FBL Financial Group, Inc.
Q3 2013 Earnings Call Transcript

Published: 1 Nov 2013

[Operator:]

Good morning, everyone, and welcome to the FBL Financial Group Third Quarter 2013 Conference Call. [Operator Instructions] Please note today's event is being recorded. I would now like to turn the conference call over to Ms. Kathleen Till Stange, Corporate Investor Relations, Vice President. Ma'am, you may begin.

[Kathleen Till Stange:]

Thank you. Good morning, and welcome to FBL Financial Group's conference call to discuss third quarter 2013 earnings. If you don't already have a copy, our earnings release and financial supplement may be found on our website at fblfinancial.com. Presenting on today's call are Jim Brannen, Chief Executive Officer; and Don Siebel, Chief Financial Officer. Also present and available to answer any questions you may have are John Currier, Chief Actuary; Charlie Happel, Chief Investment Officer; Rich Kypta, Chief Operating Officer; and Scott Stice, Chief Marketing Officer. Certain statements made today concerning FBL Financial Group's prospects for the future are forward-looking statements intended to qualify for the Safe Harbor from liability established by the Private Securities Litigation Reform Act. These statements involve certain risks and uncertainties that could cause actual results to differ materially from those expressed or implied in the forward-looking statements. These risks and uncertainties are detailed in FBL's reports filed with the SEC and are based on assumptions which FBL Financial Group believes to be reasonable. However, no assurance can be given that the assumptions will prove to be correct. You should not place undue reliance upon any forward-looking statements. FBL Financial Group 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 and our third quarter earnings release and our financial supplement, both of which may be found on our website. Today's call is being simulcast on FBL Financial Group's website. Shortly after today's call, you will find a transcript of today's prepared comments and an audio replay of the call. With that, it is now my pleasure to turn the call over to CEO, Jim Brannen.

[James Patrick Brannen:]

