Greetings. Welcome to the Horace Mann investor call. At this time, all participants are in a listen-only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. Please note this conference is being recorded. I will now turn the conference over to your host, Heather Wietzel, VP Investor Relations. Ms. Wetzel, you may begin.
Thank you, Jeremy, and good afternoon, everyone. Welcome to Horace Mann's discussion of our annuity reinsurance transaction and NTA acquisition financing. Earlier this afternoon, we issued a news release, which is available on the investor page of our website. We're in the process of posting an investor presentation that will be available shortly in the same location. Our speakers on today's call are Marita Zuraitis, President and Chief Executive Officer, and Bret Conklin, Executive Vice President and Chief Financial Officer. Matthew Sharpe, Executive Vice President, Strategy and Business Development, and Ryan Greenier, Vice President of Corporate Finance, are also available for the question and answer session that follows our prepared comments. Before turning it over to Marita, I want to note that our presentation today includes forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995.
The Company cautions investors that any forward-looking statements include risks and uncertainties and are not guarantees of future performance. These forward-looking statements are based on management's current expectations, and we assume no obligation to update them. Actual results may differ materially due to a variety of factors, which are described in our news release and SEC filings. In our prepared remarks, we do reference some non-GAAP measures. Definitions of these measures are available in the investor presentation. I'll now turn the call over to Marita.
Thanks, Heather. Good afternoon, everyone, and thank you for making time for our call today. Earlier this afternoon, we announced that Horace Mann reinsured a $2.9 billion block of Horace Mann legacy annuity business effective April 1st, 2019, with Reinsurance Group of America. Horace Mann will continue to service and administer the policies in the legacy annuity block, which were sold in 2002 or earlier and have a minimum crediting rate of 4.5%. This is a very exciting step for Horace Mann, creating significant book value growth, as well as accelerating our pace towards a double-digit ROE with an improved mix of revenues and earnings. We benefit from the opportunity to enhance shareholder value by redeploying current capital into higher return, higher growth, less capital-intensive businesses.
At the same time, we will be positioned to better meet the financial needs of the education market, a critical requirement for a mission-centric organization such as ours. We believe that our policyholders will continue to be well-served as both Horace Mann and RGA bring deep insurance experience and a history of fulfilling policyholder obligations. The transaction significantly reduces our interest spread exposure and mitigates our risk related to this older block of annuities. It releases approximately $200 million of capital, $185 million of which we intend to use as part of our purchase of National Teachers Associates. NTA's supplemental insurance business generates higher returns and is less capital-intensive than the annuity block we are reinsuring. The remainder of the stated purchase price for NTA will be funded with our revolving credit line and NTA excess capital.
After the transactions, our debt to capital and subsidiary RBC ratios will be at levels that support our current ratings. As an update on NTA, we remain on track to close this acquisition in early July. We have received approval from the Texas Department of Insurance and are awaiting approval from the New York Department of Financial Services. With growing confidence in the exact timing, we are committing to certain elements of our 2019 guidance to reflect the transactions, as well as providing a high-level look at their impact on 2020. We now expect core EPS to increase at least 10%. We will provide a full update to 2019 guidance on our second quarter earnings call. Before I turn the call over to Bret to provide more detail, I want to revisit why bringing Horace Mann and NTA together creates benefits for all of our stakeholder groups.
First, it advances each aspect of our long-term PDI growth strategy, providing products designed to meet educators' needs and protect their unique risk, growing our knowledgeable, trusted distribution tailored to educator preferences, and leveraging modern, scalable infrastructure that is easy to do business with. By joining forces with NTA, we gain additional products that educators want. More than 200 additional points of distribution with strong work site marketing expertise and a talented management team just as dedicated to the education market as we are. Supplemental insurance products fill a clear need. A recent Federal Reserve research study highlighted that nearly 40% of Americans would struggle to pay an unexpected expense of just $400, and 25% skipped necessary medical care last year because of cost.
