StanCorp Financial Group Management Discusses Q1 2014 Results - Earnings Call Transcript

Apr.24.14 | About: StanCorp Financial (SFG)

StanCorp Financial Group (NYSE:SFG)

Q1 2014 Earnings Call

April 24, 2014 12:00 pm ET

Executives

Jeffrey J. Hallin - Vice President of Investor Relations and Capital Markets

J. Gregory Ness - Chairman, Chief Executive Officer, President, Chairman of Standard Insurance Company, Chief Executive Officer of Standard Insurance Company and President of Standard Insurance Company

Floyd F. Chadee - Chief Financial Officer and Senior Vice President

Daniel J. McMillan - Vice President of Employee Benefits

Scott A. Hibbs - Chief Investment Officer, Vice President, Chief Investment Officer of Standard Insurance Company and Vice President of Standard Insurance Company

Analysts

Randy Binner - FBR Capital Markets & Co., Research Division

Seth Weiss - BofA Merrill Lynch, Research Division

A. Mark Finkelstein - Evercore Partners Inc., Research Division

Suneet L. Kamath - UBS Investment Bank, Research Division

John M. Nadel - Sterne Agee & Leach Inc., Research Division

Operator

Ladies and gentlemen, thank you for holding. Welcome to the StanCorp Financial Group, Inc. First Quarter 2014 Earnings Conference Call. [Operator Instructions] Today's conference call is being webcast live over the Internet and is also being recorded. [Operator Instructions] At this time, I would like to turn the call over to Mr. Jeff Hallin, StanCorp's Vice President of Investor Relations and Capital Markets, for opening remarks and introductions. Please go ahead, sir.

Jeffrey J. Hallin

Thank you, Raia, and welcome to StanCorp's First Quarter 2014 Earnings Conference Call. Here today to discuss the company's first quarter results are: Greg Ness, Chairman, President and Chief Executive Officer; Floyd Chadee, Senior Vice President and Chief Financial Officer; Katherine Durham, Vice President, Individual Disability Insurance, Corporate Marketing and Communications; Jim Harbolt, Vice President, Asset Management; Scott Hibbs, Vice President and Chief Investment Officer; Dan McMillan, Vice President, Employee Benefit; and Rob Erickson, Vice President and Controller. Today's call will begin with some brief comments from Greg and Floyd, and then we will open it up for questions.

Before we begin, I need to remind you that certain comments made during this conference call will include statements regarding growth plans and other anticipated developments for StanCorp's businesses and the intent, belief and expectation of StanCorp's management regarding future performance. Some of those statements made are not historical facts, but are forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995. Because these forward-looking statements are subject to risks and uncertainties, actual results may differ from those expressed or implied. Factors that could cause actual results to differ materially from those expressed or implied have been disclosed as risk factors in the company's first quarter earnings release and the 2013 Form 10-K.

With that, I'll turn the call over to Greg. Greg?

J. Gregory Ness

Thank you, Jeff, and thanks to all of you who have joined us for our first quarter earnings call. Yesterday, we reported first quarter 2014 earnings, and I like the results. The results were consistent with our expectations for the first quarter of this year. The first quarter benefit ratio improved over last year for both Employee Benefits and Individual Disability. Asset Management provided earnings in line with our guidance, and we deployed approximately $82 million of capital through the repurchase of debt and through share repurchases, while maintaining a very strong balance sheet and growing book value per share, excluding accumulated other comprehensive income by 9% over the past 12 months.

Earnings, excluding after-tax net capital losses for the first quarter of 2014, were $1.14 per share compared to $1.07 per share for the first quarter of 2013. If you exclude the $0.15 per share related to changes in our postretirement medical plan in the first quarter of last year, earnings per share increased 24% over 2013. Adjusting for the stock split in 2005, this is our highest first quarter EPS ever. In Insurance Services, pretax income for the first quarter of 2014 was $56.7 million compared to $48.8 million for the first quarter of 2013. The growth in income was largely due to more favorable claims experienced in Employee Benefits and Individual Disability. Historically, we have seen a higher benefit ratio in the first half of the year. The benefit ratio for Employee Benefits improved 310 basis points to 80.8% for the first quarter of 2014 compared to 83.9% for the first quarter of 2013. For 7 consecutive quarters, the quarterly benefit ratio for Employee Benefits has improved year-over-year.

