Good day, welcome to Torchmark Corporation's second 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 of Torchmark Corporation. Please go ahead.
Thank you. Good morning, everyone. Joining me today are Gary Coleman and Larry Hutchison, our Co-CEOs, Mark McAndrew, our Executive Chairman, Frank Svoboda, our Chief Financial Officer, and Brian Mitchell, our General Counsel. Some of our comments or answers to your questions may contain forward-looking statements that are provided for general guidance purposes only. Accordingly, please refer to our 2011 10-K and any subsequent Forms 10-Q on file with the SEC. I'll now turn the call over to Gary Coleman.
Thank you, Mike, good morning, everyone. Net operating income for the second quarter was $127 million, or $1.30 per share, a per share increase of 19% from a year ago. Net income for the quarter was $129 million, or $1.32 per share, a 4% increase on a per share basis. With fixed maturities at amortized cost, our return on equity was 15.8%, our book value was $33.26, a 10% increase from a year ago. On a GAAP reported basis with fixed maturities at market value, book value per share grew 29% to $41.38. In our life insurance operations, premium revenue grew 4% to $451 million, life underwriting margins increased 7% to $124 million. Net life sales increased 4% to $89 million. So far in July, sales are ahead of expectations, our guidance for 2012 remains unchanged.
On the health side, premium revenue excluding Part D declined 5% to $177 million, health underwriting margin declined 2% to $40 million. Health sales were $13 million, the same as the year-ago quarter. I will now turn the call over to Larry Hutchison for his comments on the insurance operations.
Thank you, Gary. At American Income, life premiums were up 9% to $164 million, and life underwriting margin was also up 12% to $54 million. Net life sales increased 10% for the quarter to $40 million. The producing agent count at the end of the second quarter was 5,318, up 23% from a year ago and up 4% during the quarter. We are pleased with the continued progress at American Income, and we are excited about the company's future prospects. We are seeing growth in the number of newly hired agents who achieve our top bonus level, which is our best indicator of agent retention. The first top bonus earners were up 60% in the second quarter. Our middle management ranks also increased by 21% in the second quarter. We expect sales growth for the remainder of the year to range from 12%-15%.
At our direct response operation at Globe Life, life premiums were up 5% to $58 million, and life underwriting margin declined 1% to $35 million. The decline in margin was due to unusual claim fluctuations, and we expect that the loss ratios will return to previous levels for the remainder of the year. Net life sales were up 4% to $38 million. We're also pleased with the results in direct response. Despite a difficult economy, we've been able to grow our sales. We'd also remind everyone of the change we initiated in our direct response underwriting in mid-2011. While improving our margins, it resulted in a reduction of our net sales due to more applications being rejected for health reasons. We expect sales growth for the remainder of the year to be in the mid-single-digit range.
Liberty National premiums declined 2% to $71 million, while life underwriting was up 21% to $18 million. Net life sales declined 18% to $8 million, while net health sales declined 12% to $4 million. However, health sales increased 9% in the second quarter compared to the first quarter. The producing agent count at Liberty National ended the quarter at 1,355, down 24% from a year ago, but up 6% for the quarter. We're very pleased with the progress being made in turning around our declines in producing agents and sales. We're optimistic that agent growth will continue going forward, which will result in improved sales at Liberty National for the balance of the year. Premium revenue from Part D grew 60% to $78 million, while the underwriting margin increased 47% to $8 million.
Part D sales for the quarter jumped 915% to $22 million due to the increase in low-income subsidized enrollees for 2012. I'll now turn the call back over to Gary.
To complete the insurance operations, administrative expenses were $40 million for the quarter, 1% less than a year ago quarter and in line with our expectations. I'd like to spend a few minutes discussing our investment operations. On our website are three schedules that provide summary information regarding our portfolio as of June 30, 2012. As indicated on these schedules, invested assets are $11.6 billion, including $11.1 billion of fixed maturities at amortized costs. 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. $10.3 billion are investment grade with an average rating of A minus. Below investment grade bonds are $764 million compared to $721 million a year ago. The percentage of below investment grade bonds of fixed maturities is 6.9% compared to 6.7% a year ago.
