Good morning, ladies and gentlemen, and welcome to the Primerica, Inc. third quarter of 2013 financial results webcast and 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, Senior Vice President of Investor Relations. Please go ahead.
Good morning, everyone. Thank you for joining us today as we discuss Primerica's results for the third quarter of 2013. Yesterday afternoon, we issued our press release reporting financial results for the quarter ended September thirtieth, 2013. A copy of the press release is available in the investor relations section of our website at investors.primerica.com. With us on the call this morning are Rick Williams, our Chairman and Co-CEO, John Addison, Chairman of Primerica Distribution and Co-CEO, and Alison Rand, our CFO. We reference certain non-GAAP financial measures in our press release and on this call. These non-GAAP measures are provided because management uses them in making financial, operating, and planning decisions, and in evaluating the company's performance. We believe these measures will assist you in assessing the company's underlying performance for the periods being reported.
These non-GAAP measures have limitations, and reconciliations between non-GAAP and GAAP financial measures are attached to our press release. You can see our GAAP results on page three of the presentation. On today's call, we will make forward-looking statements in accordance with the safe harbor provision of the Private Securities Litigation Reform Act of 1995. Forward-looking statements include any statements that may project, indicate, or imply future results, events, performance, or achievements and may contain words such as expect, intend, plan, anticipate, estimate, and believe, or similar words derived from those words. They are not guarantees, and such statements involve risks and uncertainties that could cause actual results to differ material from these statements. For a discussion of these risks, please see the risk factors contained in our Form 10-K for the year ended December thirty-first, 2012. This morning's call is being recorded and webcast live on the Internet.
The webcast and corresponding slides will be available in the investor relations section of our website for at least 30 days after the presentation. After the prepared remarks, we will open the call for questions from our dial-in participants. Now I'll turn the call over to Rick.
Thank you, Kathryn, and good morning, everyone. Beginning on page four, during the third quarter of 2013, our operating revenues grew 8%, driven by strong Investment and Savings Products performance and higher Term Life net premiums. Net operating income declined by $1.6 million in the third quarter due to a $4.8 million decline in net investment income, reflecting share repurchases as well as certain items in the prior period. Alison will discuss these items as well as the year-over-year increase in operating expenses in a minute. Although net operating income experienced some downward pressure, share repurchases over the past 12 months drove a 9% increase in operating income per diluted share to $0.78 compared with the third quarter a year ago.
Results also reflect $2.1 million of legal fees and expenses associated with the Florida Retirement System matters that reduced net income, net operating earnings by $0.02 per diluted share in the third quarter. We believe these cases are without merit and continue to vigorously defend them. In the third quarter, net operating income return on adjusted stockholders' equity increased to 15.8%, which is the highest it has been since we went public three and a half years ago. Some of the dynamics driving the sequential increase in ROE were lower than anticipated operating expenses and the full quarter benefit of the $155 million of shares retired in the second quarter of 2013. Going forward, ROE will experience downward pressure as our recurring income accumulates and stockholders' equity builds until capital is redeployed.
Over the course of the next 12-18 months, ROE should be in the 14%-15% range, assuming we execute our stated capital strategy and assuming FRS expenses come in at expected levels. As we discussed last quarter, our plan is to execute another redundant reserve transaction in mid-2014 in order to execute our multi-year capital strategy. Over the next two to three years, we anticipate being able to return approximately $150 million of capital to shareholders annually, in addition to the shareholder dividends currently paid on an annualized basis. Turning to segment results. In the third quarter, Term Life net premium increased 11% year-over-year, while Term Life insurance policies issued increased 1% from the year-ago period and were down 6% from the historically strong second quarter.
