FBL Financial Group, Inc.
Q1 2008 Earnings Call Transcript

Published: 12 May 2008

[Operator:]

Good day, everyone and welcome to the FBL Financial Group first quarter 2008 earnings conference call. Today’s call is being recorded. At this time I would like to turn the call over to Kathleen Till Stange. Please go ahead.

[Kathleen Till Stange:]

Thank you. Good morning and welcome to FBL Financial Group’s conference call to discuss first quarter 2008 earnings. If you don’t already have a copy, our earnings release and financial supplement may be found on our website at www.fblfinancial.com. Presenting on today’s call are Jim Noyce, Chief Executive Officer and Jim Brannen, Chief Financial Officer. Also present and available to answer any questions you may have are John Paule, Executive Vice President of EquiTrust Life; Rich Kypta, Executive Vice President Farm Bureau Life, General Counsel and Secretary; and Don Seibel, Vice President-Finance. Some of the comments made during this call may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act. There are a number of risks and uncertainties that could cause actual results to differ materially from those expressed or implied. Factors that could cause actual results to differ materially are discussed in our filings with the SEC. Comments during the call also include certain non-GAAP financial measures. These items are reconciled to GAAP in our fourth quarter earnings release and our quarterly financial supplement both of which may be found or our website. Today’s call is being simulcast on FBL’s website shortly after the call on our site you will find a transcript of today’s prepared comments and an audio replay of the call. It is my pleasure to now turn the call over to CEO, Jim Noyce.

[James Noyce:]

Thank you, Kathleen. Good morning everyone and thank you for joining us on today’s call. As many of you know for each of the last three quarters of 2007 and for that full year we are able to report and talk about record operating earnings for FBL. Unfortunately as you undoubtedly already know the results for the first quarter of 2008 did not follow suite and was a disappointment with net income of $0.21 per share and operating income of $0.50 per share. First quarter operating income results were negatively impacted by several factors, with poor mortality experience being the largest contributor, plus some other one-time items as well as pressure on spreads and net income was also negatively impacted by other than temporary impairments. We are going to start today’s call by digging into the details of these results for the quarter, and as equal importance to us and all of you what they imply for the rest of the year so that you can have a better understanding of why we lowered our 2008, operating income guidance to a range of $2.70 to $2.85 per share. I will turn it over to Jim Brannen to address these topics, then I will follow-up with some additional commentary before we open it up for your questions. Jim?

[James Brannen:]

