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Torchmark Corporation (NYSE:TMK)

Bank of America Merrill Lynch 2014 Insurance Conference Call

February 12, 2014 10:35 AM ET

Executives

Larry Hutchison – Co-CEO

Gary Coleman – Co-CEO

Analysts

Seth Weiss – Bank of America Merrill Lynch

Seth Weiss – Bank of America Merrill Lynch

Hi, I’m Seth Weiss, the Senior U.S. Life Insurance Analyst. Pleased to kick-off the life portion of our conference. I then introduce Gary Coleman and Larry Hutchison, Co-CEOs of Torchmark. Torchmark focuses on providing protection oriented life and supplemental health insurance products to the low to middle class.

Gary and Larry took on the co-CEO roles in mid-2012. Prior to their current roles, Gary served as CFO and Larry served as General Counsel. In those roles, they both worked as closely together and they each have over 25 years of experience at the company.

I’m going to turn it over to Larry just to read some forward-looking comments and then we will get into our Q&A.

Larry Hutchison

Yes. Before we get started, we’re required to say that some of our comments or answers or questions may contain forward-looking statements that are provided for general guidance purposes only. Accordingly, please refer to our 2012 10-K and the subsequent forms 10-Q on file with the SEC.

Seth Weiss – Bank of America Merrill Lynch

Thanks Larry. I think maybe the best place to start is on capital distribution. And thinking about the Torchmark model that one thing that’s a differentiator of the company and over the last six years we’ve distributed about $2.5 million to shareholders which is about 85% net earnings, which is, one of the highest and most consistent payout ratios among the peer groups.

Perhaps you could start talking about the business model that allows for such strong capital distribution and how it’s differentiator relative to your peers?

Larry Hutchison

Sure. We do believe that Torchmark’s business model is different from its peers in five areas, distribution, product strategy, profit margins, cash flows and capital requirements. We utilize controlled distribution to sell our middle, to sell our protection products to middle income market.

We think using controlled distribution, allows us to be more cost efficient, primarily through our union relationships and direct response, we’re able to access those segments of the market with little competition.

Our products are protection oriented and not directly affected by either the equity or the credit markets. Our life products have high underwriting margins. The key to those higher margins is our ability to control our costs to acquire business and to administer the strong cash flows with our products that have high profit margins. And we have long-term revenue streams.

With respect to capital requirements, our low risk products result in lower risk based capital requirements. This allows us to maximize the use of our cash flows through an active capital management program.

Gary Coleman

And Seth, I would add that with that high-cash flows consistent with cash flows that we have and the low capital requirements. This allows us to not only cover all the capital needs, each year of selling new business, but there’s plenty of cash left over that we didn’t just distribute at Torchmark.

And the only thing – obligations really at Torchmark levels, our interest on the debt and our dividends to shareholders. So it gives us a great deal of cash that we can then use, we’ve used as you know primarily for share repurchase over the cash here, but net cash by acquisitions are overall part of – it’s a real strength, not only the size of excess cash flow but the consistency of it.

Seth Weiss – Bank of America Merrill Lynch

If we think about that flexibility on cash, particularly after the run up the groups had in 2013, Torchmark is now trading near about two times book value up there is high. So, maybe you could help walk us through your considerations to stock value, what do you think about repurchase decision and what are some of the alternatives are to share repurchase when thinking about those cash flows?

Gary Coleman

Well, if we felt the stock was going down, we wouldn’t use the money to buy stock, we would find another use for it which. We’re committed to distributing cash to our shareholders. So it might be that we would switch the special dividend or something like that.

But even with the recent run up, we would get PE price of book. We’re not at the historical high for Torchmark. We’re still below that. But we’re always looking we calculate what we thinking in trends and value the stock is. We talk to others and in terms of where we stand versus current price to what we think the core values. We’re not there yet. And so, if we ever get though, we recognize buying greater than core value would be diluted shareholders we would stock.

Seth Weiss – Bank of America Merrill Lynch

So, thinking about some of the alternatives, 2012 I believe we made acquisition of Family Heritage. M&A is obviously an alternative to share buyback. How do you think about M&A and what businesses would you want to be in?

Gary Coleman

Well, we would like to do acquisitions. And we’ve looked pretty hard the last few years, and we did make the acquisition of Family Heritage within the 2012. The problem is that we’re pretty selective in the type of company we’re looking for. We’re looking for companies just growing our business model and that’s selling protection insurance to the middle-income market through controlled distribution.