Productivity in the third quarter of 0.19 policies issued per life licensed representative per month was consistent with historical ranges. Sequentially, productivity declined from the 0.21 policies issued per life licensed representative per month in the historically higher second quarter. During the third quarter, our average issued face amount per policy increased 3%, and annualized issued premium per policy increased 4% to $813 compared with the prior year period. Year-over-year, our Investment and Savings Product sales were strong, driven by 19% growth in retail mutual funds and 17% growth in Variable Annuity sales. managed account sales were up 53%, and managed account client asset values more than doubled as of September 30, 2013, versus the year-ago period. Sequentially, Investment and Savings Product sales were down 5% from the typically higher sales during the IRA season in the second quarter.
Strong market performance drove our total client asset values to $42.18 billion at the end of the third quarter, which was a 14% increase over the year-ago period, and a 5% increase from the end of the second quarter. Now John will discuss the distribution results.
Thanks, Rick, and good morning, everybody. As I mentioned last quarter, our goal coming out of this year's convention was to generate momentum and drive long-term sustainable growth by building distribution. Our efforts were successful with the size of our life insurance licensed sales force growing to 94,529 reps, up 2% on a sequential basis, and a 3% increase year-over-year versus the third quarter of 2012. This is the largest size of our sales force in the last two and a half years. As you can see on slide five, initiatives launched at the convention led to the recruitment of over 51,000 new reps in the quarter, an 8% increase over a year-ago period. New life insurance licenses were up 12% year-over-year and increased 9% from the second quarter due to the enhancements we made to our licensing process in 2012 and our continued sales force focus.
License ratios have significantly improved since the 2011 convention. The ratio of new recruits obtaining life licenses in the third quarter of 2013 was 19%, up from a 14% ratio for the full year 2011. We continue to work on initiatives in order to maintain the recruit-to-license ratio in the 18%-20% range going forward. Fewer non-renewals in the third quarter positively impacted the size of the sales force on both a prior year period and prior quarter basis. We expect the percentage of licensed non-renewals and terminations in relation to the size of the sales force will remain in the 8%-9% per quarter in the future. The size of the life license sales force should increase slightly by year-end. We drive towards 2014, we are working on initiatives and business enhancements focused on supporting our sales force.
This will help grow distribution and help more middle-income families navigate their financial futures. Discussed on slide six, middle-income families, which make up approximately 58 million households in the U.S., have been all but abandoned by financial institutions as they have shifted their focus to more affluent and mass affluent markets. The number of individual life policies sold in the U.S. on an annual basis has dropped 43% over the past 30 years, even as the number of households with children rose more than 21%. Over the same time period, if you adjust for inflation, the average face amount of an issued policy grew 183% as more companies targeted higher net worth clients. According to a recent LIMRA study, 35% of households have not purchased life insurance because no one has approached them, and 50% of the underinsured households say they are considering more insurance.
Not only do these families need more life insurance, 49% of Americans are not saving for retirement, according to LIMRA. Primerica's unique distribution model and educational sales approach positions us to fill these financial gaps for hardworking middle-income families. As stewards of this business, we will continue to aim initiatives at growing core distribution and expanding product offerings to meet the needs of middle-income families in order to enhance shareholder value. With that, I'll turn it over to Alison.
Thank you, John. Good morning, everyone. My remarks today will begin with our segment operating results, followed by an overview of our invested assets, as well as insurance and operating expenses. Starting with the Term Life segment on slide seven. In the third quarter, Term Life operating revenues increased 9%, driven by an 11% increase in net premiums. Net investment income allocated to Term Life grew with required assets. However, it remained flat year-over-year due to certain prior year period specific items, including an unusually high volume of called securities and the recovery of interest on a previously defaulted bond. This, coupled with higher insurance expenses, which I will discuss later, were key contributors to operating income year-over-year growth lagging revenue growth.
Net premiums grew faster than DAC amortization, reflecting general improvements in persistency, while benefits and claims grew in line with net premiums as claims experience was consistent with expectations. Non-deferred commission expense continued a declining year-over-year trend resulting from changes in agent incentive programs. In aggregate, operating income before income taxes grew 5% year-over-year. On a sequential basis, operating income declined $1.8 million from the second quarter, primarily attributable to historically strong persistency in the second quarter and relatively higher incurred claims in the third quarter. Looking to next quarter, note that fourth quarter persistency experience is typically the least favorable of the year, with DAC amortization expected to grow faster than net premiums sequentially. On a sub-segment basis, new term year-over-year results reflect the continued building of the in-force block, as well as the other factors I just described.
