Good day, ladies and gentlemen, welcome to the second quarter 2011 Primerica Incorporated earnings conference call. My name is Regina, I will be your operator for today. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. If at any time during this call you require operator assistance, please press star followed by zero, and someone will be happy to assist you. Today's event is being recorded for replay purposes. I would now like to turn the conference over to your host for today, Ms. Kathryn Kientz, Senior Vice President of Investor Relations. Please proceed, ma'am.
Good morning, everyone. Thank you for joining us today as we discuss Primerica's results for the second quarter 2011. Yesterday afternoon, we issued our press release reporting financial results for the quarter ended June 30th, 2011. A copy of the press release is available in the investor relations section of our website, investors.primerica.com. With us on the call today are Rick Williams, our Chairman and Co-CEO, John Addison, our Chairman of Primerica Distribution and Co-CEO, 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 to make 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, 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 provisions 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, such statements involve risks and uncertainties that could cause actual results to differ material from these statements. Please see the risk factors contained in our Form 10-K for the year ended March 31st, 2011, as modified by the exhibit to our Form 8-K, dated April 12th, 2011, for a discussion of these risks.
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 to questions from our dial-in participants. Now I'll turn the call over to Rick.
Thank you, Kathryn, and good morning, everyone. Welcome to Primerica's second quarter 2011 earnings call. Beginning on slide four, you can see our operating revenues increased 17% for the second quarter to $273.1 million compared to the year-ago quarter. Net operating income for the second quarter grew 21% to $45 million, or $0.59 per diluted share, reflecting growth in new term premium, strong investment and savings product sales, as well as higher client asset values, seasonally favorable persistency and a lower tax rate offset by higher expenses. Alison will walk you through the details in a minute. Net operating income return on adjusted stockholder equity was 12.7% in the second quarter of 2011, which was down from 14.2% in the first quarter, reflecting higher expenses in the second quarter and non-recurring items that enhanced first quarter ROE.
As discussed in the past, we anticipate downward pressure on ROE near term as equity grows, and longer term, we believe returns in the 14% range are achievable as we execute our capital strategy. Investment and savings products continued to drive earnings in the second quarter as total sales increased by 23% and were primarily driven by a 49% increase in variable annuity sales. During the second quarter, variable annuity sales were positively impacted by clients redeeming older contracts and not incurring surrender charges in order to purchase our current Prime Elite IV product that has an attractive living benefit that provides guaranteed lifetime income. Additionally, we recently added annuity clients to our Client Account Manager system, which has facilitated representatives' revisitation of existing variable annuity clients who have products that do not have a living benefit.
Without these transactions, total investment and savings products year-over-year sales growth would have been in line with the first quarter of 2011's year-over-year growth. Historically, this type of sale has accounted for a much smaller portion of total new variable annuity sales. We anticipate this elevated level of activity to decline and return to a more normalized level by the end of the year. Until then, variable annuity sales will be positively impacted by these transactions. Year-over-year client assets increased 21% to $36.02 billion at June 30, 2011, due to improved market conditions. Sequentially, client asset values at June 30, 2011, were flat compared with March 31, 2011, while average client assets increased 2% compared with the previous quarter, which is more indicative of driver of earnings. In our term life business, life insurance issued policies were flat in second quarter 2011 compared with a year ago.
Productivity increased slightly in the quarter with insurance policies issued per average life insurance representative increasing 5% compared with second quarter 2010, which was within our historical productivity range. Sequentially, life insurance policies issued increased 17% in the second quarter 2011, largely reflecting typical seasonality. Our average policy issued premium was flat compared with the first quarter of 2011. During the quarter, we continued to work on our long-term capital strategy. We have completed a substantial amount of the actuarial analysis and the administrative work necessary to execute a Triple X redundant reserve financing with an unfunded solution such as a letter of credit. The amount and timing of this type of transaction will be subject to regulatory approval and other factors. Right now, we are evaluating a potential transaction that can give no assurances that a transaction will be completed.
During the quarter, Moody's assigned an A2 insurance financial strength rating to Primerica Life Insurance Company and a Baa2 senior unsecured debt rating to our self-registration statement. AM Best affirmed our A+ financial strength rating and improved our outlook to stable. S&P also affirmed our AA- financial strength rating. With these ratings, we are well-positioned to approach the debt market at an opportune time. Our debt-to-capital ratio remains low at 16.2%. As I said last quarter, we will continue to give you information as our capital plans become definitive. With that, I will turn it over to John.
Thanks, Rick, and hey, everybody, how are you doing today? I will start by spending a few minutes talking about the momentum and activity generated by our convention and then go into some of the sales force dynamics for the second quarter. I want to thank everyone that is on the call that was at our convention. I hope you had a great time. It was wonderful for us to see all of you there as a part of the refounding of Primerica and our first-ever convention on our own. We told you to expect last quarter, there was a lull in recruiting activity leading into our convention with a significant increase in activity following the event. The convention has historically increased the energy level, excitement, and sense of team within the sales force, this convention truly surpassed our expectations.
