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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2003
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
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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, including Zip Code)
Registrant's Telephone Number, Including Area Code: 217-789-2500
Securities Registered Pursuant to Section 12(b) of the Act:
Name of each exchange on
Title of each class which registered
- ---------------------------------------- ---------------------------
Common Stock, par value $0.001 per share New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: None
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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 [_]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [_]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b - 2 of the Act).
Yes [X] No [_]
The aggregate market values of the voting Common Stock held by
non-affiliates of the registrant based on the closing prices of the Company's
Common Stock on the New York Stock Exchange and the shares outstanding on June
30, 2003 and February 27, 2004 were $689.1 million and $646.8 million,
respectively.
As of February 27, 2004, 42,722,701 shares of Common Stock, par value
$0.001 per share, were outstanding, net of 17,503,371 shares of treasury stock.
DOCUMENTS INCORPORATED BY REFERENCE
Certain portions of the Company's Proxy Statement for the 2004 Annual
Meeting of Shareholders are incorporated by reference into Part II Item 5 and
Part III Items 10, 11, 12, 13 and 14 of Form 10-K as specified in those Items.
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HORACE MANN EDUCATORS CORPORATION
FORM 10-K
YEAR ENDED DECEMBER 31, 2003
INDEX
Part Item Page
- ---- ---- ----
I 1. Business...................................................... 1
Forward-looking Information................................... 1
Overview and Available Information............................ 1
History....................................................... 2
Selected Historical Consolidated Financial Data............... 3
Corporate Strategy and Marketing.............................. 4
Property and Casualty Segment................................. 6
Annuity Segment............................................... 12
Life Segment.................................................. 13
Investments................................................... 14
Cash Flow..................................................... 16
Competition................................................... 17
Regulation.................................................... 17
Employees..................................................... 19
2. Properties.................................................... 19
3. Legal Proceedings............................................. 19
4. Submission of Matters to a Vote of Security Holders........... 19
II 5. Market for Registrant's Common Equity and
Related Stockholder Matters.................................. 20
6. Selected Financial Data....................................... 20
7. Management's Discussion and Analysis of Financial Condition
and Results of Operations.................................... 20
7A. Quantitative and Qualitative Disclosures About Market Risk.... 20
8. Consolidated Financial Statements and Supplementary Data...... 21
9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure.......................... 21
9A. Controls and Procedures....................................... 21
III 10. Directors and Executive Officers of the Registrant............ 21
11. Executive Compensation........................................ 21
12. Security Ownership of Certain Beneficial Owners and
Management................................................... 21
13. Certain Relationships and Related Transactions................ 21
14. Principal Accounting Fees and Services........................ 22
IV 15. Exhibits, Financial Statement Schedules, and Reports on
Form 8-K..................................................... 22
Signatures......................................................... 27
Index to Financial Information..................................... F-1
PART I
ITEM 1. Business
Forward-looking Information
It is important to note that the Company's actual results could differ
materially from those projected in forward-looking statements. Additional
information concerning factors that could cause actual results to differ
materially from those in the forward-looking statements is contained in
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
Overview and Available Information
Horace Mann Educators Corporation ("HMEC"; and together with its
subsidiaries, the "Company" or "Horace Mann") is an insurance holding company
incorporated in Delaware. Through its subsidiaries, HMEC markets and underwrites
personal lines of property and casualty and life insurance and retirement
annuities in the United States of America ("U.S."). HMEC's principal insurance
subsidiaries are Horace Mann Insurance Company ("HMIC"), Teachers Insurance
Company ("TIC") and Horace Mann Life Insurance Company ("HMLIC"), each of which
is an Illinois corporation; Horace Mann Property & Casualty Insurance Company
("HMPCIC"), a California domiciled company; and Horace Mann Lloyds ("HM
Lloyds"), domiciled in Texas.
The Company markets its products primarily to educators and other employees
of public schools and their families. The Company's one million customers
typically have moderate annual incomes, with many belonging to two-income
households. Their financial planning tends to focus on retirement, security,
savings and primary insurance needs. Management believes that Horace Mann is the
largest national multiline insurance company focused on the nation's educators
as its primary market.
The Company markets and services its products primarily through an
exclusive sales force of full-time agents employed by the Company and trained to
sell multiline products. The Company's agents sell Horace Mann's products and
limited additional third-party vendor products authorized by the Company. Many
of the Company's agents are former educators or individuals with close ties to
the educational community who utilize their contacts within, and knowledge of,
the target market. Compensation for agents includes an incentive element based
upon the profitability of the business they write. This employee agent sales
force is supplemented by an independent agent distribution channel for the
Company's annuity products.
The Company's insurance premiums written and contract deposits for the year
ended December 31, 2003 were $955.5 million and net income was $19.0 million.
The Company's total assets were $5.0 billion at December 31, 2003. The property
and casualty segment, whose primary products are private passenger automobile
and homeowners insurance, accounted for 57% of the Company's insurance premiums
written and contract deposits for the year ended December 31, 2003; the annuity
and life insurance segments together accounted for 43% of insurance premiums
written and contract deposits for the year ended December 31, 2003 (31% and 12%,
respectively).
1
The Company is one of the largest participants in the 403(b) tax-qualified
annuity market, measured by 403(b) net written premium on a statutory accounting
basis. The Company's 403(b) tax-qualified annuities are annuities purchased
voluntarily by individuals employed by public school systems or other tax-exempt
organizations. The Company has approved 403(b) payroll reduction capabilities in
approximately one-third of the 15,000 public school districts in the U.S.
The Company's investment portfolio had an aggregate fair value of $3.4
billion at December 31, 2003. Investments consist principally of investment
grade, publicly traded fixed income securities.
The Company's annual report on Form 10-K, quarterly reports on Form 10-Q,
current reports on Form 8-K, and all amendments to those reports are available
free of charge through the Company's Internet website, www.horacemann.com, as
soon as practicable after such reports are electronically filed with, or
furnished to, the Securities and Exchange Commission ("SEC"). The EDGAR filings
of such reports are also available at the SEC's website, www.sec.gov.
History
The Company's business was founded in Springfield, Illinois, in 1945 by two
Illinois school teachers to sell automobile insurance to other teachers within
the State of Illinois. The Company expanded its business to other states and
broadened its product line to include life insurance in 1949, 403(b)
tax-qualified retirement annuities in 1961 and homeowners insurance in 1965. In
November 1991, HMEC completed an initial public offering of its common stock
(the "IPO"). The common stock is traded on the New York Stock Exchange under the
symbol "HMN."
2
SELECTED HISTORICAL CONSOLIDATED FINANCIAL DATA
The following statement of operations and balance sheet data have been
derived from the consolidated financial statements of the Company. The
consolidated financial statements of the Company for each of the years in the
five year period ended December 31, 2003 have been audited by KPMG LLP. The
following selected historical consolidated financial data should be read in
conjunction with the consolidated financial statements of HMEC and its
subsidiaries and Management's Discussion and Analysis of Financial Condition and
Results of Operations.
Year Ended December 31,
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2003 2002 2001 2000 1999
------------ ------------ ------------ ------------ ------------
Statement of Operations Data: (Dollars in millions, except per share data)
Insurance premiums written and contract
deposits........................................ $ 955.5 $ 899.3 $ 875.6 $ 821.7 $ 821.2
Insurance premiums and contract charges
earned.......................................... 643.5 625.2 615.2 598.7 595.1
Net investment income............................ 184.7 196.0 199.3 192.4 188.3
Realized investment gains (losses)............... 25.5 (49.4) (10.0) (9.9) (8.0)
Total revenues................................... 853.7 771.8 804.5 781.2 775.4
Amortization of intangible assets (1)............ 5.0 5.7 5.8 8.8 0.2
Interest expense................................. 6.3 8.5 9.3 10.2 9.7
Income before income taxes....................... 19.2 7.7 28.3 9.7 93.4
Net income (2)................................... 19.0 11.3 25.6 20.8 44.5
Ratio of earnings to fixed charges (3)........... 4.0x 1.9x 4.0x 2.0x 10.6x
Per Share Data (4):
Net income:
Basic......................................... $ 0.44 $ 0.28 $ 0.63 $ 0.51 $ 1.08
Diluted....................................... $ 0.44 $ 0.28 $ 0.63 $ 0.51 $ 1.07
Shares of Common Stock -weighted average:
Basic......................................... 42.7 40.9 40.6 40.8 41.2
Diluted....................................... 42.9 41.2 40.9 41.0 41.7
Shares of Common Stock - ending outstanding...... 42.7 42.7 40.7 40.5 41.0
Cash dividends................................... $ 0.42 $ 0.42 $ 0.42 $ 0.42 $ 0.3825
Book value per share (5)......................... $ 12.42 $ 12.39 $ 11.27 $ 10.56 $ 9.75
Balance Sheet Data, at Year End:
Total investments................................ $ 3,385.7 $ 3,130.6 $ 2,975.7 $ 2,912.3 $ 2,630.2
Total assets..................................... 4,973.0 4,512.3 4,489.0 4,420.6 4,253.8
Total policy liabilities......................... 2,824.2 2,626.8 2,475.6 2,362.3 2,341.3
Short-term debt.................................. 25.0 -- 53.0 49.0 49.0
Long-term debt................................... 144.7 144.7 99.8 99.7 99.7
Total shareholders' equity....................... 530.5 528.8 459.2 428.0 400.1
Segment Information (6):
Insurance premiums written and contract deposits
Property and casualty......................... $ 546.5 $ 524.9 $ 519.3 $ 493.5 $ 495.1
Annuity....................................... 296.6 261.5 239.1 206.4 205.7
Life.......................................... 112.4 112.9 117.2 121.8 120.4
Total...................................... 955.5 899.3 875.6 821.7 821.2
Net income
Property and casualty......................... $ (17.8) $ 19.9 $ 5.2 $ 8.9 $ 39.5
Annuity....................................... 14.4 17.0 20.6 19.3 27.3
Life.......................................... 13.4 18.9 18.7 12.9 14.6
Corporate and other (2) (7)................... 9.0 (44.5) (18.9) (20.3) (36.9)
Total...................................... 19.0 11.3 25.6 20.8 44.5
- ----------
(1) Amortization of intangible assets is comprised of amortization of goodwill
and amortization of acquired value of insurance in force and is the result
of purchase accounting adjustments related to the 1989 acquisition of the
Company and the 1994 acquisition of HMPCIC. Effective January 1, 2002, the
Company adopted Financial Accounting Standard ("FAS") No. 142, "Goodwill
and Other Intangible Assets." Under FAS No. 142, goodwill amortization
ceases and the goodwill is annually tested for impairment. Goodwill
amortization was $1.6 million in each of the years ended December 31, 2001,
2000 and 1999.
(2) 1999 includes a charge of $20.0 million to record an additional federal
income tax provision representing the Company's maximum exposure for
disputed prior years' taxes (for tax years 1994 through 1997). 2000
includes a benefit of $8.7 million from resolution of tax years 1994
through 1996. 2001 includes a benefit of $1.3 million from resolution of
tax year 1997.
(3) For the purpose of determining the ratio of earnings to fixed charges,
"earnings" consist of income before income taxes and interest expense
(including amortization of debt issuance cost), and "fixed charges" consist
of interest expense (including amortization of debt issuance cost).
(4) Basic earnings per share is computed based on the weighted average number
of shares outstanding. Diluted earnings per share is computed based on the
weighted average number of shares and common stock equivalents outstanding.
The Company's common stock equivalents relate to outstanding common stock
options, Director Stock Plan units and Employee Stock Plan units and
warrants prior to their repurchase in 1999.
(5) Due to the adoption by the Company on January 1, 1994 of FAS No. 115, total
shareholders' equity included an increase, net of taxes, of $81.6 million,
$80.6 million and $26.3 million at December 31, 2003, 2002 and 2001 and a
decrease, net of taxes, of $4.0 million and $40.0 million at December 31,
2000 and 1999, respectively. Excluding the FAS 115 fair value accounting
for investments, book value per share was $10.51, $10.50, $10.62, $10.66
and $10.73 at December 31, 2003, 2002, 2001, 2000 and 1999, respectively.
(6) Information regarding assets by segment at December 31, 2003, 2002 and 2001
is contained in the Company's Notes to Financial Statements listed on page
F-1 of this report.
(7) The corporate and other segment primarily includes interest expense on debt
and the impact of realized investment gains and losses, restructuring
charges, debt retirement costs, litigation charges, provision for prior
years' taxes and certain public company expenses.
3
Corporate Strategy and Marketing
The Horace Mann Value Proposition
The Horace Mann Value Proposition articulates the Company's overarching
strategy and business purpose: Provide lifelong financial well-being for
educators and their families through personalized service, advice, and a full
range of tailored insurance and financial products.
Target Market
Management believes that Horace Mann is the largest national multiline
insurance company focused on the nation's educators as its primary market. The
Company's target market consists of educators and other employees of public
schools and their families located throughout the U.S. The U.S. Department of
Education estimates that there are approximately 3.5 million elementary and
secondary teachers in public and private schools in the U.S. The Company also
markets its products to other education-related customers, including school
administrators, education support personnel, private school teachers, community
college personnel, and customer referrals.
Exclusive Agency Force
A cornerstone of the Company's marketing strategy is its exclusive sales
force of full-time employee agents trained to sell multiline products. As of
December 31, 2003, the Company employed 888 full-time agents, approximately 70%
of which are licensed by the NASD to sell variable annuities. Many of the
Company's agents were previously teachers, other members of the education
profession or persons with close ties to the educational community. The
Company's agents are under contract to market only the Company's products and
limited additional third-party vendor products authorized by the Company.
Collectively, the Company's principal insurance subsidiaries are licensed to
write business in 49 states and the District of Columbia.
Broadening Distribution Options
Management has begun to broaden the Company's distribution options to
complement and extend the reach of the Company's agency force. This initiative
initially focuses on more fully utilizing its approved payroll deduction slots
in school systems across the country which are assigned to Horace Mann. In 2001,
the Company began building a network of independent agents who will comprise a
second distribution channel for the Company's 403(b) tax-qualified annuity
products. In addition to serving educators in areas where the Company does not
have agents, the independent agents will complement and extend the annuity
capabilities of the Company's agents in under-penetrated areas.
As an example of the potential for this initiative, in January 2002 the
Company announced that it had been selected as one of four providers of fixed
and variable annuity options to Chicago, Illinois public school employees. The
Chicago Public Schools is the third-largest school district in the U.S.
Beginning in April 2002, the Company is partnering with an independent
broker/dealer, which has been providing retirement planning services to Chicago
Public School employees for more than two decades, to pursue this opportunity to
bolster growth in its annuity business. At December 31, 2003, there were 465
independent agents approved to market the Company's annuity products throughout
the U.S. During 2003, collected contract deposits from this distribution channel
were approximately $42 million.
4
Geographic Composition of Business
The Company's business is geographically diversified. For the year ended
December 31, 2003, based on direct insurance premiums earned and contract
deposits for all product lines, the top five states and their portion of total
premiums were North Carolina, 7.8%; Illinois, 5.9%; Florida, 5.7%; Minnesota,
5.4%; and California, 5.2%.
HMEC's property and casualty subsidiaries write business in 48 states and
the District of Columbia. The following table sets forth the Company's top ten
property and casualty states based on total direct premiums in 2003:
Property and Casualty Segment Top Ten States
(Dollars in millions)
Property and Casualty
Segment
---------------------------
Direct Percent
Premiums (1) of Total
------------ ------------
State
- -------------------------------------------------
North Carolina................................... $ 43.4 8.0%
California....................................... 42.2 7.7
Florida.......................................... 39.8 7.3
Minnesota........................................ 39.3 7.2
Texas............................................ 26.5 4.9
Pennsylvania..................................... 23.9 4.4
Michigan......................................... 23.8 4.4
South Carolina................................... 22.1 4.1
Louisiana........................................ 22.0 4.0
Maine............................................ 17.2 3.2
------------ ------------
Total of top ten states....................... 300.2 55.2
All other areas.................................. 243.8 44.8
------------ ------------
Total direct premiums......................... $ 544.0 100.0%
============ ============
- ----------
(1) Defined as earned premiums before reinsurance and is determined under
statutory accounting principles.
HMEC's principal life insurance subsidiary writes business in 48 states and
the District of Columbia. The following table sets forth the Company's top ten
combined life and annuity states based on total direct premiums and contract
deposits in 2003:
Combined Life and Annuity Segments Top Ten States
(Dollars in millions)
Direct
Premiums
and Contract Percent
Deposits (1) of Total
------------ ------------
State
- -------------------------------------------------
Illinois......................................... $ 42.2 10.1%
North Carolina................................... 31.4 7.5
Indiana.......................................... 23.0 5.5
Virginia......................................... 22.8 5.5
Texas............................................ 21.9 5.2
Tennessee........................................ 19.3 4.6
Pennsylvania..................................... 16.5 4.0
Florida.......................................... 14.6 3.5
South Carolina................................... 14.4 3.4
Louisiana........................................ 13.9 3.3
------------ ------------
Total of top ten states....................... 220.0 52.6
All other areas.................................. 198.5 47.4
------------ ------------
Total direct premiums......................... $ 418.5 100.0%
============ ============
- ----------
(1) Determined under statutory accounting principles.
5
National, State and Local Education Associations
The Company has had a long relationship with the National Education
Association ("NEA"), the nation's largest confederation of state and local
teachers' associations, and many of the state and local education associations
affiliated with the NEA. The NEA has approximately 2.7 million members. The
Company maintains a special advisory board, primarily composed of leaders of
state education associations, that meets with Company management on a regular
basis. The NEA and its affiliated state and local associations sponsor various
insurance products and services of the Company and its competitors.
From 1984 to September 1993 and beginning again in September 1996, the NEA
purchased from the Company educator excess professional liability insurance for
all of its members. The NEA has entered into a contract to purchase this
insurance from the Company through August 2007. Premium from this product
represents less than 1% of all insurance premiums written and contract deposits
of the Company.
Property and Casualty Segment
The property and casualty segment represented 57% of the Company's total
insurance premiums written and contract deposits.
The primary property and casualty product offered by the Company is private
passenger automobile insurance, which in 2003 represented 41% of the Company's
total insurance premiums written and contract deposits and 73% of property and
casualty net written premiums. As of December 31, 2003, the Company had
approximately 571,000 voluntary automobile policies in force with annual
premiums of approximately $393 million. The Company's automobile business is
primarily preferred risk, defined as a household whose drivers have had no
recent accidents and no more than one recent moving violation. The Company has
instituted a program in a majority of states to provide non-preferred risk
automobile coverage to the educator market, with a third-party vendor
underwriting such insurance and the Company receiving a commission on its sale.
In 2003, homeowners insurance represented 16% of the Company's total
insurance premiums written and contract deposits and 27% of property and
casualty net written premiums. The Company insures primarily residential homes.
As of December 31, 2003, the Company had approximately 279,000 homeowners
policies in force with annual premiums of approximately $141 million. As
expected, the number of homeowners policies in force decreased in 2003,
reflecting initiatives to improve profitability in this product line.
Educator excess professional liability insurance represented less than 1%
of the Company's 2003 property and casualty premiums. See "Business -- Corporate
Strategy and Marketing -- National, State and Local Education Associations."
6
Selected Historical Financial Information For Property and Casualty Segment
The following table sets forth certain financial information with respect
to the property and casualty segment for the periods indicated.
Property and Casualty Segment
Selected Historical Financial Information
(Dollars in millions)
Year Ended December 31,
------------------------------------------
2003 2002 2001
------------ ------------ ------------
Statement of Operations Data:
Insurance premiums written (1)............ $ 546.5 $ 524.9 $ 519.3
Insurance premiums earned (1)............. 533.8 519.6 508.3
Net investment income..................... 31.9 35.2 37.7
Income (loss) before income taxes......... (35.2) 23.8 1.9
Net income (loss)......................... (17.8) 19.9 5.2
Catastrophe costs, pretax................. 33.2 11.9 11.2
GAAP Operating Statistics:
Loss and loss adjustment expense ratio.... 88.6% 78.9% 85.2%
Expense ratio............................. 23.7% 23.0% 21.6%
Combined loss and expense ratio
(including policyholder dividends)....... 112.3% 101.9% 106.8%
Combined loss and expense ratio before
catastrophes (including policyholder
dividends)............................... 106.1% 99.6% 104.6%
Automobile and Homeowners (Voluntary):
Insurance premiums written (1)............ $ 549.2 $ 513.2 $ 496.6
Insurance premiums earned (1)............. 534.8 504.3 485.5
Policies in force (in thousands) (1)...... 850 857 888
- ----------
(1) Effective December 31, 2001, Horace Mann ceased writing automobile
insurance policies in Massachusetts. As policies in force on that date
expired during the 12 months ended December 31, 2002, the following
reductions were recognized in comparison to the year ended December 31,
2001: -$25.5 million insurance premiums written; -$10.8 million insurance
premiums earned; -$18.9 million voluntary automobile insurance premiums
written; -$8.4 million voluntary automobile insurance premiums earned; and
-23 thousand voluntary automobile policies in force. For the year ended
December 31, 2002, the following amounts were included in the Company's
results and were reduced to zero in 2003: $1.2 million insurance premiums
written; $9.9 million voluntary automobile premiums earned; $15.6 million
insurance premiums earned.
7
Catastrophe Costs
The level of catastrophe costs can fluctuate significantly from year to
year. Catastrophe costs before federal income tax benefits for the Company and
the property and casualty industry for the ten years ended December 31, 2003
were as follows:
Catastrophe Costs
(Dollars in millions)
Property and
The Casualty
Company (1) Industry (2)
----------- ------------
Year Ended December 31,
2003........................................ $ 33.2 $ 12,800.0
2002........................................ 11.9 5,900.0
2001........................................ 11.2 28,100.0
2000........................................ 16.2 4,600.0
1999........................................ 19.6 8,300.0
1998........................................ 28.4 10,000.0
1997........................................ 6.2 2,600.0
1996........................................ 20.9 7,300.0
1995........................................ 13.9 8,300.0
1994........................................ 16.2 17,000.0
- ----------
(1) Net of reinsurance and before federal income tax benefits. Includes
allocated loss adjustment expenses and reinsurance reinstatement premiums.
The Company's individually significant catastrophe losses net of
reinsurance were as follows:
2003 - $12.0 million, California wildfires; $9.6 million, May hail,
tornadoes and wind; $5.0 million, Hurricane Isabel; $2.7
million early April winter storms.
2002 - $4.2 million, Hurricane Lili; $1.7 million, April Eastern
states hail, tornadoes, wind and heavy rain; $1.2 million,
Eastern states winter storms.
2001 - $3.7 million, June Midwest wind/hail/tornadoes; $2.3 million
April tornadoes; $2.2 million Tropical Storm Allison.
2000 - $5.0 million, May tornadoes; $2.7 million December winter
storms.
1999 - $5.4 million, Hurricane Floyd; $3.1 million, May tornadoes
primarily in Oklahoma.
1998 - $7.9 million, May Minnesota hailstorm; $2.9 million, May Upper
Midwest hailstorm; $2.0 million, June Midwest wind/hail; $1.6
million, Hurricane Georges.
1997 - $1.4 million, July wind/hail/tornadoes; $1.1 million, Denver,
Colorado hailstorm.
1996 - $8.2 million, Hurricane Fran.
1995 - $2.9 million, Texas wind/hail/tornadoes; $2.2 million Hurricane
Opal.
1994 - $6.0 million, Northridge, California earthquake.
(2) Source: Insurance Services Office, Inc. news release dated January 14,
2004. These amounts are net of reinsurance, before federal income tax
benefits, and exclude all loss adjustment expenses.
Fluctuations from year to year in the level of catastrophe losses impact a
property and casualty insurance company's loss and loss adjustment expenses
incurred and paid. For comparison purposes, the following table provides amounts
for the Company excluding catastrophe losses:
Impact of Catastrophe Losses (1)
(Dollars in millions)
Year Ended December 31,
---------------------------
2003 2002 2001
------- ------- -------
Claims and claim expense incurred(2).............. $ 472.9 $ 411.7 $ 433.3
Amount attributable to catastrophes............... 33.2 11.9 11.2
------- ------- -------
Excluding catastrophes(2)...................... $ 439.7 $ 399.8 $ 422.1
======= ======= =======
Claims and claim expense payments................. $ 424.6 $ 411.1 $ 411.1
Amount attributable to catastrophes............... 21.4 10.6 14.2
------- ------- -------
Excluding catastrophes......................... $ 403.2 $ 400.5 $ 396.9
======= ======= =======
- ----------
(1) Net of reinsurance and before federal income tax benefits. Includes
allocated loss adjustment expenses.
(2) Includes the impact of adverse development of prior years' reserves as
quantified in "Property and Casualty Reserves".
Property and Casualty Reserves
At December 31, 2003, all of the Company's net reserves for unpaid claims
and claim expenses were carried at the full value of estimated liabilities and
were not discounted for interest expected to be earned on reserves. Due to the
nature of the Company's personal lines business, the Company has no exposure to
claims for toxic waste cleanup, other environmental remediation or
asbestos-related illnesses other than claims under homeowners insurance policies
for environmentally related items such as toxic mold.
8
The following table is a summary reconciliation of the beginning and ending
property and casualty insurance claims and claim expense reserves, displayed
individually for each of the last three years. The table presents reserves on a
net (after reinsurance) basis. The total net property and casualty insurance
claims and claim expense amounts are reflected in the Consolidated Statements of
Operations listed on page F-1 of this report. The end of the year gross reserve
(before reinsurance) balances are reflected in the Consolidated Balance Sheets
also listed on page F-1 of this report.
Reconciliation of Property and Casualty Claims and Claim Expense Reserves
(Dollars In millions)
Year Ended December 31,
---------------------------
2003 2002 2001
------- ------- -------
Gross reserves, beginning of year................. $ 317.3 $ 306.1 $ 298.9
Less reinsurance recoverables.................. 44.7 34.1 49.1
------- ------- -------
Net reserves, beginning of year................... 272.6 272.0 249.8
------- ------- -------
Incurred claims and claim expenses:
Claims occurring in the current year........... 416.5 387.7 416.8
Increase (decrease) in estimated reserves
for claims occurring in prior years (1):
Policies written by the Company (2)......... 58.3 22.3 14.5
Business assumed from state reinsurance
facilities................................. (1.9) 1.7 2.0
------- ------- -------
Total increase........................... 56.4 24.0 16.5
------- ------- -------
Total claims and claim expenses incurred
(2) (3).................................... 472.9 411.7 433.3
------- ------- -------
Claims and claim expense payments for claims
occurring during:
Current year................................... 240.0 244.3 255.9
Prior years.................................... 184.6 166.8 155.2
------- ------- -------
Total claims and claim expense
payments................................ 424.6 411.1 411.1
------- ------- -------
Net reserves, end of period....................... 320.9 272.6 272.0
Plus reinsurance recoverables.................. 20.6 44.7 34.1
------- ------- -------
Gross reserves, end of period (4)................. $ 341.5 $ 317.3 $ 306.1
======= ======= =======
- ----------
(1) Shows the amounts by which the Company increased its reserves in each of
the periods indicated for claims occurring in previous periods to reflect
subsequent information on such claims and changes in their projected final
settlement costs. For discussion of the reserve strengthening recorded by
the Company in 2002, 2001 and 2000 see "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Results of
Operations for the Three Years Ended December 31, 2003 -- Benefits, Claims
and Settlement Expenses" listed on page F-1 of this report.
(2) For the year ended December 31, 2002, these amounts included a $1.6 million
statutory accounting charge for class action litigation which was
separately reported as Litigation Charges in the Company's Consolidated
Statements of Operations.
(3) Benefits, claims and settlement expenses as reported in the Consolidated
Statements of Operations, listed on page F-1 of this report, also include
life, annuity, group accident and health and corporate amounts of $46.1
million, $40.7 million and $42.3 million for the years ended December 31,
2003, 2002 and 2001, respectively, in addition to the property and casualty
amounts.
(4) Unpaid claims and claim expenses as reported in the Consolidated Balance
Sheets, listed on page F-1 of this report, also include life, annuity, and
group accident and health reserves of $9.0 million, $9.3 million and $8.2
million at December 31, 2003, 2002 and 2001, respectively, in addition to
property and casualty reserves.
The claim reserve development table below illustrates the change over time
of the net reserves established for property and casualty insurance claims and
claim expenses at the end of various calendar years. The first section shows the
reserves as originally reported at the end of the stated year. The second
section, reading down, shows the cumulative amounts paid as of the end of
successive years with respect to that reserve liability. The third section,
reading down, shows retroactive reestimates of the original recorded reserve as
of the end of each successive year which is the result of the Company's learning
additional facts that pertain to the unsettled claims. The fourth section
compares the latest reestimated reserve to the reserve originally established,
and indicates whether or not the original reserve was adequate or inadequate to
cover the estimated costs of unsettled claims. The table also presents the gross
reestimated liability as of the end of the latest reestimation period, with
separate disclosure of the related reestimated reinsurance recoverable. The
claim reserve development table is cumulative and, therefore, ending balances
should not be added since the amount at the end of each calendar year includes
activity for both the current and prior years.
9
In evaluating the information in the table below, it should be noted that
each amount includes the effects of all changes in amounts of prior periods. For
example, if a claim determined in 2002 to be $150 thousand was first reserved in
1993 at $100 thousand, the $50 thousand deficiency (actual claim minus original
estimate) would be included in the cumulative deficiency in each of the years
1993 - 2001 shown below. This table presents development data by calendar year
and does not relate the data to the year in which the accident actually
occurred. Conditions and trends that have affected the development of these
reserves in the past will not necessarily recur in the future. It may not be
appropriate to use this cumulative history in the projection of future
performance.
Property and Casualty
Claims and Claims Expense Reserve Development
(Dollars in millions)
December 31,
-------------------------------------------------------------------------------------------------
1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003
------- ------- ------- ------- ------- ------- ------- ------- ------- ------- -------
Gross reserves for property
and casualty claims and
claim expenses.................. $ 373.5 $ 389.1 $ 369.7 $ 340.4 $ 310.6 $ 298.9 $ 299.8 $ 298.9 $ 306.1 $ 317.3 $ 341.5
Deduct: Reinsurance
recoverables.................... 21.6 19.5 23.8 34.1 41.3 55.9 64.4 49.1 34.1 44.7 20.6
------- ------- ------- ------- ------- ------- ------- ------- ------- ------- -------
Net reserves for property
and casualty claims and
claim expenses.................. 351.9 369.6 345.9 306.3 269.3 243.0 235.4 249.8 272.0 272.6 320.9
Increase in reserves due to
purchase of HMPCIC:
Gross reserves for
property and casualty
claims and claim
expenses.................. 30.6 -- -- -- -- -- -- -- -- --
Deduct: Reinsurance
recoverables.............. 0.6 -- -- -- -- -- -- -- -- --
------- ------- ------- ------- ------- ------- ------- ------- ------- -------
Net reserves for property
and casualty claims and
claim expenses............ 30.0 -- -- -- -- -- -- -- -- --
Paid cumulative as of:
One year later................ 133.4 140.8 139.3 148.6 142.0 142.5 155.6 155.2 166.8 184.7
Two years later............... 190.5 194.5 195.3 202.1 191.4 203.2 212.7 220.1 245.7
Three years later............. 218.4 224.2 223.0 225.1 223.0 233.0 248.0 262.2
Four years later.............. 234.1 237.9 233.8 240.2 236.7 251.2 269.8
Five years later.............. 241.0 243.1 241.4 245.0 246.5 262.5
Six years later............... 243.7 247.1 242.8 250.5 252.9
Seven years later............. 246.1 247.5 246.8 254.6
Eight years later............. 246.2 250.4 249.2
Nine years later.............. 248.1 252.0
Ten years later............... 249.9
Reserves reestimated as of:
End of year................... 381.9 369.6 345.9 306.3 269.3 243.0 235.4 249.8 272.0 272.6 320.9
One year later................ 327.6 314.0 283.4 261.2 244.4 238.4 258.1 266.3 296.0 329.0
Two years later............... 281.9 269.2 249.6 250.2 239.3 261.2 276.9 287.3 325.1
Three years later............. 258.1 251.4 245.8 247.8 254.9 268.7 284.6 303.8
Four years later.............. 249.3 248.9 243.8 257.1 257.0 271.3 295.5
Five years later.............. 229.7 247.4 250.9 256.4 258.7 278.0
Six years later............... 246.6 252.9 250.1 258.8 262.7
Seven years later............. 250.2 252.6 252.2 261.2
Eight years later............. 250.2 255.0 254.3
Nine years later.............. 252.1 256.7
Ten years later............... 254.4
Reserve redundancy
(deficiency) - initial net
reserves in excess of (less
than) reestimated reserves:
Amount (1)................. $ 127.5 $ 112.9 $ 91.6 $ 45.1 $ 6.6 $ (35.0) $ (60.1) $ (54.0) $ (53.1) $ (56.4)
Percent.................... 33.4% 30.5% 26.5% 14.7% 2.5% -14.4% -25.5% -21.6% -19.5% -20.7%
Gross reestimated liability -
latest.......................... $ 283.5 $ 287.4 $ 279.8 $ 291.3 $ 291.9 $ 313.4 $ 329.3 $ 337.6 $ 360.6 $ 370.1
Reestimated reinsurance
recoverables - latest.......... 29.1 30.7 25.5 30.1 29.2 35.4 33.8 33.8 35.5 41.1
------- ------- ------- ------- ------- ------- ------- ------- ------- -------
Net reestimated liability -
latest.......................... $ 254.4 $ 256.7 $ 254.3 $ 261.2 $ 262.7 $ 278.0 $ 295.5 $ 303.8 $ 325.1 $ 329.0
Gross cumulative excess
(deficiency) (1).............. $ 120.6 $ 101.7 $ 89.9 $ 49.1 $ 18.7 $ (14.5) $ (29.5) $(38.7) $ (54.5) $ (52.8)
======= ======= ======= ======= ======= ======= ======= ======= ======= =======
- ----------
(1) For discussion of the reserve development, see "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Results of
Operations for the Three Years Ended December 31, 2003 -- Benefits, Claims
and Settlement Expenses".
10
Property and Casualty Reinsurance
All reinsurance is obtained through contracts which generally are renewed
each calendar year; however, the 2003 catastrophe reinsurance program was
comprised of two contracts, a three-year contract with rate guarantees effective
January 1, 2001 and a one-year contract effective January 1, 2003. Although
reinsurance does not legally discharge the Company from primary liability for
the full amount of its policies, it does make the assuming reinsurer liable to
the extent of the reinsurance ceded. Historically, the Company's losses from
uncollectible reinsurance recoverables have been insignificant due to the
Company's emphasis on the credit worthiness of its reinsurers. Past due
reinsurance recoverables as of December 31, 2003 were insignificant.
The Company maintains an excess and catastrophe treaty reinsurance program.
The Company reinsured 95% of catastrophe losses above a retention of $8.5
million per occurrence up to $80 million per occurrence through December 31,
2003. Effective January 1, 2004, the retention on this coverage increased to
$10.0 million. 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 $14.5 million up to $50.9 million with
the Florida Hurricane Catastrophe Fund, based on the Fund's financial resources.
These catastrophe reinsurance programs are augmented by a $75 million equity put
and reinsurance agreement.
Effective May 7, 2002, the Company entered into an equity put and
reinsurance agreement with a subsidiary of Swiss Reinsurance Company. The Swiss
Re Group is rated "A+ (Superior)" by A.M. Best. Under the 36-month agreement,
which is renewable annually at the option of the Company, the equity put
coverage of $75 million provides a source of capital for up to $115 million of
pretax catastrophe losses above the reinsurance coverage limit. The Company also
has the option, in place of the equity put, to require a Swiss Re Group member
to issue a 10% quota share reinsurance coverage of all of the Company's property
and casualty book of business. Annual fees related to this equity put option,
which are charged directly to additional paid-in capital, are 145 basis points
for the May 7, 2002 through May 7, 2004 period increasing to 150 basis points
for the May 7, 2004 through May 7, 2005 period. The agreement contains certain
conditions to Horace Mann's exercise of the equity put option including: (1) the
Company's shareholders' equity, adjusted to exclude goodwill, can not be less
than $215 million after recording the first triggering event; (2) the Company's
debt as a percentage of total capital can not be more than 47.5% prior to
recording the triggering event; and (3) the Company's S&P financial strength
rating can not be below "BBB" prior to a triggering event. The Company's S&P
financial strength rating was "A" at December 31, 2003.
For liability coverages, including the educator excess professional
liability policy, the Company reinsures each loss above a retention of $500,000
up to $20 million. Through December 31, 2003, the Company also reinsured each
property loss above a retention of $250,000 up to $2.5 million, including
catastrophe losses that in the aggregate are less than the retention levels
above. Effective January 1, 2004, the retention on the property loss coverage
increased to $500,000.
11
The following table identifies the Company's most significant reinsurers
under the traditional catastrophe reinsurance program, their percentage
participation in the Company's aggregate reinsured catastrophe coverage and
their rating by A.M. Best and Standard & Poor's Corporation ("S&P" or "Standard
& Poor's") as of January 1, 2004. No other single reinsurer's percentage
participation in 2004 or 2003 exceeds 5%.
Property Catastrophe Reinsurance Participants In Excess of 5%
Participation
A.M. Best S&P ---------------
Rating Rating Reinsurer Parent 2004 2003
- --------- ------ ------------------------------------ ----------------------------- ------ ------
A+ A+ IPCRe, Ltd. IPC Holdings, Ltd. 17% 5%
A AA- Mapfre Reinsurance Corporation Sistema MAPFRE 12% 8%
A- A Lloyd's of London Syndicates 12% *
A A- Montpelier Reinsurance Ltd. Montpelier Re Holdings, Ltd. 9% 11%
A- AA- AXA Reinsurance Company AXA Group 7% 14%
A++ AA Transatlantic Reinsurance Company American International Group, 7% *
Inc.
