Good day, and welcome to the Torchmark Corporation's third quarter 2012 earnings release conference call. Today's call is being recorded. For opening remarks and introductions, I'd like to turn the call over to Mike Majors, Vice President of Investor Relations of Torchmark Corporation. Please go ahead, sir.
Thank you. Good morning, everyone. Joining me today are Gary Coleman and Larry Hutchison, our Co-CEOs, 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 forms, 10-Q on file with the SEC. I will now turn the call over to Gary Coleman.
Thank you, Mike. Good morning, everyone. Net operating income for the third quarter was $125 million or $1.29 per share, a per share increase of 10% from a year ago. Net income for the quarter was $131 million or $1.36 per share, a 9% increase on a per share basis. With fixed maturities at amortized cost, our return on equity was 15.6%, and our book value per share was $34.39, a 9% increase from a year ago. On a GAAP reported basis, with fixed maturities at market value, book value per share grew 20% to $44.86. Excuse me. In our life insurance operations, premium revenue grew 6% to $454 million, and life underwriting margins increased 13% to $130 million. Net life sales increased 7% to $83 million.
On the health side, premium revenue, excluding Part D, declined 4% to $170 million. Health underwriting margin was $39 million, same as the year-ago quarter. Health sales were $15 million, down 6%. I will now turn the call over to Larry 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 $167 million, and life underwriting margin was also up 17% to $56 million. Net life sales increased 12% for the quarter to $41 million. The producing agent count at the end of the third quarter was 5,472, up 23% from a year ago and up 3% during the quarter. We are pleased with the continued progress at American Income and are excited about the company's future prospects. We continue to see growth in the number of newly hired agents who achieved our top bonus level. The first-time top bonus earners were up 47% in the third quarter. Our middle management ranks also increased by 14% in the third quarter. First-time bonus earners and middle management trends are both indicators of future agent growth.
Direct Response. In our Direct Response operation at Globe Life, life premiums were up 9% to $158 million, and life underwriting margin increased 8% to $37 million. Net life sales were up 3% to $31 million. While we are pleased with Direct Response sales growth, it was slightly lower than expected in the third quarter. However, the new business written during the third quarter was more profitable than the new business written in the year-ago quarter. We expect mid-single-digit sales growth for 2012 and 2013. Liberty National. At Liberty National, life premiums declined 2% to $70 million, while life underwriting margin was up 22% to $19 million.
Net life sales declined 6% to $8 million, while net health sales declined 24% to $4 million. However, both net life and net health sales have increased sequentially for two quarters in a row. The producing agent count at Liberty National ended the quarter at 1,401, down 11% from a year ago, but up 4% since the beginning of this year. The producing agent count grew to 1,420 during the first three weeks of the fourth quarter. We continue to make progress in turning around our producing agent counts and sales at Liberty National. We are optimistic that agent growth will continue going forward and expect sales growth to range from 8%-12% for 2013. Medicare Part D. Premium revenue for Medicare Part D grew 63% to $82 million, while the underwriting margin increased 8% to $7 million.
Part D sales for the quarter jumped 161% to $22 million due to the increase in low-income subsidized auto enrollees for 2012. We expect an increase of approximately 2%-3% in our Part D premiums for 2013. This is less than the 2012 increase since we don't expect as many new auto enrollees under the low-income subsidy program next year. I will now turn the call back to Gary.
To complete the insurance operations, administrative expenses were $41 million for the quarter, 2% more than the year-ago quarter, and in line with our expectations. For 2013, we expect a 5%-6% increase in administrative expenses, with most of the increase due to the acquisition of Family Heritage. However, as a percentage of premium, administrative expenses will be around the same level as 2012. 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 net policy liabilities and debt, was $55 million, a decline of $9 million, or 14%, 7% on a per share basis from the third quarter of 2011. Sequentially, excess investment income was down $8 million from the second quarter. Both the year-over-year and sequential declines are due primarily to lower investment income.
Compared to the second quarter, net investment income decreased $6 million, or 3%, while average invested assets increased by 1%. Had investment income increased at the same rate as the assets, investment income would've been up $1 million. This $7 million negative swing is due to the decline in the portfolio yield and the large increase in short-term investments, resulting primarily from the call of $300 million of bank hybrid securities early in the third quarter. We plan to invest the excess short-term funds in bonds by the end of the year. Due to the expected call of our remaining $300 million of hybrid securities and the lower new money rates, we expect excess investment income in 2013 to decrease approximately 6%-7%. However, reflecting the impact of share repurchases, we expect the 2013 excess investment income per share to be flat compared to 2012.
