Good morning. My name is Brandy, and I will be your conference operator today. At this time, I would like to welcome everyone to the Horace Mann third quarter 2012 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press star, then the number one on your telephone keypad. If you would like to withdraw your question, press the pound key. I would now like to turn the call over to Vice President of Investor Relations, Mr. Ryan Greenier. Sir, you may begin your conference.
Thank you, Brandy. Good morning, everyone. Welcome to our third quarter 2012 earnings conference call. Yesterday, we issued our earnings release, including financial statements, as well as supplemental business segment information. If you need a copy of the release, you can find it on the investor's page of our website. This morning, we will hear prepared remarks from Pete Heckman, President and Chief Executive Officer; Dwayne Hallman, Executive Vice President and Chief Financial Officer; Tom Wilkinson, Executive Vice President, Property and Casualty; Matt Sharpe, Executive Vice President, Annuity and Life; and Steve Cardinal, who is our Executive Vice President of Marketing. Following our prepared remarks will be a question and answer session. Any statements made today concerning Horace Mann's future results or actions should be considered forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995.
These forward-looking statements are based on management's current expectations and are not guarantees of future performance. Actual results may differ materially, and we assume no obligation to update these statements. For a discussion of risks and uncertainties that could affect actual results, please refer to our SEC filings and the earnings release issued yesterday. In our prepared remarks, we may use some financial measures not derived from generally accepted accounting principles, or GAAP. Definitions and reconciliations of these measures to the most comparable GAAP measures are available on the investor's page of our website. Now I'll turn the call over to Pete.
Good morning, everyone, and welcome to our call. After yesterday's market close, Horace Mann reported third quarter operating income of $0.62 per share, which was $0.38 better than last year. P&C catastrophe losses were well below both prior year and our expectations. At the same time, underlying earnings increased in all three segments of our multi-line insurance platform. Along with the favorable earnings results, the broad-based increases in new business sales and policy retention we've achieved over the last few quarters continued in the current period. Before the management team provides more detail on our financial and business segment operating results, I'd like to offer my perspective on how we're doing through the first nine months of the year relative to our five key performance priorities for 2012.
As you might expect, given the strong underlying top and bottom-line results over the last several quarters, our report card looks pretty good. Our first priority is to increase the productivity and size of our agency force. On a year-to-date basis, Horace Mann agencies continue to produce double-digit sales increases across all product lines. The number of exclusive agencies continues to grow, and we are on track to achieve a modest increase in the total agency count for the full year. The second priority is to reverse the negative growth trends in our auto line. We are pleased with auto new business production over the last 15 months. It remains strong in the current quarter, and year-to-date results are well ahead of prior year. In addition, our retention ratio continued to improve in the quarter and is also comfortably above the prior year.
As a result, the number of auto policies in force has stabilized, and we would expect to see our PIF count begin to turn in 2013. Meanwhile, as I've said before, we are committed to profitable growth in our auto business. This quarter's underlying combined ratio was 98.8, the lowest it's been in over a year, which was encouraging. Nonetheless, it's likely that we'll remain over 100 for the full year, so we're continuing to target a higher level of rate action in the last part of this year and into 2013 in order to maintain an acceptable growth-profit balance. Our third priority is to remain focused on property profitability and maintain the favorable underlying margins we achieved during the last half of 2011. The underlying property combined ratio was below prior year in both the third quarter and on a year-to-date basis, which was also encouraging.
With the inherent volatility in this line, we remain committed to our pricing, underwriting, and claims initiatives for at least the intermediate term. The fourth priority is to build upon the positive results we've achieved over the last few years in our retirement annuity business. In the third quarter, sales growth moderated somewhat relative to record levels in the prior year, but assets under management grew 3% sequentially, 13% year-over-year, and total annuity persistency is up a full point over the last 12 months to 95%. Meanwhile, underlying annuity earnings have increased more than 20% year-to-date, all of which is clear evidence of continued strong and balanced performance in this business segment. Finally, our fifth performance priority is to achieve double-digit growth in sales of Horace Mann manufactured life products, with the strategic objective of growing our underwritten mortality-based business over the long term.
