FBL Financial Group Inc. (NYSE:FFG) Q2 2016 Earnings Conference Call August 5, 2016 11:00 AM ET
Kathleen Till Stange – Vice President Corporate and Investor Relations
Jim Brannen – Chief Executive Officer
Don Seibel – Chief Financial Officer
Scott Stice – Chief Marketing Officer
Ray Wasilewski – Chief Operating Officer
Bob Glasspiegel – Janney Montgomery Scott
Greg Peters – Raymond James & Associates, Inc.
Jamie Inglis – Philo Smith & Co.
Good day and welcome to the FBL Financial Group Incorporated, Second Quarter 2016 Earnings Conference Call and Webcast. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded.
I would now like to turn the conference over to Kathleen Till Stange, Vice President Corporate and Investor Relations. Please go ahead.
Kathleen Till Stange
Thank you. Good morning and welcome to FBL Financial Group’s second quarter earnings conference call. Presenting on today’s call are Jim Brannen, Chief Executive Officer; and Don Seibel, Chief Financial Officer. Also present and available to answer your questions are Charlie Happel, Chief Investment Officer; Scott Stice, Chief Marketing Officer; and Ray Wasilewski, Chief Operating Officer. Certain statements made today may contain forward-looking statements intended to qualify for the Safe Harbor from liability established by the Private Securities Litigation Reform Act.
These statements involve risks and uncertainties that could cause actual results to differ materially from those expressed or implied. These risks and uncertainties are detailed in FBL’s report filed with the SEC and are based on assumptions which FBL believes to be reasonable. However no assurance can be given that the assumptions will prove to be correct. FBL disclaims any obligation to update forward-looking statements after this date.
Comments during this call include certain non-GAAP financial measures. These items are reconciled to GAAP in our second-quarter earnings release and financial supplement, both of which may be found on our website, fblfinancial.com. Today’s call is being simulcast on FBL’s website. An audio replay and a transcript of the prepared comments may be found on our website shortly after the call.
With that, it is now my pleasure to turn the call over to CEO, Jim Brannen.
Thanks, Kathleen. Good morning and thank you everybody who joined us on the call today. I am glad you are here. I am pleased to report that FBL Financial Group once again posted strong earnings. Net income for the second quarter came in at $0.97 per share and operating income was $1.02 per share. Overall sales for the second quarter were strong with premiums collected up 18% over the prior-year quarter. Sales were mixed with annuity premiums collected up 43% and life insurance premiums collected down 1% compared to the second quarter of 2015.
Earlier this year we reintroduced our four-year guaranteed annuity product. We regularly update the rates on the product to reflect changes in the marketplace. That allows us to provide appropriate credit rates based on available investment opportunities while meeting our pricing objectives. During the month of April, we offered a first-year bonus on the four-year product and it was well received. Since then, given the current interest environment, we’ve lowered rates a couple of times.
In addition to strong fixed rate annuity sales in the second quarter, premiums collected on our indexed annuity product also grew. We saw an increase of 78% in the second quarter compared to the second quarter of 2015. Our indexed annuity is attractive to customers because the potential for market gains along with the protection from loss with guaranteed minimum interest rates. We recently completed a direct-mail campaign on this product directed at existing Farm Bureau Financial Service clients and the momentum continues.
Life premiums collected were down 1% compared to the second quarter of 2015. Sales of whole life products have been strong but were overshadowed by declines in sales of some of our other life products. We’ve taken several actions recently to increase life sales. Last week we began an external term life insurance replacement offer. Agents are excited to have this in place. It’s targeted towards existing property casualty policy holders who own a life insurance product with another carrier. It’s a way for customers to move their life policy to a permanent plan without having to undergo full new underwritings.
A select group of carriers term policies are eligible for this new coverage replacement offer. And a number of limitations and requirements are in place to maximize the success of the term conversion program. Another recent change that has been well received is the increase in the index cap at 12% on our index universal life product. This increase is part of our ongoing monitoring of credit rates and index caps. We were able to make this change while continuing to meet our profitability targets. At recent sales rallies, we also announced greater support for our agent’s licensed sales people. Our most successful agents have multiple sales and service associates who assist them to meet the needs of their clients. We now offer certain sales incentives and recognition programs for the employees of our agents.
