Good day, and welcome to Torchmark Corporation's third quarter 2011 earnings release conference call. Today's call is being recorded, and for opening remarks and introductions, I would like to turn the call over to Mark McAndrew, Chairman and CEO of Torchmark Corporation. Please go ahead, sir.
Thank you. Good morning, everyone, and for those of you on the East Coast, good afternoon. Joining me this morning is Gary Coleman, our Chief Financial Officer, Larry Hutchison, our General Counsel, and Mike Majors, Vice President of Investor Relations. 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 2010 10-K and any subsequent Forms 10-Q on file with the SEC. Net operating income for the third quarter was $129 million, or $1.22 per share, a per share increase of 13% from a year ago. Net income was $137 million or $1.30 per share, a 38% increase on a per share basis. Excluding FAS 115, our return on equity was 14.3% for the quarter, and our book value per share was $35.20, a 10% increase from a year ago.
On a GAAP-reported basis with fixed maturities carried at market value, book value grew 16% to $40.92 per share. In our life insurance operations, premium revenue, excluding United Investors, grew 3% to $430 million, and life underwriting margins increased 5% to $121 million. Life net sales declined 1% in the quarter to $78 million. At American Income, life premiums were up 9% to $154 million, while life underwriting margins were up 8% to $51 million. Life net sales increased 8% for the quarter to $36 million. The producing agent count at the end of the third quarter was 4,448, which was up 9% from a year ago and up 3% during the quarter. I believe that American Income is back on track. New agent recruiting was up 11% from a year ago.
The number of new agents who achieved our top bonus level for the first time increased 40% from a year ago, and our mid-level sales management ranks have grown 23% from a year ago. American Income, I believe, is now in position to see renewed double-digit growth in sales during the fourth quarter and throughout 2012. In our direct response operation at Globe Life, life premiums were up 3% to $145 million, and life underwriting margin was also up 3% to $37 million. Net life sales were down 4% to $31 million. As a result of the changes in our underwriting, which we previously discussed, and improvements in our package design, we increased our insert media circulation by 22% in the third quarter. The responses received from these inserts increased 43% during the quarter.
There is a significant lag from the time those responses are received until a net sale is recognized. We are confident that the increased responses will result in net sales growth in the fourth quarter as well as subsequent quarters. For the fourth quarter, we intend to increase our insert media circulation by 38% over last year. Due to the uncertainty in the economy, our guidance projects only mid-single-digit growth in direct response sales for the fourth quarter and full year 2012. Life premiums at Liberty National declined 2% to $72 million, and life underwriting margin was up 5% to $16 million. Net life sales declined 23% to $9 million. The producing agent count at Liberty National at the end of the third quarter was 1,578, which was down 27% from a year ago.
Health sales at Liberty National jumped 47% as a result of some new product offerings in our worksite payroll deduction market. Effective January 1 of 2012, all sales office and lead expenses at Liberty National will become the responsibility of our branch managers as we continue to move Liberty National to a model similar to American Income. As of November 1st of this year, all new agents will be hired on an independent contractor basis versus employee, again, following the American Income model. While these changes may have some short-term effect on our sales, we believe they are necessary to preserve our profit margins and to put Liberty National in a position to achieve long-term growth. We continue to make excellent progress in our efforts to reduce our lapses in our life insurance businesses.
As I mentioned on the last call, during the second quarter, we were able to conserve $2.2 million of annualized premium through our new conservation initiatives. For the third quarter, we were able to conserve $5.8 million of annualized premium. These numbers will continue to grow as we expand our conservation efforts. For 2012, our guidance assumes $30 million-$35 million of annualized premium will be conserved next year. On the health side, premium revenue excluding Part D declined 6% to $177 million, while health underwriting margin was down 8% to $34 million. Health net sales grew 26% to $16 million. In addition to the previously mentioned growth at Liberty National, the United American Independent Agency sales grew 46% to $7.6 million for the quarter, reflecting improvement in the Medicare supplement marketplace in both individual and group.
