================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(MARK ONE)
[x] QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2001
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
Commission file number 1-10890
HORACE MANN EDUCATORS CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 37-0911756
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1 Horace Mann Plaza, Springfield, Illinois 62715-0001
(Address of principal executive offices) (Zip Code)
Registrant's Telephone Number, Including Area Code: 217-789-2500
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No ____
-----
As of April 30, 2001, 40,527,757 shares of Common Stock, par value $0.001
per share, were outstanding, net of 19,341,296 shares of treasury stock.
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HORACE MANN EDUCATORS CORPORATION
FORM 10-Q
FOR THE QUARTER ENDED MARCH 31, 2001
INDEX
Page
----
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
Independent Auditors' Review Report................................... 1
Consolidated Balance Sheets as of
March 31, 2001 and December 31, 2000................................ 2
Consolidated Statements of Operations for the
Three Months Ended March 31, 2001 and 2000.......................... 3
Consolidated Statements of Changes in Shareholders' Equity
for the Three Months Ended March 31, 2001 and 2000.................. 4
Consolidated Statements of Cash Flows for the
Three Months Ended March 31, 2001 and 2000.......................... 5
Notes to Consolidated Financial Statements............................ 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations................................. 13
Item 3. Quantitative and Qualitative Disclosures about Market Risk......... 27
PART II - OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders................ 27
Item 6. Exhibits and Reports on Form 8-K................................... 27
SIGNATURES........................................................................... 28
INDEPENDENT AUDITORS' REVIEW REPORT
The Board of Directors and Shareholders
Horace Mann Educators Corporation:
We have reviewed the consolidated balance sheet of Horace Mann Educators
Corporation and subsidiaries as of March 31, 2001 and the related consolidated
statements of operations, changes in shareholders' equity, and cash flows for
the three-month periods ended March 31, 2001 and 2000. These consolidated
financial statements are the responsibility of the Company's management.
We conducted our review in accordance with standards established by the
American Institute of Certified Public Accountants. A review of interim
financial information consists principally of applying analytical procedures to
financial data and making inquiries of persons responsible for financial and
accounting matters. It is substantially less in scope than an audit conducted
in accordance with auditing standards generally accepted in the United States of
America, the objective of which is the expression of an opinion regarding the
financial statements taken as a whole. Accordingly, we do not express such an
opinion.
Based on our review, we are not aware of any material modifications that
should be made to the consolidated financial statements referred to above for
them to be in conformity with accounting principles generally accepted in the
United States of America.
We have previously audited, in accordance with auditing standards generally
accepted in the United States of America, the consolidated balance sheet of
Horace Mann Educators Corporation and subsidiaries as of December 31, 2000, and
the related consolidated statements of operations, changes in shareholders'
equity, and cash flows for the year then ended (not presented herein); and in
our report dated February 8, 2001, we expressed an unqualified opinion on those
consolidated financial statements. In our opinion, the information set forth in
the accompanying consolidated balance sheet as of December 31, 2000, is fairly
stated, in all material respects, in relation to the consolidated balance sheet
from which it has been derived.
/s/ KPMG LLP
KPMG LLP
Chicago, Illinois
April 26, 2001
1
HORACE MANN EDUCATORS CORPORATION
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)
March 31, December 31,
2001 2000
---- ----
ASSETS
Investments
Fixed maturities, available for sale, at market (amortized
cost, 2001, $2,645,346; 2000, $2,615,156)...................................... $2,685,325 $2,607,738
Short-term and other investments................................................ 111,196 99,728
Short-term investments, loaned securities collateral............................ 324,740 204,881
---------- ----------
Total investments............................................................. 3,121,261 2,912,347
Cash............................................................................. 18,145 21,141
Accrued investment income and premiums receivable................................ 95,687 101,405
Value of acquired insurance in force and goodwill................................ 89,629 92,260
Deferred policy acquisition costs................................................ 140,719 141,604
Other assets..................................................................... 113,733 116,756
Variable annuity assets.......................................................... 934,721 1,035,067
---------- ----------
Total assets.................................................................. $4,513,895 $4,420,580
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Policy liabilities
Fixed annuity contract liabilities.............................................. $1,233,208 $1,217,756
Interest-sensitive life contract liabilities.................................... 490,384 481,140
Unpaid claims and claim expenses................................................ 307,261 308,881
Future policy benefits.......................................................... 180,810 180,049
Unearned premiums............................................................... 171,475 174,428
---------- ----------
Total policy liabilities...................................................... 2,383,138 2,362,254
Other policyholder funds......................................................... 122,530 122,233
Other liabilities................................................................ 456,012 324,312
Short-term debt.................................................................. 49,000 49,000
Long-term debt................................................................... 99,732 99,721
Variable annuity liabilities..................................................... 934,721 1,035,067
---------- ----------
Total liabilities............................................................. 4,045,133 3,992,587
---------- ----------
Preferred stock.................................................................. - -
Common stock..................................................................... 60 60
Additional paid-in capital....................................................... 338,096 338,243
Retained earnings................................................................ 465,065 452,624
Accumulated other comprehensive income (loss), net of taxes:
Net unrealized gains (losses) on fixed
maturities and equity securities............................................... 24,437 (4,038)
Minimum pension liability adjustment............................................ (937) (937)
Treasury stock, at cost.......................................................... (357,959) (357,959)
---------- ----------
Total shareholders' equity.................................................... 468,762 427,993
---------- ----------
Total liabilities and shareholders' equity.................................. $4,513,895 $4,420,580
========== ==========
See accompanying notes to consolidated financial statements.
2
HORACE MANN EDUCATORS CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollars in thousands, except per share data)
Three Months Ended
March 31,
-------------------
2001 2000
---- ----
Insurance premiums written and contract deposits................................. $207,772 $194,512
======== ========
Revenues
Insurance premiums and contract charges earned.................................. $149,917 $147,339
Net investment income........................................................... 48,763 47,508
Realized investment gains (losses).............................................. 4,684 (2,545)
-------- --------
Total revenues................................................................. 203,364 192,302
-------- --------
Benefits, losses and expenses
Benefits, claims and settlement expenses........................................ 107,777 103,211
Interest credited............................................................... 23,809 22,755
Policy acquisition expenses amortized........................................... 14,058 13,741
Operating expenses.............................................................. 29,494 29,205
Amortization of intangible assets............................................... 1,907 2,401
Interest expense................................................................ 2,524 2,511
-------- --------
Total benefits, losses and expenses............................................ 179,569 173,824
-------- --------
Income before income taxes....................................................... 23,795 18,478
Income tax expense............................................................... 7,097 5,752
-------- --------
Net income....................................................................... $ 16,698 $ 12,726
======== ========
Net income per share
Basic........................................................................... $ 0.41 $ 0.31
======== ========
Diluted......................................................................... $ 0.41 $ 0.31
======== ========
Weighted average number of shares
and equivalent shares (in thousands)
Basic.......................................................................... 40,524 41,156
Diluted........................................................................ 40,747 41,325
See accompanying notes to consolidated financial statements.
