant surprises as you've looked at the business a little bit more.
Jimmy, as we look at the business, there are no unpleasant surprises. The integration goes forward well. The agency is growing as expected. We're seeing some addition within the agency in terms of recruiting programs take place. Those are really our comments on Family Heritage. The sales guidance was given in our comments.
Okay. Thank you.
We'll take our next question from Paul Sarran with Evercore Partners.
Thanks. Good morning. I wanted to ask at Liberty National Life Insurance Company, is there any sort of structural reason why margins over time can't get up to the 32%-33% range that you run at American Income Life Insurance Company?
Paul, we still have higher expenses at Liberty National Life Insurance Company and have had as far as acquisition expenses. Although we have made improvements here, it's going to take a while for that to work through the results because of the large in-force block we have. I don't see us getting up to the 31% level. The 27%-28% margin level, we could get to that on a fairly soon basis.
Okay. On Direct Response, kind of towards the end of last year, beginning of this year, you were talking about new underwriting technology and a pretty big expansion of circulation, I think, well into the double digits, which I would've thought should drive pretty strong sales in the back half of this year or in 2012. Did something go wrong with that program or not as expected once you kind of implemented it?
Nothing's gone wrong with the program. I think the underwriting change you're referring to is the use of pharmaceutical data to-
Yep
in our underwriting program. Actually, that decreases the sales because you reject more business. You have greater profits on the business, but you'd see a decline in sales, and we've certainly seen that come through because we're rejecting more business as we apply that data to the underwriting process.
I think the idea was you'd increase circulation by enough to offset the higher declines. Did that not occur? Did you end up declining more business than you expected beforehand?
Paul, I think we did increase circulation, but as Larry mentioned, our response rates were down. That tended to offset the increase in circulation.
Okay. All right. Thanks.
We'll take our next question from Sarah DeWitt with Barclays.
Hi, good morning. In American Income, on the sales growth guidance, why did you lower that range modestly versus your prior guidance for 2013?
We had a slowing in the growth of the agency in the fourth quarter, and it's just slightly. It's 10-14 versus 10%-15% guidance we gave in the last quarter. It's just recognizing that we have not as many agents selling business in the first quarter as we had hoped.
Okay. Just following up on that, when you think about longer term, the opportunities that you see to grow the agent count, is the current pace sustainable over several years, and how much opportunity is there to grow before you view that as saturated?
Well, it's not saturated at all. We have a limited opportunity to grow that agency force. Eventually, I would see the agency force at 10,000-12,000 agents in American Income. I don't think it's sustainable to have 20% agency growth year in, year out. I would predict that we would see the agent count at the end of the fourth quarter of 2013 at 5,900-6,000 agents. It could vary. It could be slightly higher than that, slightly less. Certainly, 10% agent growth per year is sustainable at American Income.
Sarah, one thing that I might add to that, we expect a 10%-14% growth at American Income. You probably won't see that in the first quarter. It may be more mid-single digit in the first quarter because of the fact that we had a very large first quarter last year. As Larry mentioned, we'll be building up the agent count as we go through the year. The growth will be more toward starting with the second quarter on than, say, the first quarter.
Okay, great. Finally, just on the underwriting margin, the growth there is the strongest it's been in several years. Does that mostly reflect your pricing actions, and how should we be thinking about that going forward?
Well, first, really the underwriting margins haven't changed that much in terms of the impact of the increased premium. It's more from the reduction in the acquisition costs that we can no longer defer. We've reduced our lead costs, we made that a responsibility of the SG&A. When you look at it on a year-to-date basis, this year versus last year, the margin's 33 versus 31. Well, that two-point increase in margin came from the fact that we reduced those expenses from 5% of premium to 3% of premium.
Okay, great. Makes sense. Thanks for the answers.
Sure.
We'll take our next question from Jeff Schuman with Keefe, Bruyette & Woods.
Thanks. Good morning. Just want to circle back a couple details on Family Heritage. Can you remind us, is there any sort of obvious seasonal pattern to the earnings or premiums there?
I don't think there's a seasonal pattern. Like our other agency forces, you tend to have higher agency growth in the first eight months of the year. Usually, the fourth quarter is a little bit slower for Family Heritage, as well as the other agency operations.
