Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

StanCorp Financial Group, Inc (NYSE:SFG)

Q4 2012 Earnings Call

January 30, 2013 12:00 pm ET

Executives

Jeff Hallin – Investor Relations

Greg Ness – Chairman, President, CEO

Floyd Chadee – SVP, Chief Financial Officer

Jim Harbolt – VP Insurance Services Group

Dan McMillan – VP Insurance Services Group

Scott Hibbs – VP, Asset Management Group

Rob Erickson – VP, Controller.

Analysts

Ryan Krueger – Dowling & Partners

Mark Finkelstein – Evercore Partners

Seth Weiss – Bank of America

Bill Dezellem – Tieton Capital Management

Suneet Kamath – UBS

Randy Binner – FBR

Tom Gallagher – Credit Suisse

John Nadel – Sterne Agee

Chris Giovanni – Goldman Sachs

Steven Schwartz – Raymond James

Operator

Ladies and gentlemen, thank you for holding. Welcome to the StanCorp Financial Group, Inc. Fourth Quarter and Full Year 2012 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. Today’s conference call is being webcast live over the Internet and is also being recorded. A question-and-answer session will follow today’s presentation. (Operator Instructions)

At this time, I would like to turn the call over to Mr. Jeff Hallin, StanCorp’s Assistant Vice President of Investor Relations for opening remarks and introductions. Please go ahead, sir.

Jeff Hallin

Thank you, Kevin. And welcome, everyone, to StanCorp’s fourth quarter and full year 2012 earnings conference call. Here today to discuss the company’s fourth quarter results are Greg Ness, Chairman, President and Chief Executive Officer; Floyd Chadee, Senior Vice President and Chief Financial Officer; Jim Harbolt, Vice President, Insurance Services Group; Dan McMillan, Vice President, Insurance Services Group; Scott Hibbs, Vice President, Asset Management Group; and Rob Erickson, Vice President and Controller.

Today’s call will begin with some brief comments from Greg and Floyd and then we will open it up for questions. Before we begin, I need to remind you that certain comments made during this conference call will include statements regarding growth plans and other anticipated development for StanCorp’s businesses, and the intent, belief and expectation of StanCorp’s management regarding future performance.

Some of these statements made are not historical facts, but are forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995. Because these forward-looking statements are subject to risks and uncertainties, actual results may differ from those expressed or implied. Factors that could cause actual results to differ materially from those expressed or implied have been disclosed as risk factors in the company’s fourth quarter earnings release and the 2011 Form 10-K as modified by the current report on Form 8-K dated July 18, 2012.

With that, I would now like to turn the call over to Greg. Greg?

Greg Ness

Thank you, Jeff, and thanks to all of you who’ve joined us for our fourth quarter earnings call. As we reflect on 2012, we faced significant challenges including persistent low interest rates, elevated claims incidence and a lack of organic growth within our customer base. I’m pleased that our company has responded to these challenges.

In the group insurance business, we are making good progress in implementing our pricing actions to address higher claims incidence as well as lower interest rates. In the Asset Management segment, we saw higher earnings and growth in assets under administration. We had another strong year for commercial mortgage loans with more than $1 billion in new loan originations, and we grew book value per share and increased our annual dividend per share for the 13th consecutive year.

Turning now to our quarterly results. In our Insurance Services segment, we continue to execute our strategy of obtaining and retaining profitable business. We have repriced nearly half of our group long-term disability business to address the increasing claims incidence we have seen since mid-2011. In 2012, we also implemented further pricing actions to address the continued low interest rate environment. Our premium growth, sales and persistency reflect the pressure of our actions to deal with this current economic environment.

Group insurance premiums for the fourth quarter decreased 2.4% compared to premiums for the fourth quarter of 2011.

Group insurance sales were $73.4 million for the fourth quarter of 2012 compared to $74.7 million for the fourth quarter of 2011.

Persistency in our group insurance business was 86.7% for 2012 and that compares to 88.8% for 2011. While persistency is down some, I still view this as a very respectable result. As I’ve said, we will always protect the bottom line over the top line, and that of course starts with getting the right rate on the right risk.

In addition organic growth within our group insurance business is a significant challenge to growing premiums, as this measure depends on employment and wage growth of our current customers. Employment levels among our customers declined 2% year-over-year, continuing the trend we saw over the past three years.

The group insurance benefit ratio was 83.7% for the fourth quarter of 2012, that compares to 82.8% for the fourth quarter of 2011. The comparative increase can be attributed to a lower discount rate on our long-term disability reserves in the fourth quarter of 2012. Using a constant discount rate, the benefit ratio showed slight improvement quarter-over-quarter.

I’m pleased with the progress on our renewal actions, but I also expect that we will continue to see normal quarterly volatility. Persistent low interest rates have pressured everyone in our industry and Floyd will speak to interest rates and guidance for 2013 in just a few moments.

In Asset Management, income before income taxes was $16.3 million for the quarter of 2012, compared to $14 million for the fourth quarter of 2011. The higher income resulted primarily from $1 million in additional fee revenues due to higher assets under administration as well as $1 million from the change in fair values of the hedging assets and liabilities related to our equity-indexed annuity product. The asset management business contributed strong results and I’m encouraged by the growth in assets under administration.

