Horace Mann Educators Corporation — Q1 2017 10-Q
Reporting period: Three months ended March 31, 2017; balance-sheet figures are as of March 31, 2017, compared with December 31, 2016 where applicable. Horace Mann sells property and casualty insurance, annuities and life insurance, primarily to public-school educators and their families. Amounts below are in U.S. dollars; financial-statement amounts are converted from thousands to millions unless noted.
Financial performance
| Metric | Q1 2017 | Q1 2016 | Change |
|---|---|---|---|
| Total revenue | $287.3 million | $271.3 million | Up 5.9% |
| Net investment income | $90.7 million | $84.7 million | Up 7.1% |
| Income before tax | $17.8 million | $35.3 million | Down 49.5% |
| Net income | $15.3 million | $25.2 million | Down 39.3% |
| Diluted earnings per share | $0.37 | $0.61 | Down $0.24 |
| Operating cash flow | $72.8 million | $80.4 million | Down $7.6 million |
- Earned insurance premiums and contract charges rose 5.5% to $195.7 million. Premiums written and contract deposits increased 4.8% to $296.7 million.
- Benefits, claims and settlement expenses increased 20.6% to $144.1 million; operating expenses rose 13.8% to $48.8 million. The filing attributes the earnings decline chiefly to unusually high catastrophe losses and elevated non-catastrophe weather losses.
- Property and Casualty reported $2.7 million net income, versus $13.8 million; its combined ratio worsened to 105.5% from 93.8%. Catastrophe losses were $17.2 million pretax, compared with $12.7 million. Prior-year reserve releases were $1.0 million versus $2.0 million.
- Retirement net income rose 8.5% to $11.5 million, supported by higher net interest margin, partly offset by increased expenses. Life net income was $3.9 million, broadly unchanged.
- The effective tax rate was 14.0%, versus 28.6%. Adoption of share-based-payment accounting reduced the quarter’s income-tax provision by $2.45 million through excess tax benefits.
Financial position, debt and liquidity
- Total assets were $10.780 billion, including $8.124 billion of investments and $6.6 million of cash. Total liabilities were $9.458 billion; shareholders’ equity was $1.322 billion.
- Long-term debt was $247.3 million; there was no short-term debt or borrowing under the $150 million revolving credit facility. Debt was 18.0% of total capital excluding unrealized investment gains and losses, below the company’s 25% long-term target.
- Operating cash flow was positive, while investing activities used $84.3 million. Cash declined $10.1 million during the quarter to $6.6 million. Management said operating cash flow was expected to meet operating needs over the next 12 months.
- Fixed annuity assets had an annualized net interest spread of 183 basis points, unchanged year over year. Approximately 86.7% of deferred annuity account values were at their minimum guaranteed interest rate, limiting the ability to reduce credited rates.
- Book value per share was $32.60, up 1.4% from year-end and down 1.5% year over year; it was $27.71 excluding the net unrealized investment gain. The quarterly dividend was $0.275 per share. No shares were repurchased in the quarter.
Material changes and outlook
- Management forecast 2017 net income, excluding net realized investment gains and losses, of $1.95–$2.15 per diluted share. The outlook assumes improvement in underlying auto results, modeled catastrophe losses, modestly lower Retirement and Life earnings, and continued strategic investment.
- Management expected portfolio yield to decline about 10 basis points in 2017. It also anticipated Retirement net interest spreads grading down from 193 basis points in 2016 to the low 180s, and continued moderate expense growth from customer-service, technology and infrastructure initiatives.
- Management remained confident in achieving one point of underlying auto combined-ratio improvement for full-year 2017. It expected property profitability to be lower than a normalized level if weather losses normalize, and catastrophe losses to be below 2016 levels.
- The investment portfolio’s fixed-maturity securities had a fair value of $7.511 billion and were 95.9% investment grade. Management considered unrealized losses temporary and said it did not expect to be forced to sell impaired securities before recovery; future developments could nevertheless require impairment charges.
Risks, contingencies and other notable items
- Key exposures include catastrophe frequency and severity, concentrations in catastrophe-prone states, reinsurance availability and collectibility, interest-rate and reinvestment risk, investment credit and market valuations, and policy persistency and claims estimates.
- The company identified continued low rates as a source of potential spread compression. It estimated that a 100-basis-point decline in reinvestment rates could reduce Retirement net investment income by approximately $2.1 million in year one and $6.3 million in year two.
- The filing updated its discussion of the Department of Labor fiduciary rule: the fiduciary definition was delayed to June 9, 2017, with certain exemption conditions delayed to January 1, 2018. The company warned of possible effects on IRA sales, agent compensation, distribution, compliance costs and litigation risk; public-school 403(b) plans were described as outside the rule.
- Unfunded investment-purchase and lending commitments totaled $140.5 million. The company reported no off-balance-sheet arrangements involving unconsolidated entities.
- KPMG conducted an interim review, not an audit, and reported no material modifications needed for GAAP conformity. Management reported effective disclosure controls and no material changes in internal control over financial reporting.
Important facts for investors to verify
- Whether P&C catastrophe and weather-related losses normalize, and whether the 105.5% combined ratio improves as management expects.
- Underlying auto loss trends, planned rate increases, retention and policy counts, including the effects of underwriting actions in catastrophe-prone areas.
- Progress toward the $1.95–$2.15 full-year earnings outlook, including the expected yield decline, fixed-annuity spread pressure and strategic investment spending.
- Investment portfolio credit quality, unrealized losses, impairment judgments, interest-rate sensitivity and the collectibility of reinsurance recoverables.
- Whether capital distributions remain supported by insurance-subsidiary capital and regulatory dividend capacity; the filing reported approximately $91 million of subsidiary dividends available in 2017 without prior approval, of which $12.0 million had been paid by March 31.