Good day, everyone. Welcome to today's Torchmark Corporation second quarter 2011 earnings release call. Today's call is being recorded. 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.
Thank you. Good morning, everyone. 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 second quarter was $129 million, or $1.14 per share, a per share increase of 8% from a year ago. Net operating income per share from continuing operations increased 14%. Net income was $149 million, or $1.32 per share, up 29% from a year ago. Excluding FAS 115, our return on equity was 13.5%, and our book value per share was $33.61, an 8% increase from a year ago.
On a GAAP reported basis, with fixed maturities carried at market value, book value grew 10% to $35.40 per share. In our life insurance operations, premium revenue, excluding United Investors, grew 4% to $434 million, and life underwriting margins increased 10% to $125 million. Life net sales declined 4% in the quarter to $85.5 million, while life insurance first-year collected premiums were down 2% to $62 million. At American Income, life premiums were up 8% to $151 million, and life underwriting margin was up 11% to $51 million. Net life sales declined 2% for the quarter to $36 million. The producing agent count at the end of the quarter was 4,332, up 3% from a year ago and up 7% from last quarter. I am pleased with the continued progress being made at American Income. The agent count is now at an all-time high and growing at a strong pace.
The number of new agents who achieved our top bonus level for the first time increased 27% during the quarter. Our mid-level sales management ranks also increased 11% during the second quarter. In our direct response operation at Globe Life, life premiums were up 5% to $151 million, and life underwriting margin was up 1% to $38 million. Net life sales were down 2% to $37 million. While second quarter sales were somewhat less than expected, I remain optimistic that we will see significant growth during the second half of 2011. While the previously discussed change in our direct response underwriting, which utilizes prescription drug data, has improved our margins, it had a negative impact on our second-quarter sales as we rejected additional uninsurable applicants.
We have made a significant improvement in the design of our insert media packaging, which resulted in a 16% improvement in our initial response rates during the second quarter. As a result of the improvements made in our packaging and the additional margins from the change in underwriting, we have increased our third quarter insert media distribution in excess of 20%. While there is a 60-90 day lag before this increase is reflected in our net sales, I am confident that we will see significant growth in our direct response life sales during the second half of this year. Life premiums at Liberty National declined 2% to $73 million, and life underwriting margin was up 29% to $18 million. Net life sales declined 18% to $10 million.
The producing agent count at Liberty National at the end of the second quarter was 1,792, a decline of 3% during the quarter and down 20% from a year ago. On a bright note, health sales at Liberty National increased 10% from a year ago and 40% from the first quarter level as a result of the introduction of a new cancer policy. We've made good progress during the quarter in our efforts to conserve our in-force life insurance. During the second quarter, our new incentives conserved $2.2 million of life premium. We currently project that number to grow to $15 million-$16 million during the second half of this year and $40 million-$45 million in 2012. On the health side, premium revenue, excluding Part D, declined 7% to $185 million, while health underwriting margin was down 11% to $34 million.
Health net sales were $13 million for the quarter, 15% less than a year ago. Premium revenue for Medicare Part D was $49 million for the quarter, which was down 8%, and the underwriting margin was $5.4 million, which was up 6%. Administrative expenses were $40 million, which were up 2% from year ago quarter and in line with our expectations. 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, excess investment income, capital, and share repurchases. First, the investment portfolio. On our website are three schedules that provide summary information regarding our portfolio as of June 30, 2011. As indicated on these schedules, invested assets are $11.2 billion, including $10.7 billion of fixed maturities at amortized cost. Out of the fixed maturities, $10 billion are investment-grade with an average rating of A-minus. Below investment-grade bonds are $721 million, down from $863 million at December 2010. The $142 million decline this year is due primarily to dispositions, $119 million of sales, $12 million of calls, and $10 million in maturities. The percentage of below investment-grade bonds to fixed maturities is 6.7%, the lowest it has been since the fourth quarter of 2008. That percentage may still be a little higher relative to our peers.
