Greetings, welcome to Horace Mann's second quarter earning 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. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Heather Wietzel, Vice President of Investor Relations. Thank you. You may begin.
Thank you, Sherry, good morning, everyone. Welcome to Horace Mann's discussion of our second quarter 2018 results. Yesterday, we issued our earnings release and investor supplement. Copies are available on the investor page of our website, along with our investor presentation, which was posted this morning. Our speakers today are Marita Zuraitis, President and Chief Executive Officer, Bret Conklin, Executive Vice President and Chief Financial Officer. Bill Caldwell, Executive Vice President of Property and Casualty, Bret Benham, Executive Vice President, Life and Retirement, Ryan Greenier, Vice President, Corporate Finance, are also available for the question and answer session that follows our prepared comments. Before turning the call 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, we assume no obligation to update them. Actual results may differ materially due to a variety of factors, which are described in our press release and SEC filings. In our prepared remarks, we also use some non-GAAP measures. Reconciliations of these measures to the most comparable GAAP measures are available in the supplemental sections of our press release. I'll now turn the call over to Marita.
Thanks, Heather. Good morning, everyone, welcome to our call. Yesterday evening, we reported second quarter core earnings per diluted share of $0.13. That's up from $0.02 we reported in the second quarter last year. Six-month core earnings of $0.64, an increase of more than 60%. Core earnings increased for two reasons. First, losses from catastrophe weather events were lower than last year's near record levels. While the relatively lower weather losses this year contributed to higher first half earnings, they did put some pressure on our full year expectations. We are adjusting our full year outlook accordingly with the 2018 core earnings per share estimate of $1.90-$2.10. Bret will review our revised guidance in more detail later in the call. The second and more important contributor to the bottom line improvement is continued progress on our strategic initiatives.
This progress underscores our confidence in our ability to achieve our longer-term performance objectives of driving profitable growth and reaching a double-digit ROE. Due to continued success in P&C profitability initiatives and strong Life and Retirement performance, ROE rose again in the quarter. At 7%, it is nearly a point and a half higher than it was in mid-2017 when we introduced our hourly improvement initiative. Driving our progress over the first half of 2018 were improvements in the underlying auto loss ratio, growth in retirement assets under management, and another quarter of double-digit sales increases in our life segment. First, we achieved a 1.1 point improvement in the auto underlying loss ratio. However, much like the broader industry, we are seeing several headwinds that are impacting the pace of progress. One is the sustained higher level of non-cat weather losses affecting both auto and property.
In addition, we are also seeing a modest uptick in bodily injury severity in the auto line, similar to what other P&C companies have noted. In response to continued weather pressure and higher BI severity trends, we are increasing our 2018 auto rate plan and will now end the year up about 10 points. Given our historical experience, we do not expect any significant impact on retention. Another key contributor to our progress is the consistent growth in retirement assets under management, supported by strong persistency. Although the industry has seen a large amount of disruption over the past year with the regulatory landscape changing yet again this quarter, our sales continue at a very strong pace. We believe this continued momentum is a reflection of our strategy and strong execution in our core segments.
Put simply, our solutions are delivered through a captive distribution force of local agents who have strong relationships in the school districts they serve. Our robust set of products are aligned with the needs of this homogeneous set of customers who are facing uncertainty around retirement saving options. These will continue to be our strategic strengths, even as further regulatory proposals emerge. Finally, we continue to make great strides on our life business, with second quarter sales growing almost 50% over the prior year. Four of the highest months of life sales volume over the past 15 years have occurred in 2018. We are clearly seeing strong momentum in this business line. There is growth across every product type as agents utilize additional training and support to help meet the needs of the underserved educator market.
Strong life sales are one tangible example of our focus on increasing the quality and productivity of our distribution. Looking further ahead, we are accelerating the pace at which we will reach our strategic objectives with additional improvements in products, distribution, and infrastructure. On the product front, we continue to develop enhancements and marketing programs designed to appeal to educators throughout each stage of their lives. We are introducing these concepts at our back-to-school agent sales meetings across the country. We're excited about some of the new product features that we will be introducing to the marketplace this fall that should especially appeal to younger educators. On the distribution front, these summer agent meetings also provide new training on building strong relationships with educators. Many of these sessions are led by our most successful agents, who share best practices for solution-based selling.
