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Torchmark Corporation (NYSE:TMK)

Q3 2012 Earnings Call

October 25, 2012 11:00 AM ET

Executives

Mike Majors – VP, IR

Gary Coleman – Co-CEO

Larry Hutchison – Co-CEO

Frank Svoboda – EVP and CFO

Analysts

Jimmy Bhullar – JP Morgan

Randy Binner – FBR Capital Markets

Chris Giovanni – Goldman Sachs

Sarah DeWitt – Barclays Capital

Paul Sarran – Evercore Partners

Mark Hughes – SunTrust

Steven Schwartz – Raymond James

John Nadel – Sterne Agee

Sam Hoffman

Bob Glasspiegel – Langen McAlenney

Jeffrey Schuman – KBW

Operator

Good day, and welcome to the Torchmark Corporation’s Third Quarter 2012 Earnings Release Conference Call. Today’s call is being recorded. For opening remarks and introductions, I’d like to turn the call over to Mike Majors, Vice President of Investor Relations of Torchmark Corporation. Please go ahead, sir.

Mike Majors

Thank you. Good morning, everyone. Joining me today are Gary Coleman; and Larry Hutchison, our co-CEOs; Frank Svoboda, our Chief Financial Officer; and Brian Mitchell, our General Counsel. Some of our comments or answers to your questions may contain forward-looking statements that are provided for general guidance purposes only. Accordingly, please refer to our 2011 10-K and any subsequent Forms 10-Q on file with the SEC.

I will now turn the call over to Gary Coleman.

Gary Coleman

Thank you, Mike, and good morning, everyone. Net operating income for the third quarter was $125 million or $1.29 per share, a per share increase of 10% from a year ago. Net income for the quarter was $131 million or $1.36 per share, a 9% increase on a per share basis. With fixed maturities and amortized costs, our return on equity was 15.6% and our book value per share was $34.39, a 9% increase from a year ago. On a GAAP reported basis with fixed maturities at market value, book value per share grew 20% to $44.86.

In our life insurance operations, premium revenue grew 6% to $454 million and life underwriting margins increased 13% to $130 million. Net life sales increased 7% to $83 million. On the health side, premium revenue excluding Part D, declined 4% to $170 million and health underwriting margin was $39million, same as year-ago quarter. Health sales were $15 million, down 6%.

I’ll now turn the call over to Larry for his comments on the insurance operations.

Larry Hutchison

Thank you, Gary. First I’ll discuss American Income. At American Income, life premiums were up 9% to $167 million and life underwriting margin was also up 17% to $56 million. Net life sales increased 12% for the quarter to $41 million. The producing agent count at the end of the third quarter was 5,472, up 23% from a year ago and up 3% during the quarter. We are pleased with the continued progress at American Income, and are excited about the company’s future prospects. We continue to see growth in a number of newly hired agents who achieved our top bonus level. It’s the first time, top bonus earners were up 47% in the third quarter. Our middle management ranks also increased by 14% in the third quarter. First time bonus earners and middle management trends are both indicators of future agent growth. We expect sales growth for 2012 to range from 13% to 15%, while we expect sales growth for 2013 to range from 10% to 15%.

Now Direct Response. Our Direct Response operation worldwide life premiums were up 9% to $158 million and life underwriting margin increased 8% to $37 million. Net life sales were up 3% to $31 million. While we’re pleased with Direct Response sales growth, it was slightly lower than expected in the third quarter, however, the new business written during the third quarter was more profitable than the new business written in a year ago quarter. We expect mid single-digit sales growth for 2012 and 2013.

Now Liberty National. At Liberty National, life premiums declined 2% to $70 million, while life underwriting margin was up 22% to $19 million. Net life sales declined 6% to $8 million, while net health sales declined 24% to $4 million. However, both net life and net health sales have increased sequentially for two quarters in a row. The producing agent count at Liberty National ended the quarter at 1,401, down 11% from a year ago, but up 4% just beginning of this year. The producing agent count grew to 1,420 during the first three weeks of the fourth quarter.

We continue to make progress in turning around our producing agent counts in sales of Liberty National. We are optimistic that agent growth will continue going forward and expect sales growth to range from 8% to 12% for 2013.

Medicare Part D, premium revenue for Medicare Part D grew 63% to $83 million, while the underwriting margin increased 8% to $7 million. Part D sales for the quarter jumped 161% to $22 million due to the increase in low-income subsidized auto enrollees for 2012. We expect an increase of approximately 2% to 3% in our Part D premiums for 2013. This is less from the 2012 increase since we don’t expect this many new auto-enrollees out of our low income subsidy program next year.

I will now turn the call back to Gary.

Gary Coleman

To complete the insurance operations, administrative expenses were $41 million for the quarter, 2% more than a year ago quarter and in line with our expectations. For 2013, we expect a 5% to 6% increase in administrative expenses with most of the increase due to the acquisition of Family Heritage. However, as a percentage of premium, administrative expenses will be around the same level as 2012.

Now, I want to spend a few minutes discussing our investment operations. First, excess investment income. Excess investment income, which we define is net investment income less required interest on net policy liabilities and debt was $55 million, a decline of $9 million or 14%, 7% on a per share basis from the third quarter of 2011.