Regarding the investment portfolio, invested assets are $11.8 billion, including $10.9 billion of fixed maturities at amortized cost. There's no exposure to European sovereign debt, and there are no commercial mortgage-backed securities or securities backed by subprime or alt-A mortgages. At September 30, the company had cash and short-term investments totaling $685 million, compared to $180 million at June 30. The additional $505 million of cash in short terms is due primarily to the $268 million of proceeds from due to debt instruments issued late in the quarter and $237 million of additional funds to be invested. Of this amount, $200 million will be used for the acquisition of Family Heritage Life, we think on November 1st, $120 million for the retirement of our trust preferred debt this week, and $94 million to retire the existing August 2013 debt issue.
Of the fixed maturities, $10.2 billion are investment-grade with an average rating of A-. Below investment-grade bonds are $685 million, compared to $764 million at the end of the second quarter and $721 million a year ago. The percentage of below investment-grade bonds to fixed maturities is 6.3%, compared to 6.8% a year ago. With the portfolio leverage of three times, the percentage of below investment-grade bonds to equity, excluding net unrealized gains on fixed maturities, is 21%, which is less than most of our peers. Both of these ratios have declined slightly since the end of the quarter, as much of the excess cash held at September 30 has been invested in investment-grade fixed maturities. Overall, the total portfolio is rated at high BBB+, just slightly under the A- of a year ago.
We have net unrealized gains in the fixed maturity portfolio of $1.6 billion, compared to $942 million a year ago. Regarding investment yield, in the third quarter, we invested $326 million in investment-grade fixed maturities, primarily in the utility and industrial sectors. We invested at an average annual effective yield of 4.42%, an average rating of BBB+, and an average life of 23 years. For the year, we've invested $755 million at an average yield of 4.54% and an average rating of BBB+. The third quarter new money yield of 4.42% has declined from the 5.65% yield for all of 2011 and the 4.64% yield in the first half of 2012. Earlier this year, we indicated that the GAAP discount rates used to discount the reserves for policies issued in 2012 would be 4.75%, graded to 6.5% over seven years.
In response to the decline in new money yields and further indication that Treasury rates will continue to be near current levels for the near future, we have changed the discount rates for policies issued in 2012 to 4.25% for five years, then graded up to 6.25% over the next eight years. For the entire portfolio, the third quarter yield was 6.33%, compared to 6.54% in the third quarter of 2011. As of September 30, the yield on the portfolio is 6.33%. As mentioned, we still hold $300 million of bank hybrids that could be called. We don't know whether any of them will be called in the fourth quarter, but expect all of them to be called by the end of 2013. These bonds yield 7.35%. In assuming a 4.25% reinvestment rate, the lost annual income, if all those securities are called, will be $6 million after tax.
In our guidance, we assume that all will be called in 2013. 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 an extended period of low interest rates continues to be the impact on earnings, not the balance sheet. As we've talked about before, to maintain our underwriting margins, we raised the new business premium rates on the majority of American Income's life products and the Direct Response general products by 5% as of January 1st this year. These increases provide additional margin to help offset reductions to excess investment income on new policies without having a detrimental impact on sales. As long as we're in this low interest rate environment, the portfolio yield will continue to decline and thus pressure excess investment income.
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 remaining $300 million of hybrid prefers. In the second quarter, we conducted a stress test assuming a new money rate of 4.25% and determined that the portfolio yield at the end of 2016 would be in a range of 5.75%-5.85%. At these rates, we would earn a small spread on the net policy liabilities while earning the full 575-585 basis points on our equity. In this scenario, we will 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 primarily 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 put up additional GAAP reserves due to interest rate fluctuations. In addition, we do not foresee a negative impact on our statutory balance sheet. Now I'll turn the call over to Frank Svoboda to discuss share repurchases and capital.
Thanks, Gary Coleman. I want to spend a few minutes discussing our share repurchases and capital position. First, regarding share repurchases and parent company assets. In the third quarter, we spent $44 million to buy 874,000 Torchmark Corporation shares. For the full year through September 30th, we have spent $318 million of parent company cash to acquire 6.6 million shares. The available liquid assets at the parent consist of assets on hand and the expected free cash flow from operations. 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 Corporation shareholders. The parent began the year with liquid assets of $74 million. During the first nine months of the year, we generated about $328 million of free cash flow, but spent $318 million for Torchmark Corporation share repurchases.