Thanks, Jim and good morning everyone. As Jim mentioned the biggest part of the mix for the quarter was our mortality experience. We had a record number of death claims for both term and permanent insurance and many of those claims are well below our retention limits. As we have said in previous quarters by its very nature, mortality experience fluctuates from quarter-to-quarter. We had total death benefit for $29.4 million in this quarter; that compares to average quarterly death benefit to $21.9 million in ’07 but mortality experience was favorable. As we indicated when we discussed earnings guidance last quarter we expected mortality experience be more normalized that a higher level in 2008, but not at the level seen in the first quarter. We consider this quarter’s poor mortality experience and the quarterly fluctuation like the very favorable experience in the past two quarters. This fluctuation accounted for $0.10 per share of the short fall this quarter. Also within the traditional universal life segment we also had certain one-time reserve and [deck] adjustments, which negatively impacted results that totaled roughly $0.05 per share. Next I will turn to spreads which have been under some pressure. As of March 31 our exclusive annuity business decreased by 9 basis points to a spread of 151 basis points on a statutory basis. That’s below our target for the business of a 180 basis points, that’s the yield decrease in this segment and a large part due to loss and some fixed or floating swaps we had back in the business. In past, we had received the benefit from the swaps, but due to the decrease in LIBOR we are now in a loss position. In response to this on March 1, we lowered the crediting rate in our primary Farm Bureau Life annuity product by 30 basis points and on April 1 we also decreased the crediting rate on another block of annuity policies by 30 basis points. These rate changes will significantly make up for the short fall, but we will continue to see some spread pressure on this segment as some of the business is at guaranteed rates and much of the business is that of the surrendered charge period. Announcing our spread targets with maintaining crediting rate that are attractive to agents and consumers while at the same time providing enough to existing policy holders so that business is persistent. For traditional annuity, exclusive segment is a large contributor to FBL’s total earnings; this short fall and spread negatively impacted the results this quarter. Our death universal life was spread on a statutory basis increased by 2 basis points during to quarter to 190; that remains above our target spread for the business of a 182 to this positive as much of this business is at or near it’s minimum guarantees. Spread for EquiTrust Life independent channel fixed rate annuity business increased 4 basis points during the quarter to 98 basis points on a statutory basis at the end of the quarter and remains above our target, which is 92 basis points. This excess spread on our EquiTrust fixed rate business is positive and has failed to offset some of the deficiency we have with our EquiTrust life direct index annuity business. Its spread increased by 4 basis points during the quarter to 221 on a statutory basis which was still below our target 234 basis points. This is due to continued elevated option costs caused by volatility in the equity markets. This reflected in the fixed index, which increased on average to 26.1 in the first quarter of 2008 from 12.6 in the first quarter of 2007. Our point in time index annuity spreads in the financial supplement do not include the actual experience of our hedging program. In first quarter the proceeds were received from options exceeded index spreads, credit to policyholders by over 700,000. This is less than a benefit in the fourth quarter of $1.6 million. The reason for the decrease in the quarter was due to down equity markets and given the markets we are in we expect this hedge benefits remains at these lower levels or decreased further. Earnings from our EquiTrust Life independent channel totaled $0.10 per share this quarter, which is solid but not $0.03 sure of our expectations and a couple cents less than the fourth quarter. This reflects elevated option costs, last hedge benefit from excess hedge proceeds and higher overhead expenses been allocated to a business unit starting this quarter. Turing to our closed block co-insurance business from American equity, it contributed less than our expectations this quarter. This business provided an average quarterly contribution of $0.10 per share to operating income during 2007, but accounted only for $0.06 per share of operating income this quarter. The decline reflects less surrender charge fee income and lower spreads. This business is also experiencing continued elevated option costs, but some of the contracts from earlier years of this co-insuarnce agreement are hitting the minimum guarantees. After further analysis of this part we expect some of the pressures to continue in the near-term. Next, I want to spend sometime to discussing our rational for revised operating income guidance. Taking into consideration the various onetime items such as mortality experience, the traditional life reserve and DAC adjustments as well as lower than anticipated corporate net investment income, lower investment prepaid income and the timing of our credit and rates decreases we estimate the normalized results for the first quarter would have been about $0.70 per share. Based on those first quarter results the nature and amount of one-time items and our expectations for growth in our business over the balance of the year; we have revised the full year 2008 operating income guidance to be with in a range of $2.70 to $2.85 per share. This reduction in corporate short fall from the first quarter, existing market condition, plus reduced expectations for American equity closed block co-insurance agreements for the reminder of the year and the lack of spread expansion available on certain products due to minimum guarantees. Now I will turn to investments and other than temporary impairments, we took on favorable securities this quarter. These impairments totaled $12.2 million after tax and other offsets and were comprised of the CDO which I mentioned in the conference call last quarter; one Alt-A asset backed securities and four corporate bonds. We do have a formal process in place for determining our other than temporary impairments, all securities that have a market value of 15% less than our curing value automatically go on our watch list. All securities on our watch list are reviewed with our detailed write-offs on each one to determine if they should be impaired. We take into account the decline in price and look at the length of time the price has been down, the cash flows and our intend to hold the maturity and other facts and circumstances specific to that security. What has happened in the residential real estate world is unprecedented and I am pretty sure that I we have not seen the end of it. In the mean time we will continue to monitor our portfolio on a regular basis and provide you with a honest assessment of risks and concerns. Our goal of transparency [Inaudible] in February we filed our Form 8-K with additional detail on our investment portfolio and in this quarter we expanded Form 10-Q to include added detail on our investments. One area we are watching closely and as our investment portfolio is our exposure to mono-line insurers a large number of our municipal bond securities are wrapped, however we are concerned about these securities. We had to write municipal bonds based on underlying credit quality of the bond not based on the wrap. These types of bonds historically have low default rates or to have more concern regarding the mono-line in shares is on the wraps and our other assets backed securities portfolio. Some of the mono-line insurers have been successful at raising capital and stabilizing our ratings while others have not been as successful. Right now our assumptions or the guarantees will be honored on these securities, if they are not, then we may have further impairments of our ABS portfolio. On our Form 10-Q this quarter you will see an expanded discloser on our ABS portfolio including the amounts wrapped by the mono-line insurers. There are some pieces of good news; first with regards to our mortgage-backed security portfolio. Earlier this year as the mortgage market volatility continued we conducted a formal review of the mortgage-backed portfolio to examine details and document -- documentation refine or definitions of prime, multi and sub-prime; really be more consistent with those used by others in the industry. The result of review we determine at $157.1 million of market value in the securities should be reclassified from Alt-A up to prime residential mortgage-backed securities from the 2003 origination here. Majority of the securities reclassified had collateral or the underlying mortgages were of a higher quality than originally anticipated. In addition the credit scores beginning 2008; we are also now considering owner occupancy, level of documentation, Bloomberg data and quality of collateral for determining an appropriate classification of the securities in the portfolio. We believe the revised classifications are more consistent with the industry and more appropriate at the securities performance is highly depended upon the quality to borrower As a reminder we have a minimal exposure to sub-prime mortgages as of March 31, our three sub-prime securities at market value of $28 million that represent three tenths of a percent of our total investments. Investments are all AAA rated, fixed rate and were originated in 2005. Lastly, our capital position remains strong as of March 31 our total capitalization excluding AOCI was nearly $1.3 billion and we had cash and investments of $55 million at the holding company. We continue to target with capital levels required for our A-rating from AM Best and Standard & Poor’s. Our debt to total capitalization ratio continues to be reasonable, an appropriate 25.1% at quarter-end. I think at last when you take into consideration equity credit given for our trust preferred. With that I will turn it back to Jim Noyce.

