Horace Mann Educators Corporation Q1 2009 Earnings Call Transcript

Apr.30.09 | About: Horace Mann (HMN)

Horace Mann Educators Corporation (HMN)

Q1 2009 Earnings Call Transcript

April 30, 2009 10:00 am ET


Dwayne Hallman – SVP, Finance

Lou Lower – President and CEO

Pete Heckman – EVP and CFO

Tom Wilkinson – EVP, Property and Casualty

Brent Hamann – SVP, Annuity and Life

Steve Cardinal – EVP and Chief Marketing Officer


Bob Glasspiegel – Langen McAlenney

Steve [ph] – Langen McAlenney

Craig Rothman – Millennium Partners


My name is Demitras and I will be your conference operator today. At this time, I would like to welcome everyone to the Horace Mann first quarter earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks there will be a question-and-answer session. (Operator instructions) Thank you. Mr. Hallman, you may begin your conference.

Dwayne Hallman

Thank you and good morning everyone and welcome to our first quarter 2009 earnings conference call. Yesterday, after the market closed we released our earnings report, including financial statements as well as supplemental business segment information. If you need a copy of the release, it is available on our website under Investor Relations.

Today we’ll cover our results for the first quarter in our prepared remarks. Following management, members will make presentations today and as usual will be available for questions later in the conference call; Lou Lower, President and Chief Executive Officer; Pete Heckman, Executive Vice President and Chief Financial Officer; Tom Wilkinson, Executive Vice President, Property and Casualty; Brent Hamann, Senior Vice President, Annuity and Life; and Steve Cardinal, Executive Vice President, Marketing.

The following discussion may contain forward-looking statement regarding Horace Mann and its anticipated or expected results of operations for 2009 or subsequent periods. Our actual results may differ materially from those projected in the forward-looking statements. These forward-looking statements were made based on management’s current expectations and beliefs as of the date and time of this call. For a discussion of the risks and uncertainties that could actual results, please refer to the Company’s public filings with the SEC and in the earnings press release issued yesterday. We undertake no obligation to publicly update or revise such forward-looking statements to reflect actual results or changes in assumptions or other factors that could affect these statements.

Finally, this call is being recorded and is available live on our website. An Internet replay will be available on our website until June 1st, 2009.

Now, I will turn the call over to Lou Lower for his comments.

Lou Lower

Thanks, Dwayne. Good morning, everyone, and welcome to our call. Yesterday we reported first quarter net income before realized capital gains and losses of $0.35 per share, in line with consensus expectations. That $0.35 includes roughly $0.08 per share of cost related to claims office consolidation and distribution strategy initiatives. And as you will hear over the course of our description of the quarter, we continue to effectively navigate through a difficult financial and economic environment. We feel positive about the underlying fundamentals and profitability of our operations. Our financial foundation and key capital ratios remained healthy and consistent with our ratings and very importantly key elements of our growth strategies are taking hold despite national economic circumstances, which is most certainly encouraging for our future growth prospects.

In property and casualty, both reported and underlying profit fundamentals are solid while the current accident year combined ratio excluding cats increased 2.5 points compared to last year’s first quarter. Our expense and LAE ratios reflect those claims office consolidation and marketing transition expenses, which represent about three points on our combined ratio.

As you will hear from Tom during his report, we have further consolidated our claims offices from six to two, affording us the opportunity to better leverage the technology infrastructure that we’ve put in place over the past couple of years. The benefits we’ll be receiving going forward will be additional efficiency and claims expenses as well as further improvements in severity control.

First quarter cost associated with claims consolidation represented roughly $0.05 per share. In terms of pay back, we are projecting that our LAE expense ratio will improve by roughly a half a point in 2010 with the added benefit of improved severity control, allowing us to continue to beat the industry fast track data.

The marketing initiative expenses in the quarter comprise the remaining $0.03 of unusual charges. They relate to reorganization expenses, including severance as well as some transition incentives for our initial group of agents who converted to exclusive agent status. Both the claims and marketing charges are front-ended with modest additional amounts anticipated over the balance of the year.

In our life and annuity business, the financial markets continued to adversely impact results, further reducing our variable annuity account values and resulting fee income. Additionally, they created adverse DAC unlocking as the underlying investment sub-accounts underperformed our planned long term market return assumptions. While variable accounts values and fees decreased, fixed account values, which represent 70% of the total, are up both over prior year and sequentially.

As we experienced throughout 2008, total annuity fund flow continues to be positive while persistency increased year-over-year. While interest margins was slightly higher than a year ago, they were negatively impacted by the higher short term balances that we hold and should increase as we put those funds to work. Excluding DAC and GMDB reserve changes combined life and annuity pre-tax earnings actually increased slightly as compared to last year’s performance.