In addition to the remaining $83 million of cash and liquid assets, the parent received approximately $420 million as a result of the issuance on September 24th of 10-year senior notes and 40-year junior subordinated notes. As a result of this activity, the parent ended the second quarter with $504 million of available liquid assets, comprised of the $74 million of beginning liquid assets, plus the $328 million of free cash flow, plus $420 million of net debt proceeds, less the $318 million used for share repurchases. Going forward, along with the $504 million on hand at the end of the third quarter, we should generate approximately $22 million of free cash flow in the fourth quarter, giving us $526 million of total cash and liquid assets available for the remainder of the year.
Of this cash, $120 million was used on October 24th to redeem our 7.1% trust preferred securities, and approximately $212 million will be used to purchase the stock of Family Heritage Life Insurance Company of America, leaving us with approximately $194 million of cash and liquid assets available between now and the end of the year. It should be noted that $94 million of these assets will be invested to be used for the redemption of our $94 million of senior notes that mature on August 1st, 2013, or an earlier time if opportunities to economically repurchase the August 2013 notes become available. 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 to $60 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. For 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. At December 31st, 2011, consolidated RBC was 336%, and adjusted capital was approximately $46 million in excess of that required for the targeted 325% ratio. We expect our consolidated RBC as of the end of 2012 to be at or above this level. Now, before I turn the call back to Larry, I would like to briefly discuss our recent debt issue and the purchase of Family Heritage Life Insurance Company. First, the debt issue.
With regard to our debt, on September 24th, we closed on a $300 million, 3.8% senior debt issue maturing in 2022. The senior notes were issued to provide $94 million to pre-fund the eventual retirement of our August 2013 senior notes and $200 million to fund the acquisition of Family Heritage Life. As we wanted to fund the majority of the Family Heritage Life acquisition internally, the parent issued $150 million of these notes to two of our insurance companies. Having these companies purchase the parent senior notes enabled us to, one, efficiently use insurance company cash that resulted from the $300 million of bank hybrids they called in July and to get those funds invested at a market rate. Two, provide funds to the parent to fund the acquisition in a way that will allow these insurance companies to fully admit the asset on their statutory books.
Three, structure the transfer of funds to the parent in a way that minimizes the RBC charges that will be incurred by the insurance companies. Four, structure a public debt issue that was large enough to obtain the most efficient pricing available on the market. It should be noted that the $150 million in notes owned by the two insurance companies are limited in consolidation and thus are not treated as outstanding debt or as invested assets on our consolidated financial statements. We also issued on September 24th, $125 million of 40-year junior subordinated notes with an interest rate of 5 7/8%. Those notes are callable after five years and were issued to refinance $120 million of trust preferred securities. The trust preferred securities were called on October 24th.
As a result of the new issuances, our debt balances as of September 30th increased by approximately $268 million, temporarily increasing our debt-to-capital ratio to 29.9% if the effects of the unrealized gains on our fixed maturity investments are ignored. This ratio will be reduced to 28.1% upon redemption of the trust preferred securities and to our normal levels once the August 2013 notes are redeemed. We expect our interest expense will increase in the near term due to the pre-funding of both the retirement of our trust preferred securities and the August 2013 maturity, plus the additional debt incurred for the Family Heritage purchase. For 2012, we estimate that this increase over 2011 levels will be approximately $2.1 million, including $1.9 million in the fourth quarter.
For 2013, we estimate that our total interest expense will be approximately the same as 2012 levels, assuming the August note is retired on its August 1st maturity. Once the August note is retired, we expect to save approximately $1.5 million in annual interest expense over pre-2012 levels. With regard to the acquisition of Family Heritage Life. On July 31st, we entered into a definitive agreement to purchase all of the outstanding stock of Family Heritage Life Insurance Company, a privately held supplemental health insurance provider, for approximately $218.5 million, including the assumption of $20 million in trust preferred securities with the remainder to be paid in cash. The ultimate purchase price is subject to closing adjustments to be paid using cash from a post-closing dividend from the company. We expect to close on November 1st, assuming all regulatory approvals are received by that date.