[James Noyce:]

Thanks Jim, for that review of our earnings and guidance. Despite the short-term earnings issues which Jim address the fundamentals of our business remain sold. Farm Bureau Life continues to generate capital for our company’s by serving a core customer base of persistent Farm Bureau members and EquiTrust Life continues to grow and add towards total assets in bottom line. The strong point during the quarter was sales. In total premiums collected were up 10% from the first quarter of last year to $465 million with strong sales levels from both Farm Bureau Life and EquiTrust Life. Farm Bureau Life build on it success from 2007 with premiums collected up 9% over the first quarter of last year. After several quarters of declining traditional annuity sales, I’m pleased to say that traditional annuity premiums collected reversed their downward trading we’re up 28% for the quarter. Traditional and Universal Life premiums collected were up 3%, while variable product sales were down 3%. Within Farm Bureau Life we continue to keep our product portfolio up to-date with new product introductions. The latest to the universal life product was a secondary guarantee that we launched in early March. This has become the fastest growing universal life product within the industry, but most of the multi-line exclusive agency companies do not yet have this type of product available for their agency. The product has been well received by our agents and early sales levels are positive. Recruiting Farm Bureau Life exclusive agents remains a challenge but our agents continue to add sales and service associates to assist them and our license to sell life and annuity products. We now have nearly 1600 sales and service associates in our 15 states, in addition to our over 1900 Farm Bureau Life agents. This reflects the fact that our agency forces becoming more entrepreneurial and sophisticated as their role as agents has transformed into entrepreneurial business owners with their own producer groups. Within Farm Bureau Life we continue to focus on efficiency and streamlining operations. In the first quarter, we further implemented our scanning, imaging and automated work flow system into a number of additional areas including underwriting and life policy issuance. Our EquiTrust Life independent channel had premiums collected of $327 million during the quarter, which was up 10% over the first quarter of 2007. Contributing to the strong sales results this quarter was as steeper yield curve and the effect it has on our comparative position relative to bank CD’s. This environment led to fixed rate annuity sales of $121 million for the quarter. Index annuity premiums collected on the other hand were down 7% from last year’s first quarter. We’re a bit disappointed with the decline in indexed annuity sales, but at the same time we are balancing the rates offered in these products with our desire to make targets spreads. We have continued to enhance our immediate annuity product called confidence income. When the product was introduced we only offered period certain guarantee payoff. We added the single life option to the product last September and joint life options in March of this year. This product accounted for $64 million in premiums in 2007 and $27 million in the first quarter of 2008 and we are excited about its prospects going forward. In the first quarter, we recruited 1123 agents, a net agent growth of 945 agents and now have 20,726 EquiTrust Life independent agents appointed. As EquiTrust Life independent channel grows, we continue to expand other marketing activities. For the first time, we will be sponsoring an agent incentive trip which an agent can qualify for with EquiTrust Life production between May 1 of this year and April 30 of next. In addition, we are adding two regional wholesalers, who will spend their time in the field promoting EquiTrust Life products with our marketing organizations. To conclude I’m confident that we will navigate through the current challenges. We have a strong balance sheet and capital strength and with our solid business fundamentals we believe we are positioned for long-term success. With that, I will now turn the call over to the operator; open it up to any question, if you have.