Thanks, Kathleen. Good morning, and welcome to everybody on the call. I want to thank you for taking time to join us today and for your interest in FBL Financial Group. During the third quarter, we completed several capital management actions, grew life insurance sales and delivered outstanding results. Net income was very strong at $1.04 per share and operating income was $1.02 per share. Don will be covering the financial results and the capital management actions in detail. Our emphasis on life insurance products continues to produce results. During the third quarter, life insurance premium collected increased 24%, for a year-to-date increase of 29%. We're seeing sales growth in all of our life products, but it has been particularly strong for our suite of universal life products. Last year, we enhanced our core universal life product by adding cash value accumulation. This aligned us better with the industry, as we made this product more competitive in situations where the client wants to put in excess premium. We're also seeing increased sales in our single pay universal life product, it's a wealth transfer product called Traditions UL. We attribute these increased UL sales in part to continued strength the ag and energy sectors of the economy in our marketplace. We're pleased with the level of life sales as they produce a long-term profit stream and allow us to continue to grow earnings from sources other than spread income. Annuity premium collected during the third quarter was down 5% and down 23% year-to-date, reflecting the emphasis on life sales. As you know, we deliberately reduced annuity sales through the suspension several quarters ago of our short-term deferred and immediate annuity products. However, with the recent rise in interest rates, we've have taken several actions to modestly increase annuity sales. We're emphasizing sales of products with low guaranteed crediting rates. We have also partially restored agent commissions that we previously lowered. We also completed a direct mail campaign to existing customers most likely to purchase an annuity. That's one of our cross-selling tactics that involves agent follow-up, which reinforces the agent relationship and the practice of our regular needs assessments. And finally, we had a special incentive campaign challenging our multiline agents to increase their annuity and life applications. We've taken these actions to increase annuity sales, but we are not yet ready to reintroduce our shorter term products. We are continuing to monitor the interest rate environment and are prepared to relaunch these products when the time is appropriate. Next, I want to discuss our recent investment acquisition strategies. During the year, we bolstered yields on new acquisitions while maintaining the high credit quality of our investment portfolio. We took advantage of market sector and interest rate volatility by being very tactical as the market environment changed through the year. Our average acquisition yield for Farm Bureau Life on a tax-adjusted basis in the third quarter was 5.52% and year-to-date was 4.80%. This excludes the securities supporting our Federal Home Loan Bank funding agreements. Earlier in the year, when long-term rates were extremely low, we emphasized shorter, structured products such as floating rate CLOs and non-agency mortgage-backed securities. We accomplished this through a combination of internal expertise and selected external mandates. As loan rates rose, we shifted our emphasis to long-dated corporate bonds and municipals. We are able to take advantage of historically extreme values that developed in the tax-exempt sector during the summer months, adding more than $190 million in tax-exempt securities, largely NAIC 1s, at an average yield of 5.06%. We've also been active in the commercial mortgage loans, and are on track to achieve our 2013 loan origination goal of more than $100 million. Our commercial mortgage loan portfolio continues to be of high quality with no delinquencies as of September 30, 2013. We've also invested in several low income housing tax credit funds and have added several high-yielding equity income investments. These actions cumulatively have helped bolster our overall yields. You'll notice, we added disclosures in our financial supplement on our equity income investments, particularly, our low income housing tax credit investments. This additional disclosure should be helpful in understanding the positive impact of these investments. In September, we held our annual Life Sales Seminar. We had a record attendance at the event, with more than 625 agents and sales associates. I'm excited and inspired after having spent time with these agents that self-select and pay their own way to attend the seminar. This is an annual event and an opportunity for agents to gather share sales ideas, meet with management and hear from industry experts and great speakers on topics ranging from product positioning to effective time management strategies. They learned about prospecting, explaining life insurance solutions, cross-selling and more, all to better protect livelihoods and futures of our customers. Our cross-sell rate continues to be industry-leading at 24%. According to LIMRA statistics, this is double the industry average. While we are industry-leading in this regard, we would see opportunity to -- for further growth as some of our territories have much higher rate than others. We continue to work to make sure cross-sell best practices are in place in all regions and that cross-selling is a strong part of our culture. This means we're making sure that we have the right training and development opportunities in place for all agents, the field leadership is accountable to cross-sell results and we have the proper tools in place. We know that customer satisfaction is higher for the customers who own a life product in addition to their property, casualty products, and account retention increases with additional product ownership. Agents who cross-sell are more successful as well, both from a production and retention perspective. Before I hand it over to Don, I want to mention that we recently held our annual review meeting with A.M. Best. Our desire is to have Farm Bureau Life rated at least A (Excellent). When A.M. Best increased Farm Bureau Life's outlook from positive -- to positive from stable in January this year, they communicated that in order for us have an upgrade in the future Farm Bureau Life needs to continue to demonstrate its positive trends in life sales, earnings and capital. We have done all of that. We're confident that the Farm Bureau Life meets, even exceeds, the requirements for an upgrade and we've made a strong case. So, we wait in anticipation of A.M. Best's decision, which we expect before the end of the year. In conclusion, I'm very pleased with FBL's results to date, including the capital management actions completed in third quarter and throughout the year. Farm Bureau Life's business is growing and we're making good progress on a host of internal investments and efficiency. I'm looking forward to a strong finish to the year. Now I'll turn the call over to Don Seibel for a review for our financial results. Don?

[Donald Joseph Seibel:]