Okay. Then help us put this into context of the risk-based capital ratios you gave. I've forgotten. Does this hang off the holding company, or is this downstream? If it's downstream, is it included in the sort of consolidated RBC view that you gave earlier? Frank?
Yeah, Jeff, it is down in the subsidiaries and included in the RBC for the consolidated group.
Okay. Do you have a rough estimate of what the RBC specific to Family Heritage ended up at?
I do not at this point in time.
Okay, my recollection was at least prior to any transaction adjustments, that it was pretty high and the earnings were pretty strong. I was just wondering if there was, at this point, any capital to be extricated from there or not.
At this point in time, we don't anticipate taking out any excess capital, allowing for some growth. You are correct in that the RBC was fairly high at their company individually. On a consolidated basis, it really doesn't move the needle very much on the consolidation.
Okay. Thank you.
We'll take our next question from Mark Hughes with SunTrust.
Thank you. Good morning. The Liberty National sales force, you shared some specific outlook numbers for year-end and sustainable growth for American Income. Any similar numbers for Liberty National?
Liberty National agent count should go up by about 10% also this year. The producing agent count at the end of the year was 1,419. I'd expect that to be at 1,800 to 1,900 agents by the end of the fourth quarter.
Is that sort of pace sustainable, or what pace is sustainable?
That pace is certainly sustainable, Mark. Part of it is a sustainable Globe traditional . Excuse me Liberty National traditionally has been focused on the Southeast. As we continue to open offices outside of the Southeast, that will help that growth rate at Liberty National. The other development is as we add the extra layer of management at Liberty National, it produces more candidates to become branch managers and open new branches across the U.S. I think certainly that growth rate is sustainable for the foreseeable future.
The Medicare Part D, I think the group price competition you mentioned, any more detail you can provide there? Is the market now a little more rational, or do you expect that to continue?
I don't know if it will continue. What we saw this year was a new entrant into the market, and we feel they essentially underpriced their business. That's our experience when a new entrant underprices a business, that that ends fairly quickly. We don't think that's a trend going forward.
Thank you.
We'll take our next question from Steven Schwartz with Raymond James.
Good morning, everybody. I was hoping that possibly, I think it might've been Gary Coleman, could repeat the Family Heritage Life sales guidance? It was going fast. I didn't catch that.
I think Gary Coleman has it. Give me just a second here and I'll tell you what it was. At Family Heritage, we expect health sales to be approximately $53 million in 2013. Steven Schwartz, that would be a growth rate of 5%-9% over 2012.
Okay.
For 2013, we expect premium income to range from $195 million-$205 million. Again, we're saying that the margins as a percentage of health premium will be about 18%-19%.
Okay, great. The guidance on LNL sales, was that life only, or did that include health as well?
I believe life and health.
Then on the subject of health, I don't think there was any reference to it in your script. Maybe you could talk a little bit about what is going on at United American and what is driving that, and I guess whether or not we should be happy about it.
What's going on at United American is just gradually strengthening Medicare Supplement sales through our general agency force. Medicare Supplement is difficult to predict as you go forward. There's so many uncertainties around that market. Because the Medicare Supplement sales declined so dramatically over the last five years, we think that we'll see continued growth within Medicare Supplement. That assumes that there aren't major political changes around the Medicare Supplement arena.
Okay. All right. That's what I had. Thank you, guys.
We'll go next to Bob Glasspiegel with Langen McAlenney.
Good morning, everyone. After two months, you're getting really excited about the acquisition of Family Heritage because I think if my notes are right, you bumped up your premium expectations from $180 million to $195 million to $200 million and your margins from 14% to 17% to 18% to 19%. What are you seeing that's getting you more excited about both growth and profitability? If I work through the midpoint of the range of those two things, it looks like it's about $0.06-$0.07. Does more admin spending eat up half of it, or is there some conservatism?
Bob, we're excited about the growth potential because as we get familiar with the leadership of Family Heritage, we see strong leadership within that agency. The uncertainty of the sale of the company has been present for the last 2 years. Now that that uncertainty's been removed and they're part of Torchmark Corporation, now they're really focused on growing that agency. As they put in additional recruiting systems, additional compensation systems, I think we're going to see real growth at Family Heritage. There's also geographic expansion that can take place. We're looking at New York. We're looking at some states that they don't operate in, and some additional expansion possibilities for the company.