In 2013, we still face a low interest rate environment and likely a lack of significant job and wage growth. As we respond to the headwinds of higher incidence and low interest rates with ongoing pricing actions within our book of business, we expect a modest decline in revenue for 2013. We have already taken action in 2013 to align our operating expenses with our expected revenues.

Our success has always come from delivering high quality customer service from a position of financial strength, this will not change. We will continue to manage our business with discipline and we’ll adapt to the challenges that arise. I expect 2013 to be a good year for StanCorp.

With that, I’ll turn the call over to Floyd for a discussion of our financial results as well as our 2013 financial outlook and, of course, we’ll leave plenty of time for your questions. Floyd?

Floyd Chadee

Thank you, Greg. I will begin by focusing on our new money investment rate, and the discount rate used for newly established long-term disability claim reserves. Then I will comment on the performance of our investment portfolio, our capital position, and finally our 2013 guidance.

In spite of this low interest rate environment, our new money investment rate increased to 4.77% for the fourth quarter compared to 4.46% for the third quarter, due to a mix of new investments. The most notable change in the investment mix was a higher proportion of tax-advantaged investments in the quarter.

Although the 10-year treasury rate has improved since September, credit spreads have tightened. We expect that the continued low interest rate environment will place downward pressure on new money yields and discount rates going forward.

As part of our reserve oversight, we monitor the ongoing adequacy of the margin between our new money rate and our average reserve discount rate. The 12-month reserve interest margin was 68 basis points for the fourth quarter, up from the 57 basis points for the third quarter. This increase in the 12-month interest margin is driven by the increase in tax-advantaged investments.

Our overall portfolio margin was 45 basis points for the fourth quarter, compared to 41 basis points for the third quarter. Our fourth quarter discount rate used for newly established long-term disability claim reserves was 4% compared to 4.75% for the fourth quarter of 2011. The 75 basis point lower discount rate used for this quarter resulted in a corresponding decrease in quarterly pre-tax income of $5.4 million and an increase in the group insurance benefit ratio of approximately 110 basis points. The 95 basis point lower average discount rate for the full year increased the group insurance benefit ratio by approximately 140 basis points.

The continued low interest rate environment will likely remain a challenge for the entire industry. In such a low interest rate environment, we will aggressively take action to combat the effects on our profitability. In the second quarter, we announced a low single digit price increase in our group insurance business, and we will take additional pricing action to address the lower returns as appropriate. As Greg just mentioned, in 2013, we are also managing operating expenses to be in line with the expected decline in revenue.

Moving on to our investment portfolio. Overall, we’re pleased with the performance of our investment portfolio. We have a solid fixed maturity security portfolio. During 2012, we selectively acquired more tax-advantaged investments and took advantage of market opportunities to acquire more A- and BBB+ bonds with attractive risk adjusted returns. While this resulted in lowering our average credit quality ratings slightly from A to A-, less than 6% of our portfolio or $387 million was rated below investment grade at year end. We will continue to place high quality investments on our balance sheet in a disciplined manner.

Our commercial mortgage loan portfolio has a long history of excellent performance demonstrating our strong expertise in originating and servicing high quality loans. During the fourth quarter of 2012, we originated approximately $327 million compared to $237 million for the fourth quarter of last year. For 2012, we originated almost $1.2 billion in new loans, an increase of 17.5% over 2011, while maintaining a low 60-day delinquency rate of 40 basis points at December 31, 2012.

We are encouraged by the increased activity in the commercial real estate market and we remain committed to originating and underwriting the high quality commercial mortgage loans that have provided us a significant yield advantage.

Next, I would like to discuss our capital position. At December 31, 2012, our available capital was approximately $360 million. And the risk-based capital ratio at our insurance subsidiaries was 365%.

In November, our Board of Directors declared an annual cash dividend of $0.93 per common share, a 4.5% increase over the annual dividend paid in 2011. The 2012 dividend marks the 13th consecutive increase in our shareholder dividend since becoming a public company in 1999.

Since the final financial crisis began in 2008, StanCorp has increased its annual dividend per share by 24%. During the fourth quarter, our board also approved the new share repurchase authorization of up to 3 million shares. The new share authorization expires on December 31, 2014 and replaces the previous authorization.

We are pleased with our capital generation over the last two quarters, and we will opportunistically repurchase shares based on the consistency of capital generation and our view of equity market valuation.

I would now like to turn to 2013 guidance. Consistent with prior years, our guidance will focus on two profitability measures, earnings per share and return on equity. We expect net income per diluted share, excluding after-tax net capital gains and losses, to be in the range of $3.40 to $3.80. The midpoint of this range represents an increase of 11% over 2012. We also expect to achieve a return on average equity, excluding after tax net capital gains and losses from income and accumulated other comprehensive income from equity, in the range of 8% to 9%. We believe that this is a reasonable ROE expectation given the low interest rate environment.

As outlined in our earnings release, group insurance premiums, the group insurance benefit ratio, and the effective income tax rate are the three key factors that will affect these profitability measures in 2013. We expect a low single digit decline in our group insurance premiums for 2013 as a result of downward pressure on group insurance sales and persistency.

In addition, lack of wage and employment growth continues to be a significant headwind. We expect that the 2013 annual group insurance benefit ratio will be within the range of 81% to 84%. Improvements over the 2012 group insurance benefit ratio as a result of pricing action will be partially offset by the effects of a lower discount rate.

