We are reiterating our Neutral recommendation on the shares of the life and health insurer, Torchmark Corp. (TMK). Though we are optimistic about the company’s life insurance business, its underperforming health insurance business keeps us on the sidelines.
Torchmark distributes its Life and Health products primarily via its subsidiaries American Income Life Insurance Co. (“AIL”), Direct Response operation at Globe Life and Liberty National Life (“LNL”). While AIL and direct response have performed strongly over the last several years, LNL has lagged behind.
In the recently concluded quarter, AIL net life sales increased 11% on the back of a 12% increase in agents over the prior year. This was the result of the management’s aggressive actions to bring about a turnaround in sales.
These initiatives are progressing well, and for 2012 management is currently projecting 12%–14% growth. Given its niche in the organized labor market, where the competition is less, we believe the unit is uniquely poised to post increased sales.
Torchmark’s Globe Life also enjoys competitive advantage over its peers on account of an experienced team and effective cost control measures. While Direct Response continues to grow its traditional direct mail and insert media distribution, management is also trying to develop new distribution platforms like the Internet and social networking sites. The company expects a 6% growth in life sales at its Direct Response channel.
Torchmark is also aligning its business operations to focus on more profitable business lines. The company sold its subsidiary United Investors Life (UIL), which primarily marketed fixed and variable annuity products, generating low returns.
However, Torchmark’s subsidiary LNL has not been able to contribute meaningfully to the company earnings. Over the past 16 years, life premiums have grown by only $2 million. Moreover, the life underwriting margin in 2011 was $5 million lower than what it was 16 years ago. The underperformance of this channel was primarily due to its cost structure, which was characterized by high, fixed acquisition costs.
Though the company has taken a number of initiatives like changing the compensation structure as well as appointing new managers, the challenge to grow remains and we don’t expect this distribution channel to contribute meaningfully to the company’s earnings in the near term.
Its Health business also remains a weak spot. The lack of growth was due to discontinued sales of limited-benefit hospital-surgical health products in 2010 as well as due to a decline in agent count.
Though Medicare Supplement remains the largest contributor to total health premium, increased competition has dampened the sales of this product in recent years, resulting in premium declines in each successive year. We do not expect much growth from this segment as management continues to focus on growing its more profitable life business.
Despite the top-line pressure, we expect the company to manage its bottom-line earnings through its solid capital management strategy. With an expected free cash flow of $350–$360 million for 2012, we anticipate continual buyback activity, which would boost earnings.
Based in Birmingham, Alabama, Torchmark closely competes with Prudential Financial Inc. (PRU), Unum Group (UNM) and others. The stock currently retains a Zacks #3 Rank, which translates into a short-term Hold’ rating.
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