BOA Merrill Lynch Insurance Conference February 13, 2013

Transcription

1 Before, we get started, please be aware that our presentation includes forward looking statements, and please take note of this first slide. BOA Merrill Lynch Insurance Conference February 13, 2013 Corporation Participants Gary L. Coleman, Torchmark Corp- Co- CEO Larry M. Hutchison, Torchmark Corp- Co- CEO Frank M. Svoboda, Torchmark Corp- EVP, Chief Financial Officer Seth Weiss- Bank of American/Merrill Lynch- analyst Hi, good afternoon, everybody. For those of you who have not met me, I'm Seth Weiss, I took over the life coverage in December. But you're not here to see me. So I'm going to introduce Gary Coleman and Larry Hutchison, Co-CEOs of Torchmark. Torchmark focuses on providing protectionoriented life and supplemental health insurance to the low to middle class. It yielded very strong free cash flows and it's consistently at or near the top of the life group in terms of cash payout ratios. Gary and Larry took over the CEO role last June and prior to their current roles, Gary served as CFO and Larry as General Counsel, each has over 25 years of experience with the companies. And with that, I'll turn over the microphone. Larry Hutchison-Torchmark Corp-Co-CEO Thank you Seth, good afternoon it s a pleasure to be here again this year. Forward looking statement slide As Seth mentioned, Torchmark had a leadership transition last June when Larry and I became Co- CEO s. We re often asked why Torchmark chose a co-ceo structure. While we admit it is a little unusual, we think it s the best arrangement for the company because of the unique relationship that Larry and I have. We ve worked together for over 26 years at Torchmark and we ve worked in all our insurance operating subsidiaries; and due to that experience, our complementary skill sets, and primarily our trust in each other we think this arrangement provides a depth to the position that wouldn t exist with a single CEO. Larry Hutchison -Torchmark Corp Co-CEO The co-ceo arrangement facilitates a sound collective decision-making process and also allows us the flexibility to more easily oversee daily operations and plan for the future. We both believe in the Torchmark business model. We sell simple, protection-oriented products to middle income families through captive distribution with products that generate strong margins and high cash flow. We maintain a conservative investment approach, and we manage our capital to maximize shareholder value. Our target market is vastly underserved and provides significant opportunity for growth as has been evidenced by the Company s performance in recent years. 1

2 2012 Highlights slide Due to our focus on stable, protection oriented products and conservative management of investments, Torchmark has delivered consistent growth. As I mentioned, 2012 was a very good year for Torchmark. Our highlights include: Net operating earnings grew 15%. Net Operating Earnings per Share- slide On this slide, we show operating earnings per share and I might mention that in 2012, life insurance companies adopted accounting standard ASU , the new accounting standard regarding the deferral of acquisition costs. As part of the adoption, life companies restated earnings for the previous five years for comparability. So on this slide the EPS numbers for 2007 through 2012 reflect the new standard, while the years denoted by asterisks, 2003 through 2006, reflect the previous standard. But as you can see, under either standard, net operating earnings per share has increased at a compound annual growth rate of 8.3% over the past ten years despite the financial crisis. For the last five years earnings per share on the new accounting basis has grown at an 8.7% rate. For 2012, we grew net operating earnings per share by 15%, our best year in the past fourteen years. At American Income life sales grew 12%, while the agent count increased 18%. Our Direct Response life sales grew 3% despite a difficult economy. We also began a turnaround at Liberty National. Agent count and sales have grown steadily since February of last year, and life underwriting margin increased from 22% of premium to 26%. We completed the acquisition of Family Heritage Life, and did so without restricting future buybacks or M&A activity. We refinanced quite a bit of our debt on favorable terms, and we repurchased 7.5 million shares or 7.4% of the outstanding Torchmark shares. All in all, it was a very good year for Torchmark. Book Value per share slide Now, I will ask Larry to give his comments on our insurance operations. Torchmark has also shown consistent growth in book value per share. Larry Hutchison-Torchmark Corp-Co-CEO Excluding net unrealized gains and losses on our fixed maturities, our book value per share grew at a compound annual growth rate of 9.7% over the last five years, while our reported GAAP book value, which includes unrealized gains and losses, grew at a compound annual rate of 16% over the past five years. Components of Net Operating Income slide As you can see, the largest component of net operating income is underwriting income. 2