Educators have told us that they want flexible supplemental insurance products with a clear defined dollar benefit to protect their savings, echoing the results of that study. By adding another solution to address the needs of the education market, we build our value as a trusted advisor, not only to our current customer base, but to the 150,000 new educator households we gain with NTA. We are making important strides with our initiative to improve ROE, including significant progress in improving the underlying loss ratio in our auto business. The addition of NTA will add to that progress, including long-term upside from cross-sell opportunities. To close, we believe today's announcements show our commitment to strategically positioning Horace Mann for long-term success. We are diversifying our business mix, significantly improving our risk profile, and efficiently deploying capital to provide more solutions for educators.
The addition of NTA only strengthens our value proposition for the education market to understand and solve the issues facing educators and others who serve the community, helping them achieve long-term financial success. Thanks. With that, I'll now turn the call over to Bret.
Thanks, Marita, and welcome everyone. Marita covered the high-level overview of the transactions we announced today, which generated substantial book value growth and clearly sets the stage for profitable growth and increased shareholder value creation. I'm now going to go through the different pieces in more detail and end with a look at our updated guidance. Let me start with the reinsurance transaction. We've been considering ways to address the spread risk of our legacy annuity business for some time, taking into consideration how capital-intensive this business is. There was no question that a reinsurance transaction offered a compelling solution. Our disciplined bidding process generated significant interest, giving us options in terms of value and the type of counterparty risk we could select. RGA is both an experienced and highly rated domestic life reinsurer, and this agreement further strengthens our relationship with a solid partner.
The reinsurance is effective April 1st for a block of approximately 54,000 individual annuities with a minimum crediting rate of 4.5%. After the transaction, we will have approximately $2.1 billion in fixed annuity assets under management, of which more than half of those have minimum crediting rates under 2%. As a result, our fixed annuity crediting rate drops to 2.5%, down from 3.6% before the transaction. The transaction was structured as co-insurance for the fixed annuities, which represents about 75% of the total, and modified co-insurance for the variable annuities in separate accounts that make up the remainder. The total capital release was approximately $200 million. In conjunction with the transaction, in the second quarter, we will recognize an after-tax investment gain of $107 million on the $2.3 billion of investments that we're transferring to a dedicated trust in the transaction.
That adds about 8% to book value, excluding unrealized investment gains. The remaining investment portfolio supporting the retirement segment maintains our current investment strategy and is appropriately duration-matched against liabilities. The book yield remains very similar to the prior portfolio, and this should result in a net investment spread of about 215 basis points going forward. This is a very strong result given the current interest rate environment, which continues to pressure investment income across all business segments. The overall credit rating of our investment portfolio remains very high, with an average rating of A-plus. It continues to have a sizable allocation of highly liquid securities that will be available to opportunistically redeploy to investment-grade corporates, high yield, and structured securities in the event of a spread widening event, and this will improve investment returns in the future.
Despite the anticipated improvement in the net interest spread, keep in mind that assets under management are already lower as we ceded the reinsured business effective April 1st. 2019 after-tax core earnings for our retirement segment will be below prior guidance. As a result of that decline, we are also evaluating the $28 million of goodwill associated with the retirement segment and its potential impairment in the second quarter. This, however, would not impact core earnings. Turning to the line of credit, the new $225 million credit facility is $75 million larger than the previous line. The terms are substantially unchanged from the prior line, although we've added one new bank and extended the term by one year to 2024. We retained very attractive pricing at LIBOR plus 115, consistent with the pricing on the line we replaced.
After looking at various other options, including senior debt, this was clearly the most cost-effective and efficient way to complete the financing of NTA. We expect to draw on the credit line in July and leave approximately $135 million outstanding on the line for the next several years, which would maintain our debt-to-cap ratio below 25% and consistent with our current ratings. As we discussed when we announced the transaction, NTA has about $85 million of capital above what is required for our target RBC. We plan to utilize that capital to round out the funding of the stated purchase price of $405 million. All our insurance subsidiaries, including NTA, will have RBC ratios of 425 or higher after the transaction's close. That's the level we expect to maintain going forward.