For 2012, we currently project 10%-15% growth in our net health sales. Premium revenue for Medicare Part D declined 5% to $50 million, while underwriting margin improved 18% to $7 million. For 2012, we have developed a new lower-cost Part D plan, which will allow us to pick up 76,000 low-income subsidized auto enrollees as well as grow our individual sales. This new product is priced with the same underwriting margin as our existing products. We do expect, however, for Part D revenues to increase by 40%-50% next year. Administrative expenses were $40 million for the quarter, up 4% from a year ago. They were roughly $800,000 over our projection, primarily as a result of additional salary expenses associated with our conservation efforts. For 2012, we anticipate a 1%-2% increase in administrative expenses.
I will now turn the call over to Gary Coleman, our Chief Financial Officer, for his comments.
Thanks, Mark. I want to spend a few minutes discussing our investment portfolio, capital, and share repurchases. First, the investment portfolio. On our website are three schedules that provide summary information regarding our portfolio as of September 30th, 2011. As indicated on these schedules, invested assets are $11.2 billion, including $10.7 billion of fixed maturities at amortized cost. Of the fixed maturities, $10 billion are investment grade with an average rating of A-minus. Below investment-grade bonds were $734 million, down from the $863 million at December 2010. The $129 million decline this year is due primarily to $142 million of dispositions, offset partially by $12 million of downgrades. The percentage of below-investment-grade bonds to fixed maturities is 6.8%, compared to 8.3% at the end of 2010. That percentage may still be a little high relative to our peers.
Due to our significantly lower portfolio leverage, the percentage of below-investment-grade bonds to equity, excluding OCI, is 20%, which is likely less than the peer average. Overall, the total portfolio was rated A-minus compared to BBB-plus a year ago. We have net unrealized gains in the fixed maturity portfolio of $942 million compared to gains of $306 million at the end of the second quarter and $572 million a year ago. The increase in unrealized gains in the third quarter is due primarily to Treasury yields declining more than the credit spreads increased. Regarding our investment yield, in the third quarter, we invested $134 million in investment-grade fixed maturities, primarily in the industrial sectors. We invested at an average annual effective yield of 5.53%, an average rating of BBB-plus, and an average life of 29 years.
For the nine months, we've invested $831 million at an average yield of 5.79% and an average rating of A-minus. For the entire portfolio, the third quarter yield was 6.54% compared to 6.56% in the previous quarter and 6.68% in the third quarter of 2010. The continual decline in yield is due to the lower new money yields. As of September 30th, the yield on the portfolio is 6.53%. Regarding RBC, we plan to maintain our capital 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 the consistent statutory earnings, the relatively lower risk of our policy liabilities, and the level of our ratings.
Regarding share repurchases and parent company assets, in the first nine months, we spent $720 million to buy 17 million Torchmark shares. So far in October, we've used $14 million to buy another 400,000 shares. For the full year through today, we have used $734 million of parent company cash to acquire 17.6 million shares or 15% of the diluted outstanding shares at the beginning of the year. At September 30th, the parent company had $166 million on hand and should generate approximately $6 million of free cash flow in the fourth quarter. As of today, after deducting the $14 million of October share repurchases, the parent will have approximately $158 million available between now and the end of the year.
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. Before I turn the call back to Mark, I would like to discuss the impact of two issues, the new accounting rules for DAC and the current interest rate environment. Regarding DAC, on January 1st, 2012, the company will adopt ASU 2010-26, which changes the rules regarding the deferral acquisition cost. This standard will change the timing of GAAP profits to the extent that certain expenses deferred currently will not be deferred under the new rules. However, it does not affect our overall profitability, our cash flows, or statutory earnings.
We will elect to adopt the new rules retroactively, which means that DAC will be written down to the level as if the new standard had been in place in prior periods. Going forward, the earnings impact will be the combination of the reduction in expenses deferred on newly issued policies, somewhat offset by the reduced amortization of DAC resulting from the retroactive write-down. We currently estimate that the retroactive write-down will be between 15%-25% of the current DAC asset, which will result in a 9%-15% reduction in GAAP equity, excluding OCI. In addition, we expect that 2012 earnings will be 1%-2% or $0.06 to $0.10 per share lower than they would have been under the old accounting rules. We also project that our ROE will rise from the current 14% level to somewhere between 15% and 17%.