A A Axis Specialty Limited Axis Capital Holdings, Inc. 6% 0%
A+ NR Allied World Assurance Company, Ltd. Allied World Assurance
Holdings, Ltd. 5% 5%
A+ A Erie Insurance Exchange 0% 15%
A A+ St. Paul Fire and Marine
Insurance Company The St. Paul Companies, Inc. 0% 6%
- ----------
NR Not rated.
* Less than 5%.
For 2004, property catastrophe reinsurers representing 100% of the
Company's aggregate reinsured catastrophe coverage were rated either "A-
(Excellent)" or above by A.M. Best or "A" or above by S&P.
Annuity Segment
Educators in the Company's target market benefit from the provisions of
Section 403(b) of the Internal Revenue Code. This section of the Code allows
public school employees and employees of other tax-exempt organizations, such as
not-for-profit private schools, to reduce their pretax income by making periodic
contributions to an individual qualified retirement plan. The Company is one of
the largest participants in the 403(b) tax-qualified annuity market, measured by
403(b) net written premium on a statutory accounting basis. The Company has
approved 403(b) payroll reduction capabilities in approximately one-third of the
15,000 public school districts in the U.S. Approximately 60% of the Company's
new annuity contract deposits in 2003 were for 403(b) tax-qualified annuities;
approximately 75% of accumulated annuity value on deposit is 403(b)
tax-qualified. In 2003, annuities represented 31% of the Company's total
insurance premiums written and contract deposits.
The Company markets tax-qualified annuities primarily under a contract
which allows the contractholder to allocate funds to both fixed and variable
alternatives. The features of the Company's annuity contract contribute to
business retention. Under the fixed account option, both the principal and a
rate of return are guaranteed. Contractholders can change at any time their
allocation of deposits between the guaranteed interest rate fixed account and
available variable investment options.
The Company's 40 variable account options include funds managed by some of
the best-known names in the mutual fund industry, such as Fidelity, Strong, J.P.
Morgan, Wilshire, T. Rowe Price, Putnam, Neuberger Berman, Alliance Capital,
Ranier, Davis, Credit Suisse, BlackRock, Berger, Templeton and Ariel, offering
the Company's customers multiple investment options, regardless of their
personal investment objectives and risk tolerance. Total accumulated fixed and
variable annuity cash value on deposit at December 31, 2003 was $2.8 billion.
12
In 2003, to assist agents in delivering the Value Proposition, the Company
entered into a third-party vendor agreement with American Funds Distributors,
Inc. to market their retail mutual funds. In addition to retail mutual funds
accounts, the Company's agents can also offer a 529 college savings program and
Coverdell Education Savings Accounts through this marketing alliance.
Selected Historical Financial Information For Annuity Segment
The following table sets forth certain information with respect to the
Company's annuity products for the periods indicated.
Annuity Segment
Selected Historical Financial Information
(Dollars in millions, unless otherwise indicated)
Year Ended December 31,
-------------------------------
2003 2002 2001
--------- --------- ---------
Statement of Operations Data:
Contract deposits:
Variable................................ $ 115.3 $ 120.3 $ 122.1
Fixed................................... 181.3 141.2 117.0
Total................................ 296.6 261.5 239.1
Contract charges earned.................... 14.6 14.2 14.9
Net investment income...................... 104.4 107.7 107.7
Net interest margin (without
realized gains)........................... 33.1 39.3 39.8
Net margin (includes fees and contract
charges earned)........................... 49.6 55.5 57.0
Income before income taxes................. 19.8 23.2 30.7
Net income................................. 14.4 17.0 20.6
Operating Statistics:
Fixed:
Accumulated value....................... $ 1,650.6 $ 1,506.0 $ 1,393.7
Accumulated value persistency........... 95.1% 94.0% 93.4%
Variable:
Accumulated value....................... $ 1,119.2 $ 854.5 $ 1,008.4
Accumulated value persistency........... 92.8% 92.1% 92.4%
Number of contracts in force............... 152,515 147,084 139,410
Average accumulated cash
value (in dollars)........................ $ 18,161 $ 16,048 $ 17,230
Average annual deposit by contractholders
(in dollars).............................. $ 2,303 $ 2,317 $ 2,183
Annuity contracts terminated due to
surrender, death, maturity or other:
Number of contracts..................... 7,019 7,180 7,222
Amount.................................. $ 171.3 $ 176.0 $ 186.4
Fixed accumulated cash value grouped by
applicable surrender charge:
0%...................................... $ 528.6 $ 502.1 $ 472.5
5% and greater but less than 10%........ 968.3 846.6 752.9
10% and greater......................... 54.3 59.6 70.4
Supplementary contracts with life
contingencies not subject to
discretionary withdrawal............... 99.4 97.7 97.9
Total................................ $ 1,650.6 $ 1,506.0 $ 1,393.7
Life Segment
The Company entered the individual life insurance business in 1949 with
traditional term and whole life insurance products. The Company's traditional
term, whole life and group life business in force consists of approximately
172,000 policies, representing approximately $7.6 billion of life insurance in
force with annual insurance premiums and contract deposits of approximately
$42.0 million as of December 31, 2003. The Company also underwrites "Experience
Life," a flexible, adjustable premium life insurance contract which allows the
customer to combine elements of term life insurance, interest-sensitive whole
life insurance and an interest-bearing account. At December 31, 2003 the Company
had in force approximately 86,000 Experience Life policies representing
approximately $5.7 billion of life insurance in force with annual insurance
premiums and contract deposits of approximately $66.7 million. In 2000, the
Company instituted a program to offer long-term care and variable universal life
policies, with two third-party vendors underwriting such insurance. In 2003, the
Company expanded its third-party vendor offerings with the addition of universal
life insurance underwritten by Jefferson Pilot Financial. On business
underwritten by third-party vendors, the Company receives a commission on the
sale of that business. In 2003, the life segment represented 12% of the
Company's total insurance premiums written and contract deposits, including
approximately 1 percentage point attributable to the Company's group life and
group disability income business.
13
During 2003, the average face amount of ordinary life insurance policies
issued by the Company was $138,224 and the average face amount of all ordinary
life insurance policies in force at December 31, 2003 was $61,467.
The maximum individual life insurance risk retained by the Company is
$200,000 on any individual life and $100,000 or $125,000 is retained on each
group life policy depending on the type of coverage. The excess of the amounts
retained are reinsured with life reinsurers that are all rated "A- (Excellent)"
or above by A.M. Best. The Company also maintains a life catastrophe reinsurance
program. The Company reinsured 100% of the catastrophe risk in excess of $1
million up to $20 million per occurrence through December 31, 2003 and in excess
of $1 million up to $15 million per occurrence effective January 1, 2004. This
program covers acts of terrorism but excludes nuclear, biological and chemical
explosions as well as other acts of war.
Selected Historical Financial Information For Life Segment
The following table sets forth certain information with respect to the
Company's life products for the periods indicated.
Life Segment
Selected Historical Financial Information
(Dollars in millions, unless otherwise indicated)
Year Ended December 31,
-------------------------------
2003 2002 2001
--------- --------- ---------
Statement of Operations Data:
Insurance premiums and contract deposits... $ 112.4 $ 112.9 $ 117.2
Insurance premiums and contract charges
earned.................................... 95.1 91.4 92.0
Net investment income...................... 49.6 53.9 55.2
Income before income taxes................. 20.8 29.2 28.9
Net income................................. 13.4 18.9 18.7
Operating Statistics:
Life insurance in force:
Ordinary life........................... $ 11,527 $ 11,445 $ 11,291
Group life.............................. 1,736 1,752 1,925
Total................................ 13,263 13,197 13,216
Number of policies in force:
Ordinary life........................... 187,533 189,459 193,560
Group life.............................. 70,725 75,018 80,507
Total................................ 258,258 264,477 274,067
Average face amount in force (in dollars):
Ordinary life........................... $ 61,467 $ 60,409 $ 58,333
Group life.............................. 24,546 23,354 23,911
Total................................ 51,356 49,898 48,222
Lapse ratio (ordinary life insurance
in force)................................. 7.7% 9.1% 9.1%
Ordinary life insurance terminated due to
death, surrender, lapse or other:
Face amount of insurance surrendered
or lapsed........................... $ 932.6 $ 959.0 $ 944.0
Number of policies................ 7,466 10,799 11,865
Amount of death claims opened........ $ 32.0 $ 31.0 $ 30.1
Number of death claims opened..... 1,292 1,263 1,317
Investments
The Company's investments are selected to balance the objectives of
protecting principal, minimizing exposure to interest rate risk and providing a
high current yield. These objectives are implemented through a portfolio that
emphasizes investment grade, publicly traded fixed income securities. When
impairment of the value of an investment is considered other than temporary, the
decrease in value is recorded and a new cost basis is established. At December
31, 2003, investments in non-investment grade securities represented 5.3% of
total investments. At December 31, 2003, fixed income securities represented
96.9% of investments excluding securities lending collateral. Of the fixed
income investment portfolio, 94.1% was investment grade and 99.9% was publicly
traded. The average quality of the total fixed income portfolio was A+ at
December 31, 2003, and the average option adjusted duration of total investments
was 6.0 years. There are no significant investments in
14
mortgage loans, real estate, foreign securities, privately placed securities, or
common or preferred stocks.
The Company has separate investment strategies and guidelines for its
property and casualty assets and for its life and annuity assets, which
recognize different characteristics of the associated insurance liabilities, as
well as different tax and regulatory environments. The Company manages interest
rate exposure for its portfolios through asset/liability management techniques
which attempt to coordinate the duration of the assets with the duration of the
insurance policy liabilities. Duration of assets and liabilities will generally
differ only because of opportunities to significantly increase yields or because
policy values are not interest-sensitive, as is the case in the property and
casualty segment.
The investments of each insurance subsidiary must comply with the insurance
laws of such insurance subsidiary's domiciliary state. These laws prescribe the
type and amount of investments that may be purchased and held by insurance
companies. In general, these laws permit investments, within specified limits
and subject to certain qualifications, in federal, state and municipal
obligations, corporate bonds, mortgage-backed bonds, other asset-backed bonds,
preferred stocks, common stocks, real estate mortgages and real estate.
The following table sets forth the carrying values and amortized cost of
the Company's investment portfolio as of December 31, 2003:
Investment Portfolio
(Dollars in millions)
Percentage Carrying Value
of Total ----------------------------------
Carrying Life and Property and Amortized
Value Total Annuity Casualty Cost
---------- --------- --------- ------------ ---------
Publicly Traded Fixed Maturity Securities
and Cash Equivalents:
U.S. government and agency obligations (1):
Mortgage-backed securities......................... 19.5% $ 660.1 $ 646.6 $ 13.5 $ 647.7
Other.............................................. 8.9 300.9 248.3 52.6 295.6
Investment grade corporate and public
utility bonds........................................ 43.3 1,466.6 1,415.4 51.2 1,380.5
Municipal bonds....................................... 14.9 502.9 53.2 449.7 488.1
Other mortgage-backed securities...................... 3.2 109.9 87.8 22.1 106.0
Non-investment grade corporate and public
utility bonds (2).................................... 5.3 178.2 121.7 56.5 169.9
Foreign government bonds.............................. 1.1 36.2 36.2 -- 33.1
Short-term investments (3)............................ 0.7 25.3 9.0 16.3 25.3
Short-term investments, loaned
securities collateral (3)............................ 0.6 22.1 22.1 -- 22.1
---------- --------- --------- ------------ ---------
Total publicly traded securities................... 97.5 3,302.2 2,640.3 661.9 3,168.3
---------- --------- --------- ------------ ---------
Other Investments:
Private placements, investment grade (4).............. 0.1 3.8 3.7 0.1 3.8
Private placements,
non-investment grade (2) (4)......................... -- 0.1 0.1 -- 0.1
Mortgage loans and real estate (5).................... 0.2 4.6 4.6 -- 4.6
Policy loans and other................................ 2.2 75.0 74.0 1.0 74.4
---------- --------- --------- ------------ ---------
Total other investments......................... 2.5 83.5 82.4 1.1 82.9
---------- --------- --------- ------------ ---------
Total investments (6)........................... 100.0% $ 3,385.7 $ 2,722.7 $ 663.0 $ 3,251.2
========== ========= ========= ============ =========
- ----------
(1) Includes $302.0 million fair value of investments guaranteed by the full
faith and credit of the U.S. government and $659.0 million fair value of
federally sponsored agency securities.
(2) A non-investment grade rating is assigned to a security when it is
acquired, primarily on the basis of the Standard & Poor's Corporation
("Standard & Poor's" or "S&P") rating for such security, or if there is no
S&P rating, the Moody's Investors Service, Inc. ("Moody's") rating for such
security, or if there is no S&P or Moody's rating, the National Association
of Insurance Commissioners (the "NAIC") rating for such security. The
rating agencies monitor securities, and their issuers, regularly and make
changes to the ratings as necessary. The Company incorporates rating
changes on a monthly basis.
(3) Short-term investments mature within one year of being acquired and are
carried at cost, which approximates fair value. Short-term investments
include $25.4 million in money market funds rated "AAA", $21.9 million in
an asset-backed short-term bond rated "AAA", and $0.1 million in
certificates of deposit. The Company loans fixed income securities to third
parties, primarily major brokerage firms. The Company separately maintains
a minimum of 100% of the value of the loaned securities as collateral for
each loan.
(4) Fair values for private placements are estimated by the Company with the
assistance of its investment advisors.
(5) Mortgage loans are carried at amortized cost or unpaid principal balance
and real estate acquired in the settlement of debt is carried at the lower
of cost or fair value.
(6) Approximately 9% of the Company's investment portfolio, having a carrying
value of $288.9 million as of December 31, 2003, consisted of securities
with some form of credit support, such as insurance. All of these
securities have the highest investment grade rating.
15
Fixed Maturity Securities
The following table sets forth the composition of the Company's fixed
maturity securities portfolio by rating as of December 31, 2003:
Rating of Fixed Maturity Securities (1)
(Dollars in millions)
Percent
of Total
Carrying Carrying Amortized
Value Value Cost
-------- --------- ----------
AAA.................................. 44.6% $ 1,455.1 $ 1,422.7
AA................................... 7.7 249.5 240.8
A.................................... 23.2 757.4 710.6
BBB.................................. 18.6 605.3 567.5
BB................................... 2.0 64.8 63.0
B.................................... 3.2 104.8 101.1
CCC or lower......................... 0.6 18.0 15.4
Not rated (2)........................ 0.1 3.8 3.8
-------- --------- ----------
Total............................. 100.0% $ 3,258.7 $ 3,124.9
======== ========= ==========
- ----------
(1) Ratings are as assigned primarily by S&P when available, with remaining
ratings as assigned on an equivalent basis by 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 $3.8 million of private placement securities not
rated by either S&P or Moody's. The NAIC has rated 97.1% of these private
placement securities as investment grade.
At December 31, 2003, 29.3% of the Company's fixed maturity securities
portfolio was expected to mature within the next 5 years. Mortgage-backed
securities, including mortgage-backed securities of U.S. governmental agencies,
represented 22.7% of the total investment portfolio at December 31, 2003. These
securities typically have average lives shorter than their stated maturities due
to unscheduled prepayments on the underlying mortgages. Mortgages are prepaid
for a variety of reasons, including sales of existing homes, interest rate
changes over time that encourage homeowners to refinance their mortgages and
defaults by homeowners on mortgages that are then paid by guarantors.
For financial reporting purposes, the Company has classified the entire
fixed maturity portfolio as "available for sale". Fixed maturities to be held
for indefinite periods of time and not intended to be held to maturity are
classified as available for sale and carried at fair value. The net adjustment
for unrealized gains and losses on securities available for sale is recorded as
a separate component of shareholders' equity, net of applicable deferred tax
asset or liability and the related impact on deferred policy acquisition costs
and value of acquired insurance in force associated with interest-sensitive life
and annuity contracts. Fixed maturities held for indefinite periods of time
include securities that management intends to use as part of its asset/liability
management strategy and that may be sold in response to changes in interest
rates, resultant prepayment risk and other related factors.
Cash Flow
As a holding company, HMEC conducts its principal operations through its
subsidiaries. Payment by HMEC of principal and interest with respect to HMEC's
indebtedness, and payment by HMEC of dividends to its shareholders, are
dependent upon the ability of its insurance subsidiaries to pay cash dividends
or make other cash payments to HMEC, including tax payments pursuant to tax
sharing agreements. Restrictions on the subsidiaries' ability to pay dividends
or to make other cash payments to HMEC may materially affect HMEC's ability to
pay principal and interest on its indebtedness and dividends on its common
stock.
16
The ability of the insurance subsidiaries to pay cash dividends to HMEC is
subject to state insurance department regulations which generally permit
dividends to be paid for any 12 month period in amounts equal to the greater of
(i) net gain from operations in the case of a life insurance company or net
income in the case of all other insurance companies for the preceding calendar
year or (ii) 10% of surplus as of the preceding December 31st. Any dividend in
excess of these levels requires the prior approval of the Director or
Commissioner of the state insurance department of the state in which the
dividend paying insurance subsidiary is domiciled. The aggregate amount of
dividends that may be paid in 2004 from all of HMEC's insurance subsidiaries
without prior regulatory approval is approximately $43 million.
Notwithstanding the foregoing, if insurance regulators otherwise determine
that payment of a dividend or any other payment to an affiliate would be
detrimental to an insurance subsidiary's policyholders or creditors, because of
the financial condition of the insurance subsidiary or otherwise, the regulators
may block dividends or other payments to affiliates that would otherwise be
permitted without prior approval.
Competition
The Company operates in a highly competitive environment. The insurance
industry consists of a large number of insurance companies, some of which have
substantially greater financial resources, more diversified product lines, and
lower cost marketing approaches compared to the Company, such as direct
marketing, mail, internet and telemarketing. The Company competes in its target
market with a number of national providers of personal automobile and homeowners
insurance and life insurance such as State Farm, Allstate, Farmers and
Nationwide as well as several regional companies. The Company also competes for
automobile business with other companies, such as AIG, GEICO, Progressive and
USAA, many of which feature direct marketing distribution. For annuity business,
the marketplace has seen a competitive impact from new entrants such as mutual
funds and banks into the tax-deferred annuity products market. Among the major
national providers of annuities to educators, Variable Annuity Life Insurance
Company, a subsidiary of American International Group ("AIG"), has been among
the Company's major tax-qualified annuity competitors. Mutual fund families,
independent agent companies and financial planners are also competitors of the
Company.
Regulation
General Regulation at State Level
As an insurance holding company, HMEC is subject to extensive regulation by
the states in which its insurance subsidiaries are domiciled or transact
business. In addition, the laws of the various states establish regulatory
agencies with broad administrative powers to grant and revoke licenses to
transact business, regulate trade practices, license agents, require statutory
financial statements, and prescribe the type and amount of investments
permitted.
The NAIC has adopted risk-based capital guidelines to evaluate the adequacy
of statutory capital and surplus in relation to an insurance company's risks.
State insurance regulations prohibit insurance companies from making any public
statements or representations with regard to their risk-based capital levels.
Based on current guidelines, the risk-based capital statutory requirements are
not expected to have a negative regulatory impact on the Company's insurance
subsidiaries.
17
Assessments Against Insurers
Under insurance insolvency or guaranty laws in most states in which the
Company operates, insurers doing business therein can be assessed for
policyholder losses related to insolvencies of other insurance companies. The
amount and timing of any future assessments on the Company under these laws
cannot be reasonably estimated and are beyond the control of the Company. Most
of these laws do provide, however, that an assessment may be excused or deferred
if it would threaten an insurer's financial strength, and many assessments paid
by the Company pursuant to these laws may be used as credits for a portion of
the Company's premium taxes in certain states. For the three years ended
December 31, 2003, the Company's assessments, net of the related premium tax
credits, were not significant.
Mandatory Insurance Facilities
The Company is required to participate in various mandatory insurance
facilities in proportion to the amount of the Company's direct writings in the
applicable state. In 2003, the Company reflected a net loss from participation
in such mandatory pools and underwriting associations of $1.6 million before
federal income taxes.
California Earthquake Authority
The California Earthquake Authority ("CEA") was formed by the California
Legislature to encourage companies to write residential property insurance in
California and began operating in December 1996. All companies which write
residential property insurance in California are also required to offer
earthquake coverage. The CEA operates as an insurance company providing
residential property earthquake coverage under policies sold by companies which
have chosen to participate in the CEA. The participating companies fund the CEA
and share in earthquake losses covered by the CEA in proportion to their market
share.
The Company has not joined the CEA. The Company's exposure to losses from
earthquakes is managed through its underwriting standards, its earthquake policy
coverage limits and deductible levels, and the geographic distribution of its
business, as well as its reinsurance program. After reviewing the exposure to
earthquake losses from its own policies and from participation in the CEA,
management believes it is in the Company's best economic interest to offer
earthquake coverage directly to its homeowners policyholders. See "Property and
Casualty Segment -- Property and Casualty Reinsurance."
Regulation at Federal Level
Although the federal government generally does not directly regulate the
insurance industry, federal initiatives often impact the insurance business.
Current and proposed federal measures which may significantly affect insurance
and annuity business include employee benefits regulation, controls on the costs
of medical care, medical entitlement programs such as Medicare, structure of
retirement plans and accounts, changes to the insurance industry anti-trust
exemption, minimum solvency requirements and allowing national banks to engage
in the insurance, annuity and mutual fund businesses. With the passage of the
Financial Services Modernization Act of 1999, it is possible there will be
increased pressure for federal regulation of the insurance industry.
18
Federal income taxation of the build-up of cash value within a life
insurance policy or an annuity contract could have a materially adverse impact
on the Company's ability to market and sell such products. Various legislation
to this effect has been proposed in the past, but has not been enacted. Although
no such legislative proposals are known to exist at this time, such proposals
may be made again in the future. Changes in other federal and state laws and
regulations could also affect the relative tax and other advantages of the
Company's life and annuity products to customers.
The variable annuities underwritten by HMLIC and the Company's proprietary
mutual funds offered as investment vehicles for those products are regulated by
the SEC. Horace Mann Investors, Inc., the broker-dealer subsidiary of HMEC,
performs certain management functions for the Company's proprietary mutual funds
and also is regulated by the SEC and the NASD.
Employees
At December 31, 2003, the Company had approximately 2,500 employees,
including 888 full-time agents. The Company has no collective bargaining
agreement with any employees.
ITEM 2. Properties
HMEC's home office property at 1 Horace Mann Plaza in Springfield,
Illinois, consists of an office building totaling approximately 230,000 square
feet which is owned by the Company. The Company also owns buildings with an
aggregate of approximately 24,000 square feet at other locations in Springfield.
The Company leases buildings in Springfield with an aggregate of approximately
87,000 square feet. In addition, the Company leases office space in other states
related to claims and agency offices which are smaller in size. These properties
are adequate and suitable for the Company's current and anticipated future
needs.
ITEM 3. Legal Proceedings
The Company is not currently party to any material pending legal
proceedings other than routine litigation incidental to its business. See also
"Note 12 - Contingencies - Lawsuits and Legal Proceedings" contained in the
Index to Financial Information on page F-1 herein.
ITEM 4. Submission of Matters to a Vote of Security Holders
None.
19
PART II
ITEM 5. Market for Registrant's Common Equity and Related Stockholder Matters
HMEC's common stock began trading on the New York Stock Exchange ("NYSE")
in November 1991 under the symbol of HMN at a price of $9 per share. The
following table sets forth the high and low sales prices of the common stock on
the NYSE Composite Tape and the cash dividends paid per share of common stock
during the periods indicated.
Market Price
----------------- Dividend
Fiscal Period High Low Paid
- ------------------------------------------------- ------- ------- --------
2003:
Fourth Quarter................................ $ 15.39 $ 12.81 $ 0.105
Third Quarter................................. 16.95 14.22 0.105
Second Quarter................................ 16.91 13.06 0.105
First Quarter................................. 16.35 12.43 0.105
2002:
Fourth Quarter................................ $ 16.49 $ 13.61 $ 0.105
Third Quarter................................. 18.86 14.00 0.105
Second Quarter................................ 24.08 17.45 0.105
First Quarter................................. 23.00 19.35 0.105
As of February 27, 2004, the approximate number of holders of common stock
was 5,000.
In March 2004, the Company's Board of Directors announced a regular
quarterly dividend of $0.105 per share. The payment of dividends in the future
is subject to the discretion of the Board of Directors and will depend upon
general business conditions, legal restrictions and other factors the Board of
Directors of HMEC may deem to be relevant.
On December 10, 2002 the Company repurchased $56.0 million aggregate
principal amount of its Senior Convertible Notes, representing $26.6 million
carrying value, for $26.0 million. As consideration for the repurchase, the
Company issued 1,837,925 shares of its common stock.
During 2003, no options were exercised for the issuance of shares of the
Company's common stock.
The information required by Item 201(d) of Regulation S-K is incorporated
by reference to the Company's Proxy Statement for the 2004 Annual Meeting of
Shareholders.
ITEM 6. Selected Financial Data
The information required by Item 301 of Regulation S-K is contained in the
table in Item 1 -- "Business -- Selected Historical Consolidated Financial
Data."
ITEM 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The information required by Item 303 of Regulation S-K is contained in the
Index to Financial Information on page F-1 herein.
ITEM 7A. 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 the Index to Financial Information on page F-1 herein.
20
ITEM 8. Consolidated Financial Statements and Supplementary Data
The Company's consolidated financial statements, the report of its
independent accountants and the selected quarterly financial data required by
Item 302 of Regulation S-K are contained in the Index to Financial Information
on page F-1 herein.
ITEM 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
None.
ITEM 9A: Controls and Procedures
The Company carried out an evaluation, under the supervision and with the
participation of the Company's management, including the Company's Chief
Executive Officer and Chief Financial Officer, of the effectiveness of the
design and operation of the Company's disclosure controls and procedures as of
December 31, 2003 pursuant to Exchange Act Rule 13a-15 and 15d-15. Based upon
that evaluation, the Chief Executive Officer and Chief Financial Officer
concluded that the Company's disclosure controls and procedures are effective in
timely alerting them to material information relating to the Company (including
its consolidated subsidiaries) required to be included in the Company's periodic
Securities and Exchange Commission filings. No significant deficiencies or
material weaknesses in the Company's disclosure controls and procedures were
identified in the evaluation and therefore, no corrective actions were taken.
There were no significant changes in the Company's internal controls or in other
factors that could significantly affect these controls subsequent to the date of
their evaluation.
PART III
ITEM 10. Directors and Executive Officers of the Registrant
The information required by Items 401 and 405 of Regulation S-K is
incorporated by reference to the Company's Proxy Statement for the 2004 Annual
Meeting of Shareholders.
Horace Mann Educators Corporation has adopted a code of ethics that applies
to its principal executive officer, principal financial officer, principal
accounting officer and all other employees of the Company. In addition, the
Board of Directors of Horace Mann Educators Corporation has adopted the code of
ethics for its Board members as it applies to each Board members' business
conduct on behalf of the Company. The code of ethics is posted on the Company's
website, www.horacemann.com, under "Investor Relations -- Corporate Governance".
ITEM 11. Executive Compensation
The information required by Item 402 of Regulation S-K is incorporated by
reference to the Company's Proxy Statement for the 2004 Annual Meeting of
Shareholders.
ITEM 12. Security Ownership of Certain Beneficial Owners and Management
The information required by Items 201(d) and 403 of Regulation S-K is
incorporated by reference to the Company's Proxy Statement for the 2004 Annual
Meeting of Shareholders.
ITEM 13. Certain Relationships and Related Transactions
The information required by Item 404 of Regulation S-K is incorporated by
reference to the Company's Proxy Statement for the 2004 Annual Meeting of
Shareholders.
21
ITEM 14. Principal Accounting Fees and Services
The information required by Item 9(e) of Schedule 14A is incorporated by
reference to the Company's Proxy Statement for the 2004 Annual Meeting of
Shareholders.
PART IV
ITEM 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a)(1) The following consolidated financial statements of the Company are
contained in the Index to Financial Information on Page F-1 herein:
Consolidated Balance Sheets as of December 31, 2003 and 2002.
Consolidated Statements of Operations for the Years Ended December
31, 2003, 2002 and 2001.
Consolidated Statements of Changes in Shareholders' Equity for the
Years Ended December 31, 2003, 2002 and 2001.
Consolidated Statements of Cash Flows for the Years Ended December
31, 2003, 2002 and 2001.
(a)(2) The following consolidated financial statement schedules of the
Company are contained in the Index to Financial Information on page F-1 herein:
Schedule I - Summary of Investments - Other than Investments in
Related Parties.
Schedule II - Condensed Financial Information of Registrant.
Schedules III and VI Combined - Supplementary Insurance Information
and Supplemental Information Concerning Property and Casualty Insurance
Operations.
Schedule IV - Reinsurance.
(a)(3) The following items are filed as Exhibits. Management contracts and
compensatory plans are indicated by an asterisk (*).
Exhibit No. Description
- ------------- -----------------------------------------------------------------
(3) Articles of incorporation and bylaws:
3.1 Restated Certificate of Incorporation of HMEC, filed with the
Delaware Secretary of State on June 24, 2003, incorporated by
reference to Exhibit 3.1 to HMEC's Quarterly Report on Form 10-Q
for the quarter ended June 30, 2003, filed with the Securities
and Exchange Commission (the "SEC") on August 14, 2003.
3.2 Form of Certificate for shares of Common Stock, $0.001 par value
per share, of HMEC, incorporated by reference to Exhibit 4.5 to
HMEC's Registration Statement on Form S-3 (Registration No.
33-53118) filed with the SEC on October 9, 1992.
22
Exhibit No. Description
- ------------- -----------------------------------------------------------------
3.3 Bylaws of HMEC, incorporated by reference to Exhibit 3.2 to
HMEC's Quarterly Report on Form 10-Q for the quarter ended June
30, 2003, filed with the SEC on August 14, 2003.
(4) Instruments defining the rights of security holders, including indentures:
4.1 Indenture dated as of January 17, 1996, between HMEC and U.S.
Trust Company of California, N.A. as trustee, with regard to
HMEC's 6 5/8% Senior Notes Due 2006, incorporated by reference to
Exhibit 4.4 to HMEC's Annual Report on Form 10-K for the year
ended December 31, 1995, filed with the SEC on March 13, 1996.
4.1(a) Form of 6 5/8% Senior Notes Due 2006 (included in Exhibit 4.1).
4.2 Indenture dated as of May 14, 2002, between HMEC and JPMorgan
Chase Bank as trustee, with regard to HMEC's 1.425% Senior
Convertible Notes Due 2032, incorporated by reference to Exhibit
4.1 to HMEC's Quarterly Report on Form 10-Q for the quarter ended
June 30, 2002, filed with the SEC on August 14, 2002.
4.2(a) Form of 1.425% Senior Convertible Notes Due 2032 (included in
Exhibit 4.2).
4.3 Certificate of Designations for HMEC Series A Cumulative
Convertible Preferred Stock (included in Exhibit 10.14).
(10) Material contracts:
10.1 Credit Agreement dated as of May 29, 2002 (the "Bank Credit
Facility") among HMEC, certain financial institutions named
therein and Bank of America, N.A., as administrative agent (the
"Agent"), incorporated by reference to Exhibit 10.1 to HMEC's
Quarterly Report on Form 10-Q for the quarter ended June 30,
2002, filed with the SEC on August 14, 2002.
10.2* Stock Subscription Agreement among HMEC (as successor to HME
Holdings, Inc.), The Fulcrum III Limited Partnership, The Second
Fulcrum III Limited Partnership and each of the Management
Investors, incorporated by reference to Exhibit 10.17 to HMEC's
Annual Report on Form 10-K for the year ended December 31, 1989,
filed with the SEC on April 2, 1990.
10.3* Horace Mann Educators Corporation Deferred Equity Compensation
Plan for Directors, incorporated by reference to Exhibit 10.1 to
HMEC's Quarterly Report on Form 10-Q for the quarter ended
September 30, 1996, filed with the SEC on November 14, 1996.
10.4* Horace Mann Educators Corporation Deferred Compensation Plan for
Employees, incorporated by reference to Exhibit 10.4 to HMEC's
Annual Report on Form 10-K for the year ended December 31, 1997,
filed with the SEC on March 30, 1998.
10.5* Amended and Restated Horace Mann Educators Corporation 1991 Stock
Incentive Plan, incorporated by reference to Exhibit 10.5 to
HMEC's Annual Report on Form 10-K for the year ended December 31,
1999, filed with the SEC on March 30, 2000.
23
Exhibit No. Description
- ------------- -----------------------------------------------------------------
10.5(a)* Amendment to Amended and Restated Horace Mann Educators
Corporation 1991 Stock Incentive Plan, incorporated by reference
to Exhibit 10.1(a) to HMEC's Quarterly Report on Form 10-Q for
the quarter ended June 30, 2000, filed with the SEC on August 11,
2000.
10.5(b)* Specimen Employee Stock Option Agreement under the Horace Mann
Educators Corporation 1991 Stock Incentive Plan, incorporated by
reference to Exhibit 10.5(a) to HMEC's Annual Report on Form 10-K
for the year ended December 31, 1999, filed with the SEC on March
30, 2000.
10.5(c)* Specimen Director Stock Option Agreement under the Horace Mann
Educators Corporation 1991 Stock Incentive Plan, incorporated by
reference to Exhibit 10.5(b) to HMEC's Annual Report on Form 10-K
for the year ended December 31, 1999, filed with the SEC on March
30, 2000.
10.6* Horace Mann Educators Corporation 2001 Stock Incentive Plan,
incorporated by reference to Exhibit 10.6 to HMEC's Annual Report
on Form 10-K for the year ended December 31, 2001, filed with the
SEC on March 29, 2002.
10.6(a)* Specimen Employee Stock Option Agreement under the Horace Mann
Educators Corporation 2001 Stock Incentive Plan, incorporated by
reference to Exhibit 10.6(a) to HMEC's Annual Report on Form 10-K
for the year ended December 31, 2001, filed with the SEC on March
29, 2002.
10.6(b)* Specimen Director Stock Option Agreement under the Horace Mann
Educators Corporation 2001 Stock Incentive Plan, incorporated by
reference to Exhibit 10.6(b) to HMEC's Annual Report on Form 10-K
for the year ended December 31, 2001, filed with the SEC on March
29, 2002.
10.7* Horace Mann Educators Corporation 2002 Incentive Compensation
Plan, incorporated by reference to Exhibit 10.2 to HMEC's
Quarterly Report on Form 10-Q for the quarter ended June 30,
2002, filed with the SEC on August 14, 2002.
10.7(a)* Specimen Employee Stock Option Agreement under the Horace Mann
Educators Corporation 2002 Incentive Compensation Plan,
incorporated by reference to Exhibit 10.2(a) to HMEC's Quarterly
Report on Form 10-Q for the quarter ended June 30, 2002, filed
with the SEC on August 14, 2002.
10.7(b)* Specimen Regular Employee Stock Option Agreement under the Horace
Mann Educators Corporation 2002 Incentive Compensation Plan,
incorporated by reference to Exhibit 10.2(b) to HMEC's Quarterly
Report on Form 10-Q for the quarter ended June 30, 2002, filed
with the SEC on August 14, 2002.
10.7(c)* Specimen Director Stock Option Agreement under the Horace Mann
Educators Corporation 2002 Incentive Compensation Plan,
incorporated by reference to Exhibit 10.2(c) to HMEC's Quarterly
Report on Form 10-Q for the quarter ended June 30, 2002, filed
with the SEC on August 14, 2002.
24
Exhibit No. Description
- ------------- -----------------------------------------------------------------
10.8* Severance Agreements between HMEC and certain officers of HMEC,
incorporated by reference to Exhibit 10.7 to HMEC's Annual Report
on Form 10-K for the year ended December 31, 2001, filed with the
SEC on March 29, 2002.
10.8(a)* Revised Schedule to Severance Agreements between HMEC and certain
officers of HMEC.
10.9* Horace Mann Supplemental Employee Retirement Plan, 2002
Restatement, incorporated by reference to Exhibit 10.1 to HMEC's
Quarterly Report on Form 10-Q for the quarter ended March 31,
2002, filed with the SEC on May 15, 2002.
10.10* Horace Mann Executive Supplemental Employee Retirement Plan, 2002
Restatement, incorporated by reference to Exhibit 10.2 to HMEC's
Quarterly Report on Form 10-Q for the quarter ended March 31,
2002, filed with the SEC on May 15, 2002.
10.11* Horace Mann Nonqualified Supplemental Money Purchase Pension
Plan, incorporated by reference to Exhibit 10.3 to HMEC's
Quarterly Report on Form 10-Q for the Quarter Ended March 31,
2002, filed with the SEC on May 15, 2002.
10.12* Employment Agreement entered by and between HMEC and Louis G.
Lower II as of December 31, 1999, incorporated by reference to
Exhibit 10.12 to HMEC's Annual Report on Form 10-K for the year
ended December 31, 1999, filed with the SEC on March 30, 2000.
10.13* Transition, Retirement and Release Agreement entered by and
between Horace Mann Service Corporation and George J. Zock as of
December 31, 2003.
10.14 First Amended and Restated Catastrophe Equity Securities Issuance
Option and Reinsurance Option Agreement entered by and between
HMEC, Swiss Re Financial Products Corporation (Option Writer) and
Swiss Reinsurance America Corporation (Reinsurance Option
Writer), dated May 7, 2002, incorporated by reference to Exhibit
10.1 to HMEC's Quarterly Report on Form 10-Q for the quarter
ended September 30, 2002, filed with the SEC on November 14,
2002.
(11) Statement regarding computation of per share earnings.
(12) Statement regarding computation of ratios.
(21) Subsidiaries of HMEC.
(23) Consent of KPMG LLP.
(31) Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.1 Certification by Louis G. Lower II, Chief Executive Officer of
HMEC.