No deer antler spray, real legitimate underlying growth in the production. That's good. In the margin, 400 basis points more, that's a pretty big bump up in two months of expectations.
I'm not sure. Frank?
Yeah. Bob, the real increase in that, a big majority of that is a result of the finalizing all of our PGAAP computations. As we said on the last call, we were very early in the stages of taking a look at the purchased business and where some of the margins would be on the acquired block. Now that we finalized the PGAAP computations, the margins really on that opening block, really looking at a 15% on an after admin expense basis, which was a little bit higher or a fair amount higher than what we had originally anticipated. That's really driving a big portion of that increase in the guidance.
It's accounting or is it things are better? I lost you on that, Frank.
Well, part of it's accounting just from estimates on where the final interest rate adjustments and how reserves would be calculated and the VOBA would be calculated and amortized off.
Part of it is also just really getting better comfort in where ultimate assumptions would be and underlying margins.
Remind me whether there were any expense efficiencies to be realized.
We're probably seeing just a little bit of reduction in some of the initial cost estimates that we had, nothing real material ultimately. We're looking at admin expenses being about 5% of their premiums. They're a very efficient operation. We're seeing a little bit lower than what we had originally anticipated as well.
Too early to think about cross-selling or new products into their distribution channel, right?
Correct.
Yes.
What is that we should think about that or not at all? Would that be too confusing?
I think we want to be careful just to expand that cross-selling, Bob. Really would like to focus on expanding the agency. They're doing very well with the product mix they have now. Let's stay focused on just growing the basic agency with the existing product mix.
Thanks for the insights. Hopefully, maybe we can get some of the management on a call at some point.
I'd be glad to do that.
We'll take our next question from Eric Berg with RBC Capital Markets.
Thanks very much, and good morning, Gary, to you and to the rest of your team. My questions relate to the health business. For reasons that I think you've discussed, the Part D business had essentially no sales increase either in the quarter or in the year, and yet you're showing very strong premium growth. I presume that happens because you had very strong sales in the year before. Could you just help me understand that financial reporting dynamic?
Well, Bob, the reason we had the increased sales in 2012 really occurred at the end of last year when we received auto assignments from, I think it's 20 states or 20-plus states. That all came about at one time, that production, for the most part. We did have some production during the year, but that auto assign business, really, you get notified at the beginning of the year. That's where most of the production came in there. That accounted for the large production at the beginning of the year. At the end of the year, this year, we didn't get the auto assigns that we'd gotten in the prior years. We've been able to maintain, for the most part, what we had gotten the year before, but we did not get new auto assigns.
The guidance then is for premium level to be down modestly in 2013 from 2012 in the Part D area?
Well, we actually expected premiums to be up in 2013 slightly because not all the business is auto-assign business. The auto-assign business is about 45% of the total premium force. We also sell this through our United American General Agency and through Direct Response. We were thinking that premiums would go from $318 million in 2012 to, I think last quarter we talked about $327 million for 2013. Well, now that looks like 2013 is only going to be $300 million. The reason for that, as Larry mentioned earlier in the comments, is we lost some large groups. It's a year-to-year contract, and they elected to go with carriers that offer lower rates. We'll actually have a slight decline in premiums in 2013 from the $318 million in 2012 to around $300 million in 2013.
Then with respect to the core of your health business, I just want to build on the question and answer from earlier. Indeed, you had many years when Mark was running the company in which the health business seemed to be in decline. Now we're getting very strong sales of health products, along with, at least in the December quarter, it looks like. Just so I can turn to the red page here. Yeah, it looks like very strong premium growth as well. Is this purely a matter of the Medicare Supplement, or are we seeing a resurgence in sales and premiums of other medical products other than Med Supplement?
Eric, if you go back five or six years ago, a lot of the premium growth was in unlimited health benefits.
Right.
It was a product line that we exited in 2009, 2010. It was subject to Obamacare.
Yeah.