These estimates were included in our guidance for 2012. We will give more definitive guidance in the fourth quarter analyst call. Finally, I'd like to discuss 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 involves the impact on earnings, but not the balance sheet. In response to lower interest rates, we plan to raise the new business premium rates on the majority of American Income Life products and the direct response funeral products by 5%. These increases will provide additional margin to help offset reductions to excess investment income on new policies without having a detrimental impact on sales. However, in an extended low interest rate environment, the portfolio yield will continue to decline as we invest new money at lower rates and thus will pressure excess investment income.
However, the decline will be slower than might be expected, since on average, only 2%-3% of fixed maturities will run off each year over the next 5 years. To help quantify the impact of extended low rates on excess investment income, we conducted stress tests assuming a new money yield of 4.75% for the next 5 years, along with a GAAP reserve discount rate of 4.75% graded to 6.5% on policies issued during that time period. Under that scenario, our portfolio yield would drop to somewhere between 5.95%-6.10% after 5 years, and the average GAAP discount rate for our entire in-force block would be around 5.6%. As such, we would earn a spread of 35 to 50 basis points on the net policy liabilities while earning the full 595 to 610 basis points on our equity.
As you can see, we would still generate substantial excess investment income along with our high underwriting margins. Now let's switch to the balance sheet. Due to the nature of the products we sell and our high underwriting margins, our DAC and benefit reserve balances will not be significantly impacted by an extended low interest rate environment. Unlike many of our peers, most of our in-force business consists of straightforward protection life policies that are not interest sensitive, and they were accounted for in accordance with FAS 60. Under FAS 60, we would not increase amortization of DAC or put up additional benefit reserves due to interest rate fluctuations unless a loss recognition situation occurs. We have conducted loss recognition testing using our September 30th financial data.
In order to have a loss recognition situation in our life business, we would have to believe that our overall portfolio yield would drop to 4% and remain there permanently. We don't believe there is a reasonable set of circumstances that this scenario would occur. As such, we're not concerned about the low interest rate environment affecting our balance sheet through adjustments to DAC reserves or goodwill. The only block of business where extended low interest rates might affect the balance sheet is our fixed annuities, which were accounted for under FAS 97. However, due to the size of our annuity block, any impact would be insignificant. With regards to statutory financials, we performed the New York 7 cash flow testing scenarios at each year-end in accordance with regulatory requirements.
We updated this testing at the end of the third quarter to incorporate the lower treasury rates and determined that we still generate adequate surplus in each of the seven scenarios. Therefore, no additional statutory benefit reserves are required. Finally, a low interest rate environment can affect Torchmark's RBC related to the fixed annuities. However, any impact there would not be significant. Those are my comments. I will now turn the call back to Mark.
Thank you, Gary. For 2011, we project our net operating income per share will be within a range of $4.65-$4.69 per share. For next year, we are projecting our net operating income per share to be between $5.10 and $5.40 per share. I would like to reiterate that this guidance reflects the $0.06-$0.10 reduction as a result of the change in DAC accounting. Those are my comments for this morning. We will now open it up for questions.
Thank you. For those of you joining us by the telephone that would like to ask a question, please press the star one on your touchtone telephone. You may remove yourself from the queue at any time by pressing the pound key. Once again, if you are joining us by telephone and would like to ask a question, please press the star one keys now.
We will take our first question from the site of Jimmy Bhullar with JPMorgan. Please go ahead. Your line is open.
Hi, thanks. I had a couple of questions. First one for Mark. If you could talk about your sales expectations at Liberty National. In the past, when you've tried to make changes or adjust commissions, there's been generally more disruption than initially expected. I realize Liberty is smaller than it used to be, but it's still about 10% of your life sales. I was wondering if the momentum at American Income direct response next year would be offset by just weakness at Liberty National overall. Secondly, for Gary, you mentioned $158 million of cash at the parent company. How much do you think you'll need to maintain in this type of an environment as a cushion? Assuming that whatever that cushion is, anything above that would be used for buybacks.