The company was founded in 1989 and is headquartered in Cleveland, Ohio. It is a specialty insurer focused primarily on selling individual supplemental health insurance products with a return of premium feature. We were attracted to the company because of its offering of protection-oriented insurance to middle-income families, and that their sales are through a captive agency force that we believe we can help grow. Family Heritage has approximately 1,200 captive sales agents, 41 sales directors, and over 223,000 policies in force. We are excited about the opportunity to work with the existing management, agents, and employees of Family Heritage and currently intend to operate the company as a standalone operation. As of June 30th, 2012, statutory admitted assets of Family Heritage were approximately $526 million and net capital and surplus was $62 million. Premiums were $162 million in 2011 and $87 million through June 30th, 2012.
Since the transaction has not yet closed and the fair market value of the company's fixed maturity portfolio and other assets are not yet known, the ultimate effect of certain purchase accounting adjustments cannot yet be determined. However, we anticipate that the company will add approximately $0.01-$0.02 per share to Torchmark's net operating income in 2012, assuming a November 1st close, and will add approximately $0.13-$0.17 per share to 2013 operating earnings. Since we anticipate being able to take dividend distributions out of the company to fund the additional interest charges to be incurred by the parent, we do not believe the acquisition will have a material impact on our share buyback program.
Those are my comments. I will now turn the call back to Larry.
Thank you, Frank. This is our guidance. For 2012, we expect our net operating income will be within a range of $5.15 per share-$5.19 per share. For 2013, we expect our net operating income will be within a range of $5.45 per share-$5.85 per share. Those are our comments. We will now open the call up for questions.
Thank you, gentlemen. For those of you joining us by telephone, if you'd like to ask a question, please press the star and one on your touch-tone phone. You may withdraw yourself from the queue at any time by pressing the pound key. Once again, that is star and one to ask a question. We'll first go to the site of Jimmy Bhullar. Your line is open.
Hi, good morning. I had a few questions. The first one on just your premium conservation efforts. If you look at your lapse rates in most of the subsidiaries, they'd actually been declining. With American Income, the lapse rate this quarter was roughly flat with the third quarter of last year. Secondly, just on the Family Heritage deal, should the earnings ramp up as the year goes on, or would the first quarter of next year be a normal quarter? Just wanted to get an idea on whether you plan to do any expense savings or any marketing initiatives that would either reduce or increase earnings as the deal comes on your books. Finally, on Liberty National, you've seen a couple of quarters of decent growth in the agent count. Your sales expectations actually seem fairly positive as well.
What gives you the comfort that this is not sort of a temporary blip in the agent count? What gives you the comfort to think that the agent count is going to keep growing from here on out?
I think the first two are Liberty.
Yeah, Jimmy, as far as the lapse rates in American Income, if you look back over the last couple of years, the third quarter is generally a higher rate, and it's somewhat due to the timing of the new issues and the lapses that occur on those policies. We expect that rate to be lower in the fourth quarter. The third quarter, for some reason, is just unusually high for American.
Yeah, quarter-over-quarter results actually had been getting better. Even if I compare it to the third quarter of last year, your lapses are actually flat, whereas second quarter versus second quarter or first quarter versus first quarter, they were improving.
Well.
It's one quarter, so I just wanted to
Matter of fact, we have seen benefits of the conservation, as you mentioned, in the lapse rates from the prior quarters. Again, I think that the third quarter is just an unusual quarter from a timing standpoint. Again, I think in the fourth quarter, it'll go back to the improvement we've seen in the other quarters.
Okay.
Secondly, on Family Heritage, if I understood the question right, I would anticipate that the earnings for the first quarter, that they will grow from there. I don't think the first quarter will be indicative of the entire year. We really haven't had a chance, as Frank mentioned, to look at what the purchase accounting adjustments are going to be. Right now, we don't have a good feel for what those actual earnings are going to be.
You don't plan on the growth would be just because of organic growth in the business? You're not planning any extraordinary cost savings programs or marketing initiatives that would either increase expenses or reduce expenses over time?
No, there's no cost reduction expenses that we're factoring in. Their expense ratios are very similar to ours, and they're very efficient. The growth that we expect will be the organic growth through sales.
Okay.
Jimmy, on Liberty National, we believe that the recruiting systems are in place. We know in meeting with the different branch managers in the system, they've accepted that. In the first three weeks of this quarter, we've seen continued steady agent growth. We believe that'll continue. At Liberty National, we plan to roll out the laptop presentation in January. We think this will further help the recruiting and training of new agents. We're hoping to see 20% agent growth at Liberty National in 2013.
