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Executives

Eva Roberson - VP, IR

John Johns - Chairman, President and CEO

Rich Bielen - Vice Chairman, and CFO

Carl Thigpen - CIO

Carolyn Johnson - COO

Steve Walker - CAO

Analysts

Chris Giovanni - Goldman Sachs

Ed Spehar - Bank of America-Merrill Lynch

Steven Schwartz - Raymond James

Mark Finkelstein - Evercore Partners

Jimmy Bhullar - JPMorgan

Protective Life Corporation (PL) Q1 2012 Earnings Call May 9, 2012 10:00 AM ET

Operator

Good day, ladies and gentlemen and welcome to the first quarter 2012 Protective Life Corporation earnings conference call. (Operator Instructions) I would now like to turn the conference over to, Ms. Eva Roberson, Vice President of Investor Relations. Please proceed.

Eva Roberson

Thank you. Good morning, everyone, and welcome to Protective Life Corporation's 2012 first quarter earnings call. Today our call is hosted by John Johns, Protective's Chairman, President and CEO and Rich Bielen, our Vice Chairman and CFO. Here with us also in the room we Carl Thigpen, our Chief Investment Officer; Carolyn Johnson, our Chief Operations Officer; and Steve Walker, our Chief Accounting Officer.

Yesterday we released our earnings press release as well as the supplemental financial information, and both of these documents are posted on our website at www.protective.com. In addition to the information we released yesterday we are using a slide presentation with our discussion this morning and that slide deck is being webcast from our link in the Investor Relations page of our website and our file is available for download at that location.

Finally, today's discussion will include forward-looking statements that express our expectations of future events and results. Actual events and results may differ materially from these expectations. You can refer to our press release and the risk and uncertainties, as well as risk factors section of the company's most recent Form 10-K, for more information about the factors that may affect our future results.

Our discussion also includes non-GAAP financial information and reconciliation to the GAAP measures can be found in the supplemental financial information on our website.

At this time, I would like to turn the call over to John Johns.

John Johns

Eva, thank you and thanks to everyone for joining us on the call this morning. We are very pleased today to report another very good quarter, a very solid quarter, both operating and net earnings where $1.18 per share in the quarter. Our pre-tax operating earnings were up 56% over the first quarter of last year and 30% over the prior quarter.

The performance this quarter is positively influenced by better than expected investment income resulting in improved spreads in life marketing, annuities and stable value.

We also enjoy the benefit of stronger than expected equity market performance in our variable annuity product line. As we have previously announced, we did receive a gain of $35.5 million upon the repurchase of some notes that we issued a few years ago in connection with the securitization transaction.

Our mortality results are still good overall, were mixed among segments during the quarter. We are also pleased to report that we were able to return 39% of our after-tax earnings to share owners through a combination of share repurchase and dividends. We also are pleased that our statutory balance sheet is still very strong, we estimate and we finally closed our statutory books that our risk based capital ratio into the quarter will be in the range for about 450% to 420%.

I'm now going to turn the call over to Chief Financial Officer, Rich Bielen to give you more detail on the quarter.

Rich Bielen

Thank you, Johnny, and good morning everyone. If you turn to Slide 5, operating income for the quarter was $1.18 versus $0.71 a year ago. We had realized investment gains of $0.18 offset by a derivative loss of $0.18 resulting in net income available to our shareholders of a $1.18. Our after-tax operating income for the quarter was $99 million and our net income was $99 million.

Moving to Slide 6, to reconcile the net realized investments in derivative gains and losses, you can see in the first quarter we had $0.16 of net realized gain on our securities pursuing to just normal trading activity. Also related to the Chase transaction of 2006m, we had $0.22 of realized gains in the Modco.

We had $0.15 of impairments during the quarter, $7 million of that related to our residential mortgage back portfolio and $12 million of that was related to some corporate bonds that we've made the decision to impair.

The next line item, I'll just pull out for a second. That is the derivative activity related to VA contracts, it is a loss of $0.21, that represents that non-performance risk related to the timing of credit spreads during the quarter.