31.2 Certification by Peter H. Heckman, Chief Financial Officer of
HMEC.
25
(32) Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.1 Certification by Louis G. Lower II, Chief Executive Officer of
HMEC.
32.2 Certification by Peter H. Heckman, Chief Financial Officer of
HMEC.
(b) During the fourth quarter of 2003, HMEC filed seven Current Reports
on Form 8-K with the SEC as follows:
1. Dated October 27, 2003, regarding the Company's press release
regarding guidance on financial results for the year ended
December 31, 2003 and related October 28, 2003 Conference Call
Prepared Remarks, containing an Item 9 Regulation FD Disclosure
and an Item 7 Financial Statements and Exhibits.
2. Dated October 30, 2003, regarding the Company's press release
reporting its financial results for the three and nine month
periods ended September 30, 2003, containing an Item 12
Disclosure of Results of Operations and Financial Condition and
an Item 7 Financial Statements and Exhibits.
3. Dated November 14, 2003, regarding a press release issued by A.M.
Best Company regarding the financial strength and debt ratings of
HMEC, containing an Item 5 Other Events and Regulation FD
Disclosure and an Item 7 Financial Statements and Exhibits.
4. Dated December 2, 2003, regarding a press release issued by
Moody's Investors Service, Inc., regarding the insurance
financial strength and senior debt ratings of HMEC, containing an
Item 5 Other Events and Regulation FD Disclosure and an Item 7
Financial Statements and Exhibits.
5. Dated December 8, 2003, regarding the Company's press release
regarding guidance on financial results for the year ended
December 31, 2003, containing an Item 9 Regulation FD Disclosure
and an Item 7 Financial Statements and Exhibits.
6. Dated December 17, 2003, regarding a press release issued by
Standard & Poor's Ratings Services regarding the insurance
financial strength and senior debt ratings of HMEC, containing an
Item 5 Other Events and Regulation FD Disclosure and an Item 7
Financial Statements and Exhibits.
7. Dated December 19, 2003, regarding a press release issued by A.M.
Best Company regarding (1) the assignment of indicative ratings
of securities of HMEC's $300 million universal shelf offering
filed with the SEC on December 16, 2003 and (2) affirmation of
HMEC's financial strength ratings and ratings for outstanding
debt, containing an Item 5 Other Events and Regulation FD
Disclosure and an Item 7 Financial Statements and Exhibits.
(c) See list of exhibits in this Item 15.
(d) See list of financial statement schedules in this Item 15.
Copies of Exhibits and Horace Mann Educators Corporation's Code of Ethics may be
obtained by writing to Investor Relations, Horace Mann Educators Corporation, 1
Horace Mann Plaza, Springfield, Illinois 62715-0001. Persons requesting copies
may be charged a reasonable fee to cover reproduction and mailing expenses.
26
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, Horace Mann Educators Corporation has duly caused this
report to be signed on its behalf by the undersigned, thereunto duly authorized.
HORACE MANN EDUCATORS CORPORATION
/s/ Louis G. Lower II
- --------------------------------------
Louis G. Lower II
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of Horace Mann
Educators Corporation and in the capacities and on the date(s) indicated.
Principal Executive Officer: Directors:
/s/ Louis G. Lower II /s/ Joseph J. Melone
- -------------------------------------- --------------------------------------
Louis G. Lower II Joseph J. Melone, Chairman of the
President, Board of Directors
Chief Executive Officer and a Director
/s/ William W. Abbott
--------------------------------------
William W. Abbott, Director
/s/ Mary H. Futrell
--------------------------------------
Mary H. Futrell, Director
Principal Financial Officer:
/s/ Peter H. Heckman /s/ Donald E. Kiernan
- -------------------------------------- --------------------------------------
Peter H. Heckman Donald E. Kiernan, Director
Executive Vice President and
Chief Financial Officer
/s/ Jeffrey L. Morby
--------------------------------------
Jeffrey L. Morby, Director
/s/ Shaun F. O'Malley
--------------------------------------
Shaun F. O'Malley, Director
Principal Accounting Officer:
/s/ Bret A. Conklin /s/ Charles A. Parker
- -------------------------------------- --------------------------------------
Bret A. Conklin Charles A. Parker, Director
Senior Vice President and Controller
Dated: March 15, 2004
27
HORACE MANN EDUCATORS CORPORATION
INDEX TO FINANCIAL INFORMATION
Page
----
Management's Discussion and Analysis of Financial Condition and Results
of Operations........................................................... F- 2
Report of Management Responsibility for Financial Statements............. F-34
Independent Auditors' Report............................................. F-35
Consolidated Balance Sheets.............................................. F-36
Consolidated Statements of Operations.................................... F-37
Consolidated Statements of Changes in Shareholders' Equity............... F-38
Consolidated Statements of Cash Flows.................................... F-39
Notes to Consolidated Financial Statements
Note 1 - Summary of Significant Accounting Policies.................. F-40
Note 2 - Restructuring Charges....................................... F-51
Note 3 - Investments................................................. F-53
Note 4 - Property and Casualty Unpaid Claims and Claim Expenses...... F-57
Note 5 - Debt........................................................ F-61
Note 6 - Shareholders' Equity and Stock Options...................... F-64
Note 7 - Income Taxes................................................ F-67
Note 8 - Fair Value of Financial Instruments......................... F-68
Note 9 - Statutory Surplus and Subsidiary Dividend Restrictions...... F-70
Note 10 - Pension Plans and Other Postretirement Benefits............. F-71
Note 11 - Reinsurance................................................. F-78
Note 12 - Contingencies............................................... F-80
Note 13 - Supplementary Data on Cash Flows............................ F-80
Note 14 - Segment Information......................................... F-81
Note 15 - Unaudited Interim Information............................... F-82
Financial Statement Schedules:
Schedule I - Summary of Investments-Other than Investments in
Related Parties...................................................... F-83
Schedule II - Condensed Financial Information of Registrant........... F-84
Schedule III and VI Combined - Supplementary Insurance
Information and Supplemental Information Concerning Property
and Casualty Insurance Operations.................................... F-88
Schedule IV - Reinsurance............................................. F-89
F-1
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 future
events or the Company's future financial performance are forward-looking
statements and involve known and unknown risks, uncertainties and other factors.
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.
. Fluctuations in the market value of securities in the Company's
investment portfolio and the related after-tax effect on the Company's
shareholders' equity and total capital through either realized or
unrealized investment losses. In addition, the impact of fluctuations in
the financial markets on the Company's defined benefit pension plan
assets and the related after-tax effect on the Company's operating
expenses, shareholders' equity and total capital.
. Prevailing interest rate levels, including the impact of interest rates
on (i) unrealized gains and losses in the Company's investment portfolio
and the related after-tax effect on the Company's shareholders' equity
and total capital, (ii) the book yield of the Company's investment
portfolio and (iii) the Company's ability to maintain appropriate
interest rate spreads over the fixed rates guaranteed in the Company's
life and annuity products.
. Defaults on interest or dividend payments in the Company's investment
portfolio due to credit issues and the resulting impact on investment
income.
. The impact of fluctuations in the capital markets on the Company's
ability to refinance outstanding indebtedness or repurchase shares of
the Company's common stock.
. The frequency and severity of catastrophes such as hurricanes,
earthquakes, storms and wildfires, the ability of the Company to
maintain a favorable catastrophe reinsurance program and the
collectibility of reinsurance receivables.
. Adverse development of property and casualty loss experience and its
impact on estimated claims and claim settlement expenses for losses
occurring in prior years.
. The cyclicality of the insurance industry.
. Business risks inherent in the Company's restructuring of its property
and casualty claims operation.
. The risk related to the Company's dated and complex information systems,
which are more prone to error than advanced technology systems.
. Disruptions of the general business climate, investments, capital
markets and consumer attitudes caused by geopolitical acts such as
terrorism, war or other similar events.
. The impact of a disaster or catastrophic event affecting the Company's
employees or its home office facilities and the Company's ability to
recover and resume its business operations on a timely basis.
F-2
. The Company's ability to develop and expand its agent 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.
. Changes in federal and state laws and regulations which affect the
relative tax and other advantages of the Company's life and annuity
products to customers.
. The impact of fluctuations in the financial markets on the Company's
variable annuity fee revenues, valuations of deferred policy acquisition
costs and value of acquired insurance in force, and the level of
guaranteed minimum death benefit reserves.
. The Company's ability to maintain favorable claims-paying ability,
financial strength and debt ratings.
. Adverse changes in policyholder mortality and morbidity rates.
. The resolution of legal proceedings and related matters.
Executive Summary
During 2001, 2002 and 2003, the Company improved the underlying operating
results of its property and casualty segment and substantially increased the new
sales volume and retention of business in its annuity segment. However, that
underlying operating progress was more than offset by other factors which
suppressed the Company's net income. In all three years, the Company recorded
adverse development of prior years' property and casualty reserves, primarily
related to voluntary automobile liability claims, with 2003 reflecting the most
significant impact. 2003's results also reflected a record level of catastrophe
losses for the Company. In addition, the Company experienced declining
investment income, including related spread compression in its fixed annuity
business, over the three years as a result of credit-related investment losses
and declining investment yields. In 2002, the Company recorded a significant
level of realized investment losses, due primarily to impairments of fixed
income securities.
Critical Accounting Policies
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America ("GAAP") requires
the Company's management to make estimates and assumptions based on information
available at the time the financial statements are prepared. These estimates and
assumptions affect the reported amounts of the Company's assets, liabilities,
shareholders' equity and net income. Certain accounting estimates are
particularly sensitive because of their significance to the Company's financial
statements and because of the possibility that subsequent events and available
information may differ markedly from management's judgements at the time the
financial statements were prepared. Management has discussed with the Audit
Committee the quality, not just the acceptability, of the Company's accounting
principles as applied in its financial reporting. The
F-3
discussions generally included such matters as the consistency of the Company's
accounting policies and their application, and the clarity and completeness of
the Company's financial statements, which include related disclosures. For the
Company, the areas most subject to significant management judgements include:
liabilities for property and casualty claims and claim settlement expenses,
liabilities for future policy benefits, deferred policy acquisition costs, value
of acquired insurance in force, valuation of investments and valuation of assets
and liabilities related to the defined benefit pension plan.
Liabilities for Property and Casualty Claims and Claim Settlement Expenses
Underwriting results of the property and casualty segment are significantly
influenced by estimates of the Company's ultimate liability for insured events.
There is a high degree of uncertainty inherent in the estimates of ultimate
losses underlying the liability for unpaid claims and claim expenses. This
inherent uncertainty is particularly significant for liability-related exposures
due to the extended period, often many years, that transpires between a loss
event, receipt of related claims data from policyholders and ultimate settlement
of the claim. Reserves for property and casualty claims include provisions for
payments to be made on reported claims, claims incurred but not yet reported and
associated settlement expenses. The process by which these reserves are
established requires reliance upon estimates based on known facts and on
interpretations of circumstances, including the Company's experience with
similar cases and historical trends involving claim payment patterns, claim
payments, pending levels of unpaid claims and product mix, as well as other
factors including court decisions, economic conditions and public attitudes.
The Company continually updates loss estimates using both quantitative
information from its reserving actuaries and qualitative information derived
from other sources. Adjustments may be required as information develops which
varies from experience, or, in some cases, augments data which previously were
not considered sufficient for use in determining liabilities. The effects of
these adjustments may be significant and are charged or credited to income for
the period in which the adjustments are made. Detailed discussion of the impact
of adjustments recorded during 2003 is included in "Results of Operations for
the Three Years Ended December 31, 2003 -- Benefits, Claims and Settlement
Expenses." Due to the nature of the Company's personal lines business, the
Company has no exposure to claims for toxic waste cleanup, other environmental
remediation or asbestos-related illnesses other than claims under homeowners
insurance policies for environmentally related items such as toxic mold.
The Company completes a detailed study of property and casualty reserves
based on information available at the end of each quarter and year. Trends of
reported losses (paid amounts and case reserves on claims reported to the
Company) for each accident year are reviewed and ultimate loss costs for those
accident years are estimated. The Company engages an independent property and
casualty actuarial consulting firm to prepare an independent study of the
Company's property and casualty reserves twice a year - at June 30 and December
31.
F-4
Reserves for Future Policy Benefits
Liabilities for future benefits on life and annuity policies are
established in amounts adequate to meet the estimated future obligations on
policies in force. Liabilities for future policy benefits on certain life
insurance policies are computed using the net level premium method and are based
on assumptions as to future investment yield, mortality and withdrawals.
Mortality and withdrawal assumptions for all policies have been based on
actuarial tables which are consistent with the Company's own experience.
Liabilities for future benefits on annuity contracts and certain long-duration
life insurance contracts are carried at accumulated policyholder values without
reduction for potential surrender or withdrawal charges. In the event actual
experience varies from the estimated liabilities, adjustments are charged or
credited to income for the period in which the adjustments are made.
Deferred Policy Acquisition Costs and Value of Acquired Insurance in Force
for Annuity and Interest-Sensitive Life Products
Policy acquisition costs, consisting of commissions, policy issuance and
other costs, which vary with and are primarily related to the production of
business, are capitalized and amortized on a basis consistent with the type of
insurance coverage. For investment (annuity) contracts, acquisition costs, and
also the value of annuity business acquired in the 1989 acquisition of the
Company ("Annuity VIF"), are amortized over 20 years in proportion to estimated
gross profits. Capitalized acquisition costs for interest-sensitive life
contracts are also amortized over 20 years in proportion to estimated gross
profits.
The most significant assumptions that are involved in the estimation of
annuity gross profits include future financial market performance, interest rate
spreads, business surrender/lapse rates and the impact of realized investment
gains and losses. For the variable deposit portion of the annuity segment, the
Company amortizes policy acquisition costs and the Annuity VIF utilizing a
future financial market performance assumption of a 10% reversion to the mean
approach with a 200 basis point corridor around the mean. At December 31, 2003,
capitalized annuity policy acquisition costs and the Annuity VIF asset
represented approximately 4% of the total annuity accumulated cash value.
In the event actual experience differs significantly from assumptions or
assumptions are significantly revised, the Company may be required to record a
material charge or credit to amortization expense for the period in which the
adjustment is made. As noted above, there are a number of assumptions involved
in the valuation of capitalized policy acquisition costs and the Annuity VIF.
Generally, if all other assumptions are met, with regard to financial market
performance assumptions for the underlying mutual funds of the Company's
variable annuities, a 1% deviation from the targeted financial market
performance would currently impact amortization between $0.1 million and $0.2
million depending on the magnitude and direction of the deviation. Detailed
discussion of the impact of adjustments to the amortization of capitalized
acquisition costs and Annuity VIF is included in "Results of Operations for the
Three Years Ended December 31, 2003 -- Amortization of Policy Acquisition
Expenses and Intangible Assets".
F-5
Valuation of Investments
The Company's methodology of assessing other-than-temporary impairments is
based on security-specific facts and circumstances as of the date of the
reporting period. Based on these facts, if management believes it is probable
that amounts due will not be collected according to the contractual terms of a
debt security not impaired at acquisition, or if the Company does not have the
ability or intent to hold a security with an unrealized loss until it matures or
recovers in value, an other-than-temporary impairment shall be considered to
have occurred. As a general rule, if the fair value of a debt security has
fallen below 80% of book value for more than six months, this security will be
reviewed for an other-than-temporary impairment. Additionally, if events become
known that call into question whether the security issuer has the ability to
honor its contractual commitments, whether or not such security has been trading
above an 80% fair value to book value relationship, such security holding will
be evaluated to determine whether or not such security has suffered an
other-than-temporary decline in value.
The Company reviews the fair value of all investments in its portfolio on a
monthly basis to assess whether an other-than-temporary decline in value has
occurred. These reviews, in conjunction with the Company's investment managers'
monthly credit reports and relevant factors such as (1) the financial condition
and near-term prospects of the issuer, (2) the Company's intent and ability to
retain the investment long enough to allow for the anticipated recovery in fair
value, (3) the stock price trend of the issuer, (4) the market leadership
position of the issuer, (5) the debt ratings of the issuer and (6) the cash
flows of the issuer, are all considered in the impairment assessment. A
write-down of an investment is recorded when a decline in the fair value of that
investment is deemed to be other-than-temporary, with a realized investment loss
charged to income for the period.
A decline in fair value below amortized cost is not assumed to be
other-than-temporary for fixed maturity investments with unrealized losses due
to market conditions or industry-related events where there exists a reasonable
market recovery expectation and the Company has the intent and ability to hold
the investment until maturity or a market recovery is realized. An
other-than-temporary impairment loss will be recognized based upon all relevant
facts and circumstances for each investment, as appropriate, in accordance with
Securities and Exchange Commission Staff Accounting Bulletin ("SAB") No. 59,
"Accounting for Non-Current Marketable Equity Securities", Financial Accounting
Standards Board ("FASB") Statement of Financial Accounting Standards ("SFAS")
No. 115, "Accounting for Certain Investments in Debt and Equity Securities", and
related guidance.
Detailed discussion of charges recorded in 2003 and 2002 for the write-down
of investments due to other-than-temporary impairments is included in "Results
of Operations for the Three Years Ended December 31, 2003 -- Realized Investment
Gains and Losses".
Valuation of Assets and Liabilities Related to the Defined Benefit Pension
Plan
Effective April 1, 2002, participants stopped accruing benefits under the
defined benefit plan but continue to retain the benefits they had accrued to
date.
The Company's cost estimates for its defined benefit pension plan are
determined annually based on assumptions which include the discount rate,
expected return on plan assets, anticipated retirement rate and estimated lump
sum distributions. A discount rate of
F-6
6.25% was used by the Company at December 31, 2003, which was based on the
average yield for long-term, high grade securities having maturities generally
consistent with the defined benefit pension payout period. To set its discount
rate, the Company looks to leading indicators, including Moody's Aa long-term
bond index. The expected annual return on plan assets assumed by the Company at
December 31, 2003 was 7.50%. The assumption for the long-term rate of return on
plan assets was determined by considering actual investment experience during
the lifetime of the plan, balanced with reasonable expectations of future growth
considering the various classes of assets and percentage allocation for each
asset class. Management believes that it has adopted realistic assumptions for
investment returns, discount rates and other key factors used in the estimation
of pension costs and asset values.
To the extent that actual experience differs from the Company's
assumptions, subsequent adjustments may be required, with the effects of those
adjustments charged or credited to income and/or shareholders' equity for the
period in which the adjustments are made. Generally, a change of 50 basis points
in the discount rate would inversely impact pension expense and accumulated
other comprehensive income ("AOCI") by approximately $0.2 million and $2
million, respectively. In addition, for every $1 million increase in the value
of pension plan assets, there is an equal and offsetting decrease in AOCI.
Results of Operations For the Three Years Ended December 31, 2003
Insurance Premiums and Contract Charges
Insurance Premiums Written and Contract Deposits
Year Ended Growth Over Year Ended
December 31, Prior Year December 31,
------------------- ------------------ ------------
2003 2002 Percent Amount 2001
-------- -------- ------- -------- ------------
Automobile and property (voluntary).... $ 549.2 $ 513.2 7.0% $ 36.0 $ 496.6
Excluding Massachusetts automobile.. 549.2 513.2 7.0% 36.0 477.7
Massachusetts automobile............ -- -- -- 18.9
Annuity deposits....................... 296.6 261.5 13.4% 35.1 239.1
Life................................... 112.4 112.9 -0.4% (0.5) 117.2
-------- -------- -------- ------------
Subtotal - core lines......... 958.2 887.6 8.0% 70.6 852.9
Subtotal - core lines,
excluding Massachusetts...... 958.2 887.6 8.0% 70.6 834.0
Involuntary and other
property & casualty................... (2.7) 11.7 (14.4) 22.7
Excluding Massachusetts
automobile...................... (2.7) 10.5 (13.2) 14.9
Massachusetts automobile......... -- 1.2 (1.2) 7.8
-------- -------- -------- ------------
Total......................... $ 955.5 $ 899.3 6.2% $ 56.2 $ 875.6
======== ======== ======== ============
Total, excluding Massachusetts
automobile................... $ 955.5 $ 898.1 6.4% $ 57.4 $ 848.9
======== ======== ======== ============
F-7
Insurance Premiums and Contract Charges Earned
(Excludes annuity and life contract deposits)
Year Ended Growth Over Year Ended
December 31, Prior Year December 31,
------------------- ------------------ ------------
2003 2002 Percent Amount 2001
-------- -------- ------- -------- ------------
Automobile and property (voluntary).... $ 534.8 $ 504.3 6.0% $ 30.5 $ 485.5
Excluding Massachusetts automobile.. 534.8 494.4 8.2% 40.4 467.2
Massachusetts automobile............ -- 9.9 -100.0% (9.9) 18.3
Annuity................................ 14.6 14.2 2.8% 0.4 14.9
Life................................... 95.1 91.4 4.0% 3.7 92.0
-------- -------- -------- ------------
Subtotal - core lines......... 644.5 609.9 5.7% 34.6 592.4
Subtotal - core lines,
excluding Massachusetts
automobile................... 644.5 600.0 7.4% 44.5 574.1
Involuntary and other
property and casualty................. (1.0) 15.3 (16.3) 22.8
Excluding Massachusetts
automobile...................... (1.2) 9.6 (10.8) 14.7
Massachusetts automobile......... 0.2 5.7 (5.5) 8.1
-------- -------- -------- ------------
Total......................... $ 643.5 $ 625.2 2.9% $ 18.3 $ 615.2
======== ======== ======== ============
Total, excluding Massachusetts
automobile................... $ 643.3 $ 609.6 5.5% $ 33.7 $ 588.8
======== ======== ======== ============
The Company restructured its presence in the Massachusetts automobile
market and ceased writing automobile insurance policies in that state on
December 31, 2001. Through a marketing alliance with an unaffiliated company,
The Commerce Group, Inc. ("Commerce"), the Company's agents are authorized to
offer Massachusetts customers automobile insurance policies written by Commerce.
Horace Mann agents continue to write the Company's other products in
Massachusetts, including retirement annuities and property and life insurance.
Comparisons throughout this discussion of insurance premiums and contract
deposits exclude Massachusetts voluntary automobile premiums and policies in
force.
2003 premiums written and contract deposits for the Company's core lines
increased 8.0% over 2002 as a result of rate increases in the property and
automobile lines and an increased rate of growth in new annuity deposits in the
second half of 2003. 2002 premiums written and contract deposits increased 6.4%
over 2001 for similar reasons. Voluntary property and casualty business, a
component of the Company's core lines, represents policies sold through the
Company's marketing organization and issued under the Company's underwriting
guidelines.
The Company's exclusive agent force totaled 888 at December 31, 2003,
reflecting a decrease of 3.7% compared to 922 agents a year earlier. At December
31, 2001, the Company had 867 agents. Of the 2003 total, 378 agents were in
their first 24 months with the Company, a decrease of 4.3% compared to December
31, 2002, with full year 2003 new hires equal to 2002 and terminations exceeding
the prior year. The number of experienced agents in the agent force, 510, was
down 3.2% at December 31, 2003 compared to a year earlier, due primarily to
terminations of less-productive agents. While the year-end 2003 agent count was
lower than a year earlier, the average number of agents throughout the year was
4% higher than in 2002. In 2003, average agent productivity for all lines of
business combined increased slightly compared to 2002 following an increase of
6.5% in 2002, compared to 2001. Average agent productivity is measured as new
sales premiums from the exclusive agent force per the average number of
exclusive agents for the period. The Company continues to seek ways to improve
the retention and productivity of its exclusive agent force. 2003 total sales,
which include the independent agent distribution channel, increased 14.6%
compared to 2002,
F-8
largely due to the growing contribution of annuity business from the independent
agent distribution channel.
The Company's results have been impacted by ongoing and recurring
proceedings in North Carolina challenging private passenger automobile rates.
This has required the Company to escrow premiums received pending resolution of
these proceedings, adversely impacting 2003 earned premiums and pretax income by
$3.0 million and 2002 earned premiums and pretax income by $1.8 million.
Total voluntary automobile and homeowners premium written increased 7.0% in
2003 and 7.4% in 2002. Voluntary automobile insurance premium written increased
6.0% ($22.6 million) from 2002 to 2003 and 7.1% ($24.9 million) from 2001 to
2002. Homeowners premium increased 9.8% ($13.4 million) from 2002 to 2003 and
8.4% ($10.6 million) from 2001 to 2002. The increases in property and casualty
premiums resulted from the impact of rate increases on average premium per
policy. Average written premium was up approximately 5% in 2003 and 6% in 2002
for voluntary automobile. Homeowners average written premium increased
approximately 12% in 2003 and 14% in 2002. Average earned premium increased 5%
and 6% for voluntary automobile and 14% and 11% for homeowners for the same
periods. Through December 31, 2003, approved rate increases for the Company's
automobile and homeowners business were 7% and 13%, respectively, compared to
approved increases of 6% and 21%, respectively, during 2002. During 2003,
automobile policies in force decreased by 2,000 compared to December 31, 2002,
reflecting an increase in policies for educators which was more than offset by a
decrease in non-educator policies. Automobile policies in force at December 31,
2002 were equal to year-end 2001. Homeowners policies in force decreased 5,000
during 2003 and 8,000 during 2002 reflecting expected reductions due to the
Company's pricing and underwriting actions. At December 31, 2003, there were
571,000 voluntary automobile and 279,000 homeowners policies in force, for a
total of 850,000. At December 31, 2002, there were 573,000 voluntary automobile
and 284,000 homeowners policies in force for a total of 857,000. At December 31,
2001, there were 573,000 voluntary automobile and 292,000 homeowners policies in
force for a total of 865,000.
Based on policies in force, the property and casualty 12-month retention
rate for new and renewal policies was 88% in 2003, 87% in 2002 and 88% in 2001.
The Company plans additional rate increases in 2004 for both its automobile and
homeowners lines of business, which may have an adverse impact on policy
retention.
Involuntary property and casualty business includes allocations of business
from state mandatory insurance facilities and assigned risk business. For 2003,
involuntary and other property and casualty premiums written were comparable to
the prior year excluding the negative impact of adjustments made in the third
and fourth quarters to anticipated premiums from state mandatory insurance
facilities.
New annuity deposits increased 13.4% in 2003 and 9.4% in 2002. The 2003
growth primarily reflected a 45.8% increase in single premium and rollover
deposits partially offset by a 4.2% decrease in new scheduled annuity deposits.
New deposits to fixed accounts were 28.4%, or $40.1 million, higher than in 2002
and new deposits to variable accounts decreased 4.2%, or $5.0 million, compared
to a year earlier. The 2002 growth reflected an 8.8% increase in scheduled
deposits received and a 10.4% increase in single premium and rollover deposits.
2002 new deposits to fixed accounts were 15.6%, or $19.1 million, higher than in
2001, and new deposits to variable accounts increased 2.8%, or $3.3 million,
compared to 2001.
F-9
In 2001, the Company began building a nationwide network of independent
agents who will comprise a second distribution channel for the Company's 403(b)
tax-qualified annuity products. The independent agent distribution channel,
which included 465 authorized agents at December 31, 2003, generated $38.1
million in annualized new Horace Mann annuity sales during 2003, compared to
$10.5 million for the full year 2002 and no sales in 2001. A significant portion
of the 2002 amount, over $6 million, was produced as a result of Horace Mann
being named as one of four providers for fixed and variable annuity options to
Chicago, Illinois public school employees and the Company's partnering with an
independent broker/dealer having two decades of experience in providing
retirement planning services to Chicago Public School employees.
Total annuity accumulated cash value of $2.8 billion at December 31, 2003
increased 17.3% compared to a year earlier reflecting the growth in sales during
2003, continued favorable retention and an improving equity market. Total
annuity accumulated cash value of $2.4 billion at December 31, 2002 decreased
1.7% compared to a year earlier reflecting an increase in deposits to fixed
accounts that was more than offset by a decrease in variable accumulated funds
on deposit which were impacted by financial market values. In 2003, the number
of annuity contracts outstanding increased 4.1%, or 6,000 contracts, and in
2002, the increase was 5.8%, or 8,000 contracts.
In 2003, annuity segment contract charges earned increased 2.8%, or $0.4
million, following a decline of 4.7% in 2002, compared to 2001. Declines in
market valuations during 2002 and the first quarter of 2003 resulted in lower
variable accumulated balances in force against which contract charges are
principally applied. Market appreciation in the last nine months of 2003,
however, resulted in variable annuity accumulated balances at December 31, 2003
which were 31.0% higher than at December 31, 2002.
Life segment premiums and contract deposits declined slightly in 2003 and
decreased 3.7% in 2002. The life insurance in force lapse ratio improved to 7.7%
for the twelve months ended December 31, 2003 compared to 9.1% for the same
period in each of the prior two years.
Consistent with the Company's Value Proposition and overall strategy to
meet a broader array of consumer financial needs, the product portfolio that the
Company's agents can offer was expanded in 2003 through two new marketing
alliances. The first is with Jefferson Pilot Financial for universal life
insurance. Jefferson Pilot was a leading issuer of universal life policies in
the U.S. for 2002. The second alliance is with American Funds for retail mutual
funds. Both product rollouts began in the second quarter of 2003 and are
intended to help the Company reach more educators while deepening relationships
with existing clients. While business that the Company's agents write through
these and other partner companies is not recorded as Horace Mann premium,
generally the marketing allowance received is comparable to the Company's normal
underwriting margin, with no corresponding capital requirement.
Net Investment Income
Pretax investment income of $184.7 million for 2003 decreased 5.8%, or
$11.3 million, (4.7%, or $6.2 million, after tax) compared to the prior year as
a decline in the portfolio yield offset growth in the size of the investment
portfolio. Pretax investment income of $196.0 million for 2002 decreased 1.7%,
or $3.3 million, (1.6%, or $2.1 million after tax) compared to 2001 due
primarily to lost income related to investment credit issues and a decline in
the
F-10
portfolio yield which offset growth in the size of the investment portfolio.
Average investments (excluding securities lending collateral) increased 6.8%
during 2003 and 5.0% during 2002. The average pretax yield on the investment
portfolio was 5.9% (4.0% after tax) for 2003, 6.7% (4.5% after tax) for 2002 and
7.2% (4.8% after tax) for 2001.
Realized Investment Gains and Losses
Net realized investment gains were $25.5 million in 2003 compared to
realized investment losses of $49.4 million in 2002 and $10.0 million in 2001.
For the full year 2003, the Company recorded fixed income security impairment
charges totaling $12.5 million, $6.2 million related to two of the Company's
collateralized debt obligation ("CDO") securities, $3.1 million related to one
manufactured housing asset-backed security and the remaining $3.2 million
primarily related to two airline industry issuers. In 2002, the Company recorded
charges of $53.9 million due to the impairment of fixed income securities
primarily issued by companies in the communications sector. In 2001, $7.8
million of the $10.0 million realized loss resulted from the sale of all of the
Company's holdings in fixed income securities issued by Enron Corporation, with
the balance primarily attributable to credit-related sale and impairment of
securities issued by companies in the communications sector. Gains realized in
2003 included $16.1 million from sales of securities for which impairment
charges were recorded in 2002. Net realized investment gains and losses for
2003, 2002 and 2001 also reflected gains realized from ongoing investment
portfolio management activity.
In each of the periods, the impaired securities were marked to fair value,
and the write-downs were recorded as realized investment losses in the Statement
of Operations. These impairments were deemed to be other-than-temporary for one
or more of the following reasons: the recovery of full value was not likely, the
issuer defaulted or was likely to default due to the need to restructure its
debt, or the Company had an intent to sell the security in the near future.
F-11
The table below presents the Company's fixed maturity securities portfolio
as of December 31, 2003 by major asset class, including the ten largest sectors
of the Company's corporate bond holdings.
Pretax
Number of Fair Amortized Unrealized
Issuers Value Cost Gain(Loss)
--------- --------- --------- ----------
Corporate bonds
Banking and Finance.................... 34 $ 310.0 $ 285.9 $ 24.1
Energy................................. 40 219.1 205.4 13.7
Food and Beverage...................... 28 128.9 124.2 4.7
Utilities.............................. 19 128.9 123.3 5.6
Telecommunications..................... 15 108.8 101.2 7.6
Industry, Manufacturing................ 19 79.1 76.2 2.9
Insurance.............................. 10 77.4 73.8 3.6
Transportation......................... 10 77.2 76.7 0.5
Broadcasting and Media................. 21 51.4 46.6 4.8
Healthcare............................. 22 48.8 46.9 1.9
All Other Corporates (1)............... 104 418.8 393.8 25.0
--------- --------- --------- ----------
Total corporate bonds............... 322 1,648.4 1,554.0 94.4
Mortgage-backed securities
Government............................. 442 660.1 647.7 12.4
Other.................................. 6 56.5 53.4 3.1
Municipal bonds........................... 154 502.9 488.1 14.8
Government bonds
U.S.................................... 5 300.9 295.6 5.3
Foreign................................ 8 36.2 33.1 3.1
Collateralized debt obligations (2)....... 7 33.2 33.2 --
Asset-backed securities................... 7 20.5 19.8 0.7
--------- --------- --------- ----------
Total fixed maturity securities..... 951 $ 3,258.7 $ 3,124.9 $ 133.8
========= ========= ========= ==========
- ----------
(1) The All Other Corporates category contains 18 additional industry
classifications. Real estate, automobiles, paper, retail, defense,
chemicals, consumer products and metals represented $304.0 million of fair
value at December 31, 2003, with the remaining 10 classifications each
representing less than $27 million of the fair value at December 31, 2003.
(2) Six of the securities were rated investment grade by Standard and Poor's
Corporation and/or Moody's Investors Service, Inc. at December 31, 2003.
F-12
At December 31, 2003, the Company's diversified fixed maturity portfolio
consisted of 1,139 investment positions and totaled approximately $3.3 billion
in fair value. The portfolio was 94.1% investment grade, based on fair value,
with an average quality rating of A+. At December 31, 2003, the portfolio had
approximately $11 million pretax of total gross unrealized losses related to 113
positions. At December 31, 2002, the total pretax gross unrealized losses were
approximately $27 million related to 137 positions. The following table provides
information regarding fixed maturity securities that had an unrealized loss at
December 31, 2003, including the length of time that the securities have
continuously been in an unrealized loss position.
Investment Positions With Unrealized Losses Segmented by Quality
and Period of Continuous Unrealized Loss
As of December 31, 2003
Pretax
Number of Fair Amortized Unrealized
Positions Value Cost Loss
--------- --------- --------- ----------
Investment grade
6 Months or less....................... 65 $ 347.8 $ 352.9 $ (5.1)
7 through 12 months.................... 18 90.1 94.4 (4.3)
13 through 24 months................... 1 2.6 2.7 (0.1)
25 through 36 months................... 1 2.9 3.0 (0.1)
37 through 48 months................... -- -- -- --
Greater than 48 months................. -- -- -- --
--------- --------- --------- ----------
Total............................... 85 $ 443.4 $ 453.0 $ (9.6)
========= ========= ========= ==========
Non-investment grade
6 Months or less....................... 19 $ 11.3 $ 11.7 $ (0.4)
7 through 12 months.................... -- -- -- --
13 through 24 months................... -- -- -- --
25 through 36 months................... 1 5.9 6.1 (0.2)
37 through 48 months................... -- -- -- --
Greater than 48 months................. 2 9.4 10.0 (0.6)
--------- --------- --------- ----------
Total............................... 22 $ 26.6 $ 27.8 $ (1.2)
========= ========= ========= ==========
Not rated
Total, all 13 through 24 months..... 6 $ 2.5 $ 2.5 *
========= ========= ========= ==========
Grand total...................... 113 $ 472.5 $ 483.3 $ (10.8)
========= ========= ========= ==========
- ----------
* Less than $0.1 million
Of the securities with unrealized losses, no issuers had pretax unrealized
losses greater than $2 million and no securities were trading below 80% of book
value at December 31, 2003. The Company views the decrease in value of all of
the securities with unrealized losses at December 31, 2003 as temporary, expects
recovery in fair value, anticipates continued payments under the terms of the
securities, and has the intent and ability to hold these securities until
maturity or a recovery in fair value occurs. Therefore, no impairment of these
securities was recorded at December 31, 2003. Future changes in circumstances
related to these and other securities could require subsequent impairment in
value. The Company's investment guidelines generally limit single corporate
issuer concentrations to 4.0% (after tax) of shareholders' equity for "AA" or
"AAA" rated securities, 2.5% (after tax) of shareholders' equity for "A" rated
securities, 2.0% (after tax) of shareholders' equity for "BBB" rated securities,
and 1.0% (after tax) of shareholders' equity for non-investment grade
securities.
F-13
Benefits, Claims and Settlement Expenses
Year Ended Growth Over Year Ended
December 31, Prior Year December 31,
-------------------- --------------------- ------------
2003 2002 Percent Amount 2001
--------- --------- --------- ---------- ------------
Property and casualty..................... $ 472.9 $ 410.2 15.3% $ 62.7 $ 433.3
Annuity................................... 0.8 0.8 -- -- (0.8)
Life...................................... 45.3 39.9 13.5% 5.4 41.1
Corporate & other......................... -- -- -- -- 2.0
--------- --------- --------- ---------- ------------
Total.................................. $ 519.0 $ 450.9 15.1% $ 68.1 $ 475.6
========= ========= ========= ========== ============
Property and Casualty Claims and Claim Expenses
Year Ended December 31,
-------------------------------
2003 2002 2001
--------- --------- ---------
Incurred claims and claim expenses:
Claims occurring in the current year.............. $ 416.5 $ 387.7 $ 416.8
Increase (decrease) in estimated reserves for
claims occurring in prior years (1):
Policies written by the Company (2)............ 58.3 20.8 14.5
Business assumed from state reinsurance
facilities.................................... (1.9) 1.7 2.0
--------- --------- ---------
Total increase.............................. 56.4 22.5 16.5
--------- --------- ---------
Total claims and claim expenses
incurred (2)............................... $ 472.9 $ 410.2 $ 433.3
========= ========= =========
Net reserves, end of period.......................... $ 320.9 $ 272.6 $ 272.0
Plus reinsurance recoverables..................... 20.6 44.7 34.1
--------- --------- ---------
Gross reserves, end of period........................ $ 341.5 $ 317.3 $ 306.1
========= ========= =========
Property and casualty GAAP loss ratio:
Before catastrophe losses......................... 82.4% 76.6% 83.0%
After catastrophe losses.......................... 88.6% 78.9% 85.2%
Property and casualty GAAP loss ratio excluding net
increases in estimated reserves for claims occurring
in prior years:
Before catastrophe losses...................... 71.8% 72.0% 79.8%
After catastrophe losses....................... 78.0% 74.3% 82.0%
- ----------
(1) Shows the amounts by which the Company increased its reserves in each of
the periods indicated for claims occurring in previous periods to reflect
subsequent information on such claims and changes in their projected final
settlement costs.
