Protective Life Corp. (NYSE:PL)
Bank of America Merrill Lynch Insurance Conference Call
February 14, 2013 10:35 am ET
John D. Johns – Chairman, President and Chief Executive Officer
Seth Weiss – Bank of America Merrill Lynch
Seth Weiss – Bank of America Merrill Lynch
Good morning, we’re going to move along with Protective Life. I’m happy to introduce Johnny Johns, Chairman, President and CEO of Protective Life. Protective has been operating in the insurance industry for over 100 years. It also built a core competency in acquiring and managing close stocks of business. Also joining Johnny is Eva Robertson, Head of IR Protective Life. And with that I’m going to turn over to Johnny.
John D. Johns
Seth, thank you very much, and we appreciate the invitation to this conference, and we thank each of you for attending and hearing our presentation. And I’d also like to introduce in addition to Eva Robertson, our Chief Risk Officer, Mike Temple. He’s been with us for a few months, what a great addition to our team. So without further ado, I’d like to just launch into our presentation. Again there are forward-looking statements in the presentation; I refer you to our 10-K and 10-Q for more information about forward statements.
We finished 2012 and I’m very pleased to say on a quite strong note. For the year we reported record operating earnings, highest level in our history 105 years. Our operating earnings per share were up 15% for the year, well ahead of our own expectations in our 2012 plan, and our balance sheet continues to get stronger and stronger, statutory risk-based capital ratio. At the end of the year exceeds 500%. Again just a little step back from the chart for a moment, what I talked about and I want to say those who do not know us very well, should understand about Protective is, is how we deal with investors.
Essentially what we do is, once a year in the late fall we come up here to New York, and we host an Investors Conference. And at the conference we lay out in great detail a plan, our internal operating plan, earnings plan for the next year. We also show two more years of projected earnings again just based on our modeling technology.
What to clear that we don’t give earnings guidance, not intended to be guidance and we don’t have the plan, but what we do is every quarter we reconcile to the plan. We tell you what we expected to do and then we tell you indicator if we didn’t do it, if we exceeded of course what we tell you why.
We have planned to investors one and we are trying to be a very transparent company which is somewhat challenging in the life insurance business. As you know if you follow it is a very complex business, in some ways from a financial point of view. But we’re trying to take as much as the mystery out of it as we possibly can in the way that we deal with investors.
Again you can see in this chart our basic segments; life insurance, annuities, acquisitions which for us we consider a separate line of business, stable value and then a corporate and other line basically where we keep excess capital and expenses and are now allocated to other lines of business.
You can see that our results for the year were actually very much inline in most lines of business, slightly below in like marketing mostly due to moving some investment income out of that line, then into the corporate and others as we freed up redundant reserves during the year.
Annuities are outpaced our plan for the year, good strong market performance helped our VA line and our spreads were better than we expected, and our acquisition line continue to shrug right along, very steady pace, it’s a very solid part of our earnings story, asset protection which is a service contract business for automobiles, extended service contract business underperformed a bit. It’s in a turnaround mode now. We do expect that to improve next year, stable value spreads really great in that line of business this year. We outperformed corporate and other much better than expected generally because of better investment income than we had expected.
So you can see our plan for the year, was $3.20 we exceeded that, we delivered $3.78 for the year. Again just to come back to kind of how we think about the business, and how talk about our business, for the last four years, we put the plan out that I just described and in each of those years, we either met or exceeded the plan in some years as you saw in the last chart by a substantial margin.
Our forward-looking plans do show our expectation were continued strong growth in earnings per share, and also improvement in ROE over each of the next three years, and that’s without an acquisition. We have not built into our plan an acquisition. As I said earlier, our capital base is very strong. We are well-planned to do an acquisition, a major acquisition. We have a lot of excess capital right now, but that’s not in our plan, and that would just be upside to our plan, and also I want to be clear that our plan doesn’t assume that there is much of any improvement in the interest-rate environment.
We assume interest rates are going to be about where they are on a go forward basis, so here’s the plan, this is basically the plan, the 2013 plan that we shown investors, in our investor conference along with a model shows out in the future as you can see we do expect to see earnings kind of kicking up within ROE improving as we go forward.