We estimate our 2013 effective income tax rate will be in the range of 22% to 23%. The lower tax rate is primarily due to a purchase of tax-advantaged investments over the last couple of years. These tax credits will continue to provide ongoing benefits for the next few years. While they do drive a reduction in the reported net investment income, we gain the yield advantage through the lower effective tax rate. It is important to remember that the effective tax rate is also dependent on our level of income. As a rule of thumb, a $20 million increase or decrease in pre-tax income, results in a corresponding 1% to 1.5% increase or decrease in the effective tax rate.

Our guidance reflects our expectation of annual results. As a reminder, quarterly results have historically been lower in the first two quarters. In addition, quarterly benefit ratios can fluctuate outside of the expected annual range as a result of normal volatility.

With that, I’ll now turn the call back to Jeff to begin the question-and-answer portion.

Jeff Hallin

Thank you, Floyd. Kevin, we’re now ready to take the first question from our participants.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). We’ll now take our first question from Ryan Krueger from Dowling & Partners. Please proceed with your question.

Greg Ness

Good morning, Ryan.

Ryan Krueger – Dowling & Partners

Hey, guys good morning. Based on your 2013 earnings and premium growth guidance, could you provide an updated range on the expected free cash flow generation for 2013?

Floyd Chadee

So – you can see we generated about $30 million increase in capital this quarter. I think this – with the benefit ratio that we saw this quarter, that was the result generally of our statutory income, other things coming out in the wash. I think the actual capital generation per quarter next year will depend on the actual benefit ratio, but that is not an unreasonable estimate.

Ryan Krueger – Dowling & Partners

Okay. So if we – if things all went as you expect in your GAAP earnings guidance, $30 million per quarter would be a reasonable expectation for capital generation?

Floyd Chadee

Sure. Give or take fluctuations with the benefit ratio.

Ryan Krueger – Dowling & Partners

Okay. And then I guess related to that, given your statement that you will opportunistically pursue share repurchases seems highly dependent on generating consistent capital generation. And I guess you probably – you’ve had pretty good capital generation now for a couple of quarters, do you feel comfortable now or do you still need to see a few more quarters before you become comfortable again by next time?

Floyd Chadee

So we’re certainly pleased with having two quarters of good capital generation here. And we did say that our share repurchases were dependent on the consistency of that capital generation. As we look forward, I would say that given our priorities for the use of capital, share repurchases would certainly be a viable -- one of the viable options in how we deploy that capital next year.

Ryan Krueger – Dowling & Partners

I guess just one more follow-up on that. I mean we’re into 2013 right now, are you still -- is there something else you need to see before you start share repurchase or are you already at that point (inaudible)?

Floyd Chadee

No – so we didn’t include any specific expectation of share repurchases in our guidance. So our guidance is not dependent on that. But we certainly – with the capital generation we’ve seen, we certainly view that as a viable alternative. So it – in any one quarter and any going forward, it will depend on the specific benefit ratio that we see, but we certainly view it as an option here.

Ryan Krueger – Dowling & Partners

All right. Thanks.

Operator

Thank you. Our next question is coming from Mark Finkelstein from Evercore Partners. Please, proceed with your question.

Greg Ness

Hey, Mark.

Mark Finkelstein – Evercore Partners

Hey, good morning. Just thinking about the group benefit ratio a little bit. I know you can’t take too much from a single quarter, but after you adjust for the change in the discount rate, it’s only, call it, 20 basis points of improvement year-over-year. I guess my question is, you’re about halfway through the pricing cycle, at least the initial pricing cycle, how should we think about this benefit ratio? I mean why aren’t we seeing more improvement, and maybe talk about the underlying drivers in terms of the trends in incidence or claims recoveries.

Greg Ness

All right. Let’s take a shot of that. Jim, you want to start?

Jim Harbolt

Sure, good morning, Mark. Let’s just – let’s talk about the pricing renewal strategy a little bit. You’re right that with our large single digit price increase that we announced in 2011 that we’re about halfway through. But I think it’s important to remember, when thinking about benefit ratio improvement, think about three cohorts of pricing increases that are working their way through the block of business right now, and they’re all at different stages a little bit. Of course the late 2010 price increase we announced for low interest rates, it’s further along. The big price increase, as you stated, is about half way through, and then we announced another one last summer for the low interest rate environment we were seeing. So I think you have to think about all three of those things working through.

Dan McMillan

Mark, this is Dan. I would only add from a LTD claims perspective, we did see a moderately improved incidence in 2012 compared to 2011. And like 2011, 2012 ended the year with better incidence than at start of the year. And so we’re continuing to see that moderate improvement slower than we’d like of course, and recoveries remain strong.

Mark Finkelstein – Evercore Partners

Okay. Maybe just one follow-up on that. In terms of the – the pricing strategy, I know you did announce kind of a subsequent rate increase related to the low interest rate environment. On the earlier rate increases that you have put through, what is the strategy in terms of kind of getting the next tranche of that related to the low rate environment? Is that – are you able to do that annually or were you locked into multiyear kind of rates on those?

Jim Harbolt

You should think about our book as sort of an average of two to three years or maybe through a three-year pricing cycle. And so it takes a while for a rate increase to roll all the way through. Much like we showed on the sort of progress from the large increase – the larger high single digit increase in summer of 2011, it takes a couple of years to roll through.