The last time we held a convention was in 2007 when Primerica and the U.S. economy and the world were in a fundamentally different place. Four years later, we are our own public company, this convention was another celebration of our independence and freedom. The energetic environment, paired with the revolutionary product technology and incentive announcements, created an excitement which has led to a post-convention surge in activity that I will talk about in a minute. At the convention, we launched a new rapid-issue term life product called TermNow for client face amounts of $250,000 and below. TermNow allows a rep to take an online application, with the client's permission, the company accesses databases, including prescription drug, Medical Information Bureau, and motor vehicle records as a part of the underwriting process. This replaces the old process of taking a saliva sample at the kitchen table.
Results of those searches are reported to our underwriting system in real time in order for the underwriting system to make a decision about whether or not to rapidly issue the policy. A big announcement at the convention was moving our online sales tools from a device-specific system to an internet-based system. This allows representatives to use their current web-based devices, such as a phone or tablet, to give sales presentations and take online applications. This was a really big deal for our sales force, particularly newer reps, because previously they had to replace their existing phone if it was not compatible with the system we used and they wanted to take online applications. The new web-based sales tools and TermNow rapid-issue insurance product were a fundamental change in how reps transact business.
In our experience, even the most positive changes can be disruptive as people try to adapt their methods and sales processes around those changes. To facilitate a smooth transition, we spent a significant amount of time and effort making sure the sales force leaders had the information, tools, and training materials to adapt their businesses in advance of these process changes. It really paid off because we've experienced very quick adoption of the new processes. Prior to the convention, 60% of term life applications were received electronically. 85% of the applications for new life products introduced since the convention have been submitted electronically. To date, 80% of TermNow lives eligible for rapid issue at the time of submission were accepted in under one minute.
Prior to the convention, 24% of life applications submitted were issued within five days, and in July, that jumped to over 40% of applications issued within five days. In our investment and savings business, the launch of managed accounts at the convention generated a lot of enthusiasm among our top investment producers. The life license sales force was interested to learn more about the new indexed annuity we'll be offering through Lincoln National starting in late 2011. We also talked about the new incentive trip contest that will run through November to take 1,500 qualifiers to Orlando next February, where a highlight of the trip will be Primerica taking over Universal Studios for a night. You guys need to be there when we go to Harry Potter Land.
On the last night of the convention, we dropped the bombshell announcement that we are lowering the independent business application licensing fee that a new recruit must pay from $99 to $50 until the end of July, and we challenged the sales force to set a recruiting record. Before the convention, recruiting was trending down, but post-convention recruiting was so strong in the last two weeks of June that recruiting finished flat in the second quarter compared with a year ago. In June, we set the all-time monthly recruiting record for the company with over 29,000 recruits. To capitalize on the recruiting momentum created in June, we tried to stretch the field's vision by challenging them to recruit 40,000 people in July, which would blow away the company record.
While we're still closing out July and the numbers aren't final, we are currently already over 40,000 recruits which makes July the best recruiting month in the history of the company. The size of our life-licensed sales force into the quarter at 90,5 19, a decline of 6% from June 30th a year ago, and 2% from March 31, 2011. Our new life licenses were up 13% from the first quarter of 2011 and declined 18% from a year ago. The non-renewal rate was consistent with the first quarter but remained moderately elevated from historical levels. The year-over-year decrease in new life licenses was primarily due to the year-to-date decline in recruiting prior to the convention. I'm sure you're wondering, what does this recent recruiting surge mean to licensing? What I can say is that we are encouraged by the increase in the number of new recruits registering for classes and attending pre-licensing classes in July 2011 compared to July 2010.
Historically, significant spikes in recruiting have typically been accompanied by deterioration in the licensing pull-through rate but have generally led to more licenses. We are optimistic that the recent recruiting surge will lead to more licenses. Later today, we'll be having our monthly RVP call, where we'll be announcing a series of initiatives to encourage recruiting and incentivize new recruits to complete the licensing process. Our goal is to capitalize on the recruiting momentum in order to generate growth in the fall. The convention provided the environment and the platform to launch our new products, technology initiatives, and incentive programs, which has led to significant recruiting momentum. We must now build on that momentum to increase distribution and generate organic growth in order to positively impact future earnings. With that, I'll turn it over to Alison with the truly exciting part of today's presentation.
Thank you, John, and good morning, everyone. Given that it's been a little over a year since our IPO and that we've had an emerging operating expense base with some notable increases this quarter, I'd like to start today by walking you through the trends in operating expenses on a consolidated basis, including some detail by segment. Afterwards, I'll move into a discussion of the other earnings drivers for each of the segments. Turning to slide six, you'll see insurance and operating expenses increased $7.6 million or 15% year-over-year to $57.4 million. This variance includes some period-specific items for this year and for the prior year period, as well as ongoing variables. In the second quarter of 2011, we incurred $3.2 million of expenses associated with convention announcements, including the launch of our new term product that triggered a $2.3 million write-off of obsolete medical underwriting inventory.