With a portfolio leverage of three times, the percentage of big bonds to equity, excluding net unrealized gains on fixed maturities, is 24%, which is less than most of our peers. Overall, the total portfolio is rated a high BBB plus, just slightly under the A minus of a year ago. We have net unrealized gains in the fixed maturity portfolio of $1.2 billion, compared to $873 million in the first quarter and $156 million a year ago. Regarding investment yield, in the second quarter, we invested $197 million in investment-grade fixed maturities, primarily in the industrial sectors. We invested at an average annual effective yield of 4.49%, an average rating of BBB plus, and an average life of 27 years. For the year, we have invested $430 million at an average rating of A minus.
The new money yield of 4.49% has declined from the 5.65% yield for all of 2011 and the 4.76% yield in the first quarter of this year. For the entire portfolio, the second quarter yield was 6.43%, compared to 6.47% in the previous quarter and 6.56% in the second quarter of 2011. The decline in yield is due to the lower new money rates. As of June 30, the yield on the portfolio is 6.42%. On July 5th, the notice of proposed rulemaking regarding the 2013 changes to the capital rules for banks were issued. Subsequently, we were notified that $301 million of our $708 million of bank hybrid trust preferred securities will be called in July and August.
These securities have an average yield rate of 7.18%, and assuming the call proceeds are reinvested at 4.25%, the lost annual income will be $9 million pre-tax, or $6 million after tax. For 2012, the lost income will be approximately $3 million after tax, and the portfolio yield will be reduced by about eight basis points. This amount was accounted for in our guidance. Of the remaining bank hybrids, we anticipate that another $300 million could be called. We don't know whether any of them will be called in the last half of 2012, but expect most of them to be called by the end of 2013. These bonds yield 7.35%, and assuming the same 4.25% investment rate, the lost annual income of all those securities, if all those securities are called, will be a similar $6 million after tax.
On past analyst calls, we have 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 on the balance sheet. To maintain our underwriting margins, we raised the new business premium rates on the majority of American Income Life products and the direct response funeral products by 5% as of January 1st this year. These increases provided additional margin to help offset reductions to excess investment income on new policies, and we did so without having a detrimental impact on sales. As long as we are 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% to 3% of fixed maturities will run off each year over the next five years, and that assumes a call of the $600 million of hybrid preferreds. Last fall, we performed a stress test to determine the impact on the portfolio yield of investing all new money at 4.75% over the next five years. Under that scenario, we determined that the portfolio yield at the end of 2016 would be between 5.95% and 6.10%. We have rerun the model, this time using a new money rate of 4.25%, and determined that the portfolio yield at the end of 2016 would be around 5.75% to 5.85%. At these rates, we would earn a small spread on the net policy liabilities while earning the full 575 to 585 basis points on our equity.
Even though we don't believe our new money rate will be as low as 4.25% for the next five years, should that happen, we will still generate substantial excess investment income. As I mentioned, an extended low interest rate environment impacts 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 to discuss share repurchases and capital.
Thanks, Gary. I want to spend a few minutes discussing our share repurchases and capital. First, regarding share repurchases and parent company assets. In the second quarter, we spent $184 million to buy 3.9 million Torchmark shares at an average price of $47.42. Going into the second quarter, we had anticipated spending approximately $90 million, which we did to acquire 1.9 million shares at an average cost of $48.54 per share. Due to favorable market conditions, we made the decision to acquire an additional 2 million shares during the quarter. These additional shares were acquired for a total cost of $94 million, an average cost of $46.39 per share. This was less than the $48.54 per share paid to purchase the initial 1.9 million shares.
For the full year through June 30th, we had spent $274 million of parent company cash to acquire 5.8 million shares at an average price of $47.53. 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 shareholders. The parent began the year with liquid assets of $74 million. We expect to generate approximately $350 million of free cash for the entire year. Thus, the total liquid assets available for all of 2012 will be around $424 million. During the first six months of the year, we generated about $163 million of free cash flow, but spent $274 million for Torchmark share repurchases, purchasing 5.8 million Torchmark shares.
