FBL Financial Group, Inc.
Q3 2016 Earnings Call Transcript

Published: 6 Nov 2016

[Operator:]

Good day, and welcome to the FBL Financial Group, Inc. Third 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 Ms. 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 third-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 reports 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 includes certain non-GAAP financial measures. This items are reconciled to GAAP in our third-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.

[Jim Brannen:]

Thanks, Kathleen. Good morning. Thanks to everyone on the call. I’m glad you were able to join us today. I’m pleased that FBL Financial Group reported strong earnings in the third quarter of 2016. Net income was $1.20 per share. Operating income was $1.15 per share. Overall sales for the third quarter were muted with total premiums collected down 15% primarily due to lower fixed-rate annuity sales. Annuity premiums collected for third quarter declined 25% while life insurance premiums collected declined 1%. Earlier this year we offered a first year bonus on our four-year guaranteed annuity product and it was well received. Following that offering, we lowered crediting rates on this product a couple of times given the investment environment, resulting in the decline in sales in the third quarter. We regularly update the rates on our annuity product offerings in response to changes in the marketplace. This, of course, allows us to provide appropriate credited rates based on available investment opportunities, while maintaining financial discipline and meeting our pricing objectives. The good news is that we recently again began offering a first year bonus four-year guaranteed annuity product. We expect this to drive increased sales. Premiums collected on our indexed annuity product continue to be strong and were up 41% over the third quarter of 2015. Our index annuity is attractive to customers because of the potential for market gains along with protection from loss with guaranteed minimum crediting rates. We’ve expanded our agent training offerings on index annuities, targeting agents who have not yet sold an index product. We believe this expanded training will help to ensure agents understand all aspects of our index products and have confidence in presenting them to customers. Life premiums collected were down slightly this quarter, 1%, compared to the third quarter of 2015. Sales of whole life products continue to be strong. And sales of our relatively new index universal life product continue to grow as well. The current economic environment for our industry is challenging, as you know. In the face of headwinds, we remain focused on the fundamentals, recruiting and retaining agents and supporting them with the tools they need to be successful. As of September 30, we had 1,870 agents and agency managers, plus 72 active reserve agents in the pipeline working to complete the steps necessary to become full-time Farm Bureau agents. Our exclusive Farm Bureau agents are our most important competitive advantage. At the heart of what our agents do is connect with customers working with them to assess and fulfill their insurance needs. We do not focus on one-time sales. Rather, our agents build lifelong relationships with our customers to help them protect what matters most. We support our agents and these relationships in multiple ways. One way is through our branded review program called SuperCheck. It reinforces the message that Farm Bureau agents can make insurance simple. Our advertising dollars support SuperCheck campaign and reinforce the value that comes from having a relationship with a trusted agent. The focus on knowing our customers, meeting them regularly, and meeting their needs has led to our industry-leading cross-sell rate. Our cross-sell rate is currently at 23.7%, which is double the industry average. In September, I attended our annual sales seminar. We had record attendance with nearly 700 Farm Bureau agents there. It was a great opportunity for me to be able to spend time with our agents. They are engaged and committed to protecting the livelihoods and futures of our customers. At this event, they gained new insights and heard from renowned industry speakers with a focus on marketing activities, prospecting and lead development that ties into our corporate marketing and sales initiatives. One of our more recent sales initiatives is an external term life insurance replacement offer. This is a nice complement to our internal conversion program, whereby customers convert their term life coverage to a permanent program without having to undergo full new underwriting. We support these programs with direct mail campaigns and agent follow-up. An additional direct mail campaign we have going on now focuses on our annuity products. These mailings have resulted in increased life product ownership and cross-sell of property casualty and life products. We continue to make progress on our work to be compliant with the Department of Labor Fiduciary Rule. Efforts during the third quarter focused on changes to systems, disclosures, and agent and staff training. We expect to be ready by the first compliance date in April of 2017. Our current proprietary product offerings and agent compensation models will not change substantially as we expect to sell under the Best Interest Contract Exemption, or BICE. To conclude, I’m pleased with our results to date in 2016. Our focus on the fundamentals, having best-in-class distribution, and serving the Farm Bureau niche marketplace, and maintaining financial discipline allow me to remain positive as FBL Financial Group moves to the end of 2016 and on into 2017. Now I’ll turn the call over to Don Seibel to review of our financial results. Don?

