Good morning, and welcome to the Primerica third quarter 2016 financial results conference call. All participants will be in listen only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by 0. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then 1 on your telephone keypad. To withdraw your question, please press star then 2. Please note this event is being recorded. I would now like to turn the conference over to Kathryn Kieser, Executive Vice President of Investor Relations. Please go ahead.
Thank you, Alison. Good morning, everyone. Welcome to Primerica's third quarter earnings call. A copy of our earnings release, financial supplement, presentation, and webcast of today's call are available at our website at investors.primerica.com. Glenn Williams, our Chief Executive Officer, and Alison Rand, our Chief Financial Officer, will deliver prepared remarks, and then we'll open it up for questions. We reference certain non-GAAP financial measures in our press release and on this call. These non-GAAP measures have limitations, and reconciliations between non-GAAP and GAAP financial measures are attached to our press release. We'll also make forward-looking statements in accordance with the safe harbor provision of the Securities Litigation Reform Act. The company will not revise or update these statements to reflect new information, subsequent events, or changes in strategy.
Risks and uncertainties that could cause actual results to differ materially from those expressed or implied are discussed in the company's 2015 annual report on Form 10-K, as updated quarterly by our reports on Form 10-Q. Now I'll turn the call over to Glenn.
Thank you, Kathryn, and good morning, everyone. Today, I'm pleased to report another strong quarter of performance at Primerica. Beginning on slide three, you can see in the third quarter of 2016, operating revenues increased 8% to $383.7 million, and net operating income increased 17% to $58.1 million from the prior year period. Results were driven by strong trends in the term life segment, including 13% growth in adjusted direct premiums and claims experience below historical levels. These dynamics drove the 25% increase in term life income before income taxes year-over-year. In the third quarter, our investment and savings products operating income posted the first year-over-year quarterly gain in 2016. Solid earnings in the third quarter, as well as ongoing share repurchases, drove a 25% increase in diluted net operating income per share to $1.22, and ROAE expanded 20.3% from the year ago period.
We expect ROAE to be in the 19% range for the full year in 2016. During the third quarter, we repurchased $41 million, or approximately 743,000 shares of Primerica's common stock. Year-to-date, we have repurchased $150 million, or approximately 3 million shares of our common stock. We expect to repurchase another $125 million-$150 million in 2017, in addition to paying stockholder dividends. In addition to robust financial performance, we surpassed the very strong distribution results we achieved in the third quarter last year. On page four, you can see our life license sales force grew to 115,345 representatives at the end of the third quarter, up 10% from the prior year period and up 3% from the end of the second quarter. Year-over-year recruiting of new representatives increased 12%, and new life insurance licenses were 5% higher, indicative of continued high recruiting levels and licensing focus.
On a sequential quarter basis, recruiting increased 13%, and new life insurance licenses declined 4% from the higher level in the second quarter. Far in the fourth quarter, we have seen solid year-over-year growth in recruiting, as well as a continued increase in the size of our life insurance sales force at the end of October. We believe we continue to attract such a large number of aspiring entrepreneurs because our company gives individuals a unique chance to build their own financial services business. When a recruit joins our business, the small fee they pay allows Primerica to cover the recruit's full cost of getting life insurance licensed, including 12 to 40 hours of approved state pre-licensing classroom education and study materials, required background checks, exam fees, and state licensing fees.
Newly licensed representatives may also qualify to have their FINRA securities examinations and state license registrations covered by the company. Recruits who work through the licensing process get a financial value more than equivalent to the cost to join Primerica. Those who do not get licensed still receive real value from the array of training on financial concepts as well as coaching on sales, leadership, and business skills that they receive. We assist our sales force by continually expanding our technology platform to more effectively support our recruits and representatives. Primerica's mobile app and internet site are very convenient ways for our recruits and representatives to receive product and business training. Representatives can also electronically submit applications, access business intelligence tools, virtually manage their office, review company communications, and understand legal and compliance guidelines in order to grow their businesses.