Thanks, Jim, and good morning, everyone. I'm pleased to share with you today the details of our very strong third quarter results. I'll discuss our financial results, spreads and capital position. As Jim indicated, for the third quarter, we had net income of $1.04 per share and operating income of $1.02 per share. During the quarter, our operating income adjustments, which consist primarily of net realized gains on investments, totaled $0.02 per share. We had outstanding earnings results again this quarter. In addition to being driven by an increase in the volume of business in force, earnings for the quarter were positively impacted by several items. We experienced a one-time benefit of $0.07 per share from the refinement in the calculation of unearned revenue reserves on our universal Life secondary guarantee products. In future quarters, certain guaranteed products charges that were previously deferred and amortized into income over the lifetime of the contract will be recognized in income in the period assessed. This change in accounting resulted in a one-time increase interest to interest sensitive product charges of $6.3 million, an increase to the change in reserves of $2.5 million, and an increase to DAC amortization of $1 million. During the quarter, we continued to experience an elevated level of investment fee income, particularly in the annuity segment, but to some degree in the life insurance segment. In total, investment fee income for the quarter amounted to $0.05 per share. This fee income relates to mortgage loans and bond prepayments. While I expect this activity to slow at some point with rising interest rates, it has remained elevated for several quarters. The improved equity markets positively impacted separate account performance, resulting in lower DAC amortization for our variable products. This was a benefit of $0.02 per share and is included in our Corporate and Other segment where we report our closed block of variable business. If we were to exclude these various positive items, normalized operating earnings for the quarter would be around $0.88 per share. Results for the quarter also reflect mortality experience that was in line with expectations. At September 30, the point-in-time spread on our annuity business decreased from last quarter by 4 basis points to 215 basis points. However, this spread of 215 basis points is in excess of the target of 204 basis points for this business. We've been proactive about decreasing our crediting rates for this line of business and still have room for additional crediting rate changes. 38% of our annuity business is above the minimum guarantee with a significant portion at more than 100 basis points above the minimum. Of the block of annuities crediting interest at guarantee levels, 36% is still achieving or exceeding target spreads. Point-in-time spreads on our universal life business totaled 145 basis points at September 30, which is below our target of 163 basis points for this business for a deficiency of 18 basis points. During the quarter, we took crediting rate actions on several products, thereby narrowing this deficiency by 3 basis points. Approximately 36% of our universal life business is crediting interest at rates above the minimum guarantee, so we still have the latitude to manage crediting rates for a good portion of this business. Of the block of universal life business crediting interest at guarantee levels, 18% is still achieving or exceeding target spreads. Next, I'll comment on our recent capital deployment actions and our capital position. During the quarter, we were very active and completed a series of transactions that deployed more than $147 million of FBL's capital and reduced FBL's leverage ratio. First, we deployed $51 million of capital by paying a special dividend of $2 per share to shareholders of record as of September 6. Next, we executed a tender offer for 99% of our Class B common shares, which are only owned by the Farm Bureau entities. In order for voting interests to be maintained, all Class B shareholders had to either tender 99% of their class B shares or convert them to Class A. As a result, we repurchased 1,023,948 Class B shares for $46.4 million and several shareholders converted the 105,930 Class B shares to Class A shares. We also paid off affiliate debt of $50 million. This was scheduled to mature in May of 2015 and was pre-payable at par. This is positive as the interest we were paying on the debt, higher than our portfolio yield, so we have savings there. On top of these transactions, we also increased our regular quarterly dividend by 36% to $0.15 per share. We financed these actions in part with the $120 million dividend from Farm Bureau Life to the holding company. This dividend reduced Farm Bureau Life's company action level risk based capital ratio by roughly 100 points. However, Farm Bureau Life's RBC ratio remains very robust with an estimated RBC of 450% at September 30. These capital actions created a win-win situation for FBL and its shareholders. We were able to return excess capital to our shareholders, reduce our leverage ratio, reduce shares outstanding and, at the same time, increased FBL's public float. Collectively, these actions are accretive to operating income per share. We still have financial flexibility as there is more than adequate liquidity and capital at the holding company level with excess capital at the parent of approximately $80 million. In addition, using 425% RBC as a base, Farm Bureau Life has excess capital of approximately $30 million. To recap, FBL remains financially strong and the strategies we have in place for steady growth and profitability produced another quarter of strong earnings and shareholder value. I'm pleased to have been able to share these results and our plans with you. That concludes our prepared comments. We will now turn the call over to the operator and open it up to any questions you may have.

[Operator:]

[Operator Instructions] And our first question comes from Randy Binner from FBR Capital Markets.

[Randy Binner:]

I wanted to -- I need to clarify some of these one-timers, and I think, I got it, but the unearned revenue reserve was entirely within the life segment, is that correct? And is...

