Horace Mann Educators Corporation — Q1 2019 Form 10-Q
Business context and reporting period. The company sells property and casualty insurance, annuities and life insurance, primarily to K–12 educators, school employees and their families. This unaudited filing covers the three months ended March 31, 2019, compared with Q1 2018. KPMG reviewed the interim financial information and reported no material modifications were needed for GAAP conformity; this was a review, not an audit.
Financial performance and position
| Metric | Q1 2019 | Q1 2018 / comparison |
|---|---|---|
| Total revenue | $313.2 million | $295.5 million; up 6.0% |
| Net income | $32.2 million | $20.2 million; up 59.4% |
| Diluted EPS | $0.77 | $0.48 |
| Operating cash flow | $124.8 million | $72.1 million |
| Investing cash flow | $(146.2) million | $(33.7) million |
| Financing cash flow | $16.8 million | $(22.1) million |
- Insurance premiums and contract charges earned rose 3.3% to $209.8 million; net investment income increased 1.0% to $92.8 million. Net investment gains were $7.4 million, versus a $1.7 million loss in Q1 2018.
- Benefits, claims and settlement expenses declined 2.9% to $139.4 million. Operating expenses increased 12.0% to $54.1 million, including $2.8 million of BCG-related expenses; the prior-year period included a $2.2 million legal expense recovery.
- Property and Casualty reported net income of $15.1 million, up 54.6%; Retirement reported $12.2 million, up 7.0%; Life reported $3.3 million, down 13.2%.
- Automobile and property combined ratios were 98.0% and 90.5%, respectively, improving 3.8 and 2.8 percentage points year over year. Favorable prior-year reserve development was $2.0 million, versus $0.3 million.
- At March 31, total assets were $11.56 billion, total investments $8.56 billion and shareholders’ equity $1.42 billion. Cash was $7.3 million. Long-term debt was $297.8 million; no borrowings were outstanding under the $150 million revolving credit facility, which expires in 2023.
- Debt was 19.7% of total capital excluding net unrealized investment gains (17.3% including those gains), below the company’s stated 25% long-term target. Book value per share was $34.60, including after-tax net unrealized investment gains; excluding those gains it was $29.47.
Material changes and notable items
- Net income improved primarily due to investment gains, better auto and property loss ratios, and $2.0 million of favorable Retirement DAC unlocking. Investment gains reflected equity-security fair-value increases and realized gains.
- Operating cash flow increased, mainly from higher premium collections and lower policyholder benefit payments. Investing cash outflow included $18.2 million for the BCG acquisition.
- The company acquired Benefit Consultants Group (BCG) on January 2, 2019, in a transaction valued at $25 million. Purchase accounting recognized $10.1 million of goodwill and $16.2 million of intangible assets.
- The proposed $405 million acquisition of NTA Life remained pending at filing, subject to regulatory approvals and customary closing conditions; management expected it to close in mid-2019.
- Adoption of updated lease accounting resulted in recognition of a $14.5 million lease liability and a $13.9 million right-of-use asset, with no effect on net income or shareholders’ equity.
- Fixed maturity securities had $40.1 million of gross unrealized losses on $1.96 billion of fair value. Management considered the losses temporary and stated it did not intend, and was not more likely than not required, to sell the affected securities before recovery.
Outlook, risks and management commentary
- Management estimated 2019 net income of $2.00–$2.20 per diluted share and core return on equity of 7.0%–7.5%. It expected pretax net investment income to decline by $5–$6 million and an effective tax rate of 16%–18%. Management cautioned that it could not provide a valid forward-looking estimate of net investment gains or losses.
- For Property and Casualty, management expected underlying auto and property loss ratios to improve about 2 and 3 points, respectively. The 2019 catastrophe-cost estimate was increased 20% to $45–$55 million, or 7–7.5 points; the expense ratio was expected to remain around 27%.
- Retirement full-year net income was expected at $39–$41 million, with spread compression and lower prepayment activity partly offset by BCG-related fee and other income. Life net income was expected to decline 15%, reflecting lower investment income and modestly higher mortality costs.
- Management cited low interest rates, reinvestment risk, prepayment activity, claims experience and catastrophe exposure as relevant risks. It estimated a 100-basis-point decline in reinvestment rates could reduce Retirement investment income by about $1.8 million in year one and $5.4 million in year two.
- Moody’s ratings carried a negative outlook and Fitch ratings were on negative watch; S&P and A.M. Best outlooks were stable. Management reported no material changes to previously disclosed risk factors and concluded disclosure controls were effective.
- Cash generated from operations was expected to cover operating needs over the next 12 months. The quarterly dividend was increased to $0.2875 per share; $22.8 million remained authorized under the share repurchase program, with no shares repurchased in Q1.
Important facts for investors to verify
- Whether the NTA acquisition closed as expected, its final funding and purchase accounting, and its effect on leverage and capital.
- Progress against the full-year EPS and core ROE outlook, including the forecast investment-income decline and segment earnings assumptions.
- Auto and property loss trends, policy retention, catastrophe claims and the sustainability of favorable reserve development.
- Investment portfolio credit quality, unrealized losses, realized and fair-value gains, and sensitivity to interest rates and credit spreads.
- Retirement spread compression, minimum credited-rate obligations, annuity persistency and reinvestment risk.
- Capital and liquidity after acquisitions, debt and FHLB funding, regulatory limits on subsidiary dividends, and the status of rating-agency negative outlooks or watches.