[Don Seibel:]

Thanks, Jim, and good morning, everyone. I’m glad to be here today to provide some insights regarding our earnings and capital position. Even with the challenges of the continued low market interest rates, third-quarter results were strong and are pretty straightforward. As Jim indicated, net income for the quarter was $1.20 per share, and operating income was $1.15 per share. During the quarter, our operating income adjustments totaled $0.05 per share and consisted of the change in net unrealized gains and losses on derivatives and net realized gains on investments. I will focus the balance of my comments on operating income. The third quarter operating income was above our expectations, with variances for other investment-related income, mortality experience, and the impact of unlocking. During the third quarter, we performed a review or unlocking of the key assumptions used in the calculation of the amortization of deferred acquisition costs, unearned revenue reserves, and certain reserves on interest sensitive products. This unlocking positively impacted earnings by $0.02 per share primarily due to improved mortality assumptions. The impact of the improved mortality assumptions was partially offset by the impact of changes in assumed premium persistency on our universal life business. The unlocking impact varied by segment. It decreased pre-tax operating income in the life insurance segment by approximately $300,000 and increased pre-tax operating income in the corporate and other segment by a little over $1 million. There was no impact from unlocking on the annuity segment. You’ll recall that during the second quarter of 2016, we unlocked interest rate related assumptions to better reflect the low market interest rate environment given Brexit and other factors at the time. With those changes already made, we did not need to further unlock interest rate assumptions in the third quarter. Please see page 15 of our third-quarter investor supplement where we have included detail on the impact of this unlocking on the various financial statement line items. Turning to mortality, this quarter mortality experience was higher than our expectations due to an increase in average claim size. This resulted in higher death benefits in our closed block of variable universal life business, which is in the corporate and other segment. On a year-to-date basis, our mortality experience is better than expected. Given the nature of mortality experience, fluctuations on a quarterly basis are expected. Other investment-related income, which includes prepayment fee income, was at an elevated level again this quarter totaling $4.1 million. It was primarily in the annuity segment. This is positive in the short term as it contributes to income, but it further compresses future spreads due to the loss of higher yielding securities. Next, I’ll comment on our spreads and spread targets. I am pleased to report that we are exceeding target spreads on our annuity business. At September 30, the total spread on our annuity business was 202 basis points, above our target of 201 basis points. During the quarter, investment yields decreased 5 basis points due to the maturity of higher yielding assets and purchases of lower yielding assets. However, we were able to partially offset this spread compression by lowering crediting rates by 10 basis points on certain annuity products and by 25 basis points for the fixed portion of our indexed annuity product. Given the persistent low market interest rates, it will be a challenge for us to earn the desired target spread going forward. 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. Point-in-time spreads on our universal life business declined during the third quarter to 144 basis points at September 30, below our target for this business of 152 basis points. This is due to the maturity of higher yielding assets and purchases of lower yielding assets. Crediting rates for this block of business remained the same during the quarter. For this block, it is increasingly difficult to lower crediting rates further as we only have 20% of the business receiving a crediting rate above the minimum guarantees. Given the headwinds of the persistent low interest rate environment, over the past several years, we have focused on expense control. Operating expenses were lower in the third quarter compared to the same quarter last year, reflecting this focus and the benefit of several expense savings initiatives. Next, I’ll comment on our financial strength. At September 30, the capital position of our wholly-owned subsidiary, Farm Bureau Life, remained excellent with an estimated company action-level risk-based capital ratio of 547%. This is an increase from the June 30 level of 541%. Using 425% RBC as a base, Farm Bureau Life had excess capital of approximately $155 million at September 30. At the holding company level, we also have more than adequate liquidity and capital with excess capital at the parent of approximately $45 million at September 30. While this is a challenging time for the life insurance industry, I’m pleased that FBL Financial Group has been able to again deliver strong earnings results. With our consistent earnings results and strong capital position, I’m confident we’ll continue to maintain our financial discipline going forward. That concludes our prepared remarks. We will now turn the call over to the operator and open it up to any questions that you may have.

[Operator:]

Thank you. We will now begin the question-and-answer session. [Operator Instructions]. Our first question comes from Bob Glasspiegel of Janney. Please go ahead.

[Bob Glasspiegel:]

Does the election matter at all to FBL as far as proposals that might impact life insurance?