Turning to our agency force, as of June 30, we had 1,872 total agents and agency managers, plus 81 active reserve agents working to complete the steps necessary to become full-time Farm Bureau agents. This is an increase of 24 agents during the quarter and that’s very positive. It’s critical that we continue to grow our agency force to contract more agents and sales associates to grow agent productivity and increase agent retention. During the second quarter we tactically sold some energy investments and moved to lower our exposure to the energy sector. We’re able to manage the impact by selling securities of both gains and losses. It was a good time to execute these trades as crude oil prices had rebounded a bit.
As of June 30, our energy portfolio had a carrying value of $486 million and was trading at 100% of amortized costs. This exposure represents 5.8% of our total investment and is well-diversified across sub-sectors. Our investment area continues to do a superb job in managing our investments through the challenges of the last several years. During the second quarter 2016, the average tax-adjusted yield on investments acquired backing our long-term business was 4.46%.
Next I will comment on our progress in planning for the Department of Labor fiduciary rule. We have a project team with internal subject matter experts and consulting resources working to make sure we will be in compliance with the fiduciary rule. The work covers a wide range of initiatives such as system work from our EF vendor, internal systems development for record keeping, development of disclosures and contracts and agent and staff training.
Based on our work and analysis, we've determined that our current proprietary product offerings and agent compensation models will not change substantially. We expect to sell our proprietary qualified annuities, index and fixed, under the best interest contract exemption advice rather than using PT 8424. Having a single process creates uniformity which we believe is less of a regulatory burden for our agents than the time savings of using 8424 for fixed rate annuities only.
If consumer is behavior remains constant, we don't expect a material change in sales. We expect to comply with the rule and we'll do so in the least intrusive way possible. Having said that, some consumers may not appreciate a more lengthy sales process. New disclosures, additional fact finding for the investment recommendation, signing the vise, et cetera. We don't anticipate that expenses will change materially as a result of this rule. We estimate that the initial implementation of the rule will range from $1 million to $2 million.
The range is primarily due to a phased approach to decisions about how much automation to develop. We're developing what we need to meet the first compliance date in April of 2017. The additional cost is somewhat mitigated as many activities such as disclosure updates and ongoing agent training are expected to be handled by existing staff.
In summary, we're working our way through the DOL process. We will incur some additional expenses, change the way we market certain products, but we will comply with the new rules and continue to sell all of our proprietary products.
Before I conclude, I want to mention a couple of things we celebrated recently. First, our companies were named to the 2016 Ward's 50, a group of top-performing companies. The Ward's 50 recognizes outstanding financial results in the area of safety, consistency and performance over a five-year period. FBL Financial Group is one of only six organizations that have affiliated companies named to both the property casualty and the life health Ward's 50 group of companies.
Lastly, on July 19, we celebrated 20 years as a publicly traded company. As I look back on those 20 years, and note FBL's success has come from steadfast focus on the fundamentals. We serve the needs of the Farm Bureau niche market and provide product and services to protect what our clients value most. We're dedicated to having to best-in-class distribution with our growing exclusive farm bureau agency force. This focus on our Farm Bureau niche coupled with the financial discipline has allowed to us grow and deliver strong earnings results over these 20 years.
Despite the challenges that surround us, I feel confident as we move forward with FBL Financial group because of that focus and discipline.
Now, I will turn the call over to Don Seibel to review our financial results. Don?
Thanks, Jim. Good morning, everyone. I'm glad to be here today to share insights with you regarding our financial results and capital position. Despite the challenges of the volatile economic environment and persistent low interest rates, second-quarter results were strong. As Jim indicated, net income for the quarter was $0.97 per share and operating income was $1.02 per share. During the quarter our operating income adjustments totaled $0.05 per share and consisted primarily of net-realized losses on the sale of investments and fixed-maturity securities.
Next, I will turn to operating income. At a high level, I would characterize our second-quarter operating income as in line with our expectations. Although there were some moving pieces with unlocking, favorable mortality experience and investment fee income.
In the second quarter, we updated the interest-rate related assumptions used in the calculation of deferred acquisition costs, value of insurance in force acquired, unearned revenue reserves and certain reserves on interest-sensitive products to better reflect the current low interest-rate environment. This unlocking negatively impacted earnings by $0.15 per share.