[Operator:]

(Operator Instructions) Our first question is from Keith Walsh - Citigroup.

[Keith Walsh:]

First question is just around the mortality shortfall, may be if you give us a little more color around that. Was -- the number of policies that we are talking about is it a small number, also by policy year and anything -- any color you can give us around that and then secondly what’s your current risk based capital ratio? Thanks.

[James Noyce:]

Hi, Keith, this is Jim. In general we saw the numbers of policies in terms of death claims and in terms of perm as I said we are at record levels of -- any time in the history we could go back and find -- we also had universal life and VUL accounts that were up. Total claims would be -- I expect to leave a record for the company, but the actual death benefits we have seen a higher face amount sometime in -- it’s been a while and I think it was third quarter of '06; we actually had a higher death benefit claim number. In terms of the year of issue, I don’t have the breakdown of that available to me Keith.

[Keith Walsh:]

So, this is more just total number of claims than…

[James Noyce:]

It really was a frequency issue this quarter and the claim side, a bit smaller than we have had on average, that really means that we didn’t have a reinsurance numbers to retain all of it.

[Keith Walsh:]

Okay. That’s helpful and then risk based capital ratio?

[Don Seibel:]

Yes Keith this is Don Seibel. Farm Bureau Life's risk based capital at the company action level was 407. At the end of 2007 we estimate that to be 405, at the end of first quarter of 2008, EquiTrust Life was a 428 and we estimate that down to 380 at the end of March.

[Operator:]

Thank you, we will go to next to Steven Schwartz with Raymond James & Associates.

[Steven Schwartz:]

Hey, good morning everybody. Could you, I have got three questions. If you can help me out here, I’m trying to figure out the statement of benefits being of $5 million from 25 to; was strength up to $29.4 million with your income statement. Where does that show up? I’m looking at traditional life insurance benefits which look to be up about $2.5 million or so and then traditional life future policy benefits which seem to be up about $4 million?

[James Noyce:]

And I think the number we quoted was an average of our quarters for 2007.

[Steven Schwartz:]

Is that; okay.

[James Noyce:]

But that is what the $21.9 million we have. It’s an average of the four quarters in 2007.

[Steven Schwartz:]

Okay so comparing the two across doesn't count, okay. That’s it -- going back to the adverse mortality maybe Don can handle this, you guys were last, so you get the question I think. Any idea what is going on? If you look at your book of business are there sells are there some diseases, is it certain ages because this has been an ongoing problem for the industry this quarter, but everything seems to be different for everybody.