Employee Benefits premiums decreased 5.5% for the first quarter of 2014 compared to the first quarter of 2013. Employee Benefits annualized new sales were $62.5 million for the first quarter of 2014 compared to $97.6 million for the first quarter of 2013. The level of premiums and sales reflects decisions we made to maintain our pricing discipline. Competition in the large case market remains aggressive and federal health care reform added some distraction, which led to fewer quality quoting opportunities.

We are confident about our future prospects. We have strong relationships with our distribution partners, as evidenced by our high annual persistency. We're also investing in new ways to drive higher sales. As an example, we continue to expand our products and service capabilities in the areas of employee choice and the voluntary benefits. We're strengthening our connection with key regional partners, and we're adding sales representatives in each of our regions across the country. Proposal activity is improving, as distractions from the economy and health care regulation begin to dissipate. In addition, we see the benefits of a slowly improving economy with headcount growth among our existing customers up 0.2%. That represents the second consecutive quarter of positive growth. We're optimistic about these improvements we're seeing in these areas.

Our Individual Disability benefit ratio improved 780 basis points to 54.1% for the first quarter of 2014 compared to 61.9% for the first quarter of 2013. As a reminder, the benefit ratio for this business can be more volatile from quarter-to-quarter, and tend to be more stable when measured on an annual basis. In Asset Management, income before income taxes was $16.4 million for the first quarter of 2014 compared to $17.2 million for the first quarter of 2013. The quarter-over-quarter decrease primarily resulted from changes in the fair value of the hedging assets and liabilities related to our equity-indexed annuity product. Result this quarter were consistent with our guidance provided last quarter for this line of business. A typical quarter for Asset Management would have income before income taxes in the $16 million to $17 million range.

StanCorp is on track and off to a good start for 2014. Our mission is to provide high-quality products and services at fair prices, and distinguish ourselves with superior customer service. Our people are committed to delivering exceptional service each and every day. By focusing on our mission, we're confident in achieving our 2014 expectations.

With that, I'll turn the call over to Floyd for a further discussion of capital investments, and of course, we'll leave plenty of time for your questions. Floyd?

Floyd F. Chadee

Thank you, Greg. The first quarter financial performance demonstrates the strength of our balance sheet, investment portfolio and capital position. I would like to first discuss the new money investment rate and the discount rate used for newly established long-term disability claim reserves for the first quarter of 2014. I will then comment on the performance of our investments and our capital position.

We have a very disciplined and transparent approach to setting our discount rate. The discount rate is determined by the mix and timing of the new investments that we acquire and by the yields on these new investments less the margin. Our new money investment rate for the first quarter of 2014 increased to 4.69% from 4.33% for the fourth quarter of last year. The 12-month margin improved to 55 basis points for the first quarter compared to 49 basis points for the fourth quarter of 2013. As a result of these changes, the discount rate used for newly established long-term disability claim reserves increased 25 basis points to 4.0% for the first quarter of 2014 compared to 3.75% for the fourth quarter of 2013. The 25 basis point increase in the discount rate results in a corresponding increase in quarterly pretax income of approximately $2 million. We continue to see volatility in interest rates. In addition, new money investment rates on bond and commercial mortgages remain below our current investment portfolio yields, resulting in lower investment income. We expect this downward trend on investment income will continue throughout 2014. We have a high-quality investment portfolio composed primarily of fixed maturity securities and commercial mortgage loans. At March 31, 2014, our fixed maturity security portfolio had an average credit quality of A-. We are also known for our expertise in underwriting, originating and servicing commercial mortgage loans. At March 31, 2014, our commercial mortgage loan portfolio yield was 5.8%, and our delinquency rates remained low at 40 basis points. Our commercial mortgage loan portfolio has a long track record of providing excellent risk-adjusted returns. We will continue to leverage this expertise.