Okay, thank you.
Thank you. We'll now go to the site of Randy Binner. Your line is open.
Thanks. This is kind of a sales question, it sounds like the laptops are rolled out in January for Liberty National. Back to American Income, I guess I'd like to hear more color. I think you said middle manager counts there are up 10%. If that could be clarified, that'd be great. I guess just trying to get color on the kind of the trend there and how sustainable the increase in the ranks of those sales managers is.
Randy, the sales growth is sustainable. I don't think we're going to see 20%-25% agent growth per year, but certainly we think that 10%-12%-15% agent growth is sustainable. The focus at American Income remains, it's recruiting, it's looking at productivity in those new agents. It's also management promotions. As we promote through those different levels of management, you'll see growth in the agency. That's really the color of American Income is that those systems continue to be improved. The laptop is fully rolled out at American Income, we get constant data feedback that we can check those trends.
How about on recruiting? Is there anything new going on on the front end in how you're bringing in new recruits?
Well, the internet recruiting continues to be our biggest source of recruiting. Personal recruiting is also an emphasis at American Income. With personal recruiting, that involves college recruiting, different affinity recruiting. We're looking at military recruiting as a new initiative. As the military downsizes and we see people coming out of the military, those are strong recruits of both American Income and Liberty National. We continue to look at new recruiting systems. We hope to look at Family Heritage, study their recruiting systems, and bring some of those in-house here.
That's helpful. Just to clarify, did you say the middle manager count was up around 10%? I missed that number.
Let's see. I think I said that it was up 14%.
14%, yeah.
Okay. How about the Nat trend in particular? Is that able to stay at that level, or does that settle down now that some of the low-hanging fruit there is kind of gone?
It's not low-hanging fruit. It's having a system of automatic promotions. It's to promote persons out of the agent level to the 1st level of management, and likewise to the 1st level of management to the 2nd level of management. It's a sustainable number.
Okay. That's helpful. Thanks.
Thank you. We'll now go to the site of Chris Giovanni. Your line is open.
Thanks so much. Good morning. I guess first question just on kind of the guidance and the range. The ranges, I guess, are getting wider at least in the past couple of years. Does that suggest that EPS visibility is declining some, or is it just the issue with the drops and the timing?
Chris, I think part of the wider range this year is Family Heritage. We haven't completed that transaction. We have to study that transaction as we integrate that into Torchmark. That's some of the impact of a little wider range.
Yeah, Chris, I mean, I think last year our range was $0.30. It's $0.40 this year. I agree with Larry that a big part of it is the Family Heritage.
Okay. Are there any other M&A opportunities you guys are currently exploring, or at this point, is it primarily going to be share repurchases?
Well, Chris, we're always looking for M&A opportunities, to find the type of company that we found with Family Heritage, one that's in the middle-income market, has captive agencies, selling the type of products we like, there's not a wealth of those kind of companies out there. We'll continue to look, in the meantime, I think the share repurchases will be the bulk of use of our excess capital.
Okay. Lastly, just on the new money rate. I guess I was a little surprised just how well you guys were able to maintain the yields quarter-over-quarter given what spreads did in the quarter, I guess also you guys shortened some of the duration of the maturities of the portfolio. Curious if you can comment some on kind of where you're thinking as you look forward here into 4Q. You talked about the 425 kind of stress test that you had done. Is that the level of yield you guys are currently looking at?
Yeah, that's what we're currently seeing, and one thing that benefited us in the third quarter, I think we've talked about this before, through a partner, we've gotten involved with some private products.
Private placement.
Private placements. I think we've done $100 million of that. Most of that was in the third quarter. Those are a little bit shorter, but the yields are in between the 10 and 30 years. We were able to get a strong yield on those particular investments, and I think that helped for the quarter. That probably helped us get to the 442. Where we're standing today, and money we've invested so far, which I think we've invested well over $200 million already in October, it's around that 420-425 range.
Okay, still no plan to change the overall investment strategy?
No, not at this point. The yield curve is too steep to drop down short. Also it looks like rates are going to stay low for a while. As I mentioned, we have gotten involved in private placements where we hadn't in the past. We're still looking for other types of investments, we just haven't found anything that we feel is better than the corporate bonds.
Okay. Thanks so much.
Thank you. We'll now go to the site of Sarah DeWitt. Your line is open.