We also incurred $1.3 million of expenses associated with the secondary offering of our stock by Citi in April and other capital structuring projects. In the second quarter of 2010, we incurred $5.5 million of expenses associated with our IPO and the public company launch at a one-time premium tax refund of $900,000 and did not make an employer matching contribution as we transitioned out of the Citi 401 plan and set up a plan of our own. In considering ongoing variables, we have seen the anticipated runoff of legacy expense allowances, as well as increased expenses related to the launch of our managed account product, our Canadian segregated fund assets, and growth in premium taxes as we build out the new term block.
The launch of the Fast Start bonus accelerated the recognition of compensation expense and a record-keeping fee structure change in ISP, while earnings neutral increased our expense base. Other increases were largely related to building out our public company infrastructure. Term life insurance expenses increased $9 million year-over-year. In addition to the convention-related items, the prior year premium tax refund, and the prior year 401 match suspension mentioned earlier, incremental premium taxes contributed approximately $900,000 to expenses directly related to ongoing business growth. Additionally, legacy term expense allowances declined approximately $1.3 million and will continue to do so as the block runs off. In the second quarter of 2011, the investment savings product segment reflects approximately $4 million in year-over-year expense increases.
The increases include approximately $1.1 million related to management fees on higher Canadian segregated fund client account values and the new managed account product launched at the convention. The change in our mutual fund record-keeping fee structure, which increased our account-based revenue but eliminated our out-of-pocket expense reimbursement for certain fund families, also contributed an additional $800,000 to expense. Again, this change had no impact on net earnings. In our corporate and other segments, the largest year-over-year changes relate to the IPO and secondary offerings. Also, we are no longer obligated for Citi expense allowances. On a sequential quarter basis, in last quarter's earnings call, I highlighted expected expense increases of about $5 million, largely from management incentive normalization and the secondary offering. The additional increases were primarily associated with the convention announcements and the change in the mutual fund record-keeping fee structure, both discussed earlier.
Our ongoing expense base, absent the period-specific items, is approaching maturity. As we move forward in 2011, we expect our quarterly expense base to be in the range of $54 million-$56 million on an operating basis. This anticipates additional charges in the third quarter for our convention IBA promotion, modest capital structuring costs, and various quarter-to-quarter activities associated with managing our business. It also anticipates continued growth in premium taxes for new term and allowance runoff for legacy term. As a portion of the legacy term block reinsured with Citi runs off and the expense allowances we receive decrease, the overall earnings impact will depend on our ability to grow premiums sufficiently to replace the runoff business and to manage expenses accordingly.
As we move forward to 2012, we anticipate continued moderate increases in our ongoing expense base as our business grows and as we layer on additional future equity grants and negotiate our long-term IT contracts as they expire. Turning now to page seven. In our term life insurance segment, operating revenues grew by 21% in the second quarter of 2011 compared with the same period a year ago, primarily reflecting new term premiums following the Citi reinsurance transaction, partially offset by anticipated runoff in legacy term premiums. Operating income before income taxes also increased but at a slower pace of 4% over the prior year period.
As discussed last quarter, we expect term life operating income before income taxes to increase at a lower rate than revenues, reflecting the continued runoff of both Citi expense allowances and legacy term mortality gains, which result from actual claims being less than the historical assumptions in the benefit reserve that are locked in at the time the policy is issued under GAAP accounting rules. The flat to declining trends on allocated investment income will also cause a negative spread between top and bottom-line growth rates. In the second quarter of 2011, the gap in growth between operating revenue and operating income before income taxes also reflects higher expenses for new term, partially offset by slightly favorable mortality experience in the legacy block and the impact of favorable seasonal persistency in the new term block.
New term operating income before income taxes was $3.1 million in the second quarter of 2011, reflecting normal growth due to incremental premiums and the impact of seasonally favorable persistency, partially offset by higher expenses. Historically, second quarter persistency is more favorable than our average annual level. Favorable persistency creates both lower DAC amortization and higher reserve increases. Since new term DAC balances are much higher than benefit reserves, the new term growth, combined with the seasonally favorable persistency, resulted in a positive net income net impact of approximately $3 million to operating income before income taxes year-over-year. In comparison with the seasonally favorable second quarter, the first and third quarters of the year are more in line with our average annual persistency level, while the fourth quarter is typically lower.
Legacy term operating income before income taxes declined to $3.1 million versus prior year, or 7%, consistent with the runoff of premium on the closed block. The seasonal persistency discussed for new term does not have a significant impact on the legacy block, as the DAC balances are similar in size to the benefit reserves and the fluctuations caused by persistency in the DAC amortization are generally offset by reserve increases. Also, the DAC balances and benefit reserves do not change as much from period to period when compared to the rapidly growing new term block. Turning to page eight, you'll see the results for our investment savings product segment.
Operating revenues increased 19% to $104.6 million, and operating income before income taxes increased 14% to $30.5 million compared to the year ago period, driven by higher sales and increased client asset values, as well as a shift in the product mix to higher-margin U.S. variable annuity products. DAC amortization on our Canadian segregated fund was also higher due to the lower investment returns during the second quarter of 2011. Sales-based revenue was up $8.6 million, or 24%, and asset-based revenue was up $5.9 million or 15%, both consistent with sales and asset growth in the second quarter. Account-based revenues grew 15%, reflecting the change in record-keeping fee structure, offsetting a 5% decline in the average number of fee-generating accounts. As previously discussed, there was also a corresponding increase in operating expenses that had a slightly negative impact on operating leverage, but overall was earnings neutral.