Turning now to sales and distribution, the recession’s adverse impact on new car sales continues to pressure applications for auto insurance coverage industry-wide. As you will hear in Steve’s comments, our true new auto sales declined 5% in the most recent quarter. Offsetting sales pressure in the auto line, property sales increased 7%. Retention improved in both lines and average written premium increased, all combining to deliver positive gains in total P&C written premium, which increased 2%.

A doubling of flexible annuity sales, coupled with a 30% increase in single premium, produced an overall annuity sales increase of 50% and represented the strongest first quarter in five years. As you will learn from Brent, thanks to our financial health and our strong position in the educator marketplace we are able to take full advantage of the 403(b) payroll slots that we successfully defended over the course of last year. Compared to prior year, fixed annuity premium and deposits increased 11% while variable declined 26%, but all in all total premium and deposits are running ahead of what we had anticipated.

And, very importantly for the future growth of the Company, we had positive developments during the quarter along several key metrics that we track that are focused on enhancing distribution power in our educator niche market. For one, our agent count increased sequentially thanks to a steady level of new appointments and improved installation of more qualified agents into territories with the greatest opportunities, combined with a reduction in terminations. And that’s the first quarter since 2006 that we’ve seen positive agent growth, which we certainly expect to continue.

While it’s too early to declare a victory, we believe that the tough steps that we took last year in the way of elevated agent selection and performance standards is really starting to pay off. Incidentally, of our new agent appointments, 75% quarter-to-date have chosen to go directly into our new exclusive agent contract, which was introduced January 1st. Our experience is confirming that the new contract design is both competitive in the market and represents a superior value proposition as we have conversations with prospective agents. And that’s all resulting in improved agent appointment activity with substantially elevated quality.

That growth in agent count was accompanied by continuing growth in total points of distribution as well as increases in average agent productivity in three of our four product lines, all of which is very positive for future sales and marketing performance.

Turning to the balance sheet, as you will hear from Pete, impairments in the quarter were primarily fallen angel petrol [ph] preferreds, all of which have been impaired to market value. You will note that our unrealized loss position increased about $30 million as compared to year-end as spreads in some asset classes widened during the quarter. Now as we remain confident that our current unrealized position is largely reflective of continuing illiquidity in today’s disruptive credit markets.

As we await a return to normalcy in the financial markets, we fully have the intent and ability to hold our invested assets to recovery and maturity. The structure of the annuity liabilities, which is associated with most of the taxable fixed income portfolio is very stable, continues to demonstrate very strong persistency, and produce positive funds flow.

Elsewhere on the balance sheet, our team remains very comfortable with the strength of the Company’s P&C reserves. While favorable development in the quarter was modestly more than prior year, we don’t anticipate a full year equal to 2008. But having said that, the reserve position remains solid and near the high end of our range.

Just to complete the balance sheet highlights, our critical capital ratios are well within our target ranges with debt to CapEx FAS 115 to 27% while both life and P&C RBC ratios are consistent with our objectives and remain at the high end of our targeted range. While book value per share with FAS 115 decreased 28% year-over-year, and as you will recall that’s primarily attributable to unrealized losses in the investment portfolio, for the quarter the rate of decrease moderated to 1%. And excluding FAS 115 the year-over-year decline in book value was 1% while it increased 2% sequentially.

Today, you are going to be hearing from a new member of our senior management team. Brent Hamann joined us in February as Senior Vice President of our Annuity and Life operations. Brent comes to us from Milliman, where he was Practice Leader responsible for business development in the areas of product marketing and distribution strategy. Prior to his five years at Milliman he was with Allstate for 17 years in a series of leadership roles of increasing responsibilities, the last of which was Executive Vice President of Distributions through national, regional and independent broker/dealer firms. I think we are fortunate to have him join the team and I am confident you will feel the same way as you get to know him.

So, just to wrap it up, we are off to a good start to the year. Operating fundamentals are solid as is our financial strength. Cash flow from operations is strong and backed up by excellent liquidity. Our target market will serve to mitigate today’s recessionary forces while continuing to afford [ph] us growth opportunities well into the future. And very importantly, the results of our strategic initiatives are making Horace Mann’s marketing and distribution stronger every day.

And now, let me turn it over to Pete for some closer elaboration.

Pete Heckman

Thanks, Lou. Horace Mann posted solid results in the first quarter in spite of the continuing macroeconomic and financial market challenges. As Lou mentioned, the $0.35 per share of operating income, which included about $0.08 of expense items related to our claims and marketing strategic initiatives, was a bit better than we expected as the adverse impact of market performance on our variable annuity earnings was more than offset by favorable underlying P&C, investment income, and expense results.