Hi, good morning. On the 2013 EPS guidance, how much is embedded in your outlook in terms of share buybacks?
I think we're assuming free cash flow of around $360 million-$370 million next year. I think in our guidance, we assume that our share repurchases would be around $360 million.
That's correct, Gary.
Okay, great. Given that the midpoint of your guidance assumes about 9% EPS growth, seems like you get 8% EPS growth just from share buybacks alone. Could that be conservative given that the core business has been growing, you have Family Heritage coming on? There'll be a partial offset from the redemption of hybrids, it just seems conservative. Am I thinking about that correctly, or am I missing anything?
Well, I think one thing that is going to factor into it is the fact that our excess investment income will be lower. I think I mentioned it, probably 6% lower on a dollar basis next year. I think we're seeing good growth on the insurance side, that is a primary factor.
Okay, great. Thank you.
Thank you. We'll now go to the line of Paul Sarran. Your line is open.
Thanks. Good morning. Was there any sort of cumulative true-up in the quarter from the change in discount rate on 2012 new sales?
Yes, there was. From an underwriting income standpoint, it was pretty much a wash. There was an increase in the reserves. There's also a decrease in amortization. Where there was an impact is in the excess investment income because of the increase in the interest on the net policy liabilities. That was about a $500,000 impact in the quarter.
Okay. On Part D, I don't think you mentioned it. Did you pick up any new LIS regions for 2013?
No, we did not pick up new regions for 2013.
Did you keep the ones you added this year?
No, I think there's actually a reduction. I think we have six regions in 2013 versus about 24 regions that we had in 2012.
Okay, do you disenroll those policyholders that you added this year then, or do you keep them, you just don't add new ones? How does that work?
We do not disenroll this year's policyholders.
Yeah, just looking at the numbers, as Larry mentioned, we had 21 regions last year. In 15 of those regions, we're going to be able to keep the auto assigned, but we're not going to get new auto assigned. I think there's five regions where we will get new auto assigned. The bottom line of that is we're not going to see near the number of new auto assigned this year or in 2013 than we did in 2012.
I think of it in these terms. We're projecting premiums in 2013 to be $327 million versus $319 million in 2012.
Okay, thanks.
Thank you. We'll now go to the side of Mark Hughes. Your line is open.
Yeah, thank you. Team, good morning. The life underwriting margin up strongly this quarter. To what extent is that sustainable?
Well, I think that it was up slightly this year. I think if you look at the nine months, our life underwriting margin is 28% of premium in overall. It was 29% in a quarter. There's not a lot of difference there, but I think to be indicative of what the entire year will be, it'd be more in the 28% range.
For next year, more likely to be a 28% or slightly better?
Yeah, I think in our guidance, it is slightly better than 28%. Again, we're talking about just a small difference.
Right. The Direct Response business, it sounds like you're confident that's going to pick back up. What makes you feel good about that?
I think there's three things that make us feel good about the Direct Response business. In 2013, we think our circulation will be up about 3%. We think our internet sales will pick up about 10%. We have initiatives for 2013 in our adult products, our juvenile products, and our other mailings. A combination of those items makes us feel optimistic about Direct Response.
Right. Just to be clear, the guidance at this point does or does not include the acquisition?
It does include the acquisition of Family Heritage.
Does include it?
Right.
Thank you.
Thank you. We'll now go to the side of Steven Schwartz. Your line is open.
Hey, good morning, everybody. Just to follow up on Sarah's question, I guess I'm having a little trouble. I think it was Gary, you suggested that the excess investment income would be down about 6%-7%?
Yeah, Steve, on a dollar basis, it will.
Right.
On a per share basis, it'll be flat.
Okay, yeah. Even at $360 of share repurchase, I would imagine that your general account assets, X all the stuff with the debt being paid off in August and whatever, is still going to grow. I would think it would. In your guidance, where are you thinking the yield goes to by the end of 2013? I think you're currently at 6.33%. Where does that go to by the end of 2013?
Okay, Steve, first of all, we think by the end of the year, at the end of the fourth quarter, it'll be 6.25% will be our yield on the portfolio.
Okay.
As I mentioned earlier, we're assuming that the remaining $300 million of hybrids that we have get called in 2013, and they have an interest rate of, I think, 7.3%.
Okay.
What we're looking at is by the end of 2013, the portfolio yield will have dropped from 625 to 6.04. It sounds like these are very precise.
Right.
