Horace Mann Educators Corporation — Q3 2014 Form 10-Q
Business and period: The insurer markets property and casualty, retirement annuity, and life products primarily to public-school educators and their families. This filing covers the quarter and nine months ended September 30, 2014. Interim statements are unaudited; KPMG performed a review and reported no material modifications were needed.
Financial performance and position
Amounts below are in millions of dollars except per-share data and ratios.
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Total revenue | $265.5 | $251.9 | $791.5 | $772.1 |
| Net income | $25.4 | $23.6 | $74.2 | $76.6 |
| Diluted EPS | $0.60 | $0.57 | $1.76 | $1.85 |
| Net investment income | $82.6 | $78.5 | $247.0 | $233.2 |
- Nine-month operating cash flow was $165.6 versus $150.9; investing cash flow was negative $466.3 versus negative $337.8, and financing cash flow was $323.6 versus $217.5. Cash at quarter-end was $41.2.
- At September 30, total assets were $9.64 billion, shareholders’ equity $1.29 billion, and total investments $7.31 billion. Equity included $270.0 million of after-tax unrealized investment gains.
- Total debt was $237.9 million: $38.0 million short-term borrowings and $199.9 million long-term debt. Debt was 18.9% of capital excluding unrealized investment gains and losses, below the 25% long-term target.
- Book value per share was $31.51, or $24.91 excluding investment fair-value adjustments; management reported respective increases of 16% and 8% from a year earlier.
- For the first nine months, the property and casualty combined ratio improved to 97.5% from 99.4%. The fixed-annuity net interest spread was 204 basis points versus 198 basis points.
Material changes and management commentary
- Q3 net income rose $1.8 million year over year, supported by improved property and casualty results and higher realized investment results. Nine-month net income fell $2.4 million, mainly because after-tax realized investment gains declined to $5.6 million from $13.5 million.
- Nine-month premiums written and contract deposits increased 6.9% to $875.4 million. Annuity deposits rose 14.2%, helped by single-premium and rollover business and the new fixed indexed annuity introduced in February 2014. Earned premiums and contract charges rose 3.7% to $533.6 million.
- Nine-month segment income increased in property and casualty ($30.7 million, up $5.3 million) and annuity ($34.1 million, up $2.2 million), while life income declined to $12.8 million from $15.7 million. Life results reflected more normal mortality experience after favorable prior-year experience.
- Investment income increased 5.9% for the nine months as average invested assets grew 6.7%; the portfolio’s average pretax yield eased to 5.33% from 5.37%. Management attributed higher unrealized gains to lower Treasury yields and narrower spreads across most asset classes.
- Policy counts and retention merit attention: total voluntary auto and homeowners policies were 711,000, down from 722,000 a year earlier; auto and property retention rates also declined modestly. The company began a Florida homeowners nonrenewal program targeting about 4,800 policies, approximately 95% of its remaining Florida property book; about 2,000 had ended by September 30. Management expects lower concentration and reinsurance costs over time, but acknowledged near-term effects on policies and premiums.
Outlook, risks, and unusual items
- Management projected 2014 net income before realized investment gains and losses of $2.20–$2.30 per diluted share. It expected solid annuity and life earnings, normal life mortality, and a fourth-quarter property and casualty combined ratio—excluding catastrophes and prior-year reserve development—comparable to the prior-year quarter. This is a management estimate, not a guarantee.
- Management warned that sustained low interest rates could compress fixed-annuity spreads: approximately 86% of deferred annuity account values were at minimum guaranteed rates. A 100-basis-point decline in reinvestment rates was estimated to reduce annuity net investment income by about $2.6 million in year one and $7.8 million in year two.
- Key exposures include catastrophe frequency and severity, weather-related homeowners losses, concentration in catastrophe-prone states, reinsurance availability and collectibility, investment valuation and credit risk, interest-rate and reinvestment risk, policyholder behavior, and educator-sector employment and budget conditions. The filing reported no material changes to previously disclosed risk factors.
- The bank credit facility was amended in July, extending its expiration to July 30, 2019 and reducing its Eurodollar spread; capacity is $150 million, with $38 million drawn. The $75 million 6.05% senior notes mature in June 2015, and $125 million of 6.85% notes mature in April 2016.
- The company received an additional $250 million FHLB funding agreement in September, due in 2019 and secured by deposited securities. No impairment was recorded on securities with unrealized losses; management considered those losses temporary. New fixed-indexed-annuity derivatives are carried at fair value through earnings without hedge accounting.
- Operating cash flow was described as adequate for expected operating needs over the next 12 months. Insurance-subsidiary dividends available without prior regulatory approval were approximately $82 million for 2014, of which $36 million had been paid through September.
Most important facts for investors to verify
- Whether the $2.20–$2.30 full-year outlook is achieved, and how realized investment gains or losses affect reported earnings beyond that outlook measure.
- Trends in catastrophe and non-catastrophe homeowners losses, reserve development, and the effect of Florida nonrenewals on premiums, concentration, and reinsurance costs.
- Whether low rates, minimum guarantees, and reinvestment yields pressure fixed-annuity spreads and deferred acquisition cost amortization.
- Continued annuity deposit growth and retention, alongside changes in auto/homeowners policy counts and agent distribution.
- Portfolio valuation, credit quality, unrealized gains and losses, and the company’s refinancing plans for the 2015 and 2016 senior notes.