Horace Mann Educators Corp /De/ Q1 FY2024 Earnings Call

Good afternoon, and welcome to the Horace Mann Educators' First Quarter 2024 Investor Conference Call. I would now like to turn the conference over to Bret Conklin, Chief Financial Officer. Please proceed.

Thank you, and welcome to Horace Mann's discussion of our first quarter results. Yesterday, we issued our earnings release, 10-Q, investor supplement, and investor presentations. Copies are available on the Investors page of our website. Marita Zuraitis, President and Chief Executive Officer, and I will give the formal remarks on today's call. With us for Q&A, we have Matt Sharpe, Steve McAnena, Ryan Greenier, Mark Desrochers, and Mike Weckenbrock. Before turning it over to Marita, I want to note that our presentation today includes forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. The company cautions investors that any forward-looking statements include risks and uncertainties and are not guarantees of future performance. These forward-looking statements are based on management's current expectations, and we assume no obligation to update them. Actual results may differ materially due to a variety of factors, which are described in our news release and SEC filings. In our prepared remarks, we use some non-GAAP measures. Reconciliation of these measures to the most comparable GAAP measures is available in our investor supplement. And now I'll turn the call over to Marita.

Thanks, Bret, and welcome, everyone. Yesterday, we reported first quarter core earnings of $0.60 per diluted share, a nearly threefold increase from last year's first quarter, primarily due to the progress we've made in restoring P&C profitability. Total revenues were up 9%, and earned premiums and contract charges were up 8% over the prior year. These results reflect strong sales momentum in our retail division, led by a 35% increase in property and casualty sales premiums. We realized a dramatic improvement in the profitability of our P&C business and continued to benefit from the strength of our diversified business model built to meet the needs of educators and public sector employees. While net investment income on the managed portfolio was up 7% for the quarter, we saw a handful of real estate-related funds perform below target levels due to a mark-to-market valuation adjustment, consistent with the experience of the broader industry. This obscured some of the progress we are making in Life and Retirement and the Supplemental & Group Benefits segments. Brett will talk about the outlook for the individual segments later in the call, but at a high level, we remain confident in our 2024 full-year outlook of core EPS in the range of $3 to $3.30, net investment income closer to the lower end of the current range of $465 million to $475 million, and return on equity near 9%. Today, I would like to focus my remarks on the progress we're making across the business to reach the profitability targets and gain market share. First and foremost, we are making substantial progress towards restoring P&C segment profitability. Our reported first quarter P&C combined ratio of 99.9% was a 13 point improvement over the prior year. Combined with strong segment net investment income returns, this led to a first quarter segment profit of $11 million, a $22 million increase compared to a year ago. As an aside, first quarter catastrophe losses remain elevated. Industry losses exceeded the 10-year industry average and Horace Mann's first quarter losses also exceeded our 10-year and 5-year averages. However, when comparing quarter-over-quarter, our catastrophe and non-catastrophe losses were lower than the prior year. The majority of our combined ratio improvement is due to the successful execution of our multiyear profitability restoration strategy. From 2022 through the end of 2024, we expect our rate increases and non-rate underwriting actions to equate to total premium increases of nearly 40% in auto and nearly 50% in property. Despite these increases, policyholder retention has largely remained steady and consistent with our historically strong retention. We attribute this to our loyal customer base, our educator-specific benefits, and the overall value we provide. We strive to offer a fair price over the lifetime of a customer relationship, and we equip our agents with the information to explain the economic context to customers. Over the course of 2024, we are currently planning for a countrywide average of 10% to 15% rate increases in both auto and property. This plan includes recent approvals from California for a 22% increase in homeowners and a 13% increase in auto, both of which are now in effect. In addition, we expect an increase in property average renewal premium in the mid-single digits, attributable to higher home coverage values. We continuously review emerging trends and will adjust our rate plans as needed to ensure segment profitability. In the property line, we continue to roll out underwriting as well as terms and conditions changes to ensure we accurately price our risk. In particular, we have implemented new roof rating schedules and have received approval with effective dates within the next 90 days in 6 highly wind-prone states with filings pending in 3 additional states. These schedules set convective storm claim