The repurchases were funded by $179 million from the cash on hand and $95 million from the issuance of additional commercial paper. As a result of this activity, the parent ended the second quarter with $58 million of available liquid assets, comprised of $74 million of beginning liquid assets, plus the $163 million of free cash flow, less the $179 million used for share repurchases. Going forward, along with the $58 million on hand at the end of the second quarter, we should generate approximately $184 million of free cash flow in the next two quarters, giving us $242 million of total cash available for the remainder of the year. $95 million of this cash will be used to reduce our commercial paper to its normal level, leaving us with approximately $147 million of liquid assets available between now and the end of the year.
It should be noted that we have already reduced the commercial paper outstanding by approximately $90 million since June 30th. 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 a minimum of $50 million-$60 million of liquid assets at the parent company. Now, regarding the capital levels 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 current ratings.
At December 31st, 2011, consolidated RBC was 336% and adjusted capital was approximately $46 million in excess of the amount required for the targeted 325% ratio. Those are my comments. I will now turn the call back to Larry.
Thank you, Frank. For 2012, we expect our net operating income per share will be in the range of $5.08-$5.26 per share. Net investment income for the year will be lower than previously expected due to hybrids being called and the lower new money yields. Those are our comments for this morning. We will now open it up for questions.
Thank you very much. For the members of our telephone audience, if you would like to ask a question today, you can do so by pressing star one on your telephone keypad. If you are using a speakerphone, please ensure that your mute function is off so we can receive your signal. We'd like to remind our participants that questions will be taken only over the phones. They will not be taken on the web. Again, star one for a question. Our first question today comes from Vincent Lui with Morningstar.
Hi.
Morning.
Hi. Good morning. Hi. Thanks for taking the call. Just a question about the investment portfolio. I understand the credit rating has been dipped one notch to BBB+. How much of that would you characterize as a natural credit migration, and how much of that is a conscious effort to increase the allocation to below investment-grade securities?
Well, first of all, we're not consciously increasing the below investment-grade securities. The increase this quarter was due to downgrades.
We're not consciously moving toward a lower credit rating either. The BBB+ rounded is just under A-. It's only a slight difference from where we were the last several quarters. It really hasn't changed that much.
Okay. I just have a question about the agency count at Liberty. Is that really a target agency count there to kind of turn things around and start having sales growth again?
I don't know what you mean by a target agent count.
I mean, it's been decreasing 6% from last year, is there a target number that you're looking at?
We're looking at sequential growth each quarter, and we're confident that with the systems and the processes that have been changed with Liberty National, we'll continue to see this sequential growth through the end of this year and into next year. I'd expect that growth to pick up from 6%. It's still going to be single digit, but it's going to be 6%, 7%, 8%, hopefully in the third and the fourth quarters of this year.
Okay, great. Thank you very much.
Our next question will come from Jeff Schuman with KBW.
Thanks. Good morning. Wanted to follow up a little bit on the arithmetic around the calls and the trust preferred. There are different ways to look at the arithmetic on the guidance change. If we look at the movement in the midpoint, I guess it would suggest the midpoint maybe has moved by $0.08. I think when you kind of walk us through the math on swapping out the coupons on the $300 million that's been called so far, you got the $3 million after-tax impact, I think, for the remainder of the calendar year, which I guess is about $0.03. Trying to bridge a little bit between that amount and what seems to be maybe, by some interpretation, a bigger move in the guidance.
Is there another piece here which is that you may suffer a period where the funds are simply not deployed and we need to factor that in, or how should we think about it?
Yeah, Jeff, that's definitely a point. We had $180 million of short-term investments at the end of the quarter, and we're going to be adding another $300 million very shortly. It does take a while to get that money reinvested. To answer your question, as far as the additional, there's the outlined $0.03. Additional $0.03 comes from the fact that we are going to be slightly delayed in getting that money reinvested. Also all new money coming in beside the call will be invested at a lower rate than we had projected previously.
Okay, the rest of it is just the general movement and rates further down. Okay.
That's right.
I'm sorry, you broke up a little bit when you gave the number earlier. What is the total size of the bank trust preferred portfolio?
As of June 30, we have $708 million of bank hybrids.