Sequentially, excess investment income was down $8 million from the second quarter. Both the year-over-year and sequential declines are due primarily to lower investment income. Compared to the second quarter, net investment income decreased $6 million or 3%, while average invested assets increased by 1%. And investment income increased at the same rate as the assets, investment income would have been up $1 million. This $7 million negative swing is due to the decline in the portfolio yield and the large increase in short-term investments, resulting primarily from the call of the $300 million of bank hybrid securities early in the third quarter. We plan to invest the excess short-term funds and bonds by the end of the year. Due to the expected call of our remaining $300 million of hybrid securities and the lower new money rates, we expect excess investment income in 2013 to decrease approximately 6% to 7%. However, reflecting the impact of share repurchases, we expect that 2013 excess investment income per share to be flat compared to 2012.

Now, regarding the investment portfolio, invested assets are $11.8 billion including $10.9 billion of fixed maturities at amortized cost. There is no exposure to European sovereign debt and there are no commercial mortgage-backed securities or securities backed by sub-prime or Alt-A mortgages.

At September 30, the company had cash and short-term investments totaling $685 million compared to $180 million at June 30. The additional $505 million of cash in short terms is due primarily to the $268 million of proceeds due to debt instruments issued late in the quarter and $237 million of additional funds to be invested. Now, of this amount, $200 million will be used for the acquisitions of Family Heritage Life, we think on November 1st, $120 million for the retirement of our trust preferred debt this week and $94 million to retire the existing August 2013 debt issue.

As to fixed maturities, $2.2 billion are investment grade with an average rating of A-minus. Below investment grade bonds are $685 million compared to $764 million at the end of the second quarter and $721 million a year ago. The percentage of below investment grade bonds at fixed maturities is 6.3% compared to 6.8% a year ago. With a portfolio leverage of three times, the percentage of below investment grade bonds to equity excluding net unrealized gains on fixed maturities is 21%, which is less than most of our peers. Both of these ratios have declined slightly since the end of the quarter as much of the excess cash held at September 30 has been invested in investment grade fixed maturities. Overall, the total portfolio is rated a high BBB plus just slightly under the A-minus of a year ago. We had net unrealized gains in the fixed maturity portfolio of $1.6 billion compared to $942 million a year ago.

Regarding investment yield, in the third quarter we invested $326 million in investment grade fixed maturities, primarily in the utility and industrial sectors. We invested at an average annual effective yield of 4.42%, an average rating of BBB plus and an average life of 23 years. For the year, we have invested $755 million at an average yield of 4.54% and an average rating of BBB plus.

The third quarter new money yield of 4.42% has declined from the 5.65% yield for all of 2011 and the 4.64% yield in the first half of 2012. Earlier this year, we indicated that the GAAP discount rates used to discount the reserves from policies issued in 2012 would be 4.75% graded to 6.5% over seven years. However, in response to the decline in new money yields and further indication that treasury rates will continue to be near current levels for the near future. We have changed the discount rates for policies issued in 2012 to 4.25% for five years, then graded up to 6.25% over the next eight years. For the entire portfolio, the third quarter yield was 6.33% compared to 6.54% in the third quarter of 2011. As of September 30, the yield on the portfolio is 6.33%.

As mentioned, we still hold $300 million of bank hybrids that could be called. We don’t know whether they will be called in the fourth quarter, but expect all of them to be called by the end of 2013. These bonds yield 7.35% and assuming a 4.25% reinvestment rate, the loss to annual income with all of those securities are called will be $6 million after-tax. In our guidance, we assume that all will be called in 2013.

On past analyst calls, we have discussed the current low interest rate environment and the impact of a lower prolonged rate scenario. Our concern regarding an extended period of low interest rate continues to be impact on earnings, not the balance sheet.

As we talked about before, to maintain our underwriting margins, we’ve raised the new business premium rates on the majority of American Income Life products and the Direct Response unit products by 5% as of January 1 this year. These increases provided additional margins to help offset reductions to excess investment income on new policies without having a detrimental impact on sales.

However, as long as we are in this low interest rate environment, the portfolio yield will continue to decline and thus pressure excess investment income. However, the decline will be slowed by the fact that on average only 2% to 3% of fixed maturities will run off each year over the next five years and that assumes a call of the remaining $300 million of hybrid preferreds.

In the second quarter, we conducted a stress test assuming a new money rate of 4.25% and determine that the portfolio yield at the end of 2016 would be in a range of 5.75% to 5.85%. At these rates, we would earn a small spread on the net policy liabilities, while earning the full 575 to 585 basis points on our equity. In this scenario, we will still generate substantial excess investment income.

As I mentioned, an extended low interest rate environment impacts our income statement but not the balance sheet. Since we primarily sell non-interest sensitive protection products accounted for under FAS 60, we don’t see a reasonable scenario that will require us to write off DAC or put up additional GAAP reserves due to interest rate fluctuations. In addition, we do not foresee a negative impact on our statutory balance sheet.

Now I’ll turn the call over to Frank to discuss share repurchases and capital.

