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Protective Life Corporation (NYSE:PL)

Q4 2012 Earnings Call

February 07, 2013, 10:00 am ET

Executives

Eva Robertson - VP, Investor Relations

John Johns - Chairman, President & CEO

Rich Bielen - Vice Chairman & CFO

Carl Thigpen - EVP& Chief Investment Officer

Carolyn Johnson - EVP & COO

Analysts

Chris Giovanni - Goldman Sachs

Mark Finkelstein - Evercore Partners

Steven Schwartz - Raymond James & Associates

John Nadel - Sterne, Agee

Eric Berg - RBC Capital Markets

Seth Weiss - Bank of America-Merrill Lynch

Operator

Good day ladies and gentlemen, and welcome to the Fourth Quarter 2012 Protective Life Corporation Earnings Conference Call. My name is Alisa and 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. (Operator Instructions)

I would now like to turn the conference over to your host for today, Ms. Eva Robertson, Vice President of Investor Relations. Please proceed.

Eva Robertson

Thank you, operator and good morning everyone. Welcome to Protective Life Corporation’s [2013] 2012 fourth quarter earnings call. Our call is hosted by John Johns, Protective’s Chairman, President and CEO as well as Rich Bielen, our Vice Chairman and CFO. Here with us also we have Carl Thigpen, our Chief Investment Officer; Carolyn Johnson, our Chief Operating Officer; Mike Temple, our Chief Risk Officer and Steve Walker, our Chief Accounting Officer.

Yesterday, we released our earnings press release and supplemental financial information and both are posted on our website at protective.com. In addition to that information we released yesterday we are using a slide presentation for a discussion (inaudible) and that deck is viewable from the webcast in the link on Investor Relations’ page of our website at protective.com with files available for download from that location also.

Finally, today's discussion may include forward-looking statements which express expectations of future events and/or results. Actual events and results may differ materially from these expectations. Please refer to our press release and the risks and uncertainties as well as Risk Factors section of the company's most recent report on Form 10-K and subsequent 10-Q for more information about factors that may affect future results. Our discussion also includes non-GAAP financial information and reconciliation to the GAAP measures can also be found in the supplemental financial information on our website.

And at this time, I'll turn the call over to John Johns.

John Johns

Yes Eva, thank you very much and thanks to everyone on the call. We appreciate your joining us this morning for a review of our fourth quarter and the entire year of 2012. We are very pleased to report operating earnings for the year were up 15% as compared to last year $3.78 this year. We also are delighted to report that operating earnings for the year came in at $313 million which is a record level.

We outperformed our own expectations with respect to ROE for the year we came in for the year at 11.1%. The value increased 10% over last year and we continue to repurchase shares and pay our dividend and last year we returned 54% of after tax earnings to share owners through repurchasing dividend.

Operating earnings in our segments were good for the year. They were higher in Life Marketing, Acquisitions, Annuities, and Stable Value. And again, this is the fourth consecutive year that we have met or exceeded the annual financial plan that we set forth at our Annual Investors Conference.

In terms of how we look at the quarter, we think it was essentially in line with our plan. Our plan was [$0.88] for the quarter. There is always a lot of moving parts and items in the quarter but we think when you work through all those we came in just about where we expected to be for the quarter, and we are ahead for the year.

I am now going to turn the call over to our Chief Financial Officer, Rich Bielen. He will walk you through the numbers in more detail. Rich?

Rich Bielen

Thank you Johnny and good morning everyone. Turning to slide five, our operating earning on an earnings per share basis was $0.98 for the quarter or $3.78 for the year. We did have some realized investment gains and losses during the quarter of $0.16, resulting in $0.82 of net income available to shareholders for the fourth quarter and for the year we had $0.12 of investment losses resulting in $3.66 of net income available to shareholders.

Turning to slide six, this is a summary of the net realized investment gains and losses for the quarter. We had $0.07 of traditional trading activity in our portfolio as a positive gain. We also had $0.06 related to our Modco transaction related to the Chase transaction of 2006. We did have $0.14 of impairments during the quarter, the largest of which is we made the decision to impair some bonds on a coal-fired power plant and where the sponsor had taken the write off late in the year. That was the majority of the impairment during the quarter.

On VA contracts, the derivatives related to it, we show a loss of $0.13. Our economic hedging activity was well in line with what we expected during the quarter, but that $0.13 is really represented by the tightening of credit spreads that we saw in the financial markets and the FAS 157 effect on our VA business. Mortgage losses and other items were $0.01 in each case, resulting in a total loss for the quarter of $0.16 in net realized losses.