Mark Finkelstein – Evercore Partners

Okay. I guess just on the investment side, last question is – guidance implies a pretty decent cut in the disability discount rate, following new money, you also saw higher prepays on the mortgage book this quarter. I’m just curious if there’s kind of the wave of refis or the assumption around just more of the block coming due/refinancing, and that’s contributing to the lower discount rate.

Floyd Chadee

Yeah. The main drivers in that expectation of lower discount rate would be just a low yield environment and not being able to access as much as the tax-advantaged investments in 2013 as we did in 2012. The prepayments, theoretically, should contribute to some acceleration of our future margin. But if you look at our portfolio margin this quarter, it actually went up from the previous quarter. So you can see that effect is not material at all.

Mark Finkelstein – Evercore Partners

Okay, all right. Thank you.

Floyd Chadee

Thanks, Mark.

Operator

Thank you. Our next question is coming from Seth Weiss from Bank of America. Please proceed with your question.

Greg Ness

Good morning, Seth.

Seth Weiss – Bank of America

Hi, good morning/good afternoon. Another question on the capital, maybe to ask it a little bit of a different way from Ryan. When we think about the on-balance sheet capital, the available capital of $260 million, I think this is the highest number it’s been in several quarters – several years, excuse me. So how does that play into the decision process?

Floyd Chadee

So it certainly plays in the decision. We are confident in the level of capital that we have. And I remember $100 million or so, actually, in excess of $100 million of that came from a reinsurance. So we said on the last call that it is not our intent to use our balance sheet margins to do share repurchases, but it does give us confidence in terms of deploying capital in ways that will benefit shareholders, one of which would be share repurchases.

Seth Weiss – Bank of America

Okay, great. And just a follow-up, and I know that the benefits ratio is – can be a big driver quarter-to-quarter. If we think about that $30 million cash flow generation as a base, is the fluctuation on cash flow generation in any given quarter going to be aligned with the earnings fluctuation from a change in the benefit ratio, or is it a little bit different?

Floyd Chadee

Well, there are many things that go into the level of capital generation. One, your statutory income tends to be different from your GAAP income, you could have other effects from your non-statutory entities. So those things do provide some fluctuation, but really, the biggest driver is our benefit ratio

Seth Weiss – Bank of America

And are you able to give any kind of numbers around what fluctuation in the benefit ratio means on the cash flow generation?

Floyd Chadee

There’s not an easy rule of thumb for that because, one, your statutory results are different from your GAAP benefit ratio. So there’s not an easy rule of thumb for that.

Seth Weiss – Bank of America

Okay, great. Thanks a lot.

Floyd Chadee

Thanks.

Greg Ness

Thank you, Seth.

Operator

Thank you. Our next question is coming from Suneet Kamath from UBS. Please proceed with your question.

Greg Ness

Hey, Suneet.

Operator

I apologize. The next question is coming from Bill Dezellem from Tieton Capital Management. Please proceed with your question.

Bill Dezellem – Tieton Capital Management

Thank you. That’s Tieton Capital Management. You had a...

Greg Ness

Hey, Bill.

Bill Dezellem – Tieton Capital Management

Good morning. You had a pickup in the 60-day delinquency, I think it bumped up to 40 basis points and they had been hanging around closer to 30 basis points. How are you viewing that? And at what quarter your go forward thoughts there, please.

Greg Ness

Good question, Bill. I’ll ask Scott to take that. Scott?

Scott Hibbs

Yeah. Good morning, Bill. Thanks for the question. The fluctuation that you see there is simply a matter of a couple of loans and a slightly higher average balance in the loans delinquent. So we view it as a very small and normal fluctuation we’d expect to see. Just to kind of remind you of the perspective, we’re talking about 27 loans out of over 6,300 loans delinquent in the quarter. So it’s not anything that’s causing us concern.

Bill Dezellem – Tieton Capital Management

Thank you.

Operator

Thank you. Our next question is coming Suneet Kamath from UBS. Please proceed with your question.

Suneet Kamath – UBS

Hi there.

Greg Ness

Hey, Suneet.

Suneet Kamath – UBS

Hey, again. So I wanted to follow up on Mark’s question about pricing. I get that there’s different vintages and different, I guess, stages of various price increases that you’re going through. But if we had to just say – if I ask a question like what percentage of your cases do you think are at the right price, right now, is that something that you could help us understand?

Greg Ness

Jim.

Jim Harbolt

Well, Suneet, for competitive reasons, I don’t think we want to get into that.

Suneet Kamath – UBS

Okay. But I think people are using this 50% number, but that only represents the price increases associated with one round, and there is other rounds of price increases going on. So presumably, whatever that number is, it’s going to be south of the 50%. Is that a fair assumption?

Jim Harbolt

I think the other thing you have to remember, Suneet, when we look at rolling through price increases, that different quarters have different amounts of renewals in them. And that different quarters or different tranches of quarters behave differently. Some quarters have higher price increases, some have lower. And there’s a lot of moving parts in there.

Suneet Kamath – UBS

Okay. I guess my other question is just on the guidance, and I was trying to figure this out a little bit last night. I mean the range that you’re giving us, the $3.40 to $3.80 is obviously like $0.40 high to low. But if we just hold everything else equal, and we just look at the benefit ratio swing from 81% to 84% potentially for the full year, that just seems like it’s much more than that, almost a $1 swing high to low. So I guess I’m trying to reconcile the two. It seems like either the benefit ratio guidance is extremely conservative or perhaps, the EPS guidance might be aggressive. And I just want to make sure I’m thinking about that right or if I’m just missing something.