Frank Svoboda

Thanks, Gary. I want to spend a few minutes discussing our shares repurchases and capital position. First, regarding share repurchases and parent company assets. In the third quarter, we spent $44 million to buy 874,000 Torchmark shares. For the full year through September 30, we have spent 318 million of parent company cash to acquire 6.6 million shares.

The available liquid assets at the parent consist of assets on hand and the expected free cash flow from operations. Free cash flow results primarily from the dividends received by the parent from the subsidiaries less the interest paid on debt and the dividends paid to Torchmark shareholders. The parent began the year with liquid assets of $74 million.

During the first nine months of the year, we generated about $328 million of free cash flow but spent $318 million for Torchmark share repurchases. In addition to the remaining $83 million of cash and liquid assets, the parent received approximately $420 million as a result of the issuance on September 24th of 10-year senior notes and 40-year junior subordinated notes.

As a result of this activity the parent ended the second quarter with $504 million of available liquid assets comprised of $74 million of beginning liquid assets plus the $328 million of free cash flow, plus $420 million of net debt proceeds, less the $318 million used for share repurchases.

Going forward, along with the $504 million on hand at the end of the third quarter, we should generate approximately $22 million of free cash flow in the fourth quarters giving us $526 million of total cash and liquid assets available for the remainder of the year. Of this cash $120 million was used on October 24th to redeem our 7.1% trust preferred securities and approximately $212 million will be used to purchase the stock of Family Heritage Life, leaving us with approximately $194 million of cash and liquid assets available between now and the end of the year. It should be noted the $94 million of these assets will be invested to be used for the redemption of our $94 million of senior notes that mature on August 1, 2013 or an earlier time if opportunities to economically repurchase the August 2013 notes become available.

As noted before, we will use our cash as efficiently as possible. If market conditions are favorable we expect that share repurchases will continue to be primary use of those funds. We also expect to retain approximately $50 million to $60 million of liquid assets at the parent company.

Now, regarding RBC at our insurance subsidiaries. We plan to maintain our capital at the level necessary to retain our current ratings. For the last two years that level has been around in NAIC RBC ratio of 325%. This ratio is lower than some peer companies but is sufficient for our companies in light of our consistent statutory earnings that relatively lower risk of our policy liabilities and our ratings. At December 31, 2011, consolidated RBC was 336% and adjusted capital was approximately $46 million in excess of that required for the targeted 325% ratio. We expect our consolidated RBC as of the end of 2012 to be at or above this level.

Now before I turn the call back to Larry, I would like to briefly discuss our recent debt issue and the purchase of Family Heritage Life Insurance Company. First the debt issue. With regard to our debt, on September 24, we closed on $300 million, 3.8% senior debt issue maturing in 2022. The senior notes were issued to provide $94 million to pre-fund the eventual retirement of our August 2013 senior notes and $200 million to fund the acquisition of Family Heritage Life.

As we wanted to fund the majority of the Family Heritage Life acquisition internally, the parent issued $150 million of these notes to two of our insurance companies. Having these companies purchased the parent senior notes enabled us to one, efficiently use insurance company cash that resulted from the $300 million of bank hybrids they called in July and you get those funds invested at market rate.

Two, provide funds to the parent to fund the acquisition in a way that will allow these insurance companies to fully admit the asset on their statutory books. Three, structure of the transfer of funds to the parent in a way that minimizes the RBC charges that will be incurred by the insurance companies. And four, structure of public debt issue that was large enough to obtain the most efficient pricing available in the market. It should be noted that the $150 million of notes owned by the two insurance companies are limited in consolidation and thus are not treated as outstanding debt or the invested assets on our consolidated financial statements.

We also issued on September 24, $125 million of 40-year junior subordinated notes with an interest rate of 5% and 7%, 8%. Those notes are callable after five years and are issued to refinance $120 million of trust preferred securities. The trust preferred securities were called on October 24. As a result for the new issuances, our debt balances as of September 30 increased by approximately $268 million, temporarily increasing our debt-to-capital ratio to 29.9% if the effects of the unrealized gains on our fixed maturity investments are ignored. However, this ratio will be reduced to 28.1% upon redemption of the trust preferred securities and to our normal levels once the august 2013 notes are redeemed.

We expect our interest expense will increase in the near term due to pre-funding of both the retirement of our trust preferred securities and the August 2013 maturity, plus the additional debt incurred for the Family Heritage purchase. For 2012, we estimate that this increase over 2011 levels will be approximately $2.1 million, including $1.9 million in the fourth quarter. For 2013, we estimate that our total interest expense will be approximately the same as 2012 levels, assuming the august note is retired on its August 1st maturity. Once the August note is retired, we expect to save approximately 1.5 million in annual interest expense over pre-2012 levels.

Now, with regard to the acquisition of the Family Heritage Life. On July 31st we entered into a definitive agreement to purchase all of the outstanding stock of Family Heritage Life Insurance Company, a privately-held supplemental health insurance provider, for approximately $218.5 million, including the assumption of $20 million in trust preferred securities with the remainder to be paid in cash. The ultimate purchase price is subject to closing adjustments to be paid using cash from a post-closing dividend from the company. We expect to close on November 1st assuming all regulatory approvals are received by that date.

