HMN

Horace Mann Educators Corp. Q1 2010 Filing Summary

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended March 31, 2010. Horace Mann Educators Corporation (HMEC) is an insurance holding company marketing and underwriting personal lines property and casualty insurance, retirement annuities, and life insurance, primarily to K-12 educators and their families. The company operates through four segments: Property and Casualty, Annuity, Life, and Corporate and Other.

Key Financial Metrics

Material Changes vs. Prior Period

• Net Income Growth: Net income increased 68.7% ($9.2 million) year-over-year, driven by significant improvements in the Annuity and Life segments and a swing from net realized investment losses to gains.
• Segment Performance:
  • Annuity: Net income surged $6.1 million to $7.3 million due to improved interest margins and favorable financial market impacts on deferred policy acquisition costs.
  • Life: Net income rose $1.2 million to $4.6 million, primarily from investment income growth.
  • Property & Casualty (P&C): Net income declined $1.4 million to $11.0 million. The combined ratio worsened to 96.4% (from 94.6%) due to increased catastrophe costs ($6.8 million vs. $4.5 million) and large property losses (sinkholes in Florida), partially offset by favorable prior-year reserve development ($4.5 million).
• Investment Portfolio: Net realized investment gains improved by $3.7 million after-tax. The portfolio includes $109.6 million in gross unrealized losses, which management deems temporary. Commercial mortgage-backed securities (CMBS) held a net unrealized loss of $51.5 million.
• Premiums: Total premiums written and contract deposits increased 7.9% to $238.7 million, led by a 22.6% increase in annuity deposits.

Guidance, Outlook, and Risks

• 2010 Outlook: Management estimates full-year 2010 net income before realized investment gains/losses will be between $1.65 and $1.85 per diluted share. This assumes a moderation in auto frequency trends, continued high sinkhole losses in Florida, an 8-10% increase in the S&P 500, and normal mortality levels.
• Strategic Actions: The company ceased writing new homeowners policies in Florida and initiated non-renewals for approximately 9,600 policies to mitigate hurricane exposure and improve underwriting results by 2012.
• Risks:
  • Catastrophe Exposure: Significant exposure in Florida, California, and other coastal states; rising sinkhole claims.
  • Investment Risk: Market value risk, particularly regarding CMBS and credit spreads, though 94.1% of the fixed maturity portfolio is investment grade.
  • Regulatory: Changes in Section 403(b) regulations and potential impacts of the Patient Protection and Affordable Care Act.
• Liquidity: The company maintains a $125 million bank credit facility with $38 million outstanding. Dividend availability from subsidiaries is approximately $64 million for 2010 without regulatory approval.

Investor Verification Checklist

• Florida Exposure: Verify the impact of the new non-renewal program on future P&C premium volume and the trajectory of sinkhole loss reserves.
• CMBS Valuation: Review the $51.5 million unrealized loss in commercial mortgage-backed securities and management's assessment of credit quality and recovery potential.
• Reserve Development: Monitor the sustainability of the $4.5 million favorable prior-year reserve development in the P&C segment.
• Interest Spread: Track the net interest spread on fixed annuities (190 basis points in Q1 2010) against rising credited rates and investment yields.
• Guidance Assumptions: Assess the sensitivity of the 2010 EPS guidance to the assumed 8-10% S&P 500 increase and auto frequency trends.