Floyd Chadee

Yeah, I think you’re absolutely right, Suneet. They don’t tie in one-to-one. We gave a wider range on the benefit ratio to want to stress the fact that our benefit ratio does fluctuate and it is – and on a quarterly basis, you are going to see wide swings based on just that 90-day level of experience. And it is the one factor that is highly dependent on the external economy. So it is a wider range than our EPS guidance.

Suneet Kamath – UBS

Understood, but just to be clear, I mean the 81% to 84% is not – let’s make sure I understand this – that’s not the range that you’re saying in any given quarter, we might be 81% to 84%. It’s for the full year, we expect to be in the 81% to 84%. Is that right?

Floyd Chadee

That is correct, yes.

Suneet Kamath – UBS

Okay. Well, it still seems like maybe I’m missing something, but maybe I’ll just follow up. Just one quick thing in terms of the prepared remarks. There was some commentary around a focus on expenses sort of in line with the revenue outlook. And I know that in the quarter, there is some discussion around, I guess, lower compensation because of the lower, presumably, sales and lower persistency. Just I want to get a sense if you factor that into your guidance, is that what you mean, or is it that plus just ongoing expense reduction given the revenue environment? So any detail you could provide on that would be helpful.

Floyd Chadee

So there are two categories of expenses to think about there. One will be distribution type expenses related to sales and premiums. Those fluctuate automatically with those levels of sales and premium. But the bulk of our expenses are really operating expenses. And I think the questions you heard in our prepared remarks will refer to active management of operating expenses. And we have taken action on those and we will continue to take action to keep that in line with our revenue.

Suneet Kamath – UBS

Okay. Thanks, Floyd.

Operator

Thank you. Our next question is coming from Randy Binner from FBR. Please proceed with your question.

Greg Ness

Hey, Randy.

Randy Binner – FBR

Hey, good morning, thanks. So my question, I guess, relates to the tax issue and kind of how that might look in 2014. And I guess the way I’ll ask it is, I think, Floyd, you mentioned that you’re going to have lots of tax-advantaged investments in 2013. And so I kind of wanted to clarify that if that is the case, if you can remind us what these investments are and why they would be less available in 2013. And then I guess ultimately, they have a multiyear effect, it sounds like, so could we expect that to extend into 2014 and lower the tax rate then as well?

Floyd Chadee

So one, when we talk about the availability of these low income housing tax credits, we’re talking about putting new investments on the books, that’s what we see trailing off that for the last couple of years, the market for low investment housing tax credits – low income housing tax credits has been a dislocated market, as some of the traditional buyers have gone away and the yields in those were very, very, high. So we took advantage of that for a couple of years.

What we are seeing is that newer investments to put on our balance sheet, that is now dissipating, even as more buyers are coming into the market, generally, and taking the rates down. Now the actual impact on our income statement is a multiyear impact. So what we are seeing this year, in 2013 for example, the effective tax rate has gone down even further – our expectation, effective tax rate goes down even further from 2012. That’s the multiyear effect that you get from having placed those investments in your portfolio. So we expect that lowered income tax rate to continue for a few years.

Greg Ness

Randy, I think it’s important to note that this is a very deliberate strategy on our part when we look at the basket of available investments and the yields there. What we do is we trade off a little net investment income for investing in low income housing tax credits. And so you see it impact the net income line or it also impacts the net investment income line, but we think we get paid far more for the investment on the net income line with the reduced effective tax rate. So it’s a deliberate strategy that plays to our expertise in our mortgage business as well as our tax planning folks here.

Randy Binner – FBR

No – understood, and it helped the 2013 number versus where we were before. I’m just trying to figure out how much extra follow-through we have in 2014, and it sounds like there would be incrementally more, but not dramatically more. So that’s helpful. Thanks.

Greg Ness

Great.

Operator

Thank you. Our next question is coming from Tom Gallagher from Credit Suisse. Please proceed with your question.

Greg Ness

Hey, Tom.

Tom Gallagher – Credit Suisse

Hi there. Just – I had a question on the discount rate. I just want to make sure I get this. Did your – and the wording in the press release says, the discount rate may be lowered 50 to 75 basis points, is that what is in your guidance? Meaning does your guidance contemplate a 3.5% to 3.75% discount rate?

Floyd Chadee

Our guidance does anticipate the possibility of a significant decrease in our discount rate. We’re not really predicting interest rates, and it would depend on the actual interest rates that we see – we experience on new investments that we put on in any one quarter. But yes, we do anticipate, everything else being constant, that there will be a significant decrease in discount rate in the order that you see there.

Tom Gallagher – Credit Suisse

And is that – I presume if that’s part of your guidance, that’s indicative of what you would – what you’re seeing thus far in terms of investment opportunities in 1Q, and that’s what driving it. Is that fair to assume? Or would you still have some cushion based on how that discount rate is shaping up for 1Q based on new money opportunities?

Floyd Chadee

So we – I mean, it’s too early to really say what 1Q in totality will bring us. But clearly as we ended the year last year and we started this year, the Treasuries were up, but spreads were definitely down, and we see pressure on spreads in both our fixed income and our mortgage area.