3
HORACE MANN EDUCATORS CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
(Dollars in thousands, except per share data)
Three Months Ended
March 31,
------------------
2001 2000
---- ----
Common stock
Beginning balance.......................................................... $ 60 $ 59
Options exercised, 2001, 10,000 shares;
2000, 505,000 shares; and shares
awarded, 2000, 10,000 shares.............................................. - 1
--------- ---------
Ending balance............................................................. 60 60
--------- ---------
Additional paid-in capital
Beginning balance.......................................................... 338,243 333,892
Options exercised and shares awarded....................................... 90 4,764
Catastrophe-linked equity put option premium............................... (237) (237)
--------- ---------
Ending balance............................................................ 338,096 338,419
--------- ---------
Retained earnings
Beginning balance.......................................................... 452,624 449,023
Net income................................................................. 16,698 12,726
Cash dividends, 2001, $0.105 per share;
2000, $0.105 per share.................................................... (4,257) (4,364)
--------- ---------
Ending balance............................................................. 465,065 457,385
--------- ---------
Accumulated other comprehensive income (loss), net of taxes:
Beginning balance.......................................................... (4,975) (40,016)
Change in net unrealized gains (losses) on
fixed maturities and equity securities).................................. 28,475 1,663
(Increase) decrease in minimum pension
liability adjustment..................................................... - -
--------- ---------
Ending balance............................................................. 23,500 (38,353)
--------- ---------
Treasury stock, at cost
Beginning balance, 2001, 19,341,296 shares;
2000, 18,258,896 shares;.................................................. (357,959) (342,816)
Purchase of 393,800 shares in 2000 (See note 4)............................ - (5,965)
--------- ---------
Ending balance, 2001, 19,341,296 shares;
2000, 18,652,696 shares................................................... (357,959) (348,781)
--------- ---------
Shareholders' equity at end of period....................................... $ 468,762 $ 408,730
========= =========
Comprehensive income
Net income................................................................. $ 16,698 $ 12,726
Other comprehensive income, net of taxes:
Change in net unrealized gains (losses)
on fixed maturities and equity securities................................ 28,475 1,663
(Increase) decrease in minimum pension
liability adjustment..................................................... - -
--------- ---------
Other comprehensive income............................................. 28,475 1,663
--------- ---------
Total................................................................. $ 45,173 $ 14,389
========= =========
See accompanying notes to consolidated financial statements.
4
HORACE MANN EDUCATORS CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
Three Months Ended
March 31,
---------------------------
2001 2000
---- ----
Cash flows from operating activities
Premiums collected.............................................. $ 161,789 $ 156,915
Policyholder benefits paid...................................... (123,478) (117,889)
Policy acquisition and other operating expenses paid............ (46,814) (43,214)
Federal income taxes paid....................................... - (1,600)
Investment income collected..................................... 49,438 51,503
Interest expense paid........................................... (4,148) (4,123)
Other........................................................... (287) (1,149)
---------- ----------
Net cash provided by operating activities..................... 36,500 40,443
---------- ----------
Cash flows used in investing activities
Fixed maturities
Purchases...................................................... (358,085) (101,166)
Sales.......................................................... 262,781 60,339
Maturities..................................................... 66,699 60,886
Net cash used for short-term and other investments.............. (7,094) (32,128)
---------- ----------
Net cash used in investing activities......................... (35,699) (12,069)
---------- ----------
Cash flows used in financing activities
Purchase of treasury stock...................................... - (5,965)
Dividends paid to shareholders.................................. (4,257) (4,364)
Principal repayments on Bank Credit Facility.................... - -
Exercise of stock options....................................... 90 4,765
Catastrophe-linked equity put option premium.................... (237) (237)
Annuity contracts, variable and fixed
Deposits....................................................... 58,952 48,216
Maturities and withdrawals..................................... (53,785) (84,665)
Net transfer from (to) variable annuity assets................. (3,484) 10,971
Net increase (decrease) in life policy account balances......... (1,076) (985)
---------- ----------
Net cash used in financing activities......................... (3,797) (32,264)
---------- ----------
Net increase (decrease) in cash.................................. (2,996) (3,890)
Cash at beginning of period...................................... 21,141 22,848
---------- ----------
Cash at end of period............................................ $ 18,145 $ 18,958
========== ==========
See accompanying notes to consolidated financial statements.
5
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2001 and 2000
(Dollars in thousands, except per share data)
Note 1 - Basis of Presentation
The accompanying unaudited consolidated financial statements of Horace Mann
Educators Corporation ("HMEC"; and together with its subsidiaries, the
"Company") have been prepared in accordance with the rules and regulations of
the Securities and Exchange Commission. Certain information and note disclosures
normally included in financial statements prepared in accordance with accounting
principles generally accepted in the United States of America have been
condensed or omitted. The Company believes that these financial statements
contain all adjustments (consisting of normal recurring accruals) necessary to
present fairly the Company's consolidated financial position as of March 31,
2001 and December 31, 2000 and the consolidated results of operations, changes
in shareholders' equity and cash flows for the three months ended March 31, 2001
and 2000.
The subsidiaries of HMEC sell and underwrite tax-qualified retirement
annuities and private passenger automobile, homeowners, and life insurance
products, primarily to educators and other employees of public schools and their
families. The Company's principal operating subsidiaries are Horace Mann Life
Insurance Company, Horace Mann Insurance Company, Teachers Insurance Company,
Horace Mann Property & Casualty Insurance Company (formerly Allegiance Insurance
Company) and Horace Mann Lloyds.
It is suggested that these financial statements be read in conjunction with
the financial statements and the related notes included in the Company's
December 31, 2000 Form 10-K.
The results of operations for the three months ended March 31, 2001 are not
necessarily indicative of the results to be expected for the full year.
Note 2 - Restructuring Charges
In December 2000, the Company recorded restructuring charges of $2,236
pretax ($1,453, or $0.04 per share, after tax) reflecting two changes in the
Company's operations. Specifically, the Company restructured the operations of
its group insurance business, thereby eliminating 39 jobs, and its credit union
marketing group, eliminating 20 additional positions. The changes will improve
business results and more closely align these functions with the Company's
strategic direction. Employee termination costs, for termination of an estimated
50 individuals, represented severance, vacation buy-out and related payroll
taxes. The eliminated positions encompass management, professional and clerical
responsibilities. As of March 31, 2001, 33 individuals have been terminated with
additional terminations scheduled later in 2001. Termination of lease agreements
represented office space used by the credit union marketing group. The remaining
charge was attributable primarily to the write-off of software related to these
two areas. Restructuring charges were separately identified in the Statement of
Operations for the year ended December 31, 2000. None of the cash restructuring
costs were paid as of December 31, 2000.
6
Note 2 - Restructuring Charges-(Continued)
The following table provides information about the components of the charge
taken in December 2000, the balance of accrued amounts at December 31, 2000 and
March 31, 2001, and payment activity during the three months ended March 31,
2001.
Original Reserve at Reserve at
Pretax December 31, March 31,
Charge 2000 Payments Adjustments 2001
-------- ------------ -------- ----------- ----------
Charges to earnings:
Employee termination
costs...................... $ 1,827 $ 1,827 $ 161 - $ 1,666
Termination of lease
agreements................. 285 285 52 - 233
Write-off of capitalized
software................... 106 - - - -
Other....................... 18 18 18 - -
-------- -------- -------- -------- --------
Total..................... $ 2,236 $ 2,130 $ 231 - $ 1,899
======== ======== ======== ======== ========
Note 3 - Debt
Indebtedness outstanding was as follows:
March 31, December 31,
2001 2000
--------- ------------
Short-term debt:
$65,000 Bank Credit Facility, commitment to
December 31, 2001. (IBOR + 0.325%,
5.0% as of March 31, 2001).......................... $ 49,000 $ 49,000
Long-term debt:
6 5/8% Senior Notes, due January 15, 2006
Face amount less unaccrued discount
of $268 and $279 (6.7% imputed rate)................. 99,732 99,721
--------- ---------
Total............................................... $ 148,732 $ 148,721
========= =========
7
Note 4 - Investments
The following table presents the composition and value of the Company's
fixed maturity securities portfolio by rating category. The Company has
classified the entire fixed maturity securities portfolio as available for sale,
which is carried at market value.