The company was founded in 1989 and is headquartered in Cleveland, Ohio. It is a specialty insurer focused primarily on selling individual supplemental health insurance products with a return-of-premium feature. We were attracted to the company because of its offering of protection oriented insurance to middle income families and that their sales are through Family Heritage has approximately 1,200 captive sales agents, 41 sales directors and over 223,000 policies in force.

We are excited about the opportunity to work with the existing management, agents and employees of Family Heritage and currently intend to operate the company as a standalone operation.

As of June 30, 2012 statutory admitted assets of the Family Heritage were approximately $526 million and net capital and surplus was $62 million. Premiums were $162 million in 2011 and $87 million through June 30, 2012. Since the transaction has not yet closed and the fair market value of company’s fixed maturity portfolio and other assets are not yet known. The ultimate effect of certain purchase accounting adjustments cannot yet be determined. However, we anticipate that the company will add approximately $0.01 to $0.02 per share to Torchmark’s net operating income in 2012, assuming a November 1 close and will add approximately $0.13 to $0.17 per share to 2013 operating earnings. Since we anticipate being able to take given distributions out of the company to fund the additional interest charges to be incurred by the parent, we do not believe the acquisition will have a material impact on our share buyback program.

Those are my comments. I will now turn the call back to Larry.

Larry Hutchison

Thank you, Frank. This is our guidance. For 2012, we expect our net operating income will be within a range of $5.15 per share to $5.19 per share. For 2013, we expect our net operating income will be within the range of $5.45 per share to $5.85 per share. Those are our comments. We will now open the call up for questions.

Question-and-Answer Session

Operator

Thank you, gentlemen. (Operator Instructions) And we’ll first go to the side of Jimmy Bhullar. Your line is open.

Jimmy Bhullar – JP Morgan

Hi good morning. I had a few questions. The first one on just your premium conservation efforts, if you look at your lapse rates in most of the subsidiaries that actually been declining but American Income, the lapse rate this quarter was roughly flat with the third quarter of last year?

Then secondly just on the Family Heritage deal, should the earnings ramp up as the year goes on or with the first quarter of next year be a normal quarter, just I wanted to get an idea on whether you plan to do any expense savings or any marketing initiatives that would either reduce or increase earnings in that the deal comes on your books?

And then finally on Liberty National, you’ve seen a couple of quarters of decent growth in the agent count of your sales expectations actually seem fairly positive as well. What gives you the comfort that this is not sort of a temporary blip in the agent count and what gives you the comfort as the thing that the agent counts are going to keep going from here on out.

Larry Hutchison

Yeah, I think just Liberty...

Gary Coleman

Yeah, Jimmy as far as the lapse rates to the American Income. If you look back over the last couple of years, the third quarter is generally a higher rate and it’s somewhat due to the timing of the new issues and the lapses that occur on those policies. We expect that rate to be lower in the fourth quarter. The third quarter for some reasons is just unusually high from American....

Jimmy Bhullar – JP Morgan

Yeah. And quarter-over-quarter results actually had been getting better but even if I compare to the third quarter of last year, your lapse rates were actually flat whereas second quarter versus second quarter or first quarter versus first quarter, they were improving.

Gary Coleman

Well, I...

Jimmy Bhullar – JP Morgan

It’s one quarter, so I just wanted...

Gary Coleman

Yeah, we don’t – matter of fact we have seen benefits of the conversation. As you mentioned in the last story, so from the prior quarters, I think this is just, again I think that the third quarter is just an unusual quarter from a timing standpoint. And again I think in the fourth quarter if you go back to the improvement we’ve seen in the older quarters.

Jimmy Bhullar – JP Morgan

Okay.

Gary Coleman

And secondly on Family Heritage I understood the question right. I would anticipate that the earnings for the first quarter that will grow from there. I don’t think that the first quarter be indicative of the entire year, but we really haven’t had a change as Frank mentioned to and to look at what the purchase accounting adjustments are going to be and right now we don’t have a good feel for the facts around this going to be.

Jimmy Bhullar – JP Morgan

But you don’t plan on – the growth would be just as a organic growth in the business. You are not planning any extraordinary cost savings programs or marketing initiatives that would either increase expenses or reduce expenses overtime?

Gary Coleman

No, there is no cost reduction expense that we’re factoring in and their expense ratios are very similar to ours and they’re very efficient and so the growth as we expect will be the organic growth of sales.

Jimmy Bhullar – JP Morgan

Okay.

Frank Svoboda

Jimmy, on Liberty National, we believe that the recruiting systems are in place. We’re now meeting with the different branch managers in the system. They’ve accepted that and the first three weeks of this quarter we’ve seen continued, steady agent growth. So we believe that will continue. At Liberty National we plan to roll out a laptop presentation in January. We think this will further help in recruiting and training the new agents and we hope to see 20% of agents growth at Liberty National by 2013.

Jimmy Bhullar – JP Morgan

Okay. Thank you.

Operator

Thank you. We’ll now go to the side of Randy Binner. Your line is open.

Randy Binner – FBR Capital Markets

Thanks. So, it sounds like – and this is kind of a sales question and so it sounds like the laptops are rolled out in January for Liberty National. Back here in American Income, I guess and I would like to hear more color. I think you said middle manager accounts there are up 10%. If that could be clarified that’d be great? And then I guess just trying to get color on the kind of the trend there and how sustainable the increase in the ranks of those sales managers is?