Okay. Well, first at Liberty National. You're correct, Jimmy, that any major changes in the past, we have seen a disruption. In our guidance, we're still assuming a mid-single-digit decline in our life sales at Liberty National next year, although we do expect to see some growth in our health sales at Liberty National next year. On the other hand, we have announced these changes a couple of weeks ago, and they were well-received. I will point out, a year ago, we had 165 offices at Liberty National, and today we're down to 75. We have closed or consolidated most of the underperforming offices there. I felt like these changes were very well-received. I really believe that the branch managers that we have now have the desire to grow, the ability to grow, as well as the tools to grow.
I remain optimistic that we will see a turnaround at Liberty National next year. Although again, in our guidance, we have assumed a small continued decline in our life sales.
Jimmy, as far as the cash cushion is concerned, I would think we would have a cushion of somewhere between $50 million-$100 million. There's not any specific need that we're targeting, but we feel like we do need a cushion, and it should somewhere be in that range.
Okay. Just one more on MedSup, you mentioned or Part D, you mentioned the enrollment expectations, but what's going on in terms of pricing in the MedSup market? We've heard of some of the major medical companies trying to expand further in that business. If you could talk about just pricing trends in the Medicare market.
Well, overall, our pricing trends have been very favorable. Again, we repriced our products, I think, last year. The largest selling product, the high deductible Plan F, I know we have actually reduced our rates the last two years, which has made it more attractive. Really over the last several years, we've seen very small single-digit increases on all of our products. Even though we're seeing some activity there, it's still a very small part of our business. While we expect some growth there, we're not projecting it's going to get back to where it was 10 years ago. It will continue to be a competitive marketplace, but again, we think in a competitive situation, we're in better shape than we've been in a number of years.
Okay, thank you.
The next question comes from the site of Steven Schwartz with Raymond James. Please go ahead. Your line is open.
Hey, good morning, everybody. Mark, first on the Part D, maybe this is terminology. You've lowered the cost. You're going to pick up 76,000 auto enrollees. That's going to lead to a 40%-50% increase in revenues. You said the same margin. Now, do you mean by that the same profit margin, like around 10% or whatever, or are you talking about the ultimate earnings?
Yeah, the same margin as a percentage of premium.
Okay
As our other products. We basically came up with a product that has a little higher deductible and also a more narrow formulary as far as what prescriptions are covered. We still have the same products that we offered last year. We added another product which has a lower cost, which got us below that median pricing level, which qualified us, I think, in 21 out of 34 regions for the low-income subsidized people. In addition to the 76,000 that we're picking up immediately, we'll start picking up about 2,000 additional people each month, people turning 65 as a result of that also. Yes, we feel very comfortable that we will see that kind of growth in our Part D revenues next year.
Okay. If I may continue. On Globe, the discussion with regards to responses, those numbers sound huge, yet the sales guidance, I guess, for conservatism reasons, isn't there. What could go wrong between the responses and the sales?
Well, again.
Go wrong is probably the wrong word.
No. It's an okay terminology. You have to understand, in the insert media, the whole process, and it's a long process. We first put a very simple insert piece into some other media, whether it's a coupon pack or a newspaper or a DirecTV bill. That is what we increased that volume by 22% in the third quarter. People send us a response. Most of those responses are reply cards. They're mailed in, although they can also call in or get on the internet. Most of those people send back a reply card. Once we get the reply card in, and the number of responses we got were up, gee, Over 50%. Go ahead.
They were big numbers.
Yeah. Substantially. Once we get that reply in, we start sending a series of product offerings, really out over the, not just the next three months, but six months, 12 months, even out further than that. For example, historically, the first product offering we send out, we get 8%-9% of those people to buy. The second one, it goes down in the 3%-4% range. The third one, it goes down in the 2.5%-3% range. We continue to get people to reply to those product mailings, which include an application and rates, for an extended period of time. Even after these people send the application in, it has a dollar for the first month introductory offer. After we issue the policy, 30 days later, we send them a bill.