This is the first quarter in which we have moved that item from our operating income down below the line to the net realized investment gains and losses and we believe this is consistent with the other players in the industry. There is a recasting of prior year's earnings in the supplement you can refer to that we have adjusted that for all the prior periods.

On the commercial mortgage side, we had $0.02 of losses during the quarter and our current non-performance is 0.3% at the end of the quarter on the commercial mortgage loan portfolio. So delinquencies are extremely well.

Turning to Slide 7, our reported book value is $46.74, if we exclude the accumulated other comprehensive income of $12.37, that results in a book value excluding AOCI of $34.37.

You can see that our net unrealized gain increased to $1.872 billion from $1.835 at yearend and I'd like to point out that our gross unrealized losses declined by 29% from $448 million to $316 million during the quarter.

Now moving to the life marketing operating on Slide 8. On the highlights where return mortality where 98% of expected versus 94% a year ago, a very solid quarter. Earnings exceeded our plan by approximately $2 million. What we saw in the quarter is an unfavorable unlocking of $5 million related to the impact of lower interest rates.

We continue to review how interest rates are impacting our UL portfolio and what we do on a quarterly basis is we re-project the asset yields on the current assets in place and then assume new money at today's interest rates would be in the low-to-mid 4% range and re-project huge spreads on the entire business over the life.

And so as a result of that quarterly review, it resulted in a $5 million negative unlocking. That was offset though by better than expected expense management, better than expected spreads during the current quarter and also by some good performance in some of the supplemental lines that we have in this line of business.

Sales during the quarter were $23 million. We believe this is the trough, as you may recall we increased prices earlier last year to reflect the lower rate environment. What we have now seen is that number of competitors increasing prices during this recent period. And when we look at our backlog, we are seeing an increase in our add count and an increase in our in-house inventory. So those cases usually take about 60 to 90 days to actually turn into a sale so we would expect that we will have a sequential increase in sales during the second quarter.

Moving now to Slide 9 in the annuity segment we report $35.8 million. We had very favorable performance in both the VA and the fixed lines. When we look underneath what we see is that our VA performance was about $6 million better than the plan we presented to you, primarily as a result of the higher equity market which result in higher fees to the line and also reduced guaranteed minimum debt benefits, since obviously those claims get reduced during good markets.

On the fixed side, we saw our earnings to be about $5 million above our internal plan, $4 million of that related to favorable mortality in the life contingent annuity line and also we had about $1 million of debt spreads as expected.

Our sales were solid at $720 million for the quarter and are consistent with our $3 billion plan for the calendar year 2012 and as you can see our account balance is in this line of business increased from a year ago by $2.1 billion from $13.5 billion to $15.6 billion.

Moving on now to the acquisition segment, we report $39.1 million. The highlights are, we completed the United Investors integration. The only final step we need to complete there is that we will be merging the statutory company on July 1, so that will be one final piece.

On our Liberty Life transaction, we are on track to complete the transaction with Athene and Royal Bank of Canada, here in the second quarter.

I'd like to point out to people that in both cases, we are ahead of plan in terms of executing the conversions and the transition to these businesses. We did see some unfavorable mortality during the quarter. The combination of one favorable mortality and we terminated some old reinsurance contracts resulted in a reduction of earnings of about $5 million but that was offset partially by positive spreads in the business resulting in us being approximately $3 million below plan.

Moving on now to the stable value business, we continue to see very strong spreads there. Spreads for the quarter were 180 basis points. We were able to maintain the balance at approximately $2.8 billion. We're reporting $12.6 million of earnings that's $1 million better than expected from spreads and about a $0.5 million better than expected from higher account balances. So we're about $1.5 million better than planned in this line of business.

What we see for the second quarter is we see a slight decline in the balance to approximately $2.7 billion but we would expect the spreads will improve modestly to approximately 190 basis points.