Our retail business model our life insurance, Moody and asset protection product line are changing. We are trying to decommoditize those businesses, so much of financial services, the life insurance business is suffering from too much capacity, too much capital, too much competition for too little growth, market share kind of going on. And we’re trying to take advantage of our small class relative to the market and some of our competitors and find places where we can play within each of those lines in order to earn better than the market average in terms of margin and returns.
And we think that the key to that is really to have better understanding of consumer preference and behavior than the competition. There’s not much time to really snatch surprisingly in our industry and trying to understand why consumers are buying our products, and so we are building a lot of capabilities in-house in terms of how we do that more effectively. We do think stable value; will be a steady source of earnings for us. We expect spreads to come down a bit over the next couple of years, but we do think that they will continue to be very robust and a nice contributor to earnings, and we are very well positioned now to do major acquisition. I’ll talk about that here in the next slide.
I don’t think it’s unfair or even immodest to say that Protective is a leader in the life insurance business and doing acquisitions, our specialty is buying small companies or buying blocks of business from other players that are desiring to exit our line of business or they want to redeploy capital or they have a problem with their cost structure, they are not in scale.
As you can see in this chart over a long, long period of time, we’ve been more than 46 transactions, we’ve invested over $2 billion of capital, and you can see we’ve achieved very nice earnings growth from the acquisitions line. Again, I think it’s fair to say that no one knows how to do this more effectively than we do by virtue of our experience. We’ve never had a transaction of knock on wood in recent memory, in decades to go badly for us or for the seller. Our deals close on time, we don’t retrade.
Once we announce a transaction we stick with our word and it’s been a real advantage for us, I think in dealing with showers of properties. It is a bit concern certainly about the price they receive, but I think they are also interested in execution. The ability to get a deal done and again I think we are first in that industry in that regard.
Our investment portfolio is in excellent shape, we are basically kind of a very simple kind of investment shop. We effectively have no alternatives in our investment portfolio. We do invest in hedge funds or private equity or venture capital, most of what you see on our balance sheet are highly rated corporate securities, the credit quality of our portfolio is in the 8-ish range.
We have an unrealized gain on those securities portfolio of 3.1 billion, which is about 10% roughly of the portfolio. We are very tightly matched in terms of asset liability management which has reduced substantially our sensitivity to the low interest rate environment; our cash flows are very matched up – bit nicely matched up. We don’t have a lot of reinvestment risk in our products. We have a 5 billion-ish commercial mortgage portfolio. It’s performing extremely well, the problem loan ration there is 50 basis points, and it’s been about that level pretty consistently in recent years, and less than 5% of our portfolio, our securities portfolio are in below investment grade securities, which compares I think very favorably with our industry.
Our company is very proactive in the way we manage, we’re always looking at the horizon and over it a bit if we can, we are very engaged in our credit associations and in Washington dealing with a lot of the complex regulatory issues that are out there.
If you follow the industry carefully you know there is a lot going on with respect to have the industry finances, redundant reserves for the use of captives. There is a lot activity around unclaimed property, but we feel like we have those issues well in hand at Protective we understand them very well and we are managing that successfully through them as well as through the interest rate and macroeconomic environment.
This is how we think about the life insurance business, it’s totally different I think from the way you would think about as some kind of industrial business model, where you try to drop sales higher, and that’s kind of your primary metric is to sell more drive the top line, so and so forth, we just don’t think that works, and we collectively have hundreds and hundreds of years of experience in our senior management team in this industry, I’ve personally been in it for 20 years now, seen a lot come and go, but we think this is the only way you can successfully manage this business, that might be the case of all financial services.
You really got to think about the capital levers, you have to pull. And they are basically five, as you can see on this chart, you can sell more at the retail level, we can park capital and the stable value line for two, three years, you know we find attractive opportunities there, we can do acquisitions or we can manage capital, we can repurchase shares or we can pay dividends, increased dividends, we currently are returning to shareholders about 50% of our aftertax earnings through dividend and share repurchase.
Our share repurchase program has been running at about a $100 million a year. We pay $50 million or $60 million in dividend. We have been increasing our dividend each of the last three years at a pretty healthy clear. We really think that’s a great use of capital. I mean we think right now, with industry fundamentals where they are, with most Life companies, including Protective trading below value, that’s a very responsible use of capital we think.
