Horace Mann Educators Corporation — Q2 2013 Form 10-Q
Business context and reporting period. The company provides property and casualty insurance, retirement annuities and life insurance, primarily to K–12 educators, public-school employees and their families. This unaudited quarterly report covers the three and six months ended June 30, 2013, compared with the corresponding 2012 periods. KPMG conducted an interim review, not an audit, and reported that it was not aware of material modifications needed for GAAP conformity.
Financial performance and position
| Metric | Q2 2013 | First six months 2013 | Prior-year comparison |
|---|---|---|---|
| Total revenue | $265.6 million | $520.2 million | Up 4.5% and 4.3%, respectively |
| Net income | $26.0 million | $53.0 million | Up from $13.1 million and $39.8 million |
| Diluted EPS | $0.63 | $1.29 | Up from $0.32 and $0.96 |
| Operating cash flow | Not separately presented here | $85.3 million | Down from $94.7 million |
- Earnings drivers: First-half pretax realized investment gains were $22.3 million, versus $10.3 million; after-tax gains were $14.4 million, versus $6.7 million. The company recorded a $1.0 million impairment charge, including $0.9 million on a Detroit general obligation bond following the city’s bankruptcy filing.
- Segments, first half: Property and casualty net income was $14.3 million, annuity $20.3 million, life $9.9 million, and corporate and other $8.5 million. Property and casualty combined ratio improved to 100.3% from 103.9%; its expense ratio rose to 27.3% from 26.4%.
- Investment income and spreads: First-half net investment income was $154.8 million, up 1.8%, as larger average invested assets more than offset a lower average pretax yield: 5.40% versus 5.72%. Fixed-annuity net interest spread narrowed to 198 basis points from 211 basis points.
- Balance sheet at June 30: Total assets were $8.36 billion; investments $6.30 billion; cash $37.9 million; shareholders’ equity $1.11 billion. Book value per share was $27.72, or $22.79 excluding investment fair-value adjustments. Equity included $196.8 million of after-tax net unrealized investment gains.
- Debt and capital: Short-term debt was $38.0 million and long-term debt $199.8 million. Debt was 20.7% of total capital excluding unrealized investment gains and losses (17.7% including them), below the company’s 25% long-term target. The $150 million bank facility had $38 million outstanding; no FHLB borrowings were outstanding.
- Liquidity and capital returns: The company reported $85.3 million of operating cash flow and said cash from operations was expected to meet operating needs over the next 12 months. It paid $16.2 million in dividends and repurchased 173,428 shares for $3.9 million in the first half; $28.4 million remained authorized under its repurchase program.
Material changes versus the prior comparable period
- Net income rose substantially in both the quarter and first half, supported by greater realized investment gains and improved property and casualty results. Q2 property and casualty earnings recovered to $4.1 million from a $4.1 million loss.
- First-half catastrophe losses fell to $28.2 million from $35.1 million, while favorable development of prior-year claims also decreased, to $5.9 million from $8.5 million.
- First-half earned premiums and contract charges increased 2.7%; premiums written and contract deposits increased 1.9%. Growth reflected higher average automobile and homeowners premiums per policy.
- Life segment earnings declined to $9.9 million from $11.3 million as mortality costs returned to a more typical level. Annuity earnings increased modestly despite spread compression.
- Investment-market movements sharply reduced unrealized gains: first-half other comprehensive loss was $185.6 million, and shareholders’ equity fell to $1.11 billion from $1.25 billion at December 31, 2012. Management attributed lower unrealized gains primarily to higher Treasury yields and wider credit spreads across most asset classes.
Outlook, commentary and risks
- Management estimated 2013 full-year net income before realized investment gains and losses of $1.75–$1.95 per diluted share. It expected improved property and casualty current-year results, partly offset by less favorable prior-year reserve development; annuity earnings excluding deferred-acquisition-cost unlocking were expected to be relatively consistent with 2012; and life mortality costs were expected to return to modeled levels.
- The outlook included $3–$4 million of pretax spending on customer-service and infrastructure improvements. Management cautioned that realized investment gains and losses cannot be reliably forecast and that actual results may differ from estimates.
- Low rates remain a material pressure: about 87% of deferred annuity account values were credited at their minimum guaranteed rate. Management anticipated further fixed-annuity spread compression. Its illustrative 100-basis-point reinvestment-rate decline scenario estimated additional annuity net investment income reductions of about $1.9 million in 2013 and $5.7 million in 2014 versus 2012.
- Other key risks include catastrophe frequency and severity, exposure in catastrophe-prone states, reinsurance availability and collectibility, investment valuation and credit risk, policy persistency, claims and reserve estimates, and economic pressures on educator employment and budgets. The company reported no material changes to the risk factors in its 2012 Form 10-K.
- Management reported effective disclosure controls and no material changes in internal control over financial reporting. The company began using repurchase agreements in 2013; at June 30, securities transferred had fair value of $129.8 million and the related repurchase obligation was $134.0 million including accrued interest.
Important facts for investors to verify
- Whether earnings growth is sustained by insurance underwriting and recurring investment income, rather than realized investment gains.
- Progress on the 100.3% property and casualty combined ratio, catastrophe losses, reserve development and policy retention.
- Fixed-annuity spread trends, minimum-guarantee constraints, reinvestment yields and the assumptions behind management’s 2013 earnings outlook.
- Investment portfolio valuation and credit quality, including unrealized losses, the Detroit impairment, and exposure to interest-rate and spread changes.
- Cash generation, subsidiary dividend capacity, debt maturities and facility availability, alongside dividends, repurchases and repurchase-agreement activity.