Percent of
Carrying Value March 31, 2001
-------------------------- ----------------------
Rating of Fixed March 31, December 31, Carrying Amortized
Maturity Securities(1) 2001 2000 Value Cost
---------------------- --------- ------------ ---------- ----------
AAA.................... 37.9% 42.9% $1,018,928 $ 990,674
AA..................... 7.7 8.2 205,802 196,261
A...................... 22.2 20.5 596,239 577,565
BBB.................... 25.9 22.8 695,108 695,179
BB..................... 1.8 1.3 47,863 50,155
B...................... 3.7 4.0 99,975 106,690
CCC or lower........... 0.6 0.1 15,154 21,583
Not rated(2)........... 0.2 0.2 6,256 7,239
----- ----- ---------- ----------
Total................ 100.0% 100.0% $2,685,325 $2,645,346
===== ===== ========== ==========
(1) Ratings are as assigned primarily by Standard & Poor's Corporation ("S&P")
when available, with remaining ratings as assigned on an equivalent basis
by Moody's Investors Service, Inc. ("Moody's"). Ratings for publicly traded
securities are determined when the securities are acquired and are updated
monthly to reflect any changes in ratings.
(2) This category includes $322 of publicly traded securities not currently
rated by S&P or Moody's and $5,934 of private placement securities not
rated by either S&P or Moody's. The National Association of Insurance
Commissioners (the "NAIC") has rated 98.0% of these private placements as
investment grade.
The following table presents a maturity schedule of the Company's fixed
maturity securities. Expected maturities will differ from contractual maturities
because borrowers may have the right to call or prepay obligations with or
without call or prepayment penalties.
Percent Carrying
of Total Value
------------------------ ----------
March 31, December 31, March 31,
Scheduled Maturity 2001 2000 2001
------------------ ----- ----- ----------
Due in 1 year or less........................... 4.8% 7.0% $ 128,476
Due after 1 year through 5 years................ 27.5 28.8 739,789
Due after 5 years through 10 years.............. 29.9 28.5 802,027
Due after 10 years through 20 years............. 15.0 15.6 402,275
Due after 20 years.............................. 22.8 20.1 612,758
----- ----- ----------
Total.......................................... 100.0% 100.0% $2,685,325
===== ===== ==========
The Company's investment portfolio includes no derivative financial
instruments (futures, forwards, swaps, option contracts or other financial
instruments with similar characteristics).
8
Note 4 - Investments-(Continued)
The Company loans fixed income securities to third parties, primarily major
brokerage firms. As of March 31, 2001 and December 31, 2000, fixed maturities
with a fair value of $324,740 and $204,881, respectively, were on loan. The
Company separately maintains a minimum of 100% of the value of the loaned
securities as collateral for each loan. Financial Accounting Standards Board
("FASB") Statement of Financial Accounting Standards ("SFAS") No. 125,
"Accounting for Transfers and Servicing of Financial Assets and Extinguishment
of Liabilities," requires the securities lending collateral to be classified as
investments with a corresponding liability included in Other Liabilities in the
Company's consolidated balance sheet.
Note 5 - Shareholders' Equity
Share Repurchase Programs
During the first three months of 2001, the Company did not repurchase shares
of its common stock under its stock repurchase program consistent with
management's stated intention to utilize excess capital to support the Company's
strategic growth initiatives. Since early 1997, 8,165,100 shares, or 17% of the
shares outstanding on December 31, 1996, have been repurchased at an aggregate
cost of $203,657, equal to an average cost of $24.94 per share. Including
shares repurchased in 1995, the Company has repurchased 33% of the shares
outstanding on December 31, 1994. The repurchase of shares was financed through
use of cash and, when necessary, the Bank Credit Facility. However, the Company
has not utilized the Bank Credit Facility for share repurchases since the second
quarter of 1999. As of March 31, 2001, $96,343 remained authorized for future
share repurchases.
Note 6 - Income Taxes
As previously reported, the Company has been contesting proposed additional
federal income taxes relating to a settlement agreement with the Internal
Revenue Service ("IRS") for prior years' taxes. In the third quarter of 1999,
the Company recorded an additional federal income tax provision of $20,000
representing the maximum exposure of the Company to the IRS with regard to the
issue for all of the past tax years in question (1994 through 1997). In 2000,
the Company reached a final resolution with the IRS for the tax years 1994, 1995
and 1996 in an amount that was $8,682 less than was previously accrued. That
amount was included in net income for the year ended December 31, 2000, $2,800
in the three months ended September 30, 2000 and $5,882 in the three months
ended December 31, 2000.
9
Note 7 - Reinsurance
The Company recognizes the cost of reinsurance premiums over the contract
periods for such premiums in proportion to the insurance protection provided.
Amounts recoverable from reinsurers for unpaid claims and claim settlement
expenses, including estimated amounts for unsettled claims, claims incurred but
not reported and policy benefits, are estimated in a manner consistent with the
insurance liability associated with the policy. The effect of reinsurance on
premiums written; premiums earned; and benefits, claims and settlement expenses
were as follows:
Ceded to Assumed
Gross Other from State
Amount Companies Facilities Net
------ --------- ---------- ---
Three months ended
March 31, 2001
----------------------
Premiums written...... $210,068 $6,150 $3,854 $207,772
Premiums earned....... 152,574 6,660 4,003 149,917
Benefits, claims and
settlement expenses.. 111,274 7,790 4,293 107,777
Three months ended
March 31, 2000
----------------------
Premiums written...... $195,990 $7,920 $6,442 $194,512
Premiums earned....... 148,743 5,762 4,358 147,339
Benefits, claims and
settlement expenses.. 105,338 6,674 4,547 103,211
The Company maintains an excess and catastrophe treaty reinsurance program.
The Company reinsures 95% of catastrophe losses above a retention of $8,500 per
occurrence up to $80,000 per occurrence for 52% of the coverage and above a
retention of $7,500 per occurrence up to $80,000 per occurrence for the
remaining 48% of the coverage. In addition, the Company's predominant insurance
subsidiary for property and casualty business written in Florida reinsures 90%
of hurricane losses in that state above a retention of $10,300 up to $50,300
with the Florida Hurricane Fund, based on the Fund's resources. These programs
are augmented by a $100,000 equity put and reinsurance agreement. This equity
put provides an option to sell shares of the Company's convertible preferred
stock with a floating rate dividend at a pre-negotiated price in the event
losses from catastrophes exceed the catastrophe reinsurance program coverage
limit. Before tax benefits, the equity put provides a source of capital for up
to $154,000 of catastrophe losses above the reinsurance coverage limit. For
liability coverages, including the educator excess professional liability
policy, the Company reinsures each loss above a retention of $500 up to $20,000.
The Company also reinsures each property loss, including catastrophe losses that
in the aggregate are less than the retention levels above, above a retention of
$250 up to $2,500.
The maximum individual life insurance risk retained by the Company is $200
on any individual life and $100 is retained on each group life policy. Excess
amounts are reinsured.
10
NOTE 8 - Contingencies
Lawsuits and Legal Proceedings
In December 2000, the Company recorded an after tax charge of $5,000,
representing the Company's best estimate of the actual and anticipated costs of
defending and ultimately resolving litigation brought against the Company in
regards to its disability insurance product. The lawsuit is on behalf of
certain policyholders who purchased the Company's disability insurance product
and allege that they were not adequately made aware of certain features. While
the actual costs for the Company to resolve this issue could be either less or
more than the liability established in 2000, management believes that, based on
facts and circumstances available at the time, the amount recorded will be
adequate to resolve the matter. Disability insurance represented less than 1%
of the Company's insurance premiums written and contract deposits for the year
ended December 31, 2000.
There are various other lawsuits and legal proceedings against the Company.
Management and legal counsel are of the opinion that the ultimate disposition of
such other litigation will have no material adverse effect on the Company's
financial position or results of operations.