Gary Coleman

Randy, sales growth is sustainable. I don’t think we’re going to see sort of the 25% agent growth per year. It should be in fact a 10% to 12% to 15% increase agent growth is sustainable and those focus it and American Income remains is recruiting, is looking at forward activity in those little agents. It’s also management promotions. As we promote through those different levels of management and you’ll see growth in the agency. So that’s really the color to American Income as the both systems continue to be improved on that top is fully rolled that at the American Income, so we get cost of data feedback that we can check those trends.

Randy Binner – FBR Capital Markets

How about our recruiting, is there anything new going on, on the front end and how you’re bringing in new recruits?

Gary Coleman

The Internet recruiting continues to be our biggest source of recruiting. The personnel recruiting is also an emphasis on American Income and personnel recruiting that involves college recruiting, different exciting recruiting. When you look at military recruiting, there’s a new initiative. As the military downsizes and we see people come out of military, those are strong recruits of both the American Income and Liberty National. So we continue to look at new recruiting systems. We hope to look at Family Heritage, study their recruiting systems and having some of those in-house here.

Randy Binner – FBR Capital Markets

That’s helpful. And just to clarify, did you say the middle men accounts up around 10%, I missed that number?

Gary Coleman

Let’s see, I think I’ve said that, up 14%...

Frank Svoboda

14%, yeah.

Randy Binner – FBR Capital Markets

Okay. And how about in their trend in particular, is that able to stay at that level or does that settle down not extremely the low hanging fruit there is coming down?

Larry Hutchison

There’s not low hanging fruit, it’s having the system of automatic promotions, it will promote persons out of the agent level, first level of management, the line by asking the fresh level of management, the second level of management is the sustainable number.

Randy Binner – FBR Capital Markets

Okay, that’s helpful. Thanks.

Operator

Thank you. We’ll now go to side of Chris Giovanni. Your line is open.

Chris Giovanni – Goldman Sachs

Thanks so much. Good morning. I guess first question just on kind of the guidance in the range. I mean the ranges I guess are getting wider at least in the past couple of years. So does that suggest that suggest that EPS visibility is declining some or is this just the issue with the drops in the timing?

Gary Coleman

Well Chris I think part of the wider range this year is Family Heritage and we haven’t included that transaction. We have to study that transaction as we have a great deal into Torchmark, so that’s some of the impact of why we are at range.

Larry Hutchison

And Chris I mean I think last year our range was $0.30, its $0.40 this year. And I agree with Larry that a big part of it is the Family Heritage.

Chris Giovanni – Goldman Sachs

Okay. And then are there any other M&A opportunities you guys are currently exploring or at this point is it primarily going to be share repurchases?

Larry Hutchison

Well, Chris we’re always looking for M&A opportunities, but to find the type of company that we found with Family Heritage want us in the middle income market has kept the latency selling type of products that we like. There’s not a wealth of those kind of companies out there. We’ll continue to look and, but in the meantime I think the share repurchases will be the bulk of these of our excess capital.

Chris Giovanni – Goldman Sachs

Okay. And then lastly just on the new money rate. I guess there was a little surprise just how well you guys were able to maintain the yields quarter-over-quarter, given what’s spreads did in the quarter and then I guess also you guys shortened some of the duration of the maturities of the portfolio. So curious if you can comment some on kind of where you’re thinking as you look forward here in the 4Q you talked about the 425 kind of the stress test that you’ve done, is that the level of yield you guys are currently looking at?

Larry Hutchison

Yeah, that’s what we’re currently seeing. And one thing that benefited us in the third quarter, I think we’ve talked about this before through a partner we’ve got involved with some products...

Gary Coleman

Placements.

Frank Svoboda

Product placements and we’ve, I think we’ve done a $100 million of that, most of that was in the third quarter. And those are a little bit shorter but the yields are in between the 10 and 30 years off. We really look to get a strong yield on those on those particular investments and I think that helped for the quarter. That probably helped us get to the 442 but where we’re seeing it today and mainly we’ve invested so far which I think we’ve invested well over $200 million already in October, it’s a round up for 420 to 400 quarter range.

Chris Giovanni – Goldman Sachs

Okay. And still no plan to change the overall investment strategy?

Frank Svoboda

No, not at this point. It’s just, the yield curve is too steep to drop down short and also it looks like rates are going to stay low for a while, and as I mentioned, we have been involved in the product placements where we had in the past. We’re still looking for other types of investments but we just haven’t found anything that’s better, we feel that’s better than the corporate bonds.

Chris Giovanni – Goldman Sachs

Okay. Thanks so much.

Operator

Thank you. We’ll now go to the side of Sarah DeWitt. Your line is open.

Sarah DeWitt – Barclays Capital

Hi good morning. On the 2013 EPS guidance, how much is embedded in your outlook in terms of share buybacks?

Gary Coleman

Well, I think we’re assuming free cash flow of around $360 million to $370 million next year. And I think in our guidance we assume that our share repurchases would be around $360 million.

Larry Hutchison

That’s correct, Gary.