[James Noyce:]

That is a very good question, that’s one that we’ve asked ourselves and there is no clear answer to that. We can tie specifically back to data. One theory is that mortality experience increases when there is a long hard winter and we certainly had a very long hard winter here in the Midwestern and we have seen that in the past years and we see an uptick in mortality and given a small enough book of business that when you have some volatility on our mortality results period.

[Steven Schwartz:]

Okay, I guess that’s -- I guess we hear that one and then finally maybe for [inaudible] maybe you can -- actually two things; the AEL book of business was period of 2001 am I remembering that correctly?

[James Brannen:]

Yes, 2000.

[James Noyce:]

Yes, 2001 to 2004.

[Steven Schwartz:]

2001 to 2004…

[James Brannen:]

It's exactly a three year period. It started in like the middle of 2001 and one to the middle of 2004.

[Steven Schwartz:]

Yes, I guess I'm interested, you're hitting the guarantees what -- I would have thought in that period maybe 2004, but certainly 2001, 2002 the SAP was quite low wasn't it -- was it not at that time? I guess I don't understand why you're hitting your guarantees?

[James Noyce:]

I don't want to overemphasize the guarantee issue. There are some policies that hit guarantees during the quarter. We don't have a lot of detail on which ones they are, but, as option costs were very high in the quarter, the costs of providing that option will in fact -- has in fact driven a small amount of those policies to their guaranteed levels.

[Steven Schwartz:]

Okay and then, maybe you can walk us through -- if you add back the adverse mortality, which I guess makes some sense from your normalized earnings power, you go from $0.50 to $0.60 I guess, but to get to the low point of the range, I think you've got a average like $0.73 for the next three quarters? Does it change in your crediting rates and participation rates and what have you -- is that really the sole difference?

[James Noyce:]

First -- a couple of more things to consider I guess. I think that the mortality is big piece, but we also had a onetime adjustment of about $0.05. In our traditional reserves and DAC balances for that line; we also had less prepayment fee income which bounces around a bit. The timing of those changes in our exclusive annuity line were March 1 and April 1, so we really didn’t have anywhere near a full month of those 30 basis points in the earnings and we had a little less annuity surrenders than what we have seen on our run rate as well. A lot of small things; Steve I think you could normalize it to $0.70 and then if you consider kind of our growth and run rate and growth on both EquiTrust and Farm Bureau Life and then the AE co-insurance was as little light on surrender income as well, so that gets me in the area of our range.

[Steven Schwartz:]

Okay just follow-up the decrease in crediting rate so, that doesn’t – that doesn’t come in the immediately, you’ve got hit anniversary periods so that’s going to come into play over the next 12-months?

[James Noyce:]

No, no, its that we didn’t get imp -- we really didn’t get any impact in it from the first quarter, Steve if that we expect – one of the reasons that we think, if you normalize if you say our normalized earnings where the seven years or so. The areas where we think we will do better than that and when we say normalize we mean if you take up the one-time things. Then the areas we have think we will improve on that are grow a little bit better prepayments fee income because it was, it was low relative to expectations. The improvement had spread because of the reprising that occurred late in the first quarter is that starting to -- I may I think I …

[Steven Schwartz:]

Yeah, I get it.

[James Noyce:]

Same thing Jim said, but a little different

[James Brannem:]

I think the improvements spread I guess. The reason we got that in the normalized quarters, normally we would, wouldn’t have got that at that bit a move that late in the quarter. I would say the reason for the net income loss was the movement on LIBOR, which move pretty quickly and so the net investment income dropped a little quicker than usual and so we got the rate charges in but they didn’t take full effect on the quarter.

[Operator:]

Thank. We’ll take our next question Jukka Lipponen with KBW.

[Jukka Lipponen:]

Jim, I’M sorry if I missed it, but can you give us a little more color behind the – the back in the reserve adjustments.