We typically perform our annual review of assumptions and unlocking analysis in the third quarter. However, the disruption in interest rates influenced by Brexit and other factors caused to us reconsider our long-term interest rate assumptions and performed an unscheduled unlocking in the second quarter. We have been proactive in analyzing the impact of interest rates and have unlocked interest rate assumptions six is times in the last four years. We plan to conduct a full review of all assumptions in the third quarter as usual.
The unlocking impacted all segments with the most significant impact in the Life Insurance segment. Mortality experience this quarter was favorable due to a lower-than-expected number of claims. We had lower death benefits in the Life Insurance segment but did have higher death benefits in our closed block of variable universal life business, which is in the Corporate and Other segment.
Investment fee income was at an elevated level again this quarter totaling $3.1 million. It was mostly in the annuity segment. While this is a short-term contributor to income, it does further compress future spreads due to the loss of higher-yielding securities.
Next I will comment on our spreads and spread targets. During the quarter, the point-in-time spread on our annuity business increased by two basis points to 203 basis points. This is primarily due to changes in our default assumptions. We periodically refine long-term default charge estimates for our investments based on an annual study by Moody’s. We use these point-in-time spreads as we make credit-rating decisions so we believe it is appropriate and conservative to include a level of assumed defaults.
The total spread for the annuity business, of 203 basis points at June 30, is above our target of 201 basis points. Given the persistent low market rates, I’m pleased that we’re exceeding our spread targets. However, it is an ongoing challenge to earn the desired target spread. We have 33% of our annuity business receiving a crediting rate above the minimum guarantees, but there are competitive pressures that make it difficult to be aggressive in taking further rate actions.
Results for our Life Insurance segment were strong this quarter. In addition, our point-in-time spreads on our universal life business improved during the quarter. This is due to a decline in assumed long-term default charges, as well as a decline in credited rates. On May 15, we implemented a 25 basis-point decrease on one of our primary universal life products. These actions resulted in an 8 basis point increase in the point-in-time spreads on our universal life business to 147 basis points at June 30. This is positive but these spreads remain below our target for this business of 152 basis points.
Like the annuity segment, it will be difficult to increase universal life spreads going forward given today’s interest-rate environment. For this block, we have 20% of the business receiving a crediting rate above the minimum guarantees. Also comment on results of our Corporate and Other segment. They were below our expectations due primarily to a higher level of death benefits and the impact of unlocking.
Death benefits overall for the Company were lower, but we did see a higher number of claims and a higher average claim size with our variable universal life business. Given the nature of mortality experience and the small size of this block, fluctuations on a quarterly basis are expected.
Next, I will comment on our financial strength. At June 30, the capital position of our wholly-owned subsidiary, Farm Bureau Life, remained excellent with an estimated company actual level risk-based capital ratio of 541%. This is an increase from the March 31 level of 539%. Using 425% RBC as a base, Farm Bureau Life had excess capital of approximately $145 million at June 30.
At the holding company level, we also have more than adequate liquidity and capital with excess capital at the parent company of approximately $35 million at June 30.
Jim mentioned our 20-year anniversary as a public company. During this time FBL Financial Group has delivered consistent earnings results and maintained a strong capital position. In addition, we pay a relatively high dividend. I’m confident that we’ll continue to maintain our financial discipline.
That concludes our prepared remarks. We’ll now turn the call over to the operator and open it up to any questions you may have.
Thank you. We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Bob Glasspiegel with Janney. Please go ahead.
Congratulations on the 20 years. Can’t believe I’ve been with you guys that long. That’s impressive.
Thank you, Bob.
On the agency growth, is that sustainable? Was there something seasonality-wise we need to be mindful of? What’s behind one of your bigger recruitment gains?
The recruitment has been picking up speed over the last several quarters actually; and it’s going to be lumpy throughout the quarters, but each year, clearly, we want to put new bottoms in and move forward. And since Scott Stice has been here as the Chief Marketing Officer role, he’s put a lot of new processes in place around retention and recruitments and a lot of accountability in that. I guess I’ll let him chime in as well.