[Jim Brannen:]

That is a great question, Bob. I think you well know that maybe the president elect, I guess, has a different proposal depending on which party you are looking at. Clearly, we are under the impression that we will have to exist in either fashion and clearly with the president not being able to set tax policy, which is the one that could affect us the most, including estate taxes, that would be the one that I would look at the most. I think sometimes, unfortunately, the estate tax is going in a tougher manner help us because one of the things that we do is to help people pass that family farm along and make sure that the estate taxes don’t get a piece of the family farm. So any proposals that reduces that sometimes reduces our opportunity but honestly in the more friendly regime that we’ve had lately, still been a big opportunity because these farms are getting bigger and bigger and they exceed, many times exceed the estate tax level. Out of all the other stuff, I think that it would just be the general stuff, what’s going to be more business friendly, what’s going to be more growth friendly. I think the biggest key to our whole industry is in the economy that grows and an interest rate that starts to grow, and frankly, I care less about who sits in the seat and more about if the economy starts moving.

[Bob Glasspiegel:]

Okay. That’s a thoughtful answer. Appreciate it. How should we handicap the probability the Board considering a special dividend as far as what recommendations you’d be making given where you stand with a lot of excess capital?

[Jim Brannen:]

I can pass that along to Don, but hopefully he would have the same answer that I do, is we never would be able to tip our hand one way or another. You can continue to track along our strategy around returning capital. You can understand that we have a fairly low float, and so our opportunity with shareholders that want to return stock through stock buybacks has diminished. I think we’ve utilized that strategy about as far as it could go. We’d leave that arrow in the quiver so that we have that available to us. But clearly in terms of moving more capital, it would be along the lines of both dividends, regular dividends, and special dividends. Our current strategy of considering those two as our main opportunity for turning capital has not changed. In terms of timing, clearly we are not telegraphing any timing around what our thinking is on special dividends, but some of the things we consider, of course, are clearly the levels of excess capital, capital generation, but I would also say, what does the outside environment look like, what does the credit cycle look like, are we seeing any whiffs of deterioration in our opportunity, do we want to keep more power dry, what are the capital levels that competitors around being able to earn good ROEs for our shareholders while remaining very, very safe and sound. And clearly we think we’ve got some advantages given our very low debt to total capital ratio and our product sets in our mode of operation through exclusive agents. I think that we are in a, from a risk parameter, in a really, really good place. So we’ll be able to continue to consider those, so over time, I guess I wouldn’t take them off the table, but clearly we will have to be careful about timing and announcing and so forth.

[Operator:]

[Operator Instructions] Our next question comes from Greg Peters of Raymond James. Please go ahead.

[Greg Peters:]

Good morning, and thank you for the call and taking my questions. I wanted to step back and just, the revenue from an income statement standpoint was flat year over year and you’ve outlined some of the challenges you face. If we look at some of the line items within your income statement, one that stands out is the down interest sensitive product revenue charge revenue year over year. Is that sort of rate of decline expected to continue through 2017? And then, Don, you mentioned expense saving initiatives in 2016, and I’m curious if there’s anything on the board for 2017.

[Don Seibel:]

Yes. Sure. I’ll be happy to address both of those questions. With respect to the top-line pressure that you are seeing in looking at the financial statement line items, especially the interest sensitive product revenues, that’s really heavily influenced by the impact of the unlocking that we did during the third quarter. And with respect to our universal life business, our unlocking indicated that we are going to get more premium loads into the future, and that requires an increase to our unearned revenue reserve that, the offsets of that is to decrease interest sensitive product charges. So we are just sending more of that revenue into reserves to be earned into the future, and that totaled about $2.6 million in the third quarter, decreasing interest sensitive product charges, and if you compare that back to a year-ago quarter, we actually had $1.2 million going the other direction. So that magnifies the difference when you compare period over period. And if you take those two items into account, I think you’ll see a trending increase in interest sensitive product charges. With respect to expense savings, it is continuous for us and really have a cost-conscious culture and really monitor what we are doing from a long-term expense impact. I certainly don’t have anything to announce today with respect to specific large initiatives to significantly impact trends going forward. It’s just more of a being very cost-conscious around complement additions to the entity, projects that we take on doing a very thorough cost-benefit analysis to ensure that we are investing our dollars wisely, and we’ve seen that, keep our expenses at a reasonable level, and expect to see continuous, we will continue to have focus in this area moving forward.

[Jim Brannen:]

I guess I would add, Greg, I think the comment was really around we did sharpen our pencils as the year went along in response to the continued environment and took original plans and sharpened our pencils a bit back and cut in a lot of places. None of them were large things, but you still get a couple percent out of there, and so that’s really kind of what we are talking about.

[Greg Peters:]

So when I think about expense savings, it’s not like you are cutting back on advertising or marketing to your reps or things like that, correct?

[Jim Brannen:]

No. It has been more general, administrative, and projects.