However, there are limits to how much we can do. Currently I think the rating agencies are comfortable with about the level, where we are about half of your earnings return to shareholders, but I think there is a discomfort point out there somewhere, if you start repurchasing, leveraging your balance sheet or exhausting your capital aggressively repurchasing of paying dividends. So that’s why we are so happy, we have the other levers. And we put the capital, where we think we are going to get the best return for our shareholders, it’s just simple, just kind of finance one-on-one, but that’s what we do.
We are not trying to take market share away from our competitors. We want to have very healthy and robust retail businesses that have great shelf space and great relationship with distributors. But we sort of have the (inaudible) watch, not too much, not too little because we planned it, when you start to chase market share in this business, you start to suffer financially, you either well some combination, maybe all of this your margins and your returns go down as you chase more marginal business, and also your risk goes up, your risk profile goes up, as you have to design products that have more aggressive embedded derivatives or other attractive features from the manufacturers perspective. But as I say, we have the five levers and we put the capital where we think it’s going to earn the best return. We are very sensitive to improvement in ROE, while at the same time continuing to grow our earnings.
Having said that our life sales are very healthy and now we had a very strong fourth quarter. We expect to sell about $130 million in life insurance next year, that would be a nice level for us and this time you see we think will continue into the first quarter and next we think 2013 to be a good year for life sales.
We’ve also been very careful in our risk selection in our life business. You can see last year, we had earnings contribution almost $40 million pretax from our actual mortality in our term insurance block exceeding what we expected it to be. What we price for when the products were designed. And so we think that’s a real mark of quality and the way we run the business is that we are seeing consistent mortality gains in the business.
Likewise our Annuity business has been pretty strong actually that the variable Annuity component of it has been strong, within what we had desired. We think our products are safe and sound and solid and we’ll produce good earnings into the future but we’re trying to keep health balance. We just don’t want to become a variable annuity company. And so we are trying to manage our sales. Last year the sales variable annuities were $2.7 billion. Our expectation this year is about $2 billion or less and that would be just fine, that’s very healthy and I think appropriate level of VA sales for a company our size.
Again I won’t go through all of that but those are the assumptions you have them in terms of how our plans are put together. A step back, what are we focused on, first and foremost we want to deliver on that plan that we laid out in early December and that I showed you just a moment ago and we want again every quarter will be very clear as to why we were above and below the plan at the level of each segment, lots of granularity and lots of transparency.
We are extremely focused on planning an attractive and accretive acquisition. And I will tell you that the pipeline right now is quite busy probably as busy has it’s been in a long, long time. Why is that? I think it is because there is some fundamental restructuring going on in the life insurance business right now. You’ve seen some very dramatic developments in 2012 of the [heart] which has been in the life insurance business for I guess the company has been around for 200 plus years and I’m sure they’ve been in the life insurance business for much of that since we exited the life insurance business, life and annuity business. They sold their life franchise to Prudential, the Prudential and they are essentially see selling on most annuity products at the retail individual level.
Sun Life for Canada announced that they were exiting the U.S. individual life business. You saw some sales big companies sold or mutual, sold its U.S. life business. Aviva has announced the sale of its U.S. life business, very large franchise and that’s small players in our business and you’ve seen a number of our competitors substantially curtail their participation in some segment of life insurance or some segment of the VA business. Also think there is a whole new group of buyers coming into the space.
I mentioned Old Mutual, they were sold to the Harbinger Group. Aviva sold to an affiliate of Apollo fund management group. We actually did an acquisition Liberty Life a couple of years ago where we partnered in a sense with of being Apollo in the transaction. But refining that asset management group’s hedge funds I guess is another way to describe what they do. And the fixed annuity business very attractive and are paying prices that are considerably robust by sellers. So there is a lot of activity out there, lot of M&A activity going on in the business and I do think as I said earlier our company by virtue of our long experience in doing acquisitions extremely well positioned to take advantage of the activity and execute transactions on terms it will be accretive and attractive to our shareholders.
We are continuing to invest in the retial businesses, we’re putting a lot of money and time and effort in infrastructure, improve the capabilities to understand consumer behavior better. So we can be more successful, and they commoditize probably that a signal I need to speed up, I don’t know again we are very focused on capital allocation. We are very disciplined as I said in investments and asset liability management.