settlement rates that take into account the age and construction materials of roofs. When fully earned in, we expect about a 3-point impact on the property combined ratio. On a normalized basis, our Life and Retirement and Supplemental and Group Benefits segments are near or above target profitability. However, in the first quarter, segment earnings were impacted by lower-than-expected net investment income due to mark-to-market adjustments on 3 commercial mortgage funds and limited partnership real estate investments. This adjustment is valuation-driven and has not impacted our cash returns. The Life and Retirement segment remains a steady contributor to earnings and a strategically significant entry point to the education market. A core competency of our agency force is providing financial wellness and retirement planning workshops in schools across the country, building relationships as a trusted adviser with both educators and their employers. The Supplemental and Group Benefits segment is a less capital-intensive, higher-margin business that provides corporate earnings diversification. As we have talked about in the past, our target blended benefits ratio for this business is 43%, which takes into account pre-pandemic customer utilization levels. We are seeing the benefit ratio continue to trend towards this long-term target. This quarter, the benefit ratio was 36% compared to 33% a year ago. With our profitability targets within reach across the business, we are testing, adjusting, and scaling our strategies to grow educator households. Within the retail division, we are especially well prepared with strong momentum in our exclusive agency channel. The market has been challenging over the past few years, and we've worked with our agents to ensure their businesses remain healthy. Over the past year, we've seen a steady increase in exclusive agent recruiting, a 16% increase in average agency income, and a 22% increase in agency P&C premium production. Agent enthusiasm is strong, and we're seeing the impact in solid top line results. Looking ahead, our efforts are centered around supporting agency new business and cross-sell production, enhancing digital capabilities, and improving the effectiveness of our digital sales funnel to align with educator preferences. In general, educators want to do research and browse online. But when they are ready to buy, they are looking to talk to a trusted adviser. Let me provide a few examples. We have seen success with a hyper-local digital marketing program targeting educators. Through this and other programs, we have driven 15% more traffic to our website this year compared to last. In addition, we recently launched a new version of our website, which increased the number of quotes started by more than 50%. Over the past year, getting better leads to agents has helped contribute to an over 20% increase in new P&C business compared to the first quarter of 2023, and that's in an increasing rate environment. In the worksite division, we're building on our strong foundation to drive growth in both the employer-sponsored and worksite direct lines. We continue to refine and improve our product set to meet educator and employer expectations and to introduce product enhancements to our supplemental policy offerings. These enhanced features meet specific customer demand and provide higher average premiums. We are also seeing strong momentum in sales trends. We continue to add sales and enrollment headcount on the worksite direct side of the business. On the employer-sponsored side, we are working to leverage our existing broker partnerships to expand distribution. Since last year, we grew our number of covered lives to 836,000. Before I turn the call back to Brett, I want to touch on our efforts to have a positive impact on all of Horace Mann's stakeholders. We are in the midst of teacher appreciation week, but Horace Mann has planned events throughout the entire month of May to thank educators for everything they do. Centered around educators' desire for work-life balance, we're hosting contests, an exclusive virtual event for educators with celebrities, musicians, and self-care experts. Locally, we're announcing the winners of Springfield Public School, Educator and Administrator of the Year Awards. We also recently published our 2023 corporate social responsibility reporting, outlining the actions we've taken to support educators, our customers, our employees, our agents, and our local communities. A few highlights. We contributed nearly $1 million to charitable causes through the Horace Mann Educators Foundation and the Horace Mann Educators Corporation. We reduced our carbon emissions by 55% over the base year 2019, and we increased corporate transparency by publishing our U.S. Equal Opportunity Commission EEO-1 workforce data report. In March, our Board of Directors increased the quarterly shareholder dividend by 3%. This is the 16th consecutive year the Board has increased the shareholder dividend, underscoring our commitment to long-term shareholder value creation. In closing, by successfully executing on our strategic plans, we remain solidly on track to achieve our long-term goals, a larger share of the education market and a double-digit shareholder return on equity in 2025. Thanks. I'll now turn the call back over to Brett.

