AIZ Assurant Inc

We are reiterating our Neutral recommendation on the shares of Torchmark Corp. (TMK) following the second quarter 2011 results. The company posted core operating earnings of $1.14 per share, a dime ahead of the Zacks Consensus Estimate.

Torchmark markets its policies through different subsidiaries including Liberty National Life, American Income Life Insurance, United Investors Life Insurance, United American Insurance, as well as Globe Life and Accident Insurance.

The American Income subsidiary (Torchmark’s most profitable distribution system contributing roughly 34% of its total 2010 underwriting margin) has improved consistently over the last 10 years, with life premiums growing from $231 million to $561 million (a CAGR of 9.3%) and life underwriting margin increasing from $65 million to $186 million (a CAGR of 11.1%).

Over the last three years, the number of producing agents at the unit has surged 54% from 2,545 to 3,912 and net life sales have leaped 50% from $92 million to $138 million. However, the unit witnessed a 2% decline in life sales during the second quarter, preceded by a 7% drop in the first quarter, which marked the first decrease since the second quarter of 2006. Management is trying to combat the sales decline by increasing the number of producing agents and growing sales at the agency. These initiatives are progressing and would expectedly lead to a turnaround in sales during the second half of 2011. Given its niche in less competitive organized-labor market, we believe the unit can recapture its lost sales.

Life sales at Liberty National declined 18% year over year to $10 million in the second quarter and 19% to $45 million in 2010, after having increased 1% a year earlier. This agency had 2,001 producing agents at December 31, 2010 compared with 2,471 a year earlier, marking a decline of 19%. The agent count at Liberty had also declined year over year from 5,020 in 2009. The decrease in agent count has been partly due to the closing of several underperforming offices.

Furthermore, agent compensation issues that arose in 2009 impacted agent counts negatively. However, during 2010, the company focused on improving the underwriting margins at Liberty National. In addition to improving persistency, significant rate increases were implemented during the fourth quarter of 2010 in the life insurance portfolio. During the second quarter of 2011, these new incentives conserved $2.2 million life premium. Management currently projects the number to grow in the range of $15 million–$16 million during the second half of this year and in the range of $40 million–$45 million in 2012.

The direct response operation at Globe Life has also grown consistently. Life premiums over the last 10 years have increased from $268 million to $567 million at a 7.8% CAGR, while life underwriting margin have risen from $71 million to $145 million at a 7.4% CAGR. Direct response operation continues to perform consistently and should see better sales if the economy improves. The company expects 8% to 10% growth in life sales at its direct response channel.

However we notice that net sales, an important indicator of premium growth, is showing a downward trend. Net sales declined 4% in the first half of 2011. 2010 had witnessed a meager life net sales growth of 1%, a significant drop from a growth of 10% in 2009. Though this resulted from lower agent count and we believe that the Torchmark will be able to fix the problem by recruiting agents, we remain cautioned in the near term (at least one or two quarters). Thus, we expect a restrained growth in the life business at least over the near term.  

Also, earnings from Torchmark’s health operations have experienced intense competition in recent periods. This has resulted in a significant decline in agent counts, which in turn has caused lower sales of new health products. Health underwriting margins were flat at $170 million in 2010 after having declined $24 million or 12% in 2009. Health premium dropped 3% in 2010 after having declined 10% in 2009. Agent turnover has increased as lower premium and lower margin products offered by competitors have provided agents with products that are easier to sell. Turnover has also increased due to the company’s decision to de-emphasize the marketing of certain limited-benefit products. Sales of these de-emphasized products were discontinued altogether after September 2010. Medicare Supplement remains the largest contributor to total health premium; but, increased competition has also dampened sales of this product in recent years, resulting in premium declines in each successive year. The Medicare Part D premium declined 7% to $185 million in second quarter 2011 after having increased 14% in 2010 and 5% in 2009. However, as most of the country’s Part D enrollees selected a plan provider in 2006, no significant growth is expected in Part D business going forward. Nevertheless, management believes that after several years of decline, now the health sales have hit the bottom, and thus it anticipates a single-digit growth in new health sales for 2011.

Despite a difficult operating environment, Torchmark has maintained its capital management via share buyback and has returned wealth to shareholders in the form of dividend payment. Torchmark can be touted as a shareholder-friendly company as it has been actively increasing shareholders’ wealth through an ongoing buyback program since 1986. In August 2010, the company hiked its quarterly dividend by 7%. Its dividend yield of 1.18% supersedes the industry average of 1.08%. Though it had temporarily suspended its buyback activity since the first quarter of 2009 because of the uncertain economic environment, it reinstated the program in the first quarter of 2010. Over the last five years, the company has repurchased approximately 15% of its stock. The company has also been consistent in free cash flow generation. Considering $655 million of 2011 free cash flow expected at the parent company, we anticipate a continual buyback activity in 2011. During the first half of 2011, the company spent $602 million to purchase 14 million shares. This lies in the lower range of management’s buyback target of $600 million to $650 million for 2011, which was announced earlier.

Birmingham, Alabama-based Torckmark carries a Zacks Rank # 3, which translates into a ‘Hold’ recommendation over the short term (1-3 months). It competes with Unum Group (UNM), Aflac Inc. (AFL), and Assurant Inc. (AIZ).

 
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