Assessments for Insolvencies of Unaffiliated Insurance Companies
The Company is also contingently liable for possible assessments under
regulatory requirements pertaining to potential insolvencies of unaffiliated
insurance companies. Liabilities, which are established based upon regulatory
guidance, have been insignificant.
11
Note 9 - Segment Information
The Company conducts and manages its business through four segments. The
three operating segments representing the major lines of insurance business are:
property and casualty insurance, principally personal lines automobile and
homeowners insurance; individual tax-qualified annuity products; and life
insurance. The fourth segment, Corporate and Other, includes primarily debt
service and realized investment gains and losses. Summarized financial
information for these segments is as follows:
Three Months Ended
March 31,
-------------------
2001 2000
---- ----
Insurance premiums and contract charges earned
Property and casualty.......................... $ 123,183 $ 120,428
Annuity........................................ 3,786 4,358
Life........................................... 23,267 22,849
Intersegment eliminations...................... (319) (296)
---------- ----------
Total........................................ $ 149,917 $ 147,339
========== ==========
Net investment income
Property and casualty.......................... $ 9,027 $ 8,920
Annuity........................................ 26,659 26,177
Life........................................... 13,360 12,373
Corporate and other............................ 51 339
Intersegment eliminations...................... (334) (301)
---------- ----------
Total........................................ $ 48,763 $ 47,508
========== ==========
Net income (loss)
Operating income
Property and casualty......................... $ 7,864 $ 9,057
Annuity....................................... 4,229 5,387
Life.......................................... 3,951 2,977
Corporate and other, including interest
expense...................................... (2,391) (3,041)
----------- ---------
Total operating income...................... 13,653 14,380
Realized investment gains (losses), after tax.. 3,045 (1,654)
---------- ----------
Total....................................... $ 16,698 $ 12,726
========== ==========
Amortization of intangible assets
Value of acquired insurance in force
Annuity....................................... $ 1,031 $ 1,489
Life.......................................... 471 507
---------- ----------
Subtotal..................................... 1,502 1,996
Goodwill....................................... 405 405
---------- ----------
Total....................................... $ 1,907 $ 2,401
========== ==========
March 31, December 31,
2001 2000
---------- ----------
Assets
Property and casualty.......................... $ 753,742 $ 733,922
Annuity........................................ 2,670,243 2,639,872
Life........................................... 1,041,286 969,181
Corporate and other............................ 86,890 115,584
Intersegment eliminations...................... (38,266) (37,979)
---------- ----------
Total $4,513,895 $4,420,580
========== ==========
12
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Dollars in millions, except per share data)
Forward-looking Information
Statements made in the following discussion that state the Company's or
management's intentions, hopes, beliefs, expectations or predictions of the
future are forward-looking statements. It is important to note that the
Company's actual results could differ materially from those projected in such
forward-looking statements due to, among other risks and uncertainties inherent
in the Company's business, the following important factors:
. Changes in the composition of the Company's assets and liabilities through
acquisitions or divestitures.
. Prevailing interest rate levels, including the impact of interest rates on
(i) unrealized gains and losses on the Company's investment portfolio and
the related after-tax effect on the Company's shareholders' equity and total
capital and (ii) the book yield of the Company's investment portfolio.
. The impact of fluctuations in the capital markets on the Company's ability
to refinance outstanding indebtedness or repurchase shares of the Company's
outstanding common stock.
. The frequency and severity of catastrophes such as hurricanes, earthquakes
and storms, and the ability of the Company to maintain a favorable
catastrophe reinsurance program.
. Future property and casualty loss experience and its impact on estimated
claims and claim adjustment expenses for losses occurring in prior years.
. The Company's ability to develop and expand its agency force and its direct
product distribution systems, as well as the Company's ability to maintain
and secure product sponsorships by local, state and national education
associations.
. The competitive impact of new entrants such as mutual funds and banks into
the tax-deferred annuity products markets, and the Company's ability to
profitably expand its property and casualty business in highly competitive
environments.
. Changes in insurance regulations, including (i) those affecting the ability
of the Company's insurance subsidiaries to distribute cash to the holding
company and (ii) those impacting the Company's ability to profitably write
property and casualty insurance policies in one or more states.
. Changes in federal income tax laws and changes resulting from federal tax
audits affecting corporate tax rates or taxable income, and regulations
changing the relative tax advantages of the Company's life and annuity
products to customers.
. The Company's ability to maintain favorable claims-paying ability ratings.
. Adverse changes in policyholder mortality and morbidity rates.
. The resolution of legal proceedings and related matters.
13
Three Months Ended March 31, 2001 Compared To Three Months Ended March 31, 2000
The Horace Mann Value Proposition
In 2000, the Company's management announced steps to reenergize the
Company's core business and accelerate growth of the Company's revenues and
profits. These initiatives are intended to make the Company's products more
responsive to customer needs and preferences and expand the Company's product
lines within the personal financial services segment; grow and strengthen the
agent force and make the Company's agents more productive by improving the
products, tools and support the Company provides to them; increase cross-selling
and improve retention in the existing book of business; expand the Company's
penetration of targeted geographic areas and new segments of the educator
market; and broaden the Company's distribution options to complement and extend
the reach of the Company's agent force.
During the fourth quarter of 2000, management began implementing specific
plans that address the initiatives above. The Company has begun targeting high-
priority geographic markets with dedicated staff teams. New compensation and
evaluation systems are being implemented to improve the performance of the
Company's agents and agency managers. New approaches to customer service are
being developed and tested that will free agents to spend more time selling.
Additional distribution options are being examined to capitalize fully on the
value of the Company's payroll deduction slots in schools across the country.
And, the Company will increase its use of technology to improve the efficiency
of its agency force and its administrative operations.
The Horace Mann Value Proposition states the core of the Company's strategy
to reignite its growth: Provide lifelong financial well-being for educators and
their families through personalized service, advice and a full range of tailored
insurance and financial products.
Insurance Premiums and Contract Charges
Insurance Premiums Written and Contract Deposits
Three Months Ended Growth Over
March 31, Prior Year
----------------- ----------------
2001 2000 Percent Amount
-------- ------- ------- ------
Automobile and property (voluntary).. $117.4 $113.9 3.1% $ 3.5
Annuity deposits..................... 59.0 48.2 22.4% 10.8
Life................................. 28.6 29.1 -1.7% (0.5)
-------- ------- ------
Subtotal - core lines............. 205.0 191.2 7.2% 13.8
Involuntary and other
property & casualty................. 2.8 3.3 -15.2% (0.5)
-------- ------- ------
Total............................. $207.8 $194.5 6.8% $ 13.3
======== ======= ======
14
Insurance Premiums and Contract Charges Earned
(Excludes annuity and life contract deposits)
Three Months Ended Growth Over
March 31, Prior Year
------------------ ----------------
2001 2000 Percent Amount
------ ------ ------- ------
Automobile and property (voluntary).. $118.4 $115.3 2.7% $ 3.1
Annuity.............................. 3.8 4.4 -13.6% (0.6)
Life................................. 23.0 22.6 1.8% 0.4
------ ------ ------
Subtotal - core lines............. 145.2 142.3 2.0% 2.9
Involuntary and other
property & casualty............... 4.7 5.0 -6.0% (0.3)
------ ------ ------
Total............................. $149.9 $147.3 1.8% $ 2.6
====== ====== ======
Premiums written and contract deposits for the Company's core lines
increased 7.2% compared to the first three months of 2000, driven by double-
digit growth in the annuity segment. This comparison includes the North
Carolina settlement recorded in 2000 described below.
At March 31, 2001, the Company's exclusive agent force totaled 901, a 12.8%
decline from a year earlier. The number of experienced agents in the agent
force, 631, was down 6.5% at March 31, 2001, compared to a year earlier. The
total agent count decreased due primarily to terminations of less-productive
agents. As a result, overall agent productivity continues to increase. The
Company is in the process of changing what is expected from its agents.