In terms of our investments, the performance of our $3.4 billion fixed maturity and equity securities portfolio remains strong with an overall quality rating of A+ and is well diversified across industries, investment types, and individual issuers. Net investment income was up 2% over prior year and slightly exceeded our expectations, both in total and by segment. With regard to investment gains and losses, we completed an opportunistic capital gains program during the first quarter that generated nearly $17 million in realized gains with minimal, if any, future investment income give up.

We recorded an almost identical amount of investment impairments during the quarter, the largest component of which was a $12 million writedown of all of our below investment grade perpetual preferred stocks, including securities issued by ABN AMRO, Banc of America, Royal Bank of Scotland, and Bank of Ireland.

The remaining $5 million of investment losses was recorded primarily in our high yield bond portfolio, split between writedowns of securities sold during the quarter and securities we no longer intend to hold until recovery occurs.

The volatility in credit spreads and interest rates continued during the first three months of the year with the total fair value of our investments experiencing a modest decline from year-end. We’ve provided a supplemental exhibit at the end of our press release, packaged again this quarter – I believe it’s page number six – which contains additional disclosure related to our net unrealized loss trends and March 31st balances.

Net unrealized investment losses at the end of the first quarter totaled approximately $360 million pre-tax compared to the $327 million recorded at year-end. As you can see in the data, the direction and magnitude of the changes varied by asset class. Muni bond spreads, after widening out a bit in the fourth quarter returned to some degree of normalcy in the current period. High yield bond spreads improved as well after hitting highs in early March as investors re-entered the market amid renewed optimism that the efforts of the Federal Reserve and other authorities to contain the recession are beginning to take effect

On the flip side, commercial mortgage backed securities along with financial institution bonds and preferred stocks continued to demonstrate a high degree of volatility. With regard to CMBS, spreads widened out a bit more during the quarter, especially for the more recent vintages.

Our portfolio continues to be 100% investment grade with an overall credit rating of AA and is well diversified by property type, geography, and sponsor. Over 17% of our holdings are comprised or multi-family housing projects that are directing backed by Ginnie Mae. Another 13% is made up of fully amortizing loans to finance military housing where rental payments are appropriated by the U.S. government. And approximately 7% of the portfolio is represented by cell tower revenue and timberland securitizations, which offer further diversification.

The traditional conduit fusion portion of the portfolio is slightly less than 60% of our total holdings with over 70% of those securities in the more seasoned 1997 through 2005 vintages. And of the remaining 2006 to 2008 vintage loans, approximately 75% are super senior AAA rated. All of our CMBS securities are performing in line with contractual terms. We have not experienced any unusual deterioration in delinquencies or foreclosures during the quarter and continue to hold up well under a variety of economic stress test scenarios.

Financial institution bonds and preferred stocks performed poorly during the quarter amid economic uncertainty and pending bank stress test disclosures. As we’ve disclosed previously, our holdings in this sector are primarily large, well-recognized names, which have been broadly supported by government intervention. Given the high likelihood that his support will continue, we remain comfortable with our financial institutions portfolio while acknowledging that full recovery will take some time.

As a final comment on the overall quality of our investment portfolio and as further evidence that the increase in unrealized losses is more indicative of spread widening than inherent credit issues, consider that over 70% of the securities with fair values below 80% of book value at March 31st, have been below 80 for only six months or less. And we continue to have only about 1% of our portfolio pricing based on the so-called level three inputs, another element of conservatism and transparency in our valuations.

So, to summarize my comments on our investment portfolio, we believe the credit quality to be strong, view the current pricing in the market to be irrational and not indicative of the underlying quality and currently have the intent and ability to hold all securities to maturity or substantial recovery in value.

I would like to conclude my remarks this morning with some comments on Horace Mann’s capital and liquidity position. Horace Mann’s liquidity position remains extremely strong and there continues to be absolutely no issues on the liability side. Our insurance liabilities are extremely vanilla and stable. In the annuity and life segments, funds flows, persistency, and liquidity measures all continue to be extremely favorable, with positive trends. And at the holding company there are no business operations or extracurricular activities of any kind. No CDS, securities lending, derivative or hedging programs, et cetera.

Our bank credit facility doesn’t expire until the end of 2011 and our next senior debt maturity isn’t until 2015. Our $125 million bank line of credit provides more than adequate flexibility should the needs exist to contribute to additional capital to our insurance subsidiaries. We currently have $38 million drawn on the credit facility, the majority of which remains at the holding company. And our current debt-to-capital ratio is approximately 27%, excluding FAS 115, well within the range supported by our current ratings.