The aim is to replicate the practices of our best agents and increase productivity across the board, underscoring our commitment to increasing agent productivity and quality. On the infrastructure front, we continue to invest to improve our ease of doing business. With the first phase of our P&C administration system implementation for claims complete, we have started the second phase. This includes billing and policy administration systems, which will significantly improve customer experience and operational efficiencies. We are actively pursuing these opportunities, and we are making investments that align with our strategy. We remain focused on expense discipline as well. Overall, we continue to make solid progress across our goal of being a company of choice to provide financial solutions to meet our customers' needs, both today and in the future.
It's a message that continues to ring true with our policyholders, our agents, our employees, and the broader educational community. As our educators prepare to start a new school year, we are also getting ready to serve them with broader products, more knowledgeable distribution, and improved ease of doing business. I'm looking forward to more progress in the third quarter and beyond. With that, I'll turn the call over to Bret.
Thanks, Marita, good morning, everyone. Core earnings per share were up for both the quarter and year due to continued improvement in our strategic initiatives and favorable year-over-year comparisons of weather-related losses. However, weather losses this year were still significant and led us to revise our full-year 2018 core earnings guidance to the range of $1.90-$2.10 per share. Even at the low end of this range, our full-year core EPS would be up about 10% over 2017. While the guidance revision is largely due to those weather losses, we've seen some additional timing related puts and takes versus our original expectations. These changes basically net out, but I'll touch upon them as I cover the outlook by business segment. A full summary of these adjustments is available on page 35 of the second quarter investor presentation, which is available on our website.
In P&C, net written premiums increased 3% over last year's second quarter, driven primarily by rate actions. The second quarter reported combined ratio of 114.7 was 3.8 points better than last year, largely because catastrophe losses were 4.2 points lower. Although cat losses were significant, they are in line with our typical seasonal loss experience. We consistently have higher weather-related losses in the first half of the year, especially the second quarter. For each of the previous three years, our second quarter has accounted for more than 45% of our annual catastrophe losses. While we regularly evaluate our exposure risk, for each of these three years, property full-year results were solidly profitable because weather-related losses in the second half of the year were lighter. This is largely due to a significant reduction we have made in coastal property exposure, which has meaningfully reduced our risk for hurricane losses.
Last year, our losses from hurricanes Harvey and Irma were well below market share implied losses and significantly below peers. As a result, we remain comfortable with our original catastrophe loss estimate of 6 to 7 points. However, we now expect to be at the high end of that range due to first half results. On an underlying basis, we are also seeing the impact of elevated levels of weather losses. In auto, our underlying loss ratio decreased by 1.1 points, a solid improvement. Because of weather and elevated bodily injury severity trends that Marita mentioned, we are now targeting 1.5 to 2 points of improvement in the underlying auto loss ratio on a full-year basis. We remain committed to our goal of 5 points of improvement, and we are confident we will achieve it.
However, we now expect it may take a quarter or 2 longer than originally anticipated to achieve the full impact for a total of 18 to 24 months. Likewise, non-cat weather, particularly wind and hail, impacted our property book more than expected. As such, we now expect our underlying property loss ratio to be roughly flat with prior year's result of 47.2. We've addressed these loss trends in our rate filings, which will keep us on pace to grow P&C net written premiums by mid-single digits this year. Throughout this rate change cycle, our policyholder retention in both auto and property has remained stable, which we attribute to our loyal customer base that appreciates the educator-specific benefits and value-added programs we provide, and we expect this trend to continue.
Before moving on to Retirement, I wanted to briefly note that we expect the P&C expense ratio in the second half of the year to run above 27%, but still keeping us on track to be at roughly 27% for the full year. Turning to the Retirement segment, net income, excluding DAC unlocking, improved 18% over last year's second quarter. Higher net investment income, an increase in fee-based retirement product income, and the lower federal income tax rate offset a higher level of expenses. The annualized net interest spread was 181 basis points in the quarter, benefiting from prepayment activity that offset the challenges we faced in the current interest rate environment. We also saw favorable alternative investment returns. As a result, we now expect Retirement net income in the range of $49 million to $51 million for the full year. Retirement assets under management increased 6% year over year.
We continue to see a strong increase in mutual fund product sales. Our annuity persistency remains strong at 94.6% for variable annuities and 94.4% for fixed annuities. Moving on to the Life segment. Second quarter net income increased 5% over prior year. While mortality costs were favorable, they did increase compared to the very favorable experience last year. As Marita mentioned earlier, sales increased 49% over prior year. We continue to see the Life business as an area of significant opportunity and expect continued double-digit sales growth. Net investment income increased by more than 5% in the quarter as we experienced a significantly higher level of prepayment activity compared to the prior year. We also continue to experience favorable returns from our alternative investments. Despite the higher rate environment and modestly wider credit spreads, we continue to be disciplined in our investment purchases.