Thanks, Marita. First quarter core earnings were $24.8 million, or $0.60 per diluted share, a nearly threefold increase over the prior year. Our P&C profitability restoration strategy is making significant progress, and we remain on track to be within our full year 2024 core EPS guidance range of $3 to $3.30. Let me break down the results by individual business segment performance, starting with P&C. First quarter profit of $11 million was a $22 million improvement over the prior year. Net investment income was triple last year's returns due to solid performance in limited partnerships and higher yields on the fixed-income portfolio. Net written premiums rose more than 15% to $172 million, primarily due to the premium increases and underwriting actions we implemented over the past year. The reported combined ratio of 99.9% improved 13 points over the prior year. CAT losses added 9 points to the total combined ratio compared to nearly 15 points a year ago. In the first quarter, property claims services designated 19 events as CAT compared to 23 a year ago. As Marita mentioned earlier, from 2022 through the end of 2024, we expect total premium increases of nearly 40% in auto and 50% in property, which underscores our confidence that the P&C segment will be profitable for the full year as well as reaching our targeted combined ratio of 95% to 96% in 2025. Turning to auto, net written premiums of $117 million increased 15% over the prior year, primarily on rate actions. The combined ratio of 100.8% improved 10 points over the prior year. In terms of loss cost trends, we saw lower frequency likely attributable to milder winter weather, and severity was generally in line with expectations. Despite the higher premiums, policyholder retention remained strong at 87%. In property, net written premiums were $56 million, a 16% increase over the prior year. The combined ratio of 97.7% reflected lower non-CAT weather and CAT losses. Those CAT losses are slightly above our expectations as they are above our 5-year historic average. This is generally in line with the broader industry, which also experienced CAT losses above historical averages. Although property average written premiums were significantly higher, our policyholder retention remains strong at 90%. Turning to Life and Retirement, core earnings of $12 million were below prior year by 16% due to lower interest margins. While net investment income on the segment's fixed income and FHLB portfolios increased 4% due to higher reinvestment rates, returns on the commercial mortgage loan fund portfolio and limited partnerships were lower than both our expectations and prior year. This was due to negative returns in one commercial mortgage loan fund as well as 2 real estate equity limited partnerships. These same funds also impacted results in the Supplemental and Group Benefits segment. In the retirement business, net annuity contract deposits in total were down slightly at $105 million. However, deposits in our core 403(b) products remain strong. Over the first quarter, accounts on our fee-based mutual fund platform, Retirement Advantage, reached nearly 20,000. In addition, the market risk benefit adjustment in retirement was favorable. As Marita mentioned, our retirement products are a cornerstone of Horace Mann's value proposition and an important entry point to the education market. Annualized life sales increased 5% over the prior year. Mortality costs for the quarter were in line with the prior year and persistency remains strong at about 96%. In Supplemental and Group Benefits, earnings of $11 million were down from the prior year by $3 million due to a 14% lower net investment income and a 2.3 point increase in the benefits ratio. Premiums and contract charges earned were $64 million, down slightly from prior year, and sales of $7 million were down 20% from prior year. As a reminder, the employer-sponsored line sales are inherently lumpy, depending on case size. The sales comparison to the prior year is unfavorable, partially due to a large employer-sponsored sale in the first quarter of 2023. The long-term target for the blended benefits ratio is 43%, which assumes policyholder utilization reverts to pre-pandemic levels. In the first quarter, the benefits ratio was 36% compared to 33% a year ago. Historically, benefits usage in the employer-sponsored line is heaviest in the first quarter. Turning to investments, overall net investment income was up 5%, while returns on the managed portfolio were up 7%. Income on the fixed maturities portfolio was up 4% from the prior year, reflecting reinvestment rates that have exceeded portfolio yield for the past 8 quarters. Our core fixed income new money yield in the first quarter was 5.44%, a 124 basis points above the average portfolio yield and had an average duration of 7 years. The portfolio remains high quality at A+ and remains concentrated in investment-grade corporates, municipals, and high-quality agency and agency MBS securities, positioning us well for a potential recessionary environment without sacrificing income. Given the first quarter underperformance related to commercial mortgage loan and real estate-related limited partnership funds, we now expect full year net investment income on our managed portfolio to be closer to the low end of our guidance range of $360 million to $370 million. On a segment basis, P&C NII is ahead of expectations with Life and Retirement and Supplemental and Group Benefits below. In summary, we remain focused on long-term shareholder value creation. The year is off to a strong start with profit restoration and sales momentum taking center stage in the P&C segment. We continue to make solid progress toward our long-term objectives of an expanded market share and a double-digit shareholder return on equity in 2025. We are excited and optimistic about the future. Thank you. And operator, we're ready for questions.