Now I will turn to our capital position. We define available capital as capital in excess of our insurance subsidiaries' target RBC ratio of 300%, together with cash and capital at the holding company and noninsurance subsidiaries. At March 31, 2014, available capital was approximately $500 million. The $35 million decrease compared to December 31, 2013 was primarily due to the $82 million in capital deployed to repurchase debt and shares during the first quarter of 2014. We repurchased more than 550,000 shares for approximately $35 million at a volume average weighted price of $62.63 per share. In addition, we repurchased approximately $47 million of our 6.9% subordinated debt from a single investor. The repurchase of this debt will provide annual interest expense savings of $3.2 million. At March 31, 2014, we had approximately $253 million of subordinated debt outstanding. We will continue to be opportunistic with our capital deployment. At the insurance subsidiaries, we estimated risk-based capital ratio of approximately 400% at March 31, 2014. This is after a $40 million dividend from the insurance subsidiaries to the holding company in the first quarter. Under normal circumstances, in the absence of pressing strategic possibility, we would expect that the capital of the insurance subsidiaries would not fall below 325% of RBC, and that we would hold a buffer of approximately $200 million to take advantage of business opportunities, and to provide for external economic risk. Currently, our capital position in excess of these normal levels is approximately $200 million.

In addition to our strong available capital and estimated risk-based capital ratio, we grew book value per share, excluding AOCI, by 9% compared to March 31, 2013. We are confident in the steps we have taken, and are continuing to take to manage this business. Our foundation is built upon leveraging a strong balance sheet, investment portfolio and capital position to bring value to our customers and our distribution partners. We will continue to use this foundation to build long-term shareholder value.

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

Jeffrey J. Hallin

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

Question-and-Answer Session

Operator

[Operator Instructions] We will now take our first question from the line of Randy Binner with FBR.

Randy Binner - FBR Capital Markets & Co., Research Division

So I just want to follow up on a comment from Greg. I think you said that quote activity was starting to improve a little bit more recently versus what you saw in the first quarter. So trying to get a little bit more texture on that. I think you alluded to maybe the economy is a little bit better, and there's less Obamacare noise. But I'd be interested in both those points because it's hard to see how we can get premiums -- I think we're talking about flat premiums for 2014 when guidance was given. So just wondering how we would kind of ramp back to that after this quarter in relation to those comments from Greg.

J. Gregory Ness

Okay, Randy, let me ask Dan to take that. Dan?

Daniel J. McMillan

Good morning, Randy. This is Dan. The comments that Greg made are alluding to really what we would say was the primary driver of the lower top line number this quarter, and we alluded to that last quarter. We also alluded to the prior quarter, and that's because the primary driver there was fewer large case sales in the quarter that credited. And it's important to understand the timing there, which is, those are sales and buying decisions that were made early last year. And during that time, we were, as you know, in the midst of a repricing effort. It's also a time when the Affordable Care Act was distracting a lot of employers, particularly larger employers then, thinking about that 1/1 effective date that was coming up towards the end of the year. And so we saw not only fewer proposals, but fewer quality proposals during that time, and then that manifested into fewer sales that credited in this quarter, and that's the reason we're able to foreshadow that in the last 2 quarterly calls. I think the other comment Greg made was that the good news is that, that large case proposal activity is improving in the current environment, and that give us some optimism going forward.

Randy Binner - FBR Capital Markets & Co., Research Division

But is it improving in regards to a better economy? Or is it improving in regards to, I guess, less Obamacare noise, if you will? Because that seems to be kind of the wild card, right, is that people are hesitating to make decisions as we move past the 1/1 renewals? Are there more people who now feel like they have information to kind of put proposals out? Is that also changing?

Daniel J. McMillan

Yes, it's a little difficult to make attributions specifically to Obamacare, but the reality is we're seeing a greater number and a greater quality of proposals, and that allows us to take some good shots at good risk at the right rate.

Randy Binner - FBR Capital Markets & Co., Research Division

And then I mean, finally, and I'm not sure that you update this kind of as the year goes on, but I think you had talked about flat premiums for 2014. Is that something that would still be achievable?

Daniel J. McMillan

I think it's safe to say the first quarter sales was also going to make that challenging in the current year. However, we are very focused on improved sales order throughout the rest of this year, looking at the opportunities that are in front of us, and we're going to work hard to make that very number. We're focused on the strategy that's going to drive growth into the coming year.

Operator

Our next question comes from the line of Seth Weiss with Bank of America Merrill Lynch.

Seth Weiss - BofA Merrill Lynch, Research Division

And maybe just to expand on Randy's question, I know you don't give quarterly persistency numbers, but maybe you could provide some commentary on how the 1/1 renewal season looks. With the lower cap line number, it looks like persistency may have fallen a bit, but I'm not sure if this is just simply a function of what was lower sales.