Historically, agent compensation focus and rewards centered around
profitability, service and tenure with the Company. The new direction will
continue to focus on profitability but will also place a greater emphasis on
individual agent productivity, new premium growth, educator business, cross-
selling and business retention and will reward agents for aligning their goals
with the Company's goals. In addition, the Company's agency management team has
been strengthened through the promotions of several of its most experienced and
capable agents. Hiring of new agents during the first three months of 2001 was
ahead of the prior year's first quarter, in spite of the Company's
implementation of more stringent agent selection criteria to improve agent
productivity and retention in the future. A new compensation plan was effective
January 1, 2001 for agency managers, and the new compensation plan for all
agents will be implemented on August 1, 2001. Management believes these actions
along with other strategic initiatives will have a positive impact on agent
productivity in the future and will give every agent the opportunity to achieve
greater financial success while building a long-term relationship with the
Company.
In March 2000, following lengthy negotiations, the North Carolina Rate
Bureau and that state's Commissioner of Insurance agreed to settle the
outstanding 1994, 1996 and 1999 private passenger automobile insurance rate
filing cases resulting in an adverse impact of approximately $250 million for
the insurance industry. For the three months ended March 31, 2000, the Company
recorded an estimate of its portion of the adverse settlement of $2.5 million
pretax, comprised of $1.7 million premium refunds and $0.8 million interest
charges. North Carolina is the Company's second largest property and casualty
state representing approximately 7% of total premiums for the year ended
December 31, 2000.
15
Total voluntary automobile and homeowners premium written growth was 3.1%
for the first three months of 2001, including the effect of the North Carolina
settlement in the prior year. The average premium per policy increased for both
automobile and homeowners, as did the number of homeowners policies in force,
compared to a year earlier. The number of automobile policies in force was
slightly lower than year-earlier levels, but showed an increase as compared to
December 31, 2000. Automobile insurance premium increased 2.7% ($2.4 million)
compared to the first three months of 2000 and homeowners premium increased 4.6%
($1.1 million). The property and casualty increase in premiums written resulted
from growth in average premium per policy of 2% for automobile and 5% for
homeowners, compared to a year earlier. Over the prior 12 months, unit growth
was 0.5%, bringing policies in force at March 31, 2001 to 878,000. Compared to
December 31, 2000, total property and casualty policies in force increased 2,000
with a 1,000 unit increase in both homeowners and automobile.
Based on policies in force, the property and casualty 12-month retention
rate for new and renewal policies was 88%, equal to the 12 months ended March
31, 2000 despite implemented rate increases over the period. The Company's
plans to implement tiered rating systems for automobile and homeowners business
remain on track, which management expects will have a positive impact on both
loss ratios and business growth in the educator market. Tiered rating together
with price increases implemented and planned should return the Company to rate
adequacy with average premium growth keeping pace with average loss experience.
Growth in annuity contract deposits reached double-digit levels for the
three months ended March 31, 2001. In September 2000, the Company more than
tripled the number of choices available to its customers by introducing 21 new
investment options in its tax-deferred annuity product line. At the same time,
the Company provided its agents with proprietary asset allocation software that
helps agents assist educator customers in selecting the best retirement
investment programs for their individual needs and circumstances.
Compared to the first three months of 2000, new annuity deposits increased
22.4%, reflecting a 92.3% increase in new single premium and rollover deposits
and a 4.7% increase in scheduled deposits received. New deposits to variable
annuities decreased 1.6%, or $0.5 million, and new deposits to fixed annuities
were 69.8% higher than a year earlier. The Company offers a dollar cost
averaging program for amounts systematically transferred from the fixed annuity
option to the variable mutual fund investment options over a 12-month period.
Variable annuity accumulated funds on deposit at March 31, 2001 were $0.9
billion, $167.6 million less than a year earlier, a 15.2% decrease including the
impact of stock market values. Variable annuity accumulated deposit retention
decreased 1.5 percentage points over the 12 months to 86.3%. However, this
retention improved 2.2 percentage points compared to the 12 months ended
December 31, 2000 reflecting recent quarterly trends following the Company's
expansion of variable investment options and implementation of proprietary asset
allocation software. Fixed annuity cash value retention for the 12 months ended
March 31, 2001 was 89.4%, 1.7 percentage points lower than the same period last
year. However, reflecting recent quarterly trends, this showed improvement of
0.7 percentage points compared to retention of 88.7% for the 12 months ended
December 31, 2000. The number of annuity contracts outstanding increased 4.8%,
or 6,000 contracts, compared to March 31, 2000.
At March 31, 2001, approximately 71% of accumulated variable annuity funds
on deposit were in the Company's Equity and Balanced mutual funds. Investment
returns for these two funds have been less than their comparable Lipper average
returns in recent periods contributing to the higher level of surrenders in 2000
compared to 1999. In 2000, the Company took actions to
16
increase the variable annuity options available to customers, as described
above, and also took steps to improve the returns of its proprietary mutual
funds. For the three months ended March 31, 2001, the amount of variable annuity
surrenders was nearly 50% lower than for the same period last year.
Life segment premiums for the first three months of 2001 were 1.7% lower
than a year earlier, reflecting a decline in disability income business. In
2001, the Company began ceding a larger portion of the disability income
business as part of the group restructuring announced in the fourth quarter of
2000. Excluding this specific product from both years, life segment premiums
written and contract deposits would be 0.4% greater than the first quarter of
2000. The life insurance in force lapse ratio was 8.6% for the twelve months
ended March 31, 2001, compared to 8.7% for the same period last year.
Net Investment Income
Investment income of $48.8 million for the first three months of 2001
increased 2.7%, or $1.3 million, (2.5% after tax) compared to the prior year due
primarily to growth in the size of the investment portfolio. Average
investments (excluding the securities lending collateral) increased 1.1% over
the past 12 months. The average pretax yield on the investment portfolio was
7.1% (4.8% after tax) for the first three months of 2001, compared to a pretax
yield of 7.0% (4.7% after tax) last year.
Realized Investment Gains and Losses
Net realized investment gains were $4.7 million for the three months ended
March 31, 2001, compared to net realized investment losses of $2.5 million for
the first quarter of 2000. The net realized gains in the current period
primarily resulted from full repayment of an impaired commercial mortgage loan
and the release of a related reserve for uncollectible mortgages. For the prior
year, nearly all of the net realized gains and losses occurred in the fixed
income portfolios.
Benefits, Claims and Settlement Expenses
Three Months Ended Growth Over
March 31, Prior Year
------------------ ----------------
2001 2000 Percent Amount
------ ------ ------- ------
Property and casualty......... $ 96.2 $ 91.4 5.3% $ 4.8
Annuity....................... 0.2 - 0.2
Life.......................... 11.4 11.8 -3.4% (0.4)
------ ------ -----
Total........................ $107.8 $103.2 4.5% $ 4.6
====== ====== =====
Property and casualty
statutory loss ratio:
Before catastrophe losses.. 79.2% 73.7% 5.5%
After catastrophe losses... 78.1% 75.9% 2.2%
17
In the first three months of 2001, the Company's benefits, claims and
settlement expenses were affected favorably by a lower level of catastrophe
losses compared to a year earlier, but this was offset by a higher level of non-
catastrophe weather-related losses. Also, this year's first quarter results
reflected no net impact from prior years' property and casualty reserve changes,
compared to a net release of reserves a year ago.
Net favorable development of reserves for property and casualty claims
occurring in prior years, excluding involuntary business, was $0.3 million in
the first three months of 2001, compared to favorable development of $2.4
million for the same period in 2000, with the decline attributable to voluntary
automobile. Total reserves for property and casualty claims occurring in prior
years, including involuntary business, were unchanged for the current period,
compared to favorable development of $2.0 million in the first three months of
2000.