(2) For the year ended December 31, 2002, these amounts excluded a $1.6 million
statutory accounting charge for class action litigation which was
separately reported as Litigation Charges in the Company's Consolidated
Statements of Operations.
In 2003, the voluntary automobile loss ratio increased compared to 2002
primarily reflecting adverse development and strengthening of prior years'
reserves, as described below. The Company's benefits, claims and settlement
expenses also reflected underlying improvement in the homeowners loss ratio as a
result of loss containment initiatives and the favorable impact of rate
increases on earned premiums which was offset by an increase in catastrophe
losses. In 2002, the Company's benefits, claims and settlement expenses
reflected improvements in both the voluntary automobile and the homeowners loss
ratios, including catastrophe losses and the impact of litigation charges, as a
result of mild weather, loss containment initiatives and the favorable impact of
the Company's restructuring of its Massachusetts automobile business. Favorable
property and casualty current accident year loss trends were partially offset by
adverse development in prior years' reserves. In 2001, the Company's benefits,
claims and settlement expenses were affected adversely by strengthening of prior
years' reserves for property and casualty claims and by a high level of
non-catastrophe weather-related losses.
F-14
Excluding involuntary business, net adverse development of reserves for
property and casualty claims occurring in prior years was $58.3 million for the
full year 2003, primarily related to automobile liability loss reserves from the
2001 and 2002 accident years, compared to adverse reserve development of $22.3
million in 2002 which was primarily related to (1) automobile loss reserves from
accident years 2001 and years prior to 1997 and (2) loss adjustment expense
reserves from the 2001 and 2000 accident years for both automobile and
homeowners. Adverse development recorded in 2002 also included $1.6 million due
to a provision for the costs of resolving class action lawsuits related to
diminished value brought against the Company. Net adverse development of total
reserves for property and casualty claims occurring in prior years, including
involuntary business, was $56.4 million in 2003, $24.0 million in 2002 and $16.5
million in 2001. The Company's property and casualty reserves were $320.9
million, $272.6 million and $272.0 million at December 31, 2003, 2002 and 2001,
respectively, net of anticipated reinsurance recoverables.
During 2002 and 2003, the Company made changes in its property and casualty
claims function including hiring of new management and claim adjusters (new
hires represented over half of the Company's 300 claims employees at December
31, 2003), implementing improved processes and consolidating the previous 17
branch offices into 6 regional claims offices, which began in late-November 2002
and was completed in the first quarter of 2003. Installation and implementation
of the new claims administration system, including related process changes,
occurred in the third and fourth quarters of 2003 in the first two claims
offices with the remaining four offices planned for the first half of 2004.
As part of the claims operation redesign effort, open claim files --
particularly for automobile liability claims -- were reviewed by the new team.
In the first half of 2003, these reassessments resulted in a higher projected
ultimate liability for automobile liability claims from accident years 2001,
2000 and 1999 and prior. The high level of property and casualty paid and case
reserve activity on older bodily injury claims that was observed in the second
quarter of 2003 continued in the third quarter as the Company's new claims
organization intensified their efforts to bring older claims files up to date.
Furthermore, the acceleration of claim disposition rates extended into the third
quarter, as the new organization also moved to reduce the backlog of older
claims and handle current claims on a timely basis. As a result, the estimation
of claims costs, settlement rates and severity has been complicated in recent
quarters due to the degree of change involved.
F-15
As a result of the factors above, and in light of the pattern of adverse
prior years' reserve development observed over the five quarters ended September
30, 2003, at the end of the third quarter, the Company's management retained an
independent property and casualty actuarial and claims consulting firm to
conduct a detailed review of the Company's claims handling practices and their
integration with the Company's reserving practices. The consultant's claims and
actuarial specialists reviewed claim files as well as past and current claims
handling processes and procedures, including case reserving practices, in each
of the Company's six claims offices. They also performed an assessment of the
Company's actuarial processes for establishing IBNR and supplemental reserves.
The Company's December 31, 2003 actuarial analysis and reserve estimates
incorporated the observations of the consultant's claims and reserving practices
review. The low and high end of a reasonable range of reserve estimates for all
of the Company's coverages indicated net claim reserve levels of $286 million
and $338 million, respectively. In recording the December 31, 2003 net reserves
of $320.9 million, the Company assessed the relative weight given to emerging
claim trends resulting from recent business process changes, pricing and claims
handling. Based upon this analysis, the Company selected a higher point in the
range for reserves related to the automobile liability coverages.
F-16
The following table quantifies the amount of adverse/(favorable) reserve
development recorded in each quarter in 2003 for each line of business and the
accident years to which the re-estimates relate:
Other
Voluntary Total Property &
Total Automobile Property Casualty
----------- ----------- ----------- -----------
Three months ended
March 31, 2003
- ---------------------
Accident Years:
2002.............. $ 0.8 $ 1.1 $ (0.9) $ 0.6
2001.............. 1.4 1.7 0.6 (0.9)
2000 & Prior...... 2.1 2.8 (0.1) (0.6)
----------- ----------- ----------- -----------
Total.......... $ 4.3 $ 5.6 $ (0.4) $ (0.9)
=========== =========== =========== ===========
Three months ended
June 30, 2003
- ---------------------
Accident Years:
2002.............. $ 5.8 $ 6.4 $ (0.6) $ --
2001.............. 0.7 1.0 (0.3) --
2000 & Prior...... 3.4 2.8 0.2 0.4
----------- ----------- ----------- -----------
Total.......... $ 9.9 $ 10.2 $ (0.7) $ 0.4
=========== =========== =========== ===========
Three months ended
September 30, 2003
- ---------------------
Accident Years:
2002.............. $ 12.9 $ 10.7 $ 1.3 $ 0.9
2001.............. 8.8 9.0 0.2 (0.4)
2000 & Prior...... 8.4 7.7 0.1 0.6
----------- ----------- ----------- -----------
Total.......... $ 30.1 $ 27.4 $ 1.6 $ 1.1
=========== =========== =========== ===========
Three months ended
December 31, 2003
- ---------------------
Accident Years:
2002.............. $ 7.8 $ 6.9 $ 0.3 $ 0.6
2001.............. 1.9 1.9 -- --
2000 & Prior...... 2.4 5.0 (0.2) (2.4)
----------- ----------- ----------- -----------
Total.......... $ 12.1 $ 13.8 $ 0.1 $ (1.8)
=========== =========== =========== ===========
During 2000, the Company noted increases in paid severities in excess of the
original expectations in its direct voluntary automobile line of business. As a
result, the Company continued to monitor such severity trends until such time as
the Company believed that they were sufficiently credible to require adjustment
to the Company's claim and claim expense reserve projections. Accordingly, the
Company revised its projections in the fourth quarter of 2000 to give greater
weight to the increasing trend of claim severities.
F-17
In 2001, the Company refined its claim reserving methodologies
and trend analyses including more detailed analyses of subrogation recovery
activity on business ceded to the state automobile insurance facility in
Massachusetts. The nature of the adverse trends in the second and fourth
quarters of 2001 that caused the Company to increase reserves consisted
primarily of the following: (1) an increase in the frequency and severity of
educators excess professional liability claims; (2) the utilization of selected
ultimate subrogation recoverables that were not trending with actual recoveries;
and (3) the utilization of selected ultimate loss ratios in establishing
reserves for ceded voluntary automobile excess liability claims and ceded
Massachusetts involuntary automobile reserves that were not trending with actual
results.
In the third quarter of 2002, the Company increased its reserves for prior
accident years primarily related to allocated claim adjustment expenses for the
voluntary automobile and homeowners lines and claims for the educator excess
professional liability product. The Company had noted increases in paid claims
and claim expenses for prior accident years in these lines during the first and
second quarters of 2002 and continued to monitor such adverse trends until such
time as the Company believed that they were sufficiently credible to require
adjustment of the reserves. As a result, the Company revised its loss
projections in the third quarter of 2002, incorporating the higher paid claims
and claim expense trends.
In the fourth quarter of 2002, the Company increased its reserves for prior
accident years related primarily to (1) automobile claim reserves from accident
years 2001, 2000 and years prior to 1997 and (2) allocated and unallocated claim
expense reserves from the 2001 accident year for both automobile and homeowners.
During the third and fourth quarters of 2002, the Company continued to closely
monitor emerging trends in (1) the severity of payments on previously reported
losses for voluntary automobile and (2) paid claim adjustment expenses for these
prior accident years until such time as the Company believed that the trends
were sufficiently credible to require adjustment of the reserves. As a result,
the Company revised its projections in the fourth quarter of 2002, incorporating
the higher paid claims and claim expense trends.
As the Company's claims operation redesign efforts progressed during 2003,
the elevated level of claim payments and case reserve activity related to prior
accident years continued. Consequently, the Company revised its loss projections
throughout 2003, most notably in the third quarter, as greater relative weight
was given to the emerging claim trends.
At the time each of the reserve analyses were performed, the Company
believed that each estimate was based upon sound and correct methodology, that
such methodology was appropriately applied and that there were no trends which
indicated the likelihood of future adverse development. The financial impact of
the net reserve strengthening was therefore accounted for in the period that the
change was determined.
F-18
For 2003, total incurred property and casualty catastrophe losses were
$33.2 million, the Company's record high, compared to $11.9 million in 2002 and
$11.2 million in 2001. The 2003 increase generated approximately 4 percentage
points of the increase in the property and casualty loss ratio. Homeowners
claims from the California wildfires, net of anticipated reinsurance recoveries,
represented $12.0 million of the 2003 losses and occurred in the fourth quarter.
Claims from Hurricane Isabel, primarily in the homeowners line, represented $5.0
million of the losses and occurred in the third quarter of 2003. Incurred
catastrophe losses in 2001 included a net benefit of $1.1 million due to
favorable development of reserves for 2000 catastrophe losses.
Including the higher level of catastrophe losses, the property loss ratio
of 82.6% for 2003 increased approximately 1.5 percentage points compared to 2002
in spite of a 13 percentage point increase attributable to higher catastrophe
losses in 2003. The adverse impact of catastrophes was nearly offset by an
increase in average premium per policy and an improvement in loss frequency as a
result of loss containment initiatives such as tightened underwriting
guidelines, deductible management and an aggressive reunderwriting program. The
property loss ratio was 97.0% in 2001.
The voluntary automobile loss ratio for 2003 increased approximately 13
percentage points compared to the prior year. The loss ratio in 2003 included
14.5 percentage points due to adverse development of prior years' reserves
compared to an impact of approximately 4 percentage points a year earlier. The
voluntary automobile loss ratio for 2002 decreased approximately 2 percentage
points compared to 2001.
As disclosed in the Company's Annual Reports on Form 10-K for 2002 and
2001, early in 2001 management discovered deficiencies in the tax compliance
testing procedures associated with certain of the Company's life insurance
policies that could jeopardize the tax status of some of those life policies.
Deficiencies in the Company's computer-based monitoring of premiums, combined
with the complexity of certain of the Company's life insurance products,
resulted in the acceptance of too much premium for certain policies under the
applicable tax test the Company was using. As a result of this discovery, the
Company retained outside experts to assist with the investigation and
remediation of this issue. The deficiencies in the testing procedures related to
compliance with Internal Revenue Code ("IRC") Section 7702 (Definition of Life
Insurance) were identified and corrected. Such a problem is not uncommon in the
life insurance industry and the Company pursued a remedy following Internal
Revenue Service ("IRS") procedures that have been established to address this
type of situation. The Company recorded $2.0 million of policyholder benefits in
the Corporate and Other segment in the fourth quarter of 2001, as well as $1.0
million of operating expense, which represented the Company's best estimate of
the costs to the Company to resolve these problems. In July 2003, the Company
entered into agreements with the IRS resolving its compliance with IRC Section
7702 (Definition of Life Insurance). The accrual established at December 31,
2001 was adequate to cover these costs.
The Company is in the process of identifying and correcting any related
deficiencies in the testing procedures and quantifying any potential exposure
associated with IRC Section 7702A (Modified Endowment Contracts). The Company
recorded $0.8 million of operating expense in the Corporate and Other segment in
the second quarter of 2003 which represents
F-19
its current best estimate of the costs to the Company to complete this
correction and assessment process. By the end of 2004, the Company expects to
have completed implementation of its testing procedures. In 2005, the Company
expects to quantify its potential exposure, if any, associated with IRC Section
7702A.
Interest Credited to Policyholders
Year Ended Growth Over Year Ended
December 31, Prior Year December 31,
------------------- ------------------ ------------
2003 2002 Percent Amount 2001
-------- -------- ------- -------- ------------
Annuity............. $ 71.3 $ 68.4 4.2% $ 2.9 $ 67.9
Life................ 31.7 30.0 5.7% 1.7 28.6
-------- -------- -------- ------------
Total............ $ 103.0 $ 98.4 4.7% $ 4.6 $ 96.5
======== ======== ======== ============
Compared to the prior year, the 2003 increase in annuity segment interest
credited reflected an 8.9% increase in average accumulated fixed deposits,
partially offset by a 22 basis point decline in the average annual interest rate
credited to 4.6%. Compared to the 2001 rate of 5.1%, the fixed annuity average
annual interest rate credited decreased to 4.8% for 2002. Offsetting the decline
in the rate credited, the average accumulated fixed deposits increased 6.4% for
2002 compared to 2001. Life insurance interest credited increased in both 2003
and 2002 as a result of the growth in interest-sensitive life insurance
reserves.
Operating Expenses
In 2003, operating expenses increased $6.1 million, or 4.6%, compared to
2002 including an increase in investments in technology and property and
casualty underwriting initiatives as well as fees related to the Company's life
subsidiary surplus relief transaction. In 2002, operating expenses increased
$7.5 million, or 6.1%, compared to 2001. The higher level of company-wide
expense was due predominantly to increased employee benefits costs, including
transition costs related to changes in the Company's defined benefit pension
plan, and reduced employee incentive compensation expenses in 2001. Excluding
these factors, operating expenses for the two periods were approximately equal.
In 2001, the Company determined that it would freeze its defined benefit
pension plan in 2002 and move to a defined contribution structure. Costs of
transitioning to the new structure, based upon assumptions of future events,
were $4.8 million and $6.2 million in 2003 and 2002, respectively, and are
currently estimated to be approximately $4 million for 2004. These costs are
largely as a result of settlement accounting provisions that are expected to be
triggered as a result of the higher retirement rate currently being experienced
by the Company, coupled with more retirees choosing lump sum distributions, and
the impact of declines in the market value of the pension plan's assets in 2002
and 2001.
The Company's policy with respect to funding the defined benefit pension
plan is to contribute amounts which are actuarially determined to provide the
plan with sufficient assets to meet future benefit payments consistent with the
funding requirements of federal laws and regulations. In 2002, the Company
contributed $7.9 million to the defined benefit pension plan, which was greater
than the $1.8 million actuarially-determined required minimum amount, reflecting
a degree of conservatism which the Company believed to be appropriate in light
of the then current volatility in the financial markets. In 2003, the Company
contributed $8.8 million to the defined benefit pension plan, with the entire
amount being in excess of the required minimum amount. Based on assumptions at
the time of this Report on Form 10-K,
F-20
the Company anticipates contributing approximately $3.5 million to the defined
benefit pension plan in 2004. All defined benefit pension plan investments are
set aside in a trust fund.
The property and casualty GAAP expense ratio of 23.7% for the year ended
December 31, 2003 increased approximately 1 percentage point over 2002, and the
2002 ratio increased approximately 1.5 percentage points over 2001, in both
cases primarily reflecting the property and casualty segment's portion of the
increase in corporate-wide expenses.
Amortization of Policy Acquisition Expenses and Intangible Assets
For 2003, the combined amortization of policy acquisition expenses and
intangible assets was $69.3 million compared to $67.0 million recorded in 2002
and $63.8 million recorded in 2001. Amortization of intangible assets was $5.0
million for the year ended December 31, 2003 compared to $5.7 million for 2002
and $5.8 million in 2001. Amortization of goodwill, which was $1.6 million in
2001, was eliminated with the 2002 adoption of SFAS No. 142, "Goodwill and Other
Intangible Assets".
Amortized policy acquisition expenses of $64.3 million in 2003 were $3.0
million more than the prior year and 2002 amortization exceeded 2001 by $3.3
million, in both cases primarily related to the property and casualty segment.
Income Tax Expense
The effective income tax rate on the Company's pretax income, including
realized investment gains and losses, was a tax of 1.0% for the year ended
December 31, 2003 compared to a benefit of 46.8% for 2002 and a tax of 9.5% for
2001.
Income from investments in tax-advantaged securities reduced the effective
income tax rate 36.3, 76.2 and 13.4 percentage points for the years ended
December 31, 2003, 2002 and 2001, respectively. While the amount of income from
tax-advantaged securities in 2003 increased somewhat compared to 2002, the
reduced level of income before income taxes in 2002 resulted in this having a
more significant impact on the 2002 effective income tax rate. The impact of tax
advantaged securities in 2002 included 13.3 percentage points from the prior
year's tax return. Also in 2002 and 2001, the Company's tax provision was
reduced by $0.8 million and $3.0 million, respectively, reflecting the release
of excess tax provision previously recorded, representing 9.9 and 10.7
percentage points, respectively.
Net Income
For 2003, the Company reported net income of $19.0 million, or $0.44 per
share, compared to $11.3 million, or $0.28 per share, for 2002 and $25.6
million, or $0.63 per share, in 2001. In 2003, net income was negatively
impacted by adverse development and strengthening of prior years' property and
casualty reserves as well as a significant level of catastrophe losses,
partially offset by net realized gains on securities. 2003 net income
comparisons to 2002 were also negatively impacted by decreases in investment
income. These negative prior year comparisons were partially offset by the
impact of property and casualty rate increases on earned premiums and favorable
property loss results excluding the impact of catastrophes.
F-21
Net income in 2002 as compared to 2001 benefited from positive developments
in the Company's property and casualty segment including: the impact of rate
increases on earned premiums; improved 2002 accident year loss trends; lower
weather-related losses; and the Company's restructuring of its Massachusetts
automobile business. In addition, net income in 2002 benefited from the January
1, 2002 discontinuance of goodwill amortization. These positive prior year
comparisons were partially offset by greater adverse development of property and
casualty prior years' reserves. Net income in 2002 was also negatively affected
by (1) the significant level of realized investment losses, (2) decreases in
investment income due to lost income related to investment credit issues and
declining interest rates, (3) tightening margins on variable annuities resulting
from adverse market conditions and (4) higher company-wide operating expenses
resulting primarily from transition costs related to changes in the Company's
retirement plans and lower employee incentive compensation in 2001.
Net income (loss) by segment and net income per share were as follows:
Year Ended Growth Over Year Ended
December 31, Prior Year December 31,
--------------------------- --------------------------- ------------
2003 2002 Percent Amount 2001
------------ ------------ ------------ ------------ ------------
Net income (loss)
Property & casualty
Before catastrophe losses........... $ 3.8 $ 27.7 -86.3% $ (23.9) $ 12.5
Catastrophe losses, after tax....... (21.6) (7.8) (13.8) (7.3)
------------ ------------ ------------ ------------
Total including catastrophe
losses ......................... (17.8) 19.9 (37.7) 5.2
Annuity................................ 14.4 17.0 -15.3% (2.6) 20.6
Life................................... 13.4 18.9 -29.1% (5.5) 18.7
Corporate and other (1)................ 9.0 (44.5) 53.5 (18.9)
------------ ------------ ------------ ------------
Total............................ $ 19.0 $ 11.3 68.1% $ 7.7 $ 25.6
============ ============ ============ ============
Net income per share, diluted............. $ 0.44 $ 0.28 57.1% $ 0.16 $ 0.63
============ ============ ============ ============
Property and casualty
GAAP combined ratio:
Before catastrophe losses........... 106.1% 99.6% 6.5% 104.6%
After catastrophe losses............ 112.3% 101.9% 10.4% 106.8%
- ----------
(1) The Corporate and Other segment includes interest expense on debt, realized
investment gains and losses, certain public company expenses and other
corporate level items. The Company does not allocate the impact of
corporate level transactions to the insurance segments, consistent with
management's evaluation of the results of those segments
Net income for the property and casualty segment has been significantly
impacted by adverse development of prior years' reserves and, in 2003,
catastrophe losses which are described in "Results of Operations for the Three
Years Ended December 31, 2003 -- Benefits, Claims and Settlement Expenses".
Annuity segment net income in 2003 decreased $2.6 million compared to 2002
which, in turn, declined by $3.6 million compared to 2001. 2003 income was
adversely impacted by a reduction in the pretax net interest margin of $6.2
million, reflecting spread compression due to lower investment income. Partially
offsetting this, valuation of annuity segment deferred acquisition costs and
value of acquired insurance in force at December 31, 2003 resulted in a $2.6
million reduction in amortization compared to a minimal impact resulting from
similar valuations a year earlier. 2002 annuity segment net income, particularly
for the last half of 2002, was adversely impacted by reductions in investment
income as a result of investment credit issues, declining interest rates and the
increase in company-wide operating expenses.
F-22
Life segment net income decreased $5.5 million compared to 2002, primarily
reflecting a decline in investment income, an increase in mortality costs and
fees in 2003 related to the Company's surplus relief transactions. 2002 life
segment net income was comparable to 2001.
The change in the 2003 net income (loss) for the Corporate and Other
segment compared to 2002 primarily reflected realized investment gains in 2003
compared to realized investment losses, including impairment charges, in 2002.
Interest expense on the Company's outstanding debt decreased compared to the
prior year, reflecting refinancing transactions completed in the last eight
months of 2002. The increase in the net loss for the corporate and other segment
in 2002 compared to 2001 primarily reflected the significant increase in
realized investment losses in 2002, as described above. This segment benefited
from the change in accounting, which was effective January 1, 2002, that
eliminated goodwill amortization. For the year ended December 31, 2001,
amortization of goodwill was $1.6 million. In 2001, the loss for the corporate
and other segment reflected (1) a pretax charge of $3.0 million related to
problems with the life insurance tax status of certain of the Company's life
policies and also (2) a $3.0 million reduction of the Company's tax provision,
reflecting the release of excess tax provision previously recorded.
In May, September and October 2002, the Company used a portion of the
proceeds from the sale of its Convertible Notes to repay the balance outstanding
under the previous Bank Credit Agreement and repurchase $71.4 million of its
outstanding Senior Notes and $53.0 million aggregate principal amount, $25.2
million carrying value, of its outstanding Senior Convertible Notes. The debt
retirement in 2002 resulted in a pretax charge of $2.3 million. In June 2002,
the Company recorded a pretax charge of $1.6 million to income, representing the
Company's best estimate of the costs of resolving class action lawsuits related
to diminished value brought against the Company. In addition, in the third
quarter of 2002 the Company recorded a pretax charge of $4.2 million due to
restructuring of its property and casualty claim operations. These three charges
were reflected in the Corporate and Other net loss for the year ended December
31, 2002.
In 2001, the Company reached conclusion on its strategic direction for
automobile business in the State of Massachusetts and recorded charges of $7.3
million pretax related to actions to restructure its presence in the
Massachusetts automobile market. Also in 2001, the Company recorded federal
income tax benefits of $1.3 million due to resolution of the Company's liability
for the 1997 tax year.
Return on shareholders' equity based on net income was 3%, 2% and 6% for
the 12 months ended December 31, 2003, 2002 and 2001, respectively.
Based on the Company's full year 2003 results and generally positive
underlying operating trends, at the time of this Report on Form 10-K, management
anticipates that 2004 full year net income before realized investment gains and
losses will be within a range of $1.20 to $1.30 per share. This projection
reflects management's anticipation of improvement in the underlying (current
accident year) property and casualty combined ratio and stabilization of income
from the annuity and life segments. As described in "Critical Accounting
Policies," certain of the Company's significant accounting measurements require
the use of estimates and assumptions. As additional information becomes
available, adjustments may be required. Those adjustments are charged or
credited to income for the period in which the adjustments are made and may
impact actual results compared to management's current estimate. A projection of
net income is not accessible on a forward-looking basis because it is not
possible
F-23
to provide a reliable forecast of realized investment gains and losses, which
can vary substantially from one period to another and may have a significant
impact on net income.
Liquidity and Financial Resources
Special Purpose Entities
At December 31, 2003, 2002 and 2001, the Company did not have any
relationships with unconsolidated entities or financial partnerships, such as
entities often referred to as structured finance or special purpose entities,
which would have been established for the purpose of facilitating off-balance
sheet arrangements or for other contractually narrow or limited purposes. As
such, the Company is not exposed to any financing, liquidity, market or credit
risk that could arise if the Company had engaged in such relationships.
Related Party Transactions
The Company does not have any contracts or other transactions with related
parties that are required to be reported under the applicable securities laws
and regulations.
Ariel Capital Management, Inc., HMEC's largest shareholder with 30% of the
common shares outstanding per their SEC filing on Form 13F as of December 31,
2003, is the investment adviser for two of the mutual funds offered to the
Company's annuity customers. In addition, T. Rowe Price Associates, Inc., HMEC's
third largest shareholder with 8% of the common shares outstanding per their SEC
filing on Form 13F as of December 31, 2003, is the investment advisor for two of
the mutual funds offered to the Company's annuity customers.
Investments
Information regarding the Company's investment portfolio, which is
comprised primarily of investment grade, fixed income securities, is located in
"Business -- Investments".
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 debt.
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. For 2003, net cash provided by
operating activities decreased compared to 2002 reflecting an increase in
federal income taxes paid, a reduction
F-24
in investment income collected, and an increase in net cash used for insurance
underwriting. In 2003 and 2002, the Company made cash contributions to its
defined benefit pension plan trust fund of $8.8 million and $7.9 million,
respectively, both exceeding the actuarially-determined required minimum amount.
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 2004 without
prior approval are approximately $43 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 payment of dividends, the receipt
and withdrawal of funds by annuity contractholders, repurchases of the Company's
common stock, and borrowings, repayments and repurchases related to its debt
facilities. Fees related to the catastrophe-linked equity put option and
reinsurance agreement, which augments the Company's traditional reinsurance
program, have been charged directly to additional paid-in capital.
For the year ended December 31, 2003, receipts from annuity contracts
increased 13.4%. Annuity contract maturities and withdrawals decreased $97.0
million, or 51.1%, compared to the prior year. Cash value retentions for
variable and fixed annuity options were 92.8% and 95.1%, respectively, for the
12 month period ended December 31, 2003. Net transfers to variable annuity
accumulated cash values increased $95.8 million compared to the prior year.
F-25
Contractual Obligations
Payments Due By Period
As of December 31, 2003
------------------------------------------------------------------------
More Than
Less Than 1 - 3 Years 3 - 5 Years 5 Years
1 Year (2005 and (2007 and (2009 and
Total (2004) 2006) 2008) beyond)
------------ ------------ ------------ ------------ ------------
Short-term Obligations (1):
Bank Credit Facility................... $ 25,781 $ 550 $ 25,231 -- --
Long-Term Debt Obligations (1):
Convertible Notes Due 2032............. 256,694 3,484 6,968 $ 1,742 $ 244,500
Senior Notes Due 2006.................. 33,337 1,895 31,442 -- --
------------ ------------ ------------ ------------ ------------
Total............................... $ 315,812 $ 5,929 $ 63,641 $ 1,742 $ 244,500
============ ============ ============ ============ ============
- ----------
(1) Includes principal and interest.
The Company has entered into various operating lease agreements, primarily
for computer equipment, computer software and real estate (agency and claims
offices across the country and portions of the home office complex). These
leases have varying commitment periods with most in the 1 to 3 year range.
Payments on these leases were approximately $10 million in 2003 and
approximately $8 million for each of the years ended December 31, 2002 and 2001.
It is anticipated that the Company's payments under operating leases for the
full year 2004 will be comparable to the 2003 payments. The Company does not
have any other arrangements that expose it to material liability that are not
recorded in the financial statements.
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 total capital of the Company was $700.2 million at December 31, 2003,
including $144.7 million of long-term debt and $25.0 million of short-term debt
outstanding. Total debt represented 27.4% of capital excluding unrealized
investment gains and losses (24.2% including unrealized investment gains and
losses) at December 31, 2003, slightly above the Company's long-term target of
25%.
Shareholders' equity was $530.5 million at December 31, 2003, including a
net unrealized gain in the Company's investment portfolio of $81.6 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 $596.8 million and $13.97, respectively, at
F-26
December 31, 2003. Book value per share was $12.42 at December 31, 2003 ($10.51
excluding investment fair value adjustments).
On May 14, 2002, the Company issued $353.5 million aggregate principal
amount of 1.425% Senior Convertible Notes ("Senior Convertible Notes"), which
will mature on May 14, 2032, at a discount of 52.5% resulting in an effective
yield of 3.0%. The Senior Convertible Notes were privately offered only to
qualified institutional buyers under Rule 144A under the Securities Act of 1933
and outside the U.S. to non-U.S. persons under Regulation S under the Securities
Act of 1933. A Securities and Exchange Commission registration statement
registering the Senior Convertible Notes was declared effective on November 4,
2002. At a meeting held on September 10 and 11, 2002, the Company's Board of
Directors authorized the Company to repurchase, from time to time, for cash or
other consideration, its Senior Convertible Notes. As of December 31, 2002, net
proceeds from the sale of the Senior Convertible Notes had been used to (1)
repay the $53.0 million balance outstanding under the previous Bank Credit
Agreement on May 14, 2002, (2) repurchase a total of $71.4 million aggregate
principal amount of the Company's outstanding 6 5/8% Senior Notes due January
15, 2006 ("Senior Notes") at an aggregate cost of $74.7 million, and (3)
repurchase $53.0 million aggregate principal amount, $25.2 million carrying
value, of the Company's outstanding Senior Convertible Notes at an aggregate
cost of $22.8 million. The remaining proceeds were used for general corporate
purposes. In addition to the cash repurchase transactions, in December 2002 the
Company repurchased an additional $56.0 million aggregate principal amount,
$26.6 million carrying value, of the outstanding Senior Convertible Notes at an
aggregate cost of $26.0 million in a non-cash transaction. As consideration for
this repurchase, 1.8 million shares of HMEC's common stock were issued.
Interest on the Senior Convertible Notes is payable semi-annually at a rate
of 1.425% from November 14, 2002 until May 14, 2007. After that date, cash
interest will not be paid on the Senior Convertible Notes prior to maturity
unless contingent cash interest becomes payable. From May 15, 2007 through
maturity of the Senior Convertible Notes, interest will be recognized at the
effective rate of 3.0% and will represent the accrual of discount, excluding any
contingent cash interest that may become payable. Contingent cash interest
becomes payable if the average market price of a Senior Convertible Note for a
five trading day measurement period preceding the applicable six-month period
equals 120% or more of the sum of the Senior Convertible Note's issue price,
accrued original issue discount and accrued cash interest, if any, for such
Senior Convertible Note. The contingent cash interest payable per Senior
Convertible Note with respect to any quarterly period within any six-month
period will equal the then applicable conversion rate multiplied by the greater
of (1) $0.105 or (2) any regular cash dividends paid by the Company per share on
HMEC's common stock during that quarterly period.
The Senior Convertible Notes will be convertible at the option of the
holders into shares of HMEC's common stock at a conversion price of $26.74, if
the conditions for conversion are satisfied. Holders may also surrender Senior
Convertible Notes for conversion during any period in which the credit rating
assigned to the Senior Convertible Notes is Ba2 or lower by Moody's or BB+ or
lower by S&P, the Senior Convertible Notes are no longer rated by either Moody's
or S&P, or the credit rating assigned to the Senior Convertible Notes has been
suspended or withdrawn by either Moody's or S&P. The Senior Convertible Notes
will cease to be convertible pursuant to this credit rating criteria during any
period or periods in which all of the credit ratings are increased above such
levels. The Senior Convertible Notes are redeemable by HMEC in whole or in part,
at any time on or after May 14, 2007, at redemption
F-27
prices equal to the sum of the issue price plus accrued original issue discount
and accrued cash interest, if any, on the applicable redemption date. The
holders of the Senior Convertible Notes may require HMEC to purchase all or a
portion of their Senior Convertible Notes on either May 14, 2007, 2012, 2017,
2022, or 2027 at stated prices plus accrued cash interest, if any, to the
purchase date. HMEC may pay the purchase price in cash or shares of HMEC common
stock or in a combination of cash and shares of HMEC common stock.
The Senior Convertible Notes have an investment grade rating from Standard
& Poor's Corporation ("S&P") (BBB), Moody's Investors Service, Inc. ("Moody's")
(Baa3), Fitch Ratings, Ltd. ("Fitch") (BBB+), and A.M. Best Company, Inc. ("A.M.
Best") (bbb-). Also see "Financial Ratings". The Senior Convertible Notes are
traded in the open market (HMN 1.425).
In January 1996, the Company issued $100.0 million aggregate principal
amount of 6 5/8% Senior Notes ("Senior Notes") at a discount of 0.5% which will
mature on January 15, 2006. In 2002, the Company repurchased $71.4 million
aggregate principal amount of its outstanding Senior Notes utilizing a portion
of the proceeds from the issuance of the Senior Convertible Notes, as described
above. 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 S&P (BBB), Moody's (Baa3),
Fitch (BBB+) and A.M. Best (bbb-). The Senior Notes are traded on the New York
Stock Exchange (HMN 6 5/8).
On December 31, 2003, the Company borrowed $25.0 million under its Bank
Credit Agreement at an interest rate of Interbank Offering Rate plus 1.0%, or
2.2%. The Bank Credit Agreement provides for unsecured borrowings of up to $25.0
million, with a provision that allows the commitment amount to be increased to
$35.0 million (the "Bank Credit Facility"). The Bank Credit Facility expires on
May 31, 2005. Interest accrues at varying spreads relative to corporate or
eurodollar base rates and is payable monthly or quarterly depending on the
applicable base rate. The unused portion of the Bank Credit Facility is subject
to a variable commitment fee, which was 0.25% on an annual basis at December 31,
2003.
To provide additional capital management flexibility, the Company filed a
"universal shelf" registration on Form S-3 with the SEC in December 2003. The
registration statement, which registers the offer and sale by the Company from
time to time of up to $300 million of various securities, which may include debt
securities, preferred stock, common stock and/or depositary shares, was declared
effective on December 30, 2003. No securities associated with the registration
statement have been issued as of the date of this Report on Form 10-K.
The Company's ratio of earnings to fixed charges for the year ended
December 31, 2003 was 4.0x, reflecting the impact of $56.4 million of pretax
adverse development of prior years' property and casualty reserves recorded in
2003, compared to 1.9x for the prior year which reflected $49.4 million of
pretax realized investment losses recognized during 2002.
Total shareholder dividends were $18.0 million for the year ended December
31, 2003. In March 2004, the Board of Directors announced a regular quarterly
dividend of $0.105 per share.
Information regarding the reinsurance program for the Company's property
and casualty segment is located in "Business -- Property and Casualty Segment --
Property and Casualty Reinsurance".
F-28
On December 31, 2003, the Company's primary life insurance subsidiary,
Horace Mann Life Insurance Company ("HMLIC"), entered into a reinsurance
agreement with the United States branch of Sun Life Assurance Company of Canada
("SLACC") which replaced the 2002 agreement with Sun Life Reinsurance Company
Limited ("SLRCL"), a member of the Sun Life Financial Group. Under the terms of
the December 31, 2003 agreement, which is expected to be in place for a five
year period, HMLIC ceded to SLACC, on a combination coinsurance and modified
coinsurance basis, a 75% quota share of HMLIC's in force interest-sensitive life
block of business issued prior to January 1, 2002. SLACC assumes its
proportional share of all risks attendant to the business reinsured such as
mortality, persistency and investment risk, reducing HMLIC's liabilities under
statutory accounting principles to the extent of the ceded commission. The
initial ceded commission received by HMLIC was $50.0 million and resulted in a
$32.5 million after-tax increase in HMLIC's statutory surplus. Subsequent growth
in HMLIC's statutory surplus is expected to be reduced by approximately $6.5
million annually, as the coinsurance reserve declines over the term of the
agreement. Fees related to these transactions, which are anticipated to reduce
the Company's pretax GAAP income by approximately $1 million in 2004, are also
expected to decline over the term of the agreement. These transactions improved
the statutory operating leverage and risk-based capital ratio of HMLIC in 2003
and 2002. The agreement contains a condition whereby HMLIC must maintain an S&P
financial strength rating of BBB- or higher. If this condition is not maintained
for a period of more than 60 consecutive days, HMLIC may recapture the agreement
without penalty after giving 30 days written notice.
Financial Ratings
The Company's principal insurance subsidiaries are rated by Standard &
Poor's Corporation ("S&P"), Moody's Investors Service, Inc. ("Moody's"), Fitch
Ratings, Ltd. ("Fitch") and A.M. Best Company, Inc. ("A.M. Best"). These rating
agencies have also assigned ratings to the Company's long-term debt securities.
