Horace Mann Educators Corporation — Q3 2016 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2016. Horace Mann markets property and casualty insurance, annuities and life insurance primarily to public-school educators and their families. The interim statements were reviewed by KPMG, not audited.
Financial performance
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Total revenue | $291.2 million | $265.8 million | $846.0 million | $804.3 million |
| Net income | $26.9 million | $22.0 million | $63.9 million | $72.4 million |
| Diluted earnings per share | $0.65 | $0.52 | $1.55 | $1.71 |
| Net investment income | $94.8 million | $81.0 million | $270.7 million | $248.3 million |
| Net realized investment gains | $4.0 million | $1.3 million | $6.9 million | $8.8 million |
- Q3 net income rose about $5.0 million year over year, led by stronger investment results and higher annuity earnings. Nine-month net income fell $8.5 million, primarily due to weaker property and casualty results and lower realized investment gains.
- Q3 segment net income: property and casualty $6.7 million (down $4.5 million), annuity $15.7 million (up $7.0 million), and life $4.6 million (up $1.0 million). Nine-month results were $16.0 million, $39.3 million and $13.1 million, respectively.
- Insurance premiums and contract charges earned increased 4.5% in Q3 and 3.7% for the first nine months. Premiums written and contract deposits rose 7.8% in Q3 but declined 0.5% year to date, reflecting lower annuity deposits versus a prior-year comparison that included nonrecurring employee-plan deposits.
- For the first nine months, the property and casualty combined ratio was 102.4%, versus 96.5% a year earlier; a ratio above 100% indicates underwriting losses. Catastrophe losses were $48.4 million versus $36.8 million, and favorable prior-year reserve development was $4.3 million versus $10.0 million.
- Net investment income increased 9.0% year to date, supported by portfolio growth, prepayment gains and alternative-investment returns, partly offset by lower fixed-maturity yields. The nine-month pretax portfolio yield was 5.25%; the fixed-annuity net interest spread was 195 basis points, versus 185 basis points in 2015.
Financial position, cash flow and liquidity
- At September 30, 2016, total assets were $10.69 billion, total investments $8.17 billion, shareholders’ equity $1.44 billion and cash $53.6 million. Equity included $337.3 million of after-tax unrealized investment gains (before related deferred-policy-acquisition-cost effects as presented in the balance-sheet components).
- Book value per share was $35.94, up 12% from a year earlier; excluding investment fair-value adjustments, it was $27.54, up 4% year over year.
- Nine-month operating cash flow was $161.5 million, compared with $159.5 million in 2015. Investing activities used $229.7 million and financing activities provided $106.3 million; cash increased $38.1 million to $53.6 million.
- Long-term debt was $247.1 million, comprising $250 million principal of 4.50% senior notes due December 2025, net of discount and issuance costs. The $150 million bank facility had no amount drawn. Debt was 18.3% of total capital excluding unrealized investment gains and losses, below the company’s 25% long-term target.
- Management said operating cash flow should meet operating needs over the next 12 months. Approximately $90 million of subsidiary dividends could be paid in 2016 without prior regulatory approval; $54.6 million had been paid through September. The company paid $33.2 million in shareholder dividends and repurchased 701,410 shares for $21.5 million in the first nine months.
Outlook, risks and notable items
- Management forecast 2016 net income before realized investment gains and losses of $1.80–$1.90 per diluted share. This outlook included an estimated $9–$11 million of catastrophe losses from Hurricane Matthew, which occurred in October 2016.
- Management expected the full-year underlying property and casualty combined ratio to be 1.5–2.5 percentage points higher than in 2015, reflecting automobile loss frequency and severity pressure and higher infrastructure costs, partly offset by property-line improvements. Annuity net income was expected to exceed 2015, with the net interest spread in the mid-190-basis-point range; life net income was expected to be comparable to 2015.
- Management cautioned that low interest rates may compress fixed-annuity spreads: about 87% of deferred annuity account values were already credited at their minimum guaranteed rates. A 100-basis-point decline in reinvestment rates was estimated to reduce annuity net investment income by approximately $1.9 million in year one and $5.6 million in year two.
- Key risks include severe weather and catastrophe exposure, automobile claims severity and frequency, reinsurance availability and collectibility, investment-market and credit losses, low-rate reinvestment risk, and changes in educator employment or public-school budgets. The filing also highlights potential business and compliance impacts from the Department of Labor fiduciary rule and possible SEC fiduciary requirements.
- Other items: $7.4 million of year-to-date impairment charges were recorded, largely on Puerto Rico and energy-sector fixed maturities and some equities. Management considered remaining unrealized security losses temporary but noted future circumstances could require impairment recognition. A $1.5 million tax benefit related to filing the prior-year tax return primarily benefited annuity results. Operating expenses increased, including costs for technology, infrastructure and customer-service improvements.
Most important facts for investors to verify
- Actual 2016 earnings versus the $1.80–$1.90 per-share outlook, including the eventual Hurricane Matthew losses.
- Whether automobile loss trends, catastrophe costs and the combined ratio improve or continue to pressure property and casualty profitability.
- Fixed-annuity spread performance and sensitivity to low reinvestment rates and minimum guaranteed crediting rates.
- Investment portfolio credit quality, impairment developments and the sustainability of unrealized gains and investment-income growth.
- Execution and expense impact of technology and infrastructure projects, and effects of fiduciary-rule changes on annuity distribution and sales.