More importantly, we just didn't like the persistency. We didn't like the margins for that business. You've seen a real decline over the last few years as that block has decreased. I think it's down to about a $50 million block now. What you're seeing here is an increase on two fronts. Our individual Medicare Supplement sales have been good over the last 18 months. You're also seeing the addition of Family Heritage, which substantially changes our health insurance sales.
Ramon, I know you report what your sales would have been in health. Do you report what your premium growth, if my disclaimer, maybe anybody can tell, is do you report what your premium growth in health would have been excluding the acquisition of Family Heritage? I guess we can see that on page 10 of your analyst pack. We can see that.
We'll go next to Randy Benner with SPR.
Hey, thanks. Just a couple follow-ups here. On the Medicare sub dynamic, I guess maybe a few years ago, we thought Medicare Advantage, the other piece of the Medicare market there for supplementals was going to fade, and it held on better than we would've thought. Is part of the better Medicare sub-sales overall because folks are starting to move away from Medicare Advantage as payouts for that get constricted? Are we finally seeing that switch over?
I don't think it's a switch over. The original prediction was there'd be 17 million additional enrollees for Medicare Advantage. We simply haven't seen those numbers materialize. The interesting piece to go forward with healthcare reform, if that ever does materialize, you'd see much stronger Medicare Supplement sales. I think what's strengthening Medicare Supplement sales, we've just done a better job recruiting general agents, and we've better penetrated, particularly with the high-deductible Plan F. We've been successful in offering that plan in a number of states.
Thanks for that. From what you said, Medicare Advantage just hasn't, even though the payouts from CMS to those companies have been lower, it's been a sticky product still you're seeing with clients. Is that right?
That's what we're seeing, yes.
Okay. Back to AIA. Appreciate the guidance there for 2013, I guess people have hit it a couple of different ways, but it still seems like a confident guide and you targeted hopefully 6,000 agents there by year-end 2013. I'd like to hear maybe more color on what's going well there. Is it sales manager progression? You've talked in the past about better analytics around recruiting data and segmenting who's successful and who's not, but just would be interested. That's a major debatable point on the stock is whether or not AIA sales can hit that level. Just would like to hear more on what's driving your confidence there.
Sure, Randy, this is what drives our confidence is the item we're focused on most right now is agent retention. We're looking at different systems, everything from lead support to better training that will help that agent retention. We're also looking at changes that we could introduce in our compensation systems. If we stretch out that compensation and we keep those first-year agents longer. Structurally, what I see is a growing SGA body. We've added 5 new SGAs this year. We believe those will be successful. That also will contribute to that agent growth. What you've seen over the last five years, I think there's a lowering average age of that SGA body, I'm comfortable that those SGAs will continue to grow and expand within each. They don't have territories to expand their agencies.
SGA, is that a new office or that's just a new individual?
A new SGA is a new office and it's a new individual. Someone that's been promoted up to the system who started as an agent or an SA or they become a general agent, became an MGA, the last step of the progression is to progress to an SGA position. You open those offices depending on opportunity. You look at the lead support, you look at the recruiting support you can give in a particular office, that's how you open the new offices. It's an addition to, not a subtraction.
You did 5 new SGA offices in 2012. A similar amount expected for 2013?
For 2013, again, you're looking at who are the MGAs that are ready to take that next step. You want to make sure that the MGA is going to be successful. You look at their production, you look at their time in the business, Roger and company make that decision to promote that MGA to an SGA position.
Just one clarification. I think AIA already does business in most major metropolitan areas. When you're opening a new office, are these offices being opened in new cities, or is it adding an office in a growing suburb or something like that?
It's typically adding to. We have SGAs in all states. What you're looking at is in a particularly large metropolitan area, if you have excess leads, you have excess recruits in terms of off the internet recruiting system, the personal other recruiting systems that we have, there's extra capacity, that's where you're going to add an SGA.
All right. Understood. Thank you.
Once again, that is star one if you do have a question. We will go next to John Nadel with Sterne Agee.
Thanks for taking my question. Good morning, everybody. One on Part D and one on Direct Response. Part D, obviously a lot of great color and appreciate all the guidance there on sales and top line. The margin in Q4 was probably one of the strongest I can recall seeing at around 12%. Is there any reason to believe that we have stepped up on the margin, or should we still be thinking about something more like the 10% going forward?