And again we are investing a lot of time and effort under Mike’s leadership in a process manage, we think that’s another critical element of building shareholder values to be sure that you know your risk and that you’re managing them effectively.
So with that, I am ready to conclude my presentation, and take any question.
Unidentified Company Representative
I have a question in the back queue or Seth do you want to start, maybe has there microphone over there please?
I wonder if you could follow-up a bit on the acquisition environment, you mentioned there is a lots of stuff out there, that’s said in 2012, you did not come into a willing buyer, willing, selling agreement, anyone for yourself, any thoughts on, what has prevented a transaction closing from your perspective and anything that might change that?
John D. Johns
Yes, that’s a great question. We get asked the question a lot about not only why don’t you successful, mostly the acquisitions are done through an option process with some sort when the Wall Street firms would be retained to open a data room and so you have a lot of people coming in and looking at what’s there and I’m often reminded think about Warren Buffett said famously that the M&I business if you do it properly it is like a playing a game of baseball with the no call strikes, you get to look at every pitch, you never have to take a swing unless you like the pitch, but when you do so your pitch you like, its time to swing hard. The story behind everything we looked at, but generally we do not have an appetite for fixed annuities.
We can solve fix annuities very successfully at the retail level and we also don’t like businesses that have a lot of interest rate sensitivity and I think they are not very competitive right now I think in businesses where the value depends a lot on your view of the future trend and interest rates because they are pretty conservative.
We generally take the position. We don’t know what interest rates are going to do. You know we hope they don’t go do, but we don’t know if and when they will go up. So, we are not aggressive in our assumptions when we see businesses where the valuation is highly dependent on the path of future interest rates and some of the things we have seen this year and I have mentioned earlier there are these new competitors I think who are coming in and are looking at spread businesses like fixed annuity businesses and it basically profit strings there through their asset management, practices and businesses that we don’t.
The rest of business is asset management, so they can see an income strength for managing the assets; it’s not obvious (inaudible) we have the skillset to do that. But we are really good and where we are most interested in focus is on traditional, mortality life insurance business.
Business is very predictable, very low volatility in cash flows and where the capital you investment comes back to you very quickly, where in six, seven, eight years, you get most of your money back which you put out or you can project stable cash flows out in ten, 20 years.
We think those kind of cash flows are most attractive and we think that – just the way we think about the world, we think that’s a great way for us to build shareholder value is by successfully acquiring and executing and managing those kind of businesses, so when we see the liberty like transaction, where we reinsure thousands and thousands, almost in May and I think – actually some very small policies, very mature seasoned policies was a great example of a kind of pitch that when we see one like that coming by early swing, pretty hard.
But if we see a block of business where the value can go up or down 20%, 30% based on what you think the 10 year treasury is going to be in five years, it’s just not our strength to do that kind of deal, is that responsive?
Just a question on – you made a comment about you need to decommoditize in the industry that contracts are very mature, I think investors are also focused on decommoditizing where it means kind of risk which I know it’s not what your objective is, how do you decommoditize without offering more guarantees?
Unidentified Company Representative
Yes, I think that’s a wonderful question too, and it’s a hard question. Actually I think if you look at the way the industry has competed as products have become more commoditized, the issue with the industry business model, the retail model and the life insurance industry is essentially – you have mutual companies have their own business model mostly self non-captive distribution, not all but many do and they do it quite successfully.
The products are not particularly competitive in terms of the cost of the product because they are not compared to other products at the point of sale. But for the rest of us, the stock companies and then most of the ones which you guys would be following as investors, we sell through essentially the same – we’re manufacturers of products, they are easily compared with technology.
You can go to the Internet and you can get a quote, compare 20 term products that are essentially identical and they are differentiators essentially there is aggressiveness of the underwriting, to help underwriting, medical underwriting or the price or the commission. Those are kind of the three major levers and then if you get the variable annuity space, that’s the same thing.
The features of all kind of standardized, you can sort of compare, the roll up rate and the debt benefit and spreadsheet and so that your manufacturers of products that can been easily compared, you’re selling through independent distributors who tend not to have any real affinity for any particular manufacturer, they are really trying to get the best value for the consumer, so they kind of pitch you in kind of an auction like process and so, And that’s what it calls an escalation in people have gone more out of the risk curve and you saw that with early legacy VA products. They are quite risky and you are seeing the economic effects of that.