However, 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 is rated A-minus, compared to triple B plus a year ago. During the quarter, we recognized realized gains of $31 million pre-tax and $21 million after tax. These gains resulted primarily for dispositions below investment-grade bonds that had been impaired in previous years. We have net unrealized gains in the fixed maturity portfolio of $306 million, compared to gains of $156 million at the end of the first quarter and $178 million a year ago. The increase in unrealized gains in the second quarter is due primarily to Treasury yields declining more than credit spreads increased. Regarding the investment yield, in the second quarter, we invested $432 million in investment-grade fixed maturities, primarily in the industrial sectors.
We invested at an average annual effective yield of 5.75%, an average rating of A-minus, and an average life of 28 years. For the six months, we've invested $697 million at an average yield of 5.84%. For the entire portfolio, the second quarter yield was 6.56%, compared to 6.62% yield in the previous quarter and a 6.74% in the second quarter of 2010. The decline in yield is due to the lower new money yields. As of June 30, the yield on the portfolio is 6.55%. Now turning to excess investment income. Excess investment income is net investment income less the interest cost of the net policy liabilities and the financing cost of our debt. In the second quarter, it was $74 million, down $492,000 from a year ago.
On a per-share base, reflecting the impact of our share repurchase program, excess investment income was $0.65 per share, up 8% over the second quarter of 2010. Out of the components, net investment income was up $6 million, or 4%, slightly lower than the 5% increase in the average invested assets. Despite the lower yields in the bond portfolio, investment income increased at around the same rate as the related assets because we held significantly more cash in short-term securities during the second quarter of 2010 than we have in 2011. The interest cost on net policy liabilities increased $6 million, or 8%, in line with a 7% increase in the average liabilities. Now turning to capital. Regarding RBC, 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 the level of our ratings. Finally, regarding share repurchases and parent company assets. In the first six months, we spent $602 million to buy 14 million Torchmark shares. So far in July, we've used $15 million to buy another 350,000 shares. For the full year through today, we have used $617 million of parent company cash to acquire 14.3 million shares, or 12% of the diluted outstanding shares at the beginning of the year. The available liquid assets at the parent company consists of our assets on hand and the expected free cash flow from operations.
Free cash flow results from the dividends received up to the parent from the subsidiaries, less the dividends paid to the Torchmark shareholders and the interest paid on debt. The parent began the year with liquid assets of $205 million. We expect to generate approximately $665 million of free cash flow for the entire year. The total free cash available for all of 2011 will be around $870 million. In the first six months, we generated about $485 million of free cash flow, that included $305 million resulting from the sale of United Investors. As mentioned, the parent used $602 million in the first six months for Torchmark share repurchases.
As a result, the parent ended the quarter with $87 million of available liquid assets, and that's comprised of the $205 million of beginning assets, plus the $485 million of free cash flow, less the $602 million of share repurchases. Going forward, along with the $87 million of cash on hand at the end of the second quarter, we should generate approximately $180 million of free cash flow in the next two quarters. As of today, after deducting the $15 million of July share repurchases, the parent will have approximately $252 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. Those are my comments. I will now turn the call back to Mark.
Thank you, Gary. We are narrowing the range of our earnings guidance for 2011 and raising the low end of that range. We currently expect our net operating income per share will range from $4.60 to $4.73. Those are my comments for this morning. I 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. Once again, that's star one for a question today. For those participating via the web, the question and answer session is available to the phone audience only. If you are using a speakerphone today, we would like to encourage you to utilize your mute function so we can receive your signal. We will take our first question at this time. Jimmy Bhullar, JPMorgan.
Hi, thank you. I had a question on just the pace of buybacks. You mentioned you bought back $617 million worth of stock so far this year. Should we assume that the $252 million that's available for buybacks through year-end, most of that will be used up for buybacks or are you going to keep some of the $87 million in cushion? Are you going to keep some of that? The second question I had was just on Liberty National. The agent count declined again in the second quarter. Sales were weak. I think they were down around 18%. What your outlook is for growth in the agent count and sales in the second half of the year at Liberty National? Thanks.