These are our estimates. Those hybrids do have a big impact. Going forward from that, we'll get back to where the decline in portfolio yield is more like 10 basis points a year.
Next year, we're looking for a little over 20 basis points decline in the yield.
Okay. Well, you said 6.04 versus 6. Well, I guess you got to take averages. All right. Maybe I'll get back with Mike offline. If I could, on Family Heritage, what are those agents thinking about their business post January 1, 2014? Do they see ACA as a growth driver, or do they see that as a headwind?
I think they see an opportunity. Gary and I have addressed the top agents within the system, and they're excited about joining Torchmark. I think they see opportunities that can help with their recruiting. I think we'll bring higher ratings to the company and to be a part of Torchmark, I think will be a positive to that agency force.
I'm sure you will. I was questioning more the macro environment, if Obamacare and the macro environment and how they see that.
Well, these aren't products that are subject to Obamacare. These are products that fall outside healthcare reform.
Okay.
Those products are unaffected by that. I misunderstood your question. I apologize.
Okay. Thank you, Larry.
Thank you. We'll now go to the side of John Nadel. Your line is open.
Hi. Most of my questions have been asked and answered at this point. I've got one little nitpicky one left, I suppose, and it's on Part D. Just looking at the quarter's results, third quarter results, perhaps somewhat weak on the margin versus what we've seen here recently. As you look out, was it just sort of a blip or as you look out to 2013, what should we expect for the margin on the biz?
Well, John, first of all, we had an unusually high claim quarter and especially when you compare it back to the third quarter where we had an unusually large claim quarter, there's a big difference. The margin year to date on that business is at 10%, and we think it's 10% of premium, and we think this will end the year at 10% of premium. That's not surprising to us because we priced it at 10.5% premium. We're very close to what we priced at.
Okay. All right. That's very helpful. Thank you very much.
Thank you. We'll now go to the side of Sam Hoffman. Your line is open.
Morning. I have a question about premium growth. It looks like premium growth accelerated in the quarter from 5.7% to 7.2%, and even if you exclude the Part D, it accelerated from 1.4% to 2.6%. That's a big step up in one quarter, and it was driven, I think, by the Direct Response business. Obviously if your premium growth accelerates by 1.2% every quarter, your growth rate's going to be much higher a year from now. What I wanted to understand is what happened with the persistency in the business that caused that, and how sustainable is it?
Well, Sam, we are seeing benefits from better persistency. For example, in the Direct Response, we had a 9% increase in premium. We've been showing a 5% to 6% increase. Well, the reason we have the 9% this year was more of an issue that the third quarter premiums of last year were very low. It's just an unusual comparison. The numbers you extrapolate, I don't think you can carry forward quarter to quarter. We're looking for on life premiums next year and our guidance, we're going to be about 4.5% for this year. We're looking at the next year being at least that much, maybe up to 5%. We're going to see improvement, but maybe not at the level you were talking about.
Okay, just can you clarify a bit about what you were saying about the discount rate and the price increase? I know you said that you lowered the discount rate at the beginning of this year, you raised price, is that going to recur both the discount rate and the price increase in 2013? Just help us understand what's in guidance and how we should think about that going forward.
Well, first of all, in the guidance, we are assuming the same discount rate that I talked about earlier, the 4.25 graded up to 6.25. We feel like the situation will be very similar next year in terms of rates, and that'll be appropriate. As I mentioned, we did raise the premium rates 5% this year. The effect of changing the interest rate assumption from what we had last year to this year is issues really would require about a 2% to 3% increase in premiums. We actually increased the premium rates higher than we really needed. Going forward, we still feel like the new level that we've gone on the discount rates will be appropriate going forward.
Okay, I guess my last question is on Family Heritage. Can you talk a bit about the business and just if you could repeat the premium growth that it had and kind of how much sales it has and should be expected to grow over time?
Frank, will you want to handle that?
Sure, Larry. Yeah, the total premium in 2011, they had around $162 million of total premium income, and we really look at them growing somewhere in that 8% to 9%, 10% range over the next couple of years. Year to date through June 30th, they have premium income of about $87 million that was reported on their statutory financial statements. Obviously, just looking toward annualizing that, you end up at around $176 million $175 million, and that's around an 8.5% increase. We are, again, expecting the premiums to grow somewhere in that 8%-10% range. I believe their sales, I don't have that number handy, but I believe that it was somewhere in the $50 million range.
Okay, thanks for taking the call.
