Horace Mann Educators Corporation — Q1 2015 Form 10-Q
Business context and period. The company provides property and casualty insurance, retirement annuities and life insurance, principally to K–12 educators, school employees and their families. This filing covers the three months ended March 31, 2015; balance-sheet amounts are as of March 31, 2015 unless otherwise noted. Financial statements are unaudited and were reviewed by KPMG, which reported no material modifications needed for GAAP conformity. Amounts below are in millions except per-share data and ratios.
Financial performance and position
| Metric | Q1 2015 | Q1 2014 / comparison |
|---|---|---|
| Total revenue | $270.1 | $261.3; up 3.4% |
| Net income | $34.3 | $28.4; up 20.8% |
| Diluted earnings per share | $0.81 | $0.67 |
| Income before taxes | $48.4 | $39.7 |
| Net investment income | $83.3 | $83.0; average portfolio yield was 5.16% pretax versus 5.47% |
| Net realized investment gains | $6.1 pretax | $1.7; includes $2.3 of impairment charges, largely on energy-sector securities |
| Cash from operating activities | $67.3 | $53.1 |
| Cash at period end | $43.9 | $11.7 at December 31, 2014 |
- Insurance premiums and contract charges earned rose 2.5% to $179.7. Premiums written and contract deposits rose 17.4% to $305.7, including a $22.0 increase associated with employee retirement-plan changes; excluding that item, growth was 9.0%.
- Property and casualty net income was $17.6, up $3.6; annuity net income was $12.5, up $0.2; life net income was $3.4, down $0.5. Corporate and other contributed $0.8 versus a $1.8 loss.
- The property and casualty combined ratio improved to 90.4% from 93.7%. Catastrophe losses rose to $10.5 from $6.3; favorable prior-year reserve development was $4.0 in both periods.
- Total assets were $10.07 billion, versus $9.77 billion at year-end. Shareholders’ equity was $1.41 billion, including $335.1 of after-tax unrealized investment gains. Book value per share was $34.28, or $26.13 excluding investment fair-value adjustments.
- Total debt was approximately $238.0: $38.0 under the bank facility and $200.0 of senior notes. Debt was 18.1% of total capital excluding unrealized investment gains and losses, below the company’s 25% long-term target. The $75.0 of 6.05% notes matured June 15, 2015; $125.0 of 6.85% notes mature April 15, 2016. The $150.0 revolving facility had $112.0 of unused capacity.
- Operating cash flow was described by management as adequate for operating needs over the next 12 months. Investing activities used $80.7 and financing activities provided $45.6 during the quarter.
Material changes and management commentary
- Net income increased $5.9 year over year, reflecting improved insurance results and $2.9 more after-tax realized investment gains. Property and casualty results improved on better current-year non-catastrophe frequency and severity trends, partly offset by higher catastrophe costs.
- Annuity deposits increased 41.6%; the company said employee-plan changes accounted for $22.0 of the increase. Fixed indexed annuity sales contributed to growth. Total annuity accumulated value was $5.8 billion, up 7.7% year over year.
- Operating expenses fell 10.0% to $35.9. A correction of an immaterial prior-period restricted-stock-unit valuation error reduced incentive compensation expense and increased Q1 net income by $3.012 after tax: $2.056 property and casualty, $0.519 annuity and $0.437 life. Management said the correction was out of period.
- Fixed annuity net interest spread declined to 194 basis points from 214 basis points. About 86% of deferred annuity account values were at their minimum guaranteed rate. Management anticipated continued spread compression under persistently low rates.
- Property and casualty rate actions averaged 4% for automobile and 5% for homeowners in Q1, consistent with full-year plans for mid-single-digit average increases. The company was reducing Florida homeowners exposure: approximately 4,200 of about 4,800 policies identified for nonrenewal had terminated by quarter-end.
Outlook, risks and contingencies
- Management projected 2015 net income before realized investment gains and losses of $2.15–$2.35 per diluted share. It expected modest underlying improvement in the property and casualty combined ratio, lower favorable reserve development, low interest rates, and continued infrastructure and technology investment.
- Management expected the overall portfolio yield to decline about 20 basis points during 2015 versus 2014. Annuity net income was expected to be slightly below 2014, and life net income modestly lower; property and casualty written premiums were expected to increase.
- Management estimated that a further 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, with additional spread compression. These are estimates, not reported results.
- Principal disclosed risks include low interest rates and reinvestment risk; investment market value, credit and impairment risk; catastrophe frequency and severity and exposure in catastrophe-prone states; reinsurance availability, cost and collectibility; policy persistency and claims assumptions; and competitive, regulatory, educator-market and technology execution risks. Management reported no material changes to the risk factors previously disclosed in the 2014 Form 10-K.
- The company had $40.2 of unfunded investment and bridge-loan commitments. Its $50.0 share-repurchase authorization had $22.2 remaining; it repurchased 23,500 shares for $0.7 in the quarter and paid $10.7 in dividends. A universal shelf registration became effective March 12, 2015; no securities had been issued under it as of the filing.
Important facts for investors to verify
- How much of the reported earnings increase reflects the $3.012 after-tax compensation correction and elevated realized investment gains, versus recurring operating performance.
- Whether the company refinanced or repaid the $75.0 notes due June 15, 2015, and how it plans to address the 2016 notes.
- Whether persistently low rates further compress annuity spreads, given the high share of deferred annuity balances at minimum guaranteed rates.
- Whether catastrophe losses, Florida homeowners nonrenewals and reinsurance costs affect property and casualty underwriting results and policy counts.
- Whether the $2.3 of investment impairment charges, unrealized losses and credit assumptions require further impairment or affect capital and book value.
- Progress against the 2015 earnings outlook, including the assumptions for reserve development, weather losses, investment yields and technology spending.