And there are just not many of those kinds of companies out there that are available but Family Heritage was like that. And I think it will within a portion of the company.

We’re not closed to health, Family Heritage is a health company, but we prefer life insurance because of our profit margins and there is less regulation and less competition. So, we’ll continue to look and some of the companies available we’ll go after.

Seth Weiss – Bank of America Merrill Lynch

So, thinking about sort of the payout ratio, and what’s quite phenomenal again growth. If I think about the last couple of years since 2008, EPS is growing at a very strong cliff. Our operating earnings have been mostly flat. And this has obviously been a difficult operating environment through these economic recent low interest rate. In a more normal environment, what do you view as normalized organic growth rate?

Gary Coleman

Well, if you take, if you look at the three years, I think we’ve grown earnings per share of an average annual rate of 11%. But if we look in just dollars of operating income, we’ve grown at an annual rate between 3% and 4%. Now, we’ve been really hurt about our lower interest rate. And in that period of time, our excess investment income declined and on an annual basis about 6%, it was all said by the fact that we increased our underwriting income around 7.5% during that three year period.

But there are some unusual items there, our existing Family Heritage and there is some restructuring and non-deferred acquisition costs, those kinds of things.

Going forward, I would still say that operating earnings on just a pure dollar basis will still go between 3% and 4%. But the components are going to change with the fact that new money rates are higher, instead of decline. And excess investment income, we should increases in excess investment income of 5% to 6% going forward. And our underwriting increases will go back to more of a 3% to 4% growth rate.

Seth Weiss – Bank of America Merrill Lynch

Well, in terms of an improved interest rate environment, is there a level where the rates levels, turn into a tailwind from headwind right now?

Gary Coleman

Well, basically they are – one thing about Torchmark, we don’t have interest since the product is. So, the higher the interest rates, the better for us. But right now, in our guidance for 2014, we’re experiencing, we’re going to invest at 5.5%. And although that is still very high when you compare it to the 4.7% in 2013 and as low as 4.38% in 2012, being at 5.5% makes a big difference.

So, what’s going – where we’re seeing the decline and excess investment income because of lower rates in the last three years, we’re going to see that reverse. Even in those years, even with declining rates, we were still growing investment income though we were going at a much smaller rate than the growth in asset.

What’s going to happen in 2014 and going forward, we’re going to grow the investment income at about the same rate with growing asset. And that’s going to turn a decline excess investment income, until 2014 we’ll have a positive of 5% or 6%. Plus it’s a great improvement but we would like for the rates to continue to go up and the sooner the better.

Seth Weiss – Bank of America Merrill Lynch

And maybe just a close loop on investment income piece. Part of the price over the last couple years were called some of the high-grade preferred. If we think of elevate the next cost five years, is there anything out of the horizon that we need to figure watching for right portfolio that could cause for new attained volatility and the investment income lines?

Gary Coleman

No, as a matter of fact, our maturities over the next, looking out the next five years average about 2% of the portfolio a year. Also, the rate, the yield rate from the bonds coming out of the portfolio is now closer to the new money rate that we’re seeing. So there is – and we’re actually going to see if we keep investing at 5.5% over the next five years, we’re going to see the portfolio yield stabilize instead of decline.

Because, show you how bad it was in the last five years, our portfolio yield has declined from over 100 basis points from 698 to 590. Investing at 5.5%, we would expect five years from now it will be maybe 8 to 10 basis points lower but it won’t be the big decline we’ve had.

Seth Weiss – Bank of America Merrill Lynch

That’s helpful. So maybe transitioning away from the investment side to more for the operation side, and thinking about sales which are organization stable there is a lot of focus on sales, which can be and might be in general. But if you look at premium growth, they’re very similar to the line. Maybe you could talk a little bit about persistency trends that you’ve seen the last several years and your enforced business. And actions you’ve taken to keep that enforce in persistency high?

Gary Coleman

We’ve been selling the same protection product, especially the life products over 30 years long I’ve done in Torchmark. We have a great deal of history in terms of persistency fee rates that we – there is very little change under a year.

What we have done in the – we’ve always had our agents we’ve always incentivized them to reinstate policies that have lapsed. But one thing we’ve done, I think it’s three years ago in our home office, we put together a group and implement procedures that whenever somebody lapses the policy, we contact them, we try to get them back in the paying status.