Tom Gallagher – Credit Suisse

Got it. And then, Floyd, does this – I guess this is a little bit of a confusing issue, but this – does this have anything to do with the tax-advantaged investment strategy? and the reason I ask is because if you’re getting higher after-tax yield but lower pre-tax yield, I presume that actually would at least dampen or hurt the reported recovery, even now on an after-tax basis, things actually do end up netting out, if you will. Is that something I should be thinking about or not material enough to...

Floyd Chadee

Yeah, so that’s not material impact on how we think about the discount rate. The effect that Greg just talked about was an investment income – reported investment income effect on our income statement. So you might see the pre-tax income go down and you much more than make up for it in the effective tax rate. But I don’t think you could – you should think of that as driving – as being the factor that drives down the discount rate. The discount rate is really being driven down by the low environment – low rate environment and, in fact, the lack of availability of new and low income housing tax credits to put on the books.

Tom Gallagher – Credit Suisse

Understood. And then just a last question, can you give some color just about, broadly, how you would view the group disability market. And the reason I ask is I’ve heard, anecdotally, that for larger cases, even from medium size cases that are pretty profitable, it’s fairly competitive to the point where there actually needs to be price concessions to retain business. And obviously, from what you guys are going through, you’re getting rate, so that would be going in the other direction. But is it really a hard enough market to be able to implement what you’re planning on doing or are there – is there still enough – or is there still some pushback given the earlier comment than I made?

Greg Ness

Yeah, Tom, good question. Jim, can you handle that?

Jim Harbolt

Good morning, Tom. We would say that in the marketplace, we see evidences of prices firming out there some, but certainly not for all competitors in all marketplaces. Our guidance for next year on revenue certainly incorporates our expectations for a tough pricing market both on new case sales and in persistency.

Tom Gallagher – Credit Suisse

Got it. Thanks.

Greg Ness

Thank you, Tom.

Operator

Thank you. Our next question is coming from John Nadel from Sterne Agee. Please proceed with your question.

Greg Ness

Mr. Nadel.

John Nadel – Sterne Agee

Good morning, everybody. Sterne Agee was right. I have one quick one and then maybe one more involved. On the discount rates, so Floyd, so the guidance of 81% to 84% on the group benefit ratio already incorporates a potential 50 to 75 basis point discount rate cut, was that – did I get that right?

Floyd Chadee

Yes.

John Nadel – Sterne Agee

So how much would new money yields have to rise to avoid that 50 points to 75 basis points?

Floyd Chadee

I think the high level answer would be by that amount.

John Nadel – Sterne Agee

By 50 to 75 basis points, okay. It’s one-for-one. Okay.

Floyd Chadee

Yeah, about there.

John Nadel – Sterne Agee

The bigger picture question is this, I mean this is more for Greg. If we assumed, Greg, that everything that we see in place today from a macro perspective persists for the next couple of years and all of your rate actions are fully incorporated, by the time you get through all of that, no real improvement in claims incidence, no real improvement in employment levels, all of what we see today’s holds. Where’s your ROE by the time you get through that? So, we’re targeting 8% to 9% in 2013, maybe, a couple of swing factors that could lead that a little bit lower, a little bit higher. But let’s hold everything else constant and run your price increases through your whole book, where is the ROE by the time we’re through that?

Greg Ness

John, I think that one, it’s a hypothetical, so I intend to be a little anxious about trying to answer that. But I think it – on the whole, if you assume that all the pricing increases go through and everything else stayed exactly the same, it would have to have a positive impact on ROE.

John Nadel – Sterne Agee

I’m just trying to get – I’m trying to understand the order of magnitude. Going back pre-crisis, StanCorp was historically a low-to-mid teens ROE company.

Greg Ness

Right.

John Nadel – Sterne Agee

And obviously, we’ve got an incredibly difficult environment that we’re dealing with, and you’re holding more capital today probably than you were then as well, but..

Greg Ness

Right.

John Nadel – Sterne Agee

I’m trying to understand if the delta here is, I don’t know, 5 or 6 points on the ROE, how much of that 5 or 6 points do we get strictly from pricing and how much more do we have to count on getting more comfortable on buybacks and capital deployment, and how much more do we have to get comfortable on sort of economic improvements?

Greg Ness

Okay. John, let me start and then I’ll ask Floyd to kind of chime in here. But when you go back to 12%, 13%, 14% ROE, clearly, the conditions there were very, very different. We probably saw a 5.5% 10-year treasury and we saw spreads way beyond that in terms of our investment income.

One of the other things that’s most important then is we saw an economy at that time that was growing probably in the 2% to 3% to 4% range. That has a very significant impact on the growth – organic growth of the current business, because those employers then are adding employees, they’re increasing salaries and thus, premiums to us. So those things all play into the picture as well. So if you hold all those things constant, I don’t think it’s reasonable to look back then at 2012 or 2013 and say, what would happen with the ROE? Because you’re really comparing apples-to-oranges here in a huge way because those factors were very different at that time.

John Nadel – Sterne Agee

Yeah. I do – I understand this is a hypothetical, I really do, and that there’s so many moving parts. I guess what I’m asking for is some help from you guys who know the business inside and out, especially historically. I mean all the pricing actions that you’re taking, as you’ve described, are designed to combat

Greg Ness

Right.