3 Underwriting income is about 70% of our pre-tax operating income. Components of Underwriting Income slide agency activity at all levels of the organization; by individual agent, by individual managers, and by region. Now let s look at a breakdown of underwriting income. As you can see, life underwriting income is the largest component of underwriting income. It produces about 72% of our underwriting income, while health, excluding Part D, produces 16%. We focus on life insurance as it has higher margins, generates significant investment income and it is less competitive and less regulated than health insurance. Now let s look at our major operating units. American Income s labor union affinity and underserved target market allow it to operate in a niche that provides plentiful opportunity for future growth. We expect to see strong net life sales growth throughout the year, beginning with low to mid-single digit growth through the first quarter and then rising to 10-14% for the entire year. American Income Chart slide Direct Response Chart slide American Income is our largest and most profitable distribution channel. As you can see on this chart, life premiums at American Income have steadily increased at a 10 year compound annual growth rate of 9.1%. Underwriting margins as a percentage of premium have consistently ranged from 30-33% before administrative expenses. American Income slide was a great year for American Income. Life sales were up 12% over 2011 and agent count was up 18% over a year ago. We continue to focus on developing middle management to ensure sustainable agency growth. We also continue to refine our agent training programs and financial incentives. Our laptop sales presentation provides us with a wealth of valuable data we can use to manage the agency force. This data allows us to monitor and break down Our second largest distribution channel is Direct Response. As you can see in the chart here, Direct Response life premium has grown at a ten year compound annual growth rate of 7.1%. Our basic strategy is to continually search for new ways to reach our market. We take an innovative approach that is constantly evolving. Over the past few years, internet marketing and our inbound call center have been our fastest growing sources of new production. Five years ago, internet marketing and inbound calls produced about 5% of Direct Response s new business. Today, internet marketing and inbound calls produce approximately 40% of our direct response new business. Direct Response slide 2 Despite a difficult economy, direct response life sales grew 3% in We expect sales to be relatively flat in the first quarter, but as I said on our conference call last week, we are optimistic that the initiatives we are putting in place 3

4 throughout 2013 will increase response rates, resulting in mid-single-digit sales growth for the full year. I would like to add here that the Post Office or the Postal Service s recently announced plan to discontinue Saturday mail delivery is not expected to have any impact on our direct mail business. The changes we made are paying off as we had steady sequential growth in both sales and agent count in 2012 beginning in mid-february and our life underwriting margin as a percent of premium has increased from 22% to 26%. Family Heritage slide Liberty National Chart slide As you can see here on this chart, Liberty National has a history of stagnant premium growth. We are excited about the acquisition of Family Heritage. This is the kind of company we have been looking to acquire a company selling protection insurance to middle income families through a captive agency. Their offering of return of premium health products in non-urban areas gives them a unique operating niche. Liberty National slide 2 Several years ago we began to convert Liberty National from a fixed cost model to a variable cost model. We accelerated this process and began a turnaround program late in We made a management change at Liberty and several other significant changes, including: Office operating expenses are now the responsibility of branch managers, rather than the home office. All new agents are hired as independent contractors rather than employees. We added a new layer of middle management and we cut a significant portion of our non-deferrable acquisition costs. The integration of the Family Heritage s operation has gone very smoothly so far. We believe there is the potential for strong long-term sales growth through geographic expansion and integration of Torchmark s agent recruiting techniques. As we said earlier, this acquisition will not restrict our future share repurchases or M&A activity. I will now ask Gary to discuss our investment operations. Components of Net Operating Income slide The second major component of operating income is Excess Investment Income. While this is a significant change in the culture of this agency, we knew the changes were necessary to produce acceptable profit margins on the business we write and to put Liberty in a position to grow going forward. In 2012, it was $237 million or about 30% of pretax operating income. 4