Moving to Slide 12, asset protection, sales improved 22% over the first quarter of last year to $110 million versus $90 million. We're reporting $5 million of earnings for the quarter, but that included a $2 million legal settlement related to an old credit insurance case. Adjusted for that, we would have had a $7 million earnings quarter, very consistent with the plan. What you've also seen here in the month of April is that new car sales in this country are over $14 million. That bodes well for the sales trends.

And I would like to point out that earnings emergence in this line comes about two to three years after the increase in sales because of the way we recognize earnings from premiums. It's a single premium, but we don't really get to recognize it for a period of time. So the sales trends are very good and bode well for this line of business in future years.

Moving to the last line on Slide 13, we have our plans here in the first quarter. That's partially due to the gain on the note repurchase of $35.5 million. I'll just remind you that those are unsolicited and opportunistic. We've not seen any further activity since this repurchase at the beginning of the first quarter.

In the corporate and other line, what we also saw was approximately $3 million of prepays and make-calls that were a little better than planned. We some lower expenses here, but some of it was related to internal allocations. So the net result was probably about $2 million better than plan on expenses during the corporate and other line.

When we step back and look at all of the items in the quarter, we consider all of them to be part of the core lines of business and are just typical of normal fluctuations in interest rate expenses mortality. And so we see core earnings during the quarter being in the range of $0.85 to $0.90.

And with that, I'd like to turn it over to Johnny for some final comments.

John Johns

I'll offer just a couple of thoughts here and then we'll open the call up for questions. I think it should be obvious from the presentation we've made that we do remain upbeat and optimistic about our ability to successfully execute our plans for the year. We're essentially on track pretty much across the board. Our focus will continue to be on ensuring that our capital is allocated and invested prudently and rationally, that risk is also managed very well, very carefully and that our expenses are under control.

We are seeing an uptick in M&A activity. There are a number of things out there that we've been looking at, and we'll continue to work on those and keep our eye on them as the next quarter unfolds.

So with that, I think I will stop and open the call up for questions.

Question-and-Answer Session

Operator

(Operator Instructions) And our first question is coming from the line of Chris Giovanni from Goldman Sachs.

Chris Giovanni - Goldman Sachs

Johnny, can you maybe expand a little bit on your last comment just on the M&A environment, maybe some other deals that you're looking at consistent with the others you've done in the past, or is there anything new there? How are you comparing those to what you've consistently been doing? Within the share repurchase market, would you have the ability to do both or is it just one or the other given some of the deal sizes you're looking at?

John Johns

Chris, we are seeing an array of different kinds of deals, but we continue to think that our real distinctive competency and expertise is in the traditional block of business or company kind of acquisition within the space. Predominantly, life insurance sometimes makes sense for us as well. I wish I could give you a little bit more color on specific deals, but as you know, it is our practice not to comment on specific transactions.

In terms of allocation of capital between M&A versus share repurchase, again, it's very specific. I mean we'll take a careful look at any of the opportunities out there. We'll make a determination as to what level to bid depending on what we see when we review the facts. And we'll always have as an alternative share repurchase. So we'll carefully weigh which is the better use of capital in terms of creating long-term shareholder value.

Chris Giovanni - Goldman Sachs

And then in terms of annuities, I guess on the variable annuity side, your sales have been stabilizing here at a pretty good level over the past several quarters. There has been talk of some companies either getting out or pulling back in the market. So curious in terms of what your appetite is to try and grow that book of business further. And then some comments maybe around on just in terms of how the hedging is performing, the cost to hedge relative to some of the rider charges that you have out there.

John Johns

We like the variable annuity business. We've seen an opportunity here to grow the book of business. We're very focused though on the risk management aspect side of it. Many companies have taken number of steps over the last quarter or two to improve the margins and also to reduce the risk of the product. So we want to be a good, steady, solid player in a business that we think is attractive.

Richard Bielen

Chris, with respect to hedging, our hedging performance has very much been in line with our budgets over the last number of quarters. When we look through the attribution of that $0.21, what we saw is the economic hedges were actually modestly positive, and then the negative was related to the tightening of credit spreads during the quarter which impacted everybody in the business.

