HORACE MANN EDUCATORS CORP quarterly report, Q1 FY2012

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.

MetricQ1 2012Q1 2011Change
Total revenue$244.6$244.5Essentially flat
Net investment income$75.7$70.5+7.4%
Net realized investment gains$0.4$5.8Down $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.