In the first three months of 2001, the higher level of non-catastrophe
property losses included claims attributable to severe winter weather
experienced in many areas of the country. The non-catastrophe property loss
ratio by quarter and for the full years 2000 and 1999 was as follows:
2001 2000 1999
---- ---- ----
Non-catastrophe property
loss ratio for the:
Quarter ended March 31............... 85.1% 79.0% 81.9%
Quarter ended June 30................ 91.4% 72.8%
Quarter ended September 30........... 82.8% 78.1%
Quarter ended December 31............ 80.7% 53.3%
Year ended December 31............... 83.4% 71.0%
After determining that the increase in non-catastrophe property losses
experienced in the early months of 2000 was due to underlying loss trends,
rather than the normal cyclicality of the property business, management began
and has continued to implement pricing, underwriting and loss control
initiatives. Although the Company's actions have begun to have a positive
impact, management expects that the full impact of these changes will not be
realized until well into 2001. Management anticipates that these actions will
enable the Company to improve the profitability of its existing book of
homeowners business and attract new business that meets its profitability
standards.
For the first three months of 2001, catastrophe losses for all lines
represented a net benefit of $1.4 million due to favorable development of
reserves for 2000 catastrophe losses. Incurred catastrophe losses were $2.6
million in the first quarter of 2000.
The voluntary automobile loss ratio excluding catastrophe losses was 76.0%
for the first quarter of 2001, 4.7 percentage points higher than for the same
period in 2000 due primarily to the amount of prior years' non-catastrophe
reserve releases in 2001 versus 2000, which represented approximately 3.5
percentage points of the increase in the non-catastrophe loss ratio. Also, on a
per-policy basis for the year, average voluntary automobile earned premium
increased 1% and average current accident year loss costs increased 3% compared
to the first three months of 2000.
18
The annuity benefits of $0.2 million recorded in the first three months of
2001 represented current period mortality experience on annuity contracts on
payout status.
Life mortality experience was somewhat lower in the first three months of
2001 compared to the same period in 2000.
Interest Credited to Policyholders
Three Months Ended Growth Over
March 31, Prior Year
------------------ ----------------
2001 2000 Percent Amount
----- ----- ------- ------
Annuity................ $16.9 $16.5 2.4% $0.4
Life................... 6.9 6.3 9.5% 0.6
----- ----- ----
Total................. $23.8 $22.8 4.4% $1.0
===== ===== ====
The fixed annuity average annual interest rate credited increased to 5.2%
for the three months ended March 31, 2001, compared to 5.0% for the same period
last year. Tempering this increase was a 0.7% decrease in the average
accumulated fixed deposits for the first three months of 2001, compared to the
same period in 2000. Life insurance interest credited increased as a result of
continued growth in the interest-sensitive life insurance reserves.
Operating Expenses
For the first three months of 2001, operating expenses increased $0.3
million, or 1.0%, compared to last year. First, operating expenses for the
current period included increased costs to support business growth initiatives.
Second, in the fourth quarter of 2000 the Company increased its capitalization
threshold for software costs. Third, expenses in the first quarter of 2000
included non-recurring charges of $0.8 million for interest on the North
Carolina settlement and $0.7 million attributable to the chief executive officer
transition.
The total corporate expense ratio on a statutory accounting basis was 22.0%
for the three months ended March 31, 2001, 1.0 percentage point less than the
same period in 2000. The property and casualty expense ratio, the 14th lowest
of the 100 largest property and casualty insurance groups for 1999 (the most
recent industry ranking available), was 21.0% for the three months ended March
31, 2001, compared to 20.6% last year.
Amortization of Policy Acquisition Expenses and Intangible Assets
For the first three months of 2001, the combined amortization of policy
acquisition expenses and intangible assets of $16.0 million was comparable to
the $16.1 million recorded in the same period in 2000.
Amortization of intangible assets decreased to $1.9 million for the three
months ended March 31, 2001, compared to $2.4 million for the same period in
2000. The decline reflected the lower level of amortization of the value of
annuity business acquired in the 1989 acquisition of the Company ("Annuity VIF")
consistent with the scheduled amortization reported in the Company's Form 10-K
for the year ended December 31, 2000.
19
Policy acquisition expenses amortized for the three months ended March 31,
2001 of $14.1 million were $0.4 million greater than the same period last year
reflecting a slight increase in the annuity segment.
Income Tax Expense
The effective income tax rate on income including realized investment gains
and losses was 29.8% for the three months ended March 31, 2001, compared to
31.4% for the same period last year.
Income from investments in tax-advantaged securities reduced the effective
income tax rate 5.1 and 5.9 percentage points for the three months ended March
31, 2001 and 2000, respectively.
Operating Income
For the first three months of 2001, operating income (net income before the
after-tax impact of realized investment gains and losses) was comparable to a
year ago. Management anticipates that 2001 full year operating income will be
within a range of $1.00 to $1.20 per share and believes that first quarter 2001
results were in line with that estimate.
Operating income for the current period benefitted from lower catastrophe
losses compared to a year ago, but this benefit was offset by a higher level of
non-catastrophe weather-related losses. Also, operating income for the first
quarter of 2001 reflected no net impact from prior years' property and casualty
reserve changes, compared to a net release of reserves a year ago. Operating
income for the first quarter of 2000 reflected a non-recurring charge of $1.7
million after tax related to the first quarter settlement of private passenger
automobile rate filing cases in North Carolina.
Operating income by segment was as follows:
Three Months Ended Growth Over
March 31, Prior Year
-------------------- ---------------------
2001 2000 Percent Amount
------ ------ ----------- ------
Property & casualty
Before catastrophe losses................... $ 7.0 $10.7 -34.6% $(3.7)
Catastrophe losses, after tax............... 0.9 (1.7) 2.6
------ ----- -----
Total including catastrophe losses....... 7.9 9.0 -12.2% (1.1)
Annuity...................................... 4.2 5.4 -22.2% (1.2)
Life......................................... 4.0 3.0 33.3% 1.0
Corporate and other expense.................. (0.8) (1.4) 0.6
Interest expense, after tax.................. (1.6) (1.6) -
------ ----- -----
Total.................................... $ 13.7 $14.4 -4.9% $(0.7)
====== ===== =====
Total before catastrophe losses.......... $ 12.8 $16.1 -20.5% $(3.3)
====== ===== =====
Property and casualty
statutory combined ratio:
Before catastrophe losses................. 100.2% 94.3% 5.9%
After catastrophe losses.................. 99.1% 96.5% 2.6%
20
Property and casualty segment operating income was lower than in the first
three months of 2000 due primarily to prior years' reserve releases of $1.3
million after tax in 2000, compared to no net impact from prior years' reserves
in the current period. As discussed above, lower catastrophe losses in the
current period were offset by a higher level of non-catastrophe weather-related
losses. During the first three months of 2001, the Company's average voluntary
automobile insurance premium per policy increased 1% while average loss costs
increased 3%, compared to the prior year. The Company's plans to implement
tiered rating systems for automobile and homeowners business remain on track,
which management expects will have a positive impact on both loss ratios and
business growth for these products in the Company's target market. An adverse
industry settlement of outstanding automobile insurance rate filing cases for
1994, 1996 and 1999 in North Carolina, including interest, reduced the Company's
property and casualty segment operating income by $1.7 million after tax in the
first quarter of 2000.
