Protective Life Corporation (NYSE:PL)
Q4 FY07 Earnings Call
February 08, 2008, 09.00 AM ET
John D. Johns - Chairman, President and CEO
Richard J. Bielen - Vice Chairman and CFO
Jukka Lipponen - KBW
Welcome to today's teleconference. At this time all participants are in a listen-only mode. Later there will be an opportunity to ask questions during our Q&A session. Please note that this call may be recorded. I'll now turn the program over to your moderator Mr. Johnny Johns. Go ahead sir.
John D. Johns - Chairman, President and Chief Executive Officer
Yes. Good morning everyone, this is Johnny Johns, President and CEO of Protective Life Corporation. This is our fourth quarter and year-end conference call to discuss the earnings we reported last night. I have with me around the table here our senior management team. In a moment I'll turn the call over to Rich Bielen, our Chief Financial Officer. He'll go through the quarterly numbers and the year-end numbers in more detail.
But we are pleased to report $0.93 of operating earnings per share for the quarter that compares to $0.91 last year. We do know however there were a few unusual or we think non-recurring items in the quarter netted to about a net negative $0.06 a share that was a mark-to-market charge in a trading account in our Corporate and Other line, which accounted for about roughly $0.09 a share plus we had about a $0.03 fair value mark-to-market charge in our Annuity line but that was somewhat offset by favorable mortality in the quarter, which was approximately $0.06. So net-net we think the earnings… operating earnings were reduced about $0.06 by those items.
For the year we report $3.99 that compares to $3.39 last year that's an increase of almost 18%. You'll recall however that we did have some fairly significant charges last year relating to our asset protection division and this year we did have a gain on the sale of our direct marketing subsidiary, Matrix Direct. In terms of net income, we report $0.85 in the quarter versus $1.19 last year, the difference between operating and net of course is realized investment gains and the effects of marking-to-market derivatives under FAS 133. For the year we report $4.05 versus $3.94 of last year.
Just stepping back and looking at the year. We actually think the year turned out pretty well. We did have a record earnings in a number of our segments like marketing was up almost 9%, our pre-tax operating earnings were up almost 9% for the year, acquisitions were up almost 24% for the year, Stable Value up 6.6%, asset protection was up very significantly over 300%, and annuities were down slightly, really due to two things. One is, a fair value mark-to-market that I described a moment ago and also we're starting to expand our immediate Annuity line and there is a drag on earnings when you have an immature block of Immediate Annuity business until you began to experience some of your projected terminations due to mortality.
Step back a little bit more and you look at the company a little more broadly, we did end the year in a good solid capital position. We have excellent liquidity; our investment portfolio was performing extremely well. We did have $9 million to $10 million of participating mortgage income in the quarter, which was in line with our expectations for the quarter. We do however foresee participating income being a little harder to come back next year and we get around to talking about earnings guidance we are forecasting that participating income will not be so robust next year but at the same time we do believe that there are some other opportunities we have to make up for that through other investment activities.
We've said in recent years that the environment has been sort of difficult for us with flat yield curve, very narrow spreads, we perceived to be a mispricing of risk in the investment area where we do see those trends sort of reversing now. We think this is actually in many respects a better environment for us. We feel pretty good also about where we’re positioned in our basic retail lines and we will talk more about that when we get into the outlook for 2008.
Our ROE based on operating earnings was 11.8%, net income ROE was 11.9%, our assets during the year rose about a 5% clear to approaching $42 billion.
And now I will turn it over to Rich and let Rich kind of walk you through the details of the segments and then we will come back and I’ll talk a little bit more about the outlook for '08 and even beyond that. Rich?
Richard J. Bielen - Vice Chairman and Chief Financial Officer
I would first point that in addition to the information contained in our press release, we have certain supplemental financial information available via our website www.protective.com. Also this conference call discussion includes forward-looking statements, which express expectations of future events and our results. Actual events and results may differ materially from these expectations, please refer to our press release and Exhibit 99 of the company's most recent 10-K, 10-Q for more information about factors which may affect future results. This discussion may also contain non-GAAP financial information, please see our website for additional information and reconciliation to GAAP financial measures.
