Exhibit 99.2
Horace Mann Educators Corporation
October 28, 2003 Conference Call
Prepared Remarks of
Louis G. Lower II, President and Chief Executive Officer, Peter H. Heckman,
Executive Vice President and Chief Financial Officer, and Douglas W. Reynolds,
Executive Vice President, Property & Casualty
Louis G. Lower II
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Good Morning. And thanks for joining us on short notice.
Despite the reserving actions we took last quarter, which we believed to be
conservative at the time, more adverse claims results have emerged than we
expected requiring us to address those problems in the current quarter through
additional strengthening of reserves. As you've read, the after tax impact is 57
cents per share.
The change in our estimate of reserves is driven by new information uncovered by
the changes in our claims organization. As part of our conversation today, Doug
Reynolds will remind you of what we set out to accomplish with our new claims
team and what's emerged as we've moved from an inadequately managed claims
organization to one based on more conservative and disciplined policies,
procedures, technology and management information systems. We're confident we're
putting the right things in place. But, with that much-needed change has come an
uncovering and accelerated recognition of the shortcomings of past practices.
That "catch-up" is being reflected in our actuarial calculations for reserves.
Given our frustration with prior year adverse development, we have engaged D&T
to conduct a detailed review of the company's claim's handling practices and
their integration with our reserving practices. We have asked D&T to provide
their perspective of the adverse development experienced, identifying its causes
and possible implications for the future. Their work will be more extensive than
what would be a normal review process and will be completed in January in time
to be reflected, if needed, in our year-end results.
Instead of waiting for the results of their work, we are establishing a level of
reserves which we believe to be at the high end of a reasonable range. Our
objective was to set a level of reserves such that if the adverse development of
the 3Q repeated itself in the 4Q we would not be back having the conversations
we're having with you today.
In addition to the reserve strengthening and engagement of D&T, the Audit
Committee and management have decided to terminate Horace Mann's relationship
with its prior independent property and casualty actuarial consulting firm,
Ernst & Young. We believe we will be better served in the future by working with
different consultants in this area.
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In addition, the Audit Committee has decided to retain an independent, outside
consultant to help it review the history of how these adverse reserve
developments have come about and to help the Committee and Horace Mann
understand what needs to be done to try to prevent a recurrence of such adverse
reserve developments in the future.
A couple of closing comments before Pete and Doug provide additional detail:
1. Horace Mann's franchise with our consumer base is very healthy. As
you'll see in our 3Q earnings release and conference call later this
week, we continue to make solid progress on the sales front in meeting
the needs of our educator markets.
2. As you'll see in our 3Q results, quality indicators and current
accident year results continue to encourage us. While all the change
we're having to go through is clearly not without its challenges, we
are moving in the right direction toward the payoff we're committed to
realize.
3. Finally, as much as you are disappointed, we are more so. We fully
comprehend how significant the content of this warning is. We've been
working hard to get things right at Horace Mann. And, unfortunately,
getting things right requires improvements that sometimes unveil
adverse financial information. We believe the action we've taken is
the right thing to do----a responsible approach to the emergence of
bad news. While we can't tell you that adverse development is
completely behind us, we can tell you that we've been very
conservative in our approach to dealing with this issue.
And now let's continue with Pete Heckman's financial review.
Peter H. Heckman
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Thanks, Lou.
As I'm sure many of you who have followed us for a while are aware, the company
has strengthened its property/casualty reserves a number of times over the last
2 1/2 - 3 years. The actions we took in the fourth quarter of 2000 and again in
the second quarter of 2001 were primarily to address our deteriorating
Massachusetts auto book of business. The Massachusetts auto business is
currently in run-off as a result of the decision we reached in the 3Q 2001 to
restructure our business model in that state.
Beginning in 2002, we began making extensive changes in our P&C claims
operation, which we've discussed with you on prior calls. We had a lot of work
to do in that part of our business and, as a result, the magnitude of change
we're dealing with is significant. (Doug will elaborate on the extent of that
change process in just a moment.)
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We began seeing adverse development in our prior year's reserves, primarily in
the voluntary auto line, beginning in the third quarter of 2002. We believe that
the changes we're making in the claims area have been a significant factor in
that development - most particularly in the first three quarters of this year,
following the consolidation of our claims offices which was completed in
January.
In the second quarter of 2003, based on our internal actuarial analysis and the
independent reserve review performed by E&Y, we announced aggressive actions to
address the increased level of adverse development we observed during the
quarter. We strengthened prior years' reserves by $10 million, primarily to
address auto liability claims for 2002, as well as related reserves for loss
adjustment expenses and our provision for salvage recoveries. Consistent with
that action, we strengthened our reserve selections for the 2003 accident year
to reflect the degree of change occurring in our claims operation, and the
resulting complexity introduced in the reserving process. While we had
historically held P&C reserves at or slightly in excess of our independent
actuary's select estimate, the reserve level established at June 30, 2003 was
meaningfully above E&Y's point estimate, although still within their estimated
range.
Unfortunately the level of adverse prior years' development has continued in the
third quarter, once again primarily in auto liability coverages. We observed a
continuation of high levels of paid and case reserve activity on older bodily
injury claims - across all prior accident years - as the new claims organization
intensified their effort to bring older files up to date. As a general
observation, it would appear that the second quarter development related to
updating case reserves on the older files based on information contained in the
file. The continued case reserve development in the third quarter was also
driven by the new organization actively working those files, which uncovered
additional information and contributed to further upward development.