Okay. Well, first off, Jimmy, on share repurchase, as Gary said, I think we have $252 million available at the parent for the balance of the year. It's something that we have. Again, we have a board meeting next week that we'll continue to evaluate. We took the free cash down to $87 million at the end of last quarter. I think it's fair to assume that we'll probably keep it somewhere around that level for the balance of the year. Again, it's something we'll continue to evaluate each quarter. As far as Liberty National, the agent count decline slowed, but it was still down, I think 3% during the quarter. I'm not expecting any big turnaround. I think we're about at the bottom of that, but I'm not expecting for the balance of this year any big turnaround.
We are seeing some growth on the health side as a result of the new product we introduced. I would expect our life sales at Liberty National for the balance of the year to stay at about the same level they're at.
Okay, thanks.
Our next question will come from Jeffrey Schuman, KBW.
Thank you. You talked about the trajectory for the conserved premiums, $15 million-$16 million in the back half, $40 million-$45 million next year. I'm sure you said this, but I didn't quite follow. Was that company-wide or was that mostly specific to American Income, or what are we talking about there?
Well, that's company-wide. We'll have the most impact at American Income. Again, I think we have a new exhibit out on the website now showing lapses by distribution. We think we can conserve 20% of the lapses in 2012 at American Income, ranging down to, I think, roughly 13% at Liberty National and roughly 15% in the direct response. The bigger portion. In the second quarter, we first started with American Income because that is obviously our most profitable business. Those numbers that I gave are across the board, and we will have an impact in all three of the major distribution systems, but it'll be a little higher at American Income.
Okay, thanks for that. Then on the prescription drug underwriting impact, can you remind us what the trajectory is there? Is that something where the better mortality will bleed in over many years? Or it's something that maybe a year from now would actually be really visible to us? Or what should we expect there?
It will bleed in basically over a number of years. It will have more impact in that it will allow us to grow our sales. On the insert media side, which is about 60% of our sales, it improves our margin by, I believe it is 16%-18%. That is a significant block of business, but that is just on new business going forward. While it will have some impact and it will be a growing impact on our financials, it gives us more margin to work with as far as increasing our sales. As I mentioned earlier, partially the result of that, we are increasing our volume, our distribution volume by, I think, 22% in the third quarter, and right now we anticipate increasing our volume by 24% in the fourth quarter. You will see more of the impact on the sales side.
Okay. Thanks a lot, Mark.
Next we will hear from Randy Binner, FBR Capital Markets.
Hey, thanks. I had a question about there is some callable prefers out there, I believe, that have a pretty high coupon. I think it is 710 basis points. I think that there is $120 million worth in there callable. They were callable in June, I did not see anything in the results that indicated that those have been called. To me, it seemed like kind of a no-brainer to try and do it, just because you have such much cheaper sources of funding. I did not know if that was still on the table, if there was color around that, if the big buyback in the quarter maybe had anything to do with that. Love to hear color on that potential opportunity.
Okay. Randy, that's something we did take a look at. They became callable as of June 1st, and they're callable in whole or part at par. They'll continue to be callable. It wasn't a one-time thing. We did take a look at that. In terms of how to redeem it, if we're going to use cash, we felt that using the cash for share repurchases provided a greater return. We also looked at, though, if we refinanced it, if we issued a similar security, a similar trust preferred, the coupon would actually be a little bit higher than the 710 that we have today. Remember, this is very long term. This is another 35 years to run on this security. At 710 for long-term security, it's not that bad of a rate.
The other thing we looked at, though, is if we refinance through issuing debt. We looked at, for example, 5-10-year debt. We can do that at a lower rate, we would pick up $0.01-$0.03 maybe of earnings for share. The concern there is the refinancing risk. If we, 5-10 years from now, what interest rates would be, they may be much higher. Our current thinking is we'll kind of stay where we are and not redeem them, that's something we'll continue to look at as conditions change.
