HORACE MANN EDUCATORS CORP quarterly report, Q3 FY2011

Horace Mann Educators Corporation — Q3 2011 Form 10-Q

Business context and period. The company sells property and casualty insurance, retirement annuities and life insurance, primarily to K-12 educators and their families. This filing covers the quarter and nine months ended September 30, 2011; interim statements are unaudited and KPMG’s review is not an audit opinion.

Key financial metrics

Amounts below are in millions, except per-share data and ratios.

MetricQ3 2011Q3 2010Nine months 2011Nine months 2010
Total revenues$260.8$250.0$750.7$736.7
Net income$23.1$20.2$37.3$65.8
Diluted EPS$0.56$0.49$0.90$1.61
Net investment income$71.6$68.3$213.7$203.3
Net realized investment gains$21.1$12.1$32.7$25.3
Operating cash flowNot presented separatelyNot presented separately$76.1$128.9
  • Quarterly revenue grew about 4%, and net income rose about 15%. For the first nine months, revenue grew about 2%, while net income fell about 43%.
  • Property and casualty (P&C) produced a nine-month net loss of $11.6 million, versus $21.0 million income in 2010. Its combined ratio was 111.4%, compared with 100.8%; catastrophe losses were $81.3 million pretax versus $40.5 million.
  • At September 30, total assets were $7.34 billion, shareholders’ equity $1.06 billion, and cash $40.8 million. Equity included $257.2 million of after-tax unrealized investment gains. Book value was $26.44 per share, or $20.00 excluding investment fair-value adjustments.
  • Total debt was $237.7 million: $38.0 million short-term and $199.7 million long-term. Debt was 22.9% of capital excluding unrealized investment gains and losses (18.4% including them). The company reported $76.1 million of operating cash flow, $188.9 million of cash used in investing and $147.7 million of cash provided by financing for the nine months.

Material changes versus comparable periods

  • The nine-month earnings decline was driven principally by higher catastrophe costs and less favorable prior-year reserve development in P&C. Catastrophe costs increased $40.8 million pretax and their after-tax impact rose $26.5 million year over year.
  • Net investment income increased 5.1% for the nine months, mainly reflecting a larger average investment portfolio, although its average pretax yield declined to 5.68% from 5.83%.
  • Annuity deposits increased 10.5% year over year, driven by single-premium and rollover receipts. P&C premiums written declined 2.3%; management attributed part of the decrease to Florida homeowners non-renewals. Total policies in force and retention rates were lower than a year earlier.
  • Operating cash flow fell to $76.1 million from $128.9 million, primarily because of higher P&C claims payments, including catastrophe claims. Shareholders’ equity rose from $880.0 million at year-end 2010, substantially reflecting higher unrealized investment gains.

Outlook, management commentary and risks

  • Management estimated full-year 2011 net income before realized investment gains and losses of $0.90–$1.00 per diluted share. The estimate assumes catastrophe losses near historical levels, moderate market appreciation, minimal Florida sinkhole losses and segment results consistent with typical fourth-quarter patterns. It is subject to significant uncertainty.
  • Management said the Florida homeowners non-renewal program was completed by mid-August 2011. It expects the program to reduce catastrophe exposure and reinsurance costs and improve homeowners underwriting results, while weighing on near-term policy counts and premiums.
  • Management identified exposure to severe weather and catastrophe costs, reserve estimation, investment-market and credit movements, low interest rates and potential fixed-annuity spread compression, variable-annuity market performance, policy persistency and mortality, and educator-sector economic pressures. It also cited regulatory, competitive, reinsurance, litigation and legacy information-system risks.
  • Unrealized losses on securities were considered temporary by management; no impairment was recorded in the period. Management cautioned that changed circumstances could require future impairment charges. The portfolio was 95.1% investment grade by fair value, with an average rating of A+.
  • A new insurance-contract acquisition-cost accounting standard is expected to be adopted retrospectively from January 1, 2012. Preliminary analysis indicated an equity impact below 5% excluding unrealized investment gains and losses, but the final impact could be larger; management expected the forward-looking net income effect to be minimal.
  • After quarter-end, on October 7, the company replaced its bank facility with a $150 million unsecured facility expiring in 2015; the $38 million borrowing balance was unchanged. The facility includes debt-to-capital, minimum-net-worth and insurance-subsidiary risk-based-capital covenants.
  • Management reported effective disclosure controls and no material change in risk factors from the 2010 Form 10-K.

Important facts for investors to verify

  • Whether catastrophe losses and P&C reserve development normalize, and how the 111.4% combined ratio evolves.
  • Whether the $0.90–$1.00 full-year earnings estimate is achieved, including the assumptions for fourth-quarter catastrophes, markets and sinkhole claims.
  • Trends in policy counts, retention and sales following rate actions and Florida homeowners risk-reduction measures.
  • The sensitivity of annuity deferred acquisition-cost amortization, interest spreads and variable-annuity revenue to market performance and rates.
  • The final balance-sheet and retained-earnings effects of the new acquisition-cost accounting standard, along with investment impairment exposure and debt-facility covenant headroom.