Bank hybrids, $708, okay.
Right. Of that, $300 have already been called for July and August.
Yep.
The remaining $480 million, there's $107 million that are either not callable or they may call calls, and we're not expecting those to be called. That leaves another $301 million that could be called. Based on where rates are, we feel they probably will be called. As we talked about this on previous analyst calls, the reason these bonds are being called is there's a provision in those bonds that they can be called if there's a change in the capital rules, and they lose their capital status. Of course, under Dodd-Frank, those rules are going to be changed. Those rules will be effective in 2013. All along, we felt that these $600 million worth of bonds would probably be called, and that they'd be called in 2013.
Earlier in the year, we read where some banks were looking at the fact whenever the rules are published, which is expected to be in 2012, that that would be the triggering event, not the actual implementation of the rules in 2013. That's what's happened here with these $300 million. Those banks are considering a triggering event happening when those rules or at least a notice of the rulemaking was issued in July. What we don't know is that the other $300 million are potential calls. We don't know whether the banks will determine 2012 as a triggering year or whether we'll wait till 2013. We'll just have to wait and see what they do.
Okay. That's helpful. Just one other area quickly, if I may. Part D looks like it's tracking below the 12% margin I think you had hoped to achieve. Is it too early to conclude that maybe you're just not going to hit pricing assumptions, or how should we think about that?
I think it's a little too early to conclude what that pricing margin is going to be. If you look year-to-date, where we are this year is where we were last year.
You did see a strong uptick in the second half. Is there some normal seasonality or some reason that we can maybe think that that's likely to recur?
Yeah, Jeff, there's some seasonality there, and the latter part of the year, we got, well, probably this year too, get rebates from the government. The rebates were greater than we expected last year in the second half of the year, and that helped elevate that margin.
Okay. Thank you.
Our next question will come from Chris Giovanni with Goldman Sachs.
Thanks so much. Good morning. I think last quarter you guys talked a bit about if you made adjustments in the investment portfolio down 100 basis points or so, you could offset that on the margin side by raising premiums just 2%-3%. You talked about the 5% rate increase you did effective January 1. Are there any discussions around additional pricing changes you guys are looking to implement?
Gary, you want to handle that?
No, we don't expect to increase the rates again because of lower interest rates. We really only needed to raise the rates about 2%. We went ahead and raised them 5% knowing that maybe rates might go down a little more. I think even though rates have declined, I think the 5% that we implemented this year still gives
Okay. Then for Frank, you made the comment about being opportunistic on buybacks given the share price by using the CP. If shares did get back to that level, is that another lever you guys would be willing to pull again, or was that just sort of a one-time opportunity?
Chris, we really look at that as being more of a one-time opportunity within the year to accelerate some of the purchases really from the third quarter back into the second quarter. We've really had a philosophy of not wanting to borrow to fund the buyback program and wanting to use our existing free cash flows for those buybacks. I see that we will continue to do that.
Chris, I would add that it depends on the price. If the price got down to a very low level, where we really felt we couldn't pass up buying it, we could borrow again under our commercial paper and then pay it back with free cash flow from next year. The good thing about Torchmark is we got the $350 million of free cash this year. It'd be at least $350 million again next year and the year after that. We could pre-fund using expected free cash flow from next year. However, I agree with Frank. I don't anticipate us doing that unless there is a significant reduction in the share price.
Lastly, a competitor this morning talked about the rating agencies forcing them to hold a higher level of capital or RBC, and they said it wasn't due to the liability structure of their product mix, but because of the long durations of their investment portfolio. I guess given that your investment portfolio has a longer duration than some of your peers, have you been hearing similar messages from the rating agencies?
No, we haven't. One reason may be is, yes, our portfolio is long, but our liabilities are long too. We're matched. These other companies, there may be a mismatch in liabilities that could cause that reaction by the rating agencies, but we haven't heard anything like that.
Okay. Thanks so much.
Next, we'll take a question from Sarah DeWitt with Barclays.
Hi, good morning. I was wondering if you could elaborate on what drove the slowdown in sales growth in American Income and Direct, particularly given that the agent count at American Income continues to grow at a pretty fast pace.