You are seeing some of that in the Guaranteed UL business where people could embed interest rate guarantees into their pricing. They are out of synch with the current market and that’s why someone is concern I think about interest rate sensitivity in some of those lines, but to us, it’s the trick, if not a trick, I mean the magic will be to come up with a complete offerings to the consumer.
Remarkable thing about our industry, as I said this earlier is that all of the studies showed this enormous pent-up demand for life insurance and retirement savings. Half of the people in this country, other half people in this room if I ask you to say, I really do need more life insurance, well if you thought about it, you really don’t need for life insurance and yet people are buying and essentially no growth in life premium seldom individual basis.
The ownership of individual life is at the lowest level per household its been in 50 years. Right now and I suspect the need for life insurance is probably at the highest level its been in the long time because of the economy, but the people aren’t buying it and I think there’s lots of reasons.
I think the products are too complicated, people don’t understand them because of that and because of general distress the financial institution they didn’t trust at the consumer retail level, that the process of getting life insurance is very complicated and cumbersome, and it just takes a lot of time and effort, it’s hard to do, so our thought process is around, how can we change some of those dynamics. How can we develop simple products that are easy to understand that are sold in through our distributors or through other mechanisms that are easier to access, and make it the whole process a lot of more pleasure and enjoyable than it is now, and really give you more peace of mind about what you bought.
We think that’s a great way to de-risk the business. Have very simple straight forward products and try to get away from just comparing price is the only the dimension of competition, try to wrap it around a lot other action beats the value that consumers will value. Because people they have nothing else to base a decision on, they will base it on price, but I think in peace of mind products like retirement savings, the life insurance other dimensions of value that are fully understood or exploded by the industry as the way to differentiate, that’s we’re trying to do and all of that retail, I’m not going to say, we crack the code on that, but we’re sure working hard on it.
One more follow-up question on the capital distribution, and I think when it come to capital distribution the first two levers are well understood, you mentioned a five lever approach, M&A and share buyback, but despite instituting the share buyback again in 2011, you obviously keeps creeping out, you have to great fight a bit of show the lumpiness of M&A. I think those other levers of capital, the capital uses are a little less understood, so you may be you could talk a little bit about, how to use capital efficiently when you have a lot of it on your books right now.
John D. Jones
Right. Those I said, again we repaid to five leverage were basically the retail business, the stable value business, the acquisitions line or share repurchase or dividend those are kind of the five ways we can deploy capital. And when we end, I didn’t talk about too much stable value is actually starting to grow, stable value contract is basically just a wholesale spread product, we sell them and some of them going to 401(k) plans, some of them going to money market funds, some of them are involved with the Federal Home Loan Bank and but they’re really simple, they’ve just basically rate for term one, two, three, four, five years and then you put an asset behind them and you earn a spread and that’s it. They’re starting to grow again actually, we’re actually saying a pickup after years and years kind of toward (inaudible) in the stable value and that starting to pick up little bit too.
But again there is only so much capital we want to deploy in a retail business, but all the reasons I said earlier, because I think once you chase market share and businesses that have come, the growth characteristics you’re going after risk curve or you’re going down the margin curve or both.
So it really brings us back to M&A, I mean that really our best lever and said as you know we have a lot of capital to deploy, if you think about it, if you just assume to pick a number that 400% RBC is kind of a nice comfortable floor, which is very consistent with investment grade A rated, AA rated company as we are. We got a 100 basis points, I mean 100 points of RBC over that, 100 points is $650 million and then we have otherwise we can leverage up a little bit more.
So we could do quite substantial acquisition now, if the right opportunity were to come along and as you see, nicely with our acquisition too they are immediately accretive. I mean within the first year they are accretive, it’s not like three years to accretion. The way we do them historically at least, they have the money and the earnings come right back after just like that almost. So you can see get to your transition expenses, which really takes a quarter or two, then you start to get that kind of accretion, so it can be pretty exciting, when we get the right kind of deal. I mean really it can be very positive in terms of shareholder value creation, when we’re able to do a successful transaction.
Well, if there are no other questions again, I just want to say thank you all very much for hearing our story, and if you have other questions, you can call Eva and she’ll get the answers for you. We’re always delighted to talk with shareholders and investors. Thank you very much.
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