[Donald Joseph Seibel:]

Yes, that is correct.

[Randy Binner:]

Can you please explain, I'm not actually -- I'm not that familiar with that adjustment, what economically or kind of, in plain language -- what drove that adjustment?

[Donald Joseph Seibel:]

Sure. Well, for all of our universal life products bought for the universal life secondary guarantee price, we have per 1,000 charges that are applied. During the period, where the surrender charge is in effect and then the charge goes this -- the load goes away, GAAP tells you to defer that upfront revenue and amortize it over the life of the contact. Our universal life secondary guarantee product was accounted for in the same way, but the product is different in that the per 1,000 charges are guaranteed and they apply over the life of the contract. So, to defer those was not appropriate, so we corrected that. And that brought in those deferred revenues that we had deferred over the last several years, none of which impacted any quarter significantly, at all. This is a cumulative effect that we are correcting in this quarter. So product charges were increased $6.3 million and that runs through the life insurance segment in the line item entitled interest sensitive product charges. There is the reserve that set up related to the secondary guarantee, where it really matches the revenues and expenses, since we are recognizing this revenue in this quarter, that reserve goes up and that, actually, classified with death benefits under interest sensitive product benefits and that was $2.5 million. And then, because we had this increased profitability flow through the financial statements, we have higher DAC amortization and that was about $1 million. That all nets to about $2 million, you apply tax to that, that's a $1.8 million benefit that rolls through this quarter bottom line, and that translates to $0.07 per share.

[Randy Binner:]

But going back to the segment level, do you adjust the $2.8 million, I think, that's netting those numbers.

[Donald Joseph Seibel:]

Yes.

[Randy Binner:]

You have a core number of $11.5 million for life, is that right?

[Donald Joseph Seibel:]

Yes.

[Randy Binner:]

Which will be totaled, that will be a much more in line with normal expectations. Okay, thank you for that, and then with the investment fees, that $0.05, was that spread across investment income lines throughout the organization? Or is that mostly in the Corporate and Other area?

[Donald Joseph Seibel:]

There's about $450,000 of investment fee income that was in the life insurance segment, and about $1.8 million that was in the annuity segments, so the lion's share of the fee income was in the annuity segment.

[Randy Binner:]

Okay, its' good, all -- okay, on annuity, on life, that's helps with the one-timers, I guess, this question might come up too from the other guys, I mean, I guess, the capital management is very welcome, but you still had good margins there and I'm sure, Best will come through with that straight A rating, but I'm is there -- are you just kind of processing what you have done so far with the buyback? Or is there any thought to, like, what else you might think about doing and maybe layering into that if there's any new kind of growth opportunities you have organically?

[James Patrick Brannen:]

Yes, Randy, this is Jim. I would say, we still have a little bit of room on our buyback. We are going to continue to monitor opportunities in that space, currently don't see it is a big opportunity, so drastic actions there. We will continue to monitor that excess capital and think about how to handle that going forward. Right now, we're very pleased with the transactions we have just completed and there's nothing specific on the board other than a little bit of, I think, there's about $20 million left on our ability to do buybacks.

[Operator:]

Our next question comes from Robert Glasspiegel from Janney Capital Markets.

[Robert Glasspiegel:]

2 questions on -- on sort of core run rate. What is your interest expense going to be post the retirement of some of the debt?

[Donald Joseph Seibel:]

The only debt we will have on our books is the trust preferred securities, there's $97 million outstanding there, and that the rate on that is 5%, so a little under $5 million.

[Robert Glasspiegel:]

Okay. And the rate, remind me the rate on the old stuff that you retired.

[James Patrick Brannen:]

6.10%

[Donald Joseph Seibel:]

6.1%.

[Robert Glasspiegel:]

On $50 million?

[Donald Joseph Seibel:]

Yes.

[Robert Glasspiegel:]

Okay. So, all other things being equal, Corporates going to go down by $3 million, pre-tax, is that a fair? Or you see some other offset?