Until they pay that renewal premium, we don't treat it as a sale. In fact, I apologize, I should have better lag numbers for exactly how long after that insert media increases will we see those sales, and I will have better numbers for the next call. Again, the first step of that, the number of responses is up according to our plan. It just takes an extended period of time for that to be turned into what we report as net sales.
Okay. I appreciate all that. Let me just ask one little follow-up to that. Is there anything about, I know the new underwriting that you're doing, that could lead to the ultimate hit rate, no matter how long it takes to be lower than it has been historically?
Well, again, that's one of the things. We're issuing a smaller percentage of the applications we're getting in. That does offset somewhat.
Okay.
That we decline, I think it's 5%-6% more of the business that we're getting in. That does somewhat offset the growth in sales. If we weren't doing that, our sales would be 5%, 6% higher, although the profitability of those sales would be lower. That is one of the factors that tempers the growth in sales. Also, again, as I've mentioned before, the insert media is the one aspect of our business that the response rates do tend to follow the consumer confidence index.
We've tempered it a little bit because even though the inquiries are up, we could still see when, if you say what could go wrong, we could still see those response rates for the fulfillment packages could go down, or the percentage of the people who end up paying beyond the $1 introductory offer could go down as a result of economic conditions. We're trying to be on the conservative side there.
Okay. I appreciate that. Thank you.
The next question comes from the site of Edward Seaborn with Bank of America. Please go ahead. Your line is open.
Thank you. Good afternoon, guys. Good morning, I guess. Mark, could you go over one more time the conservation numbers for what they were in the second and third quarter, and then what your expectation is for 12?
Okay. Sure. In the second quarter, our new conservation efforts, in addition to what our agents are doing, we conserved about $2.2 million of annualized premium. In the third quarter, that number increased to $5.8 million. I would point out over 60% of that business is being conserved is at American Income, which again, it's where we focused our initial efforts because it's our highest margin business, obviously. In our guidance for next year, we have assumed somewhere between $30 million-$35 million of conserved annualized premium. Our goal is still to beat that number. That is what we've used in our guidance.
When we think about the earnings impact of a dollar of conserved premium, given the fact that it's more than 60% American Income, how should we think about what the dollar amount to the bottom line is of that?
Well, it's one of those things. For example, it takes time. The $5.8 million that we conserved this quarter had almost no impact this quarter because the vast majority of those people are paying monthly. It had almost an unnoticeable impact this quarter. As we continue to conserve business, that number will grow. In our guidance, Ed, the conservation added about $0.03 a share after tax next year is about.
Okay. It's not a big number.
Not at this point. It's something that will continue to grow over time as we continue to do that. Each quarter it will continue to add more value.
Okay. On the Part D, you're saying that the expectation is that the top and bottom line should be up 40%-50% next year versus this year?
Yes. That would be a reasonable expectation, yes.
When we think about, I know you said that there's the sort of growth from those that will be turning 65 that's a positive, but if we think about this business, when you first had a big bump up and then it was sort of like it was a one-time thing, you got it, and it just sort of stayed there. Would you think about this bump here as sort of a, we go to a new level and then it's kind of another plateau?
Well, if we continue to stay below that median, it will be more growth going forward. For example, we're going to immediately pick up 76,000 people, but we will be adding about 2,000 new people net each month. It will be, by the end of the next year, we should have grown by about 100,000 people through the auto enrollees. Those new people turning 65 will continue to add to that. No, I would expect it to contribute some growth going forward. Not as much as obviously it will next year.
Okay, the final question is, your life premium, I think, was up 3% this quarter. Your health premium was down 6%. Given all of the sales numbers that you're anticipating next year and the sales that have happened recently, are these numbers that should be relatively stable next year? I mean, in terms of the growth rates, we don't see any real pickup in those. Like you said, it's going to continue to decline mid-single digits, life maybe grow a few percent, we won't start to see growth until 2013.
Well, hold on just a second here. I've got more detailed numbers. If I look at our total life premium, I think at our midpoint, we're expecting a little over 4% growth in our life premium. I think that's slightly better than where it's at today. On the health side, we're still expecting about a 6% decline in our health premiums for next year. That's at the midpoint of our guidance. Yeah, I think that's a fair statement, Ed.