Well, it wasn't really what drove the slowdown. We were a little disappointed in June. June sales were a little lighter than expected. When we look at July, we're back in excess of the 15% for sales in July. I think it's just a one-month aberration. Our guidance for the year, we think American Income will be in the 12%-15% range.
Okay, great. On Liberty National, I think previously you had said you expect sales growth to be positive by year-end there. Is that still the case?
That's still the case. We continue to see sequential growth in the agents. By the fourth quarter, I think we'll see year-over-year growth again.
Great. Thank you.
Next is Randy Binner with FBR.
Hey, thanks. Just a quick one on the preferred issues. Can you disclose if it was larger banks that were earlier to prepay these preferreds and if we could expect maybe the smaller ones to be slower to catch up?
Yeah, Randy, I'm just looking at our list here.
Even better, specifically who prepaid and who didn't.
Well, it was the bigger banks. Bank of America, JPMorgan, they were almost half of the calls. I'm just looking at the list. It'd likely be called, they are the smaller banks.
Okay. That's what we thought, and that'll help us monitor it. I guess to pick up on what Sarah was just asking on AIA, Larry, did you say 12%-15% for AIA as the goal?
Yes.
Okay. I guess just kind of looking for a little more color, maybe this kind of is a question that spans both AIA and Liberty, but understand the agent counts, understand the sales manager count being higher, and obviously, that's probably giving you some confidence in the forward look on sales. There's been training initiatives. I think there's been new laptop presentations and other initiatives. I'd be curious kind of updates on how those other initiatives might be kind of playing into this and helping your thinking on the sales guide.
Sure. There's not one initiative, there's a number of initiatives. One is the laptop presentation, and we're introducing that, and by year-end, that'll be well underway at Liberty National Life Insurance Company. It took some time at Liberty National to get the team in place. As you introduce laptop, it takes some time to spread that throughout the field. At American Income, we still have a number of initiatives. We're seeing better training. We're producing better data to manage the training with. Some of the data, again, comes from the laptop presentation at American Income. That's fully introduced there. That's where the data that we can track down to the agents themselves, what their performance is in terms of number of presentations, their closing rates. All that helps retain agents, and that's reflected in those numbers. We're seeing more of the first-time agents hit bonus.
We're seeing middle management grow. As middle management grows, there's better training because you have more middle managers that can train those new agents
Yeah, that's a great color. Thank you.
Next we'll turn to Paul McCann, Evercore Partners.
Hi, good morning. I just wanted to follow up first on American Income, where for the last one and a half years or so, agent count growth has exceeded sales growth, and by an especially large margin over the last few quarters. Is this a trend that you think should reverse going forward? In other words, should we see productivity start to pick back up towards historical levels as new agents mature?
Yes, I think that's correct. It's not just new agents. You have managers. The middle managers are more effective in terms of their training and those closing rates of sales. I think we're a little bit level in terms of our productivity, and I expect that to pick up somewhat as those agents mature.
Okay, if you adjust for the fact that you have more new agents now, thanks to the growth, is there anything else that's impacting productivity negatively?
Not negatively. It's just, as you add new agents, there's a little bit of a catch-up period as you have a surge in new agents, and I think we'll be closer to the 15% growth at the end of the year than the 12%.
Yes. Okay
It's year-to-year, it's not month-to-month. We're seeing improvements in those numbers.
Turning to direct response, what is it that gives you confidence that the lower margins this quarter were a one-time claims fluctuation?
Paul, for one thing, I was looking at the margin. I think we were at 22%, just a little over 22%, and at 23.5% for the quarter for the prior year, or 24% for the prior quarter was 23.5%, we're not talking about a big change. What we did see is claims were a little bit lower in the first quarter, and I think we caught up in the second quarter, and we think for the year that they will be right around the 45%-46% level that they are now. We had a little bit higher amortization in the quarter, and that's a seasonal thing. We think that if you look at the year-to-date percentages as opposed to this quarter, I think that's what you're going to see for the full year.
The lower claims in the first quarter and higher in the second, do you think any of that was reporting timing or changes in IBNR, or you just think it's random fluctuation quarter to quarter?