Net asset flows were marginally positive in the second quarter. Sequentially, the segment experienced higher sales and slightly higher asset values as operating revenues increased by 4% or $3.7 million. Operating income before income taxes decreased by 2% or $600,000 in the second quarter of 2011 compared with the prior quarter, primarily due to higher DAC amortization related to Canadian segregated funds and the first quarter 2011 management compensation accrual release. On page nine, you can see that corporate and other distributed products operating revenues were flat year-over-year and operating losses before income taxes were $6.6 million in the second quarter of 2011, compared with $9.4 million in the same period of 2010. The improvement largely reflects lower expenses. Last year, we incurred one-time IPR-related expenses, and we are happily no longer obligated for Citi expense allocations.
Results for the second quarter of 2011 also reflect higher claims, primarily on short-term disability insurance products underwritten by our N.Y. insurance subsidiary. The loss experience on this block of business can be cyclical and heavily influenced by economic conditions. Although we have implemented a premium adjustment program, these adjustments lag emerging experience due to implementation timing. We expect our initiatives to return the block to normal loss levels early next year. Turning now to page 10, we'll look at our balance sheet. We continue to maintain a conservative balance sheet with a strong capital position. As of June 30th, 2011, our risk-based capital ratio is estimated to be in excess of 600%.
While we've held RBC high intentionally to fund new business surplus strain, ceded premium recoveries and favorable expenses in past periods, combined with a favorable impact from our admitted statutory deferred tax asset, has resulted in statutory surplus being higher than expected for the first half of 2011. Ongoing statutory surplus needs will be considered as we develop and implement our long-term capital strategy. Our debt-to-capital ratio remains low at less than 17%, as does our invested asset-to-equity ratio of 1.5 times. Turning to page 11, investments in cash total $2.3 billion as of June 30th, 2011. We continue to hold a high-quality invested asset portfolio with an average credit rating of A on our fixed income portfolio and a diverse mix among asset classes and sectors. Excluding cash, all but 1% of our invested assets were in fixed income investments, of which 94% were rated investment grade.
The new money rate on our purchases for the quarter was 4.45%, up from 2.72% in the first quarter, as we focused most of our purchases in 10-year corporate issues. We continue to purchase almost exclusively investment-grade securities and continue our prudent strategy of diversification across industry sectors. Our total purchases had an average duration of approximately 6.5 years, with an average credit rating of A-minus. Duration continues to increase slightly as we roll maturities further out the curve. The average book yield of investments, excluding cash, at quarter-end was 5.38%, up slightly from 5.3% at March 31st. We remain cognizant of the extreme uncertainty in the market, whether due to European sovereign issues or the ongoing U.S. fiscal policy debate. We continue to have no direct exposure to Greece or Portugal, and our exposure to Italy and Spain is primarily to telecom and utility companies.
We are comfortable with our overall global bank exposure at approximately 11% of our corporate bond portfolio, which is well below the 24% allocation of the Barclays Corporate Index at quarter-end. With that, I will turn the call back over to Rick.
Thanks, Alison. In summary, we were pleased to report solid net operating income growth reflecting our strong market position in core businesses. We continue to focus on developing meaningful shareholder value by growing earnings and building the business to enhance long-term growth. Now I'll open it up for questions.
Ladies and gentlemen, if you would like to ask a question, you can do so by pressing star followed by one on your phone. If your question has been answered or you would like to withdraw your question, you can press star two. Your first question today comes from the line of Mark Hughes with SunTrust.
Thank you very much. The better productivity on the life sales in the quarter, what drove that? Is that sustainable? Is that a function of just the sales force being a little bit smaller, you've got a more solid core of salespeople?
Yeah. I think it's a function of, one, as you say, the sales force being a bit smaller. The other dynamic is with, as you say, with a smaller sales force, having licensed fewer new people, it is slightly more productive. As I said, it's still very much within our historical productivity standards.
It really just moved. The band we've talked about with you guys a number of times, of kind of the productivity band. It did not move out of norm. It just moved up some from where it had been. Remember, it had been at a pretty, with the economy, a pretty historical low. It just moved up some within the band.
Okay. That $50 fee, have you bumped that back up to $99?
You need to be on the RVP call later when we launch the mega bombshell momentum August campaign. Yes, we are going back to the $99. Which I will be, again, don't tell anybody from the field when you're done with the call. I will be doing shortly, as soon as I'm done with this, I'll be in a little more animated version of John doing that. We have some other exciting announcements, and our announcements are very focused on continuing recruiting momentum and driving the 70,000 new members of the Primerica Class of 2011 toward being licensed. I'm going to be referring to the new people out of the convention as kind of our convention surge recruiting class. We've got incentives driving toward them getting licensed.
Right.
Yes, we are. We are readjusting. That was a short-term phenomenon.
Exactly. One final question. Alison, you described the $54 million-$56 million expense base going forward. Could you clarify that, what all that encompasses when you say $54 million-$56 million?