In terms of our capital position, on last quarter’s call I estimated that our life RBC ratio would end the year comfortably above our target level of 400% once the statutory results were finalized. In fact, our final 2008 RBC ratio was 500% in spite of the relatively high level of investment losses incurred last year. And I would expect that ratio to continue to reflect a very strong margin relative to our target level in the first quarter as well.

On the P&C side, our premium to surplus ratio finished 2008 at 1.9 to 1.0 and the RBC ratio was 399%, both results well ahead of where we were three years ago, in spite of the investment losses and near record level of catastrophe costs experienced last year. And based on first quarter results, I would expect both of those ratios to show further gains in the current period.

So, our capital and liquidity positions remain very strong in spite of the challenging financial markets and economic environment and continue to be more than adequate to support our operations and our current ratings.

And while investment performance in the financial markets remain headline issues, Horace Mann has continued to experience positive underlying trends in our insurance operations, speaking of which, here is Tom Wilkinson to comment on our P&C results. Tom?

Tom Wilkinson

Thanks, Pete, and good morning. This morning I will summarize key components of our combined ratio for the quarter, cover results by line, and discuss trends in our book of business.

But before I get into the financial results, I would like to discuss another milestone reached by our claims organization. We completed our second claims field office consolidation at the end of the quarter. Our six regional claim officer were consolidate into two regional auto offices, one in Raleigh, North Carolina, and one in Dallas, Texas, and a National Property Office also housed in Dallas.

This is another important step in the continuing development of our advanced claims environment (inaudible). The consolidation will help us gain efficiency in scale with the larger offices. At the same time, we’ll continue to retain local presence with our Company appraisers and Company claim vans in markets where we have built a base of P&C policies in force.

Consolidation is possible thanks to our continued investments in technology. Our state-of-the-art claims workstation consists of a desktop that includes our claim administrative system complete with policies, procedures, and best practices all programmed for real-time application and monitoring. We also have a unique online, real-time customer satisfaction feedback group, which allows us to address customer concerns during the claim resolution process as they happen. And our workstation includes vendor interfaces, which improves the quality and timeliness of the claims process.

Horace Mann’s investments in the claims department over the past six years have paid dividends. Our severity results trend better than the industry, our reserve position is very stable, our LAE ratio is trending down to the mid-9% range, and our customer satisfaction results continue to improve.

In the future, we will continue to look for opportunity areas to further enhance our processes with a view improve business results while becoming a best-in-class P&C claims organization serving the needs of our target market, the educator community.

Now for the financial results for the first quarter. The total P&C combined ratio was 94.6% compared to 93.5% a year ago. Total catastrophe costs were $4.5 million, which are about $900,000 lower than prior year. And favorable prior year reserve reestimates of $3.4 million were $700,000 better than last year.

Also included in the ratio, as mentioned in our press release, were a couple of extraordinary expense items related to claims and distribution initiatives. We incurred $3.1 million or 2.3% of premium related to our claim department reorganization and $1.3 million or 1% of premium for expenses related to our distribution initiatives.

So, our underlying total P&C combined ratio, excluding cats, prior year reserve reestimates, and the two expense items, was 90.5%, nine-tenths of a point lower than last year’s first quarter of 91.4%.

The auto accident year combined ratio, excluding cats, and excluding the expense items, was 94.7%, 1.8 points below prior year. Both frequency and severity results were favorable and consistent with our expectations.

Our property accident year combined ratio, excluding cats and the expense items, was 80.5%, eight-tenths of a point higher than last year. Property frequency was up in the quarter, driven by large increases in the northeast and southeast states, which were impacted by adverse non-cats weather activity. On the other hand, our severity trends were favorable. Increased reinsurance costs, driven by price increases and our decision to increase coverage are adversely impacting the property combined ratio by 1.4% [ph].

Now, turning to the top line. Total voluntary P&C written premiums on a direct basis before reinsurance was up 1.8% compared to prior year in the quarter. Auto was up 1.3% and property before reinsurance increased 2.9%. We continue to increase both our auto and property rate activity consistent with others in the industry to keep pace with increasing loss cost trends.

Total P&C policies in force were down slightly from prior year, about 4000 units, down one-half of 1%. Auto policies were down 1500 and property decreased 2500. The property policy decreases were driven by continued reductions in coastal exposure with our total coastal policy count now 3000 less than March of last year. The majority of this reduction occurred in Florida. However, educator PIF continued to increase with each line up sequentially from prior quarter in each of about 2% when compared to the first quarter of 2008.