5 Excess Investment Income Slide Below Investment Grade Bonds slide Excess investment income is our net investment income less the required interest on the net policy liabilities and the interest on our debt. Of the $12 billion of fixed maturities, $11.4 billion are investment grade, and $585 million of bonds are below investment grade bonds. The primary component is the investment income earned on our $12 billion investment portfolio. Regarding the interest on the policy liabilities, since we sell basic whole life and term insurance that is not interest sensitive, the interest on the policy liabilities is primarily the interest resulting from the discounting of the liabilities at the GAAP discount rates. Over the years, we have followed a conservative long term investment strategy. With the high underwriting margins in our insurance products we don t have to stretch for investment yield. The percentage of below investment grade bonds of total fixed maturities is 4.9% compared to 6.4% a year ago and as you can see, higher levels in prior years. At the current level, and with a portfolio leverage of 3½ X, the percentage of below investment grade (BIG) bonds to equity, excluding net unrealized gains and losses is 17%, which is less than most of our peers. Overall, the portfolio is rated A-. Low Interest Rate Environment Rate- Earnings Impact slide Investment Portfolio slide As shown on the slide, 96% of our investment portfolio consists of fixed maturities. These assets are primarily long term, investment grade corporate bonds. We have no commercial mortgage backed securities or securities backed by subprime or Alt-A mortgages. We invest in long term, fixed-rate assets because they provide the best match for our policy liabilities that have long duration and fixed rate nature of their own. Now I would like to discuss the current interest rate environment, the topic that seems to be the most concern to investors in the life insurance industry. While lower interest rates pressure the investment income of all life companies, we believe that we face less exposure to a lower for longer environment than most of our peers. As long as we are in this low interest rate environment the portfolio yield will continue to decline and thus pressure excess investment income. However, the impact on Torchmark will be diminished by the fact that on average, only 2 3% of fixed maturities will run off each year over the next five years. 5

6 To quantify the potential impact of an extended low rate environment, we performed a stress test assuming a new money rate of 4.25% for all investments made in the next 5 years. This scenario results in a portfolio yield of about 5.55% at the end of If you run the test again assuming a new money yield of 4%, it only makes a 5 basis points difference or in other words the portfolio yield at the end of 2017 would be 5.50%. As mentioned, we sell simple whole life and term products. These products are accounted for under the accounting standard previously referred to as FAS 60. As such, DAC is amortized based on premiums earned, not gross profits. In addition, interest rates are locked in at policy issuance and are only changed if it is apparent that the policy is in a loss situation. At these rates, we would still earn a small spread on the net policy liabilities while earning the full basis points on our equity. Interest Rate Environment-Balance Sheet Impact slide In either scenario we will still generate substantial excess investment income. In addition, unlike many of our peers, we don t have concerns regarding the potential impact of low interest rates on our benefit reserves or DAC. Interest Rate Environment- FAS 60 vs FAS 97 slide Companies that sell interest sensitive life, variable life and variable annuity policies follow the accounting standard that s previously referred to as FAS 97. Because of our high underwriting margins it s unlikely that we would ever experience a loss recognition situation. For loss recognition to occur because of lower interest rates, our average portfolio yield would have to decline to 4% and remain there permanently. Our portfolio yield at the end of 2012 was 6.04%. Even if new money rates remained at 4% for the next 20 years, our portfolio yield would still be in excess of 4% 20 years from now - thus no loss recognition. That standard requires annual unlocking of the assumptions used to calculate reserves and DAC. In a lower for longer environment, companies may have to lower assumptions regarding future interest rates, resulting in immediate increases in reserves and/or writedowns of DAC. With respect to our statutory balance sheet, we perform cash flow testing each year for regulatory purposes and our statutory reserves are more than adequate. In fact, in the New York 7 cash flow testing performed in 2012, the margin of adequacy in each of the company s statutory reserves was substantial. 6

7 Interest Rate Environment-Summary slide In summary, with high underwriting margins, we generate significant underwriting income and don t have to rely on excess investment income to generate positive earnings. However, from our stress testing we are confident that we can maintain or grow the current level of excess investment income per share in an extended low rate environment. inforce block that consistently generates substantial free cash flow year after year. This graph shows our free cash flow over the past ten years. As you can see, we generated strong free cash even at the height of the financial crisis. In 2013, we expect to generate free cash of around $355 to $365 million. That said, we strongly prefer higher interest rates. Share Buybacks slide Because of our product profile and our strong and consistent cash flow, we would greatly benefit from a spike in rates. On an ongoing basis, we evaluate alternative uses of free cash, but share buybacks have generally been the most efficient use. We would not be concerned about the resulting unrealized losses in the investment portfolio because we have the intent and more importantly, the ability, to hold our investments to maturity. We began our share repurchase program in 1986, and have purchased Torchmark shares in all years since then, except 1995 the year we acquired American Income Life. Now, I would like to move on to Capital Management. In the last 27 years, we have repurchased 74% of the Company s outstanding shares. Free Cash Flow slide This slide shows the free cash flow generated at the parent company in each of the last 10 years. We define free cash flow as the cash that is available to the parent company from the annual dividends received from the subsidiaries less the interest expense on our debt and less the dividends paid to Torchmark shareholders. The net amount left over is free cash that can be used for any corporate purpose. As mentioned we expect to generate $ million of free cash in If market conditions are favorable, we plan to use most, if not all, of that cash for share repurchases. Now, I would like to conclude my remarks on Capital Management by discussing our thoughts on returning cash to shareholders. Because of the products we offer and our high underwriting margins, we have a large, stable 7