I think that’s right. Our goal every year is to consistently grow the agency force 2% to 2.5%, but to do so in a way that we can ensure that we have adequate field management resources to handle it while keeping an eye on agent quality and agent retention. So quarter-to-quarter, as Jim said, it could be a little lumpy. But year-to-year, we believe we can deliver that sustained growth of 2% to 2.5% rate.
Okay. It’s always a tough slug in the industry of a couple steps forward and a couple of steps back, but this was encouraging in the quarter. Numbers question, do you quantify the favorable mortality in life?
Yes. This is Don. I would put that at about $0.04 to $0.05 per share.
Okay. And remind me where do you disclose statutory earnings in the release? Do you have that through six months we’re trending?
We do not put that in the release, but we had, for the quarter, statutory net income of about $27 million and first quarter results were strong and steady as well, of the same magnitude.
Any reason why they’re running above operating earnings? The one-timers or funny items in there?
There’s no one-timers. The big variable is deferral of acquisition costs and there is a different timing of emergence of profits on the various products between statutory and GAAP. I don’t have any further details really to share.
The growth of annuity isn’t causing any statutory strain as far as earnings?
It would cause some statutory strain.
But, I’m just saying for the statutory earnings to be running above GAAP in the quarter. I’ll hit you offline on that.
Yes, we can reconcile that.
[Operator Instructions] The next question is from Greg Peters with Raymond James. Please go ahead.
Good morning. I guess I’ll chime in alongside Bob. Congratulations on your 20 years. I have to admit, on some level it's a little bit surreal to be back on a conference call talking with you guys again, but I can tell you I certainly don't feel like I'm 20 years older.
We're glad you're here, Greg.
Don, maybe you can help me with a life insurance tutorial and walk me through in a little bit more detail the deck unlocking. And then you mentioned the regular third quarter review. So if you're going to do another full-blown review, does that necessarily mean that there's going to be another adjustment? I'm just trying to think about how to think about the company going forward. Thanks.
Sure. So deferred acquisition costs and some other related balances are amortized over the life of the product based upon the emergence of profits over the life of those products. So the components there obviously are the historical earnings and then the expectation with respect to future earnings. And annually we do review all the assumptions that go into that projection of future earnings and it's much more than an interest-related assumption around spreads. There's mortality experience, there's labs experience, there's expense experience and so on. But a key driver of variability that we've seen in our unlocking is the fluctuations that we have with respect to spread expectations because of the continued low interest-rate environment.
So every quarter we look at all of these assumptions. And we update them annually in the third quarter. But during the year, if we see a trend emerging and we get additional evidence which suggests that we know for sure we're going to have a large negative hit, when we do our annual unlock, it's our practice on full disclosure to unlock in that period in which we recognize that. The triggering events happened in the second quarter. So we took a look at our long-term interest rate assumptions, as well as the current short-term interest rate assumptions, and we modified our view of long-term interest rates. We reduced our expectation with respect to the ultimate long-term rate, target rate, and we extended the grading period with which we're going to use to get to that long-term rate, and then we reflected the current forward curve over the next three years and took that into account.
All of that decreased the spread assumptions in that model and, as a result, it decreased the amount of expected future profits which means over the life of the entire contract from hindsight, based on a revised projection, more of the profits happened in the past. That requires an acceleration of the amortization of the deferred acquisition costs, value of insurance in force and so on.
Great color. It sounds like you've done this before. So I'm looking at your balance sheet. And I see the drop-down in the deferred acquisition costs from $335 million down to $219 million. I assume that is part of the adjustment that you just discussed.
That's a small part of that change that you see on the balance sheet. Another thing that we're required to do under GAAP is we have to, and we do, we do what's called a shadow adjustment for the impact of unrealized gains or losses on investments. Our unrealized gains has increased quite a bit. That increase runs through equity. We have to do a calculation where we assume all those gains are realized, how would that impact the DAC balance that would require a write-off of DAC if we were to realize all those gains; so we adjust DAC down and then run that adjustment through equity as well.
Perfect. Thanks for the color and clarification there. And then, I though this is a minor item, but nevertheless, you brought it up on the call. You talked about the investments, compliance, et cetera, expenses for DOL. I think you said $1 million to $2 million. Is that a quarterly run rate or is that an annual expense going forward? Maybe you could add some perspective on that. That would be helpful.