John Nadel – Sterne Agee

This lower rate environment. So at 2%, call it, 10-year versus 5% or 5.5% many years ago, and higher claims incidence levels, et cetera, right? I mean that’s what the pricing is designed to combat. So I guess what I’m trying to understand is 8% to 9% goes to something, and then we need your comfort, which I assume would come along that improvement to deploy this capital...

John Nadel – Sterne Agee

Right.

John Nadel – Sterne Agee

Or at least a significant amount of that capital, your free cash flow presumably would increase...

John Nadel – Sterne Agee

Right.

John Nadel – Sterne Agee

And then we need the employment environment. So I’m just trying to understand order of magnitude, how much each of those three, if I can call them three broad categories, it counts for?

Floyd Chadee

Okay. So I don’t think, John, that we’re prepared to give you a sort of definitive answer in the long to medium term – medium to long term here on what

Greg Ness

Yeah.

Floyd Chadee

Each one of those would give. But I think to your point, which is raising all these – the question of all these levers that we could pull here, you can be absolutely sure that we would pull all of those. In this low interest rate environment, I think not only does our pricing action being very deliberate in driving that matter a great deal, but as you point out, our capital management matters a great deal too.

The one thing I’d add just along the lines that what Greg was talking about earlier, in 2008, our ROE was on the order of 16.8%. We’re not anticipating nor are we getting back to that level of ROE. In this low rate environment, it would be something south of that. As we look at 2013, we think the 8% to 9% that we gave is entirely reasonable in an adjusting economy and a low interest rate environment, but clearly, we would expect pulling all the levers that you talk about there, to be heading for improved profitability as we go forward.

John Nadel – Sterne Agee

Yeah, no, I would fully expect that as well. I guess last – I’m sorry for taking up so much time. Last quick one is just – I guess, I know it’s been asked a couple of times, I’ll ask it a little bit differently, but I’m still – I am trying to understand what’s the downside scenario that keeps you so cautious as it relates to the $360 million of available capital? I mean you’ve already refinanced your debt. You’ve got the additional $100-plus million from the reinsurance deal. Pricing increases are working through a greater proportion of your book. I guess I’m trying to understand like what is it that’s keeping you up at night, so concerned about starting some modest deployment of what appears to be a very significant level of available capital?

Floyd Chadee

So out of the many things that I’m sure that keep Mr. Ness up at night, I mean this is only one, I’m sure, but I don’t think there’s – I mean I don’t think, John, that we intend for you to hear either excessive levels of caution or excessive levels of aggressiveness when it comes to our capital action here. As we’ve said earlier in the call, we view share repurchases as one of the very viable options in 2013.

John Nadel – Sterne Agee

Okay. Thank you very much for all the time.

Greg Ness

Thanks, John.

Operator

Thank you. Our next is coming from Chris Giovanni from Goldman Sachs. Please proceed with your question.

Greg Ness

Hey, Chris.

Chris Giovanni – Goldman Sachs

Hey, thank you so much. Just wanted to follow up one on kind of the pricing outlook, what you guys are seeing. You’re pushing through for pretty meaningful rate increases, and I guess I’m surprised with the level of sales that you’re still generating and the level of persistency. So is that – by those kind of staying relatively stable, down modestly, is that basically saying the competitors are following suit and pushing for meaningful rate as well?

Greg Ness

Okay. Jim, you want to take that?

Jim Harbolt

Well, I think we’ve said earlier that we’re hearing more about price firming out there, it doesn’t happen in every case and in every market, but we are seeing more price firming. When it gets to persistency, Chris, I’ll talk about that, remember, that we’re coming off of two very high years, we’re down about 200 basis points on persistency over two prior very high years. Relative also to the industry, we start at a much higher number than most folks do. And so I think that’s important to remember. We like to put on business at the right long-term rate, that’s reflected in our historically high persistency relative to the industry. I think the pricing pressures out there are showing up in the 200 basis point drop that we saw last year in persistency.

Chris Giovanni – Goldman Sachs

Okay. And then I guess following up on the operating expense side of things. I mean if we go back since the beginning of 2008, the number of employees at StanCorp are down, close to 20% down quarter-over-quarter pretty much throughout this period. So I guess relative to your employee base now, are you – do you feel like you’re rightsized, do you feel like you have more to go? And then I guess when we start to see an improvement, should that mean that margins could be even better than where we were before? Are you going to rehire and reinvest in the business?

Floyd Chadee

So one of the things is when you do look at our trend in our employees, you do have to remember that some of those would not result directly in a cost – in a one for one cost savings because we do some outsourcing. As we look forward, I mean our intent is to manage all of expenses and as you would imagine, I mean a significant portion of our expenses is related to the employee base. But I think you’d see – you could see that over time fluctuate with our revenue as we think of doing things that would enhance revenue, I think you’d see us add to the resource base and do otherwise in the alternative scenario.

Greg Ness

Chris, this is, Greg. I think on an ongoing basis, you would expect a company like StanCorp to kind of match the expenses up with what we see in terms of revenue. So to the extent that we see revenue as potentially declining on a low single digit basis for 2013, you would expect us to manage our expenses accordingly and that is exactly what we have done.