I’d like to just start off with, as Johnny indicated operating earnings for the fourth quarter were $0.93 compared to $0.91 in the fourth quarter of the prior-year. We did have net realized gains on investments of $0.16 for the quarter while we had net realized losses on derivatives of $0.24. As a reminder to everyone in connection with the Chase acquisition we entered into some [inaudible – 6.23] arrangements with some of our reinsurance counter parties and as a result of those the realized investment gains are somewhat elevated. If we reverse those effects out what you would actually see is a net realized loss of approximately $0.04 on investments and also due to a net realized loss on derivatives of about $0.04, and both of those are just in line with our normal trading activity. There were no impairments that we took in the quarter.
Operating earnings for the year was $3.99 versus $3.39 in the prior year. The net realized investment gains for the year was $0.06 resulting in us having net income of $4.05 for the year. With respect to the Life Marketing division, earnings in the fourth quarter were $46.1 million as compared to $41.9 million in the fourth quarter of ‘06. The increase is primarily attributable to favorable mortality of $6.6 million in the quarter offset by a shift of $4 million of investment income that moved to Corporate and Other as a result of our completion of our AXXX securitization the third quarter of this year.
Life sales were $51.7 million in the fourth quarter of ‘07 versus $49.6 million in the fourth quarter of ‘06, up 4%. As expected, our Term sales are slowing a little bit. There were $31.5 million in this year's quarter versus $32.6 million in the year-ago quarter. However, our U.S. sales grew 21.2% versus last year at $17.3 million versus $15.7 million, last year. For the calendar year 2007 our total Life sales were $229 million dollars and for the full year earnings in this division were up 8.6% to a record $189 million versus $174 million last year. Just to remind everybody. We did have a gain on the sale of our Matrix Direct business earlier this year, which positively impacted this year by approximately $15.7 million. The other thing that we are very happy about is the trends in our mortality, which was favorable $12.2 million during calendar year 2007.
In the acquisitions area, earnings grew to $35.8 million in the quarter compared to $33.6 million last year. This segment had record full year earnings of $129 million versus $104.5 million in calendar year 2006. On the Chase acquisition now represent a substantial portion of the earnings of this business and what we saw is as our integration continued we saw our expenses in the Chase Insurance Group drop by about $2.5 million this quarter as we converted those systems in that business.
Moving to the Annuities area, earnings of $4.3 million in the current quarter compared to $8.4 million last year. However earnings in this area were held down due to fair value changes net of debt of approximately $4 million in the current quarter. Sales in the quarter were $411.5 million and for 2007 earnings were $23.1 million down 6.5% from 2006 earnings of $24.6 million. However that includes the impact of fair value changes of about $3.3 million for the year.
Annuity sales in 2007 were a record $1.7 billion and that is a 38.8% increase over the record level sales that we set in 2006. Fixed Annuity sales continue to show solid sales numbers with a 72% increase in our market value adjustment annuities. And this is being driven by expansion into new broker dealers as well as strong growth in our existing distribution. We also saw our Immediate Annuity sales up $22.3 million. And a very important point do note that in all of our Annuity lines we saw our net positive cash flows in all of those lines and I think given some of the industry issues with lapses, we think that’s very important in terms of future trends. We ended the year with Annuity account balances of $7.6 billion, an increase of 16.2% over the prior year.
Moving on, in the Stable Value products division, we had stronger earnings in the quarter of $12.6 million as compared to $12.5 million last year in the fourth quarter. Spreads in this year’s quarter were up to 102 basis points versus the fourth quarter of last year. And we expect those spreads at least for the first six months to stay in the triple-digit area going forward. For the full-year spreads were 101 basis points compared to 84 basis points in 2006. That increase is primarily due to higher yields on our investment portfolio. And sales for 2007 were $927 million and in the month of January, year-to-date already we've actually sold $543 million of contracts and we ended the year in account balance of $5 billion in this business.
Moving to the Asset Protection division, the core operations in this segment delivered outstanding results, pre-tax earnings were $10 million this quarter as compared to $6.6 million number in the fourth quarter of '06, earnings were a record $41.6 million in 2007 as compared to $9.8 million in the prior year. As a reminder this division had a reserve charge of $27.1 million last year related to Lender’s Indemnity. Vehicle and Marine service contracts were the primary product lines in this division. They continue to perform well with favorable loss ratios and 22% growth in sales. We did loose a couple of clients during the year and that's one of the reasons that sales in our Other line is down a little bit where we have lost those but the place where we're most focused is in the vehicle service contract business and those trends continue to be very well… go very well.