While this will be an ongoing, multifaceted process that builds over time, we're very pleased with our 25% increase in proprietary life product sales in the third quarter on top of the 37% growth recorded in the first six months of the year. All in all, we feel very good about the third quarter. Catastrophe losses were moderate, and increases in underlying earnings, sales, and retention were broad-based. We remain confident in our ability to successfully execute on our strategy of profitable growth for the remainder of 2012 and beyond. Now let me turn it over to Dwayne for some additional commentary on our financial results and outlook.
Thanks, Pete, and good morning. As Pete mentioned, Horace Mann recorded third quarter operating income of $0.62 per share, which was $0.38 ahead of last year. Lower catastrophe losses account for half the increase, with the remainder reflecting higher levels of performance in all three of our business segments. In Property and Casualty, the underlying combined ratio of 91.2% was a 1.5-point improvement from the prior year quarter. Progressive crediting rate and prudent investment portfolio management resulted in a 12-basis-point improvement over prior year in our fixed annuity spread, which was 211 basis points year to date. Within the Life segment, mortality costs were favorable to prior year. Year-to-date operating earnings per share of $1.42 were $1.20 higher than the first nine months of last year. More than half of the increase, or $0.63, was related to lower catastrophe losses.
The remaining portion was largely due to favorable interest margins in our Annuity business, stronger underlying results in our Property book, and to a lesser extent, a higher level of P&C prior year's reserve releases, positive DAC unlocking, and favorable Life mortality. Book value per share, excluding net unrealized gains, increased 3.5% sequentially and 11% over prior year to $21.24. Net unrealized gains were $648 million, up $207 million from year-end 2011, driving reported book value to $31.30 per share. This was an 8% sequential increase and 22% increase year-over-year. We are pleased with the investment performance in the quarter. Pre-tax net investment income was up 7.3% versus prior year. Our reinvestment rate was approximately 4.75 points in the third quarter, which was ahead of our expectations.
We continue to find opportunities to put money to work at attractive risk-adjusted yields without venturing into asset classes or individual securities inconsistent with our conservative investment philosophy. We recorded net realized investment gains of $11 million pre-tax for the quarter, with no impairment write-downs. As you may have seen in yesterday's earnings release, we are increasing our full year 2012 operating income guidance to $1.85-$1.95 per share. This reflects the lower than expected catastrophe losses in the third quarter, as well as stronger than anticipated earnings in the Annuity and Life segments. The revised guidance range assumes the fourth quarter underlying Property and Casualty combined ratio will be marginally unfavorable to fourth quarter 2011. We had an unusually light non-cat weather in the fourth quarter of 2011, which we are not anticipating this year.
While we expect fourth quarter auto results to be better than prior year's 108.7 combined ratio, loss results in this line have historically increased in the fourth quarter as a result of seasonality. We're expecting the underlying combined ratio to be above 100. All in, we expect our full year P&C margins to be somewhat higher than the original range of 96%-98% we targeted for 2012. Life and Annuity earnings, on the other hand, have outperformed our original guidance. While we expect those two segments to continue producing solid results, we anticipate more moderate earnings in the fourth quarter due to the low interest rate environment. We're looking for fixed annuity spreads to decline by 5-10 basis points over the next three months and anticipate Life segment earnings to be slightly below fourth quarter of 2011.
Now, to review the current results and trends in our P&C business, let me turn it over to Tom Wilkinson.
Thanks, Dwayne, and good morning. In the third quarter, property and casualty pre-tax income was $18.5 million, a significant improvement over prior year. Our combined ratio was 93, which included four points of catastrophe losses and 2.2 points of favorable prior year reserve development. This quarter's performance benefited from relatively benign weather-related losses and favorable frequency. At the same time, we are also beginning to earn the recent rate increases from the last few quarters, especially in auto. In auto, our combined ratio was 97.4% in the quarter, which included 1.3 points of cat losses, offset by 2.7 points of favorable prior year development. On a year-to-date basis, the combined ratio was 99.1%.