I guess, the buyback clearly has to slow from the pace of the first half. If there's less cash available for buyback, does it refi? Meaning, the earnings yield on your buyback is better than 710 basis points right now according to most analysts' forward numbers. I get that. If you had less cash available for buyback, would that affect the decision, or is it a longer-term decision than that?
Well, I think it's a little bit longer-term decision than that.
Yeah.
The fact of the matter, though, you know how consistent our cash flow is, the free cash flow. We'll continue to generate free cash in it. What we might do is we might start redeeming it or calling them in parts as opposed to calling the whole $120 million at one time.
All right. Very good. Thank you.
Chris Giovanni with Goldman Sachs is next.
Thanks so much. I just wanted to see if you guys can update us on sort of the liquidity buffer that you guys had been keeping at the parent company. I believe it was roughly $200 million or so. You're sort of certainly below that today. As we get kind of through here and maybe some of the economic uncertainty increases, how are you thinking about moving forward with that cushion?
Well, Chris, that's why we're not giving a lot of guidance there, because as Gary mentioned, we have $252 million available at the parent for the balance of this year. Obviously, the pace of our share repurchase so far in July, we have slowed down. It's something we'll continue to evaluate. Sure, there's some definite uncertainties out there today. Even in our guidance, I think we put in a range of $78 million, Gary, to $228 million as far as the range of share repurchase in our guidance.
Right.
Didn't make a lot of difference. It only made $0.02 difference in our earnings for the balance of the year. That's something I'm not really prepared to say how much we will spend the balance of the year. We'll continue to evaluate it as we go.
Okay. Within the agent count trends, obviously American Income, you guys are having some success there. Can you comment a little bit on sort of some of the drivers there, and are there any takeaways that you can try and pull out to try and improve sort of the downward trend we've been seeing at Liberty National?
Well, first I'll talk about American Income. I'm very pleased with where we're at. I know sales were still down 2%, but if you look at the numbers, we were down 4% going into the quarter in our agent count, and we're up 3% at the end of the quarter. We grew by almost 300 agents during the quarter. If we can continue close to that pace, if we can continue and grow 250 agents a quarter the next two, by year-end, our agent count will be up 25% from a year ago, and sales will follow that trend. There's not a lot new going on there. It's more just a refocus. As I mentioned, we've grown our middle management ranks in a very concerted effort to
Promote more people into middle management. We grew that by 11% during the quarter. The other problem we had last year, even though recruiting was up, because we did not have more middle managers and because we lost focus on the training of those new agents, our turnover went up. That's why that number, as far as new bonus earners getting the top-level bonus, those are the people we retain. For that number to be up 27% from a year ago, it is being reflected in higher agent retention. All of the things that we've talked about the last really six, nine months are panning out. We are refocused. We're hiring more agents, but we're also retaining more agents. I feel very good about where American Income is, and their sales will come back very strongly second half.
Okay, thanks. Then just one last one. Any updates on EITF 09-G in terms of impact or implementation for you guys?
No, no update on that. The current status of that is that, first of all, we will elect adopt retroactively, which I think most companies will. We're in the process of doing our calculations of what the initial write-down will be, the DAC asset. There's still a lot of implementation issues that haven't been fully resolved. I know the Big Four firms are still consulting with the SEC on how to interpret certain provisions. Of course, as we work through that affects what we're doing. I think all that should be cleared up in the third quarter, and by the time we get to the analyst call for the third quarter, we'll have pretty definitive numbers at that point.
Okay. Thanks for the time.
Next we'll hear from Colin Devine with Citi.