We will now begin the question-and-answer session. Our first question comes from Meyer Shields with KBW.

First, Marita, in your comments, you talked about lower frequency attributable to benign weather in the winter. And I'm wondering whether for your book of business, we're seeing any impact from rising gasoline prices on frequency?

Yes, Meyer, this is Mark. I'll take that question. When we look at the first quarter, overall frequency is down from an action and frequency standpoint, about 3% or 4%. I would say one-third of that more or less is weather related. Probably about another third is actually some mix in underwriting changes that we've made. And when we look at the other third, we are seeing some reduced driving activity that we would attribute some of that lower frequency to. So I think that when you look at the weather impact, that's likely to not be recurring. I think the underwriting and mix actions, we expect that benefit to continue to roll through. In terms of the driving behavior, it's a little harder to predict what that will run for the rest of the year, but certainly, it had an impact in the first quarter.

Yes. When considering the weather activity in the first quarter, whether it involves us or others in the industry, the distinction between catastrophic and non-catastrophic events is often intriguing. It's uncertain how many incidents qualify as catastrophic based on the PCS definition, as opposed to those that don't fully meet that criteria. However, I agree with Mark regarding the overall frequency trends. We're not making any assumptions there, but we are certainly encouraged by what we're observing in the auto sector.

In terms of a follow-up, if some of these favorable trends continue, how quickly can you adjust the pricing strategy to possibly see 4 or 5 to 10 for price adequacy instead of 10 to 15 for a more competitive approach?

It's interesting. With our team of actuaries, we operate in real-time. Mark and his team take information from the first quarter, and as the first quarter of last year ends, the first quarter of this year begins. In this dynamic pricing environment we've had over the past couple of years, everything moves quickly. While some states have longer timelines, we were very pleased to get our rate filing approved in California, especially for auto insurance. Once that is approved, the team begins working on the next rate filing and evaluates how the data shifts as each quarter transitions. It's a real-time process. Mark, do you have any additional insights?

Yes, I would like to add a couple of points, Marita. First, in addition to monitoring our loss ratio and rate changes compared to competitors, we closely examine our close rates, specifically our success rate in issuing policies for every quote we provide. Even though some competitors have become more aggressive recently, we haven't observed any decline in our performance. Therefore, we don’t see any issues at this point. We have the flexibility to adjust our underwriting actions regarding which companies we offer new business quotes to. If necessary, we can adopt a more aggressive pricing approach or reduce the aggressiveness of our rate changes, and we anticipate that regulatory agencies will be somewhat more accommodating when we request rate increases.

Yes, Meyer, your questions seem to suggest whether we are ready for increased competition in the market. I truly believe we are prepared for that. We fully anticipate a rise in competition. From what I observe, our distribution dynamics are strong, and our EA plant is doing well. We have successfully hired new producers and retained those we’ve had for some time. We can offer a broader range of services than many competitors. Our retention rates are stable, and new business sales have risen by 35% in key areas. We are making sound investments, and I am confident that we are ready for future competition in property and casualty. Steve, would you like to add any details about new enhancements that are beginning to show positive results?