Sarah DeWitt – Barclays Capital

Okay, great. And so given that the midpoint of your guidance assumes about 9% EPS growth. It seems like you’ve got 8% EPS growth just from share buybacks alone. So could that be conservative given that the core business have been growing, your Family Heritage coming on will be a partial offset from the redemption of hybrids but it just seems conservative. So am I thinking about that correctly or I am missing anything?

Larry Hutchison

Well, I think one thing, it is going to factor into it is the – in fact there our excess investment income will be lower, I think I mentioned, it was probably 6% lower on a dollar basis and I think that’s we’re seeing that growth in the insurance side but that is a primary factor.

Sarah DeWitt – Barclays Capital

Okay great, thank you.

Operator

Thank you. We’re now going to side of Paul Sarran. Your line is open.

Paul Sarran – Evercore Partners

Yeah thanks, good morning. Was there any sort of cumulative true up in the quarter from the change in discount rate on 2012 new sales?

Gary Coleman

Yes, there was. From an underwriting income standpoint it’s pretty much awash. So there was an increase in the reserves but there is also decrease in amortization. Where there was an impact is in the excess investment income because of the increase in the interest on the net positive our goal is an average about $500,000 impact in the quarter.

Paul Sarran – Evercore Partners

Okay. And on Part D, I don’t think you mentioned it. Did you pick up any new LIS regions for 2013?

Gary Coleman

No we did not pick up new regions for 2013.

Paul Sarran – Evercore Partners

Did you keep the ones you added this year?

Gary Coleman

I think it’s actually a reduction I think we had six regions in 2013 versus about 24 regions that we had in 2012.

Paul Sarran – Evercore Partners

Okay, so do you disenroll those policy holders that you added this year then or do you keep them, you just don’t add new ones. How does that work?

Gary Coleman

We did not disenroll this year’s policy holders that...

Gary Coleman

Yeah, if you just look at the numbers, we had, as Larry mentioned we had 21 regions last year and 15 of those regions were going to be able to key the auto science, but we’re now going to get new, new auto science. And I think there’s five reasons where we will get new auto science. So, the core amount of that is we’re not going to see near the number of new auto science this year or in 2013 than we did in 2012.

Frank Svoboda

I think in these terms we’re projecting premiums in 2013, this $327 million versus $319 million in 2012.

Paul Sarran – Evercore Partners

Okay, thanks.

Operator

Thank you. We’ll now go to side of Mark Hughes. Your line is open.

Mark Hughes – SunTrust

Yeah, thank you. Good morning. The life underwriting margin are stronger this quarter, to what extend is that sustainable?

Gary Coleman

Well, I think it was up slightly this year. I think if you look at the nine months, our life underwriting margin is 28% of premium and overall is 29% in the quarter. There’s not a lot of difference there but I think it the indicative of what the entire year will be if it is more in the 28% range.

Mark Hughes – SunTrust

Right. And so for next year more or likely to be at 28% or slightly better?

Gary Coleman

Yeah. I think in our guidance, it is slightly better than 28%. But again, we’ll talk about just a smaller difference.

Mark Hughes – SunTrust

Right. The Direct Response business is something you’re confident that’s going to pick back up, what makes you feel good about that?

Gary Coleman

Well, I think there’s three things and that is still good about the Direct Response business. In 2013, I think on circulation, we have about 3% as the current net sales will pick up about 10%. We have initiatives, for 2013 in our gold products, our durables products and our other mailings. So their combination of those items, I guess feel optimistic about direct response.

Mark Hughes – SunTrust

Right. A and just to be clear the guidance at this point does or does not include the acquisition?

Gary Coleman

It does include the acquisition of Family Heritage.

Mark Hughes – SunTrust

Does include it?

Gary Coleman

Yeah.

Mark Hughes – SunTrust

Thank you.

Operator

Thank you we’ll now go to the side of Steven Schwartz. Your line is open.

Steven Schwartz – Raymond James

Hey good morning everybody. Just a follow up on Sarah’s question, I guess I’m having a little bit of trouble. It seems Gary you suggested that the interest rate of excess investment, excuse me, would be down about 6% to 7%?

Gary Coleman

Yeah I say that on a dollar basis it will.

Steven Schwartz – Raymond James

Right.

Gary Coleman

But for share basis it will flat.

Steven Schwartz – Raymond James

Okay yeah. Your EBITDA at 360 of share repurchase I would imagine that your general account assets excels, stuff with the debt being paid off in August and whatever. It’s still going to grow. So in your guidance, I think it would, in your guidance where are you thinking the yield goes to by the end of 2013. I think you’re currently at 6.33. Where does that go to the by the end of 2013?

Gary Coleman

Okay. Steve, first of all we think by the end of year, I think at the fourth quarter it would be 6.25 would be our yield on the portfolio.

Steven Schwartz – Raymond James

Okay.

Gary Coleman

As I mentioned earlier we’re assuming that the remaining $300 million of, I presume we get called in 2013 and they have an interest rate of I think 7.3%.

Steven Schwartz – Raymond James

Okay.