In the third quarter, we benefited from lower accident frequency, but are still experiencing increased physical damage severities consistent with others in the industry, driven by increases in used car values, repair costs, and total loss estimates. We continue to increase rates in the quarter and expect an overall filed rate change of about 6% for the second half of the year to keep ahead of loss trends. As Dwayne mentioned, our fourth quarter traditionally exhibits higher loss seasonality than other quarters, as a result, we anticipate a higher sequential combined ratio in the next three months. However, this quarter's results are a step in the right direction as we remain focused on improving the profitability of our auto book of business. Turning to property, our combined ratio was 83.2% in the quarter, which included 9.1 points of cat losses, partially offset by 1.3 points of favorable development.
The underlying combined ratio was 75.4% in the quarter, 2.3 points better than last year, was about 78% year-to-date, six points better than last year. Our underlying results continue to improve, reflect ongoing underwriting initiatives, terms and condition changes, rate actions that move us closer to our targeted profitability levels of a low 90s combined ratio. Now for a look at top-line results. Total written premium grew 1.2% for the quarter, with similar growth in both auto and property. On a year-to-date basis, written premium was up almost half a percent. True new auto and property sales remain strong. On a year-to-date basis, true new auto sales are up 30%, property is up 17%, the quality of both our new business and our in-force book is solid.
Our policyholder retention continues to improve as we increase the number of customers utilizing automatic payment plans like school payroll and EFT. Auto retention improved 1.8 points above prior year to 84.3%, and property retention improved to 88.1%, marking the fourth consecutive quarter of improvement for both lines of business. In summary, the third quarter was a solid one for our P&C business. Underlying results were good, and in addition to favorable weather, reflect the targeted rate and profitability initiatives we've taken to strengthen results over the past few years. We are confident that our continued rate and underwriting actions will result in incremental margin improvement. We are encouraged by the positive new business results and the improving retention trends we see in our P&C book. Our policy in force counts were stable again this quarter, and as we move into 2013, we are setting the stage for profitable growth.
Now I'll turn it over to Matt for his commentary on annuity and life results.
Thanks, Tom, and good morning. I'll spend the next few minutes going over the profitability and growth results for the annuity and life segments. Third quarter pre-tax income for the annuity segment was $14.9 million, more than double the prior year quarter. On a year-to-date basis, pre-tax income was up over 40% to $44 million. Results for the current periods include positive pre-tax DAC unlocking of $500,000 and $1.3 million respectively, driven by strong financial market performance. In 2011, market performance resulted in decreases to annuity pre-tax income related to DAC unlocking of approximately $5 million for both the third quarter and year-to-date results. Excluding the impact of DAC unlocking, underlying earnings are up 29% for the quarter and 23% year to date. The primary drivers of these strong results are solid increases in account values and growth in net interest margin.
Fixed account values increased 10% compared to a year ago. The associated net interest margin improved 21% in the quarter and 17% year to date compared to prior year, reflecting prudent management of both crediting rates and the investment portfolio. The resulting net interest spread was 211 basis points year to date, an increase of 12 basis points compared to prior year and roughly in line with last quarter. Variable account balances increased 20% over the prior year to $1.4 billion, primarily driven by strong financial market performance. Net flows were positive in the quarter, as they have been in each quarter for the last four and a half years. Total account value persistency of 95% over the last 12 months improved one percentage point compared to a year ago. Total annuity sales for the quarter decreased 13% compared to the prior year, but are comparable on a year-to-date basis.
The decline in the quarter was primarily driven by lower single premium fixed sales, particularly from the independent agent channel. Horace Mann agency sales were in line with the prior year for the quarter. Sales, while still near record levels on a year-to-date basis, have started to plateau, and we expect that trend to continue through the remainder of the year due to the low rate environment. Turning to the life segment, pre-tax income for the quarter was $7.7 million, a 20% increase over the prior year. For the first nine months, pre-tax income of $25 million increased almost 15%, primarily due to continued improvement in mortality costs. Sales of Horace Mann manufactured life products increased 25% for the quarter and 32% year-to-date versus 2011. Our life persistency for the current period remained consistently strong at 95.8%.
In closing, it was another solid quarter for both annuity and life sales and a continuation of strong underlying earnings for both segments. With that, let me turn it over to Steve for his comments on distribution and sales.