In legacy, pre-tax operating income was 7.1% of direct premium during the current quarter, which was consistent with the previous quarter and declined from 7.8% in the prior year period. As we've noted in the past, legacy profit margins will decrease over time with some quarterly fluctuations related to mortality, persistency, and expenses. In 2014, we expect the legacy profit margin to decline to the mid 6% range. The 13% decline in pre-tax operating income in the third quarter versus the prior year period largely reflects lower allocated net investment income related to prior positive items I mentioned earlier. Since most of the assets are allocated to legacy, the net investment income variance is larger in legacy than it is in new term.
On slide eight, you'll see our Investment and Savings Products operating revenues increased 13%, and operating income before income taxes remained consistent with the prior year period, reflecting growth in sales and average client asset values offset by higher DAC amortization and operating expenses. Excluding the legal fees and expenses related to the FRS matter that Rick mentioned previously, ISP operating income before income taxes would have increased 6% to $33.6 million year-over-year. Each quarter, we adjust Canadian segregated fund DAC amortization to reflect our anticipated future revenues based on current asset values. Redemptions and market performance were in line with DAC amortization assumptions in the third quarter. However, since the third quarter of 2012 benefited from favorable amortization expense, there was a $1.1 million increase in DAC amortization year-over-year.
Sequentially, DAC amortization was $1.3 million lower than in the second quarter due to market performance in the prior quarter period. Our broad array of ISP products enables us to meet clients' needs through market cycles and generate diverse sources of revenue and income. The relationship between ISP growth in sales, revenue, and income can vary from period to period based on mix of product sales and underlying asset performance. For example, this quarter, the 14% growth in ISP sales led to a 20% increase in sales-based revenue year-over-year, primarily due to a strong new Variable Annuity sales in the quarter versus an elevated level of Variable Annuity internal transfers that generated lower commissions in the prior year period. ISP asset-based revenue and income dynamics are driven by the underlying performance of both the U.S. and Canadian markets, as well as specific product performance.
Our client asset values are primarily equities with a small fixed income component. In the third quarter, average client assets grew 15%, and asset-based revenue increased 12%, while asset-based commissions grew 21% year-over-year. Canadian segregated funds average client asset values were flat with the prior year period, creating mild pressure on revenue due to their higher relative rate of revenue generation than other sources of asset-based revenue. As we've noted in the past, we recognize asset-based revenues on Canadian segregated funds, but commission expenses associated with this product are recognized over time as amortization of DAC and insurance commissions. Asset-based revenue and asset-based commission growth are more closely aligned if Canadian segregated funds were removed from asset-based revenues in the comparison. On a sequential basis, ISP revenues increased 1%, and operating income before income taxes increased 15% compared with the second quarter.
Results reflect asset-based revenue growth, lower legal fees and expenses, and lower Canadian segregated fund DAC amortization. On slide nine, you can see that corporate and other distributed products operating revenues declined to $3.7 million, and the operating loss before income taxes increased $5.3 million from the prior year period. Net investment income allocated to corporate and other declined $4.8 million. Contributing to the decline were growth in Term Life required assets and certain prior year period-specific items. While such actions suppress net investment income, they are catalysts for both ROE and EPS expansion. In our N.Y. subsidiary, benefits and claims increased $4.4 million as a result of increases in policy reserves for certain non-Term Life insurance products.