Turning to slide seven, our book value per share ended the year at $59.60, up 30% from $45.45 a year ago. Adjusted or accumulated other comprehensive income, we ended the year at $36.84, up from $33.38 a year ago. At the end of the year, our unrealized gain on our investment portfolio was $3.1 billion; I will also point it to the fact that our gross unrealized losses during the year declined from $448 million to $141 million at the end of calendar year 2012.

Now turning to the business segments, on slide eight in the Life Marketing area, we are reporting $15.6 million of earnings for the quarter. We did see some unfavorable mortality on the term side our mortality was 92% of expected versus 86% in the year ago quarter. We also saw some unfavorable UL mortality during the quarter.

The combination of those two items was a negative mortality variance of $6.8 million for the quarter, but as you can see, our sales were up considerably from a year ago. They were up 66% to $42 million versus $25 million a year ago. That resulted in some higher expenses with the increase in sales this is the first time we have actually seen some impact that resulted in the new capitalization rules and with the increase in that account we have to write off those cases where we were not able to place them and so that resulted in an increase in expense.

The second thing that we did during the quarter is we are implementing a multi-year plan to improve our contact centers. The first phase of that implementation went into effect in the fourth quarter. There are a number of items there for consulting fees and implementation fees that are not able to be capitalized, that contributing an increase of expense of another couple million dollars during the quarter. But I would emphasize, this is part of the longer-term strategy to serve the customer better and we expect once that is completed that we will get benefits on the cost side.

With respect to our going forward sales, we see that in the first quarter we expect those sales to be in the high 30s and for 2013 we expect our sales to be consistent with our plan of $130 million. We are confident in achieving our 2013 plans for this line of business and I’ll also remind you that even though we have unfavorable mortality in this quarter, for calendar year 2012 we actually had favorable mortality of $4.4 million on cumulative basis.

Moving now to slide nine on the Annuity segment; in Annuities we are reporting a record operating income for the quarter of $45.3 million. In this line of business we benefited from some favorable mortality on some life contingent annuities that contributed $4.5 million, really offsetting the unfavorable mortality we saw in the Life Marketing area. Our account balance has increased by 18% from the fourth quarter of last year with the strong markets in 2012 we saw strong VA fee income. We also saw in the quarter that this line benefited from some participating income of $5.6 million.

During the quarter on the sales front, we report $864 million of sales that’s down from the third quarter of $913 million. Our VA sales declined from $761 million in the third quarter to $733 million. As we have indicated to you, we made some products changes late in the fourth quarter. We are seeing a reduction in our sales as we enter 2013 and we expect the first quarter of 2013 our VA sales to be in the range of $500 million to $550 million and our overall plan for 2013 is to be at approximately $2 billion of VA sales.

Now moving to slide 10 the acquisition segment, our earnings were very much in line with expectations at $42.2 million. We did see some slightly favorable mortality in this line. I would point you to the fact though that as you look over these last five quarters we integrated the prior two acquisitions we see very (inaudible) earnings resulting from the combination of all the acquisitions we've done in the past.

Now moving to slide 11, Stable Value Products, reporting $18.7 million of earnings versus $14.2 million a year ago. Our spread for the quarter was 306 basis points including $2.8 million of participating income; adjusted for that participating income we had a spread of 260 basis points that is an all time record high.

We did benefit during this quarter with some high interest expense contracts that mature late in the third quarter. We would expect that the 260 now represents the peak spread for this and as we laid out in our plan, we expect a slow decline over the next few years.

Interestingly, we have seen a pick up in traditional sales again in this space and we saw sales of $272 million and our account balance ended the year $2.5 billion.

Now moving to the Asset Protection line on slide 12, we recorded $900,000 of earnings. We did take a software write-off in this line of business of $4.1 million during the quarter. We’ve started effort a few years ago to upgrade our administrative system. We did a reassessment of that and also identified that some changes had happened on technology and alternatives in the marketplace. So as a result, we decided to discontinue that project. That represents a one-time expense.

Our GAAP earnings are in line with expectations and we did see some increased expenses in this line similar to what we saw in the Life Marketing lines as customer centric strategy in the upgrade of our call centers did impact this line too as we are going out with a project on the companywide basis, and we saw a some slight increase in claims on our recreational vehicles.

On the sales side, they were very consistent with a year ago with a $105 million versus a $106 million a year ago. We saw it on slide 13, we would take this opportunity to just summarize 2012 earnings versus the plan we presented to you late in 2011. Obviously on a quarterly basis, we see fluctuations but I [not] summarizing all that for you and give you a nice way to view the year.