John, we are looking at a margin between 10% and 11% for next year. One of the problems with Part D is that the claims do not come in evenly-
Yeah
throughout the year. From quarter to quarter, you would see some fluctuations. We priced the product at that around 10.5% level, and that is what we expect in terms of margins.
Okay. Thank you. A sort of a longer-term question around Direct Response. I get so much less mail, and I think a lot of people get so much less mail now. They've got electronic billing on so much, and the world's going more and more paperless, or at least the U.S. is. Over time, do you think that that sort of continuing trend becomes a sort of a secular impediment to the potential growth of Direct Response?
This is Larry. I don't, because if you look at Direct Response in 2007, a very small percentage of our business came through electronically, i.e., the internet or other electronic media. Today, it's a significant part of that business. It's the fastest-growing segment of Globe Life and Accident Insurance Company. Globe Life's challenge is not different today than it was 20 years ago. It's continually looking at testing, how do we reach that consumer, and I think you'll see a greater report coming through other means. The mail, still will remain an important part or foundation of the company. I think we're confident that we can grow Direct Response through other media.
Yeah, Ken, not only from the internet, but we're now putting our 1-800 phone number on mailings and inserts, and over 10% of our business now is coming in through inbound calls. As Larry mentioned, we're just trying to find all the different ways that we can reach the customer. One thing to consider, too, there is maybe less solicitations that you get in the mail. That means there's less competition in the mail for us. The mail is still going to be a vital part of it, as Larry mentioned, we've really grown the percentage of our sales. I think it's up to 40% that's either internet or inbound, whereas a few years ago, it was much less than that.
That's very helpful. I didn't realize it was that strong already. Thank you very much.
We'll take our next question from Vincent Lui with Morningstar.
Hi. Good morning. Thank you for taking my questions. I want to see if you can give me some comments about what's driving the uptick in lapse rates at American Income. Seems that there's a 15-20 percentage point increase quarter-over-quarter at the agency.
There was a small uptick in the lapse rates. We're talking about first year. If you look at renewal rates, there is not an uptick.
Yeah. Renewal rate is pretty stable. Yeah.
Right. If you inspect your agency force, if you have more new agents selling business, you'll have an uptick in your lapse rates. We had an 18% growth in our new agents last year, I'd expect to see that uptick. It's not unprecedented. If you go back two years ago, in the fourth quarter, we had the same first-year lapse rate. It's within a normal range, in my opinion.
Okay. How would you comment on the seasonality of lapse rate? Should they be pretty consistent quarter-over-quarter, or there's a more of an uptick in the fourth quarter?
If you look at agent recruiting in the agency forces, typically 80% of your agent recruiting is in the first eight months. You've been adding new agents during the year, by the time you get later in the year, you have more new agents selling business.
I think it would be logical that you'd see a small uptick in first-year lapse rates as you have more new agents selling business.
On the Direct Response side, you see seasonality more there than maybe in our agents lines. Part of that is because a good portion of our Direct Response sales occur in the first, second quarter. You see more of the lapses coming in the third, fourth quarter. You'll see a higher lapse rate in the third and fourth quarter versus the first and second quarter in Direct Response.
I think the other item that could be affecting lapse rates and Direct Response, as we mentioned earlier, we're using the pharmaceutical information to underwrite business. With that, we're issuing more substandard business, which has a higher premium rate. If you're going to issue more substandard business, and you're going to issue business with higher premium rates, you'll have slightly higher lapse rates as a result.
Right. Okay. How do you generally reflect that in your actuarial valuation or reserve? In the annual review, is it typically you change a lapse rate in reserve calculations annually after seeing this general experience?
Well, I don't think we've, getting back to Direct Response, we haven't seen any change in the experience of, as Larry mentioned, the substandard business is priced for the higher lapse rate.
Right.
Our reserves and everything are set up accordingly, expecting those lapse rates, so there's really not an adjustment necessary.
Okay. Thanks for the answers.
Sure.
There are no other questions at this time. I'd like to turn the conference back to our speakers for any closing remarks.
Hey, thank you for joining us this morning. Those are our comments, and we'll talk to you again next quarter.
Thank you, everyone. That does conclude today's conference. We thank you for your participation.