In our opinion, we are in the late stages of the credit cycle and are seeing signs of loosening covenants, increasing leverage, and overall easing of credit. We believe the most prudent approach is to continue to move the portfolio up in credit quality while maintaining a high degree of liquidity. This approach provides financial flexibility that we hope will allow us to capitalize on any market dislocation. Our purchases in the quarter focused on agency mortgage-backed securities, high-quality munis, and structured securities. We achieved a new money rate of over 4.25%, which was significantly higher than our original outlook. That said, we remain cautious on net investment income, as much of the favorable experience in the first half of the year was related to prepayment activity.
To close, while some of our key drivers have moved slightly up or down, our overarching strategy and execution remain sound, and we continue to make progress on key initiatives to create long-term shareholder value. We remain confident we are on the right path, guided by the right plan. Thanks. Now I'll turn the call over to Heather to start the Q&A.
Thanks, Bret. Sherry, could you call for questions?
Yes. 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 would 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 is from Christopher Campbell with KBW. Please proceed.
Good morning. Congrats on the quarter.
Thanks, Chris.
Okay. I guess that my first question is just kind of this increased trend you were seeing towards non-cat weather. When does this just become business as usual and automatically built into your P&C pricing algorithms?
Hey, Chris, this is William Caldwell. It happens as soon as they occur. As soon as there's increased weather, they go right into our indications, and we react with rate, not only rate, but also claims and underwriting restrictions where appropriate. Essentially, they go right into our pricing models.
Okay. Great. Just kind of backing away a little bit from the near-term focus on auto improvement, and then just looking at Horace Mann's P&C growth over time. I understand homeowners, there was a lot of coastal reductions, et cetera. If you're just looking at it over a longer period of time, the auto PIF, and I'm thinking like 2008 to present. Auto PIF is down about 12%, homeowners is down 23%. I'm just thinking structurally, as Horace Mann becomes more rate adequate, does Horace Mann have the skill set to grow with this customer base?
Yeah, this is Marita, Chris. I'll answer first, and then if Bill wants to add any specific P&C details and facts, he certainly can. I understand the question, and I think it's a good one. You mentioned retreating from the coast from a property perspective, and you see that in our more typical third quarter, cat history tends to be very low for us. Over the course of the year, that's how we're able to maintain that 6%-7%, and this year with the second quarter, maybe closer to the higher end of that range. Also embedded in this is the work that Bill and his team have done in state segmentation in moving from places that are less profitable from an auto perspective, that are more litigious.
You see that in the agent count as well as we begin to restrict agents in those places and as we begin to build agents in better geographies where our opportunity to have a better ROE and a better predominantly auto loss ratio is there. We are, when we break it down state by state, seeing some really decent PIF growth in places where we are intending to grow. It's just going to take a while for that to overcome the places that we've been constricting. We're getting close to that point. We feel good that we're seeing the increase in premium. It's what we planned, and we planned for flattish PIF growth this year.
We're right where we planned to be, and I think it's important, and you're seeing it, that you're seeing the improvement in the underlying loss ratios, you're seeing improvement in the ROE that follows this, and this has all been part of the plan. When we look at it, we see it as things are falling into place as we planned, and eventually we'll begin to see that growth emerge. I also want to remind you that it isn't just a P&C game, and we're not just a P&C carrier. This is really about the retirement assets and the life insurance that we provide to our educators. When you see that, you can see the underlying benefit that that provides to our financials.
Chris, it's Bill. I just had a couple comments to that. If you go back as far as 2008, a lot of the folks at this table weren't here then, but I believe we did have a non-educator strategy that didn't have the proper return. As we shed business, it tends to be non-educator. Not only state mix, as Marita said, but also our educator mix is up, our tier mix is up, our cross-sell penetration is up. From a mix perspective, we feel really good about it. As we work on the states that are profit-challenged, we do have the HMGA, where we keep that customer. Although you don't see it in our auto PIF numbers, we do retain that customer in our agency, and that enables Bret's business to cross-sell Life and Retirement products.
Well, that's very helpful. Thank you. Then just one final question. Just in terms of excess capital, does the really strong life sales, is that using up a lot of excess capital? How should we think about that?
Chris, this is Bret. With respect to excess capital, we ended the quarter at about 115, and as it relates to the life portion of the excess capital, the life excess is actually up this quarter versus where we were in the first quarter. Even though life sales are up 49%, on somewhat of a small volume, inherently, yes, it eats up some of the excess capital, but at this juncture, nothing significant. Like I said, our excess capital in the life company is probably up about $12 million from the first quarter.