This "catch up" on the older liability claims was accompanied - both in the
second and third quarters - with a "speed up" in claim disposition rates, as the
new organization moved to reduce the backlog of older claims and handle current
accident year claims on a timely basis. This combination of "catch up" and
"speed up" resulted in adverse development, in each of the last two quarters, of
a magnitude that was unprecedented and obviously unexpected - and which would
have been, at best, difficult to predict, using reasonable actuarial
assumptions.
Given our dated claims management information system and the significant changes
being made in the claims organization, the company hired Deloitte and Touche to
analyze the metrics generated by the claims system and validate the
interpretation of that data as it relates to our reserving process.
Specifically, as the press release describes, Deloitte claims and actuarial
specialists will be reviewing claim files as well as past and current claims
handling processes and procedures, including case reserving practices, in each
of our six new regional
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claims offices. They will also be performing a concurrent assessment of
the company's actuarial processes to establish IBNR and supplemental reserves.
This study, which will be completed in January - in time for the findings to be
incorporated in our year-end actuarial analysis - will help us better understand
and verify the impact of the claims process changes on our loss results and
reserving processes. As a result of the independent review, we expect to have a
clearly established set of metrics to monitor going forward that will allow us
to assess the continuing changes occurring in the claims organization that will
validate and/or identify necessary changes to our reserving assumptions.
Additionally, the analysis of our claims processes will identify areas for
improvement relative to industry benchmarks and "best practices".
In the meantime, as described in the press release, we have booked our September
30 reserves at $308 million, which reflects adverse development and further
strengthening of 2002 and prior accident years totaling $30 million pre-tax, as
well as approximately $8 million pre-tax strengthening of the current accident
year reserves.
The total P&L impact on third quarter results of these reserve actions is
approximately 57 cents per share, which is the primary driver of the reduced
year-end earnings guidance.
Let me assure you that a number of outside experts have provided their
perspectives on our current level of P&C reserves. E&Y has reviewed, in detail,
our internal actuarial analysis and assumptions; our external auditor, KPMG, has
reviewed our work and also conferred with E & Y; and, we've had the opportunity
to review D&T's preliminary, independent analysis of our Auto BI reserves.
Consistent with the perspective provided by these outside advisors, we believe
our reserves are positioned toward the high end of a reasonable range.
To wrap up my comments, we're very frustrated and concerned about the reserving
developments that have occurred in the last two quarters, as I know you are. As
I said earlier, the magnitude of development is unprecedented and was virtually
impossible to predict. We expect to learn a great deal more from the Deloitte
study. And while further reserve actions may be warranted as a result of their
findings, we have established our current reserve level conservatively in light
of recent developments and the continuing changes in our claims organization.
And now, let me turn it over to Doug Reynolds, who heads up our P&C
organization, to provide further detail on our claims redesign process and his
perspective on the underlying quality of our book of business. Doug . . .
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Douglas W. Reynolds
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Thanks Pete,
Let me try to add context around Pete's comments on our challenge of addressing
continuing adverse development.
As I have covered in the past we are in the process of going through a massive
claims re-design effort. As a result we are addressing a number of issues. The
identification of the large adverse development that we have discovered this
year is a direct result of the many changes we are implementing. In other words,
it is because of these changes, in process and in management, that we have more
fully discovered the deficiencies in our case reserves and IBNR. Let me take you
through some of the process changes we have made and how we have impacted
results.
As you know we have completely re-organized our claim structure and we went from
17 small branch claim offices to 6 large Regional Claim Offices. Although the
physical restructure was completed at year-end, there were obviously, many
process changes that also needed to be implemented. As a result of this
restructure we have hired approximately 175 of our 300 claim employees over the
past year. We have also re-designed many process', such as; methods of
settlement, salvage and Subrogation, litigation management, while also
introducing new software. All of these are aimed at improving our claim
procedures, controlling expenses and improving severities. Over the course of
the first 9 months some of these areas are showing improvements, while others
continue to challenge the Claim department. During the first half of this year
we have experienced dramatic improvements in our settlement rates. Let me
provide a few examples; on injury claims that are three to six months old we
have improved our disposition rates by almost 50%. On claims that are 6 to 9
months old we have improved disposition rates by 22%. These comparisons refer to
historical patterns. As we have continued to expedite our handling of these
claims, we have discovered that case reserves have not been adequate, resulting
in much greater development than previously expected.
In addition to addressing the development in auto liability we are also
reserving at current run rates for both salvage and subro and Loss adjustment
expense. On salvage\subro we were initially reflecting good improvements as the
new processes were installed, however as we began to focus on other challenges
the collection rates have reverted to historical levels. Our reserve levels now
reflect current year results without anticipating future improvements. On loss
adjustment expense, the main driver is litigation costs. We have continued to
see improvements over prior years, but we were still being to aggressive in our
expectations. We have now also reserved at our current run rate for litigation
expenses. Lastly, we continue to implement new software and we have introduced
our new Claim Technology platform in our first
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office. These tools will assist us in managing new processes into the future.
In addition to reviewing prior year claims and ensuring case reserves based on
known facts, we have also strengthened our process for continued reviews as
claims reach certain aging points. This is a process that was more fully
implemented in 2003 and will protect against claims sitting idle in the future.
I think the shifting disposition rates noted earlier reflect this change in
philosophy and direction.
As we have addressed prior years' development we have also become more cautious
in setting supplemental reserves for 2003 accident year. We are making certain
that we keep current accident year loss improvements more consistent with prior
year results. We strongly believe that as we implement the re-designed processes
in claims and continue to drive our product management processes towards the
educator segment we will achieve improved results at the desired levels.
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