Good morning or afternoon, I guess now. A couple of questions. I guess with the buybacks and the amount you've done, I appreciate you still have a fair amount of debt capacity, but does that mean that M&A is really not something that's likely to pan out this year? I suppose that also then brings up your current thinking on what to do with First Command. Then Mark, with respect to Liberty, sounds like you're getting fairly frustrated with it. What is not working there that clearly worked so well for you at American Income?
Okay, first on the M&A activity. Colin, we have looked extensively and really don't see anything out there. When we made the decision to obviously buy back that much in the quarter, it was because we didn't see any M&A activity on the short-term horizon. Your conclusion there is accurate. Liberty National, as I've mentioned before, there's so many differences between Liberty and American Income. Again, I've equated it in the past to a franchise versus a company-owned store. At American Income, it's a straight commission situation, whereas at Liberty National, the agents and managers are employees. Those are our offices. We have a lot of fixed expenses. The production per agent is substantially less. It was about half of what it is at American Income.
We've been, really over the last two or three years, trying to move Liberty more to an American Income model, and we will continue to do so, but there's just not a quick fix there. The things that work at American Income, we have tried to implement similar type programs at Liberty National, but up to this point, they have not been successful.
Let's hit First Command, if you've got any comment on that. Also Liberty, with the new sort of DAC treatment, does that sort of put that business model even under more pressure than it's at right now.
Well, that's correct. First off, as far as First Command, it's an independent agency. Their sales have been down now for a number of years. It's a very persistent business, a very consistently profitable business, there's no plans to do anything at this point. It is an independent agency that we really don't control. It's another one of those things. We don't believe we get fair value out of it. We don't control the distribution, but it's become a relatively small piece of our total. Really no plans to do anything there.
Okay. With the DAC change, does that really put even more pressure on you right now with Liberty?
It does. Again, that's something that we have been addressing and will continue to address. The number of offices that we have at Liberty, I think we're somewhere in the mid-90s now, where I believe a year ago, we were at 150. We have been very much addressing some of that, where we have been reducing our expenses there, and we're continuing to look for ways to lessen the impact of the DAC change.
Okay. Thank you.
Next we'll hear from John Nadel with Sterne Agee.
Hi, good afternoon, everybody. A couple questions for you. One is just to go back to the guidance and the buybacks, and I just want to understand. Your revised guidance, it appears, I think as you mentioned, Mark, in response to somebody's question, it seems your revised guidance includes a higher level of buybacks than you were originally assuming six or nine months ago when you originally gave us that guidance. Is that the case?
Well, there's no doubt at the beginning of the year, even though we knew what the available cash would be, the reason we had such a wide range was not just how much we would spend on share repurchase, but at what price.
Yeah.
Obviously, earlier in the year, the pre-split, the stock was up around $68. When we ran our projections out, we ran not only different amounts being spent but different prices. We did spend towards the high end of our guidance as far as the amount of money we spent, but we also got it at a lower price than what our guidance was. Now that the bulk of that share repurchase has been completed, and we know the price and the amount, it definitely took the bottom end of that range out of the picture.
Understood. I guess I was wondering if the upper end of the range would have otherwise been higher, if not for something else going on in the business relative to your original guidance. I'm not sure.
No, I think everything else is going pretty much according to plan. As far as even last quarter, even though we were under the Street estimate, we were right where our projections were, and the same this quarter, where other than the share repurchase, our earnings are about where we thought they would be at the beginning of the year.
Okay, separately, just a question on the life underwriting margin. My model definitely doesn't go back nearly as far as your business does, but as far as I can see, your underwriting margin on the life insurance business this quarter was as high as I've ever seen it. Is that sustainable? Is there something that went just really well this quarter that we ought to think about that more like we've seen it over the past few years?
Well, it was better this quarter, but particularly at Liberty, it was, I think, up 29%, but that was more a result of a year ago was a particularly bad quarter.
I guess I'm just looking at underwriting income divided by premiums.
It was a little above average. Gary, you have any comments on that?