Gary Coleman

And so we’re looking at is by the end of 2013 the portfolio yield would have dropped from 6.25 to 6.04 and this sounds like these are very precise. These are our estimates. So that’s those hybrids still have a big impact. Now going forward from that, we’ll get back to where the decline in the portfolio yield is more like 10 basis points a year. But the next year we’re looking for a little over 20% decline in the yield.

Steven Schwartz – Raymond James

Okay. Well, you said your 604 versus 612, I guess you’ve got to take averages. Maybe I’ll get back with Mike offline. If I could, only Family Heritage, what are those agents thinking about their business post January 1, 2014. Do they see HCA as a growth driver or do they see that as a headwind?

Gary Coleman

They see an opportunity. Gary and I’ve addressed the top agents within the system and they’re excited about joining Torchmark. I think they see opportunities they’re going to have with the recruiting. I think it will bring higher ratings to the company. And to be a part of Torchmark, I think it will be a positive to that agency force.

Steven Schwartz – Raymond James

No, I’m sure you will. I was questioning more the macro environment, in ObamaCare and macro environment and how they see that?

Gary Coleman

Well, these are products that aren’t subject to ObamaCare. These are products that fall aside healthcare reform.

Steven Schwartz – Raymond James

Okay.

Gary Coleman

So these products are unaffected by that, I misunderstood your question, I apologize.

Steven Schwartz – Raymond James

Okay. Thank you, Larry.

Operator

Thank you. We’ll now go to the side of John Nadel. Your line is open.

John Nadel – Sterne Agee

Hi, most of my questions have been asked and answered at this point. I’ve got one little nitpicky one left, I suppose and it’s on Part D. just looking at the quarters’ results, third quarter results, perhaps somewhat weak on the margins versus what we’ve seen here recently as you look out. Was it just sort of a blip or as you look out to 2013 what do we – what should we expect for the margin on the business?

Gary Coleman

Well, John first of all, we had an unusually high claim quarter. And so that’s when we compare back to third quarter where we had an unusually large claim quarter there is a big difference, but the margin year-to-date on that business is at 10% and we think 10% of premium that we think that’s – this will end the year at 10% of premium and that’s not as surprising just because we price it at 10.5% premium. So we’re very close to where we price that.

John Nadel – Sterne Agee

Okay. All right, that’s very helpful. Thank you very much.

Operator

Thank you. We’ll now go to side of Sam Hoffman. Your line is open.

Sam Hoffman

Good morning, I had a question about premium growth. It looks like premium growth accelerated in the quarter from 5.7% to 7.2% and even if you exclude the part D, it accelerated from 1.4% to 3.6% and so that’s the big step up in one quarter and it was driven I think by the direct response business. So I mean obviously if your premium growth accelerates by 1.2% every quarter, your growth rate is going to be much higher a year from now and so what I want to understand is what happened with the persistency in the business to cause that and how sustainable is it?

Gary Coleman

Well Sam, we are seeing advantage from better persistency but for example in direct response we had a 9% increase in premium, we’ve been showing 5% to 6% increase. Well the reason we’d 9% this year was more of an issue that the third quarter premiums of last year were very low and so it’s just an unusual comparison. I don’t think you can the numbers you extrapolate I think you can carry for our fourth quarter but we’re looking for unlike the premiums next year and our guidance, we’re going to be about 4.5% for this year. We’re looking at next year being at least that much maybe to 5%. So we’re seeing, we’re going to see improvement but maybe not at the level you’re talking about.

Sam Hoffman

Okay. And then just can you clarify a bit about what you were saying about the discount rate and the price increase? I know you said that you lowered the discount rate at the beginning of this year, and you raised price but is that going to recur both the discount rate and the price increase in 2013? And then just help us understand what’s in guidance and how we should think about that going forward?

Gary Coleman

Well, first of all, in the guidance we are assuming the same discount rate that I talked about earlier, the quarter-over-quarter graded up to six in a quarter. We don’t feel like, we feel like the situation would be very similar next year in terms of rates and that will be appropriate. As I mentioned, we did raise rates, the premium rights 5% this year, the effect of changing the interest rate assumption from what we had last year to this year, this year really we require about 2% to 3% increase in premium. So we actually increased the premium rates higher than we really needed but that – so but going forward, we still feel like the new level that we’ve gone in, the discount rates will be appropriate going forward.

Sam Hoffman

Okay. And, then I guess, my last question is on family heritage, can you talk bit about the business and just if you could repeat the premium growth that it had and kind of how much sales it has and should be expected to grow overtime?

Larry Hutchison

Frank, if you want to handle that.

Frank Svoboda

Sure Larry. Yeah, the total premium in 2011, they had around $162 million of total premium income. And we really look at them growing somewhere in that 8% to 9%, 10% range over the next couple of years. So far, year-to-date through June 30, they have premium income of about $87 million that was reported on their statutory financial statements. So obviously just looking toward annualizing that you end up at around $176 million or $175 million and that’s around an 8.5% increase. So, we are again expecting that the premiums to go somewhere in that 8% to 10% range. I believe their sales but I don’t have that that number handy but I believe that it was somewhere in the $50 million range.

Sam Hoffman

Okay. Thanks for taking the call.

Operator

Thank you. We’ll now go to side of Bob Glasspiegel. You line is open.

