Horace Mann Educators Corporation — Q1 2012 Form 10-Q
Business context and period: The company sells property and casualty insurance, retirement annuities and life insurance, primarily to K-12 educators and their families. This filing covers the three months ended March 31, 2012; comparative Q1 2011 amounts are retrospectively adjusted for an accounting change where applicable. The interim financial statements were reviewed by KPMG, not audited; KPMG reported no material modifications came to its attention.
Financial results and position
Unless otherwise indicated, amounts are in millions of dollars. Percentages compare with Q1 2011.
| Metric | Q1 2012 | Q1 2011 | Change |
|---|---|---|---|
| Total revenue | $244.6 | $244.5 | Essentially flat |
| Net investment income | $75.7 | $70.5 | +7.4% |
| Net realized investment gains | $0.4 | $5.8 | Down $5.4 |
| Income before tax | $37.5 | $36.8 | +1.9% |
| Net income | $26.7 | $25.8 | +3.3% |
| Diluted EPS | $0.64 | $0.62 | +3.2% |
| Operating cash flow | $50.7 | $42.7 | +18.8% |
- Net margin was approximately 10.9%, versus 10.6% in the prior-year quarter. P&C combined ratio remained 95.0% in both periods.
- Segment net income: P&C $13.2 (up 6.5%); annuity $11.6 (up 38.1%); life $5.2 (up 23.8%). Corporate and other recorded a $3.3 loss, compared with $0.8 income, largely reflecting lower realized investment gains.
- At March 31, total assets were $7,697, shareholders’ equity $1,089, cash $35.4 and investments $5,757. Book value per share was $27.37, including investment fair-value effects; it was $20.31 excluding those adjustments.
- Total debt was $237.8: $38.0 short-term bank facility borrowings and $199.8 long-term debt. Debt was 17.9% of total capital including unrealized investment gains and losses, below the company’s 25% long-term target. Cash rose from $7.5 at year-end to $35.4.
- Investments were predominantly fixed income; 94.9% of fixed maturities were investment grade, with an average A rating. Fixed maturities had $458.6 of pretax net unrealized gains. The filing states management considered securities with unrealized losses temporarily impaired; no investment impairment was recorded in the quarter.
Material changes and management commentary
- Premiums and contract charges earned declined 0.7% to $165.5, while premiums written and contract deposits fell 0.5% to $242.8. P&C earned premiums decreased 1.7%, partly due to fewer policies in force; annuity and life earned charges increased.
- Management cited higher average invested assets and a slightly higher portfolio yield (5.75% versus 5.71%) for investment-income growth. Q1 net realized gains fell as gross losses on disposals, primarily commercial mortgage-backed securities, nearly offset realized gains.
- P&C claims and settlement expenses decreased 2.4%, with catastrophe losses down $2.1 and Florida sinkhole losses excluding settlement expenses at zero versus $4.7 a year earlier. Favorable prior-year reserve development reduced current-quarter claims by $4.0 gross; management said this contributed approximately $2.6 to net income. Higher current-year automobile loss frequency partly offset the benefits.
- Voluntary auto and homeowners policies totaled 723,000, down from 748,000 a year earlier. Management reported stronger new-sales activity, including 41.9% growth in true new auto sales, but rate and risk-mitigation actions and policy attrition continued to weigh on the in-force base. The Florida homeowners non-renewal program was completed in 2011.
- The company adopted new guidance on insurance acquisition costs effective January 1, 2012, retrospectively. It reduced deferred acquisition costs and beginning retained earnings; management said the net effect on results was minimal and EPS unchanged. Q1 2011 net income was adjusted from $25.9 to $25.8.
Outlook, risks and contingencies
- Management estimated full-year 2012 net income, excluding realized investment gains and losses, of $1.80–$2.00 per diluted share. The outlook assumed an 8–10 percentage-point improvement in the P&C combined ratio versus 2011, driven by improved property results and substantially lower catastrophe losses. Combined annuity and life earnings were expected to be comparable to 2011; modestly lower fixed-annuity spreads were expected to be offset by asset growth and an assumed 8–10% increase in the S&P 500 Index. This is forward-looking guidance, not a reported result.
- Management warned that low reinvestment rates and limited ability to reduce credited rates could compress fixed-annuity spreads. It also identified market and credit volatility, catastrophe severity and reinsurance availability/cost, policy retention, reserve development, and educator-sector economic conditions as significant risks.
- Management estimated reasonable variability in P&C loss reserves at approximately plus or minus 6%, corresponding to roughly plus or minus $11 million of net income based on net reserves at quarter-end. Reserve estimates depend on claim frequency and severity assumptions.
- Approximately 57% of 2011 P&C direct earned premiums came from the ten largest states, including several identified as catastrophe-prone. Subsidiary dividends available to the holding company without prior regulatory approval were approximately $71 million for 2012; $18 million had been paid by March 31. The company reported no off-balance-sheet arrangements with unconsolidated entities.
- The annuity reporting unit had a limited margin of goodwill fair value over carrying value in the latest annual assessment, which management identified as a greater future impairment risk; no material change in circumstances was identified in Q1. Disclosure controls were assessed as effective, with no significant deficiencies or material weaknesses reported.
Important facts for investors to verify
- Whether the $1.80–$2.00 full-year EPS outlook and assumed improvement in the P&C combined ratio remain achievable, particularly under catastrophe and market conditions.
- How auto and homeowners policy counts, retention, pricing actions and Florida risk mitigation affect earned premiums and underwriting results.
- Whether favorable prior-year reserve development persists and how actual P&C claim frequency and severity compare with reserve assumptions.
- Whether investment yields, fixed-annuity spreads, realized losses and unrealized portfolio gains evolve as expected; the unrealized gains materially affect reported book value.
- The effect of the retrospective acquisition-cost accounting change when comparing periods, and the annuity unit’s goodwill impairment headroom.
- Debt levels, regulated subsidiary dividend capacity, capital needs and share repurchases; the company repurchased 200,120 shares for $3.3 million in Q1 and had $44.6 million remaining under authorization.