Now let's turn to our 2019 guidance, which presumes that NTA closes on July 1st, and that full year catastrophe losses come in at 7 to 7.5 points on the combined ratio. As a reminder, the second quarter is historically our most active cat quarter, and this year is no exception. However, cat losses through mid-June are on track with the level we anticipated for this quarter, and we remain confident in our guidance for the full-year cat load. On that basis, our full year 2019 core EPS and ROE guidance is unchanged. The six months of NTA earnings that we will be adding offset the additional interest expense and lower net investment income related to the acquisition, as well as nine months of lower retirement earnings.
Full year 2019 after-tax earnings from the retirement segment should be between $25 million and $27 million, with the net interest spread improving to approximately 215 basis points in the second half of the year. Looking ahead to 2020, when NTA will be part of Horace Mann for the full year, we expect core EPS to be up at least 10% year-over-year, presuming a similar catastrophe loss level. Said another way, before considering any of our other segments and initiatives underway, NTA should add approximately $0.30 to our 2019 core EPS and about $0.65 to 2020 core EPS. At the same time, the reinsurance transaction reduces the contribution to core EPS from a retirement business by about $0.30 this year and next.
This year, however, within the $0.30 will include a one-time $3 million or $0.05 write-off in 2Q of the remaining DAC balance associated with the reinsured block. Finally, the capital we're redeploying to purchase NTA will lower retirement net investment income by $0.07 this year and $0.15 next year. We'll give more color on our 2020 outlook on our normal schedule. Going forward, P&C should represent about 35% of earnings at normalized cats. Mortality and morbidity-based businesses will grow to about 45%, while retirement declines to about 20%. The benefits of our ongoing organic initiatives on our improved business mix should move ROE closer to double digits over the next several years. These initiatives include continued auto profitability improvement, expense discipline, and growth in our fee-based retirement business that we've talked about often.
We expect the benefits of potential cross-sell upside from bringing together the company's products and distribution forces will continue even beyond 2020. We also stand to gain synergies and efficiencies through our combined infrastructure. All in, we're excited about the combined company's ability to generate excess capital. Our intent for that capital remains unchanged, focusing on the most accretive uses. This includes growing our business at returns at or above our ROE targets, returning a significant portion of annual earnings back to shareholders via a compelling dividend or opportunistically buying back shares when market conditions warrant. In summary, Horace Mann is moving ahead with an even stronger, more diverse earnings base with an increased level of capital generation capacity. We're driving shareholder value and improving return on equity.
As Marita noted, we are deploying capital into higher growth, higher return, and less capital-intensive businesses while staying true to our fundamental mission, serving the financial needs of the education market. Thanks. Now I'll turn it back over to Heather for Q&A.
Great, Jeremy. We're ready for you to poll for questions.
At this time, we'll be conducting a question and answer session. If you would like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two if you'd like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. Our first question comes from the line of Meyer Shields from KBW. Please proceed with your question.
Hi, good evening.
Good evening.
My first question is on the reinsurance agreement. Firstly, how long exactly is the reinsurance agreement? For the $200 million releasing capital, how exactly will the reinsurance accounting be reflected in the balance sheet? I think Bret said it was about a $0.30 impact on EPS. Is that both 2019 and 2020?
That's correct. Both years, the impact on EPS will be $0.30. As far as the reinsurance agreement is in place basically from this point forward. Until the duration of the liabilities. I think your other question was just balance sheet related, I believe. Correct?
The accounting.
With respect to the accounting of the transaction, we are basically accounting for that under applicable deposit accounting standards. As it relates to that, we will recognize a deposit asset on our balance sheet, which that asset, if you will be accreted over time to the ultimate anticipated reinsurance recoveries through recognition of imputed interest income. We can maybe take that offline with going through all the details of the specific accounting guidance, but this is not reinsurance accounting. It is deposit accounting.