Okay. In buybacks, are we sort of assuming that, like typically all free cash flow used for buybacks, or is there any difference in what you're assuming in the guidance?
Obviously, again, it's something that we'll continue to evaluate each quarter. Right now, we feel comfortable with really about a $50 million cushion. We want to keep that for the end of the year, just until we know for sure what our year-end RBC is going to be.
Sure.
Again, barring acquisition potential or anything else, we still believe that share repurchase is a good use for it. Right now, I don't see any reason to hold more than that for a cushion.
When you think about your guidance, you're assuming that whatever free cash flow you generate in 2012 is used to buy back stock.
That's correct. In our guidance, we have assumed we would use basically our free cash. We've assumed at different price levels, but we have basically assumed that we would use it to repurchase stock.
Can Gary remind us what that number, I don't know if he's given us anything on that number expectation for next year.
Gary, free cash next year, we anticipate being about $360 million?
Yeah, it should be around $350-$360. Just based on our preliminary estimate.
Okay, that's after dividends?
Right.
Okay. Thanks a lot, guys.
Sure.
The next question comes from Jeffrey Shuman with KBW. Please go ahead. Your line is open.
Thank you. Hello. I think Ed got me started on this, maybe we can continue. I'm struggling to contemplate the 2012 guidance, particularly after you're now telling us that it incorporates the impact of the DAC change. The midpoint of your range is 525. If we back out the impact of the DAC change, it would be 530 to 535, and that's against a consensus of 510. I'm kind of running out of ways to rationalize that because I think as you run through the premium numbers, I think probably most of us aren't too far off there. I think most of us know what to anticipate in share repurchase. Conservation is only a $0.03 issue. Part D sounds like some upside. Obviously, you don't reconcile against our models, I mean.
Right
What other things should be on our list to think about?
Well, I guess that's where no doubt the impact of share repurchase is a big item. We said at the beginning of this year, we wouldn't get the full impact of the United Investors sale until the first, second quarter of next year. It was actually dilutive by $0.05 to $0.10 per share this year, and it will be accretive next year as we get the benefit of that. Other things, the expense reductions we've seen at Liberty National. Again, we've closed 90 offices in the last 12 months, and those expenses that would no longer be deferrable. Those expense changes will add about $0.11. The Part D we've increased will add about $0.05. The change in the underwriting and direct response will add about $0.02 after tax.
There's a number of different factors adding to it, still the share repurchase at the current multiple, if we would've been in a double-digit growth in earnings for sure this year without the United Investors sale. Again, you're right, we don't reconcile to your model, even at the beginning of this year, it's not far off from where we thought we would be.
Okay. That's all helpful. The share purchase is powerful, although I think most of us probably kind of have that already worked in. Probably the Liberty expenses, the Part D, a couple of the other things, maybe not so much. Those are helpful thoughts. Thanks.
You bet.
The next question comes from Colleen Devine with Citi. Please go ahead. Your line is open.
Good morning. I had just sort of three areas I'd like to talk about. First, on Liberty. Mark, I think we're now at least 27 quarters in terms of the agent force shrinking, particularly the sort of not the first-year agents, but the renewal agents, which I assume are driving a lot of the sales here. Where do you think that finally bottoms? Is it going to be next year? You've talked about, I guess, growing the number of managers. What did it take to sort of get that to finally turn around, would be question number one. Question number two, have you given any thought to changing the dividend policy? To maybe doing a little more in dividends than buybacks. The last one, on the M&A front. You mentioned in the past you've looked at some things.
Is there anything else out there that you could do that might help to give Liberty sort of a booster shot here?
Okay. Liberty National. That is still the biggest question mark that we have. Again, I feel good about the changes that we've made. I think they were received well. But the next, I would say 90 days, next three to four months, is really going to really see how well those changes were received. We have made them much more businessmen, much more entrepreneurs versus just managing our offices. The one big thing, Coleen, that you need to remember, regardless of the level of sales going forward, we have moved most of the fixed expenses at Liberty into variable expenses. At least the margins on the business that we write at Liberty National will be predictable going forward. Again, I believe that by the first of the year, we will be at a low point at Liberty National.