New business and in force quality trends remain favorable for both auto and property. Our percent educator, our percent of business in the preferred underwriting tiers, our (inaudible) percentages, including tri-line business, are all equal to or better than prior year. We continue to increase our school access and presence with additional auto payroll stock of 21% and additional PIF on payroll up 37% over prior year. Policyholder renewal rates continued to be favorable in a very competitive market. The auto renewal rate increased three-tenths and property two-tenths compared to a year ago.

In summary, our written premium is up almost 2% with total PIF count slightly below prior year. Our policy count growth continues to be impacted by coastal underwriting actions, managing our exposure to catastrophic events. Our emphasis on educator retention and school payroll initiatives continues to drive policy growth in our target educator markets.

Our underlying profit fundamentals are solid and we are on a path to continue to extract more benefits from our claims operations through our ace [ph] initiatives. We are also looking to continue our partnership in the new marketing organization to deliver profitable P&C growth.

And now, I would like to turn it over to Brent Hamann for his comments on our annuity and life results.

Brent Hamann

Thanks, Tom, and good morning, everyone. I will spend the next few minutes going over the results of the annuity and life segments. Our annuity sales were up significantly in the first quarter, driven primarily by our flexible premium sale through both Horace Mann and independent agents. Our successful efforts to retain table slots in the face of new IRS regulations are now translating into sales growth in 2009. These efforts, combined with the ongoing support of our agents’ activity resulted in our total annuity sales increasing by 50% in the first quarter compared to the prior year.

Our recurring deposit business increased 99% for the quarter while our single premium rollover deposit business, including partner product sales increased by 30%. It is important to note that our recurring deposit business, while sales are up 99%, (inaudible) deposits are recognized as money as received coming in monthly over a full 12-month period. This levelized pattern of payments combined with a modest number of payroll slots have loss [ph] compared to prior year and the primary drivers of the new contract deposit decline that Lou referenced earlier. In the end, however, both sales and new contract deposits are exceeding our expectations.

As we’ve discussed on previous calls, the new IRS regulations that took effect on January 1st of this year were supported by our efforts throughout 2007 and 2008. We deployed a number of strategies to solidify our market position and grow our business. These included numerous contact programs with our schools, distribution of compliance kits, a website to facilitate information exchange, and additional agent training. Despite our expectations that this transition could be disruptive, we are in a stronger position today and in fact are capitalizing on resulting shake-outs stemming from the new regulations.

In many districts, we find ourselves among a more selective list of approved providers and we also continually – to actively seek new payroll slot opportunities and of course to deepen the penetration of our existing payroll slots.

Wit regard to financial results, total annuity assets under management declined 10% compared to prior year due to a 37% market performance related decline in variable annuity assets. In contrast, our general account fixed annuity assets increased by 7% over prior year.

As we’ve noted in prior quarters, the stability and loyalty of our educator customer base and also the quality of our agents and their relationships within our niche market are among the Company’s most valued assets. And this has been very evident from reviewing our results in [ph] the difficult financial market environments of the past 12 months.

Annuity net fund flows, defined as premium less surrenders, deaths, and maturities were then positive in the first quarter of 2009 as they were throughout 2008. And our total 12-month account value persistency of nearly 94% is about two points over this point last year. So our liabilities continue to be extremely stable and present absolutely no liquidity issues.

Annuity pre-tax income was down $1.9 million in the quarter as compared to prior year. Unfavorable DAC unlocking of $3 million pre-tax was primarily a result of the financial markets impact on our variable deposit fund performance as well as the negative unlocking impact related to investment gains realized in the quarter.

The poor market performance in the quarter also resulted in a $500,000 increase in our GAAP GMDB reserve. The underlying earnings in the quarter were favorably impacted, however, by increased fixed annuity interest margins, which were offset by a decline in variable annuity charges and fees.

Once again, it is worth noting a key distinction regarding Horace Mann’s annuity business. While our variable annuity results are impacted by financial market performance, Horace Mann’s variable products are only minimally exposed to so-called equity market guarantee risk. Approximately two-thirds of in-force VA account value has a simple return of premium death benefit while over 25% of the business of business has no death benefit guarantee at all. And our current GAAP GMDB reserve balance of only $1.8 million reflects that conservative risk profile. We offer no other guarantees and have no hedging or derivative program exposure, whatsoever.

Turning to the life segment, total first quarter sales were down 13% with Horace Mann proprietary products down 15% and partner products down 11%. This is consistent with recent overall industry trends and also reflective of consumer’s increasingly difficult choices regarding the use of their discretionary income. Life premiums and contract deposits, which consists only of Horace Mann products, were down 2% compared to last year.