Insurance expenses at our N.Y. subsidiary decreased $2.8 million due to the release of certain state assessment accruals within our non-Term Life insurance business. Neither of these items are expected to impact future results. Turning to slide 10, our investments in cash were $1.91 billion as of September 30th, 2013, up from $1.88 billion at June 30th. Our net unrealized gain was consistent at the end of the period at $112.9 million compared with June 30th, and the level of gross unrealized losses remained low at $14 million. The average book yield on investments excluding cash at quarter end was 5.19%, down from 5.29% at June 30th, as higher yielding maturities were replaced with lower current market yields. The average yield on purchases was 3.78% for the quarter, up from recent periods.
While the increase in interest rates over the last six months has allowed us to increase the yield on recent purchases, we do not expect to be able to replace the yield on our maturities at current market rates, and therefore will continue to experience downward pressure on the yield of our portfolio. Over the next 12 months, approximately 13% of our portfolio will mature with an effective yield of around 5.5%. The liquidity profile of our holding company continues to be strong. As of September 30th, the holding company had invested assets in cash of $53.8 million. Now let's look at trends in insurance and operating expenses on slide 11. Last quarter, we provided guidance that third quarter insurance and operating expenses would be in line with second quarter levels or at about $73 million. Actual results were considerably less at $66.4 million.
The nearly $3 million release of state assessment accruals in corporate and other was not foreseen in our guidance. The guidance also assumed that FRS-related legal fees and expenses would be in the $3 million-$4 million range, while actuals were about $2 million, largely due to the rescheduling of some arbitration hearings. Year-over-year overall insurance and operating expenses increased $5.8 million, primarily from the FRS-related legal fees and expenses, $2 million in annual merit increases and an additional layer of stock compensation, $1.3 million of premium and growth-related expenses, and $1 million of incremental expenses primarily from IT infrastructure. Insurance and operating expenses also benefited from the state assessment accrual release in our N.Y. subsidiary, mostly offset by our prior year $2 million annual employee benefit accrual true-up that was not necessary in 2013.
In Q4, we anticipate total insurance and operating expenses to be approximately $68 million-$71 million, assuming FRS-related legal fees and expenses continue in the two and a half to three and a half million dollar range. Now I'll turn it back over to Rick.
Thank you, Alison. Third quarter results were marked by solid core performance across business segments. Our recurring income base and positive Investment and Savings Product performance, coupled with prior share repurchases, continued to drive expansion of operating earnings per share and ROE, underscoring the strength of our franchise. As we look to the future, we will continue to execute initiatives to grow distribution capabilities, increase earnings, and redeploy capital in order to drive long-term shareholder value. I'll open it up for questions.
Ladies and gentlemen, 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. If your question has been addressed and you would like to withdraw from the queue, you may press star then two. At this time, we will pause momentarily to assemble our roster. Our first question will come from Steven Schwartz of Raymond James. Please go ahead.
Hey, good morning, everybody.
Good morning.
A couple here. John, first on the agent persistency, you did note that it was lower than the target you were looking for. Every time this happens, it seems there's something going on, somebody delays renewals or things like that. Did anything happen in the quarter?
Yeah. I'm going to let Rick handle that because he is staring at a sheet with all of the answers on it, Steven.
Okay.
Steven, actually, no, there was nothing unusual in the quarter. We are pleased to see the numbers coming in lower than what we had originally guided everyone to. Over the course of the last year, we've implemented a whole series of programs. The intent is to improve our licensing rate and enhance the recruit success rate. SuccessNow, our new licensing system, the new comp system, our field equity program, a lot of programs could be impacting that non-renewal rate. In truth, we're not sure whether the low rate relates to those programs or potentially just the economy improving. As John mentioned, as we get additional evidence that it is low, we had changed our guidance from 8.5%-9%, down to 8%-9% for non-renewals on a quarterly basis.
The only caveat I'll add to that is for the first quarter of 2014, they'll be somewhat higher because of year-end processes. We are pleased with it, and there's nothing unusual going on in the number.
Okay, great. Rick, while I have you, I'm sure you have people in Washington. The Department of Labor seems to have backed off its fiduciary standards, but maybe you could touch on what's going on in Washington right now on that.