The property and casualty combined ratio before catastrophes of 100.2% was
5.9 percentage points higher than the first three months of 2000, reflecting the
factors cited above. The net benefit from catastrophe losses in the first three
months of 2001 included favorable development of reserves for 2000 catastrophe
losses. Favorable development of reserves for property and casualty claims
occurring in prior years, excluding involuntary business, was $0.2 million after
tax in the first three months of 2001, compared to favorable development of $1.6
million after tax for the same period in 2000. The current period reflected no
net impact from total reserves, including involuntary business, for property and
casualty claims occurring in prior years, compared to favorable development of
$1.3 million after tax last year representing 1.7 percentage points of the
increase in the combined ratio including catastrophes.
Annuity segment operating income was below the year-earlier total as a
result of reduced fee income related to decreases in both variable annuity
market values and surrender charges for fixed and variable annuities. In
addition, operating expenses increased in the current period, reflecting the
growth in annuity business volume. For the first three months of 2001, the net
interest margin was equal to the prior year and fees and contract charges earned
decreased 13.6%. Variable annuity accumulated deposits were $0.9 billion at
March 31, 2001, $167.6 million, or 15.2%, less than 12 months earlier. Fixed
annuity accumulated cash value of $1.3 billion was $5.0 million, or 0.4%,
greater than March 31, 2000.
Life insurance earnings increased compared to the first three months of
2000 due to an increase in margins and mortality costs that were somewhat lower
than in the prior year.
In the first quarter of 2000, the Corporate and Other Expense category in
the preceding table reflected higher holding company expenses, including charges
related to the chief executive officer transition.
21
Net Income
Net Income Per Share, Diluted
Three Months Ended Growth Over
March 31, Prior Year
------------------- ---------------------
2001 2000 Percent Amount
----- ------ ----------- ------
Operating income.................... $0.34 $ 0.35 -2.9% $(0.01)
Realized investment gains (losses).. 0.07 (0.04) 0.11
----- ------ ------
Net income......................... $0.41 $ 0.31 32.3% $ 0.10
===== ====== ======
Net income, which includes realized investment gains and losses, for the
first three months of 2001 increased by $4.0 million, or 31.5%, and net income
per diluted share increased by 32.3% compared to the same period in 2000. This
change includes the $0.7 million decline in operating income offset by $3.0
million of after tax realized investment gains for the first three months of
2001, compared to $1.7 million of after tax realized investment losses in the
same period last year.
Return on shareholders' equity based on both operating income and net
income was 6% for the 12 months ended March 31, 2001.
Liquidity and Financial Resources
Investments
The Company's investment strategy emphasizes investment grade, publicly
traded fixed income securities. At March 31, 2001, fixed income securities
represented 96.0% of investments excluding the securities lending collateral. Of
the fixed income investment portfolio, 93.7% was investment grade and 99.8% was
publicly traded. The average quality of the total fixed income portfolio was A+
at March 31, 2001.
The duration of the investment portfolio is managed to provide cash flow to
satisfy policyholder liabilities as they become due. The average option adjusted
duration of total investments was 4.7 years at March 31, 2001 and 4.4 years at
December 31, 2000. The Company has included in its annuity products substantial
surrender penalties to reduce the likelihood of unexpected increases in policy
or contract surrenders. All annuities issued since 1982 and approximately 78% of
all outstanding fixed annuity accumulated cash values are subject in most cases
to substantial early withdrawal penalties.
Cash Flow
The short-term liquidity requirements of the Company, within a 12-month
operating cycle, are for the timely payment of claims and benefits to
policyholders, operating expenses, interest payments and federal income taxes.
Cash flow in excess of these amounts has been used to fund business growth,
retire short-term debt, pay dividends to shareholders and repurchase shares of
the Company's common stock. Long-term liquidity requirements, beyond one year,
are principally for the payment of future insurance policy claims and benefits
and retirement of long-term notes.
22
Operating Activities
As a holding company, HMEC conducts its principal operations in the personal
lines segment of the property and casualty and life insurance industries through
its subsidiaries. HMEC's insurance subsidiaries generate cash flow from premium
and investment income, generally well in excess of their immediate needs for
policy obligations, operating expenses and other cash requirements. Cash
provided by operating activities primarily reflects net cash generated by the
insurance subsidiaries. Net cash provided by operating activities was
approximately $4 million less than the first three months of 2000.
Payment of principal and interest on debt, fees related to the catastrophe-
linked equity put option and reinsurance agreement, dividends to shareholders
and parent company operating expenses, as well as the share repurchase program,
are dependent upon the ability of the insurance subsidiaries to pay cash
dividends or make other cash payments to HMEC, including tax payments pursuant
to tax sharing agreements. The insurance subsidiaries are subject to various
regulatory restrictions which limit the amount of annual dividends or other
distributions, including loans or cash advances, available to HMEC without prior
approval of the insurance regulatory authorities. Dividends which may be paid by
the insurance subsidiaries to HMEC during 2001 without prior approval are
approximately $42 million. Although regulatory restrictions exist, dividend
availability from subsidiaries has been, and is expected to be, adequate for
HMEC's capital needs.
Investing Activities
HMEC's insurance subsidiaries maintain significant investments in fixed
maturity securities to meet future contractual obligations to policyholders. In
conjunction with its management of liquidity and other asset/liability
management objectives, the Company, from time to time, will sell fixed maturity
securities prior to maturity and reinvest the proceeds in other investments with
different interest rates, maturities or credit characteristics. Accordingly, the
Company has classified the entire fixed maturity securities portfolio as
available for sale.
Financing Activities
Financing activities include primarily repurchases of the Company's common
stock, payment of dividends, the receipt and withdrawal of funds by annuity
contractholders and borrowings and repayments under the Company's debt
facilities. Fees related to the catastrophe-linked equity put option and
reinsurance agreement, which augments its other reinsurance program, have been
charged directly to additional paid-in capital.
For the first three months of 2001, receipts from annuity contracts
increased 22.4%. Annuity contract maturities and withdrawals decreased $30.9
million, or 36.5%, compared to the same period last year, including decreases of
48.7% and 28.9% in surrenders of variable and fixed annuities, respectively.
Reflecting continued improvement in recent quarterly trends, cash value
retention for variable and fixed annuities was 86.3% and 89.4%, respectively,
for the 12 month period ended March 31, 2001. Net transfers to variable annuity
assets increased $14.5 million compared to the same period last year reflecting
the Company's expansion of its variable investment options.
23
The Company did not repurchase shares of its common stock under its stock
repurchase program during the first three months of 2001, consistent with
management's stated intention to utilize excess capital to support the Company's
strategic growth initiatives. In the first three months of 2000, 393,800 shares
were repurchased at an aggregate cost of $6.0 million. The repurchase of shares
was financed through use of cash and, when necessary, the Bank Credit Facility.
However, the Company has not utilized the Bank Credit Facility for share
repurchases since the second quarter of 1999. As of March 31, 2001, $96.3
million remained authorized for future share repurchases.
Capital Resources
The Company has determined the amount of capital which is needed to
adequately fund and support business growth, primarily based on risk-based
capital formulas including those developed by the National Association of
Insurance Commissioners ("NAIC"). Historically, the Company's insurance
subsidiaries have generated capital in excess of such needed capital. These
excess amounts have been paid to HMEC through dividends. HMEC has then utilized
these dividends and its access to the capital markets to service and retire
long-term debt, increase and pay dividends to its shareholders, fund growth
initiatives, repurchase shares of its common stock and for other corporate
purposes. Management anticipates that the Company's sources of capital will
continue to generate capital in excess of the needs for business growth, debt
interest payments and shareholder dividends.
The NAIC has codified statutory accounting practices, which are expected to
constitute the only source of prescribed statutory accounting practices and were
effective January 1, 2001. Codification changed prescribed statutory accounting
practices and resulted in changes to the accounting practices that insurance
enterprises use to prepare their statutory financial statements. The states of
domicile of the Company's principal operating subsidiaries, Illinois, California
and Texas, have adopted the NAIC's codification. As a result of adopting the
NAIC codification, the Company's statutory surplus of its insurance subsidiaries
increased approximately $19 million.