8 Return to Shareholders slide For over 25 years, Torchmark s management and board of directors have agreed on the importance of distributing the free cash to the shareholders. We have accomplished this through share repurchases and dividends, with an obvious emphasis on share repurchases. As a result, Torchmark has consistently distributed a large percentage of earnings to our shareholders. In fact, in the last 10 years, Torchmark distributed 81% of net income to the shareholders. As for the future, maintaining our cash flow at high levels and returning a substantial percentage of earnings to shareholders will continue to be an important part of our business model. Now, I will ask Larry to make some final comments. Larry Hutchison-Torchmark Corp-Co-CEO Finally, let s summarize what Torchmark has to offer shareholders and potential investors. Summary- What does Torchmark offer shareholders and potential investors slide First, Torchmark s growth potential While many people see life insurance as a mature industry, Torchmark actually operates in a vastly underserved market with little competition where the majority of individuals have no life insurance or do not have enough life insurance. Our vast experience along with our ability to control costs allows us to operate effectively in the middle income market. And with the acquisition of Family Heritage Life, we expect to reverse the recent trend of declining health sales. Our high underwriting margins Our operating margins are among the highest in the industry. We don t have to rely on investment income to generate profits. Our conservative investment philosophy - Because of our high underwriting margins, we can generate strong profits without having to take significant investment risks. A sustainable mid-double digit ROE - Our return on equity excluding net unrealized gains on our fixed maturities was 15.5% in 2012 and we expect to maintain ROE at around the 15% level. A safe haven in a low interest rate environment - We are much less exposed to the low interest rate environment than most of our peers. We are very confident that it poses no threat to our balance sheet and we expect to grow net operating earnings per share close to 10% per year even in a low interest rate environment. Our insurance operations are relatively immune to the economy - While low interest rates impact our net investment income, our insurance operations have always proven relatively immune to swings in the economy. Even though sales can be more challenging in a difficult economy, our persistency has 8

9 never been impacted and our earnings are driven by our inforce block. We have strong reliable free cash flow Our statutory earnings are driven by our large, stable inforce block. Even if we had no sales in a given year, we would still generate over $300 million dollars in free cash flow. Our return of cash to shareholders As Gary stated, Torchmark has a long history of using free cash flow to repurchase stock. Since 1986, we have purchased--repurchased 74% of our stock. We expect that the majority, if not all, of our free cash flow in 2013 will be used to repurchase shares as long as market conditions are favorable. This concludes our comments. We ll be happy to answer any questions now. Seth Weiss - Bank of America Merrill Lynch - Analyst Okay. I'll start with one. You talked a lot about free cash flow and even for share buyback. This year also, you were able to put a significant capital to work buying Family Heritage. Maybe you could talk about a little bit your view of the M&A environment and what you view as funding sources when opportunities become available? think even though it's small, we -- it has much opportunity to grow; the second, we were able to finance that acquisition using in large part insurance company funds, which didn't disturb the free cash that we could also use for share repurchase. And I'd say that share repurchase has been the most efficient use, if we find an -- like we did with Family Heritage, if we find an acquisition that is going to give us a good yield, then we'll do that as opposed to share repurchase, but we're not going to sit on money -- the great thing about Torchmark is that free cash comes in every year. When you talk about funding where our leverage is in the low-to-middle range with peers and we have that cash coming in every year, we've got multiple ways to finance the transaction. Seth Weiss -Bank of American Merrill Lynch Analyst And when you think about leverage, is there opportunity there if you see something attractive in order to ramp that up a little bit? Gary Coleman- Torchmark Corp -Co-CEO Oh, yes. We have Frank Svoboda- Torchmark Corp EVP, Chief Financial Officer Right now, our debt to cap ratio is around 28% and once we retire our maturity, our August 2013 maturity here in August, it will drop down to about 26%. Rating agencies, well, we try to really maintain it somewhere in that 25% to 30% range. So we have a little bit of capacity to increase the debt, if an opportunity came about. Well, as far as the M&A environment, the companies that we're interested in, and Family Heritage met all the criteria. Companies that sell in the middle-income market like our other operations do, have a captive or controlled distribution -- and have high underwriting margins. They're hard to find. We've been looking pretty hard for the last four or five years and there's companies that fit that criteria that we are interested in, but they're owned by other companies and are not for sale at the moment. We'll continue to look for acquisitions. We like the Family Heritage acquisition; one, we Seth Weiss -Bank of American Merrill Lynch Analyst And then, I'll ask just one more on Liberty National. You mentioned very strong results this year and the margin expansion. In the presentation, you also mentioned migrating from rural Southeastern towns to more urban areas. Can you talk about what you view as maybe the longterm growth trajectory there and where margins could eventually head? 9