Bob Glasspiegel – Langen McAlenney

I’m going to follow-up on Sam’s question and try to drill a little bit deeper into the acquisition. It seems like that you’re saying the midpoint of the range is $0.15 accretion which is $23 million of earnings and there is going to be $2 million to $3 million of, that’s pre-tax earnings and is going to require $2 million to $3 million more of underwriting. So there is $25 million of sort of pre-tax income that needs to be spread either in the underwriting, so it’s held for underwriting and/or investment income. But I think you said investment income, I think you said investment income is down 6 so that’s not going to move. So, am I right that we need about $25 million of pretax of underwriting income?

Gary Coleman

Yeah, that is correct. It is going to be health business and it is somewhere in that range. We would estimate on a pre-tax basis yeah somewhere in that $25 million to 27 million range.

Bob Glasspiegel – Langen McAlenney

So, on the $180 million of premium it’s a pretty good underwriting margin so we’re talking about roughly 15%.

Gary Coleman

Yeah, the underwriting margins before admin expense are somewhere we expect for 2013 to be in the 14% to 17%.

Bob Glasspiegel – Langen McAlenney

Okay, my math is right.

Gary Coleman

And we do as time goes on and with new business we look forward to be slightly higher than that, but with the in-force block that’s where we’re estimating at this point.

Bob Glasspiegel – Langen McAlenney

Is there anything you can do with the capital structure, expense structure or cross-selling or better productivity and that’s pretty good sales actually relative to their in-force but

Gary Coleman

With respect

Bob Glasspiegel – Langen McAlenney

Within Torchmark on the margin that you probably haven’t factored in here.

Gary Coleman

Yeah, with respect to let’s say the capital structure, they are adequately capitalized at this point in time. They do have some excess capital if you will compared to what we would normally maintain a minimum 325% level. But at this point in time we do not anticipate taking out any of that excess capital if you will and allow that to help fund some of their future growth going forward. I think as Gary has mentioned earlier, there aren’t a significant amount of any expense savings that we’re really anticipating at this point. We will continue to look at their investment portfolio and to see whether or not there is some opportunities there and Larry I may pass it to you with respect to potential sales and potential sales initiatives going forward.

Larry Hutchison

The potential sales initiatives, first of all, is where the agency force, and to do that, it is two ways, one is better recruiting methods. The second is geographic expansion. They are concentrated in the upper Midwest and Texas and we think those products could be offered in New York, Canada, other parts of U.S. So that’s another part of the expansion we’re talking about was family heritage.

Bob Glasspiegel – Langen McAlenney

So, if you guys can’t create any expense savings, this must be the most efficient small company on the planet?

Gary Coleman

Do you look at their expenses as a percentage of premium as it’s quite low, it’s a very well run company.

Bob Glasspiegel – Langen McAlenney

So it’s impressive. Look forward to learning more about them as you hopefully own it in next week? Thank you.

Operator

Thank you. (Operator Instructions) And we’ll go to side of Jeff Schuman. Your line is open.

Jeffrey Schuman – KBW

Thanks, good morning. I understand that in part D there was volatility this quarter and there will be volatility some times, but can you remind us at this point do you, is there any sort of normal, kind of base line seasonality to the margins in that business?

Gary Coleman

Well, Jeff, we really haven’t seen it. I mentioned last year third quarter was low. We can’t expect we might see that this year but we said it was higher. Yeah, this business is priced every year and we just said and the clients come at different times. We just haven’t seen seasonality that we can count on.

Jeffrey Schuman – KBW

Okay, thank you. And then this should probably be obvious but just Jimmy I mean, I guess the excess investment income compares to the down six, does that exclude Family Heritage from both periods or is that just in 2013 and you’re still down six?

Gary Coleman

That includes Family Heritage in both periods.

Jeffrey Schuman – KBW

In both periods, okay.

Gary Coleman

Yeah. Remember for 2012, we only had them for two months but yeah it includes both periods.

Jeffrey Schuman – KBW

But includes it on a pro forma basis for 2012?

Gary Coleman

No, not on a pro forma basis.

Jeffrey Schuman – KBW

Okay.

Gary Coleman

But over their actual additional access would be for those time of two months.

Jeffrey Schuman – KBW

Okay I guess just for some modeling perspective, do you have idea how that compares and would have been on an apples to apples basis?

Gary Coleman

Yeah. We’ll have to find, I missed it, but I can find that...

Jeffrey Schuman – KBW

Okay, that’s it for me. Thanks.

Gary Coleman

I have got it, excluding family service, excuse me Family Heritage, we would project for 2013 that excess investment income would be down somewhere, this is dollar amount not per share, dollars would be down somewhere between 7% and 10% and on per share basis, excess investment income would be a decline of 2% to 4%.

Jeffrey Schuman – KBW

Okay, that’s helpful. Thank you.

Gary Coleman

With Family Heritage, I was saying earlier on per share basis it will be flat for 2013.

Jeffrey Schuman – KBW

Okay, thanks for clearing that up.

Operator

Thank you. (Operator Instructions). It appears we have no further questions at this time. I’ll now turn the conference back over to our speakers for closing remarks.

Mike Majors

All right, thank you for joining us this morning, those are our comments and we’ll talk to you again next quarter.

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