Horace Mann Educators Corporation — Q2 2016 Form 10-Q
Reporting period: Three and six months ended June 30, 2016. Unless stated otherwise, amounts are in millions of dollars. The interim financial statements are unaudited; KPMG conducted a review, not an audit, and reported no material modifications were needed.
Business context
Horace Mann is an insurance holding company focused on property and casualty insurance, retirement annuities, and life insurance, marketed primarily to K-12 educators, school employees, and their families.
Financial results and position
- Q2 revenue: $283.6, up 5.6% from $268.5 a year earlier. Premiums and contract charges earned were $188.4; net investment income was $91.2.
- Q2 earnings: Net income was $11.9, down 26.7% from $16.2; diluted EPS was $0.29 versus $0.38.
- First-half revenue and earnings: Revenue was $554.9, up 3.0%; net income was $37.0, down 26.7% from $50.5. Diluted EPS was $0.89 versus $1.19.
- Segment results: Q2 property and casualty (P&C) recorded a $4.5 loss versus $3.3 income; annuity income was $13.0, up $1.2; life income was $4.6, up $1.0. First-half segment income was P&C $9.3, annuity $23.6, and life $8.5.
- P&C underwriting: The combined ratio was 111.6% in Q2 and 102.8% for the first half, versus 103.7% and 97.0%, respectively, in 2015. First-half catastrophe losses were $40.0 versus $31.8; favorable prior-year reserve development was $3.6 versus $7.2.
- Cash flow: First-half operating cash flow was $112.5, versus $98.3 in 2015. Investing cash flow was negative $127.4 and financing cash flow was positive $49.8. Cash ended the period at $50.4, compared with $15.5 at year-end 2015.
- Balance sheet and capital: Total assets were $10.47 billion, up from $10.06 billion at year-end; shareholders’ equity was $1.42 billion, up from $1.26 billion. Book value per share was $35.31, or $27.10 excluding investment fair-value adjustments. A $329.7 after-tax net unrealized investment gain was included in equity.
- Debt and liquidity: Long-term debt was $247.1, comprising $250 million principal of 4.50% Senior Notes due 2025, net of discount and issuance costs. No amount was drawn on the $150 million bank facility. Debt was 14.8% of total capital including unrealized investment gains and losses, below the company’s 25% long-term target. Management said operating cash flow should meet cash needs for the next 12 months.
Material changes and management commentary
- Higher catastrophe losses and adverse automobile loss frequency and severity drove weaker P&C results; severe weather included events in Texas and the Midwest. Homeowners non-catastrophe results improved.
- Net investment income increased, supported by portfolio growth and investment-prepayment gains, partly offset by a lower average yield. The first-half portfolio yield was 5.14%, versus 5.20% a year earlier.
- First-half premiums written and contract deposits declined 4.8% to $595.0, mainly because annuity deposits fell 16.1%. The comparison included non-recurring employee-plan deposits in 2015. P&C premiums written rose 4.6%; life premiums and deposits rose 4.1%.
- Operating expenses increased 13.4% in the first half, reflecting technology, infrastructure, customer-service and other costs, as well as a prior-year incentive-compensation reduction.
- Other-than-temporary impairment charges were $7.2 in the first half, largely related to Puerto Rico and energy-sector fixed maturities and some equity securities. Management regarded the remaining unrealized losses as temporary, but noted future conditions could require impairment recognition.
- Shareholders received $22.2 in dividends during the first half. The company repurchased 701,410 shares for $21.5, with $29.5 remaining authorized at June 30.
Outlook, risks and contingencies
- 2016 outlook: Management estimated full-year net income before realized investment gains and losses of $1.80–$2.00 per diluted share. It expected second-half catastrophe losses near historical averages, a roughly 10-basis-point decline in portfolio yield over the year, and moderate expense increases. Annuity and life combined income was expected to be comparable to 2015.
- Management anticipated ongoing pressure on annuity spreads from low interest rates; approximately 86% of deferred annuity account values were credited at their minimum guaranteed rate. It estimated that a 100-basis-point decline in reinvestment rates could reduce annuity net investment income by about $2.3 in year one and $6.8 in year two.
- Key risks include catastrophe exposure and reinsurance availability or collectability, auto claims trends, persistently low interest rates, investment valuation and credit losses, and educator-sector employment and budget conditions. Six states identified as catastrophe-prone were among the ten largest P&C states, which together represented 57% of 2015 segment direct earned premiums.
- The DOL fiduciary rule, generally applicable beginning April 10, 2017, could affect IRA sales, agent compensation and distribution, compliance costs, and annuity products. Potential SEC fiduciary rulemaking was also identified as a risk.
- Unfunded commitments to purchase investments or lend under bridge loans were $178.0. The company reported no relationships with unconsolidated entities established to facilitate off-balance-sheet arrangements.
- Management reported effective disclosure controls and no material changes to internal control over financial reporting. It reported no material changes to previously disclosed risk factors apart from the fiduciary-rule update.
Important facts for investors to verify
- Whether auto loss frequency and severity, catastrophe claims, and P&C combined ratios improve as anticipated.
- Whether the $1.80–$2.00 full-year EPS outlook remains achievable, given first-half results and realized-gain exclusions.
- How low rates affect reinvestment yields, annuity spreads, minimum guarantees, and deferred acquisition cost amortization.
- Whether investment impairment exposure, including Puerto Rico and energy holdings, or unrealized losses lead to further charges.
- How annuity deposit trends and the DOL/SEC fiduciary rules affect sales, agent retention, and distribution costs.