J. Gregory Ness

Okay. Dan, do you want to take that?

Daniel J. McMillan

You're right, Seth. We don't provide quarterly persistency guidance. I can tell you that the renewal season is one that we're very focused on this year. And while we don't renew every case, the ones that we did lose this year were lower ROE, lower profit business, and we generally have tried to hold the line there so that we're not eroding that bottom line at the same time. And persistency is something that we'll continue to very much focus on in the coming year, providing that service that supports customers and really makes them want to stay and stay with the quality carrier.

Seth Weiss - BofA Merrill Lynch, Research Division

Okay. And maybe just one -- a quick one on capital. You highlighted the $250 million of subordinated debt left. Where does that rank in terms of if we're thinking about capital priorities going forward. You're already near the low end of share repurchase guidance? Maybe if you could just help us think about how you're thinking about capital for the remainder of the year.

Floyd F. Chadee

We're not thinking of capital any differently from how we've always thought about it and how we thought about it in the first quarter here, Seth. It's -- we're very opportunistic with respect to capital deployment, and we've told you what our priorities are in the past: grow the business, acquire through M&A activity or return value to our shareholders. And during the first quarter, we had -- we were very pleased with our ability to repurchase shares, but also very pleased with the opportunity that was afforded to us in the repurchase of a 6.9% debt. That was more or less of a one-time opportunity. We don't expect that to recur. There's some sort of complicated perspectives in the rating agencies in how often you can do that. So that was good and it was one time. I mean, as we look at the rest of the year, we'll be opportunistic as always.

Operator

Our next question comes from Mark Finkelstein with Evercore.

A. Mark Finkelstein - Evercore Partners Inc., Research Division

I guess also back to sales. Are you viewing this as purely a large case competitive issue or are the issues also in the small -- in mid-case, but it's just more dramatic in the large case in terms of the competitive landscape?

J. Gregory Ness

Dan?

Daniel J. McMillan

Competitively, I would say that it really is a timing issue with that particular segment, and that a lot of those buying decisions for business will be affected in this quarter were made earlier last year. And during that time, not only did you have fewer proposal opportunities, but they were not what we would call quality opportunity. So that was the primary driver. Small case activity has been dampened by the ACA over the different periods of time, but we actually saw that manifest later in the year last year.

A. Mark Finkelstein - Evercore Partners Inc., Research Division

Okay. And I mean, obviously, you've increased rates for incidents, did some things on the interest rate side as well. With where you sit today, do you have any opportunity to refine the pricing models to maybe be a little bit more competitive in those or is the strategy continuing to be kind of this is our price and we've made the change, and we think this is the right price?

Daniel J. McMillan

We've made the changes we need to make, Mark. It's safe to say that we're making pricing adjustments every quarter as we look at markets and changes that we see out there, and that has to do with interest rates, that has to do with different ways that we see segments performing. The primary reason we focused so heavily in the past on a specific pricing change relative to LTE it seems is because of the unusual nature of that phenomena.

A. Mark Finkelstein - Evercore Partners Inc., Research Division

Okay. And then can you just break down the experience in the first quarter? Did you see adverse mortality? What where the incidence trends in disability?

Daniel J. McMillan

We saw very fairly strong contributions from all product lines, and we didn't see any big aberrations from our expectations. Incidents continues to stabilize and be within our expectations, and we didn't see anything that jumped out of this.

A. Mark Finkelstein - Evercore Partners Inc., Research Division

So no higher mortality on the -- on group life plans?

Daniel J. McMillan

No.

Operator

Our next question comes from the line of Suneet Kamath with UBS.

Suneet L. Kamath - UBS Investment Bank, Research Division

Just one more on sales if I could. If I go back to last quarter's transcript, I think, Dan, in response to a question about the sales outlook for the first quarter, you said that sales will be down a bit or a little bit, something like that. So we're looking at a quarter where sales are down, I think, 36%. So it seems to me that there was a surprise in the quarter relative to what, perhaps, you were communicating last quarter. So I just want to try to understand where the negative surprise came from.

Daniel J. McMillan

Yes, I wouldn't characterize it as a surprise. We can debate about the qualitative statements that we might make. I think it was actually third quarter that we said in a question from you that we had a disappointing 1/1 coming up. And that may have a little more flavor of what we actually saw if you compare the 2 comments together.