Yes, I'm happy to. I agree with the earlier comments regarding the health of our agency force and the sales momentum we've achieved. I'll provide some additional insights into what's going on. Marita mentioned agent recruiting in her opening remarks. This recruitment is having a significant impact now and is expected to have an even greater effect as we look ahead to 2025 and 2026. Our recruiting efforts this year are going very well; we've increased our internal recruiting staff and appointed about 70% more agents compared to last year. This is certainly strengthening our pipeline of agents. About half of our recruiting comes from referrals and educators. Marita discussed the quality of our hires, which shows we're bringing in individuals who truly understand their roles and our industry. We've experienced significant success with our appointed agents. Additionally, productivity has been driven primarily by increased activity, with nearly all new business growth stemming from more quotes. Conversion rates have remained relatively flat, indicating that our sales are being driven by activity rather than pricing. The increase in quotes is largely due to enhanced lead generation capabilities, which Marita highlighted. We have noticed a substantial rise in leads, and what excites me is that much of our current efforts haven't even been fully scaled yet. This suggests that we have promising growth opportunities that could be very beneficial moving forward. If I get into specifics on what we're doing to drive leads, I'll just give you two. One tactic that we've tested and has worked really well is co-branded marketing with education partners, which has been very successful. The other approach, without getting too technical, is the technology we use to tag and digitally market educators while they're at school, which has also yielded very effective results. We accomplish all this in partnership with our agents. Overall, we continue to add our agents, and agent productivity is increasing due to their activity. Lead volume is rising because of our digital marketing tests. The last thing I'll mention, reinforcing something from Marita's remarks, is our website. Our goal is to serve educators anytime and anywhere they need us. To support that objective, we made changes that simplified the design and streamlined some of the quoting process. I would say our lead generation efforts have shown good progress, with about a 50% increase in the number of quotes started, and I believe there is still room for improvement. We continue to make updates to the landing page almost every month to drive continuous improvement. In summary, we have been and will continue to invest in our agents and the ecosystem surrounding them to drive sustained profitable growth in support of all our educators. I am pleased with what we learned in the first quarter and look forward to building on this as we move through 2024 and beyond. Thank you for the question.

The next question is from John Barnidge with Piper Sandler.

My question is around Supplemental and Group Benefits distribution. I believe you called out in your prepared remarks a comp a year ago from a big win in the employer-sponsored space. Are there any occurring big wins from a year ago that will not be reoccurring and we should keep in mind? I know 3Q typically has heavy distribution with back-to-school.

John, thanks for the question. Thanks for the way you asked it. I think you, as usual, included the answer in your question. Due to the size of this business and the nature of the business, you said it yourself, it can be quite lumpy. I'll turn it over to Matt to see if he has any additional things that he wants to add, Matt?

Sure. I'm really excited about how the Supplemental and Group Benefits segment performed this quarter. We see a lot of growth potential for these businesses in the coming years. For the first quarter, overall sales were lower compared to last year, which is partly due to the unpredictable nature of the group business. Additionally, we had a slower start on the individual side, in part because of weather-related closures earlier this quarter. We hope that won’t happen again. On the group side, the year-over-year comparison had a 1/1 start date, but I don’t expect another one for the rest of the year. It was not a nonrenewal; it was actually a success from last year. The business tends to be unpredictable, so we could have a success later in the year that balances this out, but it’s hard to predict. Nevertheless, the momentum on the individual side remains very positive, and we are optimistic for the year. On the group side, we also maintain our optimism, keeping in mind that the business is variable, and a case or two can greatly affect our numbers.

Yes. Thanks, Matt. I mean we're getting the earnings diversification we planned. We remain very optimistic about the growth prospects. And when we look at the pipeline report, it's still quite robust.

My follow-up question, can you talk about your assumption around VII and the balance of the year and where your LP marks were concentrated, maybe from a sector perspective?

Sure, John. This is Ryan Greenier. Thanks for the question. As we said in our prepared remarks, the underperformance in the first quarter was real estate-related, and it was really driven by 3 specific funds. Two of them were real estate equity, and you saw valuation marks giving up some of the strong performance that we've seen in that space over the last couple of years. We're still ahead from an inception-to-date return perspective on those particular funds. And the CML fund that took a negative mark this quarter is one of our smaller funds. It plays more in the mezzanine lending space and had a handful of more recent vintage transitional multifamily properties that came in with some adverse valuations on the mortgage loans. We believe these are idiosyncratic. They're isolated. That's the nature of commercial real estate and real estate investments. Our overall outlook for LPs and CMLs for the remainder of the year suggests that we expect full-year returns for CMLs to fall below our historical averages due to a slow start. However, we are optimistic about the investment income diversification benefits of this asset class and the long-term value it offers. The core fixed income portfolio has shown strength, benefiting from sustained higher interest rates. We are investing at rates significantly better than what is maturing, which we find favorable. This trend has been evident for the past two years and has exceeded our initial expectations. Therefore, we believe we can recover some of the ground similar to our performance last year, where the first quarter had a negative return for LPs, but we ended up surpassing expectations. We'll see how things unfold; one quarter doesn't determine an annual trend, but I feel confident in our current positioning.

