Horace Mann Educators Corporation — Q2 2012 Form 10-Q
Business context and reporting period
Insurance holding company serving primarily K–12 educators and their families through property and casualty, annuity and life insurance businesses. This unaudited report covers the quarter and six months ended June 30, 2012; dollar amounts below are in millions unless otherwise stated. Prior-year figures reflect retrospective adjustment for the company’s accounting change to deferred policy acquisition costs. KPMG reviewed the interim statements but did not audit them.
Financial performance and position
| Metric | Q2 2012 | Q2 2011 | Six months 2012 | Six months 2011 |
|---|---|---|---|---|
| Total revenue | $254.2 | $245.4 | $498.8 | $489.8 |
| Net income (loss) | $13.1 | $(11.9) | $39.8 | $14.0 |
| Diluted EPS | $0.32 | $(0.30) | $0.96 | $0.34 |
| Net investment income | $76.3 | $71.7 | $152.0 | $142.2 |
| Net realized investment gains | $9.9 | $5.8 | $10.3 | $11.6 |
- First-half operating cash flow was $94.7, up from $50.7; investing cash use was $122.7 and financing cash provided was $52.0. Cash ended June at $31.5, versus $7.5 at year-end 2011.
- At June 30, total assets were $7,824, investments $5,950, shareholders’ equity $1,144 and total liabilities $6,680. Equity included $334.6 of after-tax net unrealized investment gains. Book value per share was $29.06, or $20.55 excluding investment fair-value adjustments.
- Debt totaled $237.8: $38.0 short-term bank borrowings and $199.8 long-term senior notes. Debt was 17.2% of total capital including unrealized investment gains and losses, and 22.7% excluding them; management cited a long-term target of 25%.
- For the first half, the property and casualty combined ratio was 103.9%, versus 114.7% a year earlier. Its loss ratio was 77.5% and expense ratio 26.4%.
Material changes versus the prior comparable period
- Q2 returned to profitability, improving $24.9 from the prior-year loss; first-half net income rose $25.8. Lower catastrophe claims were the principal driver, alongside improved underlying results across the operating segments.
- First-half P&C segment income improved to $9.1 from a $13.2 loss. Catastrophe losses declined to $35.1 from $63.0, while favorable prior-year reserve development was $8.5 versus $3.7. Higher current-year automobile bodily-injury claim frequency partly offset these benefits.
- First-half annuity income rose to $19.5 from $15.8, mainly from improved fixed-annuity interest margins. Life income increased to $11.3 from $10.1, primarily reflecting lower mortality costs.
- Premiums and contract deposits were nearly flat year over year at $503.0. Earned premiums and contract charges declined 0.4% to $331.8, mainly as fewer P&C policies offset rate increases. Total new-business sales increased 14.1%.
- Investment income increased with portfolio growth, although the first-half average pretax yield edged down to 5.72% from 5.76%. Lower Treasury yields and narrower credit spreads lifted unrealized investment gains; the company recorded no securities impairment write-downs in the first half.
- Adopting revised DAC guidance retrospectively reduced previously reported equity, with minimal net effect on operating results and no change to reported EPS. The company stated the accounting change reduces expense deferrals and amortization.
Outlook, commentary and risks
- Management projected full-year 2012 net income before realized investment gains and losses of $1.55–$1.75 per diluted share. The projection includes first-half catastrophe costs above expectations and assumes more normal catastrophe losses in the second half. Realized investment gains and losses were excluded as not reasonably forecastable.
- Management said cash generated by operations should meet operating cash needs over the next 12 months. Up to approximately $71 million of subsidiary dividends could be paid in 2012 without prior regulatory approval; $18 million had been paid by June 30.
- Low reinvestment rates and limits on further reductions to credited rates may compress fixed-annuity spreads. About 82% of deferred annuity account values were credited at their minimum guaranteed rates.
- Risk factors include catastrophe severity and reinsurance availability or collectibility, adverse claims-reserve development, investment-market and interest-rate volatility, credit losses, persistency and mortality assumptions, annuity DAC estimates, regulatory constraints and the annuity unit’s comparatively limited goodwill valuation cushion. The Florida homeowners non-renewal program reduced catastrophe and sinkhole exposure but also reduced policies in force.
- Management reported no material change to previously disclosed risk factors, no material weakness in disclosure controls, and no significant change in internal control over financial reporting.
Important facts for investors to verify
- Whether the second-half catastrophe-loss assumption underlying the $1.55–$1.75 EPS outlook proved reasonable.
- How current-year automobile claim frequency and favorable prior-year reserve releases affect P&C underwriting; reported reserve variability was estimated at approximately plus or minus 6%.
- Whether investment yields, credit quality and unrealized gains support reported equity and book value; 95.0% of fixed maturities were investment grade, while 2.1% of portfolio fair value was Level 3.
- Whether fixed-annuity spreads withstand low reinvestment rates and minimum-rate constraints, and whether annuity DAC assumptions remain supportable.
- Cash availability at the holding company, regulatory limits on subsidiary distributions, debt maturities and terms, and the remaining $36.0 million share-repurchase authorization.