Chris Giovanni – Goldman Sachs

Okay. So you don’t see, I guess, a lot of operating leverages, purely just going to be on the underwriting side where margins start to improve?

Greg Ness

I’m not certain that I would necessarily agree with that. I think there are opportunities on both sides of the equation.

Chris Giovanni – Goldman Sachs

Okay. That’s all I had. Thanks so much.

Greg Ness

You bet.

Operator

Thank you. Our final question today will come from Steven Schwartz from Raymond James & Partners. Please proceed with your question.

Steve Schwartz – Raymond James & Partners

Hey, good morning, everybody.

Greg Ness

Good morning.

Steve Schwartz – Raymond James & Partners

I want to follow up on the discount rate thing, Floyd, and I just wanted to make sure I understand what’s going on here. If you are going – your new money rate was 4.77% in the third quarter, if you need to lower your discount rate by 50 to 75 basis points, my math – and you could tell me if I’m wrong or not – but my math would indicate that your new money rate that you’re going to be assuming is in the 3.8% to 4.1% range, would that be correct?

Floyd Chadee

It could be in that range, absolutely, yeah.

Steve Schwartz – Raymond James & Partners

And then I’m a little bit confused on the discussion of the LIHTCs. Should it not – shouldn’t the competition for that and you not being able to put as much on your books actually help, not hurt the new money rate?

Floyd Chadee

Well, let’s see. I mean this was a dislocated market, and because the buyers went away from that market, the yields were quite high for quite a while. Now the traditional buyers are coming back and the yields in those assets have gone down significantly.

Steve Schwartz – Raymond James & Partners

Okay. So the yields were high even on a nominal basis?

Floyd Chadee

Absolutely.

Greg Ness

Absolutely.

Steve Schwartz – Raymond James & Partners

Okay, all right. And then just staying on this topic. One of the things that I noted looking at the numbers, you had significant variable investment income in the fourth quarter in the insurance services line. There was no call out of that for the third quarter. If you back out the variable investment income for the fourth quarter versus the third quarter, assuming there was none in the third quarter, that’s a significant decline in investment income for that segment. Maybe you could address that.

Floyd Chadee

Are you – by variable investment income, are you talking about what we referred to as (inaudible).

Steve Schwartz – Raymond James & Partners

Calls, prepays, yeah things like that.

Floyd Chadee

Prepayments, prepayments, oh, I see. Yes. So your question – I mean for the year, the prepayments amounted to about $0.14 over the previous year. For the last quarter, something on the order of $0.09. Now it’s really important to – I mean these are not like capital gains, we always have them. And if I look back for the last eight quarters, we’ve had prepays in every quarter.

They do – the amounts do change depending on the rate environment and how issuers may think about current rate versus the expectations of where rates may go. As you would expect, in this rate environment, we’re seeing more of those. And one way to think about it, it’s a natural hedge in our financial statements to a low rate environment. And so they happen all the time, $0.09 this quarter. The other thing is, one might tend to think of this as driving our portfolio margin down, which theoretically it could, but our portfolio margin actually went up this quarter. So we tend to manage on the total basis.

Steve Schwartz – Raymond James & Partners

Okay. So would you happen to know what the number was just for group insurance for the third quarter? Would you happen to have that?

Floyd Chadee

We can tease that out here. I think we don’t have the exact number just for group insurance.

Steve Schwartz – Raymond James & Partners

(Inaudible).

Floyd Chadee

For the total company, it was about $0.09 for the quarter over last year in terms of the variance over last, a lot of that actually went into the group insurance.

Steve Schwartz – Raymond James & Partners

No, I was talking about the third quarter number.

Floyd Chadee

Oh, third to fourth quarter.

Steve Schwartz – Raymond James & Partners

Yeah, just that comparison. Jeff, could get back to me later.

Floyd Chadee

Yeah, sure.

Steve Schwartz – Raymond James & Partners

And then just on the business, I’ve been reading – talking heads, prognosticators, whatever you want to think, have been talking about the states getting back – states and localities getting back into much better shape, probably the best shape they’ve been since the financial crisis, and the potential for employment gains in that area for the first time in quite a while. I was wondering if you were in fact seeing anything or had any thoughts on that.

Greg Ness

Dan.

Dan McMillan

Steven, we’re seeing some firming there, just like what you mentioned. There’s quite a bit of variability when you go from the state level to the local government level depending on the location, and we are watching that fairly closely. But the areas where you’re seeing tax bases firm up, you’re seeing those governmental entities start to look to hire as well or at least stop laying off, we are seeing some positive growth in the education segment versus last year at this time as well, which is also a positive sign.

Steve Schwartz – Raymond James & Partners

Okay. All right. Thank you, guys.

Greg Ness

Thanks, Steve.

Operator

Thank you, I would now like to turn the floor back over to management for closing or further comments.

Jeff Hallin

Thank you. I’d like to thank everyone once again for joining our call. There will be a replay of this call starting this afternoon and running through February 8. To listen to this call, you can dial 877-660-6853 and enter the conference ID number 405831. A replay of today’s webcast will also be available at www.stancorpfinacial.com. Thank you.

Operator

Thank you for participating in today’s telephone conference. You may now disconnect your lines.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: StanCorp Financial Group's CEO Discusses Q4 2012 Earnings Results - Earnings Call Transcript

Check out Seeking Alpha’s new Earnings Center »

This Transcript
All Transcripts