John Johns

And which we essentially didn't hedge, because it's a non-economic component of that calculation.

Operator

Your next question will be coming from the line of Ed Spehar from Bank of America-Merrill Lynch.

Ed Spehar - Bank of America-Merrill Lynch

Rich, the $0.85 to $0.90 sort of number that you suggested was the core EPS. Does that include any assumption for a normalized level of, I guess call it, extra income, note repurchase gains participating in comp, et cetera?

Richard Bielen

Ed, that excludes any note repurchase gains. So the math on that was $1.18. We had $0.28 of gain during the quarter. That brings us down to $0.90. Expenses were probably a little better than expected during the quarter. So that's why we're giving you a range of $0.85 to $0.90.

Ed Spehar - Bank of America-Merrill Lynch

Is that a normalized or core number for first quarter results, which I think is a seasonally weak quarter? It's not a normalized kind of average quarter for the year.

Richard Bielen

That's correct.

Ed Spehar - Bank of America-Merrill Lynch

The $3 billion for annuity sales, are you intentionally limiting sales to that number? I mean could you do more or is there a desire at all to cap production?

John Johns

That seem like a natural level for us to be given our distribution, array of products we sell. We certainly are not capping anything, but we are comfortable with our plan for the year of about $3 billion.

Operator

Your next question is coming from the line of Steven Schwartz from Raymond James.

Steven Schwartz - Raymond James

I want to follow up on Ed's question. I think it's important to try to figure out what the run rate here is. You got to that $0.90, Rich. I guess my question is are you saying here that the favorable charge to policy benefits in the annuities, the life unlock, the mortality just basically offsets, is that the takeaway here?

Richard Bielen

That is the takeaway. When you look at the overall company, we had positives and negatives, but the takeaway is they netted very close to zero.

Steven Schwartz - Raymond James

You talked a lot about positive spread. Is the message that it was better than you were looking for or that there was other things running through here that maybe we didn't account for, outside of corporate and other where you said there was?

Richard Bielen

The positive spreads across the board were better than the plan we laid out for everyone last November. Given the interest rate environment, we continue to monitor what we could execute. And we've done a little better than that really across the board, across all the lines of business.

John Johns

There is some combination of a little bit better yield on investments and a little lower credit in some cases. So a combination of the two.

Steven Schwartz - Raymond James

PBR, there is an article saying maybe NAIC would pass that or adopt that this summer? Any thoughts on that and what might be coming down the pike?

John Johns

That is our understanding is that the NAIC has an ambitious schedule to move forward with sort of final proposal with respect to principles-based reserving. It could be considered by the entire NAIC sometime late summer, early fall. So we're very impressed that the leadership shown by the commissioners involved with that that are really taking the bull by the horns and really brought be some discipline and some focus to it. So it's encouraging really to see that sort of activity there at the NAIC.

Steven Schwartz - Raymond James

I don't know what's exactly being proposed, but are you happy with seeing the way things are going?

John Johns

I think directionally it's going in the right direction. There is still a lot of important details to be worked out that would determine at the end of the day whether the reserves that you have to put up under PBR really are sufficiently in line with what we consider to be really economic reserves, but conservatively we stated that you'd expect. But I think we're hopeful and optimistic that the process will lead to a more rational set of rules around how you set up reserves for products at guarantees.

Operator

Your next question is coming from the line of Mark Finkelstein from Evercore Partners.

Mark Finkelstein - Evercore Partners

Firstly on the note repurchases, is there any sightline to additional repurchases? I think you still had $300 million left or so after what you did this quarter?

Richard Bielen

Those repurchases are just opportunistic. We're not soliciting them. So we wait for people to offer them to us. And at this point, we don't have any sight on any, and that's why I pointed that we have seen little activity since the repurchases we did early in the quarter.

Mark Finkelstein - Evercore Partners

Knowing that a repurchase and an acquisition are two very different things and you can do more with M&A deal than you can with the repurchase as you're adding earnings, how big of a deal could you realistically do on balance sheet with your current capital structure?

