Horace Mann Educators Corporation — Q2 2011 Form 10-Q
Business and period: The company sells property and casualty insurance, annuities and life insurance, primarily to K–12 educators and their families. This filing covers the quarter and six months ended June 30, 2011. Interim statements were reviewed by KPMG, not audited.
Financial performance
| Metric | Q2 2011 | Six months 2011 | Comparable period 2010 |
|---|---|---|---|
| Total revenue | $245.4 million | $489.8 million | $248.0 million Q2; $486.7 million six months |
| Net income (loss) | $(11.8) million | $14.1 million | $23.0 million Q2; $45.6 million six months |
| Diluted EPS | $(0.30) | $0.34 | $0.56 Q2; $1.12 six months |
| Net investment income | $71.7 million | $142.2 million | $69.1 million Q2; $135.0 million six months |
| Operating cash flow | Not provided for quarter | $50.7 million | $94.1 million six months |
- Q2 revenue declined 1.1% year over year, while first-half revenue increased 0.6%. First-half insurance premiums and contract charges earned fell 0.5%; investment income rose 5.3%.
- Q2 swung to a loss from prior-year profit; first-half net income declined 69%. Main driver was property and casualty catastrophe claims. First-half benefits, claims and settlement expenses rose 18.6% to $274.4 million.
- First-half property and casualty combined ratio was 114.8%, versus 97.7% in 2010; catastrophe costs added 23.0 percentage points to the current-period ratio. The homeowners loss ratio was 126.4%.
- First-half net realized investment gains were $11.6 million, down from $13.2 million. No investment OTTI write-downs were recorded in the first half of 2011.
Balance sheet, capital and liquidity
- At June 30, total assets were $7.21 billion and shareholders’ equity was $932.3 million, up from $7.01 billion and $880.0 million at December 31, 2010. Book value was $23.35 per share, including investment fair-value adjustments, and $19.52 excluding them.
- Cash was $38.3 million, compared with $5.9 million at year-end. First-half operating cash flow fell to $50.7 million from $94.1 million, largely because of higher claims payments, including catastrophe losses. Management said operating cash flow should meet operating needs for the next 12 months.
- Total debt was $237.7 million: $38.0 million short-term bank facility borrowings and $199.7 million long-term notes. Debt was 20.3% of total capital including unrealized investment gains and losses (23.4% excluding them). The $125 million bank facility matures December 19, 2011.
- Investments totaled $5.25 billion, predominantly fixed maturities. The fixed-income portfolio was 94.7% investment grade, with an average rating of A+. Unrealized investment gains improved shareholders’ equity; the filing identifies market value and interest-rate movements as material risks.
- Insurance subsidiaries could pay approximately $78 million in dividends to the parent without prior regulatory approval in 2011; $10 million had been paid by June 30.
Material changes and management commentary
- First-half catastrophe losses were $63.0 million pretax, versus $23.0 million in 2010. Q2 alone had $55.0 million, including losses from 12 catastrophe events; the May 20–27 storms, including the Joplin tornado, were particularly costly. Management also cited elevated auto liability severity, non-catastrophe weather claims and property reserve re-estimates.
- Prior-year property and casualty reserves developed favorably by $3.7 million in the first half, less than the $7.3 million favorable development in 2010. Management estimated a reasonable range of reserve variability of approximately plus or minus 6%, or about $12 million of net income based on net reserves at June 30.
- Premiums written and contract deposits increased 2.0% in the first half, led by an 11.0% increase in annuity deposits. Property and casualty premiums written declined 2.9%; voluntary auto and homeowners policy counts continued to fall. Management attributed part of the decline to rate and risk-mitigation actions.
- The Florida homeowners non-renewal program had terminated about 8,900 of approximately 9,600 targeted policies by June 30 and was scheduled to finish by mid-August 2011. Management expects lower Florida catastrophe exposure and reinsurance costs over time, while acknowledging near-term pressure on premiums and policy counts.
- Annuity segment first-half net income rose 14% to $16.2 million, reflecting improved interest margins and deferred acquisition cost effects; life segment net income fell 2% to $9.9 million. Annuity deposits and sales strengthened, including higher single-premium and rollover receipts.
Outlook, risks and unusual items
- Management projected 2011 net income before realized investment gains and losses of $1.10–$1.30 per diluted share. Assumptions included catastrophe losses in the second half near long-term historical levels, Florida sinkhole losses materially below the second half of 2010, less favorable prior-year auto reserve development, and an 8%–10% full-year increase in the S&P 500. This is an estimate, not a guarantee.
- Key risks include catastrophe frequency and severity, reserve-estimate uncertainty, Florida and other catastrophe-prone exposures, reinsurance availability and collectibility, investment credit and fair-value changes, interest-rate spreads, annuity market performance and educator-sector economic pressures.
- The 2010 comparison included a nonrecurring $1.4 million tax benefit related to a separate-account dividend deduction. The company reported no material changes to previously disclosed risk factors, no off-balance-sheet arrangements of the described type, and effective disclosure controls.
- After quarter-end, S&P lowered the U.S. government’s long-term rating from AAA to AA+ on August 5, 2011; the filing notes $570.3 million of U.S. government securities and $472.8 million of agency securities at June 30.
Important facts for investors to verify
- Catastrophe claims experience, especially homeowners losses, and the effect on combined ratios and earnings.
- Actual completion and financial effects of the Florida non-renewal program, including retention, premium volume and reinsurance costs.
- Property and casualty reserve development and the sensitivity of estimates to claim frequency and severity.
- Progress against the full-year EPS outlook and its catastrophe, market-return and reserve-development assumptions.
- Liquidity and refinancing plans for the bank facility due December 2011, alongside cash flow and regulatory limits on subsidiary dividends.
- Credit quality, unrealized losses and valuation assumptions in the investment portfolio, including CMBS and government-related holdings.