On page five, you can see term life issued policies continue to experience exemplary growth, up 13% from the strong third quarter a year ago, significantly outperforming the industry, which reported a 1% decrease in life insurance applications year-over-year according to the Medical Information Bureau Life Index. Growth in our life insurance licensed sales force, as well as productivity in the high end of our historical range, drove the strong growth in issued policies in the third quarter. Productivity in the quarter of 0.22 policies issued per life licensed representative per month was consistent with the third quarter a year ago. On a sequential quarter basis, term life insurance policies issued declined 3% from the second quarter, largely reflecting higher productivity typical of the second quarter. We've received some questions about the number of life insurance policies our representatives purchase on themselves.
Approximately 22% of our life insurance applications in 2015 were from clients who were also Primerica recruits or licensed representatives at the time of purchase. Another 5% of applications were from clients who purchased a policy before becoming a recruit. These numbers have remained constant year-to-date through September. We do not require representatives to buy a policy, although we do believe every middle-income family should own term life insurance if there is a need, whether they are a Primerica representative or not. Turning to investment in savings products, net flows were a positive $201 million in the third quarter. ISP sales declined 2% to $1.34 billion year-over-year as U.S. retail mutual fund sales increased 9% and fixed indexed annuities sales increased 32%, while variable annuity sales declined 22%, consistent with industry trends.
Average client asset values grew to a record $50.7 billion, up 6% year-over-year, and in line with market performance. On a comparative basis, both Canadian segregated funds and retail mutual funds were down year-over-year in line with the industry. Our company-wide redemption rate as a percentage of assets remained in line with historical trends. On a sequential quarter basis, investment in saving product sales were 9% lower than the seasonally strong second quarter of 2016. Total average client asset values increased 4% from the second quarter, reflecting market performance. I'll close with the Department of Labor's Fiduciary Rule. The presidential election has introduced some new uncertainties regarding the rule. As with every change in administration, agency rules are subject to review and reconsideration.
While we cannot predict where that review will go with respect to the Fiduciary Rule, Primerica has been an active participant in the rulemaking process and would expect to be involved in the future. We continue to plan for the rule as currently written. Our management team, along with the help of industry-leading consultants and service providers, is diligently working through changes we would need to make to comply with the rule. While a number of firms which serve mostly affluent clients are considering only offering IRAs and advisory programs and eliminating any IRA brokerage option, we believe a significant number of broker-dealers will continue to sell mutual funds with upfront loads after the rule goes into effect. We still believe a mutual fund with an upfront sales charge can be the most appropriate way for clients to invest and save toward their long-term retirement goals.
We plan to continue offering these products on a brokerage platform to the markets we serve. We, along with the industry, are mindful of potential legal exposure. Our implementation efforts are being thoughtfully undertaken to minimize this exposure while bringing us into compliance ahead of the deadlines. We're expending a significant amount of effort in developing enhanced point-of-sale technology for the front end of our investment sales process in order to capture a client's key decision points and support the disclosures required by the rule. Additionally, we've analyzed all of our operational processes and are making the necessary adjustments, including enhancements to our policies, procedures, training, and supervision to be in compliance with the rule when it becomes effective in April of 2017. Significant change generally creates short-term disruption, although clear communications can limit the effect of the distraction.
Throughout this rulemaking process, we've kept our top ISP licensed representatives informed about the DOL developments. We're in ongoing communications about the rule and are working with them to deliver the support ISP representatives will need to adapt to the new landscape. Primerica is uniquely positioned to make the necessary changes to comply with the rule. We remain committed to serving middle-income families while other companies continue to shift to higher-income clients. We are confident that our simple business model and our sophisticated point-of-sale technology will give us the flexibility necessary to adapt to the new rule. Today, we have a very efficient process for executing a trade while in a client's home. Ultimately, the new process should streamline the sales process so that it's easier to execute trades and creates a more attractive business for representatives considering obtaining a mutual fund license.
Alison will discuss financial results in more detail.