[Donald Joseph Seibel:]

On actuary, we are the getting $3 million. Oh, for the...

[Robert Glasspiegel:]

6% on 50?

[Donald Joseph Seibel:]

Okay. Fine. Yes.

[Robert Glasspiegel:]

Okay. And your accounting change on revenue recognition, it sounded like there's some implication in the future quarters as well, does it move?

[Donald Joseph Seibel:]

Yes, I did mention that there was no impact of any material nature in historically. And there isn't a material impact going forward, but we will be recognizing revenues quicker going forward and you will see interest sensitive product charges tick up $500,000 or so per quarter, but we will have reserve offsets to that and DAC offsets to that. So bottom line impact will not be that significant to the life insurance segment on a quarter-to-quarter basis.

[Robert Glasspiegel:]

So the cumulative catch-up is significant, but each quarter from now on immaterial? Is your...

[Donald Joseph Seibel:]

That's right.

[Robert Glasspiegel:]

Okay. And what should new -- I don't know if you gave this apologize, but if you did, but your new money yield in the quarter, compared to where it's been running? You benefited from the run-up in rates inter-quarter but we are sort of back down?

[James Patrick Brannen:]

Well, during the quarter the new money acquisition yield was 5.52%, which is tax-adjusted, there were municipal securities in there.

[Robert Glasspiegel:]

Okay. And How does that compare to, like previous quarters?

[James Patrick Brannen:]

Here today, we are at 4.80%, so that clearly was above what we've done in the first couple of quarters.

[Robert Glasspiegel:]

Okay. New money today is roughly, if you had to guess where that is now?

[Donald Joseph Seibel:]

Charlie, do you want to?

[Donald Joseph Seibel:]

We have been pretty quiet because we've moved through our cash -- we got -- we've given back meaningful amount on 10's from recent highs. It's really driven by the muni market, honestly, the availability and supply there, and we haven't done much in the last few weeks. We still think it's there. The deals we have seen unfortunately have been names we're already full on and so forth, so you could see a pretty meaningful swing in that depending on the availability of tax exempts, because that's -- if they're out there is still more stuff that is nominal close to 5, which grosses up north of 5, obviously, but if that paid the way on us then we're back to wherever the corporate bond market is. You know where that is obviously, so it's going to be a big swing, it will be hard to predict just pending supply in the tax-exempt space.

[Robert Glasspiegel:]

So Q3 helped on spread -- what your spread compression guidance was going to be in Q4. It will be a little bit less than which you thought was going to be going into the year?

[Donald Joseph Seibel:]

Yes, I would get our activities going to be -- where we are at in terms of GAAP balances so far, we are probably likely to be a little wider.

[Operator:]

[Operator Instructions] Our next question comes from Steven Schwartz from Raymond James.

[Steven D. Schwartz:]

I was actually discussing the unlocking of deferred front-end loans with another company, so I want to stick with this for just a second, Don, the per 1,000 charges that you cited, generally speaking, what are those for?

[Donald Joseph Seibel:]

Yes, it's a revenue component of the product and how it was designed. You can design a product where you get all of your margin from spreads, or you are going to set per 1,000 charges and this product has a combination source of the profits, which is good. We have some spread margin and then we also have the per 1,000 charges, in addition to positive insurance charges.

[Steven D. Schwartz:]

Okay. So here's where I'm getting a little bit lost here. Why does this affect benefits? My understanding was that the benefit expense for universal life policies, is basically, interest credit and the amount of death benefits that are paid out over the underlying account value. So why does this affect benefits?

[Donald Joseph Seibel:]

Yes, that's a good question. But this is our universal life secondary guarantee product, so there is a secondary guarantee benefit that we are expecting to pay out on some contracts. GAAP tells you to set up a reserve to pay those benefits in the future as opposed to account for those on a cash basis and it's really a complicated calculation with respect to looking at the future cash flows and discounting back and what not, but that's essentially what's running through the death benefit and other line, interest sensitive product charges and the setting up of that reserve and because there's a matching of revenues and expenses, just related to that secondary guarantee benefit, because we -- as I said earlier, because we have the additional revenue, we need to set up additional reserves, which increases that expense.