Thanks, Matt, and good morning. We are pleased with the continued positive momentum in sales and marketing efforts during the third quarter. Agent productivity continues to improve, and we increased the size of our agency force. In addition, the marketing and training programs we introduced at the beginning of last year continue to drive strong results. True new auto sales are up 30% on a year-to-date basis, and annuity sales within the Horace Mann agency channel are up 12%. Our agents lead with auto and annuity products. We are pleased to see sustained strong performance in those lines.
Moving into fourth quarter, we expect prior year comparisons for true new auto sales to moderate somewhat as our strong sales growth began last year in the third quarter. During the last three months, we expanded the size of our exclusive agency force by 33, and combined with our employee agents, the total sales force increased by 20 to end the quarter at 732. Looking ahead to the fourth quarter, our new exclusive agent pipeline is strong, and we are confident that we will end the year with a modest increase in total agents. More importantly, agent productivity continues to improve, and we are also seeing improvements in agent retention. Offering educators the ability to pay auto and life premiums and contribute to their annuity account directly from their paycheck is a key strategy to drive sales and improve retention.
Currently, we have approved payroll slots in about half of the nearly 12,000 school districts within our markets. In addition, we have had success introducing outsourced Section 125 programs as a benefit to both the district and their employees, which has yielded increased productivity and income potential for agents servicing school districts. During the third quarter, we've introduced new customer contact programs, including a seven-state pilot aimed at conducting policy holder reviews. Additionally, we maintained our focus on retirement seminars and our partnership with DonorsChoose.org. These programs reinforce our brand and further increase our ability to cross-line sales and improve customer retention rates. In summary, we are pleased with the strong sales results both in the quarter and for the year. We are confident in the success of our marketing and recruiting programs and are optimistic they will continue to generate sales results and profitable growth for Horace Mann.
Thank you, now back to Ryan.
Thank you, Steve. That concludes our prepared remarks. Brandy, you may now open the call for questions.
Certainly. If you would like to ask a question at this time, please press star one on your telephone keypad. Again, ladies and gentlemen, that is star one. We will pause for just a moment to compile the Q&A roster. Your first question is from Bob Glasspiegel with Langen.
Good morning, Glass.
Interrupt the introduction there. On auto, it seems like you aren't quite declaring victory. I was excited by the underlying improvement, and I thought the body language was, we still have a lot of work to do, and we're repricing, re-underwriting. I got excited to see the numbers and the text. You're sort of holding me back a little bit telling me Q4 is a little trickier because of the non-cat weather. Is it too early to declare victory, or where are you sort of in the recovery of this line?
Well, Bob, this is Tom Wilkinson, and I think you summed it up pretty good. We do feel good about what happened in the third quarter. I think we'd like to see a little more experience before we declare victory, as you say. We're heading into a volatile fourth quarter. We're kind of just being a little cautious about that. We feel like we're starting to see the results of the programs that we put in, some underwriting actions, the increased rate levels, and the like. I think we just kind of want to see it just a little bit more. We do feel good about the quarter, we feel good about where we're going.
Okay. Switching to annuities, you've been sort of guiding towards the inevitability of lower margins and lower spreads for a while. Spreads have widened instead of narrowed. I guess the question is, why should we believe you now? I'm kidding, but it seems like the margins have held up much better than we thought. Are you really getting higher yields than you budgeted? It just seems hard to imagine given that spreads have come in.
Hi, Glasspiegel, this is Dwayne D. Hallman. Yeah, we are pleased with our ability to maintain our spread. It's been 211 for the last three quarters. That has really been set up on a variety of fronts. One, just positioning our portfolio a couple of years ago with the idea that we thought rates would stay low for quite a period, probably longer than some others may have expected. Kept the duration a little bit longer, somewhat of a contrarian on that front. Our portfolio yield has held up much better than we expected. On the reinvestment front, we did predict and baked in some lower reinvestment rates. As I mentioned in my comments, we have been able to exceed that level, just somewhat being patient. We'll say in the third quarter, obviously, that's always a tough time in the market to put money to work.