10 Larry Hutchison- Torchmark Corp- Co-CEO I think the long-term growth strategy is you grow outside of the Southeast, but to first grow, we have to develop our middle management. So we have people we can promote to send in other states. We've started that process. In 2012, we opened an office in the Southwest and the Midwest and the Northeast. What s holding us back right now is just a lack of candidates to fill those positions. It will be an expansion in urban areas, it's easier to recruit agents in a more urban area than a more rural area, but you will see that steady progress throughout 2013 and 2014 and forward. I think the growth of Liberty National - as a standard we'd like to see low double-digit growth in our agency force and our sales. That s a standard we ll try to hold ourselves as we go forward. But you're changing the culture of a company and so you have to change that culture. And we saw steady progress last year sequentially. I think in 2013, we'll see some year-over-year growth; and , as we go forward, we'll see that growth expand. discount rate on our reserves and again, I want to -- don't want to overemphasize that, but we don't sell interest sensitive business, so we're not crediting interest to funds or whatever, simply we have to use -- we have to discount the reserves and so, we've also lowered those -- the discount rate on the reserves. So as the portfolio yield comes down, also the weighted average discount on the reserves come down as well. Frank Svoboda- Torchmark Corp EVP, Chief Financial Officer The 4.25% was just a little bit lower than what the actual new money rate that we incurred for So, that's why we went ahead and used that assuming going forward that the rates, should the rates stay stable at the 4.25%, then that you know looking at what the effect on the portfolio would be, and then as Gary had indicated, retested that down at 4% as well. Guest 1 And as far as the margin expansion, you shouldn't expect that to pick up another 3 points or 4 points the coming year. It should be around the 26 level, maybe a little bit higher than that, but what we did this past year, by making the change in moving it more to an independent, although it's still captive, more of an independent operation where the branch managers are paying -- responsible for the expenses. They re paying expenses that the Company was expensing before. And so that's why we picked up that extra margin. Guest 1 When you were talking about the interest rate assumptions used to assess your reserves and sensitivity to continued low interest rates, how did you arrive at that? Is that a mean reversion assumption or is that based on a roll-forward of your portfolio yield? What -- That -- as far as we've rolled forward the portfolio yield assuming we're earning at 4% or 4.25%. At the same token though, we've lowered the If rates stay low for a longer period, could you foresee any scenario where you could -- you may have to lower the discount rate more and there could be a reserve hit? No, I don't think there would be a reserve hit. When we lower the discount rate, we continue to have to do that, that can impair -- I shouldn't say impair, that could reduce our underwriting margins. Now, one thing we did; American Income, which is our largest operation, we increased the premium rates on new business going forward by 5% in We estimated by having to change the discount rate and reserves, we d need a 1% to 2% increase in premium rates in order to keep our underwriting margins the same. We went ahead and raised them 5%, so we've got a little bit of margin there. The great thing about that is we have the ability to raise the premiums. It's an -- well, there's not a lot of competitors. As a matter of fact, American Income really has no direct competitors. We were able to make that change without we explained it to the agents, they had no problem with it. And there s a very -- 5% on a $400 annual premium, that's not a big change. So, we were able to do 10

11 that and that helps keep our underwriting margins where they were. We'll have less investment income, but we are still protecting underwriting margins. And we'd have the ability to raise you wouldn t want to do that too often, but we'll still have the ability to raise premiums in the future. Guest 2 Just to follow up on the lower rates, I know you said it would take -- for statutory reserves to be adjusted; it would take more than 20 years. But do you have any sense if you ever did have to add to those reserves, how large that increase in reserves would be? Gary Coleman-Torchmark Corp-Co-CEO Well, actually, when we were talking about the 20 years, we were talking about GAAP reserves. From a statutory standpoint, the interest rates are very low to begin with to setting those reserves. I can't imagine us having to add anything significant to the reserves and you got to remember, we're talking about 26% profit margins. So, even if we had to add to the reserves, it would still be a profitable business. Larry Hutchison-Torchmark Corp-Co-CEO Okay. Thank you very much. Gary Coleman-Torchmark Corp-Co-CEO Thank you. 11