[Steven D. Schwartz:]

Okay, I will leave that there, and I will look forward to the transcript to understand that. By the way thank you for Page 17, I did want to follow-up on that slide, or that thing. Is there any reason to expect in the near-term -- because, Jim, you did mention, I didn't know if you are implying that you had bought more -- invested more in partnerships in the quarter, but is there a reason to suspect those line items to change significantly, and when I'm talking about here, is the OIHTC partnership income and the investment tax credit line in that?

[James Patrick Brannen:]

I will give a general answer and then, maybe I'll turn it over to Charlie to give a more specific one. I mean, at the day of our strategy, all your long has been to look at everything, keep the quality high, but look at things that maybe we normally wouldn't have looked at in a different environment, and the opportunities come to us in many different ways. Interestingly enough, being a midsize company, there is some tactical kind of things that we can do based on size biased some things that some companies are unwilling to spend the time on and other opportunities that we see. Whether we significantly increase any of these line items will really be based upon our overall objectives. The way that we look at things is on our relative value basis. How are they relative to their historical spreads, how are they relative to each other. So on a relative value basis, we could see one of these sectors heat up and we would probably step in if we got comfortable on the credit side. So, in general, these are still pretty small mandates, but not necessarily full-up on anything if it's the right relative value and, Charlie, I will see if you have anything to add.

[Charles Theodore Happel:]

I would say in specific reference to the litech, obviously, that blew out when Fannie and Freddie exited that phase. They were very dominant. So that will be yield out dramatically, and historically, we have been very active there. We have ramped-up fairly, aggressively, towards the level that was above target level, and I would say going forward, we are more incremental in terms of that allocation, just a little more yield sensitive, it's kind of waxed and waned a little bit over the last year, from being sufficient for our case, other BA assets, it's again -- it's going to -- there's other things we are looking at, but more incremental at this point pending, as Jim pointed out, it's sensible and how this is becoming compelling.

[Steven D. Schwartz:]

Okay, I guess, the question I was asking -- that was good. But the question I was asking was I gather this stuff fronts off over time, there's nothing running off any time soon?

[Donald Joseph Seibel:]

That's correct. These projects are still being funded. We have about $75 million investment currently, but the timing the tax credit can fluctuate depends upon the timing of the costs associated with project and then a portion of the residential units that are rented to low income housing tenants, but we don't expect to see great deal of volatility in the credits over the near-term.

[Charles Theodore Happel:]

We are still probably going to be kind of in a maintenance mode in terms of our allocation, as things rolling down, we are kind of back filling, but we are not expanding.

[Steven D. Schwartz:]

Okay. Great. And then one last thing Jim mentioned the -- that you had bought a bunch of muni, you took advantage, I guess, of [indiscernible] yields from Detroit. I think the yield that you cited was 5.03%, is that is a pretax yield?

[Charles Theodore Happel:]

Yes, year-to-date basis. We did -- in the third quarter, we bought like $72 million in tax exempts and about $14 million of taxable munis.

[Steven D. Schwartz:]

Okay. And historically, life insurance companies don't do this, but invest in this because you don't get the tax benefit, if I understand, but with the yields where they are, it didn't matter, is that the correct way to think about it?

[Donald Joseph Seibel:]

There's a haircut, so you don't get all the tax benefit. And, so when there is a sufficient demand, I guess, for the munis, with people that can use them completely, at least the whole tax benefit that kind of does price the life market out, but with their extreme wides, you can use part of the tax benefit company share -- and with the extreme wides they were still more compelling, a lot more compelling than the corporate bond market at that time.

[Operator:]

[Operator Instructions] And ladies and gentlemen, at this time, I'm showing no additional questions. I would like to turn the conference call back over 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 great day.

[Operator:]

Ladies and gentleman, that concludes today's conference call. We do thank you for attending. You may now disconnect.