Great, Greg. Ray, you want to take that?
I will. Greg, Ray Wasilewski. How are you doing? That's a one-time expense. So that $1 million to $2 million we talked about is our implementation cost. We will have some minor small ongoing increase in run rate. We're looking at probably that one to two staff that we'll add that would go into that run rate. But $1 million to $2 million is implementation.
Is that yet to be expensed, or has that already been expensed, or how do I think about it in terms of the financials?
Yet to be expensed. A small portion has been, as we did feasibility work and had some external sources on that, but the great bulk of that is coming up.
Perfect. All right, folks, thanks very much for the color.
The next question is from Jamie Inglis with Philo Smith. Please go ahead.
Hi, good morning. I was thinking about the commentary you shared with us about the incentives put in place to help agents and also the changes in recruitment you've undertaken in recent times. And it made me think about the agency force. I wonder if you could share with me, what does the typical agent look like today? Do you know what I mean? In terms of size, shape, age, relative to 5 or 10 years ago and how is that – and where do you think it might go?
Thank you for the question, James. This is Scott Stice. So the changes that we've made, I'll begin there and then get to the balance of your question. The changes that we've made to recruiting are really around agent selection, agent training, how they qualify to become a full-time agent with us. We've made changes to all of those things. But probably the most impactful thing that we've done is we've made a change from recruiting somebody, selecting them, running them through our selection matrix, and then appointing them full-time.
We've inserted a component into that process where the agent actually goes through a 2 month to 4 month period where we actually do joint sales work with them. We begin to train them on our products. It's really an extended interview where we can see them in action. There's certain minimum performance standards they have to hit to become eligible, and at the end of that period we jointly make a decision with the candidate whether to appoint them full-time or not. That's had a tremendous impact on our new agent retention.
In terms of what our agent looks like relative to 10 years ago, the average age has come down a couple of years. It was running 50 years old or so. Now it's somewhere in the mid-40s, 45, 46 years old. The average new agent we recruit is typically between 35 and 45 years old. We tend to focus on people who have not been in the industry before. We develop our own from the ground up.
And so, while the agency force isn't materially different than it was a decade ago, it is getting a little younger just because of our increased recruiting efforts. More of our agents have staff today than they did 10 years ago. Agency operations are more complex; marketing is different and so staff becomes an ever more critical component to our agents' long-term success.
Got it. Okay. Secondly, the comments about being 20 years a public company made me think about where this company has come from and where it may go. I guess what do you guys think about the growth of this business over, for the next 20 years, but going forward. Do you think about it relative to GDP? How do you think about it and where do you think – how do you think we can think about it very long-term?
So I guess there's several things that would run through my mind as I think about that question. The current low, long view that we have and maybe lower-longer view that we have, there are significant challenges in the spread business in terms of its growth. I tell audiences all over that, in our industry, we need a value proposition that kind of fits on a three-legged stool. There has to be something for the company to risk its capital. There has to be something for a producer to spend their time to sell the product and there has to be a good value proposition for a customer.
And you go out in today's interest-rate environments and split it up three ways and tell everybody to get excited; it's been a challenge. We're working harder and harder to get that done. Having said that, there are not a lot of good options in the marketplace for investors otherwise and so we continue on. We have worked harder for our growth, but we're still getting growth.
We're also very well-positioned because close to half of our reserves are really related to life insurance and protection. I think we're a company with a multiline exclusive agency force that we have to lean harder on our protection products than we have done in the past. And so it's really possibly for us maybe a source of earnings issue and continuing to expand and explore additional sources of earnings beyond the spread business. So I think the spread business can continue to grow. It's hard work. But I think there is great need for additional protection products in the marketplace and we'll continue to lean as heavy or heavier on that side of our business to generate our growth.
Okay, great. Thanks a lot.
[Operator Instructions] This concludes our question-and-answer session. I would like to turn the conference back over to Kathleen Till Stange for any closing remarks.
Kathleen Till Stange
Thank you to everyone who joined us on the call today. Please feel free to give us a call if you have any follow-up questions. Thanks and have a good day.
The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.
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