Thank you, Glenn, and good morning, everyone. Today, I will cover the earnings results for each of our segments and conclude with a company-wide review of insurance and operating expenses. Starting on slide six, in the third quarter, our Term Life segment continued to experience strong performance, with margins expanding to 20.1% in the period. Operating revenues and adjusted direct premiums both increased 13% year-over-year, while operating income before income taxes increased 25% from the third quarter a year ago. The benefits and claims ratio of 57.6% was low for the quarter, reflecting incurred claims that were approximately $3 million below historical levels, a portion of which comes from the implementation of a new claims adjudication system for disabled lives. The benefits and claims ratio continues to benefit from YRT reinsurance rate reductions that we negotiated on 2014 and later issue years.
Slightly unfavorable persistency experience in the third quarter also contributed to the lower benefits and claims ratio from smaller reserve increases, led to a modest increase in the DAC amortization ratio for the quarter to 15.4%. The net insurance expense ratio for the period was 7.5%, which continues to decline as fixed costs are spread over a larger in-force premium base, fueled by strong sales in recent periods. On a sequential quarter basis, term life revenues increased 6% in both income before income taxes and the term life operating margin were consistent with the second quarter of 2016. The DAC amortization ratio increased and the benefits and claims ratio declined from the prior quarter due to seasonally strong persistency in the second quarter and favorable incurred claims in the third quarter.
As we've discussed in the past, adjusted direct premiums should naturally grow over the next several years by a minimum of 10% annually as a result of the co-insurance transactions we entered into at the time of the IPO. The 18% growth in policies issued in 2015 and 16% year-to-date growth in 2016 has propelled adjusted direct premium growth further to 13% year-to-date. Beginning in 2017, in-force policies coming to the end of their first policy term will no longer be ceded to the IPO reinsurers. We expect this change to increase net premiums by approximately $15 million by the end of 2017, which will largely be offset by an increase to benefits and claims ratio, excuse me, benefits and claims and DAC. Retention of these policies may have a modestly negative impact to the benefits and claims ratio as well as term life operating margins overall.
That being said, we believe any resulting headwinds should be more than offset by the favorable term life trends we've been experiencing, including YRT reinsurance rate reductions in recent years and the spread of fixed expenses over a larger in-force premium base. On an annualized basis, we expect the benefits and claims ratio to be in the 58%-59% range and the term life operating margin to remain in the 19%-20% range in 2017. Moving now to our investment and savings product segment. On slide seven, you'll see our ISP operating revenues increased 1% and ISP operating income before income taxes increased 3% from the third quarter a year ago.
Revenue-generating product sales and sales-based revenue declined 1% and 2% respectively, reflecting a decline in variable annuity sales, largely offset by growth in U.S. retail mutual funds and indexed annuities. The sales-based net revenue ratio was high this quarter as we recognized a $1 million year-to-date catch-up of revenues to be received from one of our product providers. We expect the ratio to normalize next quarter. Asset-based revenues increased 3% and average client asset values increased 6% to $50.7 billion year over year. Positive Canadian segregated fund market performance and lower segregated fund redemptions led to an $800,000 decelerated DAC amortization in the third quarter of 2016, which, when combined with the negative performance in the prior year period, led to a $1.7 million year-over-year improvement in segregated fund DAC amortization. Account-based revenues increased 4% year over year, largely reflecting growth in our managed and retail mutual fund account positions.
On slide eight, you can see the corporate and other distributed product segment operating revenues were $31 million and operating losses before income taxes were $5.4 million in the third quarter of 2016. The modest year-over-year increase in insurance and other operating expenses was partially offset by $1.5 million of lower interest expense from a negotiated reduction in the finance charge on an IPO-related reinsurance agreement earlier this year. Allocated net investment income increased 2% from the third quarter last year as a slightly lower yield on the invested asset portfolio was more than offset by an improved mark-to-market adjustment on the deposit asset backing an IPO-related reinsurance agreement. During the quarter, we saw some improvement in fixed income prices and the net unrealized gain on our invested asset portfolio increased modestly from $105.2 million at June 30th to $110.4 million at quarter end.