Okay, got it. Just on the EPS growth, that 10% in 2020, is that just based on the NTA accretion you're expecting?
No, that's several pieces there. I think I mentioned on my remarks, NTA for 2020, we would anticipate about a $0.65 addition with NTA being recognized for a full year in 2020 versus the $0.30 addition in 2019 only assumes a half year. As we just discussed previously, there's a takeaway of roughly $0.30 in both 2019 and 2020 related to the reinsurance transaction. Obviously, with respect to the capital deployment, there'll be lower net investment income to the tune of $0.15 in 2020. The impact of that on 2019 was about $0.07.
Okay, great. Thank you. Just lastly, could you just repeat, I think you said something about a $25 million-$27 million range in income in retirement. Is that on a go-forward basis or just for the sort of-
That would be for this year, Freddy.
Okay.
That compares to our previous guidance was $39 million-$41 million in the original guidance that we issued for 2019.
Okay, got it. Thank you very much for the answers.
Sure.
Our next question comes line of Gary Ransom from Dowling & Partners. Please proceed with your question.
Hi, good evening. On the book value, I see that you'll take a realized gain. If I look at the reported book value, it appears like you will be taking a loss if I'm reading it correctly, that you'll be paying $2.3 billion in assets for the $2.2 billion of transferred liabilities. When we look at reported, are we going to see a loss from this transaction?
Well, Gary, no, there's not a loss on the reinsurance transaction. You actually follow this deposit accounting that I was referring to.
Okay
earlier. We actually do have a realized gain to the tune of $107 million that will be flowing through. That's the pre-tax number.
Is that a realized gain?
I'm sorry. Yes. I'm sorry. That $107 is after tax. I think it was $135 pre-tax. That will flow the realized investment capital gains and losses line.
I just want to be clear, is that a number that was already in AOCI before and now is being realized?
Yes, that was the unrealized gain on the assets that are being transferred into the trust.
Okay. The deposit accounting is basically going to make this almost a neutral other than the realized gain that you're booking there.
Yes.
Is that fair?
I think that's a fair statement.
Just going to the initial impetus for the transaction, it looks like there's two different benefits. You talked about the interest rate risk on the one hand, you also talked about the financing of the NTA transaction. Was one or the other the more important item in doing this transaction?
I actually think all of the items that you mentioned, Gary, are very important. I think certainly the interest rate risk, as I think I mentioned as well as Marita, in the prepared remarks, that's something that we've been looking at for quite some time and how could we come up with ways to mitigate that risk. Obviously, the ROEs for that closed block of business are not what we want, not in the double-digit that we've been striving for. Obviously, taking that capital out of the retirement segment for that closed block of business and redeploying that, if you will, as part of the financing, but into the NTA organization that I think we've communicated that their ROEs are much higher.
The redeployment of that capital at a probably almost a two times what it was in that closed block of business, it takes care of a lot of things.
Gary, this is Marita. As Bret clearly said, we have been looking at these types of transactions for some time on that closed block where the crediting rates were clearly well above that 4.5%. It frees up a fair amount of capital, without a good use for that capital, we would just be creating more redundant capital. When you also have a use for that capital to put towards much higher return business, that's when the timing made a lot of sense to us. It's clearly both.
Right. Okay. All right. Thank you very much.
Thanks, Gary.
We have reached the end of the question and answer session. I will now turn the call over to Marita Zuraitis for closing remarks.
Thank you. Thanks to everybody for joining us today. I hope that you're as excited as we are about the strategy that we've put in place here. It positions Horace Mann very well for the future. Reinsuring our legacy annuity block releases excess capital that we can redirect to this higher return business, as well as significantly reducing interest spread risk. Completing our acquisition of NTA adds in-demand, high-growth business products for our educators and an additional 200 points of distribution with strong work site marketing experience, as well as a talented management team with years of experience serving educators. The end result is a larger, stronger, more diverse company that can better serve the financial needs of the education market. Thank you.
This concludes today's conference, and you may disconnect your lines at this time. Thank you for your participation.