The total capital of the Company was $617.5 million at March 31, 2001,
including $99.7 million of long-term debt and $49.0 million of short-term debt.
Total debt represented 25.1% of capital (excluding unrealized investment losses)
at March 31, 2001, which was at the upper end of the Company's target operating
range of 20% to 25%.
Shareholders' equity was $468.8 million at March 31, 2001, including an
unrealized gain in the Company's investment portfolio of $24.4 million after
taxes and the related impact on deferred policy acquisition costs and the value
of acquired insurance in force associated with annuity and interest-sensitive
life policies. The market value of the Company's common stock and the market
value per share were $717.3 million and $17.70, respectively, at March 31, 2001.
Book value per share was $11.57 at March 31, 2001, $10.97 excluding investment
market value adjustments. At March 31, 2000, book value per share was $9.93,
$10.86 excluding investment market value adjustments. The increase over the 12
months included the effects of unrealized investment gains and losses and share
repurchases. Excluding these items, book value per share was approximately equal
to a year earlier.
In January 1996, the Company issued $100.0 million face amount of 6 5/8%
Senior Notes ("Senior Notes") at a discount of 0.5% which will mature on January
15, 2006. Interest on the Senior Notes is payable semi-annually. The Senior
Notes are redeemable in whole or in part, at any time at the Company's option.
The Senior Notes have an investment grade rating from
24
Standard & Poor's Corporation ("S&P") (A-), Fitch, Inc. ("Fitch") (A), and
Moody's Investors Service, Inc. ("Moody's") (Baa1) and are traded on the New
York Stock Exchange (HMN 6 5/8). As a result of factors impacting the Company's
earnings for the three months ended December 31, 2000, S&P placed the Company's
debt rating on "CreditWatch with negative implications" and Fitch placed the
Company's debt rating on "Rating Watch Negative". Moody's issued a statement
affirming their rating. In April 2001, Fitch reaffirmed their "A" rating and
identified the outlook for the rating as "Stable". Management has met with
representatives from S&P and anticipates that the CreditWatch status will be
resolved in the second quarter of 2001, based on further analysis of the 2000
year-end financial statements and supplemental data.
As of both March 31, 2001 and December 31, 2000, the Company had short-term
debt of $49.0 million outstanding under the Bank Credit Facility. The Bank
Credit Facility allows unsecured borrowings of up to $65.0 million at Interbank
Offering Rates plus 0.3% to 0.5% or Bank of America National Trust and Savings
Association reference rates. The rate on the borrowings under the Bank Credit
Facility was Interbank Offering Rate plus 0.3%, or 5.0%, as of March 31, 2001.
The commitment for the Bank Credit Facility terminates on December 31, 2001. The
Company anticipates entering into a replacement bank credit facility prior to
the end of 2001 and does not expect material difficulties in doing so.
The Company's ratio of earnings to fixed charges for the three months ended
March 31, 2001 was 10.5x compared to 8.4x for the same period in 2000.
Total shareholder dividends were $4.3 million for the three months ended
March 31, 2001. In February 2001, the Board of Directors announced a regular
quarterly dividend of $0.105 per share.
The Company reinsures 95% of catastrophe losses above a retention of $8.5
million per occurrence up to $80 million per occurrence for 52% of the coverage
and above a retention of $7.5 million per occurrence up to $80 million per
occurrence for the remaining 48% of the coverage. In addition, the Company's
predominant insurance subsidiary for property and casualty business written in
Florida reinsures 90% of hurricane losses in that state above a retention of
$10.3 million up to $50.3 million with the Florida Hurricane Fund, based on the
Fund's resources. These catastrophe reinsurance programs are augmented by a $100
million equity put and reinsurance agreement. This equity put provides an option
to sell shares of the Company's convertible preferred stock with a floating rate
dividend at a pre-negotiated price in the event losses from catastrophes exceed
the catastrophe reinsurance program coverage limit. Before tax benefits, the
equity put provides a source of capital for up to $154 million of catastrophe
losses above the reinsurance coverage limit.
Insurance Financial Ratings
As disclosed in the 2000 Form 10-K, certain ratings of the Company's
insurance subsidiaries are being reviewed as a result of the Company's earnings
for the three months ended December 31, 2000.
Fitch placed the Company's financial strength ratings on "Rating Watch
Negative." Although the Company's insurance subsidiaries remain in the "AA (very
strong)" rating category, in April 2001, Fitch downgraded Horace Mann's
financial strength ratings one notch from "AA" to "AA-".
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S&P placed the Company's financial strength ratings on "CreditWatch with
negative implications." Management has met with representatives from S&P and
anticipates that the CreditWatch status will be resolved in the second quarter
of 2001, based on further analysis of the 2000 year-end financial statements and
supplemental data.
Market Risk
Market risk is the risk that the Company will incur losses due to adverse
changes in market rates. The Company's primary market risk exposure is the risk
that the Company will incur economic losses due to adverse changes in interest
rates. This risk arises as the Company's profitability is affected by the
spreads between interest yields on investments and rates credited on insurance
liabilities.
The Company manages its market risk by coordinating the projected cash
outflows of assets with the projected cash outflows of liabilities. For all its
assets and liabilities, the Company seeks to maintain reasonable durations,
consistent with the maximization of income without sacrificing investment
quality and providing for liquidity and diversification. The risks associated
with mutual fund investments supporting variable annuity products are assumed by
those contractholders, and not by the Company.
There have been no material changes during the first three months of 2001 in
the market risks the Company is exposed to and the management of those risks,
which are described in "Management's Discussion and Analysis of Financial
Condition and Results of Operations" in the Company's 2000 Form 10-K.
Recent Accounting Changes
In September 2000, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 140, "Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of Liabilities"
- --a replacement of FASB SFAS No. 125. SFAS No. 140 revises the standards for
accounting for securitizations and other transfers of financial assets and
collateral, but it carries over most of SFAS No. 125's provisions without
reconsideration. This statement is effective for transactions occurring after
March 31, 2001 but is not expected to have a material impact on the Company's
accounting for its lending of fixed income securities to third parties.
26
Item 3: Quantitative and Qualitative Disclosures About Market Risk
The information required by Item 305 of Regulation S-K is contained in
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" contained in this Form 10-Q.
PART II: OTHER INFORMATION
Item 4: Submission of Matters to a Vote of Security Holders
None.
Item 6: Exhibits and Reports on Form 8-K
Exhibit
No. Description
------- -----------
(10) Material contracts:
10.1(a) Credit Agreement dated as of December 31, 1996 (the
"Bank Credit Facility") among HMEC, certain banks
named therein and Bank of America National Trust and
Savings Association, as administrative agent (the
"Agent"), incorporated by reference to Exhibit 10.1
to HMEC's Annual Report on Form 10-K for the year
ended December 31, 1996, filed with the SEC on March
26, 1997.
10.1(b) Waiver Relating to Credit Agreement.
(11) Statement re computation of per share earnings.
(21) Subsidiaries of HMEC.
(b) No reports on Form 8-K were filed by the Company during the first
quarter of 2001.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
HORACE MANN EDUCATORS CORPORATION
(Registrant)
Date May 14, 2001 /s/ Louis G. Lower II
------------------ ---------------------------
Louis G. Lower II
President and Chief
Executive Officer
Date May 14, 2001 /s/ Peter H. Heckman
------------------ ---------------------------
Peter H. Heckman
Executive Vice President
and Chief Financial Officer
Date May 14, 2001 /s/ Thomas K. Manion
------------------- ---------------------------
Thomas K. Manion
Senior Vice President
and Controller
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