It's been difficult for us and I think others as well. The portfolio itself is starting to see a bit of a decline in yield, and we saw that in the third quarter. On the crediting rate side, anticipating, obviously, the low interest rate environment, we have been aggressive in reducing crediting rates, trying to manage them on all fronts. That's somewhat offset by new business coming in that have been at very favorable spreads. All in all, we know the point is coming that the 211's not going to be able to maintain itself. We are predicting that is going to fall 5 to 10 BPS during the fourth quarter as far as the quarterly spread is concerned. We've been very pleased with it, encouraged what has happened.
I wish I could keep it at 211, unfortunately I think it is going to start to decline a bit.
Okay. The last question is on statutory capital, statutory earnings year to date, and dividends to the parent we can look for the year or year-end to support capital management. The buyback's sort of been not that vibrant. I suspect liquidity and possibly valuation is feeding in. Are you leaning towards more on dividends with excess money or a balanced approach?
A couple things, Bob. On the underlying statutory component, the statutory income has been strong for the year. The capital ratios, as you would expect, RBC ratios continue to be high. The buybacks were a bit low in the quarter. There has, as you pointed out, good price volatility. We weren't going to chase the price up, as we've mentioned before. Also it was the third quarter, which historically is the highest cat quarter, so a little bit cautious going into that. All that said, as we've historically done, the December board meeting time is the time period where we do review our annual capital management strategies, be it dividends, stock buyback programs, et cetera. To your point about dividends, that would certainly be on the table for discussion as well as other components.
As we trade up closer to a tangible book value, then obviously makes it a bit more difficult to justify stock repurchases. Could somewhat assume the emphasis would turn to dividends.
What's your statutory earnings year to date? Wait a minute, I didn't catch that.
In total, about $66 million. That's roughly $35 million in Life and $31 million in P&C.
Okay. Thank you very much.
Thanks, Bob.
As a reminder, if you would like to ask a question, please press star one on your telephone keypad. Your next question is from Frank Li with KBW.
Good morning, Frank.
Hi. Just wondering for the cat losses, how much of that was from Isaac, and maybe if you could give more color on comparison why, maybe where the other cat losses were from.
Frank, this is Tom Wilkinson. Almost all the cat losses in the quarter were from Isaac. There were a couple smaller storms where we didn't have much penetration, didn't feel much impact at all.
Okay, thanks. Just to clarify the 6% increase rate filing you have in auto, you said that was pending, or is that flowing through currently?
Well, it's pretty much flowing through. The effective dates for the fourth quarter are all come and gone. The 6% that I talked about for the second half, they're all effective.
Okay. Then one more question within the annuity. It seems like in the third quarter 2011, the fixed annuity base was a bit high. Just want to see kind of what the drop-off was in this quarter. I have it down 15%. Provide some color there, maybe what you guys see going forward with that.
Yeah, Frank, this is Steve Cardinal. Is that a question just about the sales?
The fixed annuity contract deposits.
The contract.
Yeah. It's like $89 million in the quarter. Or $88.6.
When we look at the sales component for the third quarter for the sales premium that we had coming in, there are just a couple factors when we compare it to last year, we did go through some crediting rate changes relative to where we were in third quarter of last year. Our career agents have been conducting seminars for a couple years, and we've seen their continued sales coming off our third year of record annuity sales are still riding at near record levels. We're really comfortable with how well they are positioned given our marketplace, the age of our target market, and the age of our customer base. We expect to have some pretty high continued levels of sales.
Yeah, I think, Frank, in large part, our written premium and deposits in the annuity line are impacted by single premium sales. Particularly, although our Horace Mann agency sales growth is maintaining pretty well, our independent agencies dropped off a fair amount so far this year. Most of their business comes in single premium. I think that's the primary driver. As Steve said, we use independents, as you know, as a supplemental channel where we generally don't have Horace Mann agency representation. We're feeling very good about the fact that we do have a controlled or captive distribution channel, if you will, and they're continuing to do very well by us on the annuity side.
Okay, great. Thanks. That's all I have.
There are no further questions at this time.
Well, thanks for joining us on our third quarter conference call, and as always, I am around for any additional follow-up questions. We appreciate your interest in and your support of Horace Mann. Thank you.
Thank you, ladies and gentlemen. This does conclude today's conference call. You may now disconnect your lines.