And just have never done before but making a conservative effect to do that we’ve seen a real improvement. For example, this year, or in 2013 15% of the business will lapse, we were able to get reinstated through this home-office effort. And through what the agents do, is another 2%. So we were able to save 17% of the business that lapsed.

Now, some of that business will lapse as they go forward but anytime you can say the lapse as you can get back in-forces improves your persistency.

Larry Hutchison

One thing I wanted to add is the agency is also focused on increased on our persistency. This agency as personnel has signed full time, but with our conservation and we’re seeing those improvements in each agency.

As each of the agency discovers the best practices for conservation within the agency, as shared among the Torchmark agencies, we think we can grow that conservation as far as from the home office.

Gary Coleman

Another thing I would add is that, well they’re supported by improving persistency. I don’t think people realize the value of enforced block that we have at Torchmark.

As Larry mentioned earlier, we have high profit margins on the business but we also have long revenue streams. And one reason you don’t see our growth and underlying income is the fact that in any one year, you can look at the premiums. For example, in 2013, the premiums on policies issued in 2013 only made up about 10% of our total premium income.

The other 90% came from policies we sold in prior years. When you have that big of a block of enforces, it’s hard to grow and to run income at higher rate. So what we do is we grow it very consistently.

Seth Weiss – Bank of America Merrill Lynch

So, thinking about those conservation efforts, that’s something that didn’t really come up on quarterly calls. And I think it’s an interesting point. How much more progress do you think there is in terms of conservation and improvement to persistency which is already pretty strong?

Gary Coleman

Well, as I mentioned from that home office group that we can serve 15% of the losses in 2013. Our goal for the next couple of years is to get that up to just under 20%. That’s – because I don’t know it almost would be finding new ways to get the policyholders and get to them and help them reinstate the policy.

Larry Hutchison

And part of that is a testing price as we continue to excess stream, no new means concerning that business, then constant new ideas would come up of how to contact policyholders the way ups when to contact them. Usually, grow with methodology and the testing price, best to improve our conservation efforts.

Seth Weiss – Bank of America Merrill Lynch

And maybe a little bit further on sales front. Torchmark’s position is pretty unique in terms of the focus on the mid-market. This has historically been a cohort that’s underinsured. If you think about strategies to improve penetration, both the Torchmark and the industry in terms of that middle income segment. What are the strategies that you have put forth?

Larry Hutchison

Well, first of all we’ve done a lot of research in the middle income work. And Gary and I are looking at the markets, and we come back to the middle income market because we know it’s an underserved market.

Our research tells us that 50% of consumers understand they don’t have enough insurance, and our customers don’t have any product insurance at all. I’m talking about life insurance.

In terms of penetration, the market, we’ve made lot efforts to increase our penetration over the last five years. Our market income distribution, we have long relationships with our unions. We continue to maintain those relationships. In addition to that, we use those relationships to develop a referral program.

And today, about 70% of the new business that we write at American income comes from referrals versus the traditional union member. So we’ve seen great success in that referral program to expand our footprint in that middle income market.

With respect to Globe Life asset, Global Life is selling the same life insurance products for about 50 years. In that 50 years, they develop a lot of expertise, they were kinds of scales and controlling cost. And more importantly we have a lot of data, a lot of experience in selling those products. And through that we know who to sell, when to sell and where to sell those products with the right response.

Globe Life has also used a lot of technology to change the company. Globe Life has really evolved from just a direct response company that uses the mail to now uses technology. When we look at our sales, about 40% of our new sales are now through electronic technology that would be the internet and other social media to reach our consumers.

That is our fastest growing segment, our direct response. So we continue to explore that and we see real opportunities for Globe Life in the electronic distribution.

Seth Weiss – Bank of America Merrill Lynch

And maybe on Globe Life, I’m not first of all made release, Torchmark purchased the main lines for the range ball-park, it will called the Globe Life Ballpark in Arlington. Maybe you could just describe a little bit, the thinking that I feel and also why you decided to use the Global Life brand name as opposed to using a Torchmark brand?

Larry Hutchison

We’re really excited about this opportunity for Globe Life. When we looked at the Rangers in the demographics and their customers, it really matched the demographics of Globe Life, it’s middle income fans. And obviously Globe Life is going to come to market. And traditionally Globe Life and the other Torchmark operating companies haven’t had real name recognition.