Thank you. We'll now go to the side of Bob Glasspiegel. Your line is open.
I'm going to follow up on Sam's question and try to drill a little bit deeper into the acquisition. It seems like that you're saying the midpoint of the range is $0.15 accretion, which is $23 million of earnings, and there's going to be $2 million-$3 million of that's pre-tax earnings. It's going to require $2 million-$3 million more of underwriting. There's $25 million of sort of pre-tax income that needs to be spread either in the underwriting, I assume it's health underwriting and/or investment income. I think you said investment income's down 6, so that's not going to move. Am I right that we need about $25 million of pre-tax health underwriting income?
Yeah, that is correct. It is going to be health business. It is somewhere in that range of, we would estimate on a pre-tax basis, somewhere in that $25 million-$27 million range.
On $180 million of premium, it's a pretty good underwriting margin. We're talking about roughly 15%.
Yeah, their underwriting margins before admin expense are somewhere, we expect for 2013 to be in the 14%-17% range.
Okay. My math is right.
As time goes on, and with new business, we look for it to be slightly higher than that. With the in-force block, that's what we're estimating at this point.
Is there anything you can do with the capital structure or expense structure or cross-selling or better productivity? I mean, that's pretty good sales, actually, relative to their in-force.
With respect-
What can Torchmark add on the margin that you probably haven't factored into here?
With respect to, I would say, the capital structure, they are adequately capitalized at this point in time. They do have some excess capital, if you will, compared to what we would normally maintain them at a 3%-25% level. At this point in time, we do not anticipate taking out any of that excess capital, if you will, and allow that to help fund some of their future growth going forward. I think, as Gary had mentioned earlier, there aren't a significant amount of any expense savings that we're really anticipating at this point. We will continue to look at their investment portfolio and to see whether or not there's some opportunities there. Larry, I may pass it to you with respect to potential sales and potential sales initiatives going forward.
The potential sales initiatives, first of all, is to grow the agency force. To do that is two ways. One is better recruiting methods. The second is geographic expansion. They're concentrated in the upper Midwest and Texas. We think those products could be offered in New York, Canada, other parts of the U.S. That's another part of the expansion we're talking about with Family Heritage.
Well, if you guys can't create any expense savings, this must be the most efficient small company on the planet.
If you look at their expenses as a % of premium, it is quite low. It's a very well-run company.
That's impressive. Look forward to learning more about them as you hopefully own it in the next week. Thank you.
Thank you. Once again, that is star and one to ask a question. We'll go to the side of Jeff Schuman. Your line is open.
Thanks. Good morning. Understand that in Part D there was volatility this quarter. There will be volatility sometimes. Can you remind us at this point, is there any sort of normal kind of baseline seasonality to the margins in that business?
Well, Jeff, we really haven't seen it. Like I mentioned last year, the third quarter was low. We kind of expected we might see that this year. Instead it was higher. This business is priced every year. The claims come in at different times. We just haven't seen seasonality that we can count on.
Okay. Thank you. This should probably be obvious, but just humor me, I guess. The excess investment income comparison to down six, does that exclude Family Heritage from both periods, or is that just in 2013 and you're still down six?
That includes Family Heritage in both periods.
In both periods. Okay.
Yeah. Remember for 2012, it was only half or two months. It includes it for both periods.
Includes it on a pro forma basis for 2012?
No, not on a pro forma basis.
Okay.
Whatever their actual additional excess would be for those final two months.
Okay. I guess just for some modeling perspective, do you have any idea how that comparison would have been on an apples-to-apples basis?
Yeah, Jeff, I'll have to find it. Let me see if I can find that before the call's over.
Okay. That's it for me. Thank you.
Oh, wait, I've got it. Excluding Family Heritage, we would project for 2013 that excess investment income would be down somewhere, and this is dollar amount, not per share. Dollars would be down somewhere between 7% and 10%. On a per share basis, excess investment income would be a decline of 2% to 4%.
Okay. That's helpful. Thank you.
With Family Heritage, I was saying earlier on a per share basis, it will be flat for 2013.
Okay. Thanks for clearing that up.
Thank you. Once again, if you would like to ask a question, please press the star and one on your touch-tone phone. We will pause a moment to allow further questions to queue. It appears we have no further questions at this time. I will now turn the conference back over to our speakers for closing remarks.
All right. Thank you for joining us this morning. Those are our comments, and we will talk to you again next quarter.