In terms of earnings, life segment pre-tax income was up $1 million compared to prior year. Growth in investment income and decreased mortality costs more than offset the small decline in earned premium during the quarter.

Finally, and as mentioned in the press release, excluding the impact of DAC unlocking and the change in the GMDB reserve, pre-tax income for the combined life and annuity segments increased slightly as compared to last year and exceeded our expectations in spite of the continued volatility and decline in the financial markets during the quarter. We are again encouraged by the number of payroll slots we have retained, our position within those slots and of course our sales results year-to-date.

And with that, let me turn it over to Steve Cardinal for his comments on sales and distribution.

Steve Cardinal

Thanks, Brent, and good morning. Today, I will focus my remarks on four areas, one, the status of the migration of our agency force; two, continued success we are having in our marketplace; three, the growth plans for our distribution model; and four, sales results for the first quarter.

So, let’s start with the migration of our agency force from the sales force that traditionally worked out of their homes to an agency force serving customers from outside offices. The foundation of our distribution strategy includes this transition as well as increasing the number of agents, increasing the number of licensed producers, and educating our agents on best practices and repeatable processes from our highly successful agency business school.

During the quarter, we saw an increase in the number of agents moving to outside offices and increase in the number of licensed producers, and increase in total agents, continued productivity improvement from agents that have adopted our agency business school techniques, and the successful launch of the exclusive agent agreement.

In the first quarter, we added 38 outside offices to bring the total number of agents in outside offices to 524. Last year we had 63% of agents in outside offices after the first quarter and now we are 78%. The number of agents that work in outside offices and have brought in a licensed producer have grown as well, from 309 to 334 during the first quarter. Additionally, we saw that 71 [ph] agents that migrated to the exclusive agent agreement showed early signs of success in the quarter, leveraging the new agent agreement by functioning as entrepreneurs. Our agents also continue to on-board licensed producers and now there are 412 licensed producers, a growth of 18 from year-end.

From a staffing standpoint, we saw our agent count grow from 670 to 675 during the most recent three months. This was the first time we have grown agents since the fourth quarter of 2006. This was helped by a reduction in agent terminations and an increase in new appointments compared to the first quarter of last year. We continue to see the agents that terminate come from our lowest performing groups, the majority of which work from their homes. With all of these changes, our total distribution points grew from 1064 to 1087 during the first quarter.

We are confident that our programs will enable our sales force to continue to increase throughout the year. Our field sales leadership team has been able to recruit what we believe to be a better agency candidate by leveraging of new agreement. We appointed 28 new agents during the first quarter, of which 21 chose to become exclusive agents immediately and the other seven will become exclusive agents within their first two years with the Company.

With our existing agents, we had additional 20 agents complete our agency business school during the quarter. And as we’ve said before, the agents who attended agency business school continue to outperform agents that have been through a school.

The implementation of the new marketing organization structure is helping drive our agent growth strategy. This structure is designed to drive the agency business school best practices at the local level. We have added 18 highly talented, award-winning sales leaders to our distribution leadership team. This group has now integrated into our leadership team, placing us in a much stronger position to achieve our growth plan.

In addition, we increased management focus and accountability throughout the organization by increasing the number of regions and adding eastern and western zones and at the same time we reduced management’s span of control, allowing them more time working shoulder to shoulder with their agents. All of these changes were made on a cost-neutral basis with the exception of some one-time charges, which included the elimination of some management offices and some non-revenue producing positions.

So, let’s move on to sales results. And as expected, the economy had some impact on sales during the quarter. We saw negative impacts in some lines, but this was balanced by some nice sales increases in other lines. We have taken notice that our educator market we serve is speaking of flight to quality, placing trust in companies such as ours that have a sound track record, local agents they can trust their retirement dollars to, and the ability to adequately protect their families.

Our auto unit sales decreased, our annuity business saw a spike in production during the first quarter of the year. With our elevated agent retention levels, new contracts, and trusted service, we believe our agents are doing well given this market.

And during the quarter, our average productivity increased in three out of four product lines compared to the prior year first quarter. Our average agent increased productivity in new auto unit, property unit, and new annuity sales, while the productivity declined in our life insurance sales. And overall we are pleased that our agency force productivity increased compared to prior year in three out of four major business lines.

And on property and casualty sales side, total auto unit sales were down 5% in the first quarter versus the same period in 2008 with true new auto unit sales also down 5%. Property unit sales, on the other hand, increased 7% compared to prior year. The auto sales did show positive trends during each month of the quarter but are still below prior year. The growth in our property unit sales is coming from balanced increases from several regions throughout the country. And this business is consistent with our underwriting and risk management practices, which remain unchanged.