Sure. Specifically, if you look at our financial statements, it would be the line items of insurance expenses and other operating expenses. That number, to be clear, is on an operating basis. A lot of words, a lot of operating there. Meaning that it excludes the IPO equity award that we've been operating out of our results since the IPO. That's what it incorporates, the results for all three segments.
Okay. That's insurance and other operating expenses for all three segments.
Correct. Obviously, it excludes things like commissions and DAC amortization and the like.
Exactly. Thank you.
Mark, thanks for being at the convention.
Yeah, I enjoyed it. It was fabulous. Thank you.
Your next question comes from the line of Jeff Schuman with KBW.
Thanks. Good morning. John, I was wondering if you could talk a little bit more about recruiting. This surge here is kind of new to us. Obviously, it's very big and very dramatic. I think you had signaled to us in the past that you would expect a bounce coming out of a convention. Is this something that typically plays out in weeks or months? Is there then, at some point, a lull on the back side of the surge? Or how do you view it?
Let me talk a little bit about that. It's actually always love in Kathryn's open. I'm going to use words like expect, intend, anticipate, what all the safe harbor words are. In complete candor, this was at a level that exceeded what we expected. Okay? If I could, let me just talk about that dynamic and then talk about what historically we've seen, but this is a historical surge. Okay? People have asked us, you sit around in our business, one of the things that, and a lot of you that were there that heard Art Williams on the first night, he talked about you just got to keep calling the plays. There is a lot of that that is completely true in our business. You got to just keep calling the plays.
Sometimes you think you've drawn up the greatest thing in the history of the world, and the quarterback gets sacked behind the line for 10 yards. Then sometimes you do something, you go, "My Lord, that exceeded my expectations." So there's the how much of it was the $50? How much of it was all the different dynamics? It really was a combination of everything we did and what happened at that convention. Number one, if you meet with me a month before a big convention, I'm always going, "Why are we doing this?" Okay? Dealing with John, Rick is a 55 mile an hour guy. I'm either at 100 or zero. I'm up and down, yo-yoing all over the place. About a month before the convention, I wind up going, "Why are we doing this?" Okay?
When we got there, I realized the impact of not having had that for four years. The fact that the world had truly become, quote-unquote, "the new normal" during that time frame and how different the world was, the team being there, the family being there, everything being together. Out of that, we got a historical jump. I think it was a combination of things. It was all the work we had done. We decided that we were going in there, and we were breaking every pick we had on new products, improvements, things better. At the end, with the $50, I wanted to light the fuse. My thing I was telling people is on the last night, we're putting all this in, I want to light the fuse. Okay?
Our approach had been, in all honesty, that a thing I say quite a bit or have said quite a bit is from something I read years ago, you got to cause things to happen. 1% of people make things happen, 9% of people watch things happen, and 90% of people wonder what happened. Okay. We lit a fuse there. At the last convention, 2007, we had a great convention. The economy was great. Everything was rolling and all that stuff. We introduced a lot of improvements, and we had a 24% increase in recruiting that led to a 5% increase in licensing. That was very sustainable through the time when in the fall of 2008, a meteor hit the Earth, okay. The economy fundamentally changed. We've had a historical jump. It's very early to tell what that is going to lead to.
The thing I will say is that, as I said, we're encouraged by the fact that we had a significant improvement in our attendees and people going to PFSU, which says they're moving toward getting licensed. If I could, I couldn't say what all is going to come out of that because it was compared to what we've had in the past, a jump that exceeded any jump we've ever had before. We weren't lowballing you, saying what we thought was going to happen after the convention, and then, oh, my God, yeah. It was a jump that surprised all of us here. That was kind of rambly, but did that get somewhere near what you wanted to know?
Well, I think it was a good historical explanation. I'm not sure it informed my model a whole lot.
In all honesty, I guess what I should have said is it's very hard to right now give you information that's going to inform your model a lot, other than we got a big recruiting jump coming out of that convention.
Okay. I'll just try to squeeze one other one in, if I may. It's a little bit of a loaded question. Obviously, you wouldn't have prepared to launch the indexed annuity if you didn't think it was worthwhile. As I look at the success you had with registered products, but in the context of a lot of your folks not being registered, now you come with an investment product that's available to the non-registered folks. It would seem like maybe there's a big opening there. How do you size that opportunity?
You go first, then I'll-
Yeah. In Canada, we have the SegFunds product that can be sold by life agents who are not securities licensed, that is a significant component of our Canadian business. By analogy, you would think that there would be a real opportunity for the indexed annuity. The challenge is the minimum size is $10,000, therefore, a lot of the clientele the unlicensed people speak to, it won't be appropriate for. We think there's an opportunity there. We'll wait and see. Big of one as it unfolds.
Okay. Thanks a lot, guys.
Your next question comes from the line of Steven Schwartz with Raymond James.
Hey, good morning, everybody.
How you doing?
Good. Two questions for you, if I could. First, something I'm missing here is obviously the variable annuities, the sales are affected by the turnover from a non-living benefit product to a living benefit product. Shouldn't we have seen that in redemptions? It doesn't look like there was a change in redemptions at all really, as a % of beginning value.
We record those both as redemptions as well as new sales because they're commissionable. They are reflected in both components of the asset roll.