In Life Marketing, our actual earnings were $105 million versus a plan of $126 million. We did have unfavorable unlocking due to the lower interest rate environment. We also in the quarter for the year did execute a securitization transaction that reduced this investment income by $5.5 million, partially offset by the favorable mortality.

On the annuity side, our actual earnings came in at $119 million versus a plan of $106 million. We had strong VA fee income favorable to VA mortality strong spreads in participating income offset by the unlocking we took in the third quarter. Acquisitions at a $171 million is very much in light of plan of a $168 million.

Asset protection, we came in at $17 million versus an original plan of $30 million. That plan had actually been downsized after we had been at our investor conference and the big variables there with the software write-off, some higher expense ratios and as you recall, we settled the lawsuit earlier in this year that had about $3 million impact to the business.

In Stable Value, we earned $60 million versus a plan of $43 million that's a combination of participating income and much stronger spreads than we originally planned for. And then our corporate and other segment showed a loss for the year of $3 million versus a planned loss of $57 million.

We had favorable extraordinary income. We had better than expected interest expense and we did have $38 million of note repurchase gains during the year.

If you look at our after tax operating income, at $313 million, that came in 15% better than our plan of $272 million and as we indicated, our operating earnings for the year were $378 million versus the original plan of $320 million.

And with that, I will turn it back to Johnny for some closing comments.

John Johns

Thanks, Rich and you can see, I think overall, we're very pleased with our results in the quarter and for the year. As we looked to the future, we would like to bring your attention that while we have completely closed our statutory books as yet in a position to make we think a good estimate of where our RBC ratio would be at the end of the year. And our current thinking is that it will be at an all time record high level in the range of 500% to 510% and that our total adjusted statutory capital also be at a record level of about $3.3 billion.

This is good news because I am sure you are aware, there is a lot of M&A activity out there, lot of deals in the pipeline, lot of thinking around restructuring companies and portfolios and so on and so. You know, we're looking at everything that comes down the pike and we are very pleased of the fact that we do have such robust balance sheet and will give us the opportunity to be an active participant in transactions as the year evolves.

We see our sales trends continuing to be good in all of our marketing segments. We are as Rich indicated, making some substantial investments in our infrastructure and our capabilities to support our customer centric strategy. But also as Rich said and I want to emphasize, these are not just expenses, these are investments. They are not capitalized with our investments and we do expect to see a return on those investments overtime.

So finally as always our protective story is we have a plan. We are very focused on. We work very hard to ensure that we can deliver on the plan and we are quite confident as we look to 2013, we will be on track to again deliver the plan that we have laid out at our investors conference.

So with that, I think we will end our presentation and we will open the floor for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Chris Giovanni with Goldman Sachs. Please proceed.

Chris Giovanni - Goldman Sachs

I guess, first question just tied to capital management, share repurchases and all, with the stock now I guess back at levels in the fall of ’08, does that make kind of your outlook for share repurchases, any lower as the fact you are still trading at a discounted (inaudible) buyback tool occurred despite any M&A transaction?

John Johns

Yeah thanks, Chris and good morning. You may recall from our investor’s conference that we are putting together our 2013 plan. We assume that we have repurchased about 85% of GAAP for value excluding AOCI and we are very much in that range now. We continue to think that share repurchase is a very good use of our capital, kind of income balanced portfolio. Our patient approach overall to how we allocate our capital.

Chris Giovanni - Goldman Sachs

Okay, and then I guess regarding VA sales, can you comment at all in terms of go forward strategy around potential product changes in as well as sort of targeted VA sales?

Carolyn Johnson

This is Carolyn Johnson. I think we’ve made three substantial changes in 2012 and we feel like we are in a good place right now with the product portfolio we are offering, and we are confident as Rich said earlier that the plan we got for 2013, so we are not anticipating major changes to the VA line, of course we are always watching the competitors and keeping that in mind and we would change if needed but that at this point, we feel like we can stay within our plan and our limit for 2013.

Chris Giovanni - Goldman Sachs

Okay, and then I just one quick one for Rich or Carol. The cash on your balance sheet is up, I guess 80% or so quarter-over-quarter, just curious what drove that material increase?

Rich Bielen

Chris that was just timing at the end of the year, really as you know, the fixed income market shutdown in early December and since that time Carl and his team have able to get us back to fully invested. So that cash balance is back there to a normal level.

Operator

And our next question comes from the line of Mark Finkelstein with Evercore Partners. Please proceed.