Assigned ratings as of March 1, 2004 were as follows (the insurance
financial strength ratings for the Company's property and casualty insurance
subsidiaries and the Company's principal life insurance subsidiary are the same,
except where indicated):
Insurance
Financial
Strength Ratings Debt Ratings
(Outlook) (Outlook)
---------------- ----------------
As of March 1, 2004
- -------------------------------
S&P (1)........................ A (negative) BBB (negative)
Moody's (1).................... P&C: A3 (negative) Baa3 (negative)
Life: A3 (stable)
Fitch.......................... A+ (negative) BBB+ (negative)
A.M. Best...................... A- (stable) bbb- (stable)
- ----------
(1) This agency has not yet rated Horace Mann Lloyds.
In October 2003, Fitch lowered by one notch the insurance financial
strength and senior debt ratings of Horace Mann Educators Corporation. The
financial strength ratings of the Company's insurance subsidiaries were lowered
to "A+" from "AA-" and the senior debt ratings were lowered to "BBB+" from "A-".
At that time, the outlook for each of the ratings was Stable.
F-29
Fitch indicated that the rating action reflected their belief that it will
be difficult for Horace Mann's property and casualty operations to return to the
significantly better than industry average underwriting performance that had
historically been achieved. Additionally, Fitch believed that life and annuity
earnings and surplus growth for 2003 would be below historical levels due to
spread compression on the fixed annuity products and lower levels of separate
account assets under management. Fitch also indicated that the ratings continue
to be supported by the Company's strong risk based capitalization, well defined
market niche in the educator market, strong reinsurance protection and a high
quality, liquid investment portfolio. Fitch noted that the Company continues to
have an advantageous position in the educator marketplace and reasonable
business strategies for profitable growth.
On October 27, 2003, the Company pre-announced the third quarter 2003
adverse development and strengthening of property and casualty reserves and the
related impact on net income for the third quarter of 2003. Following this
announcement, S&P placed the Company's "BBB+" debt ratings and "A+" financial
strength ratings on CreditWatch with negative implications. Moody's also placed
the Company's "Baa2" debt ratings and "A2" insurance financial strength ratings
on review for possible downgrade. Both rating agencies noted that they would
review and update their analyses of the Company's property and casualty reserve
adequacy and development trends, as well as prospective earnings, interest
coverage, capitalization levels and spread compression on the Company's annuity
business.
In November 2003, A.M. Best lowered by one notch the Company's financial
strength and debt ratings. The financial strength rating was lowered to "A-"
from "A" and the debt ratings were lowered to "bbb-" from "bbb+". A.M. Best
indicated that the downgrades reflected the decline in capitalization driven by
unfavorable operating results in recent years in the property and casualty
operations. A.M. Best also noted that, although it had declined, the property
and casualty capital position continued to support the "A- (Excellent)" rating.
A.M. Best's announcement also noted positive factors regarding the Company's
operations, similar to the Fitch announcement in October 2003. The outlook for
each of the ratings is Stable, as confirmed in a subsequent press release which
A.M. Best issued in December 2003.
In December 2003, Moody's lowered by one notch the Company's financial
strength and debt ratings primarily as a result of the Company's ongoing
struggles with adverse development of prior years' property and casualty
reserves and the impact that has had on earnings and organic capital growth. The
financial strength rating was lowered to "A3" from "A2" and its debt rating was
lowered to "Baa3" from "Baa2". The outlook for the debt rating and the financial
strength rating for the property and casualty subsidiaries remained Negative,
reflecting the agency's continued concerns with the Company's ability to improve
earnings over the near-term. The outlook for the financial strength rating of
the principal life subsidiary is Stable.
Also in December 2003, S&P lowered by one notch the Company's financial
strength and debt ratings, citing reasons similar to those of Moody's. The
financial strength rating was lowered to "A" from "A+" and the debt rating was
lowered to "BBB" from "BBB+". Although the announcement noted a number of
positive operating factors, the outlook for each of the ratings remained
Negative.
In February 2004, Fitch revised the outlook on the Company's "A+" financial
strength ratings and "BBB+" debt ratings to Negative. The change in outlook
followed the Company's announcement of fourth quarter and full year 2003
earnings which included property and
F-30
casualty results that were outside of Fitch's previous expectations. Fitch
reiterated that the Company's solid risk-based capitalization, sound catastrophe
reinsurance program and high quality, liquid investment portfolio continue to
support the ratings as assigned.
Market Value Risk
Market value risk, the Company's primary market risk exposure, is the risk
that the Company's invested assets will decrease in value. This decrease in
value may be due to a change in (1) the yields realized on the Company's assets
and prevailing market yields for similar assets, (2) an unfavorable change in
the liquidity of the investment, (3) an unfavorable change in the financial
prospects of the issuer of the investment, or (4) a downgrade in the credit
rating of the issuer of the investment. See also "Results of Operations for the
Three Years Ended December 31, 2003 -- Realized Investment Gains and Losses".
Significant changes in interest rates expose the Company to the risk of
experiencing losses or earning a reduced level of income based on the difference
between the interest rates earned on the Company's investments and the credited
interest rates on the Company's insurance liabilities.
The Company manages its market value risk by coordinating the projected
cash inflows 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, while providing for liquidity and diversification. The investment risk
associated with variable annuity deposits and the underlying mutual funds is
assumed by those contractholders, and not by the Company. Certain fees that the
Company earns from variable annuity deposits are based on the market value of
the funds deposited.
Through active investment management, the Company invests available funds
with the objective of funding future obligations to policyholders, subject to
appropriate risk considerations, and maximizing shareholder value. This
objective is met through investments that (1) have similar characteristics to
the liabilities they support; (2) are diversified among industries, issuers and
geographic locations; and (3) are predominately investment-grade fixed maturity
securities classified as available for sale. No derivatives are used to manage
the exposure to interest rate risk in the investment portfolios. At December 31,
2003, approximately 20% of the fixed investment portfolio represented
investments supporting the property and casualty operations and approximately
80% supported the life and annuity business. For a discussion regarding the
Company's investments see "Business -- Investments."
The Company's life and annuity earnings are affected by the spreads between
interest yields on investments and rates credited or accruing on life and fixed
annuity insurance liabilities. Although substantially all credited rates on
fixed annuities may be changed annually (subject to minimum guaranteed rates),
competitive pricing and other factors, including the impact on the level of
surrenders and withdrawals, may limit the Company's ability to adjust or to
maintain crediting rates at levels necessary to avoid narrowing of spreads under
certain market conditions.
Using financial modeling and other techniques, the Company regularly
evaluates the appropriateness of investments relative to the characteristics of
the liabilities that they support. Simulations of cash flows generated from
existing business under various interest rate
F-31
scenarios measure the potential gain or loss in fair value of interest-rate
sensitive assets and liabilities. Such estimates are used to closely match the
duration of assets to the duration of liabilities. The overall duration of
liabilities of the Company's multiline insurance operations combines the
characteristics of its long duration interest-sensitive life and annuity
liabilities with its short duration non-interest-sensitive property and casualty
liabilities. Overall, at December 31, 2003, the duration of both the investment
portfolio and the Company's insurance liabilities was approximately 6.0 years.
The life and annuity operations participate in the cash flow testing
procedures imposed by statutory insurance regulations, the purpose of which is
to insure that such liabilities are adequate to meet the Company's obligations
under a variety of interest rate scenarios. Based on these procedures, the
Company's assets and the investment income expected to be received on such
assets are adequate to meet the insurance policy obligations and expenses of the
Company's insurance activities in all but the most extreme circumstances.
The Company periodically evaluates its sensitivity to interest rate risk.
Based on commonly used models, the Company projects the impact of interest rate
changes, assuming a wide range of factors, including duration and prepayment, on
the fair value of assets and liabilities. Fair value is estimated based on the
net present value of cash flows or duration estimates. At December 31, 2003,
assuming an immediate decrease of 100 basis points in interest rates, the net
fair value of the Company's assets and liabilities would increase by
approximately $6 million after tax, or 1% of shareholders' equity. A 100 basis
point increase would decrease the fair value of assets and liabilities by
approximately $20 million after tax, or 4% of shareholders' equity. At December
31, 2002, assuming an immediate decrease of 100 basis points in interest rates,
the net fair value of the Company's assets and liabilities would have decreased
by approximately $21 million after tax, or 4% of shareholders' equity. A 100
basis point increase would have decreased the fair value of assets and
liabilities by $2 million after tax, or less than 1% of shareholders' equity. In
each case, these changes in interest rates assume a parallel shift in the yield
curve.
While the Company believes that these assumed market rate changes are
reasonably possible, actual results may differ, particularly as a result of any
management actions that would be taken to mitigate such hypothetical losses in
fair value of shareholders' equity. Based on the Company's overall exposure to
interest rate risk, the Company believes that these changes in interest rates
would not materially affect its consolidated near-term financial position,
results of operations or cash flows.
Information Systems Risk
The Company administers its insurance business with information systems
that are dated and complex, and require extensive manual input, calculation and
control procedures. These systems are more prone to error than more advanced
technology systems. To address these issues, over the past three years the
Company has enhanced its existing systems and technology infrastructure and has
begun installing new systems, including a new general ledger and financial
reporting system which was implemented in the second quarter of 2003 and a new
property and casualty claims administration system being implemented over the
twelve months ending June 30, 2004. In the meantime, enhanced checks and control
procedures have been established to review the output of existing information
systems, including periodic internal and external third party reviews.
Nevertheless, there are risks that
F-32
inaccuracies in the processing of data may occur which might not be identified
by those procedures and checks on a timely basis.
Business Continuity Risk
Given the events of September 11, 2001, the continuing threat of terrorism
and the current geopolitical climate, the Company has undertaken a reassessment
of its business continuity plans. While current contingency plans are felt to be
adequate to restore some of the more critical business processes and the Company
is aggressively working to strengthen its continuity plans, in the current
environment there is believed to exist a higher than acceptable level of risk
that the Company's ability to recover and resume most or all of its key business
operations on a timely basis would be compromised.
Recent Accounting Changes
SOP 03-1
In July 2003, the American Institute of Certified Public Accountants
("AICPA") issued Statement of Position ("SOP") 03-1, "Accounting and Reporting
by Insurance Enterprises for Certain Nontraditional Long-Duration Contracts for
Separate Accounts." This SOP is effective for fiscal years beginning after
December 15, 2003. The new rules change accounting for separate accounts and
sales inducements and change the liability model by expanding the definition of
"account balance" and addressing annuitization guarantees and minimum guaranteed
death benefits. The adoption of this SOP is currently not expected to have a
material impact on the Company's operating results or financial position.
Effects of Inflation and Changes in Interest Rates
The Company's operating results are affected significantly in at least
three ways by changes in interest rates and inflation. First, inflation directly
affects property and casualty claims costs. Second, the investment income earned
on the Company's investment portfolio and the fair value of the investment
portfolio are related to the yields available in the fixed-income markets. An
increase in interest rates will decrease the fair value of the investment
portfolio, but will increase investment income as investments mature and
proceeds are reinvested at higher rates. Third, as interest rates increase,
competitors will typically increase crediting rates on annuity and
interest-sensitive life products, and may lower premium rates on property and
casualty lines to reflect the higher yields available in the market. The risk of
interest rate fluctuation is managed through asset/liability management
techniques, including cash flow analysis.
F-33
REPORT OF MANAGEMENT RESPONSIBILITY FOR FINANCIAL STATEMENTS
Horace Mann Educators Corporation
The consolidated balance sheets of Horace Mann Educators Corporation and
subsidiaries as of December 31, 2003 and 2002, and the related consolidated
statements of operations, changes in shareholders' equity, and cash flows for
the years ended December 31, 2003, 2002 and 2001 have been prepared by
management, which is responsible for their integrity and reliability. The
statements have been prepared in accordance with accounting principles generally
accepted in the United States of America and include some amounts that are based
upon management's best estimates and judgements. Management has discussed with
the Audit Committee the quality, not just the acceptability, of the Company's
accounting principles as applied in its financial reporting. The discussions
generally included such matters as the consistency of the Company's accounting
policies and their application, and the clarity and completeness of the
Company's financial statements, which include related disclosures. The financial
information contained elsewhere in this annual report on Form 10-K is consistent
with that contained in the financial statements.
Management is responsible for establishing and maintaining a system of
internal control designed to provide reasonable assurance as to the integrity
and reliability of financial reporting. The concept of reasonable assurance is
based on the recognition that there are inherent limitations in all systems of
internal control, and that the cost of such systems should not exceed the
benefits derived therefrom. A professional staff of internal auditors reviews on
an ongoing basis the related internal control system design, the accounting
policies and procedures supporting this system and compliance therewith.
Management believes this system of internal control effectively meets its
objective of reliable financial reporting.
In connection with their annual audits, independent certified public
accountants perform an examination, in accordance with auditing standards
generally accepted in the United States of America, which includes the
consideration of the system of internal control to the extent necessary to form
an independent opinion on the fairness of presentation of the financial
statements prepared by management and not to provide assurance on the system of
internal controls.
The Board of Directors, through its Audit Committee composed solely of
independent directors, is responsible for overseeing the integrity and
reliability of the Company's accounting and financial reporting practices and
the effectiveness of its system of internal controls. The independent certified
public accountants and internal auditors meet regularly with this committee, and
have access to this committee with and without management present, to discuss
the results of their audit work.
F-34
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Shareholders
Horace Mann Educators Corporation:
We have audited the accompanying consolidated balance sheets of Horace Mann
Educators Corporation and subsidiaries (the Company) as of December 31, 2003 and
2002, and the related consolidated statements of operations, changes in
shareholders' equity, and cash flows for each of the years in the three-year
period ended December 31, 2003. In connection with our audits of the
consolidated financial statements, we also have audited the financial statement
schedules, as listed in the accompanying index. These consolidated financial
statements and financial statement schedules are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated financial statements and financial statement schedules based on our
audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Horace Mann
Educators Corporation and subsidiaries as of December 31, 2003 and 2002, and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 2003, in conformity with accounting
principles generally accepted in the United States of America. Also, in our
opinion, the related financial statement schedules, when considered in relation
to the basic consolidated financial statements taken as a whole, present fairly,
in all material respects, the information set forth therein.
As discussed in note 1 to the consolidated financial statements, in 2002
the Company adopted the provisions of Statement of Financial Accounting
Standards No. 142, "Goodwill and Other Intangible Assets".
/s/ KPMG LLP
KPMG LLP
Chicago, Illinois
February 17, 2004
F-35
HORACE MANN EDUCATORS CORPORATION
CONSOLIDATED BALANCE SHEETS
As of December 31, 2003 and 2002
(Dollars in thousands)
2003 2002
------------ ------------
ASSETS
Investments
Fixed maturities, available for sale, at
fair value (amortized cost 2003,
$3,124,861; 2002, $2,859,007)................ $ 3,258,674 $ 2,991,195
Short-term and other investments.............. 104,904 135,431
Short-term investments, loaned securities
collateral................................... 22,147 3,937
------------ ------------
Total investments.......................... 3,385,725 3,130,563
Cash............................................. 19,773 60,162
Accrued investment income and premiums
receivable...................................... 99,370 99,954
Deferred policy acquisition costs................ 193,703 174,555
Goodwill......................................... 47,396 47,396
Value of acquired insurance in force............. 27,259 31,945
Other assets..................................... 80,531 113,244
Variable annuity assets.......................... 1,119,231 854,470
------------ ------------
Total assets............................... $ 4,972,988 $ 4,512,289
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Policy liabilities
Fixed annuity contract liabilities............ $ 1,526,174 $ 1,385,737
Interest-sensitive life contract
liabilities.................................. 567,209 544,533
Unpaid claims and claim expenses.............. 350,501 326,575
Future policy benefits........................ 181,344 180,577
Unearned premiums............................. 198,991 189,384
------------ ------------
Total policy liabilities................... 2,824,219 2,626,806
Other policyholder funds......................... 129,888 125,108
Liability for securities lending agreements...... 22,147 3,937
Other liabilities................................ 177,325 228,441
Short-term debt.................................. 25,000 --
Long-term debt................................... 144,703 144,685
Variable annuity liabilities..................... 1,119,231 854,470
------------ ------------
Total liabilities.......................... 4,442,513 3,983,447
------------ ------------
Preferred stock, $0.001 par value, authorized
1,000,000 shares; none issued................... -- --
Common stock, $0.001 par value, authorized
75,000,000 shares; issued, 2003, 60,225,311;
2002, 60,194,615................................ 60 60
Additional paid-in capital....................... 342,306 342,749
Retained earnings................................ 456,330 455,308
Accumulated other comprehensive income
(loss), net of taxes:
Net unrealized gains on fixed maturities
and equity securities........................ 81,608 80,567
Minimum pension liability adjustment.......... (17,252) (17,265)
Treasury stock, at cost, 2003 and 2002,
17,503,371 shares............................... (332,577) (332,577)
------------ ------------
Total shareholders' equity................. 530,475 528,842
------------ ------------
Total liabilities and shareholders'
equity.................................... $ 4,972,988 $ 4,512,289
============ ============
See accompanying notes to consolidated financial statements.
F-36
HORACE MANN EDUCATORS CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollars in thousands, except per share data)
Year Ended December 31,
------------------------------------------
2003 2002 2001
------------ ------------ ------------
Insurance premiums written and contract
deposits................................. $ 955,459 $ 899,329 $ 875,566
============ ============ ============
Revenues
Insurance premiums and contract
charges earned........................ $ 643,536 $ 625,233 $ 615,242
Net investment income.................. 184,725 196,048 199,267
Realized investment gains (losses)..... 25,487 (49,407) (10,019)
------------ ------------ ------------
Total revenues...................... 853,748 771,874 804,490
------------ ------------ ------------
Benefits, losses and expenses
Benefits, claims and settlement
expenses.............................. 518,978 450,866 475,583
Interest credited...................... 102,970 98,380 96,502
Policy acquisition expenses
amortized............................. 64,345 61,297 58,048
Operating expenses..................... 137,318 131,339 123,679
Amortization of intangible assets...... 5,027 5,734 5,774
Interest expense....................... 6,339 8,517 9,250
Restructuring charges (adjustments).... (408) 4,223 7,312
Debt retirement costs.................. -- 2,272 --
Litigation charges..................... -- 1,581 --
------------ ------------ ------------
Total benefits, losses and
expenses........................... 834,569 764,209 776,148
------------ ------------ ------------
Income before income taxes................ 19,179 7,665 28,342
Income tax expense (benefit).............. 204 (3,668) 2,755
------------ ------------ ------------
Net income................................ $ 18,975 $ 11,333 $ 25,587
============ ============ ============
Earnings per share
Basic.................................. $ 0.44 $ 0.28 $ 0.63
============ ============ ============
Diluted................................ $ 0.44 $ 0.28 $ 0.63
============ ============ ============
Weighted average number of shares
and equivalent shares
Basic............................... 42,712,822 40,941,182 40,616,843
Diluted............................. 42,904,167 41,199,033 40,877,120
See accompanying notes to consolidated financial statements.
F-37
HORACE MANN EDUCATORS CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
(Dollars in thousands, except per share data)
Year Ended December 31,
------------------------------------------
2003 2002 2001
------------ ------------ ------------
Common stock
Beginning balance...................... $ 60 $ 60 $ 60
Options exercised, 2002, 107,410
shares; 2001, 207,575 shares.......... -- -- --
Conversion of Director Stock Plan
units, 2003, 30,696 shares; 2002,
10,284 shares; 2001, 10,293 shares.... -- -- --
------------ ------------ ------------
Ending balance......................... 60 60 60
------------ ------------ ------------
Additional paid-in capital
Beginning balance...................... 342,749 341,052 338,243
Options exercised and conversion of
Director Stock Plan units............. 645 2,183 3,759
Catastrophe-linked equity put
option premium........................ (1,088) (1,088) (950)
Issuance of treasury shares in 2002.... -- 602 --
------------ ------------ ------------
Ending balance......................... 342,306 342,749 341,052
------------ ------------ ------------
Retained earnings
Beginning balance...................... 455,308 461,139 452,624
Net income............................. 18,975 11,333 25,587
Cash dividends, $0.42 per share........ (17,953) (17,164) (17,072)
------------ ------------ ------------
Ending balance......................... 456,330 455,308 461,139
------------ ------------ ------------
Accumulated other comprehensive income
(loss), net of taxes:
Beginning balance...................... 63,302 14,898 (4,975)
Change in net unrealized gains
(losses) on fixed maturities and
equity securities..................... 1,041 54,231 30,374
(Increase) decrease in minimum
pension liability adjustment.......... 13 (5,827) (10,501)
------------ ------------ ------------
Ending balance......................... 64,356 63,302 14,898
------------ ------------ ------------
Treasury stock, at cost
Beginning balance, 2003,17,503,371
shares; 2002 and 2001, 19,341,296
shares................................ (332,577) (357,959) (357,959)
Issuance of 1,837,925 shares in 2002... -- 25,382 --
------------ ------------ ------------
Ending balance 2003 and 2002,
17,503,371 shares; 2001, 19,341,296
shares................................ (332,577) (332,577) (357,959)
------------ ------------ ------------
Shareholders' equity at end of period..... $ 530,475 $ 528,842 $ 459,190
============ ============ ============
Comprehensive income
Net income............................. $ 18,975 $ 11,333 $ 25,587
Other comprehensive income, net of
tax:
Change in net unrealized gains
(losses) on fixed maturities and
equity securities.................. 1,041 54,231 30,374
(Increase) decrease in minimum
pension liability adjustment....... 13 (5,827) (10,501)
------------ ------------ ------------
Other comprehensive income....... 1,054 48,404 19,873
------------ ------------ ------------
Total......................... $ 20,029 $ 59,737 $ 45,460
============ ============ ============
See accompanying notes to consolidated financial statements.
F-38
HORACE MANN EDUCATORS CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
Year Ended December 31,
------------------------------------------
2003 2002 2001
------------ ------------ ------------
Cash flows from operating activities
Premiums collected..................... $ 684,331 $ 663,682 $ 642,596
Policyholder benefits paid............. (500,634) (465,811) (487,619)
Policy acquisition and other
operating expenses paid............... (221,499) (206,457) (193,713)
Federal income taxes recovered
(paid)................................ (19,001) (2,055) 7,520
Investment income collected............ 185,359 197,872 195,086
Interest expense paid.................. (5,454) (9,540) (9,091)
Contribution to defined benefit
pension plan trust fund............... (8,780) (7,910) --
Other.................................. 3,086 (4,314) (5,922)
------------ ------------ ------------
Net cash provided by operating
activities......................... 117,408 165,467 148,857
------------ ------------ ------------
Cash flows used in investing activities
Fixed maturities
Purchases........................... (1,762,957) (1,546,528) (1,140,930)
Sales............................... 922,699 1,117,268 732,076
Maturities.......................... 560,915 274,134 283,153
Net cash (used for) provided by
short-term and other investments...... 35,437 (28,776) (2,107)
------------ ------------ ------------
Net cash used in investing
activities......................... (243,906) (183,902) (127,808)
------------ ------------ ------------
Cash flows provided by (used in)
financing activities
Dividends paid to shareholders......... (17,953) (17,164) (17,072)
Principal borrowings (repayments)
on Bank Credit Facility............... 25,000 (53,000) 4,000
Exercise of stock options.............. -- 2,183 3,759
Catastrophe-linked equity put option
premium............................... (1,088) (1,088) (950)
Proceeds from issuance of Senior
Convertible Notes..................... -- 162,654 --
Repurchase of Senior Notes and Senior
Convertible Notes..................... -- (97,523) --
Annuity contracts, variable and fixed
Deposits............................ 296,615 261,509 239,124
Maturities and withdrawals.......... (92,791) (189,824) (178,364)
Net transfer to variable annuity
assets............................. (113,074) (17,264) (53,550)
Net decrease in life policy account
balances.............................. (10,600) (5,825) (5,198)
------------ ------------ ------------
Net cash provided by (used in)
financing activities............... 86,109 44,658 (8,251)
------------ ------------ ------------
Net increase (decrease) in cash........... (40,389) 26,223 12,798
Cash at beginning of period............... 60,162 33,939 21,141
------------ ------------ ------------
Cash at end of period..................... $ 19,773 $ 60,162 $ 33,939
============ ============ ============
See accompanying notes to consolidated financial statements.
F-39
HORACE MANN EDUCATORS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except per share data)
NOTE 1 - Summary of Significant Accounting Policies
Basis of Presentation
The accompanying consolidated financial statements have been prepared in
accordance with accounting principles generally accepted in the United States of
America ("GAAP") and with the rules and regulations of the Securities and
Exchange Commission. The preparation of financial statements in conformity with
GAAP requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities, disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results could differ
from those estimates.
The consolidated financial statements include the accounts of Horace Mann
Educators Corporation and its wholly-owned subsidiaries ("HMEC"; and together
with its subsidiaries, the "Company" or "Horace Mann"). HMEC and its
subsidiaries have common management, share office facilities and are parties to
several intercompany service agreements for management, administrative, data
processing, agent commissions, agency services, utilization of personnel and
investment advisory services. Under these agreements, costs have been allocated
among the companies in conformity with customary insurance accounting practices
consistently applied. In addition, certain of the subsidiaries have entered into
intercompany reinsurance agreements. HMEC and its subsidiaries file a
consolidated federal income tax return, and there are related tax sharing
agreements. All significant intercompany balances and transactions have been
eliminated in consolidation.
The subsidiaries of HMEC market 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 and Horace Mann Lloyds.
Investments
The Company invests primarily in fixed maturity investments. These
securities are classified as available for sale and carried at fair value. The
net adjustment for unrealized gains and losses on securities available for sale,
carried at fair value, is recorded as a separate component of shareholders'
equity, net of applicable deferred tax asset or liability and the related impact
on deferred policy acquisition costs and value of acquired insurance in force
associated with interest-sensitive life and annuity contracts.
F-40
NOTE 1 - Summary of Significant Accounting Policies-(Continued)
Short-term and other investments are comprised of policy loans, carried at
unpaid principal balances; short-term fixed interest securities, carried at cost
which approximates fair value; mortgage loans, carried at unpaid principal less
a valuation allowance for estimated uncollectible amounts; real estate acquired
in the settlement of debt, carried at the lower of cost or fair value; and
equity securities, carried at fair value.
Interest income is recognized as earned. Investment income reflects
amortization of premiums and accrual of discounts on an effective-yield basis.
Realized gains and losses arising from the sale or impairment of securities
are determined based upon specific identification of securities. The Company
reviews the fair value of all investments in its portfolio on a monthly basis to
assess whether an other-than-temporary decline in value has occurred. These
reviews, in conjunction with the Company's investment managers' monthly credit
reports and relevant factors such as (1) the financial condition and near-term
prospects of the issuer, (2) the Company's intent and ability to retain the
investment long enough to allow for the anticipated recovery in fair value, (3)
the stock price trend of the issuer, (4) the market leadership position of the
issuer, (5) the debt ratings of the issuer and (6) the cash flows of the issuer,
are all considered in the impairment assessment. A write-down of an investment
is recorded when a decline in the fair value of that investment is deemed to be
other-than-temporary, with a realized investment loss charged to income for the
period.
The Company's methodology of assessing other-than-temporary impairments is
based on security-specific facts and circumstances as of the date of the
reporting period. Based on these facts, if management believes it is probable
that amounts due will not be collected according to the contractual terms of a
debt security not impaired at acquisition, or if the Company does not have the
ability or intent to hold a security with an unrealized loss until it matures or
recovers in value, an other-than-temporary impairment shall be considered to
have occurred. As a general rule, if the fair value of a debt security has
fallen below 80% of book value for more than six months, this security will be
reviewed for an other-than-temporary impairment. Additionally, if events become
known that call into question whether the security issuer has the ability to
honor its contractual commitments, whether or not such security has been trading
above an 80% fair value to book value relationship, such security holding will
be evaluated to determine whether or not such security has suffered an
other-than-temporary decline in value.
F-41
NOTE 1 - Summary of Significant Accounting Policies-(Continued)
A decline in fair value below amortized cost is not assumed to be
other-than-temporary for fixed maturity investments with unrealized losses due
to market conditions or industry-related events where there exists a reasonable
market recovery expectation and the Company has the intent and ability to hold
the investment until maturity or a market recovery is realized. Management
believes that its intent and ability to hold a fixed maturity investment with a
continuous material unrealized loss due to market conditions or industry-related
events for a period of time sufficient to allow a market recovery or to maturity
is a decisive factor when considering an impairment loss. In the event that the
Company's intent or ability to hold a fixed maturity investment with a
continuous material unrealized loss for a period of time sufficient to allow a
market recovery or to maturity were to change, an evaluation for
other-than-temporary impairment is performed. An other-than-temporary impairment
loss will be recognized based upon all relevant facts and circumstances for each
investment, as appropriate, in accordance with Securities and Exchange
Commission Staff Accounting Bulletin ("SAB") No. 59, "Accounting for Non-Current
Marketable Equity Securities", and No. 104, "Revenue Recognition", Financial
Accounting Standards Board ("FASB") Statement of Financial Accounting Standards
("SFAS") No. 115, "Accounting for Certain Investments in Debt and Equity
Securities", and related guidance.
Deferred Policy Acquisition Costs
Deferred policy acquisition costs net of accumulated amortization were
$193,703 and $174,555 as of December 31, 2003 and 2002, respectively.
Policy acquisition costs, consisting of commissions, policy issuance and
other costs, which vary with and are primarily related to the production of
insurance business, are capitalized and amortized on a basis consistent with the
type of insurance coverage. Capitalized acquisition costs for interest-sensitive
life contracts are amortized over 20 years in proportion to estimated gross
profits. For other individual life contracts, acquisition costs are amortized in
proportion to anticipated premiums over the terms of the insurance policies (10,
15 and 20 years). For investment (annuity) contracts, acquisition costs are
amortized over 20 years in proportion to estimated gross profits. For property
and casualty policies, acquisition costs are amortized over the terms of the
insurance policies (six and twelve months). The Company periodically reviews the
assumptions and estimates used in capitalizing policy acquisition costs and also
periodically reviews its estimations of gross profits. The most significant
assumptions that are involved in the estimation of annuity gross profits include
future financial market performance, interest rate spreads, business
surrender/lapse rates and the impact of realized investment gains and losses. In
the event actual experience differs significantly from assumptions or
assumptions are significantly revised, the Company may be required to record a
material charge or credit to amortization expense for the period in which the
adjustment is made.
Deferred policy acquisition costs for interest-sensitive life and
investment contracts are adjusted for the impact on estimated future gross
profits as if net unrealized investment gains and losses had been realized at
the balance sheet date. The impact of this adjustment is included in net
unrealized gains and losses within shareholders' equity.
F-42
NOTE 1 - Summary of Significant Accounting Policies-(Continued)
Deferred policy acquisition costs are reviewed for recoverability from
future income, including investment income, and costs which are deemed
unrecoverable are expensed in the period in which the determination is made. No
such costs have been deemed unrecoverable during the periods reported.
Value of Acquired Insurance In Force and Goodwill
When the Company was acquired in 1989, intangible assets were recorded in
the application of purchase accounting to recognize the value of acquired
insurance in force and goodwill. In addition, goodwill was recorded in 1994
related to the purchase of Horace Mann Property & Casualty Insurance Company.
The value of acquired insurance in force is being amortized over the following
periods, utilizing the indicated methods for life and annuity, respectively, as
follows: 20 years, in proportion to coverage provided; 20 years, in proportion
to estimated gross profits. Goodwill was amortized over 40 years on a
straight-line basis through December 31, 2001. Goodwill, net of amortization,
was $47,396 at December 31, 2001.
Effective January 1, 2002, the Company adopted SFAS No. 142, "Goodwill and
Other Intangible Assets". The Company's value of acquired insurance in force is
an intangible asset with a definite life and will continue to be amortized under
the provisions of SFAS No. 142. Goodwill will remain on the balance sheet and
not be amortized. SFAS No. 142 establishes a new method of testing goodwill for
impairment. On an annual basis, and when there is reason to suspect that its
value may have been diminished or impaired, the goodwill asset must be tested
for impairment. The amount of goodwill determined to be impaired will be
expensed to current operations. During 2002 and 2003, the Company completed the
required testing under SFAS No. 142; no impairment charges were necessary as a
result of such assessments.
The allocation of goodwill by segment was as follows:
Balance as of
January 1, 2002,
December 31, 2002
and December 31, 2003
---------------------
Annuity............................................ $ 28,025
Life............................................... 9,911
Property and casualty.............................. 9,460
---------------------
Total........................................... $ 47,396
=====================
F-43
NOTE 1 - Summary of Significant Accounting Policies-(Continued)
Net income and net income per share exclusive of goodwill amortization
expense for the years ended December 31, 2003, 2002 and 2001 were as follows:
Year Ended December 31,
-------------------------------
2003 2002 2001
--------- --------- ---------
Reported net income............................ $ 18,975 $ 11,333 $ 25,587
Add back: Goodwill amortization................ -- -- 1,618
--------- --------- ---------
Adjusted net income......................... $ 18,975 $ 11,333 $ 27,205
========= ========= =========
Reported net income per share-basic............ $ 0.44 $ 0.28 $ 0.63
Add back: Goodwill amortization................ -- -- 0.04
--------- --------- ---------
Adjusted net income per share-basic......... $ 0.44 $ 0.28 $ 0.67
========= ========= =========
Reported net income per share-diluted.......... $ 0.44 $ 0.28 $ 0.63
Add back: Goodwill amortization................ -- -- 0.04
--------- --------- ---------
Adjusted net income per share-diluted....... $ 0.44 $ 0.28 $ 0.67
========= ========= =========
For the amortization of the value of acquired insurance in force, the
Company periodically reviews its estimates of gross profits. The most
significant assumptions that are involved in the estimation of gross profits
include future financial market performance, interest rate spreads, business
surrender/lapse rates and the impact of realized investment gains and losses. In
the event actual experience differs significantly from assumptions or
assumptions are significantly revised, the Company may be required to record a
material charge or credit to amortization expense for the period in which the
adjustment is made.
The value of acquired insurance in force for investment contracts (those
issued prior to August 29, 1989) is adjusted for the impact on estimated future
gross profits as if net unrealized investment gains and losses had been realized
at the balance sheet date. The impact of this adjustment is included in net
unrealized gains and losses within shareholders' equity.
The balances of value of acquired insurance in force by segment at December
31, 2003 and 2002 were as follows:
December 31, 2003 December 31, 2002
------------------------------------- ------------------------------------
Accumulated Net Accumulated Net
Cost Amortization Balance Cost Amortization Balance
---------- ------------ --------- --------- ------------ ---------
Life................................. $ 48,746 $ 41,502 $ 7,244 $ 48,746 $ 39,877 $ 8,869
Annuity.............................. 87,553 66,657 20,896 87,553 63,255 24,298
---------- ------------ --------- --------- ------------ ---------
Subtotal.......................... $ 136,299 $ 108,159 28,140 $ 136,299 $ 103,132 33,167
========== ============ --------- ========= ============ ---------
Impact of unrealized investment
gains and losses.................... (881) (1,222)
--------- ---------
Total............................. $ 27,259 $ 31,945
========= =========
Scheduled amortization of the December 31, 2003 balances of value of
acquired insurance in force by segment over the next five years is as follows:
Year Ended December 31,
--------------------------------------------------------------
2004 2005 2006 2007 2008
---------- ---------- ---------- ---------- ----------
Scheduled amortization of
value of acquired insurance in force
Life................................. $ 1,537 $ 1,460 $ 1,394 $ 1,338 $ 1,292
Annuity.............................. 3,544 3,893 4,270 4,572 4,617
---------- ---------- ---------- ---------- ----------
Total............................. $ 5,081 $ 5,353 $ 5,664 $ 5,910 $ 5,909
========== ========== ========== ========== ==========
F-44
NOTE 1 - Summary of Significant Accounting Policies-(Continued)
The amount of interest accrued on the unamortized balance of value of
acquired insurance in force and the interest accrual rates were as follows:
Year Ended December 31,
------------------------------------
2003 2002 2001
---------- ---------- ----------
Interest accrued on the unamortized
balance of value of acquired
insurance in force
Life............................... $ 645 $ 779 $ 921
Annuity............................ 1,185 1,280 1,639
---------- ---------- ----------
Total........................... $ 1,830 $ 2,059 $ 2,560
========== ========== ==========
Interest accrual rate
Life............................... 8.0% 8.0% 8.0%
Annuity............................ 5.3% 5.4% 5.7%
The accumulated amortization of intangibles as of December 31, 2003 and
2002 was $157,136 and $152,109, respectively.
Property and Equipment
Property and equipment are carried at cost less accumulated depreciation
and are included in Other Assets in the Consolidated Balance Sheets.
Depreciation and amortization are calculated on the straight-line method based
on the estimated useful lives of the assets. The estimated useful lives of
property and equipment by asset type are generally as follows: real estate,
identified by specific property, 20-45 years; furniture, 10 years; general
office machines, 6 years; telephones, 5 years; vehicles, 3 years; and data
processing hardware and software and personal computers, 3 years.