[Donald Seibel:]

This is Don Seibel, I will tackle that we had actually three adjustments that were onetime running thought the quarter. One related to our custom, term block where each individual policy holder get specify unique terms of the contract and we can’t modal a separate plan codes for each contracts. So we do some aggregation and modeling of cells and what we did is we took a look and we trued up that’s - those calls to reflect current in force and that cause for charge earnings in the quarter. We also had a small charge to term reserves, which is the correction of a factor applied in our formulas and we had to increase our DAC amortization by about 400,000 that’s related to true up of in force business that could have been done sooner and in 2007.

[Jukka Lipponen:]

And that was in what product line?

[Donald Seibel:]

The traditional Annuity I believe.

[Jukka Lipponen:]

And then the -- my other question was I missed the -- we went through the formula how you look at I guess or how you determine, how things go on the watch list and so, can you review that criteria again and how is your watch list trending?

[James Noyce:]

We have a -- anything that’s 85% of carrying value is automatically on the watch list. Anything that’s not, anything that’s that else could go on the watch list if we know of our issue even if its price to above 85. So, something above 85 could make it on our watch list, but anything below 85 or price below 85 is definitely on the watch list. That’s just our criteria and then we have look at our security by security basis of anything that’s has unrealized losses and write reports on each and every security on that list. In terms of the watch list trends, I think it’s probably indicative of the change in unrealized loss that we saw for the quarter the less through significantly as then realized losses though pricing came in this quarter.

[Jukka Lipponen:]

And do have a same kind of test for impairments.

[James Noyce:]

Well, that's. The watch list was the beginning of the impairment analysis. We would look at each one of those securities for the times that they've been on the watch list, for our attempt whether we are able and try to hold them until their maturity. We look at specific things going on with the credit. We look to see if it's interest rate movements and look at all those securities.

[Jukka Lipponen:]

So no bright line test?

[James Noyce:]

I would say there's no bright line test. That's right.

[Operator:]

(Operator Instructions) We will go next to Jason Zucker with Viva Capital.

[Jason Zucker:]

Good morning and thank you. I had a couple of questions the first one I just wanted to follow-up on capital. It looks like it -- year end your statutory capital including AVR is about $830 million or about 27.50 a share. Could you just give us an update on that for the first quarter?

[James Noyce:]

Yes. Farm Bureau Life has ending statutory capital and surplus of about $369 million, and EquiTrust has about $359 million.

[Jason Zucker:]

Great and that include AVR? James Noyce 1 Those numbers exclude AVR.

[James Noyce:]

Farm Bureau Life a statutory total adjusted capital was essentially flat from year end and EquiTrust Life decreased about 40 million.

[Jason Zucker:]

Okay. So, all together down about 40 million from year end?

[James Noyce:]

Yes.

[Jason Zucker:]

Okay. Great and then my second question was can you just talk about the drivers of executive compensation and maybe just in particular how the EPS guidance effects that compensation?

[James Noyce:]

Sure. This is Jim Noyce. The - there was a couple of areas where it affects. We have annual cash bonuses that are - that have several goals associated with those and earnings per share is one of those - is one of the goals that is associated with the goals that are in our annual bonus plans. So with impacts that more significantly is the long-term incentive compensation which has two pieces stock options, which each year stock options are issued towards the pay act one. We target January 15th of each year and the strike price would be the closing price of January 15th. , if its a weekend or holiday, it would be next business day and so there is a series of stock options for each year that’s been granted with those strike prices and then there is a restricted stock component and the restricted stock component is just performance based restricted stock and the performance metrics are three-year cumulative operating income per share and three-year -- that that weighted 75% and 25% weighted on return on equity again also cumulative over 3 year periods. So at any point time we would have right now three grants of restricted stock from each of the last three years that would be negatively impacted by this earnings result.

[Operator:]

Thank you, and at this time it appears to be of no further questions over the call. I would like to turn the program back over to Kathleen Till Stange for any additional or closing comments.

[Kathleen Till Stange:]

Thank you for your interest in FBL Financial Group and for participating in today’s call. Please mark your calendars for our second quarter 2008 earnings release on August 6 and conference call on August 7. Please feel free to give us a call if you have any individual follow-up questions. Thank you.

[Operator:]

That does conclude today’s call. You may disconnect your lines at this time.