On the annuity sales side, our agents have seen significant growth during the quarter. We are up 50% compared to prior year first quarter and 26% sequentially from fourth quarter. This increased production comes from several states where we had great success in retaining our 403(b) payroll reduction slots and saw our competition reduced. In addition, we have seen an increased amount of single-premium deposits, reflecting the confidence our customers have in our agency force and the Company.

While we do expect that the activity will level out as we progress through the year, we are optimistic that we will continue to see elevated sales compared to prior year. And while the economy may continue to present challenges we continue to be encouraged by the strides made by our agency force and sales leadership team. We saw positive signs in sales and productivity in flex and single annuity, property insurance, growth in both our agency force and our total distribution points, and acceptance of our new exclusive agent agreement.

So, with the only agent group dedicated to serving our nation’s educators, a new marketing organization structure, and a highly talented sales leadership team, we are confident that we will continue to see some positive trends continue throughout the year.

Thank you. Now, back to Dwayne.

Dwayne Hallman

Thanks, Steve. And that concludes our prepared remarks. Demitras, if you can please move to the question-and-answer session.

Question-and-Answer Session

(Operator instructions) Your first question comes from the line of Bob Glasspiegel.

Bob Glasspiegel – Langen McAlenney

Good morning. I got an easy one and a tough one, I’ll start with the easy one. So, to what extent is the weakened economy and less driving activity factoring into results for ’09 and perhaps your pricing decisions?

Pete Heckman

Well I think we’ve seen the – now, we’ve had four quarters of declining frequencies, started last summer when – probably before the danger to the economy started, but when gas went to $4 a gallon. We’ve continued to stay with – we’ve continued to see pretty good frequency trend since then. Our first quarter this year was below first quarter prior year. We are reading it in that probably we won't have continued significant declines to prior year and the rest year though should have pretty favorable levels. In the short term, it’s not changing our pricing decision and our pricing philosophy. We still predict we’ll continue to take rate increases to match some of the severity increases and some of the overall CPI indicators that are still pointing up.

Bob Glasspiegel – Langen McAlenney

Just trying to (inaudible) your answer though, it seems like there is – I mean Progressive and other auto companies are seeing less driving, less frequency, that was not in your – that was not fully factored into your earnings guidance, I wouldn’t think, for ’09.

Pete Heckman

Well, in our projections and in our guidance, we predicted pretty conservative frequency trends and we didn’t – we weren’t predicting frequency trends to shoot back up in 2009 after the positive 2008 we had.

Bob Glasspiegel – Langen McAlenney

Okay. So, you factored in low driving in your earnings guidance for ’09?

Pete Heckman


Bob Glasspiegel – Langen McAlenney

Okay. My tougher question is when we think about the annuity business and which has been behind a lot of the sort of unrealized losses in the portfolio and we mark the sort of marks that this business has caused, you probably lost five to ten years of earnings in marks. I know we are hoping that these marks are not going to be realized, but at the end of the day when we think about – this is a business that generates returns, we do have to factor in that this business is – has put pressure on your overall capital, it’s resulted in your inability to be able to buy back stock, it would – appears to be in you minds I would think quite attractive levels. What’s the argument for staying in this business from a manufacturing point of view and taking the capital risks associated with the portfolio backing these products?

Lou Lower

Bob, I just offer that we – the argument to stay in the business, if you assume that unrealized turns – fully turns into realized losses and that subsequent investments would do absolutely the same thing. I – we turn our tails and not be in the business, but the fact is that we don’t believe that’s the case, both with the current in-force portfolio nor future investments that we are putting on the books to support the new business that we are writing.

Bob Glasspiegel – Langen McAlenney

But we do know that it’s kept you from being able to buy back stock – I mean we know that it’s put pressure on capital.

Lou Lower

That’s well sure, absolutely.

Bob Glasspiegel – Langen McAlenney

Whether or not these marks are right or wrong, the regulators, the rating agencies are treating the marks with some seriousness as are you clearly. So, how do we look at – what do we think the returns from this business over the last decade had been?

Lou Lower

Including the marks, I –

Bob Glasspiegel – Langen McAlenney

Well, just on a total economic return basis, however you think about the business.