So, we see this as our opportunity particularly in the Texas region that is Globe Life is really staged to test and see the results from running an opportunity. We know it’s going to help the other agencies, because I think there is an instant credibility, Family Heritage Life’s largest state is the State of Texas.

And one of the issues we deal with agent recruitment is when you’re talking and your agent. I’m not sure who Family Heritage Life is. And they’re able part of the Torchmark group is a publicly traded company. And now say prior to perspective agents or even customers I think I would say Family Heritage is a sister, kind of Globe Life, I’m sure you’re aware of that. That’s the ending part of with the Texas Rangers.

So, now there’s an instant credibility. And within the Texas market and the surrounding space, when others really have lived because we were licensees, they all go, we’re going to be on the social media pages. There is a lot of TV and brand new advertising that comes with the naming rights. And that’s because of the policy of such a greater recognition, of Globe Life have signed the five state area for the Rangers.

We know that the national telecast would be held for because of the visiting team on every pitch let’s say Globe Life behind home plate as they see each pitch. And then we’ll be able to test to see how meetings, what the internet traffic is, the usual is really go forward. So we really see this is a terrific opportunity for Globe Life and Torchmark companies.

We didn’t use Torchmark because within Torchmark, Torchmark doesn’t reach its customers directly. All of our products are sold to the operating companies. So, Gary and I talked about this, we really thought it made more sense to use Globe Life, then Torchmark, because Torchmark isn’t on the investment community.

Globe Life made the most sense along with Torchmark companies because it is a direct response company. And it manifests from internet traffic and other kinds of electronic communication.

Gary Coleman

Yes, I would add that we – as we have mentioned for years we’ve been planning to look at way to increase the brand awareness as well as longevity. In doing so, the expenses, especially in television throughout the country would – is really high compared – especially compared to the – our direct response policies that were able to current and looking at the profit margins very quickly, with high expense brand advertising.

Despite the core is very amount, what this costs, this is going to be an inexpensive way of doing some brand recognition for Globe. It is – they have a large, range of large television market in the five state areas that’s assigned in MA. And that is our biggest area in terms of sales and right response.

But also they play of course team throughout the country. And games are played in Arlington when the Los Angeles Angels, Los Angeles is a big area for direct response. When the Angels play they’ll see Globe Life in on the background and same for other losing teams.

And as we think of the scale, so when somebody gives an insert of a piece of merit to Globe Life, when they go to the internet and see the name go right, we think it will help with name recognition. And all it takes is just a few more people to open the merit, look at those inserts and we go online to improve our response rates, which improves our profitability.

The second part of that is as Larry mentioned the television and radio we get along with this deal. That’s where we can help with advertising for our agencies, help for recruiting. And in special Family Heritage is very nice. So we think this, it’s part of the most benefit of Globe Life that really benefits all our companies.

But I also agree with Larry we’ve been contacted by other stadiums before, we’ve never done it but it’s very gentle Torchmark. But I think with the increases, the current media and direct response, we’ve not assumed there is a strategic reason. But it’s not the Torchmark, it’s getting Globe Life name on it.

Larry Hutchison

Seth, as we tested results the only real drag in the regional branding opportunities. And as we see the actual results globally at the companies, we could say our national branding opportunities as well.

Seth Weiss – Bank of America Merrill Lynch

Should we think about a step-up in other branding advertising initiatives or should we think of this as sort step one?

Larry Hutchison

This is really step one this is really a different approach for the Torchmark companies. In the past Globe Life truly has be able to measure response rates. But it hasn’t done branding per say, so this is really a first step. But the value is that first step supports all the other initiatives with Globe Life. I mean, it fits perfectly with your direct mail campaigns, with your internet campaigns and all the ways that Globe Life tries to reach their consumer without an agent to support to the stranding effort.

Seth Weiss – Bank of America Merrill Lynch

Just want to pause and see if we have any questions from the crowd. The back right.

Question-and-Answer Session

Unidentified Analyst

So, not to harp on this, but are you going to run the expenses associated, it sounded like A, with published reports about what it’s going to cost Torchmark or Globe Life for the naming rights may have been overstated? But what I think you said earlier.

And the second question I had is a follow-up to that, would you run the expenses associated with the naming rights through the Globe Life segment or through the corporate segment?