December 31,
-----------------------
2003 2002
---------- ----------
Property and equipment................ $ 73,506 $ 73,855
Less: accumulated depreciation....... 47,959 43,921
---------- ----------
Total.............................. $ 25,547 $ 29,934
========== ==========
F-45
NOTE 1 - Summary of Significant Accounting Policies-(Continued)
Variable Annuity Assets and Liabilities
Variable annuity assets, carried at market value, and liabilities represent
tax-qualified variable annuity funds invested in various mutual funds, including
the seven proprietary Horace Mann mutual funds. Variable annuity assets were
invested in the offered mutual funds as follows:
December 31,
-------------------------
2003 2002
----------- -----------
Horace Mann Equity Fund......................... $ 325,880 $ 274,025
Horace Mann Balanced Fund....................... 270,287 240,697
Horace Mann Socially Responsible Fund........... 73,947 58,909
Horace Mann Small Cap Growth Fund............... 57,210 34,682
Horace Mann International Equity Fund........... 35,754 26,248
Wilshire Large Company Growth Portfolio -
Institutional Class and Investor Class......... 28,349 19,421
Ariel Appreciation Fund......................... 27,831 14,179
Fidelity VIP 500 Index Portfolio SC2............ 26,397 14,949
Fidelity VIP Growth Portfolio SC2............... 25,960 15,040
Wilshire 5000 Index Portfolio - Institutional
Class and Investor Class....................... 24,641 16,784
Fidelity VIP Mid Cap Portfolio SC2.............. 21,719 12,836
Horace Mann Income Fund......................... 20,843 19,313
Ariel Fund...................................... 18,665 9,689
T. Rowe Price Small Cap Value Fund - Advisor
Class.......................................... 15,843 9,255
Alliance Bernstein Premier Growth Portfolio..... 14,744 9,298
Fidelity VIP Investment Grade Bond Portfolio
SC2............................................ 13,925 9,861
Wilshire Large Company Value Portfolio.......... 13,220 8,037
Neuberger Berman Genesis Fund Advisor Class..... 12,755 7,494
T. Rowe Price Small Cap Stock Fund - Advisor
Class.......................................... 11,984 7,266
JPMorgan U.S. Large Cap Core Equity Portfolio... 11,535 6,973
Strong Opportunity Fund II...................... 8,923 5,353
Fidelity VIP Overseas Portfolio SC2............. 7,948 3,917
Rainier Small/Mid Cap Equity Portfolio.......... 7,453 4,051
Fidelity VIP Growth and Income Portfolio SC2.... 7,325 4,009
Davis Value Portfolio........................... 6,781 3,743
Strong Mid Cap Growth Fund II................... 6,557 4,086
Putnam VT Vista Fund (IB Shares)................ 5,490 3,544
Horace Mann Short-Term Investment Fund.......... 4,843 4,186
Credit Suisse Small Cap Growth Portfolio........ 4,036 2,407
Wilshire Small Company Value Portfolio.......... 2,374 1,660
Wilshire Small Company Growth Portfolio......... 1,626 847
Fidelity VIP High Income Portfolio SC2.......... 1,604 652
BlackRock Index Equity Portfolio................ 1,186 386
Putnam VT George Putnam Fund of Boston (Class
IB shares)..................................... 414 167
BlackRock Temp Fund............................. 371 180
Putnam VT International Growth Fund (Class IB
shares)........................................ 263 85
BlackRock Low Duration Bond Fund................ 218 118
BlackRock Core Bond Total Return Fund........... 209 85
T. Rowe Price Science & Technology Fund......... 111 --
Templeton Foreign Smaller Companies Fund
(Class A)...................................... 10 2
Berger Information Technology Fund.............. -- 36
----------- -----------
Total variable annuity assets................ $ 1,119,231 $ 854,470
=========== ===========
The investment income, gains and losses of these accounts accrue directly
to the policyholders and are not included in the operations of the Company.
F-46
NOTE 1 - Summary of Significant Accounting Policies-(Continued)
Future Policy Benefits, Interest-sensitive Life Contract Liabilities and
Annuity Contract Liabilities
Liabilities for future benefits on life and annuity policies are
established in amounts adequate to meet the estimated future obligations on
policies in force. Liabilities for future policy benefits on certain life
insurance policies are computed using the net level premium method and are based
on assumptions as to future investment yield, mortality and withdrawals. As a
result of the application of purchase accounting, future policy benefits for
direct individual life insurance policies issued through August 29, 1989 were
revalued using interest rates of 9% graded to 8% over 10 years. For policies
issued from August 30, 1989 through December 31, 1992, future policy benefits
are computed using an interest rate of 6.5%. An interest rate of 5.5% is used to
compute future policy benefits for policies issued after December 31, 1992.
Mortality and withdrawal assumptions for all policies have been based on
actuarial tables which are consistent with the Company's own experience.
Liabilities for future benefits on annuity contracts and certain long-duration
life insurance contracts are carried at accumulated policyholder values without
reduction for potential surrender or withdrawal charges. The liability also
includes provisions for the unearned portion of certain policy charges.
The Company has established a guaranteed minimum death benefit ("GMDB")
reserve on variable annuity contracts and regularly monitors this reserve
considering fluctuations in the financial markets. At December 31, 2003 and
2002, under GAAP, the GMDB reserve was $109 and $835, respectively. The
comparable reserve under statutory accounting principles was $155 and $1,557 at
the respective dates. The Company has a relatively low exposure to GMDB because
approximately 25% of contract values have no guarantee; approximately 70% have
only a return of premium guarantee; and approximately 5% have a guarantee of
premium roll-up at an annual interest rate of 3% or 5%. The aggregate
in-the-money death benefits under the GMDB provision totaled $35,415 and
$115,319 at December 31, 2003 and 2002, respectively.
Unpaid Claims and Claim Expenses
Liabilities for property and casualty unpaid claims and claim expenses
include provisions for payments to be made on reported claims, claims incurred
but not reported and associated settlement expenses. At December 31, 2003, all
of the Company's net reserves for property and casualty unpaid claims and claim
expenses were carried at the full value of estimated liabilities and were not
discounted for interest expected to be earned on reserves. Estimated amounts of
salvage and subrogation on unpaid property and casualty claims are deducted from
the liability for unpaid claims. Due to the nature of the Company's personal
lines business, the Company has no exposure to claims for toxic waste cleanup,
other environmental remediation or asbestos-related illnesses other than claims
under homeowners insurance policies for environmentally related items such as
toxic mold.
F-47
NOTE 1 - Summary of Significant Accounting Policies-(Continued)
Insurance Premiums and Contract Charges Earned
Property and casualty insurance premiums are recognized as revenue ratably
over the related contract periods in proportion to the risks insured. The
unexpired portions of these property and casualty premiums are recorded as
unearned premiums, using the monthly pro rata method.
Premiums and contract charges for interest-sensitive life and annuity
contracts consist of charges for the cost of insurance, policy administration
and withdrawals. Premiums for long-term traditional life policies are recognized
as revenues when due over the premium-paying period. Annuity and
interest-sensitive life contract deposits represent funds deposited by
policyholders and are not included in the Company's premiums or contract charges
earned.
Stock Based Compensation
The Company grants stock options to executive officers, other employees and
directors. The exercise price of the option is equal to the fair market value of
the Company's common stock on the date of grant. Additional information
regarding the Company's stock-based compensation plans is contained in Note 6 -
Shareholders' Equity and Stock Options. The Company accounts for stock option
grants using the intrinsic value based method in accordance with Accounting
Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to
Employees," and accordingly, recognizes no compensation expense for the stock
option grants.
Alternatively, SFAS No. 123, "Accounting for Stock-Based Compensation",
allows companies to recognize compensation cost for stock-based compensation
plans, determined based on the fair value at the grant dates. If the Company had
applied this alternative accounting method, net income and net income per share
would have been reduced to the pro forma amounts indicated below:
Year Ended December 31,
------------------------------
2003 2002 2001
--------- --------- --------
Net income
As reported................................. $ 18,975 $ 11,333 $ 25,587
Add: Stock-based compensation
expense, after tax, included in
reported net income..................... -- -- --
Deduct: Stock-based compensation
expense, after tax, determined under
the fair value based method for all
awards (1).............................. 5,368 4,437 4,418
--------- --------- --------
Pro forma................................... $ 13,607 $ 6,896 $ 21,169
========= ========= ========
Net income per share - basic
As reported................................. $ 0.44 $ 0.28 $ 0.63
Pro forma................................... $ 0.32 $ 0.17 $ 0.52
Net income per share - diluted
As reported................................. $ 0.44 $ 0.28 $ 0.63
Pro forma................................... $ 0.32 $ 0.17 $ 0.52
- ----------
(1) The fair value of each option grant was estimated on the date of grant
using the Modified Roll-Geske option-pricing model with the following
weighted average assumptions for 2003, 2002 and 2001, respectively:
risk-free interest rates of 3.8%, 5.2% and 5.1%; dividend yield of 3.0%,
2.0% and 2.3%; expected lives of 10 years; and volatility of 28.3%, 39.2%
and 46.0%.
F-48
NOTE 1 - Summary of Significant Accounting Policies-(Continued)
Income Taxes
The Company uses the liability method for calculating deferred federal
income taxes. Income tax provisions are generally based on income reported for
financial statement purposes. The provisions for federal income taxes for the
years ended December 31, 2003, 2002 and 2001 include amounts currently payable
and deferred income taxes resulting from the cumulative differences in the
Company's assets and liabilities, determined on a tax return versus financial
statement basis.
Deferred tax assets and liabilities include provisions for unrealized
investment gains and losses as well as the minimum pension liability adjustment
with the changes for each period included in the respective components of
accumulated other comprehensive income (loss) in shareholders' equity.
Earnings Per Share
Basic earnings per share is computed based on the weighted average number
of common shares outstanding. Diluted earnings per share is computed based on
the weighted average number of common shares and common stock equivalents
outstanding, to the extent dilutive. The common stock equivalents relate to
outstanding common stock options, Director Stock Plan units and Employee Stock
Plan units. The Company's Senior Convertible Notes, while potentially dilutive,
are not common stock equivalents.
The computations of net income per share on both basic and diluted bases,
including reconciliations of the numerators and denominators, were as follows:
Year Ended December 31,
------------------------------
2003 2002 2001
--------- --------- --------
Basic - assumes no dilution:
Net income for the period....................... $ 18,975 $ 11,333 $ 25,587
--------- --------- --------
Weighted average number of common shares
outstanding during the period (in thousands)... 42,713 40,941 40,617
--------- --------- --------
Net income per share - basic.................... $ 0.44 $ 0.28 $ 0.63
========= ========= ========
Diluted - assumes full dilution:
Net income for the period....................... $ 18,975 $ 11,333 $ 25,587
--------- --------- --------
Weighted average number of common shares
outstanding during the period (in thousands)... 42,713 40,941 40,617
Weighted average number of common equivalent
shares to reflect the dilutive effect of
common stock equivalent securities (in
thousands):
Stock options................................ 16 87 125
Common stock units related to Deferred
Equity Compensation Plan for Directors...... 148 140 121
Common stock units related to Deferred
Compensation Plan for Employees............. 27 31 14
--------- --------- --------
Total common and common equivalent shares
adjusted to calculate diluted earnings per
share (in thousands)........................... 42,904 41,199 40,877
--------- --------- --------
Net income per share - diluted.................. $ 0.44 $ 0.28 $ 0.63
========= ========= ========
F-49
NOTE 1 - Summary of Significant Accounting Policies-(Continued)
Options to purchase 4,105,920 shares of common stock at $14.78 to $33.87
per share were granted in 1997 through 2003 but were not included in the
computation of 2003 diluted earnings per share because the options' exercise
price was greater than the average market price of the common shares during
2003. The options, which expire in 2007 through 2013, were still outstanding at
December 31, 2003.
Comprehensive Income
Comprehensive income represents the change in shareholders' equity during a
reporting period from transactions and other events and circumstances from
non-shareholder sources. For the Company, comprehensive income is equal to net
income plus the change in net unrealized gains and losses on fixed maturities
and equity securities and the change in the minimum pension liability adjustment
for the period as shown in the Statement of Changes in Shareholders' Equity.
The components of comprehensive income were as follows:
Year Ended December 31,
------------------------------
2003 2002 2001
--------- --------- --------
Net income..................................... $ 18,975 $ 11,333 $ 25,587
--------- --------- --------
Other comprehensive income (loss):
Change in net unrealized gains (losses) on
fixed maturities and equity securities
Unrealized holding gains on fixed
maturities and equity securities
arising during period................... 27,027 34,441 32,337
Less: reclassification adjustment for
gains (losses) included in net income... 25,425 (48,991) (14,392)
--------- --------- --------
Total, before tax..................... 1,602 83,432 46,729
Income tax expense.................... 561 29,201 16,355
--------- --------- --------
Total, net of tax.................. 1,041 54,231 30,374
--------- --------- --------
(Increase) decrease in minimum pension
liability adjustment
Before tax............................... 22 (8,965) (16,156)
Income tax expense (benefit)............. 9 (3,138) (5,655)
--------- --------- --------
Total, net of tax..................... 13 (5,827) (10,501)
--------- --------- --------
Total comprehensive income......... $ 20,029 $ 59,737 $ 45,460
========= ========= ========
Statements of Cash Flows
For purposes of the Statements of Cash Flows, cash constitutes cash on
deposit at banks.
Reclassification
The Company has reclassified the presentation of certain prior period
information to conform with the 2003 presentation.
F-50
NOTE 2 - Restructuring Charges
Restructuring charges, as described below, were incurred and separately
identified in the Statements of Operations for the years ended December 31,
2002, 2001 and 2000.
The Company's Consolidated Balance Sheets at December 31, 2003 and 2002 did
not reflect any accrued amounts due to the restructuring of its Massachusetts
automobile business recorded in 2001. The following table provides information
about the components of the other charges taken in 2002, 2001 and 2000, the
balance of accrued amounts at December 31, 2003 and 2002, and payment activity
during the year ended December 31, 2003. The adjustments recorded in 2003
reflect final resolution of the printing services, group insurance and credit
union marketing operations restructures as well as additional data regarding the
restructure of the property and casualty claims operations.
Original Reserve at Reserve at
Pretax December 31, December 31,
Charge 2002 Payments Adjustments 2003
------------ ------------ ------------ ------------ ------------
Charges to earnings:
Property and Casualty Claims
Operations
Employee termination costs.... $ 2,542 $ 1,929 $ 1,759 $ 56 $ 226
Additional defined benefit
pension plan costs........... 1,179 1,179 956 (98) 125
Termination of lease
agreements................... 502 425 209 (177) 39
------------ ------------ ------------ ------------ ------------
Subtotal................... 4,223 3,533 2,924 (219) 390
------------ ------------ ------------ ------------ ------------
Printing Services Operations
Employee termination costs.... 409 38 40 2 --
Write-off of equipment........ 41 -- -- -- --
------------ ------------ ------------ ------------ ------------
Subtotal................... 450 38 40 2 --
------------ ------------ ------------ ------------ ------------
Group Insurance and Credit
Union Marketing Operations
Employee termination costs.... 1,827 291 100 (191) --
Termination of lease
agreements................... 285 -- -- -- --
Write-off of capitalized
software..................... 106 -- -- -- --
Other......................... 18 -- -- -- --
------------ ------------ ------------ ------------ ------------
Subtotal................... 2,236 291 100 (191) --
------------ ------------ ------------ ------------ ------------
Total...................... $ 6,909 $ 3,862 $ 3,064 $ (408) $ 390
============ ============ ============ ============ ============
Restructure of Property and Casualty Claims Operations
In July 2002, the Company recorded restructuring charges of $4,223 pretax,
reflecting the decision to restructure its property and casualty claims
operations. The principal restructuring activities included consolidating claims
offices, implementing a new claims administration system, and performing certain
claims reporting and adjusting functions internally versus utilizing external
service providers.
F-51
NOTE 2 - Restructuring Charges-(Continued)
Approximately 135 employees with management, professional and clerical
responsibilities were impacted by the office consolidations. Charges for
employee termination costs represent severance, vacation buy-out and related
payroll taxes. The impact of accelerated retirements on the Company's defined
benefit pension plan has been included in the restructuring charge. Termination
of lease agreements represented office space for each of the previous claims
office locations.
Massachusetts Automobile Business
In October 2001, the Company recorded restructuring charges of $7,290
pretax reflecting a change in the Company's strategic direction in the
Massachusetts automobile market. On October 18, 2001, Horace Mann announced that
it had formed a marketing alliance with an unaffiliated company, The Commerce
Group, Inc. ("Commerce"), for the sale of automobile insurance in the state of
Massachusetts. Through this alliance, and by January 1, 2002, Horace Mann's
agents are authorized to offer Massachusetts customers automobile insurance
policies written by Commerce. Horace Mann agents continue to write the Company's
other products in Massachusetts, including retirement annuities and property and
life insurance.
Horace Mann ceased writing automobile insurance policies in Massachusetts
by December 31, 2001, and on October 18, 2001 paid $6,438 to the Commonwealth
Automobile Reinsurers ("C.A.R.") as full payment of its proportionate liability
to C.A.R. for policy years 2002 and beyond. The Company also paid legal and
other related consulting costs totaling $506 pretax. The remaining $346 was
attributable primarily to the write-off of software used only to process
Massachusetts automobile business. All of the costs related to this
restructuring were paid as of December 31, 2001, and consequently the Company's
Consolidated Balance Sheet at December 31, 2001 did not reflect any accrued
amounts due to the restructure of its Massachusetts automobile business.
Printing Services, Group Insurance and Credit Union Marketing Operations
In November 2001, the Company recorded restructuring charges of $450 pretax
reflecting the decision to close its on site printing services operations based
on a cost benefit analysis. Employee termination costs, for termination of 13
individuals by December 31, 2001, which represented severance, vacation buy-out
and related payroll taxes, comprised $409 of the total charge. The eliminated
positions encompassed management, technical and clerical responsibilities. The
remaining $41 of charges was attributable primarily to the write-off of
equipment related to this function.
In December 2000, the Company recorded restructuring charges of $2,236
pretax 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. Employee termination costs, for termination of
approximately 50 individuals, represented severance, vacation buy-out and
related payroll taxes. The eliminated positions encompassed management,
professional and clerical responsibilities. 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.
F-52
NOTE 3 - Investments
Net Investment Income
The components of net investment income for the following periods were:
Year Ended December 31,
------------------------------------------
2003 2002 2001
------------ ------------ ------------
Fixed maturities.................. $ 181,716 $ 192,077 $ 192,547
Short-term and other
investments...................... 7,059 7,650 10,346
------------ ------------ ------------
Total investment income........ 188,775 199,727 202,893
Less investment expenses.......... 4,050 3,679 3,626
------------ ------------ ------------
Net investment income.......... $ 184,725 $ 196,048 $ 199,267
============ ============ ============
Realized Investment Gains (Losses)
Realized investment gains (losses) for the following periods were:
Year Ended December 31,
------------------------------------------
2003 2002 2001
------------ ------------ ------------
Fixed maturities.................. $ 21,753 $ (48,925) $ (14,371)
Short-term and other
investments...................... 3,734 (482) 4,352
------------ ------------ ------------
Realized investment gains
(losses)...................... $ 25,487 $ (49,407) $ (10,019)
============ ============ ============
Fixed Maturity Securities
At December 31, 2003, the fair value and gross unrealized losses of
investments in debt securities segregated between securities having an
unrealized loss for less than 12 months and securities having an unrealized loss
for 12 months or longer were as follows:
Less than 12 months 12 months or longer Total
--------------------------- --------------------------- ---------------------------
Unrealized Unrealized Unrealized
Fair Value Losses Fair Value Losses Fair Value Losses
------------ ------------ ------------ ------------ ------------ ------------
As of December 31, 2003
U.S. government and
agency obligations
Mortgage-backed securities....... $ 63,308 $ 1,672 $ -- $ -- $ 63,308 $ 1,672
Other............................ 75,160 1,280 -- -- 75,160 1,280
Municipal bonds..................... 94,419 2,133 -- -- 94,419 2,133
Foreign government bonds............ 3,715 329 -- -- 3,715 329
Corporate bonds..................... 188,105 3,741 18,581 740 206,686 4,481
Other mortgage-backed securities.... 24,528 550 4,683 371 29,211 921
------------ ------------ ------------ ------------ ------------ ------------
Totals........................ $ 449,235 $ 9,705 $ 23,264 $ 1,111 $ 472,499 $ 10,816
============ ============ ============ ============ ============ ============
F-53
NOTE 3 - Investments-(Continued)
At December 31, 2003, the gross unrealized loss position in the investment
portfolio was $10,816 (113 positions and less than 0.5% of the investment
portfolio). There were no securities trading below 80% of amortized cost.
Securities with an investment grade rating represented 88% of the unrealized
loss. The largest single unrealized loss was $809 on a long-term U.S. treasury
bond purchased in June 2003 when interest rates hit 40 year lows. The majority
of the unrealized losses were due to changes in interest rates. The portfolio
included 11 securities that have been in an unrealized loss position for greater
than 12 months, totaling $1,111. Securities issued by Royal Caribbean, Green
Tree Financial, Southern Natural Gas, Sutton Bridge and CSAM Funding CDO
represented $1,088 of the total. The Company views the decrease in value of all
of the securities with unrealized losses at December 31, 2003 as temporary,
expects recovery in fair value, anticipates continued payments under the terms
of the securities, and has the intent and ability to hold these securities until
maturity or a recovery in fair value occurs. Therefore, no impairment of these
securities was recorded at December 31, 2003.
The amortized cost, unrealized investment gains and losses, and fair values
of investments in debt securities as of December 31, 2003 and 2002 were as
follows:
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
------------ ------------ ------------ ------------
As of December 31, 2003
U.S. government and agency obligations
Mortgage-backed securities............. $ 647,746 $ 14,076 $ 1,672 $ 660,150
Other.................................. 295,629 6,563 1,280 300,912
Municipal bonds........................... 488,081 16,964 2,133 502,912
Foreign government bonds.................. 33,134 3,389 329 36,194
Corporate bonds........................... 1,553,959 98,878 4,481 1,648,356
Other mortgage-backed securities.......... 106,312 4,759 921 110,150
------------ ------------ ------------ ------------
Totals................................. $ 3,124,861 $ 144,629 $ 10,816 $ 3,258,674
============ ============ ============ ============
As of December 31, 2002
U.S. government and agency obligations
Mortgage-backed securities............. $ 645,787 $ 28,253 $ -- $ 674,040
Other.................................. 129,584 7,919 -- 137,503
Municipal bonds........................... 358,636 19,283 455 377,464
Foreign government bonds.................. 13,131 2,845 -- 15,976
Corporate bonds........................... 1,498,481 94,192 23,266 1,569,407
Other mortgage-backed securities.......... 213,388 6,569 3,152 216,805
------------ ------------ ------------ ------------
Totals................................. $ 2,859,007 $ 159,061 $ 26,873 $ 2,991,195
============ ============ ============ ============
The Company's investment portfolio includes no derivative financial
instruments (futures, forwards, swaps, option contracts or other financial
instruments with similar characteristics).
F-54
NOTE 3 - Investments-(Continued)
Maturities/Sales Of Investments
The amortized cost and fair value of fixed maturity securities at December
31, 2003, by estimated expected maturity, are shown below. Estimated expected
maturities differ from contractual maturities reflecting assumptions regarding
borrowers' utilization of the right to call or prepay obligations with or
without call or prepayment penalties.
Percent of
Amortized Fair Total Fair
Cost Value Value
------------ ------------ ------------
Due in 1 year or less............... $ 231,759 $ 241,683 7.4%
Due after 1 year through 5 years.... 682,752 711,989 21.9
Due after 5 years through
10 years........................... 1,291,604 1,346,914 41.3
Due after 10 years through
20 years........................... 279,656 291,631 8.9
Due after 20 years.................. 639,090 666,457 20.5
------------ ------------ ------------
Total............................ $ 3,124,861 $ 3,258,674 100.0%
============ ============ ============
Proceeds from sales/maturities of fixed maturities and gross gains and
gross losses realized for each year were:
Year Ended December 31,
----------------------------------------
2003 2002 2001
------------ ------------ ------------
Proceeds............................ $ 1,483,614 $ 1,391,402 $ 1,015,229
Gross gains realized................ 50,907 40,402 16,945
Gross losses realized............... (12,903) (35,551) (31,316)
Unrealized Gains (Losses) on Fixed Maturities
Net unrealized gains (losses) are computed as the difference between fair
value and amortized cost for fixed maturities. A summary of the net increase
(decrease) in unrealized investment gains (losses) on fixed maturities, less
applicable income taxes, is as follows:
Year Ended December 31,
----------------------------------------
2003 2002 2001
------------ ------------ ------------
Unrealized gains (losses) on fixed
maturities
Beginning of period.............. $ 132,188 $ 43,036 $ (7,418)
End of period.................... 133,813 132,188 43,036
------------ ------------ ------------
Increase for the period....... 1,625 89,152 50,454
Income taxes........................ 569 31,203 17,659
------------ ------------ ------------
Increase in net unrealized gains
(losses) on fixed maturities
before the valuation impact on
deferred policy acquisition
costs and value of acquired
insurance in force................. $ 1,056 $ 57,949 $ 32,795
============ ============ ============
F-55
NOTE 3 - Investments-(Continued)
Securities Lending
The Company loans fixed income securities to third parties, primarily major
brokerage firms. As of December 31, 2003 and 2002, fixed maturities with a fair
value of $22,147 and $3,937, respectively, were on loan. Loans of securities are
required at all times to be secured by collateral from borrowers at least equal
to 100% of the market value of the securities loaned. The Company maintains
effective control over the loaned securities and therefore reports them as Fixed
Maturity Securities in the Consolidated Balance Sheets. SFAS No. 125,
"Accounting for Transfers and Servicing of Financial Assets and Extinguishment
of Liabilities", as amended by SFAS No. 140, "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 in the Company's Consolidated Balance Sheets.
Investment in Entities Exceeding 10% of Shareholders' Equity
At December 31, 2003 and 2002, there were no investments which exceeded 10%
of total shareholders' equity in entities other than obligations of the U.S.
Government and government agencies and authorities.
Deposits
At December 31, 2003, securities with a carrying value of $17,173 were on
deposit with governmental agencies as required by law in various states in which
the insurance subsidiaries of HMEC conduct business.
F-56
NOTE 4 - Property and Casualty Unpaid Claims and Claim Expenses
The following table sets forth an analysis of property and casualty unpaid
claims and claim expenses and provides a reconciliation of beginning and ending
reserves for the periods indicated.
Year Ended December 31,
----------------------------------------
2003 2002 2001
------------ ------------ ------------
Gross reserves, beginning of year..... $ 317,321 $ 306,141 $ 298,896
Less reinsurance recoverables...... 44,701 34,104 49,056
------------ ------------ ------------
Net reserves, beginning of year....... 272,620 272,037 249,840
------------ ------------ ------------
Incurred claims and claim
expenses:
Claims occurring in the current
year.............................. 416,473 387,747 416,770
Increase (decrease) in estimated
reserves for claims occurring
in prior years (1):
Policies written by the
Company (2).................... 58,270 22,295 14,574
Business assumed from state
reinsurance facilities......... (1,900) 1,700 2,000
------------ ------------ ------------
Total increase............... 56,370 23,995 16,574
------------ ------------ ------------
Total claims and claim
expenses incurred (2)(3)....... 472,843 411,742 433,344
------------ ------------ ------------
Claims and claim expense payments
for claims occurring during:
Current year....................... 239,950 244,396 255,939
Prior years........................ 184,632 166,763 155,208
------------ ------------ ------------
Total claims and claim
expense payments............... 424,582 411,159 411,147
------------ ------------ ------------
Net reserves, end of period........... 320,881 272,620 272,037
Plus reinsurance recoverables...... 20,615 44,701 34,104
------------ ------------ ------------
Gross reserves, end of
period (4)........................... $ 341,496 $ 317,321 $ 306,141
============ ============ ============
- ----------
(1) Shows the amounts by which the Company increased or decreased its reserves
in each of the periods indicated for claims occurring in previous periods
to reflect subsequent information on such claims and changes in their
projected final settlement costs. Also refer to the paragraphs below for
additional information regarding the increases in reserves recorded in
2003, 2002 and 2001.
(2) For the year ended December 31, 2002, these amounts included a $1,581
statutory accounting charge for class action litigation which was
separately reported as Litigation Charges in the Company's Consolidated
Statements of Operations.
(3) Benefits, claims and settlement expenses as reported in the Consolidated
Statements of Operations also include life, annuity, group accident and
health and corporate amounts of $46,135, $40,705 and $42,239 for the years
ended December 31, 2003, 2002 and 2001, respectively, in addition to the
property and casualty amounts.
(4) Unpaid claims and claim expenses as reported in the Consolidated Balance
Sheets also include life, annuity, and group accident and health reserves
of $9,005, $9,254 and $8,154 at December 31, 2003, 2002 and 2001,
respectively, in addition to property and casualty reserves.
Underwriting results of the property and casualty segment are significantly
influenced by estimates of the Company's ultimate liability for insured events.
There is a high degree of uncertainty inherent in the estimates of ultimate
losses underlying the liability for unpaid claims and claim expenses. This
inherent uncertainty is particularly significant for liability-related exposures
due to the extended period, often many years, that transpires between a loss
event, receipt of related claims data from policyholders and ultimate settlement
of the claim. Reserves for property and casualty claims include provisions for
payments to be made on reported claims, claims incurred but not yet reported and
associated settlement expenses. The process by which these reserves are
established requires reliance upon estimates based on known facts and on
interpretations of circumstances, including the Company's experience with
similar cases and historical trends involving claim payment patterns, claim
payments, pending levels of unpaid claims and product mix, as well as other
factors including court decisions, economic conditions and public attitudes. The
Company continually updates loss estimates using both quantitative information
from its reserving actuaries and qualitative information derived from other
sources. Adjustments may be required as information develops
F-57
NOTE 4 - Property and Casualty Unpaid Claims and Claim Expenses-(Continued)
which varies from experience, or, in some cases, augments data which previously
were not considered sufficient for use in determining liabilities. The effects
of these adjustments may be significant and are charged or credited to income
for the period in which the adjustments are made.
Excluding involuntary business, net adverse development of reserves for
property and casualty claims occurring in prior years was $58,270 for the full
year 2003, primarily related to automobile liability loss reserves from the 2001
and 2002 accident years, compared to adverse reserve development of $22,295 in
2002 which was primarily related to (1) automobile loss reserves from accident
years 2001 and years prior to 1997 and (2) loss adjustment expense reserves from
the 2001 and 2000 accident years for both automobile and homeowners. Adverse
development recorded in 2002 also included $1,581 due to a provision for the
costs of resolving class action lawsuits related to diminished value brought
against the Company. Net adverse development of total reserves for property and
casualty claims occurring in prior years, including involuntary business, was
$56,370 in 2003, $23,995 in 2002 and $16,574 in 2001. The Company's property and
casualty reserves were $320,881 and $272,620 at December 31, 2003 and 2002,
respectively, net of anticipated reinsurance recoverables.
The Company completes a detailed study of property and casualty reserves
based on information available at the end of each quarter and year. Trends of
reported losses (paid amounts and case reserves on claims reported to the
Company) for each accident year are reviewed and ultimate loss costs for those
accident years are estimated. The Company engages an independent property and
casualty actuarial consulting firm to prepare an independent study of the
Company's property and casualty reserves twice a year - at June 30 and December
31.
During 2002 and 2003, the Company made changes in its property and casualty
claims function including hiring of new management and claim adjusters (new
hires represented over half of the Company's 300 claims employees at December
31, 2003), implementing improved processes, and consolidating the previous 17
branch offices into 6 regional claims offices, which began in late-November 2002
and was completed in the first quarter of 2003. Installation and implementation
of the new claims administration system, including related process changes,
occurred in the third and fourth quarters of 2003 in the first two claims
offices with the remaining four offices planned for the first half of 2004.
As part of the claims operation redesign effort, open claim files --
particularly for automobile liability claims -- were reviewed by the new team.
In the first half of 2003, these reassessments resulted in a higher projected
ultimate liability for automobile liability claims from accident years 2001,
2000 and 1999 and prior. The high level of property and casualty paid and case
reserve activity on older bodily injury claims that was observed in the second
quarter of 2003 continued in the third quarter as the Company's new claims
organization intensified their efforts to bring older claims files up to date.
Furthermore, the acceleration of claim disposition rates extended into the third
quarter, as the new organization also moved to reduce the backlog of older
claims and handle current claims on a timely basis. As a result, the estimation
of claims costs, settlement rates and severity has been complicated in recent
quarters due to the degree of change involved.
F-58
NOTE 4 - Property and Casualty Unpaid Claims and Claim Expenses-(Continued)
As a result of the factors above, and in light of the pattern of adverse
prior years' reserve development observed over the five quarters ended September
30, 2003, at the end of the third quarter, the Company's management retained an
independent property and casualty actuarial and claims consulting firm to
conduct a detailed review of the Company's claims handling practices and their
integration with the Company's reserving practices. The consultant's claims and
actuarial specialists reviewed claim files as well as past and current claims
handling processes and procedures, including case reserving practices, in each
of the Company's six claims offices. They also performed an assessment of the
Company's actuarial processes for establishing IBNR and supplemental reserves.
The Company's December 31, 2003 actuarial analysis and reserve estimates
incorporated the observations of the consultant's claims and reserving practices
review. The low and high end of a reasonable range of reserve estimates for all
of the Company's coverages indicated net claim reserve levels of $286,000 and
$338,000, respectively. In recording the December 31, 2003 net reserves of
$320,881, the Company assessed the relative weight given to emerging claim
trends resulting from recent business process changes, pricing and claims
handling. Based upon this analysis, the Company selected a higher point in the
range for reserves related to the automobile liability coverages.
F-59
NOTE 4 - Property and Casualty Unpaid Claims and Claim Expenses-(Continued)
During 2000, the Company noted increases in paid severities in excess of
the original expectations in its direct voluntary automobile line of business.
As a result, the Company continued to monitor such severity trends until such
time as the Company believed that they were sufficiently credible to require
adjustment to the Company's claim and claim expense reserve projections.
Accordingly, the Company revised its projections in the fourth quarter of 2000
to give greater weight to the increasing trend of claim severities.
In 2001, the Company refined its claim reserving methodologies and trend
analyses including more detailed analyses of subrogation recovery activity on
business ceded to the state automobile insurance facility in Massachusetts. The
nature of the adverse trends in the second and fourth quarters of 2001 that
caused the Company to increase reserves consisted primarily of the following:
(1) an increase in the frequency and severity of educators excess professional
liability claims; (2) the utilization of selected ultimate subrogation
recoverables that were not trending with actual recoveries; and (3) the
utilization of selected ultimate loss ratios in establishing reserves for ceded
voluntary automobile excess liability claims and ceded Massachusetts involuntary
automobile reserves that were not trending with actual results.
In the third quarter of 2002, the Company increased its reserves for prior
accident years primarily related to allocated claim adjustment expenses for the
voluntary automobile and homeowners lines and claims for the educator excess
professional liability product. The Company had noted increases in paid claims
and claim expenses for prior accident years in these lines during the first and
second quarters of 2002 and continued to monitor such adverse trends until such
time as the Company believed that they were sufficiently credible to require
adjustment of the reserves. As a result, the Company revised its loss
projections in the third quarter of 2002, incorporating the higher paid claims
and claim expense trends.
F-60
NOTE 4 - Property and Casualty Unpaid Claims and Claim Expenses-(Continued)
In the fourth quarter of 2002, the Company increased its reserves for prior
accident years related primarily to (1) automobile claim reserves from accident
years 2001, 2000 and years prior to 1997 and (2) allocated and unallocated claim
expense reserves from the 2001 accident year for both automobile and homeowners.
During the third and fourth quarters of 2002, the Company continued to closely
monitor emerging trends in (1) the severity of payments on previously reported
losses for voluntary automobile and (2) paid claims adjustment expenses for
these prior accident years until such time as the Company believed that the
trends were sufficiently credible to require adjustment of the reserves. As a
result, the Company revised its projections in the fourth quarter of 2002,
incorporating the higher paid claims and claim expense trends.
As the Company's claims operation redesign efforts progressed during 2003,
the elevated level of claim payments and case reserve activity related to prior
accident years continued. Consequently, the Company revised its loss projections
throughout 2003, most notably in the third quarter, as greater relative weight
was given to the emerging claim trends.
At the time each of the reserve analyses were performed, the Company
believed that each estimate was based upon sound and correct methodology and
such methodology was appropriately applied and that there were no trends which
indicated the likelihood of future adverse development. The financial
impact of the net reserve strengthening was therefore accounted for in the
period that the change was determined.
No other unusual adjustments were made in the determination of the
liabilities during the periods covered by these financial statements. Management
believes that, based on data currently available, it has reasonably estimated
the Company's ultimate losses.
NOTE 5 - Debt
Indebtedness and scheduled maturities at December 31, 2003 and 2002
consisted of the following:
Effective December 31,
Interest Final ----------------------
Rates Maturity 2003 2002
--------- -------- ---------- ----------
Short-term debt:
Bank Credit Facility................................. Variable 2005 $ 25,000 $ --
Long-term debt:
1.425% Senior Convertible Notes, Face
amount less unaccrued discount of $128,362.......... 3.0% 2032 116,138 116,138
6 5/8% Senior Notes, Face amount less unaccrued
discount of $35 and $53, respectively............... 6.7% 2006 28,565 28,547
---------- ----------
Total............................................. $ 169,703 $ 144,685
========== ==========
F-61
NOTE 5 - Debt-(Continued)
Credit Agreement with Financial Institutions ("Bank Credit Facility")
On May 29, 2002, the Company entered into a new Bank Credit Agreement which
provides for unsecured borrowings of up to $25,000, with a provision that allows
the commitment amount to be increased to $35,000 (the "Current Bank Credit
Facility"). The Current Bank Credit Facility expires on May 31, 2005. Interest
accrues at varying spreads relative to corporate or eurodollar base rates and is
payable monthly or quarterly depending on the applicable base rate (Interbank
Offering Rate plus 1.0%, or 2.2%, at December 31, 2003). The unused portion of
the Current Bank Credit Facility is subject to a variable commitment fee, which
was 0.25% and 0.20% on an annual basis at December 31, 2003 and 2002,
respectively.
1.425% Senior Convertible Notes ("Senior Convertible Notes")
On May 14, 2002, the Company issued $353,500 aggregate principal amount of
1.425% senior convertible notes due in 2032 at a discount of 52.5% resulting in
an effective yield of 3.0%. In 2002, the Company repurchased $53,000 aggregate
principal amount, $25,175 carrying value, of the outstanding Senior Convertible
Notes at an aggregate cost of $22,770. In addition to these cash transactions,
in December 2002 the Company repurchased an additional $56,000 aggregate
principal amount, $26,600 carrying value, of the outstanding Senior Convertible
Notes at an aggregate cost of $25,984 in a non-cash transaction. As
consideration for this repurchase, 1,837,925 shares of HMEC's common stock were
issued.