We continue to maintain a strong capital position with Primerica Life Insurance Company's statutory risk-based capital ratio estimated to be around 430% and holding company liquidity of $72.5 million at the end of the third quarter. We will continue to take out ordinary dividends from Primerica Life to the extent available, and we expect our RBC ratio to remain in excess of 400%. I'll move to a discussion of the company's insurance and other operating expenses. On slide nine, you can see our third quarter expenses of $78.1 million were $7.5 million higher than the third quarter of last year. The year-over-year change primarily reflects a $1.1 million increase in premium and growth related expenses, a $2.3 million increase in employee-related expenses, a $1.7 million in spend on DOL Fiduciary Rule implementation, as well as a $2.7 million increase in technology infrastructure and mobile initiatives.
Looking forward, we expect our fourth quarter insurance and other operating expenses to generally be in line with third quarter levels. You may have noticed, for purposes of calculating the insurance expense ratio included in the term life section of our financial supplement, that we reduce insurance expenses by other net revenues. We do this as the items included in other net revenue are not viewed by management as drivers of operating income and tend to be fully offset by operating expenses. Year-to-date, we've recognized $37 million of other net revenues on a consolidated basis, of which $31 million or 84%, was received from representatives for their subscriptions to Primerica's mobile app and internet site, or the purchase of marketing materials. The remainder represents policy administration fees, third-party printing revenues, and other miscellaneous items received from clients or business partners.
Primerica's mobile app and internet site is an ever-evolving resource for our representatives with an extensive cost structure, including design and development of client management applications, electronic sales tools, electronic office management, and the delivery of third-party software. We are continually adding content, adapting for the constant advancements in mobile delivery, ensuring that we have the IT infrastructure necessary to securely deliver this service to our representatives. The fees received from our representatives are offset by these expenses and do not drive bottom-line results. Let me close with a discussion of the DOL Fiduciary Rule implementation cost. As Glenn discussed, we are in the process of developing the best means of providing investment advice to middle-income families under the DOL Fiduciary Rule.
While we plan to leverage our already robust compliance and administrative infrastructures to comply with the rule, we expect to incur substantial implementation costs for consulting, legal guidance, sales force training, and technology platforms, as well as ongoing costs to comply with the rule. As we continue with our evaluation, our expected costs have increased modestly. Assuming there is no significant change in the rule, we expect to incur about $2 million in the fourth quarter of 2016, and roughly $10 million in 2017 for one-time and ongoing costs combined. Thereafter, we expect ongoing costs of compliance to be in the range of $4 million to $5 million per year. As we continue to work through the implementation process, we will further refine both the amount and timing expectations for these expenses. Let's open it up for questions.
Thank you. We will now begin the question and answer session. To ask a question, you may press star then one on your telephone keypad. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star then two. At this time, we will pause for a moment to assemble our roster. Our first question will come from Mark Hughes of SunTrust. Please go ahead.
Yeah, thank you. Good morning.
Good morning, Mark.
On the recruiting front, 12% growth on top of 34% growth in this quarter last year. You got a nice boost from the convention last year, you're able to top that. I'll ask my usual question, anything one-time, any unusual programs in place to boost recruiting, or is this sustainable?
Well, we did not have any specials going on, any kind of unusual one-time incentives during that period. We're very pleased, obviously, with those results, and I have to give the credit to our field force leadership, who remained very focused on recruiting since that convention and continuing to build growth on top of growth. A lot of our focus is trying to make sure that we recognize what it takes to grow, and we put all of the fundamentals in place, as well as the leadership focus, both here at the company and among the sales force. There's nothing unusual. There's no unusual incentive or one-timers in that. We had some very strong growth in our fundamental business that created that, Mark.
Okay. The insurance expenses, I think you had mentioned that you got some leverage from the growth. It looks like on an absolute basis, those in the term segment, the insurance expenses have been flat for three quarters. Are you going to be able to maintain that leverage, kind of keep them at the relatively low level compared to revenue?
I do believe so. In fact, we do think that numbers should continue to improve as we continue to build out the in-force book of business. One of the things that did drive a little bit of increase this year versus last does have to do with what I was discussing with our mobile applications and internet site. We allocate that particular cost, both the revenue that we get and the cost associated with it, between term life and ISP, largely based on agent count. The vast majority of the cost, probably around 80% of it, goes to term life. As we've said, we're spending quite a bit of money on maintaining and further developing those tools.