I think it's just a little bit of a timing. It doesn't take much of a change in timing to affect the total for a quarter. For the six months though, they're about what we expected.
On direct response sales, I was a little surprised to see sales fall sequential. I know there's some seasonality to it. You also expanded circulation pretty dramatically in the second half of last year. Are the responses not coming in as much as you would've expected, or is this in line?
It's kind of in line. We expect the responses for the year to be about what they were last year. We just had a big surge in the third and fourth quarter. That takes some time for those sales to develop.
Okay, thank you.
Mark Hughes with SunTrust has our next question.
Yeah, thank you very much. On the direct response business, are there any campaigns coming up that might lead to any increase or tougher comps perhaps in sales activity?
There's always new campaigns at Globe Life and Accident. What Globe Life and Accident does constantly, they are testing new methods of distribution. We're seeing some real growth in our electronic media, and we'll have to see how those tests develop.
Right. You would expect just a consistency?
I expect the same consistency. It's what Globe does. They continually test, and we've seen that upward ticks over time, and I'd expect that to continue.
Okay, great. Thank you.
Our next question will come from Jimmy Bhullar with J.P. Morgan. Mr. Bhullar, your line is open.
Can you hear me? Hello?
Yes, Jimmy?
Okay, hi. Just had a question on the timing of share buybacks for the second half. The stock's obviously down, but should we expect you to be buying back stock on an even basis in the third and fourth quarter? Or if it declines more, would you be opportunistic and do more of the buybacks in the third quarter? Secondly, I had a question on the agent count at Liberty National. Obviously, it's recovered nicely since, I think, February. Anything that would suggest that the recovery might be short-lived, or do you expect the agent count to continue to improve?
I'll take the second half of that first. I don't think anything we do at Liberty National is going to be instantaneous. What we have is a slow, deliberate growth. You'll see sequential growth each quarter at Liberty National. Jimmy, it takes some time to get all the systems in place that we're improving the training, the lead programs, the recruiting. All those initiatives have started at the same time. Obviously, with the sequential growth of agents, you're seeing those get some traction. I think you're going to see high single-digit growth in the fourth quarter, but I think we see the stronger growth next year as those mature and the laptop is put in place around the first of the year through 2013.
Jimmy, as far as the share repurchases, as Frank mentioned, we came in here expecting to $68 on share repurchases. As of today, I think that's where we'll end up. That means for the second half of the year, you're talking around $90 million of share repurchases. We haven't determined what we think the timing of that should be, but you're right. If there's an opportunistic chance to get a better yield on the purchases, we would accelerate it. At this point, we don't expect spending more than the $360 million.
Got you. Thank you.
Next is John Nadel with Sterne Agee.
Gary, you mentioned a 4.25% new money yield for the updated sensitivity analysis. I'm just wondering, is that around the level that might be consistent with where you're currently investing new money given the more recent drop in rates? I know you were at just under 4.5% for the full quarter.
Yeah. You're right. We're just right at 4.5, rates have dropped. That's right around where we're investing now. Maybe a little bit higher, we assumed a four and a quarter in our guidance, that's probably where we're going to be.
Yeah. I understand. Second one is just, how should we think about the outlook for Part D sales from here? Obviously, there's been some great momentum with the new product. I'm just wondering how much longer you think that runway will last.
Well, long term, John Nadel, it's hard to address. In the short term, we've submitted our pricing in June of this year. We expect CMS will publish the 2013 benchmark premiums in August. We hope to be able to maintain our existing regions and possibly add a few more regions when that is published.
Okay. Can you update us on the progress that you've been making on the premium retention program?
Yes. Our projections is this year that without the conservation program, we'd be lapsing around $250 million for the premiums. Annual premiums, annualized. Our estimate now is that for this year, we'll conserve around $31 million of that would normally have lapsed. Of course, that's an annualized amount. The actual premium collected for the year from saving that $31 million would be around $15 million.
Okay.
It's a little bit higher than what we projected coming into the year.
How do you think about that for next year? I know whether it was a quarter or two ago when you originally started talking about this program, you expected to broaden it to some of the additional channels. I'm wondering what you're thinking about in terms of the savings you might be able to garner looking out to 2013.