Moving now to Corporate and Other. Corporate and Other had a pre-tax operating loss of $6.2 million in this segment. And I’d like to take a second to go through the loss related to the trading securities. We have been managing these securities now since the year 2000 and this has been the most volatile quarter we have seen since the second quarter of 2001 when Pac Gas filed bankruptcy. The reason for the loss is that we manage this portfolio to having a in-debt duration of less than one. So, we own assets and then we have offsetting durations swaps, interest rate swaps against them. And when we look at the assets in the portfolio for the quarter, they were only down about $2 million as a result of this spread widening, they’re all investment grade asset.
In the supplement financials we have a high level of breakdown of the ratings on all the securities, they’re no sub-prime or CDOs or anything exotic in there. They were no below investment grade assets currently in the portfolio but what occurred is with the spread widening is we manage the interest rate swap hedges on the other side and with the dramatic fall in treasury rates in short swap rates, the interest rate hedge actually lost approximately $6.5 million in the quarter. So the asset side, really did not perform on the upside with the drop in rates because the spread widening but while with the bulk of the loss occurred is because of the interest rate hedges there with the dropping rates.
Participating income during the quarter in this line was $7.2 million, $2 million in addition to that was allocated to other business segments. For the full-year 2007 Corporate and Other had an operating loss of $3.4 million, our full-year participating mortgage income in this segment was $31 million and the full-year impact of these trading losses on this line was actually $10.2 million, we had a small loss during the prior-year quarter's during the year.
Other question we saw this morning in terms of some of the call notes, with respect to the investment portfolio on the sub-prime securities at December 31, the unrealized loss was $8 million, we had described to you how much we actually own there and with respect to the Alt-A securities, the unrealized loss on that position was also $8 million as of the end of the year and those are based on independent market prices that we wind up receiving.
With that I will now turn it back over to Johnny for the outlook.
John D. Johns - Chairman, President and Chief Executive Officer
Yes, Rich. Thank you and I said a moment ago, overall we thought we had solid results for the quarter and for the year we continue to maintain a strong position in our Life Marketing franchise. As you know we have struggled a bit with the emergence of profits in this line but as I will comment in just a moment we do see the stat beginning to turn in our favor. We have very good positioning with respect to our distribution. At the present time, we are a solid market share player. In Term Insurance we see opportunities to improve our competitive position in Universal Life. As the year progresses a lot of our energy and attention in the line is focused on coming out with new and more competitive Universal products during the year.
With respect to Term, our strategy there is to really not fight for market share but manage our Term portfolio to improve and maximize profitability and returns while maintaining a solid market share position but that's not our first goal there. With respect to the acquisitions line, we did find that the Chase transaction has been fully integrated now. That acquisition is performing very well. Our core acquisitions line is also performing well and we see that continuing into 2008. As we think about 2008 and our guidance we are not factoring in the impact of an acquisition during the year. Although we think it's still possible that we could find one and get it done this year, probably unlikely that we will see a major acquisition during the year that will have an impact on earnings.
With respect to Annuities, we are very excited about our Annuity franchise. We see continuing expansion of distribution. We are working on enhancing the competitiveness of our products. As I mentioned, we are going to see a little bit of drag on earnings because of the immaturity of our Immediate Annuity imports portfolio but that will begin to turn to a fairly, fairly shortly and will augment our earnings growth.
We are bullish on Stable Value. We certainly have capacity to issue new business there. We think that the opportunity to earn good spreads there is probably as good as it's ever been and that will be a focal point for us during the year as well.
The Asset Protection division continues to perform well. We think the fundamentals in the service contract line are attractive and we do not expect any major problems in this line during 2008 and actually see expansion of our service contract line and even the opportunity for some add-on fill-in acquisitions in the service contract business during the year.
With respect to investment results, as I mentioned a moment ago and as Rich commented, the results have been good. The securities portfolio is very, very solid. We think participating income is going to be harder to come by. We’ve taken that into account and thinking through our guidance.