In fact, we believe part of the reason that they're getting such tremendous use by our representatives is because we keep putting better and better content out there to support the tools. While the revenues have gone up, the expenses are keeping pace with that revenue growth.
Right. You say from a cost ratio perspective, that should improve as you get more growth?
That's overall. What I was specifically talking about is the year-over-year growth and sort of the expense number, which has a lot to do with the technology build-out. That said, we do believe that our in-force premium base will grow faster than the expense structure does overall for the term life business. Yes, we expect that ratio to continue to decline. Obviously, as you've seen in the past, we do have some timing by quarter. We have sort of a larger expense structure in the first quarter than in other quarters just because of seasonality. Overall, on an annualized basis, we expect it to continue to stay the same or decline.
Likewise, your sales-based commissions were a little lower than the trend this time. Was that a mix issue or something else?
I think you're referring to ISP. They were actually a little bit higher than historically. I mentioned it briefly in my prepared comments. We did have a one-time year-to-date catch up or true up involving their specific relationship with one product provider, which all hit this quarter versus the last three quarters. That's why it drove it up a little bit this quarter. As I said in the prepared comments, we do expect that to normalize back next quarter.
Okay. Your point about the $15 million, could you walk through that again? I think you said it had a negative impact on margins, on an absolute basis, does the extra $15 million in revenue bring some dollars to the bottom line?
Yes, it absolutely does. The reason we were highlighting some of the items about the negatives on the margin, and they are very modest, was if you look at 2016, the experience that we've had has been a very largely improving level term margin. What we just wanted to indicate to the street is that we think the margins will continue to remain very strong. We don't expect to see as much margin expansion in 2017 as we saw in 2016, largely because of this dynamic. You are absolutely correct. We do believe that it does actually create more bottom-line income, just a slightly lower overall margin.
In that $15 million, as you've gotten further from the IPO, you're ceding less to the reinsurer. Is that it?
Correct. Up until the end of this year, obviously we sell level term products, and when they come to the end of their level term, the policy can either renew, it can convert to something else we have available, a newer product, or, of course, it can lapse. To the extent that a policy has renewed or converted, that has been ceded to the IPO reinsurers consistent with any other policy, so 80%. Effective 1/1/2017, if the policy reaches that stage for the first time, we will no longer cede that risk. That is why you're seeing the changes. Essentially, this line item that's ceded to IPO reinsurers. That will go down. Adjusted direct premiums will go up.
Additionally, you'll see an adjustment on the ceded premium line because we'll no longer receive the reimbursement, if you will, from the IPO reinsurers on the YRT business, third party business that we had in force on that same business, same block.
The $15 million impact was full year 2017?
That was a full year 2017, it will emerge over the year. It'll be very small in the first quarter and start growing after that.
Okay. Thank you.
You're welcome.
Our next question will come from Adam Klauber of William Blair. Please go ahead.
Thanks. Good morning.
Good morning, Adam.
Good recruiting, good sales force growth. The registered reps are growing, obviously the sales force is growing at a much faster pace. I realize they don't usually grow at the exact same pace, at some point, would you expect the growth of the registered reps to start picking up more in line with the overall sales force?
I think like several things in that pipeline that creates our distribution system, Adam, you have delays that are built in. One of the delays is after we see an increase, an unusual increase or an unusually large increase in our life license sales force, there usually is a lag before that starts to show up in the securities license sales force. On average, it's about two years from the time a person gets a life license until they get a securities license. There's a lot of kind of deviation from that, but that's the average. You should expect a lag in that. I do think some of the uncertainty in the ISP world with the DOL regulatory change is probably giving us a small headwind on that as well.
There's a little bit of a wait and see attitude, I think, throughout our industry that might be slowing that down just a little, perhaps extending that delay. Overall, we would expect to see that pull through, with that delay accounted for, we would expect to see our security sales force begin to grow and play a little catch up to get to the same trajectory as our life sales force.