[Greg Peters:]

Yes. Got it. Jim, I think in your opening comments you also spoke about some new products. I think the index universal life. Can you just give us a sense of how that’s evolving and is that something that is going to move the needle for FBL over the next couple of years or is this slow and steady progress, I guess?

[Jim Brannen:]

Yes. I guess the first thing I would do is kind of describe in our channel, especially a new product with quite a bit of complexity to it relative to some other products in the portfolio, that that generally catches on even though we do a really good job of marketing and training agents, they tend to word-of-mouth pass it along, honestly. A few agents will start seeing some success and that’s usually our most innovative top-selling best agents that embrace it, and it’s through that gaining of trust that it starts to proliferate throughout our multi-line exclusive agency force. And I am seeing more of that happen now. There’s also little bit of difference, Greg, in the eight states where we manage the field force and in the other states where we partner with other Farm Bureaus to manage. I think there’s been a little more of an adoption rate, a little quicker in the core states in doing that. So we have plenty of upside opportunity, but it is kind of a migration and evolution versus here’s a new product and boom, it becomes another part of the portfolio. I think it will eventually, but it’s got a ways to run in terms of activity or run rate, anybody else want to comment, go ahead.

[Ray Wasilewski:]

For the length of time, this is Ray Wasilewski, Chief Operating Officer. The length of time that product has been in our portfolio, it already makes up two-thirds of our UL sales, so it is definitely taking off at a pace that we was expected, and as Jim mentioned, is increasing. We monitor our competitive position on that, and it is the one, those index products are the ones that make sense as solutions for our customers right now being that they put a downside on what you can lose and they give you that upward potential. That’s what the market is looking for.

[Greg Peters:]

Perfect. Thank you. And then there’s a lot of rhetoric in the industry around DOL. Can you just step back and just remind us on where you’re positioned? If I recollect, not a lot of exposure there but maybe you could just remind us of your perspective.

[Ray Wasilewski:]

Again, Ray Wasilewski. I will take that, Greg. We have gone through a good portion of our analysis on that, so we are confident in where we are sitting at this point. We do continue to get external expertise to go over our conclusions, and we get that from a couple different perspectives just to make sure because as you know, there is some ambiguity in this rule and so we are looking to make sure that our conclusions have found this and are in line with where the rest of the industry is going; so our position remains we don’t have to make substantial changes. We will have a small product tweak or two. We have an annuity that has very low sales that we are looking at whether we can align compensation with that to meet the differential rules. That’s the one that sticks out. We have some minor tweaks on what we will pay on some of our brokered compensation, but no major changes there. Our portfolio, being some proprietary products, we have gone through that analysis, are creating that proprietary disclosure, have no major concerns there. We used to manufacture variable products, and with that came an infrastructure that allowed us, that’s a compliance infrastructure and we have a broker-dealer; that gives us a big leg up. We have exclusive agents, as you know, and with that compliance infrastructure in place, that makes it not a big stretch to get the processes in place that we need to monitor what’s going on under that best interest contract. One other thing that we chose to do was sell all our annuities, both indexed and fixed, on those qualified plans under that Best Interest Contract Exemption. We’re not using PTE 84-24. That is our intention. That allows one process for the agent. That smoothes that sales process out for them so that it does not become overly complex. In summary, that’s it. We still are at no significant changes. A lot of work to do. We’re hiring an individual to put on staff to help review applications that they come in, and we’re well into our project for compliance.

[Operator:]

[Operator Instructions] Our next question comes from Jamie Inglis from Philo Smith. Please go ahead.

[Jamie Inglis:]

Good morning, guys. I’m looking at page 15 of your supplement, and I’m trying to understand how we should think about the unlocking in the various groups, meaning corporate and other versus life and annuity segments. I mean, how should we think about that, where the unlocking might come in those various blocks?

[Don Seibel:]

This is Don, and I will tackle that question. The unlocking process, just to take a step back, the process, you review all your assumptions that go into those models, and you take a look at experience and you true up those models for your current best estimate of what you think those assumptions should be. So the driver in any one unlocking period can really vary, and it is not something you can try to trend or try to estimate in that particular way. With respect to the adjustment that you are seeing through in the third quarter of 2016, what we are essentially doing is not having that much of a bottom-line impact, but you will see the offset kind of emerge over the life of the products subsequent to this particular reporting period, so with respect to how it’s going to impact models, I would not say it’s going to have a noticeable impact at all with respect to ongoing results, but it is, the adjustment did impact current period and should be kind of seen as a one-time item. Hopefully that helps.

[Operator:]

This concludes our question and answer session. I would like to turn the conference back over to Ms. 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.

[Operator:]

The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.