HORACE MANN EDUCATORS CORP annual report, FY2012

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Horace Mann Educators Corporation — FY 2012 Form 10-K

Reporting period: Fiscal year ended December 31, 2012. This is an annual report, not a standalone fourth-quarter filing. Horace Mann is an insurance holding company serving educators and their families through property and casualty, annuity, and life insurance businesses.

Financial performance and position

  • Revenue: Total revenue was $1,010.8 million, up 1.3% from $998.3 million in 2011. Insurance premiums and contract charges earned were $670.5 million, up 0.5%; net investment income was $306.0 million, up 6.1%; realized investment gains were $27.3 million, down from $37.7 million.
  • Profit: Net income was $103.9 million, up 47.4% from $70.5 million; diluted EPS was $2.51 versus $1.70. Pretax income was $149.2 million. Return on average equity was 9%, compared with 8% in 2011.
  • Segment net income: Property and casualty (P&C) earned $37.1 million versus $5.9 million; annuity earned $40.5 million versus $30.9 million; life earned $21.9 million versus $19.4 million. Corporate and other income fell to $4.4 million from $14.3 million.
  • P&C margins and claims: The combined ratio improved to 98.3% from 106.6%; the loss ratio was 71.3%, and the expense ratio was 27.0%. Catastrophe costs fell to $43.3 million from $86.0 million. Prior-year reserve releases were $17.2 million, versus $10.3 million in 2011.
  • Annuity and life indicators: Annuity deposits declined 3.8% to $417.6 million, while accumulated annuity cash value grew 9.8% to $4.8 billion. Life premiums and contract deposits increased 0.7% to $99.3 million.
  • Cash flow: Operating cash flow was $202.8 million, versus $115.9 million in 2011. Investing cash outflow was $354.8 million; financing cash inflow was $159.7 million. Cash increased by $7.7 million to $15.2 million.
  • Balance sheet and investments: Total assets were $8.17 billion, including $6.29 billion of investments. Shareholders’ equity was $1.25 billion, up from $1.06 billion; book value per share was $31.65 versus $26.53. The investment portfolio was predominantly fixed income, 94.8% investment grade, with an average rating of A. Net unrealized investment gains included in equity were $382.4 million after tax.
  • Debt and liquidity: Debt totaled $237.8 million: $38.0 million drawn on a $150 million credit facility and approximately $199.8 million of senior notes. Debt was 21.6% of total capital excluding unrealized investment gains and losses. Management said operating cash flow was expected to meet near-term operating needs; up to approximately $84 million of subsidiary dividends could be paid to the parent in 2013 without prior regulatory approval. Parent-company liquid assets were $29.6 million.

Changes versus prior periods

  • Net income rose sharply, driven principally by lower catastrophe losses and improved P&C results, as well as stronger underlying earnings in annuity and life.
  • P&C premiums written increased 0.9%, but policies in force declined to 721,000 from 725,000 in 2011. Higher average premiums per policy partly offset policy attrition.
  • Written premiums and contract deposits declined 1.0% to $1.07 billion, mainly because annuity deposits decreased after a notably strong 2011.
  • Net investment income increased with growth in invested assets, while portfolio yield declined to 5.63% from 5.70%. Higher net unrealized gains lifted book value.
  • The company retrospectively adopted revised accounting guidance for insurance acquisition costs in 2012. It reduced previously reported 2011 year-end deferred acquisition costs by $48.6 million and shareholders’ equity by $31.6 million; the filing says the adoption had minimal net effect on results and did not change EPS.

Outlook, commentary, and risks

  • 2013 outlook: Management estimated net income before realized investment gains and losses of $1.75–$1.95 per diluted share. The forecast assumes life mortality costs return to modeled levels, little impact from annuity acquisition-cost evaluations, improved P&C current-year results but less favorable prior-year reserve development, and lower annuity interest spreads. Planned customer-service and infrastructure spending was $3–$4 million pretax.
  • Management cautioned that several 2012 earnings contributors were more favorable than typically expected, including catastrophe experience, prior-year reserve development, Florida sinkhole losses, annuity market-related acquisition-cost effects, and life mortality. These factors may not recur at the same level.
  • Low interest rates pose a material risk to investment income and annuity spreads. About 85% of deferred fixed annuity values were already credited at minimum guaranteed rates. Management anticipated future spread compression; its sensitivity estimate indicated pretax income reductions of about $3 million in 2013 and $9 million in 2014 for each 100-basis-point decline in reinvestment rates, before any reduction in crediting rates.
  • Other key risks include catastrophe severity and reinsurance availability or collectability; adequacy of P&C loss reserves; market and credit losses on investments; educator employment and school-district budget pressures; competition and agent retention; regulatory or tax changes affecting 403(b) products; and operational, technology, and data-security risks.
  • The life reporting unit’s goodwill passed impairment testing, but with a limited valuation cushion. No goodwill impairment was recorded. The company reported no pending litigation with a reasonable possibility of material loss; statutory capital and surplus at each insurance subsidiary exceeded required levels. Management and the auditor reported effective internal control over financial reporting.

Most important facts for investors to verify

  • How much of the 2012 earnings increase reflects repeatable underwriting and investment performance versus lower catastrophes, reserve releases, and other favorable items.
  • Whether P&C policy counts, retention, and new-business growth improve without sacrificing underwriting margins, and how catastrophe exposure and reinsurance recoveries develop.
  • Whether low rates further compress fixed-annuity spreads, and whether annuity deposits, persistency, and asset growth support the 2013 outlook.
  • Whether the 2013 EPS outlook is achieved as mortality and reserve-development experience normalize, and whether planned service and infrastructure spending delivers retention or cross-selling benefits.
  • The parent company’s access to subsidiary dividends and liquidity, debt maturities in 2015–2016, and the sensitivity of equity and goodwill valuations to interest rates and investment markets.