Well, I don't have a projection for 2013, but you're right, we have extended it out. At first, it was primarily American Income. American Income is about 40% of it, but there's another 45% of it now that's in direct response. Then Liberty makes up the difference. Again, I don't have a projection for next year, but I'm sure it's going to be higher because we're improving as we go along.
John, with that, as we continue to hire within that section and train, we know that we're going to expand those efforts. So it's going to grow next year. We just don't have the percentage calculated.
Right.
We can talk about that in the next call.
Okay. I'm sorry, I have one just last one.
Sure.
Can you just walk us through why the discount rate on the policy liabilities increased? I know it was 5.65% in the second quarter. That's up from 5.60% last quarter and 5.55% a year ago. It just seems so counterintuitive with rates falling. Can you just remind us?
Yeah, John, it's all related to the fact that our in-force block of business is made up of many years of issues. Back up, really the last two years, we have reduced the discount rate, but that's a discount rate on policies issued in the year. Going back several years ago, our discount rate was more in the 6.5%-7% range. Right now, a higher percentage of the block of business is at those 6% or 7% rates. As time goes by, though
Got it
they'll decline, and the policies issued at the lower rates will become a bigger part of the in-force, and we'll have a lower discount rate. What it looks like is that discount rate will continue to increase slightly over the next two to three years. It's really at a point where it's around probably 5.75%, we think it'll start declining from that point, if interest rates are where they are today. It will rise for a little bit, and then it'll start declining.
That's very helpful. Thank you very much.
Next is Steven Schwartz, Raymond James & Associates.
Hey, good morning, everybody. John just asked a question I wanted to ask on retention. Just a quick one. The $300 million of hybrids that have not been called that are callable, that's not in this year's guidance, right?
They have to give us at least a 30-day notice on the calls. Let's say they're called at the actual money goes out on September 30th. I think that's the worst case. You're talking about $0.02.
Okay.
We did include the $0.02 in the low end. It may be less than that. I say, we don't even know how many of them will be called in 2012.
It makes sense if it's going to be called, it's going to be called by 12/31 because otherwise it's in the capital or not. I guess not in the capital.
Well, it's a legal question, though, as whether they can call them. All the provisions are slightly different, and it's not clear cut. The banks that have called them have taken the position that the announcement of the rules is a triggering event. Some of the other banks may think that you have to have the implementation of the rules, which won't be until 2013, before there is a triggering event. There's a legal question that they're probably looking at. Again, we don't know how they'll look at it, we don't know whether they'll call them in '12 or not.
Okay. All right, great. That's all I had left over.
As a reminder, if you would like to ask a question today, star one on your telephone keypad. Next, we'll hear from Ed Foden, Nomura.
Good morning. I was hoping you could quantify how much capital will be freed up as the $600 million of preferreds are called, and what the use would be of that capital.
Yes, Ed. It looks like there's a portion of the known calls that we have. There's a portion of that in fact would be NAIC Category 3 and IV. We will get some capital relief out of that. Out of the known, right now it would appear that it's maybe about $12 million of statutory capital that would be freed up. If in fact the other $300 million of the bank hybrids are in fact called before the end of the year, then an additional roughly $30 million of statutory capital would be freed up as well. Remember, that is sitting down in the statutory and the insurance companies.
Just depending upon the course of events over the remainder of the year is whether or not we can end up getting that money out before the end of the year or from the 2013, or if we need to leave it in there to meet our RBC levels.
Thank you.
Ed, I might add that just looking at the credit quality portfolio, that of the $300 million that have been called, $85 million are below investment grade. Our below investment grade bonds will decline $85 million. If the other $300 million are called, below investment grade bonds would decline by another $170 million. That's the additional capital and the fact that we're reducing below investment grade bonds is a slight positive to these calls.
Thank you.
We'll pause just one moment as we await additional responses. Currently, there are no questions in the queue. I'll turn the conference over to our host for any closing or additional remarks.
All right. Thank you for joining us this morning. Those are our comments, and we'll talk to you again next quarter.
That does conclude today's conference call. Thank you for your participation.