Larry Hutchison

I think part of that question is don’t believe everything you read about this cost for naming rights. There have been reports that we were at the range from $5,200 million. And while we have agreed to the ranges I suppose the amount we can’t say as less than the $50 million to $100 million this time reported. Gary, do you want to cover the accounting treatment?

Larry Hutchison

Yes. Also I would add to that over the 10-year period, the calls will be less than 1.5% or 1% of Torchmark’s operating levels. So, it’s really not the cost. As far as what they called, we will because we will determine what the benefits we’re getting, we’ll allocate the costs that – I think Global gets a fair amount of – but the agencies will also get in that too. As I mentioned, we’ll do some of the advertising through them. So, it will be split among the companies.

Gary Coleman

Okay, advertisement of the CEOs, each of the operating companies and there are probably other operating companies who have sized great response. They do see real benefit on this. But they can recruit with this, they got a production contest. So but possibly allocated, according to you it’s among the Torchmark companies.

Unidentified Analyst

So, I guess just a second follow-up with that. We shouldn’t expect to see a pick-up on the expense, the deterioration in the margins is, at least in year one associated with an advertising, higher advertising expenses?

Gary Coleman

No. When I think about the expenses associated with this, this is much like other campaigns or nurseries we talk about Globe Life. And I don’t see this as a campaign or initiative that is definitely more of an investment expense also the initiatives.

Larry Hutchison

And what I’m interested is when I have the 1% of the operating earnings, I would just come back to calls. But then it doesn’t know benefits projected into that. So, it really should be less than that.

Unidentified Analyst

Thanks.

Seth Weiss – Bank of America Merrill Lynch

Maybe just turning to the other business segments, you’ve had a successful turnaround in Lincoln National, I’m sorry Liberty National?

Larry Hutchison

Yes, we worked in Lincoln now.

Seth Weiss – Bank of America Merrill Lynch

Successful turnaround with Liberty. And you’ve seen some modest margin improvements in the other segments. Where should we think about margins leveling up and what are their actions that they’re allowed to take at the operating companies?

Gary Coleman

Let’s talk about Liberty first, Liberty National. We are pleased with the progress we’re making. We opened six new offices at Liberty National in 2013. And we expect to open another five offices at Liberty National in 2014. Our long-term goal at Liberty National is some open offices outside of the South East, and that strategy is paying off. We expect to see our margins at or near the same levels that we’ve seen in 2013 and what we’ll see in 2014.

Larry Hutchison

And those margins are high for industry or lower, I don’t know why we can’t include. So I think we’ll maintain those margins.

Gary Coleman

So, unless there is maintain to margins, at the same time expand our operation throughout the U.S. with Liberty National.

Seth Weiss – Bank of America Merrill Lynch

And then maybe if there are any other questions from the audience, we could end just finally supplemental health business which you commented early on that you liked the margins in life businesses in terms of where you take our position. Obviously opportunistic given that you increased supplemental health with family heritage.

How does the Affordable Care Act and the sort of evolving nature of healthcare change the operation and perhaps effect the economics of the Life business?

Gary Coleman

I just reiterate that our focus is on life insurance. 70% of our underwriting income comes from life insurance. And that remains our primary focus. That said, Family Heritage really resembles life insurance more than health insurance. They sell every term of premium product and the margins on that business are much like Life Insurance more so than health insurance.

That said, we like – partly, we like Medicare supplement. This is an opportunistic business said, we started projecting long range what that growth would be because we’re going to maintain our profit margins. And we’ll increase market share if we can maintain those margins.

Part of the reason it’s difficult to predict is that part of those margins are dependent upon, but other insurers are willing to do neither partly or Medicare supplement. As they’re going reduce their margins before lower and accepted towards the Torchmark and we’ll write less of that business.

If we see an acceptable margin, we could expand that – that is the one distribution that we write through a general agency business so it’s fairly easy to either expand or contract that business.

Larry Hutchison

And with our other supplemental insurance, the range of some of the other companies with dread disease products. Those aren’t affected by ObamaCare. So we expect to be able to continue to sell those.

Gary Coleman

Yes. Supplemental products, particularly with Liberty National are really in addition with the Life Insurance. With about 50% of our distribution of Liberty National is still the workplace. And workplace we’re offering the Life Insurance and the Supplemental health insurance products. So it’s really a compliment of the life insurance sales of Liberty National Life Insurance Company.

Seth Weiss – Bank of America Merrill Lynch

Okay, great. I think we’re going to end it there. Thank you Gary and Larry for their time.

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