Lou Lower

Yes, if I thought about the two main businesses, I would think that long term historically that the property and casualty business is a business that’s in the mid-to-high teens and the life and annuity business like others who depending on the cycle high-single digits to low-double digits. But I think more than the return, if you think about what we are – how we show up for our customers from a marketing standpoint, our two main lines, lead lines that gives us access to the customer – to our customer base, are in fact annuity and auto. Annuity is very critical. It’s part of access to customers through 403(b) payroll slots. And we think relative to others that we’ve been extremely conservative in the design of the products that we have, how we – our manufacturing process, and how we distribute. So, I fully believe that we’ll see a full, substantial recovery on the unrealized, and that we’ll continue to be in that business, but on a continued very conservative basis. I don’t know, Pete, if you have – anything you’d like to add to that, but –

Pete Heckman

No, no, nothing further, Bob. It is a tough cycle we are in. Obviously the kinds of questions you are raising are ones that are not lost on us internally as well, but we continue to believe that over the long term, although as Lou laid out, returns in the life and annuity business are salt of the P&C business. The total package continues to make sense given our niche market emphasis.


This is Steve [ph], another question, seems like you can manufacture the products, and still achieve those – it seems like you can distribute the products and not manufacture them and still achieve the objective that you think require you to be in the business, but we’ll discuss this later. Thank you.

Pete Heckman

You bet.


(Operator instructions) We do have question on the line of Craig Rothman.

Craig Rothman – Millennium Partners

Hey guys, good quarter. How did the level of statutory impairments compared to the $13.4 million of (inaudible)?

Pete Heckman

Essentially the same.

Craig Rothman – Millennium Partners

Okay. And what did you say you impaired on the preferred side – the specific securities?

Pete Heckman

The specific securities, the total was $12 million and I think there were five securities in total, Royal Bank of Scotland, ABN AMRO, Banc of America, Bank of Ireland, and Northern Rock.

Craig Rothman – Millennium Partners

Okay. Are those – and I assume bear day is still paying, right? Those all–

Pete Heckman

Yes, they are all. Yes, they area all paying, but they are perpetual preferreds, and below investment grade, which puts them in a very difficult accounting category to not deal with in terms of bringing them to market value.

Craig Rothman – Millennium Partners

Okay. They perpetual. So, did you impair a good chunk of your perpetuals? How many you have left?

Pete Heckman

We have several left, but we impaired all of the below investment grade perpetuals.

Craig Rothman – Millennium Partners

Got you, got you, okay. And then how shall we think about the claims and distribution initiatives. Shall we think about them as ongoing or are they going to be – is that more kind of one-time?

Pete Heckman

Yes, the eight-tenths in expense that we incurred in the first quarter are clearly front-ended for both of those initiatives. As Lou mentioned, there will be a penny or two here or there throughout the rest of the year in total, but the majority of those are – those initial expenses are behind us for both initiatives.

Craig Rothman – Millennium Partners

Okay. And do you guys – do you write or target any specific combined ratio on auto?

Tom Wilkinson

Yes, we do. The combined ratio, low to mid-nineties.

Craig Rothman – Millennium Partners

Low to mid nineties.

Tom Wilkinson


Craig Rothman – Millennium Partners

Okay. And what is your target RBC in the P&C subsidiary?

Pete Heckman

Well we don’t specifically target RBC. That’s just one of the factors that we look at. We generally try to look across all the rating agencies and navigate the waters of their various criteria. Probably the one we focus most closely on is the BCAR from A. M. Best, both stressed and unstressed, and like to keep that at or above 150 to 175.

Craig Rothman – Millennium Partners

Okay. Where are you now on the BCAR?

Pete Heckman

We are in that range.

Craig Rothman – Millennium Partners


Pete Heckman

The high end of that range.

Craig Rothman – Millennium Partners

High end, okay. Okay great, thanks a lot guys.

Pete Heckman

You bet.


We have a followup question from the line of Bob Glasspiegel.

Bob Glasspiegel – Langen McAlenney

Back to a soft ball here, guys. Many break out in agent count this quarter as for as the uptick. Are we now in a position where we can look for agent growth. We’ve done culling and recruiting can take over?

Steve Cardinal

This is Steve Cardinal. Yes, we are confident. We are excited about this quarter that first growth we’ve had in a couple of years for quarter (inaudible) growth and we see some good trends (inaudible) for this whole year.

Bob Glasspiegel – Langen McAlenney

Okay. So, we should be up for the year then?

Steve Cardinal


Bob Glasspiegel – Langen McAlenney

Okay. Thank you.

Steve Cardinal

Thank you.


(Operator instructions) There are no further questions at this time.

Dwayne Hallman

Thank you, Demitras. We appreciate everyone participating on the call this morning. If you have any further questions, please feel free to give me a call. Have a good day.


This concludes today’s conference call. You may now disconnect.

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