John Johns

I think it all depends on a lot variables and acquisitions. Some of the important ones are how volatile is the stream of earnings that you're purchasing, very season traditional life policies with embedded options in them are much more predictable in terms of what they'll produce versus, say, short-term fixed annuity block that has limited surrender charges. The pace at which the capital comes back to you, so how quickly you get your money back is another dimension I think we've been inclined to stretch a little bit further for a deal, as has been the case with Liberty and to a degree United Investors where the money that we've invested in those two deals, as you know, comes right back out to us very quickly.

So even though our RBC ratio will go down at a point in time when we close the deal, it bounces back very quickly. So I think it'd be dangerous for us to speculate on how big a deal we could do. But we believe we could do rather substantial transaction right now if the right opportunity presented itself. And that would be sort of more in the zone we've been playing in, in terms of deal size here in recent years.

Mark Finkelstein - Evercore Partners

On the annuity earnings, I think I understand the fixed side in terms of the favorable mortality on the block and $1 million of better spreads. But on the VA side, I think you said you had $6 million of favorability. I guess how much of that, if any, was due to one-time adjustments to GMDB or anything versus if equity markets were to kind of have been where they were on average for the quarter and gone up 2% from there, you'd expect kind of those ROAs to hold, if you will?

Richard Bielen

The GMDB component of that $6 million was approximately $3 million. So that did obviously help with the higher equity market. And then we also have seen in that better fee income with the higher equity market. We think that continues in here. When you have the better fee income, you have a little bit of retrospective unlocking, which is positive. So the net result of all that was about $6 million.

Operator

Our next question is coming from the line of Jimmy Bhullar from JPMorgan.

Jimmy Bhullar - JPMorgan

The first one is on your sales in life marketing, and obviously they've been weak in the last couple of quarters as you've been raising prices. The mortality in the blocks have been pretty good recently. Given that you are raising prices, how comfortable are you with the pricing on your enforce and the business that you sold over the last few years when you did have pretty good sales?

Secondly, just on the M&A environment a little bit, are you looking specifically for or would you be interested specifically in life insurance marks or would you look for annuities blocks as well and can you comment on your interest in variable annuity blocks of business that have guarantees on them?

John Johns

Needless to say, I think the entire industry is a bit surprised at interest rates as low as they are today. So we certainly didn't assume this level of interest rates five years ago when we were selling long duration life insurance products. But having said that, I think we're comfortable with our enforce blocks of insurance business. You can see there they're performing pretty well. Whatever your assumptions are, be it persistency or yields on new money or mortality, whatever they are, it's important that you react pretty quickly and prudently adjust your pricing to ensure that you will get a decent return on your capital as you go forward.

I think we feel very good about the steps we've taken. We think we've acted responsibly in terms of being good stewards of our shareowners' capital by waking up to the fact that (punitive) rate environment right now than we've been in. So hope that answers your question.

With respect to M&A, as you know, we have a successful track record of applying both life insurance and annuity reserves. We tend to have a preference for life insurance reserves, but we certainly have an appetite for both. We currently don't think that we really have any special expertise with respect to the acquisition of VA business. You may recall when we bought life insurance companies of your company that we actually sold the VA business that we acquired through Goldman Sachs, because they had an appetite.

So I don't think buying VA business would be higher in our list of preferences right now. We're able to see it produce a healthy level of sales doing on retail channels. And I think we'd really prefer to ease our capacity for VA business to support our own distribution.

Jimmy Bhullar - JPMorgan

And the fact that you've got buying back stock at a decent pace, should we assume that you haven't been close to executing on a deal? Is that the right way to look at it?

John Johns

Jimmy, we don't comment on M&A activity. Some think that's a good practice. I think you should infer from the level of share repurchase that that's our plan. That was in our plan for the year. That's why we did what we did in the first quarter.

John Johns

We appear to have no additional questions. So once again, we want to thank each of you for participating in our call today. We appreciate it.

Operator

Ladies and gentlemen, that concludes today's conference. We thank you for your participation. You may now disconnect. Have a great day.

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