Interest on the Senior Convertible Notes is payable semi-annually at a rate
of 1.425% beginning November 14, 2002 until May 14, 2007. After that date, cash
interest will not be paid on the Senior Convertible Notes prior to maturity
unless contingent cash interest becomes payable. From May 15, 2007 through
maturity of the Senior Convertible Notes, interest will be recognized at the
effective rate of 3.0% and will represent the accrual of discount, excluding any
contingent cash interest that may become payable. Contingent cash interest
becomes payable if the average market price of a Senior Convertible Note for a
five trading day measurement period preceding the applicable six-month period
equals 120% or more of the sum of the Senior Convertible Note's issue price,
accrued original issue discount and accrued cash interest, if any, for such
Senior Convertible Note. The contingent cash interest payable per Senior
Convertible Note with respect to any quarterly period within any six-month
period will equal the then applicable conversion rate multiplied by the greater
of (i) $0.105 or (ii) any regular cash dividends paid by the Company per share
on HMEC's common stock during that quarterly period.
F-62
NOTE 5 - Debt-(Continued)
The Senior Convertible Notes will be convertible at the option of the
holders into shares of HMEC's common stock at a conversion price of $26.74 if
the conditions for conversion are satisfied. Holders may also surrender Senior
Convertible Notes for conversion during any period in which the credit rating
assigned to the Senior Convertible Notes is Ba2 or lower by Moody's or BB+ or
lower by S&P, the Senior Convertible Notes are no longer rated by either Moody's
or S&P, or the credit rating assigned to the Senior Convertible Notes has been
suspended or withdrawn by either Moody's or S&P. The Senior Convertible Notes
will cease to be convertible pursuant to this credit rating criteria during any
period or periods in which all of the credit ratings are increased above such
levels. The Senior Convertible Notes are redeemable by HMEC in whole or in part,
at any time on or after May 14, 2007, at redemption prices equal to the sum of
the issue price plus accrued original issue discount and accrued cash interest,
if any, on the applicable redemption date. The holders of the Senior Convertible
Notes may require HMEC to purchase all or a portion of their Senior Convertible
Notes on either May 14, 2007, 2012, 2017, 2022, or 2027 at stated prices plus
accrued cash interest, if any, to the purchase date. HMEC may pay the purchase
price in cash or shares of HMEC common stock or in a combination of cash and
shares of HMEC common stock.
6 5/8% Senior Notes ("Senior Notes")
On January 17, 1996, the Company issued $100,000 face amount of Senior
Notes at an effective yield of 6.7%, which will mature on January 15, 2006.
Interest on the Senior Notes is payable semi-annually at a rate of 6 5/8%. The
Senior Notes are redeemable in whole or in part, at any time, at the Company's
option, at a redemption price equal to the greater of (1) 100% of their
principal amount and (2) the sum of the present values of the remaining
scheduled payments of principal and interest thereon discounted, on a
semi-annual basis, at the Treasury yield (as defined in the indenture) plus 15
basis points, together with accrued interest to the date of redemption.
In 2002, the Company repurchased $71,400 aggregate principal amount of its
outstanding Senior Notes utilizing a portion of the proceeds from the issuance
of the Senior Convertible Notes, as described above. The aggregate cost of the
repurchases was $74,650.
Universal Shelf Registration
To provide additional capital management flexibility, the Company filed a
"universal shelf" registration on Form S-3 with the SEC in December 2003. The
registration statement, which registers the offer and sale by the Company from
time to time of up to $300,000 of various securities, which may include debt
securities, preferred stock, common stock and/or depositary shares, was declared
effective on December 30, 2003. No securities associated with the registration
statement have been issued as of the date of this Report on Form 10-K.
Debt Retirement Charges
The repurchases of the Senior Convertible Notes and Senior Notes resulted
in a pretax charge to income for the year ended December 31, 2002 of $2,272.
F-63
NOTE 5 - Debt-(Continued)
Covenants
The Company is in compliance with all of the covenants contained in the
Senior Convertible Notes indenture, the Senior Notes indenture and the Bank
Credit Facility Agreement, consisting primarily of relationships of (1) debt to
capital and (2) insurance subsidiaries' earnings to future interest charges.
NOTE 6 - Shareholders' Equity and Stock Options
Share Repurchase Program and Treasury Shares Held
At December 31, 2001, the Company held 19,341,296 shares in treasury. In
December 2002, the Company issued 1,837,925 of the treasury shares as
consideration for the repurchase of a portion of its outstanding Senior
Convertible Notes. At December 31, 2003, the Company held 17,503,371 shares in
treasury. As of December 31, 2003, $96,343 remained authorized for future share
repurchases.
Authorization of Preferred Stock
In 1996, the shareholders of HMEC approved authorization of 1,000,000
shares of $0.001 par value preferred stock. The Board of Directors is authorized
to (1) direct the issuance of the preferred stock in one or more series, (2) fix
the dividend rate, conversion or exchange rights, redemption price and
liquidation preference, of any series of the preferred stock, (3) fix the number
of shares for any series and (4) increase or decrease the number of shares of
any series. No shares of preferred stock were outstanding at December 31, 2003,
2002 and 2001.
The Company's catastrophe reinsurance program is augmented by a $75,000
equity put and reinsurance agreement. The 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 $115,000 of catastrophe losses
above the reinsurance coverage limit. The agreement contains certain conditions
to Horace Mann's exercise of the equity put option as disclosed in Note 11 -
Reinsurance. Fees related to this equity put option totaled $1,088 for the year
ended December 31, 2003 and were charged directly to additional paid-in capital.
F-64
NOTE 6 - Shareholders' Equity and Stock Options-(Continued)
In connection with the equity put described in the preceding paragraph, the
Board of Directors has designated a series of preferred stock to be available
for use in the put. The Series so designated is Series A Cumulative Convertible
Preferred Stock (the "Series A Stock") and 100,000 shares have been assigned to
this series. None of these shares are currently issued or outstanding. The
Series A Stock is dividend paying, at a floating rate which varies with
movements in the London Interbank Offered Rate and with changes in the risk
rating of the Series A Stock as determined by Standard & Poor's Corporation. The
Series A Stock does not require any sinking fund or similar mechanism regarding
payment of such dividends. Beginning on the fourth anniversary of the issuance
of Series A Stock, the holders thereof have the right to demand conversion of
the Series A Stock into common stock of the Company at a conversion rate based
on then prevailing market prices for the common stock; however, upon receipt of
a conversion demand, the Company has the right to redeem the Series A Stock
prior to such conversion. The Series A Stock has liquidation rights which place
the Series A Stock ahead of the common stock in priority. The Series A Stock has
no voting rights other than the requirement that the Series A Stock approve any
changes in the Series A Stock, the creation of any other class of stock on a par
with or superior to the Series A Stock and certain extraordinary transactions
such as certain mergers involving the Company.
Director Stock Plan
In 1996, the shareholders of HMEC approved the Deferred Equity Compensation
Plan ("Director Stock Plan") for directors of the Company and reserved 600,000
shares for issuance pursuant to the Director Stock Plan. Shares of the Company's
common stock issued under the Director Stock Plan may be either authorized and
unissued shares or shares that have been reacquired by the Company. As of
December 31, 2003, 2002 and 2001, 147,529, 139,867 and 121,322 units,
respectively, were outstanding under this plan representing an equal number of
common shares to be issued in the future.
Employee Stock Plan
In 1997, the Board of Directors of HMEC approved the Deferred Compensation
Plan for Employees ("Employee Stock Plan"). Shares of the Company's common stock
issued under the Employee Stock Plan may be either authorized and unissued
shares or shares that have been reacquired by the Company. As of December 31,
2003, 2002 and 2001, 27,231, 30,585 and 14,303 units, respectively, were
outstanding under this plan representing an equal number of common shares to be
issued in the future.
Stock Options
The shareholders of HMEC approved the 1991 Stock Incentive Plan (the "1991
Plan"), the 2001 Stock Incentive Plan (the "2001 Plan") and the 2002 Incentive
Compensation Plan (the "2002 Plan") and reserved a total of 9,000,000 shares of
common stock for issuance under these plans. Under the 1991 Plan, the 2001 Plan
and the 2002 Plan, options to purchase shares of HMEC common stock may be
granted to executive officers, other employees and directors. The options are
exercisable in installments generally beginning in the first year from the date
of grant and generally expiring 10 years from the date of grant.
F-65
NOTE 6 - Shareholders' Equity and Stock Options-(Continued)
Changes in outstanding options and shares available for grant under the
1991 Plan, the 2001 Plan and the 2002 Plan were as follows:
Weighted Options
Average Range of ------------------------------------------
Option Price Option Prices Vested and Available
per Share per Share Outstanding Exercisable for Grant
------------ ------------- ------------ ------------ ------------
At December 31, 2000...... $ 18.98 $ 9.00-$33.87 2,736,725 903,802 1,307,412
------------ ------------ ------------
Granted................ $ 18.22 $16.83-$21.77 1,020,050 271,775 (1,020,050)
Vested................. $ 19.72 $13.84-$33.87 -- 519,860 --
Exercised.............. $ 10.18 $ 9.00-$17.56 (207,575) (207,575) --
Canceled............... $ 20.52 $15.32-$33.87 (136,950) (136,950) 136,950
------------ ------------ ------------
At December 31, 2001...... $ 19.23 $11.12-$33.87 3,412,250 1,350,912 424,312
------------ ------------ ------------
Increase in options
available for grant... -- -- 3,000,000
Granted................ $ 20.72 $15.92-$21.64 1,375,950 116,944 (1,375,950)
Vested................. $ 18.20 $13.84-$33.87 -- 724,488 --
Exercised.............. $ 16.57 $11.13-$22.42 (107,410) (107,410) --
Canceled............... $ 22.01 $15.15-$33.87 (131,370) (131,370) 131,370
------------ ------------ ------------
At December 31, 2002...... $ 19.66 $11.12-$33.87 4,549,420 1,953,564 2,179,732
------------ ------------ ------------
Granted................ $ 13.95 $13.88-$15.33 593,700 153,841 (593,700)
Vested................. $ 18.80 $14.78-$33.87 -- 852,582 --
Canceled............... $ 19.42 $13.88-$33.87 (473,150) (473,150) 473,150
------------ ------------ ------------
At December 31, 2003...... $ 18.96 $11.12-$33.87 4,669.970 2,486,837 2,059,182
============ ============ ============
The weighted average grant date fair values were $3.98, $8.99 and $8.55 for
options granted in 2003, 2002 and 2001, respectively. The weighted average
prices of vested and exercisable options as of December 31, 2002 and 2001 were
$20.22 and $19.23, respectively. For options outstanding at December 31, 2003,
information segregated by ranges of exercise prices was as follows:
Vested and Exercisable Options
------------------------------------------
Weighted Weighted
Average Range of Total Average Weighted
Option Price Option Prices Options Option Price Average
per Share per Share Outstanding Options per share Life
------------ ------------- ------------ ------------ ------------ ------------
At December 31, 2003
$ 14.35 $11.12-$16.38 749,275 265,316 $ 14.67 7.8 years
$ 19.24 $16.83-$23.31 3,750,395 2,051,221 $ 18.99 6.8 years
$ 33.05 $25.63-$33.87 170,300 170,300 $ 33.05 4.4 years
------------ ------------
Total..................... $ 18.96 $11.12-$33.87 4,669,970 2,486,837 $ 19.49 6.8 years
============ ============
F-66
NOTE 7 - Income Taxes
The federal income tax liabilities included in Other Liabilities in the
Consolidated Balance Sheets as of December 31, 2003 and 2002 were as follows:
December 31,
---------------------------
2003 2002
------------ ------------
Current liability......................... $ 2,803 $ 14,698
Deferred liability........................ 8,426 14,761
Deferred tax assets and liabilities are recognized for all future tax
consequences attributable to "temporary differences" between the financial
statement carrying amounts of existing assets and liabilities and their
respective tax bases. There are no deferred tax liabilities that have not been
recognized. The "temporary differences" that give rise to the deferred tax
balances at December 31, 2003 and 2002 were as follows:
December 31,
---------------------------
2003 2002
------------ ------------
Deferred tax assets
Discounting of unpaid claims and
claim expenses tax reserves........... $ 8,862 $ 7,103
Life insurance future policy benefit
reserve revaluation................... 29,296 26,599
Unearned premium reserve reduction..... 13,314 12,664
Postretirement benefits other than
pension............................... 10,585 10,890
Unutilized net operating loss
carryforward.......................... 17,586 1,060
Unutilized capital loss carryforward... 9,342 4,638
Impaired securities.................... 3,544 17,512
Compensation accruals ................. 6,619 5,609
North Carolina premium escrow.......... 1,715 646
Other, net............................. 4,262 5,287
------------ ------------
Total gross deferred tax assets..... 105,125 92,008
------------ ------------
Deferred tax liabilities
Unrealized gains on securities......... 43,943 43,382
Intangible assets...................... 9,849 11,181
Deferred policy acquisition costs...... 59,759 52,206
------------ ------------
Total gross deferred tax
liabilities........................ 113,551 106,769
------------ ------------
Net deferred tax liability....... $ 8,426 $ 14,761
============ ============
Based on the Company's historical earnings, future expectations of adjusted
taxable income, as well as reversing gross deferred tax liabilities, the Company
believes it is more likely than not that gross deferred tax assets will be fully
realized and that a valuation allowance with respect to the realization of the
total gross deferred tax assets is not necessary.
At December 31, 2003, the Company had available $50,245 (pretax) of net tax
operating loss carryforwards for federal income tax purposes. These
carryforwards will expire beginning in 2016 thru 2018. In addition, the Company
had available $26,694 (pretax) of capital loss carryforwards which will expire
beginning in 2006 thru 2008.
The components of federal income tax expense (benefit) were as follows:
Year Ended December 31,
------------------------------------------
2003 2002 2001
------------ ------------ ------------
Current.......................... $ 7,106 $ 29,423 $ (8,536)
Deferred......................... (6,902) (33,091) 11,291
------------ ------------ ------------
Total tax expense (benefit)... $ 204 $ (3,668) $ 2,755
============ ============ ============
F-67
NOTE 7 - Income Taxes-(Continued)
Income tax expense for the following periods differed from the expected tax
computed by applying the federal corporate tax rate of 35% to income before
income taxes as follows:
Year Ended December 31,
------------------------------------------
2003 2002 2001
------------ ------------ ------------
Expected federal tax on income... $ 6,713 $ 2,683 $ 9,920
Add (deduct) tax effects of:
Tax-exempt interest........... (5,027) (3,928) (3,826)
Tax reserve release........... -- -- (3,034)
Goodwill...................... -- -- 566
Dividend received deduction... (1,918) (2,608) (904)
Other, net.................... 436 185 1,302
------------ ------------ ------------
Income tax expense (benefit)
provided on income before
adjustment to the provision
for prior years' taxes.......... 204 (3,668) 4,024
Adjustment to the provision
for prior years' taxes.......... -- -- (1,269)
------------ ------------ ------------
Income tax expense (benefit)
provided on income.............. $ 204 $ (3,668) $ 2,755
============ ============ ============
As previously reported, the Company had 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. In 2001,
the Company's liability for the 1997 tax year was resolved, resulting in a
release of $1,269 that had previously been accrued for that tax year. That
amount was included in net income for the year ended December 31, 2001.
NOTE 8 - Fair Value of Financial Instruments
The Company is required under GAAP to disclose estimated fair values for
certain financial instruments. Fair values of the Company's insurance contracts
other than annuity contracts are not required to be disclosed. However, the fair
values of liabilities under all insurance contracts are taken into consideration
in the Company's overall management of interest rate risk through the matching
of investment maturities with amounts due under insurance contracts. The
following methods and assumptions were used to estimate the fair value of
financial instruments.
Investments - For fixed maturities and short-term and other investments,
fair value equals quoted market price, if available. If a quoted market price is
not available, fair value is estimated using quoted market prices for similar
securities, adjusted for differences between the quoted securities and the
securities being valued. The fair value of policy loans is based on estimates
using discounted cash flow analysis and current interest rates being offered for
new loans. The fair value of mortgage loans is estimated by discounting the
future cash flows using the current rates at which similar loans would be made
to borrowers with similar credit ratings and the same remaining maturities. The
carrying value of real estate is an estimate of fair value based on discounted
cash flows from operations.
F-68
NOTE 8 - Fair Value of Financial Instruments-(Continued)
Annuity Contract Liabilities and Policyholder Account Balances on
Interest-sensitive Life Contracts - The fair values of annuity contract
liabilities and policyholder account balances on interest-sensitive life
contracts are equal to the discounted estimated future cash flows (using the
Company's current interest rates for similar products including consideration of
minimum guaranteed interest rates) including an adjustment for risk that the
timing or amount of cash flows will vary from management's estimate.
Other Policyholder Funds - Other policyholder funds are liabilities related
to supplementary contracts without life contingencies and dividend accumulations
which represent deposits that do not have defined maturities. The carrying value
of these funds is used as a reasonable estimate of fair value.
Long-term Debt - The fair value of long-term debt is estimated based on
quoted market prices of publicly traded issues.
The carrying amounts and fair values of financial instruments at December
31, 2003 and 2002 consisted of the following:
December 31,
------------------------------------------------------
2003 2002
-------------------------- --------------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
------------ ------------ ------------ ------------
Financial Assets
Investments
Fixed maturities................... $ 3,258,674 $ 3,258,674 $ 2,991,195 $ 2,991,195
Short-term and other investments... 104,904 109,877 135,431 138,734
Short-term investments,
loaned securities collateral....... 22,147 22,147 3,937 3,937
------------ ------------ ------------ ------------
Total investments............... 3,385,725 3,390,698 3,130,563 3,133,866
Cash.................................. 19,773 19,773 60,162 60,162
Financial Liabilities
Policyholder account balances on
interest-sensitive life contracts.... 87,249 85,302 93,435 91,359
Annuity contract liabilities.......... 1,526,174 1,361,788 1,385,737 1,236,478
Other policyholder funds.............. 129,888 129,888 125,108 125,108
Short-term debt....................... 25,000 25,000 -- --
Long-term debt........................ 144,703 142,916 144,685 137,692
Fair value assumptions are based upon subjective estimates of market
conditions and perceived risks of financial instruments at a certain point in
time. The disclosed fair values do not reflect any premium or discount that
could result from offering for sale at one time an entire holding of a
particular financial instrument. In addition, potential taxes and other expenses
that would be incurred in an actual sale or settlement are not reflected in
amounts disclosed.
F-69
NOTE 9 - Statutory Surplus and Subsidiary Dividend Restrictions
The insurance departments of various states in which the insurance
subsidiaries of HMEC are domiciled recognize as net income and surplus those
amounts determined in conformity with statutory accounting principles prescribed
or permitted by the insurance departments, which differ in certain respects from
GAAP.
Reconciliations of statutory capital and surplus and net income, as
determined using statutory accounting principles, to the amounts included in the
accompanying financial statements are as follows:
December 31,
--------------------------
2003 2002
------------ ------------
Statutory capital and surplus of
insurance subsidiaries................... $ 438,856 $ 427,737
Increase (decrease) due to:
Deferred policy acquisition costs...... 193,703 174,555
Difference in policyholder reserves.... (40,600) (39,784)
Goodwill............................... 47,396 47,396
Value of acquired insurance in force... 27,259 31,945
Liability for postretirement
benefits, other than pensions......... (29,871) (30,253)
Investment fair value
adjustments on fixed maturities....... 133,813 132,188
Difference in investment reserves...... 30,866 19,448
Federal income tax liability........... (43,493) (38,962)
Minimum pension liability adjustment... (26,541) (26,563)
Non-admitted assets and other, net..... 1,733 5,216
Shareholders' equity of parent
company and non-insurance
subsidiaries.......................... (32,943) (29,396)
Parent company short-term and
long-term debt........................ (169,703) (144,685)
------------ ------------
Shareholders' equity as reported
herein................................ $ 530,475 $ 528,842
============ ============
Year Ended December 31,
------------------------------------
2003 2002 2001
---------- ------------ ----------
Statutory net income (loss) of
insurance subsidiaries................. $ 12,616 $ (28,741) $ 15,146
Net loss of non-insurance companies..... (4,337) (3,831) (3,313)
Interest expense........................ (6,339) (8,517) (9,250)
Tax benefit of interest expense and
other parent company current tax
adjustments............................ (2,087) 5,731 10,954
---------- ------------ ----------
Combined net income (loss).............. (147) (35,358) 13,537
Increase (decrease) due to:
Deferred policy acquisition costs.... 19,836 21,821 19,565
Policyholder benefits................ 126,999 (42,708) 9,513
Reserve adjustment on life
reinsurance ceded................... (118,813) 50,000 --
Federal income tax expense........... 5,101 32,859 (13,850)
Provision for prior years' taxes..... -- -- 1,269
Amortization of intangible assets.... (5,027) (5,734) (5,774)
Investment reserves.................. 6,446 9,009 5,425
Other adjustments, net............... (15,420) (18,556) (4,098)
---------- ------------ ----------
Net income as reported herein..... $ 18,975 $ 11,333 $ 25,587
========== ============ ==========
The Company has principal insurance subsidiaries domiciled in Illinois,
California and Texas. The statutory financial statements of these subsidiaries
are prepared in accordance with accounting principles prescribed or permitted by
the Illinois Department of Insurance, the California Department of Insurance and
the Texas Department of Insurance, as applicable. Prescribed statutory
accounting principles include a variety of publications of the National
Association of Insurance Commissioners ("NAIC"), as well as state laws,
regulations and general administrative rules.
F-70
NOTE 9 - Statutory Surplus and Subsidiary Dividend Restrictions-(Continued)
The Company's 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. The aggregate amount of dividends that may
be paid by the insurance subsidiaries to HMEC during 2004 without prior approval
is approximately $43,000.
The NAIC has adopted risk-based capital guidelines to evaluate the adequacy
of statutory capital and surplus in relation to risks assumed in investments,
reserving policies, and volume and types of insurance business written. State
insurance regulations prohibit insurance companies from making any public
statements or representations with regard to their risk-based capital levels.
Based on current guidelines, the risk-based capital statutory requirements are
not expected to have a negative regulatory impact on the Company's insurance
subsidiaries. At December 31, 2003 and 2002, statutory capital and surplus of
each of the Company's insurance subsidiaries was above required levels.
On December 31, 2003, the Company's primary life insurance subsidiary,
Horace Mann Life Insurance Company ("HMLIC"), entered into a reinsurance
agreement with the United States branch of Sun Life Assurance Company of Canada
("SLACC") which replaced the 2002 agreement with Sun Life Reinsurance Company
Limited ("SLRCL"), a member of the Sun Life Financial Group. Under the terms of
the December 31, 2003 agreement, which is expected to be in place for a five
year period, HMLIC ceded to SLACC, on a combination coinsurance and modified
coinsurance basis, a 75% quota share of HMLIC's in force interest-sensitive life
block of business issued prior to January 1, 2002. SLACC assumes its
proportional share of all risks attendant to the business reinsured such as
mortality, persistency and investment risk, reducing HMLIC's liabilities under
statutory accounting principles to the extent of the ceded commission. The
initial ceded commission received by HMLIC was $50,000 and resulted in a $32,500
after-tax increase in HMLIC's statutory surplus. Subsequent growth in HMLIC's
statutory surplus is expected to be reduced by approximately $6,500 annually, as
the coinsurance reserve declines over the term of the agreement. Fees related to
these transactions, which are anticipated to reduce the Company's pretax GAAP
income by approximately $1,000 in 2004, are also expected to decline over the
term of the agreement. These transactions improved the statutory operating
leverage and risk-based capital ratio of HMLIC in 2003 and 2002. The agreement
contains a condition whereby HMLIC must maintain an S&P financial strength
rating of BBB- or higher. If this condition is not maintained for a period of
more than 60 consecutive days, HMLIC may recapture the agreement without penalty
after giving 30 days written notice.
NOTE 10 - Pension Plans and Other Postretirement Benefits
All employees of the Company are covered by a defined contribution plan and
participate in a 401(k) plan. Employees hired on or before December 31, 1998 are
also covered under a defined benefit plan. In addition, certain employees
participate in a supplemental defined benefit plan or a supplemental defined
contribution plan or both.
Under the defined contribution plan, the Company makes a contribution to
each participant's account based on compensation and years of service.
Participants are 100% vested in this plan after 5 years of service.
F-71
NOTE 10 - Pension Plans and Other Postretirement Benefits-(Continued)
All employees of the Company participate in a 401(k) plan. Beginning
January 1, 2002, the Company automatically contributes 3% of eligible
compensation to each employee's account, which is 100% vested at the time of the
contribution. In addition, each participant may contribute up to 20% of eligible
compensation into their account. Prior to December 31, 2001, the Company
contributed an amount equal to 50% of the first 6% of eligible compensation
contributed by the employee, and the Company contribution vested over 5 years at
a rate of 20% per year of service.
Amounts earned under the defined benefit and supplemental defined benefit
plans are based on years of service and the highest average 36 consecutive
months earnings under the plan through March 31, 2002. Effective April 1, 2002,
participants stopped accruing benefits under the defined benefit and
supplemental defined benefit plans but continue to retain the benefits they had
accrued to date. Participants are 100% vested in these plans after 5 years of
service.
The Company's policy with respect to funding the defined benefit plan is to
contribute amounts which are actuarially determined to provide the plan with
sufficient assets to meet future benefit payments consistent with the funding
requirements of federal laws and regulations. For the defined contribution,
401(k) and defined benefit plans, investments have been set aside in a trust
fund; whereas the supplemental retirement plans are non-qualified, unfunded
plans.
Total expense recorded for the defined contribution, 401(k), defined
benefit and supplemental plans was $15,347, $19,259 and $10,678 for the years
ended December 31, 2003, 2002 and 2001, respectively.
Defined Contribution Plan and 401(k) Plan
Pension benefits under the defined contribution plan were fully funded and
investments were set aside in a trust fund. None of the trust fund assets for
the defined contribution plan have been invested in shares of HMEC's common
stock. The 401(k) plan was fully funded and investments were set aside through
an annuity contract underwritten by the Company's principal life insurance
subsidiary. The annuity contract includes a fixed return account option and
several variable return account options, with the account options selected by
the individual plan participants. One of the variable return account options
invests in shares of HMEC common stock. Contributions to employees' accounts
under the defined contribution plan and the 401(k) plan, which were expensed in
the Company's Consolidated Statements of Operations, and total assets of the
plans were as follows:
Year Ended December 31,
-------------------------------------
2003 2002 2001
----------- ------------ ----------
Defined contribution plan:
Contributions to employees accounts... $ 5,818 $ 6,254 $ 6,012
Total assets at the end of the year... 112,795 105,431 97,967
401(k) plan:
Contributions to employees accounts... 3,814 3,471 2,301
Total assets at the end of the year... 93,977 81,751 92,189
F-72
NOTE 10 - Pension Plans and Other Postretirement Benefits-(Continued)
Defined Benefit Plan and Supplemental Retirement Plans
The following tables summarize both the funding status of the defined
benefit and supplemental retirement pension plans and identify the assumptions
used to determine the projected benefit obligation and the components of net
pension cost for the defined benefit plan and supplemental retirement plans for
the following periods:
Supplemental
Defined Benefit Plan Retirement Plans
------------------------------------ ------------------------------------
December 31, December 31,
------------------------------------ ------------------------------------
2003 2002 2001 2003 2002 2001
---------- ---------- ---------- ---------- ---------- ----------
Change in benefit obligation:
Projected benefit obligation at beginning
of year...................................... $ 50,402 $ 50,927 $ 50,830 $ 16,014 $ 13,607 $ 12,191
Service cost.................................. -- 696 1,789 555 671 610
Interest cost................................. 3,258 3,453 3,518 1,019 907 840
Plan amendments............................... -- -- 980 -- -- (383)
Actuarial loss (gains)........................ 8,569 7,056 5,500 (103) 1,839 1,355
Benefits paid................................. (2,022) (1,484) (6,010) (1,219) (1,010) (997)
Curtailment gain.............................. -- -- (5,680) -- -- (9)
Settlements................................... (6,946) (10,246) -- -- -- --
---------- ---------- ---------- ---------- ---------- ----------
Projected benefit obligation at end of year... $ 53,261 $ 50,402 $ 50,927 $ 16,266 $ 16,014 $ 13,607
========== ========== ========== ========== ========== ==========
Change in plan assets:
Fair value of plan assets at beginning
of year...................................... $ 28,105 $ 34,569 $ 43,401 $ -- $ -- $ --
Actual return on plan assets.................. 5,812 (2,644) (2,822) -- -- --
Employer contributions........................ 8,780 7,910 -- 1,219 1,010 997
Benefits paid................................. (2,022) (1,484) (6,010) (1,219) (1,010) (997)
Settlements................................... (6,946) (10,246) -- -- -- --
---------- ---------- ---------- ---------- ---------- ----------
Fair value of plan assets at end of year...... $ 33,729 $ 28,105 $ 34,569 $ -- $ -- $ --
========== ========== ========== ========== ========== ==========
Funded status.................................... $ (19,532) $ (22,297) $ (16,358) $ (16,266) $ (16,014) $ (13,607)
Unrecognized net actuarial loss.................. 22,860 22,393 14,967 3,681 4,136 2,603
---------- ---------- ---------- ---------- ---------- ----------
Accrued benefit cost included in the
Consolidated Balance Sheets..................... 3,328 96 (1,391) (12,585) (11,878) (11,004)
Additional liability to recognize unfunded
accumulated benefit obligation.................. (22,860) (22,393) (14,967) (3,681) (4,170) (2,630)
---------- ---------- ---------- ---------- ---------- ----------
Total benefit cost............................... $ (19,532) $ (22,297) $ (16,358) $ (16,266) $ (16,048) $ (13,634)
========== ========== ========== ========== ========== ==========
Aimounts recognized in the Statements of
Financial Position consist of:
Accrued benefit cost.......................... $ 3,328 $ 96 $ (1,391) $ (12,585) $ (11,878) $ (11,004)
Minimum liability............................. (22,860) (22,393) (14,967) (3,681) (4,170) (2,630)
Accumulated other comprehensive income........ 22,860 22,393 14,967 3,681 4,170 2,630
---------- ---------- ---------- ---------- ---------- ----------
Net amount recognized...................... $ 3,328 $ 96 $ (1,391) $ (12,585) $ (11,878) $ (11,004)
========== ========== ========== ========== ========== ==========
Information for pension plans with an accumulated
benefit obligation greater than plan assets:
Projected benefit obligation.................. $ 53,261 $ 50,402 $ 50,927 $ 16,266 $ 16,014 $ 13,607
Accumulated benefit obligation................ 53,261 50,402 50,927 16,266 16,014 13,607
Fair value of plan assets..................... 33,729 28,105 34,569 -- -- --
F-73
NOTE 10 - Pension Plans and Other Postretirement Benefits-(Continued)
The increase in the Company's 2002 minimum pension liability for the
defined benefit plan of $7,426 was attributable to the following factors: (1) a
decline in asset performance, (2) an increase in the assumed frequency of lump
sum elections, (3) an increase in retirement rates and (4) a change in the
discount rate from 7.00% to 6.75%. The increase in the Company's 2001 minimum
pension liability for the defined benefit plan of $14,967 was attributable to
the following factors: (1), (2) and (3) as noted in the previous sentence and
(4) a change in the discount rate from 7.25% to 7.00%. These increases were
recorded as charges to a separate component of shareholders' equity.
Supplemental
Defined Benefit Plan Retirement Plans
--------------------------------- ------------------------------
Year Ended December 31, Year Ended December 31,
--------------------------------- ------------------------------
2003 2002 2001 2003 2002 2001
--------- --------- --------- -------- -------- --------
Components of net periodic pension (income)
expense:
Service cost.................................. $ -- $ 696 $ 1,789 $ 555 $ 671 $ 610
Interest cost................................. 3,258 3,453 3,518 1,019 907 840
Expected return on plan assets................ (2,490) (2,798) (4,021) -- -- --
Amortization of prior service cost............ -- -- (610) -- -- 314
Recognized net actuarial loss................. 1,675 980 -- 352 307 174
Curtailment (gain) loss....................... -- -- (1,614) -- -- 1,258
Settlement loss............................... 3,104 4,093 -- -- -- --
--------- --------- --------- -------- -------- --------
Net periodic pension (income) expense............ $ 5,547 $ 6,424 $ (938) $ 1,926 $ 1,885 $ 3,196
========= ========= ========= ======== ======== ========
Weighted-average assumptions used to determine
expense:
Discount rate................................. 6.38% 6.81% 7.25% 6.75% 7.00% 7.25%
Expected return on plan assets................ 7.50% 7.81% 8.75% * * *
Annual rate of salary increase................ * 4.00% 4.00% * 4.00% 4.00%
Weighted-average assumptions used to determine
benefit obligations as of December 31:
Discount rate................................. 6.25% 6.75% 7.00% 6.25% 6.75% 7.00%
Expected return on plan assets................ 7.50% 7.50% 8.75% * * *
Annual rate of salary increase................ * * 4.00% * * 4.00%
- ----------
* Not applicable.
The assumption for the long-term rate of return on plan assets was
determined by considering actual investment experience during the lifetime of
the plan, balanced with reasonable expectations of future growth considering the
various classes of assets and percentage allocation for each asset class.
In 2001, HMEC's Board of Directors approved a proposal for the curtailment
of the Company's defined benefit plans. In accordance with SFAS No. 88,
"Employers' Accounting for Settlements and Curtailments of Defined Benefit
Pension Plans and for Termination of Benefits", the curtailment gain was
recognized in 2001, the period in which the pension plan was amended.
F-74
NOTE 10 - Pension Plans and Other Postretirement Benefits-(Continued)
The allocation by asset category of the Company's defined benefit pension
plan assets at December 31, 2003, 2002 and 2001 (the measurement dates) were as
follows:
December 31,
---------------------------
2003 2002 2001
-------- -------- -------
Asset category
Equity securities (1)......................... 71.3% 55.6% 72.2%
Debt securities............................... 26.7 23.1 27.3
Cash and short-term investments............... 2.0 21.3 0.5
-------- -------- -------
Total...................................... 100.0% 100.0% 100.0%
======== ======== =======
- ----------
(1) None of the trust fund assets for the defined benefit pension plan have
been invested in shares of HMEC's common stock.
In 2002, the Company adopted an investment policy for the defined benefit
pension plan that aligns the assets within the plan's trust to a 70% equity and
30% stable value funds allocation. Management believes this allocation will
produce the targeted long-term rate of return on assets necessary for payment of
future benefit obligations, while providing adequate liquidity for payments to
current beneficiaries. During 2003, assets were rebalanced to reflect the
defined benefit pension plan's investment policy and the trustee has been
directed to review and adjust invested assets at least quarterly to maintain the
target allocation percentages.
The Company expects to contribute $3,500 to the defined benefit plan and
$1,200 to the supplemental retirement plan in 2004.
Postretirement Benefits Other than Pensions
In addition to providing pension benefits, the Company also provides
certain health care and life insurance benefits to retired employees and
eligible dependents. Through December 31, 2000, employees with ten years of
service were eligible to receive these benefits upon retirement. Effective
January 1, 2001, the eligibility requirement increased to age 55 and 20 years of
service. Employees hired on or after January 1, 2001 are not eligible for
postretirement medical benefits. Effective January 1, 2004, only employees who
are at least age 50 with at least 15 years of service are eligible to
participate in this program. Postretirement benefits other than pensions of
active and retired employees are accrued as expense over the employees' service
years.
F-75
NOTE 10 - Pension Plans and Other Postretirement Benefits-(Continued)
The following table presents the funded status of postretirement benefits
other than pensions of active and retired employees (including employees on
disability more than 2 years) as of December 31, 2003, 2002 and 2001 (the
measurement dates) reconciled with amounts recognized in the Company's
Consolidated Balance Sheets:
December 31,
---------------------------------
2003 2002 2001
--------- --------- ---------
Change in accumulated postretirement
benefit obligation:
Accumulated postretirement benefit
obligation at beginning of year...... $ 37,087 $ 35,749 $ 30,766
Changes during fiscal year
Service cost....................... 248 396 475
Interest cost...................... 1,972 2,231 2,285
Plan amendments.................... (3,947) -- --
Benefits paid...................... (2,301) (1,976) (1,676)
Actuarial (gain) loss.............. (2,822) 687 3,899
--------- --------- ---------
Accumulated postretirement benefit
obligation at end of year............ $ 30,237 $ 37,087 $ 35,749
========= ========= =========
Unfunded status.......................... $ (30,237) $ (37,087) $ (35,749)
Unrecognized prior service cost.......... (3,588) -- --
Unrecognized net loss from past
experience different from that assumed.. 3,954 6,834 6,147
--------- --------- ---------
Accrued postretirement benefit cost... $ (29,871) $ (30,253) $ (29,602)
========= ========= =========
Year Ended December 31,
---------------------------------
2003 2002 2001
--------- --------- ---------
Components of net periodic benefit
cost:
Service cost.......................... $ 248 $ 396 $ 475
Interest cost......................... 1,972 2,231 2,285
Amortization of prior service cost (359) -- --
Amortization of prior losses.......... 58 -- 30
--------- --------- ---------
Net periodic benefit cost.......... $ 1,919 $ 2,627 $ 2,790
========= ========= =========
The Company expects to contribute $2,300 to the postretirement benefit plan in
2004.