Mark Finkelstein - Evercore Partners

My first question is on stable value. Obviously the spreads are extraordinarily high, characterized as high as ever. I'm just curious about kind of what you are getting on what are the higher stable value production quarter. What are the spreads that you are getting on the sales that you booked for this quarter?

Rich Bielen

Mark our traditional pricing on the business as we look at any point in time would imply a spread of approximately 100 basis points and that's been consistent over the last couple of decades really. Here as I indicated we've been benefiting from the fact that this portfolio was a little longer than the liability; and the liabilities that have been maturing have had higher credited rates than the new business. So we haven't had to reinvest here in the short term, and so the contracts we are writing on the margin are turning out to be very profitable. We now expect that we will need to start reinvesting the portfolio over calendar year 2013, so you should see a modest decline as we go through time and we blend in the lower price business.

Mark Finkelstein - Evercore Partners

Is there an effective duration of the liabilities that you can give us?

Rich Bielen

Yeah the duration of the liabilities is approximately two and the asset duration that we've been learning is a little over three.

Mark Finkelstein - Evercore Partners

Okay. At the Investor Day and maybe even in comments prior to that you characterized the capital position as being able to support a $0.5 billion transaction and still be able to support the buyback. I'm just curious you've gotten through year end, you have an estimate on the RBC, is that still a good number, is it a little bit higher, on favorable earnings what is the capacity I guess.

John Johns

Yeah, the number is still good though it is trending higher.

Mark Finkelstein - Evercore Partners

Any commentary if the pipeline is looking more real in terms of probability of outcomes in ’13.

John Johns

Mark its always difficult to predict how things play out in the M&A market, but there are real deals out there though, they are real transactions to be done and so we will just have to wait and see how that plays out.

Operator

Your next question comes from the line of Steven Schwartz with Raymond James & Associates.

Steven Schwartz - Raymond James & Associates

Rich can we revisit the Life Marketing; I'm really not understanding the numbers here. I know you sourced about $4 million of extra expenses with regards to sales and setting up contacts and, I'm all good with that, part of what I'm missing here I think is what were you expecting the A to E to B for the quarter. I know from the presentation for 2013, we are looking for 92 and it came in at 92, so I'm a little bit confused.

Rich Bielen

Yeah, Steve as we keep measuring that it moves in time as we put on new business. We probably were expecting something closer to about 90% but let me roll forward for you the items that would represent the differences from what we presented in the investor conference in our plan last year to where we are. We are reporting 15.6 million, then we had negative mortality of 6.8 million.

Steven Schwartz - Raymond James & Associates

That’s for this quarter. That’s not versus last year.

Rich Bielen

No, that is this quarter alone and that is the combination of the term plus the term plus the UL mortality and some reinsurance in that effect on the UL that all blend together. Then what I am going to call, the expense variance was $5.1 million and that’s a combination of the contact center and the [EITF9] JFX. We also as we learnt through, we had about $2 million of other little items as we just go through our normal process. So that would bring you back to approximately $30 million in total and then we had the $5.5 million related to the Golden Gate V transaction or securitization with the geography of the net investment income moves from the light marketing division to corporate and other. And so that will build you back to an original plan a year ago of approximately $35 million.

Steven Schwartz - Raymond James & Associates

Okay, that’s growth. I appreciate. One accounting question. I know you cited $5.5 million, maybe this has to with reserves or something like that from the Golden Gate here but in the corporate and other, you talked about north of 8 million, I think it was 8.9 million off the top of my head. Is that difference reserves?

John Johns

That was just a change between investment income this quarter compared to same quarter last year. That really encompasses more than the Golden Gate V transaction at that [point in time].

Operator

And your next question comes from the line of John Nadel with Sterne, Agee. Please proceed.

John Nadel - Sterne, Agee

Most of my questions have been asked or/and answered already, so I guess I will just ask you what specific property is your company looking at?

John Johns

John if we told you we’d have to kill you.

John Nadel - Sterne, Agee

After last night I am not so sure that would be a bad idea. Thanks so much good solid results for 2012. Thank you.

Operator

And your next question comes from the line of Eric Berg with RBC Capital Markets. Please proceed.

Eric Berg - RBC Capital Markets

My first question is a general one regarding the M&A activity into the (inaudible) area. In my opinion you and Rich and some of your other colleagues are experts in mergers and acquisitions in the variable annuity area, and so I would like to get your view on all this Warren Buffet, Guggenheim. These transactions I don’t know what to think. I just heard them in class from Lincoln (inaudible), this is very good news that private equity is a smart money is getting involved. But a skeptic might look at this and say this is terrible news, it means that the private equity companies are taking value right out of the pockets of life insurance, company shareholders and that life insurance companies are giving these to put [their] business away at distress prices and they are destroying value, I don’t know who to believe and I’d figured in (inaudible) M&A your whole life you might have (inaudible) thank you.