Well, for example, 29% is, I think it's just about a point higher than where we were last quarter, and a big part of that was Liberty. We've had two, especially this quarter, was unusually low in terms of life claims. Whereas if you look at last year's comparison, the second quarter last year was a particularly high claim quarter. We're seeing some fluctuation in those life claims. We anticipate that'll get back to more of a norm. So I would think that we're not looking for that level to continue at Liberty. As a result, if it goes back to more the norm, then we'll get back to around the 28% level that we reported last couple of quarters.
Yeah.
Okay.
28% year-to-date, I think that's sustainable. We were 1 point over that in the second quarter.
Right.
Okay. I was just going to ask you if more of the year-to-date was a better indication. Okay. Thanks, guys.
As a reminder, if you would like to ask a question today, star 1 on your telephone keypad. Next we'll hear from Mark Hughes with SunTrust.
Yeah, thank you. The use of the prescription drug data for underwriting, how much did that dampen sales in the quarter, can you say?
Well, again, it had more of an impact on the insert media side, which is 60% of our sales. We're declining about an additional 5%. I'll give you a little more flavor on what's going on in direct response. Again, the insert media side, which is 60% of our direct response sales, we increased as a result of the potential gain in the underwriting margin. In the first quarter, we increased our circulation by 12%, but we saw a 13% decline in our response rates, so it kind of washed. We actually did not see an increase in the volume of new inquiries coming in, people saying that they are interested in buying life insurance. However, as I mentioned, through some testing that we did, we found a package that performed much better.
In the second quarter, our circulation there, we increased it 9%, but we had a 17% improvement in our response rates as a result of the packaging. We actually saw a 27% increase in the number of people responding in that marketplace. Going forward, again, we're now back to where we're increasing the outbound circulation there 22% and 24% in the next two quarters. We feel very good about where we're at going forward. The first quarter our response rates were disappointing there. That has definitely turned around in the second quarter, and we expect to see good growth the balance of this year and next year. The problem is that there's a lag between the initial response and the time we report sales.
Right. Now, the good package or better package you sent out in the second quarter, is that going to be more broadly distributed in Q3, or are these new packages that you're going to be distributing in the back half?
Well, no. It's something we had tested previously that we rolled out with in the second quarter. Again, that's why we went from a 13% decline in our response rates to a 16%, 17% improvement in the second quarter, as a result of rolling out with that new package. We continue to expect to see that improvement in response rates the second half of the year. Again, you need to understand, those are people that send in a card saying, "Yes, I'm interested in buying life insurance." We then, over the next six months, are sending them numerous product packages, and they in turn send an application back in. Even after the application is received, because there's a $1 introductory offer, we don't treat it as a sale until they pay the first full initial premium.
That's why I say there's a 60- to 90-day lag from the time we get that initial inquiry in before we start reporting the sales. That's why, again, the second quarter sales numbers did not grow, even though the number of new inquiries coming in grew at a very nice clip. That will be reflected in the higher sales for several quarters down the road.
You have good visibility for Q3 and Q4?
Yes.
When you look at this kind of economic environment where there's, I don't know if you can characterize it, but does it make much of a difference on your business when you've got an economic slowdown, let's say, more uncertainty in the economy? Should that have much impact?
Well, it hasn't. In direct response, it has. Again, that's our constant challenge. As I mentioned again in the first quarter, our response rates were down 13% from a year ago, basically using the same package that we were using a year ago. Barring us continuing to find ways to be better, our sales would be down fairly significantly in direct response. Again, we continue to look for ways to be better. As a result, even in the difficult economy, we fully expect to grow.
Great. Thank you.
Currently, we have no questions in the queue, I would like to take the opportunity to remind our audience, star one for a question. We'll pause just one moment. We have no questions in the queue at this time. I will turn the conference over to our host for any closing or additional remarks.
All right. Well, I want to thank everyone for joining us, I guess this afternoon now, We'll talk to you again next quarter. Have a great day.
That does conclude today's conference call. Thank you for your participation.