Any idea how much that would have contributed to the asset roll?
We think about $100 million.
About $100 million. Okay.
That's looking at the numbers in comparison to sort of what we would call a normal run rate of transfer activity.
Okay. If I may, another numbers question for you, Alison. The two DAC items that you pulled out, you were going a little fast there. I think you said favorable persistency in life insurance, that added $3 million year-over-year?
That is correct.
Okay. What would that be versus normal? I mean, as opposed to just year-over-year, let's say you were looking at the quarter.
Recognize that normal is a bit hard to define here because last year we had virtually no business. Remember, we were really in our second quarter, our first full quarter of post IPO. I would look at this and say that this was a normal seasonal result in and of itself. The thing that will exacerbate it going to future is obviously the block of business is growing exponentially just based on the nature of how we develop the new term block. Had we been in steady run rate, this would have been a normal result, basically because we were coming off a threshold of virtually no business.
Okay. You also gave some persistency guidance for seasonality?
Yes. Again, as you would expect, we develop our factors and we do our reserving and our DAC using an annual persistency assumption. The seasonality that we do see is that the second quarter has historically been the most favorable quarter from a persistency perspective. First and third quarter generally run along the lines of our average annual rates, and fourth quarter tends to be a little bit worse than the average.
Okay, that makes sense. On the, I'm not sure you gave a number of this at all, on the Canadian seg funds, it sounded like what you're talking about here was some type of unlocking.
Yes, that is correct. Remember that, I guess I should know what the ASC is, but it's a FAS 97 type product. The unlocking there is a quarterly event and obviously nothing unusual about doing unlocking for that product. We did unlock because of changes in redemption rates and returns, mostly because of returns. It had about a $900,000 negative impact in the quarter. Year-over-year, that was about a $400,000 variance because we also had a negative last year.
Okay. That's great. That's what I need. Thank you, guys.
You bet.
Good talking to you, Steven.
Hey, take care.
Your next question comes from the line of Andrew Kligerman with UBS Securities.
Hey, good morning.
Hey, Andrew.
A few questions. Rick, the securitization, Regulation XXX securitization you mentioned earlier, I assume that would be around $300 million. It sounds like, if you had to handicap it seems more likely than not that you're going to do it, that the markets could support it. I'd like to get a sense on that. The other part of it is, if you do it, that'd be a lot of excess capital that you're sitting on. Your RBC is extremely high. Would you use that money to buy back stock?
The answer is yes, we would. A transaction would free up somewhere between $300 million and $350 million of capital that could be deployed. The best use would probably be stock purchases. Yes, that's correct.
Great. Alison, with regard to the insurance expenses and the other operating expenses, that's the $57.4 million that was mentioned a little earlier. You covered a lot in that slide, was it slide six, in terms of the expenses. Is the run rate really in the $54 million to $56 million range, just X-ing out maybe the medical expense and maybe some of the convention expenses. What exactly would you say is a good run rate for the expenses, those two lines put together?
Sure. As I indicated in my prepared comments, I do think $54 million to $56 million per quarter, again, on an operating basis, so excluding the things that we take out in our operating measures or non-GAAP measures, would be appropriate for the third and fourth quarters of this year. I do think we'll see some continued development next year. Obviously, as the new term block continues to develop, grow, there are variable costs such as premium taxes associated with that. We will continue to see the runoff of the legacy allowances. Also we do have a few unique items. One is the layering in of future equity grants.
Obviously, those have a three-year vesting period. Until we get three years out, you will see a growing base there, as well as some of our long-term IT vendor contracts are still up for negotiation. We continue to work on those. We'll see some increases throughout 2012 and 2013.
You mentioned about four items then, premium tax, runoff of the legacy, future equity grants, and you said both IT contracts. Adding all those up, what could we be looking at next year then in terms of a pickup? Would it be 5%, 10%, 15% pickup off of the $54-$56 base?
Well, obviously, we will do everything we can to manage our expenses as closely as possible to the results from this year. We do have those headwinds coming up against us. Obviously, you will see some natural increases for things along the lines of just merit increases, normal cost of living type of adjustments. That said, a significant portion of our expense base is fairly fixed in nature. We will not expect to see significant growth there. We haven't fully looked at our budget. We tend not to give that long-term type of guidance or forward-looking type of information. I'm not aware of anything that would drive expenses outside of the ranges that you're talking about. It should be really more, I'll call it, a mature expense-based growth pattern rather than what we saw this year being our first year out as a public company.
Wait. Just the very tail end of your comment then, you're implying that you can stay in the $54-$56 despite all this. At first, you were saying you can't tell us the budget. Now you're saying maybe that's where the range sits anyway next year.
No, Andrew, I think what you were mentioning is that it would be a 5%, 10% type growth. I think you actually said 5%, 10%, 15%-
Yeah
I'm indicating is that I'm very comfortable that we can work within that range, although at this point, that's about as much information as I can provide.
All right. Thanks. Lastly, going back to John, you talked about this tremendous pickup in recruiting, and it's tough to say at this time where recruiting is going to go. Maybe you could talk a little bit historically about coming out of past conventions and big pickups. I'm sure recruiting always picked up. What would happen three to four months later to recruiting? Would there be sort of a recruiting fatigue? Do you think that could happen again?