Yeah. I wouldn't say they've backed off. They have continuously said that they will repropose. Originally, it was going to be in the second quarter of this year, then it was going to be in October of this year, then it was going to be at the end of this year. They keep pushing it back. I think their intent, at some point, is to repropose. The question is when and what will they repropose, because they have indicated they are making substantial changes from what was originally proposed. We watch it and are waiting, but we'll see what happens.
Any movement in Congress on the Retail Investor Protection Act?
No.
Okay. All right, thank you.
Once again, if you would like to ask a question, you may press star then one on your telephone keypad. We have a question from Jeff Schuman of KBW. Please go ahead with your question.
Morning.
Hey, Jeff.
I was wondering, the rescheduling of the arbitrations, was this just sort of a fairly normal thing, or I was just wondering if there's a possibility that the plaintiffs were sort of regrouping, I guess, in light of the very limited success they've had so far?
No, I think that's just sort of the normal course. The arbitrations, the ones that have happened, have taken longer than originally anticipated, as a result of them taking longer, it just pushes the other ones back. We have no evidence that they've reconsidered positions at this point.
Do you have the current count of arbitrations pending?
Yes, I do. There are 23 pending arbitrations. There are 32 lawsuits pending in state trial courts, and one lawsuit in federal court currently on appeal. There are 81 total claimants in those pending arbitrations and lawsuits, which is down from 91 at the end of the second quarter. That will all be in the 10-Q, but those are the new numbers.
Okay. Thank you.
Our next question will come from Daniel Bergman of UBS. Please go ahead with your question.
All right. Hi, good morning.
Good morning.
Good morning.
Wanted to see if there's any color you can give on kind of the sales impact of the new Variable Annuity and Fixed Indexed Annuity products from Lincoln that you had launched recently. Any thoughts around the interplay between that new Lincoln VA product and kind of the reduction in income benefits on your existing Met product would be helpful.
Sure. The Lincoln product has been very well received by the field. We did a rollout with a roadshow and wholesaler support. Just to give you a feel for it, in August, the Lincoln product accounted for 39% of VA sales, in September, accounted for 61%. As a percentage of the total, it's a substantial piece. I will say MetLife sales have also held up quite well and better than we'd expected as well.
Okay, great. The only other one I had was, I just want to see if there's any sense you could give on how much, if at all, the July incentive impacted both Term Life and Investment and Savings sales. Just trying to see if we should think of the reported 3Q figure as kind of a go-forward run rate, or was there any positive benefit from that July incentive in there?
I think at the end of the day, remember, we had a convention, conventions are always, every two-year convention is always a positive kind of recharge and re-energizer for our sales force. The thing we feel the best about in the quarter from a standpoint of the sales force was, you'll remember from our previous calls before the convention, that after 2011, we kind of did a half-price recruiting thing. By the way, it wasn't all negative. We had a huge jump in recruiting, and it led to good production. That was really when we focused on the fact that the licensing ratio was absolutely not strong enough, and we made some of the adjustments. We had our incentive this year, our view is it led to a very healthy increase in recruiting.
From our perspective of building distribution, more importantly, it did not lead to a degeneration in our licensing ratio of those people. Clearly, in the fourth quarter, we don't have a convention. As I've guided to and said before, that our goal is to, in the fourth quarter, have year-over-year growth in recruiting, continue to have that, and to keep our licensing ratio up so that our view is the sales force should grow slightly in the fourth quarter. Our goal is to continue to have year-over-year growth in recruiting and to have a strong licensing ratio and to drive sales force growth that way.
Yeah, just a comment. We don't believe that investment sales were impacted by the convention or any incentives that we're running. That's much more attributable to just our long-term focus on the business and also the strong market itself.
Thank you. Very helpful.
Ladies and gentlemen, that will conclude our question and answer session. This will also conclude today's Primerica conference call. We thank you for attending today's presentation, and you may now disconnect.