We're really going to have to wait and see what that is. We're still expecting a small decline again in our life sales, although we do expect our health sales to pick up. I think the next three or four months, we'll have a better answer to that. As far as dividend versus buyback, we definitely discussed that. We have been slowly raising our dividend each year for the last several years. It still comes down to at the current PE that we're trading at, we still believe buyback is a very good use of the money. It is something, particularly if we get in a very low interest rate environment, we obviously could pay a much higher dividend. At this point, there's no definite plans to change our dividend policy. That might change if the PE comes up some.
As far as M&A, particularly right now, until we see some positive results at Liberty National, in fact, I would just say I would not be interested in buying another home service company. Even though the pricing may be attractive on it, you'd almost have to look at it as a closed block of business, because particularly with changes in DAC accounting, it's going to be very difficult to show a GAAP profit in a home service business. I don't see anything on the short-term horizon there.
Okay. Well, Mark, just sort of following up then. You mentioned that obviously the change in the DAC accounting. With what you've been able to do now at Liberty, at the very least, have you made then Torchmark's earnings less sensitive to the pace of improvement at Liberty under the new rules because you've moved to this variable comp system?
Absolutely, Colleen. There's no doubt. The change in the DAC accounting, even though these were plans that we have been moving towards for a number of years, the change in the DAC accounting has definitely sped up our plan to eliminate those fixed expenses and move them to more of a variable expense. When people wonder why we're not more impacted by the change in DAC accounting, the change at Liberty National is a big piece of that. We have moved the bulk, not only the office expenses, but the lead expenses we were picking up. We have eliminated those and moved them to the branch manager.
Okay. All right. Thank you.
You're welcome.
The next question comes from the side of Randy Binner with FBR Capital Markets. Please go ahead. Your line is open.
Thank you.
Hey, thanks. Just want to go back to the interest rate disclosures that Gary gave at the top of the call. Could you just cover again what the rate increase is going to be in your life book? Well, first of all, then I have a follow-up.
Well, what I mentioned was is that for the American Income Life policies and our juvenile policies, we're going to raise the premiums on newly issued policies by 5%. Randy, a year ago we were talking, we talked about the impact of lower interest rate crediting on the profitability of our life businesses. We said a 100-basis point reduction in our interest rate crediting had about a one to 3%, it would take a one to 3% increase in our rates to offset that. We did lower this year, in 2011, our interest rate crediting on new business from, I think, six and three quarters down to five and three quarters, we did not adjust our rates.
Well, if the interest rates continue to decline the way most people think they will, we're just trying to get ahead of the game and assuming that we may have to lower our interest rate crediting again next year. We are going ahead, on January 1, we will have rate increases in effect, roughly 5% of both American Income Life and some of the products in direct response.
Okay. The elasticity of pricing, though, you have a fair amount of ability to change price on these target markets, right?
Yes.
AIA is a very strong controlled distribution. That's a sold product. Do you have much competition you think about in how they're changing pricing, or do you just think about what's best for Torchmark?
We think mostly about what's more so in the direct response. We do rate testing and determine optimum pricing levels. For the most part, we price our products to achieve desired profitability. American Income is not in a highly competitive marketplace. We have looked in the past, and it's only been a handful of policies a month that are replaced by another company. It's really not an issue at American Income. I feel confident that it won't have any negative impact. We raised rates slightly back, gee, I guess it was 1999, and it had no impact on sales there. In fact, actually the next three years, sales doubled.
That's helpful. The takeaway here is that it's the liability offset to the lower yields that we all model, and so that keeps the margin. Just real quick, if I could, because this didn't get followed up on, but Gary, on your interest rate scenario.
I guess I just wanted to confirm that the takeaway there was a spread on underwriting. Is there a way to communicate your scenario just on kind of how many basis points the overall yield on the portfolio would lose in that scenario?
Well, that's what I think I mentioned that.
Maybe we're talking about the same thing and I misunderstood it.
Yeah. What I was saying, currently, our portfolio is at 653, and what I was saying is if we invest at 4.75%, all the cash flow each year for the next five years.