Great. Well, thanks a lot, Bret.
Sure.
Good luck on next quarter.
All right. Thank you.
Thanks.
Thanks, Chris.
Our next question is from Gary Ransom with Dowling & Partners. Please proceed.
Good morning. I had a question on loss cost trends. I apologize if I missed some of your prepared remarks, but I think you were mentioning something about the bodily injury severity trends. I was interested whether that is a sort of a medical cost pressure or whether it is the legal, more litigious pressures or some combination of the both that's driving what you see.
Yeah, Gary. I'd say it's a combination of both. You could see it in the medical CPI. Costs are rising for medical injuries. There's also the legal side of this. Our attorney rep claims, when they come to us, the percentage that are handled by an attorney are up. You could turn on any TV station. I was just in Philadelphia this last weekend. The dollar spent on advertising for auto injury claims is up 10%. We're definitely seeing some pressure on the legal side. It's a macro trend across a lot of markets.
For what it's worth, I see those ads in Connecticut too.
Billboards.
Yeah.
Yeah, billboards, TV commercials, just the expense that they're putting into this to increase.
The other side of the loss trends is frequency, a couple of your large competitors have talked about frequency being down. It's been down quite a bit year-to-date, maybe 2% or 3%. Maybe that's not universal across all companies, but a couple of big ones that tell us, I just wondered what you're seeing there and whether that is giving you any offsetting benefit at this point.
Yeah. I like that you opened with loss cost because I tend to look at the blend, because when you do put in claims initiatives, sometimes they can influence your frequency, especially around bodily injuries. I think it's important to look at the combination of the two. In a generalized sense, I would call our frequency more stable. It's normalized. I wouldn't characterize it as decreasing right now.
Okay.
If you remember, the second quarter for us tends to see a lot of weather-related frequency, especially on auto, which does not go into the catastrophe bucket. Hail that causes damage to a car, that's a comp loss. That would be a cat loss. Accidents that are related to the intensified weather go into our ex-cat bucket, and you could quantify that as about 2 points for the quarter.
Okay. Shifting gears a little bit on the retirement side. I think you mentioned that you're having some success in building the assets under management with the new model that you've put in place a while back. Can you give us a little more details on how that is progressing, how it's working with the agents, and how you're adapting to that new model?
Yeah, Gary. This is Bret Benham, the other Bret.
It's been quite a year. In part, as we roll this out and done it in the heart of some of the changes with the DOL, with new products and new forms of distribution also, or new ways of taking these products out, also all the training that we've done. I think the big opportunities or the big wins that we've seen is when we're able to take what we would call the total value proposition of Horace Mann out into these school districts. I don't know how well you know this market, it tends to be very much product-oriented, people are taking products in. We, to some degree, can have to compete that way. Where our value is where we take all of Horace Mann in. Not just the 403 offerings, but auto, home, life, and everything else.
With this new record-keeping capability, when we're able to get in there and win, and win in large chunks, not just one educator at a time, but 80 educators or even get the whole school, those are wins. We're starting to see more of those opportunities, not only to propose on those, but actually starting to win those. Again, that's a good sign. It's a good validation that what we're doing is correct. It's also a good indication of the future and where we're trying to take this part of our business.
And this is Marita. I think that's well said, Bret. We're talking about tweaked models and increased capability and refreshed products. At the core of it, we always have to remind ourselves that we have an experienced captive agency plant that knows our educator market, that we have a homogeneous set of customers with simple needs that we understand, and we have a simple set of products that aren't particularly complex. That combined with the refreshment that Bret is talking about, we feel really confident as we move forward, as I said, in this ever-changing landscape. It's easier for us because we know our customers, and we've been doing it for a very long period of time.
Can you give us some idea about how many times during the first six months of the year you were getting sort of the whole school districts, or where you got the big case, sort of won it?
I don't have those numbers off the top. They are relatively small right now. Most of it gets back into that whole funnel where you're out there prospecting and then you're actually doing the RFPs, and then you see the wins later on. It does have a longer tail than our normal business. Tail to not only to win the institution and then a tail to be able to go back in and enroll the individuals one by one.
Right. Okay, well, that's helpful. Thank you very much.
You're welcome. Thank you.
Our next question is from Matthew Carletti with JMP Securities. Please proceed.
Hey, good morning.
Morning.
Morning.
I just got a couple of questions. One is actually just following up on Gary's, some of the comments, Bill, you had for Gary's question. The two points of non-cat weather that you referenced, was that related to auto in the quarter?
