Horace Mann Educators Corporation — Q1 2018 Form 10-Q
Reporting period: Three months ended March 31, 2018; comparisons are with Q1 2017 unless otherwise noted. Horace Mann sells property and casualty insurance, annuities, and life insurance, primarily to public-school employees and their families. KPMG reviewed the interim financial statements; this was not an audit.
Financial performance and position
- Revenue: $295.5 million, up 2.9% from $287.3 million. Earned premiums and contract charges rose 3.7% to $203.0 million; net investment income increased 1.3% to $91.9 million.
- Profit: Net income was $20.2 million, up 32.0% from $15.3 million. Diluted EPS was $0.48 versus $0.37. Income before tax was $23.8 million; the effective tax rate was 15.1%.
- Cash flow: Operating activities provided $72.1 million, compared with $72.8 million. Investing activities used $33.7 million and financing activities used $22.1 million. Cash at quarter-end was $24.0 million, up from $7.6 million at year-end 2017.
- Insurance performance: Property and Casualty’s combined ratio improved to 98.9% from 105.5%; catastrophe losses were $9.8 million pretax versus $17.2 million. Retirement net income was $11.4 million, roughly flat, and Life net income was $3.8 million, down slightly.
- Balance sheet and capital: Total assets were $11.07 billion, down from $11.20 billion at December 31, 2017. Shareholders’ equity was $1.40 billion, down from $1.50 billion; book value per share was $34.35, down 6.9% from year-end. The decline included a $122.1 million after-tax other comprehensive loss, primarily from lower unrealized investment gains.
- Investments: The fixed-maturity portfolio had a fair value of $7.63 billion and was 96.7% investment grade, with an average rating of A+. Management considered fixed-maturity unrealized losses temporary and recorded no impairment on those securities at quarter-end. Net investment losses were $1.7 million versus $0.2 million; the current-quarter amount included a $5.2 million equity-security fair-value loss under newly adopted accounting guidance.
- Debt and liquidity: Long-term debt was $297.5 million, including $250 million principal of 4.50% senior notes due 2025 and $50 million of FHLB borrowings; the $150 million revolving facility had no balance drawn. Debt was 19.5% of total capital excluding unrealized investment gains, below the company’s 25% long-term target. Management said operating cash flow should cover operating needs over the next 12 months.
Material changes and management commentary
- Higher Property and Casualty earnings drove the company-wide profit increase, reflecting rate actions, profitability initiatives, and lower catastrophe losses. P&C written premiums rose 4.3%; auto and property retention were 82.9% and 87.9%, respectively.
- Retirement annuity deposits fell 15.8% to $98.8 million, mainly because of lower single-premium annuity sales. Retirement assets under management increased 6.8% year over year to $6.8 billion; cash-value persistency remained strong.
- Annualized fixed-annuity net interest spread was 170 basis points, down 13 basis points year over year. Management expects spread pressure as low reinvestment yields and minimum guaranteed crediting rates constrain margins.
- The 2018 tax legislation reduced the company’s effective tax rate by 9.5 percentage points for the quarter. Accounting for certain tax effects remained provisional, pending partnership tax schedules and Treasury guidance; adjustments are due no later than year-end 2018.
- New accounting guidance effective January 1, 2018 moved equity-security fair-value changes into earnings and reclassified $15.0 million of after-tax unrealized gains from accumulated other comprehensive income to retained earnings. Revenue-recognition guidance had no reported financial-statement impact.
Outlook, risks, and contingencies
- 2018 outlook: Management estimated full-year core earnings of $2.10–$2.30 per diluted share, a non-GAAP measure. The outlook assumes 6–7 points of catastrophe losses, an effective tax rate of 15%–18%, and continued improvement in underlying auto and property combined ratios. Management anticipated a 20–30 basis-point decline in overall pretax annualized investment yield and a fixed-annuity spread around 170 basis points.
- Management cited interest-rate and reinvestment risk: approximately 87.9% of deferred annuity account values were at their minimum guaranteed rates. A 100-basis-point decline in reinvestment rates could reduce Retirement net investment income by an estimated $2.3 million in year one and $6.8 million in year two, under the stated assumptions.
- Other relevant risks include catastrophe exposure, adverse claims development, investment-market and credit risks, and potential changes to retirement-product regulation. The filing notes that a federal appeals court vacated the DOL fiduciary rule in March 2018, while SEC and state-level standards remained under consideration.
- Unfunded investment purchase commitments were $170.1 million at March 31, 2018. The company reported no material changes to previously disclosed risk factors other than the fiduciary-rule update.
Most important facts for investors to verify
- Whether P&C rate actions and underwriting improvements can sustain combined-ratio gains as catastrophe losses and non-catastrophe weather claims fluctuate.
- Whether the decline in annuity deposits persists, and how persistency, product mix, and assets under management affect Retirement earnings.
- How lower reinvestment yields and guaranteed crediting-rate floors affect spreads, investment income, and deferred acquisition cost amortization.
- Whether equity-market movements or other investment changes materially affect reported earnings and book value; distinguish realized losses from changes recorded through other comprehensive income.
- Final tax accounting adjustments, the non-GAAP basis and assumptions behind the core-earnings outlook, and any regulatory developments affecting retirement products or distribution.