Suneet L. Kamath - UBS Investment Bank, Research Division

Okay, and then, I guess, on the new money rate in the quarter, it looks like the 4.69% that Floyd mentioned was -- I think by my tracking here, is probably the highest we've seen since the fourth quarter of '12. So just curious if there is, A, anything unusual in that number that hit in the quarter; and then B, what you expect the trend should look like over the next couple of quarters of the year, if you can provide that.

J. Gregory Ness

Let me ask Scott to discuss it. Scott?

Scott A. Hibbs

Yes, Suneet, I wouldn't say there was anything unusual. That new money rate, which we use to set the discount rate is based on several factors. The level of yields on new money, the mix of investments and the timing of investments in the particular quarter. So it's the combination of those factors. And as you probably remember, there's a 60- to 90-day lag from the time of the origination of our mortgages to when they come on our books so that is a factor as well. In terms of what you should expect in coming quarters, I think we continue to see downward pressure. The decline that we saw in net investment income this quarter wasn't unexpected, and I don't think it would be unreasonable to expect a similar level of decline in future quarters compared to 2013. The other factor to think about in that investment income is bond call premiums, mortgage loan prepayments and the impact of our equity index annuity hedging, and those are all variables that cause the net investment income to fluctuate quarter-to-quarter.

Suneet L. Kamath - UBS Investment Bank, Research Division

So if we see that new money rate ticking down a little bit, if in fact it does, it would seem unlikely that we're going to get another discount rate adjustment higher in the balance of the year. Is that a fair observation?

Floyd F. Chadee

The current rate, Suneet is a function of new money rates, and it will depend on where new money rates go, and we are [indiscernible]

Suneet L. Kamath - UBS Investment Bank, Research Division

I'm just -- I'm not getting a sense of where you think the new money rates are going to go. I get that the portfolio yields are going to continue to come down, but do you think the new money rates can sustain at 4.69% or do you think that we'll probably see downward pressure on that as well?

Floyd F. Chadee

I mean, new money rates will be a function of the markets and function of both, for us, the mortgage markets and the bond markets. So I mean you know how volatile they have been.

Operator

Our next question comes from the line of John Nadel with Sterne Agee.

John M. Nadel - Sterne Agee & Leach Inc., Research Division

It continues to happen. It is what it is. The -- so I'll try this with you, Floyd, how about this. So $34 million, $35 million of buybacks in 1Q, should we -- how do you think your investors should sort of look upon that? Should they look upon that as early in the year down payments on the $40 million to $80 million range? Or should we look at that as

[Audio Gap]

opportunistically. StanCorp really liked the stock price, especially with the pullback early in the first quarter. And with a further pullback here, StanCorp likes the stock price that much more, and so maybe we think about the $40 million to $80 million range a little bit differently?

Floyd F. Chadee

Yes, I think, John, I mean, you use different words from what I would use, but I think you've described an opportunistic approach, and I think our approach is definitely opportunistic.

Operator

Thank you. We have no further questions in queue at this time. I like to turn the floor back over to management.

Jeffrey J. Hallin

Thank you. I'd like to turn the call over to Greg for some closing comments. Greg?

J. Gregory Ness

Thanks, Jeff, and thanks to all of you for joining our call today. I'd like to leave with just a few thoughts before we close. At StanCorp, we are focusing on the right things and taking care of the fundamentals. We're confident about our future growth in Employee Benefits. We have strong relationships with our distribution partners, as evidenced by our high annual persistency. We're also investing in new ways to drive higher sales. The first quarter benefit ratio improved over last year for both Employee Benefits and Individual Disability. Our Asset Management results were well within our guidance range for the quarter, and we deployed approximately $82 million of capital through the repurchase of debt and shares. Our first quarter results are on track with our expectations, and we are off to a good start at StanCorp for 2014.

Thank you, all, for joining us on this call today. Have a great day. With that, I'll turn the call back to Jeff.

Jeffrey J. Hallin

Thank you, Greg. I'd like to thank everyone for joining our call today. There will be a replay of this call, starting this afternoon and running through May 2. To listen to this call, you can dial (877) 660-6853, and enter the conference ID number 13578035. A replay of today's webcast is also available at www.stancorpfinancial.com. Thank you. Raia?

Operator

Thank you. Thank you for participating in today's telephone conference. You may now disconnect.

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