John Johns

Very flattered that you consider our views on those sorts of things of value, and truthfully we don't have a very good response to that. On the top of my head I thought that the fact that some like this is found interested parties about close lot of [VA] business was probably a somewhat positive for the industry, because it did reflect that and talk to people who obviously quite financially after careful analysis had found attractive valuation in that flock of business and that I doubt that that company was a distress (inaudible) surely not, I mean they made a business decision to sell that, so I thought that we should give the investors generally in the industry the (inaudible) business can have some of that, that you can produce consistent shareholder value overtime. Yeah, it’s an interesting question about new entrance into the industry in the M&A space and there are a number of them and you’ve seen some very large transaction announced on mutual (inaudible) and others.

We of course we partnered with [Athene] and [Palo] in the Liberty transaction and transaction I think has worked out very well for protecting (inaudible) has worked out very well for the (inaudible) and I think as far as we can tell fairly smoothly and so time will tell what the long term impacts are on non-traditional buyers, it is clear they have a different perspective on the industry, their valuations would suggest they do look at it differently than we traditional strategic buyers would or even company like Protective is more focused on this locked high transactions.

So I can (inaudible) for concern.

Eric Berg - RBC Capital Markets

That is helpful. My second and final question relates to something that has already been discussed, which is the lower life insurance earning this year versus last. Rich has gone over more than once now with the fact that you had expenses you had to [talk], because I guess it would be inaccurate to say that you got some sales not because of sales but because of the non-sales so to speak. In other words, you were out there taking applications and in the end the policy does not go to Protective, my question is are you looking at I mean you are in the business of writing insurance, not doing work and not to get insurance, that's the big way at this time. So, are you looking at your whole process to try to understand what you can do better to when you do work and get the business?

Carolyn Johnson

This is Carolyn Johnson. We are looking at the process. It is a continued focus for us on the new business and one of the things I talked about in investor conference was the shift we've made over the last year or so to really focus on the more preferred classes of life insurance business because in our analysis that really has created much stronger placements and we are seeing placement trend better as a result of refocusing on the small preferred classes. We are as well working on several other projects that will continue to drive efficiency and speed of delivery of the new business process which also leads to better placement. So that is a continued focus for us.

Operator

(Operator Instructions) Your next question comes from the line of Seth Weiss with Bank of America-Merrill Lynch. Please proceed.

Seth Weiss - Bank of America-Merrill Lynch

Two quick ones, first on the multiyear plan that they talked on the Life Marketing, could you give us a sense of what's the spend is going to look like over the next couple of years and what the costing would be on this and also if this was incorporated in the guidance that you set forth in early December.

Unidentified Company Representative

Seth this is (inaudible). Total expense budget is planned to be somewhere between $12 million to $14 million over the three years. The bulk of that expense will go to Life Marketing, some of it will actually wind up with asset protection because of the customer service there. We would view this that we can get a pay back on this within a couple of years afterward and the expense has been budgeted into our three year plan. But this was something that we started working on really in 2012 and the first phase hit now in the fourth quarter of 2012.

Seth Weiss - Bank of America-Merrill Lynch

Just one more question on the participating mortgage income. I know that this could be volatile, but is there a normalized run rate that you consider as part of the plan.

Carl Thigpen

We've built in our plant for next year at $15 million extraordinary income. What we did see in the four quarter is probably some increased activity related to concerns about the tax rates changing and so there was an increased activity of sales and prepays that I think people were trying to get ahead of a higher tax rate. So I think we did spurt and had some lesser activity spur because of that.

Seth Weiss - Bank of America-Merrill Lynch

Okay then in thinking of the 2013 plan, we see some of that shifting back to this quarter then.

Carl Thigpen

We still expect to see that normal run rate of what we anticipate of about $15 million (inaudible) income for the year. So it should go back to a normalized level in this quarter.

Operator

I will now turn the call over to Johnny for closing remarks.

John Johns

Thanks everyone. Again, we appreciate your interest in our company. I hope you feel from the tenure of this conversation today that we are quite upbeat about Protective and excited about opportunities we see out in front of us and we look forward to having a very solid year in 2013. Thanks a lot.

Operator

Ladies and gentlemen that conclude today’s conference. Thank you for your participation. You may now disconnect. Have a great day.

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