Great. That's very helpful. On the DOL, is your product line up under the DOL, which is starting in 2017? Is that mainly set at this standpoint? Is there still a lot of work to get the products lined up? I guess, where are we in that process?
Yeah. As we said in the prepared remarks, it's an unusual circumstance since the election with a lot of new uncertainties introduced.
Right.
We're continuing to operate under the expectation until we're notified differently that the Rule will be implemented as written and on time. That makes your question important. Fortunately, we have a fairly narrow product set because of the way our business has been run traditionally. That has made it easier for us to look forward and say, what would a future product set look like compared to today? We have kind of fewer products to deal with and to consider and to make sure we can meet all the rules and regulations. We are going through that process. There are a couple of product lines or product providers that we're in discussion with to try to make sure that we're all on the same page about our view of what's required by the Rule, their view of what's required by the Rule.
We're not anticipating anything that's major as far as product line changes with our providers. They're not all nailed down perfectly yet, but we're not looking for a lot of disruption on that front.
Okay. On the buyback, I realize you're spending more money next year getting, obviously, on compliance also. I think Alison talked about working more on the digital platform. If next year goes well, is that potentially conservative, or do you think that's a pretty good range?
The 125 to 150?
Yep.
Yeah. I think the 150 is where we've historically been.
Right.
I say that over the last several years. I think that's a range we think is appropriate. I think 125 to 150 is generally in that range. I wouldn't necessarily expect it to be much different than the 150 per se. Although the company does produce a lot of free capital, and to the extent there was an opportunity, we do believe that we have ways to create capital if needed. Anyway, our general goal has been to try to maintain a level fairly consistent from year to year so that investors and people looking at the stock can understand sort of what our game plan will be.
Okay, great. Thank you very much.
Again, to ask a question, please press star then one. Our next question is a follow-up from Mark Hughes of SunTrust. Please go ahead.
On the DOL rule, I assume you've kept close tabs on all of these things and are getting real-time feedback on them. What's your sense of what the new administration? Has there been any real comments on the DOL Fiduciary Rule specifically? Any sense of either the administration or anybody who might be in the administration, whether they've got a particular view on this? I appreciate your point about the uncertainty, and I would definitely agree with you, I wonder whether there's any direct intelligence or commentary that bears on this.
Right. Well, Mark, in true Primerica fashion, we stay with our finger on the pulse of all possibilities. Yes, we have done a lot of work leading up to and since the election. There is commentary on record prior to the election from one of the advisors of the new administration that said they were not in favor of the rule and would likely take some action were the administration to change. There is an indication prior to the election that it is on their radar, and it could lead to a change in the rule. They've kind of an anti-excessive regulation statement that's been made and the DOL rule mentioned specifically. As we've done our homework, there are a lot of avenues where that could happen.
Of course, I guess we view the more avenues that it could happen, it increases the likelihood that something may happen, will be a logical conclusion. President Trump will appoint a new DOL secretary, and that could lead to a delay in the rule by presidential order or by DOL secretarial order. That could be delayed a short period of time or extremely long period of time as we understand it. A new Secretary of Labor could be in place fairly quickly after President Trump takes office. That's one possibility. Congress could block the rule through legislation, is another possibility. The litigation that's taking place now could take a little bit different track if the DOL or Department of Justice decided not to pursue it as aggressively or defend it as aggressively.
We have had indications from our advisors in D.C. that it is on the Trump transition team's radar. At least it's on a list. We don't know exactly what that means, and it's really hard to speculate, but we do know there are a number of opportunities, and it is something that's been publicly discussed.
Yeah. Thank you for that detail. Do you happen to know from a congressional standpoint, is this something that would need 60 votes, or is it one of those budget items that only would need a majority in the Senate?
Not familiar with that one, Mark. Don't know that one for sure.
Okay. Thank you very much.
Ladies and gentlemen, this will conclude our question and answer session. I would like to turn the conference back over to Mr. Glenn Williams for any closing remarks.
Thank you, Alison. Thank you, everyone, for joining us today. We appreciate your time.
The conference has now concluded. Thank you for attending today's presentation. You may now disconnect your lines.