Yeah, that was related to auto. A similar story for property, a little bit less, I believe, about a point and a half for property of non-cat weather impacting the quarter.
Okay. All right. Perfect. That was where I was going with that. My other question relates to life. Marita, you spoke a bit in your opening comments about the strong sales there. I was curious if you could just give us some more color on kind of what a lot of that, the new customer looks like. Is it customers that were already part of Horace Mann that you had a P&C relationship with and you're extending that relationship into life, maybe retirement too? Is it new customers to Horace Mann, and there are P&C policies maybe coming along with that? What does that growth look like kind of more holistically, not just within the life segment?
Yeah, great question. I'll let Bret comment if he has any more specifics. I think when you look at our relatively small base, and I think if you look at our historic focus, at least in recent history on P&C, when we give agents new products and new training, and we get them back in the life business because they're good agents who know how to sell, then we see increases in sales pretty much across the board. These are educators. Many of them are educators where we already have the P&C and maybe the retirement as well. We never asked for the life insurance. Many times they might have purchased it elsewhere, and many times, they have no coverage at all. It's basically asking for it.
A good example is in our contact center, when we added to our script a simple question that said, "When was the last time someone reviewed your life insurance needs?" We saw an uptick in folks saying, "Yes, I'd be glad to have you take a look at that." That has led to some lead generation for our agents and actual sales. The talk tracks, the products, the training put in the hands of agents that are with these customers anyway, have led to those people who have that need taking up the product. I don't know if you have anything to add to that.
Yeah, Matt, what I could add to that is, nothing really more than what Marita said, and we do have a strong customer base out there that's loyal to us. Sort of the field force knows life insurance. I think there's been a rejuvenation out there. We finished the year very strong last year with a record month in December. Getting out there and visiting with them, and I think I've said this ever since I've been here, and of course, I've only been here for six months, and they're about to resend my new guy card. There is a lot of upside, in my opinion, here on the life insurance part of the business. We have seen an increase in placement rates. Through the end of last year, I think our placement rates was roughly 76% of the business that came in.
Right now, we're hovering in around 81, 82. We're doing a better job of underwriting it, which means we're getting it out quicker, we have better placement rates. Most of the work that we've done internally has been better blocking and tackling. The field force has responded. I've now come off of five of these back-to-school meetings, they're pumped up about life insurance and some of the things that we want to do going forward. They've done a good job in responding, but it's been pretty much to the same traditional customer. Nothing new, nothing exotic. I can't really point to one part of the product portfolio. It's coming in everywhere, from single premium to term insurance to recurring premium, which we like to see more and more of. Overall, just very positive and want to grow this even further.
Although 49% year-over-year seems to be something that's probably not sustainable forever, we do want to grow it.
To put a finer point on Bret's last comment, which I think is important, the growth is coming from asking. The growth is coming from better training, and better preparation, and better focus with our agency plan. It's not coming from changes in underwriting profile. It's not coming from changes in pricing. This is the standard bearer that we had available for a while.
Always been.
We increased the emphasis and we're asking more, and I feel good about what we're doing in the life skill.
The strength of the distribution.
Absolutely.
Great. Thank you for the answers, and best of luck for the rest of the year.
Thanks.
Thanks.
As a reminder, if you would like to ask a question, it is star one on your telephone keypad. We will pause for a brief moment to poll for questions. Our next question is from Bob Glasspiegel with Janney. Please proceed.
Good morning, Horace Mann. What's your new money rate at P&C and Life, and how does that compare to embedded yield? Is the spread pressure sort of alleviating on Life?
Our new money rate for the quarter was about 4.25%, which I think that brought our year-to-date to just south of 4.10% year-to-date. As you recall, Bob, in our original plan, we assumed a new money rate of about 3.50%, running better than planned.
What's your embedded yield in P&C, how does that compare to the money rates?
I mean, the overall book yield, we ended the quarter at 5.14%, pretty much up slightly from last year. At the time, I think, here again, going back to what we planned for the year was about 5%. We're doing well. We're probably 10-15 basis points above what we thought where we would be at this time. 5% overall book yield, obviously the pressure is that the new money rate is lower than the overall book yield, which obviously puts the pressure on all of our lines.
Okay. I'll follow up with Heather. Thanks a lot.
Thanks, Bob.
Thanks, Bob.
I think that looks like we've gathered questions in for today. Be available rest of the day, next week, if anyone would like any follow-up. We appreciate everyone participating today. Thank you.
Thank you. This concludes today's conference. You may disconnect your lines at this time, and thank you for your participation.