F-76
NOTE 10 - Pension Plans and Other Postretirement Benefits-(Continued)
Sensitivity Analysis
A one percentage point change in the assumed health care cost trend rate
for each year would change the accumulated postretirement benefit obligation as
follows:
December 31,
---------------------------------
2003 2002 2001
--------- --------- ---------
Accumulated postretirement benefit
obligation
Effect of a one percentage point
increase............................. $ 799 $ 904 $ 967
Effect of a one percentage point
decrease............................. (710) (805) (859)
Service and interest cost components
of the net periodic postretirement
benefit expense
Effect of a one percentage point
increase............................. $ 54 $ 45 $ 77
Effect of a one percentage point
decrease............................. (48) (40) (64)
Healthcare cost trend rate assumed....... 11.0% 12.0% 6.5%
Rate to which the cost trend rate is
assumed to decline (ultimate trend
rate)................................... 5.5% 5.5% 5.0%
Year the rate is assumed to reach the
ultimate trend rate..................... 2009 2009 2004
Weighed-average assumptions used to
determine benefit obligation and net
benefit cost as of December 31,
Discount rate......................... 6.25% 6.75% 7.00%
Expected return on plan assets........ * * *
- ----------
* Not applicable.
The discount rate of 6.25% at December 31, 2003 is based on the average
yield for long-term, high-grade securities available during the benefit payout
period. To set its discount rate, the Company looks to leading indicators,
including Moody's Aa long-term bond index.
The Company acknowledges the existence of the new government Medicare
Prescription Drug Program. The table above does not give consideration to this
new program. Any effects of this program on the postretirement health care plan
of the Company are being deferred while guidance is still pending on the
accounting for the federal subsidy in this new program. Guidance, when issued,
could require the Company to change previously reported information; however,
the impact of this program is not expected to be material to the Company.
F-77
NOTE 11 - Reinsurance
In the normal course of business, the Company's insurance subsidiaries
assume and cede reinsurance with other insurers. Reinsurance is ceded primarily
to limit losses from large exposures and to permit recovery of a portion of
direct losses; however, such a transfer does not relieve the originating
insurance company of contingent liability.
The Company is a national underwriter and therefore has exposure to
catastrophic losses in certain coastal states and other regions throughout the
U.S. Catastrophes can be caused by various events including hurricanes,
windstorms, earthquakes, hail, severe winter weather and fires, and the
frequency and severity of catastrophes are inherently unpredictable. The
financial impact from catastrophic losses results from both the total amount of
insured exposure in the area affected by the catastrophe as well as the severity
of the event. The Company seeks to reduce its exposure to catastrophe losses
through the geographic diversification of its insurance coverage, deductibles,
maximum coverage limits, the purchase of catastrophe reinsurance, and the
purchase of a catastrophe-linked equity put option and reinsurance agreement,
described below.
The total amounts of reinsurance recoverable on unpaid insurance reserves
classified as assets and reported in Other Assets in the Consolidated Balance
Sheets were as follows:
December 31,
---------------------
2003 2002
--------- ---------
Reinsurance Recoverables on Reserves
and Unpaid Claims
Life and health....................... $ 8,161 $ 9,534
Property and casualty
State insurance facilities............ 9,582 36,780
Other insurance companies............. 11,033 7,921
--------- ---------
Total.............................. $ 28,776 $ 54,235
========= =========
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 and contract deposits, premiums and contract charges earned,
and benefits, claims and settlement expenses were as follows:
Ceded to Assumed
Gross Other from State
Amount Companies Facilities Net
---------- ---------- ---------- ----------
Year ended December 31, 2003
Premiums written and contract
deposits............................. $ 971,213 $ 23,038 $ 7,284 $ 955,459
Premiums and contract charges
earned............................... 658,171 22,249 7,614 643,536
Benefits, claims and settlement
expenses............................. 523,205 8,342 4,115 518,978
Year ended December 31, 2002
Premiums written and contract
deposits............................. 905,674 20,750 14,405 899,329
Premiums and contract charges
earned............................... 642,310 33,567 16,490 625,233
Benefits, claims and settlement
expenses............................. 462,476 26,784 15,174 450,866
Year ended December 31, 2001
Premiums written and contract
deposits............................. 885,801 27,991 17,756 875,566
Premiums and contract charges
earned............................... 625,722 28,601 18,121 615,242
Benefits, claims and settlement
expenses............................. 475,991 18,416 18,008 475,583
F-78
NOTE 11 - Reinsurance-(Continued)
There were no losses from uncollectible reinsurance recoverables in the
three years ended December 31, 2003. Past due reinsurance recoverables as of
December 31, 2003 were not material.
The Company maintains an excess and catastrophe treaty reinsurance program.
The Company reinsured 95% of catastrophe losses above a retention of $8,500 per
occurrence up to $80,000 per occurrence through December 31, 2003. Effective
January 1, 2004, the retention on this coverage increased to $10,000. 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 $14,500 up to $50,900 with the Florida Hurricane
Catastrophe Fund, based on the Fund's financial resources. These catastrophe
reinsurance programs are augmented by a $75,000 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.
Effective May 7, 2002, the Company entered into an equity put and
reinsurance agreement with a subsidiary of Swiss Reinsurance Company. The Swiss
Re Group is rated "A+ (Superior)" by A.M. Best. Under the 36-month agreement,
which is renewable annually at the option of the Company, the equity put
coverage of $75,000 provides a source of capital for up to $115,000 of pretax
catastrophe losses above the reinsurance coverage limit. The Company also has
the option, in place of the equity put, to require a Swiss Re Group member to
issue a 10% quota share reinsurance coverage of all of the Company's property
and casualty book of business. Annual fees related to this equity put option,
which are charged directly to additional paid-in capital, are 145 basis points
for the May 7, 2002 through May 7, 2004 period increasing to 150 basis points
for the May 7, 2004 through May 7, 2005 period. The agreement contains certain
conditions to Horace Mann's exercise of the equity put option including: (1) the
Company's shareholders' equity, adjusted to exclude goodwill, can not be less
than $215,000 after recording the first triggering event; (2) the Company's debt
as a percentage of total capital can not be more than 47.5% prior to recording
the triggering event; and (3) the Company's S&P financial strength rating can
not be below "BBB" prior to a triggering event. The Company's S&P financial
strength rating was "A" at December 31, 2003.
For liability coverages, including the educator excess professional
liability policy, the Company reinsures each loss above a retention of $500 up
to $20,000. Through December 31, 2003, the Company also reinsured each property
loss above a retention of $250 up to $2,500, including catastrophe losses that
in the aggregate are less than the retention levels above. Effective January 1,
2004, the retention on the property loss coverage increased to $500.
The maximum individual life insurance risk retained by the Company is $200
on any individual life and a maximum of $100 or $125 is retained on each group
life policy depending on the type of coverage. Excess amounts are reinsured. The
Company also maintains a life catastrophe reinsurance program. The Company
reinsured 100% of the catastrophe risk in excess of $1,000 up to $20,000 per
occurrence through December 31, 2003 and in excess of $1,000 up to $15,000 per
occurrence effective January 1, 2004. This program covers acts of terrorism but
excludes nuclear, biological and chemical explosions as well as other acts of
war.
F-79
NOTE 12 - Contingencies
Lawsuits and Legal Proceedings
In June 2002, the Company recorded a pretax charge of $1,581 representing
the Company's best estimate of the costs of resolving class action lawsuits
related to diminished value brought against the Company. A final court hearing
on this matter was held on December 18, 2002, at which time the settlement was
approved and was within the amount previously accrued by the Company.
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 generally been insignificant. In December 2001, the Company
recorded a pretax charge of $1,314 representing its estimated portion of the
industry assessment related to the insolvency of the Reliance Insurance Group.
NOTE 13 - Supplementary Data on Cash Flows
A reconciliation of net income to net cash provided by operating activities
as presented in the Consolidated Statements of Cash Flows is as follows:
Year Ended December 31,
---------------------------------------
2003 2002 2001
----------- ----------- -----------
Cash flows from operating activities
Net income............................................... $ 18,975 $ 11,333 $ 25,587
Adjustments to reconcile net income to net cash
provided by operating activities:
Realized investment (gains) losses.................... (25,487) 49,407 10,019
Depreciation and amortization......................... 11,082 12,512 8,300
Increase in insurance liabilities..................... 147,502 91,429 124,830
(Increase) decrease in premium receivables............ 634 10,968 (7,160)
Increase in deferred policy acquisition costs......... (19,835) (21,822) (19,565)
(Increase) decrease in reinsurance recoverable........ 1,110 4,279 (5,850)
Increase (decrease) in federal income tax
liabilities.......................................... (18,791) (9,061) 3,179
Decrease in liabilities for restructuring and
litigation charges................................... (3,101) (170) (3,127)
Other................................................. 5,319 16,592 12,644
----------- ----------- -----------
Total adjustments.................................. 98,433 154,134 123,270
----------- ----------- -----------
Net cash provided by operating activities....... $ 117,408 $ 165,467 $ 148,857
=========== =========== ===========
The Company's repurchases of debt in 2002 resulted in non-cash financing
charges of $1,731.
F-80
NOTE 14 - Segment Information
The Company's operations include the following operating segments which
have been determined on the basis of insurance products sold: property and
casualty, annuity and life insurance. The property and casualty insurance
segment includes primarily personal lines automobile and homeowners products.
The annuity segment includes primarily fixed and variable tax-qualified annuity
products. The life insurance segment includes primarily interest-sensitive life
and traditional life products.
The accounting policies of the segments are the same as those described in
Note 1 - Summary of Significant Accounting Policies. The Company accounts for
intersegment transactions, primarily the allocation of agent and overhead costs
from the corporate and other segment to the property and casualty, annuity and
life segments, on a cost basis. The Company does not allocate the impact of
corporate level transactions to the insurance segments, consistent with
management's evaluation of the results of those segments.
Summarized financial information for these segments is as follows:
Year Ended December 31,
---------------------------------------
2003 2002 2001
----------- ----------- -----------
Insurance premiums and contract charges earned
Property and casualty.................................... $ 533,761 $ 519,546 $ 508,345
Annuity.................................................. 14,588 14,247 14,906
Life..................................................... 96,004 92,707 93,272
Intersegment eliminations................................ (817) (1,267) (1,281)
----------- ----------- -----------
Total.............................................. $ 643,536 $ 625,233 $ 615,242
=========== =========== ===========
Net investment income
Property and casualty.................................... $ 31,892 $ 35,180 $ 37,749
Annuity.................................................. 104,380 107,731 107,583
Life..................................................... 49,605 53,925 55,226
Corporate and other...................................... 10 387 98
Intersegment eliminations................................ (1,162) (1,175) (1,389)
----------- ----------- -----------
Total.............................................. $ 184,725 $ 196,048 $ 199,267
=========== =========== ===========
Net income
Property and casualty.................................... $ (17,805) $ 19,943 $ 5,184
Annuity.................................................. 14,353 16,963 20,619
Life..................................................... 13,431 18,899 18,646
Corporate and other (a).................................. 8,996 (44,472) (18,862)
----------- ----------- -----------
Total.............................................. $ 18,975 $ 11,333 $ 25,587
=========== =========== ===========
Amortization of intangible assets
Value of acquired insurance in force
Annuity.................................................. $ 3,402 $ 4,008 $ 2,317
Life..................................................... 1,625 1,726 1,839
----------- ----------- -----------
Subtotal.............................................. 5,027 5,734 4,156
Goodwill................................................. -- -- 1,618
----------- ----------- -----------
Total.............................................. $ 5,027 $ 5,734 $ 5,774
=========== =========== ===========
December 31,
-------------------------
2003 2002
----------- -----------
Assets
Property and casualty................. $ 795,579 $ 773,362
Annuity............................... 3,163,808 2,628,083
Life.................................. 947,468 1,036,078
Corporate and other................... 95,505 112,102
Intersegment eliminations............. (29,372) (37,336)
----------- -----------
Total.............................. $ 4,972,988 $ 4,512,289
=========== ===========
- ----------
(a) The corporate and other segment includes interest expense on debt and the
impact of realized investment gains and losses, restructuring charges, debt
retirement costs, litigation charges, provision for prior years' taxes and
certain public company expenses.
F-81
NOTE 15 - Unaudited Interim Information
Summary quarterly financial data is presented below.
Three Months Ended
------------------------------------------------------------
December 31, September 30, June 30, March 31,
------------- ------------- ------------- ------------
2003
- ----
Insurance premiums written and contract deposits...... $ 249,723 $ 251,436 $ 234,760 $ 219,540
Total revenues........................................ 232,436 211,014 209,207 201,091
Net income (loss)..................................... 23,059 (14,266) 2,083 8,099
Per share information
Basic
Net income (loss)............................... $ 0.54 $ (0.34) $ 0.05 $ 0.19
Shares of common stock - weighted average (a)... 42,722 42,722 42,707 42,700
Diluted
Net income (loss)............................... $ 0.54 $ (0.34) $ 0.05 $ 0.19
Shares of common stock and equivalent
shares - weighted average (a).................. 42,900 42,933 42,901 42,869
2002
- ----
Insurance premiums written and contract deposits...... $ 236,377 $ 232,604 $ 218,600 $ 211,748
Total revenues........................................ 210,667 189,981 163,406 207,820
Net income (loss)..................................... 13,547 549 (18,334) 15,571
Per share information
Basic
Net income (loss)............................... $ 0.33 $ 0.02 $ (0.45) $ 0.38
Shares of common stock - weighted average (a)... 41,293 40,850 40,838 40,780
Diluted
Net income (loss)............................... $ 0.33 $ 0.02 $ (0.45) $ 0.38
Shares of common stock and equivalent
shares - weighted average (a).................. 41,466 41,025 41,294 41,231
2001
- ----
Insurance premiums written and contract deposits...... $ 225,262 $ 224,307 $ 218,225 $ 207,772
Total revenues........................................ 201,889 203,131 196,106 203,364
Net income (loss)..................................... 4,758 9,057 (4,926) 16,698
Per share information
Basic
Net income (loss)............................... $ 0.12 $ 0.22 $ (0.12) $ 0.41
Shares of common stock - weighted average (a)... 40,728 40,659 40,554 40,524
Diluted
Net income (loss)............................... $ 0.12 $ 0.22 $ (0.12) $ 0.41
Shares of common stock and equivalent
shares - weighted average (a).................. 41,016 40,977 40,874 40,747
- ----------
(a) Rounded to thousands.
F-82
SCHEDULE I
HORACE MANN EDUCATORS CORPORATION
SUMMARY OF INVESTMENTS-OTHER THAN INVESTMENTS IN RELATED PARTIES
December 31, 2003
(Dollars in thousands)
Amount
shown in
Fair Balance
Type of Investments Cost(1) Value Sheet
- ---------------------------------------- ----------- ----------- -----------
Fixed maturities:
U.S. Government and U.S. Government
agencies and authorities............ $ 943,375 $ 961,062 $ 961,062
States, municipalities and political
subdivisions........................ 488,081 502,912 502,912
Foreign government bonds............. 33,134 36,194 36,194
Public utilities..................... 123,293 128,854 128,854
Other corporate bonds................ 1,536,978 1,629,652 1,629,652
----------- ----------- -----------
Total fixed maturity securities... 3,124,861 $ 3,258,674 3,258,674
----------- =========== -----------
Mortgage loans and real estate.......... 4,557 XXX 4,557
Short-term investments.................. 25,367 XXX 25,367
Short-term investments, loaned
securities............................. 22,147 XXX 22,147
Policy loans and other.................. 74,270 XXX 74,980
----------- -----------
Total investments................. $ 3,251,202 XXX $ 3,385,725
=========== ===========
- ----------
(1) Bonds at original cost reduced by repayments and adjusted for amortization
of premiums or accrual of discounts and impairment in value of specifically
identified investments.
See accompanying Independent Auditors' Report.
F-83
SCHEDULE II
HORACE MANN EDUCATORS CORPORATION
(Parent Company Only)
CONDENSED FINANCIAL INFORMATION
BALANCE SHEETS
As of December 31, 2003 and 2002
(Dollars in thousands, except per share data)
December 31,
---------------------------
2003 2002
------------ ------------
ASSETS
Investments and cash.............................. $ 7,311 $ 10,913
Investment in subsidiaries........................ 640,886 608,164
Other assets...................................... 53,297 55,764
------------ ------------
Total assets................................ $ 701,494 $ 674,841
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Short-term debt................................... $ 25,000 $ --
Long-term debt.................................... 144,703 144,685
Other liabilities................................. 1,316 1,314
------------ ------------
Total liabilities........................... 171,019 145,999
------------ ------------
Preferred stock, $0.001 par value, authorized
1,000,000 shares; none issued.................... -- --
Common stock, $0.001 par value, authorized
75,000,000 shares; issued, 2003, 60,225,311;
2002, 60,194,615................................. 60 60
Additional paid-in capital........................ 342,306 342,749
Retained earnings................................. 456,330 455,308
Accumulated other comprehensive income (loss),
net of taxes:
Net unrealized gains on fixed maturities
and equity securities......................... 81,608 80,567
Minimum pension liability adjustment........... (17,252) (17,265)
Treasury stock, at cost, 2003 and 2002,
17,503,371 shares................................ (332,577) (332,577)
------------ ------------
Total shareholders' equity.................. 530,475 528,842
------------ ------------
Total liabilities and shareholders'
equity..................................... $ 701,494 $ 674,841
============ ===========
See accompanying note to condensed financial statements.
See accompanying Independent Auditors' Report.
F-84
SCHEDULE II
HORACE MANN EDUCATORS CORPORATION
(Parent Company Only)
CONDENSED FINANCIAL INFORMATION
STATEMENTS OF OPERATIONS
(Dollars in thousands)
Year Ended December 31,
------------------------------
2003 2002 2001
-------- -------- --------
Revenues
Net investment income....................... $ 19 $ 386 $ 100
Realized investment gains (losses).......... 62 (430) 219
-------- -------- --------
Total revenues........................... 81 (44) 319
-------- -------- --------
Expenses
Interest.................................... 6,339 8,517 9,250
Debt retirement costs....................... -- 2,272 --
Amortization of goodwill.................... -- -- 1,618
Other....................................... 4,629 1,755 3,802
-------- -------- --------
Total expenses........................... 10,968 12,544 14,670
-------- -------- --------
Loss before income taxes and equity in
net earnings of subsidiaries................. (10,887) (12,588) (14,351)
Income tax benefit............................. (4,131) (3,954) (4,099)
-------- -------- --------
Loss before equity in net earnings
of subsidiaries............................... (6,756) (8,634) (10,252)
Equity in net earnings of subsidiaries......... 25,731 19,967 35,839
-------- -------- --------
Net income..................................... $ 18,975 $ 11,333 $ 25,587
======== ======== ========
See accompanying note to condensed financial statements.
See accompanying Independent Auditors' Report.
F-85
SCHEDULE II
HORACE MANN EDUCATORS CORPORATION
(Parent Company Only)
CONDENSED FINANCIAL INFORMATION
STATEMENTS OF CASH FLOWS
(Dollars in thousands)
Year Ended December 31,
---------------------------------
2003 2002 2001
--------- --------- ---------
Cash flows from operating activities
Interest expense paid...................................... $ (5,454) $ (9,540) $ (9,091)
Contribution to defined benefit pension plan trust fund.... (8,780) (7,910) --
Federal income taxes (paid) recovered...................... 6,344 7,793 (12)
Cash dividends received from subsidiaries.................. 23,300 5,900 28,650
Other, net................................................. 2,534 9,296 (4,032)
--------- --------- ---------
Net cash provided by operating activities............... 17,944 5,539 15,515
--------- --------- ---------
Cash flows provided by (used in) investing activities
Net (increase) decrease in investments..................... (3,368) (2,477) 5,707
Capital contributions to subsidiaries...................... (27,500) -- (4,500)
--------- --------- ---------
Net cash provided by (used in) investing activities..... (30,868) (2,477) 1,207
--------- --------- ---------
Cash flows provided by (used in) financing activities
Dividends paid to shareholders............................. (17,953) (17,164) (17,072)
Principal borrowings (payments) on Bank Credit Facility.... 25,000 (53,000) 4,000
Exercise of stock options.................................. -- 2,183 3,759
Catastrophe-linked equity put option premium............... (1,088) (1,088) (950)
Proceeds from issuance of Senior Convertible Notes......... -- 162,654 --
Repurchase of Senior Notes and Senior Convertible Notes.... -- (97,523) --
--------- --------- ---------
Net cash provided by (used in) financing activities..... 5,959 (3,938) (10,263)
--------- --------- ---------
Net increase (decrease) in cash............................... (6,965) (876) 6,459
Cash at beginning of period................................... 7,457 8,333 1,874
--------- --------- ---------
Cash at end of period......................................... $ 492 $ 7,457 $ 8,333
========= ========= =========
See accompanying note to condensed financial statements.
See accompanying Independent Auditors' Report.
F-86
SCHEDULE II
HORACE MANN EDUCATORS CORPORATION
(Parent Company Only)
CONDENSED FINANCIAL INFORMATION
NOTE TO CONDENSED FINANCIAL STATEMENTS
The accompanying condensed financial statements should be read in
conjunction with the Consolidated Financial Statements and the accompanying
notes thereto.
See accompanying Independent Auditors' Report.
F-87
SCHEDULE III & VI (COMBINED)
HORACE MANN EDUCATORS CORPORATION
SCHEDULE III: SUPPLEMENTARY INSURANCE INFORMATION
SCHEDULE VI: SUPPLEMENTAL INFORMATION CONCERNING
PROPERTY AND CASUALTY INSURANCE OPERATIONS
(Dollars in thousands)
Column identification for
Schedule III: A B C D E F G
Schedule VI: A B C D E F G
Discount, Other
Deferred Future policy if any, policy Premium
policy benefits, deducted in claims and revenue/ Net
acquisition claims and previous Unearned benefits premium investment
Segment costs claims expenses column premiums payable earned income
- -------------------------------- ----------- --------------- ----------- ---------- ---------- ---------- ----------
Year Ended December 31, 2003
Property and casualty........ $ 19,022 $ 341,496 $ 0 $ 190,204 $ -- $ 533,761 $ 31,892
Annuity...................... 80,469 1,528,516 xxx -- 122,104 14,588 104,380
Life......................... 94,212 755,216 xxx 8,787 7,784 96,004 49,605
Other, including
consolidating eliminations N/A -- xxx N/A N/A (817) (1,152)
----------- --------------- ---------- ---------- ---------- ----------
Total..................... $ 193,703 $ 2,625,228 xxx $ 198,991 $ 129,888 $ 643,536 $ 184,725
=========== =============== ========== ========== ========== ==========
Year Ended December 31, 2002
Property and casualty........ $ 21,388 $ 317,321 $ 0 $ 180,509 $ -- $ 519,546 $ 35,180
Annuity...................... 63,643 1,389,498 xxx -- 116,489 14,247 107,731
Life......................... 89,524 728,603 xxx 8,875 8,619 92,707 53,925
Other, including
consolidating eliminations NA 2,000 xxx NA NA (1,267) (788)
----------- --------------- ---------- ---------- ---------- ----------
Total..................... $ 174,555 $ 2,437,422 xxx $ 189,384 $ 125,108 $ 625,233 $ 196,048
=========== =============== ========== ========== ========== ==========
Year Ended December 31, 2001
Property and casualty......... $ 18,957 $ 306,141 $ 0 $ 177,023 $ -- $ 508,345 $ 37,749
Annuity....................... 54,791 1,279,891 xxx -- 113,780 14,906 107,583
Life.......................... 84,028 701,964 xxx 8,546 9,654 93,272 55,226
Other, including
consolidating eliminations N/A 2,000 xxx N/A N/A (1,281) (1,291)
----------- --------------- ---------- ---------- ---------- ----------
Total..................... $ 157,776 $ 2,289,996 xxx $ 185,569 $ 123,434 $ 615,242 $ 199,267
=========== =============== ========== ========== ========== ==========
Column identification for
Schedule III: A H I J K
Schedule VI: A H I J K
Claims and claims
Benefits, adjustment expense Amortization Paid
claims incurred related to of deferred claims
and --------------------- policy Other and claims
settlement Current Prior acquisition operating adjustment Premiums
Segment expenses year years costs expenses expense written
- -------------------------------- ---------- ---------- --------- ------------ ---------- ---------- ----------
Year Ended December 31, 2003
Property and casualty........ $ 472,843 $ 416,473 $ 56,370 $ 56,904 $ 71,078 $ 424,582 $ 546,510
Annuity...................... 72,076 xxx xxx 767 26,359 xxx xxx
Life......................... 77,029 xxx xxx 7,491 40,313 xxx xxx
Other, including
consolidating eliminations -- xxx xxx (817) 10,526 xxx xxx
---------- ------------ ----------
Total..................... $ 621,948 xxx xxx $ 64,345 $ 148,276 xxx xxx
========== ============ ==========
Year Ended December 31, 2002
Property and casualty........ $ 410,161 $ 387,747 $ 23,995(1) $ 51,804 $ 68,969 $ 411,159 $ 524,877
Annuity...................... 69,233 xxx xxx 2,740 26,784 xxx xxx
Life......................... 69,852 xxx xxx 8,020 39,597 xxx xxx
Other, including
consolidating eliminations -- xxx xxx (1,267) 18,316 xxx xxx
---------- ------------ ----------
$ 549,246 xxx xxx $ 61,297 $ 153,666 xxx xxx
Total..................... ========== ============ ==========
Year Ended December 31, 2001
Property and casualty......... $ 433,344 $ 416,770 $ 16,574 $ 47,780 $ 63,042 $ 411,147 $ 519,167
Annuity....................... 66,901 xxx xxx 3,498 21,368 xxx xxx
Life.......................... 69,840 xxx xxx 8,232 41,531 xxx xxx
Other, including
consolidating eliminations 2,000 xxx xxx (1,462) 20,074 xxx xxx
---------- ------------ ----------
Total..................... $ 572,085 xxx xxx $ 58,048 $ 146,015 xxx xxx
========== ============ ==========
- ----------
(1) Property and casualty segment claims and claims adjustment expense incurred
related to prior years includes a $1,581 statutory accounting charge for
class action litigation which was separately reported as Litigation Charges
in the Company's Consolidated Statements of Operations.
N/A Not applicable.
See accompanying Independent Auditors' Report.
F-88
SCHEDULE IV
HORACE MANN EDUCATORS CORPORATION
REINSURANCE
(Dollars in thousands)
Column A Column B Column C Column D Column E Column F
Ceded to Assumed Percentage
Gross Other from State of Amount
Amount Companies Facilities Net Assumed to Net
------------ ------------ ------------ ------------ --------------
Year ended December 31, 2003
Life insurance in force............ $ 13,263,273 $ 1,333,005 -- $ 11,930,268 --
Premiums
Property and casualty........... $ 542,500 $ 16,353 $ 7,614 $ 533,761 1.4%
Annuity......................... 14,588 -- -- 14,588 --
Life............................ 101,900 5,896 -- 96,004 --
Other, including
consolidating eliminations..... (817) -- -- (817) --
------------ ------------ ------------ ------------
Total premiums............... $ 658,171 $ 22,249 $ 7,614 $ 643,536 1.2%
============ ============ ============ ============
Year ended December 31, 2002
Life insurance in force............ $ 13,196,369 $ 1,286,109 -- $ 11,910,260 --
Premiums
Property and casualty........... $ 530,253 $ 27,197 $ 16,490 $ 519,546 3.2%
Annuity......................... 14,247 -- -- 14,247 --
Life............................ 99,077 6,370 -- 92,707 --
Other, including
consolidating eliminations..... (1,267) -- -- (1,267) --
------------ ------------ ------------ ------------
Total premiums............... $ 642,310 $ 33,567 $ 16,490 $ 625,233 2.6%
============ ============ ============ ============
Year ended December 31, 2001
Life insurance in force............ $ 13,216,146 $ 1,035,477 -- $ 12,180,669 --
Premiums
Property and casualty........... $ 514,574 $ 24,350 $ 18,121 $ 508,345 3.6%
Annuity......................... 14,906 -- -- 14,906 --
Life............................ 97,523 4,251 -- 93,272
Other, including
consolidating eliminations..... (1,281) -- -- (1,281) --
------------ ------------ ------------ ------------
Total premiums............... $ 625,722 $ 28,601 $ 18,121 $ 615,242 2.9%
============ ============ ============ ============
- ----------
NOTE: Premiums above include insurance premiums earned and contract charges
earned.
See accompanying Independent Auditors' Report
F-89
================================================================================
- --------------------------------------------------------------------------------
HORACE MANN EDUCATORS CORPORATION
EXHIBITS
To
FORM 10-K
For the Year Ended December 31, 2003
VOLUME 1 OF 1
- --------------------------------------------------------------------------------
================================================================================
The following items are filed as Exhibits to Horace Mann Educators
Corporation's Annual Report on Form 10-K for the year ended December 31, 2003.
Management contracts and compensatory plans are indicated by an asterisk (*).
EXHIBIT INDEX
Exhibit No. Description
- ----------- ---------------------------------------------------------------
(3) Articles of incorporation and bylaws:
3.1 Restated Certificate of Incorporation of HMEC, filed with the
Delaware Secretary of State on June 24, 2003, incorporated by
reference to Exhibit 3.1 to HMEC's Quarterly Report on Form
10-Q for the quarter ended June 30, 2003, filed with the
Securities and Exchange Commission (the "SEC") on August 14,
2003.
3.2 Form of Certificate for shares of Common Stock, $0.001 par
value per share, of HMEC, incorporated by reference to Exhibit
4.5 to HMEC's Registration Statement on Form S-3 (Registration
No. 33-53118) filed with the SEC on October 9, 1992.
3.3 Bylaws of HMEC, incorporated by reference to Exhibit 3.2 to
HMEC's Quarterly Report on Form 10-Q for the quarter ended June
30, 2003, filed with the SEC on August 14, 2003.
(4) Instruments defining the rights of security holders, including indentures:
4.1 Indenture dated as of January 17, 1996, between HMEC and U.S.
Trust Company of California, N.A. as trustee, with regard to
HMEC's 6 5/8% Senior Notes Due 2006, incorporated by reference
to Exhibit 4.4 to HMEC's Annual Report on Form 10-K for the
year ended December 31, 1995, filed with the SEC on March 13,
1996.
4.1(a) Form of 6 5/8% Senior Notes Due 2006 (included in Exhibit 4.1).
4.2 Indenture dated as of May 14, 2002, between HMEC and JPMorgan
Chase Bank as trustee, with regard to HMEC's 1.425% Senior
Convertible Notes Due 2032, incorporated by reference to
Exhibit 4.1 to HMEC's Quarterly Report on Form 10-Q for the
quarter ended June 30, 2002, filed with the SEC on August 14,
2002.
4.2(a) Form of 1.425% Senior Convertible Notes Due 2032 (included in
Exhibit 4.2).
4.3 Certificate of Designations for HMEC Series A Cumulative
Convertible Preferred Stock (included in Exhibit 10.14).
Exhibit No. Description
- ------------- ---------------------------------------------------------------
(10) Material contracts:
10.1 Credit Agreement dated as of May 29, 2002 (the "Bank Credit
Facility") among HMEC, certain financial institutions named
therein and Bank of America, N.A., as administrative agent (the
"Agent"), incorporated by reference to Exhibit 10.1 to HMEC's
Quarterly Report on Form 10-Q for the quarter ended June 30,
2002, filed with the SEC on August 14, 2002.
10.2* Stock Subscription Agreement among HMEC (as successor to HME
Holdings, Inc.), The Fulcrum III Limited Partnership, The
Second Fulcrum III Limited Partnership and each of the
Management Investors, incorporated by reference to Exhibit
10.17 to HMEC's Annual Report on Form 10-K for the year ended
December 31, 1989, filed with the SEC on April 2, 1990.
10.3* Horace Mann Educators Corporation Deferred Equity Compensation
Plan for Directors, incorporated by reference to Exhibit 10.1
to HMEC's Quarterly Report on Form 10-Q for the quarter ended
September 30, 1996, filed with the SEC on November 14, 1996.
10.4* Horace Mann Educators Corporation Deferred Compensation Plan
for Employees, incorporated by reference to Exhibit 10.4 to
HMEC's Annual Report on Form 10-K for the year ended December
31, 1997, filed with the SEC on March 30, 1998.
10.5* Amended and Restated Horace Mann Educators Corporation 1991
Stock Incentive Plan, incorporated by reference to Exhibit 10.5
to HMEC's Annual Report on Form 10-K for the year ended
December 31, 1999, filed with the SEC on March 30, 2000.
10.5(a)* Amendment to Amended and Restated Horace Mann Educators
Corporation 1991 Stock Incentive Plan, incorporated by
reference to Exhibit 10.1(a) to HMEC's Quarterly Report on Form
10-Q for the quarter ended June 30, 2000, filed with the SEC on
August 11, 2000.
10.5(b)* Specimen Employee Stock Option Agreement under the Horace Mann
Educators Corporation 1991 Stock Incentive Plan, incorporated
by reference to Exhibit 10.5(a) to HMEC's Annual Report on Form
10-K for the year ended December 31, 1999, filed with the SEC
on March 30, 2000.
10.5(c)* Specimen Director Stock Option Agreement under the Horace Mann
Educators Corporation 1991 Stock Incentive Plan, incorporated
by reference to Exhibit 10.5(b) to HMEC's Annual Report on Form
10-K for the year ended December 31, 1999, filed with the SEC
on March 30, 2000.
10.6* Horace Mann Educators Corporation 2001 Stock Incentive Plan,
incorporated by reference to Exhibit 10.6 to HMEC's Annual
Report on Form 10-K for the year ended December 31, 2001, filed
with the SEC on March 29, 2002.
Exhibit No. Description
- ------------- ---------------------------------------------------------------
10.6(a)* Specimen Employee Stock Option Agreement under the Horace Mann
Educators Corporation 2001 Stock Incentive Plan, incorporated
by reference to Exhibit 10.6(a) to HMEC's Annual Report on Form
10-K for the year ended December 31, 2001, filed with the SEC
on March 29, 2002.
10.6(b)* Specimen Director Stock Option Agreement under the Horace Mann
Educators Corporation 2001 Stock Incentive Plan, incorporated
by reference to Exhibit 10.6(b) to HMEC's Annual Report on Form
10-K for the year ended December 31, 2001, filed with the SEC
on March 29, 2002.
10.7* Horace Mann Educators Corporation 2002 Incentive Compensation
Plan, incorporated by reference to Exhibit 10.2 to HMEC's
Quarterly Report on Form 10-Q for the quarter ended June 30,
2002, filed with the SEC on August 14, 2002.
10.7(a)* Specimen Employee Stock Option Agreement under the Horace Mann
Educators Corporation 2002 Incentive Compensation Plan,
incorporated by reference to Exhibit 10.2(a) to HMEC's
Quarterly Report on Form 10-Q for the quarter ended June 30,
2002, filed with the SEC on August 14, 2002.
10.7(b)* Specimen Regular Employee Stock Option Agreement under the
Horace Mann Educators Corporation 2002 Incentive Compensation
Plan, incorporated by reference to Exhibit 10.2(b) to HMEC's
Quarterly Report on Form 10-Q for the quarter ended June 30,
2002, filed with the SEC on August 14, 2002.
10.7(c)* Specimen Director Stock Option Agreement under the Horace Mann
Educators Corporation 2002 Incentive Compensation Plan,
incorporated by reference to Exhibit 10.2(c) to HMEC's
Quarterly Report on Form 10-Q for the quarter ended June 30,
2002, filed with the SEC on August 14, 2002.
10.8* Severance Agreements between HMEC and certain officers of HMEC,
incorporated by reference to Exhibit 10.7 to HMEC's Annual
Report on Form 10-K for the year ended December 31, 2001, filed
with the SEC on March 29, 2002.
10.8(a)* Revised Schedule to Severance Agreements between HMEC and
certain officers of HMEC.
10.9* Horace Mann Supplemental Employee Retirement Plan, 2002
Restatement, incorporated by reference to Exhibit 10.1 to
HMEC's Quarterly Report on Form 10-Q for the quarter ended
March 31, 2002, filed with the SEC on May 15, 2002.
10.10* Horace Mann Executive Supplemental Employee Retirement Plan,
2002 Restatement, incorporated by reference to Exhibit 10.2 to
HMEC's Quarterly Report on Form 10-Q for the quarter ended
March 31, 2002, filed with the SEC on May 15, 2002.
Exhibit No. Description
- ------------- ---------------------------------------------------------------
10.11* Horace Mann Nonqualified Supplemental Money Purchase Pension
Plan, incorporated by reference to Exhibit 10.3 to HMEC's
Quarterly Report on Form 10-Q for the Quarter Ended March 31,
2002, filed with the SEC on May 15, 2002.
10.12* Employment Agreement entered by and between HMEC and Louis G.
Lower II as of December 31, 1999, incorporated by reference to
Exhibit 10.12 to HMEC's Annual Report on Form 10-K for the year
ended December 31, 1999, filed with the SEC on March 30, 2000.
10.13* Transition, Retirement and Release Agreement entered by and
between Horace Mann Service Corporation and George J. Zock as
of December 31, 2003.
10.14 First Amended and Restated Catastrophe Equity Securities
Issuance Option and Reinsurance Option Agreement entered by and
between HMEC, Swiss Re Financial Products Corporation (Option
Writer) and Swiss Reinsurance America Corporation (Reinsurance
Option Writer), dated May 7, 2002, incorporated by reference to
Exhibit 10.1 to HMEC's Quarterly Report on Form 10-Q for the
quarter ended September 30, 2002, filed with the SEC on
November 14, 2002.
(11) Statement regarding computation of per share earnings.
(12) Statement regarding computation of ratios.
(21) Subsidiaries of HMEC.
(23) Consent of KPMG LLP.
(31) Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.1 Certification by Louis G. Lower II, Chief Executive Officer of
HMEC.
31.2 Certification by Peter H. Heckman, Chief Financial Officer of
HMEC.
(32) Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.1 Certification by Louis G. Lower II, Chief Executive Officer of
HMEC.
32.2 Certification by Peter H. Heckman, Chief Financial Officer of
HMEC.