The next question is from Matt Carletti with Citizens JMP.

Actually, I want to follow up on the real estate fund question. Ryan, it sounds like you're pretty comfortable, but can you help us with maybe how many other, kind of, real estate-focused funds you're invested in if you feel that most of those are through the marks process, at least from where they stand now? Or if you do expect some further marks, are those in your annual guidance already?

Our allocations to commercial real estate are focused on the Life Retirement Supplemental and Group portfolios, which aligns with industry trends. Our overall exposure to commercial real estate is about 12% of the portfolio, with over 80% allocated to senior commercial mortgage loan funds. The average loan-to-value ratio remains solid at 71%. While we have observed some deterioration, we are still comfortable with the situation. The primary concern in the industry is the office sector. Our total office exposure is under $200 million, but we have taken more significant markdowns on our mortgage loans due to the decline in office valuations. To provide perspective, we've adjusted that portfolio to reflect roughly a 30% decrease in the underlying equity values of office properties. Estimates from NCREIF indicate a potential overall decline of about 35% for well-positioned Class A properties, which form the basis of our lending activities. So overall, we feel like right now, given our practice of marking these to market quarterly due to equity method of accounting, we feel like we've taken the bulk of our marks. We've stress tested the portfolio. We're comfortable with the outcomes. A lot of this is property-dependent and interest rate-dependent. As higher interest rates stay high, it prolongs the valuation pressure that the sector is experiencing. But like I said, we feel largely comfortable with where we were marked today, and we're monitoring office, in particular, very closely.

I just want to clarify something. When you mention achieving a sustainable double-digit ROE next year, is the denominator excluding fixed income realized gains and losses?

Yes. The only thing we take out of that, Matt, would be realized gain losses. So yes, it's a GAAP ROE metric.

The next question is from Greg Peters with Raymond James.

This is Sid on for Greg. Just wanted to go back to some of the comments on the P&C segment. And looking at risk in force, should we expect that to begin to grow over time, as the underwriting results get back to targeted levels? Or maybe I'm not looking at it correctly, so any comments you can provide there would be helpful.

No. Absolutely, we do. We talk about it a lot. I'm going to let Mark give you some detail on that.

Yes, sure. We've been originally projecting that we would expect to start to see substantial policy in force growth by early '26. I think with what we've seen with our new business momentum and the fact that our retention rates are actually holding better than we would have expected, given our normal kind of price elasticity equations, that we probably moved that up to somewhere between mid to late 2025 is when we'd expect to start to see, hopefully, meaningful growth.

And obviously, with coming quarters, second quarter, third quarter, if we continue to see sales like it is, up 35% in P&C and retention virtually holding certainly better than what we would put in our internal plans, that could also be sooner. But based on what we know right now, I agree with Mark that towards the end of 2025 is when you'd expect that to turn around.

I wanted to follow up on your comments about the benefits from product changes in property. Can you confirm if you anticipate realizing the full benefits in 2024, or if it might extend into 2025, before you mentioned a complete 3 points?

Right. I think Marita was referring to the roof schedule is probably the most substantial product change that we've made that we expect to drive that 3-point improvement. And as that earns its way in, we kind of expect maybe between a quarter and a third of that benefit in 2024, with most of the rest of it coming in 2025 and then just the very nature of the fact that homeowners' policy is at 12 months, some of it will work its way all the way into 2026 before it's fully earned.

This concludes our question-and-answer session. I would like to turn the conference back over to Bret Conklin for any closing remarks.

Just want to thank everyone for your participation on today's call, and we look forward to talking with everyone again next quarter. Thanks.

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