Five years. Yeah.
That 653 declines to, depending on different scenarios, but decline to 595 basis points to 610 basis points.
At the end of the five-year period.
At the end of the five-year period, that's what the portfolio yield would be.
Okay. In that scenario, your overall portfolio would lose 35 basis points?
Yeah, 35 to 50, somewhere in that range. Yeah.
Right.
Point to point over the five years.
Well, it goes-
Each year. No, at the end of five years.
Yeah, at the end of five years. Let's just say in between, it's going from 6.53% to 6%. At the end of the fifth year, the portfolio yield would be 6%.
Okay.
We would lose 50 basis points, but we'd lose that over a five-year period.
10 a year.
Yeah.
That would be a step function down. That'd be a linear kind of, you'd lose 10 each year as you're modeling it out.
It wouldn't be 10 exactly, but it'd be something.
Yeah.
Around there.
No, that's helpful. Thanks for the clarification.
Sure.
Yeah.
The next question comes from Mark Hughes with SunTrust. Please go ahead. Your line is open.
Thank you very much. This is actually Jack Sherck for Mark. I may have missed that because I had to hop off for a second, but what I was wondering about was the increase in the response rate was 43% on the inserts this quarter versus 16% last quarter. I know you revamped your strategy there in the actual insert itself. When did that go into place? Do you attribute that to anything else or just the better marketing or better advertising piece?
Well, we really rolled out with that in the second quarter, even though we saw improvement in our initial response rates in the insert media, which is why we increased our circulation in the third and fourth quarters as a result of the improvements we saw in the second quarter. I do attribute it to, it's a rather large change in the packaging in those inserts, and that's what has caused that increase.
So-
It's about a 17% improvement in the response rate.
Right. In your view, it's more the marketing piece itself rather than a change in the environment.
Yes.
Okay, great. Thank you.
The next question comes from Bob Glasspiegel with Langen McAlenney. Please go ahead. Your line is open.
First of all, good luck tonight and hope you guys pop some champagne.
We're planning on it.
Are you heading there to St. Louis or are you going to just watch it live?
Well, I might go up for game seven if it goes seven.
Yep. Good luck. On that score, I'm with you. Tax rate, came down a little bit. Is the full nine-month rate a good sort of run rate? You had talked before about some tax things that you were doing, so I was wondering if you could expand on that.
Bob, the main reason the tax rate came down is we got increased tax benefits from our investment in low-income housing tax credits. That brought the rate down to just about 32%, where it had been 33.7%. What we expect to happen is we'll end the year at 32.7%, and that should be about the rate we have in 2012. It's all due to getting increased tax benefits that we weren't expecting.
Right
off those investments.
That's a little bit of help in Mr. Shuman's answer for, Jeff's answer.
Right
For question for next year is the tax rate is a left-fielder positive going into next year.
Right. It's going to be about, well, 33.7 to 32.7, so we're picking up a % there.
I apologize, you were fading out on just the cash flow dynamics of the fourth quarter. Just remind me, your cash is 168, at the end of the third quarter?
I think it was 166.
Yeah, 166.
What dividends are you getting?
The addition to the cash flow for the quarter will be $6 million. That would give us $172 million available, but we've already spent $14 million.
Right. You got that. You said you could take that to 50?
Yeah.
That's your cushion?
Right.
Okay. Okay, that's it. Thank you.
Okay, Bob.
Our next question comes from John Nadel with Sterne Agee. Please go ahead. Your line is open.
Are you there, John?
Your line is open.
Okay.
Oh, Byron. B-Y-R-O-N.
Please go ahead, John.
Then T-O-N.
I think we lost him.
As a reminder, if you would like to ask a question, it is star one. It looks like we have a follow-up from Steven Schwartz with Raymond James. Please go ahead. Your line is open.
Nope, I asked and answered. I didn't know how to turn it off.
Okay.
It goes.
At this time, we have no further questions.
Okay. Well, I want to thank everyone for joining us today, and we will talk to you again next quarter. Have a great day.
This does conclude your teleconference. Thank you for your participation. You may now.