No. As I said, as I talked about 2007, which probably is the one that is the closest from a standpoint, we had a significant improvement in the kind of front-end process then. We had an immediate 24% increase in recruiting that led to kind of a 5% increase in licensing. As I said, that carried through, really was very sustainable through 2008 until really the kind of the day the world ended. As you look at it, this is a historical jump, okay? We've never had a jump in recruiting like this, okay? If I could, I really couldn't say, how does that sustain? What do you do?
Clearly, you just had the record recruiting month, which was 40-plus thousand recruits compared to the record recruiting month, 29,000 the month before, which you got to go back a number of years in the past to have kind of a 28,000 recruit. Our goal out of that and our goal when we did what we did at the convention was to create. People had been through a pretty tough time economically and with all the things, to create a jump where people go to a level that just stretches people's vision of what can happen, a belief level, and then establish a kind of new plateau type level above where you were at.
Given what happened, okay, it's very hard to say right now, even if I wasn't on an earnings call or whatever, if it was just you and I having a beer somewhere talking about it's very hard to say what's going to happen out of that. The one thing I can say is we had a historical jump, and the early indicators, which are people registering for class and all that, look good, okay? What I've got to do this afternoon is to, instead of pouring a bucket of cold water on a fire, pour some lighter fluid on it, and that's the goal at 2:00 this afternoon.
Great. Thanks a lot.
Your next question comes from the line of Sean Dargan with Wells Fargo Securities.
Thank you and good morning.
Hey, Sean.
Hi. A question about the TermNow product. All else being equal, what's the average, I guess, increase in premium over the existing term life product?
You mean, the average size that we're currently getting in is about the same as it was to the previous term product on average size premium per policy.
Okay, for the same face value, I imagine it's more expensive, right?
Yes, it is. The way we did it is the TermNow product is slightly more expensive, and the Custom Advantage product, which is the fully underwritten with blood, is less expensive. Roughly, there was a 5%-10% price increase on the TermNow and about the equivalent decrease on the Custom Advantage.
Okay. I guess, what's the sales pitch then to someone who presumably would pass with flying colors through the fully underwritten product? Why would they, I guess, choose to buy TermNow?
Well, understand, number one, we are going to homes that typically insurance companies, particularly the "high-end term companies," they're very focused on upper incomes in what they're selling. We're going to a lot of younger people's home, younger families' homes that, and if they don't want to get on the internet or they don't go, just have to run into someone, no one's talking to them about insurance.
What we believe that has been the genuine excitement and, in all honesty, again, to the things that we say is, as I went into the convention, I said in my script that any change is disruptive, even if it's really good change. The adoption rate of this by our sales force has been very quick. The real answer is you don't have to go get blood tested. You don't have to go through this attenuated process of messing around with this. People today, the younger people are used to do this now. Okay, get online, order a book now, do whatever now. You sit down, you do the presentation, for example, on an iPad, show them what we're doing. A healthy 33-year-old, you take the app, $240,000 of coverage when today they by and large, they have zero.
You hit enter, 54 seconds later, they've got everything emailed to them, and they're done. The pitch, for lack of a better word, is, number 1, this is a great company. This is an awesome company. We do great things. We're sitting there with you in your kitchen right now, and we can get you issued now. That's why we call it TermNow. It's not term, blood test, drag out, and then hopefully one of these days you get a policy in the mail.
The other thing just to understand is below 150, the TermNow is the only product offered. It overlaps between 150 and 250, and then above 250, you have to go to the Custom Advantage product, and TermNow is not available. There is an overlap area, but there's also face amounts where you have to go one way or the other.
Thanks. That's very helpful. Alison was talking about receiving some issuer ratings. Can you just remind us, obviously, you have some debt capacity, but what might be a use of proceeds from any debt issuance?
Yeah. The first use of proceeds would probably be the paying off of the Citi note. As part of the IPO transaction, we have a $300 million Citi note, and there's undertakings to repay that at various points in time. Anything raised above that, if we chose to do that, would again go to stock repurchases.
Yeah. Thank you.
Thank you.
Your next question comes from the line of Colin Devine with Citi.
What's up, Mr. Devine?
Exactly. My name's changed again. Anyway, two questions for you. One, on recruiting. I was wondering if you could just provide a little more detail on how things are going with the registered reps, because when I think about what really drives a lot of your long-term growth, it's getting those people in and also if you like their production trends, because that's what's getting you the annuities and the mutual funds and some of the recurring cash inflows. Then the second thing.
Yep.
Alison doesn't feel left out. If we can talk about what the impact changes to DAC accounting may mean for you in terms of how you're running your business and your sales process. What you think the, if you have any indication now, what you think the adjustment might be.
Okay. On registered representatives, Rick, from a standpoint of aggregate number or whatever, just be.
Yeah. We had total registered reps of 21,000 at the end of June.