In terms of our long-term growth prospects, we continue to believe that 8% to 10% is the right range to think about in terms of ROE targets. We think 13% to 14% is still within our grasp. It's not an easy environment out there that's for sure but we do think we have a very solid franchise and a lot of good ideas about how we can grow and improve our capital efficiency.
Our guidance for 2007 is a range, that is for operating earnings of $3.80 per share to, on the half side $4.20 a share. Some of the key assumptions that go into that forecast are that we will continue to see favorable mortality in our Life Marketing segment and we feel good about that. We think we have got a really top-notch underwriting shop at Protective and we see the trends it's moving in the favorable direction there.
We do plan during the year to move our financed redundant XXX reserves out of the warehouse facility and into a more permanent structure and that event, we will incur about a $7 million charge for debt extinguishment and that is built into the estimate. We do contemplate and expect that we will see some nice growth in our Stable Value account value and we will maintain our spreads there. And we also think that we will be able to successfully execute some yield enhancement strategies within our investment portfolio that will cause us to receive investment income that will largely offset the decline that we anticipate in participating mortgage income and we're actually expecting about a 50% reduction in participating income overall for the year from approximately $40 million to about $20 million.
Though we do not give earnings guidance on a quarterly basis, we do think that the buildup in growth and earnings will sort of occur and kind of build up more towards the end of the year as we execute these strategies to take advantage of the current spread environment in our investment portfolio.
Lastly, I want to say that I hope those of you who follow the company closely will attend our Investors Conference, March, the 13th in Boston. We were extremely hard over the last year to enhance our ability to forecast our earnings and our returns out into the future particularly in our Life line where we have had this profit emergence issue. At the Investors Conference, we will lay out some fairly detailed forecast into the future as to what we think our growth prospects are and where we see our ROE going in the future and we are encouraged by what we see.
We do believe that 2008 is sort of the transitional year. We do see profit growth starting to turn in the Life blocks in 2009 and beyond and we do see the opportunity next year and the next year and the next year for us to get solidly on the track of maintaining the view we have as to our long-term growth forecast in our ROE targets. So, again I think it will be a nice opportunity for us to really drill down and explain some of this to you in more detail at that meeting.
With that, I think I will end our presentation and we will turn it over to you and we will respond to your questions.
Question and Answer
Thank you. [Operator Instructions] We'll take our first question from Jukka Lipponen, with KBW. Go ahead please.
Jukka Lipponen - KBW
Good morning. My first question is regarding the guidance, I guess the range seemed somewhat wide to me and also you're referring to the earnings emergence how that's factored into the guidance, so can you give us color on those two items?
John D. Johns -
Chairman, President and Chief Executive Officer
Yes. Jukka, we just think that it's appropriate to have a fairly wide range in the current market conditions. We are for example subject to fair value adjustments in a number of product lines now and that’s something is very hard to forecast or predict. And there just can’t be more volatility in earnings. I think you see it across the industry right now. So we just think it's prudent to have a fairly wide range. We will as we have in the past narrow the range as the year goes along as we get more visibility on where we are headed.
With respect to profit emergence I think our models show that this year we are not going to see very much growth and our core Life insurance earnings has the effects of this phenomenon of the first year or two not contributing to earnings and then it turns around, we kind of been to about the third year of that now under our new securitization model and this the transitional year though we do expect to see turnaround next year and for our earnings contribution from our Life insurance lines to get back on a track, consistent with our long-term growth forecast.
Jukka Lipponen - KBW
And then my second question in the context of excess capital M&A versus buyback can you give us some additional color how you're seeing the opportunities out there and then especially your current share valuation, would you be more inclined to buy back stock than you perhaps have been in the past?
John D. Johns - Chairman, President and Chief Executive Officer
Yes. The answer to your question is yes. We have not built any share repurchase into our earnings guidance but that is certainly a possibility as the year goes along, as we continue to build capital and we don't see attractive alternative uses for the capital.
[Operator Instructions] I am sorry sir. There appears as if we have no further questions at this time.
John D. Johns - Chairman, President and Chief Executive Officer
Well, thank you very much. We appreciate everyone's participation on the call and as always our team is available offline if you want us to fill in any details on the presentation we have made this morning. Thank you very much.
This concludes today's teleconference. Thank you for your participation and you may disconnect at any time.
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