Right. What we're doing there, if you look at our business and me giving you my view of game plan of what we wanted to do out of the convention, is first and foremost, we needed to get a recruiting jump, okay? That is the aggregate number of people flowing into the business opportunities. A significant amount of our work that's going on within the company right now, whether it was on managed accounts, whether it's on improvements in our platform and in everything we do, are to incent and drive growth of our registered reps, of getting people through the pipeline and then getting people up to a level in our sales force where it actually makes sense for them to sit down and work toward becoming a registered representative in our business.
We just had a big meeting, an incentive trip at The Breakers a couple of weeks ago, where it was for our securities producers. I will say that the level as you look at our sales force, these are the people that are more the show me, cerebral, study the numbers kind of side of the business. They were at a level of energy and excitement that I have not seen them at in years coming out of the convention. Our approach is we're going to build the platform and build out what we're doing on our security side of the business and increase the intensity and focus on creating new licensed people there. In our business, this is not something where you can focus on a billion things at one time.
Our number 1 laser focus coming out of the convention was to increase aggregate recruiting on the front end of the business so that the licensing trends that you guys look at very well, that we can move our aggregate insurance licenses in the right direction.
Okay, you're going to grow the registered reps organically.
Absolutely.
Okay.
One of the things that's interesting is I think that over time, there are a lot of options and alternatives for us that as we build out our platform, which now with our first step into managed accounts, is becoming more and more compelling. As you look out there are a lot of people that are kind of disenfranchised with where they are. I think there's some opportunities there, but Primerica is organic, okay? That we view that the best person to build and do business with at Primerica is not somebody who is a mercenary, rolling in for a little bit or whatever. Our business is built with people who become Primerica patriots and grow up here, and we develop ourselves. Our strategy is and will continue to be organic development of the new people that we see in.
What percentage of your life sales this quarter came from the registered reps?
The people with a securities license. I don't know that off the top of my head.
Yeah, I don't know that off the top of my head either.
We can.
Be helpful, because you sort of are running two sales forces and.
It is. We're actually running 10 or 12 different sales forces. Trying to say Primerica is all in one nice little basket, there are multiple different components of it. You're right, there are people, and like I said, I was just with them, who gravitate far more to the annuity and the security side of the business, and they are different. Okay? They develop out of the front end of what we do. With that, yeah.
John, you don't want to answer the DAC question?
I'll let-
Okay.
No, John.
I'd be happy to answer them. You asked a few different questions there, Colin. The first part of your question was associated with things along the lines of, are we going to change how we run the business, the things that we do? The simple answer to that is no. We don't think that this accounting change in and of itself would drive any significant changes in the method to which we do business or how we really compensate our sales force. We are working through with our internal staff, as well as our external auditors, very specific items associated with compensation. Obviously, that's a big component of our deferral expense base, and we feel like we're making very good progress there. With regard to the compensation component, do you really believe that the core components of our compensation system will remain deferrable?
There may be some pieces on the fringe, certain special bonuses or things that we do that we may need to no longer defer. For the vast majority of the expense, we believe that will remain deferrable. If you look at page four in the financial supplement, you see the breakdown between general expenses that are deferred and commissions deferred. A lot of the work's really being done on the general expense deferrals. Again, where we see that we will have changes are going to be along the lines of indirect costs, which are currently being deferred, which will no longer be deferred, as well as unsuccessful efforts. I think I've quoted in the past that we think our unsuccessful effort rate somewhere in the 25% range. You will definitely see a haircut along those lines.
With that said, we do feel pretty confident, although it is not assured yet, that we will be able to do a retrospective adoption. I do think it's premature for me to provide numbers. Along the lines of how we feel we'd be impacted vis-a-vis perhaps our peer group, on the actual write-off, the retrospective adoption, I think that we will be well within or below a range of some of the peers, simply because with the Citi transaction, our DAC balance is relatively small vis-a-vis the peer group in relation to the overall size of the financial statements. In looking at where we think we'll be on future deferrals, we have been participating in several industry groups and do think that you will see an increase in our deferrals pretty consistent with what we're hearing from the peers, somewhere in the 20%-50% range.
Excuse me, I shouldn't say an increase in our deferrals, a decrease in our deferrals. That is specifically on the general expenses. Anyway, hope that answers your question.
Right. Alison, you haven't put out the number today. This looks like it's going to be about a 25% reduction to the DAC. I appreciate you said it's premature, but when you're referring to, since that's the only company that's out there publicly.
I didn't say a 25% reduction in the DAC. Just to clarify, Colin, what I indicated was that if you look at what we're capitalizing today, and you look at the general expense component, the two things that will be haircutted there are going to be associated with indirect costs as well as unsuccessful efforts. Right now, because right now we defer costs on all efforts, like medical underwriting, for example. What I indicated was 25% of our current efforts are unsuccessful. That's a component of the haircut you'll see on that specific line. By no means was I referring to a 25% DAC adjustment. It is way too premature for us to provide those numbers.
Okay, thanks.
Thanks, Mr. Devine.
This does conclude the question and answer portion of today's event. I'd like to turn the call back over to management for closing remarks.
Okay. Thank you, everybody. We appreciate your time and look forward to talking to you again next quarter.
Ladies and gentlemen, this does conclude the presentation. You may disconnect. Have a great day.